A
Survey of M&A In
Course Syllabus
Shen Jie
May 2002
This course is an introductory to the landscape of Mergers and Acquisitions
in
The
class meeting time is every Wednesday (
To
earn credit for this class, a student must work in teams to: (i) write a short
paper on a topic related to this class; or (ii) draft a piece of legislation
with “Chinese-character” that addresses one of the issues raise in the course
and write a release report. Each team may constitute 1-4 students, and at no
time should a team have more than 4 members. The final work product of each
team, due
Office hours TBA during the first class.
Course Plan and Reading List
I. Introduction and Overview – History and Theory (5/29 – 5/30)
A. Class introduction and miscellaneous arrangements
B. What is M&A ?
1. Capital Manipulation
a. Chinese Version
b. US Version -- Corporate Raiders: Sohu.com
2. Public Company Acquisition
3. Acquisition of Assets/Subsidiaries and Divestitures/Spin-Offs
4. LBOs and Going-Private Transactions
5. “Hostile” vs. “Friendly”
C.
M&A history and
deal theories in
1. Growth of the Firm -- Merging for Monopoly
2. Antitrust Laws
3. Separation of Ownership and Control
4. Proxy Rules
5. Conglomerate Mergers
6. Tenders Offers and the Williams Act
7. Going Private
8. Two-Tier Junk-Bond Boot-Strap Bust-Up Takeovers
9. State Takeover Statutes and Rights Plans
10. Recaps, White Knights and LBOs
11. Boesky, Milken and Drexel
12. End of the 1980s:, RJR, UAL and Time-Warner
13. Rebirth of the Strategic Acquisition
14. Stock-for-Stock Mergers
15. Mega-Mergers and Tightening of the Regulatory Noose
16. The European Explosion
17. 90’s Takeover/Acquisitions Environment
a. Institutional Shareholders
b. Role in Takeovers
c. Monitoring, Influence and Control
d. Shareholder Proposals
e. Proxy Reform
f. Binding Bylaw Amendment Proposals
g. Regulation M-A
18. Current Market Environment
D. Why M&A? – Acquiror’s Perspective
1. Strategy
2. Justin Yifu Lin’s Viability Theory
a. There is no “Normal Management” – only better or worse
3. Synergies and Cost Savings
a. pricing vs. anti-trust
b. Economy of Scale -- Market share
i. Citicorp vs. JP Morgan Chase
ii. Microsoft vs. AOL Time Warner
iii. Microsoft support of Comcast in AT&T bid
c. Cross Selling
i. Citibank and Travelers
d. Job Cutting
e. Sales Channel and Product Pipeline
f. Product integration – offer integrated solution to customers
g. Low cost of capital – GE, Tyco. Low interest rate buy growth.
4. Tax
a. Deal structures to a large extent dictated by tax considerations
5. Accounting
a. Pooling vs. Purchase
b. Accounting of the Goodwill and Intangibles
i. Amortization – 40 years, effect on earnings
ii. Now accounted as asset, impairment – AOL Time Warner 55 Billion write-off
iii. Pre-Enron – subject to abuse; Efficient Market should not care.
6. Diversification
7. Displacement of Inefficient Management
8. Corporate Raiders
9. Private Equity Transaction
E. M&A and Competitive Advantage of Chinese Enterprises
1. Component of Profitability
a. Cost of Capital,
b. Material, Labor
c. Medium Level Labor
d. Technology (including High Level Labor)
2. All related to Management
3. Free market that evaluates management
4. Competitive market allow the survival of the fittest
F.
Open Questions on
the Theory of the Corporation in both
1. Are
Takeovers Good, Bad or Indifferent? Does
2. How Efficient Are the Financial Markets? Chinese Gambling Market Theory? -- Fair and Competitive Market.
3. Are
Current Laws Efficient? What part of
4. How
Important Are Current Laws? -- Some outdated may still be borrowed by
5. Should
Corporate Law Be Federalized? Parochialism in
6. Who Counts? Who Should Count? How Do They Count?
a. Shareholders
b. Management
c. Employees – Job Loss and Social Security
d. Consumers and Lenders
e. Collectives -- The “Community,” The “Public,” and The “State” (Government)
f. “We the people” -- San1 Ge4 Dai4 Biao3 – two of them.
