Lecture 11 Cross Border Mergers and Acquisitions Mergers

Lecture 11 Cross Border Mergers and Acquisitions

Mergers and Acquisitions as Part of FDI FOREIGN DIRECT INVESTMENT JOINT VENTURES MERGERS WHOLLY OWNED SUBSIDIARIES GREENFIELD INVESTMENT ACQUISITIONS

Mergers and Acquisitions Examples • Mergers (a marriage between two companies): – Royal Dutch Petroleum (60%) and Shell (UK) Transport and Trading (40%) merged in 1907 as Royal Dutch Shell Group. World’s #1 oil and gas firm; headquarters: The Hague, The Netherlands; owns or has interests in about 50 refineries worldwide. It operates more than 46, 000 gas stations worldwide. – Sony Corp. and Bertelsmann AG and announced plans (Nov 6, 2003) to merge Sony Music Entertainment and Bertelsmann's BMG. The new company, to be called Sony BMG, would be equally owned by Sony (Japan) and Bertelsmann (Germany). It would bring together the world's No. 2 and No. 5 music companies. • Acquisition (one company acquiring another): – Ford Motor Company buying Jaguar Cars Limited for $2. 8 billion in 1990. – Daimler-Chrysler; In 1998 Daimler-Benz acquired Chrysler; Automotive; headquarters: Stuttgart, Germany; manufacturing facilities in 37 countries

Historical Cross-Border M&A Activity Cross-Border Mergers & Acquisitions: Developed Countries (billions of US dollars)

Historical Cross-Border M&A Activity Cross-Border Mergers & Acquisitions: Developing Countries (billions of US dollars)

Cross Border M&A Data • For year 2000: – Total $1, 229 billion • $1, 143 billion (92%) in developed countries – $324 billion in U. S. – $586 billion in EU. • $86 billion (8%) in developing countries – Most in Latin America and Asia.

The Driving Force for Cross-Border M&A • The main reason for cross-border M&A is to create shareholder value (Anglo-Saxon view). • Public firms’ measure of enhancing shareholder is mainly reflected in their stock price. – If the MNE’s share price is a combination of earnings and the market’s opinion of those earnings (i. e. , the price to earnings multiple) then management should strive to grow both.

Creating Shareholder Value The Goal: Increase the share price of the firm Price Increasing the share price means increasing earnings. = EPS Management, directly controls through its efforts the earnings per share of the firm. P E Management only indirectly influences the market’s opinion of the company’s earnings as reflected in the P/E. So building “value” means growing the firm to grow earnings. One growth potential is through going global.

Other Cross-Border M&A Drivers • Additional cross-border M&A drivers can be viewed as Micro (i. e. , firm and industry level) in nature: – – To gain access to strategic proprietary assets To gain market power and dominance To achieve synergies To become larger and realize benefits of size in competition and negotiation – To diversify and spread risk – To exploit financial opportunities • And Macro (i. e. , global competitive environment) in nature: – Technological changes – Changes in regulation (deregulation) – Globalization of capital markets

Cross-Border M&A Drivers Cross - Border M & A activity MACRO FORCES: Changes in the Global Environment New business • Technology opportunities • Regulatory frameworks and risks • Capital market changes Strategic responses by firms to defend and enhance their competitive positions in a changing environment. MICRO FORCES: Firms Undertake M&A to: • Access strategic proprietary assets • Gain market power & dominance • Achieve synergies • Become larger • Diversify & spread risks • Exploit financial opportunities time Source: UNCTAD, World Development Report 2000: Cross-border Mergers and Acquisitions and Development, figure V. 1. , p. 154.

Cross-Border M&A Process • Although most M&A is viewed solely as a process of valuation, there is much more to the process. • The process of acquiring an enterprise has three common elements – Identification and valuation of the target firm – Completion of the ownership change transaction – Management of the post-acquisition transition

Three Stages of Cross-Border M&A Stage I Strategy Corporate strategy and & identification Management of target firm Financial Analysis & Strategy Valuation & negotiation Stage III Completion of the ownership change transaction (the tender) Management of the post-acquisition transition; integration of business and culture Financial settlement & compensation Rationalization of operations; integration of financial goals; achieving synergies

Stage 1: Identification and Valuation • Stage 1: Identification and Valuation – This requires a well defined corporate strategy and focus. – Identification stage of the target market typically comes before the identification of the target firm. • Highly developed markets offer wide choice of publicly traded companies to select from. – Valuation stage comes after identification of target firm has taken place • A variety of techniques can be used • DCF, multiples, comparables, etc.

