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Merger & Acquisition
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A PROJECT REPORT
Submitted by:
Ketan Shivarkar
Roll No. 01549
NAME OF THE GUIDE
Prof. Hemant Katole
in partial fulfillment for the award of the degree
of
MASTER OF BUSINESS ADMINISTRATION
MARKETING
DEPARTEMNT OF MANAGEMENT SCIENCES
UNIVERSITY OF PUNE
MAY 2011-13
2
Competitor- Merger & Acquisition ‘Fundamentals’ Analysis
A PROJECT REPORT
Submitted by:
Roll: 01549
Dec 2012
Project Guide: Prof. Hemant Kalote
Pune University,
Executive MBA Program
Competitor- Merger & Acquisition Fundamental’s Analysis
3
UNIVERSITY OF PUNE
CERTIFICATE
Certified that this project report “Competitor- Merger & Acquisition Fundamental
Analysis” is the bonafide work of “Ketan Shivarkar” who carried out the project work
under my supervision.
SIGNATURE
Prof. Hemant Katole
SUPERVISOR, FACULTY
DEPARTEMNT OF MANAGEMENT SCIENCES
UNIVERSITY OF PUNE, GANESHKHIND, PUNE 411 007
HEAD OF THE DEPARTMENT
DEPARTEMNT OF MANAGEMENT SCIENCES
UNIVERSITY OF PUNE, GANESHKHIND, PUNE 411 007
External Examiner
Competitor- Merger & Acquisition Fundamental’s Analysis
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EXECUTIVE SUMMARY
Student information:
Name: Ketan D. Shivarkar
Roll No: 01549
Email: [email protected]
Occupation: Engineering Lead/ Team Manager at Cisco Systems India Pvt. Ltd.
Organization Information:
Cisco Systems India Pvt. Ltd.
Address:
Pride Silicon Plaza
106-A, Ground Floor
Senapati Bapat Road
Pune - 411016
Maharashtra, India
Industry: Computer Networking/Datacenter Gear and Enterprise Software
Title of the Project: Merger & Acquisition ‘Fundamental’ Analysis.
Objective of the Project: Cisco Systems has been known as the serial acquirer over the
years, this has been based upon the 148 acquisitions executed over the years in the
industry. In this project I plan to analyze the core fundamentals, which constitute to a
successful acquisitions and contribute to shareholder value.
Competitor- Merger & Acquisition Fundamental’s Analysis
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ACKNOWLEDGEMENT
I (Ketan Shivarkar) owe a great many thanks to a great many people
who helped and supported me during the research and writing this project
report.
I sincerely acknowledge the support and guidance given by our mentor Prof.
Hemant Katole, without whom, the project would not have taken shape in
the desired direction. Every single bit put in by our mentors is precious in its
own way. He has taken pain to go through the project and make necessary
correction as and when needed.
The thought and Analysis presented in this project report are materials that I
acquired in article, books and published research reports. I make no claim to
be comprehensive. A special thanks to the authors mentioned in the
bibliography page. Special thanks to Prof. Aswath Damodaran (Professor of
Finance at the Stern School of Business at NYU) for sharing this knowledge
on valuation principles, which formed the base of the project undertaken.
I would also thank my Institution and my faculty members without
whom this project would have been a distant reality. I also extend my
heartfelt thanks to my family and well-wishers.
Competitor- Merger & Acquisition Fundamental’s Analysis
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CERTIFICATE
This is to certify that Mr Ketan Shivarkar, student of 2nd year Executive MBA( Operations), has done his semester project titled “Competitor- Merger & Acquisition Fundamental’s Analysis” at Cisco Systems India Pvt. Ltd., Pune during the academic year 2012-13.
Mr. Dipesh Chheda
Solutions Manager
Cisco Systems India Pvt. Ltd., Pune
Place: Pune
Date: 26 Dec 2012
Competitor- Merger & Acquisition Fundamental’s Analysis
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INDEX
Sr. No Particulars Pages
1 Company Profile
About Cisco 8 -- 11
Cisco Acquisition History 12 -- 20
2 M & A – Industry Wide Analysis 21 -- 24
3 Analyzing a Deal Gone Bad
The HP-Autonomy Acquisition 26 -- 27
Acquisition Price Build Up 28 -- 31
Role Of Investment Bankers 32 -- 35
Over Confident CEO's &
Complaint Boards 36 -- 37
4 Creating Value from M&A Deals 38 -- 45
5 Bibliography 46
Competitor- Merger & Acquisition Fundamental’s Analysis
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COMPANY PROFILE
Competitor- Merger & Acquisition Fundamental’s Analysis
9
ABOUT CISCO
Cisco Systems, Inc. is the worldwide leader in networking for the Internet. Today,
networks are an essential part of business, education, government, and home
communications. Cisco hardware, software, and service offerings are used to create the
Internet solutions that make these networks possible, giving individuals, companies, and
countries easy access to information anywhere, at any time. In addition, Cisco has
pioneered the use of the Internet in its own business practice and offers consulting
services based on its experience to help other organizations around the world. Cisco was
founded in 1984 by a small group of computer scientists from Stanford University. This
year, the company celebrates 20 years of commitment to technology innovation, industry
leadership, and corporate social responsibility. Since the company’s inception, Cisco
engineers have led in the innovation of Internet Protocol (IP)-based networking
technologies. This tradition of IP innovation continues with the development of industry-
leading products in the core technologies of routing and switching, along with Advanced
Technologies in areas such as home networking, IP telephony, optical networking,
security, storage area networking, and wireless technology. In addition to its products,
Cisco provides a broad range of service offerings, including technical support and
advanced services. Cisco sells its products and services, both directly through its own
sales force as well as through its channel partners, to large enterprises, commercial
businesses, service providers, and consumers.
As a company, Cisco operates on core values of customer focus and corporate social
responsibility. We express these values through global involvement in educational,
community, and philanthropic efforts.
