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558 EXHIBIT 16.8 Example of output from a decision suppor t system. Information Technology and the Firm 559 what categories of items sold better than others. After finding an underper- forming category, she may check how different groups or districts of stores performed for that category. Knowing how each store performed, she might ex- plode down, looking at individual items, and compare their performance to that of a prior week or year. This process is like taking the Rubic’s cube and continually rotating the levels, looking at each of the cube’s faces. Each face of each small cube represents data for a piece of merchandise for a store for a pe- riod of time. That is why this process is referred to as “slice and dice.” You can slice and turn the data any which way you desire. The data can also be viewed and sorted in a tabular or graphical mode. The same theory applies whether the database contains retailing data, stock market data, or accounting data. Ex- hibits 16.7 and 16.8 show examples of a decision support system’s output. The output was created by Pilot Software’s executive information system. ADVANCED TECHNOLOGY Many new technologies are on the horizon, two of which are database mining and intelligent agents. Both address the issue of information overload. In the 1970s, the average database was perhaps 100 megabytes (millions of bytes) in size. In the 1980s, databases were typically 20 gigabytes (billions of bytes). Now, databases are in the terabytes (trillions of bytes). Wal-Mart has a data warehouse that exceeds 100 terabytes. With all that data, it is difficult for a user to know where to look. It is not the question that the user knows to ask that is necessarily important, but, rather, the question that the user does not know to ask that will come back to haunt him. These new technologies examine entire databases, scanning them for any data that does not fit the business’s model and identifying any data that the user needs to examine further. These data mining techniques can be used suc- cessfully in many industries. For example, auditors might use them to scan client transaction detail to look for transactions that do not conform to com- pany policies, and stock analysts can use them to scan data on stock prices and company earnings over a period of time in order to look for opportunities. CONCLUSION The world of business has changed dramatically in the past 10 years. What was unimaginable then is ordinary today. Product life-cycle times have decreased from years to months. New technology is being introduced every day. An Inter- net year is equal to three or four calendar months. The manager who is com- fortable with and understands the practical implications of technology will be one of the first to succeed. Imagination and creativity are vital. Don’t be afraid of change. Understand it, and embrace it. 560 Making Key Strategic Decisions FOR FURTHER READING Amor, Daniel, The E-business (R)Evolution (Upper Saddle River, NJ: Prentice-Hall, 2000). Frenzel, Carroll, Management of Information Technology, 3rd ed. (Danvers, MA: Boyd & Fraser, 1999). Fried, Louis, Managing Information Technology in Turbulent Times (New York: John Wiley, 1995). Kanter, Jerry, Information Literacy (Wellesley, MA: Babson Press, 1996). Kanter, Jerry, Information Technology for Business Managers (New York: McGraw- Hill, 1998). Kalakota, R., and M. Robinson, E-Business 2.0 (Boston: Addison-Wesley, 2000). Nickerson, Robert, Business and Information Systems, 2nd ed. (Upper Saddle River, NJ: Prentice-Hall, 2001). Pearlson, Keri, Managing and Using Information Systems (New York: John Wiley, 2001). Reynolds, George, Information Systems for Managers (St. Paul, MN: West, 1995). Turban, E., E. McLean, and J. Wetherbe, Information Technology for Management, 2nd ed. (New York: John Wiley, 2001). Turban, E., J. Lee, D. King, and H. M. Chung, Electronic Commerce—A Managerial Perspective (Upper Saddle River, NJ: Prentice-Hall, 2001). INTERESTING WEB SITES www.ariba.com ARIBA www.baan.com BAAN www.commerceone.com Commerce One www.esri.com ESRI www.greatplains.com Great Plains Software www.intel.com Intel www.intuit.com INTUIT www.macola.com Macola Software www.microsoft.com Microsoft www.microstrategy.com Microstrategy www.oracle.com ORACLE www.retailexchange.com Retail Exchange www.sap.com SAP www.staples.com Staples www.sun.com Sun Microsystems www.verticalnet.com VerticalNet www.wwgrainger.com W. W. Grainger 561 17 PROFITABLE GROWTH BY ACQUISITION Richard T. Bliss The subject of this chapter is growth by acquisition; few other business transac- tions receive more scrutiny in both the popular and academic presses. There are several reasons for this attention. One is the sweeping nature of the deals, which typically result in major upheaval and job losses up to the highest levels of the organizations. A second is the sheer magnitude of the deals—the recently an- nounced merger between Time-Warner and AOL, worth more than $150 bil- lion, exceeds the annual GDP of 85% of the world’s nations! Thirdly, the products involved are known to billions around the globe. Daimler-Benz, Coca