Module 7, Quiz 7 - Sharon Watson PDF

Preview

Summary

Sharon Watson...

Description

Module 7: Mergers & Acquisitions Lecture ● Reasons for Acquisitions ○ In same industry/business which they already compete ■ Enter new geographic area ■ Buy market share ■ Eliminate competitor ■ Acquire existing manufacturing, distribution channels ■ Growth → economies of scale, market power ■ Speed -a lot faster than internal growth ○ In different industry/business ■ Enter faster growing industry ■ New set of customers ■ Overcome entry barriers ■ Buy tech or know how ■ Leverage existing skills in new businesses ■ Speed -a lot faster to grow ● Basic Types of M&As ○ “Not all M&As are alike and that matters” -Joseph Bower ■ 1,000s of M&As lumped together represent very different strategic activities ■ Identified 5 basic types based on their strategic intent ■ M&As should be done for a specific strategic reason ●

The Overcapacity M&A ○ In industries with substantial overcapacity ■ Mature, capital intensive, high exit barriers ○ Acquire, close inefficient plants, layoff managers and workers, combine administration ○ Result: greater market share, efficiency, market clout, decreased industry capacity ○ Rationale: reduce industry capacity

●

The Geographic Roll-up ○ In fragmented industries with large number of local competitors ○ Expand geographically by acquiring (rolling up) companies in adjacent territories ex: banking industry, expanding and rolling up others now more nationwide banking system ■ Pharmacy industry -far fewer local pharmacies as roll up of local ones and now more nationwide companies ○ Operations may stay local if relationships with local customers are important ○ Result: ■ Decreased operating costs (economies of scale) ■ Increased value for customers ■ Industry consolidations- building of industry giants

●

Product or Market Extension M&A ○ To extend product line or geographic reach to entirely new market such as international market ○ Often between large companies ○ Success depends on relative sizes of the two companies, can be difficult to impose acquiring company on larger well established companies ○ Key : the farther from core product/market, more difficult ■ Integration difficulties ■ *Key to stay relatively close to core product or core market because becomes more difficult the farther apart they are ○ Ex: whirlpool - acquired phillips in europe, same industry but different geographic market =market extension, and continued to acquire till become global competitor ○ Ex: Dell- series of product extension acquisitions = acquires Boomi (cloud), compellent (storage), AppAssure (backup & storage), Quest software (enterprise solutions), Credant Tech (data protection solutions)

●

The M&A as R&D ○ Substitute for in house R&D ○ To build position quickly in fast life cycle industry -such as high tech, biotech industries ○ Cheaper to buy than develop product in house ○ Keys: buy 1st rate technology to stay ahead of curve ○ Keep people you ‘buy’ because within these people acquired knowledge presides ■ Keep people happy so they stay -knowledge resources ■ Cultural due diligence need to assimilate quickly ○ Ex: pharmaceutical industry ○ Ex: tech companies such as google and facebook

●

Industry Convergence M&A ○ Combine two industries in attempt to create a new industry/business model ○ Looks for synergies between resources from different industries that can be combined in a new way ○ Can be a big galbe because don’t know if it will work -creation of a new model ■ Ex: Disney has been successful combining companies to create multi media entertainment company -ABC, animation studios, ESPN- combined in a unique way to create a creative industry convergences ■ Ex: Time Warner and AOL -to combine content with aol online distribution capability -because of major cultural differences between companies it didn’t work out well at all ○ Big management challenge- need to integrate very different businesses to achieve needed synergy

●

Evaluating Bower’s Categories

○

○

Are they mutually exclusive? ■ Google’s acquisition of Motorola -production extension, or M&A as R&D? ● Can be multiple strategic reasons Are they exhaustive? ■ there other types of M&As that don’t fit these 5 categories ■ Main point to remember that M&As should be done for specific strategic reason not just because management wanted to make a deal

●

Many Acquisitions Fail ○ Over half of acquisitions made determined to be unsuccessful ○ Integration difficulties ■ Corporate culture and management style -National Culture ■ Inability of achieve synergies -over estimated potential synergies ■ Large debt -impacts credit and investment opportunities, restricts ability for future acquisitions and ability to grow core business as lack funds ■ Over diversified -own too many businesses to run effectively ■ Inadequate due diligence- poor evaluation of target, buying target’s problems too

●

3 Tests of an Acquisition 1. The Attractiveness Test a. Industry attractiveness of target company b. Attractiveness of target company in its industry 2. The Cost of Entry Test a. Valuation b. Price paid for the acquisition c. The Earnings Multiple i. Acquisition Price = X * Earnings of target co. 1. X=Earning Multiple 2. X= Acquisition Price/Target Earnings (EBITDA) ii. What is a good X? 1. Look at comparable acquisitions in similar target company, same industry 2. General rule of thumb (but depends on market): a. If X 12 - High but look at comparables! 3. The Better-Off Test a. Better off together than apart? b. Synergies between acquiring and target company?

