Financing's New Language
(CFO Magazine) Dealmaking language is changing, signaling less freedom for issuers and more protection for investors and banks. Gone are dividend recaps, refinancing, covenant-light deals, second-lien loans, and payment-in-kind (PIK). Back in the lexicon are market clauses, covenants, earnouts, and sellers' notes.
The return of vigilance is evident in the commitment letters banks give buyers to finance acquisitions. During the buyout frenzy, private-equity buyers often committed to purchasing companies without financing contingencies (like buying a house without the assurance you will be approved for a mortgage). In turn, private-equity firms pressed banks for firm financing commitments. Banks issued commitment letters without strong escape clauses and, as a result, were stuck with billions in debt they were unable to unload. Banks are now inserting tighter terms, including market clauses, which give them an out if market conditions worsen.
Covenants, once a staple, were removed in the frenzy, hence covenant-light deals. Omitting these agreements, which protect investors, enabled issuers to sell debt without obligating them to meet performance benchmarks. Covenant-light deals are now gone and traditional covenants are back. Also gone are PIK clauses. These toggle-like features enabled issuers to pay investors in bonds instead of cash at their choosing.
Financial buyers will also have to do without dividend recaps, which allowed buyers to reap a windfall long before exiting an investment by loading companies with extra debt. (Think Hertz and the $1 billion in additional debt that Clayton, Dubilier & Rice Inc., Merrill Lynch, and The Carlyle Group paid themselves just six months after acquiring the company in September 2005.) Ditto for refinancing. With debt tighter, companies on the edge may not be able to refinance with new cheap debt and instead may have to be sold. Gone too is unsecured debt such as second-lien loans.
With banks retrenching, buyers and sellers in M&A deals can expect more negotiations about bridging financing gaps. Helping close such gaps are earnouts and sellers' notes. Earnouts are benchmarks a company has to meet after it is sold, while sellers' notes mean a seller agrees to hold part of the debt. For example, to complete the sale of its wholesale unit in August, Home Depot had to agree to finance $1 billion of the deal price.
Showing posts with label mergers and acquisitions. Show all posts
Showing posts with label mergers and acquisitions. Show all posts
Wednesday, October 24, 2007
Livedoor illustrates some interesting mechanics in the financial markets
The Trouble Behind Livedoor
Q&A with: Robin Greenwood
Published: February 6, 2006
Author: Sean Silverthorne
(HBS) Takafumi Horie, the thirty-three-year-old CEO of Livedoor, had become Japan's anti-establishment enfant terrible: rich, hard charging, willing to take big risks such as the ultimately failed attempt to acquire a controlling interest in Nippon Broadcasting Systems. While many traditionalists thought Horie represented all that is wrong with Western-style capitalism, others saw him as the future of the country's media industry, and a man of the people.
But last month, Horie was arrested on suspicion of accounting fraud and illegal securities trading. When investigators raided Livedoor's offices, panic selling caused an unprecedented early shutdown of the Tokyo Stock Exchange. Horie, who denies wrongdoing, was arrested on January 23.
What went wrong at Livedoor, and what are we to learn from its undoing? Robin Greenwood, an assistant professor in the Finance Unit at Harvard Business School, has researched stock price manipulation in Japan and looked specifically at firms like Livedoor. He says the Livedoor episode may, in the end, do some good by paving the road for reform of Japan's "abysmal" corporate governance.
Sean Silverthorne: Could you tell us about your research into market manipulation, especially in Japan?
Robin Greenwood: Generally speaking, market manipulation comes in two forms: manipulating investor expectations, or manipulating investors' ability to trade. Financial economists know a lot more about the former than the latter.
Unusually in Japan, manipulating investors' ability to trade was an important aspect of price manipulation for many firms over the past few years. My research looks at how firms used stock splits to manipulate the float—the fraction of shares available to trade—in an effort to keep stock prices high. Livedoor was the most prominent abuser of stock splits, and we are now seeing the results. The market is jittery because it worries that there are more firms like Livedoor waiting to be exposed.
Q: Between 2003 and 2004, Livedoor split its stock three times, once in a ratio of 100-for-1. An investor who owned one share in early 2003 would have 10,000 shares today. Why would a company want to cut the trading price of its stock by so much?
A: In a stock split, each share of the firm is divided into more units, but the proportional ownership of each shareholder stays the same. In the U.S., firms split to keep their price in a relatively narrow trading band, say between $20 and $50. In a typical year, about 300 firms split their shares, and most splits are in ratios of 2-for-1 or 3-for-2. There are some famous examples of firms that have decided not to split, like Berkshire Hathaway and recently Google, but these are rare.
In Japan, things were very different. If you were to look at stock prices at the end of 2000, you would have found many stocks with prices over $10,000. Many of these firms had never split, even once. Because stocks were expensive, individual investors could not, for the most part, participate in the equity markets unless they had a lot of money. In 2001, however, a law requiring net assets per share to remain above 50,000 yen was repealed, clearing the way for firms to split to lower prices, and thus attract retail investors.
When a stock split occurs in Japan, the new shares are not distributed for several months. During this time, investors can buy or sell their "old" shares, but are unable to sell the shares they are about to receive. For example, if the stock splits 2-for-1, an investor who owns one share will hold on to the old share during the split but will not receive the new share for several months, at which point he can sell it. This system is the result of ownership being tracked on paper rather than electronically—it takes time to print out new share certificates. Because investors do not have access to the new shares, a significant fraction of the firm cannot trade. When investors cannot sell, prices rise.
Livedoor understood that once it decided to do a stock split, there was no reason to stop at 2-for-1. In December 2003, they announced a 100-for-1 split. At the time of the announcement, Livedoor had a price of around ¥156,000. Following the split, an owner of one share of Livedoor retained his one share worth only ¥1560 and received a claim to receive in two months ninety-nine more shares of the same value. Thus in a firm that was worth over $1 billion, investors only had access to $10 million to trade. From the date that Livedoor announced the split, the price rose nearly tenfold.
With the stock split came an increase in publicity, which helped maintain capital inflows from individual investors. The media has drawn a lot of attention to Horie's boyish antics—he is a regular guest on national talk shows and drives a Ferrari around the streets of Tokyo—but I suspect that this was all part of a plan to maintain investor interest in his stock. Livedoor had more than 200,000 shareholders, mostly individuals. This is an incredible number.
Together with Livedoor, hundreds of firms around Japan have announced stock splits over the past few years, often with gigantic increases in price. These events became so widespread that they earned the name "stock split bubble."
Q: So Livedoor was part of a greater phenomenon?
A: Absolutely. Between 2003 and 2004, over 400 firms split their shares. This number can be compared with only thirty-four firms that announced stock splits between 1995 and 1998! My research shows that on average, firms that executed stock splits during this time went up by over 30 percent more than the market. About half of these returns were reversed when the new shares were distributed to investors, consistent with investors trying to sell as soon as possible. Many of these firms have come down further in price, but there will probably be more. Regulators have recently put into place safeguards that will prevent high-ratio stock splits in the future.
If anything, Livedoor was the cleverest of the stock splitters, as it recognized that a high post-split stock price would allow the firm to complete stock financed acquisitions. As long as investors in the target company were willing to accept overpriced Livedoor stock as a form of payment, Livedoor could keep gobbling up other firms. Over the past few years, Livedoor acquired more than twenty companies, most paid for with stock. Livedoor's most famous transaction, its failed attempt to buy Nippon Broadcasting Systems last year, was financed with convertible debt. However, the debt was converted into equity almost immediately, making that, too, an essentially stock-financed transaction.
Many of Livedoor's acquisitions were great companies, and continued to perform well under the Livedoor brand. This probably explains why the pyramid scheme did not come tumbling down much earlier. However, it now appears that some of the acquisitions were used to shield Livedoor losses.
Q: Does this behavior teach us anything about financial markets?
A: At first glance, Livedoor appears to be like many firms in markets around the world, which have used a high stock price to foster equity financed growth. But I think there are broader lessons in the specific way that stock splits helped maintain high prices. While the institutional irregularity is unusual to Japan, a more general principle that emerges is that firms will try to restrict their investors from trading. A researcher at Yale recently showed that many firms try to discourage short-sellers of their stock by launching ad campaigns threatening to them. Not surprisingly, this behavior seems to work. A more benign form of this occurs when firms spend resources to attract a particular kind of investor. Institutional investors, for example, are thought to be attractive holders for your stock because they do not trade much.
Getting back to Japan, the stock splits can be thought of a form of float manipulation. By limiting the number of shares on the market, and making it difficult to sell, prices can only go up. A similar mechanism occurs in initial public offerings, where the supply of shares offered to the public is very small. Because only optimistic investors buy, and it is difficult for others to go short, many IPOs end up being overpriced.
Q: What do you think Livedoor's legacy will be?
A: It is possible that Livedoor will be remembered as just a fraud. And to some extent, this is well deserved. However, I think Horie deserves some credit. Although he may not have been good at operations, he had a deep understanding of financial markets and a perception of what investors wanted to hear. In some sense, he figured out that selling stock to investors was much easier than selling product to customers. But more importantly, he revitalized Japan's sleepy market for corporate control. In the attempt to acquire Nippon Broadcasting Systems, Livedoor drew attention to the cronyism that governs Japan's corporate world.
I worry that members of Japan's old guard will use the Livedoor event try to rationalize anti-takeover defenses. Their argument might be that the next time a firm tries to take them over, it is only using overpriced equity and hence is bad for target shareholders. But this would take Japan in the wrong direction. Corporate governance in Japan is abysmal—most firms are run in spite of, rather than for, their shareholders. And a world in which the managers are making investment decisions for the shareholders is a scary one. If investors want to overpay, they have only themselves to blame. Let the markets work it out.
Q&A with: Robin Greenwood
Published: February 6, 2006
Author: Sean Silverthorne
(HBS) Takafumi Horie, the thirty-three-year-old CEO of Livedoor, had become Japan's anti-establishment enfant terrible: rich, hard charging, willing to take big risks such as the ultimately failed attempt to acquire a controlling interest in Nippon Broadcasting Systems. While many traditionalists thought Horie represented all that is wrong with Western-style capitalism, others saw him as the future of the country's media industry, and a man of the people.
But last month, Horie was arrested on suspicion of accounting fraud and illegal securities trading. When investigators raided Livedoor's offices, panic selling caused an unprecedented early shutdown of the Tokyo Stock Exchange. Horie, who denies wrongdoing, was arrested on January 23.
What went wrong at Livedoor, and what are we to learn from its undoing? Robin Greenwood, an assistant professor in the Finance Unit at Harvard Business School, has researched stock price manipulation in Japan and looked specifically at firms like Livedoor. He says the Livedoor episode may, in the end, do some good by paving the road for reform of Japan's "abysmal" corporate governance.
Sean Silverthorne: Could you tell us about your research into market manipulation, especially in Japan?
Robin Greenwood: Generally speaking, market manipulation comes in two forms: manipulating investor expectations, or manipulating investors' ability to trade. Financial economists know a lot more about the former than the latter.
Unusually in Japan, manipulating investors' ability to trade was an important aspect of price manipulation for many firms over the past few years. My research looks at how firms used stock splits to manipulate the float—the fraction of shares available to trade—in an effort to keep stock prices high. Livedoor was the most prominent abuser of stock splits, and we are now seeing the results. The market is jittery because it worries that there are more firms like Livedoor waiting to be exposed.
Q: Between 2003 and 2004, Livedoor split its stock three times, once in a ratio of 100-for-1. An investor who owned one share in early 2003 would have 10,000 shares today. Why would a company want to cut the trading price of its stock by so much?
A: In a stock split, each share of the firm is divided into more units, but the proportional ownership of each shareholder stays the same. In the U.S., firms split to keep their price in a relatively narrow trading band, say between $20 and $50. In a typical year, about 300 firms split their shares, and most splits are in ratios of 2-for-1 or 3-for-2. There are some famous examples of firms that have decided not to split, like Berkshire Hathaway and recently Google, but these are rare.
In Japan, things were very different. If you were to look at stock prices at the end of 2000, you would have found many stocks with prices over $10,000. Many of these firms had never split, even once. Because stocks were expensive, individual investors could not, for the most part, participate in the equity markets unless they had a lot of money. In 2001, however, a law requiring net assets per share to remain above 50,000 yen was repealed, clearing the way for firms to split to lower prices, and thus attract retail investors.
When a stock split occurs in Japan, the new shares are not distributed for several months. During this time, investors can buy or sell their "old" shares, but are unable to sell the shares they are about to receive. For example, if the stock splits 2-for-1, an investor who owns one share will hold on to the old share during the split but will not receive the new share for several months, at which point he can sell it. This system is the result of ownership being tracked on paper rather than electronically—it takes time to print out new share certificates. Because investors do not have access to the new shares, a significant fraction of the firm cannot trade. When investors cannot sell, prices rise.
Livedoor understood that once it decided to do a stock split, there was no reason to stop at 2-for-1. In December 2003, they announced a 100-for-1 split. At the time of the announcement, Livedoor had a price of around ¥156,000. Following the split, an owner of one share of Livedoor retained his one share worth only ¥1560 and received a claim to receive in two months ninety-nine more shares of the same value. Thus in a firm that was worth over $1 billion, investors only had access to $10 million to trade. From the date that Livedoor announced the split, the price rose nearly tenfold.
With the stock split came an increase in publicity, which helped maintain capital inflows from individual investors. The media has drawn a lot of attention to Horie's boyish antics—he is a regular guest on national talk shows and drives a Ferrari around the streets of Tokyo—but I suspect that this was all part of a plan to maintain investor interest in his stock. Livedoor had more than 200,000 shareholders, mostly individuals. This is an incredible number.
Together with Livedoor, hundreds of firms around Japan have announced stock splits over the past few years, often with gigantic increases in price. These events became so widespread that they earned the name "stock split bubble."
Q: So Livedoor was part of a greater phenomenon?
A: Absolutely. Between 2003 and 2004, over 400 firms split their shares. This number can be compared with only thirty-four firms that announced stock splits between 1995 and 1998! My research shows that on average, firms that executed stock splits during this time went up by over 30 percent more than the market. About half of these returns were reversed when the new shares were distributed to investors, consistent with investors trying to sell as soon as possible. Many of these firms have come down further in price, but there will probably be more. Regulators have recently put into place safeguards that will prevent high-ratio stock splits in the future.
If anything, Livedoor was the cleverest of the stock splitters, as it recognized that a high post-split stock price would allow the firm to complete stock financed acquisitions. As long as investors in the target company were willing to accept overpriced Livedoor stock as a form of payment, Livedoor could keep gobbling up other firms. Over the past few years, Livedoor acquired more than twenty companies, most paid for with stock. Livedoor's most famous transaction, its failed attempt to buy Nippon Broadcasting Systems last year, was financed with convertible debt. However, the debt was converted into equity almost immediately, making that, too, an essentially stock-financed transaction.