At Cisco (NASDAQ: CSCO) customers come first and an integral part of our DNA is
creating long-lasting customer partnerships and working with them to identify their needs
and provide solutions that support their success.
Competitor- Merger & Acquisition Fundamental’s Analysis
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Founded in 1984 by a small group of computer scientists from Stanford University, Cisco
engineers have been leaders in the development of Internet Protocol (IP)-based
networking technologies since the company's inception. This tradition of innovation
continues with industry-leading products in the core areas of routing and switching, as
well as advanced technologies in areas such as Unified Communications, Network
Security, Video, Virtualization and Cloud Computing.
Innovation is a core part of the Cisco culture and annually $4.5 Billion is invested in
R&D; Cisco has more than 22,000 Engineers in more than 10 labs worldwide; more than
4200 patents have been awarded to Cisco inventors. Currently 722 patents have been
filed and 420 issued for innovations across all technologies.
Cisco Global Facts
Incorporated on December 10, 1984 in California
Went public on February 16, 1990. NASDAQ NM: CSCO (Common Stock)
Q4 FY'12 Employee Count: 66,639
John T. Chambers is the Chairman and Chief Executive Officer, Cisco
FY'12 Revenue: $46.06 billion
Cisco India
With sales and marketing operations spread across key cities in India and a
software development centre in Bangalore, Cisco leads the networking market in
core technologies of routing and switching, as well as WLAN and network
security.
Cisco India Facts
Cisco India commenced operations in 1995
India, as a region, is part of the APAC theater
Cisco has 7 Sales Offices in the region - New Delhi, Mumbai, Bangalore,
Chennai, Pune, Kolkata and Hyderabad.
India headcount is 8700+ including R&D, sales and business support staff
Competitor- Merger & Acquisition Fundamental’s Analysis
11
o The Cisco Global Development Center is in Bangalore, this is the largest
outside of the US. The Cisco ASR 901 Router developed by Cisco's
engineering team in India has received the NASSCOM Innovation Award
2012 for innovation in creating a unified platform to serve the needs of
2G/3G/4G mobile backhaul and Carrier Ethernet applications.
o Joint Development Centers with Wipro Technologies and Infosys
Technologies in Bangalore; HCL Technologies in Chennai and Zensar
Technologies in Pune.
Cisco's go-to-Market strategy is through partners
o 2500+ Partners
o 11 Gold Certified Partners – Accenture Services Pvt Ltd, British Telecom
India Pvt ltd, Bharti Airtel Services Ltd, Dimension Data India Ltd, HCL
Comnet , HCL Infosystems Ltd, IBM, Orange Business Services, AGC
Networks, Wipro and TCS
o 9 Silver Certified Partners – Velocis (formerly Integrix), Proactive, Locuz,
PC Solutions , Nirmal Datacomm, SK International, Allied Digital
Services Ltd, Netplace Technologies Pvt Ltd and Central Data Systems P.
Ltd
o 4 Distributors– Ingram Micro, Redington, Compuage and Comstor
Support and Service - Extensive support system for customers with 18 logistics
centers (premium depots). Besides that, Cisco is the only vendor to have a support
program called ARNBD (advance replacement next business day) for its resellers
Cisco Capital was launched in 2005 to offer flexible leasing and financial services
to customers and partners
Currently, there are 197 Active Cisco Networking Academies across 23 states &
union territories with 22,379 Active Students, 31% of which are women students.
Overall these academies have impacted 70,304 students since the program
inception in India. India has 18,738 Cisco Certification Ready Course
completions through the Cisco Networking Academies.
India Market Share Leadership
Competitor- Merger & Acquisition Fundamental’s Analysis
12
Core Technologies
Router: 71.5%; Switch: 66.4% Total LAN: 68.1% (CY Q2'12, IDC LAN Tracker,
Aug 2012)
Advanced Technologies
WLAN: 36.7% (CY Q2'12, IDC, Sep 2012)
Security: 34.0% (CY Q2'12, Frost & Sullivan, Sep 2012)
Enterprise Telephony: 28.0% (CY Q2'12, Frost & Sullivan, Oct 2012)
IP PBX: 43.4% (CY Q2'12, Frost & Sullivan, Oct 2012)
Competitor- Merger & Acquisition Fundamental’s Analysis
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Cisco Acquisition History
Cisco did not acquire a company for the first seven years of its existence, but on
September 24, 1993, Cisco acquired Crescendo Communications, a LAN switching
company. Since then, acquisitions have constituted 50% of the company. The company's
largest acquisition as of April 2008 is the purchase of Scientific-Atlanta, a manufacturer
of cable television, telecommunications, and broadband equipment, for US$6.9 billion.
The majority of companies acquired by Cisco are based in the United States. A total of
148 companies have been acquired as of March 2011. Most of the acquired companies
are related to computer networking, including several LAN switching and Voice over
Internet Protocol companies.
