Introduction to

Mergers, Acquisitions,
& Other Restructuring
Activities
 If you give a man a fish, you feed him for a day.
If you teach a man to fish, you feed him for a life time.

—Lao Tze
 Success is a Personal Choice
We can choose to be successful by
• Setting goals,

• Having high expectations of ourselves,

• Never quitting,
• By not making excuses, and
• By accepting personal responsibility
 Exhibit 1: Course Layout: Mergers,
Acquisitions, and Other
Restructuring Activities

Part I: M&A Part II: M&A Process Part III: M&A Part IV: Deal Part V: Alternative
Environment Valuation and Structuring and Business and
Modeling Financing Restructuring
Strategies

Ch. 1: Motivations for Ch. 4: Business and Ch. 7: Discounted Ch. 11: Payment and Ch. 15: Business
M&A Acquisition Plans Cash Flow Valuation Legal Considerations Alliances

Ch. 2: Regulatory Ch. 5: Search through Ch. 8: Relative Ch. 12: Accounting & Ch. 16: Divestitures,
Considerations Closing Activities Valuation Tax Considerations Spin-Offs, Split-Offs,
Methodologies and Equity Carve-Outs

Ch. 3: Takeover Ch. 6: M&A Ch. 9: Financial Ch. 13: Financing the Ch. 17: Bankruptcy
Tactics, Defenses, and Postclosing Integration Modeling Basics Deal and Liquidation
Corporate Governance

Ch. 10: Private Ch. 14: Applying Ch. 18: Cross-Border

Company Valuation Financial Models to Transactions
Deal Structuring
 Course Learning Objectives

Students will learn

•What corporate restructuring is and why it occurs;
•Commonly used valuation techniques and how they are employed;
•How corporate restructuring creates/destroys value;
•Commonly used takeover tactics and defenses and when they should be
employed;
•A highly practical “planning based” approach to managing the M&A process;
•The challenges and solutions associated with each phase of the M&A process;
•The advantages and disadvantages of alternative M&A deal structures;
•How to apply financial models to value, structure and negotiate deals; and
•How to plan, structure, and manage JVs, partnerships, alliances, licensing
arrangements, equity partnerships, franchises, and minority investments
Current Chapter Learning Objectives

• Primary objective: What corporate restructuring is

and why it occurs
• Secondary objective: Provide students with an
understanding of
– M&A as a form of corporate restructuring
– Alternative ways of increasing shareholder value
– M&A activity in an historical context
– The primary motivations for M&A activity
– Key empirical findings
– Primary reasons some M&As fail to meet
expectations
 M&As as a Form of
Corporate Restructuring

• Restructuring Activity • Potential Strategy

– Corporate Restructuring – Redeploy Assets
• Balance Sheet • Mergers, Break-Ups, &
Spin-Offs
• Assets Only • Acquisitions,
divestitures, etc.
– Financial Restructuring – Increase leverage to lower
cost of capital or as a
takeover defense; share
repurchases
– Operational Restructuring – Divestitures, widespread
employee reduction, or
reorganization
 Alternative Ways of
Increasing Shareholder Value
• Solo venture (AKA “going it
alone” or “organic growth”)
• Partnering
(Marketing/distribution alliances,
JVs, licensing, franchising, and
equity investments)
• Mergers and acquisitions
• Minority investments in other
firms
• Asset swaps
• Financial restructuring
• Operational restructuring
 Discussion Questions

1. What factors do you believe are most likely to

impact senior management’s selection of one
strategy (e.g., solo venture, M&A) to increase
shareholder value over the alternatives? Be
specific.
2. In your opinion, how might the conditions of the
business (e.g., profitability) and the economy
affect the choice the strategy?
 Motivations for M&A

• Strategic realignment
– Technological change
– Deregulation
• Synergy
– Economies of scale/scope
– Cross-selling
• Diversification (Related/Unrelated)
• Financial considerations
– Acquirer believes target is undervalued
– Booming stock market
– Falling interest rates
• Market power
• Ego/Hubris
• Tax considerations
 Illustrating Economies of Scale
Period 1: Firm A (Pre-merger) Period 2: Firm A (Post-merger)

Assumptions: Assumptions:
• Price = $4 per unit of output sold • Firm A acquires Firm B which is producing
• Variable costs = $2.75 per unit of output 500,000 units of the same product per year
• Fixed costs = $1,000,000 • Firm A closes Firm B’s plant and transfers
• Firm A is producing 1,000,000 units of output per production to Firm A’s plant
year • Price = $4 per unit of output sold
• Firm A is producing at 50% of plant capacity • Variable costs = $2.75 per unit of output
• Fixed costs = $1,000,000

Profit = price x quantity – variable costs Profit = price x quantity – variable costs
– fixed costs – fixed costs
= $4 x 1,000,000 - $2.75 x 1,000,000 = $4 x 1,500,000 - $2.75 x 1,500,000
- $1,000,000 - $1,000,000
= $250,000 = $6,000,000 - $4,125,000 - $1,000,000
= $875,000

