978-0128150757 Chapter 18 Solution Manual Part 1 C corporations are relatively easy to organize quickly, since all states permit such structures

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Chapter 18 Cross-Border Mergers and Acquisitions:

Analysis and Valuation

Answers to End of Chapter Discussion Questions

18.1 Discuss the circumstances under which a non-U.S. buyer may choose a U.S. corporate

structure as its acquisition vehicle. A limited liability company? A partnership?

Answer: A C corporation is the typical acquisition vehicle used by foreign buyers of U.S.

businesses due to its flexibility. C corporations are relatively easy to organize quickly, since all

states permit such structures and no prior governmental approval is required. There is no

limitation on non-U.S. persons or entities acting as shareholders in U.S. corporations, except for

certain regulated industries. The C corporation also allows for limited liability (i.e., limited to the

extent of the shareholder’s investment) and management autonomy (i.e., operational independence

18.2 What factors influence the selection of which tax rate to use (i.e., the target’s or the

acquirer’s) in calculating the weighted average cost of capital in cross-border transactions?

Answer: Marginal corporate tax rates vary significantly among countries. Consequently, the

question of whether the acquirer or target’s marginal tax rate should be used is complex. However,

certain guidelines may be followed. In general, the appropriate marginal tax rate used in

calculating cash flows and the discount rate should be that applicable to the country in which the

18.3 Discuss adjustments commonly made in estimating the cost of debt in emerging countries.

Answer: When a local bond rate is not available, the cost of debt for a specific firm may be

estimated by adjusting the U.S. Treasury bond rate. The cost of debt for an emerging market

(iemfirm) firm should be adjusted for the potential for default due to events related to the country and

those specific to the firm. Both a country risk premium (CRP) and a firm default risk premium

18.4 Find an example of a recent cross-border transaction in the business section of a newspaper.

Discuss the challenges an analyst might face in valuing the target firm.

Answer: Walmart acquired Grupa Cifra, Mexico’s largest retail store chain, in 1997. In addition

18.5. Discuss the various types of adjustments for risk that might be made to the global CAPM

before valuing a target firm in an emerging country. Be specific.

Answer: To estimate the cost of equity for a firm in an emerging economy (ke,em), the domestic

CAPM can be modified for specific country risk as follows:

FSP = Firm size premium reflecting the additional return smaller firms must earn

relative to larger firms to attract investors

Note that the specific country risk premium should be added to the estimate of the cost of equity

only if the U.S. Treasury bond rate is used as a proxy for the risk free rate. If the local country

government rate were used, the risk free rate would already reflect risk specific to that country.

18.6 Do you see the growth in Sovereign Wealth Funds (SWFs) as important sources of capital to the

M&A market or as a threat to the sovereignty of the countries in which they invest? Explain your

answer.

Answer: SWFs represent an important source of recycling capital from abroad to satisfy the needs

of domestic capital markets. SWFs have had a propensity to be long–term investors and, as such,

are not subject to “flight risk” as are more speculative forms of capital. In this regard, SWFs

18.7 What are the primary factors contributing to the increasing integration of the global capital

markets? What factors could derail the trend toward globalization?

Answer: Factors contributing to the integration of global capital markets include the reduction in

trade barriers, removal of capital controls, the harmonization of tax laws (which reduce the impact

of different tax rates on trade and investment), floating exchange rates, and the free convertibility

18.8 Give examples of economic and political risk that you could reasonably expect to encounter in

acquiring a firm in an emerging economy.

Answer: Examples of political and economic risk include excessive local government regulation,

18.9 During the 1980s and 1990s, changes in the S&P 500 (a broadly diversified index of U.S. stocks)

were about 50 percent correlated with the MSCI EAFE Index (a broadly diversified index of

European and other major industrialized countries stock markets). In recent years, the correlation

has increased to more than 80 percent. Why? If an analyst wishes to calculate the cost of equity,

which index should they use in estimating the equity risk premium?

Answer: The free flow of information and capital among the world’s major capital markets

18.10 Comment on the following statement: “The conditions for foreign buyers interested in U.S. targets

could not be more auspicious. The dollar is weak, M&A financing is harder to come by for

financial sponsors (private equity firms), and many strategic buyers in the U.S. are hard-pressed to

make acquisitions at a time when earnings targets are being missed.”

