impact of merger on financial profitability

8/14/2019 Impact of Merger on financial profitability

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Impact of Merger on Profitability of

Alliance Boots

Ganesh Adhikari

ABE membership number: W07304

05 September 2013


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DECLARATION

I declare that this assignment is my own work and I have appropriately acknowledged

the work of others. This assignment is produced in accordance with the ABE regulations

and guidelines.

......

28 July 2013


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Table of Contents

EXECUTIVE SUMMARY ............................................................................................ 5

1. INTRODUCTION .................................................................................................... 6

2. EVALUATION OF THE STRATEGIC DECISION ...................... ............. ............. ... 7

2.1.1 Suitability ...................................................................................................................... 72.1.2 Acceptability .................................................................................................................. 8

2.1.3 Feasibility ...................................................................................................................... 8

2.2 Validity and Reliability .......................................................................................................... 8

2.3 A quantitative appraisal of the decision ......... ......... .......... ......... .......... ......... ......... ......... ...... 9

2.4 Other non quantifiable issues ............................................................................................ 10

2.4.1 Political issues ............................................................................................................ 10

2.4.2 Organisational issues .................................................................................................. 10

3. CRITICAL EVALUATION OF THE MERGER ............. ............. ............. ............. ... 11

3.1 Impact of Merger ............................................................................................................... 11

3.2 Appraisal of the decision ......... ......... .......... ......... .......... ......... ......... .......... ......... .......... ...... 12

3.3 Tension among Stakeholders ............................................................................................ 13

3.3.1 Shareholders ............................................................................................................... 14

3.3.2 Employees .................................................................................................................. 14

3.3.3 Customers................................................................................................................... 14

3.3.4 Government ................................................................................................................ 14

3.4 International aspects and complexities .............................................................................. 15

3.4.1 International Aspects ................................................................................................... 15

3.4.2. Financing issues ........................................................................................................ 15

3.5 Risk management in decision making process .................................................................. 15

3.5.1 Identified Risks ............................................................................................................ 16

3.5.2 Management of risks ................................................................................................... 16

4. CONCLUSIONS ................................................................................................... 17

4.1 Strengths of the decision making process.......................................................................... 17


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4.1.1Mission driven .............................................................................................................. 17

4.1.2 Followed the structures and practices ......................................................................... 17

4.1.3 Stakeholder analysis ................................................................................................... 17

4.1.4 Commitment to accomplish required synergy .............................................................. 17

4.2 Weakness in decision making process .............................................................................. 174.2.1Timeframe .................................................................................................................... 18

4.2.2 Organisational culture ................................................................................................. 18

4.2.3 Weak liquidity and profitability ..................................................................................... 18

4.3 Evaluation of the success ......... ......... .......... ......... ......... .......... ......... .......... ......... ......... .. 18

4.4 Recommendations ............................................................................................................. 18

5. REFRENCES ............ ............. ............. ............. ............. ............. ............. ............. . 19

APPENDIX ................... ............. ............. ............. ............. ............. ............. ............. . 23


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Executive summary

This report provides an analysis and evaluation of the past, current and prospective

profitability, liquidity and financial stability of Alliance Boots. Identification, calculation

and interpretation of available data were required to measure the financial performance

of Alliance Boots before and after merger. To do so key performance ratios as well asreturn on investment measures were applied. Financial data from Balance Sheets, Cash

Flow Statements and profit and loss account of Alliance Boots have been used to

calculate and analyse the different accounting ratios which were the key performance

indicators. Additionally the data on office of fair trading (OFT) available on its websites

was also applied.

The purpose of using different source of data was to establish validity and reliability of

the research. Most of the calculations can be found in the appendices. Results of data

analysed show that majority of the ratios in the report are below industry averages after

the merger. In particular Liquidity and profitability immediately after the merger was

weak. However company was able to achieve consistent increase in revenue, trading

profit and the operating cash. It was also able to achieve the highest market share in the

UK market as well as the greater product portfolio.

Similarly group was able to expand its operations in major European market as

expected however there were few concerns over the regional politics and economy as

well as the impact of exchange rates.

The report also have some limitations which include the data provided in the internet is

not sufficient to calculate all the required ratios. Similarly the data about the impact on

stakeholders was not widely available as the merger took place in 2006.


