To Merge or Not to Merge? Mergers or acquisitions only make sense when the combined entities create greater value together than they can separately. Locate and provide a l

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JWI 531 (1202) Page 1 of 8

JWI 531: Financial Management II

Week Four Lecture Notes

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JWI 531 (1202) Page 2 of 8

MERGERS, ACQUISITIONS, AND VALUATION

What It Means

In a competitive and multifaceted market, there is a multitude of opportunities for companies to join forces

in order to leverage synergies. This can include competitors coming together to expand into new markets.

It can come from a company acquiring one of its suppliers or distributors in order to have greater control

over the supply chain. It can come from improving operating efficiencies by reducing redundant costs.

While all these can generate important strategic wins, the central question from the financial perspective

is whether the combined organization is more valuable together than apart.

Why It Matters

 Competitive dynamics are constantly changing, and even if your organization is not considering a

merger or acquisition, one of your competitors might be. And if they pull it off, they may very well

take market share from you.

 Investors need to understand how the risks and opportunities of a merger or acquisition would

impact the valuation of the companies.

 Given the frequent cultural and operational challenges that come with a merger or acquisition,

finance leaders need to help strategy leaders – including the CFO and Board – quantify the

upside and downside potential in order to assess whether it makes sense to go forward.

“Successful mergers create a dynamic

where 1+1=3, catapulting the company’s

competitiveness literally overnight.

You just have to do it right.”

Jack Welch

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JWI 531 (1202) Page 3 of 8

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

Depending on your industry, mergers and acquisitions may be relatively common occurrences, or they

may be quite rare. Either way, if you want to be a more effective financial leader or make better

investment decisions, you have to understand both why they occur and the advantages and challenges

they can bring.

The challenges in a merger or acquisition are myriad. These include, but are not limited to, the following:

 Identifying the opportunities and potential for a merger or acquisition

 Approaching the acquisition target to feel them out

 Navigating regulations and antitrust laws that place restrictions on the merger

 Valuating the acquisition or merger

 Crafting terms for the merger that will be attractive for the acquired company without

overspending

 Fending off your competitors who, if they get wind of the merger, may decide to sweep in with a

better offer

 Satisfying your lenders and shareholders who need to approve the acquisition

As if all this weren’t enough, the two companies, once the ink is dry, have to actually make the merger

work. This integration can take years. It will involve merging operating systems and HR functions, making

tough decisions about reductions in workforce, and deciding who gets promoted to bigger roles. There

are also the conflicts that can come from cultural differences and bad blood when former competitors

decide to join forces. And in the end, the merger has to make financial sense for the long term.

In light of all this, it’s tempting to just give up on mergers and acquisitions. But when done properly, they

can be a powerful way to grow the business and fend off competition. They can open doors to new

markets, improve operating efficiency by reducing redundant functions, and better leverage core

strengths and best practices from each organization.

Senior financial leaders are critical players in the merger process. In fact, no merger strategy is distinct

from a finance strategy. The two are inseparable. As you engage with the course materials and activities

this week, stay focused on the core theme of our course – the role of finance as a strategic tool. A

successful merger or acquisition is only possible when it is supported by careful financial analysis and

planning that is focused on increasing revenues, managing expenses, and reducing risk.

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JWI 531 (1202) Page 4 of 8

YOUR STARTING POINT

1. If someone asked you what a merger with one of your competitors, suppliers, or customers

could do for your business, what would you say? Could you explain the financial benefits and

risks?

2. What would happen if that same question was applied to one of your competitors? Which

companies, if they were to merge, would create the biggest disruption in the playing field?

3. As an investor interested in your company, how would a merger with your fiercest competitor

impact the valuation of the newly combined company?

4. If you are a financial leader in a merged organization, what impact would the merger process

have on your day-to-day business?

5. Can you think of examples of companies that have merged where the results were positive,

and where they were not? In terms of the latter, what went wrong?

6. How can you keep your eyes open for new merger or acquisition opportunities?

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JWI 531 (1202) Page 5 of 8

MAKING MERGERS WORK

The Building Blocks of an Acquisition

“Mergers mean change. But change isn’t bad. And mergers, in general, are very good.

They are not only a necessary part of business, they have the potential to deliver

profitable growth and put you in a new and exciting strategic position at a speed that

organic growth just cannot match. Yes, mergers and acquisitions have their challenges,

and all kinds of research will tell you that more than half don’t add value. But nothing says

you have to fall victim to that statistic.”

Winning, pp. 242-43

Our course materials this week address several topics in finance strategy related to mergers and

acquisitions. When done properly, a merger or acquisition offers a pathway to growth that outpaces what

can be achieved by organic growth alone. Of course, the key word here is properly. To break down what

a proper acquisition must include, our core text and supporting materials explore the following:

 Strategy – the reasons companies pursue acquisitions or mergers

 Due Diligence – the investigation of the target company prior to signing the agreements

 Valuation – determining what the business being acquired is worth

 Payment – options for how an acquisition can be funded

 Legal Structure – ways to maximize tax benefits and limit liabilities

 Integration – making the acquisition work

Why Should We Do This?

“[M]ergers and acquisitions give you a faster way to profitable growth. They quickly add

geographical and technological scope, and bring on board new products and customers.

Just as important, mergers instantly allow a company to improve its players – suddenly

there are twice as many people ‘trying out’ for the team.”

