Introduction to M&A

Mergers (combining companies), acquisition (buying companies), disposal (selling companies), de-
merger /spinoff (splitting companies).
M&A for corporate restructuring:
• Corporate restructuring: Balance sheet (mergers, breakups, and spin offs)
Assets only (acquisitions, divestitures, etc.)
• Financial restructuring: Liabilities (Increase leverage to reduce the cost of capital or as a
takeover defense)
• Operational restructuring: divestitures, widespread employee reduction, or reorganization

Merger Waves: some factors that contribute are industry shocks, high liquidity and low cost of
capital, overvaluation of acquirer shares relative to target share prices
• Horizontal consolidation 1897- 1904: slack antitrust laws
• Increasing concentration 1916 – 1929: post war boom
• Conglomerate era 1965 – 1969: Overvalued firms acquire undervalued high growth
• Retrenchment era 1981 – 1989: First half led by multinationals; second half led by financial
buyers (junk bonds financed LBO)
• Strategic Megamergers 1992 – 2000
• Cross border and horizontal megamergers 2003 – 2007: Concentrated in banking,
telecommunications, utilities, healthcare, commodities
Similarities: Periods of high economic growth, low interest rates, growing stock market
Differences: New tech, industry focus, type of transaction
Recent trends: North America 54% & Europe25%, PE backed 20%, Tech 20%, mid-market range 97%,
cross border deals 55%

Key Roles & Players

Corporations: Any firm private or public

Chinese Wall: Imaginary line that divides the market.
Everyone above the wall possesses confidential
information, below the line can’t have confidential
information about the M&A. There are Chinese walls
even within the same IB between different divisions.
Jobs outside IB:
• Brokers: Execute trades for clients, earn
commissions. They are asset gatherers and make the
market by generating liquidity to each asset class.
• Investors Invest in securities (buy stocks through
brokers, buy mutual fund shares, invest directly in
companies via Dividend Reinvestment Plans). They have
different impatience levels for returns.
• Portfolio Managers: Manage investment portfolios for institutions and individuals. They try
to diversify risk by investing in different asset classes. They have patience for returns.
Jobs inside IB
• Institutional Sales: Provide research and insight for portfolio managers. They are the link
between portfolio managers to traders. They are specialists by industry and understand buy
side and sell side.
• Analysts: Specialized in specific industries. They prepare reports and suggest share price,
they influence the market with valuation reports. When on sell side, they sell research to
 buy side; When on buy side they report to portfolio managers. They link management and
investors
• Investment Bankers: Advise on M&A, take a % of the deal as fee. There are 3 job levels:
analysts (modeling & presentations), associates, VPs (relationship management)
• Traders

Who talks to who? Employees cannot cross the Chinese wall.

-Corporations & IB talk
-IB can talk to capital market groups when they need to
structure financing and issue some debt or equity
instruments for client
-Research analysts can have selective talks with the client
& IB
-Sales & Trading can only access public information
* Whenever there’s abnormal increase/decrease in the
trade of the stock in the market, suspect insider trading
before M&A deal. (Someone knew about the project and
took advantage of it by buying/selling)

Roles of Research: *Research divisions are organized by type of security:

• Equity research: Research on specific stock, specific industry; they forecast stock prices
(recommendations to buy/sell)
• Fixed Income Research: Research on global economic analysis; analysis and forecasts of wide
range of economic data
• Global Economics Research: Research across a broad spectrum of corporate and
Government bonds
Roles of IB: Two main roles:
• Capital Raising / Financing: Equity or fixed income financing, convertibles, refinancing,
warrants, other derivative structures
• Strategic Advisory: M&A, sales, divestitures, restructuring, stock buy backs.
Roles of Sales & Trading: Organized by type of security:
• Equity: Sale of equity securities (IPOs, follow ons, convertibles), after-market trading
support.
• Fixed income: Sale of fixed income securities (corporate and government bonds, high yield),
after-market trading support

Investment Bank Divisions:

Asset Management: Manage different investments of the bank.
Private Client Services: Manage assets on behalf of private
clients
Equities Division: Stock & Equities
IB Division: Equity, M&A
Fixed Income Division: Debt securities

IB
Division
Can be divided by product groups or industry
groups
 Equities Division
Capital Market & Syndicate: People who issue
new equity
Equity Sales: People who sell the research
Equity Trading: People who trade the equity
Equity Research: People making the research

Fixed Income Division

Debt Capital Markets & Syndicate: People who
issue the debt
Fixed Income S&T: People who sell the
research
Fixed Income Research: People who do the
research

