Chapter 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities
Answers to End of Chapter Discussion Questions
1.1 Discuss why mergers and acquisitions occur.
1.2 What is the role of the investment banker in the M&A process?
1.3 In your opinion, what are the motivations for two mergers or acquisitions in the news?
1.4 What are the arguments for and against corporate diversification through acquisition? Which do you support
and why?
1.5 What are the primary differences between operating and financial synergy? Give examples to illustrate your
statements.
1.6 At a time when natural gas and oil prices were at record levels, oil and natural gas producer, Andarko
Petroleum, announced on June 23, 2006 the acquisition of two competitors, Kerr–McGee Corp. and Western
Gas Resources, for $16.4 billion and $4.7 billion in cash, respectively. These purchase prices represent a
substantial 40 percent premium for Kerr-McGee and a 49 percent premium for Western Gas. The acquired
assets strongly complement Andarko’s existing operations, providing the scale and focus necessary to cut
overlapping expenses and to concentrate resources in adjacent properties. What do you believe were the
primary forces driving Andarko’s acquisition? How will greater scale and focus help Andarko to reduce its
costs? Be specific. What are the key assumptions implicit in your argument?
1.7 On September 30, 2000, Mattel, a major toy manufacturer, virtually gave away The Learning Company, a
maker of software for toys, to rid itself of a disastrous foray into software publishing that had cost the firm
literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit
to an affiliate of Gores Technology Group for rights to a share of future profits. Was this related or unrelated
diversification for Mattel? How might this have influenced the outcome?
3
1.8 In 2000, AOL acquired Time Warner in a deal valued at $160 billion, excluding assumed debt. Time Warner is
the world’s largest media and entertainment company, whose major business segments include cable networks,
magazine publishing, book publishing and direct marketing, recorded music and music publishing, and film and
TV production and broadcasting. AOL viewed itself as the world leader in providing interactive services, Web
brands, Internet technologies, and electronic commerce services. Would you classify this business combination
as a vertical, horizontal, or conglomerate transaction? Explain your answer.
1.9 Pfizer, a leading pharmaceutical company, acquired drug maker Pharmacia for $60 billion. The purchase price
represented a 34 percent premium to Pharmacia’s pre-announcement price. Pfizer is betting that size is what
matters in the new millennium. As the market leader, Pfizer was finding it increasingly difficult to sustain the
double-digit earnings growth demanded by investors. Such growth meant the firm needed to grow revenue by $3–
$5 billion annually while maintaining or improving profit margins. This became more difficult due to the
skyrocketing costs of developing and commercializing new drugs. Expiring patents on a number of so-called
blockbuster drugs intensified pressure to bring new drugs to market. In your judgment, what were the primary
motivations for Pfizer wanting to acquire Pharmacia? Categorize these in terms of the primary motivations for
mergers and acquisitions discussed in this chapter.
1.10 Dow Chemical, a leading chemical manufacturer, announced that it had reached an agreement to acquire in late
2008 Rohm and Haas Company for $15.3 billion. While Dow has competed profitably in the plastics business for
years, this business has proven to have thin margins and to be highly cyclical. By acquiring Rohm and Haas,
Dow will be able to offer less cyclical and higher margin products such as paints, coatings, and electronic
materials. Would you consider this related or unrelated diversification? Explain your answer. Would you
consider this a cost effective way for the Dow shareholders to achieve better diversification of their investment
portfolios?
Solutions to End of Chapter Case Study Questions
Microsoft Acquires Nokia in the Ongoing Smartphone Wars
Discussion Questions
1. Using the motives for mergers and acquisitions described in Chapter 1, which do you think apply to Microsoft’s
acquisition of Nokia? Discuss the logic underlying each motive you identify. Be specific.
2. Speculate as to why Microsoft and Nokia initially decided to form a partnership rather than have Microsoft simply
acquire Nokia? Why was the partnership unsuccessful?
3. Speculate as to why Microsoft used cash rather than some other form of payment to acquire Nokia?
4. The Nokia takeover is an example of vertical integration. How does vertical integration differ from horizontal
integration? How are the two businesses (software and hardware) the same and how are they different? What are
the potential advantages and disadvantages of this vertical integration for Microsoft? Be specific.
