The Game of Mergers and Acquisitions in The Markets
In the 1980s, hostile takeovers and LBO acquisitions were all the rage. Companies sought to acquire others through aggressive stock purchases and cared little about the target company's concerns. The 90s has been the decade of friendly mergers, dominated by a few sectors in the economy. Mergers in the telecommunications, financial services, and technology industries have been commanding headlines as these sectors go through dramatic change, both regulatory and financial. But giant mergers have been occurring in virtually every industry (witness the biggest of them all, the merger between Exxon and Mobil). While the giant takeovers by LBO firms that characterized the 1980s haven't materialized this decade, M&A business has been consistently brisk, as demands to go global, to keep pace with the competition, and to expand earnings by any possible means have been foremost in the minds of CEOs.
When a public company acquires another public company, the target company's stock often shoots through the roof while the acquiring company's stock often declines. Why? One must realize that existing shareholders must be convinced to sell their stock. Few shareholders are willing to sell their stock to an acquirer without first being paid a premium on the current stock price. In addition, shareholders must also capture a "takeover premium" to relinquish control over the stock. For example, the management of the selling company may require a substantial premium to give up control of their firm.
M&A transactions can be roughly divided into either mergers or acquisitions. These terms are often used interchangeably in the press, and the actual legal difference between the two involves arcana of accounting procedures, but we can still draw a rough difference between the two.
Acquisition - When a larger company takes over another (smaller firm) and clearly becomes the new owner, the purchase is called an acquisition. Typically, the target company ceases to exist post-transaction (from a legal corporation point of view) and the acquiring corporation "swallows" the business. The stock of the acquiring company continues to be traded.
Merger - Merger occurs when two companies, often roughly of the same size, combine to create a new company. Such a situation is often called a "merger of equals." Both companies' stocks are tendered (or given up), and new company stock is issued in its place. For example, both Chrysler and Daimer-Benz ceased to exist when their firms merged, and a new combined company, DaimlerChrysler was created.
M&A advisory services
For an I-bank, M&A advising is highly profitable, and the possibilities of types of transactions are virtually unlimited. Perhaps a small private company's owner/manager wishes to sell out for cash and retire. Or perhaps a big public firm aims to buy a competitor through a stock swap. Whatever the case, M&A advisers come directly from the corporate finance departments of investment banks. Unlike public offerings merger transactions do not directly involve salespeople, traders or research analysts. In particular, M&A advisory falls onto the laps of M&A specialists and fits into one of the two buckets: seller representation or buyer representation (also called target representation and acquirer representation).
Representing the Target
An I-bank that represents a potential seller has a much greater likelihood of completing a transaction (and therefore being paid) than an I-bank that represents a potential acquirer. Also known as sell-side work this type of advisory assignment is generated by a company that approaches an investment bank and asks the bank to find a buyer of either the entire company or a division. Often, sell-side representation comes when a company asks an investment bank to help it sell a division, plant or subsidiary operation.
Generally speaking, the work involved in finding a buyer includes writing a "Selling Memorandum' and then contacting potential strategic or financial buyers of the client. If the client hopes to sell a semiconductor plant, for instance, the I-bankers will contact firms in that industry, as well as "buyout" firms that focus on purchasing technology or high-tech manufacturing operations.
Buyout firms, which are aptly named financial buyers, acquire companies by borrowing substantial cash. These buyout firms (also called LBO firms) implement a management team they trust, and ultimately seek an "exit strategy" (usually a sale or IPO) for their investment within a few years. These firms are driven to achieve a high return on investment (ROI), and focus their efforts toward streamlining the acquired business and preparing the company for a future IPO or sale. It is quite common that a buyout firm will be the selling shareholders in an IPO or follow-on offering.
Representing the Acquirer
In advising sellers, the I-bank's work is complete once another party purchases the business up for sale, i.e. once another party buys your client's company or division or assets. Buy-side rep work is an entirely different animal.
The advisory work itself is straightforward: the investment bank contacts the firm their client wishes to purchase, attempts to structure a palatable offer for all parties, and make the deal a reality. However, 99 percent of these proposals do not work out; few firms or owners are willing to readily sell their business. And because the I-banks primarily collect fees based on completed transactions, their work often goes unpaid.
Consequently, when advising clients looking to buy a business, an I-bank's work often drags on for months. Often a firm will pay a non-refundable retainer fee to hire a bank and say, "Find us a target company to buy." These acquisition searches can last for months and produce nothing except associate and analyst fatigue as they repeatedly build merger models and work all-nighters.
