 Corporations strive to increase their

earnings per share over time.

 Methods
◦ “Organic” approaches:
 Increase sales of existing divisions while maintaining
level operating margins
 Increase operating margins with constant sales
◦ Mergers and Acquisitions:
 Seek to merge or acquire another corporation, with
resulting corporation’s size and earnings enhanced
by combination
 M&A transactions date back to 19th century
 Horizontal acquisitions: acquiring
competitors in the same industry and then
systematically reducing costs of acquired
company by integrating its operations into
acquirer's company
 Vertical acquisitions: acquiring companies in
own supply chain
 Enormous trusts, or business holding
companies
 In the 1920’s, 1960’s, and 1980’s, M&A
activity reached historic highs and
corresponded to positive performance of the
stock market.
◦ 1920’s: combinations of firms within industries
◦ 1960’s: conglomerate approach (e.g. LTV, ITT)
◦ 1980’s: use of large amounts of debt as the means
to finance acquisitions of companies with cheaply
priced assets through leveraged buyouts
 In the 2000’s, Wall Street declined due to lower
asset values and increased government
regulation; strategic horizontal mergers are
becoming more common.
◦ Strong banks are absorbing weak ones before/after
FDIC seizes them.
◦ Chemical, pharmaceutical and commodities firms are
merging in order to increase global reach and reduce
cost per unit of production.
◦ Leveraged buyout firms (now private equity firms)
have decreased their activity due to losses from
2007/2008 vintage investments and reduction in debt
availability.
◦ Completed deals have lower levels of debt and
therefore, either a lower price or more equity.
 Article 2 of the Uniform Commercial Code
(UCC): set of contractual rules for sale of
goods between companies
 Vendor-customer relationships are governed

by purchase orders (POs): short form of

contract, containing standard provisions and
blank spaces for price, quantity, and
shipment date of goods involved
 Strategic alliance (or teaming agreement):
parties work together on a single project for a
finite period of time
◦ Do not exchange equity
◦ Do not create permanent entity to mark
relationship
◦ Written memorandum of understanding (MOU):
memorializes strategic alliance and sets forth how
parties plan to work together
 Joint venture: parties work together for
lengthy or indeterminate period of time
◦ Form new, third entity
◦ Divide ownership and control of new entity,
determine who will contribute what resources
◦ Advantage: two entities can remain focused
on their core businesses while letting joint
venture pursue the new opportunity
◦ Downside: governance issues and economic
fairness issues create friction and eventual
disbandment
 Acquisition: acquired company becomes
subsidiary of purchasing company
◦ Most permanent
◦ Eliminates governance and economic fairness
issues
◦ Forms of acquisitions
 Merger
 Stock acquisition
 Asset acquisition
 Merger: two companies legally become one
 All assets and liabilities being merged out
of existence become assets and liabilities
of surviving company
 Stock acquisition: acquired company becomes

subsidiary of acquiring company

 Asset acquisition: assets but not liabilities

become assets of acquiring firm

 If acquisition will create positive present
value when weighing outflow (acquisition
price) versus future inflow (cash flow of
acquired company plus any synergies), then
transaction makes financial sense.
◦ Difficulty: determine what exactly are the outflows,
inflows, and synergies (both revenue/cost
synergies)
 Common synergies
 Cost Savings:
◦ One has lower existing costs due to efficiency,
scale, etc.
◦ One has better cost management
◦ Combined company has greater economies of scale
◦ One has better credit rating/balance sheet and
therefore cheaper financing costs
◦ Transactions costs eliminated in vertical merger
◦ Reduction in employee costs (layoffs)
◦ Reduction in taxes if acquirer has NOLs and is not
limited by Section 382 of IRC
 Common synergies (continued)
 Revenue enhancements:

