Veritas Financial GroupIntroduction to the Financial Universe

Week 2 – Mergers and Acquisitions

Review from last week / Today’s focus

cash Investors

Secondarymarkets

Government

securities

Cash flow

reinvest

tax

Corporation

dividends,etc.

Today’s discussion

Today’s Agenda – M&A

• What are Mergers and Acquisitions?

• Why do companies enter M&A deals?

• How do they pay for these deals?

• Case Example: Kraft-Cadbury deal

• What role does the investment bank play in M&A transactions?

• How do companies figure out how much to pay?

Refresh: Intro to the Banking System

Retail BanksRetail Banks

Universal BanksUniversal BanksInvestment Banks*Investment Banks*

Commercial BanksCommercial Banks

Introduction to the Banking System

Arranging FinancingArranging Financing Advising on M&AAdvising on M&A

• Client: • Corporations• Financial Sponsors• Governments• Large non-profits

• Services• Equity• Debt• Convertible Securities

• Client: • Corporations• Financial Sponsors

• Services• Advising Buyer• Advising Seller

M&A: What is it?

• An acquisition takes place when one company acquires a smaller one

• A merger takes place when two companies or relatively equal size form one larger company.

• Under current law, all mergers are technically acquisitions.• One company is always the “surviving”

company, even if it is a merger of equals.

Why complete a M&A deal?

Source: Wikipedia

What are they actually buying?

Shareholders Equity = Assets – Liabilities Shareholders Equity = Assets – Liabilities

Assets = Liabilities + Shareholders Equity Assets = Liabilities + Shareholders Equity

The Big Picture: - Mergers and Acquisitions enable a company

to get ownership of another company - There are many reasons a company might

want to do this

The Big Picture: - Mergers and Acquisitions enable a company

to get ownership of another company - There are many reasons a company might

want to do this

Clarification: Public versus Private

Public CompaniesPublic Companies Private CompaniesPrivate Companies

• Refers to Equity Ownership• Equity, in the form of

shares, is split up and listed in a stock exchange

• Shares are made available to the public

• The ‘shareholders’ own a small piece of the company If own voting shares, get a vote on corporate affairs

• Also refers to Equity ownership

• Equity is owned in chunks by founders, individuals, investors

• Ownership is more concentrated and controlled

• Not traded on the stock market

Clarification: Public versus Private

M&A can be done in many forms: • A public company with another public company • A private company ‘taking over’ or merging with

a public company • A public company ‘taking over’ or merging with a

private company • A private company and a private company• An acquisition by an investment firm

Why complete a M&A deal?

• Financial Reasons• Investment will produce attractive return

• Strategic Reasons • Growth

• Access to new markets • Access to new products

• Synergies • Cost and revenue

• Eliminate competitors

Source: Wikipedia

Revenue Synergies

• Allow the merged company to take in more money than the sum of the two prior companies, all at the same costs.

• Example: Bank of America buys MBNA (credit card firm)• BofA markets cards in its branches, so revenue

increases with only a minimal increase in costs.

Overly Simplified Hypothetical

•BofA sells no credit card products

•MBNA has 1 million credit accounts

•BofA buys MBNA and sells MBNA legacy products to BofA customers using existing branches, tellers, etc.

•BofA subsequently sells 500,000 cards.

•This is a revenue synergy.

Cost Synergies

• Allow the merged company to reduce costs below the total costs of the two prior companies, but without experiencing a drop in revenue.

• Example: Coca-Cola buys Vitaminwater• Coca-Cola shuts down/sells Vitaminwater

distribution network • Coca-Cola then uses its existing distribution and

marketing network to sell Vitaminwater products.

• Goal: eliminate redundancy.

Question

If a company is worth $10 billion, would you ever pay $15 billion for it?

Synergies and the Deal Premium

• Deal Value - Market Value = Deal Premium

• A deal premium may be due to synergy potential

• If the company is worth $10 billion, but the synergies are worth $5 billion, as long as the company pays less than $15 billion, it will come out ahead.

