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Bridge financing is usually expected to be replaced within two years after the closing
date of the LBO transaction. True or False
Answer:
Purchaser-supplier relationships are also called logistics alliances. True or False
Answer:
Form of payment may consist of something other than cash, stock, or debt such as
tangible and intangible assets.
True or False
Answer:
In partnerships, the allocation of profits and losses among partners will normally follow
directly from the allocation of shares or partnership interests. True or False
Answer:
A planning-based acquisition process consists of both a business plan and acquisition
plan, which drive all subsequent phases of the acquisition process. True or False
Answer:
A section of the U.S. tax code known as 1031 forbids investors to make a "like kind"
exchange of investment properties. True or False
Answer:
The maximum purchase price is the minimum price plus the present value of sources of
value. True or False
Answer:
Individual investors can generally diversify their own stock portfolios more efficiently
than corporate managers who diversify the companies they manage. True or False
Answer:
Antitrust regulatory agencies may make their approval of a merger contingent on the
willingness of the merger partners to divest certain businesses. True or False
Answer:
U.S. antitrust regulatory authorities generally view the creation of R&D alliances
among businesses in the same industry as anticompetitive, even if the alliance shares its
research with all alliance participants. True or False
Answer:
Management may sell assets to fund diversification opportunities? True or False
Answer:
M&As can provide quick access to a new market; and, they are subject to fewer
problems than domestic M&As. True or False
Answer:
Many corporations, particularly large, highly diversified organizations, constantly are
reviewing ways in which they can enhance shareholder value by changing the
composition of their assets, liabilities, equity, and operations. True or False
Answer:
Coca Cola is an example of a company that pursues both a differentiation and cost
leadership strategy. True or False
Answer:
In the absence of earnings, other factors that drive the creation of value for a firm may
be used for valuation purposes. True or False
Answer:
A collection of markets is said to comprise an industry. True or False
Answer:
A transaction generally will be considered non-taxable to the seller or target firm's
shareholder if it involves the purchase of the target's stock or assets for substantially all
cash, notes, or some other nonequity consideration. True or False
Answer:
Insider trading involves buying or selling securities based on knowledge not available
to the general public. True or False
Answer:
Preferred stock often is issued in LBO transactions, because it provides investors a
fixed income security, which has a claim that is junior to common stock in the event of
liquidation. True or False
Answer:
LBOs can be of an entire company or divisions of a company. True or False
Answer:
Financial considerations, such as an acquirer believing the target is undervalued, a
booming stock market or falling interest rates, frequently drive surges in the number of
acquisitions. True or False
Answer:
So-called contract related transition issues often involve how the new employees will
be paid and what benefits they should receive. True or False
Answer:
In constructing the enterprise value, the market value of the firm's common equity value
is added to the market value of the firm's long-term debt and the market value of
preferred stock. True or False
Answer:
In an equity carve-out, the cash raised by the subsidiary in this manner may be
transferred to the parent as a dividend or as an inter-company loan. True or False
Answer:
Obtaining additional investment funds from others is the primary motivation for
creating various types of alliances. True or False
Answer:
In many countries, family owned firms have been successful because of their shared
interests and because investors place a higher value on short-term performance than on
the long-term health of the business. True or False
Answer:
Earnouts are generally very poor ways to create trust and often represent major
impediments to the integration process. True or False
Answer:
Antitrust regulators take into account the likelihood that a firm would fail and exit a
market if it is not allowed to merger with another firm. True or False
Answer:
If the discount rate is assumed to be 8% and the current cash flow is $1.5 million and is
expected to remain at that level in perpetuity, the implied valuation is $18.75 million.
True or False
Answer:
Only interest payments on ESOP loans are tax deductible by the firm sponsoring the
ESOP. True or False
Answer:
The so-called PEG ratio is calculated by dividing the firm's price-to-earning ratio by the
expected growth rate in the firm's share price. True or False
Answer:
Unlike other legal structures, a corporate structure does not have to be dissolved
because of the death of the owners or if one of the owners wish to liquidate their
ownership position.
True or False
Answer:
Whether an analyst should use a short or long-term interest rate for the risk free rate in
calculating the CAPM depends on when
the investor receives their future cash flows. True or False
Answer:
Which of the following statements best describes the business judgment rule?
a. Board members are expected to conduct themselves in a manner that could
reasonably be seen as being in the best interests of the shareholders.
b. Board members are always expected to make good decisions.
c. The courts are expected to 'second guess' decisions made by corporate boards.
d. Directors and managers are always expected to make good decisions.
e. Board decisions should be subject to constant scrutiny by the courts.
Answer:
Which of the following factors influences corporate governance practices?
a. Securities legislation
b. Government regulatory agencies
c. The threat of a hostile takeover
d. Institutional activism
e. All of the above
Answer:
Case Study. Private Equity Firms Acquire Yellow Pages Business
Qwest Communications agreed to sell its yellow pages business, QwestDex, to a
consortium led by the Carlyle Group and Welsh, Carson, Anderson and Stowe for $7.1
billion. In a two stage transaction, Qwest sold the eastern half of the yellow pages
business for $2.75 billion in late This portion of the business included directories in
Colorado, Iowa, Minnesota, Nebraska, New Mexico, South Dakota, and North Dakota.
The remainder of the business, Arizona, Idaho, Montana, Oregon, Utah, Washington,
and Wyoming, was sold for $4.35 billion in late 2003. Caryle and Welsh Carson each
put in $775 million in equity (about 21 percent of the total purchase price).
Qwest was in a precarious financial position at the time of the negotiation. The telecom
was trying to avoid bankruptcy and needed the first stage financing to meet impending
debt repayments due in late 2002. Qwest is a local phone company in 14 western states
and one of the nation's largest long-distance carriers. It had amassed $26.5 billion in
debt following a series of acquisitions during the 1990s.
The Carlyle Group has invested globally, mainly in defense and aerospace businesses,
but it has also invested in companies in real estate, health care, bottling, and
information technology. Welsh Carson focuses primarily on the communications and
health care industries. While the yellow pages business is quite different from their
normal areas of investment, both firms were attracted by its steady cash flow. Such cash
flow could be used to trim debt over time and generate a solid return. The business'
existing management team will continue to run the operation under the new ownership.
Financing for the deal will come from J.P. Morgan Chase, Bank of America, Lehman
Brothers, Wachovia Securities, and Deutsche Bank. The investment groups agreed to a
two stage transaction to facilitate borrowing the large amounts required and to reduce
the amount of equity each buyout firm had to invest. By staging the purchase, the
lenders could see how well the operations acquired during the first stage could manage
their debt load.
The new company will be the exclusive directory publisher for Qwest yellow page
needs at the local level and will provide all of Qwest's publishing requirements under a
fifty year contract. Under the arrangement, Qwest will continue to provide certain
services to its former yellow pages unit, such as billing and information technology,
under a variety of commercial services and transitional services agreements (Qwest:
2002).
Discussion Questions:
1) Why was QwestDex considered an attractive LBO candidate? Do you think it has
significant growth potential? Explain the following statement: "A business with high
growth potential may not be a good candidate for an LBO.
2) Why did the buyout firms want a 50-year contract to be the exclusive provider of
publishing services to Qwest Communications?
3) Why would the buyout firms want Qwest to continue to provide such services as
billing and information technology support? How might such services be priced?
4) Why would it take five very large financial institutions to finance the transactions?
5) Why was the equity contribution of the buyout firms as a percentage of the total
capital requirements so much higher than amounts contributed during the 1980s?
Answer:
PG&E SEEKS BANKRUPTCY PROTECTION
Pacific, Gas, and Electric (PG&E), the San Francisco-based utility, filed for bankruptcy
on April 7, 2001, citing nearly $9 billion in debt and un-reimbursed energy costs. The
utility, one of three privately owned utilities in California, serves northern and central
California. The intention of the Chapter 11 reorganization was to make the utility
solvent again by protecting the firm from lawsuits or any other action by those who are
owed money by the utility. The bankruptcy will also allow the utility to deal with all of
the firm's debts in a single forum rather than with individual debtors in what had
become a highly politicized venue. The following time line outlines the firm's road to
bankruptcy.
Utility industry analysts saw PG&E's move as largely an effort to escape the political
paralysis that had befallen the state's regulatory apparatus. The bankruptcy filing came
one day after Governor Davis dropped his opposition to raising retail rates. However,
the Governor's reversal came after five month's of negotiations with the state's privately
owned utilities on a rescue plan.
PG&E's common shares fell 37 percent on the day the firm filed for reorganization.
Fearing a similar fate for San Diego Gas and Electric, the shares of Sempra Energy,
SDG&E's parent corporation, also dropped by 35 percent
In an attempt to insulate California ratepayers from escalating wholesale electricity
prices, the state entered into a series of 5-to-10 year contracts with electricity power
generators that account for more than two-thirds of the state's projected power needs.
The last contracts were signed by the state in June 2001. By September, a slowing
economy pushed the wholesale price of electricity well below the level the state was
required to pay in the "take or pay" contracts the state had just signed. Estimates
suggest that California taxpayers will have to pay between $40 and $45 billion in power
costs over the next decade depending on what happens to future energy costs. PG&E
has continued to supply its customers without disruption or blackout while being under
the protection of the bankruptcy court.
Southern California Edison, nearing bankruptcy for reasons similar to those that drove
PG&E to seek protection from its creditors, reached agreement with the Public Utility
Commission to pay off $3.3 billion in debt owed to power generators from customer
revenues. Previously, the PUC had forbid the utility to use monies generated from two
previous rate increases for this purpose. The U.S. District Court judge approved the
plan on October 5, 2001. While some creditors complained that the settlement was not
reassuring because it did not include a timetable for repayment of outstanding debt,
others viewed the agreement as a voluntary reorganization plan without going through
the expensive process of filing for bankruptcy with the federal court.
Discussion Questions:
1) In your judgment, did regulators attenuate or exacerbate the situation? Explain your
answer.
2) PG&E pursued bankruptcy protection, while Southern California Edison did not.
What could PG&E have been done differently to avoid bankruptcy?
Answer:
Which of the following are used by antitrust regulators to determine whether a proposed
transaction will be anti-competitive?
a. Market share
b. Barriers to entry
c. Number of substitute products
d. A and B only
e. A, B, and C
Answer:
Vertical mergers are likely to be challenged by antitrust regulators for all of the
following reasons except for
a. An acquisition by a supplier of a customer prevents the supplier's competitors from
having access to the customer.
b. The relevant market has few customers and is highly concentrated
c. The relevant market has many suppliers.
d. The acquisition by a customer of a supplier could become a concern if it prevents the
customer's competitors from having access to the supplier.
e. The suppliers' products are critical to a competitor's operations
Answer:
Which of the following is not true of taxable asset purchases?
a. Net operating losses carry over to the acquiring firm
b. The acquiring firm may step up its basis in the acquired assets.
c. The target firm is subject to recapture of tax credits and excess depreciation
d. Target firm shareholders' are subject to a potential immediate tax liability
e. Target firm net operating losses and tax credits cannot be transferred to the acquiring
firm
Answer:
Moody's credit rating agency defines instances of default as which of the following:
a. Missed or delayed payment of interest or principal
b. Bankruptcy
c. Receivership
d. Any exchange (equity for debt) diminishing the value of what is owed to bondholders
e. All of the above
Answer:
Which of the following are examples of business alliances?
a. Mergers
b. Acquisitions
c. Joint ventures
d. Equity partnerships
e. C and D
Answer:
Total consideration is a legal term referring to the composition of the purchase price
paid by the buyer for the target firm. It may consist of which of the following:
a. Cash
b. Cash and stock
c. Cash, stock, and debt
d. A, B, and C
e. A and B only
Answer:
Which of the following is generally not considered a source of value to the acquiring
firm?
a. Duplicate facilities
b. Patents
c. Land on the balance sheet at below market value
d. Warranty claims
e. Copyrights
Answer:
Which of the following is not true about integrating business alliances?
a. Teamwork is the underpinning that makes alliances work.
b. Control is best exerted through coordination
c. Decisions are made at the top of the organization
d. Decisions are based on the premise that all participants to the alliance have had an
opportunity to express their opinions.
e. The failure of one party to meet commitments will erode trust
Answer:
Pacific Surfware acquired Surferdude and as part of the transaction both of the firms
ceased to exist in their
form prior to the transaction and combined to create an entirely new entity, Wildly
Exotic Surfware. Which one of the following terms best describes this transaction?
a. Divestiture
b. Tender offer
c. Joint venture
d. Spinoff
e. Consolidation
Answer:
Which of the following are often participants in the acquisition process?
a. Investment bankers
b. Lawyers
c. Accountants
d. Proxy solicitors
e. All of the above
Answer:
Which of the following are common takeover tactics?
a. Bear hugs
b. Open market purchases
c. Tender offers
d. Litigation
e. All of the above
Answer:
Debt restructuring of a bankrupt firm is usually accomplished in which of the following
ways:
a. An extension
b. A composition
c. A debt for equity swap
d. Some combination of a, b, or c
e. All of the above
Answer:
Joe's barber shop buys Jose's Hair Salon. Which of the following terms best describes
this deal?
a. Joint venture
b. Strategic alliance
c. Horizontal
d. Vertical
e. Conglomerate
Answer:
Xon Enterprises is attempting to take over Rayon Group. Rayon's shareholders have the
right to buy additional
shares at below market price if Xon (considered by Rayon's board to be a hostile
bidder) buys more than 15 percent of Rayon's outstanding shares. What term applies to
this antitakeover measure?
a. Share repellent plan
b. Golden parachute plan
c. Pac Man defense
d. Poison pill
e. Greenmail provision
Answer:
Antitrust regulatory authorities tend to look most favorably on which type of alliances?
a. Equity partnerships
b. Marketing alliances among competitors
c. Global alliances
d. Project oriented ventures involving collaborative research
e. None of the above
Answer:
Which of the following are the basic principles on which the market model is based?
a. Management incentives should be aligned with those of shareholders and other major
stakeholders
b. Transparency of financial statements
c. Equity ownership should be widely dispersed
d. A & B only
e. A, B, and C only
Answer:
Which of the following is not a characteristic of a joint venture corporation?
a. Profits and losses can be divided between the partners disproportionately to their
ownership shares.
b. New investors can become part of the JV corporation without having to dissolve the
original JV corporate structure.
c. The JV corporation can be used to acquire other firms.
d. Investors' liability is limited to the extent of their investment.
e. The JV corporation may be subject to double taxation.
