Mergers & Acquisitions (2/2)

In this lesson, you’re expected to learn about:
– motives for M&A
– valuing a business
– paying for an M&A

What are Divestitures?

Divestiture is a broad term that can include several different potential methods for accomplishing the same thing: getting rid of assets. In the case of M&A, if a division/branch/operation within the company can’t stand alone as a company it probably needs to shut down those operations and liquidate the hard assets for whatever it can get for them.

If that division or whatever has the potential to operate independently of the company, it probably spins off into its own company. In other words, it stops being a part of the larger company and operates independently.

Here’s a perfect example of a merger-gone-wrong that resulted in a divestiture. 

In 2007, Daimler sold its Chrysler operations to a capital investing firm, following weak sales by Chrysler and an inability by Daimler to do anything successful with it. Chrysler was sold and later repurchased by another car manufacturer (Fiat).

Daimler decided it was better to sell the division for what it could get and take the loss, instead of lose everything trying to sort out a company it didn’t have the ability to help.

Identifying Motives For M&A

The ultimate goal for any M&A activity is to make money, but then that’s the primary motivation behind all businesses’ activities. But you don’t simply sign an M&A agreement and money appears out of nowhere. The top people in charge need to know how to extract that money from the arrangement and derive value from integrating.

M&A can improve a company’s financial performance in several different ways. The financial aftermath of any M&A is where you make the distinction between managers who know what they’re doing and those that are just pretending, which is all highly dependent on the ability of managers to recognize in advance that money can be made by integrating companies. If an M&A results in the company losing money, this is because of a bad managerial decision.

If you agree to integration under the simple assumption that it’s for the best, you’re probably guessing and should look for a different job. If you can define exactly how your company’s going to make money (and how much), you truly understand your motivations for M&A and can move forward with the deal.

Discovering Diversification

Diversification means the same thing in this context as it does with investment portfolios: it’s the process of making something more varied. With investment portfolios, diversification means holding unrelated investments to avoid risk and volatility for the whole portfolio that may otherwise be caused by just one or two investments.

In M&A, diversification refers to attempts to make the product portfolio or operations more varied.

Diversification can be financially beneficial because it enables a company to operate in different areas of the market (or even a different market), but you need to be careful to make sure diversification is appropriate for the company. There’s no point investing in diversification if doing so isn’t going to reap rewards (in other words, make money).

Financially, a merger means greater revenues, less volatile earnings and more efficient operations through lower average overhead per unit of output. Thus, your M&A is a success!

Expanding Geographically

M&A is a popular way to expand into foreign markets or new areas within the same nation that are already dominated by established competitors. This approach allows the company to expand into these territories while using a name that’s already recognizable and people who already have expertise in the area.

M&A is a great way to enter into new markets and increase total sales. If you’re lucky, M&A can also mean generating economies of scale.

Daimler’s merger with Chrysler was primarily motivated by geographic expansion. Daimler is a German company with very little presence in the United States, while Chrysler was faltering but still had a prominent US presence. Daimler saw merging with Chrysler as an opportunity to enter into the highly lucrative American automotive market.

The Daimler and Chrysler merger failed, however, because of cultural differences and organizational culture. Daimler was a very hierarchical company with a clear chain of command and respect for authority. Chrysler, on the other hand, favored a more team-oriented approach. This example shows that there’s more to consider in an M&A than simply profit — a target company (the potential acquiree) may do things a lot differently than the bidding company (the potential acquirer) and managing these differences ineffectively can doom an M&A to failure.

Daimler’s merger with Chrysler was primarily motivated by geographic expansion. Daimler is a German company with very little presence in the United States, while Chrysler was faltering but still had a prominent US presence. Daimler saw merging with Chrysler as an opportunity to enter into the highly lucrative American automotive market.

The Daimler and Chrysler merger failed, however, because of cultural differences and organizational culture. Daimler was a very hierarchical company with a clear chain of command and respect for authority. Chrysler, on the other hand, favored a more team-oriented approach. This example shows that there’s more to consider in an M&A than simply profit — a target company (the potential acquiree) may do things a lot differently than the bidding company (the potential acquirer) and managing these differences ineffectively can doom an M&A to failure.

Benefiting from economies of scale

Buying in bulk saves money. If you’ve ever shopped at a cash-and-carry retailer such as Costco, you’ve definitely bought things in large quantities to save cash. Many people buy kitchen rolls in cases of 12 rolls because it’s cheaper per roll than buying one or two at a time.

Well, that’s basically how economies of scale work: you operate in larger quantities to make production cheaper per unit.