Reading Assignment:
1. Sohu.com 1Q financial statement
2. Li Yongjun, The theories of Lin Yifu: Viability and Comparative Advantage Development Strategy (http://jlin.ccer.edu.cn/lyf2.asp) (For more detailed discussion, if interested, please see Lin Yifu: Development Strategy, Viability and Economic Convergence (http://jlin.ccer.edu.cn/article/article.asp?id=72))
II. Corporate Acquisition: Motives, Mechanics, Financing and Accounting of M&A and Private Equity Transaction (5/30, 5/31)
A. Who are the key players?
1. Public Companies
2. Financial Buyers
3. Board of Directors
4. Management
5. Wall Street
6. Employees and Unions
7. Government
8. Shareholders: Institution, Insiders, Arbitrageurs and “Mom & Pop”
B. M&A legal overview – sources of law
1. Securities Exchange Act of 1934
a. Section 12 – “Public Company”
b. Williams Act
c. Proxy Rules
2. State Corporate Law
3. Securities Act of 1933
4. Stock Exchange and NASD Rules
5. Other
a. Accounting Standards
b. Tax Law
c. Antitrust Law
d. Regulated Industries -- Banking, FCC, Insurance
e. Foreign Law and Regulations
B. Basic M&A Mechanics -- Legal Alternatives and choosing a transaction structure
1. Forms of Acquisition
a.
Straight forward
–
i. Stock deal vs. Cash deal – what target shareholder end up with
ii. Shareholder vote – target yes; charter says; Stock exchange rules.
b. Forward Triangular Merger
i. Merger Sub survives
ii. Shareholder vote
c. Reverse Triangular Merger
i. T survives
2. Contract Terms
a. Lender – change in control provision; assignment provision.
b. License, lease, supply contracts – assignment provisions.
3. Tax issues:
a. Stock vs. cash – tax free treatment vs. step up in asset basis
4. Shareholder approval –
a.
b. Charter – look at Sohu’s charter
c. Stock as consideration – stock exchange rules
5. Freeze-outs
a.
b.
Appraisal Rights
–
i. Limitations – no appraisal rights if consideration is publicly traded stock and the merger is not short form
ii. Practical difficulty – litigation cost and court ill-equipped to do valuations – case law: focus on value of consideration at the time of Merger
C. LBO Transactions and Merchant Banking
1. Sohu is an extreme example, more likely cash flow steady company, not growth oriented – able to service the debt
a. Leverage -- 9:1 early days and now 3:1 more usual
i. Debt:Euiqty – 1:1 – ROA: 10%, Interest 7%, Tax Rate: 30% -- Earning: 91; ROE: 9.1%; Total Value (10% return required): 1000 + 910 = 1910
ii. Debt:Equity – 3:1 – ROA: 5%, Interest 7%, Tax Rate: 30% -- Earning: 59.5 ROE: 11.9%; Total Value (10% return required): 1500 + 595 = 2095
b. Operational Enhancement:
i. Key – retain management
ii. More often – management suffer bastard child syndrome
iii. Align personal interest – proper incentives
2. Merchant Banking Funds:
a. Buyer – Financial Buyer; leveraged basis; constantly looking for exit
i. Many major investment banks – cross selling;
ii. fees fees fees – finders fees; financing commitment fees; underwriting fees etc.
iii. Portfolio Theory
iv. Group of funds – never commingle (downside limited; upside unlimited) – “Carry”
b. Key to success of LBO transaction and Merchant Banking
i. Cash flow – debt service; hidden cost – environmental, retirement; Pricing and Pricing adjustment
ii. Hindrance to Exit -- private sale and public offering
iii. Shareholder Rights – relationship between levels of financing
c. Financing
i. Capital Structure: equity – the less the better; Mezzanine – insurance company, high yield, sub to senior debt, preferred, converts, seller financing, sub debt; Bank – senior debt.
ii. Senior Debt – secures everything; dual simultaneous closing; using target’s asset to borrow
iii. Negotiation of Commitment Letter – Outs (conditions, MAC, Market out/flex; Due Diligence out) provided in the letter; its impact of M&A side
iv. Capital restructuring shortly.
Reading Assignment:
(1) Delaware General Corporate Law Section 251-253, 262, 271
(2) Sohu.com Inc. Certificate of Incorporation
III. Williams Act (5/31, 6/5, 6/6)
A. Background to the Williams Act
B. Section 13
1. “Group”
2. “Equity Security” – no non-voting securities
3. 10-day requirement
4. “Beneficial Ownership”
a. options, warrants, rights – 60days
b. except – material future contingency
c. indirect power
d. “Parking” – first City
5. Contents of Schedule 13D – purpose of acquisition
6. Amendment to 13D – promptly
7.