Answer:
The riskiness of highly leveraged transactions declines overtime due to which of the
following factors?
a. Debt reduction assuming nothing else changes
b. Increasing discount rates
c. A rising unlevered beta
d. An unchanging cost of equity
e. An unchanging weighted average cost of capital
Answer:
For a firm having common and preferred equity as well as debt, common equity value
can be estimated in which of the following ways?
a. By subtracting the book value of debt and preferred equity from the enterprise value
of the firm
b. By subtracting the market value of debt from the enterprise value of the firm
c. By subtracting the market value of debt and the market value of preferred equity
from the enterprise value of the firm
d. By adding the market value of debt and preferred equity to the enterprise value of the
firm
e. By adding the market value of debt and book value of preferred equity to the
enterprise value of the firm
Answer:
The purpose of a "fairness" opinion from an investment bank is
a. To evaluate for the target's board of directors the appropriateness of a takeover offer
b. To satisfy Securities and Exchange Commission filing requirements
c. To support the buyer's negotiation effort
d. To assist acquiring management in the evaluation of takeover targets
e. A and B
Answer:
An LBO can be valued from the perspective of which of the following?
a. Equity investors
b. Lenders
c. All those supplying funds to finance the transaction
d. A and B only
e. A, B, and C
Answer:
Which of the following is true of the enterprise valuation model?
a. Discounts free cash flow to the firm by the cost of equity
b. Discounts free cash flow to the firm by the weighted average cost of capital
c. Discounts free cash flow to equity by the cost of equity
d. Discounts free cash flow to equity by the weighted average cost of capital
e. None of the above
Answer:
Which of the following is not true of liquidity or marketability risk or discount?
a. It is measurable.
b. It is believed to have declined in recent years
c. The magnitude of the discount or risk is inversely related to the size of the investor's
equity ownership in the business.
d. The magnitude of the discount or risk is directly related to the size of the investor's
equity ownership in the business.
e. It is important to adjust the discount rate for liquidity risk.
Answer:
Which of the following represent common components of the global capital asset
pricing model when applied to valuing firms in emerging countries?
a. Risk free rate of return
b. Specific country's risk premium
c. Firm size risk premium
d. Emerging country firm's global beta
e. All of the above
Answer:
Inbev Acquires an American Icon
For many Americans, Budweiser is synonymous with American beer and American
beer is synonymous with Anheuser-Busch (AB). Ownership of the American icon
changed hands on July 14, 2008, when beer giant Anheuser Busch agreed to be
acquired by Belgian brewer InBev for $52 billion in an all-cash deal. The combined
firms would have annual revenue of about $36 billion and control about 25 percent of
the global beer market and 40 percent of the U.S. market. The purchase is the most
recent in a wave of consolidation in the global beer industry. The consolidation
reflected an attempt to offset rising commodity costs by achieving greater scale and
purchasing power. While likely to generate cost savings of about $1.5 billion annually
by 2011, InBev stated publicly that the transaction is more about the two firms being
complementary rather than overlapping.
The announcement marked a reversal from AB's position the previous week when it
said publicly that the InBev offer undervalued the firm and subsequently sued InBev for
"misleading statements" it had allegedly made about the strength of its financing. To
court public support, AB publicized its history as a major benefactor in its hometown
area (St. Louis, Missouri). The firm also argued that its own long-term business plan
would create more shareholder value than the proposed deal. AB also investigated the
possibility of acquiring the half of Grupo Modelo, the Mexican brewer of Corona beer,
which it did not already own to make the transaction too expensive for InBev.
While it publicly professed to want a friendly transaction, InBev wasted no time in
turning up the heat. The firm launched a campaign to remove Anheuser's board and
replace it with its own slate of candidates, including a Busch family member. However,
AB was under substantial pressure from major investors, including Warren Buffet, to
agree to the deal since the firm's stock had been lackluster during the preceding several
years. In an effort to gain additional shareholder support, InBev raised its initial $65 bid
to $70. To eliminate concerns over its ability to finance the deal, InBev agreed to fully
document its credit sources rather than rely on the more traditional but less certain
credit commitment letters. In an effort to placate AB's board, management, and the
myriad politicians who railed against the proposed transaction, InBev agreed to name
the new firm Anheuser-Busch InBev and keep Budweiser as the new firm's flagship
brand and St. Louis as its North American headquarters. In addition, AB would be given
two seats on the board, including August A. Busch IV, AB's CEO and patriarch of the
firm's founding family. InBev also announced that AB's 12 U.S. breweries would
remain open.
Discussion Questions:
1) Why would rising commodity prices spark industry consolidation?
2) Why would the annual cost savings not be realized until the end of the third year?
3) What is a friendly takeover? Speculate as to why it may have turned hostile?
4) InBev launched a proxy contest to take control of the Anheuser-Busch Board and
includes a Busch family member on its slate of candidates. The firm also raised its bid
from $65 to $40 and agreed to fully document its loan commitments. Explain how each
of these actions helped complete the transaction?
5) InBev agreed to name the new company Anheuser-Busch InBev, keep Budwieser
brand, maintain headquarters in St. Lous, and not to close any of the firm's 12 breweries
in North America. How might these decisions impact InBev's ability to realize projected
cost savings?
Answer:
Which one of the following is not a characteristic of a corporate legal structure?
a. Unlimited liability
b. Double taxation
c. Continuity of ownership
d. Managerial autonomy
e. Ease of raising money
Answer:
A steel maker acquired a coal mining company. Which of the following terms best
describes this deal?
a. Vertical
b. Conglomerate
c. Horizontal
d. Obtuse
e. Tender offer
Answer:
Adobe's Acquisition of Omniture: Field of Dreams Marketing?
On September 14, 2009, Adobe announced its acquisition of Omniture for $1.8 billion
in cash or $21.50 per share. Adobe CEO Shantanu Narayen announced that the firm
was pushing into new business at a time when customers were scaling back on
purchases of the company's design software. Omniture would give Adobe a steady
source of revenue and may mean investors would focus less on Adobe's ability to
migrate its customers to product upgrades such as Adobe Creative Suite.
Adobe's business strategy is to develop a new line of software that was compatible with
Microsoft applications. As the world's largest developer of design software, Adobe
licenses such software as Flash, Acrobat, Photoshop, and Creative Suite to website
developers. Revenues grow as a result of increased market penetration and inducing
current customers to upgrade to newer versions of the design software.
In recent years, a business model has emerged in which customers can "rent" software
applications for a specific time period by directly accessing the vendors' servers online
or downloading the software to the customer's site. Moreover, software users have
shown a tendency to buy from vendors with multiple product offerings to achieve better
product compatibility.
Omniture makes software designed to track the performance of websites and online
advertising campaigns. Specifically, its Web analytic software allows its customers to
measure the effectiveness of Adobe's content creation software. Advertising agencies
and media companies use Omniture's software to analyze how consumers use websites.
It competes with Google and other smaller participants. Omniture charges customers
fees based on monthly website traffic, so sales are somewhat less sensitive than
Adobe's. When the economy slows, Adobe has to rely on squeezing more revenue from
existing customers. Omniture benefits from the takeover by gaining access to Adobe
customers in different geographic areas and more capital for future product
development. With annual revenues of more than $3 billion, Adobe is almost ten times
the size of Omniture.
Immediately following the announcement, Adobe's stock fell 5.6 percent to $33.62,
after having gained about 67 percent since the beginning of In contrast, Omniture
shares jumped 25 percent to $21.63, slightly above the offer price of $21.50 per share.
While Omniture's share price move reflected the significant premium of the offer price
over the firm's preannouncement share price, the extent to which investors punished
Adobe reflected widespread unease with the transaction.
Investors seem to be questioning the price paid for Omniture, whether the acquisition
would actually accelerate and sustain revenue growth, the impact on the future
cyclicality of the combined businesses, the ability to effectively integrate the two firms,
and the potential profitability of future revenue growth. Each of these factors is
considered next.
Adobe paid 18 times projected 2010 earnings before interest, taxes, depreciation, and
amortization, a proxy for operating cash flow. Considering that other Web acquisitions
were taking place at much lower multiples, investors reasoned that Adobe had little
margin for error. If all went according to plan, the firm would earn an appropriate return
on its investment. However, the likelihood of any plan being executed flawlessly is
problematic.
Adobe anticipates that the acquisition will expand its addressable market and growth
potential. Adobe anticipates significant cross-selling opportunities in which Omniture
products can be sold to Adobe customers. With its much larger customer base, this
could represent a substantial new outlet for Omniture products. The presumption is that
by combining the two firms, Adobe will be able to deliver more value to its customers.
Adobe plans to merge its programs that create content for websites with Omniture's
technology. For designers, developers, and online marketers, Adobe believes that
integrated development software will streamline the creation and delivery of relevant
content and applications.
The size of the market for such software is difficult to gauge. Not all of Adobe's
customers will require the additional functionality that would be offered. Google
Analytic Services, offered free of charge, has put significant pressure on Omniture's
earnings. However, firms with large advertising budgets are less likely to rely on the
viability of free analytic services.
Adobe also is attempting to diversify into less cyclical businesses. However, both
Adobe and Omniture are impacted by fluctuations in the volume of retail spending.
Less retail spending implies fewer new websites and upgrades to existing websites,
which directly impacts Adobe's design software business, and less advertising and retail
activity on electronic commerce sites negatively impacts Omniture's revenues.
Omniture receives fees based on the volume of activity on a customer's site.
Integrating the Omniture measurement capabilities into Adobe software design products
and cross-selling Omniture products into the Adobe customer base require excellent
coordination and cooperation between Adobe and Omniture managers and employees.
Achieving such cooperation often is a major undertaking, especially when the Omniture
shareholders, many of whom were employees, were paid in cash. The use of Adobe
stock would have given them additional impetus to achieve these synergies in order to
boost the value of their shares.
Achieving cooperation may be slowed by the lack of organizational integration of
Omniture into Adobe. Omniture will become a new business unit within Adobe, with
Omniture's CEO, Josh James, joining Adobe as a senior vice president of the new
business unit. He will report to Narayen. This arrangement may have been made to
preserve Omniture's corporate culture.
Adobe is betting that the potential increase in revenues will grow profits of the
combined firms despite Omniture's lower margins. Whether the acquisition will
contribute to overall profit growth depends on which products contribute to future
revenue growth. The lower margins associated with Omniture's products would slow
overall profit growth if the future growth in revenue came largely from Omniture's Web
analytic products.
Discussion Questions:
1) Who are Adobe's and Omniture's customers and what are their needs?
2) What factors external to Adobe and Omniture seem to be driving the transaction? Be
specific.
3) What factors internal to Adobe and Omniture seem to be driving the transaction? Be
specific.
4) How would the combined firms be able to better satisfy these needs than the
competition?
5) Do you believe the transaction can be justified based on your understanding of the
strengths and weaknesses of the two firms and perceived opportunities and threats to
the two firms in the marketplace? Be specific.