Winning, p. 219

In chapter 6 of The CFO Guidebook, Bragg presents an overview of the most common reasons why

companies merge. We will not attempt to replicate that summary, but below is a brief preview to set the

stage for your reading:

 Diversification to move away from the core business

 Full service to increase the number of products and services

 Geographic growth into new regions

 Market window strategy to take advantage of a new opportunity

 Product supplementation strategy to sell bundled offerings

 Roll-up strategy to acquire smaller businesses and merge them into a consolidated business

 Sales growth strategy to leverage new channels

 Synergy strategy to reduce costs

 Vertical integration strategy to have greater control over the supply chain

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JWI 531 (1202) Page 6 of 8

Whatever the drivers for the acquisition are, the critical point is that the acquisition strategies should be

active, not passive. Rather than waiting for an opportunity to surface and then evaluating it, companies

should determine what they need to do to grow, and then actively seek out potential candidates that meet

their strategic requirements.

Due Diligence

Doing your homework well in advance of the closing date for an acquisition is critical. Failure to dig deeply

enough can open the door for unpleasant surprises that can have serious financial consequences. This

investigation should include questions about why the company is interested in being acquired, what the

culture is like, how the management team and compensation plans are structured, etc. And, of course, it

goes without saying that financials must be thoroughly examined. If something doesn’t look right, you

must push and probe until you get the answers you need. Never be afraid to walk away from a deal if the

due diligence process turns up something that just doesn’t feel right. As Jack often says, you have to trust

your gut. Bragg presents a helpful checklist for this (pp. 104-110), followed by a summary of the

indicators of a strong acquisition candidate. Make sure you take time to carefully review these, especially

if your own company is considering an acquisition or merger.

How Much Should You Pay?

Overpayment for an acquisition is a huge risk, especially when companies feel they are locked in a life-

and-death battle for market share. In fact, Jack identifies this danger as one of his Seven Pitfalls of

Mergers and Acquisitions. “The sixth pitfall is paying too much. Not 5 or 10 percent too much, but so much

that the premium can never be recouped in the integration” (Winning, p. 237). In our course materials, you

will review various methodologies that CFOs and analysts use to value an acquisition, including:

 Liquidation value

 Enterprise value

 Multiples analysis

 Discounted cash flows

 Replication value

 Comparison analysis

 Strategic purchase

Still, as a veteran of well over one thousand acquisitions during his tenure at GE, Jack reminds us:

“There is no real trick to avoiding overpayment, no calculation you can use as a rule of

thumb to know when a sum is too much. Just know that, except in very rare cases of

industry consolidation, if you miss a merger on price, life goes on. There will be another

deal. There is no last best deal – there’s just deal heat that makes it feel that way.”

Winning, pp. 238-39

Of course, identifying and valuing the acquisition is just the beginning. Bragg devotes the second half of

the chapter to options for funding and managing the integration – a must read for financial leaders!

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JWI 531 (1202) Page 7 of 8

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes

for the week and how they can be applied to your job.

 Examine the potential benefits of mergers and acquisitions

Consider the opportunities that exist in your own business and market. Never assume that even if

you’re not at the top of the ladder, you can’t uncover great opportunities for a merger or

acquisition. Think about the suppliers you deal with. Is there anything you hear from their reps

that could be a hint they are open to being acquired? What about your customers? If you are in a

B2B business, there may be benefits from a closer integration with a wholesaler or distributor for

one of your products. And, of course, don’t forget about your competitors. Don’t let rivalries blind

you to the potential benefits of joining forces. It’s better to consider this before you pick up the

paper and read that two of them have just announced a merger or acquisition that radically

disrupts the playing field and could put you out of business. If you have an idea, flesh it out. Bring

it to your boss. You never know where there may be opportunities.

 Explore methodologies to value an acquisition target

Accurately assessing the valuation of acquisitions and mergers can be especially difficult. Even

the most seasoned financial experts get it wrong all the time. Why? The answers run the gamut

from “circumstances have changed” to “the integration didn’t go as planned.” Still, every

acquisition or merger has to be assigned a value. Review the text section in chapter 6 of The

CFO Guidebook on valuation methodologies. Do some real-world research by looking at

companies who have merged over the last few years. How has their stock price changed? Have

they grown more than they would have on their own? How could you validate that? What are

their CEOs saying publicly about the success of the merger? Do the analysts agree? Why or why

not?

 Assess the advantages and disadvantages of different ways to fund an acquisition

As you look at real-world examples, pay attention to how the acquiring company paid for the

acquisition. Paying cash or borrowing is often a sign that the acquiring company is in a strong

financial position with plenty of cash in reserves. It also suggests the company is confident that

its own stock price will rise significantly above current prices, and thus, they want to hang on to

as much of it as they can. However, equity ownership is one of the greatest drivers of employee

performance. Paying for an acquisition with stock gives stakeholders in the acquired company

(which now own shares of the parent company) a strong motivation to make the merger work. If

you have identified a potential merger or acquisition target for your own company, how would

you fund it, and why?

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JWI 531 (1202) Page 8 of 8

ACTION PLAN

To apply what I have learned this week in my course to my job, I will…

Action Item(s)

Resources and Tools Needed (from this course and in my workplace)

Timeline and Milestones

Success Metrics