Chapter 19

Cross-Border Mergers, Acquisitions, and Valuation

Cross-Border Mergers, Acquisitions, and Valuation

Although there are many pieces to the puzzle of building shareholder value, ultimately it comes down to growth. An increasingly popular route to going global in search of new markets, resources, productive advantages, and other elements of competition and profit is through cross-border mergers and acquisitions.

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Cross-Border Mergers, Acquisitions, and Valuation

Cross-border mergers, acquisitions, and strategic alliances all face similar challenges: they must value the target enterprise on the basis of its projected performance in its market. An enterprises potential value is a combination of the intended strategic plan and the expected operational effectiveness to be implemented post-acquisition.

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Cross-Border Mergers and Acquisitions

The number and dollar value of cross-border mergers and acquisitions (M&A) have grown rapidly in recent years, but the growth and magnitude of activity are taking place in the developed countries, not developing countries. The following exhibit illustrates that the growth in M&A within developed countries has been torrid in recent years (particularly within the EU and US).

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Exhibit 19.1 Cross-Border Mergers & Acquisitions: Developed Countries (billions of US dollars)
European Union United States Japan Other

600 500 400 300 200 100 0 1995 1996 1997 1998 1999 2000
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Source: United Nations Center for Trade and Development (UNCTAD).

Cross-Border Mergers and Acquisitions

The next slide, presents evidence of cross-border M&A activity among the developing countries. While the growth and magnitude looks impressive, it is clear that the total M&A activity in developing countries was only a fraction (at 8%) of the total.

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Exhibit 19.2 Cross-Border Mergers & Acquisitions: Developing Countries (billions of US dollars)
Africa Asia Latin America West Asia Eastern Europe

70 60 50 40 30 20 10 0 1995 1996 1997 1998 1999 2000

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Source: United Nations Center for Trade and Development (UNCTAD).

Cross-Border Mergers and Acquisitions

Among the developing regions of the world, cross-border M&A activity has been focused nearly exclusively on Latin America and Asia.

West Asia, Eastern Europe and Africa have largely been bypassed in the international rush to acquire.

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Cross-Border Mergers and Acquisitions

The true motivation for cross-border mergers and acquisitions is a traditional one: to build shareholder value. The following exhibit justifies this global expansion as a result of the following:
Publicly traded MNEs live and die, in the eyes of the shareholders, by their share price If the MNEs share price is a combination of the earnings of the firm and the markets opinion of those earnings and the price-to-earnings multiple, management must strive to grow both
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Cross-Border Mergers and Acquisitions

Managements problem is that it does not directly influence the markets opinion of its earnings Although managements responsibility is to increase the P/E ratio, this is a difficult, indirect, and long-term process of communication and promise fulfillment However, management does control EPS and often must look outward to build value The global marketplace can offer greater growth potential or bang for the buck when compared to struggling within a domestic market for market share and profits
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Exhibit 19.3 Building Shareholder Value Means Building Earnings

The Goal: Increase the share price of the firm

Price

EPS

P E

Increasing the share price means increasing earnings.

Management, directly controls through its efforts the earnings per share of the firm.

Management only indirectly influences the markets opinion of the companys earnings as reflected in the P/E.

So building value means growing the firm to grow earnings. The largest growth potential is global.

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Cross-Border Mergers and Acquisitions

In addition to the desire to grow, MNEs are motivated to undertake cross-border mergers and acquisitions by a number of other factors. The United Nations Conference on Trade and Development (UNCTAD), has summarized the M&A drivers in the following exhibit.

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Exhibit 19.4 Driving Forces Behind Cross Border M&A

Cross - border M & A activity Changes in the Global Environment
Technology Regulatory frameworks Capital market changes

New business opportunities and risks

Firms Undertake M&As to:

Access strategic proprietary assets Gain market power & dominance Achieve synergies Become larger Diversify & spread risks Exploit financial opportunities

Strategic responses by firms to defend and enhance their competitive positions in a changing environment.

time
Source: UNCTAD, World Development Report 2000: Cross-border Mergers and Acquisitions and Development, figure V.1., p. 154.
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Cross-Border Mergers and Acquisitions

The drivers of M&A activity are both macro in scope (the global competitive environment) and micro in scope (the variety of industry and firm-level forces and actions driving individual firm value). The primary forces of change in the global competitive environment technological change, regulatory change, and capital markets change create new business opportunities for MNEs.
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Cross-Border Mergers and Acquisitions

As shown in exhibit 19.4, MNEs undertake crossborder M&A for a variety of reasons. The drivers are strategic responses by MNEs to defend and enhance their global competitiveness by:
Gaining access to strategic proprietary assets Gaining market power and dominance Achieving synergies in local/global operations across different industries Becoming larger, and then reaping the benefits of size in competition and negotiation Diversifying and spreading their risks wider Exploiting financial opportunities they may possess
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Cross-Border Mergers and Acquisitions

As opposed to a greenfield investment, a cross-border acquisition has a number of significant advantages. First, it is quicker (shortening the time required to gain a presence and facilitate competitive entry into the market). Second, acquisition may be a cost-effective way of gaining competitive advantages such as technology, brand names, and/or logistic/distribution capabilities while eliminating a local competitor. Third, specific to cross-border acquisitions, international economic, political, and foreign exchange conditions may result in market imperfections, allowing target firms to be undervalued.

