MERGERS AND ACQUISITIONS ROCK SPRING 2012
CHAPTER 1: THE HISTORY OF BUSINESS COMBINATIONS
Four waves of U.S. M&A Activity
1887-1904
Influencing Factors
Characteristics
Why ended?
1. Recovery from the depression of 1883.
2. Changes in transportation, communications, manufacturing technology, competition and legal institutions.
Consolidation of numerous producers into firms dominating the markets they supplied (“market dominance through merger” / “mergers for monopoly”).
1. The depression of 1904.
2. Legal precedents showing that market-dominating mergers could be attacked successfully under the antitrust laws.
1916-1929
Influencing Factors
Characteristics
1. Conversion to war production in 1918-1919.
2. Adjustment recession in 1921-1922.
1. Much of the activity occurred in the electrical and gas utility sector.
2. In the manufacturing sector most mergers created a large “number two” firm (“mergers for oligopoly”).
3. More vertical integration and diversification mergers.
1960s
Influencing Factors
Characteristics
1950 amendments to antitrust laws to include tougher restraints against horizontal and vertical mergers and corresponding court precedents.
1. Diversification (conglomerate) mergers.
2. Use of financial innovations such as “funny money” (convertible preferred stock and debentures).
1980s
Influencing Factors
Characteristics
1. Stock market slump (making stock purchase cheaper than building plants and replacing equipment).
2. Regan administration took office in 1981 – reduced probability of government challenge.
3. Expansive monetary policy adopted by the FRB in 1983 (and consequential market boom).
4. Collapse of Stock prices on October 19, 1987.
1. Bargain-hunting merger activity led by foreign acquirers.
2. Hostile tender offers.
3. Use of junk bonds, large number of LBO transactions.
4. Attempts of horizontal mergers.
5. Large mergers in the petroleum industry due to changes in market conditions.[1]
6. M&A activity in the banking, finance, transportation brokerage and investment industries due to deregulation.
7. Divestiture transactions (spin offs of subsidiaries) by parent corporations trying to focus their operations in their most profitable lines of business.[2]
8. Development of much of the law governing M&A.
M&A Activity in Recent Years
Influencing Factors
Characteristics
1. Recovery from the 1991-1992 recession.
2. More efficient firms (due to restructuring and belt-tightening during the 1980s).
3. Changes in medical care delivery, computers and communications.
1. Few hostile takeovers. Mainly negotiated transactions.[3]
2. Huge acquisitions.
3. Lesser use of high yield securities.
4. Less LBOs until after 2001 (due to the growth of private investment entities after the 2001 market crash).
Legal Climate
Development of Antitrust Laws
1. The Sherman Antitrust Act – prohibits combinations in restraint of trade and monopolizing or attempting to monopolize interstate Commerce.
2. The Clayton Antitrust Act – passed in 1914. Section 7 was amended in 1955 to prohibit corporate acquisitions that may substantially lessen competition or tend to create a monopoly.
ð Statutes applied to all kinds of mergers: horizontal (among competitors), vertical (suppliers-customers) and conglomerate acquisitions.
3. 1968 Merger Guidelines – suggesting the Justice Department would take action where a firm with 4% of a market is purchased by a firm with 4% of that market, if the four largest firms in that market represented less than 75% of the output.
4. 1982 Merger Guidelines – recognition of “rivalrous competition” so that where one or two firms dominate the market, the creation of a strong third firm enhances competition.
5. In 1976 section 7A was added to the Clayton Act requiring premerger notification of all mergers above a minimum size and imposing a waiting period for mergers.
Federal Securities Laws – Regulation of Cash Tender Offers
1. State securities legislation initially regulated sellers (by requiring a registration statement).
2. The Securities Act of 1933[4] – regulates purchasers when:
· They resell their securities and become underwriters for issuers.
· When the acquiring firm proposed to issue its securities in the acquisition. The need for a registration statement delayed the completion of transactions ð allowed management to resist and auctions to develop (by making cash tender offers).
The SEC does not verify the truthfulness of the statement (which is assured by civil liability and criminal sanctions).