Key Constituents in IB
• M&A and Strategic Advisory: A good investment banker is a trusted advisor to their client - a
CEO’s first call for strategic advice. Investment bankers are most valuable when they provide
unique insight regarding a company’s operations or strategic direction and show clients
strategic ideas that may or may not be obvious to their client. CEOs often use their bankers to
approach potential counterparties on an informal basis. Investment bankers typically handle
negotiations and most other aspects of the M&A process, allowing management to focus on
running their business. Two of their main tasks are:
- Raising Capital: IBs assist companies for this, they are the intermediaries between users
of capital and providers (sources) of capital. Ways to raise capital:
Equity: IPO, Secondary Offering, Preferred Stock
Debt: Investment Grade, High Yield Debt, Structured & New Product Financing
- Optimize the capital structure in terms of equities and debt.
Recapitalization: debt buyback, share buyback, M&A
Restructuring
• Markets and Banks: Transfer the money to those who need it
Corporate securities:
- Bonds (fixed income): “What can go wrong?” mentality, give the money back with
interest. Principal protected but limited upside
- Stocks (equity); “What can go right?” mentality, own part of the company and
participate in upside. Unlimited upside and downside.
Equity Capital Markets:
- Equity origination: Subgroups organized by sector
- Product groups: IPOs, follow-ons, Block trades, Equity linked securities, Spin-offs, carve-
outs, Tracking stocks
- Institutional Marketing: Execution team focused on offering to investors
Fixed Income Capital Markets:
- Origination Groups: Cross Border Capital Markets, Financial Institutions Fixed Income
Capital Markets, Latin America Capital Markets, Industrial Fixed Income Capital Markets
- Product groups: Asset Backed Finance, Asset Based Finance, Asset Finance Groups,
Derivatives Solutions, Export/Agency Finance, Global Capital Structuring, Global Loans
Capital Markets, Global New Products, Global Portfolio Optimization, Global Structured
Bonds, Global Structured Credit Products, Infrastructure/Energy Finance, Leveraged
Finance, Liability Management, Money Markets Origination, Mortgage Finance, Real
Estate Finance, Securitization
 • Sales & Trading: Most Investment Banks provide Sales and Trading service. In addition, they
conduct proprietary trading for the firm's own accounts. Sales forces provide a link between
the firm's customers and the marketplace (identify clients' needs and utilize the Firm’s
resources to meet these needs, Traders provide liquidity for securities around the globe).
Successful salespeople and traders are prudent decision makers with an aptitude for
numbers—they possess market knowledge, discipline, good judgment, and intuitive ability to
recognize market trends and learn from experience.
Who are the players? – Buy-Side, Sell-Side
Who are “Institutional” clients? Mutual Funds, Pension Funds, Hedge Funds, State Funds,
Insurance Companies
What is the Sales & Trading environment like? Dynamic, Ever Changing, Energetic,
Meritocracy

IB Financing and Advisory Products:

When companies have financial needs, they consult IB how to raise money:
● Before an IPO, can raise capital by Venture Capital Funds, and they can go for private
placement before going public.
● After IPO:
-Additional issuance of equity in the -Stock buy- backs
market -Divestitures (spin-offs, carve-outs)
-M&A -Issue fixed income (bonds)
-Issue different securities (warrants, -LBO (only mature companies)
convertible bonds etc.)

Motivations for M&A

Seller: access capital, grow faster, shares can be overvalued, exit strategy, focus on other businesses,
company isn’t performing well, making the corporate structure linear, organizational turn around
Buyer: achieve key skills, acquire key assets, diversify risk, increase market presence, faster option
than SA, overcome the size barrier to enter an industry or go public.
Managerial (Not in the best interest of the firm and shareholders): Increase firm size, reduce risk

Primary motive should be creating synergies (additional value created). Types of synergies:
• Operating synergies: economies of scale/scope, complementary strengths
• Efficiency increases: New management is more efficient that the current management
• Financing synergies: Reduce cashflow variability, increase debt capacity, reduce average
issuing costs, reduce information problems
• Tax benefits: better use of tax deductions (before expiry, deduction in higher tax bracket,
deductions to offset taxable income)
• Strategic realignments: new strategies that weren’t feasible before
*Shareholder value at risk (SVAR): Potential that synergies are not realized, or that the premium paid
is higher than the synergies. When using cash the acquirer bears all risk, with share swaps the risk is
split by shareholders in both companies. Firms using cash are more careful about acquisition price.

M&A drivers in general:

• Macroeconomic: economic boom, over capacity, cheap money, industry consolidation,
globalization
• Strategic: gain share, eliminate competition, capture operating opportunities, diversify
portfolio, retire excess industry capacity,
• Financial: Improve valuation of acquirer, invest idle cash
• Others: greed, ego
 Types of takeovers

Takeover: Transfer of control to a different ownership group (minorities are not takeover)
• Cash transaction: Receipt of cash for shares
• Share transaction: Acquiring company offers shares (or combination cash-shares)
• Going private transaction: The purchaser already owns a majority stake in the target and
offers to buy the residual shares to go private.

