vision statement for a corporation.) If you were the CEO of Google, what might your vision for its future be? Explain
the rationale for your answer.
2. In the context of M&A, synergy represents the incremental cash flows generated by combining two businesses.
Identify the potential synergies you believe could be realized in Google’s acquisition of Nest that could be achieved by
leveraging other Google products and services. Be specific. Identify synergies Google is not likely to realize by
operating the firm as a wholly-owned largely autonomous subsidiary. Speculate as to why Google has chosen to
operate Nest in this manner.
3. Describe Google’s investment strategy? What are the factors driving their investment strategy? How might
shareholders eventually react to this strategy? How might this investment strategy hurt the firm long-term?
22
4. Describe what you believe to be Google’s business strategy? Would you describe their strategy as cost leadership,
differentiation, focus or a hybrid strategy? Explain your answer. To what extent do you believe it is driven by changes
in the firm’s external environment? To what extent have factors internal to the firm driven Google’s business strategy?
5. What are the potential threats to Google’s current vision and business strategy?
Exxon Mobil’s (Exxon) Unrelenting Pursuit of Natural Gas
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Key Points
Believing the world will be dependent on carbon-based energy for many decades, Exxon continues to pursue aggressively
amassing new natural gas and oil reserves.
This strategy is consistent with its core energy extraction, refining, and distribution skills.
As the world’s largest energy company, Exxon must make big bets on new reserves of unconventional gas and oil to
increase future earnings.
_____________________________________________________________________________________
Exxon has always had a reputation for taking the long view. By necessity, energy companies cannot respond to short-term
gyrations in energy prices, given the long lead time required to discover and develop new energy sources. While energy
23
prices will continue to fluctuate, Exxon is betting that the world will remain dependent on oil and gas for decades to come
and that new technology will facilitate accessing so-called unconventional energy sources.
During the last several years, Exxon continued its headlong rush into accumulating shale gas and oil properties that
began in earnest in 2009 with the acquisition of natural gas exploration company XTO Energy. While natural gas prices
have remained well below their 2008 level, Exxon used the expertise of the former XTO Energy personnel, who are among
the most experienced in the industry in extracting oil and gas from shale rock, to identify the most attractive sites globally
for future shale development. In 2010, Exxon acquired Ellora Energy Inc., which was active in the Haynesville shale fields
in Texas and Louisiana, for $700 million and properties in Arkansas’s Fayetteville shale fields from PetroHawk Energy
Corp. In 2011, Exxon bought TWP Inc. and Phillips Resources, which were active in the Marcellus shale basin, for a
combined $1.7 billion. Exxon is betting that these properties will become valuable when natural gas prices again rise. By
mid-2011, Exxon Mobil had added more than 70 trillion cubic feet of unconventional gas and liquid reserves since the XTO
deal in late 2009 through acquisitions and new discoveries. Exxon is now the largest natural gas producer in the United
States.
The sheer size of the XTO acquisition in 2009 represented a remarkable departure for a firm that had not made a major
acquisition during the previous 10 years. Following a series of unsuccessful acquisitions during the late 1970s and early
1980s, the firm seemed to have developed a phobia about acquisitions. Rather than make big acquisitions, Exxon started
buying back its stock, purchasing more than $16 billion worth between 1983 and 1990, and spending about $1 billion
annually on oil and gas properties and some small acquisitions.
Exxon Mobil Corporation stated publicly in its 2009 annual report that it was committed to being the world’s premier
petroleum and petrochemical company and that the firm’s primary focus in the coming decades would likely remain on its
core businesses of oil and gas exploration and production, refining, and chemicals. According to the firm, there appears to
be “a pretty bright future” for drilling in previously untapped shale energy properties—as a result of technological advances
in horizontal drilling and hydraulic fracturing. No energy source currently solves the challenge of meeting growing energy
needs while reducing CO2 emissions.6
Traditionally, energy companies have extracted natural gas by drilling vertical wells into pockets of methane that are
often trapped above oil deposits. Energy companies now drill horizontal wells and fracture them with high-pressure water,
a practice known as “fracking.” That technique has enabled energy firms to release natural gas trapped in the vast shale oil
fields in the United States as well as to recover gas and oil from fields previously thought to have been depleted. The
natural gas and oil recovered in this manner are often referred to as “unconventional energy resources.”
