Chapter 4 Merger and Acquisition Strategy Development – Global Mergers and Acquisitions, Volume I

CHAPTER 4

Merger and Acquisition Strategy Development

Enterprises operate in evolving, complex environments, and to survive they must change their strategic plans. Strategies provide frameworks for firms on how to cope with and adjust operations to survive and prosper in the changing environment. Strategies are important determinants of the future of enterprises and are used in the formulation of visions, objectives, policies, and cultures of organizations.

Development of strategies requires planning processes, which should include all members of the organization, even though the chief executive or chief executive group in charge of strategy development must be responsible and accountable for the outcome of the strategic planning.

Developing strategies requires knowledge of the terminologies used in the literature of strategy development. We define these terms next.

1. Strategy: A strategy determines the goals of an organization. Furthermore, strategies define the visions, plans, policies, and cultures of an organization over the long run. Strategies must be reformulated over time.

2. Vision: A vision explains why the organization exists and where it wants to go.

3. Goals: Goals are broad, long-term results the organization wishes to achieve. For example, a goal of strategy in cross-border acquisition might be the firm’s desire to acquire capabilities and resources to gain sustainable, competitive advantage.

4. Objectives: Objectives are short-term, specific steps the organization needs to implement to achieve the goals.

5. Competitive Advantage: Competitive advantage implies that a firm can make value growth (sales or profit) above the average firm in its product or service market. Competitive advantage can occur in cost structure, product offerings, distribution network, and customer services. For example, Southwest Airlines uses its airplane fleet 11.5 hours per day compared with an average of 8.6 hours by other airlines in the United States.

6. Corporate or Organizational Culture: Many definitions for culture, in general, and corporate culture, in particular, exist. However, a common definition of the term refers to a set of shared assumptions, beliefs, and understanding among the members of an organization, or in a broader societal sense, among members of a community. An economic definition of organizational culture provided by Arrow (1974) is very concise. Arrow defined culture as a collection of “codes” developed by organizations in their coordination activities.

Building on Arrow’s definition, which is based on the notion of economic coordination as a set of “pleasing activities,” Cremer (1993) defines culture as “the part of the stock of knowledge that is shared by a substantial portion of the employees of the firm, but not by the general population from which they are drawn” (Cremer 1993, 354).

The monolithic view in defining culture, which is implicit in the definitions above, should not lead to the belief that corporations or societies have a single culture. In industrial settings, many firms have several subcultures according to occupational, functional, product, or geographic lines that influence the behaviors of the employees (Nahavandi and Malekzadeh 1988).

Cultures evolve endogenously through collective experiences of the members of the community, either organizational or national, over a long time. The shared experiences (the process of socialization and passing on the traditions) increase common understanding among the members of the community and in organizations, either private or public, and are helpful in the coordination activities of the firm.

Choosing Strategic Objectives

It is a widely held view that M&A activities of a firm should be based on the company’s overall strategic plans. Companies can select from some strategic objectives through M&A including:

Growth

The growth strategy is achieved by increasing revenue, increasing profit, or by reducing the cost of production (achieving economies of scale).

Employing workers with the necessary skills

Employing skilled and talented employees to remain competitive is another objective of M&A.

Collection of a set of businesses that complement each other

Such a group of complementary companies aims to maximize existing or evolving capabilities and reduce risk.

Defensive action

To pre-empt potential takeover by acquiring companies or resolving the existing business problems.

Take advantage of opportunities

To capitalize on unique opportunities that have emerged.

Globalization

To expand market share abroad, acquire new technologies, and gain marketing capabilities elsewhere.

Additionally, many M&As are opportunistic decisions based on the circumstances and needs of the acquiring and target companies. For example, in the cross-border acquisition deal between French car company Renault and Japanese automobile firm Nissan in 1999, Renault’s motivations were long-term, and Nissan’s were short-term. The market, technological, and financial conditions for Renault were sound. Renault’s focus was to have a global partner. However, Nissan faced high debt, was unable to generate profit, and had experienced a decade-long decline in market share (Emerson 2001). In short, one can find myriad reasons for M&A among companies.

How to Develop an M&A Strategy

To choose an M&A strategy, a planner should consider the following factors:

Make versus buy consideration

Which option is most beneficial: producing the good or service internally or outsourcing?

Regulatory challenges

Would regulatory authorities block the proposed acquisition or merger?

Competitive environment

What is the structure of industry of the target firm? Is it relatively competitive or do rival firms with a great deal of market power exist in the industry?

Availability of capital

How to finance the proposed M&A? Is raising capital to fund the acquisition a challenging proposition?

Barriers to entry

What are the barriers to entry? Do legal barriers such as patents or regulatory requirements, or marketing barriers such as massive advertising expenditure in the target company’s industry exist?

Cultural obstacles

Understanding the cultural distances, both at the firm and in cross-border M&A cases, in broader societal levels is of paramount importance. However, even though many business executives believe cultural fit is essential for successful, that is, value-enhancing mergers and acquisitions, an overwhelming majority of them believe that culture is difficult to define (Engert et al. 2010). Given the importance of cultural fit for a successful M&A, the cultural distances must be critically reviewed in the development of the strategy for M&A. See Chapter 13 for further discussions of the role of cultural distance in successful M&As.

