Investing in External Growth

Term Paper, 2016

36 Pages, Grade: 1,7


Table of Contents

List of Figures

List of Tables

List of Abbreviations

1 Introduction

2 Inorganic Growth: Forms and Strategies of Mergers and Acquisitions
2.1 Organic versus Inorganic Growth
2.2 Forms of Mergers and Acquisitions
2.3 Strategies of Mergers and Acquisitions

3 Mergers and Acquisitions at Siemens AG: Dresser-Rand

4 Business Valuation Methods
4.1 Net Asset Value Methods
4.2 Income Value Methods
4.2.1 Income Approach
4.2.2 Discounted Cash Flow Method: WACC approach
4.3 Market Value Methods

5 Valuation of the Dresser-Rand Acquisition

6 Conclusion

A-1: Dresser-Rand consolidated balance sheet
A-2: Dresser-Rand consolidated statement of income
A-3: Calculations based on the balance sheet and statement of income
A-3.1 Enterprise Value
A-3.2 P/E multiple
A-3.3 Income Approach


Internet Bibliography

List of Figures

Figure 1: Overview of business valuation methods

Figure 2: Dresser-Rand consolidated balance sheet

Figure 3: Dresser-Rand consolidated statement of income

List of Tables

Table 1: Acquisitions of 2011 to 2016

Table 2: Summarised results of the applied methods

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

External growth in forms of Mergers & Acquisitions (M&A) is massively driving the growth of many companies. In 2015, the total amount of 3.81 to 5 trillion to US-Dollars (USD) was spent on M&A, marking it as the year of the highest spending ever. Vivid sectors are healthcare and technology: in 2015, both accounted for over 700 billion USD each.2

Latest news reports a joint venture between Siemens and Gamesa merging their wind business and creating a new leading market player.3 If everything proceeds as planned, this will be the next big portfolio change after 2015’s acquisition of Dresser-Rand for approximately 7.8 billion USD.4

These latest developments in general and in particular within the Siemens AG are investigated in this paper with the objective of answering the question: What is the strategy behind M&A and how to evaluate the price of an acquisition? Thereby the case of the acquisition of Dresser-Rand Group Inc. by Siemens AG is covered.

Handling this topic the first step is defining the strategies to grow a company either with organically or inorganically growth. Subsequently, a closer look is taken at external growth in forms of M&A. The common forms of inorganic growth are introduced and the connected strategy is examined and evaluated. In addition, Siemens’ key acquisitions are considered to derive the underlying strategy.

The second part highlights how a possible acquisition can be evaluated. Therefore, different approaches are explained and used to value the acquisition of Dresser-Rand by Siemens AG. The different approaches are compared to the original price and each other concluding in a comparison and evaluation of the various methods.

2 Inorganic Growth: Forms and Strategies of Mergers and Acquisitions

This chapter defines the differentiation between organic and inorganic growth. Furthermore, the different types of M&A are examined, and the strategies and goals are presented. The given theoretical background is used to evaluate the past M&A activities of Siemens AG.

2.1 Organic versus Inorganic Growth

Typically, an enterprise passes different phases of the enterprise life cycle model. It all starts with the foundation of the company, followed by a growth stage and changing to maturity stage. In maturity stage, the business is well-established but the enterprise’s growth is stagnating. After maturity, there is either a stage of decline or crisis, ending in worst-case shutdown or in best-case renewed growth.5

Generally, one of the entrepreneur’s or managing board’s long-term goals is to keep the company in the market and establish ongoing growth. There are two strategies ensuring growth:

- Organic or internal growth
- Inorganic or external growth

Organic growth can be defined as growth generated by internal organs of the company.6 All business units of the value chain, unless they are supporting or primary activities, are involved in generating revenue and responsible to ensure profitability.7 Therefore, all activities of the value chain are able to increase growth but some particular business units are considered to be more adequate. Especially, investments in the Research and Development (R&D) department or Marketing and Sales can ensure a long-term and lasting surplus in growth.8 Concluding, organic growth is an investment in enterprise value.

In contrast, external growth focuses on other companies and growth takes place in form of M&A9. Either a company purchases another business in an acquisition or two companies merge into a new one. In both cases the participants within the process are the buyer (also called acquirer or bidder) and a target firm. The buyer has to purchase the assets or stocks of the target firm either in cash or in shares.10 Both forms are often referred to as a takeover.