In an effort to bolster its position in the development of unconventional natural gas and oil, Exxon announced on
December 14, 2009, that it had reached an agreement to buy XTO Energy in an all-stock deal valued at $31 billion. The
deal also included Exxon’s assumption of $10 billion in XTO’s current debt. This represented a 25% premium to XTO
shareholders at the time of the announcement. XTO shares jumped 15% to $47.86, while Exxon’s fell by 4.3% to $69.69.
The deal values XTO’s natural gas reserves at $2.96 per thousand cubic feet of proven reserves, in line with recent deals
and about one-half of the NYMEX natural gas futures price at that time.
Known as a wildcat or independent energy producer, the 23-year-old XTO competed aggressively with other
independent drillers in the natural gas business, which had boomed with the onset of horizontal drilling and well fracturing
to extract energy from older oil fields. However, independent energy producers like XTO typically lack the financial
resources required to unlock unconventional gas reserves, unlike the large multinational energy firms like Exxon. The
geographic overlap between the proven reserves of the two firms was significant, with both Exxon and XTO having a
presence in Colorado, Louisiana, Texas, North Dakota, Pennsylvania, New York, Ohio, and Arkansas. The two firms’
combined proven reserves are the equivalent of 45 trillion cubic feet of gas and include shale gas, coal bed methane, and
shale oil. These reserves also complement Exxon’s U.S. and international holdings.
Exxon is the global leader in oil and gas extraction. Given its size, it is difficult to achieve rapid future earnings growth
organically through reinvestment of free cash flow. Consequently, megafirms such as Exxon often turn to large acquisitions
to offer their shareholders significant future earnings growth. Given the long lead time required to add to proven reserves
and the huge capital requirements to do so, energy companies by necessity must have exceedingly long-term planning and
investment horizons. Acquiring XTO is a bet on the future of natural gas. Moreover, XTO has substantial technical
expertise in recovering unconventional natural gas resources, which complement Exxon’s global resource base, advanced
R&D, proven operational capabilities, global scale, and financial capacity.
6 Rex Tillerson, Exxonmobil CEO, 2009 Exxonmobil Annual Report.
In the five-year period ending in 2010, the U.S. Energy Information Administration (EIA) estimates that the U.S. total
proven natural gas reserves increased by 40% to about 300 trillion cubic feet, or the equivalent of 50 billion barrels of oil.
Unconventional natural gas is projected by the EIA to meet most of the nation’s domestic natural gas demand by 2030,
representing a substantial change in the overall energy consumption pattern in the United States. At current consumption
rates, the nation can count on natural gas for at least a century. In addition to its abundance, natural gas is the cleanest
burning of the fossil fuels.
A sizeable purchase price premium, the opportunity to share in any upside appreciation in Exxon’s share price, and the
tax-free nature7 of the transaction convinced XTO shareholders to approve the deal. Exxon’s commitment to manage XTO
on a stand-alone basis as a wholly owned subsidiary in which a number of former XTO managers would be retained
garnered senior management support. By keeping XTO largely intact in Fort Worth, Texas, Exxon was able to minimize
differences due to Exxon Mobil’s and XTO’s dissimilar corporate cultures.
Discussion Questions and Answers:
1. What was the total purchase price or enterprise value of the transaction?
2. Why did Exxon Mobil’s shares decline and XTO Energy’s shares rise substantially immediately following the
announcement of the takeover?
3. What do you think Exxon Mobil believes are its core skills? Based on your answer to this question, would
you characterize this transaction as a related or unrelated acquisition? Explain your answer.
4. Identify what you believe the key environmental trends that encouraged Exxon Mobil to acquire XTO Energy.
5. How would you describe Exxon Mobil’s long-term objectives, business strategy, and implementation
strategy? What alternative implementation strategies could Exxon have pursued? Why do you believe it chose
an acquisition strategy? What are the key risks involved in ExxonMobil’s takeover of XTO Energy?
25
Microsoft Invests in Barnes & Noble’s Nook Technology
_________________________________________________________________________________________________
Key Points
Firm size often dictates business strategy.
Diversifying away from a firm’s core skills often is fraught with risk.
Accumulated corporate cash balances often create potential agency problems.