5. What are the critical assumptions that Microsoft is making in buying Nokia? Do you believe these assumptions are
realistic? Explain your answer.
Examination Questions and Answers
True/False: Answer True or False to the following questions:
1. A divestiture is the sale of all or substantially all of a company or product line to another party for cash or
securities. True or False
2. The target company is the firm being solicited by the acquiring company. True or False
3. A merger of equals is a merger framework usually applied whenever the merger participants are comparable in
size, competitive position, profitability, and market capitalization. True or False
4. A vertical merger is one in which the merger participants are usually competitors. True or False
5. Joint ventures are cooperative business relationships formed by two or more separate parties to achieve
common strategic objectives True or False
6. Operational restructuring refers to the outright or partial sale of companies or product lines or to downsizing by
closing unprofitable or non-strategic facilities. True or False
7. The primary advantage of a holding company structure is the potential leverage that can be achieved by
gaining effective control of other companies’ assets at a lower overall cost than would be required if the firm
were to acquire 100 percent of the target’s outstanding stock. True or False
8. Holding companies and their shareholders may be subject to triple taxation. True or False
9. Investment bankers offer strategic and tactical advice and acquisition opportunities, screen potential buyers and
sellers, make initial contact with a seller or buyer, and provide negotiation support for their clients.
True or False
10. Large investment banks invariably provide higher quality service and advice than smaller, so-called boutique
investment banks. True or False
11. Financial restructuring generally refers to actions taken by the firm to change total debt and equity structure.
True or False
12. An acquisition occurs when one firm takes a controlling interest in another firm, a legal subsidiary of another
firm, or selected assets of another firm. The acquired firm often remains a subsidiary of the acquiring
company. True or False
13. A leveraged buyout is the purchase of a company using as much equity as possible. True or False
14. In a statutory merger, both the acquiring and target firms survive. True or False
15. In a statutory merger, the acquiring company assumes the assets and liabilities of the target firm in accordance
with the prevailing federal government statutes. True or False
16. In a consolidation, two or more companies join together to form a new firm. True or False
17. A horizontal merger occurs between two companies within the same industry. True or False
18. A conglomerate merger is one in which a firm acquires other firms, which are highly related to its current core
business. True or False
19. The acquisition of a coal mining business by a steel manufacturing company is an example of a vertical
merger. True or False
20. The merger of Exxon Oil Company and Mobil Oil Company was considered a horizontal merger. True or
False
21. Most M&A transactions in the United States are hostile or unfriendly takeover attempts. True or False
22. Holding companies can gain effective control of other companies by owning significantly less than 100% of
their outstanding voting stock. True or False
23. Only interest payments on ESOP loans are tax deductible by the firm sponsoring the ESOP. True or False
24. A joint venture rarely takes the legal form of a corporation. True or False
25. When investment bankers are paid by a firm’s board to evaluate a proposed takeover bid, their opinions are
given in a so-called “fairness letter.” True or False
26. Synergy is the notion that the combination of two or more firms will create value exceeding what either firm
could have achieved if they had remained independent. True or False
27. Operating synergy consists of economies of scale and scope. Economies of scale refer to the spreading of
variable costs over increasing production levels, while economies of scope refer to the use of a specific asset to
