Exam 4: Planning: Developing Business and Acquisition Plans: Phases 1 and 2 of the Acquisition Process

In selecting an appropriate business strategy, all of the following are relevant questions except for

Management can obtain insight into the firm's probable future cash requirements and in turn its value by determining its position in its industry's product life cycle.

.Discuss the types of analyses inside GE that may have preceded GE's 2008 announcement that it would spin-off its consumer and industrial business to its shareholders.

Describe how Facebook has chosen to deal with cultural differences that may exist between it and the firms it acquires? What are the advantages and disadvantages of Facebook's approach to dealing with cultural differences?

Resource limitations in developing the acquisition plan include money, borrowing capacity, as well as management time and skills.

Years in the Making: Kinder Morgan Opportunistically Buys El Paso Corp. for $20.7 Billion Companies often hold informal merger talks for protracted periods until conditions emerge that are satisfactory to both parties. Capital requirements and regulatory hurdles often make buying another firm more attractive than attempting to build the other firm’s capabilities independently. ______________________________________________________________________________________________________ Using a combination of advanced horizontal drilling techniques and hydraulic fracturing, or “fracking” (i.e., shooting water and chemicals deep underground to blast open gas-bearing rocks), U.S. natural gas production has surged in recent years. As a result, proven gas reserves have soared such that the Federal Energy Information Administration estimates that the overall supplies of natural gas would last more than 100 years at current consumption rates. But surging supplies have pushed natural gas prices to $4 per million BTUs down from a peak of $13 in July 2008. Despite the depressed prices, energy companies around the globe have rushed to enter the business of producing shale gas. With energy prices depressed, independent players are struggling to find financing for their projects, prompting larger competitors to engage in buyouts. Exxon acquired XTO Energy in 2009, and Chesapeake Energy sold a partial stake in its shale gas reserves to Chinese companies for billions of dollars. In 2011 alone, oil and gas firms announced $172 billion worth of acquisitions in the continental United States, accounting for about two-thirds of the $261 billion spent on oil and gas acquisitions worldwide. The increase in energy supplies has strained current pipeline capacity in the United States. Today more than 50 pipeline companies transport oil and gas through networks that do not necessarily transport the fuel where it is needed from where it is being produced. For example, pipeline construction in the Marcellus shale field in Pennsylvania has not kept pace with drilling activity there, limiting the amount of gas that can be sent to the northeast. In the Bakken field in North Dakota, producers are shipping much of their new oil production by train to west coast refineries, and excess gas is being burned off. In the meantime, new oil and gas fields are being developed in Ohio, Kansas, Oklahoma, Texas, and Colorado. According to the Interstate Natural Gas Association of America Foundation, a trade group, pipeline companies are expected to have to build 36,000 miles of large-diameter, high-pressure natural gas pipelines by 2035 to meet market demands, at a cost of $178 billion. Responding to these developments, on October 17, 2011, Kinder Morgan (Kinder) agreed to buy the El Paso Corporation (El Paso) for $21.1 billion in cash and stock. Including the assumption of debt owed by El Paso and an affiliated business, El Paso Pipeline Partners, the takeover is valued at about $38 billion. This represents the largest energy deal since Exxon Mobil bought XTO Energy in late 2009. Kinder Morgan’s stock had been declining throughout 2011, and the firm was looking for a way to jumpstart earnings growth. The acquisition offers Kinder both the scale and the geographic disposition of pipelines necessary to support the burgeoning supply of shale gas and oil supplies. The acquisition makes Kinder the largest independent transporter of gasoline, diesel, and other petroleum products in the United States. It will also be the largest independent owner and operator of petroleum storage terminals and the largest transporter of carbon dioxide in the United States. The combined firms will operate the only oil sands pipeline to the west coast. To attempt to replicate the El Paso pipeline network would have been time consuming, required large amounts of capital, and faced huge regulatory hurdles. Kinder will own or operate about 67,000 miles of the more than 500,000 miles of oil and gas pipelines stretching across the United States. Kinder’s pipelines in the Rocky Mountains, the Midwest, and Texas will be woven together with El Paso’s expansive network that spreads east from the Gulf Coat to New England and to the west through New Mexico, Arizona, Nevada, and California. In buying El Paso, Kinder creates a unified network of interstate pipelines. By increasing its dependence on utilities, Kinder will reduce its exposure to the more volatile industry end user market. The acquisition also offers significant cost-cutting opportunities resulting from reconfiguring existing pipeline networks. Kinder paid 14 times El Paso’s last 12 months’ earnings before interest, taxes, depreciation, and amortization of $2.67 billion. Investors applauded the deal by boosting Kinder’s stock by 4.8% to $28.19 on the announcement date. El Paso shares climbed 25% to $24.81. For each share of El Paso, Kinder paid $14.65 in cash, .4187 of a Kinder share, and .640 of a warrant entitling the bearer to buy more Kinder shares at a predetermined price. The purchase price at closing valued the deal at $26.87 per El Paso share and constituted a 47% premium to El Paso 20-day average price prior to the announcement. Kinder’s debt will increase to $14.5 billion from $3.2 billion after the acquisition. To help pay for the deal, Kinder is seeking a buyer for El Paso’s exploration business. The combined firms will be called Kinder Morgan. Richard D. Kinder, the founder of Kinder Morgan, will be the chairman and CEO. The proposed takeover was not approved by regulators until May 2, 2012, on the condition that Kinder Morgan agree to sell three U.S. natural gas pipelines. The deal represents the culmination of years of discussion between Kinder Morgan and El Paso. Kinder, which went private in 2006 in a transaction valued at $22 billion, reemerged in an IPO in February 2011, raising nearly $2.9 billion. The IPO made the deal possible. While Kinder had for years held talks with El Paso’s management about a merger, it needed the “currency” of a publicly traded stock to complete such a deal. El Paso shareholders wanted to be able to participate in any future appreciation of the Kinder Morgan shares. Whether the combination of these two firms makes sense depends on the magnitude and timing of the expected resurgence in natural gas prices and the acceptability of shale gas and “fracking” to the regulators. -What factors external to Kinder Morgan and El Paso seemed to drive the transaction? Be specific.