Date Company Business
Acquisition
Cost
September 24, 1993 Crescendo Communications LAN switching $94,500,000
July 12, 1994 Newport Systems Solutions Routers $95,000,000
October 24, 1994 Kalpana LAN switching $204,000,000
December 8, 1994 LightStream LAN switching $120,000,000
August 10, 1995 CombinetRemote desktop
software$114,200,000
September 6, 1995 Internet Junction Gateway $5,500,000
October 27, 1995 Network Translation Firewalls $30,000,000
November 6, 1995 Grand Junction Networks LAN switching —
January 23, 1996 TGV SoftwareInternet software
company
April 22, 1996 StrataCom ATM switching $4,000,000,000
July 22, 1996 Telebit Modems $200,000,000
August 6, 1996 Nashoba Networks LAN switching $100,000,000
Competitor- Merger & Acquisition Fundamental’s Analysis
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September 3, 1996 Granite Systems Computer networking $220,000,000
October 14, 1996 Netsys Technologies Network simulation $79,000,000
Dec-96 Metaplex Computer networking —
March 26, 1997 TelesendBroadband Internet
access—
June 9, 1997 Skystone SystemsSynchronous optical
networking$89,100,000
June 24, 1997Global Internet Software
GroupFirewall $40,250,000
June 24, 1997 Ardent CommunicationsBroadband Internet
access$156,000,000
September 2, 1997 Integrated Network Digital subscriber line —
December 22, 1997 LightSpeed InternationalVoice over Internet
Protocol$160,000,000
February 18, 1998 WheelGroup Computer security $124,000,000
March 10, 1998 NetSpeedBroadband Internet
access$236,000,000
March 11, 1998 Precept Software Internet television $84,000,000
May 4, 1998 CLASS Data Systems Computer networking $50,000,000
July 28, 1998 Summa Four LAN switching $116,000,000
August 21, 1998 American Internet Computer networking $56,000,000
September 15, 1998 Clarity Wireless Wireless networking $157,000,000
October 14, 1998 Selsius SystemsVoice over Internet
Protocol$145,000,000
December 2, 1998 PipelinksSynchronous optical
networking$126,000,000
April 8, 1999 Fibex Systems Digital loop carrier $250,000,000
April 8, 1999 Sentient NetworksVoice over Internet
Protocol$195,000,000
April 13, 1999 GeoTel CommunicationsVoice over Internet
Protocol$2,000,000,000
Competitor- Merger & Acquisition Fundamental’s Analysis
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April 28, 1999 Amteva TechnologiesVoice over Internet
Protocol$170,000,000
June 17, 1999TransMedia
CommunicationsGateways $407,000,000
June 29, 1999StratumOne
Communications
Synchronous optical
networking$435,000,000
August 16, 1999 CalistaPrivate branch
exchange$55,000,000
August 18, 1999 MaxComm TechnologiesVoice over Internet
Protocol$143,000,000
August 26, 1999 Monterey NetworksSynchronous optical
networking$500,000,000
August 26, 1999 CerentSynchronous optical
networking$6,900,000,000
August 31, 1999IBM Networking Hardware
DivisionComputer networking $2,000,000,000
September 15, 1999 COCOM A/S Cable modems $65,600,000
September 22, 1999 Webline Communications Contact management $325,000,000
October 26, 1999 Tasmania Network Systems Web cache $25,000,000
November 9, 1999Aironet Wireless
CommunicationsWireless LAN $799,000,000
November 11, 1999 V-Bits Digital video $128,000,000
December 16, 1999 Worldwide Data SystemsInformation technology
consulting$25,500,000
December 17, 1999 Internet Engineering GroupSynchronous optical
networking$25,000,000
December 20, 1999 Pirelli Optical SystemsFiber-optic
communication$2,150,000,000
January 19, 2000 Compatible SystemsVirtual private
networking$317,000,000
January 19, 2000 Altiga Networks Virtual private $250,000,000
Competitor- Merger & Acquisition Fundamental’s Analysis
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networking
February 16, 2000 Growth Networks Chipsets $355,000,000
March 1, 2000 Atlantech Technologies Network management $180,000,000
March 16, 2000 JetCell Mobile telephones $200,000,000
March 16, 2000 infoGear TechnologyInformation
management$301,000,000
March 29, 2000 SightPath Content delivery $800,000,000
April 11, 2000 PentaCom LAN switching
April 12, 2000 Seagull Semiconductor Computer networking $19,000,000
May 5, 2000Arrowpoint
CommunicationsLAN switching $5,700,000,000
May 12, 2000 Qeyton SystemsWavelength-division
multiplexing$800,000,000
June 5, 2000 HyNEX Internet access $127,000,000
July 7, 2000 Netiverse LAN switching $210,000,000
2001 AuroraNetics Computer networking $150,000,000
July 25, 2000 Komodo TechnologyVoice over Internet
Protocol$175,000,000
July 27, 2000 NuSpeed Internet Systems iSCSI $450,000,000
August 1, 2000 IPmobile Mobile software $425,000,000
August 31, 2000 PixStreamMedia player
(application software)$369,000,000
September 28, 2000 IPCell TechnologiesVoice over Internet
Protocol$200,000,000
September 28, 2000 Vovida NetworksVoice over Internet
Protocol$169,000,000
October 20, 2000 CAIS SoftwareIntegrated development
environment$170,000,000
November 10, 2000 Active VoiceCommunication
software$266,000,000
November 13, 2000 Radiata Wireless networking $295,000,000
Competitor- Merger & Acquisition Fundamental’s Analysis
17
December 14, 2000 ExiO Communications Wireless networking $155,000,000
July 27, 2001 Allegro SystemsVirtual private
networks$181,000,000
May 1, 2002 Hammerhead Networks Computer networking $173,000,000
May 1, 2002 Navarro Networks Computer networking $85,000,000
July 25, 2002 AYR Networks Computer networking $113,000,000
August 20, 2002 Andiamo Systems Data storage $2,500,000,000
October 22, 2002 Psionic Software Intrusion detection $12,000,000
January 24, 2003 Okena Intrusion detection $154,000,000
March 19, 2003 SignalWorks Echo cancellation $13,500,000
March 20, 2003 Linksys Computer networking $500,000,000
November 12, 2003 Latitude Communications Web conferencing $80,000,000
March 12, 2004 Twingo Systems Computer security $5,000,000
March 22, 2004 Riverhead Networks Computer security $39,000,000