Answer: A weak dollar makes U.S. targets cheaper when valued in terms of foreign currency.

Also, the competition for U.S. targets is lessened by a withdrawal of private equity firms and in

Solutions to End of Chapter Case Study Questions

THE ROLE OF M&As IN CHINA’S INDUSTRIAL POLICY:

CHEMCHINA ACQUIRES SYNGENTA

Discussion Questions:

1. What are the advantages and disadvantages of ChemChina, the acquirer, being a government

owned enterprise?

Answer: As a state owned enterprise in an industry that was designated by the Chinese

government as critical to the future development of the country, ChemChina’s proposal to

2. In 2017, the global economies and financial markets were characterized by historically low

interest rates, flat to falling agricultural commodity prices, and lackluster economic growth. Does

the use of large amounts of debt to finance the deal make sense in the conditions prevailing in

2017? Be specific.

Answer: Abnormally low interest rates encourage the use of debt as a primary source of funds in

financing a takeover. However, the amount borrowed can become excessive in that the borrower

cannot generate sufficient cash flow to meet required interest and principal payments.

3. Why did ChemChina use cash rather than equity or some combination of equity and cash to

acquire Syngenta?

4. What are the key assumptions implicit in ChemChina’s takeover of Syngenta? Which do you

believe are the most critical? Be Specific.

Answer: The firm’s willingness to assume so much debt suggests that ChemChina’s

management is assuming that the combined firms can generate sufficient future cash flow

to meet principal and interest repayment on a timely basis. This in turn assumes that the demand

5. What alternatives to acquisition could ChemChina have pursued? Speculate as to why a

takeover was the preferred option?

Answer: ChemChina could have pursued a “go it alone strategy” or a partnership as

alternatives to an acquisition. However, the former could have been viewed as too

True and False Examination Questions

1. Globally integrated capital markets provide foreigners with unfettered access to local capital

markets and local residents to foreign capital markets. True or False

2. Factors contributing to the integration of global capital markets include the reduction in trade

barriers, removal of capital controls, the growing disparity in tax rates among countries, floating

exchange rates, and the free convertibility of currencies. True or False

3. Like globally integrated capital markets, segmented capital markets exhibit different bond and

equity prices in different geographic areas for different assets in terms of risk and maturity. True

or False

4. Arbitrage should drive the prices in different markets to be the same, as investors sell those assets

that are undervalued to buy those that are overvalued. True or False

5. Investors in segmented markets will bear a lower level of risk by holding a disproportionately

large share of their investments in their local market as opposed to the level of risk if they invested

in a globally diversified portfolio. True or False

6. Firms investing in industries or countries whose economic cycles are highly correlated may lower

the overall volatility in their consolidated earnings and cash flows. True or false

7. Excess capacity in many industries often drives M&A activity as firms strive to achieve greater

economies of scale and scope, as well as pricing power with customers and suppliers. True or

False

grow by exploiting these advantages in emerging markets. True or False

9. Quotas and tariffs on imports imposed by governments to protect domestic industries tend to

discourage foreign direct investment. True or False

10. Appreciating foreign currencies relative to the dollar increase the overall cost of investing in the

U.S. True or False

11. M&As can provide quick access to a new market; and, they are subject to fewer problems than

domestic M&As. True or False

12. The disadvantages of exporting include high transportation costs, exchange rate fluctuations, and

possible tariffs placed on imports into the local country. True or False

13. Licensing allows a firm to purchase the right to manufacture and sell another firm’s products

within a specific country or set of countries. True or False

14. M&As represent by far the most profitable means of entering foreign markets. True or False

15. A C corporation is the typical acquisition vehicle used by foreign buyers of U.S. businesses due to

its flexibility. True or False

16. There is no limitation on non-U.S. persons or entities acting as shareholders in U.S. corporations,

except for certain regulated industries. True or False

17. Target shareholders most often receive shares rather than cash in cross-border transactions. True

or False

18. While a foreign buyer may acquire shares or assets directly, share acquisitions are generally the

simplest form of acquisition. True or False

19. A tax- free reorganization or merger is one in which target shareholders receive acquirer stock in

exchange for substantially all of the target’s assets or shares. The target firm merges with a U.S.

subsidiary of the foreign acquirer in a statutory merger under state laws.

