Download pdf - Mergers Final

7/17/2019 Mergers Final

http://slidepdf.com/reader/full/mergers-final 1/31

Mergers & Acquisitions

Prepared by: Ali Al Blooshi



Reasons for M &A



Introduction

Mergers and acquisitions represent the ultimate in change for a business. No other event is more difficult,challenging, or chaotic as a merger and acquisition. It is imperative that everyone involved in the process has aclear understanding of how the process works.

Mergers and acquisitions are now a normal way of life within the business world. In today's global, competitiveenvironment, mergers are sometimes the only means for long-term survival. In other cases, such as isco!ystems, mergers are a strategic component for generating long-term growth.

"irtually every ma#or company in the $nited !tates today has e%perienced a ma#or acquisition at some point inhistory. &nd at any given time, thousands of these companies are ad#usting to post-merger reality. or e%ample, so far in the decade of the ())*'s +through une ()), )/,*0* companies have come under new ownership worldwide indeals worth a total of 1 2.) trillion - and that's #ust counting acquisitions valued at 1 3 million and over. &dd to this themany smaller companies and nonprofit and governmental entities that e%perience mergers every year, and the M 4 &universe becomes large indeed.

M & A Defined

5hen we use the term 6merger6, we are referring to the merging of two companies where one new company willcontinue to e%ist. 7he term 6acquisition6 refers to the acquisition of assets by one company from anothercompany. In an acquisition, both companies may continue to e%ist. 8owever, throughout this course we willloosely refer to mergers and acquisitions + M 4 & as a business transaction where one company acquiresanother company. 7he acquiring company will remain in business and the acquired company +which we willsometimes call the 7arget ompany will be integrated into the acquiring company and thus, the acquiredcompany ceases to e%ist after the merger.

Mergers can be categori9ed as follows:

8ori9ontal: 7wo firms are merged across similar products or services. 8ori9ontal mergers are often used as away for a company to increase its market share by merging with a competing company. or e%ample, themerger between ;%%on and Mobil will allow both companies a larger share of the oil and gas market.

"ertical: 7wo firms are merged along the value-chain, such as a manufacturer merging with a supplier. "erticalmergers are often used as a way to gain a competitive advantage within the marketplace. or e%ample, Merck,



a large manufacturer of pharmaceuticals, merged with Medco, a large distributor of pharmaceuticals, in order togain an advantage in distributing its products.

onglomerate: 7wo firms in completely different industries merge, such as a gas pipeline company merging with ahigh technology company. onglomerates are usually used as a way to smooth out wide fluctuations in earnings and

provide more consistency in long-term growth. 7ypically, companies in mature industries with poor prospects forgrowth will seek to diversify their businesses through mergers and acquisitions. or e%ample, <eneral ;lectric +<;has diversified its businesses through mergers and acquisitions, allowing <; to get into new areas like financialservices and television broadcasting.

Reasons for M & A

;very merger has its own unique reasons why the combining of two companies is a good business decision.7he underlying principle behind mergers and acquisitions + M 4 & is simple: 0 = 0 > 3. 7he value of ompany &is 1 0 billion and the value of ompany ? is 1 0 billion, but when we merge the two companies together, wehave a total value of 1 3 billion. 7he #oining or merging of the two companies creates additional value which wecall 6synergy6 value.

!ynergy value can take three forms:

@evenues: ?y combining the two companies, we will reali9e higher revenues then if the two companies operateseparately.

;%penses: ?y combining the two companies, we will reali9e lower e%penses then if the two companies operateseparately.

ost of apital: ?y combining the two companies, we will e%perience a lower overall cost of capital.

or the most part, the biggest source of synergy value is lower e%penses. Many mergers are driven by the need tocut costs. ost savings often come from the elimination of redundant services, such as 8uman @esources,

&ccounting, Information 7echnology, etc. 8owever, the best mergers seem to have strategic reasons for the businesscombination. 7hese strategic reasons include:



Aositioning - 7aking advantage of future opportunities that can be e%ploited when the two companies arecombined. or e%ample, a telecommunications company might improve its position for the future if it were toown a broad band service company. ompanies need to position themselves to take advantage of emergingtrends in the marketplace.

<ap illing - Bne company may have a ma#or weakness +such as poor distribution whereas the other companyhas some significant strength. ?y combining the two companies, each company fills-in strategic gaps that areessential for long-term survival.

Brgani9ational ompetencies - &cquiring human resources and intellectual capital can help improve innovativethinking and development within the company.

?roader Market &ccess - &cquiring a foreign company can give a company quick access to emerging globalmarkets.

Mergers can also be driven by basic business reasons, such as:

?argain Aurchase - It may be cheaper to acquire another company then to invest internally. or e%ample,suppose a company is considering e%pansion of fabrication facilities. &nother company has very similar facilitiesthat are idle. It may be cheaper to #ust acquire the company with the unused facilities then to go out and buildnew facilities on your own.

Civersification - It may be necessary to smooth-out earnings and achieve more consistent long-term growth andprofitability. 7his is particularly true for companies in very mature industries where future growth is unlikely. Itshould be noted that traditional financial management does not always support diversification through mergersand acquisitions. It is widely held that investors are in the best position to diversify, not the management ofcompanies since managing a steel company is not the same as running a software company.

!hort 7erm <rowth - Management may be under pressure to turnaround sluggish growth and profitability.onsequently, a merger and acquisition is made to boost poor performance.

