CHAPTER 3
MOTIVES FOR ENGAGING IN M&AS
LEARNING OUTCOMES:
- Discuss the main reasons why comp engage in M&As
- Explain what is meant by growth in context of M&As
- Explain the possible sources of a competitive advantage
- Apply Porter’s five competitive forces model in developing a comp’s corporate strategy to strengthen its
comp advantage
- Describe the benefits associated w external growth through M&As
- Distinguish between motives for vertical & horizontal integration
- Explain what is meant by the term ‘synergy’
- Differentiate between operating & financial synergies
- Distinguish between economies of scale & economies of scope
- Describe the appropriate circumstances for undertaking acquisitions to access new techs, patents,
licenses, skills and capabilities
- Outline the benefits og acquiring targets to access new techs, patents, licenses, skills and capabilities
- Explain the advantages &disadvantages of cross-border M&As
- Explain the appropriate circumstances for restructuring the org and ownership of an entity
- Explain other motivations for undertaking M&As
WHY ENGAGE IN M&AS?
Remember:
- Should only be undertaken after careful analysis, consideration & planning – should be fully aligned to the
strategic plans of the company & these plans should be revised
Reasons why: GROWTH
1. Organic/Internal growth –company will expand from within
a. Usually takes longer; company will have to penetrate a market/industry without acquiring a
company that is already in the M/I
b. But also lower financial risk option (than acquiring a whole new company and it failing)
2. External growth – m&a
[Company can choose both approaches]
- Adds value to the shareholders -NB.
- Objective of seeking growth = LT profitability and sustainability of the company
- Value is driven by maximizing future CFS at lowest risk possible.
o Greatest amount of capital is deployed; financed through most optimal capital structure
o THEREFORE – growth must positively impact these drivers
- Growth can destroy value – by expanding beyond a comp’s borders w/o considering the risk
o Eg. David Jones and Woolworths. A failed marketing strategy with loss of market share and a decline
in revenue.
- Can be achieved through:
o Expand products/markets (product development/expansion)
o Strengthening the brand (market development)
o Cost reduction
o Growth in market share
o diversification
- Growth strategies: (recap of chapter 2)
o Expanding in same industry
o Vertical integration (forward or backward)
o Diversification
o Joint ventures/strategic alliances
- The choice of growth strategy is often difficult decision to make & management often gets it wrong. Tools to
use to determine growth strategy:
o Systematic analysis
▪ Understanding the factors driving the competitive nature of a specific market/industry
▪ Determine potential sources of a competitive advantage
COMPETITIVE ADVANTAGE ANALYSIS -WHAT DO WE NEED TO GROW?
Q: How do we know what to look for to ENABLE growth / what is the comp’s strategy?
- Should be a focus on strengthening / establishing a competitive advantage.
- Once management has a clear understanding of their competitive position in industry, they can decide what
corporate action is necessary.
- 3 methods to establish CA:
o Cost leadership
▪ Delivering/producing services/goods at the lowest cost possible; therefore pricing their
product lower than their competitors.
Eg. Airline industry. Budget airlines focus on providing a service at an acceptable level of
quality, but a focus on price.
Reducing costs are done by passengers buying their own food on the place, limitations on
leg room, and small chairs to sit in (to maximise the number of passengers per flight).
▪ Goes with principles of economies of scale = mass production means lower cost.
• Companies may decide to acquire/merge with another entity to reduce production
cost or increase revenue. By doing that, it strengthens its competitive advantage.
Eg. Mcdonalds. Considered a cost leader because they acquired some of their
suppliers through vertical integration and thereby reducing cost even further.
o Differentiation
▪ Being different from other competitors in industry (through making p/s unique/distinct from
others)
Eg. Coca-cola recipe, Nandos and their advertising
▪ Can lead to brand loyalty
o Market segmentation
▪ Focusing on a specific segment of a market (based on analysis of each market segment)
▪ Often referred to as a focus strategy – focusing on one segment of the market instead of the
whole market.
Alternative approach to gain/maintain CA: PORTER’S FIVE COMPETITIVE FORCES FRAMEWORK
PORTER’S FIVE COMPETITIVE FORCES FRAMEWORK
- Helps to inform management on possible plans of action than can be taken to strengthen its CA
- Useful framework to do an industry analysis
- Provides useful info to a potential acquirer = will also be valuable to conduct a similar analysis for the target
(especially if the target is in a different industry).
