Chapter 11: Structuring the Deal:
Payment and Legal Considerations
Answers to End of Chapter Discussion Questions
11.1 What are the advantages and disadvantages of a purchase of assets from the perspective of the buyer and seller?
11.2 What are the advantages and disadvantages of a purchase of stock from the perspective of the buyer and seller?
11.3 What are the advantages and disadvantages of a statutory merger?
11.4 What are the reasons some acquirers choose to undertake a staged or multi-step takeover?
11.5 What forms of acquisition represent common alternatives to a merger? Under what circumstances might these
alternative structures be employed?
11.6 Comment of the following statement. A premium offered by a bidder over a target’s share price is not necessarily
a fair price; a fair price is not necessarily an adequate price?
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11.7 In early 2008, a year marked by turmoil in the global credit markets, Mars Corporation was able to negotiate a
reverse breakup fee structure in its acquisition of Wrigley Corporation. This structure allowed Mars to walk away
from the transaction at any time by paying a $1 billion fee. Speculate as to the motivation behind Mars and
Wrigley negotiating such a fee structure?
11.8 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 Finally, TLC’s brands were becoming outdated.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. Despite being aware of extensive problems, Mattel
proceeded to acquire The Learning Company. Why? What could Mattel to better protect its interests? Be specific.
`11.9 Describe the conditions under which an earnout may be most appropriate?
11.10 In late 2008, Deutsche Bank announced that would buy the commercial banking assets (including a number of
branches) of Netherland’s ABN Amro for $1.13 billion. What liabilities, if any, would Deutsche Bank have to (or
want to) assume? Explain your answer.
Solutions to Chapter Case Study Questions
T-Mobile and MetroPCS Complete a Multibillion Dollar Reverse Merger
Discussion Questions:
1. The Deutsche-Telekom board decided against a divestiture of T-Mobile or an initial public offering to pursue a reverse
merger. What other alternatives to merging its wholly-owned subsidiary T-Mobile with another firm could Deutsche–
Telekom have pursued? Be specific. What are the advantages and disadvantages of the other options?
16.
A spin-off involves the payment of the stock of T-Mobile held by Deutsche-Telekom to its shareholders as a
dividend. Procedurally, it is relatively straight forward as the board of directors has the sole right to declare the type
(cash or stock) and timing of dividends. Properly structured the dividend would be tax-free to Deutsche-Telekom’s
shareholders. The distribution would have the added advantage of giving the receiving shareholder the right to
determine what to do with the shares: hold or sell. Spin-offs can be complicated by significant amounts of
intercompany loans between the parent and the subsidiary. If the parent burdens the subsidiary with excessive amounts
of debt before spinning off the unit, the spun-off unit may be forced into bankruptcy. Under fraudulent conveyance
laws, the parent may be forced to take back the unit and to pay-off its creditors.
2. What are the primary disadvantages and advantages of a reverse merger strategy?
3. In what way might the use of the T-Mobile/MetroPCS impact value?
4. What are the key assumptions implicit in the Deutsche-Telekom restructuring strategy for T-Mobile?
5. What is the form of payment used in this deal? Why might this form have been selected? What are the advantages and
disadvantages of the form of payment used in this deal?
6. What is the form of acquisition used in this deal? Why might this form have been chosen? What are the advantages and
disadvantages of the form of acquisition used in this case study?
Examination Questions and Answers
1. Deal structuring is fundamentally about satisfying as many of the primary objectives of the parties involved and
deciding how risk will be shared. True or False
2. The acquisition vehicle is the legal structure used to acquire the target. True or False
3. Such legal structures as holding company, joint venture, and limited liability corporations are suitable only for
acquisition vehicles but not post closing organizations. True or False
4. Employee stock ownership plans cannot be legally used to acquire companies. True or False
5. Form of payment refers only to the acquirer’s common stock used to make up the purchase price paid to target
shareholders. True or False
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6. The appropriate deal structure is that which satisfies, without regard to risk, as many of the primary objectives of
the parties involved as necessary to reach overall agreement. True or False
7. Form of payment may consist of something other than cash, stock, or debt such as tangible and intangible assets.
True or False
8. If the form of acquisition is a statutory merger, the seller retains all known, unknown or contingent liabilities.
True or False
9. The form of payment does not affect whether a transaction is taxable to the seller’s shareholders. True or False
10. The assumption of seller liabilities by the buyer in a merger may induce the seller to demand a higher selling price.