Stage 2: The Tender and Settlement • Stage 2: The Tender and the Settlement – Occurs after target firm has been identified and valued. – Tender stage includes the securing the approval of the management and ownership of the target to governments and regulatory bodies. • May result in friendly takeover (or need for hostile takeover). • Regulatory approval is important for anti-monopolistic threats. – Settlement (compensation) stage involves payment to shareholders of the target firm. • Payment can be in forms from cash to common stock of the acquiring company. • If common stock it is usually some ratio of acquiring company share to target company shares • A variety of factors determine the method of settlement: availability of cash, size of the target firm.

Regulatory Approval • Whether the mergers take place domestically or cross border, there are potentially serious competition policy concerns for other countries. If the largest producers in, say, the US automobile industry merge, this may not only lead to anti-competitive behavior in the US but also similar or worse behavior in other countries (e. g. cartelization of markets, increased barriers to entry). • In the 1997 Boeing-Mc. Donnell Douglas takeover case, although both companies were located in the US, the European Community objected to the merger on account of its potentially competitionreducing effects in Europe, arguing it would create a global airline monopoly. The European Union could not stop the deal but it did threaten to fine Boeing and restrict its business with European airlines Thus, the Community was able to extract important concessions from Boeing before the merger was approved. • Thus, it is also now commonplace for jurisdictions in other industrial countries to scrutinize separately all large proposed mergers for their effects on competition even if they occur abroad.

Stage 3: Post-acquisition Management • Stage 3: Post-acquisition Management – May actually be the most critical stage • Will determine the success or failure of the acquisition. • This stage can affect the ability of the deal to create shareholder value. • Potential problems: – If the anticipated synergies are not met – If the costs of integration become higher than anticipated – If the melding of the two corporate cultures proves difficult.

Wealth Gains from Cross Border Acquisitions AVERAGE WEALTH GAINS FROM CROSS-BORDER ACQUISITIONS: FOREIGN ACQUISITIONS OF U. S. FRIMS, 1979 -1990 Country of Acquirer Canada Japan U. K. Others Total # of cases 10 15 46 32 103 Average Wealth Gains (in Millions of US Dollars) Acquirer Target Combined $14. 93 227. 83 -122. 91 -47. 46 -35. 01 $85. 69 170. 66 94. 55 89. 48 103. 19 $100. 53 398. 49 -28. 36 42. 02 68. 18 • Conclusions: U. S. target shareholders realized significant wealth gains, $103. 19 million on average. The wealth gains to acquiring shareholders, however, varied greatly across acquiring countries. • Source: Eun, Kolodny and Scheraga (1996, Journal of Banking and Finance).

Financial Variables and FDI • Question: What macroeconomic and financial variables play key roles in the cross border merger and acquisition decision of firms? • Julian di Giovanni. “What Drives Capital Flows? The Case of Cross. Border M&A Activity and Financial Deepening” (University of California Working Paper, January 2002 • This question is addressed in this paper using a large data set of cross-border Merger & Acquisition deals for the period 1990 -1999. Author finds that financial variables and other institutional factors in the acquiring company’s country seem to play a significant role in M&A flows. • In particular the size of financial markets, as measured by the stock market capitalization to GDP ratio and the credit provided to the private sector by financial institutions to GDP ratio in the domestic economy, have sizeable positive effects on the incentives for domestic firms to invest abroad.

Summary of Lecture 11 • The number and dollar value of cross-border mergers and acquisitions has grown rapidly in recent years, but the growth and magnitude of activity is taking place in developed countries, not developing countries • The global marketplace offers greater growth potential. There a variety of ways for an MNE to enter foreign markets including Greenfield investments and acquisitions • The drivers of M&A activity are both macro in scope, the global competitive market, and micro in scope, the variety of industry and firm-level forces and actions driving individual firm value • The process of acquiring an enterprise has three common elements, (1) identification and valuation of the target, (2) completion of the ownership change transaction and (3) the management of postacquisition transition