M&A and Value Creation: A SWOT analysis 9788892108479, 8892108476

Table of contents :
Cover
Quartino
Index
Preface
Notes on Contributors
Chapter 1. M&A as a value creation strategy
Chapter 2. A SWOT analysis of acquisition
strategy
Chapter 3. An empirical lens-Case Studies
Appendix 1. An operative lens. Limits and opportunities for mergers based on Italian law, di Francesco Greggio
Appendix 2. Mergers & Acquisitions from an International Tax Planning perspective, di Gino Reolon
Questionnaire on M&A
Some final thoughts
References
Ultimato di stampare

Citation preview

M&A AND VALUE CREATION A SWOT analysis

Giovanna Mariani

M&A AND VALUE CREATION A SWOT analysis with contributions by Francesco Greggio and Gino Reolon

G. Giappichelli Editore

© Copyright 2017 - G. GIAPPICHELLI EDITORE - TORINO VIA PO, 21 - TEL. 011-81.53.111 - FAX: 011-81.25.100

http://www.giappichelli.it ISBN/EAN 978-88-921-0847-9

Il volume è stato oggetto di procedura di referaggio doppio cieco (double blind peer review) ad opera di tre referee, secondo il procedimento concordato con l’editore, che ne conserva la relativa documentazione.

Stampa: Stampatre s.r.l. - Torino

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V

M&A and Value Creation

Index page Preface

IX

Notes on Contributors

XI

Chapter 1

M&A as a value creation strategy 1.1. Merger&Acquisition strategy: definitions and study approaches 1.2. M&A cyclic trend 1.3. Performance, value creation and failure risk 1.3.1. Market performance 1.3.2. Accounting based analysis 1.3.3. M&A effect on failure risk

1 3 21 28 31 36

Chapter 2

A SWOT analysis of acquisition strategy 2.1. Introduction 2.2. A SWOT analysis of a successfully deal 2.2.1. Strenghts 2.2.2. Weaknesses 2.2.3. Threats and Opportunies

39 40 41 72 73

VI

M&A and Value Creation

page

Chapter 3

An empirical lens-Case Studies 3.1. Introduction 3.2. Case 1: Amplifon’s acquisition behaviour 3.2.1. Company overview 3.2.2. M&As portfolio 3.2.3. M&As strategy 3.2.4. M&As performance effects 3.2.5. Amplifon’s SWOT analysis in M&As strategy 3.3. Case 2: Autogrill’s acquisition behaviour 3.3.1. Company overview 3.3.2. M&As portfolio 3.3.3. M&As strategy 3.3.4. M&As performance effects 3.3.5. Autogrill’s SWOT analysis in M&As strategy 3.4. Case 3: Campari’s acquisition behaviour 3.4.1. Company overview 3.4.2. M&As portfolio 3.4.3. M&As strategy 3.4.4. M&As performance effects 3.4.5. Campari’s SWOT analysis in M&As strategy 3.5. Case 4: Luxottica’s acquisition behaviour 3.5.1. Company overview 3.5.2. M&As portfolio 3.5.3. M&As strategy 3.5.4. M&As performance effects 3.5.5. Luxottica’s SWOT analysis in M&As strategy 3.6. Case 5: Reply’s acquisition behaviour 3.6.1. Company overview 3.6.2. M&As portfolio 3.6.3. M&As strategy 3.6.4. M&As performance effects 3.6.5. Reply’s SWOT analysis in M&As strategy

79 81 81 82 84 84 89 91 91 92 94 94 99 101 101 101 103 104 108 109 109 110 112 112 116 118 118 119 121 121 125

Index

VII page

Appendix 1

An operative lens. Limits and opportunities for mergers based on Italian law Francesco Greggio 1. Preamble 2. The Merger Process 2.1. Evaluation stage 2.2. Information stage 2.3. Decision making stage 2.4. Final stage 3. Final observations: Limits and tax benefits associated with Mergers

127 130 131 135 136 138 138

Appendix 2 Mergers & Acquisitions from an International Tax Planning perspective Gino Reolon 1. 2. 3. 4. 5. 6.

Introduction Motives for legitimate international tax planning Main international avoidance techniques Abuse of rights in Mergers & Acquisitions operations Article 10 bis of the Taxpayer Bill of Rights Conclusion

143 144 145 147 150 151

Questionnaire on M&A

153

Some final thoughts

157

References

163

VIII

M&A and Value Creation

I would like to express my sincere appreciation to Francesco Greggio e Gino Reolon for their ongoing support to my students and for having enthusiastically welcomed this project. I would like to express my sincere thanks also to all those who have assisted me and offered their support throughout the period of writing this book, in particular Alfredo Scarfò, for his help in data collection and advices, and Elena Bruno, colleague and friend, for her active support. I am extremely grateful to the companies and my students for the interviews. A particular heartfelt gratitude goes to Maurizio and to my precious jewels, Lisa and Laura, that have endured my several moments of dismay. I would like to express my sincere thanks to my sister, Silvia, without whose full encouragement and real support this book would never have been undertaken. Also, I want to thank my mom and my father’s spirit to their unconditioned trust. Finally, I wish to thank the anonymous referees for constructive suggestions to the book.

IX

M&A and Value Creation

Preface Most literature research argues that Merger&Acquisitions (M&As) is one of the mechanisms by which companies gain access to new resources, increase revenues, efficiency and cost reducing. Many multinational companies around the world today are the result of M&A between two or more companies. Strategists argue that mergers and acquisitions main issues relate to the strategy taken by companies. However, manager’s ultimate goal, based on economic rationality, is the maximization of shareholder value. So, one expects to see companies making decisions to have increase shareholders’ wealth. In view of this, every deal should realize, positive results in terms of value, although to varying degrees and either directly or in the long term. Instead, recent studies have found a high failure rate, regardless of sector, country, or historical phase. Whereas the adverse effects that acquisition failure have on the system, academic literature, but also stakeholders and policy makers, have investigated this phenomenon, by highlighting also some irrational motivations that can push management to promote an operation, to which is added their poor planning skills. It should also be observed that, despite these failures, there are well-structured companies that promote M&A, thanks to which they have reached international size and success speedily. With these strategies, some sectors and countries’ economies have undergone far-reaching changes. In this historical phase, in which the market has contracted “time to market” of innovation development, where technological start-ups are rejuvenating the international market, the economy revolves around 4.0, the achievement of certain leadership positions necessarily moves through external growths. The market, in fact, is questioning if it is surfing the seventh wave. New emerging countries, therefore, are driving their growth mainly through M&A operations to shorten times and competitive gaps. In some sectors and for some companies, in fact, the corporate acquisitions have become part of the ordinariness of managing, preserving their extraordinary nature in relation to the complexity of the process and the vastness of the key factors. The global regulatory system and tax differential play their role both as factors of attractiveness or deterrent. The debate is again focused on the complexity of the process that must necessarily integrate all the different factors, especially among practitioners. Literature on M&A

X

M&A and Value Creation

is extensive and “cyclically” the discussion has been fuelled by new contributions. Anyway, the more debated question regarding the strategic profile of acquisitions and their contribution on the value creation process periodically claimed the interests of scholars but also entrepreneurs and policy makers. The literature on the subject, as already mentioned, is extensive and authoritative: this book fits within this debate with some peculiarities by focusing on the Strengths, Opportunities, Weaknesses and Threats of a successful deal, so that it has a real strategic value. In detail, Chapter 1 is dedicated to the introduction of the leit-motif of the book: the strategic relevance of M&A and its key factors. The analysis of their cyclic trend is developed to highlight the various strategic lens that inspired the companies in acquisition activity, according to economic, regulatory and fiscal historical dimensions. When the analysis issue is a strategic dimension, under a corporate finance perspective it behoves to focus on performance effects, and more generally on value creation process. In the first chapter, we have discussed the strategic significance of the acquisition investment. As an investment, we focused on its implication in terms of effects on performance and on failure risk. In connection with this, in the second chapter, the aim is to deepen the study of the different drivers that the acquisition team has to tune together in the complex evaluation process that a successful deal requires. Using the strategic tool, SWOT analysis, we study the different Strengths, Weaknesses, Opportunities and Threats always under the value creation perspective. Between the Strengths, a particular focus is on the evaluation process, with all the implications in terms of synergies evaluation and financial structure management. Chapter 3 opens a window on some “serial acquirers” that consider M&A the strategic base of their wealth creation mission. With the presentation of the case studies, the aim is to draw the attention on the strategic dimension of the corporate acquisition behaviour. In the Appendix 1 and 2, the debate moves to the lens of operations, with a focus on the normative and tax determinants. Appendix 1, in particular, gives a real practitioners vision on the limits and opportunities in Italian low for merger and acquisition strategies. In it, Francesco Greggio, experienced acquisition advisor, draws the attention to the merger process that the Italian Commercial Law has provided for the merger processing and its implications. In the Appendix 2, with Gino Reolon, Colonel of Guardia di Finanza (fiscal police), it is interesting to compare the strategic priority of the drivers according to a different observation angle. He highlights that merger and acquisition are operations intrinsically linked to international tax planning. However, tax planning is a determining factor for acquisition strategy success and in some transactions the fiscal implications could have managed with strong professionalism. In summary, the main objective of this book is to tune together academic and empirical perspectives, that recognize the strategic vision of the M&A as a value creation tool.

XI

M&A and Value Creation

Notes on Contributors

Francesco Greggio is partner of RQR & Partners. His field of expertise within the firm RQR & Partners concern mainly corporate taxation, taxation of groups, extraordinary corporate financial transactions and assistance concerning Vat. He also hold the position as judicial liquidator appointed by the court within arrangements before bankruptcy and he is appointed as an official receiver by the bankruptcy court in relation to the insolvency procedure. He collaborates with Corporate Finance Advanced course, at the Department of Economia and Management at the University of Pisa. Gino Reolon is a Colonel in the Guardia di Finanza (Italian Revenue Protection Force) at the Inter-Regional Headquarters in Florence. He is qualified in forensics, enrolled on the Register of Accounting Auditors, and is a Business and Economics graduate. He is a Corporate Finance expert for the post-graduate course in Banking, Corporate Finance and Financial Markets at the Department of Economia and Management at the University of Pisa. Throughout his career in the Guardia di Finanza, he has earned numerous accolades and awards in recognition of his achievements, and has gained extensive experience in Judiciary and Revenue Protection Police investigations in the financial sector.

XII

M&A and Value Creation

1

CHAPTER 1

M&A as a value creation strategy

SUMMARY: 1.1. Merger&Acquisition strategy: definitions and study approaches. – 1.2. M&A cyclic trend. – 1.3. Performance, value creation and failure risk. – 1.3.1. Market performance. – 1.3.2. Accounting based analysis. – 1.3.3. M&A effect on failure risk.

1.1. Merger&Acquisition strategy: definitions and study approaches As the history of many multinationals, or FTSE 100 companies, would attest, Merger and Acquisitions (M&As) have been the cornerstone of the growth strategy of many firms and have influenced competitive and industry dynamics globally across sectors (Hill and Jones, 2009; Lynch, 2006). The merger is defined as a combination of the assets of two (or more) previously separate companies into a new legal entity (Faulkner et al., (2012), pag. 374) and all or one ceases to exist legally. According to DePamphilis (2012), an acquisition occurs when one company takes a controlling ownership interest in another firm, a legal subsidiary business, or selected assets, such as a manufacturing facility 1. Many multinational companies today are the result of acquisitions between two or more companies (Arnold, 2013). This phenomenon was promoted directly by the market and it has been common corporate practice for more of a century. Undoubtedly, corporate acquisition is one of the more debated issues. In a vast amount of literature, researchers have made a variety of contradictory assumptions and empirical studies were unable to provide clear evidence of different aspects of M&A strategies (Krishnakumar and Seth, 2012), by highlighting an essential “multi-dimensional eterogeneity” (Zollo and Singh, 2004). 1

The differences between Merger and Acquisition are essentially under the legal perspective, especially in some European countries. In line with Conca (2010), in Italy, for example, commercial law provides two different definitions, without any complementarity. In the Anglo-Saxon system, however, merger and acquisition has the same regulations, with the same the economic perspective. In this book, the merger and acquisitions are analysed under the common acronym M&A, drawing the attention to the distinctions where it’s necessary.

2

M&A and Value Creation

After the seminal work of McKinsey (1929), in which he discussed the effects and implications of mergers, in 60 years M&A has also captured the attention of the academy study. The first studies have focused the scholars attention on the challenges of managing the acquisitions (Kitching, 1967; Mace and Montgomery, 1962), while Ansoff (1965) has launched the debate on the role of M&As as strategic moves. In the 70’s, the acquisition strategical and financial implications opened new themes in management literature, which is still debated. With the first important failures of integrations, the studies, in fact, enriched the list of critical factors with the human side management, by showing evidence that employee reactions and culture dimension could thwart the efforts of every decision-making process, especially if cross-border (Borys et al., 1989; Birkinshaw et al., 2000; Faulkner, et al., 2012). In the 1990’s, with growth in terms of the importance of European acquisition activity, the cultural dimension and the knowledge management became the critical lens to the success of the deals (Cartwright et al., 1998). In essence, with the first studies of the 60’s M&A gradually became a defined field of study and institutionalized itself, by drawing the attention of scholars, practitioners and politicians. Today, the field attracts hundreds of researchers worldwide, who remain, by and large, split as to whether the topic of M&A is to be viewed from a finance, strategy, managerial or human perspectives (Birkinshaw et al., 2000; Faulkner et al., 2012; Larsson and Finkelstein, 1999). According to Carwright et al. (2012), M&A research is more focused on specific “themes” than theory development. In their review research on articles on M&A, in the period 1963-2009, they found process management and strategy as the two major and more widely debated themes. About a third of papers focuses on M&A management matters, with more attention on integration management, human side and resource management, corporate governance, cultural issues, knowledge related perspective. More of 60% of the studies analyse the strategic perspective, with a prevalence regards on performance of M&A and the importance of an evaluation process of the deal. Corporate acquisition strategy needs an in-dept managerial decision-making to evaluate many aspects: the types of economic activities carried out by the parties and the form of operation (horizontal, vertical mergers and conglomerate); domestic and crossborder deals; the modes (friendly mergers or aggressive takeovers); the ownership and those who make decisions (managers or shareholders); the forms of financing (debt, equity, cash flows). All of these aspects, indeed, open up several debates. Some authors, for example, have highlighted the strategic influence of the method of payment (Linn and Switzer, 2000; Chatterjee and Kuenzi, 2001); others have discussed the critical role of corporate governance on the success of the deal, especially after the 90’s (Basu et al., 2009; Caprio et al., 2011; Mariani et al., 2015). In several studies, the focus is on the relation between the operations and the surrounding market. Wong and Cheng (2009), on the other hand, have reached various results for different analyzed markets, often showing important contradictory considerations. Furthemore, most research argues that cor-

M&A as a value creation strategy

3

porate acquisition is one of the mechanisms by which companies gain access to new resources through redeployment, increase revenues, efficiency and costs reduction (§ 2). Another of the discussion topics, in the Finance and Industrial Economy studies, that have arisen since the end of the 60’s, is the relationship between stock market cycles, or economic trends, and M&A activity. Nelson (1959, 1966) was the first scholar that hypotisized a relation between merger activity and share prices, and other studies show the same results (Melicher et al., 1983; Geroski, 1984; Clarke and Ioannidis, 1996; Mitchell and Mulherin, 1996; Cartwright and Schoenberg, 2006; Martynova and Renneboog, 2006). Also if the M&As have a recent history and need of an efficient financial market, they have represented an economic phenomenon of very large dimensions in the last part of the century. Thomson Reuters recorded a total of 752,000 deals around the world from 1985 to the end of 2012, demonstrating the enormous scale of this phenomenon. It is typical of the Anglo-Saxon countries which traditionally have more evolved financial markets. Over the last several decades, they have also had a significant increase also in the rest of Europe. In the last few years, this phenomenon has assumed a wordwide dimension, with Asia and Africa that have become strategic players in acquisition activity. Moreover, Gaughan (2002) and other scholars have emphasized that M&A typically occurred in cyclical patterns, merger waves: periods of intense merger activity have been followed by intervening periods of fewer mergers.

1.2. M&A cyclic trend As previously anticipated, in literature it is common knowledge that M&A activity is cyclic (merger waves) and that acquisitions reveal a positive correlation between values and S&P 500 index. Reid (1968, p. 15) define waves as “periods of time characterized by relatively large numbers of mergers reported simultaneously in many industries”, where this activity intensifies at an increasing rate and then declines rapidly. Merger and acquisition waves are periods of intense acquisition activities closed with a significant drop of the activity regressing to a pre-wave dimension (Carow et al., 2004; McNamara et al., 2008; Faulkner et al., 2012). Every wave has a specific market connotation, some warnings and a strategy, that becomes a “pressing” for every company. In a competitive market, the acquisition strategy, indeed, could become a must. Sometimes it develops into an imitative behaviour: or you buy or another company buys you! The merger waves analysis is especially observed in the USA market, historically more efficient and innovative, but the phenomenon has gradually involved worldwide companies. Traditionally, economists have described six waves, but some recent studies have discovered some signals for the seventh one (tab. 1 Waves). While the starting date of the waves could be different in various studies, there is convergence in the conclusion. The waves change direction because of important financial and historical events (Lipton, 2006).

USA, UK, EU, ASIA, AFRICA

USA, UK, EU, ASIA

USA, UK, EU, ASIA

USA, UK, EU, ASIA

USA, UK, EU

USA

USA

COUNTRIES

11.679

(1)

20.700

4.500

618

46

7.3

6.9

VALUE (in $Billion)

130.967

277.451

31.152

9617

(2) Information non available.

ND

4828

3012

NUMBER OF DEALS

(1) Value and numbers of deals in the period 2014-2016.

2014-?

7-wave

2003-2009

6-wave

1992-2000

5-wave

1980-1989

4-wave

1955-1969

3-wave

1916-1929

2-wave

1897-1904

1-wave

PERIOD

Tab. 1. – The waves

Global leaders, corporate reorganisations, international monopoly

Rebirth of leverage

International expansion, crossborder

Rentrechment era, specialization, corporate internazionalization

Conglomerate era

Vertical merger, Increasing industry concentration, to realize oligopoly

Horizontal consolidations, to realize monopoly situation

STRATEGY

Rational aims, costs cutting, new technologies, new competitive vantagies

Financial aim, globalization of Derivates Securities, private equity

Globalization, deregulation, privatization, synergies

Elimination of conglomerate structure and inefficiencies, cut-costs

Managerial interest, diversification, false apparence on the market

Economy of scale and scope

Economy of scale, drive for efficiency in production

MOTIVATIONS

Understimated targets worldwide, private equity and financial investors

Federal Reserve low interests policy, liquidity availability

IT revolution, deregulation, reduction trade barriers, trend privatization

Antitrust lower pressure, deregulation of financial market, economy prosperity, financial engineering tools

Exploiting efficiency of internal capital allocation markets, economy prosperity, CellerKafauver Act, Agency theory

Restrictive antitrust regolamentation

Lack of antitrust regolamentation, westward migration

ENVIRONMENTAL ANTECEDENTS

(2)

Subprime mortgages

Tech Bubble (2000), financial scandals (Enron, Worldcom)

RJR Nabisco failure, junk bond collapse, bank system crisis

Oil crisis, crash conglomerate stocks

Stock market crash of 1929 and Calyton Act

Fraudolent financing, crash of the equity market 1903-1905, Sherman Antitrust Act

COLLAPSE EVENTS

Cash

Stock

Stock

Cash

MODES OF PAYMENT

TLC, pharma and banking , hi-tech sector, media

Financial Services

Cash/stock

Cash

ICT, communication, internet, banks, me- Stock dia, luxury, utilities

Bank system

All sectors

Petrolium, primary metall industries, automotive

Metals, trasportation, mining and oil

INDUSTRIES

(2)

Private equity, shareholder attivism, corporate governance control

Mega-deal, global deal, corporate governance mechanisms

Leverage buy out, hostyle takeover, corporate raiders, junk bonds, bustup takeover

Leverage stress, bidder medium firm and small firms with different line of business, Bootstrap game

Creation of vertical integration of medium companies

Creation giant Firm, changes in technology, economic espansion, legislation, stock exchanges activity

SYSTEM EFFECTS

(2)

Poor returns for bidders. Some positive effects for targets

Positive effects only for target shareholders

Positive effects for targer firms. Bidder results only in related acquisition

Positive effects for targer firms. For bidder: positive effect at announcement, in long term insignificant

CAR 15% for the target but no effects for bidder sharholders

CAR 12%-18%

PERFORMANCE EFFECTS

5

M&A as a value creation strategy

5

The waves start with the reaction to operating environments, such as a new innovation, new tecnologies, commodity prices, the need to find a new competitive advantage, a particular law and fiscal system and deregulation. The acquisition propensity may be increased also in a market in recession, with the opportunity for the companies to buy underestimated targets (Granata and Chirico, 2010). In line with agency theory scholars, the deviant management behaviour is recognized as another trigger for acquisitions (Bruner, 2004). Lipton (2006) has also shown some questionable reasons for promoting an acquisition: the need to create monopoly or oligopoly positions, the conqueror obsession of the manager (corporate raiders) to have a bigger company to manage, with more private benefits. Gugler et al. (2012) gave evidence, also, that stock market booms and merger waves are both driven by increases in optimism in the financial markets. They underlined that optimism in financial markets explains the volume of assets acquired through mergers in a period. In every decision-making process it is, indeed, very important to know the environment in which the operations could evolve and the critical drivers to manage. Unlike Shughart and Tollison studies (1984), in which it is suggested that M&A could be random. Moreover, according to other recent scholars, merger waves represented periods of non-random spikes in acquisition activities (Harford, 2005, McNamara et al., 2008). Thus recent research has provided strong compelling empirical evidence supporting the common belief that acquisition occur in waves. In the context of finance, it is likely that many errors that occurred in earlier periods will reoccur. Understanding history can help the companies to identify the proximity to a new wave of M&A. It’s important, therefore, to investigate if we are riding the wave or if we risk to be swept out by the wave. DePamphilis (2012) argues that stock market rewards the companies forerunners, while pays lower prices for the target firms that come into play after. So, we have to study the preceding events to plan the deal: the first step of the corporate acquisition analysis is just the definition of the environment background, especially about the deal feasablity, the structure and financial implications.

The First Wave (1897-1904) The first wave, the Great Merger Wave, has involved essentially US companies that were driven to realize monopoly situations and to reach more efficiency, especially in the production activities. From historical analysis, there were some warnings factors in the system that fostered the acquisition propensity, such as lack of antitrust regulation and westward migration. This wave was characterized by horizontal consol-

6

M&A and Value Creation

idation to realize economies of scale, especially in capital-intensive industries, such as metals, transportation, mining and oil. There were operations essentially relied on cash-setted, with positive effects on the economic system and on performance. The Great Merger wave produced the development of giant firms, radical changes in technology, economic expansion, new legislation and evolution of industrial stock exchanges (Martynova and Renneboog, 2008). Baneerjje and Eckard (1998) have demonstrated some positive effects on performance, founding Cumulative Abnormal Returns of the 12-18% (CARs). The good trend was shocked by fraudolent financing that produced a crash of the equity market in 1903-1905. The decision of the Supreme Court to give full application of the Sherman Antitrust Act to the horizontal mergers was a real collapse event. The first wave, as anticipated, was played in the US economy. A few English companies did however promote some operations, especially in traditional industries, in order to rationalize production. They aimed at reducing costs, by implementing internal and external economies of scale to stand up to the competition of the USA (Capasso, 1990).

The Second Wave (1916-1929) The negative effects of the previous wave and the new anti-trust regulation fuelled different strategies. The companies promoted vertical mergers, with the aim of increasing industry concentration and realizing an oligopoly situation. The medium firms were the actors of the second wave. They wanted to obtain economy of scale and scope, by creating value in a vertical organization, avoiding therefore anti-trust restrictions. It was the wave of petrolium and primary metal industries, but the most important event was the development of automotive industry, such as Ford Motor Company, that was the precursor of a fully vertical integration. In contrast to the previous period, the M&As of the second wave was financed mainly with stocks. The studies about the performance effects of the acquisition activity reveal essentially positive effects for the targets, with CARs of the 15%, while bidder shareholders were unable to obtain results. The end of the wave was tragic. The stock market crash of 1929 produced dramatic defaults of big companies and the general fall of the system, with the beginning of the Great Depression. The first two waves were dominated to US companies. In the period 1920-1929, at European level, only Great Britain companies showed a weak interest for acquisition activity, mainly with the aim of horizontal consolidations (Ceddaha, 2007), favored by the antitrust regulation. English politicians have traditionally left companies to get on

M&A as a value creation strategy

7

with merging and acquiring unhindered. In the same period, fascist concentration policy encouraged the larger Italian companies to promote some first acquisitions. After the 1929 collapse, some industrial groups bought underevaluated small firms in default with the support of IRI 2, that created the system of governament partecipation.

The Third Wave (1955-1969) The third wave was promoted by an economy prosperity in USA. European companies begin to play a strategic role in the worldwide M&A activity. To contrast antitrust laws, with the Celler-Kafauver Act, and the general legal constraints that obstruct the concentration, the medium companies moved the attention to conglomeration acquisition strategy (Rumelt et al., 1994; Weston Weaver, 2001). With the development of public companies and the growth of the corporate capitalism in the USA, a process of separation of ownership and control occurred. The exploiting efficiency of internal capital allocation markets and management self-interest gave a great boost to acquisitions (Scherer, 1986). The manager, buying medium and small firms, with different lines of business, realized a large growth in the market, involving all industries. According to modern portfolio theory, the aim of the bidder is to satisfy the portfolio diversification, to reduce specific risk. The manager recognizes that to conglomerate acquisition could be a real wealth creation for shareholders, who are handing over power to management. The corporate acquisition complexity requires high professionalization, so the managers become indispensable to the company (Shleifer and Vishny, 1989). The manager, on the other hand, began to see acquisition as a driver for gaining private benefits (Jensen, 1986; Tosi et al., 2000). So they promoted M&As also with false appearance of economic gains (bootstrape game, § 4). These produced progressive increasing of target prices, so to finance the acquisitions there was an increasing leverage of the conglomerates. After a few years, when the companies stop mergers and expansions, earnings per share will decrease and the stock price along with it. This result, with the excessive leverage, has triggered the market collapse of 1969. The economic effects of this wave are contradictory. Some scholars (Hubbard and Palia, 1999) higlighted positive CARs for bidders, recognizing the benefit of diversification. Other evidence has shown positive effects for targets only and with an insignificant long term profitability for the bidders (Ravenscraft et al., 1987). Shleifer and Vishny (1989), indeed, show a positive effect at announcement for the bidders, but insignificant in the long term. 2 IRI,

the Institute for Industrial Reconstruction, set up in 1933 and closed in 2000, was a holding company that regulated public industries and banking.

8

M&A and Value Creation

With the collapse of the system a lot of conglomerations revisited the core business, selling the previously acquired targets, declaring the failure of diversification policy. The stock collapse and the oil crisis of 1973 forced the market to develop more caution, especially in managing leverage and in corporate governance. The main European continental countries, Germany and France, come into play only after the Second World War. For these countries, the real first M&A wave was in the late 60’s. The European propensity activity was promoted by an important external growth both obtaining a consolidation position in domestic markets and reaching a critical mass for international competitiveness. Regarding Great Bretain, the English government has played an active role first in post-war reconstruction and then for industrial restructuring (IRC) 3. Anyway, because of weak anti-trust regulation the conglomerate acquisitions in Great Britain were less popular compared to USA trend. The poor performances of these operations and the Monopolies and Merger Commission restrictive policies against horizontal concentrations, have provoked acquisition strategy changes (Capasso, 1990). In Italy, as in France, there was less acquisition activity as the result of the dampening impact of domestic factors. In Italy, in particular, some important market conditions and political strings attached should be mentioned. The first most important brake to M&As activity, in this historical period, was the low development of the Italian stock market, mostly due to a significant State interference. In 1965, Italian law has been modified by reducing taxation on corporate acquisitions. The Italian State interference in the capital of the companies, both in direct way and through banks or state bodies, imposed a political reason in acquisition strategy. This market distortion has hindered the development of competitive dynamics of Italian companies and the birth of a real market for corporate control. The few transactions took place off-exchange, without any speculative activity. So this wave didn’t have the impact like in the US market.

The Fourth Wave (1980-1989) This wave is characterized by the introduction of a lot of innovations for the system, especially of financial tools (high yield bonds). The negative performance of the previous wave gave the start to hostile takeovers of the 80’s (Fray et al., 1985), with a new skill, the corporate raiders and the birth of investment banks (Lipton, 2006). The M&As frenzy involved larger companies, both as bidders and targets, in the same line of industries, with a specialization strategy. It is the wave of the mega-mergers (fig. 1). 3 Industrial

Reorganization Corporation (IRC) had an active role in M&A in GB.

9

M&A as a value creation strategy

Fig. 1. – Worldwide M&A trend in the period 1985-2016 N° DEALS

VALUE 10.000

50.000

48.086 46.575

9.000

42.655

41.895

41.222

46.434

40.314

8.000

42.313 40.000

41.288 36.204 34.356

7.000

31.630

28.135

39.779

36.819

35.000

33.152

31.720

6.000

45.000

42.220

25.926

30.000

30.251 27.456

5.000

25.000

21.806

4.000 3.000 2.000 1.000

11.646 10.134 7.442

15.000 4.214 4.053

5.279 4.229 2.675

2.815 1.831 1.223 1.043 347 435 506 777 758 541 398 402 518 705

4.961 4.071

2.859 2.094 2.104 1.419 1.318

4.847 3.490 2.564 2.396 2.542 2.393 2.198

3.098

3.446

10.000 5.000 0

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0

20.000

18.135 15.428 15.901 15.652

VALUE

N°DEALS

The aim of elimination of conglomerate structures and inefficiencies gave impulse to specialization strategy: in the groups more “deadwoods” were disinvested (Baghat et al., 1990). The companies promoted more international expansion to widen new markets: the multinational corporate is the further competitive phenomenon (Smith, 1991). The companies look for the new market share in wealthy and fast-growing countries, especially to cut costs by outsourcing production to low-wage economies. The US companies acquire targets in Europe, Canada and in Asia, but for the first time foreign bidders promoted more takovers of american companies. The crossborder activities explodes. Together with the hostile takeover, the 80’s christend two other new aggressive phenomena: the Leverage Buy Out (LBO) and Bustup takeover. With the need to eliminate conglomerate structure inefficiences, some conglomerates began to divest unrelated acquisitions made in 1980 (Bustup takeover-Ravenscraft et al., 1987). The LBO model introduced the opportunity to acquire a company mainly through borrowing, with the target’s cash flow as collateral used to secure and repay the borrowed money. LBO produced a more strategical role of the bank system. With the support of the banks, managers power increased with the opportunity of MBO (management buy out). In this wave, the cash financing prevailed.

10

M&A and Value Creation

In the Reagan era, because of the financial market deregulation, the bank system introduced a lot of new financial tools to finance the acquisitions, which financial investors welcomed. Another innovation of this wave, infact, was the birth of financial investors and fringe players with an essential speculative and aggessive aim (Stearns and Allan, 1996). With some LBO failures (RJR Nabisco), the merger activity tapered off in line with an economic slowdown. The junk bonds real nature emerged and the bank system was invaded by a general lack of confidence, with new regulatory acts. As regard economic effects, in this period there are light and shadow in the studies, with controversial findings. The studies of Morck et al. (1990) show the bidders good results only in related acquisitions, while Healy et al. (1992) found general positive effects for target firms only. The reports of the European Commission reflect an increased percentage of M&As among enterprises from different member states of the EEC and also the fact that, at the end of the 80’s, many European firms were acquired by foreign firms, especially American (European Commission, 1999). According to the European Commission (1996), if during the period 1985-1987 the value of mergers and acquisitions that involved the European companies accounted for 20% of the world total, the share rose to 43% in the period 1991-1993. The European stock market was still relatively small, without excesses of speculation. In Europe, the majority of the share capital is under the control of a few shareholders, so the stock market will negotiate exclusively minority blocks. The bidder companies continue to be bigger than the targets. The high yields, as a main source of M&A financing, did not find any interest in European acquisitions. European companies have promoted operations under an industrial vision. Even European companies have focused on their core business, with lateral or horizontal integration and geographic diversification. Especially the EU has prompted firms to find new competitive advantages especially abroad (Capasso, 1990). In the second half of the 80’s, the development of mergers and acquisitions reached the dimension of a real process for Italian company development. Some special conditions of the Italian financial and industrial system were responsible for the delay of a corporate acquisition strategy development. The restricted liquidity of the companies, due over-indebtedness accumulated during the period of rapid development of the 60’s and worsened by underfunding problems of the crisis of the 70’s, which was an important brake for acquisition activity in Italy (fig. 2). The underdeveloped Italian stock market, with the traditional Italian entrepreneurs aversion to open the shareholder base, have slowed mergers financed by exchange of

11

M&A as a value creation strategy

shares. Another important braking element, especially for foreign investors, was the power of the unions of the 70’s. Italian unions hindered the downsizing processes but also employment restructuring making the processes of concentration difficult. Fig. 2 – M&A trend in Italy in the period 1985-2016 N° DEALS

VALUE 300

1000 920

250

900

788

800

730 691

200

652

641

700

648

597

613

605

583

150

524

555 454

416 417

496

457 467

557

459 329 340

385

100

600

543

540

400

381

148

200 56

39

31

26

28

34

20

55

197 50

129 95 29

57

49

68

50

28

25

VALUE

100

2014 2015 2016

2010 2011 2012 2013

2007 2008 2009

2003 2004 2005 2006

1999 2000 2001 2002

17

300

0 1995 1996 1997 1998

12

10

25

16

1991 1992 1993 1994

21

8

1987 1988 1989 1990

1985 1986

0

100

144

129

279

50

500

N°DEALS

The rapid growth of the operations of the 80’s, infact, was facilitated by a trade union party more favorable to flexibility and mobility of labor. Violent acts of terrorism contributed to hold back acquisition development. By the end of the 80’s Italian firms discover the strategical value of acquisition. They promoted horizontal concentration by realizing economies of scale and scope. The bigger companies focused the activity in the same industries, by obtaining synergies in the production, marketing and logistic (Bianchi et al., 1988). SMEs acquired other competitors in the same market. The small companies aim was to expand competition to fill market niches that are not attractive to the biggers. According to typical Italian corporate governance structure, in this period the transactions were carried out negotiated between the parties and carried out through packages off-exchange. Despite the US trend, in Italy there weren’t hostile deals, because of the rigid Italian legislative system. In this period, the Italian companies discovered cross-border operations especially in food, pharmaceuticals and financial services.

12

M&A and Value Creation

The Fifth Wave (1992-2000) The continue deregulation, technology innovation, internet development and the market integration rivitalize the acquisiton market after the 80’s collapse. In the fifth wave, corporate acquisition activity reaches volumes and numbers unprecedented in the history of M&A, reaching seven time the volume and tripling the numbers of the previous wave, especially involving ICT, communication, media, internet and bank industries. It is the wave of the global deals and the megadeal: seven of the ten major deals of the M&A history are developed in this period. In this wave, the acquisitions are promoted by strategic aims, to realize synergies. However, some research have revealed that some deals were promoted also by CEO narcissism (Zhu and Chen, 2015). The hostile takeover leaves the market to related acquisitions; prevailed equity financing, so the bidders gave the preference to finance transactions with stocks. This was the first truly global wave and it has presented the same features, in the U.S., Europe and Asia (fig. 3). The merger activity is more global, with an important role of the european companies and especially with cross-border operations, which are more complex, riskier, with difficulties of managing integration. European companies play a more international strategy, while the USA are looking more forward the domestic market (Ceddaha, 2007; Gregoriou and Renneboog, 2007; Gouali, 2009). Fig. 3 – M&A trend in different countries VALUE

5.000 4.500 4.000 3.500 3.000 2.500 2.000 1.500 1.000 500 0

Americas

Asia

Africa/Middle East

Europe

Japan

Other Countries

M&A as a value creation strategy

13

This wave has an important new innovation, a new entry, a trend reversal: large companies in emerging countries that promote acquisitions of firms of advanced countries (Morresi and Pezzi, 2014). The great acquisition propensity of this period, the market excitement for the new dot.com, for the new economy, unleashed a targets overpayment. This situation has been detained by the Internet bubble burst. Despite the introduction of corporate governance mechanisms, including independent directors on the boards and monitoring systems, the fifth wave closed with devastating financial scandals (Enrom, Worldcom) and the destruction of all the value realized in the period. The tragedy of 11th of September declared the closing of this period of buoyant economic growth. The studies on performance implications of M&A of the fifth merger reveal positive effects for target firms, while for the bidding companies the operation were unable to create wealth for the shareholders, especially for difficulties of managing the integration (Martynova et al., 2008). The fifth merger wave also took hold in Europe and in 1999 the number of European transactions exceeded the acquisition record of USA. Asia was part of the large number of M&A transactions since 1998. According to a European Commission report (1996), in the period 1990-1995, more than 70% of all transactions in the EU-15 were national ones, a level that was approximately the same as in the period 1986-1990. Countries such as Germany, Spain and Italy have recorded above all domestic transactions. Smaller countries, such as Austria and Ireland, have been involved in several cross-border transactions. According to data from the European Commission, in this period we deduce that Britain was the most active country, followed by Germany, France, Holland and Italy. Thus, during this wave, an analysis of sectorial distribution of M&A operations in Europe reveals, among other things, that the activity was concentrated mainly in certain sectors: business services, real estate, financial intermediation, wholesale trade, basic metal products, foodstuffs and tobacco. Global economy went into recession and the year 2001 marked the end of this first international wave. The revolution of the global economic system has produced big changes in the competitive structure of different industries, by giving impulse also to acquisition activity in Italy, in the 90’s. This was the real first wave for Italian companies, with big deals in the bank system and in communication sector (Banca Intesa, TelecomOlivetti). Acquisition of minority holding were the major kind of concentration, with the growth of 145%, in 1999. Companies of the food, textile, transport, communication and utilities ware able to quadruple the deals, in the period 1992-1995, with a boom above all in ITC, banks, utilities and publishing (KPMG, 2001). They promoted hori-

14

M&A and Value Creation

zontal strategy, with production integration more than concentration (Sicca and Napolitano, 2001). In this period, international activity of Italian companies increases, becoming the most active in Europe in the acquisitions of US targets, with the big deals in 1999 (Fiat, Luxottica). With the crisis of 2000, the Italian acquisition activity encountered an initial setback.

