Mergers &

Acquisitions
Term Paper

Bhooshan Parikh

Copenhagen Business School

FT MBA 2008-09
11 May 2009
1. Make a critical analysis of the synergy statement by Ian Cook, President and COO,
Colgate, shown on page 2, based on all the information in the case.

Colgate has been the market leader in the oral care business in the US as well as globally.
The company was facing increasing challenges from its biggest competitors (P&G) and
also the declining growth in the oral health care market. Consumer trends had changed
with an inclination towards using more environmentally friendly products and
natural/green products that were free from potentially harmful chemicals. What is most
evident from the information provided in the case is that there is no mention of Colgate’s
efforts toward environment and towards the better health of consumers. This is also
reflected in the statement made by Ian Cook, President and COO of Colgate. All
information in the case study indicates that the main reason behind Colgate’s acquisition
of ToM was higher earnings and higher profits. This contradicts significantly with the
philosophy of Tom and Kate, who were very active in philanthropy and community
service and it becomes a very sensitive issue for Colgate in how it can continue with this
tradition. It might be easy to argue that creating synergies was not the only motive
behind this acquisition especially with the distribution channel. Colgate already had a
strong global presence and an efficient supply chain system and the acquisition of ToM
would have no effect on its existing operations.

The statement made by Ian Cook might also reflect the inability of Colgate to develop or
introduce its own natural products brand and an acquisition of ToM would be the easy
way out, even if the two companies were culturally and traditionally diverse. At the same
time one might argue that Colgate’s acquisition of ToM was driven by market
expectations that after the merger of P&G and Gillette, Colgate would also adopt
inorganic growth in the oral health care business. This means that what Cook has
mentioned in his statement may not necessarily be the true reason behind the acquisition.
From the perception of Colgate it might seem that they are happy to concentrate on oral
and personal care products and in that sense the acquisition of ToM does help in
diversifying their product portfolio in this business. However, it should be noted that
lesser diversification means higher risk. This was further increased by the sale of its
laundry detergent business to P&G. With this strategy, Colgate has lowered its ability to
offset weak market cycles.

Furthermore, it might be argued that the Cook’s statement is highly ambitious from
Colgate’s point of view but at the same time it might be a bit naive to apply the same
Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 1
 theory on a global basis. The naturals market might be growing at 15 % in the US but that
may not be the same all around the world. It might also hold true for markets like Europe
and the UK but what is important for Colgate is to consider the emerging economies and
the growing markets. With majority of the global growth being experienced in these
areas, it will be difficult for Colgate to sell the highly priced ToM’s products. This also
does not fit in well with Colgate’s global expansion strategy. Besides the above, with
rising prices and continuing inflationary conditions one cannot be sure of the profitability
of the acquisition and the claim by Colgate that it will be experience positive growth in
2007 may be insubstantial and based on speculation.

Finally, the matter of integration of the two companies also plays a vital role in the
overall success of the merger not only in the completion of the process but also
considering its post-merger growth. The paper has clearly brought out that consumer
sentiments were hurt by this takeover and that the ethical ratings of ToM dropped
significantly from 5 to 16. This clearly signifies that there is loss of firm value and
consumer loyalty, at least in the initial stages following the merger with Colgate. Intense
competition and low switching costs for consumers provides a golden opportunity for
ToM’s competition to take advantage of this situation. It would be a very interesting
situation to be able to assess the situation of this acquisition once Tom has finished his
stipulated three years on the management of ToM. This could potentially lead to a
complete failure of the merger as there remains a strong possibility that the employees of
ToM may not want to continue working once Tom has left and this would create serious
problems for Colgate in their ability to maintain the same quality and efficiency of ToM’s
products.

2. Tom and Kate from ToM are to remain in the management of ToM after Colgate
has gained control of ToM (page 3 and page 8). Is this a good or a bad idea?