produce multiple related products or services. True or False
28. Most empirical studies support the conclusion that unrelated diversification benefits a firm’s shareholders.
True or False
29. Deregulated industries often experience an upsurge in M&A activity shortly after regulations are removed.
True or False
30. Because of hubris, managers of acquiring firms sometimes believe their valuation of a target firm is superior to
the market’s valuation. Under these circumstances, they often end up overpaying for the firm. True and False
31. During periods of high inflation, the market value of assets is often less than their book value. This often
creates an attractive M&A opportunity. True or False
32. Tax benefits, such as tax credits and net operating loss carry-forwards of the target firm, are often considered
the primary reason for the acquisition of that firm. True or False
33. Market power is a theory that suggests that firms merge to improve their ability to set product and service
selling prices. True or False
34. Mergers and acquisitions rarely pay off for target firm shareholders, but they are usually beneficial to acquiring
firm shareholders. True or False
35. Pre-merger returns to target firm shareholders can exceed 30% around the announcement date of the
transaction. True or False
8
36. Post-merger returns to shareholders often do not meet expectations. However, this is also true of such
alternatives to M&As as joint ventures, alliances, and new product introductions. True or False
37. Overpayment is the leading factor contributing to the failure of M&As to meet expectations. True or False
38. Takeover attempts are likely to increase when the market value of a firm’s assets is more than their
replacement value. True or False
39. Although there is substantial evidence that mergers pay off for target firm shareholders around the time the
takeover is announced, shareholder wealth creation in the 3-5 years following a takeover is often limited.
True or False
40. A statutory merger is a combination of two corporations in which only one corporation survives with the
merged corporation goes out of existence. True or False
41. A subsidiary merger is a merger of two companies where the target company becomes a subsidiary of the
parent. True or False
42. Consolidation occurs when two or more companies join to form a new company. True or False
43. An acquisition is the purchase of an entire company or a controlling interest in a company. True or False
44. A leveraged buyout is the purchase of a company financed primarily by debt. This is a term commonly applied
to a firm going private financed primarily by debt. True or False
45. Growth is often cited as an important factor in acquisitions. The underlying assumption is that that bigger is
better to achieve scale, critical mass, globalization, and integration. True or False
46. The empirical evidence supports the presumption that bigger is always better when it comes to acquisitions.
True or False
47. The empirical evidence shows that unrelated diversification is an effective means of smoothing out the
business cycle. True or False
48. Individual investors can generally diversify their own stock portfolios more efficiently than corporate
managers who diversify the companies they manage. True or False
49. Financial considerations, such as an acquirer believing the target is undervalued, a booming stock market or
falling interest rates, frequently drive surges in the number of acquisitions. True or False
50. Regulatory and political change seldom plays a role in increasing or decreasing the level of M&A activity.
True or False
9
Multiple Choice: Circle only one.
1. Which of the following are generally considered restructuring activities?
a. A merger
b. An acquisition
c. A divestiture
d. A consolidation
e. All of the above
2. All of the following are considered business alliances except for
a. Joint ventures
b. Mergers
c. Minority investments
d. Franchises
e. Licensing agreements
3. Which of the following is an example of economies of scope?
a. Declining average fixed costs due to increasing levels of capacity utilization
b. A single computer center supports multiple business units
c. Amortization of capitalized software
d. The divestiture of a product line
e. Shifting production from an underutilized facility to another to achieve a higher overall operating rate
and shutting down the first facility
4. A firm may be motivated to purchase another firm whenever
a. The cost to replace the target firm’s assets is less than its market value
b. The replacement cost of the target firm’s assets exceeds its market value
c. When the inflation rate is accelerating
d. The ratio of the target firm’s market value is more than four times its book value
e. The market to book ratio is greater than one and increasing
5. Which of the following is true only of a consolidation?
a. More than two firms are involved in the combination
b. One party to the combination disappears
c. All parties to the combination disappear
d. The entity resulting from the combination assumes ownership of the assets and liabilities of the
acquiring firm only.
e. One company becomes a wholly owned subsidiary of the other.
6. Which one of the following is not an example of a horizontal merger?
a. NationsBank and Bank of America combine
b. U.S. Steel and Marathon Oil combine
c. Exxon and Mobil Oil combine
d. SBC Communications and Ameritech Communications combine
e. Hewlett Packard and Compaq Computer combine
7. Buyers often prefer “friendly” takeovers to hostile ones because of all of the following except for:
a. Can often be consummated at a lower price
10
b. Avoid an auction environment
c. Facilitate post-merger integration
d. A shareholder vote is seldom required
e. The target firm’s management recommends approval of the takeover to its shareholders
8. Which of the following represent disadvantages of a holding company structure?
a. Potential for triple taxation
b. Significant number of minority shareholders may create contentious environment
c. Managers may have difficulty in making the best investment decisions
d. A, B, and C
e. A and C only
9. Which of the following are not true about ESOPs?
a. An ESOP is a trust
b. Employer contributions to an ESOP are tax deductible
c. ESOPs can never borrow
d. Employees participating in ESOPs are immediately vested
e. C and D
10. ESOPs may be used for which of the following?
a. As an alternative to divestiture
b. To consummate management buyouts
c. As an anti-takeover defense
d. A, B, and C
e. A and B only
11. Which of the following represent alternative ways for businesses to reap some or all of the advantages of
M&As?
