Developing Business and Acquisition Plans: Phases 1 & 2 of the Acquisition Process

If you dont know where you are going, any road will get you there. Alice in Wonderland

Course Layout: M&A & Other Restructuring Activities

Part I: M&A Environment

Part II: M&A Process

Part III: M&A Valuation & Modeling Public Company Valuation

Part IV: Deal Structuring & Financing Payment & Legal Considerations Accounting & Tax Considerations Financing Strategies

Part V: Alternative Strategies Business Alliances

Motivations for M&A

Business & Acquisition Plans Search through Closing Activities M&A Integration

Regulatory Considerations Takeover Tactics and Defenses

Private Company Valuation Financial Modeling Techniques

Divestitures, Spin-Offs & Carve-Outs Bankruptcy & Liquidation

Cross-Border Transactions

Current Learning Objectives

Primary learning objectives: To provide students with an understanding of a highly practical planning based approach to managing the acquisition process and the issues associated with each phase of the M&A process Secondary learning objectives: To provide students with an understanding of how to select the correct strategy from a range of reasonable alternatives and develop an acquisition plan

The Acquisition Process

Pre-Purchase Decision Activities Phase 1: Business Plan Phase 2: Acquisition Plan Phase 3: Search Phase 4: Screen Phase 5: First Contact Phase 6: Negotiation Phase 7: Integration Plan Phase 8: Closing Phase 9: Integration Phase 10: Evaluation

Post-Purchase Decision Activities

Phase 1: Business Plan

Industry/market definition (Where have we chosen to compete?) Example: Automotive industry (a collection of markets) Passenger car market by size and by geographic area Truck market by size and geographic area After-market

Why is it important to start by defining the target market?

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers): Five Forces Framework
Key objective: Identification of industry trends and whether they constitute opportunities or threats Example: Automotive industry What is changing with respect to Customers by vehicle size and geographic area Current competitors include Toyota, Daimler, GM, Ford, etc. Potential entrants include China Cherie and Indias Tata Motors Substitute products/technologies for internal combustion engine include hybrids, all electric car, hydrogen car, etc. Suppliers include material vendors, lenders, labor, etc. How will these changes impact my business?

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers) Internal analysis (strengths and weaknesses as compared to the competition) Key questions: Do our strengths enable us to pursue opportunities identified in the external analysis? Do our weaknesses make us vulnerable to the threats identified in the external analysis? Example: Automotive industry If our targeted customer values fuel efficiency, do our strengths enable us to produce high quality fuel efficient cars better than our competition? To what extent do our strengths help us satisfy our customers needs better than the competition? To what extent do our weaknesses make us vulnerable to losing customers?

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers) Internal analysis (strengths and weaknesses as compared to the competition) Opportunities/threats (from external and internal analyses) Summarizing strengths and weaknesses versus opportunities and threats using a SWOT matrix Example: Amazon.com Opportunity is to be perceived as the preferred online retail department store Threat is that Walmart, Best Buy, and Costco increase their online presence

Hypothetical Amazon.com SWOT Matrix

Opportunity: To be perceived by internet users as the preferred online retail department store Amazon.coms Strengths Relative to the opportunity: Brand recognition Convenient online order entry system Information technology infrastructure Fulfillment infrastructure for selected products (e.g., books) Relative to the opportunity: Inadequate warehousing and inventory management systems to support quantum sales growth Limited experience in merchandising non-core retail products (e.g., electronics) Limited financial resources Solo venture Partner Acquire Threat: Walmarts, BestBuys, Costcos increasing presence on the internet Relative to the threat: Extensive experience in online marketing, advertising, and fulfillment

Amazon.coms Weaknesses

Relative to the threat: Substantially smaller retail sales volume limits ability to exploit purchase economies Limited financial resources Limited name recognition in selected markets (e.g., consumer electronics) Lack of retail management depth Solo venture Partner Acquire Exit business

Strategic Options

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers) Internal analysis (strengths and weaknesses as compared to the competition) Opportunities/threats (from external and internal analyses) Business vision/mission (Defines direction and provides means of communicating succinctly with key stakeholder groups) How do we wish to be perceived by key stakeholders? What quantifiable objectives will be used to determine progress in achieving vision/mission? (e.g., market share, customer surveys indicating how we are perceived, etc.) Hypothetical Example: Amazon.com wishes to be perceived by consumers as the preferred online department store

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers) Internal analysis (strengths and weaknesses as compared to the competition) Opportunities/threats (from external and internal analyses) Business vision/mission Business Strategies (cost, differentiation, focus, or some combination) Which of these generic business strategies best enables to firm to achieve its vision/mission and objectives?