20. To qualify as a U.S. corporation for tax purposes, the foreign firm must own at least 80% of the

stock of the domestic subsidiary. True or False

21. The forward triangular cash merger is the most common form of taxable transaction. The target

company merges with a U.S. subsidiary of the foreign acquirer with shareholders of the target firm

receiving acquirer shares as well as cash, although cash is the predominate form of payment. True

or False

22. Acquiring businesses outside the U.S. involves additional obstacles atypical of domestic

acquisitions. True or False

23. In common law countries (e.g., U.K., Canada, Australia, India, Pakistan, Hong Kong, Singapore,

and other former British colonies), the acquisition vehicle will be a corporation-like structure.

True or False

24. In civil law countries (which include Western Europe, South America, Japan, and Korea), the

acquisition will generally be in the form of a share company or limited liability company. True or

False

25. Payment in transactions involving non-U.S. firms is most likely to be cash. True or False

26. In cross-border M&As, acquirer shares often are less attractive to potential targets because of the

absence of a liquid market for resale or because the acquirer is not widely recognized by the target

firm’s shareholders. True or False

27. With tax avoidance and fraud common in many countries, the buyer may find that some assets will

transfer encumbered by tax liens. True or False

28. Mergers are legal in all countries. True or False

29. International transactions tend to be highly challenging, as they typically involve multiple tax and

legal jurisdictions. True or False

30. If the acquisition is structured as an asset purchase because the target is only a division of a

foreign company or because the seller agrees to sell assets, the U.S. buyer of the assets must

decide whether to acquire them directly or to use a new or existing foreign company to do so. The

choice will affect future U.S. and non-U.S. tax consequences. True or False

31. Despite accounting practices varying widely from country to country, the seller should not be

required to confirm that their financial statements have been prepared in accordance with

generally accepted accounting principles if to do so would endanger the deal. True or False

32. Product liability claims are generally more frequent and judgments are larger outside the U.S.

True or False

33. Employees receive far greater legal protection in many developed foreign countries than they do in

the U.S. True or False

34. As in the U.S., any representations and warranties in an acquisition agreement are intended to

cause the seller to disclose significant information. However, because of local custom, they are

often more extensive in foreign countries than in the U.S. True or False

35. Bonds of a non-U.S. issuer registered with the SEC for sale in the U.S. public bond markets are

called “Yankee” bonds. True or False

36. The American Depository Receipt (ADR) market evolved as a means of enabling foreign firms to

raise funds in the U.S. equity markets. True or False

37. The Euroequity market reflects equity issues by a foreign firm tapping a larger investor base than

the firm’s home equity market. True or False

38. Language barriers, different customs, working conditions, work ethics, and legal structures create

a new set of challenges in integrating cross-border transactions. True or False

39. In choosing how to manage an acquisition in a new country, a manager with an in-depth

knowledge of the acquirer’s priorities, decision-making processes, and operations is appropriate,

especially when the acquirer expects to make very large new investments. True or False

40. It is easy to differentiate between political and economic risks, since they are generally unrelated.

True or False

41. A sometimes overlooked challenge is the failure of the legal system in an emerging country to

honor contracts. True or False

42. Unanticipated changes in exchange rates rarely influence the competitiveness of products

produced in the local market for export to the global marketplace. True or False

43. The decision to buy political risk insurance depends on the size of the investment and the

perceived level of political and economic risk. True or False

44. In emerging countries where financial statements may be haphazard and gaining access to the

information necessary to adequately assess risk is limited, it may be impossible to perform an

adequate due diligence. Under these circumstances, acquirers may protect themselves by

including a put option in the agreement of purchase and sale. Such an option would enable the

buyer to require the seller to repurchase shares from the buyer at a predetermined price under

certain circumstances. True or False

45. The methodology for valuing cross-border transactions using discounted cash flow analysis is

substantially different from that employed when both the acquiring and target firms are within the

same country. True of False

46. The basic differences between within-country and cross-border valuation methods is that the latter

involves converting cash flows from one currency into another and adjusting the discount rate for

risks not generally found when the acquirer and target firms are within the same country. True or

