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In this thoroughly revised Fourth Edition, author and business valuation expert Patrick Gaughan provides a fresh perspective on M&As in today's global business landscape, and how your company can reap the benefits from the various forms of restructurings available. Packed with the most up-to-date research, graphs, and case studies, Mergers, Acquisitions, and Corporate Restructurings, Fourth Edition explores: Recent takeover trends including the role of private equity firms and hedge funds, Most effective offensive and defensive tactics in hostile bids, A review of the effect of shareholder wealth on a variety of takeover actions, Modern, historical, and global perspectives on the field, The various forms of downsizing including divestitures, spinoffs, and equity carve-outs, Bankruptcy as an effective restructuring technique, Latest developments in corporate governance, Pros and cons of joint ventures and strategic alliances, Primary methods used to value public and private companies.
Following up on his groundbreaking book, winner of the Book of the Year Award in its category from the Association of American Publishers, author and business valuations expert Patrick Gaughan illustrates how mergers, acquisitions, and other vital forms of restructuring can work for your company.
Note: The Figures and/or Tables mentioned in this chapter do not appear on the web.
After a short hiatus, mergers and acquisitions had resumed the frantic pace that was established during the fourth merger wave of the 1980s and by the mid-1990s we were in the middle of the fifth merger wave, which featured deal volume that surpassed the level reached in the 1980s. The 1980s represented one of the most intense periods of merger activity in U. S. economic history. This period witnessed the fourth merger wave of the twen-tieth century. One such wave occurred at the end of the 1960s, with the two prior waves occurring in the 1920s and at the turn of the century.
The fourth wave was unique compared with the three prior waves. It specifically featured the hostile takeover and the corporate raider. In addition, in the 1980s the junk bond market grew into a tool of high finance whereby bidders for corporations obtained access to billions of dollars to finance raids on some of the largest, most established corporations in the United States. This access to capital markets allowed megamerger deals to become a reality. The resurgence of merger and acquisition activity in the 1990s quickly shifted into the fifth merger wave. The intensity of this wave is underscored by the fact that several of the ten largest deals in U. S. history took place in 1998 alone (Table 1.1).
The 1980s featured an unprecedented volume of merger and acquisition activity compared with prior historical periods. Not only did the volume of mergers and acquisitions reach an all-time high in the 1980s (Table 1.2 and Figure 1.1), but also the average price of each acquisition increased steadily (Table 1.3 and Figure 1.2). Before the 1980s larger U. S. companies had little need to worry about preserving their independence. With the advent of the hostile raid, however, they erected formidable defenses against takeovers and increasingly called on state governments to pass laws to make hostile acquisitions more difficult.
The 1980s also featured the rapid growth and decline of the leveraged buyout (LBO)--the use of debt capital to finance a buyout of the firm's stock. In an LBO, a public company goes private by purchasing its publicly outstanding shares. This financing technique was popular in the mid-1980s but became a less viable alternative toward the end of the decade as the number of good LBO targets declined. The end of the decade also signaled a dramatic decline in the junk bond market as raiders and LBO firms lost some of their access to the financing necessary to complete leveraged transactions (Figure 1.1). The falloff in merger and acquisition activity at the beginning of the 1990s reversed in 1992 when the volume of transactions intensified. By 1993 we were once again in the throes of a full-scale merger wave. However, this wave was distinctly different from the wave that preceded it. The deals of the 1990s are not the highly leveraged hostile transactions that were common in the 1980s. Rather, the 1990s feature more strategic mergers that are not motivated by short-term profits or dependent on highly leveraged capital structures. The mergers and acquisitions of the 1990s use more equity and less debt. In doing so, the 1990s dealmakers are hoping to avoid the bankruptcies that followed the collapse of some of the highly leveraged transactions of the fourth merger wave.
This book describes the growth and development of the field of mergers and acquisitions through a historical focus followed by a review of the laws or rules that govern the game of mergers and acquisitions. In addition, the strategy and motives that inspire mergers and acquisitions are examined. The offensive and defensive techniques of hostile acquisitions are also discussed. The vast array of defenses that may be implemented to thwart a hostile bid are then reviewed. Offensive and defensive methods from the viewpoints of both management and shareholder are explored. In addition, the impact on the shareholder wealth is examined through a review of the wealth effects of these different offensive and defensive tactics.
Also analyzed in detail are the techniques of leveraged buyouts: the junk market, which is one of the main sources of LBO financing; and employee stock ownership plans, an important financing technique for certain types of LBOs.
Leveraged transactions may rely on the utilization of tax benefits. Therefore, the various tax issues involved in both leveraged and nonleveraged transactions are reviewed. Corporate restructuring that involves a contraction, as opposed to acquisition-related expansion, is discussed in detail. Various forms of corporate restructuring, including divestitures, spinoffs, and equity carve-outs have become more commonplace in the 1990s as some firms pursued a downsizing strategy while others expanded through mergers and acquisitions. Other firms that were in a more distressed financial condition were forced to use the corporate reorganization process available under the bankruptcy laws. Having covered a thorough background of the field, the rest of the book is dedicated to valuation.
