Chapter 10Studying Mergers and Acquisitions

2

OBJECTIVES

Explain the motivations behind acquisitions and show how they’ve changed over time

1

Explain why mergers and acquisitions are important vehicles of corporate strategy

2

Identify the various types of acquisitions 3

Understand how the pricing of acquisitions affects the realization of synergies

4

Outline the alternative ways to integrate acquisition and explain the implementation process

5

Discuss the characteristics of acquisitions in different industry contexts

6

3

THE eBAY-PAYPAL ACQUISITION

The partnership made sense … … but would it work?

Rely on transaction-based revenue

No inventory or warehousing

No sales force

Can we recoup the $250 millionpremium we paid with savingsand revenue growth?

4

THE eBAY-PAYPAL BUSINESS MODELS

eBay business model

Post

s au

ctio

n,

pays

fee

Wins

auction

eBay

BuyerSellerContract and

payment occur between buyer

and seller

PayPal business model

PayPal

PayeePayer

eBay revenue comes from sellers paying auction posting fees

PayPal’s revenue comes from float in the personal accounts and fees for pre-mier and business accounts

Send

s m

oney

Receives m

oney

(pays fee)

5

MERGER VS. ACQUISITION

Merger

Acquisition

A

A

B

B

C

A

The purchase of one firm by another so that ownership transfers

The “merger”of Daimler with Chrysler

in 1997 is considered by manyto have been an acquisition

in disguise

The consolidation or combinationof one firm with another

6

MOTIVES FOR MERGERS AND ACQUISITIONS

Sometimes termed “Managerialism”, manager can conceivably make acquisitions-and even willingly overpay for them-to maximize their own interests at the expense of shareholder wealth

Managers may make mis-taken valuation and have unwarranted confidence in their valuation and in their ability to create value because of pride, over-confidence, or arrogance

Managers may believe that the value of the firms combined can be greater than the sum of the two independently

• Reduced threats

• Increased market power and access

• Realized cost savings

• Increased financial strength

• Sharing and leveraging capabilities

Managerial self-interest Hubris Synergy

7

M&A – A VEHICLE THAT IMPACTS ALL ELEMENTS OF THE STRATEGY DIAMOND

M&A and the Strategy DiamondWhile mergers and acquisition are explicitly vehicles of strategy, they have major implications for arenas staging, and economic logic as well

Economiclogic

Arenas

VehiclesStaging

Differentiators

Source: Adapted from Hambrick and Fredrickson, “Are You Sure You Have a Strategy?” Academy of Management Executive 15:4 (2001) 48-59

8

US ACQUISITION ACTIVITY

0

2,000

4,000

6,000

8,000

10,000

12,000

1990 91 92 93 94 95 96 97 98 99 2000 01 02 2003

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

Source: Data compiled from SDC Platinum, a product of Thompson Financial

Value of transactions ($, 2003)

Number of transactions

Value of transactions($, 2003)No. of transactions

9

19721`1`

In 1972, brothers-in-law Leonard Marsh and Hyman Golden and Arnold Greenberg, Marsh’s childhood friend, founded a business called the Unadulterated Food Corporation and began selling juice in Queens. The name Snapple was coined while trying to develop an apple soda. In 1987, Snapple introduced iced teas with fun names and flavors and enlisted (2) controversial radio personalities, Howard Stern and Rush Limbaugh, to promote them

Cadbury Schweppes buys Snapple from Triarc for $1.45 billion. Snapple is now part of the very successful America’s Beverage division, which includes 7up, Dr. Pepper, Mystic, and Mott’s juices, among other brands. Has Snapple found its home?

Fewer than three years later, Quaker throws in the towel and sells Snapple for $300 million to Triarc

UPs AND DOWNs AT SNAPPLE

1994 1997 2000

After sizzling success,Snapple is sold to Quakerfor $1.8 billion

10

BENEFITS AND DRAWBACK OF ACQUISITIONS OVER INTERNAL DEVELOPMENT

• Speed

• Critical Mass

• Access to complementary assets

• Reduced competition

• More expensive

• Inherit adjunct businesses

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

• Potential for organizational conflict

11

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), 92-101

12

PRICING MERGERS AND ACQUISITIONS

Market value

Intrinsic value

Target value Synergy value

Current market capitalization of firm (i.e., what stock market believe company is worth )

Market value of two firms combined with synergies taken into account

Fundamental value of cash flows

Fundamental value of cash flows of two firms with synergies taken into account

13

PREMIUMS

Percent of market value

130

15

145

100

Acquisitionprice

~ 30 - 45%

Market value

Average pre-miums in US range:

30 - 45%

14

THE SYNERGY TRAP

Acquisition premiums Create two problems for managers

Premiums increase the level of returns

the combined businesses must

extract

The longer it takes to implement performance

improvements, the more likely the

acquisition will fail

15

HOW WOULD YOU DO THAT? – PAYPAL ACQUISITION

eBay paida $250 million premium for PayPal, nowthey must earn that premium back

Years until synergies are implemented

Cost of capital

0

1

2

3

4

5

0.100

0.110

0.121

0.133

0.146

0.161

10%

0.150

0.173

0.198

0.228

0.262

0.302

15% 20%

0.200

0.240

0.288

0.346

0.415

0.498

• “How much incremental net income must you generate if you implement synergies in two years?

