CCMA: Group Assignment 2
Paramount 94
Submitted by Anurag Verma- 61210048 Ashish Mahajan-61210419 Karthik Kuchimanchi-61210633 Paras Arora - 61210350 Shwetank Anand-61210637
CCMA: Paramount 94
1. ANALYSIS OF THE SITUATION
Since the initial set of bids placed by Viacom and QVC for acquiring Paramount, an interesting series of events has occurred leading to escalated competing bids by the two acquirers. First, multiple other players collaborated with Viacom and QVC in their attempt to acquire Paramount. On one hand, QVC collaborated with Tele-Communications Inc. (TCI) while placing its bid. In addition, Cox Enterprises and Advanced Publications, each agreed to invest $500 Million in QVC contingent to its successfully acquiring Paramount. On the other hand, Blockbuster Entertainment Corp agreed to invest $600 million in Viacom conditional to its acquiring Paramount. Also, Nynex Corp agreed to invest $1.2 Billion in Viacom by purchasing its convertible preferred stock. Second, soon after QVC placed its first competitive bid along with TCI, Viacom filed a federal lawsuit accusing QVC and TCI of attempting to monopolize the cable industry. Also, in response to Paramounts inaction on the negotiation, QVC commenced an action in the Delaware Chancery Court naming defendants Paramount, its directors and Viacom. This action was sought to invalidate Viacoms option to purchase 23.7 million Paramount shares and prevent it from using its Poison pills. Third, QVC and Viacom publicly announced that they would begin to tender offer for 51% of Paramount Common Stock and follow it up with a second-step merger. While QVC revised its bid with the help of a $1.5 Billion bid by Bell South, Paramounts board rejected the offer as too conditional. Each of these attempts reflects two important aspects of this case: 1) the perceived synergies from acquiring Paramount for both acquirers and 2) possible empire building attempts by Barry Diller and Redstone. Finally, on November 24, 1993 the Delaware Chancery Court ruled that Paramount directors consider that bid which brings the best value to Paramounts shareholders. In light of this ruling, Paramount set an absolute deadline of February 1, 1994 for both the parties to place their bids for the tender offer. Accordingly, Viacom and QVC placed revised bids for Paramount. Paramount also consulted with Lazard Freres who opined that both bids were equally attractive from Paramount shareholders standpoint.
2. ANALYSIS OF OFFERS
QVC Offer: QVC offered $104 per share for 50.1% of Paramounts shares. Second-step of merger will provide a) 1.2361 shares of QVC Common Stock, b) 0.2386 shares of New QVC Merger Preferred Stock, and c) 0.32 ten year warrants for each remaining Paramount share. Value of Viacom and QVC offer is given in Exhibit 1. As there is a bidding war, we are assuming that the shareholders will tender their share to either Viacom or QVC. Also we have assumed that either Viacom or QVC will win the bid Scenario 1: Viacom succeeds and investor tendered his share to Viacom
CCMA: Paramount 94
The payoff in this case will be $107 per share (assuming that investor is in the top 50.1% shareholders). Scenario 2: Viacom succeeds and investor didnt tender to Viacom In this case, investor will have to tender the share to Viacom therefore the payoff will be $52.124 per share. Scenario 3: QVC succeeds and investor tendered his share to QVC In this scenario, payoff will be $104 per share (assuming that investor is in the top 50.1% shareholders). Scenario 4: QVC succeeds and investor didnt tender to QVC Now, investor will have to tender the share to QVC and his payoff will be $91.824 per share. As we can see in Exhibit 2, there is no clear dominant strategy. The weighted average offer from Viacom is $83.357 per share and QVCs offer is $85.906 per share. As such there is no substantial difference between the two offers. Assumptions: Since there is no dominant strategy, we assume that approximately half the shareholders will accept Viacoms offer and the other half will accept QVCs offer. This assumption is fair one to make in the absence of a clear choice. All the values used are estimates of the trading values provided by Lazard Feres in Exhibit 5 of case. Even after doing an explicit valuation of the instruments in Tier 2 offering (Exhibit 3), we still dont reach equilibrium (Exhibit 4). However, if the shareholders were to go purely with current valuations, they may want to tender shares to Viacom as no one would like to be saddled with a low payoff in case the deal does go through.
3. CONCLUSION
As there is no clear choice, the shareholders should choose Viacoms offer. There are two primary reasons for this. First, a significant portion of both offers depends on the future performance of the merged entity. This is because the offers includes stocks besides instruments such as warrants and CVRs. Given that Viacom would have a better shot at achieving the synergies from the merger than QVC would, it makes more sense to go with Viacoms offer. Second, the investment bank Lazard Feres has opined that Viacoms offer is marginally better. This would have two effects: the offer would not be scrutinized by courts on ground of fleecing shareholders and there is a slightly higher likelihood that the shareholders would tender their shares to Viacom. This in effect would increase the chance of Viacom winning the bid, hence tendering to Viacom would be the optimum decision for shareholders.
