Implementation: Search Through Closing --Phases 3-10

1
Implementation Search Through Closing --Phases
3-10
2
A man that is very good at making excuses is
probably good at nothing else.
Ben Franklin
3
(No Transcript)
4
Current Learning Objectives

• To Provide Students with an understanding of
• how to conduct an acquisition search, to screen
  potential candidates, and to make initial contact
  with potential targets
• the four concurrent activities within the
  negotiation phase and how they interact to
  determine purchase price, and
• the importance of pre-closing planning and
  post-closing execution

5
The Acquisition Process

• Phase 1 Business Plan
• Phase 2 Acquisition Plan
• Phase 3 Search
• Phase 4 Screen
• Phase 5 First Contact
• Phase 6 Negotiation
• Phase 7 Integration Plan
• Phase 8 Closing
• Phase 9 Integration
• Phase 10 Evaluation

6
Phase 3 Initiating the Search

• Two step procedure
• Establish primary selection criteria (e.g.,
  industry and maximum size of transaction)
• Develop search strategy to identify potential
  targets using computerized databases directory
  services legal, banking, and accounting firms
  and the Internet.
• Brokers and finders
• A broker has a fiduciary responsibility to either
  the seller or buyer.
• A finder introduces both parties without
  representing either party.
• Fee structures are normally negotiated and may
  include a basic fee, a closing fee, and an
  extraordinary fee (i.e., fees paid if closing
  delayed due to obtaining antitrust approval, a
  hostile takeover, etc.)
• Put everything in writing

7
Phase 4 The Screening Process

• As a refinement of the search process, screening
  involves increasing the number of selection
  criteria to reduce the list of potential
  candidates.
• In addition to the industry and maximum size of
  transaction used in the search process,
  additional criteria could include
• Market segment
• Product line
• Profitability
• Degree of leverage
• Market share
• Cultural compatibility (e.g., AOL/Time Warner)

8
Phase 5 First Contact

• The appropriate approach strategy depends on
• Size of target
• Whether target is publicly or privately held
• Acquirers timeframe for completing transaction
• Trust and relationship building when time is not
  critical
• Discussing value
• Preliminary legal documents
• Confidentiality agreements
• Term sheets (price range/formula, form of
  acquisition, extent of due diligence, no-shop
  provision))
• Letter of intent (price range/formula, form of
  acquisition, form of payment, non-competes,
  employee contracts, no-shop provision)

9
Phase 6 Viewing Negotiation as a Process
If No, Walk Away1
Perform Due Diligence
Profiling Target Market Firm
First Contact
Structuring the Deal Form of
Acquisition Form of Payment Tax
Considerations Accounting Considerations Acquisiti
on Vehicle Post-Closing Organization Legal Form
of Selling Entity
Develop Financing Plan/ Structure
Decision Proceed to Closing or Walk Away
If Yes, Initiate Negotiations
Refine Initial Valuation
Negotiation
Process
1Alternatively, the potential buyer could adopt a
more hostile approach such as initiating a tender
offer to achieve a majority stake in the target
firm.
10
Phase 6 Negotiation

• Negotiating strategy
• Initially determine areas of agreement and
  disagreement
• Solve the easiest areas of disagreement first
• Establish and maintain trust throughout the
  process
• Concurrent activities
• Refining valuation
• Deal structuring
• Conducting due diligence (buyer, seller, and
  lender)
• Developing the financing plan

11
Key Deal Structuring Considerations

• Form of Acquisition
• Form of Payment
• Tax Considerations
• Accounting Considerations
• Acquisition Vehicle
• Post-Closing Organization
• Legal Form of Selling Entity

12
Phase 6 Buyer Due Diligence During Negotiation

• Objectives
• Validate preliminary valuation assumptions (e.g.,
  growth, cost, productivity, etc.)
• Identify additional sources/destroyers of value
  (i.e., those providing upside potential fatal
  flaws)
• Activities
• Detailed legal (e.g., contracts) and financial
  record reviews
• Management interviews (consistency in questions
  asked)
• Site visits (e.g., inspect equipment, inventory,
  etc.)
• Customer and supplier interviews

13
Determining the Purchase Price

• Total consideration (TC)
• PVTC C PVS PVND
• Where C, PVS and PVND represent Cash, PV of
  acquirer stock, and PV of acquirer debt issued to
  seller, respectively.
• Composition of offer price
• Total purchase price (TPP) or enterprise value
  (EV)
• PVTPP
  PVTC PVAD
• Where PVTPP, PVTC, and PVAD PV of total
  purchase price, PV of total consideration, and PV
  of assumed debt, respectively.
• Offer price plus long-term
  assumed liabilities
• Net purchase price (NPP)
• PVNPP PVTPP PVOAL- PVDA
• (C PVS PVND PVAD) PVOAL- PVDA
• Where PVOAL and PVDA represent PV of oethr
  assumed liabilities and PV of discretionary
  assets, respectively.
• Actual cash cost of
  acquisition

