Reasons for Firms to Combine
A frequent economic phenomenon is the combining of two or more businesses into a single entity under common management and owner control. During recent decades, the United States and the rest of the world have experienced an enormous number of corporate mergers and takeovers, transactions in which one company gains control over another. According to Thomson Financial, the number of mergers and acquisitions globally in 2008 exceeded 39,597 with a total value of more than $2.9 trillion. Of these deals more than $1.5 trillion in- volved a U.S. firm. As indicated by Exhibit 2.1, the magnitude of recent combinations con- tinues to be large.
As with any other economic activity, business combinations can be part of an overall man- agerial strategy to maximize shareholder value. Shareholders—the owners of the firm—hire managers to direct resources so that the firm’s value grows over time. In this way, owners receive a return on their investment. Successful firms receive substantial benefits through enhanced share value. Importantly, the managers of successful firms also receive substantial benefits in salaries, especially if their compensation contracts are partly based on stock mar- ket performance of the firm’s shares.
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If the goal of business activity is to maximize the firm’s value, in what ways do business combinations help achieve that goal? Clearly, the business community is moving rapidly toward business combinations as a strategy for growth and competitiveness. Size and scale are obviously becoming critical as firms compete in today’s markets. If large firms can be more ef- ficient in delivering goods and services, they gain a competitive advantage and become more profitable for the owners. Increases in scale can produce larger profits from enhanced sales volume despite smaller (more competitive) profit margins. For example, if a combination can integrate successive stages of production and distribution of products, coordinating raw mater- ial purchases, manufacturing, and delivery can result in substantial savings. As an example, Ford Motor Co.’s acquisition of Hertz Rental (one of its largest customers) enabled Ford not only to ensure demand for its cars but also to closely coordinate production with the need for new rental cars. Other cost savings resulting from elimination of duplicate efforts, such as data processing and marketing, can make a single entity more profitable than the separate parent and subsidiary had been in the past.
Although no two business combinations are exactly alike, many share one or more of the following characteristics that potentially enhance profitability:
• Vertical integration of one firm’s output and another firm’s distribution or further processing.
• Cost savings through elimination of duplicate facilities and staff.
• Quick entry for new and existing products into domestic and foreign markets.
• Economies of scale allowing greater efficiency and negotiating power.
• The ability to access financing at more attractive rates. As firm size increases, negotiating power with financial institutions can increase also.
• Diversification of business risk.
Business combinations also occur because many firms seek the continuous expansion of their organizations, often into diversified areas. Acquiring control over a vast network of dif- ferent businesses has been a strategy utilized by a number of companies (sometimes known as conglomerates) for decades. Entry into new industries is immediately available to the parent without having to construct facilities, develop products, train management, or create market recognition. Many corporations have successfully employed this strategy to produce huge, highly profitable organizations. Unfortunately, others have discovered that the task of manag- ing a widely diverse group of businesses can be a costly learning experience. Even combina- tions that purportedly take advantage of operating synergies and cost savings often fail if the integration is not managed carefully.2
Overall, the primary motivations for many business combinations can be traced to an in- creasingly competitive environment. Three recent examples of large business combinations provide interesting examples of some distinct motivations to combine: Bank of America and Merrill Lynch, InBev and Anheuser-Busch, and Pfizer and Wyeth. Each is discussed briefly in turn.
EXHIBIT 2.1
Recent Notable Business Combinations
Acquirer Target Deal Value (in billions)
Pfizer Wyeth $67.3
InBev Anheuser-Busch 52.0
Merck Schering-Plough 41.1
Bank of America Merrill Lynch 29.1
Verizon Wireless Alltel 28.1
Mars Wm. Wrigley, Jr. 23.2
Oracle Sun Microsystems 7.4
Delta Airlines Northwest Airlines 3.4
EMC Data Domain 2.4
Abbott Laboratories Advanced Medical Optics 1.4
2Mark Sirower, “What Acquiring Minds Need to Know,” The Wall Street Journal—Manager’s Journal, February 22, 1999.
