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Mergers & Acquisitions Can Result from Strategic Alliances
Alliances frequently result in mergers and/or acquisitions. Partnering relationships, such as joint ventures or strategic alliances, can sometimes lead to a merger or acquisition situation. After companies work together for a period of time and get to know one another’s strengths, weaknesses, and synergistic possibilities, new relationship opportunities become apparent. One could argue that a joint venture or strategic alliance is simply the getting to know each other part of a courtship between companies and that the real marriage does not occur until the relationship has been consummated by a merger or acquisition.
To make the point, Dan McQueen, president, at Fluid Components International (FCI) built a Partnering relationship with Vortab, a small technology company. Vortab produced static mixers, a technology suitable for flow conditioning that complemented FCI’s product offering. While Vortab also had three other distribution partners in addition to FCI, FCI’s volume with Vortab continued to grow to the point that Vortab’s technology became an important part of FCI’s total sales volume. After about three years into the relationship, FCI acquired Vortab.
Because of the close relationship between Vortab and FCI, when the Vortab was put up for sale McQueen knew its true value. Resulting from his knowledge, FCI was able to purchase Vortab at a much more realistic price than Vortab’s asking price. The Vortab technology integrated well with FCI’s core competency technology and today FCI also distributes Vortab through some of its non-direct competitors.
The following list demonstrates some of the specific values created or developed from the various organizational blending methods:
· Operational resource sharing
· Functional skill transfer
· Management skill transfer
· Leverage (economies of scale)
· Capability increases
Mergers occur when two or more organizations come together to blend or link their strengths. Also in the deal is a blending of their weaknesses. The hopeful result is a new more powerful organization that can better produce goods and services, access markets, and deliver the highest quality customer service. Mergers offer promise for synergistic possibilities. This is achieved by the blending of cultures and retaining the core strengths of each. In this scenario, a new and different organization generally emerges. The goal is a sharing of power, but usually the strongest rise to the top leadership.
Exxon – Mobil
The Federal Trade Commission gave Exxon and Mobil the green light On November 30, 1999 for their $80 billion merger. The next day the transaction was completed. The merged organization officially became Exxon Mobil Corp. The merger actually brings “the companies back to their roots when they were part of John Rockefeller’s Standard Oil empire. That company was the largest oil firm in the world before it was busted up by the government in 1911.”
At the 1998 announcement of their intention to merge, Mobil chairman, Lucio Noto made a comment about the need to merge. He said, “Today’s announcement combination does not mean rhat we could not survive on our own. This is not a combination based on desperation, it’s one based on opportunity. But we need to face some facts. The world has changed. The easy things are behind us. The easy oil, the easy cost savings, they’re done. Both organizations have pursued internal efficiencies to the extent that they could.”
While part of the deal was the selling of a Northern California refinery and almost 2,500 gas station locations, the divestiture represents only a fraction of their combined $138 billion in assets. Lee Raymond, Exxon chairman, now chairman and chief executive of the merged company said, “The merger will allow Exxon Mobil to compete more effectively with recently combined multinational oil companies and the large state-owned oil companies that are rapidly expanding outside their home areas.”
Exxon Mobil is now like a small oil-rich nation. They have almost 21 billion barrels of oil and gas reserves on hand, enough to satisfy the world’s entire energy needs for more than a year. Yet, there is still the opportunity to cut costs. The companies expect their merger’s economies of scale to cut about $2.8 billion in costs in the near term. They also plan to cut about 9,000 jobs out of the 123,000 worldwide.
AOL – Time Warner
On January 10, 2000, Steve Case, chairman and chief executive of America Online (AOL), sent an e-letter to his 20 million members. He said, “Less than two weeks ago, people all over the world came together in a global celebration of the new century, and the new millennium. As I said in my first Community Update of the 21st Century, all of us at AOL are extremely excited by the challenges and prospects of this new era, a time we think of as the Internet Century.
