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Chapter 5
Implementation: Search through Closing—Phases 3 to 10
Answers to End of Chapter Discussion Questions
5.1 Identify at least three criteria that might be used to select a manufacturing firm as a potential acquisition candidate.
A financial services firm? A high technology firm?
Answer: Selection criteria that may be employed in a search for a manufacturing firm could include the industry;
geographic location; maximum size expressed in terms of profitability, revenue, or market value; and market
5.2 Identify alternative ways to make ‘‘first contact’’ with a potential acquisition target. Why is
confidentiality important? Under what circumstances might a potential acquirer make its intentions public?
Answer: Small companies, in which the buyer has no direct contacts, may be approached by using a vaguely
worded letter identifying yourself, expressing interest in a joint venture or marketing alliance, and indicating why
5.3 What are the differences between total consideration, total purchase price/enterprise value, and net purchase price?
How are these different concepts used?
Answer: In the agreement of purchase and sale, the total consideration consists of cash, stock, new debt issues, or
some combination of all three. The total purchase price or enterprise value of the target firm consists of the total
consideration plus the market value of the target firm’s debt assumed by the acquiring company. The net purchase
5.4 What is the purpose of the buyer and seller performing due diligence?
Answer: Buyer due diligence is undertaken to confirm the validity of key assumptions underlying the valuation of
the target, to identify any sources and destroyers of value not previously recognized, and to identify any “fatal
5.5 Why is pre-closing integration planning important?
2
Answer: Integration planning is a highly important aspect of the acquisition process that must be done before
closing. Once closing occurs, the acquiring company loses much of the leverage it may have had before the
transaction was completed. Without adequate planning, integration is unlikely to provide the synergies anticipated
5.6 In a rush to complete its purchase of health software producer HBO, McKesson did not perform adequate due
diligence but rather relied on representations and warranties in the agreement of sale and purchase. Within six
months following closing, McKesson announced that it would have to reduce revenue by $327 million and net
income by $191.5 million for the past 3 fiscal years to correct for accounting irregularities. The company’s
stock fell by 48 percent. Assume HBO’s financial statements had been declared to be in accordance with GAAP,
would McKesson have been justified in believing that HBO’s revenue and profit figures were 100 percent
accurate?
Answer: No. Even if HBO’s financials had been declared to have been compiled in accordance with GAAP, there
is no assurance that revenue and profits would be accurate. GAAP is rule-based. Off-balance sheet items and
5.7 Find a transaction currently in the news. Speculate as to what criteria the buyer may have employed to identify
the target company as an attractive takeover candidate. Be specific.
5.8 In mid-2008, Fresenius, a German manufacturer of dialysis equipment, acquired APP Pharmaceuticals for $4.6
billion. The deal includes an earn-out, under which Fresenius will pay as much as $970 million, if APP reaches
certain future financial targets. What is the purpose of the earn-out? How does it affect the buyer and seller?
Answer: An earn-out may have been used to bridge the gap between what the buyer was willing to pay based on
current information and what the seller believed the business is worth. The form of payment shifts the upside risk
5.9 Material adverse change clauses (MACs) are a means for the parties to the contract to determine who will bear the
risk of adverse events that occur between the signing of an agreement and the closing. MACs are frequently not
stated in dollar terms. How might MACs affect the negotiating strategies of the parties to the agreement during the
period between signing and closing?
Answer: Buyers typically will use these clauses to drive the acquisition price down to exploit changing market
5.10 Despite disturbing discoveries during due diligence, Mattel acquired The Learning Company (TLC), a leading
developer of software for toys, in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel had
determined that TLC’s receivables were overstated, a $50 million licensing deal had been prematurely put on the
balance sheet, and that TLC’s brands were becoming outdated. TLC also had substantially exaggerated the amount
of money put into research and development for new software products. Nevertheless, driven by the appeal of
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rapidly becoming a big player in the children’s software market, Mattel closed on the transaction aware that TLC’s
cash flows were overstated. After restructuring charges associated with the acquisition, Mattel’s consolidated 1999
net loss was $82.4 million on sales of $5.5 billion. Mattel’s stock fell by more than 35 percent during 1999 to end
the year at about $14 per share. What could Mattel have done to better protect its interests? Be specific.