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40 Chapter 2
Bank of America and Merrill Lynch
On January 1, 2009, Bank of America completed its acquisition of Merrill Lynch in exchange for common and preferred stock valued at $29.1 billion.3At the time of the acquisition, Bank of America was the nation’s largest retail bank, credit card company, and retail lender, while Merrill Lynch was a worldwide leader among investment banking and wealth management firms. Bank of America had made several previous attempts to establish its brokerage business but had struggled in doing so. Rather than continue to try and build this business internally, Bank of America determined that acquiring Merrill Lynch was a better option. With the addi- tion of Merrill Lynch, Bank of America became the nation’s largest brokerage firm. Merrill Lynch was also expected to help expand Bank of America’s presence in the worldwide market.4 Merrill Lynch’s motivation for accepting the deal was largely a matter of survival. During the third quarter of 2008, like almost all large investment banks, Merrill Lynch was hit hard by the credit crisis. Because of its large position in mortgage-backed securities, as the number of mortgage defaults rose dramatically, Merrill’s stock decreased significantly and the company reported large losses. Most of the nation’s top investment banks were also under duress and forced to make decisions affecting their survival. Some, like Lehman Brothers, were unable to secure government assistance and filed for bankruptcy, while others like Goldman Sachs shifted their business structures. Merrill Lynch opted for a takeover strategy and accepted Bank of America’s offer.5Despite Merrill’s 2008 large losses and stock price decline, Bank of America recorded $5 billion of goodwill from the combination.
While the two companies did not have a large overlap in services, Bank of America esti- mated annual pretax savings of $7 billion by the year 2012. These savings were expected to result primarily through the elimination of duplicate jobs within Bank of America’s weak brokerage sector.
InBev and Anheuser-Busch
On July 13, 2008, the Belgian beer company InBev and the American company Anheuser- Busch announced their combination, creating the world’s largest beer company and one of the world’s top five consumer products companies. Under the terms of the deal, Anheuser-Busch shareholders received $70 in cash for each share held, and Anheuser-Busch became a wholly owned subsidiary of the newly named Anheuser-Busch InBev company. The total cost of the acquisition was $52 billion.6
From a geographical standpoint, the two firms complemented each other. In the United States, for example, InBev should be able to reduce costs by utilizing Busch’s long-established distribution system for its own brands like Bass, Becks, and Stella Artois. Anheuser-Busch, on the other hand, may now be able to take advantage of InBev’s established European presence to improve its product reception in Europe, where it had traditionally done poorly. The two compa- nies also complemented each other in the Chinese market, where InBev brands were strong in the Northwest and Busch’s Budweiser brand was strong in the Southeast.
In addition to creating a more globally integrated firm, InBev expects the combination to produce annual cost savings of $1.5 billion by 2011. Because there is not much overlap between the two firms geographically, the cost reductions are expected to come from economies of scale, combination of corporate functions, and knowledge sharing. Significant financial impacts from plant- and distribution-level layoffs are not anticipated given the com- plementary nature of the firms’ mostly distinct operating locations.7
Pfizer and Wyeth
On January 26, 2009, pharmaceutical giant Pfizer announced that it would acquire its smaller competitor, Wyeth, for $68 billion in cash and stock. Wyeth shareholders were offered $33 in
3Some initial announcement date reports indicated a $50 billion price for Merrill Lynch. However, as revealed in Bank of America’s March 31, 2009, 10-Q report, the final value assigned to the acquisition was $29.1 billion.
4Bank of America press release, September 18, 2008.
5Jonathan Stempel, “Bank of America/Merrill Merger Wins Shareholder OK,” Reuters, December 8, 2008.
6Anheuser-Busch press release, July 14, 2008.
7AB InBev press release, November 18, 2008.
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cash and 0.985 share of Pfizer for each share of Wyeth.8Pfizer had been looking to diversify its sales product portfolio, as the majority of its revenues were comprised of only a few key drugs. Wyeth was seen as a potential fit for Pfizer as its strengths in the vaccines and biologic drug markets were areas in which Pfizer lacked a strong presence. Additionally, the Wyeth acquisition was anticipated to solidify Pfizer’s position atop the pharmaceutical industry.
The deal was expected to benefit both companies, as they each had patents expiring on many of their drugs. The patent on Pfizer’s top-earning drug Lipitor is scheduled to expire in November of 2011 and, at the time of the acquisition announcement, Lipitor accounted for 25 percent of Pfizer’s revenues. According to estimates, by 2015, 70 percent of Pfizer’s rev- enue could be lost due to the expiration of drug patents. Wyeth was in a similar position, as patents for its two largest revenue-producing drugs, Effexor and Protonix, were set to expire in 2010 and 2011, respectively. With no new drug creation on the horizon, Pfizer’s manage- ment determined that acquiring Wyeth would lessen its risks as well as aid in new drug devel- opment. Once the merger is completed, no one drug will account for more than 10 percent of the combined revenues.9
While Pfizer’s management maintained that the motivation for the acquisition was to di- versify its sales portfolio, Pfizer also expects to benefit from cost synergies. Upon completion of the acquisition, Pfizer planned to close 5 of its 46 manufacturing plants and eliminate 20,000, or 15 percent, of jobs between the two companies. As a result of these job cuts, Pfizer estimated savings of $4 billion by 2012.