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Cross-Border Mergers and Acquisitions

Cross-border acquisitions are not, however, without their pitfalls. There are still problems with paying too much or suffering excessive financing costs. Melding corporate cultures can also be traumatic. In addition, management of the post-acquisition process is extremely difficult to do successfully. Internationally, additional difficulties arise from host governments intervening in pricing, financing, employment guarantees, market segmentation, and general nationalism and favoritism.
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The Cross-Border Acquisition Strategy

The process of acquiring an enterprise anywhere in the world has three common elements:
Identification and valuation of the target Completion of the ownership change transaction (the tender) Management of the post-acquisition transition

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Exhibit 19.5 The Cross-Border Acquisition Process

Stage I Strategy & Management
Identification & valuation of the target

Stage II
Completion of the ownership change transaction (the tender)

Stage III
Management of the post-acquisition transition; integration of business and culture

Financial Analysis & Strategy

Valuation & negotiation

Financial settlement & compensation

Rationalization of operations; integration of financial goals; achieving synergies

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The Cross-Border Acquisition Strategy

Stage I Involves the identification task for firms that have promising market opportunities and may be amenable to suitors in addition to valuation using traditional (DCF) and multiples (earnings and cash flows) analysis.

Stage II Requires gaining the approval of the target company (target company management support), regulatory approval and the appropriate compensation settlement for target shareholders.
Stage III This critical process requires the realization of the motivations for the transaction itself and can be extremely difficult for a variety of reasons.
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Corporate Governance and Shareholder Rights

One of the most controversial issues in shareholder rights is at what point in the accumulation of shares is the bidder required to make all shareholders a tender offer. While every country possesses a different set of rules and regulations for the transfer of control, the market for corporate control has been the subject of enormous debate in recent years. There are many elements involved in the regulation of cross-border takeovers.
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Cross-Border Valuation
Illustrative case: The potential acquisition of Tsingtao brewery Company, Ltd., China
In January 2001, Anheuser Busch (AB) was considering acquiring a larger minority interest in Tsingtao Brewery Company Ltd., China AB had originally acquired a 5% equity interest in 1993 when Tsingtao had first been partly privatized Since AB had already identified the target (Phase I), it would only need to value the targets shares (Phase II) and to assess its prospects for post acquisition influence on Tsingtaos operations
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Cross-Border Valuation
In 1999, negotiations had broken down between AB and Tsingtao because Tsingtao would not offer AB a voice in its operations. However, by 2001, Tsingtao needed an equity infusion to grow its business. Key questions for AB were:
The valuation of Tsingtao shares in an illiquid Chinese market The percentage of Tsingtaos total equity to be purchased The terms of the transaction The prospects for AB to contribute management skills to Tsingtao The degree of future compatibility between the two corporate cultures The potential for future rationalization of operations

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Cross-Border Valuation
As a fundamental metric in the determination of value, free cash flow (FCF) is a critical input in the valuation of any enterprise.
FCF = NOPAT + D&A in NWC CAPEX

Where:
NOPAT = net operating profit after tax D&A = depreciation and amortization NWC = net working capital CAPEX = capital expenditures

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Cross-Border Valuation
Analyzing Tsingtaos FCF for 2000 shows a healthy operating cash flow (OCF) but a negative FCF due to enormous capital expenditures. For valuation purposes, this (and previous years) detailed financial data is utilized in forecasting expected future free cash flows (in this example in local currency).

These free cash flows are valued using a risk-adjusted discount rate; in this methodology the Tsingtao (local currency) WACC is used.
In addition, the terminal value of the firm, beyond the FCF projection period, is also added to the value of the FCF to determine the entity value. Equity value is determined by subtracting the PV of debt capital.
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Cross-Border Valuation
In addition to the DCF exercise, a multiples analysis is performed by analyzing (in this case):
Price/Earnings Ratio (P/E) - an indication of what the market is willing to pay for a currency unit of earnings Market/Book Ratio (M/B) - provides some measure of the markets assessment of the employed capital per share versus what the capital cost Other multiples including (in this case) price/sales or entity/enterprise value to EBTIDA (business earnings)
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