Transaction Framework

Joseph V. RizziMarch, 2013

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Transaction Framework

Strategic Issues • Do I make the acquisition?

Valuation • How much do I pay?

Financing • How do I pay?

Integration • Implementation of acquisition

Tactics • How do I make the offer?

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Transaction and Structuring Overview

Accounting

TaxCorporate

Law

Securities

Regulatory and AntitrustContract

BusinessPlan

TransactionCharacteristics

FinancialPreferences

MarketConditions

Deal

CompetingBidders

Creditors Rights

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Transaction and Structuring Overview

Accounting

TaxCorporate

Law

Securities

Regulatory and AntitrustContract

BusinessPlan

TransactionCharacteristics

FinancialPreferences

MarketConditions

Deal

CompetingBidders

Creditors Rights

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Summary of Complicating Factors

ContractFormConsiderationPricingConditionsRepos and WarrantiesIndemnitiesChange of ControlCovenants

TaxCapital Gains toSellerWHT 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/ConsolidationAntitrustHart/Scott/RodinoSherman ActHHIEuropean CommissionMonopolies & Mergers Commission

AccountingGoodwillFair Market ValueNet WorthConsolidation

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Complex Corporate Structure

Equity#1

Equity#2

EuropeanHolding Company

United StatesHolding Company

NEWCO

United States Target

ForeignOperating

Subsidiary*

DomesticOperatingSubsidiary

DomesticOperatingSubsidiary

DomesticOperatingSubsidiary

Collapsed

After Closing

Equity

Preferred Stock

High Yield/Sub Notes

Due to the structural nature ofSubordination in Europe, bankDebt would be placed at the Operating subsidiary level.

Bank Deal with Upstream Guarantee

* Tax limitations surrounding guarantees from foreign subs.

Guarantee

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Structure of an LBO Transaction

100%= 30 (equity)

+ 70 (debt financing)

Players LBO financing package Target company (2)

Equity30%

LBO funds (1)

Banks

Hedge funds

CLO

Senior debt60%

Debt financing 70%

Second lien loans5%

Subordinated debt5%

Debt financing

70%

Leverage effect =debt/EBITDA

=70/12=5.8

(EBITDA 12%)Mezzanine funds

Public Markets High Yield, PIK

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LBO Fund

Fund I

(1) LBO fund

GeneralPartner

Investment A

Investment B

InvestmentC

Target

Holdco I

Holdco II

OPCO

US Investors Exempt US InvestorsNon US Investors

LPLP LPA B C

(2) Target

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Negotiated Cash Merger Timeline

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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Auctions and negotiations differ on five dimensions

Negotiation Auction

Competition Low or no competition unless target and buyer can convince each other that they have strategic alternatives

to a negotiated transaction (e.g., LBO, liquidation, etc.)

Highly competitive

Structure Few rules and deadlines. Some uncertainty about whether target will

be sold at all.

Clear rules and deadlines. Strong

probability that the target will be sold.

Goals and control Controlled by target management. Social issues important.

Independent directors control. Price

important.

Flexibility High Low

Speed Slow Fast

Robert F. Bruner, Copyright © 2007,Used by Permission

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Due Diligence

– Legal

– Contingencies: ABB

– Accounting: McKesson/HBOC

– Business

– Licenses

– Employment

– Leases

– EPA

– Etc.

Earnings Revisions Study (Messod D. Beneish)

Typical violations of U.S. GAAP include:

– Recording revenues that are fictitious, unearned, or uncertain

– Recording fictitious inventory

– Improperly capitalizing costs

Violators tend to be smaller (by sales and assets), more leveraged, and faster growing.

Warning signs include:

– Increase in days receivables

– Decrease in gross margin

– Increase in percentage of total assets represented by assets other the PP&E.

– Comparatively hgh rate of sales growth

– Increase in percentage of total assets represented by accruals.

• Making sure you get what you thought you were getting

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Issues in Structuring a Deal

• 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

• Some Seller Shareholder Objectives:

– Maximize after-tax price received

– Minimize risk of the offer (for a given dollar value of the deal)

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Issues in Structuring a Deal

• 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

• Some Seller Shareholder Objectives:

– Maximize after-tax price received

– Minimize risk of the offer (for a given dollar value of the deal)

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Deal Terms

• Price

• Form of Transaction

• Form of Payment

• Control and Governance

• Social Issues

• Timing and Deadlines

• Transaction Hedges

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Deal Terms - Price

• Price

– Tends to be the focus, but is linked to virtually all

other deal terms as well as a number of external

influences

– Influenced by

– Economic cycle

– Premiums are higher in buoyant stock market

conditions

– Current target stock price

– Comparable deal premiums

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Interplay of Price and Range

Financial Terms

Non-Financial Terms

Seller’s Min Terms

Buyer’s Max Terms

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Price/Premium Paid

• Does the price/premium paid really matter if the

acquirer is offering its own stock to pay for the deal?