Many of Livedoor's acquisitions were great companies, and continued to perform well under the Livedoor brand. This probably explains why the pyramid scheme did not come tumbling down much earlier. However, it now appears that some of the acquisitions were used to shield Livedoor losses.
Q: Does this behavior teach us anything about financial markets?
A: At first glance, Livedoor appears to be like many firms in markets around the world, which have used a high stock price to foster equity financed growth. But I think there are broader lessons in the specific way that stock splits helped maintain high prices. While the institutional irregularity is unusual to Japan, a more general principle that emerges is that firms will try to restrict their investors from trading. A researcher at Yale recently showed that many firms try to discourage short-sellers of their stock by launching ad campaigns threatening to them. Not surprisingly, this behavior seems to work. A more benign form of this occurs when firms spend resources to attract a particular kind of investor. Institutional investors, for example, are thought to be attractive holders for your stock because they do not trade much.
Getting back to Japan, the stock splits can be thought of a form of float manipulation. By limiting the number of shares on the market, and making it difficult to sell, prices can only go up. A similar mechanism occurs in initial public offerings, where the supply of shares offered to the public is very small. Because only optimistic investors buy, and it is difficult for others to go short, many IPOs end up being overpriced.
Q: What do you think Livedoor's legacy will be?
A: It is possible that Livedoor will be remembered as just a fraud. And to some extent, this is well deserved. However, I think Horie deserves some credit. Although he may not have been good at operations, he had a deep understanding of financial markets and a perception of what investors wanted to hear. In some sense, he figured out that selling stock to investors was much easier than selling product to customers. But more importantly, he revitalized Japan's sleepy market for corporate control. In the attempt to acquire Nippon Broadcasting Systems, Livedoor drew attention to the cronyism that governs Japan's corporate world.
I worry that members of Japan's old guard will use the Livedoor event try to rationalize anti-takeover defenses. Their argument might be that the next time a firm tries to take them over, it is only using overpriced equity and hence is bad for target shareholders. But this would take Japan in the wrong direction. Corporate governance in Japan is abysmal—most firms are run in spite of, rather than for, their shareholders. And a world in which the managers are making investment decisions for the shareholders is a scary one. If investors want to overpay, they have only themselves to blame. Let the markets work it out.
Monday, October 8, 2007
SAP to buy Business Objects
SAP Agrees to Buy Business Objects in Biggest Strategy Shift
By Kenneth Wong and Rudy Ruitenberg
Oct. 8 (Bloomberg) -- SAP AG, the world's largest maker of business-management software, agreed to buy Business Objects SA for more than 4.8 billion euros ($6.8 billion), the biggest purchase in its 35-year history.
SAP will offer 42 euros in cash for each Business Objects share, 20 percent more than the closing price on Oct. 5 in Paris, SAP said in a statement late yesterday. Business Objects, based in the Paris suburb of Levallois-Perret, is the world's largest maker of software to track corporate databases.
The deal marks a departure from Walldorf, Germany-based SAP's strategy of relying on organic growth and making smaller so-called ``tuck-in'' acquisitions. Oracle Corp., SAP's largest rival in the software that helps companies manage processes such as billing and payroll, spent more than $25 billion on purchases since 2005, making it the most acquisitive company in the software industry.
``That's a dramatic shift in strategy,'' said Thomas Hofmann, an analyst at Landesbank Baden-Wuerttemberg in Stuttgart, Germany, who has a ``buy'' rating on SAP shares. ``They're really moving toward the direction of Oracle and maybe that's because they're feeling Oracle is coming closer.''
Business Objects's management board supports the ``friendly takeover'' and plans to recommend the offer to shareholders subject to certain regulatory requirements, SAP said. The company will finance the purchase using available cash and borrowings.
Earnings Effect
The deal will increase SAP's earnings per share under U.S. accounting standards starting in 2009, SAP said. It will be ``dilutive'' to earnings per share ``by mid single digits'' euro cents in 2008, the company said. SAP said it expects the transaction to be completed in the first quarter of 2008.
SAP Chief Executive Officer Henning Kagermann said as recently as last month that he wasn't under ``any pressure'' to make a large acquisition.
``It's the unique combination of two market leaders,'' Kagermann said on a conference call yesterday. ``We like the open-ended, independent business-intelligence platform of Business Objects. We found out in our talks with Business Objects that we can enter the market directly.''
Kagermann's biggest purchase to date was the acquisition of TopTier Software Inc., an unprofitable maker of Internet software, for $400 million in 2001. In 2005, Oracle outbid SAP on retail-software maker Retek, paying $643.3 million. SAP spent about 500 million euros last year on acquisitions. Its biggest purchase so far this year is OutlookSoft Corp., a maker of software that helps companies make financial forecasts.
Business Performance
Business Objects ranks ahead of Cognos Inc. and Hyperion Corp. in the market for business-intelligence software, used by companies to extract data from across departments to help managers analyze business performance. Oracle bought Hyperion for $3.3 billion earlier this year.
The French company made at least eight takeovers in the past two years to add to its business-intelligence software. In April, it agreed to buy Cartesis SA for 225 million euros for its financial reporting software.
Business Objects customers include Adecco SA, Boeing Co., Walt Disney Co. and Unilever NV. The French company's latest version of its data-tracking and mining software is called BusinessObjects XI and was introduced in January 2005.
Business Objects shares rose 4.7 percent on Sept. 17 after Le Figaro reported the company hired Goldman Sachs Group Inc. to find a buyer. The newspaper mentioned SAP as the top candidate among five potential bidders.
Preliminary Earnings
Business Objects said late yesterday its third-quarter sales were between $366 million and $370 million, and earnings per share were 4 cents to 6 cents under U.S. accounting rules. License sales, an indicator of future revenue from maintenance and consulting, reached $137 million to $139 million. The company didn't provide year-earlier comparisons.
License revenue was ``below expectations'' and caused a shortfall in earnings, Chief Executive Officer John Schwarz said in the statement.
The French company reported in July that second-quarter net income more than doubled to $21.6 million from $7.9 million euros a year earlier, boosted by demand for its products in Europe and the acquisition of Cartesis in France.
In the three months through June, operating profit more than doubled to $33 million from $13.5 million as sales and marketing costs as well as research and development spending increased at a slower pace than sales. Business Objects' operating margin rose to 9.1 percent in the quarter from 4.6 percent a year earlier.
Second-quarter sales rose 23 percent to $363 million, while license fees, an indicator of future revenue growth, jumped 21 percent to $149 million. The company forecasts full-year sales of between $1.52 billion and $1.53 billion.
Shares Gain
SAP shares rose 1.5 percent to 41.63 euros in Frankfurt on Oct. 5, bringing the gain to 3.4 percent this year and valuing the company at 52.8 billion euros. Business Objects shares rose 3.6 percent to 35 euros on Oct. 5 and are up 18 percent this year.
Business Objects CEO Schwarz said in June he wasn't interested in a takeover by Oracle, SAP or Microsoft Corp. because customers prefer an independent company whose software can be used across different systems.
In September 2005, Schwarz replaced the company's founder Bernard Liautaud, who remained chairman. Prague-born Schwarz holds a Canadian passport and was previously president of Symantec Corp., the world's biggest maker of anti-virus software.
SAP was founded by five former International Business Machines Corp. employees.
By Kenneth Wong and Rudy Ruitenberg
Oct. 8 (Bloomberg) -- SAP AG, the world's largest maker of business-management software, agreed to buy Business Objects SA for more than 4.8 billion euros ($6.8 billion), the biggest purchase in its 35-year history.
SAP will offer 42 euros in cash for each Business Objects share, 20 percent more than the closing price on Oct. 5 in Paris, SAP said in a statement late yesterday. Business Objects, based in the Paris suburb of Levallois-Perret, is the world's largest maker of software to track corporate databases.
The deal marks a departure from Walldorf, Germany-based SAP's strategy of relying on organic growth and making smaller so-called ``tuck-in'' acquisitions. Oracle Corp., SAP's largest rival in the software that helps companies manage processes such as billing and payroll, spent more than $25 billion on purchases since 2005, making it the most acquisitive company in the software industry.
``That's a dramatic shift in strategy,'' said Thomas Hofmann, an analyst at Landesbank Baden-Wuerttemberg in Stuttgart, Germany, who has a ``buy'' rating on SAP shares. ``They're really moving toward the direction of Oracle and maybe that's because they're feeling Oracle is coming closer.''
Business Objects's management board supports the ``friendly takeover'' and plans to recommend the offer to shareholders subject to certain regulatory requirements, SAP said. The company will finance the purchase using available cash and borrowings.
Earnings Effect
The deal will increase SAP's earnings per share under U.S. accounting standards starting in 2009, SAP said. It will be ``dilutive'' to earnings per share ``by mid single digits'' euro cents in 2008, the company said. SAP said it expects the transaction to be completed in the first quarter of 2008.
SAP Chief Executive Officer Henning Kagermann said as recently as last month that he wasn't under ``any pressure'' to make a large acquisition.
``It's the unique combination of two market leaders,'' Kagermann said on a conference call yesterday. ``We like the open-ended, independent business-intelligence platform of Business Objects. We found out in our talks with Business Objects that we can enter the market directly.''
Kagermann's biggest purchase to date was the acquisition of TopTier Software Inc., an unprofitable maker of Internet software, for $400 million in 2001. In 2005, Oracle outbid SAP on retail-software maker Retek, paying $643.3 million. SAP spent about 500 million euros last year on acquisitions. Its biggest purchase so far this year is OutlookSoft Corp., a maker of software that helps companies make financial forecasts.
Business Performance
Business Objects ranks ahead of Cognos Inc. and Hyperion Corp. in the market for business-intelligence software, used by companies to extract data from across departments to help managers analyze business performance. Oracle bought Hyperion for $3.3 billion earlier this year.
The French company made at least eight takeovers in the past two years to add to its business-intelligence software. In April, it agreed to buy Cartesis SA for 225 million euros for its financial reporting software.
Business Objects customers include Adecco SA, Boeing Co., Walt Disney Co. and Unilever NV. The French company's latest version of its data-tracking and mining software is called BusinessObjects XI and was introduced in January 2005.
Business Objects shares rose 4.7 percent on Sept. 17 after Le Figaro reported the company hired Goldman Sachs Group Inc. to find a buyer. The newspaper mentioned SAP as the top candidate among five potential bidders.
Preliminary Earnings
Business Objects said late yesterday its third-quarter sales were between $366 million and $370 million, and earnings per share were 4 cents to 6 cents under U.S. accounting rules. License sales, an indicator of future revenue from maintenance and consulting, reached $137 million to $139 million. The company didn't provide year-earlier comparisons.
License revenue was ``below expectations'' and caused a shortfall in earnings, Chief Executive Officer John Schwarz said in the statement.
The French company reported in July that second-quarter net income more than doubled to $21.6 million from $7.9 million euros a year earlier, boosted by demand for its products in Europe and the acquisition of Cartesis in France.
In the three months through June, operating profit more than doubled to $33 million from $13.5 million as sales and marketing costs as well as research and development spending increased at a slower pace than sales. Business Objects' operating margin rose to 9.1 percent in the quarter from 4.6 percent a year earlier.
Second-quarter sales rose 23 percent to $363 million, while license fees, an indicator of future revenue growth, jumped 21 percent to $149 million. The company forecasts full-year sales of between $1.52 billion and $1.53 billion.
Shares Gain
SAP shares rose 1.5 percent to 41.63 euros in Frankfurt on Oct. 5, bringing the gain to 3.4 percent this year and valuing the company at 52.8 billion euros. Business Objects shares rose 3.6 percent to 35 euros on Oct. 5 and are up 18 percent this year.
Business Objects CEO Schwarz said in June he wasn't interested in a takeover by Oracle, SAP or Microsoft Corp. because customers prefer an independent company whose software can be used across different systems.
In September 2005, Schwarz replaced the company's founder Bernard Liautaud, who remained chairman. Prague-born Schwarz holds a Canadian passport and was previously president of Symantec Corp., the world's biggest maker of anti-virus software.
SAP was founded by five former International Business Machines Corp. employees.
Thursday, September 27, 2007
Structuring investments in China
Legal Issues
Rethinking M&A in China
With China's new mergers and acquisitions rules in place, foreign and domestic investors need to find more creative ways to structure their investments
by Marcia Ellis and Auria Styles
Foreign private equity investors for the past several years have often invested in PRC companies by bringing the Chinese founders of such companies offshore and investing together with the founders in an offshore special purpose vehicle (SPV). The investors successfully exited their investments by listing the SPV on a foreign stock exchange or selling the shares—through a trade sale—to another fund or strategic investor. This investment strategy, commonly known as "round-tripping," was essentially prohibited when the Provisions on Acquisition of Domestic Enterprises by Foreign Investors (mergers and acquisitions [M&A] rules) took effect on September 8, 2006.
As a result, private equity investors must rethink their investment structures and move their joint ventures (JVs) with the Chinese founders of the investee companies from relatively unregulated tax havens, such as the Cayman Islands and British Virgin Islands, to the more restrictive environment of mainland China. These changes, however, have not deterred foreign investors and their Chinese partners from structuring investments in Chinese JVs that replicate, to the extent possible, the features of their offshore JVs.
Anatomy of the M&A rules
The final M&A rules are similar to the 2003 Interim Provisions on the Acquisition of Domestic Enterprises by Foreign Investors, which provided the first firm legal basis for the acquisition of the equity of a non-foreign-invested PRC company by a foreign investor and permitted a number of transaction structures that previously had been of dubious legality. For foreign investors, the most troubling aspect of the interim measures was the antitrust provisions that required the PRC Ministry of Commerce (MOFCOM) and the State Administration for Industry and Commerce to review acquisitions that met certain thresholds. In retrospect, however, these provisions appear largely to have been a trial balloon for China's long-awaited Antimonopoly Law—slated to pass this year—and have yet to be used by MOFCOM to block foreign acquisitions.
The final M&A rules retain most of the provisions of the interim measures but also include sections that attempt to control the various forms of round-tripping by requiring MOFCOM approval for such transactions, regardless of the size of the investment. The criteria that MOFCOM currently uses to determine which, if any, round-trip transactions it will approve remain unclear, and, to date, there have been few reported cases of such approvals. Thus, many private equity funds are seeking alternative means of structuring investments to avoid the requirement of MOFCOM approval.
Onshore investments
Structural challenges
To avoid MOFCOM approval for round-tripping transactions, companies can invest directly in JVs in China. The fundamental nature of foreign-invested enterprises (FIEs), however, renders onshore investments more difficult. For example, in the United States and offshore tax havens, it is possible to create two classes of stock—preferred and common—but in China, only one class of equity is available for FIEs. As a result, it is difficult to structure investments in a way that would allow funds to enjoy some of the basic preferential rights associated with private equity investments, such as preferential payment of dividends and liquidation proceeds. In addition, without two classes of shares it is impossible to effect a value adjustment—for instance, when the investee company fails to meet certain financial targets—by automatically adjusting the rate at which preferred shares are converted into common shares. Investors without these protections are relatively unprotected in a downside scenario, making these onshore investments in China inherently more risky.
