Merger & Acquisition Strategy and Motives

UNIVERSITAS KATOLIK INDONESIA Merger & Acquisition Strategy and Motives

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

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

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

Ex: Selling Private Business

Introduction: Popularity of M&A Motives and Strategies • Popular strategy among U.S. firms for many years • Can be used because of uncertainty in the competitive landscape • Popular as a means of growth • Should be used to increase firm value and lead to strategic competitiveness and above average returns

1. Growth Strategy

2. Synergy The primary motive should be the creation of synergy. Synergy value is created from economies of integrating a target and acquiring a company; the amount by which the value of the combined firm exceeds the sum value of the two individual firms.

synergistic reaction occurs in chemistry when two chemicals combine to produce a more potent total reaction than the sum of their separate effects. Synergy is ability of merged company to generate higher shareholders wealth than the standalone entities Popular definition: 1 + 1 = 3

Synergy The anticipated existence of synergistic benefits allows firms to incur the expenses of the acquisition process and still be able to afford to give target shareholders a premium for their shares. Synergy may allow the combined firm to appear to have a positive net acquisition value (NAV). VAB = the combined value of the two firms VB = the value of B VA = the value of A P = premium paid for B E = expenses of the acquisition process NAV = VAB − [VA + VB] − P − E NAV = [VAB − (VA + VB)] − (P + E)

The two main types of synergy operating synergy • revenue enhancements and • cost reductions. These revenue enhancements and efficiency gains or operating economies may be derived in horizontal or vertical mergers financial synergy the possibility that the cost of capital may be lowered by combining one or more companies.

Operating Synergies • Economies of Scale • Reducing capacity (consolidation in the number of firms in the industry) • Spreading fixed costs (increase size of firm so fixed costs per unit are decreased) • Geographic synergies (consolidation in regional disparate operations to operate on a national or international basis) • Economies of Scope • Combination of two activities reduces costs • Complementary Strengths • Combining the different relative strengths of the two firms creates a firm with both strengths that are complementary to one another.

Efficiency Increases • New management team will be more efficient and add more value than what the target now has. • The combined firm can make use of unused production/sales/marketing channel capacity Financing Synergy • Reduced cash flow variability • Increase in debt capacity • Reduction in average issuing costs • Fewer information problems

Tax Benefits • Make better use of tax deductions and credits • Use them before they lapse or expire (loss carry-back, carry-forward provisions) • Use of deduction in a higher tax bracket to obtain a large tax shield • Use of deductions to offset taxable income (non-operating capital losses offsetting taxable capital gains that the target firm was unable to use) Strategic Realignments • Permits new strategies that were not feasible for prior to the acquisition because of the acquisition of new management skills, connections to markets or people, and new products/services.

3. Managerial Motivations Managers may have their own motivations to pursue M&As. The two most common, are not necessarily in the best interest of the firm or shareholders, but do address common needs of managers • Increased firm size • Managers are often more highly rewarded financially for building a bigger business (compensation tied to assets under administration for example) • Many associate power and prestige with the size of the firm. • Reduced firm risk through diversification • Managers have an undiversified stake in the business (unlike shareholders who hold a diversified portfolio of investments and don’t need the firm to be diversified) and so they tend to dislike risk (volatility of sales and profits) • M&As can be used to diversify the company and reduce volatility (risk) that might concern managers.

4. Other Motives • Increased market power • Exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are lower than those of its competitors • Sources of market power include • Size of the firm • Resources and capabilities to compete in the market • Share of the market • Entails buying a competitor, a supplier, a distributor, or a business in a highly related industry

To increase market power firms use • Horizontal Acquisitions • Acquirer and acquired companies compete in the same industry • Vertical Acquisitions • Firm acquires a supplier or distributor of one or more of its goods or services; leads to additional controls over parts of the value chain • Related Acquisitions • Firm acquires another company in a highly related industry

Overcoming entry barriers into: • New product markets – product diversification • New international markets – geographic diversification • Cross-border acquisitions – those made between companies with headquarters in different country • Cost of new product development and increased speed to market • Can be used to gain access to new products and to current products that are new to the firm • Quick approach for entering markets (product and geographic)

Lower risk compared to developing new products • Easier to estimate acquisition outcomes versus internal development • Internal development has a very high failure rate • Increased diversification • Most common mode of diversification when entering new markets with new products • Hard to internally develop products that differ from current lines for markets in which a firm lacks experience • The more related the acquisition the higher the chances for success

Reshaping firm’s competitive scope • Can lessen a firms dependence on one or more products or markets • Learning and developing new capabilities • When you acquire a firm you also acquire any skills and capabilities that it has • Firms should seek to acquire companies with different but related and complementary capabilities in order to build their own knowledge base

