Mergers And Acquisitions (Business 696)

Mergers, Acquisitions, and Other Corporate Restructuring Activities MBAF 624 Course Syllabus-Fall 2002 (8/26/02-12/13/02) Monday 7:15-10:00, Hilton 107

Instructor:

Name: Don DePamphilis, Ph.D. Office: Hilton 210 Phone: 310-338-7415 E-mail: [email protected] (easiest way to contact) or [email protected] Office Hours: Mondays 4:00-6:45 P.M.; Wednesdays 1:00-4:00 P.M.; or by appointment.

Course Overview:

Learning Objectives: To provide students with knowledge of

1. what corporate restructuring is and why it occurs; 2. the impact of the regulatory environment on the M&A environment; 3. how value is created (or destroyed) as a result of corporate mergers, acquisitions, divestitures, spin-offs, etc., through in-depth analysis of how to “do a deal.”; 4. how risks associated with the various approaches to creating value can be identified and managed; 5. commonly used takeover tactics and defenses; 6. a process for selecting appropriate takeover tactics depending upon the types of anti- takeover defenses in place at a target company; 7. how and when to apply valuation techniques under special circumstances; 8. the practical limitations of the various valuation techniques; 9. the importance of understanding assumptions underlying business valuations; 10. a highly practical “planning based approach” to managing the acquisition process; 11. challenges associated with each phase of the M&A process from developing acquisition plans through post-closing integration; 12. the advantages and disadvantages of alternative deal structures; 13. how the various components of the deal structuring process interact to determine price; 14. how to manage the deal structuring process to minimize the risk that a business combination will not meet expectations; 15. advantages and disadvantages of alternative ways to exit businesses; 16. applying financial modeling tools to evaluating mergers and acquisitions; 17. how the many tools and skills that have been learned in this and other courses are used in an integrated manner in completing an acquisition; and 18. alliances/joint ventures as alternatives to mergers and acquisitions.

Description: The course is divided into two discrete sections: (1) Developing an in-depth understanding of how and when to apply the appropriate tools and skills to successfully complete a transaction and (2) the application of what has been learned to solving “real” world business problems. All major elements of the acquisition process will be discussed in the context of a logical process. The course will involve the application of what the student may have learned in such courses as finance, accounting, business law, micro and macroeconomics, management, negotiation, new ventures, entrepreneurship, strategic planning, and business policy/organization. As part of pre-class preparation and in-class discussion, students will be asked to solve both quantitative and qualitative problems and to analyze both publicly traded and privately owned companies involving valuing synergy, control premiums, and leveraged buy-outs. Illustrations will include practical ways to evaluate IPOs, new ventures, and Internet-related companies.

Students will be asked to form acquisition teams to develop highly realistic business and acquisition plans that could be used to convince top management of an acquiring corporation, a venture capital firm or a lender to fund their proposal. The focus will be on how to effectively manage the process. As a key part of the learning experience, the course will require primary research to obtain the necessary data to develop the acquisition plan, working within teams, and the development of project management skills. The professor will illustrate how the process works in practice by drawing upon his personal experience in managing more than 30 acquisitions, divestitures, alliances, joint ventures, equity partnerships, minority investments, and licensing arrangements from the planning through implementation stages.

The professor will frequently relate concepts discussed in class to transactions currently in the news to illustrate their application and limitations.

Who should take this course?: Those who are seeking to become entrepreneurs, financial analysts, chief financial officers, operating managers, investment bankers, business brokers, portfolio managers, investors, corporate development managers, strategic planning managers, bank lending officers, auditors, venture capitalists, business appraisers, actuaries, corporate attorneys, or who simply have an interest in the subject.

Prerequisites: The course presumes that students have knowledge of basic accounting, economics, and financial management concepts and tools. Students should have had at least one course in accounting, finance, and economics within the last two years or relevant work experience.

Required Texts: Mergers, Acquisitions, and Other Restructuring Activities: An Integrated Approach to Process, Tools, Cases, and Solutions by Donald M. DePamphilis, Academic Press, San Diego, Ca., 2001 (ISBN: 012-210-735-7) and Techniques of Financial Analysis: A Guide to Value Creation, 10th edition, by Erich A. Helfert, Irwin McGraw-Hill, New York, 2000 (ISBN: 0- 07-229988-6).

Reference Texts: Financial Management: Theory and Practice, 8th edition, by Brigham, Eugene F. and Gapenski, Louis C., The Dryden Press, Fort Worth, Tx. 1997.

