Robert Downs’ Merger & Acquisition Fall 2012
I. Introduction to Acquisitions (1-29)
A. Merger- Any kind of a combination deal, also called acquisition. Use of this term does not always indicate a statutory merger. A statutory merger is where one company is combined with another and one of them goes away. Another way is that the acquiring company will buy all or nearly all of the assets of the target company. This is sometimes called a sale of assets, the buyer gets all the assets and the target is left with cash, stock in the buyer, or a combination of the two. For this buy to be a statutory buy, a company must buy all or substantially all of the targets assets. The third way is a buy of the controlling stock in a company; if a company cannot buy all of the stock they may buy controlling interests and then do a cash out merger.
B. Takeover- Normally implies a hostile move by the acquiring company. This is usually done by a tender offer for a publicly traded company. This can also be done by a proxy fight.
C. Leveraged Buy Out (LBO)- used to describe the acquisition of a company with borrowed money. Moves equity out to shareholders and replaces it with debt. It leaves the target company weak but gives the only remaining shareholders with all the stock in the company. Winners in this deal are almost always the shareholders of the target company. The losers are the bidders who drive up the price.
D. Re-Organization- Can be done under the state law of the incorporating state to change capital structure of the company or when you change the state where you are incorporated. The tax term version is a merger or purchase of assets or stocks which is done in a way where it qualifies for tax deferral. (A) deal is a merger, (B) deal is a purchase of stock, (C) deal is a purchase of assets.
E. Securities regulation- Almost always involved in an acquisition. Rule 145- deals with business combinations. Does the deal have to be registered and the preference is to do it without registration. If no registration there can be re-sale issues. Rule 145 generally does not affect (B) deals.
Process
A. In big public deals the first contact is often done by the CEO’s but some companies have a merger and acquisition group who study possible target companies. This is common in the technology sector. The parties will often enter into a confidentiality agreement so any info. gained in the discussion phase has to remain secret. Damages from a breach of one of these agreements are traditionally hard to determine. A liquidated damages clause in the agreement can help to solve this problem but people may be reluctant to sign this type of deal.
B. Next step is commonly the letter of intent which can spell out the price and structure of the deal and this is often negotiated with the help of lawyers. Almost always called a non-binding letter of intent. It may contain a non-solicitation statement so the targets’ employees do not get hired away and also another confidentiality agreement, these two items are binding even though the deal can be voided.
C. Investment bankers get involved to provide financing and advice. Accountants are always involved. There may also be realtors, appraisers, and other who work in a team to push the deal through.
D. Due Diligence- In order to show you reasonably relied on a fraudulent statement you must do everything you can to ascertain the truth of any representations by the target company. If you have made every effort to discover any untruth you have been duly diligent. If you do not try to discover the true position of the target company you will not be able to bring a fraud lawsuit because you did not do your homework. This is done to find out about the company and it gives you the protection of securities and common law fraud litigation.
E. Definitive agreement- this is the contract that executes the deal and must often be approved by the board of directors and the shareholders before it is signed. In a merger or a sale of assets board approval is always required. Once approved by the board it is presented to the shareholders for approval by a certain date set in the agreement.
F. Time and responsibility schedule- Says who has to do what and by what date the tasks have to be completed by. This allocates the work among various people.
G. Closing- Just like in real estate, you pick a date and finalize everything, get certifications, check for liens, lawsuits, get a bill of sale. All the paper work is then signed and bound.
H. After the deal is closed you prepare the “Deal Book” which contains one signed copy of everything and has all the certificates. This is all done up in one big binder and will contain all the information from the deal. “Deal Cube” started with securities registration and is about the size of a rubix cube and when a company first goes public they will put a prospectus inside the cube and is kind of like a little merger trophy.
Valuation
A. Usually done of the target company but if the target is getting stock from the acquirer then that company will also have a valuation done.
B. If the two companies are in different lines of business or will continue to operate on a stand alone basis a valuation is always done.
C. If they are in the same line the two companies will be looking for synergy to gain a competitive advantage or offset costs for certain lines of business or business functions, like accounting, which can be combined.
D. The other type of business synergy is when two products compliment each other and can be sold in combination to boost sales of both products
E. Synergies are often over exaggerated and do not always come to fruition, often times employees from at least one of the companies are let go after the merger.
F. Most companies who acquire the stock of the target company pay 25-40% more than the market price for the stock because market price is often the price that people will not sell their stock for. Plus stock that is traded on the market is often not the stock that controls the company and control has big value called the control premium. In tender offers the premium is often a little higher than during a friendly deal.
G. In private deals the valuation can be harder because there is no market.
H. Ebitda- this is earnings before interest, taxes, depreciation, and amortization. This helps to evaluate a company in a comparable way. How many times the ebitda do you have to offer? The riskier the business the lower the offer, the more stable the higher the offer. The average is 11 times the ebitda.
I. Discounted Cash Flow Method- What you do is you estimate the earnings for next year based on the earnings of last year and then figure out the present value of those earnings. You do this for several years and always bring the estimated earnings back to a present value. Once you get way out into the future the present value of earnings gets really small plus there are so many variables that go into a business cycle this method is unreliable if you project too far into the future.
J. The other method for valuation of a private company is to find a comparable company to use as a measuring rod for the price of the target company. This is not exactly easy both because geography, employees, customer base, etc. can make it really hard to use this method and it is typically only a starting point.
K. Deferred Pricing- If you tie the price of the company to the stock price there is usually a limit to what the market will be allowed to do to the total price for the deal. The parties may want a cap on market fluctuation or a walk away price.
