Acquisitions
10 June 2005
1. Introduction
Mergers and acquisitions represent a major
source of organizational change.
Strategic Risk
Management
Project
Mgmt of
Change
Definitions
A merger or acquisition in a company sense is
the combination of two or more companies into
one new company.
Rationales
Rationales consist of the higher-level reasoning that
represent conditions for a merger decision.
Strategic: Achieves a set of
strategic objectives (including
defense)
Speculative: acquired
company is a commodity
Management failure: by the
time strategic variance is
detected, it is sometimes too
late to correct it by itself
Drivers
Drivers are mid-level specific (often operational)
influences that justify the merger.
Drivers
Continued
Vertical Integration
Vertical integration is the merger with suppliers
(backward) or retailers (forward).
Combined processes
Reduced risk and/ or enhanced risk management
Configuration (i.e., data flow) management
Quality management
Reduced negotiation, although perhaps at the
expense of decreased leverage
Proprietary and intellectual property protection
Individualization: controlling aspects of an
operation to protect quality and image
The Players
The early stages tend to be dominated by the strategic
planners (or equivalent), who are responsible for
initiating the merger and for making a strategic
evaluation of the decision.
External consultants are primarily involved in setting up
the contract and related aspects.
The post-deal work is largely dominated by the
implementation team.
Measuring Success
There is a tendency for the shares of a target
company to inflate. In terms of short-term gain
by the acquirer, most mergers and acquisitions
fail.
Long-term performance can depend on a wide
range of variables. Usually the form of payment
(cash, shares or both) and the effectiveness of
the implementation are key determinants.
Merger Waves
Five major waves since late 19th century:
2. Strategic Focus
should be on the competencies that are central to
the achievement of the Companys strategic objectives.
Misconceptions
Mergers are standard practice.
Misconceptions, 2
Targets tend to oppose.
Misconceptions, 3
It is easy to assess financial value.
Strategic Assumptions
If the targets core activities are related to those of the
acquirer, the strengthened core increases likelihood of
success. But,
Strategic Assumptions, 2
A company using funds generated by mature activities
to acquire companies operating under growth
conditions increases the prospect of long-term
revenues. But,
Financial Considerations
Acquisitions require cash or access to financial
capital.
Strategic Alliance
An alternative the strategic alliance often
amounts to a trial marriage.
Long-term relationship
Significant interdependency
Joint control across a range of areas
Continued contributions by the parents
However,
The Partner
The Outcome
Unrelated Diversification
Focused companies concentrate on one sector or
industry. Diversified companies have assets across
different sectors and industries (conglomeration).
Obvious targets are companies with undervalued assets
or in financial difficulty.
Sell it (intact)
Spin it off
Liquidate
Improve employee
motivation and commitment
Improve competitiveness in
industry or sector
Improve competitiveness in
the economy as a whole
Take advantage of favorable
external changes, like
deregulation
Regulators
Regulatory scrutiny is particularly likely when the
merging companies might affect the price of goods and
services in a market.
There is some effort being made to coordinate these
reviews, especially between the EU and the US, there
are still issues of:
Strategic Focus
is the concentration of attention around the
core competencies of an organization.
Strategic Focus, 2
Stage 1: Identify an achievable and strategicallycorrect focus area (four Cs) akin to SWOT
Strategic Focus, 3
Stage 3: Strategic Change
A Project
has five characteristics:
The value chain itself has a structure and fit with the
organization, and vice versa.
Inbound
Logistics
HR
Operations
Infrastructure
Technology
Outbound
Logistics
Marketing
and Sales
Service
Supplier relationship
Management
Customer Relationship
Management
Suppliers
Customers
The Supply
Chain
Balanced Scorecard
Kaplan and Norton focus on four aspects of
performance:
Characteristics Mapping
The acquirer or both merging entities must
evaluate the degree of fit in the proposed
conjunction.
Characteristics Mapping, 2
The method breaks down the acquirer and target into a
number of key functions, then considers a number of
fit drivers along the opposite axis.