The process of valuation for mergers and acquisitions is covered in three parts:1. A review of financial analysis to ensure that the reader has a common body of fi-nancial knowledge with which to approach the valuation process
Throughout this book, the material is presented from both a pragmatic and an academic viewpoint. The pragmatic focus utilizes a "how to" approach and a detailed description of the real world of mergers and acquisitions rather than a theoretical treatment. This approach is complemented by a more traditional academic analysis of the relevant research literature in each of the areas described. This dual pragmatic and academic approach will give the reader the benefits of practitioners' experience as well as researchers' work on the frontier of the field. Research that lacks pragmatic value is not reviewed.
A merger is a combination of two corporations in which only one corporation survives and the merged corporation goes out of existence. In a merger, the acquiring company assumes the assets and liabilities of the merged company. Sometimes the term statutory merger is used to refer to this type of business transaction. A statutory merger differs from a subsidiary merger, which is a merger of two companies in which the target company becomes a subsidiary or part of a subsidiary of the parent company. The acquisition by General Motors of Electronic Data Systems, led by its colorful Chief Executive Officer Ross Perot, is an example of a subsidiary merger. In a reverse subsidiary merger, a subsidiary of the acquirer is merged into the target.
A merger differs from a consolidation, which is a business combination whereby two or more companies join to form an entirely new company. All of the combining companies are dissolved and only the new entity continues to operate. For example, in 1986 the computer manufacturers Burroughs and Sperry combined to form UNISYS. In a consolidation, the original companies cease to exist and their stockholders become stockholders in the new company. One way to look at the differences between a merger and a consolidation is that with a merger A B A, where company B is merged into company A. In a consolidation, A B C, where C is an entirely new company. Despite the differences between them, the terms merger and consolidation, as is true of many of the terms in the mergers and acquisitions field, are sometimes used interchangeably. In general, when the combining firms are approximately the same size, the term consolidation applies; when the two firms differ significantly by size, merger is the more appropriate term. In practice, however, this distinction is often blurred, with the term merger being broadly applied to combinations that involve firms of both different and similar sizes.
Another term that is broadly used to refer to various types of transactions is takeover. This term is more vague and sometimes refers only to hostile transactions; at other times it refers to both friendly and unfriendly mergers.
Mergers are often categorized as horizontal, vertical, or conglomerate mergers. A horizontal merger occurs when two competitors combine. For example, in 1994 two defense firms, Northrop and Grumman, combined in a $2.17 billion merger. If a horizontal merger causes the combined firm to experience an increase in market power that will have anticompetitive effects, the merger may be opposed on antitrust grounds. In recent years, however, the government has been somewhat liberal in allowing many horizontal mergers to go unopposed.
Vertical mergers are combinations of companies that have a buyer-seller relationship. For example, in 1993 Merck, the world's largest drug company, acquired Medco Containment Services, Inc., the largest marketer of discount prescription medicines, for $6 billion. The transaction enabled Merck to go from being the largest pharmaceutical company to also being the largest integrated producer and distributor of pharmaceuticals. This transaction was not opposed by antitrust regulators even though the combination clearly resulted in a more powerful firm. Ironically, regulators cited increased competition and lower prices as the anticipated result.
Aconglomerate merger occurs when the companies are not competitors and do not have a buyer-seller relationship. One example would be Philip Morris, a tobacco company,which acquired General Foods in 1985 for $5.6 billion. Clearly, these companies were in very different lines of business. The advisability of conglomerate acquisitions is discussed in Chapter 4.
As is discussed in Chapter 4, there are several possible motives or reasons that firms might engage in mergers and acquisitions. One of the most common motives is expansion. Acquiring a company in a line of business or geographic area into which the company may want to expand can be a quicker way to expand than internal expansion. An acquisition of a particular company may provide certain synergistic benefits for the acquirer, such as when two lines of business complement one another. However, an acquisition may be part of a diversification program that allows the company to move into other lines of business.
In the pursuit of expansion, firms engaging in mergers and acquisitions cite the pursuit of synergistic gains as one of the reasons for the transaction. Synergy exists when the sum of the parts is more productive and valuable than the individual components. There are many potential sources of synergy and they are discussed in Chapter 4.
Financial factors motivate some mergers and acquisitions. For example, an acquirer's financial analysis may reveal that the target is undervalued. That is, the value of the buyer may be significantly in excess of the market value of the target, even when a premium that is normally associated with changes in control is added to the acquisition price.
Other motives, such as tax motives, also may play a role in an acquisition decision. These motives and others are critically examined in greater detail in Chapter 15.
