Pricing Issues and Post-Transaction
issues:
Chapter 13
Defenses against hostile takeovers=
A) Pre-bid defenses=
a) Communicate effectively with shareholders
b) Revalue non-current assets
c) Poison pill strategy (target company before a bid tries to
make itself less attractive to a potential bidder, most
common way is for existing shareholders to be given
rights to buy future bonds or preference shares)
d) Super majority (may require 80% of shareholders to vote
for a takeover)
B) Post-bid defenses=
a) Appeal to their own shareholders (well-managed
defensive campaign would include= aggressive publicity
on behalf of the company preferably before a bid is
received, direct communication with shareholders in
writing stressing the financial and strategic reasons for
remaining independent.
b) Attack the bidder= dubious accounting policies, methods
of increasing EPS, bidder’s management style etc.
c) White knight strategy= This is where directors of the
company offer themselves to a more friendly outside
interest. This is the last resort. This method is acceptable
as long as the information given to a preferred bidder is
also given to a hostile bidder.
d) Counterbid/ Pacman defense= where the bidding
company itself is the subject to a takeover bid.
e) Competition authorities= convincing them that the
takeover is not in public interest.
Form of consideration for a takeover= 2 questions=
What form of consideration should be offered and if a cash offer is to
be made, how should the cash be raised?
Form of consideration=
A) Cash= cash per share offered, likely to be suitable only for
relatively small acquisitions, unless the bidding entity has an
accumulation of cash
a) Advantages= when sufficient cash is available it is quick
and easy, shareholders will have certainty about the bids
value, increased liquidity i.e. accepting cash is a good way
of realizing their investment, the acceptable consideration
is likely to be less per share than a share exchange as it is
less risk and thus this reduces the cost of the bid for the
bidding company.
b) Dis-advantages= larger acquisitions involve borrowing
and this may have an adverse effect on gearing, for target
company shareholders In some countries, taxable gains
will arise if shares are sold for cash rather than shares
exchanged, target company shareholders may be
unhappy with a cash offer because they will be bought
out and will not participate any longer in the new group.
B) Share exchange= bidding company issues some new shares
and then exchanges them with the target company
shareholders. The target company’s shareholders end up
with shares in the bidding company and the target
company’s shares all end up in possession of the bidding
company.
a) Advantages= no need to raise cash, can bootstrap EPS if it
has a higher P/E ratio than acquired entity, shareholder
capital is increased and gearing improves, can be used to
finance very large acquisitions.
b) Dis-advantages= current shareholders will have lower
control and will have to share future gains with the
acquired entity, there is a risk that the market price of the
bidding company will fall during the bidding process
which may result in the bid failing.
C) Earn-out= Procedure where owners/managers selling an
entity receive a portion of their consideration linked to the
financial performance of the business during a specified
period after sale.
Gives a measure of security to new owners. Some amount is
paid upfront and the deferred balance will only be payable if
certain targets are achieved.
Often take place only when buyer and seller disagree about
the expected growth and the future performances of the
target company. Takes place over a 3-5-year period and may
involve 10% to 50% of the purchase price being deferred and
paid across during that period.
Popular against private equity investors. Targets could be
based upon revenue, net income, EBITDA, EBIT targets.
Sellers tend to prefer revenue and buyers tend to prefer net
income.
a) Limitations of earn-outs= they generally work best when
the business is operated as envisioned at the time of the
transaction, in some cases the buyer may have the ability
to block the earn-out targets from being met. Outside
factors also affect the ability of the company to meet
earn-out targets, earn out terms need to be negotiated
carefully.
Key issues relating to terms of consideration of different
stakeholders=
a) Position of target company’s shareholders= Target
company’s shareholders may want to retain an interest in
the business
b) Position of bidding company to its shareholders= issuing new
shares for acquisition required consent of shareholders in a
general meeting. Impact on financial statements must be
considered.
Method of financing a cash offer=
Amount of finance needed might be higher than expected if
there is a plan to repay the target entity’s debt at the time of
acquisition.
a) Debt= borrow from bank or issue bonds, will increase
gearing
b) Rights issue= gearing is protected, problem with rights issue
is that it is the shareholders themselves who have to find the
money to invest.
(Source: Kaplan F3 Textbook)
Bootstrapping and post-acquisition values =
Based on the assumption that the market will assume that the
management of the larger company will be able to apply common
approach to both companies after the takeover thus improving
performance of the acquired company by using the method that they
have been using on their own company before the takeover.
In calculations of value of the new company use P/E ratio of bigger
company.
Value of synergy= value of new company – value of both old
companies.
Treatment of target entity debt=
a) Applying appropriate P/E ratio to company’s earnings or
discounting forecast cash flows to equity using the cost of
equity gives the “Value the equity”
b) Discounting cash flows of all investors at WACC gives value
of the “whole entity”
c) Asset valuation could either be EQUITY or ENTITY valuation.
d) When calculating it is necessary to ascertain whether the
valuation already includes the value of both debt and
equity whether it is just an equity valuation calculation.
Post-merger or post-acquisition integration process=
Drucker’s golden rules=
a) Ensure a common core of unity is shared by the whole
entity.
b) Acquirer must not only think “what is in it for us” they
should also consider of “what we can offer them”.
c) Acquirer must treat product, market, customers of the
acquired entity with respect.
d) Within 1 year the acquirer should provide appropriately
skilled top management for the acquired company.
e) Within 1 year the acquirer should make several cross-
entity promotions of staff.
Key points to consider when determining strategy for the combined
entity=
a) Integration strategy must be in place before the acquisition
is finalized
b) Review each of the business units for potential cost
cuttings/synergies or potential asset disposals, they should
be in good shape before they are sold.
c) Consider the effect on workforce and determine
redundancies.
d) Risk diversification may lower the cost of capital and
therefore increase the value of the entity.
e) Cost of capital of the entity must be re-valued.
f) Economies of scale must be identified.
g) Prevent staff demotivation and make a positive effort to
communicate the post-acquisition intentions within the
entity.
h) Undertake review of assets, or resource audit and consider
selling non-performing non-core elements
i) Pursue a more aggressive marketing strategy
j) Risks of acquisition must be evaluated
k) Harmonization of corporate objectives.