Say that you have a machine that produces 1,000 units per year. You sell only 500 units per year, though. So, if you have overhead of $1,000 per year and you’re only selling 500 units per year, you have an average overhead of $2 per unit ($1,000 in overhead / 500 units = $2 per unit).

You decide to perform a little M&A to get into a foreign market, which increases sales to 1,000 units per year. Your overall overhead stays the same, which means that your average overhead reduces to just $1 per unit ($1,000 in overhead / 1,000 units = $1 per unit). This reduces your overhead per unit by 50% through M&A.

Enjoying economies of scope

Economies of scope is about reducing average cost of production, but unlike economies of scale you’re attempting to reduce average costs by offering different product lines that use much of the same resources.

If two companies that manufacture stationery and paper plates merge, the new company is working out of a single manufacturing facility, which greatly reduces the overhead to produce the products both firms were making using two facilities. This increase in production for equivalent fixed costs is also a form of economies of scale.

An example is Kimberly Clark, a conglomerate that sells a huge range of personal care goods. These products all use the same branding, marketing and design, so the indirect costs associated with the supporting activities (for example, marketing, finance etc.) can be applied to a wider range of products, reducing their cost per unit.

Integration

Companies can integrate in different directions, within the same supply chain or even across industries.

Vertical Integration
Vertical integration occurs when a company acquires another company that is up or down the supply chain in the same industry:
– Backward integration: When a company acquires a company from which it buys.
– Forward integration: The acquisition of a company to which it sells.

Horizontal Integration

Horizontal integration focuses on combining different companies at the same level in the supply chain. It’s extremely common in technology companies, where developers acquire other developers or manufacturers acquire different manufacturers.

They do so not only to get rid of competitors, but also to gain the rights to new ideas and patents and to increase market share to compete against more established companies. In all cases, the point is to cut costs or increase revenues.

Conglomerate Integration

Conglomerate integration is the acquisition by one company of a company that’s nowhere in the same supply chain, horizontally or vertically. The untrained eye may think that these forms of integration have no more benefit than simply the additional revenues generated by investing in another company. If you look a little bit closer, though, you can often see much more.

Say that a bank buys a car dealership. Many people may see this move as a simple case of diversification. If you examine the types of loans that the bank makes, however, you spot that the number of car loans it issues increases dramatically. This integration is conglomerate integration because the two companies aren’t in the same business, but they do complement each other. The bank continues to operate normally but provides loans to the dealership it owns at lower rates than would be possible with a standard financing agreement.

Eliminating Competitors

M&A is a common way for larger companies to eliminate potential competitors from the pool of smaller but quickly growing companies.

In 2007, for example, Coca Cola acquired Energy Brands, a company that produces several lines of bottled water. Coca Cola recognized the growing demand for bottled water and other non-sugar based beverages as a replacement for soda as populations around the world become more health-conscious, and so it picked one of the more promising companies in that trend and bought it. Coca Cola eliminated one of its competitors by purchasing it, while also diversifying its product portfolio with a product competing with its primary line of products.

Seeking Manager Compensation

Although not exactly the most financially sound motivation, or the most honest, compensation packages have been a primary motivation for far more than one case of M&A. Instead of making the best decision for the companies involved, these actions are taken by individuals seeking self-benefit, such as the following:

– Getting bonuses for short-term performance manipulation.
– Receiving golden parachutes (huge benefits that top executives receive when the company is taken over by another company and the executive leaves the company being taken over).
– Manipulating greenmail circumstances (purchasing enough shares to threaten a takeover so that the company buys them back at a higher value).

M&A is a big deal, even for large companies, and a lot of money gets shifted around very quickly during M&A deals. As a result of the deals themselves and the short-term aftermath, frequently executives are in a position of personally making a huge amount of money.

Of course, this extra income is usually at the cost of the long-term financial health of the company; but, rightly or wrongly, income is often a primary motivator in decisions to participate in M&A, or at least the decision to start looking for M&A partners.

Gaining Synergies

The world is increasingly seeing M&A based on operations between companies that match well, but not for the usual supply chain or competitive reasons. A lot of these integrations focus on the philosophy of ‘one person’s rubbish is another’s treasure’, all designed, of course, to cut costs and generate revenues between both firms.

For example, more integration between manufacturing firms and energy companies is occurring whereby the heat or smoke from a processing plant that normally gets disbursed into the air is used to produce electricity and sold back to the utility companies.

[Optional] 15 Financial Ratios Every Investor Should Use

 

 

Jim Rohn Sứ mệnh khởi nghiệp