Although it is possible to structure dividend preferences in an onshore investment in a cooperative JV (CJV), obtaining approval for such investment vehicles is becoming increasingly difficult in some areas of China. Some local PRC officials are now carefully scrutinizing CJV structures to ensure that investors do not abuse the flexibility of the structure for purposes of creating dividend preferences that are not otherwise permitted. Currently, PRC law allows for liquidation preferences in both equity and cooperative JVs, and in several localities in China, foreign investors have obtained approvals for favorable liquidation preferences in their onshore JVs.
Another difficulty with setting up mainland JVs is that conversion price adjustments (sometimes called valuation adjustment mechanisms [VAMs]) require skillful structuring in an onshore investment. VAMs essentially permit investors to exchange their preferred shares for a larger number of common shares if the investee company does not meet certain financial targets. For example, an investor generally calculates its purchase price based on a multiple of the investee company's earnings for the following year. If the investee's earnings do not meet that amount, a VAM will be triggered, and the percentage of the total number of the investor's preferred shares that can be converted into the common shares of the investee will increase. Because there is only one class of equity in FIEs, and thus no conversion of preferred shares into common shares, it is impossible to directly implement a VAM in an FIE.
To structure VAM-like mechanisms in FIEs, foreign investors must use either debt that is capitalized at a different rate, depending on whether the relevant financial targets are met, or use a holdback provision—which transfers a certain percentage of equity to the founder if and when the financial targets are met. Provisions incorporating these features into the transaction documents must be drafted carefully to avoid various pitfalls—such as potential conflicts with statutory rights of first refusal—and comply with PRC law. In some cases, these provisions must also comply with extra-legal requirements imposed by approval authorities when reviewing JV contracts. For example, investors must address officials' concerns that foreign parties are obtaining too many benefits and that an overall "fairness" requirement has been breached.
Finally, structuring and implementing call and put options—the rights to purchase or sell equity at a certain time at a certain price—in an FIE is also challenging. Although it is possible to receive approval for call and put provisions in a JV contract that comply with PRC law, implementing them proves more difficult. After the initial JV contract approval, the actual transfer of equity requires additional board and government approvals. If the JV partner is a state-owned enterprise, it may not determine, at the time of the original transaction, the exercise price because the value of the interest to be transferred must be appraised by a duly qualified asset valuation firm at the time of the transfer, and the exercise price cannot be less than the appraised value. Thus, such structuring requires creativity and deep knowledge of PRC regulations and how they are implemented.
Exit challenges
Perhaps the greatest challenge faced by a foreign private equity investor that invests in an onshore JV is finding a viable exit strategy. Without round-tripping, an overseas listing would be hard to accomplish. Although the M&A rules permit founders and investors to swap the equity of an onshore entity for the shares of an SPV incorporated for the purpose of a listing shortly before it lists, such an undertaking cannot occur unless other requirements in the M&A rules are met. For example, a minimum initial public offering price must be set months before it actually takes place. Because these requirements are so onerous, and the uncertainty of obtaining approval so great, most private equity funds are, for the moment, pursuing other methods.
A-share listing
One of those options is to list A shares on a Chinese domestic stock exchange. To do so, an FIE must first obtain MOFCOM approval at the national level to convert into a foreign-invested company limited by shares (FICLS), which must then apply to the China Securities Regulatory Commission (CSRC) for listing. If approval is obtained and the shares of the FICLS listed, each shareholder of the FICLS will be subject to lock-ups stipulated by law and the rules of the relevant stock exchange that prohibit the sale of shares of stock for a specified period—from one to three years depending on when each shareholder made its investment and the percentage interest it holds in the FICLS. After the lock-up period expires, an investor can either sell its shares on the A-share market or effect a private sale.
Because investors face long waiting periods for approvals and lock-ups, it is unclear whether the domestic stock markets will be developed enough to provide the desired liquidity at the time of exit. Despite these hurdles, a number of funds are optimistic about the possibility of exits through A-share listings.
Swap for shares of a listed entity
Another exit alternative permitted under the M&A rules is to make the original investment through a share swap, in which the equity of the domestic investee company is swapped for shares of an offshore listed company. Again, MOFCOM must approve such swaps, but once approved, the fund's ability to exit the investment is essentially guaranteed because it already holds listed shares.
Another possibility would be to swap the shares of an offshore special purpose acquisition corporation (SPAC) for the equity of a PRC domestic company. US securities regulations allow a SPAC to be incorporated and listed immediately, before it acquires any assets. In effect, the SPAC is simply a holding company with a plan to acquire assets but has no existing assets at the time of listing. After listing, the founders of the PRC domestic company could receive the SPAC's shares in exchange for their equity in the domestic company. In turn, the proceeds from the SPAC's listing could be used to expand the business of the domestic company. Implementing such a share swap under the M&A rules and relevant US regulations could present certain difficulties, not the least of which is that listed shares being swapped must have been steadily traded for the 12-month period prior to the swap—a requirement that many SPACs would be unable to meet.
The Internet structure
Some funds are adopting a structure that has been widely used in China's Internet sector to circumvent the need for MOFCOM approval of a round-trip transaction. Often called a Sohu, Sina, or NetEase structure after the PRC Internet giants that pioneered its use, the structure has been used in industries where foreign investment is restricted, such as telecom and media and publishing. Under this structure, the foreign private fund and the PRC founder establish an offshore SPV that in turn forms a wholly foreign-owned enterprise (WFOE) in China. The PRC founder continues to hold all of the equity of the actual onshore operating company, which then enters into a series of contractual arrangements with the WFOE that allows it to take over the operating company and to receive all the after-tax profits of the operating company as fees.
The advantages of this structure are that it does not require MOFCOM approval at the national level because it is not considered a round-trip investment and that the fund can obtain a VAM and enjoy all of the features normally associated with private equity investments through an SPV. In addition, the fund can achieve an exit through an SPV listing.
The disadvantage of this structure is that despite being replicated many times by Chinese media and Internet companies, it is confusing to some foreign investors that are unfamiliar with it. Moreover, MOFCOM could claim that such a transaction constitutes round-tripping since the M&A rules include a broad catch-all provision under which such contractual arrangements could fall. (This provision, set forth in Article 11 of the rules, prohibits parties from using domestic investment by an FIE "or any other means" to circumvent MOFCOM approval.) Finally, even if MOFCOM accepts this structure and does not regard it as "any other means" of circumventing approval, it is unclear whether CSRC will block the SPV listing because of the use of this structure. CSRC officials have stated that they would at least examine closely any such contractual arrangements that were entered into after September 8, 2006 to determine whether the contracts were intended to circumvent MOFCOM approval.
Next steps?
The M&A rules have, for the time being, achieved their unstated purpose: to curtail round-trip investment. In addition, they have slowed private equity investment in China because funds must now pause to consider options for structuring investments and become comfortable with the levels of risk involved in such structures. For now, however, with a bit of creativity and patience, investors are finding novel ways around the more onerous requirements of the M&A rules.
Rethinking M&A in China
With China's new mergers and acquisitions rules in place, foreign and domestic investors need to find more creative ways to structure their investments
by Marcia Ellis and Auria Styles
Foreign private equity investors for the past several years have often invested in PRC companies by bringing the Chinese founders of such companies offshore and investing together with the founders in an offshore special purpose vehicle (SPV). The investors successfully exited their investments by listing the SPV on a foreign stock exchange or selling the shares—through a trade sale—to another fund or strategic investor. This investment strategy, commonly known as "round-tripping," was essentially prohibited when the Provisions on Acquisition of Domestic Enterprises by Foreign Investors (mergers and acquisitions [M&A] rules) took effect on September 8, 2006.
As a result, private equity investors must rethink their investment structures and move their joint ventures (JVs) with the Chinese founders of the investee companies from relatively unregulated tax havens, such as the Cayman Islands and British Virgin Islands, to the more restrictive environment of mainland China. These changes, however, have not deterred foreign investors and their Chinese partners from structuring investments in Chinese JVs that replicate, to the extent possible, the features of their offshore JVs.
Anatomy of the M&A rules
The final M&A rules are similar to the 2003 Interim Provisions on the Acquisition of Domestic Enterprises by Foreign Investors, which provided the first firm legal basis for the acquisition of the equity of a non-foreign-invested PRC company by a foreign investor and permitted a number of transaction structures that previously had been of dubious legality. For foreign investors, the most troubling aspect of the interim measures was the antitrust provisions that required the PRC Ministry of Commerce (MOFCOM) and the State Administration for Industry and Commerce to review acquisitions that met certain thresholds. In retrospect, however, these provisions appear largely to have been a trial balloon for China's long-awaited Antimonopoly Law—slated to pass this year—and have yet to be used by MOFCOM to block foreign acquisitions.
The final M&A rules retain most of the provisions of the interim measures but also include sections that attempt to control the various forms of round-tripping by requiring MOFCOM approval for such transactions, regardless of the size of the investment. The criteria that MOFCOM currently uses to determine which, if any, round-trip transactions it will approve remain unclear, and, to date, there have been few reported cases of such approvals. Thus, many private equity funds are seeking alternative means of structuring investments to avoid the requirement of MOFCOM approval.
Onshore investments
Structural challenges
To avoid MOFCOM approval for round-tripping transactions, companies can invest directly in JVs in China. The fundamental nature of foreign-invested enterprises (FIEs), however, renders onshore investments more difficult. For example, in the United States and offshore tax havens, it is possible to create two classes of stock—preferred and common—but in China, only one class of equity is available for FIEs. As a result, it is difficult to structure investments in a way that would allow funds to enjoy some of the basic preferential rights associated with private equity investments, such as preferential payment of dividends and liquidation proceeds. In addition, without two classes of shares it is impossible to effect a value adjustment—for instance, when the investee company fails to meet certain financial targets—by automatically adjusting the rate at which preferred shares are converted into common shares. Investors without these protections are relatively unprotected in a downside scenario, making these onshore investments in China inherently more risky.
Although it is possible to structure dividend preferences in an onshore investment in a cooperative JV (CJV), obtaining approval for such investment vehicles is becoming increasingly difficult in some areas of China. Some local PRC officials are now carefully scrutinizing CJV structures to ensure that investors do not abuse the flexibility of the structure for purposes of creating dividend preferences that are not otherwise permitted. Currently, PRC law allows for liquidation preferences in both equity and cooperative JVs, and in several localities in China, foreign investors have obtained approvals for favorable liquidation preferences in their onshore JVs.
Another difficulty with setting up mainland JVs is that conversion price adjustments (sometimes called valuation adjustment mechanisms [VAMs]) require skillful structuring in an onshore investment. VAMs essentially permit investors to exchange their preferred shares for a larger number of common shares if the investee company does not meet certain financial targets. For example, an investor generally calculates its purchase price based on a multiple of the investee company's earnings for the following year. If the investee's earnings do not meet that amount, a VAM will be triggered, and the percentage of the total number of the investor's preferred shares that can be converted into the common shares of the investee will increase. Because there is only one class of equity in FIEs, and thus no conversion of preferred shares into common shares, it is impossible to directly implement a VAM in an FIE.
To structure VAM-like mechanisms in FIEs, foreign investors must use either debt that is capitalized at a different rate, depending on whether the relevant financial targets are met, or use a holdback provision—which transfers a certain percentage of equity to the founder if and when the financial targets are met. Provisions incorporating these features into the transaction documents must be drafted carefully to avoid various pitfalls—such as potential conflicts with statutory rights of first refusal—and comply with PRC law. In some cases, these provisions must also comply with extra-legal requirements imposed by approval authorities when reviewing JV contracts. For example, investors must address officials' concerns that foreign parties are obtaining too many benefits and that an overall "fairness" requirement has been breached.
Finally, structuring and implementing call and put options—the rights to purchase or sell equity at a certain time at a certain price—in an FIE is also challenging. Although it is possible to receive approval for call and put provisions in a JV contract that comply with PRC law, implementing them proves more difficult. After the initial JV contract approval, the actual transfer of equity requires additional board and government approvals. If the JV partner is a state-owned enterprise, it may not determine, at the time of the original transaction, the exercise price because the value of the interest to be transferred must be appraised by a duly qualified asset valuation firm at the time of the transfer, and the exercise price cannot be less than the appraised value. Thus, such structuring requires creativity and deep knowledge of PRC regulations and how they are implemented.
Exit challenges
Perhaps the greatest challenge faced by a foreign private equity investor that invests in an onshore JV is finding a viable exit strategy. Without round-tripping, an overseas listing would be hard to accomplish. Although the M&A rules permit founders and investors to swap the equity of an onshore entity for the shares of an SPV incorporated for the purpose of a listing shortly before it lists, such an undertaking cannot occur unless other requirements in the M&A rules are met. For example, a minimum initial public offering price must be set months before it actually takes place. Because these requirements are so onerous, and the uncertainty of obtaining approval so great, most private equity funds are, for the moment, pursuing other methods.
A-share listing
One of those options is to list A shares on a Chinese domestic stock exchange. To do so, an FIE must first obtain MOFCOM approval at the national level to convert into a foreign-invested company limited by shares (FICLS), which must then apply to the China Securities Regulatory Commission (CSRC) for listing. If approval is obtained and the shares of the FICLS listed, each shareholder of the FICLS will be subject to lock-ups stipulated by law and the rules of the relevant stock exchange that prohibit the sale of shares of stock for a specified period—from one to three years depending on when each shareholder made its investment and the percentage interest it holds in the FICLS. After the lock-up period expires, an investor can either sell its shares on the A-share market or effect a private sale.
Because investors face long waiting periods for approvals and lock-ups, it is unclear whether the domestic stock markets will be developed enough to provide the desired liquidity at the time of exit. Despite these hurdles, a number of funds are optimistic about the possibility of exits through A-share listings.
Swap for shares of a listed entity
Another exit alternative permitted under the M&A rules is to make the original investment through a share swap, in which the equity of the domestic investee company is swapped for shares of an offshore listed company. Again, MOFCOM must approve such swaps, but once approved, the fund's ability to exit the investment is essentially guaranteed because it already holds listed shares.
Another possibility would be to swap the shares of an offshore special purpose acquisition corporation (SPAC) for the equity of a PRC domestic company. US securities regulations allow a SPAC to be incorporated and listed immediately, before it acquires any assets. In effect, the SPAC is simply a holding company with a plan to acquire assets but has no existing assets at the time of listing. After listing, the founders of the PRC domestic company could receive the SPAC's shares in exchange for their equity in the domestic company. In turn, the proceeds from the SPAC's listing could be used to expand the business of the domestic company. Implementing such a share swap under the M&A rules and relevant US regulations could present certain difficulties, not the least of which is that listed shares being swapped must have been steadily traded for the 12-month period prior to the swap—a requirement that many SPACs would be unable to meet.