Cola, and Louis Vuitton are just a few of the world-renowned brand names re- cently involved in merger and acquisition (M&A) transactions. Finally, the per- sonalities and plots in M&A deals are worthy of any novelist or Hollywood scriptwriter. The 1988 acquisition of Nabisco Foods by RJR Tobacco—at that time the largest deal ever, at $25 billion—was the subject of a New York Times best-seller and a popular film, both called Barbarians at the Gate. Since then, there have been numerous other best-selling books and movies based on real and fictional M&A deals. In spite of this publicity and the huge amounts of money involved, it is im- portant to remember that M&A transactions are similar to any other corporate investment, that is, they involve uncertainty and the fundamental tradeoff be- tween risk and return. To lose sight of this simple fact or to succumb to the emotion and frenetic pace of M&A deal-making activities is a sure path to an unsuccessful result. Our goal in this chapter is to identify the potential pitfalls you may face and to create a road map for a successful corporate M&A strat egy. 562 Making Key Strategic Decisions We review the historical evidence and discuss some of the characteristics of both unsuccessful and successful deals. The importance of value creation is highlighted, and we present simple analytical tools that can be used to evaluate the potential of any merger or acquisition. Practical aspects of initiating and structuring M&A transactions are presented and the issues critical to the suc- cessful implementation of a new acquisition are briefly described. It is impor- tant to understand that there are many legal and financial intricacies involved in most M&A transactions. Our objective here is not to explain each of these in detail, since there are professional accountants, lawyers, and consultants avail- able for that. Instead, we hope to provide valuable and concise information for busy financial managers so that they can design and implement an effective M&A strategy. DEFINITIONS AND BACKGROUND Before examining the historical evidence on acquisitions, we need to define some terminology. An acquisition is one form of a takeover, which is loosely de- fined as the transfer of control of a firm from one group of shareholders to an- other. In this context, control comes with the ability to elect a majority of the board of directors. The firm seeking control is called the bidder and the one that surrenders control the target. Other forms of takeovers include proxy con- tests and going private, but the focus of this chapter is takeover via acquisition. As we can see, acquisitions may occur in several ways. In a merger, the target is absorbed by the bidder and the target’s original shareholders receive shares of the bidder. In a consolidation, the firms involved become parts of an entirely new firm, with the bidder usually retaining control of the new entity. All original shareholders hold shares in the new firm after the deal. The two transactions have different implications for shareholders, as the following ex- amples make clear. Example 1 There has recently been a wave of takeover activity in the stuffed animal industry. Griffin’s Giraffes Inc. (GGI) has agreed to merge Takeover Acquisition Proxy contest Going private Merger or consolidation Stock acquisition Asset acquisition Profitable Growth by Acquisition 563 with Hay ley’s Hippos Inc. (HHI). GGI offers one of its shares for three shares of HHI. When the transaction is completed, HHI shares will no longer exist. The original HHI stockholders own GGI shares equal in number to one-third of their original HHI holdings. GGI’s original shareholders are unaffected by the transaction, except to have their ownership stake diluted by the newly is- sued shares. Example 2 Kristen’s Kangaroos Inc. (KKI) wishes to take over the operations of Michael’s Manatees Inc. (MMI) and Brandon’s Baboons Inc. (BBI). Rather than giving its shares to the owners of MMI and BBI, KKI decides to establish a new firm, Safari Ventures Inc. (SVI). After this consolidation, shareholders of the three original companies (KKI, MMI, and BBI) will hold shares in the new firm (SVI), with KKI having the controlling interest. The three original firms cease to exist. Another method of acquisition involves the direct purchase of shares, either with cash, shares of the acquirer, or some combination of the two. These stock acquisitions may be negotiated with the mangers of the target firm or by appealing directly to its shareholders, often via a newspaper advertisement. The latter transaction is called a tender offer, which typically occur after nego- tiations with the target firm’s management have failed. Finally, an acquisition can be effected by the purchase of the target’s assets. Asset acquisitions are sometimes done to escape the liabilities (real or contingent) of the target firm or to avoid having to negotiate with minority shareholders. The downside is that the legal process of transferring assets may be expensive. Acquisitions can be categorized based on the level of economic activity involved according to the following: • Horizontal: The target and