Exam 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities

Restaurant chain, Camin Holdings, acquired all of the assets and liabilities of Cheesecakes R Us. The combined firm is known as Camin Holdings and Cheesecakes R Us no longer exists as a separate entity. The Acquisition is best described as a:

Which one of the following is not an example of a horizontal merger?

Dell Moves into Information Technology Services Dell Computer’s growing dependence on the sale of personal computers and peripherals left it vulnerable to economic downturns. Profits had dropped more than 22 percent since the start of the global recession in early 2008 as business spending on information technology was cut sharply. Dell dropped from number 1 to number 3 in terms of market share, as measured by personal computer unit sales, behind lower-cost rivals Hewlett-Packard and Acer. Major competitors such as IBM and Hewlett-Packard were less vulnerable to economic downturns because they derived a larger percentage of their sales from delivering services. Historically, Dell has grown “organically” by reinvesting in its own operations and through partnerships targeting specific products or market segments. However, in recent years, Dell attempted to “supercharge” its lagging growth through targeted acquisitions of new technologies. Since 2007, Dell has made ten comparatively small acquisitions (eight in the United States), purchased stakes in four firms, and divested two companies. The largest previous acquisition for Dell was the purchase of EqualLogic for $1.4 billion in 2007. The recession underscored what Dell had known for some time. The firm had long considered diversifying its revenue base from the more cyclical PC and peripherals business into the more stable and less commodity-like computer services business. In 2007, Dell was in discussions about a merger with Perot Systems, a leading provider of information technology (IT) services, but an agreement could not be reached. Dell’s global commercial customer base spans large corporations, government agencies, healthcare providers, educational institutions, and small and medium firms. The firm’s current capabilities include expertise in infrastructure consulting and software services, providing network-based services, and data storage hardware; nevertheless, it was still largely a manufacturer of PCs and peripheral products. In contrast, Perot Systems offers applications development, systems integration, and strategic consulting services through its operations in the United States and ten other countries. In addition, it provides a variety of business process outsourcing services, including claims processing and call center operations. Perot’s primary markets are healthcare, government, and other commercial segments. About one-half of Perot’s revenue comes from the healthcare market, which is expected to benefit from the $30 billion the U.S. government has committed to spending on information technology (IT) upgrades over the next five years. In 2008, Hewlett-Packard (HP) paid $13.9 billion for computer services behemoth, EDS, in an attempt to become a “total IT solutions” provider for its customers. This event, coupled with a very attractive offer price, revived merger discussions with Perot Systems. On September 21, 2009, Dell announced that an agreement had been reached to acquire Perot Systems in an all-cash offer for $30 a share in a deal valued at $3.9 billion. The tender offer (i.e., takeover bid) for all of Perot Systems’ outstanding shares of Class A common stock was initiated in early November and completed on November 19, 2009, with Dell receiving more than 90 percent of Perot’s outstanding shares. Mars Buys Wrigley