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Exam 4: Planning: Developing Business and Acquisition Plans: Phases 1 and 2 of the Acquisition Process

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Question 61

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Consolidation in the Global Pharmaceutical Industry: The Glaxo Wellcome and SmithKline Beecham Example By the mid-1980s, demands from both business and government were forcing pharmaceutical companies to change the way they did business. Increased government intervention, lower selling prices, increased competition from generic drugs, and growing pressure for discounting from managed care organizations such as health maintenance and preferred provider organizations began to squeeze drug company profit margins. The number of contact points between the sales force and the customer shrank dramatically as more drugs were being purchased through managed care organizations and pharmacy benefit managers. Drugs commonly were sold in large volumes and often at heavily discounted levels. The demand for generic drugs also was declining. The use of formularies, drug lists from which managed care doctors are required to prescribe, gave doctors less choice and made them less responsive to direct calls from the sales force. The situation was compounded further by the ongoing consolidation in the hospital industry. Hospitals began centralizing purchasing and using stricter formularies, allowing physicians virtually no leeway to prescribe unlisted drugs. The growing use of formularies resulted in buyers needing fewer drugs and sharply reduced the need for similar drugs. The industry’s first major wave of consolidations took place in the late 1980s, with such mergers as SmithKline and Beecham and Bristol Myers and Squibb. This wave of consolidation was driven by increased scale and scope economies largely realized through the combination of sales and marketing staffs. Horizontal consolidation represented a considerable value creation opportunity for those companies able to realize cost synergies. In analyzing the total costs of pharmaceutical companies, William Pursche (1996) argued that the potential savings from mergers could range from 15–25% of total R&D spending, 5–20% of total manufacturing costs, 15–50% of marketing and sales expenses, and 20–50% of overhead costs. Continued consolidation seemed likely, enabling further cuts in sales and marketing expenses. Formulary-driven purchasing and declining overall drug margins spurred pharmaceutical companies to take action to increase the return on their R&D investments. Because development costs are not significantly lower for generic drugs, it became increasingly difficult to generate positive financial returns from marginal products. Duplicate overhead offered another opportunity for cost savings through consolidation, because combining companies could eliminate redundant personnel in such support areas as quality assurance, manufacturing management, information services, legal services, accounting, and human resources. The second merger wave began in the late 1990s. The sheer magnitude and pace of activity is striking. Of the top-20 companies in terms of global pharmaceutical sales in 1998, one-half either have merged or announced plans to do so. More are expected as drug patents expire for a number of companies during the next several years and the cost of discovering and commercializing new drugs continues to escalate. On January 17, 2000, British pharmaceutical giants Glaxo Wellcome PLC and SmithKline Beecham PLC agreed to merge to form what was at the time the world’s largest drug company. The merger was valued at $76 billion. The resulting company was called Glaxo SmithKline and had annual revenue of $25 billion and a market value of $184 billion. The combined companies also would have a total R&D budget of $4 billion and a global sales force of 40,000. Total employees would number 105,000 worldwide. Although stressed as a merger of equals, Glaxo shareholders would own about 59% of the shares of the two companies. The combined companies would have a market share of 7.5% of the global pharmaceutical market. The companies projected annual pretax cost savings of about $1.76 billion after 3 years. The cost savings would come primarily from job cuts among middle management and administration over the next 3 years -What was driving change in the pharmaceutical industry in the late 1990s?

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Profit margin pressures continued to mou...

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How did the acquisition of Countrywide fit BofA's business strategy? Be specific. What were the key assumptions implicit the BofA's business strategy? How did the existence of BofA's mission and business strategy help the firm move quickly in acquiring Countrywide?

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BofA mission is to become the nation's l...

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Stakeholders include which of the following groups?

Financial risk refers to the buyer's willingness and ability to leverage a transaction as well as the willingness of shareholders to accept near-term earnings per share dilution.

The evolution of the growth of a product can be characterized in four stages: embryonic, growth, maturity, and decline. This description is called a business attractiveness matrix.

