Acquisitions & Differentiation
- The empirical evidence shows that acquisitions are unrewarding and should be avoided".
Discuss.
- Why is diversification often problematic? How might it be managed successfully?
- Why do companies diversify when successful diversification is so difficult to achieve?
Explain using examples.
Introduction
Empirical Data on Mergers and Acquisitions:
o Christensen (2011): the failure rate for M&A is between 70% and 90%.
o Montgomery (1994): on average, firms with higher levels of diversification are
less profitable than firms with lower levels of diversification and acquisitions
often do not lead to increases in corporate wealth for bidding firms.
o Moeller et al (2005): acquiring-firm shareholders lost 12 cents around acquisition
announcements per dollar spent on acquisitions for a total loss of $240 billion
from 1998 through 2001. The average abnormal return of -10.6%.
o Shleifer & Vishny (1991): Investors mark down the stock of acquirers following
takeover announcements which indicates their belief that acquiring managers
have overpaid
o Andrade, Mithcell & Stafford (2001): Target firms share price increased by 16%
following the announcement BUT acquirer’s share price fell by 1%
o Barney (1988): Shareholders of target firms achieve abnormal returns but not
those of the bidding firms as the price of a target firm rises to its NPV
o Meanwhile, Agrawal, Jaffe & Mandelker (1992): shareholders of acquiring firms
suffer a 10% loss on average over a 5-year period
o Berger & Ofek (1995) found the value of conglomerates to be 13-15% less than
for non-conglomerate firms in the same industries
Corporate Strategy: what businesses to be in/how to manage them
o Corporate strategy makes the whole add up to more than the sum of its business
units
Empirical data does show that acquisitions may be unrewarding but that does not imply
that all acquisitions are unrewarding and should be avoided.
Hapeslagh & Jemison (1987): acquisition should be a means for a firm to acquire
capacity or a position important to its renewal or development strategy.
o If an acquisition does not achieve this, it will unrewarding.
Acquisitions following a certain well-defined criterion can be rewarding, showing that a
moderate level of diversification into related industries may be optimal.
o Beyond a certain level of diversification, acquisitions may be not be optimal and
should therefore be avoided.
P1: Benefits of acquisitions/ Diversification: Economies of Scale and Scope
Acquisitions allow for economies of scale and scope: firms can leverage brands,
reputation or political connections across industries
o Virgin:
Large economies of scale for information can share R&D, technology, and expertise
across industries.
, Firm-specific assets and innovations in one business unit can be transferred and
exploited in multiple other (complementary) new markets
o BUT This may lead to a lack of in-depth experience/expertise in any one industry
Managerial EoS
o Centralised decision-making incurs costs/devotes resources to internal politics
Diversified firms can internalize market failures
P2: Benefits of acquisitions/ Diversification: Market Power
Montgomery (1994): Market Power View: Acquisitions allow for cross-subsidization to
support predatory pricing activities in another sector, as well as mutual forbearance,
whereby competitors meeting each other in multiple markets recognize their
interdependence and therefore compete less vigorously.
The interrelationships among large diversified firms foreclose markets to smaller
competitors.
P3: Benefits of acquisitions/ Diversification: Leveraging Financial Resources
When excess resources exist that are open to transaction costs or lack of markets, firm
might diversify to make use of the unused resources.
Internal funding may be cheaper – do not need to pay interest/no TCs
An internal capital market may be more efficient because the firms has a greater
amount of information about the businesses it owns than external investors
o Can invest money from mature industries (cash cows) into divisions with highly
profitable growth opportunities (stars)
BUT cross-subsidisation could cover inefficient components of the firm
o Can enable overinvestment in failing units
o Business unit managers may bias information which would lead to inefficient
resource allocations
P4: Benefits of acquisitions/ Diversification: Risk Reduction
CFs of diversified firms are less risky, especially if in cyclical businesses
o Poor performance of one business unit has lower consequences for the
corporation
Diversification increases the likelihood that a firm can meet its debt repayment
obligations which indirectly benefits equity holders
BUT For employees and managers, NOT shareholders
o Investors can diversify their own portfolio
o EV if worker security is greater, employees may make more firm-specific investments
o EV financial markets are undeveloped diversification into new industries may
decrease risk if individual investors cannot diversify their individual portfolio
Barney (1987): Risk reduction may be more beneficial for unrelated diversification
Other benefits specific to Mergers & Acquisitions:
o Bargain purchase price, another company has essential but underused assets
o Broader market access, quick access to markets otherwise difficult to penetrate
o Technology acquisition, such as a 4G license
o Filling a weakness with another firm’s strength
o Short-term growth, if there is a pressure to turn-around.