Mergers may be paid for in several ways. Transactions may use all cash, all securities, or a combination of cash and securities. Securities transactions may use the stock of the acquirer as well as other securities such as debentures. The stock may be either common stock or preferred stock. They may be registered, meaning they are able to be freely traded on organized exchanges, or they may be restricted, meaning they cannot be offered for public sale, although private transactions among a limited number of buyers, such as institutional investors, is permissible.
Stock transactions may offer the seller certain tax benefits that cash transactions do not provide. However, securities transactions require the parties to agree on the value of the securities. This may create some uncertainty and may give cash an advantage over securities transactions from the seller's point of view. For large deals, all cash compensation may mean that the bidder has to incur debt, which may carry with it unwanted adverse risk consequences. Although such deals were relatively more common in the 1980s, securities transactions became more popular in the 1990s. The various advantages and valuation effects of cash versus securities transactions are discussed in Chapters 13 and 15.
When a company decides it wants to acquire or merge with another firm, it typically does so by using the services of outside professionals. These professionals usually include investment bankers, attorneys, accountants, and valuation experts. Investment bankers may provide a variety of services, including helping to select the appropriate target, valuing the target, advising on strategy, and raising the requisite financing to complete the transaction. During the heyday of the fourth merger wave in the 1980s, merger advisory and financing fees were a significant component of the overall profitability of the major investment banks. Table 1.4 shows a ranking of merger and acquisition financial advisors.
Investment banks are often faced with the concern about conflicts between various departments of these large financial institutions, which may play very different roles in the merger process. Investment banks often have arbitrage departments that may accumulate stock in companies that may be taken over. If they purchase shares before the market is convinced that a company will be acquired, they may buy at a price significantly below the eventual takeover price, which usually includes a premium above the price at which that stock had been trading. This process, which is fraught with risks, is known as risk arbitrage. If an investment bank is advising a client regarding the possible acquisition of a company, it is imperative that a Chinese wall between the arbitrage department and the advisers working directly with the client be constructed so that the arbitragers do not benefit from the information that the advisers have but that is not yet readily available to the market. To derive financial benefits from this type of inside information is a violation of the law. This is discussed further in Chapter 3.
The role of investment banks changed somewhat in the 1990s. The dealmakers who promoted transactions just to generate fees became unpopular. Companies that were engaged in mergers and acquisitions tended to be more involved in the deals and took over some of the responsibilities that had been relegated to investment bankers in the 1980s. More companies directed the activities of their investment bankers as opposed to merely following their instructions as they did in the prior decade.
Given the complex legal environment that surrounds mergers and acquisitions, attorneys also play a key role in a successful acquisition process. Law firms may be even more important in hostile takeovers than in friendly acquisitions because part of the resistance of the target may come through legal maneuvering. Detailed filings with the Securities and Exchange Commission (SEC) may need to be completed under the guidance of legal experts. In both private and public mergers and acquisitions, there is a legal due diligence process that attorneys should be retained to perform. Table 1.5 shows the leading legal merger and acquisition advisors in 1998.
Accountants play an important role in mergers and acquisitions. They have their own accounting due diligence process. In addition, accountants perform various other functions such as preparing pro forma financial statements based on scenarios put forward by management or other professionals.
Still another group of professionals who provide important services in mergers and acquisitions are valuation experts. These individuals may be retained by either a bidder or a target to determine the value of a company. We will see in Chapters 13 and 14 that these values may vary depending on the assumptions employed. Therefore, valuation experts may build a model that incorporates various assumptions, such as revenue growth rate or costs, which may be eliminated after the deal. As these and other assumptions vary, the resulting value derived from the value also may change.
In an LBO a buyer uses debt to finance the acquisition of a company. The term is usually reserved, however, for acquisition of public companies where the acquired company becomes private. This is referred to as going private because all of the public equity is purchased, usually by a small group or a single buyer, and the company is no longer traded in securities markets. One version of a leveraged buyout is a management buyout. In a management buy-out, the buyer of a company, or a division of a company, is the manager of the entity. Most LBOs are buyouts of small and medium-sized companies or divisions of large companies. However, in what was then the largest transaction of all time, the 1989 $25.1 billion leveraged buyout of RJR Nabisco by Kohlberg Kravis & Roberts shook the financial world.
Leveraged buyouts, which were more common in the 1980s, have declined dramatically in the 1990s (Figure 1.3). There are several reasons for this, including the collapse of the junk bond market. These issues are discussed at length in Chapters 7 and 8.
Users of the term corporate restructuring usually are referring to asset selloffs such as divestitures. Companies that have acquired other firms or have developed other divisions through activities such as product extensions may decide that these divisions no longer fit into the company's plans. The desire to sell parts of a company may come from poor performance of a division, financial exigency, or a change in the strategic orientation of the company. For example, the company may decide to refocus on its core business and sell off noncore subsidiaries. This type of activity increased after the end of the third merger wave as many companies that engaged in diverse acquisition campaigns to build conglomerates began to question the advisability of these combinations.