• Time Warner – AOL

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Deal Terms – Form of Transaction

• Form of Transaction – Influencing Factors

– Taxable or Tax Deferred

– What are the tax consequences for buyer and seller? Is seller subject to double taxation?

– Risk Exposure

– Does the structure isolate the hidden liabilities of the target?

– Control

– Will it require a vote of S/Hs of the target and/or buyer? How will voting control be affected?

– Continuity

– Which, if either firm will survive? What are the implications for ability to assign leases & licenses, for corporate identity, and for stat of incorporation

– Strongly linked to Form of Payment

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Deal Structure: Stock vs. Asset Purchase

Advantages Disadvantages

Stock

Purchases

• Avoids double taxation• Higher net proceeds to seller shareholders• Less documentation

• Risk fo unknown liabilities

• No future tax savings

Asset

Purchases

• Buyer avoids unknown liabilities• Possible step-up of asset tax basis• Seller keeps identity

• Buyer loses seller’s NOLs and tax credits • Rights to licenses, franchises, patents are not transferred• Double taxation

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Deal Structure: Stock vs. Asset Purchase

Advantages Disadvantages

Stock

Purchases

• Avoids double taxation• Higher net proceeds to seller shareholders• Less documentation

• Risk fo unknown liabilities

• No future tax savings

Asset

Purchases

• Buyer avoids unknown liabilities• Possible step-up of asset tax basis• Seller keeps identity

• Buyer loses seller’s NOLs and tax credits • Rights to licenses, franchises, patents are not transferred• Double taxation

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A Note About Taxes

• Tax factors are significant in some mergers (<10% of

mergers)

• Tax effects not the main motivation for mergers

• Tax effects that are seen in mergers could generally be

replicated by a stand-alone firm changing its own

leverage or engaging in an asset sale/leaseback

transaction

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A Note About Taxes

• Tax factors are significant in some mergers (<10% of

mergers)

• Tax effects not the main motivation for mergers

• Tax effects that are seen in mergers could generally be

replicated by a stand-alone firm changing its own

leverage or engaging in an asset sale/leaseback

transaction

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A Note About Taxes

Form ofTransaction

Price, & Formof Payment

Tax Consequences(after-tax proceeds)

OwnershipClaims

(dilution)

RiskinessOf Future

Cash Flows(creditworthiness

)

EPS Consequences(manager/investor perceptions)

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Deal Terms – Form of Payment

• Payments to Target Shareholders

– Fixed payments (cash or senior debt) – resolves target S/H uncertainty about deal value

– Contingent payments (mezzanine or “junk” debt, preferred, or common equity, earn-outs, convertibles, caps, floors & collars) – allows target S/Hs to participate in upside potential, resolve strong disagreements about target value, and limit post announcement adverse stock price movements

• Side Payments

– Payments to other stakeholders that may influence the success of the post-merger firm (golden parachutes, buyouts of employments contracts, consulting commitments to target management)

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Method of Payment

Type Characteristics of deal

Cash • Target shareholders exchange for cash

• Typically taxable transactions

Stock • Firms negotiate a ratio of acquirer shares to exchange for target

• Market risk high – target shareholders lose when acquirer stock fails

Stock with collar

• 25% of stock deals use collars to lower risk

• Many types of collars:

– Specify dollar amount of stock exchanged

– Fixed dollar amount within a max and min

– Fixed stock ratio within a max and min

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Contingent Payments

• Earnouts and contingent payments in mergers (used in 2.5% of

deals)

– Payment based on future performance of target

– Provides incentive for owner-managers to stay with acquirer

– Mostly used to buy small firms with key employees (high tech,

service, etc.)

– Problem: hard to measure in post-merger performance (high

frequency of lawsuits)

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Other Deal Terms

• Control & Governance

– Relative proportions of share ownership and voting rights,

composition of the new board

• Social Issues

– Identity of executive management team, corporate name,

headquarters location

• Timing and Deadlines

– Time value of money impact on valuation and ability to structure

post-merger integration efforts

• Transaction Hedges

– Walk-away fees

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Documentation

• Confidentiality Agreement

• Letter of Intent

– Exclusive

– Nonexclusive

• Acquisition Agreement

– Reps and Warranties

– Conditions