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.
Answer: The primary motivations for M&As include an attempt to realize synergy by combining the acquiring
and target firms, diversification, market power, strategic realignment, hubris, buying what are believed to be
undervalued assets, so-called agency problems, managerialism, and tax considerations. Synergy is the notion
that combining two firms results in a valuation of the combined firms that exceeds the sum of the two firms
valued on a standalone basis. Synergy represents the incremental cash flows only achievable by combining the
acquirer and target firms. Synergy is often realized by achieving economies of scale, the spreading of fixed
costs over increasing levels of production, or economies of scope, the utilization of a specific set of skills or an
asset currently employed to produce a specific product to produce related products. Financial synergy
1.2 What is the role of the investment banker in the M&A process?
Answer: Investment bankers serve as advisors to firms developing business strategies. They also recommend
1.3 In your opinion, what are the motivations for two mergers or acquisitions in the news?
Answer: In 2002, Hewlett Packard announced its interest in acquiring Compaq Computer, a major competitor.
The justification was to achieve cost savings by eliminating duplicate overhead and by closing under-utilized
1.4 What are the arguments for and against corporate diversification through acquisition? Which do you support
and why?
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Answer: In discussing diversification, it is important to distinguish between unrelated and related
diversification. Firms often justify unrelated diversification if they believe their current core business is
maturing or is too “cyclical.” By shifting their focus to higher growth areas, management argues they can
improve shareholder value. Moreover, by moving into an industry whose cash flows are uncorrelated with
1.5 What are the primary differences between operating and financial synergy? Give examples to illustrate your
statements.
Answer: Operating synergy includes economies of scale and scope. Economies of scale may be realized when
two firms with manufacturing facilities operating well below their capacity merge. If such facilities are
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?
Answer: Given the escalation in oil prices and the increasing difficulty in finding new reserves, Andarko
concluded that it would be cheaper to buy reserves rather than to explore and develop new reserves.
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?
Answer: The Learning Company represented the application of software to the toy industry; however, The
Learning Company was still a software company. Mattel was in a highly unrelated business. Perhaps propelled
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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.
Answer: If one defines the industry broadly as media and entertainment, this transaction could be described as a
vertical transaction in which AOL is backward integrating along the value chain to gain access to Time Warner’s
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.
Answer: The deal was an attempt to generate cost savings from being able to operate manufacturing facilities at a
higher average rate (economies of scale), to share common resources such as R&D and staff/overhead activities
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?
Answer: This acquisition should be viewed as related to Dow’s core competence in producing chemicals and
chemical-based products. It does not represent an efficient way for individual investors to achieve portfolio
Solutions to End of Chapter Case Study Questions
Occidental Outbids Chevron in High Stakes Energy Deal
Discussion Questions and Solutions:
1. Is the highest bid necessarily the best bid? Explain your answer.
Answer: While intuitively it seems that the highest offer price should always be selected, it often is not the
case. The board also needs to assess whether the bidder making the highest bid will actually be able to close
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2. Speculate as to why Chevron did not increase its initial offer price following Occidental’s initial bid?
Revised bid?
3. When, if ever, is it appropriate for a board to prevent shareholder votes on matters involved in selling a firm?
Answer: The answer to this question is rooted in whether boards are perceived to be acting in the interests of
all shareholders or simply attempting to entrench themselves and current management. Once an unsolicited bid
is initiated, the composition of a target firm’s shareholders moves from its long-term investors, who often sell
4. What were the motivations for Chevron and Occidental to be interested in acquiring Anadarko? Be
specific. What were the key assumptions implicit in both firms’ efforts to take control of Anadarko?
Answer: Chevron was interested in replenishing its declining oil and gas reserves, diversifying its reserves by
increasing its ownership of oil and gas properties in the Permian Basin, and in collocating its exploration and
5. What does the reaction of investors tell you about how they felt about Occidental’s takeover of Anadarko? Be
specific.
Answer: Once it appeared to be highly likely to close, investors bid up Anadarko’s share price to Occidental’s
revised offer price. Investors boosted Chevron’s share price despite failing to acquire Anadarko recognizing
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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
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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
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.
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
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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
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
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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
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
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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
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
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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.
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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
Case Study Short Essay Examination Questions
CENTURYLINK ACQUIRES LEVEL 3
IN A SEARCH FOR SCALE
___________________________________________________________________________
KEY POINTS
• Mergers between competitors generally offer the greatest potential synergy, but they also often face the
greatest scrutiny by regulators
• Acquirer share prices often fall when investors feel that the buyer paid too much or became excessively
leveraged as a result of a takeover
• Realizing anticipated synergy on a timely basis often is elusive
___________________________________________________________________________
CenturyLink Inc.’s (CenturyLink) announcement on October 31, 2016 that it had reached an agreement to acquire Level
3 Communications Inc. (Level 3) was met with great skepticism, as the firm’s shares fell more than 13% during the next
few days. Investors fretted that CenturyLink was paying too much for Level 3 and that its increased leverage would
constrain its ability to grow in the future. In contrast, Level 3’s shares rose sharply as the CenturyLink offer price
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its revenue from selling network services to businesses. The remainder of its revenue comes from selling landline
telephone services in mostly rural areas. The firm’s revenue has been declining over the last few years as it has been
losing market share to its larger competitors.
