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

The actual price paid for a target firm is unaffected by the buyer's due diligence.

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 Finally, TLC’s brands were becoming outdated.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. -Why was Gore Technology Group able to do what Mattel could not do in a year.?

All of the following are true of buyer due diligence except for

Each of the following is true about the acquisition search process except for

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. -Describe the measurable and non-measurable damages to McKesson's shareholders resulting from HBO's fraudulent accounting activities.

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. -are the key factors external and internal to Microsoft driving its investment in Barnes & Noble?

The number of selection criteria should be as extensive as possible to ensure that all factors relevant to the firm's decision-making process are considered.

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. -With substantially higher operating margins than Cingular, what strategies would you expect Verizon Wireless to pursue? Explain your answer.

Even though time is critical, it is always critical to build a relationship with the CEO of the target firm before approaching her with an acquisition proposal.

Buyers should not be concerned about performing an exhaustive due diligence since in doing so they could degrade the value of the target firm because of the disruptive nature of a rigorous due diligence. The buyer can be assured that all significant risks can be handled through the standard representations and warranties commonly found in agreements of purchase and sale.

The appropriate approach for initiating contact with a target firm is essentially the same for large or small, public or private companies.