Master in Business Administration Semester 3 MF0011 Mergers and Acquisitions - 4 Credits

(Book ID: B1209) Assignment Set- 1 (60 Marks)

Q.1 What are the cultural aspects involved in a merger. Give sufficient examples. Ans: Companies are joined nearly every day, but often two companies end up weaker together than they were separately. Indeed, a KPMG study showed that 83% of mergers and acquisitions failed to produce any benefits - and over half actually ended up reducing the value of the companies involved. One of the main problems is that mergers and acquisitions are often planned and executed based on perceived cost savings or market synergies; rarely are the people and cultural issues considered. Yet, it is the people who decide whether an acquisition or merger works. Customer and employee reactions determine whether the newly combined organization will sink or swim. Before the merger Before the merger takes place, the leaders of both organizations - at least, of the dominant one - should have a strategy mapped out, including communications to employees and customers, where layoffs will take place (if any do), and how the cultures should be merged. A SWOT (strengths, weaknesses, opportunities, and threats) analysis should be done for the combined company. If possible, a brief culture survey (preferably done via interviews as well as paper or Web/email) should be undertaken in both companies to discover what the cultural differences are. Sometimes this will be obvious in some aspects -e.g. one culture values teams and bottom-up innovation, the other favors command-and-control tactics - but not in others, such as how and whether individuals and teams are rewarded for innovations, how failure is dealt with, whether conflict is addressed openly, etc. This will prevent disconcerting delays between the announcement and the implementation of the merger/takeover. If the real purpose of the merger is to acquire another companys assets, in terms of a particular product or brand, its factories or patents, etc., that should be acknowledged and dealt with up front. If employees are fooled at first by pleasant words, they will react more strongly when those words become taunts. Finally, before the merger or acquisition takes place, the leadership teams should consider the nonfinancial issues. Will people in the two companies be able to work together? Will acquiring a company, or merging with it, destroy the properties or drive away the talent that made it worth having? Can a simple partnership, alliance, or even stock ownership without integration provide more benefits than

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combining the two companies? These issues may be overlooked by the leadership teams just as they are often ignored or downplayed by investment bankers who want to do the deal. Power relationships In many ways, it makes sense to consider mergers in the same light as acquisitions. It has become a truism that there is no such thing as a merger one side will come out dominant in each function, even in the friendliest of mergers. There can, in the end, only be one CEO, one head of each function, one head of each department. Therefore, we will generally consider mergers and acquisitions to be interchangeable. Power issues should be confronted directly to avoid drawn-out conflicts and confusion for employees. Conflicts must be controlled but addressed, to avoid protracted turf wars, lasting bitterness, and employee withdrawal and retention. (Withdrawal can be psychological as well as physical - employees can simply not go that extra mile, and do the absolute minimum required of them. They can also sabotage change efforts and new initiatives. This can last for many years, long after outsiders have forgotten about the merger.) Personal issues In most takeovers, both companies staff lose some productivity (and people) as employees divert their attention to their own place in the future, merged company. Will they still have a job? Will they have advancement prospects? What will be their role? Will the company gain or lose? This is the time when the best employees may jump ship, because they will find it easiest to get jobs elsewhere which strengthens the competition even as it weakens the integrated company. Mergers can be a profoundly demoralizing time, especially if communications from the leaders are sparse or misleading. Many agree that the best way to handle this is to constantly communicate to everyone in the company, using a variety of methods - face to face included - so that people understand the reasons for the acquisition, the combined companies strategy, and how the two companies will combine. If layoffs need to be made, they should be announced quickly and directly, again with the reasons and rationale clearly expressed. As people devote more time to exchanging rumors, trying to find out their status, and dwelling on the change, productivity tends to drop. In the absence of credible, continued information, the grapevine will spread inaccurate rumors with amazing ease. For that reason, the transition should be as short as possible. If there are layoffs, the role and situation of the survivors should be addressed. There is a separate line of research on this, which we will not delve into. As the integration of the companys proceeds, many may feel that their past ways of working and their contributions are not valued. In addition to celebrating success, the company must show in word and in deed that it value the best of the old ways, the tradition and heritage of the company being taken over. If the new organization shows YASHDEEP GUPTA 581112528