●

Attributes of Successful Acquisitions

○ ○ ○ ○ ○

●

Pass 3 tests of an acquisition Target has complementary assets Friendly than hostile takeovers Careful selection and negotiation -avoid overpayment Acquirer has adequate finances ~low to moderate debt in order to take more debt for the acquisition ○ Experience with organizational change and or other acquisitions ○ Communication during integration Mergers & Acquisitions ○ Can be an effective way to: ■ Grow a business, enter new markets, enter new business ○ Occur across all sectors ○ But also very risky ○ Successful acquisitions require: ■ Careful analysis and evaluation beforehand and effective integration afterward

Quiz: 1. Mergers and acquisitions a. All too frequently do not produce the hoped-for outcomes 2. Acquisition of an existing business is an attractive strategy option for entering a promising new industry because it a. Is an effective way to hurdle entry barriers, is usually quicker than trying to launch a new start-up operations and allows the acquirer to move directly to the task of building a strong position in the target industry 3. What is NOT one of the reasons why many acquisitions fail? a. The acquirer is carrying too little long term debt on its balance sheet due to overpayment 4. All of the following are attributes of most successful acquisitions EXCEPT a. The target has valuable technology 5. Industry convergences M&As a. Are highly risky because they involve the trying to blend companies operating in different industries 6. Which of the following is the best example of an M&A as R&D a. Facebook’s acquisition of Instagram, an online photo sharing service? b. *not the dupont acquisition 7. The Geographic Roll-up M&A type usually occurs a. In fragmented industries with local competitors 8. To test whether a particular acquisition move has good prospects for creating added shareholder value, corporate strategist should use a. The attractiveness test, the cost of entry test, and the better off test 9. The 3 test for judging whether a particular acquisition can create value for shareholders are a. The attractiveness test, the cost of entry test and the better off test

10. The better off test for evaluating an acquisition involves a. Evaluating whether the move offers potential for the company’s existing businesses and new businesses to perform better together under a single corporate umbrella

Eccles article: Are you paying too much for that acquisition? ● Key is knowing what your top price is and having the discipline to stick to it ● Many acquisitions fail: irrational exuberance about the strategic importance of the deal, enthusiasm built up during excitement of negotiations, weak integration skills, acquiring company paid too much ● Ex: Quaker Oats’ acquisition of Snapple ~ 1.7 billion purchase, some industry analysts estimated $1billion too much, there were then problems with implementation, downturn in market, performance problem and 28 months later Quaker sold Snapple to Triarc Companies for less than 20% of what it had paid ● Researched 75 senior executives from 40 companies -learned there’s a systematic way for senior managers to think about pricing acquisitions, even experienced acquirers get too attached to a deal and when that happens essential to have organizational disciplines in place that will rein in the emotion ●

●

No single, Correct Price ○ Most deals are too rich, executives get caught up in the excitement of the race and offer more than they should ○ Most deals do not create value and market is fairly good at predicting which ones will and which ones won’t ○ Deals with low premiums often fail and vice versa -list of 20 deals ~size of premium does not always correlate success ○ *know maximum price you can pay and discipline to pay not a penny more ○ The right price is relative and different companies can pay different things, no single correct price for an acquisition ○ Ex: AirTouch -Bell Atlantic and Vodafone ■ ~market had negative reaction to Bell Atlantic's modest premium and positive reaction to Vodafone’s high premium because… ■ Airtouch created more valuable synergies for Vodafone -first complete pan european cellular telephone company that would be able to save on roaming fees paid to other cellular operators and interconnection feeds paid to fix line operators, savings from high volume purchases of equipment ■ while Bell Atlantic had far less potential ■ This example shows vast differences between price one company can pay for an acquisition and price another can pay, when tempted to ignore financial case and overpay to acquire direct competitors is nearly always a mistake Pricing the Deal

○

●

●

Concepts of value: ■ Intrinsic Value: net present value of expected future cash flows completely independent of any acquisition. That assumes company continues under current management with whatever revenue growth and performance improvements have already been anticipated by the market ■ Market Value: market may add a premium to reflect likelihood that an offer for the company will be made (or a higher offer will be tendered than one currently on the table ● Same as “Current market capitalization” -same as share price, reflects market participants valuation of the company ■ Purchase Price: “anticipated takeout value” price a bidder anticipates having to pay to be accepted by target shareholders ■ Synergy Value: net present value of cash flows that will result from improvements made when companies are combined. Improvements above and beyond the those the market already anticipates each company would make if acquisition didn’t occur ■ Value Gap: difference between the intrinsic value and purchase price ● Acquirer and target company know purchase price will be higher than intrinsic value -buyer will most likely pay a premium ● That premium allocates some of future benefits of combination to target shareholders, absent a premium most target shareholders would refuse to sell so managers need to figure out how large a value gap their company can bridge through synergies for acquirer to calculate how high price can be pushed & more than 1 potential acquirer competition pressures price up even higher

