Acquisition & Restructuring Strategies Chapter Seven BA

7–2 Today’s Agenda Background on Mergers & AcquisitionsBackground on Mergers & Acquisitions Reasons for AcquisitionsReasons for Acquisitions Problems in Achieving Acquisition SuccessProblems in Achieving Acquisition Success Effective AcquisitionsEffective Acquisitions RestructuringRestructuring KLC-KinderCare AcquisitionKLC-KinderCare Acquisition Wrap-upWrap-up

7–3 Background on Mergers & Acquisitions

7–4 Trends in M&A Trends in M&A Mergers & Acquisitions peaked in 2000 at about $3.4B and fell to about $1.75B in 2001Mergers & Acquisitions peaked in 2000 at about $3.4B and fell to about $1.75B in 2001 The global volume of announced acquisition agreements was up 41% from 2003 to $1.95 trillion for 2004The global volume of announced acquisition agreements was up 41% from 2003 to $1.95 trillion for – 45% of acquisitions in recent years have been made across country borders40 – 45% of acquisitions in recent years have been made across country borders In In the acquisition boom between 1998 and 2000, acquiring firm shareholders experienced significant lossesIn In the acquisition boom between 1998 and 2000, acquiring firm shareholders experienced significant losses

7–5 Mergers, Acquisitions, and Takeovers: What are the Differences? MergerMerger  Two firms agree to integrate their operations on a relatively co-equal basis. AcquisitionAcquisition  One firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio. TakeoverTakeover  A special type of acquisition when the target firm did not solicit the acquiring firm’s bid for outright ownership.

7–6 Reasons for Acquisitions

7–7 Reasons for Acquisitions Learning and developing new capabilities Reshaping firm’s competitive scope Increaseddiversification Cost of new product development Overcoming entry barriers Increase speed to market Increased market power Making an Acquisition

7–8 Acquisitions: Increased Market Power Market power is increased when:Market power is increased when:  There is the ability to sell goods or services above competitive levels.  Costs of primary or support activities are below those of competitors.  A firm’s size, resources and capabilities gives it a superior ability to compete. Acquisitions intended to increase market power are subject to:Acquisitions intended to increase market power are subject to:  Regulatory review  Analysis by financial markets

7–9 Acquisitions: Increased Market Power Market power is increased by:Market power is increased by:  Horizontal acquisitions: other firms in the same industry  Vertical acquisitions: suppliers or distributors of the acquiring firm  Related acquisitions: firms in related industries

7–10 Market Power Acquisitions Acquisition of a company in the same industry in which the acquiring firm competes increases a firm’s market power by exploiting:Acquisition of a company in the same industry in which the acquiring firm competes increases a firm’s market power by exploiting:  Cost-based synergies  Revenue-based synergies Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics.Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics. Horizontal Acquisitions

7–11 Market Power Acquisitions Acquisition of a supplier or distributor of one or more of the firm’s goods or servicesAcquisition of a supplier or distributor of one or more of the firm’s goods or services  Increases a firm’s market power by controlling additional parts of the value chain. Horizontal Acquisitions Vertical Acquisitions

7–12 Market Power Acquisitions (cont’d) Acquisition of a company in a highly related industryAcquisition of a company in a highly related industry  Acquisition target is typically a complementor, not a competitor. Horizontal Acquisitions Vertical Acquisitions Related Acquisitions

7–13 Acquisitions: Overcoming Entry Barriers Entry BarriersEntry Barriers  Factors associated with the market or with the firms operating in it that increase the expense and difficulty faced by new ventures trying to enter that market Economies of scaleEconomies of scale Brand loyaltyBrand loyalty Distribution channelsDistribution channels Cross-Border AcquisitionsCross-Border Acquisitions  Acquisitions made between companies with headquarters in different countries Fastest way to enter new marketsFastest way to enter new markets Provide more control over foreign operations than utilizing alliances Can be difficult to negotiate and operate because of the differences in foreign cultures

7–14 Acquisitions: Cost of New-Product Development and Increased Speed to Market Internal development of new products is often perceived as high-risk activity.Internal development of new products is often perceived as high-risk activity.  Acquisitions allow a firm to gain access to new and current products that are new to the firm.  Returns are more predictable because of the acquired firms’ experience with the products. Must be wary of acquisitions replacing need for innovation in the firm.Must be wary of acquisitions replacing need for innovation in the firm.