Friendly Acquisition: Target is willing to be taken over. The target provides access to confidential
information to facilitate due diligence.
Timeline: Its often initiated by the target
1. Approach target & Information Memorandum: Target uses a M&A advisory firm or IB to
prepare an offering memorandum
2. NDA
3. LOI: Signals the willingness of the parties to move on
4. Due diligence
5. Final sale agreement
6. Ratified
Structure: Both parties can structure the deal to their mutual satisfaction including:
• Taxation: Cash transaction triggers capital gains, shares transaction is an alternative
• Asset purchase rather than shares: Gives cash to the target to reimburse debt and
restructure financing and gives the acquirer a new asset base. Moreover, it permits to
escape from contingent liabilities (environmental lawsuits and control orders)
• Earn outs: There is an agreement for an initial purchase price with conditional later
payments depending on the performance of the target after acquisition

Hostile Takeover: The target has no desire in being acquired and actively rejects the acquirer. Usually
the acquirer has already 10-20% of the outstanding shares.
Timeline:
1. Slowly acquire a toehold without attracting attention
2. When an acquirer reaches a % by slowly buying shares from the market, they must
communicate and comply with SEC rules; generally hostile takeover companies try to stay
below this threshold
3. Accumulate a % (below threshold) of shares.
4. Make a tender offer to bring ownership percentage to desired level (usually contains a
provision that it will be made only if a minimum % is obtained)
*Acquirer monitors management/board and fight their defensive tactics attempts.
Capital market reactions:
• Market price jumps above offer price: Competing offer is likely or bid price is too low
• Market price stays close to offer price: Fair offer price and deal will likely go through
• Little shares trading: Bad sign for acquirer (shareholders are reluctant to sell)
• Great deal of shares trading: Shares being sold from normal investors to arbitrageurs who
are building a position to negotiate a bigger premium by coordinating a response to the
tender offer.
Defense tactics:
• Shareholders rights plan (“poison pill” or “deal killer”): Give non-acquiring shareholders the
right to buy 50% more shares at a discount price in the event of a takeover
• Selling the crown jewels: Selling the key assets that the acquirer is interested in. Can involve
a large dividend to remove excess cash.
• White knight: Seek out another acquirer considered friendly to make a counteroffer.
Classifications of M&A:
• Horizontal: Firms in the same industry to achieve economies of scale/scope
• Vertical: Acquire supplier or firm closer to customer to control supply or distribution
channels
• Conglomerate: Firms in unrelated business to diversify
• Cross border: Domestic & foreign firm

Strategic Approach to Acquisition Process

1. Proactive strategic thinking: Assess impact on long-term shareholder value

2. Screening: Look for companies that strengthen the corporation
3. Execution: Make better decisions upfront and identify deal breaker issues
4. Capture full value: Communicate corporate vision and begin integration process early

The focus of strategic M&A should be where there’s the highest value creation opportunity and the
strongest parenting advantage
• Parenting advantage: Value created by acquiring target under same umbrella
• Value creation opportunities: Generate full value by buying cheap (take advantage of market
inefficiencies & spot early new market trends) or add value to underperforming assets (spot
early new market trends & generate synergies).

Key areas to focus in M&A: relatedness of the target in relation to our company; strategic strength of
the target with refer to key competitors; market dynamics.

Competitive intelligence (information + analysis=intelligence) 5 steps:

1. Make the right questions
2. Collect and organize data
3. Analyze information
4. Disseminate intelligence (results of analysis)
5. Evaluate effectiveness
Types of competitive intelligence:
• Market intelligence: Current & future trends
Frameworks: 4Ps, segmentation, AIDA, Conjoint Analysis
Application Areas: new product concept identification, pricing, benefit segmentation,
competitive analysis, brand repositioning, etc.
• Competitors intelligence: Evaluate evolution of competitive strategy
Frameworks: 3Cs, Porter, SWOT, New markets & adjacency matrix
Application Areas: competitive analysis, new markets expansion, repositioning,
restructuring, market entry, strategic partnerships, M&A, business development, etc.
• Tech intelligence: Cost/benefit of current & new tech
Frameworks: Porter, SWOT, New Product Matrix
Applications Areas: new product concept identification, R&D, market entry/exit, strategic
partnerships/M&A, cost improvement, etc.
 General Approach to Company’s Strategy

Business definition
An incorrect one can destroy shareholders value.
Evaluate according to cost sharing & customer sharing.
To define if the companies can be one business use the
business definition matrix.

