Exam 5: Implementation: Search Through Closing: Phases 3 to 10 of the Acquisition Process

Due diligence is the process of validating assumptions underlying the initial valuation of the target firm as well as the uncovering of factors that had not previously been considered that could enhance or detract from the value of the target firm.

Case Study Short Essay Examination Questions 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. Case Study Short Essay Examination Questions 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. Discussion Questions: -How might the internet affect the toy industry? What potential conflicts with customers might be created?

In what way do you think the Oracle strategy was targeting key competitors? Be specific.

Case Study Short Essay Examination Questions Case Study: 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.?

Conduct an external and internal analysis of Oracle.Briefly describe those factors that influenced the development of Oracle's business strategy.Be specific.

All of the following are true of closing except for

Case Study Short Essay Examination Questions The Cash Impact of Product Warranties Reliable Appliances, a leading manufacturer of washing machines and dryers, acquired a marginal competitor, Quality-Built, which had been losing money during the last several years. To help minimize losses, Quality-Built reduced its quality-control expenditures and began to purchase cheaper parts. Quality-Built knew that this would hurt business in the long run, but it was more focused on improving its current financial performance to increase the firm's prospects for eventual sale. Reliable Appliances saw an acquisition of the competitor as a way of obtaining market share quickly at a time when Quality-Built's market value was the lowest in 3 years. The sale was completed quickly at a very small premium to the current market price. Quality-Built had been selling its appliances with a standard industry 3-year warranty. Claims for the types of appliances sold tended to increase gradually as the appliance aged. Quality-Built's warranty claims' history was in line with the industry experience and did not appear to be a cause for alarm. Not surprisingly, in view of Quality-Built's cutback in quality-control practices and downgrading of purchased parts, warranty claims began to escalate sharply within 12 months of Reliable Appliances's acquisition of Quality-Built. Over the next several years, Reliable Appliances paid out $15 million in warranty claims. The intangible damage may have been much higher because Reliable Appliances's reputation had been damaged in the marketplace. : -Should Reliable Appliances have been able to anticipate this problem from its due diligence of Quality-Built? Explain how this might have been accomplished.

Which of the following is not typically true of post-closing evaluation of an acquisition?

Case Study Short Essay Examination Questions 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. : -Do you believe the cross option and unusual fee structure in this transaction were in the best interests of the Wachovia shareholders? Explain your answer.

Case Study Short Essay Examination Questions 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. Case Study Short Essay Examination Questions 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. Discussion Questions: -What alternatives to acquisition could Mattel have considered? Discuss the pros and cons of each alternative?

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.

The financing plan is included in which phase of the acquisition process?

Case Study Short Essay Examination Questions The Downside of Earnouts In the mid-1980s, a well-known aerospace conglomerate acquired a high-growth systems integration company by paying a huge multiple of earnings. The purchase price ultimately could become much larger if certain earnout objectives, including both sales and earnings targets, were achieved during the 4 years following closing. However, the buyer's business plan assumed close cooperation between the two firms, despite holding the system integrator as a wholly owned but largely autonomous subsidiary. The dramatic difference in the cultures of the two firms was a major impediment to building trust and achieving the cooperation necessary to make the acquisition successful. Years of squabbling over policies and practices tended to delay the development and implementation of new systems. The absence of new systems made it difficult to gain market share. Moreover, because the earnout objectives were partially defined in terms of revenue growth, many of the new customer contracts added substantial amounts of revenue but could not be completed profitably under the terms of these contracts. The buyer was slow to introduce new management into its wholly owned subsidiary for fear of violating the earnout agreement. Finally, market conditions changed, and what had been the acquired company's unique set of skills became commonplace. Eventually, the aerospace company wrote off most of the purchase price and merged the remaining assets of the acquired company into one of its other product lines after the earnout agreement expired. : -Describe conditions under which an earnout might be most appropriate.

Letters of intent are usually legally binding on the potential buyer but rarely on the target firm.

Case Study Short Essay Examination Questions 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.

The development of search criteria is included in which of the following activities?