In a practical business environment, most activities revolve around profitability and

decisions are rarely made in favour of non-profitable activities, especially in mergers and
acquisitions. Considering the same and information available in the case study, it may be
said that it was a good decision to retain Tom and Kate to manage ToM even after its
acquisition by Colgate. The following reasons explain why this might be possible.

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 2

From the perspective of managing change, Tom and Kate’s presence in the acquired ToM
was essential for a smooth and lasting integration of the cultures and traditions of the two
companies. Tom and Kate had intimate knowledge about the complete activities and
employees of ToM and this familiarity would be highly valuable from the point of view
of Colgate. Moreover, one of the difficulties of mergers is change of leadership and it
invariably becomes important for the acquiring company to ensure that the employees of
the other company remain as motivated and willing as they were before. The arrangement
called for Tom to be retained only for the next three years following the acquisition and
as per the estimates of Colgate, ToM would start showing profits from 2007. This
seemed like a very favourable situation for Colgate as Tom’s presence would be critical
in realising positive earnings only after one year. For Colgate, retaining Tom and Kate
was the best way forward at doing this and maintaining the same synergies that existed
earlier. This would also facilitate quick amalgamation of the two companies, which is an
important requisite of a successful M & A.

Besides the above, Tom is also a 16 % stakeholder in the merged company and so as a
manger of ToM he has an incentive to perform well in order to get maximum returns not
only for Colgate but also more importantly for himself. As far as the customers of ToM
were concerned, Tom’s presence on the management would retain the sense of
genuineness in the minds of the loyal customers and thus the loss of customer loyalty
would be minimised in this highly competitive market. Additionally, assuming that it was
a precondition specified by ToM that Tom and Kate be retained on the management of
the merged company, it served Colgate well as this would help Colgate gain the
confidence of ToM’s existing employees and at the same time also allow Tom and Kate
to ensure that their formulas and products are not tampered with.

However, every aspect has a low side to it and so does this merger have some possible
drawbacks concerning the retention of Tom and Kate by Colgate in the management of
ToM. It may be argued that Tom’s presence in the management could lead to agency
costs in terms of ‘empire building’. In this situation, in spite of the change of ownership,
Tom practically has large amount of control over the activities of ToM. However, this is
different from the earlier situation when he was the owner, the difference being the risks
involved. With ownership with Colgate, Tom’s personal risk in the activities of ToM is
restricted to his share of 16 %. Moreover, Tom’s acquaintance with the existing
employees of ToM for many years could also play a major role in his influence in the

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 3

 company’s performance. As far as Kate is concerned, she too, as a consultant, is in a
strong position to exert influence on Colgate’s activities regarding ToM as well as on the
ToM management. Generally, it may not be perceived as a good idea to retain two
members of a family run business that has been taken over and there are chances that
Colgate might face difficulties in handling this sensitive issue, especially when there are
important advantages involved with it.

3. Make a critical analysis of Colgate’s restructuring plan (page 5)

Based on the information provided in the case study, it may be argued that the
restructuring plan implemented by Colgate was well planned and strategically sound.
Colgate had a major restructuring in 2002 following high inflationary conditions that
forced companies to lower prices in order to remain competitive in the market. This
could also be seen at from a point of view of achieving price stability through cost cutting
and maintaining the level of demand. Since Colgate was dealing with commodities it was
important for the company to maintain its market share even at low profitability. Due to
intense competition in this market, there was also a need for Colgate to create
differentiation of its products from those of its competitors. This also meant that Colgate
needed to focus more on its core business area of oral care. In fact, it may also be
assumed that the planned termination of its laundry detergent business could have been an
outcome of this approach by Colgate towards its core business area.