There are several forms of corporate selloffs, with divestitures being only one of them.Spinoffs enjoyed increased popularity in the early 1990s, while equity carveouts provided another way that selloffs could be accomplished. The relative benefits of each of these alternative means of selling off part of a company are discussed in Chapter 10.
Other forms of corporate restructuring are cost and work force restructuring. In the 1990s we saw many companies engage in corporate downsizing as they strove to become more efficient. This was encouraged by several factors, including the 1990-91 recession and the international competitive pressure of the globalization of world markets. During the 1990s it was not unusual to see companies that were reporting increased profits announce large-scale layoffs as they reacted to actions of competitors who were also taking steps to become more efficient. The strong economy, however, provided assurance that the corporate downsizing did not cause net unemployment as a result of the growth in job opportunities in the labor market.
Another form of corporate restructuring is financial restructuring, which refers to alterations in the capital structure of the firm, such as adding debt and thereby increasing financial leverage. Although this type of restructuring is important in corporate finance and is often done as part of the financing activities for mergers and acquisitions, it is not treated in this text as a form of corporate restructuring. Rather, the term <>restructuring is reserved for the more physical forms of restructuring such as divestitures.
Most mergers and acquisitions are negotiated in a friendly environment. The process usually begins when the management of one firm contacts the target company's management, often through the investment bankers of each firm. The management of both firms keep the respective boards of directors up-to-date on the progress of the negotiations because mergers usually require the boards' approval. Sometimes this process works smoothly and leads to a quick merger agreement. A good example of this was the 1995 $19 billion acquisition of Capital Cities/ ABC Inc. by Walt Disney Co. In spite of the size of this deal, there was a quick meeting of the minds by management of these two firms and a friendly deal was completed relatively quickly. In other instances, friendly negotiations may break down, leading to the termination of the bid or a hostile takeover. An example of a negotiated deal that failed and led to a hostile bid was the 1995 tender offer by Moore Corporation for Wallace Computer Services, Inc. Here negotiations between two archrivals in the business forms and printing business proceeded for five months before they were called off, leading to a $1.3 billion hostile bid.
Except for hostile transactions, mergers usually are the product of a negotiation processbetween the managements of the merging companies. The bidding firm typically initiates, the negotiations when it contacts the target's management to inquire whether the company is for sale and to express its interest in buying the target. This interest may be the product of an extensive search process to find the right acquisition candidates. However, it could be a recent interest that was inspired by the bidder's investment bank approaching it with a proposal that it believes would be a good fit for the bidder. For small-scale acquisitions, this intermediary might be a business broker.
Both the bidder and the target should conduct their own valuation analyses to determine what the target is worth. As is discussed in the valuation chapters, the value of the target for the buyer may be different from the value of that company to the seller. Valuations can differ due to varying uses of the target assets or different opinions on the future growth of the target. If the target believes that it is worth substantially more than what the buyer is willing to pay, a friendly deal may not be possible. If, however, the seller is interested in selling and both parties are able to reach an agreement on price, a deal may be possible. Other important issues, such as financial and regulatory approvals, if necessary, would have to be completed before the negotiation process could lead to a completed transaction.
Before 1988 it was not clear what obligations companies involved in merger negotiations had to disclose their activities. However, in 1988, in the landmark Basic Inc. v. Levinson decision, the U. S. Supreme Court made it clear that a denial that negotiations were taking place when the opposite was the case is improper. Companies may not deceive the market by disseminating inaccurate or deceptive information, even when the discussions are preliminary and do not show much promise of coming to fruition.
The Court's position reversed earlier positions that had treated proposals or negotiations as being immaterial. The Basic v. Levinson decision does not go so far as to require companies to disclose all plans or internal proposals involving acquisitions. Negotiations between two potential merger partners, however, may not be denied.
The exact timing of the disclosure is still not clear. Given the requirement to disclose, a company's hand may be forced by the pressure of market speculation. It is often difficult to confidentially continue such negotiations and planning for any length of time. Rather than let the information slowly leak, the company has an obligation to conduct an orderly disclosure once it is clear that confidentiality may be at risk or that prior statements the company has made are no longer accurate.
In cases in which there is speculation that a takeover is being planned, significant marketmovements in stock prices of the companies involved-- particularly the target-- may occur. Such market movements may give rise to an inquiry from the exchange on which the company trades or from the National Association of Securities Dealers (NASD). Although exchanges have come under criticism for being somewhat lax about enforcing these types of rules, an insufficient response from the companies involved may give rise to disciplinary actions against the companies.