Answer: Mattel could have protected itself by withholding a portion of the purchase price in escrow, negotiating a
Solutions to End of Chapter Case Study Questions
Roche Acquires Spark Therapeutics in Move to Replenish Drug Pipeline
Discussion Questions and Answers:
1. What external and internal factors drove the merger between Roche and Spark Therapeutics?
Answer: Internally, Roche saw many of its important revenue generating drugs affecting as much as $21 billion of its
annual revenue lose patent protection. This meant that more than one-third of the firm's total annual revenue would be
2. What options other than an acquisition could Roche have pursued? Speculate as to why they chose to acquire rather
than to pursue other alternatives.
Answer: Roche's alternatives ranged from developing gene therapies internally, partnering with leaders in this field
with an option to market drugs that were developed, or acquire a leader in the field of gene therapy. Roche was under
3. What are the major assumptions implicit in Roche's takeover strategy? Be specific.
4. Speculate as to why Roche chose to operate Spark as a wholly owned subsidiary? What are the advantages and
disadvantages in operating the business independently from the parent?
Answer: Roche wanted to preserve Spark's innovative culture and to limit any loss of key personnel that might have
Examination Questions and Answers
True/False Questions: Answer true or false to the following:
1. The first step in establishing a search plan for potential acquisition or merger targets is to identify the primary
screening or selection criteria. True or False
2. The number of selection criteria should be as extensive as possible to ensure that all factors relevant to the firm’s
decision-making process are considered. True or False
3. Only acquiring firms perform due diligence. True or False
4. Banks are commonly used to provide bridge or temporary financing to pay all or a portion of the purchase price
and meet possible working capital requirements until permanent financing can be found. True or False
5. The targeted industry and the maximum size of the potential transaction are often the most important selection
criteria used in the search process. True or False
6. Advertising in the business or trade press is generally a very efficient way to locate attractive acquisition target
candidates. True or False
7. An excessively long list of screening criteria used to develop a list of potential acquisition targets can severely
limit the number of potential candidates. True or False
8. The appropriate approach for initiating contact with a target firm is essentially the same for large or small, public
or private companies. True or False
9. In contacting large, publicly traded firms, it is usually preferable to make initial contact through an intermediary
and at the highest level of the company possible. True or False
10. Rumors of impending acquisition can have a substantial deleterious impact on the target firm. True or False
11. So-called permanent financing for an acquisition usually consists of long-term unsecured debt. True or False
12. Confidentiality agreements are usually signed before any information is exchanged to protect the buyer and the
seller from loss of competitive information. True or False
13. Confidentiality agreements often cover both the buyer and the seller, since both are likely to be exchanging
confidential information, although for different reasons. True or False
14. Confidentiality agreements usually also cover publicly available information on the potential acquirer and target
firms. True or False
15. A letter of intent formally stipulates the reason for the agreement, major terms and conditions, the responsibilities
of both parties while the agreement is in force, a reasonable expiration date, and how all fees associated with the
transaction will be paid. True or False
16. The signing of a letter of intent usually precludes the target firm from suing the potential acquiring company if the
acquirer eventually withdraws its initial offer. True or False
17. “No shop” provisions are seldom found in letters of intent. True or False
18. The letter of intent often specifies the type of information to be exchanged as well as the scope and duration of the
potential buyer’s due diligence. True or False
19. Letters of intent are usually legally binding on the potential buyer but rarely on the target firm. True or False
20. The actual price paid for a target firm is unaffected by the buyer’s due diligence. True or False
21. Total consideration refers to what is to be paid for the target firm and usually only consists of cash or stock,
exclusively. True or False
22. The total purchase price paid by the buyer should also reflect the assumption of liabilities stated on the target’s
balance sheet, but it should exclude all off balance sheet liabilities. True or False
23. Discretionary assets are undervalued or redundant assets not required to run the acquired business and which can
be used by the buyer to recover a portion of the purchase price. True or False
24. The actual purchase price paid for a target firm is determined doing the negotiation process and is often quite
different from the initial offer price stipulated in a letter of intent. True or False
25. Buyers routinely perform due diligence on sellers, but sellers rarely perform due diligence on buying firms. True
or False
26. Due diligence is the process of validating assumptions underlying the initial valuation of the target firm as well as
the uncovering of factors that had not previously been considered that could enhance or detract from the value of
the target firm. True or False
27. It is usually in the best interests of the seller to allow the buyer unrestricted access to all seller employees and
records doing due diligence in order to create an atmosphere of cooperation and goodwill. True or False
28. Buyers should not be concerned about performing an exhaustive due diligence since in doing so they could
degrade the value of the target firm because of the disruptive nature of a rigorous due diligence. The buyer can be
assured that all significant risks can be handled through the standard representations and warranties commonly
found in agreements of purchase and sale. True or False
29. Bridge financing refers to the temporary financing obtained by the buyer to pay all or a portion of the purchase
price until so-called permanent financing can be arranged. True or False
30. Seller financing represents a very important source of financing for buyers. True or False
31. Elaborate multimedia presentations made to potential lenders in an effort to “shop” for the best financing are often
referred to as the “road show.” True or False
32. The buyer’s ability to obtain adequate financing is a closing condition common to most agreements of purchase
and sale. True or False
33. Closing is a phase of the acquisition process that usually occurs shortly after the target has been fully integrated
into the acquiring firm. True or False
34. Shrewd sellers often negotiate a break-up clause in an agreement of purchase and sale requiring the buyer to pay
the seller an amount at least equal to the seller’s cost associated with the transaction. True or False