Case Study Short Essay Examination Questions The Anatomy of a Transaction: K2 Incorporated Acquires Fotoball USA Our story begins in the early 2000s. K2 is a sporting goods equipment manufacturer whose portfolio of brands includes Rawlings, Worth, Shakespeare, Pflueger, Stearns, K2, Ride, Olin, Morrow, Tubbs and Atlas. The company's diversified mix of products is used primarily in team and individual sports activities, and its primary customers are sporting goods retailers, many of which are not strongly capitalized. Historically, the firm has been able to achieve profitable growth by introducing new products into fast-growing markets. Most K2 products are manufactured in China, which helps ensure cost competitiveness but also potentially subjects the company to a variety of global uncertainties. K2's success depends on its ability to keep abreast of changes in taste and style and to offer competitive prices. The company's external analysis at the time showed that the most successful sporting goods suppliers will be those with the greatest resources, including both management talent and capital, the ability to produce or source high-quality, low-cost products and deliver them on a timely basis, and access to distribution channels with a broad array of products and brands. Management expected that large retailers would prefer to rely on fewer and larger sporting goods suppliers to help them manage the supply of products and the allocation of shelf space. The firm's primary customers are sporting goods retailers. Many of K2's smaller retailers and some larger retailers were not strongly capitalized. Adverse conditions in the sporting goods retail industry could adversely impact the ability of retailers to purchase K2 products. Secondary customers included individuals, both hobbyists as well as professionals. The firm had a few top competitors, but there were other large sporting goods suppliers with substantial brand recognition and financial resources with whom K2 did not compete. However, they could easily enter K2's currently served markets. In the company's secondary business, sports apparel, it did face stiff competition from some of these same suppliers, including Nike and Reebok. K2's internal analysis showed that the firm was susceptible to imitation, despite strong brand names, and that some potential competitors had substantially greater financial resources than K2. One key strength was the relationships K2 had built with collegiate and professional leagues and teams, not easily usurped. Larger competitors may have had the capacity to take some of these away, but K2 had so many that it could withstand the loss of one or two. The primary weakness of K2 was its relatively small size in comparison to major competitors. As a long-term, strategic objective, K2 set out to be number one in market share in the markets it served by becoming the low-cost supplier. To that end, K2 wanted to meet or exceed its corporate cost of capital of 15 percent; achieve sustained double-digit revenue growth, gross profit margins above 35 percent, and net profit margins in excess of 5 percent within five years; and reduce its debt-to-equity ratio to the industry average of 25 percent in the same period. The business strategy for meeting this objective was to become the low-cost supplier in new niche segments of the sporting goods and recreational markets. The firm would use its existing administrative and logistical infrastructure to support entry into these new segments, new distribution channels, and new product launches through existing distribution channels. Also, K2 planned to continue its aggressive cost cutting and expand its global sourcing to include low-cost countries other than China. All this required an implementation strategy. K2 decided to avoid product or market extension through partnering because of the potential for loss of control and for creating competitors once such agreements lapse. Rather, the strategy would build on the firm's great success, in recent years, acquiring and integrating smaller sporting goods companies with well-established brands and complementary distribution channels. To that end, M&A-related functional strategies were developed. A potential target for acquisition would be a company that holds many licenses with professional sports teams. Through its relationship with those teams, K2 could further promote its line of sporting gear and equipment. In addition, K2 planned to increase its R&D budget by 10 percent annually over five years to focus on developing equipment and apparel that could be offered to the customer base of firms it acquired during the period. Existing licensing agreements between a target firm and its partners could be enhanced to include the many products K2 now offers. If feasible, the sales force of a target firm would be merged with that of K2 to realize significant cost savings. K2 also thought through the issue of strategic controls. The company had incentive systems in place to motivate work towards implementing its business strategy. There were also monitoring systems to track the actual performance of the firm against the business plan. In its acquisition plan, K2's overarching financial objective was to earn at least its cost of capital. The plan's primary non-financial objective was to acquire a firm with well-established brands and complementary distribution channels. More specifically, K2 sought an acquisition with a successful franchise in the marketing and manufacturing of souvenir and promotional products that could be easily integrated into K2's current operations. The acquisition plan included an evaluation of resources and capabilities. K2 established that after completion of a merger, the target's sourcing and manufacturing capabilities must be integrated with those of K2, which would also retain management, key