BUSS4

Mergers and Takeovers

KEY DEFINITIONS

Takeover
- Where one business acquires a controlling interest in another business
- A change of ownership
Merger
- A combination of two previously separate businesses into a new business
Diversification
- Expanding into new markets with new products
- The riskiest growth strategy
KEY STRATEGIC DRIVERS OF M&A ACTIVITY

Rapid technological change

Need for scale to remain competitive
Need to be able to supply customers globally
Low demand growth in mature economies
Access to wider distribution networks
Invest in faster-growing emerging markets

TAKEOVERS: 3 MAIN MOTIVES

Strategic Motives
- Improve and develop the business
- Closely linked to competitive advantage
- E.g. economies of scale
Financial Motives
- Make best use of financial resources for shareholders
- Improve financial performance
- E.g. higher profits
Managerial Motives
- Self-interest of managers
- Not necessarily in the best interest of shareholders
- E.g. want to lead a bigger business
EXAMPLES OF SUCCESSFUL DEALS

LOral and The Body Shop

- More shops, higher profits
Google and YouTube
- Rapid growth and advertising revenue
Tata and Jaguar Land Rover
- 1bn profits in 2011
Santander & Abbey, Alliance & Leicester, Bradford & Bingley
- Higher profits and market leadership in UK
Taylor Woodrow and George Wimpey
- Economies of scale for two leading house builders merged together
KEY FINANCIAL MOTIVES FOR M&A
http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Make use of surplus cash and high share price

-E.g. businesses with high cash balances can potentially earn a better
return by investing in other firms
Bargain hunting and Asset Stripping
- Can the target be bought at a knock-down price?
- Potential to sell surplus assets and cut costs and still retain the business
that was wanted in the first place
KEY MANAGERIAL MOTIVES FOR M&A

Personal ambition and financial reward

- Director Rewards may be linked to growth
- Big takeovers attract media boosts ego/reputation?
- Takeovers as vanity projects
Bandwagon effect/ peer pressure
- Pressure to do takeovers (if competitors are too)
- Concern that firm may be being left behind
- Over-confidence
- Pressure from advisers and media (e.g. investment bankers)
EXAMPLES OF MOTIVES

Kraft and Cadbury

- Establish global market leadership in confectionary and access emerging
markets
Google and Motorola
- Acquire valuable smartphone patents and manufacturing expertise
Tata and JLR
- Economies of scale and acquire expertise, brands, capacity and
distribution
RBS and ABN-Amro
- Management vanity; continue reputation for big deals; over-confidence
Santander and Abbey
- Market entry (UK) and establish base for further acquisitions to build
market share
WM Morrison and Safeway
- Increase market share and exploit economies of scale to improve
competitiveness
British Airways and Iberia
- Consolidation; economies of scale and survival: positioning for further
takeovers
IMPORTANT EVALUATION POINTS

Does the takeover or merger fit with the objectives of the business?
Will shareholders gain from synergy?

TWO KINDS OF SYNERGY

Cost Savings
- Eliminate duplicated functions and services

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

- Better deals from suppliers

- Higher productivity and efficiency from shared assets
Revenues
- Cross selling to customers of both businesses
- New distribution channels
- Brand extensions
- New geographic markets opened up
OVERVIEW OF THE TAKEOVER PROCESS

Target identification and choice

Valuation and offer
Due diligence
Integration

Key Evaluation Point

Things can go wrong in each part of the takeover or merger

- Wrong target
- Pay too much
- Dont check what you are buying
- Poor integration planning
EXAMPLES OF DEALS THAT FAILED

News Corp and Myspace

- Bought for 580m
- Sold for $25m
ITV and Friends Reunited
- Bought for 175m
- Sold 3 years later for 25m
Cisco and Flip
- Bought for $590m
- Closed down in a year
RBS and ABN-Amro
- Bought for 10bn
- Results in losses of at least 15bnn and nationalisation
Terra Firma and EMI
- Bought for 4.2bn
- Sold 3 years later for a loss of 1.75bn
- One of the biggest private equity failures
BUILDING ANALYSIS AND EVALUATION ON TAKEOVER INTEGRATION
Success of takeover integration will depend on

Importance of synergies
Extent to which firms are similar
- E.g. products, markets
Quality of integration planning and action
- E.g. communication, leadership

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Evaluating the importance of culture in a takeover

Are the two cultures significantly different?