The Sixth Wave (2003-2008) This is the wave of the rehabilitation of financial tools, the period of the globalization of the derivatives securities and securities collateralised by debt packages and loan obligations with high risk. The attentention of the companies is on financial tools; the leverage increases in the financial structures. Federal Reserve promoted a low interest rates policy, favoring an overoptimistic expectation in the market and by increasing the consumer credit and home loans. Especially in the US financial market, LBO transactions increase and the private investors play a fundamental role in particular for start-ups, but also for the development strategies. This historical period is remembered also for shareholders activism to control management hubris better (Billet and Qian, 2008). The corporate governance quality, in fact, is one of the drivers in wealth creation for the shareholders, so the bidder promoted deals with an high synergies value. The acquisition activity involved especially companies in luxury, utilities and financial sectors. Alexandridis et al. (2012) prove in their analysis that premiums paid during this wave are significantly lower than those paid in the past. Acquisition are motivated by more rational aims. However, acquirers still destroyed at least as much value for their shareholders as during the fifth merger wave. The deals are predominantly cash financed and the overall amount of equity used to finance the acquisitions decreases. The sixth wave came to an end as a result of several factors. First, the upturn of long-term interest rates made the credit conditions unsustainable. This situation has favoured the collapse of subprime mortgages market, giving an important stoppage to the bank system that answered with a credit crunch policy. In consequence, the credit market for private equity leveraged financing has encountered an initial setback. The situation was made worse by the escalation of oil prices in 2007-2008, triggering the worldwide financial crisis in 2008-2009 and the concomitant slump in acquisition transactions, particularly those that were highly leveraged. Also because of the terrorism escalation, international acquisition activity has suffered a setback. The sixth wave is also remembered for a poor returns to acquirers and only for target shareholders were showed some positive effects. This is the wave that comes at a time of increased merger activity across Europe.

M&A as a value creation strategy

15

After few years of calm, in fact, M&A activity in the European Union resumed its upward trend, since 2004, the year in which EU economy has gained a significant share in the global M&A market. At the European level, the euro, globalization, technological innovation, deregulation and privatization, low interest rates (Campa and Moschieri, 2008), the financial markets boom (Sherman and Hart, 2006; Ceddaha, 2007; DePamphilis, 2010) and existing liquidity (Alexandritis et al., 2010) have spurred M&A activity. Following the introduction of the euro, the downtrend of cross-border transactions between EMU countries in the total transactions ended. Fligstein and Merand (2002) believe that European firms have focused mainly towards operations in Europe and that the Single Market and the euro have favored the “Europeanization” of firms. Thus, European companies saw M&A as a way to survive the fierce competition that has increased due to the creation of the single market. The euro has put more pressure on businesses and eliminated all currency risks in the European countries. In this period, M&A activity increased, particularly in the EU-15 countries (France, UK, Germany, Italy, Portugal, Spain, Netherlands, Ireland, Denmark, Luxembourg, Greece, Belgium, Austria, Finland and Sweden). However, there was an increase in the number and value of transactions recorded in the new EU member states (Poland, Czech Republic, Cyprus, Lithuania, Latvia, Slovenia, Estonia, Slovakia, Hungary, Malta, Bulgaria and Romania). In this wave, the EU economy, which has the largest share across Europe, recorded values of sales and purchases in cross-border M&A transactions in excess of those recorded by the U.S. and Japan. European countries, especially those from the European Union, represented attractive targets of cross-border M&As. This wave of mergers and acquisitions was relatively short, but intense. In 2005, the value of European mergers and acquisitions topped $1 trillion for the first time since the days of the dot.com bubble, with nearly half of the money going on cross-border deals. The boom intensified during the first months of 2006. When the economic and financial crisis, which began in 2007, restricted firms’ access to credit, the acquisition propensity ended quickly. Thus, if the United States M&A market started to decline since 2007, in Europe, 2008 saw the decline as the recession began to include the economies of many countries. Unlike the US market, in the period 2001-2005, in Italian M&A activity a negative trend takes over, with a decline of 40%, compared to the previous period. However, the year after, the transactions increased by 21%. This wave in Italy was promoted essentially by banks, utilities, furniture, telecommunication and commerce companies. It was just a flash in the pan. Acquisition activity is on track to decline (– 52% in

16

M&A and Value Creation

2009 vs. 2008). Anyway, this crisis introduced uncertainty about the future trend of demand and, in addition, the bank locked themselves up in a credit crunch, with tragic effect for the businesses. This situation has questioned the acquisition strategies, with a collapse of deals. At the same time, in this buoyant period some sound enterprises were attracted to buy understimated targets in difficulties (Capaldo et al., 2009; Melwani and Rehm, 2010). Financial crisis, which began in 2008, continued to have its impact on M&A activity in subsequent years (Netter et al., 2010), but unlike the previous waves, the acquisition activity post 2009 is steady, without the collapse observed previous economic downturns. In fact, in 2008, with a positive change of the stock index, the values have increased, while in times of market downturn the values were equally negative, if not in a more accentuated way. Only in 2009-2010, despite the positive changes of the S&P 500 index, M&As signed a contraction, as a symptom of minor investor confidence compared to the first signs of recovery from the subprime crisis (KPMG, 2013; Wan and Yiu, 2009; Cartwright and Schoenberg, 2006). In the 2010, then, the global M&A activity increased, especially in emerging markets. In 2012 M&A transactions decreased, by reaching their minimum level (Zephyr, 2013). Compared to 2007, in which 78,715 transactions were registered for a total value of more than 5,600 billion $, in this year the number of deals decreased by 17.3% (65,060 deals) and the total value of transactions decreased by 44%, contracting to 3,100 billion $. These are the lowest levels since 2004. M&A activity declined in North America and Europe, historical players, but also in the new entry countries, in East and Central Asia. The values have dropped so much because of the lack of confidence and a low risk attitude that characterized M&A markets in 2012. If there is no need to sell, in this situation companies prefer to keep their assets, waiting for more favorable conditions. We can also observe that, in this period of crisis, there is a great opportunity for companies that have liquidity. These companies may have advantages over their competitors by purchasing underestimated targets (Granata and Chirico, 2010). 2013 confirms the critical situation of the previous year, with a total of value of 2,044 billion $, but a little contraction of the number of operations (– 4%).

The Seventh Wave (2014 and ?) For the global acquisition activity, 2014 is a very interesting year. Optimism seems to be returning in the market. Global merger and acquisition activity hit $3.5 trillion, which is up 47% from the year before, by reaching the largest volume of transactions

M&A as a value creation strategy

17

since 2007. This result is for few, but big deals: the overall number of global M&A transactions, indeed, only rose by 6% (Thomson Reuters, 2015). What is observed is that the business environment after the 2008 crisis, characterized by risk aversion and a focus on organic growth by firms, is dissipating. Companies are beginning to understand that this volatile world is the new habitat. In such an environment, it may not be possible to rely only an organic growth, costs cutting, to deliver consistent financial results. Managers seem, to once again, believe that it is easier to buy growth rather than build it. After the market scandals and disasters of the previous period, the corporate governance improvements introduced from Sarbanes-Oxley Act in the second half of 2002 are refined. Some scholars, by analysing the effect of the quality of corporate governance of the bidder on the M&As, have revealed a negative correlation with the offer premium (Starks and Wei, 2004; Wang and Xie, 2009). After celebrating the long expected turnabout in M&A activity in 2014, the US market confirmed a positive trend in 2015, by posting the best results since the outbreak of the financial crisis. No fewer than 10,286 completed deals, worth $1,691 billion, grew 31% in terms of value on the previous year (M&A completed, target or bidder). 2015 performance was not too far from the all-time high posted in 2000, when the US M&A market had generated $ 1,902 billion with 11,258 completed deals (KPMG, 2015). M&A activity in 2015 is promoted by some positive strategic challenges in the economic system. Companies are increasingly pursuing growth strategies through acquisitions; the consolidation processes among TLC, pharma and banking sector players are still ongoing; there is huge capital availability from private equity funds and financial investors; acquisitions driven by the need to acquire new technologies are fueling the acquisition propensity. The US and Asian companies are the players of this period. Ten of the year’s 15 largest acquisitions were for American bidders, where volume increased by 51.4% of the total volume. It is the year dominated by mega-deals (no fewer than 37 transactions worth more than $10 billion were completed in 2015). With the consolidation of American acquisition activity and the growth in Asia Pacific, the market remembers 2015 as the year that saw the actual recovery of the global M&A market, whose performance de facto absorbed the losses incurred after the sub-prime crisis. A particularly significant acquisition activity is also recorded in Asia Pacific, which grew more than 50% in terms of value of 2014, reaching a new all-time high of $ 872 billion. This region was boosted most of all by China, whose M&A activity rose 80% on the previous year, reaching a new record value of more than $ 370 billion and becoming the second top contributor to the global M&A market after the United States. AsiaPacific reach the record high, with $716 billion of volume. In the seventh wave, Asia and Africa have become strategic players in acquisition activity.

18

M&A and Value Creation

In Europe, 2014 starts with an uncertain macro-economic scenario, characterized by deflationary trends and still limited access to credit, the geopolitical tensions played a major role (from the uncertainties related to the Greek economy, to the embargo against Russia). Europe M&A maintained its leading position in the global market in terms of volumes (38% of completed deals), but their impact on global values dropped from 29% in the previous year to 24%). 2015 is a great year also for European M&A activity increasing by 55%, especially for French deals, while Germany was on the flipside (– 21.6%). The market volatility at the beginning of 2016, the expectations for a possible rise in interest rates and the impacts of Brexit, require operators to be more cautious and could lead to a slowdown in M&A activity for the future (KPMG, Report 2015). Infact, in the first quarter of 2016, deals, slightly lower than those closed in the same period of the previous year, were completed, with volumes down 19%. In 2016, there is a consolidation in the banking sector, while a large number of transactions are promoted in the insurance market. In this period, the Italian M&A activity shows a market under observation, as result of both the structural credit crunch and the continuing macroeconomic challenges facing Italy and Europe, which are producing profound structural and business changes. However, the entrance of sovereign wealth funds and financial investors have given great impetus to transactions. In this scenario, the Italian mergers and acquisitions market has performed well, reaching in volume 49.9 billion Euro from 30.9 billion Euro recorded in 2013 (+ 60%) and with a sharp increase in volumes (543 transactions compared to 381 of the previous year). In terms of values M&A activity reduced by 24%. After the break due to the sovereign debt crisis, there was a return of interest in foreign investors for the Italian assets: 201 deals were completed in 2014 (almost twice the value of the previous year) for 26.6 billion Euro (about 40% of the total market, a trend in line with the 43% registered in 2013). Among the Top Ten deals in terms of value, seven are foreign acquisitions of Italian companies (Rottapharm, Indesit Company). American investors have again begun to look at Italy with an interest in carrying out M&A activities. Important Italian companies, such as Indesit (Whirlpool) and Poltrona Frau (Haworth), in the 2014 came under American control. Another important Italian companies buyer is China (CDP Reti, ENI, Enel, Telecom, FCA Fiat Chrysler, Mediobanca and Saipem). There were also 249 domestic deals, amounting to about 10 billion Euro in 2014. The consolidation process among Italian companies is still late in blooming, particularly in the services sector. The insurance sector was affected by the significant integration process involving primary Italian players (Fondiaria Sai and Unipol Assicurazioni, Premafin Finanziaria and Compagnia di Assicurazione di Milano for 2.7 billion Euro). For Italian acquisition activity the 2015 is a pivotal year with 583 completed deals (+ 7% on 2014) and €56.4 billion of total value of (+ 13% on the previous year), by

M&A as a value creation strategy

19

resuming the same result achieved in 2008, the first year of the crisis. Italian M&A market in 2015 has many mergers of significant value, which were not so much (or not only) the result of corporate scope redefinition, but most of all have the clear strategic intent of creating global leaders in the relevant sectors (IGT Plc, YOOX Net-A-Porter Group, LivaNova Plc and Alperia SpA). The acquisition activity has an high strategic profile, with corporate reorganisations promoted by leading Italian groups (Exor, Enel, Finmeccanica, Generali Assicurazioni, ENI, etc.). The aim is the focusing of their businesses and the sale of non-core assets, to strengthen and expand their activities (KPMG, 2015). The basic pillar for M&A activity in Italy is cross-border transactions with a renewed confidence of international investors in the domestic market and, on the other, the willingness of Italian players to expand their range of action beyond national borders. In 2015, M&A cross-border activity reaches 75% of all the Italian market in terms of value. Specifically, foreign investments in Italy were worth an all-time high (€32.1 billion), with the United States and China firmly at the top of the list of bidding countries. Financial operators, Italian and international private equity funds, as well as sovereign wealth funds, revealed a real new interest for investments in Italian assets (first of all, infrastructure and luxury companies) and in the large reorganization processes launched in the financial services sector (Istituto Centrale delle Banche Popolari Italiane SpA). The first nine months of 2016 are apparently alligned to the trend of the previous year. Despite the still sluggish economic recovery and the financial markets volatily, the buoyant activity of the first months of the year and the confirmed interest of foreign operators (financial investors and private equity funds for Italian targets) are grounds for cautious optimism on the favourable moment that the Italian M&A market has been enjoying since the end of 2013. The Italian M&A market of the 2016 was also moved by the deals generated by private equity funds which were still pending. There are important deals in different industries of the Italian economic system (Deloitte, 2016). In the consumer markets sector, for example, Davide Campari-Milano SpA shows a high acquisition propensity. The industrial markets sector companies, HeidelbergCement AG and Italmobiliare SpA (Pesenti family) closed the agreement for the sale of Italmobiliare’s investment in Italcementi SpA. The Energy & Utilities companies promoted acquisitions to complete the consolidation and efficiency improvement process started from 2000 onwards. Telecommunications media & technology sectors are living a real state of turmoil, with some critical takeovers (Vivendi SA and Mediaset SpA). Largest of a notable number of transactions involved companies operating in the pharmaceutical and health sectors, with an active role of Italian bidder (Chiesi Farmaceutici SpA, Sorin Group SpA, Recordati Group). The Italian market’s positive performance was mainly impacted by foreign investments, which, with a new all-time high of € 32 billion, con-

20

M&A and Value Creation

tributed to more than half of the total value. Also in 2016, China joined the United States at the top of the list of the countries most interested in acquiring Italian companies, while further confirming its role of global investor looking for opportunities abroad. Among the top ten deals in terms of value, five of them were completed by foreign investors, which identified interesting brands and know-how in Italy’s production system. Clear examples of these are China National Chemical Corporation’s tender offer for Pirelli, Vivendi’s acquisitions of stakes in Telecom Italia (which enabled it to become its largest shareholder) and the sale of Italcementi to the German group HeidelbergCement (which is still underway). Conversely, Italian acquisitions abroad were less dynamic: while there was a slight increase in volumes (97 deals), values stood at slightly over € 10 billion. As analysed above for the European dimension, also for the Italian M&A activity, the positive forecasts for the end of 2016 and for the next year, should be revised. In the light of the significant volatility of the financial markets, impacted by the slowdown of BRIC countries (foremost, China), the effects of Brexit and the strong uncertainties related to the UK leaving the European Union. The postponement of already planned listings and the development of large British private equity funds’ activities will also affect the M&A scenario. In the conclusion of this M&A waves snapshot, the question is: Is the M&A market surfing the 7th wave? In tab. 1, we have developed the different connotations of the various waves; so we can match the characteristics of the acquisition activity in the period 2014-2016 to demonstrate, or not, if the market is experiencing a real wave. Any way, we can discuss only on the top of the wave, without forecasts on when and how the trend will change direction. As analysed above, every wave has to react to some environment conjectures. Above all, as expressed in tab. 1 every wave has some strategical antecedents. We can observe that the post-crisis of 2007 has, infact, fertilized a humus for a new increase in transactions. Considerable interest has been aroused by some important private equity funds, financial investors and sovereign wealth funds to buy understimated worldwide targets resulting in a corporate scope redefinition. There is huge capital availability from private equity funds and financial investors; acquisitions driven by the need to acquire new technologies are fueling the acquisition propensity. Regarding the strategic motivations, in fact, after 2007, the companies have the need to look for new technology and they have the occasion to branch off in all different directions at a global level. The aim is always to reduce costs, reach new competitive advantages, gain monopoly at international level, but most of all to have the clear strategic intent of creating global leaders in the relevant sectors, avoiding any antitrust

M&A as a value creation strategy

21

restrictions (banks, ITC). In this period, acquisition activity has an high strategic profile, with corporate reorganisations promoted by leading international groups. Companies are increasingly pursuing growth strategies through acquisitions; the consolidation processes among consumer market, especially for TLC, pharma and banking firms. Also in Italy, the aim is the focusing of the businesses and the sale of non-core assets, to strengthen and expand their activities. With the arrival of Africa as a new player, M&A has more and more a worldwide dimension. The global dimension is also about industries involved in M&As activity, with the lively contribution of ITC, financial and insurance services, communication, pharma. At the moment, the shares were sold partly in cash and partly with a share exchange. Naturally the consideration about collapse events and performance effects belong to the future. According to Bauer and Matzler (2014), there is strong evidence that a new M&A wave has already started. The global M&A market is now under observation to capture the first warning signals of rapid change of direction, when the M&As will decline rapidly. Only then, it will clear if this M&A can be considered a wave, the seventh wave.

1.3. Perfomance, value creation and failure risk As in the previous parts highlighted above, scholars, but also practitioners and politicians, are still debating if acquisition strategies could be considered one of the main ways of corporate growth (Teece et al., 1997; DePamphilis, 2012). Management must endeavour every occasion of maximixing value: so the question is if the acquisition could be a value creation strategy (Seth, 1990; Copeland et al., 1990; Guatri, 1994). Acquisitions of companies and branches are therefore important instruments of development by improving significantly the competitiveness and profitability. An acquisition can help a bidder to take positions on the market rapidly, especially on the international market and to guarantee the possibility for realizing all the potential benefits from activities integration (Keil and Laamanen, 2011). The external growth operations, therefore, can pursue the goal of value creation within the companies involved. On the other hand, Marks and Mirvis (2010) define acquisition as the most rapid strategy of growth, but also more expensive. In the last decades, scholars have debated on M&A performance, but above all on the relationship between acquisitions and value creation.

22

M&A and Value Creation

Numerous studies have been conducted with analytical tools and different performance indicators regarding various kinds of operations, in diverse institutional contexts and historical periods (Schoenberg, 2006). Papadakis and Thanos (2012) found that the first paper measuring M&A performance appeared in 80’s, showing that interest in M&A performance is relatively young in the management area, as opposed to the finance scholars that have published influential papers on M&A performance since the early 1950s. The surveys have investigated M&A effects on accounting and market performance; competition force and growth (Healy et al., 1992; Guest et al., 2010; Sirower and O’Byrne, 1998; Kwoka and Pollitt, 2010); on innovative performance and productivity (Ahuja and Katila, 2001). The debate is intricate: empirical researches have led to contradictory results and many scholars make a critical analysis of different methodologies (Capasso and Meglio, 2007; Guest et al., 2010; Kumar, 2009; Shukla and Gekara, 2010; Uddin and Boateng, 2009). In this respect, it should not come as a surprise that over the recent years, the results from the study of M&A are in dispute, be it with regard to what M&A performance is and how it is measured (Meglio and Risberg, 2011; Very, 2011; Zollo and Meier, 2008), how M&A perform (King et al., 2004), or the antecedents of M&A performance (Haleblian et al., 2009). Meglio and Risberg (2011), by defining M&A performance as “something out there to capture: scholars only need to find the best way to do so”, give an idea of state of this debate. Given these considerations, from the beginning of the current century, many papers explored this heterogeneous world of M&A. They focused on the different characteristics of the operations to highlight which may be the crucial aspects that lead to a better performance post-merger. What all the bibliometric kind of papers agree is that Corporate Acquisition is a complex and heterogeneous phenomenon under many aspects, i.e. such as the industrial sectors of the merging firms, and so the kind of M&A operation (vertical, horizontal and conglomerate), the modes, the ownership and the forms of financing (Mariani et al., 2015). Martynova et al. (2006), for example, focalize on testing some kinds of those hypothetical determinants, such as the chosen method of payment; the atmosphere of the deal; the liquidity of the acquirer; the industry; the relative size of the target and the distinction between domestic and cross-border deals. Some other authors concentrated on methods of payment (Linn and Switzer 2000; Chatterjee and Kuenzi, 2001), others on the acquiring firms’ ownership structure (Basu et al., 2009; Caprio and Croci, 2011). Others again show a relation between the operation and the surrounding market (Wong and Cheng, 2009, Crancinckx and Huyghebaert, 2011), by reaching various results that change by the analysed market, often showing some contradictory statements from the study of different markets.

M&A as a value creation strategy

23

In the M&A bibliometric research engaged by Cartwright et al. (2012), 3 different themes are identified among the M&A performance papers: strategy, management and finance. They highlight, however, that quantitative analysis is often preferred to qualitative one. In addition, they found a general propensity of the scholars to prefer the traditional tools, like the linear regression and the event history study, such as the examination of the dynamics of chosen proxies for firms performance. On the other hand, we may find in Healy et al. (1992) and Sirower and O’Bryne (1998), the milestones of the structured studies, shared methodology for capturing M&A performance. They proposed the examination of cash flows and measures such as the Economic Value Added or the Cash Flow Return on Investments. An important part of literature has underlined the need to analyse, other potentially relevant dimensions of firm performance, non financial, and other important additional qualitative factors driving acquisitions: cost-synergies, economies of scale and scope, productivity increase, overhead reduction, headcount reduction, cost savings, revenue-synergies, customer retention, new customers acquisition, productivity rate, employees’ satisfaction, resources, knowledge transfer at R&D unit, new products, new patents, managerial skills and systems transfer and critical financial choices (King et al., 2004; Laabs and Schiereck, 2010; Kwoka and Pollitt, 2010). By the examination of the existing literature, basically, the study of over-all and operational performance can be distinguished (Meglio and Risberg, 2011) in two different and recurring domains of study: a Financial domain and a non-Financial one (fig. 4). A summary of findings from latest major empirical studies and their relevant features about the performance of M&A deals is displayed in table 2.

Schoenberg, 2006

CARs

segue

Managers’ assessments, He showed no significant correlation between divestment data and the performance data generated by the alterexpert informants’ native market metrics. assessments

Positive relationship between the M&A and the operating performance. Essentially, the deals create value for the target shareholders. CARs 3 days

Operating Margins misurati dal rapporto tra cash flow e fatturato

Andrade et al., 2001

Negative long-run performance following mergers, though performance is non-negative (and perhaps even positive) following tender offers. The negative correlation is stronger for stockfinanced acquisitions.

Positive correlation between the present value of the five-year excess shareholder return and the capitalized future value of the EVA-based measure of operating performance.

Strong positive relation between post-merger increases in operating cash flows and abnormal returns at merger announcements.

FINDINGS

Pre-tax cash flow return

CARs long-time perspective

CARs short-time perspective

Event Study

NON-FINANCIAL

Linn et al., 2000

Indices

MARKET BASED

The results indicate that the change in performance of the merged firms is significantly larger for cases in which the acquiring company offered cash as compared to stock offers. The results are not sensitive to whether the combination involved a tender offer or a negotiated merger, to offer size, industry relatedness between the bidder’s and the target’s businesses or bidder leverage.

Agrawal et al., 2000

EVA, Cash Flow Return on Investment

Sirower and O’Byrne 1998

Other indices

Operating Cash Flows

Profitability Ratios

ACCOUNTING BASED

Healy et al., 1992

AUTHORS

Tab. 2. – M&A and performance

5

Cash flow divided by sales

segue

Organizational slack, number and dimension of the M&A

ROA, ROE, Debt/Equity

Number of acquisitions are positively correlates with performance, whereas size of acquisitions has a negative correlation. As for slack, it has a positive correlation with performance. They found general support that corporate acquisitions are positively related to firm performance during an environmental jolt, but the same relationship before and after a jolt is negative.

Basu et al., 2009

Wan Yiu, 2009

The authors provide evidence of a significant positive relationship between abnormal returns for the bidder, with a particular focus on an important driver, the family ownership dimension of the acquirer. Family ownership, change in family ownership.

Family firms destroy value when they acquire. Firms with large boards and more insiders are more likely to acquire and to create value when they do acquire.

CARs over a two-day event window

Founding family presence and larger boards with more inside directors

CARs long-time perspective

CARs 3 days

The authors, by studing 50 mergers in the UK from 1989 to 2002, agreed that target shareholders have realized more gains than acquiring firms’ shareholders over a three-day period surrounding the announcement.

None of the takeover characteristics (such as means of payment, geographical scope, and industryrelatedness) explain the post-acquisition operating performance. The authors find an economically significant difference in the long-term performance of hostile versus friendly takeovers, and of tender offers versus negotiated deals: the performance deteriorates following hostile bids and tender offers.

Wong et al., 2009

Tobin’s Q

Pre-acquisition leverage and cash holdings of the acquirer

Method of payment: cash versus equity; Deal atmosphere: friendly versus hostile takeovers; Industry relatedness: focus versus diversification strategy; Relative size of the target

The authors have found that the announcement of a forthcoming acquisition is considered good news for the bidder shareholders, but not for the target shareholders. In addition, they confirm the hypothesis that the abnormal return for the shareholders of bidding firms during the post-announcement period depends on the type of acquisition.

Bauguess et al., 2008

Arnold and Parker, 2007

Martynova et al., 2006

EBITDA, EBITDA minus changes in working capital, EBITDA/BOOK VALUE, EBITDA/ SALES

CARs BHARs

ROA, ROS, ROI, ROE ROCE.

Papadakis et al., 2012

Rossi, 2012

CARs

Market growth rate of sales, capitalization, liquid asset, leverage, Market-to-book tangible asset value

ROA

Caprio et al., 2011

Sales, profits, Operating cash flows

CARs

CARs long-time perspective

Abnormal operating performance

ROA adjusted for industry effects, ROS

Profits, Sales

Craninckx et al., 2011

Papadakis et al., 2010

Gugler et al., 2010

Results indicate that when acquirers and targets are listed, lower M&A announcement returns are consistently and significantly associated with higher M&A failure probabilities and long-term losses.

Accounting-based measures are positively correlated to managers’ subjective assessments. Contrarily, cumulative abnormal returns are not correlated to either accounting-based measures or managers’ subjective assessments.

segue

The deals of all sectors in Italy, during the period 1994-2006, have registered a statistically significant value creation for the shareholders of both the bidder and target companies, values also confirmed by combined analysis. For the banks, however, he found negative values for bidder companies and positive values for target companies. In the 36 months following the merger, the portfolios showed a significant destruction of value.

The main aim is to review the use of accountingbased measures of merger and acquisition (M&A) performance.

Ownership is negatively correlated with the probability of launching a takeover bid, and family firms are less likely to make acquisitions, especially when the family don't have the conAmount of voting rights trol. Family control reduces the probability of held by largest ultimate being acquired. No evidence that family-controlowner. Family control. led firms destroy wealth when they acquire other companies. Ownership and family control, while being negatively correlated with M&A activity, are not negatively correlated with growth in firm size.

Target divestment

Managers subjective assessments

Abnormal returns and the ex-post profitability of mergers are positively and significantly correlated for merging firms. This results is particularly true when using long pre-announcement event windows. They give empirical evidence that the event study methodology might be useful for the ex-ante competitive analysis of mergers.

Kyriazopoulos et al., 2015

Grigorieva et al., 2015

Net income, profit margins

Arvanitis et al., 2015

EBITDA/BV assets, EBITDA/sales, (EBITDA-ΔWC)/ BVassets, (EBITDAΔWC)/sales, Economic Profit (Return on capital employed-WACC) x Capital employed of the year before)

Investment expenditures, sales, sales of innovative products per employee. Value added per employee

ROA, ROE

R&D expenses as percentage of operating expenses

ROI

Srivastava et al., 2014

Mariani et al., 2015 Tobin’s Q

CARs 3 days

CARs

Method of payment, business similarity and type of geographical expansion (cross-border versus local deals)

Number of employees

Accounting performance measures work as well as economic profit measure in assessing the effects of M&A deals on company performance. Both types of performance indicators demonstrate the deterioration in performance of combined firms after M&A deals.

Positive abnormal returns for targets are existent. This finding is particularly supported by the 3-day cumulative abnormal returns around the announcement date. However, excess returns gradually vanish after the announcement date supporting the efficient market hypothesis.

The study found positive statistically significant performance effects arising from M&As for three of five critical performance indicators utilized. Furthermore, the evidence suggests that growth is a principal motive for external mergers, while efficiency is more influential on internal mergers.

The results indicate no statistically significant difference in the mean values of all the measures except R&D expenses as percentage of operating expenses for the acquirer Indian firms before and after the M&A event. The mean values of abnormal returns were less than those before the M&A activity.

The authors find that UK companies are more active in acquisition activity but that activity does not produce generally positive effects on accounting (ROI) and market (Tobin Q) performance. The acquisition strategies of Italian companies show a predominance of a neutral effect on performance.

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M&A and Value Creation

About financial domain, scholars have developed the analysis under two types of measures: market and accounting performance. 1.3.1. Market performance Market performance is inspired essentially to shareholder perspective, measuring returns based on share value. The shareholder return measurement through an event study methodology seems to be the most popular research approach, underpinning a majority of the studies by economists and finance scholars (Andrade et al., 2001; King et al., 2004; McNamara et al., 2008; Tuch and O’Sullivan, 2007). This approach is based on capital market efficiency theory, which assumes that current stock prices reflect future earnings potential (Duso et al., 2010). The studies with the aim of measuring performance of financial domain are inspired by two different analysis techniques. 1. A group of research focus on future dynamics of the companies, with predictive models based on the analysis of abnormal returns of stock prices. 2. Some studies analyses, indeed, how, historically, the operation has impacted on market performance of the companies involved in the transactions. Frequently, these indicators complete with some accounting measures, to examine the acquisition effects on two different views. Undoubtedly, the event study technique is the approach used most in the analysis of M&A market effects. Generaly, in the event study research the analysis is only on the evaluation of Cumulative Abnormal Returns (CARs), attributable to the event (announcement) being studied by adjusting for the return that stems from the price fluctuation of the market as a whole 4. In a financial market with an high efficiency, the assumption is that stock prices are able to represent the value of future profits (Gugler et al., 2010). The announcement of a merger between two or more companies, infact, can be analysed to see whether investors believe the merger will create or destroy value. In this assumption, the scholars promote a short-time perspective (Cranincks et al., 2011). However, Agrawal and Jaffe (2000) have discussed a first group of event study research with a long-term perspective. 4 CAR

(Cumulative Abnormal Returns) used as market performance indicator (Masulis et al., 2007), obtained, as the differences between a single stock or portfolio’s performance and the expected return over a set period of time. Usually a broad index, such as the S&P 500 or a national index like the Nikkei 225, or FTSE-All Share Italy, is used as a benchmark to determine the expected return.

M&A as a value creation strategy

29

As regards the event study methodology there are some open questions. The first is about the event window. In literature, there is no consensus on what should be the right length of the event window (McWilliams et al., 1997). Some scholars (Markides and Ittner, 1994; Anand and Delios, 2002) have adopted multiple windows, with examples including two-days and 11-days (Haleblian and Finkelstein, 1999; Walters et al., 2007; Gubbi et al., 2010). In other research, the event window is longer, reaching 21 days (Seth et al., 2002; Capron and Pistre, 2002; McNamara et al., 2008; Aybar and Ficici, 2009). Anyway, in literature the studies on Cumulative Abnormal Returns of the mergers have produced contradictory results: some that have shown positive correlation between a deal and performance and others where the transactions have produced a negative impact, o insignificant effects. Regarding the studies with negative results, Agrawal et al. (2000) have revealed negative long-run performance following mergers, though performance is nonnegative (and perhaps even positive) following tender offers. The negative correlation is stronger for stock-financed acquisitions. In contrast, others research has found positive evidence, still in term of abnormal return. Andrade et al. (2001) have developed a first overview of M&A operations in different US markets, in 1973-1998. They have observed abnormal returns in the 3 days before the announcement. The scholars have revealed a positive abnormal return for the bidders (+ 1.8%) and an increasing of 16% of the targets stocks value. The abnormal return for the targets grew more than 23% if the observation period before the announcement increases of 20 days. The authors have highlighted a success of the deal, essentially for the targets shareholders. Also some additional more recent research has found positive evidence in terms of abnormal return, introducing other performance drivers. Basu et al. (2009), for example, provide evidence of a significant positive relationship between abnormal returns for the bidder, with a particular focus on an important driver, the family ownership dimension of the acquirer. Wong et al. (2009), have found that the announcement of a forthcoming acquisition is considered good news for the bidder shareholders, but not regarded as good news for the shareholders of the target firms. In addition, they confirm the hypothesis that the abnormal return for the shareholders of bidding firms during the postannouncement period depends on the type of acquisition. Duso et al. (2010), show that abnormal returns and the ex-post profitability of mergers are positively and significantly correlated for merging firms. This results is particularly true when using long pre-announcement event windows. They give empirical evidence that the event study methodology might be useful for the ex-ante competitive analysis of mergers. Other scholars have revealed contradictory results. Rossi (2012) investigated the mergers value for shareholders in both the short and long term. The short-term analy-

30

M&A and Value Creation

sis was conducted in order to estimate the cumulative abnormal returns (CARs) in the time window around the announcement date (– 10, + 10). The results are singular. The deals of all sectors in Italy, during the period 1994-2006, have registered a statistically significant value creation for the shareholders of both the bidder and target companies, values also confirmed by combined analysis. For the banks, however, he found negative values for bidder companies and positive values for target companies. Negative values also seem to be confirmed by the results of the combined analysis both at the date of announcement and throughout the entire period of observation. For the longterm analysis, the Buy and Hold Abnormal Returns (BHARs) methodology was used, with which it was possible to observe the returns for three years. In the 36 months following the merger, the portfolios showed a significant destruction of value. Sinthetically, a large part of event studies suggest, in fact, that are target firms’ shareholders to obtain significant positive return because of the large premiums often paid for acquisitions (Sudarsanam and Mahate, 2006; Markides and Oyon, 1998). Arnold and Parker (2007) by studing 50 mergers in the UK from 1989 to 2002, agreed that target firms’shareholders have realized more gains than acquiring firms’ shareholders over a three-day period surrounding the announcement. In contrast, Schoenberg (2006) in his analysis showed no significant correlation between the performance data generated by the alternative market metrics. Always in relation to market performance, a large part of papers have promoted the Tobin’s Q ratio 5, as measure able to capture the market expectations on the deal. An improvement in this index can mean a good reception of the operation in the market, while a decreasing expresses negative expectations. Evidence is provided about the relationship between a firm’s decision to make acquisitions and Tobin’s Q (Holly and Longbottom, 1988). More recent scholars highlight that Tobin’s Q could be a real proxy of growth opportunities (Jensen, 2005; Moeller et al., 2005; Bauguess and Stegemoller, 2008). In the group of market based measures, some scholars have introduced other parameters, the market multiples, typical indexes of enterprises evaluation, such as Price/Earning (P/E), Price/Ebit, Price/Ebitda. They are mixed performance measures. They have a real market measure (Price) as numerator, while an accounting based measure is the denominator (Earning, Ebit, Ebitda). In market based measures, some research has proposed market capitalization, market to book value (Caprio et al., 2010), price index, total return index, enterprice- value and Buy and Hold Abnormal Returns (BHARs).

5 The Tobin’s Q ratio is a ratio devised by James Tobin of Yale University, who hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs.

M&A as a value creation strategy

31

1.3.2. Accounting based analysis With the accounting based analysis changes the evaluation perspective. Accounting research tries to evaluate post-merger operating performance by defining the profitability and efficiency changes in the combined entity following mergers or acquisitions, comparing the performance of the two entities separately. Typically, these studies examine operating margins and Return On Assets (ROA) over one, two or three years after the merger. Scholars adopting these types of measures usually compare the average post-M&A returns of the acquiring, or the combined firms, with the weighted pre-M&A average returns of the target and acquiring firm. To obtain further robust results, they also adjust for industry returns by subtracting from the above calculation the mean average industry profitability and exclude from the analyses the year of the deal (Ramaswamy, 1997). The use of accounting-based measures, as a proxy for M&A performance, has two main advantages. First, they measure actual performance as reported in the annual financial statements and not investors’ expectations for the future (as short-term measures of M&A performance do-Grant et al. 1988). Secondly, the relevant literature holds that potential synergies from an M&A are best depicted in long-term accounting-based ratios, such as ROA (Return On Assets), ROE (Return On Equity), etc. (Hitt et al., 1998). Following this line of argument, it would seem that the best way to evaluate potential synergies is to use accounting-based measures (Papadakis and Thanos, 2012). A series of accounting ratios has been employed by M&A researchers, the most popular of which is undoubtedly the ROA (Barkema and Schijven, 2008; Desai et al., 2005; Zollo and Singh, 2004; Hitt et al., 1998; Ramaswamy, 1997; Krishnan et al., 1997; Weber, 1996; Harrison et al., 1991; Kusewitt, 1985). Other scholars used ROE to express accounting measures (Kroll et al., 1990; Fowler and Schmidt, 1989, 1988), while few authors have added also ROI, ROCE (Singh et al., 2012, Papadakis et al., 2012; Grigorieva et al., 2015), identified more expressively to evaluate the development of post-merger company efficiency. There are only a few empirical studies that examine the performance using the concept of economic profit and employing such measures as economic value added (EVA) and residual income (Sirower, 1998; Yook, 2004; Kan and Ohno, 2012; Singh et al., 2012; Leepsa and Mishra, 2013). Starting out with the idea that acquisition effects analysis needs of a long-term vision, a large part of literature has completed accounting studies introducing a dynamic perspective, by measuring increase in sales, earnings and assets (Stahl and Voigt 2008; Morosini et al., 1998). In the accounting analysis, in addition, the authors can measure the performance matching the company cash flow with industry benchmarks 6. 6A

quarter of the companies of sample studied by Healy et al. (1992) shows operating cash flows cas decreasing in post-merger transaction.

