Deal%20Design

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Deal Design

• P.V. Viswanath

Class Notes for EDHEC course on Mergers and
Acquisitions
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Deal Design

• What is deal design?
• In essence, it is a solution to an economic
  problem between two players

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Elements of MA Deal Design

• Create Value
• Value Transfer
• Value Destruction
• Improve reported financial results avoid EPS
  dilution
• Accounting Dilution (reduction in reported EPS
  following a stock-for-stock acquisition)
• Economic Dilution (reduction in stockholder
  wealth)
• Voting dilution (reduction in voting power) (cf.
  Arcelor/Mittal)
• Improve control
• Voting control by stockholders
• Control by lenders and preferred stockholders
  through covenants
• Control can be thought of as an option on the
  strategy of the firm.

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Elements of MA Deal Design

• Build financial flexibility
• Cash deals draw down cash balances or require the
  issuance of debt securities reduce debt
  capacity.
• Stock-for-stock deals entail equity issuance may
  not be possible to issue equity again in the near
  future
• Financial flexibility is like a call option on
  future financing (Revco drug stores find other
  examples RJR Nabisco?)
• Manage risk
• Possibility of adverse movements in security
  prices MA transactions take long from deal
  design to consummation and security prices can
  move in the interim.
• If the deal spans international borders, exchange
  rate fluctuations may matter.

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Elements of MA Deal Design

• Preserve and improve competitive standing
• Retain good retail locations, customer
  relatinoships, assets and talent these lay the
  foundation for strategic success.
• Manage signals to the capital markets
• Share-for-share deals tell the market that the
  acquirer is overpriced.
• Manage incentives
• The resulting capital structure can provide more
  or less incentives to the managers to do better.
  For example, increased debt can reduce free
  cashflow and put pressure on managers to produce
  1980s hostile mergers.

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Elements of MA Deal Design

• Enhance the governance and management structure
• Can affect the composition of the shareholder
  group, board of directors or management team.
• Research shows that acquisition of small private
  targets in stock-for-stock deals can create
  monitoring shareholder block.
• Shape impact on employees and communities
• Provide continuity of employment for employees
• Protect pension assets
• Minimize impact of plant closings
• Build employee morale (Arcelor/ Mittal merger)

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Terms

• Price
• Form
• Fixed Payments cash and senior debt securities
• Little uncertainty about value conveyed resolves
  uncertainty
• Contingent payments mezzanine debt securities,
  preferred stock, common stock
• Value less certain than cash/senior debt
• Earnouts, warrants, convertible bonds, contingent
  value rigths, puts, guarantees, caps, collars,
  floors used to resolve disagreements regarding
  firm value.
• Contingent payments are often structured so that
  if the target performs well in the future, the
  targeted shareholders receive some extra payoff.
• Contingent payments are also used to hedge risk
  for one or both sides of the transaction.

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Terms

• Form
• Side payments payments to parties other than
  owners of the target firm.
• Examples golden parachutes, warrantes, bonuses,
  buyouts of employment contracts, consulting
  commitments to managers of the target firm.
• Guarantees of work rules, job, training to unions
• Guarantees against plant closing to
  governments/municipalities.
• Bribes
• Financing
• Timing and Deadlines
• Time Value of Money
• Deferring payments grants the payer an option to
  renege on the deal.

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Terms

• Commitments Options granted by seller to buyer
  greater the uncertainty, greater the value of the
  option.
• Assumption by seller of various liabilities
• Environmental
• Product
• Liabilities from lawsuits in progress
• Product Warranties
• Seller required to maintain and hand over at
  closing items that affect the value of the firm
  as a going concern.
• Brand names
• Patents
• Trademarks
• Customer lists
• Noncompete clauses for executives

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Terms

• Control and Governance (Agency problem
  resolution)
• Composition of new Board
• Limitations on voting power (through standstill
  agreements)
• Financial covenanats
• Creation of fixed income securities (reducing
  free cashflow)
• Risk Management
• Likelihood that the value of compensation offered
  can change due to market circumstances
• Possible entry of a competing bidder
• The parties could change their mind
• Can be mitigated by walk-away fees and guarantees
  to pay counterpartys costs.

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Terms

• Accounting Choices
• Form of Transaction and Tax Exposure to the
  parties
• Social issues
• Interplay of titles, compensation and ego in
  establishing governance and managerial hierarchy
  of new company.
• Social Welfare
• Branch closings, employee layoffs, headquarters
  locations
• In some countries, available choices may be
  restricted by law.