Market profiling requires an analysis of all of the following factors except for:

Determining where a firm should compete starts with deciding who the firm's current or potential customers are and what are their needs.

How does planning facilitate the acquisition process?

Why is it important to understand the assumptions underlying a business plan or an acquisition plan?

BofA Acquires Countrywide Financial Corporation On July 1, 2008, Bank of America Corp (BofA) announced that it had completed its acquisition of mortgage lender Countrywide Financial Corp (Countrywide) for $4 billion, a 70 percent discount from the firm’s book value at the end of 2007. Countrywide originates, purchases, and securitizes residential and commercial loans; provides loan closing services, such as appraisals and flood determinations; and performs other residential real estate–related services. This marked another major (but risky) acquisition by Bank of America's chief executive Kenneth Lewis in recent years. BofA's long-term intent has been to become the nation's largest consumer bank, while achieving double-digit earnings growth. The acquisition would help the firm realize that vision and create the second largest U.S. bank. In 2003, BofA paid $48 billion for FleetBoston Financial, which gave it the most branches, customers, and checking deposits of any U.S. bank. In 2005, BofA became the largest credit card issuer when it bought MBNA for $35 billion. The purchase of the troubled mortgage lender averted the threat of a collapse of a major financial institution because of the U.S. 2007–2008 subprime loan crisis. U.S. regulators were quick to approve the takeover because of the potentially negative implications for U.S. capital markets of a major bank failure. Countrywide had lost $1.2 billion in the third quarter of 2007. Countrywide's exposure to the subprime loan market (i.e., residential loans made to borrowers with poor or nonexistent credit histories) had driven its shares down by almost 80 percent from year-earlier levels. The bank was widely viewed as teetering on the brink of bankruptcy as it lost access to the short-term debt markets, its traditional source of borrowing. Bank of America deployed 60 analysts to Countrywide's headquarters in Calabasas, California. After four weeks of analyzing Countrywide's legal and financial challenges and modeling how its loan portfolio was likely to perform, BofA offered an all-stock deal valued at $4 billion. The deal valued Countrywide at $7.16 per share, a 7.6 discount to its closing price the day before the announcement. BofA issued 0.18 shares of its stock for each Countrywide share. The deal could have been renegotiated if Countrywide experienced a material change that adversely affected the business between the signing of the agreement of purchase and sale and the closing of the deal. BofA made its initial investment of $2 billion in Countrywide in August 2007, purchasing preferred shares convertible to a 16 percent stake in the company. By the time of the announced acquisition in early January 2008, Countrywide had a $1.3 billon paper loss on the investment. The acquisition provided an opportunity to buy a market leader at a distressed price. The risks related to the amount of potential loan losses, the length of the U.S. housing slump, and potential lingering liabilities associated with Countrywide’s questionable business practices. The purchase made BofA the nation's largest mortgage lender and servicer, consistent with the firm's business strategy, which is to help consumers meet all their financial needs. BofA has been one of the relatively few major banks to be successful in increasing revenue and profit following acquisitions by "cross-selling" its products to the acquired bank's customers. Countrywide's extensive retail distribution network enhances BofA's network of more than 6,100 banking centers throughout the United States. BofA had anticipated almost $700 million in after-tax cost savings in combining the two firms. Almost two-thirds of these savings had been realized by the end of 2010. In mid-2010, BofA agreed to pay $108 million to settle federal charges that Countrywide had incorrectly collected fees from 200,000 borrowers who had been facing foreclosure. -What capabilities did the acquisition of FleetBoston Financial and MBNA provide BofA? How did the Countrywide acquisition complement previous acquisitions?

