Value creation or destruction. Similarities and differences between the cross-border transactions of KUKA AG and Adam Opel AG

Contents

Abstract

List of Figures

List of Tables

List of Abbreviations

A: Theoretical Part
1 Introduction
2 Business Alliances – Alternatives to M&A
2.1 Definition of business alliances
2.2 Forms of business alliances, benefits and drawbacks
3 Mergers and Acquisitions
3.1 Definition of and types of M&A
3.2 Motives, benefits and drawbacks of M&A
3.3 Advantage and disadvantages of M&A relative the alternatives
3.4 Corporate takeover market and common practice
4 The M&A Process
4.1 Stage 1 – Strategic analysis and concept
4.2 Stage 2 – Transaction
4.3 Stage 3 – Post merger integration

B: Practical Part
5 Value definition and valuation basics
5.1 Definition of value
5.2 Restructuring value
5.3 Stakeholder vs. shareholder value and value drivers
5.4 Value of synergies
5.5 Value creation in cross-border M&A
5.6 Common calculation methods
5.7 Multiples (relative valuation)
5.8 Discounted cash flow
6 Pre-merger analysis and valuation by the example of KUKA AG
6.1 M&A market and process in China
6.2 Pre-merger analysis
6.3 Screening of KUKA AG
6.4 Valuation by transaction multiples
6.5 DCF Valuation of KUKA AG and Midea Group
6.5.1 Risk parameters and cost of capital (WACC)
6.5.2 Estimation of earnings and cash flows
6.5.3 Estimation of growth rate
6.5.4 Terminal value calculation
6.5.5 Summary and results of DCF model
6.6 Synergy projection and evaluation of takeover effects
6.7 Interim result
7 Pre-merger analysis and valuation by the example of the Adam Opel AG
7.1 Screening of Opel AG
7.2 Valuation of by CTA multiples
7.3 DCF Valuation
7.3.1 Estimation of risk parameters and cost of capital
7.3.2 Estimation of earnings and cash flows
7.3.3 Estimation of growth rate
7.3.4 Terminal value calculation
7.3.5 Summary and results of DCF model
7.4 Synergy projection and evaluation of takeover effects
7.5 Second interim result
8 Discussion and outlook

References

List of Appendices

9 References

Abstract

The global Mergers & Acquisitions (M&A) market has reached new all-time highs since the meltdown of the financial crisis in 2008. In 2015, the global M&A transaction volume reached its peak amounting to USD 4.7 trillion. While this way of strategic inorganic growth is often aimed at creating value to its shareholders and stakeholders respectively, the major concern of value creation using M&A remains. Recent studies testify a negative performance from the buyers’ perspective, as such as about 60% - 70% of all M&A transactions fail to generate value.

Among others, the reasons include flawed valuation and thus overestimations of synergies and to unexpected high integration costs lead to value destruction. While these reasons hold true for domestic acquisitions and developed markets, there are further reasons for cross-border transactions, particularly for China, as Chinese buyer play an increasing role in worldwide M&A activities. Value destruction in such cross-border transactions is mostly associated with cultural differences, poor communications between the involved parties, lack of experience or local market know how.

The findings suggest that the probability of value creation is higher if a buyer has broad experience in M&A activities, undertakes many small acquisitions, focus on cost reduction rather than growth motives and understands the market of the target company. The acquisitions of KUKA AG and Opel AG show many positive attributes, which lead to a higher probability of value creation. Beyond that, both companies are familiar with their targets and gained experience in acquisitions, which further reduce the factors that might lead of value destruction.

List of Figures

Figure 1: Investment stages in M&A

Figure 2: M&A deals worldwide by number and value

Figure 3: Number and value of M&A deals by industry 1985-2016

Figure 4: Different types of acquisitions

Figure 5: M&A process

Figure 6: Stage 1 of an acquisition

Figure 7: M&A Process – Stage 2

Figure 8: Post merger and integration phase

Figure 9: Pricing in M&A transactions

Figure 10: Stakeholder groups

Figure 11: Shareholder value approach

Figure 12: DCF value drivers

Figure 13: Valuation methods

Figure 14: Combined free cash flow calculation

Figure 15: Midea company overview

Figure 16: Midea company facts & industry comparison 2015

Figure 17: Revenue streams of Midea Group (2016)

