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2. What might J&J have done differently to avoid igniting a bidding war?
3. What evidence is given that J&J may not have taken Boston Scientific as a serious bidder?
4. Explain how differing assumptions about market growth, potential synergies, and the size of the potential
liability related to product recalls affected the bidding?
Buyer Consortium Wins Control of ABN Amro
The biggest banking deal on record was announced on October 9, 2007, resulting in the dismemberment of one of Europe’s
largest and oldest financial services firms, ABN Amro (ABN). A buyer consortium consisting of The Royal Bank of
Scotland (RBS), Spain‘s Banco Santander (Santander), and Belgium’s Fortis Bank (Fortis) won control of ABN, the largest
bank in the Netherlands, in a buyout valued at $101 billion.
European banks had been under pressure to grow through acquisitions and compete with larger American rivals to avoid
becoming takeover targets themselves. ABN had been viewed for years as a target because of its relatively low share price.
However, rival banks were deterred by its diverse mixture of businesses, which was unattractive to any single buyer. Under
pressure from shareholders, ABN announced that it had agreed, on April 23, 2007, to be acquired by Barclay’s Bank of
London for $85 billion in stock. The RBS-led group countered with a $99 billion bid consisting mostly of cash. In response,
Barclay’s upped its bid by 6 percent with the help of state-backed investors from China and Singapore. ABN’s management
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favored the Barclay bid because Barclay had pledged to keep ABN intact and its headquarters in the Netherlands. However,
a declining stock market soon made Barclay‘s mostly stock offer unattractive.
While the size of the transaction was noteworthy, the deal is especially remarkable in that the consortium had agreed
prior to the purchase to split up ABN among the three participants. The mechanism used for acquiring the bank represented
an unusual means of completing big transactions amidst the subprime-mortgage-induced turmoil in the global credit
markets at the time. The members of the consortium were able to select the ABN assets they found most attractive. The
consortium agreed in advance of the acquisition that Santander would receive ABN’s Brazilian and Italian units; Fortis
would obtain the Dutch bank’s consumer lending business, asset management, and private banking operations, and RBS
would own the Asian and investment banking units. Merrill Lynch served as the sole investment advisor for the group’s
participants. Caught up in the global capital market meltdown, Fortis was forced to sell the ABN Amro assets it had
acquired to its Dutch competitor ING in October 2008.
Discussion Questions:
1. In your judgment, what are likely to be some of the major challenges in assembling a buyer consortium to acquire
and subsequently dismember a target firm such as ABN Amro? In what way do you thing the use of a single
investment advisor might have addressed some of these issues?
2. The ABN Amro transaction was completed at a time when the availability of credit was limited due to the sub–
prime mortgage loan problem originating in the United States. How might the use of a group rather than a single
buyer have facilitated the purchase of ABN Amro?
3. The same outcome could have been achieved if a single buyer had reached agreement with other banks to acquire
selected pieces of ABN before completing the transaction. The pieces could then have been sold at the closing.
Why might the use of the consortium been a superior alternative?
and can break up the businesses have access to more accurate and timely information.
Pfizer Acquires Wyeth Labs Despite Tight Credit Markets
Pfizer and Wyeth began joint operations on October 22, 2009, when Wyeth shares stopped trading and each Wyeth share
was converted to $33 in cash and 0.985 of a Pfizer share. Valued at $68 billion, the cash and stock deal was first announced
in late January of 2009. The purchase price represented a 12.6 percent premium over Wyeth’s closing share price the day
before the announcement. Investors from both firms celebrated as Wyeth’s shares rose 12.6 percent and Pfizer’s 1.4 percent
on the news. The announcement seemed to offer the potential for profit growth, despite storm clouds on the horizon.