a. Joint ventures and strategic alliances
b. Strategic alliances, minority investments, and licensing
c. Minority investments, alliances, and licensing
d. Franchises, alliances, joint ventures, and licensing
e. All of the above
12. Which of the following are often participants in the acquisition process?
a. Investment bankers
b. Lawyers
c. Accountants
d. Proxy solicitors
e. All of the above
13. The purpose of a “fairness” opinion from an investment bank is
a. To evaluate for the target’s board of directors the appropriateness of a takeover offer
b. To satisfy Securities and Exchange Commission filing requirements
c. To support the buyer’s negotiation effort
d. To assist acquiring management in the evaluation of takeover targets
e. A and B
14. Arbitrageurs often adopt which of the following strategies in a share for share exchange just before or just after
11
a merger announcement?
a. Buy the target firm’s stock
b. Buy the target firm’s stock and sell the acquirer’s stock short
c. Buy the acquirer’s stock only
d. Sell the target’s stock short and buy the acquirer’s stock
e. Sell the target stock short
15. Institutional investors in private companies often have considerable influence approving or disapproving
proposed mergers. Which of the following are generally not considered institutional investors?
a. Pension funds
b. Insurance companies
c. Bank trust departments
d. United States Treasury Department
e. Mutual funds
16. Which of the following are generally not considered motives for mergers?
a. Desire to achieve economies of scale
b. Desire to achieve economies of scope
c. Desire to achieve antitrust regulatory approval
d. Strategic realignment
e. Desire to purchase undervalued assets
17. Which of the following are not true about economies of scale?
a. Spreading fixed costs over increasing production levels
b. Improve the overall cost position of the firm
c. Most common in manufacturing businesses
d. Most common in businesses whose costs are primarily variable
e. Are common to such industries as utilities, steel making, pharmaceutical, chemical and aircraft
manufacturing
18. Which of the following is not true of financial synergy?
a. Tends to reduce the firm’s cost of capital
b. Results from a better matching of investment opportunities available to the firm with internally
generated funds
c. Enables larger firms to experience lower average security underwriting costs than smaller firms
d. Tends to spread the firm’s fixed expenses over increasing levels of production
e. A and B
19. Which of the following is not true of unrelated diversification?
a. Involves buying firms outside of the company’s primary lines of business
b. Involves shifting from a firm’s core product lines into those which are perceived to have higher
growth potential
c. Generally results in higher returns to shareholders
d. Generally requires that the cash flows of acquired businesses are uncorrelated with those of the firm’s
existing businesses
e. A and D only
20. Which of the following is not true of strategic realignment?
a. May be a result of industry deregulation
b. Is rarely a result of technological change
12
c. Is a common motive for M&As
d. A and C only
e. Is commonly a result of technological change
21. The hubris motive for M&As refers to which of the following?
a. Explains why mergers may happen even if the current market value of the target firm reflects its true
economic value
b. The ratio of the market value of the acquiring firm’s stock exceeds the replacement cost of its assets
