Mergers & Acquisitions in High Tech Industry

By: Abhishek Breja
feb 2004CreatingCreating ValueValue
throughthrough M&AM&A
Defining M&A and value
Mgmt. thought leadership
Some empirical evidences
High-tech industry trends
Case Study – Cisco Systems
Common biases in valuation
Acquisition strategy framework
Conclusion

By: Abhishek Breja
Case Study– Cisco Systems
Conclusion

3M&A and Value
Forms of Takeover
Slide
1.1
Source: Corporate Finance: Ross Westerfield and Jaffe (5th
Edition)
The Basic Principle of valuation applies: a firms should be
acquired if it generates a positive value to the shareholders of
the acquiring firm
Takeovers
Going Private/ LBO
Proxy Contest
Acquisition
Acquisition of Assets
Acquisition of Stock
Merger or Consolidation

4
Takeovers
Going Private/ LBO
Proxy Contest
Acquisition
M&A and Value
Forms of Takeover
Slide
1.2
• A merger refers to the absorption of one firm by another. The
acquired firm retains its name and it acquires all of the assets and
liabilities of the acquired firm. After the merger the acquired firm
ceases to exist
• A consolidation is same as merger except that an entirely new firm is
created
Edition)

5
Takeovers
Going Private/ LBO
Proxy Contest
Acquisition
M&A and Value
Forms of Takeover
Slide
1.3
• To purchase the firm’s voting stock in exchange for cash, shares of
stock or other securities. Though this may start as private offer from
the mgmt. Of one fir to another, the offer may be taken directly to the
selling firm’s stock holders – called TENDER OFFER.
Edition)

6
Takeovers
Going Private/ LBO
Proxy Contest
Acquisition
M&A and Value
Forms of Takeover
Slide
1.4
• One firm can acquire another firm by buying all of its assets. A formal vote
of the shareholders of the selling firm is required. This approach will avoid
the potential problem of having minority shareholders which can occur in an
acquisition of stock.
Edition)

7M&A and Value
Forms of Takeover
Slide
1.5
Takeovers
Going Private/ LBO
Proxy Contest
Acquisition
• Proxy contest occur when a group of shareholders attempt to gain
controlling seats on the board of directors by voting in new directors
• Going private refers to what happens when the publicly owned stock in a
firm is purchased by a private group, usually composed of existing
management. These transactions are frequently leveraged buyouts (LBOs).
In a LBO, cash offer price is financed with a large amount of debt.
Edition)

8M&A and Value
The value comes from Synergies
Slide
1.6
ΔCFt = Δ Revenue t – Δ Cost t – Δ Taxes t – Δ Capital Requirements t
r = risk-adjusted discount rate appropriate for the incremental cash flow, at
date t, from the merger
T
Synergy =ΣT =1
ΔCFt
(1+r)t
Synergy = Vab – (Va + Vb)
Va = Value of Firm A Vb = Value of Firm B
Vab = Value of the combined Firm
Edition)

9M&A and Value
Sources of synergy from acquisition
Slide
1.7
Sources of Synergy
1 Revenue Enhancement  Marketing Gains
 Strategic Benefits
 Market or monopoly power
2 Cost Reduction  Economies of scale
 Economies of vertical integration
 Complementary resources
 Elimination of inefficient management
3 Tax Gains  Net operating losses
 Unused debt capacity
 Surplus funds
4 The Cost of Capital  Reduced cost of issuing securities
Edition)

11
StrategicObjectivesExample
Distinct activities means differing challenges
Slide
2.1
Source: Not all M&As are alike and that matters, HBR article Mar 2001
By Joseph L. Bower
The over capacity
M&A
Geographic
Roll-up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence
M&A
Daimler-Benz
acquire Chrysler
Banc one buys
scores of local
banks in the
1980s
GE acquires many
product companies,
Quaker oat bys
Snapple
Cisco acquires
62 companies
Viacom buys
Paramount and
Blockbuster; AT&T
buys NCR,McCaw
and TCI
Acquiring
Company will
eliminate
capacity, gain
market share
and create a
more efficient
operations
Company
expands
geographically;
operating unit
remains local
Acquisition
extends a
company’s
product line or its
international
coverage
Acquisitions
are used in lieu
of in house
R&D to build a
market position
quickly
A company bets
that a new
industry is
emerging and
tries to establish a
position by culling
resources from
existing industries
whose boundaries
are eroding
Mgmt. thought leadership

12
Rationales for M&A activity (1997-1999)
Slide
2.2
Data for the chart comprises of
all M&A deals over $500
million made between 1997
and 1999.
Had we looked at $250mm to
$499mm range, we’d have
seen a higher % of R&D deals
By Joseph L. Bower

13
Slide
2.3
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
• You can’t run a merged company until you’ve rationalized it,
so decide what to eliminate quickly
• If it is the merger of equals and process and value differ
greatly that except trouble
• Also in case of Merger of Equals expect the management
groups to fight for control
• These tend to be one time event, so they’re especially hard to
pull off.
By Joseph L. Bower