CenturyTel Buys Qwest Communications to Cut Costs and Buy Time as the Landline Market Shrinks • Market segmentation can be used to identify “underserved” segments which may sustain firms whose competitive position in larger markets is weak. • A firm’s competitive relative is best viewed in comparison to those firms competing in its served market rather than with industry leading firms. ____________________________________________________________________________________________ In what could best be described as a defensive acquisition, CenturyTel, the fifth largest local phone company in the United States, acquired Qwest Communications, the country’s third largest, in mid-2010 in a stock swap valued at $10.6 billion. While both firms are dwarfed in size by AT&T and Verizon, these second-tier telecommunications firms will control a larger share of the shrinking landline market. The combined firms will have about 17 million phone lines serving customers in 37 states. This compares to AT&T and Verizon with about 46 and 32 million landline customers, respectively. The deal would enable the firms to reduce expenses in the wake of the annual 10 percent decline in landline usage as people switch from landlines to wireless and cable connections. Expected annual cost savings total $575 million; additional revenue could come from upgrading Qwest’s landlines to handle DSL Internet. In 2010, about one-fourth of U.S. homes used only cell phones, and cable behemoth Comcast, with 7.6 million residential and business phone subscribers, ranked as the nation’s fourth largest landline provider. CenturyTel has no intention of moving into the wireless and cable markets, which are maturing rapidly and are highly competitive. While neither Qwest nor CenturyTel owns wireless networks and therefore cannot offset the decline in landline customers as AT&T and Verizon are attempting to do, the combined firms are expected to thrive in rural areas where they have extensive coverage. In such geographic areas, broadband cable Internet access and fiber-optics data transmission line coverage are is limited. The lack of fast cable and fiber-optics transmission makes voice over Internet protocol (VOIP)—Internet phone service offered by cable companies and independent firms such as Vonage—unavailable. Consequently, customers are forced to use landlines if they want a home phone. Furthermore, customers in these areas must use landlines to gain access to the Internet through dial-up access or through a digital subscriber line (DSL). -Why might the acquisition of Qwest be described as defensive?

A good mission statement should be

The acquisition plan provides the detail needed to implement effectively the firm's business strategy,

Consolidation in the Global Pharmaceutical Industry: The Glaxo Wellcome and SmithKline Beecham Example By the mid-1980s, demands from both business and government were forcing pharmaceutical companies to change the way they did business. Increased government intervention, lower selling prices, increased competition from generic drugs, and growing pressure for discounting from managed care organizations such as health maintenance and preferred provider organizations began to squeeze drug company profit margins. The number of contact points between the sales force and the customer shrank dramatically as more drugs were being purchased through managed care organizations and pharmacy benefit managers. Drugs commonly were sold in large volumes and often at heavily discounted levels. The demand for generic drugs also was declining. The use of formularies, drug lists from which managed care doctors are required to prescribe, gave doctors less choice and made them less responsive to direct calls from the sales force. The situation was compounded further by the ongoing consolidation in the hospital industry. Hospitals began centralizing purchasing and using stricter formularies, allowing physicians virtually no leeway to prescribe unlisted drugs. The growing use of formularies resulted in buyers needing fewer drugs and sharply reduced the need for similar drugs. The industry’s first major wave of consolidations took place in the late 1980s, with such mergers as SmithKline and Beecham and Bristol Myers and Squibb. This wave of consolidation was driven by increased scale and scope economies largely realized through the combination of sales and marketing staffs. Horizontal consolidation represented a considerable value creation opportunity for those companies able to realize cost synergies. In analyzing the total costs of pharmaceutical companies, William Pursche (1996) argued that the potential savings from mergers could range from 15–25% of total R&D spending, 5–20% of total manufacturing costs, 15–50% of marketing and sales expenses, and 20–50% of overhead costs. Continued consolidation seemed likely, enabling further cuts in sales and marketing expenses. Formulary-driven purchasing and declining overall drug margins spurred pharmaceutical companies to take action to increase the return on their R&D investments. Because development costs are not significantly lower for generic drugs, it became increasingly difficult to generate positive financial returns from marginal products. Duplicate overhead offered another opportunity for cost savings through consolidation, because combining companies could eliminate redundant personnel in such support areas as quality assurance, manufacturing management, information services, legal services, accounting, and human resources. The second merger wave began in the late 1990s. The sheer magnitude and pace of activity is striking. Of the top-20 companies in terms of global pharmaceutical sales in 1998, one-half either have merged or announced plans to do so. More are expected as drug patents expire for a number of companies during the next several years and the cost of discovering and commercializing new drugs continues to escalate. On January 17, 2000, British pharmaceutical giants Glaxo Wellcome PLC and SmithKline Beecham PLC agreed to merge to form what was at the time the world’s largest drug company. The merger was valued at $76 billion. The resulting company was called Glaxo SmithKline and had annual revenue of $25 billion and a market value of $184 billion. The combined companies also would have a total R&D budget of $4 billion and a global sales force of 40,000. Total employees would number 105,000 worldwide. Although stressed as a merger of equals, Glaxo shareholders would own about 59% of the shares of the two companies. The combined companies would have a market share of 7.5% of the global pharmaceutical market. The companies projected annual pretax cost savings of about $1.76 billion after 3 years. The cost savings would come primarily from job cuts among middle management and administration over the next 3 years -What do you think was the major motivating factor behind the Glaxo SmithKline merger and why was it so important?

