Chapter 10 Studying Mergers and Acquisitions

1. Chapter 10Studying Mergers and Acquisitions

2. 1 • Explain the motivations behind acquisitions and show how they’ve changed over time 2 • Explain why mergers and acquisitions are important vehicles of corporate strategy 3 • Identify the various types of acquisitions 4 • Understand how the pricing of acquisitions affects the realization of synergies 5 • Outline the alternative ways to integrate acquisition and explain the implementation process 6 • Discuss the characteristics of acquisitions in different industry contexts OBJECTIVES

3. THE eBAY-PAYPAL ACQUISITION • The partnership made sense … • … but would it work? ? • Rely on transaction-based revenue • No inventory or warehousing • No sales force • Can we recoup the $250 millionpremium we paid with savingsand revenue growth?

4. Payer • Payee THE eBAY-PAYPAL BUSINESS MODELS • eBay business model • PayPal business model • eBay • PayPal • Posts auction, pays fee • Wins auction • Receives money(pays fee) • Sends money • Contract and payment occur between buyer and seller • Seller • Buyer • PayPal’s revenue comes from float in the personal accounts and fees for pre-mier and business accounts • eBay revenue comes from sellers paying auction posting fees

5. MERGER VS. ACQUISITION • A • B • C • The consolidation or combinationof one firm with another • Merger + • A • B • A • The purchase of one firm by another so that ownership transfers • Acquisition + • The “merger”of Daimler with Chryslerin 1997 is considered by manyto have been an acquisitionin disguise

6. MOTIVES FOR MERGERS AND ACQUISITIONS • Managerial self-interest • Hubris • Synergy • Sometimes termed “Managerialism”, manager can conceivably make acquisitions-and even willingly overpay for them-to maximize their own interests at the expense of shareholder wealth • Managers may make mis-taken valuation and have unwarranted confidence in their valuation and in their ability to create value because of pride, over-confidence, or arrogance • Managers may believe that the value of the firms combined can be greater than the sum of the two independently • Reduced threats • Increased market power and access • Realized cost savings • Increased financial strength • Sharing and leveraging capabilities

7. Arenas • Economiclogic • Staging • Vehicles • Differentiators M&A – A VEHICLE THAT IMPACTS ALL ELEMENTS OF THE STRATEGY DIAMOND • M&A and the Strategy DiamondWhile mergers and acquisition are explicitly vehicles of strategy, they have major implications for arenas staging, and economic logic as well Source: Adapted from Hambrick and Fredrickson, “Are You Sure You Have a Strategy?” Academy of Management Executive 15:4 (2001) 48-59

8. US ACQUISITION ACTIVITY • Value of transactions ($, 2003) • Number of transactions • Value of transactions($, 2003) • No. of transactions Source: Data compiled from SDC Platinum, a product of Thompson Financial

9. 1972 • 1994 • 1997 • 2000 UPs AND DOWNs AT SNAPPLE 1` • In 1972, brothers-in-law Leonard Marsh and Hyman Golden and Arnold Greenberg, Marsh’s childhood friend, founded a business called the Unadulterated Food Corporation and began selling juice in Queens. The name Snapple was coined while trying to develop an apple soda. In 1987, Snapple introduced iced teas with fun names and flavors and enlisted (2) controversial radio personalities, Howard Stern and Rush Limbaugh, to promote them • Cadbury Schweppes buys Snapple from Triarc for $1.45 billion. Snapple is now part of the very successful America’s Beverage division, which includes 7up, Dr. Pepper, Mystic, and Mott’s juices, among other brands. Has Snapple found its home? • After sizzling success,Snapple is sold to Quakerfor $1.8 billion • Fewer than three years later, Quaker throws in the towel and sells Snapple for $300 million to Triarc

10. BENEFITS AND DRAWBACK OF ACQUISITIONS OVER INTERNAL DEVELOPMENT • More expensive • Inherit adjunct businesses • Cannot spread commitment over several years (one-time, all-or-nothing decision) • Potential for organizational conflict + • Speed • Critical Mass • Access to complementary assets • Reduced competition

11. CLASSIFICATION OF ACQUISITIONS • Product/MarketExtension • OvercapacityM&A • Industry Convergence • Roll-up-M&A • M&A as R&D • Example • DaimlerChryslermerger • Service Corporation International more than 100 acquisitions of funeral homes • Pepsi’s acquisition of Gatorade • Intel’s dozens of acquisitions of small high tech companies • AOL’s acquisition Time-Warner • Objectives • Eliminating capacity, gaining market share, and increasing efficiency • Efficiency of larger operations (e.g., economies of scale, superior management) • Synergy of similar but expanded product lines of geographic markets • Short cut innovation by buying it from small companies • Anticipation of new industry emerging; culling resources from firms in multiple industries whose boundaries are eroding • Percent ofall M&A deals • 37% • 9% • 36% • 1% • 4% Source: J.L. bower, “ Not All M&As Are Alike – and That Matters,” Harvard Business Review 79:3 (2001), 92-101

12. PRICING MERGERS AND ACQUISITIONS • Target value • Synergy value • Current market capitalization of firm (i.e., what stock market believe company is worth ) • Market value of two firms combined with synergies taken into account • Market value • Fundamental value of cash flows • Fundamental value of cash flows of two firms with synergies taken into account • Intrinsic value

13. 130 PREMIUMS • Percent of market value • 145 • ~ 30 - 45% • 100 • Average pre-miums in US range:30 - 45% • Market value • Acquisitionprice

