Acquisition & Restructuring

Strategies

Acquisition & Restructuring

Strategies

Chapter SevenChapter Seven

BA 495.009BA 495.009

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Today’s AgendaToday’s Agenda

• Background on Mergers & AcquisitionsBackground on Mergers & Acquisitions• Reasons for AcquisitionsReasons for Acquisitions• Problems in Achieving Acquisition SuccessProblems in Achieving Acquisition Success• Effective AcquisitionsEffective Acquisitions• RestructuringRestructuring• KLC-KinderCare AcquisitionKLC-KinderCare Acquisition• Wrap-upWrap-up

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Background on Mergers & Acquisitions

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Trends in M&ATrends in M&A

• Mergers & Acquisitions peaked in 2000 Mergers & Acquisitions peaked in 2000 at about at about $3.4B$3.4B and fell to about $1.75B in 2001 and fell to about $1.75B in 2001

• The The global volume of announced acquisition global volume of announced acquisition agreements was up 41% from 2003 to $1.95 agreements was up 41% from 2003 to $1.95 trillion for 2004trillion for 2004

• 40 – 45% of acquisitions in recent years have 40 – 45% of acquisitions in recent years have been made across country bordersbeen made across country borders

• In In In the acquisition boom between 1998 and In the acquisition boom between 1998 and 2000, acquiring firm shareholders experienced 2000, acquiring firm shareholders experienced significant lossessignificant losses

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Mergers, Acquisitions, and Takeovers: Mergers, Acquisitions, and Takeovers: What are the Differences?What are the Differences?• MergerMerger

Two firms agree to integrate their operations on a Two firms agree to integrate their operations on a relatively co-equal basis.relatively co-equal basis.

• AcquisitionAcquisition One firm buys a controlling, or 100% interest in One firm buys a controlling, or 100% interest in

another firm with the intent of making the acquired another firm with the intent of making the acquired firm a subsidiary business within its portfolio.firm a subsidiary business within its portfolio.

• TakeoverTakeover A special type of acquisition when the target firm did A special type of acquisition when the target firm did

not solicit the acquiring firm’s bid for outright not solicit the acquiring firm’s bid for outright ownership.ownership.

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Reasons for Acquisitions

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Reasons for AcquisitionsReasons for Acquisitions

Learning andLearning anddevelopingdeveloping

new capabilitiesnew capabilities

Reshaping firm’sReshaping firm’scompetitive scopecompetitive scope

IncreasedIncreaseddiversificationdiversification

Cost of newCost of newproduct product

developmentdevelopment

OvercomingOvercomingentry barriersentry barriers

Increase speedIncrease speedto marketto market

IncreasedIncreasedmarket powermarket power

Making anMaking anAcquisitionAcquisition

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Acquisitions: Increased Market PowerAcquisitions: Increased Market Power

• Market power is increased when:Market power is increased when: There is the ability to sell goods or services above There is the ability to sell goods or services above

competitive levels.competitive levels. Costs of primary or support activities are below those Costs of primary or support activities are below those

of competitors.of competitors. A firm’s size, resources and capabilities gives it a A firm’s size, resources and capabilities gives it a

superior ability to compete.superior ability to compete.

• Acquisitions intended to increase market power Acquisitions intended to increase market power are subject to:are subject to: Regulatory reviewRegulatory review Analysis by financial marketsAnalysis by financial markets

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Acquisitions: Increased Market PowerAcquisitions: Increased Market Power

• Market power is increased by:Market power is increased by:

Horizontal acquisitions:Horizontal acquisitions: other firms in the same other firms in the same industryindustry

Vertical acquisitions:Vertical acquisitions: suppliers or distributors of the suppliers or distributors of the acquiring firm acquiring firm

Related acquisitions:Related acquisitions: firms in related industries firms in related industries

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Market Power AcquisitionsMarket Power Acquisitions

• Acquisition of a company in the Acquisition of a company in the same industry in which the same industry in which the acquiring firm competes acquiring firm competes increases a firm’s market power increases a firm’s market power by exploiting:by exploiting:

Cost-based synergiesCost-based synergies

Revenue-based synergiesRevenue-based synergies

• Acquisitions with similar Acquisitions with similar characteristics result in higher characteristics result in higher performance than those with performance than those with dissimilar characteristics.dissimilar characteristics.