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Total word count: 3784

1. Introduction

Merger has always been the most reliable choice for the companies to expand their

business. It is commonly argued that the merger helps companies to gain access to

new resources through increased revenue and wider customer reach. If managed

effectively merger can be a vital turnaround for any company. Merger is the mechanism

for improving competitiveness of companies through gaining greater market share,

broadening the portfolio to reduce business risk, for entering new markets and

geographies, and capitalizing on economies of scale.

Boots is the established household name in UK market. However, Boots has been

struggling in the competitive British market by facing consecutive fall in profits. Boots

began trading in 1849 and has seen its sales fall in recent years as its aggressive

segmenting and targeting strategy didnt clicked (Boots website, 2006). There was

strong call among stakeholders that the company should immediately seek effective

way to overcome those problems. To overcome these challenges Boots plc merged with

Alliance Unichem in July 2006. However there were many other rationale behind the

merger which include

The creation of Europes leading pharmacy -led healthcare group

To expand the number of retail stores and pharmacies

To create wholesale network to serve over 88,000 outlets

Enhances international growth opportunities

To deliver substantial cost savings

For the generation of incremental revenue opportunities

To deliver value for both sets of shareholders

After the merger The Group has constantly recorded increase in revenue and profit. In

the financial year 2010/11 company recorded the revenue of 23 billion with trading

profit of 1195 million.

This merger of two major players in the health and beauty industry in UK generates the

larger scale of operations and increased product range. By making 1000 job cuts initially

company saves around 100 million in its operation related activities. Despite the fact


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that job were lost as a result of merger, yet in the long term the financial performance

and increased market share of merged company has resulted more job creation.

Reduction in the cost of production has secured sustained profitability of the company in

following years. There are still some challenges in the market. The competitive rivalry

among the retailers has forced many companies to seek different ways to gain

competitive advantage. Rapid change in internet technology, financing efficiency and

favourable regulatory law are the main reason driving mergers.

There are various complex reasons behind any merger therefore a single doctrine

cannot justify the motives of merger. In many case merger is used as the strategic tool

to enhance financial performance of the company. Merger and acquisition are also seen

as major strategic tools to expand business and accelerate growth, however in many

studies their success remain contested in long term profit making. A study by Bruner

(2002) suggested that in many cases mergers were not able to provide adequate

amount of return to the shareholders in long run. In contrast to that the study of Paul

(2009) shows that post acquisition operating performance of the merged companies

was higher than the industry average. Similarly the study by Tower Watson (2011) for

Cass business school shows that the acquiring companies have the better performance

than the average market index.

2. Evaluation of the strategic decision

2.1.1 Suitability

Boots UK was the leading health and beauty retailer in the UK market. However it was

facing strong challenge from the rival retailer like Tesco, Sainsbury and Superdrug.Therefore to secure the growth and profitability of the company in longer term it was

essential for Boots to take strategic decision to exploit the opportunities and avoid any

threats in the environment. Therefore the suitable strategic decision to make was to

merge with the rapidly expanding company within same industry. This was the forward

integration where the company was able to expand its activity through increased

product portfolio and market share (Alliance Boots, 2013). With careful external and

internal environmental analysis along with Porter five forces analysis it was found thatthe Boots was in very sound and competitive position to acquire Alliance Unichem to

form the largest Health and Beauty Company in the UK. Boots core competence was its


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size and number of outlets in every corner of the UK, its product portfolio, service

delivery and the brand image. It was suitable for Boots to merge with the Unichem

which is the key wholesale player in health and beauty market. Therefore Boots has

been able to enjoy the consistent superiority in the market after the merger.

2.1.2 Acceptability

Acceptability focuses on the interaction between the strategic decision and the

stakeholders reaction to this (Thomas wu, 2010). In this case there was minor

opposition among the shareholders in the general meeting of the Boots for the proposed

change. However the majority of the shareholders were agreed with the strategic

decision of the company on the basis of various financial measurements like economic

value added, cost benefit analysis and shareholder value analysis. Similarly the detailed

analysis of return and risk helped group of stakeholders and investors to reduce their

discomfort. Medlow power interest index was utilised by the management to measure

the interest and power of various stakeholders in the environment and help make

decision accordingly.

