Section A, ii)
Luminar plc is owner, developer and operator of themed bars, nightclubs and restaurants. Today the firm is UK’s largest operator of licensed late-night venues. For the fiscal year ending March 2006, the company announced a turnover of £338 million, a decrease of 10% against the previous year. Due to a general downturn, and over-capacity of the market sector, Luminar experiences a hard time to realize further growth in the home market. (Datamonitor 2005, Luminar Annual Report 2006). Consequently, the firm is looking for ways to expand its business by evaluating possibilities for growth such as exporting the successful concept to markets outside the UK
One strategic option Luminar is evaluating regarding entry mode into foreign markets is cross-border M&A. The author will discuss this method with regard to reasons, success factors and failure rates, and possible difficulties. The author concludes that Luminar should be conscientious in implementing this method as it may have negative effects on shareholder wealth.
It is observed that many managers seek to maximize size of the firm rather than shareholder value through M&A (Walker 2000). Figure1 in the appendix exhibits some major motives for international M&A activities. Other objectives are economies of scale, risk spreading, market power increase, diversification, and the ability to move quickly at comparably low cost (Schuler et al. 2001, Walker 2000).
It should be one of the main objectives of a firm to increase the wealth of its shareholders (Bruner 2002). Shareholder wealth, or sooner the correlating term shareholder value, is here defined as “the present value of expected future cash flows discounted at a rate that appropriately reflects the relevant risk” (McCarthy 2004:11). In general, shareholders aim for growth in profits (MacDonald 2005). Besides other options, shareholder value is created when a firm’s management makes incremental investments which yield rates of return higher than the invested cost of capital (McCarthy 2004).
Managers then have to make a decision whether to grow internally by starting their own business which is very time- and resource-intensive, or by purchasing of or merging with a company in the same or related branches of business and thus saving time and strength (Picot 2002).
Today’s expanding markets are increasingly influenced by deregulation, globalization, need for economic of scales and rapid reaction to market conditions, which are factors that have driven M&A activity in the past (Schuler et al. 2001). Examples for this are the DaimlerChrysler merger and the takeover of Mannesmann by Vodafone.
If you plan to get involved in M&A you should be aware of the following: It is mainly the transaction itself that is expected to bring about an increase in shareholder value, not just the potential additional business that may follow such transactions. Capital markets value firms on their performance in the market, which is directly influenced by their success on transactions such as M&A (Picot 2002).
Here comes into play a major downside of this strategic option: It is commonly observed that about 70-80% of all M&As fail to achieve their financial goals. It is a fact that most mergers rather erode shareholder wealth than create additional value. After the DaimlerChrysler merger in 1998 one of the main investors sued the company for destroying shareholder value. The failed attempt to merge Renault with Volvo in 1993 temporarily erased 22% of Volvo’s market value (Bruner 2002). Figure2 in the appendix illustrates that most M&A transactions fail to bring the desired increase in value and greater ROI.
Also, firms that went through M&A generally do not outperform firms in a similar position that did not go for this strategic option (Walker 2000). In many cases the stock price after an M&A transaction even underperformed stock price of peer firms (MacDonald 2005). However, some researchers point out that performance cannot be compared easily for these firms (Picot 2002).
It is a question, furthermore, how to scientifically assess the success of M&A at all. It is indicated that all measures employed so far show systematic weaknesses as they consider only quantitative criteria (Picot 2002). Figure 3 gives an overview of a general tendency regarding the rate of unsuccessful acquisitions without addressing this issue in detail (see appendix).
Reasons for failed M&A transactions are manifold. Often, companies overpay, they fail to overcome cultural conflicts, lack required resources, or apply poor integration processes. In many cases, even a clear communication strategy towards shareholders and stakeholders of the company is missing (MacDonald 2005).
Key success factors, on the other hand, comprise a thorough due diligence, an experienced and well-managed M&A team, strong leadership, realistic expectations and time-scale, extensive and timely internal and external communication, a shared vision, and cultural integration, among others. The focus should not just be on integration but also on value-creation, though (Picot 2002).
There is a major difference in the perspective of merging firms: Acquiring firms can expect their stock price to rise in half of the cases while firms that are to be acquired experience rising stock prices in 92% of the cases (Picot 2002, Bruner 2002). A main reason for this is that acquiring firms tend to overpay on their targets for various reasons while the investment underperforms (MacDonald 2005). It can also be observed that the immediate reaction of the financial markets to M&A announcement is very modest regarding the stock price of the acquiring firm (Walker 2000). On the other hand, for firms that are to be acquired this may indeed have a rather large impact.
These combined empirical and scholar findings show some major implications for Luminar considering to extend its business through M&A activity. First, you should carefully elaborate on the premium that you are willing to pay for an acquisition and should avoid overpaying (Walker 2000, Bruner 2002). This would have a negative impact on your firm’s stock price and future financial performance. Shareholder value is directly derived from a firm's valuation in capital markets. The markets will only benefit profitable growth as the single effective way to create shareholder value (McCarthy 2004). Growth itself is not creating value automatically. It is an implicit objective to have a return on capital that is above the cost of capital.