True or False
11. The acquirer may reduce the total cost of an acquisition by deferring some portion of the purchase price. True or
False
12. A holding company structure is the preferred post-closing organization if the acquiring firm is interested in
integrating the target firm immediately following acquisition. True or False
13. The acquired company should be fully integrated into the acquiring company if an earn–out is used to consummate
the transaction. True or False
14. When buyers and sellers cannot reach agreement on price, other mechanisms can be used to close the gap. These
include balance sheet adjustments, earn-outs, rights to intellectual property, and licensing fees. True or False
15. In a balance sheet adjustment, the buyer increases the total purchase price by an amount equal to the decrease in
net working capital or shareholders’ equity of the target company. True or False
16. Because they can be potentially so lucrative to sellers, earn-outs are sometimes used to close the gap between what
the seller wants and what the buyer might be willing to pay. True or False
17. Earn-outs tend to shift risk from the seller to the buyer in that a higher price is paid only when the seller has met or
exceeded certain performance criteria. True or False
18. Rights to intellectual property, royalties from licenses and employment agreements are often used to close the gap
on price between what the seller wants and what the buyer is willing to pay because the income generated is tax
free to the recipient. True or False
19. Asset purchases require the acquiring company to buy all or a portion of the target company’s assets and to assume
at least some of the target’s liabilities in exchange for cash or stock. True or False
20. Stock purchases involve the exchange of the target’s stock for cash, debt, stock of the acquiring company, or some
combination. True or False
21. Sellers may find a sale of assets attractive because they are able to maintain their corporate existence and therefore
ownership of tangible assets not acquired by the buyer and intangible assets such as licenses, franchises, and
patents. True or False
22. In a statutory merger, only assets and liabilities shown on the target firm’s balance sheet automatically transfer to
the acquiring firm. True or False
23. Statutory mergers are governed by the statutory provisions of the state in which the surviving entity is chartered.
True or False
24. Staged transactions may be used to structure an earn-out, to enable the target to complete the development of a
technology or process, to await regulatory approval, to eliminate the need to obtain shareholder approval, and to
minimize cultural conflicts with the target. True or False
25. Decisions made in one area of a deal structure rarely affect other areas of the overall deal structure.
True or False
26. The acquisition vehicle refers to the legal structure created to acquire the target company. True or False
27. A post-closing organization must always be a C corporation. True or False
28. A holding company is an example of either an acquisition vehicle or post-closing organization. True or False
29. The forward triangular merger involves the acquisition subsidiary being merged with the target and the target
surviving. True or False
30. The reverse triangular merger involves the acquisition subsidiary being merged with the target and subsidiary
surviving. True or False
31. By acquiring the target firm through the JV, the corporate investor limits the potential liability to the extent of their
investment in the JV corporation. True or False
32. ESOP structures are rarely used vehicles for transferring the owner’s interest in the business to the employees in
small, privately owned firms. True or False
33. Non-U.S. buyers intending to make additional acquisitions may prefer a holding company structure.
True or False
34. If the acquirer is interested in integrating the target business immediately following closing, the holding structure
may be most desirable. True or False
35. Decision-making in JVs and partnerships is likely to be faster than in a corporate structure. Consequently, JVs and
partnerships are more commonly used if speed is desired during the post-closing integration. True or False
36. A corporate structure is the preferred post-closing organization when an earn-out is involved in acquiring the
target firm. True or False
37. In an earnout agreement, the acquirer must directly control the operations of the target firm to ensure the target
firm adheres to the terms of the agreement. True or False.
38. When the target is a foreign firm, it is often appropriate to operate it separately from the rest of the acquirer’s
operations because of the potential disruption from significant cultural differences. True or False
39. A financial buyer may use a holding company structure because they expect to sell the firm within a relatively
short time period. True or False
40. A partnership or JV structure may be appropriate acquisition vehicle if the risk associated with the target firm is
believed to be high. True or False
41. Sellers who are structured as C corporations generally prefer to sell assets for cash than acquirer stock because of
more favorable tax treatment. True or False
42. Whether cash is the predominant form of payment will depend on a variety of factors. These include the acquirer’s
current leverage, potential near-term earnings per share dilution of issuing new shares, the seller’s preference for
cash or acquirer stock, and the extent to which the acquirer wishes to maintain control over the combined firms.
True or False
43. Acquirer stock is a rarely used form of payment in large transactions. True or False
44. The seller’s preference for stock or cash will reflect their desire for liquidity, the attractiveness of the acquirer’s
shares, and whether the seller is organized as a joint venture corporation. True or False
45. A bidder may choose to use cash rather than to issue voting shares if the voting control of its dominant shareholder
is threatened as a result of the issuance of voting stock to acquire the target firm. True or False
46. Using stock as a form of payment is generally less complicated than using cash from the buyer’s point of view.
True or False
47. The use of convertible preferred stock as a form of payment provides some downside protection to sellers in the
form of continuing dividends, while providing upside potential if the acquirer’s common stock price increases
above the conversion point. True or False
48. Bidders may use a combination of cash and non-cash forms of payment as part of their bidding strategies to
broaden the appeal to target shareholders. True or False
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49. The risk to the bidder associated with bidding strategy of offering target firm shareholders multiple payment
options is that the range of options is likely to discourage target firm shareholders from participating in the
bidder’s tender offer for their shares. True or False.