c. Agency problems
d. Market power
e. The Q ratio
22. Around the announcement date of a merger or acquisition, abnormal returns to target firm shareholders
during the last several decades have been
a. Trending down
b. Trending up
c. Unchanged
d. Doubling each decade
e. None of the above
23. Around the announcement date of a merger, acquiring firm shareholders of large publicly traded firms
normally earn
a. 30% positive abnormal returns
b. –20% abnormal returns
c. Zero to slightly negative returns
d. 100% positive abnormal returns
e. 10% positive abnormal returns
24. Which of the following is the most common reason that M&As often fail to meet expectations?
a. Overpayment
b. Form of payment
c. Large size of target firm
d. Inadequate post-merger due diligence
e. Poor post-merger communication
25. Post-merger financial performance of the new firm is often about the same as which of the following?
a. Joint ventures
b. Strategic alliances
c. Licenses
d. Minority investments
e. All of the above
26. Restaurant chain, Camin Holdings, acquired all of the assets and liabilities of Cheesecakes R Us. The
combined firm is known as Camin Holdings and Cheesecakes R Us no longer exists as a separate entity. The
acquisition is best described as a:
a. Merger
b. Consolidation
c. Tender offer
d. Spinoff
e. Divestiture
27. Pacific Surfware acquired Surferdude and as part of the transaction both of the firms ceased to exist in their
form prior to the transaction and combined to create an entirely new entity, Wildly Exotic Surfware. Which
one of the following terms best describes this transaction?
a. Divestiture
b. Tender offer
c. Joint venture
d. Spinoff
e. Consolidation
28. News Corporation of America announced its intention to purchase shares in another national newspaper chain.
Which one of the following terms best describes this announcement?
a. Divestiture
b. Spinoff
c. Consolidation
d. Tender offer
e. Merger proposal
29. Which one of the following statements accurately describes a merger?
a. A merger transforms the target firm into a new entity which necessarily becomes a subsidiary of the
acquiring firm
b. A new firm is created from the assets and liabilities of the acquirer and target firms
c. The acquiring firm absorbs only the assets of the target firm
d. The target firm is absorbed entirely into the acquiring firm and ceases to exist as a separate legal
entity.
e. A new firm is created holding the assets and liabilities of the target firm and its former assets only.
30. An investor group borrowed the money necessary to buy all of the stock of a company. Which of the following
terms best describes this transaction?
a. Merger
b. Consolidation
c. Leveraged buyout
d. Tender offer
e. Joint venture
31. A steel maker acquired a coal mining company. Which of the following terms best describes this deal?
a. Vertical
b. Conglomerate
c. Horizontal
d. Obtuse
e. Tender offer
32. Joe’s barber shop buys Jose’s Hair Salon. Which of the following terms best describes this deal?
a. Joint venture
b. Strategic alliance
c. Horizontal
d. Vertical
e. Conglomerate
14
Case Study Short Essay Examination Questions:
Google Acquires Motorola Mobility in a Growth-Oriented as well as Defensive Move
Key Points
The acquisition of Motorola Mobility positions Google as a vertically integrated competitor in the fast-growing
wireless devices market.
The acquisition also reduces their exposure to intellectual property litigation.
______________________________________________________________________________
By most measures, Google’s financial performance has been breathtaking. The Silicon Valley–based firm’s revenue
in 2011 totaled $37.9 billion, up 29% from the prior year, reflecting the ongoing shift from offline to online advertising.
While the firm’s profit growth has slowed in recent years, the firm’s 26% net margin remains impressive. About 95% of
the firm’s 2011 revenue came from advertising sold through its websites and those of its members and partners.1 Google
is channeling more resources into “feeder technologies” to penetrate newer and faster-growing digital markets and to
increase the use of Google’s own and its members’ websites. These technologies include the Android operating system,
designed to power wireless devices, and the Chrome operating system, intended to attract Windows– and Mac-based
computer users.
Faced with a need to fuel growth to sustain its market value, Google’s announcement on August 15, 2011, that it
would acquire Motorola Mobility Holdings Inc. (Motorola) underscores the importance it places on the explosive
growth in wireless devices. The all-cash $12.5 billion purchase price represented a 63% premium to Motorola’s closing
price on the previous trading day. Chicago-based, Motorola makes cellphones, smartphones, tablets, and set-top boxes;
its status as one of the earliest firms to develop cellphones and one of the leading mobile firms for the past few decades
meant that it had accumulated approximately 17,000 patents, with another 7,500 pending. With less than 3% market
share, the firm had been struggling to increase handset shipments and was embroiled in multiple patent-related lawsuits
with Microsoft.
As Google’s largest-ever deal, the acquisition may be intended to transform Google into a fully integrated mobile
phone company, to insulate itself and its handset-manufacturing partners from patent infringement lawsuits, and to gain
clout with wireless carriers, which control cellphone pricing and distribution. Revenue growth could come from license
fees paid on the Motorola patent portfolio and sales of its handsets and by increasing the use of its own websites and
those of its members to generate additional advertising revenue.