________________________________________________________________________________________________
Microsoft, like Apple, has been in business for three decades. Unlike Apple, Microsoft has failed to achieve and sustain the
high growth in earnings and cash flow needed to grow its market value. For years, Microsoft has attempted to reduce its
dependence on revenue generated from its Windows operating system software and the Office Products software suite by
targeting high-growth segments in the information technology industry. Despite these efforts, the firm continues to generate
more than four-fifths of its annual revenue from these two product lines.
The firm’s ongoing dependence on its legacy products is not due to a lack of effort to diversify. Since 2009, Microsoft
has spent more than $10 billion in financing strategic alliances and takeovers. A 2009 Internet search partnership with
Yahoo Inc. designed to assist Microsoft in overtaking Google by increasing use of its Bing search engine has gained little
traction. In 2011, the firm agreed to supply the mobile operating system for smartphones sold by Nokia Corp. Thus far,
Windows-powered smartphones have yet to gain significant market share. That same year the software maker also acquired
Skype, the Internet telephony firm, for $8.5 billion in the biggest acquisition in the firm’s history. Its contribution to
Microsoft’s revenue and profit growth is unclear at this time.
Despite a number of acquisitions during the last few years, Microsoft amassed a cash hoard of more than $60 billion by
the end of March 2012. The amount of cash creates considerable pressure from shareholders wanting the firm either to
return the cash to them through share buybacks and dividends or to reinvest in new high-growth opportunities. In recent
years, Microsoft has tried to do both.
Continuing to move aggressively, the software firm announced on April 30, 2012, that it would invest a cumulative $605
million (consisting of $300 million upfront with the balance paid over the next five years to finance ongoing product
development and international expansion) in exchange for a 17.6% stake in a new Barnes & Noble (B&N) subsidiary
containing B&N’s e-titles and the Nook e-reader technology. The new subsidiary also houses B&N’s college business,
viewed as a growth area for e–books. Analysts valued the new B&N subsidiary at $1.7 billion, more than twice B&N’s
consolidated value at the close of business on May 1, 2012. After the announcement, B&N’s market value jumped to $1.25
billion.
As a result of the deal, the two firms will settle their patent infringement suits, and B&N will produce a Nook e–reading
application for the Windows 8 operating system, which will run on both traditional PCs and tablets. Microsoft, through its
Windows 8 product, has been forced to radically redesign its Windows operating system to accommodate a future in which
web browsing, movie watching, book reading, and other activities occur on tablets as well as PCs and other mobile devices.
While Windows 8 will have an “app store,” it is likely to have to be closely aligned with a service for buying books and
other forms of entertainment to match better the offerings from its rivals. The partnership is not exclusive to Microsoft, in
that B&N can pursue other alliances with the likes of Google. B&N’s e-book business is to remain aligned with the brick–
and-mortar stores, of which the firm has 691 retail stores and 641 college bookstores.
In making the B&N investment, Microsoft is placing another bet on an industry in which it lags behind its competitors
and puts it in competition with Amazon.com Inc., Apple Inc., and Google Inc. The Nook currently runs on Google’s
Android software, as does Amazon’s Kindle Fire. The two firms will share revenue from sales of e-books. The partnership
also has the potential for Microsoft to manufacture e-readers and for future Nook devices to be powered by Microsoft
operating systems. In addition to a much-needed cash infusion, B&N will capture additional points of distribution from
hundreds of millions of Windows users around the world, potentially reaching consumers who did not do business with
B&N.
Previously concerned that B&N would be a marginal competitor in the e-book marketplace, investors boosted B&H
shares by 58% to $20.75 on the news. This was the firm’s highest closing price in two years. The firm’s conventional
26
(physical) book business has declined rapidly. With revenue and profits declining, B&N was looking for a strategic partner
to accelerate the growth of its e-book business globally. B&N had been accepting offers from a number of potential
partners since it accepted a $204 million investment from Liberty Media in 2011 and had been considering a sale or spin–
off of the e-book business.
B&N claims to have 27% of the U.S. e-book title sales, with Amazon capturing 60%. At one time, Amazon had almost a
90% market share of the e-book market, but this has eroded as new players, such as Apple, Google and now Microsoft,
have entered. According to market research firm IHS iSuppli, Apple had 62% of the tablet market in 2011, reflecting the
success of its iPad, with Amazon’s Kindle having a 6% share and B&N’s Nook a 5% share. Book publishers appear to have
been encouraged by Microsoft’s investment in B&N due to their growing concern that Amazon would dominate the e-book
market and the pricing of e-books if B&N were unable to become a viable competitor to Amazon.com.