I believe we have only just begun to see clearly how the interactive medium will transform our economy, our society, and our lives. And we are determined to lead the way at AOL, as we have for 15 years–by bringing more people into the world of interactive services, and making the online experience an even more valuable part of our members’ lives.
That is why I am so pleased to tell you about an exciting major development at AOL. Today, America Online and Time Warner agreed to join forces, creating the world’s first media and communications company for the Internet Century. The new company, to be created by the end of this year, will be called AOL Time Warner, and we believe that it will quite literally change the landscape of media and communications in the new millennium.”
The next day newspaper headlines read, “America Online, Time Warner Propose $163-Billion Merger.” The Los Angeles Times said, “In an audacious deal bringing together traditional entertainment and the new world of the Internet, America Online and Time Warner Inc. on Monday announced they will merge in the largest business transaction in history.”
The story later revealed the value comparisons of the companies. While AOL earns less than Time Warner, the stock market thinks AOL’s shares are worth more. “America Online is valued by the stock market at nearly twice Time Warner–$173 billion, compared with $101 billion as of Friday’s [1/7/00] market close–even though it has one-third Time Warner’s annual revenues.” The article also stated “AOL earned $762 million on $4.8 billion in sales in the year ended Sept. 30 .”
AOL chairman, Case wants to move fast. The Times article stated, “Case said the two chairman began discussing a combination this fall , he has tried to impress upon Levin [Gerald Levin, chairman at Time Warner] the need to operate the new company at Internet speeds.” (We all know the rest of the story…nothing is forever.)
The prophets of gloom are always ready to point out the down side to deals. In UPSIDE magazine, Loren Fox reported some of the challenges to the marriage. They are:
· “The holy grail of strategic synergy has been elusive in the media world.”
· “In the offline world, it’s notable that Time and Warner Brothers have continued to run fairly independently despite a decade as Time Warner.”
· “‘From any standpoint, this has not been a success to date,’ says Yahoo President and COO Jeff Mallett.”
· “When you buy the company, you get things you don’t need.”
· “Warner might make these deals easier, but it might also bring new risks–even for AOL, a veteran of 25 acquisitions over the last six years. Employees might flee to pure dot-com companies, ego clashes could stymie plans or financial gains may never cover the large premium paid for Time Warner.”
· “You don’t need to own everything to do what AOL and Time Warner are doing.”
Merger mania can make strange bedfellows, let alone promises unfulfilled. Alliances can lead to mergers. Warner-Lambert is an example of all the above. This is corporate soap opera at its best.
· June 16, 1999, Warner-Lambert Company announced that it has signed a letter of intent with Pfizer Inc. to continue and expand its highly successful co-promotion of the cholesterol-lowering agent Lipitor (atorvastatin calcium). The companies, which began co-promoting Lipitor in 1997, will continue their collaboration for a total of ten years. Further, with a goal of expanding their product collaborations, the companies plan to explore potential Lipitor line extensions and product combinations and other areas of mutual interest.
· November 4, 1999, newspapers across America report on “one of the biggest mergers of any kind, ever.” The Wall Street Journal said, “Now, American Home is set to merge with Warner-Lambert Co. in a stock deal that is valued at about $72 billion. It stands as the biggest deal in drug-industry history and one of on the biggest mergers of any kind, ever.” Also reported, “Warner-Lambert held talks with Pfizer Inc. at the same time it was negotiating with American Home.”
· November 4, 1999, The New York Times runs a story titled, “Can a Strong-Willed Chief Share Power in a Merger?” The article lead with, “The planned merger between American Home Products and Warner-Lambert once again raises the question of whether John R. Stafford, American Home’s famously strong-willed chairman and chief executive, is capable of sharing and, perhaps more important, letting go of power.”
· January 13, 2000, Warner-Lambert Company indicated that, as a result of changing events, it is exploring strategic alternatives, including meeting with Pfizer, following Pfizer’s recent approach. In that regard, Warner-Lambert said that its Board of Directors has authorized management to enter into discussions with Pfizer to explore a potential business combination. The Company stated that, in light of changing circumstances, its Board had concluded that there is a reasonable likelihood that Pfizer’s previously announced conditional proposal could lead to a transaction, reasonably capable of being completed, that is better financially for Warner-Lambert shareholders than the proposed merger with American Home Products.
