PhD Professional Assessment Evaluation II

Candidate: John L Mahaffey

Date: 07 July 2009
Word Count: 9,410
Introduction

In 2006 two of the world’s largest steel companies, Mittal Steel and Arcelor S.A.
engaged in a merger that started out as a hostile takeover and over six months ended as
friendly merger. During this period, both companies engaged in a number of activities
and tactics designed to facilitate the outcome of their choice; negating the merger in the
case of Arcelor and completing the merger in the case of Mittal Steel.

The case study Arcelor vs. Mittal Steel provides insight into the complex world of
international mergers and acquisitions (M&A). In this case, Arcelor, the targeted
company, is a European based firm with ties to local and national governments as well as
the European Union. As such, the case serves as a good review of emerging issues
associated with international M&A activities, especially those involving European based
companies.

This paper provides an assessment of the case with emphasis on the changing status of
hostile M&A activities, European corporate governance and options for successful
completion of deals within the international environment. The paper will first describe
the Arcelor – Mittal merger, with emphasis on the application of defensive and offensive
tactics and their results; followed by a discussion of basic M&A activities, hostile
takeovers and corporate governance. The paper will conclude with a description of
investment banking and its importance to the successful completion of M&A deals.

Arcelor Mittal Steel

Formed in 2006 by the merger of Arcelor and Mittal Steel, Arcelor Mittal is the largest
steel company in the world, with 326,000 employees in more than 60 countries [Arcelor
Mittal, 2009]. The company is a world leader in the supply of refined steel for
automotive, construction, household appliances and packaging [Arcelor-Mittal.com,
2009]. In 2008, the company was ranked at 39th on the 2008 Fortune Global 500 list
[CNN, 2008]. The company is headquartered in Luxembourg City, the former seat of
Arcelor Steel [Arcelor Mittal, 2009].

Arcelor S.A.

Prior to 2004, Arcelor S.A. was the world's largest steel producer in terms of turnover
and the second largest in terms of steel output, with a turnover of 30.2 billion and
shipments of 45 million metric tons of steel [Yahoo Finance, 2009]. The company was
created by a merger of the former companies Aceralia (Spain), Usinor (France) and
Arbed (Luxembourg) in 2002 [Cagna, 2007].

As a single company, Arcelor S.A. produced long steel, flat steel and stainless-steel
products for the manufacturing of automobiles, household appliances packaging and
general industry. In 2005, the year before the merger with Mittal Steel, Arcelor S.A. was
rated as the world's largest steel manufacturer with total sales of over 30 billion Euro
[Cagna, 2007].
Mittal Steel

The Mittal Steel Company was the world's largest steel producer by volume and turnover.
Prior to the 2006 merger, CEO Lakshmi Mittal's family owned 88 percent of the
company. Mittal Steel was based in Rotterdam but, managed from London, UK by Mittal
and his family. Mittal Steel was originally formed when Ispat International N.V.
acquired LNM Holdings N.V. then merged with International Steel Group Inc. in 2004
[Cagna, 2007].

The Arcelor Mittal Merger

In January 2006 Mittal Steel made a surprise 18.6 billion Euro bid for Arcelor S.A.
Because they were uninvited, the Mittal Steel bid was immediately regarded as hostile by
the Arcelor Management. As a first defense, Arcelor S.A. announced a large dividend
and a very positive profit report. Both of which were later found to be inflated. Arcelor
then began a series of strategic and tactical maneuvers both inside and outside of the
company in an effort to stop the Mittal Steel bid.

During this period Arcelor management, principally Chief Executive Guy Dollé and
various European politicians criticized the Mittal bid as 150 percent hostile. Mr. Dollé
went further, in several cases making the criticism personal, describing Mittal, products
as low-grade “eau de cologne” compared with “perfume” produced by Arcelor. Mr. Dollé
also had described Mittal's shares as "monkey money.” The term Monkey Money is a
common French expression for something of little value, but regarded by some as having
racist overtones in the context of a deal with India-born Lakshmi Mittal, the founder of
Mittal Steel [Kanter, 2006]. Mr. Dollé further stated that Mittal did not share the same
vision and values as the European based Arcelor.

In an effort to curry political favor and complicate the Mittal bid, Arcelor engaged the
Luxembourg government requesting takeover law be written, specifically designed to
shut out Mittal Steel’s bid. This is significant as the Luxemburg Government was
Arcelor's largest shareholder, at 5.6 percent. Prime Minister of Luxembourg Jean-Claude
Juncker, further attacked Indian steel tycoon Lakshmi Mittal saying the hostile bid called
for 'a reaction at least as hostile [Morgan, 2006].

The new law as written would prevent Mittal Steel from resubmitting its offer for one
year if the conditions of the targeted company changed during the M&A process. For
example, if Arcelor were to issue more shares, sell some of its assets or purchase another
company, Mittal would be prevented from submitting an adjusted bid for the duration of
the one-year period [Reuters, 2006].

Arcelor did just that with the purchased Dofasco Steel of Canada albeit for other reasons
as well. First, the acquisition of Dofasco Steel required Mittal to seek authority from US
antitrust authorities. Since Mittal Steel already owned the US based International Steel
Group (ISG) [Cagna, 2007], the addition of another major North American steel company
could in theory be denied by US antitrust regulators.

The second and more compelling reason for the takeover of Dofasco was to force Mittal
to withdraw its bid, thereby requiring a full year before resubmitted. During this period,
Arcelor could build further defenses against future Mittal overtures [Aaron et al, 2007].

Arcelor then implemented a white knight1 defense through a strategic partnership with
the Russian steel company, SeverStal. Arcelor believed acquisition of SeverStal was
both consistent with Arcelor’s plans for growth and could be presented as a viable
alternative to Mittal Steel’s original offer [Aaron et al, 2007]. In this case, Arcelor
courted a strategic partner to provide an alternative to the shareholders and the board. By
doing so, the company could become the leading partner in the M&A, maintaining its
identity while integrating a new and potentially valuable asset.