- The empirical evidence shows that acquisitions are unrewarding and should be avoided".
Discuss.
- Why is diversification often problematic? How might it be managed successfully?
- Why do companies diversify when successful diversification is so difficult to achieve?
Explain using examples.
Introduction
Empirical Data on Mergers and Acquisitions:
o Christensen (2011): the failure rate for M&A is between 70% and 90%.
o Montgomery (1994): on average, firms with higher levels of diversification are
less profitable than firms with lower levels of diversification and acquisitions
often do not lead to increases in corporate wealth for bidding firms.
o Moeller et al (2005): acquiring-firm shareholders lost 12 cents around acquisition
announcements per dollar spent on acquisitions for a total loss of $240 billion
from 1998 through 2001. The average abnormal return of -10.6%.
o Shleifer & Vishny (1991): Investors mark down the stock of acquirers following
takeover announcements which indicates their belief that acquiring managers
have overpaid
o Andrade, Mithcell & Stafford (2001): Target firms share price increased by 16%
following the announcement BUT acquirer’s share price fell by 1%
o Barney (1988): Shareholders of target firms achieve abnormal returns but not
those of the bidding firms as the price of a target firm rises to its NPV
o Meanwhile, Agrawal, Jaffe & Mandelker (1992): shareholders of acquiring firms
suffer a 10% loss on average over a 5-year period
o Berger & Ofek (1995) found the value of conglomerates to be 13-15% less than
for non-conglomerate firms in the same industries
Corporate Strategy: what businesses to be in/how to manage them
o Corporate strategy makes the whole add up to more than the sum of its business
units
Empirical data does show that acquisitions may be unrewarding but that does not imply
that all acquisitions are unrewarding and should be avoided.
Hapeslagh & Jemison (1987): acquisition should be a means for a firm to acquire
capacity or a position important to its renewal or development strategy.
o If an acquisition does not achieve this, it will unrewarding.
Acquisitions following a certain well-defined criterion can be rewarding, showing that a
moderate level of diversification into related industries may be optimal.
o Beyond a certain level of diversification, acquisitions may be not be optimal and
should therefore be avoided.
P1: Benefits of acquisitions/ Diversification: Economies of Scale and Scope
Acquisitions allow for economies of scale and scope: firms can leverage brands,
reputation or political connections across industries
o Virgin:
Large economies of scale for information can share R&D, technology, and expertise
across industries.
, Firm-specific assets and innovations in one business unit can be transferred and
exploited in multiple other (complementary) new markets
o BUT This may lead to a lack of in-depth experience/expertise in any one industry
Managerial EoS
o Centralised decision-making incurs costs/devotes resources to internal politics
Diversified firms can internalize market failures
P2: Benefits of acquisitions/ Diversification: Market Power
Montgomery (1994): Market Power View: Acquisitions allow for cross-subsidization to
support predatory pricing activities in another sector, as well as mutual forbearance,
whereby competitors meeting each other in multiple markets recognize their
interdependence and therefore compete less vigorously.
The interrelationships among large diversified firms foreclose markets to smaller
competitors.
P3: Benefits of acquisitions/ Diversification: Leveraging Financial Resources
When excess resources exist that are open to transaction costs or lack of markets, firm
might diversify to make use of the unused resources.
Internal funding may be cheaper – do not need to pay interest/no TCs
An internal capital market may be more efficient because the firms has a greater
amount of information about the businesses it owns than external investors
o Can invest money from mature industries (cash cows) into divisions with highly
profitable growth opportunities (stars)
BUT cross-subsidisation could cover inefficient components of the firm
o Can enable overinvestment in failing units
o Business unit managers may bias information which would lead to inefficient
resource allocations
P4: Benefits of acquisitions/ Diversification: Risk Reduction
CFs of diversified firms are less risky, especially if in cyclical businesses
o Poor performance of one business unit has lower consequences for the
corporation
Diversification increases the likelihood that a firm can meet its debt repayment
obligations which indirectly benefits equity holders
BUT For employees and managers, NOT shareholders
o Investors can diversify their own portfolio
o EV if worker security is greater, employees may make more firm-specific investments
o EV financial markets are undeveloped diversification into new industries may
decrease risk if individual investors cannot diversify their individual portfolio
Barney (1987): Risk reduction may be more beneficial for unrelated diversification
Other benefits specific to Mergers & Acquisitions:
o Bargain purchase price, another company has essential but underused assets
o Broader market access, quick access to markets otherwise difficult to penetrate
o Technology acquisition, such as a 4G license
o Filling a weakness with another firm’s strength
o Short-term growth, if there is a pressure to turn-around.