[diagram]
THREAT OF NEW ENTRANTS
- Barriers to entry = factors that makes it diff to enter the market
o Regulatory requirements, significant capital requirement, patent protection
- Economies of scale = the unit cost is optimized and comp is able to offer p/s at a lower price to customers
(mass production)
- Brand loyalty = a well-developed distribution channel fall under this
- Capital requirements = how much capital must be invested before income can be generated
- Cumulative experience
- Government policies
- Access to distribution channels
- *Switching costs = costs related to changing one product to another (switching to a new system)
BARGAINING POWER OF BUYERS
- Number of customers
- Size of each customer order
- Differences between competitors
- Price sensitivity
- Buyer’s ability to substitute
- Buyer’s info availability
- *Switching costs
THREAT OF SUBSTITUTE P/S
- Number of substitute p/s available
- Buyer propensity to substitute
- Relative price performance of substitute
- Perceived level of product differentiation
- *Switching costs
BARGAINING POWER OF SUPPLIERS
- Number & size of suppliers (monopolies – eg. Eskom)
- Uniqueness of each supplier’s product
- Focal company’s ability to substitute
RIVALRY/COMPETITION AMONG EXISTING COMPETITORS
- Number of competitors
- Diversity
- Industry concentration
- Industry growth
- Quality differences
- Brand loyalty = same as earlier; but low brand loyalty makes an industry more accessible to new entrants &
add to the competitiveness of an industry
- Barriers to exit
o eg. Highly specialized industries – equipment may be specialized to only fit that company. Exiting the
industry leads to writing off the assets at significant loss
o companies that are contractually obligated to provide a certain service
- *Switching costs = focus on customer; will not be able to switch without incurring significant expenses or
unacceptable switching costs
So what do you do after the industry analysis?
- Consider all the opportunities and develop the most appropriate strategy. This with an understanding of the
comp’s strategy (cost, differentiation, segmentation) will provide input into the chosen future direction of the
company.
- Example of Qs to consider when deciding on best strategy:
o What is the COMPs CA?
o How do we enter a market/strengthen the CA?
o Can this be done through internal/external growth?
o What are barriers to entry/exit?
5 MAIN GROWTH STRATEGIES
EXPANDING IN THE SAME INDUSTRY (HORIZONTAL GROWTH)
- Although a company may have a unique core competency, it may not be able to exploit it if the company is
too small. This problem can be addressed by joining forces & resources w other entities
- Chances of success in the same industry are higher when:
o Target’s competitive strategy is in line with the acquirer
o When entities have similar management styles & resource allocation partners
- Same industry M&As can clearly enhance comp’s SIZE & POWER in industry – enables companies to:
o Reduce expenses
o Meet customers’ demands for wider range of p/s
o Reduce the time to market for new p/s
o Improve economies of scale & scope
o Access talent, R&D capabilities, patents and technologies
o Access existing distribution channels
o Negotiate better terms & discounts w suppliers
EXPANIDING INTO AN UNRELATED INDUSTRY
- M&As are often undertaken if a company wants to enter an unrelated industry in which there are high barriers
to entry.
o Barriers are factors that make it more expensive and/or challenging for new entrants to compete
effectively in an industry.
o Barriers exist when customers are very brand loyal, economies of scale are critical, new entrants
can’t access suitable locations or suppliers, ‘first movers’ dominate the market (think of Facebook
and Google) and when patens prevent competitors from copying ideas.
o Barriers are generally higher in industries that are dominated by a few large competitors.
- As barriers protect incumbent firms, new entrants incur costs to “break into” the industry.
o Just think how much time, effort and money is required for a new cell phone company to set up shop
in South Africa…
o To avoid these costs, companies could buy established entities through conglomerate M&As. Other
options to “break into” the industry include joint ventures and strategic alliances.
- An important benefit of expanding into an unrelated industry is that of diversification or the so-called
coinsurance effect.
o Recall , decreasing returns in one industry could be offset by increasing returns in another, thereby
lowering earnings volatility.
