M&A: Question and Answer - Negotiation and Takeover Strategies

Negotiation and Takeover Strategies

• Why can't acquirer retain control by simply purchase shares on market?
• Regulations --> limit the purchase amount of shares and transparency
• Shareholders hold-out problems.
• Difficult to buy large ownership blocks on publicly traded market, since they not actively trade their shares.
• What is the theoretical final offer price in a tender offer if shareholders are rational and there is no info asymmetry?
• Final offer price is the final decisions made by acquirer about their offer price and target wouldn't accept more than this.
• Reservation price reflect all synergies and all available benefits.
• No extension --> clear and final
• Does the holdout problem come back to hurt target shareholders and how do they deal with this problem?
• Target shareholder will probably lose the deal and lose the premium price.
• They could deal this situations by performing:
• Collective voting / auction environment, in order to attract more acquirer or potential white knight. Thus, this will push-up the bid price, close to target's reservation price. 
• Wait & see -- attract multiple acquirer and discover their reservation price (target's board play for time to attack acquirer's financing strength and earn more profits).
• What are some tactics that acquirer can use to overcome the holdout problem?
• Purchase a toehold --> purchase less than 5% of target's stock in the market (not required to register and explain one's purchase to the SEC until one meets the 5% threshold). In the instance of a shareholder vote, toehold shareholders hold a significant place in such votes.
• Partially tender offer for target's share --> to discover the price and obtaining necessary control with minimum amount of capital.
• Partially asset acquisition --> Dictate and create an implicit threat to holdout shareholders that they interest may not be protected. Creating an option to acquire the asset fully in the future.
• Intense negotiation with large block of shareholders --> no collective actions, only to communicate with 1 block. --> create a threat that holdout shareholders interest may be diluted or expropriated. 
• Private Bear Hug --> Bypass CEO, go directly to board. Intense on board to board communication.
• Public Bear Hug --> media rumours to create pressure to shareholders. 
• Why is it important for acquirers to achieve control of the M&A process? What are their common bargaining chips?
• To dictate the negotiation process.
• Limit target flexibility and extract the reservation price.
• Bargaining chips: 
• Final price bid --> final offer, acquirer's final decisions, price will not going up no more, exit  negotiations if target continue to ask more.
• Deadline: timing of the offer price, not valid any more in certain due date.
• Offer reasonable price for more synergies and benefits. Push more target to negotiation table.
• Penalty and limit of the offer.
• Should you set your reservation prices based on the theoretical boundary formulae? How should you set your initial bid price?
• Due to information asymmetry --> acquirer should limit the reservation price and be prepared to switch to other target.
• Initial bid price: reasonable low, but not too low. Push target to negotiate and place a bid and discover they true value, try to dictate and renegotiate the bid price close to acquirer's reservation price.
• What is the value created from an auction environment? Why do you think that most auctions in M&As are a hybrid between open and sealed bid auctions?
• Auction environment could trigger multiple acquirer and push-up the bid price.
• Give control of the process back to the seller.
• Save time and effort (of target management), high probability that the target will be sold.
• Open Auctions: First bidder advantages, since no body will put the first bid forward close to their reservation price. The last bidder can free-ride previous bidders by offering higher bid price.
• Sealed Auctions: Overpayment risk, since overall the bidder will place their best price as high or close to reservation price.

M&A: Hostile Takeover, Defensive Strategies and Merger Arbitrage

Hostile Takeover:

• Mostly are off-market purchase, can turn friendly and vise versa.
• Hostile threats have a disciplining effect on target's managers but also bring higher premium (benefit for target).
• Hostile carry element of surprise, allow bidder to take advantage of poor target valuation, reduce the likelihood of competing bidders, limit hold-out problems (target's board play for time), bypass highly entrenched board, create pressure for board to go back to the negotiation table (opportunistic benefits for acquirer).
• Costs: 
• no due diligence
• protracted (lasting longer than expected), difficult to win control, high premium.
• Tougher merger integration --> strong enough to withstand adverse conditions, lots difficulty, require great efforts. 

Merger Arbitrage

• Arbitrageur's strategy:
• Long position on target shares --> buy target shares, hoping the price will go-up since the competitive bids will drive-up acquirer's offer price and arbitrageur will earn more.
• Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
• Short position on bidder shares (usually for stock deal) --> short the acquirer shares, hoping the price will go-down for unexplained reasons.
• The acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur may then short sell the acquirer and buy the stock of the target. This process is called "setting a spread." After the merger is completed, the target's stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his short position to complete the arbitrage.
• Collar --> the exchange ratio is not constant but changes with the price of the acquirer.
• Net position is highly leveraged.
• Risks: 
• The deal will fail and the price will go down significantly.
• Degree of exposure amplified through leverage.
• Arbitrage spread:
• Difference between the offer price and the target's post announcement market price.
• Positive: higher offer.
• Roles of Arbitrageur
• Providing liquidity: merger arbitrageurs provide liquidity that target shareholders demand to avoid blow-up risk.
• Ameliorating shareholder hold-out problems: Arbitrageurs round up free float shares in the market, making the coordination problem less severe.
• Information revelation: Is another higher offer forthcoming? What is the probability of deal failure?

