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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,#,Cross-Border Mergers and Acquisitions: Analysis, Structuring and Valuation,Cross-Border Mergers and Acqui,1,Courage is not the absence of fear.,It is doing the thing you fear the most.,Rick Warren,Courage is not the absence of,2,Exhibit 1: Course Layout: Mergers, Acquisitions, and Other,Restructuring Activities,Part IV: Deal Structuring and Financing,Part II: M&A Process,Part I: M&A Environment,Ch. 11: Payment and Legal Considerations,Ch. 7: Discounted Cash Flow Valuation,Ch. 9:,Financial Modeling Techniques,Ch. 6: M&A Postclosing Integration,Ch. 4: Business and Acquisition Plans,Ch. 5: Search through Closing Activities,Part V: Alternative Business and Restructuring Strategies,Ch. 12: Accounting & Tax Considerations,Ch. 15: Business Alliances,Ch. 16: Divestitures, Spin-Offs, Split-Offs, and Equity Carve-Outs,Ch. 17: Bankruptcy and Liquidation,Ch. 2: Regulatory Considerations,Ch. 1: Motivations for M&A,Part III: M&A Valuation and Modeling,Ch. 3: Takeover Tactics, Defenses, and Corporate Governance,Ch. 13: Financing the Deal,Ch. 8: Relative Valuation Methodologies,Ch. 18: Cross-Border Transactions,Ch. 14: Valuing Highly Leveraged Transactions,Ch. 10:,Private Company Valuation,Exhibit 1: Course Layout: Merg,3,Learning Objectives,Primary Learning Objective: To provide an overview of how to analyze, structure, and value cross-border M&As,-Illustrate using July 1, 2011 Nestle takeover of,Chinas Hsu Fu Chi,Secondary Learning Objectives: To provide an understanding of,Motives for international expansion,Common international market entry strategies,A structured cross-border M&A process,Planning and implementing cross-border transactions in developed countries,Planning and implementing cross-border transactions in emerging countries.,Characteristics and determinants of cross-border M&As,Valuing cross-border transactions,Empirical studies of financial returns to international diversification,Learning ObjectivesPrimary Lea,4,Globally Integrated Versus Segmented Capital Markets,Globally integrated capital markets provide foreigners with unfettered access to local capital markets and local residents to foreign capital markets.,Segmented capital markets,Exhibit different bond and equity prices in different geographic areas for identical assets in terms of risk and maturity.,Arise when investors are unable to move capital from one market to another due to capital controls or a preference for local market investments,Globally Integrated Versus Se,5,Developed Versus Emerging Countries,Developed countries: Characterized by,Significant/sustainable per capita GDP growth;,Globally integrated capital markets;,Well-defined legal system;,Transparent financial statements;,Currency convertibility; and,Stable government.,Emerging countries: Characterized by,A lack of many of the characteristics of developed countries,Developed Versus Emerging Coun,6,Motives for International Expansion,Geographic and industrial diversification,Accelerating growth,Industry consolidation,Utilization of lower raw material and labor costs,Leveraging intangible assets,Minimizing tax liabilities,Avoiding entry barriers,Avoiding fluctuating exchange rates,Following customers,Motives for International Exp,7,Common Market Entry Strategies,Mergers & acquisitions (Offer quick access but often expensive, complex, and beset by cultural issues),Greenfield or solo ventures (May offer above average returns but total investment is at risk),Alliances and joint ventures (Allows risk/cost sharing but must share profits and creates potential competitors),Exporting (Cheaper than establishing local operations but still requires local marketing/distribution channels),Licensing (Least profitable and risky entry strategy and lack of control could jeopardize brand or trademark),Common Market Entry Strategies,8,Discussion Questions,What are the differences between segmented and globally integrated capital markets? How do these distinctions affect prices of financial assets of comparable risk and maturity in various countries?,Of the various motives for international expansion, which do you believe is the most common and why?,Do you believe that some market entry strategies are more suitable for emerging than for developed countries? Explain your answer.,Discussion QuestionsWhat are t,9,Characteristics and Determinants of Cross-Border Mergers and Acquisitions,On average, about one-third of global M&A activity involve cross-border transactions.,Most cross-border M&As involve private firms outside of the U.S.,Geography (proximity), accounting disclosure, and bilateral trade increase the likelihood of mergers between two countries.,Firms in countries with rising stock markets, appreciating currencies, and whose shares may be overvalued