Joseph V. Rizzi Amsterdam Institute of Finance December, 2015.

Joseph V. RizziAmsterdam Institute of Finance

December, 2015

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•Translate General Strategy into M&A Strategy•Determine Screening Criteria•Identify Targets•Screen/Prioritize•Output: Target with Investment Thesis (Business Case)•Outcome: Go forward decision•Next Step: Contact Target

•Valuation (synergies, sensitivity analysis, walk-away price)•Due Diligence•Deal Structure•Negotiation•Pro forma business model•Integration Planning (degree/scope of integration, etc.)•Output: Due Dili Report; Full/Final Business case including Final Financials•Outcome: Go/No Go Decision; Close the Deal

•Leadership •PMI Project Office/Team•100 Day Plan•Communication Plan•Operating Integration•Customer Integration•Cultural Integration•Performance & Synergy Tracking•Fix/Adjust Process•Post Closing Evaluation•Outcome: Accomplish Investment Thesis

Amsterdam Institute of Finance December, 2015

Goal of deal structure should be to maximize value – but different parties have different objectives.

Some Buyer Shareholder Objectives:– Minimize after-tax price paid for the acquisition– Minimize the dilution of their pre-merger ownership stake– Protect deal

Some Seller Shareholder Objectives:– Maximize after-tax price received– Minimize risk of the offer (for a given dollar value of the

deal) e.g. termination and go shop

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Seller

Maximize Value

Create competitive environment among bidders

Avoid surprises from bidders’ diligence

Control information release

Balance length of process against stakeholder expectations

Limit warranties and indemnifications

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Common Goals

Preserve value

Reduce uncertainty

Create efficient tax structure

Minimize distractions

Maintain credibility

Enhance reputation

Separate smoothly

Minimize post-closing disputes

Buyer

Lower Price

Highlight liabilities and risks

Challenge run rates and forecasts

Understand sustainability

Develop advantage over other bidders

Analyze costs and synergies in detail

Maximize warranties and indemnifications

Balance exclusivity and break-frees


Seller Buyer

Maximize Value

Common Goals

Lower Price

AcquisitionNDALOIOffering MemorandumSPA

FinancingBank BookTerm SheetCommitment LetterFee LetterCredit Agreement(s)Intercreditor Agreement(s)Security Document


Price Form of Transaction Form of Payment Control and Governance Social Issues Timing and Deadlines Transaction Hedges


Accounting

Tax CorporateLaw

Securities

Regulatory and AntitrustContract

Structuring Environment

BusinessPlan

TransactionCharacteristics

FinancialPreferences

MarketConditions

Deal

CompetingBidders

Creditors Rights

Amsterdam Institute of Finance December, 2015 7

ContractFormConsiderationPricingConditionsRepos and WarrantiesIndemnitiesChange of ControlCovenants

TaxCapital Gains to SellerWHT on divs and intBasisNOL’sInterest deductibilityTax treatiesConsolidationExit planning

Rating Agencies

Regulatory

Competing BidsSizeFinancial StrengthDilution AnalysisStrategic Fit

SecuritiesNoticeS/H VoteTendersPreemption RightsTriggers

Bankruptcy Framework(Inter-creditor Concerns)SubordinationGuarantees

CorporateNoticePercent by Region/StateLock-Up/Break Up Fee/No ShopPills/DefensesMerger/Consolidation

AntitrustHart/Scott/RodinoSherman ActHHIEuropean CommissionMonopolies & Mergers Commission

AccountingGoodwillFair Market ValueNet WorthConsolidation


Buyer Issues Share Valuation: avoid using undervalued shares

Synergy Risk: use cash if synergy risk low to retain upside Market Risk: who bears risk of shares charging price post offer/pre close Fixed price: seller assumes risk Fixed share: buyer assumes risk Collars/caps: share

Dilution Earnings Book value Ownership

Taxes Asset write-up Tax domicile

Credit Ratings

Seller Issues Valuation: DD on buyer Taxes: defer seller capital gains taxes Liquidity: share float, lock-ups and Regulation Rights


Issues: tax, accounting

Forward: Target merges into buyer’s wholly owned subsidiary with subsidiary as Continuing entityPre transaction Post closeBuyer Buyer

Subsidiary Target Subsidiary(including old target)

Reverse: Target merges into buyer’s wholly owned subsidiary with target as continuing entity. Subsidiary shares converted into target shares; shares converted into buyer sharesPre transaction Post closeBuyer Buyer