50. The multiple option bidding strategy introduces a certain level of uncertainty in determining the amount of cash
the acquirer will have to ultimately pay out to target firm shareholders, since the number choosing the all cash or
cash and stock option is not known prior to the completion of the tender offer. True or False
51. Balance sheet adjustments most often are used in purchases of stock when the elapsed time between the agreement
on price and the actual closing date is short. True or False
52. Buyers and sellers generally view purchase price adjustments as a form of insurance against any erosion or
accretion in assets, such as plant and equipment. True or False.
53. An earnout agreement is a financial contract whereby a portion of the purchase price of a company is to be paid to
the buyer in the future contingent on the realization of a previously agreed upon future earnings level or some
other performance measure. True or False
54. The value of an earnout payment is never subject to a cap so as not to discourage the seller from working
diligently to exceed the payment threshold. True or False
55. Earnouts tend to shift risk from the seller to the acquirer in that a higher price is paid only when the seller or
acquired firm has met or exceeded certain performance criteria. True of False
56. Offering sellers consulting contracts to defer a portion of the purchase price is illegal in most states. True or False
57. Collar agreements provide for certain changes in the exchange ratio contingent on the level of the acquirer’s share
price around the effective date of the merger. True or False
58. A fixed exchange collar agreement may involve a fixed exchange ratio as long as the acquirer’s share price
remains within a narrow range, calculated as of the effective date of the signing of the agreement of purchase and
sale. True or False
59. Both the acquirer and target boards of directors have a fiduciary responsibility to demand that the merger terms be
renegotiated if the value of the offer made by the bidder changes materially relative to the value of the target’s
stock or if their has been any other material change in the target’s operations. True or False
60. Stock purchases involve the exchange of the target’s stock for acquirer stock only. True or False.
61. If an acquirer buys most of the operating assets of a target firm, the target generally is forced to
liquidate its remaining assets and pay the after-tax proceeds to its shareholders. True or False
1. Which of the following should be considered important components of the deal structuring process?
a. Legal structure of the acquiring and selling entities
b. Post closing organization
c. Tax status of the transaction
d. What is being purchased, i.e., stock or assets
e. All of the above
2. Which of the following may be used as acquisition vehicles?
a. Partnership
b. Limited liability corporation
c. Corporate shell
d. ESOP
e. All of the above
3. In a statutory merger,
a. Only known assets and liabilities are automatically transferred to the buyer.
b. Only known and unknown assets are transferred to the buyer.
c. All known and unknown assets and liabilities are automatically transferred to the buyer except for those
the seller agrees to retain.
d. The total consideration received by the target’s shareholders is automatically taxable.
e. None of the above.
4. 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.
5. Which of the following are commonly used to close the gap between what the seller wants and what the buyer is
willing to pay?
a. Consulting contracts offered to the seller
b. Earn-outs
c. Employment contracts offered to the seller
d. Giving seller rights to license a valuable technology or process
e. All of the above.
6. Which of the following is a disadvantage of balance sheet adjustments?
a. Protects buyer from eroding values of receivable before closing
b. Audit expense
c. Protects seller from increasing values of receivables before closing
d. Protects from decreasing values of inventories before closing
e. Protects seller from increasing values of inventories before closing
7. Which of the following are disadvantages of an asset purchase?
a. Asset write-up
b. May require consents to assignment of contracts
c. Potential for double-taxation of buyer
d. May be subject to sales, use, and transfer taxes
e. B and D
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8. Which of the following is not true of mergers?
a. Liabilities and assets transfer automatically
b. May be subject to transfer taxes.
c. No minority shareholders remain.
d. May be time consuming due to need for shareholder approvals.
e. May have to pay dissenting shareholders appraised value of stock
9. Which of the following is true of collar arrangements?
a. A fixed or constant share exchange ratio is one in which the number of acquirer shares exchanged for
each target share is unchanged between the signing of the agreement of purchase and sale and closing.
b. Collar agreements provide for certain changes in the exchange ratio contingent on the level of the
acquirer’s share price around the effective date of the merger.
c. A fixed exchange collar agreement may involve a fixed exchange ratio as long as the acquirer’s share
price remains within a narrow range, calculated as of the effective date of merger.
d. A fixed payment collar agreement guarantees that the target firm shareholder receives a certain dollar
value in terms of acquirer stock as long as the acquirer’s stock remains within a narrow range, and a fixed
exchange ratio if the acquirer’s average stock price is outside the bounds around the effective date of the
merger.
e. All of the above.