Schedule 13G – passive
investors
C. Remedies for Violations of Section 13
1.
2. Sterilization – can’t vote them
3. Fact specific
4.
Cause of Action –should
target company have a cause of action?
D. Calls for Reform – Does China need Section 13(d)?
1. 10 day window period
2. Usefulness questionable – Anti-trust regulation; Defensive Tactics
3.
Does
E. Section 14 and Regulation M-A
1. “Prisoners’ Dilemma”
2. Types of Tender Offers
3. What is a “Tender Offer”?
a. 8 factor test
4. Who is a “Bidder”?
5. Tender Offer Rules
6. Tender Offer Disclosure Requirements and Forms
a. Schedule TO
b. Schedule 14D-9 – target cannot comment on TO until file 14D-9; within 10 days of commencement target must file Schedule 14D-9
c. Regulation M-A
7. Timing of a Tender Offer:
a. Pre-commencement Communications
b. Target Response
c. Commencement
d. Filing Obligations upon Commencement
e. Additional or Updated Tender Offer Material
f. Minimum Offer Period and Extensions
g. Prompt Payment Rule
h. Withdrawal Rights
i. Proration
j. All Holders/Best Price Rule
k. Subsequent Offering Period
l. Conditions to Tender Offers
m. Added complexity to Exchange Offer
8. Remedies: Injunctive Relief
F. Cross-Border Transactions
1. What Law Applies?
a.
b. Plessey v. G.E. – steps taken to avoid this effect
c. Imperialistic – try to find ways to get control
d.
Result –
2. How do U.S. Holders Participate?
3. The New SEC Release -- Three tiers
a. Bottom line -- U.S. Holder must get same treatment
b. Less than 10% -- anti-fraud rules
c. More then 10% but less than 40% -- some relief
d.
More than 40% --
all
G. Other factors to consider in Tender Offer
1. Corporate Charter and Shareholder Rights Plans
2. Antitrust Laws
a. Size of Transaction, Size of Person tests
i. Result in acquiring person holding assets or voting securities in excess of $50 million
ii. For transaction resulting in holdings valued at $200 million or less, then reporting required if one party had annual sales or net assets in excess off $100 million and the other had over $10 million.
b. Filing with FTC and Antitrust Division of DOJ
c. HSR Waiting Period – 15 days for cash tender offer, 30 days for the rest; early termination; Second Request maybe issued during waiting period – another 30 days; then DOJ or FTC must file a lawsuit to block transaction.
3. State anti-takeover laws
a.
First Generation
– State power to review tender-offer merits and disclosure
b. Second Generation
i. “control share acquisition statute” – any shares over 20% no voting power unless independent shareholders vote to grant them
ii. “fair price” – second step squeeze out receive same price; MD – 80% approval and supermajority disinterested approval required for merger step unless all shareholder receive best price
iii. “constituency” or “stakeholder” statute – consider employees, communities; long-term and short-term interest
c. Third Generation – “Moratorium” statute
i. Unless approved by the target’s incumbent management, the second step of the two-step merger is delayed or impeded. E.g. Del. §203 – if acquirer becomes greater than 15% holder an d without board approval, then 3 year waiting period, but exempt if acquirer gets 85% of the stock.
Reading Assignment:
(1) Exchange Act of 1934: Section 13(d) and Exchange Act Rules 13d-1 through 13d-7 and 13f-1
(2) Case: Sec v.
(3) Section 14(d)(e)(f) and (g)(3), and Exchange Act Rules 14d-1 through 14d-11, 14e-1 through 14e-8 and 14f-1
(4) Case: Hanson Trust plc
IV. Proxy Rules and Proxy Fights (6/7)
A. Proxy Rules
1. “Proxy” and “Solicitation”
a. Proxy – Rule 14a-1;
b. Solicitation – Broad definition;
c. Not subject to proxy rules:
i. <10 holders rule
ii. intra-shareholder communications -- shareholder without material interest (not a 13D filer)
2. Filing Requirements
3. Schedule 14A
4. Proxy Reforms in the 1990s
B. Shareholder Proposals and Rule 14a-8
1. Rule 14a-8
a. insurgent can force company at its expense to include in its proxy/information statement your proposal and mail it out to shareholders
b. Insurgent own $2,000 or 1% of the stock, whichever is less, and have held at least 1 year
c. One proposal per meeting
d. 120 days prior to anniversary of the previous year’s meeting
2. ground for exclusion:
a. Not a Proper Action for Shareholder under State Law –
i. Precatory Shareholder Proposals go around by Precatory (strong suggest); company ignores
ii. Binding Bylaw Amendment Proposals – shareholder can always have the power to amend bylaws; Del law also provide that Board can amend or rescind bylaws; Case: Union take a proposal to add a new bylaw provision to rescind poison pill and provided that Board cannot amend this. They got the vote and Federal court upheld this; Conflict – Charter says one thing and Bylaw says the other. Charter trumps bylaw. Flemming case rubbles M&A bar. But many SEC no action letters etc. provide opposite view.
