Merger and Acquisition Strategies
The Role of Diversification
Merger
Two firms agree to integrate their operations on a relatively co-equal basis
Acquisition
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
Takeover
An acquisition in which the target firm do not solicit the acquiring firms bid for complete ownership
Reasons for acquisitions
- Increased market power
- Overcoming entry barriers
- Cost of new product development
- Increase speed to market
- Lower risk than developing new products
- Increased diversification
- Reshaping firms competitive scope
- Learning and developing new capabilities
a) Increased market power
- Factors increase market power when:
- costs of primary or support activities are below those of competitors
- a firms size, resources and capabilities gives it a superior ability to compete
- Acquisitions intended to increase market power are subject to:
- regulatory review
- analysis by financial markets
- Market power is increased by:
- horizontal acquisitions of other firms in the same industry
- vertical acquisition of suppliers or distributors of the acquiring firm
- related acquisitions of firms in related industries
1. Horizontal Acquisitions
Acquisition of a firm in the same industry in which the acquiring firm competes. It increases a firms market power by exploiting:
- Cost-based synergies
- Revenue-based synergies
Acquisitions with similair characteristics result in higher performance than those with dissimilar characteristics
2. Vertical Acquisitions
Acquisition of a supplier or distributor of one or more of the firms goods or services
- Increases a firms market power by controlling additional parts of the value chain
3. Related Acquisitions
Acquisition of a firm in a highly related industry
- because of the difficulty in attaining synergy related acquisitions are often difficult to implement.
b) Overcoming Entry Barriers
Factors associated with the market or with the firms operating in it that increase the expense and difficulty for new firms in gaining immediate market access
Cross Border Acquisitions
Acquisitions made between firms with headquarters in different countries:
- are often made to overcome entry barriers
- Can be difficult to negotiate and operate because of the differences in foreign cultures
c) Cost of New Product Development & Increased speed to market
Internal development of new products is often perceived as a 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 past experience with its products
d) Increased Diversification
- 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
e) Reshaping the firms competitive scope
- An acquiring firm can gain capabilities that the firm does not currently possess:
- special technological capability
- a broader knowledge base
- Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base.
Problems in Achieving Acquisition Success
- Integration difficulties
- Inadequate target evaluation
- Extraordinary debt
- Inability to acheive synergy
- Too much diversification
- Managers only focused on acquisition
- Acquiring firm becomes too Large
a) Integration challenges
- Melding two disparate corporate cultures
- linking different financial and control systems
- building effective working relationships (when management styles differ)
- resolving problems regarding the status of the newly acquired firms executives
- loss of kew personnel weakens the acquired firms capabilities and reduces its values
b) Inadequate Evaluation of Target
- Due 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:
- Financing of the intended transaction
- differences in culture between the firms
- tax consequences of the transaction
- actions necessary to meld the two workforces
c) Large or Extraordinary Debt
High debt can
- increase the likelihood of bankruptcy
- lead to a downgrade of the firms credit rating
d) Inability to achieve synergy
Synergy: When assets are worth more when used in conjunction with each other than when they are used separately.
- Firms tend to underestimate indirect costs when evaluating a potential acquisition
e) Too much Diversification
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
f) Managers overly focused on Acquisitions
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
Managers of Target firms:
- may become hesitant to make decisions with long-terrm consequences until negotiations have been completed
- may develop a short-term operating perspective and a greater aversion to risk
g) Acquiring firm becomes too large
- Larger size may lead to more bureaucratic controls.
- Formalised controls often lead to relatively rigid and standardised managerial behaviour.
- The firm may produce less innovation
Effective Acquisition Strategies
Complementary Assets/ Resources
Buying firms with assets that meet current needs to build competitiveness
Friendly Acquisitions
Friendly deals make integration go more smoothly
Careful Selection Process
Deliberate evaluation and negotiations are more likely to lead to easy integration and building synergies
Maintain Financial Slack
Provide enough additional financial resources so that profitable projects would not be foregone
Restructuring
- 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
- Downsizing
- Downscoping
- Leveraged buyouts
a) Downsizing
- A reduction in the number of a firms employees and sometimes in the number of its operating units
- May or may not change the composition of businesses in the firms portfolio
- Typical reasons for downsizing
- Expectation of improved profitability from cost reductions
- Desire or necessity for more efficient operations
b) Downscoping
- Refers to spin-offs, or some other means of eliminating businesses unrelated to a firms core businesses
- A set of actions that causes a firm to strategically refocus on its core businesses
- May be accompanied by downsizing but not the elimination of key employees from its primary businesses
- Results in a a smaller firm that can be more effectively managed by the top management team
c) Leveraged Buyout (LBO)
- A restructuring strategy whereby a party buys all of a firms assets in order to take the firm private
- Significant amounts of debt may be incurred to finance the buyout, followed by an immediate sale of non-core assets to pare down debt