Subsidiary Target Target(including subsidiary)


HSR Review Period (30 Calendar Days)

•Engage Investment Bankers• Prepare Merger Agreement, Stockholders Agreement & HSR Premerger Notification• Due Diligence• Fairness Opinion Issued and Boards Approve Merger Agreement• Arrange Financing• Determine Structure (Tax, Accounting, Form, Consideration)

• Sign Merger Agreement & Stockholders Agreement• File HSR Premerger Notification• Commence Preparation of Preliminary Proxy Materials (Schedule 14A)• Issue Press Release• File 8Ks and Schedules 13D

• FilePreliminaryProxy Materials(Schedule 14D)with SEC

• Print and Mail Proxy Materials To Target Stockholders (Assumes Definitive Proxy Materials Are Available)

• HSR Waiting Period Expires, Assuming No Second Request

• Target Stockholder Meeting

• Close Merger

Pre-Commencement Day 1 Calendar CalendarCalendarCalendar Week 7

Period (1 Week) Week 2 Day 10 Day 20 Day 30 Day 40


FinancialFlexibility

TargetCreditRating

DetermineCapital

Structure

Hedge No Action

BankFunding

Acquisition

Bridge Takedow

n

CreditRating

Fixed Income

Asset Carveout Securitization \ Prop Co

Bank Financing

Equity / Near Equity

RefinanceBridge

Fixed-Rate

Floating-Rate

Advisory / Origination Underwriting Product Execution


Purchase/Sale

• Nondisclosure Agreement

• Offering Memorandum

• Data Room

• Letter of Intent

• Sale and Purchase Agreement

Financing

• Commitment Letter(s)

• Term Sheet

• Credit Agreements

• Intercreditor Agreements


BusinessLegalEntity BasisBankruptcyPayment PrioritiesProvisionsReps/Warranties: What are the facts?Operating Covenants: Pre CloseFinancial Covenants: Preserve dealRemediesStructures to reduce credit riskGuaranteesIndemnitiesPledges of StockSubordinationDeposits / Escrows

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PartiesDefinitionsForm: Merger, Tender, Asset Sale,…Consideration: Type, Payment, Mechanics, Calculation,…Reps/Warranties: Duration, Survival

Target: MACBuyer: Issue when stock used

Ordinary Course Covenants: Target will operate as usual during signing/closing gap periodOther Agreements: Filings, Meetings,…Closing Conditions: Regulatory, ShareholderTermination & Expenses: Drop Dead Fee, Drop Dead Date, Termination FeesOther Stuff: Choice of Law, Specific Performance

Useful Sitesapps.americanbar.org/…/mspd-letter-of-Icontracts.onecle.comPLI.edu


Commitment LettersMACDue Diligence

SyndicationFlexMarketing Periods

Fraudulent Conveyance

Loan DocumentationIntercreditorCovenantsConditions

See: lma.eu.com/documents for drafts


Rule of Thumb Measures◦ Balance Sheet Model◦ Cash Flow Model

Detailed Model◦ Matching markets to the need◦ Reverse inquiry◦ Projections (amortization capability)


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LHS Transaction RHS (value) (Claims)

(A) Income / DCF (A) Mechanics (A) Concerns FOCF = NOPAT– (WCI + T + CAPEX) Issues Ratings targets WACC Tax Market availability - menus Ke – Rf x 2 or CAPM Legal IRR Debt = ref rate + spread Accounting MDC (B) Relative Value Regulation (B) Funded Debt Multiples (FDX) Comps Focus (C) Framework Multiples Form R/C – tied to BB Trading Payment Senior (SDX) Transaction (B) Purchase Price Multiple TL/A (amortization tied to projections) (C) Breakup Value (C) Value Allocation 3 – 4X FLL Vp = PreBid Trading + Premium 0.5 – 1X SLL Vr = PreBid value + Synergy T/LB NVAs = Premium - Synergy SDX - T/LA Other Debt FDX - SDX Equity PPX – FDX Subject to IRR constraint


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Purchase Price + Expenses◦ Minimum/Maximum◦ Recapitalization Dividend

Debt Refinancing◦ Callability◦ Premiums◦ Tax Issues

Expenses

Other Uses


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Revolvero Tied to advance against current assetso Crossing liens

Term Loan Ao Macro: Ratio of 3-4x EBITDAo Micro: Amortization analysis tied to cash flow in years 1-7

