Monday, November 12, 2007

M&A - Points to Refresh - Weston's Book Ch.22

Implementation and Management Guides for M&As

General guidelines for successful M&A activity

M&A program must be part of long-range strategic planning
Recognize that in seeking new opportunities for value enhancement, internal investments and restructuring can be used in conjunction with external investments and M&A activity
Know the industry and its competitive environment as basis for making projections for the future

Be sure that elements of relatedness are present,
Combine firms with relatively unique relationships that other firms cannot match
Avoid multiple bids that could drive up price of target excessively
Acquired unit should be worth more as part of acquirer firm than alone or with some other firm
Recognize appropriate times to be a buyer — at times prices may get too high
Communicate as soon as possible when major investment and restructuring decisions are made; continued communications through implementation process
Top executives must be involved in M&A activity and in other major investment programs

Strong emphasis on maintaining and enhancing managerial rewards and incentives in postmerger period; incentives must exist in order that management of all companies combined in merger stay and contribute to combined company

Top management must be involved in postmerger coordination

Future promotions must not use distinctions based on employment in historical components of company;

if employees have to be separated, it should be done in most enlightened way possible (e.g., assistance with placement activities, insurance coverage)
Managing integration of cultures and coordinating all systems and informal processes of the combining firm should be a top priority

Wishful thinking about potential merger benefits should be avoided; if acquiring firm pays too much, the result will be a negative net present value investment
Restructuring and renewal requirements for an organization should be continuously reassessed in the firm's strategic planning processes
A good deal becomes a bad deal if you overpay

Why Mergers Fail?

1. Pay too much
2. Overoptimistic expected synergies
3. No business logic to the deal.
4. Businesses unrelated.
5. Did not understand what they bought.
6. Unduly hyped by investment bankers, consulting firms, and/or lawyers
7. Underestimated regulatory delays or prohibitions
8. Hubris of top executives – ambition to run a bigger firm and increase salary
9. Top executives want to cash out stock options
10.Culture clashes
11. Ineffective integration – poorly planned, poorly executed, too slow, too fast
12. Suppression of effective business systems of target firms, destroying the basis of their prior success.
13. Too much debt – future interest payments burden
14. Too much short term debt – repayment before synergies are realised
15. Power struggles or incompatibility in board room
16.Mergers of equals - delay requisite decisions
17. Target resistance – white knights, scorched earth, antitrust
18. Multiple bidders cause overpayment
19. Hostile takeovers prevent obtaining sufficient information, fail to uncover basis incompatibilities
20. Basic industry problems such as overcapacity (auto, steel, telecoms)

The Acquisition Process

Strategy formulation
Economics of the industry
Organization system
Multiple strategies for value growth
Search processes
Economic basis — synergy potentials
Restructuring potentials
Due diligence – legal and business
Cultural factors
Deal structuring
Implementation and integration
Reviews and renewal process

Acquisition Process in More Detail

Strategy formulation

Formulate firm's strategies
Articulate goals
Assess strengths and weaknesses in relationship to goals
Eliminate weaknesses
Identify resources and capabilities needed to enforce strengths
Iterative procedure because of dynamic environmental changes in competitive thrusts

Economics of the industry

Firm defined by business economic characteristics of its industry
Consumer versus producer products
Durable versus nondurable
Product versus services versus information
Stage in life cycle
Tangible versus intangible
Pace of technological and other changes
Business activity greatly influenced by increased dynamism of economic, political, and cultural environments

Industry have characteristics that influence responses to change
Some industries are impacted more than others by rates of growth in gross domestic product (GDP)
Nature of industry may influence relative advantage of large and small firms
Industry characteristics influence opportunities for industry roll-ups or need for consolidations

Organization system

Organization structure consistent with firm's strategies and operations
Resources and capabilities consistent with market-product activities
Information flow systems related to performance measurements
Compensation systems based on contributions to value creation
Clear strategic vision and strong organization framework required to embrace expanded and new activities

Operational efficiency
Solid basis for adding capabilities and resources
Align more effectively to changes and opportunities by acquisitions
Multiple strategies for value growth
Internal growth — product expansion and new product programs
Alliance and joint ventures — extend possibilities with smaller investment needs
Licensing from other firms — provides additional revenues with small incremental direct costs
Divestitures — harvest successes or correct mistakes; increased focus
Carve-outs plus spin-offs — source of funds and increased corporate focus
Financial engineering — use of debt and share repurchases may enhance value

Search processes
Ongoing activity of firm
Firm should have dedicated business development group — core group that builds up experience and expertise on acquisition process
Surveillance of firm's environment
Employees — source of research information on potential acquisition candidates
Customers — information on products and market effectiveness

Competitors — information of best practices in relation to industry
Suppliers — information on product improvements and opportunities for vertical integration of operations
Trade shows and technical forums
Financial analysts and market analysts — knowledge about best practices

Economic basis — synergy potentials
Economic reasons
Internet sector — growth driven by new technologies, new information systems, and new distribution systems
Formulate new concepts and expand it rapidly by acquisitions — Yahoo, Amazon Inc.
Acquisition of critical set of technological capabilities — Cisco Systems, Oracle
Reflects new technologies and intensified competition
Competitive pressures on incumbent firms; acquisitions to reinvent itself

