The market for corporate control, or the merger market and acquisition market, has been part of the fabric of American business for more than a century. During the last 40 years, particularly on the past decade, this market has become increasingly sophisticated and some what ritualized. The result has been the growth of a variety of advisers, coun- sels, lawyers, and expert witnesses, all of whom not only facilitate the M&A (Merger & Acquisition) process but fuel the continued evolution of the M&A market itself.

For today, it is fair to say that it is the rule, rather than the exception, that at some point in their career, most individuals will anticipate, either directly, in a merger or acquisition proposal that will materially affect their economic lives.

Merger and Acquisitions Activity in the 1980s: The decade of the 1980s was marked by watershed growth in merger and acquisition activity in the U.S. and abroad. The total dollar volume of international M&A deals was about $50 billion in 1980. It gradually increased to $150 billion by 1985, plateaued at that level through 1987, and then spiked to almost $250 billion in 1988. The decline in activity was even more abrupt. Dollar volume fell to $188 billion in 1989 and fell again by more than 50% to $91 billion in 1990. In 1991, the dollar volume of U.S. deals fell by another 30%. Transaction volume fell drama -tically in the early 1990s, as credit became more difficult to secure, despite low levels of real interest rates, and as recessionary influences forced many companies to focus their energies on internal operation. Furthermore, the strong stock market made the public equity offering the exit strategy of choice for many sellers seeking liquidity.

The 1980s also was a period of dramatic growth in international mergers and acquisi-tions. Between 1980 and 1990, the percentage of U.S. transactions in which foreign firms acquired American companies increased from 9.8% in 1980 to about 12% in 1990. Simi- larly, the growth in purchases in foreign companies by U.S. companies was even more substantial, growing from 5.4 % of total announced deals in 1980 to 12.6% in 1990. Thus, the increase in cross-border M&A was dis-proportionate to the over all level of acti- vity for the period, and, although the number has decline lightly since 1990, most one- quarter of M&A transactions involving a U.S. corporation still are cross-border.

Merger activity has always ebbed and flowed, and the characteristics of each new wave are different in significant ways. Chronically low stock prices and relentless inflation were the principle causes of the corporate mergers of the 1970s. It was cheaper to buy than to build from scratch. In 1984 the new move- ment has begun, and this time the strategy of corporate acquirers has changed. Rather than reaching into new areas of business , corporations were intent on sticking to what they knew best. They now bought companies in their own or closely related fields. So-called conglomeration was no longer fashionable. The leveraged buy-out became a popular method of acquiring companies. Stock and debentures frequently were used as a means of payment; in the 1970s, it had usually been cash. With the exceptional increase in opportunity in mergers, he role of arbitrageur was reintroduced. Throughout each successive merger wave, the basic role of the risk arbitrageur remained the same: to make a living by investing in companies being acquired.

There individuals who have taken advantage of the opportunity to "make" money. They are: Classic Arbitrage and Risk Arbitrage . Classic Arbitrage is the arbitrageur's function that equates the price of a commodity in one market to the price available in another market. He buys goods, commodities, or securities that are selling too cheaply in one market, he then sells them in a marketplace where the price is higher.

Risk Arbitrage- has its roots in classic arbitrage. The risk arbitrageur bids for announced take-over targets that he believes are undervalued in the marketplace relative to their ultimate value. But in doing, he provides liquidity to the mar- ketplace. Unlike classic arbitrage, he also takes on risk that the rest of the market will not accept. The arbitrageur's job may seem simple, but once a merger pro- posal or takeover bid is announced, the arbitrageur must assess all the factors that will determine the outcome of the bid.

There is always considerable risk that a deal will not go through. An arbitra- geur must consider many issues that are often bewildering, while pursuing his profitable prize. Many novice arbitrageurs have been right about the outcome of a proposed merger, only to lose money on the deal. A delay in completing a merger, for example, can significantly alter the potential return. The terms of the deal might change if the overall economy changes. The action of an anti-trust agency can suddenly end a merger.

February 17, 1984 the biggest merger in history - Texaco took over Getty Oil. Other giant oil mergers were to follow. A new wave of mergers had clearly begun. Risk arbitrage was more exciting and lucrative than ever before. Every major financial house had its own arbitrageur. It was no longer an esoteric spe- cialty practiced by a few secretive individuals. Arbitrage had arrived.