Answer:
Financing LBOs--The SunGard Transaction
With their cash hoards accumulating at an unprecedented rate, there was little that
buyout firms could do but to invest in larger firms. Consequently, the average size of
LBO transactions grew significantly during 2005. In a move reminiscent of the
blockbuster buyouts of the late 1980s, seven private investment firms acquired 100
percent of the outstanding stock of SunGard Data Systems Inc. (SunGard) in late
SunGard is a financial software firm known for providing application and transaction
software services and creating backup data systems in the event of disaster. The
company's software manages 70 percent of the transactions made on the Nasdaq stock
exchange, but its biggest business is creating backup data systems in case a client's
main systems are disabled by a natural disaster, blackout, or terrorist attack. Its large
client base for disaster recovery and back-up systems provides a substantial and
predictable cash flow.
SunGard's new owners include Silver lake Partners, Bain Capital LLC, The Blackstone
Group L.P., Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co.,
Providence Equity Partners Inc. and Texas Pacific Group. Buyout firms in 2005 tended
to band together to spread the risk of a deal this size and to reduce the likelihood of a
bidding war. Indeed, with SunGard, there was only one bidder, the investor group
consisting of these seven firms.
The software side of SunGard is believed to have significant growth potential, while the
disaster-recovery side provides a large stable cash flow. Unlike many LBOs, the deal
was announced as being all about growth of the financial services software side of the
business. The deal is structured as a merger, since SunGard would be merged into a
shell corporation created by the investor group for acquiring SunGard. Going private,
allows SunGard to invest heavily in software without being punished by investors, since
such investments are expensed and reduce reported earnings per share. Going private
also allows the firm to eliminate the burdensome reporting requirements of being a
public company.
The buyout represented potentially a significant source of fee income for the investor
group. In addition to the 2 percent management fees buyout firms collect from investors
in the funds they manage, they receive substantial fee income from each investment
they make on behalf of their funds. For example, the buyout firms receive a 1 percent
deal completion fee, which is more than $100 million in the SunGard transaction.
Buyout firms also receive fees paid for by the target firm that is "going private" for
arranging financing. Moreover, there are also fees for conducting due diligence and for
monitoring the ongoing performance of the firm taken private. Finally, when the buyout
firms exit their investments in the target firm via a sale to a strategic buyer or a
secondary IPO, they receive 20 percent (i.e., so-called carry fee) of any profits.
Under the terms of the agreement, SunGard shareholders received $36 per share, a 14
percent premium over the SunGard closing price as of the announcement date of March
28, 2005, and 40 percent more than when the news first leaked about the deal a week
earlier. From the SunGard shareholders' perspective, the deal is valued at $11.4 billion
dollars consisting of $10.9 billion for outstanding shares and "in-the-money" options
(i.e., options whose exercise price is less than the firm's market price per share) plus
$500 million in debt on the balance sheet.
The seven equity investors provided $3.5 billion in capital with the remainder of the
purchase price financed by commitments from a lending consortium consisting of
Citigroup, J.P. Morgan Chase & Co., and Deutsche Bank. The purpose of the loans is to
finance the merger, repay or refinance SunGard's existing debt, provide ongoing
working capital, and pay fees and expenses incurred in connection with the merger. The
total funds necessary to complete the merger and related fees and expenses is
approximately $11.3 billion, consisting of approximately $10.9 billion to pay SunGard's
stockholders and about $400.7 million to pay fees and expenses related to the merger
and the financing arrangements. Note that the fees that are to be financed comprise
almost 4 percent of the purchase price. Ongoing working capital needs and capital
expenditures required obtaining commitments from lenders well in excess of $11.3
billion.
The merger financing consists of several tiers of debt and "credit facilities." Credit
facilities are arrangements for extending credit. The senior secured debt and senior
subordinated debt are intended to provide "permanent" or long-term financing. Senior
debt covenants included restrictions on new borrowing, investments, sales of assets,
mergers and consolidations, prepayments of subordinated indebtedness, capital
expenditures, liens and dividends and other distributions, as well as a minimum interest
coverage ratio and a maximum total leverage ratio.
If the offering of notes is not completed on or prior to the closing, the banks providing
the financing have committed to provide up to $3 billion in loans under a senior
subordinated bridge credit facility. The bridge loans are intended as a form of temporary
financing to satisfy immediate cash requirements until permanent financing can be
arranged. A special purpose SunGard subsidiary will purchase receivables from
SunGard, with the purchases financed through the sale of the receivables to the lending
consortium. The lenders subsequently finance the purchase of the receivables by issuing
commercial paper, which is repaid as the receivables are collected. The special purpose
subsidiary is not shown on the SunGard balance sheet. Based on the value of
receivables at closing, the subsidiary could provide up to $500 million. The obligation
of the lending consortium to buy the receivables will expire on the sixth anniversary of
the closing of the merger.
The following table provides SunGard's post-merger proforma capital structure. Note
that the proforma capital structure is portrayed as if SunGard uses 100 percent of bank
lending commitments. Also, note that individual LBO investors may invest monies
from more than one fund they manage. This may be due to the perceived attractiveness
of the opportunity or the limited availability of money in any single fund. Of the $9
billion in debt financing, bank loans constitute 56 percent and subordinated or
mezzanine debt comprises represents 44 percent.
SunGard Proforma Capital Structure
1The roman numeral II refers to the fund providing the equity capital managed by
the partnership.
Case Study Discussion Questions:
1) SunGard is a software company with relatively few tangible assets. Yet, the ratio of
debt to equity of almost 5 to 1. Why do you think lenders would be willing to engage in
such a highly leveraged transaction for a firm of this type?
2) Under what circumstances would SunGard refinance the existing $500 million in
outstanding senior debt after the merger? Be specific.
3) In what ways is this transaction similar to and different from those that were
common in the 1980s? Be specific.
4) Why are payment-in-kind securities (e.g., debt or preferred stock) particularly well
suited for financing LBOs? Under what circumstances might they be most attractive to
lenders or investors?
5) Explain how the way in which the LBO is financed affects the way it is operated and
the timing of when equity investors choose to exit the business. Be specific.
Answer:
Promises to PeopleSoft's Customers Complicate Oracle's Integration Efforts
When Oracle first announced its bid for PeopleSoft in mid-2003, the firm indicated that
it planned to stop selling PeopleSoft's existing software programs and halt any additions
to its product lines. This would result in the termination of much of PeopleSoft's
engineering, sales, and support staff. Oracle indicated that it was more interested in
PeopleSoft's customer list than its technology. PeopleSoft earned sizeable profit
margins on its software maintenance contracts, under which customers pay for product
updates, fixing software errors, and other forms of product support. Maintenance fees
represented an annuity stream that could improve profitability even when new product
sales are listless. However, PeopleSoft's customers worried that they would have to go
through the costly and time-consuming process of switching software. To win customer
support for the merger and to avoid triggering $2 billion in guarantees PeopleSoft had
offered its customers in the event Oracle failed to support its products, Oracle had to
change dramatically its position over the next 18 months.
One day after reaching agreement with the PeopleSoft board, Oracle announced it
would release a new version of PeopleSoft's products and would develop another
version of J.D. Edwards's software, which PeopleSoft had acquired in 2003. Oracle
committed itself to support the acquired products even longer than PeopleSoft's
guarantees would have required. Consequently, Oracle had to maintain programs that
run with database software sold by rivals such as IBM. Oracle also had to retain the
bulk of PeopleSoft's engineering staff and sales and customer support teams.
Among the biggest beneficiaries of the protracted takeover battle was German software
giant SAP. SAP was successful in winning customers uncomfortable about dealing with
either Oracle or PeopleSoft. SAP claimed that its worldwide market share had grown
from 51 percent in mid-2003 to 56 percent by late 2004. SAP took advantage of the
highly public hostile takeover by using sales representatives, email, and an international
print advertising campaign to target PeopleSoft customers. The firm touted its
reputation for maintaining the highest quality of support and service for its products.
Discussion Questions
1) How did the commitments Oracle made to PeopleSoft's customers have affected its
ability to realize anticipated synergies? Be specific.
2) Explain why Oracle's willingness to pay such a high premium for PeopleSoft and its
willingness to change its position on supporting PeopleSoft products and retaining the
firm's employees may have had a negative impact on Oracle shareholders. Be specific.
Answer:
McKesson HBOC Restates Revenue
McKesson Corporation, the nation's largest drug wholesaler, acquired medical software
provider HBO & Co. in a $14.1 billion stock deal in early 1999. The transaction was
touted as having created the country's largest comprehensive health care services
company. McKesson had annual sales of $18.1 billion in fiscal year 1998, and HBO &
Co. had fiscal 1998 revenue of $1.2 billion. HBO & Co. makes information systems
that include clinical, financial, billing, physician practice, and medical records software.
Charles W. McCall, the chair, president, and chief executive of HBO & Co., was named
the new chair of McKesson HBOC.
As one of the decade's hottest stocks, it had soared 38-fold since early 1992.
McKesson's first attempt to acquire HBO in mid-1998 collapsed following a news leak.
However, McKesson's persistence culminated in a completed transaction in January
1999. In its haste, McKesson closed the deal even before an in-depth audit of HBO's
books had been completed. In fact, the audit did not begin until after the close of the
1999 fiscal year. McKesson was so confident that its auditing firm, Deloitte & Touche,
would not find anything that it released unaudited results that included the impact of
HBO shortly after the close of the 1999 fiscal year on March 31, 1999. Within days,
indications that contracts had been backdated began to surface.
By May, McKesson hired forensic accountants skilled at reconstructing computer
records. By early June, the accountants were able to reconstruct deleted computer files,
which revealed a list of improperly recorded contracts. This evidence underscored
HBO's efforts to deliberately accelerate revenues by backdating contracts that were not
final. Moreover, HBO shipped software to customers that they had not ordered, while
knowing that it would be returned. In doing so, they were able to boost reported
earnings, the company's share price, and ultimately the purchase price paid by
McKesson.
In mid-July, McKesson announced that it would have to reduce revenue by $327
million and net income by $191.5 million for the past 3 fiscal years to correct for
accounting irregularities. The company's stock had fallen by 48% since late April when
it first announced that it would have to restate earnings. McKesson's senior
management had to contend with rebuilding McKesson's reputation, resolving more
than 50 lawsuits, and attempting to recover $9.5 billion in market value lost since the
need to restate earnings was first announced. When asked how such a thing could
happen, McKesson spokespeople said they were intentionally kept from the due
diligence process before the transaction closed. Despite not having adequate access to
HBO's records, McKesson decided to close the transaction anyway.
Discussion Questions:
1) Why do you think McKesson may have been in such a hurry to acquire HBO without
completing an appropriate due diligence?
2) Assume an audit had been conducted and HBO's financial statements had been
declared to be in accordance with GAAP. Would McKesson have been justified in
believing that HBO's revenue and profit figures were 100% accurate?
3) McKesson, a drug wholesaler, acquired HBO, a software firm. How do you think the
fact that the two firms were in different businesses may have contributed to what
happened?
4) Describe the measurable and non-measurable damages to McKesson's shareholders
resulting from HBO's fraudulent accounting activities.
Answer:
eBay Struggles to Reinvigorate Growth
Founded in September 1995, eBay views itself as the world's online market place for
the sale of goods and services to a diverse community of individuals and small
businesses. Currently, eBay has sites in 24 different countries, and it offers a wide
variety of tools, features, and services enabling members to buy and sell on its sites.
The firm's primary business is Markeplaces consisting of eBay, Shopping.com, and
classified websites. In 2006, this business accounted for 90 percent of eBay's sales and
profits. Historically, acquisitions made by eBay have always been related to
e-commerce. For example, concern about slowing growth in its core U.S. market
caused eBay to acquire online payments provider, PayPal, in 2002. The firm achieved
significant synergy between eBay and PayPal by facilitating payments between buyers
and sellers.
In late 2005, eBay announced that it had acquired Skype International SA, a firm whose
software enabled PC users to make calls over the internet, for $2.6 billion. Skype had
revenue of $60 million in 2005, a tiny fraction of eBay's $4.4 billion in 2005 sales, and
it was unprofitable. Skype's existing businesses include services that give people the
ability to call landline phones for about 3 cents a minute, voicemail, and providing a
traditional phone number for Skype accounts. Skype is facing new competition from
Google, Yahoo!, and many startups.
eBay expects Skype to facilitate trade on their sites by increasing the ability of buyers
and sellers to negotiate. In addition to paying eBay listing and completed-auction fees,
sellers also could pay eBay a fee for getting an internet call, or lead, via Skype. eBay
will also use Skype to facilitate entering new markets, such as new cars, travel, real
estate, and personal and business services. Skype software gives eBay an advantage in
China, Eastern Europe and Brazil, where online trust is not well-established and where
haggling may be more a part of the culture.
