Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-1 Chapter 10

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 2 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-2 MissionObjectives External Analysis Internal Analysis Strategic Choice Strategy Implementation Competitive Advantage The Strategic Management Process Corporate Level Strategy Which Businesses to Enter? Vertical Integration Diversification Strategic Alliances Mode of Entry? Mergers & Acquisitions

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 3 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-3 Logic of Corporate Level Strategy Applies Corporate level strategy should create value: 2)such that businesses forming the corporate whole are worth more than they would be under independent ownership 3)that equity holders cannot create through portfolio investing 1)such that the value of the corporate whole increases

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 4 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-4 Mergers & Acquisitions Defined MergersAcquisitions two firms are combined on a relatively co-equal basis one firm buys another firm the words are often used interchangeably even though they mean something very different merger sounds more amicable, less threatening

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 5 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-5 parent stocks are usually retired and new stock issued name may be one of the parents’ or a combination can be a controlling share, a majority, or all of the target firm’s stock can be friendly or hostile MergersAcquisitions Mergers & Acquisitions Defined usually done through a tender offer one of the parents usually emerges as the dominant management

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 6 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-6 Do Mergers and Acquisitions Create Value? The Logic Unrelated M&A Activity there would be no expectation of value creation due to the lack of synergies between businesses there might be value creation due to efficiencies from an internal capital market there might be value creation due to the exploitation of a conglomerate discount a corporate raider who buys and restructures firms

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 7 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-7 Mergers & Acquisitions Defined Types of M&A Activity FTC Categories Vertical Horizontal Product Extension Market Extension Conglomerate » suppliers or customers » competitors » complementary products » complementary markets » everything else Related Unrelated

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 8 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-8 Do Mergers and Acquisitions Create Value? The Logic Related M&A Activity value creation would be expected due to synergies between divisions economies of scale economies of scope transferring competencies sharing infrastructure, etc.

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 9 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly 10-9 Do Mergers and Acquisitions Create Value? The Empirical Evidence this reflects the market’s assessment of the expected value of the merger or acquisition these studies look at what happens to the price of both the acquirer’s stock and the target’s stock thus, we can see who is capturing any expected value that may be created Research is based on stock market reaction to the announcement of M&A activity

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 10 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Do Mergers and Acquisitions Create Value? The Empirical Evidence Acquiring Firms Target Firms M&A Activity creates value, on average, as follows: no value created value increases by about 25% related M&A activity creates more value than unrelated M&A activity M&A activity creates value, but target firms capture it

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 11 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Do Mergers and Acquisitions Create Value? Expected versus Operational Value April 2000:Wells Fargo offers to acquire First Security Bank for about $3 billion Wells Fargo: down $0.25 to $39.50 First Security: up $1.19 to $13.38 Stock Price Market Cap. 12/1999 $40.44 $65.7 B 12/2000 $56.69 $95.2 B 12/2001 $43.60 $74.0 B 12/2002 $46.87 $82.0 B 12/2003 $58.89 $100.0 B 12/2004 $62.15 $105.0 B Stock values were: Wells Fargo: $43.69 First Security: $15.50 The Deal:.355 shares of WF for each share of FS stock Expected Operational

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 12 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? Survival Free Cash Flow cash generating, normal return investment avoid competitive disadvantage avoid scale disadvantages

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 13 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? Agency Problems Managerial Hubris managers benefit from increases in size managers benefit from diversification managers believe they can beat the odds

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 14 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Why is M&A Activity So Prevalent? If managers know that acquiring firms do not capture any value from M&A’s, why do they continue to merge and acquire? Above Normal Profits proposed M&A activity may satisfy the logic of corporate level strategy managers may see economies that the market can’t see some M&A activity does generate above normal profits (expected and operational over the long run)

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 15 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Yes, if managers’ abilities meet VRIO criteria Competitive Advantage Can an M&A strategy generate sustained competitive advantage? 2 Managers may be good at doing ‘deals’ 1 Managers may be good at recognizing & exploiting potentially value-creating economies with other firms 3 Managers may be good at both

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 16 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Competitive Advantage Recognizing and Exploiting Economies of Scope Private EconomiesFirm A Firm B Firm C $10,000 $12,000 Firm C’s recognized value is $10,000 Firm A can earn a profit of $2,000 only if the economy remains private BiddersTarget Firm A sees value of $12,000 in Firm C

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 17 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Competitive Advantage Recognizing and Exploiting Economies of Scope Costly-to-Imitate Economies Firm A Firm B Firm C $10,000 $12,000 BiddersTarget if the economy between A & C is costly to imitate, it doesn’t matter if other firms know Firm A can still earn a $2,000 profit

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 18 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Competitive Advantage Recognizing and Exploiting Economies of Scope Firm A Firm B Firm C $10,000 BiddersTarget Unexpected Economies Firm C has a market value of $10,000 Firm A buys Firm C for $10,000 Firm C turns out to be worth $12,000 $12,000

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 19 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Implementation Issues Structure, Control, and Compensation M&A activity requires responses to these issues: m-form structure is typically used management controls & compensation policies are similar to those used in diversification strategies Managers must decide on the level of integration: target firm may remain somewhat autonomous target firm may be completely integrated

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 20 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Implementation Issues Cultural Differences high levels of integration require greater cultural blending cultural blending may be a matter of: combining elements of both cultures essentially replacing one culture with the other integration may be very costly, often unanticipated the ability to integrate efficiently may be a source of competitive advantage

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 21 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly International Issues Government Policy governments may constrain ownership by foreign firms governments may restrict repatriation of profits government labor policy may limit a firm’s ability to apply management practices to target firm

Mergers & Acquisitions Strategic Management & Competitive Advantage – Barney & Hesterly 22 Mergers and Acquisitions Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & Hesterly Summary M&A activity is a mode of entry for vertical integration and diversification strategies M&A activity can create economic value at announcement, but target firms usually capture that value A firm’s M&A strategy should satisfy the logic of corporate level strategy M&A activity can create value over the long term for the acquiring firm