Question 1

Discuss why mergers and acquisitions occur.

Accepted Answer

The primary motivations for M&As include an attempt to realize synergy by combining the acquiring and target firms, diversification, market power, strategic realignment, hubris, buying what are believed to be undervalued assets, so-called agency problems, managerialism, and tax considerations. Synergy is the notion that combining two firms results in a valuation of the combined firms that exceeds the sum of the two firms valued on a standalone basis. Synergy represents the incremental cash flows only achievable by combining the acquirer and target firms. Synergy is often realized by achieving economies of scale, the spreading of fixed costs over increasing levels of production, or economies of scope, the utilization of a specific set of skills or an asset currently employed to produce a specific product to produce related products. Financial synergy represents another source of increased value that may be realized by lowering the combined firm's cost of capital if the new firm experiences lower overall transaction costs in raising capital and a better matching of investment opportunities with internally generated funds. Diversification may be either related or unrelated. Both forms represent an effort by the acquirer to shift assets away from a lower growth, less profitable focus to a higher growth, potentially more profitable area. Strategic realignment represents a radical departure from a firm's primary business to another area of focus often because of changes in regulations or technology, which makes obsolete the firm's primary business.
Hubris is often the motivation for M&As even if the market correctly values a firm, since the acquiring firm's management may believe that there is value in the target firm that investors do not see. Firms may also be motivated to buy another firm if the firm's market value is less than what it would cost to replace such assets. Agency problems arise when there is a difference between the interest of incumbent managers and the firm's shareholders. By acquiring the firm, value is created when managers whose interests are more aligned with shareholders replace current management; and, as such, these new managers are more inclined to make value enhancing investments rather than those intended to entrench management or contribute to their overall compensation. Firms may acquire another firm to achieve greater market share in an effort to be able to gain more control over pricing. Managerialism is a situation in which a firm's managers acquire other firms simply to increase the acquiring firm's size and their own compensation. Finally, an acquirer with substantial taxable income may wish to acquire a target firm with significant loss carryforwards and investment tax credits in order to shelter more of their taxable income.

Question 2

What are the critical assumptions that Microsoft is making in buying Nokia? Do you believe these assumptions are realistic? Explain your answer.

Accepted Answer

The key assumption Microsoft is making is that the marketplace wants an alternative to Google's Android and Apple's IOS operating systems. The marketplace consists of distributors, handset manufacturers, app developers, and end users. Distributors such as Verizon, AT&T, and Vodafone can use the option of another operating system to gain leverage in their negotiations with vendors. The same thing is true with handset manufacturers such as Samsung and HTC. However, app developers may be less enthusiastic about Windows Phone 8 powered Nokia handsets, because they represent such a small installed base of users. From the viewpoint of end users (those actually using the smartphone), the existing operating systems (Android and IOS) and hardware manufacturers such as Apple and Samsung have created huge entry barriers for Microsoft such as their wide appeal and huge user bases. It is unclear if Microsoft teaming with Nokia can come up with a demonstrably superior product to drive customers away from existing operating systems and handset vendors.

Question 3

Using the motives for mergers and acquisitions described in Chapter 1, which do you think apply to Microsoft's acquisition of Nokia? Discuss the logic underlying each motive you identify. Be specific.

Accepted Answer

Microsoft has been struggling to strategically realign itself into a leading global mobile technology competitor due to the market shift to smartphones and tablet computers to offset the substitution of these new technologies for its PC products. The failure to do so threatened the entire Microsoft franchise. Initially, the firm tried to introduce its own smartphone operating system and to license it to wireless carriers with little success. This was followed with an unsuccessful partnership with Nokia. Frustrated in these efforts, the firm achieved complete control by acquiring Nokia. This move represented related diversification in that Microsoft was vertically integrating into the handset business in an effort to integrate its Windows Phone 8 operating system with hardware (handsets). It should be considered related diversification in that it represented the sale of existing products (i.e., a Microsoft operating system powered handset) that it had been selling under the prior partnership with Nokia to its current customers.
Microsoft also was motivated to buy Nokia's undervalued assets in that such a move represented a less expensive alternative to building a handset manufacturing capability within Microsoft. Potential operating synergies could be realized by merging global marketing and distribution activities and administrative overhead. Also, certain purchase price discounts could be realized by buying chips commonly used in both smartphones and tablets in larger volumes. Tax considerations also may have played a role in that Microsoft was able to avoid paying a high tax rate on profits repatriated to the U.S. by using such profits to pay for the takeover of Nokia.

Question 4

A divestiture is the sale of all or substantially all of a company or product line to another party for cash or securities.

Accepted Answer

Divestiture involves selling all or a significant part of a company or product line. This can be done for cash or securities, and the assets being sold are typically no longer considered part of the company's operations.

Question 5

In your opinion, what are the motivations for two mergers or acquisitions in the news?

Accepted Answer

The answer of In your opinion, what are the motivations...