Horizontal Horizontal AcquisitionAcquisition

ss

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Market Power AcquisitionsMarket Power Acquisitions

• Acquisition of a supplier or Acquisition of a supplier or distributor of one or more of the distributor of one or more of the firm’s goods or servicesfirm’s goods or services

Increases a firm’s market Increases a firm’s market power by controlling additional power by controlling additional parts of the value chain.parts of the value chain.

Horizontal Horizontal AcquisitionAcquisition

ssVertical Vertical

AcquisitionAcquisitionss

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Market Power Acquisitions (cont’d)Market Power Acquisitions (cont’d)

• Acquisition of a company in a Acquisition of a company in a highly related industryhighly related industry

Acquisition target is typically Acquisition target is typically a complementor, not a a complementor, not a competitor.competitor.

Horizontal Horizontal AcquisitionAcquisition

ssVertical Vertical

AcquisitionAcquisitionss

Related Related AcquisitionAcquisition

ss

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Acquisitions: Overcoming Entry BarriersAcquisitions: Overcoming Entry Barriers• Entry BarriersEntry Barriers

Factors associated with the market or with the firms operating in Factors associated with the market or with the firms operating in it that increase the expense and difficulty faced by new ventures it that increase the expense and difficulty faced by new ventures trying to enter that markettrying to enter that market

• Economies of scaleEconomies of scale

• Brand loyaltyBrand loyalty

• Distribution channelsDistribution channels

• Cross-Border AcquisitionsCross-Border Acquisitions Acquisitions made between companies with headquarters in Acquisitions made between companies with headquarters in

different countriesdifferent countries• Fastest way to enter new marketsFastest way to enter new markets• Provide more control over foreign operations than utilizing alliances• Can be difficult to negotiate and operate because of the differences

in foreign cultures

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Acquisitions: Cost of New-Product Acquisitions: Cost of New-Product Development and Increased Speed to Development and Increased Speed to MarketMarket• Internal development of new products is often Internal development of new products is often

perceived as high-risk activity.perceived as high-risk activity.

Acquisitions allow a firm to gain access to new and Acquisitions allow a firm to gain access to new and current products that are new to the firm.current products that are new to the firm.

Returns are more predictable because of the acquired Returns are more predictable because of the acquired firms’ experience with the products.firms’ experience with the products.

• Must be wary of acquisitions replacing need for Must be wary of acquisitions replacing need for innovation in the firm.innovation in the firm.

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Acquisitions: Increased DiversificationAcquisitions: Increased Diversification

• Using acquisitions to diversify a firm is the Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio quickest and easiest way to change its portfolio of businesses.of businesses.

• Both Both relatedrelated diversification and diversification and unrelatedunrelated diversification strategies can be implemented diversification strategies can be implemented through acquisitions.through acquisitions.

• The The more relatedmore related the acquired firm is to the the acquired firm is to the acquiring firm, acquiring firm, the greaterthe greater is the probability that is the probability that the acquisition will be successful.the acquisition will be successful.

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Acquisitions: Reshaping the Firm’s Acquisitions: Reshaping the Firm’s Competitive ScopeCompetitive Scope

• An acquisition can:An acquisition can:

Reduce the negative effect of an intense rivalry on a Reduce the negative effect of an intense rivalry on a firm’s financial performance.firm’s financial performance.

Reduce a firm’s dependence on one or more products Reduce a firm’s dependence on one or more products or markets.or markets.

• Reducing a company’s dependence on specific Reducing a company’s dependence on specific markets alters the firm’s competitive scope.markets alters the firm’s competitive scope.

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Acquisitions: Learning and Developing Acquisitions: Learning and Developing New CapabilitiesNew Capabilities• An acquiring firm can gain capabilities that the An acquiring firm can gain capabilities that the

firm does not currently possess:firm does not currently possess:

Special technological capabilitySpecial technological capability

A broader knowledge baseA broader knowledge base

Reduced inertiaReduced inertia

• Firms should acquire other firms with different Firms should acquire other firms with different but related and complementary capabilities in but related and complementary capabilities in order to build their own knowledge base.order to build their own knowledge base.