Unlike rivals such as Apple, Microsoft has relied mainly on partners to create hardware that runs its software, with the
exception of the Xbox video game unit and the company’s ill-fated Zune media player. Microsoft is constrained by its
partnerships, in that if the firm begins to create its own hardware, then it puts itself into direct competition with partners
who make hardware such as tablet devices powered by Microsoft operating systems.
Discussion Questions:
1. Speculate as to why Microsoft seems to be having trouble diversifying its revenue stream away from Windows and
the Office Products suite?
2. What are the key factors external and internal to Microsoft driving its investment in Barnes & Noble?
3. Speculate as to how analysts valued B&H’s e–book subsidiary at $1.7 billion. In what way might this number
understate the value of the subsidiary at the time the Microsoft investment was made?
4. In your opinion, what does Microsoft bring to this partnership? What does Barnes & Noble contribute? What are
likely to be the challenges to both parties in making this relationship successful?
27
Sony’s Strategic Missteps
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Key Points
Realizing a complex vision requires highly skilled and consistent execution.
A clear and concise business strategy is essential for setting investment priorities.
Corporate financial and human resources most often need to be concentrated in support of a relatively few key initiatives to
realize a firm’s vision.
__________________________________________________________________________________________________
As the fifth-largest media conglomerate (measured by revenues), Sony Corporation (Sony) continues to struggle to get it
right. Its products and services range from music and movies to financial services, TVs, smartphones, and semiconductors.
The firm’s top-three profit contributors include its music, financial services, and movie operations; TV manufacturing has
been its greatest profits drag. As the third–largest global manufacturer of TVs, behind Korea’s Samsung and LG
Electronics, Sony has been unable to offset the slumping demand in the United States and Europe for Bravia TVs,
recording nine consecutive yearly losses.
Sony’s corporate vision is to provide consumers easy, ubiquitous access to an array of entertainment content. Sony
wants to provide both the content and the means to enable consumers to access the content. However, rather than a roadmap
outlining how the firm intends to achieve this vision, its business strategy lists four broad themes or areas in which it will
invest. These themes include networked products and services (LCD TVs, games, mobile phones, and tablet computers), 3-
D world (digital imaging), differentiated technologies, and emerging markets. The firm intends to become the leading
provider of networked consumer electronics and entertainment, consisting of LCD TVs, games, and mobile phones. Sony
intends to enable users of these devices to move seamlessly from one product to another to access content such as movies
and television programming. Sony can draw on music from 13 U.S. labels and on movies from Sony Pictures Classics,
Columbia, and TriStar Pictures.
As with many companies, Sony’s vision seems to exceed its ability to execute. Derailed in recent years by an
appreciating yen, a lingering global economic slowdown, an earthquake that crippled its factories, and flooding in Thailand
that forced factory closings, Sony recorded its fifth consecutive annual loss for the fiscal year ending March 2012.
Cumulative five-year losses totaled more than $6 billion. In 2000, the firm was worth more than $100 billion; however, by
late 2012, it was valued at less than $18 billion. This compares to its major competitors, Apple and Samsung, which were
valued at $364 billion and $134 billion, respectively, at that time. While whipsawed by a series of largely uncontrollable
events, the firm seems to lack the focus to allow it to concentrate its prodigious resources ($17 billion in cash on the
balance sheet) behind a relatively few strategic initiatives.
Rather than focus its efforts, Sony’s investments have been wide ranging. In 2011 alone, the firm spent $8.5 billion to
acquire nine businesses in an effort to shore up its phone and content businesses. Sony teamed with Apple, Microsoft,
Research in Motion, Ericsson, and EMC Corp. to purchase patents owned by Nortel Networks Corp used in mobile phones
and tablet computers for $4.5 billion in cash. Sony, along with the Blackstone Group and others, also acquired EMI Music
Publishing from Citigroup for $2.2 billion. In addition, Sony bought out Ericsson’s 50% stake in their mobile phone
venture for $1.5 billion in order to integrate the smartphone business with its gaming and tablet offerings. Little progress
28
seems to have been made in shoring up its money–losing TV manufacturing business. The firm’s lack of focus or more
narrowly defined priorities may be at the center of the firm’s poor financial performance.