In contrast to investing in M&A or internal growth and increase an enterprise’s assets there is divestment. Divestment or divestiture is the opposite of M&A and aims to decreasing company’s assets by selling parts of the company to third party. There are different types of divestments like direct sale, carve outs or spin-offs.11 In further process, the paper focuses on the investment side in forms of M&A.

2.2 Forms of Mergers and Acquisitions

There is a distinct variety of forms of acquisitions. In literature the forms are often classified by their direction12,13,14:

- Horizontal Acquisition
- Vertical Acquisition
- Conglomerate Acquisition

A Horizontal acquisition takes place within the same industry e.g. two breweries merge. Vertical acquisitions can be directed forwards or backwards, also labelled as forward or backward integration. In this case, the acquisition integrates either a supplier or customer of the buying company’s industry.15 An example for a forward integration is the acquisition of a personal computer manufacturer by a microchip manufacturer. A backward integration is directed to the supplier side, for instance the buy of an iron ore mine by a steel producer. If both acquirer and target are active in completely different industries, it is a matter of conglomerate acquisition.

Moreover, a takeover can be either hostile or friendly. If the acquirer places a direct offer to a firm’s director or managing board, it is called friendly takeover. Bypassing the company’s head and place an offer directly aimed at the shareholders directly is defined as hostile takeover.16

As an example given in the introduction of Siemens merging its wind business with Gamesa is a joint venture. Siemens will hold 59 percent of the shares of the new company and the existing shareholders of Gamesa will hold the remaining 41 percent.17 Risk reduction is one of the main goals of a joint venture.18 In this case, synergies and a highly complementary portfolio are the main drivers to merge.19 Besides that, there are additional forms of cooperation possible. All these processes have in common that the companies taking part in the cooperation will keep their economic independency. They bond to each other just in a specific business of their companies unlike in an acquisition.20

2.3 Strategies of Mergers and Acquisitions

The diversity of M&A results from a large number of reasons to acquire and merge with other firms. There are a plenty of underlying strategies and goals justifying the slightly uncertain investment of an acquisition. Most acquirers’ willingness to pay an acquisition premium is based on the expectation to add economic value due to synergies resulting from the e.g. merge21. Moreover, it is unlikely that the bidder will be able to acquire the target for less than the regular stock value therefore the premium must be paid to offer an enticement.

Talking about synergy means the acquirer is investing or buying a firm with a positive net present value (NPV). An investor buying stocks gets the exact amount of stocks in exchange for cash, meaning his investment was zero-NPV. An acquirer expects a surplus, so his investment is of positive-NPV.22

The formula to account the synergy makes this very clear. If firm A is acquiring firm B, the value of firm A is VA and for firm B it is VB. The acquisition results in firm AB with its value VAB so the Synergy is23:

Abbildung in dieser Leseprobe nicht enthalten

That a positive-NPV is only possible if VAB is larger than the combined values of Firm A and B and therefore a positive synergy value is achieved.

Generally, there are two kinds of synergies: cost reduction and revenue gains.24 The cost reduction synergy is also referred to as overcapacity M&A with the main goal to eliminate overcapacity and create a more efficient operating company.25 Revenue gains are reached through many different synergies. Therefore, a closer examination of the different synergies and strategies of a M&A is needed.

Especially, larger companies benefit from the effect of economies of scale and scope.26 Through an acquisition the production volume can increase, so the fixed costs per unit produced can decrease27. Furthermore, the bargaining power towards the supplier side can increase. Overall, the economies of scale can lead to higher savings due to a higher efficiency. However, this is limited to the optimal size of a firm and the herewith connected minimal costs. Exceeding the optimal size means diseconomies of scale linked with rising production costs.28 The economies of scope can be beneficial for larger firms as well. The combination of marketing and distribution of two firms with complementary portfolio could offer new distribution channels for both firm’s products.29

The product or market extension M&A can also provide access to emerging markets, which were primarily point of action for the acquired target company.30

With continuing growth, a company becomes more difficult to manage. Vertical integration can be a mean to improve coordination.31 Improvement of coordination is achieved by closer related operations and common goals of both companies.32 Therefore, growing vertically towards supply or demand-side can be beneficial. That is not limited to ease up coordination but can help to improve product quality by acquiring advanced technology.33

An acquisition can also be an approach to obtain new technologies, brands, patents or licensing but particularly expertise.34 Depending on the technology connection M&A can substitute R&D to some extent.35 Instead of running R&D in-house a company can buy the needed technology or expertise, which helps to respond to shortening product life cycles and faster changing market trends.36 This strategy helps to invest in promising new technologies by acquiring start-up firms.37 On the one hand, this is a mean to specialise into a certain product segment38, on the other hand it is a step to complete gaps in an existing portfolio. The acquisition of Dresser-Rand by Siemens is an example for completing an existing portfolio for the oil and gas industry.