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Problems in Achieving Acquisition Success

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Problems in Achieving Acquisition Problems in Achieving Acquisition SuccessSuccess

Too largeToo large

Managers Managers overly focused onoverly focused on

acquisitionsacquisitionsExtraordinary debtExtraordinary debt

InadequateInadequatetarget evaluationtarget evaluation

Too muchToo muchdiversificationdiversification

Inability toInability toachieve synergyachieve synergy

IntegrationIntegrationdifficultiesdifficulties

ProblemsProblemswithwith

AcquisitionsAcquisitions

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Integration DifficultiesSuccess: Integration Difficulties• Integration challenges include:Integration challenges include:

Melding two disparate corporate culturesMelding two disparate corporate cultures

Linking different financial and control systemsLinking different financial and control systems

Building effective working relationships (particularly Building effective working relationships (particularly when management styles differ)when management styles differ)

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

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

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Example – Culture ClashExample – Culture Clash

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

Grants seats based on Grants seats based on seniorityseniority

Discounted flight Discounted flight privileges for employeesprivileges for employees

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

More traditional More traditional uniformsuniforms

UniformsUniforms More casual uniformsMore casual uniforms

Offers Coca Cola and Offers Coca Cola and Miller beerMiller beer

In-flight beveragesIn-flight beverages Serves Pepsi and Bud Serves Pepsi and Bud Light beerLight beer

Unions want to protect Unions want to protect the seniority standings the seniority standings of their membersof their members

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

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Inadequate Evaluation of the Success: Inadequate Evaluation of the TargetTarget• Due Diligence: The process of evaluating a Due Diligence: The process of evaluating a

target firm for acquisitiontarget firm for acquisition Ineffective due diligence may result in paying an Ineffective due diligence may result in paying an

excessive premium for the target company.excessive premium for the target company.

• Evaluation requires examining:Evaluation requires examining: Financing of the intended transactionFinancing of the intended transaction

Differences in culture between the firmsDifferences in culture between the firms

Tax consequences of the transactionTax consequences of the transaction

Actions necessary to meld the two workforcesActions necessary to meld the two workforces

The value the target firm will offer to the acquiring firmThe value the target firm will offer to the acquiring firm

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Large or Extraordinary DebtSuccess: Large or Extraordinary Debt• High debt can:High debt can:

Increase the likelihood of bankruptcyIncrease the likelihood of bankruptcy

Lead to a downgrade of the firm’s credit ratingLead to a downgrade of the firm’s credit rating

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

• Research and developmentResearch and development

• Human resource trainingHuman resource training

• MarketingMarketing

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Inability to Achieve SynergySuccess: Inability to Achieve Synergy

• Synergy:Synergy: When assets are worth more when When assets are worth more when used in conjunction with each other than when used in conjunction with each other than when they are used separately.they are used separately.

• Transaction costsTransaction costs

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

Firms tend to underestimate indirect costs Firms tend to underestimate indirect costs when evaluating a potential acquisition.when evaluating a potential acquisition.

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Too Much DiversificationSuccess: Too Much Diversification• Diversified firms must process more information Diversified firms must process more information

of greater diversity.of greater diversity. Increased operational scope created by diversification Increased operational scope created by diversification

may cause managers to rely too much on financial may cause managers to rely too much on financial rather than strategic controls to evaluate business rather than strategic controls to evaluate business units’ performances.units’ performances.

Strategic focus shifts to short-term performance.Strategic focus shifts to short-term performance.

Acquisitions may become substitutes for innovation.Acquisitions may become substitutes for innovation.

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Managers Overly Focused on Success: Managers Overly Focused on AcquisitionsAcquisitions• Managers invest substantial time and energy in Managers invest substantial time and energy in

acquisition strategies in:acquisition strategies in:

Searching for viable acquisition candidates.Searching for viable acquisition candidates.

Completing effective due-diligence processes.Completing effective due-diligence processes.

Preparing for negotiations.Preparing for negotiations.

Managing the integration process after the acquisition Managing the integration process after the acquisition is completed.is completed.

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Managers Overly Focused on Success: Managers Overly Focused on AcquisitionsAcquisitions• Managers in target firms operate in a state of Managers in target firms operate in a state of

virtual suspended animation during an virtual suspended animation during an acquisition.acquisition. Executives may become hesitant to make decisions Executives may become hesitant to make decisions

with long-term consequences until negotiations have with long-term consequences until negotiations have been completed.been completed.