False

47. M&A practitioners utilize nominal cash flows except in circumstances of high rates of inflation,

when real cash flows are preferable. True or False

48. Nominal or real cash flows should give different net present values if the expected rate of inflation

used to convert future cash flows to real terms is the same inflation rate used to estimate the real

discount rate. True or False

49. Interest rates and expected inflation in one country compared to another country seldom affect

exchange rates between the two countries. True or False

50. For developed countries, such as Western Europe, the interest rate parity theory provides a useful

framework for estimating forward currency exchange rates (i.e., future spot exchange rates). True

or False

51. The interest rate parity theory relates forward or future spot exchange rates to differences in

interest rates between two countries adjusted by the spot rate. True or False

52. The purchasing power parity theory states that one currency will appreciate (depreciate) with

respect to another currency according to the expected relative rates of inflation between the two

countries. True or False

53. In general, the appropriate marginal tax rate used in calculating cash flows and the discount rate

should be that applicable to the country in which the cash flows are produced. True or False

54. Developed economies seem to exhibit significant differences in the cost of equity due to the

relatively high integration of their capital markets in the global capital market. True or False

55. Whenever the target firm’s projected cash flows are in local currency, the risk free rate is the local

country’s government bond rate. True or False

56. If cash flows are in terms of local currency and the U.S. Treasury bond rate is used to estimate the

risk free rate, the analyst should add the expected inflation rate in the local country relative to that

in the U.S. to convert the U.S. Treasury bond rate to a local country nominal rate. True or False

57. In globally integrated markets, it makes little difference whether the ß is calculated by regressing

the target firm’s (or a similar firm’s) historical returns against the returns for a broadly defined

global index, U.S. equity market index, or a broadly defined equity index in the target’s country.

True or False

58. If individual country’s capital markets are segmented, the global capital asset pricing model must

not be adjusted to reflect the tendency of investors in individual countries to hold local country

rather than globally diversified equity portfolios. True or False

59. An analyst can determine if a country’s equity market is likely to be segmented from the global

equity market if the ß derived by regressing returns in the foreign market with returns on the

global equity market is significantly different from one. True or False

60. Due to absence of historical data in many emerging economies, the equity risk premium often is

estimated using the prospective method implied in the constant growth valuation model. True or

False

Multiple Choice Examination Questions

1. Which of the following factors contribute to the integration of the global capital markets?

a. The reduction in trade barriers

b. The removal of capital controls

c. The harmonization of tax laws

d. Floating exchange rates

e. All of the above

2. Which of the following is true about segmented capital markets?

a. Exhibit different bond and equity prices in different geographic areas for identical assets

in terms of risk and maturity.

b. Exhibit the same bond and equity prices in different geographic areas for identical assets

in terms of risk and maturity.

c. Exhibit different bond and equity prices in the same geographic areas for identical assets

in terms of risk and maturity.

d. Exhibit different bond prices but the same equity prices in different geographic areas for

identical assets in terms of risk and maturity.

e. None of the above

3. Which of the following is generally not a motive for firms to expand internationally?

a. Desire to achieve geographic diversification

b. Desire to accelerate growth

c. Desire to consolidate industries

d. Desire to avoid entry barriers

e. Desire to enter countries with less favorable tax rates

4. Firms are likely to achieve significant diversification by investing in all of the following except for

a. Different but uncorrelated industries in the same country

b. Different companies in the same industry in the same country

c. The same industries in different countries

d. Different industries in different countries.

e. Different companies in different industries in the different countries

5. Excess capacity in many industries often drives M&A activity as firms strive to achieve which of

the following?

a. Greater economies of scale

b. Greater economies of scope

c. Greater pricing power with customers

d. Greater pricing power with suppliers

e. All of the above

6. Which of the following represent common international market entry strategies?

a. Mergers and acquisitions

b. Licensing

c. Exporting

d. Greenfield or solo ventures

e. All of the above

7. Local country firms may be interested in alliances for which of the following reasons?

a. To gain access to the technology

b. To gain access to a widely recognized brand name

c. To gain access to innovative products

d. A, B, and C

e. A and B only

8. Which of the following is not true of exporting as a market entry strategy?

a. Exporting does not require the expense of establishing local operations

b. Exporters do not need to establish some means of marketing and distributing their

products at the local level

c. Exporters incur high transportation costs

d. Exporters may be adversely impacted by exchange rate fluctuations

e. Exporters may be adversely impacted by tariffs placed on imports into the local country

