Veritas Financial Group Introduction to the Financial Universe Week 2 – Mergers and Acquisitions

Review from last week / Today’s focus cash Investors Secondary markets Government securities Cash flow reinvest tax Corporation dividends, etc. Today’s discussion

Today’s Agenda – M&A What are Mergers and Acquisitions? Why do companies enter M&A deals? How do they pay for these deals? Case Example: Kraft-Cadbury deal What role does the investment bank play in M&A transactions? How do companies figure out how much to pay?

Refresh: Intro to the Banking System Retail Banks Universal Banks Investment Banks* Commercial Banks

Introduction to the Banking System Arranging Financing Advising on M&A Client: Corporations Financial Sponsors Governments Large non-profits Services Equity Debt Convertible Securities Client: Corporations Financial Sponsors Services Advising Buyer Advising Seller

M&A: What is it? An acquisition takes place when one company acquires a smaller one A merger takes place when two companies or relatively equal size form one larger company. Under current law, all mergers are technically acquisitions. One company is always the “surviving” company, even if it is a merger of equals.

Why complete a M&A deal? Source: Wikipedia

What are they actually buying? Shareholders Equity = Assets – Liabilities Assets = Liabilities + Shareholders Equity The Big Picture: - Mergers and Acquisitions enable a company to get ownership of another company - There are many reasons a company might want to do this The Big Picture: - Mergers and Acquisitions enable a company to get ownership of another company - There are many reasons a company might want to do this

Clarification: Public versus Private Public Companies Private Companies Refers to Equity Ownership Equity, in the form of shares, is split up and listed in a stock exchange Shares are made available to the public The ‘shareholders’ own a small piece of the company If own voting shares, get a vote on corporate affairs Also refers to Equity ownership Equity is owned in chunks by founders, individuals, investors Ownership is more concentrated and controlled Not traded on the stock market

Clarification: Public versus Private M&A can be done in many forms: A public company with another public company A private company ‘taking over’ or merging with a public company A public company ‘taking over’ or merging with a private company A private company and a private company An acquisition by an investment firm

Why complete a M&A deal? Financial Reasons Investment will produce attractive return Strategic Reasons Growth Access to new markets Access to new products Synergies Cost and revenue Eliminate competitors Source: Wikipedia

Revenue Synergies Allow the merged company to take in more money than the sum of the two prior companies, all at the same costs. Example: Bank of America buys MBNA (credit card firm) BofA markets cards in its branches, so revenue increases with only a minimal increase in costs.

Overly Simplified Hypothetical BofA sells no credit card products MBNA has 1 million credit accounts BofA buys MBNA and sells MBNA legacy products to BofA customers using existing branches, tellers, etc. BofA subsequently sells 500,000 cards. This is a revenue synergy.

Cost Synergies Allow the merged company to reduce costs below the total costs of the two prior companies, but without experiencing a drop in revenue. Example: Coca-Cola buys Vitaminwater Coca-Cola shuts down/sells Vitaminwater distribution network Coca-Cola then uses its existing distribution and marketing network to sell Vitaminwater products. Goal: eliminate redundancy.

Question If a company is worth $10 billion, would you ever pay $15 billion for it?

Synergies and the Deal Premium Deal Value - Market Value = Deal Premium A deal premium may be due to synergy potential If the company is worth $10 billion, but the synergies are worth $5 billion, as long as the company pays less than $15 billion, it will come out ahead.

Synergies and Deal Premium: Illustration Market Value$10.0 billion Expected Revenue Synergies$2.5 billion Expected Cost Synergies$2.5 billion Expected Total Synergies$5.0 billion Bid PriceMarket ValueDeal PremiumValue to bidder $10.0 billion $0.0$5.0 billion $11.0 billion$10.0 billion$1.0 billion$4.0 billion $12.0 billion$10.0 billion$2.0 billion$3.0 billion $13.0 billion$10.0 billion$3.0 billion$2.0 billion $14.0 billion$10.0 billion$4.0 billion$1.0 billion $15.0 billion$10.0 billion$5.0 billion$0.0 billion $16.0 billion$10.0 billion$6.0 billion-$1.0 billion

How do companies pay for M&A deals? Stock Better for shareholders if there is confidence in the deal Shareholders expectations still high Cash or Debt Better for shareholders if the deal is shaky Easier to close if there is opposition Difficult to raise cash Most deals are paid by both shares-issuance and cash

Case Study: Kraft and Cadbury Largest European food and beverage deal on record Why might Kraft and Cadbury want to merge? Synergies! Cadbury has strong growth in emerging markets, like India and Latin America. Kraft (Oreo cookies and Philadelphia cream cheese) derives over half its sales from the mature North American market

Case Study: Kraft and Cadbury Kraft was advised by Lazard, Citi, Deutsche Bank and Centerview Partners Cadbury was advised by Goldman Sachs, Morgan Stanley and UBS. The Deal: The cash-and-stock agreement Valued each Cadbury share at 840 pence Split between 500p of cash and new Kraft shares

Role of Banks in M&A Transactions Primary role of banks is to advise clients on both sides of deals Valuation How much should we pay? How much should we accept? Price depends on synergies. Bankers spend months scouring the ‘books’ for synergies. Consultants often assist with synergies and PMI Banks also help arrange financing

The Pitchbook Main output from Bankers Can Include: Executive Summary Bank’s Experience Market and Company Positioning Valuation (Potential Buyers) (Financing)

Valuation Three common ways to analyze ‘value’ Generally all three are taken into account Discounted Cash Flow (“DCF”) “Present Value” of how much cash this company generate in the future Comparable market values (“Comps”) What are peers trading at? Past transactions multiples How much have another companies paid in the past?

What is a DCF? Discounted Cash Flow: A way of valuing an asset or company through the concept of time value of money Would you rather have a dollar today or a dollar tomorrow?

What is present value? Would you rather have a dollar today or a dollar tomorrow? You should always value a dollar today over a dollar tomorrow This is because something might happen before you get the dollar tomorrow So, dollars in the future are worth less than a dollar today If you want to give me dollars in the future, I will need to be compensated somehow for taking on this risk This is the concept behind “present value”

What is a DCF? Every DCF analysis needs two things: Projected cash flows A discount rate

What is a DCF? Let’s go to the Excel…

What is a DCF? To get to the present value, you need a discount rate A discount rate is interest rate used to calculate the present value of the cash flows Rate of compensation that you need to receive be willing to have money in the future versus receiving it today The discount rate can be subjective Weighted Average Cost of Capital (WACC) Capital Asset Pricing Model (CAPM) Market based Discount RatePresent Value 12%$1,039 10%$1,104 8%$1,175 6%$1,253 4%$1,338 2%$1,432 0%$1,536

Leading Investment Banks for M&A Bulge-Bracket Firms 2010 Global M&A League Tables Goldman, Sachs & Co. Bank of America Merrill Lynch JPMorgan Chase & Co. Morgan Stanley Citi Boutique Firms Lazard Greenhill & Company Perella Weinberg Moelis & Company William Blair Firm Deal Value Deal Count 1. Goldman Sachs $399.2bn Morgan Stanley $355.1bn JPMorgan $353.1bn Credit Suisse $274.8bn BofA Merrill Lynch $263.4bn Deutsche Bank $250.5bn Barclays Capital $236.0bn UBS $203.9bn Lazard $180.7bn Citi $180.3bn130

In the News: PPD LBO Why are the largest private equity deals in 2011 so much smaller than they were in 2007? Many of the biggest PE deals in the last two years have been in the healthcare industry, why do you think that is? Carlyle and H&F paid a 30% premium for the stock, why do you think they feel comfortable doing this?