Popularity of M&A Strategies = Popular strategy among U.S. firms for many yearsPopularity of M&A Strategies = Popular strategy among U.S. firms for many years = Last decade, many emerging market firms started following this strategy = Can be used because of uncertainty in the competitive landscape = Popular as a means of firm growth = Buying growth — external growth = Commonly used with corporate, business and international strategies = Should be used to increase firm value and lead to strategic competitiveness and above average _ returns iPopularity of M&A Strategies MBA India Mergers & Acquisitions IndiaReality of M&A oe & The reality is that value creation from "M&A teas are often challenging = GOOD NEWS: Shareholders of ACQUIRED firms often earn above-average returns from acquisitions = BAD NEWS: Shareholders of ACQUIRING firms earn returns that are close to zero: In 2/3 of all acquisitions, the acquiring firm’s stock price fell immediately after the intended transaction was announced @ This negative response reflects investors’ skepticism about projected synergies being capturedMergers, Acquisitions, and Takeovers = Merger = Two firms agree to integrate their operations on a relatively co-equal basis (ExxonMobil) = Acquisition = One firm buys a controlling, 100 percent interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio (Tata-Bhushan Steel) Takeover = Special type of acquisition strategy wherein the target firm did not solicit the acquiring firm's bid Unfriendly/ hostile acquisition (L&T — MindTree)Reasons for Acquisitions "1. Increased market power = Exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are lower than those of its competitors = Sources of market power include » Size of the firm » Resources and capabilities to compete in the market » Share of the market = Entails buying a competitor, a supplier, a distributor, or a business in a highly related industryReasons for Acquisitions = 2. Overcoming entry barriers into: = New product markets or industries — product diversification = New international markets — geographic diversification Cross-border acquisitions — those made between companies with headquarters in different country = 3. Cost of new product development and increased speed to market = Internal product development is risky and has a high failure rate = Acquisitions can be used to gain access to new products and to current products that are new to the firm = Can also provide more predictable returns and faster market entry (product and geographic) aReasons for Acquisitions = 4. Lower risk compared to developing new products = Easier to estimate acquisition outcomes versus internal product development = Internal development has a very high failure rate = 5. Increased diversification = Most common mode of diversification when entering new markets with new products = Difficult to internally develop products for markets in which a firm lacks experience = The more related the acquisition the higher the chances for success :Reasons for Acquisitions SS = 6. Reshaping firm’s competitive scope = Can be used to lessen a firm’s dependence on one or more products or markets = 7. Learning and developing new capabilities = When you acquire a firm you also acquire its skills and capabilities = Firms should seek to acquire companies with different but related and complementary capabilities in order to build their own knowledge baseProblems in Achieving Acquisition Success = Research suggests = 20% of all mergers and acquisitions are successful = 60% produce disappointing results = 20% are clear failures = Successful acquisitions generally involve = Having a well conceived strategy for selecting the right target firm = Not paying too high of a price premium = Employing an effective integration process = Retaining target firm’s human capitalProblems in Achieving Acquisition Success = Integration difficulties = Post-acquisition integration is the most important determinant of shareholder value creation = Culture, financial and control systems, working relationships = Status of newly acquired firm’s executives = Inadequate evaluation of target = Due diligence — process through which a potential acquirer evaluates a target firm for acquisition = Can result in paying excessive premium for target companyProblems in Achieving Acquisition Success —= = Inability to achieve synergy = Synergy: exists when the value created by units working together exceeds the value those units cold create working independently » Achieved when the two firms’ assets are complementary in unique ways = Yields a difficult-to-understand or imitate competitive advantage » Generates gains in shareholder wealth that they could not duplicate or exceed through their own portfolio diversification decisions = Firms tend to underestimate costs and overestimate synergyProblems in Achieving Acquisition Success = Too much diversification = Firms can become over diversified which can lead to a decline in performance = Diversified firms must process more information of greater diversity — they can be harder to manage = Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate performance of business units = Acquisitions may become substitutes for internal innovationProblems in Achieving Acquisition Success = Too large = Larger size may lead to more bureaucratic controls » Bureaucratic controls = Formalized supervisory and behavioral rules and policies designed to ensure consistency of decisions and actions across different units of a firm — formalized controls decrease flexibility = Formalized controls often lead to relatively rigid and standardized managerial behavior = Additional costs may exceed the benefits of the economies of scale and additional market power = Firm may produce less innovationEffective Acquisitions = Have complementary assets or resources = Friendly acquisitions facilitate integration of firms = Effective due-diligence process (assessment of target firm by acquirer, such as books, culture, etc.) = Financial slack (cash or a favorable debt position) = Merged firm maintains low to moderate debt position = Continued emphasis on innovation and R&D activities = Acquiring firm manages change well and is flexible and adaptable 8M&A Process © Identify a Target = Valuation = Mode of Acquisition = Mode of Payment = Accounting of Acquisition © Integration ProcessM&A Process (Continued) ty a = Identify a Target: = Based on a sound strategy that can increase shareholders’ wealth = Focus on “Value Related Reasons” = Acquisitions are usually initiated by the acquiring firm = Sometimes a target can announce that it is for saleM&A Process (Continued) ns - = Valuation: = Should not ignore the value of strategic options and payment terms = In general an acquisition creates wealth for the acquirer if: [Target plone + Synergies + Other] >= [Cash Paid + Stock Paid + Debt Assumed]M&A Process (Continued) : is es = Mode of Acquisition: = Refers to whether a proposed acquisition is friendly or hostile to target managers = Friendly acquisitions are approved by board of directors of each firm = Then shareholders vote on the proposal = If no negotiation possibility exists, then an acquirer can proceed with a tender offer to target shareholders — making it hostile © Hostile takeover can be quite time consuming especially when target managers fight against the tender offer feM&A Process (Continued) 4 Db = Mode of Payment: = How an acquisition is paid for: cash, stock or mixed = If the stock is believed to be undervalued, then stock should not be used for payment = If the stock is overvalued, then the stock payment should/can be usedTakeover Defense ———=<_=—=——— = Golden parachute = A contract designed to give executives substantial compensation if they are dismissed following a takeover = Poison pills = It is a type of defense tactic utilized by a target company to prevent or discourage attempts of a hostile takeover by an acquirer. Such plans allow existing shareholders the right to purchase additional shares at a discount, effectively diluting the ownership interest of any new, hostile party. It is effective against raiders who seek to acquire controlling interest. 2