Introduction to

Mergers, Acquisitions,
& Other Restructuring
Activities

If you give a man a fish, you feed

him for a day. If you teach a man
to fish, you feed him
for a life time.
Lao Tze

Course Layout: M&A & Other

Restructuring Activities

Part I: M&A
Environment

Part II: M&A

Process

Part III: M&A

Valuation &
Modeling

Part IV: Deal

Structuring &
Financing

Part V:
Alternative
Strategies

Motivations for
M&A

Business &
Acquisition
Plans

Public Company
Valuation

Payment &
Legal
Considerations

Business
Alliances

Regulatory
Considerations

Search through
Closing
Activities

Private
Company
Valuation

Accounting &
Tax
Considerations

Divestitures,
Spin-Offs &
Carve-Outs

Takeover Tactics
and Defenses

M&A Integration

Financial
Modeling
Techniques

Financing
Strategies

Bankruptcy &
Liquidation

Cross-Border
Transactions

Course Learning Objectives

Define what corporate restructuring is and why it occurs

Identify commonly used valuation techniques
Describe how corporate restructuring creates/destroys value
Identify commonly used takeover tactics and defenses
Develop a highly practical planning based approach to
managing the M&A process
Identify challenges and solutions associated with each phase of
the M&A process
Describe advantages and disadvantages of alternative M&A
deal structures
Describe how to plan, structure, and manage JVs, partnerships,
alliances, licensing arrangements, equity partnerships,
franchises, and minority investments

Current Chapter Learning Objectives

Primary objective: What corporate restructuring is
and why it occurs
Secondary objective: Provide students with an
understanding of
M&A as a form of corporate restructuring
Alternative ways of increasing shareholder value
M&A activity in an historical context
The primary motivations for M&A activity
Key empirical findings
Primary reasons some M&As fail to meet
expectations

M&As as a Form of
Corporate Restructuring
Restructuring Activity
Corporate Restructuring
Balance Sheet
Assets Only
Financial Restructuring
(liabilities only)
Operational Restructuring

Potential Strategy
Redeploy Assets
Mergers, Break-Ups, &
Spin-Offs
Acquisitions,
divestitures, etc.
Increase leverage to lower
cost of capital or as a
takeover defense
Divestitures, widespread
employee reduction, or
reorganization

Alternative Ways of
Increasing Shareholder Value
Solo venture (AKA going it alone or organic growth)
Partnering (Marketing/distribution alliances, JVs,
licensing, franchising, and equity investments)
Mergers and acquisitions
Minority investments in other firms
Asset swaps
Financial restructuring
Operational restructuring

Discussion Questions
1. What factors do you believe are most likely to
impact senior managements selection of one
strategy (e.g., solo venture, M&A) to increase
shareholder value over the alternatives? Be
specific.
2. In your opinion, how might the conditions of
the business (e.g., profitability) and the
economy affect the choice the strategy?

Remembering the Past

Those who do not remember the past
are condemned to relive it.
Alexis De Tocqueville

Merger Waves
(Boom Periods)

Horizontal Consolidation (1897-1904)

Increasing Concentration (1916-1929)
The Conglomerate Era (1965-1969)
The Retrenchment Era (1981-1989)
Age of Strategic Megamerger (1992-2000)
Age of Cross Border and Horizontal
Megamergers (2003-2007)

Causes and Significance

of M&A Waves

Factors contributing to merger waves:

Shocks (e.g., technological change, deregulation, and escalating
commodity prices)
Ample liquidity and low cost of capital
Overvaluation of acquirer share prices relative to target share
prices
Why it is important to anticipate M&A waves:
Financial markets reward firms pursuing promising opportunities
early on and penalize those that follow later in the cycle.
Acquisitions made early in the wave often earn substantially
higher financial returns than those made later in the cycle.

