💰Corporate Finance Analysis Unit 14 – Mergers & Acquisitions: Corporate Restructuring

What's the Deal with M&A?

• Mergers and acquisitions (M&A) involve combining two or more companies into a single entity
• M&A transactions can be friendly or hostile, depending on the target company's receptiveness to the deal
• Mergers typically involve two companies of similar size joining forces, while acquisitions involve a larger company buying a smaller one
• M&A deals can be structured as stock purchases, asset purchases, or a combination of both
• The goal of M&A is often to create synergies, reduce costs, gain market share, or acquire new technologies or expertise
• M&A activity tends to be cyclical, with periods of high activity followed by lulls
• The success of M&A deals depends on factors such as strategic fit, cultural compatibility, and effective integration

Types of M&A: Picking Your Flavor

• Horizontal mergers involve two companies in the same industry and at the same stage of production (Exxon and Mobil)
• Vertical mergers involve companies at different stages of the supply chain, such as a manufacturer acquiring a supplier or distributor (Amazon acquiring Whole Foods)
• Conglomerate mergers involve companies in unrelated industries (Berkshire Hathaway acquiring GEICO)
• Concentric mergers involve companies with related but not identical products or services (Disney acquiring Pixar)
• Reverse mergers allow private companies to go public without an IPO by merging with a shell company that is already publicly traded
• Cash mergers involve the acquiring company paying cash for the target company's shares
• Stock mergers involve the acquiring company exchanging its own shares for the target company's shares
  • The exchange ratio determines how many shares of the acquiring company are exchanged for each share of the target company

Motives Behind M&A: Why Companies Tie the Knot

• Synergies are a common motive for M&A, as combining two companies can lead to cost savings, revenue growth, or both
  • Cost synergies can be achieved through economies of scale, eliminating redundancies, or improving efficiency
  • Revenue synergies can be achieved through cross-selling, expanding market reach, or developing new products
• Diversification is another motive, as acquiring companies in different industries can reduce risk and smooth out earnings
• Acquiring new technologies, patents, or expertise can be faster and less risky than developing them in-house
• Increasing market share or eliminating a competitor can improve a company's competitive position
• Tax considerations, such as acquiring a company with tax losses to offset future profits, can also drive M&A
• Ego and empire-building can sometimes motivate executives to pursue M&A, even if it doesn't create shareholder value
• Acquiring undervalued companies can create value for the acquiring company's shareholders

Valuation Techniques: Putting a Price Tag on Companies

• Discounted cash flow (DCF) analysis estimates a company's value based on its expected future cash flows, discounted to present value
  • The discount rate used in DCF analysis reflects the riskiness of the cash flows and the company's cost of capital
• Comparable company analysis values a company based on the multiples (such as price-to-earnings or EV/EBITDA) of similar publicly traded companies
• Precedent transaction analysis values a company based on the multiples paid in similar M&A transactions
• Asset-based valuation estimates a company's value based on the fair market value of its assets minus its liabilities
• Leveraged buyout (LBO) analysis estimates the returns to a private equity firm from acquiring a company using a combination of debt and equity
• The weighted average cost of capital (WACC) is often used as the discount rate in DCF analysis and reflects the company's cost of debt and equity
• Synergies and control premiums can justify paying a higher price for a target company than its standalone value

The M&A Process: From Courtship to Closing

• The M&A process typically begins with a strategic review to identify potential targets that fit the acquirer's criteria
• Non-disclosure agreements (NDAs) are signed before sharing confidential information
• A letter of intent (LOI) outlines the key terms of the proposed deal, such as the price, structure, and timeline
• Due diligence is conducted to verify the target company's financials, legal and regulatory compliance, and other key aspects of the business
• A definitive agreement is negotiated and signed, which contains the final terms of the deal
• Regulatory approvals, such as antitrust clearance, are obtained as necessary
• Financing is arranged, which may include issuing debt or equity or using cash on hand
• The deal is closed, and the purchase price is paid to the target company's shareholders
  • Any necessary post-closing adjustments are made based on the target company's financial performance or other factors

Legal and Regulatory Hurdles: Jumping Through Hoops

• Antitrust regulators, such as the Department of Justice or Federal Trade Commission in the US, review M&A deals for potential anticompetitive effects
  • Deals that significantly increase market concentration or reduce competition may be blocked or require divestitures
• Securities laws, such as the Securities Act of 1933 and the Securities Exchange Act of 1934, govern the issuance and trading of securities in M&A transactions
• Tax laws, such as the Internal Revenue Code, determine the tax consequences of M&A deals for the parties involved
• Labor and employment laws, such as the Worker Adjustment and Retraining Notification (WARN) Act, may require advance notice or severance payments for layoffs resulting from M&A
• Environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), can impose liability for environmental contamination on the acquiring company
• Foreign investment laws, such as the Committee on Foreign Investment in the United States (CFIUS), may restrict or prohibit M&A deals involving foreign acquirers
• Shareholder approval may be required for certain types of M&A transactions, such as mergers or sales of substantially all assets

Post-Merger Integration: Making It Work

• Post-merger integration (PMI) is the process of combining two companies after an M&A deal closes
• PMI typically involves integrating the companies' operations, systems, processes, and cultures
• A successful PMI plan identifies key integration tasks, timelines, and responsibilities
• Communication is critical during PMI to manage expectations, address concerns, and maintain morale
• Retaining key employees, especially those with critical skills or customer relationships, is important for ensuring business continuity
• Realizing synergies requires careful planning and execution to avoid disruptions and capture cost savings or revenue growth
• Cultural differences between the two companies can be a significant challenge during PMI and may require active management to avoid clashes or turnover
• Measuring and tracking the success of PMI is important for ensuring that the deal delivers the expected benefits and for identifying areas for improvement

M&A Case Studies: Learning from the Pros and Cons

• The AOL-Time Warner merger in 2000 is often cited as a cautionary tale of the risks of overvaluing synergies and underestimating cultural differences
• The Disney-Pixar acquisition in 2006 is an example of a successful acquisition that combined complementary strengths and maintained creative autonomy
• The Daimler-Chrysler merger in 1998 is an example of a cross-border merger that failed due to cultural clashes and strategic misalignment
• The Kraft-Heinz merger in 2015 is an example of a cost-focused merger that struggled to generate growth and ultimately led to significant write-downs
• The Facebook-WhatsApp acquisition in 2014 is an example of a tech giant acquiring a fast-growing startup to expand its user base and capabilities
• The Pfizer-Allergan merger attempt in 2015 is an example of a tax inversion deal that was ultimately blocked by changes in tax regulations
• The Amazon-Whole Foods acquisition in 2017 is an example of a vertical merger that gave Amazon a foothold in the grocery industry and access to valuable customer data