Profit margin (%)1 = $250,000 / $4,000,000 = 6.25% Profit margin (%)2 = $875,000 / $6,000,000 = 14.58%
Fixed costs per unit = $1,000,000/1,000,000 = $1 Fixed costs per unit = $1,000,000/1.500,000 = $.67

Key Point: Profit margin improvement is due to spreading fixed costs over more units of output.
1
Margin per unit sold = $4.00 - $2.75 - $1.00 = $.25
2
Margin per units sold = $4.00 - $2.75 - $.67 = $.58
 Illustrating Economies of Scope
Pre-Merger: Post-Merger:

• Firm A’s data processing center • Firm A’s and Firm B’s data
supports 5 manufacturing facilities processing centers are combined
into a single operation to support
• Firm B’s data processing center all 8 manufacturing facilities
supports 3 manufacturing facilities • By combining the centers, Firm A
is able to achieve the following
annual pre-tax savings:
– Direct labor costs = $840,000.
– Telecommunication expenses
= $275,000
– Leased space expenses =
$675,000
– General & administrative
expenses = $230,000

Key Point: Cost savings due to expanding the scope of a single center to
support all 8 manufacturing facilities of the combined firms.
 Empirical Findings
• Abnormal (or excess) financial returns are those earned by acquirer and target
shareholders above or below what would have been earned without a takeover.
• Around transaction announcement date, abnormal returns:1
– For target shareholders averaged 25.1% during the 2000s as compared to
18.5% during the 1990s
– For acquirer shareholders generally positive averaging about 1-1.5%
– However, zero to slightly negative for acquirer shareholders for deals involving
large public firms and those using stock to pay for the deal1
• Positive abnormal returns to acquirer shareholders often are situational and include
the following:
– Target is a private firm or a subsidiary of another firm
– The acquirer is relatively small (large firm management may be more prone to
hubris)
– The target is small relative to the acquirer
– Cash rather than equity is used to finance the transaction
– Transaction occurs early in the M&A cycle
• No evidence that alternative strategies (e.g., solo ventures, alliances) to M&As are
likely to be more successful
1
These conclusions are based on recent studies using large samples over lengthy time periods involving U.S., foreign, and cross-border deals
(including public and private firms). See J. Netter, M. Stegemoller, and M. Wintoki, 2011 Implications of Data Screens on Merger and
Acquisition Analysis: A Large Sample Study of Mergers and Acquisitions, Review of Financial Studies 24 2316-2357 and J. Ellis, S. B.
Moeller, F.P. Schlingemann, and R.M. Stulz, 2011 Globalization, Governance, and the Returns to Cross-Border Acquisitions, NBER
Working Paper No. 16676.
Primary Reasons Some M&As Fail
to Meet Expectations

• Overpayment due to over-estimating

synergy

• Slow pace of integration

• Poor strategy
 Discussion Questions

1. Discuss whether you believe current conditions

in the U.S. and global markets are conducive
to high levels of M&A activity? Be specific.
2. Of the factors potentially contributing to current
conditions, which do you consider most
important and why?
3. Speculate about what you believe will happen
to the number of M&As over the next several
years in the U.S.? Globally? Defend your
arguments.
 Application: Xerox Buys ACS
In 2010, Xerox, a slower growing, cyclical an office equipment manufacturer, acquired
Affiliated Computer Systems (ACS) for $6.4 billion. With annual sales of about $6.5 billion,
ACS handles paper-based tasks such as billing and claims processing for governments
and private companies. With about one-fourth of ACS’ revenue derived from the healthcare
and government sectors through long-term contracts, the acquisition gives Xerox a greater
penetration into markets which should benefit from the 2009 government stimulus spending
and 2010 healthcare legislation. There is little customer overlap between the two firms. The
sale of services tends to be more stable and offers higher margins than product
companies.
Previous Xerox efforts to move beyond selling printers, copiers, and supplies and into
services achieved limited success due largely to poor management execution. While some
progress in shifting away from the firm’s dependence on printers and copier sales was
evident, the pace was far too slow. Xerox was looking for a way to accelerate transitioning
from a product driven company to one whose revenues were more dependent on the
delivery of business services.
More than two-thirds of ACS’ revenue comes from the operation of client back office
operations such as accounting, human resources, claims management, and other
outsourcing services, with the rest coming from providing technology consulting services.
ACS would also triple Xerox’s service revenues to $10 billion. Xerox chose to run ACS as a
separate standalone business.

