mergers & acquisitions: business strategy

Mergers & Acquisitions

Saurabh Shekhar

07bs3884

1/27/2009 1Saurabh Shekhar.07bs3884,IBS Hyderabad

Mergers & Acquisitions:????

• A merger is a combination of two or more corporationsin which only one corporation survives and the mergedcorporations go out of business.

• An acquisition refers to the process of gaining partial orcomplete control of one company by another companyfor some strategic reasons.


MERGER VS. ACQUISITION

Merger

Acquisition

A

A

B

B

C

AThe purchase of one firm by another so that ownership transfers

The consolidation or combinationof one firm with another


Classifications : Mergers and Acquisitions

• Horizontal– A merger in which two firms in the same industry combine.– Often in an attempt to achieve economies of scale and/or scope.

• Vertical– A merger in which one firm acquires a supplier or another firm that is

closer to its existing customers.– Often in an attempt to control supply or distribution channels.

• Conglomerate– A merger in which two firms in unrelated businesses combine.– Purpose is often to ‘diversify’ the company by combining uncorrelated

assets and income streams

• Cross-border (International) M&As– A merger or acquisition involving firms from two different countries


Mergers and Acquisition Activity

• M&A activity seems to come in ‘waves’ through theeconomic cycle domestically, or in response toglobalization issues such as:

– Formation and development of trading zones orblocks (EU, North America Free Trade Agreement

– Deregulation

– Sector booms such as energy or metals


CLASSIFICATION OF ACQUISITIONS

OvercapacityM&A Roll-up-M&A

Product/MarketExtension M&A as R&D

Industry Convergence

Example DaimlerChryslermerger

Service Corporation International more than 100 acquisitions of funeral homes

Pepsi’s acquisition of Gatorade

Intel’s dozens of acquisitions of small high tech companies

AOL’s acquisition Time-Warner

Objectives Eliminating capacity, gaining market share, and increasing efficiency

Efficiency of larger operations (e.g., economies of scale, superior management)

Synergy of similar but expanded product lines of geographic markets

Short cut innovation by buying it from small companies

Anticipation of new industry emerging; culling resources from firms in multiple industries whose boundaries are eroding

Percent ofall M&A deals 37% 9% 36% 1% 4%

Source: J.L. bower, “ Not All M&As Are Alike – and That Matters,” Harvard Business Review 79:3 (2001), 92-1011/27/2009 6Saurabh Shekhar.07bs3884,IBS Hyderabad

M&As IN DYNAMIC CONTEXTS

Technological change

Cisco and Microsoft both use acquisitions to ensure they maintain their strong competitive positions

Demographic change

Geopolitical change

Trade liberalization

When the Tribune Company merged with Times-Mirror in 2000, it acquired Spanish-language “Hoy” to target the growing U.S Hispanic market

IBM divested its PC division to a Chinese company as that country emerges

Wal-Mart acquired Mexican retail giant, Cifra, in wake of NAFTA

DeregulationAT&T divested local operations into “Baby Bells” and set off a state of almost constant M&A


M&As AND INDUSTRY LIFE CYCLE

Introduction

M&As tend to be R&D and product-related

Growth Maturity

M&As tend to be for acquiring products that are proven and gaining acceptance

M&As primarily for dealing with over capacity in the industry


Motivations for Mergers and Acquisitions


Managerial Motivations for M&As

• Managers may have their own motivations to pursue M&As.The two most common, are not necessarily in the bestinterest of the firm or shareholders, but do address commonneeds of managers

• Increased firm size– Managers are often more highly rewarded financially for building a bigger

business (compensation tied to assets under administration for example)– Many associate power and prestige with the size of the firm.

• Reduced firm risk through diversification– Managers have an undiversified stake in the business (unlike

shareholders who hold a diversified portfolio of investments and don’tneed the firm to be diversified) and so they tend to dislike risk (volatilityof sales and profits)

– M&As can be used to diversify the company and reduce volatility (risk)that might concern managers.


Synergy – a Quest for Holy GrailWHAT IS IT?

• Popular definition: 1 + 1 = 3

• Roundabout definition: If am I willing to pay 6 for thebusiness market-valued at 5 there has to be theSynergy justifying that

• More technical definition: Synergy is ability ofmerged company to generate higher shareholderswealth than the standalone entities


Synergy – a Quest for Holy Grail

WHAT IS IT? – cont’d

• Synergy value is created from economies ofintegrating a target and acquiring a company; theamount by which the value of the combined firmexceeds the sum value of the two individual firms.


Value Creation Motivations for M&AsOperating Synergies

• Operating Synergies– Economies of Scale

• Reducing capacity (consolidation in the number of firms in theindustry)

• Spreading fixed costs (increase size of firm so fixed costs per unitare decreased)

• Geographic synergies (consolidation in regional disparateoperations to operate on a national or international basis)

– Economies of Scope• Combination of two activities reduces costs

– Complementary Strengths• Combining the different relative strengths of the two firms creates

a firm with both strengths that are complementary to one another.


Value Creation Motivations for M&AEfficiency Increases and Financing Synergies

• Efficiency Increases– New management team will be more efficient and add

more value than what the target now has.– The combined firm can make use of unused

production/sales/marketing channel capacity

• Financing Synergy– Reduced cash flow variability– Increase in debt capacity– Reduction in average issuing costs– Fewer information problems


Value Creation Motivations for M&ATax Benefits and Strategic Realignments

• Tax Benefits– Make better use of tax deductions and credits

• Use them before they lapse or expire (loss carry-back, carry-forwardprovisions)

• Use of deduction in a higher tax bracket to obtain a large tax shield• Use of deductions to offset taxable income (non-operating capital

losses offsetting taxable capital gains that the target firm was unableto use)

• New firm will have operating income to make full use of available CCA.

• Strategic Realignments– Permits new strategies that were not feasible for prior to the

acquisition because of the acquisition of new managementskills, connections to markets or people, and newproducts/services.


BENEFITS AND DRAWBACK OF ACQUISITIONS OVER INTERNAL DEVELOPMENT

•Speed

•Critical Mass

•Access to complementary assets

•Reduced competition

•Move expensive

•Inherit adjunct businesses

•Cannot spread commitment over several years (one-time, all-or-nothing decision)

•Potential for organizational conflict


APPROACH TO M&A

Don’t let acquisitions determine your

strategy

A ready meeting of minds on what business

is about

A model to improve both parties’ competitive

position

Focusing on how the model will work

Agreeing a price where both benefit

Demonstrating “success without a heavy

hand”

Re-establishing the Governing Objective

Strategic Fit

Pre-Conditions for

Success

Pre-Merger Discussions

Post-Merger Integration

Move from an acquisitions strategy, to acquisition as the manifestation of

strategy


CONCLUSIONS

Mergers and acquisitions can transform a business, butthey can also be a risky, uncertain means of achievingshareholder value Poor due diligence• Hidden merger costs• Massive leadership challenge• Unpredictable events

Some lessons Does it fit with our current strategy? Is it a manifestation of it? Is it capable of integration with our existing business? Will it enhance our competitive advantage? Do the economics stand up to the test? Most acquisitions are

killed by the premium required, which cannot be recaptured.


Remember::

A merger or acquisition only creates anopportunity. It is execution that createsvalue.


mergers & acquisitions: business strategy

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