Exam 5: Implementation: Search Through Closing: Phases 310 of the Acquisition Process

Which of the following is generally not true of integration planning?

The total purchase price paid by the buyer should also reflect the assumption of liabilities stated on the target's balance sheet, but it should exclude all off balance sheet liabilities.

Microsoft Invests in Barnes & Noble’s Nook Technology Firm size often dictates business strategy. Diversifying away from a firm’s core skills often is fraught with risk. Accumulated corporate cash balances often create potential agency problems. ________________________________________________________________________________________________ Microsoft, like Apple, has been in business for three decades. Unlike Apple, Microsoft has failed to achieve and sustain the high growth in earnings and cash flow needed to grow its market value. For years, Microsoft has attempted to reduce its dependence on revenue generated from its Windows operating system software and the Office Products software suite by targeting high-growth segments in the information technology industry. Despite these efforts, the firm continues to generate more than four-fifths of its annual revenue from these two product lines. The firm’s ongoing dependence on its legacy products is not due to a lack of effort to diversify. Since 2009, Microsoft has spent more than $10 billion in financing strategic alliances and takeovers. A 2009 Internet search partnership with Yahoo Inc. designed to assist Microsoft in overtaking Google by increasing use of its Bing search engine has gained little traction. In 2011, the firm agreed to supply the mobile operating system for smartphones sold by Nokia Corp. Thus far, Windows-powered smartphones have yet to gain significant market share. That same year the software maker also acquired Skype, the Internet telephony firm, for $8.5 billion in the biggest acquisition in the firm’s history. Its contribution to Microsoft’s revenue and profit growth is unclear at this time. Despite a number of acquisitions during the last few years, Microsoft amassed a cash hoard of more than $60 billion by the end of March 2012. The amount of cash creates considerable pressure from shareholders wanting the firm either to return the cash to them through share buybacks and dividends or to reinvest in new high-growth opportunities. In recent years, Microsoft has tried to do both. Continuing to move aggressively, the software firm announced on April 30, 2012, that it would invest a cumulative $605 million (consisting of $300 million upfront with the balance paid over the next five years to finance ongoing product development and international expansion) in exchange for a 17.6% stake in a new Barnes & Noble (B&N) subsidiary containing B&N’s e-titles and the Nook e-reader technology. The new subsidiary also houses B&N’s college business, viewed as a growth area for e-books. Analysts valued the new B&N subsidiary at $1.7 billion, more than twice B&N’s consolidated value at the close of business on May 1, 2012. After the announcement, B&N’s market value jumped to $1.25 billion. As a result of the deal, the two firms will settle their patent infringement suits, and B&N will produce a Nook e-reading application for the Windows 8 operating system, which will run on both traditional PCs and tablets. Microsoft, through its Windows 8 product, has been forced to radically redesign its Windows operating system to accommodate a future in which web browsing, movie watching, book reading, and other activities occur on tablets as well as PCs and other mobile devices. While Windows 8 will have an “app store,” it is likely to have to be closely aligned with a service for buying books and other forms of entertainment to match better the offerings from its rivals. The partnership is not exclusive to Microsoft, in that B&N can pursue other alliances with the likes of Google. B&N’s e-book business is to remain aligned with the brick-and-mortar stores, of which the firm has 691 retail stores and 641 college bookstores. In making the B&N investment, Microsoft is placing another bet on an industry in which it lags behind its competitors and puts it in competition with Amazon.com Inc., Apple Inc., and Google Inc. The Nook currently runs on Google’s Android software, as does Amazon’s Kindle Fire. The two firms will share revenue from sales of e-books. The partnership also has the potential for Microsoft to manufacture e-readers and for future Nook devices to be powered by Microsoft operating systems. In addition to a much-needed cash infusion, B&N will capture additional points of distribution from hundreds of millions of Windows users around the world, potentially reaching consumers who did not do business with B&N. Previously concerned that B&N would be a marginal competitor in the e-book marketplace, investors boosted B&H shares by 58% to $20.75 on the news. This was the firm’s highest closing price in two years. The firm’s conventional (physical) book business has declined rapidly. With revenue and profits declining, B&N was looking for a strategic partner to accelerate the growth of its e-book business globally. B&N had been accepting offers from a number of potential partners since it accepted a $204 million investment from Liberty Media in 2011 and had been considering a sale or spin-off of the e-book business. B&N claims to have 27% of the U.S. e-book title sales, with Amazon capturing 60%. At one time, Amazon had almost a 90% market share of the e-book market, but this has eroded as new players, such as Apple, Google and now Microsoft, have entered. According to market research firm IHS iSuppli, Apple had 62% of the tablet market in 2011, reflecting the success of its iPad, with Amazon’s Kindle having a 6% share and B&N’s Nook a 5% share. Book publishers appear to have been encouraged by Microsoft’s investment in B&N due to their growing concern that Amazon would dominate the e-book market and the pricing of e-books if B&N were unable to become a viable competitor to Amazon.com. Unlike rivals such as Apple, Microsoft has relied mainly on partners to create hardware that runs its software, with the exception of the Xbox video game unit and the company’s ill-fated Zune media player. Microsoft is constrained by its partnerships, in that if the firm begins to create its own hardware, then it puts itself into direct competition with partners who make hardware such as tablet devices powered by Microsoft operating systems. -In your opinion, what does Microsoft bring to this partnership? What does Barnes & Noble contribute? What are likely to be the challenges to both parties in making this relationship successful?