Industry Analysis: How attractive is the industry in

which the company is? Related tools:
• Market overview analysis: Determine industry
attractiveness by segmenting the market and
identifying growth opportunities. Tools to
identify growth opportunities:

• Value Chain analysis: Systematic method for disaggregating a company into its major
activities to understand sources of competitive advantage. Steps:
1) What are the activities? Determine key steps
2) Which activities are most critical?
Cost drivers: (Allocate costs to each major activity
Customer decisions: Determine which activities drive purchase decision
3) Which critical activities provide the most opportunity?
Most controllable costs, determine where largest relative performance gap lies
Greatest relative opportunity to improve performance relative to competitors
• Profit Pools: Helps to understand what is driving profitability in the industry, how these
drivers can shift, and what are the threats that affect these drivers. Steps:
1) Define the pool
2) Determine the size of the pool
3) Estimate the distribution of profits
4) Reconcile the estimates
• Market Forces analysis (Porters 5 Forces): Industry Rivalry - Barriers to Entry - Bargaining
power of buyers - Bargaining power of suppliers - Threat of substitutes
Competitor Analysis
Provides context to generate winning strategies, to learn from competitors (dynamics, benchmark),
and to anticipate-respond to their moves.
Key questions: business model? Market position? How financially strong is it? Organization &
ownership structure?
Understand if the competitor is trying to win on:
• Cost:
Economies of scale
Process effectiveness: management skills (supply chain, tech, distribution). IKEA
Factor costs: labor, raw materials, cost of capital. Ryanair
Privileged assets: patents, natural resources, logistical advantage. Duty free
• Differentiation
Quality: design, features, performance. Swatch
Customer service: policies, delivery time, personnel. Dell
Range: interoperability. Microsoft
Special relationships: trade, customer. De Beers
Distinctive capabilities: innovation, management. 3M
Brand Equity: Image, prestige. Rolex
The same 2 concepts are the drivers of differential profitability:
• Lower cost: scale economies, operating efficiencies, product design
Problem: long term sustainability
• Price premium: product differentiation, product or channel mix, niche position
Problem: customer must perceive the premium value added
How to examine competitors? SWOT
Strengths: internal abilities associated with competitive advantages
Weaknesses: Internal limitations associated with competitive disadvantages
Opportunities: External trends associated with competitive prospects
Threats: External trends associated with competitive obstacles
Bottom-Line Improvements :
• Revenue Enhancement: (soft synergies)
- Increase the volume sold: new sales distribution channels, cross-selling products,
product quality improvements etc.
- Increase the prices
- Or Both
• Cost Reduction: (hard synergies)
- Reduce variable costs: increase labor productivity, transportation efficiency, etc.
- Reduce fixed costs: lower sales & marketing costs, distribution costs etc.
 M&A process

Sell side:
1. Asses and value opportunity: Understand reasons and explore alternatives
2. Packaging and marketing: Key documents, blind profile, intro letters, offering memorandum,
executive summaries, company presentation.
3. Buyers scouting and screening: List of potential buyers, approach them anonymously,
shortlist and send memo book
4. Letter of intent and due diligence: Data room, set time for bid or LOI
5. Final negotiation and closing
Other view of disposal process:
1. Preparation
2. Marketing: contact, NDA, indicative bid
3. Preliminary valuation: short list bidders, management presentation, data room, dd
4. Final evaluation: Evaluate offers, final offer, negotiate SPA
5. Negotiations and closing

Buy side:
1. Strategic planning and organization: Understand business model and define list of target
criteria
2. Target scouting and screening: List of candidates, preliminary profile
There are three levels of screening:
Broad screen: Helps to rapidly narrow down by evaluating market position (sector,
company size, company growth, market share, financials)
Fine screen: Helps to shortlist candidates by evaluating relatedness (KSF, competitive
position, synergies opportunity.
Thorough screen: Is a detailed assessment of the value creation potential (stand-
alone value and improved potential)
3. Negotiation and deal structure: Valuation, estimate purchase price, deal structure
4. Target company due diligence: financial and legal due diligence, commercial and operational
due diligence if needed.
The due diligence helps to identify potential deal breakers and synergies potential, to adjust
the business plan, and to do the valuation. Types of due diligence:
Financial: KVD, BS, P&L, BP, Cf
Legal: litigations, warranty claims, licenses, patents, trademarks
Tax: deferred taxes, double taxation, dividend policy
HR: Organizational chart
Pension: pension and funds
IT/MIS
Commercial:
Market: product margins, market size, market share, market growth
Operational: plants, production, inventory, supply management
Technical: R&D, quality control
Treasury and risk management
Real estate: rate utilization, location, expansion plans
Environmental: medical risks, waste management
5. Transaction closing: closing terms negotiation, integration plan

M&A advisor’s objectives & activities during the M&A process:

1. Acquisition screening
Objective: Identify potential candidates
 Activities: Determine targets
2. Due diligence
Objectives: Improve chances of success and make better decisions
Activities: Look for synergies, understand market dynamics, analyze quality
3. Valuation
Objectives: Understand full strategic value
Activities: DCF that values stand-alone and synergies
4. Integration
Objectives: Define actions to speed integration process
Activities: Transition plan, cost reduction, revenue enhancement