Finally, in a last ditch effort to stop Mittal Steel, the Arcelor Board called an
extraordinary meeting of shareholders on June 30, 2006, to vote on the SeverStal
transaction with full knowledge of the Mittal offer. To be denied, more than 50 percent
of the then outstanding Arcelor shares had to oppose the merger with SeverStal. If more
than 50 percent opposed the merger would fail, opening the way for Mittal to complete its
bid [Aaron et al, 2007].

In response to the pending SeverStal merger, Mittal Steel increased the price of its offer
and reduced its demand for corporate governance above 50 percent. As a result, the
Arcelor shareholders voted to deny the SeverStal bid and subsequently approved the
Mittal bid [Aaron et al, 2007].

After the SeverStal bid was declined, Arcelor was left open for acquisition by Mittal
Steel. However, the final bid required Mittal to give up a great deal more than previously
offered. In particular, the successful bid cost 45 percent more than the previous offer and
more importantly, reduced the Mittal Family’s majority stake in their own company from
88 percent to 43 percent [Cagna, 2007]. In fact, for the first time, the Mittal Family
would not control the board with only six of 18 members being allocated from Mittal
[Cagna, 2007].

Arcelor Mittal Defense

A review of the merger in the aftermath revealed interesting trends and tactics for future
M&A, especially with regard to European companies. The following paragraphs
describe some of Arcelor’s defensive tactics and the rationale behind them.

1 A White Knight is a company that comes to the defense of another company that is subject to an
unwanted merger attempt. A white knight often will purchase the targeted company in order to prevent its
merger with the would-be acquirer [Webster, 2003].
..
To even the casual observer, this Arcelor-Mittal merger could only be characterized as a
hostile takeover. Both companies were operating successfully and each had good
potential for growth over the next few years. Each company also operated within
separate niches inside the steel industry so overlap and direct competition was
minimized. In fact, given their markets and products, the two companies were not likely
to compete heavily for the other’s business. As a result, in terms of market positioning,
the merger of the two companies would then be seen as a conglomerate, operating within
their respective markets, but leveraging common capabilities and resources to increase
efficiency.

The problem lay with the different plans, goals and objectives of each company. Mittal
desired to become a conglomerate, expanding its markets and product lines through the
acquisition of a well positioned company. This contrasted with Arcelor’s desire to
remain a single company, operating successfully within its own markets. In essence,
there was no meeting of the minds on the merger. Like a mismatched couple, two
companies were simply not moving in the same direction.

As a result, Mittal Steel, like a spurned suitor, decided to press their case for merger to
the ultimate authority, the stockholders themselves the merger became hostile. As
expected, Arcelor, sensing its survival was on the line, began what could be described as
a multiple layered defense against the “aggressor” company.

Mergers and Acquisitions (M&A) - Basics

Mergers and Acquisition (M&A) is the general used as a general term to describe the
action of one or more companies combining their assets and operations under one single
overarching company. The recent buyout and merger of Northwest Airlines into Delta
Airlines is one example of M&A on a large scale. M&A can be described as one
company is buying another in order to create synergy that will increase the value of the
single company of that of the two companies individually.

There are a number of reasons companies enter into M&A. One is to increase a
company’s share of a specific market sector. Another is to leverage the capabilities,
products or property of another company in order to increase one company’s
competiveness within a market sector. Still another reason for M&A is to negate a
potential rival by buying them out, and leveraging their share of the market. In short, the
basic principle behind M&A is simply, two companies are more valuable together than as
separate entities

Interestingly, during bear markets and difficult times in market sectors, M&A activities
grow substantially. During these periods, financially healthy companies often buy
weakened companies to create a more competitive, cost-efficient company.

In some cases, targeted companies will not only agree to be purchased, but actively seek
buyers when their survival is threatened by decreasing markets or emerging capabilities
they cannot compete with. Two weak companies, both facing an uncertain future may
also decide execute a “cooperative merger” in order to make a more competitive
company. In other cases, stronger, healthier companies will attempt to merge or acquire
its weaker competitors in what can be described as a hostile takeover.

The term mergers and acquisition are often used to describe a single activity. However,
the individual terms, merger and acquisition, are actually different.

Acquisition is the act of one entity taking over another and clearly establishing itself as
the new owner. Legally, the target company ceases to exist.

A merger happens when two entities agree to continue as a new entity. Mergers are
normally completed between two entities of similar size. In economic terms, two
companies surrender their original identities and begin operation as a new company
[Investopedia, 2009-1].

Mergers between two companies of similar size and strength is often described as a
“merger of equals.” However, most often one of the companies is usually stronger than
the other but does not have the resources to initiate a complete buyout [Investopedia,
2009-1].

Semantically, merger and acquisition carry very different meanings as well. The act of
merging two companies is usually seen as a positive, friendly activity while the
acquisition of a company is most often seen as an unfriendly or hostile activity
[Investopedia, 2009-1]. In other words, the difference between merger and acquisition
depends on whether the purchase is friendly or hostile. However, in the final analysis,
both merger and acquisition result in some new entity made up of at least two or more
previous entities (companies).

Mergers and acquisitions are not all the same. There are several types of mergers
depending on the type of company’s products or services, market strength and potential
for growth.

A horizontal merger is describes as the merger of two companies in direct competition

within the same markets [Investopedia, 2009-1]. The merger between XM Radio and
Sirius radio was a horizontal merger of the two primary providers of satellite radio in the
USA.

A vertical merger takes place when a company buys one of its main suppliers
[Investopedia, 2009-1]. For example, a computer manufacturer such as Dell Computers
may purchase a chip maker to provide better access to first line manufacture red goods
(e.g. Pentium chipsets).