2.1.3 FeasibilityMcKinsey 7s framework was used to analyse the capabilities of the company and was

found that the strategic decision made by the Boots was in control with its internal

capabilities (Mind tools, 2013). Boots has analysed all the financial costs involved with

the transaction of the proposed merger. The other internal factors are termed as 5M

factor which stand for money, machinery, material, manpower, market and makeup,

need careful consideration before implementing the strategic decision (Wikipedia,

2013). The major capabilities of the firm at the time of merger were its workforce,

system, product portfolio, supply chain and both companies being in same industry has

helped them gain more value through efficient integration of system. However there was

a bit of concern among the employee about the possible job cuts however these issues

were settled among the HR department and the leaders of the unions.

2.2 Validity and Reliability

The decision of the Boots management to merge with Alliance Unichem was directedtowards future growth and the increasing financial performance in the longer term.

Similarly it was also to expand the business internationally and maximise return to the


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shareholders. To appraise the potential decision of investment on merger Boots has

carried out the analysis on long term investment. Similarly the rates of return and

payback period were key indicator to measure the validity of the decision. The

consistent growth of the company around the globe after the merger shows that the

decision to merge was valid in terms of growth. Similarly the increased profitability in all

following years suggests that the decision was reliable too.

2.3 A quantitative appraisal of the decision

Profitability ratios

Ratios (%) 2007/8 2008/9 2009/10

Gross profit Margin 8.4 5.9 3.21

Operating Margin 4.51 4.07 4.2

Return On Equity 1.01 1.028 0.26

Return On Asset 1.2 0.6 0.8

ROCE 0.4 0.086 3.2

In terms of profitability after the merger company was in line with the expectations of the

management. There was a reduction in the profit in 2008/9 but this may be the impact of

the worldwide recession. Much lower cash was generated from the groups oper ational

activities which were not enough to secure increased profitability. However the Groups

profitability were rose again significantly in 2010/11 showing that the company is moving

into right direction.

The financial results for the five consecutive years suggest that the group was in right

track in terms of trading profit and cash generations.

Groups trading profit and cash generation from operations has rose significantlyfollowing the merger:

Financial year Trading profit growth

(millions)

Cash from operations

(millions)

2007/8 836 1,152

2008/9 929 1,045

2009/10 1,042 1,130

20010/11 1,176 1,3092011/12 1,300 1,601

Source: www.allianceBoots.com
http://www.allianceboots.com/http://www.allianceboots.com/


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2.4 Other non quantifiable issues

2.4.1 Political issues

When the decision was made to acquire Alliance Unichem, the situation in external

market were challenging. Issues like uncertain political and economic times, pressures

on public spending and global economic weakness were taken into account while

making decision. Additionally there was the pressure of the powerful unions regarding

the possible job losses and the economy was slowing down.

2.4.2 Organisational issues

Software

Culture

Human resource

Pay scheme Pensions plan

Supply chain integration

Legal issue

Finance

Formation of Board of directors

General meetings

There was also the concern among leaders involved about the organisation culture,

training and development of the staff. Board of directors was formed consisting top level

managers and directors of both companies. Similarly the integration of the software,

systems, supply chain and deliveries were the non financial issues which were

integrated successfully. The merger was highly publicised in the UK therefore the

interest among the public was higher. Therefore product portfolio for the merged stores

and pricing policy was integrated by using appropriate framework.


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3. Critical evaluation of the Merger

3.1 Impact of Merger

On 31 July 2006 the Boots UK acquired the entire share capital of Alliance Unichem Plcfor consideration, including costs, of 3.9 billion. The provisional goodwill arising on the

acquisition is 2.2 billion and the initial assessment of the fair value of the intangible

assets acquired, which predominantly comprises pharmacy licences and customer

related assets, is 1.7 billion. Boots share price went up by 4% to 633 pence and

Unichem by 1% to 875 pence. Boots share price went up by 4% to 633 pence and

Unichem by 1% to 875 pence. Even though the Boots profitability was sliding in recent

years (BBC, 2006) but the share price were going up because of the speculation aboutthe future growth perspective of the company. Therefore this surge in the shares

appraised the decision of merger to create infinite advantage for the shareholders.

