M&A Roadmap W578 Final Project Key elements, potential problems, safeguards and remedies for a successful successful transaction.
KELLEY SCHOOL OF BUSINESS, INDIANA UNIVERSITY May 3, 2011 Authored by: JP Vega
Introduction ² An Overview of the M&A Process
Figure 1: The M&A Process
The process of mergers and acquisitions (M&As) is complex and integrated by nature. Figure 1 captures the fundamental configuration of M&As in stages that describe a natural flow of the transaction, processes that should take place during every stage, and background factors that ²albeit not directly manageable ² exert a major influence in the transaction.Eight business areas are involved during each stage, and they represent required inputs from the corresponding departments in the acquirer·s company to achieve a prosperous outcome. The arrowed semi-circle that surrounds the stages represents the iterative and interrelated nature of the M&A process. A stage should never be considered ¶closed·; the people involved in the transaction must maintain a highlevel view of its purpose and not get lost in the details from each stage. Additionally, Additionally , there is a certain overlap between the stages (e.g., successful integration begins during due diligence, and might even be achieved by terms in the structure of the deal).
Background factors As mentioned before, the background factors affect the outcome in different ways. The interest of the acquirer·s and seller·s owners is value creation, which in turn is the main driver of the deal; consequently, the value that managers expect to extract from the deal must be properly justified to the owners to obtain their buy-in. The economy plays the role of determining key financing conditions and may influence valuations in times where M&As are, in fashion terms, ¶in· or ¶out·. A special effort should be placed to maintain customer satisfaction in both corporate entities, to ensure that they will remain loyal, and to help them understand why the transaction will also provide value for them. Competitors· reactions reaction s to the announcement and execution of the deal should be anticipated; it is a fatal mistake to assume that the competitive landscape is static and that competitors will simply observe the event and carry on with their operations as they did before. Finally, the government plays a supervising supervising role that seeks to preserve healthy competitive environments and transparent financial reporting through various agencies; unless their conditions are met, the deal will not be approved.
Processes An effective communications policy is primordial to a deal·s realization; it should outline who needs to know what, at both ends (acquirer/seller), (acquirer/selle r), and at all times. Communication flow between the the stakeholders is essential. Financial analysis dictates if the transaction is within budget, and provides a forecast of the target·s growth and expected economic contribution contributio n to the acquirer. As more details details are unveiled across the stages, these forecasts will become more accurate. Failure mode and effects analysis (FMEA) (FMEA) is a procedure from operations management whose goal is to identify potential failure modes based on past experience (in this context, previous M&As) and classify them by severity and likelihood1. This concept also suggests that companies get better at M&As as they gain more experience. Negotiation begins the moment the acquirer contacts the potential target for the first time to show their interest; it peaks during the structure and due diligence stages, when the deal·s terms are tailored and then adjusted to reflect risks that were discovered discover ed in the process. Coordination mechanisms should ensure that every member of the acquisition team has a clear grasp on what is expected from the deal and how it fits with the overall corporate strategy. Once established, these mechanisms mechanisms provide data for planning purposes. These plans must be constantly updated to reflect the latest findings in each stage of the M&A process. 1From
Failure mode and effects analysis (Wikipedia)
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Phase I ² Strategy The objective of the merger merger or acquisition determines the challenges faced by the acquirer. Table 1 illustrates the strategies that dominate contemporary deals and presents recommendations to face the challenges that arise from each of them2. Table 1: M&A Strategies and Challenges
The
Overcapacity M&A Example
Strategic Objectives
Major Concerns
Chemical Bank buys Manufacturers Hanover and Chase; DaimlerBenz acquires Chrysler. The acquirer (within an industry with excess capacity) will eliminate capacity, gain market share, and become more efficient. You can·t run a merged company until you·ve rationalized it, so rationalize quickly. Don·t assume your resources are better than the acquired companies· resources. If the acquired company is as large as the acquiring one and its processes and values differ greatly, expect trouble. These tend to be onetime events, so they·re especially hard to pull off.
y
The
Geographic The Product or Roll-up M&A Market Extension M&A
R&D
The
Industry Convergence M&A
Quaker Oats buys Snapple.
Cisco acquires 62 companies.
Viacom buys Paramount and Blockbuster; AT&T buys NCR, McCaw, and TCI.
A successful successful company expands geographically; operating units remain local.
Acquisitions extend a company·s product line or its international coverage.
Acquisitions are used in lieu of inhouse R&D to build a market position quickly.