CCMA: Paramount 94
EXHIBITS Exhibit 1: Viacom and QVCs offer Viacoms Offer Security Cash Sub Debt CVR Warrant-3 Year Warrant-5 Year Common Total QVCs Offer Security Cash Preferred Warrant-10 Year Common Total Value 104.000 32.420 14.654 44.750 Ratio 0.501 0.499 0.499 0.499 Net Value Amount 1.000 0.239 0.320 1.236 Per Share 52.104 3.860 2.340 27.602 85.906 Value 107.000 0.963 8.312 3.246 5.478 34.125 Ratio 0.501 0.499 0.499 0.499 0.499 0.499 Net Value Amount 1.000 17.500 0.931 0.500 0.300 0.931 Per Share 53.607 8.410 3.860 0.810 0.820 15.850 83.374
Exhibit 2: Game theoretic perspective Tender Viacom Success QVC Success 107.000 104.000 Dont Tender 52.124 91.824
CCMA: Paramount 94
Exhibit 3: Valuation of Tier 2 payout by Viacom & QVC Viacom offer Valuation of CVRs CVRs resemble European bear spreads using puts. CVRs issued by Viacom have a reference price of $48 and a floor price of $36. The payoffs from this CVR are the same as those from a short position in a put on Viacom class B shares with a strike price of $36 and a long position in a put with strike price of $48 on the same underlying asset. Thus, we can price these CVRs based on prices of these two put options. p = Ke(-rT)N(-d2) S0N(-d1) where d1 = [ln(S0/K)+(r+2/2)T]/*sqrt(T), d2 = d1 *sqrt(T) Here, K1=36 & K2 =48, r (Risk free rate, continuously compounded, with maturity T =1 to match with maturity of CVR = 3.44%, S0= Price of Viacom class B shares on Feb 1, 1994 = $34.125, = Volatility of Class B Viacom shares = 33% (0.33) Using the formulas we get price for put with strike price 36 = 4.851 and price for put with strike price 48 = 13.491, Therefore, value of this CVR on Feb 1, 1994 = 13.491 4.851 = $8.64 Valuation of warrant Price of call option, c = S0N(d1) - Ke(-rT)N(d2), Price of warrant is given by N/(N + M) * Price of call option. N = Total number of shares outstanding, M = no of warrants issued, assuming gamma = 1 No of 3 year warrants issued = 49.9% * 120 * 0.5 million = 29.94 million, strike price = $60 No of 5 year warrants issued = 49.9% * 120 * 0.3 million = 17.96 million, strike price = $70 We can price the call option on Viacom class B shares with maturity of 3 yrs using the formula. In this case we will take r = 4.03% (continuously compounded with maturity of 3 yrs), T =3, K = 60, rest all values are as in pricing of put option, we get d1 = -0.4899, d2 = -1.0615 and using these values of d1 & d2 price of call option as 2.984 Similarly price for 5 year call option, (r = 4.45%, T = 5, K = 70) = 4.6544 Therefore, price of 3 year warrant using the formula = 2.39(Dilution factor = 0.80) & price of 5 yr warrant = 4.05(Dilution factor = 0.87). Valuation of debt Rate of discount taken as discount rate of AA Long term debt
CCMA: Paramount 94
Coupon rate Principal amount
8% 17.5
Value of Debenture ( 12 years) Year 1 2 Payoff 1.4 1.4 NPV for 12 years @ 7.06% $18.80
3 1.4
4 1.4
5 6 7 1.4 1.4 1.4
8 9 10 11 1.4 1.4 1.4 1.4
12 19
Total payout/share therefore as per computed prices in Tier 2 offering =
Security share Value QVC offer
0.93065 34.125
0.5 2.39
0.3 4.05
1 18.8
0.93065 Total 8.64 61.01
Pricing of 10 year warrant First price the call as before S0 = 44.75, K = 70.34, r = 5.79% (Continuously compounded, Ten year treasury zero), T = 10, = 0.5(Volatility of QVC shares) Price of call option = $26.74, d1 = 0.8707, d2 = -0.7104 Number of 10 year warrants issued = 49.9% * 120 * 0.32 million = 19.16 million Dilution factor = N/N+M = 0.862, (assuming gamma = 1) therefore price of warrant = $23.07 Preferred stock Taking discount rate as AA Perpetuity value = $50*0.06/7.06% = $42.49 Total payout/share therefore as per computed prices in Tier 2 offering Security share Value 1.2361 44.75 0.32 23.07 0.2386 Total 42.49 72.84
CCMA: Paramount 94
Exhibit 4: Game theoretic perspective based on calculated numbers Tender Viacom Success QVC Success 107.000 104.000 Dont Tender 61.01 72.84