A Market-extension merger is described as two companies selling the same products and
services in different markets. This is similar to a product-extension merger, described as
two companies selling different but related products in the same market [Investopedia,
2009-1]. In this case, Dell Computers may purchase Logitech to provide enhanced
human machine interface (HMI) capabilities for their computers (e.g. wireless keyboards,
web cameras).

Finally, two companies that have no common products, services or markets may form a
Conglomerate [Investopedia, 2009-1]. For example, an automotive company may
acquire an agriculture company in order to leverage options for growth in the agriculture
industry related to the production of ethanol. Ultimately, the two companies see their
products as intertwined (e.g. ethanol as a fuel for automobiles) but initially, there is little
or no connection between the two.

There are two other types of mergers based on the company’s financing method;
purchase and consolidation. A purchase merger occurs when one company purchases
another. The purchase may be made with cash or through the issue of some kind of debt
instrument (e.g. stock in the acquiring merged company). Consolidation mergers occur
when both companies are bought and combined under the new entity [Investopedia,
2009-1].

Regardless of whether two companies are brought together by the merger or acquisition,
the issues associated with the action and the resulting company are in most cases very
similar. These include but are not limited to rationalization of resources (e.g. over
capacity), anti-trust and decreased competition in the market place and brand
management and marketing.

Ideally these issues will be settled prior to or during them merger or acquisition. When
they are not, the company is forced to spend precious resources, effort and time fixing the
problems before they erupt into public battles that can lead to labor unrest, legal action
and in some cases, governmental intervention.

Hostile M&A

Hostile M&A, also known as hostile takeovers are caused by a number of additional
factors. In many cases, stronger, more financially healthy companies take advantage of
opportunities provided by stable economic conditions to achieve growth through
acquisition of weaker companies [Aaron, et al, 2007]. This is especially true of industries
that provide basic materials (e.g., steel) for growth of other industries such as
automobiles and construction. Some hostile M&A are punitive in nature. Punitive M&A
has been used to remove an incompetent CEO and/or board. In other cases, hostile M&A
is the only option left for some companies to survive weak economic conditions.

In the case of Arcelor and Mittal, none of these factors existed. Both companies were
profitable and were forecasting reasonable growth. Neither board was deemed
incompetent and prospects for continued growth of the steel industry were excellent. The
merger, while beneficial in increasing market share for both companies, was in fact, not a
necessity brought about by weak economic data and/or poor performance. As a result,
the acquiring company (Mittal) was not seen as a welcome suitor, but as an unwelcome
aggressor.
As the targeted company (Arcelor) was required to engage in defensive tactics for its own
survival. These tactics include but are not limited to the courting of other potential
private partners, buyback of company shares, engagement of local, national and
international government bodies and regulators, civil legal action, creation and
integration of poison pills2 and even defamation of the acquiring company and its
management.

It should be remembered that a hostile M&A is by its own definition, a “fight to the
death,” there is a victor and a loser. The degree of victory or loss is likely to be decided
during final agreements. But until that agreement has been signed and the new company
takes shape, an otherwise healthy that has been targeted will likely continue to battle the
aggressor until the stakeholders decide its final fate.

M&A Defense

When it comes to the battle for control of a company, the phrase ‘all is fair in love and
war,” is often used to justify behavior that is unseemly, unethical and potentially
damaging to the company both in the short and long term. History is rife with examples
of companies that have engaged in suicidal behavior in order to complete or defend
against a hostile takeover. Even mergers that are beneficial to both companies have been
the subject of brutal and destructive battles for control. In the end, the type and scope of
the defense and the offence, determines the end-state of the companies involved.

Military commanders understand the need for static and active defenses to thwart
attacking forces. Static defenses include physical obstacles such as battlements,
barricades and mine fields. Active defenses include intelligence and information
gathering, patrolling and when necessary, pre-emptive attack. Active defense is best
described by the famous Vince Lombardi quote “the best defense is a good offence.” If
you can attack your enemy before being attacked, then you have the advantage.

Arcelor did not want to become part of the Mittal Steel Empire, either by acquisition or
by merger. As a result, they started a campaign against Mittal from a defensive position.
However, for most of history, few campaigns are ever won from a defensive. At some
point, the victor must go on the offense. Further, the nature and size of the both the
offense and defense are not always the key factors in the success of a campaign. Many
guerilla wars have been fought and won by numerically and technically inferior forces.
Sometimes the simple commitment to wait until the enemy force tires of battle and
departs or relents is in itself a strategy. This of course assumes the adversary does not
have the will, the capability or the commitment to see the campaign to its end.
Unfortunately for Arcelor, the high cost and rapid advancement of the Mittal Steel bid,
denied them this option.

As noted above, a successful defense is not a passive act; it requires commitment of

resources and direction. The direction given to the company is governed by the Chief

2
A Poison Pill is a strategy used by corporations to discourage a hostile takeover by another company. The
target company attempts to make its stock less attractive to the acquirer [Investopedia.com, 2009-2]
Executive Officer’s (CEO) goals and objectives. These objectives describe the desired
end state and what they are willing to do to accomplish them. In the military, this
direction is known as commander’s intent.

Commander’s intent provides the basis for all decisions on allocation of resources
(forces), end state objectives and the way the battle will be fought (rules of engagement).
The way in which a company fights for its survival will in many ways, determine its
future, whether the battle is won or lost. There are many ways to prosecute a campaign,
however most plans revolve around a few basic strategies; the negotiated settlement, the
fight for survival and scorched earth3 campaigns.

In the negotiated settlement, Commanders or in this case the CEO commits their
resources parsimoniously, engaging in mature, respectful negotiation in hopes of fending
off the challenge with their stockholders. These leaders look to the future of the
company, trying to ensure its survival either as a lone entity or as part of a new company.
The Lockheed Martin acquisition of the Loral Defense Electronics and Systems
Corporation is such an example.