Google was under pressure from its handset partners, including HTC and Samsung, to protect them from patent
infringement suits based on their use of Google’s Android software.2 Microsoft has already persuaded HTC to pay a fee
for every Android phone manufactured, and it is seeking to extract similar royalties from Samsung. If this continues,
such payments could make creating new devices for Android prohibitively expensive for manufacturers, forcing them to
turn to alternative platforms like Windows Phone 7. With a limited patent portfolio, Google also was vulnerable to
lawsuits against its Android licenses.
Innovation in information technology usually relies on small, incremental improvements in software and hardware,
which makes it difficult to determine those changes covered by patents. Firms have an incentive to build up their patent
portfolios, which strengthens their negotiating positions with firms threatening to file lawsuits or demanding royalty
payments. Historically, firms have simply cross-licensed each other’s technologies; today, however, patent infringement
1 Google views its members (customers) as the over 1 million businesses that post advertisements on its websites;
partners consist of website publishers on whose sites Google posts advertisements and with whom Google shares
revenue from those advertisements. At 69% of total Google revenue, advertising revenue from Google websites grew at
34% in 2011, while advertising revenue from its members contributed 27% of total and grew by 18%.
2 Apple, Microsoft, and Oracle accused Google or the companies that use its Android operating system in the handsets
they manufacture, such as Motorola and HTC, a Taiwan handset maker, of infringing on their patents. Each has filed its
own patent infringement lawsuit. In late 2012, Apple won its U.S. patent case against Samsung.
15
lawsuits create entry barriers to potential competitors, as the threat of lawsuits may discourage new entrants. It now
pays competitors to sue routinely over alleged patent infringements.
Risks associated with the deal include the potential to drive Android partners such as Samsung and HTC to consider
using Microsoft’s smartphone operating system, with Google losing license fees currently paid to use the Android
operating system. The deal offers few cost savings opportunities due the lack of overlap between Google, an Internet
search engine that also produces Android phone software, and handset manufacturer Motorola. Google is essentially
becoming a vertically integrated cellphone maker. Furthermore, when the deal was announced, some regulators
expressed concern about Google’s growing influence in its served markets. Finally, Google’s and Motorola’s growth
and profitability differ significantly, with Motorola’s revenue growth rate less than one-third of Google’s and its
operating profit margin near zero.
Samsung, HTC, Sony Ericsson, and LG are now both partners and competitors of Google. It is difficult for a firm
such as Google to both license its products (Android operating system software) and compete with those licensees by
selling Motorola handsets at the same time. Nokia has already aligned with Microsoft and abandoned its own mobile
operating system. Others may try to create their own operating systems rather than become dependent on Google.
Samsung released phones in 2011 that run on a system called Bada; HTC has a team of engineers dedicated to
customizing the version of Android that it uses on its phones, called HTC Sense.
Motorola Mobility’s shares soared by almost 57% on the day of the announcement. Led by Nokia, shares of other
phone makers also surged. In contrast, Google’s share price fell by 1.2%, despite an almost 2% rise in the S&P 500
stock index that same day.
Discussion Questions:
1. Many acquisitions are intended to create measureable synergy between the acquirer and target firms. In what
sense is Motorola Mobility’s role in this transaction unclear? Identify sources of synergy between Google and
Motorola Mobility. What factors are likely to make the realization of this synergy difficult? Be specific.
2. Using the motives for mergers and acquisitions described in Chapter 1, which do you thing apply to Google’s
acquisition of Motorola Mobility? Be specific.
16
3. Speculate as to why the share price of Motorola Mobility did not increase by the full extent of the premium and
why Google’s share price fell on the day of the announcement. Be specific.
4. Speculate as to why the shares of other handset manufacturers jumped on the announcement that Google was
buying Motorola Mobility. Be specific.
5. How might the growing tendency for technology companies to buy other firms’ patents affect innovation? Be
specific.