Figure 18: SWOT analysis Midea

Figure 19: World robotic industry overview

Figure 20: Robot density in selected countries and wages in China

Figure 21: KUKA revenues

Figure 22: Demography and robots sold in China

Figure 23: Weighted WACC KUKA AG

Figure 24: Bottom-up beta and CRP Midea

Figure 25: Revenues PSA Group

Figure 26: Overview automotive industry

Figure 27: SWOT– analysis PSA

Figure 28: Opel revenue and EBIT development

List of Tables

Table 1: Advantages and disadvantages of alliances

Table 2: M&A dimensions

Table 3: M&A advantages and disadvantages

Table 4: Business plan requirements

Table 5: Three-stage environmental analysis

Table 6: Product/market matrix

Table 7: Characteristics of selling and buying companies

Table 8: Typical restructuring disciplines

Table 9: CTA analysis KUKA AG

Table 10: Summary of WACC Calculation Midea/KUKA

Table 11: FCFF calculation KUKA

Table 12: R&D expenses KUKA

Table 13: Operating lease commitments KUKA

Table 14: R&D expenses Midea

Table 15: High growth rate KUKA AG

Table 16: High growth Rate Midea Group

Table 17: Normalized net cap ex growth

Table 18: Non-cash nwc KUKA AG

Table 19: DCF calculation KUKA AG

Table 20: Net Capex and non-cash nwc growth Midea Group

Table 21: DCF calculation of Midea Group

Table 22: Assumptions for synergies Midea & KUKA

Table 23: DCF for synergies Midea & KUKA 1

Table 24: DCF for synergies Midea & KUKA 2

Table 25: CTA Opel AG

Table 26: Operating income growth PSA

Table 27: DCF calculation Adam Opel AG

Table 28: Net cap ex and non-nwc growth PSA

Table 29: Lease adjustments PSA

Table 30: DCF calculation PSA Group

Table 31: Synergies PSA & Opel

Table 32: DCF for synergies PSA & Opel

List of Abbreviations

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A: Theoretical Part

1 Introduction

Merger and Acquisitions activities are strategic options for companies to enhance their competitive position. There are many reasons for companies engaged in M&A, achieving synergies, market power, diversification or cost reduction are only few of them. Not only buyers from the developed markets but also buyers from emerging markets play an increasing role in M&A activities. The tripled transaction volume from USD 259 bn. to USD 735 bn., between 2013 and 2015, indicates the increasing appetite of Chinese buyers. The scarcity of attractive domestic targets leads Chinese buyers to consider targets abroad.¹

The current favorable environment, for example the historic low level of the average cost of capital since 2004, and the high volume of capital available in the market, propels worldwide M&A activities. The new peak in worldwide deal volume of USD 4.7 trillion in 2015 supports this argument.² In comparison to the peak in 2015, the deal volume thirty years ago 1985 amounted to only USD 347 billion.

Globalization and technological development are one of the main drivers for the sharply increasing Cross-border M&A that reached 36% of the worldwide M&A market.

On the one hand, M&A activities are highly complex; this is demonstrated by the fact, that more than 58% of all deals between 1992 and 2006 destroyed the acquirer’s shareholder value. On the other hand, M&A can also create value for the targets investors.³ Despite the rising appetite in China, the probability to create value for South East Asian buyers is at a low level of only 24%. This may imply diverse reasons such as cultural differences, poor communication, lack of experience or local market know how and overpaying premiums. Even though, Chinese buyers undertake more and more acquisitions, the buy side gains more experience and becomes more professional in execution.⁴

Good examples for recent undertaken acquisitions, in developed and emerging markets represent the recent acquisitions of Adam Opel AG by the France based PSA Group and, KUKA AG by the China based Midea Group.

The main purpose of this paper focuses on the analysis of similarities and differences of the two transactions. Moreover, this paper examines if value can be created or is destroyed by the transactions, and which factors have the most impact on value creation.

This paper is comprised of a theoretical (A) and a practical part (B). Part A serves as a theoretical background for the practical application. The next section provides a description of the applied methodology to this paper. Chapter 2 describes the alternatives for M&A and the third chapter focuses on the theory M&A. The next chapter describes a typical M&A process and the steps, which are also used in the analysis in the sixth chapter. Chapter 5 continues with a definition of value, valuation basics and how value can be created. In the sixth chapter a pre-merger analysis and a valuation by the example of KUKA AG are performed, that is based on the predefined theoretical framework, ending with an interim result. Chapter 7 focuses on a pre-merger analysis and valuation by the example of the Opel AG, concluding with a second interim result. The last chapter summarizes the main results and conclusions.

The methods conducted in this thesis are qualitative and quantitative. Qualitative aspects covered by the analysis of the different transactions are based on theoretical practices performed in an M&A process. The quantitative analysis is based on relative and DCF valuation and a synergy projection in order to make conclusions whether value can be created or not. There is a wide literature on the implications of mergers and acquisitions, especially cross-border acquisitions and the market for corporate control for value creation. This paper shows data regarding past acquisition success factors. In addition, it provides the existing evidence suggesting what type of firm characteristics make it more likely that a particular merger will generate or destroy shareholder value. This paper relies on recent studies that analyze samples of mergers that have taken place during the last decade.

2 Business Alliances – Alternatives to M&A

Business alliances represent feasible alternatives to M&A, in as much as they might create more value and thus make more sense for companies than M&A. The following chapters will explain forms of business alliances such as joint ventures, strategic partnerships, and business partnerships. Moreover, this chapter will give a brief overview with respect to the advantages and disadvantages of business alliances.

2.1 Definition of business alliances

Business alliances or strategic alliances refer to all kinds of business combinations different from mergers and acquisitions.⁵ An alliance can be described as a cooperative agreement between at least two parties. These two companies combine their resources and capabilities in order to achieve common and individual strategic goals. Individual companies that make up the alliance remain autonomous compared to other forms of strategy implementation at the corporate level e.g. mergers and acquisitions. Moreover, an alliance is a voluntary agreement to exchange resources, provisions of services, products, or technologies in co-development.⁶ In addition, alliances do not require a formation of a separate legal entity and may be a preliminary step to a joint venture, partnership or an acquisition. In general, alliances are not passive, therefore imply cross-training, coordinated product development, and long-term contracts based on quality measures rather than price.⁷

Competition clause:

Alliances are established to create competitive advantage. Therefore, competitive impacts to the partners have to be discussed before forming an alliance. An alliance agreement can be exclusive or not exclusive. An exclusive alliance excludes entering into a similar cooperation with other organization. It may lead to better partner commitment. However, exclusivity is not always preferable, because it can limit the development of a company and the incentive to improve. Hence, if a company recognizes, that its partner may form another alliance, it will be pressured to improve and develop itself. Moreover, agreements may be established in that way, that rules are set that prescribe how the companies will compete after the alliance ends. So, it can be agreed on if the companies will compete after the alliance ends or not. In contrast, the companies can agree on a non-competition clause that prohibits to compete in each other’s territories or the alliance territory for several years. Additionally, it is necessary to clarify if the knowledge exchanged and generated through the alliance is confidential or can be shared with others.

Exit agreement:

As the nature of an alliance is temporary, corporations have to think about what will happen after the ending of such an alliance. Exit clauses may help to deal with difficult issues that may arise in future e.g. ownership of intellectual property rights, dissolution costs, geographic market allocation, reasons and timing for an exit and much more. Well thought out exit clauses not only help to reduce risk but also save the partners legal costs.

