Mergers & Acquisitions

The desk at a glance

Mergers and acquisitions is the business of moving ownership of a company from one set of hands to another. Everything else on this desk — the auctions, the offers, the defences, the separations — is a variation on that one sentence, and the variations exist because the seller, the buyer and the law each impose different conditions on how it may be done.

Two things make this desk unlike every market on the other half of this site. There is no continuous price: a company is sold once, to one buyer, at a number two boards negotiated, and the next sale may be years away and at a completely different multiple. And there is no anonymity: both sides know exactly who they are dealing with, which is why so much of the work is about information — who knows what, when they are allowed to know it, and what happens the moment it leaks.

The consequence a newcomer feels first is that time is the risk. Between the day a deal is agreed and the day it completes, months pass in which a regulator, a court, a shareholder vote or the buyer's own financing can end it. The gap between the offer price and where the target's shares actually trade is the market's daily estimate of exactly that, and it is readable by anybody.

Who does what

• The seller's adviser runs the process: who is approached, in what order, on what timetable, and how the competitive tension is kept alive. Most of the price is made here rather than in the model — see the sell-side auction.
• The buyer's adviser does the opposite job: finding the deal before it is a process, and, once inside one, arguing that this buyer is worth choosing on something other than price.
• Lawyers on both sides write the conditions. Which approvals are needed, who bears the risk that one is refused, and what either side may walk away from are all contract terms, and they are worth more than a percentage point of price.
• The financing banks decide the ceiling for any buyer paying with borrowed money — see leveraged finance, where a bid is a financing package with a price attached.
• The regulators — competition authorities, foreign-investment screens, sector supervisors — hold the only veto nobody in the room can negotiate away.
• The arbitrage funds arrive after the announcement, buy the shares from holders who want certainty, and become the register that votes.

What decides whether this desk is busy

Six mechanisms, each with the direction it pushes in and the thing to watch. None of them is a forecast, and none is a number that goes out of date.

The calendar this business keeps

Every desk has a rhythm its regulars plan around and a newcomer discovers by being surprised by it.

How this desk reaches the rest of the site

The deals and the instruments are one subject. These are the corridors — each one a mechanism, not a resemblance.

What the client is actually paying for

Advisory fees on this desk are structured rather than quoted, and the structure is more informative than any number. A typical arrangement has three parts, and each exists to solve a specific conflict:

• A retainer, paid whether or not anything happens. Small, and its job is to make the adviser's time real rather than free — an adviser paid nothing until completion has an interest in completion rather than in the right answer.
• An announcement fee, paid when the deal is signed. It recognises that most of the work is finished at signing, and it protects the adviser against a deal that dies at a regulator months later through nobody's fault.
• A completion fee, much the largest, paid only if the transaction closes. Usually a percentage of the value of the deal, sometimes with a step-up above a threshold price so that the adviser is paid more for getting more.

The step-up is the interesting part, and it is a conflict rather than a solution. A percentage of value pays an adviser more for a bigger deal, which is not the same as a better one — and the seller's adviser is paid nothing at all if the board decides the standalone plan is better. Nothing here is a comment on any firm's conduct; the point is structural, it is disclosed in takeover documents, and it is one of the first things to look for in one.

A fairness opinion is often paid for separately and flat, for exactly this reason: an opinion on whether a price is fair should not be delivered by somebody whose fee depends on the answer.

Which blocker decides across this desk

• Price4 of 15The two sides cannot agree what it is worth.Decides: Hostile takeover, Minority stake, Sell-side auction, Tender offer. Matters on 8 more.
• Financing1 of 15The money is not there, or its cost moved under the deal.Decides: Take-private. Matters on 7 more.
• Approval8 of 15A regulator, a court, a board or a shareholder vote says no.Decides: Activist campaign, Joint venture, Merger of equals, Recommended offer, Scheme of arrangement, Spin-off, Squeeze-out, Take-private. Matters on 3 more.
• Diligence3 of 15What was found when the buyer actually looked.Decides: Carve-out, Private share purchase, Sell-side auction. Matters on 4 more.
• Execution9 of 15Documents, disclosure, timetable, and the people running it.Decides: Activist campaign, Asset purchase, Carve-out, Hostile takeover, Joint venture, Merger of equals, Scheme of arrangement, Spin-off, Tender offer. Matters on 6 more.