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

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Problems in Achieving Acquisition Problems in Achieving Acquisition Success: Too LargeSuccess: Too Large

• Additional costs of controls may exceed the Additional costs of controls may exceed the benefits of the economies of scale and additional benefits of the economies of scale and additional market power.market power.

• Larger size may lead to more bureaucratic Larger size may lead to more bureaucratic controls.controls.

• Formalized controls often lead to relatively rigid Formalized controls often lead to relatively rigid and standardized managerial behavior.and standardized managerial behavior.

• The firm may produce less innovation.The firm may produce less innovation.

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Effective Acquisitions

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Attributes of Successful AcquisitionsAttributes of Successful Acquisitions

• Target firm has resources/core competencies Target firm has resources/core competencies that are complementary to the acquiring firmthat are complementary to the acquiring firm

• Acquisition is friendlyAcquisition is friendly

• Effective due diligence is conductedEffective due diligence is conducted

• Acquiring firm has financial slackAcquiring firm has financial slack

• Merged firm maintains low to moderate debt Merged firm maintains low to moderate debt positionposition

• Merged firm continues R&DMerged firm continues R&D

• Acquiring firm manages change wellAcquiring firm manages change well

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Results of Successful AcquisitionsResults of Successful Acquisitions

• Higher probability of synergy and ultimately, Higher probability of synergy and ultimately, competitive advantagecompetitive advantage

• Faster, more effective integrationFaster, more effective integration

• Overpayment for acquisition is avoidedOverpayment for acquisition is avoided

• Financing is easier and less costly to obtainFinancing is easier and less costly to obtain

• Avoidance of trade-offs associated with high Avoidance of trade-offs associated with high debtdebt

• Long-term competitive advantageLong-term competitive advantage

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Restructuring

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RestructuringRestructuring

• A strategy through which a firm changes its set A strategy through which a firm changes its set of businesses or financial structure.of businesses or financial structure. Failure of an acquisition strategy often precedes a Failure of an acquisition strategy often precedes a

restructuring strategy.restructuring strategy.

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

• Restructuring strategies:Restructuring strategies: DownsizingDownsizing

DownscopingDownscoping

Leveraged buyoutsLeveraged buyouts

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Types of Restructuring: DownsizingTypes of Restructuring: Downsizing

• A reduction in the number of a firm’s employees A reduction in the number of a firm’s employees and sometimes in the number of its operating and sometimes in the number of its operating units.units. May or may not change the composition of May or may not change the composition of

businesses in the company’s portfolio.businesses in the company’s portfolio.

• Typical reasons for downsizing:Typical reasons for downsizing: Expectation of improved profitability from cost Expectation of improved profitability from cost

reductionsreductions

Desire or necessity for more efficient operationsDesire or necessity for more efficient operations

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Types of Restructuring: DownscopingTypes of Restructuring: Downscoping

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

• A set of actions that causes a firm to strategically A set of actions that causes a firm to strategically refocus on its core businesses.refocus on its core businesses. May be accompanied by downsizing, but not May be accompanied by downsizing, but not

eliminating key employees from its primary eliminating key employees from its primary businesses.businesses.

Smaller firm can be more effectively managed by the Smaller firm can be more effectively managed by the top management team.top management team.

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Restructuring: Leveraged Buyouts Restructuring: Leveraged Buyouts (LBO)(LBO)• A restructuring strategy whereby a party buys all A restructuring strategy whereby a party buys all

of a firm’s assets in order to take the firm private.of a firm’s assets in order to take the firm private. Significant amounts of debt may be incurred to Significant amounts of debt may be incurred to

finance the buyout.finance the buyout.

Immediate sale of non-core assets to pare down debt.Immediate sale of non-core assets to pare down debt.

• Can correct for managerial mistakesCan correct for managerial mistakes

• Can facilitate entrepreneurial efforts and Can facilitate entrepreneurial efforts and strategic growth.strategic growth.

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Restructuring OutcomesRestructuring Outcomes

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KLC-KinderCare Merger

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Wrap-up

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Wrap-upWrap-up

• Background on Mergers & AcquisitionsBackground on Mergers & Acquisitions• Reasons for AcquisitionsReasons for Acquisitions• Problems in Achieving Acquisition SuccessProblems in Achieving Acquisition Success• Effective AcquisitionsEffective Acquisitions• RestructuringRestructuring• KLC-KinderCare AcquisitionKLC-KinderCare Acquisition• QuestionsQuestions