Exam 5: Implementation: Search Through Closing: Phases 3 to 10 of the Acquisition Process

Refining the target valuation based on new information uncovered during due diligence is most likely to affect which of the following

Case Study Short Essay Examination Questions Cingular Acquires AT&T Wireless in a Record-Setting Cash Transaction Cingular outbid Vodafone to acquire AT&T Wireless, the nation's third largest cellular telephone company, for $41 billion in cash plus $6 billion in assumed debt in February 2004. This represented the largest all-cash transaction in history. The combined companies, which surpass Verizon Wireless as the largest U.S. provider, have a network that covers the top 100 U.S. markets and span 49 of the 50 U.S. states. While Cingular's management seemed elated with their victory, investors soon began questioning the wisdom of the acquisition. By entering the bidding at the last moment, Vodafone, an investor in Verizon Wireless, forced Cingular's parents, SBC Communications and BellSouth, to pay a 37 percent premium over their initial bid. By possibly paying too much, Cingular put itself at a major disadvantage in the U.S. cellular phone market. The merger did not close until October 26, 2004, due to the need to get regulatory and shareholder approvals. This gave Verizon, the industry leader in terms of operating margins, time to woo away customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers because of poor customer service. By paying $11 billion more than its initial bid, Cingular would have to execute the integration, expected to take at least 18 months, flawlessly to make the merger pay for its shareholders. With AT&T Wireless, Cingular would have a combined subscriber base of 46 million, as compared to Verizon Wireless's 37.5 million subscribers. Together, Cingular and Verizon control almost one half of the nation's 170 million wireless customers. The transaction gives SBC and BellSouth the opportunity to have a greater stake in the rapidly expanding wireless industry. Cingular was assuming it would be able to achieve substantial operating synergies and a reduction in capital outlays by melding AT&T Wireless's network into its own. Cingular expected to trim combined capital costs by $600 to $900 million in 2005 and $800 million to $1.2 billion annually thereafter. However, Cingular might feel pressure from Verizon Wireless, which was investing heavily in new mobile wireless services. If Cingular were forced to offer such services quickly, it might not be able to realize the reduction in projected capital outlays. Operational savings might be even more difficult to realize. Cingular expected to save $100 to $400 million in 2005, $500 to $800 million in 2006, and $1.2 billion in each successive year. However, in view of AT&T Wireless's continued loss of customers, Cingular might have to increase spending to improve customer service. To gain regulatory approval, Cingular agreed to sell assets in 13 markets in 11 states. The firm would have six months to sell the assets before a trustee appointed by the FCC would become responsible for disposing of the assets. SBC and BellSouth, Cingular's parents, would have limited flexibility in financing new spending if it were required by Cingular. SBC and BellSouth each borrowed $10 billion to finance the transaction. With the added debt, S&P put SBC, BellSouth, and Cingular on credit watch, which often is a prelude in a downgrade of a firm's credit rating. : -What are some of the reasons Cingular used cash rather than stock or some combination to acquire AT&T Wireless? Explain your answer.

