Chapter 1:

Introduction to M&A,
Business Alliances,
Ventures & Other
Restructuring
Activities
 If you give a man a fish, you feed him for a day.
If you teach a man to fish, you feed him for a life time.

Lao Tze
 Success is a Personal Choice

We can choose to be successful by

Setting goals,

Having high expectations of ourselves,

Never quitting,

By not making excuses, and

By accepting personal responsibility

 Phase 1: Business Plan Develop a strategic plan for the entire business

Phase 2: Acquisitions Plan Develop the acquisition plan supporting the business plan

Phase 3: Search Search actively for acquisition candidates

Phase 4: Screen Screen and prioritize potential candidates

Phase 5: First Contact Initiate contact with the target

Phase 6: Negotiation Refine valuation, structure the deal, perform due diligence, and
develop the financing plan

Phase 7: Integration Plan Develop a plan for integrating the acquired business

Phase 8: Closing Obtain the necessary approvals, resolve postclosing issues, and
execute the closing

Phase 9: Integration Implement the postclosing integration

Phase 10: Evaluation Conduct the postclosing evaluation of acquisition.

Current Chapter Learning Objectives

Primary objective: What corporate restructuring is

and why it occurs
Secondary objective: Provide students with an
understanding of
MA & BA as a form of corporate restructuring
Alternative ways of increasing shareholder value
MA & BA activity in an historical context
The primary motivations for MA & BA activity
Key empirical findings
Primary reasons some MA & BAs fail to meet
expectations
MA & BAs as a Form of
Corporate Restructuring
 Introduction to MA & BAs

Merger
Two firms agree to integrate their operations on a
relatively co-equal basis
Horizontal Merger, Vertical merger, Conglomerate merger
Acquisition
One firm buys a controlling interest in another firm with
the intent of making the acquired firm a subsidiary
business within its portfolio.
Takeover
Special type of acquisition strategy wherein the target
firm did not solicit the acquiring firm's bid
Hostile Takeover: Unfriendly takeover that is
unexpected and undesired by the target firm
 MA & BAs as a Form of
Corporate Restructuring
Statutory Merger: Combination of two corporations in which
only one corporation survives in accordance with the statutes
of the state in which the surviving firm is incorporated. A
statutory merger is the same as an acquisition, where one of
the entities survives the transaction
Subsidiary Merger: A merger of two companies resulting in
the target company becoming a subsidiary of the parent. The
acquiring company uses its subsidiary company to acquire a
target company
Consolidation: Two or more companies join to form a new
company (e.g., Daimler-Benz and Chrysler)
Acquisition: Purchase of an entire company or a controlling
interest in a company
 MA & BAs as a Form of
Corporate Restructuring
Divestiture: The sale of all or substantially all of a company or
product line to another party for cash or securities.
LBO: The purchase of a company financed primarily by debt.
The term is often applied to a firm going private financed
primarily by debt.
MBO: A leveraged buyout in which the managers of the firm
buy the stakes to be taken private are also equity investors
Holding company: A single company with investments in a
number of other, often diverse, operating companies
Acquirer: A firm attempting to merge or acquire another
company
Target: The firm being solicited by the acquiring firm.
 MA & BAs as a Form of
Corporate Restructuring
Horizontal merger: Occurs when two firms in the same industry combine
Vertical merger: Mergers in which the two firms are in different stages of
the value chain
Conglomerate mergers: Mergers between companies in largely unrelated
industries

being acquired and recommend that the shareholders approve the

transaction
Hostile takeover: Occurs when the initial offer was unsolicited by the
target, the target was not seeking a merger at the time it was approached,

