Themes, Analysis, Decisions

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Themes, Analysis, Decisions?

• What are the key themes?-what do we know about
  the industry/competition /company/management?-ho
  w might these influence the decisions?
• Initial decisions to be made-how much to
  offer-how to approach CCI management
• What should each party do after contact made?
• How about what advisors should they retain?

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Acquirer background

• CompuTech bitten by merger bug
• Founder a college drop out
• Company idea based on personal experience of
  need
• VC financing followed by IPO fueled growth
• Solid reputation for innovation, etc.
• No spreadsheet product

3
Candidate background

• Specializes in accounting, finance, tax software
• Financed by VCs followed by IPO
• Lacks diversity in software offerings
• Stock thinly traded
• Beta 1.6
• 30 management ownership

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Types of Mergers

• Horizontal (same product)
• Congeneric (same industry)
• Vertical (supplier, customer)
• Conglomerate (different industries)
• Operating merger operations of firms are
  integrated for synergies
• Financial merger firms will bot be operated as a
  single unit.

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Common rationale for mergers

• Tax considerations (Example)
• Diversification (Example, pitfalls, benefit to
  whom?)
• Control/Competitive (legal issues)
• Purchase of assets below replacement cost
  (chop-shop approach)
• Synergy

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Societal considerations

• Which of these reasons are justifiable?
• Which are not?
• Why is this question relevant to a company like
  CompuTech, which is considering a specific
  acquisition?

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Synergy

• Operating economies of scale in management,
  production, marketing, or distribution
• Financial economies, which could include higher
  debt capacity, lower transactions costs, or
  better coverage by securities' analysts which can
  lead to higher demand for the combined company's
  stock, and hence to higher stock prices

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Synergy 2

• Differential managerial efficiency, which implies
  that a new management can increase the value of
  the firm's operating assets
• Increased market power due to reduced competition

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Valid motives?

• Diversification-is this in investors best
  interest?
• Purchase of assets below replacement cost
• Control-defensive mergers-often benefit
  management more than shareholders!

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Hostile vs. Friendly Mergers

• Hostile merger -Management resists
  merger-Suitor bypasses management by going
  directly to shareholders (tender offer)-Proxy
  fight
• Friendly merger negotiated with managers of both
  companies
• Tender offer does not need to be hostile, but
  often is

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Negotiation stances

• Low initial offer with subsequent concessions
• High initial offer as a preemptive move
• Tender offer to shareholders
• Best deal is a win win, although there are lots
  of negotiators out there that take the win/lose
  approach.

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What would you offer? What would you counter?

• If you were CompuTech, what would be your
  offer?-Offer range from x.xx to y.yy/share
• If you were CCI, what would you ask?-You dont
  know the value of this business to CompuTech
• What is the range in which both win?
• What if there are other bids?

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Standard Valuation yardsticks

• Market value, if publicly traded-In this case
  1.50/share
• Valuation multiples-cash flow-sales-net
  income-market/book
• DCF
• De-novo (not in most books)
• Merger premium?

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CCI
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Pro-forma assumptions
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(No Transcript)
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How to divide the value added?
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Graphically...
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Sensitivity Analysis
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Merger vs. Typical Capital Budgeting Analysis

• In typical capital budgeting analysis, financing
  is not considered
• In a merger, financing is material, and must be
  considered, and it may also change.
• FCFNIDepreciation-Retention for growth
  (Investments in assets)
• Discounted at CCIs risk adjusted ke, as these are
  CFs that belong to shareholders (sensitivity)
• Terminal Value FCF(1g)/ks-g

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Required Retention

• Investment in acquired business
• Usually-Working capital increases-Known/anticipa
  ted capital expenses (planned plant expansions,
  etc.)
• Here-Asset growth rate given-Debt rate after
  merger given
• Therefore, retention/investment calculated as
  (Ayrx1-Ayrx)-(Dyrx1-Dyrx)

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Unlevered Levered beta ke
Ke rfr(km-rfr)beta 6.551.78 15.4
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Terminal Value
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Different buyer - different value!

• Different buyers might arrive at a different
  valuation, at least using the DCF method
• Basic assumptions
• Synergy assumptions (value created)
• Discount rate
• Debt used
• Strategic option value may differ for firms

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What if?

• CCIs management has a substantial ownership
  interest in the company, but not enough to block
  a merger.
• If CCIs managers want to keep the firm
  independent, what are some actions they could
  take to discourage potential suitors?

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Remaining independent -options

• A leveraged buyout
• Poison pill-requiring a supermajority of
  stockholders to vote for a merger
• setting up an ESOP, which would own a sizable
  block of stock-presumably would be voted in
  management's favor
• Issuing a lot of debt and using the funds to
  repurchase common stock.

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What if?

• If CCIs managers conclude that they cannot
  remain independent
• What are some actions they might take to help
  their stockholders (and themselves) get the
  maximum price for their stock?

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Maximizing Stock Price

• Present any data or other factors in the most
  favorable light
• Have an appraisal of value done for use in the
  negotiation process
• Seek other bids from other potential acquirers

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What if?

• If CCIs managers conclude that the maximum price
  others are willing to bid for the company is less
  than its "true value" ...
• ...is there any other action they might take that
  would benefit both outside stockholders and the
  managers themselves?

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Agency Issue?

• Do CCIs managers face any potential conflicts of
  interest in their negotiations with CompuTech?
• If so, what might be done to reduce conflict of
  interest problems.

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Is there value in mergers?

• In friendly mergers, stock prices for target
  companies generally increase by 20
• In hostile mergers, they increase by 30
• Shareholders of target firms reap virtually all
  gains produced by mergers-can say no-can wait
  for others-acquiring company managers personal
  interests-in friendly mergers, managers usually
  retained

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Pitfalls of External Growth

• Mergers can be an effective way to grow when
  internal growth slows
• However, there are some non-financial issues that
  can kill the financial benefits-cultural
  mismatch-hidden liabilities not uncovered during
  due diligence-the intellectual capital does not
  stay

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If you were a consultant...

• What other information would you gather in this
  or other cases?
• How would you go about gathering it

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Different Valuation Techniques

• There are many different valuation techniques
  available
• They will provide a range of answers
• Along with sensitivity analysis, using them can
  help set parameters when DCF assumptions are
  questioned
• Use of multiple methods also allows calculation
  of statistical range

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List of various techniques(Mostly used with
private companies)

• Prior sales of company stock (1yr)
• Sales of comparable companies
• Book value
• Adjusted book value
• P/E ratios of comparable public companies
• Ratio of Market/Book for comparable public
  companies
• Capitalized adjusted earnings

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Techniques

• Capitalized excess adjusted earningsNet Worth
• Capitalized adjusted net operating income
• Capitalized adjusted cash flow
• Capitalized excess adjusted cash flow plus
  adjusted net work

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Techniques

• Discounted future earnings adjusted net worth
• Discounted future cash flows adjusted net worth
• Alcar method
• Capitalized dividends
• Dividend paying capacity
• Gordon model

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Techniques

• Weighted return on investment
• Purchasers required return on investment
• Gross revenue times industry multiplier