Mergers and Aquisitions

Planning and Action

G. Richard Young, G. Richard Young

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136513459
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Thoroughly discussing the problems of uniting two independent companies (problems which are commonly underestimated), this book covers a wide range of subjects such as: laws and regulations governing mergers; consideration of financial and material resources; tax views; research and development prospects, as well as the matching and augmenting of skills and equipment of both companies and the adjustments to be made to stock-holders and servicers.The issues of morale, retaining trained personnel, and the rearrangement of employee benefits and pensions are also examined.Check lists, tabulated examples, a hypothetical case history and a comprehensive bibliography made up the extensive appendices.

Part I

Planning

Chapter I

Definition of Corporate Objectives

Careful definition of objectives is a vital primary step in all corporate planning whatever route of action is selected: internal growth through research and development; joint venture; or merger/acquisition. Because a merger or acquisition generally results in a substantial financial commitment at the time of consummation, extra emphasis is made in this study to encourage a definite understanding of objectives.

Corporate objectives, simple or complex, are the foundation for all future plans and their implementation because they provide a basis both for decision-making and for evaluating results. Since merger and acquisition often have a long-term impact on a company’s operations, management should define objectives which will be valid for a maximum period of time. Nevertheless, the definition—and periodic review and revision—of corporate objectives is a continuing job since the environment in which a company operates, and the relative importance of various influences on its course of action, are constantly changing.

The nature of the ownership, whether widely held or individually owned, as well as the philosophies, capabilities, experiences, and motivations of directors and/or influential management will have a decided effect on whether an enterprise views the corporate goals as the quantitative measurement of equity value or whether other purposes for corporate existence will also be recognized and require both definition and a means of measurement. A predominant group of businesses look to a goal of a level, or rate of in crease, of return on investment (not complicated here as to means of measurement) as the only objective. They call the other constraints and policies as a means of controlling the actions to attain that single objective. Indian Head Mills, for example, has a brief, explicit objective of increasing the value of its common stock, with the various means to that end not to be confused as objectives in themselves. Experience has shown that other groups of business leaders who are involved in a profit-motivated enterprise (we are confining this treatise only to profit-oriented industry and commerce and not to philanthropic or public, non-profit organizations) view their objectives as composed of a parallel, although not equally weighted, set of aims. They may be motivated, for example, by a desire to excel in creative development for the public good, with a minimum profit goal as one necessary aim. Whatever the aspirations or methods of implementation, it is appropriate to establish the purpose, goals, policies, limitations or any other semantic description of desire and direction in order to initiate and control action.

Within the broad interpretation of objectives, we can characterize a program of merger/acquisition as having a high probability of success if decisions can be made on a forward plan with enough flexibility to change with new influences. The following sections should be reviewed as leading up to acquisition criteria and actions which follow. If an individual or company relies only on intuition, luck, or cold devotion to only one specific aim of the greatest possible profit (short-term, long-term, or average) the detail of considering objectives, resources, and developing a plan to reach the objectives is perhaps wasted energy. In this case, however, there is a greater probability of risk.

Although top management has the ultimate responsibility for defining and approving corporate objectives, all persons in a position to influence the company’s operation should be encouraged to participate in their formulation to derive objectives which they can understand, and, hopefully, accept. Charles W. Percy of Bell & Howell has stated this principle as follows:

“We believe firmly that our business should be the expression of the ideas and objectives of our entire management group and, as far as humanly possible, of our employee group.”

In another sense, a company will disintegrate if its objectives do not allow associated individuals to pursue their interests and ambitions. Management thus has a two-fold task: to establish corporate objectives that yield benefits to the individuals associated with the company; and to motivate the same individuals to adopt personal goals that are compatible with the corporate objectives.

