Preface
In the last decades, the volume of merger and acquisition activity has
increased across the world, affecting virtually all industries, regardless of size
and type of firm involved. Mergers and acquisitions occur in waves and
represent a way to grow quickly, seizing the opportunities arising in certain
industries. It also represents a way to easily overcome the barriers to entry, to
profit from fiscal advantages, and to achieve a positive effect on the firm’s
image.
Through mergers and acquisitions, firms can seize the opportunities to
grow and create new economic value, but, as a wide empirical evidence
proves, they can also destroy value for shareholders.
This highlights that the decision to carry out an M&A is certainly a risky
decision, because of the number of variables influencing the final
performance, but it is also a decision frequently based on wrong objectives
and an incorrect evaluation process. This firm belief led us to study in depth
how this decision should be taken to increase shareholder value. For this to
happen it is necessary that the value of the combined firms is greater than the
sum of the values of the bidding and target firms, operating independently.
But, for this to happen, it is also necessary for the estimated synergies to be
well predicted, evaluated and carried out, appropriately managing the
integration of companies.
With this as our starting point, the study aims at offering solutions for
reducing the currently high percentage of M&A failures. To contribute to this
result it is believed that the following is necessary:
to acknowledge the creation of value for shareholders of the
acquiring firm as the fundamental objective of an M&A;
to define analytical models suitable for properly evaluating M&A;
to design appropriate organizational structure and processes to
implement M&As.
The approach of the book is normative; it uses a theoretical analysis to
show what managers should do to increase shareholder value through M&A
strategies and what the conditions are for favouring one or the other type of
M&A. The perspective of the analysis is that of a company which considers
the opportunity of acquiring another company for integrating its activities in
a merger.
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Preface ix
It is important also to specify that very often M&As are also motivated by
the value of control, that is the value that occurs post deal when the target
firm is managed more effectively by the new management. In this case an
acquirer believes that incremental value can be created by running a target
firm more efficiently.
In our analysis, we do not consider these types of M&As, but only M&As
carried out to exploit the value of synergies, that is the value realized by
combining the two different entities in an M&A deal. Even if it is difficult to
separate the two values, it is necessary to clarify that synergies are obtained
by combining the two different entities in an M&A deal, while the value of
control does not require an analysis of the acquiring firm, because the value
of control resides entirely in the target firm.
The order of presentation of the topics reflects the actual growth of many
firms: expansion starts within a core industry and it is undertaken to enhance
or protect a firm’s position in that business (horizontal expansion). Then, a
firm moves outside its initial industry integrating its activities or phases along
its value chain (vertical integration expansion) until over the years it
becomes increasingly more and more diversified, entering different related
industries and finally unrelated industries (product diversification expansion).
Each M&A is viewed as an investment decision directed at creating value
for shareholders, exploiting the various opportunities offered by the internal
firm resources and the environment. Each M&A strategy implies different
changes in the firm’s system and causes different effects on the firm’s long-
term cash flows. Therefore, defining a growth strategy which creates value
requires examining the internal conditions of the acquiring and the target
firms, evaluating the dynamics of the external environment in which the
firms operate and estimating the expected effects on the value of the
combined company.
To evaluate whether or not an M&A strategy can create value, we present
some analytical models capable of specifying the relevant conditions under
which each type of strategy can create value and be suitable for practical use.
However, we know that, in order for a defined strategy to create value, it is
also necessary to adapt the firm’s organizational structure so as to effectively
manage the increased complexity of the new business system. To reach this
aim the organizational structures which can offer the best solution with
respect to each growth strategy are analysed.
The book highlights the fact that growth through M&A does not
necessarily produce an increase in the enterprise and in the shareholder value;
that clearly results only under particular conditions. Thus, top managers must
carefully evaluate every growth alternative.
The book contains 13 formal chapters.
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x Merger and acquisition strategies
Chapter 1 introduces a fundamental terminology and some basic concepts
concerning M&A strategies, pointing out the principal patterns of firm
development.
Chapter 2 examines the empirical evidence on M&A performance,
according to a large and authoritative literature. The results of empirical
studies indicate that a high percentage of M&As fail in terms of profits and
value created for shareholders.
Chapter 3 provides the essential theory concerning the firm value and the
evaluation of an M&A strategy.
Chapter 4 illustrates how to analyse in depth the structure of firms
involved in an M&A, for discovering which activities and resources offer the
best opportunities for producing synergies. Then, it illustrates how to analyse
the industry structure and dynamics, to properly understand opportunities and
risks in an M&A.
Chapter 5 examines the characteristics of horizontal M&As and the
conditions under which they can create value. In particular, it examines the
economic conditions from which synergies derive and proposes an analytical
model that defines when an M&A can create value for the shareholders of the
acquiring firm.
Chapter 6 addresses the economic rationale for vertical M&A strategies.
Chapter 7 shifts the focus onto product diversified M&As, examining the
conditions for which they can create value.
Chapter 8 examines the alternatives for financing M&As and the effect on
the merger value.
Chapter 9 examines the appropriate organizational models for managing
M&A integration.
Chapter 10 presents a summary of results and the conclusions of the first
part of the study.
In these chapters the theoretical exposition is often followed by numerical
examples and simulations.
In Part II of the book some cases of successful M&As are presented. The
purpose of these cases is to highlight how a firm chooses and implements a
defined M&A strategy creating value. Chapters 11, 12 and 13 analyse three
cases of successful M&A strategies: L’Oreal, Campari and Luxottica. These
companies are all characterized by a long period of continuous growth
mainly based on M&A strategies, accompanied by a systematic creation of
value for shareholders. Each company is characterized by specific M&A
strategies and reveals its own original pattern. At the same time, all three
companies present a common behavioural pattern: each of them makes
leverage on its specific resources and exploits its strategic assets to cope with
industry dynamics and environmental changes. The direct analysis of these
cases confirms that an M&A can be a fundamental instrument for growth,
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Preface xi
increasing competitive advantage and creating value for shareholders. Thus,
the cases provide a link between theory and practice, making, we hope, the
analysis more real and interesting.
The book is based on established traditions in strategic management
research. In particular, a number of insights are drawn from three distinct
bodies of research: the resource-based view of the firm; organizational
economics − in particular transaction costs analysis − and the fundamentals
of corporate finance. All these theoretical traditions made a substantial
contribution to the arguments advanced here.
In particular, we believe that M&A strategies have to be based both on the
existing firm’s system characteristics, that is the firm’s assets, resources and
capabilities, and on the dynamics of industry structure. Heterogeneity of
resources and firm-specific characteristics form the basis of diversity and the
strategic variety of firms.
The book is mainly directed at researchers and students in economics and
management. As it offers useful tools for managerial decisions, we think it is
also of interest to managers and consultants.
This book is the result of some years of research developed at the School
of Economics and Management at the University of Siena and at the LUISS
University of Rome. Outside school I have learned a lot from my experience
as a management consultant and as a member of the board of directors of
some industrial companies and banks.
Prof. Angelo Dringoli
Siena, February 2016
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To Simonetta and Tommaso
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