Excess capacity and intense product competition
Stimulate acquisitions such as in automobile industry
Stimulate alliances, joint ventures, and mergers
Strong pressure for cross-border mergers
Bargain acquisitions in countries suffering economic reversals
Industry roll-ups
Consolidation of highly fragmented industry
Industry characteristic favorable for roll-up
Initial fragmentation
Substantial industry annual revenues
Companies with robust cash flows
Economies of scale

Restructuring potentials

Improvement in collection period for receivables
Reduction in inventory costs
Control of fixed asset investments by improved models of production management and material flows
Savings in management of financing forms and sources
Innovative dividend policy through use of share repurchases

Leveraging best practices to achieve efficiency increases
Improvement of products, and development of new products
Effective utilization of investments
Improvement in asset and liability management

Due diligence — both legal and business
Examine all aspects of prospective partners
Make sure there are no legal problems such as pension funding, environmental or product liabilities
Assess accounting records
Assess maintenance and quality of equipment
Assess possibility of maintaining cost controls

Evaluate potentials for product improvements or superiorities
Evaluate management relationships, shortcomings, and needs
Evaluate how two management systems will fit together
Assess any new developments that will benefit firm or require adjustments

Cultural factors
Corporate culture
Defined by organization's values, traditions, norms, beliefs, and behavior patterns
Articulated in formal statements of organization values and aspirations
Expressed in informal relationships and networks
Reflected in company's operating style
Corporate culture is conveyed by the kinds of behavior that are rewarded in an organization
Firm must manage its own corporate culture effectively before engaging in merger activity
Firm must recognize cultural factors in planning for external growth
Due diligence must include full coverage of cultural factors

End solutions
Recognize cultural differences and respect them
Exchange executives across organization
Ultimately, cultures may move toward similarity
Differences may be valued as sources of increased efficiency

Valuation analysis to provide disciplined procedure for arriving at a price
Price too low — target may resist and seek other bidders
Price too high — premium may never be recovered
Mergers increase value when value of combined firm is greater than adding premerger values of independent entities

Negotiation (Coming to an Agreement)

Principled negotiation
Use standards of fairness in seeking to meet interests of both parties
Produce agreements that build good future relationships
Negotiation strategy and techniques
Good preparation
Assess strengths and weaknesses
Identify resources and capabilities required
Develop solid quantification of firm's BATNA (best alternative to a negotiated agreement)
Realistic identification of gains, synergies, and their sources
Analyze value relationships
Comparable companies and comparable transactions
Discounted cash flows
Premium paid must have sound foundation in estimates of synergy and savings

Deal structuring

Understand tax consequences of combining firms
Understand true economic consequences of accounting treatment
Consider method of payment — cash, stock, debt, and combinations
Cash reduces uncertainty for seller, but has tax consequences
Stock makes actual return to seller dependent on future outcome of combination
Assess use of explicit contingency payout, and formulation of standards for bonus or penalty


Implementation Capability is a condition for thinking about M&As
Firm must have implemented all aspects of effective operations before it can effectively combine organizations
Must have shareholder value orientation
Must have strategies and organization structures compatible with its multiple business units
Firm must formulate advance integration plans that can effectively accomplish goals of M&A processes
Companies should seek mergers that further their corporate strategy
Strengthen weaknesses
Fill gaps
Extend capabilities
Develop new growth opportunities
Integration leadership is required
Must have management experience
Must have experience with external constituencies
Must have credibility with various integrating participants
Must have good communications plans
Provide early, frequent, and clear integration messages
Address clearly concerns of employees
Cross-functional teams should be created to devote attention to integration issues
Firm must balance between speed and disruption

Reviews and renewal processes
Firm must continuously adjust to new opportunities and challenges
Must monitor change forces in environment in which firm operates
Must recognize impacts of competitors
Firm must have broad strategy that guides success in its business markets

Rules for Successful Mergers

Drucker's merger rules (1981)
Drucker five commandments
Acquirer must contribute something to acquired firm
Common core of unity required
Acquirer must respect business of acquired firm
Acquirer must provide top management to acquired firm within a year or so of merger
Managements in both firms should receive promotions across entities within first year of merger

Simplification of Drucker rules
Merging companies must be related in some way
Well-structured incentives must be offered to managers of both firms — acquiring firm must be prepared to replace departing key managers in target firm
Drucker rules may be unduly restrictive if interpreted too literally

Additional commentaries to Drucker rules
Relatedness necessary; complementarities are also important
Relatedness/complementarities apply to general management functions and to specific managerial capabilities
Negative returns will result if acquirer pays too much
Greater uncertainty in merger than in internal investments
Recovery of premium paid must be based on real economies — operating and/or financial

Anslinger and Copeland (1996)
- Studied 21 successful acquirers of two types
- Diversified corporate acquirers
- Financial buyers such as leveraged buyout firms

Seven key principles of success

Acquire companies with track record of innovative operating strategies
Capable managerial talent is most important for creating value
Use strong incentive compensation systems such as stock purchase programs so top managers have large part of their net worth in company
Link compensation incentives to future changes in cash flows
Push pace of change to make turnarounds happen within first two years of merger
Develop information and feedback systems that promote continuing dynamic relationships among owners, managers, and the board
Acquiring firms must use executives with expertise and demonstrated experience as deal makers

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