Each state has a statute that authorizes mergers and acquisitions of corporations. The rules may be different for domestic and foreign corporations. Once the board of directors of each company reaches an agreement, they adopt a resolution approving the deal. This resolution should include the names of the companies involved in the deal and the name of the new company. The resolution should include the financial terms of the deal and other relevant information such as the method that is to be used to convert securities of each company into securities of the surviving corporation. If there are any changes in the articles of incorporation, these should be referenced in the resolution.
At this point the deal is taken to the shareholders for approval. Once approved by the shareholders, the merger plan must be submitted to the relevant state official, usually the secretary of state. The document that contains this plan is called the articles for merger or consolidation. Once the state official determines that the proper documentation has been received, it issues a certificate of merger or comnsolidation.
The board of directors may choose to form a special committee of the board to evaluate the merger proposal. Directors who might personally benefit from the merger, such as when the buyout proposal contains provisions that management directors may potentially profit from the deal, should not be members of this committee. The more complex the transaction, the more likely that a committee will be appointed. This committee should seek legal counsel to guide it on legal issues such as the fairness of the transaction, the business judgment rule, and numerous other legal issues. This committee, and the board in general,needs to make sure that it carefully considers all relevant aspects of the transaction. Acourt may later scrutinize the decision-making process, such as what occurred in the Smith v. Van Gorkom case, which is discussed in Chapter 13. In that case the court found the directors personally liable because it thought that the decision-making process was inadequate, even though the decision itself was apparently a good one for shareholders.
It is common for the board to retain an outside valuation firm, such as an investment bank or a firm that specializes in valuations, to evaluate the transaction's terms and price. This firm may then render a fairness opinion in which it may state that the offer is in a range that it determines to be accurate. These opinions may be somewhat terse and usually are devoid of a detailed financial analysis. Presumably, however, underlying the opinion itself is such a detailed financial analysis. As part of the opinion that is rendered, the evaluator should state what was investigated and verified and what was not. The fees received and any potential conflicts of interest should also be revealed.
Upon reaching agreeable terms and receiving board approval, the deal is taken before the shareholders for their approval, which is granted through a vote. The exact percentage necessary for stockholder approval depends on the articles of incorporation, which, in turn, are regulated by the prevailing state corporation laws. Following approval, each firm files the necessary documents with the state authorities in which each firm is incorporated. Once this step is completed and the compensation has changed hands, the deal is completed.
A short-form merger may take place in situations in which the stockholder approval process is not necessary. Stockholder approval may be bypassed when the corporation's stock is concentrated in the hands of a small group, such as management, which is advocating the merger. Some state laws may allow this group to approve the transaction on its own without soliciting the approval of the other stockholders. The board of directors simply approves the merger by a resolution.
A short-form merger may occur only when the stockholdings of insiders are beyond a certain threshold stipulated in the prevailing state corporation laws. This percentage varies depending on the state in which the company is incorporated.
A majority of shareholders must provide their approval before a merger can be completed.A 51% margin is a common majority threshold. When this majority approves the deal, minority shareholders are required to tender their shares, even though they did not vote in favor of the deal. Minority shareholders are said to be frozen out of their positions. This majority approval requirement is designed to prevent a holdout problem, which may occur when a minority attempts to hold up the completion of a transaction unless they receive compensation over and above the acquisition stock price.
This is not to say that dissenting shareholders are without rights. Those shareholders who believe that their shares are worth significantly more than what the terms of the merger are offering may go to court to pursue their shareholder appraisal rights. To successfully pursue these rights, dissenting shareholders must follow the proper procedures. Paramount among these procedures is the requirement that the dissenting shareholder object to the deal within the designated period of time. Then they may demand a cash settlement for the difference between the "fair value" of their shares and the compensation they actually received. Of course, corporations resist these maneuvers because the payment of cash for the value of shares will raise problems relating to the positions of other stockholders. Such suits are very difficult for dissenting shareholders to win. Dissenting shareholders may only file a suit if the corporation does not file suit to have the fair value of the shares determined, after having been notified of the dissenting shareholders' objections. If there is a suit, the court may appoint an appraiser to assist in the determination of the fair value.
The most common form of merger or acquisition involves purchasing the stock of the merged or acquired concern. An alternative to the stock acquisition is to purchase the target company's assets. In doing so, the acquiring company can limit its acquisitions to those parts of the firm that coincide with the acquirer's needs. When a significant part of the target remains after the asset acquisition, the transaction is only a partial acquisition of the target. When all the target's assets are purchased, the target becomes a corporate shell with only the cash or securities that it received from the acquisition as assets. In these situations, the corporation may choose to pay stockholders a liquidating dividend and dissolve the company. Alternatively, the firm may use its liquid assets to purchase other assets or another company.
