When to ALLY

and

When to ACQUIRE

Introduction:

•Why acquisitions and alliances - To boost sales, profits and stock prices.

•American companies created a titanic wave - 74000 acquisitions and 57000 alliances from 1996 through 2001.

•Most of them fail.

•Acquisitions either destroy or don’t add to shareholders value.

•Alliances create little wealth for shareholders.

•Share prices fall between 0.34% and 1% within 10 days after announcing collaborations

-Strategic Management Journal.

Always compare the two strategies i.e. Alliance or Acquisition before picking one.

Companies generally take over firms that they should have collaborated with and ally with those, they should have bought. Thus making a mess of both acquisitions and alliances.

Companies must weigh the merits and demerits of both the above mentioned strategies before choosing horses for courses.

ACQUISITIONS

•Competitive•Based on Market Prices.•Risky•Motive - Increase sales or cut costs.

ALLIANCES

•Cooperative•Based on Negotiations. •Less Risky.•Motive – Entering into new markets, regions & customer segments.

Wrong Understanding regarding:

When to Ally & When to Acquire.

Coca Cola and P&G created a $4 billion joint venture in Feb,2001.

Agreement Terms -

a. Coke would transfer Minute Maid , Sonfil, Cappy, Qoo etc. to the new company and P&G would contribute two beverage brands- Punica,Sunny delight and Pringles chips.

b. Coke would tap P&G’s nutritional expertise to develop new drinks and P&G’s flagging brands would get a boost from Coke’s extensive distribution network.

Aim – The new venture would slash costs by $50 million.

Consequences –

a. Coke’s stock dropped by 6% and P& G’s Stock rose by 2%.

b. Investors wondered why Coke had agreed to share 50% of the profits from a fast growing segment with a weak rival & that too in its core business.

The alliance was terminated within 5 months.

Intel paid $1.6 billion in 1999 to buy the $131 million DSP Communications.

Motive:-. An opportunity to break into wireless communication market.

Consequences:-

a. Intel’s stock prices fell by 11% within 3 days.

b. Investors were basically concerned about two factors i.e.

1. 40% premium that Intel paid for DSP’s shares.

2. People tend to leave high tech firms, when bigger companies absorb them.

c. Intel lost most of DSP's key people and its biggest wireless customer Kyocera.

Intel had to write off $600 million of goodwill by 2003.

RESOURCES & SYNERGIES

SYNERGIES•There are three types of synergies:Modular Synergies

Sequential Synergies

Reciprocal Synergies

•Require different levels of coordination between firms and result in different forms of collaboration.

MODULAR SYNERGIES

•When they manage resources independently, pool only results for greater profits.•Modular synergies- independent resources generate them•Non equity alliances best suited to generate them.

•Examples:1. Airline and a hotel chain plan a collaboration.2. Hewlett Packard & Microsoft have created a non equity alliance that pools the company’s system integration and enterprise’s software skills respectively to create technology solutions.

SEQUENTIAL SYNERGIES

•When one company completes its task and passes on the result to a partner to do its bit .•Resources are sequentially interdependent.•Partners sign rigid contract that they monitor carefully.•Enter into equity based alliances.

For instance:When a biotech firm that specializes in discovering new drugs say , Abgenix, wishes to work with a pharmaceutical giant say, AstraZeneca that is familiar with FDA approvals are seeking sequential synergies.

RECIPROCAL SYNERGIES

•By working closely together and executing task through an iterative knowledge sharing process.•Combine and customize resources to make them reciprocally interdependent.•Acquisitions are better than alliances for he companies that desire reciprocal synergies.

•For instance :Exxon and Mobil realized that they have to become more efficient in almost every art of the value chain, be it – research , oil exploration or marketing. Thus they decided to merge rather than pursuing an alliance.

NATURE OF RESOURCES

•Resources are of two kinds: a. Hard Resources b. Soft Resources

Hard resources - Acquisition because their valuation is easy & synergies can be quickly generated.Human Resources – Avoid Acquisitions , because in acquisitions employees tend to become unproductive.

