business growth takeovers and mergers

The Growth of Firms

Key definitions

• Organic growth: growth from “within the business” e.g. new products; expansion into new markets

• External growth: use of takeovers & mergers

With strategy – firms have a CHOICE

Innovation

Diversification

International Expansion

Cost leadership

Strategy Methods

Organic growth

Takeovers / mergers

Joint ventures or strategic alliances

Types of Integration

• Horizontal Integration: two businesses in the same industry at the same stage of production becoming one

Horizontal Integration

• Tata buying Jaguar Land Rover from Ford• Volkswagen buying Porsche• Asda buying Netto (food supermarkets)• Amazon buying LoveFilm• Virgin Money buying Northern Rock• Verizon’s $130bn purchase of Vodafone’s interest in

its US mobile joint venture• Suntory of Japan paid £1.35bn to buy

GlaxoSmithKline’s drinks brands Lucozade & Ribena

Microsoft - Nokia

http://www.bbc.co.uk/news/business-23947921

Advantages of Horizontal + Lateral Integration

• Internal economies of scale • Cost savings from rationalisation• Potential to secure revenue “synergies”• Wider range of products - (diversification) -

Opportunities for economies of scope• Reduces competition by removing rivals – increases

market share and pricing power• Can make the entry barriers higher for new rivals


• Vertical integration: acquiring a business in the same industry but at different stages of the supply chain

– Forward vertical: Closer to the consumers e.g. a manufacturer buying a retailer

– Backward vertical: Closer to the raw materials in the supply chain e.g. a manufacturer buying a raw material supplier

Authors/Agents

Wholesalers

Retailers

Consumers

Publishers/Distributors

BookstoresChains

IndependentBookstores

SupermarketsInternetRetailers

Book Clubs

Vertical Markets: The Book Industry Supply Chain

Amazon – Huge Market Power Volume Value

% %

Chain bookshops* 29 36

Independent bookshops 4 5

Bargain bookshops 9 4

Supermarkets 13 10

Other shops 12 8

Book clubs 6 6

Internet-only retailers# 27 31

* Waterstone’s, WHSmith, Blackwell# Internet only – e.g. Amazon, Play.com

Internet Only Book Sales in UK (2011)

Market share

Amazon 70%The Book Depository 4-5%Play.com 3-4%Others (including publishers’ direct)

22%

Hotel ChocolatA vertically integrated business that owns and operates cocoa plantations in St Lucia (the Rabot Estate pictured above) and which roasts and manufactures chocolate in Cambridgeshire + owns many retail units across the UK

Amazon – Market Power Volume Value

% %

Chain bookshops* 29 36

Independent bookshops 4 5

Bargain bookshops 9 4

Supermarkets 13 10

Other shops 12 8

Book clubs 6 6

Internet-only retailers# 27 31

* Waterstone’s, WHSmith, Blackwell# Internet only – e.g. Amazon, Play.com

Internet Only Book Sales in UK (2011)

Market share

Amazon 70%The Book Depository 4-5%Play.com 3-4%Others (including publishers’ direct)

22%

Other examples of vertical integration

• Film distributors owning cinemas + digital streaming platforms• Brewers owning/operating pubs (forward vertical) or buying

hop farms (backward vertical)• Record labels and radio / online music stations• Drinks manufacturers integrating with bottling plants• Pig processing business buying a pig farm• Technology companies growing vertically through hardware,

software and services– PayPal, acquired by eBay for $1.5bn in 2002– Google buying Motorola, a phone maker

Recent Deals

Advantages of Vertical Integration

• Control of the supply chain – this helps to reduce costs and improve the quality of inputs into the production process

• Improved access to key raw materials perhaps at the expense of rival businesses

• Better control over retail distribution channels• Removing suppliers and information from

competitors which helps to make a market less contestable


• Lateral integration: companies joining together that produce similar but related products

• Conglomerate: Disparate businesses

What type of integration here?

A B

Mergers and Takeovers

• Takeover: Where one business acquires a controlling interest in another business = a change of ownership

• Merger: a combination of two previously separate businesses into a new business

• Diversification: expanding into new markets with new products – the riskiest growth strategy

Some key strategic drivers of M&A activity

• Rapid technological change• Need for scale to remain competitive• Need to be able to supply customers globally• Low demand growth in mature economies• Access to wider distribution networks• Invest in faster-growing emerging markets

Takeovers: 3 main motives

Strategic motives

• Improve & develop the business

• Closely linked to competitive advantage

• E.g. economies of scale

Financial motives

• Make best use of financial resources for shareholders

• Improve financial performance

• E.g. higher profits

Managerial motives

• Self-interest of managers

• Not necessarily in the best interest of shareholders

• E.g. want to lead a bigger business

Shareholder value - example

Original Target Combined0

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8

10

12

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16

Busi

ness

Val

ue (£

m) £10m

£2m

£15m

Examples of successful deals

Successful takeovers and mergers

L’Oreal & The Body Shop (more shops, higher profits)

Google & YouTube (rapid growth & advertising revenue)

Tata & Jaguar Land Rover (£1bn profits in 2011)

Santander & Abbey, Alliance & Leicester, Bradford & Bingley (higher profits & market leadership in UK)

Taylor Woodrow & George Wimpey (economies of scale for two leading house builders merged together)

Kraft / Cadbury – market leadership

Cadbury’s strategic fit with Kraft

Key financial motives for M&A

• E.g. businesses with high cash balances can potentially earn a better return by investing in other firms

Make use of surplus cash and high share price

• Can the target be bought at a knock-down price?• Potential to sell surplus assets & cut costs & still

retain the business that was wanted in the first place

Bargain hunting & Asset Stripping

Key managerial motives for M&A

• Director rewards may be linked to growth• Big takeovers attract media – boosts ego / reputation?• Takeovers as “vanity projects”

Personal ambition & financial reward

• Pressure to do takeovers (if competitors are too)• Concern that firm may be being left behind• Over-confidence• Pressure from advisers & media (e.g. investment bankers)

Bandwagon effect / peer pressure

Some examples of motivesTakeover / merger Main motives for the transaction

Kraft / Cadbury Establish global market leadership in confectionery & access emerging markets

Google / Motorola

Acquire valuable smartphone patents & manufacturing expertise

Tata / JLR Economies of scale & acquire expertise, brands, capacity and distribution

RBS / ABN-Amro Management vanity; continue reputation for big deals; over-confidence

Santander / Abbey

Market entry (UK) & establish base for further acquisitions to build market share

WM Morrison & Safeway

Increase market share & exploit economies of scale to improve competitiveness

British Airways / Iberia

Consolidation; economies of scale & survival: positioning for further takeovers

The most important evaluation point

Strategic FitDoes the takeover or merger fit with the objectives of

the business?Does it make sense?

1

13

The next most important evaluation point….

Will shareholders gain from synergy?Can 1 + 1 = 3?

WhatIs

SYNERGY?

An example of synergy…

Similar concept to “adding value”

Two kinds of “synergy”

Eliminate duplicated functions & services

Better deals from suppliers

Higher productivity & efficiency from shared assets

Cost SavingsCross-selling to customers of both businesses

New distribution channels

Brand extensions

New geographic markets opened up

Revenues

Overview of the takeover process

Target Identification & Choice

Valuation & Offer

Due Diligence

Integration

Key evaluation point: Things can go wrong in each part of the takeover or merger

Target Identification

& Choice

Valuation & Offer

Due Diligence

Integration

Wrong target

Pay too much

Don’t check what you are buying

Poor integration planning

E.g. Paying too much!

Valuation has to strike a balance

Interests of buyer

shareholders

Interests of target

shareholders

Don’t pay too much!

Get the best price!