Which of the following is true about integration planning? Without integration planning, integration is not likely to

Buyers routinely perform due diligence on sellers, but sellers rarely perform due diligence on buying firms.

Identify at least three criteria that might be used to select a manufacturing firm as a potential acquisition candidate. A financial services firm? A high technology firm?

Bank of America Acquires Merrill Lynch Against the backdrop of the Lehman Brothers' Chapter 11 bankruptcy filing, Bank of America (BofA) CEO Kenneth Lewis announced on September 15, 2008, that the bank had reached agreement to acquire mega–retail broker and investment bank Merrill Lynch. Hammered out in a few days, investors expressed concern that the BofA's swift action on the all-stock $50 billion transaction would saddle the firm with billions of dollars in problem assets by pushing BofA's share price down by 21 percent. BofA saw the takeover of Merrill as an important step toward achieving its long-held vision of becoming the number 1 provider of financial services in its domestic market. The firm's business strategy was to focus its efforts on the U.S. market by expanding its product offering and geographic coverage. The firm implemented its business strategy by acquiring selected financial services companies to fill gaps in its product offering and geographic coverage. The existence of a clear and measurable vision for the future enabled BofA to make acquisitions as the opportunity arose. Since 2001, the firm completed a series of acquisitions valued at more than $150 billion. The firm acquired FleetBoston Financial, greatly expanding its network of branches on the East Coast, and LaSalle Bank to improve its coverage in the Midwest. The acquisitions of credit card–issuing powerhouse MBNA, U.S. Trust (a major private wealth manager), and Countrywide (the nation's largest residential mortgage loan company) were made to broaden the firm's financial services offering. The acquisition of Merrill makes BofA the country's largest provider of wealth management services to go with its current status as the nation's largest branch banking network and the largest issuer of small business, home equity, credit card, and residential mortgage loans. The deal creates the largest domestic retail brokerage and puts the bank among the top five largest global investment banks. Merrill also owns 45 percent of the profitable asset manager BlackRock Inc., worth an estimated $10 billion. BofA expects its retail network to help sell Merrill and BlackRock's investment products to BofA customers. The hurried takeover encouraged by the U.S. Treasury and Federal Reserve did not allow for proper due diligence. The extent of the troubled assets on Merrill's books was largely unknown. While the losses at Merrill proved to be stunning in the short run—$15 billion alone in the fourth quarter of 2008—the acquisition by Bank of America averted the possible demise of Merrill Lynch. By the end of the first quarter of 2009, the U.S. government had injected $45 billion in loans and capital into BofA in an effort to offset some of the asset write-offs associated with the acquisition. Later that year, Lewis announced his retirement from the bank. Mortgage loan losses and foreclosures continued to mount throughout 2010, with a disproportionately large amount of such losses attributable to the acquisition of the Countrywide mortgage loan portfolio. While BofA's vision and strategy may still prove to be sound, the rushed execution of the Merrill acquisition, coupled with problems surfacing from other acquisitions, could hobble the financial performance of BofA for years to come. When Companies Overpay—Mattel Acquires The Learning Company Mattel, Inc. is the world’s largest designer, manufacturer, and marketer of a broad variety of children’s products selling directly to retailers and consumers. Most people recognize Mattel as the maker of the famous Barbie, the best-selling fashion doll in the world, generating sales of $1.7 billion annually. The company also manufactures a variety of other well-known toys and owns the primary toy license for the most popular kids’ educational program “Sesame Street.” In 1988, Mattel revived its previous association with The Walt Disney Company and signed a multiyear deal with them for the worldwide toy rights for all of Disney’s television and film properties Business Plan Mission Statement and Strategy Mattel’s mission is to maintain its position in the toy market as the largest and most profitable family products marketer and manufacturer in the world. Mattel will continue to create new products and innovate in their existing toy lines to satisfy the constant changes of the family-products market. Its business strategy is to diversify Mattel beyond the market for traditional toys at a time when the toy industry is changing rapidly. This will be achieved by pursuing the high-growth and highly profitable children’s technology market, while continuing to enhance Mattel’s popular toys to gain market share and increase earnings in the toy market. Mattel believes that its current software division, Mattel Interactive, lacks the technical expertise and resources to penetrate the software market as quickly as the company desires. Consequently, Mattel seeks to acquire a software business that will be able to manufacture and market children’s software that Mattel will distribute through its existing channels and through its Website (Mattel.com). Defining the Marketplace The toy market is a major segment within the leisure time industry. Included in this segment are many diverse companies, ranging from amusement parks to yacht manufacturers. Mattel is one of the largest manufacturers within the toy segment of the leisure time industry. Other leading toy companies are Hasbro, Nintendo, and Lego. Annual toy industry sales in recent years have exceeded $21 billion. Approximately one-half of all sales are made in the fourth quarter, reflecting the Christmas holiday. Customers. Mattel’s major customers are the large retail and e-commerce stores that distribute their products. These retailers and e-commerce stores in 1999 included Toys “R” Us Inc., Wal-Mart Stores Inc., Kmart Corp., Target, Consolidated Stores Corp., E-toys, ToyTime.com, Toysmart.com, and Toystore.com. The retailers are Mattel’s direct customers; however, the ultimate buyers are the parents, grandparents, and children who purchase the toys from these retailers. Competitors. The two largest toy manufacturers are Mattel and Hasbro, which together account for almost one-half of industry sales. In the past few years, Hasbro has acquired several companies whose primary products include electronic or interactive toys and games. On December 8, 1999, Hasbro announced that it would shift its focus to software and other electronic toys. Traditional games, such as Monopoly, would be converted into software. Potential Entrants. Potential entrants face substantial barriers to entry in the toy business. Current competitors, such as Mattel and Hasbro, already have secured distribution channels for their products based on longstanding relationships with key customers such as Wal-Mart and Toys “R” Us. It would be costly for new entrants to replicate these relationships. Moreover, brand recognition of such toys as Barbie, Nintendo, and Lego makes it difficult for new entrants to penetrate certain product segments within the toy market. Proprietary knowledge and patent protection provide additional barriers to entering these product lines. The large toymakers have licensing agreements that grant them the right to market toys based on the products of the major entertainment companies. Product Substitutes. One of the major substitutes for traditional toys such as dolls and cars are video games and computer software. Other product substitutes include virtually all kinds of entertainment including books, athletic wear, tapes, and TV. However, these entertainment products are less of a concern for toy companies than the Internet or electronic games because they are not direct substitutes for traditional toys. Suppliers. An estimated 80% of toy production is manufactured abroad. Both Mattel and Hasbro own factories in the Far East and Mexico to take advantage of low labor costs. Parts, such as software and microchips, often are outsourced to non-Mattel manufacturing plants in other countries and then imported for the assembly of such products as Barbie within Mattel-owned factories. Although outsourcing has resulted in labor cost savings, it also has resulted in inconsistent quality. Opportunities and Threats Opportunities New Distribution Channels. Mattel.com represents 80 separate