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Joseph V. RizziAmsterdam Institute of Finance
December, 2015
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•Translate General Strategy into M&A Strategy•Determine Screening Criteria•Identify Targets•Screen/Prioritize•Output: Target with Investment Thesis (Business Case)•Outcome: Go forward decision•Next Step: Contact Target
•Valuation (synergies, sensitivity analysis, walk-away price)•Due Diligence•Deal Structure•Negotiation•Pro forma business model•Integration Planning (degree/scope of integration, etc.)•Output: Due Dili Report; Full/Final Business case including Final Financials•Outcome: Go/No Go Decision; Close the Deal
•Leadership •PMI Project Office/Team•100 Day Plan•Communication Plan•Operating Integration•Customer Integration•Cultural Integration•Performance & Synergy Tracking•Fix/Adjust Process•Post Closing Evaluation•Outcome: Accomplish Investment Thesis
Amsterdam Institute of Finance December, 2015
Goal of deal structure should be to maximize value – but different parties have different objectives.
Some Buyer Shareholder Objectives:– Minimize after-tax price paid for the acquisition– Minimize the dilution of their pre-merger ownership stake– Protect deal
Some Seller Shareholder Objectives:– Maximize after-tax price received– Minimize risk of the offer (for a given dollar value of the
deal) e.g. termination and go shop
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Seller
Maximize Value
Create competitive environment among bidders
Avoid surprises from bidders’ diligence
Control information release
Balance length of process against stakeholder expectations
Limit warranties and indemnifications
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Common Goals
Preserve value
Reduce uncertainty
Create efficient tax structure
Minimize distractions
Maintain credibility
Enhance reputation
Separate smoothly
Minimize post-closing disputes
Buyer
Lower Price
Highlight liabilities and risks
Challenge run rates and forecasts
Understand sustainability
Develop advantage over other bidders
Analyze costs and synergies in detail
Maximize warranties and indemnifications
Balance exclusivity and break-frees
Amsterdam Institute of Finance December, 2015
Seller Buyer
Maximize Value
Common Goals
Lower Price
AcquisitionNDALOIOffering MemorandumSPA
FinancingBank BookTerm SheetCommitment LetterFee LetterCredit Agreement(s)Intercreditor Agreement(s)Security Document
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Price Form of Transaction Form of Payment Control and Governance Social Issues Timing and Deadlines Transaction Hedges
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Accounting
Tax CorporateLaw
Securities
Regulatory and AntitrustContract
Structuring Environment
BusinessPlan
TransactionCharacteristics
FinancialPreferences
MarketConditions
Deal
CompetingBidders
Creditors Rights
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ContractFormConsiderationPricingConditionsRepos and WarrantiesIndemnitiesChange of ControlCovenants
TaxCapital Gains to SellerWHT on divs and intBasisNOL’sInterest deductibilityTax treatiesConsolidationExit planning
Rating Agencies
Regulatory
Competing BidsSizeFinancial StrengthDilution AnalysisStrategic Fit
SecuritiesNoticeS/H VoteTendersPreemption RightsTriggers
Bankruptcy Framework(Inter-creditor Concerns)SubordinationGuarantees
CorporateNoticePercent by Region/StateLock-Up/Break Up Fee/No ShopPills/DefensesMerger/Consolidation
AntitrustHart/Scott/RodinoSherman ActHHIEuropean CommissionMonopolies & Mergers Commission
AccountingGoodwillFair Market ValueNet WorthConsolidation
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Buyer Issues Share Valuation: avoid using undervalued shares
Synergy Risk: use cash if synergy risk low to retain upside Market Risk: who bears risk of shares charging price post offer/pre close Fixed price: seller assumes risk Fixed share: buyer assumes risk Collars/caps: share
Dilution Earnings Book value Ownership
Taxes Asset write-up Tax domicile
Credit Ratings
Seller Issues Valuation: DD on buyer Taxes: defer seller capital gains taxes Liquidity: share float, lock-ups and Regulation Rights
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Issues: tax, accounting
Forward: Target merges into buyer’s wholly owned subsidiary with subsidiary as Continuing entityPre transaction Post closeBuyer Buyer
Subsidiary Target Subsidiary(including old target)
Reverse: Target merges into buyer’s wholly owned subsidiary with target as continuing entity. Subsidiary shares converted into target shares; shares converted into buyer sharesPre transaction Post closeBuyer Buyer
Subsidiary Target Target(including subsidiary)
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HSR Review Period (30 Calendar Days)
•Engage Investment Bankers• Prepare Merger Agreement, Stockholders Agreement & HSR Premerger Notification• Due Diligence• Fairness Opinion Issued and Boards Approve Merger Agreement• Arrange Financing• Determine Structure (Tax, Accounting, Form, Consideration)
