M&A: Deal Structuring and Financing

Structuring choice

• Straight merger --> buyer merges with target and target ceases to exist
• Buyer absorbs all target's asset and liabilities.
• buyer shareholders must approve merger
• Triangular merger --> Buyer subsidiary and target merge
• Buyer absorbs all target's asset and liabilities --> cabins all in buyer subsidiary
• Not require buyer's parent shareholder vote.
• Target shareholders receive cash, notes or buyer parent stock
• Forward triangular merger: target ceases to exist.
• Reverse triangular merger: buyer subsidiary ceases to exist.
• Stock acquisition/purchase (including tender offer) --> buyer acquires all (or some of) target's stock for cash, acquirer's debt or stock.
• Target becomes a subsidiary of Buyer (not the case in partial acquisition)
• Target financial liabilities remain in target subsidiary.
• Asset acquisition --> buyer acquires specific target assets for cash, debt or stock
• Buyer only buy target's selected asset, not absorb their liabilities.
• Issues: tax implication --> identify existing double tax-system (from capital gain and dividend payment)
• In general, differences between purchase price and fair value of assets could be allocated as goodwill, of which the amortisation can create tax saving.

Price versus Terms

Price is the headline of M&A transactions, but secondary to terms
If one of the terms changes, price will changes. Both of them is subject to intense negotiation.
Bidding sends stronger signal than talking. Better by using the time limits, withdrawals, threats and other bargaining chips.

• M&A Terms:
• Condition of the purchase.
• Timing and proceeding of the purchase.
• Financing of the purchase.
• Payment forms and contingencies.
• Legal structure of the combined entity after the purchase.

Main concern of M&A participants --> to negotiate on terms

• Objectives / desirable:
• value creation.
• control and incentives
• financing flexibilities
• minimising transaction risks and adverse market signals
• enhancing governance, social responsibility.
• Constraints:
• Counter party objectives / desirables --> Zone of potential agreement (ZOPA)
• Owner's collective action: free-rider problems.
• Other stakeholders interests --> cost pay to lawyers, consultant, or government regulations.
• Contracting and financing costs.
• governance and tax regulations.
• Adverse selection:
• Outside investors cannot ascertain the true value of the firm.
• But suspect: managers issue shares --> if the firm is currently overvalued.
• Issue shares are "bad" signal --> high cost, share ownership of the firm, or as last resort (the firm cannot borrow any debt).

Payment choice

• Fixed payment: 
• often in the form of cash or debt securities.
• resolving uncertainty about the transaction.
• Semi-fixed payment:
• often in the form of junk bonds (very low credit worthiness), preferred stock and common stock.
• value may change upon the announcement of the deal --> different time of announcement date and arrival of other news?
• uncertainty about the realisation of the deal.
• may reveal negative investors reaction.
• Contingency payment:
• in the form of: earn-outs (additional payment to be made to target depend on performance in the future), warrants (a right, without obligation, to buy or sell something at an agreed price), convertible debts (the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value).
• value may change depending on the future target performances.
• Side payment:
• payments parties other than target owners
• Example: parties that influence in design & consummation of transaction to success of post-merger. Payment to union, guarantee of work rules, job security, government.

Financing choice (bidder financing decisions):

• New debt or reduce cash
• Effect: increase leverage, raising risk of bankruptcy and raise target taxes.
• Increase overpayment risk --> usually target's market share price is lower than the bidder's cash offer, thus no real measurement about under or overpayment.
• quick conclusion, reduce uncertainty about the deal overcome.
• Market reactions --> POSITIVE (buyer stock price will go up) due to market suspect: buyer's optimism about the future value of merger synergies and undervalued buyer's intrinsic firm value.
• Requires buyer financial strength --> must have sufficient excess of liquid assets or unused debt capacity.
• New debt will influence management discipline and increase monitoring of performance.
• Faster executions.
• Avoid buyer shareholder vote to approve deal.
• New equity
• Effect: dilute ownership, share deal risk with target (reflected in future share price, performance low --> share price decrease), raise stock liquidity (how easy it is to buy and sell shares without seeing a change in price).
• Floatation costs --> paid by the company that issues the new securities and includes expenses such as underwriting fees, legal fees and registration fees.
• Drawn out battle --> lots of effort, more difficulty and time consuming.
• Market reactions --> NEGATIVE (buyer stock price will go down) due to market suspect: buyer's lack of internal financial capabilities (last resort) and overvalued buyer's intrinsic firm value. 
• Reduce buyer's risk of overpaying for a target. Performance of target decreasing --> stock price will decrease as well, target sharing risk of lower stock price between announcement of takeover and final due date.
• Buyer shareholders may have right to vote on the deal (because have a large block share  which meet the criteria to vote).
• Floatation exchange rate: adjusting the ratio price the acquirer decrease by 35%, thus price M&A will decrease by 35% (always remaining the same proportion).
• Risk bearing impact of financing choice
• Cash Deal:
• Buyer shareholders bear all deal risk --> overpayment risk (unrealised expected synergies & operating improvement)
• Target: no risk
• Stock Deal:
• Target shareholders bear short-term purchase price risk --> acquirer stock price will change up/down until deal completion date.
• Target overpayment shortfalls cause acquirer share price will fluctuate as investors learn about the true value of synergies & control benefits.
• What are potential problems if Buyer's share price falls substantially?
• Acquirer will issue more share to maintain the same offer price --> ownership will diluted for something that wasn't the fault of acquirer.
• Solution?
• Minimum purchase price guarantee --> buyer gives target owners put options on its stock (right to sell stock back to buyer)
• Purchase price Collar --> with a fixed exchange rate, target owners get a minimum $ purchase price, but they also accept a maximum $ price.
• Walk away clause --> deal is cancelled if Buyer's stock price falls too far.
• Special dividend --> shareholder is happy because excess of imputation credit --> get back to shareholders as dividend and also transferring tax credit.
• Equity-linked contingent Financing:
• M&A payments are contingent on Buyer or Target stock price or on Target asset value or profitability after deal completion.
• Contingent contract mechanisms are often used when:
• wide disagreement exists about a Target's current value & target will be operated as a separate subsidiary or division of Buyer.
• Target shareholders retain a minority interest in Target --> than fear expropriation by Buyer (ex: buyer purchase only 50.1% control)
• In stock deals where Buyer stock is highly risky, Buyer can offer a long term price guarantee on it's stock future value.