What outcomes do horizontal merger and acquisition strategies intend

Mergers, Acquisitions, and Corporate Restructurings

TheWiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the pro!tability of their company, from accounting and !nance to internal controls and performance management.

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Mergers, Acquisitions, and Corporate Restructurings

Sixth Edition

PATRICK A. GAUGHAN

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Contents

Preface xi

PART I: BACKGROUND

Chapter 1: Introduction 3

Recent M&A Trends 3 Terminology 12 Valuing a Transaction 15 Types of Mergers 15 Merger Consideration 16 Merger Professionals 17 Merger Arbitrage 20 Leveraged Buyouts and the Private Equity Market 21 Corporate Restructuring 21 Merger Negotiations 23 Merger Agreement 30 Merger Approval Procedures 30 Deal Closing 32 Short-Form Merger 33 Freeze-Outs and the Treatment of Minority Shareholders 33 Reverse Mergers 34 Holding Companies 38

Chapter 2: History of Mergers 41 Merger Waves 41 What Causes Merger Waves? 42 First Wave, 1897–1904 42 Second Wave, 1916–1929 48 The 1940s 49 Third Wave, 1965–1969 49

v

vi ◾ Contents

Trendsetting Mergers of the 1970s 56 Fourth Wave, 1984–1989 62 Fifth Wave 67 Sixth Merger Wave 73

Chapter 3: Legal Framework 75

Laws Governing Mergers, Acquisitions, and Tender Offers 76 Other Specific Takeover Rules in the United States 88 International Securities Laws Relating to Takeovers 89 U.S. State Corporation Laws and Legal Principles 98 State Antitakeover Laws 101 Regulation of Insider Trading 109 Antitrust Laws 111 Measuring Concentration and Defining Market Share 117 European Competition Policy 121

Chapter 4: Merger Strategy 125

Growth 125 Synergy 136 Operating Synergy 138 Diversification 148 Types of Focus Increases 154 Focus Increasing Asset Sales Increase Firm Values 154 Explanation for the Diversification Discount 155 Do Diversified or Focused Firms Do Better Acquisitions? 159 Other Economic Motives 159 Hubris Hypothesis of Takeovers 169 Do Managerial Agendas Drive M&A? 173 Other Motives 177

PART II: HOSTILE TAKEOVERS

Chapter 5: Antitakeover Measures 187

Management Entrenchment Hypothesis versus Stockholder Interests Hypothesis 188

Rights of Targets Boards to Resist: United States Compared to the Rest of the World 189

Preventative Antitakeover Measures 189 Changing the State of Incorporation 214

Contents ◾ vii

Active Antitakeover Defenses 214 Information Content of Takeover Resistance 247

Chapter 6: Takeover Tactics 249

Preliminary Takeover Steps 250 Tender Offers 257 Advantages of Tender Offers over Open Market Purchases 272 Proxy Fights 279

Chapter 7: Hedge Funds as Activist Investors 291

Macroeconomic Foundations of the Growth of Activist Funds 294 Hedge Funds as Acquirers 301

PART III: GOING-PRIVATE TRANSACTIONS AND LEVERAGED BUYOUTS

Chapter 8: Going-Private Transactions and Leveraged Buyouts 311

Terminology 311 Historical Trends in LBOs 312 Management Buyouts 319 Conflicts of Interest in Management Buyouts 323 U.S. Courts’ Position on Leveraged Buyout Conflicts 325 Financing for Leveraged Buyouts 332 Returns to Stockholders from LBOs 340 Returns to Stockholders from Divisional Buyouts 341 Empirical Research on Wealth Transfer Effects 346 Protection for Creditors 347 Intra-industry Effects of Buyouts 347

Chapter 9: The Private Equity Market 349

History of the Private Equity and LBO Business 349 Private Equity Market 350 Secondary Market for Private Equity Investments 369

Chapter 10: The Junk Bond and the Leveraged Loan Market and Stapled Financing 371