• Sign Merger Agreement & Stockholders Agreement• File HSR Premerger Notification• Commence Preparation of Preliminary Proxy Materials (Schedule 14A)• Issue Press Release• File 8Ks and Schedules 13D
• FilePreliminaryProxy Materials(Schedule 14D)with SEC
• Print and Mail Proxy Materials To Target Stockholders (Assumes Definitive Proxy Materials Are Available)
• HSR Waiting Period Expires, Assuming No Second Request
• Target Stockholder Meeting
• Close Merger
Pre-Commencement Day 1 Calendar CalendarCalendarCalendar Week 7
Period (1 Week) Week 2 Day 10 Day 20 Day 30 Day 40
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FinancialFlexibility
TargetCreditRating
DetermineCapital
Structure
Hedge No Action
BankFunding
Acquisition
Bridge Takedow
n
CreditRating
Fixed Income
Asset Carveout Securitization \ Prop Co
Bank Financing
Equity / Near Equity
RefinanceBridge
Fixed-Rate
Floating-Rate
Advisory / Origination Underwriting Product Execution
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Purchase/Sale
• Nondisclosure Agreement
• Offering Memorandum
• Data Room
• Letter of Intent
• Sale and Purchase Agreement
Financing
• Commitment Letter(s)
• Term Sheet
• Credit Agreements
• Intercreditor Agreements
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BusinessLegalEntity BasisBankruptcyPayment PrioritiesProvisionsReps/Warranties: What are the facts?Operating Covenants: Pre CloseFinancial Covenants: Preserve dealRemediesStructures to reduce credit riskGuaranteesIndemnitiesPledges of StockSubordinationDeposits / Escrows
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PartiesDefinitionsForm: Merger, Tender, Asset Sale,…Consideration: Type, Payment, Mechanics, Calculation,…Reps/Warranties: Duration, Survival
Target: MACBuyer: Issue when stock used
Ordinary Course Covenants: Target will operate as usual during signing/closing gap periodOther Agreements: Filings, Meetings,…Closing Conditions: Regulatory, ShareholderTermination & Expenses: Drop Dead Fee, Drop Dead Date, Termination FeesOther Stuff: Choice of Law, Specific Performance
Useful Sitesapps.americanbar.org/…/mspd-letter-of-Icontracts.onecle.comPLI.edu
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Commitment LettersMACDue Diligence
SyndicationFlexMarketing Periods
Fraudulent Conveyance
Loan DocumentationIntercreditorCovenantsConditions
See: lma.eu.com/documents for drafts
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Rule of Thumb Measures◦ Balance Sheet Model◦ Cash Flow Model
Detailed Model◦ Matching markets to the need◦ Reverse inquiry◦ Projections (amortization capability)
Amsterdam Institute of Finance December, 2015
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LHS Transaction RHS (value) (Claims)
(A) Income / DCF (A) Mechanics (A) Concerns FOCF = NOPAT– (WCI + T + CAPEX) Issues Ratings targets WACC Tax Market availability - menus Ke – Rf x 2 or CAPM Legal IRR Debt = ref rate + spread Accounting MDC (B) Relative Value Regulation (B) Funded Debt Multiples (FDX) Comps Focus (C) Framework Multiples Form R/C – tied to BB Trading Payment Senior (SDX) Transaction (B) Purchase Price Multiple TL/A (amortization tied to projections) (C) Breakup Value (C) Value Allocation 3 – 4X FLL Vp = PreBid Trading + Premium 0.5 – 1X SLL Vr = PreBid value + Synergy T/LB NVAs = Premium - Synergy SDX - T/LA Other Debt FDX - SDX Equity PPX – FDX Subject to IRR constraint
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Purchase Price + Expenses◦ Minimum/Maximum◦ Recapitalization Dividend
Debt Refinancing◦ Callability◦ Premiums◦ Tax Issues
Expenses
Other Uses
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Revolvero Tied to advance against current assetso Crossing liens
Term Loan Ao Macro: Ratio of 3-4x EBITDAo Micro: Amortization analysis tied to cash flow in years 1-7
Term Loan Bo Senior debt ratio less Term Loan A amortizationo 1% P.A./Balloon
Second Lieno Macro: 0.5-1x EBITDAo Limited amortizationo Longer term
Senior/Subordinated Unsecured Other Debt
o Total Debt/EBITDA less Senior Debt/EBITDA
Equityo Funding need less Total Debt/EBITDA
Senior Secured First Lien
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Current Asset approach
◦ Use standard advance rates Accounts Receivable 80% Inventory 60% PP&E/Net 40%
◦ Consider the following factors Seasonal Needs Future Working Capital Growth Unexpected Liquidity Needs
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Term Loans = Maximum Senior Debt - Revolver
Focus is on Free Operating Cash Flow
Market conditions also dictate the maximum tenor of the loan and the amount required to be amortized
Acceptable asset coverage is also a consideration in determining the size of the term loans
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Typical bank financings as structured as follows:Revolving CreditTerm Loan A (amortising)Term Loans B & C (bullet/balloon)
• T/LC Rare
Large unfunded revolvers are seldom used today due to the fact that it is capital unfriendly to banks and companies don’t like to pay for unused commitments.
