Mergers & Acquisitions

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1 Mergers & Acquisitions 2013

2 Program 1 st week Introduction M&A business Marked overview, Motivation doing a deal and Reasons of failing acquisitions Shareholder Value requirements and reality, Example RWE, Example Blazic/Furwa Applied valuation and transaction price Adjusted financial results First value indication with a Multiple analysis and distressed valuation M&A process Types of investors M&A advisors /advisory agreement Long and short list approach, Confidentiality Agreement, Letter of Intent, Due Diligence, Closing conditions, Earn Out agreement and Asset/Share Deal Case Study 1: DCC/Reha Group discussion (Adjustments, Value and LOI) Students presentations The story behind the deal DCC/Reha; typical key issues in M&A deals exler.de 2

3 2 nd week Case Study 2: GWM/GGT, DePamphilis, Donald (2005) Mergers, Acquisitions, and Other Restructuring Activities, Amsterdam (pp ). DCF analysis, the European approach Exercise Free Cash flow WACC calculation Introduction > IPO, advisory agreement, research process Group discussions: Valuation and Earn Out agreement Case Study 3: SHS/Polar Students presentations Negotiating strategy, critical aspects of DCF approach, final conditions, Earn out agreement, deal financing, post merger integration and financial restructuring Final examination Slides, case studies and selected text book pages exler.de 3

4 Global M&A deal flow Value global M&A deals from H to H1 2012: 4% Reasons: Private equity investments North America Asia Pacific Central Asia Western Europe Middle East Sources: Bureau van Dijk, M&A Report Global, H exler.de 4

5 Group discussions What are typical reasons to acquire a target company? Increase market share New clients / customers New products New technologies Management skills Economical improvement What could be typical reasons that acquisitions fail? Cultural differences 35 % Less integration 20 % Unrealistic expectations 13 % Due Diligence mistakes 11 % No employee motivation 10 % Key Manager leaves company 8 % What couldbefactors of success referring the post merger integration? Adapt organisation Adapt company culture Adapt Prozesses Adapt informations Systems Improve communication Improve motivation Incentives to key management What could be suitable reasons payinghigh prices? 5

6 RWE Acquisition criteria Source: RWE AG (25/11/2011) Facts & Figures, p 45 6

7 Share vs Asset deal Share deal Buyer acquires company s assets as well as all existing and potential liabilities, all company s contracts with all related rights and obligations are taken over. Sales price includes everything! Asset deal Buyer acquires assets (and part of precisely defined liabilities, certain contracts, employees etc.) This means acquiring the business and not legal entity. Distressed M&A Bankruptcy Target (legal entity) Assets Cash NewCo Consolidation Investor s group 7

8 Enterprise value Shareholder Value = Market value of equity Enterprise value Rappaport 1986 Rappaport, Alfred (1986) Creating Shareholder Value: The New Standard for Business Reporting, New York External value Market capitalization Internal value Income valuation Total discounted cash flows minus financial liabilities plus cash Normally overvaluation > Future confidence Increase internal value with an acquisition! exler.de 8

9 Discounted Cash flow analysis (DCF) 1. Detailed plannedperiod 2. Terminal Value Enterprise value Equity Value = T t=1 FCFadjusted WACC t + (1 + ) FCF (1 +/ g ) WACC T (1 + ) WACC T 3. Net debt (financial liabilities cash, cash equivalents and securities) Long term provisions (European approach) + Value of assets no longer required for operating activities Source: Exler 2010, p 319 exler.de 9

10 How increasing enterprise value? Increasing EBIT and Rappaport 1986 Working capital management Shareholder Value = Equity value Cash flow quantities Avoiding research & development costs Inventories Trade receivables Financial liabilities Outsourcing pension provisions Assets no longer required Investments Internal value Income valuation Total discounted adjusted free cash flows minus net debts Postbone relevant investments and avoide investments not really required for operating activities kufstein.ac.at 10

11 What could be typical adjustments? Naaznine, Avik, Sourav Depreciations Working Capital politics Goodwill Vinay, Sumedha, Disha Earnings transfer to another company R&D investments Cars, business trips etc. Bindi, Salleen, Jatin Interest expenses Earnings transfer to another period Investments under construction Restructuring costs M. Exler Impairment charges to good will, property, plant and equipment Losses / income from the disposal of fixed assets exler.de 11

12 Financial and management accounting Income from operating activities (+ Income from the disposal of fixed assets) Financial accounting Management accounting Operating expenses ( Loss from the disposal of fixed assets) = EBITDA Depreciations and amortizations = EBIT /+ Financial result Income taxes = Profit after tax +/ Non recurring items (+) restructuring costs; (+) impairment charges to good will, property, plant and equipment; ( ) income from the disposal of fixed assets = Adjusted profit Investments (Capex and Working Capital) = Distributed net profit (cash dividends to the shareholders) exler.de 12