Question 6

Dow Chemical, a leading chemical manufacturer, announced that it had reached an agreement to acquire in late 2008 Rohm and Haas Company for $15.3 billion. While Dow has competed profitably in the plastics business for years, this business has proven to have thin margins and to be highly cyclical. By acquiring Rohm and Haas, Dow will be able to offer less cyclical and higher margin products such as paints, coatings, and electronic materials. Would you consider this related or unrelated diversification? Explain your answer. Would you consider this a cost effective way for the Dow shareholders to achieve better diversification of their investment
portfolios?

Accepted Answer

The answer of Dow Chemical, a leading chemical manufacturer, announced...

Question 7

In 2000, AOL acquired Time Warner in a deal valued at $160 billion, excluding assumed debt. Time Warner isvthe world's largest media and entertainment company, whose major business segments include cable networks, magazine publishing, book publishing and direct marketing, recorded music and music publishing, and film and TV production and broadcasting. AOL viewed itself as the world leader in providing interactive services, Web brands, Internet technologies, and electronic commerce services. Would you classify this business combination as a vertical, horizontal, or conglomerate transaction? Explain your answer.

Accepted Answer

The answer of In 2000, AOL acquired Time Warner in...

Question 8

On September 30, 2000, Mattel, a major toy manufacturer, virtually gave away The Learning Company, a
maker of software for toys, to rid itself of a disastrous foray into software publishing that had cost the firm
literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit
to an affiliate of Gores Technology Group for rights to a share of future profits. Was this related or unrelated
diversification for Mattel? How might this have influenced the outcome?

Accepted Answer

The answer of On September 30, 2000, Mattel, a major...

Question 9

Joint ventures are cooperative business relationships formed by two or more separate parties to achieve common strategic objectives

Accepted Answer

This statement accurately describes joint ventures.

Question 10

A merger of equals is a merger framework usually applied whenever the merger participants are comparable in size, competitive position, profitability, and market capitalization.

Accepted Answer

A merger of equals usually refers to a merger where both companies are similar in size, competitiveness, profitability, and market capitalization, making it an appropriate framework for such a scenario.

Question 11

At a time when natural gas and oil prices were at record levels, oil and natural gas producer, Andarko Petroleum, announced on June 23, 2006 the acquisition of two competitors, Kerr-McGee Corp. and Western Gas Resources, for $16.4 billion and $4.7 billion in cash, respectively. These purchase prices represent a substantial 40 percent premium for Kerr-McGee and a 49 percent premium for Western Gas. The acquired assets strongly complement Andarko's existing operations, providing the scale and focus necessary to cut overlapping expenses and to concentrate resources in adjacent properties. What do you believe were the primary forces driving Andarko's acquisition? How will greater scale and focus help Andarko to reduce its costs? Be specific. What are the key assumptions implicit in your argument?

Accepted Answer

The answer of At a time when natural gas and...

Question 12

Pfizer, a leading pharmaceutical company, acquired drug maker Pharmacia for $60 billion. The purchase price represented a 34 percent premium to Pharmacia's pre-announcement price. Pfizer is betting that size is what matters in the new millennium. As the market leader, Pfizer was finding it increasingly difficult to sustain the double-digit earnings growth demanded by investors. Such growth meant the firm needed to grow revenue by $3- $5 billion annually while maintaining or improving profit margins. This became more difficult due to the skyrocketing costs of developing and commercializing new drugs. Expiring patents on a number of so-called blockbuster drugs intensified pressure to bring new drugs to market. In your judgment, what were the primary motivations for Pfizer wanting to acquire Pharmacia? Categorize these in terms of the primary motivations for mergers and acquisitions discussed in this chapter.

Accepted Answer

The answer of Pfizer, a leading pharmaceutical company, acquired drug...

Question 13

The Nokia takeover is an example of vertical integration. How does vertical integration differ from horizontal integration? How are the two businesses (software and hardware) the same and how are they different? What are the potential advantages and disadvantages of this vertical integration for Microsoft? Be specific.

Accepted Answer

The answer of The Nokia takeover is an example of...

Question 14

The target company is the firm being solicited by the acquiring company.

Accepted Answer

The target company is the company that the acquiring company is attempting to acquire.

Question 15

What are the arguments for and against corporate diversification through acquisition? Which do you support and why?

Accepted Answer

The answer of What are the arguments for and against...

Question 16

What is the role of the investment banker in the M&A process?

Accepted Answer

The answer of What is the role of the investment...

Question 17

A vertical merger is one in which the merger participants are usually competitors.

Accepted Answer

A vertical merger involves companies at different stages of production for a specific product or service, not competitors at the same stage.

Question 18

What are the primary differences between operating and financial synergy? Give examples to illustrate your statements.

Accepted Answer

The answer of What are the primary differences between operating...

Question 19

Speculate as to why Microsoft used cash rather than some other form of payment to acquire Nokia?

Accepted Answer

The answer of Speculate as to why Microsoft used cash...

Question 20

Speculate as to why Microsoft and Nokia initially decided to form a partnership rather than have Microsoft simply acquire Nokia? Why was the partnership unsuccessful?

Accepted Answer

The answer of Speculate as to why Microsoft and Nokia...

Quiz 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities