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put itself at a major disadvantage in the U.S. cellular phone market. The merger did not close until October 26, 2004, due to
the need to get regulatory and shareholder approvals. This gave Verizon, the industry leader in terms of operating margins,
time to woo away customers from AT&T Wireless, which was already hemorrhaging a loss of subscribers because of poor
customer service. By paying $11 billion more than its initial bid, Cingular would have to execute the integration, expected
to take at least 18 months, flawlessly to make the merger pay for its shareholders.
Discussion Questions:
1. What is the total purchase price of the merger?
2. What are some of the reasons Cingular used cash rather than stock or some combination to acquire AT&T
Wireless? Explain your answer.
3. How might the amount and composition of the purchase price affect Cingular’s, SBC’s, and BellSouth’s cost of
capital?
Answer: The all-cash offer required the parents of Cingular, SBC and BellSouth, to each borrow $10 billion. All
three were subsequently put on the credit watch list of the major credit rating agencies. Since this is often a
4. With substantially higher operating margins than Cingular, what strategies would you expect Verizon Wireless to
pursue? Explain your answer.
Answer: Verizon Wireless is in a position to lure Cingular customers with potentially lower prices and better
Bank of America Acquires Merrill Lynch
Against the backdrop of the Lehman Brothers’ Chapter 11 bankruptcy filing, Bank of America (BofA) CEO Kenneth Lewis
announced on September 15, 2008, that the bank had reached agreement to acquire mega–retail broker and investment bank
Merrill Lynch. Hammered out in a few days, investors expressed concern that the BofA’s swift action on the all-stock $50
billion transaction would saddle the firm with billions of dollars in problem assets by pushing BofA’s share price down by
21 percent.
BofA saw the takeover of Merrill as an important step toward achieving its long-held vision of becoming the number 1
provider of financial services in its domestic market. The firm’s business strategy was to focus its efforts on the U.S. market
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by expanding its product offering and geographic coverage. The firm implemented its business strategy by acquiring
selected financial services companies to fill gaps in its product offering and geographic coverage. The existence of a clear
and measurable vision for the future enabled BofA to make acquisitions as the opportunity arose.
Since 2001, the firm completed a series of acquisitions valued at more than $150 billion. The firm acquired FleetBoston
Financial, greatly expanding its network of branches on the East Coast, and LaSalle Bank to improve its coverage in the
Midwest. The acquisitions of credit card–issuing powerhouse MBNA, U.S. Trust (a major private wealth manager), and
Countrywide (the nation’s largest residential mortgage loan company) were made to broaden the firm’s financial services
offering.
When Companies Overpay—Mattel Acquires The Learning Company
Mattel, Inc. is the world’s largest designer, manufacturer, and marketer of a broad variety of children’s products selling
directly to retailers and consumers. Most people recognize Mattel as the maker of the famous Barbie, the best-selling
fashion doll in the world, generating sales of $1.7 billion annually. The company also manufactures a variety of other well-
Business Plan
Mission Statement and Strategy
Mattel’s mission is to maintain its position in the toy market as the largest and most profitable family products
marketer and manufacturer in the world. Mattel will continue to create new products and innovate in their existing toy lines
to satisfy the constant changes of the family-products market. Its business strategy is to diversify Mattel beyond the market
for traditional toys at a time when the toy industry is changing rapidly. This will be achieved by pursuing the high-growth
Defining the Marketplace
The toy market is a major segment within the leisure time industry. Included in this segment are many diverse
companies, ranging from amusement parks to yacht manufacturers. Mattel is one of the largest manufacturers within the toy
segment of the leisure time industry. Other leading toy companies are Hasbro, Nintendo, and Lego. Annual toy industry
sales in recent years have exceeded $21 billion. Approximately one-half of all sales are made in the fourth quarter,
reflecting the Christmas holiday.
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Customers. Mattel’s major customers are the large retail and e-commerce stores that distribute their products. These
retailers and e-commerce stores in 1999 included Toys “R” Us Inc., Wal-Mart Stores Inc., Kmart Corp., Target,
Consolidated Stores Corp., E-toys, ToyTime.com, Toysmart.com, and Toystore.com. The retailers are Mattel’s direct
customers; however, the ultimate buyers are the parents, grandparents, and children who purchase the toys from these
retailers.
