and sell off noncore subsidiaries. This type of activity increased after the end of the third merger wave as many companies that engaged in diverse acquisition campaigns to build conglomerates began to question the advisability of these combinations. There are several forms of corporate sell-offs, with divestitures being only one kind. Spin and equity carve-outs are other ways that sell-offs can be accomplished. The relative benefits of each of these alternative means of selling off part of a company are discussed in Chapter 11.
Merger Negotiations
Most M&As are negotiated in a friendly environment. For buyer-initiated takeovers the process usually begins when the management of one firm contacts the target company's management, often through the investment bankers of each company. For seller-initiated deals the seller may hire an investment banker, who will contact prospective bidders. If the potential bidders sign a confidentiality agreement and agree to not make an unsolicited bid, they may receive nonpublic information. The seller and its investment banker may conduct an auction or may choose to negotiate with just one bidder to reach an agreeable price. Auctions can be constructed more formally, with specific bidding rules established by the seller, or they can be less formal.
The management of both the buyer and seller keep their respective boards of directors up to date on the progress of the negotiations because mergers usually require the boards' approval. Sometimes this process works smoothly and leads to a quick merger agreement. A good example of this was the 2009 $68 billion acquisition of Wyeth Corp. by Pfizer. In spite of the size of this deal, there was a quick meeting of the minds by management of these two firms and a friendly deal was agreed to relatively quickly. However, in some circumstances a quick deal may not be the best. AT&T's $48 billion acquisition of TCI is an example of a friendly deal where the buyer did not do its homework and the seller did a good job of accommodating the buyer's (AT&T's) desire to do a quick deal at a higher price. Speed may help ward off unwanted bidders, but it may work against a close scrutiny of the transaction.
Sometimes friendly negotiations may break down, leading to the termination of the bid or a hostile takeover. An example of a negotiated deal that failed and led to a hostile bid was the tender offer by Moore Corporation for Wallace Computer Services, Inc. Here negotiations between two archrivals in the business forms and printing business proceeded for five months before they were called off, leading to a $1.3 billion hostile bid. In 2003 Moore reached agreement to acquire Wallace and form Moore Wallace. One year later Moore Wallace merged with RR Donnelley.
In other instances a bid is opposed by the target right away and the transaction quickly becomes a hostile one. One classic example of a very hostile bid was the 2004 takeover battle between Oracle and PeopleSoft. This takeover contest was unusual due to its protracted length. The battle went on for approximately a year before PeopleSoft finally capitulated and accepted a higher Oracle bid.
Most merger agreements include a material adverse change clause. This clause may allow either party to withdraw from the deal if a major change in circumstances arises that would alter the value of the deal. This occurred in late 2005 when Johnson & Johnson (J&J) stated that it wanted to terminate its $25.4 billion purchase of Guidant Corporation after Guidant's problems with recalls of heart devices it marketed became more pronounced. J&J, which still felt the criticism that it had paid too much for its largest prior acquisition, Alza (acquired in 2001 for $12.3 billion), did not want to overpay for a company that might have unpredictable liabilities that would erode its value over time. J&J and Guidant exchanged legal threats but eventually seemed to agree on a lower value of $21.5 billion. J&J's strategy of using the material adverse change clause to get a better price backfired, as it opened the door for Boston Scientific to make an alternative offer and eventually outbid J&J for Guidant with a $27 billion final.
Many believe that auctions may result in higher takeover premiums. Boone and Mulherin analyzed the takeover process related to 377 completed and 23 withdrawn acquisitions that occurred in the 1990s.6 Regarding the auctions in their sample, they found that on average 21 bidders were contacted and 7 eventually signed confidentiality and standstill agreements. In contrast, the private negotiated deals featured the seller dealing with a single bidder.
Boone and Mulherin found that more than half of deals involved auctions; the belief in the beneficial effects of auctions raised the question of why all deals are not made through auctions. One explanation may be agency costs. Boone and Mulherin analyzed this issue using an event study methodology, which compared the wealth effects to targets of auctions and negotiated transactions. Somewhat surprisingly they failed to find support for the agency theory. Their results failed to show much difference in the shareholder wealth effects of auctions compared to private negotiated transactions. This result has important policy implications as there has been some vocal pressure to require mandated auctions. The Boone and Mulherin results imply that this pressure may be misplaced.
When two companies engage in negotiations the buyer often wants access to nonpublic information from the target, which may serve as the basis for an offer acceptable to the target. A typical agreement requires that the buyer, the recipient of the confidential information, not use the information for any purposes other than the friendly deal at issue. This excludes any other uses, including making a hostile bid. While these agreements are negotiable, their terms often are fairly standard.
Confidentiality agreements, sometimes also referred to as non-disclosure agreements (NDAs), usually cover not just information about the operations of the target, including intellectual property like trade secrets, but also information about the deal itself. The latter is important in instances where the target does not want the world to know it is secretly shopping itself. In addition, these agreements often include a standstill agreement, which limits actions the bidder can take, such as purchases of the target's shares. Standstill agreements often cover a period such as a year or more. We discuss them further in Chapter 5. However, it is useful to merely point out now that these agreements usually set a stock purchase ceiling below 5 %, as purchases beyond that level may require a Schedule 13D disclosure (discussed in Chapter 3), which may serve to put the company in play.
In a recent Delaware Chancery Court decision, Chancellor Strine underscored that a confidentiality agreement does not automatically assume a standard agreement.7 However, he also stated that the NDA may limit the ability of one party to use information covered by the NDA to take actions not allowed under the agreement, including a hostile bid.
When the parties have reached the stage where there are clear terms upon which the buyer is prepared to make an offer that it thinks the seller may accept, the buyer prepares a term sheet. This is a document that the buyer usually controls but that the seller may have input into. It may not be binding, but it is prepared so that the major terms of the deal are set forth in writing, thus reducing uncertainty as to the main aspects of the deal. The sale process involves investing significant time and monetary expenses, and the term sheet helps reduce the likelihood that parties will incur such expenses and be surprised that there was not prior agreement on what each thought were the major terms of the deal. At this point in the process, a great deal of due diligence work has to be done before a final agreement is reached. When the seller is conducting an auction for the firm, it may prepare a term sheet that can be circulated to potential buyers so they know what is needed to close the deal.
While the contents will vary, the typical term sheet identifies the buyer and seller, the purchase price and the factors that may cause that price to vary prior to closing (such as changes in the target's financial performance). It will also indicate the consideration the buyer will use (i.e., cash or stock) as well as who pays what expenses. While there are many other elements that can be added based on the unique circumstances