The Internet structure
Some funds are adopting a structure that has been widely used in China's Internet sector to circumvent the need for MOFCOM approval of a round-trip transaction. Often called a Sohu, Sina, or NetEase structure after the PRC Internet giants that pioneered its use, the structure has been used in industries where foreign investment is restricted, such as telecom and media and publishing. Under this structure, the foreign private fund and the PRC founder establish an offshore SPV that in turn forms a wholly foreign-owned enterprise (WFOE) in China. The PRC founder continues to hold all of the equity of the actual onshore operating company, which then enters into a series of contractual arrangements with the WFOE that allows it to take over the operating company and to receive all the after-tax profits of the operating company as fees.
The advantages of this structure are that it does not require MOFCOM approval at the national level because it is not considered a round-trip investment and that the fund can obtain a VAM and enjoy all of the features normally associated with private equity investments through an SPV. In addition, the fund can achieve an exit through an SPV listing.
The disadvantage of this structure is that despite being replicated many times by Chinese media and Internet companies, it is confusing to some foreign investors that are unfamiliar with it. Moreover, MOFCOM could claim that such a transaction constitutes round-tripping since the M&A rules include a broad catch-all provision under which such contractual arrangements could fall. (This provision, set forth in Article 11 of the rules, prohibits parties from using domestic investment by an FIE "or any other means" to circumvent MOFCOM approval.) Finally, even if MOFCOM accepts this structure and does not regard it as "any other means" of circumventing approval, it is unclear whether CSRC will block the SPV listing because of the use of this structure. CSRC officials have stated that they would at least examine closely any such contractual arrangements that were entered into after September 8, 2006 to determine whether the contracts were intended to circumvent MOFCOM approval.
Next steps?
The M&A rules have, for the time being, achieved their unstated purpose: to curtail round-trip investment. In addition, they have slowed private equity investment in China because funds must now pause to consider options for structuring investments and become comfortable with the levels of risk involved in such structures. For now, however, with a bit of creativity and patience, investors are finding novel ways around the more onerous requirements of the M&A rules.
Tuesday, August 28, 2007
Bragging Rights
Who's Advising on ABN Deal? Only 19 Who Insist `I'm Spartacus'
By Ambereen Choudhury
Aug. 28 (Bloomberg) -- Like the rebellious Roman slaves who vowed to save their leader by declaring ``I'm Spartacus,'' the contested sale of ABN Amro Holding NV has 19 investment banks each insisting it is advising the would-be winner in the financial industry's largest takeover.
The Romans never found Spartacus and no one may ever know the real adviser to the victor of this six-month battle. Goldman Sachs Group Inc., UBS AG, Morgan Stanley, Lehman Brothers Holdings Inc. and N.M. Rothschild & Sons Ltd. make equal claim to coaching Amsterdam-based ABN Amro.
For its 61 billion-euro ($83.5 billion) bid for the Netherlands' biggest bank, Barclays Plc has retained Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, JPMorgan Cazenove Ltd. and Lazard Ltd. as counselors. A Royal Bank of Scotland Group Plc-led group appointed Merrill Lynch & Co. the strategist for its 72 billion-euro counter offer and enlisted Greenhill & Co., Fox-Pitt, Kelton Ltd., NIBC Holding NV, Banco Santander SA, Fortis and its own executives for extra help.
``I cannot recall a deal that has so many advisers,'' said Scott Moeller, a professor of mergers and acquisitions at Cass Business School in London and a former banker at Morgan Stanley and Deutsche Bank. ``The most significant issue is bragging rights. It's more important to the bank than the client.''
No securities firm can afford to be left out if it hopes to be counted among the leaders in a record year for mergers and acquisitions. Takeovers already surpassed $3.28 trillion in 2007, just $277 billion short of last year's total, according to data compiled by Bloomberg.
Full Credit
Each banker to ABN Amro will be credited with the full value of the purchase in mergers tables. Those representing London- based Barclays and Edinburgh-based Royal Bank only get recognized if their suitor wins. Santander of Santander, Spain, and Fortis, based in Brussels and the Dutch city of Utrecht, are bidding with Royal Bank.
This year's top three advisers -- New York-based Goldman, Citigroup and Morgan Stanley -- have little more than ABN Amro's $90 billion market value separating them in the rankings.
Goldman and Morgan Stanley's spots are safe no matter who wins because they are working for ABN Amro. Citigroup will lose its No. 2 ranking if the Barclays bid fails, while Merrill would drop as low as eighth place from fifth should Royal Bank lose.
A handful of the firms will get the lion's share of what New York-based Freeman & Co. estimates to be as much as $459 million in M&A fees because most are providing limited services for their clients, said people with knowledge of the talks. Bankers may collect another $170 million for underwriting the stocks and bonds needed to finance the acquisition, according to Freeman.
`Trophy Deal'
The purchase of the biggest Dutch bank will eclipse Travelers Group Inc.'s $69.9 billion buyout of Citicorp in 1998, until now the biggest in the financial industry. It also may become the third-largest ever, behind the $186 billion acquisition of America Online Inc. by Time Warner Inc. in 2000 and Vodafone Group Plc's $185 billion hostile takeover of Mannesmann AG in 1999, according to Bloomberg data.
``Nobody wants to miss it,'' said David Dodds, an investment analyst who helps manage $1.2 billion at SVM Asset Management in Edinburgh. ``It's a trophy deal.''
ABN Amro has become more important after the rout in securities related to subprime mortgages caused investors to shun riskier assets, increasing costs for financing mergers.
Fees from advising in mergers accounted for about 5 percent, or about $6.4 billion, of the combined revenue last year at Goldman, Morgan Stanley, Merrill and Lehman. Fixed-income and equities trading generated about half of the firms' revenue and underwriting accounted for almost 9 percent.
Slowest Month
August has been the slowest month for deals since July 2005, Bloomberg data show. London-based Cadbury Schweppes Plc, the world's biggest candy maker, and Virgin Media Inc. have delayed asset sales. Atlanta-based Home Depot Inc., the biggest home- improvement retailer, had to cut the price on its contractor- supply business by 18 percent to $8.5 billion to salvage a sale.
Using a group of banks allows companies to reward financiers and eliminate support for rival bidders.
``Companies hire advisers to honor prior favors and relationships,'' said Roy Smith, professor of finance at New York University's Stern School of Business and former head of Goldman's London office. ``It probably doesn't make too much difference how many you have, except that the chairman will get fewer frantic pleading calls if he hires several.''
Six Banks
Barclays hired JPMorgan Cazenove and Lazard in February and added Citigroup, Credit Suisse and Deutsche Bank in March, the month it announced the merger talks. It also has about 15 of its own employees on the deal.
Until last year, Barclays Chairman Marcus Agius, 61, was the U.K chairman of New York-based Lazard, the firm run by Bruce Wasserstein. He helped arrange Halifax Group Plc's 9.8 billion- pound ($20 billion) purchase of Bank of Scotland in 2001 to create HBOS Plc, the biggest U.K. mortgage lender.
Lazard's team is led by Jeffrey Rosen, 59, who advised Wal- Mart Stores Inc., the world's biggest retailer, in its acquisition of U.K. supermarket chain Asda Group Plc for $10.8 billion in 1999.
JPMorgan Cazenove's corporate-broking relationship with Barclays stretches back more than two decades. Cazenove, overseen by Chairman David Mayhew, 67, formed a joint venture with New York-based JPMorgan Chase & Co.'s U.K. unit in 2004.
Corporate Brokers
Corporate brokers, unique to the U.K., act as liaisons with investors and help companies comply with London Stock Exchange rules. They accept nominal fees or work for free, expecting the relationship will lead to underwriting and M&A assignments.
Credit Suisse, the second-largest Swiss bank, has been Barclays's other broker for about 15 years. Zurich-based Credit Suisse worked on the U.K. company's largest deals, including the 5.9 billion-pound purchase of Woolwich Plc in 2000, and bought Barclays's BZW equities and investment-banking arm 10 years ago. The team is led by London-based European mergers chief David Livingstone, 44, and Ewen Stevenson.
Frankfurt-based Deutsche Bank's team is led by Tony Burgess, 48, and Tadhg Flood, 35, while Citigroup's is under Hamid Biglari, 48, and Christopher Williams. The biggest German bank and Citigroup, the largest U.S. financial-services company, were hired for their relationships with hedge funds and prime- brokerage businesses, according to two people with knowledge of the deal.
Balance Sheets
``A number of the advisers are there to prevent them representing others,'' said Philip Keevil, a senior partner in London at Compass Advisers LLP and former head of European mergers at Salomon Smith Barney Inc. ``Some of them are there because they have large balance sheets and could help push the ball over the line.''
Morgan Stanley's Donald Moore and UBS's John Cryan are the lead advisers to ABN Amro. Zurich-based UBS arranged the Dutch bank's sale of its Bouwfonds property management units for 1.69 billion euros last year. UBS, the biggest Swiss bank, and Morgan Stanley, the second-largest U.S. securities firm by market value, have been paid about 39 million euros each, according to U.S. regulatory filings.
ABN Amro's own employees are playing a part, along with bankers from Goldman, New York-based Lehman and London-based N.M. Rothschild.
The Royal Bank-led group is relying on a team of about 15 Merrill bankers led by Andrea Orcel, 44, and London-based Matthew Greenburgh, 46. Merrill has advised Royal Bank since about 1999, when the company bought National Westminster Bank Plc in a 23.6 billion-pound hostile takeover. Merrill has also advised Santander, according to Bloomberg data.
Merrill Lynch
New York-based Merrill, the third-biggest U.S. brokerage firm, may earn about 90 million euros from advising the Royal Bank group if it's successful, according to a person with direct knowledge of the talks. It may get another $120 million for helping finance the deal, Freeman's estimates show.
The members of the Royal Bank group are also using advisers from their own companies as well as New York-based Greenhill, NIBC, based in the Hague, and Fox-Pitt, Kelton, a London firm specializing in the financial industry, according to Bloomberg data.
ABN Amro spokesman Jochem van de Laarschot said the company has ``a number of advisers and they each have their role.'' Spokespeople for all the banks weren't immediately available or declined to comment.
Multiple advisers are common in larger deals. The 13 billion-euro takeover battle for Altadis SA, the Spanish maker of Gauloises cigarettes, and the 63 billion-euro contest for Endesa SA, Spain's largest power company, both attracted about a dozen investment banks, according to Bloomberg data.
``Increasing the number of advisers doesn't increase the quality of the advice,'' said Compass's Keevil. ``It's payback time for the relationship banks, particularly for ABN Amro, for which this is the last deal.''
By Ambereen Choudhury
Aug. 28 (Bloomberg) -- Like the rebellious Roman slaves who vowed to save their leader by declaring ``I'm Spartacus,'' the contested sale of ABN Amro Holding NV has 19 investment banks each insisting it is advising the would-be winner in the financial industry's largest takeover.
The Romans never found Spartacus and no one may ever know the real adviser to the victor of this six-month battle. Goldman Sachs Group Inc., UBS AG, Morgan Stanley, Lehman Brothers Holdings Inc. and N.M. Rothschild & Sons Ltd. make equal claim to coaching Amsterdam-based ABN Amro.
For its 61 billion-euro ($83.5 billion) bid for the Netherlands' biggest bank, Barclays Plc has retained Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, JPMorgan Cazenove Ltd. and Lazard Ltd. as counselors. A Royal Bank of Scotland Group Plc-led group appointed Merrill Lynch & Co. the strategist for its 72 billion-euro counter offer and enlisted Greenhill & Co., Fox-Pitt, Kelton Ltd., NIBC Holding NV, Banco Santander SA, Fortis and its own executives for extra help.
``I cannot recall a deal that has so many advisers,'' said Scott Moeller, a professor of mergers and acquisitions at Cass Business School in London and a former banker at Morgan Stanley and Deutsche Bank. ``The most significant issue is bragging rights. It's more important to the bank than the client.''
No securities firm can afford to be left out if it hopes to be counted among the leaders in a record year for mergers and acquisitions. Takeovers already surpassed $3.28 trillion in 2007, just $277 billion short of last year's total, according to data compiled by Bloomberg.
Full Credit
Each banker to ABN Amro will be credited with the full value of the purchase in mergers tables. Those representing London- based Barclays and Edinburgh-based Royal Bank only get recognized if their suitor wins. Santander of Santander, Spain, and Fortis, based in Brussels and the Dutch city of Utrecht, are bidding with Royal Bank.
This year's top three advisers -- New York-based Goldman, Citigroup and Morgan Stanley -- have little more than ABN Amro's $90 billion market value separating them in the rankings.
Goldman and Morgan Stanley's spots are safe no matter who wins because they are working for ABN Amro. Citigroup will lose its No. 2 ranking if the Barclays bid fails, while Merrill would drop as low as eighth place from fifth should Royal Bank lose.
A handful of the firms will get the lion's share of what New York-based Freeman & Co. estimates to be as much as $459 million in M&A fees because most are providing limited services for their clients, said people with knowledge of the talks. Bankers may collect another $170 million for underwriting the stocks and bonds needed to finance the acquisition, according to Freeman.
`Trophy Deal'
The purchase of the biggest Dutch bank will eclipse Travelers Group Inc.'s $69.9 billion buyout of Citicorp in 1998, until now the biggest in the financial industry. It also may become the third-largest ever, behind the $186 billion acquisition of America Online Inc. by Time Warner Inc. in 2000 and Vodafone Group Plc's $185 billion hostile takeover of Mannesmann AG in 1999, according to Bloomberg data.
``Nobody wants to miss it,'' said David Dodds, an investment analyst who helps manage $1.2 billion at SVM Asset Management in Edinburgh. ``It's a trophy deal.''
ABN Amro has become more important after the rout in securities related to subprime mortgages caused investors to shun riskier assets, increasing costs for financing mergers.
Fees from advising in mergers accounted for about 5 percent, or about $6.4 billion, of the combined revenue last year at Goldman, Morgan Stanley, Merrill and Lehman. Fixed-income and equities trading generated about half of the firms' revenue and underwriting accounted for almost 9 percent.
Slowest Month
August has been the slowest month for deals since July 2005, Bloomberg data show. London-based Cadbury Schweppes Plc, the world's biggest candy maker, and Virgin Media Inc. have delayed asset sales. Atlanta-based Home Depot Inc., the biggest home- improvement retailer, had to cut the price on its contractor- supply business by 18 percent to $8.5 billion to salvage a sale.
Using a group of banks allows companies to reward financiers and eliminate support for rival bidders.
``Companies hire advisers to honor prior favors and relationships,'' said Roy Smith, professor of finance at New York University's Stern School of Business and former head of Goldman's London office. ``It probably doesn't make too much difference how many you have, except that the chairman will get fewer frantic pleading calls if he hires several.''
Six Banks
Barclays hired JPMorgan Cazenove and Lazard in February and added Citigroup, Credit Suisse and Deutsche Bank in March, the month it announced the merger talks. It also has about 15 of its own employees on the deal.