b. Personal Grievance
c. Anything related to Ordinary Operations of Business
d. Immaterial Question
e. Proposal relates election
f. Proposal conflicts with Company’s proposal
g. Already substantially implemented: moot issue
h. Materially Misleading or in itself violates the law.
C. Overview and Anatomy of a Proxy Fight
1. Three Problems:
a. Rational Apathy
b. Free Rider Problem
c. Fairness Problem
2. Rule 14a-11 and 14a-12
a. Permits certain solicitations in a proxy fight prior to furnishing stockholders with a proxy statement – OK to solicit shareholders before filing proxy statement if a solicitation in opposition exists -- When opposition exist? No one knows:
i. No proxy card provided (see c below)
ii. Communication lists participants in the solicitation and their interest
iii. A proxy statement is provided ASAP
b. If material in writing, must file with SEC upon use.
D. Large Institutional Investors
1. Pension Funds, Insurance Company and Professional Money Managers
2. What they after?
a. Anti-takeover measures – moral hazard to management
b. Executive Compensation
c. Better Governance – Independent Director Majority; Special Committee consisting of Independent Directors; Remove Staggered Board; SEC audit committee initiative; Enron Debacle
Reading Assignment:
(1) Exchange Act Section14(a); Exchange Act Rule14a-1(l); Rule 14a-2; Rule 14a-3; Rule 14a-8, Rule 14a-10 and Rule 14a-12
V. Anti-trust and Merger Control (6/12 Guest Speaker: Ma Dongjun)
1.
2. Clayton Act
3. Federal Trade Commission Act of 1914
4. Celler-Kefauver Act of 1950
5. Hart-Scott_Rodino Antitrust Improvements Act of 1976
1. DOJ and FTC
2. Merger Guidelines
1. Roles of Economists in Support of M&A Deals
2. Market Definition
3. How to Measure Concentration
4. Traditional and New Techniques for Analyzing Anti-Competition Effects of Mergers
5. Horizontal versus Vertical Mergers, Entry
6. Case Studies:
a. Electric Utilities Merger
b. Food Producers Merger
VI. Fiduciary Duty of Directors (6/13, 6/14)
1. BJR – Business Judgment Rule
a. Primary Rule
b. Board is great – Court defer to board on business judgment and no second guessing
c. Business Judgment must be made on an informed basis, and good faith in the best interest of the Company (not shareholder)
d. Court will not examine reasonableness of the decision
2. Duty of Care
a. With care that a reasonably prudent person in a similar position would use under the similar circumstance.
b. Must act on Informed Basis
c. The Standard is Gross Negligence -- may rely on Investment Bankers -- Smith v. Van Gorkam – reliance cannot be reckless and not act hastily.
d. Lessons:
i. Hire independent Legal Counsel and Independent I-Banker
ii. Hold more than 1 Board meeting; opportunity to think
iii. Give written information prior to Board meeting and a chance to study
iv. Formality of Board Meeting – Banker presentation, Legal and Management presentation to provide Basis for Action.
3. Duty of Loyalty – Self-interested Transaction
a. Directors should not act to advance their own interests or that of the management in detriment to the shareholders’ interest
b. No bright line rule
c. A director is interested in a transaction when:
i. Director appears on both side of the transaction, or
ii. Derive a financial interest not otherwise available to the Company or the stockholders
d. E.g. golden parachute, relationship with Buyer; employment or new position with the acquire; merely to keep one’s own job/entrenchment not enough.
e. Establish a special committee of disinterested directors, often with its own advisors.
4. Entire Fairness Rule
a. In case of a violation of Duty of Care/Loyalty
b. Case: Weinburg vs. UOP Inc.:
i. Fair Dealings
ii. Fair Price
iii.
Special Committee
of independent directors to insulate from subsequent attack.