Arbitrage is one of the fastest paced of investment activities, represent the best of America's entrepreneurial spirit, and a basic trading function in any market- place. Its practice is essential to the smooth running of a efficient financial mar- ket. The goal of arbitrage is to equate the values of the same or equivalent secu- rities products, or commodities in different markets. Over the years, arbitrage activities have embraced far more than stock and currency trading.

M&A Arbitrage - In the past two decades, it has come to be the dominant form of all risk arbitrage. When two companies announce a merger or one company announces a bid for another (whether it be friendly or hostile), a risk-arbitrage opportunity is created.

Merger arbitrage is not merely buying a takeover target if you think an ac- quisition will be completed. Merger arbitrage is not guessing correctly whether or not a merger will go through nor it is a one-decision investment, nor it is a part-time activity. It is an on going process: prices fluctuate, the economy changes, government actions are taken, stock is always being bought and sold; requires a constant vigilance. Its ultimate effect is to equate values in the market place. Arbitrageur also provides liquidity to the marketplace, buys typically from those who do not want to bear the risk of waiting to see if a deal will be consummated. He will buy the stock, usually at a sizable profit to the financial institution. In turn, he expects to sell that stock to the acquiring company at a profit. The arbitrageur can attach a higher value to the stock because he is more knowledgeable about the risks, has unique analytical skills, can trade more effec- tivelly, has considerable experience, and can act more quickly. He is forcing upthe price of the target company closer to what is in his opinion its realistic value.

Merger arbitrage came to full fruition in the 1960s. The spate of mergers that was to sweep over the American financial community in the late 1960s was in many ways unprecedented. Unusual high stock prices dramatically set the stage, as did liberal accounting rules. Many corporations found they could ac- quire companies with an exchange of their high-priced stock and raise their earnings per share virtually automatically. As with such movements, there was some logic to it. At that time, many of the best minds in business management believed there were synergistic benefit in combining two companies. It was the age of conglomeration. The volume of mergers triple between the mid-1960 and the late 1960s. The opportunities for arbitrageurs were excellent. A great deal of money was made.

When stock prices came down, so did merger activity, at least temporarily. But in the 1970s, a new merger wave began. The time the stage was set by run- away inflation and the energy crisis, cash, not stock became the most overvalued of financial commodities. Stock prices fell so low that most companies were sell- ing a bargain prices. It became much cheaper to buy than to build. Cash tenders were widespread, and if a company did not choose to be acquired, then major corporations did not hesitate to go ahead with a tender offer anyway. Hostile mergers became common. Total merger activity set new records, rising from about $12 billion in 1971 to $44 billion in 1984. Again, arbitrage opportunity bounded. In deed, arbitrageurs have play a central role in the two merger waves of the past quarter century and they will continue to do so.

What is a merger???

A merger occurs when two separate companies combine into one. Depend- ing on legal, tax, and accounting considerations, a merger can take three forms:

1. Two companies can create an entirely new legal and corporate entity.
2. One company can be absorbed into the operations of another.
3. One company can become a division or wholly owned subsidiary of another.

There are several basic kinds of mergers:

• Stock for Stock - A stock-for-stock merger is the most basic transaction and typically the easiest in which to determine the work-out value. When AmeriFed, Joliet former local bank, was bought by NBD (National Bank of Detroit), for eve- ry share of AmeriFed stock, the share-holders would receive roughly 1.6 shares of NBD's. So if you own 100 shares of AmeriFed Stock, you would receive about 166 shares of NBD stock. AmeriFed shares were traded at time of the offering at $45.00 per share versus NBDs at $26.50 per share. Monetary wise, stockholders still have the same amount of money originally invested. The difference is that they own more stock at a lower price per share. Of course, NBD stock jumped to $43.00 per share at conversion of the two institutions, March of 1994. Many big and small time arbitrageurs were sitting happy and enjoy the one in the life time ride (AmeriFed's stock was offered at $11.00 per share in 1991).

• Cash and Stock - The Coco-Cola Company and Columbia Pictures Industries were merged with cash and stock termed:

1. For every share of Columbia Pictures, Coco-cola will receive (on the fifteen trading days prior to the effective date of the merger) $32.625 pus additional cash equal to 1.2 times the average of its closing price.
2. 1.2 shares of Coco-Cola plus additional shares equal to $32.625 at the time of merger (computed by dividing $32.625 by the average market price $32.625).