Approaches to M&A
• Bilateral sales process: Identification and contacting the “most natural buyer”, exclusive
negotiations with potential buyer.
Competition among potential buyers is low, confidentiality is very high, flexibility during
process is very high (they can arrange themselves according to each other), Time burden on
operational business is high.
• Controlled Auction Process: Confidential approach to limited number of potential buyers.
Negotiation with one or several interested bidders.
Competition among potential buyers is high (collecting offers), confidentiality is high but not
so much because we need to provide data room, flexibility moderate, Time burden on
operational business is high.
• Public Auction: (want to sell the 100% and make the most out of it, company must be good
so it can gather a lot of offers). Press release and contact to broad group of potential buyers.
Obtaining unbinding and binding offers. Negotiation with highest.
Competition among potential buyers is high (collecting offers), confidentiality is low ,
flexibility is very low (providing guideline for the process), Time burden on operational
business is low

What drives transaction value?

Negotiating position (relative strengths) between seller and buyer depends on many factors: selling
reasons, time pressure (the seller needs to sell), # of potential buyers etc.
• Seller can have relative strength on transaction value: if; - strong company reputation, -
unique business plan, - important key assets, -if buyers see a lot of possible synergies and
strategic fit etc.
• Buyer can have relative strength on transaction value: if; -seller is under time pressure, if
there are not many potential buyers etc.

Important documents
1. Teaser (blind profile): Document sent to potential buyers to give brief information. The
name of the company is not mentioned. Contains: executive summary, products, customers,
production, distribution, valuable assets, financial data
2. Confidentiality Agreement / NDA: Agreement that all the information provided will remain
confidential
3. Process Letter: Provides the process guidelines to potential buyers (sent with the
information memorandum). Sent after signing NDA
4. Information memorandum: The final decision isn’t made based on it; its main purpose is to
bring a purchaser to the negotiating table by enabling potential purchasers to decide if
company is a suitable acquisition target. The information memorandum is essentially a
selling tool which can be varied to highlight features of particular interest to specific
purchasers. Commercially sensitive information, such as the names of customers or
 suppliers, or gross margins on a product basis can be excluded from copies sent to direct
competitors. Contains: Important notice, executive summary, company overview, industry
overview, products & services, sales & marketing, know how & technical capabilities,
Property & Plant & Equipment, Information Technology, Organization & Key management,
financial overview, recent financial initiatives, Current outstanding debt, Financial
projections
5. Letter for indicative bid/offer (Heads of Agreement, LOI, Term Sheet or Memorandum of
understanding): Letter issued by the potential buyer to the seller describing T&C. If offer is
attractive to the seller, potential buyer will be invited to due diligence. Content: Purchase
price range, premises, financing, strategic rationale, management, schedule
6. Management presentation: Key to maintaining and enhancing the interest shown by a
purchaser following a review of the information memorandum. The key selling points
contained in the information memorandum should be repeated and reinforced. It should be
made as bespoke as possible for each purchaser especially in the context of trade buyers
(highlight attractions of the business to each purchaser such as cost savings, product fit and
customer synergies). Contains: more detailed (and commercially sensitive) information
regarding matters such as new product developments, product specific profit margins and
growth prospects as well as an update on the company’s year to date financial performance.
*From a purchaser’s perspective, the most important element is the opportunity to assess
the capabilities of the management team.
7. Data room: Ensures that final offers are made based on full disclosure of all relevant
information. Contains: all key financial, commercial, and legal information on the company
including detailed management accounts, copies of all contracts, particulars of all employees
and properties and where appropriate, a vendor due diligence report. Seller companies
should be very careful about competitors entering the data room!
- On-line data room: via a third-party provider with password protected internet access.
Advantage is that it is accessible simultaneously by multiple users, it also provides
valuable feedback in terms of the information on which respective purchasers have
focused, the number of representatives who have viewed the data room and the
amount of time they have spent reviewing the contents.
8. Due diligence check list
9. SPA Shares Purchase Agreement
 Strategic Alliances

There are many areas to create value: new line, new market, new know how, structural change,
competitive positioning. Once the company has a goal for adding value it can: do it internally, buy
from the market, Strategic Alliances, M&A. To choose the best option, the company must do a
benefit/cost analysis.
Range of relationships:
• Transactional alliances: Arm length, <5 years
Collaboration marketing, shared distribution, licensing, franchising
• Strategic Alliances: >5 years, parent remains independent
Joint R&D, long term sourcing agreement, long term shared distribution, joint
manufacturing, joint market development
* Conditions for SA: independence, shared benefits & control, ongoing contributions
• M&A: No independence
When the strategic motivation for the partner is low (but high for you), the only option is to acquire
them because they won’t be willing to go into a partnership.