June 17, 2004 Procket Networks Routers $89,000,000
June 29, 2004 Actona Technologies Data storage $82,000,000
July 8, 2004 Parc Technologies Routers $9,000,000
August 23, 2004 P-CubeService Delivery
Platform$200,000,000
September 9, 2004 NetSolve Information technology $128,500,000
September 13, 2004 dynamicsoftCommunication
software$55,000,000
October 21, 2004 Perfigo Computer networking $74,000,000
November 17, 2004 Jahi Networks Network management $16,000,000
December 9, 2004 BCN Systems Routers $34,000,000
December 20, 2004 Protego Networks Network security $65,000,000
January 12, 2005 Airespace Wireless LAN $450,000,000
April 14, 2005 Topspin Communications LAN switching $250,000,000
April 26, 2005 Sipura TechnologyVoice over Internet
Protocol$68,000,000
May 23, 2005 Vihana Semiconductors $30,000,000
Competitor- Merger & Acquisition Fundamental’s Analysis
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May 26, 2005 FineGround Networks Network security $70,000,000
June 14, 2005 M.I. Secure CorporationVirtual private
networks$13,000,000
June 27, 2005 Netsift Computer networking $30,000,000
July 22, 2005 KISS TechnologyEntertainment
technology$61,000,000
July 26, 2005 Sheer Networks Service management $97,000,000
September 30, 2005 Nemo Systems Computer networking $12,500,000
November 18, 2005 Scientific-Atlanta Digital cable $6,900,000,000
November 29, 2005 Cybertrust Information gathering $14,000,000
March 7, 2006 SyPixx Networks Surveillance $51,000,000
June 8, 2006 MetreosVoice over Internet
Protocol$28,000,000
June 8, 2006 AudiumVoice over Internet
Protocol$19,800,000
July 6, 2006 Meetinghouse Computer security $43,700,000
August 21, 2006 Arroyo Video Solutions Video on demand $92,000,000
October 10, 2006 Ashley Laurent Gateways —
October 25, 2006 Orative Mobile software $31,000,000
November 13, 2006 Greenfield Networks Semiconductors —
December 15, 2006 Tivella Digital signage / IPTV —
January 4, 2007 IronPort Computer security $830,000,000
February 9, 2007 Five AcrossSocial networking
service—
February 21, 2007 Reactivity Web services $135,000,000
March 5, 2007 Utah Street NetworksSocial networking
service—
March 13, 2007 NeoPath Data storage
March 15, 2007 WebEx Web conferencing $3,200,000,000
March 28, 2007 SpansLogic Computer networking —
May 21, 2007 BroadWare Technologies Surveillance —
Competitor- Merger & Acquisition Fundamental’s Analysis
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September 18, 2007 Cognio Mobile software —
September 27, 2007 LatigentBusiness performance
management—
October 23, 2007 Navini Networks WiMAX $330,000,000
November 1, 2007 SecurentDigital rights
management$100,000,000
April 8, 2008 Nuova Systems, Inc. Computer networking $678,000,000
June 10, 2008 DiviTech A/SDigital service
management—
July 23, 2008 Pure Networks, Inc. Computer software $120,000,000
August 27, 2008 PostPath Email $215,000,000
September 19, 2008 Jabber, Inc. Presence —
January 27, 2009Richards-Zeta Building
Intelligence
Building management
systems—
March 19, 2009 Pure Digital Technologies Digital video $590,000,000
May 1, 2009 Tidal SoftwareIntelligent Application
Management$105,000,000
October 27, 2009 ScanSafeSaaS Web Security
Provider$183,000,000
November 2, 2009Set-top box business of
DVNCable —
December 18, 2009 Starent NetworksSystem Architecture
Evolution$2,900,000,000
April 18, 2010 Tandberg Videoconferencing $3,300,000,000
May 18, 2010MOTO Development
GroupProduct design —
May 20, 2010 CoreOpticsDigital signal
processing—
August 26, 2010 ExtendMedia Video —
September 2, 2010 Arch Rock Corporation Smart Grid —
December 1, 2010 LineSider Technologies Network Management —
Competitor- Merger & Acquisition Fundamental’s Analysis
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Software
January 26, 2011 Pari Networks
Network Configuration
and Change
Management (NCCM)
—
February 4, 2011 Inlet Technologies
Adaptive Bit Rate
(ABR) digital media
processing platforms
$95,000,000
March 29, 2011 newScale Inc.[Cisco Intelligent
Automation for Cloud]—
August 21, 2011AXIOSS Software and
Talent
IT Service Management
Software$31,000,000
August 29, 2011 Versly Integrated Software —
October 20, 2011 BNI Video Video $99,000,000
March 15, 2012 NDS Group Conditional Access $5,000,000,000
The “buy” pillar of the company's three pillars of innovation: “build,” “buy,” and
“partner”. Cisco focuses on acquisitions that capitalize on new technologies and business
models. Cisco's growth strategy is based on identifying and driving market transitions.
Corporate Development focuses on acquisitions that help Cisco capture these market
transitions.
Cisco segments acquisitions into three categories: market acceleration, market expansion,
and new market entry. The target companies might bring different types of assets to
Cisco, including great talent and technology, mature products and solutions, or new go-
to-market and business models. Cisco particularly seeks acquisitions with the potential to
reach billion dollar markets.
Integration is essential to successful acquisitions. Our overall business development
effort includes engaging from the early diligence phase through to mainstream business,
by investing in dedicated integration resources across the company at the corporate and
functional levels. We have a long history of integration, achieving best practices through
Competitor- Merger & Acquisition Fundamental’s Analysis
21
continuous learning and deep experience with a process that challenges all companies
who repeatedly make acquisitions.
Leaders in IT and other markets frequently seek Cisco's advice on acquisition integration.
Our integration process starts with the entire acquisition strategy. Cisco seeks
acquisitions where there is not only a strong business case but also a shared business and
technological vision, and where compatibility of core values and culture foster an
environment for success.