Key financial indicators before and after Merger

2005(millions) 2006(millions)

4 936 Sales Revenue 5 027

2 809 Cost of Sales 2 7832 127 Gross Profit 2 244

1 767 Less Expenses 1 895

360 Net Profit 349

A through and objective review of the financial statements of an acquisition or merger

candidate is an essential component of open market transactions (Johnson, 2001). The

analysis of the pre and post merger financial statements suggests that the performanceof the group were according to the expectations. According to the interim results

published on 30 September 2006 the shareholders expectations were met, revenue,

trading and underlying profit and earnings per share are all up to comparative figures.

However the profitability of the group was less after the merger which suggests that the

group was unable to generate earnings comparing its costs and expenses. Similarly the

profitability of the group were not excellent compared to the year before merger but

however were in line with the expectations of the management.


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Profitability ratios before and after the merger:

Post merger 2007 Profitability ratios Pre merger 2006

1.14% Return on Asset 1.47%

2.0% Return on Equity 3.04%3.83% Gross profit margin 7.34%

3.3.2 Appraisal of the decision

Merger is the long-term strategic decision which will have large impact on whole

organisation. Therefore the investors must determine whether if it is beneficial for the

firm to invest in merger or not. Healy, Palepu and Ruback (1990), Paul (2009), Tower

Watson (2011) found that merged firms have significant improvements operating cash

flow returns after the merger, resulting from increases in asset productivity.

Groups liquidity ratios suggest that the group was in strong position to meet its long and

short term obligations. Data from the following table shows that the Groups debts were

far lower in 2009/10 compare to 2007/8. The ratio of liabilities was higher over the

current assets in 2007/8 but company reduces it in following years by making efficient

use of its inventory.

Liquidity ratios

Ratios 2007/8 2008/9 2009/10

Current Ratio 1.301 1.183 1.228

Quick Ratio 0.125 0.82 0.824

Cash ratio 0.124 0.111 0.085

Activity based costing approach was utilised by boots to secure examine the value

created by each activity for the groups integration plan (Alliance Boots, 2013). The

Group was able to save 100 million in 18 months ahead of schedule after the merger

mainly through the job cuts and restructuring the supply chain (Alliance Boots 2006).


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Additionally priority of the board of newly formed company was to reduce the cost by

implementing cost synergy plan. Initially company was able to save 20 million merger

cost by implementing new organisational structure, utilising existing office space,

harmonising buying prices, reducing corporate costs and integrating the distribution

channel.

Immediately after the merger all the Boots brands and products were made available in

all 500 pharmacies of Alliance Unichem. Which helps increase customer reach as well

Boots products were supplied though the channel of Alliance Unichem in Europe.

Similarly the diversification of the product range and the increase in operating platforms

has created the opportunity for the Group to increase strategic customer offering. The

merger has reduced the cost of re-engineering the process of supply chain and product

costing which helped group to achieve competitive advantage.

Similarly the integration plan was applied to achieve business excellence and value

chain. The combined operations of two companies in same sector made it easier for

them to integrate core operations to deliver excellent customer service.

3.3 Tension among Stakeholders

Financial objectives of the Group were

Europes leading retail pharmacy business

Enhanced international growth opportunities

Cost savings of at least 100 million

Incremental revenue opportunities

Financial objectives of the company were to create a global leader in the field of

pharmacy led health and beauty group by utilisation of all the possible international

opportunities. However this decision of the management to merge with pan-European

Company has created dissatisfaction among the large section of British community.

Critics were worried about the possible exit of the Boots from The UK to Europe.

According to Rhodes (2002) merger is not only about financial ownership it is also about

integration of ideology, culture and practice. Therefore only the business relation

between the merging firms does not appear to be the major determinant of post-merger


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performance. Factors like balance of power, employee welfare, compensation for the

affected parties and technology and interests of shareholders are equally important.