The acquisition of a telephony company represented a marked departure for eBay,
which had previously acquired companies directly related to e-commerce. eBay is
venturing into new territory without any overt request from or support of its buyers and
sellers. Historically, buyers and sellers guided eBay into new markets through their
activities, such as embracing PayPal years before eBay acquired it, or by requesting
new features. In the past when eBAy has gone off on its own, such as collaborating with
Christy's for live auctions, it has been unsuccessful. Only time will tell how well this
acquisition will work.
Discussion Questions:
1) Do you believe this acquisition if related or unrelated to eBay's business? What are
the implications of your answer..
2) What are some of the key assumptions implicit in eBay's decision to make this
acquisition?
Answer:
Cingular Acquires AT&T Wireless in a Record-Setting Cash Transaction
Cingular outbid Vodafone to acquire AT&T Wireless, the nation's third largest cellular
telephone company, for $41 billion in cash plus $6 billion in assumed debt in February
2004. This represented the largest all-cash transaction in history. The combined
companies, which surpass Verizon Wireless as the largest U.S. provider, have a network
that covers the top 100 U.S. markets and span 49 of the 50 U.S. states. While Cingular's
management seemed elated with their victory, investors soon began questioning the
wisdom of the acquisition.
By entering the bidding at the last moment, Vodafone, an investor in Verizon Wireless,
forced Cingular's parents, SBC Communications and BellSouth, to pay a 37 percent
premium over their initial bid. By possibly paying too much, Cingular put itself at a
major disadvantage in the U.S. cellular phone market. The merger did not close until
October 26, 2004, due to the need to get regulatory and shareholder approvals. This
gave Verizon, the industry leader in terms of operating margins, time to woo away
customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers
because of poor customer service. By paying $11 billion more than its initial bid,
Cingular would have to execute the integration, expected to take at least 18 months,
flawlessly to make the merger pay for its shareholders.
With AT&T Wireless, Cingular would have a combined subscriber base of 46 million,
as compared to Verizon Wireless's 37.5 million subscribers. Together, Cingular and
Verizon control almost one half of the nation's 170 million wireless customers. The
transaction gives SBC and BellSouth the opportunity to have a greater stake in the
rapidly expanding wireless industry. Cingular was assuming it would be able to achieve
substantial operating synergies and a reduction in capital outlays by melding AT&T
Wireless's network into its own. Cingular expected to trim combined capital costs by
$600 to $900 million in 2005 and $800 million to $1.2 billion annually thereafter.
However, Cingular might feel pressure from Verizon Wireless, which was investing
heavily in new mobile wireless services. If Cingular were forced to offer such services
quickly, it might not be able to realize the reduction in projected capital outlays.
Operational savings might be even more difficult to realize. Cingular expected to save
$100 to $400 million in 2005, $500 to $800 million in 2006, and $1.2 billion in each
successive year. However, in view of AT&T Wireless's continued loss of customers,
Cingular might have to increase spending to improve customer service. To gain
regulatory approval, Cingular agreed to sell assets in 13 markets in 11 states. The firm
would have six months to sell the assets before a trustee appointed by the FCC would
become responsible for disposing of the assets.
SBC and BellSouth, Cingular's parents, would have limited flexibility in financing new
spending if it were required by Cingular. SBC and BellSouth each borrowed $10 billion
to finance the transaction. With the added debt, S&P put SBC, BellSouth, and Cingular
on credit watch, which often is a prelude in a downgrade of a firm's credit rating.
Discussion Questions:
1) What is the total purchase price of the merger?
2) What are some of the reasons Cingular used cash rather than stock or some
combination to acquire AT&T Wireless? Explain your answer.
3) How might the amount and composition of the purchase price affect Cingular's,
SBC's, and BellSouth's cost of capital?
4) With substantially higher operating margins than Cingular, what strategies would you
expect Verizon Wireless to pursue? Explain your answer.
Answer:
Calpine Emerges from the Protection of Bankruptcy Court
Following approval of its sixth Plan of Reorganization by the U.S. Bankruptcy Court
for the Southern District of New York, Calpine Corporation was able to emerge from
Chapter 11 bankruptcy on January 31, 2008. Burdened by excessive debt and court
battles with creditors on how to use its cash, the electric utility had sought Chapter 11
protection by petitioning the bankruptcy court in December 2005. After settlements
with certain stakeholders, all classes of creditors voted to approve the Plan of
Reorganization, which provided for the discharge of claims through the issuance of
reorganized Calpine Corporation common stock, cash, or a combination of cash and
stock to its creditors.
Shortly after exiting bankruptcy, Calpine cancelled all of its then outstanding common
stock and authorized the issuance of 485 million shares of reorganized Calpine
Corporation common stock for distribution to holders of unsecured claims. In addition,
the firm issued warrants (i.e., securities) to purchase 48.5 million shares of reorganized
Calpine Corporation common stock to the holders of the cancelled (i.e., previously
outstanding) common stock. The warrants were issued on a pro rata basis reflecting the
number of shares of "old common stock" held at the time of cancellation. These
warrants carried an exercise price of $23.88 per share and expired on August 25, 2008.
Relisted on the New York Stock Exchange, the reorganized Calpine Corporation
common stock began trading under the symbol CPN on February 7, 2008, at about $18
per share.
The firm had improved its capital structure while in bankruptcy. On entering
bankruptcy, Calpine carried $17.4 billion of debt with an average interest rate of 10.3
percent. By retiring unsecured debt with reorganized Calpine Corporation common
stock and selling certain assets, Calpine was able to repay or refinance certain project
debt, thereby reducing the prebankruptcy petition debt by approximately $7 billion. On
exiting bankruptcy, Calpine negotiated approximately $7.3 billion of secured "exit
facilities" (i.e., credit lines) from Goldman Sachs, Credit Suisse, Deutsche Bank, and
Morgan Stanley. About $6.4 billion of these funds were used to satisfy cash payment
obligations under the Plan of Reorganization. These obligations included the repayment
of a portion of unsecured creditor claims and administrative claims, such as legal and
consulting fees, as well as expenses incurred in connection with the "exit facilities" and
immediate working capital requirements. On emerging from Chapter 11, the firm
carried $10.4 billion of debt with an average interest rate of 8.1 percent.
The Enron ShuffleA Scandal to Remember
What started in the mid-1980s as essentially a staid "old-economy" business became the
poster child in the late 1990s for companies wanting to remake themselves into
"new-economy" powerhouses. Unfortunately, what may have started with the best of
intentions emerged as one of the biggest business scandals in U.S. history. Enron was
created in 1985 as a result of a merger between Houston Natural Gas and Internorth
Natural Gas. In 1989, Enron started trading natural gas commodities and eventually
became the world's largest buyer and seller of natural gas. In the early 1990s, Enron
became the nation's premier electricity marketer and pioneered the development of
trading in such commodities as weather derivatives, bandwidth, pulp, paper, and
plastics. Enron invested billions in its broadband unit and water and wastewater system
management unit and in hard assets overseas. In 2000, Enron reported $101 billion in
revenue and a market capitalization of $63 billion.
The Virtual Company
Enron was essentially a company whose trading and risk management business strategy
was built on assets largely owned by others. The complex financial maneuvering and
off-balance-sheet partnerships that former CEO Jeffrey K. Skilling and chief financial
officer Andrew S. Fastow implemented were intended to remove everything from
telecommunications fiber to water companies from the firm's balance sheet and into
partnerships. What distinguished Enron's partnerships from those commonly used to
share risks were their lack of independence from Enron and the use of Enron's stock as
collateral to leverage the partnerships. If Enron's stock fell in value, the firm was
obligated to issue more shares to the partnership to restore the value of the collateral
underlying the debt or immediately repay the debt. Lenders in effect had direct recourse
to Enron stock if at any time the partnerships could not repay their loans in full. Rather
than limiting risk, Enron was assuming total risk by guaranteeing the loans with its
stock.
Enron also engaged in transactions that inflated its earnings, such as selling time on its
broadband system to a partnership at inflated prices at a time when the demand for
broadband was plummeting. Enron then recorded a substantial profit on such
transactions. The partnerships agreed to such transactions because Enron management
seems to have exerted disproportionate influence in some instances over partnership
decisions, although its ownership interests were very small, often less than 3 percent.
Curiously, Enron's outside auditor, Arthur Andersen, had a dual role in these
partnerships, collecting fees for helping to set them up and auditing them.
Time to Pay the Piper
At the time the firm filed for bankruptcy on December 2, 2001, it had $13.1 billion in
debt on the books of the parent company and another $18.1 billion on the balance
sheets of affiliated companies and partnerships. In addition to the partnerships created
by Enron, a number of bad investments both in the United States and abroad
contributed to the firm's malaise. Meanwhile, Enron's core energy distribution business
was deteriorating. Enron was attempting to gain share in a maturing market by paring
selling prices. Margins also suffered from poor cost containment.
Dynegy Corp. agreed to buy Enron for $10 billion on November 2, 2001. On November
8, Enron announced that its net income would have to be restated back to 1997,
resulting in a $586 million reduction in reported profits. On November 15, chairman
Kenneth Lay admitted that the firm had made billions of dollars in bad investments.
Four days later, Enron said it would have to repay a $690 million note by
mid-December and it might have to take an additional $700 million pretax charge. At
the end of the month, Dynegy withdrew its offer and Enron's credit rating was reduced
to junk bond status. Enron was responsible for another $3.9 billion owed by its
partnerships. Enron had less than $2 billion in cash on hand.
The end came quickly as investors and customers completely lost faith in the energy
behemoth as a result of its secrecy and complex financial maneuvers, forcing the firm
into bankruptcy in early December. Enron's stock, which had reached a high of $90 per
share on August 17, 2001, was trading at less than $1 by December 5, 2001.
In addition to its angry creditors, Enron faced class-action lawsuits by shareholders and
employees, whose pensions were invested heavily in Enron stock. Enron also faced
intense scrutiny from congressional committees and the U.S. Department of Justice. By
the end of 2001, shareholders had lost more than $63 billion from its previous 52-week
high, bondholders lost $2.6 billion in the face value of their debt, and banks appeared to
be at risk on at least $15 billion of credit they had extended to Enron. In addition,
potential losses on uncollateralized derivative contracts totaled $4 billion. Such
contracts involved Enron commitments to buy various types of commodities at some
point in the future.
Questions remain as to why Wall Street analysts, Arthur Andersen, federal or state
regulatory authorities, the credit rating agencies, and the firm's board of directors did
not sound the alarm sooner. It is surprising that the audit committee of the Enron board
seems to have somehow been unaware of the firm's highly questionable financial
maneuvers. Inquiries following the bankruptcy declaration seem to suggest that the
audit committee followed all the rules stipulated by federal regulators and stock
exchanges regarding director pay, independence, disclosure, and financial expertise.
Enron seems to have collapsed in part because such rules did not do what they were
supposed to do. For example, paying directors with stock may have aligned their
interests with shareholders, but it also is possible to have been a disincentive to question
aggressively senior management about their financial dealings.
The Lessons of Enron
Enron may be the best recent example of a complete breakdown in corporate
governance, a system intended to protect shareholders. Inside Enron, the board of
directors, management, and the audit function failed to do the job. Similarly, the firm's
outside auditors, regulators, credit rating agencies, and Wall Street analysts also failed
to alert investors. What seems to be apparent is that if the auditors fail to identify
incompetence or fraud, the system of safeguards is likely to break down. The cost of
failure to those charged with protecting the shareholders, including outside auditors,
analysts, credit-rating agencies, and regulators, was simply not high enough to ensure
adequate scrutiny.
What may have transpired is that company managers simply undertook aggressive
interpretations of accounting principles then challenged auditors to demonstrate that
such practices were not in accordance with GAAP accounting rules (Weil, 2002). This
type of practice has been going on since the early 1980s and may account for the
proliferation of specific accounting rules applicable only to certain transactions to
insulate both the firm engaging in the transaction and the auditor reviewing the
transaction from subsequent litigation. In one sense, the Enron debacle represents a
failure of the free market system and its current shareholder protection mechanisms, in
that it took so long for the dramatic Enron shell game to be revealed to the public.
However, this incident highlights the remarkable resilience of the free market system.
The free market system worked quite effectively in its rapid imposition of discipline in
bringing down the Enron house of cards, without any noticeable disruption in energy
distribution nationwide.
Epilogue
Due to the complexity of dealing with so many types of creditors, Enron filed its plan
with the federal bankruptcy court to reorganize one and a half years after seeking
bankruptcy protection on December 2, The resulting reorganization has been one of the
most costly and complex on record, with total legal and consulting fees exceeding $500
million by the end of 2003. More than 350 classes of creditors, including banks,
bondholders, and other energy companies that traded with Enron said they were owed
about $67 billion.