Oracle’s Efforts to Consolidate the Software Industry
Key Points:
• Industry-wide trends, coupled with the recognition of its own limitations, compelled Oracle to alter radically its
business strategy.
• A rapid series of acquisitions of varying sizes enabled the firm to respond rapidly to the dynamically changing
business environment.
• Increasingly, the major software competitors seem to be pursuing very similar strategies.
• The long-term winner often is the firm most successfully executing its chosen strategy.
_____________________________________________________________________________________________
Oracle ‘s completion of its $7.4 billion takeover of Sun Microsystems on January 28, 2010 illustrated how in somewhat
more than five years the firm has been able to dramatically realign its focus. Once viewed as the premier provider of
proprietary database and middleware services (accounting for about three–fourths of the firm’s revenue), Oracle is now seen
as a leader in enterprise resource planning, customer relationship management, and supply chain management software
applications. What spawned this rapid and dramatic transformation?
The industry in which Oracle competes has undergone profound and lasting changes. In the past, the corporate
computing market was characterized by IBM selling customers systems that included most of the hardware and software in
a single package. Later, minicomputer manufacturers pursued a similar strategy in which they would build all of the crucial
pieces of a large system, including its chips, main software, and networking technology. The traditional model was upended
by the rise of more powerful and standardized computers based on readily available chips from Intel and an innovative
software market. Customers could choose the technology they preferred (i.e., “best of breed”) and assemble those products
in their own data centers networks to support growth in the number of users and the growing complexity of user
requirements. Such enterprise-wide software (e.g., human resource and customer relationship management systems)
became less expensive as prices of hardware and software declined under intensifying competitive pressure as more and
more software firms entered the fray.
Although the enterprise software market grew rapidly in the 1990s, by the early 2000s, market growth showed signs of
slowing. This market consists primarily of large Fortune 500 firms with multiple operations across many countries. Such
computing environments tend to be highly complex and require multiple software applications that must work together on
multiple hardware systems. In recent years, users of information technology have sought ways to reduce the complexity of
getting the disparate software applications to work together. Although some buyers still prefer to purchase the “best of
breed” software, many are moving to purchase suites of applications that are compatible.
In response to these industry changes and the maturing of its database product line, which accounted for three-fourths of
its revenue, Oracle moved into enterprise applications with its 2004 $10.3 billion purchase of PeopleSoft. From there,
Oracle proceeded to acquire 55 firms, with more than one–half focused on strengthening the firm’s software applications
business. Revenues almost doubled by 2009 to $23 billion, growing through the 2008–2009 recession.
Oracle, like most successful software firms, generates substantial and sustainable cash flow as a result of the way in
which business software is sold. Customers buy licenses to obtain the right to utilize a vendor’s software and periodically
renew the license in order to receive upgrades. Healthy cash flow minimized the need for Oracle to borrow. Consequently,
it was able to sustain its acquisitions by borrowing and paying cash for companies rather than having to issue stock and
potentially diluting existing shareholders.
In helping to satisfy its customers’ challenges, Oracle has had substantial experience in streamlining other firms’ supply
chains and in reducing costs. For most software firms, the largest single cost is the cost of sales. Consequently, in acquiring
other software firms, Oracle has been able to apply this experience to achieve substantial cost reduction by pruning
unprofitable products and redundant overhead during the integration of the acquired firms. Oracle’s existing overhead
structure would then be used to support the additional revenue gained through acquisitions. Consequently, most of the
additional revenue would fall to the bottom line.
For example, since acquiring Sun, Oracle has rationalized and consolidated Sun’s manufacturing operations and
substantially reduced the number of products the firm offers. Fewer products results in less administrative and support
overhead. Furthermore, Oracle has introduced a “build to order” mentality rather than a “build to inventory” marketing
approach. With a focus on “build to order,” hardware is manufactured only when orders are received rather than for
inventory in anticipation of future orders. By aligning production with actual orders, Oracle is able to reduce substantially
the cost of carrying inventory; however, it does run the risk of lost sales from customers who need their orders satisfied
immediately. Oracle has also pared down the number of suppliers in order to realize savings from volume purchase
discounts. While lowering its cost position in this manner, Oracle has sought to distinguish itself from its competitors by
being known as a full-service provider of integrated software solutions.
