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Step 2: Schering-Plough Merger:
c. Former shareholders in Merck now hold shares in “New Merck” (i.e.,
a renamed Schering-Plough)
d, Merger Sub 2, a subsidiary of “New Merck,” now owns Merck.
“New Merck”
(Schering-Plough)
1 Share of Schering-Plough
Common
Merck Shareholders
Merck
Merger Sub 2
“New Merck”
1 Share of “New Merck” common
1 Share of Merck Common
Merger
33
Concluding Comments
In reality, Merck was the acquirer. Merck provided the money to purchase Schering-Plough, and Richard Clark, Merck’s chairman and
CEO, will run the newly combined firm when Fred Hassan, Schering-Plough’s CEO, steps down. The new firm has been renamed Merck
to reflect its broader brand recognition. Three-fourths of the new firm’s board consists of former Merck directors, with the remainder
coming from Schering-Plough’s board. These factors would give Merck effective control of the combined Merck and Schering-Plough
operations. Finally, former Merck shareholders own almost 70 percent of the outstanding shares of the combined companies.
J&J initiated legal action in August 2009, arguing that the transaction was a conventional merger and, as such, triggered the change of
control provision in its partnership agreement with Schering-Plough. Schering-Plough argued that the reverse merger bypasses the change
of control clause in the agreement, and, consequently, J&J could not terminate the joint venture. In the past, U.S. courts have tended to
focus on the form rather than the spirit of a transaction. The implications of the form of a transaction are usually relatively explicit, while
determining what was actually intended (i.e., the spirit) in a deal is often more subjective.
In late 2010, an arbitration panel consisting of former federal judges indicated that a final ruling would be forthcoming in 2011.
Potential outcomes could include J&J receiving rights to Remicade with damages to be paid by Merck; a finding that the merger did not
constitute a change in control, which would keep the distribution agreement in force; or a ruling allowing Merck to continue to sell
Remicade overseas but providing for more royalties to J&J.
Discussion Questions
Discussion Questions:
1. Do you agree with the argument that the courts should focus on the form or structure of an agreement and not try to interpret
the actual intent of the parties to the transaction? Explain your answer.
2. How might allowing the form of a transaction to override the actual spirit or intent of the deal impact the cost of doing business
for the parties involved in the distribution agreement? Be specific.
Answer: When form trumps the actual intent of the parties to an agreement, the risks associated with doing deals increase. For
agreements to work well, they must ultimately require that the parties to an agreement trust each other. The purpose of such
3. How did the use of a reverse merger facilitate the transaction?
Answer: The use of a reverse merger enabled the transaction to be considered tax free in that both the continuity of ownership
and business enterprise principles were satisfied. The reverse merger procedure was actually used twice. Merger Sub 1 was to
be merged with Schering-Plough and Merger Sub 2 with Merck.
Merck
Cablevision Uses Tax Benefits to Help Justify the Price Paid for Bresnan Communications
In mid-2010, Cablevision Systems announced that it had reached an agreement to buy privately owned Bresnan Communications for
$1.37 billion in a cash for stock deal. CVS’ motivation for the deal reflected the board’s belief that the firm’s shares were undervalued
and their desire to expand coverage into the western United States.
CVS is the most profitable cable operator in the industry in terms of operating profit margins, due primarily to the firm’s heavily
concentrated customer base in the New York City area. Critics immediately expressed concern that the acquisition would provide few
immediate cost savings and relied almost totally on increasing the amount of revenue generated by Bresnan’s existing customers.
CVS saw an opportunity to gain market share from satellite TV operators providing services in BC’s primary geographic market.
Bresnan, the nation’s 13th largest cable operator, serves Colorado, Montana, Wyoming, and Utah. CVS believes it can sell bundles of
services, including Internet and phone services, to current Bresnan customers. Bresnan’s primary competition comes from DirecTV and
DISH Network, which cannot offer phone and Internet access services.
In order to gain shareholder support, CVS announced a $500 million share repurchase to placate shareholders seeking a return of cash.