32

M&A and Value Creation

The seminal work of Healy et al. (1992), by discussing on the low significance of the event studies, unable to distinguish if the increasing of the stock prices are due to a real acquisition value creation or only the inefficiency and market distortions, promote measuring M&A with the operative cash flow. Operative cash flows are company data influenced only by operative structure and industry. Studies where authors used performance measures based on cash flow (such as operating cash flow to the total market value of a firm, or the book value of a firm, or sales) usually suggest improved company performance following acquisitions (Healy et al., 1992; Switzer, 1996; Manson et al., 1994; Sirower, 1998; Powell and Stark 2005; Devos et al., 2009). While other studies, that use profitability based measures (return on assets or return on equity), indicate that mergers perform as well as relevant benchmarks, or merged companies experience have a significant decline in margins (Yeh and Hoshino, 2002; Sharma and Ho, 2002; Tsung-Ming and Hoshino, 2000). Sirower et al. (1998) develop the analysis by observing EVA and Cash Flow Return on Investment. The initial returns are highly correlated with long-term stock returns. Positive correlation between the present value of the five-year excess shareholder return and the capitalized future value of EVA-based measure of operating performance were highlighted. Linn et al. (2000) have observed pre-tax cash flow return. The results indicate that the change in performance of the merged firms is significantly larger for cases in which the acquiring company offered cash as compared to stock offers. The results are not sensitive to whether the combination involved a tender offer or a negotiated merger, to offer size, industry relatedness between the bidder’s and the target’s businesses or bidder leverage. Papadakis et al. (2012) elaborated a study by observing ROA, ROS, ROI, ROE ROCE, sales, profits and operating cash flows. The main aim of this chapter is to review the use of accounting-based measures of merger and acquisition performance. They suggests that accounting rules may distort performance measurement and lead to a negative assessment of mergers. The diverse results are also due to differences in national environments, accounting standards, sample size, sample period and statistical methodology (Sudarsanam, 2003; Bruner, 2004). Accounting studies are criticized for their shortcomings in guiding shareholder wealth maximization (Yook, 2004). In summary, also the few studies focused on operating performance of acquiring firms, thus far, in other countries, have reported mixed results, with findings ranging from slightly positive to significantly negative impact on operating performance of bidders, following mergers. As mentioned above, an important part of literature has develop analysis on M&A performance using both market and accounting based parameters. In light of this mix perspective, some research has revealed strong positive relations between post-

M&A as a value creation strategy

33

merger increases in operative cash flows and abnormal stock returns at merger announcements (Healy et al., 1992). Andrade et al. (2001) have focused on the evaluation on operating margins, by finding a positive relation between cash flows and sales. They show evidence of improved operating performance following mergers, relative to industry peers. The deals create value only for the target shareholders. Kyriazopoulos et al. (2015), analysing various accounting indexes (ROA, ROE net income, profit margins) and Abnormal Cumulative Returns, have highlighted positive abnormal returns for targets. This finding is particularly supported by the 3-day CARs around the announcement date. However, excess returns gradually vanish after the announcement date supporting the efficient market hypothesis. More recent studies have enriched the M&A performance analysis, market and accounting based, with non financial drivers (fig. 4). Schoenberg (2006) has studied the CARs with Managers’ assessments, divestment data and expert informants’ assessments. While they showed a positive relationship between managers’ and expert informants’ subjective assessments, no significant correlation was found between the performance data generated by the alternative metrics. Ex-ante capital market reactions to an acquisition announcement exhibited little relation to corporate managers’ ex-post assessment. Martynova et al. (2006), in the analysis of post-acquisition operating performance mixed a lot of financial and non financial parameters (EBITDA, EBITDA minus changes in working capital, EBITDA/BOOK VALUE, EBITDA/SALES, preacquisition leverage and cash holdings of the acquirer, method of payment, deal atmosphere, industry relatedness, relative size of the target). They have found that none of the takeover characteristics (such as means of payment, geographical scope, and industry-relatedness) have relevance. Still, they showed an economically significant difference in the long-term performance of hostile versus friendly takeovers and of tender offers versus negotiated deals: the performance deteriorates following hostile bids and tender offers. Wan and Yiu (2009) have observed ROA, ROE, Debt/Equity, Cash flow/sales with some qualitiative parameters (organizational slack, number and dimension of the M&A). The number of acquisitions positively correlates with performance, whereas size of acquisitions has a negative correlation. As for slack, it has a positive correlation with performance. They found general support that corporate acquisitions are positively related to firm performance during an environmental jolt, but the same relationship before and after a jolt is negative in comparison. Bauguess et al. (2008) have studied Tobin’s Q with founding family presence and larger boards with more inside directors. Family firms destroy value when they acquire; whit large boards and more insiders they are more likely to acquire and to create value.

34

M&A and Value Creation

Papadakis et al. (2010) have observed ROA adjusted for industry effects, ROS, CARs and managers subjective assessments. They found that accounting-based measures are positively correlated to managers’ subjective assessments. Contrarily, abnormal returns are not correlated to either accounting-based measures or managers’ subjective assessments. Caprio et al. (2011) extend the analysis to different markets, by measuring accounting and non financial performance measures (ROA, growth rate of sales, liquid asset, leverage, tangible asset, market capitalization, market-to-book value, Cars, voting rights held by largest ultimate owner, family control). The authors discovered that ownership is negatively correlated with the probability of launching a takeover bid. Family control reduces the probability of being acquired by an unrelated party. There is no evidence that family-controlled firms destroy wealth when they acquire other companies. Ownership and family control express a negative correlation with M&A activity and not with the growth in firm size. Craninckx et al. (2011) have studied operating performance, CARs and target divestment. Results indicate that when acquirers and targets are listed, lower M&A announcement returns are consistently and significantly associated with higher M&A failure probabilities and long-term losses. In contrast, when targets are privately held, they find no evidence of such an association. Mariani et al. (2015) analyze the relation between different M&A strategies and performance in terms of ROI and Tobin Q. The study is based on the evidence stemming from the sample of listed on Milan Stock Exchange companies, benchmarked with the sample of UK listed companies, that are traditionally considered to be more active in the financial market. The authors find that UK companies are more active in acquisition activity but that activity does not produce generally positive effects on accounting (ROI) and market (Tobin Q) performance. The acquisition strategies of Italian companies show a predominance of a neutral effect on performance. Srivastava et al. (2014) have observed Abnormal Cumulative Returns with the R&D expenses value, as a percentage of operating expenses. The results indicate no statistically significant difference in the mean values of all the measures except R&D expenses for the acquirer Indian firms before and after the M&A event. The mean values of abnormal returns were less than those before the M&A activity. Arvanitis et al. (2015) focus on different parameters, value added per employee, investment expenditures, sales, sales of innovative products per employee, number of employees. The study found positive statistically significant performance effects arising from M&As for three out of five critical performance indicators utilized (sales, value added per employee e sales of innovative products). Furthermore, the evidence suggests that growth efficiency is more influential on internal mergers. Grigorieva et al. (2015) have developed a research with few accountig measures (EBITDA/BV assets, EBITDA/sales, (EBITDA-ΔWC)/BVassets, (EBITDA – ΔWC)/sales, Economic Profit × (Return on capital employed – WACC) × Capital employed of

M&A as a value creation strategy

35

the year before) and other acquisition factors (method of payment, business similarity and type of geographical expansion, cross-border versus local deals). Accounting performance measures work as well as economic profit measures in assessing the effects of M&A deals on company performance. Both types of performance indicators demonstrate the deterioration in performance of combined firms after M&A deals. As observed above, extensive literature on post-merger performance reveals light and shadow: in some studies are highlighted gains and negative or no gains in others. Overall, there is evidence of limited consensus on post-M&A performance improvements (Healy et al., 1992; Meglio and Risberg, 2011; Papadakis and Thanos, 2010; Schoenberg, 2006; Tuch and O’Sullivan, 2007). Regarding this, Sharma and Ho (2002) assert that the inconsistency in prior studies might be attributable to different measures used to capture changes in operative performance. Accounting studies are criticized for their shortcomings in guiding shareholder wealth maximization and for the bookkeeping manipulations (Yook, 2004). Grigorieva et al. (2015) observed that the common used book value measures (ROA, ROE, EBITDA margins, OCF to market value of assets, among others) are unable to assess the impact of M&As on company value. According to Penman, (2003), infact, these parameters ignore the cost of capital. So, a company can earn a high accounting rate of return, but it may reduce shareholder value because its return on equity may be lower than a shareholder’s required rate of return or opportunity costs. Additional limitations are related to the firms level, thus they do not capture the effects of isolated events such as acquisitions (Larsson and Finkelstein, 1999; Capron, 1999; Bruton et al., 1994; Datta, 1991). Accounting tools cannot be used in crossborders, interfirm or intra industry comparison of studies of M&A performance because of the different accounting standards and rules followed by firms (Tuch and O’Sullivan, 2007; Hitt et al., 1998; Montgomery and Thomas, 1988). These shortcomings require other tools to assess value creation. M&As are longterm strategies so the evaluation of the effects has to analyse long period data, of at least five years. Some authors propose the concept of economic profit to solve the deficiencies of traditional accounting measures (Yook, 2004; Guest et al., 2010; Sirower and O’Byrne, 1998). To sum up, therefore, despite extensive research in this area over the last three decades, the evidence suggests that post-merger performance tends to fall short of expectations both in terms of real operating performance and of stock market value. However, the evidence across all of this research is at best mixed and at times conflicting. These mixed findings may be attributed to two factors: differing definitions of the construct “post-merger performance” and the wide variety of methodologies used to measure it. Different scholars have observed that research on M&A and performance focused on specific aspects avoiding a real theory development (Trautwein, 1990; Sinatra and Dubini, 1994; Greenwood et al., 1994; Carwright et al., 2012).

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M&A and Value Creation

1.3.3. M&A effect on failure risk In the previous parts, we have analysed the lively literature that discussed the M&A strategy as the main way for firms to grow and to create value (Bigelli and Mengoli 1999; Healy et al., 1992; Heron and Lie, 2002). On the other hand, M&A operations require, in every kind of company, high investments in order to create value. Some scholars have observed that acquisitions may generate high integration costs, by producing negative effects in terms of uncertainty and risk (Datta et al., 1992; Sitkin et al., 1996; Cartwright and Schoenberg, 2006), further compounded in the case of an environmental jolt (Wan and Yiu, 2009; Park and Mezias, 2005). Furthermore, deals could expose the acquiring company to higher economic and financial risks, due to the request of debt financing to fund the deal. High investments and high debts could produce a failure risk increase. In this regard, there are considerable observations on the unsuccessful outcome of many transactions and they note the failure rates of between 60 and 80% (Marks and Mirvis, 2001). King et al. (2004), with a meta-analysis of 93 studies, with data on 206,910 acquisitions, also revealed that the post-acquisition performance of acquiring firms fails. Christensen et al. (2011) even speak of failure rates between of 70 and 90 percent. Cartwright and Schoenberg (2006) has developed an examination of the returns of acquiring firm shareholders revealing that acquisitions continue to produce negative effects on value creation, with a critical impact in terms of risk. The failure rates of mergers and acquisitions have remained consistently high. Cross-border mergers, particularly, are often expensive and time-consuming due to a growing number of countries requiring pre-merger filing requirements (Berchicci et al., 2012). In the cross-border operations, in fact, the difficulties could be generated by underestimation of the necessary investment and time to achieve the objectives. Gomes et al. (2011) added that business formulas not always repeatable in different contexts, with diverse business cultures could produce the failure of integration. According to DePamphilis (2012), there are 3 causes to explain M&A failure: overpaying often due to overstimating synergies, the slow pace of postmerger integration and a flawed strategy. Regarding these considerations, in the analysis of the first M&A effects some attention should be devoted also to the first warning signs of decline, to plan and evaluate the appropriate actions to solve the difficulties before they end up in default. Predicting the probability of failure or survival of firms is an important problem in this kind of investment for all the stakeholders, especially for investors, banks and politicians. Standard bankruptcy prediction models focus on accounting data and financial ratio analysis. They are based on the assumption of management inefficiency that, together with random events, often lead to a systematic deterioration of a firm’s financial and operational performance and, ultimately, to its failure (Scott, 1981). Several crisis forecasting models range from the use of classic comparative financial

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analysis, with the use of ratios and the application of more sophisticated methods. For example, econometric procedures, that are able to highlight the variables in more detail by classifying the companies concerned and determining the correct coefficient (Altman, 1977, 2000, 2002; Altman and Hotchkiss, 2006; Beaver, 1966, 1968; Friedman, 1994). In addition, data on the stock market evaluation of public firms has proved helpful information in bankruptcy prediction. Summarizing the empirical literature, Altman (1994) found that ratios of solvency, liquidity, profitability and leverage tend to serve as the most important indicators of impending bankruptcy. The most popular prediction tool is Altman’s Z Score, widespread in theory and practice. It predicts the probability that a firm will go into bankruptcy in two years and it is used to predict corporate defaults (Altman, 1968). Some scholars have discussed the importance of measuring the probability of failure in the specific situation of acquisition of firms in financial distress (Åstebro and Winter, 2012), but the number of empirical studies is limited. In the next parts (§3), with some case studies the relevance of measure probability of failure will be deepened. In M&A studies, regarding the performance perspective the debate was and is very lively, due to the fact that for a strategy its performance effects are a must and also for the contradictory results of empirical research. Anyway, an acquisition team has to manage all the evaluation process with the focus on economic-financial implications; so the strengths, but especially the weaknessess and the threats must be identified and kept in check to avoid destroying the value. In the following chapter, the focus is on the different key factors that the acquisition team has to coordinate together for a successful deal.

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Fig. 4. – M&A Perfomance domain Risk (eg, Z-Score, Leverage, Jensen’s Alpha, Beta) Market performance

PERFORMANCE DOMAIN

Financial drivers Accounting performance

Market value (eg, CARs, BHARs, Tobin’s Q, market multiples, Enterprice Value, Market to book value, Price Index, Total Return Index) Profitability (eg. ROA, ROI, ROE, Ebitda, Ebit) Growth (eg, Sales Assets, employess) Value (EVA, cash flow)

Marketing (eg, Market share) Operational performance

Structure (n. employees, manager’s assessment)

Non-Financial drivers Success (eg, Attainment of M&A goals) Overall performance Survival (eg, Divestiture)

Source: Adaptation by Meglio and Risberg, (2011).

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CHAPTER 2

A SWOT analysis of acquisition strategy

SUMMARY: 2.1. Introduction. – 2.2. A SWOT analysis of a successfully deal. – 2.2.1. Strenghts. – 2.2.2. Weaknesses. – 2.2.3. Threats and Opportunies.

2.1. Introduction In the first chapter, we have observed that 2016’s acquisition activities might indicate that the market has crested the seventh wave, with a worldwide dimension. This type of heated pace once again poses the issue, as already discussed, about the real wealth creation of M&A strategies. According to Sudarsanam (2012), managers ability to create value depends on the robustness of the acquisition strategy, moved by rational motives. If the strategy is somehow flawed, management implementation ultimately erodes shareholder value. Some scholars have pointed out that sometimes managers formulate acquisition strategy with imperfect knowledge and so, when they occasionally encounter obstacles in the way of implementation, they are unable to manage them. They often are motivated by considerations that are not necessarily rational relative to desired ends and their strategic decisions frequently misstate shareholder value. Also, the communication to stakeholders of the rationale for the deal is ineffective. Thus these misstantements translate into an overstimation of the synergies and the estimation of a good return on investment, with a mispricing of the deal. As discussed in Fiorentino and Garzella (2014-2015), in M&A the management has to control the several M&A process stages, the synergies valuation with a careful attention on the synergies management pitfalls during the integration. An effective consolidation requires a thorough assessment of the goal, societal, competitive and regulatory contexts in which the deal occurs. From a strategy perspective, the ultimate aim should be to ensure that the decision to acquire and the choice of target are consistent with the acquiring firm’s long-term goals and perspectives. In addition, time is crucial, such as if the market is in a M&A wave peak and the economic cycle characteristics. Winning and creating value in this environment may require a detailed plan action to help companies to transact strategic deals and prevent the mis-

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takes, by identifying the different weaknesses and threats rather than glorify the strengths and opportunities.

2.2. A SWOT analysis of a successfully deal As debated above, there is clear empirical evidence that there is not one single success factor, but rather the interdependencies of several constructs that determine deal success. This pertains to management, organizational, cultural, social, human resources, political and geographical factors (Beaulieu et al., 2005; Bertrand and Betschinger, 2012; Clark and Mills, 2013). After having defined the deal motivation, the management has to determine an acquisition’s optimal structure for the successful deal. Structuring a corporate acquisition, including its form and types of consideration, dependes upon several factors, that have analysed the impact nuture, what could have a positive impact, strengths, or weaknesses, that could turn the deal into a failure. A company’s executive team members should assess the organization’s strengths, weaknesses and opportunities for growth, both in revenue and value. The aim of SWOT is exactly to identify for a company the internal strengths and weaknesses that are relevant in meeting external opportunities and threats, in particular situations, such as M&A investment (Humphrey, 2005). In this situation, we exploit the SWOT analysis approach to emphasize the strengths, weaknesses, opportunities and threats, which have, or may have, an impact on the success of a deal. This is paramount to guide the decision-making process. Therefore, regarding this research perspective, the owner process has to rely on some internal pillars of strength that management must develop for the acquisition success. In synthesis, we focus the attention on some activities and/or company characteristics that could contribute the success or, if unevaluated, they could represent a critical mistake (Hassan and Ghauri, 2014). We can propose the following elements (fig. 5). Fig. 5 – SWOT of acquisition strategy Strengths

Weaknesses

a) Deal rationale b) Self-Assessment process c) Staff’s professionalism d) Acquisition evaluation drivers e) Family control

a) Cultural disparity b) Management Narcissism c) Family control

Opportunities

Threats

a) Environmental characteristics b) Legislation c) Financial market

a) Environmental characteristics b) Legislation c) Financial market

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The management should give special consideration the factors that could hinder the achievement of the goal. Characteristics of the business that place the business or project at a disadvantage relative to others. They are weaknesses that if not managed, or unforeseen, may decree the failure of investment. We draw the attention that some elements can have also a negative perspective, such as the family control (§ 2.2.1 a)). This double meaning is even stronger in the Opportunities and Threats. It is appropriate to examine even outside factors that could provide opportunities, force vectors that can play a part in the success, or as Threats that could nullify the value, even destroy the wealth created. The careful analysis is strategic also for matching and converting the different factors. Matching is used to find competitive advantages by matching the strengths to opportunities. Another tactic is to convert weaknesses or threats into strengths or opportunities. If the threats or weaknesses cannot be converted, a company should try to minimize or avoid them (Forbis et al., 2000).

2.2.1. Strengths a) Merger and acquisitions rationales Besides controversial literature results on acquisition performance effects, scholars have spent a lot of time on the issue of why mergers occur. Economic theory has provided many possible reasons why mergers might occur: efficiency-related reasons that often involve economies of scale or other synergies; attempts to create market power, perhaps by forming monopolies or oligopolies; market discipline, as in the case of the removal of incompetent target management. Other researchers argue that managers could have also different motivations to make acquisitions. These motivations are not based on shareholders’ value creation, but are based on maximizing managers’ own utility functions (Jensen, 1986). Variables that would increase their utility function may not be monetary, such as power or personal risk diversification, through the diversification of the company’s risk (Pazarskis et al., 2006). M&As may occur for economic or noneconomic reasons, analyzing the strategy in its own terms is usually the best way to determine whether the merger will be profitable or not. A large part of literature, investigating on the failure of some transactions, has observed that mergers and acquisitions could be considered also as an effective mechanism for correcting market or managerial inefficiencies. Shleifer and Vishny (1988) justify mergers and acquisitions as an irrational transaction driven by managers’ own interest. There are also various types of M&A transactions that can occur, both in terms of the dynamics of the transaction and the structuring of it (DePamphilis, 2012; Faulkener et al., 2012; Arnold, 2013; Brealey et al., 2014). In the previous part (infra,

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§ 1.2) we have observed that every wave is characterized by a specific type of acquisition strategy, moved by a specific motive. A classification refer to types, which differ according to the business structure of the merging firms. (Shy, 1995). Mergers are defined as horizontal, vertical and conglomerate. Mergers are horizontal when the two companies are in direct competition and share the same product lines and markets. They are vertical when one is a costumer of the other, i.e., when they have a downstream-upstream structure in which the former buys inputs to the latter to produce the final output. Finally, mergers are conglomerate when firms are in different markets and/or do not have business lines in common (tab. 3). Tab. 3 – Types and motives of merger and acquisition strategy Type

Characteristic

Motives

Horizontal merger

Companies are in the same line of business, often competitors

Economies of scale, increase market power, which increases profit margins and sales

Vertical merger

Companies are in the same line of production (e.g., supplier-customer)

Economies of scale for efficient logistics management Economies of scope

Conglomerate merger

Companies are in unrelated lines of business

Managerial interest, diversification, false apparence on the market, financial aim

Cross-border

Economy of scale and scope

Regarding the complex system of motives for merger and acquisition they can divided into two important classes (Halpern, 1983; Napier, 1989). The key distinction between these two groups of merger motives is to realize merger gains. The first group, Rational motives, includes drivers that increase the value of the merging firms because they raise actual or future profits and in which the effective claimants are therefore the owners of the firms, i.e., the shareholders. Irrational motives, indeed, includes a list of reasons that go in the interest of the manager of the firm and not necessarily in the firm’s value. a1) Rational motives-Synergies As expressed by Sudarsanam (1995, p. 13): Acquisition motives may be defined in terms of the acquirer’s corporate and business strategy objectives. Synergies are the main argument to justify mergers and acquisitions. Synergy motive is hypothesized to be in the interest of acquiring shareholders, which the operation of a corporate combination is more profitable than the individual profits of the firms that were combined, as reported by Gjirja, (2003). In this case, the sum of an individual company is smaller

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than their combined sum. Sirower (1997) argues that synergies raises competitiveness and because of that, there is an increase in cash flows compared to the ones obtained by the companies individually. The theory is that the management of an organization expects that synergistic benefits from investing in the M&A will be enough to pay for the activity and a premium to the shareholders; therefore, engaging in M&A activity becomes a motivation. The effects of synergistic activities are comprehended when the combined efforts of the two organizations involved produces a greater effect than the sum of efforts of the organizations functioning autonomously as reported by Gjirja (2003). Damodaran (2005) defines synergy as the additional value that is generated by combining two firms, creating opportunities that would not been available to these firms operating independently. M&A deals are often justified, based on the anticipated synergy, which should have a positive effect on the post M&A performance of the company. According to Damodaran (2005), acquisition can realize operating and/or financial synergies.

 Operating and Financial synergies • Operating synergies allow companies to increase operating income, increase growth, or both (Roller et al., 2006). Commonly cited motives in this literature focus upon firms gaining competitive advantage through cost reduction or increasing market power. Those synergies can be classified as follow: – Cost reductions: economies of scale, economies of scope, integration economies, price power (both to buy and/or sell) and a combination of different operating strengths. The consolidation of two companies can produce a reduction in the production cost per unit of output as total output increases, realizing economies of scale. The main factor is a more efficient operation and management. With a merger, two firms can get rid of double fixed costs, i.e. costs that involve administrative tasks, customer service and billing. Economies of scale in short-run can also be achieved by a reallocation of output across different business units of firms involved in the deal. In the long run, economies of scale are produced if the increase in output more than doubles the increase in all the inputs. This might arise when a larger and financially stronger firm invests in new technologies that substantially improve its production process and its research and development areas (Tirole, 1988). Those synergies are common in horizontal mergers, whether the two companies involved in the transaction belong to the same industry and can take advantage of increases in the quantity produced. It also gives big companies access to a larger market by allowing them to operate with greater geographical reach. In vertical integrations, it is more common to find reductions

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based on more efficient logistics management (Haugen and Langetieg, 1975). Economies of scope are economies of scale generalized to multi-product firms, or to firms related by a chain of supply. Economies of scope can be achieved by selling the added range of products and services through the combined network of the company. They are reached if the average cost of producing two products separately decrease when the products are produced jointly. This will occur in a situation where it is cheaper to produce a wider range of products rather than specialize in just a handful of products. In essence, the expansion of the product range will help to exploit the value of existing brands and it is a good way of exploiting economies of scope. Furthermore, the economies of scope motivate M&A in the several business sectors because it becomes possible for the companies to sell the products and services from the merged or acquired company. This will result in the increase in the number of products and services made available for the customers of the company (Motta, 2004). In vertical integration, efficiency gains could be realized in the acquisitions of technical support, promotion, training, equipment and financing. Economies of vertical integration are revealed when the sum of the cost of separately owned stages of production decreases when a single firm performs the two stages of production. In this context, positive effects on specific investments that manufacturers and retailers may have together are also presented as an argument of efficiency gains in vertical mergers. Also, when an upstream firm finds it difficult to induce retailers’ behavior on its own interest, vertical integration can be an alternative to vertical restraints (i.e., quantity discounts, resale price maintenance, exclusivity contracts, etc.), by doing so, operation costs decrease and thus efficiencies of vertical integration are revealed. Consolidation strategy can allow growing in either the actual or a new market. Market power growth has been extensively argued as one of the most important motives for mergers and acquisitions (Scott, 2005). Through acquisitions, companies may penetrate new markets that otherwise it would not be able to enter and to realize an increase of revenues. This hypothesis states that a merger between diversified sellers can create market power in the individual market in which sellers compete. That is, the market power of a seller in a particular market can be increased through its contacts in other markets. Growth is easily measurable, which is one of the premises of management’s goals. Other reasons can be to follow clients. That is, when clients are internationalizing suppliers who may have to supply the materials in foreign countries. In addition, companies can adopt a follower strategy, that is, to follow the leader in the market. When the leader begins to take positions in international markets, the followers try to do the same and they can develop that process through consolidations with foreign companies. Finally, the saturation of the local market can help to make the decision of going to other markets. Usually, competition is high in international markets. Because of that, consolidation may be an efficient tool. A merger could be promoted to raise entry barriers to facilitate the enhancement of market power. ower. Such entry

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barriers may be attained if the merger unifies two potentially competing technologies or facilitates tying strategies. In the 60s and 70s, growth was a common accepted practice. Bodie et al. (2002) argue that investors are not looking only for growth. Market power growth will increase firm value only if the company invests in project with attractive returns. That is, when the return on equity obtained with this strategy is higher than the cost of equity. For that reason, management has to differentiate “growth” from “growth opportunities”, which are the ones that create value for shareholders. During the 90s, technology companies were specially valued based on their potential growth. That is, investors paid for expected but highly uncertain cash flows. Those companies achieved incredible prices compared to their fundamentals (Kohers and Kohers, 2000). Acquirers were looking to obtain profits from the potential for growth that existed in the overall technology sector. At that stage with a hot technology sector, particularly the internet, investors were paying not for actual returns but for potential ones. Advantages of a dominant position in the market are monopoly or monopsony. Companies with market power exercise it establishing entrance barriers and increasing the period, they obtain abnormal profits. Antitrust law protects consumers of abuses made by companies with market power. The antitrust tribunal plays an important role in the merger and acquisition industry, analyzing how deals can affect consumers. • Financial synergies Financial synergies can produce a higher cash flow, but its major source is to reduce the cost of capital. This can be possible by acquiring a target firm with excess cash but few growth opportunities. The acquiring company, with high return projects but cash constrains, may use the cash targets as financial resources, instead of obtaining the funds in the financial markets. The financial synergy theory also states that when the cash flow rate of the acquirer is greater than that of the target, capital is relocated to the acquired firm and its investment opportunities improve. A combination of companies with different cash flow positions and investment opportunities may produce a financial synergy effect and achieve lower cost of capital; therefore, the operating margin of the combined companies will however be greater than the revenueweighted operating margin of the individual firms. An additional method to detect financial synergy is by examining financial slack, by looking at the differences between the acquirer and targets financial leverage. Financial slack is then calculated both as the arithmetic and absolute difference between the acquirer and the targets financial leverages. To summarize, some of the financial synergies are: – Combination of a company with excess cash but few growth opportunities and a company with high return projects but cash constrains. Usually it happens when big corporations buy small companies and when companies are in different stages of their life cycle.

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– Lower cost of capital. It can happen when a big company absorbs a small company. (Melle, 2001) shows that there is asymmetric information in the credit market, implying that small companies may not get into debt at their rate in an efficient market. When small corporations are absorbed by public companies, they can finance projects with new instruments such as corporate bonds Thank to this co-insurance effect the small company may reduce the cost of debt (Lewellen, 1971; Kim and McConnell, 1977). – Increase in debt (leverage) capacity after the consolidation, because of more stable or predictable cash flows, that would be translated in a higher leverage capacity or lower cost. – Tax savings. Regarding tax saving, it can be realized when the two firms merge, their combined debt capacity may be greater than the sum of their individual capacities. The combining of the two firms can lead to tax benefits that can be shared by the two firms, if one of the firms has tax deductions that it cannot use because it is losing money, while the other firm has income on which it pays significant taxes. The value of this synergy is the present value of the tax savings that accrue because of the merger. a2) Irrational Reasons for Mergers and Acquisitions The Irrational motives essentially pursue managerial gains and they are founded in agency theory. They are managers’ strategies seeking to increase their own wealth (at the expense of the firm’s value). The corporate diversification is one of the more popular management ideas that has fallen from grace because of the numerous scandals. Based on diversification theory, risk averse companies can minimize risk through investing in other businesses, balancing their profits. It was the argument used in the 60s and 70s to support conglomerates. Diversification strategy affects to the firm’s stakeholders in different ways. Managers may buy a company of another sector to reduce their personal risk or increase their compensation. Creditors may prefer a more diversified firm in which cash flows are more stable and predictable. Stockholders, with a diversified portfolio, may not want this strategy, because they can diversify the portfolio at a lower cost. Researchers have argued that a firm’s diversification has different motivations, such as building empires and personal risk management. This motive can create benefits via economies of scale or scope (Weston, 1970; Chandler, 1977), higher debt ratio and internal capital markets, by eliminating asymmetric information problems. Companies with imperfectly correlated activities may get more stable cash flows. Diversification costs are typical agency problems and the struggle within divisions. According to some scholars (Amihud and Lev, 1981; Morck et al., 1990), conglomerates are often involved in diversified acquisitions either to minimize the potential risks of one business industry not performing well in the future or to maximize the synergies and revenues. Diversification can take different forms:

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– Industrial diversification: firms expand their activities across industries creating conglomerates that operate in more than one business. During the 50s and 60s, companies took massive diversification programs. The theoretical arguments supporting such actions were the increase in operating efficiency and cost cuttings. Berger and Ofek, (1995) showed that there is destruction in value through this strategy, but only one half of the discount in their sample can be attributed to negative valuation consequences from this strategy. Agency theory argues that diversification can be driven by different motivations from a value-maximizing strategy. That is, managers’ private benefits or personal goals obtained through this strategy are the key driver. Aggarwal and Samwick (2003) explain company’s diversification within this theory. First, managers increase their utility function through the company’s diversification. That happens because managers have a big amount of their personal wealth invested in the company, so they do not have a diversified investment portfolio. They can reduce their personal risk diversifying the company’s portfolio of investments. Secondly, managers can have higher private benefits in more diversified firms such as social prestige, higher career opportunities and remuneration. These results only support the proposition of private benefits as the main reason for corporate diversification. Some researchers have argued that diversification is not a value maximizing strategy. Jensen (1986) argues that the greater the diversification the more companies invest in negative cash flow projects compared to non-diversified companies. Servaes (1996) analyzes value created through diversification in the 60s and 70s. His results support that diversification has damaged shareholders. That may explain why companies began to focus on their core businesses in the late 70s. One of the main findings in this study is that diversification produces a discount and does not have other effects. Morck and Yeung (1990) study why companies diversify, under the internalization and agency theory. They find that geography, within industries and size diversifications create value under the presence of intangibles based on R&D and publicity, but destroy value when they are not driving the process. It may happen because of agency problems. They argue that the capital market in the 60s and 70s was not as developed as it is nowadays. Matsusaka (2001) argues that corporate diversification and shareholders value creation are not substitutive goals. The author suggests that the diversification discount provokes diversification, but not the other way around. The model shows that companies with the worst matches of organizational capabilities will liquidate; only firms whose matches are not bad will hold on their existing businesses and diversify. Diversification may be good due to a signaling effect, because firms avoid liquidation option. More generally, the model predicts that the market reaction will depend on the characteristics of the announcing company. One of the main implications of his model is that companies can be discounted in the stock market, even when diversification’s goal is to value maximization. Haspeslagh and Jemison (1991) criticize financial research in mergers and acquisitions. The authors argue that success from a financial point of view is based on the immediate mar-

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ket response to the announcement. For the authors, this is a very simplistic analysis of this phenomenon and for that, reason managers and academics trust in it. They say that the key success factors are the firm’s capabilities, same as Matsusaka. Through capabilities, companies can develop sustainable competitive advantages. New research in corporate diversification has created divergence against the traditional view of the diversification discount associated with diversify firms. The idea is that diversified and non-diversified firms have different fundamentals and once controlling for those characteristics the discount may even change to a premium. Villalonga, (1999) addresses the econometric problems studying diversification. Diversification is not the cause but one of the effects. Diversified firms trade at a discount prior to the diversification process. That is, low performance causes diversification. Other interpretation to those results is that in efficient capital markets, stocks would be trading at a discount because of the possibility of managerial decisions that would be against shareholders’ interests. The author finds that after controlling for specific factors, the diversification discount turns in a premium. Campa and Kedia (2002) after modeling diversification like an endogenous variable argue that diversification does not cause diversification discount. Finally, another study by Villalonga (1999) highlights the skepticism of the results obtained using COMPUSTAT. The author finds that diversified firms traded at a significant premium. The author provides two plausible explanations for the results: “Relatedness” and “strategic accounting”. Under the Relatedness hypothesis, there is a discount for unrelated diversification and a premium for related diversification. Conglomerates use to diversify into related businesses, being the overall effect positive. Under the Strategic Accounting Hypothesis, companies trade at a discount because of an aggregation of segments that make them appear to be low performance relative to single segment firms. It is not clear if diversification creates or destroys value for companies involved in such an activity. – Geographic diversification Companies can diversify internationally, looking to reduce recessive periods in the local market. Microeconomic theory supports international expansion when companies want to increase their economic rents. Adler and Dumas (1975) argue that the managerial decision to diversify is irrelevant when investors can substitute completely it through local diversification. However, when there are economies of scale or the cost of diversification is substantially higher for investors, Adler and Dumas’ proposition is less sustainable. International diversification can create value through increasing management skills. Ezzamel (1998) highlights that benefits from diversification, such as managerial power, reduction in the risk of firing managers, maximize size and managers’ personal wishes, are not related to value creation. However, managers can increase the ability to manage companies in a much more complicated environment. Thus, they can use this knowledge in the local market. Therefore, the net value of diversification would be the difference between the costs such as overpayment due to

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management’s personal goals and the profits from increasing their ability to manage companies. Bodnar et al. (1997) argue that the potential diversification advantages are economies of scale, optimization of tax liabilities, more production flexibility in the more efficient countries and adjustment of demand between countries. On the other hand, disadvantages associated to global diversification are basically that cost can be higher than benefits. In addition, investors have more difficulties to monitor the activities of managers. The more complex the organization the more difficult it is to monitor. Speculation. Under this theory, the market undervalues companies and managers can find those attractive investments. Barney (1986) argues that the market undervalues some companies. The reason is that there are imperfections in the market for strategic factors and that produces difficulties around the valuation. Private information plays an important role, because if managers can have information of the other market players, they can acquire companies with a discount. Barney (1986) defines two possibilities for speculation. First, myopic market focuses on short-term periods because important players such as institutional investors are focused on short-term returns. Consequently, companies with long-term investment horizons are undervalued in the market. Thus, those companies are attractive targets for acquirers with financial resources. Secondly, firms can have a market price under their real value. When that happens, companies looking for growth will acquire firms as a strategy to increase production capacity. Shleifer and Vishny (1988) develop a model in which mergers are driven by the stock market. That is, managers of the acquirer choose those targets that are disvalued by the market. This model is based on opposite assumptions to the “hubris” hypothesis argued by Roll (1986) in which markets are efficient and managers are irrational. Neoclassical Theory considers mergers and acquisitions as efficient responses to shock in the industry. The main assumptions are that markets are inefficient, so some firms are valued incorrectly. In contrast, managers are rational and take advantage of those inefficiencies in the market. Market valuations drive mergers and acquisitions. The bases for this model are the development of behavioral finance and the arbitrage made by managers, finding undervalued companies in the market. The model predicts: 1. managers time the market, using the method of payment as the tool for that. They prefer stock payment when the stocks are overvalued or otherwise in cash; 2. the volume of stock acquisition increases with the dispersion of valuations among firms; 3. managers resistance to some tender offers is in the interest of shareholders; 4. bidders in stock acquisition show signs of overvaluation. Despite the long run negative returns, acquisitions for stocks serve the interest of the long-term shareholders of the bidders because they arise from the overvaluation of the bidder relative to the target, even acquisitions made by glamour bidders seem to be a defensive strategy in their model. The premises of the model are that companies can

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reduce the principal-agent conflict between shareholders and managers, who can detect undervalued companies applying rationality. Some companies based their acquisition strategy in firms with a prior bad management. That is, those companies have good fundamentals such as growth prospects and attractive products but the market correct those companies’ values because they are not efficiently run. – Agency problems: there are conflicts between the agents participating in the process. Investment banks get a commission over the total amount of the deal. Thus, they have incentive to increase the size of the deal as much as possible. (Kesner et al., 1994). Agency problems between shareholders and managers are not a new concept in financial economics. Already, Berle and Mean (1933) recognize the potential divergence of interests existing between owners and managers of a corporation when property is diffused. According to Empire building theory (Mueller, 1969) the objective is to increase the size of the organization. Managers’ salary may be related to the company’s size and not to the company’s returns (Lubatkin, 1983; Schmidt and Fowler, 1990). In addition, managers may look for a higher social position and power, not for shareholders’ value maximization. As shown by Jensen (1986), companies with high leverage and free cash flows tend to make low benefit takeovers, even destroying value. Diversification strategies are usually included in this type, thus these strategies tend to underperform. The model predicts hostile takeovers, increase in leverage and break those empires in which synergies were not successful. – Roll’s hubris hypothesis. Roll (1986) has coined the word “hubris” to express managers that have overconfidence in themselves. Based on this, managers can make decisions even when the market is punishing the company stock’s price for that, because the market is not efficient. The premium paid is a signal of the potential profits that the bidder may create through this action. The basis of this theory is that managers believe that markets are inefficient and do not understand their strategies. This theory is developed under the assumption of strong-form market efficiency. That is, stock prices can contain all the information. Product and labor markets are efficient. The predictions for takeovers are an overall decrease in the value of the bidding and target firms driven by a decrease in the bidding company, while the target would increase the value. Another premise of the hubris theory is that managers do not make profitable takeovers, but it may be due to valuation mistakes or divergences with the goals of shareholders. Clearly the Board of Directors has a passive role under the hubris hypothesis accepting CEOs’ decisions. However, when the same person is the CEO and Chairman, the mechanism may be less efficient. Jensen (1986) considers that when the internal control system does not work efficiently, mergers and acquisition are an external disciplinary system. That happens when a management team finds that substituting another company’s management can create value. In order to obtain the acceptance of the offer, there has to be a premium over the target’s market value. That is, the target’s shareholders will keep some of the benefits of this restructuring. Under this theory, the market for corporate control through mergers and acquisitions would mitigate