Computer skill requirements: Students will need to know how to use spreadsheet software (e.g., Micorsoft Excel) no later than the fourth class meeting.

Grading: Students will be evaluated in five different ways: Grade Points: Examination (2 exams—100 points each) 200 points Acquisition Team Project (see discussion below)1 230 points Peer Review (see discussion below) 30 points Assignments --Assignment #1 10 points --Assignment #2 50 points --Assignment #3 40 points Class participation (see discussion below) 40 points 600 points

2 1Team project leaders have the potential to earn an additional 20 points based on an anonymous review of their performance by their team mates.

Final letter grades will be assigned according to the following point scale: A 576 - 600 A- 550 - 575 B+ 533 - 549 B 500 - 532 B- 480 - 499 C 450 - 479 D 420 - 449 F < 420

At the end of the year, the professor reserves the right to lower the scale in the student’s favor.

Assignments will not be accepted after their due date, which is defined as the end of the class on the day on which they are due. If the student is unable to attend a class, the student is expected to send the instructor the assignment via e-mail no later than the due date. Make-up examinations will be given only in cases of verified illness or death in the immediate family. The best way to contact me is through e-mail (see first page for address).

Students are encouraged to ask the professor at any time for an “informal” evaluation of how they are doing in the class.

Class Participation. Learning to speak clearly and succinctly on an impromptu or informal basis in large groups is an essential skill that needs to be developed in whatever career the student pursues. In the workplace environment, we are often judged as much by what we don’t say as by what we do. Under no circumstances will a student have to feel concerned about being embarrassed in front of their classmates. In-class discussion will always be treated in a professional, non-threatening manner.

In the absence of active participation, the professor will call on students. Active participation is defined to include both questions and comments. To receive the maximum number of points in this category, the student will be expected to participate during every class by asking questions or by making thoughtful comments. The quality of both questions and comments will receive greater weight than frequency in determining the final participation point score. Obviously, the student must attend most of the classes in order to get the maximum number of points.

Acquisition Team Project: Early in the term students will divide themselves into “teams” of four-to-six students each to share the research, analysis, and field work required to design a viable corporate acquisition proposal. The purpose of the Acquisition Project is to give students the opportunity to apply the tools they have learned in an increasingly common situation, i.e., mergers and acquisitions.

Each team will be asked to represent an acquiring company or investment group whose business strategy involves an acquisition or merger. The acquiring and target firms must be in the same industry. The acquisition can involve a recent transaction (i.e., last 12 to 18 months), a current transaction, or a hypothetical transaction involving two publicly traded firms, private companies, or some combination. The use of publicly traded companies will facilitate data collection, and the selection of companies in the same industry will simplify the analysis by eliminating the need to analyze two different industries.

3 Selecting Companies to Study: The success of the Project will be greatly dependent on the Team’s ability to understand the company’s operations, products, and the competitive dynamics of the industry in which it competes and to obtain financial, technical and market-related information on the company. Teams are encouraged (but not required) to select a publicly traded company, because both internal financial and operating data, as well as market/industry data, is likely to be more readily available (e.g., through Disclosure, Value Line, Standard & Poors Corporate Register, Thomas Register, etc.) than for a privately owned firm.

It is helpful, although not essential, that the acquiring companies, target companies, or corporate divisions you evaluate be located in Southern California. This would enable teams to interview key corporate personnel to obtain additional information. Keep in mind that detailed financial information on publicly traded companies is likely to be available only on a consolidated basis. Consequently, efforts to obtain detailed financial information on a specific operating division of a diversified publicly traded company are likely to be very frustrating.

While there are no restrictions on the size and type of company you select, I suggest that teams select relatively small, uncomplicated businesses such as single product, independent companies or operating units within larger companies. For those teams that choose to select privately owned companies here in Southern California, small companies, particularly those that are considering “going public” or attempting to obtain additional funding from venture capitalists, may be more receptive to cooperating with your team. Contacting the president, general manager, or chief financial officer of the company or division is a good place to start. Commercial and industrial parks (e.g., the Irvine Spectrum in Irvine, California) offer dozens of potential candidates for your analysis.

For those that choose a private company, assure management that they will be provided with a final report and presentation in order to more readily obtain the necessary information. Emphasize to senior management that the report will contain a recommendation(s) of how to increase the “going concern” value of their business and a valuation of the business. Also emphasize that the results of the study and any information that they provide to your team will be kept confidential.