Calculating Synergy Value ○ Keys to success in pricing an acquisition 1. Make sure those individuals calculating a target’s synergy value are rigorous and they work with realistic assumptions 2. Ensure the acquirer pays no more than it should Acquirers base their calculations on 5 types of synergies -value of each depends on particular skills and circumstances of acquirer 1. Cost savings a. “Hard syngergies” -level of certainty they will be achieved is quite high, come from eliminating jobs, facilities and related expenses that are no longer needed when functions are consolidates or come from economies of scale purchasing b. Cost savings large when company acquires another from isame industry in same country c. Overly optimistic projections do occur so need to look carefully at numbers presented with & be aware of 3 common problems: i. 1) analysts may overlook fact that definitions of cost categories vary from company to company so may appear

there are more easily eliminated costs than turn out to be 2) costs are incurred in different places depending on structure of each company so may assume can eliminate more than they can because essential work getting done in unexpected places 3) is easier to eliminate positions that the people who fill them talented person must be shifted elsewhere in company ~200 jobs cut doesn’t mean 200 salaries cut d. Often underestimate how long it will take to realize cost savings because plan specifying how integration will processed are insufficiently detailed, or because people both companies are resistant to change and delay making tough cost cutting decisions 2. Revenue enhancements a. Notoriously hard to estimate because involve external variables out of control such as consumer reactions-sometimes possible for acquirer and target to achieve higher level of sales growth together though b. Some wise companies don’t include them when calculating synergy value because so hard to predict -they may model it but never factor it in c. “Soft synergies” discounts heavily in calculations of synergy value d. But revenue enhancements can create real value ~taking advantage of distribution channels and together making more sales e. Can also occur when the bigger, post acquisition company gains sufficient critical mass to attract revenue neither would have been able to achieve alone 3. Process improvements a. When managers transfer best practices and core competencies from one company to another that results in both cost savings and revenue enhancements b. Product development process can also be improved so new products can be produced at lower cost and get to market faster c. Hard to forecast accurately as most calculations of synergy value occur under bad conditions -time pressure, limited information, confidentiality 4. Financial engineering a. Can increase size of a company to a level where there are clear economic benefits to pooling working capital finance requirements and surplus cash as well as netting currency positions b. A transaction may allow a company to refinance the target’s debt at the acquirer’s more favorable borrowing rate without affecting credit rating c. Not a good reason to do a deal is thinking if you borrow cash to

finance a transaction, will reduce weighted average cost of capital --if either acquirer or target company could afford to take on more debt, each could have borrowed it on its own 5. Tax benefits a. Very difficult to asses b. “Tax structuring” -makes deal possible, avoid as many one time tax costs as possible which may include capital and transfer duties, change of ownership provisions that can trigger capital gains or prevent tax losses from being carried forward c. “Take engineering” -ensures overall tax rate of combined company is equal to or lower than blended tax rates of two companies before the deal ~ shouldn’t make deals on these benefits alone d. Tax related synergies: Transfer of brands and other intellectual property to a low tax subsidiary, placing shared services and central purchasing in tax advantaged locations, reorganizing within a country to pool taxes, pushing down debt into high tax subsidiaries, obtaining tax benefits neither company could have realized on its own ●

On Doing Deals for Strategic Reasons ○ Despite compelling strategic reasons, if the numbers don’t work, it’s not a good deal ○ Emotional Atmosphere -many deals happen because managers fall in love with the idea of the deal ○ Analyze the strategic reasons themselves as rigorously as you can if trying to convince the deal is good when numbers don’t work with strong, persuasive skeptics within acquisition team ○ Introduce more sophisticated analytical techniques ~ real-options valuation can help managers quantify potential but not definite, future benefits -can help managers identify decisions they will have to make about future investments or other courses of action when those decisions need to be made

●

Organizational Discipline and Pricing ○ Many companies don’t let negotiating manager set price as fear become too personally invested and overpay -higher level manager sets price ceiling before negotiations begin and to go over must get explicitly approval ○ Strict project discipline in companies pays off and gives more successful acquisitions ■ --ex: must meet certain requirements for awards to managers or Borelli’s has 3 criteria must meet or very strict and won’t do the deal -left them in a better position long term to take advantage of better opportunities ○ Some companies routinely review each completed acquisition to better understand what makes for success o r failure ○ Some companies keep data on performance of previous acquisitions to help

price future deals --nearly all study or used some kind of post transaction monitoring process to track how well acquisition or merger was performing relative to expectations and to draw lessons for future...