As is true of other large pharmaceutical companies, Pfizer expects to experience serious erosion in revenue due to
expiring patent protection on a number of its major drugs. Pfizer faced the expiration of patent rights in 2011 to the
cholesterol-lowering drug Lipitor, which accounted for 25 percent of the firm’s $52 billion in 2008 revenue. Pfizer also
faces 14 other patent expirations through 2014 on drugs that, in combination with Lipitor, contribute more than one-half of
the firm’s total revenue. Pfizer is not alone, Merck, Bristol-Myers Squibb, and Eli Lilly are all facing significant revenue
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reduction due to patent expirations during the next five years as competition from generic drugs undercuts their pricing.
Wyeth will also be losing its patent protection on its top-selling drug, the antidepressant Effexor XR.
Pfizer’s strategy appears to have been to acquire Wyeth at a time when transaction prices were depressed because of the
recession and tight credit markets. Pfizer anticipates saving more than $4 billion annually by combining the two businesses,
with the savings being phased in over three years. Pfizer also hopes to offset revenue erosion due to patent expirations by
diversifying into vaccines and arthritis treatments.
By the end of 2008, Pfizer already had a $22.5 billion commitment letter in order to obtain temporary or “bridge”
financing and $26 billion in cash and marketable securities. Pfizer also announced plans to cut its quarterly dividend in half
to $0.16 per share to help finance the transaction. However, there were still questions about the firm’s ability to complete
the transaction in view of the turmoil in the credit markets.
Many transactions that were announced during 2008 were never closed because buyers were unable to arrange financing
and would later claim that the purchase agreement had been breached due to material adverse changes in the business
climate. Such circumstances, they would argue, would force them to renege on their contracts. Usually, such contracts
contain so-called reverse termination fees, in which the buyer would agree to pay a fee to the seller if they were unwilling
to close the deal. This is called a reverse termination or breakup fee because traditionally breakup fees are paid by a seller
that chooses to break a contract with a buyer in order to accept a more attractive offer from another suitor.
Negotiations, which had begun in earnest in late 2008, became increasingly contentious, not so much because of
differences over price or strategy but rather under what circumstances Pfizer could back out of the deal. Under the terms of
the final agreement, Pfizer would have been liable to pay Wyeth $4.5 billion if its credit rating dropped prior to closing and
it could not finance the transaction. At about 6.6 percent of the purchase price, the termination fee was about twice the
normal breakup fee for a transaction of this type.
What made this deal unique was that the failure to obtain financing as a pretext for exit could be claimed only under
very limited circumstances. Specifically, Pfizer could renege only if its lenders refused to finance the transaction because of
a credit downgrade of Pfizer. If lenders refused to finance primarily for this reason, Wyeth could either demand that Pfizer
attempt to find alternative financing or terminate the agreement. If Wyeth had terminated the agreement, Pfizer would have
been obligated to pay the termination fee.
Using Form of Payment as a Takeover Strategy:
Chevron’s Acquisition of Unocal
Unocal ceased to exist as an independent company on August 11, 2005 and its shares were de-listed from the New York
Stock Exchange. The new firm is known as Chevron. In a highly politicized transaction, Chevron battled Chinese oil–
producer, CNOOC, for almost four months for ownership of Unocal. A cash and stock bid by Chevron, the nation’s second
largest oil producer, made in April valued at $61 per share was accepted by the Unocal board when it appeared that
CNOOC would not counter-bid. However, CNOOC soon followed with an all-cash bid of $67 per share. Chevron amended
the merger agreement with a new cash and stock bid valued at $63 per share in late July. Despite the significant difference
in the value of the two bids, the Unocal board recommended to its shareholders that they accept the amended Chevron bid
in view of the growing doubt that U.S. regulatory authorities would approve a takeover by CNOOC.
In its strategy to win Unocal shareholder approval, Chevron offered Unocal shareholders three options for each of their
shares: (1) $69 in cash, (2) 1.03 Chevron shares; or (3) .618 Chevron shares plus $27.60 in cash. Unocal shareholders not
electing any specific option would receive the third option. Moreover, the all–cash and all-stock offers were subject to
proration in order to preserve an overall per share mix of .618 of a share of Chevron common stock and $27.60 in cash for
all of the 272 million outstanding shares of Unocal common stock. This mix of cash and stock provided a “blended” value
of about $63 per share of Unocal common stock on the day that Unocal and Chevron entered into the amendment to the
merger agreement on July 22, 2005. The “blended” rate was calculated by multiplying .618 by the value of Chevron stock
on July 22nd of $57.28 plus $27.60 in cash. This resulted in a targeted purchase price that was about 56 percent Chevron
stock and 44 percent cash.