Informal aspects of alliances:

Informal factors may enhance the formal framework of an alliance agreement. Such issues may improve the communication between the partners, which is vital for any partnership. Examples of these informal aspects are e.g. personal relationship between the partners, common norms and values for the behavior in an alliance, right skills and knowledge background, trust and commitment and informal communication such as sounding out ideas or managing expectations, empathy for the partner’s perspective, flexibility for agreements depending on the circumstances, strategic outlook and many other things. Such aspects can be seen as a psychological contract between the partners’ in changing and uncertain environment. If those aspects do completely not correspond with the potential partners’ view, it might be not the right partner for an alliance.⁸

2.2 Forms of business alliances, benefits and drawbacks

A joint venture, a special form of strategic alliance, is a commitment of funds, facilities, and services by two or more legally independent parties, for a limited duration, committing them to a company doing business in common, sharing business profits and losses, risks and chances, and aiming for long-term cooperation.⁹ Joint ventures can be differentiated according to the direction of cooperation and capital or voting rights. Therefore, a joint venture with one or several parties in the same sector is called a horizontal joint venture. On the other hand, a vertical joint venture is when the parties have in down- or upstream activities according to the value chain. Moreover, there is a contractual and an equity joint venture and it can be created between foreign partners and between foreign and local partners. A contractual joint venture is where the parties form a joint venture with the intention to complete a certain project, without creating a separate entity and of limited time (long-term or short-term). An entity joint venture is established by creating an entity, which is owned by the parties, especially founded subsidiaries or by purchasing an existing entity in equal or agreed proportions. The newly formed entity can take different legal forms available under applicable national, state or local law.¹⁰ Joint ventures are often established to enter foreign markets where the party of the host country requires to gain access to the market in exchange of progressive technology and know-how. The advantages of such alliances can result in positive and negative directions. On the one hand, a joint venture can lead to strong ties, trust, and commitment between the partners. On the other hand, such alliance can imply long negotiations and significant costs. Moreover, dissolving the joint venture, if it did not work out as expected can also lead to noteworthy expenses. Additionally, the shared know-how with the new partner can be abused by inappropriate conduct. Lastly, any profit must be shared between all partners.¹¹

Partnerships

A partnership is a form of business alliance and describes a cooperative relationship between at least two partners, which is organized in a legal form. There are two main distinctions characteristics of partnerships, general partnerships, and limited partnerships. A general partnership is typical for the allocation of investments, profits, losses, and operational responsibilities to the partners. A partnership is favorable when the cooperation is expected to be for a short-term (three to five years) and a high degree of commitment by the management is required. The advantages of a general partnership can be summarized as double taxation avoidance because the profits and losses are allocated to the partners, is very flexible in regards of investment, profit and loss and responsibility allocation. The disadvantages are, that the partners have unlimited liability and therefore each partner is jointly liable for each of the debts of the partnership. The partnership lacks continuity of a corporate structure because it must be dissolved if one partner dies. Moreover, the partnership interests are illiquid because there is no public market for interests. Finally, each party has the right to bind the partnership to contract, if one partner decides to buy inventory for the company, the other partner is obligated to pay if the other partner cannot afford it. Regarding mergers and acquisitions, partnerships intended to hold for short-term periods, therefore unwinding the partnerships after a merger could be very complicated due to the interest involved in the acquired or merged company.¹²

Licensing

Licensing is generally a long-term contract that allows firms to exploit intellectual property such as a patent, trademark or copyright in exchange for a royalty or fee.¹³ There is no sharing of risk or reward for such an agreement. Generally, there are two parties in such an agreement, a licensor who is the owner of the right or intellectual property and the licensee or license holder who acquires the rights of use of such a license.¹⁴ The payments to the licensor are based on the future sales made by the license holder.¹⁵ Moreover, licensing is not a stand-alone strategy, it is rather a part of the marketing-mix inhabited in a marketing strategy of a company. Therefore, it aims to offer new products or services, to keep existing offers and customers and also to acquire new customers. Consequently, licensing is a strategy for the licensor as well as the license holder to reach strategic goals of the company.¹⁶ From the perspective of the licensor, the advantages of a license are the expansion and maintenance of market shares and also the revenue streams. On the other hand, the license holder is able to use an existing brand, product or service which does not have to be created, which is mostly cheaper than creating or developing an own brand, product, or service. Moreover, the choice of the license holder by the licensee can be very difficult and may include risks as the creditworthiness of the licensee, that means if the licensee is able to pay at all. Additionally, the licensor has to be aware of the risk, that giving the license to a wrong licensee can harm the image of the company. Especially, if the license is given to a producer in a less developed country, where production or ecological and other standards are not the same as in the home country of the licensor. Nevertheless, licensing can reduce entrepreneurial risk. Product development, advertisement, and particularly the specification in the new markets can be highly time and money consuming in advance of market entry.¹⁷

Table 1 summarizes the advantages and disadvantages of the above mentioned business alliances.

Table1: Advantages and disadvantages of alliances.¹⁸

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The next chapter discusses the M&A subject in detail and points out, in which cases M&A makes more sense in comparison to business alliances.

3 Mergers and Acquisitions

This chapter defines the term M&A, explains the most important types of M&A, summarizes the motives M&A transactions, discusses the advantages and disadvantages of M&A in contrast to alternatives. It further gives a brief overview of the M&A market and the common practice applied in transactions.