toy and software offerings. Mattel hopes to spin this operation off as a separate company when it becomes profitable. Mattel.com lost about $70 million in 1999. The other new channel for distributing toys is directly to consumers through catalogs. The so-called direct channels offered by the internet and catalog sales help Mattel reduce its dependence on a few mass retailers. Aging Population. Grandparents accounted for 14% of U.S. toy purchases in 1999. The number of grandparents is expected to grow from 58 million in 1999 to 76 million in 2005. Interactive Media. As children have increasing access to computers, the demand for interactive computer games is expected to accelerate. The “high-tech” toy market segment is growing 20% annually, compared with the modest 5% growth in the traditional toy business. International Growth. In 1999, 44% of Mattel’s sales came from its international operations. Mattel already has redesigned its Barbie doll for the Asian and the South American market by changing Barbie’s face and clothes. Threats Decreasing Demand for Traditional Toys. Children’s tastes are changing. Popular items are now more likely to include athletic clothes and children’s software and video games rather than more traditional items such as dolls and stuffed animals. Distributor Returns. Distributors may return toys found to be unsafe or unpopular. A quality problem with the Cabbage Patch Doll could cost Mattel more than $10 million in returns and in settling lawsuits. Shrinking Target Market. Historically, the toy industry has considered their prime market to be children from birth to age 14. Today, the top toy-purchasing years for a child range from birth to age 10. Just-In-Time Inventory Management. Changing customer inventory practices make it difficult to accurately forecast reorders, which has resulted in lost sales as unanticipated increases in orders could not be filled from current manufacturer inventories. Internal Assessment Strengths Mattel’s key strengths lie in its relatively low manufacturing cost position, with 85% of its toys manufactured in low-labor-cost countries like China and Indonesia, and its established distribution channels. Moreover, licensing agreements with Disney enable Mattel to add popular new characters to its product lines. Weaknesses Mattel’s Barbie and Hot Wheels product lines are mature, but the company has been slow to reposition these core brands. The lack of technical expertise to create software-based products limits Mattel’s ability to exploit the shift away from traditional toys to video or interactive games. Acquisition Plan Objectives and Strategy Mattel’s corporate strategy is to diversify Mattel beyond the mature traditional toys segment into high-growth segments. Mattel believed that it had to acquire a recognized brand identity in the children’s software and entertainment segment of the toy industry, sometimes called the “edutainment” segment, to participate in the rapid shift to interactive, software-based toys that are both entertaining and educational. Mattel believed that such an acquisition would remove some of the seasonality from sales and broaden their global revenue base. Key acquisition objectives included building a global brand strategy, doubling international sales, and creating a $1 billion software business by January 2001. Defining the Target Industry The “edutainment” segment has been experiencing strong growth predominantly in the entertainment segment. Parents are seeing the importance of technology in the workplace and want to familiarize their children with the technology as early as possible. In 1998, more than 40% of households had computers and, of those households with children, 70% had educational software. As the number of homes with PCs continues to increase worldwide and with the proliferation of video games, the demand for educational and entertainment software is expected to accelerate. Management Preferences Mattel was looking for an independent children’s software company with a strong brand identity and more than $400 million in annual sales. Mattel preferred not to acquire a business that was part of another competitor (e.g., Hasbro Interactive). Mattel’s management stated that the target must have brands that complement Mattel’s business strategy and the technology to support their existing brands, as well as to develop new brands. Mattel preferred to engage in a stock-for-stock exchange in any transaction to maintain manageable debt levels and to ensure that it preserved the rights to all software patents and licenses. Moreover, Mattel reasoned that such a transaction would be more attractive to potential targets because it would enable target shareholders to defer the payment of taxes. Potential Targets Game and edutainment development divisions are often part of software conglomerates, such as Cendant, Electronic Arts, and GT Interactive, which produce software for diverse markets including games, systems platforms, business management, home improvement, and pure educational applications. Other firms may be subsidiaries of large book, CD-ROM, or game publishers. The parent firms showed little inclination to sell these businesses at what Mattel believed were reasonable prices. Therefore, Mattel focused on five publicly traded firms: Acclaim Entertainment, Inc., Activision, Inc., Interplay Entertainment Corp, The Learning Company, Inc. (TLC), and Take-Two Interactive Software. Of these, only Acclaim, Activision, and The Learning Company had their own established brands in the games and edutainment sectors and the size sufficient to meet Mattel’s revenue criterion. In 1999, TLC was the second largest consumer software company in the world, behind Microsoft. TLC was the leader in educational software, with a 42% market share, and in-home productivity software (i.e., home improvement software), with a 44% market share. The company has been following an aggressive expansion strategy, having completed 14 acquisitions since 1994. At 68%, TLC also had the highest gross profit margin of the target companies reviewed. TLC owned the most recognized titles and appeared to have the management and technical skills in place to handle the kind of volume that Mattel desired. Their sales were almost $1 billion, which would enable Mattel to achieve its objective in this “high-tech” market. Thus, TLC seemed the best suited to satisfy Mattel’s acquisition objectives. Completing the Acquisition Despite disturbing discoveries during due diligence, Mattel acquired TLC in a stock-for-stock transaction valued at $3.8 billion on May 13, 1999. Mattel had determined that TLC’s receivables were overstated because product returns from distributors were not deducted from receivables and its allowance for bad debt was inadequate. A $50 billion licensing deal also had been prematurely put on the balance sheet. Finally, TLC’s brands were becoming outdated. TLC had substantially exaggerated the amount of money put into research and development for new software products. Nevertheless, driven by the appeal of rapidly becoming a big player in the children’s software market, Mattel closed on the transaction aware that TLC’s cash flows were overstated. Epilogue For all of 1999, TLC represented a pretax loss of $206 million. After restructuring charges, Mattel’s consolidated 1999 net loss was $82.4 million on sales of $5.5 billion. TLC’s top executives left Mattel and sold their Mattel shares in August, just before the third quarter’s financial performance was released. Mattel’s stock fell by more than 35% during 1999 to end the year at about $14 per share. On February 3, 2000, Mattel announced that its chief executive officer (CEO), Jill Barrad, was leaving the company. On September 30, 2000, Mattel virtually gave away The Learning Company to rid itself of what had become a seemingly intractable problem. This ended what had become a disastrous foray into software publishing that had cost the firm literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit to an affiliate of Gores Technology Group for rights to a share of future profits. Essentially, the deal consisted of no cash upfront and only a share of potential future revenues. In lieu of cash, Gores agreed to give Mattel 50% of any profits and part of any future sale of TLC. In a matter of weeks, Gores was able to do what Mattel could not do in a year. Gores restructured TLC’s seven units into three, set strong controls on spending, sifted through 467 software titles to focus on the key brands, and repaired relationships with distributors. Gores also has sold the entertainment division and is seeking buyers for the remainder of TLC. -What are the primary barriers to entering the toy industry?

