Mergers and acquisitions are back in the news thanks to the successful takeover of America’s second largest cable company, Time Warner, by Charter Communications, the nation’s fourth largest cable company. This deal follows the recently failed attempt by third largest cable provider Comcast at getting its hands on Time Warner.
Meanwhile in the UK BT is trying to acquire EE while property site Zoopla has successfully snapped up U-Switch. Poundland is currently doing its best to get hold of 99p Stores.
These deals are far from straightforward and a number of criteria must be in place before the two companies will even talk.
Here are the key elements that precede these famous mergers and acquisitions.
Obvious value creation
One of the first and most important criteria for any buyer to examine is the potential for value creation.
This typically comes in one of two ways, improvement of a struggling company or immediate cost savings to the buyer. Both may happen when you’re very lucky. Without obvious value creation, the would-be acquirer has a hard time justifying the move.
When former boss of the New Covent Garden Soup Company William Kendal acquired a controlling stake in Green & Blacks chocolate, he was taking a big punt on a failing business.
With annual turnover of £2.5m and unsustainable costs due to their ethical sourcing policy, the chocolate maker demonstrated obvious room for improvement.
When Cadbury Schweppes acquired Green & Blacks for an estimated £20m 2005, Kendal got his investment back almost ten times over.
Though this isn’t always the case. The “winner’s curse” phenomenon can often come into play during the postmerger integration phase and it is the smaller company that gleans the value.
A report by McKinsey estimates that the smaller entity in any merger will enjoy a boost in value of between 10 and 35 percent, effectively meaning the buyer pays them twice.
Successful risk assessment
Before any corporate lawyer worth her salt signs off on a tender document the compliance and risk teams conduct a thorough risk assessment, checking for any impending litigation, intellectual property issues or other legal banana skins.
The financial state of the company will also be subject to close scrutiny.
A healthy balance sheets typically make a company attractive, although underperformers can be had at a cheap cost with a view to improving and reselling. This is typical with private equity acquisitions.
A memorable recent example of an intellectual property driven deal is Twitter’s acquisition of video sharing platform Vine. Before Vine had even launched, Twitter slapped a reported $30 million on the table to own the concept of six-second video clips.
Any interesting intellectual property can make a company extremely attractive. Even a brand name on its own can be an asset. When Texas Air Corporation (who?) took over the smaller Continental Airlines in 1981, they immediately started using the name for themselves. A similar thing happened when Westinghouse took over CBS in 1995.
Accelerated route to new markets and new supply chains
This one can work both ways; either the acquiring company benefits from selling its product to a market dominated by the target company, or it identifies a product owned by the target that it can sell into markets in which it already dominates.
The Charter-Time Warner merger will give Charter approximately 24 million new customers, just like that. Crucially these customers are in locations previously untapped by the comms giant, including Washington and South Carolina.
In April 2015 Enterprise Rent-A-Car announced that it had acquired City Car Club, the by-the-hour rental service. This opened up its traditional car rental offer to a market of tech-literate, predominantly young, car-free motorists.
But it’s not just markets and customers that prove attractive. When Cadbury Schweppes acquired Green & Blacks, it was benefiting from a previously untapped procurement base in Green & Blacks’ ethical cocoa supply chain. Cadbury’s could now add the Fair Trade feather to its cap.
“Acquisitions can be a very effective way to quickly enhance supply chain capabilities and achieve cost efficiencies, while offering more value to customers. Consider the Kraft-Heinz mega-merger; the combined entities have enhanced supply chains that can help them achieve greater results, reduce costs and offer more to consumers.”
– James Ferguson, founder of procurement platform Supplibase.
Disclosure from the buyer
In 2011 the Panel of Takeovers and Mergers revised its takeover code to ensure companies gave more information to target companies before executing a merger or acquisition.
This was predominantly driven by the acquisition of Cadbury Schweppes by American giant Kraft, who announced plans to close down Cadbury’s Somerdale factory just a week after assuring Cadbury’s staff, post acquisition, that this wasn’t going to happen. Job losses ensued and MPs got involved to make sure it couldn’t happen again.
Finance and due diligence are all well and good, but when the acquired company’s own assets are living, breathing people you’d better hope there’s a cultural fit.
Which is what Terra Firma, a private equity firm headed by English financier Guy Hands, found out when they took over the much loved music publishing company EMI.
Within a year of the deal, Radiohead and the Rolling Stones both jumped ship, amid speculation that they were unhappy with how things were being run.
“EMI – that’s a name I try and forget,”
– Guy Hands.
Talking about mergers and acquisitions as if they’re a done deal can be a dangerous game. Even as the ink dries on the agreements between the interested parties, regulatory approval can often throw a spanner in the works.
In fact, as of this blog going live, the Charter-Time Warner deal remains subject to regulatory approval. That said most commentators see it as a done deal.
The music industry provides numerous examples of regulatory approval scuppering potential mergers and acquisitions. The Noughties turned out to be merger central for record and publishing labels.
Warner Music Group famously tried to buy EMI in 2006 but failed due to competition regulators, before EMI turned the tables and attempted to buy Warners. Meanwhile, Sony and BMG managed to merge following protracted regulatory negotiations.
Fast forward a decade you’ve got a similar, albeit less glamorous example of inter-market cannibalisation; Poundland is currently working with the Competition and Markets Authority to push through its £55m takeover of rival 99p Stores.