14
Slide
2.4
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
• Members of the acquired group may welcome your
streamlined processes. If they don’t you can afford to ease
them in slowly
• If a strong culture is in place, introduce new values with
extreme care. Use carrot not sticks
• These are win-win scenario and they often go smoothly
By Joseph L. Bower

15
Slide
2.5
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
• Know what you are buying; the farther you get from home the
harder it is to be sure
• Expect cultural and governmental differences to interfere with
integration
• The bigger you are relative to your target company, the better
your chances for success
• The more practice you have the better your chances for
success
By Joseph L. Bower

16
Slide
2.6
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
• Build industrial strength evaluation processes so that you buy
first class businesses
• This category allows no time for slow assimilation so cultural
due diligence is a must
• Put first rate well connected executives in charge. Make it a
high visibility assignments
• Hold on the the talent if you can
By Joseph L. Bower

17
Slide
2.7
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
• Give the acquired company a wide berth. Integration should
be driven by specific opportunities to create value, not by a
perceived need to create a symmetrical organization
• As a top manager, be prepared to make the call about what
to integrate and what to leave alone; also be ready to change
that decision
By Joseph L. Bower

18
Slide
2.8
The over capacity
M&A
Geographic Roll-
up M&A
Product or Market
extension M&A
M&A as R&D Industry
Convergence M&A
You can’t run a
merged company until
you’ve rationalized it,
so decide what to
eliminate quickly
If it is the merger of
equals and process
and value differ
greatly that except
trouble
Also (MOE) expect the
management groups
to fight for control
These tend to be one
time event, so they’re
especially hard to pull
off.
Members of the
acquired group may
welcome your
streamlined
processes. If they
don’t you can afford
to ease them in
slowly
If a strong culture is
in place, introduce
new values with
extreme care. Use
carrot not sticks
These are win-win
scenario and they
often go smoothly
Know what you are
buying; the farther you
get from home the
harder it is to be sure
Expect cultural and
governmental
differences to interfere
with integration
The bigger you are
relative to your target
company, the better
your chances for
success
The more practice you
have the better your
chances for success
Build industrial
strength evaluation
processes so that
you buy first class
businesses
This category
allows no time for
slow assimilation so
cultural due
diligence is a must
Put first rate well
connected
executives in
charge. Make it a
high visibility
assignments
Hold on the the
talent if you can
Give the acquired
company a wide berth.
Integration should be
driven by specific
opportunities to create
value, not by a
perceived need to
create a symmetrical
organization
As a top manager, be
prepared to make the
call about what to
integrate and what to
leave alone; also be
ready to change that
decision
By Joseph L. Bower

19
Slide
2.9
Areas of Integration The over
capacity
Geographic
Roll-up
Product or
Market ext.
R&D Industry
Convergence
MOE - MOE - MOE - MOE - MOE -
Leadership VH H L VH L L H
Facilities, BU’s VH L L L L L L
Retaining People L M M H H VH L
Business
Processes/ IT
VH H M VH H VH M
Culture VH L L H M H L
Values VH H H H M H L
VH Very High M Medium MOE Mergers of
Equals
H High L Low

20
Slide
2.10
Source: HBR March 2004
The Sin in Synergy by DON MOYER

21
The Sin in Synergy by DON MOYER
Slide
2.11
Source: HBR March 2004

22
Alternatives to the big deal
Slide
2.12
Pick up the Scraps
Stay Home
Keep your eye on the Ball
Make friends
Stalk your target
Sell out
As Peter Drucker noted, for every
mega-merger or large acquisition, there
are usually several spin-offs,
divestments or asset sales that can
give companies – especially smaller
ones – lot of growth opportunities
BP- Amoco merger in 1998 led to the
disposal of 12 oil storage terminal
scattered across North America
Source: The Dubious logic of Global Mega-mergers, HBR article July 2000
By:Pankaj Ghemawat and Fariborx Ghaddar

23
Slide
2.13
Pick up the Scraps
Stay Home
Make friends
Stalk your target
Sell out
It may still make sense to grow regionally
rather than globally. Acquire companies
– if needed – in a particular region that
you understand well. Global merger
demands a phenomenal integration
which very few companies have
Maytag and Lloyd’s Bank

24
Slide
2.14
Pick up the Scraps
Stay Home
Make friends
Stalk your target
Sell out
A big deal takes a lots of time and
consumes lots of managerial attantion. If
others in you industry are busy with their
mega-deals, you can exploit that fact to
improve your own competitive position.
While Glaxo Wellcome and SmithKline
Beecham are busy in their post merger
integrations. Merck decided to stay out
an improve its position through
aggressive marketing and other
initiatives