Due to M&A there exists an opportunity to create a market leader or monopoly and rule the market. Most countries have established antitrust laws to prevent global players and competitors to buy each other. Reducing competition normally results in increasing profits.39 This is one way to increase efficiency in form of boosting profits. The other way is the cost reduction by the earlier mentioned cost reduction synergies.

Diversification is another strategy with multiple advantages. Merging or acquiring firms from different industries in a conglomerate merge helps to reduce risk.40 Enlarging a portfolio reduces the overall risk and splits it on distinct businesses. However, this diversification leads to an intricate business catchier to manage and increasing the costs to run the company.41 Nevertheless, diversification is advantageous for liquidity, larger firms buying smaller companies ease the access to capital.42 Therefore, it easier for the smaller acquired firm to develop due to higher availability of capital to invest.

Acquiring a firm creates another useful incentive in forms of tax gains. There a different effects which can be used to reduce tax load. First to mention are tax losses from net operating losses (NOL) in forms of carryback and carryforward provisions43 allowed by the Internal Revenue Service (IRS)44. Besides that, depreciation incentives are possible for example by using pension provisions to generate cash flow and using it for investments.45

Secondly, unused debt capacity can increase after an acquisition. Therefore, it can be a goal to rearrange business to reach the optimal debt-equity ratio, where the “marginal tax benefit from additional debt is equal to the marginal increase in the financial distress costs from additional debt”.46 So, it does not matter whether to make new debts or pay taxes.

The last aspect involves surplus funds. If a firm has free cash flow available after paying all taxes, interest, etc. the surplus funds can either be used to pay dividends to shareholders, rebuy shares or purchase shares from another firm.47 The latter is the most beneficial option, because the company pays little income tax on dividends received from shares of other firms. This strategy is limited by the IRS but a complete acquisition of the firm results in no tax payments at all on the dividends for the shares from the target.48

Large-scale firms like Google managed to pay nearly no taxes due to a complex trust structure.49 Other huge companies like Pfizer recently use M&A to shift headquarters to countries with lower taxes.50 Tax avoidance is a possibility to increase profits or support R&D by reduced tax and thus increase shareholder value.

The elimination of inefficient management is a possibility to increase a firm’s value because the incumbent management is not aware of certain changes in the market. Therefore, a restructuring is needed but the present managers are either not aware of it or unwilling to initiate change.51

Managerial motivation can sometimes be a reason why companies decide to acquire or merge. Main reasons for managers to merge are an increasing salary, prestige due to more responsibility in managing a larger firm and aspiring for new challenges and mightier position.52 Another aspect is the minimised risk the managing board faces if a merger is not as successful as promised. Concerning the expectation to receive a higher salary, the possible loss in shareholder value is marginal even if the manager owns a certain amount of the firm he manages.53

Additional problems and disadvantages of M&A are the low success rates, only half of all mergers achieve their objectives.54 Besides that, the misallocation of capital can reduce the profitability and efficiency of the entire company, such as subsidising low performing or redundant business units instead of shutting them down.55

3 Mergers and Acquisitions at Siemens AG: Dresser-Rand

Siemens has a very large portfolio of products within the electrical engineering and electronics industry. There are different business divisions suited to the industrial market as follows:56

- Power and Gas
- Wind Power and Renewables
- Power Generation Services
- Energy Management
- Building Technologies
- Mobility
- Digital Factory
- Process Industries and Drives
- Healthcare
- Financial Services

In 2015, the enterprise employed 348,000 employees, which created revenue of 75,636 million Euros.57 Siemens’ total assets accounts for 120,348 billion Euros with a 29 percent share of capital and 71 percent share of debt capital.58

M&A is an essential part of the global strategy to extend the portfolio or divest parts of the company to stay competitive and profitable. During the last five years various acquisitions and divestments have taken place. The acquisition volume was 13.8 bn. Euro and 11,7 bn. Euro was divested.59 The largest acquisitions are described in the following table:60

