7.

Merger and Acquisition &

Restructuring Strategies
 Introduction:
Popularity of M&A Strategies

• Firms diversify to use excess resources

• Often firms use M&A in concert with diversification strategies to
become more diversified
• These are used to grow in domestic markets and challenge from
global competition worldwide
• They are used to position in existing markets and expansion in new
markets
• Popular strategy among U.S. firms for many years, helped
restructure the economy to create benefits for economy
• During recent financial crisis led to tight credit markets forcing firms
to avoid mega deals
• Weak Dollar attracted foreign buyers of US businesses
• Often the trend is smaller deals with complementary/ related
businesses
• It has been observed that acquiring firm shareholders earn close to
zero returns whereas acquired firms shareholders benefit from M&A
• Often the share prices of acquiring firm fall soon after merger
announcement
• There is skepticism among shareholders that synergies equal to
transaction cost and premium paid can not be realized
• NetApp’s proposed acquisition of Data Domain at $33.50 B is 419
times the earning of the firm in 2009- huge premium
• This implies that it is challenging to offset through synergy the
premium paid.
• M&A can be used because of uncertainty in the competitive
landscape in order to
– Increase market power because of competitive threat
– Spread risk due to uncertain environment
– Shift core business into different markets
• Due to industry or regulatory changes
• Intent: increase firm’s strategic competitiveness and value – the
reality, however, is returns are close to zero
Introduction:
Merger vs. Acquisition vs. Takeover (Cont’d)

• Merger
– Two firms agree to integrate their operations on a
relatively co-equal basis
– Towers Perrin and Watson Wyatt merged making the
combined entity the worlds' largest employee benefit
consultancy company
– They appear equal partner but in reality one partner
dominates the other because one party has larger
market share, size, or value of assets
– Same is the case with Swiss-based Xstrata and Ango-
American- mining firms
• Acquisition
– One firm buys a controlling, 100 percent interest in another firm
with the intent of making the acquired firm a subsidiary business
within its portfolio.
– The management of acquired firm reports to the management of
acquiring firm
• Takeover
– Special type of acquisition strategy wherein the target firm did
not solicit the acquiring firm's bid
– Hostile Takeover: Unfriendly takeover that is unexpected and
undesired by the target firm
– The hostile takeover gives higher gains to acquired firm than
friendly acquisition
– In acquisitions pricing the target is the core issue
– Excelon bid for NRG Energy at $7.5 billion
Reasons for Acquisitions
– There are many reasons for acquisition and there are
problems because they are not always successful
• 1. Increased market power
• Achieving market power is the primary reason for
acquisitions. Is defined as ‘when a firm is able to sell its
goods above market price or cost of Value Chain activities is
lower than competitive levels’
– Sources of market power include
• Size of the firm, resources and capabilities to compete in the
market and share of the market
• Designed to gain CA in the acquiring firm’s primary market
• If it gains enough power it becomes the leader
• Acer is contemplating to acquire Asustek or Lenovo to become
the leader in PC business
Types of Acquisitions

– Horizontal Acquisitions
• Acquirer and acquired companies compete in the same
industry
• It increases market power by exploiting cost-based or
revenue-based synergies
• i.e., McDonald’s acquisition of Boston Market
• Toys “R”Us acquisition by toy company FAO Schwartz is an
example of horizontal merger. This will reduce purchasing
cost of toys from market
• Horizontal mergers are successful when both firms have
similar attributes: strategy, management style, resource
allocation patterns. It supports integration of businesses and
divest duplicated assets
– 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 and thus increased market power
• i.e., Walt Disney Company’s acquisition of Fox Family
Worldwide.
• CVS acquisition of Caremark- a pharmacy benefits manager
(PBM). It now controls multiple parts of value chain. Can get
economies in purchase of medicines because of its large size
– Related Acquisitions
• Firm acquires another company in a highly related industry
• Synergies can be generated by integrating some of their
resources and capabilities
• Boeing recently acquired eXMeritus for its software and
hardware for defense security use of classified info
• Synergies may not be realized- FAO Schwartz acquisition of Best
Co. Failed
• Horizontal, vertical and related mergers to complete their market
power are subject to regulatory and market review
• P&G acquisition of Gillette Co. in 2006 with potential of $1.5 billion
annual synergy was subjected to FTC –government and market
review.
• It has to sell of several businesses to acquire Gillette under FTC
pressure
• This shows that firms acquiring other firms should pay attention to
political and regulatory segment of the environment
Reasons for Acquisitions (Cont’d)