Pepsi Buys Quaker Oats in a Highly Publicized Food Fight On June 26, 2000, Phillip Morris, which owned Kraft Foods, announced its planned $15.9 billion purchase of Nabisco, ranked seventh in the United States in terms of sales at that time. By combining Nabisco with its Kraft operations, ranked number one in the United States, Phillip Morris created an industry behemoth. Not to be outdone, Unilever, the jointly owned British–Dutch giant, which ranked fourth in sales, purchased Bestfoods in a $20.3 billion deal. Midsized companies such as Campbell’s could no longer compete with the likes of Nestle, which ranked number three; Proctor & Gamble, which ranked number two; or Phillip Morris. Consequently, these midsized firms started looking for partners. Other companies were cutting back. The U.K.’s Diageo, one of Europe’s largest food and beverage companies, announced the restructuring of its Pillsbury unit by cutting 750 jobs—10% of its workforce. PepsiCo, ranked sixth in U.S. sales, spun off in 1997 its Pizza Hut, KFC, and Taco Bell restaurant holdings. Also, eighth-ranked General Mills spun off its Red Lobster, Olive Garden, and other brand-name stores in 1995. In 2001, Coca-Cola announced a reduction of 6000 in its worldwide workforce. As one of the smaller firms in the industry, Quaker Oats faced a serious problem: it was too small to acquire other firms in the industry. As a result, they were unable to realize the cost reductions through economies of scale in production and purchasing that their competitors enjoyed. Moreover, they did not have the wherewithal to introduce rapidly new products and to compete for supermarket shelf space. Consequently, their revenue and profit growth prospects appeared to be limited. Despite its modest position in the mature and slow-growing food and cereal business, Quaker Oats had a dominant position in the sports drink marketplace. As the owner of Gatorade, it controlled 85% of the U.S. market for sports drinks. However, its penetration abroad was minimal. Gatorade was the company’s cash cow. Gatorade’s sales in 1999 totaled $1.83 billion, about 40% of Quaker’s total revenue. Cash flow generated from this product line was being used to fund its food and cereal operations. Gatorade’s management recognized that it was too small to buy other food companies and therefore could not realize the benefits of consolidation. After a review of its options, Quaker’s board decided that the sale of the company would be the best way to maximize shareholder value. This alternative presented a serious challenge for management. Most of Quaker’s value was in its Gatorade product line. It quickly found that most firms wanted to buy only this product line and leave the food and cereal businesses behind. Quaker’s management reasoned that it would be in the best interests of its shareholders if it sold the total company rather than to split it into pieces. That way they could extract the greatest value and then let the buyer decide what to do with the non-Gatorade businesses. In addition, if the business remained intact, management would not have to find some way to make up for the loss of Gatorade’s substantial cash flow. Therefore, Quaker announced that it was for sale for $15 billion. Potential suitors viewed the price as very steep for a firm whose businesses, with the exception of Gatorade, had very weak competitive positions. Pepsi was the first to make a formal bid for the firm, quickly followed by Coca-Cola and Danone. By November 21, 2000, Coca-Cola and PepsiCo were battling to acquire Quaker. Their interest stemmed from the slowing sales of carbonated beverages. They could not help noticing the explosive growth in sports drinks. Not only would either benefit from the addition of this rapidly growing product, but they also could prevent the other from improving its position in the sports drink market. Both Coke and PepsiCo could boost Gatorade sales by putting the sports drink in vending machines across the country and selling it