in One Sweet Deal Under considerable profit pressure from escalating commodity prices and eroding market share, Wrigley Corporation, a U.S. based leader in gum and confectionery products, faced increasing competition from Cadbury Schweppes in the U.S. gum market. Wrigley had been losing market share to Cadbury since 2006. Mars Corporation, a privately owned candy company with annual global sales of $22 billion, sensed an opportunity to achieve sales, marketing, and distribution synergies by acquiring Wrigley Corporation. On April 28, 2008, Mars announced that it had reached an agreement to merge with Wrigley Corporation for $23 billion in cash. Under the terms of the agreement, unanimously approved by the boards of the two firms, shareholders of Wrigley would receive $80 in cash for each share of common stock outstanding. The purchase price represented a 28 percent premium to Wrigley's closing share price of $62.45 on the announcement date. The merged firms in 2008 would have a 14.4 percent share of the global confectionary market, annual revenue of $27 billion, and 64,000 employees worldwide. The merger of the two family-controlled firms represents a strategic blow to competitor Cadbury Schweppes's efforts to continue as the market leader in the global confectionary market with its gum and chocolate business. Prior to the announcement, Cadbury had a 10 percent worldwide market share. Wrigley would become a separate stand-alone subsidiary of Mars, with $5.4 billion in sales. The deal would help Wrigley augment its sales, marketing, and distribution capabilities. To provide more focus to Mars' brands in an effort to stimulate growth, Mars would transfer its global nonchocolate confectionery sugar brands to Wrigley. Bill Wrigley, Jr., who controls 37 percent of the firm's outstanding shares, would remain executive chairman of Wrigley. The Wrigley management team also would remain in place after closing. The combined companies would have substantial brand recognition and product diversity in six growth categories: chocolate, nonchocolate confectionary, gum, food, drinks, and pet-care products. The resulting confectionary powerhouse also would expect to achieve significant cost savings by combining manufacturing operations and have a substantial presence in emerging markets. While mergers among competitors are not unusual, the deal's highly leveraged financial structure is atypical of transactions of this type. Almost 90 percent of the purchase price would be financed through borrowed funds, with the remainder financed largely by a third party equity investor. Mars's upfront costs would consist of paying for closing costs from its cash balances in excess of its operating needs. The debt financing for the transaction would consist of $11 billion and $5.5 billion provided by J.P. Morgan Chase and Goldman Sachs, respectively. An additional $4.4 billion in subordinated debt would come from Warren Buffet's investment company, Berkshire Hathaway, a nontraditional source of high-yield financing. Historically, such financing would have been provided by investment banks or hedge funds and subsequently repackaged into securities and sold to long-term investors, such as pension funds, insurance companies, and foreign investors. However, the meltdown in the global credit markets in 2008 forced investment banks and hedge funds to withdraw from the high-yield market in an effort to strengthen their balance sheets. Berkshire Hathaway completed the financing of the purchase price by providing $2.1 billion in equity financing for a 9.1 percent ownership stake in Wrigley. -Why was market share in the confectionery business an important factor in Mars' decision to acquire Wrigley?