total disregard for the heritage of groups being taken over, people will take longer to get over the shock of transition, and may sabotage change or simply vote with their feet. Cultural issues Culture - the shared values, beliefs, and preferred ways to behave - is hard to control, and in most mergers, it seems that nobody tries very hard to do it. The end result is that the culture usually is not as productive as it should be in the combined organization, moulded primarily by the leaders actions and politically adept or powerful people in each organization. The goal in a merger is for the better of two companies to be preserved, resulting in synergy and continued profit. This applies to culture as well as to operational processes and technologies. The cultures of each company should be carefully examined, and care taken to guide the combined organizations culture so it incorporates the best of each. One interesting note on cultural change is that it often seems to come about only when an organization feels that its very survival is threatened. A merger or acquisition provides a fine opportunity for change! The role of organizational development When an OD consultant is brought into the merger/acquisition process, there are a number of roles they can play: Helping the leaders to agree on a clear and specific set of goals for the merger. Setting up measures helps the leadership team to focus on tangible, measurable results, which brings misunderstandings and con- fiict into the open. Measurement is also an excellent communication tool, since it is an action which gives the words more credibility. Measuring the results at a number of milestones can also point to potential problems before they become crises, helping to make the merger/acquisition smoother and increasing the likelihood of success. It also helps to keep leaders focused on a balanced set of issues. Scenario planning - will the merger work if there is a market decline? What are the likely responses of customers and regulators? We wonder if, in the Daimler-Benz takeover of Chrysler, anyone considered reactions to Chrysler no longer being an American company, including a loss of sales (since most of its customers are in the United States) and the de-listing from many indexed mutual funds. The 2001 power crises in California were also seen as a result of lack of scenario planning - in this case, testing the assumption that natural gas prices would stay fiat. The OD consultant should not usually lead the scenario planning, but they should be there as a process consultant to ensure that every team members contribution is heard, and that people are honest with each other and with themselves. (If that sounds too touchy-feely, just think about the plight of the California utilities). Exploring options - are there other ways to accomplish the same goals without a merger? Again, going back to Chrysler, the company was seeking international expansion and financial security. A partnership with Daimler-Benz, or acquiring an Asian or European automaker, would probably have served the YASHDEEP GUPTA 581112528

company more than becoming a division of a culturally very different conglomerate. Once more, the OD consultant may be most effective as a process consultant rather than as a leader. Investigating assumptions - while usually not a separate exercise, the OD consultant, as an outsider, is in a unique position to bring out hidden assumptions. This should be done continuously throughout the process, though scenario planning and exploring options are expressly designed to explore and test assumptions. Sometimes, brief tactical surveys can be taken to test assumptions; sometimes, questions are enough. Communication - ensuring that a steady stream of information is released by the organizations leaders; keeping that information balanced, direct, clear, and accurate; and preventing undesirable subtexts from being communicated. The OD consultant should also probe leaders when their words and actions contradict each other, to clarify one or change the other. Rewards - compensation systems are one thing; intangible rewards are another. Research shows that most people are generally not motivated by money, though they may take a job (or keep a job) for financial reasons. Even where bonuses or profit-sharing help to increase motivation, the money itself is often symbolic, a measuring stick for achievement. The OD professional should help the organization to set up milestones and celebrate small and large successes along the route to integration, so that people not only feel progress, but also feel that their achievements are being rewarded. Otherwise, integration may seem like a long, long road. Cultural assessment - clarifying each organizations culture to make the task of integration easier, and to ensure that communications and actions do not accidentally because more harm than good. Cultural change - working with both organizations to clarify their shared vision of what the culture should be, and then working to make it that way. Johnson & Johnson maintains a shared culture among a large number of companies, some acquired, some home-grown; they do it by having a clear, shared vision and values, and by working with newly acquired firms to ensure that their culture is brought to the J&J way. Leader coaching to integrate the leadership team, address conflicts, and assure mutual involvement and dedication to the merging process. OD professionals should work at every level of the organization where the merger is taking effect. The goal is to build the ability of the leaders to communicate their intentions accurately, build trust, and manage conflict and tension. Strong leader credibility is key to successful integration. Working with process teams to identify the best practices in each organization and assure that they are not overtaken by less effective standard procedures from the dominant company, but become the standard procedures for both. This includes operational and service processes, but can also be applied to aspects of the culture. Integrating initiatives - one problem that is not unique to mergers and acquisitions is initiative overload, where managers are overwhelmed with not just the merging of two organizations, but also quality YASHDEEP GUPTA 581112528

