M&A Acquisitions Premium for Debt? How to Pay off Bond Holders?

So when Oracle bought Sun Microsystems it paid a premium for the equity but how did it pay for the debt? Or how is debt treated?

Wouldn't the debt holders want a premium? Or does the debt just get transferred to Oracle? Is it different for public companies vs property?

I'm asking this since when you buy a house don't you pay for the entire house not just the equity portion of the house owner?

 

I'm not familiar with the Sun Micro deal, but generally debt just gets repaid at principal/par plus outstanding interest under the voluntary prepayments provisions in the term loan/bond indenture.

Often there are restrictions on this in the initial years ie where borrower can't repay in a particular period (eg 1 year non-call) or has to pay a premium if it repays in a particular period (eg 102 in year 1, 101 in year 2 means you have to pay $1.02 for each $1.00 of principal if you repayment in year one, $1.01 in year 2, $1.00 after).

Other than those restrictions in initial years, debt holders don't get a premium. That's the nature of debt.

No difference for public companies versus non-public, unless the debt terms specify that (which would be unusual).

Debt is not transferred to the buyer. Buyer will typically refinance through acquisition debt that is used partly to retire existing debt, partly to fund the purchase price. That's just like a house - you pay the entire price (sometimes partly financed from a new mortgage) and the seller uses the proceeds to repay her mortgage first, then takes the remainder as payment for her equity in the house.

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Change of Control @ 101

With certain bonds having portability features (i.e., no CoC event) when leverage is below a level.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 

On change of control vs my last paragraph - to clarify, I mean debt is not transferred from the target entity to the buyer entity. Buyer may have the option to leave existing debt in the target entity if there is no prepayment triggered by change in control (as per @Oreos comment). If buyer does that, debt stays within the target (ie is not transferred to the buyer entity and remains a legal obligation of the target, not the buyer), but would be consolidated for accounting and appear as part of group debt in the consolidated financial statements of the group.

A strategic buyer can typically get cheaper pricing on the debt via refinance (eg via providing intergroup guarantees which provide lenders access to strong credit support for the loan), but you can have circumstances where the target's debt has cheaper pricing or is cov-lite because that debt was issues when credit markets were cheaper/more lax compared to the state of play when the acquisition is done.

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Thanks for the response but 2 things….

1) So…when company A acquires company B and its announced in the news: Oracle buys Company X for 300 million.

How does the deal go down. Oracle pays shareholders 300 million and then what about the bond holders who pays them? I know you said they can keep the debt with the company (portability) but what if the debt holders demand they pay them off (due to a clause). Can the deal still go through without the bond holders approval?

Comparing this to a house, you can't just borrow 500,000 for a 600,000 home and then sell that house to your brother/friend for 100,000.

And I know that as shareholders we're not liable to service the debt. Once I get my $10,000 Oracle investment upon closing deposited in my trading account I don't need to use that fund to pay off the bond holders.

This is different from houses since I get paid the entire value of the house (all the assets) and then I pay off the mortgage. Clarifications?

2) Why no premium for bond holders? Aren't corporate bonds actively traded? Why would I be happy if I bought a $30000 bond from Company X (thinking that the price would be even higher) and then the par value on that is $28000 but I was in this for a quick trade but then the next day Oracle announced its buyout of X.

 

Oracle doesn't pay the $300m to shareholders. It pays them $300m less the debt in the company. It pays the remainder (ie the debt) to existing lenders of the target, sometimes using excess cash in the company.

Yes, corporate bonds are actively traded. The risk of voluntary repayment is taken into account with pricing. If you buy above par and the next day a takeover with refinance is announced, then yes, you are unhappy and it sucks to be you.

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I guess my question is when its announced on the news: Dell makes a tender offer to take Dell private for 300 million dollars- isn't that referring to just the market capitalization? Or am I wrong.

For example say Dell was trading at $12/share and the market cap is 100. Dell offers to take company private for $14/share making the market cap 140 and eventually bidders bid it to $14/share. Isn't that what happens how is debt addressed in this example? I never see news on how debt is serviced on M&A only news on price/share

 

When Michael Dell says he wants to take it private for $14 share. Does he also pay off the debt (behind the scenes). And how does the whole M&A process work.

Does he first acquire all the shares and then he pays off the debt holders using the company's current cash position (from the balance sheet regarding the Enterprise value formula) or does he have to go a bridge lender and pay off the debt and then access the cash on the company balance sheet to pay the bridge lender off?

 

From the company and lenders' perspective, purchase price is normally done on an enterprise value basis. For example:

Buyer is buying Target for $1bn (10x pro forma EBITDA of $100m)

Target has $200m debt, has $720m market cap based on 800 shares trading at $0.90/share on 30 day pre-announcement VWAP basis

Ignoring transaction costs/fees, Buyer is buying Target for $1bn, paying $200m to pay off the debt and $800m to buy the equity, reflecting a $1/share equity price, which is a 11% (10/90) premium to 30 day VWAP

Most people in IB would think of this primarily as a 10x EV/EBITDA deal. I think equity research guys will probably emphasis the premium to VWAP and P/E because they are writing for an audience with an equities perspective, but someone who reads more equity research than I do may want to correct me on that. If the takeovers market is active, the IB guys will pay a little more attention to the control premium paid to equity because that indicates how much sugar you have to put on top for equity holders, but they'd most likely start with an EV/EBITDA or DCF valuation to get enterprise value of a comparable business, then check the debt numbers so they can work out the equity value, then add the premium to that.

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Best Response

This is how I see it: 1. Acquiror announces $3.5 billion merger with target (consideration: 100% stock)

  1. MergerMarket or other media outlets report the deal is worth $3.5 billion • http://www.nytimes.com/2009/11/03/business/03deal.html?_r=0

- actually, this is the amount that goes to equityholders, who of course own the company - so the offer value should be reported as $3.5 billion, not transaction value 3. The Transaction Value is the $3.5 billion (the offer value) + Net Assumed Liabilities (0.896 billion) = $4.6 billion - this sum ($4.6 billion) is the number that goes on the list of precedent transactions

On the subject of debt: 4. Upon change of control, the debt becomes due. The issuer has to retire outstanding debt • http://watchyourwallet.blogspot.com/2007/02/change-of-control-covenants…http://www.weil.com/~/media/files/pdfs/Finance_Digest_May_12_2009.pdf - but the issuer is now owned by the acquiror, so the acquiror becomes responsible for the repayment.

  1. What the acquiror actually pays to make the deal happen (Uses of Funds) is different from Transaction Value.
 

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