9. Which of the following is not true of licensing?

a. Licensing allows a firm to purchase the right to manufacture and sell another firm’s

products within a specific country or set of countries.

b. The licensor is normally paid a royalty on each unit sold.

c. Licensors have considerable control the manufacturing and marketing of their products

marketed in foreign countries.

d. The licensee takes the risks and makes the investments in facilities for manufacturing,

marketing and distribution of goods and services.

e. Licensing is an increasingly popular entry mode for smaller firms with insufficient capital

and limited brand recognition.

10. Greenfield operations represent an appropriate entry if which of the following is true?

a. Entry barriers are low

b. Cultural differences are high

c. Entrant has limited multinational experience

d. Entrant is risk adverse

e. A and B only

11. Which of the following represent common law countries?

a. United Kingdom

b. Australia

c. India

d. Pakistan

e. All of the above

12. Which of the following represent common political and economic risks in entering an emerging

market?

13. The most common form of payment involving non–U.S. firms engaged in M&As is

a. Stock

b. Cash

c. Cash and stock

d. Debt

e. Cash, stock and debt

14. For an acquirer evaluating a target firm in another country, the target’s cash flows can be

expressed in which of the following ways?

a. Expressed in the home country’s currency

b. Local country’s currency

c. In real terms

d. A & B only

e. A, B, and C

15. Which of the following represent common components of the global capital asset pricing model

when applied to valuing firms in emerging countries?

a. Risk free rate of return

b. Specific country’s risk premium

c. Firm size risk premium

d. Emerging country firm’s global beta

e. All of the above

Short Essay Questions

CHIP INDUSTRY CONSOLIDATION

______________________________________________________________________________

Key Points

• Industry consolidation often is an important factor in triggering merger waves.

• Market value can be grown dramatically through an aggressive and well executed acquisition

strategy

• Differences in corporate tax rates among countries can give foreign acquirers an edge in acquiring

domestic firms

________________________________________________________________________

With a market value of less than $3.5 billion, chip maker Avago Technologies (Avago) was viewed as a

modest competitor in the semiconductor industry when it went public in 2009. By 2015, the firm’s market

value exploded to $35 billion. The rapid expansion of the firm’s market value in six years reflected its

successful growth through acquisition strategy.

Avago’s strategy emphasizes acquiring complementary businesses, quickly paring overlapping costs,

and selling off businesses no longer critical to its growth plan. In the past four years, Avago acquired five

companies that helped it further its motion control encoder technology and optical fiber technology.

During the same period, Avago sold several noncore businesses enabling it to focus on strengthening its

remaining businesses and to pay off debt incurred in making prior acquisitions.

The aggressive pace of acquisitions was fueled by historically low cost debt financing during this

period, a rapidly appreciating share price, and low tax rates. Avago’s share price has grown at an

approximate 39% compound annual average rate since its 2009 IPO when it traded at $17.38 per share

industry. In recent years chip makers have turned to buying growth to cut costs using mergers to combine

sales forces and back end operations. By achieving larger scale, the chip makers can remain attractive to

customers wanting to reduce the number of their suppliers. The deal also enables the new company to free

up billions in cash that was previously trapped overseas and helps to eliminate potential U.S. tax liabilities.

Many multinational U.S. firms have been reluctant to repatriate their foreign earnings to the U.S. due to the

35% applicable tax rate, the highest among developed countries. According to SEC filings, Broadcom is no

exception. As of 2014, Broadcom had $3.13 billion of cash and cash equivalents held by its foreign

subsidiaries.

The Broadcom and Avago merger closed in March 2016. Since Broadcom was acquired by a foreign

1 On April 5, 2016, the U.S. treasury introduced new regulations giving the government more authority to

treat interest payments on intercompany cash transfers as dividend payments, not deductible under U.S.

law. The new rules apply to intercompany loans after that date. How this will impact this and future deals

will depend on how the rules are applied. For more detail, see Chapter 12.