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the hubris behaviour. Asymmetric information plays an important role protecting hubris behaviour in an imperfect market. Further research on the hubris hypothesis is carried out by Hayward and Hambrick (1997). They argue that hubris is an essential piece that explains management behaviour in acquisitions strategies. – Earnings per share (EPS) myopia hypothesis (bootstrap game). EPS has always been one of the management quality indicators. EPS has been used as a measure of health. One of the justifications for mergers and acquisitions in the 60s and 70s was an increase in EPS. This theory suggests that managers are more focused on EPS than in other variables because management believe that EPS drives stock prices. This obsession relates to the high premium paid for target’s stock, based on that increase in EPS. However, using this mechanism will limit a company’s future prospects; Block (2002) observes that EPS is not an indicator of value created through acquisitions. Managers may have their remuneration associated to accounting profits. Then, there may be an incentive to carry out mergers and acquisitions when they help increase EPS. In addition, managers may not understand key drivers of stock prices. They may act myopically. That is, they are too focused on shortterm accounting indicators such as EPS, so they do not realize the future implications of this strategy. Another common valuation metric is the PE ratio. There are two different views of this ratio: PE ratio is inconsistent due to the heterogeneity of the result. The numerator is then price per share (PPS), which in an efficient capital market is the present value of the expected future cash flows. The denominator is EPS, which are the profits per share obtained last year. This ratio is a measure of the extrapolation of past performance in future expectations of growth in returns for stocks (Lakonishok et al., 1994). When a company acquires another with a lower PE ratio, the consolidated EPS increases. Assuming investors make their investment strategies based on EPS, it would be the optimal managerial strategy. Companies with low PE ratios have less growth opportunities. Thus, this technique does not increase acquirers’ value per se. If market values these actions positively a bubble might be created in the long run. – “Glamour” Companies: Rau and Vermaerlen (1998) argue that markets are inefficient and overreact to past information, overvaluing companies with good past returns and undervaluing companies with poor past returns. At the same time, managers and decision makers (larger shareholders and the Board of Directors) that have to approve the acquisition, obtain feedback from the market. In companies with low book to market ratios (glamour firms), managers have a higher probability to overestimate the ability to carry out the acquisition. Good past returns in glamour firms, such as high stock return and cash flow and profits growth, increase managers’ selfconfidence (hubris effect). This overconfidence makes glamour firms overpay for target companies. That translates into a poor future performance. – Excess free-cash flows. Another irrational motive is by acquiring a target with excess free-cash flows. Indeed, it has been discussed that companies that hold high free-cash flows could become targets in hostile takeovers. Bidder managers prefer to reinvest corporate earnings even when this is not in the shareholder. Jensen (1986) af-

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firms that one way to solve this agency problem is imposing acquiring managers to finance the deal by debt. Using debt would discipline the acquiring firm’s managers by reducing their post-merger discretion in the use of the free-cash flow.

b) Self-Assessment process There is no magic formula to make acquisitions successful. Empirical analysis of specific acquisition strategies offers limited insight, largely because of the wide variety of types and sizes of acquisitions and the lack of an objective way to classify them by strategy. What’s more, the stated strategy may not even be the real one: companies typically talk up all kinds of strategic benefits from acquisitions that are really entirely about cost cutting. If an acquisition does not fit one or more of these archetypes, it is unlikely to create value. As widely debated above, executives, of course, often justify acquisitions by choosing from a much broader menu of strategies, including roll-ups, to improve competitive behavior, transformational mergers and buying at a low price. While these strategies can create value, we find that they seldom do. The integration risks are often not fully understood or fully scoped at the time the deal is signed. Similarly, integration risks are rarely seen as a high priority at that stage. The acquisition process is very complex. According to DePamphilis (2012) it contains several phases: acquisition plan; target search; first contact; negotiations; integration plan; closing; integration and post-integration evaluation. Furthermore, the negotiations stage consists of other four largely concurrent and interrelated activities (due diligence, refined valuation, deal structuring and financing plan) and it is a vital phase in an acquisition process. Like any other business process, they are not inherently good or bad, but any deal must have its own strategic logic. In the most successful deals, a well-articulated decision-making process was carried out. For less successful deals, the strategic rationales and critical factors tend to be vague. This process is not without pitfalls and careful thought must be given to the planning of both the execution and the post-deal integration phase. A good planning expedites sound decision-making and the success of the investment. Successful integration begins with an acquisition plan that will enable those synergies to start taking effect on day one. Value-minded executives should view them into a detailed plan, first with a self-assessment perspective and then to communicate outside. b1) The Acquisition plan Among the most cited causes of failure of M&A operations, there is a deficient strategic or inappropriately plan. A well-defined acquisition plan is the most strengths for the deal success. The ability to articulate a clear vision of the road to be taken and of the expected results is undoubtedly a success factor in M&A. If the ultimate goal is still universally recognized value creation, the management must be able to set goals,

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to do so and this implies the ability to plan, monitor and measure those goals. In the case of the preparation of an acquisition plan, it may use two different choices. The operation could be the evaluation of a pre-defined opportunity, resulting from the strategy outlined in the ordinary course of a planning process. This process is regularly undertaken by management, usually on an annual basis, to analyze the external environment, in which the company operates. In the plan it has evaluate internal resources available, to articulate a vision on the future of business managed and define a strategy to implement the acquisition. In this context, the opportunity to realize an extraordinary transaction could be detected, whose effects would be assessed within the framework of the corporate acquisition plan. Alternatively, the operation to assess it could be an unexpected opportunity, which occurs suddenly to the occurrence of certain conditions not foreseeable by the ordinary planning process. For example, a competitor enters in a state of insolvency; the shareholders are unable to recapitalize by providing the opportunity to acquire their leading brand company to the competitors. In this case, the existence of a well-prepared acquisition plan allows rapid determination of value that might be created through the acquisition. Some scholars have observed that business planning as one of the most important tool of knowledge for the company (Hormozi et al., 2002; Barringer and Ireland, 2008), both for an inside and external analysis, especially in corporate acquisition strategy, that involves several stakeholders (Mancuso 1985; Pinson and Jinnet 1996; Ford et al., 2003). In this complex investment the power team can also interest people not directly involved in the business, that are able to acquire a global vision of the business idea and manager professionalism. Especially in expansion strategies, the acquisition plan gives the opportunity to legitimize the project (Zimmerman and Zeith, 2002), in particular in fund raising. It constitutes, undoubtedly, the central document through which the power team is able to define the complex of the financial requirements for the deal, also for the future integration activities, the financial results and the time extension of them (Carlesi, 1999). The acquisition plan preparation has a pivotal role within the internal knowledge and the external communication of the company’s development projects and performance expectations, in terms of income and cash flows. The Plan elaboration is widespread by the company buyer (bidder), both for strategic analysis for decision-making and as a communication tool for the stakeholders. The acquisition plan is a valuable negotiation tool in dealing with a seller's concern on the value and continued growth of buyer’s stock. A list of statement of objectives are another important acquisition plan content. Furthermore, it also provides a road map and serves as a screen to filter out the deals that do not meet acquisition criteria or long-term objectives (Sherman and Hart, 2006). The acquisition team, through the plan, has to carry out an evaluation of internal and external aspects, in relation to market and company structure. In this kind of strategy, the evaluation process has taken care of both quantitative and qualitative matters (Chelimsky, 1997; Aybar and Ficici, 2009; Bing and Wingrove, 2012; Ghauri and

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Hassan, 2014) with a particular attention to integration phases and costs. Regarding the internal aspects, the analysis of a wide range of information has a fact-finding objective of different information, such as: • quantification of the financial requirements level necessary to support the operation; • the impact assessment on the value creation; • the effects of the risk management; • the ‘financial compatibility’. There is no question about the role of acquisition plan as a communication medium for fund raising (Bewayo, 2001; Kaplan and Warren, 2007). It was the motivation of its diffusion and success inside the international economic system (Gendron, 2004; Karlsoon and Honig, 2009). In the acquisition plan, the deal motive, the effects on the different players, the financial requirements, the economic and financial results and their timing are accurately defined. It becomes a fundamental knowledge tool for the stakeholders, such as potential investors, banks or private equity funds, but also for corporate partners and for legislators (Hormozi et al., 2002). For the acquisition team, the plan is the opportunity to legitimize their project (Zimmerman and Zeith, 2002), especially with regard to fund raising. Bank or a credit provider can find in it key information to analyze the company’s creditworthiness for a risk evaluation (Kaplan and Warren, 2007; Sahalmn, 1990; Timmons and Spinelli 2007; Bewayo, 2010). The main goal of the acquisition plan is the deal feasibility evaluation (Mariani, 2012). Therefore, there are four levels for the overall project feasibility assessment: 1. Entrepreneurial Feasibility; 2. Market Feasibility; 3. Inside Feasibility; 4. Economic-Financial and Equity Feasibility. The question to which the Entrepreneurial Feasibility assessment has to address, the key questions can be synthesized: Does the acquisition team have the required professionalism? Has the management put into play the governance, the appropriate skill in order to “build” the new project? What is the quality of the entrepreneurial team and the collaborators? In fig. 6, the basic knowledge drivers of the acquisition plan are summarized, regarding the different perspectives of the acquisition team and a private equity investor 1. 1 The following analysis focuses on information specificities, respectively of the acquisition team and an external analyst, the latter represented by equity funds, consider useful in a acquisition plan in terms of feasibility and risk analysis. The following considerations also take account of interviews to practitioners, both as author and evaluator, which allowed us to add operational perspectives.

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Fig. 6. – Knowledge drivers in M&A operations a) FEASIBILITY

ACQUISITION TEAM

EXTERNAL EVALUATOR

1) Inside Feasibility a. Clear definition of deal objectives b. Company target description c. Technical, marketing and human resources plans 2) Market Feasibility Market, Sector 3) Economic-Financial Feasibility – Analysis target – Growth opportunities – Cost, revenue, tax and financial synergies – Marginality Indebtedness – Purchase price, exchange ratio, – Value stand-alone ex ante and ex post – Wacc – Timing analysis of cash flow – on a monthly basis – NPV

4) Entrepreneurial Feasibility Team management skills 5) Inside Feasibility a. Clear definition of deal objectives b. Company target description c. Planning of all resources required for real operative feasibility d. Technical, marketing and human resources plans. 6) Market Feasibility a. Market size and competitive positioning b. SWOT bidder analysis 7) Economic-Financial Feasibility – The project provides realistic performance and potentially attractive – Timing analysis of cash flow on a monthly basis – Purchase price/exchange ratio – Way out and capital gains hypothesis

b) Risk analysis Market risk

8)

9) – Beta – Entry barriers – Growth rate – Competition aggressiveness – Market share – Competitions drivers – Company size

Economic and financial risk

Total project risk

– Entry barriers – Growth rate – Competition aggressiveness – Regulatory, legal gradients – Costs structure – Market share – Competitions drivers – Company size 10) Indebtedness index 11) Indebtedness index – Adequate liquidity – Leverage – Leverage – Free Operating Cash Flow/Finan– Free Operating Cash Flow/Ficial debts nancial debts – Cost structure flexibility – Working capital ratios – Working capital ratios – Ebitda/Sales – Ebitda/Sales – Ros, Roi – CapEx/EBITDA – CapEx – Default risk 12) Financial structure post-mer- 13) Financial structure post-merger, ger, NPV, IRR, BEP IRR, BEP, Stock Market Multiples

Above all the external evaluator, in fact, before embarking on a particular transaction, expects clear results that the bidder management has made a detailed and de-

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tached process of self-evaluation (fig. 6). This should detect the strengths and weaknesses of the acquirer company, as well as the key skills to be put into play. Therefore, in the process of the project execution devastating vacatio management will not occur which could jeopardize the results, due to improvised and unprepared behavior. The presence of skills, motivation and alignment about the business strategy, between different actors and the investor, is a basic element for the purpose of the feasibility assessment. Fig. 6 (point 4) shows, however, a misalignment of views between the two players: the acquisition team considers this aspect without any importance, by underestimating the relevant cognitive significance for the other party, which considers acquisition team’s professionalism and their past experience as a basic piece of information of the Entrepreneurial Feasibility. Only when the deal objectives are clear the acquisition plan can be developed. This information is strategic both for the acquisition team and for the external analyst, for whom the plan must give elements on the real feasibility. This is the key word of Inside Feasibility (fig. 6, points 1 and 5). The question for the external evaluator, such as private equity investor is: Does the acquirer company have a well-defined structure (technical, administrative, legal skills etc.) to support a successful deal? For feasibility analysis, this information has a strategic role. The analyst interest is to have all information useful to evaluate if the acquisition team has planned all resources required for a real operative feasibility. A strategic part of this phase of analysis, for both players, is the status quo of the target. In this planning phase, the acquisition team can explore solely the information available on the market, but they will gradually be integrated during the negotiation, until arriving at a complete in depth understanding with due-diligence. The fact-finding objective is to outline the opportunities and risks that may be generated by the integration. It is necessary to draw attention to the fact that the difficulty of the integration is one of the main critical points in the process of value creation in acquisition (Gomes et al., 2012). In essence, the analyst expects to be able to detect information in the plan about a company’s historical numbers, because the past is an indicator of the future: the equity investor, in fact, seeks to evaluate the “reasonableness of the assumptions of a growth trend seeking confirmation, or denial, just from the past” (Piana, 2012). Fig. 6 shows that both actors consider the information about the Market Feasibility and the Economic-Financial Feasibility strategic, issues on which the acquisition team focuses attention. The market analysis, Market Feasibility (fig. 6, points 2-3, 6-7), must be quite detailed as it pertains to the sector, by creating a benchmark with the main competitors. It focuses on competitive levers and any critical elements to act on, especially if the strategic option is the diversification. These opportunities include choosing the most attractive customer segments and geographies, serving customers in ways competitors cannot replicate and understanding the ca-

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pabilities and market access required achieving those goals. Essentially, a company should develop M&A strategy to complement the strengths and backfill weaknesses, with a bidder company SWOT. A company that has not gone through that process will likely trap itself into being a reactive acquirer, working backwards from the deal into a strategy. For the external growth strategies implementation, the company has to rely on some internal pillars of strength, which management might develop for the acquisition success. On the other hand, the acquisition team has to highlight especially the factors that could hinder the achievement of the goal and the characteristics of the business that place it at a disadvantage relative to others. They are weaknesses that if not managed, or unforeseen, may make it a non-cost effective operation. It is appropriate to examine even though there may be factors outside the enterprise that could provide opportunities that the bidder can intercept. The analysis has also to investigate on the threats that can frustrate growth efforts, nullifying the value, even destroy the wealth created, by planning a solution to manage them. According to external analyst perspective, this information are essential to the process of evaluation, which aims to evaluate the feasibility of the operation, determining the merit, worth and value of things (Scriven, 1991; Coman and Ronen, 2009). It may be observed that the investor considers the competitive situation analysis decisive (fig. 6, points 3a and 9), especially for an accurate assessment of the market risk, as it will be clarified in the specific section that follows. It is a complex investment and the synthesis driver for the evaluation purposes is the Economic-Financial Feasibility, where the cognitive interests of the acquisition team crisscross external party vital factors, albeit with some specificities. The acquisition team, in fact, focuses on reviewing the complementarity areas and overlaps of business units involved in the enhancement of synergies. They have to identify the value drivers affected by synergies, from nature and their probability of realization: this phase requires special attention and care, because the analyst understands that, often, as previously highlighted, bidder management tends to overestimate synergies or underestimate costs or integration times. The internal evaluation purpose is, in essence, to gather information that may be included in the calculation of net present value (NPV) acquisition (§ d). Among the critical factors, particular attention must be paid to the timing of cash flows, to measure the ability to service debt that the company will be able to guarantee. In combination with the historical analysis of the company involved in the transaction and of the sector, that information is essential to define the company targets stand-alone value that often is the starting point to decide the appropriateness of the deal, the price assumptions and/or exchange rate 2, the response times and the possible funding arrangements (§ d). From the investor’s side, especially for private equity, the cognitive goals, in addition to those mentioned above, are also represented by the information on the level of 2 In

Appendix 1.

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criticality for the entire operation. Therefore, in the acquisition plan investors seek information on the strengths and weaknesses that the bidder company could meet and must resolve. The investors tend to reformulate their own assumptions in terms of price and/or exchange rate, of course to verify the exit strategy (IPO, trade sale, secondary market, etc.) and the level of capital gain potentially achievable. Acquisition team builds an undoubted cognitive value also for all stakeholders, involved in any way in the transaction, such as trade unions, suppliers, customers, the financial community, public bodies and all players whose could have an active role. Sometimes they could have opposition, involved in the transaction, which can be decisive for the cost and the concrete implementation of an M&A. Regarding the holding period of the market, there is a distinction between the two players: the management believes that it is simply a yearly planning horizon, while the equity investor recognizes that this assumption has a higher element of risk than a monthly level timing, especially for monitoring. Risk analysis In addition to the prospective impact on economic, financial and capital values mentioned above, integrating operations also affect the risk profile, in terms of market risk (variability of revenues), economic-financial risk (operating leverage and financial leverage), of the companies involved, as well as the project total risk. The analysis of deal risk is undoubtedly one of the fundamental process in a complete project under equity investor perspective (fig. 6, part b). All elements need to be interpreted, to perceive if an opportunity is attractive or not, within quantitative rational expectations about the future of a company, to evaluate primarily the risk-return profile. This aspect is a crucial knowledge driver, especially for an investor (fig. 6, points 9, 11, 13). With regard to a market risk, substantial alignment of cognitive interest between the two players can be located: meaningful data on competitive positioning and market share that the new structure will boast, must be considered together with the competitive advantage factors and variables related to enterprises size. Equity investor is particularly interested in checking if there are any areas of improvement of economies of scale and market barriers of entry, which could involve challenging investments being input from one side, but ensuring high margins for companies already present. The acquisition team also believes that the acquisition plan should produce information about the degree of regulatory, the presence of legal and gradients and their effect on the cost structure. It becomes important, in fact, to evaluate if cost structure is flexible and capable of dealing with any “aggression” in terms of price competition. The quantitative information must then be accompanied by qualitative indications on the possible risks that could nullify the synergies, such as the organizational and cultural risks, that for cross-border transactions may represent the major critical point. Financial risk focuses on the attention of two optical analyses, because the perception of the default level becomes important and has immediate effects on the cost of

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capital, the degree of reliance and on the covering process of requirements in general. In this regard, especially an equity investor might be interested in depth study of the default risk by an analysis of the risk of insolvency, through various predictive models, such as Altman’s Z-score (Altman, 2000, 2007; Mariani, 2012b). The differential of risk produced by the operation (Zanetti, 2000) on the structures involved might represent a discriminating factor in evaluating the NPV (fig. 6, points 12, 13). The analysis focuses on the degree of indebtedness of the bidder company, pre and post operation and on the debt cost; this typically emerges from the ratio analysis included in the acquisition plan. Two perspectives agree with identifying some evaluation ratios. Among these, may be mentioned the debt and working capital management ratios: Debt/equity and the leverage, usually related to a covenant on bank financing, the FOCF/debt, sometimes tied to mandatory refund mechanisms on bank financing, as well as EBITDA/sales. Divergent opinions are expressed on the solvency and liquidity ratios, financial debt ratio, (considered basic to the acquisition team for the purposes of self-assessment processes), while the cost structure flexibility and the net financial position are considered decisive for the external evaluator. Regarding the total risk of the project, through the Plan, the relationship between planned investments and projections in terms of growth and profitability of the cash flows can be highlighted. The financial structure post-acquisition must be analyzed because, in the view of the acquiring company, for example, the excessive indebtedness post-operation may cause damage to the new structure, even the case of profitable businesses (§ d). For both professionals, more appropriate financial evaluation methods are the IRR and the Break even point (BEP). The IRR (internal rate of return) is seen primarily by the investor as the market parameter, although the stock market multiples are frequent, with Ebit. The evaluation through the NPV, is not considered necessary for the investor, while the acquisition team prefers to develop it separately, not in the plan (§ d). After analyzing the deal feasibility, sustainability and profitability, the pre-merger evaluation process is completed with due diligence that resolves light and darkness and leads at closing. Operating and financial synergies should be carefully identified, quantified and validated by both management teams during the transaction. During the due-diligence phase, the pressure on the decision makers is to make the best possible deal, analyze the potential acquisition and seek choices that seem to provide synergies. This process, while time-consuming, focuses mostly on the numbers and systems, with little if any time spent on assessing the organizational culture as a part of the merger process. This is probably because “taking the temperature” of the organizational culture involves surveying the employees, from whom this activity needs to be kept secret during the early phases.

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c) Staff’s professionalism M&A literature has been dominated by finance discourse, the human side having emerged only in 1980s, now it considered as paramount in succeding in M&A. The issues of M&A dynamics, executive turnover, as well as leadership and merger management are discussed. Some scholars have emphasized the employee reactions leading to compliance or resistance to change (Marks and Mirvis, 1986; Scweiger et al., 1987. According to Scweiger et al. (1987) employees can play a strategic role in the acquisition success, with five concerns. They can feel a loss of identity, lack of information, obsession with selfsurvival, loss of talent and family repercussions that can produce devastating effects on deal success (Cartwright and Cooper, 1990). They show that the entire workforce can originate conflict and resistance on the transactions. Mirvis (1985) observes that the distribution of power is important in an acquisition process in a long-term perspective. Other scholars have discussed the importance of the leadership in the acquisition process. Sitkin and Pablo (2005) argue that while very general notions of the importance of leadership are abundant in the M&A literature, there is an incomplete understanding of what M&A leadership is and how it can influence deal outcomes. However, because most M&As reshape organizations and deeply affect the employees of the merging organizations, understanding the role of effective leadership during the integration process is especially important in the fluid M&A context. Junni and Sarala, (2013) define M&A leadership as steering the efforts of organizational members towards achieving mutual goals (Yukl, 2012) during integration. This definition highlights the importance of leadership in accomplishing shared goals following M&As. The behavioral perspective clearly dominated recent empirical leadership studies. These studies found that specific leadership behavior aimed at creating a common organizational culture (Bertoncelj and Kovac, 2007; Grimpe, 2007) or identity (Clark et al., 2010; Drori et al., 2013) contributed to post-M&A outcome. This kind of behavior were found to mitigate negative employee reactions (Bartels et al., 2009; Bligh, 2006; Chreim and Tafaghod, 2012; Froese and Goeritz, 2007; Froese et al., 2008; Schweiger and Goulet, 2005), support cultural integration (Barmeyer and Mayrhofer, 2008), create a shared identity (Clark et al., 2010; Drori et al., 2013; Langley et al., 2012; Minbaeva and Muratbekova-Touron, 2011) and improve overall M&A performance (Bertoncelj and Kovac, 2007; Colombo et al., 2007; Gill, 2012; Grimpe, 2007). However, the study by Pioch (2007) showed that M&A leadership can also have unintended social outcome, such as cultural fragmentation. Literature on the human role in M&A builds on perceptions of the relative power of the merging organizations. It has entered fully in the acquisition strategy studies.

d) Acquisition evaluation drivers The corporate acquisition is a complex investment that need to be evaluated by regarding its ability to create value. In this perspective, some considerations are required on the evaluation process and regarding the capital structure.

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With the seminal work of Modigliani and Miller (1958), the debate on the relationship between the capital structure and the value of the firm has involved several scholars. Traditional theories of capital structure suggest that firms have target debt ratios that are determined by balancing the costs and benefits of debt financing. After this debate on the effects of tax-deductibility of interest payments and the costs of financial distress on optimal leverage ratio, academics started to pay more attention on the factors causing difference in capital structures in the companies. With the new empirical perspective of 1980s, the research on this topic was focusing on the firm level attributes that are reflected in the capital choices. Although the effect of a leverage deficit on security issuance decisions is welldocumented, there are still limited understanding of the effects of a capital structure overleveraged, or underleveraged, on long term strategic moves, such as an acquisition. However, firms often deviate from their target capital structures, and these deviations influence subsequent corporate decisions. With Jensen studies, who have theorized management self-interest in investment decision and showed an important effect of cash reserves on acquisitions, the debate on this topic is lively. Regarding this discussion, Martin (1996) observed that companies with higher valuation are more likely to use equity to finance acquisitions but showed, also, that the probability decreases with higher cash reserves. Harford (1999) in his first research studied the relation of cash holdings and acquisition behaviour. He noticed that cash rich companies are more likely make noncompeted, value-destroying cross-industry acquisitions, highlighting agency problems. Other scholars drew the attention on the fact that companies do take into account their capital structure when making acquisitions. In a view of corporate strategy, M&A and capital structure both target long-term performance. Morellec and Zhdanov (2008) pointed out that companies with below industry average leverage ratio are more likely to win the acquisition bids, albeit they should lever up once the acquisition is made. Clayton and Ravid (2002) also observed that companies with higher leverage ratio tend to make lower bids thus being less likely to win. Ghosh and Jain (2000) noticed that post-acquisition leverage ratios tend to be clearly higher than before acquisition. They assumed the increased debt capacity to be the main driver for the growth of leverage ratio but didn’t address how the pre-acquisition leverage ratio could contribute to the successfulness of the bid. The studies of Harford et al. (2009) and Uysal (2011) have focused on how the deviation from optimal capital structure is reflected in acquisitions. Harford et al. (2009), at first, found clear evidence that acquisitions companies do not want modify their target capital structure because of the costs of readjustments. They state that companies tend to tailor the consideration in a way that it would help them to reach the target leverage ratio or at least not to deviate more from it. Thus overleveraged companies are more likely to use equity and the underleveraged prefer cash.

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Apart from financial synergy achieved by firms’ movement toward an optimal capital structure, post-merger performance can also be improved by changes in absolute financial leverage. Uysal (2011) additionally found interesting results that overleveraged companies are less likely to make acquisitions, but that those acquisitions are also more value-enhancing and receive higher abnormal returns at announcement. Overleveraged companies tend to redress the balance by issuing equity, if they are planning acquisitions in the near future (Uysal, 2011). He also reported lower premiums paid on targets in acquisitions where acquirer is overleveraged and lower probability of using cash. He observe that also if overleveraged companies are less likely get their bids accepted they are still able to capture the value better than underleveraged companies. In the post-merger, underleveraged companies seem to increase their leverages, but Harford et al. (2009) observed that also overleveraged companies will move towards their target capital structure after the acquisition. Harford et al. (2009) noticed that during the 5 year time period after the acquisition overleveraged companies have heavily cut their debt ratios. It seems that companies do follow trade-off theory but may differ from the optimal capital structure if needed to secure the success in acquisitions. Almazan et al. (2010) reported that companies located in industry clusters with higher competition on possible acquisition targets have larger cash balances and more financial slack and those companies also execute more acquisitions than their peers. More recently, Bouraoui and Ping (2014) have observed that leverage changes have a negative impact on performance, in both the short and long run after Mergers & Acquisitions, indicating that financial flexibility contributes to acquirers’ post-merger performance. The results also show that acquirers with movement toward target leverage ratio enjoy better performance after M&A, but the correlation is not significant in the long run. Therefore, high financial flexibility created by low leverage is more essential to acquirers facing costly and sophisticated post-merger integration, than target leverage ratio that minimizes financing cost immediately. These arguments suggest that acquirers’ post-merger performance are improved by an adjustment toward target capital structure. The positive relationship, between firms’ performance and adjustment toward target leverage ratio, has been supported by optimal capital structure theory and most empirical studies (Harford et al., 2009; Yang et al., 2011). However, adjustment in absolute leverage ratio is confusing in its effect on performance. On the one hand, increasing leverage ratio shows acquirers’ increasing debt capacity, and allows them to enjoy more leverage benefits, and therefore improves firm value as a whole (Maloney et al., 1993; Ghosh and Jain, 2000). On the other hand, reduction in leverage ratio contributes to post-merger performance by creating more financial flexibility, and ensuring future investment (Lang et al., 1996; Yang, 2011; Huang et al., 2011). Another area that sellers often don’t think about is the adjustments made to the deal

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after closing. Most often this is in the form of a working capital adjustment, which occurs when the working capital (receivables and inventory minus payables) on the estimated balance sheet seller provided at closing doesn’t match up with the actual balance sheet that the buyer prepares at a later, agreed-upon date (usually 30 to 60 days after closing). Buyer and seller do a working capital adjustment to true up (reconcile) their accounts; this adjustment is typically (though not always) minor. If the actual working capital comes in lower than the estimate, seller refunds a bit to buyer (often by knocking some money off the purchase price). If the figure comes in higher than the estimate, buyer cuts seller a check. Why take working capital adjustments? Simply put, working capital is an asset, and if less of that asset is delivered at closing, buyer is due a discount from the agreedupon purchase price (and vice versa). Without a working capital adjustment, seller would have every incentive to collect all the receivables (even if done at deep discounts), sell off all the inventory, and stop paying bills, thus inflating payables. In the evaluation process, as anticipated in the analysis of economic and financial feasibility of the Plan, the acquisition team has to draw the attention if the synergy motives may allow the combined company to have a positive NPV. The valuation decision is treated as a capital budgeting decision using the Discounted Cash Flow (DCF) Model. In the evaluation of the feasibility of M&A, according to the model of stratification of the value we can reported the equation (Massari, 1998; Zanetti, 2000):

NPVacq = Wacq – P – Ci – Ct Where;

Wacq= Wtarget + WS + W Δ risk + Wop Wtarget = target stand alone value; WS = value of synergies; WΔ risk = value of the risk spread; Wop = value of new opportunities; P = target price; Ci = integration costs; Ct = transaction costs. Anyway, the NPV analysis is useful in post-merger phase, to monitor systematically if the acquisition is creating/destroying value and to examine potential corrective measures to turn the tide rapidly. In pre-merger evaluation, the Price represents the price that the acquisition team estimates adequate to the target stand-alone value. In a post-merger analysis, it will be the real price payed.

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The integration and reorganization costs (Ci) are related to every activity needs to realize the success of the investment. These costs are associated with exit or disposal activities, which do not meet the criteria of discontinued operations. They include costs for employee and lease terminations, facility closing or other exit activities. Additionally, these costs include expenses directly related to integrating and reorganizing acquired businesses and include items such as employee retention costs, recruiting costs, certain moving costs and several duplicative costs during integration and asset impairments. These costs are forecasted for the first post-merger period; the integration activities planned for the different years post-merger will contribute to the definition of the cash flows to discounting. Mergers, acquisitions and divestitures are major financial transactions that involve numerous and significant transaction costs (Ct) and expenses along the way. These fees and expenses can have a major after-tax impact on the final cost of a transaction. Both buyers and sellers incur various costs in connection with a business combination. These costs can include professional service costs are primarily legal, accounting, advertising costs, investment banking fees, particularly fees paid only on the successful completion of a transaction (success-based fees), paid to either traditional investment banks or private equity firms or related entities. The primary concern to taxpayers incurring transactions costs in an M&A transaction is the ability of the taxpayer to receive a deduction for the costs. These kind of costs also include regulatory and filing fees and transaction financing fees. Synergies evaluation The value of acquisition (Wacq) is the strategic dimension of the M&A evaluation process both for the uncertainty and risk that its different components could express. Between these, synergies evaluation craves careful attention. Synergies are the more important rationale in the acquisition strategy, the more critical aspect in acquisition evaluation process and the more dangerous “deal killers” (Faulkner et al., 2012). In the analysis of historical results in term of M&A value creation, investors they have some skepticism regarding the existence and the value of the acquisition synergies (Damodaram, 2005). The synergies evaluation, therefore, is difficult and risky because the management overestimate them by giving the illusion of value creation (Christofferson et al., 2004). Some scholars discuss the way to evaluate synergy by avoiding overestimation risk. The management has to define a first draft in the acquisition plan and then to update the value through the due-diligence process. Synergies that lie close to the center tend to be cost saving and can be realized quickly and are likely to succeed. On the other hand, revenue generating synergies, which require greater time and management and are less likely to succeed. In the synergy evaluation, process must be considered requirement investments need to capture the synergies (McKinsey et al., 2010). The implementation costs and negative effects arising from potential conflicts in the company involved may nullify

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the synergy value. As has already been said many times, acquisition team tends to have an optimistic view about the value and timing of the synergies (Christofferson et al., 2004; Cullinan et al., 2004). The value of the synergies can be obtained both in direct and indirect procedure. With an indirect perspective, it is possible to quantify the total value of the synergies as difference between the value of the combined firm, with synergy and Value of the combined firm, without synergy. We can realize a direct synergies value if the effects of synergy are built into expected growth rates and cash-flows by discounting expected cash flows to each firm at the firms involved in the merger are valued independently, by discounting expected cash flows to each firm at an appropriate discount rate. In this way, we can obtain the value of any specific synergy. Regarding this direct way, for every kinds of synergies, there are different assumptions for the evaluation that must be revised in relation to new information, which may become available long the acquisition process evaluation. The synergies evaluation process has to define the following assumptions: • Potential Value-synergy’s effect on the combined cash flows. • Timetable to implementation. • Probability of being realized. • Discount rates. • Requirement investments. Regarding positive effects of the acquisition, of course, the acquisition team provides the evaluation only for rationale motives. In the estimation of potential value, the synergies can be divided into two categories: cost and revenue synergies. In almost all transactions, the acquisition team identified cost synergies, especially for economies of scales, whose the quantification is more reliable. Some kinds of costsaving, such as in manufacturing, in procurements and in administration, especially in term of staff-costs reduction, could be easily quantifiable; while in sales and marketing, the evaluation could have more uncertainty because the market influence. If the acquisition team has to value of revenues synergies generating, the reliability of evaluation and the overvaluation risk growth. The definition of the time and probability of the cost saving need more attention. The first key question is about when any kinds of synergy is reasonably expected to start affecting cash flows. The risk to anticipate the period of the realization of the cash flow over evaluate the real value. In addition, the probability of chances of being realized can change the value of the cash flows produced. This uncertainty must be considered in the choice of the appropriate discount rate for calculating present values. Corporate finance studies give more attention on the appropriate discount rate in the investment evaluation (Damodaran, 2009; Brealey et al., 2015). As discussed before, any synergy could have a different reliability level; one of the

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more important assumptions is the cost of capital configurations, with the lower risk free for the fiscal synergy, as deductibility of losses, and the opportunity cost to discount the uncertainty of revenue synergies. The discount rate used should match the risk associated with the free cash flows. If the expected free cash flows are highly uncertain, this increases risk and so the discount rate. We can observe that the discount rate is one of the more important driver in the evaluation and there are different cost of capital configurations (fig. 7). Fig. 7. – Synergies and discount rates Synergies Cost reduction high reliability Cost reduction low reliability Cost reduction uncertain Tax-savings for losses deducibility Tax-savings uncertain Other Financial synergies uncertain Revenues increase Revenues increase uncertain

Discount rates Cost of debt Wacc Cost of equity Free risk rate Wacc/Opportunity costs Wacc/Opportunity costs Wacc Opportunity costs

Cost of capital depends on the mode of financing used – it refers to the cost of equity if the business is financed solely through equity or to the cost of debt if it is financed solely through debt. Many companies use a combination of debt and equity to finance their businesses, and for such companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC-Damodaran, 2009; Brealey et al., 2015). When the uncertainty of expected free cash flows is high, the opportunity cost could be useful to discount them. In acquisition investment, synergy is so seldom realized because it is incorrectly valued, with an inadequately timing planned. However, they are much more difficult to create in practice than it is to compute on paper (Damodaran, 2005). The more important acquisition drama is related to synergy value and so determining how much to pay for the synergy. The value of the risk spread (WΔ risk) The acquisitions produce changes on operating and financial characteristics of the undertakings concerned and therefore on the risk profile, in particular: – Market risk. – Economic risk. – Financial risk.