Type of takeover
- E.g. cross-border, private equity
Can be a short term problem, but in the long term, one culture will prevail

SUMMARY: DRAWBACKS OF ACQUSITIONS

High cost involved

Problems of valuation
Clash of cultures
Upset customers
Problems of integration (change management)
Resistance from employees
Non-existent synergy
Incompatibility of management styles, structures and culture
Questionable motives
High failure rate
Diseconomies of scale

JOINT VENTURES

Joint ventures occur when businesses join together to pursue a common

project
The businesses remain separate in legal terms
Joint ventures are becoming common as firms want to benefit from
collaborative work in reaching a mutually-agreed strategic target
- An example might be joint-research projects to share the fixed costs
EXAMPLES OF JOIN VENTURES

Vodafone and Telefonica

- Agreed to share their mobile network
BMW and Toyota
- 2001
- Agreed to co-operate on hydrogen fuel cells, vehicle electrification,
lightweight materials and future sports cars
West Coast
- Join venture between Virgin Rail and Stagecoach
Google and NASA
- Developing Google Earth
Hollywood studies
- Combining to fight internet piracy
Alliances in airline industry
- E.g. Star Alliance and One World
Starbucks and Tata Beverages
- Break into the Indian retail market

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Joint Ventures between universities to deliver Massive Open Online

Courses
- A fast expanding sector of the higher education industry

De- Mergers
When a firm decides to split into separate firms

KEY MOTIVATIONS

Focusing on core businesses to streamline costs and improve profit

margins
Reduce the risk of diseconomies of scale and diseconomies of scope
- By reducing the range of functions in a business, lower management
costs
Raise money from asset sales and return to shareholders
A defensive tactic to avoid the attention of the competition authorities
who might be investigating possible monopoly power in a market
EXAMPLES OF DE-MERGERS

The US pharmaceutical company Pfizer sold their infant nutrition business

to Nestle
Demerger of Cadburys US drinks business creating a business called Dr
Pepper Snapple Group
Severn Trent Water demerged its waste management business Biffa
Demerger of British Gas into a gas pipeline business Transco + an oil and
gas exploration company
Talk-Talk demerged from Carphone Warehouse in 2010
Fosters Group de-merging its two main operating divisions
- One focusing on beer, the other on wine
Punch and Spirit pub groups created out of demerger of Punch Taverns in
2011
US food giant Sara Lee sold of coffee business Douwe Egberts
Quantas demerged their airline business and run stand-alone domestic
and international airline businesses with each having their own profit and
loss account
News International demerged their Film and TV and Publishing businesses

THE REALITY OF MARKET POWER

Pricing power
Entry barriers
Monopsony
Supply chain control
Economies of scale

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

The Motives for Takeovers

and Mergers and How These
Link with Corporate Strategy
KEY POINTS

A wide variety of motives for mergers and takeovers

Takeovers or mergers are optional
- Just one part of a growth strategy
Distinguish between strategic, financial and managerial motives

KEY DEFINITIONS

External Growth
- Use of takeovers and mergers
Organic Growth
- Growth from within the business
- E.g. New products, expansion into new markets
Diversification
- Expanding into new markets with new products
- The riskiest growth strategy
KEY THEORIES TO CONSIDER

Ansoffs Matrix
- A model that analyses four growth options
- Product development
- Market penetration
- Market development
- Diversification
Porter Generic Strategies
- 3 strategies commonly used by businesses to achieve competitive
advantage
- Cost leadership
- Differentiation
- Focus
Economies of Scale
- Where unit costs fall as a result of increased scale or scope of operations
- Key to strategy of cost leadership
HOW M&T FITS INTO A STRATEGY

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

WHY IS STRATEGY ALL ABOUT CHOICE?

A key concept to remember and build into essay answers

Takeovers and mergers are rarely forced on a business
- They are optional
If M&T is optional, then there must be some alternatives
E.g. could a joint venture of strategic alliance be as effective as a cross-
border takeover
WHAT IS STRATEGIC FIT?