3. The Securities Exchange Act of 1934 –
· Rule 10b-5 was used in respect of mergers involving the sale of securities (including fraudulent purchases for cash).
· Prior to 1968 it was generally agreed that a bidder in a hostile tender offer owed no disclosure duties to target shareholders under Rule 10b-5 as his relationship with target shareholders was adversary.
4. The Williams Act –
· First proposed in October 1965 in order to protect issuers in light of the common use of cash tender offers during the 1960s conglomerate merger mania.
Possible reasons for the use of cash tender offers:
1. Increased corporate liquidity and readily available credit.
2. Comparatively depressed price/earnings ratios, book values and cash or quick asset ratios.
3. Greater knowledge and sophistication with respect to this technique.
4. Lack of regulation.
5. Quick and more successful results than in a proxy contest.
6. Greater flexibility (no irrevocable commitment).
7. Psychology – no need to convince shareholder that insurgent will be more efficient.
8. Reduced costs.
9. Cash tender offers were considered more “respectable” than in the past.
· Second introduction in 1967 and amendment of the Securities Exchange Act of 1934 in 1968.
For the Williams Act
Against the Williams Act
1. Greater recognition of the desirability of basic substantive protections (through full disclosure) to investors confronted with a cash tender offer.
2. Tender offers are a form of industrial sabotage.
1. Tender offers might promote the interest of society by removing entrenched and inefficient management – the act gives incumbent management an unfair advantage.
2. The act enhances the powers of the SEC whereas a tender offer is an open market transaction that promotes the interests of investors and the market.
The Act: (1) provides investors with full disclosure and other substantive protections, (2) grants the SEC the authority to regulate corporate repurchases of their own securities and (3) requires disclosure by persons acquiring more than a specified percentage of certain equity securities other than pursuant to a tender offer.
5. 1970 Amendment of the Williams Act –
· Disclosure requirement triggered by 5% stock ownership.
· Extension of the act to cover e
Value of $ 4 PER SHARE.
– In a valuation of a company, the buyer has also to estimate “how much would cost to duplicate the business of the target”. What would be more expensive to the buyer??
1 – buying the target company, or
2 – duplicating target’s structure by buying the same equipments, similar plants and all infra-structure required to be in the same business and with the same conditions as the target.
– The most relevant issue when valuing a company is the perspective of the company to generate cash flows overtime. How much cash the company will generate in the future?? What would be the “lifetime” of the target company?
o For this reason, the buyer has to make some assumptions and estimate how much money the target will generate in the future and bring to the present time this value that the buyer estimates that the company will receive in the future. Doing this, the buyer will be calculating the PRESENT VALUE of the target.
PRESENT VALUE: is the value in the present time of the cash flows that a company expects to receive in the future. This value received in the “future” is calculated in the “present” by using a discount rate for the appropriate number of years where it is possible to “foreseen” the cash flow of the company in the future.
– An extension of the understanding of Present Value is the concept of PERPETUITY. Perpetuity means that you assume that the cash flow will go on to infinity.
o Use of Perpetuity: a shareholder of a company assumes that the shares he owns will pay the same amount of dividends each year and even when the shareholder dies, his heirs will be the owners of these shares and will receive these dividends.
o Calculation of the Present Value of a Perpetuity:
a) Without expectation of growth:
[1] These included:
a. Wider use of enhanced oil recovery techniques.
b. Divergent expectations concerning the future prices of crude oil.
c. Phased decontrol of crude oil.
d. Decline in demand for petroleum products (creating an excess capacity and leading to consolidations).
[2] Divestitures occur when:
a. Firms undo previous acquisitions that did not work as planned.
b. Firms decided to raise cash (to reduce debt raised by earlier acquisitions or to invest in new projects).
c. To focus the parent corporation’s operations.
[3] Possible explanations for the replacement of hostile tender offers by negotiated transactions:
a. Effectiveness of takeover defenses.
b. Cultural change in boards (aware of their duties and seeking to maximize shareholder wealth) due to Delaware court decisions and increased pressure from financial institutions.
[4] The Act adopted a disclosure philosophy and requires the filing of a registration statement before any offers could be made (with certain exemptions) and “effectiveness” of the registration statement before sales.
