American Airlines Fights Acquisition

Airlines have often suffered losses and were hit particularly hard during the COVID-19 pandemic. As a result, American Airlines (AA) has amassed significant losses. In fact, AA has an accrued tax benefit benefit due to $16.5 billion in net operating losses. To help avoid a hostile takeover which would allow the acquirer to claim the tax benefit, as well as a takeover for any other reason, AA has implemented a rights offering. Under the terms of the rights offering, AA will issue one preferred stock purchase right in the form of a dividend to each shareholder if an outside investor acquires more than 4.9 percent of the stock in the company. Each right will allow investors to purchase one share of stock at a 50 percent discount. This would serve to make a hostile takeover more expensive.

Adidas Kicks Out Reebok

In 2006, Adidas purchased Reebok for about $3.8 billion. The goal was to increase the company's presence in the sneaker market to better compete with Nike. In the past several years, Adidas' sales have grown, while Reebok's sales have been poor. As a result, Adidas has agreed to sell Reebok to Authentic Brands Group for about $2.5 billion, abandoning its investment in Reebok.

Amazon Acqui-Hires Zoox

Amazon offered $1.3 billion to buy Zoox last month. So what are you buying when you buy a tech company? Since there are often limited fixed assets, generally, you are seeking to get the employees. In this case, two Zoox senior engineers had already accepted offers from other companies. So Amazon upped the offer by $100 million to compensate the employees who stay after the acquisition. The new condition of the acquisition is that all of the employees on a "key list" must stay and at least 19 employees on a second list must stay. Finally, three schedules of other employees was created. 90 percent of the employees on the first two schedules must stay and 88 percent on the lowest schedule must stay, otherwise, Amazon can walk away from the deal.

Schwab Breaks And Buys Ameritrade

Charles Schwab is nearing a deal to buy fellow broker Ameritrade for $26 billion, a premium on Ameritrade's $22.4 billion market cap. But what makes this really interesting is that Ameritrade was valued at $25.3 billion in October before Schwab helped to drop Ameritrade's price! Schwab makes more money from commissions than Ameritrade does. When Schwab announced that it was eliminating commissions, Ameritrade was forced to follow suit. Naturally, Ameritrade's price dropped more than Schwab's, so when Schwab announced the purchase of Ameritrade, the price was much less than it would have been a month earlier before commissions were eliminated. 

A Southwest Acquisition?

Southwest, which is known for its all 737 fleet, reportedly lost out on $175 million in income during the second quarter due to the continued grounding of the 737 Max. So how is Southwest to grow? There is speculation that the way to growth may be the acquisition of another airline such as Spirit or JetBlue. This would allow Southwest to rapidly increase fleet size and diversification as other airlines' fleets include Airbus jets. So what does one analyst think about this possibility? A Stifel analyst downgraded Southwest stock on speculation of an acquisition, an indication that any possible acquisition will be over-priced.

Fiat Chrysler/Peugeot Synergies

Fiat Chrysler and Peugeot have announced a 50/50 merger, with sales of $190 billion for the combined company. A key reason for the merger is an annual cost savings of $4.1 billion from “a more efficient allocation of resources for large-scale investments in vehicle platforms, powertrain, and technology and from the enhanced purchasing capability inherent in the combined group’s new scale.” As with most mergers or acquisitions, whether they synergies are realized will be an important determinant of whether the merger is successful.

M&A Checklist

In the textbook, we discuss how to value an acquisition. But what are the some considerations in the valuation of the target? The recent acquisition of Wells Fargo's retirement and trust business by Principal can give you some insight. For example, Principal had to consider whether recent problems at Wells Fargo had extended into the retirement area. Additionally, future revenues from the acquisition depend on how many of the current customers stay when the acquisition is complete. In this case, a payment will be made in two years contingent on the percentage of current customers of Wells Fargo remain at that time.

