Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry
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Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry

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Mergers and acquisition is a regular term in business community. In this article we will try to cover the difference between mergers/acquisitions, types, general issues, advantages/disadvantages, and ...

Mergers and acquisition is a regular term in business community. In this article we will try to cover the difference between mergers/acquisitions, types, general issues, advantages/disadvantages, and some important concepts related. In addition, we will have a deeper look for mergers and acquisition from the technology companies perspectives, in addition to some historical background and finally few success and failure cases in the technology domain. Also different techniques and methods for the valuation of small and medium software companies is covered due to the special nature of such companies.

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Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry Document Transcript

  • Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry.A literature review by: Al-Motaz Bellah Al-Agamawi,Version One August 2010, Revised Version March 2012.Email: magamawi@gmail.com, Skype ID: magamawi, Linkedin Profile:http://www.linkedin.com/in/motazalagamawi, SlideShare Profile: http://www.slideshare.net/magamawiContentsIntroduction ................................................................................................................................................... 1What is Merger and Acquisition? ................................................................................................................. 2The Types of Merger and Acquisition. ......................................................................................................... 2Why Companies is seeking Merger and Acquisition? .................................................................................. 3General Companies Valuation Techniques ................................................................................................... 3Valuation Techniques for Technology Based SMEs .................................................................................... 5Merger and Acquisition Effect of Venture Capitals ..................................................................................... 6The History of Merger and Acquisition on National Level .......................................................................... 8Work Cited:................................................................................................................................................... 9Keywords: Merger, Acquisition, Vertical Integration, Horizontal Integration, Related Merger, Unrelated Merger, Types ofMergers, Types of Acquisitions, Motives for Mergers, Motives for Acquisitions, Valuation Techniques, Comparative Ratio,Discounted Cash Flow, DCF, Replacement Cost, Comparable Transactions, Net Asset Test, Earn outs, COCOMO Model, FirstMover Advantage, GAP Accounting, Blue Chip Accounts, Venture Capitals, High Technology Companies, SMEs, Small andMedium Enterprises, History of Merger and Acquisition, The great Merger Movement. INTRODUCTIONMergers and acquisition is a regular term in business community. In this article we will try tocover the difference between mergers/acquisitions, types, general issues,advantages/disadvantages, and some important concepts related. In addition, we will have adeeper look for mergers and acquisition from the technology companies perspectives, in additionto some historical background and finally few success and failure cases in the technologydomain.
  • WHAT IS MERGER AND ACQUISITION?Simply the main idea about both mergers and acquisitions is to increase the performance, oneplus one makes three. This equation is simply simplifying the target behind a merger or anacquisition between two companies. The idea behind is creating value for shareholders over andabove the sum of the two companies, two companies together are more valuable than twoseparate ones (investopedia2010). A merger is when integrating two companies together inwhich the two companies will share control and equity with each other. Acquisition is when acompany buys the other company and end up controlling it (Mer101). Usually mergers happensbetween two equal size companies who agrees to go forward as a single new company, this kindof mergers is called “merger of equals”. For example, both Daimler-Benz and Chrysler formed anew entity named DaimlerChrysler upon merger. Actual mergers of equals are not very often.Usually, one company will buy another and as part of the deal’s terms, allow the acquired firm toclaim that the action is a merger of equals, even if it is an acquisition, this is because equalmerger usually sound better than acquisition in the market (investopedia2010). THE TYPES OF MERGER AND ACQUISITION.From the business perspective, there are many types of business mergers, distinguished based onthe relation between the two companies going in the process. Based on the US Federal Tradeclassification mergers types includes: Horizontal mergers which involve companies closelyrelated from the product or service they produce, Vertical mergers which includes companiesthat had a potential or existing buyer-seller relation before merger, and Conglomerate orunrelated involve essentially companies that unrelated in terms of products-markets in whichthey are operating and the main target of this type of mergers is diversifying strategy. Literatureseems to suggest that both Horizontal and vertical mergers are more successful than unrelatedmergers. From a practical perspective, this seems logic, because both horizontal and verticalmergers are more suspect to benefit from the economy of scale and scope, strategic fit of thecompany in terms of relatedness of the product-markets in which they are operating(DUYSTERS, 2002).