MAJOR REGULATORY AND INTEGRATION HURDLES FOR THE ANHEUSER-BUSCH

INBEV AND SABMILLER MERGER

____________________________________________________________________________________

Case Objectives: To illustrate challenges common to cross-border M&As including

• Regulatory obstacles;

• Challenges of postmerger integration efforts; and

• The impact of regulatory and postmerger considerations on recovering the purchase price

premium.

______________________________________________________________________________________

While the motives that drive cross-border deals may be compelling, the challenges of closing and

postmerger integration often are underestimated, especially if the participants are doing business in many

uneven application of such laws.

Actions required to gain regulatory approval usually involve selling off some portion of the combined

business in countries where increased concentration is a concern. In doing so, the economics of the deal

may be changed profoundly, especially when the assets to be divested represent a significant portion of the

anticipated synergies resulting from combining the firms. The greatest synergy often comes from buying

Once regulatory approval is achieved, integrating the target’s operations with those of the acquirer can

be even more challenging than dealing with regulators. Labor laws in developed and emerging countries

may limit the acquirer’s ability to terminate “redundant” workers or allow acquirers to do so only at great

expense. Country cultures may also inhibit the ability of the acquirer to introduce more modern

management, production, and distribution methods. All of these factors contribute to delaying and possibly

2016 takeover of the second largest beer company SABMiller. The combined firms’ leadership position

should result in lower relative costs than competitors due to economies of scale, brand recognition, and the

ability to negotiate lower raw material costs. The new firm could also experience greater pricing power

because of brand recognition and differentiation.

But in closing this deal, AB InBev created a substantial hurdle to overcome. To complete the

With market growth tepid overall and declining in some regions, the global beer industry is undergoing

major changes as people in many developed countries are turning to locally brewed craft beer.

Furthermore, future growth globally is expected to come mainly in emerging countries and in regions such

as Africa.

To prosper in this changing environment, AB InBev sought to enlarge its presence in faster growing

regional beer offerings, and then guided customers toward Budweiser, which is three times more expensive

than Chinese beers, and to its own higher priced Chinese beer, Harbin. The strategy has been so effective

that Budweiser is now consumed more outside than inside the U.S. The firm is expected to repeat this

strategy with its acquisition of SABMiller as the primary means of recovering its purchase price premium

and earning the cost of capital.

they would have otherwise incurred if they had sold their holdings entirely for cash. Altria expects to get a

10.5% stake in the combined company and two board seats. The Santo Domingo family is expected to

receive about a 6% ownership share and one board seat. The support of these shareholders is contingent

upon no other shareholders opting for the partial cash and stock alternative.

The restricted shares are subject to a 5 year lockup, meaning they will not be listed on any public

exchange for 5 years and that they cannot be traded during that period. At the time the merger agreement

initial 5% discount from the all-cash alternative. This could have become a complicating factor since AB

InBev’s board had indicated that it was not willing to issue more than 326 million new shares to limit

dilution to current shareholders. However, anticipating this problem, the merger agreement allowed for

modifying the offer price either by raising the all-cash offer, lowering the cash-portion of the cash and

stock alternative, or both.

suppliers, distributors and retailers. For AB InBev, regulatory approval had to be won in the U.S., the

European Union, China, South Africa, Colombia, Australia and India.

The primary argument for approving the deal rested on the limited geographic overlap of the two firm’s

markets, but the sale of certain brands was necessary. Resistance was expected to be to be greatest in the

U.S. and China. Why? The MillerCoors joint venture in which SABMiller owned a 58% stake, formed by

included the global rights to the Miller brand and would make Molson Coors the second–largest brewer in

the U.S. behind AB InBev. Molson Coors would retain the rights to sell brands it currently owns in the U.S.

The sale was contingent on the closing of the AB InBev and SABMiller deal. Following closing, Molson

Coors will control about 26% of the U.S. beer market. AB InBev’s share would remain unchanged at its

pre-SABMiller deal level of 45%.