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Regarding the market risk, the acquisition could produce effects on revenues cyclical nature of sales and/or sales variability. If a company is able to reduce revenues cyclicity, the Beta may decrease with effects on the shares value. When the acquisition can diversify specific risk, it can reduce the revenues variability. For example, for an acquisition that could plan the production in different locations, by reducing natural disaster risks or cross-border transaction to manage the change risk. Anyway, these effects on the risk degree must be compared with the other factors analysed above (price). Furthermore, the conglomerate structure produces some negative effects on economic risk, in terms of costs of bureaucracy and inefficiencies of the large enterprise. Regarding the economic risk, the aim is to reduce the fixed costs impact and the break even point value. The importance of control financial risk was discussed in various part of this chapter, in terms of failure risk and the strategic role of leverage control in pre-merger and post-merger capital structure. Changes of risk and economic market are reflected on Beta and so on equity cost. Any reduction of the financial risk has a positive impact on the debt costs and cost of equity, with a lower WACC in the discounting process (Damodaran, 2009; Brealey et al., 2015). The value of new opportunities (Wop) In the corporate acquisition process some strategic real options for the acquiring companies could be revealed. The idea of real options is an old one, but the term “real options” was introduced in Myers, (1977), four years after Black and Scholes presented their famous option pricing formula for European financial options (Black and Scholes, 1973). Since the coining of the term, using option valuation models to frame analogous real investment problems has been growing and real options are a subject of increasing attention among academics and practitioners. The real options are those that exist on the strategic level and are different from the real options, which reside within the acquisition candidate companies as stand-alone. Some authors have considered acquisition synergies as real options and as sequential real options to acquisition timing and the rather special case of acquiring businesses with divestible non-core assets (Smith and Triantis, 1995). They discuss strategic acquisitions that create real options able to increase upside potential, while truncating downside risk. They argue that synergies have an effect on the growth options that an acquirer has on a target. They state that in the long run, the success of an acquisition program is determined by the options acquired, created, or developed and the actions taken for the optimal exercise of these options. In their studies, they identify three classes of real options important in acquisitions: growth options, flexibility options and divestiture options. If synergies are the additional new real options (the possibility to create synergies) brought to the table by the acquiring company, then acquisitions can be NPV positive, even if fair price (even with premium) is paid for the target company, and win-win. This means that when acquisition synergies are priced they

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should be valued as the real options that the acquiring company brings to the acquisition process plus the added value of strategic capital. Viewing synergies as options is in line with reality, as synergy benefits are not given (do not auto-generate), but most often require investments and their size is uncertain. In the acquisition strategy, the evaluation process might also consider some supplementary opportunities that the transaction could open in the future. So, for example, the new structure might give the opportunities to enter in a new market, to realize an innovation, a new product. Frequently there difficulties to hypnotize the value but also the timing. Therefore, they are initiatives expected to generate more new investment opportunities in the future than synergies, as defined beforehand. With this in mind, the high evaluation difficulties and the uncertainty on the final result of the differential options lead to an avoidance in an estimation in the project feasibility analysis. Target evaluation 3 Although numerous viable finance manuals expose methods for assessment of a company or more generally of an investment opportunity, in fact the most used in practice are essentially two: the method of discounting cash flows and market multiples method (inter alia, AICPA, 2007; Damodaran, 1994; Damodaran, 2012). The method of discounting CASH FLOWS is defined for practice DCF (Discounted Cash Flow). This approach is based on the expectation of future cash flows of the initiative (or the company) for a certain period (eg. 5 years) and their conversion into a present value that is determined by dividing the cash flow of each period for a discounting coefficient. The discounting coefficient reflects the required return by the investor to invest capital in the initiative. With reference to the above, if the evaluation is made from the point of view of the shareholder and then referring to the cash flow to equity (FCFE), the coefficient of actualization is the Ke. If the evaluation is made from the perspective of a company and then with respect to cash flow to the firm (FCFF), the coefficient of discounting the WACC. At the end of the period of cash flow forecast (plan period or explicit period), it is estimated the scale value at the company that corresponds to the value of future cash flows at the end of the plan period. The value so determined is then discounted using the same discount factor used in explicit period and added to the present value of the cash flows of the plan period. Under the DCF methodology there are three different approaches: the method of compounding, this method is used when there are no prospective cash flows to grow or are expected to grow at a constant rate. If the expected growth is zero, the value of the initiative corresponds to the perpetual capitalisation of constant cash flow. W0,FCFF = FCFF0/WACC W0,FCFE = FCFE0/Ke 3

On these issues, we reports some essential considerations.

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Where: FCFF0 = Free cash flow to the firm at time 0 Wacc = Weighted Average Cost of Capital Ke = Cost of equity If the expected growth is constant, you must first extract the manufacturing growth rate over the last 5-10 years and on the basis of this rate estimate prospective cash flows: W0,FCFF = FCFF0 (1+g)/ (WACC – g) W0,FCFE = FCFE0 (1+g)/ (Ke – g) The method of evaluating variable growing many companies go through periods of strong growth, followed by a phase of slower growth and stable. In practice, in order to assess this type of companies you add two components: the present value of the cash flows of the period of strong growth, corresponding to the period of the plan (or explicit period) and the present value of cash flows generated during the period of stable growth, when cash flows are at peak (Terminal value). The Terminal value is determined by using the model of Gordon, consisting in the perpetual capitalisation of cash flow, where the capitalization rate is estimated as the difference between cost of capital and cash flow growth rate over the plan period. In summary: W0,FCFF =

FCFFt

 (1  WACC) t 1

Where:

t



Pn (1  WACC )n

Pn = FCFFn × (1+gn) / (WACCn – gn) gn = growth rate

For the purposes of determining the investment opportunities, the estimated growth rate in cash flow regime is an important factor. Given the level of subjectivity in estimation of the growth rate g, you should always override this parameter to a sensitivity analysis in the context of determining the value of the initiative. This means give a range of values for this parameter and verify the changing value of the initiative with the variation of that parameter. The long-term growth rate, normally is less than or equal to the rate of growth of the industry in which the company operates to evaluate or rate of growth of the economy as a whole. In practical terms, the growth rate may be determined with reference to the weighted average historical growth rates of the company or industry, purified from exceptional events. In summary: g = (tn/t1)1/n – 1

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To establish the length of the explicit period of plan in determining cash flow, intuitively you may agree that this period should be the longer the greater the difference between the current rate of growth of the activity to be evaluated relative to the longterm growth rate. Another rule of thumb frequently used in practice is that if the scale value represents a very high percentage of the total value, for example if it exceeds the 70-80%, we recommend that you extend the explicit period so as to reduce the incidence of terminal value in the overall rating. The Market Multiples Method is a scientifically much less solid than the discounting of cash flows but that, despite the objective limits arising, is widespread in practice for the evaluation of M&A operations. This method is based on the principle, not always acceptable, that the value that the market recognizes to a certain business incorporates all available information related to different business but with similar characteristics (such as belonging to the same industry). Based on this approach the value of a particular business is determined by applying measures of market value of other companies in the same industry to the company to evaluate. The measure most frequently used in M&A is the ratio of companies of the same sector EV/EBITDA or recent transactions relating to companies in the same sector. A more scientific approach to assessment would suggest using this method solely as a method of controlling the value obtained with an analytical assessment and specification of the target company. The comparable companies’ method involves identifying the part of the analyst of listed companies that are substantially similar to the company to evaluate. The advantage of this method is that for evaluation based on objective market values. The limit is that in practice it is almost comparable with respect to locate companies will actually seeing company to be evaluated in terms of products, markets, size, indebtedness, etc. The comparable transaction method is conceptually similar to the above but the multiples used to estimate the value of the target company are referred to recent sales transactions of comparable companies. The main limitation of this method, of course, is the ability to locate comparable companies will actually have been recently transaction object. Buyers would take possession of a business that has been severely hampered by the previous owner. Buyers then have to spend money to rebuild inventories and pay off the old bills and don’t have the benefit of receivables.

e) Family control: both strength and weakness Regarding the “Strengths”, some scholars recognize the family firm’s tendency to make acquisitions as an expression of their long-time horizons, given their interest in transferring the business to future generations (James, 1999). The convergent expectations between shareholders and managers reduce agency conflicts in family businesses, especially when the level of family control is high (Villalonga and Amit, 2006). According to agency theorists (Shleifer and Visny, 1997), in fact, a higher dimension of the majority interest gives more powers to control managers’ decisions. The family

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nature can fertilize some “Opportunities” and produce some effects on the firm’s strategical choices (Corbetta and Salvato, 2004). Family firms’ behavior, therefore, follows a strategic orientation imprinted by the family culture (André et al., 2014; Miller et al., 2010). According to a resource based view, the family-specific social capital (Miller and Le Breton-Miller, 2005) represents an essential opportunity in M&A activity, also for the continuity and stability of strategy afforded by the family. On the other hand, M&A operations require huge investments and they may generate enhanced costs of integration, producing important effects in terms of uncertainty and risk (Sitkin et al., 1996). A part of literature shows, in fact, that the family nature can express some “Weaknesses” and “Threats” for the growth strategies. In term of weaknesses, an intense merger activity could produce a dilution of the family control in the company’s capital (Bianco et al., 2009; Bauguess and Stegemoller, 2008). The fear of diluting family control prevents the businesses from using new finance to support acquisitions (Caprio et al., 2011). Moreover, the preference towards family members in decision making positions, regardless of their managerial preparation, by confusing property with capacity, more than professional managers (nepotism), can produce a lack of managerial competence (Jaskiewicz et al., 2013). Family directors, in fact, have a greater aversion towards transactions characterized by greater uncertainty and, therefore, by higher levels of risk. They could decide to avoid important strategic decisions, such as an acquisition, and to manage the company as a family (informality and lack of discipline), only with the intention of transferring the same business across future generations (Bianco et al., 2009). The family control, which is responsible for the aforementioned family firms’ peculiarities, could be more efficient with a higher family participation. In fact, important studies note that the extent of family ownership determines some strategic actions of the family firms (Caprio et al., 2011; Miller et al., 2010). Other contributions highlight that when the family participation in ownership and in management is high, the presence of non-professional (family) managers in the executive committee, with less adept skills to manage the complex acquisitions processes (Claessens et al., 2002), is more frequent. Bernini et al. (2016) show that the proportion of shares owned by the family does not significantly help explain the number and the frequency of M&As, even if the sign of the coefficient is always negative. However, they observe that “frequently acquiring companies” have a lower family presence on the Board of Directors. A smaller family presence in the executive committee is associated, finally, with a lower frequency and number of M&As. The family control on the decision-making positions could be a threat for an external growth strategy: the lack of entrepreneurial talent (Le Breton-Miller et al., 2015) and the high-risk aversion could represent a deterrent to manage the acquisition process. The richness of the non-economic relationship, linked to the resource endowments of the family, with professionalization enriched, could fuel the external growth investments (Craig et al., 2014). Moreover, the valuable reputation and the social

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capital could be recognized as a guarantee for the financiers, to support the high investments of the deals. The presence of the patient capitals, the social capital, the continuity and stability of strategy, could be important strengths also to support acquisitions for the market, producing even better effects on the level of the risk.

2.2.2. Weaknesses a) Cultural disparity 4 Mergers are apt to be more successful if both organizations focus on resolving corporate culture issues (i.e., integrating both the cultures of the employees and the organizational cultures): post deal period severely hindered their chance of deal success, compared with those who dealt with them early in the process (Rottig et al., 2014). One of the prime causes of failure is the lack of integration of both the cultures of the employees and the organizational cultures (Weber and Tarba, 2013). Effective integration requires either the people element to work, but not enough attention is paid to the organizational cultures within which the people work or the internal values (embedded cultural orientation) of the employees that drive how they approach the integration. Despite these widely known facts, organizations typically (Rottig et al., 2014): • Conduct insufficient cultural due-diligence post-announcement, even though it is possible and practical to: measure and compare the current organizational cultures, and agree on a “vision” for the merged organizational culture. • Assess whether the internal values of employees will be a help or a hindrance in moving toward that new/vision culture. • Have arduous and lengthy processes to define and communicate the new strategy and direction (this often takes months). • Do not have enough access to the data on which to make informed decisions about the strategy by which to define the new organizational structure. If the current culture of the two organizations considering joining is radically different, the integration will take longer and be more painful for employees from both organizations. Even if an organizational cultural assessment was conducted on the “now” cultures of the two organizations during due diligence, the same analysis can be conducted with a view to the “vision culture” (i.e., what each organization believes to be the direction of change). Ironically, this discussion rarely occurs, which is why each party is left wondering why the other is going off in a separate direction; each is operating on a different perception of what “should” happen. Defining the target of the 4 On

these issues, we reports some essential considerations.

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new organization and aligning expectations is key to assuring that all the subsequent integration activities are aligned.

b) Management narcissism As discussed above, the management hubris is a more debated irrational motive (Roll, 1986). Some authors have studied how that management personality significantly influence information processing and decision-making. In the different facets of personality, CEOs narcissism could have a great influence in strategic decisions (Chatterjee and Hambrick, 2007, 2011). Narcissism—the degree to which an individual has an inflated self-view and craves affirmation of that self-view (Raskin and Terry, 1988; Campbell, 1999) tends to give to CEOs excessively confident about their intelligence and judgment and to be arrogant and disagreeable (Rhodewalt and Morf, 1998; Billett and Y- Qian, 2008; Campbell and Miller, 2011). They also seek continuous affirmation of their inflated self-view by exhibiting their superiority, devaluing others and reacting aggressively to criticism (Paulhus and Williams, 2002; Carlson et al., 2011). Zhu and Chen (2015) suggest that narcissism is likely to influence a CEO’s learning based on prior experience with corporate strategies on other boards and may affect the CEO’s processing of information related to fellow directors’ prior experience with these strategies. More-narcissistic CEOs are tending to adopt corporate strategies that are similar to those they have witnessed themselves on other boards, past experiences. In addition, more-narcissistic CEOs are less likely to be influenced by corporate strategies witnessed by fellow directors on other boards. In addition, these effects are strengthened if the other firms to which the CEO has interlock ties have high status and if the CEO is powerful. Through longitudinal analyses of Fortune 500 companies’ decisions (from 1997 to 2006), the authors have found that narcissistic CEOs’ desire to exhibit superiority and reaffirm their self-image tends. When deciding the focal firm’s corporate strategies, they find inspiration by their own prior experiences and less on the prior experiences of other directors.

2.2.3. Threats and Opportunities 5 a) Environmental characteristic In this critical period every debate, or publication, has a common denominator: the match crisis-opportunity. The discussion is lively on what may be the best strategies to create value and to “react” to the crisis (Wan and Yiu, 2009, Cartwright and Schoenberg, 2006). Entrepreneurs and policy makers are debating on the real contribution that merger and acquisitions can play on the value creation process (Bigelli and Mengoli, 1999) and on 5 On

these issues, we reports some essential considerations.

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the different factors of attractiveness that a market in recession can present, including the opportunity to deal underestimated targets (Granata and Chirico, 2010). If the crisis “can be a real blessing to any person, to any nation and if all crises bring progress” (Einstein, 1955) in these global financial crisis (GFC) the debate is on what strategies can help the companies to “react” (Cartwright and Schoenberg: 2006), but especially to create value. The crisis must be lived as an opportunity (Braden et al., 2005; Wan and Yiu 2009). Thus, the crisis must be addressed as a moment of deep analysis, of repositioning, of skimming, to identify growth opportunities. The companies can promote strategies of innovation, internationalization, globalization, strategic renewal, to reduce cost, to enter into new markets, to create value. This interpretative key of the crisis, acquires interest in the companies that Churchill would have defined “optimistic”: in any “danger"” they see an opportunity! They don’t play only in defense, but especially with a constructive attitude: they are looking for situations that can create value, including the corporate acquisitions. Nevertheless, many studies emphasized the critical effects that this typology of investment can have on performance and on risk, but also on the stakeholders system (Cartwright and Schoenberg, 2006; Datta et al., 1992), further compounded in the case of environmental jolt, as the current one (Wan and Yiu, 2009; Park and Mezias, 2005). Previous studies (Chevalier and Redor, 2005; Lubatkin and O’Neill, 1987; Saikevicius, 2013) shows that, during downturn periods, managers and stockholders turn to more risk-adverse positions and set a higher capital cost than there is during growth periods, thus decreasing the number of M&A. However, this reduction does not necessarily mean that also the decrease in quality of the transactions should take place simultaneously. In fact, that smaller number of transactions, higher risk-adversity of dealmakers as well as higher cost of capital required, should result in transactions, which are less opportunistic and have clear strategy of value creation. There is no evidence found in the investigation that transactions concluded during crisis period create more value than those at the pre-crisis period.

b) Legislation The regulatory framework and fiscal stance, indeed, plays a fundamental role in the acquisition decisions and in the market valuation of these operations (Feito-Ruiz and Menendez-Requejo, 2010). Previous studies (Feito-Ruiz and Menéndez-Requejo, 2011; Siems and Simon, 2010; Chen et al., 2011) show that the volume of M&A activity is significantly larger in countries with better accounting standards and stronger shareholder protection. The probability of an all-cash bid decreases with the level of shareholder protection in the acquirer country. In cross-border deals, targets are typically from countries with poorer investor protection than their acquirers’ countries, suggesting that cross-border transactions play a governance role by improving the degree of investor protection within target firms.

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The Italian setting is also worthy of exploration in order to study M&A strategies, because the Italian legal framework could make the pre-acquisition negotiation more difficult, so increasing the risk linked to the success of the operation (Feito-Ruiz and Menendez-Requejo, 2010). In fact, a low investors protection (La Porta et al., 1998), underdeveloped equity markets and very high ownership concentration characterize Italian corporate governance regime. In this context, minority shareholders need a higher return on their invested capital. Differently, in the countries when minority shareholders are protected better, the capital market is more developed and the capital concentration is lower, there is consequently a more active acquisitions activity (Rossi and Volpin, 2004). The USA occupies the first place in the world, regarding the volume of M&A activities, while China is the second player and the UK is the third. The United Kingdom has quite a high M&A level compared to the rest of Europe, thanks to more laissezfaire attitude of the British Government towards mergers and acquisitions and a stronger stock market influence in society. It should be noted that corporate acquisition development is strongly influenced by the lively financial market in which the bidder can intercept the financial support for the needs of such operations. In both Britain and Germany, politicians tend to let companies get on with merging and acquiring unhindered. Britain has long welcomed foreign investors, even those interested in corporate icons. Germany, too, has largely resisted the temptation to resort to economic nationalism, though hostile bids are still frowned upon, even after Vodafone's highly controversial contested takeover of Mannesmann in 2000. However, the rise of cross-border deals has unleashed a wave of protectionism as governments attempt to protect old national treasures and create new ones. France, also, unveiled plans to use a stateowned investment fund to block future foreign takeovers. The French government has produced a list of 11 “strategic sectors” that it thinks should enjoy legal protection from takeovers. Other members of the European Union have talked about throwing up barriers too. Spain’s government, for example, has been trying to encourage a homegrown utility deal similar to the Suez/GdF tie-up, to prevent a German company from getting its hands on Endesa. Poland has resisted a banking merger driven by foreigners. Italy has talked about increasing protectionism in response to the French and Spanish moves, always in the bank system. Although the EU’s bureaucrats in Brussels have reacted with alarm to these growing distortions of the market, they can do to counter the brute force of economic nationalism. The European Commission has few powers in such cases, other than persuasion and the remote threat of lengthy court proceedings. Yet, countries, which decide that “strategic” industries need cosseting, do not have it all their own way. There are encouraging signs that business is fighting back against the forces of protection.

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c) Financial market The changes regarding regulation are important determinants of the merger and acquisition waves. It is considered (Martynova and Renneboog, 2005; Gregoriou and Renneboog, 2007) that the first waves, those of the 1890s and ’20s, were generated by the antitrust laws while those of the ’90s seems to have been generated by the markets’ large scale deregulation. In the last years, the merger and acquisition activity concentrated on sectors making the object of deregulations, for example financial services, health, utilities, media, telecommunications or defence. There are in the literature significant proofs regarding the fact that the merger and acquisition activity is intensified in the deregulated sectors as compared to the regulated sectors (Jensen, 1988; Mitchell and Mulherin, 1996; Mulherin and Boone, 2000). The deregulation has eliminated the artificial barriers within these sectors and stimulated competition (yet, it had other effects, negative). The evolution of these operations is characterized by recurrence, in other words, the succession of intense activity periods followed by periods when only few transactions are recorded. Current operations are different from those of few years ago, both in what the size is concerned and their internationalization, a consequence of an economy subscribing to the tendency of globalization. Thomson Reuters recorded a total of 752,000 deals around the world from 1985 to the end of 2012, demonstrating the enormous scale of this phenomenon. It is typical of the Anglo-Saxon countries, which traditionally have more evolved financial markets. Over the last several decades, they have also had a significant increase also in the rest of Europe. In the last years, this phenomenon has assumed a worldwide dimension, with Asia and Africa that have become strategic players in acquisition activity. Moreover, Gaughan (2002) and other scholars have emphasized that M&A typically occurred in cyclical patterns, merger waves: periods of intense merger activity have been followed by intervening periods of fewer mergers. Empirical studies in the literature have shown that there is a strong correlation between the evolution of stock exchange markets and the merger and acquisition activity, many operations taking place in periods of stock exchange euphoria (Jensen, 1988; Mitchell and Mulherin, 1996; Mulherin and Boone, 2000). Gugler et al. (2012) gave evidence that stock market booms and merger waves are both driven by increases in optimism in the financial markets. They underlined that optimism in financial markets explains the volume of assets acquired through mergers in a period. In Europe, the United Kingdom, that traditionally has financial markets more evolved and thanks to more laissez-faire attitude of British Government towards mergers and acquisitions, has higher development of corporate acquisitions, with better performance. Mariani et al. (2015), in their comparison between British and Italian acquisition behaviour, found that UK companies are more active, their M&A operations fluctuated widely year to year in comparison with Italian “merger waves”. They

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completed almost three times as many operations as Italian firms did. It may be noted that the presence of a more efficient financial market and a favourable governmental attitude had spurred external growth. Both in the UK and Italy year 2009 was the worst year for M&A operations. Since 2009 an upswing in the number of transactions in both countries has been observed. Italian companies are less active, but more cautious, confirming the more conservative and risk-aversion behaviour. In an environmental jolt, where there is a capital rationing, they responded with a contraction of M&A deals since the first period, anticipating “the quiet period” of the waves. Unlike other companies, they showed an aversion to high-risk operations only later. In fact, the drop in number of M&A deals in Italy started a year earlier (2006) than in the UK (2007). British businesses showed dimensional growth objectives for strengthening the economies of scale, aiming for a product-driven strategy. In 76% of cases they made mergers, aiming for a horizontal expansion. In expansion of core businesses they preferred vertical integration (59%), especially forward vertical integration (about 70%). Italian companies chose a “market-driven” strategy, the specialization that characterizes Italian manufacturing economy strongly influenced by Far East production price competition. This behaviour is observed under the performance lens. UK companies that made vertical integration (or vertical mergers together with horizontal) showed better performance. The number of companies with improved ROI is bigger than with the worsened. This fact can be explained by obtaining all the advantages that vertical mergers give to the bidder, such as a greater degree of vertical integration, certainty of supply or market outlet, an increase in market power and many others (Klein et al., 1976). Regression analysis shows for British firms strong correlations between the value of ROI and Tobin Q and the cross-border M&A, highlighting that during the crisis the opening to foreign markets allows companies to cope with recessionary effects, or, at least, to defend themselves. For Italian bidder corporate acquisition produced neutral effect on accounting and market performance. They highlight that horizontal operations produced better effect on ROI due to the economies of scale, but the market recognized more value for vertical integration (Tobin’s Q), according to Nocke and White (2010), who showed that some downstream buyers may be more “disruptive” of collusive schemes than others. For Italian companies only cross-border activity presented a significant correlation but with a negative sign. The active companies, internalizing synergies from information based assets via geographical diversification, could underestimate the problems of post-merger integration due to cultural dissonance (Conn et al., 2005). In their study, the investment required for the acquisition strategy for about 90% of the companies did not create value. In Italy, despite the still sluggish economic recovery and the financial markets volatility, the buoyant activity of the first months of the year and the confirmed interest of

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M&A and Value Creation

foreign operators (financial investors and private equity funds for Italian targets), are grounds for cautious optimism on the favorable moment that the Italian M&A market has been enjoying since the end of 2013. The Italian M&A market of the 2016 was also moved by the deals generated by private equity funds that were still pending. Those inefficacies bias the estimated discount rates use in evaluation process (§ d1).

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CHAPTER 3

An empirical lens-Case Studies

SUMMARY: 3.1. Introduction. – 3.2. Case 1: Amplifon’s acquisition behaviour. – 3.3. Case 2: Autogrill’s acquisition behaviour. – 3.4. Case 3: Campari’s acquisition behaviour. – 3.5. Case 4: Luxottica’s acquisition behaviour. – 3.6. Case 5: Reply’s acquisition behaviour.

3.1. Introduction The aim of this chapter is to analyse some case studies of Italian “serial acquirers”, to investigate the kind of strategies that have given impulse to the deals and their effects on performance. According to Kumar and Peiro (1994), the case study method is an extremely useful approach for the twin purpose of exploring the managerial tasks and contextual factors. Therefore, this methodology is able to show the inter-relationship and the description of the dynamics of the integration process on the other. Regarding the methodology, we have developed the analysis in four steps. At first, we defined the top five serial acquirers as the companies that made 5 (Italian average) or more deals during the period 2007-2015, based on data provided in KPMG reports (tab. 4). Tab. 4 – The top five “serial acquirers” (2007-2015) Serial acquirers

n. deals

Amplifon

8

Autogrill

6

Campari

11

Luxottica

9

Reply

10

Italian average in the period

5

In the second step, we defined for every bidder the details of the acquisition activity during the considered period, with the information by Zephyr and Datastreem. To

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M&A and Value Creation

analyse the strategic behaviour of every company, we sent a personalized questionnaire filled during a direct phone interview to the corporate finance managers, directly involved in the deals. (Appendix 3). They are companies with family control on the ownership and in administrative roles. The aim of the third step was to evaluate the performance effects. Instrumental data for the creation of performance indicators (deducted from the financial statement and market prices) and risks were produced from Datastream database, the site of the Italian Stock Exchange, YahooFinance and companies website. According to Martynova et al., 2006, the performance effects are measured with indexes accounting and market based, with a long-term perspective. In tab. 5, the different accounting and marked based parameters chosen for the performance analysis are described. Tab. 5 – M&A performance measures Accounting based

Description

SALES

Total revenues in the year. Source: Datastream.

ASSETS

Total current assets, long-term receivables, investment in unconsolidated subsidiaries, other investments, net property plant and equipment and other assets. Source: Datastream.

ROA

Return On Assets. Source: Datastream.

ROE

Return On Equity. Source: Datastream.

ROI

Return On Investment. Source: Datastream.

EBITDA

Earning before Depreciation and Amortization. Source: Datastream.

EBIT

Earning before Interest and Taxes. Source: Datastream.

LEVERAGE

(Long Term Debt + Short Term Debt & Current Portion of Long Term Debt)/ Common Equity (AS FINANCIAL RISK INDICATOR). Source: Datastream.

Z-SCORE

Z-Score = (1.2*Working Capital/Assets) + (1.4*Retained Earnings/Assets) + (3.3*ROI) + (0.6*Equity/Assets) + (0.999*Return On Sales). Source: Datastream.

Market based MARKET TO BOOK VALUE

Market value of the ordinary (common) equity divided by the balance sheet value of the ordinary (common) equity in the company (Worldscope).

ENTERPRISE VALUE

Market Capitalization at fiscal year end date + Preferred Stock + Minority Interest + Total Debt minus Cash. Source: Datastream.

PRICE INDEX

Price of an equity as a percentage of its value on the base date, adjusted for capital changes. Source: Datastream.

TOT. RETURN INDEX

Shows a theoretical growth in value of a share holding over a specified period, assuming that dividends are re-invested to purchase additional units of an equity or unit trust at the closing price applicable on the ex-dividend date. Source: Datastream.

TOBIN-Q

Total assets – equity book value + equity market value)/total assets. Where equity market value is represented by market cap. Source: Datastream.

An empirical lens-Case Studies

81

In the light of the considerations developed above (§ 1.3), on the effect in term of failure risk that the deals could have, we added the study of post-merger failure probability level, with the evaluation of Z-Score, as a default risk indicator (Altman, 1968; Altman et al., 1977; Altman, 2000; Platt and Platt, 2002).According to Altman (1968): Z-Score = (1.2 * X1) + (1.4 * X2) + (0.19 * X3) + (0.6 * X4) + (0.999 * X5) X1 = Working Capital/Assets. X2 = Retained Earnings/Assets. X3 = ROI. X4 = Equity/Assets. X5 = ROS. We highlighted that if Z-Score is less than 1.8, the probability of corporate failure is high, while if Z is between 1.8 and 2.7 the company has a critical financial situation, with a middle-high probability of failure. The operating nature of the components described makes the Z-Score more capable and easy to explain the risk linked to the operational aspect of the business than other indicators. The research question of the case studies is to define the strategy behaviour of the bidders and to evaluate the acquisitions effects in terms of performance and on failure risk. It is important to make clear that a proper analysis of performance requires a comparison with companies comparable or with the industry average. Because of lack of other listed firms really comparable and that sometimes the company is the only quoted in the sector, we decided to avoid the match.

3.2. Case 1: Amplifon’s acquisition behaviour 3.2.1. Company overview 1 Amplifon was founded in Milan by Algernon Charles Holland in 50’s. His vision was to provide customized hearing solutions that addressed the many hearing problems developing as a result of the Second World War. With the first years of the 90’s, the company shift the focus on European expansion, by setting up Amplifon Iberica. Between 1998 and 2000, the company starts with its growth external strategy. In 2001, Amplifon is listed on the STAR segment of the Italian Stock Exchange.

1 Company

naire/interview.

information comes from their website, others documents published and the question-

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M&A and Value Creation

Through a network of over 3,650 points of sale, 3,600 service centers and 1,750 affiliates, Amplifon is active in 22 countries across 5 continents. Now it is the global leader in hearing solutions and services for retail expertise, customization and consumer care. It has the reputation as a pioneer in innovative digital technologies and continuously develops unique services, tools and protocols to offer the best hearing experience to each and every person.

3.2.2. M&As portfolio As introduced above, the Amplifon acquisition activity starts in 1998 with some transactions in Switzerland, Austria, France, Holland and in the United States. In 2002, Amplifon acquired the Sonus Corporation in the US and in 2003 the National Hearing Centres, a company with stores in big shopping centers. In the following years, with the change of its marketing strategy, it promoted some acquisitions in the Netherlands, Germany, UK, Ireland and Belgium. In 2006, Amplifon acquired Ultravox Group – an established and trusted brand in UK since 1961. In 2010, it made the largest acquisition in the group’s history. Amplifon, in fact, acquired 100% of National Hearing Care (NHC) in Australia, New Zealand and India, thus completing its presence in all five continents, becoming therefore a world leader in its sector. In 2012, Amplifon increases the territorial coverage of India. In the same year, the group enters in Turkey, through the acquisition of 51% of Maxtone society and in Poland, with the establishment of Amplifon Poland, increasing its geographical presence in 22 countries, in which it operates directly or indirectly through companies subsidiaries (tab. 6).

Germany.

100%.

1. Industrial goods and services; 2. Healthcare.

1. Automobiles and components; 2. Healthcare equipments and supplies.

COUNTRY TARGET

SHARE %

TARGET SECTOR

TARGET ACTIVITY

2

1. Knaus Tabber; 2. Group GmbH.

2007

TARGET

DEALS

2008 0

2009 1

Medical, dental and hospital equipment & supplies.

Healthcare.

100%.

Belgium.

Dialogue.

Tab. 6 – Amplifon’s deals (2007-2015) 2

1. Medical, dental and hospital equipment & supplies; 2. Offices and clinics of doctors of medicine.

Healthcare; Healthcare.

100%; 100%

Luxemburgh; Australia.

1. Auditions Luxembourg Sarl; 2. NHC.

2010

2011 0

Orthopedic, prosthetic and surgical supplies.

Healthcare.

51%.

Turkey.

Maxtone.

2012 1

1

2014

Orthopedic, prosthetic and surgical supplies.

Healthcare.

100%.

Germany.

1

Medical, dental and Hospital equipment & supplies.

Healthcare.

100%.

Italy.

Kind Hallascen- Audica Italia trum Kft. Srl-Retail Chain.

2013

2015 0

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M&A and Value Creation

3.2.3. M&As strategy Amplifon acquisition activities express primarily an internationalization strategy, with a focus on the core business and streamlining activities. The main purpose which led the company to the cross-border acquisitions is the “consolidation” of the market position in order to increase its market share and profitability. All this was possible through: • diversification of products / services (customization); • investment in technological innovation; • improvement of cost structure efficiency and standardizing operating systems. During the interview, the chief business & innovation development has observed that, regarding local market characteristics, the company has various strategies to enter into new markets. Options may be different, such as acquisitions or start-ups – on the model of Amplifon strategy in India, Turkey and Poland – including the development of local partnerships, especially where the cultural background is very different. The company’s growth strategy plot is developed in four groups of countries revolving around the two competitivity dimensions: market leadership and redditivity. In the first group, there are the countries where Amplifon has a market leadership (market share of 20%), with a very extensive distribution network. In these markets (Australia, Switzerland, the USA, etc.), where the redditivity is already high, the strategy aim is to maintain and strengthen the leadership. Amplifon’s leadership has to raise the performance level like the first group also in countries like France and Germany. In this second group, the market share and sales are not optimal. In the third group there are countries, such us UK, with critical challenges in terms of market structure and regulamentation, where the company has yet to reach an acceptable redditivity. The fourth group includes emerging countries in which Amplifon has a long term growth strategy. Amplifon’s purpose is to increase and consolidate its world leadership by improving its market share in developed countries, but also in emerging economies. At the same time, it strengthens its presence in high-potential markets, with interesting development opportunities.

3.2.4. M&As performance effects Amplifon has promoted a steady acquisition activity in the period (2007-2015), responding positively to environmental jolt (fig. 8). In this period, it has made 8 deals with internationalization strategies, by focusing on the core business. The company

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An empirical lens-Case Studies

has carefully managed the external growth, with a consolidation pause after an intense trading season (2008-2011-2015). Regarding the performance effects, firstly we have to point out that the company performance is the result of all business activities, which include corporate acquisitions. Thus, in this part we are analysing all Amplifon’s performance on the whole period considered, even if especially the share prices are very sensitive to acquisitions announcement. The M&A effects are included into the results of all the company activities, in particular in terms of accounting measures. The sales trend, for example, is a typical result of all company activities, such us marketing campaign, trade credit policies, extension of production capacities, including acquisitions. Amplifon growth process, anyway, is giving a regular positive trend of the sales, in 2015 they by doubling the initial value. Fig. 8 – Amplifon’s sales and assets trend (2007-2015) 1200000 1000000 800000 600000 400000 200000 0 2007

2008

2009

2010 SALES

2011

2012

2013

2014

2015

ASSETS

This increase is essentially due to the sales in the new foreign markets, who have contributed to the company expansion. With the exception in the critical years, 2008-2009, the sales expansion is higher in the post-deals periods: in 2010, the revenues rise of the 8% in a year, while in 2011 the company has a record (+ 17%). In the last two years, the sales trend gives up hope for the next period (2014, + 8%; 2015, + 16%). Furthermore, the assets trend shows a progressive consolidation of assets structure. According to accounting based analysis, the positive results above are backed up also in term of profitability, with an upward trend and high indexes value (fig. 9). In particular, in the last year, ROA reaches the value of 23%. Regarding the opera-

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M&A and Value Creation

tive profitability, the final ROI value is the same of 2007, also if it has a more cyclic trend rather than the previous index, with two drops in 2008 (in the heat of the financial crisis) and in 2013, then it re-grew. Fig. 9 – Amplifon’s performance: accounting based measures (2007-2015) 70% 60% 50% 40% 30% 20% 10% 0% 2007

2008

2009

2010

2011

ROA

ROE

2012

2013

2014

2015

ROI

Anyway, with an average value of 23%, it shows a healthy structure able to support company development. Ebit and Ebitda, naturally, have a significant development: in particular, in 2015 the Ebit on the sales rapport is double that of the first year (fig. 10). The profitability indexes increase is above all due to the operating margins. Additionally, the Return on Equity (ROE) trend shows that Amplifon could be a good investiment also for shareholders. Fig. 10 – Amplifon’s Ebit and Ebitda trend (2007-2015) 200.000 150.000 100.000 50.000 2007

2008

2009

2010 EBITDA

2011

2012 EBIT

2013

2014

2015

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An empirical lens-Case Studies

As explained above, a large part of literature discussed that one way of determining the effect of the merger is through the examination of the stock market value of the firms involved in the deals. Regarding Amplifon, the investors could really appreciate its acquisition strategy: with the exception of the same critical situation in 2009, the investors believe in the growth of the company (fig. 11). Price index and Total Return Index, as expressions of stock value trend on the base IPO data, marked a gradual appreciation, after the collapse of the GFC 2008-2009, although not reaching even the values in 2007. Fig. 11 – Amplifon’s market based performance indexes-Price Index and Total Return Index (2007-2015) 400 350 300 250 200 150 100 50 0 2007

2008

2009

2010

2011 PI

2012

2013

2014

2015

TRI

This consideration is hereby confirmed by Enterprise Value evolution, as a market based performance index (fig. 12). Also for this measurement, there is the drop in 2008, but expressing the annual growth, it is able to show the real increase of the market capitalization.

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M&A and Value Creation

Fig. 12 – Amplifon’s Enterprise Value trend (2007-2015) 2.500.000 2.000.000 1.500.000 1.000.000 500.000 2007

2008

2009

2010

2011

2012

2013

2014

2015

Tobin’s Q, despite being a market ratio, includes also accounting data, giving therefore a more complete expression of the value. Normally, competitive companies, with known brands and exclusive technologies, have Tobin’s Q greater than 1. If the index increases, it shows a good reception from the market. Amplifon’s Tobin’s Q varies within the range 2.57-1.50, with a more orderly development compared with the other market indexes, more susceptible to financial market trends (fig. 13). Fig. 13 – Amplifon market based performance indexes- Tobin’s Q and Market to Book Value (2007-2015) 7,00 6,00 5,00 4,00 3,00 2,00 1,00 0,00 2007

2008

2009

2010

2011

TOBIN Q

2012

2013

2014

2015

MBV

Shifting the optical analysis on the risk, we can observe that the Leverage, as expression of financial risk, is gradually reducing, by reaching the value of 0.82, in

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An empirical lens-Case Studies

2015. The company is gradually modifying its financial structure by replacing the short-term funds with long-term loans. The careful management of company profitability and financial structure is producing a positive impact in terms of Z-Score (fig. 14). Z-score, in-fact, has an exact opposite trend of the Leverage. Z-score is always in the solidity area, by reaching the value of 3.05 in the last few years. Fig. 14 – Amplifon’s default risk indexes (2007-2015) 3,50 3,00 2,50 2,00 1,50 1,00 0,50 0,00 2007

2008

2009

2010

2011

Z-SCORE

2012

2013

2014

2015

LEV

3.2.5. Amplifon’s SWOT analysis in M&As strategy As above anticipated, the positive performance considerations are the results of all the company activities, including M&As. An analysis on the different strengths, weaknesses, opportunities and threats through a SWOT approach could give more information about these results but also for the future Amplifon strategic behaviour (fig. 15). Strengths. Amplifon is the largest player in a sector with a highly heterogeneous and fragmented offer. In all countries in which it operates, it has a leadership position. Amplifon is the only operator with a geographical presence so extensive with a widespread distribution network. It is important for Amplifon customers, represented by older people (on average 70 years of age), for which the proximity to the point of sale is a decisive factor in the purchase decision. The consolidated local presence, supported by continuous marketing and advertising activities, makes the reputation of its brands very widespread. The attention to customer service quality also results in a

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M&A and Value Creation

very high degree of customer loyalty, up to 80% in Italy The company also has a qualified partnership with the more important hearing aid suppliers, with co-makerships for new products development but also for methodologies and application solutions. Amplifon has also established an ongoing relationship with the medical community (over 7,500 medical specialists in Europe) through the Centre for Research and Studies research activity, by providing biomedical equipment for otologic diagnostic and thanks to scientific communication. Weaknesses. In recent years, the company has given a strong boost to the external growth and now it is completing the integration process. As analysed above, the management began to produce positive results, however there is no guarantee to complete the integration activities with the times and the desired ways. The market for the production of hearing aids is characterized by a high degree of concentration: 6 groups (Siemens, GNResound, Starkey, William Demant, Phonax and Widex) account for over 90% of the market and all are Amplifon suppliers. However, the largest supplier is the Siemens group with 36% of the total acquired, with Amplifon dependence on the supplier companies. For the management, other critical aspects are less commercial flexibility and the small dimension of biomedical activity. Opportunities. Regarding the opportunities, the expansion of the activity is justified by the progressive aging population and the increasing need of hearing aids. Furthermore, there are cultural changes of older people both in their life style and in a weakening of the prejudice of hearing aids as a handicap. The investment in technological innovation are producing new products and medical solutions. Threats. In its development strategy, Amplifon has to manage some threats. First, the progressive horizontal integration of the suppliers are producing a supply system with an incredible bargaining position. Still on market threats, the company reports great difficulties of finding specialized personnel, notwithstanding it operates in almost every country in the world. Identification of alternative therapies for hearing difficulties. Another important threat, is the risk that some researcher might discover alternative therapies for hearing difficulties and thus the radical obsolescence of the Amplifon products.