Competitor- Merger & Acquisition Fundamental’s Analysis
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M & A – Industry
Wide Analysis
Competitor- Merger & Acquisition Fundamental’s Analysis
23
The evidence suggests that a growth strategy built around acquisitions, especially of other
publicly traded firms, is more likely to fail than succeed. To back this statement, you can
look at three pieces of evidence
a) The behavior of the acquiring company's stock price, around the announcement of
an acquisition
b) The post-deal performance (stock price & profitability) of firms after acquisitions
c) The overall track record of acquisition-based growth strategies, relative to other
growth strategies
When an acquisition of a publicly traded company is announced, the attention is
generally on the target firm and its stock price, but the market's reaction to the event is
better captured in what happens to the acquiring firm's stock price. In the figure below,
take a look at the target and acquiring firm stock behavior in the twenty days before and
after the acquisition announcement across hundreds of acquisition announcements:
Competitor- Merger & Acquisition Fundamental’s Analysis
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The winner in public company acquisitions is easy to spot and it is the target company
stockholders, who gain about 18% over the 41 days. On average, bidding company
stockholders have little to show in terms of price gains; the stock price for acquiring
firms drops about 2% during the announcement period and about 55% of all acquiring
firms see their stock prices go down. Note that while the percentage price drop is small
(relative to the price increase for the target firm), acquiring firms are typically much
larger than target firms and the absolute value that is lost by acquiring firm stockholders
from acquisitions can be staggering. A study of 12,023 acquisitions by large market cap
firms from 1980 to 2001 estimated that their stockholders lost $218 billion in market
value because of these acquisitions. While this number was inflated by some especially
bad deals done between 1998 and 2000, they illustrate the potential for massive value
losses from acquisitions and the reality that one big, bad deal can undo decades of careful
value creation in a company.
Post-deal stock price performance: KPMG studied the 700 biggest mergers between
1996 and 1998 and compared the stock price performance for a year after the deal was
closed to that of the peer group to conclude that 83% of the companies underperformed
after acquisitions. Thus, the negative reaction to acquisition announcements does not
seem to dissipate over longer periods. In some good news, KPMG has updated its M&A
study five more times since its 1999 study and reports that there has been some
improvement between 1999 and 2011. While only 31% of deals made in the last study
(looking at 2007-2009 deals) were value adding, that is an improvement over the 17%
from the 1999 study
Competitor- Merger & Acquisition Fundamental’s Analysis
25
Competitor- Merger & Acquisition Fundamental’s Analysis
26
ANALYSING A
DEAL GONE BAD
Competitor- Merger & Acquisition Fundamental’s Analysis
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THE HP-AUTONOMY ACQUISITION
Hewlett Packard (HP) had a terrible day on November 20 2012. In a surprise
announcement, the company announced that it was taking a write off of $8.8 billion of
the $11.1 billion that it paid to acquire Autonomy, a UK based technology company, in
October 2011, and that a large portion of this write off ($ 5 billion) could be attributed to
accounting improprieties at Autonomy. Even by the standards of acquisition mistakes,
which tend to be costly to acquiring company stockholders, this one stood out on three
dimensions:
1. It was disproportionately large : While there have been larger write offs of
acquisition mistakes, this one stands out because it amounts to approximately
80% of the original price paid.
2. The preponderance of the write off was attributed to accounting manipulation :
Most acquisition write offs are attributed either to over optimistic forecasts at the
time (the investment banker made us do it) of the merger or changes in
operations/markets after the acquisition (it was not our fault). HP's claim is that
the bulk of the write off ($5 billion of the 8.8 billion) was due to accounting
improprieties (a polite word for fraud) at Autonomy.
3. The market was surprised : Most acquisition write offs, which take the form of
impairments of goodwill, are non-news because they lag the market and have no
cash flow effects. In other words, by the time accountants get around to admitting
a mistake from an acquisition, markets have already admitted the mistake and
moved on. In HP's case, the market was surprised and HP's stock price dropped
about $ 3 billion (12%) on the announcement. Put differently, the market had
priced in an acquisition mistake of $5.8 billion into the value already and was
surprised by the difference.
Competitor- Merger & Acquisition Fundamental’s Analysis
28
The blame game
• Meg Whitman, the current CEO of HP, blamed the prior top management at the
company, and said that "(t)he two people that should have been held responsible
are gone ".
• Leo Apotheker, the prior CEO who orchestrated the acquisition, claimed to be shocked
at the "accounting improprieties" at Autonomy.
• Michael Lynch, the founder of Autonomy, said that two major auditors had performed
"due diligence" on the financial statements and had found no improprieties at the
company.
• Deloitte LLP, the auditor for Autonomy, denied all knowledge of accounting
misrepresentations and claimed to be cooperating with authorities.
• The advisers on the deal (Perella Weinberg & Barclay's Capital for HP, Quatalyst,
UBS, Goldman Sachs, Chase & BofA for Autonomy) have all been mysteriously
silent, though none have offered a refund of their advisory fees.
Competitor- Merger & Acquisition Fundamental’s Analysis
29
BUILDING UP THE ACQUISITION PRICE
Before we look at the numbers, it is worth reviewing the history of the two companies
involved. Autonomy was a company founded at the start of the technology boom in 1996,
which soared and crashed with that boom and then reinvented itself as a
business/enterprise technology company that grew through acquisitions between 2001
and 2010. Hewlett Packard, with a long and glorious history as a pioneer in
computers/technology, had fallen on lean times as its PC business became less
competitive/profitable and due to top management missteps.
On August 18, 2011, HP's then CEO, Leo Apotheker (who had worked at SAP)
announced his intent to get out of the PC business and expand the enterprise technology
business by buying Autonomy. While the deal making began on his watch, the actual deal
was officially completed on October 3, 2011, with Meg Whitman as CEO. If she was a
reluctant participant in the deal, it was not obvious in the statement she released at the
time where she said "the exploding growth of unstructured and structured data and
unlocking its value is the single largest opportunity for consumers, businesses and
governments. Autonomy significantly increases our capabilities to manage and extract
meaning from that data to drive insight, foresight and better decision making."