- The coinsurance effect works best if companies in defensive and cyclical industries are combined.
o Defensive: sales are not that sensitive to changes in the economy (eg. Food and health care)
o Cyclical: sales are very sensitive to changes in the economy, (eg. Construction and household
appliances)
- Over the years Sir Richard Branson’s Virgin Group has expanded into many diverse sectors from travel to
telecoms, health to banking, and music to leisure. According to the comp’s website, there are > 60 Virgin
companies worldwide, employing approx 71k ppl in 35 countries
o Although the Virgin Group is diversified across industries, the COVID-19 pandemic has still had a
significant impact on sales and earnings. So much so that Virgin Australia has been bought by US
private equity group Bain Capital after falling into administration due to coronavirus travel
restrictions. The airline was struggling with long-term debt of $3.17bn even before the pandemic
struck. Australia's second biggest airline had unsuccessfully asked for a government loan before its
collapse in April. The Australian government is grateful that it did not have to intervene and that the
prospect of a Qantas monopoly has \been avoided.
SEEKING SYNERGIES
- Synergies = add valye that can be unlocked by combining 2/> economic units
o 2+2 = 5 (the whole is more than the sum of its parts)
o Operating vs financial synergies
- Oerating synergis allow companies to increase rev and/or decrease costs (ECONOMIES OF SCALE VS
ECONOMIES OF SCOPE)
ECONOMIES OF SCALE
- Refers to cost savings that arise when a company increases its production output
- (Massa produksie)
o It costs R3 000 to produce 100 magazines, but only R4 000 to produce 1 000 magazines.
o By producing more units, the average cost falls from R30 per magazine to R4 per magazine.
o Average cost per unit falls as fixed costs (e.g. design and editing) are spread over more units (see
illustration on next slide).
- Although economies of scale are usually associated with manufacturers, retailers can also benefit from
being large as this enables them to buy in bulk and negotiate discounted prices.
Example:
According to a business journalist, the 2018
announcement that online fashion retailers Spree
and Superbalist would merge was not
unexpected. At the time both e-commerce players
were majority owned by Naspers. Naspers owned
53.5% of Takealot (which owned 100% of
Superbalist) and 85% of Media24 (which owned
100% of Spree). “This reshuffling is about one
thing: scale”. He continued to say: “Until now,
each of these businesses has operated
completely independently. This means there are
two buying teams, two technical teams, two
marketing teams, two operations teams, two
warehousing teams, two logistics units and two
customer-facing support teams. Yet they target a
very similar (or as the merger announcement
described it: “if not the same”) customer. In e-
commerce, with generally razor-thin margins,
scale wins. Ask Amazon. A combined entity,
regardless of the customer-facing brand(s) it
retains, will benefit greatly from being run as a
single operation.”
ECONOMIES OF SCOPE
- Ability to use one set ofinputs to provide a broader range of p/s.
o Reflects a company’s ability to produce additional products at a lower cost due to experience
gained with existing products. (cost savings that arise)
- Often occurs when companies combine their R&D experience either formally / throughJVs and strategic
alliances
- Would a seasoned cross-border acquirer be in a better position to benefit from economies of scope than a
company that has never done business beyond its home country? Motivate your answer.
o Answer:
- Example:
o Proctor & Gamble produces hundreds of hygiene-related products such as Ariel, Pampers, Always,
Gillette, Old Spice, Pantene and Oral B. It is estimated that more than four billion people around the
world use their products. Economies of scope are derived from common inputs in that the company
can afford to hire expensive graphic designers and marketing experts who use their skills across the
company's product lines, adding value to each one. If these employees are salaried, each additional
product they work on increases the company's economies of scope as the average cost per unit
decreases.
FINANCIAL SYNERGIES
- Refers to company’s capital structure. Includes access to:
o Capital
o The cost of capital
o Risk related to the capital structure of the company
- Unlocked through M&As include:
o Higher cash flows
o A lower WASS (due to lower business risk)
o A combination of the above
- Could create opportunities that wold otherwise not have been available/ possible.
o Example: Company X is a mature company with lots of cash, but few investment opportunities,
whereas Company Y is a cash-strapped start-up. The start-up, however, has many lucrative
investment opportunities. As individual companies, neither X or Y would be able unlock further value
of their shareholders. By joining forces, they can take advantage of Y’s investment opportunities
using X’s cash reserves.