Prior to the Sun acquisition, Oracle’s primary competitor in the enterprise software market was the German software
giant SAP. However, the acquisition of Sun’s vast hardware business pits Oracle for the first time against Hewlett-Packard,
IBM, Dell Computer, and Cisco Systems, all of which have made acquisitions of software services companies in recent
years, moving well beyond their traditional specialties in computers or networking equipment. In 2009, Cisco Systems
diversified from its networking roots and began selling computer servers. Traditionally, Cisco had teamed with hardware
vendors HP, Dell, and IBM. HP countered Cisco by investing more in its existing networking products and by acquiring the
networking company 3Com for $2.7 billion in November 2009. HP had purchased EDS in 2008 for $13.8 billion in an
effort to sell more equipment and services to customers often served by IBM. Each firm seems to be pursuing a “me too”
strategy in which they can claim to their customers that they and they alone have all the capabilities to be an end–to–end
service provider. Which firm is most successful in the long run may well be the one that successfully integrates their
acquisitions the best.
Investors’ concern about Oracle’s strategy is that the frequent acquisitions make it difficult to measure how well the
company is growing. With many of the acquisitions falling in the $5 million to $100 million range, relatively few of
Oracle’s acquisitions have been viewed as material for financial reporting purposes. Consequently, Oracle is not obligated
to provide pro forma financial data about these acquisitions, and investors have found it difficult to ascertain the extent to
which Oracle has grown organically (i.e., grown the revenue resulting from prior acquisitions) versus simply by acquiring
new revenue streams. Ironically, in the short run, Oracle’s acquisition binge has resulted in increased complexity as each
new acquisition means more products must be integrated. The rapid revenue growth from acquisitions may indeed simply
be masking underlying problems brought about by this growing complexity.
Discussion Questions and Answers:
1. How would you characterize the Oracle business strategy (i.e., cost leadership, differentiation, niche, or some
combination of all three)? Explain your answer.
2. Conduct an external and internal analysis of Oracle. Briefly describe those factors that influenced the
development of Oracle’s business strategy. Be specific.
3. In what way do you think the Oracle strategy was targeting key competitors? Be specific.
4. What other benefits for Oracle, and for the remaining competitors such as SAP, do you see from further industry
consolidation? Be specific.
Cingular Acquires AT&T Wireless in a Record-Setting Cash Transaction
Cingular outbid Vodafone to acquire AT&T Wireless, the nation’s third largest cellular telephone company, for $41 billion
in cash plus $6 billion in assumed debt in February 2004. This represented the largest all-cash transaction in history. The
combined companies, which surpass Verizon Wireless as the largest U.S. provider, have a network that covers the top 100
U.S. markets and span 49 of the 50 U.S. states. While Cingular’s management seemed elated with their victory, investors
soon began questioning the wisdom of the acquisition.
By entering the bidding at the last moment, Vodafone, an investor in Verizon Wireless, forced Cingular’s parents, SBC
Communications and BellSouth, to pay a 37 percent premium over their initial bid. By possibly paying too much, Cingular
put itself at a major disadvantage in the U.S. cellular phone market. The merger did not close until October 26, 2004, due to
the need to get regulatory and shareholder approvals. This gave Verizon, the industry leader in terms of operating margins,
time to woo away customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers because of poor
customer service. By paying $11 billion more than its initial bid, Cingular would have to execute the integration, expected
to take at least 18 months, flawlessly to make the merger pay for its shareholders.