Abbildung in dieser Leseprobe nicht enthalten

Table 1: Acquisitions of 2011 to 2016

As shown in Table 1, mainly the Power and Gas and additionally the Digital Factory business have been continuously extended. The largest purchase was the acquisition of Dresser-Rand in 2015, at an overall price of 6.692 bn. USD plus a debt payback of 1.142 bn. USD. Therefore, the combined price was 7.834 bn. USD, which equals 7 bn. Euros.61 62 63 64 The horizontal acquisition of Dresser-Rand aimed to extend Siemens’ Power and Gas portfolio. Dresser-Rand produces compressors, steam and gas turbines and engines comparable to Siemens, therefore they are active in the same business.65

Both enterprises’ regional markets are complementary to each other, thus business growth can be expected. There is potential for synergies from the combined portfolio, purchasing, R&D and a combined service coverage.66 Furthermore, Dresser-Rand has a large installed base and creates half of its revenues from services.67 Additional effects are the technological differentiation due to the high-speed engine technology of Dresser-Rand, the better positioning in the liquefied natural gas (LNG) business and in the United States due to the location of Dresser-Rand’s headquarters in Houston.68 Besides that, the Sulzer AG was interested in acquiring Dresser-Rand too.69 To sum it up, the Dresser-Rand acquisition is based on financial, strategical as well as reputational motivation. Dresser-Rand. In Siemens’ 2015 annual report a purchase price of 5.981 bn. Euro (without debt payback) besides goodwill of 4.058 bn. Euro is mentioned.70

Next, different approaches are presented to calculate a company’s value. Afterwards, the presented approaches are applied to calculate the value of Dresser-Rand. Finally, they are compared among each other and to the purchase price Siemens has paid.


1 Cp. Baigorri, M. (2016). 2015 Was Best-Ever Year for M&A; This Year Looks Good Too [online]. Bloomberg, January 6. year-for-m-a-this-year-looks-pretty-good-too [accessed on June 26, 2016].

2 Cp. Dealogic. (2015). Dealogic data shows 2015 M&A volume surpasses $5 trillion [online]. PR Newswire, December 28. [accessed on June 26, 2016].

3 Cp. Siemens AG. (2016a). Merger of Siemens' and Gamesa's wind businesses [online]. June 17. [accessed on June 26, 2016].

4 Cp. Siemens AG. (2015a). Siemens gets green light from EU Commission for Dresser-Rand acquisition [online]. June 29.[]=Corp [accessed on June 26, 2016].

5 Cp. Portisch, W. (2008). Theorie der Finanzierung. In: W. Portisch, ed. Finanzierung im Unternehmenslebenszyklus. Munich: Oldenbourg Wissenschaftsverlag GmbH, pp. 11 - 16.

6 Cp. Bea, F.X. et al. (2004). Allgemeine Betriebswirtschaftslehre – Band 1: Grundfragen. 9th ed. Stuttgart: Lucius & Lucius Verlagsgesellschaft mbH, pp. 398 - 399.

7 Cp. Porter, M. E. (1985). The Competitive Advantage: Creating and Sustaining Superior Performance. NY: Free Press. (Republished with a new introduction, 1998.), pp. 36 - 38.