employees, customers, distributors, vendors and other business partners of both companies. An evaluation of financial risk showed that borrowing under K2's existing $205 million revolving credit facility and under its $20 million term loan, as well as potential future financings, could substantially increase current leverage, which could - among other things - adversely affect the cost and availability of funds from commercial lenders and K2's ability to expand its business, market its products, and make needed infrastructure investments. If new shares of K2 stock were issued to pay for the target firm, K2 determined that its earnings per share could be diluted unless anticipated synergies were realized in a timely fashion. Moreover, overpaying for any firm could result in K2 failing to earn its cost of capital. Ultimately, management set some specific preferences: the target should be smaller than $100 million in market capitalization and should have positive cash flows, and it should be focused on the sports or outdoor activities market. The initial search, by K2's experienced acquisition team, would involve analyzing current competitors. The acquisition would be made through a stock purchase - and K2 chose to consider only friendly takeovers involving 100 percent of the target's stock - and the form of payment would be new K2 non-voting common stock. The target firm's current year P/E should not exceed 20. After an exhaustive search, K2 identified Fotoball USA as its most attractive target due to its size, predictable cash flows, complementary product offering, and many licenses with most of the major sports leagues and college teams. Fotoball USA represented a premier platform for expansion of K2's marketing capabilities because of its expertise in the industry and place as an industry leader in many sports and entertainment souvenir and promotional product categories. K2 believed the fit with the Rawlings division would make both companies stronger in the marketplace. Fotoball also had proven expertise in licensing programs, which would assist K2 in developing additional revenue sources for its portfolio of brands. In 2003, Fotoball had lost $3.2 million, so it was anticipated that they would be receptive to an acquisition proposal and that a stock-for-stock exchange offer would be very attractive to Fotoball shareholders because of the anticipated high earning growth rate of the combined firms. Negotiations ensued, and the stock-for-stock offer contained a significant premium, which was well received. Fotoball is a very young company and many of its investors were looking to make their profits through the growth of the stock. The offer would allow Fotoball shareholders to defer taxes until they decided to sell their stocks and be taxed at the capital gains rate. An earn-out was also included in the deal to give management incentives to run the company effectively and meet deadlines in a timely order. Valuations for both K2 and Fotoball reflected anticipated synergies due to economies of scale and scope, namely, reductions in selling expenses of approximately $1 million per year, in distribution expenses of approximately $500,000 per year, and in annual G&A expenses of approximately $470,000. The combined market value of the two firms was estimated at $909 million - an increase of $82.7 million over the sum of the standalone values of the two firms. Based on Fotoball's outstanding common stock of 3.6 million shares, and the stock price of $4.02 at that time, a minimum offer price was determined by multiplying the stock price by the number of shares outstanding. The minimum offer price was $14.5 million. Were K2 to concede 100 percent of the value of synergy to Fotoball, the value of the firm would be $97.2 million. However, sharing more than 45 percent of synergy with Fotoball would have caused a serious dilution of earnings. To determine the amount of synergy to share with Fotoball's shareholders, K2 looked at what portion of the combined firms revenues would be contributed by each of the players and then applied that proportion to the synergy. Since 96 percent of the projected combined firms revenues in fiscal year 2004 were expected to come from K2, only 4 percent of the synergy value was added to the minimum offer price to come up with an initial offer price of $17.8 million, or $4.94 per share. That represented a premium of 23 percent over the market value of Fotoball's stock at the time. The synergies and the Fotoball's relatively small size compared to K2 made it unlikely that the merger would endanger K2's credit worthiness or near-term profitability. Although the contribution to earnings would be relatively small, the addition of Fotoball would help diversify and smooth K2's revenue stream, which had been subject to seasonality in the past. Organizationally, the integration of Fotoball into K2 would be achieved by operating Fotoball as a wholly owned subsidiary of K2, with current Fotoball management remaining in place. All key employees would receive retention bonuses as a condition of closing. Integration teams consisting of employees from both firms were set to move expeditiously according to a schedule established prior to closing the deal. The objective would be to implement the best practices of both firms. On January 26, 2004, K2 Inc. completed the purchase of Fotoball USA in an all-stock transaction. Immediately after, senior K2 managers communicated (on-site, where possible) with Fotoball customers, suppliers, and employees to allay any immediate concerns. Discussion Questions: -How did the K2 negotiating strategy seek to meet the primary needs of the Fotoball shareholders and employees?

The negotiation process consists of all of the following except for

Which of the following statements are true about due diligence?

Fees charged by investment bankers are never negotiable.