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Soliciting bids is an effective way to sell a business -- but review your strategy first.
Edward Teach, CFO Magazine
April 1, 2003
When fitness-magazine publisher Weider Publications was put up for bids late last year, the owner of the National Enquirer, American Media, flexed its financial muscle with a winning $350 million offer. Meanwhile, The Blackstone Group was buying TRW Automotive at auction from Northrop Grumman for $4.7 billion. That was just after Blackstone had teamed up with two other private buyout groups, Thomas L. Lee Partners and Bain Capital, to win Vivendi Universal's auction of book publisher Houghton Mifflin with a $1.66 billion bid.
Competitive auctions for healthy companies remain alive and well, despite the recent lean years for mergers and acquisitions in general. In March, AOL Time Warner received the first round of nonbinding bids for its book-publishing division; among the suitors were British media giant Pearson and German media giant Bertelsmann. Needing to pay down some of its $29 billion in debt, AOL Time Warner is hoping to raise at least $400 million from the sale.
For the seller, auctions are also an effective way to shed noncore operations, as Pfizer Inc. is demonstrating. While the company is making headlines with its proposed $60 billion acquisition of Pharmacia Corp. — which won conditional approval from the European Commission in February — Pfizer is also selling off companies at auction to purify itself as a pharmaceutical and health-care colossus. During a recent three-month period, for a collective sum exceeding $5 billion, the company accepted winning bids for three subsidiaries: Tetra, an aquarium and pond-supplies firm; Adams, a confectionary business; and shaving-products company Schick-Wilkinson Sword. All had been acquired in Pfizer's 2000 merger with Warner-Lambert.
Divesting the businesses was "a tough decision," says Pfizer executive vice president and CFO David L. Shedlarz, though he calls it "an appropriate decision, in terms of where [the businesses] fit in the longer-term strategy of Pfizer." But the choice of the auction vehicle was much easier: five years ago, Shedlarz used it to divest the three businesses that formed Pfizer's Medical Technology Group.
Like many companies with assets to purvey, Pfizer sees the auction as a robust, transparent process that can ensure the best deal. But the company insists on more than just top dollar, says Shedlarz: it stipulates that bidders agree to treat employees of the acquired business fairly (see "Pfizer's Rx," at the end of this article).
While every deal is different, M&A experts agree that there are some useful guidelines to observe when selling a company through a controlled auction. And there are also pitfalls to avoid.
An auction is a complex, drawn-out affair, compared with a one-on-one sale, and can place enormous strain on a company. "Businesses begin to fall apart during these processes," comments Frederick S. Green, senior partner and head of the M&A practice at law firm Weil, Gotshal & Manges LLP in New York. "It's a tremendous distraction [for] management to meet with buyers and present the company. Employees become very unsettled. Some of your best and most mobile people are going to prepare their résumés and get out while the getting is good."
Before going the auction route, in fact, CFOs should consider whether that is the best way to sell, says Mark L. Sirower, who leads the M&A practice at The Boston Consulting Group in New York. The buyer that will pay the most ought to be the one that has the strongest economic case for buying an asset, he notes. But sometimes that buyer is a company that refuses to participate in auctions. Sirower suggests some investigation to uncover "buyers who may not be buyers if there is an auction."
In situations where there is clearly a single best buyer, and where possible competitors are unlikely to offer much, just the suggestion of an auction may be enough. "Sometimes we advise a client to use the threat of an auction as its lever to get a reasonable deal done with the best buyer," says Donald Meltzer, co-head of global M&A at Credit Suisse First Boston LLC (CSFB) in New York, which advised AT&T on its $72 billion auction of its broadband unit in 2001.
Once an auction is chosen, though, the first rule is to do no harm, says Mark A. Filippell, manager of the private-company M&A practice at McDonald Investments Inc. in Cleveland, which specializes in middle-market deals. In particular, Filippell warns against investment bankers that use the auction process as a marketing tool.