initiatives, customer projects, SAP implementation, etc. One of the more challenging projects for an OD professional is integrating initiatives and helping leaders to make tough judgement calls on which ones should be suspended, eliminated, or combined. Watch key processes - often forgotten in the integration are key processes such as new hire orientation, training, and even compensation systems. These processes all support or sabotage both the present and desired culture. OD professionals understand the role of each organizational system plays in the culture; they must keep an eye on all important systems and processes. By remembering what makes mergers succeed and fail, keeping an eye on the human issues as well as the financials, and using the most appropriate organizational development tools, companies can avoid bad mergers and make the good ones work.

Q.2 What are the sources of operating synergy? Ans: Some sources of synergy are: (a) Operating economies; (b) Market power; (c) Financial gains; and (d) Others. Each of the above sources is described in details below: (a) Economies of scale Horizontal mergers (acquisition of a company in a similar line of business) are often claimed to reduce costs and therefore increase profits due to economies of scale. These can occur in the production, marketing or finance areas. Note that these gains are not automatic and diseconomies of scale may also be experienced. These benefits are sometimes also claimed for conglomerate mergers (acquisition of companies in unrelated areas of business) in financial and marketing costs. (b) Economies of vertical integration Some acquisitions involve buying out other companies in the same production chain, eg, a manufacturer buying out a raw material supplier or a retailer. This can increase profits by cutting out the middle man. (c) Complementary resources

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It is sometimes argued that by combining the strengths of two companies a synergistic result can be obtained. For example, combining a company specializing in research and development with a company strong in the marketing area could lead to gains. (d) Elimination of inefficiency If the victim company is badly managed its performance and hence its value can be improved by the elimination of inefficiencies. Improvements could be obtained in the areas of production, marketing and finance.

Q.3 Explain the process of a leveraged buyout. Ans: The process typically starts with a private equity firm looking to buy a company using a combination of equity and debt. The interesting twist in the LBO structure is the use of the acquired company's assets to secure a portion of the debt used in the buyout. The private equity firm also uses the cash generated by the acquired company to pay down the debt. A successful leveraged buyout results in abnormally high returns to equity holders. Once successful, equity holders typically decide to execute an exit strategy that includes options such as: Recapitalization - by replacing equity with additional debt, it may be possible to extract even more money from the acquired company. Complete Sale - it's possible to sell the entire company if a strategic match can be found among potential buyers. Initial Public Offerings - while it's not always possible to sell the entire company, an IPO allows equity holders to realize a gain on their initial investment. Transaction Financing The cost of the LBO can include transaction fees, lender's fees, bank fees, and sponsor costs. Most leveraged buyouts involve three sources of funding: senior debt, mezzanine debt, and private equity. Private Equity - typically funds 25% of the total transaction. This is also the most expensive source of financing. Sources of this equity can include the target company's management team, a pool of buyout funds held by LBO firms, as well as investment banks. Equity structures may include preferred stock held by the LBO firm, while employees and management teams receive common stock. Mezzanine Financing - typically funding 25% of the total transaction, this type of financing got its name because it fills the gap between equity and senior debt. Mezzanine financing is junior to all other

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debt. For this reason, it carries a higher level of risk and interest rate to compensate investors for that risk. Senior Debt - also known as term debt, this type of debt will usually fund approximately 50% of the total transaction. This debt is frequently secured by assets of the acquired company, and is the least costly way to fund the buyout. Identifying LBO Candidates At a high level, potential LBO candidates would be undervalued stocks with strong cash flows, and relatively low debt. Other characteristics of target companies include: Large asset base Low future capital requirements Potential for process improvements or cost reductions Strong market position Relatively low enterprise value

Finally, the ideal leveraged buyout candidate would be a company that can be easily separated into logical subdivisions and / or presents the acquirer with a clear exit strategy.

