Mergers and Acquisitions
Session 5
Types of Foreign Direct Investment
Green-field investment
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Establishment of a new
operation
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Merger / Acquisition
Acquiring or merging
with an existing firm
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a minority 10-49%
majority: 50-99%
full out-right (completely)
stake: 100%
Objectives behind M&A
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Product diversification
Geographical diversification
Economies of scale
Acquisition of specific assets/competencies (management,
technology, distribution channels, workers, etc.)
Sourcing of raw materials or other products for sale outside
the host country
Financial (portfolio) diversification
Types of M&A
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Horizontal
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Vertical
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The acquired firm has the same market but different
technology or the same technology but different market
Conglomerate
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Acquired firm becomes a supplier of the acquiring firm
(backward integration)
Or a customer of the acquiring firm (forward integration)
Concentric
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The product lines and markets of the acquired and
acquiring firms are similar.
The acquired firm is in the different industry from that of
the acquiring firm
Advantages and disadvantages of M&A’s
(as a foreign market entry mode)
Advantages
Disadvantages
1. A faster start in expoiting the
1. Locating and evaluating
foreign target market, because
acquisition candidates can be
the investor gets a going
extraordinarily difficult.
enterprise with existing products 2. Host and home government
and markets.
policies.
2. Acquisition entry promises a
shorter payback period by
creating immediate income for
the investor.
3. It may provide a resource that is
scarce in the target country and
is not available in the open
market
4. Acquisition of new product lines.
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Key success factors in M&A
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The quality of the pre-acquisition process: how
companies make the M&A decision, give it a value and
negotiate the deal
The quality of the post-acquisition process: how the
integration is managed. This process is considered the
most important source of success or failure
The pre-acquisition and postacquisition processes in global M&As
INTEGRATION PROCESS
Achieving the value through the management of
the acquired company
DECISION-MAKING
PROCESS
Justifying the economic
rationale of the
acquisition
• Value-creation logic
• Target selection
• Due diligence and
valuation
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Integration Framework
• Preservation
• Absorption
• Symbiosis
Transition Management
• Interface management
• New sense of purpose
• Operational focus
• Mutual understanding
• Respect
• Measurement and control
• Winning spiral
• Credibility
Consolidation
Inserting the acquired company in the overall global
strategic/organisational corporate network
Deciding on the M&A:
Value creation
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The economics of M&As: a merger or an acquisition is justified if,
and only if, the value of the new merged or combined entity is
bigger than the sum of the value of the independent entities prior to the
merger.
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From a strategic point of view M&As can create the following types of
value:
 Consolidation of companies operating in the same business area –
horizontal M&A
 Global reach – extension to international markets
 Vertical integration – merging of businesses which are suppliers or buyers
of each other’s products
 Diversification – companies operating in different business domains
 Acquisition of a firm in a new technology or market to monitor its
evolution (a.k.a. Option acquisitions)
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Value creation modalities
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Short-term one-off value
 comes from the one-off post-merger realization of cash benefits coming
from a tax shield, asset disposals and immediate cost savings or debts
leverage.
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Long-term strategic value
 comes from the competitive advantage gained from the merger:
 enhanced differentiation capabilities
 a larger market
 new growth opportunities
 enhanced competencies
 cost advantages through economies of scale or scope
 These advantages are often referred as the synergistic’ effects of a
merger.
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Value creation in M&As
Types of value creation
Benefits
Short-term value creation
Tax shield
Diminution of tax bill (cost benefits)
Asset disposals
Lower capital invested (higher return, lower cost):
– Lower cost of capital (assuming cost of debts lower
than cost of equity)
– Total market value increased after the merger
(assuming a P/E differential between buyer and seller
and a positive market reaction)
Financial engineering:
– Debt leverage
– Price/earnings (P/E) ratio
leverage
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Value creation in M&As
Types of value creation
Benefits
Long-term value creation
Pooling and sharing resources
and assets
– Joint purchasing
– Manufacturing rationalisation
– Joint distribution and logistics
– Common IT and central services
– Common Treasury
Economies of scale and scope (cost benefits)
Enlarged market
– Geography
– Products
– Growth potential enhanced
– Richer value proposition (higher reach and
possibly higher differentiation)
Transfer of competencies
– Technology
– Best practices
– Higher differentiation
– Processes more effective
– Innovation (higher differentiation and lower
costs)
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Due diligence
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Due diligence – the process of investigation, performed
by investors, into the details of potential investment, such
as an examination of operations and management and the
verification if material facts.
