Here, we look at other considerations.
The bid price is just one of several things that the seller and their financial advisor will consider in the transaction – appreciating that the financial advisor also is incentivised to select the highest bid as the fee is based on transaction value.
Financing is very important – the seller wants to make sure the transaction will have a timely close and certainty of closing. As such, companies that clearly have the means to make a purchase will be looked at more favorably – for instance, if a small restaurant chain was putting itself up for sale and the highest bid at $200 million was from a small private equity firm without secured financing and the second bidder was McDonalds at $190 million, they would almost certainly choose McDonalds because $190 million is a drop in the bucket for McDonalds where they could just pay it with monthly cash flow – of course, the seller would still try to tell McDonalds “$200 and its yours”.
This is why coming with financing secured is attractive for bids. If a bidder comes in and says that they have $2 billion cash on hand and JP Morgan has already secured $10 billion that will be taken out with high yield bonds and equity, it is a huge check box for the seller.
Transaction structure can also be important. Purchasing an asset is very different than purchasing a corporate. In purchasing an asset, you may leave liabilities behind for the seller. Offering cash is very different than offering stock.
They do not want this, so this has to be baked into the price.
This also has differing tax implications and will be considered by tax advisors on both the buyer and seller side.
Contracts and Legal Agreements for Sale Leaseback Transactions
For sale and leaseback transactions, the seller will want to negotiate the terms of the agreement so that they are protected as a tenant or lessee in conjunction with an internal legal team, external counsel and their investment bankers.
For example, when a retailer gets rid of its real estate, there will be a rental agreement negotiated so that there is no rent escalation for a set number of years, a right to first refusal on renewing the lease and other protections.
Infrastructure Sale and Leaseback
This is particularly important for infrastructure deals, especially if the infrastructure is a key part of the seller’s business. So for instance, if a copper mine owns an exporting terminal closeby, the export terminal is inextricably linked to the business and may be the difference in the project being economic or not economic.
The copper producer may look to monetize the terminal for a variety of reasons.
For instance, the terminal trades at a higher multiple as a standalone entity than the copper producer so it could unlock shareholder value being sold off. Otherwise, the proceeds from the terminal could be used to pay down debt, or possibly is lucrative to a company that specializes in commodity logistics that would be willing to pay a premium.
Nonetheless, the copper company will have to take precautions to keep operations the same other than the new transportation cost burden/tariff. The copper company may want a certain amount of volume guaranteed for their use or at least their option. So for instance, if the terminal has capacity for 8 million tonnes the copper company may want 5 million tonnes guaranteed for cargo that cannot be sold to a competitor because they are offering a better price. This volume is firm and committed.
To preserve economics and lock in acceptable rates of return for their business, the fee may be set at whatever dollars per tonne for firm transport with no escalation beyond inflation per year.
The buyer may also be obligated to operate the terminal as long as the copper company is paying (otherwise jeopardizing the copper business) and possibly be required to expand if the copper mine ramps up production.
Depending on how important the messaging is to shareholders, the copper company may opt for a longer contracted term in exchange for a higher headline purchase price so that they can put out a press release that they sold the terminal for $800 million instead of $750 million.
In a way, selling infrastructure is very similar to raising debt for an asset. In exchange for upfront proceeds via the monetization, the seller is now obligated to paying certain charges each month/year. As you would surmise, the new owner of the infrastructure would be receiving debt like cash flows – stable and fixed (depending on how the contract is set up).
Reps and Warranties/Due Diligence in Mergers and Acquisitions
Representations and warranties are the claims that both transacting parties make that are relied on by the other party as justification for the transaction. Lawyers drop this phrase all the time – and it usually shows up in any business legal agreement and gives the buyer an out if certain representations and warranties are not valid.
Are the financials actually true? Who are the contracted counterparties for shipping for your tankers? Have all taxes been paid to the relevant authorities and were contracts based on proper process.
These representations will have to be vetted via a thorough due diligence process – although the transaction is technically void if representations and warranties are found to be not true, it can be tricky getting money back – just like in buying a house.
Due diligence is even more important when considering what is not represented. Under a legal contract, no assumptions can be made. The excel model the vendor sends over is based on the narrative the seller and their advisor are trying to convey. These assumptions need to be tested under various scenarios and questions need to be asked about what leads them to those assumptions.
There is a fine balance, however – with certain assets how they operate is quite straightforward and a seller may be turned off by a buyer with onerous due diligence requirements. However, a buyer with legitimate concerns about a business should be prepared to walk away if they do not feel they can get the factfinding they need to have comfort in transacting.
When companies do not have adequate due diligence, they are on the hook for liabilities after the transaction. When they do not properly look at the value of the property, they may overpay and upon realizing the value is not reasonably close to the price – this is impaired and the company takes a huge charge for the quarter and much embarassment from shareholders. Examples include Microsoft’s purchases of aQuantive and Nokia.
Winning Over Target Shareholders
An additional layer of complexity still is when the bid is for a public company – whether via a sale process initiated by the selling company (like Tesla’s recent “financing secured” tweet) or via a hostile take over.
The buyer has to put in a price that is compelling enough for certain majority thresholds of shareholders to be met before they can transact. As such they have to consider price factors involving premiums (unless it is a savvy transaction for a distressed company, current shareholders will almost never agree to a sale without a substantial premium unless the stock has gone nowhere forever).
As such, M&A transactions involving a public company will always include analysis on how the premium is to the 20-day VWAP or some iteration (Volume Weighted Average Price the stock has been trading at) as well as to last trading day closing price. Depending on the shareholder composition (long term holders, transitory shareholders) they will look at what price they got in at and whether or not they perceive this to be a fair premium in the context of comparable company multiples and premiums paid in precedent transactions of this nature.
If the target company board feels that the bid is inadequate – and this happens quite a bit because this means that they are basically getting fired/packaged out after the transaction – they will cite things such as Wall Street equity research analyst targets (which is meaningless because they all have buy ratings to generate interest in the stock – in fact that is what they are paid to do) and the “bid not representing the intrinsic value of the company” or that the company will realize more value by staying public. The bid either has to be sweetened to the point where it is worth their while to leave or if they are offered similarly decent roles in the new organization.
Without their support, the bid becomes hostile and the conversation is between the acquiror and the shareholders, bypassing the board. This topic will be reserved for a future post – maybe.