History of the Junk Bond Market 371 Leveraged Loan Market 382 Stapled Financing 386

viii ◾ Contents

PART IV: CORPORATE RESTRUCTURING

Chapter 11: Corporate Restructuring 391 Divestitures 393 Divestiture and Spin-Off Process 404 Market Liquidity and the Decision to Divest a Unit 406 Round-Trip Wealth Effects 406 Wealth Effects of Sell-Offs 407 Managerial Ownership and Sell-Off Gains 410 Activists and Sell-Offs 410 Shareholder Wealth Effects of Spin-Offs: U.S. versus Europe 416 Equity Carve-Outs 421 Voluntary Liquidations or Bust-Ups 427 Tracking Stocks 428 Master Limited Partnerships and Sell-Offs 430

Chapter 12: Restructuring in Bankruptcy 433

Types of Business Failure 434 Causes of Business Failure 435 Bankruptcy Trends 440 U.S. Bankruptcy Laws 444 Reorganization versus Liquidation 445 Reorganization Process 446 Benefits of the Chapter 11 Process for the Debtor 453 Prepackaged Bankruptcy 457 Workouts 461 Corporate Control and Default 469 Liquidation 469 Investing in the Securities of Distressed Companies 471

Chapter 13: Corporate Governance 477

Structure of Corporations and Their Governance 477 Golden Parachutes 486 CEO Severance Payments 490 Reform of Excesses of Golden Parachutes and Severance

Payments 491 Managerial Compensation, Mergers, and Takeovers 491 CEO Compensation and Power 493

Contents ◾ ix

Compensation Characteristics of Boards That Are More Likely to Keep Agency Costs in Check 496

Role of the Board of Directors 496 Regulatory Standards for Directors 506 Antitakeover Measures and Board Characteristics 507 Disciplinary Takeovers, Company Performance, CEOs, and Boards 510 Merger Strategy and Corporate Governance 511 CEO Compensation and M&A Programs 511 Do Boards Reward CEOs for Initiating Acquisitions and Mergers? 512 CEO Compensation and Diversification Strategies 513 Agency Costs and Diversification Strategies 513 Interests of Directors and M&As 514 Managerial Compensation and Firm Size 516 Corporate Control Decisions and Their Shareholder Wealth Effects 516 Does Better Corporate Governance Increase Firm Value? 518 Corporate Governance and Competition 519 Executive Compensation and Postacquisition Performance 519 Mergers of Equals and Corporate Governance 520

Chapter 14: Joint Ventures and Strategic Alliances 531

Contractual Agreements 531 Comparing Strategic Alliances and Joint Ventures with Mergers and

Acquisitions 532 Joint Ventures 532 Strategic Alliances 538

Chapter 15: Valuation 547

Valuation Methods: Science or Art? 549 Managing Value as an Antitakeover Defense 550 Benchmarks of Value 550 How the Market Determines Discount Rates 562 Valuation of the Target’s Equity 575 Marketability of the Stock 575 Takeovers and Control Premiums 578 Valuation of Stock-for-Stock Exchanges 583 Shareholder Wealth Effects and Methods of Payment 583 Exchange Ratio 589 Fixed Number of Shares versus Fixed Value 597

x ◾ Contents

Merger Negotiations and Stock Offers: Halliburton vs Baker Hughes 597 International Takeovers and Stock-for-Stock Transactions 598 Desirable Financial Characteristics of Targets 598

Chapter 16: Tax Issues in M&A 607

Financial Accounting for M&As 608 Taxable versus Tax-Free Transactions 608 Tax Consequences of a Stock-for-Stock Exchange 611 Asset Basis Step-Up 612 Changes in the Tax Laws 613 Role of Taxes in the Merger Decision 614 Role of Taxes in the Choice of Sell-Off Method 616 Organizational Form and M&A Premiums 616 Capital Structure and Propensity to Engage in Acquisitions 617 Leverage and Deal Structure 618 Taxes as a Source of Value in Management Buyouts 618 Miscellaneous Tax Issues 619

Glossary 623

Index 633

Preface

THE FIELD OF MERGERS and acquisitions has undergone tumultuous changesover the past 20 years. The 1990s witnessed the !fth merger wave—a mergerwave that was truly international in scope. After a brief recessionary lull, the merger frenzy began once again and global megamergers began to !ll the corporate landscape. This was derailed by the subprime crisis and the Great Recession. When the economic recoverywas slow, so toowas the rebound inM&Aactivity. However, by 2013 and 2014 M&As began to rebound more strongly.