Most common adjustments required after due diligence:
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Inventories may be overvalued
Employees’ retirement benefits may not appear or may be
underfunded and provisions have to be made for future
liabilities
Real estate has to be valued at market prices, and necessary tax
adjustments have to be made
Hidden liabilities such as legal actions may be uncovered.
Economic valuation
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Economic valuation is necessary in order for a
potential buyer to decide at what price it is willing to
conclude the deal – or, in the case of a merger, the
relative proportions of shares to be exchanged.
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Three main methods are used for such valuations:
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Asset-based valuation
Market-based valuation
Cash flow-based valuation
Asset-based valuation
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This method determines the actual value of assets minus
liabilities, using a replacement price for physical assets and
adjusting for inventories or debtors book value.
Intangible assets and goodwill are estimated using comparable
value for similar businesses or using formulas such as dollars
per customer.
When use of Asset based valuation is preferred?
 When company’s assets are predominantly physical
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Market-based valuation
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This approach relies on direct market valuation if the company is
listed on a stock exchange or otherwise on market equivalent
valuation.
When using stock exchange market value, the transaction will
require that the bidder puts a premium on the deal. Premiums
are based on an anticipation of value added from the merger.
When the target company is not listed on the stock market, one
can use market equivalent measurements such as P/E ratio,
price/cash flow ratio or price/revenues ratio calculated from
similar deals or comparable companies listed on the stock
exchange.
When use of Market based valuation is preferred?
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When company is listed on a stock exchange
Cash flow-based valuation
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Economic theory would say that this is the only valid method,
apart from the actual market price put on the stock market
when the market is efficient.
Two kinds of future cash flows needs to be
valued in M&As:
 The future cash flow of the merging or of
the acquired company calculated as if the
company continued its activities without
the merger. This is the standalone value.
 The future value of the added value brought
in short-term and long-term by the merger
of the two companies. This is the
synergies value.
Bargaining
range
*More on cash flow analysis see Session on Investment Entry
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Value resulting
from merger
NPV of synergies
cash flows
Stand-alone
value
NPV of stand-alone
cash flows
Integrating the companies:
The integration phase
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Integration process is structured in three phases:
1
2
3
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• The integration framework
leading to an integration plan
• The transition management
• The strategic consolidation
Failures in the integration process (1)
Source of failure in integration
process
Effects
Lack of strategic direction
Actions and decisions not understood
Resistance to change
Unco-ordinated decisions
Lack of integration plan
Improvisation
Time lost
Anxiety not reduced
Lack of quick response to events
Leadership vacuum
Anxiety not reduced
Bureaucratic hassles
Politic fights
Determinism (stubborn
implementation
of the integration plan)
Trying to impose ‘pre-fabricated’ solutions
Arrogant behavior from acquirers’ employees
Discouragement of front-line staff
Lack of communication
Anxiety not reduced
Fears and rumours
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Failures in the integration process (2)
Source of failure in integration
process
Effects
Cultural mishandling
Stereotyped clashes, ‘Them and us’ syndrome
Politicking
Retreat
Lack of operational focus
Too much talk, no action
Lack of concrete results
No ‘quick wins’
Loss of key management talent
Less productive workforce
Negative signaling to internal and external
stakeholders
Wrong synergies
Loss of efficiency
Dysfunctional operations
Waste of financial resources
Lack of buy-in
No motivation, passivity
Politicking
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Integration frameworks
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Integration frameworks belong to two broad
categories:
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Linear frameworks: step-by-step or checklist approaches
to integration that apply to all M&As.
Contingent frameworks: differentiate integration
processes according to environmental and strategic factors.
This type of framework does not assume a unique
approach to integration.