25
Slide
2.15
Pick up the Scraps
Stay Home
Make friends
Stalk your target
Sell out
An alternative to Merger is building scale
through alliances and other
relationships. Alliances bring about less
resistance within companies, from
government, and from other interested
parties
IBM entered into a standing agreement
to purchase low prices PCs from Acer to
resell under IBM brand

26
Slide
2.16
Pick up the Scraps
Stay Home
Make friends
Stalk your target
Sell out
Even if it make sense for your
organization to pursue global
consolidation ask yourself if your
industry offer significant firms mover
advantages (for consolidation). If not it
may be smarter for someone else go
ahead and clear the path
Tricon’s (Pizza Hut, Taco Bells and KFC)
international strategy explicitly target
markets in which McDonalds’s has
already established a significant
presence

27
In case of AOL Time Warner acquisition.
TW’s shareholders did well in the
immediate aftermath of the
announcement; many of them rushed to
cash out
Slide
2.17
Pick up the Scraps
Stay Home
Make friends
Stalk your target
Sell out
Even in cases where the big deals makes
sense, it may be better for your
company’s shareholders if you are the
seller rather than the buyer

29Some empirical evidences
 Experience shows that 70% to 80% of acquisitions fail, meaning
they create no wealth for the share owners of the acquiring company.
 Deal volume during the historic M&A wave of 1995 to 2000 totaled
more than $12 trillion. By an extremely conservative estimate,
these deals annihilated at least $1 trillion of share-owner
wealth. For perspective, consider that the whole dot-com bubble
probably cost investors $1 trillion at most.
Slide
3.1Do acquisitions benefit shareholders?
Source: M&A needn’t be a loser’s game, HBR article June 2003
By Larry Selden and Geoffrey Colvin

30
 The Short Run
Do acquisitions benefit shareholders ?
(empirical evidence)
Slide
3.2
Abnormal Stock Price change associated with corporate takeover bids
Takeover Techniques Target Bidders
SuccessfulBids
Tender offer 30% 4%
Merger 20% 0
Proxy contest 8% n.a.
Tender offer -3% -1%
UnsuccessfulBids
Merger -3% -5%
Proxy contest 8% n.a.
Source: Modified from Michael C. Jensen and Richard S. Ruback, “ The market for Corporate control: The
scientific Evidence, “Journal of Financial Economics 11 (April 1983)
Some empirical evidences

31
 The Long Run
Do acquisitions benefit shareholders ?
(empirical evidence)
Slide
3.3
Abnormal Five Year stock return of Acquiring firms (1970-1989)
Acquirers using unfriendly cash tender offers 61.7 %
Acquirers who pay cash 18.5 %
All acquirers - 6.5 %
Acquirers using stock - 24.2%
Source: T.Lounghran and A.Vijh, “ do Long term shareholder benefit from corporate acquisitions” Working
paper (April 1997)

32
Slide
3.4
Prof. Harbir Singh and Prof. Maurizio Zollo, in the 1998 study,
titled ‘Creating value in post acquisition integration
process’ studied 228 acquisition in banking industry and tried
to analyze the impact of the following on the performance of
the acquisitions and also among them selves:
 Relatedness of resources
 Quality of the target
 Replacement of leadership
 Integration of merged entities
 Experience of acquisitions by the acquirer
 Codification of post acquisition experience
Harbir Singh
Professor of
Management, Wharton
Maurizio Zollo
Asso Professor of Strategy
and Management, INSEAD
What really adds value and what destroys value
Source: Createing value in Post-Acquisition integration process,
By Prof Harbir Singh and Prof. Muurizio Zollo

33
Characteristics
of the target firm
What really adds value and what destroys value
Slide
3.5
Relatedness
Quality
Acquisition
Performance
Post Acquisition
decisions
Replacement
Integration
Learning
Mechanism
Codification
Experience
-
+
-
-
+
+
+
+
The fit between codification
and integration has a very
strong positive effect on
performance
Source: Createing value in Post-Acquisition integration process,
By Prof Harbir Singh and Prof. Muurizio Zollo

34
Fast and Steady acquirers have done better
Slide
3.6
Source: Your best M&A Strategy, HBR article
by Sam Rovit and Catherine Lemire

35
Fast and Steady acquirers have done better
Slide
3.6
Most important: these frequent buyers excelled
at walking away from risky deals. At Cintas
and Cisco, every deal gets scrutinized by a
dispassionate executives.
Source: Your best M&A Strategy, HBR article
by Sam Rovit and Catherine Lemire

36
Mixed ResultsTop-line tribulations
3
6
1
4
12
13
25
36
<30 30-50 51-60 61-70 71-80 81-90 91-100 >100
Slide
3.7
Capturing Synergies is easy said than done
% of companies (n=77)
% of anticipated revenue synergies captured after merger
70% of mergers failed to achieve
expected revenue synergies
One quarter overestimated
cost synergies by at least
25%
% of companies (n=92)
23
5
13
7
14
8
13
17
0
5
10
15
20
25
<30 30-50 51-60 61-70 71-80 81-90 91-100 >100
% of anticipated cost synergies captured after merger

37
What Does the market Prefer
Slide
3.8
Rewards Penalize
Expansionists Transformatives
Acquisitions Joint venture, Merger or sale
Company that is:
 In a growing industry
 In a fragmented industry
 under-performing
Company that is:
 In a stable industry
 In a consolidated industry
 Performing well
Source: McKinsey quarterly 2001 Number 1.