  • WHY COMPANIES IS SEEKING MERGER AND ACQUISITION?Companies in different industries are seeking mergers and acquisitions for many reasons andmotives but in general, companies are looking forward to increase profits and rapid growth.Motives to increase financial performance includes: Economy of scale and scope, increase bothrevenue and market share, cross selling, synergy to increase managerial specialization orpurchasing economies, taxation when a profitable company buys a loss one to use the loss in itsbenefit, geographic diversification, business diversification, resources and knowhow transformvertical integration of products or technologies, absorption of similar business under the samemanagement, and competition elimination (wikipedia10). When it comes to High-tech industry,in addition to the above motives, companies are looking forward to: joint or complimentaryR&D programs, integrating both upstream and downstream partners, integration of users canhelp to identify market need for new technology and for large technology companies they arealways looking forward to acquire new innovative ideas to guarantee leadership in their markets(DUYSTERS, 2002). For SMs- small and medium size technology companies, acquisition canprovide strategic, operating and financial benefit. Also large companies carrying the acquisitionof small/medium companies benefits. Strategic acquisition can benefit SMs shareholders withearlier liquidity than IPO, with less risk and dilution. It also can provide SMs with immediateleverage of large companies established distribution and manufacturing infrastructure, withoutthe required time and risk of internal development. Large companies benefit from the ownershipof new products and technologies necessary to maintain its competitive advantage, growth rateand profitability (Mergers & Acquisitions: A Strategy for High Technology Companies, 2003). GENERAL COMPANIES VALUATION TECHNIQUESCompany valuation is always a very important part in closing either a merger or an acquisitiondeal, especially when it comes to high-tech companies and in particular when a small or amedium size company is involved in the process. There are many type and techniques forcompanies valuation, we will try to summarize the most standard and well none valuation types.First widely used technique is comparative ratio either price earning ration or enterprise-value-to-sales ratio. Price earning ration is simply apply a standard industry multiple for the earning ofthe target company, then company valuation will be equal its earning multiplied by a multiple. View slide
  • Looking at the Price/ Earnings for all the stocks within the same industry group will give theacquiring company good guidance for what the targets P/E multiple should be. Enterprise-value-to-sales ration is very close to Price earnings ratio, valuation will be equal to a multiple to therevenue.Second valuation technique is discounted cash flow DCF; discounted cash flow analysisdetermines a companys current value according to its estimated future cash flows. Forecastedfree cash flows (net income + depreciation/amortization - capital expenditures - change inworking capital) are discounted to a present value using the companys weighted average costs ofcapital.Third valuation technique is, Replacement Cost - In a few cases, acquisitions are based on thecost of replacing the target company. For simplicitys sake, suppose the value of a company issimply the sum of all its equipment and staffing costs. The acquiring company can literally orderthe target to sell at that price, or it will create a competitor for the same cost (investopedia2010).Comparable Transactions is another way of determining a company. Valuation is determined as acomparison of the amount paid in acquisitions for other companies in some industry. PurchasePrice Denomination is another way, when a large company pays cash for smaller company, largecompany will express the purchase price in dollars.In an acquisition where large company issues stock to pay for smaller company, large companymay express its offered purchase price in any of the following ways: as a dollar value of itsshares, fixed number of shares, or a percentage of combined entity.Net Asset Test is a technique in which, if either large company or smaller company believes thatthe balance sheet is likely to become significantly weaker or stronger between the date thedefinitive agreement is signed and the closing date, it may suggest that the purchase price beadjusted to reflect a change in the net assets.Earn outs is another technique. In an "earn out," some portion of small company’s purchase pricewill be paid by large company only if small company achieves negotiated performance goalsafter the closing. Parties typically use an earn out when they agree that a higher valuation would View slide