If the acquirer buys all the target's stock, it assumes the seller's liabilities. The change in stock ownership does not free the new owners of the stock from the seller's liabilities. Most state laws provide this protection, which is sometimes referred to as successor liability. One way the acquirer can try to avoid assuming the seller's liabilities is to buy only the assets rather than the stock of the target. In cases in which a buyer purchases a substantial portion of the target's assets, the courts have ruled that the buyer is responsible for the seller's liabilities. This is known as the trust funds doctrine. The court may also rule that the transaction is a de facto merger-- a merger that occurs when the buyer purchases the assets of the target, and, for all intents and purposes, the transaction is treated as a merger.
The issue of successor liability may also apply to other commitments of the firm, such as union contracts. The National Labor Relations Board's position on this issue is that collective bargaining agreements are still in effect after acquisitions.
One of the advantages of an asset acquisition, as opposed to a stock acquisition, is that the bidder may not have to gain the approval of its shareholders. Such approval usually is only necessary when the assets of the target are purchased using shares of the bidder and when the bidder does not already have sufficient shares authorized to complete the transaction. If there are not sufficient shares authorized, the bidder may have to take the necessary steps, which may include amending the articles of incorporation, to gain approval. This is very different from the position of the target company where their shareholders may have to approve the sale of a substantial amount of the company's assets. The necessary shareholder approval percentage is usually the same as for stock acquisitions.
When a corporation chooses to sell off all its assets to another company, it becomes a corporate shell with cash and/ or securities as its sole assets. The firm may then decide to distribute the cash to its stockholders as a liquidating dividend and go out of existence. The proceeds of the assets sale may also be distributed through a cash repurchase tender offer. That is, the firm makes a tender offer for its own shares using the proceeds of the asset sale to pay for shares. The firm may also choose to continue to do business and use its liquid assets to purchase other assets or companies.
Firms that choose to remain in existence without assets are subject to the Investment Company Act of 1940. This law, one of a series of securities laws passed in the wake of the Great Depression and the associated stock market crash of 1929, applies when 100 or more stockholders remain after the sale of the assets. It requires that investment companies register with the SEC and adhere to its regulations applying to investment companies. The law also establishes standards that regulate investment companies. Specifically, it covers:
If a company that sells off all its assets chooses to invest the proceeds of the asset sale in Treasury bills, these investments are not regulated by the act.
There are two kinds of investment companies: open-end investment companies and closed-end investment companies. Open-end investment companies, commonly referred to as mutual funds, issue shares that are equal to the value of the fund divided by the number of shares that are bought, after taking into account the costs of running the fund. The num-ber of shares in a mutual fund increases or decreases depending on the number of new shares sold or the redemption of shares already issued.
Closed-end investment companies generally do not issue new shares after the initial issuance. The value of these shares is determined by the value of the investments that are made using the proceeds of the initial share offering.
Rather than a merger or an acquisition, the acquiring company may choose to purchase only a portion of the target's stock and act as a holding company, which is a company that owns sufficient stock to have a controlling interest in the target. Holding companies trace their origins back to 1889, when New Jersey became the first state to pass a law that allowed corporations to be formed for the express purpose of owning stock in other corporations.
If an acquirer buys 100% of the target, the company is known as a wholly owned subsidiary.However, it is not necessary to own all of a company's stock to exert control over it. In fact, even a 51% interest may not be necessary to allow a buyer to control a target. For companies with a widely distributed equity base, effective working control can be established with as little as 10% to 20% of the outstanding common stock.
Holding companies have certain advantages that may make this form of control transaction preferable to an outright acquisition. Some of these advantages are:
Holding companies receive dividend income from a company that has already been taxed at the corporate level. This income may then be taxed at the holding company level before it is distributed to stockholders. This amounts to triple taxation of corporate income. However, if the holding company owns 80% or more of a subsidiary's voting equity, the Internal Revenue Service allows filing of consolidated returns in which the dividends received from the parent company are not taxed. When the ownership interest is less than 80%, returns cannot be consolidated, but between 70 and 80% of the dividends are not subject to taxation.
Another type of business combination is a joint venture. In a joint venture, companies can enter into an agreement to provide certain resources toward the achievement of a particular business goal. For example, one company could provide financing while another firm contributes physical assets or technological expertise. The venture would realize certain returns, and they would be shared among the venture partners according to a prearranged formula.
In recent years a number of international joint ventures have taken place in the automobile industry. United States companies have entered into agreements with Japanese manufacturers to take advantage of certain comparative advantages these firms might enjoy, such as technological advantages and quality controls. Some of the ventures provided for the establishment of manufacturing facilities in the United States to produce automobiles to be sold in the U. S. market under American manufacturers' brand names. The goal was to enable American manufacturers to produce cars that offered some of the beneficial features of Japanese cars, such as quality, durability, and fuel economy, without having to invest the significant resources to develop this technology and manufacturing know-how. The Japanese manufacturers would also be able to take advantage of the American manufacturers'brand names, distribution network, and other marketing advantages that American manufacturers enjoyed, such as good financing subsidiaries. In addition, the agreements using U. S. manufacturing facilities and U. S. workers would allow Japanese manufacturers to avoid trade restrictions that might affect them if they were to sell directly to the U. S. market. One example of such an arrangement was the joint venture between Chrysler Motors and Mitsubishi Motors, in which the companies agreed to jointly manufacture automobiles in Bloomington, Illinois.