Until last year, Barclays Chairman Marcus Agius, 61, was the U.K chairman of New York-based Lazard, the firm run by Bruce Wasserstein. He helped arrange Halifax Group Plc's 9.8 billion- pound ($20 billion) purchase of Bank of Scotland in 2001 to create HBOS Plc, the biggest U.K. mortgage lender.
Lazard's team is led by Jeffrey Rosen, 59, who advised Wal- Mart Stores Inc., the world's biggest retailer, in its acquisition of U.K. supermarket chain Asda Group Plc for $10.8 billion in 1999.
JPMorgan Cazenove's corporate-broking relationship with Barclays stretches back more than two decades. Cazenove, overseen by Chairman David Mayhew, 67, formed a joint venture with New York-based JPMorgan Chase & Co.'s U.K. unit in 2004.
Corporate Brokers
Corporate brokers, unique to the U.K., act as liaisons with investors and help companies comply with London Stock Exchange rules. They accept nominal fees or work for free, expecting the relationship will lead to underwriting and M&A assignments.
Credit Suisse, the second-largest Swiss bank, has been Barclays's other broker for about 15 years. Zurich-based Credit Suisse worked on the U.K. company's largest deals, including the 5.9 billion-pound purchase of Woolwich Plc in 2000, and bought Barclays's BZW equities and investment-banking arm 10 years ago. The team is led by London-based European mergers chief David Livingstone, 44, and Ewen Stevenson.
Frankfurt-based Deutsche Bank's team is led by Tony Burgess, 48, and Tadhg Flood, 35, while Citigroup's is under Hamid Biglari, 48, and Christopher Williams. The biggest German bank and Citigroup, the largest U.S. financial-services company, were hired for their relationships with hedge funds and prime- brokerage businesses, according to two people with knowledge of the deal.
Balance Sheets
``A number of the advisers are there to prevent them representing others,'' said Philip Keevil, a senior partner in London at Compass Advisers LLP and former head of European mergers at Salomon Smith Barney Inc. ``Some of them are there because they have large balance sheets and could help push the ball over the line.''
Morgan Stanley's Donald Moore and UBS's John Cryan are the lead advisers to ABN Amro. Zurich-based UBS arranged the Dutch bank's sale of its Bouwfonds property management units for 1.69 billion euros last year. UBS, the biggest Swiss bank, and Morgan Stanley, the second-largest U.S. securities firm by market value, have been paid about 39 million euros each, according to U.S. regulatory filings.
ABN Amro's own employees are playing a part, along with bankers from Goldman, New York-based Lehman and London-based N.M. Rothschild.
The Royal Bank-led group is relying on a team of about 15 Merrill bankers led by Andrea Orcel, 44, and London-based Matthew Greenburgh, 46. Merrill has advised Royal Bank since about 1999, when the company bought National Westminster Bank Plc in a 23.6 billion-pound hostile takeover. Merrill has also advised Santander, according to Bloomberg data.
Merrill Lynch
New York-based Merrill, the third-biggest U.S. brokerage firm, may earn about 90 million euros from advising the Royal Bank group if it's successful, according to a person with direct knowledge of the talks. It may get another $120 million for helping finance the deal, Freeman's estimates show.
The members of the Royal Bank group are also using advisers from their own companies as well as New York-based Greenhill, NIBC, based in the Hague, and Fox-Pitt, Kelton, a London firm specializing in the financial industry, according to Bloomberg data.
ABN Amro spokesman Jochem van de Laarschot said the company has ``a number of advisers and they each have their role.'' Spokespeople for all the banks weren't immediately available or declined to comment.
Multiple advisers are common in larger deals. The 13 billion-euro takeover battle for Altadis SA, the Spanish maker of Gauloises cigarettes, and the 63 billion-euro contest for Endesa SA, Spain's largest power company, both attracted about a dozen investment banks, according to Bloomberg data.
``Increasing the number of advisers doesn't increase the quality of the advice,'' said Compass's Keevil. ``It's payback time for the relationship banks, particularly for ABN Amro, for which this is the last deal.''
Friday, August 24, 2007
Restructuring distressed companies using debt-equity swaps
Germany: Corporate Acquisitions Through Debt-Equity Swaps in Germany
01 August 2006
By Dr. Volker Kammel and Dr. Markus Bauer
The German economy has experienced minimal growth for a number of years. Insolvencies have reached record levels, and the number of businesses outside of formal insolvency proceedings, but in need of restructuring, is significant. Recently, however, a number of positive factors have fueled hopes for a revival of the German economy. There has been a strong increase in German industrial production activity and a substantial increase in the generation of new orders and capital expenditures by German businesses. Agreements with employees regarding wage and salary increases have been moderate on the whole, and financing conditions for businesses have been favorable. Although German companies have undergone significant operational restructuring in the past, many continue to exhibit weak balance sheets.
Not surprisingly, economic stagnation and record insolvency levels have left many German banks with large amounts of bad debt on their books. Estimates of aggregated bad debt range from €160 to €300 billion. German banks have historically held bad debt due to strong customer ties. However, beginning in 2003 and continuing in 2004 and 2005, German banks have sold non-performing loan portfolios as well as loans to single borrowers. Banks have become motivated to sell their non-performing loans for a number of reasons. Among them are the new risk-weighting criteria introduced by the Basel II banking accord, which will significantly increase the equity costs associated with banks holding non-performing assets and therefore create a strong incentive for them to sell.
The current market conditions provide excellent investment opportunities with respect to distressed companies and have attracted international investors, particularly U.S. investors who are familiar with distressed asset transactions. Investors typically acquire high-risk loans to companies with turnaround potential at a purchase price significantly below par. They attempt to generate high returns by performing an intensive workout of the acquired loans, usually in connection with a restructuring of the target company.
Structure of the Investment
The structure of the investment depends largely on the needs of the target company. While the specific restructuring measures are normally identified on a case-by-case basis by means of a restructuring plan drafted by turnaround advisors, target companies are invariably in need of new funds and a reduction of their debt burden.
The recapitalization of a distressed company typically involves a reduction of its statutory share capital to reflect the real amount of equity remaining after netting out historical losses. The registered share capital is then increased and new equity is contributed either in the form of cash or by releasing the company from a portion of its debt (debt-equity swap). Frequently, both types of capital increase are combined. The deal structures in this context are flexible and can be adapted to the requirements of different types of investors. Traditional private equity investors typically will seek to acquire 100 percent of the corporate debt in order to take control of the target company after the debt-equity swap and realize their return through an exit after three to five years. More passive investors, on the other hand, might only seek to provide financial resources for the restructuring without taking an active role in the process. These investors are more inclined to execute a modified debt-equity swap where instead of shares, they take convertible bonds or similar mezzanine instruments that are flexible and can be tailored to the specific needs of the investor. Over and above the actual capital measures, the investor may have to provide new lending facilities to the company and/or extend the maturity of any loans remaining after the debt-equity swap.
A successful implementation of a debt-equity swap transaction requires both (i) substantial restructuring expertise and an in-depth knowledge of the target’s industry by the investor and (ii) the full support of at least a majority of the existing shareholders. If these conditions are fulfilled, the debt-equity swap can both save the target company from a possible winding-up and be a very interesting investment.
A number of issues under German law need to be addressed when implementing an investment that involves a debt-equity swap.
Restructuring Plan
Before undertaking the investment, an investor will need to convince himself of the turnaround potential of the target company. Normally, a restructuring plan drawn up by turnaround advisors on the instructions of the target company will be available. Management of a German company in financial difficulty is required to explore restructuring opportunities. Management typically will involve external turnaround specialists when approaching banks for new loans. In order to avoid lender liability exposure, banks will extend loans to companies in financial difficulty only after a restructuring plan has been drawn up that demonstrates that the company is capable of being successfully restructured. The German Institute of Chartered Accountants (Institut der Wirtschaftsprüfer) requires a restructuring plan to set forth an analysis of the situation of the company together with the causes of the crisis and to specify the concrete measures that need to be implemented in order to return the company to profitability, including any necessary contributions by the various stakeholders (e.g., investors, existing shareholders, employees, creditors, etc.).
Consent of Existing Shareholders
To restructure a company successfully through a debt-equity swap transaction, it is important to obtain the consent of at least a majority of the existing shareholders, for both legal and practical reasons. The implementation of the capital measures, in particular the capital decrease and the ensuing capital increase, requires approval by the existing shareholders. Depending on the corporate form of the target and the provisions in the articles of association, the required shareholder approval percentage is usually at least 75 percent. In order to allow the investor to subscribe to the desired number of shares, the subscription rights of the existing shareholders must be waived. In order to convince shareholders whose shareholdings are being diluted that this waiver is necessary for the implementation of the restructuring, the support of a majority of the shareholders and the management of the company is vital. The same is also true for the discussions with the tax and securities authorities regarding necessary exemptions, which are described in more detail below.
Where the investor is unable or unwilling to obtain the consent of the existing management and shareholders to the investment and wants to pursue a more hostile approach, he can theoretically purchase the loans without the consent of the target company, provided that the bank — which typically has a long-standing business relationship with the target — is willing to sell. As the new owner of the non-performing loans, the investor then has significant leverage in the negotiations with management and shareholders. While an acquisition of shares may need to be disclosed, there are no disclosure obligations regarding the holding of certain portions of outstanding corporate debt. Needless to say, the risk that the investor will not achieve his aims with respect to equity in the target company is much higher with a hostile approach than with a consensual approach.
Acquisition of the Loans
Once the investor has decided to invest, he must acquire the company’s debt from the banks. The level of complexity associated with the debt acquisition varies greatly, depending on the structure of the loans, the security (in particular if a security pool agreement is in place), and the selling bank(s) involved. Providing information regarding the loans and the debtor to the investor during a due diligence review can be an issue under German banking secrecy rules unless management has consented to the investment and agrees to the provision of due diligence information to the investor.
The acquisition of the loans can be structured as (i) a subparticipation in the loans and the underlying security, (ii) an assignment of the claims under the loans and the security, or (iii) a complete transfer of the loan agreements and the security agreements. A complete transfer of the loan agreements will usually be chosen where revolving or partially undrawn credit lines are acquired that need to remain available to the company. A transfer requires the consent of all the parties to the agreements that are being transferred and is more complicated as a result. If the loan is part of a syndicated loan or the underlying security is subject to a security pooling agreement, the bank must also transfer its contractual position under these agreements in order to allow the investor to assert his rights against the other members of the syndicate or the security pool. Under German law, the transfer of these contractual positions requires the consent of all other members of the syndicate or the security pool, which adds to the complexity and may delay the process.
Specific issues arise where the loans are secured by a government guaranty. The investor is well advised to approach the government at an early stage because its approval is generally required for a transfer of the guaranty to the investor. In any case, the investor and his advisors must ensure that the contractual positions assigned to the investor allow him to implement the workout strategy, in particular, contribution of the loans to the company in the debt-equity swap and the associated release of security.
Restructuring in Formal Insolvency Proceedings
In Germany, companies in financial difficulty are usually restructured outside of formal insolvency proceedings. The impact of a formal insolvency proceeding on business relations with suppliers and customers is usually severe, and there is a substantial risk that key employees will leave the company due to speculation that the company will be unable to continue with its business operations. However, the high volume of insolvencies in recent years has resulted in a number of successful restructurings in formal insolvency proceedings. Examples such as these are beginning to change the stakeholders’ perception that a formal insolvency process will most probably result in a winding-up of the business.
Formal insolvency proceedings offer a number of advantages for the restructuring of the company, in particular the ability to terminate (and possibly renegotiate the terms of) contracts and the easing of restrictions on the dismissal of employees. Restructuring in formal insolvency proceedings is achieved by means of an insolvency plan. It can be proposed by the insolvent company itself as a prepackaged plan in conjunction with the commencement of insolvency proceedings. The plan can be freely arranged and include all provisions that could be made in an ordinary restructuring agreement (e.g., waiver and deferral of claims, alteration of security, an undertaking of the investor to contribute the acquired loans and/or to provide new capital to the company, or an undertaking of a stakeholder to extend financing to the company to fund the reorganization).
Increasingly, an insolvency plan proposal is combined with a motion for "self-management" by the management of the insolvent company, which is similar to the concept of a chapter 11 "debtor in possession" under U.S. law. Under self-management, the management of the insolvent company remains in control of business operations but is placed under the supervision of a creditors’ trustee. To date, German insolvency courts have rarely left management in control, generally appointing an insolvency administrator who takes control of the company’s business operations. Self-management has the distinct advantage of retaining the experience and market know-how of existing management. An insolvency administrator who is unfamiliar with the company and its operations has very little time to acquaint himself with the business. The chances of prevailing on a motion for self-management can be improved if the insolvent company appoints proven restructuring experts to its board prior to filing an insolvency application. The main advantage of self-management is that the identity and expertise of the personnel who will be implementing the restructuring are known to the stakeholders at the outset of the proceedings. Investors are much more reluctant to invest if it is unclear who is managing the business, and whether such manager will implement the restructuring plan, as is frequently the case when an insolvency administrator is appointed.
Valuation of the Debt
During the course of a debt-equity swap, the non-performing loans will be contributed to the target company as a contribution in kind in exchange for the issuance of new shares that are issued in connection with the increase in the target’s capital. If the loans are contributed to a corporation (either a stock corporation ("AG") or a limited liability company ("GmbH")) or by a limited partner of a limited partnership ("KG"), the fair market value of the contribution (i.e., the claims against the target company based upon the loans) must be at least equal to the nominal value of the shares or partnership interest issued for it. Should the fair market value of the contribution in kind be below the nominal value of the shares, the investor runs the risk that (i) the commercial register will refuse to register and thus prevent the capital increase, or (ii) if the deficiency in the value is discovered after the registration, the investor will be personally liable to pay the shortfall. Because in turnaround situations the fair market value of the loan will be substantially below its nominal value, the exact value has to be determined by means of an expert opinion of an auditor. In the case of a capital increase in a stock corporation, such opinion has to be provided by a court-appointed neutral auditor. In the case of a limited liability company, an expert opinion will typically be requested by the commercial register before the capital increase is registered.
Equitable Subordination of Loans
Typically, an investor will convert only a portion of the purchased loans into equity and will retain the remainder in the form of shareholder loans. Shareholder loans to a company in financial difficulty may be subject to the rules of equitable subordination and may be treated as if they were equity. During an insolvency, equitably subordinated loans rank behind the claims of normal creditors. Outside of formal insolvency, the company may be entitled to refrain from repaying such loans until its financial difficulties have been resolved.
In order to provide an incentive for investors to provide new funds to distressed companies, the rules of equitable subordination were modified by the introduction of the so-called restructuring privilege. Under these rules, existing and new loans by an investor will not be subject to the rules of equitable subordination, provided that the investor becomes a shareholder of the company in a crisis situation with the aim of restructuring the company. Nevertheless, an investor should carefully review whether the requirements of the restructuring privilege have been met.
