1. AQA A2 Business Studies Unit 4
The motives for takeovers and mergers and how these link with corporate strategy

2. Key definitions
Takeover: Where one business acquires a controlling interest in another business = a change of ownership
Merger: a combination of two previously separate businesses into a new business
External growth: use of takeovers & mergers
Organic growth: growth from “within the business” e.g. new products; expansion into new markets
Diversification: expanding into new markets with new products – the riskiest growth strategy

3. Key theories to consider
Ansoff matrix: a model that analyses four growth options: product development; market penetration; market development & diversification
Economies of scale: where unit costs fall as a result of increased scale or scope of operations (key to strategy of cost leadership)

4. How M&A fits into a strategy
Methods
Organic / internal growth
Innovation
Diversification
International Expansion
Cost leadership
Takeovers / mergers
Joint ventures or strategic alliances

5. Why is strategy all about CHOICE?
A key concept to remember and build into essay answers
Takeovers and mergers are rarely forced on a business - they are optional
If M&A is optional, then there must be some alternatives
E.g. could a joint venture or strategic alliance be as effective as a cross-border takeover?

6. M&A: 3 main motives Strategic motives Financial motives
Focused on improving & developing the business
Closely linked to competitive advantage
Financial motives
Focused on making best use of financial resources for shareholders
Concerned with improved financial performance
Managerial motives
Focused on the self-interest of managers
Not necessarily in the best interest of shareholders
Source: adapted from Exploring Strategy, Johnson, Whittington & Scholes, 2011

7. Some examples of motives
Takeover / merger
Main motives for the transaction
Kraft / Cadbury
Establish global market leadership in confectionery & access emerging markets
Google / Motorola
Acquire valuable smartphone patents & manufacturing expertise
Tata / JLR
Economies of scale & acquire expertise, brands, capacity and distribution
RBS / ABN-Amro
Management vanity; continue reputation for big deals; over-confidence
Santander / Abbey
Market entry (UK) & establish base for further acquisitions to build market share
WM Morrison & Safeway
Increase market share & exploit economies of scale to improve competitiveness
HMV / MAMA
Diversification into fast-growing markets & reduce reliance on retailing
British Airways / Iberia
Consolidation; economies of scale & survival: positioning for further takeovers

8. The role of private equity
Professional investors who invest on behalf of specific funds
Responsible for a large number of takeovers each year
Wide range of industries, markets, types of investment
Their aim - to earn a target rate of return for the investment fund

9. What makes private equity takeovers different?
Financial motive is key (rather than strategic motive)
Look to invest in fast-growing firms or those where financial performance can be significantly improved
Takeover usually financed by both equity (shares) and debt (loans)
Advise rather than get involved in day-to-day management of the target
Synergies not usually important to the deal (unless the are links with similar investments in the portfolio)

10. Common criticisms of private equity takeovers
Too many involve mature businesses which don’t really need the investment
Over-geared: too much debt used to finance the transaction
Short-termism: not always a long-term investor
Too much focus on cost cutting and asset stripping

11. Summary: advantages of acquisitions
Overcomes barriers to entry
Helps spread risk (wider range of products and greater geographical spread)
Revenue growth opportunities (synergy)
Cost saving opportunities (synergy)
Reduces competition
May enable economies of scale

12. Summary: drawbacks of acquisitions
High cost involved
Problems of valuation
Clash of cultures
Problems of integration (change management)
Resistance from employees
Non-existent synergy
Incompatibility of management styles, structures and culture
Questionable motives
High failure rate
Diseconomies of scale

13. Key Case Study – Kraft & Cadbury
Transformational takeover which was seen by Kraft as the final piece in its strategic jigsaw
All about achieving leadership in faster-growing confectionery and snack markets

14. Cadbury’s strategic fit with Kraft

15. Kraft / Cadbury – product strategy

16. Kraft / Cadbury – geographical leadership

17. Kraft / Cadbury – market leadership

18. AQA A2 Business Studies Unit 4
The problems of takeovers and mergers including difficulties integrating businesses successfully

19. Key terms
Merger integration: the process of bringing together the functional areas of buyer & target business (e.g. organisational structure, systems, operations, marketing, people, merging cultures)
Dis-synergy: costs or lost revenues that arise as a result of the transaction (e.g. lost customers)
Cross-border: buyer and seller based in different countries (although both may be multinationals)

20. Key theories & concepts
Corporate culture: the “way that things are done”; often different, even amongst firms in the same market.
Stakeholders: different people and groups who have an interest in the effect of the M&A transaction (e.g. customers, employees, local community).