  • be justified if acquired company were to meet forecasted performance goals (Mergers &Acquisitions: A Strategy for High Technology Companies, 2003). VALUATION TECHNIQUES FOR TECHNOLOGY BASED SMESAlways there is a dilemma when it comes to merger or acquisition of a small or mediumsoftware company. One problem in selling a small technology company is that they do not haveany of the brand names, distribution, or standards leverage that the big companies possess.Therefore, on their own, they cannot create this profitability leverage. The acquiring company,however, does not want to compensate the small seller for the post acquisition results that aredirectly attributable to the buyers market presence. This is what we refer to as the valuation gap.To solve such valuation gap there are some techniques and methods but practically some of themare very hard to apply on the practical ground and other needs specialized professionals to apply.Those techniques includes:Cost for the buyer to write the code internally, this technique could be applied throughdeveloping a constructive cost model for projecting the programming costs for writing computercode, COCOMO model.Also first mover advantage from a competitor or, worse, customer defections, there is a real costof not having your product today, this could be by justifying the entire purchase price based onthe number of client defections the acquisition would prevent.Another technique is restating historical financials using the pricing power of the brand nameacquirer. The end-user customers perception of risk is usually greater with the small company.We can literally double the financial performance of small company on paper and present acompelling argument to the large company buyer that those economics would be immediatelyavailable to him post acquisition. It certainly not GAP Accounting, but it is as effective as a toolto drive transaction value.Another component is for any contracts that extend beyond one year. We take an estimate of thegross margin produced in the firm contract years beyond year one and assign a five X multiple tothat and discount it to present value.
  • In addition, another method is trying to assign a value for miscellaneous assets that the seller isproviding to the buyer. Do not overlook the strategic value of Blue Chip Accounts. Thoseaccounts become a platform for the buyers entire product suite being sold post acquisition intoan installed account. It is far easier to sell add-on applications and products into an existingaccount than it is to open up that new account. These strategic accounts can have huge value to abuyer.Finally, you can use a customer acquisition cost model to drive value in the eyes of a potentialbuyer by calculating the 100% sales person yearly quota salary, divide it by the typical numberof deals which could be closed per year, you will have the cost of new customer acquisition, thenmultiply it by the number of clients you have, by this you will know your company valuationbased on your customer base and this could be one of the methods used in valuation andnegotiation (Kauppi, 2008). MERGER AND ACQUISITION EFFECT OF VENTURE CAPITALSFinally, we would like to confer with the effect of merger and acquisition on venture capitals inthe high-tech markets. The uncertain nature of technological innovation and a potentialmisunderstanding of the complexities of high tech operations can lead to much speculation aboutthe true worth of high tech firms. This valuation uncertainty is expected to heighten theinformation sensitivity of investors in high tech industries. Investors in industry-related firms arehighly sensitive to merger announcements involving high-tech targets and that the industryresponses are even stronger in takeovers with high information impact factors (KOHERS, 2004).Growth is important because companies create shareholder value through profitable growth. Yetthere is powerful evidence that once a company’s core business has matured, the pursuit of newplatforms for growth entails daunting risk. Roughly, one company in ten is able to sustain thekind of growth that translates into an above-average increase in shareholder returns over morethan a few years. Too often, the very attempt to grow causes the entire corporation to crash. Evenexpanding firms face a variant of the growth imperative.No matter how fast the growth treadmill is going, it is not fast enough. The reason: Investorshave an annoying tendency to discount into the present value of a company’s stock pricewhatever rate of growth they foresee the company achieving. Thus, even if a company’s core