Lodewijk J.R. de Vink, chairman, president and chief executive officer of Warner-Lambert, stated, “It has always been the Board’s objective to secure the best possible transaction for Warner-Lambert shareholders and we will now pursue discussions with Pfizer to determine if a combination with them to achieve that goal is possible.” The Company emphasized that there can be no assurance that any agreement on a transaction with Pfizer, or that any other transaction, will eventuate.
· January 24, 2000, in response to inquiries, Warner-Lambert Company said that it would continue to explore strategic alternatives, including discussions with Pfizer. The Company’s unwavering goal is to provide the greatest value to Warner-Lambert shareholders. Warner-Lambert officials emphasized that there can be no assurance that any transaction will be completed and offered no further comment.
Was American Home Products the bride left at the altar? The Wall Street Journal didn’t think so, in fact they called American Home the Runaway Bride in their November article. Additionally they listed several companies that American Home has them selves left at the altar.
· Early November 1997, American Home Products and SmithKline Beecham begin merger talks.
· January 30, 1999, Talks break off.
· June 1, 1998, American Home and Monsanto announce agreement to merge.
· October 13, 1998, American Home and Monsanto cancel plans to merge.
· November 3, 1999, American Home and Warner-Lambert Co. in talks to merge.
An acquisition is basically the function of one company consuming and digesting another. The result is that the acquiring company shores up core weaknesses or adds a new capability without giving up control, as might occur in a merger. Added capabilities, rather than synergy is usually the reasoning behind acquisitions. In this situation, the acquiring company’s culture prevails. Frequently one company will acquire another for their intellectual property, their employees or to increase market share. There are numerous strategies and reasons why one company acquires another, as you will soon discover.
Guardian Protection Services has been acquiring alarm companies within its northeast region of operation to supplement its internal growth. Russ Cersosimo, president says, “This is just another way for us to satisfy our appetite for growth. Our desire is to expand our opportunities in the other offices. That is another reason why it is attractive for us to look to acquire companies, to get their commercial base and commercial sales force that is in place in those offices. We wanted to make sure that we can digest the new accounts without putting strain on our paper flow and the systems we have in place.”
Who does R&D acquisitions well? Electronics Business recently answered, “Cisco Systems Inc., San Jose, the networking equipment company, which boasts many success stories among its 40 acquisitions of the past six years.” None of their acquisitions were in mature markets, rather all were leading edge, allowing Cisco to broaden its product offering. Cisco hedges its acquisition bets through volume. Ammar Hanafi, director of the business development group at Cisco says it counts on two out of three acquisitions succeeding and the remaining third doing just okay. Acquiring people, intellectual properties and specialized skills is important to companies like Cisco. They think that even if the acquired technology does not pan out, they have the engineers. Generally, any fast growing company like Cisco cannot hire people fast enough and the acquired personnel are a boon to the company’s progress. Retention of acquired employees is at the heart of their acquisition strategy. “If we’re going to lose the people who are important to the success of the target company, we’re probably not going to have an interest,” says Cisco controller Dennis Powell.
“Cisco doesn’t do big acquisitions, the cultural issues are too huge,” Hanafi says. Cisco buys early stage companies with little or no revenues. While they often have paid extremely high prices for the acquisition, they seem to do better than most with their selection. Between 1993 and 1996, Cisco bought cutting edge LAN switching technologies for a total of $666 million in stock. More than half was spent on Grand Junction Networks Inc., which developed fast Ethernet switchers. At the time of purchase, it is estimated that Grand Junction’s annual revenues were $30 million. “Today, the four LAN switching acquisitions account for $5 billion of Cisco’s $12 billion in annual revenues.” “We acquire companies because we believe they will be successful. If we didn’t believe in their success, we would not acquire them,” says Powell.