Linear integration framework (1)
Post-merger
integration element
Guiding principles/best practices
Vision
• Agree on strategic intent and let it guide vision for
merger integration
• Work to get both sides of the deal to buy into vision
and intent
• Explicitly identify critical sources of expected value
Architecture for
change
• Begin planning early and create detailed plans
• Set the right pace; work with a sense of urgency
• First attack opportunities that combine the lowest risk
with the highest reward
Architecture for the
new company
• Focus on relentless identification of sources of value
(revenues, cost, etc.)
• Incorporate strengths of both companies
• Restructure the organization to maximize value
• Handle personnel issues swiftly
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Linear integration framework (2)
Post-merger
integration element
Leadership
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Guiding principles/best practices
• Choose new leadership quickly
• Pick the right people and dedicated resources for the
integration process
• Show fairness and objectivity by using data to make
decisions and by including people from both companies in
the decision-making process
• Set credible milestones and maintain pressure for
progress by providing incentives to reach targets
• Keep focus of the integration team on economic valuecreation
• Address cultural issues directly with an explicit plan
• Communicate clearly, early, honestly and often; use a
decisive tone; do not forget those outside the two
companies
Contingent integration framework
(Haspeslagh and Jemison, 1991)
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Haspeslagh and Jemison identified three modes of
integration, depending on:
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The degree of required operational interdependencies
between the two companies that are needed to achieve
synergies (e.g. rationalization of manufacturing or the transfer of
competencies between companies)
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The degree of required organizational autonomy that the
acquired company would need because of the difference
in market and environment conditions with the acquirer
(e.g. an acquisition in a different business or country)
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Contingent integration framework
(Haspeslagh and Jemison, 1991)
Symbiosis
Preservation
High
Required
organizational
autonomy
• Keep businesses separate
• Stimulate business
development
• Accumulate learning and
organise transfer of
competencies (if valuable)
• Start with preservation
• Identify joint sources of
synergies
• Develop common culture
• Implement progressively
needed interdependencies
• Preserve autonomy
Absorption
• Consolidate and
rationalise quickly
• Adopt best practice
• Instill dominant culture
• Recognise
complementarities
Low
Low
High
Required operational interdependencies
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Preservation mode
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The preservation mode fits with situations in which:
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Very few operational synergies can be gained
Business context calls for a large autonomy of decision-making (diversification or
option acquisitions).
Key objective is first to ‘preserve’ the identity and autonomy of the
acquired company, keeping in place the existing management and learning
progressively the ‘rules of the game’ of the business.
The source of value here essentially comes from an enlargement of markets
and products as well from the transfer of resources or new competencies.
Transfer of resources comes essentially from the injection of capital or
stimulation of business development by giving access to logistical, IT or
distribution facilities to the acquired company.
Transfer of people has to be done more for learning than for controlling
purposes
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Absorption mode
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The absorption mode of acquisitions takes place when value
is to be expected from the realization of operational synergies
in companies operating in similar business contexts.
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The objective is to achieve the necessary consolidation and
rationalization as rapidly as possible.
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Since the businesses are very similar, the top management of
the acquirer or the top management of the merging firms are
competent rapidly to find sources of savings and to understand
which best practices have to be adopted.
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Symbiotic mode
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The symbiotic mode of acquisitions tries to achieve a
balance between interdependencies and autonomy.
This is often the case in cross-border horizontal acquisitions…
… where a lot of value is gained from the achievement of
synergies but the differences in contexts require a high degree
of autonomy.
In this mode, the starting point is to use a preservation mode
and to find jointly the real sources of synergies and their
practicalities.
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Integrating the companies:
The transition phase
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The transition period is the one during which the acquirer or the merging
partners establish their credibility and demonstrate their ability to manage the new
concern.
Main issues to be solved during this stage:
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The appointment of an executive team capable of leading the integration process
and managing the interface between the two companies
The expression of a new sense of purpose, demonstrating to stakeholders that the
acquisition or the merger was well planned
The focus on concrete operational results that motivate employees and distract
them from sterile rumours.
The development of a mutual understanding, bridging or palliating the cultural gap
The showing of respect for the acquired company personnel, avoiding arrogant
behavior and preventing the ‘brain drain’ of valuable employees
The installation of measurement tools to measure and control progress
The creation of a ‘winning spiral’ that reinforce a sense of success and achievement
The demonstration of credibility that reassures stakeholders and reduces anxiety.
