1. Diversification & Synergy
This is only a summary. Please read the text book and additional readings for
details. Removal of errors and omissions, if any, in this ppt are your responsibility.
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3. Synergy
In M&A – it is value creation for the shareholders that they
would not have been able to garner on their own
For valuation of synergies, usual DCF works, often need
advanced option valuation techniques
Theory offers no suggestions on the discount rate to be used
Judgment, intuition and experience
Need significant analysis to ‘justify’ approach
Analysis is company, industry and economic-condition specific
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4. Numerical
Firm A announced a merger proposal with Firm T.
Both have an overall cost of capital of 10%. Currently
Firm A generates an after-tax cash flow of 0.5 billion
per year and firm T generates an after-tax cash flow of
0.3 billion per year. If the two firms merge it is
expected that they will generate after tax cash flow of
1billion per year.
• Should they merge?
• What is the gain from the takeover (merger)?
• What is the value of firm T to firm A?
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5. Numerical
The acquiring firm A has two options when acquiring the target firm T.
Below are some details of the two firms.
Firm A Firm T
Price per share $30 $20
# O/S shares 1.7 billion 1.1 billion
MV of equity $51 billion $ 22 billion
Firm A expects to generate cost savings and other synergies
equating to additional annual net profit after tax of $6 billion in the
foreseeable future. Both firms have an overall cost of capital of
10.5% and are in the same marginal tax bracket.
• What is the gain to the acquirer firm A, and price per share of the merged entity
when the target, firm T will accept cash of $25 billion for the merger?
• What is the gain to the acquirer firm A, and price per share of the merged entity
when the target, firm T will accept shares worth $25 billion for the merger?
• What is the gain to the acquirer firm A, and price per share of the merged entity
when the target, firm T will accept 0.6 shares of firm A for 1 share of firm T?
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6. Diversification
Diversification
• A collection of businesses under one corporate
umbrella (referred to as conglomerates)
• A firm is diversified when it is in two or more lines of
business
• It is through coherent overarching strategy and
actions that the corporation will create shareholder
value in the long term and be sustainable as a
multi-business entity
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7. Diversification
Peter Drucker : a company should be diversified in
products, markets and end-uses and highly
concentrated in its basic knowledge area or
It should be diversified in its knowledge area and
highly concentrated in product, markets, end-uses
This is by no means exact but a directional approach
or indicator to understanding related and unrelated
diversification (and core or non-core activities of the
firm) – very tenuous
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8. Diversification
Microsoft – tracing its history is it related or unrelated
diversification?
Network 18 – related or unrelated diversification?
GE
Google
Wipro
Jain Irrigation
Jindals
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9. Diversification
Adjacencies
When a firm moves out of core into adjacent space
Expand along the value chain (mfg and retail)
Grow new products and services (IBM moved into global
services which now accounts for just over 50% of its pre
tax profits)
Use new distribution channel (Dell, Landmark)
New markets (Indian IT companies, Tesco from UK to
US)
New Customer segment (CAF from prime to sub-prime)
New space(AA sets up Sabre which led to Travelocity)
Hybrid approaches (Nike customer experience)
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11. Diversification
Berkshire Hathaway (BH)
• One of the successful conglomerates with over 60
subsidiary operating business
• Has grown by acq of firms in
insurance, bricks, furniture, jewelry…
• Business model is simple: surplus cash from low
growth business is invested in high growth
business, key acq or stock market investment
• Market perception is that the success of BH is due
to its equity investment portfolio – the portfolio only
contributes 20% of the market value of BH
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12. Diversification
Berkshire Hathaway (BH)
Firm groupings as per 2008 annual report
• Insurance group (GEICO, General Re…)
• Finance and financial products group (various)
• Marmon (130 mfg and service business)
• McLane Co (wholesale distn of grocery and non-food items)
• MidAmerican (regulated el. and gas, power gen and distn US and
overseas)
• Shaw Industries (carpet and flooring)
• Mfg (Brown shoe Co, FTL, ACME building…)
• Service (Bufallo news, Business wire…)
• Retailing (Helzberg Diamonds, Nebraska furniture…)
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13. Diversification
Berkshire Hathaway (BH)
Business model
• Insurance group generated a lot of float which
helped the business
• Ensure that businesses generate free cash
especially on the aggregate
• Owner orientation – own diversified business, o/w
own parts of businesses, price of a business is a
major factor (seek undervalued firms), choose
managers astutely (not much interference in day-today tactics)
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14. Diversification
Berkshire Hathaway (BH)
Business model
• Prefer negotiated transactions
• Yet, will buy shares of interested firms in the stock
market when the price is right
• Since the 1990s investment has been in several
100% owned businesses
• Conglomerate strategy anchored by the core
business: insurance
• Very effectively and efficiently managed – low
corporate headcount
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