$ndervalued 7arget - 7he 7arget ompany may be undervalued and thus, it represents a good investment.!ome mergers are e%ecuted for 6financial6 reasons and not strategic reasons. or e%ample, Dohlberg Dravis 4@oberts acquires poor performing companies and replaces the management team in hopes of increasingdepressed values.

l Process

Objectives



Over all process

7he Merger 4 &cquisition Arocess can be broken down into five phases:

Ahase ( - Are &cquisition @eview: 7he first step is to assess your own situation and determine if a merger andacquisition strategy should be implemented. If a company e%pects difficulty in the future when it comes to maintainingcore competencies, market share, return on capital, or other key performance drivers, then a merger and acquisition+M 4 & program may be necessary.

It is also useful to ascertain if the company is undervalued. If a company fails to protect its valuation, it may finditself the target of a merger. 7herefore, the pre-acquisition phase will often include a valuation of the company -

&re we undervaluedE 5ould an M 4 & Arogram improve our valuationsE

7he primary focus within the Are &cquisition @eview is to determine if growth targets +such as (*F marketgrowth over the ne%t 2 years can be achieved internally. If not, an M 4 & 7eam should be formed to establish aset of criteria whereby the company can grow through acquisition. & complete rough plan should be developedon how growth will occur through M 4 &, including responsibilities within the company, how information will begathered, etc.

Ahase 0 - !earch 4 !creen 7argets: 7he second phase within the M 4 & Arocess is to search for possibletakeover candidates. 7arget companies must fulfill a set of criteria so that the 7arget ompany is a goodstrategic fit with the acquiring company. or e%ample, the target's drivers of performance should complementthe acquiring company. ompatibility and fit should be assessed across a range of criteria - relative si9e, type of business, capital structure, organi9ational strengths, core competencies, market channels, etc.

It is worth noting that the search and screening process is performed in-house by the &cquiring ompany. @elianceon outside investment firms is kept to a minimum since the preliminary stages of M 4 & must be highly guarded andindependent.

Ahase 2 - Investigate 4 "alue the 7arget: 7he third phase of M 4 & is to perform a more detail analysis of thetarget company. Gou want to confirm that the 7arget ompany is truly a good fit with the acquiring company.7his will require a more thorough review of operations, strategies, financials, and other aspects of the 7argetompany. 7his detail review is called 6due diligence.6 !pecifically, Ahase I Cue Ciligence is initiated once a

target company has been selected. 7he main ob#ective is to identify various synergy values that can be reali9edthrough an M 4 & of the 7arget ompany. Investment ?ankers now enter into the M 4 & process to assist withthis evaluation.

& key part of due diligence is the valuation of the target company. In the preliminary phases of M 4 &, we willcalculate a total value for the combined company. 5e have already calculated a value for our company +acquiringcompany. 5e now want to calculate a value for the target as well as all other costs associated with the M 4 &. 7hecalculation can be summari9ed as follows &AA@BH:



"alue of Bur ompany +&cquiring ompany

&;C 3/****

"alue of 7arget ompany

(/***

"alue of !ynergies per Ahase I Cue Ciligence

2***

Jess M 4 & osts +Jegal, Investment ?ank, etc.

)***

7otal "alue of ombined ompany

&;C /3***







Ahase K - &cquire through Negotiation: Now that we have selected our target company, it's time to start theprocess of negotiating a M 4 &. 5e need to develop a negotiation plan based on several key questions:

8ow much resistance will we encounter from the 7arget ompanyE

5hat are the benefits of the M 4 & for the 7arget ompanyE

5hat will be our bidding strategyE

8ow much do we offer in the first round of biddingE

7he most common approach to acquiring another company is for both companies to reach agreement concerning theM 4 &L i.e. a negotiated merger will take place. 7his negotiated arrangement is sometimes called a 6bear hug.6 7henegotiated merger or bear hug is the preferred approach to a M 4 & since having both sides agree to the deal will goa long way to making the M 4 & work. In cases where resistance is e%pected from the target, the acquiring firm willacquire a partial interest in the targetL sometimes referred to as a 6toehold position.6 7his toehold position putspressure on the target to negotiate without sending the target into panic mode.

In cases where the target is e%pected to strongly fight a takeover attempt, the acquiring company will make a tenderoffer directly to the shareholders of the target, bypassing the target's management. 7ender offers are characteri9ed bythe following:

7he price offered is above the target's prevailing market price.

7he offer applies to a substantial, if not all, outstanding shares of stock.

7he offer is open for a limited period of time.

7he offer is made to the public shareholders of the target. & few important points worth noting:

<enerally, tender offers are more e%pensive than negotiated M 4 &'s due to the resistance of targetmanagement and the fact that the target is now 6in play6 and may attract other bidders.

Aartial offers as well as toehold positions are not as effective as a (**F acquisition of 6any and all6 outstandingshares. 5hen an acquiring firm makes a (**F offer for the outstanding stock of the target, it is very difficult to turnthis type of offer down.



&nother important element when two companies merge is Ahase II Cue Ciligence. &s you may recall, Ahase ICue Ciligence started when we selected our target company. Bnce we start the negotiation process with thetarget company, a much more intense level of due diligence +Ahase II will begin. ?oth companies, assuming wehave a negotiated merger, will launch a very detail review to determine if the proposed merger will work. 7his

requires a very detail review of the target company - financials, operations, corporate culture, strategic issues,etc.