This mix of cash and stock implied that Chevron would pay approximately $7.5 billion (i.e., $27.60 x 272 million
Unocal shares outstanding) in cash and issue approximately 168 million shares of Chevron common stock (i.e., .618 x 272
million of Unocal shares) valued at $57.28 per share as of July 22, 2005. The implied value of the merger on that date was
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$17.1 billion (i.e., $27.60 x 272 million Unocal common shares outstanding plus $57.28 x 168 million Chevron common
shares). An increase in Chevron’s share price to $63.15 on August 10, 2005, the day of the Unocal shareholders’ meeting,
boosted the value of the deal to $18.1 billion.
Option (1) was intended to appeal to those Unocal shareholders who were attracted to CNOOC’s all cash offer of $67
per share. Option (2) was designed for those shareholders interested in a tax-free exchange. Finally, it was anticipated that
option (3) would attract those Unocal shareholders who were interested in cash but also wished to enjoy any appreciation in
the stock of the combined companies.
The agreement of purchase and sale between Chevron and Unocal contained a “proration clause.” This clause enabled
Chevron to limit the amount of total cash it would payout under those options involving cash that it had offered to Unocal
shareholders and to maintain the “blended” rate of $63 it would pay for each share of Unocal stock. Approximately 242
million Unocal shareholders elected to receive all cash for their shares, 22.1 million opted for the all-stock alternative, and
10.1 million elected the cash and stock combination. No election was made for approximately .3 million shares. Based on
these results, the amount of cash needed to satisfy the number shareholders electing the all-cash option far exceeded the
amount that Chevron was willing to pay. Consequently, as permitted in the merger agreement, the all-cash offer was
prorated resulting in the Unocal shareholders who had elected the all-cash option receiving a combination of cash and stock
rather than $69 per share. The mix of cash and stock was calculated as shown in Exhibit 1.
Exhibit 1. Prorating All-Cash Elections
1. Determine the available cash election amount (ACEA): Aggregate cash amount minus the amount of cash
to be paid to Unocal shareholders selecting the combination of cash and stock (i.e., Option 3).
2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the
number of shares of Unocal common stock electing the all-cash option.
4. Determine the prorated cash merger consideration (PCMC): An amount in cash equal
to $69 multiplied by the cash proration factor.
5. Determine the prorated stock merger consideration (PSMC): 1.03 multiplied by 1 – CPF.
6. Determine the stock and cash mix (SCM): Sum of the prorated cash (PCMC) and stock
(PSMC) merger considerations exchanged for each share of Unocal common stock.
If too many Unocal shareholders had elected to receive Chevron stock, those making the all-stock election would not
have received 1.03 shares of Chevron stock for each share of Unocal stock. Rather, they would have received a mix of
stock and cash to help preserve the approximate 56 percent stock and 44 percent cash composition of the purchase price
desired by Chevron. For illustration only, assume the number of Unocal shares to be exchanged for the all-cash and all-
stock options are 22.1 and 242 million, respectively. This is the reverse of what actually happened. The mix of stock and
cash would have been prorated as shown in Exhibit 2.
Exhibit 12. Prorating All-Stock Elections
1. Determine the available cash election amount (ACEA): Same as step 1 above.
2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the number of shares of
Unocal common stock electing the all-cash option.
4. Determine the prorated cash merger consideration (PCMC): EXCA divided by number of Unocal shares
elected the all-stock option.
5. Determine the stock proration factor (SPF): $69 minus the prorated cash merger
consideration divided by $69.
