Merger Structures
December 9, 2020
What are Merger Structures?
Merger can be a misnomer, as the term is also loosely used for an acquisition involving a share swap between the shareholders of two companies; often the underlying transaction is really an acquisition, with one of the companies being the dominant player where the acquirer will still be expected to pay a control premium.
Real mergers, also known as ’merger of equals’, are rare and describe transactions which are all stock deals where the two parties’ shareholders will have similar percentage shareholdings in the combined (normally new) entity, and potentially a similar number of board seats. The underlying contribution of financials can diverge from the 50/50 split as it depends on the relative valuation of each company. In mergers of equals, an acquisition premium is not paid. One such deal is the merger of L3 with Harris, both global defense companies in the US, creating a combined entity with an equity value of approx. $34bn post deal.
Where a company offers to buy the shares of a target company with cash, the consideration can be financed with existing cash on the buyer’s balance sheet, debt raised in the markets or potential secondary or rights issues. Buyers generally avoid the raising of additional equity due to the relatively high cost of equity compared to the cost of debt, and significant issuance fees and discounts offered to shareholders. Exceptions are mega-deals such as Bayer-Monsanto where the sheer size of the transaction required utilizing a variety of different instruments.
Key Learning Points
- Merger of equals are M&A transactions where two companies join together; there is no control premium; no acquirer and no target
- Strategic rationale should underpin any M&A transaction, and financial rational alone is not sufficient for a sound M&A transaction
- Ability to generate synergies will help create value in the deal
- Acquirer has to pay a control premium in order to acquire the target; the control premium is a key assumption in an M&A model
- Financing is one of the key assumptions in an M&A model and is driven by leverage considerations, ownership considerations, and availability of financing
We Have to Talk about Tax!
Tax issues are often key to driving acquisition structures and funding considerations. Generally, most stock transactions are tax-free and will only attract capital gains tax when shareholders decide to sell their shareholding. Depending on the jurisdiction, there might be an opportunity for corporates to reduce tax liabilities even in cash transactions, depending on the provision of substantial shareholding exemptions which are subject to holding periods and a minimum level of share ownership. While this is common across Europe, one notable exception is the US. The recent US tax reform has the potential to increase corporates’ review of their asset portfolio, as the gain on disposal is now taxed at 21% rather than the 35% tax rate previously. A lot of emphasis was based on the tax implications of Verizon’s acquisition of Vodafone’s stake in the company and potentially had an impact on the final valuation.
Black Hawk Down – Tax Depreciation Up
In addition, acquisitions can be structured as asset or share deals which will have different tax implications for both buyer and seller. Lockheed Martin’s acquisition of Sikorsky (Black Hawk) was structured as an asset deal under US tax rules despite being a share deal. This allowed Lockheed to utilize higher tax breaks as a result of asset step ups, worth a whopping NPV of $1.9 billion. So, the purchase price of headline $9 billion was in effect $7.1 billion.
Scheme of Arrangement
A structure used in most acquisitions involving a UK target requires 75% of target shareholders votes for a court-approved scheme which is initiated by the target company itself. If the 75% threshold can be achieved, the buyer can legally acquire 100% of the target shares thus eliminating the need to get to 90% to squeeze out any disapproving shareholders in an ordinary tender offer. This structure is also used in Australia, Hong Kong, and South Africa. A recent UK transaction involving the £3.9bn acquisition of Nex by Chicago Mercantile Exchange (CME) was structured as such a scheme. Acquisitions in the UK which start out as a tender offers often convert into a scheme of arrangement when both boards of directors recommend the transaction.
Cash, Stock, Convertibles – What Else?
Heard of the decision made by the German government to exit nuclear and phase out coal over the next 20 years? Two power giants in Germany, E.ON and RWE, have been heavily involved in M&A transactions mainly structured as asset swaps (in particular, RWE’s majority stake in innogy), allowing for two refocused giants – RWE = renewables, E.ON = regulated networks. Valuation of the different components in an asset swap can present a separate challenge.