Ahase 3 - Aost Merger Integration: If all goes well, the two companies will announce an agreement to merge thetwo companies. 7he deal is finali9ed in a formal merger and acquisition agreement. 7his leads us to the fifth andfinal phase within the M 4 & Arocess, the integration of the two companies.

;very company is different - differences in culture, differences in information systems, differences in strategies,etc. &s a result, the Aost Merger Integration Ahase is the most difficult phase within the M 4 & Arocess. Now all

of a sudden we have to bring these two companies together and make the whole thing work. 7his requirese%tensive planning and design throughout the entire organi9ation. 7he integration process can take place atthree levels:

ull: &ll functional areas +operations, marketing, finance, human resources, etc. will be merged into one newcompany. 7he new company will use the 6best practices6 between the two companies.

Moderate: ertain key functions or processes +such as production will be merged together. !trategic decisionswill be centrali9ed within one company, but day to day operating decisions will remain autonomous.

Minimal: Bnly selected personnel will be merged together in order to reduce redundancies. ?oth strategic andoperating decisions will remain decentrali9ed and autonomous.

If post merger integration is successful, then we should generate synergy values. 8owever, before we embarkon a formal merger and acquisition program, perhaps we need to understand the realities of mergers andacquisitions.

A Reality

&s mentioned at the start of this course, mergers and acquisitions are e%tremely difficult. ;%pected synergyvalues may not be reali9ed and therefore, the merger is considered a failure. !ome of the reasons behind failedmergers are:



Aoor strategic fit - 7he two companies have strategies and ob#ectives that are too different and they conflict with oneanother.

ultural and !ocial Cifferences - It has been said that most problems can be traced to 6people problems.6 If thetwo companies have wide differences in cultures, then synergy values can be very elusive.

Incomplete and Inadequate Cue Ciligence - Cue diligence is the 6watchdog6 within the M 4 & Arocess. If you failto let the watchdog do his #ob, you are in for some serious problems within the M 4 & Arocess.

Aoorly Managed Integration - 7he integration of two companies requires a very high level of qualitymanagement. In the words of one ;B, 6give me some people who know the drill.6 Integration is often poorlymanaged with little planning and design. &s a result, implementation fails.

Aaying too Much - In today's merger fren9y world, it is not unusual for the acquiring company to pay a premiumfor the 7arget ompany. Aremiums are paid based on e%pectations of synergies. 8owever, if synergies are notreali9ed, then the premium paid to acquire the target is never recouped.

Bverly Bptimistic - If the acquiring company is too optimistic in its pro#ections about the 7arget ompany, thenbad decisions will be made within the M 4 & Arocess. &n overly optimistic forecast or conclusion about a criticalissue can lead to a failed merger.

7he above list is by no means complete. &s we learn more about the M 4 & Arocess, we will discover that the M4 & Arocess can be riddled with all kinds of problems, ranging from organi9ational resistance to loss ofcustomers and key personnel.

5e should also recogni9e some cold hard facts about mergers and acquisitions.

!ynergies pro#ected for M 4 &'s are not achieved in *F of cases.

ust 02F of all M 4 &'s will earn their cost of capital.

In the first si% months of a merger, productivity may fall by as much as 3*F.

7he average financial performance of a newly merged company is graded as - by the respective Managers.



In acquired companies, KF of the e%ecutives will leave the first year and 3F will leave within the first threeyears of the merger.

6;ven in situations where the acquired company is in the same line of business as the acquirer and is smallenough to allow for easy post-merger integration, the likelihood of success is only about 3*F.6

Co not despair - there is some good news in all of this 7he success rate in recent years has improved dramatically. &s more and more companies gain e%perience in the M 4 & process, they are becoming very successful. In ()),Mercer Management onsulting released a study which showed that mergers during the ())*'s substantiallyoutperformed mergers during the ()*'s.

!o let us move on and see if we can better understand the nuts and bolts behind mergers and acquisitions.

Summary

Legal and Regulatory Considerations

5hen one company decides to acquire another company, a series of negotiations will take place between thetwo companies. 7he acquiring company will have a well-developed negotiating strategy and plan in place. If the7arget ompany believes a merger is possible, the two companies will enter into a 6Jetter of Intent.6

7he Jetter of Intent outlines the terms for future negotiations and commits the 7arget ompany to giving seriousconsideration to the merger. & Jetter of Intent also gives the acquiring company the green light to move intoAhase II Cue Ciligence. 7he Jetter of Intent attempts to answer several issues concerning the proposed merger:

8ow will the acquisition price be determinedE

5hat e%actly are we acquiringE Is it physical assets, is it a controlling interest in the target, is it intellectualcapital, etc.E

8ow will the merger transaction be designedE 5ill it be an outright purchase of assetsE 5ill it be an e%changeof stockE

5hat is the form of paymentE 5ill the acquiring company issue stock, pay cash, issue notes, or use acombination of stock, cash, andor notesE



5ill the acquiring company setup an escrow account and deposit part of the purchase priceE 5ill the escrowaccount cover unrecorded liabilities discovered from due diligenceE

5hat is the estimated time frame for the mergerE 5hat law firms will be responsible for creating the M 4 & &greementE

5hat is the scope of due diligenceE 5hat records will be made available for completing due diligenceE

8ow much time will the 7arget ompany allow for negotiationsE 7he Jetter of Intent will usually prohibit the7arget ompany from 6shopping itself6 during negotiations.