Tax Exemption for "Restructuring Profits"
Because the nominal amount of the shares issued as consideration for the contribution of the non-performing loans in a debt-equity swap will be significantly lower than the nominal amount of such debt on the books of the company, the target company will show a restructuring profit in the amount of the difference. If this restructuring profit were subject to regular taxation (i.e., income and trade tax), the benefits of the restructuring to the company would be largely eliminated.
In order to address this conflict between the taxation of restructuring profits and the aim of the German Insolvency Code to facilitate the restructuring of a distressed company, the German Federal Finance Ministry on March 27, 2003, issued a letter to the state tax authorities providing that income tax on restructuring profits shall be deferred and subsequently waived under the principles of equity (sachliche Billigkeitsgründe) if the following conditions are met: the company is (i) in a crisis but (ii) capable of being restructured and (iii) the tax waiver is a suitable and sufficient restructuring measure and (iv) the investor intends to restructure the company. The tax authorities will normally require the company to provide them with its restructuring plan to determine whether these conditions have been fulfilled.
Once the tax authority has qualified the profits as privileged restructuring profits and agreed to defer and waive the respective income tax, the company can apply to the municipality where the company’s operations are located for a similar decision with respect to the trade tax. Although these are two separate proceedings and the municipality is not bound by the decision of the tax authority, the municipality generally follows the lead of the tax authority, particularly if the waiver of the trade tax is necessary for a successful restructuring of the company and the decision will keep jobs and a (potential) taxpayer in the city.
Exemption From Mandatory Tender Offer
If the target company is listed on a stock exchange, the rules of the German Takeover Code (Wertpapiererwerbs- und Übernahmegesetz) apply. Pursuant to the German Takeover Code, an investor who acquires shares in a listed company as a result of a debt-equity swap or otherwise and subsequently directly or indirectly holds at least 30 percent of the voting rights in the company must make a mandatory tender offer for all of the remaining shares of the company. This obligation generally makes any debt-equity swap transaction regarding a public company unattractive for an investor who, alone or jointly with other investors, intends to take a controlling interest in the company in order to implement the restructuring plan. In order to address this concern, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, or "BaFin") may exempt an investor from the obligation to make a tender offer if the investor gains control of the target company in connection with the restructuring of the company.
The decision to grant an exemption is in the discretion of BaFin. However, the exemption will generally be granted if the interests of the other shareholders are not negatively affected and the investor can demonstrate to BaFin that the target company is in a serious crisis and that the planned restructuring measures are suitable to restructure the company. In addition, the investor seeking the exemption must make a substantial restructuring contribution to the company, which in the case of a debt-equity swap will be the waiver of the claims under the acquired loans plus, in most cases, the provision of new money. The investor can apply for the exemption either before he assumes a controlling interest in the company or within seven days thereafter.
Conclusion
German companies in financial difficulty continue to provide interesting investment opportunities for international investors. The acquisition of controlling stakes by means of debt-equity swaps is no longer a novelty in the German market. Although it is potentially more complicated than a straightforward M&A transaction, a debt-equity swap can still offer extremely attractive returns.
01 August 2006
By Dr. Volker Kammel and Dr. Markus Bauer
The German economy has experienced minimal growth for a number of years. Insolvencies have reached record levels, and the number of businesses outside of formal insolvency proceedings, but in need of restructuring, is significant. Recently, however, a number of positive factors have fueled hopes for a revival of the German economy. There has been a strong increase in German industrial production activity and a substantial increase in the generation of new orders and capital expenditures by German businesses. Agreements with employees regarding wage and salary increases have been moderate on the whole, and financing conditions for businesses have been favorable. Although German companies have undergone significant operational restructuring in the past, many continue to exhibit weak balance sheets.
Not surprisingly, economic stagnation and record insolvency levels have left many German banks with large amounts of bad debt on their books. Estimates of aggregated bad debt range from €160 to €300 billion. German banks have historically held bad debt due to strong customer ties. However, beginning in 2003 and continuing in 2004 and 2005, German banks have sold non-performing loan portfolios as well as loans to single borrowers. Banks have become motivated to sell their non-performing loans for a number of reasons. Among them are the new risk-weighting criteria introduced by the Basel II banking accord, which will significantly increase the equity costs associated with banks holding non-performing assets and therefore create a strong incentive for them to sell.
The current market conditions provide excellent investment opportunities with respect to distressed companies and have attracted international investors, particularly U.S. investors who are familiar with distressed asset transactions. Investors typically acquire high-risk loans to companies with turnaround potential at a purchase price significantly below par. They attempt to generate high returns by performing an intensive workout of the acquired loans, usually in connection with a restructuring of the target company.
Structure of the Investment
The structure of the investment depends largely on the needs of the target company. While the specific restructuring measures are normally identified on a case-by-case basis by means of a restructuring plan drafted by turnaround advisors, target companies are invariably in need of new funds and a reduction of their debt burden.
The recapitalization of a distressed company typically involves a reduction of its statutory share capital to reflect the real amount of equity remaining after netting out historical losses. The registered share capital is then increased and new equity is contributed either in the form of cash or by releasing the company from a portion of its debt (debt-equity swap). Frequently, both types of capital increase are combined. The deal structures in this context are flexible and can be adapted to the requirements of different types of investors. Traditional private equity investors typically will seek to acquire 100 percent of the corporate debt in order to take control of the target company after the debt-equity swap and realize their return through an exit after three to five years. More passive investors, on the other hand, might only seek to provide financial resources for the restructuring without taking an active role in the process. These investors are more inclined to execute a modified debt-equity swap where instead of shares, they take convertible bonds or similar mezzanine instruments that are flexible and can be tailored to the specific needs of the investor. Over and above the actual capital measures, the investor may have to provide new lending facilities to the company and/or extend the maturity of any loans remaining after the debt-equity swap.
A successful implementation of a debt-equity swap transaction requires both (i) substantial restructuring expertise and an in-depth knowledge of the target’s industry by the investor and (ii) the full support of at least a majority of the existing shareholders. If these conditions are fulfilled, the debt-equity swap can both save the target company from a possible winding-up and be a very interesting investment.
A number of issues under German law need to be addressed when implementing an investment that involves a debt-equity swap.
Restructuring Plan
Before undertaking the investment, an investor will need to convince himself of the turnaround potential of the target company. Normally, a restructuring plan drawn up by turnaround advisors on the instructions of the target company will be available. Management of a German company in financial difficulty is required to explore restructuring opportunities. Management typically will involve external turnaround specialists when approaching banks for new loans. In order to avoid lender liability exposure, banks will extend loans to companies in financial difficulty only after a restructuring plan has been drawn up that demonstrates that the company is capable of being successfully restructured. The German Institute of Chartered Accountants (Institut der Wirtschaftsprüfer) requires a restructuring plan to set forth an analysis of the situation of the company together with the causes of the crisis and to specify the concrete measures that need to be implemented in order to return the company to profitability, including any necessary contributions by the various stakeholders (e.g., investors, existing shareholders, employees, creditors, etc.).
Consent of Existing Shareholders
To restructure a company successfully through a debt-equity swap transaction, it is important to obtain the consent of at least a majority of the existing shareholders, for both legal and practical reasons. The implementation of the capital measures, in particular the capital decrease and the ensuing capital increase, requires approval by the existing shareholders. Depending on the corporate form of the target and the provisions in the articles of association, the required shareholder approval percentage is usually at least 75 percent. In order to allow the investor to subscribe to the desired number of shares, the subscription rights of the existing shareholders must be waived. In order to convince shareholders whose shareholdings are being diluted that this waiver is necessary for the implementation of the restructuring, the support of a majority of the shareholders and the management of the company is vital. The same is also true for the discussions with the tax and securities authorities regarding necessary exemptions, which are described in more detail below.
Where the investor is unable or unwilling to obtain the consent of the existing management and shareholders to the investment and wants to pursue a more hostile approach, he can theoretically purchase the loans without the consent of the target company, provided that the bank — which typically has a long-standing business relationship with the target — is willing to sell. As the new owner of the non-performing loans, the investor then has significant leverage in the negotiations with management and shareholders. While an acquisition of shares may need to be disclosed, there are no disclosure obligations regarding the holding of certain portions of outstanding corporate debt. Needless to say, the risk that the investor will not achieve his aims with respect to equity in the target company is much higher with a hostile approach than with a consensual approach.
Acquisition of the Loans
Once the investor has decided to invest, he must acquire the company’s debt from the banks. The level of complexity associated with the debt acquisition varies greatly, depending on the structure of the loans, the security (in particular if a security pool agreement is in place), and the selling bank(s) involved. Providing information regarding the loans and the debtor to the investor during a due diligence review can be an issue under German banking secrecy rules unless management has consented to the investment and agrees to the provision of due diligence information to the investor.
The acquisition of the loans can be structured as (i) a subparticipation in the loans and the underlying security, (ii) an assignment of the claims under the loans and the security, or (iii) a complete transfer of the loan agreements and the security agreements. A complete transfer of the loan agreements will usually be chosen where revolving or partially undrawn credit lines are acquired that need to remain available to the company. A transfer requires the consent of all the parties to the agreements that are being transferred and is more complicated as a result. If the loan is part of a syndicated loan or the underlying security is subject to a security pooling agreement, the bank must also transfer its contractual position under these agreements in order to allow the investor to assert his rights against the other members of the syndicate or the security pool. Under German law, the transfer of these contractual positions requires the consent of all other members of the syndicate or the security pool, which adds to the complexity and may delay the process.
Specific issues arise where the loans are secured by a government guaranty. The investor is well advised to approach the government at an early stage because its approval is generally required for a transfer of the guaranty to the investor. In any case, the investor and his advisors must ensure that the contractual positions assigned to the investor allow him to implement the workout strategy, in particular, contribution of the loans to the company in the debt-equity swap and the associated release of security.
Restructuring in Formal Insolvency Proceedings
In Germany, companies in financial difficulty are usually restructured outside of formal insolvency proceedings. The impact of a formal insolvency proceeding on business relations with suppliers and customers is usually severe, and there is a substantial risk that key employees will leave the company due to speculation that the company will be unable to continue with its business operations. However, the high volume of insolvencies in recent years has resulted in a number of successful restructurings in formal insolvency proceedings. Examples such as these are beginning to change the stakeholders’ perception that a formal insolvency process will most probably result in a winding-up of the business.
Formal insolvency proceedings offer a number of advantages for the restructuring of the company, in particular the ability to terminate (and possibly renegotiate the terms of) contracts and the easing of restrictions on the dismissal of employees. Restructuring in formal insolvency proceedings is achieved by means of an insolvency plan. It can be proposed by the insolvent company itself as a prepackaged plan in conjunction with the commencement of insolvency proceedings. The plan can be freely arranged and include all provisions that could be made in an ordinary restructuring agreement (e.g., waiver and deferral of claims, alteration of security, an undertaking of the investor to contribute the acquired loans and/or to provide new capital to the company, or an undertaking of a stakeholder to extend financing to the company to fund the reorganization).
Increasingly, an insolvency plan proposal is combined with a motion for "self-management" by the management of the insolvent company, which is similar to the concept of a chapter 11 "debtor in possession" under U.S. law. Under self-management, the management of the insolvent company remains in control of business operations but is placed under the supervision of a creditors’ trustee. To date, German insolvency courts have rarely left management in control, generally appointing an insolvency administrator who takes control of the company’s business operations. Self-management has the distinct advantage of retaining the experience and market know-how of existing management. An insolvency administrator who is unfamiliar with the company and its operations has very little time to acquaint himself with the business. The chances of prevailing on a motion for self-management can be improved if the insolvent company appoints proven restructuring experts to its board prior to filing an insolvency application. The main advantage of self-management is that the identity and expertise of the personnel who will be implementing the restructuring are known to the stakeholders at the outset of the proceedings. Investors are much more reluctant to invest if it is unclear who is managing the business, and whether such manager will implement the restructuring plan, as is frequently the case when an insolvency administrator is appointed.
Valuation of the Debt
During the course of a debt-equity swap, the non-performing loans will be contributed to the target company as a contribution in kind in exchange for the issuance of new shares that are issued in connection with the increase in the target’s capital. If the loans are contributed to a corporation (either a stock corporation ("AG") or a limited liability company ("GmbH")) or by a limited partner of a limited partnership ("KG"), the fair market value of the contribution (i.e., the claims against the target company based upon the loans) must be at least equal to the nominal value of the shares or partnership interest issued for it. Should the fair market value of the contribution in kind be below the nominal value of the shares, the investor runs the risk that (i) the commercial register will refuse to register and thus prevent the capital increase, or (ii) if the deficiency in the value is discovered after the registration, the investor will be personally liable to pay the shortfall. Because in turnaround situations the fair market value of the loan will be substantially below its nominal value, the exact value has to be determined by means of an expert opinion of an auditor. In the case of a capital increase in a stock corporation, such opinion has to be provided by a court-appointed neutral auditor. In the case of a limited liability company, an expert opinion will typically be requested by the commercial register before the capital increase is registered.
Equitable Subordination of Loans
Typically, an investor will convert only a portion of the purchased loans into equity and will retain the remainder in the form of shareholder loans. Shareholder loans to a company in financial difficulty may be subject to the rules of equitable subordination and may be treated as if they were equity. During an insolvency, equitably subordinated loans rank behind the claims of normal creditors. Outside of formal insolvency, the company may be entitled to refrain from repaying such loans until its financial difficulties have been resolved.
In order to provide an incentive for investors to provide new funds to distressed companies, the rules of equitable subordination were modified by the introduction of the so-called restructuring privilege. Under these rules, existing and new loans by an investor will not be subject to the rules of equitable subordination, provided that the investor becomes a shareholder of the company in a crisis situation with the aim of restructuring the company. Nevertheless, an investor should carefully review whether the requirements of the restructuring privilege have been met.
Tax Exemption for "Restructuring Profits"
Because the nominal amount of the shares issued as consideration for the contribution of the non-performing loans in a debt-equity swap will be significantly lower than the nominal amount of such debt on the books of the company, the target company will show a restructuring profit in the amount of the difference. If this restructuring profit were subject to regular taxation (i.e., income and trade tax), the benefits of the restructuring to the company would be largely eliminated.
In order to address this conflict between the taxation of restructuring profits and the aim of the German Insolvency Code to facilitate the restructuring of a distressed company, the German Federal Finance Ministry on March 27, 2003, issued a letter to the state tax authorities providing that income tax on restructuring profits shall be deferred and subsequently waived under the principles of equity (sachliche Billigkeitsgründe) if the following conditions are met: the company is (i) in a crisis but (ii) capable of being restructured and (iii) the tax waiver is a suitable and sufficient restructuring measure and (iv) the investor intends to restructure the company. The tax authorities will normally require the company to provide them with its restructuring plan to determine whether these conditions have been fulfilled.
Once the tax authority has qualified the profits as privileged restructuring profits and agreed to defer and waive the respective income tax, the company can apply to the municipality where the company’s operations are located for a similar decision with respect to the trade tax. Although these are two separate proceedings and the municipality is not bound by the decision of the tax authority, the municipality generally follows the lead of the tax authority, particularly if the waiver of the trade tax is necessary for a successful restructuring of the company and the decision will keep jobs and a (potential) taxpayer in the city.