Case Study Short Essay Examination Questions First Union Buys Wachovia Bank: A Merger of Equals? First Union announced on April 17, 2001, that an agreement had been reached to acquire Wachovia Corporation for about $13 billion in stock, thus uniting two fiercely independent rivals. With total assets of about $324 billion, the combination created the fourth largest bank in the United States behind Citigroup, Bank of America, and J.P. Morgan Chase. The merger also represents the joining of two banks with vastly different corporate cultures. Because both banks have substantial overlapping operations and branches in many southeastern U.S. cities, the combined banks are expected to be able to add to earnings in the first 2 years following closing. Wachovia, which is much smaller than First Union, agreed to the merger for only a small 6% premium. The deal is being structured as a merger of equals. That is a rare step given that the merger of equals' framework usually is used when two companies are similar in size and market capitalization. L. M. Baker, chair and CEO of Wachovia, will be chair of the new bank and G. Kennedy Thompson, First Union's chair and CEO, will be CEO and president. The name Wachovia will survive. Of the other top executives, six will be from First Union and four from Wachovia. The board of directors will be evenly split, with nine coming form each bank. Wachovia shareholders own about 27% of the combined companies and received a special one-time dividend of $.48 per share because First Union recently had slashed its dividend. To discourage a breakup, First Union and Wachovia used a fairly common mechanism called a "cross option," which gives each bank the right to buy a 19.9% stake in the other using cash, stock, and other property including such assets as distressed loans, real estate, or less appealing assets. (At less than 20% ownership, neither bank would have to show the investment on its balance sheet for financial reporting purposes.) Thus, the bank exercising the option would not only be able to get a stake in the merged bank but also would be able to unload its least attractive assets. A hostile bidder would have to deal with the idea that another big bank owned a chunk of the stock and that it might be saddled with unattractive assets. The deal structure also involved an unusual fee if First Union and Wachovia parted ways. Each bank is entitled to 6% of the $13 billion merger value, or about $780 million in cash and stock. The 6% is about twice the standard breakup fee. The cross-option and 6% fee were intended to discourage other last-minute suitors from making a bid for Wachovia. According to a First Union filing with the Securities and Exchange Commission, Wachovia rebuffed an overture from an unidentified bank just 24 hours before accepting First Union's offer. Analysts identified the bank as SunTrust Bank. SunTrust had been long considered a likely buyer of Wachovia after having pursued Wachovia unsuccessfully in late 2000. Wachovia's board dismissed the offer as not being in the best interests of the Wachovia's shareholders. The transaction brings together two regional banking franchises. In the mid-1980s, First Union was much smaller than Wachovia. That was to change quickly, however. In the late 1980s and early 1990s, First Union went on an acquisition spree that made it much larger and better known than Wachovia. Under the direction of now-retired CEO Edward Crutchfield, First Union bought 90 banks. Mr. Crutchfield became known in banking circles as "fast Eddie." However, acquisitions of the Money Store and CoreStates Financial Corporation hurt bank earnings in late 1990s, causing First Union's stock to fall from $60 to less than $30 in 1999. First Union had paid $19.8 billion for CoreStates Financial in 1998 and then had trouble integrating the acquisition. Customers left in droves. Ill, Mr. Crutchfield resigned in 2000 and was replaced by G. Kennedy Thompson. He immediately took action to close the Money Store operation and exited the credit card business, resulting in a charge to earnings of $2.8 billion and the layoff of 2300 in 2000. In contrast, Wachovia assiduously avoided buying up its competitors and its top executives frequently expressed shock at the premiums that were being paid for rival banks. Wachovia had a reputation as a cautious lender. Whereas big banks like First Union did stumble mightily from acquisitions, Wachovia also suffered during the 1990s. Although Wachovia did acquire several small banks in Virginia and Florida in the mid-1990s, it remained a mid-tier player at a time when the size and scope of its bigger competitors put it at a sharp cost disadvantage. This was especially true with respect to credit cards and mortgages, which require the economies of scale associated with large operations. Moreover, Wachovia remained locked in the Southeast. Consequently, it was unable to diversify its portfolio geographically to minimize the effects of different regional growth rates across the United States. In the past, big bank deals prompted a rash of buying of bank stocks, as investors bet on the next takeover in the banking sector. Banks such as First Union, Bank of America (formerly NationsBank), and Bank One acquired midsize regional banks at lofty premiums, expanding their franchises. They rationalized these premiums by noting the need for economies of scale and bigger branch networks. Many midsize banks that were obvious targets refused to sell themselves without receiving premiums bigger than previous transactions. However, things have changed. Back in 1995 buyers of banks paid 1.94 times book value and 13.1 times after-tax earnings. By 1997, these multiples rose to 3.4 times book value and 22.2 times after-tax earnings. However, by 2000, buyers paid far less, averaging 2.3 times book value and 16.3 times earnings. First Union paid 2.47 times book value and 15.7 times after-tax earnings. The declining bank premiums reflect the declining demand for banks. Most of the big acquirers of the 1990s (e.g., Wells Fargo, Bank of America, and Bank One) now feel that they have reached an appropriate size. Banking went through a wave of consolidation in the late 1990s, but many of the deals did not turn out well for the acquirers' shareholders. Consequently, most buyers were unwilling to pay much of a premium for regional banks unless they had some unique characteristics. The First Union-Wachovia deal is remarkable in that it showed how banks that were considered prized entities in the late 1990s could barely command any premium at all by early 2001. : -What integration challenges do you believe these two banks will encounter as they attempt to consolidate operations?