Students should not consider financial services companies such as banks, insurance, or leasing companies as we will not be discussing how to deal with these types of firms. Furthermore, it is recommended that students not select airlines due to the extensive use of equipment leasing, which create challenges not adequately addressed in the course.

Teams may also choose to represent an acquiring company, which has actually completed an acquisition within the last 12-to-18 months. If students choose to evaluate a recent transaction, they must address the key elements of the acquisition as outlined below as if the transaction had not taken place. However, based on their analysis, they must be able to answer the question of whether the acquiring firm overpaid, underpaid, or paid “fair market value” for the target firm and why. This may require that the Team undertake several activities or evaluate options that may not have actually been undertaken by the acquiring company. In this instance, the Team must determine and justify what it considers to be appropriate terms and conditions for the transaction. Alternatively, the Team must vigorously justify the actual terms and conditions of the transaction.

Students are encouraged to consult with the Professor about selecting a “Target” company early in the selection process if there are questions about the appropriateness of a potential Target. The Professor will have final approval of the companies to be used in the Acquisition Project.

4 In the past, students have developed business plans for their own companies (both public and private) and for a business they were planning to start. The latter option represents an excellent opportunity to get input from both the Professor and other students.

Each acquisition team is encouraged to develop mission statements, strategies and action plans that are different from what the selected company may be saying publicly if the team feels that this is appropriate.

The Acquisition Team Project will be completed by each team submitting a business plan to the Professor in both hard copy form and on a diskette. The cover page should indicate the team members and the section(s) each member was responsible for completing, e.g., Julie Chang completed the financial statements for the acquiring and target companies, David Martino and Leslie Van Houton were responsible for developing the business strategy, etc.

Acquisition Team Project Business and Acquisition Plans: Each team will submit a business plan, which includes an acquisition plan, not to exceed 50 pages including supporting financial tables. The acquirer’s business plan should include the following elements:

Introduction 1. Executive Summary: In 1-2 pages, describe what you are proposing to do, why, how it will be accomplished, and by what date.

Business Plan (for acquiring firm) 1. Industry/market definition: Define the industry/market in which the target firm competes in terms of size, growth rate, product offering, and other pertinent characteristics. 2. External analysis: Describe industry/market dynamics in terms of customers, competitors, potential entrants, product/service substitutes, and suppliers. 3. Internal analysis: Describe the acquiring company’s strengths and weaknesses and how they compare to the competition. 4. Opportunities/threats: Discuss major opportunities and threats that exist because of the industry’s competitive dynamics. Be sure that you can show how these threats or opportunities are a consequence of the industry dynamics described in (2). 5. Business mission/vision statement: Describe what industry/market needs are to be satisfied, who the targeted customers are, and what resources or capabilities will be used to satisfy these targeted customer needs. 6. Quantified strategic objectives (including completion dates): Indicate both financial (e.g., rates of return, sales, cash flow, share price, etc.) and non-financial (market share, being perceived by customers or investors as number one in the targeted market in terms of market share, product quality, price, innovation, etc.) goals. 7. Business strategy: Identify how the mission and objectives will be achieved (e.g. become a cost leader, adopt a differentiation strategy, or focus on a specific market segment). 8. Implementation strategy: From a range of reasonable options (build or “go it alone” strategy, partner via a joint venture or less formal business alliance, license, minority investment, and acquisition), indicate which option would enable the acquiring firm to best implement its chosen business strategy. Because of the nature of the course, you must indicate that an implementation strategy involving an acquisition is preferred to the other options and why. 9. Acquirer’s business plan valuation: Provide projected five year “standalone” income, balance sheet, and cash flow statements for the acquiring company and estimate the firm’s value based on the acquirer’s projected cash flows. State key forecast assumptions underlying the projected financials and the valuation.