current share price

 MA & BAs as a Form of
Corporate Restructuring

Restructuring Activity Potential Strategy

Corporate Restructuring Redeploy Assets
Balance Sheet Mergers, Break-Ups, &
Assets Only Spin-Offs
Operational Restructuring Acquisitions, divestitures,
(partial sale of companies or etc.
product lines or downsizing by Increase leverage to lower
closing unprofitable or cost of capital or as a takeover
nonstrategic facilities.) defense; share repurchases
Financial Restructuring Divestitures, widespread
(Actions by the firm to change employee reduction, or
its total debt and equity reorganization
structure.)
Understanding key participants in the
MA & BA process
Investment bankers: Often hired by acquiring and target firms, they provide their clients
with strategic and tactical advice and acquisition opportunities, screen potential buyers
and sellers, make initial contact with the seller or buyer, and provide valuation,
negotiation, and deal structuring support.
Lawyers: Provide specialized legal expertise in such areas as MA & BAs, tax, employee
benefits, real estate, antitrust, securities, environment, and intellectual property.
Accountants: Provide advice on the optimal tax structure, on financial structuring, and on
performing due diligence.

addresses and to design strategies to educate shareholders and communicate why

boards to promote their positions to shareholders.

Public relations firms: Assist in developing consistent messages for communicating to the
various stakeholder groups of the firm.
Institutional investors: Private and public pension funds, insurance firms, investment
companies, bank trust departments, and mutual funds who may seek to take either a
passive or activist role in how a firm is managed by how they vote their shares.
Arbitrageurs: Investors who attempt to profit from small differences between the offer
price for a target firm and its actual share price
 Motivations for MA & BA
Strategic realignment
Technological change
Deregulation
Synergy
Economies of scale/scope
Cross-selling
Diversification (Related/Unrelated)
Financial considerations
Acquirer believes target is
undervalued
Booming stock market
Falling interest rates
Market power
Ego/Hubris
Tax considerations
Why do MA & BAs happened?
 Illustrating Economies of Scale
Period 1: Firm A (Pre-merger) Period 2: Firm A (Post-merger)

Assumptions: Assumptions:
Price = $4 per unit of output sold Firm A acquires Firm B which is producing
Variable costs = $2.75 per unit of output 500,000 units of the same product per year
Fixed costs = $1,000,000
Firm A is producing 1,000,000 units of output per
year Price = $4 per unit of output sold
Firm A is producing at 50% of plant capacity Variable costs = $2.75 per unit of output
Fixed costs = $1,000,000

Profit = price x quantity variable costs Profit = price x quantity variable costs
fixed costs fixed costs
= $4 x 1,000,000 - $2.75 x 1,000,000 = $4 x 1,500,000 - $2.75 x 1,500,000
- $1,000,000 - $1,000,000
= $250,000 = $6,000,000 - $4,125,000 - $1,000,000
= $875,000

Profit margin (%)1 = $250,000 / $4,000,000 = 6.25% Profit margin (%)2 = $875,000 / $6,000,000 = 14.58%
Fixed costs per unit = $1,000,000/1,000,000 = $1 Fixed costs per unit = $1,000,000/1.500,000 = $.67

Key Point: Profit margin improvement is due to spreading fixed costs over more units of output.
1Margin per unit sold = $4.00 - $2.75 - $1.00 = $.25
2Margin per units sold = $4.00 - $2.75 - $.67 = $.58
 Illustrating Economies of Scope
Pre-Merger: Post-Merger:

supports 5 manufacturing facilities processing centers are combined

into a single operation to support
all 8 manufacturing facilities
supports 3 manufacturing facilities By combining the centers, Firm A
is able to achieve the following
annual pre-tax savings:
Direct labor costs = $840,000.
Telecommunication expenses
= $275,000
Leased space expenses =
$675,000
General & administrative
expenses = $230,000

Key Point: Cost savings due to expanding the scope of a single center to
support all 8 manufacturing facilities of the combined firms.
These conclusions are based on recent studies using large samples over lengthy time periods involving U.S., foreign, and cross-border deals
(including public and private firms). See J. Netter, M. Stegemoller, and M. Wintoki, 2011 Implications of Data Screens on Merger and
Acquisition Analysis: A Large Sample Study of Mergers and Acquisitions, Review of Financial Studies 24 2316-2357 and J. Ellis, S. B.
Moeller, F.P. Schlingemann, and R.M. Stulz, 2011 Globalization, Governance, and the Returns to Cross-Border Acquisitions, NBER
Working Paper No. 16676.
Financial synergy is when the combination of two
firms together results in greater value than if they
were to operate separately

cost of capital due to a merger or acquisition

This could occur if the merged firms have cash flows that
are relatively uncorrelated
cash flows are uncorrelated can indeed lead to a
reduction in systematic risk
multi-product line firms with less correlated business unit
cash flows can have less systematic risk than firms
whose business unit cash flows are correlated
Products Current Market New Market