Little known West Coast Texas Pacific Group (TPG) has been acquiring at a feverish pace. Their semiconductor and telecom buying spree includes, GT Com in 1995, AT&T Paradyne (from Lucent Technologies Inc.) in 1996, Zilog Inc. in 1997, Landis & Gyr Communications SA in 1998, ON Semiconductor (from Motorola Inc.), Zhone Technologies Inc., MVX.COM and Advanced TelCom Group Inc. in 1999.
TPG banks heavily on intellectual capital. Many believe that by being part of TPG, their single biggest advantage is access to broad pool of talented and well-connected people. CEOs can take advantage of TPG’s contacts in other industries around the world. “TPG has this ability to build a virtual advisory board…that they don’t even have to pay for,” says Armando Geday, president and CEO of GlobeSpan Inc.
Lucent Technologies, Inc. has also been rampaging through the same market as Cisco. Lucent’s 1999 (January to August) acquisitions as listed in CFO magazine include:
· Kenan Systems for $1 billion
· Ascend Communications for $24 billion
· Sybarus for $37 million
· Enable Semiconductor for $50 million
· Mosaix for $145 million
· Zetax Tecnologia, $ N/A
· Batik Equipamentos, $ N/A
· Nexabit Networks for $900 million
· CCOM, Edisin, $ N/A
· SpecTran for $99 million
· International Network Services for $3.7 billion.
An advantage that Lucent has over its competitors is access to its 25,000-employee Bell Labs idea factory. As such, they are more likely to purchase technology rather than R&D. Still, Lucent continually reviews the comparative advantages of technology and R&D in relationship to its own projects in reviewing acquisition possibilities. Lucent executive vice president and CFO Donald Peterson says, “In every space in which we have acquired, we have had simultaneous research projects inside. It makes us knowledgeable, and lets us have a build-versus-buy option.”
Lucent wants their units as a hole to do well and if acquisition helps that cause, they acquire. Peterson also says, “We view acquisition as a tool among many that our business units can use to advance their business plans. We evaluate acquisitions one by one, in the context of the business strategy of the unit.”
Tyco International Ltd. is a diversified global manufacturer and supplier of industrial products and systems with leadership positions in each of its four business segments: Disposable and Specialty Products, Fire and Security Services, Flow Control, and Electrical and Electronic Components. Through its corporate strategies of high-value production, decentralized operations, growth through synergistic and strategic acquisitions, and expansion through product/market globalization, Tyco has evolved. From Tyco’s beginnings in 1960 as a privately held research laboratory, it has transformed into today’s multinational industrial corporation that is listed on the New York Stock Exchange. The Company operates in more than 80 countries around the world and had fiscal 1999 revenues in excess of $22 billion.
In the mid-1980s, Tyco returned its focus to sharply accelerating growth. During this period, it reorganized its subsidiaries into the current business segments listed above. The Company’s name was changed from Tyco Laboratories, Inc. to Tyco International Ltd. in 1993, to reflect Tyco’s global operations more accurately. Furthermore, it became, and remains, Tyco’s policy to focus on adding high-quality, cost-competitive, low-tech industrial/commercial products to its product lines that can be marketed globally.
In addition, the Company adopted synergistic and strategic acquisition guidelines that established three base-line standards for potential acquisitions, including:
1. A company to be acquired must be in a business related to one of Tyco’s four business segments.
2. A company to be acquired must be able to expand the product line and/or improve product distribution in at least one of Tyco’s business segments.
3. A company to be acquired that will introduce a new product or product line must be using a manufacturing and/or processing technology already familiar to one of Tyco’s business segments.
Tyco also developed a highly disciplined approach to acquisitions based on three key criteria that the Company continues to use today to gauge potential acquisitions:
1. Post-acquisition results will have an immediate positive impact on earnings;
2. Opportunities to enhance operating profits must be substantial;
3. All acquisitions must be non-dilutive to shareholders.
FASB Accounting Rule Change
The rules of the game are changing. Some of the accounting benefits of acquisition will soon disappear. Spending some extra time with your accounting and legal departments could prove beneficial in the long-term.