3.1 Definition of and types of M&A

Mergers and acquisitions is a strategic instrument to achieve corporate and business objectives. Business objectives refer to strategies to achieve, maintain or strengthen competitive advantage in product markets. Whereas, corporate strategy relates to options a company has to optimize the portfolio of business that it already is engaged in and, how this portfolio can be diversified to serve the interest of the firms stakeholders.¹⁹ However, corporate takeovers, mergers or acquisitions are often referred to as mergers and acquisitions, whereas these terms must be clearly differentiated. Thus, a takeover or an acquisition is defined as activities, where the acquiring companies are able to control over 50% of the equity of a target firm. Unlike in an acquisition, at least two companies are combined into an entirely new legal entity. Simply stated a merger is A + B = C, where A, B,C represent legal entities respectively. ²⁰ Other authors define a merger as ‘‘a merger is a combination of two or more businesses in which only one of the corporations survives”. ²¹ In an acquisition, one firm takes over the ownership of another and integrates into their own organization. The acquirer often pays a premium for the acquired company (target), that is above the market value.²² An acquisition can be either a share deal, this is when company shares are transferred to another company, an asset deal. This is when all or certain assets and liabilities are transferred to another company or a combination of both. A typical result of an acquisition of the target company is a partial or complete loss of independence whereas the acquirer does not.²³ In the context of this paper mergers and acquisitions will be used as a term for corporate takeover, where the acquirer seeks to gain the controlling interest (acquiring over 50%) of a company.

M&A transactions can be characterized according to different dimensions and characteristics. Table 1 shows a summarized overview according to Jansen, which is separated in characteristics and forms of combinations. While the most are self-explanatory the most important will be explained in detail and also further types will be added in the following chapters.

Table2: M&A dimensions.²⁴

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The types of M&A can be distinguished according to their strategic focus. The strategic orientation is derived from the strategic goals and motives. These motives and goals are mainly reflected by the direction of the acquisition. There are three types of directions, horizontal, vertical and lateral, which is also called conglomerate.

Horizontal means, that the merging companies are competitors in the same sector or industry and are on the same level on the value stage. The goals of a horizontal transaction are to increase capacity and therefore market consolidation. Moreover, volume effects or economies of scale, that means positive impacts on the cost structure through increasing product quantity within the own value chain and synergies that are achieved through a broader product range. Additionally, a higher efficiency, especially in research and development, production and also in distribution, can be realized through successful integration. A vertical combination is when the companies are in the same sector or industry but in a different phase of the value chain. This can be further subdivided in a downstream or upstream integration also called backward or forward integration. Downstream means that a customer will be acquired or integrated, while upstream means, that supplier will be acquired or integrated. The goal of a vertical integration is therefore an increase in production and performance depth. Synergies may be achieved by the reduction of interfaces and optimized processes in contrast to the previous supplier or customer. Further reasons a vertical direction are access to technological components that are owned by a supplier or access to end customers without intermediate distribution stages. Finally, a lateral integration or conglomerate is, when companies integrate other companies that are not in the same sector or industry, so there is no compliance with the product or market. The goal of such a transaction is mostly a diversification of the own product portfolio in order to spread risks.²⁵

Acquisitions can be distinguished between minority, parity, majority and complete acquisition of shares. Minority interest generally do not allow controlling influence on the target company by the acquirer. The first important level of minimum level on influence is the blocking minority which may vary from country to country. As an example, in Germany the blocking minority is reached with 25% of the capital, in France e.g. 33,33%. Investors who reach that blocking minority can influence and prevent important decision, these are change of corporate statutes, business purpose of the company, suspension of subscription rights, contingent capital increase and closing of company contracts. However, if the capital spread is high and many shareholders are often not present at the annual general meetings, having less than 50% of all shares may lead to a majority. Minority interest are often used for strategic alliances, where competences and cooperations are mostly regulated by contracts. Minority interests are advantageous because of the low capital intensity; companies are able to realize strategic objectives. However, an integration of the company and therefore synergies cannot be realized. Only a majority participation (>50%) allows controlling interest in a target company, which is an acquisition in narrow sense. Due to the acquisition the company is considered a group, which leads to a unified management system. Strategic investors mainly have interest in a majority acquisition to achieve their goals. An important threshold within the majority is the elimination of the blocking minority. An entire freedom to act is only assured, if the acquirer has 100% of the target company. In addition to a minority and majority stake, it is also possible to acquirer exactly 50% of a company. In such case, the control of the company is dependent on the ownership structure of the other 50%. A special case is, when two partner companies have 50% stake in another company, this is called a parity joint venture. Thus, important corporate issues can be solved only jointly.²⁶

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Figure1: Investment stages in M&A.²⁷

Types of buyers

The types of buyers can also categorize M&A acquisitions. There are three main groups, such as strategic buyers, the management of the company and finance investors. Strategic buyers have the intention to gain control over all activities in a company in order to raise the company’s value. They are mostly in the same or a related industry. Increasing market share through an international acquisition or buying patents in order to produce a new product generation are typical strategies of this group. Hence, strategic buyers have a long-term engagement in companies and an exit strategy is not their primary focus. A special party of strategic buyers is the management of the company or in the most cases the business area. In such a Management Buy Out (MBO), the management of a business area acquires the control of the activities or the property rights of the managed business area from the mother company. Such transactions have many diverse advantages for the acquirers as well as for the M&A process. However, the last group are the financial investors. Finance investors, in this context are mainly Private Equity (PE) companies. In contrast to strategic investors, finance investors such as private equity investors, invest only for a medium-term (5-7 years), whereat the exit is dependent on a possibly high rate of return.²⁸

Private & public M&A

The relation between buyer and seller is categorized as public or private takeover depending on whether the target is a listed company (public takeover) non-listed company (private takeover). In a private transaction, the acquirer negotiates with certain shareholders of the target company. The relationship is closer and direct and the contractual takeover offer has not to be published. Such a transaction is also less regulated than a public takeover. Thus, in the second case in a public takeover the acquire must deal with many shareholders (owners) of a company, and therefore has to submit the takeover offer publicly. The relationship between buyer and seller is mostly anonymously. The main negotiating partner here is the management board.²⁹

