Mergers & Acquisitions: Business Strategy

Mergers & Acquisitions

Saurabh Shekhar 07bs3884 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Mergers & Acquisitions:???? • A merger is a combination of two or more corporations in which only one corporation survives and the merged corporations go out of business.

• An acquisition refers to the process of gaining partial or complete control of one company by another company for some strategic reasons.

1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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MERGER VS. ACQUISITION A

B

C The consolidation or combination of one firm with another

Merger

A

B

A

The purchase of one firm by another so that ownership transfers

Acquisition

1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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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 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Mergers and Acquisition Activity • M&A activity seems to come in ‘waves’ through the economic cycle domestically, or in response to globalization issues such as: – Formation and development of trading zones or blocks (EU, North America Free Trade Agreement

– Deregulation – Sector booms such as energy or metals 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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CLASSIFICATION OF ACQUISITIONS Overcapacity M&A

Roll-up-M&A

Product/ Market Extension

M&A as R&D

Industry Convergence

Example

DaimlerChrysler merger

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

37%

9%

36%

1%

4%

Percent of all M&A deals

1/27/2009 Shekhar.07bs3884,IBS Hyderabad Source: J.L. bower, “ Not All M&As Are Alike – andSaurabh That Matters,” Harvard Business Review 79:3 (2001), 92-101

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M&As IN DYNAMIC CONTEXTS Technological change

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

Demographic change

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

Geopolitical change

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

Trade liberalization

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

Deregulation

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

1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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M&As AND INDUSTRY LIFE CYCLE

Introduction

M&As tend to be R&D and productrelated

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Growth

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

Maturity

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

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Motivations for Mergers and Acquisitions

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Saurabh Shekhar.07bs3884,IBS Hyderabad

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Managerial Motivations for M&As • Managers may have their own motivations to pursue M&As. The two most common, are not necessarily in the best interest of the firm or shareholders, but do address common needs 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’t need the firm to be diversified) and so they tend to dislike risk (volatility of sales and profits) – M&As can be used to diversify the company and reduce volatility (risk) that might concern managers. 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Synergy – a Quest for Holy Grail WHAT IS IT? • Popular definition: 1 + 1 = 3 • Roundabout definition: If am I willing to pay 6 for the business market-valued at 5 there has to be the Synergy justifying that

• More technical definition: Synergy is ability of merged company to generate higher shareholders wealth than the standalone entities 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Synergy – a Quest for Holy Grail WHAT IS IT? – cont’d

• Synergy value is created from economies of integrating a target and acquiring a company; the amount by which the value of the combined firm exceeds the sum value of the two individual firms.

1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Value Creation Motivations for M&As Operating Synergies • Operating Synergies – Economies of Scale • Reducing capacity (consolidation in the number of firms in the industry) • Spreading fixed costs (increase size of firm so fixed costs per unit are decreased) • Geographic synergies (consolidation in regional disparate operations 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. 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Value Creation Motivations for M&A Efficiency 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 – – – – 1/27/2009

Reduced cash flow variability Increase in debt capacity Reduction in average issuing costs Fewer information problems Saurabh Shekhar.07bs3884,IBS Hyderabad

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Value Creation Motivations for M&A Tax 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-forward provisions) • 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 unable to 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 management skills, connections to markets or people, and new products/services. 1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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BENEFITS AND DRAWBACK OF ACQUISITIONS OVER INTERNAL DEVELOPMENT •Move expensive •Inherit adjunct businesses •Cannot spread commitment over several years (one-time, all-or-nothing decision)

•Potential for organizational conflict •Speed •Critical Mass •Access to complementary assets •Reduced competition

1/27/2009

Saurabh Shekhar.07bs3884,IBS Hyderabad

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APPROACH TO M&A Move from an acquisitions strategy, to acquisition as the manifestation of strategy

Strategic Fit

Don’t let acquisitions determine your strategy

Pre-Conditions for Success

A ready meeting of minds on what business is about A model to improve both parties’ competitive position

Pre-Merger Discussions

Focusing on how the model will work Agreeing a price where both benefit Demonstrating “success without a heavy hand”

Post-Merger Integration

Re-establishing the Governing Objective

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Saurabh Shekhar.07bs3884,IBS Hyderabad

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CONCLUSIONS Mergers and acquisitions can transform a business, but they can also be a risky, uncertain means of achieving shareholder value  • • •

Poor due diligence Hidden merger costs Massive leadership challenge Unpredictable events

Some lessons    

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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.

Saurabh Shekhar.07bs3884,IBS Hyderabad

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Remember::

A merger or acquisition only creates an opportunity. It is execution that creates value.

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Saurabh Shekhar.07bs3884,IBS Hyderabad

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