With AT&T Wireless, Cingular would have a combined subscriber base of 46 million, as compared to Verizon
Wireless’s 37.5 million subscribers. Together, Cingular and Verizon control almost one half of the nation’s 170 million
wireless customers. The transaction gives SBC and BellSouth the opportunity to have a greater stake in the rapidly
expanding wireless industry. Cingular was assuming it would be able to achieve substantial operating synergies and a
reduction in capital outlays by melding AT&T Wireless’s network into its own. Cingular expected to trim combined capital
costs by $600 to $900 million in 2005 and $800 million to $1.2 billion annually thereafter. However, Cingular might feel
pressure from Verizon Wireless, which was investing heavily in new mobile wireless services. If Cingular were forced to
offer such services quickly, it might not be able to realize the reduction in projected capital outlays. Operational savings
might be even more difficult to realize. Cingular expected to save $100 to $400 million in 2005, $500 to $800 million in
2006, and $1.2 billion in each successive year. However, in view of AT&T Wireless’s continued loss of customers,
Cingular might have to increase spending to improve customer service. To gain regulatory approval, Cingular agreed to sell
assets in 13 markets in 11 states. The firm would have six months to sell the assets before a trustee appointed by the FCC
would become responsible for disposing of the assets.
SBC and BellSouth, Cingular’s parents, would have limited flexibility in financing new spending if it were required by
Cingular. SBC and BellSouth each borrowed $10 billion to finance the transaction. With the added debt, S&P put SBC,
BellSouth, and Cingular on credit watch, which often is a prelude in a downgrade of a firm’s credit rating.
Discussion Questions:
1. What is the total purchase price of the merger?
2. What are some of the reasons Cingular used cash rather than stock or some combination to acquire AT&T
Wireless? Explain your answer.
31
3. How might the amount and composition of the purchase price affect Cingular’s, SBC’s, and BellSouth’s cost of
capital?
4. With substantially higher operating margins than Cingular, what strategies would you expect Verizon Wireless to
pursue? Explain your answer.
Bank of America Acquires Merrill Lynch
Against the backdrop of the Lehman Brothers’ Chapter 11 bankruptcy filing, Bank of America (BofA) CEO Kenneth Lewis
announced on September 15, 2008, that the bank had reached agreement to acquire mega–retail broker and investment bank
Merrill Lynch. Hammered out in a few days, investors expressed concern that the BofA’s swift action on the all-stock $50
billion transaction would saddle the firm with billions of dollars in problem assets by pushing BofA’s share price down by
21 percent.
BofA saw the takeover of Merrill as an important step toward achieving its long-held vision of becoming the number 1
provider of financial services in its domestic market. The firm’s business strategy was to focus its efforts on the U.S. market
by expanding its product offering and geographic coverage. The firm implemented its business strategy by acquiring
selected financial services companies to fill gaps in its product offering and geographic coverage. The existence of a clear
and measurable vision for the future enabled BofA to make acquisitions as the opportunity arose.
Since 2001, the firm completed a series of acquisitions valued at more than $150 billion. The firm acquired FleetBoston
Financial, greatly expanding its network of branches on the East Coast, and LaSalle Bank to improve its coverage in the
Midwest. The acquisitions of credit card–issuing powerhouse MBNA, U.S. Trust (a major private wealth manager), and
Countrywide (the nation’s largest residential mortgage loan company) were made to broaden the firm’s financial services
offering.
The acquisition of Merrill makes BofA the country’s largest provider of wealth management services to go with its
current status as the nation’s largest branch banking network and the largest issuer of small business, home equity, credit
card, and residential mortgage loans. The deal creates the largest domestic retail brokerage and puts the bank among the top
five largest global investment banks. Merrill also owns 45 percent of the profitable asset manager BlackRock Inc., worth an
estimated $10 billion. BofA expects its retail network to help sell Merrill and BlackRock’s investment products to BofA
customers.
The hurried takeover encouraged by the U.S. Treasury and Federal Reserve did not allow for proper due diligence. The
extent of the troubled assets on Merrill’s books was largely unknown. While the losses at Merrill proved to be stunning in
the short run—$15 billion alone in the fourth quarter of 2008—the acquisition by Bank of America averted the possible
demise of Merrill Lynch. By the end of the first quarter of 2009, the U.S. government had injected $45 billion in loans and
capital into BofA in an effort to offset some of the asset write-offs associated with the acquisition. Later that year, Lewis
announced his retirement from the bank.
Mortgage loan losses and foreclosures continued to mount throughout 2010, with a disproportionately large amount of
such losses attributable to the acquisition of the Countrywide mortgage loan portfolio. While BofA’s vision and strategy
may still prove to be sound, the rushed execution of the Merrill acquisition, coupled with problems surfacing from other
acquisitions, could hobble the financial performance of BofA for years to come.