A company bets on a new emerging industry and tries to establish a position by culling resources from existing industries whose boundaries are eroding. Give the acquired company a wide berth. Integration should be driven by specific opportunities to create value, not by a perceived need to create a symmetrical organization. As a top manager, be prepared to make the call about what to integrate, and what to leave alone; also, be ready to change that decision.
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M&A as
Banc One buys scores of local banks in the 1980s.
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The
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Members of the acquired group may welcome your streamlined processes. If they don·t, you can afford to ease them in slowly. It·s more important to hold on to key employees ² and customers ² than to realize efficiencies quickly. If a strong culture is in place, introduce new values with extreme care. Use carrots, not sticks. These are win-win scenarios, and they often go smoothly.
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Know what you·re buying: the farther you get from home, the harder it is to be sure. Understand how the target achieved the success that led you to buy it. Expect cultural and governmental differences to interfere with integration. The bigger you are relative to your target company, the better your chances for success. The more practice you have, the better your chances for success.
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Build industrialstrength evaluation processes so that you buy first-class businesses. This category allows no time for slow assimilation, so cultural due diligence is a must. Put first-rate, well-connected executives in charge of integration. Make it a highvisibility assignment. Above all else, hold on to the talent if you can.
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From Not All M&As Are Alike ² and That Matters (article)
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Best practices The list below encapsulates practices that tend to increase the rate of success in M&As, as well as indicators of potential problematic areas3. Figure 2: M&A strategy - best practices and potential problems
Best Practices
What Can Go Wrong?
Remember that the ultimate goal of M&A is to provide value to shareholders through profitable growth. The M&A process should begin with the identification of gaps in the company·s resources or capabilities by applying the tools for profitable growth: Strategy ² Porter·s Five Forces, Forces, Porter·s Value Chain Analysis, Analysis, SWOT SWOT analysis, Balanced Scorecard, etc« Marketing Marketing ² 4 Ps Framework Framework (Product, Price, Place, Promotion) Promotion) Supply Chain Chain ² cost, quality, quality, delivery, delivery, resource optimization Finance Finance ² sources sources of cash cash Human Resources evaluation Scan the marketplace marketplac e constantly. Look at all potential deals in your market, not not just the deal at hand. Define line-of-sight measures that track the value you expect to gain from the acquisition. Use measures consistently for both deal evaluation and long-term performance measurement. measurement. Lack of a clearly articulate ar ticulated d vision of what makes a target attractive leads to inaccurate inaccura te valuations. Make sure you know what you·re buying before you start looking for targets. Don·t cast strategy aside in the face of an exciting opportunity. If the transaction is related to an industry or market that is new to you (and your your company), delusive cash-flow projections are common. To avoid this pitfall, commission outside help from consultants and/or investment bankers, and look beyond the financial statements of each potential target. Enforce managerial discipline by aligning incentives to the success of each deal (as opposed to simply simply its execution). execution). This will stop managers from pursuing deals to improve their personal reputation.
From Mergers and Acquisitions: From A to Z (chapter (chapter 3), The Fine Art of Friendly Acquisition (article), Secrets of the M&A Masters: Revealing the paths to a successful deal (article), and class discussions.
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Phase II ² Structure Although there are countless ways to structure a deal, Figure 3Error! Reference source not found. lists what might e considered as the core five structural alternatives of M&As 4. Other non-traditio non-traditional nal structures include spin-offs, consolidations/rollups, leveraged buyouts (LBOs), and employee stock ownership plans (ESOPs). The 10 key issues that affect the structure of each deal are:
Figure 3: M &A Structural Alternatives
1. How will tangible and intangible assets be transferred to the purchaser from the seller? 2. At what price will they be transferred, and according to what terms? 3. What issues discovered during due diligence may affect the price, terms, or structure of the deal? 4. What liabilities will be assumed by the purchaser? How will risks be allocated among the parties? 5. What are the tax implications for the buyer and the seller? 6. What are the long-term objectives of the buyer? 7. What role will the seller have in the management and growth of the underlying business after closing? 8. To what extent will third-party consents or government filings or approvals be necessary? 9. What arrangements will be made for the key management team of the seller (who may not necessarily be among the selling owners of the company)? 10. Does the buyer currently have access to all of the consideration to be paid to the seller, or will some of these funds need to be raised from debt or equity markets?
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From Mergers and Acquisitions: From A to Z (chapter 7)
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Valuation
overview
Table 2 presents a summary of the three predominant valuation approaches and under which scenarios they can be most useful5. Problem type Operations (assets-inplace)
Recommended valuation method Adjusted present value
Opportunities (real options)
Simple option pricing
Equity claims
Equity cash flow
Summary
Other considerations
Apply basic discounted cash flow relationship to each of the business· various kinds of cash flows and add up their present values. v alues. Cash, time value, and risk all still matter ² each enters the analysis in two ways: as an option, and as an underlying asset.
