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Company Gains

Special Report - Joining Forces

If airlines get the opportunity to merge across borders, evidence from other industries suggests they almost certainly will. With the merger and acquisition (M&A) deals worldwide estimated in the trillions of dollars, it seems most companies see something of value in the model.

Following the opening up of the UK gas market, the number of companies increased from an original monopoly supplier to 21, before consolidating again to nine (six of which account for 99% of the market).

 EU banking reveals another pattern in merger activity. Initially, acquisitions occurred within national boundaries but the buyout strategy of Spanish bank Santander highlights increasing cross ‑border consolidation.

The crucial question is whether such patterns have resulted in positive results for the merged entities.

Pharmaceuticals

During the 10 years ending 31 December 2009, the pharmaceutical industry saw no less than 1,345 mergers and acquisitions with a combined value of $694 billion, according to DealSearchOnline.com.

The largest single deal was the $74 billion combination of Glaxo Wellcome and SmithKline Beecham into GlaxoSmithKline. This is now widely regarded as a successful entity, with a well resourced research and development (R&D) arm able to bring innovative products to market.

The targets for takeovers are generally publicly traded, revenue-producing companies with viable products. It is common for big corporations to be involved in an ever-increasing amount of acquisition activity, suggesting the big get bigger. Indeed, KPMG International estimates the average size of the deals in the pharma industry at $164 million prior to 2005, increasing to $430 million for the 2005–2009 period.

The second-largest deal in the past 10 years was Pfizer’s $68 billion purchase of Wyeth. Although Pfizer is the world’s largest pharma company, it reportedly struggled to come up with the money and industry insiders suggest that the costs incurred are now a heavy burden to bear. There are synergies, and announcements predicted a staff reduction of about 20,000 and a number of manufacturing plant and R&D facility closures.

Another round of mega-mergers in the pharmaceutical sector is expected in the year ahead.

Automotive industry

Governments appear to have few qualms about the automotive industry being foreign owned. One example is the UK being left without an independent mass production manufacturer in the mid ‑1990s when Rover ultimately transferred to German-owned BMW.

Conventional wisdom in the sector suggests that fierce competition among global companies and their positioning in certain markets has led to a well-defined market structure. Premier carmakers include General Motors (GM), Ford, Toyota, and Volkswagen.

Not all mergers in the industry have been successful. The Chrysler-Daimler deal is often cited in this respect. Daimler  paid $36 billion for Chrysler but sold more than 80% of the business to Cerberus Capital for just $7.4 billion less than 10 years later. A culture clash, wage disparity, and differing business models added to the poor performance.

It is suggested that a stronger trend in more recent times has been the break-up of multi-brand groups, for example Ford’s loss of Aston-Martin, Jaguar, and Land Rover. Others predict, however, that smaller companies will lack the scale to be serious competitors and the way forward may be via alliances that stop short of a full merger. This has the benefit of protecting shareholders from potential disaster.

Some deals may simply be too big to contemplate. GM lost more than $18  billion in the first half of 2008 and was widely tipped to merge with Chrysler. But it seems no company had the financial capability for the deal, and the United States government was forced into bailouts for its Big Three.

Meanwhile, the jury is still out on the Fiat-Chrysler tie-up. Fiat supplies a platform for small, efficient car production, while Chrysler brings the huge US market. Possible advantages include a relatively neat dovetailing of strengths, although cynics suggest that two mediocre brands don’t make one great one.

Interestingly from an airline point of view, India and China are the upcoming powerhouses. The Chinese government is looking to consolidate its automotive manufacturers to strengthen the industry, while Tata Motors of India now counts Daewoo, Jaguar, and Land Rover among its brands. Aside from India, it has production and assembly operations in several other countries, including South Korea, Thailand, South Africa, and Argentina. Reports say it is planning to set up plants in Turkey, Indonesia and Eastern Europe.

Telecoms

Merger activity in telecoms fell to only $80 billion in 2009 from a high of $285 billion in 2005, according to Mergermarket. 2010 is expected to be a bumper year, however, with the market growing about 50%. The world’s richest man, Carlos Slim, will play a part, with $24 billion going on consolidating his Latin American holdings. Other deals include Bharti Airtel of India offering more than $10 billion for the African businesses of Kuwaiti firm Zain.

The more mature European market is relatively static although Telecom Italia Spa is reported to be in talks with Spain’s Telfónica, even though the Italian government is reputedly none too keen on the deal. The joint venture between the mobile phone subsidiaries of France Telecom and Deutsche Telekom in the UK will give the new venture a leading market share, overcoming current top dog O2.

Meanwhile, Vodafone has shied away from deals with investors wary of waning profitability. A decade ago, a merger frenzy resulted from a newly freed industry and a belief that size alone would be an advantage. Now, according to Clare McCarthy at consultancy Ovum, deals need to be clearly quantifiable. And the emphasis is on true integration rather than a collection of independent entities.

Some 42% of M&A volume in the past three years has been between national rivals, says Credit Suisse. And there has been increasing consolidation in emerging markets, where customer growth remains strong. One example is the purchase of the Senegalese company Sonatel by France Télécom in April 2009. Private equity transactions—effectively buying on credit—have dwindled due to the financial crisis, and companies are now looking to alternative financial measures.

Lessons learned

Supporters of consolidation have drawn several positives from merger activity in other industries. Best practice is more easily transferred, leading to productivity increases and, because companies tend to compete over a longer term, innovation in product and service becomes commonplace. Market response improves as a result, and with it the viability of the company. The whole package is wrapped in economies of scale and scope, which means investment becomes easier to attract.

 Mergers are often better than organic growth. They bring with them local market knowledge, brand loyalty, and more effective distribution channels. Importantly, a merger boosts market capital—great news for shareholders.

There are challenges, though. Downward pressure on prices through even fiercer competition with global rivals is entirely possible, although it should be offset by lower costs, greater efficiency, and potential economies of scale.

Diversification—which has been termed diworseification by its opponents—is a natural consequence of consolidation and can also be a problem, with many claiming that it leads to a loss of strategic focus.
Then there are the cultural aspects of the merger to be considered. This matter has damaged many a combination that made sense on the balance sheet; AOL Time Warner received its fair share of criticism in this regard. The deal soured further as broadband connectivity hit the market soon after, losing AOL its market advantage.

 

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