35. The purchase price for a target firm may be fixed at the time of closing, subject to future adjustment, or be
contingent on future performance. True or False
36. Brokers or finders should never be used in the search process. True or False.
37. More and more firms are identifying potential target companies on their own without the use of investment
bankers. True or False
38. Fees charged by investment bankers are never negotiable. True or False
39. Debt-to-equity ratios may be used to measure a firm’s degree of leverage and are frequently used as a search
40. Even though time is critical, it is always critical to build a relationship with the CEO of the target firm before
approaching her with an acquisition proposal. True or False
41. There is no substitute for performing a complete due diligence on the target firm. True or False
42. Confidentiality agreements are rarely required when target and acquiring firms exchange information. True or
False
43. The financing plan may be affected by the discovery during due diligence of assets that can be sold to pay off debt
accumulated to finance the transaction. True or False
44. There is no need for the seller to perform due diligence on its own operations to ensure that its representations and
warranties in the definitive agreement are accurate. True or False
45. The closing often involves getting all the necessary third-party consents and regulatory and shareholder approvals.
True or False
46. The purchase price may be fixed at the time of closing, subject to future adjustment, or it may be contingent on
future performance of the target business. True or False
47. Earnouts are generally very poor ways to create trust and often represent major impediments to the integration
process. True or False
48. Loan covenants are promises made by the borrower that certain acts will be performed and others will be avoided.
True or False
49. Buyers generally want to complete due diligence on the seller as quickly as possible. True or False
50. A data room is a method commonly used by sellers to limit buyer due diligence. True or False
51. Total consideration is a legal term referring to the composition of what is paid for the target company and can
consist of cash, stock, debt or some combination of all three.
Multiple Choice Questions.
1. Each of the following is true about the acquisition search process except for
a. A candidate search should start with identifying the primary selection criteria.
b. The number of selection criteria should be as lengthy as possible.
c. At a minimum, the primary criteria should include the industry and desired size of transaction.
d. The size of the transaction may be defined in terms of the maximum purchase price the acquirer is willing
to pay.
e. A search strategy entails the use of electronic databases, trade publications, and querying the acquirer’s
law, banking, and accounting firms for qualified candidates.
2. The screening process represents a refinement of the search process and commonly utilizes which of the following
as selection criteria
a. Market share, product line, and profitability
b. Product line, profitability, and growth rate
c. Profitability, leverage, and growth rate
d. Degree of leverage, market share, and growth rate
e. All of the above
3. Initial contact should be made through an intermediary as high up in the organization for which of the following
firms
a. Companies with annual revenue of less than $25 million
b. Medium sized companies between $25 and $100 million in annual revenue
c. Large, publicly traded firms
d. Small, privately owned firms
e. Small, privately owned competitors
4. All of the following statements are true about letters of intent except for
a. Are always legally binding
b. Spells out the initial areas of agreement between the buyer and seller
c. Defines the responsibilities and rights of the buyer and seller while the letter of intent is in force
d. Includes an expiration date
e. Includes a “no shop” provision
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5. All of the following are true about a confidentiality agreement except for
a. Often applies to both the buyer and the seller
b. Stipulates the type of seller information available to the buyer and how the information can be used
c. Limits the use of information about the seller that is publicly available
d. Includes a termination date
e. Limits the ability of either party to disclose publicly the nature of discussion between the buyer and seller
6. The actual price paid by the buyer for the target firm is determined when
a. The initial offer is made
b. As a result of the negotiation process
c. When the letter of intent is signed
d. Following the completion of due diligence
e. Once a financing plan has been approved
7. In a merger, the acquiring firm assumes all liabilities of the target firm. Assumed liabilities include all but which
of the following?
