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Universit di Torino Facolt di Economia Course of Business Combination

Introduction to Mergers and Acquisitions

November 2012

M&A: What Is It?

An Acquisition is a set of activities aimed at taking a stake in (or selected assets of) a company in exchange for cash or stock

A Divestiture is a set of activities aimed at selling a stake in (or selected assets of) a company in exchange for cash or stock

M&A: Several Different Transactions

Merger: combination of two or more companies, in which the acquiring company absorbs the

target one, that stops to exist

Merger by union: a new entity is created and includes both the acquiring and the target company Tender offer: purchase of outstanding shares, usually publicly traded, at a specific price Purchase of selected assets Buyout (Leveraged Buy-Out LBO / Management Buy-OutMBO): Acquisition financed

largely by debt
Spin-off: the parent creates a new legal subsidiary and distributes shares it owns in it to its

current shareholders
Subsidiary offering: the parent issues a portion of the stocks of a subsidiary to the public IPO: first sale of stock by a private company to the public Restructuring: corporate restructuring/debt-financial restructuring Capital increase: without pre-emptive rights in favour of third-party Joint Ventures: industrial agreements

The Deal Structuring: the Buy-Side

OK II. Search and Selection of Alternative Options III. Selection of a Small Number of Targets (Short List)

I. Define the Strategy and Goals

VI. b. Due Diligence and Closing

IV. Planning of the Negotiation

V. Negotiations VI. b. Search of New Targets


Define the main features of the ideal target company Set timeline and budget Market analysis

Search of potential targets First screening and ranking of the potential targets Approach letter

First contacts with target companies Choice of the seller objectives Analysis of the information on the target companies (information memorandum)

Selection of a target and beginning of negotiation Confidentiality agreement Target valuation

Negotiations Letter of intent (LOI) Planning of the process (up until closing) Non binding/binding offer

Contract negotiations Preliminary agreement Due diligence Closing In case of failure in the negotiation, search for another target

The Deal Structuring: the Sell-Side

OK I. Define the Strategy and Search Potential Buyers II. First Contacts, Confidentiality Agreement and Blind Profile

III. Information Memorandum and Meetings

VI. b. Due Diligence and Closing

IV. Choice of the Buyer

V. Negotiations VI. b. Search of Other Buyers


Define the main objectives of the deal: time and price Market analysis

Search of potential buyers Approach letters Teaser and Confidentiality Agreement Prepare Information Memorandum and Business Plan

Deliver Info Memo Meetings

Reception of the offers from potential buyers Binding/non binding [buds] Analysis of the documents and choice of the best offer

Negotiations Letter of Intent Planning of the process (up until closing)

Contract negotiations Preliminary agreement Due diligence Closing In case of failure in the negotiation, search of another buyer

M&A: The Base of the Deal

Strategic Rationale (SWOT Analysis)

Economics Prospects

Culture and Organisation of Governance

Financial Structure Sustainability

Brand and Intangibles

Regulatory and Legal Implications

Accounting and Tax Implications

M&A: The Actions of the Players

Partner Selection

Due Diligence





M&A: The Outcome of the Deal

Creation of Shareholder Value

Financial Strength and Stability

Strategic and Competitive Advantages

Organisational Benefits

Enhanced Brand and Intangibles

The Search for the Target

When the selection process is structured, you follow a specific process: Definition of the main parameters for research (industry, size, performance, geographical market) Use of databases to identify all the potential targets Search of additional business (better description of the business and of the main products) and economic (ratios) information Long-list for a first screening process and ranking of the possible targets

The Target Selection

The identification of the acquisition target is a complex task, affected by the kind of acquirer and the objective to be pursued Many different kind of buyers Strategic buyer Financial buyer Hedge fund Sovereign Wealth Funds


Objectives of the Players

Seller Corporate Industrial Financial Family

Objectives for the Acquirer: higher market share, synergies, product extension, international growth Objectives for the Target Divesting non-strategic assets Deleverage Objectives for the Target Exit and investment return Objectives for the Target Monetize value due to lack of financial resources or succession problem

Buyer Financial Objectives for the Acquirer: invest in high growth/return companies (high exit-multiples) Objectives for the Target Divesting non-strategic assets in very short timeframe Objectives for the Target Exit and investment return Rotate investment portfolio Objectives for the Target Plan exit from the Company Capital injection Internationalization


Financial vs. Strategic Buyer

Financial Sponsor Financial Target Capital gain (IRR)

Strategic Buyer Create value for shareholders (share price increase and distributed dividend) Medium Long-Term

Risk Appetite Investment Horizon Deal Structure

High Short-Medium Term (35 years to maximise IRR) Minority stake with influence Joint control for larger deals High: usually high sub-investment grade Involved in the management of the Company with specific attention to financial aspects Low because of pressure over returns

Control or joint ventures


Maintain Investment Grade Rating


Integration of the acquired company of the Group/operating synergies

Price Paid

High because of resources and synergies Radical transformations

Main Risk for the Target

More freedom in the day-by-day activity


Strategic Buyers: Different M&A Strategies

Acquisitions occur for several reasons: Deal with overcapacity through consolidation in mature industries Acquire/roll-up competitors in geographically fragmented industries Expand into new products or markets Acquire know-how Move beyond industry boundaries


Strategic Buyers: Different M&A Strategies (contd)

Overcapacity M&A Key Features: typical of mature industries with excess capacity Strategic Objective: reduce capacity and duplication and create a more

efficient operation
Risks: cultural differences, need to impose the acquirers culture and processes quickly (high execution risk) Better When: target firm is smaller than the acquirer and/or company

values are similar

Example: FIAT Chrysler


Strategic Buyers: Different M&A Strategies (contd)