Good planning expedites sound decision making.

Stakeholders only include a firm's shareholders.

Overpayment risk involves the dilution of EPS or a reduction in its growth rate resulting from paying significantly more than the economic value of the acquired firm.

Which of the following are true of real options?

Given the nature of technology, do you believe it is possible for one firm to dominant the mobile messaging space? Explain your answer.

A diversification strategy involves a firm moving into only those businesses which are unrelated to the firm's current core business.

Contingency plans are actions that are taken as an alternative to the firm's current business strategy.

Nokia’s Gamble to Dominate the Smartphone Market Falters The ultimate success or failure of any M&A transaction to satisfy expectations often is heavily dependent on the answer to a simple question. Was the justification for buying the target firm based on a sound business strategy? No matter how bold, innovative, or precedent-setting a bad strategy is, it is still a bad strategy. In a bold move that is reminiscent of the rollout of Linux, Nokia, a Finnish phone handset manufacturer, announced in mid-2008 that it had reached an agreement to acquire Symbian, its supplier of smartphone operating system software. Nokia also announced its intention to give away Symbian's software for free in response to Google’s decision in December 2008 to offer its Android operating system at no cost to handset makers. This switch from a model in which developers had to pay a license fee to create devices using the Symbian operating system software to a free (open source) model was designed to supercharge the introduction of innovative handheld products that relied on Symbian software. Any individual or firm can use and modify the Symbian code for any purpose for free. In doing so, Nokia is hoping that a wave of new products using Symbian software would blunt the growth of Apple’s proprietary system and Google’s open source Android system. Nokia is seeking to establish an industry standard based on the Symbian software, using it as a platform for providing online services to smartphone users, such as music and photo sharing. According to Forrester Research, the market for such services is expected to reach $92 billion in 2012 (almost twice its size when Nokia acquired Symbian), with an increasing portion of these services delivered via smartphones. In its vision for the future, Nokia seems to be positioning itself as the premier supplier of online services to the smartphone market. Its business strategy or model is to dominate the smartphone market with handsets that rely on the Symbian operating system. Nokia hopes to exploit economies of scale by spreading any fixed cost associated with online services over an expanding customer base. Such fixed expenses could include a requirement by content service providers that Nokia pay a minimum level of royalties in addition to royalties that vary with usage. Similarly, the development cost incurred by service providers can be defrayed by selling into a growing customer base. The implementation strategy involved the acquisition of the leading supplier of handset operating systems and subsequently to give away the Symbian software free. The success or failure of this vision, business strategy, and implementation strategy depends on whether Symbian can do a better job of recruiting other handset makers, service providers, and consumers than Nokia's competitors. The strategy to date seems to be unraveling. At the time of the acquisition, Symbian supplied almost 60 percent of the operating system software for smartphones worldwide. Market researcher Ovum estimates that the firm’s global market share fell to less than 50 percent in 2010 and predicts the figure could decline to one-third by 2015, reflecting the growing popularity of Google’s Android software. Android has had excellent success in the U.S. market, leapfrogging over Apple’s 24 percent share to capture 27 percent of the smartphone market, according to the NPD Group. Research-In-Motion (RIM), the maker of the Blackberry, remained the U.S. market share leader in 2010 at 33 percent. Dell Computer’s Drive to Eliminate the Middleman Historically, personal computers were sold either through a direct sales force to businesses (e.g., IBM), through company-owned stores (e.g., Gateway), or through independent retail outlets and distributors to both businesses and consumers (e.g., CompUSA). Retail chains and distributors constituted a large percentage of the customer base of other PC manufacturers such as Compaq and Gateway. Consequently, most PC manufacturers were saddled with the large overhead expense associated