Comcast-Time Warner Cable Acquisition and The Whole Deal Concept

The Comcast (COM) Time Warner Cable (TWC) Acquisition illustrates the importance of looking beyond just price to the whole deal when evaluating M&A. As Ralph likes to note, you can name the price if I can name the other terms, and I will win every time. As such, this complements Ralph's Post on the Comcast-Time Warner transaction by focusing on the tradeoff between deal price and non price terms.

TWC had been pursued by Charter Communications (CC) for months resisting three unsolicited bids-the last being a cash and stock offer valued at $132.50 per share. This February, COM surfaced as a White Knight with an all stock deal then valued at $158.82 per share for a total of $45.2B. That price was close to the $160 mentioned by TWC’s management as full value. Since that announcement, COM’s stock price has dropped almost 10% reducing the per share price to $143.55 per share-just 8% above CC’s last bid.

The COM deal is a Fixed Exchange Ratio (FXR) offer-2.875 shares for each TWC share.TWC shareholders will own 23% of the combined firm. Under a FXR the number of shares is fixed, but their value, and hence the transaction’s value, is not determined until closing. The seller bears the risk of a drop in the buyer’s share price until that time. It can gain, however, should the buyer’s stock appreciate. FXR are more common, as opposed to floating exchange ratio structures.

TWC could have mitigated its COM price risk by negotiating for a Collar specifying a range around the initial value within which the price could move. Collars are used in 15-20% of FXR deals. Another interesting feature is the absence of a break-up fee from COM to TWC should the deal not receive anti-trust clearance-which is a real concern here given the size of the firms.  My observations are:

1)     TWC wanted to get as close as possible to its stated full value of $160 per share to distance           itself from CC’s “inadequate” $132.50 price.

2)     Collar and break-up features are valuable options. COM’s offer price would have been                   negatively impacted had TWC insisted upon these protective provisions.

3)     TWC willingly gave up the protection to achieve a higher nominal share price.

4)     TWC’s bet has not worked out and the deal may be endangered. COM is increasing the size of         its share repurchase from $3B to $5.5B post close to support its stock price. Who knows -  the         stock may actually increase in value before the close.

The bottom line is to focus on the whole deal when evaluating transactions. TWC and COM used non price features to help close a price gap. COM could top-up its bid by offering more shares and suffer the resulting dilution. This depends on how concerned COM is with losing the upcoming TWC shareholder approval of the deal due to its falling stock price.

J

Acquisition Risk, Collars and the Comcast Time Warner Deal

An article in yesterday’s Wall Street Journal illustrates one of the risks in stock swap acquisitions – by the time the deal closes the stock price of either target or bidder could change, sometimes dramatically.  What once looked like a good deal could now fall apart.  In this case, the article notes that Comcast’s stock price has dropped nearly 10% since the deal was announced, reducing the value to Time Warner shareholders from $159 per share to $144 per share.  The deal is set to close in the summer.   By that time Comcast’s price could recover – or it could drop further.  Meanwhile Charter Communications waits in the wings with threats to renew its own bids for Time Warner.

One of the topics that always draws considerable interest in our Acquisition Course in Amsterdam is how to mitigate risk in acquisitions.  In the case of the Comcast – Time Warner deal, the risk associated with the change in stock prices could be mitigated through the use of collars.   A collar, comes in various forms, but basically outlines how the value of an offer must change with variations in stock price at deal completion.

The two basic forms of a collar are illustrated below in a chart from an article by Micah Officer.   The formal names of Fixed Exchange Collar and Fixed Price Collar are illustrated graphically by the diagrams and humorously by Micah’s nicknames of Travolta’s and Egyptian’s, respectively.  (Presumably, one can imagine John Travolta striking a similar pose as panel A in Saturday Night Fever.)

Panel A shows the fixed exchange-ratio collar.  This is the most basic collar, setting a minimum and maximum share price at which a deal would be completed.  Imagine striking a deal somewhere in the middle of the chart on the sloped portion of the payoff line.  Small deviations in the bidders stock price produce deviations in the value received (paid) by target (bidding) shareholders at deal completion.  Both sets of shareholders receive some protection from extreme swings in stock price, however. If the bidder’s stock price has increased at deal completion, target shareholders gain and bidding shareholders pay more, but only up to a pre-determined threshold.  Beyond that threshold, the maximum price is reached, illustrated by the upper, horizontal line.   

Conversely, a drop in the bidder’s stock price at deal completion results in target shareholders receiving less and bidding shareholders paying less, but again, only to the point of a pre-determined threshold.  In this case, the lower barrier identifies the minimum value that target shareholders would receive.  Thus, bidders are protected on the upside and target shareholders are protected on the downside.

Perhaps more difficult to understand is the fixed price collar.  In this case the amount received and paid is fixed within a given middle range but varies at the extremes.  Thus, target and bidder are certain of the deal price in some (perhaps plausible) range.   Beyond the thresholds, however, target and bidding stockholders share upside gains and downside losses in response to changes in the bidder’s stock price at closing.   (Still, it is hard to imagine target shareholders suffering extreme losses on the downside without at least trying to walk away from the deal.)

In the case of Time Warner shareholders, there is currently no collar in place.  It will be interesting to watch the vote for approval in the summer if Comcast’s stock price remains low.

All the best,

Ralph

Acquisition Finance - Training in Amsterdam!

We are approaching the next offering of our Acquisition Finance Course in Amsterdam and that also means approaching the deadline to sign up.   I thought I'd show last year's program to give an idea of our coverage.  This year's program will change to reflect current market conditions.  (One of the principal concepts we address in the program is the need to understand current market conditions.)  The basic content will remain the same, however, as will our approach: a highly interactive program combining theory and practice taught by an active researcher and an active practitioner.  We hope to see you there.

Joe and Ralph

Acquisition Finance - Overview of the Program

Day 1

Introduction to M&A Deal Design and Acquisition Finance

• M&A strategy
• Components of an M&A deal – where finance fits in optimizing M&A deal design
• Current conditions and trends in acquisition finance

Valuing the Highly Levered Transaction

• Techniques of valuing the target firm
• How financing creates – or destroys – value

Non-investment Grade Leveraged Financing

Private Equity Requirements

Framework for Analysis: the "Whole Deal" Approach

Case Analyses: Participants analyze and structure deals to better understand the interplay of capital structure, cost of capital, market products and deal design

Day 2

Designing the Capital Structure

• Identifying the range of financing alternatives
• Choosing the right mix of financing
• How lenders and investors look at the mix of debt and equity

Structuring the Financing

• Designing the terms of financing instruments
• Pricing the instruments
• The syndicated loan market
  -  Covenant late
  -  Second lien

• Developing the term sheet
• Risk analysis

Fixing the Broken Deal

• Decreasing senior debt
• Adding a back ended T/L C held by the originating bank
• Additional covenants
• Increased pricing

Additional Case Analyses of the Dynamics of Acquisition Finance

Day 3

Acquisition Financing in the Context of Negotiations and Auctions

• Acquisitions as bargaining outcomes; Behavioral finance
• Varieties of auctions and the incentives they create
• Hostile takeovers as settings for negotiations and auctions

How Financing Can Influence Outcomes in Negotiations and Auctions

Negotiating the Deal

• Understanding the needs of the other party
• The inter-related elements of deal design
• Bargaining on many fronts
• The ‘whole deal’ approach

Dealing with Risk in Acquisition Finance

• Earnouts – a great technique for closing the deal
• Toeholds
• Collars
• Termination Fees

Additional Case Analyses

Concluding Case in Deal Design