Level 3 Communications Inc. (Level 3) is situated in Bloomfield Colorado and is the second largest U.S. provider of
Ethernet services which enable its business customers to transmit data across high bandwidth internet connections.
Unlike CenturyLink, Level 3 generates all of its revenues from business customers. Like CenturyLink, Level 3 was
struggling to compete with AT&T and Verizon Communications incurring ongoing operating losses in recent years.
To compete more effectively in the business data transmission market, the two firms expect to realize cost and
END OF CHAPTER CASE STUDY: AMAZON MOVES TO CONQUER THE CONSUMER
RETAIL BUSINESS
BY ACQUIRING WHOLE FOODS
Case Study Objectives: To Illustrate
• How technology can disrupt industry supply chains,1
• How M&As often are used to overcome industry entry barriers,
• Why successful industry consolidation requires both vision and aggressive cost cutting, and
• Why competitor strategies must change to reflect changing market conditions.
___________________________________________________________________________
When Jeff Bezos, the richest man on the planet, speaks people listen. Why? Because of his impressive track record in
realizing his long held vision for his firm, Amazon.com Inc. (Amazon). Bezos is known for having a clear focus and an
15
a place where people can come to find and discover anything they might want to buy online.”2 This vision has informed
Bezo’s decision making since the firm’s formation in 1994 to what it has become today: the top internet retailing
company in the world.
Over the years, the firm has made numerous acquisitions often to fill holes in its product offering. But none compare
in size and boldness to the firm’s decision to acquire Whole Foods Inc. (Whole Foods), a move likely to drive further
grocery industry consolidation. Whole Foods is self-described as an American grocery chain dedicated to “…the finest
natural and organic foods available, to maintaining the strictest quality standards in the industry, and having an
unshakeable commitment to sustainable agriculture.3
For Whole Foods, the handwriting was on the wall. The firm has seen its traditional competitors such as Wal-Mart
and Kroger erode its market share by offering more natural and organic items. Price cutting by competitors also eroded
the firm’s profit margins. Reflecting these factors, the firm’s shares have lost nearly one half of their value since their
peak in 2013 as sales at stores open at least one year have slumped. The takeover by Amazon offered Whole Foods’
board and management an opportunity to turn the firm around.
Entry into such industries as the grocery business is limited by such barriers as the need to achieve substantial
scale/volume to negotiate effectively with suppliers and the requirement for widespread geographic coverage to grow
the business. The acquisition gives Amazon a scale and geographic distribution that would have taken years to build had
Amazon attempted to reinvest in its own start up grocery business. Whole Foods’ 460 store network provides a broad
geographic distribution network enabling Amazon to offer in-store pickup of merchandise purchased online and an
additional means of offering its expanding product offering to consumers who prefer to shop for certain things in stores.
16
are members of Amazon’s Prime service. Whole Foods could roll out its own order online/pick up in store service just
as Wal-Mart has done.
Ultimately, the motivation for Amazon to acquire Whole Foods could center on its desire to disrupt the current
grocery industry supply chain, just as it did in books and other industries. Amazon’s massive regional distribution
centers could eliminate many wholesalers who now dominate the grocery industry’s supply chain. Whole Foods
currently sources many of its perishable and specialty products from a network of suppliers, giving Amazon an
opportunity to remake how business is done.
Whole Foods also has a reputation of taking good care of its employees while Amazon‘s relationship with its
employees is more problematic. Aggressive cost cutting efforts could demoralize Whole Food employees causing
productivity and customer service to suffer eventually triggering customer attrition. While their presence in the grocery
industry would be significantly improved, the combined companies would still trail market leaders as the fifth-largest
Discussion Questions and Solutions:
1. Why does it make sense to include Whole Foods’ debt as part of the $13.7 billion purchase price Amazon paid
for Whole Foods?
2. What is the synergy between Amazon and Whole Foods?
Answer: Synergy is defined as the incremental value that is created by combining the two businesses in excess
of the sum of the standalone value of each business. By combining, the two firms can generate cost savings by
automating many of the Whole Foods’ labor intensive activities. The opportunity also exists for each firm to
17
3. What are some of the hurdles Amazon has to overcome to realize this synergy?
Answer: The two firms’ have very different cultures and business strategies: Amazon is a price cutter while
Whole Foods sells premium products at premium prices. Also, Whole Foods has a reputation for being
4. What is the motivation for this merger from Amazon’s point of view? From Whole Foods shareholders’ point
of view? (Hint: Consider those factors discussed in this chapter about why M&As happen)?