Current Lower Growth/ Lower Risk Higher growth / Higher

Risk (related
diversification
New Higher Growth / Higher risk (related Higher growth / higher
diversification) risk (Unrelated
diversification)

Diversification may create financial synergy that reduces the cost of

capital as noted above.
shift from its core product line (s) to those having higher growth
prospects

Drugstore chain (a drug retailer)

healthcare products line are examples of such related diversification

Firms that operate in a number of largely unrelated industries are
called conglomerates
Firms use MA & BAs to adjust to changes in their external
environment such as regulatory changes and technological
innovation
Technological advances create new products and industries
and force a radical restructuring of existing ones
In 2016 Facebook acquired FacioMetrics, a facial feature
emotion recognition corporate spin-off by Carnegie Mellon
University. In the same year Apple Inc. acquired the facial
feature emotion recognition start-up Emotient.[179] By the end
of 2016 commercial vendors of facial recognition systems
offered to integrate and deploy emotion recognition
algorithms for facial features.
CEOs with successful acquisition track
records may pay more than the target is
worth due to overconfidence.
Having overpaid, such acquirers may feel
remorse at having done so experiencing

In addition to CEO hubris, the presence of

multiple bidders may contribute to
overpaying as acquirers get caught up in
the excitement of an auction environment
The Q-ratio is the ratio of the market value of the

Replacement cost is a term referring to the amount of

money a business must currently spend to replace an
essential asset like a real estate property, an investment
security, a lien, or another item, with one of the same or
higher value
Firms can choose to invest in new plant and equipment or
obtain the assets by buying a company with a market
value less than what it would cost to replace the assets
(i.e., a market-to-book or Q-ratio that is less than 1).
This theory is useful in explaining MA & BA activity when
stock prices drop well below the book value (or historical
cost) of firms.
Agency problems arise when the interests of
managers and shareholders differ.
Managers may make acquisitions to add to
their prestige, build their influence, increase
compensation, or for self-preservation
Fairness opinions to evaluate the
appropriateness of bidder offer prices and
special committees consisting of
independent directors to represent
shareholders may be used to mitigate
agency problems in target firms.
the taxable nature of the transaction often
plays a more important role in determining
whether a merger takes place than do any
tax benefits accruing to the acquirer
Tax free status of the transaction as a
prerequisite for the deal to take place
Taxes also are an important factor
motivating firms to move their corporate
headquarters to low cost countries
The market power theory suggests that
firms merge to improve their ability to set
product prices by reducing output or by
colluding
Sources of market power include Size of
the firm, resources and capabilities to
compete in the market and share of the
market
investors may periodically incorrectly value a
firm
Misvaluation contributes to market inefficiencies:
the winning bidder may not be the one with the
greatest synergy potential and the purchase

economic value
The effects of misvaluation tend to be short-
lived, since the initial overvaluation of an
3