Powerful, versatile, easy to learn. Shows value of each ¶piece· of the target. Easily adapted from WACC.
Estimate the company·s share of expected future cash flows, adjusted for fixed financial claims, and discount them at an opportunity cost that compensates the company for the risk it is bearing.
Hard to discern what is a project characteristic and what is an option characteristic Most useful as a supplement, not a replacement, for the valuation methodology already in use. Hard to learn. Doesn·t fit naturally into most companies· existing capital-budgeting systems. Leverage is difficult to measure properly when it is high and changing (it works more like a call option). More specialized than APV. Requires more support or, at a minimum, more inputs from corporate financial and capitalbudgeting systems.
Table 2: Valuation methodologie methodologies s
Figure 4: Financing sources
Financing The key factors in financing an acquisition are the size and complexity of the transaction, the buyer·s cash position, the market for the buyer·s securities, the terms of the purchase price, and the macro financial-market conditions. Figure 4 offers a summary of the sources that an acquirer can utilize to meet the financial terms of the deal. 6
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From W hat·s hat·s It W orth? orth? A General Manager·s Guide to Valuation (article) Mergers and Acquisitions: From A to Z (Chapter 9)
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Phase III ² Due Diligence The due diligence work is commonly divided between two teams that must remain in constant communication: the financial and strategic team (managed by the buyer·s management team with assistance from its accountants), and the legal team (buyer·s counsel with assistance from technical experts). The best way to ensure that no stone remains unturned is through effective preparation and planning, which is usually achieved with a comprehensive checklist7. The framework in Figure 5can be used as a guide to the due diligence process 8: Figure 5: Due diligence framework
Com Compati patibi bili lity ty audit dit
Fina inancial ial audit dit
Production audit
Macro-environment audit
Management audit
Legal/environment audit
Information systems audit
Marketing audit
Reconciliation Reconciliation audit
Key considerations and common mistakes Table 3 lists the main factors that should be kept in mind during the due diligence process, as well as some of the most common pitfalls that ultimately lead to unsuccessful transactions 9. Table 3: Due diligence reminders
Key consideration considerations s
Common mistakes
1. It is common for sellers to become defensive, evasive, and impatient during DD. 2. Keep a foot on the brake. Recognize at all times that there may be a need to terminate negotiation if the risks or potential liabilities in the deal exceed what is anticipated and there is no effective way to insure against them. 3. The best way to ensure that no stone remains unturned is through effective preparation and planning, typically achieved with a comprehensive checklist. 4. Dedicate time to determine whether there is a cultural fit. Don·t underestimate the importance of finding and retaining strong management teams. 5. Supplement qualitative research on the management team with quantitative research on market trends from independent market surveys. 6. Work with operational managers to confirm the ¶deliverability· of synergy assumptions and provide the reassurance that the identified benefits are robust. 7. Begin planning the integration of both companies at this stage.
1. Mismatch between the (complexity of) documents provided by the seller and the (lack of) skills of the buyer·s review team. 2. Poor communication and misunderstandings. 3. Lack of planning and focus in the preparation of the DD questionnaires and in the interviews with the seller·s team. 4. Inadequate time devoted to tax and financial matters. 5. Lack of reasonable accommodations and support for the buyer·s DD team. 6. Ignoring ´the real storyµ behind the numbers.