8 Cp. Bartling, H. & Luzius, F. (2004). Grundzüge der Volkswirtschaftslehre, pp. 389 - 399.

9 Ibid.

10 Cp. Berk, J. and DeMarzo, P. (2014). Corporate Finance. 3rd ed. Pearson, p. 931.

11 Cp. Grinblatt M. & Titman, S. (2002). Financial Markets and Corporate Strategy. McGraw-Hill Irwin, pp. 650 - 651.

12 Cp. Berk, J. and DeMarzo, P. (2014), p. 933.

13 Cp. Bea, F.X. et al. (2004), pp. 401 - 402.

14 Cp. Ross, Westerfield and Jaffe. (2003). Corporate Finance. 6th ed. Mc Graw-Hill, p. 818.

15 Cp. Bea, F.X. et al. (2004), pp. 401- 402.

16 Cp. Grinblatt M. and Titman, S. (2002), pp. 694.

17 Cp. Siemens AG. (2016a).

18 Cp. Bea, F.X. et al. (2004), p. 403.

19 Cp. Siemens AG. (2016a).

20 Cp. Bea, F.X. et al. (2004), p. 402.

21 Cp. Berk, J. and DeMarzo, P. (2014), pp. 933-934.

22 Ibid, p. 934.

23 Cp. Ross, Westerfield and Jaffe. (2003), p. 828.

24 Cp. Berk, J. and DeMarzo, P. (2014), p. 934.

25 Cp. Bower, J.L. (2001). Not all M&As are alike – and that Matters. Harvard Business Review, March, 92 - 101, p. 94.

26 Cp. Berk, J. and DeMarzo, P. (2014), p. 935.

27 Cp. Bea, F.X. et al. (2004), p. 400.

28 Cp. Ross, Westerfield and Jaffe. (2003), pp. 830 - 831.

29 Cp. Berk, J. and DeMarzo, P. (2014), p. 935.

30 Cp. Bower, J.L. (2001), p. 94.

31 Cp. Berk, J. and DeMarzo, P. (2014), p. 935.

32 Cp. Ross, Westerfield and Jaffe. (2003), p. 831.

33 Ibid.

34 Cp. Kumar, N. (2009). How Emerging Giants Are Rewriting the Rules of M&A. Harvard Business Review, May, p. 4.

35 Cp. Cassiman, B. et al. (2003). The Impact of M&A on the R&D Process. An Empirical Analysis oft he Role of Technology and Market Relatedness. Research Report 0307. Katholieke Universiteit Leuven, pp. 28-29.

36 Cp. Bower, J.L. (2001), p. 99.

37 Cp. Berk, J. and DeMarzo, P. (2014), p. 936.

38 Cp. Bea, F.X. et al. (2004), p. 400.

39 Cp. Berk, J. and DeMarzo, P. (2014), p. 936.

40 Ibid., p. 938.

41 Ibid.

42 Cp. Bea, F.X. et al. (2004), p. 400.

43 Cp. Ross, Westerfield and Jaffe. (2003), p. 833.

44 Cp. Berk, J. and DeMarzo, P. (2014), p. 937.

45 Cp. Bea, F.X. et al. (2004), p. 401.

46 Cp. Ross, Westerfield and Jaffe. (2003), p. 833.

47 Ibid.

48 Ibid.

49 Cp. Barford, V. & Holt, G. (2013). Google, Amazon, Starbucks: The rise of ‘tax shaming‘, BBC News Magazine, May 21, [accessed July 1, 2016].

50 Cp. BBC News. (2014). US politicians raise questions over Pfizer bid, May 9, [accessed June 7, 2016].

51 Cp. Ross, Westerfield and Jaffe. (2003), p. 828.

52 Cp. Bea, F.X. et al. (2004), p. 399.

53 Cp. Berk, J. and DeMarzo, P. (2014), p. 940.

54 Cp. Kumar, N. (2009), p. 2.

55 Cp. Grinblatt M. and Titman, S. (2002), pp. 706.

56 Cp. Siemens AG. (2016b). Siemens at a Glance [online]. [accessed on August 15, 2016].

57 Ibid.

58 Cp. Siemens AG. (2015b). Geschäftsjahresbericht 2015, p. 66.

59 Cp. Siemens AG. (2016c). Acquisitions & Divestments [online]. [accessed on August 16, 2016].

60 Ibid.

61 Original purchase price: 382 mn C$ converted into Euro at an exchange rate of 1 C$ at 0.7621 Euro.

62 Cp. Siemens AG. (2015b), p. 77.

63 Original purchase price: 970 mn USD converted into Euro at an exchange rate of 1 USD at 0.8777 Euro.

64 Ibid.

65 Cp. Siemens AG. (2015a).

66 Cp. Siemens AG. (2014). Executing Vision 2020 – Acquisition of Dresser-Rand Divestment of B/S/H/ [online]. [accessed on August 17], p. 9.

67 Ibid., p. 7.

68 Ibid., p. 4.

69 Cp. Sutherland, B. (2014). Sulzer Needs Deal After Losing on Dresser-Rand: Real M&A [online]. Bloomberg, November 5. [accessed on August 17, 2016].

70 Cp. Siemens AG. (2015b). pp. 77 - 78.

Excerpt out of 36 pages


Investing in External Growth
The FOM University of Applied Sciences, Hamburg
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ISBN (Book)
Investing in External Growth, Master of Business Administration, MBA, FOM, Financial Management, FOM Hamburg, Assignment, Hausarbeit, Seminararbeit, Mergers and Acquisitions, Mergers, Acquisitions, M&A, Inorganic Growth, Organic Growth, Business Valuation Methods, Net Asset Value, Income Value, Income Approach, Discounted Cash Flow Method, Discounted Cash Flow, DCF, WACC, DCF WACC, WACC approach, Market Value Method, Market Value, Dresser-Rand, Enterprise Value, P/E multiple, Due Diligence, Weighted Average Cost of Capital, FOM Assignment, FOM Hausarbeit
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Florian Beyer (Author), 2016, Investing in External Growth, Munich, GRIN Verlag,


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