Term Loan Bo Senior debt ratio less Term Loan A amortizationo 1% P.A./Balloon

Second Lieno Macro: 0.5-1x EBITDAo Limited amortizationo Longer term

Senior/Subordinated Unsecured Other Debt

o Total Debt/EBITDA less Senior Debt/EBITDA

Equityo Funding need less Total Debt/EBITDA

Senior Secured First Lien


Current Asset approach

◦ Use standard advance rates Accounts Receivable 80% Inventory 60% PP&E/Net 40%

◦ Consider the following factors Seasonal Needs Future Working Capital Growth Unexpected Liquidity Needs


Term Loans = Maximum Senior Debt - Revolver

Focus is on Free Operating Cash Flow

Market conditions also dictate the maximum tenor of the loan and the amount required to be amortized

Acceptable asset coverage is also a consideration in determining the size of the term loans


Typical bank financings as structured as follows:Revolving CreditTerm Loan A (amortising)Term Loans B & C (bullet/balloon)

• T/LC Rare

Large unfunded revolvers are seldom used today due to the fact that it is capital unfriendly to banks and companies don’t like to pay for unused commitments.

In the interest of keeping flexibility for the long term, additional indebtedness baskets should be negotiated upfront. This allows companies to access either the bank or bond markets under their existing credit agreements and saves the costs of having to refinance.


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Long Term Debt = Max Total Debt - Max Senior Secured Debt◦ Senior unsecured◦ Sub Debt◦ Other – unitranche, PIK, …

Equity:◦ Equity = Total Uses - Max Total Debt◦ Common◦ Hybrids

Convertibles Preferred


Senior lenders are concerned with the implications of having high yield investors at the table during a restructuring.

EURO High Yield investors to date have not been as vocal as senior bank lenders, viewing the issue as one of pricing rather than principle.

All other things being equal, sophisticated investors will probably price structural subordination at premium.


Holding Company

Intermediate Holding

Company

Operating Company

Operating Company

OperatingCompany

100% EquityInterest

Issues

Issues

High Yield Bonds

SubordinationAgreement

Senior SecuredLoan


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Guarantees

To whatrestructuring

CashAssets

Holding Company

Intermediate Holding

Company

Operating Company

Operating Company

OperatingCompany

100% EquityInterest

Issues

Issues

High Yield Bonds

Support Package

Senior SecuredLoan


There are no standard covenants. They must be tailored to fit each deal and loan structure. The steps in structuring the covenants are:

o Identify the risks (business, financial and structural)o Select Covenants to monitor the risks

• Need to prioritize the risks to monitor because it will be impossible to monitor every risk

• The time and cost to monitor the covenants must be considered (i.e., sometimes one covenant can cover multiple risks)

o Set Appropriate Levels• Want the covenants to trigger a warning before any principal

or interest payments become delinquent. Need to factor in any seasonal needs to the covenant levels.


Major Covenants (financial maintenance) – Industry VariationCAPEXDebt ServiceFixed ChargeFunded DebtNet WorthEarnings

Reason for DeclineInstitutional Loan InvestorsHigh Yield MarketCompetition


Most acquirers fail to consider how deal type impacts what you integrate andhow you handle people issues

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“Scale” deals “Scope” deals

Degree ofIntegration:

• Integrate comprehensively• Ensure Integration approach is coordinated across regions

• Integrate selectively, only where there is overlap• Ensure business models align and cross-fertilize strengths

OrganizationStructure:

• Blend structures; assimilate where the target is small or under-performing• Make decisions early, but don’t sacrifice more informed decisions for speed

• Keep organizations separate; blend structures where there is overlap• Define the role of the center and regional/ functional superstructure• Make decisions as early as possible

ExecutiveSelection:

• Select a small proportion of the target’s executives; select more where the target is larger or better performing• Make decisions early; ideally before announcement

• Retain a high proportion of the target’s executives• Make decisions before announcement• Make retention a priority and offer retention incentives

EmployeeRetention:

• Target early talent critical to the transition/integration

•Target early talent critical to success of company

CulturalIntegration:

• Integrate the two cultures, typically by selecting the “best of both”• Win the hearts and minds of both companies’ employees

• Preserve the two cultures• Harmonize at the leadership level (clarify “way of working” and how decisions are made)

Joseph V. Rizzi Amsterdam Institute of Finance December, 2015.

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