In the interest of keeping flexibility for the long term, additional indebtedness baskets should be negotiated upfront. This allows companies to access either the bank or bond markets under their existing credit agreements and saves the costs of having to refinance.
Amsterdam Institute of Finance December, 2015
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Long Term Debt = Max Total Debt - Max Senior Secured Debt◦ Senior unsecured◦ Sub Debt◦ Other – unitranche, PIK, …
Equity:◦ Equity = Total Uses - Max Total Debt◦ Common◦ Hybrids
Convertibles Preferred
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Senior lenders are concerned with the implications of having high yield investors at the table during a restructuring.
EURO High Yield investors to date have not been as vocal as senior bank lenders, viewing the issue as one of pricing rather than principle.
All other things being equal, sophisticated investors will probably price structural subordination at premium.
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Holding Company
Intermediate Holding
Company
Operating Company
Operating Company
OperatingCompany
100% EquityInterest
Issues
Issues
High Yield Bonds
SubordinationAgreement
Senior SecuredLoan
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Guarantees
To whatrestructuring
CashAssets
Holding Company
Intermediate Holding
Company
Operating Company
Operating Company
OperatingCompany
100% EquityInterest
Issues
Issues
High Yield Bonds
Support Package
Senior SecuredLoan
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There are no standard covenants. They must be tailored to fit each deal and loan structure. The steps in structuring the covenants are:
o Identify the risks (business, financial and structural)o Select Covenants to monitor the risks
• Need to prioritize the risks to monitor because it will be impossible to monitor every risk
• The time and cost to monitor the covenants must be considered (i.e., sometimes one covenant can cover multiple risks)
o Set Appropriate Levels• Want the covenants to trigger a warning before any principal
or interest payments become delinquent. Need to factor in any seasonal needs to the covenant levels.
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Major Covenants (financial maintenance) – Industry VariationCAPEXDebt ServiceFixed ChargeFunded DebtNet WorthEarnings
Reason for DeclineInstitutional Loan InvestorsHigh Yield MarketCompetition
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Most acquirers fail to consider how deal type impacts what you integrate andhow you handle people issues
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“Scale” deals “Scope” deals
Degree ofIntegration:
• Integrate comprehensively• Ensure Integration approach is coordinated across regions
• Integrate selectively, only where there is overlap• Ensure business models align and cross-fertilize strengths
OrganizationStructure:
• Blend structures; assimilate where the target is small or under-performing• Make decisions early, but don’t sacrifice more informed decisions for speed
• Keep organizations separate; blend structures where there is overlap• Define the role of the center and regional/ functional superstructure• Make decisions as early as possible
ExecutiveSelection:
• Select a small proportion of the target’s executives; select more where the target is larger or better performing• Make decisions early; ideally before announcement
• Retain a high proportion of the target’s executives• Make decisions before announcement• Make retention a priority and offer retention incentives
EmployeeRetention:
• Target early talent critical to the transition/integration
•Target early talent critical to success of company
CulturalIntegration:
• Integrate the two cultures, typically by selecting the “best of both”• Win the hearts and minds of both companies’ employees
• Preserve the two cultures• Harmonize at the leadership level (clarify “way of working” and how decisions are made)