An empirical lens-Case Studies

91

Fig. 15 – Amplifon’s SWOT Strengths

Weaknesses

    

Strong competitive position Partnership with suppliers Efficient distribution network Brand repution Good relationship with the medical profession  Centre for Research and Studies

Opportunities  Aging population  Technological innovation for new products  Cultural changes of older people both in their life style and in a weakening of the prejudice of hearing aids as a handicap

 Less commercial flexibility  Small biomedical activity dimension (in sales and market share)  Management of integration process with a lot of targets

Threats  Horizontal integration of suppliers  Identification of alternative therapies for hearing difficulties.  Problems of finding specialized personnel

3.3. Case 2: Autogrill’s acquisition behaviour 3.3.1. Company overview 2 Autogrill is an Italian-based, multinational catering company, which is controlled with a 50.1% stake by the Edizione Holding investment vehicle of the Benetton family. Autogrill runs operations in 40 different countries, primarily in Europe and North America, with over 250 licensed and proprietary brands. Over 90% of the company’s business derives from outlets in airport terminals and motorway service areas. Autogrill was founded in 1977 when SME, a division of Italian state-owned conglomerate Istituto per la Ricostruzione Industriale (IRI), purchased then merged Italian restaurant groups Motta, Pavesi and Alemagna. Pavesi had begun to operate a service area on the Milan-Novara motorway in 1947, replacing it with a bridge structure accessible by travellers in both directions fifteen years later. Having grown both domestically and through foreign acquisitions, Autogrill was privatised by the Italian Government in 1995 as IRI shed its food and beverage businesses. Edizione Holding, the financial holding company of the Benetton family, acquired 2 Company

terview.

information comes from their website, others documents published and the questionnaire/in-

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M&A and Value Creation

a controlling stake through the process, in 1995. Edizione floated the company on the Milan Stock Exchange in 1997. Now it operates in 2 sectors: Food&Beverage and Travel Retail & Duty Free. Autogrill in 2015 has reached revenues of 4.36 billion euros and 57,000 employes. With 75% of the Italian motorway catering market and respective shares of 60% and 50% of motorway and airport catering in North America, Autogrill looks well placed to preserve its world leadership in travel catering through organic growth and acquisitions.

3.3.2. M&As portfolio Autogrill has developed a constant external growth. To enter the foreign markets, Autogrill in 1993 acquired 100% of Les 4 Pentes (Elitair group-France); in Spain, Cepsa, Spain’s second oil company and Curvaceous (50%), catering company. By the end of 1998, it promotes several acquisitions in overseas markets. Autogrill had secured full control of French operator Sogerba, AC Restaurants and Hotels of Benelux as well as 14 branches of the Wienerwald chain in Austria and Germany. In July 1999, the group made its first entry into both the United States and airport concession markets by acquiring Host Marriott Services (HMSHost). Other major acquisitions by the group included the Swiss firm Passaggio (completed in 2001), 70% of high-speed train station operator (Receco in 2002) and Spanish-based airport dutyfree retailer Aldeasa, in 2005. In 2007, it closed the transaction with Altadis and Belgium’s Carestel. Autogrill acquired the remaining 50% in Aldeasa for complete control in 2008. In the same year, it also purchased Alpha Group and World Duty Free Europe and merged them with Aldeasa in 2011, to create World Duty Free Group, a super-retailer at airports. Later that year, the company was placed on the Est-European market with the acquisition of 49% of Autogrill Polska, while the year after it developed a domestic transaction with a diversification strategy acquisition of a company of media and entertainment industry (tab. 7).

TARGET ACTIVITY

3. Restaurants specializing in New York bagels and deli sandwiches.

2. Retail and catering services for airlines and airports;

1. Carries the Pizza Pause, Self Pause and Subito Brands;

Retail.

Industrial;

Retail;

100%

1

Offering five core merchandise categories including beauty, liquor, tobacco, confectionery and fine food

Retail

100%

100%;

SHARE %

TARGET SECTOR

UK

100%;

2008

World Duty Free Europe LTD

IT, UK, UK

3. Alpha2

2. Alpha Group;

1. Trentuno Spa;

3

COUNTRY TARGET

TARGET

DEALS

2007

Tab. 7 – Autogrill’s deals (2007-2015) 2009

2010 1

Restaurants, bars and miscellaneous retail outlets including groceries, cigarette, lottery ticket and newspaper that are located along motorways.

Retail

49%

POLAND

Autogrill Polska SP Z OO

2011 1

Multifunctional arena management services.

Media and Entertainment

100%

ITALY

Forumnet SPABranches

2012

2013

2014

2015

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M&A and Value Creation

3.3.3. M&As strategy Autogrill today is the leading provider of food and beverage (F&B) and retail services for travellers worldwide. It is also one of the few Italian companies having a true global footprint. The company has promoted a geographical, business and channel diversification. It has managed its acquisition strategy alternating with adjustment periods to have the possibility of proceeding with a gradual internal reorganization, with a careful attention to economic and financial equilibrium. Autogrill strategic structure evolves to anticipate and exploit key mega-trends and rapid changes in global demands. The company strongly rebalanced its market coverage, looking for channels with higher dynamism as well as markets with stronger travel flow growth rates. This has allowed it to mitigate risks and stabilize revenues, especially in the financial jolt that has involved economic systems in different ways. Autogrill is working to streamline the organization and corporate processes as well as improving operating efficiency. It invested in the Group’s knowhow and internal competencies with international teams and projects, focusing on operational excellence and productivity. Another competitive plus is to match an international organization with local excellent products.

3.3.4. M&As performance effects Autogrill has promoted a lively international growth since the first years of privatization (1995). In the period of our analysis, it has closed 6 transactions with a strategy of internationalization and diversification. Also, Autogrill has some intensive acquisition stages (2007-2008 and 2011-2012) and subsequently undergoes a period of reorganization. This activity has produced a positive effect on the sales after the first twoyear period; while in the second phase, also because of the economic crisis, the sales have declined under the initial value. With 2013, the sales inverted the trend by retrieving nearly the value of 2007. The assets, indeed, after a revaluation in 2011 and 2012 are seeing a progressive downturn: the value of 2015 represents only an index number 74 (the base year 2007), revealing a progressive depreciation of assets and low new investments (fig. 16).

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Fig. 16 – Autogrill’s sales and assets trend (2007-2015) 8.000.000 7.000.000 6.000.000 5.000.000 4.000.000 3.000.000 2.000.000 1.000.000 2007

2008

2009

2010

2011

SALES

2012

2013

2014

2015

ASSETS

The relative resizing showed by the previous parameters for accounting based analysis is more relevant. All the indexes reveal a sharp contraction, especially after the first acquisition two-year period. In 2009, in particular, probably also because of financial crisis, both the ROI and ROE reach an index number of approximately 20 (respectively 21.6 and 22.3), in relation to the base year 2007. In the subsequent years, the three ratios are unable to recover the carrying amount of the initial readings. The ROE, in particular, is on a roller coaster. In 2014, in fact, it reveals another drop reaching the index number of 19.8. All these indexes show only weak signs of recovery in the last year, but the value remains far from the initial performance (fig. 17). Fig. 17 – Autogrill’s performance: accounting based measures (2007-2015) 35,00% 30,00% 25,00% 20,00% 15,00% 10,00% 5,00% 0,00% 2007

2008

2009

2010 ROA

2011 ROE

2012 ROI

2013

2014

2015

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M&A and Value Creation

Whereas the value of the assets remained constant, the collapse of performance indexes are partly attributable to the inputs to the numerator, Ebit and Ebitda. In fig. 18, the trend of these two parameters is gradually shrinking, with two peaks at 2008 and 2011, the two years of acquisition. They amplify the sales trend. In this first stage, acquisition costs were higher compared to the increase in revenues. In this case, too, the 2013 gives the more critical result of the earnings, while in the last two years they offer hope for a recovery, thanks also to the reorganizations implemented by Autogrill. Regarding these considerations, we have to remember that the potential synergies can begin to produce effects also after 12-24 months. It is the critical element of the evaluation process, on which we drew attention in several parts above. Fig. 18 – Autogrill’s Ebit and Ebitda trend (2007-2015) 700.000 600.000 500.000 400.000 300.000 200.000 100.000 2007

2008

2009

2010 EBITDA

2011

2012

2013

2014

2015

EBIT

The market, also, has expressed little confidence for Autogrill’s acquisition strategy in the first period (2008-2009), where the Price Index and Total Return Index register a strong scaling (fig. 19). Then, the market indexes grow gradually, overcoming the initial share values already in 2014, with a small timeout in the second period of activity (2011-2012). In order to give a definitive judgement in terms of price, the market took an attitude of anticipation, waiting accounting results and communication feedbacks.

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Fig. 19 – Autogrill’s market based performance indexes-Price Index and Total Return Index (2007-2015) 900 800 700 600 500 400 300 200 100 0 2007

2008

2009

2010

2011 PI

2012

2013

2014

2015

TRI

However, in general, the market seems to reward the strategic orientation of the company in a new market, the expansion of the range of services offered and the reducing competition abroad by buying competitors (Aldeasa in Spain). Tobin’s Q and Market to Book Value, by including both market variables and accounting, have a mixed trend (fig. 20). Regarding Tobin’s Q, comments previously raised on the assets can be responsible of a first index appreciation in the first twoyears. However, in the second acquisition stage, a progressive trend of downsizing starts, up to the index number of 72.9 in 2015. Because of the appreciation of the market value or the equity, in 2013 the Market to Book Value shows a strong value resumption. It appears to be a flash in the pan: the following two-year it shows a decided downsizing compared with the initial data.

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M&A and Value Creation

Fig. 20 – Autogrill’s market based performance indexes-Tobin’s Q and Market to Book Value (2007-2015) 10,00 8,00 6,00 4,00 2,00 0,00 2007

2008

2009

2010

2011

TOBIN Q

2012

2013

2014

2015

MBV

In the first period, the enterprise value suffers also of critical financial management, with Leverage values that express a doubling of the debt burden on equity (Fig. 22). The company has probably stressed out the financial structure to support the first acquisition stage. Then, Autogrill focused on a gradual reduction of debt exposure up to almost halve the Leverage in 2015. The Enterprise Value, as synthesis of all the comments developed above, shows a gradual retrenchment, especially in the period 2013-2014, corresponding to the second acquisition stage. Even, this index confirms an inversion of tendency in 2015 (fig. 21). Fig. 21 – Autogrill’s Enterprise Value trend (2007-2015) 5.000.000 4.000.000 3.000.000 2.000.000 1.000.000 2007

2008

2009

2010

2011

2012

2013

2014

2015

The initial choices in terms of Leverage, the explosion of working capital with the respective reduction of the assets and critical profitability culminate in the Z-Score worsening. Because of rebalancing and restructuring of the financial structure, Autogrill has a sharp increase of Z-Scores, towards a situation of low default risk (fig. 22).

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Fig. 22 – Autogrill’s default risk indexes (2007-2015) 6 5 4 3 2 1 0 2007

2008

2009

2010

2011

Z-SCORE

2012

2013

2014

2015

LEV

3.3.5. Autogrill’s SWOT analysis in M&As strategy In contrast to the Amplifon situation and other case studies analysed below, Autogrill shows a situation of light and shade. There are, in fact, several trends not yet clearly delineated and therefore they still require some reorganization activities and integrations. To understand the strategic and economic position of Autogrill, some remarks on strengths and weaknesses, opportunities and threats are developed (fig. 23). Fig. 23 – Autogrill’s SWOT Strengths  Experienced business units  Skilled workforce  Presence in all the major channels of mobility  Distribution and sales networks Opportunities      

New markets New products and services Growth rates and profitability Increase in airport traffic. Project large stations. Increased customer attendance centers (many, liberalisation schedules)

Weaknesses     

Future cost structure Downsizing sales Small business units Lack of coverage of the Adriatic coast Loss of reputation

Threats       

Tax changes Financial capacity Growing competition and lower Profitability Increasing costs Technological problems Government regulations Rising cost of raw materials

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M&A and Value Creation

Strengths. Autogrill is the largest player in the two sectors Food&Beverage and Travel Retail & Duty Free. The company has a broad geographic spread but it retains an interest in typical local products, with international brands and licensees. It is also exploring other emergent countries. Over time, it has experienced business units and skilled workforce. The company can also count on a wide distribution network. Autogrill focuses on the maximization of key performance indicators such as euros of revenues per airline passenger. Furthermore, it has instilled a focus on operational excellence and productivity in every partners, forever with attention on the improvement of their bottom line. Weaknesses. Regarding the weaknesses, Autogrill has to improve the cost structure to consolidate the prevalence recorded in recent years. Sales showed a trend towards downsizing. As analyzed previously, profitability must be improved so that the market will continue to give confidence to the company’s strategic vision. Despite the strong growth internationally, Autogrill detected a low presence on the Adriatic coast. The global dimension collides with very small business units. The partial loss of competitiveness compared with other players is another major weakness. It may be noted that the acquisitions carried out especially in the first period they pursued a more strategic objective than a financial purpose. Opportunities. Over the last year, however, Autogrill is in a stage when many performance accounting and market measures present interesting growth trends. It has a focus both on countries with large domestic markets, such as the US, and emerging economies, providing higher growth rates. The large increase in airport traffic and worldwide interest for project large stations represent a great expansion opportunities for Autogrill. Threats. Regarding the threats, there are several variables. Oil price volatility and the downsizing of highway traffic are some specific criticisms. There are also some problems related to uncertainty in relation to taxation and government regulations of the different countries where Autogrill is present. With the development of emerging countries, there are new competitors with good operational capability, low cost and innovative content. The company highlights also a financial structure revision to prepare the organization to new development opportunities.

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3.4. Case 3: Campari’s acquisition behaviour 3.4.1. Company overview 3 Campari was founded in 1860 by Gaspare Campari that invented the bright red bittersweet aperitif in downtown Milan. From 1888 onwards, his successor and son, Davide Campari, developed and implemented an extensive campaign to grow the brand globally, featuring a winning marketing strategy (the creation of the first single-serve aperitif, Campari Soda, in 1932). In the 1960s, Gruppo Campari’s distribution power had already reached over 80 countries. In the second half of the 1990s, the beverage industry was characterized by a strong M&A trend, which led to the creation of corporations with global dimensions and remarkable portfolios appealing to a broad consumer dynamic. Therefore, Campari chose to expand not only via organic growth but also via external growth, turning from a single-brand company as late as 1995 to a multinational company, with a solid and expansive portfolio with international appeal today. In 2001, Davide Campari listed on the Italian Stock Exchange. Campari with around 4,000 collaborators is a leading player in the global branded beverage industry with a portfolio counting more than 50 premium and super premium brands, which spans three main segments: spirits, wines and soft drinks. The group is today the 6th largest player worldwide in the premium spirits industry, and its products are marketed and distributed in more than 190 countries in the world, with leading positions in Europe and the Americas.

3.4.2. M&As portfolio Campari focuses its external growth efforts on spirits, the strategic thinking is driven by the desire to reach or enhance critical mass in key geographic markets. Campari has a significant track record of successful acquisitions, having executed 26 since 1995, for an overall value of more than € 2 billion (tab. 8). It is the more active of the top fives, with 11 deals and 10 of which are cross-border.

3 Company

naire/interview.

information comes from their website, others documents published and the question-

USA; USA.

80%; 100%.

Retail; Retail.

1. Manufactures and sells tequila and accesories; 2. Wholesale and retail liquor such as wine andother fermented spirits.

COUNTRY TARGET

SHARE %

TARGET SECTOR

TARGET ACTIVITY

2

1. Cabo Wabo Enterprises; 2. Daucourt Martin Imports Llc.

TARGET

DEALS

2007 2

1. Produces and wholesales tequila; 2. Produces and wholesales liquor.

Consumer staples; Consumer staples.

100%; 70%.

1 Austin Nichols & Co-Wild Turkey American Bourbon Businesse.

2009

American straight bourbon and related businesses of Austin Nichols & Co.

Consumer staples.

100%.

MEXICO; USA. ARGENTINA.

1. Destiladora San Nicolas; 2. Sociedad Anonima De Bebitas Internacionales Y Argentinas s.

2008

Tab. 8 – Campari’s deals (2007-2015) 1

Wholesales liquors such as schotch and whisky under brand names including Glenfiddich, Grants The Balvenie among other brands.

Consumer Staples.

100%.

UK.

William Grant & Sons Ltd.

2010 2

1. Wholesales liquor and soft drinks; 2. Produces alcoholic liquors (specialized in cachaca).

Retail; Consumer Staples.

80%; 100%.

RUSSIAN FEDERATION; BRAZIL.

1. Sagatiba Brasil Sa; 2. Ooo “Vasko Sng”.

2011

2012 0

1

Produces liquors, rums, wines and sugar segments through its three distributing entities.

Consumer Staples.

100%.

JAMAICA.

Lascelles Demercado & Co Ltd.

2013 2

1. Produces and wholesales liquors and wines; 2. Produces and wholesales liquor.

Consumer Staples; Consumer Staples.

100%; 100%.

CANADA; ITALY.

1. Forty Creek Distillery Ltd; 2. Fratelli Averna Spa.

2014

2015 0

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3.4.3. M&As strategy 4 Campari has historically invested in a growth strategy on the expansion of the international footprint of its own enriched brand portfolio and on external growth through acquisitions. The first step in the establishment of this large portfolio starts in 1995, when Campari bought Crodino, Cynar, Lemonsoda and some other brands. In 1998, the group purchased a minority interest and the distribution rights in the world (except the United States) by SKYY Spirits LLC, owner of the brand SKYY Vodka, the American best selling premium vodka in the U.S. market and the fifth largest worldwide. Half of the revenue growth is achieved via 26 acquisitions and 10 disposals are completed. Gruppo Campari’s growth strategy aims to generate steady growth in key local priorities through periodical renewals with a rigorous cost discipline to reinvest savings into strategic brand building and develop the presence in high-potential markets. Any strategy has to agree with a financial discipline. Campari implemented various different strategies, especially diversification, concentration and internationalization (tab. 9). Tab. 9 – Campari’s acquisition strategies (2007-2015) Diversification strategy

Differentiation strategy

X

X

Lascellas de Marcado Urciuolo, Fasi Battaglia, Mouton Gadet

Concentration strategy

Internationalization strategy

X

Sagatiba

X

X

X

Coralans, Irish Mist, Frangelico

X

X

X

Wild Turchey

X

X

Odessa Plant

X

X

X-Rated

X

Cabo Wabo Tequila

X

X X X

X

X

X

Sources: questionnaire/interview.

In table 10, it is evidence that the strategic orientation is guided by an operational synergies perspective, both for costs and revenues. Absent are the motives of tax source and little sought financial ones.

4 Public

information and management interview.

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Tab. 10 – Synergies (2007-2015) Cost synergies

Revenues Synergies

Lascellas de Marcado

X

X

Sagatiba

X

X

Wild Turchey

X

X

Odessa Plant

X

X

X-Rated

X

X

Cabo Wabo Tequila

X

X

Financial synergies

Fiscal synergies

Coralans, Irish Mist, Frangelico

X

Sources: questionnaire/interview.

3.4.4. M&As performance effects The Campari growth has produced undoubtedly positive results both in terms of sales and capital structure, with an increase of assets tripling almost the value of 2007 (fig. 24). Fig. 24 – Campari’s sales and assets trend (2007-2015) 2000000 1500000 1000000 500000 0 2007

2008

2009

2010 SALES

2011

2012

2013

2014

2015

ASSETS

Regarding the profitability, Campari, while presenting a progressive reduction of the value of the three indicators, sees a trend inversion in 2014 and 2015 (fig. 25).

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Fig. 25 – Campari’s performance: accounting based measures (2007-2015) 16 14 12 10 8 6 4 2 0 2007

2008

2009

2010

2011

ROA

2012

ROE

2013

2014

2015

ROI

It should be noted that the reduction of profitability ratios should not be interpreted negatively, but they are attributable mainly to denominators increases. The value of the two configurations of earnings, in fact, has grown. Ebitda and Ebit have developed steadily over the period, with a small decline in 2014, by achieving respectively an index number 159 and 150 in 2015 (fig. 26, year base 2007). Fig. 26 – Campari Ebit and Ebitda trend (2007-2015) 400.000 350.000 300.000 250.000 200.000 150.000 100.000 50.000 2007

2008

2009

2010 EBITDA

2011

2012

2013

2014

2015

EBIT

The market has fully recognized the Campari’s growth strategy value. After a contraction in the period of the crisis, Campari has increased the share value until 2015, with the PI index number 154 and 173 for TRI (fig. 27).

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Fig. 27 – Campari’s market based performance indexes-Price Index and Total Return Index (2007-2015) 600 500 400 300 200 100 0 2007

2008

2009

2010

2011 PI

2012

2013

2014

2015

TRI

With the analysis of Tobin’s Q and Market to Book Value, which mix market and accounting variables, the above comments are confirmed. The Tobin’s Q starts from a value just below 1 in 2007 (0.93) increases, by reaching 1.4 in the last year. The MBV, however, detects a progressive contraction especially due to denominator, book value, showing a strengthening of the balance sheet (fig. 28). Fig. 28 – Campari’s market based performance indexes – Tobin’s Q and Market to Book Value (2007-2015) 3 2,5 2 1,5 1 0,5 0 2007

2008

2009

2010

2011

TOBIN Q

2012

2013

2014

2015

MBV

The trends analysed above found a synthesis in the Enterprise Value. By involving, both market and capital structure parameters, the EV has a very positive trend. Whilst

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with two slight contractions in 2008 and 2014, in 2015 the final value is 2.5 times the initial data (fig. 29). Fig. 29 – Campari’s Enterprise Value trend (2007-2015) 6000000 5000000 4000000 3000000 2000000 1000000 0 2007

2008

2009

2010

2011

2012

2013

2014

2015

The great Campari acquisition strategy has created effects on Leverage that in 7 years reveals a gradual worsening, rising from 0.56 to 1. The value is reasonable, however, for a serial acquirer. Moreover, the profitability has been able to support financial expenses increases, due to the debt (fig. 30). Z-Score foreshadows a sustainable financial risk situation for the company, although it starts to decline, because of the increased Leverage and working capital and liabilities. In fact, the firm has financed acquisition operations with senior debt (100%). Fig. 30 – Campari’s default risk indexes (2007-2015) 3,5 3 2,5 2 1,5 1 0,5 0 2007

2008

2009

2010

2011

Z-SCORE

2012 LEV

2013

2014

2015

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M&A and Value Creation

3.4.5. Campari’s SWOT analysis in M&As strategy Campari has increased its revenues steadily over time through organic growth, with a brand awareness and a solid financial position. Currently, the group has a portfolio of products, into different sectors and markets, which offer a balanced selection of items with different levels of profitability in both mature and emerging markets. Swot analysis gives interesting information on the company strategic perspective (fig. 31). Strengths. The company has driven a gradual expansion of the portfolio. In several markets, it reached a leadership through the acquisition of successfully domestic companies. The strong strategic vision with a careful economic and financial control has obtained recognition also by the financial market. Campari has aimed to provide high cash flows, which have enabled new acquisitions. It has given more interest to realize a solid financial structure. A further plus is consolidated and experienced managers.

Weaknesses. Regarding the weaknesses, the fast development on emerging markets could expose the firm to political, legal and fiscal volatility, especially for a product that could also collide with religious and cultural barriers. Strong exposure to foreign currencies, mainly the US dollar, Brazilian Real, Australian dollar and the dangerous competition in the US about drinks with vodka, are other critical elements. Moreover, the historical risk of taxes increasing on spirits due to the fiscal consolidation process are still alive. Opportunities. The market phase is undoubtedly a propitious moment for the growth of the business, thanks to the synergies that Campari has planned. To promote the society consolidation, some investments to revitalize some brands must be evaluated. There are good opportunities to increase profitability. Threats. The greatest difficult that the company sees at the moment is the financial exposure. At this stage of low rates, the marginality of the company it does not constitute great threats. However, the company has to prevent the risks of the deterioration of this situation. The development of the emerging countries gives new opportunities but open also to new competitors.

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Fig. 31 – Campari’s SWOT Strengths

Weaknesses

 Rich products portfolio  Critical mass in several markets  Economic and financial equilibrium Opportunities  Positive economic trend  Investments to revaluation brands

 Political, legal and fiscal volatility  Cultural barriers

Threats  Financial exposure  New competitors  Interest rate increase

3.5. Case 4: Luxottica’s acquisition behaviour 3.5.1. Company overview 5 Luxottica Group S.p.A. offers a range of fashion, luxury, sports and performance eyewear. The group operates in the Americas, Asia-Pacific, Europe, Middle East and Africa (EMEA). It has a headquarters in Milan, Italy. The group’s strong brand portfolio helps in reaching out to a larger customer base, as well as penetrating into new markets, both of which help in revenue generation. However, increasing availability of counterfeit goods can adversely impact Luxottica’s revenue. Luxottica designs, manufactures and distributes a range of optical products. The group’s in-house proprietary brands include Ray-Ban, Oakley, Vogue Eyewear, Persol, Oliver Peoples, Alain Mikli and Arnette. The license brands include Giorgio Armani, Bvlgari, Burberry, Chanel, Coach, Dolce & Gabbana, DKNY, Michael Kors, Paul Smith, Prada, Starck Eyes, Tiffany & Co., Tory Burch, Versace, Ralph Lauren and Miu Miu. The group operates through two business segments: retail distribution, and manufacturing and wholesale distribution. The retail distribution segment sells prescription frames and sunglasses manufactured by the group as well as frames, lenses and other ophthalmic products manufactured by other companies. The manufacturing and wholesale distribution segment is involved in the design, manufacture, wholesale distribution and marketing of proprietary brand and designer lines of mid- to premium-priced prescription frames and sunglasses, and performance optics products. The group operates six production facilities in Italy, three factories in China, one in Brazil and one sports and performance eyewear production facility in 5 Luxottica

Group S.p.A.report 1/24/2017.

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M&A and Value Creation

the US. The group also operates a production facility in India, which serves the local market. Luxottica’s wholesale distribution network encompasses more than 150 countries across five continents and has over 50 commercial subsidiaries providing direct operations in key markets. The wholesale distributions are also supported by 100 independent distributors in other markets, with high technical and stylistic quality. In 1999, Luxottica enters in Wall Street and in 2000 the company was listed on the Milan stock exchange. Luxottica mission is to improve customer’s welfare and to create value for its employees and for the communities in which the company works.

3.5.2. M&As portfolio 1969 is the turning point of the Luxottica with the transformation in subcontractor to independent company, launching the first Luxottica eyes. In 1974, the Italian society of distribution Luxottica purchases Scarrone, giving way to vertical integration strategy, which represented one of the competitive advantages of the enterprise. Luxottica has alternated external growth operations to those of internal type. In 1981, in fact, it constitutes the first international units, in Germany, which opens a period of international expansion marked by acquisitions of foreign distributors and the creation of strategic joint ventures. The late ’80s the company changed the product placement onto high quality, by comparing it to a clothing accessory rather than a visual aid. In this perspective, the major fashion label licensing agreements. After listing Luxottica acquires numerous Italian and foreign brands. It has increased then the presence in the retail market by purchasing OPSM established in Australia in 2003, Pearle Vision and Cole National in 2004 and Oakley in 2007. In the period, 2007-2015 Luxottica with 9 deals has expanded its international coverage, with transactions to target in South Africa, New Zealand and USA. Also it continued its vertical integration strategy with the acquisition of wholesalers, but also some highly specialized production units in optical research.

2

SOUTH AFRICA; USA.

100%; 100%.

Consumer Products and Services; Consumer Staples.

1. Wholesale and retail sunglasses; 2. Manufacture, design and wholesale high-performance men and women’s eyewear, footwear, watches, apparel, bags and backpacks, goggles and accesories.

SHARE

TARGET SECTOR

TARGET ACTIVITY

1. Undisclosed Sunglasses Distribution Chains; 2. Oakley.

COUNTRY TARGET

DEALS TARGET

2007

2008 0

2009 1

Manufactures and wholesales optical equipment such as eyeglasses, sunglasses, contact lenses.

Healthcare.

100.

SPAIN.

Multiopticas International.

Tab. 11 – Luxottica’s deals (2007-2015) 2010 0

2

2012

1. Manufactures, retails and wholesales eye glassframes; 2. Manufactures and wholesales optical equipment such as eyeglasses, sunglasses, contact lenses.

Consumer product and services; Healthcare.

100%; 57%

NEW ZEALAND; SPAIN.

Retails optical products including eyeglasses and sunglasses.

Healthcare

100.

SPAIN/PORT UGAL.

1. My Sight Sun Planet. Vision Specialists Group; 2. Multiopticas International.

2011 1

2

2014

1. Designs and wholesales spectacles; 2. Optical goods retailer.

Healthcare; Retail.

100%; 36,33%.

SPAIN; ITALY.

1

Manufactures and wholesales traditional and designer eyewear (mid and high priced segments of the market).

Healthcare.

100%.

USA

1. Alain Mikli Glasses.Com. International Sas; 2. Salmoiraghi & Vigano’ Spa.

2013

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2015

79

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M&A and Value Creation

3.5.3. M&As strategy Luxottica’s long-term strategy is to continue to expand in the eyewear and eye care sectors by growing its various businesses, whether organically or through acquisitions. The company will continue to focus on the following strategic pillars: vertical integration, design and technological innovation, brand portfolio management, market expansion, financial discipline and the development of talented and committed employees. Luxottica is committed to maintaining and strengthening its position in the markets in which it operates. It also focuses on evaluating opportunities to penetrate further emerging markets, a key driver of its long-term growth strategy. Luxottica aims at increasing its market expansion through stronger retail distribution while consolidating its wholesale network and further developing its presence in e-commerce, department stores and travel retail. Luxottica’s founder and Chairman, Leonardo del Vecchio, has embraced the idea of a vertical integration in the last decades understanding the importance of caring for every little aspect of the supply chain. A decision which ended up being extremely significant and profitable for the firm that integrated vertically in both directions: upwards, towards the supply or distribution, and downwards, towards the retail acquiring optical shops or optical chains. Luxottica’s decision to adapt a vertical integration in their business model ended up being a success for the firm that in a few years became leader in the market and managed to achieve the numbers we stated before. Although it was a success, like many decisions, there were pros and cons. Vertical integration, first, helped Luxottica to have a faster and more detailed flow of information inside the firm. The firm also managed to reduce transaction costs. By integrating upwards, towards the design and manufacture steps, Luxottica increased the control over the quality of the products becoming a luxury eyewear producer and distributor. The result was a competitive advantage over their competitors as they built a new and modern concept of sunglasses and eyeglasses. Integrating downwards, towards the retail and final step, helps Luxottica get a direct contact with their customers and understand which are their tastes and their needs over the years. This keeps the firm in track with new trends and fashion styles making it an innovative and technologically advanced company. Luxottica’s structure is the result of a unique business model in its industry, as seen from the outstanding results obtained by the long lasting partnerships with leading luxury and fashion brands.

3.5.4. M&As performance effects The sales and assets growth shows a constantly consolidation, by achieving the number 178 index for sales and 148 for the assets (fig. 32).

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Fig. 32 – Luxottica’s sales and assets trend (2007-2015) 10000000 9000000 8000000 7000000 6000000 5000000 4000000 3000000 2000000 1000000 0 2007

2008

2009

2010

2011

SALES

2012

2013

2014

2015

ASSETS

Regarding the profitability, instead, the company reveals a more stable trend than as observed for the previous parameters. Luxottica detects an early period of high performances in terms of profitability, with a return for shareholders nearly 21% and ROI of 11.65%. After a sharp drop in 2009, Luxottica’s management linked to the first major acquisitions on the one hand and the critical macroeconomic conditions, anyway it achieves the starting values (fig. 33). Fig. 33 – Luxottica’s performance: accounting based measures (2007-2015) 25 20 15 10 5 0 2007

2008

2009

2010 ROA

2011 ROE

2012 ROI

2013

2014

2015

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M&A and Value Creation

The trend of profitability is in line with that of the absolute values of margins, proving that the growth of indexes is generated by an increase of all elements of the numerator and denominator (fig. 34). Fig. 34 – Luxottica’s Ebit and Ebitda trend (2007-2015) 2000000 1500000 1000000 500000 0 2007

2008

2009

2010

2011

EBITDA

2012

2013

2014

2015

EBIT

The market recognizes the strategic validity of Luxottica development projects. The two indicators, while confirming the economic deadlock of 2008-2009, then they move again by reaching in 2015 values more than double compared to the beginning period (fig. 35). Fig. 35 – Luxottica’s market based performance indexes-Price Index and Total Return Index (2007-2015) 400 350 300 250 200 150 100 50 0 2007

2008

2009

2010

2011 PI

2012

2013

2014

2015

TRI

Even the MBV trend is in line with the other two market indicators, albeit in more limited measure due to the influence of the accounting data. Despite the drop of 2009,

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MBV in 2015 can pass through the initial value. The trend of the Tobin’s Q, however, is negative. It differs from the market value for the book variables, especially for the assets that slash the value of the index. In 2015, the index sees the value of 0.75 relative to a given initial 1.8 (fig. 36). Fig. 36 – Luxottica’s market based performance indexes- Tobin’s Q and Market to Book Value (2007-2015) 5 4 3 2 1 0 2007

2008

2009

2010

2011

TOBIN Q

2012

2013

2014

2015

MBV

Generally speaking, after the controversial data referred to above, the Enterprise Value sums up the trend of enterprise in the period. The value of the company grows, with the exception of 2009, by achieving a number index of 234 in 2015 (fig. 37). Fig. 37 – Luxottica’s Enterprise Value trend (2007-2015) 35000000 30000000 25000000 20000000 15000000 10000000 5000000 0 2007

2008

2009

2010

2011

2012

2013

2014

2015

The good performances recorded during the period by Luxottica, both for financial market confidence and accounting data, shows positive effects on failure risk. ZScore, in fact, despite being party with high values, in the last year it is appreciated

116

M&A and Value Creation

further in the period up to double the given to 2007 (fig. 38). Moreover, the company has promoted its growth strategy with a careful management of financial structure with a low Leverage and in continuous decline, even during times of critical market. The presence of the company on the stock exchange, in fact, was promoted precisely to find resources to finance international growth strategy (fig. 38). Fig. 38 – Luxottica’s default risk indexes (2007-2015) 7 6 5 4 3 2 1 0 2007

2008

2009

2010

2011

2012

Z-SCORE

2013

2014

2015

LEV

3.5.5. Luxottica’s SWOT analysis in M&As strategy The good performance of Luxottica are the results of a careful attention to company organization and the acquisition process. Luxottica management has shown the following issues (fig. 39). Fig. 39 – Luxottica’s SWOT analysis Strengths  Driving growth through innovation and product development  Strong brand portfolio  Strong Manufacturing system  Strong distribution network Opportunities  Increasing demand for eyewear  Growing e-retailing platform  Strategic partnerships

Weaknesses  Ongoing anti-corruption practice claim  Geographic concentration and dependence on few suppliers

Threats  Currency rate fluctuations  Growing availability of alternatives  Rampant existence of counterfeit products

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Strengths. Driving growth through innovation and product development, Luxottica has been able to maintain its leadership position in the sunglasses market by continuously offering its customers eyewear developed with the use of high level of technology. The group is also committed to implementing emerging fashion trends in its products, to address changing lifestyles, needs and tastes of consumers. In 2014, Luxottica entered into a partnership with Google, to design, develop and distribute a new line of eyewear for Glass, which would include Ray-Ban and Oakley brand names from Luxottica’s proprietary brands portfolio. Towards the end of the year, the group signed a multi-year research and development collaboration with Intel Corporation, to launch premium, luxury and sports eyewear with smart technology. Luxottica invests in research and development activities regarding its manufacturing processes on a regular basis to increase its manufacturing capacity in Italy, China, the US, Brazil and India; as well as for innovation and technology enhancements. Regarding the brand portfolio, Luxottica is leader in fashion, luxury and sports eyewear. Therefore, a strong brand portfolio comprising leading house brands and popular licensed brands helps the group target a wider customer base as well as penetrate new markets. Luxottica has a globally integrated distribution system, which is supplied with the finished products from a centralized manufacturing platform. The group has four main distribution hubs in strategic locations serving major markets: Sedico in Italy, Atlanta, Georgia in the US, Dongguan in China and Jundiai in Brazil. These canters operate as centralized facilities, with highly automated order management system that reduces delivery times and keeps the inventory levels low. Thus, a strong distribution network allows Luxottica to increase its market presence and provide better customer service. Weaknesses. Regarding ongoing anti-corruption practice claims, the group’s French subsidiaries, Luxottica France, were named in an investigation conducted by the French Competition Authority (the FCA) relating to the industry pricing and sales practices adopted by the companies. Luxottica generates majority of its revenues from the North American market. In FY2015, North America, the group’s largest geographic market, accounted for 58.3% of the total revenues. Luxottica’s dependence on this market makes it vulnerable to the economic changes in this region. While Luxottica’s geographic concentration of operations limits its growth prospects, excessive dependence on few suppliers like Essilor could affect the group’s bargaining power. Opportunities. Increasing demand for eyewear, which comprises items worn on the eye for vision correction and cosmetic purposes, has been rapidly increasing in recent times. Growing population, increasing number of visual deficiencies and improv-

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ing purchasing power are driving the growth in this market. Luxottica has a strong product portfolio, which includes prescription frames, sunglasses, vision care products and lenses in the eyewear category. Therefore, the group is well positioned to benefit from the growth trend. Luxottica has expanded its market presence through strategic partnerships in the recent past. Therefore, such strategic partnerships will significantly expand the group’s market presence by helping it to penetrate into new markets. It also enables Luxottica to serve as an expanded customer base. Threats. Luxottica operates its principal manufacturing facilities in Italy. The group also has manufacturing facilities in China, Brazil, India and the US as well as sales and distribution facilities throughout the world. Therefore, the group’s results of operations could be adversely affected by foreign exchange rate fluctuations. Therefore, currency exchange rate fluctuations could have material adverse effects on the financial condition of the group. The group’s business can be negatively impacted by the growing availability and acceptance of vision correction alternatives to prescription eyeglasses, such as refractive optical surgery and contact lenses. The high proliferation of counterfeit goods and accessories is adversely affecting the sales of branded accessories the world over.