Lam Research Buys Novellus Systems to Consolidate Industry
______________________________________________________________________________________________
Key Points
Industry consolidation is a common response to sharply escalating costs, waning demand, and increasing demands
of new technologies.
Customer consolidation often drives consolidation among suppliers.
______________________________________________________________________________________________
Highly complex electronic devices such as smartphones and digital cameras have become ubiquitous in our everyday
lives. These devices are powered by sets of instructions encoded on wafers of silicon called semiconductor chips
(semiconductors). Consumer and business demands for increasingly sophisticated functionality for smartphones and
cloud computing technologies require the ongoing improvement of both the speed and the capability of semiconductors.
This in turn places huge demands on the makers of equipment used in the chip-manufacturing process.
To stay competitive, makers of equipment used to manufacture semiconductor chips were compelled to increase
R&D spending sharply. Chip manufacturers resisted paying higher prices for equipment because their customers, such
as PC and cellphone handset makers, were facing declining selling prices for their products. Chip equipment
manufacturers were unable to recover the higher R&D spending through increasing selling prices. The resulting erosion
in profitability due to increasing R&D spending was compounded by the onset of the 2008–2009 global recession.
The industry responded with increased consolidation in an attempt to cut costs, firm product pricing, and gain access
to new technologies. Industry consolidation began among chip manufacturers and later spurred suppliers to combine. In
February 2011, chipmaker Texas Instruments bought competitor National Semiconductor for $6.5 billion. Three months
later, Applied Materials, the largest semiconductor chip equipment manufacturer, bought Varian Semiconductor
Equipment Associates for $4.9 billion to gain access to new technology. On December 21, 2011, Lam Research
Corporation (Lam) agreed to buy rival Novellus Systems Inc. (Novellus) for $3.3 billion. Lam anticipates annual cost
savings of $100 million by the end of 2013 due to the elimination of overlapping overhead.
Under the terms of the deal, Lam agreed to acquire Novellus in a share exchange in which Novellus shareholders
would receive 1.125 shares of Lam common stock for each Novellus share. The deal represented a 28% premium over
the closing price of Novellus’s shares on the day prior to the deal’s public announcement. At closing, Lam shareholders
owned about 51% of the combined firms, with Novellus shareholders controlling the rest.
In comparison to earlier industry buyouts, the purchase seemed like a good deal for Lam’s shareholders. At 2.3 times
Novellus’s annual revenue, the purchase price was almost one-half the 4.5 multiple paid by industry leader Applied
Materials for Variant in May 2011. The purchase premium paid by Lam was one-half of that paid for comparable
transactions between 2006 and 2010. Yet Lam shares closed down 4%, and Novellus’ shares closed up 28% on the
announcement date.
Lam and Novellus produce equipment that works at different stages of the semiconductor-manufacturing process,
making their products complementary. After the merger, Lam’s product line would be considerably broader, covering
more of the semiconductor-manufacturing process. Semiconductor-chip manufacturers are inclined to buy equipment
from the same supplier due to the likelihood that the equipment will be compatible. Lam also is seeking access to
cutting-edge technology and improved efficiency. Technology exchange between the two firms is expected to help the
combined firms to develop the equipment necessary to support the next generation of advanced semiconductors.
Customers of the two firms include such chip makers as Intel and Samsung. By selling complementary products, the
firms have significant cross-selling opportunities as equipment suppliers to all 10 chip makers globally. Together, Lam
and Novellus are able to gain revenue faster than they could individually by packaging their equipment and by
developing their technologies in combination to ensure they work together. Lam has greater penetration with Samsung
and Novellus with Intel.
Lam also stated on the transaction announcement date that a $1.6 billion share repurchase program would be
implemented within 12 months following closing. The buyback allows shareholders to sell some of their shares for cash
such that, following completion of the buyback, the deal could resemble a half-stock, half-cash deal, depending on how
many shareholders tender their shares during the buyback program. The share repurchase will be funded out of the
firms’ combined cash balances and cash flow. Structuring the deal as an all-stock purchase at closing allows Novellus
shareholders to have a tax-free deal.3
Discussion Questions:
1. Why did Lam’s shares close down 4 percent on the news? Why did Novellus’ shares close up 28 percent?