38
Revenue growth through M&A is not easy
Slide
3.9
Standard deviation of pre- and post-
merger revenue growth from industry
mean1
, for mergers in 1995 and 1996
1
Sample of >160 acquisitions by 157
publicly listed companies across 11
industry sectors; revenue growth
calculated for combined entity 2–3 years
before and after merger in question.

39
The illusion of growth
Slide
3.10
 1
Compound annual
growth rate.
 2
Last full reporting year
prior to acquisition;
revenues of 5 acquired
companies by year
include $368 million,
1994; $502 million,
1995; $94 million, 1996;
$88 million, 1999; $968
million, 1999.
 3
Total revenue growth
expected had acquirer
and each target
continued to grow at
average growth rates for
industry.

40
Slide
3.11
Whatever the merger’s
objectives, revenue actually
hits the bottom line harder.
As shown, fluctuations in
revenue can quickly outweigh
fluctuations in planned cost
savings.Given a 1 percent
shortfall in revenue growth, a
merger can stay on track to
create value only if a company
achieves cost savings that are
25 percent higher than those it
had anticipated. Beating target
revenue growth rates by 2 to 3
percent can offset a 50 percent
failure on costs.

41
Slide
3.11
Whatever the merger’s
objectives, revenue actually
hits the bottom line harder.
As shown, fluctuations in
revenue can quickly outweigh
fluctuations in planned cost
savings.Given a 1 percent
shortfall in revenue growth, a
merger can stay on track to
create value only if a company
achieves cost savings that are
25 percent higher than those it
had anticipated. Beating target
revenue growth rates by 2 to 3
percent can offset a 50 percent
failure on costs.
Other reasons that make revenue more important
 The market penalizes revenue slippage hard: failing to meet
an earnings target by only 5 percent can result in a 15 percent decline in
share prices
 Better for motivating talented employees - on either side

By: Abhishek Breja
Case Study – Cisco Systems
Conclusion

43
• Database
• Desktop applications
• Storage
• Middleware, application
server
Semiconductors ($174 billion)
• Logic
• Micro components
• Memory
• Analog
• Semiconductor
equipment
• Discrete
IT Services ($243 billion)
• Professional and
Outsourcing services
Software ($146 billion)
• Enterprise application
• Operating systems
• Vertical applications
• Network/ systems
management, security
Hardware ($299
billion)
• PCs/ notebooks
• Servers
• Networking
• Printers
• Storage
• Smart handhelds
Ripe for restructuring
Slide
4.1
Key IT industries and segments, 2002 % of revenues
Ripe for restructuring
High-tech industry trends

44
 If through consolidation and exits
companies can reach the profit and
cost structures of the current top
three in each industry, total annual
operating profits could rise by up to
$18 billion$18 billion
 The Sector would gain $230 billion$230 billion
in market value (15 to 20% of total)
The scope of sectoral inefficiency
Slide
4.2
Potential EBIT improvement (Y), $ billion
 PCs/ Notebook
 Networking
 Storage
2.15
0.65
0.05
Hardware 2.85
 Memory
 Semiconductor equipment
 Logic
1.30
0.85
0.55
Semiconductor 2.70
 Enterprise application
 Middleware, application server
 Network/ systems management, security
 Storage
0.95
0.75
0.55
0.40
Software 2.85
IT Services 0.80
Total 9.00
Assuming that half of this
efficiency is achievable

45
Broad strategy
Slide
4.3
Type of Company Scale Scope Exit
Market Leaders Grow bigger; buy or
block challengers
Cross sell to boost
customer dependence
Challengers Merge with peers Buy adjacent businesses
Small Companies Carve out
sustainable niche
Maximum sale value
Shape it or leave it

46
M&A driving forces
Slide
4.4
Activity Drivers Examples
Scale –
Peer
consolidation
 Improved fixed cost structures (SG&A, R&D,
Depreciation)
 Customer preference for bigger suppliers
 Network platform effects
 Logic
 Memory
 Network/ systems mgmt, security
 Storage hardware
Scope-
Strategic
cross
segment
moves
 Customer preferances for broader-reaching
suppliers
 Channel cross selling synergies
 Technological synergies (networrking and storage)
 Value migration from hardware to software,
services
 Maturing core business; capital market pressure
 Database, middleware,
application server
 Hardware: IT services
 Networking hardware: storage
hardware, software
 Semiconductor equipment
Exit  Desire to limit losses, free up capital
 Refocusing resources on other businesses
 Logic
 PCs/ notebooks