Acquirer
Characteristic
Procurement
Marketing
Sales
Logistics
Service
Target
Degree of
Difference
Desired State
Degree of
Change
Required
Likelihood of
achieving
Extent to
which change
is essential
Mid-course Corrections
may not be possible if there has been some
significant intervening event. Otherwise:
Resource consumption
Throw-away costs
Consumer attitude
Drift Monitoring
Internal
Phased strategic review
Analysis of Critical Success
Factors (CSF)
Analysis of Key Performance
Indicators (KPI)
Analysis of Critical Business
Activities and Measures (CBAM)
Linking basic operational and
functional unit to strategy
Supporting issues (e.g., systems
alignment, incentives)
External
Customer demand
Competitor behavior
Commodity prices (incl.
interest and F/X)
Innovation and new
technologies
Statutory regulation
Key Environmental
Indicators (KEI)
broader economic focus
Scenario Planning
is a method of considering strategic objectives in the
context of possible changes in the internal
environment:
Shareholder rejection
Negotiation failure
Regulator block
Strategic failure
Cultural failure
Financial failure
Integrative failure
Information technology
failure
Leadership failure
Risk management failure
Globalization issue
Shareholder Rejection
In a merger, the majority of shareholders in both
companies must favor the arrangement.
In an acquisition, a majority of target
shareholders must tender their shares to the
acquirer.
Negotiation Failure
The two companies may be unable to agree on
merger terms and conditions that are mutually
acceptable.
During the course of negotiation, an event
including market reactions to the proposal can
significantly affect the value for one or the
other.
The targets Board or shareholders may be
hostile to the bid, thus raising the effective cost
of acquisition.
Regulator Block
A regulatory intervention is believed by some to
act as a control albeit often a stupid and
ineffective one to prevent a combined
company from exercising significant influence
over products or pricing.
Strategic Failure
Mergers often fail because they do not
demonstrate sufficient strategic alignment.
Strategic Failure, 2
inaccurate
unachievable
contradictory
obsolete or superseded by external events.
incomplete
wrongly structured
based on inaccurate or unreliable assumptions
based on assumed resources that are not forthcoming
insufficiently flexible to allow for change.
Strategic Failure, 3
implementation impracticable
5. cost limits are reached before implementation is
achieved
6. major unforeseen cultural issues arise
Cultural Failure
The cultural aspects of mergers and acquisitions are
very often underestimated when the implementation
process is being both planned and executed.
These might be characterized by:
Integrative Failure
A common problem is the erosion of senior
management interest as the integration process
takes place.
4. Valuation
This module is concerned with defining the financial,
rather than strategic, advantage of merging.
Financial markets require managers to make investment
decisions that provide an expected return at least equal
to that obtainable from comparable investments.
Determining Cost
The cost is the amount by which the cash price
exceeds the present value of the target:
Valuation Methods
Three approaches:
Description
Certainty Valuation
Tactical synergy
Reduced operating
expense
Revenue enhancement
from existing products
High
DCF
Strategic
Opportunity
Differentiation
Specialization
Economies of scope and
scale
Medium
Risk Adjusted
Discount
Real options
Transformation
Paradigm shift
Low
Real options
$
A
(B)
C
(D)
E
W
X
(T)
F
Purchase Price
Purchase of equity
+ Cost of debt assumed
+ Transaction costs
- Excess cash in target
Net cost of acquisition
Exit Price
The value beyond the forecast period can be
calculated using a pricing model, using a
multiple or valuing a perpetuity.
Cost of Capital
is not an arbitrary number, but a hurdle rate
required to compensate providers of capital for
giving up alternative investments (opportunity
cost).
Most firms use a combination of equity and debt
for financing. The weighted-average cost of
capital (WACC) gives the discount rate for the
business.
Growth Opportunities
One of the motivations for acquisition is that it
expands the range of business possibilities for the
combined entity.