Takeover Defence Strategies

• Why do targets need to defend against hostile takeovers?
• Keeping management entrenched (firmly established and difficult to change)
• Protecting stakeholders (eg employees) welfare.
• Deterring (prevent the occurrence of) opportunistic and not serious bidders.
• Providing a fair M&A playground for all shareholders
• Extracting more value for target's shareholders.
• Buying more time.
• Wrestling control of the process back to the target.
• Reducing shareholder holdout by forcing target shareholders to coordinate.
• Giving the board more bargaining power at the negotiation table
• Making acquirers to offer higher premium.
• Common Strategies:
• Pre-emptive defences: 
• Implemented before a hostile bid.
• Legal mechanisms and some strategic & financial defences.
• Reactive Defences:
• Defences put in place after a hostile bid is made.
• Tailored to defeat or discourage a specific bidder.
• Defensive strategies in Australia:
• Poison pills not widely used (Takeover Panel Guidance Note 12) such as:
• issues new share/repurchase shares significantly in the context of the bid.
• Acquiring major asset or disposing one.
• Undertaking significant liabilities or materially changing terms of its debt.
• Declaring a special or abnormally large dividend.
• Significantly changing company share plan.
• Entering into joint venture.
• Staggered Board
• Board recommendations: significant impact on shareholders decisions, often accompanied by independent expert valuation reports, can be supported by marketing campaign in the media.
• Value diversion: special dividend, share buyback.
• Information management: updating profit forecasts, bring forward the release of confidential information.
• Restructuring: sale of non-core assets, increasing leverage, de-merger.
• Creating an auction environment: approaching potential white knights, setting up an auction for an asset/division.
• Taking advantage of resistance from regulators/public: Takeover Panel/Foreign Investment Review Board rulings.
• Most importantly, asking for a higher price --> pointing out that price < synergy, attacking acquirer's financing, stock price potential (in stock deals)
• Empirical Results for Australia (Maheswaran and Pinder, 2005):
• Bid resistance increases target shareholder wealth in post announcement period.
• Bid hostility associated with larger targets, weak target performance.
• Hostility unrelated to size of premium offered.
• Hostility decreases probability of success, increases likelihood of revision, does not scare off competitors.

M&A Basic Concept & Terminology

• Takeover: transfer of controlling ownership (involves shares); Acquisition: purchase of one firm (involves assets); Merger: combination of two firms into a new legal entity, both shareholders must approved the transaction; Scheme of Arrangement: court approved union of two firms, governed by a set of contract.
• Hostility -- Hostile takeover: takeover without consultation and un-support by target's management. Tender offer, general offer from acquirer to target's shareholder with premium price. Friendly takeover: merger between two firms with support of target's management, target might solicit offer from other potential acquirers (hold-out problem).
• Relatedness -- Horizontal: merger of two firms in the same industry or similar product line; Vertical: merger of two firms in different steps of a production process (supply chain), merger to its upstream suppliers or its downstream buyers; Conglomerate: merger of two firms in unrelated business, to diversify by combining unrelated assets and income stream.
• Financing -- Cash deals: finance by acquirer cash or additional borrowing, size of combined firm less than acquirer+target size (1+1 < 2); Stock deal: finance by acquirer stock, target exchange their shares for acquirer shares, often with specified exchange ratio, size of combined firm near equal or more than acquirer+target size (1+1 = or > 2); Mixed deal: each target share is exchange for either cash or acquirer's shares. Note: buyers tend to offer stock deal when they believe their shares are overvalued and cash deal when their shares are undervalued. Stock deal: target shareholders still remain to control with their stocks, but Cash deal: target shareholders were removed permanently and the company under the indirect control of the bidder's shareholders.
• Vertical benefits: lower transaction costs (when making an economic exchange),;synchronisation of supply and demand along the chain of products; ability to monopolize market through the chain; strategic independence (especially when inputs are rare or highly volatile in price). Vertical disadvantage: higher coordination costs; higher organisation costs of switching to different suppliers/buyers; weaker motivation at the start of supply chain.
• M&A transaction costs might arise from: information asymmetries from searching information of target's synergic benefits; bargaining costs: costs required to reach an acceptable agreement with target; monitoring costs: cost of making sure the other party stick in the rules.
• Corporate control: a party has a dominant control of the firm if they have the veto power over the use of its assets.
• Economic driving forces of M&As waves: technology changes, competition environment, deregulation, privatisation, globalisation, equity and market conditions.
• Benefits of M&As: synergies, change of control (replace inefficient management), market power (to give additional revenue by increase the price), undervalued target (market price < intrinsic value), tax savings (acquire target company that losses in the past but should not in the future).
• Costs of M&As: overpayment (management hubris), merger integration costs (in the initial phase, usually decreasing in profits), agency costs (less of monitoring activities), increased bankruptcy risk (differ in leveraged), taxes, M&As advisory fees.
• Synergy definition: additional value created from combining two firms operations and financial structure. PV(AB) > PV(A) + PV(B) or 1+1 more than 2.
• Sources of synergy: economies of scale, economies of scope, complementary of resources, synergy from financial efficiencies, diversification, adopt a new financial structure, reduced bankruptcy costs.
• Gains in M&As: value of bidder without acquisition+value of a target as a stand alone company+synergies and operating improvements (synergic benefits and control benefits)+profit on sale of excess assets.
• M&As Deal Failures: poor post merger integration, unrealised synergies & control benefits, poor post deal management of target, overoptimism-over bidding-poor due diligence.