Merger Arbitrage A Fundamental Approach to Event-Driven Investing
Lionel Melka Amit Shabi
)WILEY A John Wiley & Sons, Ltd., Publication
Contents Foreword by Michael Zaoui
xiii
Acknowledgements
xix
About the Authors
xxi
Introduction
xxiii
PART I THE ARBITRAGE PROCESS
1
1
3 4 7 9
The Role of the Market in Mergers and Acquisitions 1.1 Structural Changes to the Financial Markets 1.2 Changes to M&A Practice 1.3 Market Evaluation of M&A 1.3.1 The price offered to shareholders of the target company 1.3.2 Structure - the key to evaluating an offer 1.4 Types of Synergies and Waves of M&A 1.4.1 Justification for transactions 1.4.1.1 Better efficiency 1.4.1.2 Obtaining market power 1.4.1.3 Acquiring specific resources 1.4.1.4 Benefiting from the intellectual property of the target company 1.4.1.5 Hindering the progress of a troublesome competitor 1.4.1.6 Blocking new entrants to a sector
9 9 11 11 11 12 13 13 13 14
Contents
1.4.2 Waves of M&A Case Study: The Alcan/Pechiney Deal
14 18
2
The]Different Types of Transactions 2.1 Types of Transactions 2.1.1 Cash transactions 2.1.2 All-share transactions 2.1.3 Mixed cash-and-share transactions 2.1.4 Collars 2.2 The Choice of Payment Method
33 33 33 39 46 53 57
3
Risk and Return Factors 3.1 The Different Outcomes 3.1.1 The transaction is completed 3.1.1.1 The probability of success 3.1.1.2 Risks of failure 3.1.2 The transaction fails 3.1.2.1 Estimating failure 3.1.2.2 Estimating potential losses 3.1.3 The transaction is completed at a price lower than the initial offer 3.1.4 Rival bids and bidding wars 3.2 M&A Timetable 3.2.1 Timetable considerations according to offer type 3.2.1.1 Takeovers 3.2.1.2 The unique case of tender offers 3.2.1.3 Mergers 3.2.2 Sector differences
59 59 59 59 60 65 66 66
The Merger Arbitrage Strategy 4.1 The Long-Term Profitability of the Strategy 4.2 The Factors that Influence Returns 4.3 The Different Approaches to the Strategy Developed by Specialist Managers 4.3.1 The deal's risk zone 4.3.2 The use of leverage 4.3.3 The use of options or bonds 4.3.4 Investment portfolio analysis 4.3.5 Portfolio concentration
81 81 82
4
70 70 73 73 73 75 76 77
85 86 87 87 89
Contents
4.4
4.3.6 The role of trading 4.3.7 Classifications The Conclusions of Academic Studies 4.4.1 Studies on the returns generated by merger arbitrage strategies 4.4.2 The role of arbitrageurs in the execution of M&A transactions 4.4.3 Other characteristics of merger arbitrage strategies
PART II ANALYZING THE RISK OF FAILURE
90 90 91 92 94 96
97
Financing Risk 5.1 The Different Financing Methods 5.1.1 Revolving credit 5.1.2 Bridge loan 5.1.3 Term loan 5.1.4 Syndicated loan 5.1.5 Mezzanine loans 5.1.6 The bond market 5.1.7 Contingent value rights (CVRs) 5.2 The Legal Security of the Financing 5.2.1 The UK legal framework 5.2.2 The US legal framework 5.2.3 The European legal framework in general Case Study: The Dow Chemical/Rohm & Haas Deal
Competition Risk 6.1 Origins and Regulatory Framework of Competition Law * 6.1.1 United States 6.1.2 Europe 6.2 Competent Authorities and Approval Process 6.2.1 United States 6.2.2 Europe 6.2.3 China 6.3 Competition Remedies 6.4 Country Differences in Evaluation
129 129 129 132 133 133 137 140 143 145
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The Allocation of Competition Risk between the Parties Case Study: The Oracle/Sun Deal
6.5
7
Legal 7.1 7.2 7.3
7.4
8
Aspects of Merger Agreements The Different Documents Structure of a Merger Agreement MAC Clauses 7.3.1 A negative definition of the MAC clause 7.3.2 MAC clauses and court decisions 7.3.3 MAC clauses and private-equity transactions 7.3.4 Why these clauses? Other Legal Clauses 7.4.1 Go-shop clause 7.4.2 Break-up-fee clause 7.4.3 Matching-rights clause 7.4.4 Specific-performance clause 7.4.5 Dissenters'-rights clause
Other Risks 8.1 Administrative Authorizations 8.1.1 United States ,8.1.1.1 The role of the CFIUS 8.1.1.2 Sector authorities 8.1.1.3 PSCs 8.1.2 Canada 8.1.3 Europe 8.2 Political Risk Natural-Disaster Risk 8.3 8.4 The Risk of Fraud or False Accounting
Hostile Transactions 9.1 A General Overview of Hostile Transactions 9.1.1 Profile of the target company 9.1.2 The different parties involved in hostile offers 9.1.2.1 The buyer 9.1.2.2 The target company and its constituent parts
201
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9.1.2.3 Other potential buyers 9.1.2.4 Arbitrageurs 9.1.3 The offer strategies 9.1.3.1 Direct purchase on the market 9.1.3.2 Tender offer 9.1.3.3 Directly approaching the board of directors 9.1.3.4 Proxy contest 9.1.3.5 Legal battle 9.1.4 The matter of price 9.2 Regulatory Frameworks for Hostile Offers and How They Differ in Different Countries 9.3 Defense Mechanisms 9.3.1 Preventive measures 9.3.1.1 Staggered vs unstaggered boards 9.3.1.2 Fair-price provision 9.3.1.3 Supermajority provision 9.3.1.4 Dual-class recapitalization 9.3.1.5 Golden parachutes 9.3.1.6 Employee stock ownership plans 9.3.1.7 Poison pill 9.3.2 Mechanisms adopted during an offer 9.3.2.1 The crown jewel defense 9.3.2.2 Litigation 9.3.2.3 Just say no 9.3.2.4 Countertender offer: Pac-Man 9.3.2.5 Asset restructuring 9.3.2.6 White knight and white squire 9.3.2.7 Going-private transaction/LBO 9.3.2.8 Greenmailing 9.4 Regulatory Differences in Different Countries 9.4.1 The UK 9.4.2 Continental Europe Case Study: The Sanofi/Genzyme Deal 10 Leveraged Buyouts 10.1 Main Characteristics of LBOs 10.1.1 Principles 10.1.2 The different oarties
10.1.2.1 The target company 10.1.2.2 The investment funds 10.1.2.3 The banks 10.1.2.4 The management 10.1.3 Exit opportunities 10.2 A Brief History of Private Equity 10.2.1 Emergence and growth of private equity 10.2.2 The explosion of private equity 10.3 How LBOs Affect Arbitrage 10.3.1 The reasons for the transaction 10.3.2 Financing 10.3.3 Competition risk 10.3.4 Agreement terminology and the use of reverse termination fees 10.3.5 Management and a potential conflict of interests Case Study: LBO as an Arbitrage Opportunity: Del Monte Foods