47
In high tech winners take it all
Slide
4.5
Source: 2001 McKinsey survey of
485 high-tech companies

48
The golden rule
Slide
4.6

49
Recipe for success–steady diet of small deals
Slide
4.7

Growing with Acquisitions
A case study on how Cisco Systems has
mastered the art of acquisitions and integration

52
M&A in Cisco’s 12 general product categories
Slide
5.1
Vignette – Cisco Systems
 Switching
 Routing/IP/VPN (8)
 Network Management/Internet
 Security Components
 ATM
 Token Ring
Source: Understanding Cisco’s Acquisition and Development Strategy (Working paper , 2004)
By: Prof. Martin F. Kenney, Department of Human and Community Development, Univ. of California
 DSL/ISDN (8)
 Optical Platforms (7*)
 Next Generation Voice (11)
 Cable CMTS
 Wireless
 Content Delivery Devices
* In general, the greater the aggregate deal count and the aggregate deal size, the more valuable
the market can be assumed to be. From this perspective, the Optical Platforms category
dwarfed the others accounting for 32.2 percent of total acquisition expenditures, and this is
despite having made only seven acquisitions. Here, price was a direct function of the
telecommunications bubble of the late 1990s.

53
Acquisitions
breakup by region
32
10
6
4
11
8
0
5
10
15
20
25
30
35
Northern
California
Boston Texas Israel Other U.S. Non-U.S.
Annual number
of acquisition
1
5
9
16
21
30
45
7169
0
5
10
15
20
25
30
1993 1994 1995 1996 1997 1998 1999 2000 2001
0
10
20
30
40
50
60
70
80
Acquisition characteristics
Slide
5.2

54
Acquisition Success and Failure
Slide
5.3
Name Market
Capitalization
Cisco Systems, Inc. 153674.92
LM Ericsson (ADR) 48591.23
Nortel Networks Corporation 30589.21
Lucent Technologies Inc. 17068.24
Juniper Networks, Inc. 9652.59
CIENA Corporation 2697.7
Extreme Networks, Inc 941.66
General Indicator

55
Slide
5.4
General
Indicator
Companies Acquired
Closing
date
Total value
$ Closing
Total Value $
2/4/97 % Return
(in millions) (in millions)
Crescendo Sep-93 95 504 431%
Newport Aug-94 93 526 466%
Kalpana Dec-94 240 942 293%
Lightstream Jan-95 120 120 Cash Deal
Combinet Oct-95 132 252 91%
Internet Junction Oct-95 6 10 67%
Grand Junction Nov-95 400 630 58%
Network Translation Inc. Nov-95 33 53 61%
TGV Software Mar-96 138 186 35%
Stratacom Jul-96 4666 5112 10%
Nasboba Aug-96 100 114 14%
Granite Sep-96 220 247 12%
Telebit Oct-96 200 200 Cash Deal
Netsys Nov-96 79 84 6%

56
Slide
5.5
 Market Average: During the late 1990s Silicon Valley, employee turnover averaged 30
percent per annum (O'Reilly 2000: 50) and according to a 2000 Best Practices survey in
the first year post-acquisition turnover is approximately 33 percent per annum (Thurm
2000).
 Cisco’s Performance : On an annualized basis as of 2001, 100 percent
of the acquisitions had an overall annual turnover rate under 10 percent
(n = 44) and 95 percent had an annual turnover rate among engineers of
under 10 percent.
 Cost per acquired employee increased dramatically from roughly $1.8
million per person prior to 1996 to an average of $5.6 million in 2000.
Retention

57
Slide
5.6
Retention
A.Total T/O A. Eng T/O Category Y.Founded Location
Compatible Systems 6.71 2.11 R 2000 Boulder, CO
Geotel Communications 8.12 2.71 NGV 1999 Lowell, MA
Amteva Technologies 7.28 3.15 NGV 1999 Glenn Allen, VA
Cocom A/S 5.51 3.8 C 1999 Copenhagen, Denmark
Fibex Systems 5.46 4.13 DSL 1999 Petaluma, CA
WheelGroup 6.41 6.06 SW 1998 San Antonio, TX
Sentient Networks 9.83 6.42 ATM 1999 Milpitas, CA
Webline Communications 9.4 7.55 SW 1999 Burlington, MA
Precept Software 8 8.7 R 1998 Palo Alto, CA
Altiga Networks 8.38 13.33 R 2000 Franklin, MA
Netsys Technologies 7.78 13.33 S 1996 Palo Alto, CA
(R = Routing, NGV = Next Generation Voice, C = Cable, DSL = DSL, ATM = Asynchronous Transfer Mode,
SW = Software, S = Switching).

