Strategic benefits some acquisitions promise a

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STRATEGIC BENEFITS Some acquisitions promise a strategic advantage. This is an op- portunity to take advantage of the competitive environment if certain things occur or, more generally, to enhance management flexibility with regard to the company’s future opera- tions. In this latter regard, a strategic benefit is more like an option than a standard invest- ment opportunity. For example, suppose a sewing machine manufacturer can use its technology to enter other businesses. The small-motor technology from the original business can provide opportunities to begin manufacturing small appliances. Similarly, electronics expertise gained in producing appliances can be used to manufacture more sophisticated consumer products. S y n e r g y Firms A and B are competitors with very similar assets and business risks. Both are all-equity firms with aftertax cash flows of $10 per year forever, and both have an overall cost of capital of 10 percent. Firm A is thinking of buying Firm B. The aftertax cash flow from the merged firm would be $21 per year. Does the merger generate synergy? What is V B * ? What is V ? The merger does generate synergy because the cash flow from the merged firm is CF $1 greater than the sum of the individual cash flows ($21 versus $20). Assuming that the risks stay the same, the value of the merged firm is $21/.10 $210. Firms A and B are each worth $10/.10 $100, for a total of $200. The incremental gain from the merger, V , is thus $210 200 $10. The total value of Firm B to Firm A, V B * , is $100 (the value of B as a separate company) plus $10 (the incremental gain), or $110. E X A M P L E 2 1 . 1
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9 The word beachhead has been used in describing the process of entering a new indus- try to exploit perceived opportunities. The beachhead is used to spawn new opportunities based on “intangible” relationships. One example is Procter & Gamble’s initial acquisition of the Charmin Paper Company as a beachhead that allowed Procter & Gamble to develop a highly interrelated cluster of paper products—disposable diapers, paper towels, feminine hygiene products, and bathroom tissue. 3 MARKET POWER One firm may acquire another to increase its market share and market power. In such mergers, profits can be enhanced through higher prices and reduced compe- tition for customers. Of course, mergers that substantially reduce competition in the market may be challenged by the U.S. Department of Justice or the Federal Trade Commission on antitrust grounds. As a recent example, consider the problems faced by satellite radio companies XM and Sirius. The two companies, both losing large amounts of money, proposed a merger in February 2007, but they ran into strong resistance on antitrust grounds. On the one hand, because at the time they were the only two satellite radio companies in existence, a merger between the two would have resulted in a monopoly. On the other hand, the com- panies argued that they were facing intense competition from conventional terrestrial radio (which is free), particularly since the new HD (high-definition) format was becoming more prevalent. The companies also cited intensifying competition from digital music players,
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  • Spring '12
  • Scott
  • Firm, Firm B

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