Another example that illustrates the combination of the characteristics of a joint venture and a holding company is the 1995 relationship formed between Packard Bell and NEC, in which NEC purchased a 20% stake in the closely held Packard Bell for $170 million. In addition to providing Packard Bell with needed cash, the companies agreed to supply components to each other and to make joint purchases of computer parts and engage in jointproduct development. The companies also agreed to the mutual use of each firm's marketing channels.
An alternative to a joint venture is a strategic alliance. A strategic alliance is a more flexible concept than a joint venture and refers to a myriad of arrangements between firms whereby they work together for varying periods of time to accomplish a specific goal. Through such alliances links can be readily established and easily disbanded. An organizational entity usually is not created with a strategic alliance, whereas it often is in a joint venture. This may be an advantage because the potential agency costs associated with the managers of the joint venture are not incurred. The added flexibility of strategic alliances may be of special benefit to growing firms because it allows them to quickly establish links when they are needed. These links can often accomplish goals that may require a significant investment and financial resources. This is another reason growing firms, such as high technology companies, may find this alternative of particular benefit. One example of a high-tech development alliance was NCR's 1990 agreement with Seagate Technology to jointly develop high-performance storage systems. An example of a high-tech marketing agreement was the alliance between 3Com Corporation and Sync Research, in which 3Com Corporation would provide marketing assistance to Sync Research's products.
The downside of alliances is the greater potential for opportunistic behavior by the partners. Companies that share business strategy and business secrets may put these valuable intangible assets at greater risks than what might occur in a more integrated organizational structure.
Given the usual loose nature of alliances, there is a tendency to have posturing by the partners so that they create a need for each other. This may involve sharing only essential information when necessary. The partners will continue to cooperate only as long as there is a benefit from the association. If the partners can show each other that there are benefits from a continued association into the future, there is an incentive for greater cooperation.
Part 1 Background 1
1 Introduction 3
Recent M&A Trends 3
Valuing a Transaction 13
Types of Mergers 13
Reasons for Mergers and Acquisitions 14
Merger Consideration 15
Merger Professionals 16
Merger Arbitrage 19
Leveraged Buyouts and the Private Equity Market 20
Corporate Restructing 21
Merger Negotiations 21
Structuring the Deal 24
Merger Agreement 24
Merger Approval Procedures 25
Deal Closing 26
Short-Form Merger 26
Freezeouts and the Treatment of Minority Shareholders 27
Purchase of Assets Compared with Purchase of Stock 27
Assumption of the Seller's Liabilities 28
Advantages of Asset Acquisitions 28
Asset Selloffs 28
Reverse Mergers 29
Holding Companies 33
2 History of Mergers 35
Merger Waves 35
What Causes Merger Waves? 36
First Wave, 1897-1904 36
Second Wave, 1916-1929 42
The 1940s 44
Third Wave, 1965-1969 44
Trendsetting Mergers of the 1970s 51
Fourth Wave, 1984-1989 57
Fifth Wave 63
Sixth Merger Wave 71
3 Legal Framework 74
Laws Governing Mergers, Acquisitions, and Tender Offers 75
Other Specific Takeover Rules in the United States 86
International Securities Laws Relating to Takeovers 88
Business Judgment Rule 95
State Antitakeover Laws 97
Regulation of Insider Trading 104
Antitrust Laws 107
Recent Trends in Antitrust Enforcement in the United States 114
Measuring Concentration and Defining Market Share 116
European Competition Policy 120
Antitrust Remedies 122
4 Merger Strategy 125
Operating Synergy 134
Other Economic Motives 156
Hubris Hypothesis of Takeovers 168
Other Motives 174
Part 2 Hostile Takeovers 181
5 Antitakeover Measures 183
Management Entrenchment Hypothesis versus Stockholder Interests Hypothesis 184
Preventative Antitakeover Measures 185
Changing the State of Incorporation 206
Active Antitakeover Defenses 206
Information Content of Takeover Resistance 240
6 Takeover Tactics 243
Preliminary Takeover Steps 245
Tender Offers 250
Open Market Purchases and Street Sweeps 267
Advantages of Tender Offers Over Open Market Purchases 269
Arbitrage and the Downward Price Pressures around M&A Announcements 271
