Northrop Grumman Makes a Bid for TRW: How Collar Arrangements Affect Shareholder Value On March 5,..

Northrop Grumman Makes a Bid for TRW: How Collar
Arrangements Affect Shareholder Value

Don't use plagiarized sources. Get Your Custom Essay on
Northrop Grumman Makes a Bid for TRW: How Collar Arrangements Affect Shareholder Value On March 5,..
For as low as $7/Page
Order Essay

 On March 5, 2002, Northrop Grumman initiated a tender offer
for 100% of TRW’s common shares by offering to exchange $47.00 in market value
of Northrop Grumman common stock for each share of TRW common stock. The tender
offer would expire at the end of the month. Northrop implicitly was offering to
exchange .4352 (i.e., $47/$108) of its own common shares (based on its March
5th share price of $108.00) for each share of TRW stock. However, the actual
share-exchange ratio would be based on the average Northrop share price during
the last 5 business days of the month. The $47.00 offer price is assured within
a narrow range to TRW shareholders by placing a collar of plus 5% ($113.40) or
minus 5% ($102.60) around the $108.00 Northrop share price on the tender offer
announcement date. The range of share-exchange ratios implied by this collar is
as follows:

The .4581 and .4145 share-exchange ratios represent the
maximum and minimum fraction of a share of Northrop stock that would be offered
for each TRW share during this tender offer period. The collar gave TRW
shareholders some comfort that they would receive $47.00 per share and enabled
Northrop to determine the number of new shares it would have to issue within a
narrow range to acquire TRW and the resulting impact on EPS of the combined
firms. An increase in Northrop’s share price to $117.40 on April 10, 2002,
enabled Northrop to increase its offer price to $53.00 per share of TRW stock
outstanding on April 15, 2002, without issuing more than the maximum number of
shares it was willing to issue in its March 5 offer. This could be accomplished
because the maximum share-exchange ratio of .4581 would not be exceeded as long
as the share price of Northrop stock remained above $115.75 per share (i.e.,
4581×$11575 = $5300). In an effort to boost its share price, TRW repeatedly rejected
Northrop’s offers as too low and countered with its own restructuring plan.
This plan would split the firm into separate defense and automotive parts
companies while selling off the aeronautical systems operation. TRW also moved
aggressively to solicit bids from other potential suitors. TRW contended that
its own restructuring plan was worth as much as $60 per share to its
shareholders. In June, TRW reached agreement with Goodrich Corporation to sell
the aeronautical systems unit for $1.5 billion. Northrop Grumman and TRW
finally reached an agreement on July 1, 2002. Under the terms of the agreement,
Northrop would acquire all of TRW’s outstanding common stock for $60 per share
in a deal valued at approximately $7.8 billion. Northrop also agreed to assume
approximately $4 billion of TRW’s debt. Moreover, Northrop withdrew its
original tender offer. The actual share-exchange ratio would be determined by
dividing the $60 offer price by the average of the reported prices per share of
Northrop common stock on the 5 consecutive trading days prior to the closing
date. Under a revised collar arrangement, the exchange ratio would not be less
than .4348 or more than .5357 of Northrop’s shares. The merger makes Northrop
Grumman the second largest U.S. defense contractor, behind Lockheed Martin

Case Study Discussion Questions

 1. What type of collar arrangement did Northrop use (i.e.,
fixed exchange rate or fixed payment)? Explain your answer.

2. What would have been the implications for TRW shareholders
had a fixed exchange ratio without a collar been used? Explain your answer.

Leave a Reply

Your email address will not be published. Required fields are marked *