Opportunities and Threats
Opportunities
New Distribution Channels. Mattel.com represents 80 separate toy and software offerings. Mattel hopes to spin this
operation off as a separate company when it becomes profitable. Mattel.com lost about $70 million in 1999. The other new
channel for distributing toys is directly to consumers through catalogs. The so-called direct channels offered by the internet
and catalog sales help Mattel reduce its dependence on a few mass retailers.
Aging Population. Grandparents accounted for 14% of U.S. toy purchases in 1999. The number of grandparents is
expected to grow from 58 million in 1999 to 76 million in 2005.
Threats
Decreasing Demand for Traditional Toys. Children’s tastes are changing. Popular items are now more likely to include
athletic clothes and children’s software and video games rather than more traditional items such as dolls and stuffed
animals.
Distributor Returns. Distributors may return toys found to be unsafe or unpopular. A quality problem with the Cabbage
Patch Doll could cost Mattel more than $10 million in returns and in settling lawsuits.
Shrinking Target Market. Historically, the toy industry has considered their prime market to be children from birth to
age 14. Today, the top toy-purchasing years for a child range from birth to age 10.
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Internal Assessment
Strengths
Mattel’s key strengths lie in its relatively low manufacturing cost position, with 85% of its toys manufactured in low-
labor-cost countries like China and Indonesia, and its established distribution channels. Moreover, licensing agreements
with Disney enable Mattel to add popular new characters to its product lines.
Weaknesses
Acquisition Plan
Objectives and Strategy
Mattel’s corporate strategy is to diversify Mattel beyond the mature traditional toys segment into high-growth segments.
Mattel believed that it had to acquire a recognized brand identity in the children’s software and entertainment segment of
the toy industry, sometimes called the “edutainment” segment, to participate in the rapid shift to interactive, software-based
Defining the Target Industry
The “edutainment” segment has been experiencing strong growth predominantly in the entertainment segment. Parents
are seeing the importance of technology in the workplace and want to familiarize their children with the technology as early
Management Preferences
Mattel was looking for an independent children’s software company with a strong brand identity and more than $400
million in annual sales. Mattel preferred not to acquire a business that was part of another competitor (e.g., Hasbro
Interactive). Mattel’s management stated that the target must have brands that complement Mattel’s business strategy and
Potential Targets
Game and edutainment development divisions are often part of software conglomerates, such as Cendant, Electronic
Arts, and GT Interactive, which produce software for diverse markets including games, systems platforms, business
management, home improvement, and pure educational applications. Other firms may be subsidiaries of large book, CD-
with a 44% market share. The company has been following an aggressive expansion strategy, having completed 14
acquisitions since 1994. At 68%, TLC also had the highest gross profit margin of the target companies reviewed. TLC
Completing the Acquisition
Despite disturbing discoveries during due diligence, Mattel acquired TLC in a stock-for-stock transaction valued at $3.8
billion on May 13, 1999. Mattel had determined that TLC’s receivables were overstated because product returns from
Epilogue
For all of 1999, TLC represented a pretax loss of $206 million. After restructuring charges, Mattel’s consolidated 1999
net loss was $82.4 million on sales of $5.5 billion. TLC’s top executives left Mattel and sold their Mattel shares in August,
just before the third quarter’s financial performance was released. Mattel’s stock fell by more than 35% during 1999 to end
the year at about $14 per share. On February 3, 2000, Mattel announced that its chief executive officer (CEO), Jill Barrad,
was leaving the company.
Discussion Questions:
1. Why was Mattel interested in diversification?
Answer: With more than one-third of its revenue coming from a mature product like Barbie, Mattel was
2. What alternatives to acquisition could Mattel have considered? Discuss the pros and cons of each
alternative?
Answer: Mattel could have considered building the capability internally by leveraging its small, but growing
software division. Alternatively, Mattel could have considered creating a joint venture corporation with a leading
“edutainment” software company. Both parties would contribute certain assets. Mattel could contribute certain of
3. How might the internet affect the toy industry? What potential conflicts with customers might be
created?
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4. What are the primary barriers to entering the toy industry?
Answer: Barriers to entry include the well-established distribution channels of the major manufacturers, based on
long-standing relationships with retailers such as Wal-Mart and Toys “R” Us. Companies like Mattel and Hasbro
entertainment companies.
5, What could Mattel have done to protect itself against risks uncovered during due diligence?
Answer: Mattel could have protected itself by shifting some of the risk to The Learning Company (TLC). This
First Union Buys Wachovia Bank: A Merger of Equals?
