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  1. 1. Diversification & SynergyThis is only a summary. Please read the text book and additional readings fordetails. Removal of errors and omissions, if any, in this ppt are your responsibility. 1
  2. 2. AgendaSynergyDiversification 2
  3. 3. SynergyIn M&A – it is value creation for the shareholders that theywould not have been able to garner on their ownFor valuation of synergies, usual DCF works, often needadvanced option valuation techniquesTheory offers no suggestions on the discount rate to be usedJudgment, intuition and experienceNeed significant analysis to ‘justify’ approachAnalysis is company, industry and economic-condition specific 3
  4. 4. NumericalFirm A announced a merger proposal with Firm T.Both have an overall cost of capital of 10%. CurrentlyFirm A generates an after-tax cash flow of 0.5 billionper year and firm T generates an after-tax cash flow of0.3 billion per year. If the two firms merge it isexpected that they will generate after tax cash flow of1billion per year. • Should they merge? • What is the gain from the takeover (merger)? • What is the value of firm T to firm A? 4
  5. 5. NumericalThe acquiring firm A has two options when acquiring the target firm T.Below are some details of the two firms. Firm A Firm T Price per share $30 $20 # O/S shares 1.7 billion 1.1 billion MV of equity $51 billion $ 22 billionFirm A expects to generate cost savings and other synergiesequating to additional annual net profit after tax of $6 billion in theforeseeable future. Both firms have an overall cost of capital of10.5% and are in the same marginal tax bracket. • What is the gain to the acquirer firm A, and price per share of the merged entity when the target, firm T will accept cash of $25 billion for the merger? • What is the gain to the acquirer firm A, and price per share of the merged entity when the target, firm T will accept shares worth $25 billion for the merger? • What is the gain to the acquirer firm A, and price per share of the merged entity when the target, firm T will accept 0.6 shares of firm A for 1 share of firm T? 5
  6. 6. DiversificationDiversification• A collection of businesses under one corporate umbrella (referred to as conglomerates)• A firm is diversified when it is in two or more lines of business• It is through coherent overarching strategy and actions that the corporation will create shareholder value in the long term and be sustainable as a multi-business entity 6
  7. 7. DiversificationPeter Drucker : a company should be diversified inproducts, markets and end-uses and highlyconcentrated in its basic knowledge area orIt should be diversified in its knowledge area andhighly concentrated in product, markets, end-usesThis is by no means exact but a directional approachor indicator to understanding related and unrelateddiversification (and core or non-core activities of thefirm) – very tenuous 7
  8. 8. DiversificationMicrosoft – tracing its history is it related or unrelateddiversification?Network 18 – related or unrelated diversification?GEGoogleWiproJain IrrigationJindals 8
  9. 9. DiversificationAdjacenciesWhen a firm moves out of core into adjacent space  Expand along the value chain (mfg and retail)  Grow new products and services (IBM moved into global services which now accounts for just over 50% of its pre tax profits)  Use new distribution channel (Dell, Landmark)  New markets (Indian IT companies, Tesco from UK to US)  New Customer segment (CAF from prime to sub-prime)  New space(AA sets up Sabre which led to Travelocity)  Hybrid approaches (Nike customer experience) 9
  10. 10. DiversificationDevelop new core• One example - Barrick the largest gold mining firm• ITC 10
  11. 11. DiversificationBerkshire Hathaway (BH)• One of the successful conglomerates with over 60 subsidiary operating business• Has grown by acq of firms in insurance, bricks, furniture, jewelry…• Business model is simple: surplus cash from low growth business is invested in high growth business, key acq or stock market investment• Market perception is that the success of BH is due to its equity investment portfolio – the portfolio only contributes 20% of the market value of BH 11
  12. 12. DiversificationBerkshire Hathaway (BH)Firm groupings as per 2008 annual report• Insurance group (GEICO, General Re…)• Finance and financial products group (various)• Marmon (130 mfg and service business)• McLane Co (wholesale distn of grocery and non-food items)• MidAmerican (regulated el. and gas, power gen and distn US and overseas)• Shaw Industries (carpet and flooring)• Mfg (Brown shoe Co, FTL, ACME building…)• Service (Bufallo news, Business wire…)• Retailing (Helzberg Diamonds, Nebraska furniture…) 12
  13. 13. DiversificationBerkshire Hathaway (BH)Business model• Insurance group generated a lot of float which helped the business• Ensure that businesses generate free cash especially on the aggregate• Owner orientation – own diversified business, o/w own parts of businesses, price of a business is a major factor (seek undervalued firms), choose managers astutely (not much interference in day-today tactics) 13
  14. 14. DiversificationBerkshire Hathaway (BH)Business model• Prefer negotiated transactions• Yet, will buy shares of interested firms in the stock market when the price is right• Since the 1990s investment has been in several 100% owned businesses• Conglomerate strategy anchored by the core business: insurance• Very effectively and efficiently managed – low corporate headcount 14