1. Chapter 16 Acquisitions and selling a business
Corporate Financial Strategy 4th edition
Dr Ruth Bender
Chapter 16 Acquisitions and selling a business

2. Acquisitions: contents
Learning objectives
Some reasons for making an acquisition
Relating synergies to value drivers
Synergy checklist
Adding value in an acquisition
Classifying synergies
Illustrative due diligence
Financing the acquisition with cash
Financing the acquisition with shares
Buying a company for shares – some issues
Buying a company for cash – some issues
Acquisition strategies to enhance eps
Financing the deal – who gets what?
Financing strategy – regardless of the acquisition
Earn-outs and deferred consideration
Some defence strategies
Indicative sales process

3. Acquisitions: learning objectives
Understand how and why companies make acquisitions.
Critically evaluate the synergies claimed for an acquisition, and how they affect the valuation of the target business.
Explain the different ways in which an acquisition can be financed, and understand how to select the most appropriate funding strategy.
Appreciate the governance and finance issues surrounding hostile bids.
Identify situations where an earn-out might be of use, and explain the advantages and disadvantages of this deal structure.
Outline some key areas of consideration in the sale of a business.

4. Some reasons for making an acquisition
 Support strategy
Complement strategy by adding in: products, markets, risk reduction, supply of raw materials, geographic expansion, etc.
 Grow the business
Support growth that can’t be achieved organically
 Frustrate competitors
Make an acquisition in order to prevent a competitor doing so
 Show better profits
Manipulating published financial results can improve appearance but does not add shareholder value
 Managerial utility
Acquisitions are quite good fun!

5. Relating synergies to value drivers
Examples of some possible synergies
Increase sales growth
Use Target distribution network for Bidder products, or vice versa.
Complementary products can increase volumes for both.
Increase operating profit margin
Cost efficiencies (e.g. economies of scale or scope, or better procurement practices).
Increase selling prices, e.g. due to economies of scope.
Reduce cash tax rate
More tax-efficient location of operations.
Reduce incremental investment in capital expenditure
Combine operations and sell off surplus assets.
Reduce investment in working capital
Combine operations and reduce inventories.
Increase time period of competitive advantage
Strengthened branding or R&D from the business combination.
Reduce cost of capital
Should only occur if one of the companies is not already financed in the most efficient manner.

6. Synergy checklist Strategic Financial Operational
Which of the value drivers will be affected by this transaction?
In which direction?
Why?
Financial
By how much will it change?
When will this happen?
Operational
What critical success factors need to be in place to ensure this happens?
What needs to be measured?
Who is responsible for making it happen?

7. Adding value in an acquisition
Working capital
Deal costs
Cost efficiencies
Zone of negotiation
Increased sales
Value to Vendor
Value to Acquirer
Maximum to pay

8. Classifying synergies
Synergies that any bidder could realize
(E.g., arising through better management)
Synergies that any bidder within the industry could realize
(E.g. arising through consolidation of manufacturing, or distribution chains)
Synergies unique to this bidder
(E.g., involving the application of a particular brand or R&D capability)

9. Illustrative due diligence
Financial performance
historical information
systems of internal control
accounting policies
review of forecasts
Taxation
existing and potential liabilities
arrangements (intra-group)
transaction
Economic and commercial
industry analysis and key players
PESTLE
competitive position
strategic assets
order book
contracts
Production and operations
technologies and systems
Information systems
IT systems and integration
People and culture
who’s who – management and lower tiers
capabilities
cultural fit
Environmental and social
potential liabilities
legal & regulatory impact
CR stance
Intellectual property
existence and ownership
Legal and governance
review of contracts
potential problems and contingencies
competition issues?
Pensions
scheme details
deficit? (And assumptions)
powers of trustees

10. Financing the acquisition with cash
Bidder
Cash paid to shareholders
Bidder
Shareholders in Target
Shareholders in Target
Target
Target’s shareholders have no stake in the business after the acquisition
Target
Before the acquisition
After the acquisition

11. Financing the acquisition with shares
Bidder
Bidder
Shareholders in Target
Shareholders in Target
Target’s shareholders own shares in an enlarged Bidder after the acquisition
Target
Target
Before the acquisition
After the acquisition