1. Hopelessly Muddy – Directors’ self-interest unavoidably involved in such transactions.
2. Takeover Defenses:
a. Case: Unocal v.
i. Proportionality test: when taking defensive measures, directors must first prove that they had reasonable grounds for believing that a threat to corporate policy and effectiveness existed and the defensive measures adopted were reasonable in relation to the threat proposed.
b. Case: Unitrin v. American General Corp.
i.
To meet the proportionality
test, the defensive measure must not be “preclusive” or “coercive”
3.
a. Case: Revlon Inc. v. Mac Andres & Forbes Holdings, Inc.
i. Once Management decides to offer the company for sale, or decides that a sale is inevitable, it may no longer use defensive measures, and must instead make every effort to achieve the best price for the shareholders.
b. Case: Paramount Communications, Inc. v. Time Incorporated
i. Board’s right to “just say no”. Directors are not obliged to abandon deliberately conceived corporate plans for a short-term shareholder profit, unless there is clearly no basis to sustain the corporate strategy.
ii. Sale of Control depends on whether company has long term plan
c.
Case:
i.
ii. Sale of Control occurs when shareholders have lost the opportunity to have a continuing equity investment in the entity, when a majority is cashed out.
d. How about a stock for stock merger?
i.
ii.
If the target is merged into a
friendly acquirer tat is already held by public at large with no single controlling
shareholder or group, there will be no duty of enhanced scrutiny. True even
if target’s holders have gone from being majority holders to being minority
holders of the merged entity.
4. Summary: So what is the director’s duty when a serious offer to acquire the Company is received (or when choosing between competing offers after a decision to sell the Company has reached?
a. The directors, in consultation with its advisors, may consider, among other things:
i. Adequacy of price offered
ii. Quality of consideration being offered (if not all cash)
iii. Terms, nature and timing of offer
(a) Coercive (perclusive for higher offer, disparate treatment between tender or non-tender)
(b) Right time to sell company (is this the time when market undervalue the company by mistake?)
(c) Consistent with Company’s long term plan
iv. Proposed or actual financing for the offer and its consequence
v. Risk of nonconsummation
vi. Question of illegality
vii. Offeror’s identity, background and prior business experiences, including past actions in takeover contests
viii. Basic stockholder interests at stake
ix. Impact of offer and potential acquisition on other constituencies provided it bears a reasonable relationship to general stockholder interests
x. Available alternative
b. If directors believe in good faith after due consideration that an offer is not in the best interests of the Company and its stockholders, the Board has a duty or at least a right to oppose such offer
c. Directors are not obligated, if they conclude that it is not in the best interests of stockholders:
i. To negotiate in response to an invitation to enter into negotiations with respect to the sale of the Company,
ii. To negotiate in response to an offer to acquire the Company (duty is only to respond to offer as presented)
iii. To agree to sell Company, even if offer is at premium to market, or
iv. To put Company up for auction, even if it decides to sell Company (subject to loss of Control Premium test)
d. When loss of control premium (cease to be a going concern or otherwise), must have a duty to act in a manner reasonably designed to obtain the best price for stockholders (Revlon duty)
Reading Assignment:
(1) Case: Smith v. Van Gorkam
(2) Case: Weinburg vs. UOP Inc.
(3) Case:
Unocal v.
(4) Case: Unitrin v. American General Corp.
(5) Case: Revlon Inc. v. Mac Andres & Forbes Holdings, Inc.
(6) Case: Paramount Communications, Inc. v. Time Incorporate
(7) Case:
(8) Case:
VII. Structural
Defense and Related Matters (6/14)
1. Dual Class Capitalization – must be in Charter
2. Time Phased Vote – must be in Charter (long term holding greater rights)
3. Classified/Staggered Board
4. Limit right of stockholders to call special meeting or act by written consent
5. Limit right of stockholders to remove directors or to increase size of Board and to fill vacancies on Board
a. Removal for cause
6. Picket Fences: supermajority approval required to amend a Shark Repellant Charter
7. Bylaw Amendment:
a. Can be put in place by Board as long as Charter says so
b. State law says the shareholders have this power too
c. Shark repellents require supermajority votes to amend bylaws
8. Advanced Notice Provision – advanced notice requirement on shareholder proposal. Proxy rule require 120 days. Bylaws require 90-120 days advanced notice. Thus renders shareholder proposal impossible.
9. Fair price provision
10. Supermajority Approval for Merger
11. Golden Parachute: huge pay if change of control – promote takeover by make management indifferent to take over; yet it is a cost to acquire – thus shark repellent. (Director GP highly criticized; Management GP ok.)
12. Sufficient amount of common stock and blank check preferred stock.
13.
KEY: in
1.