Cross-border M&A

M&A can have an international context, which is not directly noticeable for all parties. A merger can be cross-border even if both companies are domestic located companies. This takes place, if the target company have substantial operations or shareholders in foreign countries. A better example for a cross-border transaction is, if both companies are located in different countries. However, the business and the legal concept of such transactions are mostly similar to an usual acquisition. Nevertheless, there are special issues that must be identified and managed. Besides different foreign practices, international antitrust laws must be considered, moreover other laws such as employment laws and labor relations. Not to forget, the tax consequences are also subject of such transactions.³⁰

Distressed M&A

The term “distressed” in context with M&A refers to “financial distress” of a company, more precisely a financial and an economic crisis. There are different views regarding the definition. From the Anglo-Saxon point of view: „Financial distress, by definition, occurs when firms’ cash flows are low in relation to their fixed contractual obligations.“³¹ However, the functional application is dependent on how the transaction process or the funding for a sale (Sell Side) or an acquisition (Buy Side) of a distressed company differs from a healthy company. Other authors delimit financial distress from economic distress, according to that financial distress is linked to a company’s debt equity ratio (leverage) decision due to the company’s broken promise to creditors or difficulty to settle its obligations. Whereas, an economic distress means that the company’s operations are not efficient and therefore there is no connection with the firm’s leverage. Thus, financial distressed companies may have viable real assets operations and therefore are not economically distressed.³²

3.2 Motives, benefits and drawbacks of M&A

General Motives

Mergers and Acquisitions can be regarded as a strategic form of corporate development with which companies react to changing economic environment. In general, every M&A transaction provides opportunities and risks for the parties involved. The motives for M&A activities are mainly focused on the positive outcome of a transaction. These motives are separated into real motives, speculative motives and management motives.³³ The following explanations will mainly consider real and management motives.

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Real Motives:

- Market power/ monopoly hypothesis:

The company’s ability to control the quality, price and supply of its products, as a positive effect of the scale of their operations, is called market power.³⁴ Takeover may promise a fast opportunity to grow and can be seen as a strategy for a company to widen the control over a broad geographic region and also increase the business sphere.³⁵ Monopoly allows to generate “monopoly income” in procurement or in distributional channels and is tried to be achieved through M&A.³⁶

P rocurement market: Avoidance of bottlenecks as well as assurance of high quality are considered the main motives for procurement. A further motive is rationalization of warehousing processes through completely centralization. Basically, procurement considers material access to resources and immaterial access to resources. Material resources are raw materials or intermediate goods. A sustainable assurance of resources is often an important reason for M&A transactions. Immaterial resources are rights and patents and also explicit and implicit know how or intellectual property right (IPRs) of target companies.³⁷

Distributional market: The promotion of the distribution channels is the second major market motive for M&A. Formerly separate companies are able to combine distribution activities and therefore achieve both synergies and competitive advantages.³⁸ Another reason for distribution based acquisitions is improvement of market power over competitors and customers. Market power can on the one hand impact the sales prices and on the other hand it can be demonstrated to the competitors through increasing output quantity.³⁹

- Efficiency theories (Economies of scale/scope):

Efficiency theories in this context include differential efficiency theory and inefficiency management theory. The differential efficiency theory states, that the increase of efficiency is assigned to the merger of companies, if the management of a company A is more efficient in comparison to company B, and if company A acquires company B and increases the efficiency of company B to the same level as company A. This would be both a social and a private benefit and thus contribute to a higher efficiency for the economy. While the inefficiency management theory implies, that information about company B’s inefficiency is publicly available and not only company A but also other acquiring companies can reach the same level of acquiring company by a takeover. Thus, the differential efficiency theory serves a rationale for horizontal mergers, whereas the inefficiency management theory is congruent for conglomerate mergers.⁴⁰ Economies of scope enables to achieve cost advantages of heterogeneous products relative to company size. That means, that cost advantages can be achieved if a diversified product portfolio is produced commonly instead of in several separated production sites. Therefore, economies of scope can be exploited is the same factors are used in different production areas.⁴¹

- Synergy

Synergies arise if functional activities are combined or rationalized across the value chain. In context of M&A this means, that synergies normally arise due to common utilization of resources and abilities of the partner companies. Therefore, synergies can arise in primary activities as research and development, procurement, production or distribution or in secondary activities as administration/HR/IT.⁴² Financial synergies arise in form of higher cash flows, a lower cost of capital (discount rate), or both. These synergies include:

1. A combination of a company with cash, or cash slack (and limited project opportunities) and a company with high-return projects (and limited cash) can deliver a higher yield for the new combined company. The excess cash enables to undertake projects, that otherwise would not have been undertaken.
2. Debt capacity that can increase if two companies are combined. As the earnings and cash flows potentially become more stable and predictable, it allows higher borrowings for the new company. This also brings tax benefits, in form of lower cost of capital.
3. Tax benefits can either be generated by write-ups of the targets’ assets (law exploitations) or from income reduction due to net operating losses. This means that, a profitable company can minimize its tax burden by the acquisition of a money-losing company. As an alternative, if depreciation charges are increased, a company benefits from tax savings.