Binomial Valuation
Apply the volatility terms to determine the outcomes at
each node:
Up move: u = et
Down move: d = 1 / u
Drift: a = er(t)
= (a d) / (u d)
Work back to t = 0
Black-Scholes-Merton
C = SN(d1) Ke-rt N(d2)
Real Option
Variable
Cost of investment
Time to expiry
(T t)
Value leakage
q or D
5. Bid Tactics
The objective is to persuade the target companys
shareholders and management that selling or merging is
the right decision.
Market Reaction
to the announcement is a reliable predictor of the
subsequent performance of the takeover.
A market model would predict a general relationship
between a shares return (ri) and market return (rM),
where the latter is measured by an index:
ri, t = i + irM,t where
Merger Performance
Run-up
Event period
Post-event
Game Theory
Merger or acquisition presents a variant of the
prisoners dilemma, where the benefits of
cooperation outweigh the alternative strategy
but only if the opposing side can be trusted to
cooperate.
Offense
If the targets management is receptive, the acquirer will
always choose a friendly approach.
If the targets management is hostile, then the acquirer
can:
Abandon
Force a negotiated settlement through a bear hug an offer
so attractive that its refusal could prompt a legal action
forcing directors to justify under the business judgment rule
Forego a settlement and: (1) make a tender offer, (2) buy up
shares in the market, or (3) commence a proxy fight.
A dawn raid is an attempt to buy a large position in the target
prior to a bid.
Defense
A radar alert might be watching for buying activity in company
shares.
Advisors, Directors
Both sides of the transaction are likely to use
professional firms and specialists to advise and
assist their aims.
Business judgment rule (USA): directors must be
able to demonstrate to a court of law that they
have acted in the best interests of the
shareholder in a transaction.
Role of Regulation
Regulation of takeovers takes two forms:
Industry Concentration
Regulators have been concerned with measuring the
effect of an industrys concentration on
competitiveness.
The Herfindahl and Hirshman index (HHI) is the sum
of the squares of the market shares.
6. Due Diligence
is the investigative step after the bidding stage and
preceding the conclusion of the contract.
Pre-bid analysis has been based on information in the
public domain. For due diligence, there is access to the
targets internal information.
Planning
Clarification of the scope, depth, requirements and aims
of the process will minimize the risk of subsequent
problems.
Corporate Disruption
Mergers and acquisitions usually lead to significant
changes in managerial structure and systems:
Cultural Factors
The target will have a formal management structure
giving the task and reporting relationships that control,
coordinate and motivate employees.
There will also be an informal set of values and norms
a culture that determines how people and groups
within the firm interact with each other and with
stakeholders outside the organization, such as
customers and suppliers.
Cross-Border Factors
A failure to understand how to operate in a
particular country in terms of management and
business practice can seriously jeopardize the
success of an acquisition.
Revising Probability
Bayes theorem is used whenever probabilities
are revised in light of some new information
(e.g., a sample).
Bayesian Revision
Variable
Prior
probability
of variable
(T)
(V)
P(V)
Test
accuracy
P(T|V)
P(T|V)
Posterior
probability
P(V) x P(T|V)
P(V|T)
Materiality
is used to describe the significance of financial and
other information to its users.
Sampling
It is impossible to examine everything in a due diligence
process.
Non-random sampling
There may be reasons to select a sample that is
not representative of the population.
Sampling Criteria
A confidence level is the mathematical
probability that the sample will not differ from
the population by more than a stated amount.
Precision is the element of certainty that the
error rate in the sample applies proportionately
to the population.
Reliability Factor
The reliability factor is simply the negative
natural logarithm of the risk percentage
associated with the confidence level.
7. Implementation
as a process involves taking planned objectives and
converting them into real outcomes.
It takes place under conditions of change, and even
with detailed and accurate planning, there is an element
of uncertainty:
Change Management
In most change processes, people from Company A
plan and implement change that will affect only
Company A. In a merger, people in Company A and
Company B plan an outcome to be experienced by
Company C (the merged entity).
Effective monitoring of the change requires the
development of a baseline strategic project plan (SPP)
that sets out the practices and procedures (including
calibration, monitoring and control) that are to form
the implementation process.