6. Determine the prorated stock price consideration (PSPC): The number of shares of
Chevron stock equal to 1.03 multiplied by the stock proration factor.
7. Determine the stock and cash mix (SCM): Each Unocal share to be exchanged in an
all-stock election is converted into the right to receive the prorated cash merger
consideration and the prorated stock merger consideration.
It is typical of large transactions in which the target has a large, diverse shareholder base that acquiring firms offer
target shareholders a “menu” of alternative forms of payment. The objective is to enhance the likelihood of success by
appealing to a broader group of shareholders. To the unsophisticated target shareholder, the array of options may prove
appealing. However, it is likely that those electing all-cash or all-stock purchases are likely to be disappointed due to
probable proration clauses in merger contracts. Such clauses enable the acquirer to maintain an overall mix of cash and
stock in completing the transaction. This enables the acquirer to limit the amount of cash they must borrow or the number
of new shares they must issue to levels they find acceptable.
Discussion Questions
1. What was the form of payment employed by both bidders for Unocal? In your judgment, why were they
different? Be specific.
2. How did Chevron use the form of payment as a potential takeover strategy?
3. Is the “proration clause” found in most merger agreements in which target shareholders are given several ways in
which they can choose to be paid for their shares in the best interests of the target shareholders? In the best
interests of the acquirer? Explain your answer.
Blackstone Outmaneuvers Vornado to Buy Equity Office Properties
Reflecting the wave of capital flooding into commercial real estate and the growing power of private equity investors, the
Blackstone Group (Blackstone) succeeded in acquiring Equity Office Properties (EOP) following a bidding war with
Vornado Realty Trust (Vornado). On February 8, 2007, Blackstone Group closed the purchase of EOP for $39 billion,
consisting of about $23 billion in cash and $16 billion in assumed debt.
EOP was established in 1976 by Sam Zell, a veteran property investor known for his ability to acquire distressed
properties. Blackstone, one of the nation’s largest private equity buyout firms, entered the commercial real estate market for
the first time in 2005. In contrast, Vornado, a publicly traded real estate investment trust, had a long–standing reputation for
savvy investing in the commercial real estate market. EOP’s management had been under fire from investors for failing to
sell properties fast enough and distribute the proceeds to shareholders.
EOP signed a definitive agreement to be acquired by Blackstone for $48.50 per share in cash in November 2006, subject
to approval by EOP’s shareholders. Reflecting the view that EOP’s breakup value exceeded $48.50 per share, Vornado bid
$52 per share, 60 percent in cash and the remainder in Vornado stock. Blackstone countered with a bid of $54 per share, if
EOP would raise the breakup fee to $500 million from $200 million. Ostensibly designed to compensate Blackstone for
expenses incurred in its takeover attempt, the breakup fee also raised the cost of acquiring EOP by another bidder, which as
the new owner would actually pay the fee. Within a week, Vornado responded with a bid valued at $56 per share. While
higher, EOP continued to favor Blackstone’s offer since the value was more certain than Vornado’s bid. It could take as long
as three to four months for Vornado to get shareholder approval. The risks were that the value of Vornado’s stock could
decline and shareholders could nix the deal. Reluctant to raise its offer price, Vornado agreed to increase the cash portion of
the purchase price and pay shareholders the cash more quickly than had been envisioned in its initial offer. However,
Vornado did not offer to pay EOP shareholders a fee if Vornado’s shareholders did not approve the deal. The next day,
Blackstone increased its bid to $55.25 and eventually to $55.50 at Zell’s behest in exchange for an increase in the breakup
fee to $720 million. Vornado’s failure to counter gave Blackstone the win. On the news that Blackstone had won,
Vornado’s stock jumped by 5.8 percent and EOP’s fell by 1 percent to just below Blackstone’s final offer price.
Discussion Questions:
1. Describe Blackstone’s negotiating strategy with EOP in its effort to counter Vornado’s bids. Be specific.
2. What could Vornado have done to assuage EOP’s concerns about the certainty of the value of the stock
portion of its offer?