◦ Use of each other’s distributors and other channels

◦ “Bundling” opportunities from combined product
offering makes company more attractive
◦ Combined company can raise prices (greater
market power)
 Companies will hire a group of advisors to
assist in evaluating and consummating
transaction  investment bank, law firm with
expertise in mergers and acquisitions,
accounting firm, valuation firm
• Investment bank
 Primary financial advisor
 Puts together financial model to analyze cash
flows of combined company on pro forma basis
 Evaluates comparable transaction in order to
render advice on price
 Offers advice on tax and accounting structure
for transaction
 Helps raise capital needed to complete
transaction
 Law firm
◦ Responsible for drafting and negotiation of
transaction documents
◦ Reviews appropriate tax, employment,
environmental, corporate governance, securities,
real property, and other applicable international,
federal, state and local laws
◦ Advise Board of Directors on fulfilling its fiduciary
duties of care and loyalty to shareholders
 Accounting firm
◦ Advise company on proper tax and accounting
treatment of transaction
◦ Assist in valuing certain specific assets
◦ “Comfort letter” on certain accounting issues
◦ Consent letter needed if publicly registered
securities offering is made in connection with
transaction
 Key political elements of a transaction
1. Which entity will survive or be parent company
2. What will new company’s board of directors look
like
3. Who will manage company day-to-day
 Smaller company will typically become
subsidiary of larger company
◦ Smaller company may have token representation on
Board of Directors of parent
◦ Management of smaller company will typically
either remain at subsidiary or exit
 Board positions often allocated 50/50
 “Office of the Chairman” or “Office of CEO”:

formed to share management authority

 Murky lines of authority or shared power can

lead to difficulty and conflict

 Buyer will offer price based on whether
transaction will be accretive: increases
earnings per share of acquiring company
 Seller will seek premium over its existing
stock price (if public) or price in line with
public traded comparables or recent public
disclosed M&A transaction multiples based on
price to earnings, price to EBITDA or price to
sales (if private)
 Leveraged Buy Outs (LBOs): purchases of
stock of company where a significant
percentage of purchase price is paid for
with proceeds of debt
◦ Became prominent in 1970’s and 1980’s with
rise of LBO shop
◦ Debt financing to fund:
 High yield (junk) bonds
 Hostile takeovers: acquisition in which “target’s” board
of directors does not consent to transaction
 Tender offer: Potential buyer or “raider” makes cash offer
directly to shareholders, thereby bypassing board of
directors
 Three major events altered landscape to reduce
incidence of hostile takeovers:
1. Creation of poison pills: companies issued
convertible preferred stock to exiting
shareholders with provisions which made a
potential tender offer prohibitively expensive
2. State of Delaware passed new provision of
Delaware General Corporate Law, Section 203:
requires hostile buyer to acquire at least 85% of
target company in order to consummate hostile
takeover
3. U.S. Congress passed revision of tax code: limited
tax deductibility of certain high yield debt (HYDO
rules), thus reducing attractiveness of junk bonds
as means of financing acquisitions
Reverse M&A (add value through divestiture)
 Four forms of reverse M&A:

1. Simple sale of division or subsidiary: asset

sale, stock sale, or merger
2. Spin-off: corporation issues dividend of
shares of subsidiary to be spun-off
corporation’s shareholders
◦ Shareholders of parent participate in spin-off on
pro rata based on their ownership percentage in
parent
◦ Prior to spin-off, parent may extract cash from
subsidiary
 “19.9% IPO”: subsidiary is taken public and all or large
portion of proceeds are then allocated to parent
 Transfer certain debts to subsidiary so that parent ends
up with less leveraged balance sheet post spin-off
 Parent has subsidiary dividend to parent a portion of
subsidiary’s cash
3. Split-off: shareholder in parent corporation
elects to take shares in subsidiary being
split-off, but ends up with fewer shares of
parent corporation
4. Split-up: shareholder elects to take shares in
one part of split company or other
◦ Less common than spin-offs and split-offs
because most shareholders like having parts of
both parent and entity divested