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4.4. Joint venture as a form of a merger

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Mergers and Acquisitions – The Relentless Pursuit of Synergy

Institut de physique et de technologie de Moscou

4.4 (22 notes) | 3K étudiants inscrits

Cours 4 de 5 dans Understanding Modern Finance Spécialisation

The area of mergers and acquisitions (M&As) is special in finance. Incredible amounts of money are employed in such transactions. Deals draw a lot of public attention and dispute. Oftentimes, stories look more like fairy tales rather than financial reality. The key idea in any M&A transaction is to create value through a potentially synergetic activity. To this end, it is important to have a clear motive and implementation plan. Of special importance are the correct valuation, proper financing, and actual deal completion. But this is not the end – value mostly accrues from the post-merger integration. The understanding of the motives of various stakeholders is instrumental in the analysis of the potential creation of value. The learners will gain insight into the core value creating M&A strategies. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. Finally, the Course is very helpful in successful completion of the Specialization’s Final Project.

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4.4 (22 notes)

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M&A Financing. LBOs and MBOs

In Week 4 we study M&A financing. Motives, theories, and deal mechanics are fine – but where’s the money? If a transaction is friendly, a stock payment is likely to help. But what if there’s a conflict? Then a lot of cash is needed, and a lot of debt must be issued. One way is issuing junk bonds. We discuss both facts and myths about junk bonds. Then we consider LBO and MBO transactions. First, we analyze how a company may be taken private through heavy borrowing and further gradual debt repayment. We illustrate the mechanics of an LBO/MBO transaction on a detailed example. Finally, comments on a famous LBO case – RJR Nabisco – are provided.

4.1. M&A financing an overview11:09

4.2. Junk bonds (1) – facts12:11

4.3. Junk bonds (2) – legends11:14

4.4. Joint venture as a form of a merger7:42

4.5. LBOs and MBOs (1) – a way of financing11:04

4.6. LBOs and MBOs (2) – an example22:33

4.7. An example of an LBO – the RJR Nabisco case (1988)10:46

Enseigné par

Konstantin Kontor
Director and Professor of Finance and Strategy

Transcription

In the previous episodes when we talked about financing,

we made an emphasis on junk bonds as the vehicle that is really full of legends.

In what follows we'll talk about another legendary approach that is linked to junk

bonds.

That is the buyout of the company.

But for now, I would like to say a few words about the topic that seems to

be far from just financing.

This is the idea of joint ventures.

And I am putting that here specifically to give you an idea that it

also can be thought of as a way of,

let's say, quote, saving on these financing.

So joint ventures.

Well, The idea here

is that instead of a full fledged merger when two companies

engage in a joint venture they commit some part of the resources,

expertise, the general capacity, knowledge,

technology to the combined project.

Now the key story is that this scope is limited,

that the lifetime of this venture is also limited.

And, strictly speaking, the companies do not commit most

of their really most valuable assets and capacity.

So therefore they are sort of doing that in a way that does

allow them hopefully to get some results easier and qoutedly cheaper.

I just explain in a few moments what I mean by that.

But, at the same time, they keep their most valuable things to themselves.

Now, that has both pluses and minuses.

And again, the main goal of joint venture is a risk sharing and knowledge sharing.

So I would put it here, goals.

So this is risk sharing, And then knowledge.

I would put knowledge acquisition, but quoted acquisition.

Because it's not really paid for.

And here I would put quoted financing.

So one of the ideas, and here I'll make an emphasis and

that sort of explains why I put it here,

is that idea of lower commitment or under commitment if you will.

So clearly, in a joint venture project,

both companies can save significantly and

specifically the one, let's say one company's bigger.

So the one that initializes this.

And then for this company there are two options.

One option is a full fledged merger in which you pay for this company and

you most likely pay a premium.

And the other way is when you do not pay and you engage in

a joint venture that is sort of limited, and in this case you save fundamentally.

Well, one of the ideas here is also,

the rationale for that is that one idea is strategy.

Because sometimes you can pursue different strategies.

And neither company would like to completely change its strategy.

But in this joint venture they can change it somewhat.

And then that may result in a strategic alliance in which some goals are achieved.

But the major strategy of both companies stays the same.

Now the rationale for this, I would put it here just for,

is oftentimes associated with

the Transaction Cost Theory Of the firm.

So this theory basically says that if you create a firm,

then maybe you can save on something.

Because you cannot enter into a contract with some of your employees every time.

They just have job description.

And they keep delivering their services or their jobs.

But, at the same time, when it comes at the level of top management,

we see the problems associated with the agency theory.

We see problems associated with the free cash flow theory and all these things.

So basically, the idea is here that if you do not

have a lot of commitment,

then clearly If your commitment is lower, then your cost is lower too.

But the same set of potential pluses in this savings, that creates problems.

Because when both parties are sort of undercommitted,

then they do not work hard enough.

And it had been seen that as many as 70%

of joint ventures, they actually disbanded without reaching their goals.

So you can see how sometimes

if you try to save on your commitment that may fight back.

That is the only reason why I put these

short comments on joint ventures in this part.

Clearly, this topic has much

broader coverage in both our handouts and in the book.

And therefore you can easily read that.

But now I would just like to make this distinction if you will.

Smaller costs that are associated with small commitment, but

the smaller probability of success.

It's again some people in a jokey way say,

a merger is sort of as a marriage, which is a contract after all.

Not only your feelings, not only just, while joint venture is more like trying

your feelings by living together without any legally binding agreement.

Well, that may be a poor analogy because here we are talking about companies and

not people.

But to some extent, we can say that it really requires some mutual commitment

to be able to reach goals in this market environment.

So this wraps up my comments with respect to joint ventures.

And then in what follows, we will talk about leverage buyouts and

management buyouts.

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