8ow much compensation +referred to as bust up fees will the acquiring company be entitled to in the event thatthe target is acquired by another companyE Bnce news of the proposed merger leaks out, the 7arget ompanyis 6in play6 and other companies may make a bid to acquire the 7arget ompany.

5ill there be any operating restrictions imposed on either company during negotiationsE or e%ample, the twocompanies may want to postpone hiring new personnel, investing in new facilities, issuing new stock, etc. until themerger has been finali9ed.

If the two companies are governed by two states or countries, which one will govern the merger transactionE

5ill there be any ad#ustment to the final purchase price due to anticipated losses or events prior to the closing of themergerE

M&A AGREEMENT

&s the negotiations continue, both companies will conduct e%tensive Ahase II Cue Ciligence in an effort toidentify issues that must be resolved for a successful merger. If significant issues can be resolved and bothcompanies are convinced that a merger will be beneficial, then a formal merger and acquisition agreement willbe formulated.



7he basic outline for the M 4 & &greement is rooted in the Jetter of Intent. 8owever, Ahase II Cue Ciligence willuncover several additional issues not covered in the Jetter of Intent. onsequently, the M 4 & &greement can bevery lengthy based on the issues e%posed through Ahase II Cue Ciligence.

&dditionally, both companies need to agree on the integration process. or e%ample, a 7ransition !ervice

&greement is e%ecuted to cover certain types of services, such as payroll. 7he 7arget ompany continues tohandle payroll up through a certain date and once the integration process is complete, the acquiring companytakes over payroll responsibilities. 7he 7ransition !ervice &greement will specify the types of services,timeframes, and fees associated with the integration process.

Representations

Bne very important element within the M 4 & &greement is representation by both companies. ?oth sides mustprovide some warranty that what has been conveyed is complete and accurate. rom the buyers +acquiring firmviewpoint, full and complete disclosure is critical if the buyer is to understand what is being acquired. Ciscoveryof new issues that have been misrepresented by the seller can relieve the buyer from proceeding with themerger.

rom the seller's point of view, full disclosure requires e%tensive time and effort. &dditionally, it is difficult to coverevery possible representation as 6full and accurate.6 7herefore, the seller prefers to limit the number ofrepresentations within the M 4 & &greement. Bne way of striking the right balance is to establish materiality limits oncertain representations. 7he M 4 & &greement will also include language, such as 6to the best of the sellers

knowledge,6 in order to alleviate some representation

Indemnification

&nother important element within the M 4 & &greement is indemnification. 7he M 4 & &greement will specify thenature and e%tent to which each company can recover damages should a misrepresentation or breach of contractoccur. & 6basket6 provision will stipulate that damages are not due until the indemnification amount has reached acertain threshold. If the basket amount is e%ceeded, the indemnification amount becomes payable at either thebasket amount or an amount more than the basket amount. 7he seller +7arget ompany will insist on having a

ceiling for basket amounts within the M 4 & &greement.

!ince both sides may not agree on indemnification, it is a good idea to include a provision on how disputes willbe resolved +such as binding arbitration. inally, indemnification provisions may include a 6right of sell off6 forthe buyer since the buyer has deposited part of the purchase price into an escrow account. 7he @ight to !ell Bff allows the buyer +acquiring company to offset any indemnification claims against amounts deferred within thepurchase price of the merger. If the purchase price has been paid, then legal action may be necessary toresolve the indemnification.



Confidentiality

It is very important for both sides to keep things confidential before announcing the merger. If customers,suppliers, employees, shareholders, or other parties should find out about the merger before it is

announced, the target company could lose a lot of value: Dey personnel resign, productivity drops,customers switch to competing companies, suppliers decide not to renew contracts, etc. In an effort toprevent leaks, the two companies will enter into a onfidentiality &greement whereby the acquiring firmagrees to keep information learned about the 7arget ompany as confidential. !pecifically, the onfidentiality

&greement will require the acquiring firm to:

Not contact customers, suppliers, owners, employees, and other parties associated with the 7arget ompany.

Not divulge any information about the target's operating and financial plans or its current conditions.

Not reproduce and distribute information to outside parties.

Not use the information for anything outside the scope of evaluating the proposed merger.

M & A Closing

Bnce all issues have been included and addressed to the satisfaction of both companies, the merger andacquisition is e%ecuted by signing the M 4 & &greement. 7he buyer and the seller along with their respectivelegal teams meet and e%change documents. 7his represents the closing date for the merger and acquisition.7he transaction takes place through the e%change of stock, cash, andor notes. Bnce the agreement has beenfinali9ed, a formal announcement is made concerning the merger between the two companies.

It should be noted that due diligence e%tends well beyond the closing date. 7herefore, actual payment may bedeferred until legal opinions can be issued, financial statements audited, and the full scope of Ahase II Cue

Ciligence can be completed. It is not uncommon for many conditions to remain open and thus, the M 4 & &greement may require amendments to cover the results of future due diligence.