• 2. Overcoming entry barriers

• Entry barriers increases the expense and difficulty when
trying to enter a new market
• Economies of scale or established customer relationships can
be source of entry barriers or overcoming differentiated
benefits that incumbent firms enjoy would require huge
resources in advertising and marketing, may require selling at
lower prices
• It may be easier to acquire the established firm overcoming
entry barriers. In fact more are the entry barrier more likely
the firm will acquire existing firm
• This may be more the case in international entry decisions to
overcome the liability of foreignness and gain local market
knowledge
• Developed market MNCs use this mode to enter BRIC nations
• Cross-border acquisition: headquarters in different country
• The acquisition of UK carmaker Jaguar and Land Rover by
Tata Motors of India is an example of cross-border acquisition
• During 1990s there had been intense M&A activity which
declined during economic crises of 2008-10. The declined
continued because of shrinking economies, volatile markets,
scarce debt
• However higher activity will resume once the crisis is over as
M&A are very popular with corporate entities
• Earlier Western companies were very active in M&A but of late
the emerging market MNCs have become very active
• The Chinese companies are active in natural resources
markets. They are engaging in horizontal mergers
• Weakening Dollar and supportive role of Indian government is
encouraging Indian MNC s to engage in M&A activity in the
West
• They are particularly involved in acquiring innovation
capabilities, new brands and distribution channels in the West
• The risk in emerging markets include cultural, regulatory, due
diligence and legal obstacles
3. Cost of new product development and
increased speed to market

• Introducing new products internally is costly and time

consuming with greater risk
• Estimated 88% innovations fail. Record of M&A success is
above 20%
• Approximately 60% innovations are successfully imitated
within 4 years of patent grant.
• This makes internal innovations highly risky
• Through acquisitions of brands, products and companies can
lead to gain innovative products in portfolio.
• This mode provides more predictable returns and faster entry
• The value of new products can be assessed before acquisition
• AOL acquired Patch Media Corp and Going Inc for local media
and online community which will support the MapQuest and
Bebo businesses in local markets
• Pharma companies are using these strategies like Pfizer
acquisition of Wyeth
Pfizer proposed acquisition of Wyeth

– Like many Pharma companies Pfizer allocates 15% of

revenues to R&D-huge amount with little innovation
output
– The M&A activity creates business focus, diversification,
consolidates the industry removing inefficiencies and
excess capacity
– Wyeth is the third largets biotechnology company with
good innovation track record. No internal innovation
from Pfizer, good revenue base of Wyeth replacing
Lipitor sales decline after patent expiration
– It would cost$68 billion to acquire Wyeth with 29%
premium over current value. This is a horizontal and
related diversification because of complementary
products and markets beside innovation capability.
– Wyeth is biotechnology company with vaccines as well
– Lipitor patent is expiring in November 2011, which
contributes to 25% of revenues and perhaps higher
profit percentage. Patent expiry will result in both
revenue and profit loss by a huge margin. There is no
clear pipeline to fill this vacuum except acquisition of
company like Wyeth
– Pfizer will fill revenue and profit gap, complement its
product line, major entry in biotechnology company
and sustain its share price after Lipitor patent expires
– Both the businesses will fit together well given R&D
focus, innovation strategy, complementary products
and broadened scope of product markets
– Increased speed to introduce new drugs
4. Lower risk compared to developing new
products

– The outcome of merger can be estimated easily and

accurately than new product, acquisition is seen as less
risky
– But acquisition may become substitute for innovation,
which is improper because other firms can also compete in
the market for acquisition which is not the case with
innovation
– No resources left for innovation
– Therefore acquisition should be strategic rather than
defensive- cost or revenue synergies- instead of getting
short run revenues through acquisitions.
– Pfizer should continue to invest in innovation even after
acquisition of Wyeth.
 5. Increased diversification

• Acquisitions are used to diversify firms

• Diversification through acquisition helps to get new products which
is not possible from internal development because they lack
experience
• Cisco Systems is an example of a firm that uses acquisitions to
become more diversified .Hardware components were built through
this mode e.g. IronPort, Riverhead Networks, Protego Networks
and Perfigo were purchased to diversify Cisco business. They
created value for Cisco
• Both related and unrelated strategies can be attempted
• UTC uses acquisition for unrelated corporate strategy by acquiring
noncyclical businesses like Otis Elevator
• P&G acquired Gillette to complement beauty product line is a
related strategy
• Related diversification has more probability of success than
unrelated
6. Reshaping firm’s competitive scope

• In order to reduce competitive rivalry, firms use

acquisition to create vertical integration or multimarket
competition
• Reducing the dependence on specific markets shapes
firm’s competitive scope
• Every time UTC enters new business (UTC power) it
shapes its competitive scope
• P&G also shaped its competitive scope by acquiring
Gillette and divesting some businesses in order to agree
with FTC orders
7. Learning and developing new capabilities

• Some times firms complete acquisitions to gain access to

capabilities they lack- special technological capability
• Firms can broaden their knowledge base and reduce intertia
through acquisitions
• Acquisition of diverse talent could be source of new knowledge and
vigor
• They should acquire different but related capabilities to build their
knowledge base
• Pharma companies are acquiring biotechnology firms in order to
create ‘ big molecules”- acquiring drugs and capabilities
• The biotechnology firms go through additional regulatory hurdle
and thus are defensible and create competitive advantage for
acquiring firm.
Reasons for Acquisitions and Problems in
Achieving Success
Reasons for Acquisitions Problems in Achieving Success

