Corporate Restructuring

Lecture 2

Strategic Approaches to M&A

Rationale behind each M&A deal differs. More often than not strategic considerations outweigh the financial considerations.

Unfortunate but true. Recall the Synergy Trap. Also remember that entrepreneurs are by nature driven by an adventurous spirit.

Market Entry Strategy & M&A

Choice of entry mode depends on many factors:

Regulatory framework.

Licensing regime.

Indian Insurance and Telecom sectors.

Anti-monopoly laws. Other statutory issues New entrants face the risk of pre-emptive action by incumbents.

Degree of competition in host market.

Market Entry Strategy & M&A

Choice of entry mode depends on many factors:

Higher risk in green-field projects.

To be off-set against problems associated with integration issues.

Advantages of fast entry. Resource availability.

R&D and Technical know-how. Marketing skills etc.

Market Entry Strategy & M&A

Type of acquisition depends on strategic choice made by acquirer:

Market penetration:

Target selling same product. Target serves as channel for acquirers existing products. Target is in business of complementary products.

Market extension:

Product extension:

Diversification

Value Creation Strategy & M&A

In M&A value is created in following ways:

Donor-recipient mode:

Transfer of resources and capabilities from acquirer improves performance of acquired firm. In the past, I've observed that may acquisition-hungry managers were apparently mesmerized by their childhood reading of the story about frog-kissing princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations. Initially, disappointing results only deepen their desire to round up new toads.

Value Creation Strategy & M&A

In M&A value is created in following ways:

Donor-recipient mode:

Ultimately, even the most optimistic manager must face reality. Standing knee deep in unresponsive toads, he then announces an enormous "restructuring" charge. In this corporate equivalent of a Head Start program, the CEO receives the education, but the stockholders pay the tuition... In my early days as a manager I, too, dated a few toads. They were cheap dates - I've never been much of a sport but my results matched those of acquirers who courted higher-priced toads. I kissed and they croaked. Warren Buffett in 1992

Value Creation Strategy & M&A

In M&A value is created in following ways:

Participative mode:

Two way exchange of resources and capabilities.

Collusive mode:

Augmentation of strategic assets. Formation of Cartels also falls in this category.

Growth Strategy & M&A

Companies can grow:

Organically, or Inorganically: thru M&A.

In case of New Projects:

NPV = Discounted Free Cash Flows from the project reduced by Initial Investment. NPV = Discounted Free Cash Flows from the acquisition reduced by Investment required for Acquisition.

In case of Acquisitions:

Growth Strategy & M&A

New Project Route Young markets Less expensive Slow cash flow generation Integration issues not there Environmental considerations more Lesser valuation problems Investment more in tangible assets M&A Route Usually in mature markets Often more expensive Fast cash flow generation Variety of integration issues Lesser problems on this aspect Complex valuation issues Investment in both tangible & intangible assets

Corporate Objectives & M&A

M&A decisions are a result of a complex interplay of firms corporate objectives and styles:

Firms have different secondary corporate objectives:

High quality product/service provider Technology leadership Lowest cost producer

Risk averse: characterized by low leverage.

Firms also differ in their management styles:

Corporate vs. Business Strategy

Corporate Strategy Broader scope: Which industries we should be in? Responsibility of top management Decisions include: Investment in diversification, vertical integration, acquisitions, and new ventures; the allocation of resources between the different businesses of the firm; and divestments. Business Strategy Focuses on narrower markets: How should we compete? Responsibility of SBU Heads

Warren Buffetts Acquisition Strategy

Great track record in acquisitions; So whats his strategy? Answer: There is no strategy

No corporate planning department actively looking for acquisitions

To a Man with a Hammer, everything looks like a nail.

We have no view of the future that dictates what

business or industries we will enter. Indeed, we think it's usually poison for a corporate giant's shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own and the personal characteristics of managers with whom we wish to associate - and then hope we get lucky in finding the two in combination.

Warren Buffetts Acquisition Strategy

Even so, we do have a few advantages, perhaps the greatest being that we don't have a strategic plan. Thus we feel no need to proceed in an ordained direction (a course leading almost invariably to silly purchase prices) but can instead simply decide what makes sense for our owners. In doing that, we always mentally compare any move we are contemplating with dozens of other opportunities open to us, including the purchase of small pieces of the best businesses in the world via the stock market. Our practice of making this comparison of acquisitions against passive investments is a discipline that managers focused simply on expansion seldom use. Instead, he focuses on a few simple principles.

Warren Buffetts Acquisition Strategy

Focuses only on businesses he understands and about which he can make accurate predictions. Does not have any corporate planning department

Gets interested in the stock market when he gets better value there. Never looks at projections of investment bankers of the sellers.

Does not engage in bidding contests.

Don't ask the barber whether you need a haircut.

Only friendly transactions Does not overpay

The smarter side to take in a bidding war is often the losing side.