The Regulatory Environment



!o far, we have discussed the overall process for mergers and acquisitions as well as some important legaldocuments. 5e now need to understand some of the regulations that can affect the merger and acquisition. Inthe $nited !tates, regulations can be divided into three categories: !tate Jaws, ederal &nti-7rust Jaws, andederal !ecurity Jaws. !ince discussion of state law is beyond the scope of this course, we will focus on federal

related laws. 7he ederal 7rade ommission +7 and the $.!. ustice Cepartment +$!C administer federalanti-trust laws. 7he !ecurities and ;%change ommission +!; administers federal security laws forcompanies registered with the !;.

Anti Trust Laws

Bne of the most important federal laws is !ection of the layton &ct which stipulates that a merger cannotsubstantially lessen competition or result in a monopoly. In determining if a merger is anti-competitive, federalagencies will look at the markets served and the type of commerce involved. !everal factors are considered,

such as si9e of market, number of competing companies, financial condition of companies, etc.

7he si9e of the newly merged company in relation to the market is very important. 7he $!C uses an acid test knownas the 8erfindahl-8irshman Inde% +88I to determine if action should be taken to challenge the merger. 7he 88Imeasures the impact the merger will have on increased concentration within the total marketplace. 88I is calculatedby summing the squares of individual market shares for all companies and categori9ing market concentration intoone of three categories. 7he three categories are:

Jess than (***: $nconcentrated market, merger is unlikely to result in anti-trust action.

(*** - (**: Moderate concentration. If the change in the 88I e%ceeds (** points, there could be concentration inthe marketplace.

&bove (**: 8ighly concentrated market. If the change in the 88I e%ceeds 3* points, there are significant anti-trustconcerns.

Example

Cetermine if a merger will raise anti-trust actions based on the 88I.

!i% companies compete in the retail home ;lectronics in the electronics market. 7he si% companies have marketshares of:



Ikon

3F

&ftron

3F

!ony

0*F

!amsung

3*F

Ahilips

3F

7oshiba

(3F

&ftron and Ahilips have decided to merge. 5ill this merger be viewed as anti-competitive based on the 88IE

Example

Step 1 - alculate Are Merger 88I:

Step 2 - alculate Aost Merger 88I:

Ikon

3 % 3 >

03

Ikon

03

&ftron

3 % 3 >

03

&ftron Ahilips

(**

!ony

0* % 0* >

K**

!ony



K**

!amsung

3* % 3* >

03**

!amsung

03**

Ahilips

3 % 3 >

03

7oshiba

003

7oshiba

(3 % (3 >

003

Are Merger 88I

20**

Aost Merger 88I

203*

Step : alculate change in points, compare to 88I categories. 203* - 20** > 3* point change within third

category. 7he 88I is above (** points and the point change is right at the threshold for significant concern. &ftron and Ahilips should be prepared to defend their merger as not reducing competition.

Notifying to FTC and !"D



7he 7 +ederal 7rade ommission and the $!C +$nited !tates ustice Cepartment become involvedwithin the merger and acquisition process by way of the 6(/ Aage orm.6 7he (/ Aage orm is filed with the7 and $!C whenever a merger involves one company with 1 (** million or more in assets or sales and theother company has 1 (* million or more in assets or sales and the transaction involves an offer of 1 (3 million or more in assets or stock or the transaction involves more than 3*F ownership of a company with 1 (3 million ormore in assets or sales.

7he (/ Aage orm requires disclosure concerning the type of transaction and a description of both companies.7he (/ Aage orm is filed by the acquiring company when it announces its tender offer to acquire the 7argetompany. Jikewise, the 7arget ompany must file a (/ Aage orm within (3 days of the filing by the acquiringcompany.

Security La!s

ompanies registered with the !ecurities and ;%change ommission +!; must deal with several scheduleswhenever a merger takes place. & full discussion of all regulatory requirements is beyond the scope of thiscourse. In any event, here are some highlights that affect many mergers:

orm D: 5henever a company acquires in e%cess of (*F of book values of a registered company, the !;must be notified on orm D within (3 days.

!chedule (2C: 5henever someone acquires 3F or more of the outstanding stock of a public company, theacquisition must be disclosed on !chedule (2C. !i% copies of !chedule (2C must be filed with the !; within(* days of acquiring the stock. & registered copy must be sent to the 7arget ompany.

!chedule (2<: !hort version of !chedule (2C for cumulative buildup of 3F. If during the last (0 months, nomore than 0F of the outstanding stock was acquired and there is no intention of controlling the company, thepurchase may be disclosed on !chedule (2< in lieu of !chedule (2C.

!chedule (KC-( +7ender Bffer !tatement: 5hen a company makes a tender offer to acquire the stock ofanother company, the acquiring company must file a 7ender Bffer !tatement +7B on !chedule (KC-(. 7he7B must disclose:

Name of target company

Cescription of securities purchased



&ny past contact with the target company

!ource of funds to acquire the stock

Cescription of plans to change the target company, such as selling off assets.

omplete set of financial statements of the acquiring company

;%hibits related to financing of the stock purchase

In cases where a hostile takeover attempt is involved, it is not unusual for the 7arget ompany to contest the

7B. or e%ample, the 7arget ompany may argue that the acquiring firm lacks the necessary financing tocomplete the tender offer.

Bnce the acquiring firm has announced the tender offer, it has 3 days to file the 7B!. 7he acquiring firm musthand deliver a copy to the 7arget ompany and any other company that is engaged in acquiring the targetcompany. & copy must also be sent to all e%changes where the 7arget ompany's stock is traded.