In 2004, Colgate initiated a four year restructuring plan that aimed at both business model
and technological innovation and moved away from cost cutting to improve profitability.
This was evident from the increased spending that was allocated to marketing activities.
Most likely the there would not have been any improvement in the inflationary situation
since 2002 and with low prices, maintaining profitability would have been a difficult goal
and increased spending on marketing would become the obvious strategy for Colgate to
remain profitable. In this restructuring, one of the main focuses was on innovation.
Evidently, Colgate was poor as far as its innovation management was concerned and it
may also be assumed that Colgate found it a better to buy innovation rather than create its
own. Most probably, the takeover of ToM in 2006 would have been part of this four year
restructuring plan and in the process getting innovative products under its umbrella
leading to differentiation. Moreover, by creating an image of being innovative, Colgate

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 4

 was able to counter the media statements which put Colgate in bad light compared to its
competitors.

When Colgate sold off its laundry detergent business to P&G, it seemed that this business
area of Colgate was turning into a ‘Dog’ as per the BCG Matrix. With Colgate looking
towards emerging economies and the growing markets in the BRIC countries, an
approach focused on core business areas was more practical from Colgate’s point of view.
The acquisition of ToM was soon after Colgate sold off its laundry detergent business and
so they were able to use the proceeds of this sale to buy out ToM. This explains why
Colgate expected change in profit for 2006 to be neutral. Moreover, by taking over ToM,
Colgate was now able to internalise innovative capabilities as well as build up further on
a natural product line, which none of its competitors had at that time.

4. Is the acquisition of ToM an advantage for Colgate against its rival P&G?

Pros and cons exist in answering this question from Colgate’s point of view. In 2006, at
the time when Colgate took over ToM, it was the first company in that line of business to
have its own green/natural product line, which P&G did not have. ToM held a majority
60 % market share in the US natural oral care market and with $ 50 million in earnings
and a total market size of approximately $ 3 billion; this was considerable advantage for
Colgate over its rivals, especially over its strongest competitor P&G. Colgate now had its
own natural product brand and could further consolidate the total oral care business in the
US as well as globally. Another advantage for Colgate was its existing network due to
which Colgate was able to easily introduce ToM’s products to foreign markets and also
achieve economies of scope due to its strong supply chain.

Colgate had earned the ‘first mover’ advantage by hiving off its laundry detergent
business and by concentrating on its core oral care business. This lead to higher profits
and a greater market share in as ToM had 2 % market penetration in the US and its
products were priced at a considerable 30 % higher than other normal products. With
increasing global awareness about natural products and the dangers of using chemicals in
oral/health care products, Colgate had a big advantage over P&G as it was able to enter
Europe and Asia including the emerging economies. The acquisition of ToM was most
importantly beneficial for Colgate in the sense that, Colgate could now have access to all

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 5

 the loyal customers of ToM, which potentially guaranteed demand and a market share
especially in the US.

Although the whole deal sounds like a win-win situation for both Colgate and ToM, there
might be certain underlying limitations of this deal as far as competition is concerned.
P&G held more diversified businesses and was highly successful in offsetting the effects
of weak cycles with strong cycles and thus being more stable in terms of profitability.
This was not so for Colgate as it was facing reduced diversification in its business after it
sold off its laundry detergent business. Moreover, in view of its expansion plans in the
emerging countries and growing markets, ToM’s products may not have been successful
due to its high prices. Over and above these limitations, there could always be a
possibility that P&G could take advantage of the drop in ethical rating for ToM and steal
customers from Colgate.

5. Are there any negative synergies associated with Colgate’s acquisitions of ToM?

As seen from the earlier paragraphs, limitations do exist in this acquisition. As a result,
negative synergies are also present but at the same time it should also be noted that there
may also be certain challenges for Colgate, which, if not addressed judiciously, could lead
to negative synergies at a later stage. The main issue here for Colgate would be of
cannibalisation of its products, especially the common product range of Colgate and ToM.
Due to increasing trend of environmentally friendly products, ToM’s products could end
up competing directly with Colgate’s oral care range.

Reiterating the fact that diversification creates a balance between weak and strong cycles,
it may be seen that as a result of the restructuring plan, Colgate had to sell off its laundry
detergent business, followed by the acquisition of ToM. With this purchase, although
Colgate had gained a considerable advantage over its rivals in the natural oral care market,
it was getting less diversified in its businesses creating greater risk for Colgate.

