The latest edition of Business Cafe, our digital case study magazine for business students and teachers is now available for download. Many thanks to editor Andy Reeve and his team of contributors for another excellent selection of eight student-friendly articles. The topics covered are summarised below.
Business Cafe - February 2012
Album Sales down in UK but up in US
It is interesting to compare two reports on the music industry that news channels have written. Bloomberg reported that the sales of albums in the United States was up on 2010 figures in November 2011, whilst the BBC have reported that overall sales of a lbums in the United Kingdom are down on 2010 levels.
Will Temporary Agency Staff Become a Thing of the Past?
In a bid to increase competitiveness, many businesses have what we call flexible workforces. In other words, they may have core workers (full-time, permanent workers with specific skills) alongside peripheral workers (part-time, temporary, self-employed staff used then needed). The idea is that rather than having all staff working permanently and therefore having high overheads, by having some staff working temporarily, i.e. only employing people when the business is busy, overheads can be reduced which can help a business keep prices low and, therefore, improve competitiveness. However, recent EU legislation means that employing staff on a temporary basis may not be attractive as it was before.
Counterfeit goods
It is hardly surprising that in difficult economic times - with apparently worse to come in terms of falling incomes - consumers should seek out bargains, especially on higher priced goods. There is also, and always has been, another way to save money; buying counterfeit goods. Counterfeit goods are copies of (usually) ‘luxury’ items that people want to buy. They are also known as ‘pirated’ goods and the most common sorts of fakes are designer clothes, perfumes, CDs, DVDs and computer games.
Executive Pay
Christmas has come and gone but the season of bank bonuses is with us once again and looks certain to stir up the same strong feelings as it has done for several years. David Cameron has surprised some by announcing that shareholders could be given the legal right to block executive pay awards that they feel are excessive. There seems to be a view amongst all of the political parties that executive pay is out of control and creating a vast divide between the rich and the poor.
Holiday Prices are cut to compete with the Olympics
The economic slowdown continues to detrimentally affect the leisure and travel sectors of the economy and the Olympics of 2012 are an additional strain on the major tour operators who are battling against people staying at home to watch the games.
Christmas and New Year sales
Measuring footfall for retail outlets is a good indication of popularity and shows businesses the success of any marketing activity. The figures allow businesses to measure demand for their products and help maximise sales.
Targeting China’s Top Range Tastes
As the effects of recession continue to bite in the UK, stores selling luxury goods are increasingly looking elsewhere for customers with money to spend. A visit to Harrods and Selfridges in London or to Bicester Shopping Village will show UK shoppers how important wealthy Chinese tourists have become to these stores.
Tesco Tax – Targeting Retailers in Northern Ireland
Large retailers in Northern Ireland are being targeted by the Northern Ireland Executive in the New Year. The Finance Minister, Sammy Wilson, stated that the “large-retailer” taxation will be in place by April.
Firms that pursue takeovers should look to create value, not headlines. That’s one of the lessons I’ve picked up from some analysis of successful takeover strategies listed in the 2010 KPMG survey of global M&A. Here is a brief summary of their recommendations for approaches which are more likely to result in a takeover or merger..
(1) Don’t start with the deal (start the detail planning early)
The worst time to start evaluating the potential benefits and drawbacks of the deal is when the transaction is just about to be completed (or worse, just after). Integration planning needs to start as as soon as possible and it needs to be wide-ranging (i.e. not just limited to financial and marketing aspects).
(2) Define the strategy
Obvious really, but still essential. The buyer needs to have a clear and agreed understanding of the strategic rationale for the deal.
(3) Don’t just focus on costs
Cost synergies are important, but they shouldn’t be the only focus. It is important to work hard to identify and evaluate potential revenue synergies as well so that shareholders are better informed when they analyse whether to support the proposed deal.
(4) Focus due diligence on the future
The process of due diligence is often too focused on understanding the past performance of the target business. However, many takeover targets operate in markets which are changing rapidly - how reliable is the past in predicting performance in the future? For example, due diligence should critically analyse the competitive environment of the target, including the prospects for market growth.