In your opinion, what are the motivations for two mergers or acquisitions in the news?

An acquisition occurs when one firm takes a controlling interest in another firm, a legal subsidiary of another firm, or selected assets of another firm. The acquired firm often remains a subsidiary of the acquiring company.

The target company is the firm being solicited by the acquiring company.

V.F. Corp Buys Timberland Acquisitions often are used to change a firm’s product focus rapidly. Acquisitions of direct competitors often represent significant revenue growth and cost-saving opportunities. The timely realization of synergies is critical to recovering purchase price premiums. Widely recognized in the United States and Europe as a maker of rugged outdoor apparel, Timberland (TBL) had stumbled in recent years. Its failure to turn around its money-losing Yellow Boot brand, the limited success of its advertising campaign to encourage consumers to think of Timberland apparel as a year-round brand, and overly ambitious expansion plans in China caused earnings to deteriorate. Despite annual revenues growing to more than $1.6 billion in fiscal year 2011, the firm was losing market share to such competitors as the Gap and Sears Holdings. Timberland’s share price declined as investor confidence in management waned when the firm failed to meet its quarterly earnings forecasts. Timberland was ripe for takeover. With annual revenue of $7.7 billion, apparel maker V.F. Corporation (VFC), owner of such well-known brands as The North Face, Wrangler, and Lee, was always on the prowl for firms that fit its business strategy. VFC has grown historically by adding highly recognizable brands with significant market share. The strategy has been implemented largely through acquisition rather than through partnering with others or developing its own brands. Furthermore, the firm was shifting its product offering toward the rapidly growing outdoor-apparel business. With its focus on outdoor apparel, Timberland became a highly attractive target, especially as its share price declined. VFC pounced on the opportunity to add the highly recognizable Timberland trademark to its product portfolio. On June 13, 2011, VFC announced that it had reached an agreement to pay TBL shareholders $43 per share in an all-cash deal, a 43% premium over the prior day’s closing price. The deal valued TBL at about $2 billion. Including the Timberland acquisition, VFC’s outdoor and action sports product lines were expected to contribute about one-half of the firm’s total annual revenue in 2012, ultimately rising by more than 60% by 2015. In buying Timberland, VFC gained access to new retail outlets and the opportunity to better position TBL as a lifestyle brand in the apparel and accessories market. VFC also hoped to use TBL’s rapidly growing online business to help it achieve its online sales goal of more than $400 million by 2015, more than three times their 2011 total. VFC hoped to accelerate the growth in TBL product sales by expanding their availability through its own e-commerce site and through its international operations. Likewise, VFC expected to achieve substantially larger discounts on raw material purchases than TBL because of its larger bulk purchases and to reduce overhead expenses by eliminating redundant positions. Xerox Buys ACS to Satisfy Shifting Customer Requirements In anticipation of a shift from hardware and software spending to technical services by their corporate customers, IBM announced an aggressive move away from its traditional hardware business and into services in the mid-1990s. Having sold its commodity personal computer business to Chinese manufacturer Lenovo in mid-2005, IBM became widely recognized as a largely “hardware neutral” systems integration, technical services, and outsourcing company. Because information technology (IT) services have tended to be less cyclical than hardware and software sales, the move into services by IBM enabled the firm to tap a steady stream of revenue at a time when customers were keeping computers and peripheral equipment longer to save money. The 2008–2009 recession exacerbated this trend as corporations spent a smaller percentage of their IT budgets on hardware and software. These developments were not lost on other IT companies. Hewlett-Packard (HP) bought tech services company EDS in 2008 for $13.9 billion. On September 21, 2009, Dell announced its intention to purchase another IT services company, Perot Systems, for $3.9 billion. One week later, Xerox, traditionally an office equipment manufacturer announced a cash and stock bid for Affiliated Computer Systems (ACS) totaling $6.4 billion. Each firm was moving to position itself as a total solution provider for its customers, achieving