Exemption From Mandatory Tender Offer
If the target company is listed on a stock exchange, the rules of the German Takeover Code (Wertpapiererwerbs- und Übernahmegesetz) apply. Pursuant to the German Takeover Code, an investor who acquires shares in a listed company as a result of a debt-equity swap or otherwise and subsequently directly or indirectly holds at least 30 percent of the voting rights in the company must make a mandatory tender offer for all of the remaining shares of the company. This obligation generally makes any debt-equity swap transaction regarding a public company unattractive for an investor who, alone or jointly with other investors, intends to take a controlling interest in the company in order to implement the restructuring plan. In order to address this concern, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, or "BaFin") may exempt an investor from the obligation to make a tender offer if the investor gains control of the target company in connection with the restructuring of the company.
The decision to grant an exemption is in the discretion of BaFin. However, the exemption will generally be granted if the interests of the other shareholders are not negatively affected and the investor can demonstrate to BaFin that the target company is in a serious crisis and that the planned restructuring measures are suitable to restructure the company. In addition, the investor seeking the exemption must make a substantial restructuring contribution to the company, which in the case of a debt-equity swap will be the waiver of the claims under the acquired loans plus, in most cases, the provision of new money. The investor can apply for the exemption either before he assumes a controlling interest in the company or within seven days thereafter.
Conclusion
German companies in financial difficulty continue to provide interesting investment opportunities for international investors. The acquisition of controlling stakes by means of debt-equity swaps is no longer a novelty in the German market. Although it is potentially more complicated than a straightforward M&A transaction, a debt-equity swap can still offer extremely attractive returns.
Wednesday, August 22, 2007
Cash rich Asian corporates to participate in M&A
Asian Corporate Takeovers to Rise as Buyout Firms Lose Edge
By Denise Kee
Aug. 22 (Bloomberg) -- Mergers and acquisitions by Asian companies will increase as competition from buyout firms declines, said Philip Lee, JPMorgan Chase & Co.'s chief executive officer for Southeast Asia.
The credit crunch caused by defaults on U.S. subprime mortgages will make it more expensive for private equity firms to raise funds for takeovers, he said in Singapore yesterday.
Announced mergers and acquisitions in Southeast Asia by buyout firms accounted for almost half of the $11.1 billion of deals in the 12 months ended Aug. 21, compared with about 10 percent a year earlier, Bloomberg data show. Lee said this trend is set to reverse.
``A lot of companies that are non-private equity and non- hedge funds didn't participate as much in the mergers & acquisition transactions because they were simply out-priced by some of the private equity companies,'' he said.
Low borrowing rates helped buyout firms typically raise two- thirds of the cost of a leveraged takeover by borrowing and then using the target company's cash flow to repay lenders.
``The good days of getting cheap credit will not be there, there will be re-pricing of risk,'' said Lee. ``But buying assets is cheaper than six months ago. There is a trade off between the valuation of acquisitions and fund-raising costs.''
More than 45 companies around the world postponed or reworked their debt sales in the past seven weeks and investors shunned loans and bonds used to fund buyouts, including Kohlberg Kravis Roberts & Co.'s planned takeover of U.K. pharmacy chain Alliance Boots Plc.
Banks including JPMorgan, Goldman Sachs Group Inc. and Deutsche Bank AG have been unable to sell debt for leveraged buyouts they have underwritten, according to Citigroup analyst Keith Horowitz in New York.
JPMorgan is stuck with $40.8 billion of debt, according to Horowitz's estimates, while Goldman is holding $31.9 billion and Deutsche Bank has $27.3 billion.
By Denise Kee
Aug. 22 (Bloomberg) -- Mergers and acquisitions by Asian companies will increase as competition from buyout firms declines, said Philip Lee, JPMorgan Chase & Co.'s chief executive officer for Southeast Asia.
The credit crunch caused by defaults on U.S. subprime mortgages will make it more expensive for private equity firms to raise funds for takeovers, he said in Singapore yesterday.
Announced mergers and acquisitions in Southeast Asia by buyout firms accounted for almost half of the $11.1 billion of deals in the 12 months ended Aug. 21, compared with about 10 percent a year earlier, Bloomberg data show. Lee said this trend is set to reverse.
``A lot of companies that are non-private equity and non- hedge funds didn't participate as much in the mergers & acquisition transactions because they were simply out-priced by some of the private equity companies,'' he said.
Low borrowing rates helped buyout firms typically raise two- thirds of the cost of a leveraged takeover by borrowing and then using the target company's cash flow to repay lenders.
``The good days of getting cheap credit will not be there, there will be re-pricing of risk,'' said Lee. ``But buying assets is cheaper than six months ago. There is a trade off between the valuation of acquisitions and fund-raising costs.''
More than 45 companies around the world postponed or reworked their debt sales in the past seven weeks and investors shunned loans and bonds used to fund buyouts, including Kohlberg Kravis Roberts & Co.'s planned takeover of U.K. pharmacy chain Alliance Boots Plc.
Banks including JPMorgan, Goldman Sachs Group Inc. and Deutsche Bank AG have been unable to sell debt for leveraged buyouts they have underwritten, according to Citigroup analyst Keith Horowitz in New York.
JPMorgan is stuck with $40.8 billion of debt, according to Horowitz's estimates, while Goldman is holding $31.9 billion and Deutsche Bank has $27.3 billion.
Wednesday, August 8, 2007
Grooming up for Sale
Preempting hostile takeovers
Companies that stick to valuation basics can capture any value that would make them attractive for takeover bids.
Jenny Askfelt Ruud, Johan Näs, and Vincenzo Tortorici
(McKinsey Quarterly) The market for corporate control is undergoing a fundamental change: it is not only growing—M&A activity reached record levels in 2006, peaking at nearly $4 trillion globally—but also getting more aggressive. Last year more than 100 hostile transactions, valued at over $520 billion, were announced around the world (Exhibit 1). That’s three times the previous record, in 1999, according to data from Dealogic.
This activity is driven in part by a host of new players—including private-equity firms, hedge funds, and activist shareholders—that seem more and more willing to put companies in play at a moment’s notice. Further complicating the landscape, notably in Europe, is a recent flood of value-creating cross-border opportunities that have appeared as traditional barriers to hostile pursuits erode.
Amid this frenzy, many managers wonder uneasily how vulnerable their companies might be to takeover and contemplate fixes to ward off unwanted attention. Especially when they are under attack, their first reaction may not be the one that would create the most value: they often take last-minute defensive action to resist hostile bids at all costs. Typically, such responses aim only to protect a company’s independence, whether or not it’s in the best interests of shareholders.
In our experience, the best approach both to serve shareholders and to position companies for long-term strategic independence is to think and act preemptively. Even in today’s intense M&A market, companies can proactively assess the “extractable” value that an alternative owner might see and then move to capture it themselves. Much of this approach is simply good housekeeping: sticking to the basics of corporate strategy and rigorously implementing value-creating measures that the best managers have been executing all along. In this way, a company has the best opportunity to capture the value of strategic, operational, financial, and portfolio moves that might otherwise make it an enticing target for an acquisition or hostile takeover by value-hungry predators. Managers who neglect these basics for too long—often as a consequence of noneconomic constraints perceived as unbeatable—not only destroy value by failing to implement sound management practices but may also be hard pressed to explain why a company wouldn’t be better off with new owners.
Yet, incumbent managers enjoy a natural advantage over any potential acquirer because they have superior information about their companies’ operations and overall status. So in theory, they should be able to capture at least as much value as any hostile predator envisions if they can preempt whatever value creation measures a predator may plan and execute them with rigor. By tackling these opportunities well in advance of a possible takeover bid, managers will generate the greatest possible value for current shareholders, even if a hostile bidder never materializes. They will also improve their companies’ positions in the market for corporate control and help prevent the accompanying trauma of a hostile takeover. The value created from such an aggressive stand-alone strategy should be substantial and may therefore induce potential buyers to look elsewhere for “buy-low” opportunities.
A few enduring conceptual frameworks offer managers a structure for diagnosing the vulnerability of their companies to takeover, identifying where outsiders may see pockets of value waiting to be captured, and planning a path forward (Exhibit 2). Many companies have significant untapped potential to create value by improving their operations, restructuring their portfolios, managing their balance sheets, and improving their governance. Management can also take measures to ensure that current market valuations reflect current strategy and performance, as well as improvements over time.
Operational improvements. Companies with untapped operational potential—even solid but average performers—make interesting restructuring candidates, particularly for their leading industry peers and for active-ownership companies that could readily improve their performance. Management should conduct pragmatic, objective private equity-like due diligence to identify ambitious—yet achievable—performance targets for all levers that could create operational value. Companies must identify and act on such opportunities as quickly as possible—for example, by developing a stronger performance culture through renewed incentives, implementing lean processes, or moving or outsourcing production.
Portfolio restructuring. A company with a significant part of its capital in businesses that could be worth more or grow faster under alternative owners will inevitably attract interest—even if those businesses are profitable to the current owners. The lower the value to acquirers and the greater the potential synergies with other players, the more enticing they become.2 Companies can dampen that interest by evaluating the business logic, future strategy, and “M&A tradability” of their own current portfolio and by looking for opportunities to improve its composition. Companies can, for instance, sell noncore assets and commit the proceeds either to high-growth, high-return businesses or to additional shareholder dividends. In one recent example, a large European telecommunications company divested noncore assets worth 15 to 20 percent of its total corporate value to rid itself of businesses and projects that made it an attractive candidate to predators eyeing its valuation if it were broken up.
Balance sheet management. An underperforming financial structure will leave any company vulnerable to acquisition, though of all levers this is one of the fastest (and often least contentious) to pull. Indeed, the fact that appropriate measures can be taken so quickly acts as a powerful enticement to outside investors—particularly private-equity firms. Extraordinary long-term cash balances, high working-capital levels, and underleveraged balance sheets all attract outside attention, for good as well as not-so-good reasons. Management should analyze the company’s balance sheet to identify any pockets of excess capital that can be released (for example, in the form of extra dividends to shareholders) while retaining sufficient cash for productive future growth. The impact of increased leverage will be seen not only in a company’s immediate financial results but also in stronger performance incentives, such as a cash flow orientation among managers and a renewed sense of urgency.
Better governance. Strong or weak governance weighs on all the measures already mentioned. Perceptions of weak governance or a management group whose interests aren’t aligned with those of the shareholders can make a company vulnerable to attack from both external suitors and its own shareholders. For example, once shareholder activists and hedge funds acquired significant control of the Stockholm-based insurance group Skandia, they were able to use their position to exercise material influence over the board’s composition and agenda. Special events, such as option program scandals and turbulent changes in management and the board, made Skandia vulnerable. When governance is an issue, remedies include aligning the interests of top managers with those of the shareholders, increasing the transparency of governance, and making targeted changes in the board of directors and the management team to align the company’s core competencies with its current challenges and, more generally, with global best practices. Installing best-practice performance-management and incentive structures and linking potential upside and downside effects to corporate performance (similar to what private-equity firms implement for their portfolio companies) signal management’s commitment to increasing shareholder value.
Addressing perceptions. As managers implement these strategies, it will be crucial to eliminate any gaps in perception between a company’s market value and its potential value after the improvements it undertakes; companies trading at low multiples compared with their industry counterparts attract extra attention. Differences in perceptions develop when investors don’t see or understand how a company is going about creating value or when they lack confidence in management’s ability to deliver it. To address the former problem, executives should ensure that the company has the best possible investor communications, issues candid earnings guidance, liaises routinely with its more professional shareholders, and manages expectations adroitly. To a limited extent, companies can also proactively manage the composition of their investor base by targeting strategic long-term investors to create stability during periods of transformation. This approach may force a company to rebuild its credibility through more aggressive steps, such as replacing senior management or recruiting new board members.
Each of these measures helps companies anticipate and manage the forces that make them most vulnerable, including consolidation and M&A frenzy in their industries, the value that other owners might hope to extract, and still more powerful enablers, such as internal conflicts, failed attempts at hostile takeovers, risk or accounting issues, and bad press.
Do preemptive measures to unlock a company’s full value guarantee its long-term strategic independence? They don’t—and shouldn’t. In some cases, alternative owners may have intrinsic, unique sources of value creation that stand-alone companies can’t match. In others, aggressive players may be deliberately willing to overpay in their quest for size and for leadership in an industry segment. The rational choice for shareholders is then to capture the highest net present value by selling out and pursuing other investments. In daily M&A activity, value creation isn’t always the key driver for acquisitions. But one thing is certain: when a company captures all available pockets of value and systematically closes gaps (that is, opportunities for predators), it will fetch a much higher price if it should ultimately be acquired—and its shareholders should be happy.
Companies that stick to valuation basics can capture any value that would make them attractive for takeover bids.
Jenny Askfelt Ruud, Johan Näs, and Vincenzo Tortorici
(McKinsey Quarterly) The market for corporate control is undergoing a fundamental change: it is not only growing—M&A activity reached record levels in 2006, peaking at nearly $4 trillion globally—but also getting more aggressive. Last year more than 100 hostile transactions, valued at over $520 billion, were announced around the world (Exhibit 1). That’s three times the previous record, in 1999, according to data from Dealogic.
This activity is driven in part by a host of new players—including private-equity firms, hedge funds, and activist shareholders—that seem more and more willing to put companies in play at a moment’s notice. Further complicating the landscape, notably in Europe, is a recent flood of value-creating cross-border opportunities that have appeared as traditional barriers to hostile pursuits erode.
Amid this frenzy, many managers wonder uneasily how vulnerable their companies might be to takeover and contemplate fixes to ward off unwanted attention. Especially when they are under attack, their first reaction may not be the one that would create the most value: they often take last-minute defensive action to resist hostile bids at all costs. Typically, such responses aim only to protect a company’s independence, whether or not it’s in the best interests of shareholders.
In our experience, the best approach both to serve shareholders and to position companies for long-term strategic independence is to think and act preemptively. Even in today’s intense M&A market, companies can proactively assess the “extractable” value that an alternative owner might see and then move to capture it themselves. Much of this approach is simply good housekeeping: sticking to the basics of corporate strategy and rigorously implementing value-creating measures that the best managers have been executing all along. In this way, a company has the best opportunity to capture the value of strategic, operational, financial, and portfolio moves that might otherwise make it an enticing target for an acquisition or hostile takeover by value-hungry predators. Managers who neglect these basics for too long—often as a consequence of noneconomic constraints perceived as unbeatable—not only destroy value by failing to implement sound management practices but may also be hard pressed to explain why a company wouldn’t be better off with new owners.
