Deal Structuring Process (part-I)

Presented by Prof. (Dr.) Manish Popli

 The Deal Structuring Process

• The deal structuring process is fundamentally about satisfying as many of the

primary objective (or needs) of the parties involved.

• What are the common examples of Buyer objectives?

– paying a “reasonable” purchase price,

– Form/Mode of Payment

– Risk Management (Pre-closing and Post-closing)

• What are the common examples of Seller’s objectives?

– To obtain a tax-free transaction

– Private or family owned firms may be more concerned about the reputation and or
closure of the brand

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 The Deal Structuring Process

• Decisions made in one area inevitably affects the other areas of the deal structure.
There is indeed a strong coupling.

• The process may be complex in some cases because of involvement of multiple

parties, approvals, form of payments, sources of financing.

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 Overview of the Deal Structuring Process

POST CLOSING FORM/MODE OF

ORGANIZATION PAYMENT

FORM OF
MANAGING RISKS
ACQUISITION

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Post Closing Organization

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 Post Closing Organization

Type Motive
Corporate or division The acquirer is most likely to be able to gain the greatest
structure control using this structure

Holding company structure Acquired company is managed as a wholly owned subsidiary

In which situations would you prefer this?

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Form of Payment

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 Form of Payment

• Cash
• Simplest and commonly used means of payment for acquiring shares or assets.

• Does not affect the shareholding pattern of the________ ??

• Although cash payments generally result in an immediate tax liability for the target
company’s shareholders, there is no ambiguity about the value of the transaction, as
long as no portion of the payment is deferred.

• Stock-swap transactions
• The use of common equity may involve certain tax advantages for the parties
involved. This is especially true for selling company shareholders.

• Results in increase in number of shares of the acquiring company

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 Form of Payment

• Using a combination of Cash and Stock

• Bidders may use a combination of cash and noncash forms of payment as part of
their bidding strategies to broaden the appeal to target shareholders

• The cash option appeals to those shareholders who either place a high value on
liquidity or do not view acquirer stock as attractive

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 Form of Payment

• Using a combination of Cash and Stock

• The all-stock option is attractive to target shareholders who may be interested in

deferring their tax liabilities in a stock-swap deal or who find the acquirer shares
attractive

• Finally, the combination of cash and stock should appeal to those who value cash but
also want to participate in any appreciation in the acquirer’s stock

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 Form of Payment

• Stock or Cash?

• What does the reading “Stock or Cash? The trade offs for buyers and sellers in
Mergers and Acquisitions” say?

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 Stock or Cash: Factors

• Acquirer’s liquidity position

– In particular if it is young firm, with limited access to financing

• Performance of acquirer’s share in stock market

• Nature of business – if the business is volatile– stock-swap preferred

• Pre-acquisition leverage of the acquirer

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 Stock or Cash: Factors

• Other considerations

– promoters may not like to dilute their ownership

– Tax considerations

– Regulatory considerations (RBI)

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 Let’s study an example from your Reading!!

• Buyer Inc. wants to acquire Target Inc.

• Market cap of Buyer Inc. is $5 billion (50 million shares @ $100 each)

• Market cap of Target Inc. is $2.8 billion (40 million shares @ $70 each)

• Buyer Inc. estimates a synergy of $1.7 billion

• Thus Buyer Inc. is willing to buy Target Inc. at $ 4 billion

• A premium of $ 1.2 billion over pre-announcement price

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 SVA Sharing in cash deal

SVA for consideration in cash

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 4.0
Premium paid by buyer($ Billion) 1.2
Value of synergy perceived by buyer 1.7 B$
SVA
Post-merger shareholding
Sharing of SVA

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 SVA Sharing in cash deal

SVA for consideration in cash

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 4.0
Premium paid by buyer($ Billion) 1.2
Value of synergy perceived by buyer 1.7 B$
SVA 0.5 B$
Post-merger shareholding 100% 0%
Sharing of SVA 500 M$ 0

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 Shareholder Value added (SVA) for Cash!

• Cash offer

– If Buyer Inc. pays in cash, SVA for its shareholders = $ 500 million (expected
synergy – acquisition premium)

– Most merger gains go to the Target Inc. shareholders

– If synergy is not materialized the SVD will be borne fully by Buyer Inc.

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 Shareholder Value added (SVA) for Stock-swap deal!!