Synergies and Deal Premium: Illustration

Market Value $10.0 billion

Expected Revenue Synergies $2.5 billion

Expected Cost Synergies $2.5 billion

Expected Total Synergies $5.0 billion

Bid Price Market Value Deal Premium Value to bidder

$10.0 billion $10.0 billion $0.0 $5.0 billion

$11.0 billion $10.0 billion $1.0 billion $4.0 billion

$12.0 billion $10.0 billion $2.0 billion $3.0 billion

$13.0 billion $10.0 billion $3.0 billion $2.0 billion

$14.0 billion $10.0 billion $4.0 billion $1.0 billion

$15.0 billion $10.0 billion $5.0 billion $0.0 billion

$16.0 billion $10.0 billion $6.0 billion -$1.0 billion

How do companies pay for M&A deals?

• Stock• Better for shareholders if there is confidence in the

deal• Shareholders expectations still high

• Cash or Debt• Better for shareholders if the deal is shaky• Easier to close if there is opposition• Difficult to raise cash

• Most deals are paid by both shares-issuance and cash

Case Study: Kraft and Cadbury

• Largest European food and beverage deal on record

• Why might Kraft and Cadbury want to merge?

Synergies!

• Cadbury has strong growth in emerging markets, like India and Latin America.

• Kraft (Oreo cookies and Philadelphia cream cheese) derives over half its sales from the mature North American market

Case Study: Kraft and Cadbury

• Kraft was advised by Lazard, Citi, Deutsche Bank and Centerview Partners

• Cadbury was advised by Goldman Sachs, Morgan Stanley and UBS.

• The Deal: • The cash-and-stock agreement• Valued each Cadbury share at 840 pence • Split between 500p of cash and 0.1874 new Kraft shares

Role of Banks in M&A Transactions

• Primary role of banks is to advise clients on both sides of deals

• Valuation • How much should we pay? How much should

we accept?• Price depends on synergies.• Bankers spend months scouring the ‘books’ for

synergies.• Consultants often assist with synergies and PMI

• Banks also help arrange financing

The Pitchbook

• Main output from Bankers

• Can Include: • Executive Summary• Bank’s Experience• Market and Company Positioning• Valuation• (Potential Buyers)• (Financing)

Valuation

• Three common ways to analyze ‘value’• Generally all three are taken into account

• Discounted Cash Flow (“DCF”) • “Present Value” of how much cash this company generate

in the future

• Comparable market values (“Comps”) • What are peers trading at?

• Past transactions multiples• How much have another companies paid in the past?

What is a DCF?

Discounted Cash Flow: A way of valuing an asset or company through the concept of time value of money

Would you rather have a dollar today or a dollar tomorrow?

What is present value?

Would you rather have a dollar today or a dollar tomorrow?

•You should always value a dollar today over a dollar tomorrow•This is because something might happen before you get the dollar tomorrow•So, dollars in the future are worth less than a dollar today •If you want to give me dollars in the future, I will need to be compensated somehow for taking on this risk

This is the concept behind “present value”

What is a DCF?

Every DCF analysis needs two things:

Projected cash flows

A discount rate

What is a DCF?

• Let’s go to the Excel…

What is a DCF?

• To get to the present value, you need a discount rate• A discount rate is interest rate

used to calculate the present value of the cash flows

• Rate of compensation that you need to receive be willing to have money in the future versus receiving it today

• The discount rate can be subjective

• Weighted Average Cost of Capital (WACC)

• Capital Asset Pricing Model (CAPM)• Market based

Discount Rate Present Value

12% $1,039

10% $1,104

8% $1,175

6% $1,253

4% $1,338

2% $1,432

0% $1,536

Leading Investment Banks for M&A

Bulge-Bracket Firms 2010 Global M&A League Tables

• Goldman, Sachs & Co.• Bank of America Merrill Lynch• JPMorgan Chase & Co.• Morgan Stanley• Citi

Boutique Firms• Lazard• Greenhill & Company• Perella Weinberg• Moelis & Company• William Blair

FirmDeal Value

Deal Count

1. Goldman Sachs $399.2bn 263

2. Morgan Stanley $355.1bn 287

3. JPMorgan $353.1bn 223

4. Credit Suisse $274.8bn 221

5. BofA Merrill Lynch $263.4bn 173

6. Deutsche Bank $250.5bn 192

7. Barclays Capital $236.0bn 111

8. UBS $203.9bn 202

9. Lazard $180.7bn 199

10. Citi $180.3bn 130

In the News: PPD LBO

• Why are the largest private equity deals in 2011 so much smaller than they were in 2007?

• Many of the biggest PE deals in the last two years have been in the healthcare industry, why do you think that is?

• Carlyle and H&F paid a 30% premium for the stock, why do you think they feel comfortable doing this?