differentiation from its competitors by offering a broader range of both hardware and business services. While each firm focused on a somewhat different set of markets, they all shared an increasing focus on the government and healthcare segments. However, by retaining a large proprietary hardware business, each firm faced challenges in convincing customers that they could provide objectively enterprise-wide solutions that reflected the best option for their customers. Previous Xerox efforts to move beyond selling printers, copiers, and supplies and into services achieved limited success due largely to poor management execution. While some progress in shifting away from the firm’s dependence on printers and copier sales was evident, the pace was far too slow. Xerox was looking for a way to accelerate transitioning from a product-driven company to one whose revenues were more dependent on the delivery of business services. With annual sales of about $6.5 billion, ACS handles paper-based tasks such as billing and claims processing for governments and private companies. With about one-fourth of ACS’s revenue derived from the healthcare and government sectors through long-term contracts, the acquisition gives Xerox a greater penetration into markets which should benefit from the 2009 government stimulus spending and 2010 healthcare legislation. More than two-thirds of ACS’s revenue comes from the operation of client back office operations such as accounting, human resources, claims management, and other business management outsourcing services, with the rest coming from providing technology consulting services. ACS would also triple Xerox’s service revenues to $10 billion. Xerox hopes to increases its overall revenue by bundling its document management services with ACS’s client back office operations. Only 20 percent of the two firms’ customers overlap. This allows for significant cross-selling of each firm’s products and services to the other firm’s customers. Xerox is also betting that it can apply its globally recognized brand and worldwide sales presence to expand ACS internationally. A perceived lack of synergies between the two firms, Xerox’s rising debt levels, and the firm’s struggling printer business fueled concerns about the long-term viability of the merger, sending Xerox’s share price tumbling by almost 10 percent on the news of the transaction. With about $1 billion in cash at closing in early 2010, Xerox needed to borrow about $3 billion. Standard & Poor’s credit rating agency downgraded Xerox’s credit rating to triple-B-minus, one notch above junk. Integration is Xerox’s major challenge. The two firms’ revenue mixes are very different, as are their customer bases, with government customers often requiring substantially greater effort to close sales than Xerox’s traditional commercial customers. Xerox intends to operate ACS as a standalone business, which will postpone the integration of its operations consisting of 54,000 employees with ACS’s 74,000. If Xerox intends to realize significant incremental revenues by selling ACS services to current Xerox customers, some degree of integration of the sales and marketing organizations would seem to be necessary. It is hardly a foregone conclusion that customers will buy ACS services simply because ACS sales representatives gain access to current Xerox customers. Presumably, additional incentives are needed, such as some packaging of Xerox hardware with ACS’s IT services. However, this may require significant price discounting at a time when printer and copier profit margins already are under substantial pressure. Customers are likely to continue, at least in the near term, to view Xerox, Dell, and HP more as product than service companies. The sale of services will require significant spending to rebrand these companies so that they will be increasingly viewed as service vendors. The continued dependence of all three firms on the sale of hardware may retard their ability to sell packages of hardware and IT services to customers. With hardware prices under continued pressure, customers may be more inclined to continue to buy hardware and IT services from separate vendors to pit one vendor against another. Moreover, with all three firms targeting the healthcare and government markets, pressure on profit margins could increase for all three firms. The success of IBM’s services strategy could suggest that pure IT service companies are likely to perform better in the long run than those that continue to have a significant presence in both the production and sale of hardware as well as IT services. -Based on your answers to questions 1 and 2, do you believe that investors reacted correctly or incorrectly to the announcement of the transaction?