3.3.1 Shareholders

There was a clear authority to the management of both companies to take decision from

the shareholders. Therefore there was not any conflict between the owner and the

agency. More than 95.5% of share holders in both companies agreed to the deal to

merge however the small group of shareholders disagreed on the deal citing company

should focus on bringing new ideas rather than buying more shops. Similarly they also

stressed that the management should create more value from its existing space by

reducing cost and polishing up their brand name.

3.3.2 Employees

Employees were concerned about the possible job losses after the merger deal. More

than 1000 jobs were lost in the process to create synergy in the merger. Series of

meetings were held with union leaders in UK to settle down the issue.

3.3.3 Customers

The impact of merger on the customers is vital in the modern market environment.

Consumers are interested in the decision made by the corporations. More specifically

the health and beauty retail sector has the direct connection with the customer. Boots

has the wide brand loyalty among its customers and the It system has played important

role in creating customer loyalty. Therefore it was crucial for Boots to analyse the

customer choice before and after merger.

3.3.4 Government

Government and regulation bodies were concern about competition standards and

possible impact off the merger into the government income as tax. The office of fair

trading said there were 100 local areas where the merger would create competition

concerns (OFT, 2006).


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3.4 International aspects and complexities

3.4.1 International Aspects

Boots UK has the strong presence in the UK market however the AllianceUnichem was

third largest pharmacy led health and beauty wholesaler in Europe. Boots has greater

brand equity and product development capabilities and the major objective of the

merger was to combine these with international distribution reach and long established

relationships of Unichem outside UK. This also helped gain consumer and investors

confidence in brand as well as reasserts the companys dominance in the UK retail

health and beauty market. However there were challenges like exchange rates, laws in

Europe and other countries, taxation, Global economic issues and different legal

requirements to run the business various nations.

3.4.2. Financing issues

Although the decision of merger was supported by majority of shareholders the concern

over the investment in expansion of business in difficult time was objected by few.

Similarly the liquidity ratio of the company after the merger not as good as desired.

Higher liquidity ratio creates more margins of safety to the investors. Therefore the

Group faced future investment challenges after the year of the merger.

Liquidity ratios comparison

Post merger 2007 Liquidity ratios Pre merger 2006

1.32 Current ratio 2.06

0.84 Acid test ratio 1.43

3.5 Risk management in decision making process


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3.5.1 Identified Risks

Lynch (2009) believes that mergers might be successful in some cases but it does not

guarantee superior financial performance. Merger could lead towards problem if too

much money is paid or not have any experience of merger (Johnson, Wittington andScholes, 2009). Conflict arises while integrating the cultures of both companies. If the

firm try to crush those cultural differences then it might create problems. Difficulties in

gaining commitment of employees, problems of cultural fit and uncertainties in customer

confidence create chaos (chui, 2011). The decision to merge with the huge rival

company brought risk with it for employee to fit within new culture.

The risks identified were macro economic and political environment, the impact of

regulation; changes and trends in consumer behaviour; competition; health, safety and

environmental risks; product/services risk; major operational business failures;

increased costs; change management; acquisitions; currency exchange; funding and

interest rate risks; pension contributions; and data protection.

Similarly critics of the decision were also worried about the impact of tax on merger

which will force group to move out of the UK and finally in 2008 the group headquarter

was moved to Switzerland to enjoy lower corporation tax (Alliance Boots,2013).Furthermore the law in many European countries did not allow operating as a

chain retailer and the working hours and minimum wages to the employee were

different in Europe which was additional complexity in the process. Additionally there

was risk of strong resistance to change because of the possible job cuts create fear

among the employee.

3.5.2 Management of risks

All the identified risk were monitored and then assessed to minimise their effect on the

decision. Human resource of the group played key role in minimising the cultural

difference in both companies by identification of the potential barriers to cultural fit.

Similarly the complexities in the integration of the systems, supply chain and payment

structures were integrated with an appropriate planning in advance within the available

budget. Similarly the legal experts at the group were negotiation with trade unions,

government regulatory bodies and other related parties.


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Similarly standards were set for all the newly merged stores and departments along with

supply chain to mitigate risks associated with health, safety and the environment which

were also closely monitored and regularly audited.