a. Current liabilities
b. Long-term debt
c. Warranty claims
d. Fully depreciated operating equipment
e. Off-balance sheet liabilities
8. The negotiation process consists of all of the following concurrent activities except for
a. Refining valuation
b. Deal structuring
c. Integration planning
d. Due Diligence
e. Developing the financing plan
9. All of the following are true of buyer due diligence except for
a. Due diligence is the process of validating assumptions underlying valuation.
b. Can be replaced by appropriate representations and warranties in the agreement of purchase and sale.
c. Primary objectives are to identify and to confirm sources and destroyers of value
d. Consists of operational, financial, and legal reviews.
e. Endeavors to identify the “fatal flaw” that could destroy the deal
10. Which of the following are commonly used sources of financing for M&A transactions?
a. Asset based lending
b. Cash flow based lending
c. Seller financing
d. A and B only
e. All of the above
11. Which of the following is generally not true of a financing contingency?
a. It is a condition of closing in the agreement of purchase and sale
b. Trigger the payment of break-up fees if not satisfied.
c. Protects both the lender and seller
d. Primarily protects the buyer
e. Primarily protects the seller
12. Which of the following is generally not true of integration planning?
a. Is of secondary importance in the acquisition process.
b. Is crucial to the ultimate success of the merger or acquisition
c. Represents an opportunity to earn trust among all parties to the transaction
d. Involves developing effective communication strategies for employees, customers, and suppliers.
e. Is often neglected in the heat of negotiation.
13. All of the following are true of closing except for
a. Consists of obtaining all necessary shareholder, regulatory, and third party consents
b. Requires significant upfront planning
c. Is rarely subject to last minute disagreements
d. Involves the final review and signing of such documents as the agreement of purchase and sale, loan
agreements (if borrowing is involved), security agreements, etc.
e. Fulfillment of the so-called closing conditions
14. Which of the following do not represent typical closing documents in an asset purchase?
a. Letter of intent
b. Listing of any liabilities to be assumed by the buyer
c. Loan and security agreements if the transaction is to be financed with debt
d. Complete descriptions of all patents, facilities, and investments
e. Listing of assets to be acquired
15. Which of the following is not typically true of post-closing evaluation of an acquisition?
a. It is important not to change the performance benchmarks against which the acquisition is measured
b. It is critical to ask the tough questions
c. It is an opportunity to learn from mistakes
d. It is commonly done
e. It is frequently avoided by acquiring firms because of the potential for embarrassment.
16. Which of the following is true about integration planning? Without integration planning, integration is not likely to
a. Provide anticipated synergies
b. Proceed without significant disruption to the target business’ operations
c. Proceed without significant disruption to the acquirer’s operations
d. Be completed without experiencing substantial customer attrition
e. All of the above
17. Which of the following statements are true about due diligence?
a. The seller should perform due diligence on its own operations.
b. The seller should perform due diligence on the buyer.
c. The seller should perform due diligence on the lender used by the buyer to finance the transaction.
d. A & B
e. A, B, & C
18. Which of the following is not true of the financing plan?
a. It is rarely affected by the discovery during due diligence of target assets not required to operate the
business.
b. It may include both stock and debt.
c. It may include a combination of stock, debt, and cash.
d. It serves as a reality check on the buyer.
e. None of the above.
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19. Refining the target valuation based on new information uncovered during due diligence is most likely to affect
which of the following
a. Total consideration
b. The search process
c. The business plan
d. The acquisition plan
e. The target’s business plan
20. The negotiation process consists of all of the following except for
a. Refining valuation
b. Due diligence
c. Closing
d. Developing a financing plan
e. Deal structuring
21. Closing is included in which of the following activities?
a. Development of a business plan
b. Development of an acquisition plan
c. The search process
d. The negotiation process
e. None of the above
22. Integration planning is included in which of the following activities?
a. Development of a business plan
b. The search process
c. Development of a financing plan
d. Post-closing integration
e. None of the above
23. The development of search criteria is included in which of the following activities?
a. Development of a business plan
b. Development of the acquisition plan
c. Post-closing integration
d. Post-closing evaluation of the acquisition process
e. None of the above
24. The financing plan is included in which phase of the acquisition process?
a. The development of the business plan
b. The negotiation phase
c. The integration planning phase
d. The development of the acquisition plan
e. None of the above
25. Which of the following is not true of the acquisition process?
a. It always follows a predictable sequence of steps.