Slovakia. U.S. regulatory approval in late 2016 allowed AB InBev to retain Budweiser, Beck’s and Stella

Artois while selling the Miller’s brand in the U.S. In June, AB InBev resolved one of the more knotty

hurdles when it received regulatory approval in South Africa conditioned on the sale of certain local brands

and setting aside a trust fund to make payments to workers who could lose their jobs as a result of the

merger. Other regulatory issues that were resolved included AB InBev’s serving as a bottler for Pepsi in

integration process with senior executives focusing on critical decisions such as how to combine

administrative, operations and supply chain networks. While AB InBev sent a few executives to integrate

the two companies’ operations, “99% of the people” planning and implementing the integration was

Modelo staff. However, with Modelo and AB InBev, the integration involved combining operations in

Mexico and the U.S. But with SABMiller, the integration will involve many countries. AB InBev now will

renegotiating packaging and bottling contracts, and through job cuts by eliminating overlapping

headquarters and management teams. Anheuser-Busch InBev said that it expected to achieve about $1.4

billion in annual pre-tax cost savings by the end of the fourth year after the deal’s completion. While the

firm has both a reputation and demonstrable track record for being able to effectively extract these savings,

the magnitude of the challenge remains daunting: SABMiller employs 69,000 people in 83 countries while

will keep a regional headquarters in Johannesburg and plans to seek to have its shares listed on the on the

Johannesburg Stock Exchange as soon as possible. These actions are planned to assuage local unions,

investors and government officials.

Successfully integrating businesses often comes with a much higher price tag than initially believed. In

applying the business strategy it has successfully used in the past, AB InBev will try to eliminate regional

The combination of AB InBev and SABMiller has to weather successfully the loss of revenues and

profits due to the sale of lucrative assets to gain regulatory approval and the perils of postmerger

integration. AB InBev may be unable to sell assets required by regulatory approval at their fair market

value. While an estimate of the financial impact of potential asset sales should have been included in AB

InBev’s initial valuation of SABMiller, the size, complexity and length (as much as four years) of the

consuming market, recorded its slowest economic growth rate in more than 25 years. By paying such a

steep price for SABMiller, AB InBev may find the realization of their objectives far more demanding than

first thought. Past success is a two edged sword in that it gives management a template to follow for future

acquisitions but it can also create excessive confidence. Could the firm’s past success in making and

integrating their acquisitions have caused them to be more optimistic in agreeing to the purchase price for

SABMiller than they should have been? Time will tell.

Discussion Questions:

1. What are the key assumptions implicit in Anheuser-Busch InBev’s takeover of SABMiller? Which

do you believe are the most critical? Be Specific.

Answer: Key assumptions can be categorized as to those over which management has some degree of

control and those which are uncontrollable. In valuing SABMiller, AB InBev’s board and management

had to make assumptions about the types of divestitures that would be required to get regulatory

2. Why did the deal include restricted stock in AB InBev’s stock and cash options rather than unrestricted

shares? How does the lockup on the restricted stock included in AB InBev’s stock and cash

combination affect the value of these shares?

Answer: In this instance, AB InBev agreed to use a combination of stock and cash to get SABMiller’s

largest shareholders to support the deal. Restricted shares rather than unrestricted shares were used to

3. What were the primary motives for the merger from AB InBev’s perspective stated in the case?

Review the common motives for cross-border deals discussed in this chapter; speculate as to what

other motives for this acquisition other than those indicated in the case might AB InBev have had in

buying SABMiller.

Answer: The case states that the main driver to the merger for AB InBev was the desire to gain access

to faster growing regional and country markets in which it could apply its long–standing strategy of

eliminating local brands and driving consumers to the firm’s more expensive and recognizable brands.

4. What alternatives to acquisition could AB InBev have pursued? Speculate as to why a

takeover was the preferred option?

Answer: AB InBev could have pursued a “go it alone strategy” or a partnership as alternatives to a

merger. However, the former could have been viewed as too expensive and risky. Partnerships

required shared control and profit and often are hard to negotiate and fail as partner expectations

Ireland-Based Drug Maker Actavis Buys

U.S. Pharmaceuticals Firm Forest Labs

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Case Study Objectives: To Illustrate

Alternative motives for cross-border acquisitions,

How taxes impact cross-border deals and capital flows, and

How activist investors can impact corporate decisions.

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Reflecting the escalating costs of developing blockbuster drugs (i.e., those with the potential to deliver

more than $1 billion in annual revenue) and the loss of patent protection on many substantial revenue

producing medications, the pharmaceutical industry has been undergoing a wave of consolidation for more

than a decade. The takeover strategy in many instances appeared to be largely formulaic: acquire rivals,

slash costs, and minimize taxes.