Q.4 What are the basic steps in strategic planning for a merger? Ans: Mergers & Acquisitions are strategic decisions which are taken by the management of any company after thorough examination of many important facts and considerations. Since decisions regarding Mergers & Acquisitions, like capital budgeting decisions are irreversible in nature important that due attention must be paid to some basic issues before planning about it. Hence the strategic planning can be broken down into five steps: Step 1: Pre Acquisition Review The first step is related with the assessment of companys own situation to determine if a Merger & Acquisition strategy should be implemented or is there any other alternative? If a company expects difficulty in the future when it comes to maintaining growth, core competencies, market share, return on capital, or other key performance variable, then a Merger & Acquisition (M & A) program may be necessary. If a company is undervalued or fails to protect its valuation, it may find itself the target of a merger. Therefore, the pre-acquisition review will include issues like the projected growth rate, inability of the company to sustain its market share in the future because of the potential threat from its YASHDEEP GUPTA 581112528

competitor firms, under valuation of the company etc.

The company must address to a fundamental question. Would the Merger help improve the situation regarding the above or not? Will it affect the valuation in a positive manner? Step 2: Searching and Screening of the targets The second step in the Merger & Acquisition process is to search for those companies which can be the potential takeover candidates. It is important for the merging company to see whether the company to be acquired has strategic compatibility with the acquiring company or not. Compatibility and fit should be assessed across a range of criteria size, kind of business, capital structure, core competencies, etc. Searching and screening process should and must be performed by the management of the Acquiring Company without taking the help of any outside agency. Dependence on external firms should be kept minimum however if it is important to take the help of any outside agency. Step 3: Valuation of the target company The third step in the Merger & Acquisition process is to perform a thorough and detailed analysis of the target company. Acquiring company must confirm that the Target Company is truly a good fit with the acquiring company. This requires a thorough review of operational, strategic, financial, and other aspects of the Target Company. This detail review is called due diligence. Due diligence is the process of identifying and confirming or disconfirming the business reasons for the proposed capital transaction. Various factors like, customer needs, strategic fit, shareholder value etc is at the core of the analysis. Several functions are involved in due diligence related to potential acquisitions, including strategy, finance, legal, marketing, operations, human resources, and internal audit services. The direction of due diligence efforts depends on what the company expects to gain from the transaction: employees, customers, processes, products, or services. Due Diligence is initiated once a target company has been selected. The main objective is to identify various synergy values that can be realized through an M & A of the Target Company. A key aspect of due diligence is the valuation of the target company. In the preliminary phases of M & A. Total value of the company is calculated keeping in mind the value of the synergy expected from the combination and costs involved in the transaction. An example should give an idea of the calculation involved. Value of Acquiring Company = Rs. 500 lakh Value of Target Company = Rs. 250 lakh Value of Synergies as per Phase I Due Diligence = Rs. 150 lakh YASHDEEP GUPTA 581112528

M & A Costs = Rs. 60 lakh Total Value of Combined Company = Value of the acquiring company + Value of the target company + Value of the Synergy M & A cost Hence Total value of the combined company = 500 + 250 + 150 60 = Rs 840 lakh. Step 4: Negotiation After selecting the target company its time to start the process of negotiating. A negotiation plan is developed based on several key questions: How much resistance Acquiring Company is expected to encounter from the Target Company? What are the benefits of the Merger for the Target Company? What will be the acquiring companys bidding strategy? How much acquiring company should offer in the first round of bidding? The most common approach to acquire a company is for both companies to reach an agreement concerning the Merger & Acquisition. The idea is to go for a negotiated merger. The negotiated merger should be the preferred approach to a M & A since when both the companys agree to the deal then there are chances that the process will be a smooth one and will go a long way in making the merger a successful one. Step 5: Post Merger Integration If everything goes as per planning, the two companies announce an agreement to merge the two companies. This leads to the fifth and final phase within the M & A Process, the integration of the two companies. Every company is different in terms of operations, in terms of structure, in terms of culture, in terms of strategies etc. The Post Merger Integration Phase is the most difficult phase within the M & A Process. It is the responsibility of the management of the two companies to bring the two companies together and make the whole thing work. This requires extensive planning and design throughout the combined organization. If post merger integration is successful, then it should result in the generation of synergy and that is the final objective of any Merger & Acquisition program.