synergies wanes
Primary Reasons Some MA & BAs Fail
to Meet Expectations

Overpayment due
to over-estimating
synergy

Slow pace of
integration

Poor strategy
 Discussion Questions

1. Discuss whether you believe current conditions

in the global markets are conducive to high
levels of MA & BA activity? Be specific.
2. Of the factors potentially contributing to current
conditions, which do you consider most
important and why?
3. Speculate about what you believe will happen
to the number of MA & BAs over the next
several years in Indoensia? Globally? Defend
your arguments.
 Application: Xerox Buys ACS
In 2010, Xerox, a slower growing, cyclical an office equipment manufacturer, acquired
Affiliated Computer Systems (ACS) for $6.4 billion. With annual sales of about $6.5 billion,
ACS handles paper-based tasks such as billing and claims processing for governments
and private companies. With about one-
and government sectors through long-term contracts, the acquisition gives Xerox a greater
penetration into markets which should benefit from the 2009 government stimulus
spending and 2010 healthcare legislation. There is little customer overlap between the two
firms. The sale of services tends to be more stable and offers higher margins than product
companies.
Previous Xerox efforts to move beyond selling printers, copiers, and supplies and into
services achieved limited success due largely to poor management execution. While some
evident, the pace was far too slow. Xerox was looking for a way to accelerate transitioning
from a product driven company to one whose revenues were more dependent on the
delivery of business services.
More than two-
operations such as accounting, human resources, claims management, and other
outsourcing services, with the rest coming from providing technology consulting services.
separate standalone business.

Discussion Questions:
1. What alternatives to buying ACS do you think Xerox could have considered?
2. Why do you think they chose a merger strategy? (Hint: Consider the
advantages and disadvantages of alternative implementation strategies.)
3.
4. How might the decision to manage ACS as a separate business affect realizing the full
value of the transaction? What other factors could limit the realization of synergy?
Remembering the Past

Alexis De Tocqueville
Alternative Takeover Strategies
 Alternative Operational Restructuring
A joint venture involves two or more businesses pooling their resources and expertise to
achieve a particular goal. The risks and rewards of the enterprise are also shared
A divestiture is the partial or full disposal of a business unit through sale, exchange,
closure, or bankruptcy. A divestiture most commonly results from a management decision
to cease operating a business unit because it is not part of a core competency
Spinoff happened when a company creates a new independent company by selling or
distributing new shares of its existing business. A company creates a spinoff expecting
that it will be worth more as an independent entity. A spinoff is also known as a spin out
To consolidate (consolidation) is to combine assets, liabilities, and other financial items
of two or more entities into one. Consolidation also refers to the union of smaller
companies into larger companies through mergers and acquisitions (MA & BA)
Statutory Consolidation: When businesses are combined into a new entity, the original
companies cease to exist. By combining them together, they create a new, larger
corporation. As such, statutory consolidation is normally done through a merger
A subsidiary merger is a type of merger that occurs when the acquiring company uses its
subsidiary company to acquire a target company. Following the deal, the target company
then becomes a wholly-owned subsidiary of the acquiring company, with the buyer (the
parent company) as the sole shareholder
A minority investment or a minority interest refers to the non-controlling share in a
company held by an investor or another company. The minority investment is usually
less than 50% of the total outstanding shares of the company.
 Alternative Financial Restructuring

A leveraged buyout (LBO) occurs when someone purchases a company using

almost entirely debt. The purchaser secures that debt with the assets of the
company they're acquiring and it (the company being acquired) assumes that debt.
The purchaser puts up a very small amount of equity as part of their purchase
A carve-out is the partial divestiture of a business unit in which a parent company
sells a minority interest of a subsidiary to outside investors. A carve-out allows a
company to capitalize on a business segment that may not be part of its core
operations
Liquidation in finance and economics is the process of bringing a business to an
end and distributing its assets to claimants. It is an event that usually occurs
when a company is insolvent, meaning it cannot pay its obligations when they are
due. ... General partners are subject to liquidation
Stock buybacks refer to the repurchasing of shares of stock by the company that
issued them. A buyback occurs when the issuing company pays shareholders the
market value per share and re-absorbs that portion of its ownership that was
previously distributed among public and private investors
 Alternative Ways of
Increasing Shareholder Value

Partnering
(Marketing/distribution alliances,
JVs, licensing, franchising, and
equity investments)
Mergers and acquisitions
Minority investments in other
firms
Asset swaps
Financial restructuring
Operational restructuring
 Discussion Questions

1. What factors do you believe are most likely to

strategy (e.g., solo venture, MA & BA) to

increase shareholder value over the
alternatives? Be specific.
2. In your opinion, how might the conditions of
the business (e.g., profitability) and the
economy affect the choice the strategy?
 Things to Remember