Value Creation
Value can be created only if the imple-mentation
process achieves the planned synergies from the
merger or acquisition.
Integration Level
Mergers and acquisitions can require varying
levels of integration:
Identifying Synergy
Synergies in an M&A context should result in improved
competitive advantage from:
Exploiting Synergy
The implementation objective is to:
Implementation
is where plans are converted into reality by the
application of real tools and techniques.
at the strategic level, relates to the achievement of
long-term organizational objectives.
at the operational level, relates to developing the
new processes required to generate whatever it is that
the company produces as a product.
at the project level, relates to the completion of
individual projects that support or enhance the
operational processes.
Common Problems
Implementations tend to me messy, since they require
the disintegration and reintegration of the companies
involved.
The project team is often inexperienced with merger
implementation, is working together for the first time,
and members often retain functional responsibilities.
There are power and authority conflicts as the new
order evolves.
Moving goalposts project objectives are redefined in
response to changes or discoveries in the internal and
external environments.
Implementation Elements
Initial concept and strategy formulation: one or both
companies identify a requirement to merge.
Pre-implementation planning: the collection of all
information relevant for the planning process.
Informal approaches: often coincide with industry
rumor of merger discussions.
Preliminary evaluation: respective shareholders consider
their comfort with the arrangement, and a price or
exchange ratio is developed.
Commitment to proceed: an agreement might include a
provision for damages if the merger is abandoned, or
this may take the form of a declaration of a hostile
takeover.
Implementation Elements, 2
Shareholder brief
Design: of the new companys business strategy,
organizational structure, marketing, suppliers, etc. This
forms the basis of the SPP.
Merger contract negotiations
Shareholder vote
Final agreement: often very complex in order to be
complete.
Disintegration
Implementation management
Formation of the new company
Implementation Elements, 3
Disposal of the old companies: these usually cease to
exist.
Share redistribution
Competency and capability mapping
Integration: linking the organizational structures into a
coherent new unit.
Commissioning: even if there is no clear end point, the
company declares completion.
Post-merger evaluation and feedback: the vital (and
often neglected) step of capturing the learning from the
project experience.
CSFs / Hazards
Critical Success Factors
Enterprise-wide risk
management: change risks
are high
Enterprise-wide connectivity:
merger objectives to stay
aligned with organizational
objectives
Competency balance
Information management
System design and
programming
Hazards
Merger / organization
objective misalignment
Inadequate customer care
Disproportionate
organizational focus: loss of
external awareness
Key competency erosion:
flight of key staff
Organizational conflict
Implementation rate:
processes that are rushed are
more likely to go wrong
Risk Classification
Some risks can be classified in terms of likelihood and
consequence. The first-level equation for risk:
Risk = f (event, likelihood, impact)
Risk Mapping
A risk map plots various risks according to their
likelihood (x-axis) and impact (y-axis). The analysis then
divides the map into four quadrants:
Risk Mapping, 2
The map is dynamic, which means that the different
risks can migrate over time with changes in the
operation, its controls or the occurrence of other
events.
Successful management would shift risks down (lower
impact) and to the left (lower likelihood).
Responses
Risk reduction
Risk transfer
Risk avoidance
Seek further information
Risk retention
Managerial Levers
Leadership
Transformation Tools
Selecting appropriate leaders is important enough to
warrant time and effort in a rigorous assessment
process.
Competency Function
is the individuals overall characteristic set derived
from the competency profile:
8. Project Management
is a multidisciplinary and interdisciplinary generic set
of techniques. It is concerned with multiple objectives
and the various trade-offs that exist in achieving them.
Features of a Project
One-off, unique works where
the characteristics are defined
by the individual case.
Client specific
Relatively complex
Usually have a number of
clear and distinct objectives
Probably make use of limited
knowledge transfer
Obstacles to Implementation
Insufficient planning
Plans are effective only if adhered to, and if divergences are corrected
quickly. A process change requires re-planning.
Irreconcilable and unforeseen incompatibilities
These can arise from fundamental changes in demand or competition.
