If a bidder offers its stock in exchange for the target's shares, this offer may provide for either a fixed or floating exchange ratio. When the exchange ratio is floating, the bidder offers a dollar value of shares as opposed to a specific number of shares. The number of shares that is eventually purchased by the bidder is determined by dividing the value offered by the bidder's average stock price during a prespecified period. This period, called the pricing period, is usually some months after the deal is announced and before the closing of the transaction. The offer could also be defined in terms of a “collar,” which provides for a maximum and minimum number of shares within the floating value agreement.
Stock transactions may offer the seller certain tax benefits that cash transactions do not provide. However, securities transactions require the parties to agree on not only the value of the securities purchased but also the value of those that are used for payment. This may create some uncertainty and may give cash an advantage over securities transactions from the seller's point of view. For large deals, all-cash compensation may mean that the bidder has to incur debt, which may carry with it unwanted, adverse risk consequences.
Merger agreements can have fixed compensation or they can allow for variable payments to the target. It is common in deals between smaller companies, or when a larger company acquires a smaller target, that the payment includes a contingent component. Such payments may include an “earn out” where part of the payments are based upon the performance of the target. The opposite type of variable compensation is one that includes contingent value rights (CVRs). The CVRs guarantee some future value if the acquirer's shares that were given in exchange for the target's shares fall below some agreed-upon threshold. One innovative use of CVRs was Viacom's 1994 offer for QVC, which provided for the sellers to receive the difference between Viacom's stock price at closing and $48. At the time of the offer Viacom's stock price was $40. If a seller believes that its stock is undervalued and will rise in value in the foreseeable future, it may offer a CVR as a way of guaranteeing this. Buyers may possess asymmetric information on the possible future value of their stock that sellers do not have. Chatterjee and Yan found that announcement period returns for offers that include CVR were higher than stock-only bids.5
Sometimes merger agreements include a holdback provision. While alternatives vary, such provisions in the merger agreement provide for some of the compensation to be withheld based upon the occurrence of certain events. For example, the buyer may deposit some of the compensation in an escrow account. If litigation or other specific adverse events occur, the payments may be returned to the buyer. If the events do not occur, the payments are released to the selling shareholders after a specific time period.
Merger Professionals
When a company decides it wants to acquire or merge with another firm, it typically does so using the services of attorneys, accountants, and valuation experts. For smaller deals involving closely held companies, the selling firm may employ a business broker who may represent the seller in marketing the company. In larger deals involving publicly held companies, the sellers and the buyers may employ investment bankers. Investment bankers may provide a variety of services, including helping to select the appropriate target, valuing the target, advising on strategy, and raising the requisite financing to complete the transaction. Table 1.5 is a list of leading investment bankers and advisors.
Table 1.5 U.S. Financial Advisor Rankings, 2013
Source: Mergerstat Review, 2014.
The work that investment bankers do for clients is somewhat different based upon whether they are on the sell side or the buy side of a transaction. On the buy side they can assist their clients in developing a proposal that, in turn, contemplates a specific deal structure. They may handle initial communications with the seller and/or its representatives. In addition, they do due diligence and valuation so that they have a good sense of what the market value of the business is. Investment bankers may have done some of this work in advance if they happened to bring the deal to the buyer.
On the sell side investment bankers consult with the client and develop an acquisition memorandum that may be distributed to qualified potential buyers. The banker screens potential buyers so as to deal only with those who both are truly interested and have the capability of completing a deal. Those who qualify then have to sign a confidentiality agreement prior to gaining access to key financial information about the seller. Once the field has been narrowed, the administrative details have to be worked out for who has access to the “data room” so the potential buyers can conduct their due diligence.
The investment banker often will handle communications with buyers and their investment bankers as buyers formulate offers. The bankers work with the seller to evaluate these proposals and select the most advantageous one.
Given the complex legal environment that surrounds M&As, attorneys also play a key role in a successful acquisition process. Law firms may be even more important in hostile takeovers than in friendly acquisitions because part of the resistance of the target may come through legal maneuvering. Detailed filings with the Securities and Exchange Commission (SEC) may need to be completed under the guidance of legal experts. In both private and public M&As, there is a legal due diligence process that attorneys should be retained to perform. Table 1.6 shows the leading legal M&A advisors. Accountants also play an important role in M&As by conducting the accounting due diligence process. In addition, accountants perform various other functions, such as preparing pro forma financial statements based on scenarios put forward by management or other professionals. Still another group of professionals who provide important services in M&As are valuation experts. These individuals may be retained by either a bidder or a target to determine the value of a company. We will see in Chapter 14 that these values may vary, depending on the assumptions employed. Therefore, valuation experts may build a model that incorporates various assumptions, such as different revenue growth rates or costs, which may be eliminated after the deal. As these and other assumptions vary, the resulting value derived from the deal also may change.
Table 1.6 U.S. Legal Advisor Rankings, 2013
Source: Mergerstat Review, 2014.
Avis: A Very Acquired Company
Sometimes companies become targets of an M&A bid because the target seeks a company that is a good strategic fit. Other times the seller or its investment banker very effectively shops the company to buyers who did not necessarily have the target, or even a company like the target, in their plans. This is the history of the often-acquired rent-a-car company, Avis.
Avis was founded by Warren Avis in 1946. In 1962 the company was acquired by the M&A boutique investment bank Lazard Freres. Lazard then began a process where they sold and resold the company to multiple buyers. In 1965 they sold it to their conglomerate client ITT. When the conglomerate era came to an end, ITT sold Avis off to another conglomerate, Norton Simon. That company was then acquired by still another conglomerate, Esmark, which included different units, such as Swift & Co. Esmark was then taken over by Beatrice, which, in 1986, became a target of a leveraged buyout (LBO) by Kohlberg Kravis & Roberts (KKR).
KKR, burdened with LBO debt, then sold off Avis to Wesray, which was an investment firm that did some very successful private equity deals. Like the private equity firms of today, Wesray would acquire attractively priced targets and then sell them off for a profit – often shortly thereafter.
This deal was no exception. Wesray sold Avis to an employee stock ownership plan (ESOP) owned by the rent-a-car company's employees at a