Under the reorganization plan, unsecured creditors received an estimated 14 cents for
each dollar of claims against Enron Corp., while those with claims against Enron North
America received an estimated 18.3 cents on the dollar. The money came in cash
payments and stock in two holding companies, CrossCountry containing the firm's
North American pipeline assets and Prisma Energy International containing the firm's
South American operations.
After losing its auditing license in 2004, Arthur Andersen, formerly among the largest
auditing firms in the world, ceased operation. In 2006, Andrew Fastow, former Enron
chief financial officer, and Lea Fastow plead guilty to several charges of conspiracy to
commit fraud. Andrew Fastow received a sentence of 10 years in prison without the
possibility of parole. His wife received a much shorter sentence. Also in 2006, Enron
chairman Kenneth Lay died while awaiting sentencing, and Enron president Jeffery
Skilling received a sentence of 24 years in prison.
Citigroup agreed in early 2008 to pay $1.66 billion to Enron creditors who lost money
following the collapse of the firm. Citigroup was the last remaining defendant in what
was known as the Mega Claims lawsuit, a bankruptcy lawsuit filed in 2003 against 11
banks and brokerages. The suit alleged that, with the help of banks, Enron kept
creditors in the dark about the firm's financial problems through misleading accounting
practices. Because of the Mega Claims suit, creditors recovered a total of $5 billion or
about 37.4 cents on each dollar owed to them. This lawsuit followed the settlement of a
$40 billion class action lawsuit by shareholders, which Citicorp settled in June 2005 for
$2 billion.
Case Study Discussion Questions:
1) In your judgment, what were the major factors contributing to the demise of Enron?
Of these factors, which were the most important?
2) In what way was the Enron debacle a break down in corporate governance
(oversight)? Explain your answer.
3) How were the Enron partnerships used to hide debt and inflate the firm's earnings?
Should partnership structures be limited in the future? If so, how?
4) What should (or can) be done to reduce the likelihood of this type of situation arising
in the future? Be specific.
Answer:
Justice Department Blocks Microsoft's Acquisition of Intuit
In 1994, Bill Gates saw dominance of the personal financial software market as a means
of becoming a central player in the global financial system. Critics argued that, by
dominating the point of access (the individual personal computer) to online banking,
Microsoft believed that it may be possible to receive a small share of the value of each
of the billions of future personal banking transactions once online banking became the
norm. With a similar goal in mind, Intuit was trying to have its widely used financial
software package, Quicken, incorporated into the financial standards of the global
banking system. In 1994, Intuit had acquired the National Payment Clearinghouse Inc.,
an electronic bill payments system integrator, to help the company develop a
sophisticated payments system. By 1995, Intuit had sold more than 7 million copies of
Quicken and had about 300,000 bank customers using Quicken to pay bills
electronically. In contrast, efforts by Microsoft to penetrate the personal financial
software market with its own product, Money, were lagging badly. Intuit's product,
Quicken, had a commanding market share of 70% compared to Microsoft's 30%.
In 1994 Microsoft made a $1.5 billion offer for Intuit. Eventually, it would increase its
offer to $2 billion. To appease its critics, it offered to sell its Money product to Novell
Corporation. Almost immediately, the Justice Department challenged the merger, citing
its concern about the anticompetitive effects on the personal financial software market.
Specifically, the Justice Department argued that, if consummated, the proposed
transaction would add to the dominance of the number-one product Quicken, weaken
the number two-product (Money), and substantially increase concentration and reduce
competition in the personal finance/checkbook software market. Moreover, the DoJ
argued that there would be few new entrants because competition with the new Quicken
would be even more difficult and expensive.
Microsoft and its supporters argued that government interference would cripple
Microsoft's ability to innovate and limit its role in promoting standards that advance the
whole software industry. Only a MicrosoftIntuit merger could create the critical mass
needed to advance home banking. Despite these arguments, the regulators would not
relent on their position. On May 20, 1995, Microsoft announced that it was
discontinuing efforts to acquire Intuit to avoid expensive court battle with the Justice
Department.
Discussion Questions:
1) Explain how Microsoft's acquisition of Intuit might limit the entry of new
competitors into the
financial software market.
2) How might the proliferation of Internet usage in the twenty-first century change your
answer
to question 1?
3) Do you believe that the FTC might approve of Microsoft acquiring Intuit today?
Why or why
not?
Answer:
Baxter to Spin Off Heart Care Unit
Baxter International Inc. announced in late 1999 its intention to spin off its
underperforming cardiovascular business, creating a new company that will specialize
in treatments for heart disease. The new company will have 6000 employees worldwide
and annual revenue in excess of $1 billion. The unit sells biological heart valves
harvested from pigs and cows, catheters and other products used to monitor hearts
during surgery, and heart-assist devices for patients awaiting surgery. Baxter conceded
that they have been ''optimizing'' the cardiovascular business by not making the
necessary investments to grow the business. In contrast, the unit's primary competitors,
Guidant, Medtronic, and Boston Scientific, are spending more on research and
investing more on start-up companies that are developing new technologies than is
Baxter.
With the spin-off, the new company will have the financial resources that formerly had
been siphoned off by the parent, to create an environment that will more directly
encourage the speed and innovation necessary to compete effectively in this industry.
The unit's stock will be used to provide additional incentive for key employees and to
serve as a means of making future acquisitions of companies necessary to extend the
unit's product offering.
Discussion Questions
1) In your judgment, what did Baxter's management mean when they admitted that they
had not been "optimizing" the cardiovascular business in recent years? Explain both the
strategic and financial implications of this strategy.
2) Discuss some of the reasons why you believe the unit may prosper more as an
independent operation than as part of Baxter?
Answer:
Johnson & Johnson Sues Amgen
In 1999, Johnson & Johnson (J&J) sued Amgen over their 14-year alliance to sell a
blood-enhancing treatment called erythropoietin. The disagreement began when
unforeseen competitive changes in the marketplace and mistrust between the partners
began to strain the relationship. The relationship had begun in the mid-1980s with J&J
helping to commercialize Amgen's blood-enhancing treatment, but the partners ended
up squabbling over sales rights and a spin-off drug.
J&J booked most of the sales of its version of the $3.7 billion medicine by selling it for
chemotherapy and other broader uses, whereas Amgen was left with the relatively
smaller dialysis market. Moreover, the companies could not agree on future products
for the JV. Amgen won the right in arbitration to sell a chemically similar medicine that
can be taken weekly rather than daily. Arbitrators ruled that the new formulation was
different enough to fall outside the licensing pact between Amgen and J&J.
Case Study Discussion Questions
1) What could these companies have done before forming the alliance to have mitigated
the problems that arose after the alliance was formed? Why do you believe they may
have avoided addressing these issues at the outset?
2) What types of mechanisms could be used other than litigation to resolve such
differences once they arise?
Answer:
Consolidation in the Global Pharmaceutical Industry:
The Glaxo Wellcome and SmithKline Beecham Example
By the mid-1980s, demands from both business and government were forcing
pharmaceutical companies to change the way they did business. Increased government
intervention, lower selling prices, increased competition from generic drugs, and
growing pressure for discounting from managed care organizations such as health
maintenance and preferred provider organizations began to squeeze drug company
profit margins. The number of contact points between the sales force and the customer
shrank dramatically as more drugs were being purchased through managed care
organizations and pharmacy benefit managers. Drugs commonly were sold in large
volumes and often at heavily discounted levels.
The demand for generic drugs also was declining. The use of formularies, drug lists
from which managed care doctors are required to prescribe, gave doctors less choice
and made them less responsive to direct calls from the sales force. The situation was
compounded further by the ongoing consolidation in the hospital industry. Hospitals
began centralizing purchasing and using stricter formularies, allowing physicians
virtually no leeway to prescribe unlisted drugs. The growing use of formularies resulted
in buyers needing fewer drugs and sharply reduced the need for similar drugs.
The industry's first major wave of consolidations took place in the late 1980s, with such
mergers as SmithKline and Beecham and Bristol Myers and Squibb. This wave of
consolidation was driven by increased scale and scope economies largely realized
through the combination of sales and marketing staffs. Horizontal consolidation
represented a considerable value creation opportunity for those companies able to
realize cost synergies. In analyzing the total costs of pharmaceutical companies,
William Pursche (1996) argued that the potential savings from mergers could range
from 1525% of total R&D spending, 520% of total manufacturing costs, 1550% of
marketing and sales expenses, and 2050% of overhead costs.
Continued consolidation seemed likely, enabling further cuts in sales and marketing
expenses. Formulary-driven purchasing and declining overall drug margins spurred
pharmaceutical companies to take action to increase the return on their R&D
investments. Because development costs are not significantly lower for generic drugs, it
became increasingly difficult to generate positive financial returns from marginal
products. Duplicate overhead offered another opportunity for cost savings through
consolidation, because combining companies could eliminate redundant personnel in
such support areas as quality assurance, manufacturing management, information
services, legal services, accounting, and human resources.
The second merger wave began in the late 1990s. The sheer magnitude and pace of
activity is striking. Of the top-20 companies in terms of global pharmaceutical sales in
1998, one-half either have merged or announced plans to do so. More are expected as
drug patents expire for a number of companies during the next several years and the
cost of discovering and commercializing new drugs continues to escalate.
On January 17, 2000, British pharmaceutical giants Glaxo Wellcome PLC and
SmithKline Beecham PLC agreed to merge to form what was at the time the world's
largest drug company. The merger was valued at $76 billion. The resulting company
was called Glaxo SmithKline and had annual revenue of $25 billion and a market value
of $184 billion. The combined companies also would have a total R&D budget of $4
billion and a global sales force of 40,000. Total employees would number 105,000
worldwide. Although stressed as a merger of equals, Glaxo shareholders would own
about 59% of the shares of the two companies. The combined companies would have a
market share of 7.5% of the global pharmaceutical market. The companies projected
annual pretax cost savings of about $1.76 billion after 3 years. The cost savings would
come primarily from job cuts among middle management and administration over the
next 3 years
Discussion Questions:
1) What was driving change in the pharmaceutical industry in the late 1990s?
2) In your judgment, what are the likely strategic business plan objectives of the major
pharmaceutical companies and why are they important?
3) What are the alternatives to merger available to the major pharmaceutical
companies? What are the advantages and disadvantages of each alternative?
4) How would you classify the typical drug company's strategy in the 1970s and 1980s:
cost leadership, differentiation, focus, or hybrid? Explain your answer. How have their
strategies changed in recent years?
5) What do you think was the major motivating factor behind the Glaxo SmithKline
merger and why was it so important?
Answer:
M&A Gets Out of Hand at Cisco
Cisco Systems, the internet infrastructure behemoth, provides the hardware and
software to support efficient traffic flow over the internet. Between 1993 and 2000,
Cisco completed 70 acquisitions using its highflying stock as its acquisition currency.
With engineering talent in short supply and a dramatic compression in product life
cycles, Cisco turned to acquisitions to expand existing product lines and to enter new
businesses. The firm's track record during this period in acquiring and absorbing these
acquisitions was impressive. In fiscal year 1999, Cisco acquired 10 companies. During
the same period, its sales and operating profits soared by 44% and 55%, respectively. In
view of its pledge not to layoff any employees of the target companies, its turnover rate
among employees acquired through acquisition was 2.1%, versus an average of 20% for
other software and hardware companies.
Cisco's strategy for acquiring companies was to evaluate its targets' technologies,
financial performance, and management talent with a focus on ease of integrating the
target into Cisco's operations. Cisco's strategy was sometimes referred to as an R&D
strategy in that it sought to acquire firms with leading edge technologies that could be
easily adapted to Cisco's current product lines or used to expand it product offering. In
this manner, its acquisition strategy augmented internal R&D spending. Cisco
attempted to use its operating cash flow to fund development of current technologies
and its lofty stock price to acquire future technologies. Cisco targeted small companies
having a viable commercial product or technology. Cisco believed that larger, more
mature companies tended to be difficult to integrate, due to their entrenched beliefs
about technologies, hardware and software solutions.
The frequency with which Cisco was making acquisitions during the last half of the
1990s caused the firm to "institutionalize" the way in which it integrated acquired
companies. The integration process was tailored for each acquired company and was
implemented by an integration team of 12 professionals. Newly acquired employees
received an information packet including descriptions of Cisco's business strategy,
organizational structure, benefits, a contact sheet if further information was required,
and an explanation of the strategic importance of the acquired firm to Cisco. On the day
the acquisition was announced, teams of Cisco human resources people would travel to
the acquired firm's headquarters and meet with small groups of employees to answer
questions.
