Strategy Marketing

(M&A)

M&A

Faced with the need to muscle out competitors, companies are increasingly pursuing

inorganic growth as a strategy for capturing new markets, adding new business lines, and

scaling up quickly. The corporate world has experienced spikes of mergers and acquisitions

activity in the past, but nothing compares to the volume of megadeals in the past two

decades.

In 1990, there were nearly 10,000 M&A deals with a combined value equivalent to 2 percent

of world GDP. Since 2008, there have been some 30,000 deals a year totaling roughly 3

percent of world GDP. The total value of worldwide deals in 2014 was $3.5 trillion, up 25

percent from the previous year and its highest level since the global financial crisis. Ninety-

five deals exceeding $5 billion were announced in that year alone.

Emerging-market companies have been significant players in this trend:

Types of M&A transactions:

1. ACQUISITION: acquire a controlling stake in a company (target) (acquire of another

company for reducing costs, acquire of foreign markets, …); consider pursuing if: the

opportunity is not going to last, the target is undervalued, it will ease entry to a new market,

skills and competencies are complementary, the target fits and enhances the company’s

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portfolio.

2. JOINT VENTURE: join forces with another company, strong partnership with another

company (weaker than acquisition and with lower risk). Consider pursuing if: it will ease

entry to a new market, skills and competencies are complementary, you are not ready to

commit to a full blown acquisition, additional resources are needed for a compelling project.

3. DIVESTITURE: sell a whole business unit/brand to another company. Consider pursuing if:

the unit needs more resources or capital than you can provide.

Advantages of acquisition: once a company has decided to change corporate scope,

acquisitions have at least three advantages compared with internal development:

- they are faster to accomplish than internal development, because the company

acquired is typically “up and running” (enter a new market is faster than developing

it internally);

- compared with internal development, more information is available to the

prospective acquirer to evaluate the move (developing a new product is risky: it may

not succeed but if the product is already sold we reduce the risk);

- a certain percentage of internally developed new business fail. By acquiring a going

concern, the acquirer does not need to pay for any of the failures along the way (the

new product has not a customer base: an established brand has no need of marketing

activities: also the customer is “bought”).

The final objective of M&A is the value creation: 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.

Main types of synergies:

1. Cost Saving: this is the most common type of synergy and the easiest to estimate, and

they are also labelled as “hard synergies”. They often come from eliminating jobs, facilities,

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

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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 to refinance

the Target’s debt at the Acquirer’s more favorable borrowing rate, without negatively

affecting the Acquirer’s credit rating.

Synergies play a role in: Valuation, Negotiation, Integration

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 materialize only

through a successful integration.

Synergies are a process: how do company valuate? A proper evaluation of the value of the

target is needed. First of all it is necessary to check info about the target company, then

provide a value including future opportunities (usually higher than the actual value) and

finally decide to pay in money or in shares (own part of it). The process takes years.

Reasons for making acquisition:

1) increase market power: toward suppliers, with customers. 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 acquisition: company operating at the same level;

o vertical acquisition: company on a different stage of value chain (ex. supplier,

o distributor);

related acquisitions.

o

2) overcome entry barriers (cross-border acquisition); barriers to entry include:

- economies of scale in established competitors; 81

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- differentiates 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.

3) cost of new product development: faster and less risky to acquire; significant investments

of a firm’s resources are required to:

- develop new products internally;

introduce new products into the marketplace.

4) lower risk compared to developing new products: an acquisition’s outcomes can be

estimates more easily and accurately compared to the outcomes of an internal product

development process. Therefore, managers may view acquisitions as lowering risk.

5) increased diversification: internally not enough knowledge and resources; it may be

easier to develop and introduce new products in markets currently serves 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 à

acquisition are the quickest and easiest way to diversify a firm and change its portfolio of

businesses.

6) reshaping the firm’s competitive scope (deliver an offer to another target market); firms

may use acquisition 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:

1. they are faster to accomplish than internal development, because the company acquired

is typically “up and running”;

2. compared with internal development, more information is available to the prospective

Acquirer to evaluate the move.

7) learning and developing new capabilities (patents and technological knowledge).

Acquisitions may gain capabilities that the firm does not possess. Acquisitions may be used

to:

- acquire a special technological capability;

- broaden a firm’s knowledge base;

- reduce inertia.

Problems with acquisition (most of them destroy value) 82

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1) integration difficulties: different approaches and structures, require a lot of time and it’s

expensive; integration challenges include:

- melding two disparate corporate culture;

- linking different financial and control systems;

- building effective working relationships (particularly when management styles differ);

- resolving problems regarding the status of the newly acquired firms’ executives;

- loss of key personnel weaken the acquired firm’s capabilities and reduces its value.

2) inadequate evaluation of target: evaluation requires that hundreds of issues be closely

examined, including:

- financing for the intended transaction;

- differences in cultures between the acquiring and target firm;

- tax consequences of the transaction;

- actions that would be necessary to successfully meld the two workforces.

Ineffective due-diligence process may result in paying excessive premium for the target

company.

3) large or extraordinary debts: a big investment is required (interest of the debt cause

instability); firm may take on significant debt to acquire a company. High debt can:

- increase the likelihood of bankruptcy;

- lead to 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

conjunctions 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.

6) 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.

7) 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 behavior.

Most of the time the costs are higher that the expectations and the reaction of the market

is not as expected. The value is destroyed. 83

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