21. Overview of the takeover process
Target Identification & Choice
Valuation & Offer
Due Diligence & Completion
Post-acquisition Integration

22. Characteristics of a badly-managed takeover
Limited due diligence
Price to high
Over-estimate of potential for synergies
Lack of, or too simplistic, integration plan
Indecision once the takeover is complete
Poor communication with key stakeholders

23. Complications for public companies
The existing share price indicates the market value of the firm
However, takeover usually requires a substantial bid premium
Bid premium typically 30-40% more than share price prior to bid announcement
Regulation of bid via Takeover Panel rules adds complexity & cost

24. But acquisitions usually fail
It is widely accepted that over 50-70% of takeovers destroy shareholder value

25. The danger of over-valuation
The easiest way to destroy shareholder value is to over-pay
Extra danger of over-paying is trying to cut costs too quickly to justify price paid

26. Example of the Winner’s Curse - RBS
In 2007, RBS was part of a consortium that bid £49bn as it competed to buy ABN-Amro
RBS clearly overpaid for the takeover
The subsequent effect on RBS's capital reserves led to the forced nationalisation of RBS in 2008 to avoid a collapse of the UK banking system

27. Checking what you are buying: due diligence
Financial
Commercial
Legal

28. Another possible problem: friendly or hostile takeover?
Target Board
Rejects Offer
Friendly
Target Board
Accepts / Supports Offer

29. Friendly takeovers The vast majority of takeovers are friendly
Buyer approaches target Board with offer
Target Board negotiates & agrees price / terms
Shareholders of both firms approve the deal
Legal completion of takeover
The vast majority of takeovers are friendly

30. Hostile takeovers
Buyer approaches target Board with offer
Target Board rejects offer
Buyer makes offer direct to target shareholders
Target shareholders decide whether to accept
Hostile takeovers are unusual, often bitterly contested and costly

31. Some common problems with hostile takeovers
Senior management in the target often leave en masse = loss of experience & expertise
Resentment amongst target stakeholders (local community, employees)
Increased risk that the buyer pays too much for the takeover

32. Ways to avoid integration problems
Detailed due diligence – focused on the likely areas of risk (e.g. IT systems, impact on customers etc.)
Careful integration planning – a detailed action plan based on pre-takeover due diligence.
Act quickly: the first 100 days are often considered vital for the overall success of the takeover or merger.
Clear communication about the objectives of the transaction and the honesty about the implications for key stakeholders (particularly employees).
Respect the culture of the target business

33. Some examples of integration (+ & -)
Takeover / merger
Integration Experience / Issues
Kraft / Cadbury
Most senior Cadbury managers have left; but little effect on operations or sales
Daimler / Chrysler
Disastrous clash of corporate cultures – eventually split up in 2007
Tata / JLR
Excellent example of well-planned takeover & sensitive long-term integration plan
RBS / ABN-Amro
Very poor quality due diligence & absence of realistic integration plan
Santander / Abbey
Textbook example of how to integrate takeovers – focusing on IT systems
News Corp / Myspace
Entrepreneurial online culture fails to thrive in a bureaucratic, corporate culture
Coca-Cola / Innocent
Need for integration reduced by allowing target to continue operating independently
Orange UK / T- Mobile UK
Difficult integration due to many overlaps in systems, operations and management

34. The factors influencing the success of takeovers and mergers
AQA A2 Business Studies Unit 4
The factors influencing the success of takeovers and mergers

35. Key definitions
Cost synergies: cost savings that arise as a direct result of the transaction (in both the target and buying business)
Revenue synergies: increased revenues (for both businesses) arising from the transaction
Due diligence: verifying the financial, legal and commercial position of the target business
Shareholder value: the return on investment achieved by shareholders in the buying/acquiring firm

36. Key theory & concepts
Sources of cost synergies: Eliminate duplicated functions & services; better deals from suppliers; higher productivity & efficiency from shared assets
Sources of revenue synergies: Cross-selling to customers of both businesses; access to new distribution; brand extensions; new geographic markets opened up

37. Short-term measures of success
Share price (if the buyer is a quoted company)
Revenues, operating costs and profits (mainly of the target business)
Achievement of planned synergies
Customer retention & service levels
Staff retention (often cited as the main HRM problem of takeovers)

38. Longer-term measures of success
Market competitiveness (market share; reputation, brand strength)
Return on investment (ROCE, profitability of enlarged business)
Sustainable growth rate (revenues, profit, profit quality, sustainable revenue synergies)

39. Why synergies are so important?
They justify paying more than the standalone value of a target firm
They are the means by which shareholder value is created
They focus management on making a takeover achieve its objectives
They are a means to improve competitiveness and achieve competitive advantage