- Competition hypothesis

The competition hypothesis states that competitive advantage can be generated by choosing an attractive industry, development of cost leadership and a configuration of an efficient value chain.⁴³ An attractive industry can be determined with help of Porters Fiver-Forces and is described as an industry where the entry barriers are high, suppliers and buyers have only modest bargaining power, substitute products or services are few, and the rivalry among competitors is stable.⁴⁴ Cost leadership can be achieved on the basis of the learning curve effect and economies of scale. In order to exploit these effects, it is necessary to have a high market share. In contrast, differentiation aims to reach a higher level of quality or performance.⁴⁵ Finally, in regards of the value chain configuration, competitive advantage can be achieved by efficient embedment of primary and secondary (supporting) functions.⁴⁶

- Portfolio theory:

According to Markowitz, it is beneficial for investors to spread or diversify their investments, because that leads to risk reduction of the whole portfolio.⁴⁷ With regards to the portfolio theory, business risk can be reduced by diversification of the businesses or business activities. Risks can be classified either in short-term or long-term risks. Short-term risk occurs due to a companys’ dependency on specific products or specific sectors and can be reduced by the extension of its products or services or establishing itself in new business areas. A long-term risk reduction can be regarded as advancing in growth markets that encounters dependency on stagnating or highly competitive markets.⁴⁸

Management Motives

- Hybris Hypothesis

This hypothesis states, that managers tend to overestimate synergies and therefore pay to high premium for companies. According to Roll, managers believe that they can better evaluate a company than the market does and therefore engage in M&A transactions.⁴⁹

- Agency theory (Managerialism):

Agency theory describes the differentiation between the company owners and the managers interest. The essence of the theory states, that principals and agents are all rational and wealth seeking and therefore are trying to maximize their own utility function. Whereby, the agent represents the shareholder and the principal represents the management of a company.⁵⁰

- Free cash flow hypothesis:

This hypothesis is interrelated to agency theory. “Free cash flow is cash flow in excess of that require to fund all projects that have positive net present values when discounted at the relevant cost of capital.”⁵¹ High free cash flows arise especially in mature and shrinking industries, and are conditionally used for replacement or new investments. As a result, managers obtain new degrees of freedom which enables them to focus on their own interests which according to the agency hypothesis are earnings and power maximization.⁵²

- Diversification:

There are two distinctions between diversification strategies. On the one hand diversification into related business areas and the other one into not related business areas. The first strategy refers to diversification concerning the exploitation of operating synergies. In the other form of diversification, the firm seeks to increase its leverage, and therefore stability of cash flows. Diversification of business operations means not to focus on just one business area but on different industries. Thus, it is a strategy that reduces risk and can ensure future income flows.⁵³

Speculative motives:

Apart from the strategic motives, M&A transactions can be led by strictly financial motives. These could be a better access to capital markets, undervaluation or restructuring, accounting or tax motives. A merger usually improves the access to new capital, national and international, due to the new, bigger size of the company.⁵⁴

Information hypothesis:

The information hypothesis assumes that not publicly available information can cause a revaluation of companies under the presumption of efficient markets. Thus, takeover announcements have the effect, that the companies, which might be undervalued are revaluated again. There are basically two different forms of the information hypothesis. The ‘sitting on a goldmine’ hypothesis, declares that the disclosure of new information is immediately registered by the market and causes revaluation of target shares. The other argues that new information permit the management of a company on its own to implement a higher-valued operating strategy. This is also known as ‘kick in the pants’. Both versions imply that the information that is publicly not available and superior information are beneficial for takeover proposals.⁵⁵

- Bankruptcy avoidance hypothesis:

The bankruptcy avoidance rationale states, that a takeover can save a company from bankruptcy. According to Shireves and Stevens, a merger is less costly compared to liquidation in regards of legal and administrative costs. Moreover, the going concern value in a merger is higher compared to a liquidation value. Additionally, tax-loss carry-overs are also possible.⁵⁶ There are not only general motives for M&A, but also motives for cross-border M&A, which are defined below.⁵⁷

Motives for cross-border M&A

- Geographical and industrial diversification

Geographical diversification implies that companies may invest in different industries in the home market, in the same industry in foreign countries, or in different industries in foreign countries.

- Accelerating growth

Foreign markets may be a better growth opportunity for domestic firms. Corporates having slower growth in their home market are most likely willing to undertake foreign acquisitions, particularly in high growth markets.

- Industry consolidation

Oversupply in many industries is often a driver for M&A transactions, as companies aspire to increase economies of scale and scope as well as pricing power with customers and suppliers.

- Utilization of lower labor and raw material costs

Low labor costs, access to inexpensive material resources, and low levels of regulations can be often found in emerging markets. Shifting the production to more favorable locations helps companies to reduce operating expenses and become more competitive globally.

- Avoiding entry barriers

Foreign direct investment is often encouraged by protective measures such as quotas and tariffs on imports imposed by governments. Foreign companies may use acquisitions in these regions to bypass such measures.

- Fluctuating exchange rates

FDI is significantly influenced by currency fluctuations. The appreciation of one currencies relative to another reduces the overall cost of investing in the country where the currency is devaluated.

- Following customers

In order to better satisfy the needs of their customers, suppliers are frequently encouraged to invest abroad. In example, many auto part suppliers have established production facilities next to large car producers in China.⁵⁸ Having provided the reasons and motives for M&A activities, the next chapter will conclude by summarizing the advantages and disadvantages for M&A relatively to the alternatives from Chapter 2.

3.3 Advantage and disadvantages of M&A relative the alternatives

M&A transactions are characterized by a high degree of freedom to act when comparing to other forms of cooperation’s. A sole acquisition is associated with a high level of uncertainty and risk. Table 3 shows advantages and disadvantages of acquisitions in contrast to alliances. Moreover, the motives for acquisitions underpin the decision for acquisitions.