While Valeant Pharmaceuticals and Endo Health Solutions have employed this strategy effectively, drug

maker Actavis is the perhaps the most successful, tripling its market value during the last three years.

Actavis is a global, integrated specialty pharmaceutical company focused on developing, manufacturing,

and distributing generic and branded products in more than 60 countries. Structured as a holding company,

its global headquarters is located in Dublin, Ireland. The firm’s U.S. administrative headquarters is in

Parsippany, New Jersey. Actavis historically has focused on generic drugs, but in recent years it has

expanded through acquisition into branded drugs.

Actavis on February 18, 2014 announced that it had reached an agreement to buy Forest Laboratories

for $25 billion in cash and stock to create a pharmaceuticals firm with substantial exposure to branded and

generic drugs. Forest Labs is a fully integrated specialty pharmaceutical firm focused on the U.S. market,

with a portfolio of branded products. The combined revenues of the two specialty pharmaceutical

companies are expected to be more than $15 billion in 2015. The new company announced that it would be

increasing its annual budget for pharmaceutical research and development to more than $1 billion.

Strategically, Forest Labs represented an opportunity for Actavis to diversify into branded drugs and for

Forest Labs to penetrate foreign markets not currently survived. Forest Labs also has an impressive

number of drugs in the pipeline.

2013 increasing his influence on board decisions.

Under the terms of the deal, Forest shareholders will receive $26.04 in cash and .3306 of a share of

Actavis, equivalent to $89.48 per share. This represents a premium of 25% from Forest Lab’s closing price

the prior day. Forest shareholders will own 35% of the combined firms. Forest Labs agreed to pay a

termination fee of $875 million if it backs out of the agreement in favor of a competing takeover proposal

Actavis announced that it expects to realize a combination of operating and tax savings of $1 billion

annually to be realized beginning in the first full year of operation of the combined firms. Assuming a

discount rate of 12%, the present value of these savings in perpetuity is $8.3 billion ($1 billion/.12), well in

excess of the $5 billion acquisition premium paid for Forest Labs. Not surprisingly, investors greeted news

of the merger favorably. Shares of Forest rose 30% and those of Actavis were up 12%.

tax evasion strategies by the U.S. taxing authorities as long as they can be justified by good business

reasons such as getting nearer to a firm’s customers or suppliers. Tax evasion is the avoidance of taxes

through illegal means such as misrepresenting income on a tax return.

The maximum corporate tax rate in Ireland is 12.5% compared to 35% in the United States. Forest Labs

earnings which had been taxed at the higher U.S. rate will be taxed at the lower Irish rate currently paid by

company typically become shareholders of the new foreign parent company. In essence, the legal location

of the company changes through a corporate inversion from the United States to another country. An

inversion typically does not change the operational structure or location of a company. In most cases, an

inversion simply means the addition of a small office in the company’s new foreign “home.” Therefore, a

re-incorporation rarely, if ever, leads to the loss of American jobs. However, it does lead to a loss of tax

Discussion Questions:

1. Using the common motives for cross-border deals discussed in this chapter, speculate as to the reasons

Actavis acquired Forest Labs.

Answer: The global pharmaceutical industry has been consolidating in part reflecting the escalating

cost of conducting pharmaceutical research and development. Consequently, pharmaceutical firms

must achieve a certain scale to be able to finance the huge R&D budgets deemed necessary to sustain

2. What alternatives to acquisition could Actavis have pursued? Speculate as to why a takeover was the

preferred option?

Answer: Actavis could have pursued a “go it alone strategy” or a partnership as alternatives to a

3. Speculate as to how Actavis’s takeover of Forest Labs may have created shareholder value?

4. Do you believe firms should be allowed to engage in tax inversions?

Answer: Some argue that tax inversions are nothing more than a gimmick to escape high U.S. tax rates

and therefore are tantamount to tax evasion. Others argue that with the highest corporate tax rates in

the world, the U.S. is making itself less attractive to foreign investment. Tax inversions would not be

5. Why is Actavis organized as a holding company in Ireland?

Answer: A holding company structure enables a foreign parent to offset gains from one subsidiary with

losses generated by another, serves as a platform for future acquisitions, and provides the parent with