through their worldwide distribution network. PepsiCo’s $14.3 billion fixed exchange stock bid consisting of 2.3 shares of its stock for each Quaker share in early November was the first formal bid Quaker received. However, Robert Morrison, Quaker’s CEO, dismissed the offer as inadequate. Quaker wanted to wait, since it was expecting to get a higher bid from Coke. At that time, Coke seemed to be in a better financial position than PepsiCo to pay a higher purchase price. Investors were expressing concerns about rumors that Coke would pay more than $15 billion for Quaker and seemed to be relieved that PepsiCo’s offer had been rejected. Coke’s share price was falling and PepsiCo’s was rising as the drama unfolded. In the days that followed, talks between Coke and Quaker broke off, with Coke’s board unwilling to support a $15.75 billion offer price. After failing to strike deals with the world’s two largest soft drink makers, Quaker turned to Danone, the manufacturer of Evian water and Dannon yogurt. Much smaller than Coca-Cola or PepsiCo, Danone was hoping to hype growth in its healthy nutrition and beverage business. Gatorade would complement Danone’s bottled-water brands. Moreover, Quaker’s cereals would fit into Danone’s increasing focus on breakfast cereals. However, few investors believed that the diminutive firm could finance a purchase of Quaker. Danone proposed using its stock to pay for the acquisition, but the firm noted that the purchase would sharply reduce earnings per share through 2003. Danone backed out of the talks only 24 hours after expressing interest, when its stock got pummeled on the news. Nearly 1 month after breaking off talks to acquire Quaker Oats because of disagreements over price, PepsiCo once again approached Quaker’s management. Its second proposal was the same as its first. PepsiCo was now in a much stronger position this time, especially because Quaker had run out of suitors. Under the terms of the agreement, Quaker Oats would be liable for a $420 million breakup fee if the deal was terminated, either because its shareholders didn’t approve the deal or the company entered into a definitive merger agreement with an alternative bidder. Quaker also granted PepsiCo an option to purchase 19.9% of Quaker’s stock, exercisable only if Quaker is sold to another bidder. Such a tactic sometimes is used in conjunction with a breakup fee to discourage other suitors from making a bid for the target firm. With the purchase of Quaker Oats, PepsiCo became the leader of the sports drink market by gaining the market’s dominant share. With more than four-fifths of the market, PepsiCo dwarfs Coke’s 11% market penetration. This leadership position is widely viewed as giving PepsiCo, whose share of the U.S. carbonated soft drink market is 31.4% as compared with Coke’s 44.1%, a psychological boost in its quest to accumulate a portfolio of leading brands. -Do you think PepsiCo may have been willing to pay such a high price for Quaker for reasons other than economics? Do you think these reasons make sense? Explain your answer.

Examples of management preferences used in an acquisition plan include their preference for an asset or stock purchase or openness to partial rather than full ownership of the target firm.

The market targeted by the firm should reflect the fit between the corporation's primary strengths and competencies and its ability to satisfy customer needs better than the competition.

After having acquired the OfficeMax superstore chain in 2003, Boise Cascade announced the sale of its core paper and timber products operations in late 2004 to reduce its dependence on this highly cyclical business. Reflecting its new emphasis on distribution, the company changed its name to OfficeMax, Inc. How would you describe the OfficeMax mission and business strategy implicit in these actions.

An acquisition plan entails all of the following except for

Why is it important to get senior management heavily involved early in the acquisition process?