Loan covenants are promises made by the borrower that certain acts will be performed and others will be avoided.

Confidentiality agreements often cover both the buyer and the seller,since both are likely to be exchanging confidential information,although for different reasons.

Confidentiality agreements are usually signed before any information is exchanged to protect the buyer and the seller from loss of competitive information.

More and more firms are identifying potential target companies on their own without the use of investment bankers.

The purchase price for a target firm may be fixed at the time of closing,subject to future adjustment,or be contingent on future performance.

In a merger,the acquiring firm assumes all liabilities of the target firm.Assumed liabilities include all but which of the following?

Earnouts are generally very poor ways to create trust and often represent major impediments to the integration process.

The purchase price may be fixed at the time of closing,subject to future adjustment,or it may be contingent on future performance of the target business.

The financing plan may be affected by the discovery during due diligence of assets that can be sold to pay off debt accumulated to finance the transaction.

The closing often involves getting all the necessary third-party consents and regulatory and shareholder approvals.

Seller financing represents a very important source of financing for buyers.

Bridge financing refers to the temporary financing obtained by the buyer to pay all or a portion of the purchase price until so-called permanent financing can be arranged.

Case Study Short Essay Examination Questions Case Study: Mattel Overpays for the Learning Company Despite disturbing discoveries during due diligence, Mattel acquired The Learning Company (TLC), a leading developer of software for toys, in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel had determined that TLC's receivables were overstated because product returns from distributors were not deducted from receivables and its allowance for bad debt was inadequate. A $50 million licensing deal also had been prematurely put on the balance sheet. Finally, TLC's brands were becoming outdated. TLC had substantially exaggerated the amount of money put into research and development for new software products. Nevertheless, driven by the appeal of rapidly becoming a big player in the children's software market, Mattel closed on the transaction aware that TLC's cash flows were overstated. For all of 1999, TLC represented a pretax loss of $206 million. After restructuring charges, Mattel's consolidated 1999 net loss was $82.4 million on sales of $5.5 billion. TLC's top executives left Mattel and sold their Mattel shares in August, just before the third quarter's financial performance was released. Mattel's stock fell by more than 35% during 1999 to end the year at about $14 per share. On February 3, 2000, Mattel announced that its chief executive officer (CEO), Jill Barrad, was leaving the company. On September 30, 2000, Mattel virtually gave away The Learning Company to rid itself of what had become a seemingly intractable problem. This ended what had become a disastrous foray into software publishing that had cost the firm literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit to an affiliate of Gores Technology Group (GTG) for rights to a share of future profits. Essentially, the deal consisted of no cash upfront and only a share of potential future revenues. In lieu of cash, GTG agreed to give Mattel 50 percent of any profits and part of any future sale of TLC. In a matter of weeks, GTG was able to do what Mattel could not do in a year. GTG restructured TLC's seven units into three, put strong controls on spending, sifted through 467 software titles to focus on the key brands, and repaired relationships with distributors. GTG also sold the entertainment division. : -Despite being aware of extensive problems,Mattel proceeded to acquire The Learning Company.Why? What could Mattel to better protect its interests? Be specific.

Advertising in the business or trade press is generally a very efficient way to locate attractive acquisition target candidates.