An important concept which can be used to evaluate the motives of a

takeover or merger
Does the transaction fit with
- The capabilities of the firm?
- The corporate objectives of the firm?
E.g. a takeover involving a diversification has a good strategic fit for an
objective of spreading risk by investing in a variety of products and
markets
KEY STRATEGIC DRIVERS OF M&T ACTIVITY

Technological change
Need for scale to remain competitive
Need to be able to supply customers globally
Low growth in mature economies
Access to wider distribution
Invest in emerging markets

M&A: 3 MAIN MOTIVES

Strategic Motives
- Focused on improving and developing the business
- Closely linked to competitive advantage
Financial Motives
- Focuses on making best use of financial resources for shareholders
- Concerned with improved financial performance

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Managerial Motives
- Focused on the self-interest of managers
- Not necessarily in the best interest of shareholders
KEY STRATEGIC MOTIVES

Extend the business

- Locations
- Markets
- Globalisation
Change competitive structure
- Consolidation
- Remove competition
- Economies of scale
Improve business capabilities
- Access better technology
- Stimulate innovation
KEY FINANCIAL MOTIVES

Make use of surplus cash and high share price

- E.g. businesses with high cash balances can potentially earn a better
return by investing in other firms
Bargain hunting and asset stripping
- Can the target be bought at a knock-down price?
- Potential to sell surplus assets and cut costs and still retain the business
that was wanted in the first place
KEY MANAGERIAL MOTIVES

Personal ambition and financial reward

- Director rewards may be linked to growth
- Big takeovers attract media which may boost ego and reputation
- Takeovers as vanity projects"
Bandwagon effect/ peer pressure
- Pressure to do takeovers (if competitors are too)
- Concern that firm may be being left behind
- Over-confidence
- Pressure from advisers and media (e.g. investment bankers)
WHAT MAKES PRIVATE EQUITY TAKEOVERS DIFFERENT?

Financial motive is key (rather than strategic motive)

Look to invest in fast growing firms or those where financial performance
can be significantly improved
Takeover usually financed by both equity (shares) and debts (loans)
Advise rather than get involved in day-to-day management of the target

Synergies not usually important to the deal

- Unless there are links with similar investments in the portfolio
COMMON CRITICISMS OF PRIVATE EQUITY TAKEOVERS

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Too many involve mature businesses which dont really need the
investment
Over-geared: too much debt used to finance the transaction
Short-termism: not always a long term investor
Too much focus on cost cutting and asset stripping

IT DEPENDS ON...

Is the firm at a competitive disadvantage?

- If so, then a strategic acquisition might have potential to transform its
position
Does the acquiring firm have the financial resources to be able to pursue
an external growth strategy?
- How supportive are its shareholders and lenders?
Is the takeover/ merger opportunistic or part of a long-term strategic plan?

EVALUATION OPPORTUNITIES

The size/ scale of the takeover/merger

- How significant is it?
- Does the firm have a track record of successful M&A?
- If so, this should reduce the risks involved in subsequent transactions,
particularly if of a similar size/type
Is/ was the takeover/merger consistent with the firm's corporate
objectives?
Is /was there an alternative to takeover or merger which might have a
similar benefit at a lower level of risk (e.g. a joint venture or strategic
alliance)?
Which of the three main motive types was the most significant or
influential?
SUMMARY: ADVANTAGES OF ACQUISITIONS

Quick access to resources and skills the business needs

Overcomes barriers to entry
Helps spread risk
Revenue growth opportunities
Cost saving opportunities
Reduces competition
May enable economies of scale

SUMMARY: DRAWBACKS OF ACQUISITIONS

High cost involved

Problems of valuation
Clash of cultures
Upset customers
Problems of integration (change of management)
Resistance from employees
Non-existent synergy
Incompatibility of management styles, structures and culture
http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers
BUSS4

Questionable motives
High failure rate
Diseconomies of scale

http://beta.tutor2u.net/economics/blog/unit-3-micro-business-growth-takeovers-
and-mergers
http://beta.tutor2u.net/business/blog/revision-presentation-motives-for-
takeovers-and-mergers