L. True-up- What happens if there is a major change in the balance sheet? The price is generally adjusted or the buyer can have the option to walk away from the deal.
M. Earn Out- This is used when the buyer thinks the company is too expensive and the seller thinks it is worth more. What can happen is the buyer gives the seller a percentage of the earnings if the company is as profitable as the seller believes. These tend to go 5-8 years and the percentage can be as high as 50%. This set-up is really risky because the buyer can elevate costs through growth or R & D. You want to negotiate with the buyer to control costs after sale.
N. Contingent value right- used in case the stock of the company you received goes down substantially within a certain period of time, this gives the seller a right to further payment.
State Corporate Codes
A. All the rules for a company are controlled by the state it is incorporated in. If a company wants to do a merger or acquisition they must comply with their home states rules for mergers or acquisitions.
B. Delaware corporate law is company and management friendly. A simple majority will allow you to do a merger. Dissenter’s rights are non-existent during an asset purchase. There is a lot of case law in Delaware and stability. The judiciary is highly specialized in the corporate law area and writes good opinions. Plus the market likes Delaware so there are a lot of companies who use Delaware so lawyers for both sides know all of Delaware’s rules. Plus the investment banking industry likes Delaware so if you want to be a public company or do national business Delaware is a good place to start.
C. Voting and Dissenter’s rights- It used to be that to do a merger 100% of the shareholders had to agree. Many states went to 2/3 or ¾ vote. The dissenter’s do not have to become a shareholder in the new company and can instead take the cash value of their stock. These rights apply to both mergers and a sale of substantially all of the company’s assets. Any shareholder who does not vote is presumed to be a no vote. Sometimes a company will say that no more than a certain percentage of shareholders exercise dissenter’s rights.
D. Two Step Deals- The acquiring company will buy controlling stock in the market and then merge by paying off the minority shareholders afterwards. There are no dissenter’s rights
vely vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and the purpose of the corporations”
(i) Assets are quantitatively vital to the operation of the corporation and
(ii) Out of the ordinary course of business and
(iii) Substantially affects the existence and purpose of the corporation
B. Asset For Stock Consideration (57-63)
(1) Stock for Asset can be similar to Stock for Stock merger in terms of end result: but Bidder doesn’t have to assume all liabilities, and Bidder S/H don’t get voting rights.
(2) Katz v. Bregman (Del) (42)
Corp had many assets, was only selling 1, but it was only income-producing asset. Ct. held that this was covered by §271 even though only accounted for 51% of their assets and 45% of sales. (quantitative)
(3) Gimbel v. Signal Companies, Inc. (Del) (41)
Sets out 3 elements to judge §271 whether all or substantially all…: 1) assets are quantitatively vital to the operation of the corporation, 2) out of the ordinary course of business, 3) substantially affects the existence and purpose of corporation.
(4) Helibrunn v. Sun Chemical (Del) (58)
The court said the structure is not the problem. The T s/h would have a reason to gripe via dissenters rights but the acquiring co’s s/h have no dissenters rights. There is no de facto merger deal in DE!
(5) Hariton v. Arco Electronics (Del) (64) (EQUAL DIGNITY RULE – DELAWARE)
Stock holders are arguing de facto merger; No de facto merger even if there is mandatory dissolution of target. This court said you do it one way you get s/h rights, you do it the other way you don’t.
Tender Offers
A. Good b/c 1) passes Target’s Board, 2) no S/H vote, 3) no appraisal rights, 4) T remains whole & intact
Bad b/c can be really expensive, might need to borrow $,
B. Cash for Stock Acquisitions (48-49)
C. Stock for Stock Acquisitions (65-68) (§251 / §11.04)
D. Irving Bank Corp. v. Bank of New York Co., Inc. (NY) (66)
Ct comes up w/ a 2 part test for applying ‘de facto merger’ doctrine: 1) merger has to happen almost immediately after initial transaction, 2) Target has to cease to exist quickly. Since 1) IBC will survive as a corporate entity w/ all assets intact, and 2) although a merger may happen in future, its not now = no s/h vote.
Transactions to Circumvent Statutory Requirements
A. Reverse Asset Sales (63-65)
B. Triangular Acquisitions (70-80)
(1) Triangular Merger – Bidder will drop down a wholly-owned shell, subsidiary will merge w/ Target
(2) Cash-out Merger – don’t need to use cash, can also use debt; BUT NOT voting stock
(3) Rauch v. RCA Corp. (2nd Cir.) (70) (reverse triangular merger)
(i) Ct. goes with equal dignity – if you can legally perform a transaction under 1 part of the code, it doesn’t matter if you can legally do it under another part of the code. (S/H are charged w/ knowledge that this can happen & careful lawyers could have put a liquidation preference in so this wouldn’t happen).
(ii) Main points: 1) equal dignity, & 2) only limited by duty to deal fairly
(iii) when you merge a sub into a target, this is called a reverse triangular merger.
(iv) Equal dignity rule says if you do it under X statute, then that statute controls.
(4) Equity Group Holdings v. DMG. Inc. (Southern Dist. Of Florida) (76)
(i) dmg is parent of dmi; carl is going to merge into (see handwritten); s/h of dmg said this is a de fecto merger b/c Carl ceo becomes ceo, most of the new bd of new co are former directors of Carl; b/c of all the stock that went to carl, this was a change of control and P said this triggers a vote of a majority of all outstanding shares i/o quorum of shares (NYSE standard); they’re trying to get the court to say this was a merger which requires larger voting standard (If in MO, it’s 2/3 of all outstanding shares);
(ii) Court says no to de facto merger.
