Maximizing Corporate Value through Mergers and Acquisitions

1. Chapter 10

2. The Strategic Management Process External Analysis Strategic Choice Strategy Implementation Competitive Advantage Mission Objectives Which Businesses to Enter? Internal Analysis • Vertical Integration Corporate Level Strategy • Diversification Mode of Entry? • Strategic Alliances • Mergers & Acquisitions

3. 1) such that the value of the corporate whole increases 2) such that businesses forming the corporate whole are worth more than they would be under independent ownership 3) that equity holders cannot create through portfolio investing Logic of Corporate Level Strategy Applies Corporate level strategy should create value:

4. Acquisitions Mergers Mergers & Acquisitions Defined • one firm buys another firm • two firms are combined on a relatively co-equal basis • the words are often used interchangeably even though they mean something very different • merger sounds more amicable, less threatening

5. Acquisitions Mergers Mergers & Acquisitions Defined • can be a controlling share, a majority, or all of the target firm’s stock • parent stocks are usually retired and new stock issued • name may be one of the parents’ or a combination • can be friendly or hostile • one of the parents usually emerges as the dominant management • usually done through a tender offer

6. Do Mergers and Acquisitions Create Value? The Logic Unrelated M&A Activity • there would be no expectation of value creation due to the lack of synergies between businesses • there might be value creation due to efficiencies from an internal capital market • there might be value creation due to the exploitation of a conglomerate discount • a corporate raider who buys and restructures firms

7. FTC Categories Mergers & Acquisitions Defined Types of M&A Activity Vertical » suppliers or customers Horizontal » competitors Related » complementary products Product Extension » complementary markets Market Extension Conglomerate » everything else Unrelated

8. Do Mergers and Acquisitions Create Value? The Logic Related M&A Activity • value creation would be expected due to synergies between divisions • economies of scale • economies of scope • transferring competencies • sharing infrastructure, etc.

9. Do Mergers and Acquisitions Create Value? The Empirical Evidence Research is based on stock market reaction to the announcement of M&A activity • this reflects the market’s assessment of the expected value of the merger or acquisition • these studies look at what happens to the price of both the acquirer’s stock and the target’s stock • thus, we can see who is capturing any expected value that may be created

10. • value increases by about 25% • no value created Do Mergers and Acquisitions Create Value? The Empirical Evidence M&A Activity creates value, on average, as follows: Target Firms Acquiring Firms • related M&A activity creates more value than unrelated M&A activity M&A activity creates value, but target firms capture it

11. April 2000: Wells Fargo offers to acquire First Security Bank for about $3 billion Expected Operational The Deal: Stock values were: Wells Fargo: $43.69 First Security: $15.50 .355 shares of WF for each share of FS stock Do Mergers and Acquisitions Create Value? Expected versus Operational Value Stock Price Market Cap. 12/1999 $40.44 $65.7 B 12/2000 $56.69 $95.2 B 12/2001 $43.60 $74.0 B 12/2002 $46.87 $82.0 B 12/2003 $58.89 $100.0 B 12/2004 $62.15 $105.0 B Wells Fargo: down $0.25 to $39.50 First Security: up $1.19 to $13.38

12. Survival Free Cash Flow Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? • avoid competitive disadvantage • avoid scale disadvantages • cash generating, normal return investment

13. Agency Problems Managerial Hubris Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? • managers benefit from increases in size • managers benefit from diversification • managers believe they can beat the odds

14. Above Normal Profits Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? • some M&A activity does generate above normal profits (expected and operational over the long run) • proposed M&A activity may satisfy the logic of corporate level strategy • managers may see economies that the market can’t see

15. Yes, if managers’ abilities meet VRIO criteria Managers may be good at doing ‘deals’ 2 Managers may be good at recognizing & exploiting potentially value-creating economies with other firms 1 Managers may be good at both 3 Competitive Advantage Can an M&A strategy generate sustained competitive advantage?

16. Private Economies Firm A Firm C Firm B Competitive Advantage Recognizing and Exploiting Economies of Scope • Firm C’s recognized value is $10,000 $12,000 • Firm A sees value of $12,000 in Firm C $10,000 • Firm A can earn a profit of $2,000 only if the economy remains private Bidders Target

17. Costly-to-Imitate Economies Firm A Firm C Firm B Competitive Advantage Recognizing and Exploiting Economies of Scope • if the economy between A & C is costly to imitate, it doesn’t matter if other firms know $12,000 $10,000 • Firm A can still earn a $2,000 profit Bidders Target

18. Unexpected Economies Firm A Firm C Firm B Competitive Advantage Recognizing and Exploiting Economies of Scope • Firm C has a market value of $10,000 $10,000 $12,000 • Firm A buys Firm C for $10,000 $10,000 • Firm C turns out to be worth $12,000 Bidders Target

19. M&A activity requires responses to these issues: Managers must decide on the level of integration: Implementation Issues Structure, Control, and Compensation • m-form structure is typically used • management controls & compensation policies are similar to those used in diversification strategies • target firm may remain somewhat autonomous • target firm may be completely integrated

20. • high levels of integration require greater cultural blending • cultural blending may be a matter of: • integration may be very costly, often unanticipated • the ability to integrate efficiently may be a source of competitive advantage Implementation Issues Cultural Differences • combining elements of both cultures • essentially replacing one culture with the other

21. • governments may constrain ownership by foreign firms • governments may restrict repatriation of profits • government labor policy may limit a firm’s ability to apply management practices to target firm International Issues Government Policy

22. M&A activity is a mode of entry for vertical integration and diversification strategies A firm’s M&A strategy should satisfy the logic of corporate level strategy M&A activity can create economic value at announcement, but target firms usually capture that value M&A activity can create value over the long term for the acquiring firm Summary