Mergers & Acquisitions

MERGERS & ACQUISITIONS INTRODUCTION Why merge? Why sell? 1. A division of a company might no longer fit into larger corp’s plans, so corp sells division 2. Infighting between owners of corp. Sell and split proceeds 3. Incompetent management or ownership 4. Need money 5. Business is declining 6. Industry-specific conditions 7. Economies of scale BASIC DEFINITIONS: MERGER: Owners of separate, roughly equal sized firms pool their interests in a single firm. Surviving firm takes on the assets and liabilities of the selling firm. PURCHASE: Purchasing firm pays for all the assets or all the stock of the selling firm. Distinction between a purchase and a merger depends on the final position of the shareholders of the constituent firms. TAKEOVER: A stock purchase offer in which the acquiring firm buys a controlling block of stock in the target. This enables purchasers to elect the board of directors. Both hostile and friendly takeovers exist. FREEZE-OUTS (also SQUEEZE-OUTS or CASH-OUTS): Transactions that eliminate minority SH interests. HORIZONTAL MERGERS: Mergers between competitors. This may create monopolies. Government responds by enacting Sherman Act and Clayton Act VERTICAL MERGERS: Mergers between companies which operate at different phases of production (e.g. GM merger with Fisher Auto Body.) Vertical mergers prevents a company from being held up by a supplier or consumer of goods. LEVERAGED BUYOUTS (LBOs): A private group of investors borrows heavily to finance the purchase control of an ongoing business. RECAPITALIZATIONS: Does not involve the combination of two separate entities. Here, a firm reshuffles its capital structure. In a SWAP, the corp takes back outstanding equity stocks in return for other types of securities (usually long term bonds or preferred stock) RESTRUCTURINGS: This term refers to a corporation’s changing form to downsize their operations. Examples of restructurings are divestitures, carve-outs, split-ups, and spin-offs. 1 STEPS UNDERTAKEN TO COMPLETE A MERGER: 1. Preliminary negotiation: High level executives get together, letter of intent, and confidentiality agreement. No binding Ks are signed yet 2. Serious negotiation: Bring in the lawyers, I-Bankers, and other professionals. Lawyers go over the affairs of the companies. Due diligence is done. Lawyers raise legal issues 3. Acquisition K Binding agreement to finish the deal. Board votes on the transaction 4. SH notice and proxies mailed out. Boards disclose relevant information and recommend that SHs approve the deal. 5. SH vote If SHs vote yes, then close the deal. If SHs vote no, then back to the drawing board 6. Closing Forms sent to secretary of state. 2 companies become one. 7. Appraisal Dissenting SHs sue merged corp to get fair value of pre-merger stock they owned Risk involved w/mergers: There is a risk between the end of negotiations (step 3) and closing (step 6) that one corp’s stock will rise or fall in price so much that the deal is no longer worthwhile to pursue. In order to protect against the risk, there can be a walk-away clause in the acquisition K that kicks in if one corp’s stock fluctuates too much. Also, there can be a provision that if the stock price of the acquiring corp falls too much, that the acquiring corp must make up the difference in cash. Other ways to reduce risk: 1. Floating exchange ratio (an exchange ratio that is set when the board votes on the agreement of merger and does not change through the closing. Seller’s SHs bear the general market risk and the specific risk associated with value of buyer’s stock.) 2. Price collars (upper and lower market price limits to the transaction) 3. Walk away provision (an express condition that gives the seller the option to walk away if the buyer firm’s stock price falls below a specified price level.) 4. Fill or kill option (If buyer’s stock price falls, they can waive the price collar and also gain the right to issue seller’s SHs more buyer corp’s shares in order to make seller corp’s SHs whole. This way, the merger can go through.) 