Mergers and Acquisitions Chapter 10 Mergers and Acquisitions

The Strategic Management Process External Analysis Strategic Choice Strategy Implementation Competitive Advantage Mission Objectives Which Businesses to Enter? Internal Analysis • Vertical Integration Corporate Level Strategy • Diversification Mode of Entry? • Strategic Alliances • Mergers & Acquisitions

Logic of Corporate Level Strategy Applies Corporate level strategy should create value: 1) such that the value of the corporate whole increases 2) such that businesses forming the corporate whole are worth more than they would be under independent ownership 3) that equity holders cannot create through portfolio investing

Mergers & Acquisitions Defined • one firm buys another firm • two firms are combined on a relatively co-equal basis • the words are often used interchangeably even though they mean something very different • merger sounds more amicable, less threatening

Mergers & Acquisitions Defined • parent stocks are usually retired and new stock issued • can be a controlling share, a majority, or all of the target firm’s stock • name may be one of the parents’ or a combination • can be friendly or hostile • one of the parents usually emerges as the dominant management • usually done through a tender offer

Do Mergers and Acquisitions Create Value? The Logic Unrelated M&A Activity • there would be no expectation of value creation due to the lack of synergies between businesses • there might be value creation due to efficiencies from an internal capital market • there might be value creation due to the exploitation of a conglomerate discount • a corporate raider who buys and restructures firms

Mergers & Acquisitions Defined Types of M&A Activity FTC Categories Vertical » suppliers or customers Horizontal » competitors Related Product Extension » complementary products Market Extension » complementary markets Unrelated Conglomerate » everything else

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Section 2 Do M&As work?

Do Mergers and Acquisitions Create Value? The Logic Related M&A Activity • value creation would be expected due to synergies between divisions • economies of scale • economies of scope • transferring competencies • sharing infrastructure, etc.

Do Mergers and Acquisitions Create Value? The Empirical Evidence Research is based on stock market reaction to the announcement of M&A activity • this reflects the market’s assessment of the expected value of the merger or acquisition • these studies look at what happens to the price of both the acquirer’s stock and the target’s stock • thus, we can see who is capturing any expected value that may be created

M&A activity creates value, but target firms capture it Do Mergers and Acquisitions Create Value? The Empirical Evidence M&A Activity creates value, on average, as follows: Acquiring Firms Target Firms • no value created • value increases by about 25% • related M&A activity creates more value than unrelated M&A activity M&A activity creates value, but target firms capture it

Do Mergers and Acquisitions Create Value? Expected versus Operational Value April 2000: Wells Fargo offers to acquire First Security Bank for about $3 billion Expected Operational Stock values were: Wells Fargo: $43.69 First Security: $15.50 The Deal: .355 shares of WF for each share of FS stock Stock Price Market Cap. 12/1999 $40.44 $65.7 B 12/2000 $56.69 $95.2 B 12/2001 $43.60 $74.0 B 12/2002 $46.87 $82.0 B 12/2003 $58.89 $100.0 B 12/2004 $62.15 $105.0 B Wells Fargo: down $0.25 to $39.50 First Security: up $1.19 to $13.38

Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? Survival • avoid competitive disadvantage • avoid scale disadvantages Free Cash Flow • cash generating, normal return investment

Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? Agency Problems • managers benefit from increases in size • managers benefit from diversification Managerial Hubris • managers believe they can beat the odds

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Section 3 Does M&A Create a Competitive Advantage?

Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? • some M&A activity does generate above normal profits (expected and operational over the long run) Above Normal Profits • proposed M&A activity may satisfy the logic of corporate level strategy • managers may see economies that the market can’t see

Competitive Advantage Can an M&A strategy generate sustained competitive advantage? Yes, if managers’ abilities meet VRIO criteria 1 Managers may be good at recognizing & exploiting potentially value-creating economies with other firms 2 Managers may be good at doing ‘deals’ 3 Managers may be good at both

Competitive Advantage Recognizing and Exploiting Economies of Scope Private Economies • Firm C’s recognized value is $10,000 Firm A $12,000 Firm C • Firm A sees value of $12,000 in Firm C $10,000 Firm B • Firm A can earn a profit of $2,000 only if the economy remains private Bidders Target

Competitive Advantage Recognizing and Exploiting Economies of Scope Costly-to-Imitate Economies Firm A • if the economy between A & C is costly to imitate, it doesn’t matter if other firms know $12,000 Firm C $10,000 Firm B • Firm A can still earn a $2,000 profit Bidders Target

Competitive Advantage Recognizing and Exploiting Economies of Scope Unexpected Economies Firm A • Firm C has a market value of $10,000 $10,000 $12,000 Firm C • Firm A buys Firm C for $10,000 $10,000 Firm B • Firm C turns out to be worth $12,000 Bidders Target

Competitive Advantage Doing the Deal Search for Rare Economies Seek Thinly Traded Markets Limit Information to Other Bidders Bidding Firm’s Perspective Close the Deal Quickly Limit Information to the Target Avoid Bidding Wars

Competitive Advantage Doing the Deal Seek Information from Bidders Target Firm’s Perspective Invite Other Bidders to Join in Bidding Contest Delay, But Do Not Stop the Acquisition

Implementation Issues Structure, Control, and Compensation M&A activity requires responses to these issues: • m-form structure is typically used • management controls & compensation policies are similar to those used in diversification strategies Managers must decide on the level of integration: • target firm may remain somewhat autonomous • target firm may be completely integrated

Implementation Issues Cultural Differences • high levels of integration require greater cultural blending • cultural blending may be a matter of: • combining elements of both cultures • essentially replacing one culture with the other • integration may be very costly, often unanticipated • the ability to integrate efficiently may be a source of competitive advantage

Summary M&A activity is a mode of entry for vertical integration and diversification strategies A firm’s M&A strategy should satisfy the logic of corporate level strategy M&A activity can create economic value at announcement, but target firms usually capture that value M&A activity can create value over the long term for the acquiring firm