Corporate Development Office, M&A Strategy Development, and Target Acquisitions

Many acquiring companies rely on their corporate development office (CDO) for most, if not all M&A and restructuring activities. The corporate development teams are involved in the planning and execution of strategies to achieve organizational goals. The actions of corporate development planners include recruitment of a new management team, entry or exit from specific markets, identification and selection of targets for acquisition or merger, formation of strategic alliances, securing financing, spin-offs of assets or divisions, and increasing intellectual property rights of the organization.

According to a 2011 survey of more than 200 executives from major global companies, 87 percent of CDOs led and 52 percent performed investing activities (Ernst & Young 2011). The lion’s share of these activities involves different phases of M&A, which included acquisitions and forming alliances, planning and structuring transactions to maximize stakeholder returns, focusing on due diligence to mitigate risk and drive value, valuing assets, and cost- and tax-efficient deal structuring. When CDO team members were questioned about deal satisfaction, about one-third of the respondents indicated that they were not satisfied with the efficiency of due diligence processes. The survey also found that the key areas in which the CDOs seek outside help are financial, legal, tax due diligence, and tax structuring (Ernst & Young 2011).

Given the complexity and extensiveness of due diligence, many acquiring firms are inclined to relegate at least part of the due diligence activities to outside advisers such as law firms, accounting firms, investment banks, and consulting firms. Studies have shown that the choice of external advisers varies according to the national cultures of the executives of the acquiring firms (Angwin 2001). For example, the French rely on top corporate executives to contact commercial banks in searching for targets, while the businesses in the United Kingdom rely heavily on commercial banks and accounting firms to identify targets. The Germans put heavy emphasis on their staff, and in the Nordic countries, businesses use a variety of approaches in finding target firms. Moreover, business executives from different European countries, who were interviewed about identifying those aspects of outside due diligence that contribute the most in value-enhancing M&A deals, had attributed different values to the due diligence areas. However, all of them ranked due diligence, ensuring that the target firm has no substantial unwarranted liabilities, the highest.

Lead Advisers in M&As

The Ernst & Young’s survey results point to the challenges corporate executives (lead advisers) face in developing and implementing the M&A strategies. The results also imply that M&As are complicated undertakings that require expertise in a variety of subjects such as law, accounting, finance, and economics. Accordingly, a team of professionals, who are experts in these matters, must be organized to lead in the earlier M&A processes such as strategy development, target screening, transaction implementation, and postmerger integration. The main tasks of the team should be to prioritize among the opportunities and challenges, to harmonize strategic and financial objectives with corporate missions, and to manage the M&A process. Specifically, principal advisers are responsible for implementing the following responsibilities:

Developing the appropriate M&A strategy

Leading the implementation of the strategy

Closing the deal within a reasonable timeframe

Helping in appointment of other supporting advisers and experts as needs arise

Involving staff of information technology and human resource departments in the early stage of M&A activities for smooth postmerger functional, departmental, and cultural integration

Table 4.1 shows the roles and responsibilities of lead advisers in M&A processes.

Table 4.1 The roles and responsibilities of lead advisers in M&A processes

Type of adviser

Roles and responsibilities

Legal

Draft legal documents such as letter of intent, sales and purchase agreement, share subscription agreement, shareholder agreement, and other documents

Review all legal documents

Assist in implementing all legal procedures including convening shareholders’ meeting if the target firm is a listed company

Conduct legal due diligence on the target company

Assist in obtaining government approvals for acquisition of the target firm

Accounting

Analyze earnings and assets of the target firm

Analyze the exposure of the target firm to debt, liabilities, and contingencies

Review contracts and agreements, which might have financial implications on the potential transactions

Evaluate target company’s forecasts

Assess the impact of the acquisition on acquiring company’s financial statement by close examination of cost of acquisition, purchase price allocation, pro forma valuation of intangibles, goodwill, accretion or dilution of earnings per share

Assist in determining purchase price for inclusion in the sales and purchase agreement

Determine the tax implications of the deal

Determine the transaction costs

Recommend tax-saving deal structures and financing alternatives

Analyze the impact of postacquisition and suggest efficient integration or restricting steps

Value assessor

Assess the value of tangible assets such as property, machinery, and real estate

Source: Deloitte (2011).

As stated in Table 4.1, the lead M&A adviser is responsible for advising in three critical areas in any M&A. These areas include legal, accounting, and valuing the target firm. In subsequent chapters, we will discuss many of the tasks listed in Table 4.1.

Challenges

M&As also involve difficulties that must be resolved by the lead advisers. These problems include:

Inability to find appropriate acquisition targets

Finding a suitable target for acquisition is often a challenging task. Accordingly, many firms in search of a business to acquire rely on a finder or broker to find an appropriate target firm. A finder does not represent either party to a transaction, while a broker acts as a legal fiduciary that represents one side of the deal, generally the seller. The broker is legally bound to protect the interest of the party it represents. The recommendations for target firms by finders or brokers may not be suitable for the acquiring company. Moreover, recommendation of a proper target does not necessarily imply further negotiation will take place due to the following factors:

Inaccessibility of the selected targets due to the lack of interest on the part of the target firms to be acquired.

Inaccessibility of the target because of the target’s perception that the acquisition is an attempt at hostile takeover.

The acquiring company can make no reasonable offer to purchase the target company because of insufficiency of information about the target firm.

Inordinate price request for the target firm by the management of the target company.

Summary

After defining specific terminologies used in corporate M&A strategy development, the chapter discussed objectives that are considered in the implementation of M&A strategy. Moreover, it discussed the factors that arise in M&A strategic planning and examined the critical role a corporate development team plays in M&A activities. Finally, we reviewed the role and challenges of lead advisers in M&A.