The two choices were substantially identical in value on the day of the mer- ger. The Columbia shareholder received 1.2 shares of Coca-Cola and the equiva- lent in Coke shares of $32.625 (based on the average market price for the prior fifteen day), or $32.625 in cash plus additional cash worth 1.2 shares of Coke (also based on the average market price).

• Two-Step Merger: Cash and Debt - In the early 1980s, so-called two-step trans -actions became common. An acquiring company could gain effective control of the target by merely tendering an offer for majority of the shares- in other words, more than 50% of the shares. As for the second step the remainder of the shares could be exchanged for a security rather than for cash. The U.S. Steel Corporation's take-over of the Marathon Oil Company is a good illustration. It also is a case when a new debt security was issued.

Early in 1981, U.S. Steel made a successful cash tender offer for 51% of the shares of the Marathon Oil. It paid $125.00 per share for 30 million shares. A month later, U.S. Steel offered a new 12 1/2% guaranteed note with a face value of $100.00 due in 1994 for the remaining shares of Marathon.

Stock for Cash or Combination of Securities-- ConAgra and Peavey Companies:

1. Peavey share = $30.00 in cash or
2. A package of newly issued convertible preferred stock plus common stock of ConAgra.

The company offers cash for only 30% of all the outstanding shares of the target company. The remaining 70% of the shares would be exchanged for a package of convertible preferred stock, newly created for this purpose, and common shares equal to a stated amount of cash. This protect the acquiring company, but it also makes hedging the transaction virtually impossible.

Techniques of Acquiring- The following techniques have been used frequently and successfully in most mergers and acquisitions in the past decade and still continuously being used today.

Tender-Offers- In the U.S., the tender-offer is a relatively recent takeover techni- que. It is the most fast-paced and exciting. First, the tender-offer is the principal weapon in waging battle to acquire a company that will not agree to a merger. The unsolicitated or hostile tender became a common practice in the 1970s and bidding wars among competing acquired companies often drove premiums to 60% and more above the original market price of the target company. Second, a tender offer is typically the fastest of merger transactions. An acquisition valued in billions of dollars can be completed very quickly. Indeed, such a transaction can be completed in 20 business days. Finally, despite the adoption of disclosure requirements, there is usually less information available to the public about the company involved in a tender than in a traditional merger. The tender-offer has been an extraordinarily successful means of take-over in most cases. It is a cash offer by a corporation, individual, or other legal entity made directly to the shareholders of another company in exchange for the shareholders' stock (either for all or part of their holding). The traditional use of tender-offers was to buy minority interest in one's own company.

Tender-offer grew in popularity in 1960s and when the economic conditions shifted drastically in the 1970s, the tender-offer was to become more popular than ever. It was simply far more economical to buy an exiting company that to build a new plant.

"Saturday Night Special" - In the early 1970s, the "Saturday Night Special" quickly became a successful takeover technique. The William Act originally re- quired a minimum of seven calendar days between the time a tender was publi- cally announced and its deadline (it is now 20 days). Investment bankers reali- zed that announcing a tender to management over the weekend would reduce the effective working time for a response. In effect, the acquiring company made a sudden grab for its prey. This quick strike, occurring most often on a Satur- day evening, soon was dubbed the "Saturday Night Special". It was very effec- tive for several years.

The Bear hug- As the "Saturday Night Special" lost its effectiveness, a new technique, dubbed the "Bear Hug", achieve a limited success. The acquiring compa- ny would simply send a letter to the target company's board of directors and offered to buy the company at a significant premium above the current market. The directors were reminded that they had a "fiduciary responsibility" to the shareholders to accept the bid in their interest. Often the directors felt they were obligated to make the letter public. In other words, they were squeezed (or bear hug) into submission. For example, Exxon Corporation's bid for Reliance Elec- tric Company began with a letter to management making a bid for the company. The letter was received, the information made public, and the stock price rose. Reliance soon agreed to the merger.

Defensive Tactics Target Companies Used to Defend and Thwart off Bids - If legal objections are the first line of defense, financial and structural changes in a target company are the most dramatic methods of defending a corporation against a proposed takeover. These changes may include acquisitions, liquida- tions, spin-off, self-tender, and so-called Pac-Man defenses that might stop an acquirer. Each of these defenses is discussed below.