Finally, an important consideration is the cultural fit between the two companies. The value of the synergies, as well as the continuation of the current cash flows of the target company into the future, often depend on culture. If employees of the target company are thrust into a new culture, it may lead to an exodus of employees, resulting in a decrease in ongoing cash flows as well as reducing expected synergies. A culture clash was allegedly a major cause of why the AOL-Time Warner merger flopped so badly.

Breaking Up Is Hard To Do

There are numerous examples of a company splitting into separate companies. Of course, splitting up may not always be the best option. For example, earlier this month, CBS and Viacom announced terms of a a merger deal 13 years after the companies had split. Now, Phillip Morris and Altria are in talks to merge. The companies had split in 2008, but declining tobacco sales, coupled with the diversification of the companies into other areas such as vape pens and cannabis have made a merger seem advantageous.

McDonald's Acquires Dynamic Yield

Some companies, like Alphabet, which has acquired 220 companies since 2003, are serial acquirers. Other companies, like McDonald's, make fewer acquisitions. However, McDonald's made a splash when it announced the acquisition of Dynamic Yield for $300 million. This is McDonald's largest acquisition since it bought Chipotle more than 20 years ago. Dynamic Yield is a technology company whose product will allow McDonald's to vary electronic menus. The new menus will vary depending on the time of day, the weather, and regional preferences, which McDonald's believes will yield increased sales.

M&A Dis-Synergies

So why don't all mergers and acquisitions work? Probably the main reason is that acquisitions are done based on assumptions about the future, and these assumptions may not be realized. A major assumption generally involves the synergies that are expected to be realized from the acquisition. A recent article argues that in failed acquisitions, the buyer pays too much, often due to dis-synergies. For example, GE has performed poorly because poor acquisitions over the past 20 years, which were often based on a poor analysis of synergies. And, athough we don't discuss the topic of corporate culture in Finance, many times a combination of two companies with dramatically different corporate cultures will result in a combined company that fights with itself. Although such an analysis is important to evaluate before an acquisition, and valuing a corporate culture clash is difficult, be aware that it does add to the risk of an acquisition.

Bond Ratings And Mergers

A recent article in Bloomberg highlights a potential threat to the bond market. Recent years have seen a number of high-priced acquisitions funded by debt. As a result, many of these companies have dramatically increased leverage as measured by Debt/EBITDA. This has caused a drop in credit ratings, with $2.47 trillion worth of debt now rated as BBB, more than three times the 2008 level of BBB debt. Even though many of the deals are funded through debt, a common assumption is that synergies and the improved cash flow would allow the company to quickly pay down debt. But a hiccup in the economy or synergies not materializing could limit debt pay down. In the last three recessions, from 7 to 15 percent of investment grades bonds were downgraded to junk status. Given the higher amount of debt with lower credit ratings, a recession in the next couple of years could push a massive amount of corporate debt into junk territory.

Papa John's Extra Cheese

Papa John's stock has been battered this year after comments made by founder John Schnatter on a conference call. Schnatter resigned as chairman in July, but still owns about 30 percent of the company's stock. In a nod to the bidding wars that can occur in a takeover battle, the stock jumped nearly 8 percent today when it was announced that Trian Fund Management is considering a bid to buy the company and take it private.

And The Winner Loses

In a nod to the winner's curse, Comcast stock fell 8 percent today when it was announced that the company outbid rival Fox in the three round auction of British broadcaster Sky. Comcast's winning bid was for $40 billion. The price was about 27 percent higher than Comcast's initial bid. In any auction, the winner ultimately is the bidder willing to pay more than any other bidder, increasing the likelihood that the winner overbid, resulting in a a negative NPV.