A leveraged buyout is the purchase of a company using as much equity as possible.

Lam Research Buys Novellus Systems to Consolidate Industry Industry consolidation is a common response to sharply escalating costs, waning demand, and increasing demands of new technologies. Customer consolidation often drives consolidation among suppliers. ______________________________________________________________________________________________ Highly complex electronic devices such as smartphones and digital cameras have become ubiquitous in our everyday lives. These devices are powered by sets of instructions encoded on wafers of silicon called semiconductor chips (semiconductors). Consumer and business demands for increasingly sophisticated functionality for smartphones and cloud computing technologies require the ongoing improvement of both the speed and the capability of semiconductors. This in turn places huge demands on the makers of equipment used in the chip-manufacturing process. To stay competitive, makers of equipment used to manufacture semiconductor chips were compelled to increase R&D spending sharply. Chip manufacturers resisted paying higher prices for equipment because their customers, such as PC and cellphone handset makers, were facing declining selling prices for their products. Chip equipment manufacturers were unable to recover the higher R&D spending through increasing selling prices. The resulting erosion in profitability due to increasing R&D spending was compounded by the onset of the 2008–2009 global recession. The industry responded with increased consolidation in an attempt to cut costs, firm product pricing, and gain access to new technologies. Industry consolidation began among chip manufacturers and later spurred suppliers to combine. In February 2011, chipmaker Texas Instruments bought competitor National Semiconductor for $6.5 billion. Three months later, Applied Materials, the largest semiconductor chip equipment manufacturer, bought Varian Semiconductor Equipment Associates for $4.9 billion to gain access to new technology. On December 21, 2011, Lam Research Corporation (Lam) agreed to buy rival Novellus Systems Inc. (Novellus) for $3.3 billion. Lam anticipates annual cost savings of $100 million by the end of 2013 due to the elimination of overlapping overhead. Under the terms of the deal, Lam agreed to acquire Novellus in a share exchange in which Novellus shareholders would receive 1.125 shares of Lam common stock for each Novellus share. The deal represented a 28% premium over the closing price of Novellus’s shares on the day prior to the deal’s public announcement. At closing, Lam shareholders owned about 51% of the combined firms, with Novellus shareholders controlling the rest. In comparison to earlier industry buyouts, the purchase seemed like a good deal for Lam’s shareholders. At 2.3 times Novellus’s annual revenue, the purchase price was almost one-half the 4.5 multiple paid by industry leader Applied Materials for Variant in May 2011. The purchase premium paid by Lam was one-half of that paid for comparable transactions between 2006 and 2010. Yet Lam shares closed down 4%, and Novellus’ shares closed up 28% on the announcement date. Lam and Novellus produce equipment that works at different stages of the semiconductor-manufacturing process, making their products complementary. After the merger, Lam’s product line would be considerably broader, covering more of the semiconductor-manufacturing process. Semiconductor-chip manufacturers are inclined to buy equipment from the same supplier due to the likelihood that the equipment will be compatible. Lam also is seeking access to cutting-edge technology and improved efficiency. Technology exchange between the two firms is expected to help the combined firms to develop the equipment necessary to support the next generation of advanced semiconductors. Customers of the two firms include such chip makers as Intel and Samsung. By selling complementary products, the firms have significant cross-selling opportunities as equipment suppliers to all 10 chip makers globally. Together, Lam and Novellus are able to gain revenue faster than they could individually by packaging their equipment and by developing their technologies in combination to ensure they work together. Lam has greater penetration with Samsung and Novellus with Intel. Lam also stated on the transaction announcement date that a $1.6 billion share repurchase program would be implemented within 12 months following closing. The buyback allows shareholders to sell some of their shares for cash such that, following completion of the buyback, the deal could resemble a half-stock, half-cash deal, depending on how many shareholders tender their shares during the buyback program. The share repurchase will be funded out of the firms’ combined cash balances and cash flow. Structuring the deal as an all-stock purchase at closing allows Novellus shareholders to have a tax-free deal. -Why did Lam's shares close down 4 percent on the news? Why did Novellus' shares close up 28 percent?