Problems in Achieving Acquisition Success • Research suggests • 20% of all mergers and acquisitions are successful • 60% produce disappointing results • 20% are clear failures • Successful acquisitions generally involve • Having a well conceived strategy for selecting the right target firms • Not paying too high of a price premium • Employing an effective integration process • Retaining target firms human capital

Problems in Achieving Acquisition Success • Integration difficulties • Most important determinant of shareholder value creation • Culture, financial and control systems, working relationships • Status of newly acquired firm’s executives • Inadequate evaluation of target • Due diligence – process through which a potential acquirer evaluates a target firm for acquisition • Can result in paying excessive premium for target company

Problems in Achieving Acquisition Success Large or extraordinary debt Junk bonds: financing option whereby risky acquisitions are financed with money (debt) that provides a large potential return to lenders (bondholders) High debt can negatively effect the firm Increases the likelihood of bankruptcy Can lead to a downgrade in a firm’s credit rating May preclude needed investment in other activities that contribute to a firm’s long-term success R&D, human resource training, marketing 27

Problems in Achieving Acquisition Success • Inability to achieve synergy • Synergy: Value created by units exceeds value of units working independently • Achieved when the two firms' assets are complementary in unique ways • Yields a difficult-to-understand or imitate competitive advantage • Generates gains in shareholder wealth that they could not duplicate or exceed through their own portfolio diversification decisions • Private synergy: Occurs when the combination and integration of acquiring and acquired firms' assets yields capabilities and core competencies that could not be developed by combining and integrating the assets with any other company • Very difficult to create private synergy • Firms tend to underestimate costs and overestimate synergy

Problems in Achieving Acquisition Success • Too much diversification • Firms can become overdiversified which can lead to a decline in performance • Diversified firms must process more information of greater diversity • Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate performance of business units • Acquisitions may become substitutes for innovation

Problems in Achieving Acquisition Success • Managers overly focused on acquisitions • Necessary activities with an acquisition strategy include • Search for viable acquisition candidates • Complete effective due-diligence processes • Prepare for negotiations • Managing the integration process after the acquisition • Diverts attention from matters necessary for long-term competitive success (i.e., identifying other activities, interacting with important external stakeholders, or fixing fundamental internal problems) • A short-term perspective and greater risk aversion can result for target firm's managers

Problems in Achieving Acquisition Success • Too large • Larger size may lead to more bureaucratic controls • Bureaucratic controls • Formalized supervisory and behavioral rules and policies designed to ensure consistency of decisions and actions across different units of a firm – formalized controls decrease flexibility • Formalized controls often lead to relatively rigid and standardized managerial behavior • Additional costs may exceed the benefits of the economies of scale and additional market power • Firm may produce less innovation

Effective Acquisitions • Have complementary assets or resources • Friendly acquisitions facilitate integration of firms • Effective due-diligence process (assessment of target firm by acquirer, such as books, culture, etc.) • Financial slack (cash or a favorable debt position) • Merged firm maintains low to moderate debt position • High debt can… • Increase the likelihood of bankruptcy • Lead to a downgrade in the firm’s credit rating • Emphasis on innovation and R&D activities • Acquiring firm manages change well and is flexible and adaptable

Restructuring • Restructuring • A strategy through which a firm changes its set of businesses or financial structure • Can be the result of • A failed acquisition strategy • The majority of acquisitions do not enhance strategic competitiveness • 1/3 to 1/2 of all acquisitions are divested or spun-off • Changes in a firms internal and external environments • Poor organizational performance

Restructuring • 3 restructuring strategies • Downsizing • Reduction in number of firms’ employees (and possibly number of operating units) that may or may not change the composition of businesses in the company's portfolio • An intentional proactive management strategy • Downscoping • Refers to divesture, spin-off, or some other means of eliminating businesses that are unrelated to firms’ core businesses • Strategic refocusing on core businesses • Often includes downsizing

Restructuring • 3 restructuring strategies • Leveraged buyouts (LBOs) • One party buys all of a firm's assets in order to take the firm private (or no longer trade the firm's shares publicly) • Private equity firm: Firm that facilitates or engages in taking a public firm private • Three types of LBOs • Management buyouts • Employee buyouts • Whole-firm buyouts

Glosary: Restrukturisasi: Perubahankomposisibisnisperusahaandan/ataustrukturkeuangan. Downsizing : Penguranganjumlahkaryawan, kadangjumlah unit operasi, namun denganatautanpamengubahkomposisibisnisdalam portfolio perusahaan. Downscoping : Pelepasan, pengecilanataupenghapusanbisnis yang tidakberkaitan denganbisnisutamaperusahaan. Leveraged Buyout: Restrukturisasidimanamanajer Perusahaan dan/ataupihakeksternal pembeliseluruh asset bisnis, biasanyadibiayaihutang, dan membuatnyamenjadiperusahaanpribadi.

Merger & Acquisition Strategy and Motives