First Union announced on April 17, 2001, that an agreement had been reached to acquire Wachovia Corporation for about
$13 billion in stock, thus uniting two fiercely independent rivals. With total assets of about $324 billion, the combination
created the fourth largest bank in the United States behind Citigroup, Bank of America, and J.P. Morgan Chase. The merger
also represents the joining of two banks with vastly different corporate cultures. Because both banks have substantial
overlapping operations and branches in many southeastern U.S. cities, the combined banks are expected to be able to add to
earnings in the first 2 years following closing. Wachovia, which is much smaller than First Union, agreed to the merger for
only a small 6% premium.
The deal structure also involved an unusual fee if First Union and Wachovia parted ways. Each bank is entitled to 6% of
the $13 billion merger value, or about $780 million in cash and stock. The 6% is about twice the standard breakup fee. The
cross-option and 6% fee were intended to discourage other last-minute suitors from making a bid for Wachovia.
According to a First Union filing with the Securities and Exchange Commission, Wachovia rebuffed an overture from
an unidentified bank just 24 hours before accepting First Union’s offer. Analysts identified the bank as SunTrust Bank.
SunTrust had been long considered a likely buyer of Wachovia after having pursued Wachovia unsuccessfully in late 2000.
Wachovia’s board dismissed the offer as not being in the best interests of the Wachovia’s shareholders.
Union’s stock to fall from $60 to less than $30 in 1999. First Union had paid $19.8 billion for CoreStates Financial in 1998
and then had trouble integrating the acquisition. Customers left in droves. Ill, Mr. Crutchfield resigned in 2000 and was
replaced by G. Kennedy Thompson. He immediately took action to close the Money Store operation and exited the credit
Back in 1995 buyers of banks paid 1.94 times book value and 13.1 times after-tax earnings. By 1997, these multiples
rose to 3.4 times book value and 22.2 times after-tax earnings. However, by 2000, buyers paid far less, averaging 2.3 times
book value and 16.3 times earnings. First Union paid 2.47 times book value and 15.7 times after-tax earnings. The
declining bank premiums reflect the declining demand for banks. Most of the big acquirers of the 1990s (e.g., Wells Fargo,
Bank of America, and Bank One) now feel that they have reached an appropriate size.
Discussion Questions:
1. In your judgment, was this merger a true merger of equals? Why might this framework have been used in this
instance? Do you think it was a fair deal for Wachovia stockholders? Explain your answer.
Answer: In a true merger of equals, the synergy created by combining the firms is about equally attributable to
each firm and the size and market capitalization of the two firms involved are usually comparable. Consequently,
the resulting combination of the firms is such that the target firm’s shareholders do not receive a significant
premium for their stock. Moreover, governance in terms of board representation is usually equally shared between
the boards of the acquiring and target firms. Often, a Co-CEO arrangement is established for the new firm
consisting of the CEOs of the acquiring and target firms.
2. Do you believe the cross option and unusual fee structure in this transaction were in the best interests of the
Wachovia shareholders? Explain your answer.
3. How did big banks during the 1990s justify paying lofty premiums for smaller, regional banks? Why do you think
their subsequent financial performance was hurt by these acquisitions?
Answer: Big banks typically justified the payment of huge premiums by touting the anticipated huge cost savings
that could be realized by eliminating overlapping operations. While this is true in theory, there is little evidence
4. What integration challenges do you believe these two banks will encounter as they attempt to consolidate
operations?
Answer: Both banks had different cultures. Consequently, getting cooperation between management teams is
likely to prove daunting. Moreover, the power sharing arrangement at the CEO level is likely to slow the decision-
making process and to contribute to disarray at middle and lower management levels. These factors will retard the
5. Speculate on why Wachovia’s management rebuffed the offer from SunTrust Banks with the ambiguous statement
that it was not in the best interests of Wachovia’s shareholders?
McKesson HBOC Restates Revenue
McKesson Corporation, the nation’s largest drug wholesaler, acquired medical software provider HBO & Co. in a $14.1
billion stock deal in early 1999. The transaction was touted as having created the country’s largest comprehensive health
care services company. McKesson had annual sales of $18.1 billion in fiscal year 1998, and HBO & Co. had fiscal 1998
revenue of $1.2 billion. HBO & Co. makes information systems that include clinical, financial, billing, physician practice,
and medical records software. Charles W. McCall, the chair, president, and chief executive of HBO & Co., was named the
new chair of McKesson HBOC.