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Q.5 Study a recent merger that you have read about and discuss the synergies that resulted from the merger. Ans: Below are excerpts from an interesting Harvard Business School Case Study (February 22, 2004) providing insight to the scale and value of the HP/Compaq Merger. John Benders role as Executive Director of Merger Integration gave him a front-row seat to the largest merger in tech history. Day-1 of the new HPs operations are viewed as best-in-class. Successful early integration of two massive IT infrastructures included hp.com (online store) being open for business, @hp employee portal with more than 2 million hits/day accessible to all employees, 1, 193 company networks connected at key strategic locations , active directory and enterprise directory synchronized and all E-mail systems interconnected linking more than 229,000 mailboxes and a quarter million desktops. More than $3.7B in synergies and 95% of integration milestones were achieved in the first 12 months spanning nearly every aspect of the new HP, and focused on key synergy areas of procurement & supply chain, headcount reduction, administrative facilities closures, and IT integration. Results easily exceeded Wall Street expectations of $1.4B. Excerpts from The New HP: The Clean Room and Beyond, Harvard Business School Case Study, February 22, 2004. In fiscal 2001, HP was the second largest computer company, behind IBM, with pre-merger revenue of $45 billion, 19th on the Fortune 500, with over 88,000 employees in more than 120 countries. However, HP was struggling with difficult economic conditions and a technology industry slump. At the time, Compaq was the third largest computer company, behind IBM and HP, with revenue of $42 billion in fiscal 2001. The company had 66,000 employees in over 200 countries, and was ranked 27th in the Fortune 500. Compaq integration of Tandem and Digital in 1997 and 1998 respectively proved difficult; further pressured by the computer industrys intense competition, Compaqs stock took a beating. When Fiorina approached Capellas about a licensing deal, he suggested a broader relationship between HP and Compaq. Capellas felt that there was too much capacity in the industry and that it made sense to consolidate during an economic downturn. The idea of a merger excited Fiorina, who saw it as an opportunity to create a highly competitive technology giant that was well positioned in virtually all of its markets. Historically, mergers within the technology industry had proven difficult, and both HP and Compaq had less than perfect track records with their prior acquisitions. Fiorina, recognizing the multiple obstacles to the mergers success, had created a dedicated integration team immediately after the merger was announced. The clean room, as the integration office came to be known, consisted of pairs of pre-merger HP and pre-merger Compaq employees who were responsible for planning the details of the execution of the merger upon its close. When the merger between HP and Compaq was first announced in early September of 2001 (eight months before it was approved), Fiorina and Capellas tapped Webb McKinney of HP and Jeff Clarke of Compaq to run the merger integration team. Together, McKinney and Clarke created a small integration YASHDEEP GUPTA 581112528

office known as the clean room where they could begin planning the details of the merger without violating antitrust laws. The clean room started with a small group of employees but involved almost 2,500 people by the time of the mergers close. The clean room was responsible for developing a master plan to be implemented upon the mergers closure; this road map was to encompass all aspects of the combined company. The scope of decisions involved in melding the two companies was immense, ranging from larger issues with more strategic impactsuch as branding, product lines, and corporate cultureto smaller details, such as cash management systems and financial reporting practices. The integration team was responsible for establishing direction for the newly combined companies, setting priorities, and defining the details of its future operations. Members of the clean room used an adopt and go strategy to manage their decision-making process. Category by category, the team reviewed elements of the approaches used by each premerger company, and thenrather than using a hybrid or redesigning each systemselected the best method to use going forward. McKinney noted, Before the close, we were planning just about every aspect of the launch of the new company and how the new company would integrate. In a sense, it was almost like leading a traditional organization. The only unusual thing was that we were spending most of our time on planning. We could do some prototyping, but that was about it. It was like launching an $80 billion start-up except that the only thing we could do was plan. Once the merger closed, the clean room couldnt allow people to think that they could change everything that had been done for the last eight or nine months. It would just slow things down too much. Instead, as the teams form and you get together, your job is to understand and implement the decisions that have been made because speed is the number one thing. HPs cultural integration team rolled out Fast Start, a program designed to ease the transition, explain the new business model, and help define the culture of the newly combined companies. The Fast Start workshops were conducted in groupsled by team managers and a facilitatorand were designed to be highly interactive. All 155,000 people in the organization were required to complete the program.