The documents, in the order they appear

• The non-disclosure agreement — before anything else. It usually also contains a standstill: the recipient may not buy shares or launch a bid outside the process it has just been let into.
• The teaser and the information memorandum — one page without the company's name, then a hundred pages with it. See the playbook on reading one.
• The process letter — the seller's rules: what a bid must contain, by when, and what happens to bids that do not comply.
• The non-binding indication, then the binding offer — the second comes with a mark-up of the seller's draft contract, which is where the real negotiation is.
• The sale and purchase agreement — price, conditions, warranties, indemnities and the long stop date. The playbook takes it apart clause by clause.
• The announcement — for a public company, a regulated document with rules about what it must say and when it may be said.
• The scheme document or offer document — sent to shareholders, containing the recommendation, the valuation analyses relied on and the irrevocable undertakings already given.
• The completion accounts — weeks after closing, adjusting the price for the cash, debt and working capital actually there on the day.

Run the numbers

Interactive: the exchange ratio, and who ends up owning whatMedium

Fix a premium on the target's share price and the ratio follows. So does the split of the combined company, which is the number both boards are really arguing about.

Target share price Acquirer share price Premium offered % Target shares (m) Acquirer shares (m)

Offer value per target share

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Exchange ratio

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New shares issued

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Target holders own

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Acquirer holders keep

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Equity consideration

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Reading

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A fixed ratio, struck at today's prices. Every day until completion the implied premium moves with the acquirer's shares, and nothing in the agreement moves with it. Information and education only. Not advice, not a valuation, and not a quote for anything.

Interactive: what the synergies have to be worthMedium

The premium is paid once, at closing. The synergies arrive over years, are taxed, and cost something to achieve. This is the test the buyer's own board paper has to pass.

Target market value ($m) Premium % Annual pre-tax synergies ($m) Tax rate % Discount rate % One-off cost to achieve ($m)

Premium paid

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Present value of the synergies

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Pre-tax synergies needed to break even

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Coverage of premium plus cost

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Net to the buyer's holders

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Reading

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A perpetuity on a flat synergy number, which is generous: it assumes they arrive in full, on time, and never decay. Information and education only. Not advice, not a valuation, and not a quote for anything.

Interactive: what an earn-out actually paysMedium

A deferred payment against a target. The shape decides everything — a cliff pays nothing one percent short, a linear one pays almost all of it.

Target EBITDA ($m) Achieved EBITDA ($m) Maximum earn-out ($m) ShapeCliff — all or nothingLinear above a floor Floor, % of target Discount rate % Years to payment

Target achieved

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Earn-out earned

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Present value at completion

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Not earned

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Sensitivity

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Reading

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Straight arithmetic on one measurement date. It says nothing about the definition of EBITDA in the agreement, which is where the actual dispute lives. Information and education only. Not advice, not a valuation, and not a quote for anything.

Interactive: the break fee, both waysEasy

What a broken deal costs each side, and whether the fee is a deterrent or a rounding error against the work already done.

Target equity value ($m) Break fee % Reverse break fee % Months from signing to long stop Buyer's own deal costs ($m)

Payable by the target

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Payable by the buyer

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Buyer's net recovery

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Deal cost per month

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Asymmetry

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Reading

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Fee levels are a matter of contract and, in several jurisdictions, of a takeover code. Nothing here states what any code permits. Information and education only. Not advice, not a valuation, and not a quote for anything.

How a deal dies here

Rarely in the dramatic way. The ordinary endings, in roughly descending order of frequency:

• The price gap never closes. The seller's number came from what it paid or what it needs; the buyer's came from what it can fund at a return. Neither is wrong and no analysis reconciles them.
• Diligence finds something. Not fraud — a customer contract that ends, a pension deficit measured properly, environmental liability, a tax position that will not survive review.
• The financing moves. A bid built on debt priced in one quarter is not fundable in the next, and the bidder withdraws rather than fund it with equity.
• The regulator takes too long, or asks for too much. Remedies that remove the reason for the deal are a refusal by another name.
• Shareholders say no — the target's, because the price is too low, or increasingly the buyer's, because the price is too high.
• Something leaks. A confidential process that becomes public before it is ready either accelerates into a bad outcome or stops entirely.

Those five reasons are the subject of what kills a deal, which reads the same table the other way round — by blocker rather than by transaction.

Concepts to master

• Enterprise value is not equity value, and neither is the offer price. Debt, cash, pensions, leases and minorities sit between them, and most valuation errors are a comparison of one with another — see discounted cash flow.
• Consideration is a signal. Cash says the buyer is certain; paper says the buyer would like the seller to share the risk, and thinks its own shares are worth using. See the exchange ratio.
• Conditionality is priced. Every approval a deal needs is a probability and a delay, and both are visible in the spread between the offer and the market price.
• Control has a value of its own, separate from the business: the ability to change the strategy, the capital structure and the management. It is why a minority stake trades below its arithmetic share.
• Synergies are a forecast made by the party that needs them to be true — and the buyer's shareholders pay for them at announcement, whether or not they arrive. See synergies.