On paper the merger of Lockheed Martin and Loral brought many economies of scale for
aerospace electronics, tactical systems, and information technology [Lockheed-
Martin.com, 2009]. The two companies did however have competing products within the
same market niche. As a result, negotiations for a more integrated merger were initiated
in order to better leverage each companies assets while reducing duplication.

By inviting Chairman and CEO of Loral to join the Lockheed Martin’s board of directors
in a three-man office of chairman, the Loral Corporation was better able to both defend
its interests while providing resources (e.g. personnel, property, product lines, facilities,
etc.) to the new company. As a result, Lockheed Martin emerged both stronger and
deeper, better prepared to exploit the emerging opportunities and mitigate the risks
associated with the vastly reduced budgets of the mid-1990s.

In the fight for survival, CEOs may decide to commit maximum resources to the fight;
engaging in bitter and destructive battles that often land in court or in a shareholder’s
meeting. Because these battles are fights to the death, they can leave the company
weaker than before the takeover bid started. Bad blood from these battles may resonate
within the company and the industry for years.

The name Carl Icahn is infamous in aviation circles for his devastating takeover of Trans
World Airlines (TWA). While Mr. Icahn successfully took over TWA, the company,
weakened by the need to leverage its own assets for financing, never actually recovered
and fell victim to another takeover bid by American Airlines several years later.

3 The scorched earth policy is a classic military strategy in which to burn any land, crops, trees,
infrastructure and anything else of value as they retreated in order to deny supplies or sustenance to an
advancing army [Answers.com, 2009].
The term scorched earth in business parlance is a reaction to a takeover attempt that
involves liquidating valuable assets and assuming liabilities in an effort to make the
proposed takeover unattractive to the acquiring company [Investopedia, 2009]. CEOs
that engage in scorched earth tactics fall into two categories, the desperate savior and the
destroyer.

The desperate savior is a CEO who engages in scorched earth tactics to either provide
immediate and overwhelming resources to fight off a more powerful invader (e.g. sale of
valuable assets) or to make the company unattractive for acquisition (e.g. poison pills,
mergers with other companies).

The destroyer simply wants to ensure the acquiring company gets a destroyed and
ineffective asset. The tactics used by the destroyer are the same as the desperate savior
but the expected outcome is different. The desperate savior wants the company to
survive, accepting its weakened condition. The destroyer only wants to force the
acquiring company or the invader, to pay heavily for their decision to engage in a hostile
takeover of his or her company.

The proposed Microsoft Merger is one example of the scorched earth defense. In this
case, Yahoo CEO Jerry Yang engaged in a number of questionable and destructive tactics
in an attempt to stop Microsoft’s takeover. First, Mr. Yanh encouraged all 14,000 Yahoo
employees to quit if Microsoft succeeded in buying the company [Donovon, 2008]. As
human capital is a direct component of a company’s research and development,
production, project management, marketing and business development, it is a highly
valuable asset. If key employees depart before or during transition, key processes in the
company may be affected. Moreover, highly qualified and motivated employees could
move to competitor companies or start firms of their own, entering into direct
competition with their new employer.

Mr Yang also planted a poison pill in the form of an extraordinarily generous severance
package plan for Yahoo employees at the time of the merger. The plan called for a
substantial severance package that was subject to a so called double trigger. The double
trigger severance plan first required Microsoft to pay benefits to everyone who lost their
jobs as a result of the merger. The second trigger also required severance for employees
remaining on the payroll if their jobs changed (e.g. moving to a new division or a new job
title). Ironically, evaluation of the plan revealed the fact that Yahoo employees were
better off getting fired than being retained [Donovon, 2008].

Finally, the CEO and other executives declined to provide the full amount of information
about the merger to their employees. According to court documents, Yahoo executives
declined to tell employees that Microsoft was prepared to offer them $1.5 billion in
retention bonuses if they would stay with the company after a merger was completed
[Donovon, 2008]. Without this knowledge, Yahoo employees were left to ponder the
future of their company at the hands of Microsoft with no incentive to stay, but both
financial and familial incentives to leave. Given these parameters, the cost of acquisition
greatly outweighed the value of the company leading Microsoft to cancel the merger.
In the case of Yahoo vs. Microsoft, the CEO Mr Yang, could be characterized a
destroyer. His decision to engage in subterfuge by calling for a mass walkout while not
providing actual information was targeted at the employees in an effort to deny Microsoft
the human capital it needed to integrate Yahoo effectively. His decision to insist on the
excessive severance package as a poison pill targeted Microsoft directly, making the
acquisition too costly to complete. In the end however, Mr Yang’s objective was to
avoid the merger or leave a company that was not worth its cost and therefore, was
virtually useless. In other words, he meant to save Yahoo or destroy it, the decision to do
so remained with Microsoft.

M&A Stakeholders

One would hope that all key players would not engage in these sorts of battles. But as
hostile takeovers are technically life or death activities, most battles fall somewhere
between the negotiated settlement and scorched earth. The key players, defined as the
stakeholders, determine the type of battle and its ultimate outcome.

Mergers and acquisitions are ultimately dependent upon the requirements, objectives and
actions of the stakeholders. The stakeholders are those groups, organizations and
individuals that have an interest in the companies and in turn any M&A activity.

Stakeholders may further be described as direct and indirect. Examples of direct

stakeholders include CEO and corporate board, shareholders, employees, financiers,
suppliers, customers and in some cases, governmental and non-governmental
organizations.

Indirect stakeholders are less well defined because they do not participate directly in the
actions of the company and therefore, appear to have little if any direct influence over the
company’s actions. In actuality however, indirect stakeholders may in fact be key
players in the success or failure of a hostile takeover. Examples of indirect stakeholders
include industry competitors, local populations and supporting industries (e.g. housing)
as well as companies engaged in research and development of systems supporting the
company’s products or services.