• What if they take five years to implement?

16

PAYING TOO MUCH

“The market, like the Lord, helps those who help themselves. But,

unlike the Lord, the market does not forgive those who know not what they do… (A) too-high purchase price for the stock of an excellent

company can undo the effects of a subsequent decade of favorable

business development “

17

THE ACQUISITION PROCESS

Source: Adapted from P.C. Haspeslagh and D.B. Jemison, Managing Acquisitions: Creating Value Through Corporate Renewal (New York Free Press, 1991), 42

A process perspective

Idea

Justification due diligence, negotiation

Acquisitionintegration

Results

Decision-makingprocess problems

Integration process problems

18

ACQUISITION SCREENING

“Soft-fit” acquisition screening by Cisco systems

Screening criteria Means of achieving criteria

Offer both short- and long-term win-wins for Cisco acquired company

• Have complementary technology that fills a need in Cisco’s core product space

• Have a technology that can be delivered through Cisco’s existing distribution channels

• Have a technology and products that can be supported by Cisco's support organization

• Is able to leverage Cisco’s existing infrastructure and resource base to increase its overall value

Share a common vision and chemistry with Cisco

• Have a similar understanding and vision of the market• Have a similar culture• Have a similar risk-taking style

Be located (preferably) in Silicon Valley or near one of Cisco’s remote sites

• Have a company headquarters and most manufacturing facilities close to one of Cisco's main sites

19

ABSORPTION

Need for strategic interdependence

Need for organizational autonomy

High

Low

High

Preservation Symbiosis

Holding Absorption

Low

Acquiring company completely absorbs the target company. If the target company is large, this can take time (e.g., Franklin Quest’s acquisition of the Covey Leadership Center to create Franklin Covey)

20

PRESERVATION

Need for strategic interdependence

Need for organizational autonomy

High

Low

High

Preservation Symbiosis

Holding Absorption

Low

The acquiring company makes very few changes to the target , and instead learned from it in preparation for future growth (e.g., many of Wal-Mart’s early international acquisitions)

21

HOLDING

Need for strategic interdependence

Need for organizational autonomy

High

Low

High

Preservation Symbiosis

Holding Absorption

Low

The acquiring company allows little autonomy - yet does not integrate the target into its businesses (e.g., Bank One’s acquisitions of local banks )

22

SYMBIOSIS

Need for strategic interdependence

Need for organizational autonomy

High

Low

High

Preservation Symbiosis

Holding Absorption

Low

The acquiring company integrates the target in order to achieve synergies but allows for autonomy, for example to retain and motivate employees. This is possibly the most difficult to implement (e.g., Cisco's acquisitions which cost the firm $1 million per employee on average)

23

KEY LESSONS FOR IMPLEMENTING M & As

Integration management is a full-time jobIntegration management is a full-time jobMany successful acquirers appoint an “integration manager” becauseintegration is too much work for acting managers to add to their workloads

Key decisions should be made swiftlyKey decisions should be made swiftlySpeed is of the essence because of the cost and time value of money

Integration should address technical and cultural issuesIntegration should address technical and cultural issues

Most managers focus on technical issues only. This is a mistake

It’s a continual process, not an eventIt’s a continual process, not an eventStart the integration process long before the deal is closed

24

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

25

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

26

SUMMARY

Explain the motivations behind acquisitions and show how they’ve changed over time

1

Explain why mergers and acquisitions are important vehicles of corporate strategy

2

Identify the various types of acquisitions 3

Understand how the pricing of acquisitions affects the realization of synergies

4

Outline the alternative ways to integrate acquisition and explain the implementation process

5

Discuss the characteristics of acquisitions in different industry contexts

6

27

EXERCISES

•CLASS EXERCISE–Identify a company that has recently undertaken an acquisition. Study the terms of the deal and identify to the extent possible the intrinsic value of the target, its market value, and the acquisition price. What was the acquisition premium? Calculate the required performance improvements with different assumptions as to how long it will take to implement them, say one, three, and five years. Is this believable?

•GROUP EXERCISE–Pick a firm of interest to your group. Identify potential acquisition candidates. Explain why these companies would make sense as an acquisition target. Evaluate and describe possible implementation barriers to this acquisition.

•POST ACQUISITION EXERCISE –Yincom and Yangnet