  • business is growing vigorously, the only way its managers can deliver a rate of return toshareholders in the future that exceeds the risk-adjusted market average is to grow faster thanshareholders expect. Changes in stock prices are driven not by simply the direction of growth,but largely by unexpected changes in the rate of change in a company’s earnings and cash flows.A company must deliver the rate of growth that the market is projecting just to keep its stockprice from falling. It must exceed the consensus forecast rate of growth in order to boost its shareprice. This is a heavy, omnipresent burden on every executive who is sensitive to enhancingshareholder value. In most cases companies fall in a trap by following this behavior and strategywithout considering the other parameters related to merger and acquisition.A relative case is AT&T. In the space of a little over ten years, AT&T had wasted about $50billion and destroyed even more in shareholder value, all in the hope of creating shareholdervalue through growth. The first AT&T attempt arose from a widely shared view that computersystems and telephone networks were going to converge. In 1991, AT&T acquires NCR, at thetime the world’s fifth-largest computer maker, for $7.4 billion. AT&T lost another $2 billiontrying to make the acquisition work. AT&T finally abandoned this growth vision in 1996, sellingNCR for $3.4 billion. In 1994, the company bought McCaw Cellular, at the time the largestnational wireless carrier in the United States, for $11.6 billion, eventually spending $15 billion intotal on its own wireless business. When Wall Street analysts subsequently complained that theywere unable to properly value the combined higher-growth wireless business within the lower-growth wireline company, AT&T decided to create a separately traded stock for the wirelessbusiness in 2000. This valued the business at $10.6 billion, about two-thirds of the investmentAT&T had made in the venture. In 1998, it embarked upon a strategy to enter and reinvent thelocal telephony business with broadband technology. Acquiring TCI and MediaOne for acombined price of $112 billion made AT&T Broadband the largest cable operator in the UnitedStates. Then, more quickly than anyone could have foreseen, the difficulties in implementationand integration proved insurmountable. In 2000, AT&T agreed to sell its cable assets to Comcastfor $72 billion.We could cite many cases of companies’ similar attempts to create new-growth platforms afterthe core business had matured. They follow an all-too-similar pattern. When the core businessapproaches maturity and investors demand new growth, executives develop seemingly sensible
  • strategies to generate it (Raynor, 2003). Merger and acquisition has many benefits but the mostimportant is wise evaluation for the decision and the clear strategy and motive behind suchattempt. Going through the process just and only for the sake of growth cause failure in manycases, other parameters as increasing competency, fostering innovation capabilities, capitalizingon market share and increasing efficiency and decreasing costs must be included among other toincrease the success probability of mergers and acquisitions. THE HISTORY OF MERGER AND ACQUISITION ON NATIONAL LEVELOn the national level, there are more than one case for a wave of merger and acquisitions mainlyin the USA and UK.At the turn of the twenties century the United States have witnessed the largest manufacturingmergers and acquisition in its economy, this mergers named as “The Great Merger Movement inAmerican Business”. Between 1895 and 1904 over 1800 firm disappeared into horizontalcombination, many of which acquired a substantial share of the markets in which they operated.There are many opinions related to main motives and reasons behind such merger movement, butwe can summarize the widely agreed upon reasons as follows:the development of capital-intensive mass-production manufacturing technique in the late 19thcentury, the very rapid growth experienced by many capital-intensive industries after 1887 andthe deep depression which dominated the mid 1890s. One of the opinions argues that themovement was not a result from the rise of large-scale manufacturing but it was an attempt byentrepreneurs to escape severe price competition. This argument stress on the importance ofmarket control motive in favor of the drive of efficiency motive, it suggest that in the period ofrapid growth, new firms with extensive capital investments, high fixed charges, and noestablished pattern of marketing, suffered from considerable price warfare and formedconsolidations. Once established, this consolidations, whatever their level of efficiency, wereable to control the competitive environment in the short run. Nevertheless, in the long run mostof these giant enterprises encounter higher costs and could not retain their dominance unless theycreated barriers to entry through such means as controlling the supply of raw materials ormassive spending on advertisements (Ulen, 1987).