The following section discusses seven basic types of corporate objectives, and some of the problems associated with them. These seven major categories of corporate objectives are:

1. Financial

2. Product and marketing

3. Research, development, and engineering

4. Manufacturing

5. Personnel

6. Community relations

7. Corporate image

In general, corporate management will have a basis for its preliminary preparation of objectives through its inherent recognition of a variety of existing resources, skills, policies, preferences, and other internal and external influences. The formal process of analysis is an interplay of goals and capabilities which affect a dynamic set of objectives. The “hen or the egg” evolution has its counterpart in this interaction, but there is no need to make a strong point for which comes first and they may not be mutually exclusive. To establish objectives which will be more than “to improve stockholders’ invested values,” requires a practical awareness of some strengths and weaknesses. As the corporation then constructs its goals a review of resources will generally indicate the need to shore-up some deficiencies or to add skills, capital, or manufacturing facilities. All this process, taken within the constrictions of a time plan, can lead to the long-range plan in which acquisition or corporate reorganization is an appropriate road.

Financial: Profitability, a basic requirement, is usually put in terms of return on investment, and may specify a minimum, an average, and/or a goal to strive for under optimum business conditions or at some future date. For a company just starting in business or a company which finds itself in difficulties and is suffering losses, a time scale is particularly important. For example, the profitability objective might be stated as a break-even operation two years hence and a specific minimum return on investment within four years, or it might be put in terms of a payout period, i.e., recovery of the initial investment over a period of X years, or a cumulative percentage return within Y years.

As a measure of operating performance, return on investment is often stated in terms of before-tax-income on applied total assets or capital employed in the business. For measuring financial performance, after-tax return on net worth is frequently employed. From the stockholder’s standpoint, earnings per share of common stock and/or dividends per share are useful bases.

But what return is to be set as the corporate goal, how is the return to be reached, and what will be the attitude toward balancing other objectives, policies, and methods as they may affect the primary goal of return on investment?

Some managements look to the leaders of their industry for appropriate targets. Others cause impossible demands on themselves by selecting rates which may exist for other industries at given times in their life cycles but which really have no basis for attainment since competition within their own industry, for example, may not allow gross margins sufficient to provide the return goal. During the last several years segments of the paper industry have been faced with overcapacity leading to lower margins. A corporation either in the paper industry, or wishing to enter, would be setting improbable goals by looking at performances in the cement, pharmaceutical, food, or other industries where the profits have been well above average. However, it is just this sort of condition which has caused some managements to reach to diversification through merger or acquisition as a way to increase return on investment and to attain other financial goals.

A profit objective stated in terms of net income on sales is generally of some use as an operating measure, and it may be the most useful and practical means in a low-investment business or a personal service business where almost all the profit is taken out in the form of commissions, bonuses, and incentives. In businesses which involve a substantial capital investment, the ratio of sales to investment may be relatively inflexible and is strongly influenced by competitive conditions.

Profit on sales is frequently a highly inaccurate tool for evaluating alternatives, particularly mergers and acquisitions outside the company’s normal field of activity, because the profit on sales required to earn a given return on investment varies substantially from industry to industry. On the other hand, comparable data on income-to-sales ratios among companies in a given industry are often easier to obtain than return on investment information, and the definition of what constitutes the base against which income is measured is less subject to confusion. In such cases profit on sales can be a useful yardstick.

The rate of growth desired as well as the goals as to the size of the operation several years hence may be a financial objective since growth is, to a considerable degree, controlled by the availability of funds for investment in the enterprise and is dependent upon the way in which these funds are utilized. Financial growth objectives should be stated in terms of the total profit dollars desired and capital gains or equity appreciation.

Volume objectives such as total sales in dollars more properly belong under the area of marketing objectives. As a financial objective, volume objective is derivative in nature; that is, it is based on primary profit and return on investment objectives and assumptions as to financial relationships which will prevail. Therefore the stated volume objectives must be met in order to achieve the desired profitability.

In some entrepreneurial types of businesses, and under certain conditions, growth in the market value of the company may be of primary importance where the objective is to make a profit primarily through the sale of the enterprise within the foreseeable future.

Smaller companies particularly may formulate an objective as to the marketability of the stock. A closely held company whose stock is not traded should periodically review the desirability of creating a market for the stock in terms of the flexibility of investment needed by the owners, especially in connection with the retirement and estate problems as against the problems of maintaining control of the enterprise. The extent of distribution of the stock, i.e., number of stockholders, should be considered as a basis for plans and decisions regarding stock splits, new issues, ease of implementing merger plans, communication with stockholders, etc.