10. Which of the represent disadvantages of a cash purchase of target stock?
a. Buyer responsible for known and unknown liabilities.
b. Buyer may avoid need to obtain consents to assignments on contracts.
c. NOLs and tax credits pass to the buyer.
d. No state sales transfer, or use taxes have to be paid.
e. Enables circumvention of target’s board in the event a hostile takeover is initiated.
11. The form of acquisition refers to which of the following:
a. Tax status of the transaction
b. Acquisition vehicle
c. What is being acquired, i.e., stock or assets
d. Form of payment
e. How the transaction will be displayed for financial reporting purposes
12. The tax status of the transaction may influence the purchase price by
a. Raising the price demanded by the seller to offset potential tax liabilities
b. Reducing the price demanded by the seller to offset potential tax liabilities
c. Causing the buyer to lower the purchase price if the transaction is taxable to the target firm’s shareholders
d. Forcing the seller to agree to defer a portion of the purchase price
e. Forcing the buyer to agree to defer a portion of the purchase price
13. The seller’s insistence that the buyer agree to purchase its stock may encourage the buyer to
a. offer a lower purchase price because it is assuming all of the target firm’s liabilities
b. offer a higher purchase price because it is assuming all of the target firm’s liabilities
c. offer a lower purchase price because it is receiving all of the target’s tax benefits
d. use its stock rather than cash to purchase the target firm
e. use cash rather than its stock to purchase the target firm
14. A holding company may be used as a post-closing organizational structure for all but which of the following
reasons?
a. A portion of the purchase price for the target firm included an earn-out
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b. The target firm has a substantial amount of unknown liabilities
c. The acquired firm’s culture is very different from that of the acquiring firm
d. Profits from operations are not taxable
15. Form of payment can involve which of the following:
a. Cash
b. Stock
c. Cash and stock
d. Rights, royalties and fees
e. All of the above
16. A “floating or flexible share exchange ratio is used primarily to
a. Protect the value of the transaction for the acquirer’s shareholders
b. Protect the value of the transaction for the target’s shareholders
c. Minimize the number of new acquirer shares that must be issued
d. Increase the value for the acquiring firm
Case Study Short Essay Examination Questions
Sanofi Acquires Genzyme in a Test of Wills
Key Points
Contingent value rights help bridge price differences between buyers and sellers when the target’s future earnings
performance is dependent on the realization of a specific event.
They are most appropriate when the target firm is a large publicly traded firm with numerous shareholders.
______________________________________________________________________________
Facing a patent expiration precipice in 2015, big pharmaceutical companies have been scrambling to find new sources of
revenue to offset probable revenue losses as many of their most popular drugs lose patent protection. Generic drug
companies are expected to make replacement drugs and sell them at a much lower price.
Focusing on the biotechnology market, French-based drug company Sanofi-Aventis SA (Sanofi) announced on February
17, 2011, the takeover of U.S.-based Genzyme Corp. (Genzyme) for $74 per share, or $20.1 billion in cash, plus a
contingent value right (CVR). The CVR could add as much as $14 a share or another $3.8 billion, to the purchase price if
Genzyme is able to achieve certain performance targets. According to the terms of the agreement, Genzyme will retain its
name and operate as a separate unit focusing on rare diseases, an area in which Genzyme has excelled. The purchase price
represented a 48% premium over Genzyme’s share price of $50 per share immediately preceding the announcement.
The acquisition represented the end of a nine-month effort that began on May 23, 2010, when Sanofi CEO Chris
Viehbacher first approached Genzyme’s Henri Termeer, the firm’s founder and CEO. Sanofi expressed interest in Genzyme
at a time when debt was cheap and when Genzyme’s share price was depressed, having fallen from a 2008 peak of $83.25
to $47.16 in June 2010. Genzyme’s depressed share price reflected manufacturing problems that had lowered sales of its
best-selling products. Genzyme continued to recover from the manufacturing challenges that had temporarily shut down
operations at its main site in 2009. The plant is the sole source of Genzyme’s top–selling products, Gaucher’s disease
treatment Cerezyme and Fabry disease drug Fabrazyme. Both were in short supply throughout 2010 due to the plant’s
shutdown. By yearend, the supply shortages were less acute. Sanofi was convinced that other potential bidders were too
occupied with integrating recent deals to enter into a bidding war.
In an effort to get Genzyme to engage in discussions and to permit Sanofi to perform due diligence, Sanofi submitted a
formal bid of $69 per share on July 29, 2010. However, Sanofi continued to ignore the unsolicited offer. The offer was 38%
above Genzyme’s price on July 1, 2010, when investors began to speculate that Genzyme was “in play.” Sanofi was betting
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that the Genzyme shareholders would accept the offer rather than risk seeing their shares fall to $50. The shares, however,
traded sharply higher at $70.49 per share, signaling that investors were expecting Sanofi to have to increase its bid.