bidder in a horizontal merger are involved in the same type of business activity and industry. These mergers typically result in market consolidation, that is, more market share for the com- bined firm. Because of this, they are subject to extra antitrust scrutiny. The pending acquisition of USAir by United Airlines is an example of a horizontal merger (see p. 564). Because the combined entity would be the world’s largest airline and have a dominant market share in the United States, the Justice Department has demanded that certain assets and routes be divested before approval for the deal will be granted. • Vertical: A vertical merger involves firms that are at different levels of the supply chain in the same industry. For example, stand-alone Internet service provider/portal AOL functions primarily as a distribution chan- nel. Its pending merger with Time Warner will allow AOL to move up the home entertainment industry supply chain and control content in the form of Time Warner’s music and video libraries. • Conglomerate: In a conglomerate merger, the target and bidder firms are not related. These were popular in the 1960s and seventies but are rare 564 Making Key Strategic Decisions today. An auto manufacturer acquiring an ice cream producer would be an example. Armed with a basic understanding of the types of acquisitions and how they occur, we now turn our attention to the track record of M&A transactions. Be forewarned that it is spotty at best and that many practitioners, analysts, and academics believe that the odds are stacked against acquirers. We do not say this to dissuade anyone from pursuing an acquisition strategy, but rather to highlight the fact that without careful planning, there is little chance of success. THE TRACK RECORD OF MERGERS AND ACQUISITIONS There has been tremendous growth in the number and dollar value of M&A transactions over the last two decades (see Exhibit 17.1). In 1998, the total an- nual value of completed transactions exceeded one trillion dollars for the first time in history. The number of deals fell in 1999, but larger deals resulted in a total deal value of almost $1.5 trillion. Exhibit 17.2 lists the largest deal for each of the years between 1990 and 2000. While the data in Exhibits 17.1 and 17.2 focus on large transactions, the growth trend for all M&A deals is similar. And in 1999, for the first time in history, there were more deals done abroad than in the United States. By any SOURCE : The Wall Street Journal, December 20, 2000. Profitable Growth by Acquisition 565 mea sure, the 1990s was an increasingly acquisitive decade around the world. This explosion in deal making might lead one to assume that mergers and ac- quisitions are an easy way for corporate managers to create value for their shareholders. To assess this, we now examine the empirical evidence on merg- ers and acquisitions. Let’s begin with the wealth of academic studies that ana- lyze M&A performance. 1 M&A activity has been the focus of volumes of academic research over the last 40 years. The evidence is mixed, but we can draw several clear con- clusions from the data. We break our discussion into two pieces: short-term EXHIBIT 17.1 M&A activity, 1981–1999. a a Data is for deals valued at at least $5 million and involving one U.S. company. SOURCE : Mergers & Acquisitions, September 2000. 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 Year Number of deals Value (billions) Number of deals (left axis) Total value (right axis) 0 2,000 4,000 6,000 8,000 10,000 12,000 0 200 400 600 800 1,000 1,200 1,400 1,600 EXHIBIT 17.2 A decade of megadeals . Price Year Bidder Target (billions) 1990 Time Inc. Warner Communications $ 12.6 1991 AT&T Corp. NCR Corp. 7.5 1992 BankAmerica Corp. Security Pacific Corp. 4.2 1993 Merck & Co. Medco Containment Services 6.2 1994 AT&T Corp. McCaw Cellular Inc. 18.9 1995 AirTouch Communications US West Inc. 13.5 1996 Walt Disney Co. Capital Cities/ABC Inc. 18.9 1997 Bell Atlantic Corp. NYNEX Corp. 21.3 1998 Travelers Group Inc. Citicorp 72.6 1999 Exxon Corp. Mobil Corp. 78.9 2000 America Online Inc. Time Warner Inc. 156.0 SOURCE : Mergers & Acquisitions, September 2000. 566 Making Key Strategic Decisions and long-term M&A performance. The short-term is a narrow window, typi- cally three to five days, around the merger announcement. Long-term studies examine postmerger performance two to five years after the transaction is completed. We can offer three unambiguous conclusions about the short-term finan- cial impact of M&A transactions: 1. Shareholders of the target firms do very well, with average premiums be- tween 30% and 40%. 2. Returns to bidders have fallen over time as the market for corporate con- trol becomes more competitive; recent evidence finds bidder returns in- distinguishable from zero or even slightly negative. 3. The combined return of the target and the bidder, that is, the measure of overall value creation, was slightly positive. However, these results are highly variable depending on the specific samples and time periods analyzed. The findings on the long-term performance of mergers and acquisitions are not any more consistent or encouraging. Agrawal et al. report “shareholders of acquiring firms experience a wealth loss of about 10% over the five years following the merger completion.” 