End of Chapter Case Study: Thermo Fisher Acquires Life TechnologiesCase Study Objectives: To Illustrate How Acquirers Ut

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End of Chapter Case Study: Thermo Fisher Acquires Life
TechnologiesCase Study Objectives: To Illustrate How Acquirers
Utilize Financial Models To• Evaluate the impact of a range of
offer prices for the target firm, including what constitutes the
“maximum price”• Determine which financing structures are
consistent with maintaining or achieving a desired credit rating•
Investigate the implications of different payment structures (form
and composition of the purchase price)• Identify the impact of
changes in operating assumptions such as different revenue growth
rates or the amount and timing of synergy.BackgroundAlmost 9 months
after reaching an agreement to combine their operations, the merger
between Life Technologies Corporation (Life Tech) and Thermo Fisher
Scientific Inc. (Thermo Fisher) was completed on January 14, 2014.
Thermo Fisher is the largest provider by market value of analytical
instruments, equipment, reagents and consumables, software, and
services for scientific research, analysis, discovery, and
diagnostics applications. Life Tech is the second largest by market
value provider of similar products and services to the scientific
research and genetics analysis communities. While the fanfare
surrounding the closing echoed sentiments similar to those
expressed when the deal was first announced, the hard work of
integrating the two firms was just beginning. What led to this
moment illustrates the power of financial models.Life Tech had been
evaluating strategic options for the firm since mid-2012,
concluding that putting itself up for sale would be the best way to
maximize shareholder value (see Case Study 11 titled “Life Tech
Undertakes a Strategic Review” for more detail.). After entering
into discussions with Thermo Fisher in late 2012, the two firms
announced jointly on April 15, 2013, that they had reached an
agreement to merge. Exuding the usual optimism accompanying such
pronouncements, Mark N. Casper, president and chief executive
officer of Thermo Fisher stated “We are extremely excited about
this transaction, because it creates the ultimate partner for our
customers and significant value for our shareholders… enhancing all
three elements of our growth strategy: technological innovation, a
unique customer value proposition, and expansion in emerging
markets.” Expressing similar confidence, Greg T. Lucier, chairman
and chief executive officer of Life Tech noted “This transaction
brings together two companies intent on accelerating innovation for
our customers and achieving greater success in a highly competitive
global industry.”This case study utilizes the publicly announced
terms of the merger of Life Tech into a wholly owned subsidiary of
Thermo Fisher, with Life Tech surviving. The terms were used to
develop pro forma financial statements for the combined firms.
These statements are viewed as a “base case.”42The financial model
discussed in this chapter is used to show how changes in key deal
terms and financing structures impacted the base case scenario. The
discussion questions following the case address how the maximum
offer price for Life Tech could be determined, what the impact of
an all-debt or all-equity deal would have on the combined firms’
financial statements, and the implications of failing to achieve
synergy targets. Such scenarios represent the limits of the range
within which the appropriate capital structure could fall and could
have been part of Thermo Fisher’s predeal evaluation. As announced
by Thermo Fisher, the appropriate capital structure is that which
maintains an investment grade credit rating following the merger.
Thermo Fisher’s senior management could have tested various capital
structures between the two extremes of all-debt and all-equity
before reaching agreement on the form of payment with which they
were most comfortable. Therefore, the form of payment and how the
deal was financed were instrumental to the deal getting
done.Payment and Financing TermsAccording to the terms of the deal,
Thermo Fisher acquired all of Life Tech’s common shares
outstanding, including all vested and unvested outstanding stock
options, at a price of $76 per share in cash, with the Life Tech
shares canceled at closing. The actual purchase price consisted of
an equity consideration (i.e., what was paid for Life Tech’s
shares) of $13.6 billion plus the assumption of $2.2 billion of
Life Tech’s outstanding debt.The purchase price was funded by a
combination of new debt, equity, and cash on Thermo Fisher’s
balance sheet. Thermo Fisher executed a commitment letter, dated
April 14, 2013, with JPMorgan Chase Bank, N.A., J.P. Morgan
Securities LLC, and Barclays Bank PLC that provided a commitment
for a $12.5 billion 364-day unsecured bridge loan facility. The
facility enabled the firm to pay for much of the purchase price
before arranging permanent financing by issuing new debt and equity
in late 2013.Maintaining an Investment Grade Credit RatingIn an
effort to retain an investment grade credit rating43 by limiting
the amount of new borrowing,44 Thermo Fisher issued new common
equity and equity linked securities such as convertible debt and
convertible preferred totaling $3.25 billion to finance about
one-fourth of the $13.6 billion equity consideration. The $3.25
billion consisted of $2.2 billion of common stock sold in
connection with its public offering prior to closing, and up to a
maximum of $1.05 billion of additional equity to be issued at a
later date in the form of convertible debt and preferred shares.
Thermo Fisher financed the remaining $10.35 billion of the purchase
price with the proceeds of subsequent borrowings and $1 billion in
cash on its balance sheet.Thermo Fisher and Life Tech compete in
the medical laboratory and research industry. The average
debt-to-total capital ratio for firms in this industry is 44.6%,45
and the average interest coverage ratio is 4.0.46 Thermo Fisher
expects that available free cash flow will allow for a rapid
reduction in its debt. The firm expects to be below the industry
average debt-to-total capital ratio by the end of the third full
year following closing and about 12 percentage points below it
within 5 years after closing. The firm’s interest coverage ratio is
expected to be equal to the industry average by the second year and
well above it by the third year and beyond. These publicly stated
goals established metrics shareholders and analysts could use to
track the Thermo Fisher’s progress in integrating Life
Tech.Consistent with management’s commitment to only make deals
that immediately increase earnings per share, Thermo Fisher expects
the deal to increase adjusted earnings per share during the first
full year of operation by as much as $0.70–$1.00 per share.