Viehbacher said he might increase the bid if Genzyme would be willing to disclose more information about the firm’s
ongoing manufacturing problems and the promising new market potential for its multiple sclerosis drug.
In a letter made public on August 29, 2010, Sanofi indicated that it had been trying to engage Genzyme in acquisition
talks for months and that its formal bid had been rejected by Genzyme without any further discussion on August 11, 2010.
The letter concludes with a thinly disguised threat that “all alternatives to complete the transaction” would be considered
and that “Sanofi is confident that Genzyme shareholders will support the proposal.” In responding to the public disclosure
of the letter, the Genzyme board said it was not prepared to engage in merger negotiations with Sanofi based on an
opportunistic proposal with an unrealistic starting price that dramatically undervalued the company. Termeer said publicly
that the firm was worth at least $80 per share. He based this value on the improvement in the firm’s manufacturing
operations and the revenue potential of Lemtrada, Genzyme’s experimental treatment for multiple sclerosis, which once
approved for sale by the FDA was projected by Genzyme to generate billions of dollars annually. Despite Genzyme’s
refusal to participate in takeover discussions, Sanofi declined to raise its initial offer in view of the absence of other bidders.
Sanofi finally initiated an all-cash hostile tender offer for all of the outstanding Genzyme shares at $69 per share on
October 4, 2010. Set to expire initially on December 16, 2010, the tender offer was later extended to January 21, 2011,
when the two parties started to discuss a contingent value right (CVR) as a means of bridging their disparate views on the
value of Genzyme. Initially, Genzyme projected peak annual sales of $3.5 billion for Lemtrada and $700 million for Sanofi.
At the end of January, the parties announced that they had signed a nondisclosure agreement to give Sanofi access to
Genzyme’s financial statements.
The CVR helped to allay fears that Sanofi would overpay and that the drug Lemtrada would not be approved by the
FDA. Under the terms of the CVR, Genzyme shareholders would receive $1 per share if Genzyme were able to meet
certain production targets in 2011 for Cerezyme and Fabrazyme, whose output had been sharply curtailed by viral
contamination at its plant in 2009. Each right would yield an additional $1 if Lemtrada wins FDA approval. Additional
payments will be made if Lemtrada hits certain other annual revenue targets. The CVR, which runs until the end of 2020,
entitles holders to a series of payments that could cumulatively be worth up to $14 per share if Lemtrada reaches $2.8
billion in annual sales.
The Genzyme transaction was structured as a tender offer to be followed immediately with a back-end short-form
merger. The short-form merger enables an acquirer, without a shareholder vote, to squeeze out any minority shareholders
not tendering their shares during the tender offer period. To execute the short-form merger, the purchase agreement
included a “top–up” option granted by the Genzyme board to Sanofi. The “top–up” option would be triggered when Sanofi
acquired 75% of Genzyme’s outstanding shares through its tender offer. The 75% threshold could have been lower had
Genzyme had more authorized but unissued shares to make up the difference between the 90% requirement for the short-
form merger and the number of shares accumulated as a result of the tender offer. The deal also involved the so-called dual-
track model of simultaneously filing a proxy statement for a shareholders’ meeting and vote on the merger while the tender
offer is occurring to ensure that the deal closes as soon as possible.
Discussion Questions
1. The deal was structured as a tender offer coupled with a “top up” option to be followed by a backend short
form merger. Why might this structure be preferable to a more common statutory merger deal or a tender offer
followed by a backend merger requiring a shareholder vote?
2. Speculate as to the purpose of the dual track model in which the bidder initiates a tender offer and
simultaneously files a prospectus to hold a shareholders meeting and vote on a merger
3. Describe the takeover tactics employed by Sanofi. Discuss why each one might have been used.
4. Describe the antitakeover strategy employed by Genzyme. Discuss why each may have been employed. In
your opinion, did the Genzyme strategy work?
5. What alternatives could Sanofi used instead of the CVR to bridge the difference in how the parties valued
Genzyme? Discuss the advantages and disadvantages of each.
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6. How might both the target and bidding firm benefit from the top-up option?
7. How might the existence of a CVR limit Sanofi’s ability to realize certain types of synergies? Be specific.
Swiss Pharmaceutical Giant Novartis Takes Control of Alcon
_________________________________________________________________________________________________
Key Points
Parent firms frequently find it appropriate to buy out minority shareholders to reduce costs and to simplify future decision
making.
Acquirers may negotiate call options with the target firm after securing a minority position to implement so-called
“creeping takeovers.”