2 Other studies’ con- clusions range from underperformance to findings of no abnormal postmerger performance. The strongest conclusions offered by Weston et al. are that, “It is likely, therefore, that value is created by M&As,” and that, “Some mergers perform well, others do not.” 3 So much for the brilliance of the academy! This level of confidence hardly seems to justify the frenetic pace of merger activity chronicled in Exhibits 17.1 and 17.2. If the academic literature seems ambivalent about judging the financial wisdom of M&A decisions, the popular business press shows no such hesitancy. In a 1995 special report, Business Week carefully analyzed 150 recent deals valued at $500 million or more and reported “about half destroyed shareholder wealth” and “another third contributed only marginally to it.” The article’s last paragraph makes it clear that this is not a benign finding and places the blame squarely on corporate CEOs. All this indicates that many large-company CEOs are making multibillion- dollar decisions about the future of their companies, employees, and share- holders in part by the seat of their pants. When things go wrong, as the evidence demonstrates that they often do, these decisions create unnecessary tumult, losses, and heartache. While there clearly is a role for thoughtful and well-conceived mergers in American business, all too many don’t meet that description. Moreover, in merging and acquiring mindlessly and flamboyantly, deal- makers may be eroding the nation’s growth prospects and global competitive- ness. Dollars that are wasted needlessly on mergers that don’t work might better be spent on research and new-product development. And in view of the growing number of corporate divorces, it’s clear that the best strategy for most would-be marriage partners is never to march to the altar at all. 4 Profitable Growth by Acquisition 567 A 1996 survey of 150 companies by the Economist Intelligence Unit in London found that 70% of all acquisitions failed to meet the expectations of the initia- tor. Coopers and Lybrand studied the postmerger performance of 125 com- panies and reported that 66% were financially unsuccessful. We now turn our attention to several specific M&A transactions. While unscientific, this approach is more informative and certainly more interesting than reviewing academic research. We purposely focus on failed deals in an at- tempt to learn where the acquirers went wrong. In the next section, we exam- ine the acquisition strategy and policies of Cisco Systems, the acquirer ranked No. 1 in a recent survey of corporate M&A practices. As you read about these dismal transactions, can you speculate on the rea- sons for failure? On their faces, they seemed like strategically sound transac- tions. While one might question AT&T’s push into personal computers, the other two deals were simple horizontal mergers, that is, an extension of the ex- isting business into new product lines or geographic markets. In hindsight, each deal failed for different reasons, but there are some common issues. The lessons learned are critical for all managers considering growth by acquisition. We now examine these colossal failures in more detail. Analysts believe that the merger between AT&T and NCR failed due to managerial hubris, overpayment, and a poor understanding of NCR’s products and markets. A clash between the two firms’ cultures proved to be the final nail in the coffin. In 1990 AT&T’s research division, Bell Labs, was one of the worlds premier laboratories. With seven Nobel prizes and countless patents to its name, it was where the transistor and the UNIX operating system had been invented. AT&T’s executives mistakenly believed that this research prowess Disaster Deal No. 1 Between 1985 and 1990, AT&T’s computer operations lost approximately $2 billion. The huge conglomerate seemed unable to compete effectively against the likes of Compaq, Hewlett Packard and Sun Microsystems. They decided to buy rather than build and settled on NCR, a profitable, Ohio-based personal computer (PC) manufacturer with 1990 revenues of $6 billion. NCR did not want to be purchased and this was made clear in a letter from CEO Chuck Exley to AT&T CEO Robert Allen: “We simply will not place in jeopardy the important values we are creating at NCR in order to bail out AT&T’s failed strategy.” OUCH! However, after a bitter takeover fight—and an increase of $1.4 billion in the offer price (raising the premium paid to more than 100%!)—AT&T acquired NCR in September 1991 for $7.5 billion. Aftermath: In 1996, after operating losses exceeding $2 billion and a $2.4 bil- lion write-off, AT&T spun-off NCR in a transaction valued at about $4 billion, approximately half of what it had paid to acquire NCR less than five years before. . 558 EXHIBIT 16.8 Example of output from a decision suppor t system. Information. receive shares of the bidder. In a consolidation, the firms involved become parts of an entirely new firm, with the bidder usually retaining control of