George Donnelly, in his article in CFO magazine writes, “The current state of accounting rules is clearly a factor in the frenetic acquisition activity at Cisco Systems and Lucent Technologies Inc. Like many high-tech companies, the two giants can acquire with little drag on their finances, because pooling-of-interest accounting enables them to avoid onerous goodwill charges that otherwise would ravage earnings.
But because of the death sentence the Financial Accounting Standards Board has levied on pooling, companies must use straight-purchase accounting after January 1, 2001. Then buyers will have to amortize goodwill for no more than 20 years.”
Consolidations and Rollups
Bill Wade in Industrial Distribution said: “The basic premise couldn’t be any simpler. Take a highly fragmented industry–like distribution–facing technological change, customer upheaval or chronic financing difficulties. Add in a few well-healed foreign firms or, worse, a couple of previously unknown competitors from outside the business. Since the industry leaders are probably family-run businesses with limited succession strategies, the next step to protect profit and continue growth is clear: consolidate.”
A consolidation or rollup, as it’s frequently called, generally occurs when an organization or individual with deep pockets sets out to buy several small companies in a fragmented industry and rein them in under a new or collective pennant. In 1997 the National Association of Wholesale-Distributors reported that 42 of the 54 industries they studied had been significantly affected by consolidation. Frequently a professional management and buying strength create economies of scale that allows the consolidator to pluck the low hanging fruit in the industry. They will invest significantly in systems to eliminate the duplication of effort and inefficiencies that exist within the industry being consolidated.
While some call it smoke and mirrors, many consolidators are yielding outstanding results. In 1997, at 39 years old, financial whiz Jonathan Ledecky pulled off a bold deal. As reported in CFO magazine, He went to the public equity markets and raised half a billion dollars for his company, Consolidation Capital Corp., in a brazen initial public offering. Without revenues, assets, operating history or identity (name or industry), he raised the capital in a blind pool on the strength of his reputation alone.
U.S. Office Products (USOP) is the result of 220 acquisitions. Sharp Pencil was one of six privately owned office-supply companies that Ledecky put together. But he didn’t stop, after two years, and 220 acquisitions later, USOP was a member of the Fortune 500, with $3.8 in revenues. “It was crazy,” says Donald Platt, senior vice president and CFO at USOP. Platt did rely highly on outside resources, including a team of lawyers and accountants to get the job done (the 220 acquisitions). “We restricted then to well-managed, profitable companies. At worst, we would still be making money,” says Platt.
H. Wayne Huizenga is the owner of the Florida Marlins baseball team. He is also the king of consolidators. He pioneered his technique by rolling-up trash-truck businesses to create Waste Management Inc., the nation’s largest waste company. He went on to create the largest video chain, Blockbuster Video. With AutoNation, Huizenga, now struggling, is attacking the retail automobile industry. In mid-December 1999 AutoNation had 409 retail franchises but announced the closing of 23 of their used-car superstores.
Michael Riley learned about consolidations while serving as personal attorney for Huizenga. In July 1999, Riley’s company, Atlas Recreational Holdings Inc., paid $14 million to purchase controlling interest in the only publicly traded RV dealership chain in the United States, Holiday RV Superstores Inc., in Orlando, Florida. Riley’s avowed intention is to grow the company from $74 in annual sales in 1998 to $1 billion by 2003 by acquiring other dealerships.
Riley says, “Consolidations really will help. We can bring advantages to sales and service. We can make a difference in warranty. There is a real value added when you put these companies together.”
Same Industry, Different Strategies
In mid-1997, roll-ups, United Rentals and NationsRent were formed. They are in a race, but are using different strategies to achieve their results. After two years of ravenously gobbling up companies, United had 482 locations while NationsRent had accumulated only 138 stores. NationsRent has been developing a nationwide identity with stores that look-alike and have the same signage and layout. United Rentals presence is virtually unknown since the stores retain their previous appearance.