On the internal aspects, there would obviously be problems with cultural integration of
the staff of ToM and Colgate. Although it was a good strategy for Colgate to create an
independent subsidiary out of ToM, at some point of time, Colgate would need to have
better integration of the two entities and therefore, cultural integration would become an
issue at that time. The fall in ethical ratings for ToM from 5 to 16 was not a good sign and
it now became the responsibility of Colgate to improve the image of the company. With

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 6

 low switching costs for consumers and intense competition in the natural oral care market,
many of ToM’s customers might have changed their preferences due to this fall in ethical
ratings. Hurting consumer sentiments leads them away and results in reduced customer
loyalty for ToM as well as Colgate.

In every merger, it is very important to pay due attention to certain post-merger activities.
For Colgate, retaining all the 170 employees of ToM and also keeping Tom and Kate in
the management would not be enough in the long run. It becomes imperative for Colgate
to implement concrete steps to avoid conflicts in values of the two firms. Preserving and
promoting the values and traditions of ToM is another difficult task for Colgate. Unless
Colgate achieves success in these areas, it would not be able to remain profitable in the
long run; it would fail to retain trained employees of ToM; this would lead to poor quality
and reduced consumer loyalty and an unprofitable business. Ultimately the time may
come when continuing the ToM’s and natural products business may become highly
unprofitable for Colgate leading to a failure of the merger. With this it may also be said
that ToM was looked upon as a down-to-earth, simple and genuine firm and at the same
time it was unique in its ways of functioning. It would have been a tough challenge for
Colgate to preserve the distinctiveness of ToM and to keep ToM’s uniqueness and
quirkiness alive.

6. Could there be other reasons for Colgate than synergies for taking over ToM?

There was growing consumer awareness and knowledge about natural and green products
and a trend was developing amongst companies to acquire better ethical credentials and
ratings. Colgate had no natural products in its oral care portfolio and it might seem that
one of the reasons behind the taking over of ToM would have been to acquire ethical
credentials. Besides this, there was also the threat of a slowing market growth in this
segment and innovative products were the main drivers of growth. Colgate did not have
any innovative products in its portfolio and I needed a quick solution. There were also
negative reports about chemicals being used in oral care products and their harmful
effects and therefore Colgate needed to find a way out of this and improve its brand
image. It could be argued here that ToM had no benefit in this regard and it cannot be
said that the acquisition was based only on the existing synergies.

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 7

 The merger between P&G and Gillette was termed as a big inorganic growth strategy for
P&G and there was lot of speculation in the market about how would Colgate react.
Colgate was already focusing on its core oral care business and in view of the same there
could have been increasing market pressure for Colgate to follow P&G in an inorganic
growth strategy. Therefore, the acquisition of ToM by Colgate could well have been due
to market forces and not due to the synergies per se.

7. What do you think about the price Colgate paid for their 84 % ownership stake in
ToM?

It has been mentioned in the case that Colgate paid approximately $ 100 million for its
share of ToM’s and it might seem that this was at a good bargain price for Colgate.
According to the information in the case, ToM’s had achieved annual sales of $ 50
million and in that sense Colgate could practically recover all the costs of the acquisition
within two years and make it a profitable deal in a very short period. The US oral care
market was facing declining growth and was likely to grow at just 2 %. With sales in
2004 amounting to $ 7.2 billion we can say that at a 2 % growth rate the sales for 2005
may be estimated at approximately $ 7.4 billion ($ 7.2 billion x 1.02). Using this figure of
$ 7.4 billion, we can arrive at a crude estimate of the market value of ToM’s in order to
ascertain whether Colgate paid a good price for it or not.