58
Slide
5.7
Market Share Growth
70%
60% 60% 60%
30%30%
40%
30% 30% 30% 30%
20%
25%
5%
10%
30%
20%
30%
129
3970
6727
5237
11061
1755
98612191279
250
0%
10%
20%
30%
40%
50%
60%
70%
80%
Routing/IP/VPN
Switching
Token Ring
Cable CMTS
Next
Generation
Voice ContentDeliveryDevices
ATM
DSL/ISDN
Optical
Platforms Wireless
0
2000
4000
6000
8000
10000
12000
Market Share
5 yr. Annualized Growth
Dealsize

59
Cisco’s acquisition strategy
Slide
5.9
In 1997 John Chambers, the Cisco CEO,
articulated five guidelines by which to
judge the desirability of potential
acquisitions (Rifkin 1997)
John Chambers
President and CEO

60
Cisco’s acquisition strategy
Slide
5.10
 Both firms must share similar visions “about where the industry is
going [and] what role each company wants to play in the industry. So you
have to look at the visions of both companies and if they are dramatically
different, you should back away.”
 The acquisition must “produce quick wins for [the] shareholders.”
 There must be “long-term wins for all four constituencies --
shareholders, employees, customers, and business partners.”
 “The chemistry (between the companies) has to be right.” He
thought that this was difficult to define, but involved both parties being
comfortable with their counterparts.
 Geographic proximity is important. If the newly acquired firm is
located close to Cisco, then interaction will be easier.

62
Seven steps back to sanity
Slide
6.1
Common biases in valuation
 The cost of equity used for an investment should reflect the risk of the
investment and not the risk characteristics of the investor who raised the
funds.
 Risky businesses cannot become safe just because the buyer of these
businesses is in a safe business.
Source: Aswath Damodaran, Prof. Of Finance, NYU Stern
Step 7: Don’t transfer your risk characteristics to the target
firm
If you fail on this principle, safe companies will end up overvaluing and overpaying for risky
companies (as many did in the late 1990s)

63
Slide
6.2
 As an acquiring firm, it is entirely possible that you can borrow much
more than the target firm can on its own and at a much lower rate. If you
build these characteristics into the valuation of the target firm, you are
essentially transferring wealth from your firm’s stockholder to the target
firm’s stockholders.
 When valuing a target firm, use a cost of capital that reflect’s the debt
capacity and the cost of debt that would apply to the firm.
Step 6: Render unto the target firm that which is the target
firm’s but not a penny more..Don’t transfer your risk
characteristics to the target firm
The minute you start building into the valuation strengths that flow from you (as the
acquiring firm), you start giving target firm stockholders premiums that they do not deserve.

64
Slide
6.7
 Valuation is cluttered with rules of thumb. After painstakingly valuing a
target firm, using your best estimates, you will be often be told that It is
common practice to add arbitrary premiums for brand name, quality of
management, control etc…
 The target company is cheap if it trades at below some arbitrary value –
8 times EBITDA, 15 times earnings, PE less than the growth rate, below
book value…
Step 5: Beware of rules of thumb
Rules of thumb in billion dollar valuations are signs of laziness and indicate an
unwillingness to actually estimate the value of control or what a reasonable value to EBITDA
multiple is for a firm.

65
Slide
6.8
 Through time, acquirers have always found ways of justifying paying for
premiums over estimated value by using buzz words - synergy in the
1980s, strategic considerations in the 1990s and real options in this
decade.
 While all of these can have value, the onus should be on those pushing
for the acquisitions to show that they do and not on those pushing
against them to show that they do not.
Step 4: Don’t pay for buzz words

66
Slide
6.8
 All too often acquisitions are justified by using one of the following two
arguments:
• Every one else in your sector is doing acquisitions. You have to do the same
to survive.
• The value of a target firm is based upon what others have paid on
acquisitions, which may be much higher than what your estimate of value for
the firm is.
 With the right set of comparable firms (selected to back up your story),
you can justify almost any price.
Step 3: Don’t be a lemming
The fact that everyone else in the sector is doing bad acquisitions and over paying for them
is not a good reason to join the group. It is entirely possible that you are operating in a value
destroying sector and it may be time for you to consider shrinking.

67
Slide
6.9
 If you define your objective in a bidding war as winning the auction, you
will win. But beware the winner’s curse.
 The premiums paid on acquisitions often have nothing to do with
synergy, control or strategic considerations (though they may be
provided as the reasons). They may just reflect the biases of the CEOs
of the acquiring firms and I-Banker’s valuation.
 The opinions of investment banks on the value of the deal itself are worth
nothing (though they will charge you a substantial fee for offering them).
Investment bankers make their money on the size of the deal and not on
it’s quality.
Step 2: Don’t let egos or investment bankers get the better of
common sense…

68
Slide
6.10
 Firms that do acquisitions often do so because they want to grow fast
and at low cost.
 It is true that mature companies can buy growth companies and thus
push up earnings growth, but at what price? If you pay too much for
growth, your stockholders will be worse off…
 On average, the stock prices of acquiring firms falls on the date of the
acquisition announcement by 3-4%.
Step 1: With acquisitions, recognize that the odds are against
you…