13 Enterprise value indication with the Multiple analysis Adjusted EBIT x industrial multiple Enterprise (Entity) value Net debt (Financial liabilities cash securities) Long term provisions (European approach with pension provisions) Average liquidity referring Working Capital (Private Equity investors approach if WC management from target company is not doing well) Equity Value represents value of the company (debt & cash free) Source: Exler 2010, p 324 exler.de 13

14 Financial multiples according previous transactions EBIT multiple Consulting services Software Telecommunication Media Retail & E Commerce Transport, logistic, touristic Electronic Automotive Engineering Chemistry & cosmetics Pharmaceutical Textile Food Energy Construction Average EBIT multiple M&A boutique panel market research Source: research.de exler.de 14

15 Transaction procedure I. Information period (1) First contact (2) Product and market analysis (3) Financial analysis (4) First purchase price indication (5) M&A advisory agreement II. Transaction period (6) Enterprise valuation (7) Business documentation (8) Research of potential investors (9) Short list (10) Confidentiality Agreement (11) Discussion process (12) Letter of Intent (LOI) (13) Due Diligence review (14) Negotiation of purchase price (Refining valuation) and conditions (15) Closing conditions (16) Closing III. Integration period (17) Communication / Integration manager, employees and customer / suppliers (18) Value management concept / Performance benchmarks / Synergies 15

16 Letter of Intent, LOI (1/2) A letter of intent (LOI) stipulated the reason for the agreement and major terms and conditions. It indicates the responsibility of both parties while the agreement is in force. Major terms and conditions include the purchase price, a brief outline of the structure of the transaction, which may entail the payment of cash or stock for certain assets (share deal or asset deal), the assumption of certain target company liabilities and other financial conditions, earn out agreement, description of due diligence process, exclusivity agreement, raps and warranties, time table, specifies the types of all additional required informations to be exchanged and milestones to the closing date. The proposed purchase price may be expressed as specific Euro figure, as a range, or as a multiple of some measure of value, such as operating earnings or cash flow and an indication of an earn out agreement. After due diligence performance both parties agree in the closing conditions the final purchase price after refining valuation. Other standard conditions include an exclusivity agreement for a certain period, a time table referring due diligence process like duration and requirements, employment contracts for key target firm executives and an indicated date for signing the final contracts with closing conditions. The LOI usually will terminate if the buyer and the seller do not reach an agreement by a certain date and who is paying legal and consulting fees. Depending on how it is written, the LOI may or may not be legally binding. A well written LOI usually contains language limiting the extent to which the agreement binds the two parties. The LOI becomes the governing document for the deal that the potential acquirer can show to prospective financing sources. Source: DePamphilis 2012, 177 exler.de 16

17 Letter of Intent, LOI (2/2) Reason for the agreement and major terms and conditions Content Brief outline of the structure of the transaction Legal structure of purchase (Share deal or Asset deal) Indication of purchase price (range / method) Earn out agreement conditions Employment conditions for key target firm executives Exclusivity agreement Due Diligence procedere Fee agreeement Specification of all additional required informations to be exchanged Time table with milestones and closing date exler.de 17

18 Earn Out agreement An earn out agreement is a financial contract whereby a portion of the purchase price of a company is to be paid in the future. Earn outs tend to shift risk from the acquirer to the seller in that a higher price is paid only when the seller has met or exceeded certain performance criteria. Content Earn out amount (In privately companies the average is 45 %) Milestones like revenue targets, profit, diversification of clients, management follower etc. Floor and cap of the total amount Payment period and method Tax issues Interest charges Consideration of CAPEX Escrow account Further reading: DePamphilis 2012, 423 exler.de 18

19 Literature Bureau van Dijk, M&A Report Global, H DePamphilis, Donald (2012) Mergers, Acquisitions, and Other Restructuring Activities, 6 th edition, Amsterdam. Particularly: Chapter 5 Acquisitions process, pp ; Search and screening process first contact Letter of Intent Due Diligence negotiation with refining valuation and deal structuring closing Chapter 10 Analysis and Valuation of Privately Held Companies, pp ; Characteristics Adjusting Financial Statements Applying valuation methodologies and developing discount rates Chapter 7 and 8 Valuation, pp , and 314 (just further reading) WACC Calculating Free cash flows DCF valuation Multiple valuation DePamphilis, Donald (2005) Mergers, Acquisitions, and Other Restructuring Activities, Amsterdam: Case Study GWT/GGT, pp exler.de 19

20 Dr Markus W Exler Professor & Director Corporate Restructuring Kufstein University of Applied Sciences kufstein.ac.at Assistance: Ms Monika Puchner kufstein.ac.at/urs Visiting Professor S P Jain School of Global Management, Dubai and Singapore Institute of Management Technology and Galgotias University, India Mälardalen University, Sweden Partner at Quest Consulting AG, Rosenheim exler.de

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