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Discussion Questions:
1. Why do you think McKesson may have been in such a hurry to acquire HBO without completing an appropriate
due diligence?
2. Assume an audit had been conducted and 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%
accurate?
3. McKesson, a drug wholesaler, acquired HBO, a software firm. How do you think the fact that the two firms were
in different businesses may have contributed to what happened?
4. Describe the measurable and non-measurable damages to McKesson’s shareholders resulting from HBO’s
fraudulent accounting activities.
The Cash Impact of Product Warranties
Reliable Appliances, a leading manufacturer of washing machines and dryers, acquired a marginal competitor, Quality-
Built, which had been losing money during the last several years. To help minimize losses, Quality-Built reduced its
quality-control expenditures and began to purchase cheaper parts. Quality-Built knew that this would hurt business in the
long run, but it was more focused on improving its current financial performance to increase the firm’s prospects for
eventual sale. Reliable Appliances saw an acquisition of the competitor as a way of obtaining market share quickly at a time
Discussion Questions:
1. Should Reliable Appliances have been able to anticipate this problem from its due diligence of Quality-Built?
Explain how this might have been accomplished.
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2. How could Reliable have protected itself from the outstanding warranty claims in the definitive agreement of
purchase and sale?
The Downside of Earnouts
In the mid-1980s, a well-known aerospace conglomerate acquired a high-growth systems integration company by paying a
huge multiple of earnings. The purchase price ultimately could become much larger if certain earnout objectives, including
both sales and earnings targets, were achieved during the 4 years following closing. However, the buyer’s business plan
assumed close cooperation between the two firms, despite holding the system integrator as a wholly owned but largely
autonomous subsidiary. The dramatic difference in the cultures of the two firms was a major impediment to building trust
Discussion Questions:
1. Describe conditions under which an earnout might be most appropriate.
Answer: Earnouts are applicable when the parties are far apart on price, the seller’s shareholders are few in
2. In your opinion, are earnouts more appropriate for firms in certain types of industries than for others? If so, give
examples. Explain your answer.
Case Study: Sleepless in Philadelphia
Closings can take on a somewhat surreal atmosphere. In one transaction valued at $20 million, the buyer intended to
finance the transaction with $10 million in secured bank loans, a $5 million loan from the seller, and $5 million in equity.
However, the equity was to be provided by wealthy individual investors (i.e., “angel” investors) in amounts of $100,000
each. The closing took place in Philadelphia around a long conference room table in the law offices of the firm hired by the
buyer, with lawyers and business people representing the buyer, the seller, and several banks reviewing the final
documents. Throughout the day and late into the evening, wealthy investors (some in chauffeur-driven limousines) and
Discussion Question:
1. What do you think are the major challenges faced by the buyer in financing small transactions transaction in this
manner?
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Answer: Frequently, small transactions are more difficult to finance because the relative lack of sophistication of
Case Study: Mattel Overpays for the Learning Company
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 because product returns from distributors were not deducted from receivables and its
allowance for bad debt was inadequate. A $50 million licensing deal also had been prematurely put on the balance sheet.
For all of 1999, TLC represented a pretax loss of $206 million. After restructuring charges, Mattel’s consolidated 1999
net loss was $82.4 million on sales of $5.5 billion. TLC’s top executives left Mattel and sold their Mattel shares in August,
just before the third quarter’s financial performance was released. Mattel’s stock fell by more than 35% during 1999 to end
the year at about $14 per share. On February 3, 2000, Mattel announced that its chief executive officer (CEO), Jill Barrad,
was leaving the company.
On September 30, 2000, Mattel virtually gave away The Learning Company to rid itself of what had become a
seemingly intractable problem. This ended what had become 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
Discussion Questions:
1. Despite being aware of extensive problems, Mattel proceeded to acquire The Learning Company. Why? What
could Mattel to better protect its interests? Be specific.
2. Why was Gore Technology Group able to do what Mattel could not do in a year.?
Answer: Gore specialized in turnarounds and restructuring and had skills not readily available inside Mattel.
Moreover, as a smaller, more specialized firm without public shareholders, Gore was able to make decisions
more rapidly.
