Design of Corporate Restructuring and Mergers

Recently I was going through JDA Software’s (JDAS) Form 8K dated Nov 2 2012. Something interesting caught my eye that I will like to discuss here.

“Item 1.01. Entry into a Material Definitive Agreement.

On November 1, 2012, JDA Software Group, Inc., a Delaware corporation (the "Company"), entered into an Agreement and Plan of Merger (the "Merger Agreement") with RP Crown Parent, LLC, a Delaware limited liability company ("Parent"), and RP Crown Acquisition Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of Parent ("Merger Sub"). Parent and Merger Sub are affiliates of RedPrairie. The Merger Agreement was unanimously approved by the Company's Board of Directors.

Pursuant to the Merger Agreement, upon the terms and subject to the conditions thereof, Merger Sub will commence a tender offer (the "Offer") no later than November 15, 2012 to acquire all of the outstanding shares of common stock, $0.01 par value per share, of the Company (the "Company Common Stock") at a purchase price of $45.00 per share, net to the seller in cash without interest (the "Offer Price"). As promptly as practicable after the expiration of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will accept for payment, and pay for, any shares of Company Common Stock validly tendered and not validly withdrawn pursuant to the Offer, at which point Merger Sub will merge with and into the Company (the "Merger") and the Company will become a wholly-owned subsidiary of Parent.”

This section of SEC filing describes how this reorganization is being accomplished. Design of corporate restructuring is a complex task and is accomplished by a specialized team of corporate lawyers and tax experts. Such designs are done to properly address issues related to liabilities, cost basis of assets, asset ownership, contractual obligations, financial obligations, capital gain taxation, licensing, customer support and country specific laws. Even though such design is usually transparent to most of us, it is still worthwhile to know how it gets accomplished.

In this bog I will describe three well known designs for corporate mergers.

Most simple and straight-forward of these structure is a direct sales and transfer of ownership. In such reorganization, called “A” reorganization, acquiring company (acquirer) buys shares of target company (target) from target company’s shareholders.  Payment can be in form of acquirer’s shares or equivalent cash.

Another commonly used approach for corporate merger is a “Forward Triangular Merger”. In this approach, Acquirer  created a fully owned subsidiary (Merger Sub). Target merges with “Sub” with “Sub” surviving as final company. Ownership of Target’s asset is transferred to Sub.

Third and most commonly used approach in USA is “Reverse Triangular Merger”. This kind of merger is also accomplished through a subsidiary of Acquirer. However, in this case, “sub” merges in to “target” and “target” survives as a wholly owned subsidiary of Acquirer. Ownership of target’s assets remain with “target” that is now a subsidiary. JDA-Red Prairie merger is a Reverse Triangular Merger.

Such structures become even more complex when you look at international mergers. For example, Eaton Corporation of Ohio USA recently acquired Cooper Industries of Ireland. This merger was accomplished through a complex set of subsidiaries in the Ireland, the Netherlands and the USA. First, a new company, called “New Eaton”, was created in Ireland. Cooper Industries got acquired by and became a wholly owned subsidiary of “New Eaton”.  New Eaton through a chain of wholly owned subsidiaries (Comdell Ireland: a subsidiary of New Eaton,   Turlock B.V. The Netherlands: a subsidiary of Comdell) established a subsidiary “Turlock Corporation: A subsidiary of Turlock B.V” in USA. Eaton Corporation USA merged with Turlock Corporation and surviving as merged company. In summary, both Eaton Corporation USA and Cooper Industries Ireland become wholly owned subsidiaries of the “New Eaton”. Subsequently “New Eaton” requested SEC to list its share on stock exchange in replacement of Eaton Corporation USA’s shares. Such complex structures are needed to stay in compliance with country specific rules and regulations.

 

I will update this blog and add few more real-life examples. I hope that you will also find design of corporate mergers an interesting subject and share your insights and other examples. I look forward to your feedback.    

RedPrairie JDA Merger

On November 1, 2012, JDA Software and RedPrairie announced that they have entered into a definite merger agreement, wherein, JDA Software Group agreed to be acquired by privately held RedPrairie for a total value of $1.9 billion. According to this agreement, RedPrairie will make an offer to buy all outstanding shares of JDA for $45 per share, representing a 33% premium to JDA stock price on Oct 26.

In this brief note I will share my perspective on JDA-RedPrairie merger and discuss few vital financials that caught my attention.

First item that we must examine is any redundancies & conflicts between solutions provided by JDA and RP. Following table examines overlap between software products of JDA and RedPrairie.

 

 

JDA’s products are more focused on supply chain planning, optimization and forecasting. RedPrairie’s strength is in Supply chain execution. JDA has some products in supply chain execution (JDA logistics) that directly compete with RP’s warehouse and transportation management products. Both companies have their own set of platform tools to handle message integration & business process management. In short term, JDA-RP combine will need to convince customers about future roadmap for such conflicting products. In long term, they will need to drop one of the offering, and provide upgrade path to impacted customers. Payback period on a supply chain implementation is approximately 5 years. Hence JDA-RP combine may need to keep supporting existing products for at least 5 and maybe for many more years. There is a risk that some of the new customer implementations of products in supply chain execution may be put on hold till new combined company provides clear direction to its customers.

Second, we must also pay attention to difference in underlying architecture & technology behind software products from JDA and RP. Any desire to leverage synergies of software development will require that JDA-RP combine must bring all products to a common architecture. Such process can take anything between 2 to 4 years. Till that time customers will see a collection of different looking products that they will need to integrate using complex tools. This scenario can be used as a weapon by competitors.

Third, we should look at balance sheets of JDA for any obvious challenges that will hamper value creation. I am copying below an extract of balance sheet for Q3 2012

First item that caught my eye was $231M goodwill and $108M other intangibles on balance sheet. “Other intangibles” include three components and I will like to quote directly from JDA’s annual report for Q3 2012

“Customer-based intangible assets include customer lists, maintenance relationships and future technological enhancements, service relationships and covenants not-to-compete; technology-based intangible assets include acquired software technology; and marketing-based intangible assets include trademarks and trade names. Customer-based and marketing-based intangible assets are being amortized on a straight-line basis. Technology-based intangible assets are being amortized on a product-by-product basis with the amortization recorded for each product being the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future revenue for that product, or (b) the straight-line method over the remaining estimated economic life of the product including the period being reported on.”

I will be wary of value placed on Goodwill and other-intangibles as they are prone to impairment. JDA owns lots of patents. However, in my opinion, these patents do not help JDA-RP in getting a virtual monopoly or dominant position in that business domain. Supply chain domain is well researched and a competitor with sufficient will and investment can create competing products that do not conflict with JDA-RP patents. In short, I will heavily discount values of these assets.

Second item on balance sheet that we should look at is $273M of long term debt. JDA-RP combine will need to also pay this debt.

RP’s private equity owners will need to find $1.9B upfront for JDA and $273M for paying debt. JDA’s (current asset – current liabilities) are $273M. It requires $270M annually as cost of revenue.

Hence, my conclusion is that road for JDA-RP combine is full of challenges.

Overall, in long run, reduction in competing software solutions should help customers. Market has now consolidated to 2 or 3 dominant players.

PS: Those aware of M&A activities will recognize this merger as a “reverse triangular merger”. Functionally it will be categorized a co-generic merger as merging companies are complementing each other in market space.