Yet, incumbent managers enjoy a natural advantage over any potential acquirer because they have superior information about their companies’ operations and overall status. So in theory, they should be able to capture at least as much value as any hostile predator envisions if they can preempt whatever value creation measures a predator may plan and execute them with rigor. By tackling these opportunities well in advance of a possible takeover bid, managers will generate the greatest possible value for current shareholders, even if a hostile bidder never materializes. They will also improve their companies’ positions in the market for corporate control and help prevent the accompanying trauma of a hostile takeover. The value created from such an aggressive stand-alone strategy should be substantial and may therefore induce potential buyers to look elsewhere for “buy-low” opportunities.
A few enduring conceptual frameworks offer managers a structure for diagnosing the vulnerability of their companies to takeover, identifying where outsiders may see pockets of value waiting to be captured, and planning a path forward (Exhibit 2). Many companies have significant untapped potential to create value by improving their operations, restructuring their portfolios, managing their balance sheets, and improving their governance. Management can also take measures to ensure that current market valuations reflect current strategy and performance, as well as improvements over time.
Operational improvements. Companies with untapped operational potential—even solid but average performers—make interesting restructuring candidates, particularly for their leading industry peers and for active-ownership companies that could readily improve their performance. Management should conduct pragmatic, objective private equity-like due diligence to identify ambitious—yet achievable—performance targets for all levers that could create operational value. Companies must identify and act on such opportunities as quickly as possible—for example, by developing a stronger performance culture through renewed incentives, implementing lean processes, or moving or outsourcing production.
Portfolio restructuring. A company with a significant part of its capital in businesses that could be worth more or grow faster under alternative owners will inevitably attract interest—even if those businesses are profitable to the current owners. The lower the value to acquirers and the greater the potential synergies with other players, the more enticing they become.2 Companies can dampen that interest by evaluating the business logic, future strategy, and “M&A tradability” of their own current portfolio and by looking for opportunities to improve its composition. Companies can, for instance, sell noncore assets and commit the proceeds either to high-growth, high-return businesses or to additional shareholder dividends. In one recent example, a large European telecommunications company divested noncore assets worth 15 to 20 percent of its total corporate value to rid itself of businesses and projects that made it an attractive candidate to predators eyeing its valuation if it were broken up.
Balance sheet management. An underperforming financial structure will leave any company vulnerable to acquisition, though of all levers this is one of the fastest (and often least contentious) to pull. Indeed, the fact that appropriate measures can be taken so quickly acts as a powerful enticement to outside investors—particularly private-equity firms. Extraordinary long-term cash balances, high working-capital levels, and underleveraged balance sheets all attract outside attention, for good as well as not-so-good reasons. Management should analyze the company’s balance sheet to identify any pockets of excess capital that can be released (for example, in the form of extra dividends to shareholders) while retaining sufficient cash for productive future growth. The impact of increased leverage will be seen not only in a company’s immediate financial results but also in stronger performance incentives, such as a cash flow orientation among managers and a renewed sense of urgency.
Better governance. Strong or weak governance weighs on all the measures already mentioned. Perceptions of weak governance or a management group whose interests aren’t aligned with those of the shareholders can make a company vulnerable to attack from both external suitors and its own shareholders. For example, once shareholder activists and hedge funds acquired significant control of the Stockholm-based insurance group Skandia, they were able to use their position to exercise material influence over the board’s composition and agenda. Special events, such as option program scandals and turbulent changes in management and the board, made Skandia vulnerable. When governance is an issue, remedies include aligning the interests of top managers with those of the shareholders, increasing the transparency of governance, and making targeted changes in the board of directors and the management team to align the company’s core competencies with its current challenges and, more generally, with global best practices. Installing best-practice performance-management and incentive structures and linking potential upside and downside effects to corporate performance (similar to what private-equity firms implement for their portfolio companies) signal management’s commitment to increasing shareholder value.
Addressing perceptions. As managers implement these strategies, it will be crucial to eliminate any gaps in perception between a company’s market value and its potential value after the improvements it undertakes; companies trading at low multiples compared with their industry counterparts attract extra attention. Differences in perceptions develop when investors don’t see or understand how a company is going about creating value or when they lack confidence in management’s ability to deliver it. To address the former problem, executives should ensure that the company has the best possible investor communications, issues candid earnings guidance, liaises routinely with its more professional shareholders, and manages expectations adroitly. To a limited extent, companies can also proactively manage the composition of their investor base by targeting strategic long-term investors to create stability during periods of transformation. This approach may force a company to rebuild its credibility through more aggressive steps, such as replacing senior management or recruiting new board members.
Each of these measures helps companies anticipate and manage the forces that make them most vulnerable, including consolidation and M&A frenzy in their industries, the value that other owners might hope to extract, and still more powerful enablers, such as internal conflicts, failed attempts at hostile takeovers, risk or accounting issues, and bad press.
Do preemptive measures to unlock a company’s full value guarantee its long-term strategic independence? They don’t—and shouldn’t. In some cases, alternative owners may have intrinsic, unique sources of value creation that stand-alone companies can’t match. In others, aggressive players may be deliberately willing to overpay in their quest for size and for leadership in an industry segment. The rational choice for shareholders is then to capture the highest net present value by selling out and pursuing other investments. In daily M&A activity, value creation isn’t always the key driver for acquisitions. But one thing is certain: when a company captures all available pockets of value and systematically closes gaps (that is, opportunities for predators), it will fetch a much higher price if it should ultimately be acquired—and its shareholders should be happy.
Tuesday, August 7, 2007
Tying up loose ends - Fortis gains investor approval for ABN bid, rights issue approval to follow; Barclays wins EU anti-trust approval
Fortis Shareholders Back Proposal for ABN Amro Bid (Update2)
By Martijn van der Starre and John Martens
Aug. 6 (Bloomberg) -- Fortis, Belgium's largest financial- services company, moved a step closer to buying part of ABN Amro Holding NV after shareholders backed a plan to raise as much as 13 billion euros ($17.9 billion) to pay for the deal.
Investors at a meeting in Brussels approved the 72 billion- euro joint bid by Fortis and two other banks for Amsterdam-based ABN Amro, Fortis said today. More than 93 percent endorsed a rights offer to finance the transaction, which also needs the backing of a meeting in Utrecht this afternoon.
The agreement paves the way for Fortis, Royal Bank of Scotland Group Plc and Banco Santander SA, whose offer is mostly in cash, to trump a competing 65.3 billion-euro share and cash offer from Barclays Plc, said Alan Beaney, who helps manage $2 billion at Principal Investment Management.
``The Royal Bank consortium will win now with their higher offer,'' said Sevenoaks, England-based Beaney, whose holdings include shares of Barclays and Royal Bank. ``Ironically, Barclays's share price and their offer will rise because investors think they are less likely to do the deal.''
Barclays stock rose 0.8 percent to 684.5 pence as of 2:30 p.m. in London. Shares of Fortis fell 1.6 percent to 28 euros in Brussels, valuing the company at 36.5 billion euros.
Fortis plans to pay 24 billion euros for the Dutch retail and commercial banks, as well as the asset-management and private-banking units. It's bidding for 40 percent of ABN Amro, the largest part after ABN Amro sells its Chicago-based LaSalle unit to Bank of America Corp.
`Major Step Forward'
Fortis would increase the number of branches in the Netherlands to 720 from 159 and add more than 4 million retail customers with the purchase. The combined private banking and asset-management units would manage about 500 billion euros in assets, Fortis, based in Utrecht and Brussels, said.
The purchase would be ``a major step forward for our company and we'll be able to speed up our development on an international level,'' Fortis Chief Executive Officer Jean-Paul Votron told shareholders before the vote. It will lead to ``diversification and a better balance in our portfolio,'' Votron said.
ABN Amro withdrew its recommendation of the Barclays bid on July 30, saying it's financially inferior to the proposal by the Royal Bank group. The original agreement with Barclays, announced April 23, won European Union antitrust approval today.
``We continue to believe that Barclays's offer will ultimately deliver more value to ABN Amro shareholders with a low degree of risk and a high certainty of completion,'' Barclays CEO John Varley said today in comments passed on by spokesman Alistair Smith. The formal offer to shareholders, ``is another tangible step towards the merger with ABN Amro,'' Varley said.
`Blow Through Numbers'
Barclays made its formal offer to shareholders today and will hold a meeting with its shareholders to approve the offer Sept. 14. London-based Barclays bid 2.13 ordinary shares and 13.15 euros a share for each ordinary share of ABN Amro.
``The bid of the others is basically maximized,'' Barclays board member and head of consumer banking Frits Seegers said in an interview in Mumbai on Aug. 4. ``Our bid with the rise in share price will blow through these numbers.''
Edinburgh-based Royal Bank is to hold a meeting with its shareholders Aug. 10. ABN Amro shareholders will consider both bids Sept. 20. ABN Amro spokesman Jochem van de Laarschot declined to comment today. Spokespeople for Royal Bank and Barclays also declined to comment.
The acquisition of ABN Amro would be the largest financial- services takeover, exceeding the $69.9 billion combination of Citicorp and Travelers Group Inc. in 1998. Under the plan, Royal Bank would take the Dutch bank's investment banking and Asian consumer units and Banco Santander, Spain's largest bank, would take its Italian and Brazilian unit.
Fortis Share Slump
Fortis also sold 2 billion euros of notes last month that would automatically convert to securities tradable for stock, contingent on Fortis shareholders approving the rights issue. The company agreed to sell its stake in a Spanish insurance venture for 980 million euros.
Fortis shares fell 18 percent through yesterday from April 13, the day ABN Amro said it received a letter from the Royal Bank-led group asking for ``exploratory talks.'' ABN Amro's stock rose 5 percent, valuing the company at 67.3 billion euros.
After today's meeting at the Centre for Fine Arts in Brussels, shareholders discussed the vote and sipped on drinks from strawberry juice to Absolut Vodka and Duval-Leroy champagne.
Stichting VSBfonds, which owns about 4.99 percent of Fortis, voted in favor of the plans, said Luuk van Term, a Utrecht-based spokesman for the non-profit organization.
The takeover is ``very good for growth and employment,'' said Gunther Van Sant, a Belgian who owns Fortis shares and voted in favour of the resolutions. ``If this doesn't take place Fortis may end up being a prey itself.''
``I voted in favor of the bid to support the Fortis management,'' said Roger Smets, who manages about 1.2 million euros at the non-profit Belgian Society for Cremation. Smets said he has ``rock-solid'' confidence in management's plans.
By Martijn van der Starre and John Martens
Aug. 6 (Bloomberg) -- Fortis, Belgium's largest financial- services company, moved a step closer to buying part of ABN Amro Holding NV after shareholders backed a plan to raise as much as 13 billion euros ($17.9 billion) to pay for the deal.
Investors at a meeting in Brussels approved the 72 billion- euro joint bid by Fortis and two other banks for Amsterdam-based ABN Amro, Fortis said today. More than 93 percent endorsed a rights offer to finance the transaction, which also needs the backing of a meeting in Utrecht this afternoon.
The agreement paves the way for Fortis, Royal Bank of Scotland Group Plc and Banco Santander SA, whose offer is mostly in cash, to trump a competing 65.3 billion-euro share and cash offer from Barclays Plc, said Alan Beaney, who helps manage $2 billion at Principal Investment Management.
``The Royal Bank consortium will win now with their higher offer,'' said Sevenoaks, England-based Beaney, whose holdings include shares of Barclays and Royal Bank. ``Ironically, Barclays's share price and their offer will rise because investors think they are less likely to do the deal.''
Barclays stock rose 0.8 percent to 684.5 pence as of 2:30 p.m. in London. Shares of Fortis fell 1.6 percent to 28 euros in Brussels, valuing the company at 36.5 billion euros.
Fortis plans to pay 24 billion euros for the Dutch retail and commercial banks, as well as the asset-management and private-banking units. It's bidding for 40 percent of ABN Amro, the largest part after ABN Amro sells its Chicago-based LaSalle unit to Bank of America Corp.
`Major Step Forward'
Fortis would increase the number of branches in the Netherlands to 720 from 159 and add more than 4 million retail customers with the purchase. The combined private banking and asset-management units would manage about 500 billion euros in assets, Fortis, based in Utrecht and Brussels, said.
The purchase would be ``a major step forward for our company and we'll be able to speed up our development on an international level,'' Fortis Chief Executive Officer Jean-Paul Votron told shareholders before the vote. It will lead to ``diversification and a better balance in our portfolio,'' Votron said.
ABN Amro withdrew its recommendation of the Barclays bid on July 30, saying it's financially inferior to the proposal by the Royal Bank group. The original agreement with Barclays, announced April 23, won European Union antitrust approval today.
``We continue to believe that Barclays's offer will ultimately deliver more value to ABN Amro shareholders with a low degree of risk and a high certainty of completion,'' Barclays CEO John Varley said today in comments passed on by spokesman Alistair Smith. The formal offer to shareholders, ``is another tangible step towards the merger with ABN Amro,'' Varley said.
`Blow Through Numbers'
Barclays made its formal offer to shareholders today and will hold a meeting with its shareholders to approve the offer Sept. 14. London-based Barclays bid 2.13 ordinary shares and 13.15 euros a share for each ordinary share of ABN Amro.
``The bid of the others is basically maximized,'' Barclays board member and head of consumer banking Frits Seegers said in an interview in Mumbai on Aug. 4. ``Our bid with the rise in share price will blow through these numbers.''
Edinburgh-based Royal Bank is to hold a meeting with its shareholders Aug. 10. ABN Amro shareholders will consider both bids Sept. 20. ABN Amro spokesman Jochem van de Laarschot declined to comment today. Spokespeople for Royal Bank and Barclays also declined to comment.
The acquisition of ABN Amro would be the largest financial- services takeover, exceeding the $69.9 billion combination of Citicorp and Travelers Group Inc. in 1998. Under the plan, Royal Bank would take the Dutch bank's investment banking and Asian consumer units and Banco Santander, Spain's largest bank, would take its Italian and Brazilian unit.
Fortis Share Slump
Fortis also sold 2 billion euros of notes last month that would automatically convert to securities tradable for stock, contingent on Fortis shareholders approving the rights issue. The company agreed to sell its stake in a Spanish insurance venture for 980 million euros.
Fortis shares fell 18 percent through yesterday from April 13, the day ABN Amro said it received a letter from the Royal Bank-led group asking for ``exploratory talks.'' ABN Amro's stock rose 5 percent, valuing the company at 67.3 billion euros.
After today's meeting at the Centre for Fine Arts in Brussels, shareholders discussed the vote and sipped on drinks from strawberry juice to Absolut Vodka and Duval-Leroy champagne.
Stichting VSBfonds, which owns about 4.99 percent of Fortis, voted in favor of the plans, said Luuk van Term, a Utrecht-based spokesman for the non-profit organization.
The takeover is ``very good for growth and employment,'' said Gunther Van Sant, a Belgian who owns Fortis shares and voted in favour of the resolutions. ``If this doesn't take place Fortis may end up being a prey itself.''
``I voted in favor of the bid to support the Fortis management,'' said Roger Smets, who manages about 1.2 million euros at the non-profit Belgian Society for Cremation. Smets said he has ``rock-solid'' confidence in management's plans.
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