One of the perils of assessing "big" merger deals is that the fog of deal making, composed
of hyperbole, buzzwords and general uncertainty, obscures the facts. So, lets stick with
the facts that were available at the time the deal was done (a time period that stretched
from August 18, 2011, to October 3, 2011):
4. Acquisition Price: While there have been varying numbers reported about what HP
paid for Autonomy, partly reflecting when the story was written (between August
& November) and partly because of exchange rate movements (HP paid
£25.50/share), the actual cost of the deal was $11.1 billion.
Competitor- Merger & Acquisition Fundamental’s Analysis
30
5. Market Price prior: Autonomy's market cap a few days prior to the deal being
announced was approximately $5.9 billion.
6. Pre-deal accounting book value : The book value of Autonomy's equity, prior to the
deal, was estimated to be $2.1 billion. (Source: Autonomy's balance sheet from its
annual report for 2010)
7. Post-deal accounting book value: After acquisitions, accountants are given a limited
mission of reappraising the value of existing assets and this appraisal led to an
adjusted book value of $ 4.6 billion for Autonomy. (Source: HP's 2011 annual
report, page 99)
The advantage of working with these numbers is that differences between them are
revealing. In the figure below, I attempted to deconstruct the $11.1 billion paid by HP
into its constituent parts:
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31
Acquisition Price Build Up
You can see the build up to the price paid by HP as a series of premiums:
1. The accounting "write up" premium for book value: One of the residual effects of
the changes that have been made to acquisition accounting is that accountants are
allowed to reassess the value of a target company's existing assets to reflect their
"fair" value. For technology companies such as Autonomy, this becomes an
exercise in putting values to technology patents and other intangible assets and
that exercise added $2,533 million to the original book value of equity.
2. The pre-deal "market" premium over book value ($1.3 billion over post-deal book
value): Even if accountants write up the value of assets in place to fair value,
Competitor- Merger & Acquisition Fundamental’s Analysis
32
markets may still attach a premium for growth potential and future investments.
As with any market number, this number can be wrong, too high for some
companies and too low for others. Prior to the HP deal, the market was attaching a
value of $6.2 billion to Autonomy, $3,833 million higher than the original book
value of equity and $1.3 billion more than the post-deal accounting book value of
equity.
3. The acquisition premium ($5.2 billion): To justify this premium, HP would have
to had to believe that one or more of the following held:
(i) The market was undervaluing Autonomy, i.e., that the true value of Autonomy
was much higher than the $ 5.9 billion,
(ii) There are synergies between HP and Autonomy that have value, i.e., that there
are value-enhancing actions that the combined firm (HP+Autonomy) can take
that could not have been taken by the firms independently and/or
(iii) That Autonomy was badly run and that changing the way it was run could
make it more valuable, i.e., there is a control premium.
Even without the benefit of hindsight, neither undervaluation nor the control premium
seemed to fit as motives in this acquisition. The market was pricing Autonomy richly
in August 2011; the market cap of $ 5.9 billion was roughly 6 times revenues and 15
times earnings and neither number looked like a bargain.
The reaction to the deal was negative, at the time that it was done. The analysts and
experts were generally down on the deal, but more importantly, the markets voted
against the deal by pushing down HP's stock price.
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33
ROLE OF INVESTMENT BANKERS
HP paid $30.1 million in advisory fees to Perella Weinberg and Barclay’s Capital for guidance on
how much to pay for Autonomy and whether the deal made sense. So why did they not spot the
accounting manipulation or recognize that synergy would be elusive? In general, why, if
acquiring firms pay so much for "expert" advice, do so many deals go bad?
Conflicting roles: The answer can be seen in an imperfect analogy. Asking an investment
banker whether a deal makes sense is analogous to asking a plastic surgeon whether there is
anything wrong with your face. After all, if either party says “No”, they have no business to
transact and no revenues to generate. Allowing the dealmaker (the investment banker) to also
be the deal analyst (provide advice on whether the deal is a good deal) is a recipe for bad deals
and we have no shortage of those. The solution is simple in the abstract but transitioning to it
may be difficult. The deal making has to be separated from the deal analysis. Put differently,
investment bankers should do what they do best, which is to manage the mechanics of the deal,
and be paid for the service. There should be a third party, with absolutely no stake in the deal's
success or failure, whose job it is to assess the deal to see if it makes sense, with compensation
provided just for that service. Why has this common sense change not happened yet? First,
many acquiring companies want affirmation of decisions that they have already made (to
acquire), rather than good advice. Second, the same entity (say, Goldman Sachs or Morgan
Stanley) cannot slip back and forth between being a deal maker on one deal and a deal analyst
on another, since there will be a shared and collusive interest then in shirking the deal analyst
role. You would need credible entities whose primary business is valuation/appraisal and not
deal making.
The Deal Table: In many businesses, companies measure their success based upon market
share and revenues. M&A bankers are no different and their success is often measured by
where they fall in the deal table rankings. Here, for instance, is the latest deal table from
Bloomberg, listing the top bankers for M&A globally, in 2011 and 2012.
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34
Note that the rankings are based upon the dollar value of deals done, and that there are no
extra columns for good deals and bad deals. Consequently, a banker who does a $11
billion bad deal will be ranked more highly than one who does a $4 billion good deal.
There are three implications that follow.
1. When a big deal surfaces, bankers line up to be part of that deal, willing to bear
almost any cost to get involved.
2. The bigger the deal, the worse the advice you are likely to get; the conflict of
interest that we mentioned earlier gets magnified, as the deal gets larger.
3. Individual bankers will be judged on their capacity to get deals done and not on
the quality of their deal advice or valuation expertise. Thus, it is not surprising
that the biggest stars in the M&A firmament are the dealmakers.
