Risk Minimizing Strategies for Corporate Mergers, Acquisitions and

Divestitures

Richard A. Michelfelder, Ph.D.

Clinical Associate Professor of Finance

July 21, 2014

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Today’s DiscussionOverall Introduction to Today’s Discussion

What is a Merger versus an Acquisition?Large Firms:

• A Successful Divestiture• The Business Plan• Divestiture & Acquisition– buy or sell portions of a firm• Strategic Alliances• Size of the deal• Advance Contracting

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Today’s DiscussionNew Ventures / Venture Capital:

• Additional Considerations for New Ventures:– Minimum Size– Venture Capital Firms’ Challenge– Have Large Cash Outflows– Use the “S” Curve to Predict New Product Sales & Revenues – Do Not be Afraid to Acquire Larger or Earlier

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What are Mergers & Acquisitions?There is no difference! Both involve buying a firm’s assets with either

stock, cash or both.

With a deal one has to be buyer and seller.

Acquiring all or part of a firms assets, tangible or intangible, is done for the purpose of creating new equity value.

An acquisition strategy is meant to create equity value growth for the acquirer by purchasing target firms that have something the acquirer does not.

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What are Mergers & Acquisitions?Key purpose is to buy equity value growth by purchasing assets

that have strategic value to your firm.

Alternative is to grow internally at a slower pace; possibly face a competitive threat. Here’s an example:

• Pepsico buys Pepsi Bottling 8/2009 (too much cash)• Coca Cola buys Coca Bottling 2/2010 (strategic threat)

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Keys for a Successful Divestiture Many businesses do not have a business plan

• Some Fortune 500 firms, closely-held, publicly-traded, large, small

Euphemisms for business plans• Financial plan• Marketing plan• Sales Plan• Strategic Plan• Operating Plan• Exit Strategy

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A Successful Divestiture

Understanding and Using the Keys to a Successful Divestiture is the Best Guide to Managing Your Business.

Successful Divestiture: Get Highest Possible Price!

Always Manage Your Business as if it’s Always Actively for Sale.

When You Raise Capital for an Acquisition, Pay the Lowest Cost of Capital (get high stock prices and low interest rates)

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Many Keys to a Successful Divestiture

Have and use business plan!

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"We studied firms that had developed a business plan at the outset, and found that 85% were still in business after three years. I think that fact speaks for itself," says Jonathan Goldhill, a small-business consultant and former director of an economic development center in California's San Fernando Valley.

quoted from “The Bottom Line on Startup Failures” Karen E. Klein, Business Week, March 4, 2002

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The Question Is: “What Is A Business Plan?”

Let start by stating what it’s not. It’s not any one of these:• Vision• Mission• Strategies• Marketing Plan• Sales Plan• Operational Plan• Financial Projections / Plan• Exit Plan• Report developed by investment bankers, consultants, the “planning

department,” or the lawyers• Offer Memorandum

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Case 1: The Straight and Narrow “Business Plan”

Publicly-Traded Electric Utility (many US electric utilities)

Vision: “provide cheap, reliable electric power and a attractive return to shareholders”

Mission: “generate, transmit, and deliver electricity Long-term plan horizon: 25 years Operational plan horizon: 15 years Operational objective: 99.999% reliable power Results: “Same old, same old” (read: flat stock price)

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Case 2:“Lets buy earnings growth & diversify & stock price will grow”

Diversification of US electric companies:• Banking, hotels, telecommunications, airplanes, etc.

Typical Board / Management Meeting Agenda:• Electric / Gas financials 2 hours• Electric / Gas operating statistics 1 hour• Electric / Gas investment plan 1.5 hours• Our banks, hotels, phone companies

& airlines 20 minutes Results: Chapter 11 bankruptcies / falling stock

prices

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Case 3: “Lets stick to our core business and compete for others’ customers”

Question: Do we have marketing skills to work with customers?

Sure. We have 2 million “ratepayers” right now.

The result:• In California, tripling of electric prices, 2 of 3

utilities in Chapter 11• In New Jersey and Pennsylvania, nothing!

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Case 4: “Lets grow by consolidation: after all, bigger is better”

110 publicly-traded electric utilities in late 80’s down to 60 and dropping

The result:Stock price growth of acquired utility firm nil at 1 to 4%Typical acquisition premium of target firm stock: 20-40%

Investors did not see the value creation from the “big will win in competitive markets” so why acquisitions.

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What’s the problem with these cases?

No Business Plan!

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Case 5: The High Tech Start-Up with the Offer Memorandum

New York City investment banker wrote the plan to raise equity $• Six months to write• 18 months and 30 investor presentations:

The results: • No venture capital firm investors • Angel investor getting anxious • Start-up management very anxious• Cash “burn rate” rising and cash running low

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Case 5: “We need to plan, so we know where we are going”

Developed by management for management in two sleepless days after finally repudiating the banker’s offer memo

The Results:• Revenues from $1 million to over $20 million in one year and

two years after start-up, cash flow and profits attractive to investors

• Multiple syndicated private equity investments • Initial Public Offering in 2006

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Case 5: “What was our problem?”

Investment

Banker’s Plan, Not Ours!

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Case 6: Steady as she goes• Successful 20 year old boutique consulting firm• “Problem”:

– Revenues, profits, cash flow strong every year but flat

• Review of business plan shows they had none but called it one

• Developed a plan with everyone engaged; revenues, profits, cash flow more than doubled in one year

• Real problem? You know the answer by now.