Motivations for acquisitions:

Strategic realignment
Synergy
Diversification
Financial considerations
Hubris
Common reasons MA & BAs fail to meet expectations
Overpayment due to overestimating synergy
Slow pace of integration
Poor strategy
MA & BAs typically reward target shareholders far more than bidder
shareholders
Success rate of MA & BA not significantly different from alternative
ways of increasing shareholder value
 Merger Waves1
(Boom Periods)
Horizontal Consolidation (1897-
1904)
Increasing Concentration (1916-
1929)
The Conglomerate Era (1965-
1969) Unrelated Industries
The Retrenchment Era (1981-
1989) - Downsizing
Age of Strategic Megamerger
(1992-2000) Large corporations
Age of Cross Border and
Horizontal Megamergers (2003-
2007)

1Periods characterized by robust increases in the number and value of transactions.

 Causes and Significance
of MA & BA Waves

Factors contributing to increasing MA & BA activity:

Shocks (e.g., technological change, deregulation, and escalating
commodity prices)
Ample liquidity and low cost of capital
Overvaluation of acquirer share prices relative to target share
prices
Improving business confidence
Why it is important to anticipate MA & BA waves:
Financial markets reward firms pursuing promising (often
undervalued) opportunities early on and penalize those that
follow later in the cycle.
Acquisitions made early in the wave often earn substantially
higher financial returns than those made later in the cycle.
Horizontal Consolidation (1897-1904)
Spurred by
Drive for efficiency,
Lax enforcement of antitrust laws
Westward migration, and
Technological change
Resulted in concentration in metals,
transportation, and mining industry
MA & BA boom ended by 1904 stock market
crash and fraudulent financing
Increasing Concentration (1916-1929)

Spurred by
Entry of U.S. into WWI
Post-war boom
Boom ended with
1929 stock market crash
Passage of Clayton Act which more clearly
defined monopolistic practices
The Conglomerate Era (1965-1969)

Conglomerates buy earnings streams to boost

their share price
Overvalued firms acquired undervalued high
growth firms
Number of high-growth undervalued firms
declined as conglomerates bid up their prices
Higher purchase price for target firms and
increasing leverage of conglomerates brought
era to a close
The Retrenchment Era (1981-1989)

Strategic U.S. buyers and foreign multinationals

dominated first half of decade
Second half dominated by financial buyers
Buyouts often financed by junk bonds
Drexel Burnham provided market liquidity
Era ended with bankruptcy of several large
LBOs and demise of Drexel Burnham (Michael
Milken)
 Age of Strategic Megamerger
(1992-2000)

Dollar volume of transactions reached record in each

year between 1995 and 20001
Purchase prices reached record levels due to
Soaring stock market
Consolidation in many industries
Technological innovation
Benign antitrust policies
Period ended with the collapse in global stock markets
and worldwide recession

1The cumulative dollar value of MA & BAs during this period in the U.S. was $6.5 trillion, With $3.5
trillion taking place in the last two years.
 Age of Cross Border and
Horizontal Megamergers (2003 2007)

Average merger larger than in 1980s and 1990s, mostly

horizontal, and cross border
Concentrated in banking, telecommunications, utilities,
healthcare, and commodities (e.g., oil, gas, and metals)
Spurred by
Continued globalization to achieve economies of
scale and scope;
Ongoing deregulation;
Low interest rates;
Increasing equity prices, and
Expectations of continued high commodity prices
Period ended with global credit market meltdown and
2008-2009 recession
 Similarities and Differences
Among Merger Waves

Similarities
Occurred during periods of sustained high economic
growth
Low or declining interest rates
Rising stock market
Differences
Emergence of new technology (e.g., railroads,
Internet)
Industry focus
Type of transaction (e.g., horizontal, vertical,
conglomerate, strategic, or financial)
 Discussion Questions

1. What can senior management learn by

studying historical merger waves?
2. What can government policy makers learn by
studying historical merger waves?
3. What can investors learn by studying historical
merger waves?