5 Acquisition Plan (developed by acquiring firm) 1. Plan objectives: Identify the specific purpose of the acquisition. This should include what specific goals are to be achieved (e.g., cost reduction, access to new customers, distribution channels or proprietary technology, expanded production capacity, etc.) and how the achievement of these goals will better enable the acquiring firm to implement its business strategy (see (7) above). 2. Timetable: Establish a timetable for completing the acquisition including integration if the target firm is to be merged with the acquiring firm’s operations. Identify key activities that need to be accomplished and indicate the estimated time required to complete activities. Also, estimate resources (i.e., people, money, licenses, etc.) needed to complete each activity. 3. Resource/capability evaluation: Evaluate the acquirer’s financial and managerial capability to complete an acquisition. Identify affordability limits in terms of the maximum amount the acquirer should pay for an acquisition. Explain how this figure is determined. 4. Tactics: Indicate the acquirer’s preferences for a “friendly” acquisition, controlling interest, using stock, debt, cash, or some combination, etc. 5. Search plan: Develop screening criteria for identifying potential target firms and explain plans for conducting the search, why the target ultimately selected was chosen, and how you will make initial contact with the target firm. 6. Negotiation strategy: Identify key buyer/seller issues. Recommend a deal structure that addresses the primary needs of all parties involved. Comment on the major elements of the deal structure including the proposed acquisition vehicle, post closing organization, form of payment, form of acquisition, and tax structure. Explain the justification for the approach your team adopted in dealing with each aspect of the deal structure (e.g., why was a particular tax strategy selected). Indicate how you might “close the gap” between the seller’s price expectations and the offer price. 7. Purchase (offer) price estimate: Provide projected five year income, balance sheet, and cash flow statements for the target firm and for the consolidated acquirer and target firms. Develop a preliminary minimum and maximum purchase price range for the target. Specify potential sources of and destroyers of value. List key forecast assumptions. Identify an initial offer price, the composition (i.e., cash, stock, debt, or some combination) of the offer price, and why you believe this price is appropriate in terms of meeting the primary needs of both target and acquirer shareholders. The appropriateness of the offer price should reflect your preliminary thinking about the deal structure. 8. Financing plan: Using the combined/consolidated financial statements, determine if the proposed offer price can be financed without endangering the combined firm’s credit worthiness or seriously eroding near-term profitability and cash flow. 9. Integration plan: Identify potential integration challenges and possible solutions. (For those teams characterizing themselves as financial buyers, an integration plan may not apply. Instead, they should identify an “exit” strategy.)

Each student will receive a financial model based on Microsoft’s Excel software illustrating how deals may be structured and valued. Students may use the model for completing the acquisition project, modify it to reflect the unique characteristics of their situation, or develop their own model.

Acquisition Team Project Assessment

The total possible point score of 230 points for the project will be apportioned as follows:

 33% for completeness: How well did the team address each point on the syllabus outline for the Acquisition Team Project?

6  33% for quality of application: Did the team apply correctly tools and concepts learned in this course? (Hint: Each team member should apply a number of different tools and concepts in each section for which they are responsible.)  33% on creativity: Did the team specify clearly the acquirer’s and target’s objectives/needs? Deal the address common deal structuring questions? Were they successful in meeting the highest priority needs of both parties? Was the proposed deal structure realistic.

Each team member will receive the project’s total score adjusted for the professor’s evaluation of the section(s) for which they are responsible. For example, while a paper may receive 200 points, individual team members may receive 105% (i.e., 210 points) or 95% (i.e., 190 points) of the project’s total score.

Team Member Peer Review: Each team member will be asked to anonymously evaluate their team members by assigning a letter grade to their overall contribution to the team paper. The student’s overall grade will be calculated by a simple average of the grades assigned by their team members, with A=30, B=20, C=10, D=5, and F=0.

Project Leader Peer Review: Each team member will also be asked to evaluate anonymously their project leader’s performance, with A = 20, B = 15, C = 10, and D = 5, and F = 0. The project leader should be evaluated in terms of their leadership in scheduling meetings, setting meeting agendas, facilitating meetings, motivating others to satisfy their commitments, and overall quality control. Quality control refers to effort expended to ensure that all portions of the final document have been completed and that the document reads as if it written by a single individual.

Assignments: Answers to assignments, other than problem sets, should be typed. Answers to each question should be double-spaced and not exceed one page in length. Submissions that are not typed will automatically lose one-half of the total potential point score. Answers to problem sets should be legible.

Class Schedule

Week Subject Class Preparation

August 26 1. Defining expectations Following the first class, lecture notes will be 2. Course overview emailed to students prior to class each week. If 3. Introduction to M&A the notes are not received within two days of A. What is the success class, the student should notify the professor rate? immediately via email. B. Why do they occur? C. What are the key characteristics of mergers & acquisitions that meet expectations? D. Future of M&A Activity 3. Discuss forming teams September 2 University Holiday (Labor Day) September 9 1. Common Takeover Required Reading: Chapters 1 (entire chapter) Tactics and Defenses and 3 (pp. 89-124) in DePamphilis and lecture 2. Class time will also be notes entitled “Common Takeover Tactics and used to allow students to Defenses.”