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So then, what is a business plan? Includes ALL of these:

• Vision: What does success look like?• Mission: What are we doing now?• Strategies: Paths for getting there• Marketing Plan: Compelling offer sold to whom?• Sales Plan: Implementing the marketing plan• Operational Plan: Resource needs and deployment• Financial Projections / Plan: Value of success, cash

and capital needs • Exit Plan: If new venture, how do you extract some of the

financial value• EXECUTE: Lets call it business planning and doing!!!!

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That’s the recipe, now just add the ingredients?

No.• The plan must be yours – those who execute the business• Live by your plan. Its not primarily a tool to raise money

or to sell your business. It answers the following questions for everyone in the business:What you are doing?What does success look like? Not in moneyWhat business are you in? Example: McDonald’sWhy are you doing it? Hopefully not for moneyWhy will you succeed?What is the shareholder value created if you succeed?Goals – Are you getting there or not?

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PriceWaterHouseCoopers Keys for Successful Divestiture: Links to Bus. PlanPWC Step No. PWC 10 Steps Michelfelder’s Business Plan

Components

1 Align Org. Objectives Vision / Mission

2 Develop a Divestiture Plan Exit Strategy

3 Assemble Team of Trusted Advisors & Deal Specialists

Operational Plan / Exit Strategy

4 Get “Financial House” in Order Financial Projections / Plan

5 Develop Credible Financial Projections – A Compelling Story

Financial Projections / Plan & entire business plan

6 Understanding Subjective Value – Seeing Your Business through the Eyes of the Buyer

Exit Strategy

7 Initiate Buyer Identification / Assessment Process

Exit Strategy

8 Evaluate Potential Structuring Alternatives

Exit Strategy

9 Re-Visit Specific Transition Objectives and Priorities

Deal Process – not part of business plan

10 Determine Specific Sales Timeline and Execute

Deal Process – not part of business plan

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Personal Note • As an academic researcher, consultant, and entrepreneur, my

message is that a primary key to business and divestiture success is having and executing a business plan with a trusted team of outside advisors

• US Dept. of Commerce survey recently showed that out of 10 start-ups in a specific year, only 2 will exist in 5 years

• I have started or took the helm of 7 businesses, some in large corporations, partnerships, solely-owned LLC’s, consulting, high-tech, energy, real estate, commercial construction; they are all thriving today – I believe, to a large degree, due to business planning and execution, and having outside advisors who kept us in check!

Divestitures & Acquisition: Sell & Buy Only What You Want

If you want a division of a firm, go after only that division, no need to buy the whole firm – save your precious capital.• Example: Lucent Technologies Automated

Metering Division; Scientific Atlanta Controls Systems Division

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Divestitures & Acquisition: Do Not Pay for Value that You

Will CreateThe average acquisition premium for US

publicly traded firms is 40%. Value is not what someone is willing to pay;

there is an objective fundamental financial value based on cash flow and risk.

Example:

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Strategic AlliancesIf you want access to the assets of another

firm, but don’t want to use capital, develop a strategic alliance – save your precious capital.• They are easy to create: a discussion and a one-

page agreement.

• Easy to terminate: Written notification.

• Assess what your firm has that potential alliances may benefit from.

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Size of the DealIf you plan to have an initial public offering

(IPO) of your stock, be sure that the value of your firm is large enough.

Approximately $500 million or larger in firm value will be required to interest investment bankers in an IPO.

Investment banking fees are 3% to 5%.

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Advanced ContractingFor project financing, securing a contract in

advance for the sale of the majority of product output is critical for financing.

Examples: • Electric Power Plant Construction

• Office Building Purchase or Construction

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Discussed So Far:What is a Merger versus an Acquisition?

Large Firms:

• A Successful Divestiture• The Business Plan• Divestiture & Acquisition– buy or sell portions of a firm• Strategic Alliances• Size of the deal• Advance Contracting

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Now We Discuss:New Ventures / Venture Capital:

• Additional Considerations for New Ventures:– Minimum Size– Venture Capital Firms’ Challenge– Have Large Cash Outflows– Use the “S” Curve to Predict New Product Sales & Revenues – Do Not be Afraid to Acquire Larger or Earlier

Minimum SizeEarly stage VC Investment generally have

to be at least $3 to $5 million.

If your plan cannot justify investment at that level, you will not get VC attention.

Why?

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Venture Capital Firm’s Challenge Most VC firms are small, maybe 10 or less people.

Principals have to invest at least $100 million to cover costs

with 2% management fees.

Principals can manage about 5 investments.

With 4 principals managing 5 deals each, investments have to average $5 million each to invest $100 million.

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Large Cash Outflows: Think Big

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New Product Life Cycle Curve: Bass Model or the “S” Curve

The marketing research literature has concluded that new product life cycle curves typically follow an S pattern:

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20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

Time

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t S

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Acquire Larger & Earlier If Needed

There is no reason or business logic for an acquiring firm to be larger than the target acquisition or more mature in stage of business.

All that you need is the money.

If deal is compelling with a good business plan it can be financed by “OPM” or, Other People’s Money.

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Thank you for the invitation to speak to this distinguished group!

Richard A. Michelfelder, Ph.D.

Clinical Associate Professor of Finance

Rutgers University

School of Business – Camden

225 Penn Street

Camden, New Jersey 08203 USA

E-Mail: richmich@rutgers.edu

Mobile phone: 001-609-214-0986

Office: 001-856-225-6919

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