40. Shareholder value - example

41. Common ways shareholder value can be destroyed by a takeover
Paying too much (over-valuation or poor negotiation)
Poor quality due diligence (e.g. fails to identify potential liabilities or highlight poor profit quality)
Lack of integration planning
Too much focus on cost synergies rather than revenue synergies
Failure to retain elements which made the target attractive in the first place (e.g. innovation, culture, skills)

42. Examples of successful deals
Successful takeovers and mergers
L’Oreal & The Body Shop (more shops, higher profits)
Google & YouTube (rapid growth & advertising revenue)
Tata & Jaguar Land Rover (£1bn profits in 2011)
Santander & Abbey, Alliance & Leicester, Bradford & Bingley (higher profits & market leadership in UK)
Taylor Woodrow & George Wimpey (economies of scale for two leading house builders merged together)

43. However: the golden rule of M&A
At least 70% of takeovers and mergers destroy shareholder value

44. Examples of deals that failed
Failed takeovers and mergers
News Corp & Myspace (bought for £580m; sold for $25m)
ITV & FriendsReunited (bought for £175m; sold 3 years later for £25m)
Cisco & Flip (bought for $590m; closed down in a year)
RBS & ABN-Amro (bought for £10bn; results in losses of at least £15bn & nationalisation)
Terra Firma & EMI (bought for £4.2bn; sold 3 years later for loss of £1.75bn) – one of biggest private equity failures

45. Some truly awful deals (2)
SOLD
£25m

46. Some truly awful deals (3)
£10bn
Written Off + New Liabilities
£15bn+

47. We are sorry we bought ABN Amro.”
“In retrospect we bought ABN at the top of the market, so everything we paid was not worth it.
A significant part of the goodwill write-off, £15bn, is ABN Amro, but I couldn’t tell you how much we lost on ABN. Basically, the bulk of what we paid for ABN Amro, which was £10bn, will be written off.
We are sorry we bought ABN Amro.”

48. AQA A2 Business Studies Unit 4
The impact of takeovers and mergers on the performance of the businesses involved

49. Key Definitions
Shareholder value: the return on investment achieved by shareholders of the buying/acquiring firm. The return needs to be at least equal to the required rate of return of shareholders
Value destruction: where shareholder value falls as a result of the transaction

50. Key theories & concepts
Profitability: the overall level of profits (a key return) in the enlarged business
Market capitalisation: the monetary value (usually represented by the share price x shares in issue) of a business
Porter’s Five Forces: a model of competitive rivalry which analyses the attractiveness of a market from the point of view of existing competitors

51. Potential positive & negative effects
Positive Impacts
Improved revenues and profits
Reduced competition (market more attractive)
Greater capabilities (e.g. technology, capacity, innovation)
Better market access (e.g. distribution; new territories)
Negative Impacts
One-off costs and effect of integration (disruptive for both buyer and target business)
Too much focus on cost synergies can damage revenue & growth potential
Cultural conflicts
Risk of overpayment for the transaction

52. Some examples of M&A effects
Takeover / merger
Impact on performance (+ or -)
Tata / Jaguar Land Rover
+ve: significant increase in profits & rapid expansion into Chinese market
Google / Youtube
+ve: rapid growth in video upload & viewing supported by Google services
Cadbury / Green & Blacks
+ve: doubled turnover to £40m under Cadbury ownership
Santander / Abbey
+ve: substantial rise in profitability as a result of cost synergies
Pearson & Edexcel
+ve: rapid rise in profits for Edexcel under Pearson ownership
News Corp / Myspace
-ve: dramatic loss of market share (to Facebook etc) & heavy losses
Daimler & Chrysler
-ve: collapse in market value as merger plan unravelled spectacularly
Terra Firma & EMI
-ve: substantial fall in revenues & profits, partly due to opposition from EMI artists

53. Evaluation opportunities
Distinction needs to be made between tangible measures (e.g. revenues, profits, market share etc) and more intangible measures such as brand & customer service reputation.
Are we looking at the impact on the businesses involved over the short-term or longer-term? The full impact (positive or negative) might take some years to fully assess.
Hard to measure impact for many takeovers, since the businesses concerned “disappear” into the result of the acquiring firm. Impact not so transparent in many cases.

54. The impact on, and reaction of, stakeholders to takeovers and mergers
AQA A2 Business Studies Unit 4
The impact on, and reaction of, stakeholders to takeovers and mergers

55. Key definitions
Stakeholders: A stakeholder is someone or some organisation/institution that has an interest in the success of a business.
Post-merger integration: the process of bringing all aspects of the acquired business into the business organisation of the buyer (including customers, employees etc.)