(5) Is a takeover really the right answer?
A vital question to ask. Is a takeover the best option to deliver the growth objectives of the business? Are alternative external growth options a better bet (e.g. joint venture, licensing deals, strategic partnership etc). KPMG make the important point that some management teams become committed to takeovers too readily without critically evaluating whether an acquisition is the right tool.
(6) Recognise the hard truths about the soft issues
KPMG report a statistic that “45% of Fortune 500 CFOs blame post-M&A failure on unexpected people problems”. The key soft issues to address include choosing the right management team post deal, handling differences in culture between the buyer and target, and managing communication about the deal.
(7) One size does not fit all
An interesting one this - and a great “depends-on” evaluation point for students to make in an exam essay. There is no such thing as a standard takeover or merger. Every transaction has significant individual elements that need addressing in order to make it a success. Maybe a key customer needs to be brought on-board. Maybe there is a risk of the loss of highly-skilled and business-critical employees. Perhaps there is a strong entrepreneurial culture in the target business which needs to be embraced and nurtured in order for value to be created. Every takeover and merger is different - each requires careful thought and planning.
(8) Balance risk and reward
Another great point for evaluation. A business should not become over-reliant on acquisitions to sustain growth. As KPMG point out, being busy with takeovers is not the same thing as being busy creating value for shareholders. Once bought, every business needs detailed attention to make it even more successful.
Look at any major takeover or merger in the news and you’ll come across the concept of synergies….
For example:
‘‘The deal has potential synergies that make some observers drool.’‘
That’s the Wall Street Journal, commenting on Time Warner’s merger with AOL in 2000. How wrong they were!
But, sometimes the doubters are also proved wrong.
Back in 2004, investors and analysts were doubtful that Spanish banking giant Santander would be able to achieve its ambitious plan of stripping out £300million of costs from Abbey National when it made a £9.6bn bid. In fact, Santander delivered the £300million of cost synergies a year ahead of schedule. Profits at Abbey, which were £16million in the year of takeover, rose to £1.5bn at Santander UK in 2009.
More recently, the Kraft Foods takeover of Cadbury involved the acquirer (Kraft) assuming significant potential for cost and revenues synergies to help justify the price paid for Cadbury. At the time of the deal, Kraft targeted around £450million of annual cost savings by the end of the third year. It remains to be seen whether Kraft will achieve this target.
The role of synergies in M&A
The primary objective of any takeover is to create value for shareholders that exceeds the cost of the acquisition. In fact, synergies are fundamentally the only tangible justification for a takeover.
Synergies represent the extra value that can be created from the takeover. Assuming that the buyer has to pay a reasonable price for the takeover target, then no value has been created at that point.
For example, consider a business valued at £10 million by the market (e.g. from the market capitalisation on the stock market).
A buyer comes along and, after negotiation and due diligence, agrees to pay £13 million to complete the takeover. The buyer has paid a bid premium of 30% (or £3 million) to complete the takeover.
The shareholders of the target business are happy. But the shareholders of the buyer business will need to be convinced that the price was worth paying. They have had to pay £3 million over the apparent value
of the business to achieve the takeover.
How can the bid premium be justified? Only if the takeover achieves synergies worth at least £3 million in value terms (e.g. the NPV of future synergies).
In practice, synergies are “easier said than done.” While cost synergies are difficult to achieve, revenue synergies are even harder. The implication is that many mergers fail to live up to expectations and wind up destroying shareholder value rather than create it.
Cost synergies
Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations
Potential sources of cost synergies include:
- Headcount reduction (redundancies)
- Elimination of surplus facilities
- Reduced overheads (e.g. consolidate functions such as accounting, IT and marketing)
- Increased purchasing power (greater bargaining power with suppliers due to greater combined size)
Revenue synergies
Revenue synergies refer to the ability to sell more products/services or raise prices due to the deal.
Potential revenue synergies include:
- Marketing and selling complementary products
- Cross-selling into a new customer base
- Sharing distribution channels
- Access to new markets (e.g. through existing expertise of the takeover target)
- Reduced competition
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