New on FinoLib · Volume II: Capital Markets
My latest article is now live on FinoLib, the free finance library I write: Stock Deal vs Asset Deal and Strategic vs Financial Buyers, from Volume II: Capital Markets. Read the summary below for the substance of the topic, then continue to FinoLib for the complete treatment.
2.2 Stock Deals vs Asset Deals
The idea in plain words
A buyer can buy a company in two ways. In a stock deal you buy the legal entity itself, with all its debts and past problems, and its tax records carry over. In an asset deal you pick the assets and liabilities you want, and the tax value of those assets is reset higher, called a step-up. That step-up saves real money, $65.8 million on a $790 million deal in this chapter, so the choice is really a negotiation over who bears the tax and the legal risk.
Key points
■Purchase price allocation marks assets to fair value; in a stock deal the step-up creates a deferred tax liability and larger goodwill ($325 million versus $270 million here).
■Asset-deal goodwill and customer intangibles are amortized for tax over 15 years (Section 197).
■A 338(h)(10) election gives stock-deal simplicity with asset-deal tax for S corporations and group subsidiaries.
A closer look
An acquirer can structure a purchase in two fundamentally different ways. In a stock deal, the acquirer buys the target’s shares directly from its shareholders, taking on the entire legal entity — including all its assets, but also all its liabilities and contractual obligations, known and unknown. In an asset deal, the acquirer instead buys specific assets (factories, brands, contracts, customer lists) directly, leaving the target’s original legal entity — and, crucially, its liabilities — behind with the seller.
Decision rule
As a buyer, compare the present value of the tax step-up ($65.8 million above) with the extra tax the seller would bear in an asset sale, because the seller will ask for that much in price. If the target is an S corporation or a group subsidiary, elect 338(h)(10): the step-up is cheap. If it is a standalone C corporation owned by individuals, expect a stock deal, since the second layer of tax usually exceeds the step-up’s value.
The costliest mistake
Buying the entity, and with it liabilities nobody priced. Bank of America acquired Countrywide Financial, completed July 1, 2008, for about $2.5 billion; by June 2012 the Wall Street Journal tallied more than $40 billion of mortgage losses, repurchase funds and legal settlements attributed to the deal, including the purchase price. The defense is to price the liability tail explicitly: diligence the litigation and repurchase exposure, then demand escrow, indemnity or a lower price, or restructure as an asset purchase.
2.3 Strategic vs Financial Buyers
The idea in plain words
Two kinds of buyers can bid for the same company, and each has its own ceiling. A strategic buyer is another company that can combine the businesses. It can pay up to the target’s standalone value plus the value of the savings from combining, minus the cost of combining. A financial buyer, like a buyout fund, can pay only up to the price at which it still earns its target return. In this chapter’s example the strategic buyer can go to $1,050 million, the fund only to $919.5 million.
Key points
■Walk-away price is a calculation, written down before bidding.
■A sponsor’s maximum price falls fast as its target IRR rises: 8.0x at 20%, 7.35x at 25%.
■Every dollar a strategic buyer pays above standalone value hands synergy value to the seller.
Strategic buyers can usually justify paying more, because they can capture synergies — covered next — that a financial buyer running the target standalone cannot.
Decision rule
Before bidding, write down your walk-away price. A financial buyer: the price at which the base-case LBO just meets the fund’s target IRR with no multiple expansion (8.0x here at 20%). A strategic buyer: standalone value plus the present value of synergies you can document, minus integration costs (9.13x here), and count cost synergies at full value but revenue synergies at a heavy discount or zero. Never let the bid exceed the walk-away price because a rival is close: the rival’s number is not evidence about your synergies.
The costliest mistake
Paying away the whole synergy case and then missing it. If the strategic buyer above bids its full $1,050 million and synergies arrive at half the plan ($10 million a year), the value it actually bought is 920 + 10 × 8.0 − 30 = $970 million: an $80 million loss on day one of integration, with no upside left to offset it. Bid at a price that still creates value if synergies come in at half.
What the full article covers
In the full article I take you through these sections:
■2.2 Stock Deals vs Asset Deals
■2.3 Strategic vs Financial Buyers
It includes worked examples, a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, Stock Deal vs Asset Deal and Strategic vs Financial Buyers, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
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