Stakeholders, both direct and indirect have a significant bearing on the success or failure
of an M&A. The Arcelor vs. Mittal merger details a number of stakeholders and their
effect on the merger. The following paragraphs describe the Arcelor Mittal merger and
the emergence of certain trends regarding M&A, especially with regard to corporate
control of European companies operating within a global environment.

International Corporate Governance

Corporate governance deals with the mechanisms that ensure investors are treated fairly
and legally within a company [Shleifer and Vishny, 1997]. Corporate governance is
normally a national requirement; specific to the country the company is chartered in.
Companies domiciled in different countries are subject to different levels of corporate
governance [Doidge, et al, 2006]. As a result, international investors must be aware of
corporate governance regulations and laws for the companies they invest in.

Corporate governance is important because it lays out the legal framework within which
a company operates. This in turn provides credibility, thereby allowing increased access
capital markets on better terms. In essence, financiers need to trust the company they are
lending to. The quality of governance practice has been found to be positively related to
growth opportunities, the need for external financing, and the protection of investor
rights, and is negatively related to the concentration of ownership [Doidge, et al, 2006]. If
the company is bound by a strong set of governance principles, investors will feel more
confident about the return on their money.

With regard to international investment, national rules on corporate governance are

important because they influence the costs incurred to bond themselves [Doidge, et al,
2006]. Better governance reduces a firm’s funding cost since investors legally protected
from fraudulent and wasteful decisions by the company. This in turn allows the company
to access to capital markets on better terms.

Conversely, for firms located in countries with poor governance, raising capital can be
significantly more expensive as the risk to investors is higher. In countries where
governance is weak, firms wishing to obtain financing at better rates must adopt
governance processes of their own or adopt those from the nations they are doing
business in. By doing so, firms from poorly developed nations operating in the
globalized marketplace may be able to mitigate weak national governance in two ways.
First, firms that have access to foreign capital markets and financial institutions are less
dependent on the financial or economic development of their country. Second,
international firms may adopt the investor protections of the countries they borrow from,
specifically those with higher levels of protection [Doidge, et al, 2006].

Corporate Governance Characteristics

The two main types of corporate governance are the shareholder and the block holder
based system. The shareholder based systems of corporate governance relies on legal
rules emphasizing the rights of shareholders. This system is primarily in use in the United
Kingdom, the Unites States of America and the Commonwealth Countries. The block
holder-based system emphasizes rules protecting the company’s stakeholders (e.g.
creditors and employees) [Martynova, 2006]. Block holder systems are prevalent in most
Continental European companies.

The two systems differ in the rationale behind their legal rules and in the terms of their
ownership and control. Block holder systems like those in Europe are majority or near-
majority owned few investors. The shareholder system used by US, UK and
Commonwealth companies is characterized by dispersed ownership through a wider
population of shareholders [Martynova, 2006].
Another characteristic of the European governance is the prevalence of government
ownership in private companies. In the case of Arcelor S.A., the Luxemburg National
Government and the Belgian State of Wallonia held 5.6 percent and 3.2 percent of the
company’s stock respectively [Cagna, 2007].

Government bodies invest in companies for various reasons. However, the two primary
reasons are job creation for their local economies and capital appreciation, especially
with regard to state pension funds and social programs. As a result, the government
investment is based on both profit and sustainment. Given the choice of profit over
sustainment, governments looking for long-term stability would likely choose
sustainment over profit if in meant the company’s factories remained open even if the
rate of return was lower.

This does not mean the shareholder system focuses only on profit at the expense of the
company and its future development. If this were the case, the lifecycle of US, UK or
Commonwealth companies would be very short. Investors would simply buy into the
company then force the board to sell as soon as the share price met their expectations or
requirements. Many shareholders are in fact, long term investors, hoping to profit
through dividends, splits, appreciation and the company’s hopeful growth within the
market.

In many ways, the shareholders and the block holders share many of the same objectives.
The main difference is how the company’s leadership manages their investors and their
expectations. In the case of shareholders, the CEO and the board must be salesmen as
well as management. They must routinely convince the shareholders that they are
moving in the right direction, even when that direction leads to reduced dividends, share
price and in some cases, market share.

Block holders differ only in the need to convince a smaller but ultimately more powerful
group of investors, some with access to very potent tools. For example, a government
owner can change investment laws in support of its company. This can provide easier
access to government and private capital as well as protection from and/or support for
hostile and friendly M&A activities.

During the Mittal bid, Arcelor asked the Luxemburg Government to change an
investment law already on the books in order to frustrate Mittal Steel’s takeover bid.
Arcelor asked that the Luxemburg investment law be changed to add a time requirement
for re-bid by non-EU companies. In this case, any change to the target company would
require the acquiring company to wait one year before resubmitting a new bid. In effect,
in an effort to fight off a hostile takeover, Arcelor could simply buy or sell assets that
would change the company’s value. Mittal Steel, as the aggressor company, would have
to wait one year before submitting another bid.

The strategy failed because even though Mittal Steel was owned by an Indian National
living in the UK, its headquarters was actually in Rotterdam, Netherlands. Because the
company was a European Company, the rules did not apply.
Another characteristic difference between shareholders and block holders is the power
and influence of their stakeholders. As noted earlier, each company reports to or is
effected a number of direct and indirect stakeholders. Also, many of these stakeholders
are the same for each model of governance.

In the shareholder system, the shareholders generally have the ultimate authority to
remove the board and to force the company to sell out, the power and influence of other
stakeholders is somewhat reduced (e.g. unions). Shareholders of the XYZ corporation
may force the board to close a marginally profitable factory in Boston Massachusetts,
transferring production to less expensive facility in Ponca City Oklahoma. In order to
ensure the highest rate of return for shareholder investors, outsourcing of manufacturing
and services has for many years followed this model. If the board refuses and cannot
justify its decision on legal, economic and/or in some cases social terms, the shareholders
can replace them.