Desired debt-to-equity ratios should be indicated, i.e., the leverage desired and the acceptable degree of risk in this area. The extent to which a company’s operations are financed by loans is not always fully controllable and may depend on such things as business conditions, the state of the capital market, and interest rates. However, there is often wide latitude in the choice of debt-equity ratios; in smaller and medium-sized companies the strong prejudice against debt may have an important impact on expansion decisions.

Product and Marketing: The company should consider very carefully the types of products and services it provides, and intends to provide. A careful examination of existing circumstances will often point out that the products and services being offered are not compatible with future plans and thus do not provide a good basis for planning. Product and service objectives can be quite detailed, but should have a concise general theme.

Most product and service activity, however specialized, falls within some broader definition. The discipline of setting product and service objectives exposes a company to the problem of considering a broadening of the product line and the means by which this might be accomplished. For example, a manufacturer of lead acid batteries might have as an objective the manufacture of automotive starting, lighting, and ignition batteries. He might change this objective to the production of a full range of automotive and industrial lead acid batteries, and then further change it to the manufacture of many different kinds of batteries, including lead acid, alkaline, and dry cell. Similarly, a company specializing in wooden shingles might formulate the objective of offering a variety of roofing and siding materials and of providing installation service.

Product and service objectives may also be stated in terms of desired pricing and quality levels. Clearly, Rolls Royce and Volkswagen differ in this regard. Although both produce automobiles, one caters to the luxury market, building the very finest that is obtainable almost without regard to price, while the other strives to provide transportation of the best quality obtainable for a low price. Many products must meet minimum quality standards in order to be saleable to all, and yet there is a considerable range in the quality of products which are sold. It is not always true that the minimum quality, lowest-priced product has the largest volume potential. In setting pricing and quality objectives, a shift from an established pattern can be hazardous, particularly if the change is made suddenly.

A company should define the types of markets and customers which it intends to serve. In making merger/acquisition decisions, the company should consider whether it will serve additional markets, compete with its customers, or offer additional products to the markets it is already serving. As with product and service objectives, market and customer objectives should have a general theme, but it may be spelled out in considerable detail.

The general statement of types of products and services and the statement of types of markets and customers can often be combined; for example, “the objective of this company is to produce specialty valves of the type required by steam power plants.” or “the objective is to build advanced design submarines for the U. S. Navy,” or “the objective is to manufacture safe, good-quality, educational toys for the three to seven year age group.”

Companies often set objectives as to the share of market which should be attained. The market share objective can be stated as a percentage of the total industry volume or it can be stated in other terms. In a rapidly growing market, the percentage of total approach has particular validity when it is projected over a period of time and is used as a check point for making decisions concerning investment in additional capacity or withdrawal from the market. A company should develop its share-of-market objective before the market reaches maturity since it is much more difficult to change market-share goals after the market matures.

In setting market-share objectives, a firm must be very realistic about the prospects of achieving a major position in the face of strong or entrenched competition. Quite frequently, companies are hazy about “market,” since a market may be defined in several ways and may be comprised of a number of identifiable segments in terms of customer groups, price ranges, etc. Incidentally, this question can be of considerable importance in antitrust deliberations. In the cellophane case, Du Pont argued that cellophane was in active competition with a wide range of other flexible wraps and constituted less than 20% of all flexible packaging materials sales. The Department of Justice had charged that Du Pont accounted for approximately 75% of the sales of cellophane, and that it, therefore, had achieved a monopoly in violation of Section 2 of the Sherman Act. After due deliberation, the Court found that cellophane was not the market, since other flexible wrappings were reasonably interchangeable and, therefore, competitive.

In a comparatively cyclical industry, market share is often a better measure of performance than is volume, particularly in the short term. For example, a company which fails to maintain an existing market share in a period of rising sales may have great difficulty in regaining its former position in the future.

A firm may specify a market-share objective, rather than a ...