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In fact, it is interesting that Perella Weinberg is listed as one of HP”s advisors on the
Autonomy deal. Joe Perella, co-founder of the firm has a long history in the acquisition
business that goes back almost four decades to his position as co-head of M&A at First
Boston in the 1970s. He left the firm; with the other co-hear of the First Boston M&A
team, (Bid 'em up) Bruce Wasserstein, to create Wasserstein Perella, a lead player in the
some of the biggest acquisitions of the 1980s. He returned to head M&A at Morgan
Stanley for a few years before leaving again to found Perella Weinberg. Through all the
years, it seems that the singular skill that he possesses is not his capacity to value target
companies but that he can get any deal done.
So what can we do to change this focus on deal making? We do have to begin by
changing the way we compensate bankers in deals but we also have to follow up on
deals. I would like to see some entity generate deal tables that track the largest deals from
five years ago and report how much those deals have made (or lost) for stockholders in
the acquiring firms. It would be interesting to see the list of the top 10 bankers in terms of
value creating and value destructive deals.
Compensation: The third factor that contributes to the deterioration of deal advice is
the way in which the deal advisors get compensated for their services. In most deals, the
deal advisors get paid for getting the deal done and there is no accountability for deal
performance. Neither Perella Weinberg nor Barclay’s Capital will have to return any of
the advisory fees that they received for the HP/Autonomy deal, even though the advice
that was offered was atrocious. I think that there is a solution, even within the existing
system. Rather than tie the entire fee to getting the deal done, a significant portion should
be contingent on post-merger performance. Thus, if the acquiring firm’s stock price or
profitability fails to beat the peer group’s stock price performance or profitability in the
years (two, three or five) that follow, the bankers will either not get a large portion of
their fee or be forced to return a proportion of the fees that they have already been paid.
Bankers will complain that this puts them at the mercy of macroeconomic shifts and
mismanagement of the post-merger integration, but those are variables that they should
be considering when assessing whether a deal should get done.
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In closing, though, acquiring firms are quick to blame bankers for bad advice. I think that
the ultimate blame has to lie with the top managers of the acquiring firms. No acquirer is
ever forced to do an acquisition at the wrong price and if they chose to do so, they should
be held responsible.
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Over Confident CEOs & Compliant Boards
Given the manpower, data power and model power that are brought into the acquisition
process. How can all these smart people working with sophisticated models and updated
data be so wrong so often?
The answer lies in a simple fact: in most acquisitions, the decision to acquire is made first
and the analysis follows, and all too often, the decision is not only made at the top of the
organization, but at the very, very top by the CEO. That is not the way organizations are
supposed to work. Big ideas, no matter who originates them, are supposed to be
discussed honestly and openly, analyzed fully and then vetted by an independent, well
informed board of directors to make sure that stockholder interests are being served. That
may still happen in some organizations, but consider this alternate reality. In a moment of
inspiration (insanity) or brilliance (lunacy), the CEO decides to do an acquisition of a
target firm for strategic (empire-building) reasons. The managers around him or her,
recognizing that the die has been cast, choose not to voice their opinions, get bulldozed
when they do, or decide to join the CEO in pronouncing the acquisition a great idea. An
investment banker is found to affirm that the deal is, in fact, a great deal and the rest as
they say is history.
If the acquisition process is prone to failure, as the evidence suggests that it is, there are
many potential culprits that you can blame. The investment bankers who facilitate the
deals for huge advisory fees are an easy target and the accountants/auditors who dress up
the books are a close second, but the primary culprit has to be the top management (and
particularly the CEO) of the acquiring firm. After all, once a CEO gets set on doing a
deal, he can go about picking the facilitators (the investment bankers and accountants) to
make the deal look good. As we bring behavioral finance into play, the evidence suggests
that over confident CEOs play a key role in greasing the skids for large (bad)
acquisitions. To measure confidence, Malmendier and Tate, who have a series of
interesting papers on how over confident CEOs manage, developed two measures.
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They looked at a sample of 394 large US firms and found that over confident CEOs were
65% more likely to do acquisitions than cautious CEOs, though they were also less likely
to draw on external financing; their over confidence led them to believe that the market
was underpricing their stock and thus made them more reluctant to use stock in
acquisitions. They were also more like to acquire just to diversify, and the market
reaction to their acquisitions is more negative than to acquisitions by cautious CEOs.
Can no one stop a headstrong CEO? There is a counterweight built into the system, the
board of directors, and it can act as a restraint on a CEO embarking on a value-
destructive path. Unfortunately, one common feature shared by value-destroying
acquirers is a compliant board, which shirks its responsibility to protect shareholder
interests. It is not surprising that it HP, which has had issues with corporate governance
and board oversight, was the ill-fated acquirer of Autonomy.
In summary, then, a headstrong, over confident CEO, combined with a compliant board
creates a decision making process where there are no checks on hubris and large, value
destroying actions often follow. If investors want to prevent their firms from embarking
on deals like the HP/Autonomy deal, they need to pay attention to corporate governance,
and not just at the surface level. After all, the board at HP met all the Sarbanes/Oxley
requirements for a "good" board and may even have scored high on the corporate
governance scores in 2010. The problem with corporate governance watchdogs,
legislation and scores is that they are far too focused on what the board looks like and far
too little on what it does. In my view, it matters little whether a board is small or large,
whether it is filled with luminaries or unknowns, experts or novices and whether it meets
the criteria for independence. It does matter whether the board acts as a check on the
dreams and acts of imperial CEOs.
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CREATING VALUE FROM M&A DEALS
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Go where the odds favor you
While acquisitions in the aggregate, and on average, have not been good news for
acquirers, there are some subsets of acquisitions where acquiring company stockholders
do much better.
a) Small versus Large acquisitions : Acquiring smaller companies seem to
provide much better odds of success than mergers of equals. In the graph below,
for instance, take a look at the returns to acquirers around acquisition
announcements of targets, with the targets classified based upon their size in
market cap terms, relative to the acquiring company. Markets are much more
welcoming of small deals than big ones, justifiably wary of the integration costs
and culture clashes that mergers of equal inevitably bring.