Increased Integration
Market power difficulties

Overcoming Inadequate
Entry barriers Evaluation of target

Cost of new
Large or
product development and
Extraordinary debt
increased speed to
market

Lower risk Inability to

compared to developing Achieve synergy
new products

Increased Too much

diversification diversification

Reshaping the firm’s Managers overly

competitive scope Focused on acquisitions

Learning and
developing new Too large
capabilities
Problems in Achieving
Acquisition Success
• The reasons mentioned can help firms to achieve CA through
acquisitions and earn above average returns.
• But when pursued for value creating reasons they are not problem
free
• It is estimated that 20% of acquisitions and mergers are
successful; 60% produced disappointing results and 20% as
complete failure
• Companies have acquired sophistication in using M&A and the
success accrues to firms that are able to
– Select the right target
– Avoid paying too high premium
– Effectively integrate the operations
– Retain the target’s human capital
– Integrate systems; and
– Integrate culture
1. Integration difficulties

• Post merger integration is the most important issue for

value creation/ destruction
• Melding two cultures, linking different financial and
control systems, building effective relationship, status of
target firm management are indeed challenging issues
• UPS acquired Mail Box run on franchisee model, had
difficulty accepting new management and had many
integration difficulties
2. Inadequate evaluation of target

• Due diligence involves hundreds of issues: financing,

culture, tax, workforce, systems etc
• It is commonly performed by investment firms like
Goldman Sachs, beside own groups doing due diligence
• Failure can result in excessive payment
• In good times prices are driven by other bidders and
comparable targets- value may not be achieved
• ‘Bidding war’ can result in winner’s curse because of too
high premium paid.
• Firms should focus on due diligence parameters and quit
the bidding war if the cost goes beyond these parameters
3. Large or extraordinary debt

• Firms often fund the acquisitions with Debt raised

through junk bonds
• Junk bonds: financing option whereby risky acquisitions
are financed with money (debt) that provides a large
potential return to lenders (bondholders)
• Some time the interest rate goes upto 18-20%
• Some time these high debts discipline the management
• Tata Motors took $3 billion debt to fund the acquisition of
Land Rover and Jaguar, which can be source of trouble at
Tata Motors
• High debts can lead to risk of bankruptcy, lowered credit
rating, which makes further debt costly
• Some may divest some assets to cover up debt
4. Inability to achieve synergy

– Synergy: Value created by units exceeds value of units

working independently
– Derived from economies of scale and scope and the
acquisition should generate private synergy
• Achieved when the two firms' assets are complementary in
unique ways
• Yields a difficult-to-understand or imitate competitive
advantage
– 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
– While creating synergy there may be many transaction costs
involved in acquisitions
5 . Too much diversification

– 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
6. Managers overly focused on acquisitions

– Necessary activities with an acquisition strategy

• 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
7. Too large

– 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
– Additional costs 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
Table 1:Attributes of successful acquisition
• Attributes
• Target firm has assets and
resources complementary to
acquiring firm
• Acquisition is friendly
• Conducts due diligence related to
culture, finance and human
resource
• Acquiring firm has slack: cash or
debt capacity
• Merged firm maintains low to
moderate debt position
• Acquiring firm has sustained
emphasis on innovation and R&D
• Acquiring firm manages change
and is flexible and adaptable
• Results
• High probability of synergy and CA
by maintaining strengths
• Faster and more effective integration
and possibly lower premiums
• Firms with strong complementarities
are acquired and overpayment is
avoided
• Financing debt or equity is easier
and less costly to obtain
• Lower financing cost, lower risk of
bankruptcy, avoidance of debt trade
offs
• Maintain long term Competitive
Advantage in markets
• Faster and more effective integration
facilitates achievement of synergy
Restructuring

• Restructuring defined: Firm changes set of

businesses or financial structure
• Three restructuring strategies
– 1. 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
– 2. Downscoping
• Eliminating businesses unrelated to firms’ core businesses
through divesture, spin-off, or some other means
Restructuring (Cont’d)

• Three restructuring strategies (Cont’d)

– 3. 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
• Why LBOs?
– Protection against a capricious financial market
– Allows owners to focus on developing innovations/bring them to
market
– A form of firm rebirth to facilitate entrepreneurial efforts
Restructuring

• Restructuring Outcomes
– Short-term
• Reduced costs: labor and debt
• Emphasis on strategic controls
– Long-term
• Loss of human capital
• Performance: higher/lower
• Higher risk
 Restructuring and Outcomes

Alternatives Short-Term Outcomes Long-Term Outcomes

Reduced labor Loss of human

costs capital

Downsizing

Reduced debt Lower

costs performance

Downsizing

Emphasis on Higher
Strategic control performance

Leveraged
buyout
High debt costs Higher risk