Working with the acquired firm's management, integration team members would help
place new employees within Cisco's workforce. Generally, product, engineering, and
marketing groups were kept independent, whereas sales and manufacturing functions
were merged into existing Cisco departments. Cisco payroll and benefits systems were
updated to reflect information about the new employees, who were quickly given access
to Cisco's online employee information systems. Cisco also offered customized
orientation programs intended to educate managers about Cisco's hiring practices, sales
people about Cisco's products, and engineers about the firm's development process. The
entire integration process generally was completed in 46 weeks. This lightning-fast pace
was largely the result of Cisco's tendency to purchase small, highly complementary
companies; to leave much of the acquired firm's infrastructure in place; and to dedicate
a staff of human resource and business development people to facilitate the process
(Cisco Systems, 1999; Goldblatt, 1999).
Cisco was unable to avoid the devastating effects of the explosion of the dot.com
bubble and the 20012002 recession in the United States. Corporate technology buyers,
who used Cisco's high-end equipment, stopped making purchases because of economic
uncertainty. Consequently, Cisco was forced to repudiate its no-layoff pledge and
announced a workforce reduction of 8500, about 20% of its total employees, in early
2001. Despite its concerted effort to retain key employees from previous acquisitions,
Cisco's turnover began to soar. Companies that had been acquired at highly inflated
premiums during the late 1990s lost much of their value as the loss of key talent
delayed new product launches.
By mid-2001, the firm had announced inventory and acquisition-related write-downs of
more than $2.5 billion. A precipitous drop in its share price made growth through
acquisition much less attractive than during the late 1990s, when its stock traded at lofty
price-to-earnings ratios. Thus, Cisco was forced to abandon its previous strategy of
growth through acquisition to one emphasizing improvement in its internal operations.
Acquisitions tumbled from 23 in 2000 to 2 in 2001. Whereas in the past, Cisco's
acquisitions appeared to have been haphazard, in mid-2003 Cisco set up an investment
review board that analyzes investment proposals, including acquisitions, before they
can be implemented. Besides making sure the proposed deal makes sense for the overall
company and determining the ease with which it can be integrated, the board creates
detailed financial projections and the deal's sponsor must be willing to commit to sales
and earnings targets.
Discussion Questions:
1) Describe how Cisco "institutionalized" the integration process. What are the
advantages and disadvantages to the approach adopted by Cisco?
2) Why did Cisco have a "no layoff" policy? How did this contribute to maintaining or
increasing the
value of the companies it acquired?
3) What evidence do you have that the high price-to-earnings ratio associated with
Cisco's stock during the late 1990s may have caused the firm to overpay for many of its
acquisitions? How might overpayment have complicated the integration process at
Cisco?
Answer:
Maturing Businesses Strive to "Remake" Themselves--
UPS, Boise Cascade, and Microsoft
UPS, Boise Cascade, and Microsoft are examples of firms that are seeking to redefine
their business models due to a maturing of their core businesses. With its U.S. delivery
business maturing, UPS has been feverishly trying to transform itself into a logistics
expert. By the end of 2003, logistics services supplied to its customers accounted for
$2.1 billion in revenue, about 6% of the firm's total sales. UPS is trying to leverage
decades of experience managing its own global delivery network to manage its
customer's distribution centers and warehouses. After having acquired the OfficeMax
superstore chain in 2003, Boise Cascade announced the sale of its core paper and timber
products operations in late 2004 to reduce its dependence on this highly cyclical
business. Reflecting its new emphasis on distribution, the company changed its name to
OfficeMax, Inc. Microsoft, after meteoric growth in its share price throughout the
1980s and 1990s, experienced little appreciation during the six-year period ending in
2006, despite a sizeable special dividend and periodic share buybacks during this
period. Microsoft is seeking a vision of itself that motivates employees and excites
shareholders. Steve Ballmer, Microsoft's CEO, sees innovation as the key. However, in
spite of spending more than $4 billion annually on research and development, Microsoft
seems to be more a product follower than a leader.
Discussion Questions:
1) In your opinion, what are the primary challenges for each of these firms with respect
to their employees, customers,
suppliers, and shareholders? Be specific.
2) Comment on the likely success of each of this intended transformation?
Answer:
TYCO Rescues AMP from Allied Signal
In late November 1998, Tyco International Ltd., a diversified manufacturing and service
company, agreed to acquire AMP Inc., an electrical components supplier, for $11.3
billion. In doing so, AMP successfully fended off a protracted takeover attempt by
AlliedSignal Inc. As part of the merger agreement with Tyco, AMP rescinded its $165
million share buyback offer and its plan to issue an additional 25 million shares to fund
its defense efforts. Tyco, the world's largest electronics connector company, saw the
combination with AMP as a means of becoming the lowest cost producer in the
industry.
Lawrence Bossidy, CEO of AlliedSignal, telephoned an AMP director in mid-1998 to
inquire about AMP's interest in a possible combination of their two companies. The
inquiry was referred to the finance committee of the AMP board, which expressed no
interest in merging with AlliedSignal. By early August, AlliedSignal announced its
intention to initiate an unsolicited tender offer to acquire all of the outstanding shares of
AMP common stock for $44.50 per share to be paid in cash. The following week
AlliedSignal initiated such an offer and sent a letter to William J. Hudson, then CEO of
AMP, requesting a meeting to discuss a possible business combination. Bossidy also
advised AMP of AlliedSignal's intention to file materials shortly with the SEC as
required by federal law to solicit consents from AMP's shareholders. The consent
solicitation materials included proposals to increase the size of AMP's board from 11 to
28 members and to add 17 AlliedSignal nominees, all of whom were directors or
executive officers of AlliedSignal. Within a few days, the AMP board announced its
intentions to continue to aggressively pursue its current strategic initiatives, because the
AlliedSignal offer did not fully reflect the values inherent in AMP businesses. In
addition, the AMP board also replaced Hudson with Robert Ripp as chair and CEO of
AMP.
The AMP board also authorized an amendment to the AMP rights agreement dated
October 25, 1989. The amendment provided that the rights could not be redeemed if
there were a change in the composition of the AMP board following the announcement
of an unsolicited acquisition proposal such that the current directors no longer
comprised a majority of the board. A transaction not approved by AMP's board and
involving the acquisition by a person or entity of 20% or more of AMP's common stock
was defined as an unsolicited acquisition proposal.
By early September, AlliedSignal amended its tender offer to reduce the number of
shares of AMP common stock it was seeking to purchase to 40 million shares.
AlliedSignal also stated that it would undertake another offer to acquire the remaining
shares of AMP common stock at a price of $44.50 in cash following consummation of
its offer to purchase up to 40 million shares. In concert with its tender offer,
AlliedSignal also announced its intention to solicit consents for a proposal to amend
AMP's bylaws. The proposed amendment would strip the AMP board of all authority
over the AMP rights agreement and any similar agreements and to vest such authority in
three individuals selected by AlliedSignal. In response, the AMP board unanimously
determined that the amended offer from AlliedSignal was not in the best interests of
AMP shareholders. The AMP board also approved another amendment to the AMP
rights agreement, lowering the threshold that would make the rights redeemable from
20% to 10% of AMP's shares outstanding. AlliedSignal immediately modified its tender
offer by reducing the number of shares it wanted to purchase from 40 million to 20
million shares at $44.50 per share.
AMP announced a self-tender offer to purchase up to 30 million shares of AMP
common stock at $55 per share. The AMP self-tender offer was intended to provide
AMP shareholders with an opportunity to sell a portion of their shares of common stock
at a price in excess of AlliedSignal's $44.50 per share offer. Also, on September 28,
1998, AMP stated its intention to create a new ESOP that would hold 25 million shares
of AMP common stock. Allied Signal indicated that if the self-tender were
consummated, it would reduce the consideration to be paid in any further Allied Signal
offers to $42.62 per share
.
Credit Suisse, AMP's investment banker, approached a number of firms, including
Tyco, concerning their possible interest in acquiring AMP. In early November, Tyco
stepped forward as a possible white knight. Based on limited information, L. Dennis
Kozlowski, Tyco's CEO, set the preliminary valuation of AMP at $50.00 per share. This
value assumed a transaction in which AMP shares would be exchanged for Tyco shares
and was subject to the completion of appropriate due diligence.
In mid-November, Ripp and Bossidy met at Bossidy's request. Bossidy indicated that
AlliedSignal would be prepared to increase its proposed acquisition price for AMP by a
modest amount and to include stock for a limited portion of the total purchase price.
The revised offer also would include a minimum share exchange ratio for the equity
portion of the purchase price along with an opportunity for AMP shareholders to
participate in any increase in AlliedSignal's stock before the closing. The purpose of
including equity as a portion of the purchase price was to address the needs of certain
AMP shareholders, who had a low tax basis in the stock and who wanted a tax-free
exchange. Ripp indicated that the AMP board expected a valuation of more than $50.00
per share.
Tyco indicated a willingness to increase its offer to at least $51.00 worth of Tyco
common shares for each share of AMP common stock. The offer also would include
protections similar to those offered in AlliedSignal's most recent proposal. On
November 20, 1998, the AMP board voted unanimously to approve the merger
agreement and to recommend approval of the merger to AMP's shareholders. They also
voted to terminate the AMP self-tender offer, the ESOP, and AMP's share repurchase
plan and to amend the AMP rights agreement so that it would not apply to the merger
with Tyco.
In early August, AlliedSignal filed a complaint against AMP in the United States
District Court against the provisions of the AMP rights agreement. The complaint also
questioned the constitutionality of certain anti-takeover provisions of Pennsylvania state
statutes. Concurrently, AMP shareholders filed four shareholder class-action lawsuits
against AMP and its board of directors. The suits alleged that AMP and its directors
improperly refused to consider the original AlliedSignal offer and wrongfully relied on
the provisions of the AMP rights agreement and Pennsylvania law to block the original
AlliedSignal offer.
In late August, AMP filed a complaint in the United States District court against
AlliedSignal, seeking an injunction to prevent AlliedSignal from attempting to pack the
AMP board of directors with AlliedSignal executive officers and directors. The
complaint also alleged that the Schedule 14D-1 SEC filing by Allied-Signal was false
and misleading. The complaint alleged that the filing failed to disclose that some of
AlliedSignal's proposed directors had conflicts of interest and that the packing of the
board would prevent current board members from executing their fiduciary
responsibilities to AMP shareholders.
In early October, the court agreed with AMP and enjoined AlliedSignal's board-packing
consent proposals until it stated unequivocally that its director nominees have a
fiduciary duty solely to AMP under Pennsylvania law. The court also denied
AlliedSignal's request to deactivate anti-takeover provisions in the AMP rights
agreement. The court further held that shareholders might not sue the board for
rejecting the AlliedSignal proposal.
AlliedSignal immediately filed in the United States Court of Appeals for the Third
Circuit. The court ordered that although AlliedSignal could proceed with the consent
solicitation, its representatives could not assume positions on the AMP board until the
court of appeals completed its deliberations. The district court ruled that the shares of
AMP common stock acquired by AlliedSignal are "control shares" under Pennsylvania
law. As a result, the court enjoined AlliedSignal from voting its AMP shares unless
AlliedSignal's voting rights are restored under Pennsylvania law. AlliedSignal was able
to overturn the lower court ruling on appeal.
Discussion Questions:
1) What types of takeover tactics did AlliedSignal employ?
2) What steps did AlliedSignal take to satisfy federal securities laws?
3) What anti-takeover defenses were in place at AMP prior to AlliedSignal's offer?
4) How did the AMP Board use the AMP Rights Agreement to encourage AMP
shareholders to vote against
AlliedSignal's proposals?
5) What options did AlliedSignal have to neutralize or circumvent AMP's use of the
Rights Agreement?
6) Why did AlliedSignal, after announcing it had purchased 20 million AMP shares at
$44.50, indicate that it would reduce the price paid in any further offers it might make?
7) What other takeover defenses did AMP employ in its attempt to thwart AlliedSignal?
8) How did both AMP and AlliedSignal use litigation in this takeover battle?
9) Should state laws be used to protect companies from hostile takeovers?
10) Was AMP's Board and management acting to protect their own positions (i.e., the
Management Entrenchment Hypothesis) or in the best interests of the shareholders (i.e.,
the Shareholder Interests Hypothesis)?
Answer:
Mattel Overpays for The Learning Company
Despite disturbing discoveries during due diligence, Mattel acquired The Learning
Company (TLC), a leading developer of software for toys, in a stock-for-stock
transaction valued at $3.5 billion on May 13, 1999. Mattel had determined that TLC's
receivables were overstated because product returns from distributors were not
deducted from receivables and its allowance for bad debt was inadequate. A $50 million
licensing deal also had been prematurely put on the balance sheet. Finally, TLC's brands
were becoming outdated. TLC had substantially exaggerated the amount of money put
into research and development for new software products. Nevertheless, driven by the
appeal of rapidly becoming a big player in the children's software market, Mattel closed
on the transaction aware that TLC's cash flows were overstated.
For all of 1999, TLC represented a pretax loss of $206 million. After restructuring
charges, Mattel's consolidated 1999 net loss was $82.4 million on sales of $5.5 billion.