_________________________________________________________________________________________________
In December 2010, Swiss pharmaceutical company Novartis AG completed its effort to acquire, for $12.9 billion, the
remaining 23% of U.S.-listed eye care group Alcon Incorporated (Alcon) that it did not already own. This brought the total
purchase price for 100% of Alcon to $52.2 billion. Novartis had been trying to purchase Alcon’s remaining publicly traded
shares since January 2010, but its original offer of 2.8 Novartis shares, valued at $153 per Alcon share, met stiff resistance
from Alcon’s independent board of directors, which had repeatedly dismissed the Novartis bid as “grossly inadequate.”
Novartis finally relented, agreeing to pay $168 per share, the average price it had paid for the Alcon shares it already
owned, and to guarantee that price by paying cash equal to the difference between $168 and the value of 2.8 Novartis
shares immediately prior to closing. If the value of Novartis shares were to appreciate before closing such that the value of
2.8 shares exceeded $168, the number of Novartis shares would be reduced. By acquiring all outstanding Alcon shares,
Novartis avoided interference by minority shareholders in making key business decisions, achieved certain operating
synergies, and eliminated the expense of having public shareholders.
In 2008, with global financial markets in turmoil, Novartis acquired, for cash, a minority position in food giant Nestlé’s
wholly owned subsidiary Alcon. Nestlé had acquired 100% of Alcon in 1978 and retained that position until 2002, when it
undertook an IPO of 23% of its shares. In April 2008, Novartis acquired 25% of Alcon for $143 per share from Nestlé. As
part of this transaction, Novartis and Nestlé received a call and a put option, respectively, which could be exercised at $181
per Alcon share from January 2010 to July 2011. On January 4, 2010, Novartis exercised its call option to buy Nestlé’s
remaining 52% ownership stake in Alcon that it did not already own. By doing so, Novartis increased its total ownership
position in Alcon to about 77%. The total price paid by Novartis for this position amounted to $39.3 billion ($11.2 billion in
2008 plus $28.1 billion in 2010). On the same day, Novartis also offered to acquire the remaining publicly held shares that
it did not already own in a share exchange valued at $153 per share in which 2.8 shares of its stock would be exchanged for
each Alcon share.
While the Nestlé deal seemed likely to receive regulatory approval, the offer to the minority shareholders was assailed
immediately as too low. At $153 per share, the offer was well below the Alcon closing price on January 4, 2010, of
$164.35. The Alcon publicly traded share price may have been elevated by investors’ anticipating a higher bid. Novartis
argued that without this speculation, the publicly traded Alcon share price would have been $137, and the $153 per share
price Novartis offered the minority shareholders would have represented an approximate 12% premium to that price. The
minority shareholders, who included several large hedge funds, argued that they were entitled to $181 per share, the amount
paid to Nestlé. Alcon’s publicly traded shares dropped 5% to $156.97 on the news of the Novartis takeover. Novartis’
shares also lost 3%, falling to $52.81. On August 9, 2010, Novartis received approval from European Union regulators to
buy the stake in Alcon, making it easier for it to take full control of Alcon.
With the buyout of Nestlé’s stake in Alcon completed, Novartis was now faced with acquiring the remaining 23% of the
outstanding shares of Alcon stock held by the public. Under Swiss takeover law, Novartis needed a majority of Alcon board
members and two-thirds of shareholders to approve the terms for the merger to take effect and for Alcon shares to convert
automatically into Novartis shares. Once it owned 77% of Alcon’s stock, Novartis only needed to place five of its own
nominated directors on the Alcon board to replace the five directors previously named by Nestlé to the board. Alcon’s
independent directors set up an independent director committee (IDC), arguing that the price offered to minority
shareholders was too low and that the new directors, having been nominated by Novartis, should abstain from voting on the
Novartis takeover because of their conflict of interest. The IDC preferred a negotiated merger to a “cram down” or forced
merger in which the minority shares convert to Novartis shares at the 2.8 share-exchange offer.
Provisions in the Swiss takeover code require a mandatory offer whenever a bidder purchases more than 33.3% of
another firm’s stock. In a mandatory offer, Novartis would also be subject to the Swiss code’s minimum-bid rule, which
would require Novartis to pay $181 per share in cash to Alcon’s minority shareholders, the same bid offered to Nestlé. By
replacing the Nestlé-appointed directors with their own slate of candidates and owning more than two-thirds of the Alcon
shares, Novartis argued that they were not subject to mandatory-bid requirements. Novartis was betting on the continued
appreciation of its shares, valued in Swiss francs, due to an ongoing appreciation of the Swiss currency and its improving
operating performance, to eventually win over holders of the publicly traded Alcon shares. However, by late 2010,
Novartis’ patience appears to have worn thin. While not always the case, the resistance of the independent directors paid off
for those investors holding publicly traded shares.
Discussion Questions
1. Speculate as to why Novartis acquired only a 25 percent stake in Alcon in 2008.
2. Why was the price ($181 per share) at which Novartis exercised its call option in 2010 to increase its stake in
Alcon to 77 so much higher than what it paid ($143 per share) for an approximate 25 percent stake in Alcon in
early 2008?
