AB InBev and SABMiller: Negotiating the Deal

Negotiating the deal is crucial to bidder success and target shareholder welfare.  From the bidder’s side, increasing the bid premium reduces the ultimate rate of return on investment, but paying a premium too low could result in a failed offer.  Target shareholders generally want the maximum price they can obtain, but other factors also come into play including timing of the deal, ownership after the deal, seats on the combined firm board, etc.

Both sides are concerned about deal structure and we’ve said many times that it is important to bargain on many fronts.  In addition to the bid premium we must consider form of payment, structure of the deal, timing, taxation, residual ownership, warranties and representations, employee and stakeholder welfare, regulatory concerns and numerous other factors. 

The maximum price a bidding firm should pay is the estimated net present value of the target under their control.  But paying this amount produces a NPV of zero, with no room for error.  The minimum price a public target will accept is generally the pre-offer market price.  Where the final deal settles in this range is determined by the relative bargaining power of the two sides.  Numerous factors go into bargaining power including ownership structure (concentrated or dispersed, toeholds owned by the bidding firm, the percentage of shares controlled by management, etc). 

Bargaining power is also impacted by how important the deal is to each side and this is related to the alternatives available to bidder and target. Is this bidder the only firm that can purchase this target?  Advantage – Bidder. 

Are many bidders vying for the target?  Are obvious synergies available to many parties?  Advantage target..  Is the target management really anxious to cash out?  Is the timing of the deal crucial to the bidder, etc.

There is considerable empirical evidence on negotiating tactics and shareholder welfare.  An overriding finding is that target shareholder value is maximized by management that forcefully negotiates, but does not ultimately block the deal.

A good illustration of these elements is the AB InBev acquisition of SABMiller.  According to the Wall Street Journal, both sides stood to gain from the deal but SABMiller’s chairman was convinced that AB InBev wanted the deal more.  His resistance and negotiation led to a sweetened offer – a 50% premium over the pre-offer (and rumor) market price and a $3 billion breakup fee if the deal doesn’t go through.  Other aspects of the deal including the social terms (who stays on the board, the name of the combined firm, etc.  are yet to be disclosed.  Also unclear is the degree to which regulatory authorities will oppose the deal or force concessions. 

SABMiller’s ability to negotiate these terms is even more interesting given that Altria Group, Inc which owns about 27% of the target signaled they would back a lower bid.  But SAB’s chairman Jan du Plessis was also active in courting large shareholders, getting Colombia’s Santo Domingo family on his side.  The family controls about 14% of the company and is the second largest shareholder.

The skill of SAB’s chairman, comes in part, from experience.  According to the WSJ he was chairman of Rio Tino PLC when it fended off a takeover bid from Glencore PLC. 

All the best,

Ralph

Rejecting the Top Dollar

We’ve seen numerous multi-bidder deals this year.  (See, for example, Unique Synergies and theTyson Foods/Hillshire Merger.)  One of the more interesting is the current deal involving Family Dollar Stores.  Two bidders, Dollar General and Dollar Tree are seeking to own Family Dollar.  One of the bids (Dollar General) is clearly superior, yet management of Family Dollar favors the lessor bid of Dollar Tree.  One can wonder why.  (See Miriam Gottfried’s article in yesterday’s Wall Street Journal for additional details.)

 The Dollar Tree bid is valued at $74.50 a share.  The Dollar General bid is $80.   Advantage to shareholders: Dollar General.

Dollar Tree’s bid is 80% cash and 20% stock.  Dollar General’s bid is all cash.  Advantage to shareholders: Dollar General.

There is a breakup fee on Dollar Tree’s bid of $305 million agreed to by Family Dollar.  Dollar General said it would pay this.  Advantage to shareholders: Neutral.

Yet management of Family Dollar favors the Dollar Tree bid citing anti-trust concerns.  Are these valid?  True Dollar General and Family Dollar have similar business models, but there are other dominant competitors to the firms, namely Wal-Mart.  In addition, Dollar General has agreed to divest as many as 1500 stores in an attempt to head off any anti-trust issues. 

We have shown in our research that opposition by target management is the single biggest factor determining whether a deal goes through. So the opposition by Family Dollar clearly gives an advantage to Dollar Tree. The Dollar General bid is clearly superior from a shareholder’s point of view.  Management is supposed to represent the shareholders.  Management opposes the Dollar General bid.  Hmmm.  In view of the clearly superior bid by Dollar General, one must wonder at management’s own incentives and how (and why) they factor into the decision. 

Ralph

Astrazenca-Pfizer: Bird-in the Hand or Just the Bird?