The Anatomy of a Transaction: K2 Incorporated Acquires Fotoball USA
Our story begins in the early 2000s. K2 is a sporting goods equipment manufacturer whose portfolio of brands includes
Rawlings, Worth, Shakespeare, Pflueger, Stearns, K2, Ride, Olin, Morrow, Tubbs and Atlas. The company’s diversified
mix of products is used primarily in team and individual sports activities, and its primary customers are sporting goods
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Management expected that large retailers would prefer to rely on fewer and larger sporting goods suppliers to help them
manage the supply of products and the allocation of shelf space.
The firm’s primary customers are sporting goods retailers. Many of K2’s smaller retailers and some larger retailers were
not strongly capitalized. Adverse conditions in the sporting goods retail industry could adversely impact the ability of
retailers to purchase K2 products. Secondary customers included individuals, both hobbyists as well as professionals.
The firm had a few top competitors, but there were other large sporting goods suppliers with substantial brand
recognition and financial resources with whom K2 did not compete. However, they could easily enter K2’s currently served
markets. In the company’s secondary business, sports apparel, it did face stiff competition from some of these same
suppliers, including Nike and Reebok.
All this required an implementation strategy. K2 decided to avoid product or market extension through partnering
because of the potential for loss of control and for creating competitors once such agreements lapse. Rather, the strategy
would build on the firm’s great success, in recent years, acquiring and integrating smaller sporting goods companies with
well-established brands and complementary distribution channels. To that end, M&A-related functional strategies were
developed. A potential target for acquisition would be a company that holds many licenses with professional sports teams.
Through its relationship with those teams, K2 could further promote its line of sporting gear and equipment.
In its acquisition plan, K2’s overarching financial objective was to earn at least its cost of capital. The plan’s primary
non-financial objective was to acquire a firm with well-established brands and complementary distribution channels. More
specifically, K2 sought an acquisition with a successful franchise in the marketing and manufacturing of souvenir and
promotional products that could be easily integrated into K2’s current operations.
The acquisition plan included an evaluation of resources and capabilities. K2 established that after completion of a
merger, the target’s sourcing and manufacturing capabilities must be integrated with those of K2, which would also retain
Ultimately, management set some specific preferences: the target should be smaller than $100 million in market
capitalization and should have positive cash flows, and it should be focused on the sports or outdoor activities market. The
initial search, by K2’s experienced acquisition team, would involve analyzing current competitors. The acquisition would
be made through a stock purchase – and K2 chose to consider only friendly takeovers involving 100 percent of the target’s
stock – and the form of payment would be new K2 non-voting common stock. The target firm’s current year P/E should not
exceed 20.
Negotiations ensued, and the stock-for-stock offer contained a significant premium, which was well received. Fotoball is
a very young company and many of its investors were looking to make their profits through the growth of the stock. The
offer would allow Fotoball shareholders to defer taxes until they decided to sell their stocks and be taxed at the capital gains
rate. An earn-out was also included in the deal to give management incentives to run the company effectively and meet
deadlines in a timely order.
Valuations for both K2 and Fotoball reflected anticipated synergies due to economies of scale and scope, namely,
reductions in selling expenses of approximately $1 million per year, in distribution expenses of approximately $500,000 per
year, and in annual G&A expenses of approximately $470,000. The combined market value of the two firms was estimated
at $909 million – an increase of $82.7 million over the sum of the standalone values of the two firms.
Organizationally, the integration of Fotoball into K2 would be achieved by operating Fotoball as a wholly owned
subsidiary of K2, with current Fotoball management remaining in place. All key employees would receive retention
bonuses as a condition of closing. Integration teams consisting of employees from both firms were set to move
expeditiously according to a schedule established prior to closing the deal. The objective would be to implement the best
practices of both firms.
Discussion Questions:
1. How did K2’s acquisition plan objective support the realization of its corporate mission and strategic objectives?
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2. What alternatives to M&As could K2 have employed to pursue its growth strategy? Why were the
alternatives rejected?
Answer: K2 could have achieved some improvement in revenue by entering into a series of strategic cross–
3. What was the role of “strategic controls” in implementing the K2 business plan?
Answer: K2 employed a series of incentive plans and performance monitoring systems to increase the likelihood
that their business strategy would be implemented successfully. The incentive plans were designed to motivate
4. How did the K2 negotiating strategy seek to meet the primary needs of the Fotoball shareholders
and employees?
Answer: K2 employed a share for share exchange such that the transaction would qualify as a tax-free transaction
that would enable the Fotoball shareholders to defer the payment of taxes until they sold their K2 stock. Moreover,