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Chapter 7 – Acquisitions & Restructuring Strategies

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Mergers, Acquisitions, & TakeoversMerger

A strategy through which two firms agree to integrate their operations on a relatively co-equal basis

Acquisition

A strategy through which one firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio

Takeover

A special type of acquisition when the target firm did not solicit the acquiring firm’s bid for outright ownership

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Friendly acquisition

The management of the target firm wants the firm to be acquired

Unfriendly acquisition (hostile takeover)

The management of the target firm does not want the firm to be acquired (direct negotiations with the firm’s owners; tender offer; bear hug)

Mergers, Acquisitions, & Takeovers

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Regional M&A Activity in 2006

North America$1.73 trillion

(+39%)

Latin Americaand the Caribbean

$127 billion(+295%)

Europe$1.43 trillion

(+38%)

Middle Eastand Africa$65 billion(+111%)

Japan$103.2 billion

(-36%)

Asia-Pacific$343 billion

(+49%)

Announced deals; percentage change compared to 2005Source: Thomson Financial.

World-wide$3.80 trillion

(+38%)

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Acquisitions

Increased market power

Avoiding excessive competition

Overcoming entry barriers

Learning and developing new

capabilities

7 Reasons for Acquisitions

•Horizontal•Cost-based synergies•Revenue-based synergies

•Vertical•Control over value chain

•Related

•Economies of scale•Differentiated products•Cross-border acquisitions

•New capabilities•Broaden knowledge base•Reduce inertia

•Reduce rivalry•Reduce dependence on• one market or product

Increased diversification

Lower riskcompared to developing

new products

Cost new product development/increased

speed to market

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Too large

Acquisitions

Inadequate evaluation of

target

Integration difficulties

Large or extraordinary debt

Inability to achieve synergy

Too much diversification

Managers overly focused on acquisitions

7 Problems in Acquisitions

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Inadequate Evaluation of TargetDue Diligence

The process of evaluating a target firm for acquisition

Ineffective due diligence may result in paying an excessive premium for the target company

Evaluation requires examining:

Financing of the intended transaction

Differences in culture between the firms

Tax consequences of the transaction

Actions necessary to meld the two workforces

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Example – Culture Clash

Grants seats based on seniority Discounted flight privileges employees

Grants seats based on a first-come, first-served basis

More traditional uniforms Uniforms More casual uniforms

Offers Coca Cola and Miller beer

In-flight beverages Serves Pepsi and Bud Light beer

Unions want to protect the seniority standings of their members

Seniority rankings Workers are concerned about being ranked as less senior than US Airways staffers

Source: The Wall Street Journal, March 7, 2006, B2.

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Integration DifficultiesIntegration challenges include:

Linking different financial and control systems

Melding two disparate corporate cultures

Building effective working relationships (particularly when management styles differ)

Resolving problems regarding the status of the newly acquired firm’s executives

Loss of key personnel weakens the acquired firm’s capabilities and reduces its value

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Large or Extraordinary DebtHigh debt can:

Increase the likelihood of bankruptcy

Lead to a downgrade of the firm’s credit rating

Preclude investment in activities that contribute to the firm’s long-term success such as:

• Research and development

• Human resource training

• Marketing

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Inability to Achieve SynergySynergy exists when assets are worth more when used in conjunction with each other than when they are used separately

Firms experience transaction costs when they use acquisition strategies to create synergy

Firms tend to underestimate indirect costs when evaluating a potential acquisition

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Too Much DiversificationDiversified 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 business units’ performances

Acquisitions may become substitutes for innovation

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Managers Overly Focused on AcquisitionsManagers invest substantial time and energy in acquisition strategies in:

Searching for viable acquisition candidates

Completing effective due-diligence processes

Preparing for negotiations

Managing the integration process after the acquisition is completed

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Managers in target firms operate in a state of virtual suspended animation during an acquisition

Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed

The acquisition process can create a short-term perspective and a greater risk aversion among executives in the target firm

Managers Overly Focused on Acquisitions – cont’d

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Too LargeAdditional costs of controls may exceed the benefits of the economies of scale and additional market power

Larger size may lead to more bureaucratic controls

Formalized controls often lead to relatively rigid and standardized managerial behavior

Firm may produce less innovation

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Attributes of Successful Acquisitions

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RestructuringA strategy through which a firm changes its set of businesses or financial structure

Failure of an acquisition strategy often precedes a restructuring strategy

Restructuring may occur because of changes in the external or internal environments

Restructuring strategies:

Downsizing

Downscoping

Leveraged buyouts

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Restructuring and Outcomes

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DownsizingA reduction in the number of a firm’s employees and sometimes in the number of its operating units

May or may not change the composition of businesses in the company’s portfolio

Typical reasons for downsizing:

Expectation of improved profitability from cost reductions

Desire or necessity for more efficient operations

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DownscopingA divestiture, spin-off, or other means of eliminating businesses unrelated to a firm’s core businesses

A set of actions that causes a firm to strategically refocus on its core businesses

May be accompanied by downsizing, but not eliminating key employees from its primary businesses

Firm can be more effectively managed by the top management team

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Leveraged Buyouts (LBOs)A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private

Significant amounts of debt are usually incurred to finance the buyout

Can correct for managerial mistakes

Managers making decisions that serve their own interests rather than those of shareholders

Can facilitate entrepreneurial efforts and strategic growth