with a direct sales force, a chain of company-owned stores, a demanding and complex distribution chain contributing a substantial percentage of revenue, or some combination of all three. Michael Dell, the founder of Dell Computer, saw an opportunity to take cost out of the distribution of PCs by circumventing the distributors and selling directly to the end user. Dell Computer introduced a dramatically new business model for selling personal computers directly to consumers. By starting with this model when the firm was formed, Dell did not have to worry about being in direct competition with its distribution chain. Dell has changed the basis of competition in the PC industry not only by shifting much of its direct order business to the internet but also by introducing made-to-order personal computers. Businesses and consumers can specify online the features and functions of a PC and pay by credit card. Dell assembles the PC only after the order is processed and the customer’s credit card has been validated. This has the effect of increasing customer choice and convenience as well as dramatically reducing Dell’s costs of carrying inventory. The Dell business model has evolved into one focused relentlessly on improving efficiency. The Dell model includes setting up super-efficient factories, keeping parts in inventory for only a few days before they are used, and selling computers based on common industry standards like Intel chips and Microsoft operating systems. By its nature, the Dell model requires aggressive expansion. As growth in the PC market slowed in the late 1990s, the personal computer became a commodity. Since computers had become so powerful, there was little need for consumers to upgrade to more powerful machines. To offset growth in its primary market, Dell undertook a furious strategy to extend the Dell brand name into related electronics markets. The firm started to sell “low end” servers to companies, networking gear, PDAs, portable digital music players, an online music store, flat-panel televisions, and printers. In late 2002, the firm began to sell computers through the retail middleman Costco. Michael Dell believes that every product should be profitable from the outset. His focus on operating profit margins has left little for product innovation. Dell’s budget for new product R&D has averaged 1.3% of revenues in recent years, about one-fifth of what IBM and Hewlett-Packard spend. Rather than be viewed as a product innovator, Dell is pursuing a “fast follower” strategy in which the firm focuses on taking what is currently highly popular and making it better and cheaper than anyone else. While not a product innovator, Dell has succeeded in process innovation. The company has more than 550 business process patents, for everything from a method of using wireless networks in factories to a configuration of manufacturing stations that is four times as productive as a standard assembly line. Dell’s expansion seems to be focused on its industry lead in process engineering and innovation resulting in super efficient factories. The current strategy seems to be to move into commodity markets, with standardized technology that is widely available. In such markets, the firm can apply its finely honed skills in discipline, speed, and efficiency. For markets that are becoming more commodity-like but still require some R&D, Dell takes on partners. For example, in the printer market, Dell is applying its brand name to Lexmark printers. In storage products, Dell has paired up with EMC Corp. to sell co-branded storage machines. As these markets become more commodity-like, Dell will take over manufacturing of these products. This is what happened at the end of 2003 when it took over production of low-end storage production from EMC. In doing so, Dell was able to cut production costs by 25%. The success of Michael Dell’s business model is evident. Its share of the global PC market in 2003 topped 16%; the company accounts for more than one-third of the hand-held device market. At the end of 2003, Dell’s price-to earnings ratio exceeded IBM, Microsoft, Wal-Mart, and General Electric. Dell has had some setbacks. In 2001, the firm scrapped a plan to enter the mobile-phone market; in 2002 Dell wrote off its only major acquisition, a storage-technology company purchased in 1999 for $340 million. Dell also withdrew from the high-end storage business, because it decided its technology was not ready for the market. -How would you characterize Dell's original business strategy (i.e., cost leadership, differentiation, niche, or some combination? Give examples to illustrate your conclusions. How has Dell's strategy evolved over time? Give examples to illustrate your answer.