TLC's top executives left Mattel and sold their Mattel shares in August, just before the
third quarter's financial performance was released. Mattel's stock fell by more than 35%
during 1999 to end the year at about $14 per share. On February 3, 2000, Mattel
announced that its chief executive officer (CEO), Jill Barrad, was leaving the company.
On September 30, 2000, Mattel virtually gave away The Learning Company to rid itself
of what had become a seemingly intractable problem. This ended what had become a
disastrous foray into software publishing that had cost the firm literally hundreds of
millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the
unit to an affiliate of Gores Technology Group for rights to a share of future profits.
Essentially, the deal consisted of no cash upfront and only a share of potential future
revenues. In lieu of cash, Gores agreed to give Mattel 50 percent of any profits and part
of any future sale of TLC. In a matter of weeks, Gores was able to do what Mattel could
not do in a year. Gores restructured TLC's seven units into three, set strong controls on
spending, sifted through 467 software titles to focus on the key brands, and repaired
relationships with distributors. Gores also has sold the entertainment division.
Discussion Questions:
1) Why did Mattel disregard the warning signs uncovered during due diligence?
Identify which motives for
acquisitions discussed in this chapter may have been at work.
2) Was this related or unrelated diversification for Mattel? How might this have
influenced the outcome?
3) Why could Gores Technology do in a matter of weeks what the behemoth toy
company, Mattel, could not
do?
Answer:
Case Study: Sleepless in Philadelphia
Closings can take on a somewhat surreal atmosphere. In one transaction valued at $20
million, the buyer intended to finance the transaction with $10 million in secured bank
loans, a $5 million loan from the seller, and $5 million in equity. However, the equity
was to be provided by wealthy individual investors (i.e., "angel" investors) in amounts
of $100,000 each. The closing took place in Philadelphia around a long conference
room table in the law offices of the firm hired by the buyer, with lawyers and business
people representing the buyer, the seller, and several banks reviewing the final
documents. Throughout the day and late into the evening, wealthy investors (some in
chauffeur-driven limousines) and their attorneys would stop by to provide cashiers'
checks, mostly in $100,000 amounts, and to sign the appropriate legal documents. The
sheer number of people involved created an almost circus-like environment. Because of
the lateness of the hour, it was not possible to deposit the checks on the same day. The
next morning a briefcase full of cashiers' checks was taken to the local bank.
Discussion Question:
1) What do you think are the major challenges faced by the buyer in financing small
transactions transaction in this manner?
Answer:
Financing Challenges in the Home Depot Supply Transaction
Buyout firms Bain Capital, Carlyle Group, and Clayton, Dubilier & Rice (CD&R) bid
$10.3 billion in June 2007 to buy Home Depot Inc.'s HD Supply business. HD Supply
represented a collection of small suppliers of construction products. Home Depot had
announced earlier in the year that it planned to use the proceeds of the sale to pay for a
portion of a $22.5 billion stock buyback.
Three banks, Lehman Brothers, JPMorgan Chase, and Merrill Lynch agreed to provide
the firms with a $4 billion loan. The repayment of the loans was predicated on the
ability of the buyout firms to improve significantly HD Supply's current cash flow.
Such loans are normally made with the presumption that the they can be sold to
investors, with the banks collecting fees from both the borrower and investor groups.
However, by July, concern about the credit quality of subprime mortgages spread to the
broader debt market and raised questions about the potential for default of loans made
to finance highly leveraged transactions. The concern was particularly great for
so-called "covenant-lite" loans for which the repayment terms were very lenient.
Fearing they would not be able to resell such loans to investors, the three banks
involved in financing the HD Supply transaction wanted more financial protection.
Additional protection, they reasoned, would make such loans more marketable to
investors. They used the upheaval in the credit markets as a pretext for reopening
negotiations on their previous financing commitments. Home Depot was willing to
lower the selling price thereby reducing the amount of financing required by the buyout
firms and was willing to guarantee payment in the event of default by the buyout firms.
While Bain, Carlyle, and CD&R were willing to increase their cash investment and pay
higher fees to the banks, they were unwilling to alter the original terms of the loans.
Eventually the banks agreed to provide financing consisting of a $1 billion
"covenant-lite" loan and a $1.3 billion "payment-in-kind" loan. Home Depot agreed to
assume the loan payments on the $1 billion loan if the investor firms were to default
and to lower the selling price to $8.5 billion for 87.5 percent of HD Supply, with Home
Depot retaining the remaining 12.5 percent.
By the end of August, Home Depot had succeeded in raising the cash needed to help
pay for its share repurchase, and the banks had reduced their original commitment of $4
billion in loans to $2.3 billion. While they had agreed to put more money into the
transaction, the buyout firms had been successful in limiting the number of new
restrictive covenants.
Case Study Discussion Questions:
1) Based on the information given it the case, determine the amount of the price
reduction Home Depot accepted for HD Supply and the amount of cash the three
buyout firms put into the transaction?
2) Why did banks lower their lending standards in financing LBOs in 2006 and early
2007? How did the lax
standards contribute to their inability to sell the loans to investors? How did the
inability to sell the loans once made curtail their future lending?
Answer:
JDS UniphaseSDL Merger Results in Huge Write-Off
What started out as the biggest technology merger in history up to that point saw its
value plummet in line with the declining stock market, a weakening economy, and
concerns about the cash-flow impact of actions the acquirer would have to take to gain
regulatory approve. The $41 billion mega-merger, proposed on July 10, 2000, consisted
of JDS Uniphase (JDSU) offering 3.8 shares of its stock for each share of SDL's
outstanding stock. This constituted an approximate 43% premium over the price of
SDL's stock on the announcement date. The challenge facing JDSU was to get
Department of Justice (DoJ) approval of a merger that some feared would result in a
supplier (i.e., JDS UniphaseSDL) that could exercise enormous pricing power over the
entire range of products from raw components to packaged products purchased by
equipment manufacturers. The resulting regulatory review lengthened the period
between the signing of the merger agreement between the two companies and the actual
closing to more than 7 months. The risk to SDL shareholders of the lengthening of the
time between the determination of value and the actual receipt of the JDSU shares at
closing was that the JDSU shares could decline in price during this period.
Given the size of the premium, JDSU's management was unwilling to protect SDL's
shareholders from this possibility by providing a "collar" within which the exchange
ratio could fluctuate. The absence of a collar proved particularly devastating to SDL
shareholders, which continued to hold JDSU stock well beyond the closing date. The
deal that had been originally valued at $41 billion when first announced more than 7
months earlier had fallen to $13.5 billion on the day of closing.
The Participants
JDSU manufactures and distributes fiber-optic components and modules to
telecommunication and cable systems providers worldwide. The company is the
dominant supplier in its market for fiber-optic components. In 1999, the firm focused
on making only certain subsystems needed in fiber-optic networks, but a flurry of
acquisitions has enabled the company to offer complementary products. JDSU's
strategy is to package entire systems into a single integrated unit, thereby reducing the
number of vendors that fiber network firms must deal with when purchasing systems
that produce the light that is transmitted over fiber. SDL's products, including pump
lasers, support the transmission of data, voice, video, and internet information over
fiber-optic networks by expanding their fiber-optic communications networks much
more quickly and efficiently than would be possible using conventional electronic and
optical technologies. SDL had approximately 1700 employees and reported sales of $72
million for the quarter ending March 31, 2000.
As of July 10, 2000, JDSU had a market value of $74 billion with 958 million shares
outstanding. Annual 2000 revenues amounted to $1.43 billion. The firm had $800
million in cash and virtually no long-term debt. Including one-time merger-related
charges, the firm recorded a loss of $905 million. With its price-to-earnings (excluding
merger-related charges) ratio at a meteoric 440, the firm sought to use stock to acquire
SDL, a strategy that it had used successfully in eleven previous acquisitions. JDSU
believed that a merger with SDL would provide two major benefits. First, it would add
a line of lasers to the JDSU product offering that strengthened signals beamed across
fiber-optic networks. Second, it would bolster JDSU's capacity to package multiple
components into a single product line.
Regulators expressed concern that the combined entities could control the market for a
specific type of pump laser used in a wide range of optical equipment. SDL is one of
the largest suppliers of this type of laser, and JDS is one of the largest suppliers of the
chips used to build them. Other manufacturers of pump lasers, such as Nortel Networks,
Lucent Technologies, and Corning, complained to regulators that they would have to
buy some of the chips necessary to manufacture pump lasers from a supplier (i.e.,
JDSU), which in combination with SDL, also would be a competitor. As required by the
HartScottRodino (HSR) Antitrust Improvements Act of 1976, JDSU had filed with the
DoJ seeking regulatory approval. On August 24, the firm received a request for
additional information from the DoJ, which extended the HSR waiting period. On
February 6, JDSU agreed as part of a consent decree to sell a Swiss subsidiary, which
manufactures pump lasers chips, to Nortel Networks Corporation, a JDSU customer, to
satisfy DoJ concerns about the proposed merger. The divestiture of this operation set up
an alternative supplier of such chips, thereby alleviating concerns expressed by other
manufacturers of pump lasers that they would have to buy such components from a
competitor.
The Deal Structure
On July 9, 2000, the boards of both JDSU and SDL unanimously approved an
agreement to merge SDL with a newly formed, wholly owned subsidiary of JDS
Uniphase, K2 Acquisition, Inc. K2 Acquisition, Inc. was created by JDSU as the
acquisition vehicle to complete the merger. In a reverse triangular merger, K2
Acquisition Inc. was merged into SDL, with SDL as the surviving entity. The
postclosing organization consisted of SDL as a wholly owned subsidiary of JDS
Uniphase. The form of payment consisted of exchanging JDSU common stock for SDL
common shares. The share exchange ratio was 3.8 shares of JDSU stock for each SDL
common share outstanding. Instead of a fraction of a share, each SDL stockholder
received cash, without interest, equal to dollar value of the fractional share at the
average of the closing prices for a share of JDSU common stock for the 5 trading days
before the completion of the merger.
Under the rules of the NASDAQ National Market, on which JDSU's shares are traded,
JDSU is required to seek stockholder approval for any issuance of common stock to
acquire another firm. This requirement is triggered if the amount issued exceeds 20% of
its issued and outstanding shares of common stock and of its voting power. In
connection with the merger, both SDL and JDSU received fairness opinions from
advisors employed by the firms.
The merger agreement specified that the merger could be consummated when all of the
conditions stipulated in the agreement were either satisfied or waived by the parties to
the agreement. Both JDSU and SDL were subject to certain closing conditions. Such
conditions were specified in the September 7, 2000 S4 filing with the SEC by JDSU,
which is required whenever a firm intends to issue securities to the public. The
consummation of the merger was to be subject to approval by the shareholders of both
companies, the approval of the regulatory authorities as specified under the HSR, and
any other foreign antitrust law that applied. For both parties, representations and
warranties (statements believed to be factual) must have been found to be accurate and
both parties must have complied with all of the agreements and covenants (promises) in
all material ways.
The following are just a few examples of the 18 closing conditions found in the merger
agreement. The merger is structured so that JDSU and SDL's shareholders will not
recognize a gain or loss for U.S. federal income tax purposes in the merger, except for
taxes payable because of cash received by SDL shareholders for fractional shares. Both
JDSU and SDL must receive opinions of tax counsel that the merger will qualify as a
tax-free reorganization (tax structure). This also is stipulated as a closing condition. If
the merger agreement is terminated as a result of an acquisition of SDL by another firm
within 12 months of the termination, SDL may be required to pay JDSU a termination
fee of $1 billion. Such a fee is intended to cover JDSU's expenses incurred as a result of
the transaction and to discourage any third parties from making a bid for the target firm.
The Aftermath of Overpaying
Despite dramatic cost-cutting efforts, the company reported a loss of $7.9 billion for the
quarter ending June 31, 2001 and $50.6 billion for the 12 months ending June 31, 2001.
This compares to the projected pro forma loss reported in the September 9, 2000 S4
filing of $12.1 billion. The actual loss was the largest annual loss ever reported by a
U.S. firm up to that time. The fiscal year 2000 loss included a reduction in the value of
goodwill carried on the balance sheet of $38.7 billion to reflect the declining market
value of net assets acquired during a series of previous transactions. Most of this
reduction was related to goodwill arising from the merger of JDS FITEL and Uniphase
and the subsequent acquisitions of SDL, E-TEK, and OCLI..
The stock continued to tumble in line with the declining fortunes of the
telecommunications industry such that it was trading as low as $7.5 per share by
mid-2001, about 6% of its value the day the merger with SDL was announced. Thus, the
JDS UniphaseSDL merger was marked by two firststhe largest purchase price paid for a
pure technology company and the largest write-off (at that time) in history. Both of
these infamous "firsts" occurred within 12 months.