Block holders on the other hand are less dependent on individual investors for survival.
Indeed, direct and indirect stakeholders have a great deal more power over the block
holder company. Using the example above, the XYZ Corporation would like to close its
marginally profitable factory in Charleroi Belgium, transferring production to a less
expensive facility in Gdansk, Poland. The board must convince its shareholders and its
stakeholders including Governments of Belgian and Wallonia, the trade unions and the
European Union itself. Each of these stakeholders has the theoretical authority to stop
the company from making its move.

The key to this power is the way in which the law secures the rights of the stakeholders
over the investors for bloc holder based, or European companies. For example in the
US, the unions may protest the movement of XYZ from Boston to Ponca City by
organizing labor action in sister factories but they cannot generally go to the government
and demand the company remain in place at its detriment.

In Europe, the labor union can go to one of several governments to halt the move. This
course of action may be temporary, resulting in the delay of the move, but as noted
earlier, delaying tactics can give the complainants time to negotiate a better solution. For
example, the factory might be allowed to move its operations to Poland after providing a
larger severance package to the workforce.

The Effect of Globalized Investment

As the old saying goes, “that was then this is now.” The past few years have seen a
gradual change in block holder systems with globalization and the advent of institutional
investment, especially from outside of the European Union.

Globalization has enabled the growth of investment at all levels throughout the world.
Arguably, this phenomenon has been driven in no small part to the explosion of the
Internet and its access to near real time information 24 hours a day, seven days a week.
American investors using online investment banks and brokerages can now purchase
European stocks from their living rooms. Mutual funds made up of so-called “foreign
stock” are available in every major brokerage house and have become a cornerstone in a
diversified investor’s portfolio.

Most international funds are created to leverage growth in sectors of one or more
economies or to exploit a specific niche in an economy. Two examples of common funds
include the USAA World Growth Fund (USAWX) and the Matthews Asian Technology
(MATFX) fund. The USAA World Growth fund is focused on capital appreciation
investing primarily in equity securities of both foreign and domestic issuers [USAA.com,
2009]. Matthews Asian Technology fund is also focused on long-term capital
appreciation. However, the fund is highly specialized, investing at least 80% of its assets
in Asian companies involved in the manufacturing and sale of in technology-related
products and/or services [Yahoo Finance, 2009].

Because these funds own stock in several companies, crossing multiple boundaries, their
direct ownership of a single company is somewhat diluted. They do however; represent a
growing block of investors, seeking appreciation over stability. If necessary, they can
become a formidable block should a CEO or board decide to choose stability over for
appreciation, especially for non-economic reasons such as local employment sustainment.

Emergence of Sovereign Wealth Funds

Another set of funds making their way into the international market are the Sovereign
Wealth Funds (SWF). SWFs are normally associated with nations that have high
budgetary surpluses and minimal international debt. Most nations holding these funds
have economies that are based heavily on the export of natural resources such as oil and
gas. Many of these countries are also characterized by reduced diversification in other
industries. As a result, these national economies are subject to market volatility
associated with the narrow set of resources produced by that nation.

Oil and gas are prime examples of this. When oil and gas are expensive, countries such
as Kuwait, Saudi Arabia, Qatar and the United Arab Emirates enjoy high levels of
income and liquidity. When the cost of oil goes down, the bottom line of these countries
suffer because they have few other industries available to them to diversify and mitigate
losses.

For this reason, some countries use SWFs to reduce market volatility on government
revenues while others manage pension funds and national retirement accounts. The
Government Pension Fund of Norway is an SWF that is almost wholly funded by oil
revenues from Norwegian North Sea oil operations.

Since 2000, the number of SWFs has grown dramatically along with record growth of the
globalized economy. This is especially true for SWFs associated with countries that
export oil and gas. In 2008, SWFs managed accounts valued at $3.8 trillion [Maslakovic,
2009]. Further, there was an additional $5.5 trillion held in other sovereign investment
vehicles, such as pension reserve funds, development funds and state-owned
corporations’ funds and also $6.1 trillion in other official foreign exchange reserves. In
total, SWFs are worth more than $15 trillion worldwide, giving these funds huge
influence wherever they are invested [Maslakovic, 2009].

Traditionally, SWFs accumulate assets in the form of foreign currency reserves, usually
through the purchase of government bonds. However, the low returns associated with
these investments have prompted nations with excess foreign reserves to invest in
equities to achieve higher returns [Fernandes, 2009]. As a result, SWFs are becoming
more common in the market prompting a number of governmental and non-governmental
organizations to look at the issues associated with these new sources of capital.

Further, SWFs have emerged as a major source of capital following the 2008 market
crash. After the 2008 crash, many investors and fund managers moved their assets away
from corporations [Fernandes, 2009]. Many companies in need of financing are turning
to SWFs as more traditional sources such as banking and the stock market dry up.

One issue associated with SWFs is a general lack of transparency for both investors and
regulators. Because these SWFs are in many ways, the instrument of national
governments the actual size and source of funds, investment goals, internal checks and
balances, disclosure of relationships and holdings in private equity funds may be clouded
by national law. As a result, investors may not know the true value of the fund and
regulators may not know if the funds are being used to manipulate markets.

The strength, influence and lack of transparency of SWFs is another issue that has been
of particular interest. In particular, individual countries may be able to use their SWFs to
flood the market with funds, manipulating stock and commody prices. This has raised
national security concerns in some governments, especially if the purpose of the
investment might be to secure control of strategically important industries for political
rather than financial gain [The Economist, 2008]. Several national and multinational
governments have considered options for the restriction of these funds within their capital
markets, even at the risk of starting a new wave of international protectionism.