14
Due Diligence and Negotiation

• Reliable Appliances, a leading manufacturer
  of washing machines and dryers, acquired the
  stock of competitor, Quality-Built, which had
  been losing money during the last several years
  for 100 million in cash. Reliable also assumed
  20 million (present value 18 million) of
  Quality-Builts outstanding long-term debt. To
  help minimize losses, Quality-Built reduced its
  quality-control expenditures and began to
  purchase cheaper parts. Quality-Built knew that
  this would hurt business in the long run, but it
  was more focused on improving its current
  financial performance in the months prior to
  being sold. Reliable Appliances saw the
  acquisition as a way of obtaining market share
  quickly at a time when Quality-Builts market
  value was the lowest in 3 years.
• Quality-Built had been selling its
  appliances with a standard industry 3-year
  warranty. Claims for the types of appliances sold
  tended to increase gradually as the appliance
  aged. Quality-Builts warranty claims history
  was in line with the industry experience and did
  not appear to be a cause for alarm. Not
  surprisingly, in view of Quality-Builts cutback
  in quality-control practices and downgrading of
  purchased parts, warranty claims began to
  escalate sharply within 12 months of Reliable
  Appliances acquisition of Quality-Built. Over
  the next several years, Reliable Appliances paid
  out 15 million in warranty claims (PV 12
  million). The intangible damage may have been
  much higher because Reliable Appliances
  reputation had been damaged in the marketplace.
  At the end of the second year, Reliable sold
  certain non-strategic Quality-Built assets for 2
  million, equivalent to a PV of 1.5 million.
• 1. What was the total consideration, total
  purchase price, and net purchase price ultimately
  
• paid for Quality-Built?
• 2. Why was it important to Quality-Built to
  improve its current financial performance?
• 3. How should Reliable Appliances have been able
  to anticipate this warranty problem from its due
  diligence of Quality-Built?
• 4. How could Reliable have protected itself from
  the outstanding warranty claims in the
  definitive agreement of purchase and sale?
• 5. In what sense had Reliables reputation been
  damaged?

15
Discussion Questions

1. Identify several criteria that might be used to
   select a manufacturing firm as a potential
   acquisition target? A financial services firm? A
   hi-tech firm?
2. Describe how the various activities that occur
   concurrently during the negotiation process
   affect the determination of the final purchase
   price for the target. Be specific.

16
Phase 7 Developing the Integration Plan

• Use due diligence to determine post-closing
  sequencing of events necessary to realize
  potential savings and revenue enhancements
• Resolve contract-related transition issues in
  purchase agreement
• Employee payroll and benefit claims processing
• Seller reimbursement for products shipped before
  closing for which payment not received
• Buyer reimbursement for vendor supplies/services
  received before closing for which payment had not
  yet been made
• Ensure contract closing conditions include those
  necessary to facilitate integration (e.g.,
  employee contracts, agreements not to compete)
• Develop post-merger integration organization
  consisting of both target and acquirer managers
  to
• Build a master schedule of what should be done,
  by whom and by what date
• Establish work teams to determine how each
  function and business unit will be combined
• Establish post-closing communication strategy for
  all stakeholders

17
Phase 8 Closing

• Obtain all necessary consents
• Shareholder
• Regulatory (e.g., state and federal)
• Third party (e.g., customer, lender, and vendor)
• Complete definitive agreement
• Purchase price
• Allocation of purchase price
• Assumption of liabilities
• Representations and warranties
• Covenants
• Closing conditions
• Indemnification
• Loan documents
• Etc.

18
Phase 9 Implementing Post-Closing Integration

• Communication plans (e.g., consistent and
  continuous)
• Employee retention (e.g., retention bonuses)
• Satisfying cash flow requirements (e.g., deferred
  maintenance expenditures)
• Employing best practices (e.g., competitor or
  similar business)
• Cultural issues (e.g. joint work teams,
  co-location of acquirer and target employees)

19
Oracle Integrates Sun Microsystems

• Following closing its acquisition of Sun in early
  2010, Oracle must rationalize and consolidate
  Suns manufacturing operations and substantially
  reduce the number of products the firm offers.
  Fewer products will mean less administrative and
  support overhead. Furthermore, Oracle has
  introduced a build to order mentality rather
  than a build to inventory marketing approach.
  With a focus on build to order, hardware is
  manufactured only when orders are received rather
  than for inventory in anticipation of future
  orders. By aligning production with actual
  orders, Oracle expects to reduce substantially
  the cost of carrying inventory however, it does
  run the risk of lost sales from customers who
  need their orders satisfied immediately. Oracle
  also intends to pare the number of suppliers in
  order to realize savings from volume purchase
  discounts. Historically, Oracle has been a more
  bottom line and less bureaucratic firm than
  Sun.
• Discussion Questions
• 1. What specific challenges do you believe
  Oracle will face in its efforts to integrate Sun
  Microsystems?
• 2. What do you believe Oracle should do to
  overcome each of these challenges? Be specific.

20
Phase 10 Conducting Post-Closing Evaluation

• Dont change performance benchmarks
• Ask the difficult questions
• Learn from mistakes

21
Discussion Questions

1. What is the purpose of the buyer and the seller
   performing due diligence? What other parties
   might want to perform due diligence on the target
   firm?
2. Describe the financing plan. In what sense is it
   a reality check?
3. Of the various activities conducted during
   post-closing integration, which do you believe is
   the most important and why?

22
Things to remember...

• The search phase involves using relatively few
  criteria to identify potential targets, while
  screening involves narrowing the list by
  employing more criteria
• How first contact is initiated depends on target
  size, availability of intermediaries with
  contacts in target, and time criticality
• Actual purchase price determined during the
  negotiation phase
• Integration planning must be done before closing
  when buyer has greatest leverage with the seller
• Closing involves completion of final
  documentation, obtaining necessary approvals, and
  resolving remaining transition issues
• Post-closing integration focuses on effective
  communication to all stakeholders, employee
  retention, and identifying and resolving
  immediate cash flow needs
• Post-closing evaluation provides opportunity to
  learn what worked and what didnt