Q.6 What are the motives for a joint venture, explain with an example of a joint venture. Ans: Joint venture, we have all heard of this term one time or another, but what exactly is a joint venture? In lay-mans terms a joint venture is wherein two or more parties build a relationship, they enter into some agreement to work towards a common goal. Although they have the same goals these parties remain separate and distinct from each other. Joint ventures take place across most industries where companies may combine forces for a specific project but may even be competitors for others. A joint venture is truly a great and proven way to access millions of potential partnerships across countries. Moreover joint venture is indeed a great way to combine efforts, resources, and ideas which will eventually increase sales for both sides of the party. YASHDEEP GUPTA 581112528

The sales of your online business are more likely to increase with an increase in the number of people you reach through your joint venture effort. If you are an online entrepreneur and you are looking for new strategies to make your business a success, a joint venture may be in the cards and just the thing to create that success. Keep in mind that joint ventures are business partnerships that require cooperation and trust. However, they do not have to be permanent nor does a business owner need to share all his or her secrets to take advantage of a joint venture partnership. Here are some advantages a joint venture brings to your online business: 1. Joint venture enables you to access bigger markets. A strategic joint venture partnership can provide access to larger customer bases and geographical markets. Say for example you are running an online business that specializes in promotional items like shirts, coffee mugs, pens, and other merchandise with company logos. By forming a joint venture with a business consultant who has a wide-range of business contact network, you can supply them with unique promotional items and gain access to a large catalogue mailing list. There is a huge marketing possibility with a joint venture. Since marketing and promotion are always something you need to focus on for your business, getting otherwise inaccessible market taps can help your business grow. 2. Joint ventures give your business longer marketing efforts. The beauty of a joint venture is that not only will it enable you to access a larger market it also gives you a chance to extend your marketing efforts. If you are just starting up your online business then you may not have the budget yet for advertisements, however if you are part of a strategic joint venture you would be able to gain new marketing channels. Additionally, a joint venture strategy may give you more direct access to decision makers. 3. Joint venture gives you access to new resources / technology. Every online entrepreneur dreams of expanding his business with the use of technology. However have you ever thought of rather than trying to obtain venture capital for technology expansion, a joint venture is more appropriate and practical. When you loan money from the back or borrow from someone else, you have the obligation to pay it back before you recognize any considerable profit. But if we use the resources and technology already utilized by a joint venture partner, you could build business and raise revenues faster by sharing the profits.

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4. Joint venture gives you access to a bigger and longer prospect list. As of the moment how big is your current opt-in list? Is there any way that you can expand and make your list grow? If you have a bigger opt-in list will that mean you get bigger chances of increasing your profits? A joint venture has the ability to broaden and grow your opt-in list in a lot of ways. If you are list leveraging with a partner, then anyone who responds visits your website, or makes a purchase is added to your opt-in list. Doing cross promotions have the same list building capabilities. Say for example you went ahead and posted an ad for your partner in your newsletter and they post an ad for you, then eventually everyone on their list that responds to your ad is now on your opt-in list. 5. Joint ventures promote better customer relationships. As an entrepreneur your credibility is important, and in offering your customers a new opportunity, a new product, or a new service with a reputable partner gives you instant credibility. Your customers also see you as someone that thinks about his customers and takes the time and effort to find and present quality opportunities to them. When you offer your customers an excellent product or service, you not only increase your credibility with them, you increase the likelihood that they are going to buy from you again. 6. A joint venture presents you with an opportunity to gain capacity and expertise. When you enter into a joint venture always remember that you should be able to gain as much from the other company as they can from you. This is one of the biggest advantages of a joint venture that should not be overlooked. 7. When you enter a joint venture any risk that you might get into is shared by you and the other party. Since the liability is shared there is less pressure on your part, and likewise the other group as well. Also the flexibility in a joint venture can make your life a lot easier. Like what I have said earlier a joint venture is good for as long as your contract stands. The life span of the agreement can be just enough to cover what you want as a joint venture is not a life time partnership. A joint venture is joining forces for one particular project and not putting two companies together forever and ever.

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