Discussion Questions:
1. What alternatives to buying ACS do you think Xerox could have considered?
2. Why do you think they chose a merger strategy? (Hint: Consider the
advantages and disadvantages of alternative implementation strategies.)
3. Speculate as to Xerox’s primary motivations for acquiring ACS?
4. How might the decision to manage ACS as a separate business affect realizing the full
value of the transaction? What other factors could limit the realization of synergy?
 Remembering the Past

“Those who do not remember the past

are condemned to relive it.”
Alexis De Tocqueville
 1
Merger Waves
(Boom Periods)
• Horizontal Consolidation
(1897-1904)
• Increasing Concentration
(1916-1929)
• The Conglomerate Era
(1965-1969)
• The Retrenchment Era
(1981-1989)
• Age of Strategic Megamerger
(1992-2000)
• Age of Cross Border and
Horizontal Megamergers
(2003-2007)

1
Periods characterized by robust increases in the number and value of
transactions.
 Causes and Significance
of M&A Waves

• Factors contributing to increasing M&A activity:

– Shocks (e.g., technological change, deregulation, and escalating
commodity prices)
– Ample liquidity and low cost of capital
– Overvaluation of acquirer share prices relative to target share
prices
– Improving business confidence
• Why it is important to anticipate M&A waves:
– Financial markets reward firms pursuing promising (often
undervalued) opportunities early on and penalize those that
follow later in the cycle.
– Acquisitions made early in the wave often earn substantially
higher financial returns than those made later in the cycle.
Horizontal Consolidation (1897-1904)
• Spurred by
– Drive for efficiency,
– Lax enforcement of antitrust laws
– Westward migration, and
– Technological change
• Resulted in concentration in metals,
transportation, and mining industry
• M&A boom ended by 1904 stock market
crash and fraudulent financing
Increasing Concentration (1916-1929)

• Spurred by
– Entry of U.S. into WWI
– Post-war boom
• Boom ended with
– 1929 stock market crash
– Passage of Clayton Act which more clearly
defined monopolistic practices
The Conglomerate Era (1965-1969)

• Conglomerates buy earnings streams to boost

their share price
– Overvalued firms acquired undervalued high
growth firms
– Number of high-growth undervalued firms
declined as conglomerates bid up their prices
– Higher purchase price for target firms and
increasing leverage of conglomerates brought
era to a close
The Retrenchment Era (1981-1989)

• Strategic U.S. buyers and foreign multinationals

dominated first half of decade
• Second half dominated by financial buyers
– Buyouts often financed by junk bonds
– Drexel Burnham provided market liquidity
• Era ended with bankruptcy of several large
LBOs and demise of Drexel Burnham (Michael
Milken)
 Age of Strategic Megamerger
(1992-2000)

• Dollar volume of transactions reached record in each

year between 1995 and 20001
• Purchase prices reached record levels due to
– Soaring stock market
– Consolidation in many industries
– Technological innovation
– Benign antitrust policies
• Period ended with the collapse in global stock markets
and worldwide recession

1
The cumulative dollar value of M&As during this period in the U.S. was $6.5 trillion, With $3.5 trillion
taking place in the last two years.
 Age of Cross Border and
Horizontal Megamergers (2003 – 2007)

• Average merger larger than in 1980s and 1990s, mostly

horizontal, and cross border
• Concentrated in banking, telecommunications, utilities,
healthcare, and commodities (e.g., oil, gas, and metals)
• Spurred by
– Continued globalization to achieve economies of
scale and scope;
– Ongoing deregulation;
– Low interest rates;
– Increasing equity prices, and
– Expectations of continued high commodity prices
• Period ended with global credit market meltdown and
2008-2009 recession
Debt Financed 2003-2007 M&A Boom

Low Interest Foreign

Rates & Declining Banks & Investors
Risk Aversion Investment Hedge Funds Buy
Drive Increasing Banks: Create: Highest
--Sub-Prime Repackage & --Collateralized Rated
Mortgage Underwrite Debt Debt
Lending --Mortgage Obligations
--LBO Financing Backed (CDOs)
--Collateralized Hedge
& --High Yield Funds
Other Highly Bonds Loan
Obligations Buy Lower
Leveraged Rated debt
Transactions CLOs)

Investment Banks Lend to Hedge Funds

 Similarities and Differences
Among Merger Waves

• Similarities
– Occurred during periods of sustained high economic
growth
– Low or declining interest rates
– Rising stock market
• Differences
– Emergence of new technology (e.g., railroads,
Internet)
– Industry focus
– Type of transaction (e.g., horizontal, vertical,
conglomerate, strategic, or financial)
 Discussion Questions

1. What can senior management learn by

studying historical merger waves?
2. What can government policy makers learn by
studying historical merger waves?
3. What can investors learn by studying historical
merger waves?
 Things to Remember

• Motivations for acquisitions:

– Strategic realignment
– Synergy
– Diversification
– Financial considerations
– Hubris
• Common reasons M&As fail to meet expectations
– Overpayment due to overestimating synergy
– Slow pace of integration
– Poor strategy
• M&As typically reward target shareholders far more than bidder
shareholders
• Success rate of M&A not significantly different from alternative ways
of increasing shareholder value