Joe's barber shop buys Jose's Hair Salon. Which of the following terms best describes this deal?

Speculate as to why Microsoft and Nokia initially decided to form a partnership rather than have Microsoft simply acquire Nokia? Why was the partnership unsuccessful?

The Nokia takeover is an example of vertical integration. How does vertical integration differ from horizontal integration? How are the two businesses (software and hardware) the same and how are they different? What are the potential advantages and disadvantages of this vertical integration for Microsoft? Be specific.

Which of the following are not true about economies of scale?

Google Acquires Motorola Mobility in a Growth-Oriented as well as Defensive Move Key Points The acquisition of Motorola Mobility positions Google as a vertically integrated competitor in the fast-growing wireless devices market. The acquisition also reduces their exposure to intellectual property litigation. ______________________________________________________________________________ By most measures, Google’s financial performance has been breathtaking. The Silicon Valley–based firm’s revenue in 2011 totaled $37.9 billion, up 29% from the prior year, reflecting the ongoing shift from offline to online advertising. While the firm’s profit growth has slowed in recent years, the firm’s 26% net margin remains impressive. About 95% of the firm’s 2011 revenue came from advertising sold through its websites and those of its members and partners. Google is channeling more resources into “feeder technologies” to penetrate newer and faster-growing digital markets and to increase the use of Google’s own and its members’ websites. These technologies include the Android operating system, designed to power wireless devices, and the Chrome operating system, intended to attract Windows- and Mac-based computer users. Faced with a need to fuel growth to sustain its market value, Google’s announcement on August 15, 2011, that it would acquire Motorola Mobility Holdings Inc. (Motorola) underscores the importance it places on the explosive growth in wireless devices. The all-cash $12.5 billion purchase price represented a 63% premium to Motorola’s closing price on the previous trading day. Chicago-based, Motorola makes cellphones, smartphones, tablets, and set-top boxes; its status as one of the earliest firms to develop cellphones and one of the leading mobile firms for the past few decades meant that it had accumulated approximately 17,000 patents, with another 7,500 pending. With less than 3% market share, the firm had been struggling to increase handset shipments and was embroiled in multiple patent-related lawsuits with Microsoft. As Google’s largest-ever deal, the acquisition may be intended to transform Google into a fully integrated mobile phone company, to insulate itself and its handset-manufacturing partners from patent infringement lawsuits, and to gain clout with wireless carriers, which control cellphone pricing and distribution. Revenue growth could come from license fees paid on the Motorola patent portfolio and sales of its handsets and by increasing the use of its own websites and those of its members to generate additional advertising revenue. Google was under pressure from its handset partners, including HTC and Samsung, to protect them from patent infringement suits based on their use of Google’s Android software. Microsoft has already persuaded HTC to pay a fee for every Android phone manufactured, and it is seeking to extract similar royalties from Samsung. If this continues, such payments could make creating new devices for Android prohibitively expensive for manufacturers, forcing them to turn to alternative platforms like Windows Phone 7. With a limited patent portfolio, Google also was vulnerable to lawsuits against its Android licenses. Innovation in information technology usually relies on small, incremental improvements in software and hardware, which makes it difficult to determine those changes covered by patents. Firms have an incentive to build up their patent portfolios, which strengthens their negotiating positions with firms threatening to file lawsuits or demanding royalty payments. Historically, firms have simply cross-licensed each other’s technologies; today, however, patent infringement lawsuits create entry barriers to potential competitors, as the threat of lawsuits may discourage new entrants. It now pays competitors to sue routinely over alleged patent infringements. Risks associated with the deal include the potential to drive Android partners such as Samsung and HTC to consider using Microsoft’s smartphone operating system, with Google losing license fees currently paid to use the Android operating system. The deal offers few cost savings opportunities due the lack of overlap between Google, an Internet search engine that also produces Android phone software, and handset manufacturer Motorola. Google is essentially becoming a vertically integrated cellphone maker. Furthermore, when the deal was announced, some regulators expressed concern about Google’s growing influence in its served markets. Finally, Google’s and Motorola’s growth and profitability differ significantly, with Motorola’s revenue growth rate less than one-third of Google’s and its operating profit margin near zero. Samsung, HTC, Sony Ericsson, and LG are now both partners and competitors of Google. It is difficult for a firm such as Google to both license its products (Android operating system software) and compete with those licensees by selling Motorola handsets at the same time. Nokia has already aligned with Microsoft and abandoned its own mobile operating system. Others may try to create their own operating systems rather than become dependent on Google. Samsung released phones in 2011 that run on a system called Bada; HTC has a team of engineers dedicated to customizing the version of Android that it uses on its phones, called HTC Sense. Motorola Mobility’s shares soared by almost 57% on the day of the announcement. Led by Nokia, shares of other phone makers also surged. In contrast, Google’s share price fell by 1.2%, despite an almost 2% rise in the S&P 500 stock index that same day. -Many acquisitions are intended to create measureable synergy between the acquirer and target firms. In what sense is Motorola Mobility's role in this transaction unclear? Identify sources of synergy between Google and Motorola Mobility. What factors are likely to make the realization of this synergy difficult? Be specific.

Pacific Surfware acquired Surferdude and as part of the transaction both of the firms ceased to exist in their form prior to the transaction and combined to create an entirely new entity, Wildly Exotic Surfware. Which one of the following terms best describes this transaction?

Although there is substantial evidence that mergers pay off for target firm shareholders around the time the takeover is announced, shareholder wealth creation in the 3-5 years following a takeover is often limited.

Holding companies and their shareholders may be subject to triple taxation.

An investor group borrowed the money necessary to buy all of the stock of a company. Which of the following terms best describes this transaction?

Market power is a theory that suggests that firms merge to improve their ability to set product and service selling prices.

Investment bankers offer strategic and tactical advice and acquisition opportunities, screen potential buyers and sellers, make initial contact with a seller or buyer, and provide negotiation support for their clients.