!chedule (KC-): 7he target company is required to respond to the 7B! on !chedule (KC-) within (* days ofcommencement of the tender offer. !chedule (KC-) must disclose the target company's intentions regarding the tender

offer - accept, re#ect, or no action.

It should be noted that tender offers must remain open for at least 0* days per the 5illiams &ct. &lso, if othercompanies decide to bid for the 7arget ompany, the tender offer period is sub#ect to an e%tension for aminimum period of (* days from the date of other tender offers.

;%ample 0 - ;%tension of 7ender Bffer Aeriod

Bn anuary (, ()), 7ri-!tar made a tender offer to acquire Jipco. 7he tender offer will e%pire in 0* days onanuary 0*, ()). Bn anuary (, ()), another company, !elmer, made a tender offer to acquire Jipco. 5hatis the new closing date for 7ri-!tar's tender offerE

!ince a minimum period of (* days is required for all tender offers, 7ri-!tar's offer period is e%tended by another days to cover the (* day minimum. 7he new closing date is now anuary 0, ()).



Accounting Principles

Bne last item that we should discuss is the application of accounting principles to mergers and acquisitions.urrently, there are two methods that are used to account for mergers and acquisitions +M 4 &:

Aurchase: 7he M 4 & is viewed prospectively +restate everything and look forward by treating the transaction asa purchase. &ssets of the 7arget ompany are restated to fair market value and the difference between theprice paid and the fair market values are posted to the ?alance !heet as goodwill.

Aooling of Interest: 7he M 4 & is viewed historically +refer back to e%isting values by combining the book values ofboth companies. 7here is no recognition of goodwill. It should be noted that Aooling of Interest applies to M 4 &'s thatinvolve stock only.

In the good old days when physical assets were importantL the Aurchase Method was the leading method for M 4 &accounting. 8owever, as the importance of intellectual capital and other intangibles has grown, the Aooling of Interest

Method is now the dominant method for M 4 & accounting. 8owever, therein lies the problem. ?ecause intangibleshave become so important to businesses, the failure to recogni9e these assets from an M 4 & can seriously distortthe financial statements. &s a result, the inancial &ccounting !tandards ?oard has proposed the elimination of theAooling of Interest Method. If Aooling is phased out, then it will become much more important to properly arrive at fair market values for the target's assets.

NB7;: Most &dvanced &ccounting te%tbooks will provide comprehensive information about accounting formergers and acquisitions. & full treatment of this topic is beyond the scope of this !hort ourse. @eaders areadvised to refer to an &dvanced &ccounting te%tbook for more information about M 4 & &ccounting.

"ue "iligence

7here is a common thread that runs throughout much of the M 4 & Arocess. It is called Cue Ciligence. Cuediligence is a very detail and e%tensive evaluation of the proposed merger. &n over-riding question is - 5ill thismerger workE In order to answer this question, we must determine what kind of 6fit6 e%ists between the twocompanies. 7his includes:

Investment it - 5hat financial resources will be required, what level of risk fits with the new organi9ation, etc.E

!trategic it - 5hat management strengths are brought together through this M 4 &E ?oth sides must bringsomething unique to the table to create synergies.



Marketing it - 8ow will products and services compliment one another between the two companiesE 8ow welldo various components of marketing fit together - promotion programs, brand names, distribution channels,customer mi%, etcE

Bperating it - 8ow well do the different business units and production facilities fit togetherE 8ow do operating

elements fit together - labor force, technologies, production capacities, etc.E

Management it - 5hat e%pertise and talents do both companies bring to the mergerE 8ow well do theseelements fit together - leadership styles, strategic thinking, ability to change, etc.E

inancial it - 8ow well do financial elements fit together - sales, profitability, return on capital, cash flow, etc.E

Cue diligence is also very broad and deep, e%tending well beyond the functional areas +finance, production,human resources, etc.. 7his is e%tremely important since due diligence must e%pose all of the ma#or riskassociated with the proposed merger. !ome of the risk areas that need to be investigated are:

Market - 8ow large is the target's marketE Is it growingE 5hat are the ma#or threatsE an we improve it through amergerE

ustomer - 5ho are the customersE Coes our business compliment the target's customersE an we furnishthese customers new services or productsE

ompetition - 5ho competes with the target companyE 5hat are the barriers to competitionE 8ow will a mergerchange the competitive environmentE

Jegal - 5hat legal issues can we e%pect due to an M 4 &E 5hat liabilities, lawsuits, and other claims areoutstanding against the 7arget ompanyE

&nother reason why due diligence must be broad and deep is because management is relying on the creation of

synergy values. Much of Ahase I Cue Ciligence is focused on trying to identify and confirm the e%istence ofsynergies between the two companies. Management must know if their e%pectation over synergies is real orfalse and about how much synergy can we e%pectE 7he total value assigned to the synergies givesmanagement some idea of how much of a premium they should pay above the valuation of the 7argetompany. In some cases, the merger may be called off because due diligence has uncovered substantially lesssynergies then what management e%pected.



Making Due Diligence work

!ince due diligence is a very difficult undertaking, you will need to enlist your best people, including outsidee%perts, such as investment bankers, auditors, valuation specialist, etc. <oals and ob#ectives should beestablished, making sure everyone understands what must be done. ;veryone should have clearly defined rolessince there is a tight time frame for completing due diligence. ommunication channels should be updatedcontinuously so that people can update their work as new information becomes availableL i.e. due diligencemust be an iterative process. 7hroughout due diligence, it will be necessary to provide summary reports tosenior level management.