7–15 Acquisitions: Increased Diversification Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio of businesses.Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio of businesses. Both related diversification and unrelated diversification strategies can be implemented through acquisitions.Both related diversification and unrelated diversification strategies can be implemented through acquisitions. The more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful.The more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful.

7–16 Acquisitions: Reshaping the Firm’s Competitive Scope An acquisition can:An acquisition can:  Reduce the negative effect of an intense rivalry on a firm’s financial performance.  Reduce a firm’s dependence on one or more products or markets. Reducing a company’s dependence on specific markets alters the firm’s competitive scope.Reducing a company’s dependence on specific markets alters the firm’s competitive scope.

7–17 Acquisitions: Learning and Developing New Capabilities An acquiring firm can gain capabilities that the firm does not currently possess:An acquiring firm can gain capabilities that the firm does not currently possess:  Special technological capability  A broader knowledge base  Reduced inertia Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base.Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base.

7–18 Problems in Achieving Acquisition Success

7–19 Problems in Achieving Acquisition Success Too large Managers overly focused on acquisitions Extraordinary debt Inadequate target evaluation Too much diversification Inability to achieve synergy Integrationdifficulties Problems with Acquisitions

7–20 Problems in Achieving Acquisition Success: Integration Difficulties Integration challenges include:Integration challenges include:  Melding two disparate corporate cultures  Linking different financial and control systems  Building effective working relationships (particularly when management styles differ)  Resolving problems regarding the status of the newly acquired firm’s executives  Loss of key personnel weakens the acquired firm’s capabilities and reduces its value

7–21 Example – Culture Clash Source: The Wall Street Journal, March 7, 2006, B2 Grants seats based on seniority Discounted flight privileges for employees Grants seats based on a first-come, first- served basis More traditional uniforms Uniforms More casual uniforms Offers Coca Cola and Miller beer In-flight beverages Serves Pepsi and Bud Light beer Unions want to protect the seniority standings of their members Seniority rankings Workers are concerned about being ranked as less senior than US Airways staffers

7–22 Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target Due Diligence: The process of evaluating a target firm for acquisitionDue Diligence: The process of evaluating a target firm for acquisition  Ineffective due diligence may result in paying an excessive premium for the target company. Evaluation requires examining:Evaluation requires examining:  Financing of the intended transaction  Differences in culture between the firms  Tax consequences of the transaction  Actions necessary to meld the two workforces  The value the target firm will offer to the acquiring firm

7–23 Problems in Achieving Acquisition Success: Large or Extraordinary Debt High debt can:High debt can:  Increase the likelihood of bankruptcy  Lead to a downgrade of the firm’s credit rating  Preclude investment in activities that contribute to the firm’s long-term success such as: Research and developmentResearch and development Human resource trainingHuman resource training MarketingMarketing

7–24 Problems in Achieving Acquisition Success: Inability to Achieve Synergy Synergy: When assets are worth more when used in conjunction with each other than when they are used separately.Synergy: When assets are worth more when used in conjunction with each other than when they are used separately. Transaction costsTransaction costs  Firms experience transaction costs when they use acquisition strategies to create synergy.  Firms tend to underestimate indirect costs when evaluating a potential acquisition.

7–25 Problems in Achieving Acquisition Success: Too Much Diversification Diversified firms must process more information of greater diversity.Diversified firms must process more information of greater diversity.  Increased operational scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances.  Strategic focus shifts to short-term performance.  Acquisitions may become substitutes for innovation.

7–26 Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions Managers invest substantial time and energy in acquisition strategies in:Managers invest substantial time and energy in acquisition strategies in:  Searching for viable acquisition candidates.  Completing effective due-diligence processes.  Preparing for negotiations.  Managing the integration process after the acquisition is completed.