Post-acquisition change risk
in strategy, in operational processes or at the project level. These can
be planned or imposed; and originate inside or outside the organization.
Organizational resistance
results from a basic misalignment of the senior management view of
the change and the view of those working in the operations. It is driven
by the level of dissatisfaction with the status quo, the desirability of the
end state, and the practicality and risk associated with the end state.
The Concept
Project management offers a set of tools and
techniques for planning and implementing the merger.
Quality
Cost
Time
Project Functions
Planning covers the activities to be accomplished and
the sequence in which they are to be executed.
Project Functions, 2
Project managers are interested in authority
from two perspectives:
Project Functions, 3
Controlling (from a people perspective) is essentially a four-stage
process:
Project Functions, 4
There are nine primary stages in any good team-building process:
1. Establishing individual and
team commitment.
2. Generating a sustainable
team spirit.
3. Obtaining all necessary
resources.
4. Establishing clear individual
goals and success/ failure
criteria.
5. Procuring the support of
senior management.
6. Demonstrating effective
leadership.
7. Developing effective
communications systems.
8. Applying appropriate reward
and retribution systems.
9. Identifying and managing
conflict, whether of
argument or incompatible
working practices.
Project Functions, 5
Classic leadership traits include the following:
1. Decision-making ability
2. Problem-solving ability
3. Ability to integrate new
team members
4. Interpersonal skills
5. Ability to identify and
manage conflict
6. Communication skills
7. Factor-balancing skills
8. Interface management
skill
A project manager is in
the unusual position of
reporting upwards to the
senior managers,
horizontally to the
functional managers, and
downwards to the
individual project team
members.
3.
6.
7.
Derivative calculations:
This baseline SPP can be compared to any thencurrent version, incorporating changes made along
the way.
Combinations of foreseen and unforeseen changes
will mean that the original series of estimated times
will become obsolete very quickly, and a series of
corrective or realignment calculations will be needed
in order to bring the program back into line.
9. Implementation Plan
Between inception and the signing of the deal, the
project is broken down into components and then
organized into a comprehensive project plan.
After the deal is signed, the project plan is used to
develop successful outcomes through monitoring and
control.
Acquisitions and mergers put people under a unique set
of pressures.
Plan Detail
There is usually a functional relationship between the
detail of planning carried out and the success of the
project.
In practice, the level of detail demanded is that which
satisfies the level of control demanded by the
management team.
The Plan
The objective of planning is to develop and agree upon
a set of directions that tells the project team:
What is to be done
When it is to be done
How much it is going to cost
What resources are to be used
The plan itself is the link between the vision stages and
the execution stages.
Integration Stages
Initialization
Synthesis analysis
Integration Stages, 2
Transition
Correction
The trick is to be able to detect the divergence at
an early stage and then take action to ensure that
the divergence is corrected as quickly and
effectively as possible.
Sometimes divergences are the first indication
that the plan cannot be implemented in the
current form and a new plan must be drawn up.
A starting point
A desired end point
A progression curve
A current value
Analysis of current against projected values
Corrective action
Monitoring
Re-evaluation of performance versus objectives
Precedents
The integration process is generally preceded by
four key strategic decisions:
Successful Integration
uses an organization-wide approach.
Successful Integration
Successful Integration
achieves quick wins.
makes use of authority.
Achieving Synergies
often requires overcoming resistance in
existing:
Strategic Issues
The strategy could have been incorrectly
planned.
The original objectives may have been
incorrectly assessed.
The original objectives may now have changed.
Unforeseen events may impact on the
implementation of the strategy.
New strategies may have evolved.
People Issues
Confusion
Contractual Issues
These issues end to revolve around the due diligence
process.
The incorporation process usually involves accepting all
of the stated liabilities of the acquired, which includes
warranties.
Where events create a right of termination:
Technical Issues
Common technical issues are time delays, cost
overruns and missed performance targets.
Project scope
Project objectives
Resource availability
Extended due diligence
Competitor behavior
Customer demand