Table3: M&A advantages and disadvantages.⁵⁹

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International business strategies of multinational enterprises (MNEs), and particularly of M&A operations are not only driven by competitive, localization or ownership advantages. The political position of a company determines opportunities and consequently the goals of MNE’s and may inhabit discriminatory access to some resources, including target companies. In this light, a company with political privileges may improve its performance at the expense of competitors and other actors.⁶⁰

3.4 Corporate takeover market and common practice

Overview of M&A activities

The global Mergers & Acquisitions market in 2015 with its peak of about USD 4.8 trillion, and with a volume of USD 3.9 trillion in 2016, reached despite several uncertainties, the third best year in line. Geopolitical tensions, intensified regulatory measures, and speculation around both Brexit and China, made 2016 a highly unpredictable year. In defiance, the market remained still vital and provides a positive outlook for 2017.⁶¹ Moreover, uncertainty factors as the election of Donald Trump and the unpredictable outcome of the elections in France, influenced the M&A market in the US and Europe. However, a recent change to legislation China, whereby the government will examine overseas transactions over USD 2 billion to reduce capital outflows that are consuming foreign exchange reserves and depreciating the renminbi, will likely slow down the growth in M&A activities in China in 2017.⁶² In 2016, the US was again leading in M&A by both deal value and count, with over 4,951 deals and a total volume of USD 1.5 trillion. Moreover, Chinas appetite for oversea transactions rose again to a peak of 258 transactions worth USD 185.3 billion in 2016. Not to forget the European market with an overall volume of USD 973 billion in 2016 declined after a peak in 2015. To sum it up, the US (47.5%), Europe (24.6) and Asia-Pacific (20.3%) are the leading regions in terms of M&A with an overall market share of 92.4%.

Abbildung in dieser Leseprobe nicht enthalten

Figure2: M&A deals worldwide by number and value.⁶³

As demonstrated in Figure 1, most transactions were counted within the Industrials (13.9%) with more than 126,000 transactions and at least in the Telecommunications sector (2.6%) with about 23,000 transactions between the years 1985 and 2016. The second most attractive sector with over 117,000 announced deals is the high technology sector. All in all, cross-border deals accounted for 36% of overall volume in 2016, an increase from 31% in 2015. Numerous mergers were strategically oriented, as buyers strive to achieve external and inorganic growth. Due to the all times low costs of funding, 62% of all transactions in 2016 were settled in cash, in comparison to 54% in 2015. Technology was the most favorite sector in 2016, followed by power, real estate, and health care.⁶⁴

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Figure3: Number and value of M&A deals by industry 1985-2016.⁶⁵

Approaches in the takeover market and common practice

Acquisition can be initiated either by the seller or by the buyer. The buyer has the choice between an auction or exclusive negotiations with potential candidates. In a public auction a public announcement should address numerous possible candidates and the sales process takes place in an auction procedure. Whereas in a limited auction in a limited auction, only preselected candidates may bid for the offered “assets”. However, an exclusive negotiation is mostly between the seller and solely one interested party. This could be for example a customer, who can realize certain synergies. The biggest advantage in an exclusive negation is that the seller must provide confidential information to only one party. In contrast to this, a major disadvantage is that the potential buyers are limited which could lead to a price that is not in line with the market.⁶⁶

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Figure4: Different types of acquisitions.⁶⁷

The buyers’ initiative is dependent on the approval of the target thus, M&A transactions can be friendly or hostile. A friendly takeover takes places when the management of the target company receives an offer of the acquiring company and accepts this offer, mostly also in accordance with the shareholders. Whereas a hostile takeover takes place, when the offer is directed to the shareholders without knowledge or acceptance of the management of the target company.⁶⁸ In a hostile takeover, the acquirer often offers a higher price for the shares, than the current market share price. The difference between the market price and the acquisition price is called premium and is not dependent on the acquisition approach.⁶⁹ In advance to a hostile takeover, a bidder might attempt to contact the target informally. This is also called a casual pass. Such a procedure may be initiated by a member of the bidder’s management or from one its representative e.g. investment banker. Hence, a casual pass may be applied if the targets reply is uncertain. This is the case if the target has already been the subject of other rejected hostile takeover attempts or if the target has published to stay independent. This action may have positive as well as negative effects, because the target is aware in advance, that it is a target of a takeover. Mostly in takeover battles, the target tries slow down such an action, while the bidder’s interest is to finalize the battle as quick as possible. Managers of targets are often advised by their attorneys to declare their independence explicitly.

A tender offer is broad request by company or a third party to acquire a considerable amount of a company’s equity or units for a limited period. The offer usually higher than the current market price (premium) and is generally limited on shareholders tender of a fixed number of their shares or units.⁷⁰ A tender offer can be differentiated into two categories a cash or a stock tender offer. In a cash tender offer, the bidder directly addresses the shareholders of the target company. However, in some cases, a bidder may try to pressure the management of the target before making a tender offer. This takes place by contacting the board of directors and expressing interest in acquiring their company a suggested intent to contact the shareholders with a tender offer if this overtures are spurned. This approach Is called the bear hug and can also be practiced together with a public announcement of the bidder’s purpose to make a tender offer. Through the bear hug, the target’s board is forced to take a public position on a potential takeover. A tender directly to the shareholders usually follows, if such offers are rejected. Therefore, the bear hug additionally puts pressure on the board of directors because it may have violated its fiduciary duties.⁷¹

After the definition of M&A and the overview of the takeover market and the common approaches, the next chapter explains the M&A process in detail.

4 The M&A Process

This chapter explains the whole M&A process based on three general stages. A typical M&A process can be separated in three core stages, Stage 1: Pre-merger, Stage 2: Transaction and Stage 3: Post merger Activities. The steps within the stages may vary depending on authors, but in essence they describe the same procedures, which have to be performed before, during and after an M&A Transaction. This work is based on the M&A process according to Jansen.

Abbildung in dieser Leseprobe nicht enthalten

Figure5: M&A process.⁷²

4.1 Stage 1 – Strategic analysis and concept

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Figure6: Stage 1 of an acquisition.⁷³

Stage 1 is separated in three main areas. The three areas are company analysis, competition analysis, and strategic concept for the acquisition. An analysis of the companys’ objectives, potentials and business purpose serves as groundwork for a detailed growth strategy. The first step is an internal analysis of the company. Analyses of strength and weaknesses, success factor analyses, diversification test, core competencies and, other play a big role in this analysis. Furthermore, a business plan can also serve as an analysis tool, which defines the overall management strategy and enables to monitor short-term and mid-term strategic objectives. Substantial elements of a business plan are briefly stated in Appendix 1.