"It's the dirty little secret of a lot of M&A firms," he charges. "They make a beautiful book [describing what's on the block] and send it to 100, even 200 potential buyers." Most of them won't be interested, but the M&A firms "get a chit with all the groups they show a deal to," says Filippell. Meanwhile, the seller's confidentiality "is blown to hell," and the word that a company is for sale can seriously damage its relations with customers, trading partners, and employees.
Chocolate for Sale
In a controlled auction, investment banks first narrow the universe of potential buyers to a reasonable number. For some deals it's easy to identify the likeliest bidders, but for others, more effort is required. McDonald frequently conducts a blind screen, shopping a client anonymously to interested parties. Recently, for one distributor of aerospace fasteners, Filippell used the technique to quickly reduce a pool of 50 potential buyers to 6. "Why tell the whole world?" asks Filippell. Many times, a low-key, less-formal auction with a handful of bidders is best, he says.
On the other hand, some businesses have characteristics that make them more attractive to a broader range of buyers — a business model that is easy to understand, for example, and stand-alone capability. Such a company, with "hard assets and a real set of financial statements, is more likely to be financeable," says CSFB's Meltzer. "If so, then you can be pretty certain that the financial-buyer universe is likely to be interested."
But when a deal is expected to attract several strongly interested strategic buyers, there may be little point in casting the auction net wide and snaring a lot of financial buyers. Why? Strategic buyers have synergies to exploit and are generally prepared to pay higher premiums. A case in point is last year's controversial auction of Hershey Foods Corp. by the company's controlling charitable trust. The trust board received two offers, from strategic bidders: Wm. Wrigley Jr. Co., and a combination of Nestlé SA and Cadbury Schweppes Plc. Wrigley's offer was worth more, at $12.5 billion, but that wasn't high enough for the trust board, which took Hershey off the block. (Other considerations also influenced the board's decision to halt the auction.) Some observers had thought Hershey could fetch $15 billion or more — a price too steep for financial buyers.
"Was Hershey a business you could borrow against? Sure, but the price that the financial players were going to offer was simply not going to be a price that the sellers would be interested in selling at," comments Meltzer. "In effect, you have a target price — a strategic price — and you want to have the strategic parties compete against each other."
In the Data Room
Serious bidders gain access to the data room, where they inspect documents on nearly every facet of the business for sale — from financials to "management contracts, leases in detail, depreciation schedules, the labor union agreement, all the details of the audit, the working papers for the audit, pension documents, environmental reports, and more," says McDonald's Filippell. The data room may be at the company or a law office — or simply a banker's box shipped to a bidder. Increasingly it's virtual, a Web site with password access.
Signed confidentiality agreements are required to gain entry, although some information still may be off-limits until successive rounds of bidding are reached, and the remaining participants have established their credibility. When a rival is bidding, "there may be some information that they're not going to be able to see — period," says Green. Typically that restricted information involves a seller's most sensitive margins and prices. Sometimes, a third party — an accounting firm, say, or management consultancy — is hired to review the information and summarize it for strategic bidders, adds Green. If bids from strategic buyers aren't handled with care, "you could end up giving them a graduate education," warns Filippell.
Eventually, the auction's endgame is reached, ideally leaving three "really interested parties," says Meltzer. Should one party fall out, the seller still has negotiating leverage. Even if two parties drop out, the remaining bidder needn't know it. "You want to maintain the optics of competition," says Green. "The last thing you want is that the buyer knows it is the only bidder."
Wait to define your endgame, advises Meltzer, and maintain a competitive process as long as you can, particularly when buyout groups are involved. They have an obligation to their investors to buy at the lowest price possible, and usually strive to obtain "an exclusive position, without having a contractual obligation to pay a price." Such a position might be obtained through a letter of intent to buy at a price, subject to due diligence, for example. And if a seller has gone through an arduous auction process, and is far down the road with one buyer, "it's pretty hard to walk away from the table over a modest price decrease," says Meltzer.
Sometimes, though, the decrease is anything but modest — as when British spirits company Diageo Plc sold Burger King Corp. last December. The fast-food chain was put on the block in the spring of 2002, and Diageo accepted an offer of $2.26 billion in July from a consortium led by investment firm Texas Pacific Group. But the offer was conditional on Burger King's meeting certain performance targets. When the company failed to do so, the consortium insisted in November on reworking the deal. After weeks of negotiations, Diageo finally settled on a price of $1.5 billion — $750 million south of the original bid.
Weighing the Bids
In many cases — especially with all-cash deals — choosing the winning bid is fairly straightforward. Says Pfizer's Shedlarz, who prefers cash, "If you're going to divest a business, you want to come as cleanly out of that business as you possibly can. Also, the ability to pay in cash helps define [the bidder's] financial viability." (Private companies, however, may tend to select the suitor that seems most likely to keep the business intact and preserve the owner's business values, paying less attention to the high bid than may be the case at a public company.)
Selecting a winner, though, can be very difficult when offers combine cash and stock, or have postclosing-liability strings attached, or potentially involve thorny regulatory or antitrust issues.
When the deal involves a public-company merger, the board's overriding responsibility is to act in the best interests of the company and its shareholders, says Green. Under Delaware principles, the directors' observance of "duty of care" requires that board members be well informed and that they do what they reasonably believe is in the best interests of the company. Shareholder litigation over accepted offers is common, Green notes, but the board has a good defense if it can justify its decision process. Merger agreements also contain a "fiduciary out" — meaning that if a better offer comes in the interval between announcing a merger and obtaining the shareholder vote, a board may be able to legally withdraw its original recommendation (and pay an agreed-on breakup fee) to accept the better offer.
Each auction is different, and that includes the time it takes to conduct one. Big, complicated deals with several strong bidders may drag on well past the half-year mark. But a smaller, low-key auction can take as little as four and a half months if everything goes smoothly — "a month to put the offering book together and think of buyers, another month to screen buyers, another month for bids and due-diligence meetings, and another six weeks or so to close," according to McDonald's Filippell.
Pfizer auctioned off its three subsidiaries in remarkably quick succession; the Tetra deal closed in December, and the Adams and Schick deals are near closing. "That's quite an accomplishment," says CFO Shedlarz, "for the team that worked on these in Pfizer, the outside advisers, the [employees of the companies], senior management, and the board." And quite an endorsement for auctions, too.
Edward Teach is articles editor of CFO.
At Pfizer, CFO David Shedlarz has auctioned off a half-dozen businesses in the past five years. Here are his top five auction guidelines:
1) Make a Clear Strategic Decision about a Divestiture. Each company that Pfizer sold was "a well-run organization with strong growth," but none fit in with Pfizer's focus on health care. Do the analysis and consider all vehicles available for divesting the business.
2) Always Communicate. "You have to communicate very robustly throughout the entire process," first to senior management and the board, and eventually to the employees. "Don't come to the board with a full-blown elephant at the last moment."
3) Form a Dedicated Internal Team to Handle the Deal. It isn't reasonable to expect employees to manage these lengthy, complex transactions in addition to their day jobs.
4) Hire Principals, Not the Investment Bank. "We don't necessarily hire Bear, Stearns or Merrill Lynch or Morgan Stanley or Lazard Frères; we hire the individuals within those organizations," says Shedlarz. That means finding the advisers with the expertise and experience best suited for a given deal.
5) Make Sure Employees Will Be Treated Fairly. Pfizer sets "hard and fast rules" in its negotiations and terms of sale regarding how the acquirer will treat its new employees. Such rules cover everything "from opportunities for assignments in the new company, to the amount of pay they would get, to the type of benefits they would receive, to the extent to which they would honor the benefits that Pfizer had offered over an extended time frame." —E.T.