Current research on the role and effect of SWFs in the market is limited. To date, there is
little empirical data to support the notion that SWFs affect markets through collusion
and/or other unethical activities. In fact, investment SWF has actually been associated
with higher premiums on firm value for SWF investments as well as significant
improvements in operating performance. This in turn suggests that SWFs contribute to
creating long-term shareholder value instead of threatening investors and manipulating
markets and industries for political gain [Fernandes, 2009].

These investors and their funds provide investment capital for companies throughout the
world and in turn diversify the ownership of companies formerly held by small groups of
large block investors. It can be argued that because these companies have a more
diversified ownership, the power and influence of the more traditional stakeholders is
becoming diluted. In some ways this is correct, the CEO and the board must now be
more responsible to the shareholders, but the stakeholders still remain very powerful.
Especially with regard to government ownership and their inherent ability to change the
basic landscape of competition through legislation designed to favor companies.

Arcelor’s CEO attempted to manage the Mittal Steel bid with his board and his
government stakeholders, with what appeared to be little regard for the shareholders.
Traditionally, he would have had a fairly free hand in the decision to reject or accept
Mittal Steel’s offer. Ultimately however, the shareholders forced the final sale of the
company when they refused the SeverStal bid.

Investment Bankers and M&A Activities – Pilots Navigating Complex Waters

In the world of shipping, the Captain is the final authority aboard his or her vessel. He or
she is responsible for the successful voyage from the loading of the cargo in one port to
the offload in another and all operations in between. The Captain commands the ship’s
crew and the maintenance of the ship and is responsible for compliance with national and
international regulations regarding immigration, customs, maintenance and security.
Basically, the Captain, like the CEO of a company has ultimate responsibility for the
ship’s successful and continued operation.

There is however, one place where the Captain gives up full command. When the ship is
entering and leaving ports of call or navigating through complex and dangerous stretches
of water, the Captain hands the immediate operation and navigation of the ship to a pilot.
A pilot is someone who has expert knowledge of the complex and dangerous waters a
ship must navigate to successfully complete the voyage

Pilots are not generalists. They are highly experienced in their geographical area. A
Rotterdam pilot could not pilot a ship into and out of the port of New York. Their
knowledge is much too detailed, requiring years of training and testing by maritime
officials. They must know every channel, sandbar and mud bank without consulting a
map. They must further know the complete layout of the port, where the piers, security
teams, fueling stations and anchorages are.

In most cases, pilots are trained over years, being retested and licensed constantly. The
captain may visit hundreds of ports each year. As such, he or she cannot be expected to
know the enough details about each port to enter operate and exit safely. For this, the
captain needs and expert, and that expert is the pilot.

We can use the metaphor of the ship to a company and the ship’s captain to the CEO.
Because M&A activities are not normal procedures, the CEO cannot be expected to know
the full details for each legal requirement. This is especially true for international M&A
activities that must satisfy the regulations and laws of multiple national and international
governments and organizations. In the M&A field, the pilot is the investment banker.

An investment banker acting as an underwriter or agent provides expertise and advice for
the CEO and other interested stakeholders. Investment bankers are usually associated
with an investment bank or firm providing broker and dealer services as well as corporate
restructuring when required [Investorwords.com, 2009]. Essentially, the Investment
Banker is the “go to guy” for advice and support for a company involved in both friendly
and hostile M&A activities.

How do Investment Bankers support M&A activities and what are their duties? First and
foremost, investment bankers are middlemen, acting as the conduit for a company to
obtain funding, successfully navigate legal issues and maintain over watch of the deal
from before the announcement to the completion [Giannini, 2003]. During the
preparation phase an investment banker confirms expectations of value and terms by the
board, determines the value of the company from an analytical point of view and assesses
future challenges for the merger, sale or acquisition. If required the Investment banker
will also assist in recruiting other members of the team not already on board including
but not limited to attorneys and accountants with experience required to complete the
transaction [Giannini, 2003].

Once the team is in place and the company is valued, the investment banker identifies and
evaluates potential buyers and develops marketing strategies. As a consultant, the
Investment Banker should provide first hand introductions between the principles
[Giannini, 2003]. In this case, the banker uses his or her personal expertise and
relationships to strengthen the team and provide confidence of success to the board.

The investment banker then prepares and executes the documentation required to market
the company to be sold or facilitates the receipt of the documents from a company to be
acquired. Since security is imperative and the threat of competition from other
companies is always present, the investment banker must ensure that signed
confidentiality and non-disclosure agreements are accomplished by both the seller and
the buyer [Giannini, 2003].

During the sale phase of the M&A, the investment banker monitors interest in the
company and arranges visits to facilities as required. The banker will also research and
qualify potential buyers as they are identified. At this point, the investment banker may
be required to research the backgrounds, history and culture of the targeted company
[Giannini, 2003]. The collected information must then be analyzed to ensure the buyer or
seller’s in honest in their intent and the company being acquired meets requirements.

Now that buyers or sellers have been identified and vetted, the investment banker
becomes very much a salesman by managing buyers’ visits [Giannini, 2003]. This
includes but is not limited to preparing documents and data for briefings, preparing tours
and demonstrations of the company’s products and services and ensuring the company is
at its best presentation (e.g. clean, well organized).

As the deal is being struck, the investment banker reverts back to his or her role as a
facilitator or pilot. In this role, the banker prepares and executes a schedule of each step
as well as agreements between the principles on responsibilities and benchmarks. Once
this is in place, the banker then manages the flow of information between company and
buyers [Giannini, 2003].

The banker then confirms the buyer’s decision to accept or decline the offer and to assist
in the negotiation of terms and payment. Payments may be in a number of forms,
including cash, stock or notes. In some cases, the buyers only want to buy partial assets
(e.g. a factory). Other buyers may decide to leave behind some assets (e.g. real estate) or
negotiate away the company’s liabilities [Giannini, 2003]. The investment banker will
help evaluate different deal structures in the context of the seller’s requirements (e.g.
cash, tax liabilities, etc).