Horizontal Consolidation (1897-1904)

Spurred by
Drive for efficiency,
Lax enforcement of antitrust laws
Westward migration, and
Technological change
Resulted in concentration in metals,
transportation, and mining industry
M&A boom ended by 1904 stock market
crash and fraudulent financing

Increasing Concentration (1916-1929)

Spurred by
Entry of U.S. into WWI
Post-war boom
Boom ended with
1929 stock market crash
Passage of Clayton Act which more clearly
defined monopolistic practices

The Conglomerate Era (1965-1969)

Conglomerates buy earnings streams to boost
their share price
Overvalued firms acquired undervalued high
growth firms
Number of high-growth undervalued firms
declined as conglomerates bid up their prices
Higher purchase price for target firms and
increasing leverage of conglomerates brought
era to a close

The Retrenchment Era (1981-1989)

Strategic U.S. buyers and foreign multinationals
dominated first half of decade
Second half dominated by financial buyers
Buyouts often financed by junk bonds
Drexel Burnham provided market liquidity
Era ended with bankruptcy of several large
LBOs and demise of Drexel Burnham

Age of Strategic Megamerger

(1992-2000)
Dollar volume of transactions reached record in each
year between 1995 and 2000
Purchase prices reached record levels due to
Soaring stock market
Consolidation in many industries
Technological innovation
Benign antitrust policies
Period ended with the collapse in global stock markets
and worldwide recession

Age of Cross Border and

Horizontal Megamergers (2003 2007)
Average merger larger than in 1980s and 1990s, mostly
horizontal, and cross border
Concentrated in banking, telecommunications, utilities,
healthcare, and commodities (e.g., oil, gas, and metals)
Spurred by
Continued globalization to achieve economies of scale
and scope;
Ongoing deregulation;
Low interest rates;
Increasing equity prices, and
Expectations of continued high commodity prices
Period ended with global credit market meltdown and
2008-2009 recession

Debt Financed 2003-2007 M&A Boom

Low
LowInterest
Interest
Rates
Rates&&Declining
Declining
Risk
Aversion
Risk Aversion
Drive
DriveIncreasing
Increasing
--Sub-Prime
--Sub-Prime
Mortgage
MortgageLending
Lending
--LBO
Financing
--LBO Financing&&
Other
OtherHighly
Highly
Leveraged
Leveraged
Transactions
Transactions

Investment
InvestmentBanks:
Banks:
Repackage
Repackage &&
Underwrite
Underwrite
--Mortgage
--Mortgage
Backed
Backed
--High
--HighYield
Yield
Bonds
Bonds

Banks
Banks&&
Hedge
HedgeFunds
Funds
Create:
Create:
--Collateralized
--Collateralized
Debt
DebtObligations
Obligations
(CDOs)
(CDOs)
--Collateralized
--Collateralized
Loan
LoanObligations
Obligations
CLOs)
CLOs)

Investment Banks Lend to Hedge

Funds

Foreign
Foreign
Investors
Investors
Buy
BuyHighest
Highest
Rated
RatedDebt
Debt

Hedge
Hedge
Funds
Funds
Buy
BuyLower
Lower
Rated
Rateddebt
debt

Similarities and Differences

Among Merger Waves
Similarities
Occurred during periods of sustained high economic
growth
Low or declining interest rates
Rising stock market
Differences
Emergence of new technology (e.g., railroads,
Internet)
Industry focus
Type of transaction (e.g., horizontal, vertical,
conglomerate, strategic, or financial)

Discussion Questions
1. What can senior management learn by
studying historical merger waves?
2. What can government policy makers learn by
studying historical merger waves?
3. What can investors learn by studying historical
merger waves?

Motivations for M&A

Strategic realignment
Technological change
Deregulation
Synergy
Economies of scale/scope
Cross-selling
Diversification (Related/Unrelated)
Financial considerations
Acquirer believes target is undervalued
Booming stock market
Falling interest rates
Market power
Ego/Hubris
Tax considerations

Illustrating Economies of Scale

Period 1: Firm A (Pre-merger)

Period 2: Firm A (Post-merger)

Assumptions:

Price = $4 per unit of output sold

Variable costs = $2.75 per unit of output

Fixed costs = $1,000,000

Firm A is producing 1,000,000 units of output per

year

Firm A is producing at 50% of plant capacity

Assumptions:

Firm A acquires Firm B which is producing

500,000 units of the same product per year

Firm A closes Firm Bs plant and transfers

production to Firm As plant

Price = $4 per unit of output sold

Variable costs = $2.75 per unit of output

Fixed costs = $1,000,000

Profit = price x quantity variable costs

fixed costs
= $4 x 1,000,000 - $2.75 x 1,000,000
- $1,000,000
= $250,000

Profit = price x quantity variable costs

fixed costs
= $4 x 1,500,000 - $2.75 x 1,500,000
- $1,000,000
= $6,000,000 - $4,125,000 - $1,000,000
= $875,000