For instance Bank-America picked up Montgomery Securities, key employees headed for the door, Bank-America never benefited from the acquisition.

•Equity alliances are better bets where people are involved –allows company to control the actions of their partners, monitor performance & align the interest of two firms more closely.

REDUNDANT RESOURCES

•Estimate the amount of redundant resources.

•Use the surplus resources to generate economies of scale, or cut costs by eliminating resources.

•Large amount of redundant resources - Opt for Acquisitions or Mergers.

For instance:Drivers behind Hewlett Packard & Compaq Merger are :-

-Resource Redundancy.-Aim to generate $2 billion of savings in fiscal 2003.-Eliminate redundancies across value chain

COMPETITION

•Wise to check if there are rivals for potential partners.

•Avoid takeovers when business uncertainty is high.

For instance:-

Pfizer used alliance with Warner Lambert in the marketing of Lipitor as gateway to acquisition.

MARKET FACTORS Evaluate the degree of uncertainty- low/high/moderate associated with technology or product discussed.

Technology must be superior to existing or potential rivals.

Assess if consumers will use the technology/product &how much time will it take to gain acceptance.

If the outcome is highly or moderately uncertain -Non equity or equity alliance rather than acquisition.

• CISCO over the years has emerged as a Networking Giant.

• It followed a Dual growth strategy :-

a. Absorbed 36 firms.

b. Entered into more than 100 alliances.

• Key Reason:- Cisco has one Senior Vice President , as the in charge of Corporate Development and Critical Cost Benefit Analysis is done for all the three alternatives :

a. M&A

b. Strategic Alliances.

c. Technology Incubation.

• Cisco has used alliances as the Stepping Stones to Acquisitions(25% of acq. were started as small equity investments.)

Application to Indian Industry

Renault-Bajaj ALLIANCE :-

This is apparently the right way ahead for Bajaj, as it is entering a sector where it has little experience in.

The alliance benefits Bajaj by reducing it’s risk, and Renault as it can obtain local know how and Bajaj‘s infrastructure.

Jet-Sahara Deal {ACQUISITION}

When hard assets are to be acquired, which can be easily valued, acquisitions make more sense.

SYNOPSIS: Tata Steel UK, a unit of Tata

Tata Steel Ltd acquired the entire ordinary share capital of Corus Group, London-based manufacturer steel products, for $11.917 in cash per share or a total value of 14.719 billion, after an extensive bidding war with CSN.

TATA STEEL

Framework Assessment:

Synergies: As both Tata and Corus were in the same business, the synergies in collaboration would be reciprocal in nature. Thus, the framework points towards M&A.

Resources: The two were in the same business and a combination of resources would provide economies of scale along with increased capacity.

Risks and Uncertainty: In a commodity industry, demand is relatively stable. Hence uncertainty would tend to be on the low/moderate side.

Competition: Corus was a highly coveted company, and the keen interest of CSN in acquiring it created a scenario where acquisition was the only option.

OUR EVALUATION: The framework clearly points towards M&A from Tata’s perspective, where Tata probably made a mistake was the price that it paid for Corus. Corus was highly overvalued at 608 pence per share, when the ideal value should have been close to 525 pence (Source-UBS). Though Tata got it‘s strategy right, this enormous overvaluation should have been avoided.

CRITIQUEKnowing when to use which strategy may be a greater source of competitive advantage than knowing how to executee.g. Corning didn't know how to execute acquisition

It may so happen that organizations are unable to misjudge their own environment in terms of resources utilized, synergies required, degree of market uncertainties etc ; as these are of utmost importance to take a right decision

Flawed intentions of top management involved can neglect the factors which are important to be considered e.g. to boost executive ego or big bonus are there for big merger deals

Coping with a merger can make top managers spread their time too thinly that they happen to neglect their core business which may be spelling doom.

THANK YOU

SAURABH ARORA