The deal was financed by a $1 billion nonrecourse loan and $370 in cash from Cablevision. CVS points out that the firm’s direct
investment in BC will be more than offset by tax benefits resulting from the structure of the deal in which both Cablevision and Bresnan
agreed to treat the purchase of Bresnan’s stock as an asset purchase for tax reporting purposes (i.e., a 338 election). Consequently, CVS
will be able to write up the net acquired Bresnan assets to their fair market value and use the resulting additional depreciation to generate
significant future tax savings. Such future tax savings are estimated by CVS to have a net present value of approximately $400 million
Discussion Question:
1. How is the 338 election likely to impact Cablevision System’s earnings per share immediately following closing? Why?
2. As an analyst, how would you determine the impact of the anticipated tax benefits on the value of the firm?
3. What is the primary risk to realizing the full value of the anticipated tax benefits?
Teva Pharmaceuticals Buys Ivax Corporation
0.8471 of American depository receipts (ADRs) representing Teva shares or $26 in cash. ADRs represent the receipt given to U.S.
investors for the shares of a foreign-based corporation held in the vault of a U.S. bank. Ivax shareholders wanting immediate liquidity
chose to exchange their shares for cash, while those wanting to participate in future appreciation of Teva stock exchanged their shares for
Teva shares.
35
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
announced more than 7 months earlier had fallen to $13.5 billion on the day of closing.
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. This would reduce the number of vendors that fiber optic
$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.
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 th, 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 laser 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
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
36
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.
history. Both of these infamous “firsts” occurred within 12 months.
Case Study 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?
Answer: In theory, goodwill represents the value of the acquired firm’s intangible value including brand, intellectual property,
good customer relations, and high employee morale. Goodwill is calculated as the excess of the purchase price over the target’s
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.
Answer: The lofty JDSU share price in 1999 and early 2000 made it a very attractive acquisition “currency.” Management
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.
Answer: Both forward and reverse triangular mergers are used to effect tax-free transactions. Forward and reverse mergers are
similar in that they both require purchase of at least 80% of the FMV of the target’s net assets, allow acquirer to retain the
target’s tax attributes, limit parent exposure to target liabilities, require target shareholder vote, and freeze out minority
37
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?
Answer: The value of intellectual property may be estimated by looking at recent comparable sales, by estimating the cost of
5. Why do boards of directors of both acquiring and target companies often obtain so-called “fairness opinions” from outside
investment advisors or accounting firms? What valuation methodologies might be employed in constructing these opinions?
Should stockholders have confidence in such opinions? Why/why not?
Answer: Fairness opinions are often obtained to minimize potential liability from shareholder lawsuits which might ensue if it is
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
38
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
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.
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.
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
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
Vodafone would create the largest mobile telecommunication company at the time, with significant presence in the United Kingdom,
United States, continental Europe, and Asian Pacific region. The scale and scope of the operations is expected to make the combined
firms the vendor of choice for business travelers and international corporations. Interests in operations in many countries will make
Vodafone AirTouch more attractive as a partner for other international fixed and mobile telecommunications providers. The combined
scale of the companies also is expected to enhance its ability to develop existing networks and to be in the forefront of providing
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
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
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.
40
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
2. The Vodafone proposal had a current market value of $97 per share of AirTouch stock based on Vodafone’s ordinary shares (i.e.,
common) on January 17, 1999.
3. Following the merger, the market value of the Vodafone American Depository Shares (ADSs) to be received by AirTouch shareholders
under the Vodafone proposal could decrease.
4. Following the merger, the market value of Bell Atlantic’s stock also could decrease, particularly in light of the expectation that the
proposed transaction would dilute Bell Atlantic’s EPS by more than 10% through 2002.
In addition to Vodafone’s higher value, the board tended to favor the Vodafone offer because it involved less regulatory uncertainty.
As U.S. corporations, a merger between AirTouch and Bell Atlantic was likely to receive substantial scrutiny from the U.S. Justice
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?
Answer: Vodafone was intent on becoming a global carrier. To achieve this goal, it was necessary for the firm to achieve
41
3. What are the potential risk factors related to the merger?
Answer: The risks include the potential for having overpaid and for not being able to earn Vodafone’s cost of capital on the
4. Is this merger likely to be tax free, partially tax free, or taxable? Explain your answer.
5. What are some of the challenges the two companies are likely to face while integrating the businesses?
Answer: While no integration is ever easy, the two companies are compatible in many ways. They are managed on a
decentralized basis, have a shared vision of how to grow the cellular business, and have relatively young workforces.
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?
6. Was the transaction non-taxable, partially taxable, or wholly taxable to HiTech shareholders? Why?