12. Buying a company for shares – some issues
1. If the consideration is shares, who is buying whom?
2. Issuing new shares may dilute the voting control of a dominant shareholder – especially if the target has a block-holder
3. Selling shareholders share the risk of the transaction
4. Selling shareholders share the synergies
5. Both companies need to be valued
6. Offer a fixed number of shares, or fixed value?
7. Tax implications – sellers can defer a gain
8. May not be possible to offer shares in a cross-border transaction
9. Cash resources may not be available
10. Buying for shares may increase eps if acquirer has higher p/e

13. Buying a company for cash – some issues
1. Can we afford it?
2. How much will be bridge financing, how much will be longer term?
3. If bridging, when and how will a refinancing be effected?
4. Effect on the company’s credit rating, banking covenants, etc.
5. Where to raise the debt? (Banks or capital markets?)
6. Additional considerations for cross-border acquisitions
– where do we raise the money?
– in what currency?
– tax issues, etc.
7. Buying for cash might increase eps if interest rates are less than inverse of target P/E

14. Acquisition strategies to enhance eps
‘Rule’ 1
Buy companies with a higher p/e using debt or an earn-out, to avoid dilution of eps in the short term
Buy companies with a lower p/e using equity
‘Rule’ 2
Use debt if after-tax cost of debt is less than inverse of target p/e
Enhancing eps is not the same as increasing shareholder value

15. Funding the deal – who gets what?
Seller gets
Cash
Shares
Deal may not be structured as all cash or all debt – could be a mixture
Deal may also be structured so that seller gets loan stock – still has some exposure to the buyer
Need to consider raising funds conditionally
Initial funding may not be the final structure. Borrow to do the deal, and then refinance. The refinancing may be with new debt (on better terms) or with convertibles, or with equity. Alternatively, the refinancing may be from selling assets.
No further relationship between buyer and seller. No risk to seller. Buyer is geared.
Cash/ debt
Unlikely
Buyer raises
Buyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offer
Seller gains from synergies and shares all risks
Shares

16. Financing strategies – regardless of the acquisition
GROWTH
LAUNCH
business risk – high
financial risk – low
funding – equity
divi pay-out – nominal
p/e high
business risk – v. high
financial risk – v. low
funding – equity
divi pay-out – nil
p/e v. high
MATURITY
DECLINE
business risk – med
financial risk – medium
funding – debt
divi pay-out – high
p/e – med
business risk – low
financial risk – high
funding – debt
divi pay-out – total
p/e v. low H  X
The financial strategy for the acquisition should be in line with the company’s overall financing strategy
Gearing X  L
Business risk H

17. Earn-outs and deferred consideration
BUYER CONSIDERATIONS
Delays payment, or delays issue of new shares
Limits eps dilution if share eventually issued at higher price
Limits dilution of control, ditto
Useful if future results of target are uncertain
Retain managers’ commitment in handover period
But…
Is it sloppy negotiating?
Can be difficult to combine businesses
Who runs the business?
Short termism. What happens after the earn-out?
What if own share price falls before the end of the period?
SELLER CONSIDERATIONS
Gives possibility of more consideration at a later date
May wish to earn salary in handover period
Retains their involvement in their business
But…
Is it sloppy negotiating?
May not want to stay on
Protect against buyer changing the business model
Will buyer have sufficient funds to meet the eventual liability?
Fixed value or fixed number of shares for additional consideration?
Will we be able to sell the shares?
Tax issues need to be considered

18. Some defence tactics
Make sure company is priced correctly
Strategic issues and profit forecast
Good relations with City
Friendly shareholders
Buy another company
Sell/demerge units
Look for a white knight
Referral to competition authorities
Joint ventures
Poison pills

19. Indicative sales process
In the pre-sale period you need to choose advisers, undertake pre-sale grooming, review the alternatives
Information memorandum to be prepared
Identify potential purchasers and make contact. (Use confidentiality letters?)
Initial meetings are likely to be off-site; after receiving indicative valuations, preferred bidders can have site visits
Negotiations around price (often P/E-based), deal structure and conditions will lead to Heads of Agreement with preferred bidder
Due diligence is done. (May use a data room)
Legals completed – contracts, warranties, etc.
Based on ‘Selling a Business, Corporate Finance Faculty, ICAEW, Feb 2009