7From
Mergers and Acquisitions: From A to Z (chapter 5) Due Diligence, a Strategic and Financial Approach 9From Mergers and Acquisitions: From A to Z (chapter 5), Secrets of the M&A Masters: Revealing the paths to a successful deal(article), Unlocking Shareholder Value: The Keys To Success (article) 8From
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Regulatory factors reference Every merger or acquisition is circumscribed in a regulatory environment. The next sections refer to the relevant legislations and entities that exert influence within this environment. 10
Environmental laws In general, environmental laws require notification to government authorities in the event of chemical releases and other emergencies. Some of these laws are: the Clean Water Act; the Toxic Substances Control Act (TSCA), the Resource Conservation and Recovery Act (RCRA); the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA, or ´Superfundµ); and the Emergency Planning and Community Right-to-Know Act (EPCRA), along with other state laws. These legislations present the problem of allocating allocating liability for potential environmental problems. Both seller and buyer will usually seek environmental audits to uncover these risks, and buyers tend to request coverage with representations and warranties. The
Securities and Exchange Commission (SEC) SEC regulations apply to any publicly-held company that intends to acquire a ¶significant· target ² which is defined as a company whose assets or pretax income is greater than 10% of the acquirer·s.In these cases, the SEC requires notifications in the acquirer·s 10-Q and 10-K reports, registration statements (if the acquirer wants to issue new securities for the target·s shareholders), proxy information (if the transaction must be approved by the acquirer·s or the target·s shareholders), and tender offers (i.e., offers directly to shareholders rather than negotiating through management). Federal Antitrust Laws In essence, these laws prohibit acquisitions acquisition s that may may substantially lessen competition in any given industry. For vertical acquisitions ² which are rarely a problem ², the issue in question is whether the deal will result in the creation of unacceptable barriers to entry by forcing entrants to enter at both supplier and purchaser levels. In the more troublesome horizontal acquisitions, there is an ample variety of factors to be considered, such as market shares, market concentration (as measured by the Herfindahl-Hirschman Index), resulting barriers of entry, changing market conditions, and product characteristics that affect the possibility of price collusion. The entities in charge of deciding if a transaction can proceed are the Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ). The Hart-Scott-Rodino Antitrust Improvements Act requires advance notification of the deal and submission of information about business operations to both of these entities if the qualifying criteria is met (the size of the transaction exceeds $212M, or is between $53M and $212 and one of the parties has annual net sales or assets exceeding $106M). There is a filing fee that ranges from $45,000 to $280,000 depending on the size of the transaction.
Sarbanes-Oxley (SOX) Act This U.S. federal law appeared as a result of the major corporate and accounting scandals of the early 2000s, and sets new or enhanced standards for all U.S. public company boards, management and public accounting firms (1). Even though SOX doesn·t explicitly mention M&As, it has lead acquirers to enhance their due diligence processes to ensure that the target company successfully complies with the new transparency standards. Failure to do so might result in embarrassing and costly surprises, personal liability for executive officers, and/or damage to the acquirer·s market reputation11.
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From Mergers and Acquisitions: From A to Z (chapter 6) Sarbanes Oxley: Impact on Corporate M&A(presentation)
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Phase IV ² Integration Integration planning should begin at the strategy phase of the transaction, and continue to be refined as the deal evolves. Most integration plans address the business areas shown inTable 4 12. Table 4: Elements of an integration plan
Management team Cultural Alignment Manufacturing Processes Post-closing Post-clo sing Registrations Environmental Rectification Consolidation/Redundancies Consolidati on/Redundancies Compensation and Benefits Corporate Policies Tax Filings The
Organization/Responsibiliti Organization/ Responsibilities es Information Systems Customer Retention Technology Technolog y Transfer Process Restructuring Plan Legal Issues Supply Chain/Vendors Distribution Distrib ution Channels Marketing PLans
Corporate Identification Identificati on Product Definition Services Standardization Standardizati on Sale of Surplus Assets Performance Measurements Accounting Practices Communication Plan Training Plans
integration team
Integration Integrati on must be treated as as a parallel project, rather than a phase, in the company·s existence. Ideally, by following this approach, the integration will be less disruptive to the firm·s day-to-day operations. Accordingly, the bulk of the work involved in executing the integration plan should not rest on the newly formed leadership team. Instead, a team of preferably experienced individuals from both firms ² including someone who is a ¶champion of the merger· ² should be appointed to handle the integration efforts prior to closing the deal, in order to allow for proper planning. In cases where there is a lack of knowledge in post-merger post-merg er integration, outside consultants can 13 provide advice and guidance.