Discussion Questions:
1) What is goodwill? How is it estimated? Why did JDS Uniphase write down the value
of its goodwill in 2001? Why does this reflect a series of poor management decisions
with respect to mergers completed between 1999 and early 2001?
2) How might the use of stock, as an acquisition "currency," have contributed to the
sustained decline in JDS Uniphase's stock through mid-2001? In your judgment what is
the likely impact of the glut of JDS Uniphase shares in the market on the future
appreciation of the firm's share price? Explain your answer.
3) What are the primary differences between a forward and a reverse triangular merger?
Why might JDS Uniphase have chosen to merge its K2 Acquisition Inc. subsidiary with
SDL in a reverse triangular merger? Explain your answer.
4) Discuss various methodologies you might use to value assets acquired from SDL
such as existing technologies, "core" technologies, trademarks and trade names,
assembled workforce, and deferred compensation?
5) Why do boards of directors of both acquiring and target companies often obtain
so-called "fairness opinions" from outside investment advisors or accounting firms?
What valuation methodologies might be employed in constructing these opinions?
Should stockholders have confidence in such opinions? Why/why not?
Answer:
Consolidation in the Wireless Communications Industry: Vodafone Acquires
AirTouch
Deregulation of the telecommunications industry has resulted in increased
consolidation. In Europe, rising competition is the catalyst driving mergers. In the
United States, the break up of AT&T in the mid-1980s and the subsequent deregulation
of the industry has led to key alliances, JVs, and mergers, which have created cellular
powerhouses capable of providing nationwide coverage. Such coverage is being
achieved by roaming agreements between carriers and acquisitions by other carriers.
Although competition has been heightened as a result of deregulation, the
telecommunications industry continues to be characterized by substantial barriers to
entry. These include the requirement to obtain licenses and the need for an extensive
network infrastructure. Wireless communications continue to grow largely at the
expense of traditional landline services as cellular service pricing continues to decrease.
Although the market is likely to continue to grow rapidly, success is expected to go to
those with the financial muscle to satisfy increasingly sophisticated customer demands.
What follows is a brief discussion of the motivations for the merger between Vodafone
and AirTouch Communications. This discussion includes a description of the key
elements of the deal structure that made the Vodafone offer more attractive than a
competing offer from Bell Atlantic.
Vodafone
Company History
Vodafone is a wireless communications company based in the United Kingdom. The
company is located in 13 countries in Europe, Africa, and Australia/New Zealand.
Vodafone reaches more than 9.5 million subscribers. It has been the market leader in the
United Kingdom since 1986 and as of 1998 had more than 5 million subscribers in the
United Kingdom alone. The company has been very successful at marketing and selling
prepaid services in Europe. Vodafone also is involved in a venture called Globalstar, LP,
a limited partnership with Loral Space and Communications and Qualcomm, a phone
manufacturer. "Globalstar will construct and operate a worldwide, satellite-based
communications system offering global mobile voice, fax, and data communications in
over 115 countries, covering over 85% of the world's population".
Strategic Intent
Vodafone's focus is on global expansion. They are expanding through partnerships and
by purchasing licenses. Notably, Vodafone lacked a significant presence in the United
States, the largest mobile phone market in the world. For Vodafone to be considered a
truly global company, the firm needed a presence in the Unites States. Vodafone's
strategy is focused on maintaining high growth levels in its markets and increasing
profitability; maintaining their current customer base; accelerating innovation; and
increasing their global presence through acquisitions, partnerships, or purchases of new
licenses. Vodafone's current strategy calls for it to merge with a company with
substantial market share in the United States and Asia, which would fill several holes in
Vodafone's current geographic coverage.
Company Structure
The company is very decentralized. The responsibilities of the corporate headquarters in
the United Kingdom lie in developing corporate strategic direction, compiling financial
information, reporting and developing relationships with the various stock markets, and
evaluating new expansion opportunities. The management of operations is left to the
countries' management, assuming business plans and financial measures are being met.
They have a relatively flat management structure. All of their employees are
shareowners in the company. They have very low levels of employee turnover, and the
workforce averages 33 years of age.
AirTouch
Company History
AirTouch Communications launched its first cellular service network in 1984 in Los
Angeles during the opening ceremonies at the 1984 Olympics. The original company
was run under the name PacTel Cellular, a subsidiary of Pacific Telesis. In 1994, PacTel
Cellular spun off from Pacific Telesis and became AirTouch Communications, under the
direction of Chair and Chief Executive Officer Sam Ginn. Ginn believed that the most
exciting growth potential in telecommunications is in the wireless and not the landline
services segment of the industry. In 1998, AirTouch operated in 13 countries on three
continents, serving more than 12 million customers, as a worldwide carrier of cellular
services, personal communication services (PCS), and paging services. AirTouch has
chosen to compete on a global front through various partnerships and JVs. Recognizing
the massive growth potential outside the United States, AirTouch began their global
strategy immediately after the spin-off.
Strategic Intent
AirTouch has chosen to differentiate itself in its domestic regions based on the concept
of "Superior Service Delivery." The company's focus is on being available to its
customers 24 hours a day, 7 days a week and on delivering pricing options that meet the
customer's needs. AirTouch allows customers to change pricing plans without penalty.
The company also emphasizes call clarity and quality and extensive geographic
coverage. The key challenges AirTouch faces on a global front is in reducing churn (i.e.,
the percentage of customers leaving), implementing improved digital technology,
managing pressure on service pricing, and maintaining profit margins by focusing on
cost reduction. Other challenges include creating a domestic national presence.
Company Structure
AirTouch is decentralized. Regions have been developed in the U.S. market and are run
autonomously with respect to pricing decisions, marketing campaigns, and customer
care operations. Each region is run as a profit center. Its European operations also are
run independently from each other to be able to respond to the competitive issues
unique to the specific countries. All employees are shareowners in the company, and the
average age of the workforce is in the low to mid-30s. Both companies are comparable
in terms of size and exhibit operating profit margins in the mid-to-high teens. AirTouch
has substantially less leverage than Vodafone.
Merger Highlights
Vodafone began exploratory talks with AirTouch as early as 1996 on a variety of
options ranging from partnerships to a merger. Merger talks continued informally until
late 1998 when they were formally broken off. Bell Atlantic, interested in expanding its
own mobile phone business's geographic coverage, immediately jumped into the void
by proposing to AirTouch that together they form a new wireless company. In early
1999, Vodafone once again entered the fray, sparking a sharp takeover battle for
AirTouch. Vodafone emerged victorious by mid-1999.
Motivation for the Merger
Shared Vision
The merger would create a more competitive, global wireless telecommunications
company than either company could achieve separately. Moreover, both firms shared
the same vision of the telecommunications industry. Mobile telecommunications is
believed to be the among the fastest-growing segment of the telecommunications
industry, and over time mobile voice will replace large amounts of telecommunications
traffic carried by fixed-line networks and will serve as a major platform for voice and
data communication. Both companies believe that mobile penetration will reach 50% in
developed countries by 2003 and 55% and 65% in the United States and developed
European countries, respectively, by 2005.
Complementary Assets
Scale, operating strength, and complementary assets were given as compelling reasons
for the merger. The combination of AirTouch and Vodafone would create the largest
mobile telecommunication company at the time, with significant presence in the United
Kingdom, United States, continental Europe, and Asian Pacific region. The scale and
scope of the operations is expected to make the combined firms the vendor of choice for
business travelers and international corporations. Interests in operations in many
countries will make Vodafone AirTouch more attractive as a partner for other
international fixed and mobile telecommunications providers. The combined scale of
the companies also is expected to enhance its ability to develop existing networks and
to be in the forefront of providing technologically advanced products and services.
Synergy
Anticipated synergies include after-tax cost savings of $340 million annually by the
fiscal year ending March 31, 2002. The estimated net present value of these synergies is
$3.6 billion discounted at 9%. The cost savings arise from global purchasing and
operating efficiencies, including volume discounts, lower leased line costs, more
efficient voice and data networks, savings in development and purchase of
third-generation mobile handsets, infrastructure, and software. Revenues should be
enhanced through the provision of more international coverage and through the
bundling of services for corporate customers that operate as multinational businesses
and business travelers.
AirTouch's Board Analyzes Options
Morgan Stanley, AirTouch's investment banker, provided analyses of the current prices
of the Vodafone and Bell Atlantic stocks, their historical trading ranges, and the
anticipated trading prices of both companies' stock on completion of the merger and on
redistribution of the stock to the general public. Both offers were structured so as to
constitute essentially tax-free reorganizations. The Vodafone proposal would qualify as
a Type A reorganization under the Internal Revenue Service Code; hence, it would be
tax-free, except for the cash portion of the offer, for U.S. holders of AirTouch common
and holders of preferred who converted their shares before the merger. The Bell Atlantic
offer would qualify as a Type B tax-free reorganization. Table 1 highlights the primary
characteristics of the form of payment (total consideration) of the two competing offers.
Morgan Stanley's primary conclusions were as follows:
1) Bell Atlantic had a current market value of $83 per share of AirTouch stock based on
the $53.81 closing price of Bell Atlantic common stock on January 14, 1999. The collar
would maintain the price at $80.08 per share if the price of Bell Atlantic stock during a
specified period before closing were between $48 and $52 per share.
2) The Vodafone proposal had a current market value of $97 per share of AirTouch
stock based on Vodafone's ordinary shares (i.e., common) on January 17, 1999.
3) Following the merger, the market value of the Vodafone American Depository Shares
(ADSs) to be received by AirTouch shareholders under the Vodafone proposal could
decrease.
4) Following the merger, the market value of Bell Atlantic's stock also could decrease,
particularly in light of the expectation that the proposed transaction would dilute Bell
Atlantic's EPS by more than 10% through 2002.
In addition to Vodafone's higher value, the board tended to favor the Vodafone offer
because it involved less regulatory uncertainty. As U.S. corporations, a merger between
AirTouch and Bell Atlantic was likely to receive substantial scrutiny from the U.S.
Justice Department, the Federal Trade Commission, and the FCC. Moreover, although
both proposals could be completed tax-free, except for the small cash component of the
Vodafone offer, the Vodafone offer was not subject to achieving any specific accounting
treatment such as pooling of interests under U.S. generally accepted accounting
principles (GAAP).
Recognizing their fiduciary responsibility to review all legitimate offers in a balanced
manner, the AirTouch board also considered a number of factors that made the
Vodafone proposal less attractive. The failure to do so would no doubt trigger
shareholder lawsuits. The major factors that detracted from the Vodafone proposal were
that it would not result in a national presence in the United States, the higher volatility
of its stock, and the additional debt Vodafone would have to assume to pay the cash
portion of the purchase price. Despite these concerns, the higher offer price from
Vodafone (i.e., $97 to $83) won the day.
Acquisition Vehicle and Post Closing Organization
In the merger, AirTouch became a wholly owned subsidiary of Vodafone. Vodafone
issued common shares valued at $52.4 billion based on the closing Vodafone ADS on
April 20, 1999. In addition, Vodafone paid AirTouch shareholders $5.5 billion in cash.
On completion of the merger, Vodafone changed its name to Vodafone AirTouch Public
Limited Company. Vodafone created a wholly owned subsidiary, Appollo Merger
Incorporated, as the acquisition vehicle. Using a reverse triangular merger, Appollo
was merged into AirTouch. AirTouch constituted the surviving legal entity. AirTouch
shareholders received Vodafone voting stock and cash for their AirTouch shares. Both
the AirTouch and Appollo shares were canceled. After the merger, AirTouch
shareholders owned slightly less than 50% of the equity of the new company, Vodafone
AirTouch. By using the reverse merger to convey ownership of the AirTouch shares,
Vodafone was able to ensure that all FCC licenses and AirTouch franchise rights were
conveyed legally to Vodafone. However, Vodafone was unable to avoid seeking
shareholder approval using this method. Vodafone ADS's traded on the New York Stock
Exchange (NYSE). Because the amount of new shares being issued exceeded 20% of
Vodafone's outstanding voting stock, the NYSE required that Vodafone solicit its
shareholders for approval of the proposed merger.
Following this transaction, the highly aggressive Vodafone went on to consummate the
largest merger in history in 2000 by combining with Germany's telecommunications
powerhouse, Mannesmann, for $180 billion. Including assumed debt, the total purchase
price paid by Vodafone AirTouch for Mannesmann soared to $198 billion. Vodafone
AirTouch was well on its way to establishing itself as a global cellular phone
powerhouse.
Discussion Questions:
1) Did the AirTouch board make the right decision? Why or why not?
2) How valid are the reasons for the proposed merger?
3) What are the potential risk factors related to the merger?
4) Is this merger likely to be tax free, partially tax free, or taxable? Explain your
answer.
5) What are some of the challenges the two companies are likely to face while
integrating the businesses?
Answer:
