Introduction P.V. Viswanath Class Notes for FIN 648: Mergers and Acquisitions

P.V. Viswanath2 Mergers and Other Combinations  Merger is a combination of two corporations in which only one corporation survives.  The surviving firm assumes all the assets and liabilities of the merged company.  In an acquisition, the buyer purchases some or all of the assets or the stock of the selling firm.  If the stock of the selling firm is acquired, typically a controlling interest is obtained.  Notwithstanding the above definitions, the terms merger and acquisition are often used loosely to refer to any combination.

P.V. Viswanath3 Hostile and Friendly Combinations  The active firm is usually called the acquirer, and the passive one, the target. Usually the acquirer is larger than the target; and, usually, the acquirer survives, while the target ceases to exist upon completion of the merger.  Often, one company tries to acquire another against the will of the target company’s management and board. This is usually referred to as a takeover.  Often this is done through a tender offer. A tender offer is where an acquirer makes a direct offer to the shareholders of the target firm to buy up their shares for a given price.

P.V. Viswanath4 Economic Classification  Horizontal mergers are combinations between two competitors. For example, Pfizer’s acquisition of Warner Lambert in  Vertical mergers are deals between companies that have a buyer and seller relationship with each other. For example, Merck’s acquisition of Medco Containment Services in  A conglomerate deal is a combination of two companies that do not have a business relationship with each other. For example, General Electric’s acquisition of Kidder Peabody in 1986.

P.V. Viswanath5 Regulatory Framework  When there is a significant event, such as a M&A above a certain size, companies must file a Form 8K.  Hirsch International Corp. 8K dated July 20, 2005  On July 20, 2005, we entered into a definitive merger agreement concerning the previously announced merger with Sheridan Square Entertainment, Inc., a privately-held producer and distributor of recorded music, and SSE Acquisition Corp., our wholly owned subsidiary. Upon the terms and conditions set forth in the merger agreement, SSE Acquisition Corp. will be merged with and into Sheridan Square, and Sheridan Square will survive the merger as our wholly-owned subsidiary. Post-merger, the embroidery equipment distribution business and music business will operate as separate independent divisions.

P.V. Viswanath6 Securities Acts  Securities Act of 1933 required the registration of securities to be offered to the public.  Securities Exchange Act of 1934 established the Securities and Exchange Commission that was charged with enforcing federal securities law.  There have been many amendments to the Securities Acts The Williams Act, passed in 1968 regulates tender offers

P.V. Viswanath7 Tender Offer Regulation  Section 13(d) requires that if an entity acquires 5% or more of a company’s shares, it must file a Schedule 13D within 10 days of reaching the 5% threshold.  The Schedule 13D includes information regarding the identity of the acquirer, its intentions and the purpose of the transaction – e.g. if it intends to launch a hostile takeover, or if the securities are being acquired for investment purposes.  This is important for shareholders who may not want to sell their shares if there is a bidder who is about to make an acquisition bid that would usually mean a higher stock price (including a takeover premium).

P.V. Viswanath8 Tender Offer Regulation  Section 14(d) gives information to target company shareholders that they can use to evaluate a tender offer.  It requires that the bidder wait 20 days before completing purchase of the shares.  During that period other bidders may come forward with competing bids.  This might lead to an extension of the original waiting period.  From the viewpoint of a potential acquirer, this could lead to a higher price having to be paid for a target; it could effectively lead to an auction situation.

P.V. Viswanath9 Why a takeover premium?  When there is a takeover, there is often a transfer of control, or, at least, a major change in the way that the firm is being run.  The acquirers believe that such changes will increase the value of the firm substantially.  Given the Williams Act and the natural operation of the market, the acquirers are forced to share their gains with target shareholders.  Another reason is that existing management will probably lose out, in terms of their human capital. Consequently, they are likely to resist. A higher takeover price is required to forestall or counter such resistance, as well.

P.V. Viswanath10 Insider Trading Laws  The possibility of large takeover premiums in takeovers makes advance information valuable. While an acquirer might be less able to obtain enough shares in the target to complete the acquisition by stealth, a single individual might very well be able to trade with uninformed target shareholders.  This is, nevertheless, unfair to the shareholders who sell out too early.  One might argue that an acquirer who has a better plan to use target company assets should be able to benefit from foresight. However, there is no economic rationale why acquiring firm officers (or other insiders) should be able to benefit from trading on insider information.

P.V. Viswanath11 Antitrust Laws  The Sherman Antitrust Act was passed in 1890 to prevent anticompetitive activities.  Section One addresses monopolies and tries to limit a firm’s ability to monopolize an industry.  Section Two seeks to prevent combinations from engaging in business activities that limit competition.  The Clayton Act of 1914 regulated anticompetitive mergers.  The Federal Trade Commission Act created the Federal Trade Commission, which, inter alia, enforces competition laws along with the Justice Department.  The Hart-Scott-Rodino Antitrust Improvements Act of 1976 requires that firms engaged in mergers provide sales and shipments data to the Justice Dept and the FTC. Such information can prospectively prevent anti-competitive mergers.

P.V. Viswanath12 Antitakeover Laws  Fair Price Laws – all shareholders in tender offers must receive a fair price (prevents two-tier tender offers).  Business Combination Statutes – prevent unwanted bidders from taking control of the target company’s assets unless it acquires a minimum number of shares, e.g. 85%.  Control share provisions – target company shareholders must approve before the bidder can acquire shares.  Cash-out statutes – a bidder must purchase shares of the shareholders whose stock may not have been purchased by a bidder, if such purchase provides bidder with control in the target. This prevents target shareholders from being unfairly treated by a controlling shareholder.

P.V. Viswanath13 Hostile Takeovers  Refers to the taking control of a corporation against the will of its management and/or directors.  Sometimes this opposition is bad for shareholders, sometimes it’s good.  The target might object to the acquisition, so as to attract other bidders and raise the premium.  Management might object, because they are likely to lose their jobs.

P.V. Viswanath14 Hostile Takeover  In a friendly takeover, the bidder would contact target company management  If this contact is rejected, the bidder can: Go to the Board of Directors Go to shareholders directly through a tender offer Engage in a proxy fight – bidder tries to get enough votes to throw out the current board of directors and their managers. The insurgent then presents its own proposals.

P.V. Viswanath15 Takeover Defenses  File a suit alleging antitrust violations.  Get white knights – friendly bidders.  Preventive Takeover defenses: Poison pill/ Shareholder rights plans Greenmail Supermajority Provisions Dual Capitalizations

P.V. Viswanath16 Poison Pill Example  As reported in the Wall Street Journal of Feb. 11, 2000  American Homestar Corp. said its board approved a poison-pill anti-takeover measure that gives shareholders the right to purchase shares at a discount in the event of an attempt to acquire the company. The manufactured-housing company said the plan is triggered when a person or group acquires 15% or more of its common stock.