Over the past quarter of a century we have noticed that merger waves have become longer and more frequent. The time periods between waves also has shrunken. When these trends are combinedwith the fact thatM&Ahas rapidly spread across themodern world, we see that the !eld is increasingly becoming an ever more important part of the worlds of corporate !nance and corporate strategy.

As the M&A !eld has evolved we see that many of the methods that applied to deals of prior years are still relevant, but new rules are also in effect. These principles consider the mistakes of prior periods along with the current economic and !nancial conditions. It is hoped that these new rules will make the mergers of the future sounder and more pro!table than those of prior periods.However,while dealmakers have asserted that they will pursue such goals, wewould be remiss if we did not point out thatwhen deal volume picked up dramatically such intentions seemed to fall by the wayside andM&Amistakes started to occur. In fact, as with many other areas of !nance, learning from past mis- takes proves challenging. Lessons that are learned tend to be short-lived. The failures of the fourthmerger wave were so pronounced that corporate decisionmakers loudly pro- claimed that they would never enter into such foolish transactions. However, there is nothing like a stock market boom to render past lessons dif!cult to recall while bathing in the euphoria of rising equity values.

The focus of this book is decidedly pragmatic. We have attempted to write it in a manner that will be useful to both the business student and the practitioner. Since the world of M&A is clearly interdisciplinary, material from the !elds of law and economics is presented along with corporate !nance, which is the primary emphasis of the book. The practical skills of !nance practitioners have been integratedwith the research of the academic world of !nance. In addition we have an expanded chapter devoted to the val- uation of businesses, including the valuation of privately held !rms. This is an important topic that usually is ignored by traditional !nance references. Much of the !nance liter- ature tends to be divided into two camps: practitioners and academicians. Clearly, both

xi

xii ◾ Preface

groups have made valuable contributions to the !eld of M&As. This book attempts to interweave these contributions into one comprehensible format.

The increase in M&A activity has given rise to the growth of academic research in this area. In fact,M&Aseems to generatemore research thanother areas of !nance. This book attempts to synthesize some of the more important and relevant research studies and to present their results in a straightforward and pragmatic manner. Because of the voluminous research in the !eld, only the !ndings of the more important studies are highlighted. Issues such as shareholder wealth effects of antitakeover measures have important meanings to investors, who are concerned about how the defensive actions of corporations will affect the value of their investments. This is a good example of how the academic research literaturehasmade important pragmatic contributions that have served to shed light on important policy issues. It is unfortunate that corporate decision makers are not suf!ciently aware of the large body of pragmatic, high-quality research that exists in the !eld of M&A. One of the contributions we seek to make with this book is to render this body of pragmatic research readily available, understandable, and con- cisely presented. It is hoped then that practitioners can use it to learn the impacts of the deals of prior decision makers.

We have avoided incorporating theoretical research that has less relevance to those seeking a pragmatic treatment of M&As. However, some theoretical analyses, such as agency theory, can be helpful in explaining some of the incentives for managers to pur- sue management buyouts. Material from the !eld of portfolio theory can help explain some of the risk-reduction bene!ts that junk bond investors can derive through diversi- !cation. These more theoretical discussions, along with others, are presented because they have important relevance to the real world ofM&As. The rapidly evolving nature of M&As requires constant updating. Every effort has beenmade to include recent develop- ments occurring just before the publication date. We wish the reader an enjoyable and pro!table trip through the world of M&As.