Case Study Short Essay Examination Questions First Union Buys Wachovia Bank: A Merger of Equals? First Union announced on April 17, 2001, that an agreement had been reached to acquire Wachovia Corporation for about $13 billion in stock, thus uniting two fiercely independent rivals. With total assets of about $324 billion, the combination created the fourth largest bank in the United States behind Citigroup, Bank of America, and J.P. Morgan Chase. The merger also represents the joining of two banks with vastly different corporate cultures. Because both banks have substantial overlapping operations and branches in many southeastern U.S. cities, the combined banks are expected to be able to add to earnings in the first 2 years following closing. Wachovia, which is much smaller than First Union, agreed to the merger for only a small 6% premium. The deal is being structured as a merger of equals. That is a rare step given that the merger of equals' framework usually is used when two companies are similar in size and market capitalization. L. M. Baker, chair and CEO of Wachovia, will be chair of the new bank and G. Kennedy Thompson, First Union's chair and CEO, will be CEO and president. The name Wachovia will survive. Of the other top executives, six will be from First Union and four from Wachovia. The board of directors will be evenly split, with nine coming form each bank. Wachovia shareholders own about 27% of the combined companies and received a special one-time dividend of $.48 per share because First Union recently had slashed its dividend. To discourage a breakup, First Union and Wachovia used a fairly common mechanism called a "cross option," which gives each bank the right to buy a 19.9% stake in the other using cash, stock, and other property including such assets as distressed loans, real estate, or less appealing assets. (At less than 20% ownership, neither bank would have to show the investment on its balance sheet for financial reporting purposes.) Thus, the bank exercising the option would not only be able to get a stake in the merged bank but also would be able to unload its least attractive assets. A hostile bidder would have to deal with the idea that another big bank owned a chunk of the stock and that it might be saddled with unattractive assets. The deal structure also involved an unusual fee if First Union and Wachovia parted ways. Each bank is entitled to 6% of the $13 billion merger value, or about $780 million in cash and stock. The 6% is about twice the standard breakup fee. The cross-option and 6% fee were intended to discourage other last-minute suitors from making a bid for Wachovia. According to a First Union filing with the Securities and Exchange Commission, Wachovia rebuffed an overture from an unidentified bank just 24 hours before accepting First Union's offer. Analysts identified the bank as SunTrust Bank. SunTrust had been long considered a likely buyer of Wachovia after having pursued Wachovia unsuccessfully in late 2000. Wachovia's board dismissed the offer as not being in the best interests of the Wachovia's shareholders. The transaction brings together two regional banking franchises. In the mid-1980s, First Union was much smaller than Wachovia. That was to change quickly, however. In the late 1980s and early 1990s, First Union went on an acquisition spree that made it much larger and better known than Wachovia. Under the direction of now-retired CEO Edward Crutchfield, First Union bought 90 banks. Mr. Crutchfield became known in banking circles as "fast Eddie." However, acquisitions of the Money Store and CoreStates Financial Corporation hurt bank earnings in late 1990s, causing First Union's stock to fall from $60 to less than $30 in 1999. First Union had paid $19.8 billion for CoreStates Financial in 1998 and then had trouble integrating the acquisition. Customers left in droves. Ill, Mr. Crutchfield resigned in 2000 and was replaced by G. Kennedy Thompson. He immediately took action to close the Money Store operation and exited the credit card business, resulting in a charge to earnings of $2.8 billion and the layoff of 2300 in 2000. In contrast, Wachovia assiduously avoided buying up its competitors and its top executives frequently expressed shock at the premiums that were being paid for rival banks. Wachovia had a reputation as a cautious lender. Whereas big banks like First Union did stumble mightily from acquisitions, Wachovia also suffered during the 1990s. Although Wachovia did acquire several small banks in Virginia and Florida in the mid-1990s, it remained a mid-tier player at a time when the size and scope of its bigger competitors put it at a sharp cost disadvantage. This was especially true with respect to credit cards and mortgages, which require the economies of scale associated with large operations. Moreover, Wachovia remained locked in the Southeast. Consequently, it was unable to diversify its portfolio geographically to minimize the effects of different regional growth rates across the United States. In the past, big bank deals prompted a rash of buying of bank stocks, as investors bet on the next takeover in the banking sector. Banks such as First Union, Bank of America (formerly NationsBank), and Bank One acquired midsize regional banks at lofty premiums, expanding their franchises. They rationalized these premiums by noting the need for economies of scale and bigger branch networks. Many midsize banks that were obvious targets refused to sell themselves without receiving premiums bigger than previous transactions. However, things have changed. Back in 1995 buyers of banks paid 1.94 times book value and 13.1 times after-tax earnings. By 1997, these multiples rose to 3.4 times book value and 22.2 times after-tax earnings. However, by 2000, buyers paid far less, averaging 2.3 times book value and 16.3 times earnings. First Union paid 2.47 times book value and 15.7 times after-tax earnings. The declining bank premiums reflect the declining demand for banks. Most of the big acquirers of the 1990s (e.g., Wells Fargo, Bank of America, and Bank One) now feel that they have reached an appropriate size. Banking went through a wave of consolidation in the late 1990s, but many of the deals did not turn out well for the acquirers' shareholders. Consequently, most buyers were unwilling to pay much of a premium for regional banks unless they had some unique characteristics. The First Union-Wachovia deal is remarkable in that it showed how banks that were considered prized entities in the late 1990s could barely command any premium at all by early 2001. : -In your judgment,was this merger a true merger of equals? Why might this framework have been used in this instance? Do you think it was a fair deal for Wachovia stockholders? Explain your answer.