Profit margin (%)1 = $250,000 / $4,000,000 = 6.25% Profit margin (%)2 = $875,000 / $6,000,000 = 14.58%
Fixed costs per unit = $1,000,000/1.500,000 = $.67
Fixed costs per unit = $1,000,000/1,000,000 = $1
Key Point: Profit margin improvement is due to spreading fixed costs over more units of output.
1
2

Margin per $ of revenue = $4.00 - $2.75 - $1.00 = $.25

Margin per $ of revenue = $4.00 - $2.75 - $.67 = $.58

Illustrating Economies of Scope

Pre-Merger:

Post-Merger:

Firm As data processing center

supports 5 manufacturing facilities
Firm Bs data processing center
supports 3 manufacturing facilities

Firm As and Firm Bs data

processing centers are combined
into a single operation to support
all 8 manufacturing facilities
By combining the centers, Firm A
is able to achieve the following
annual pre-tax savings:
Direct labor costs = $840,000.
Telecommunication expenses
= $275,000
Leased space expenses =
$675,000
General & administrative
expenses = $230,000

Key Point: Cost savings due to expanding the scope of a single center to
support all 8 manufacturing facilities of the combined firms.

Empirical Findings

Around transaction announcement date, abnormal returns average

20% for target shareholders in friendly transactions; 30-35% in
hostile transactions
Bidders shareholders on average earn zero to slightly negative
returns

Positive abnormal returns to bidders often are situational and

include the following:
Target is a private firm or a subsidiary of another firm
The acquirer is relatively small
The target is small relative to the acquirer
Cash rather than equity is used to finance the transaction
Transaction occurs early in the M&A cycle

No evidence that alternative strategies (e.g., solo ventures,

alliances) to M&As are likely to be more successful

Primary Reasons Some M&As Fail to

Meet Expectations
Overpayment due to over-estimating
synergy
Slow pace of integration
Poor strategy

Discussion Questions
1. Discuss whether you believe current conditions
in the U.S. and global markets are conducive
to high levels of M&A activity? Be specific.
2. Of the factors potentially contributing to current
conditions, which do you consider most
important and why?
3. Speculate about what you believe will happen
to the number of M&As over the next several
years in the U.S.? Globally? Defend your
arguments.

Application: Xerox Buys ACS

In late 2009, Xerox, traditionally an office equipment manufacturer, acquired Affiliated Computer
Systems (ACS) for $6.4 billion. With annual sales of about $6.5 billion, ACS handles paper-based
tasks such as billing and claims processing for governments and private companies. With about
one-fourth of ACS revenue derived from the healthcare and government sectors through long-term
contracts, the acquisition gives Xerox a greater penetration into markets which should benefit from
the 2009 government stimulus spending and 2010 healthcare legislation. There is little customer
overlap between the two firms.
Previous Xerox efforts to move beyond selling printers, copiers, and supplies and into services
achieved limited success due largely to poor management execution. While some progress in
shifting away from the firms dependence on printers and copier sales was evident, the pace was
far too slow. Xerox was looking for a way to accelerate transitioning from a product driven
company to one whose revenues were more dependent on the delivery of business services.
More than two-thirds of ACS revenue comes from the operation of client back office operations
such as accounting, human resources, claims management, and other outsourcing services, with
the rest coming from providing technology consulting services. ACS would also triple Xeroxs
service revenues to $10 billion. Xerox chose to run ACS as a separate standalone business.
Discussion Questions:
1. What alternatives to a merger do you think they could have considered?
2. Why do you think they chose a merger strategy? (Hint: Consider the
advantages and disadvantages of alternative implementation strategies.)
3. How are Xerox and ACS similar and how are they different? In what way will their
similarities and differences help or hurt the long-term success of the merger?
4. How might the decision to manage ACS as a separate business affect realizing the full
value of the transaction?

Things to Remember

Motivations for acquisitions:

Strategic realignment
Synergy
Diversification
Financial considerations
Hubris
Common reasons M&As fail to meet expectations
Overpayment due to overestimating synergy
Slow pace of integration
Poor strategy
M&As typically reward target shareholders far more than bidder
shareholders
Success rate of M&A not significantly different from alternative ways
of increasing shareholder value