Patrick A. Gaughan

IPART ONE Background

1C H A P T E R O N E Introduction

RECENT M&A TRENDS

The pace of mergers and acquisitions (M&As) picked up in the early 2000s after a short hiatus in 2001. The economic slowdown and recession in the United States and elsewhere in 2001 brought an end to the record-setting !fth merger wave. This period featured an unprecedented volume of M&As. It followed on the heels of a prior record-setting merger wave—the fourth. This one in the 1990s, however, was very different from its counterpart in the previous decade. The !fth wave was truly an international one, and it featured a heightened volume of deals in Europe and, to some extent, Asia, in addition to the United States. The prior merger waves had been mainly a U.S. phenomenon. When the fourth merger wave ended with the 1990–1991 recession, many felt that it would be a long time before another merger wave like it would occur. However, after a relatively short recession and an initially slow recovery, the economy picked up speed in 1993, and by 1994 the world was on a path to another record-setting merger period. This wave would feature deals that would make the ones of the 1980s seem modest. There would be many megamergers and many cross-border deals involving U.S. buyers and sellers, but also many large deals not involving U.S. !rms.

Figure 1.1 shows that both European and U.S. M&A volume began to rise in 2003 and by 2006–2007 had reached levels comparable to their peaks of the !fth wave. Sim- ilar trends were apparent in Europe. With such high deal volume huge megamergers were not unusual (see Table 1.1 and 1.2). However, by 2008 the effects of the global recession and the subprime crisis began to take hold. The U.S. recession, which began in

3

4 ◾ Introduction

(b)(a)

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Value of Europe M&A: 1980–2014

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Number of U.S. M&A Deals: 1980–2014

FIGURE 1.1 Value of M&As 1980–2014: (a) United States and (b) Europe. Source: Thom- son Financial Securities Data, March 6, 2015.

January 2008, caused potential acquirers to reign in their acquisition-oriented expan- sion plans. Those bidders who were still inclined to go ahead with proposed deals found that their access to !nancing was sharply curtailed. Many bidders who had reached agreements with targets sought to renegotiate the deals or even back out altogether. Deals were canceled with increased frequency.

Deal volume in most regions of the world generally tended to follow the patterns in the United States and Europe. Australia, for example, exhibited such a pattern, with deal volume growing starting in 2003 but falling off in 2008 and 2009 for the same reason it fell off in the United States and Europe. The situation was somewhat differ- ent in China and Hong Kong. The value of deals in these economies has traditionally been well below the United States and Europe but had been steadily growing even in 2008, only to fall off sharply in 2009. China’s economyhas realized double-digit growth for a number of years and is now more than one-half of the size of the U.S. economy

TABLE 1.1 Top 10 Worldwide M&As by Value of Transaction

Date Announced

Date Effective

Value of Transaction ($ mil) Target Name Target Nation Acquirer Name Acquirer Nation

11/14/1999 6/19/2000 202,785.13 Mannesmann AG Germany Vodafone AirTouch PLC United Kingdom

1/10/2000 1/12/2001 164,746.86 Time Warner United States America Online Inc United States

9/2/2013 2/21/2014 130,298.32 Verizon Wireless Inc United States Verizon Communications Inc United States

8/29/2007 3/28/2008 107,649.95 Philip Morris Intl Inc Switzerland Shareholders Switzerland

4/25/2007 11/2/2007 98,189.19 ABN-AMRO Holding NV Netherlands RFS Holdings BV Netherlands

11/4/1999 6/19/2000 89,167.72 Warner-Lambert Co United States Pfizer Inc United States

12/1/1998 11/30/1999 78,945.79 Mobil Corp United States Exxon Corp United States

1/17/2000 12/27/2000 75,960.85 SmithKline Beecham PLC United Kingdom Glaxo Wellcome PLC United Kingdom

10/28/2004 8/9/2005 74,558.58 Shell Transport & Trading Co United Kingdom Royal Dutch Petroleum Co Netherlands

3/5/2006 12/29/2006 72,671.00 BellSouth Corp United States AT&T Inc United States

Source: Thomson Financial Securities Data, February 19, 2015.