14. THE SYNERGY TRAP • Acquisition premiums • Create two problems for managers • The longer it takes to implement performance improvements, the more likely the acquisition will fail • Premiums increase the level of returns the combined businesses must extract

15. Years until synergies are implemented • Cost of capital • 10% • 15% • 20% • “How much incremental net income must you generate if you implement synergies in two years? • What if they take five years to implement? • eBay paida $250 million premium for PayPal, nowthey must earn that premium back • 0 • 0.100 • 0.150 • 0.200 • 1 • 0.110 • 0.173 • 0.240 • 2 • 0.121 • 0.198 • 0.288 • 3 • 0.133 • 0.228 • 0.346 • 4 • 0.146 • 0.262 • 0.415 • 5 • 0.161 • 0.302 • 0.498 HOW WOULD YOU DO THAT? – PAYPAL ACQUISITION

16. PAYING TOO MUCH • “The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do… (A) too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business development “

17. THE ACQUISITION PROCESS • A process perspective • Results • Acquisitionintegration • Justification due diligence, negotiation • Idea • Decision-makingprocess problems • Integration process problems Source: Adapted from P.C. Haspeslagh and D.B. Jemison, Managing Acquisitions: Creating Value Through Corporate Renewal (New York Free Press, 1991), 42

18. ACQUISITION SCREENING • “Soft-fit” acquisition screening by Cisco systems • Screening criteria • Means of achieving criteria • Offer both short- and long-term win-wins for Cisco acquired company • Have complementary technology that fills a need in Cisco’s core product space • Have a technology that can be delivered through Cisco’s existing distribution channels • Have a technology and products that can be supported by Cisco's support organization • Is able to leverage Cisco’s existing infrastructure and resource base to increase its overall value • Share a common vision and chemistry with Cisco • Have a similar understanding and vision of the market • Have a similar culture • Have a similar risk-taking style • Be located (preferably) in Silicon Valley or near one of Cisco’s remote sites • Have a company headquarters and most manufacturing facilities close to one of Cisco's main sites

19. ABSORPTION • Need for strategic interdependence • Low • High • High • Preservation • Symbiosis • Need for organizational autonomy • Low • Holding • Absorption • Acquiring company completely absorbs the target company. If the target company is large, this can take time (e.g., Franklin Quest’s acquisition of the Covey Leadership Center to create Franklin Covey)

20. PRESERVATION • Need for strategic interdependence • Low • High • High • Preservation • Symbiosis • Need for organizational autonomy • Low • Holding • Absorption • The acquiring company makes very few changes to the target , and instead learned from it in preparation for future growth (e.g., many of Wal-Mart’s early international acquisitions)

21. HOLDING • Need for strategic interdependence • Low • High • High • Preservation • Symbiosis • Need for organizational autonomy • Low • Holding • Absorption • The acquiring company allows little autonomy - yet does not integrate the target into its businesses (e.g., Bank One’s acquisitions of local banks )

22. SYMBIOSIS • Need for strategic interdependence • Low • High • High • Preservation • Symbiosis • Need for organizational autonomy • Low • Holding • Absorption • The acquiring company integrates the target in order to achieve synergies but allows for autonomy, for example to retain and motivate employees. This is possibly the most difficult to implement (e.g., Cisco's acquisitions which cost the firm $1 million per employee on average)

23. It’s a continual process, not an event • Start the integration process long before the deal is closed • Integration management is a full-time job • Many successful acquirers appoint an “integration manager” becauseintegration is too much work for acting managers to add to their workloads • Key decisions should be made swiftly • Speed is of the essence because of the cost and time value of money • Integration should address technical and cultural issues • Most managers focus on technical issues only. This is a mistake KEY LESSONS FOR IMPLEMENTING M & As

24. Introduction • Growth • Maturity • M&As tend to be R&D and product-related • M&As tend to be for acquiring products that are proven and gaining acceptance • M&As primarily for dealing with over capacity in the industry M&As AND INDUSTRY LIFE CYCLE

25. Technological change • Demographic change • Geopolitical change • Trade liberalization • Deregulation M&As IN DYNAMIC CONTEXTS • Cisco and Microsoft both use acquisitions to ensure they maintain their strong competitive positions • When the Tribune Company merged with Times-Mirror in 2000, it acquired Spanish-language “Hoy” to target the growing U.S Hispanic market • IBM divested its PC division to a Chinese company as that country emerges • Wal-Mart acquired Mexican retail giant, Cifra, in wake of NAFTA • AT&T divested local operations into “Baby Bells” and set off a state of almost constant M&A

26. 1 • Explain the motivations behind acquisitions and show how they’ve changed over time 2 • Explain why mergers and acquisitions are important vehicles of corporate strategy 3 • Identify the various types of acquisitions 4 • Understand how the pricing of acquisitions affects the realization of synergies 5 • Outline the alternative ways to integrate acquisition and explain the implementation process 6 • Discuss the characteristics of acquisitions in different industry contexts SUMMARY

27. EXERCISES • CLASS EXERCISE • Identify a company that has recently undertaken an acquisition. Study the terms of the deal and identify to the extent possible the intrinsic value of the target, its market value, and the acquisition price. What was the acquisition premium? Calculate the required performance improvements with different assumptions as to how long it will take to implement them, say one, three, and five years. Is this believable? • GROUP EXERCISE • Pick a firm of interest to your group. Identify potential acquisition candidates. Explain why these companies would make sense as an acquisition target. Evaluate and describe possible implementation barriers to this acquisition. • POST ACQUISITION EXERCISE • Yincom and Yangnet