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Horizontal Scope

Horizontal Scope. James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB. Cross Media Rivalry Matrix. Exhibit 1. One of The Problems. Percent of Adults Reached. Daily Newspaper 1. 70%. 60%. 50%. Prime Time TV 2.

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Horizontal Scope

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  1. CH-ZWA645-005jsmGB Horizontal Scope James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

  2. Cross Media Rivalry Matrix

  3. Exhibit 1 One of The Problems Percent of Adults Reached Daily Newspaper1 70% 60% 50% Prime Time TV2 40% 30% Morning Drive Radio3 20% 10% Prime Time Cable4 0% 1996 1997 1998 Spring 1999 Fall 1999 Spring 2000 1 Average day readership 2 Average half hour 3 Average quarter hour 4 Average half hour Sources: Scarborough Research 1999 Release 2, Top 50 Market Report Prepared by NAA Research Department Note: Radio drive times reflect Mondy-Friday average quarter hour

  4. MOTIVATIONS FOR A MERGER AT TIME INC. • Slow growth in magazine division • Growth in cable networks • Time Inc.’s decision to enter the entertainment industry is being driven primarily by deregulation enabling vertical integration in media. • Vertical integration in being motivated by • Increasing risk of holdup in acquiring programming and outlets for Time’s HBO and Cinemax • Reduced risk of losses from growing film production costs due to guaranteed runs in self owned outlets • Multipoint competition

  5. TIME’S OFFER FOR WARNER • Time shareholders offer a 59% stake in the merged firm to acquire Warner (through a stock swap) • MVT = $109.125 * 57M shares = $6,220,125 M • MVW = $45.875 * 178.5M shares = $8,188.6875 M • Assumes share prices at the data of the announcement • Completion of the acquisition requires shareholder approval; combined T-W value = $14.4B

  6. EVALUATING THE WARNER OFFERIs Warner worth giving up 59% of Time Warner? • Market value of T-W is $14.4B • Time pays 0.59 x 14.4B = $8.496B for Warner • For Time shareholders to be indifferent between holding Time and holding 41% of T-W must have a value of $15.17B. • $6.22B x 100% = Value T-W x 41%; Value T-W = $15.17B • Time-Warner must create an additional $771M in synergies beyond their cumulative market values. • This requires about $75M in additional annual cash flows. • Assuming a perpetuity with a 10% discount rate.

  7. EVALUATING THE PARAMOUNT OFFERIs Warner worth giving up the Paramount Offer? • With Paramount’s offer, Times value increases to $9.975B • $175 x 57M shares = $9.98B • For Time shareholders to be indifferent between holding Time (cash from Paramount) and 41% of TimeWarner, T-W must have a value of $24.3 B. • $9.98B x 100% = VALUE (T-W) x 41%; VALUE (T-W) = $24.3B • Time-Warner must create an additional $9.929B in synergies for shareholders to justify spurning Paramount’s offer. • This requires almost $1B in additional annual cash flows. • Assuming a perpetuity with a 10% discount rate.

  8. ANALYTICAL ISSUES • Which stakeholder interests should be served? • Which interests are being served? (agency problems) • How do we value the options? • Where do we find the potential synergies?

  9. TIME’S DECISION • Time dropped its stock offer for Warner and paid a higher price ($13.1B; $72/share) for Warner with cash. • This avoided the need for shareholder approval of the merger that surely would have failed given the Paramount offer. • Paramount boosted its offer to $200 per share and indicated a willingness to go higher. • Paramount sued based on the business judgment rule and lost.

  10. CORPORATE-LEVEL STRATEGY- How big is the sandbox?The Scope of the Firm • Corporate-Level Strategy is action taken to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets. • Vertical Integration • Diversification • 1. Choose business areas to participate in • 2. Choose strategies to enter/exit business areas

  11. CREATING VALUE THROUGH DIVERSIFICATION • Diversification is a strategy attempting to improve long-run profitability by acquiring and managing new business lines. • Related diversification – value chain commonalities • Unrelated diversification – totally new business activities Different Value Chains Similar Value Chain Travel Insurance Food Softlines Hardlines

  12. EVALUATING DIVERSIFICATION • How can diversification create value? • Acquiring and restructuring • Transferring competencies • Economies of scale • Economies of scope • How can diversification dissipate value? • Bureaucratic Costs • Information overload • Coordination limitations • Pooling Risk • Managerial Opportunism (Agency Problems)

  13. CREATING VALUES THROUGH ECONOMIES OF SCALE • Eliminate operational redundancies • Reduce costs in common activities • Eliminate a competitor • Reduce competition and rivalry; increase prices through increased market power

  14. CREATING VALUE THROUGH ECONOMIES OF SCOPE • Operational Economies of Scope • Shared activities • Core competencies • Financial Economies of Scope • Internal capital allocation • Risk reduction • Tax advantages • Anticompetitive Economies of Scope • Multipoint competition • Exploiting market power

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