Cue diligence must be aggressive, collecting as much information as possible about the target company. 7hismay even require some undercover work, such as sending out people with false identities to confirm criticalissues. & lot of information must be collected in order for due diligence to work. 7his information includes:

orporate @ecords: &rticles of incorporation, by laws, minutes of meetings, shareholder list, etc.

inancial @ecords: inancial statements for at least the past 3 years, legal council letters, budgets, assetschedules, etc.

7a% @ecords: ederal, state, and local ta% returns for at least the past 3 years, working papers, schedules, correspondence,etc.

@egulatory @ecords: ilings with the !;, reports filed with various governmental agencies, licenses, permits,decrees, etc.

Cebt @ecords: Joan agreements, mortgages, lease contracts, etc.

;mployment @ecords: Jabor contracts, employee listing with salaries, pension records, bonus plans, personnelpolicies, etc.

Aroperty @ecords: 7itle insurance policies, legal descriptions, site evaluations, appraisals, trademarks, etc.

Miscellaneous &greements: oint venture agreements, marketing contracts, purchase contracts, agreementswith Cirectors, agreements with consultants, contract forms, etc.

<ood due diligence is well structured and very pro-activeL trying to anticipate how customers, employees,suppliers, owners, and others will react once the merger is announced. 5hen one analyst was asked about the



three most important things in due diligence, his response was 6detail, detail, and detail.6 Cue diligence mustvery in-depth if you e%pect to uncover the various issues that must be addressed for making the merger work.

What can go wrong

ailure to perform due diligence can be disastrous. 7he reputation of the acquiring company can be severelydamaged if an announced merger is called-off. or e%ample, the merger between @ite &id and @evco failed toanticipate anti-trust actions that required selling off retail stores. &s a result, e%pected synergies could not bereali9ed. 5hen asked about the merger, rank ?ergon9i, hief inancial Bfficer for @ite &id remarked: 6Gouspend a lot of money with no results.6

& classic case of what can wrong is the merger between 8! Inc and $ International. our months after themerger was announced, it was disclosed that there were significant accounting irregularities. $pon the news,the newly formed company, endant, lost 1 (K billion in market value. ?y late ()), endant's hairman hadresigned, investors had filed over 3* lawsuits, and nine of fourteen Cirectors for $ had resigned. &nd in theyear 0***, ;rnst 4 Goung was forced to settle with shareholders for 1 223 million.

onsequently, due diligence is absolutely essential for uncovering potential problem areas, e%posing risk andliabilities, and helping to ensure that there are no surprises after the merger is announced. $nfortunately, intoday's fast-paced environment, some companies decide to by pass due diligence and make an offer based on

competitive intelligence and public information. 7his can be very risky.

@esults of a !urvey on Cue Ciligence by ?ra%ton &ssociates:

Curation of Cue Ciligence - !uccessful Mergers K to / months

Curation of Cue Ciligence - ailed Mergers 0 to 2 months

Reworking the Financials

ertainly one goal of due diligence is to remove distortions from the financial statements of the targetcompany. 7his is necessary so that the acquiring company can ascertain a more realistic value for thetarget. 7here are several issues related to the ?alance !heet:



$nderstatement of liabilities, such as pensions, allowances for bad debts, etc.

Jow quality assets - what are the relative market values of assetsE !ome assets may be overvalued.

8idden liabilities, such as contingencies for lawsuits not recogni9ed.

Bverstated receivables - receivables may not be collectable, especially inter-company receivables.

Bverstated inventories - rising levels of inventory over time may indicate obsolescence and lack ofmarketability. JIB reserves can also distort inventories.

"aluation of short-term marketable securities - If the 7arget ompany is holding marketable securities,are they properly valuedE If the target is holding investments that are not marketable, are theyoverstatedE

Intangibles - ertain intangibles, such as brand names, may be seriously undervalued.

<enerally, you should e%pect to see significant differences between book values and market values. Ifthe two are not substantially different, then due diligence should dig deeper to ensure there is nomanipulation of values. Jikewise, the Income !tatement should consist of 6quality6 earnings. 7hecloser you are to 6cash6 earnings and not 6accrual6 type earnings, the higher the integrity of theIncome !tatement.

!ince mergers are often aimed at cutting cost, due diligence might result in several upwardad#ustments to earnings for the 7arget ompany. 7his is especially true where the target is a privatecompany where e%cesses are common. 8ere are some e%amples:

Bfficer's salaries are e%cessive in relation to what they do.

If salaries are high, then pensions will be high.

?onuses, travel, and other perks are e%cessive.

"ehicles and other assets are unnecessary.

amily members are on the payroll and they play no role in running the business.

onsultants with strong ties to management are providing unnecessary services.



7he ob#ective is to get back to real values and real profits that will e%ist after the merger. Bnce allnecessary ad#ustments have been made, a forecast can be prepared.

Going Beyond the Financials

&s we previously noted, due diligence must be broad and deep. 7his includes things like cultural andhuman resource issues. It is these types of 6people6 issues that will be e%tremely important when it comestime to actually integrate the two companies. 7herefore, due diligence helps set the foundation for post-merger integration.

ultural due diligence looks at corporate cultures and attempts to ascertain an organi9ational fitbetween the two merging companies. ;ach company will have its own culture, derived from severalcomponents - corporate policies, rules, compensation plans, leadership styles, internal

communication, physical work environment, etc. ultural due diligence attempts to answer thequestion - 7o what e%tent can the two companies change and adopt to differences between the twocorporate culturesE 7he wider the cultural gap, the more difficult it will be to integrate the twocompanies. onsequently, cultural due diligence identifies issues that are critical to integration andhelps management plan necessary actions for resolving these differences before the merger isannounced.

