1. Mergers and Acquisitions
Chapter 10
Mergers and Acquisitions

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. End Section 1

9. Section 2
Do M&As work?

10. 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.

11. 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

12. 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

13. 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/ $ $65.7 B
12/ $ $95.2 B
12/ $ $74.0 B
12/ $ $82.0 B
12/ $ $100.0 B
12/ $ $105.0 B
Wells Fargo: down $0.25 to $39.50
First Security: up $1.19 to $13.38

14. 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

15. 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

16. End Section 2

17. Section 3
Does M&A Create a Competitive Advantage?

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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