Example of the Winner’s Curse - RBS

• In 2007, RBS was part of a consortium that bid £49bn as it competed to buy ABN-Amro

• RBS clearly overpaid for the takeover

• The subsequent effect on RBS's capital reserves led to the forced nationalisation of RBS in 2008 to avoid a collapse of the UK banking system

Some truly awful deals (1)

£175m

SOLD£25m

Some truly awful deals (2)

£10bn

Written Off + New Liabilities

£15bn+

Examples of deals that failedFailed takeovers and mergers

News Corp & Myspace (bought for £580m; sold for $25m)

ITV & FriendsReunited (bought for £175m; sold 3 years later for £25m)

Cisco & Flip (bought for $590m; closed down in a year)

RBS & ABN-Amro (bought for £10bn; results in losses of at least £15bn & nationalisation)

Terra Firma & EMI (bought for £4.2bn; sold 3 years later for loss of £1.75bn) – one of biggest private equity failures

The problems of

MergerIntegration

Imagine we are all responsible for managing this takeover…

Identify three areas that would be likely to be the hardest part of integrating the

takeover

Marks & Spencer Poundland

Building analysis & evaluation on takeover integration…

• Importance of synergies• Extent to which firms are similar (e.g. products, markets)• Quality of integration planning and action (e.g.

communication, leadership)

Success of takeover integration will depend on…

• Are the two cultures significantly different?• Type of takeover – e.g. cross-border, private equity• Can be a short-term problem, but in the long-term, one

culture will prevail

Evaluating the importance of culture in a takeover

Summary: drawbacks of acquisitions

• High cost involved• Problems of valuation• Clash of cultures• Upset customers• Problems of integration (change management)• Resistance from employees

• Non-existent synergy• Incompatibility of management styles, structures

and culture• Questionable motives• High failure rate• Diseconomies of scale

Joint ventures

• Joint ventures occur when businesses join together to pursue a common project

• The businesses remain separate in legal terms• Joint ventures are becoming common as firms

want to benefit from collaborative work in reaching a mutually-agreed strategic target. An example might be joint-research projects to share the fixed costs

Examples of joint ventures

• Vodafone & Telefónica agreed to share their mobile network• BMW and Toyota agreed in 2011 to co-operate on hydrogen fuel cells,

vehicle electrification, lightweight materials and future sports car• West Coast – joint venture between Virgin Rail & Stagecoach• Google and NASA developing Google Earth• Hollywood studios combining to fight internet piracy• Alliances in airline industry e.g. Star Alliance and One World• Starbucks - JV with Tata Beverages to break into the Indian retail

market• Joint Ventures between universities to deliver Massive Open Online

Courses (MOOCs) – a fast-expanding sector of the higher education industry

De-mergers

• When a firm decides to split into separate firms• Some of the key motivations for de-merger include:

– Focusing on core businesses to streamline costs and improve profit margins

– Reduce the risk of diseconomies of scale and diseconomies of scope by reducing the range of functions in a business, lower management costs

– Raise money from asset sales and return to shareholders– A defensive tactic to avoid the attention of the competition authorities

who might be investigating possible monopoly power in an industry / market

Examples of de-mergers

• The US pharmaceutical company Pfizer sold their infant nutrition business to Nestle

• Demerger of Cadbury's US drinks business creating a business called Dr Pepper Snapple Group

• Severn Trent Water demerged its waste management business Biffa

• Demerger of British Gas into a gas pipeline business Transco + an oil and gas exploration company

• Talk Talk demerged from Carphone Warehouse in 2010

Examples of de-mergers

• Fosters Group de-merging its two main operating divisions – one focusing on beer, the other on wine

• Punch and Spirit pub groups created out of demerger of Punch Taverns in 2011

• US food giant Sara Lee sold off coffee business Douwe Egberts• Quantas demerged their airline business and run stand-alone

domestic and international airline businesses with each having their own profit and loss account

• News International demerged their Film and TV and Publishing businesses

News InternationalFi

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nd T

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• Fox News• 20th Century Fox• Sky• Fox Television

Publ

ishi

ng

• Dow Jones• Wall Street Journal• New York Post• The Times• The Sun• Harper Collins

The Reality of Market Power

Pricing Power

Entry Barriers

MonopsonySupply Chain

Control

Economies of Scale

The Reality of Market PowerIndustry Leadership Benchmark Businesses

Profits to re-invest Habitual consumption