It is usually in the best interests of the seller to allow the buyer unrestricted access to all seller employees and records doing due diligence in order to create an atmosphere of cooperation and goodwill.

Case Study Short Essay Examination Questions McKesson HBOC Restates Revenue McKesson Corporation, the nation's largest drug wholesaler, acquired medical software provider HBO & Co. in a $14.1 billion stock deal in early 1999. The transaction was touted as having created the country's largest comprehensive health care services company. McKesson had annual sales of $18.1 billion in fiscal year 1998, and HBO & Co. had fiscal 1998 revenue of $1.2 billion. HBO & Co. makes information systems that include clinical, financial, billing, physician practice, and medical records software. Charles W. McCall, the chair, president, and chief executive of HBO & Co., was named the new chair of McKesson HBOC. As one of the decade's hottest stocks, it had soared 38-fold since early 1992. McKesson's first attempt to acquire HBO in mid-1998 collapsed following a news leak. However, McKesson's persistence culminated in a completed transaction in January 1999. In its haste, McKesson closed the deal even before an in-depth audit of HBO's books had been completed. In fact, the audit did not begin until after the close of the 1999 fiscal year. McKesson was so confident that its auditing firm, Deloitte & Touche, would not find anything that it released unaudited results that included the impact of HBO shortly after the close of the 1999 fiscal year on March 31, 1999. Within days, indications that contracts had been backdated began to surface. By May, McKesson hired forensic accountants skilled at reconstructing computer records. By early June, the accountants were able to reconstruct deleted computer files, which revealed a list of improperly recorded contracts. This evidence underscored HBO's efforts to deliberately accelerate revenues by backdating contracts that were not final. Moreover, HBO shipped software to customers that they had not ordered, while knowing that it would be returned. In doing so, they were able to boost reported earnings, the company's share price, and ultimately the purchase price paid by McKesson. In mid-July, McKesson announced that it would have to reduce revenue by $327 million and net income by $191.5 million for the past 3 fiscal years to correct for accounting irregularities. The company's stock had fallen by 48% since late April when it first announced that it would have to restate earnings. McKesson's senior management had to contend with rebuilding McKesson's reputation, resolving more than 50 lawsuits, and attempting to recover $9.5 billion in market value lost since the need to restate earnings was first announced. When asked how such a thing could happen, McKesson spokespeople said they were intentionally kept from the due diligence process before the transaction closed. Despite not having adequate access to HBO's records, McKesson decided to close the transaction anyway. : -McKesson,a drug wholesaler,acquired HBO,a software firm.How do you think the fact that the two firms were in different businesses may have contributed to what happened?