When Companies Overpay—Mattel Acquires The Learning Company
Mattel, Inc. is the world’s largest designer, manufacturer, and marketer of a broad variety of children’s products selling
directly to retailers and consumers. Most people recognize Mattel as the maker of the famous Barbie, the best-selling
fashion doll in the world, generating sales of $1.7 billion annually. The company also manufactures a variety of other well-
known toys and owns the primary toy license for the most popular kids’ educational program “Sesame Street.” In 1988,
32
Mattel revived its previous association with The Walt Disney Company and signed a multiyear deal with them for the
worldwide toy rights for all of Disney’s television and film properties
Business Plan
Mission Statement and Strategy
Mattel’s mission is to maintain its position in the toy market as the largest and most profitable family products
marketer and manufacturer in the world. Mattel will continue to create new products and innovate in their existing toy lines
to satisfy the constant changes of the family-products market. Its business strategy is to diversify Mattel beyond the market
for traditional toys at a time when the toy industry is changing rapidly. This will be achieved by pursuing the high-growth
and highly profitable children’s technology market, while continuing to enhance Mattel’s popular toys to gain market share
and increase earnings in the toy market. Mattel believes that its current software division, Mattel Interactive, lacks the
technical expertise and resources to penetrate the software market as quickly as the company desires. Consequently, Mattel
seeks to acquire a software business that will be able to manufacture and market children’s software that Mattel will
distribute through its existing channels and through its Website (Mattel.com).
Defining the Marketplace
The toy market is a major segment within the leisure time industry. Included in this segment are many diverse
companies, ranging from amusement parks to yacht manufacturers. Mattel is one of the largest manufacturers within the toy
segment of the leisure time industry. Other leading toy companies are Hasbro, Nintendo, and Lego. Annual toy industry
sales in recent years have exceeded $21 billion. Approximately one-half of all sales are made in the fourth quarter,
reflecting the Christmas holiday.
Customers. Mattel’s major customers are the large retail and e-commerce stores that distribute their products. These
retailers and e–commerce stores in 1999 included Toys “R” Us Inc., Wal-Mart Stores Inc., Kmart Corp., Target,
Consolidated Stores Corp., E-toys, ToyTime.com, Toysmart.com, and Toystore.com. The retailers are Mattel’s direct
customers; however, the ultimate buyers are the parents, grandparents, and children who purchase the toys from these
retailers.
Competitors. The two largest toy manufacturers are Mattel and Hasbro, which together account for almost one-half of
industry sales. In the past few years, Hasbro has acquired several companies whose primary products include electronic or
interactive toys and games. On December 8, 1999, Hasbro announced that it would shift its focus to software and other
electronic toys. Traditional games, such as Monopoly, would be converted into software.
Potential Entrants. Potential entrants face substantial barriers to entry in the toy business. Current competitors, such as
Mattel and Hasbro, already have secured distribution channels for their products based on longstanding relationships with
key customers such as Wal-Mart and Toys “R” Us. It would be costly for new entrants to replicate these relationships.
Moreover, brand recognition of such toys as Barbie, Nintendo, and Lego makes it difficult for new entrants to penetrate
certain product segments within the toy market. Proprietary knowledge and patent protection provide additional barriers to
entering these product lines. The large toymakers have licensing agreements that grant them the right to market toys based
on the products of the major entertainment companies.
Product Substitutes. One of the major substitutes for traditional toys such as dolls and cars are video games and
computer software. Other product substitutes include virtually all kinds of entertainment including books, athletic wear,
tapes, and TV. However, these entertainment products are less of a concern for toy companies than the Internet or
electronic games because they are not direct substitutes for traditional toys.
Suppliers. An estimated 80% of toy production is manufactured abroad. Both Mattel and Hasbro own factories in the Far
East and Mexico to take advantage of low labor costs. Parts, such as software and microchips, often are outsourced to non–
Mattel manufacturing plants in other countries and then imported for the assembly of such products as Barbie within
Mattel-owned factories. Although outsourcing has resulted in labor cost savings, it also has resulted in inconsistent quality.
Opportunities and Threats
Opportunities
New Distribution Channels. Mattel.com represents 80 separate toy and software offerings. Mattel hopes to spin this
operation off as a separate company when it becomes profitable. Mattel.com lost about $70 million in 1999. The other new