Mattel Overpays for the Learning Company Despite disturbing discoveries during due diligence, Mattel acquired The Learning Company (TLC), a leading developer of software for toys, in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel had determined that TLC’s receivables were overstated because product returns from distributors were not deducted from receivables and its allowance for bad debt was inadequate. A $50 million licensing deal also had been prematurely put on the balance sheet. Finally, TLC’s brands were becoming outdated. TLC had substantially exaggerated the amount of money put into research and development for new software products. Nevertheless, driven by the appeal of rapidly becoming a big player in the children’s software market, Mattel closed on the transaction aware that TLC’s cash flows were overstated. For all of 1999, TLC represented a pretax loss of $206 million. After restructuring charges, Mattel’s consolidated 1999 net loss was $82.4 million on sales of $5.5 billion. TLC’s top executives left Mattel and sold their Mattel shares in August, just before the third quarter’s financial performance was released. Mattel’s stock fell by more than 35% during 1999 to end the year at about $14 per share. On February 3, 2000, Mattel announced that its chief executive officer (CEO), Jill Barrad, was leaving the company. On September 30, 2000, Mattel virtually gave away The Learning Company to rid itself of what had become a seemingly intractable problem. This ended what had become a disastrous foray into software publishing that had cost the firm literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit to an affiliate of Gores Technology Group (GTG) for rights to a share of future profits. Essentially, the deal consisted of no cash upfront and only a share of potential future revenues. In lieu of cash, GTG agreed to give Mattel 50 percent of any profits and part of any future sale of TLC. In a matter of weeks, GTG was able to do what Mattel could not do in a year. GTG restructured TLC’s seven units into three, put strong controls on spending, sifted through 467 software titles to focus on the key brands, and repaired relationships with distributors. GTG also sold the entertainment division. -Despite being aware of extensive problems, Mattel proceeded to acquire The Learning Company. Why? What could Mattel to better protect its interests? Be specific.