• Share offer

• Suppose Buyer Inc. issues one share for each share of Target

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 SVA Sharing in stock-swap deal

SVA at Stock Exchange ratio kept at 1:1

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 4.0
Premium paid by buyer
Value of synergy perceived by buyer
SVA
Post-merger shareholding
Sharing of SVA

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 SVA Sharing in stock-swap deal

SVA at Stock Exchange ratio kept at 1:1

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 4.0
Premium paid by buyer 1.2 B$
Value of synergy perceived by buyer 1.7 B$
SVA 0.5 B$
Post-merger shareholding 56% 44%
Sharing of SVA 0.28 B$ 0.22 B$

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 SVA Sharing in stock deal

SVA at Stock Exchange ratio kept at 1:0.8

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 3.2 B$
Premium paid by buyer
Value of synergy perceived by buyer
SVA
Post-merger shareholding
Sharing of SVA

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 SVA Sharing

SVA at Stock Exchange ratio kept at 1:0.8

Buyer Inc. Target Inc.

Pre-merger outstanding shares 50 M 40 M
Market price on date of Proposal 100 $ 70 $
Market capitalization 5.0 B$ 2.8 B$
Deal value @100 per share cash ($ Billion) 3.2 B$
Premium paid by buyer 0.4
Value of synergy perceived by buyer 1.7
SVA 1.3
Post-merger shareholding 61% 39%
Sharing of SVA 0.79 0.51

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 How can companies Chose?

• How should the Companies Chose?

• Valuation of the Acquirer Share:

– Using stock sends a signal that stocks are overvalued
– More cause of concern for the managers who believe that their stocks are
actually under-valued.

• Synergy risks
– Cash payments are deemed as Confident deals.
– Also markets react more favourably to cash deals.
– But the company may not have cash or debt-capacity.

• Pre-closing Market Risk

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Stock-swap deals: Fixed Value / Fixed Share Deals

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 Fixed Value / Fixed Share Deals

• There are two ways to structure an offer for an exchange of shares

• Companies can either issue

• a fixed number of shares or

• a fixed value of shares

• What would Fixed shares deal would imply?

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 Fixed Shares

• The number of shares to be issued is certain, but the value of the deal may fluctuate
between the announcement of the offer and the closing date, depending on the
acquirer‘s share price.

• Both acquiring and selling shareholders are affected by those changes.

• But it does not affect the proportional ownership of the two sets of shareholders in the
combined company.

• In a fixed-share deal, shareholders in the acquired company are vulnerable to a fall in

the price of the acquiring company‘s stock

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 Fixed Value

• The other way to structure a stock deal is for the acquirer to issue a fixed value of
shares.

• In these deals, the number of shares issued is not fixed until the closing date and
depends on the prevailing price.

• What would this imply?

• The proportional ownership of the ongoing company is left in doubt until closing. The
acquiring company bears all the price risk on its shares between announcement and
closing.

• If the stock price falls, the acquirer must issue additional shares to pay sellers their
contracted fixed-dollar value.

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Use of Floor and Caps: Pre-closing Market risks

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 Example

• Insurance to target shareholders against price fluctuation between deal

announcement and closing

• Example:
• Acquirer offers to buy 100% of Small Company through exchange of stock.

Acquirer Co. Target Co.

No. of Shares 100 Million 1Million
Pre-announcement Price Rs. 100 Rs. 75
Market cap Rs 10 Billion Rs 75 Million

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 Use of Floor: Downside Protection for Target Co.

• TarCo managers could be worried that Acquirer Co. shares will fall below, say
$90 (for deal value of $100 per share)

• In order to protect the interests of Target Co. shareholders, they request a floor
on the consideration

• X = 1 for 1 as long as Acquirer Co. Pstk > $90; if on the day of transaction
Acquirer Co. Pstk <$90, then X will be adjusted so that Acquirer Co. Pstk * X = $90

• This ensures that Target Co. shareholders receive at least $90

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 Upside Protection for Acquirer Company

• AcqCo managers could be worried that AcqCo shares will rise above, say $120
(for deal value of $100 per share)

• In order to protect the interests of AcqCo shareholders from overpayment, they

request a cap on the consideration

• X = 1 for 1 as long as AcqCo Pstk < =$120; if on the day of transaction, AcqCo Pstk
> 120, then X will be adjusted so that AcqCo Pstk * X = $120

• This ensures that AcqCo shareholders do not pay more than $120 Effectively

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 Summary: Pre-closing risks

• Fixed shares Offer

• Use of Ceiling and Floors is used for?

– Managing the overpayment and underpayment

• Fixed Value Offer

• Use of Ceiling and Floors is used for?

– A ceiling ensures that the shareholding of acquirer’s shareholding is not diluted

– A floor ensures that seller’s shareholders get a minimum value of shareholding
if the share price rises.

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 Deal Termination Clauses & Walk Away Options

• Instead of a floor, TarCo might also opt for right to terminate the deal if
consideration falls below a certain value

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 SVAR and Premium at Risk

• What is SVAR?

– Shareholder value at Risk is the metric to measure the percentage of the

acquirer market value at risk
– Premium divided by market value of the acquirer
– Using the hypothetical example of reading, SVAR = 1.2/5 = 24%

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Thanks!

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