69
Synergy: Oft promised, seldom delivered…
Slide
6.11
• McKinsey and Co. examined 58 acquisition programs between 1972 and 1983 for
evidence on two questions –
- Did the return on the amount invested in the acquisitions exceed the cost of
capital?
- Did the acquisitions help the parent companies outperform the competition?
• They concluded that 28 of the 58 programs failed both tests, and 6 failed at least
one test.
• KPMG in a more recent study of global acquisitions concludes that most mergers
(>80%) fail - the merged companies do worse than their peer group.
• Large number of acquisitions that are reversed within fairly short time periods. In
studies that have tracked acquisitions for longer time periods (ten years or more)
the divestiture rate of acquisitions rises to almost 50%.

70
Slide
6.12
As a firm becomes badly run, the status quo value can very quickly deviate
from the optimal value. In practice, getting an optimal value will require
assumptions about:
 Investment policy: What types of margins and returns on capital a well run firm will have
in this business? (You can compare your firm to the industry averages, for instance)
 Capital structure: Is your firm under levered?
 Dividend and Reinvestment policy: Is the firm reinvesting too little (if the ROC is way
above the cost of capital) or too much (if it is earning well below the cost of capital)
Once you value control, you have to figure out how much of the control you are
willing to concede to target firm stockholders and how much you will claim for
yourself. As a general rule, you should try to lay claim to any part of control
that you feel would be impossible to claim without your intervention.
How much Mgmt. Control worth?

71
When do Synergies work better
Slide
6.13
In general,
 Mergers of equals are less likely to work than mergers of unequals -
the political and cultural clashes are much more difficult to resolve.
 Cost saving mergers seem to have better odds of success than growth
synergy mergers. (Perhaps cost savings are more tangible and easier to
deliver)
 Some of the most successful acquisition strategies have been directed
towards acquiring private firms where you do not have premium on the
market price.
 Mergers are more likely to work when firms plan for synergy before the
merger rather than just hope that synergy shows up.

73
M&A
Identification
Framework
Evaluation
methodology
Individual investment lifecycle
Slide
7.1
Acquisition Strategy Framework
Acquire
funds to
invest
Identify
investment
needs
Investigate
available
products
Effect
transaction
Integrate
Manage
& make
profits
Sell
Reinvent

74
Identification framework (iF)
Slide
7.2
ALLIANCE /
ACQUISITION
IMPERATIVE

75
Identification framework
Slide
7.3
Source: Booz-Allen & Hamilton
Over capacity
Geographic Roll-up
Mkt. Extension
R&D
Ind. Convergence
iF

76
0
2
4
6
8
10
Distribution skills
Netw ork coverage
Cash
Market share
Company Credibility
Public Acceptability
R&D
Sales and Marketing
Customer Service
Market Know how
Technical Skills
Opeartion Skills
Capabilities and position asset analysis
Slide
7.4
Source: Booz-Allen & Hamilton
CAPABILITIES POSITIONAL ASSETS
Know-How
• Technology
• Application
experience
• Customer
knowledge
Mkt. Presence
• Market chare
• Product
portfolio
• Franchise
Processes
• Technology
• Delivery
• Management/
Control
Infrastructure
• Facilities
• Distribution
chains
• Supply
chains
• Systems
iF

77
Identification framework
Slide
7.5
Over capacity
Geographic Roll-up
Mkt. Extension
R&D
Ind. Convergence
OPPORTUNITY
SIZE
iF

78
Looking at acquisition through a balance sheet
Slide
7.6
Before
Acquisition
After
Acquisition
Revenue 1,000$ 1,000$
Cost 900$ 900$
Net operating profit after tax 100$ 100$
Invested capital 500$ 3,000$
Return on invested capital 20.00% 3.33%
Cost of capital 10% 10%
Economic profit 50$ (200)$
Market value/ intrinsic value 2,000$ 2,000$
Share owner value creation 1,500$ (1,000)$
eF

79
Looking at acquisition through a balance sheet
Slide
7.7
Before
Acquisition
After
Acquisition
Revenue 1,000$ 1,000$
Cost 900$ 700$
Net operating profit after tax 100$ 300$
Invested capital 500$ 3,000$
Return on invested capital 20.00% 10.00%
Cost of capital 10% 10%
Economic profit 50$ -$
Market value/ intrinsic value 2,000$ 2,000$
Share owner value creation 1,500$ (1,000)$
Even $ 200 MM in cost
cutting (though quite
unlikely)
Leads to
eF

80
 Wall Street analysts have shown that
the deal will not dilute earnings.
(Preoccupation with the Income St.)
Wall St. Analyst
What happens in (unperfected) real world
Slide
7.8
 CFO is waving around discounted cash
flow analyses (heavily loaded on the
back end, with the payoff coming five
to ten years out)
Mr. CFO
eF