b. It sometimes deviates from the sequence outlined in this chapter.
c. It involves a negotiation phase
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d. It involves the development of a business plan
e. None of the above
Case Study Short Essay Examination Questions
IN THE WAKE OF INDUSTRY CONSOLIDATION
DISCOVERY COMMUNICATIONS BUYS SCRIPPS NETWORKS
KEY POINTS
Consolidation among customers often drives suppliers to combine
New technologies spawn new business models which can quickly make existing business models obsolete
Friendly acquisitions often offer the greatest potential for synergy and frequently are the product of long-term relationships
between board members and senior management
Cable-TV distributors buy much of their content from cable-TV content providers. With continuing consolidation among
cable-TV distributors, content companies are under increasing pressure to combine. Distributors such as AT&T Inc. and
Charter Communications Inc. have completed acquisitions in recent years. Smaller content providers have been under
pressure from investors to merge to gain additional clout in their negotiations with the huge cable-TV distributors to
improve their cut of subscriber fees paid to the cable-TV companies.
Cord cutting has accelerated largely as a result of the attractiveness of such online streaming services as Netflix and
Amazon's Prime. In mid-2017, Netflix subscribers exceeded 50 million, more than the 48.5 million subscribers to the major
cable-TV providers. Services like Alphabet's (Google) YouTube enable users to provide short videos online for free.
Moreover, the number of potential customers for the smaller media company's content has been shrinking as video
streaming sites such as Hulu and YouTube have excluded the content of such providers as Discovery and Scripps from their
offering.
The larger cable-TV providers have attempted to adjust to the changing industry dynamics through mergers or by
developing targeted services. In 2016, Time Warner Inc. agreed to be acquired by AT&T in a deal valued at $85.4 billion.
This followed AT&T's acquisition of DirecTV in mid-2015 for $48.5 billion. Walt Disney Co., which owns ESPN, is
developing an online service to reach sports fans that have chosen not to use traditional cable-TV providers.
Increasing concentration among cable-TV distributors spurred greater concentration among content providers. On July
31, 2017, Discovery Communications Inc. (Discovery) agreed to buy Scripps Networks Interactive (Scripps) for $11.9
billion in a bet that a larger footprint in "lifestyle programming" will help it weather cable TV industry upheaval. Including
Scripps' debt, the deal is valued at $14.6 billion.
12
streamed 7 billion times monthly. Finally, the combined firms expect to pare costs by $350 million annually be eliminating
redundant overhead.
A bigger portfolio of channels specializing in "lifestyle television" would give the combined firms an edge in talks with
advertisers who covet female and younger audiences. A critical mass of programs about home renovations, cooking
contests, and similar programming have put Discovery and Scripps in a position to offer a web-TV bundle directly to
consumers who are cutting the cord to cable and turning to offerings from Netflix, Hulu and other competitors.
INTEL BUYS MOBILEYE IN A BET
ON SELF-DRIVING CAR TECHNOLOGY
Case Study Objectives: To Illustrate
• The challenges of strategic diversification,
• The tenuous nature of competitive advantage,
• The risk of overpaying, and
• The benefits and risks to being first to market.
_______________________________________________________________________
Someone once said that it is difficult to make predictions especially about the future. But that has not gotten in the way of
prognosticators peering into their crystal balls about the outlook for driverless or autonomous cars. The autonomous vehicle
components and advanced driver assisted systems market is expected to ramp up very quickly over the next few years from
a relatively modest $3 billion level in 2015. Consulting firm Bain & Company sees this sector achieving annual sales of
$25 billion by 2025. Goldman Sachs' analysts see the market growing to $96 billion in 2025 before reaching a mind-
numbing $290 billion in 2035.
Emboldened by such optimism, familiar names like Google and Uber have raced ahead of their competitors by investing
billions of dollars in developing their own technologies, building test cars, and recording millions of miles on city streets.
They have also signed partnerships with automakers such as Chrysler and Volvo. Similarly, Tesla has clocked 1.3 billion
test miles from its proprietary Auto Pilot equipped cars.
13
semiconductor markets. In recent years, the firm's revenue and profits have stagnated resulting in the firm laying off 12,000
employees in 2016. At a conference in April 2016, Intel CEO Brian Krzanich discussed plans to transform the firm from
one focused on PCs to one that "powers the cloud and billions of smart, connected computing devices." How would this
transformation take place? By focusing on high-growth, data intensive applications where it can achieve leadership
positions, while making the firm more efficient and profitable. One such opportunity is the driverless vehicle market. For
Intel, Mobileye may have appeared to be a "must do deal" to gain a competitive edge in this market and to prevent
competitors from buying the firm.