Rumors of impending acquisition can have a substantial deleterious impact on the target firm.

The actual purchase price paid for a target firm is determined doing the negotiation process and is often quite different from the initial offer price stipulated in a letter of intent.

First Union Buys Wachovia Bank: A Merger of Equals? First Union announced on April 17, 2001, that an agreement had been reached to acquire Wachovia Corporation for about $13 billion in stock, thus uniting two fiercely independent rivals. With total assets of about $324 billion, the combination created the fourth largest bank in the United States behind Citigroup, Bank of America, and J.P. Morgan Chase. The merger also represents the joining of two banks with vastly different corporate cultures. Because both banks have substantial overlapping operations and branches in many southeastern U.S. cities, the combined banks are expected to be able to add to earnings in the first 2 years following closing. Wachovia, which is much smaller than First Union, agreed to the merger for only a small 6% premium. The deal is being structured as a merger of equals. That is a rare step given that the merger of equals’ framework usually is used when two companies are similar in size and market capitalization. L. M. Baker, chair and CEO of Wachovia, will be chair of the new bank and G. Kennedy Thompson, First Union’s chair and CEO, will be CEO and president. The name Wachovia will survive. Of the other top executives, six will be from First Union and four from Wachovia. The board of directors will be evenly split, with nine coming form each bank. Wachovia shareholders own about 27% of the combined companies and received a special one-time dividend of $.48 per share because First Union recently had slashed its dividend. To discourage a breakup, First Union and Wachovia used a fairly common mechanism called a “cross option,” which gives each bank the right to buy a 19.9% stake in the other using cash, stock, and other property including such assets as distressed loans, real estate, or less appealing assets. (At less than 20% ownership, neither bank would have to show the investment on its balance sheet for financial reporting purposes.) Thus, the bank exercising the option would not only be able to get a stake in the merged bank but also would be able to unload its least attractive assets. A hostile bidder would have to deal with the idea that another big bank owned a chunk of the stock and that it might be saddled with unattractive assets. The deal structure also involved an unusual fee if First Union and Wachovia parted ways. Each bank is entitled to 6% of the $13 billion merger value, or about $780 million in cash and stock. The 6% is about twice the standard breakup fee. The cross-option and 6% fee were intended to discourage other last-minute suitors from making a bid for Wachovia. According to a First Union filing with the Securities and Exchange Commission, Wachovia rebuffed an overture from an unidentified bank just 24 hours before accepting First Union’s offer. Analysts identified the bank as SunTrust Bank. SunTrust had been long considered a likely buyer of Wachovia after having pursued Wachovia unsuccessfully in late 2000. Wachovia’s board dismissed the offer as not being in the best interests of the Wachovia’s shareholders. The transaction brings together two regional banking franchises. In the mid-1980s, First Union was much smaller than Wachovia. That was to change quickly, however. In the late 1980s and early 1990s, First Union went on an acquisition spree that made it much larger and better known than Wachovia. Under the direction of now-retired CEO Edward Crutchfield, First Union bought 90 banks. Mr. Crutchfield became known in banking circles as “fast Eddie.” However, acquisitions of the Money Store and CoreStates Financial Corporation hurt bank earnings in late 1990s, causing First Union’s stock to fall from $60 to less than $30 in 1999. First Union had paid $19.8 billion for CoreStates Financial in 1998 and then had trouble integrating the acquisition. Customers left in droves. Ill, Mr. Crutchfield resigned in 2000 and was replaced by G. Kennedy Thompson. He immediately took action to close the Money Store operation and exited the credit card business, resulting in a charge to earnings of $2.8 billion and the layoff of 2300 in 2000. In contrast, Wachovia assiduously avoided buying up its competitors and its top executives frequently expressed shock at the premiums that were being paid for rival banks. Wachovia had a reputation as a cautious lender. Whereas big banks like First Union did stumble mightily from acquisitions, Wachovia also suffered during the 1990s. Although Wachovia did acquire several small banks in Virginia and Florida in the mid-1990s, it remained a mid-tier player at a time when the size and scope of its bigger competitors put it at a sharp cost disadvantage. This was especially true with respect to credit cards and mortgages, which require the economies of scale associated with large operations. Moreover, Wachovia remained locked in the Southeast. Consequently, it was unable to diversify its portfolio geographically to minimize the effects of different regional growth rates across the United States. In the past, big bank deals prompted a rash of buying of bank stocks, as investors bet on the next takeover in the banking sector. Banks such as First Union, Bank of America (formerly NationsBank), and Bank One acquired midsize regional banks at lofty premiums, expanding their franchises. They rationalized these premiums by noting the need for economies of scale and bigger branch networks. Many midsize banks that were obvious targets refused to sell themselves without receiving premiums bigger than previous transactions. However, things have changed. Back in 1995 buyers of banks paid 1.94 times book value and 13.1 times after-tax earnings. By 1997, these multiples rose to 3.4 times book value and 22.2 times after-tax earnings. However, by 2000, buyers paid far less, averaging 2.3 times book value and 16.3 times earnings. First Union paid 2.47 times book value and 15.7 times after-tax earnings. The declining bank premiums reflect the declining demand for banks. Most of the big acquirers of the 1990s (e.g., Wells Fargo, Bank of America, and Bank One) now feel that they have reached an appropriate size. Banking went through a wave of consolidation in the late 1990s, but many of the deals did not turn out well for the acquirers’ shareholders. Consequently, most buyers were unwilling to pay much of a premium for regional banks unless they had some unique characteristics. The First Union–Wachovia deal is remarkable in that it showed how banks that were considered prized entities in the late 1990s could barely command any premium at all by early 2001. -How did big banks during the 1990s justify paying lofty premiums for smaller, regional banks? Why do you think their subsequent financial performance was hurt by these acquisitions?

