If strategy is choice, then what motives lie behind a choice to take a risk by investing in a takeover or merging with another firm? It’s an important question and one that students researching external growth via takeovers and mergers need to consider. By understanding the key motives for a takeover, it makes it easier for students to evaluate the likely success or failure of the transaction, including the potential for synergies to provide sufficient shareholder value.
I like the approach taken by Johnson & Scholes, who divide up the motives for M&A into three main groups:
Of course, there can be motives from all three of these groups involved in a particular transaction. However, it is important to identify the main motivation for each takeover or merger - by allocating it to one of the three groups.
I’ve outlined the key differences between each of these three merger motive groups below. Let’s take a brief look at how the distinction can be made between them.
In general, strategic motives tend to be the easiest to justify and the majority of transactions they are the most influential and important. However, just because there is a strong stated strategic motive doesn’t guarantee success. The chosen takeover target might be the wrong one; the price paid might be too high; the integration process poorly managed.
On balance, though, if a takeover has a sensible strategic fit (it makes sense in that it supports the achievement of corporate objectives) then a student can legitimately suggest a takeover had the right motives.
As you can see from the graphic below, there is a wide variety of potential strategic motives. Indeed, a takeover can have more than one strategic motive - it all depends on what the corporate objectives are.
For example, takeovers that involve horizontal integration (e.g. Cooperative / Somerfield & WM Morrison / Safeway) are often pursued to increase both the scale and the market share of the combined firm. Successful horizontal integration ought to involve the achievement of significant cost synergies,which in turn ought to lead to higher profit margins and lower unit costs, which therefore ought to be make the combined business more competitive. In theory!
I must admit, I find the strategic motives behind takeovers fascinating. These days it is rarely about a firm simply becoming bigger. More often, it is about a firm wanting to use a takeover to acquire capabilities and competences, often related to technological change or geographical change. For example, Google’s takeover of Motorola Mobility in 2011 was really about Google gaining access to /control of a wide variety of patents and other technologies that will enable it to support the Android operating eco-system against Apple and Microsoft/Nokia.
Students ought to be able to identify at least one main strategic motive involving any takeover or merger involving two corporates (see below for the complication involving private equity investors). So for example, I would say that the strategic motives for the following takeovers were:
Transaction (Main motives for the transaction)
Kraft / Cadbury: Establish global market leadership in confectionery & access emerging markets
Google / Motorola: Acquire valuable smartphone patents & manufacturing expertise
Tata / JLR: Economies of scale & acquire expertise, brands, capacity and distribution
Santander / Abbey: Market entry (UK) & establish base for further acquisitions to build market share
WM Morrison & Safeway: Increase market share & exploit economies of scale to improve competitiveness
HMV / MAMA: Diversification into fast-growing markets & reduce reliance on retailing
British Airways / Iberia: Consolidation; economies of scale & survival: positioning for further takeovers
All takeovers and mergers have financial motives of one kind or another - each is designed to achieve a satisfactory rate of return for the investment and risk been taken, However, there are also circumstances where the underlying motive for the transaction is financial rather than strategic. In other words, it is the financial returns that are most important and which drive the deal.
A good example for students to consider would be any takeover involving a private equity (or venture capital) buyer. Private equity firms are professional investors who manage investment funds specifically designed to be used in corporate transactions. These can range from relatively small-scale management buy-outs to much larger “leveraged buy-outs” where a substantial proportion of the finance used is in the form of debt (rather than equity).
Private equity firms have been highly active in takeovers across developed economies for many years now. Almost by definition, they do not have strategic motives for their investments, since they are simply acting as financial investors.
Here’s how it works, in a nutshell. A private equity firm raises the cash to make investments by launching a “fund”. Who invests in that fund? Usually pension schemes, high net worth individuals etc - who are looking to achieve high returns by passing their money onto professional investors (the private equity people).
Once the fund is raised, the private equity team gets to work making investments in its target sectors. It might have criteria relating to markets, industries, deal size, geography. The private equity fund will often specialise in particular industries or types of transaction, in order to better understand the risks being taken. This also helps them identify potential takeover targets.
So, back to those financial motives. Typically a private equity fund will aim to achieve an annual rate of return of around 25-40% p.a. over the course of the fund’s life. A private equity takeover is unlikely to offer many opportunities for cost or revenue synergies (since the investor is just a professional finance firm). So how is a return achieved? By picking target investments that still have good growth potential and/or where significant opportunities exist for profit improvement (e.g. through cost cutting). Not for nothing is venture capital (private equity) also sometimes referred to as “vulture capital”!
Students should be able to find lots of examples of private equity takeovers in recent years. We’ve listed a few below to get them started.
KKR buys Pets At Home £1bn http://goo.gl/qjrsP
Apax Partners buys Tommy Hilfiger $1.6bn http://goo.gl/IbHLF
Blackstone Group buys Center Parcs £205m http://goo.gl/R2BDd
Blackstone Group buys Legoland Parks £259m http://goo.gl/hkYsF
KKR buys Alliance Boots £11.1bn http://goo.gl/swyfD
Terra Firma buys EMI £4.2bn http://goo.gl/jT7va
Blackstone Group buys Hilton Hotels $26bn http://goo.gl/NtcSN
Bridgepoint Capital buys Pret A Manger http://goo.gl/VjX5T
Blackstone Group buys SeaWorld $2.3bn http://goo.gl/3cWIb
Doughty Hanson buys Vue Entertainment £450m http://goo.gl/NlzVb
Bridgepoint Capital buys Wiggle£180m http://goo.gl/pyQXw
CVC Capital Partners buys Virgin Active £450m http://goo.gl/NOMdN
When a takeover or merger fails, you can often trace it back to what are called “managerial motives”. In general these are bad news for the shareholders of a business that is pursuing the takeover; it often results in a transaction that destroys significant amounts of shareholder value.
Perhaps the best example recently was the RBS takeover of part of Dutch banking giant ABN Amro. RBS paid £10bn for their part of the deal (they invested alongside Belgian Bank Fortis and Santander Group). RBS got their part of the takeover horribly wrong, and ended up buying something that was worthless with an extra £5bn of liabilities thrown in for good measure. What followed is history - RBS had to be rescued by the UK Government before it took most of the UK banking sector down with it.
How could RBS have got things so wrong? Well, much went wrong with the takeover process (poor due diligence & inadequate integration planning). But the main problem was the the takeover was motivated by the wrong reasons. It was partly motivated by the vanity and egos of the senior management team, who believed in their own hype and simply wanted to continue building the RBS global empire.
Students are very unlikely to have any experience of the financial system and cultural forces that encourage Boards of Directors to pursue takeovers and mergers. An entire industry populated by very bright and highly paid professionals exists in order to encourage and facilitate takeovers and mergers, often focusing on managerial motives rather than strategic. When the vanity of a management team overcomes simple strategic logic and pushes on with a risk takeover, it should be time for shareholders to get out…quick