  • On the other hand, the emergence of large firm in Great Britain started in 1870 to 1914. In 1905,following and largely the result of the first great merger movement in the United States, anumber of very large enterprises with capitalizations exceeding £2 million had come into beingin UK. Yet this increase does not appear to have been on a scale comparable with thatexperienced in the United States. The biggest of these possessed assets far in excess of thelargest British concerns, appear to have achieved a far greater share of their respective markets,and covered a far broader range of manufacturing and mining activity than did the biggest Britishenterprises (Payne, December 1967).One of the very important technological merger and acquisition is the British computer industry.In 1968, with the blessing of the British, Industrial Reorganization Corporation, English electricComputers Ldt., Plessey Computer division and International Computers and Tabulators joinedtogether to form the only existing British computer company of any size, InternationalComputers Ldt., known as ICL. There had been also considerable earlier merger activities in theindustry, involving Elliott Automation, Leo Computer Ltd., Ferranti, and General Electric in justthe post of 1960 period. The main justification for 1968 merger was on the ground oftechnological progressiveness. It was felt that only as a merger industry could British computermanufacturing compete with its US rivals on a technological level. In addition, the existence ofincreasing returns to scale in computer manufacturing which coupled with IBM’s world marketshare of approximately 70% makes the chance of any small company using price-cutting as asuccessful competitive weapon very remote. One can argue that if the British computer industrywas to make inroads into the US position of supremacy the it must be based on the technologysuperiority. To evaluate this case, studies shows that the number of British computer patients wasalmost equal to IBM within the period after the acquisition, British computer industry marketshare have increased but we do not have an accurate figure to measure it against US marketshare, but finally we can confirm that the British computer industry has at least been able to holdits own against the US companies (Stoneman, 1978).WORK CITED:  DUYSTERS, JOHN HAGEDOORN & GEERT. 2002. The Effect of Mergers and Aquisitions on the Technology Performance of Companies in a High-tech enviroment. s.l. : Technology Analysis & Strategic Management, Vol. 14, No. 1, Carfax Publishing, 2002.
  •  Kauppi, Dave. 2008. Sell A Software Company - The Valuation Dilema. articlesbase. [Online] June 16, 2008. [Cited: August 5, 2010.] http://www.articlesbase.com/advertising-articles/sell-a-software-company- the-valuation-dilema-450743.html. KOHERS, N. KOHERS and T. 2004. Information sensitivity of high tech industries: evidence from merger announcements. Applied Financial Economics. 2004. MERGERS & ACQUISITIONS AND TECHNOLOGICAL PERFORMANCE. VALENTINI, GIOVANNI. 2005. s.l. : Academy of Management, 2005. Mergers & Acquisitions: A Strategy for High Technology Companies. Daunt, Jacqueline A. 2003. s.l. : Fenwick & West LLP, 2003. Mergers and acquisitions. businesslink.gov.uk. [Online] [Cited: August 5, 2010.] http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1074407579#. Mergers and acquisitions. [Online] [Cited: August 5, 2010.] http://en.wikipedia.org/wiki/Mergers_and_acquisitions. Muthukumar, R. 2006. Case Studies on Mergers, Acquisitions and Alliances – Vol. II. s.l. : The Institute of Chartered Financial Analysts of India, 2006. Payne, P. L. December 1967. The Emergence of Large-scale Company in Great Britain, 1870-1914. s.l. : Blackwell Publishing Limitted, December 1967. Raynor, Clayton M. Christensen and Michael E. 2003. The Innovators Solution: Creating and Sustaining Successful Growth. s.l. : Harvard Business School Publishing, 2003. 1578518520. Stoneman, P. 1978. Merger and Technological Progressiveness: the case of British computer industry. s.l. : Applied Economics, 1978. Trust (monopoly). [Online] [Cited: August 5, 2010.] http://en.wikipedia.org/wiki/Trust_(19th_century). Tutorials, Mergers and Acquisitions. investopedia. [Online] investopedia.[Cited: Augusy 5, 2010.] http://www.investopedia.com/university/mergers/mergers1.asp. Ulen, Thomas S. 1987. The great merger movement in American business, 1895-1904 . s.l. : Journal of Economic Literature, 1987.