Phase 1: Business Plan

Industry/market definition External analysis (customers, current competitors, potential entrants, substitute products, and suppliers) Internal analysis (strengths and weaknesses as compared to the competition) Opportunities/threats (from external and internal analyses) Business vision/mission Business Strategies (cost, differentiation, focus, or some combination) Implementation strategy (selected from a range of options) Solo ventures or go it alone Merger or acquisition Alliances (including JVs, partnerships, and licensing) Minority investments and Asset swaps

Application
1. Discuss how you would use information obtained from the external, internal, and opportunities/threats identification analyses conducted during the business planning process to select an appropriate business strategy. Be specific. 2. Discuss how you would select the appropriate implementation strategy. Be specific. (Hint: Consider the resourcesbroadly defined--required/currently available to exploit potential opportunities and threats.)

Adobe Acquires Omniture Case Study

On 9/14/09, Adobe announced the acquisition of Omniture for $1.8 billion in cash Adobe: Makes web design tools (e.g., Acrobat, Flash, and Creative Suite incl. Photoshop and Illustrator) and sells customers perpetual licenses Targeted Markets/Spaces1: Web designers, online retailers, and media firms (e.g., News Corp) Omniture: Makes software capable of tracking how users utilize web sites (e.g., tracking page views); users pay monthly fees to subscribe to service Targeted Markets/Spaces: Online retailers, advertisers, and media firms At $3 billion in annual revenue, Adobe 10 times larger than Omniture Both firms losing revenue Adobe faced difficulty in upgrading existing clients and adding new clients due to recession Omniture revenue erosion reflected introduction of free analytical software by Google and reduced advertising spending due to recession
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Note markets or spaces consist of customers with homogeneous needs

Adobe External Analysis: Customer Value Chain

Create Deliver User Engages Via Interface Analyze

Optimize

Customer Needs: To cost-effectively create content, display/deliver content, generate web user
activity/transactions, analyze how site utilized, and improve process to increase transactions

Adobe External Analysis Continued

Key Trends: Renting software online Customers buying multiple software capabilities from a single vendor to ensure compatibility Business model/strategy based on perpetual licensing of software highly cyclical (i.e., customers can postpone upgrades to new products)

Adobe Internal Analysis

Adobes core skills focused on developing website design software Sales concentrated on only one segment of the value chain (i.e., create content) Limited experience in how to develop a subscription-based business model/strategy

Adobes Mission, Business, and Implementation Strategies

Adobe's vision/mission: To revolutionize how the world engages with ideas and information Business Strategy/Model: To move From selling customers perpetual software licenses and increasing revenue by upgrading current clients and attracting new clients To a monthly subscription model Implementation Strategy1 Acquire a vendor targeted at a different phase of the customer value chain whose revenues are based on the subscription model
1

Alternative implementation strategies include solo venture, partnering, or acquisition.

Discussion Questions
1. Why might Adobe have decided to acquire Omniture rather than to partner with Omniture or to build a similar capability on its own? 2. What considerations might have made Omniture an attractive acquisition target for Adobe?

Application
1. Discuss how you would use information obtained from the external, internal, and opportunities/threats identification analyses conducted during the business planning process to select an appropriate business strategy. Be specific. 2. Discuss how you would select the appropriate implementation strategy. Be specific. (Hint: Consider the resourcesbroadly defined--required/currently available to exploit potential opportunities and threats.)

Phase 2: Acquisition Plan (How to implement the acquisition)

Plan objectives (support the realization of key business plan objectives) How will the acquired firm enable the acquiring firm to better realize its vision/mission and business plan objectives?

Examples of Linkages Between Business and Acquisition Plan Objectives Business Plan Objective Financial: The firm will Achieve rates of return that will equal or exceed its cost of equity or capital by 20?? Maintain a debt/total capital ratio of x% Size: The firm will Be the number one or two market share leader by 20?? Achieve revenue of $x million by 20?? Growth: The firm will achieve through 20?? annual average Revenue growth of x% Earnings per share growth of y% Operating cash-flow growth of z% Diversification: The firm will reduce earnings variability by x%. Flexibility: Achieve flexibility in manufacturing and design. Technology: The firm will be recognized by its customers as the industrys technology leader. Quality: The firm will be recognized by its customers as the industrys quality leader. Service: The firm will be recognized by its customers as the industrys service leader. Cost: The firm will be recognized by its customers as the industrys low-cost provider. Innovation: The firm will be recognized by its customers as the industrys innovation leader. Acquisition Plan Objective Financial returns: The target firm should have A minimum return on assets of x% A debt/total capital ratio y% Unencumbered assets of $z million Size: The target firm should be at least $x million in revenue

