4.1. M&A financing an overview

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Из курса от партнера Moscow Institute of Physics and Technology

Mergers and Acquisitions – The Relentless Pursuit of Synergy

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Moscow Institute of Physics and Technology

Mergers and Acquisitions – The Relentless Pursuit of Synergy

5 оценки

Курс 4 из 5 — Specialization Understanding Modern Finance

The area of mergers and acquisitions (M&As) is special in finance. Incredible amounts of money are employed in such transactions. Deals draw a lot of public attention and dispute. Oftentimes, stories look more like fairy tales rather than financial reality. The key idea in any M&A transaction is to create value through a potentially synergetic activity. To this end, it is important to have a clear motive and implementation plan. Of special importance are the correct valuation, proper financing, and actual deal completion. But this is not the end – value mostly accrues from the post-merger integration. The understanding of the motives of various stakeholders is instrumental in the analysis of the potential creation of value. The learners will gain insight into the core value creating M&A strategies. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. Finally, the Course is very helpful in successful completion of the Specialization’s Final Project.

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M&A Financing. LBOs and MBOs

In Week 4 we study M&A financing. Motives, theories, and deal mechanics are fine – but where’s the money? If a transaction is friendly, a stock payment is likely to help. But what if there’s a conflict? Then a lot of cash is needed, and a lot of debt must be issued. One way is issuing junk bonds. We discuss both facts and myths about junk bonds. Then we consider LBO and MBO transactions. First, we analyze how a company may be taken private through heavy borrowing and further gradual debt repayment. We illustrate the mechanics of an LBO/MBO transaction on a detailed example. Finally, comments on a famous LBO case – RJR Nabisco – are provided.

4.1. M&A financing an overview11:09

4.2. Junk bonds (1) – facts12:11

4.3. Junk bonds (2) – legends11:14

4.4. Joint venture as a form of a merger7:42

4.5. LBOs and MBOs (1) – a way of financing11:04

4.6. LBOs and MBOs (2) – an example22:33

4.7. An example of an LBO – the RJR Nabisco case (1988)10:46

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Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Welcome, everyone, to the fourth week of our M&A course.

So far, we've talked about a lot of things in the M&A process.

But namely, we talked about the idea, the strategy,

the way to complete the transaction, if you will.

And lastly about valuation,

namely about how much to pay, how much is too much?

What are the ways to make sure that we invest

in the case in which we are likely to create value, and so on and so forth.

This week will be devoted to something, let's say,

more plain vanilla, but still crucially important,

and this is all about M&A financing.

Let me put it here, the case, Of financing.

What are we talking about?

Well, let's say that we have a great idea, researched the market and

identified the target.

We did the valuation of this target.

We have an idea how to complete the transaction, we're all set.

Now the question is, where will we get the money?

Now, the key problem in M&As is that they deal with transactions

that are huge, in volumes.

For now, to have a valuation of $100 billion is nothing too exceptional.

Well, this is not an average amount.

And the question is, where will we get such a huge amount of money?

I'm not saying that we are overpaying.

Let's say we did careful valuation,

and this is indeed the amount that we're willing to pay for this company.

But the question persists, where's the money?

And this is a big question.

Well, let's start thinking about that.

So I'll put it like,

where, Is the money?

Well, let's say one very straightforward answer is that,

well, maybe we can pay with our own stock.

We are also a public company.

Our stock is outstanding and it is traded, so this is a good proxy for cash.

So one idea is stock payments.

Well, in this case, at a first glance, it solves the problem.

We do not have to pile up this billions of cash, but

first of all, we have to have the stock.

Let's say if the company has all its stock in free float,

then someone else owns the stock, so this someone else can pay, but not we.

So somehow, we have to either have

treasury stock that we keep in our vault,

or we can have an issue of that.

Or we can make it really interesting for our shareholders that own this free float,

to say, well, you exchange one share of stock in our company in,

let's say, whatever, x shares of stock in the combined company.

But in this case, we have to recruit all the shareholders.

We have to persuade them that this is a good investment for

them, because if not, these people can say, well, I'll stay out.

And so it always seems that stock payments

are an immediate and an easy solution to the ideal financing.

Well, not only that, you can see that here,

there are lots of negotiations.

And stock payments are likely to be suitable for

friendly mergers when we negotiate with the target company.

What if, for whatever reason, these negotiations fail?

Then we arrive at another way

of payment that is sort of eternal and can always be applied.

This is cash payment.

First of all, well, cash is always preferred to stock, because,

well, who knows what happens to the stock?

Who knows what success will we see in the implementation of post-merger integration?

Cash is cash, and it's up here right now.

But here we are back to the question,

where would we get this whatever, $100 billion in cash?

Well, first of all, clearly, no one, no company has so

much cash available in its accounts.

Well, there are companies that are very cash rich, but

most often, that just seems to be a temporary thing.

And these companies are looking to buy something or

to invest this cash somewhere.

So in general, cash is equivalent to borrowing.

Again, I said that cash is a universal form of payment.

But it's specifically the form of payment in hostile takeovers,

in which companies go directly to the shareholders of the target and

they circumvent the management.

When, for whatever reason,

they cannot agree with the management, they have to bypass them and

go directly to the final principals of the target company, its shareholders.

In this case, most likely, these guys will take only cash.

Now, if this is borrowing, and as you can see, this is heavy borrowing.

Then this borrowing can take two ways.

This is private.

And this is loans.

Or it may be public borrowing.

And this is bonds.

Now, the key story here is that we are dealing with a risky transaction.

Specifically, if this is a hostile transaction,

then it's aggravated by the premium paid,

by the need to do a lot of work in this post-merger integration.

And therefore, we have a lot of risk here.

That is why these loans are risky and these bonds are risky, and

that leads us to a special case, and this special case is the case of junk bonds.

We talked about junk bonds in our capital markets course.

We mentioned them in our corporate finance course.

Now it's the time to talk about that a little bit more directly.

So this basically sets up the story,

but before I proceeded,

I would like to make some other observations about this financing case.

Well, in financing, we deal with the market,

and I'll put that, the market appetite.

So far, as we started talking about risk, then this is sort of a,

Jargon word or buzzword, if you will, right now, the risk appetite.

So sometimes investors are willing to buy risky assets.

Sometimes they are turning

to something that is less risky or riskless, if you will.

So we can see that this is a classic

case of the risk-return tradeoff.

And to the extent we deal with bonds,

Those are also risky.

Now, when we talk about risky bonds, that by itself does not mean that they're junk.

However, if the future of a transaction is vague,

then the forecast of redeeming these bonds becomes vaguer.

And that is very much likely that the people whose job is to rate those bonds,

to affix a label to them, what is the level of risk to them?

So these people are likely to vote for

the fact that these bonds are likely to be junk.

We'll put junk bonds in the future.

And like I said, we mentioned that before.

And what follows, we will, first of all,

describe the role of the junk bond financing in one

of the most powerful merger moves that happened in the 80s.

So it was almost 30-something years ago, but that was clearly the field

day of this kind of financing.

And at the same time, we will try to identify

what is known about these bonds, and what is more of a myth.

So in the next two episodes, we will first talk about facts about junk bonds,

and then we'll say a few words about legends that are around junk bonds.

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