The deal itself starts with a Letter Of Intent (LOI) or an offer. For this the investment
banker will often interface with the buyer directly as well as the attorneys, accountants
and others required to be involved. The company must then accomplish due diligence for
the acquisition [Giannini, 2003]. The investment banker will prepare the company, then
organize and manage the process in an effort to expedite its completion prior to
acquisition. During this period, the banker will also track progress and open issues in all
areas of the deal in order to minimize opportunities for unplanned and unwanted surprises
[Giannini, 2003].

Once due diligence is completed the investment banker will normally help the final
definitive purchase agreement [Giannini, 2003]. This agreement covers the full range of
issues associated with the sale of the company to include notes, security agreements,
consulting, employment contracts, non-compete contracts, licenses, leases and any other
assets or liabilities to be transferred.

Finally, the investment banker will remain with the company until the deal if finally
closed. He or she will ensure that any missing or incorrect documents, agreements or
other legal documents and/or requirements are completed satisfactorily.

As with a ship’s captain and the pilot, only after the ship has departed the complex and
dangerous waters of the port will the pilot depart for yet another ship. The investment
banker, as the CEOs pilot remains with the company until the deal is finished and the
company is once again operating in familiar territory.

The employment of investment bankers supporting M&A activities is documented.

Studies have shown that the employment of investment bankers has a significant
association with M&A announcement period returns, operating performance, and the
long-term returns of the acquiring company [Ertugrul, Krishnan, 2009].

Not all investment bankers are alike however. Limited research has shown that
investment bankers with graduate degrees from highly respected universities, targeted
industry expertise, and high levels of experience are associated with better performance,
shorter deal completion times, and higher probabilities of deal completion [Ertugrul,
Krishnan, 2009]. As a result, the employment of an investment banker during M&A
activities is an important element in the company’s ultimate success.
Conclusion

What conclusions and/or lessons learned can be drawn from the Arecelor Mittal merger
and what do they mean with regards to current international M&A activities? First and
foremost, we have learned that international M&A has a potent political component
endowed with the ability to shape and form a deal through the application or
misapplication of law. Furthermore, the goals and objectives of the political stakeholder
are not always aligned with that of financial stakeholders such as the shareholders. In
most cases, the political stakeholder is more interested in economic stability and long
term appreciation than in profit. To be successful, the acquiring company must find ways
to co-opt the political stakeholders while ensuring the financial stakeholders
(shareholders, financiers and owners) remain satisfied. This in turn greatly complicates
the deal.

Second, we have noted fundamental changes to the nature of finance and corporate
ownership on a globalized scale. These changes are being driven in part by two emerging
factors communications and institutional investment. Advanced communications via the
internet and a twenty four hour news cycle have expanded the investor pool dramatically.
Individual and institutional investors now have the opportunity to buy and sell shares on
an almost immediate basis.

The emergence of well financed international funds made up of investors and countries
from around the world are able dilute the power and influence of the block investors that
previously controlled many European companies. The net result of this is a more
accountable CEO and board as investors demand higher levels of return even in the face
of pressure from entrenched management and political stakeholders.

Third, we have seen the need for a multilayered defensive strategy for companies that are
fighting a hostile takeover. These tactics run the gamut from legal maneuvering, to
poison pills to unethical and even unseemly behavior on the part of the full range of
stakeholders. The strategies employed to fight the takeover can range from a benign
negotiated settlement to the purposeful destruction of the company through scorched
earth tactics.

The defensive strategy, be it negotiated settlement, fight for survival or scorched earth, is
largely the decision of the CEO. In military parlance, the CEO as the General of forces
does this by publishing his or her commander’s intent. The commander’s intent sets out
the objectives, the goals and most importantly the rules of engagement that subordinate
commanders would plan their own operations against.

As a general of forces, the CEO decides the objectives, goals and rules that will be
followed during a defensive or indeed an offensive takeover. However, each decision has
consequences. Whether the decision is to fight the takeover as a negotiated settlement or
as a fight for survival, the company will ultimately change in some fundamental way.
These consequences lie almost wholly with the CEO for deciding the strategy to be used.
And like military leaders throughout history, the CEO can and is often replaced when the
board and the stakeholders lose confidence in their leadership. In this matter Mr Guy
Dolle and Gen Douglas MacArthur share the experience of being moved aside, when
their strategy became misaligned with their primary stakeholders.

As noted, international M&A is a very complex undertaking. Successful completion of

an international M&A then requires expertise beyond that of most companies, no matter
what size. Like a ship captain navigating unfamiliar waters, the CEO and the company
needs a pilot or guide to keep them on track. Investment bankers with industry expertise
and experience with international M&A activities are important members of the team. As
advisors and guides, investment bankers provide critical over watch of the M&A process
from before the first offer to the completion of the seal. As a result, a well planned M&A
campaign should ensure the presence and support of an investment bank and an
investment banker, dedicated to the success of the campaign.
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Certification of Authorship:

I hereby certify that I am the author of this paper and that any assistance I received in its
preparation is fully acknowledged and fully disclosed in this paper. I have also cited any
sources (footnotes or endnotes) from which I used data, ideas, theories, or words,
whether quotes directly or paraphrased. I further acknowledge that this paper has been
prepared by me specifically for this course.

Candidates Name: John L Mahaffey

Date: 07 July 2009

Declaration of Originality of Work:

I, hereby affirm that the attached work is entirely my own, except where the words or
ideas of other writers are specifically acknowledged according to accepted citation
conventions. This assignment has not been submitted, either in part or in whole, for any
other course or credit granting activity at the International School of Management or any
other institution. I have revised, edited and proofread this paper.

Candidates Name: John L Mahaffey

Date: 07 July 2009