56. The Stakeholder Model
Stakeholder model: requires that “all of the parties affected by management decisions, in addition to the shareholders themselves, management, employees, customers, suppliers, communities in which the business operates and the environment from local to global, all must be considered as fairly and justly as possible.”

57. Who are the Stakeholders?
An individual or group with an interest in an organisation
Any individual or group who can affect or are affected by the achievement of a firm’s objective
Groups/individuals that:
have an interest in the well being of the company
and/or are affected by the goals, operations, activities of the organisation
They have a stake in what the organisation does

58. Examples of stakeholders (all can be affected by M&A)
Shareholders or business owners
Managers & employees
Customers
Suppliers
Banks and other finance providers
Government
Local community
Other external groups (e.g. pressure groups)
Competitors
The media

59. Potential conflicts between stakeholders
Takeover or Merger Decision
Supported By?
Opposed By?
Cut jobs to reduce costs
Shareholders
Banks
Employees
Local community
Transfer production to overseas location
Management
Customers & suppliers
Introduce new machinery to replace manual work
Customers
Increase selling prices by 10% to improve profit margins

60. Likely negative impact on stakeholders
Most takeovers and mergers are associated with:
Job losses in the acquired business (a direct result of cost synergies) & knock on effects on local economy.
Uncertainty & more job insecurity – particularly as organisational structures & systems are integrated.
Potential closure and / or transfer of capacity to other international locations (e.g. to emerging markets).
Change in the taxation status of the firm – profits may be transferred overseas with a loss of corporation tax for the UK economy.

61. Many examples of adverse reaction

62. Ways to manage stakeholder impact
Stakeholders need to be considered & included in the takeover / merger integration plan.
Clear, early and honest communication about the intentions & plans of the acquiring firm.
Focus efforts on the most important stakeholder groups. For example existing customers of the acquired firm are crucial, as are employees / management that the buyer wishes to retain (staff retention consistently shown as a major HR problem with takeovers).

63. Examples of stakeholder response
Takeover / merger
Stakeholder reaction
Kraft / Cadbury
Hostile reaction from employees, unions & local community – supported by media - but not enough to persuade Cadbury shareholders from eventually agreeing to the bid.
L’Oreal / Body Shop
Hostile reaction from pressure groups, media and some customers (raising concerns about L’Oreal record on animal testing); but quickly died down.
Dubai Ports World / P&O
Negative reaction in the USA to the takeover by a UAE-owned firm that would involve foreign ownership of six ports in America.
Coca-Cola / Innocent
Widespread customer criticism of Innocent’s decision to sell a stake in their ethically-friendly business to Coca-Cola (who later took control)
Fenway Sports Group & Liverpool FC
Broad agreement from Liverpool FC supporters who welcomed the takeover from the previous owners (compare & contrast with continued hostility to US ownership of MUFC

64. Opportunities for promotion Investment by the buyer
Why employees of the target business might welcome or support a takeover...
Opportunities for promotion
Investment by the buyer
A change of culture
A fresh start (particularly with a merger)
Business not well run by existing management (i.e. a better future)

65. Evaluation opportunities
Which stakeholder groups actually have the power to impact the eventual success or failure of a takeover? Whilst there might be widespread opposition from media & local community – are other stakeholder groups (customers, employees) much more important?
Too easy to assume that a takeover will have a negative effect on internal stakeholders like employees. The transaction might actually benefit them in the long-run if their business is stronger as a result.

66. AQA A2 Business Studies Unit 4
The reasons why governments might support or intervene in takeovers and mergers

67. Key definitions
Competition policy: Government policies to prevent and reduce the abuse of monopoly power
Enterprise Act 2002: major reform of the control of mergers and takeovers in the UK, removing the decision-making powers of government, other than exceptional cases, and passing responsibility to Office of Fair Trading and the Competition Commission.
Monopoly: where a firm has a dominant position in an industry or market – e.g. is able to control supply and pricing

68. Key theory & concepts
Abuse of monopoly power: Abuse of monopoly power can lead to market failure and be against the public interest. Therefore Governments are concerned to intervene and protect the interests of the consumers
Cadbury’s Law: a suggested change to UK legislation to make it harder for UK firms to accept takeovers (60% vote rather than 50% & only long-term shareholders may vote); not yet implemented.
Laissez-faire: an approach to market regulation which largely leaves the market to look after itself

69. Reasons for government intervention or support
Where a takeover / merger might be considered likely to result in one firm having undue market power (typically market share of 40% or more)
Specific situations in which the public interest might be threatened: e.g. Competition Act 2002 allows the Secretary of State to intervene in the media market to ensure there is a sufficient plurality of persons with control of media enterprises.
To support (or waive through) a takeover that might be in public interest – e.g. partial nationalisation (Lloyds HBOS)

70. UK Competition Policy Competition Commission Office of Fair Trading
an independent public body which conducts in-depth inquiries into mergers, markets and the regulation of the major regulated industries
Office of Fair Trading
Wide-ranging activities, including mergers
The OFT is responsible for reviewing merger situations, and where they may lead to a lessening of competition, refers them to the Competition Commission for further investigation.