Geographic Roll-up M&A Key Features: typical of industries/markets at an earlier stage in life

cycle/underdeveloped; acquirer holds on to the target companys resources but imposes its own processes
Strategic Objective: achieve economies of scale and scope to build

industry giants
Risks: if cultural differences, use carrots not sticks (low execution risk) Better When: target firm is smaller than the acquirer (succession, access

to capital, modern technology and marketing)

Example: Santander acquiring banks in Spain and abroad (success in

imposing its own culture/processes management style)


Strategic Buyers: Different M&A Strategies (contd)

Product or Market Expansion M&A Key Features: they can involve both medium and big companies Strategic Objective: extend companys product line Risks: cultural differences and governmental regulations (medium execution risk) Better When: target firm is much smaller than the acquirer and/or the

acquirer has long practice

Example: Facebook - Instagram


Strategic Buyers: Different M&A Strategies (contd)

M&A as Know-How Acquisition Key Features: typical of high-tech and bio-tech companies Strategic Objecting: acquisition as substitute for in-house R&D, to build a

market position quickly, detailed economic benefit analysis, faster time to market
Risks: cultural differences, risk of loosing key people (medium execution risk) Better When: acquirer has industrial-strength evaluation processes, to be

sure to buy first-class businesses; executives are in charge of the integration (high-visibility assignment)
Example: LVMH - Bulgari (acquisition of brand and know-how in watches

and jewels)


Strategic Buyers: Different M&A Strategies (contd)

Industry Convergence M&A Key Features: radical reconfiguration of an industry whose boundaries are

Strategic Objective: take advantage of changing environment and

Risks: wrong assumption and hypothesis (very high execution risk) Better When: the unproven hypothesis about industry boundaries proves

to be right + integration is properly managed

Example: Google - Motorola


Critical Aspects in Estimating the Target Value

Business plan reliability Proper choice of the valuation method to be used (cash flows, market/precedent multiples) Identification of the proper terminal value Choice of the discount rate Consider potential consequences for the potential buyer, such as:
Synergies Cannibalisation

Easier access to capital

Fiscal advantages Accounting implications


Valuation Drivers

In M&A all these factors play a key role in determining the valuation of the target company
Competitive Tension

Scarcity Factor Fundamental Valuation (DCF)

Deal Momentum

Comparables Market Peers Accounting Implications Precedent Deals

Financial Implications Loss to Key Competitors

Tax Benefits

Market Conditions


When to Acquire from a Financial Standpoint

From a financial point of view, for an acquisition to be economically convenient for the buyer, the current value of future cash flows (PV), minus the financial debt of the target company (D), has to be higher than the acquisition price (P) to be paid to the seller, net of the costs of the deal itself (C)

PV - D P + C From a seller point of view the deal is convenient if the current value of future cash flows (PV), minus the financial debt of the target company (D), is lower than the acquisition price (P), net of the costs of the deal itself (C)

PV - D P + C This is very reasonable, but that means that the estimates of the assets value have to be different for the deal to succeed


Factors Affecting the Acquisition Price

Strategic Factors

Importance for the Companys general strategy Existing and rationale of each transaction alternative Competitive scenario

Market Factors

Recent acquisition multiples Comparison with market multiples

Negotiation Factors

Payment clauses Contractual clauses (Protection, Conditions Representation and Warranties)


From Value to Price

Valuation Framework

Maximum Price (0 NPV)

Value Creation Average Price Range Area

Lower Price (+ NPV)

Fundamendal Valuation

Financial Synergies

Cost Synergies

Revenue Synergies

Potential Price


Premia Paid Remain High

EMEA Public Target(1) (2)

Premia Paid EMEA Public Targets vs. NTM P/E MSCI Europe (1)(2)(3)
All Transactions Premia Paid (%) 100 NTM P/E MSCI Europe (x) 30



60 49

56 46 44 42 36 33 29 28 25 24 25 29 36 37 32


45 12




0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 YTD

Premia Paid


Notes 1. Includes announced bids for control of EMEA public targets with an aggregate value of $100MM or more, where premia to unaffected price is available. Excludes terminated transactions, ESOPs, self-tenders, spin-offs, share repurchases, minority interest transactions, exchange offers, recapitalizations, and restructurings. Includes transactions announced on or before 30 June 2012 2. Annual amounts based on mean of percentage premia paid over unaffected stock price which is defined as stock price four week prior to deal announcement date 3. For 2006-2012 average premia are adjusted to exclude transactions with negative premia or premia above 200%

CapIQ, Thomson Reuters as of 30 June 2012


M&A and Value Creation: Does M&A pay?

What Is the M&As Impact on Value?

In finance, the best benchmark for evaluating investment performance is the

return required by investors

The return that investors could earn on another investment with similar risk
Value creation, when the returns on the investment exceed the required rate 1

of return
Value destruction, when the investment returns fall short of the return rate 2

required by investors
Value conservation, when investors earn exactly the required rate of return 3


M&A and Value Creation: Shareholders

What Is the Impact on Shareholders Value?

Target shareholders benefit from Substantial premium paid by the bidder Increasing sophistication of takeover defenses Competitive situations

Bidder shareholders: statistically, studies have proved that returns are either negative or slightly negative, due to the increase in purchase premiums, unless significant synergies are generated in the deal


M&A and Diversification

Diversification might pay if:

There is high closeness/ complimentarity in terms of industrial focus between the target and the buyer Favour knowledge transfer across divisions Creates critical mass to face the competition Exploits better transparency and monitoring through internal
capital markets Managers are properly motivated and rewarded Practical Suggestions

Better if related diversification Diversify only if there is a sound economic rationale