Proxy Fights 271
Hedge Funds as Activist Investors 286
Part 3 Going-Private Transactions and Leveraged Buyouts 291
7 Leveraged Buyouts 293
Historical Trends in LBOs 293
Costs of Being a Public Company 302
Management Buyouts 304
Conflicts of Interest in Management Buyouts 307
U.S. Courts' Position on Leveraged Buyouts Conflicts 307
Financing for Leveraged Buyouts 316
Returns to Stockholders From LBOs 321
Returns to Stockholders From Divisional Buyouts 322
Empirical Research on Wealth Transfer Effects 329
Protection for Creditors 329
8 Topics in Going-Private Transactions 335
Private Equity Market 335
Junk Bonds' Financing of Takeovers 344
Stapled Financing 361
Securitization and M&A Financing 362
9 Employee Stock Ownership Plans 366
Historical Growth of ESOPs 366
Types of Plans 367
Characteristics of ESOPs 368
Leveraged versus Unleveraged ESOPs 369
Corporate Finance Uses of ESOPs 369
Voting of ESOP Shares 371
Cash Flow Implications 371
Valuation of Stock Contributed into an ESOP 372
Eligibility of ESOPs 372
Put Options of ESOPs 372
Dividends Paid 373
ESOPs versus a Public Offering of Stock 373
Employee Risk and ESOPs 375
Securities Laws and ESOPs 376
Tax Benefits of LESOPs 376
Balance Sheet Effects of ESOPs 377
Drawbacks of LESOPs 377
ESOPs and Corporate Performance 378
ESOPs as an Antitakeover Defense 381
ESOPs and Shareholder Wealth 382
ESOPs and LBOs 383
Part 4 Corporate Restructuring 387
10 Corporate Restructuring 389
Divestiture and Spinoff Process 402
Wealth Effects of Selloffs 410
Equity Carve-Outs 424
Voluntary Liquidations or Butups 428
Tracking Stocks 430
Master Limited Partnerships and Selloffs 431
11 Restructuring in Bankruptcy 435
Types of Business Failure 435
Causes of Business Failure 437
Bankruptcy Trends 440
U.S. Bankruptcy Laws 446
Reorganization Versus Liquidation 447
Reorganization Process 448
Benefits of the Chapter 11 Process for the Debtor 454
Prepackaged Bankruptcy 457
Corporate Control and Default 465
Bankruptcy Fire Sales 466
Investing in the Securities of Distressed Companies 467
12 Corporate Governance 473
Failed Corporate Governance: Accounting Scandals 473
Sarbanes-Oxley Act 475
Other Regulatory Changes 477
Corporate Governance 477
Golden Parachutes 487
Managerial Compensation, Mergers, and Takeovers 490
CEO Compensation and Power 492
Compensation Characteristics of Boards That Are More Likely to Keep Agency Costs in Check 494
Role of the Board of Directors 495
Interlocking Boards 496
Independence of Directors 497
Regulatory Standards for Directors 503
Antitakeover Measures and Board Characteristics 504
Disciplinary Takeovers, Company Performance, CEOs, and Boards 506
Merger Strategy and Corporate Governance 507
Do Boards Reward CEOs for Initiating Acquisitions and Mergers? 507
CEO Compensation and Diversification Strategies 509
Agency Costs and Diversification Strategies 509
Interests of Directors and M&As 510
Managerial Compensation and Firm Size 511
Corporate Control Decisions and Their Shareholder Wealth Effects 512
Does Better Corporate Governance Increase Firm Value? 513
Corporate Governance and Competition 514
Executive Compensation and Postacquisition Performance 514
Mergers of Equals and Corporate Governance 515
13 Joint Ventures and Strategic Alliances 523
Contractual Agreements 523
Comparing Strategic Alliances and Joint Ventures with Mergers and Acquisitions 524
Joint Ventures 524
Strategic Alliances 530
14 Valuation 538
Valuation Methods: Science or Art? 540
Managing Value as an Antitakeover Defense 540
Benchmarks of Value 541
How the Market Determines Discount Rates 553
Valuation of the Target's Equity 562
Takeovers and Control Premiums 564
Marketability of the Stock 566
Valuation of Stock-for-Stock Exchanges 575
Trends in Cash versus Stock Percentage of Takeover Financing 576
Shareholder Wealth Effects and Methods of Payment 580
Exchange Ratio 586
Fixed Number of Shares versus Fixed Value 593
Adjusting Stock Offers for the Effects of Stock Options and Convertible Securities 593
International Takeovers and Stock-for-Stock Transactions 593
Desirable Financial Characteristics of Targets 594
15 Tax Issues 607
Financial Accounting For M&As 607
Taxable Versus Tax-Free Transactions 608
Tax Consequences of a Stock-For-Stock Exchange 610
Asset Basis Step-Up 613
Changes in The Tax Laws 614
Role of Taxes in The Merger Decision 616
Role of Taxes in the Choice Selloff Method 617
Organizational Form and M&A Premiums 617
Capital Structure And Propensity to Engage in Acquisitions 618
Leverage and Deal Structure 618
Taxes as a Sources of Value in Management Buyouts 619
Miscellaneous Tax Issues 620