71. Examples of UK Govt Intervention
Takeover / merger
Government / regulator response
Kraft / Cadbury
No specific response – other than raising possibility of Cadbury’s Law
News Corp / Sky TV
Important case – UK Govt pressurised to refer the takeover bid to the Competition Commission as a result of phone-hacking scandal & concerns over media plurality; eventually News Corp withdrew bid as scale of public opposition became clear
Lloyds TSB / HBOS
Government decided not to refer the Lloyds emergency rescue of HBOS (despite obvious concerns over potential market dominance) because of the need to protect the viability of the UK banking system
Ferrovial / BAA
Competition Commission ruled that BAA had to sell Gatwick, Stansted and a Scottish airport as a condition of is takeover by Ferrovial – in the interests of passengers

72. European Union Competition Policy
Main criteria used for evaluating a takeover / merger:
The market position of the merged firm (market share and other competitive advantages)
Strength of the remaining competitors
Customers’ buying power
Potential competition from new entrants

73. UK regulation – arguments for a “light touch”
Encourages inward investment to help develop successful UK firms (e.g. HP & Autonomy; Tata and JLR)
UK firms have shareholders from around the world
Not the business of government to decide who owns a business (laissez-faire)

74. UK regulation – arguments against a “light touch”
Some firms are strategic assets for the UK economy (energy, transport, utilities) - they need to be protected
Increased risk that UK jobs will be lost
Resist takeovers by short-termist investors who don’t have the long-term interests of the business at heart

75. Depends on factors
How significant is the takeover or merger in terms of size or potential impact?
Does the takeover or merger take place in a market in which the government wants to exert greater control / regulation? E.g. financial services, media or of national interest?
The geographical reach of the businesses involved: e.g. determines whether competition regulation in the US and Europe applies.

76. Evaluation opportunities
UK competition policy – often described as having a “light touch” towards regulation. Consensus is that it is relatively easy for firms to be bought and sold in the UK.
A key benefit of relatively relaxed laws about takeovers and mergers is that inward investment in UK firms is encouraged.
Counter-argument: light-touch regulation leaves UK firms exposed to hostile takeovers that are not in the long-term interests of the UK and its economy.

77. Key case studies – News Corp & Sky (2011)
Sky News – important UK broadcaster, owned by BSkyB
News Corp has a 39.1% stake in BSkyB – wanted to complete a takeover
Govt initially prepared to allow the transaction to proceed
Widespread concerns over media plurality & News Corp ethics (phone hacking) led to eventual withdrawal of the bid
No formal involvement of the competition regulators

78. Key case studies – Lloyds TSB & Abbey National (2001)
Lloyds TSB made a £18bn bid for Abbey National in 2001
Govt Minister (Patricia Hewitt) blocked the deal saying it was "against the public interest"
Competition Commission had recommended the deal be blocked after a 4 month investigation
They believed the deal would reduce competition in the current account market, in which the combined Lloyds/Abbey group would have a 27% share.
In 2004 Abbey was sold to Santander for £8bn

79. Key case studies – Merger of Ryanair and Aer Lingus (2010)
Ryanair launched a £1,5bn hostile bid for Aer Lingus after building a stake after it was privatised in 2006
2007: European Commission declared takeover was incompatible with EU competition rules
EU reason; two airlines controlled more than 80% of all European flights to and from Dublin airport
European Court of Justice finally blocked the takeover in 2010 but allowed Ryanair to keep its 29.9% stake
The Irish Govt retains a 25% stake in Aer Lingus

80. Key case studies – Takeover of HP by Heinz (2006)
In 2006 US conglomerate Heinz announced the takeover of UK sauce producer HP for £470m
Together, the two brands would have over 80% of the branded sauce and ketchup market
The Competition Commission reviewed the deal, fearing higher prices for brown sauce and tomato ketchup.
Shortly after the deal was cleared to proceed
In 2007 Heinz closed the HP factory in Birmingham, moving production to Holland with the loss of 125 jobs