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3. Explain the reaction of EOP’s and Vornado’s share prices to the news that Blackstone was the winning bidder.
What does the movement in Vornado’s share price tell you about the likelihood that the firm’s shareholders
would have approved the takeover of EOP?
Vivendi Universal and GE Combine Entertainment Assets to Form NBC Universal
Ending a four-month-long auction process, Vivendi Universal SA agreed on October 5, 2003, to sell its Vivendi Universal
Entertainment (VUE) businesses, consisting of film and television assets, to General Electric Corporation’s wholly owned
NBC subsidiary. Vivendi received a combination of GE stock and stock in the combined company valued at approximately
$14 billion. Vivendi would combine the Universal Pictures movie studio, its television production group, three cable
networks, and the Universal theme parks with NBC. The new company would have annual revenues of $13 billion based on
2003 pro forma statements.
This transaction was among many made by Vivendi in its effort to restore the firm’s financial viability. Having started as
a highly profitable distributor of bottled water, the French company undertook a diversification spree in the 1990s, which
pushed the firm into many unrelated enterprises and left it highly in debt. With its stock plummeting, Vivendi had been
under considerable pressure to reduce its leverage and refocus its investments.
Applying a multiple of 14 times estimated 2003 EBITDA of $3 billion, the combined company had an estimated value
of approximately $42 billion. This multiple is well within the range of comparable transactions and is consistent with the
share price multiples of television media companies at that time. Of the $3 billion in 2003 EBITDA, GE would provide $2
billion and Vivendi $1 billion. This values GE’s assets at $28 billion and Vivendi’s at $14 billion. This implies that GE
assets contribute two thirds and Vivendi’s one third of the total market value of the combined company.
NBC Universal’s total assets of $42 billion consist of VUE’s assets valued at $14 billion and NBC’s at $28 billion.
Vivendi chose to receive an infusion of liquidity at closing consisting of $4.0 billion in cash by selling its right to receive
$4 billion in GE stock and the transfer of $1.6 billion in debt carried by VUE’s businesses to NBC Universal.
Vivendi would retain an ongoing approximate 20 percent ownership in the new company valued at $8.4 billion after
having received $5.6 billion in liquidity at closing. GE would have 80 percent ownership in the new company in exchange
for providing $5.6 billion in liquidity (i.e., $4 billion in cash and assuming $1.6 billion in debt). Vivendi had the option to
sell its 20 percent ownership interest in the future, beginning in 2006, at fair market value. GE would have the first right
(i.e., the first right of refusal) to acquire the Vivendi position. GE anticipated that its 80 percent ownership position in the
combined company would be accretive for GE shareholders beginning in the second full year of operation.
Discussion Questions:
1. From a legal standpoint, identify the acquirer and the target firms?
2. What is the form of acquisition? Why might the parties involved in the transaction have agreed to this form?
3. What is the form of acquisition vehicle and the post-closing organization? Why do you think the legal entities you
have identified were selected?
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4. What is the form of payment or total consideration? Why do you think this form of payment may have been
selected by the parties involved?
5. Is this transaction likely to be non-taxable, wholly taxable, or partially taxable to Vivendi? Explain your answer.
6. Based on a total valuation of $42 billion, Vivendi’s assets contributed one–third and GE’s two–thirds of the total
value of NBC Universal. However, after the closing, Vivendi would only own a 20% equity position in the
combined business. Why?
News Corp.’s Power Play in Satellite Broadcasting
The share prices of Rupert Murdoch’s News Corp., Fox Entertainment Group Inc., and Hughes Electronics
Corp. (a subsidiary of General Motors Corporation) tumbled immediately following the announcement that
News Corp had reached an agreement to take a controlling interest in Hughes on April 10, 2003.
Immediately following the announcement, shares of Fox fell by 17 percent, News Corp.’s ADRs (i.e.,
shares issued by foreign firms trading on U.S. stock exchanges) by 6.5 percent and Hughes by 9.8 percent.