4. ConclusionsMerger between Boots and Alliance Unichem was the positive sign for the future

growth. The increase in the share price after the merger was announced help gain

confidence of the investors which secured the future investment opportunities among

the investors. Similarly the financial objectives of the group were according to the

expectations of the management after the merger. However the liquidity and the

profitability of the group were not as expected instantly the deal was done but within a

matter of years Alliance Boots was able to achieve both up to industry average.

Therefore Boots was able to secure strong financial position although in the time of

recession in 2008 till 2013. However it needs to look into some key areas if it wants to

improve the market presence and growth.

4.1 Strengths of the decision making process

4.1.1Mission drivenThe decision of merger was directed towards the mission to be the leading pharmacy

led health and beauty group in the world.

4.1.2 Followed the structures and practices

Established merger committee, bring both boards together and agreed all the activity to

do according to the schedule purposed.

4.1.3 Stakeholder analysis

Decision was followed by the stakeholder analysis to measure the impact and power

which could affect the decision.

4.1.4 Commitment to accomplish required synergy

The decision was motivated by the cost saving plans which has enhanced the profit

making ability of the group.

4.2 Weakness in decision making process


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4.2.1Timeframe

Timeframe was not allocated about when the synergy plan will achieve the expected

outcome, which takes longer than expected.

4.2.2 Organisational culture

There was not any model or structure for the culture of new group which created chaos

among the staff about the future.

4.2.3 Weak liquidity and profitability

Due to the unproductive resources and overheads group was not able to achieve the

required level of liquidity and profitability.

4.3 Evaluation of the success

It is found that the merger could be an effective tool to improve product portfolio, growth

and expansion of the business. If effectively applied merger could bring huge financial

benefits to the company. However not only finance the other dimensions of business

are equally important in this modern age of information and technology. Therefore the

relationships with customers, employees and investors are also a key indicator in the

success of any merger. Therefore business must try to win the confidence of all the

stakeholders before making any strategic decision. Even though the small sections of

stakeholders were not satisfied with the merger between two major players in the health

and beauty sector, Group has successfully managed the balance of interest among its

stakeholders including shareholders, employee and management.

4.4 Recommendations

The report suggests that the Boots UK provide valid reason to merge with Alliance

which helped firms growth and e xpansion. It must also explore other possible ways ofexpansion into the emerging markets around the globe. The Group has done well in

terms of profitability, revenue and market share growth however it should seek possible

ways to increase its liquidity slightly by making effective use of inventory and assets.

Similarly, Group should look out for possible way to expand its product portfolio in

international market to secure future profitability. Additionally, non quantifiable issues

must remain as important as financial issues while expanding the business in another

market.


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Appendix

A. Returns on investment ratios:

Post merger 2007 Ratios Pre merger 2006

6.3% ROCE 13.98%

7.88% Return on shareholders

fund

21.13%

B. Key financial indicators:

Revenue - continuing operations 3,933 million (H1 05/06: 2,339million)Profit from operations - continuing 156 million (H1 05/06: 282 million)

Profit for the period attributable to equityshareholders 135 million (H1 05/06: 273 million)

Basic earnings per share - total 21.8 pence (H1 05/06: 38.2 pence)

Basic earnings per share - continuing 19.0 pence (H1 05/06: 33.9 pence)

C. Comparing financial performance before and after merger:

Results in 31 st March 2007 Combined results of year (2005/6)

Revenue up 3.6% to 14,608

Trading profit up 6.3% to 641

million

Underlying trading profit up 7.4%

to 641 million

Adjusted earnings up 11.5% to

467 million

Adjusted earnings per share up

11.4% to 48.7 pence

(2005/06 14,096 million)

(2005/06 603 million)

(2005/06 597 million2)

(2005/06 419 million)

(2005/06 43.7 pence)

D. Profitability ratios


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Ratios (%) 2007/8 2008/9 2009/10

Gross profit Margin 8.4 5.9 3.21

Operating Margin 4.51 4.07 4.2

Return On Equity 1.01 1.028 0.26

Return On Asset 1.2 0.6 0.8

ROCE 0.4 0.086 3.2

E. Liquidity ratios

Ratios 2007/8 2008/9 2009/10

Current Ratio 1.301 1.183 1.228

Quick Ratio 0.125 0.82 0.824

Cash ratio 0.124 0.111 0.085


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impact of merger on financial profitability

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