tend to be acquirers.,Firms in countries with declining stock markets, depreciating currencies and whose shares may be undervalued tend to be targets.,Source: Isil Erel, Rose C. Liao, and Michael S. Weisbach, Determinants of Cross-Border Mergers and Acquisitions, forthcoming,Journal of Finance, 2012. Results reflect 59,172 M&A transactions between 1990 and 2007.,Characteristics and Determinan,10,The Acquisition Process,Pre-Purchase Decision Activities,Post-Purchase Decision Activities,Phase 1: Business Plan,Phase 2: Acquisition Plan,Phase 3: Search,Phase 4: Screen,Phase 5: First Contact,Phase 6: Negotiation,Phase 7: Integration Plan,Phase 8: Closing,Phase 9: Integration,Phase 10: Evaluation,The Acquisition ProcessPre-Pur,11,Implementing Cross-Border Transactions in Developed Countries,Foreign acquirers of U.S. businesses,Acquisition vehicle: Often use C-corporations, limited liability companies, or partnerships,Form of payment: Most often cash,Form of acquisition: Share acquisitions generally the simplest,Post-merger organization: Centralized organization (division structure) used to rapidly realize synergies but decentralized operations (holding company) used where cultural differences significant,Tax strategies:,Share for share acquisitions may defer tax liability for target firm shareholders,Cash for share acquisitions may trigger tax liability for target firm shareholders,Why is cash the preferred form of payment in most cross-border M&As?,Implementing Cross-Border Tran,12,Implementing Cross-Border Transactions in Developed Countries Contd.,Acquisitions by U.S. and Non-U.S acquirers of foreign businesses,Acquisition vehicle: Corporate-like structures in common law countries (e.g., U.S.); share companies or limited liability countries in civil law nations (e.g., China),Form of payment: Generally cash,Form of acquisition: Share acquisitions generally simplest,Post-closing organization: Holding company structure if target to be operated as independent unit or integrated with acquirers existing “in-country” operations,Tax strategies: Highly complex and vary with local tax and legal jurisdictions,Implementing Cross-Border Tran,13,Implementing Cross-Border Transactions in Emerging Countries,Poses challenges not common to developed countries such as political and economic risks including:,Excessive local government regulation;,Confiscatory tax policies;,Restrictions on cash remittances;,Currency inconvertibility;,Expropriation of foreign assets;,Local corruption; and,Civil war and local insurgencies,Managing risk through insurance (e.g., OPIC, World Bank) and contract options (e.g., puts),Implementing Cross-Border Tran,14,Valuing Cross-Border Transactions,Methodology similar to that employed when acquirer and target in same country,Discounted cash flow (i.e., converting future cash flows to a present value),Relative valuation multiples (i.e., purchase price as a multiple of the target firms annual revenue),Basic differences between within country and cross-border include the following:,Need to convert target cash flow projections into acquirer home country currency,Adjusting discount rate,1,for risks uncommon in “within country” valuations (e.g., political/business risk, exchange rate risk),1,The discount rate is the cost of capital used to convert future cash flows to a present value.,Valuing Cross-Border Transacti,15,Projecting Future Currency Exchange Rates,Objective: Convert target (local country),projected,cash flows into acquirer (home country) currency,How: Predict forward (future spot) exchange rates based on interest rate parity (IRP) or purchasing power parity (PPP) theories,Spot exchange rates ($/) = the current number of dollars required to buy one Euro,Forward exchange rate = the rate at which a bank is willing to exchange one dollar for one Euro at some specified future date,Forward exchange rates are determined by differences between interest rates (IRP) and prices (PPP) in the two countries,Projecting Future Currency Exc,16,Interest Rate Parity Theory,Projecting the,Forward,Dollar/Euro Exchange Rate Based on U.S. Interest Rates Compared to Eurozone Country Interest Rates,:,($/,),n,/($/,),0,= (,1 + R,$n,),n,/(1 + R,n,),n,($/,),n,=,(,1 + R,$n,),n,/(1 + R,n,),n, x ($/),0,Where ($/),n,= Forward $ exchange rate n periods into the future,($/),0,= $/Euro spot rate,R,$n,= Interest rate in U.S.,R,n,= Interest rate in European Union,Projecting the Forward Euro/Dollar Exchange Rate Based on Eurozone Country Interest Rates Compared to U.S. Interest Rates:,(,/$),n,/(,/$),0,= (,1 + R,n,),n,/(1 +,R,$n,),n,(,/$),n,=,(,1 + R,n,),n,/(1 + R,$n,),n, x (/$),0,Where (/$),n,= Forward Euro exchange rate n periods into the future,(/$),0,= Euro/$ spot rate,Interest Rate Parity TheoryPro,17,2012 2013 2014,Targets Euro-Denominated 124.5 130.7 136.0,FCFF Cash Flows ( Millions),Target