- Could lead to more stable earnings & CFs and could increase the borrowing capacity of the combined entity
- The VALUE of synergies should be determined when estimating the value of the target company
ACCESSING NEW TECHS, SKILLS AND CAPABILITIES
- Internet and tech has become increasingly important since the start of the COVID-19 pandemic
- Many companies find it cheaper and faster to acquire new techs, skills and capabilties through M&As than
to develop these in-house
o Other way to acquire these = research and development
- Joint ventures & strategic alliances are useful when pursuing a ST tech goal
RESTRUCTURING A COMPANY’S ORG, MANAGEMENT AND OWNERSHIP STRUCTURE
- As economic conditions, legislation, competition and consumer preferences constantly change, companies
need to change the way in which they are structured & financed from time to time
In chapter 1 – different types of transactions that companies can undertake
OTHER MOTIVES
- Gain control over supply chain
- Take advantage of favourable tax regimes in other countries
- Some deals are also undertaken by overconfident (hubris filled) managers who believe they can manage a
target more effectively than the target’s incumbent management
o The temptation for managers to ‘build empires’ is larger in companies w large cash reserves
o By growing a company through M&As, overconfident managers try to entrench their positions &
increase their compensation
- ‘Empire building’ transactions tend to be less successful than those undertaken for valid strategic, operating
or financial reasons. To ensure success the acquirer must:
o Be able to identify companies that are truly trading below their fair value
o Have access to funds
o Show skill in the execution of M&As
- An increasing number of joint ventures & strat alliances are also undertaken to improve companies’ ESG
performance
o The use of water is particularly NB in the beer industry as it takes about 6 litres of water to produce 1
litre of beer
CHAPTER 4
MERGER WAVES AND RECENT M&A TRENDS
LEARNING OUTCOMES
- Describe the main characteristics of the 6 horizontal merger waves identified by M&A scholars
- Compare the role that investment bankers performed in M&As before & after the third merger
wave
- Justify the claim that merger waves occur during periods of strong economic growth & robust
financial market performance
- Describe recent M&A trends in the global arena
- Describe the impact of the COVID-19 pandemic on the global M&A landscape
- Discuss the main reasons for the surge in M&A activities in the tech & health care industries due
to the advent of the COVID-19 pandemic
- Explain why the African continent might be an attractive destination for foreign investors from an
M&A POV
- Appraise some of the main challenges that acquirers experience when undertaking M&As on the
African continent
- Compare the nature of M&As in SA pre- and post-democratisation
- Explain the impact of B-BBEE legislation on M&A activities in SA
MERGER WAVES
- Six periods of intense M&A activity (Table 4.1).
o Waves develop during periods of sustained economic growth, low interest rates and rising share
prices (bull markets).
o Often initiated by technological shocks and regulatory changes.
FIRST MERGER WAVE (1897 – 1904)
- Many horizontal mergers occurred, particularly in the mining and manufacturing industries.
Example:
JD Rockefeller devised a plan to consolidate oil refineries in Cleveland into one org. He realized an industry
consolidation (or roll-up) would eliminate excess capacity & price-cutting among competitors. He handled all
negotiations personally & started by acquiring the most profitable oil refineries first – leading him to buy almost all the
competitors.
This led to a monopoly in the US oil industry, making him one of the wealthiest men in the world at that time. (He used
share-based funding which also helped him as the US interest rates later on).
- Why did these so-called industry roll-ups occur?
o To achieve economies of scale (Chapter 3).
o To gain exclusive control of raw materials and distribution channels.
- The absence of anti-trust (anti-competitive) laws and ineffective law enforcement enabled monopolists to:
o control supply / consumer choices;
o disregard consumers’ rights; and
o manipulate prices
- Wave ended when Wall Street crashed in 1904.
SECOND MERGER WAVE (1916 – 1929)
- Strong economic growth in the USA initiated this wave. New laws and stricter law enforcement resulted in
more vertical mergers.
- Several oligopolies and cartels emerged.
o A cartel is a type of oligopoly that occurs when competitors collude to create explicit, formal
agreements to fix prices and/or production quantities.
- In contrast to the 1st wave, debt was mostly used to finance transactions during this wave.
- Wave ended when then stock market crashed in October 1929.