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3. Alcon and Novartis shares dropped by 5 percent and 3 percent, respectively, immediately following the
announcement that Novartis would exercise its option to buy Nestle’s majority holdings of Alcon shares.
Explain why this happened.
4. How do Swiss takeover laws compare to comparable U.S. laws. Which are more appropriate and why?
1. Discuss how Novartis may have arrived at the estimate of $137 per share as the intrinsic value of Alcon.
What are the key underlying assumptions? Do you believe that the minority shareholders should receive the
same price as Nestle?
Illustrating How Deal Structure Affects Value—The FaceBook / Instagram Deal
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Key Points
Deal structures affect value by limiting risk to the parties involved or exposing them to risk.
The value of cash received at closing is certain, whereas the value of stock is not.
Mechanisms exist to limit such risk; however, they often come with a cost to the party seeking risk mitigation.
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While we always look smarter after the fact, social networking giant Facebook’s acquisition of Instagram, a popular photo-
sharing service, highlights risk common to such deals. Instagram’s user base was exploding; Facebook viewed it as a
potential competitor and as a means of extending its own product offering to photo sharing on smartphones and tablet
computers. However, the two-year-old Instagram had no revenue and consisted of a technology platform, a growing and
active user base, and 24 employees. Facebook announced on April 12, 2012, that it had reached an agreement, reportedly
hammered out in less than 48 hours, to buy Instagram for $1 billion, an outsized valuation by most measures.
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The purchase price consisted of $300 million in cash and 23 million shares of common stock for all of the outstanding
Instagram shares. The combination of cash and stock is usually offered to give selling-firm shareholders the favorable tax
advantages of acquirer stock, the certainty of cash, and the opportunity to participate in any potential appreciation of the
acquiring firm’s shares. The deal value was predicated on a Facebook share price of $31 per share, giving Facebook a
market value at the time of $75 billion. What is perhaps most remarkable about this transaction is the price paid, the speed
with which it was negotiated, and the absence of protections for the Instagram shareholders. These issues are discussed
next.
Called an important milestone by Facebook founder and CEO Mark Zuckerberg, the deal reflected the dangers of
valuing a firm primarily on its potential. This is an issue that Facebook tackled following its IPO on May 18, 2012.
Originally offered at $38 per share, the stock soon plummeted to less than half that value as investors doubted the firm’s
long-term profitability.
Facebook’s dual class shareholder structure gives Mr. Zuckerberg effective control of the firm, despite owning only
28.4% of outstanding class B shares. This control made it possible for the lofty valuation to be placed on Instagram and for
the deal to be negotiated so rapidly. Indeed, the Instagram offer price may have reflected the euphoria preceding the
Facebook IPO. The heady environment immediately prior to the Facebook IPO also may have convinced the Instagram
shareholders that they had little to lose and much to gain by accepting a mostly stock deal involving a fixed share–exchange
ratio. That is, the number of Facebook shares exchanged for each Instagram share would remain unchanged, despite any
appreciation (depreciation) in Facebook shares between the signing of the agreement and the closing of the deal.
The downside risk to Instagram shareholders was evident by the September 6, 2012, closing date, for the value of the
deal had plummeted to about $715 million, with Facebook shares having closed at $18.05 a share. Instagram shareholders
experienced a substantial loss in value, which could have been averted by adjusting the purchase price within a range if
Facebook’s share price fluctuated significantly between signing and closing. Alternatively, Instagram could have negotiated
the right to cancel the deal due a material change in the value of the transaction.
Boston Scientific Overcomes Johnson & Johnson to Acquire Guidant—A Lesson in Bidding Strategy
Johnson & Johnson, the behemoth American pharmaceutical company, announced an agreement in December 2004 to
acquire Guidant for $76 per share for a combination of cash and stock. Guidant is a leading manufacturer of implantable
heart defibrillators and other products used in angioplasty procedures. The defibrillator market has been growing at 20
percent annually, and J&J desired to reenergize its slowing growth rate by diversifying into this rapidly growing market.
Soon after the agreement was signed, Guidant’s defibrillators became embroiled in a regulatory scandal over failure to
inform doctors about rare malfunctions. Guidant suffered a serious erosion of market share when it recalled five models of
its defibrillators.
The subsequent erosion in the market value of Guidant prompted J&J to renegotiate the deal under a material adverse
change clause common in most M&A agreements. J&J was able to get Guidant to accept a lower price of $63 a share in
mid-November. However, this new agreement was not without risk.
The renegotiated agreement gave Boston Scientific an opportunity to intervene with a more attractive informal offer on
December 5, 2005, of $72 per share. The offer price consisted of 50 percent stock and 50 percent cash. Boston Scientific, a
leading supplier of heart stents, saw the proposed acquisition as a vital step in the company’s strategy of diversifying into
the high-growth implantable defibrillator market.