It is usually in the best interests of the seller to allow the buyer unrestricted access to all seller employees and records doing due diligence in order to create an atmosphere of cooperation and goodwill.

Cingular Acquires AT&T Wireless in a Record-Setting Cash Transaction Cingular outbid Vodafone to acquire AT&T Wireless, the nation’s third largest cellular telephone company, for $41 billion in cash plus $6 billion in assumed debt in February 2004. This represented the largest all-cash transaction in history. The combined companies, which surpass Verizon Wireless as the largest U.S. provider, have a network that covers the top 100 U.S. markets and span 49 of the 50 U.S. states. While Cingular’s management seemed elated with their victory, investors soon began questioning the wisdom of the acquisition. By entering the bidding at the last moment, Vodafone, an investor in Verizon Wireless, forced Cingular's parents, SBC Communications and BellSouth, to pay a 37 percent premium over their initial bid. By possibly paying too much, Cingular put itself at a major disadvantage in the U.S. cellular phone market. The merger did not close until October 26, 2004, due to the need to get regulatory and shareholder approvals. This gave Verizon, the industry leader in terms of operating margins, time to woo away customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers because of poor customer service. By paying $11 billion more than its initial bid, Cingular would have to execute the integration, expected to take at least 18 months, flawlessly to make the merger pay for its shareholders. With AT&T Wireless, Cingular would have a combined subscriber base of 46 million, as compared to Verizon Wireless's 37.5 million subscribers. Together, Cingular and Verizon control almost one half of the nation's 170 million wireless customers. The transaction gives SBC and BellSouth the opportunity to have a greater stake in the rapidly expanding wireless industry. Cingular was assuming it would be able to achieve substantial operating synergies and a reduction in capital outlays by melding AT&T Wireless's network into its own. Cingular expected to trim combined capital costs by $600 to $900 million in 2005 and $800 million to $1.2 billion annually thereafter. However, Cingular might feel pressure from Verizon Wireless, which was investing heavily in new mobile wireless services. If Cingular were forced to offer such services quickly, it might not be able to realize the reduction in projected capital outlays. Operational savings might be even more difficult to realize. Cingular expected to save $100 to $400 million in 2005, $500 to $800 million in 2006, and $1.2 billion in each successive year. However, in view of AT&T Wireless's continued loss of customers, Cingular might have to increase spending to improve customer service. To gain regulatory approval, Cingular agreed to sell assets in 13 markets in 11 states. The firm would have six months to sell the assets before a trustee appointed by the FCC would become responsible for disposing of the assets. SBC and BellSouth, Cingular's parents, would have limited flexibility in financing new spending if it were required by Cingular. SBC and BellSouth each borrowed $10 billion to finance the transaction. With the added debt, S&P put SBC, BellSouth, and Cingular on credit watch, which often is a prelude in a downgrade of a firm's credit rating. -What is the total purchase price of the merger?

Buyers generally want to complete due diligence on the seller as quickly as possible.

Cingular Acquires AT&T Wireless in a Record-Setting Cash Transaction Cingular outbid Vodafone to acquire AT&T Wireless, the nation’s third largest cellular telephone company, for $41 billion in cash plus $6 billion in assumed debt in February 2004. This represented the largest all-cash transaction in history. The combined companies, which surpass Verizon Wireless as the largest U.S. provider, have a network that covers the top 100 U.S. markets and span 49 of the 50 U.S. states. While Cingular’s management seemed elated with their victory, investors soon began questioning the wisdom of the acquisition. By entering the bidding at the last moment, Vodafone, an investor in Verizon Wireless, forced Cingular's parents, SBC Communications and BellSouth, to pay a 37 percent premium over their initial bid. By possibly paying too much, Cingular put itself at a major disadvantage in the U.S. cellular phone market. The merger did not close until October 26, 2004, due to the need to get regulatory and shareholder approvals. This gave Verizon, the industry leader in terms of operating margins, time to woo away customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers because of poor customer service. By paying $11 billion more than its initial bid, Cingular would have to execute the integration, expected to take at least 18 months, flawlessly to make the merger pay for its shareholders. With AT&T Wireless, Cingular would have a combined subscriber base of 46 million, as compared to Verizon Wireless's 37.5 million subscribers. Together, Cingular and Verizon control almost one half of the nation's 170 million wireless customers. The transaction gives SBC and BellSouth the opportunity to have a greater stake in the rapidly expanding wireless industry. Cingular was assuming it would be able to achieve substantial operating synergies and a reduction in capital outlays by melding AT&T Wireless's network into its own. Cingular expected to trim combined capital costs by $600 to $900 million in 2005 and $800 million to $1.2 billion annually thereafter. However, Cingular might feel pressure from Verizon Wireless, which was investing heavily in new mobile wireless services. If Cingular were forced to offer such services quickly, it might not be able to realize the reduction in projected capital outlays. Operational savings might be even more difficult to realize. Cingular expected to save $100 to $400 million in 2005, $500 to $800 million in 2006, and $1.2 billion in each successive year. However, in view of AT&T Wireless's continued loss of customers, Cingular might have to increase spending to improve customer service. To gain regulatory approval, Cingular agreed to sell assets in 13 markets in 11 states. The firm would have six months to sell the assets before a trustee appointed by the FCC would become responsible for disposing of the assets. SBC and BellSouth, Cingular's parents, would have limited flexibility in financing new spending if it were required by Cingular. SBC and BellSouth each borrowed $10 billion to finance the transaction. With the added debt, S&P put SBC, BellSouth, and Cingular on credit watch, which often is a prelude in a downgrade of a firm's credit rating. -What are some of the reasons Cingular used cash rather than stock or some combination to acquire AT&T Wireless?