Motivations for Consolidators
There are several good reasons why consolidators attack a particular industry. The following list provides some of the rational that assist them in their decision making process. As you look to profit from the trend, keep these elements in mind as you make your selection on whom to acquire.
· Confidence by the players that they can capture significant and highly profitable additional market share by implementing the cutting edge management, procurement, distribution and service practices that will give them a competitive edge over smaller players.
· Gain national customers through increased capabilities in delivering the highest levels of standardized service and national geographical coverage.
· Larger customers of independent distribution channels are seeking broader geographic coverage and networks of locations that allow for greater service capabilities, and the smaller customers want a high level of customer service and response.
· Customers’ desire for more product sophistication.
· Insurance and financing synergies.
Fragmented Industries Are Ripe for Consolidations and Rollups
Some industries that are ready for consolidations or rollup examples include heavy-duty truck repair, office products, recreational vehicle dealerships, rental stores (equipment, tools and party) and distribution. Consolidation does not just happen. It is triggered by shifts in supplier and customer expectations. Consolidation in a supplier base or customer pool often alters the economic rational for the structure of an industry. Functional shifts are accompanied by serious margin shifts among channel participants.
Take notice of the speed in which an industry can experience consolidation. If you are a consolidator, pick the low hanging fruit before another beats you to it. If you are fighting consolidation, take notice of the state of your industry and make adjustments (like strategic alliances) to your business plan if your industry is highly fragmented.
· TruckPro, the $150 million sales creation of Haywood and Stephens Investments, was sold in May 1998 to AutoZone, the $3 billion distribution king of do-it-yourself auto parts.
· In June 1998, nine heavy-duty distribution companies with volumes of $6 to $37 million, simultaneously merged and raised $46 million from the public for their brand new $200 million company, TransCom USA.
· Brentwood Associates, a venture capital company, during Spring and Summer1998, created HAD Parts System, Inc. a $145 million operation, by acquiring three companies in the Southeast.
· In July 1998, Aurora Capital’s QDSP acquired majority interest in nine heavy-duty companies from FleetPride, a $200 million parts and service operation.
Stated in Truck Parts & Service, “Here the independent suffers a staggering disadvantage to roll-ups. Consolidators have access to large amounts of capital. The independent businessperson, however, must primarily finance his growth by earnings retains from current operations. New high efficiency service bays, significant and growing training expenses, data processing and communications technology all clamor for increased working capital. The large players’ acquisition cost advantage eventually will win him all the mega-fleet business and the vast majority of business from mid-sized fleets.
Supplementing his parts acquisition cost advantage, the consolidator will be able to lower many overhead costs through centralized management and volume discounts…Combined savings in parts acquisition cost and overhead reduction should easily exceed 4% of sales.”
Some of the indicators that an industry (any industry) is poised for consolidation are listed below. If you notice your industry has similar issues, it is just a matter of time. Plan now for what is coming. Where do you want to be when the train arrives?
· A high degree of fragmentation with numerous smaller companies and few, if any, dominating players.
· A large industry that is stable and growing.
· Multiple benefits for economies of scale.
· Synergies that can be achieved by consolidating companies.
· Infrequent use of advanced management information systems.
· Limited access to public capital markets and somewhat inefficient capital structures among companies.
· Lack of opportunities, historically, for owners to liquidate their businesses if they wish to leave the industry.
Reasons for Business Owners Selling to Consolidators
The reasons for a business owner to sell his or her business are as varied as there are people. Usually it is not one reason but several combined reasons that influence a seller’s decision. The following list provides you with the general areas that might drive a selling decision:
· First generation owner, without heirs, nearing retirement.
· Lack of capital to make necessary technological and capital improvements to compete, within an industry, and with new competitors.
· Flat growth rate in industry.
· Better profitability as part of a larger organization.
· Centralized buying.
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