Internal Controls And Acuisitions

It is widely known that a large percentage of acquisitions fail to deliver pre-aqcuisition promises, but new research indicates that there may be an indication of trouble ahead. When a company acquires another company, it can exclude the acquired company from Section 404 of Sarbanes-Oxley. Section 404 requires external auditors to assess the the internal controls are adequate. Although inadequate controls result from a myriad of reasons, they are noted in 30 percent of cases where fraud is ultimately determined. One explanation of an acquiring company not being willing to comply with Section 404 is that new, unfavorable information, was found after the acquisition. 

Merger Math

Several big merger or acquisition announcements have been in the news recently. And, although we argue that the analysis of a potential merger is an NPV analysis with consideration for synergies, many mergers and the payment are done by the "seat of your pants" method. For example, when Elon Musk announced he was considering taking Telsa private at $420 per share, his bid was based on a 20 percent premium to the current stick price, rounded up to $420 dollars per share. A cash flow analysis of Tesla was not necessary since it has no operating cash flows. And when Disney announced it was increasing its bid for 21st Century Fox by $19 billion, it was because the intrinsic value of these assets has increased, notably due to tax reform and operational improvements." While mergers tend to be a tricky analysis, we have severe doubts about any merger done by the seat of your pants method.

AT&T Buys Time Warner

AT&T announced that it had agreed to purchase Time Warner for about $85 billion. Under the terms of the deal, Time Warner shareholders will receive $107.50 per share, half in stock and half in cash. The share price represents about a 20 percent premium to Time Warner's closing price on Friday. Even though the terms of the deal have been announced, Time Warner shareholders and the Department of Justice still must approve the deal, and the chair of the Senate subcommittee on antitrust said the committee would examine the deal as well. Of course this is not the first time that Time Warner has been acquired: In 2000, AOL purchased Time Warner for $160 billion in one of the worst deals in history. In fact, the company had a $99 billion loss in 2003 and things went so bad, the merged company eventually changed its name back to Time Warner.

You Can't Keep A Good Twinkie Down

In 2013, facing imminent bankruptcy, Hostess, the maker of the iconic Twinkie, was sold for $410 million. Since then, the company has been turned around and a deal was recently announced that values the company at about $2.3 billion. Private equity group Gores Group bought Hostess and will take the company public. So, while you have been able to eat Twinkies, you will soon be able to invest in them again.

Activist Investing Increases

Activist investing has been on the rise in recent years. According to CFO, FactSet reported 355 activist campaigns in 2015, with 127 resulting in at least one board seat, while Ernst & Young reported 516 activist encounters. However, today's activist investors seem to be more collaborative than corporate raiders of the past. Importantly, the rise in activist investors appears to have lead to increased conversations between management and investors, which is a positive result. In fact, clear conversations between management and investors can head off confrontations as management may have information that shows an action desired by investors is a bad idea. While activist investing does not seem to be slowing any time soon, it does appear that in many cases, it has resulted in management becoming more focused on company performance and becoming more transparent.

Divestitures Expected To Increase

A recent survey by EY indicates that corporate divestitures are expected to increase in the next two years. Forty nine percent of the companies surveyed indicated possible divestitures in 2016, and only five percent of companies did not plan a divestiture over the next two years. Seventy percent of the companies that are planning a divestiture expect to reinvest in core businesses, invest in new products and markets, or make an acquisition. Divestitures have proven to be a method to increase shareholder wealth in recent years as companies that have divested more than 10 percent of their value have outperformed the stock market by more than six percent.

Pfizer-Allergan Acquisition

Pfizer announced that it would buy rival pharmaceutical company Allergan for about $160 billion. The new company will be based in Ireland, a tax inversion deal that will lower Pfizer's tax rate from 25 percent to 15 percent. The deal makes 2015 a record breaking year for mergers and acquisitions. For example, healthcare M&A deals have topped $600 billion, shattering the previous high of $362 billion in 2014. Energy and power M&A currently stands at $572 billion, while high technology M&A has reached $514 billion. And, worldwide, total M&A activity has reached $4.2 trillion, topping the previous high of $4.1 trillion set in 2007.