Acquisition -There are several objectives for an acquisition by the target company:

1. To create an anti-trust conflict. In the bidding situation, company seeks to ac- quire another company that would put it in direct competition with the raider, making it subject to the anti-trust laws.
2. To create a regulatory conflict. An acquisition of a company in a federally re- gulated business will at least delay a merger until the necessary approvals are won. It also can provide obstacles because the raiding company may not qualify or may be not allowed to own a company in the industry.
3. To utilize attractive financial assets. A target company ca make an acquisition in order to reduce its cash or increase its debt. The goal here is to reduce the target company's financial assets-assets which are its principle attractiveness to the corporate raiders. Sale of Business - In some cases, a corporation acquirer is principally interested in a specific business or asset, such as a natural resource, that is owned by the target company. The company can sell that business or asset, often called the "Crown Jewel", thus reducing its attractiveness to the would be buyer. For ex- ample, in facing a hostile bid from Limited, Inc. , in 1984 Carter Hawley Hale gave General Cinema Corporation an option to buy its most successful property, Walden Books. Along with other tactics, the action helped to defeat the hostile bid.

Partial Liquidation and Spin-offs - A target company can sell undervalued business or undervalued asset for the going market value and distribute the pro- ceeds to the stockholders. This is called a partial liquidation. The undervalued business can also be sold in what has come to termed a spin-off. In a spin-off, the shareholders usually are given shares in the spun-off venture so that they retain their interest. The sale is then not subject to the risk of not getting top price in the rush to sell. Also, unlike a liquidation distributed in cash, which is taxable to the stockholders, securities are generally tax-free.

Self-Tender- In response to a tender-offer, a target company may choose to ten- der for a portion of its own share at a higher price than is being offered by the raiding company. This is especially attractive to a cash rich company. Complete Liquidation - A company, especially one rich in undervalued assets, may choose to liquidate entirely rather than accept the acquiring company's bid. This is an option if the total values are substantially in excess of the bidder's offering price and shareholders can be convinced to wait a few months required to implement the plan. In 1980, U.V. Industries was able to defeat a hostile bid from Victor Posner (through Sharon Steel Corporation) by liquidating itself.

Outlook in M&A Future- M&A is unlikely to return to the volume of the last decade. However, the market will continue to develop and evolve in response to fundamental macro-economic changes: the creation of EC (European Commu- nity) Market, the fall of communism in Eastern Europe, certain merger related developments like changes in anti-trust and tax legislation. Most importantly, the merger market will become increasingly global.

For several reasons, hostile tender-offers are unlikely to return to their previous levels. First, management and investors can better recognize the potential value of "hidden" assets. This recognition by investors decreases the value of the potential arbitrage. While management is more likely to consider ways to se- curitize or otherwise capture values that previously would have remained "hidden". Secondly, many of the potential arbitrage opportunity that existed in the 1980s have already been affected. Few firms, for example, still have bonds outstanding with antiquated covenants that permit risk-transfers. Large conglo- merates with extra-ordinary dis-economies of scale or scope feel underpressure to re-evaluate their strategies. The public's contempt for hostile transactions, government's recognition of the tax revenues lost from mergers in 1980s; and the economic cost of its weak anti-trust enforcement make it unlikely that Washing- ton would permit many of the arbitrages that drove certain hostile transaction in the 1980s. Finally, bank credit often extended to nearly insolvent companies in the 1980s, no longer is granted so freely. Also the use of proxy involve share- holders voting to protect the majority interests which discouraged a hostile tender.

These changes among others will have a profound impact on the environment in which the merger professionals operate. Merger advisory assignments will become more global, and hence, more competitive. Non-traditional competitors will continue to enter the arena, but will be increasingly hard-pressed to compete effectively, given the heightened sophistication of the market, the demand for auxiliary services, the amount of available business, and the new nature of the corporation governance. Firms that enjoy relationships with both management and shareholders will be uniquely situated to provide high-quality advice and develop state-of-the-art merger products.

Although the hectic pace of the 1980s is unlikely to return in the near future, the merger market will continue to become more sophisticated, more global, more competitive, and more important to the world economy than ever.

References:

Boesky, Ivan F. . Merger Mania: Arbitrage, Wall Street's Best kept Money Making Secret.

Tuller, Lawrence W. . M&A Mergers and Qcquisitions Hand-Book: Entreprenurial Growth Strategies.

AmeriFed/NBD Published News Letters, 1993,1994,1995 Personal Acknowledgement, Kim DiBartolomeo (employee).