7 begin to form teams September 16 3. Acquisition Process: Required reading: Chapter 4 in DePamphilis Developing Business and and lecture notes entitled “Acquisition Process Acquisition Plans Phases 1 & 2” and Chapters 1 (pp. 16-25) and 4 (pp. 151-159) in Helfert.

By this date, students are to have organized themselves into teams of four to five students each. Teams will submit a listing of all team members including names and email addresses. Teams will also be expected to appoint a project leader. The project leader’s responsibilities include scheduling team meetings and developing meeting agendas, motivating team members to meet their commitments, and for “quality control.” The project leader will have the potential to receive as many as 20 additional points based on a peer review by other team members. September 23 1. Acquisition Process: Required Reading: Chapters 5 (entire chapter) Search through Closing and 6 (pp. 223-245; 254-261) in DePamphilis and lecture notes entitled “Acquisition Notes Phases 3-10.” September 30 1. Discounted Cash Flow Required reading: Chapter 7 (pp. 271- 293) in Valuation Methodologies DePamphilis and Chapter 6 (pp. 220-243) in Helfert as well as lecture notes entitled “Discounted Cash Flow Valuation.” Optional Reading: Chapter 8 (pp. 298-319) in Helfert. Assignment #1: Each Acquisition Team will provide the Professor with the name of their team’s acquiring company and acquisition target, LBO candidate, etc., and 2-3 page project plan. The project plan should include key objectives (i.e., why the acquiring company wants to acquire the target firm), key activities that must be completed to meet the project deadline, completion dates for each activity, and the individuals(s) responsible for completing each activity. October 7 1. Relative Valuation Required Reading: Chapter 7 (pp. 293-307; 310- Methodologies 312) in DePamphilis and Chapter 10 (pp. 357- 2. Discuss Assignment #2 362) in Helfert as well as lecture notes entitled “Relative Valuation Methodologies.” Assignment #2: Answer practice problems 1-10 distributed in prior class. Each student must show all work to receive full credit. The professor will have emailed the problems to the students one week prior to class. October 14 First Exam Review required reading material in DePamphilis and Helfert, as well as class notes,

8 and homework assignments. Calculators required. October 21 1. Application of Financial Required Reading: Chapter 8 and lecture notes Modeling Techniques to entitled “Applying Financial Modeling M&A Techniques to Mergers and Acquisitions.”

October 28 1. Application of Financial Assignment #3: Read Chapter 14 (Gee Whiz Modeling Techniques to Media Business Case). The professor will email M&A Cont’d. a set of 5 questions about the case to the 2. Discuss Assignment #3 students in advance of class. Typed answers to the questions are to be limited to no more than one page per question and to be submitted for credit. Students should be prepared to discuss the questions in class.

Work on Acquisition Team Project November 4 1. Analyzing Privately Held Required Reading: Chapter 9 in DePamphilis Companies and lecture notes entitled “Analyzing Private 2. One-half hour of in-class Companies” and Appendix III (pp. 453-466) in time will be devoted to Helfert. acquisition team meetings Work on Acquisition Team Project. By this time, students should have completed Sections 1-5 of the Business Plan portion of the Acquisition Project November 11 1. Deal Structuring Process: Required Reading: Chapter 10 (pp. 387-407) in Form of Payment, DePamphilis and lecture notes entitled “Deal Acquisition Vehicle, and Structuring.” Post Acquisition Organization Work on Acquisition Team Project By this 2. One-hour of in-class time time, teams should have completed will be devoted to Sections 6-9 of the Business Plan for the acquisition team meetings Acquisition Project November 18 1. Deal Structuring Cont’d.: Required Reading: Chapter 10 (pp. 407-428) in Tax and Accounting DePamphilis and lecture notes on tax and Treatment accounting treatment. . 2. One-half hour of in-class time devoted to Work on Acquisition Team Project acquisition team meetings November 25 1. Analyzing and Valuing Required Reading: Chapter 11 and lecture notes Leveraged Buyouts entitled “Leveraged Buyouts” 2. One-half hour of in-class time devoted to Work on Acquisition Team Project acquisition team meetings December 2 3. Alternative Exit and Required Reading: Chapter 13 in DePamphilis Restructuring Strategies and lecture notes entitled “Alternative 2. Peer review Restructuring Strategies.”

Acquisition Team Projects due. None will be accepted after this date.

9 December 9 Final Exam Review required reading material, as well as class notes, since the mid-term exam.