Despite disturbing discoveries during due diligence, Mattel acquired The Learning Company (TLC), a leading developer of software for toys, in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel had determined that TLC's receivables were overstated, a $50 million licensing deal had been prematurely put on the balance sheet, and that TLC's brands were becoming outdated. TLC also had substantially exaggerated the amount of money put into research and development for new software products. Nevertheless, driven by the appeal of rapidly becoming a big player in the children's software market, Mattel closed on the transaction aware that TLC's cash flows were overstated. After restructuring charges associated with the acquisition, Mattel's consolidated 1999 net loss was $82.4 million on sales of $5.5 billion. Mattel's stock fell by more than 35 percent during 1999 to end the year at about $14 per share. What could Mattel have done to better protect its interests? Be specific.

McKesson HBOC Restates Revenue McKesson Corporation, the nation’s largest drug wholesaler, acquired medical software provider HBO & Co. in a $14.1 billion stock deal in early 1999. The transaction was touted as having created the country’s largest comprehensive health care services company. McKesson had annual sales of $18.1 billion in fiscal year 1998, and HBO & Co. had fiscal 1998 revenue of $1.2 billion. HBO & Co. makes information systems that include clinical, financial, billing, physician practice, and medical records software. Charles W. McCall, the chair, president, and chief executive of HBO & Co., was named the new chair of McKesson HBOC. As one of the decade’s hottest stocks, it had soared 38-fold since early 1992. McKesson’s first attempt to acquire HBO in mid-1998 collapsed following a news leak. However, McKesson’s persistence culminated in a completed transaction in January 1999. In its haste, McKesson closed the deal even before an in-depth audit of HBO’s books had been completed. In fact, the audit did not begin until after the close of the 1999 fiscal year. McKesson was so confident that its auditing firm, Deloitte & Touche, would not find anything that it released unaudited results that included the impact of HBO shortly after the close of the 1999 fiscal year on March 31, 1999. Within days, indications that contracts had been backdated began to surface. By May, McKesson hired forensic accountants skilled at reconstructing computer records. By early June, the accountants were able to reconstruct deleted computer files, which revealed a list of improperly recorded contracts. This evidence underscored HBO’s efforts to deliberately accelerate revenues by backdating contracts that were not final. Moreover, HBO shipped software to customers that they had not ordered, while knowing that it would be returned. In doing so, they were able to boost reported earnings, the company’s share price, and ultimately the purchase price paid by McKesson. In mid-July, McKesson announced that it would have to reduce revenue by $327 million and net income by $191.5 million for the past 3 fiscal years to correct for accounting irregularities. The company’s stock had fallen by 48% since late April when it first announced that it would have to restate earnings. McKesson’s senior management had to contend with rebuilding McKesson’s reputation, resolving more than 50 lawsuits, and attempting to recover $9.5 billion in market value lost since the need to restate earnings was first announced. When asked how such a thing could happen, McKesson spokespeople said they were intentionally kept from the due diligence process before the transaction closed. Despite not having adequate access to HBO’s records, McKesson decided to close the transaction anyway. -Why do you think McKesson may have been in such a hurry to acquire HBO without completing an appropriate due diligence?

Integration planning is included in which of the following activities?

Refining the target valuation based on new information uncovered during due diligence is most likely to affect which of the following