What needs to be integrated? An exhaustive revision of potential integration synergies should be made in every area of the target·s business in order to highlight the parts that, through integration, will provide the most value to shareholders ² ideally, in the short term. Consequently, a merger does not imply full integration; each deal has a different ¶ideal· degree of integration. integrati on. Table 5exemplifies some of the available choices in this aspect 14. Table 5: Integration extent for deal r ationales
Buyouts / Private Equity Active Investing Low y y
Corporations Scope
Scale
Functional Overlap
Minimal integration Fix or improve existing culture
High Functional Overlap y y
Selective integration Keep different cultures; harmonize where integrating
y y
Comprehensive integration Adopt dominant culture or combine to gain best of both
Selecting the management team The selection of the management team depends on the strategy behind the acquisition, and the extent to which it is necessary to integrate both companies 15, as illustrated in Figure 6. In most cases, it is vital to maintain at least part of the existing leadership team in the newly formed entity ² after all, these managers were responsible for making the company an attractive acquisition target in the first place, and they have a profound understanding about their business model that it would take others a long time to develop. 12
From class discussions
13From Note On Postmerger Integration (article) 14 From W here here Do You Really Need to Integrate? 15From
(article) Unlocking Shareholder Value: The Keys To Success (article)
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Several measures can be taken to ensure that the leadership team stays on board, but the key is demonstrating long-term commitment to its people. This can be achieved by: y y
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Proposing salary and wage adjustments Establishing an incentive bonus plan tied to realistic, attainable goals Providing employee contracts to key members of the management team Reviewing the seller·s benefit plans and assuring employees that the transfer will be orderly and fair Explaining any potential structural changes with care and clarity 16
Figure 6: Integration level versus management team
Portfolio Business Replace the management team
Full Integration Retain and incorporate existing managers
An interesting trend is observed in recent Asian acquisitions 17, where the acquirers usually build the leadership team of the acquired company from its incumbent management along with select local hires, and they refrain from placing their own staff into key roles. This practice is believed to build trust within the acquired employees by showing them that their way of doing business will continue to be respected.
Cultural integration Culture issues should take a place of privilege in the integration list of priorities. Each cultural conflict that is dismissed as non-relevant can potentially affect employee motivation, which will inevitably translate into a decrease in productivity, and ultimately, profits. In addition, cultural differences that get pushed back to a later stage of integration will reinforce certain practices that eventually will have to be dealt with, which will make it more difficult for the acquirer to steer the company in the right path. To achieve effectiveness in cultural integration, the tactics depicted in Figure 7can be implemented 18.
Figure 7: Cultural integration's hard tactics
Decision making
People selection
Designate clearly who makes decisions, and how
Make the tough "people decisions" quickly and cascade this priority downward through the organization
Compensation system/incentives
Promotion / career development / performance-evaluation
Reflect the new vision Reward employees for meeting new performance goals
HR should redesign its systems so that they support and reflect the new culture
Key performance indicators Adjust metrics to the company's new vision and strategy as quickly as possible
Internal and external external communication Continuously and consistently reinforce key messages on vision, strategy, strategy, and culture cu lture
16From
Mergers and Acquisitions: From A to Z (chapter 3) lighter touch for p postmerger ostmerger integration integration (article) 18 From W here here Do You Really Need To Integrate? (article) 17From A
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Works Cited 1. Sarbanes-Oxley Act.
ikipedia. W ikipedia.
[Online] [Cited: 04 27, 2011.] http://en.wikipedia.org/wiki/Sarbanes-oxley.
2. Not All M&As Are Alike--and That Matters. Bower, Joseph L. s.l. : Harvard Business Review, 2001. #R0103F. 3. The Fine Art of Friendly Acquisition. Watkins, Robert J. Aiello and Michael D. s.l. : Harvard Business Review, 2000. # R00602. 4. Sherman, Andrew J. Mergers and Acquisitions from A to Z, Third Edition. s.l. : AMACOM, 2011. ISBN 978-0-81441383-8. 5. O'Sullivan, Kate. Secrets of the M&A Masters: Revealing the paths to a successful deal. CFO Magazine. 2005. 6. W hat's hat's it W orth? orth? A General Manager's Guide to Valuation. Luerhmann, Timothy A. s.l. : Harvard Business Review, 1997. # 97305. 7. Gillman, Luis. Due Diligence, a Strategic and Financial Approach (2nd ed.). 2010. ISBN 9780409046991. 8. Zietsman, Megan. Sarbanes Oxley: Impact on Corporate M&A. Bureau van Dijk. [Online] 2004. [Cited: 04 28, 2011.] http://www.bvdep.com/expertforum/Deloitte-Sarbanes-Oxley.pdf. 9. Failure mode and effects analysis. W ikipedia. ikipedia. [Online] [Cited: 05 01, 2011.] http://en.wikipedia.org/wiki/Failure_mode_and_effects_analysis. 10. Kelly, John, Cook, Colin and Spitzer, Don. Unlocking Shareholder Value: The Keys To Success. 1999. 11. Note On Postmerger Integration. Patel, Lipi and Bourgeois, L.J. s.l. : Darden Business Publishing, 2009. # UV 1024. 12. W here here Do You Really Need to Integrate?: Mastering the Merger. Harding, David and Rovit, Sam. s.l. : HBR- HBS Press Chapter, 2004. Prod. # 2371BC. 13. A lighter touch for postmerger integration. Cogman, David and Tan, Jacqueline. s.l. : McKinsey Quarterly, 2010.
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