The tie-up between Intel and Mobileye could potentially accelerate innovation in autonomous car technology. Much of
the impetus for Mobileye's innovation has come from Mr. Shashua. Mobileye's advance driver assisted systems collect
imaging and location data that can be used to create what the company calls RoadBook, a vast digital map of roadways in
the U.S. and Europe. This will help autonomous vehicles navigate safely city streets.
Intel also aims to broaden its offerings beyond just chips to a wider suite of products that driverless vehicles will require.
By doing so, Intel hopes to attract auto makers wanting to produce driverless cars but who do not want to invest in
developing their own in-house expertise.
The deal promises to roil the automotive suppliers market. Suppliers like Nvidia and Qualcomm, whose products are
currently more aligned with the automakers needs, could soon see this competitive advantage weakened as autonomous car
technology takes hold in the industry. Intel will be the first supplier to offer a fully integrated end-to-end cloud computing
based solution to autonomous car driving. This means that Intel will be the first supplier to offer the software capability to
capture and verify a car sensor's recognition of a road obstacle by transmitting the image through a network to a cloud
based server for validation in real time.
14
Another concern is that Intel's track record in exploiting new opportunities does not inspire confidence. Intel has been
able to corner the PC market for more than 30 years. But in recent years it has lost its mojo in dominating other fast
growing segments of the chip market. Critics argue that Intel substantially overpaid for Mobileye as it did for cyber security
firm, formerly known as McAfee. In 2016, it sold the McAfee for $4.3 billion, $3.2 billion less than it had paid five years
earlier.
Much of the creativity in Mobileye is centered around a relatively few people. Intel knows that it must be careful not to
allow its bureaucracy to alienate Mobileye personnel. This probably explains why Intel has merged its driverless car unit
with Mobileye, with Mobileye management in control.
Discussion Questions and Solutions:
1. What key factors are driving Intel's board and management to attempt to transform the firm? Be specific.
Answer: Accounting for about one-half of the firm's business, the global PC market is maturing. Continued
dependence on this market virtually assures limited revenue growth and narrowing margins. Competitors in mature
2. Characterize Intel's business strategy as a cost leadership, differentiation, focus, or some combination. Justify your
answer.
Answer: Given what they paid for Mobileye, it is clear that a disproportionate amount of the firm's resources will be
devoted to the driverless car market in the future. Intel will now be the first supplier to offer a fully integrated end-to-
3. A corporate vision can be described narrowly or broadly. Describe Intel’s vision. How useful do you find this vision
statement in providing guidance for future investment decisions? (Hint: Discuss the advantages and disadvantages of a
broad versus narrow corporate vision statement.)
Answer: Intel sees itself becoming the firm that "powers the cloud and billions of smart, connected computing devices"
by focusing on high growth data intensive applications where it can achieve leadership positions, while making the
4. Speculate as to whether you think Intel will be able to earn financial returns demanded by their shareholders on its
acquisition of Mobileye. Discuss what you believe are the factors likely to boost returns and those likely to reduce
returns.
Answer: Being first to market offers the potential for Mobileye to become the dominant camera and sensor technology
supplier to the autonomous car market. Given this market's potential for explosive growth, the firm's market leading
position should support dramatic increases in revenue and profit. Moreover, technological innovation could be
substantial given Intel's skill in designing ever more powerful chips and in cloud connectivity, which could be
integrated into a package with the Mobileye camera and sensor technology. First mover advantage also creates the
IN THE WAKE OF INDUSTRY CONSOLIDATION
DISCOVERY COMMUNICATIONS BUYS SCRIPPS NETWORKS
KEY POINTS
Consolidation among customers often drives suppliers to combine
New technologies spawn new business models which can quickly make existing business models obsolete
Friendly acquisitions often offer the greatest potential for synergy and frequently are the product of long-term relationships
between board members and senior management
Cable-TV distributors buy much of their content from cable-TV content providers. With continuing consolidation among
cable-TV distributors, content companies are under increasing pressure to combine. Distributors such as AT&T Inc. and
16
content provider revenues. With subscriber revenues under pressure from so-called "cord cutting,"7 smaller media content
providers are competing for a shrinking subscriber revenue pool. The trend among cable-TV distributors is to offer a more
select lineup of channels known as "skinny bundles" making it increasingly difficult for content providers to be included in
such offerings.