Growth: The target firm should Have annual revenue, earnings, and operating cash-flow growth of at least x%, y%, an z% Provide new products and markets of x% by 20?? Possess excess annual production capacity of x million units Diversification: The target firms earnings should be largely uncorrelated with the acquirers earnings. Flexibility: Target should use flexible manufacturing techniques. Technology: The target firm should possess important patents, copyrights, and other forms of intellectual property. Quality: The target firms product defects must be <x per million units manufactured. Warranty record: The target firms customer claims per million units sold should be not greater than x. Labor costs: The target firm should be nonunion and not subject to significant government regulation. R&D capabilities: The target firm should have introduced at least x new products in the last 18 months.

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Defined by activity completion dates, deliverables (what is to be achieved), and individual (s) responsible for satisfying objectives Example: Daniel Stuckee is to have completed identifying a list of potential targets by 2/24/20??

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Determine maximum size of acquisition in terms of P/E. sales, cash flow, purchase price, etc. Assess internal management capabilities (Can acquirer continue to manage current businesses as well as integrate the acquired firm?)

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences (Senior management guidelines to acquisition team) Examples: Prefer an asset or a stock purchase Use cash only Will consider competitors as potential targets Want controlling interest Limit EPS dilution to two years following closing

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences Search plan Key search criteria include industry/geographic area and maximum size of acquisition Relatively few criteria used to avoid limiting list of potential targets

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences Search plan Negotiation strategy Starts with assessment of the needs of parties involved Determine proposals to satisfy the highest priority needs of the parties involved. For example, consider Using acquirer stock if seller wants a tax free sale Long-term employment contract if seller wants to stay with the business Having seller sign a non-compete to avoid future competition with seller

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences Search plan Negotiation strategy Determine initial offer price Requires buyer to estimate Minimum purchase price (i.e., standalone or market price for purchase of shares or liquidation value for asset purchase) Synergy created by combining acquirer and target firms Percent of synergy acquirer willing to share with target (often reflects premium paid on recent similar transactions or the portion of synergy contributed by the target)

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences Search plan Negotiation strategy Determine initial offer price Financing plan (acid test) How will you pay for acquisition? Will someone lend you the money? Will acquirer shareholders tolerate EPS dilution?

Phase 2: Acquisition Plan

Plan objectives (support the realization of key business plan objectives) Timetable Resource/capability review Management preferences Search plan Negotiation strategy Determine initial offer price Financing plan Integration plan Objective: Combine businesses as rapidly as practical What projects offer the greatest likelihood of realizing synergy? What must be done to retain key people? What investments must be made to keep businesses operational? What is the appropriate communication plan? How will the corporate cultures be best integrated?

Applications
1. 2. 3. Identify at least 3 criteria that might be used to select a manufacturing firm as a potential acquisition candidate? A financial services firm? A high technology firm? Despite weeks of sometimes heated negotiation, the seller continues to insist on a purchase price that is $5 million more than the potential buyer is willing to pay. How can the buyer and seller close the price gap? Be specific. Following due diligence, the buyer is concerned about the outcome of pending litigation facing the seller. The potential impact over the next three years if the firm were to lose the lawsuits could be as high as $4 million. How can the buyer protect herself against this potential liability if she acquires the target firm? The CEO of the acquiring firm insists that the integration of the target firm must be completed as rapidly as possible in order to realize the full value of estimated synergies. Why might the CEO feel this way? What are the risks associated with a rapid integration of the target firm into the acquirer? What are the risks of a slow integration of the target firm into the acquirer? The CEO of a small start-up firm has just been contacted by a potential acquirer, who is offering to buy the firm for a very attractive purchase price. However, the CEO refuses to provide any data on her firm until the potential buyer provides her with three years of signed Federal income tax statements, personal bank statements, and a net worth statement. Why? Is the CEO being reasonable? What alternatives does she have if the buyer refuses to provide this information?

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Things to remember...
The success of an acquisition is dependent on the focus, understanding, and discipline inherent in a thorough and thoughtful business plan An acquisition is only one of many options available for implementing a business plan Once a decision has been made that the implementation of the firms business strategy requires an acquisition, an acquisition plan is required.