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by Derek Loosvelt | March 10, 2009


In the 1980s, hostile takeovers and LBO acquisitions were all the rage. Companies sought to acquire others through aggressive stock purchases and cared little about the target company's concerns. The 1990s has been the decade of friendly mergers, dominated by a few sectors in the economy. Mergers in the telecommunications, financial services, and technology industries have been commanding headlines as these sectors go through dramatic change, both regulatory and financial. But giant mergers have been occurring in virtually every industry (witness the biggest of them all, the merger between Exxon and Mobil). While the giant takeovers by LBO firms that characterized the 1980s haven't materialized this decade, M&A business has been consistently brisk, as demands to go global, to keep pace with the competition, and to expand earnings by any possible means have been foremost in the minds of CEOs.

When a public company acquires another public company, the target company's stock often shoots through the roof while the acquiring company's stock often declines. Why? One must realize that existing shareholders must be convinced to sell their stock. Few shareholders are willing to sell their stock to an acquirer without first being paid a premium on the current stock price. In addition, shareholders must also capture a "takeover premium" to relinquish control over the stock. The large shareholders of the target company typically demand such an extraction. For example, the management of the selling company may require a substantial premium to give up control of their firm.

M&A transactions can be roughly divided into either mergers or acquisitions. These terms are often used interchangeably in the press, and the actual legal difference between the two involves arcana of accounting procedures, but we can still draw a rough difference between the two.

Acquisition -- When a larger company takes over another (smaller firm) and clearly becomes the new owner, the purchase is called an acquisition. Typically, the target company ceases to exist post-transaction (from a legal corporation point of view) and the acquiring corporation "swallows" the business. The stock of the acquiring company continues to be traded.

~Merger -- A merger occurs when two companies, often roughly of the same size, combine to create a new company. Such a situation is often called a "merger of equals." Both companies' stocks are tendered (or given up), and new company stock is issued in its place. For example, both Chrysler and Daimler-Benz ceased to exist when their firms merged, and a new combined company, DaimlerChrysler was created.

M&A advisory services

For an I-bank, M&A advising is highly profitable, and the possibilities of types of transactions are virtually unlimited. Perhaps a small private company's owner/manager wishes to sell out for cash and retire. Or perhaps a big public firm aims to buy a competitor through a stock swap. Whatever the case, M&A advisors come directly from the corporate finance departments of investment banks. Unlike public offerings, merger transactions do not directly involve salespeople, traders or research analysts. In particular, M&A advisory falls onto the laps of M&A specialists and fits into one of either two buckets: seller representation or buyer representation (also called target representation and acquirer representation).

Representing the target

An I-bank that represents a potential seller has a much greater likelihood of completing a transaction (and therefore being paid) than an I-bank that represents a potential acquirer. Also known as sell-side work, this type of advisory assignment is generated by a company that approaches an investment bank and asks the bank to find a buyer of either the entire company or a division. Often, sell-side representation comes when a company asks an investment bank to help it sell a division, plant or subsidiary operation.

Generally speaking, the work involved in finding a buyer includes writing a "Selling Memorandum" and then contacting potential strategic or financial buyers of the client. If the client hopes to sell a semiconductor plant, for instance, the I-bankers will contact firms in that industry, as well as "buyout" firms that focus on purchasing technology or high-tech manufacturing operations.

~Representing the acquirer

In advising sellers, the I-bank's work is complete once another party purchases the business up for sale, i.e. once another party buys your client's company or division or assets. Buy-side rep work is an entirely different animal. The advisory work itself is straightforward: the investment bank contacts the firm their client wishes to purchase, attempts to structure a palatable offer for all parties, and make the deal a reality. However, 99 percent of these proposals do not work out; few firms or owners are willing to readily sell their business. And because the I-banks primarily collect fees based on completed transactions, their work often goes unpaid.

Consequently, when advising clients looking to buy a business, an I-bank's work often drags on for months. Often a firm will pay a non-refundable retainer fee to hire a bank and say, "Find us a target company to buy." These acquisition searches can last for months and produce nothing except associate and analyst fatigue as they repeatedly build merger models and work all-nighters.Deals that do "get done," though, are a boon for the I-bank representing the buyer because of their enormous profitability. Typical fees depend on the size of the deal, but generally fall in the 1 percent range. For a $100 million deal, an investment bank takes home $1 million.


Filed Under: Finance