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Types of M&A Transactions: Value Creation in Acquisition
Companies engage in M&A activity with the objective of creating value for their shareholders. The value can be generated through stand-alone improvements and synergies. However, the majority of acquisitions fail to create value, and many of them destroy shareholder value.
Companies decide to acquire another company to get its know-how or to get its brand equity (its history). In order to acquire a company, they have to assess a certain value and pay an extra premium price, which is expected to be lower than the expected benefits they believe they will get from the acquisition and the exploiting of synergies. Behind an acquisition, there is the concept that they are able to create extra value. They can get extra benefits since they expect to create synergies.
There are many types of synergies:
- Cost Saving: This is the most common type of synergy and the easiest to estimate, and they are also labeled as "hard synergies". They often come from eliminating jobs, facilities,
1. Cost Savings: these can be achieved through the elimination of duplicate functions and related expenses that are no longer needed when functions are consolidated, or they come from economies of scale in purchasing.
2. Revenue Enhancements: it is sometimes possible for an Acquirer and its Target to achieve a higher level of sales growth together than either company could do on its own. In fact, sometimes the Target brings a superior or complementary product to the more extensive distribution channel of the Acquirer. In other instances, a Target's distribution channel can be used to escalate the sales of the Acquirer's product. Revenue enhancements are notoriously hard to estimate, and they are often described as "soft synergies".
3. Process Improvements: they occur when managers transfer best practices and core competencies from one company to the other. That results in both cost savings and revenue enhancements. The transfer of best practices can flow in either direction.
4. Financial Engineering: an example is when a transaction allows the Acquirer
torefinance the Target's debt at the Acquirer's more favourable borrowing rate, without negatively affecting the Acquirer's credit rating. The synergies between the Acquirer and the Target are specific to each Acquirer. The value of synergies is normally "split" between the two as part of the price negotiation. The quantification of synergies is part of the valuation process. Synergies can materialise only through a successful integration. REASONS FOR MAKING ACQUISITION 1. Increased market power Factors increasing market power: - when a firm is able to sell its goods or services above competitive levels, or - when the costs of its primary or support activities are below those of its competitors; - usually it is derived from the size of the firm and its resources and capabilities to compete. Market power is increased by: - horizontal acquisitions; - vertical acquisitions; - related acquisitions. 2. Overcome barriers to entry Barriers to entry include: - economies of scale inestablished competitors;
differentiated products by competitors;
enduring relationships with customers that create product loyalties with competitors.
Acquisition of an established company may be more effective than entering the market as a competitor offering an unfamiliar good or service that is unfamiliar to current buyers
Cross-border acquisitions
3. Cost of new product development
Significant investments of a firm's resources are required to:
- develop new products internally;
- introduce new products into the marketplace.
Acquisitions are faster to accomplish than internal development, because the company acquired is typically "up and running"
4. Lower risk compared to developing new products
An acquisition's outcomes can be estimated more easily and accurately compared to the outcomes of an internal product development process. Compared with internal development, more information is available to the prospective acquirer to evaluate the move. Therefore, managers may
view acquisitions as lowering risk.
Increased diversification
It may be easier to develop and introduce new products in markets currently served by the firm. It may be difficult to develop new products for markets in which a firm lacks experience. It is uncommon for a firm to develop new products internally to diversify its product lines. Acquisitions are the quickest and easiest way to diversify a firm and change its portfolio of businesses.
Reshaping the firms' competitive scope
Firms may use acquisitions to reduce their dependence on one or more products or markets. Reducing a company's dependence on specific markets alters the firm's competitive scope. Once a company has decided to change corporate scope, acquisitions have at least two advantages compared with internal development:
- They are faster to accomplish than internal development, because the company acquired is typically "up and running".
- Compared with internal development, more
1. Inadequate due diligence
Firm may not thoroughly assess the target company's financial health, operations, and potential risks. This can lead to:
- Overlooking hidden liabilities or legal issues
- Underestimating the target company's true value
- Failure to identify potential synergies
2. Poor integration planning
Failure to plan and execute the integration of the two companies effectively can result in:
- Loss of key employees and talent
- Disruption of operations and customer relationships
- Difficulty in aligning cultures and business processes
- Challenges in achieving cost savings and operational efficiencies
- Uncertainty and resistance from employees
- Issues related to:
- Technology integration
- Supply chain management
- Financial reporting and control systems
- Legal and regulatory compliance
3. Large or extraordinary debt
Firm may take on significant debt to acquire a company. High debt can:
- Increase the likelihood of bankruptcy
- Lead to a downgrade in the firm's credit rating
- Preclude needed investment in activities that contribute to the firm's long-term success
4. Inability to achieve synergies
Synergies exist when assets are worth more when used in conjunction with each other than when they are used separately. Firms experience transaction costs (e.g., legal fees) when they use acquisition strategies to create synergies. Firms tend to underestimate indirect costs of integration when evaluating a potential acquisition
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 business units' performances. Acquisitions may become substitutes for innovation.
Managers overly focused on acquisition. Managers in Target firms may operate in a state of virtual suspended animation during an acquisition. Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed. Acquisition process can create a short-term perspective and a greater aversion to risk among top-level executives in a Target firm.
Too large. 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 behaviour.
M&A is a complex task: 65% of M&A projects fail. Why it is complex?
- It requires negotiation so I could attribute to the target the wrong value
- Mismatching culture
100 years ago, the market was very homogeneous, all individuals wanted the same products to satisfy the same need (H. Ford): basic market with unsophisticated expectations.
Around the 60s, segmentation became extremely important, since market started being characterized by diversity in terms of customers' expectations: e.g. given the mobility problem, people were looking for different cares (different colors, product performances, etc.).
Segmentation became a crucial topic in order to analyze such differentiation and deal somehow with this market diversity: the arrival of digital economies and the usage of data, the quality of the segmentation we run is improved.
The objectives:
Manage the issue of diversity and identify homogeneous groups of customers (from a general view point), it is important to qualify the conditions under which the group is considered homogeneous.
Coke companies e.g. segmented the market too: red coke was the only one and the company sold
the same product all over the world: mass marketing at the product and advertising level (the campaign was the same all over the world). Coke companies realized later that there was a progressive trend defining the need to qualify segmentation: light, zero, etc. There are different requirements (e.g. sugar content, tastes). A differentiated strategy was carried out for the product portfolio: the market was becoming heterogeneous and different segments could be identifies. They didn't simply modify the program, but the campaign too: the advertisement message was adapted to specific sensibilities of the local market.
It is not enough to work accordingly to a segmented approach: segments should correspond to individuals. The digital economy pushed companies to
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