A SA can be with competitors, suppliers, customers, complementors. Partner goals don’t have to be
the same but must be compatible in the long and near term.
Motivations for SA: Risk sharing, access to new markets, globalization (China), cost reduction,
prelude to acquisitions or exit.
Cross border SA: Sensible alternative to M&A (leads to acquire more than wanted). The rise of
alliances correlates to increase in tech innovation & meltdown of globalization barriers.
Alternative legal forms of BA: Franchising, equity partnerships, written contracts.
Approach to Alliance Formation:
1. Partner solicitation 5. Structure & governance
2. Due diligence 6. Capital Access
3. Valuations 7. Negotiations
4. Partner trade offs 8. Documentation
*Structuring issues: scope, control & management, contribution of resources, governance, profit
allocation, termination, ongoing capital requirements
Critical success factors: synergies, risk reduction, cooperation, purpose clarity, win-win situation,
compatible time frames, support, similar financial expectations.
Reasons of failure: No clear focus, wrong partners, wrong alliance structure, bad management plan.
Valuing Business Alliances:
1. Agree on measure of value (EBITDA to compare businesses with different leverage and
depreciation methods)
2. Determine contribution oof each party to that measure
3. Estimate total value of alliance by applying industry multiple
4. Determine ownership% based on each partner’s contribution
Examples:
• Fiat Chrysler • Complementary Assets: Intimissimi –
• Hermes – Shang Xia Victoria’s Secret
• Marketing: Evian vs San Pellegrino • Value Chain: Lavazza-Saeco
• Competitors: Model Co • Collaborative advantage: McDonalds
– Kenco
 Strategic vs Financial Investors

Strategic: Companies wanting to integrate to increase long term shareholder value

Financial: PE, VC, Hedge Funds, UHNWs. Want to invest to realize a return
You must approach them differently:
Business Evaluation:
SB: Fit with existing company: synergies & integration
FB Stand alone. Often buy partially with debt to scrutinize cashflow generation. Focus on
cash generation and earnings growth.
Determining Investment Merits of the industry
SB: Less risk of process failing due to industry attractiveness
FB: Need time to understand macro view of the industry
Strength of Back Infrastructure (IT, HR, legal, etc.)
SB: Focus less because they will be eliminated
FB: Revise it in due diligence because they will need it. Often even strengthen it post
acquisition
Investment Horizon
SB: Indefinite
FB: 4-7 years. Sensitive to business cycle risk. Think of exit strategies before buying
Transaction efficiency
SB: No dedicated M&A team. Slow BoD & managers
FB: Core competence
*SB can take longer but, in any case, the process lasts 6-12 months

Venture Capital & Private Equity

PE is an asset class, an alternative investment strategy with illiquid investments (5 10 years). Its key
feature is the private nature of the assets.
Structure: Limited Partnership
• Limited Partners: Investors
• General Partners: Daily management.
Management fee 2% annually (0.5% quarterly) + incentive fee of 20% of the carry
*LP can’t manage, but GP also commits investment capital
Spectrum:
VC funds. Seed Financing
Start up financing (Early-stage ventures)
Expansion financing (Late-stage ventures)
Buyout Funds Replacement Capital Secondary Purchase (replacement capital)
Management Buyout
Buyouts Management Buy In
LBO
 LBO

LBO Pre-merger:
Bridge loan: Provided only for 18 months with the obligation to make the acquisition/merger, should
be paid after 18 months if the merger is not completed.
NewCo gives cash to sellers (owners of the target) to acquire the shares of the target. If seller is the
minority shareholder (NewCo does not acquire 100% of the target), the seller can cash in some part
of the money to the company.

LBO Post-merger:
Bank transforms bridge loan into term loan (long term facility loan) which is protected by the list of
collateral. In LBO debt is reimbursed with the cash flows produced by the target or allenating the
non-strategic assets owned by the target. Banks lend maximum 4,5x EBITDA, especially after the
economic crisis don’t lend higher than 5x EBITDA.
*If target has excess cash, it will be used to pay the debts (banks, suppliers, employees can have
right over the future cash flows of the companies before the shareholders, ranking of rights over
cash flows of the company)

Financing Term Sheet: Signed between NewCo and the bank that lends bridge loans. It has the
details and the division of how and what % of money can be used for different purposes, timeline,
how the bridge loan will be made available to the company, interest period and rates, how the loan
will be paid back, garanties over the loan (account receivables, stocks of the company, real estate
belonging to the company etc.), conditions to interrupt the agreement, commitments of
shareholders, covenants (constraints over debt cover ratio, net financial position over the years
etc.). If the company cannot reach the ratios or net financial position bank has right to put the
company on fold or use the garanties.

LBO Operating Assets Financing: NewCo has operating assets (shares of the target) which are
capitalized by equity, junior debt, and mostly senior
debt. Each type of debt has different priority on the
future cash flows according to the risk.