Ordinarily we focus on buyer value destruction. The Astrazenca (AST) – Pfizer (PF) Drama illustrates sellers are also capable of snatching defeat from the jaws of victory. PF offered $120B - 45% in cash- representing a 45% premium to AST’s pre bid price. PF’s premium was based on cost synergies and tax savings from a planned Tax Inversion. AST claimed the bid undervalued the value of their drug development pipeline and the firm by at least 7% and rejected the offer. AST’s stock price dropped 11% upon the rejection while PF’s rose slightly. (This post will focus on the valuation issues of the bid and ignore the political issues of potential Job Cuts and U.S. taxes.)

AST’s sales and income have fallen from $33.5B and $12.7B in 2011 to $25.7B and $3.7B, respectively, in 2013. The large decline is due to the Patent Cliff faced by many firms in the big phrama industry. AST alleges –warning: hockey stick alert - its new drug pipeline will return sales to 2011 levels by 2017. Furthermore, 2023 sales will increase to $45B - a 75% increase over current levels.

This raises a classic valuation duel. Is a $120B bird in the hand now worth more than a bush containing the promise of something –TBD - larger in 10 years? All valuation questions involve three questions:

1)   How Much: what are the cash flows - not just revenues but the costs and investments associated with a 75% sales increase over 10 years?

2)   How Long: gets to the time value of money- more dollars are needed in 10 years to offset a current dollar.

3)   How Sure: how risky are the cash flows?

The market response to these questions for AST was reflected in the lower pre bid price. Clearly the market did not share AST’s optimistic view of its product pipeline. AST can respond by stating the market did not understand the pipeline - but whose fault is that - investors or AST for not explaining it well enough? More likely, investors are concerned with the high-risk nature of developing drugs as reflected in the continued decline in AST revenues since 2011. So what is going on here? My belief is management is trying to preserve its jobs by staying independent - the shareholders be damned.

Hopefully, shareholder outrage over management’s rejection of a valuable bird in the hand in exchange for receiving a management bird in the face will result in one of the following:

1)   Shareholder Action will force management to reconsider the bid

2)   Replace management and the board - bring in the lawyers

3)   Tie management’s compensation to the targets they believe justify the rejection. If management wants shareholders to roll the dice on the new drug pipeline, then management should join the shareholders and put its money where its mouth is and wager their future compensation - ante up boys.

OMG you can’t make this stuff up-

J

Agency Theory,Corporate Governance and Acquisitions

We’ve mentioned that one of the ways going private creates value is through improved governance.  In fact, governance is strongly linked to mergers and acquisitions.  Consider the following:

Governance involves aligning the interests of owners and managers.  A merger changes the ownership of target and possibly bidding firms.  Thus, it creates possibilities for altering the alignments that previously existed.

Governance issues are called agency problems in the academic literature because they involve agents (the CEO, the board and management) working on behalf of the owners (shareholders).  Agency problems occur naturally because the best interests of owners may not coincide with those of the agents they hire.  Good governance seeks to align these interests. 

In future posts, we’ll spend more time on some of the potential agency conflicts that arise naturally in corporations and in particular in mergers and acquisitions.  They include, but are certainly not limited to:

CEO compensation.  It is natural for an executive to desire more and for owners to want to pay what is justified.

Consumption of perquisites by the executive team.  A sole proprietor may have a Spartan office and fly coach.  If he/she does not, they bear 100% of the costs of any perquisites.  This is not true for the CEO of the typical large corporation who probably owns less than 1% of the equity and hence bears that proportion of the costs of perquisites.  Suddenly the private jet looks more appealing.

Resistance to mergers.  A merger in the best interests of shareholders may nevertheless cost a target CEO his or her job.  Enough said.

Acquiring for the sake of building the empire.  An executive may desire to expand the empire for personal reasons.  After all, the size of a company is linked to measures of ‘prestige’ like being part of the ‘Fortune 500.’  And, of course, there is a strong link between size of the firm and size of the CEO’s pay.

Getting caught up in deal fever and overpaying.  We’ve noted a good deal becomes a bad deal at some price.  Most of us have encountered a bidding situation, on eBay or elsewhere, where we’ve gotten caught up in the momentum of bidding and gone beyond our preset upper limits.  Ego can also becomes a factor in heated bidding wars.  Neither of these situations is best for us as individuals and they certainly aren't best when playing with shareholder's money.

Conflicts between classes of capital.  Less obvious are the conflicts that can exist between equity holders and debt holders.  In a share repurchase, for example, equity holders may gain at debtholders expense.  This can occur when the collateral protecting the debt holders (including cash) is reduced for share repurchase.

These are but a few of the potential conflicts that must be handled carefully in mergers and related transactions.  In a subsequent post, we'll talk about the incentives created when an owner (say an institution) holds both debt and equity in a deal.    

Ralph