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Note that the biggest successes are with target firms that are small, with market
caps, less than 6% of the acquiring firm's market cap and returns get progressively
worse as target firm size increases.
b) Cash versus Stock : There is no consensus finding here, but looking at the
figure above, paying with stock seems to deliver higher returns for small
acquisitions, but paying with cash seems deliver better returns with larger
acquisitions. Perhaps, target company stockholders recognize the propensity of
acquiring companies to pay with "overpriced' stock and demand higher premiums.
c) Private versus Public targets : Acquirers who focus on buying privately
owned businesses rather than public companies earn much more positive returns,
mostly because they don’t have to pay premiums over a market price that already
incorporates much of what they are paying for. In fact, looking at the figure
below, the very best targets are divisions of public companies, often divested at
bargain basement prices by CEOs who want to get rid of high profile failures.
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d) Cost synergies versus growth synergies : While it is good to be skeptical
about promised synergies in acquisitions, companies seems to be much better at
delivering cost synergies than growth synergies, as evidenced in the figure below.
This phenomenon may reflect the fact that cost synergies are easier to plan for and
deliver than amorphous growth synergies.
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Do your valuation, before you make your offer and value all the "good" stuff
I believe that the biggest problem with an acquisition based strategy remains the price
paid. If you pay too much for a target company, no matter how well matched that
company may be to yours, you have a bad deal. The key to a successful acquisition
strategy then becomes doing your homework in valuing not only the target company but
all of the other goodies that you see coming with the deal, control and synergy being
foremost. It is also critical that this valuation not be outsourced to bankers or consultants.
They may be well intentioned, but it is not their money that is being spent. Here is the
three-step process for valuing an acquisition:
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Step 3:
Value
Synergy
Value the combined firm with synergy built in. This may include
a. A higher growth rate in revenues: growth synergy
b. Higher operating margins, because of economies of scale
c. Lower taxes, because of tax benefits: tax synergy
d. Lower cost of debt: financing synergy
e. Higher debt ratio because of lower risk: debt capacity
Subtract the value of the target firm (with control premium) + value of
the bidding firm (pre-acquisition). This is the value of the synergy.
Step 2:
Control
Premium
Value the company as if optimally managed. This will usually mean that
investment, financing and dividend policy will be altered:
Investment Policy: Higher returns on projects and divesting unproductive
projects.
Financing Policy: Choose a financing mix/ type that reduces your cost of
capital
Dividend Policy: Return unused cash, especially if you are punished for
it.
Value of control = Target company value with optimal management -
Status quo target company value from step 1.
Step 1:
Status Quo
Value
(Target firm)
Value the target company as is, with the existing management’s
investment, financing and dividend policy (even if it is optimal or
efficient)
Each of these steps will require estimates and forecasts, but that is true for any
investment. In fact, I would wager that many companies spend far more time making
these assessments with small capital budgeting projects than they do with multi-billion
dollar acquisitions. Managers will also claim that synergy is too qualitative and fuzzy to
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45
value, which would be fine if they were paying with qualitative dollars, but they are not.
Get a Share of the Spoils
Just because you have valued control and synergy in a merger does not mean that you
should offer to pay that amount as a premium. If you do, target company stockholders
walk away with the spoils of your “hard” work (in delivering control and synergy value)
and your stockholders get nothing. Thus, a key step in acquisition is negotiating for a fair
share of both the control and synergy values. That fair share will depend upon how
integral the acquiring company is to generating these additional values; the more
important the role of the acquirer, the greater the share of the premium it should demand.
In fact, if bankers are true deal makers, this is where they should earn their fees.
Have a plan to deliver the good stuff
While many acquirers seem to view getting the deal done as the climax of the process, it
is really the beginning of a long (and often tricky) process of integration. Good acquirers
not only have clear plans for what they will do after the acquisition but they also set aside
the resources (people, funds) to put those plans into operation. When mergers work, it is
almost never by accident. The KPMG surveys of global mergers over the years have
emphasized this planning and post-deal integration as a key component to deal success.
Hold decision makers accountable
If you want acquisitions to deliver value, you have to hold everyone in the process
accountable. I would start with the managers in the acquiring firm but I would also
include the bankers and consultants to the acquiring company. In particular, I think that
management compensation and deal fees should have clawback provisions that are
conditioned on the performance of the merged firm (in stock prices and profitability).
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Be ready to walk away
You have to be willing to walk away from a deal, if it does not make sense for you. In too
many deals, the objective for the acquiring firm becomes getting the deal done, rather
than getting a good deal done. In addition to staying disciplined, i.e., not going back and
fudging the valuation numbers to make a deal look good, there is another simple rule that
acquirers should consider following. If you get into a bidding war over a target firm, walk
away. In fact, while you may nominally be labeled the “loser” in the bidding war, it is far
better for your stockholders to be the loser rather than the winner, as evidenced by the
figure below:
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BIBLOGRAPHY
http://www.cisco.com/web/about/doing_business/corporate_development/acquisitions/
about_cisco_acquisitions.html
http://www.hp.com/hpinfo/newsroom/press/2011/111003xb.html
http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-
newsArticle&ID=1760639&highlight=
http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=AUTNF&dataset=balanceSheet&period=A¤cy=native
http://www.stern.nyu.edu/%7Eadamodar/pc/blog/HP2011annual.pdf
http://emlab.berkeley.edu/%7Eulrike/Papers/OCmergers_19_05_06_Final_Tables.pdf
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1340514
http://en.wikipedia.org/wiki/Main_Page
http://emlab.berkeley.edu
http://www.kpmg.com/global/en/pages/default.aspx
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1573395
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=385023
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1340514
www.imaa-institute.org/docs/m&a/kpmg_01_Unlocking%20Shareholder%20Value%20-
%20The%20Keys%20to%20Success.pdf
http://www.globoforce.com/gfblog/2012/6-big-mergers-that-were-killed-by-culture/
Competitor- Merger & Acquisition Fundamental’s Analysis