Table4: Business plan requirements.⁷⁴

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Analysis of business objectives and potentials

The business plan itself may imply important analysis methods e.g. Porter five-forces or a SWOT analysis. The second step is an external analysis which concentrates on the chances and risks for the company influenced by the stakeholders of that company e.g. government, society and policy. This is an important issue for a company in regards of anticipation of such influencing factors. Hereby it is important to be highly sensitive for so called “weak signals”, that are not so obvious and easy to detect. An external analysis can be performed according to a three-stages approach illustrated in the following table.

Table5: Three-stage environmental analysis.⁷⁵

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The internal potential analysis is preliminary for a subsequent gap-analysis between the current state and the realistically distinguished strategic objectives. These identified gaps serve as a basis for strategic decision concerning growth.

Acquisition environment

A logical consequence after the decision for the acquisition, is the analysis of the acquisition environment. There are three main analysis levels, country specific, market oriented, and business area (industry) analysis. A country specific analysis examines the country as a potential distribution market or as a potential location for production with the purpose to identify and specify acquisition candidates regionally. Besides, a market oriented analysis involves the stock and the capital market. Moreover, financing sources, economic situation, and legislation are crucial factors within this analysis. Additionally, business segment analysis examines the acquisition environment in a specific area. This can help to obtain indications for acquisition premiums in a specific business sector.

After this, the analysis continues with a definition of an acquisition strategy based on the motives and objectives for the strategy. A frequent used instrument is the product/market matrix according to Ansoff.

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¹ cf.jpmorgan.com 2017a

² cf.jpmorgan.com 2017b: 1–5jpmorgan.com 2017b

³ cf.bcgperspectives.com 2017

⁴ cf.Chakravarty/Ghee 2012: 48–50

⁵ cf. DePamphilis 2014: 21

⁶ cf. Cropper 2010: 94

⁷ cf. DePamphilis 2014: 532

⁸ cf. Man 2014: 37–40

⁹ cf. Bitzenis 2012: 100–102

¹⁰ cf. Kutschker 2011: 890

¹¹ cf. Rothärmel 2017: 306

¹² cf. DePamphilis 2014: 539–544

¹³ cf. Rothärmel 2017: 262

¹⁴ cf. Brandt 2012: 21–22

¹⁵ cf. DePamphilis 2014: 532

¹⁶ cf. Brandt 2012: 13

¹⁷ cf. Brandt 2012: 68–78

¹⁸ own illustration

¹⁹ cf.Sudarsanam 2011: 4

²⁰ cf. Lee 2013: 540–542

²¹ Hampton 2007: 394

²² cf. McGrath 2011: 7–8

²³ cf. Lucks/Meckl 2015: 5 ff.

²⁴ own table according tocf. Jansen 2004: 46

²⁵ cf. Lucks/Meckl 2015

²⁶ cf. Lucks/Meckl 2015: 31–33

²⁷ own illustration according tocf. Scholz 2000: 9 ff.

²⁸ cf. Lucks/Meckl 2015: 33 ff.

²⁹ cf. Lucks/Meckl 2015: 42

³⁰ cf. Miller/Segall 2017: 282 ff.

³¹ Gilson 1990: 257

³² cf. Senbet 2012: 7

³³ cf. Wirtz 2003: 57 ff.

³⁴ cf. Lee 2013: 546

³⁵ cf. Leigh/North 1978: 227 ff.

³⁶ cf. Jansen 2016: 171

³⁷ cf. Binder et al. 2016: 299 ff.

³⁸ cf. Buxmann et al. 2011: 82 ff.

³⁹ cf. Kirchner 1991;Brasic 2011: 18

⁴⁰ cf. Copeland/Weston 1988: 683

⁴¹ cf. Pausenberger 1993: 4436–4448

⁴² cf. Wirtz 2003: 66 ff.

⁴³ cf. Jansen 2016: 188

⁴⁴ cf. Porter 2014: 173–207

⁴⁵ cf. Porter 2014: 66

⁴⁶ cf. Porter 1986: 59–92

⁴⁷ cf. Markowitz 1952: 77 ff.

⁴⁸ cf.Wirtz 2003: 55 ff.

⁴⁹ Roll 1986: 197 ff.

⁵⁰ cf. Jensen/Meckling 1976: 305 ff.

⁵¹ Jensen 1986: 623

⁵² cf. Jensen 1986: 623–627

⁵³ cf. Amit/Livnat 1988: 1

⁵⁴ cf. Wirtz 2003: 69 ff.

⁵⁵ cf.Bradley et al. 1983: 183 ff.

⁵⁶ cf. Shrieves/Stevens 1979: 501 ff.

⁵⁷ cf. Bradley/Desai 1983b: 184 ff.

⁵⁸ cf.DePamphilis 2014: 641 ff.

⁵⁹ cf.Jansen 2016: 301

⁶⁰ cf.Economakis et al. 2010: 11 ff.

⁶¹ cf. IMAA Institute 20172016

⁶² cf. mergermarket.com 2017: 2–3

⁶³ own illustration according to IMAA Institute 2016

⁶⁴ cf. J.P.Morgan 2017: 2–4

⁶⁵ cf. mergermarket.com 2017

⁶⁶ cf. Lucks/Meckl 2015: 41 ff.

⁶⁷ cf.Berens 2013: 31 ff.

⁶⁸ cf. Lorenz 2006: 11

⁶⁹ cf. Damodaran 2008: 3

⁷⁰ cf. SEC 2013

⁷¹ cf. Gaughan 2011: 246–247

⁷² own illustration according toJansen 2016: 293

⁷³ cf.Jansen 2016: 293

⁷⁴ cf.Jansen 2016: 295

⁷⁵ own Illistration according to Pümpin inSteinöcker 1993: 20