Answer: Given the size of the grocery industry, Amazon sees the merger as an opportunity to sell new
products to existing retail customers and to new customers. Therefore, it is a form of diversification. It is
also an attempt to achieve the operating scale and geographic diversification necessary to be competitive in the
industry. Amazon is also buying assets that could be undervalued. It is gaining the widely recognized
5. How does this deal further the realization of Amazon’s vision for the future of the firm?
Answer: Amazon’s vision can be summarized as becoming a firm whose customers could buy anything they
want at any time and any place. The firm has grown far above its original roots in the book selling business and
sells a full range of products to its retail customers. To grow rapidly, the firm had to identify a large and
BATTLE OF THE DISCOUNT RETAILERS—DOLLAR TREE ACQUIRES FAMILY DOLLAR
KEY POINTS
• Mergers between competitors offer the greatest potential shareholder value creation, but they also face the greatest
scrutiny from regulators
• Protracted bidding wars and negotiations can weaken operationally both the acquirer and target firms
• Realizing anticipated synergy on a timely basis often is elusive
• Postmerger integration is often the determining factor in the ultimate success or failure of a merger
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combined, offered the greatest potential for significant value creation (synergy) and for receiving regulatory approval
because few store locations overlap. Although their business strategies or models are different, the limited operational
overlap provides greater geographic coverage and access to new customers. Common overhead offers significant
opportunities for reducing operating costs and buying in larger volume provides increased negotiating leverage with
vendors.
When the deal closed in mid-2015, Dollar General, previously the biggest of the three dollar store competitors, faced
a larger competitor that had more locations around the country. The combined Dollar Tree and Family Dollar
companies will operate more than 13,000 stores nationwide, not including the 330 they had to sell to gain regulatory
approval, and annual revenue of more than $20 billion. By comparison, Dollar General operates 12,000 stores in 43
states. The new Dollar Tree will keep both brands and operate both dollar store business models.
The deal’s announcement prompted an aggressive response by the then much bigger Dollar General which offered
$9.1 billion or $80 per share offer for Family Dollar. Uncertainty over whether the higher takeover bid would receive
regulatory approval eventually sank Dollar General’s chances. Family Dollar argued that any deal with its bigger
competitor would require divesting as many as 4,500 stores in order to get regulatory approval.
CHARTER COMMUNICATIONS ACQUIRES TIME WARNER CABLE
AMID INDUSTRY TURMOIL
Case Study Objectives: To Illustrate
• The role of changing technologies in forcing rapid industry consolidation
• How the pace of consolidation often is the greatest in industries with high fixed expenses
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• Why successful consolidation requires both vision and aggressive cost cutting and
• Why business strategies must change to reflect changing competitive conditions
No successful business strategy can remain static. Significant and sustained changes in a firm’s external environment
will ensure that efforts to “stay the course” will result eventually in business failure. The U.S. cable industry is a prime
example of how changing technologies are making obsolete the industry’s traditional business model of monthly
subscriptions to access “bundles” of channels. This model worked for decades, but now cable customers can “cut the
cord” and move to online video.
While going online doesn’t mean free, since streaming service still costs money, the cost to the consumer often is
lower than monthly cable subscriptions and online streaming enables users to pay only for what they actually want. At
the time of this writing, Hulu runs $8 per month, Netflix is $9 per month and Amazon is $99 per year. The new HBO
Now costs $15 per month, and Sling TV — which has an assortment of “cable” channels, including AMC and ESPN —
starts at $20 per month. In addition, some shows are not part of unlimited streaming plans, requiring you to pay for
individual episodes or seasons.
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In 2013, Charter Communications Inc. (Charter) made several offers for Time Warner Cable (TWC) but was
repeatedly rejected. In 2014, it made an unsuccessful hostile bid but was thwarted by TWC accepting a richer Comcast
bid. Charter’s aggressive tactics seem to reflect the instincts of cable mogul John Malone. He has substantial influence
on Charter’s strategy through Liberty Broadband Corporation’s (Liberty) substantial equity stake in Charter. Malone is
the controlling shareholder in Liberty.
Including debt and equity, the transaction value (also called enterprise value) of TWC was $78.7 billion. The deal
enables Charter to quadruple its number of cable subscribers, with much of the increase coming in such key cities as
New York, Los Angeles, and Dallas. The combined businesses will have more than 24 million cable customers, second
only to Comcast’s 27 million. In addition, the combined firms will have greater leverage in negotiating contracts with
television networks wanting to distribute their content to the new firm’s cable customers. TWC shares rose 7.3% on the
deal’s announcement date, or about one-half of the offer price premium. Charter’s shares gained 2.5%.
In the wake of the failure of market leader Comcast to get approval to acquire TWC, why did Charter believe it could
get approval? There is little market overlap between Time Warner, Charter and Bright House and the combined
businesses will still not be as big a Comcast’s broadband/cable business. By some estimates, a tie-up between Comcast
and TWC would have given the combined firms almost two thirds of the broadband market. Moreover, Charter is not as
vertically integrated as Comcast which produces considerable amounts of its own content. The Federal Communication
Commission’s clearer definition of so-called net neutrality rules, which essentially bans discrimination against
businesses wishing to access the internet through gateway services such as cable, makes it more difficult for a cable
firm to hamper access to potential competitors. Finally, the emergence of online video alternatives to cable promotes
increased competition for the traditional cable firms.