Deals that do "get done," though, are a boon for the I-bank representing the buyer because of their enormous profitability. Typical fees depend on the size of the deal, but generally fall in the 1 percent range. For a $100 million deal, an investment bank takes home $1 million! Not bad for a few months' work.
Private Placements
A private placement, which involves the selling of debt or equity to private investors, resembles both I public offering and a merger. A private placement differs little from a public offering aside from the fact that a private placement involves a firm selling stock or equity to private investors rather than to public investors. Also, a typical private placement deal is smaller than a public transaction. Despite these differences, the primary reason for a private placement - to raise capital - is fundamentally the same as a public offering. From an M&A point of view, a private placement is similar to a merger because it usually involves an institution (rather than numerous public investors) acquiring a stake (assets) in a company.
Why Private Placements?
As mentioned previously, firms wishing to raise capital often discover that they are unable to go public for a number of reasons. The company may not be big enough; the markets may not have an appetite for IPOs, or the company may simply prefer not to have its stock be publicly traded. Such firms with solidly growing businesses make excellent private placement candidates. Often, firms wishing to go public may be advised by investment bankers to first do a private placement, as they need to gain critical mass or size to justify in IPO.
Private placements, then, are usually the province of small companies aiming ultimately to go public. The process of raising private equity or debt changes only slightly from a public deal. One difference is that private placements do not require any securities to be registered with the SEC, nor do they involve a roadshow. In place of the prospectus, I-banks draft a detailed Private Placement Memorandum, or PPM for short, this divulges information similar to a prospectus. Instead of a roadshow, companies looking to sell private stock or debt will host potential investors as interest arises, and give presentations detailing how they will be the greatest thing since sliced bread.
Most often, one firm will be the sole investor in a private placement. In other words, if a company sells stock through a private placement, usually only one venture capital firm will buy the stock offered. Conversely, in an IPO, shares of stock fall into the hands of literally thousands of buyers immediately after the deal is completed.
The I-bank's role in private placements
The investment banker's work involved in a private placement is quite similar to sell-side M&A representation. The bankers attempt to find a buyer by writing the Private Placement Memorandum and then contacting potential strategic or financial buyers of the client.
In the case of private placements, however, financial buyers are venture capitalists rather than buyout firms, which is an important distinction. A VC firm invests in less than 50 percent of a company's equity, whereas a buyout firm purchases greater than 50 percent of a company's equity, thereby gaining control of the firm. Note that the same difference applies to private placements on the sell-side. A sale occurs when a firm sells greater than 50 percent of its equity (giving up control), but a private placement occurs when less than 50 percent of its equity is sold.
Because private placements involve selling equity and debt to a single buyer, the investor and the seller (the company) typically negotiate the terms of the deal. Investment bankers function as negotiators for the company, helping to convince the investor of the value of the firm.
Fees involved in private placements work like those in public offerings. Usually they are a fixed percentage of the size of the transaction. (Of course, the fees depend on whether a deal is consummated or not.) A common private placement fee is 5 percent of the size of the equity/debt sold.
Financial Restructurings
When a company cannot pay its cash obligations - for example, when it cannot meet its bond payments or its payments to other creditors (such as vendors) - it goes bankrupt. In this situation, a company can, of course, choose to simply shut down operations and walk away. On the other hand, it can also "restructure" and remain in business.
What does it mean to restructure? The process can be thought of as two-fold: financial restructuring and organizational restructuring. Restructuring from a financial viewpoint involves renegotiating payment firms on debt obligations, issuing new debt, and restructuring payables to vendors. Bankers provide guidance to the firm by recommending the sale of assets, the issuing of special securities such as convertible stock and bonds or even selling the company entirely.
From an organizational viewpoint, a restructuring can involve a change in management, strategy and focus. I-bankers with expertise in "re-orgs" can facilitate and ease the transition from bankruptcy to viability.
Fees in Restructuring Work
Typical fees in a restructuring depend on whatever "retainer fee" is paid upfront and what new securities are issued post-bankruptcy. When a bank represents a bankrupt company, the brunt of the work is focused on analyzing and recommending financing alternatives. Thus, the fee structure resembles that of private placement. How does the work differ from that of a private placement? I-bankers not only work in securing financing, but may assist in building projections for the client (which serve to illustrate to potential financiers what the firm's prospects may be), in renegotiating credit terms with lenders, and in helping to re-establish the business as a going concern.
Because a firm in bankruptcy already has substantial cash flow problems, investment banks often charge minimal monthly retainers, hoping to cash in on the spread from issuing new securities. Like other public offerings, this can be highly lucrative and steady business.