*Subordinated High Yield Debt (“Junk bonds”): behave

like equity (often have equity participation but have tax
advantage over equity and allow increased financial
leverage. Big market in USA (institutional investors) and
increasing in Europe. Often used in connection with M&A and LBOs
Motivations: Optimization of financial leverage, Regulatory-driven capital requirements, Rated asset
securitizations (senior-sub structure in asset backed securities), Insider or supplier-credit
subordination (e.g., in project finance), Workouts and restructurings (existing borrowers agree to
seniority of new loans, to buy time)
Big Problem: HIGH INTEREST RATE!
Solutions: Deep discount subordinated debt, Subordinated debt with equity warrants (debt + equity
warrants), Convertible subordinated debt (convertibles), Participating subordinated debt, Puttable
subordinated debt (put options)
 Target Valuation

Multiples: Comparable trading market multiples & comparable transaction multiples

Assumptions: stocks are correct for comparables but wrong for target, similar risk, similar capital
structure, similar accounting information.
Procedure:
1. Select a set of comparable firms
2. Pick a measure
3. Calculate the value for each company as a multiple of measure
4. Apply multiple to target
Most used: Revenue multiple = Market value of equity / revenue
EBITDA multiple = Market value of equity / EBITDA
Problems: Difficult to apply in VC where high growth firms have no earnings
Revenue multiples might need to be based on future revenues
In VC, accounting data may not be available on comparable private firms

DCF valuation Forces to understand the drivers of value, client must make the firm worth.
First do multiples to obtain a range of values, then the DCF should fit.
Three components: cashflow, long-term, risk
Operating FCF: Cashflow after all investments, it is available to pay debt holders (interests) and
equity holders (dividends). If its negative, the company must raise external funds.
Interest expenses are excluded because they are considered in the cost of capital.
Taxes are adj not to double the interest effect on the tax shield (it is in the WACC)
To forecast we use value drivers:
Sales Sales:
-Cash operating expenses Sales1 = Sales0(1+G)
-Noncash changes
EBIT:
EBIT1 = Sales1*P
EBIT P = (Sales-Operating costs)/ Sales
-Adjusted taxes
Adjusted taxes:
NOPLAT1 = EBIT1 (1-T)
NOPLAT
+Noncash changes (dep) Dep Expenses:
GrossCF1 = NOPLAT1 + D (Sales1 – Sales 0)

Operating CF Fixed Capex:

-Fixed capital investments
F = Net Capex / Incremental Sales
-Required Working capital investments
Required WCI:
W = Incremental WCI / Incremental Sales
FCF

Calculate Present Value of all FCF projected and discount them at the WACC
Continuing value: VN = FCFN + 1 / (WACC – g)
PV of FCF + PV of Continuous Value = Value of the Firm (V)
-Value of debt
=Shareholder Value (E)
/ Number of shares
= Value per share (P)
The VC method:
1. Estimate Terminal Value: At planned exit date, typically 4-7 years after investment. Estimate
by using a multiple applied to the projected net income of the company in the projected exit
year. P/E ratios for comparable public companies will be used as a benchmark, recognizing
that P/E ratios for public companies are higher due to their greater liquidity relative to a
private company. The choice of multiple for the valuation will be discussed during the
venture capital negotiations.
- For example, the projected net income is $20 million in the planned exit year. This yields
a projected exit value of $300 million in year 7.
2. Discounting the Terminal Value to Present Value: Use the target rate of return to calculate
the present value of the projected terminal value (instead of WACC). The target rate of
return is typically very high (30-70%) in relation to conventional financing alternatives.
(Target rate of return is in line with the riskiness of the business)
- For example, the projected terminal value in year 7 of $300 million is discounted to a
present value of $17.5 million using a target rate of return of 50%.
- PV = FV/(1+r)^n = $300m/(1+0.50)^7 = $17.5 million
3. Calculate the Required Ownership Percentage to meet the target rate of return: Amount to
be invested by the venture capitalist divided by the present value of the terminal value of
the company.
- In this example, it is assumed that $5 million is being invested.
$5M / $17.5 M = required ownership 28.5%
- Company currently has 500,000 shares outstanding.
After investment: the venture capitalist 28.5% & current owners 71.5% of shares.
500,000/0.715 = 700,000 shares outstanding after the investment
The venture capitalist will own 200,000 of the 700,000 shares.
- Meaning that, venture capitalist invests $5 M to acquire 200,000 shares
$5M/200,000 = $25 per share.
- Pre-money valuation: 500,000 shares x $25 per share = $12.5 million
Post-money valuation: 700,000 shares x $25 per share = $17.5 million.
4. Required Current Ownership % Given Expected Dilution: Venture companies experience
multiple rounds of financing and shares are also often issued to key managers as a means of
building an effective, motivated management team. The venture capitalist factors future
share issues into the investment analysis, by increasing the ownership percentage going into
the deal to compensate for the expected dilution of equity in the future.
Required Current Ownership = Required Final Ownership / Retention Ratio
- For example, if shares amounting to 10% of equity are expected to be sold to managers
and 30% of shares of the common stock will be sold to the public in an IPO.
- Retention Ratio is [1/(1+0.1)/(1+0.3)] = 70%
Required Current Ownership = 28.5%/70% = 40.7%
To preserve 28.5% final ownership at exit, must get a 40.7% ownership going into the
deal, given the expected future dilution.
- 500,000/(1-40.7%) – 500,000 = 343,373 new shares to be issued at the outset.
$5M/343,373 = $14.56 price per share.
 Turnaround & distressed investment