Hughes Electronics is a world leader in providing digital television entertainment, broadband satellite
networks and services (DirecTV), and global video and data broadcasting. The News Corporation is a
diversified international media and entertainment company with operations in a number of industry
segments, including filmed entertainment, television, cable network programming, magazines and inserts,
newspapers and book publishing.
News Corp.’s Chairman Rupert Murdoch, had pursued control of Hughes, the parent company of
DirecTV, for several years. News Corp.’s bid valued at about $6.6 billion to acquire control of Hughes
Electronics Corp. and its DirecTV unit gives News Corp a U.S. presence to augment its satellite TV
operations in Britain and Asia. In one bold move, News Corp became the second largest provider of pay–
TV service to U.S. homes, second only to Comcast. By transferring News Corp.’s stake in Hughes to Fox,
Fox gained control over 11 million subscribers. It gives Fox more leverage for its cable networks when
negotiating rights fees with cable operators that compete with DirecTV. In negotiating with film studios or
sports companies over pay television rights, News Corp. is now the only global customer, with satellite
systems spanning Europe, Asia, and Latin America. Moreover, News Corp. can cross–promote among
DirecTV and its others businesses (e.g., packaging DirecTV subscriptions with subscriptions to TV Guide).
General Motors was motivated to sell its investment in Hughes because of its poor financial
performance in recent years and GM’s need for cash. GM and Hughes had first agreed to a deal with rival
satellite broadcaster EchoStar Communications Inc. However, the deal was blocked by antitrust regulators.
Subsequent discussions between GM/Hughes with SBC Communications and Liberty Media proved
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unproductive with these firms offering primarily a share for share exchange. GM’s desire to quickly pull
cash out of Hughes made News Corp.’s offer the most attractive. Consequently, they chose to accept News
Corp.’s proposal rather than pursue a riskier proposal for a Hughes’ management-sponsored leveraged
buyout.
News Corp. financed its purchase of a 34.1% stake in Hughes (i.e., GM’s 20% ownership and 14.1%
from public shareholders) by paying $3.1 billion in cash to GM, plus 34.3 million in nonvoting American
depository receipts (ADRs) in News Corp. shares. Hughes’ public shareholders will be paid with 122.2
million nonvoting ADRs in News Corp. Each ADR is equivalent to four News Corp. shares. The resulting
issue of 156.5 million shares would dilute News Corp. shareholders by about 13%. Immediately following
closing, News Corp.’s ownership interest was transferred to Fox in exchange for a $4.5 billion promissory
note from Fox and 74 million new Fox shares. This transfer will saddle Fox with $4.5 billion in debt. This
debt would need to be serviced by Fox’s cash flow and could limit Fox’s access to new capital.
Now that News Corp. controls DirecTV through its 81 percent ownership in Fox, it must find away to
revitalize DirecTV. Against tough cable-TV competition, DirecTV has experienced a 20% turnover rate
among its subscribers, due in part to GM’s benign neglect while it looked for a buyer. News Corp. will
now have to compete against larger, better financed cable operations, as well as the nimble, low cost
EchoStar Communications Corp’s Dish Network. As an indication of the extent to which Hughes has
stumbled in recent years, News Corp. made a formal bid to acquire all of Hughes for about $25 billion in
cash in 2001. News Corp.’s current investment stake implies a valuation of less the $20 billion for 100
percent ownership of Hughes (i.e., $6.6 billion/.341).
Discussion Questions:
1. Why did the share prices of News Corp., Fox, and Hughes fall precipitously following the
announcement? Explain your answer.
2. How did News Corp.’s proposed deal structure better satisfy GM’s needs than those of other
bidders?
3. How can it be said that News Corp. obtained a controlling interest in Hughes when its stake
amounted to only about one-third of Hughes outstanding voting shares? Explain your answer.