Countrys Interest Rate (%) 4.50 4.70 5.30,U.S. Interest Rate (%),4.25,4.35 4.55,Current Spot Rate ($/) = 1.2044,Projected Spot Rate ($/) = 1.2015 1.1964 1.1788,Targets Dollar-Denominated,$149.59,a,$156.37 $160.32,FCFF Cash Flows ($ Millions),Notes: Calculating the projected spot rate using Interest Rate Parity.,($/),2012,= (1.0425)/(1.0450) x 1.2044,=,1.2015,($/),2013,= (1.0435),2,/(1.0470),2, x,1.2044,= 1.1964,($/),2014,= (1.0455),3,/(1.0530),3, x 1.2044 = 1.1788,Converting Euro-Denominated into Dollar-Denominated Free Cash Flows to the Firm Using Interest Rate Parity Theory,a,$149.59 =,124.5,x,1.2015,Converting Euro-Denominated i,18,Purchasing Power Parity Theory,Projecting the Forward Dollar/Peso Exchange Rate Based on U.S. Price Levels Compared to Mexican Price Levels:,($/Peso),n,/($/,Peso),0,= (,1 + P,us,),n,/(1 +,P,mex,),n,($/,Peso),n,= (1 + P,us,),n,/(1 + P,mex,),n,) x ($/Peso),0,Where ($/Peso),n,= Forward $/Peso exchange rate n periods into the future,($/Peso),0,= Spot $/Peso exchange rate,P,us,= Expected U.S. inflation rate,P,mex,= Expected Mexican inflation rate,Projecting the Forward Peso/Dollar Exchange Rate Based on Mexican Price Levels Compared to U.S. Price Levels:,(Peso/$),n,/(,Peso/$),0,= (,1 + P,mex,),n,/(1 +,P,us,),n,(,Peso/$),n,= (1 + P,mex,),n,/(1 + P,us,),n,) x (Peso/$),0,Where (Peso/$),n,= Forward Peso/$ exchange rate n periods into the future,(Peso/$),0,= Spot Peso/$ exchange rate,Purchasing Power Parity Theory,19,2012 2013 2014,Targets Peso-Denominated P1,050.5 P1,124.7 P1,202.7,FCFF Cash Flows (Millions of Pesos),Mexican Expected Inflation Rate = 6%,U.S. Expected Inflation Rate = 4%,Spot Rate ($/Peso) = .0877,Projected Spot Rate ($/Peso) .0860 .0844 .0828,Targets Dollar-Denominated,$90.34,a,$94.92 $99.58,FCFF Cash Flows (Millions of $),Notes: Calculating the projected spot rate using Purchasing Power Parity.,($/,Peso),2012,= (1.04)/(1.06) x .0877,=,.0860,($/,Peso),2013,= (1.04),2,/(1.06),2, x .0877 = .0844,($/,Peso),2014,= (1.04),3,/(1.06),3, x .0877 = .,0828,a,$90.34 = P1,050.5 x .0860,Converting Peso-Denominated Into,Dollar Denominated Free Cash Flows to the Firm Using Purchasing Power Parity Theory,Converting Peso-Denominated I,20,Estimating Cost of Equity for Developed Countries,Developed countries exhibit little differences in cost of equity because of globally integrated capital markets. Therefore, the Global CAPM can be written as follows:,k,e,dev,= R,f,+ ,devfirm,global,(R,m, R,f,) + FSP,Where,k,e,dev,= Required return on equity for a firm in a developed,country,R,f,= Local countrys risk-free rate of return if cash flows in,local currency or U.S. treasury bond rate if in dollars,devfirm,global,= Nondiversifiable risk for globally diversified portfolio or,well-,diversified,portfolio highly correlated with the,global portfolio,(R,m, R,f,) = Difference in expected return on global market,portfolio, U.S. equity index, or broadly defined index in,the local country and the R,f,FSP = Premium small firms must earn to attract investors,Key Point: When,capital markets are fully integrated, equity investors hold globally diversified,portfolios and the equity premium is the same for all investors when measured in the same currency.,Estimating Cost of Equity for,21,Estimating Cost of Equity for Emerging Countries,Emerging countries may exhibit significant differences in the cost of equity due to segmented capital markets. Therefore, the CAPM may be written as follows:,k,e,em,= R,f,+ ,emfirm,global,(R,country, R,f,) + FSP + CRP,where,R,f,= Local risk free rate or U.S. treasury bond rate converted to a local,nominal rate if cash flows are in the local currency; if cash flows in,dollars, the U.S. treasury rate,(R,country, R,f,) = Difference between expected return on a broadly defined equity,index in the local country or in a similar country and the risk free,rate,emfirm,global,= Emerging country firms global beta,CRP = Specific country risk premium expressed as difference between the,local countrys (or a similar countrys) government bond rate and the,U.S. treasury bond rate of the same maturity,FSP = Premium small firms must earn to attract investors,Key Point: For emerging countries, the equity risk premium may not reflect all the risk associated with investing in that country and the cost of equity may have to be adjusted for such things as political risk.,Estimating Cost of Equity for,22,Estimating the Cost of Debt,For developed countries, the targets local or the acquirers home country cost of debt.,For emerging countries, the cost of debt (i,emfirm,) is as follows:,i,emfirm,= R,f,+ CRP + FRP,Where,R,f,= Risk free rate (see preceding slide.),CRP = Specific country risk premium (see preceding slide),FRP = Firms default risk premium (i.e., additional premium for similar,firms rated by credit rating agencies or estimated by comparing,interest