3.6. Case 5: Reply’s acquisition behaviour 3.6.1. Company overview 6 Reply births in 1995. It is a company specialised in Consulting, Systems Integration and Digital Services with a focus on the conception, design and implementation of solutions based on the new communication channels and digital media. Reply partners with key industrial groups in defining and developing business models made possible by the new technological and communication paradigms such as Big Data, Cloud Computing, Digital Communication, the Internet of Things and Mobile and Social Networking. In so doing, it aims to optimise and integrate processes, applications and devices. Reply’s offer is aimed at fostering the success of its customers through the introduction of innovation along the whole economic digital chain. Given its knowledge of specific solutions and due to a consolidated experience, Reply addresses the main core issues of the various industrial sectors. Reply supports the main European Industrial groups operating in Telco and Media, Banking, Insurance and Financial companies, Industry and Services, 6 Company

naire/interview.

information comes from their website, others documents published and the question-

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Energy and Utilities and Public Administration market segments. Technological innovation has formed the basis for the development of Reply, a company that has always pursued the objective of providing its clients with the tools necessary to increase flexibility and efficiency. Reply is involved in a continuous process of research, selection and marketing of innovative solutions for sustaining the creation of value within organisation. December 2000: Reply was listed on the New Market of the Italian Stock Exchange. 3.6.2. M&As portfolio In 2005, Reply acquires a branch from the Fiat Group dedicated to the management of the “third-party customers” of Fiat Gesco, a company specialised in process management solutions. With this acquisition, Reply adds a new important component to its offering including Consulting, System Integration, Application Management and Process Management. In the same year, it signs an agreement for the takeover of Syskoplan AG, a German company listed on the Frankfurt Stock Exchange, which is leader in CRM consulting. For Reply starts an important acquisition season. With its 10 deals in the period, it is one of the more active company in this strategy (tab. 12).

ITALY.

100%.

HIGH TECHNOLOGY.

Provide information technology services.

COUNTRY TARGET

SHARE %

TARGET SECTOR

TARGET ACTIVITY

1

Axcel Srl.

2007

TARGET

DEALS

2

1. Provides information Security Systems, consulatancy, integration and management services; 2. Provides consulting services specializing in Enterprise Architecture, solution design and SOA.

1. High Technology. 2. Consumer Product and Services.

100%; 100%;

ITALY; UK.

1. Communication Valley Spa 2. Glue: Ltd.

2008

Tab. 12 – Reply’s deals (2007-2015) 2009 0

1

1

2

100%; 1,57%.

UK; GERMANY.

1. Avvio Design Associates Ltd; 2. Syskoplan Ag.

2012

1. Provides internal communication services, consultancy, implementation of strategies and solutions for brand management and internal communications; 2. Develops software, consulting services.

High Technology. 1. Consumer Product and Services; 2. High Technology.

80%.

UK.

Portal Technology Systems Ltd.

2011

Provides software Design, impleconsulting servi- mentation, inteces. gration and support websites and web based transactional solutions for multichannel retailing.

Consumer Product and Services.

75,02%.

GERMANY.

Riverland Solutions Gmbh.

2010 2

1. Provides Information technology services, consultancy and development of technology solutions for the insurance market; 2. Provides information technology services, consultancy and development of cloud solutions for Microsoft, design and build of business applications.

1. High Technology; 2. High Technology.

76%; 100%.

BRAZIL; UK.

1. Mind Services Informatica Ltda; 2. Solidsoft Ltd.

2013 1

Manufactures sports garments that include socks, bra and tshirt.

1) Consumer Product and Services.

20%.

USA.

Sensoria Inc.

2014

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3.6.3. M&As strategy Replay, is younger than other serial acquirers, but it operates in a market relatively new and highly innovative, exposed to a number of risks, both external (risks related to the evolution of services relating to ITC) and inside. Because of these considerations, in acquisition policy, the company had to take under consideration those drivers. The acquisitions carried out by Reply in the period followed both strategic and financial objectives. In essence, Reply has focused its interest on targets in the same industry, with high technology know-how, but with different locations, both in the domestic market as in Europe, in Brazil and USA. Reply’s strategy has therefore been to promote acquisitions to increase the internalization of activities with an international perspective. The company for the growth strategy is investing in external deals, to enter in new markets and to eliminate competition. The aim is to realize economies of scale and revenue synergies.

3.6.4. M&As performance effects From 1997, the first complete financial year Reply was established, the company has achieved important financial results, with constant and significant growth. In the period of observation, in fact, there has been a sharp increase in both asset and sales, arriving almost to triple their initial value (fig. 40). Fig. 40 – Reply’s sales and assets trend (2007-2015) 800000 700000 600000 500000 400000 300000 200000 100000 0 2007

2008

2009

2010 SALES

2011

2012

2013

2014

2015

ASSETS

Reply growth is confirmed by a consolidation of profitability. All three indexes, while presenting a more constant trend that shown for sales, detect a strong apprecia-

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tion of values in 2007, despite a slight decline in 2009 (fig. 41). Especially the indicator of return on equity reaches the value of 20.74% in 2015. Fig. 41 – Reply’s performance: accounting based measures (2007-2015) 25 20 15 10 5 0 2008

2009

2010

2011

ROA NA

2012

2013

ROE NA

2014

2015

ROI NA

Even for the profitability indexes, they are the results of the appreciation of the greatness in the numerator and those in the denominator. Ebit and Ebitda, evident from fig. 42, are constantly strengthening, by reaching double the initial value. Fig. 42 – Reply’s Ebit and Ebitda trend (2007-2015) 120000 100000 80000 60000 40000 20000 0 2007

2008

2009

2010 EBITDA

2011

2012

2013

2014

2015

EBIT

The market begins to give confidence to the company projects only from 2013 onwards, when the trend of the two indicators takes almost a hyperbolic behaviour, arriv-

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ing in 2015 at more than triple the figure for 2007 (fig. 43). Because of the relative youth of the enterprise and the uncertainty of the sector, the market before investing in Reply development projects has expected some first results of the accounting performance. Fig. 43 – Reply’s market based performance indexes-Price Index and Total Return Index (2007-2015) 500 400 300 200 100 0 2007

2008

2009

2010

2011 PI

2012

2013

2014

2015

TRI

The considerations developed above are confirmed in Tobin’s Q and data Market to Book Value (fig. 44). While the MBV, albeit with a different trend than the pure market indicators, shows anyway an appreciation at the end of the period, the Tobin’s Q, however, remains almost constant, although with a higher value to the unit (1.44 to 2007 to reach 1.32 to 2015). Fig. 44 – Reply’s market based performance indexes- Tobin’s Q and Market to Book Value (2007-2015) 2,5 2 1,5 1 0,5 0 2007

2008

2009

2010 2011 2012 TOBIN Q MBV

2013

2014

2015

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M&A and Value Creation

Enterprise Value follows the trend of market indicators. After a period of stagnation, with value reduction in the period of financial crisis, the index increases exponentially reaching in 2015 at a value nearly six times the initial value (fig. 45). Fig. 45 – Reply’s Enterprise Value trend (2007-2015) 1400000 1200000 1000000 800000 600000 400000 200000 0 2007

2008

2009

2010

2011

2012

2013

2014

2015

Market positive performance is also due to the Reply choices on the financial structure. The company seems to have fully used the stock market to finance its growth investments. Leverage, in fact, is constantly under the unit and under careful control (fig. 46). All considerations above have produced positive effects on the risk of failure. Z-Score, in fact, is high and growing. Fig. 46 – Reply’s default risk indexes (2007-2015) 5 4,5 4 3,5 3 2,5 2 1,5 1 0,5 0 2007

2008

2009

2010

2011

Z-SCORE

2012 LEV

2013

2014

2015

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3.6.5. Reply’s SWOT analysis in M&As strategy Fig. 47 – Reply’s SWOT Strengths  Driving growth through innovation and product development  Strong brand portfolio  Strong Manufacturing system  Strong distribution network Opportunities  Increasing demand for eyewear  Growing e-retailing platform  Strategic partnerships

Weaknesses  Ongoing anti-corruption practice claim  Geographic concentration and dependence on few suppliers

Threats  Currency rate fluctuations  Growing availability of alternatives Rampant existence of counterfeit products

Strength and Opportunities. Reply gives a particular importance to pre-merger analysis. Management, indeed, emphasizes the strategical role of the acquisition plan enriched by a NPV and a real option evaluation. This attention has developed strong planning expertise in the company. Another focus is on financial management. The company, in fact, has a financial structure able to capture any new market opportunities. Weaknesses and Threats. Regarding Weaknesses and Threats, the company has drawn the attention on integration difficulties, where the human factors are determinant. This aspect has delayed the cash flows realization, but the prudential evaluation behaviour has limiting the negative effects. The difficulties of obtaining financial funds adequate for the acquisition process are the most critical obstacle for new transactions, that in this period of underestimated companies could be good investments.

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An operative lens

APPENDIX 1

127

An operative lens. Limits and opportunities for mergers based on Italian law Francesco Greggio

SUMMARY: 1. Preamble. – 2. The Merger Process. – 2.1. Evaluation stage. – 2.2. Information stage. – 2.3. Decision making stage. – 2.4. Final stage. – 3. Final observations: Limits and tax benefits associated with Mergers.

1. Preamble The terms Merger and Acquisition (M&A) refer to any extraordinary financial operations that lead to two or more companies merging. Due to differing practices, mergers are usually defined by corporate doctrine and procedures. Mergers can be distinguished based on two general categories: • Mergers (by consolidation): When the companies involved cease to exist and a new economic and legal entity is formed; • Mergers by acquisition (acquisitions): If the companies involved in the operation are linked by partnership obligations, the merger may be: i) Direct if the stakeholding company takes over an investee; ii) Reverse if the investee takes over the stakeholding company. Mergers have not been explicitly defined by Italian law but the law does specify types of mergers and procedural steps. Pursuant to Article 2501 of the Italian Civil Code, mergers may consist of the creation of a new company (referred to as a merger by consolidation, where participating companies cease operations without being liquidated), or the acquisition of one or more companies (the surviving entity increases share capital and shares are allocated to shareholders of the company being acquired, in respect of shares or units owned by them).

128

M&A and Value Creation Merger by acquisition Shareholder A

Step 1) Before a merger

Company A

Company B

Shareholder B

Shareholder C Shareholder D

Shareholder A

Step 1) After a merger

Shareholder B

Company A (where B is acquired)

Shareholder C Shareholder B

Merger (by consolidation) Shareholder A

Step 1) Before a merger

Company A

Shareholder B

Shareholder B Shareholder C Shareholder B

Shareholder C Shareholder D

Shareholder A

Step 1) After a merger

Company B

Company A (A + B)

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Revers Merger Shareholder A

Step 1) Before a merger

Shareholder B

Company A 100% Company B

Step 2) After a merger

Shareholder A Shareholder B

Company B (where A is acquired)

Economically speaking, mergers are characterized by their means of implementation, as well as other operations of an extraordinary nature, and essentially respond to a company’s need to restructure and reorganize with the ultimate result of pursued objectives and economic considerations being as diverse as possible. Nonetheless, mergers are, generally speaking, mainly aimed at corporate concentration, integrating corporate structures and consolidating the companies involved. Mergers are a means of achieving company growth with resulting economies of scale. Indeed, the objectives that a company preparing to enter into a merger intends to pursue can be defined based on the following characteristics: i) Productive: To improve the usage and utilization of facilities so that greater integration of production capacity is achieved; ii) Technological: Acquiring trademarks and patents, licenses, trade secrets, knowhow and exploitation rights; iii) Achieving economies of scale; iv) Financial: Compensation of imbalances resulting from the structures and net financial positions of merging companies and improvements in trading conditions; v) Commercial: Increasing competitiveness, reduced competition thanks to the acquisition of a competing company, increase in market share and the expansion and integration of product ranges. On the one hand, M&As are implemented to improve external growth opportunities or as typical private equity activities; on the other hand, the high risk posed by M&As, with regard to pursuing objectives from strategic decision making, namely the creation of additional value for shareholders and investors, is very widely known. Many studies 1 have shown that more than 50% of M&As do not experience benefits initially anticipated and that they often prove to be damaging instead of actually adding value. Therefore, with this in mind, evaluative assess-

1

Cfr. C. CRISTOFORI, Operazioni di Finanza Straordinaria, Sole 24 ore, 2010.

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ments (or due diligence) are of particular importance when a company wishes to undertake a certain course of action. Furthermore, consideration should be given to the relevant regulatory framework (Articles 2501 to 2505c of the Italian Civil Code), which, while cumbersome for the companies involved that are required to comply with procedural processes, is largely aimed at protecting creditors and minority shareholders. With regard to the legal nature of mergers, two contrasting theories exist: • One theory suggests that mergers amend the corporate contracts of participating companies and, as a result, these do not cease to exist and no new companies are created. • The other theory suggests that mergers are a process whereby initial companies cease to exist and new companies are formed as successors (universal succession). With this in mind, it should be noted that Community Legislature (Article 2 of Directive 28/891/EEC and Article 3 of Directive 78/885/EEC) stipulates that mergers and spin-offs involve the dissolution (without liquidation) of a company being merged. In principle, regulations concerning mergers apply to all types of company. In particular, horizontal merger occurs when the merging companies are similar in type, whereas conglomerate merger occurs where the merging companies differ in type. However, the provision of Paragraph 2 in Article 2501 stipulates that companies in liquidation that have begun distributing assets are prohibited from participating in a merger. Essentially, the liquidator must not be obliged to reimburse (in whole or in part) the shareholder for its quota. In the event where a merger occurs between companies in liquidation, the liquidation status is revoked.

2. The Merger Process The process through which a merger is carried out in compliance with Italian regulations is characterized by a number of key stages described below.

Civil Code: Articles 2501 to 2505-quater 30 days

60 days

Merger Plan

Merger Deliberations

Article 2501-ter, drafted by directors

Article 2502, Approval from shareholders of each participating company Autorization from all shareholders

Merger Deed

Article 2504, Carried out by the directors of the company formed by the merger or the surviving entity Time in which creditors can express opposition

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It should be noted that, at the initial stage, a number of informative documents are prepared, which shareholders of the participating companies use as a basis when deciding whether a merger is a viable and convenient solution. Finally, before beginning to analyze the process based on its key stages, we can see how directors play a crucial role in the merger process. These are responsible for the merger plan, preparing financial reports, drafting a report on the process itself and, finally, providing the deed for the merger. Therefore, the merger process can be structured based on the following stages: i) Evaluation stage. The stage where relationships and contacts are established among directing bodies and where documents needed for the process to begin are produced (due diligence, merger plan, balance sheets and director/expert reports); ii) Information stage. The stage where previously prepared documents are filed at the registered office of a company; iii) Decision making stage. The stage where a board meets and prepares to decide whether or not to grant approval to a merger based on documents provided; iv) Final stage, in which the program is implemented.

2.1. Evaluation stage In this context, the implementation of due diligence is now generally considered an integral part of the transactional process. Due diligence particularly applies to Mergers & Acquisitions, which are key extraordinary financial operations. An explicit definition of due diligence, which is, by now, a standard concept, does not exist in corporate literature, nor does it exist in the regulations of countries or stock markets where due diligence is, more or less, a mandatory requirement, as revealed by major acquisitions carried out by listed companies in American or English markets. The aim of due diligence is to reduce the information gap between the proponent of the merger, the target company and other parties that are involved (lenders) so that a more accurate understanding and evaluation of the companies involved, in terms of their business and overall financial performance (for both the present and future), may be obtained. This will enable decisions to be made simultaneously based on a comprehensive knowledge framework. The company endorsing the merger or an investor will always base initial steps on a framework of information that has been acquired, in part, via external sources and, in part, via the target company. Therefore, the aim of due diligence is to confirm any preliminary information acquired in as punctual a manner as possible or to highlight any discrepancies that may appear. It also seeks to identify any critical issues that may, by their very nature, be considered deal breakers. Generally speaking, the directing body is the proponent of the merger, in the sense that administrators implement a number of preliminary negotiations likely to lead to the terms of the merger being agreed. Drafting the merger plan is simply a preliminary fulfillment of the merger itself and, as previously described, this is the exclusive responsibility of the directors. This legal requirement is justified by the fact that a merger, beyond modifying the Articles of Asso-

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ciation, also presents itself as a ‘management agreement’ for a company and is designed to optimize its production capacity. Regulations regarding the merger plan, namely any agreements established between the board of directors of the companies participating in the merger, are stipulated in Article 2501-ter of the Italian Civil Code. It should be specified that the final paragraph of the aforementioned article allows for a waiver, by means of unanimous shareholder consent, of the time limit (between registration of terms and the fixed date for the ultimate decision concerning the merger itself) for the filing of the merger plan, provided that shareholders are made aware of this. From a legal point of view, a proposal addressed to shareholders, with the aim of being entirely exclusive, constitutes this management agreement. These considerations are drawn from Article 2380-bis of the Italian Civil Code, which is outlined as follows: “The management of the company’s activities lies exclusively with the directors who carry out the operations necessary for the fulfillment of the company’s object”. Therefore, for public limited companies, if directors make the independent decision to submit the merger plan to the board, approvals will not be binding as, within this framework, directors alone are tasked with making decisions. However, with public limited companies, there are no particular issues of note. With private limited companies, it is wise to pay close attention when the drafting of the merger plan is the responsibility of the company shareholders (a particularly significant situation). Firstly, it must be noted that with a private limited company, there is no strict separation between the activities of shareholders and directors (unlike with a public limited company), in the sense that these can be easily changed via the Articles of Association. As a result of this, there are two situations in which the merger plan may be the responsibility of the shareholders instead of the directors of the company: • When the Articles of Association of the private limited company make no specific provisions for the organizational model (Article 2479, Paragraph 2, no.2 of the Italian Civil Code). In this instance, a situation that is similar to that of a partnership may arise (Article 2257 of the Italian Civil Code) in which individual shareholders would have authority as directors. • When the Articles of Association stipulate that activities concerning operations of particular importance are reserved for shareholders instead of directors. As well as being accompanied by a balance sheet, it is crucial that the merger plan is accompanied by a report from the directing body (Article 2501-quinquies of the Italian Civil Code). The aim of the report from the directing body is to illustrate to shareholders that the assets of the companies participating in the merger are robust. Information in the expert report is then evaluated in accordance with Article 2501-sexies of the Italian Civil Code. The purpose of the report from the directing body is to provide information and is presented as a document illustrating the robustness of assets involved in the operation to shareholders so that they can carry out their own evaluation regarding the advantages of a merger and potentially withdraw from the company and third party creditors. This means that their right to object is recognized. Mergers may pose significant risks and therefore, balance sheets and the merger plan may not suffice in providing interested parties (whether these are shareholders or company creditors) with a framework that they deem to be reasonable. To this effect, the report from the directing body must make up for shortcomings within either of these documents, including ap-

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propriate information needed to provide a more complete framework regarding the merger and its economic, financial and equity implications. Indeed, Article 2501-quinquies of the Italian Civil Code stipulates that a written report illustrates and provides “reasons for the merger on legal and economic grounds, specifying the share or quota exchange ratio”. The provision is not very clear and may lead to certain doubts as to how it should be interpreted. This report must outline the merger plan and provide vital information for all parties involved in the operation. • Legal information regarding operational aspects and timings, etc. • Economic information linked to operational aspects and considerations that relate to the implementation of the operation and any advantages/disadvantages that may derive from it. • Information regarding the exchange ratio: Considerations regarding the evaluative methods used to determine the economic value attributable to companies and, in particular, the ways in which these methods affect the exchange ratio appear to be significant. Economically speaking, for a merger to be legitimate, it must either respond to company interests or result in economic advantages for it. It is without doubt that economic viability leaves a wide margin for discretion, in the sense that economic viability also depends on positions and opinions that are entirely subjective. It goes without saying that a merger is not legitimate if its objectives are fraudulent or motivated by antisocial intentions on the part of directors. From a legal point of view, this illustrates the implications of a merger with respect to the rights of shareholders where the shares and characteristics of the entity being formed are being negotiated in terms of the type of company that will be created (if indeed it is a merger by consolidation). The most important piece of information from the report of the directing body is the exchange ratio. This must be handled with great care. Procedurally speaking, the exchange ratio is defined as the number of shares or units earned by a company as the result of a merger. The shareholders of a company that ceases to exist receive these in return for their original equity investment after the merger takes place. For the exchange ratio to be determined correctly, an estimate of the economic capitals of the participating companies is required. In the event of a merger, evaluations must first be carried out based on consistent evaluative criteria. These criteria are used to ensure that results obtained can be compared. For example, let us imagine that within a merger by consolidation, two companies (X and Y) will constitute a third company (Z). The share capital of Z is the collective share capital of X and Y. Firstly, different economic weights must be determined: i) Economic value of X/ Economic value of Z = % of the weight of X. ii) Economic value of Y/ Economic value of Z = % of the weight of Y. Shares from Z are assigned to shareholders from the two merged companies X and Y based on: i) The exchange ratio for shareholders from X = number of shares from Z to be allocated to shareholders from X / the total number of shares of X.

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ii) The exchange ratio for shareholders from Y = number of shares from Z to be allocated to shareholders from Y / the total number of shares of Y. Finally, by multiplying the weight percentage of X and Y by the social capital of Z and dividing it by the total value of shares of Z, the number of shares to be allocated to shareholders from X and Y is determined. The reduction of assets in each of the companies involved and the convergence of shareholders within an individual organizational structure (which continues the activities of the preexisting companies that cease to exist) allow us to identify a merger. The dissolution of companies involved in a merger does not weaken the position of shareholders; they become shareholders of the newly formed company (an acquisition in the event of a merger by acquisition, or a new company in the event of a standard merger). Based on an exchange ratio, they receive shares from the newly formed company in exchange for shares owned within the previous companies so that their position as shareholders is maintained. Generally, the allocation of new shares to shareholders occurs via an increase in capital within a merger by acquisition. The exchange ratio is defined within the merger plan, which is drafted jointly by directors of the companies involved. Determining the exchange ratio is a very sensitive issue with mergers. If directors of the companies involved draw up the so-called merger balance sheet, deducing certain important elements needed for the evaluation of capital holdings (e.g. future prospects for growth and development) will not be possible using the balance sheet. In any event, this is determined based on a comparison of the companies that are merging. The law protects minority shareholders from possible abuses by requiring that all relevant shareholder information is provided and that the suitability of the exchange ratio is ascertained prior. Directors of the companies involved must draft a report in which criteria used to determine the exchange ratio are present and any possible difficulties that may be encountered by the companies are outlined. As described, the merger plan specifies the exchange ratio in simplistic numerical terms, whereas this document must outline aspects of the ratio that are more significant and technical. Also, with regard to the exchange ratio, directors benefit from a certain degree of discretion, in the sense that they are able to choose between various means of corporate evaluation (evaluation of assets, revenue, a mixture of assets and revenue, or financial evaluations). As a consequence, they must specify how the method chosen has affected how the exchange ratio is determined. From this, we can conclude that within the directing body report, adding basic annotations outlining the method used is sufficient, without having to explain more technical areas within the calculation. This is also done to maintain the confidentiality of corporate data. It should be specified that the final paragraph of Article 2501 quinquies of the Italian Civil Code stipulates that “The report referred to in subsection one shall not be required if the shareholders and holders of the other financial instruments granting voting rights of each merging company unanimously waive it”. Determining the exchange ratio is, without doubt, the most sensitive and complex aspect involved in a merger. For this reason, the law stipulates that one or more experts must “draft a report on the consistency of the share or unit exchange ratio”. Article 2501-sexies, Paragraph 3 of the Italian Civil Code. The expert is chosen from parties registered with the registry for chartered accountants or from audit companies from the registry established by the Italian Min-

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istry of Justice (obligatory if the company is listed on regulated markets) and must be appointed by the court of the district in which the company has its registered office if the surviving entity or company resulting from the merger is a public limited company or a share partnership company. Experts (who are external professionals) are tasked with evaluating the validity of the method or methods adopted by directors so that the exchange ratio may be determined; in other words, determining whether the ways in which shareholders from the merged companies participate in the capital of the beneficiary company or surviving entity are reasonable or not. Therefore, the expert report is a means of evaluating shareholders’ participation and acts as a guarantee for them, in the sense that expert intervention is ultimately, by definition, impartial and of a technical nature. In particular, experts must confirm that the exchange ratio is balanced and that it does not result in unjustified damage being caused to the shareholders of one company in relation to those of another, or that it does not result in advantages for shareholders of one company and not of another.

2.2. Information stage Paragraphs 3 and 4 of Article 2501-ter of the Italian Civil Code stipulate that “the merger plan is filed for entry on the Business Register in the location where the companies taking part in the merger are based. As an alternative to the filing for entry on the Business Register, the merger plan is published on the company website with modalities aimed to guarantee the security of the website, the authenticity of the documents and the certitude of the date of publication”. The article also states that “At least thirty days must elapse between filing the plan or its publication on the website and the date set for resolving on the merger, unless shareholders unanimously waive this term”. Essentially, a form of external and internal publicity exists. Firstly, it should be noted that internal publicity protects individual shareholders (but not third-party creditors). These shareholders may waive the 30-day term with unanimous consent. Concerning external publicity, one should refer to both the filing for entry of the merger plan with the appropriate Business Register and any notifications that may be necessary with regard to market regulations. When mergers carry particular economic and territorial relevance, they are subject to checks that verify whether or not they are compatible with regulations regarding free competition; this is commonly defined as Antitrust law. The type of checks and the implementation of relevant procedure on the part of appropriate authorities at national and community levels both depend on the size of a merger. If operations are relevant on both national and community levels, Antitrust law applies. In both cases, only mergers that do not lead to or reinforce – within a market or a substantial part of it – a market position that is so dominant as to eliminate or mitigate competition in a substantial and sustained manner are compatible with regulations concerning market competition. Within the domestic market, the body responsible for receiving notifications and evaluating the compatibility of mergers with internal regulations concerning fair competition is the the

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Antitrust Authority 2, in compliance with Law no. 287/90 and its subsequent modifications and extensions, and regulations regarding investigative procedures (Presidential Decree no. 217/1998). Article 5 of Law no. 287/1990 identifies mergers where: i) Two or more companies merge between themselves; ii) One or more parties controlling at least one or more companies assumes direct or indirect control (as provided for in Article 2359 of the Italian Civil Code) of companies, in whole or in part, by either purchasing shares or assets, by means of a contract, or by other means; iii) Two or more companies form a joint venture through the formation of a new company. Pursuant to Article 16 of Law no. 287/1990, domestic mergers are subject to checks where national turnover is reported at the following values: • All companies involved produce a combined turnover that is greater than Euro 495,000,000; • The turnover of the acquired company is greater than Euro 50,000,000. Any merger that exceeds the regulated materiality threshold distorts free competition when it leads to, or strengthens, dominant market positioning within the national market if such positioning leads to competition being eliminated or mitigated in a substantial and sustained manner. To ensure that the conditions outlined above are met, companies that intend to merge must communicate with the Antitrust Authority, providing all necessary information accompanied by attachments and essential elements to ensure that a comprehensive evaluation takes place. Obviously, no such obligation exists when mergers have no economic effects on the Italian market. If elements arise that justify the prohibition of a merger, the Antitrust Authority may, after being notified by the promoting company, obstruct and consequently block a merger by restoring conditions for effective competition. It may also allow the merger to continue. However, when mergers exceed the minimum materiality threshold established by European regulations, the competent body responsible for regulation is the European Commission, with its rules contained within Regulation (EC) no. 139/2004 and its implementing Regulation (EC) no. 802/2004. Mergers have community relevance when the total turnover of companies involved is greater than Euro 5 billion, and the individual Community turnover of at least two of the companies is greater than Euro 250 million, except where each of the companies involved earns more than 2/3 of its total Community turnover within one and the same Member State. Furthermore, it should be highlighted that, for companies listed on regulated markets, certain specific market disclosure obligations are required, as amended by the Consob resolution of May 13, 2010, corrective part of (Issuers’ Regulations) Rule 11971, dedicated to “significant mergers, spin-offs or share capital increase by means of the conferral of assets in kind, acquisitions and sales”. This concerns operations that lead to a company being required to release an informative document to the market. 2

Autorità Garante della Concorrenza e del mercato.

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2.3. Decision making stage Article 2502 of the Italian Civil Code stipulates that a merger is approved by the boards of companies participating in a merger, which operate via differing means depending on the company type (Articles 2502, Paragraph 1; 2368; 2369; 2460; 2479; 2479-bis of the Italian Civil Code). Resolving on a merger is, quite simply, a statement of a company’s intent to approve a merger plan; this is significant for the interests of both shareholders (internal) and company creditors (external). Regulations provide that, unless the Articles of Association or Bylaws state otherwise, resolving on a merger within partnerships is undertaken through the consent of the majority of shareholders determined based on the portion of profits to which each shareholder is eligible. In joint stock companies, this is undertaken by the board of shareholders with voting quorums that vary depending on the company type. Deliberations must result in directors being given a mandate to establish a merger deed within the 60-day period given to creditors to oppose the merger. Based on the inherent risks associated with a merger, it should be taken into account that dissenting shareholders have the right to withdrawal in the event that a merger is carried out. Regulations pertaining to the right to withdrawal are defined in Articles 2502, 2437 and 2473 of the Italian Civil Code and circumstances vary based on whether the company is a partnership or a joint stock company. As previously mentioned, when partnerships decide on a merger, a majority, in terms of shareholder consent, is sufficient without prejudice to the right of withdrawal of one or more shareholders if they have not consented to the merger. However, with regard to joint stock companies, processes differ between shareholders of public and private limited companies. The right to withdrawal of a dissenting shareholder within a private limited company automatically applies (Article 2473 of the Italian Civil Code), whereas no such guarantee exists for shareholders within public limited companies. (Article 2437 of the Italian Civil Code). As is known, a merger involves the intermixing of assets of participating companies. Such intermixing of assets may entail reduced guarantees for the creditors of participating companies. Intermixing of assets may, in fact, pose great difficulties for company creditors in terms of seeing a return on their credit. This is a major risk factor. An example of this may include a company experiencing significant financial difficulties; this company’s risk of insolvency may potentially have a negative impact on the company formed by the merger. Based on these reasons, guarantees need to be in place for company creditors. Pursuant to Article 2503 of the Italian Civil Code, creditors may express opposition to a merger. This provision stipulates that a merger may be implemented 60 days after registrations for the participating companies are completed, allowing company creditors to express opposition to the merger within this deadline. However, the court of the district in which the resolving company has its registered office may nonetheless order that the merger can take place if any danger of prejudice is deemed groundless or the company has granted an adequate guarantee.

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2.4. Final stage As a rule, the merger takes effect as soon as the final registration of the merger deed is made with the Business Register. However, Article 2504-bis, Paragraph 2 of the Italian Civil Code stipulates that the date that the merger takes effect may be postponed or brought forward. Postponing the merger taking effect is only possible for acquisitions, whereas the date for the sharing of profits from shares/quotas owned by the companies that cease to exist and the date from which the operations of the companies that cease to exist are chargeable to the budget of the surviving entity or the company benefiting from the merger may be backdated. The fundamental effect, which carries more significance than the merger itself, is the fact that surviving entity or the beneficiary company takes on the merging companies’ preexisting contractual relations and processes. In essence, the new company continues all prior relations. Therefore, starting from the date on which the merger takes effect, the merged or acquired companies cease to exist and their rights and obligations are assumed by the surviving entity or the company formed by the merger. The merger process concludes with the drafting of one single document, namely the merger deed. According to Article 2504 of the Italian Civil Code, the merger deed must be sanctioned by public deed, undersigned by the directors and subsequently filed with the relevant Business Register. It contains all conclusions from the deliberations of the boards and, in this sense, the document is closely related to, and associated with, the merger plan. For the sake of comprehensive information, it should be noted that Article 2504-bis of the Italian Civil Code, in addition to the general rule stating that a merger takes legal effect from the registration date with the appropriate Business Register, enables acquisitions to postpone a merger from taking legal effect until a later date (Legal postponement). In this case, any legal, accounting and tax obligations shall take effect from the date on which the merger deed is established. In addition to the possibility of postponing the merger taking legal effect, the provision also enables the date by which all operations are assigned to the surviving entity to be backdated. It should be specified that this backdating is only relevant for accounting and tax reasons and has no legal significance. In conclusion, it should be noted that the provision allows for a simplified process when wholly-owned companies merge, as no particular guarantees are required if the exchange ratio is absent. Indeed, Article 2505 of the Italian Civil Code provides that the directors’ report may be waived, the expert report may not be necessary and that information within the merger plan may be further simplified.

3. Final observations: Limits and tax benefits associated with Mergers A comprehensive analysis concerning both the legal benefits introduced that aid mergers and the limitations in place aimed at preventing abuse and elusive practices is provided below. Companies involved in mergers within the domestic market benefit from tax relief, meaning that mergers represent genuine financial opportunities.

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Indeed, pursuant to Article 172 of the T.U.I.R. 3 (Income Tax Consolidation Act), “A merger occurring between several companies does not result in taxable capital gains from assets that belong to the merged or acquired companies being made or distributed ...”. Based on the principle of neutrality, the assets of the company that ceases to exist (merged or acquired) are incorporated into the surviving entity or the company formed by the merger without any tax base appearing. Therefore, all assets from the company that ceases to exist are incorporated into the company formed by the merger or the surviving entity without any taxable capital gains or capital losses with respect to values recorded within accounting entries. Legislature provides that assets from the company that ceases to exist maintain, for either the company formed by the merger or the surviving entity, their original taxable value. It should be noted that Article 2504-bis, Paragraph 4 of the Italian Civil Code outlines regulations for the first financial statements subsequent to a merger and stipulates that assets and liabilities are drafted based on values written to the accounts on the date that the merger came into effect. Therefore, at this stage any surplus or deficit within accounting entries is covered by the fundamental principle of fiscal neutrality as stipulated by Paragraph 2 of Article 172 of the Tuir “When determining the turnover of companies that are formed by mergers or acquisitions, surpluses or deficits recorded within balance sheets are not taken into account due to the exchange ratio of shares/quotas or cancellation of shares/quotas of any of the merged companies that are owned by others”. Procedures for accounting and determining the exchange ratio may lead to differential values, namely merger differences defined as “exchange differences” and “cancellation differences”.

Exchange deficit

Changes in share capital (company resulting from the merger or surviving entity) > Quota of net assest of minority interests

Exchange surplus

Changes in share capital (company resulting from the merger or surviving entity) < Quota of net assest of minotity interests

Cancellation deficit

Value of the equity investment in the merger company (recorded within financial reports of surviving entity) > Corresponding quota of the merged company’s net assest

Cancellation surplus

Value of the equity investment in the merged company (recorded within financial reports of surviving entity) < Correspondig quota of the merged company’s net assets

In particular, exchange differences arise from comparisons made between the share capital 3

Testo Unico delle Imposte sui Redditi D.p.r. no. 917 December 22, 1987.

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of the company formed by the merger and the net assets of the merged companies, or from the increase in share capital of the surviving entity and the quota of net assets of the acquired company, which is owned by third-party shareholders. Therefore, generally speaking, we can say that exchange differences arise whenever a merger leads to the formation of a new company and the relations of the merged companies are transferred to the new economic entity or whenever the surviving entity possesses less than 100% of the acquired company’s capital. On the other hand, cancellation differences arise whenever the surviving entity possesses an equity investment within the acquired company that leads to a “cancellation surplus” or a “cancellation deficit”. A cancellation surplus corresponds to the negative difference between the value of canceled equity investments and the corresponding quota of net assets. In short, a cancellation surplus occurs when the value of the canceled equity investment is less than the corresponding quota of net assets. Therefore, it can either indicate that the surviving entity has achieved a good deal by acquiring the equity or that the investee’s assets have been overvalued, that the liabilities have been undervalued or that future losses are expected. On the other hand, the cancellation deficit corresponds to the positive difference between the value of the canceled equity investments and the corresponding quota of accountable net assets. This may constitute: The revaluation of equity investments over time due to special laws, while sole assets are not revalued: • Latent capital gains on corporate assets or goodwill being present; • The investee company’s losses, on the date that the equity investment was purchased, not being upheld on the date of the merger; • Or simply bad business through the purchase of the equity investment. The principal of fiscal neutrality for mergers only covers the individual assets of the companies involved. However, it does also cover the subjective positions of shareholders who, at the time of a merger or an acquisition, see their investments replace those that are newly issued (this does not apply to wholly-owned companies). Paragraph 3 of Article 172 of the Tuir stipulates that “The exchange of original investments does not result in taxable capital gains or capital losses being made or distributed, nor does it result in revenue being received by shareholders of the acquired or merged company”. However, legal restrictions concerning the reporting of losses and the deductibility of interest expenses have been implemented in order to prevent any abuses or elusive practices that may arise from a merger. Paragraph 7 of Article 172 of the Tuir stipulates that “losses incurred by companies participating in a merger, including the surviving entity, may be deducted from the revenue of the company formed by the merger or acquisition provided that the amount does not exceed the relevant net equity amount indicated by the last financial statement, or if lower, by the balance sheet referred to in Article 2501-quater of the Italian Civil Code (contributions or payments undertaken during the 24 months before the date of this balance sheet are not taken into account) and on the condition that the profit and loss account of the company whose losses may be brought forward shows, for the financial year prior to the merger resolution, that revenues

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relating to the core business of the company and employment costs referred to in Article 2425 of the Italian Civil Code are higher than 40% of the average of the two prior financial years”. This provision is based on the desire to prevent mergers that involve non-operating companies, with the sole aim of compensating losses with future profits, from taking place. Restrictions in place for the reporting of losses are also applied when non-deductible interest expense tax is reported during subsequent periods. The final part of Paragraph 7 of Article 172 of the Tuir stipulates that “These provisions also apply to non-deductible interest expenses, which are subject to being brought forward as outlined in Paragraph 4 of Article 96”. However, it should be noted that the restrictions established by this provision may cease to be applicable in the event that the taxpayer provides a private letter ruling, pursuant to Article 11, Paragraph 2 of Law 4 no. 212/2000 (Taxpayer Bill of Rights), that demonstrates a valid economic and legal reason for the operation. As outlined in the previous chapter, Paragraph 9 of Article 172 of the Tuir enables any issues relating to taxes resulting from a merger to be backdated “from a date that does not precede the date on which the final financial year of the merged companies ended …”. Backdating enables the process to be simplified further. Under normal conditions, a merger entails the cessation of operations for companies being acquired or companies being merged. This means that a legitimate interim financial report should be drafted (with tax consequences considered) so that company operations carried out up until the date on which the merger takes effect can be identified clearly. With the option for backdating available, issues concerning taxes and accounting can be made clear from the date on which operations of the company formed by the merger began. This means that any problems that arise as a result of the cessation of operations are alleviated.