Determining Deal Structuring Components
BigCo has decided to acquire Upstart Corporation, a leading supplier of a new technology believed to be crucial to the
successful implementation of BigCo’s business strategy. Upstart is a relatively recent start-up firm, consisting of about 200
employees averaging about 24 years of age. HiTech has a reputation for developing highly practical solutions to complex
technical problems and getting the resulting products to market very rapidly. HiTech employees are accustomed to a very
informal work environment with highly flexible hours and compensation schemes. Decision-making tends to be fast and
casual, without the rigorous review process often found in larger firms. This culture is quite different from BigCo’s more
highly structured and disciplined environment. Moreover, BigCo’s decision making tends to be highly centralized.
While Upstart’s stock is publicly traded, its six co-founders and senior managers jointly own about 60 percent of the
outstanding stock. In the four years since the firm went public, Upstart stock has appreciated from $5 per share to its
current price of $100 per share. Although they desire to sell the firm, the co-founders are interested in remaining with the
firm in important management positions after the transaction has closed. They also expect to continue to have substantial
input in both daily operating as well as strategic decisions.
Upstart competes in an industry that is only tangentially related to BigCo’s core business. Because BigCo’s senior
management believes they are somewhat unfamiliar with the competitive dynamics of Upstart’s industry, BigCo has
decided to create a new corporation, New Horizons Inc., which is jointly owed by BigCo and HiTech Corporation, a firm
whose core technical competencies are more related to Upstart’s than those of BigCo. Both BigCo and HiTech are
interested in preserving Upstart’s highly innovative culture. Therefore, they agreed during negotiations to operate Upstart
as an independent operating unit of New Horizons. During negotiations, both parties agreed to divest one of Upstart’s
product lines not considered critical to New Horizon’s long-term strategy immediately following closing.
New Horizons issued stock through an initial public offering. While the co-founders are interested in exchanging their
stock for New Horizon’s shares, the remaining Upstart shareholders are leery about the long-term growth potential of New
Horizons and demand cash in exchange for their shares. Consequently, New Horizons agreed to exchange its stock for the
co–founders’ shares and to purchase the remaining shares for cash. Once the tender offer was completed, New Horizons
owned 100 percent of Upstart’s outstanding shares.
Discussion Questions:
1. What is the acquisition vehicle used to acquire the target company, Upstart Corporation? Why was this legal
structure used?
2. How would you characterize the post-closing organization? Why was this organizational structure used?
3. What is the form of payment? Why was it used?
4. What was the form of acquisition? How does this form of acquisition protect the acquiring company’s rights to
HiTech’s proprietary technology?
5. How would the use of purchase accounting affect the balance sheets of the combined companies?
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6. Was the transaction non-taxable, partially taxable, or wholly taxable to HiTech shareholders? Why?
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
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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.
Table 1. Comparison of Form of Payment/Total Consideration
Vodafone
Bell Atlantic
5 shares of Vodafone common plus $9 for each
share of AirTouch common
1.54 shares of Bell Atlantic for each share of AirTouch common
subject to the transaction being treated as a pooling of interest under
U.S. GAAP.
Share exchange ratio adjusted upward 9 months out to reflect the
payment of dividends on the Bell Atlantic stock.
A share exchange ratio collar would be used to ensure that AirTouch
shareholders would receive shares valued at $80.08. If the average
closing price of Bell Atlantic stock were less than $48, the exchange
ratio would be increased to 1.6683. If the price exceeded $52, the
exchange rate would remain at 1.54.1
1The collar guarantees the price of Bell Atlantic stock for the AirTouch shareholders because $48 1.6683 and $52 1.54
both equal $80.08.
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
2. The Vodafone proposal had a current market value of $97 per share of AirTouch stock based on Vodafone’s ordinary
3. Following the merger, the market value of the Vodafone American Depository Shares (ADSs) to be received by
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
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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.
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5. What are some of the challenges the two companies are likely to face while integrating the businesses?
JDS Uniphase–SDL 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 Uniphase–SDL) 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
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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 Hart–Scott–Rodino (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 Uniphase–SDL merger was marked by two firsts—the 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.
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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?