81
 Wall Street analysts have shown that
the deal will not dilute earnings.
(Preoccupation with the Income St.)
Wall St. Analyst
What should happens in a perfect world
Slide
7.9
 CFO is waving around discounted cash
flow analyses (heavily loaded on the
back end, with the payoff coming five
to ten years out)
Mr. CFO
What investors should really worry about is not earnings
dilution but rather dilution of ROIC and economic profit.
The acquisition in our example is hugely dilutive to
economic profit, which declines from $50 million to
negative $200 million.
eF

82
Buying apples in a grocery store
Slide
7.10
Apples
1 Pound
$ 0.89
$ 1.29 / pound
V/S
eF

83
What’s the common theme?
Slide
7.11
Ten largest M&A deals
 AOL and Time Warner
 Pfizer and Warner-Lambert
 Exxon and Mobil
 Comcast and AT&T Broadband
 Verizon and GTE
 Travelers and Citicorp
 SBC and Ameritech
 Pfizer and Pharmacia
 NationsBank and Bank of America
 Vodafone and AirTouch
CUSTOMERS
Its all about
cross selling
Of course, there are other reasons to buy a
company: to get real estate / other
facilities, brands, trademarks, patents,
technology, or employees. But ultimately,
it’s still about the customers. The acquirer
buys those capabilities to help it serve
existing customers better or to help it
acquire new ones.
eF

84
New customer portfolio approach to M&A
Slide
7.12
For two years Larry and Geoffrey analyzed
companies – not in the traditional way, as a
portfolio of products, services, territories, or
functions, but rather as a portfolio of
customers. One implication of this research is
that managers who want to increase the value
of their company must understand the true
economic profitability of customers. They
must also understand that their company’s
value is actually the aggregated value of their
customers.
Larry Selden
Professor of finance
and economics at
Columbia University’s
Graduate School of
Business
Geoffrey Colvin
senior editor-at-large at
Fortune magazine and
co-anchor of Wall
Street Week with
Fortune on PBS.
They are also the authors of
Angel Customers & Demon Customers
eF

85
Segmenting the customer portfolio
Slide
7.13
Recall the deal we imagined earlier, this time supposing that the target
company’s customers are classified into four profitability quartiles. From most
profitable quartile to least, we’ll call them the Darlings, the Dependables, the
Duds, and the Disasters.
For simplicity, the company’s capital is divided equally among the four quartiles. Each customer
quartile is assigned an after-tax operating profit;
eF

86
Slide
7.14
Segmenting the customer portfolio
eF

87
Rationalizing M&A using customer profitability
Slide
7.15
eF

88
Steps to ‘customer portfolio‘ acquisition
Slide
7.16
Step one Build your customer profitability portfolio
Step two Build the target company’s customer profitability portfolio
(May be guesstimate or could be a detail analysis if the
target co. agrees to it)
Step three Rationalize target co.’s customer portfolio and assess the
value
Step four Rationalize combined cust. portfolio and assess the value
add to both your customers and the target co.’s customers.
eF

90
A few points worth thinking
Slide
8.1
Final facts of M&A
 BIG may not be Bogus but it’s surely dangerous (Though investment
bankers love big deals)
 Acquiring publicly traded companies is more complicated (and
expensive) than private companies (Though investment bankers love the former)
 In Knowledge industry acquisition success depends a lot on
employee retention of the acquired firm (friendly takeovers)
 Practice makes the man (and companies) perfect; Experienced
acquirers perform relatively better – only when they codify the
experience/ process
 Transformation M&A’s have higher chance of failure than
Expansion M&A (shareholders can diversify themselves)

91
Slide
8.2
Final facts of M&A
 High performers are good to admire, but not so good to acquire
 Successful acquirers have learnt the art of walking away from
deals
 viii.The uncertainty in M&A is mostly about culture and operations
(Post deal, when I-Bankers are not around), involving people, from both
sides, who know the culture and operations is a good way to
hedge such risks
 Winners of bidding war may face the winner’s curse
 A detailed rationalization plan is needed before the deal is
finalized (with a built in exit plan)

92
Slide
8.3
Final facts of M&A
 There are other innovative ways to M&A
• Venture investment oriented M&A
• Buying/ partnering in the venture funded deals
• JVs with built in buy out options
• Buying small and private companies that are under performing
• Buying out leftovers from big deals
• And many more…

94
 Deals that are part of an “expansion program” in which
company seek to boost its market share by consolidating.
• NOT the deals that are “transformative” deals, those that seek to
move companies into new lines of business or to remove the chunk
of an otherwise healthy portfolio

95
 Acquisition create the most
market value overall,
despite the well known
“winner’s curse”.

96
 Finally, if a company competes in a growing or fragmented
industry, or if the performance of the company has recently
lagged behind that of its peers, some signs indicate that the
market may reward its transaction more than those of
stronger performers.

By: Abhishek Breja
Vignette – Cisco Systems
Conclusion

Mergers & Acquisitions in High Tech Industry

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