8uman resource due diligence attempts to evaluate how people are managed between the twocompanies. !everal issues need to be analy9ed:

8ow do we continue to ma%imi9e the value of human resource capitalE

5hat is the appropriate mi% of pay and benefits for the new organi9ationE

5hat incentive programs are needed to retain essential personnel after the merger is announcedE

8ow are employees rewarded and compensated by the 7arget ompanyE

8ow does base pay compare to the marketplaceE

8ow do we merge pension plans, severance pay, etc.E

It is very important to get your 8uman @esource Cepartment involved in the merger and acquisitionprocess early on since they have strong insights into cultural and human resource issues. ailure toaddress cultural, social, and human resource issues in Ahase II Cue Ciligence is a ma#or reasonbehind failed mergers. &s one e%ecutive said: 65e never anticipated the people problems and how



much they would prevent integration.6 7herefore, make sure you include the 6people6 issues in AhaseII Cue Ciligence +which kicks-in once the Jetter of Intent is signed.

In an era of widespread acknowledgement that mergers entail disproportionate risks and failures, the

surprising fact is not that 6culture6 should become such a critical issue during integration, rather what issurprising is that organi9ational culture and other issues essential to integration have not yet becomemore central to e%ecutive-level deal making.

Re#erse Mergers

?efore we leave due diligence and dive into valuations +covered in part 0 of this short course, one areathat warrants special attention when it comes to due diligence is the @everse Merger. @everse mergers area very popular way for small start-up companies to 6go public6 without all the trouble and e%pense of anInitial Aublic Bffering +IAB. @everse mergers, as the name implies, work in reverse whereby a smallprivate company acquires a publicly listed company +commonly called the !hell in order to quickly gainaccess to equity markets for raising capital. 7his approach to capitali9ation +reverse merger is commonpractice with internet companies like stamps.com, photoloft.com, etc.

or e%ample, ichargeit, an e-commerce company did a reverse merger with Aara-Jink, a publicly listeddistributor of diet products. &ccording to esse ohen, ;B of ichargeit, an IAB would have cost us 12 - 3 million and taken over one year. Instead, we acquired a public company for 1 2**,*** and issuedstock to raise capital.

7he problem with reverse mergers is that the !hell ompany sells at a serious discount for a reasonL itis riddled with liabilities, lawsuits, and other problems. onsequently, very intense due diligence isrequired to 6clean the shell6 before the reverse merger can take place. 7his may take si% months.

&nother problem with the !hell ompany is ownership. heap penny stocks are sometimes pushed bypromoters who hold the stock in 6street name6 which mask's the true identity of owners. Bnce thereverse merger takes place, the promoters dump the stock sending the price into a nose-dive.7herefore, it is absolutely critical to confirm the true owners +shareholders of shell companies involvedin reverse mergers

Conclusion



Mergers and acquisitions are among the most difficult of business transactions. 7here is no shortageof stress. &ll of a sudden a new company must be formed with:

Newer and more ambitious financial goals.

Ouicker turnaround times for growth.

@estructuring of departments and the old company.

Introduction of cultural differences.

8igher rates of employee turnover.

Jower levels of productivity.

ommunication problems.

7here are numerous reasons why companies decide to merge. !ome studies indicate that companiesmerge for improving efficiencies and lowering costs. Bther studies show that companies merge toincrease market share and gain a competitive advantage. 7he ultimate goal behind a merger andacquisition is to generate synergy values. <ood strategic planning is the key to understanding ifsynergy values do in fact e%ist. & well-researched and realistic plan will dramatically improve the

chances of reali9ing synergy values.

!everal legal documents will solidify the merger and acquisition process, including a Jetter of Intent,which scrutini9es the proposed merger and the Merger 4 &cquisition &greement, which finali9es thedeal.

Mergers are also sub#ect to government regulation. Bne such regulation is anti-trust which attempts toprevent companies from forming a monopoly. In a competitive marketplace, companies sell products andservices where prices equal marginal costs. 7his results in an industry characteri9ed by low prices and high

levels of production. &n industry characteri9ed by a monopoly allows the company to produce at lowerlevels and higher prices to the customer.

7he main control within the merger and acquisition process is Cue Ciligence. Cue diligence obtains asmuch information as possible about the target company and attempts to build a comparison betweenthe target company and the acquiring company to see if there is a good fit. If there is a good fit, thereis the possibility that a merger between the two companies will improve growth, market share,earnings, etc. Bne area that should not be overlooked is social and cultural issues. 7hese 6people6



related issues will become e%tremely important when it comes time to actually combine or integrate thetwo companies.

@eferences

(. 7he &rt of Merger and &cquisition Integration, &le%andra @eed Ja#ou%0. 7he omplete <uide to Mergers and &cquisitions, the authors 7imothy . <alpin and Mark

8erndon

<alpin and 8endon in their book 7he omplete <uide to Mergers and &cquisitions

3 Measuring and Managing the "alue of ompanies