We also know from the information provided that in 2004 ToM’s had a market
penetration rate of 2 % in the US oral care market. Assuming that this rate remains the
same for 2005, we can determine the market capitalisation of ToM’s at approximately
$ 148 million ($ 7.4 billion x 0.02). Considering this as the value of the firm at the end of
2005 it is very clear that the $ 100 million paid by Colgate to acquire ToM’s is almost
33 % of the actual value and thus the acquisition may be considered to be undervalued.

At the same time if this was so clear it is surprising to see why Tom and Kate agreed to
the acquisition in the first place. The following arguments explain certain reasons why
this low priced acquisition might have been carried out.

Contrary to self-funded growth, an inorganic growth for ToM’s allows much more rapid
expansion through the ability of Colgate to reach new markets faster and efficiently.
ToM’s also gets access to the R&D facilities and the financial backing required for such
expansion. With this acquisition, ToM’s can avoid taking the IPO route for raising

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 8

 financing and this also is beneficial from the point of view of demarcating accountability
and performance, and thereby avoiding pressure to perform as per stock market analysts.
With this acquisition, ToM’s was most probably able to define its terms and conditions by
way of covenants that might be more suitable for its performance. In this case, we can
safely say that the retention of Tom and Kate in the management of the acquired firm
could have been one such covenant. This might also explain why Colgate paid a lower
price than ToM’s actual value, as Colgate could have agreed to ToM’s demands in
exchange of a lower price, thus making this deal seem undervalued. Thus, while on one
hand, ToM’s gains the capital and management expertise of Colgate, on the other hand
Colgate acquires the brand image, innovative expertise and know-how of ToM’s. Thus,
although it might seem like an unbalanced acquisition, in reality, both ToM’s and Colgate
might be able to achieve their respective goals.

8. What is your estimate of the coming year’s growth in the “traditional” as well as in
the “ethical” market segment?

It should be noted here that at the time of this merger in 2006, the current global financial
crisis was not anticipated and therefore, most companies and stakeholders would have
been very optimistic about the growth potential of these market segments. It has already
been stated that the US oral care market was experiencing declining growth and the
expected growth was at just 2% over the previous year. As per Exhibit I it may be noted
that although the overall market growth has been estimated to be higher than 2%, the
share of oral care products has been below this estimated average. Most of the growth
may be attributable to the ancillary products like gum, mouth wash, breath fresheners, etc.

It may be estimated that the developed and knowledgeable markets like the US and
Europe would experience a low growth in the ‘traditional’ market segment. With
increasing trends towards environmentally friendly and ethical products, more people in
such markets are likely to buy green/natural products, thus leading to a declining growth
in the ‘traditional’ segment. However, this decline is likely to be at a very gradual rate
and in most probability it will fall to a certain level before stabilising. It is highly unlikely
that the ‘traditional’ market will stop growing completely, even in developed markets.
The situation in growing markets and emerging economies is quite the opposite as the
consumers are less knowledgeable about environmentally friendly products. The high

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 9

costs of these products act as a strong deterrent for consumers in these markets and
consequently, the ‘traditional’ markets will continue to experience above average growth.
As far as the ‘ethical’ market segment is concerned, the estimated 15 % growth in the US
may be expected to continue over the next few years, as an increasing number of people
turn towards buying natural and chemical-free products. At the same time, with
increasing competition the prices of such products will become more competitive over
time and although it is not likely that the prices will match those of ‘traditional’ products,
they will become considerably low so as to increase its growth rate even in emerging
economies. It should be noted that this may not take place in a couple of years and would
probably take about a decade to reach this position. Other factors like bad publicity of
chemical based ‘traditional’ products, Governmental support for ‘ethical’ products and
more educated consumers will further lead to an increase in the ‘ethical’ market segment.
However, the 15 % growth rate cannot be expected to continue in the long run and will
probably see a gradual decline after about 10 years. As the market reaches saturation, this
growth will most likely stabilise at a constant and more realistic rate that may be expected
to continue for a longer period.

Bhooshan Parikh | CBS FT MBA 2008-09 | Term Paper-Mergers And Acquisitions 10