Cord cutting has accelerated largely as a result of the attractiveness of such online streaming services as Netflix and
Amazon's Prime. In mid-2017, Netflix subscribers exceeded 50 million, more than the 48.5 million subscribers to the major
cable-TV providers. Services like Alphabet's (Google) YouTube enable users to provide short videos online for free.
Together, these two firms will collect 20% of the fees paid for content by the cable-TV distributors. They will also have
a strong international presence as a result Discovery's international distribution network. With a limited global presence,
Scripps can now bring programming such as Home and Garden TV (HGTV), the Food Network, and the Travel Channel to
millions of viewers outside the U.S. Discovery can benefit from Scripps' success in creating short videos similar to
YouTube's content that it could utilize with its own Group Nine Media. The two firms expect that their short videos will be
streamed 7 billion times monthly. Finally, the combined firms expect to pare costs by $350 million annually be eliminating
redundant overhead.
END OF CHAPTER CASE STUDY: MICHAEL DELL COMPLETES THE BIGGEST DEAL IN TECH
HISTORY IN BUYING STORAGE MAKER EMC
Case Study Objectives: To Illustrate
• Challenges of strategically realigning a firm
• What it takes to achieve a “competitive edge”
17
The importance of getting out in front of rather than simply reacting to market changes
_______________________________________________________________________With the PC market maturing,
Michael Dell continued his effort to shift the firm more toward software and services. In doing so, he closed the biggest
deal in tech history in 2016 in acquiring data storage provider EMC in a deal valued at more than $63 billion. Dell
reasoned that the takeover would enable Dell Inc. to achieve a “competitive edge” over others battling it out in the software
and services marketplace. A competitive advantage involves a strategy allowing a firm to gain sales, increase profit
margins, or both over its primary competitors by better satisfying customer needs than its competitors. A competitive
The takeover of EMC represented another bold move by Michael Dell to reposition the firm bearing his name for the
21st century. What follows is a discussion of Dell’s efforts to transform the company from one concentrating on personal
computers to a firm offering customers an array of integrated solutions to problems whose resolution was critical to the
performance of their businesses, the methods used, and the challenges remaining to achieve this transformation.
Dell Computer was founded by Michael Dell in his college dormitory room in 1987. One year later, he took the
company public at 23 years of age. He was 29 when his firm hit 1 billion dollars in revenue and 31 when it achieved $5
billion. By 2001, the company became the global leader in PCs. Over the next 3 years, the firm sustained continued growth
by diversifying into servers, storage, printers, mobile phones, and MP3 players. In 2004, Dell stepped down from the day-
to-day operations as CEO, appointing Kevin Rollins to that position, but he retained his role as Chairman of the board.
The transformation to become a more ESS-driven business proved to be more challenging than first believed. Other tech
firms had a commanding lead in the software and services business including HP, IBM, Cisco, and Oracle. As a global IT
company with significant dependence on the PC market, the Company continued to be highly vulnerable to the fundamental
long-term changes in this market.
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premium over Dell’s share price 90 days prior to the merger announcement date, and which valued the Company at $24.9
billion.8 The deal included Michael Dell’s 16% ownership stake, valued at more than $3 billion, and another $750 million
of his cash along with $21.2 billion from Silver Lake Partners, a consortium of lenders, and excess cash on Dell Inc.’s
balance sheet. The transaction boosted Michael Dell’s ownership stake in the firm to 75%, with Silver Lake holding the
remaining equity.
In 2015, the new Dell Corporation has more than 160,000 channel distribution partners (i.e., parties selling Dell
products), with about $20 billion of the firm’s $65 billion in annual revenue coming from these partners. This compares to
zero in 2008. The firm has also doubled the number of sales specialists with technical training to 8,000 from 2009. The firm
is experiencing increasing success in encouraging existing customers to buy more expensive products and services. About
90% of its customers that buy PCs also buy other products and services.
With 110,000 employees worldwide, the firm’s current objectives are cash flow and growth: cash flow to pay off the
firm’s debt and growth to increase the firm’s value when it is again taken public. Incremental cash flow is expected to come
from increased sales and slashing costs, with a target of $2 billion in annual cost savings. As a private firm, it will have
fewer regulatory hurdles and disclosures than a public firm, allowing for a speedier execution of its business strategy of
growing its enterprise solutions business.