Which of the following represent key components of the acquisition process

HP Implements a Transformational Strategy, Again and Again Failure to develop and implement a coherent business strategy often results in firms reacting to rather than anticipating changes in the marketplace. Firms reacting to changing events often adopt strategies that imitate their competitors. These “me too” strategies rarely provide any sustainable competitive advantage. _______________________________________________________________________________________________________ Transformational, when applied to a firm’s business strategy, is a term often overused. Nevertheless, Hewlett-Packard (HP), with its share price at a six-year low and substantially underperforming such peers as Apple, IBM, and Dell, announced what was billed as a major strategic redirection for the firm on August 18, 2011. The firm was looking for a way to jumpstart its stock. Since Leo Apotheker took over as CEO in November 2010, HP had lost 44% of its market value through August 2011. A transformational announcement appeared to be in order. HP, the world’s largest technology company by revenue, announced that, after an extensive review of its business portfolio, it had reached an agreement to buy British software maker Autonomy for $11.7 billion. The firm also put a for-sale sign on its personal computer business, with options ranging from divestiture to a spinoff to simply retaining the business. HP said the future of the PC unit, which accounted for more than $40 billion in annual revenue and about $2 billion in operating profit, would be decided over the next 12 months. Apotheker had put this business in jeopardy after he had announced that the WebOS-based TouchPad tablet would be discontinued due to poor sales. The announcement was transformational in that it would move the company away from the consumer electronics market. Under the terms of the deal, HP will pay 25.50 British pounds, or $42.11, in cash for Autonomy. The price represented a 64% premium. With annual revenue of about $1 billion (only 1% of HP’s 2010 revenue), the purchase price represents a multiple of more than 10 times Autonomy’s annual revenues. HP’s then-CEO, Leo Apotheker, indicated that the acquisition would help change HP into a business software giant, along the lines of IBM or Oracle, shedding more of the company’s ties to lower-margin consumer products. Autonomy, which makes software that searches and keeps track of corporate and government data, would expedite this change. HP said that the acquisition of Autonomy will complement its existing enterprise offerings and give it valuable intellectual property. Investors greeted the announcement by trashing HP stock, driving the share price down 20% in a single day, wiping out $16 billion in market value. While some investors may be sympathetic to moving away from the commodity-like PC business, others were deeply dismayed by the potentially “value-destroying” acquisition of Autonomy, the clumsy handling of the announcement of the wide range of options for the PC business, and HP’s disappointing earnings performance. By creating uncertainty among potential customers about the long-term outlook for the business, HP may have succeeded in scaring off potential customers. With this announcement, HP once again appeared to be lagging well behind its major competitors in implementing a coherent business strategy. It agreed to buy Compaq in 2001 in what turned out to be widely viewed as a failed performance. In contrast, IBM transformed itself by selling its PC business to China’s Lenovo in late 2004 and establishing its dominance in the enterprise IT business. HP appears to be trying to replicate IBM’s strategy. Heralded at the time as transformational, the 1997 $25 billion Compaq deal turned out to be hotly contested, marred by stiff opposition from shareholders and a bitter proxy contest led by the son of an HP cofounder. While the deal was eventually passed by shareholder vote, it is still considered controversial, because it increased the firm’s presence in the PC industry at a time when the growth rate was slowing and margins were declining, reflecting declining selling prices. HP planned to move into the lucrative cellphone and tablet computer markets with the its 2010 purchase of Palm, in which it outbid three other companies to acquire the firm for $1.2 billion, ultimately paying a 23% premium. However, sales of webOS phones and the TouchPad have been disappointing, and the firm decided to discontinue making devices based on webOS, a smartphone operating system it had acquired when it bought Palm in late 2010. In contrast to the mixed results of the Compaq and Palm acquisitions, HP’s purchase of Electronic Data Systems (EDS) for $13.9 billion in 2008 substantially boosted the firm’s software services business. IBM’s successful exit from the PC business early in 2004 and its ability to derive the bulk of its revenue from the more lucrative services business has been widely acclaimed by investors. Prospects seemed good for this HP acquisition. However, in an admission of the firm’s failure to realize EDS’s potential, HP in mid-2012 wrote off $8 billion of what it had paid for EDS. HP has purchased 102 companies since 1989, but with the exceptions of its Compaq and its $1.3 billion purchase of VeriFone, it has not paid more than $500 million in any single deal. These deals were all completed under different management teams. Carly Fiorina was responsible for the Compaq deal, while Mark Hurd pushed for the acquisitions of EDS, Palm, and 3Par. Highly respected for his operational performance, Hurd was terminated in early 2010 on sexual harassment charges. Under pressure from investors to jettison its current CEO, HP announced on September 22, 2011, that former eBay CEO, Meg Whitman, would replace Leo Apotheker as Chief Executive Officer. In yet another strategic flip-flop, HP announced on October 27, 2011, that it would retain the PC business. The firm’s internal analysis indicated that separating the PC business would have cost $1.5 billion in one-time expenses and another $1 billion in increased expenses annually. Citing the deep integration of the PC group in HP’s supply chain and procurement efforts, Whitman proclaimed the firm to be stronger with the PC business. In mid-December 2011, HP announced that it would also reverse its earlier decision to discontinue supporting webOS and stated that it would make webOS available for free under an open-source license for anyone to use. The firm will continue to make enhancements to the webOS system and to build devices dependent on it. By moving to an open-source environment, HP hopes others will adopt the operating system, make improvements, and develop mobile devices using webOS to establish an installed user base. HP could then make additional webOS devices and applications that could be sold to this user base. This strategy is similar to Google’s when it made its Android mobile software available for cellphones under an open-source license. HP’s share price plunged 11% on November 25, 2012, to $11.73 following its announcement that it had uncovered “accounting irregularities” associated with its earlier acquisition of Autonomy. The revelation required the firm to write down its investment in Autonomy by $8.8 billion, about three-fourths of the purchase price. The charge contributed to a quarterly loss of $6.9 billion for HP. Confidence in both the firm’s management and board plummeted, further tarnishing the once-vaunted HP brand. -Discuss the advantages and disadvantages of fully integrating business units within a parent firm? Be specific.

Which of the following are common objectives of an external analysis?