5. Contingent value rights (selling SHs who take buyer’s stock get a price protection in the form of additional compensation by the buyer) TYPES OF MERGERS: A Corp = Buyer B Corp = Seller STOCK FOR STOCK MERGERS (a.k.a. The stock swap statutory merger): Mechanics (Del Corp. Code §§ 251, 259-61): 1. A corp gives its stock to B corp. 2. B “magically” ceases to exist and B shares become worthless 3. A is surviving corp 3. All of B’s assets and liabilities go to A 4. B SHs get A corp stock 5. A corp takes on all assets and liabilities of B. B creditors now have a claim against A Voting: 1. A board and A SHs vote, as long as this is not an 80%-20% “whale-minnow” merger in Del. (If it is whale-minnow, then only A board votes – A’s SHs do not vote) 2. B board and B SHs vote 3. Majority of outstanding shares must vote in favor of agreement 4. B creditors and tort claimants cannot vote on proposed merger 2 5. Preferred SHs do not get to vote on merger under Del. law, but they do get to vote under MBCA 6. Appraisal rights for A (if they get to vote) and B SH dissenters 7. SH voting rules may be augmented by K 8. Dissenting B SHs must give up their shares, but they get appraisal rights. Taxes: This is a tax-free transaction (an A reorganization) CASH FOR ASSETS (Del. Corp Code §§ 122, 271): Mechanics: 1. A pays B cash consideration for B’s assets 2. A and B get to choose which of B’s assets and liabilities are transferred to A 3. (Optional step 2 of transaction) B dissolves, dispensing cash to creditors and SHs 4. Creditors don’t usually (but sometimes do) have claims against A. Claimants must sue directors and SHs of B Voting: 1. A and B boards vote 2. B SHs vote if B is selling “substantially all the assets” 3. B SHs get to vote (again) if B plans to dissolve after sale 4. A SHs do not vote 5. B SHs do not get appraisal rights Taxes: This is a taxable transaction SALE OF “SUBSTANTIALLY ALL OF THE ASSETS”: DEL. CORP LAW §271 If corp sells all or “substantially all” its assets, corp’s SHs are entitled to vote on the transaction. A majority of all outstanding shares entitled to vote must approve the transaction in order for transaction to be approved. §271 covers “sale, lease, or exchange” dispositions. §272 says that SHs do not get to vote if corp mortgages or pledges its assets. MBCA says that “substantially all” means any disposition that would leave the corp without a significant continuing business activity. SALE OF SUBSTANTIALLY ALL ASSETS CASES: Gimbel v. Signal Companies, Inc (29) (Del. 1974) Ct said that Signal did not sell “substantially all” its assets, because the total amount (value) of assets sold constituted only a small portion of Signal’s total assets. Ct used a quantitative test here. However, if case came up a couple of years later (when the oil crisis hit), the assets sold would have been quantitatively “substantially all” its total assets. The determination of what is substantially all depends upon the value of the assets sold at the time of sale. Katz v. Bregman (29) (Del. 1981) Court adopted a qualitative test for determining whether substantially all the assets were sold. Court determined that the sale affected the “existence and purpose” of the selling corp. There is no 51% threshold of the value of assets sold. This means that a Delaware court may determine that “substantially all” the assets were sold if either the quantitative or qualitative tests were met. Cash for Stock Acquisition: §122 of Del Corp Law (Corporate Tender Offer) Mechanics: 1. A corp buys stock directly from volunteering B corp SHs in exchange for cash. 2. After the transaction, A corp owns B corp stock. A becomes the parent of B corp (which becomes the subsidiary of A.) If all B SHs sell, B becomes a 100% owned subsidiary of A corp. 3. No change in the certificates of incorporation of A or B corp. Voting: 1. NEITHER A nor B SHs get to formally vote on the transaction 2. But B SHs “vote” by selling its shares to A corp. 3 3. A’s Board votes to commence the offering, but B’s board does not get to vote, since A corp approaches B’s SHs directly. But B board can recommend to its SHs that they either sell or don’t sell. (Is the rule that A SHs do not get to vote a good or bad thing? A’s SHs may try to argue that they get to vote and get appraisal rights using a de facto merger argument.) Taxes: This is a taxable transaction. Stock for assets acquisition: Mechanics: 1. Just like cash for assets acquisition, but instead of A corp giving B corp cash for assets, A corp gives B corp its stock. 2. If A corp takes all of B corp’s liabilities as well as assets, the end result is just like a statutory merger (but with a few advantages.) 3. B’s creditors usually don’t have claims against A (see discussion under cash-for –assets) 4. B corp normally dissolves after the sale and the stock of A corp held by B corp goes to B’s SHs.

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