THIRD MERGER WAVE (1965 – 1969)
- Even more & stricter legislation led to the formation of conglomerates during this wave
Example:
The general electric company was founded by Thomas Edison in 1889. It originally only manufactured electrical
equipment, but later branched out into diverse areas such as aviation, computers, plastics, banking, & even television
broadcasting. Today GE is one of the leaders in power, renewable energy & aerospace, materials science & data analytics
- The role of investment bankers changed during this wave
- Transactions were mostly financed w equity given high interest rates & booming stock market in USA
- Bull market led to excessive optimism & unrealistic valuations
- The market corrected itself in 1969
Important event in 1974: first hostile takeover
- The electric storage battery company was acquired by the international Nickel Company against the board’s
wishes
- Corporate raiders soon began to appear on the scene
o Indvs who buy companies and rip them apart “to unlock value”
FOURTH MERGER WAVE (1984 – 1989)
- Several leveraged buyouts & management buyouts occurred during this wave
- Many deals were financed w junk bonds
- Wave ended w market crash in 1989
FIFTH MERGER WAVE
- Many conglomerates unbonded to focus on core competencies – they divested non-core subsidiaries
- Some mega deals occurred – eg. Exon and Mobil
- Intense M&A activity no longer limited to the USA
o Important drivers of M&A activity during this wave:
▪ High consumer demand
▪ Globalization
▪ Deregulation of certain industries
▪ New technologies
- Most deals were financed w equity
- Spectacular growth in share prices led to excessive optimism
- Wave ended when IT-bubble burst in march 2000
SIXTH MERGER WAVE (2003 – 2008)
- M&As have become a global phenomenon
- A number of mega deals took place in Europe and Asia
- Many M&A were undertaken to acquire intangible assets
- Wave ended in 2008 due to credit crunch in USA and resultant global financial market crisis
SITUATION NOW?
2020/2021:
- Due to uncertain trading circumstances and financial challenges brought about by the Covid-19 pandemic,
global M&A activity was substantially lower in 2020 than in the preceding 3 years. Many were undertaken to
enhance companies’ ICT capabilties
- In 2021, global deal value was the highest since official record keeping commenced in the 1980s, exceeding
$5.5 trillion.10
o The previous record was set in 2007, just before the global financial crisis.
o Some attribute the 2021 record to historically low interest rates and strong equity markets.
2022/2023:
SUMMARY:
- Three criteria are necessary for the formation of a wave:
o Strong economic growth
o Low interest rates
o Rising share prices
- Excessive optimism and herding can be dangerous as it creates bubbles. When a bubble bursts, a great deal
of shareholder wealth gets destroyed
- Legislation is NB
TRENDS SHAPING THE CURRENT GLOBAL M&A LANDSCAPE
- Special purpose acquisition companies (SPACs), venture capitalists and private equity investors are playing
a more prominent role (see next slide).
- More joint ventures, strategic alliances and buyouts are taking place.
- More cross-border deals are taking place.
- Companies with sound environmental credentials are becoming more attractive targets
M&A ACTIVITY IN AFRICA
- Growth pre-2015 can be largely ascribed to:
o Positive developments in the natural resource industries
o Strong economic growth in certain African countries
o More accessible financing options
o Increased spending power amongst the rapidly growing middle class
- Impact on crises on M&As in Africa?
- Which countries have undertaken the most M&As as of late?
o SA, Morocco, Kenya, Nigeria, Egypt
- Which industries have seen the most action?
o Natural resources, technology, media, and telecommunications
- Challenges complicating the M&A process:
o Currency risks.
o Political risks (e.g. expropriation of assets without compensation, higher taxes tighter repatriation or
currency controls and restrictions on prices charged).
o Corruption.
o Red tape – laws and regulations associated with the deal
o Data security.
o Lack of reliable market data.
o Poorly maintained infrastructure.
- The way forward?
M&A ACTIVITY IN SOUTH AFRICA
- Several conglomerates were created pre-1994 due to international sanctions. Most of them unbundled post-
94 to refocus on core activities
- In 2018, M&As in SA plummeted after international ratings agencies downgraded govt bonds to junk status
- The B-BBEE Act (No. 53 of 2003) was promulgated to:
o “promote economic transformation to enable meaningful participation of black people in the
economy;
o achieve a substantial change in the racial composition of ownership and management structures
and in the skilled occupations of existing and new enterprises;
o increase the extent to which communities, workers, cooperatives and other collective enterprises
own and manage existing and new enterprises and
o increase their access to economic activities, infrastructure and skills training”.
- The act resulted in several M&As in the years since.
- Compliance levels and scorecard:
- A significant increase was noted in the & of black women being appointed as directors on the boards of
Top100 JSE-listed companies betw 2011 and 2019.
- However, only 5.45% of black women were exec directors in 2019, which was considerably lower than the
B_BBEE act’s target of 25%
- Many B-BBEE M&As have taken the form of dual-class recapitalisations.
- In 2011, the JSE created a set of listing requirements and rules that enable a secondary market for shares
previously traded on the over-the-counter BEE market.