7–27 Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions Managers in target firms operate in a state of virtual suspended animation during an acquisition.Managers in target firms 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.  The acquisition process can create a short-term perspective and a greater aversion to risk among executives in the target firm.

7–28 Problems in Achieving Acquisition Success: Too Large Additional costs of controls may exceed the benefits of the economies of scale and additional market power.Additional costs of controls may exceed the benefits of the economies of scale and additional market power. Larger size may lead to more bureaucratic controls.Larger size may lead to more bureaucratic controls. Formalized controls often lead to relatively rigid and standardized managerial behavior.Formalized controls often lead to relatively rigid and standardized managerial behavior. The firm may produce less innovation.The firm may produce less innovation.

7–29 Effective Acquisitions

7–30 Attributes of Successful Acquisitions Target firm has resources/core competencies that are complementary to the acquiring firmTarget firm has resources/core competencies that are complementary to the acquiring firm Acquisition is friendlyAcquisition is friendly Effective due diligence is conductedEffective due diligence is conducted Acquiring firm has financial slackAcquiring firm has financial slack Merged firm maintains low to moderate debt positionMerged firm maintains low to moderate debt position Merged firm continues R&DMerged firm continues R&D Acquiring firm manages change wellAcquiring firm manages change well

7–31 Results of Successful Acquisitions Higher probability of synergy and ultimately, competitive advantageHigher probability of synergy and ultimately, competitive advantage Faster, more effective integrationFaster, more effective integration Overpayment for acquisition is avoidedOverpayment for acquisition is avoided Financing is easier and less costly to obtainFinancing is easier and less costly to obtain Avoidance of trade-offs associated with high debtAvoidance of trade-offs associated with high debt Long-term competitive advantageLong-term competitive advantage

7–32 Restructuring

7–33 Restructuring A strategy through which a firm changes its set of businesses or financial structure.A strategy through which a firm changes its set of businesses or financial structure.  Failure of an acquisition strategy often precedes a restructuring strategy.  Restructuring may occur because of changes in the external or internal environments. Restructuring strategies:Restructuring strategies:  Downsizing  Downscoping  Leveraged buyouts

7–34 Types of Restructuring: Downsizing A reduction in the number of a firm’s employees and sometimes in the number of its operating units.A reduction in the number of a firm’s employees and sometimes in the number of its operating units.  May or may not change the composition of businesses in the company’s portfolio. Typical reasons for downsizing:Typical reasons for downsizing:  Expectation of improved profitability from cost reductions  Desire or necessity for more efficient operations

7–35 Types of Restructuring: Downscoping A divestiture, spin-off or other means of eliminating businesses unrelated to a firm’s core businesses.A divestiture, spin-off or other means of eliminating businesses unrelated to a firm’s core businesses. A set of actions that causes a firm to strategically refocus on its core businesses.A set of actions that causes a firm to strategically refocus on its core businesses.  May be accompanied by downsizing, but not eliminating key employees from its primary businesses.  Smaller firm can be more effectively managed by the top management team.

7–36 Restructuring: Leveraged Buyouts (LBO) A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private.A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private.  Significant amounts of debt may be incurred to finance the buyout.  Immediate sale of non-core assets to pare down debt. Can correct for managerial mistakesCan correct for managerial mistakes Can facilitate entrepreneurial efforts and strategic growth.Can facilitate entrepreneurial efforts and strategic growth.

7–37 Restructuring Outcomes

7–38 KLC-KinderCare Merger

7–39 Wrap-up

7–40 Wrap-up Background on Mergers & AcquisitionsBackground on Mergers & Acquisitions Reasons for AcquisitionsReasons for Acquisitions Problems in Achieving Acquisition SuccessProblems in Achieving Acquisition Success Effective AcquisitionsEffective Acquisitions RestructuringRestructuring KLC-KinderCare AcquisitionKLC-KinderCare Acquisition QuestionsQuestions