5

TABLE 1.2 Top 10 European M&As by Value of Transaction

Date Announced

Date Effective

Value of Transaction ($ mil) Target Name Target Nation Acquirer Name Acquirer Nation

11/14/1999 06/19/2000 202,785.134 Mannesmann AG Germany Vodafone AirTouch PLC United Kingdom

08/29/2007 03/28/2008 107,649.948 Philip Morris Intl Inc Switzerland Shareholders Switzerland

04/25/2007 11/02/2007 98,189.193 ABN-AMRO Holding NV Netherlands RFS Holdings BV Netherlands

01/17/2000 12/27/2000 75,960.847 SmithKline Beecham PLC United Kingdom Glaxo Wellcome PLC United Kingdom

10/28/2004 08/09/2005 74,558.583 Shell Transport & Trading Co United Kingdom Royal Dutch Petroleum Co Netherlands

02/25/2006 07/22/2008 60,856.454 Suez SA France Gaz de France SA France

01/26/2004 08/20/2004 60,243.380 Aventis SA France Sanofi-Synthelabo SA France

07/05/1999 03/27/2000 50,070.051 Elf Aquitaine France Total Fina SA France

05/30/2000 08/22/2000 45,967.068 Orange PLC United Kingdom France Telecom SA France

06/15/2014 01/26/2015 42,729.867 Covidien PLC Ireland-Rep Medtronic Inc United States

Source: Thomson Financial Securities Data, February 19, 2015.

6

TABLE 1.3 Top 10 Asian M&A by Value of Transaction

Date Announced

Date Effective Target Name Target Nation Acquirer Name Acquirer Nation

Value of Transaction ($ mil)

03/26/2014 08/25/2014 CITIC Ltd China CITIC Pacific Ltd Hong Kong 42,247.47

02/29/2000 08/17/2000 Cable & Wireless HKT Hong Kong Pacific Century CyberWorks Ltd Hong Kong 37,442.15

10/04/2000 11/13/2000 Beijing Mobile, 6 others China China Telecom Hong Kong Ltd Hong Kong 34,161.79

05/25/2008 10/15/2008 China Netcom Grp (HK) Corp Ltd Hong Kong China Unicom Ltd Hong Kong 25,416.14

08/01/2012 12/31/2012 China Netcom Corp-3G Assets China China Telecom Corp Ltd China 18,047.28

05/12/2008 11/17/2008 St George Bank Ltd Australia Westpac Banking Corp Australia 17,932.98

04/11/2007 07/25/2007 SK Corp-Petrochemical Business South Korea Shareholders South Korea 16,984.45

07/02/2007 11/23/2007 Coles Group Ltd Australia Wesfarmers Ltd Australia 15,287.79

10/27/2006 07/16/2007 Rinker Group Ltd Australia Cemex SAB de CV Mexico 14,247.73

02/11/2007 05/08/2007 Hutchison Essar Ltd India Vodafone Group PLC United Kingdom 12,748.00

Source: Thomson Financial Securities Data, February 19, 2015.

7

8 ◾ Introduction

(although on a purchasing power parity basis it is approximately the same size). How- ever, there aremany regulatory restrictions imposed onM&As in China that inhibit deal volume from rising to levels thatwould naturally occur in a less controlled environment. The Chinese regulatory authorities have takenmeasures to ensure that Chinese control of certain industries and companies ismaintained even as the economymoves to amore free market status. This is whymany of the larger Asian deals !nd their origins in Hong Kong (see Table 1.3).

In the rest of Asia, deal volume generally expanded starting in 2003 and declined with the global recession in 2008 and 2009. Thiswas the case in India and SouthKorea

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Australia

FIGURE 1.2 Value of M&A 1984–2014: By Nation. Source: Thomson Financial Securities Data, March 6, 2015.

Recent M&A Trends ◾ 9

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Number of South Korea M&A Deals: 1984–2014

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Number of Tawain M&A Deals: 1984–2014

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19 84