Exxon Mobil’s (Exxon) Unrelenting Pursuit of Natural Gas Believing the world will be dependent on carbon-based energy for many decades, Exxon continues to pursue aggressively amassing new natural gas and oil reserves. This strategy is consistent with its core energy extraction, refining, and distribution skills. As the world’s largest energy company, Exxon must make big bets on new reserves of unconventional gas and oil to increase future earnings. _____________________________________________________________________________________ Exxon has always had a reputation for taking the long view. By necessity, energy companies cannot respond to short-term gyrations in energy prices, given the long lead time required to discover and develop new energy sources. While energy prices will continue to fluctuate, Exxon is betting that the world will remain dependent on oil and gas for decades to come and that new technology will facilitate accessing so-called unconventional energy sources. During the last several years, Exxon continued its headlong rush into accumulating shale gas and oil properties that began in earnest in 2009 with the acquisition of natural gas exploration company XTO Energy. While natural gas prices have remained well below their 2008 level, Exxon used the expertise of the former XTO Energy personnel, who are among the most experienced in the industry in extracting oil and gas from shale rock, to identify the most attractive sites globally for future shale development. In 2010, Exxon acquired Ellora Energy Inc., which was active in the Haynesville shale fields in Texas and Louisiana, for $700 million and properties in Arkansas’s Fayetteville shale fields from PetroHawk Energy Corp. In 2011, Exxon bought TWP Inc. and Phillips Resources, which were active in the Marcellus shale basin, for a combined $1.7 billion. Exxon is betting that these properties will become valuable when natural gas prices again rise. By mid-2011, Exxon Mobil had added more than 70 trillion cubic feet of unconventional gas and liquid reserves since the XTO deal in late 2009 through acquisitions and new discoveries. Exxon is now the largest natural gas producer in the United States. The sheer size of the XTO acquisition in 2009 represented a remarkable departure for a firm that had not made a major acquisition during the previous 10 years. Following a series of unsuccessful acquisitions during the late 1970s and early 1980s, the firm seemed to have developed a phobia about acquisitions. Rather than make big acquisitions, Exxon started buying back its stock, purchasing more than $16 billion worth between 1983 and 1990, and spending about $1 billion annually on oil and gas properties and some small acquisitions. Exxon Mobil Corporation stated publicly in its 2009 annual report that it was committed to being the world’s premier petroleum and petrochemical company and that the firm’s primary focus in the coming decades would likely remain on its core businesses of oil and gas exploration and production, refining, and chemicals. According to the firm, there appears to be “a pretty bright future” for drilling in previously untapped shale energy properties—as a result of technological advances in horizontal drilling and hydraulic fracturing. No energy source currently solves the challenge of meeting growing energy needs while reducing CO2 emissions. Traditionally, energy companies have extracted natural gas by drilling vertical wells into pockets of methane that are often trapped above oil deposits. Energy companies now drill horizontal wells and fracture them with high-pressure water, a practice known as “fracking.” That technique has enabled energy firms to release natural gas trapped in the vast shale oil fields in the United States as well as to recover gas and oil from fields previously thought to have been depleted. The natural gas and oil recovered in this manner are often referred to as “unconventional energy resources.” In an effort to bolster its position in the development of unconventional natural gas and oil, Exxon announced on December 14, 2009, that it had reached an agreement to buy XTO Energy in an all-stock deal valued at $31 billion. The deal also included Exxon’s assumption of $10 billion in XTO’s current debt. This represented a 25% premium to XTO shareholders at the time of the announcement. XTO shares jumped 15% to $47.86, while Exxon’s fell by 4.3% to $69.69. The deal values XTO’s natural gas reserves at $2.96 per thousand cubic feet of proven reserves, in line with recent deals and about one-half of the NYMEX natural gas futures price at that time. Known as a wildcat or independent energy producer, the 23-year-old XTO competed aggressively with other independent drillers in the natural gas business, which had boomed with the onset of horizontal drilling and well fracturing to extract energy from older oil fields. However, independent energy producers like XTO typically lack the financial resources required to unlock unconventional gas reserves, unlike the large multinational energy firms like Exxon. The geographic overlap between the proven reserves of the two firms was significant, with both Exxon and XTO having a presence in Colorado, Louisiana, Texas, North Dakota, Pennsylvania, New York, Ohio, and Arkansas. The two firms’ combined proven reserves are the equivalent of 45 trillion cubic feet of gas and include shale gas, coal bed methane, and shale oil. These reserves also complement Exxon’s U.S. and international holdings. Exxon is the global leader in oil and gas extraction. Given its size, it is difficult to achieve rapid future earnings growth organically through reinvestment of free cash flow. Consequently, megafirms such as Exxon often turn to large acquisitions to offer their shareholders significant future earnings growth. Given the long lead time required to add to proven reserves and the huge capital requirements to do so, energy companies by necessity must have exceedingly long-term planning and investment horizons. Acquiring XTO is a bet on the future of natural gas. Moreover, XTO has substantial technical expertise in recovering unconventional natural gas resources, which complement Exxon’s global resource base, advanced R&D, proven operational capabilities, global scale, and financial capacity. In the five-year period ending in 2010, the U.S. Energy Information Administration (EIA) estimates that the U.S. total proven natural gas reserves increased by 40% to about 300 trillion cubic feet, or the equivalent of 50 billion barrels of oil. Unconventional natural gas is projected by the EIA to meet most of the nation’s domestic natural gas demand by 2030, representing a substantial change in the overall energy consumption pattern in the United States. At current consumption rates, the nation can count on natural gas for at least a century. In addition to its abundance, natural gas is the cleanest burning of the fossil fuels. A sizeable purchase price premium, the opportunity to share in any upside appreciation in Exxon’s share price, and the tax-free nature of the transaction convinced XTO shareholders to approve the deal. Exxon’s commitment to manage XTO on a stand-alone basis as a wholly owned subsidiary in which a number of former XTO managers would be retained garnered senior management support. By keeping XTO largely intact in Fort Worth, Texas, Exxon was able to minimize differences due to Exxon Mobil’s and XTO’s dissimilar corporate cultures. -Identify what you believe the key environmental trends that encouraged Exxon Mobil to acquire XTO Energy.