While taking the firm private appears to have improved the firm’s financial performance, Michael Dell believed that
more change was necessary to achieve his strategic vision. Dell saw EMC as an opportunity to accelerate movement toward
realizing this vision. Dell believed that acquiring EMC would enable the firm to combine its server businesses with EMC’s
storage and virtualization businesses to offer a broader range of products to challenge Cisco Systems, IBM and HP in the
areas of cloud computing, mobility and cyber security. In striking its deal for storage provider EMC, Dell and its financial
partner, private equity firm Silver Lake, are betting that this huge acquisition will help Dell, one of the best-known names
in the industry, move increasingly into the fastest growing areas of the information technology industry. Both Michael Dell
and his private equity partner Silver Lake had shown an ability to consolidate industries.
Understanding how the EMC transaction unfolded requires an appreciation of the personalities of the CEOs of the firms
involved. Billionaire Michael Dell had a passion for preserving and growing the business bearing his name, and the 68 year
old EMC CEO Joseph Tucci sought to protect his legacy. He had been considering retiring since 2009 but postponed it
several times amid his firm’s slumping stock performance, pressure from activist investors, and a changing environment for
computer storage. In agreeing to the deal, Mr. Tucci had an opportunity to establish a positive legacy and generate almost
$27 million more in compensation than he would have received had he willingly retired. His employment contract provided
for his receiving the additional compensation if he were ousted due to a change in control of the firm. He built EMC into
what it is. EMC had become his identity, and he didn’t want to see it dismembered.
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As a collection of largely unrelated businesses ranging from data storage to networking to content management, the value
of EMC’s shares suffered from a conglomerate discount.
But Mr. Tucci balked at the idea of spinning off VMware. Instead, he sought to be acquired by Hewlett-Packard,
although these talks reportedly ended in late 2014 after more than a year of discussions. The failure of these discussions
provided an opportunity for Michael Dell to contact Mr. Tucci.
Dell agreed to pay the equivalent of $33.15 per share for all of EMC’s outstanding shares. The offer consisted of $24.05
in cash and tracking stock valued at $9.10. The tracking stock mirrors the value of the roughly 20 percent of VMware’s
outstanding shares already trading on the New York Stock Exchange. In theory, the tracking stock should fluctuate with the
value of VMware’s publicly traded shares as investors have the option of holding either the tracking shares or the VMware
common shares traded publicly. The purchase price represents an approximate 27% premium over EMC’s trading price just
prior to the announcement of the deal.9
The new firm (including EMC) has more than $50 billion in debt on its consolidated balance sheet. Interest paid on the
debt amounts to $2.5 billion annually. That is $2.5 billion less to spend on R&D and other critical activities, thereby
potentially limiting new product development and improving customer service. In addition, integrating EMC and Dell,
which combined have more than $75 billion in revenue and nearly 200,000 employees, is a massive undertaking and an
enormous distraction for employees and their management team as two very different cultures come together and a new
business strategy is implemented. Moreover, bringing two business portfolios together will require a significant amount of
pruning overlapping and unprofitable products, which will be disruptive to their business and create confusion for their
customers. Customers simply will not know if the products they are buying today from either company will be supported in
a year or two. Finally, since many of these products are sold through distributors, this merger is going to cause chaos in the
distribution channels as they bring together two different distributor programs and marketing approaches.
4. What are the key trends external to Dell Inc. that you believe are driving Michael Dell’s effort to transform the firm?
Be specific.
Answer: Major trends external to Dell that forced Michael Dell to dramatically reposition the firm are the global
5. Speculate as to the strengths and weaknesses of the new firm (i.e., the combined Dell Inc. and EMC). Consider the
various stakeholder groups in your answer. Be specific.
Answer: The new firm has a broader service and product offering to appeal to customers seeking a “one stop shop” for
IT solutions. The shift to services whose prices have been more resistant to competitive pressures has helped to offset
falling PC prices. Services and software also offer considerably greater growth potential than other segments of the
6. Characterize Dell Inc.’s business strategy as a cost leadership, differentiation, focus, or some combination. Justify your
answer.
Answer: Dell may have to compete primarily on cost. A cost based strategy may be more readily achievable as a
private firm than for a public firm since decision making is a least theoretically more rapid. Also, financial reporting
7. In what sense was Dell’s takeover strategic and in what way was it opportunistic? Be specific.
Answer: Dell’s takeover was both strategic and opportunistic. It was strategic in that it further propelled the firm into