coverage ratios used by rating agencies to the firms,interest coverage ratios to determine how they would rate the,firm.),Estimating the Cost of DebtFor,23,Evaluating Emerging Country Risk Using Scenario Planning,Risk may be incorporated into the valuation by considering alternative economic scenarios for the emerging country.,Projected cash flows for alternative scenarios could reflect different GDP growth rates, inflation rates, interest rates, foreign exchange rates, or alternative political conditions.,If risk is included by calculating a weighted average of alternative scenarios, the discount rate should not be adjusted for specific country risk.,Evaluating Emerging Country Ri,24,Financial Returns to Cross-Border Mergers and Acquisitions,Combined “excess” financial returns,1,(including acquirer and target firm shareholders) in M&A transactions worldwide average15% on the announcement date. (Returns may vary with the characteristics of the deal, e.g., hostile versus friendly),Most of the combined financial return is earned by target firm shareholders,Acquiring firm shareholders experience “excess” financial returns of 1 to 1.5%,Key Point,: Contrary to conventional wisdom, acquisitions on average,create value for both acquirer and target firm shareholders.,1,Excess financial returns are those realized over and above what would have been earned had no acquisition occurred.,Source: Jeffrey Netter, Mike Stegemoller, and M. Babajide Wintoki, Implications of Data Screens on Merger and Acquisition Analysis: A Large Sample Study of Mergers and Acquisitions from 1992 to 2009,Review of Financial Studies, 24, 2011, pp. 2242-2285. Results,reflect 311,894 transactions between 1992 and 2009.,Financial Returns to Cross-Bor,25,Nestle Buys Controlling Interest in Chinese Candy Maker: Case Study Background,Acquirer: Nestle Corporation (Worlds largest food company),Nestle operated in China for 20 years and currently has sales of $3.3 billion,Operates 23 plants and has 14,000 employees,Nestle intends to grow emerging markets share of total revenue from one-third in 2010 to 45% by 2020,Target: Hsu Fu Chi (Chinas largest confectionary products manufacturer),$800 million in annual revenue and $91 million in profit,6.6% market share and established nationwide distribution network and retail outlet chain,Hsu family and Baring Private Equity Asia own 57% and 15% of shares, respectively. Remaining shares owned by non-founding family and non-institutional shareholdersso-called independent shareholders,Announcement Date: July 11, 2011,Shares traded on Singapore stock exchange,Sell at 21% discount to comparable firms,Have underperformed peers during last several years,Nestle Buys Controlling Intere,26,Deal Characteristics,Nestle offer price equivalent to $1.7 billion U.S. dollars for a 60% ownership stake, which represented 3.3 times Hsu Fu Chis annual revenue,Nestle to buy 43.6% of firms shares from independent shareholders for 4.35 Singapore dollars (equivalent to 3.65 U.S. dollars) and a 16.5% stake from the Hsu founding family.,The purchase price represented a 24% premium over the 6 months ending on July 1, 2011.,Hsu Fu Chis current CEO and Chairman would continue to manage the firm,Deal CharacteristicsNestle off,27,Potential Synergies,From Nestls Perspective:,Increases exposure to Chinas fast growing consumer market,Provides a platform for future acquisitions in the food industry in China,Hsu Fu Chis established national distribution network and chain of retail outlets provides barrier to entry for potential competitors,From Hsu Fu Chis Perspective:,Enables both Hsu family and independent shareholders to “cash out” of a portion of their investment,Provides resources for potential international expansion,Provides global brand and distribution network to support international expansion,Potential SynergiesFrom Nestl,28,Comparable Valuation Multiples,Nestle paid 3.3 times Hsu Fu Chis 2010 annual revenue,Comparable transaction multiples:,U.S. based Kraft Foods paid 2.4 times revenue for British candy maker, Cadbury, in 2010,U.S. based Mars Candy Company acquired U.S. gum manufacturer Wrigley Corporation for 4.2 times revenue in 2008,French food manufacturer purchased Dutch rival, Numico, for 4.5 times sales in 2007,Comparable Valuation Multiples,29,Case Study Discussion Questions,What were Nestles motives for acquiring Hsu Fu chi? What were Nestls alternatives to acquiring Hsu Fu Chi? Why do you believe they were not pursued?,What alternatives did the majority shareholders in Hsu Fu Chi have to grow the firm? Speculate as to why they may have chosen to sell a controlling interest to Nestle?,Speculate as to why Nestle used cash rather than its stock to acquire its ownership interest in Hsu Fu Chi?,Why do you believe the non-founding and no
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