Despite the more favorable offer, Guidant’s board decided to reject Boston Scientific’s offer in favor of an upwardly
revised offer of $71 per share made by J&J on January 11, 2005. The board continued to support J&J’s lower bid, despite
the furor it caused among big Guidant shareholders. With a market capitalization nine times the size of Boston Scientific,
the Guidant board continued to be enamored with J&J’s size and industry position relative to Boston Scientific.
Boston Scientific realized that it would be able to acquire Guidant only if it made an offer that Guidant could not refuse
without risking major shareholder lawsuits. Boston Scientific reasoned that if J&J hoped to match an improved bid, it
would have to be at least $77, slightly higher than the $76 J&J had initially offered Guidant in December 2004. With its
greater borrowing capacity, Boston Scientific knew that J&J also had the option of converting its combination stock and
cash bid to an all-cash offer. Such an offer could be made a few dollars lower than Boston Scientific’s bid, since Guidant
investors might view such an offer more favorably than one consisting of both stock and cash, whose value could fluctuate
between the signing of the agreement and the actual closing. This was indeed a possibility, since the J&J offer did not
include a collar arrangement.
Boston Scientific decided to boost the new bid to $80 per share, which it believed would deter any further bidding from
J&J. J&J had been saying publicly that Guidant was already “fully valued.” Boston Scientific reasoned that J&J had created
a public relations nightmare for itself. If J&J raised its bid, it would upset J&J shareholders and make it look like an
undisciplined buyer. J&J refused to up its offer, saying that such an action would not be in the best interests of its
shareholders. Table 1 summarizes the key events timeline.
Table 1
Boston Scientific and Johnson & Johnson Bidding Chronology
Date
Comments
December 15, 2004
J&J reaches agreement to buy Guidant for $25.4 billion in stock and cash.
November 15, 2005
Value of J&J deal is revised downward to $21.5 billion.
December 5, 2005
Boston Scientific offers $25 billion.
January 11, 2006
Guidant accepts a J&J counteroffer valued at $23.2 billion.
January 17, 2006
Boston Scientific submits a new bid valued at $27 billion.
January 25, 2006
Guidant accepts Boston Scientific’s bid when J&J fails to raise its offer.
A side deal with Abbott Labs made the lofty Boston Scientific offer possible. The firm entered into an agreement with
Abbott Laboratories in which Boston Scientific would divest Guidant’s stent business while retaining the rights to Guidant’s
stent technology. In return, Boston Scientific received $6.4 billion in cash on the closing date, consisting of $4.1 billion for
the divested assets, a loan of $900 million, and Abbott’s purchase of $1.4 billion of Boston Scientific stock. The additional
cash helped fund the purchase price. This deal also helped Boston Scientific gain regulatory approval by enabling Abbott
Labs to become a competitor in the stent business. Merrill Lynch and Bank of America each would lend $7 billion to fund a
portion of the purchase price and provide the combined firms with additional working capital.
To complete the transaction, Boston Scientific paid $27 billion, consisting of cash and stock, to Guidant shareholders
and another $800 million as a breakup fee to J&J. In addition, the firm is burdened with $14.9 billion in new debt. Within
days of Boston Scientific’s winning bid, the firm received a warning from the U.S. Food and Drug Administration to delay
the introduction of new products until the firm‘s safety procedures improved.
Between December 2004, the date of Guidant’s original agreement with J&J, and January 25, 2006, the date of its
agreement with Boston Scientific, Guidant’s stock rose by 16 percent, reflecting the bidding process. During the same
period, J&J’s stock dropped by a modest 3 percent, while Boston Scientific’s shares plummeted by 32 percent.
As a result of product recalls and safety warnings on more than 50,000 Guidant cardiac devices, the firm’s sales and
profits plummeted. Between the announcement date of its purchase of Guidant in December 2005 and year–end 2006,
Boston Scientific lost more than $18 billion in shareholder value. In acquiring Guidant, Boston Scientific increased its total
shares outstanding by more than 80 percent and assumed responsibility for $6.5 billion in debt, with no proportionate
increase in earnings. In early 2010, Boston Scientific underwent major senior management changes and spun off several
business units in an effort to improve profitability. Ongoing defibrillator recalls could shave the firm’s revenue by $0.5
billion during the next two years.1 In 2010, continuing product-related problems forced the firm to write off $1.8 billion in
impaired goodwill associated with the Guidant acquisition. At less than $8 per share throughout most of 2010, Boston
Scientific’s share price is about one-fifth of its peak of $35.55 on December 5, 2005, the day the firm announced its bid for
Guidant.
Discussion Questions
1. What were the key differences between J&J’s and Boston Scientific’s bidding strategy? Be specific.