Distressed investment: Purchase securities in firms that are unlikely to meet debt obligations. They
may have filed for bankruptcy already. Since equity is worth 0, investors must understand the real
value.
This type of investment is attractive because the securities are traded below nominal value, can
receive higher settlement in liquidation or make profits with corporate restructuring.
The best time to invest is when valuation is the lowest, but there will be more competition.
Key elements: understand reasons behind poor performance, pay attention to market trends,
valuation of debt and equity, know the local insolvency law, identify elements to restructure the
Balance Sheet.
Opportunities to look for: industries in transition with cyclical downturn, overleveraged capital
structures, target transactions.
Five keys for a successful transaction:
1. Understanding the company’s situation: Asses how long it can survive
- Broken Balance Sheet (generates cash f but its overleveraged): there’s more time
- Cash burn: Immediate action required. Critical care to stabilize the operations,
conserve cash, communicate to maintain the business and allow time to consummate
the sale.
2. Setting expectations by communications with all constituents: All the necessary stakeholders
should be in line to maintain EV while the process finishes
3. Running the right sale process: Focus, speed and tenacity are required
4. Finding the right buyer: When comparing offers the most important thing is having the
confidence that the buyer will close the agreement quickly and under the LOI parameters.
Usually, the most successful buyers are the quick buyers, but must beware of financial
buyers with a too good LOI.
5. Clearing obstacles to closing: Make sure that deal breaking issues are resolved and egos set
aside. All parties must stay focused and committed to close the deal.

Corporate Debt Restructuring

1. Crisis ID: short term liquidity? Sustainable debt? Positive Shareholders Equity?
Signals for identifying the crisis:
- Business/operations: wrong acquisitions, customer/supplier troubles, bad
management
- Financial structure: Non bearable (debt level, debt reimbursement scheduling)
- Industry: Business cyclicity, regulation changes
- Global economy: Poor liquidity in the market, demand shortage
- Nonbusiness/operations: lawsuits, frauds, accounting irregularities.
The sooner the crisis is detected, the better tools available:
- Early: debt standstill, equity cure, covenant reset, debt repurchase, equity increase,
asset disposal
- Late: less convenient asset disposal, quasi equity rights
- Super late: less convenient asset disposal, debt-equity swap
*When the crisis is recognized early it can be managed out of court, but when this isn’t
feasible in court reorganization takes place.
2. Restructuring Plan: Bank standstill, new business plan, independent business review,
financial proposal arrangement
Standstill Request to banks:
1) Liquidity analysis: If OCF > Debt Service à Not necessary standstill request
If OCF < Debt services à Standstill request needed
2) Agreement terms:
- Pactum de non petendo: Interest or principal payment suspension 3-6 months
- Credit line confirmation: short term credit line for the needed period to finalize
restructuring process
- Other provisions:
Covenant holiday: Decrease the requirements of covenants
Possible suspension of other commitments (cash weeps, …)
Financial Proposal Arrangement
1) Debt sustainability analysis
First determine if EV>Debt (equity cushion), or EV<Debt (equity injection needed).
Then, judge debt sustainability based on some ratios:
- Debt service coverage = Operating cashflow / debt service amount
Should be at least 1x so we can proof cashflows cover debt
- Interest coverage = EBITDA / net interests
4x – 5x If we cannot even cover the interests, the company is in a very bad situation
- Debt cover = Net debt / EBITDA
2.5x – 3x
2) Financial Proposal Arrangement
If sustainable debt < actual debt à Actual debt can’t be paid (this generally happens
when EV < debt). The company asks bank to write off the debt but must offer
something in exchange:
- Equity rights: ordinary shares, special shares
Problems: regulation issues, governance, exit method
- Quasi-equity rights: convertible bonds, warrants, options
Problems: governance, exit

3. Plan negotiation: Consensus creation, creditors seniority, shareholders, different debt layers
management
Consensus creation process: Managing the various debt layers
1) Seniority identification
2) Possible approaches to manage different financial holders
- Pari passu
- Waterfall

4. Plan implementation: Sign agreement with bank, amendments to related specific financing
agreements, board approval.