Adjusted earnings per share exclude the impact on earnings of
transaction-related expenses and expenses incurred in integrating
the two businesses. Including these expenses in the calculation of
EPS is expected to result in a $(0.16) per share during the first
full year following closing, but excluding these expenses will
result in $0.99 per share.47Quantifying Anticipated
SynergyRealizing synergy on a timely basis would be critical for
Thermo Fisher to realize its publicly announced goal that the deal
would be accretive on an adjusted earnings per share basis at the
end of the first full year of operation. Synergies anticipated by
Thermo Fisher include the realization of additional gross margin of
$75 million and the realization of $10 million in SG&A savings
in 2014, the first full year following closing. Gross margin
improvement and SG&A savings are projected to grow to $225
million and $25 million, respectively, by 2016, and to be sustained
at these levels indefinitely. Most of the cost savings are expected
to come from combining global infrastructure operations.
Revenue-related synergy is expected to reach $25 million annually
from cross-selling each firm’s products into the other’s customer
base by the third year, up from $5 million in the first
year.ConclusionsMark Fisher, CEO of Thermo Fisher knew that the key
to unlocking value for shareholders once the deal closed was
realizing the anticipated synergy on a timely basis. However,
rationalizing facilities by reducing redundant staff, improving
gross margins, and increasing revenue was fraught with risk.
Eliminating staff had to be done in such a way as not to demoralize
employees retained by the firm and increasing revenue could only be
achieved if the loss of existing customers due to the attrition
that often follows M&As could be kept to a minimum. He also
knew to expect the unexpected, despite having completed what he
believed was an extensive due diligence.Having been through
postmerger integrations before, he knew first hand the challenges
accompanying these types of activities. At the time of closing,
many questions remained. What if synergy were not realized as
quickly and in the amount expected? What if expenses and capital
outlays would be required in excess of what had been anticipated?
How patient would shareholders be if the projected impact on
earnings per share, a performance metric widely followed by
investors and Wall Street Analysts alike, was not realized? Only
time would tell.Discussion QuestionsAnswer questions 1–4 using as
the base case the firm valuation and deal structure data in the
Microsoft Excel model available on the companion site to this book
entitled Thermo Fisher Acquires Life Technologies Financial Model.
Please see the Chapter Overview section of this chapter for the
site’s internet address. Assume that the base case assumptions were
those used by Thermo Fisher in its merger with Life Tech. The base
case reflects the input data described in this case study. To
answer each question you must change selected input data in the
base case, which will change significantly the base case
projections. After answering a specific question, either undo the
changes made or close the model and do not save the model results.
This will cause the model to revert back to the base case. In this
way, it will be possible to analyze each question in terms of how
it is different from the base case.1. Thermo Fisher paid $76 per
share for each outstanding share of Life Tech. What is the maximum
offer price Thermo Fisher could have made without ceding all of the
synergy value to Life Tech shareholders? (Hint: Using the
Transaction Summary Worksheet, increase the offer price until the
NPV in the section entitled Valuation turns negative.) Why does the
offer price at which NPV turns negative represent the maximum offer
price for Life Tech? Undo changes to the model before answering
subsequent questions.2. Thermo Fisher designed a capital structure
for financing the deal that would retain its investment grade
credit rating. To do so, it targeted a debt-to-total capital and
interest coverage ratio consistent with the industry average for
these credit ratios. What is the potential impact on Thermo
Fisher’s ability to retain an investment grade credit rating if it
had financed the takeover using 100% senior debt? Explain your
answer. (Hint: In the Sources and Uses section of the Acquirer
Transaction Summary Worksheet, set excess cash, new common shares
issued, and convertible preferred shares to zero. Senior debt will
automatically increase to 100% of the equity consideration plus
transaction expenses.48) Undo changes to the model before answering
subsequent questions.3. Assuming Thermo Fisher would have been able
to purchase the firm in a share for share exchange, what would have
happened to the EPS in the first year? Explain your answer. (Hint:
In the form of payment section of the Acquirer Transaction Summary
Worksheet, set the percentage of the payment denoted by “% Stock”
to 100%. In the Sources and Uses section, set excess cash, new
common shares issued, and convertible preferred shares to zero.)
Undo changes made to the model before answering the remaining
question.4. Mark Fisher, CEO of Thermo Fisher, asked rhetorically
what if synergy were not realized as quickly and in the amount
expected. How patient would shareholders be if the projected impact
on earnings per share was not realized? Assume that the integration
effort is far more challenging than anticipated and that only
one-fourth of the expected SG&A savings, margin improvement,
and revenue synergy are realized. Furthermore, assume that actual
integration expenses (shown on Newco’s Assumptions Worksheet) due
to the unanticipated need to upgrade and colocate research and
development facilities and to transfer hundreds of staff are $150
million in 2014, $150 million in 2015, $100 million in 2016, and
$50 million in 2017. The model output resulting from these
assumption changes is called the Impaired Integration Case.What is
the impact on Thermo Fisher’s earning per share (including Life
Tech) and the NPV of the combined firms? Compare the difference
between the model “Base Case” and the model output from the
“Impaired Integration Case” resulting from making the changes
indicated in this question. (Hint: In the Synergy Section of the
Acquirer (Thermo Fisher) Worksheet, reduce the synergy inputs for
each year between 2014 and 2016 by 75% and allow them to remain at
those levels through 2018. On the Newco Assumptions Worksheet,
change the integration expense figures to reflect the new numbers
for 2014, 2015, 2016, and 2017.)