Transition phase: (1) Appointment of an
executive team and interface management
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In the case of a merger, the critical issue is to install a management team
that is capable of understanding the cultures of the two parties and
transforming them into a new culture.
Managerial personnel problems (who is in charge?) need to be sorted out
before the beginning of the transition phase, at least for the key roles.
In acquisitions, the critical issue is to trade off the need to control and the
need to preserve the key contacts and knowledge of the previous
management team. There is also the need to make sure that the appointed
management team will be an efficient interface between the acquired
company and the foreign acquirer.
The best way to achieve an efficient interface is to appoint, as managing
director, an executive or a team of executives having the capabilities to
understand the cultures of both the seller and the buyer organization, and
to serve as a bridge between the newly acquired entity and the new
owners.
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Transition phase:
(2) New sense of purpose
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Anxiety and resistance reduction can best be achieved if new
management communicates credible goals, demonstrating to
stakeholders that the merger or the acquisition was well
planned, thus reassuring them of a determination to lead the
company to success.
Systematic and structured communication campaigns need to be
organized.
Through meeting with managers, and employees, publications
or social events, the new management can disseminate the
main messages: what are the objectives, what main direction is
the company going to take?
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Transition phase:
(3) Operational focus
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Focusing the attention on concrete operational details and
performance targets have following advantages:
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It is likely to erase the uncertainty created by the takeover by
demonstrating that the company is back in business. One of the
most powerful methods is to create integration teams. Task forces are
appointed made up of personnel from the acquirer and acquired
companies for each of the key operational activities (accounting,
purchasing, quality, etc.) and ask the working party to discuss and
propose concrete solutions to operational aspects.
Such an approach gives people a tangible sense of participation in the
integration process.
It also helps to develop mutual understanding among the employees
of both the buyer and seller organizations.
Transition phase:
(4) Mutual understanding and respect
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Cross-cultural issues are likely to arise, and especially in crossborder mergers. The ability of the two entities to understand each
other is critical for the success of any integration.
The objective at the transition phase is not so much to merge the
two cultures as to create a climate of mutual understanding.
The kind of culture that will surface from the merger is contingent
upon the mode of acquisition. A preservation mode will not
attempt to blend the two cultures but on the contrary will keep
them separate, while absorption would seek to create a common
culture.
Acquirers should instill a climate of mutual understanding by
studying carefully the existing practices of the acquired company, and
seeking opinions from the employees before introducing change.
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Transition phase:
(5) Measurement and control
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Discussing issues or progress in reaching goals and objectives
using facts and figures helps communication, allows a measure
the improvement and reduces the risk of ‘cultural excuses’.
The cultural excuses are used in the event of difficulties or
disagreements, and are based on impressionistic or
stereotypical judgments.
The collection of marketing, operational and financial hard
facts and figures is a necessary condition for an efficient and
productive dialogue.
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Transition phase:
(6) Winning spiral
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The search for tangible immediate performance improvement
should also be on the agenda of the transition-period
management.
‘Quick wins’ are usually derived from the joint efforts of the
integration teams.
Rapid performance improvements in quality, costs and market
success give people a sense of achievement and enhance their
confidence in the whole acquisition process.
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Transition phase:
(7) Credibility
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Confidence is not likely to be established if the various
stakeholders do not perceive that what the new owners say,
and do, is credible.
Credibility relies essentially on the quality of the people who are
put in place to run the company, and the perception of their
real power within the mother organization.
It is essential that managers appointed to run the acquired
company work closely with the back-up of central
headquarters to make sure that the acquisition is well
supported by the centre, and that sufficient resources are
devoted to making it work.
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Integrating the companies:
The consolidation phase
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The consolidation phase is the one that sees the final
integration of the two companies and the definition of the
respective strategic roles of the merged company.
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In the case of a merger, it consists of creating and finalizing a
new organizational structure in which the ex-merging firms
dissolve themselves into the new design.
In the case of an acquisition, the consolidation phase consists
of providing the acquired company with a strategic identity and
making sure that it has a specific role in the overall regional or
global strategy of the acquirer.