4

Statuto del Contribuente.

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APPENDIX 2

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Mergers & Acquisitions from an International Tax Planning perspective Gino Reolon

SUMMARY: 1. Introduction. – 2. Motives for legitimate international tax planning. – 3. Main international avoidance techniques. – 4. Abuse of rights in Mergers & Acquisitions operations. – 5. Article 10 bis of the Taxpayer Bill of Rights. – 6. Conclusion.

1. Introduction In corporate finance, mergers & acquisitions (M&A) operations are intrinsically linked to international tax planning (or ITP). Quality planning aims to keep such operations within solid economic and financial parameters and – crucially – in line with the law. The main aim of ITP is to streamline a corporation’s tax burden by putting specific operational, management and structural plans into action. It constitutes a driving force for growth, enabling the company to expand their business horizons and pursue ambitious productivity goals, but also firmly places it in a position where a range of scenarios are available to support general tax obligations. Essentially, alongside other objectives (including capitalizing financial income, exploiting additional resources and reducing unproductivity), M&A operations play a role in the company’s desire to bring their tax burden down to within acceptable limits. ITP is an essential element of any business in a global economic system which increasingly operates beyond and between national borders. Using ITP, an efficient and well-structured company can optimize its income tax, taking full advantage of opportunities provided by taxation rules while remaining comfortably within legal boundaries 1. ITP is carried out through coordinating a variety of techniques in accounting and other fields, which are all closely linked to the composition and type of income – in other words, they relate to both its production phase and its allocation to a geographical location 2. These 1

For in-depth information on ITP see (among others): E. TOMSETT, N. NOBLE, Company Reorganisation: Tax and Tax Planning, London, Butterworths, 1990 and D. CAMPBELL, International Tax Planning, London, Kluwer Law International, 1995. 2 See A. DRAGONETTI V. PIACENTINI, A. SFONDRINI, Manuale di fiscalità internazionale, Milano, Ipsoa, (2008), p. 123.

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techniques, which are nearly always integrated, are used in a particular way to deal with corporation income and its variable nature. In other words, there are a range of tactics which come into play both at the moment of income production (with its consequent creation of profit), and at the moment of its ‘relocation’ to geographical areas with more advantageous fiscal regimes. There are also other techniques (for example, adjusting costs) which are used solely to reduce income, others that facilitate the relocation of income sources to areas with more accommodating tax regimes, and so forth. In summary, effective ITP, in conjunction with M&A operations, largely tends to reroute positive income components to more lenient tax jurisdictions and negative components to less convenient locations.

2. Motives for legitimate international tax planning As part of expanding beyond national borders and deciding to widen its reach, a company must undertake a comparative analysis between different tax legislation. This research must match the unique operational characteristics of the company with the tax rules of the country it is aiming to expand into. The ITP process therefore needs to take into account the various foreign legislation, choosing the best solution to streamline the tax burden and facilitate the company’s business. Managing ITP effectively as part of company-wide business planning involves choosing a path through the various tax regimes – and their legislative ‘asymmetry’ 3 – in line with the law, in a way that does not present obstacles to the company’s expansion. Clearly, corporations by their very nature are inclined to make decisions based on spending as little tax as possible: their raison d’être is commercial in nature. However, the sheer variety of legislation, the existence of agreements to avoid double taxation between countries, and the existence of certain territorial areas (for example tax havens) which attract foreign liquid assets through highly encouraging taxation policies, all constitute an additional, enticing reason for companies to look beyond their own borders. To limit its tax burden, a company undertakes skilled management of income streams alongside an ingenious reallocation of production structures. It gears its executive strategy and arranges its logistical and accounting techniques in line with specific tax advantages. These ad-

3 “International ‘asymmetry’ in legislation (anomalies in the tax system which have a distorting effect on allocation and distribution mechanisms), allows taxpayers to “temporarily dislocate, both in terms of time and most of all in terms of geographic location, the moment of taxation from the (figuratively connected) successive enjoyment of public products and services funded by it. (A. CERRETELLI, in il Sole 24 Ore, 3 April 2000). Clearly, avoiding or reducing their tax burden as much as possible is likely to be among the transnational taxpayer’s priorities. If these asymmetries feature in a plan of action, carried out by the more shrewd commercial taxpayers, they facilitate global operations (including investments and divestments, corporate restructuring, commercial transaction networks and so forth) which take advantage of grey areas in tax legislation on two levels: by obtaining the minimum level of taxation, and by delaying the effective cash outlay for as long as possible. In general terms, this strategy consists of taking the whole taxable amount – often by means of fiscal splitting – and reallocating it or redistributing it in a differentiated fashion across the various tax jurisdictions (called tax shifting or shipping). In other words, international tax planning”. From S. NOTA, L. SPERLINI, G. PEZZELLA, Aspetti di Patologia, in N. POLLARI, Lezioni di Diritto Tributario Internazionale, Ed. Laurus Robuffo, 2005, p. 304.

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vantages can be the product of one or more accounting matrices, which may also coexist on a global level. Therefore, in most cases, the company carries out ITP as part of its M&A operations by identifying and (if necessary) implementing acquisition techniques based on the specific advantage (or advantages) it hopes to gain. As a result, if the company wants to improve the performance of its global income it will tend to research and acquire foreign companies whose operational characteristics will allow it to benefit from reductions in tax. For example, capital gains tax may be significantly reduced if a company, as part of its M&A operations, acquires another whose operational and accounting practices allow for such a reduction. Similarly, if a company aims to limit tax on income from dividends and/or royalties, it needs to procure companies which benefit from lower withholding tax via their adherence to certain international treaties. A company can also set up a trust 4 to limit tax as part of its succession planning (sometimes attempting to mask the actual existence of a company). In light of this, ITP – as part of M&A operations – can be seen as an international corporate strategy aimed at gaining tax advantages, which remains within the law despite involving sophisticated management, logistical and accounting techniques.

3. Main international avoidance techniques We have seen how careful ITP aims to create a close relationship between operational aspects of the business and specific areas of international taxation. When a company decides to expand internationally, the main objective of ITP is to avoid the problem of double taxation, which could clearly impact on the normal circulation of revenue between countries, as well as negatively impact on a company’s business ambitions. It is important to highlight that the correct meaning of ITP as a complex strategy aimed at streamlining the tax burden, and not a predisposition for tactics to make illegitimate tax savings. As we have seen, it must be acknowledged that corporations often use ITP to exploit weak links in tax legislation and engage in dubious practices 5, peddled as a legitimate desire to limit their tax liability. The most evident manifestations of these avoidance techniques – which can be wideranging and change over time – are those which include either of the following: the redomiciliation (or relocation) of the taxpaying subject, i.e. transferring the company to a country or area 4 A trust is a type of arrangement where a settlor transfers the ownership of their assets or property to a trustee, who manages these for the benefit of a third party (beneficiary) or agreed purpose. Essentially, a trust operates in line with a trust deed, a legal document, which sets out how the trust should be used and provides all details including the setup, beneficiary and management of the trust, which work together to achieve its final aim. A key feature of a trust is that the assets within the trust are legally separate from the assets of the parties involved. 5 These practices also create problems of unfair competition between two types of company: companies that have brought their commercial operations in line with tax legislation (often increasing their administration costs through this launch into a fiercely competitive international market), and other companies which, on the contrary, have chosen to disregard the law and subsequently benefit from considerable cost savings and greatly facilitated access to this same market.

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known for its lenient tax rules, or transferring taxable assets by changing the location of income generation or by using sophisticated accounting techniques. Corporation income is subject to tax wherever it is produced (adhering to the worldwide taxation principle), so there is a concrete risk of companies relocating – at least on paper – their place of tax residence to areas with lighter taxation, and where the income generated is subject to more favourable treatment. The reallocation of taxable items, however, is carried out through multiple channels. Broadly speaking, the most frequently used method is to manipulate items of income through either overstating or understating transactions between companies, which are part of the same group, or in some way connected 6. Alongside these, more ‘usual’ methods exist other more sophisticated systems, which respond instantly to wider international economic and financial developments. These prompt the introduction of new clauses or the improvement of existing ones within national legislation. Included in the last category is the ‘presence’ (in any country) of foreign commercial organizations, which do not physically exist, hidden thanks to the creation of entities with independent legal status. Another sophisticated method is artificially overstating costs between associated companies (for example those linked to royalties 7 and interest) with the aim of modifying the type of dividend in an income component creates a different configuration which benefits the company through a lower tax burden. The concept of treaty shopping is also worth mentioning. This is a particularly widespread practice where a company, as part of its tax strategy, exploits the opportunities presented by double taxation agreements (or treaties), effectively ‘purchasing’ a ready structure within one of the countries party to the agreement in question 8. Alongside treaty shopping, rule shopping is another recent phenomenon, which is evolving constantly. In this case, the company researches bilateral agreements between countries to align its operations with any potential tax advantages suggested by the text 9. Another technique, transfer pricing, involves the reciprocal reworking of the price of assets transferred between companies. Affiliated companies, which are tax resident in different coun-

6 A typical example is when company (X), based in a country or area known for its high taxation, sells assets below cost to an affiliated company (Y) which is located in a country with a favourable tax regime, simultaneously minimizing the affiliated company’s income and achieving a saving based on the lower overall taxable amount. Similarly, company (X) can exploit the same tax advantage by selling assets to (Y) at a greater (overstated) cost if they are in a country with less onerous taxation rules. 7 This practice involves basing the royalty-owning company in an area, which assures preferential treatment of proceeds from shared use of non-material goods, and where one or more affiliated companies benefit from tax deductions related to costs of issuing royalties – an attractive prospect in terms of corporate strategy. 8

For example, if company (X) is located in a country, which does not have an agreement with country (Y), it acquires a company based in country (Z) which does have an agreement with country (Y). 9 One of these strategies involves exploiting the rules related to dividends. To avoid deductions, the taxpaying entity transfers the assumed income to the realm of another treaty or agreement. A typical example is dividend stripping, which involves researching and exploiting specific clauses related to capital gains.

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tries can reorganize taxable amounts through accounting practices with the aim of reducing the overall tax burden 10. In summary, M&A operations from an ITP perspective open up the possibility of tax avoidance, which presents itself in various forms. One approach is to coordinate elements to bring the taxable amount within a legal framework or physical location subject to lighter taxation 11. Another guise is through transactions carried out by entities, which appear independent with different purposes, but which in fact work towards a common goal and form part of an integrated corporate plan 12. Yet another approach takes the form of transactions that allow the taxable amount to be transferred from one company to another through ‘acceptable’ reciprocal financing strategies, but which in fact disguise dubious distribution operations 13. The brief outline above includes common techniques that can indicate suspicious M&A operations. Particularly intricate acquisition and accounting manoeuvres are often a clear sign of tax avoidance, having no clear link with straightforward accounting requirements. On the other hand, a lack of detail in accounting – an inability to provide transparency – also gives rise to doubt as to the legitimacy of the techniques. Two elements should be considered in evaluating operations from a tax avoidance perspective: the common interest of the acquiring company and the acquired company to hide the taxable nature of the operation, and the presence of M&A agreements, which do not conform to correct accounting principles or economic rationale.

4. Abuse of rights in Mergers & Acquisitions operations Before we deal with the issues related to abuse of rights, it is worth remembering that the Supreme Court of Cassation (Rome) has highlighted the importance of applying this principle with the upmost caution. This is especially true in the case of large-scale commercial operations, where it is fundamental to identify a clear and fair line between exercising a right through choosing legal forms and aggressive ITP 14.

10 For example, company (X), located in a country with high taxation, sells to an associated company (Y) in an advantageous location for tax. They agree on a transfer price, which is lower than the market value in order to concentrate profit creation in the destination country. A similarly advantageous transaction takes place if company (Y) sells goods or services to company (X) at a price higher than the market value, which has the effect of increasing tax deductible costs for the company (X). 11

See the 21 February 2006 sentence of the European Court of Justice in the case C-255/2002. This was regarding a British credit institute,which set up and used an affiliated company to create a tax avoidance strategy designed to enable the institute to reclaim more VAT (value added tax) than it was entitled to as part of building and renovation works. 12 When a company (X) acquires another company (Y), and (Y) appears to be clearly distinct from (X) ‘on paper’ but is basically part of the same structure and operates in a sector which closely corresponds to that of (X). 13 This is related to the concept of thin capitalisation. This occurs when one company controls another and artificial financing operations are carried out instead of a more logical movement of capital. They can be arranged, for example, between a lending company (X) and a borrowing company (Y). Tax deductions can therefore be made from both the interest due from the borrowing company and from the movement of capital carried out by the lender. 14

Supreme Court of Cassation, Sent. no. 1372 of 21 January 2011.

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As we have seen, ITP can also mean exploiting the relationship between two nations’ tax legislation, creating a corporate fiscal ‘style’ which blends the rules of the various jurisdictions. For any company, solid and legitimate ITP – which fits within credible economic and financial criteria and remains in line with the law - is a driving force for functional growth. It can launch a company onto an international platform and position it in a way that ensures fair tax contributions. Key targets of ITP include creating an environment which (legally) attracts foreign investment while providing benefit in terms of tax savings. This is a delicate balance, where recognized ethical and legal/economic values are protected as part of a complex legal framework which anti-abuse rules form part of. Tax management as part of international expansion is legitimate if it manages to reconcile the interests of the company/entity in question with those of the relevant countries (both the place of tax residence and the ‘destination’ country). Corporations naturally attempt to maximise profit and minimize taxation. This prompts two typical approaches. The first attempts to reduce the tax burden relatively speaking, by shifting it onto other platforms or entities (transferring). The second attempts to reduce the tax burden in an absolute fashion, which is referred to as tax evasion. We will not deal with the topic of tax evasion or tax insolvency here, but tax avoidance requires further analysis. Tax avoidance (as opposed to evasion, which takes place further ‘downstream’ within the process) is premeditated, involving a strategy which circumvents legal technicalities and effectively cancels out the taxable amount before it comes into being, rendering it unable to attract taxation. A company that carries out tax avoidance pre-establishes a methodology, and is therefore, in a formal sense, ‘legitimate’. This is where the concept of abuse of rights comes in. The term acknowledges the greater attention given to legal technicalities of tax avoidance, through either violation or bypassing of the law. The area of law concerned with abuse of rights is located in the ‘grey area’, which separates lawful tax savings from unlawful ones, and also outlines the legal system’s response to tax avoidance. “Tax avoidance and abuse of rights are correlated ideas. If the taxpaying entity does not apply the rules of the appropriate tax regime (and instead applies more favourable legislation) abuse of rights is the category of law which determines the extent to which this behaviour can be considered legally elusive/evasive)” 15. As we will see, the complexity of this area of law is due to the various requirements for fair taxation along with sufficient identification of the details to establish taxable amounts – principles outlined in the Italian constitution, in articles 54 and 23. For the first time in the Italian legal system, article 10bis of the “Rights of the taxpayer” 16 explicitly outlines a legal definition of abuse of rights, where one or more operations “show a lack of economic substance; and, despite being formally in compliance with the law, enable the taxpayer to achieve undue tax advantages. These operations are not opposable to the tax authorities, which shall disregard the tax advantages so achieved and compute the taxes on the basis of the rules and principles that have been circumvented, taking into ac-

15 16

See: F. TESAURO, Istituzioni di diritto tributario, 2009, p. 240.

Article 10 bis was introduced into Law no. 212 of the 7 July 2000, “Regulations on abuse of rights and tax evasion” (Rights of the taxpayer), from article 1 of Legislative decree no. 128 of 5 August 2015 implemented in articles 5, 6 and 8, co. 2, of Law no. 23, 11 March 2014.

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count any tax payments made by the taxpayer in connection with the abusive transactions” 17. Further reading of the legislation clarifies the concept of abuse: operations relating to tax which are not carried out “in good faith”. The legislation on abuse of rights is a clear response to evasive techniques that may not constitute a glaring transgression of the law, but nevertheless involve underhand accounting devices which both appear legitimate and result in a tax reduction. The aim of these techniques is in contrast with correct fiscal management, which makes decisions based on sound economics. The various points of contact between ITP, tax avoidance and abuse of rights merit further reflection. In general terms, however, any practice which oversteps a boundary set by a government in terms of a reasonable approach to taxation (where a taxable amount is disintegrated and reduced by corporate strategies exploiting ambiguous areas of the law) can be considered as an abuse of rights. Typical avoidance scenarios as part of M&A operations include, for example, when the transfer of a business involves illegitimate tax deductions relating to the merger deficit 18, or when losses are deliberately incorrectly valued and may be offset by capital gains accrued during the company transfer 19. Similarly, if a company transfer is carried out which also involves the transfer of entire stakes in either company; this should give rise to well-founded doubts about its legitimacy and the likelihood of avoidance techniques. Avoidance scenarios can also be found in mergers, which provide an environment for offsetting gains and losses 20 or where the composition of the two companies’ net worth (or the valuation of their assets and liabilities) allows them to avoid specific levies 21. De-mergers 22 (the splitting up of a company group) may also provide cover for tax avoidance when it is used to separate assets and to divide them under the guise of shares, without undergoing a liquidation process of the de-merged company or an actual operation to distribute shares between the partner companies.

17 See Italian Tax Reform: New Legislation on Abuse of Law and Statute of Limitations, V. Salvadori di Wiesenhoff, in Tax Planning International, vol. 17, no. 10, October 2015, ISSN 1754-1646. 18 A controlling company (A) acquires a controlled company (B) in its entirety, including payables and receivables, which is subsequently free of assets and wound up. An avoidance scenario would be if company (A) uses the merger deficit to its advantage for tax purposes if this deficit does not in fact reflect the actual situation. 19

If a company sale or merger lacks convincing economic motives, the likelihood of it having been carried out to avoid tax is higher. 20 See the following articles for limits on tax losses for companies participating in mergers: article 172, comma 7 of the TUIR, and 37-bis of the Presidential Decree no. 600/1973. 21 The classic scenario is where a company (A) presents tax-suspended reserves in the net worth area of their balance sheet, which are only subject to tax upon distribution. This is then consolidated within another company (B)’s balance sheet without reporting a merger surplus or increasing the capital of company (B). 22 De-mergers are also used legitimately as part of entrepreneurial endeavours. These include revisiting company structures to achieve better access to markets, and to diminish risk by differentiating and distributing assets among the various components.

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5. Article 10 bis of the Taxpayer Bill of Rights When a company operates on an international level, it is not always simple to identify which activities form part of the normal (and legitimate) tendency to find the least onerous tax solutions, and which can be considered as tax avoidance. Generally speaking, governments can adopt specific legislation to combat tax avoidance as part of M&A operations, or (as happens more often) utilize elements of broader conventions or agreements which have been ratified within the legal system of that country. The above-mentioned legislative solutions are applied to the re-entry of taxable amounts, which have been strategically located abroad. The appropriate revenue agencies employ a method which actually disregards the tax advantages achieved from M&A operations, when it is clear that the objective of such operations is an illegitimate tax saving (as outlined in the previous section). Taxes are then computed on the basis of the rules and principles that have been circumvented. These agencies look at the details of the operations and ascertain whether the M&A operations constitute a lack of economic substance (or a lack of clear economic motives). If this proves to be the case, they can disregard the tax saving and proceed with appropriate action 23. This approach requires the authorities to prove that corporate actions do not have ‘clear economic substance’, whilst not hindering in any way legitimate and economically justified corporate practices and conduct. We should look at the technical significance of Article 10 bis of the Taxpayer Bill of Rights, and it is worth noting that abuse of rights (among other elements) is no longer considered in the context of national law as a tax crime. The European Commission Recommendation 2012/772/EU on ‘aggressive tax planning’ provides a point of reference for action on this type of conduct, and describes tax avoidance as “an artificial arrangement or an artificial series of arrangements which has been put into place for the essential purpose of avoiding taxation, and leads to a tax benefit”. In other words, the elements which define abusive commercial practice are the ‘artificial’ nature of the practice, and its aim of achieving a tax saving through avoidance. Commas 1 and 2 of Article 10 bis (which follows EU guidelines in terms of structure) deals with the key aspects and defining features of abusive practices. Specifically, comma 1 outlines how “abuse of rights is constituted by one or more operations which lack economic substance and, despite being formally in compliance with taxation laws, essentially create undue tax advantages […]”. Comma 2 describes the concept of this ‘lack of economic substance’, which is identifiable as follows: “facts, acts and contracts, which may be interconnected, and which in themselves are not able to provide economic effects other than tax advantages. Inconsistencies between individual transactions, in the underlying legal rational for their aggregation, or a mismatch between legal instruments adopted and standard market practices can be regarded as a lack of economic substance”. Tax advantages are described as “benefits, even if not immediately received, which are in conflict with the purpose of the tax provisions or with the principles of the tax legal framework” 24. 23 24

See commas 2 and 7 of article 37-bis, Presidential Decree no. 600/1973.

Adapted from Italian Tax Reform: New Legislation on Abuse of Law and Statute of Limitations, V. SALVADORI DI WIESENHOFF, in Tax Planning International, vol. 17, no. 10, October 2015, ISSN 1754-1646.

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Essentially, the contents of article 10 bis provide continuity from a previously enacted piece of legislation – article 37 bis of Presidential Decree no. 600/1973 – which links the presence of tax avoidance not so much to the aim of tax saving, but rather to the extent to which various elements of corporate conduct are biased towards this aim. Therefore, the existence of valid corporate aims and objectives doesn’t necessarily mean that pursuing tax savings is an integral part of these 25. With the introduction of this clause, the legislation provides more conclusive criteria in an often-confusing sector, whose complexities have undoubtedly had a negative impact on the development of international corporate strategy. For the legislator, the concept of abuse can be associated with corporate conduct which is in conflict with the principle of carrying out business “in good faith” (in the traditionally legal definition of the term). M&A operations can be considered as ‘abusive’ (or as tax avoidance) to the extent to which they are planned and developed to reach an improper objective: the undue benefit of a tax saving to which the company is not entitled.

6. Conclusion Business expansion is an essential part of creating added value to a company. However, the development of an international strategy should avoid risks that could have a negative impact. Corporations and entrepreneurs should endeavour to create a plan which launches them on an international level and gives due care and attention to a series of elements – including aspects relating to taxation. Companies mainly undertake M&A operations to strengthen their position within the market and improve their competitiveness. Strategies may pursue growth through broadening both their commercial offering and their structure. The latter involves restructuring and redefining the existing organisational framework 26. This analysis in this chapter maintains the importance of understanding if the motives behind these operations can be solely to realign a company structure with its economic rationale, or to integrate commercial needs with tax-saving objectives. Conducting these types of operation – commonly known as international tax planning, is currently the best method for optimizing investments to mitigate the company’s tax burden. As part of M&A, they sometimes show evidence of malpractice, particularly where a desire for tax savings becomes an undue tax advantage. It should also be acknowledged that achieving a tax benefit does not automatically mean engaging in illicit activities to achieve it – in any case a clear line should be drawn between what is considered a legitimate tax saving, and what is considered tax avoidance. The accepted view is that ITP is “an approach aimed at creating legal relationships and sit-

25

Comma 3 of article 10 bis establishes how “there is no abuse when a transaction is justified by sound reasons including managerial and organizational reasons – which are independent of tax operations and are aimed at improving the structure or the functionality of the business” [see footnote above for source]. 26 See L. POTITO, “Valide ragioni economiche” di cui all’art. 37 bis del D.P.R. n. 600/1973: considerazioni di un economista di azienda, in Rass. trib., 1999, I, pp. 59-60.

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uations which provide the basis for optimising (i.e. reducing) the tax burden” 27. In an international context the entrepreneur, or corporate body, must evaluate a series of needs, including finding a reasonable balance between tax issues and other types of challenges for the company. Planning M&A operations means knowing how to exploit the characteristics of single tax jurisdictions as well as the links between multiple jurisdictions, with the view that optimising tax obligations should involve the legitimate and legal integration of points of contact present in various national legislation.

27 See G. PEZZELLA, Operazioni transattive cross-countries commerciali (scambi con paradisi fiscali, etc.), Para. III, Subpara. 2.3.1, p. 328, in N. POLLARI, op. cit.

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Questionnaire on M&A a) General information 1. Interviewee position:

____________________________________________________________________ 2. Number of employees of the company:

____________________________________________________________________ 3. a) Is the control kept from the family-owened members? □ Yes □ No

3. b) If “Yes”, what is the share (%) of the family members in the: > Equity > Board > Executives > Other positions

_____________ _____________ _____________ _____________

b) Questions on the M&A policy 4. Next to each acquisition made by your company (2007-2012) are kindly asked to check the box corresponding to the type of strategy pursued and the type of synergies that are intended to achieve through the operation.

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Target

Type of Strategy

Type of synergies

DEAL 1

□ diversification □ Str. concentration □ Str. differentiation □ Str. internationalization

□ Syn. Operative □ Syn. of Revenue □ Syn. Fiscal □ Syn. Financial

DEAL 2

□ Str. diversification □ Str. concentration □ Str. differentiation □ Str. Internationalization

□ Syn. Operative □ Syn. of Revenue □ Syn. Fiscal □ Syn. Financial

DEAL 3

□ Str. diversification □ Str. concentration □ Str. differentiation □ Str. internationalization

□ Syn. Operative □ Syn. of Revenue □ Syn. Fiscal □ Syn. Financial

5. Indicate the importance of the precontractual phase on a scale from 0 to 5 (especially of duediligence) in successful operations of M&A? ___ 6. Have you undergone M&A operations for a feasibility study in the precontractual phase? □ Yes □ No

7. What was the most widely used method for conducting the feasibility assessment in the precontractual phase? (Please indicate next to each method the importance on a scale from 0 to 5). □ Preparation of the Business Plan _____________________________________________________________________ □ Net Present Value Analyses (NPV) _____________________________________________________________________ □ Identification of the Real Option _____________________________________________________________________ □ Other _____________________________________________________________________

8. What is the best financial scheme to support the financial requirement generated by a M&A operation? (define the percentage (%) is deemed more appropriate and select the boxes about the best coverage for all forms of finance concerned).

Questionnaire on M&A Financing form

Type of coverage for each financing form

§ Indebtedness ___%

□ Senior debt □ Hybrid struments □ Mezzanino Debt □ Convertible bond □ Securitisations □ Sale/lease back

155

§ Self-financing ___% § Equity ___%

□ New shareholders incoming □ Existing shareholders

9. With reference to a period of 24 months from the conclusion of the negotiation, what is the M&A operation that has created more value? □ DEAL 1 □ DEAL 2 □ DEAL 3 □ ETC

10. What are some factors of strength, weakness, opportunities and criticalities generated by M&A operations concluded? (Swot Analysis)? a) Strenghts  _____________________  _____________________  _____________________

b) Weakness  _______________________  _______________________  _______________________

c) Opportunities  _____________________  _____________________  _____________________

d) Threats  _______________________  _______________________  _______________________

11. What integration difficulties has your company met in the post-acquisition phase? □ Organizational □ Management □ Legal □ Culture □ Other ____________________________________________________________

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12. The current economic situation of the market represents a: □ Brake factor to the difficulty of finding sources of funding □ Stimulus factor to any low prices □ Other ____________________________________________________________

13. Are the M&A transactions creators of value for the bidder company who make use of this strategy? (specify on a scale from 0 to 5) ___

Thank you for your collaboration!

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Some final thoughts In this reflection on the strategic essence of the acquisition operations, we relocated these operations within the ordinary investments. They no longer belong to the group of exceptional operations in those companies, which are most active and wellstructured. That statement doesn’t want to downgrade the strategic importance of M&A, but simply take note of the birth of an acquisition mind-set, in the most active companies with an international vision. These are not necessarily enterprises of large scale but “large businesses” with a “large management”. However, they maintain the exceptional nature in terms of the complexity and the number of variables to be assessed and/or to be kept under control. The difficulty that a company finds in a deal, in fact, is to handle the amount of variables that play a critical role. The leit-motif is “a lot of”. Each operation, in fact, involves “a lot of players”, both within the company organization and outside, such as consultants, but especially the various stakeholders. One might observe that Freeman, in formulating the stakeholder theory, was particularly inspired by M&A. There are, in fact, “a lot of players”, more or less affected: employees, customers, suppliers, financiers, communities, governmental bodies, political groups, trade associations and trade unions. Even competitors are sometimes counted as stakeholders. Each of these subjects naturally has to supervise self-interests, with effects on the deal. M&A operations are distinguished also for “a lot of time”. There are, in fact, various investigation activities and time-consuming assessments for different professionals, but especially for the acquisition team. In the course of this work (Chapter 2) in fact, we have highlighted the different drivers that need attention in the large pre-merger assessment process and post-merger that are explored in “a lot of documents”, acquisition plan, due diligence, communications, integration plan and reports. Listed companies, in particular, have to raise awareness of “a lot of information” to the market in order to obtain the share value maximization. In the pre-merger stage, it could be useful to create some information asymmetry, about the expected synergies. In some transactions, with high evaluation uncertainty, it could be appropriate that the acquisition team does not give full communication to the target of all the synergies that it expects to realize, especially for fi-

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nancial synergies and for revenue. Target’s shareholders, indeed, might require sharing a portion of the future synergies in the price, by capturing a hypothetic value, with high uncertainty in terms of timing and cash flows for the acquirers. There are “a lot of drivers” that acquisition teams must define in the acquisition plan, including “a lot of motives”, rationale or irrational, that might inspire the operation in order to create or destroy value. Another deal key determinant is “a lot of economic and financial resources” for cost transactions, internal costs for managing the process, integration costs and the need to pay the price in cash. All elements that require important decisions in terms of financial structure, by producing “a lot of risk”. In this book, in fact, we had the opportunity to reflect on the different positive and negative effects that the hurricaneM&A can generate on different risk configurations. They are issues that absorb the businesses fully. It is obvious that the management and control of all the aspects mentioned above, which do not cover all the issues related to the transactions, “absorb” the management and the organization as a whole. Activities that can be handled specifically in individual companies, even in relation to the greater or lesser sensitivity to some of the issues mentioned before. At the same time, the results may differ within individual companies, both for the motives and the way in which a transaction has been addressed. After exploring the controversial positions of literature on this phenomenon, in Chapter 3 we went on to observe a sample of firms in order to find some “empirical” evidence on deal structures and the effects produced on the organizations. We focused on the top five “serial acquirers”. They are five enterprises, listed on Milan stock exchange, that have promoted a continual acquisition activity. This is a sample, albeit content numerically, has a high qualitative significance. In fact, while representing excellence, the companies are representative of the Italian economic system, by sector, by size and for being family businesses. As noted in the course of the book, according to different motives the family nature can fuel or hinder the operations of external growth. The results of this survey, both for the number of the companies involved and by the nature of “serial acquirers”, cannot be generalised to all the companies. These results, however, can be significant in order to highlight behavior and results of a number of businesses, few for the Italian market, many more in the international system, that have made the M&A a “stable” strategic vision. First, regardless of size, sector, age, it could be observed that the “serial acquirers” can boast good results both accounting and market-based performance, during the period 2007-2015. Overall, they have developed a total of 44 deals, mainly cross-border (38). These operations were stimulated above all by internationalization and diversification strategies, especially with the goal of reducing activity risk. The main objective of these deals was to achieve economic results (economies of scale, increase in market power and in terms of revenue).

Some final thoughts

159

Of course, it should be noted that the accounting performance could not be fully attributed to acquisitions: there are also operational and managerial activities, normally handled by enterprises. In any case, having before highlighted that the M&A are complex operations with a 360° organizational involvement; the lively acquisition activity of the top five has played an important role in the total results. In the book, we have previously observed that as many as 75% of operations fail, often provoking also acquirers’ failure, submerged by problems to handle and, above all, by transaction costs and integration activities not carefully planned. In the case studies we analyzed some of the accounting and market based performance as described in the first chapter (§ 1.3). During the period 2007-2015, the top five present positive trends in terms of turnover and assets, albeit with some bad tips in 2008-2009. As it is well known, the GFC has hit financial markets since the summer of 2007, slowing also the corporate acquisition activity. It is interesting to note that the market confirmed the fundamentals analysis considerations. In general, in fact, for all companies of the sample, the market has recognized the strategic value of M&A operations, by enhancing the value of the title. Accounting performance represents an ex-post measure, while market based parameters show the future expectations of value creation. On several occasions, the market, though, before expressing “to buy” has expected some first sign of acquirer robustness. The deal success depends both largely on the financial situation of the company (pre-merger and post) and the financial choices for the transaction, which may produce negative effects on the value creation, also if frequently they are partly submerged. The top five show full awareness of financial criticality: Leverage values are quite content and still in decline, despite many operations being financed with senior debt. The companies have declared that they prefer a funding mix, equity, debt and selffinancing, fuelled by past profits. Even the working capital and of short-term financial debt management, two other critical financial drivers, have received due consideration. Some structure parameters, such as size and trend of the working capital and of liabilities are built in Altman’s Z-Score, which represents good values for all the companies. In addition, questionnaires and interviews information have enable to “account” also the strategic-qualitative factors, in the SWOT matrix showed (fig. 48) In terms of Strengths, the companies have indicated that the fast response that the market imposes gives boosts to external growth, with significantly faster effects than in growth internally. Thanks to these operations, the company can quickly widen the range of products, often with premium brands acquisition. The particular Opportunities, that especially emergent markets can create, can be immediately satisfied from an acquisition that increases also the critical mass. In particular, the cross-border operations and international brand acquisition can completely change the product positioning and competitive levers for the acquirers. A strong strategic orientation to external growth can produce interesting effects on company profitability in a short time. Anyway, a successful deal needs a well-developed acquisition plan with a careful tar-

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get assessment, an accurate synergies measurement and the forecast of integration costs. During the interviews, managers have emphasized the importance of careful planning in the pre-merger stage, with an acquisition plan updated on the basis of all new feedback. It is precisely the integration stage, which could represent one of the major factors of Weaknesses and Threats in acquisition processes. In these activities, the acquisition team must pay particular attention to the socio-cultural variables, especially in operations that affect different countries, of emerging economies. In these countries, moreover, acquirers are required to handle the forecast difficulties for the political, economic and legislative uncertainty, especially on taxation. As also pointed out by Greggio, each operation must start with a thorough planning process, with a careful study of legal and fiscal implications. Especially tax implications can absorb the whole procedure. In order to search for synergies, Reolon, drew the attention on the importance of tax planning for each M&A operation, especially if cross-border. He concludes that in an international context the entrepreneur must evaluate a series of needs, including finding a reasonable balance between tax issues and other types of challenges for the company. Fig. 48 – SWOT’S analysis of case studies Strengths  Driving growth through innovation and product development  Strong brand portfolio  Critical mass  Premium brands Opportunities  New markets  New customer’s needs  New technologies

Weaknesses  Integration difficulties  Financial weeknesses  Planning weeknesses

Threats  Markets volatility  Political and fiscal uncertainty

The reflections developed above add an empirical vision to the academic debate. In the first two chapters, we have explored, although synthetically, the different positions of academic studies in M&A, so, also in this case, it is necessary to use the adjective “a lot of studies”. Very briefly, we can “close” with some literature axioms. About a third of papers focuses on M&A management matters, with particular attention on integration management, human side and resource management, corporate governance, cultural issues and knowledge related perspective. More of 60% of the studies analyse the strategic perspective, with a prevalence on performance and on the importance of a careful evaluation process.

Some final thoughts

161

Regarding the more debated acquisition performance drama, scholars offer limited insight, largely because of the wide variety of types and sizes of acquisitions and the lack of an objective way to classify them by strategy. From past accounting and finance research, there is a common agreement that studies on stock price performance are unable to determine whether M&A create real economic gains or losses. They provide evidence on the sources of any merger-related economic result, as it is difficult to distinguish between stock-market inefficiencies and improvements in economic performance resulting from the merger. The examined high equity values are typically attributed to some unmeasured source of real economic factors (such as synergy) or a general and not a well-established idea (as management past decisions). It is obvious that this kind of research could partially not be correct, as many other factors influence stock prices and their conclusions do not provide clear results, as reported by Pazarskis et al. (2009). Despite “a lot of pages” in literature, some questions remain the effects on performance (on which everything and the opposite of everything is debated) but above all the need to define adequate theories on M&A phenomenon. As evidenced by Cartwright et al. (2012), the research on M&A should move away from efficiency theories toward more process related theories. To define a theory one must thoroughly understand the phenomenon. This book attempts to add another piece to this cognitive goal especially by observing the M&A phenomenon through the lens both of scholars and of businesses. In particular for those companies that have proven to be able to look deeply into acquisition strategy, by leveraging the Strengths and Opportunities and by managing the Weaknesses and Threats with a Machiavellian logic of value maximization.

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