M&A and Private Equity
Question – Amazon buys Whole Foods
Amazon stirred the pot with the acquisition of Whole Foods, a U.S. retailer, on June 16th, 2017. Many analysts interpret this move as gaining a stronger presence in the food delivery service.
Before the acquisition, Amazon was already active in the grocery market through its Amazon Fresh service, but its infrastructure was very limited, operating in only about 20 locations across the United States. While Whole Foods controls only 1.4% of the market, it operates about 350 stores. Amazon, on the other hand, has built up its Prime service and is capable of deliveries in 2 hours.
This means that while Whole Foods commands only a tiny share of the grocery market, investors saw the potential this deal holds and reacted by divesting shares of its competitors, such as Walmart and Kroger, whose shares sank.
Write a critical essay (700-1000 words), answering the following questions:
1) Identify and critically analyse what possible synergies the acquisition can bring.
2) Whole Foods is an upscale grocery shop. Identify how it fits into Amazon’s strategy.
The Harvard style of referencing is required.
(Please read Misamore, B. (2017) ‘CREATING VALUE: AMAZON’S ACQUISITION OF WHOLE FOODS’, Business Insights, June 26 (online) Available at: https://online.hbs.edu/blog/post/creating-value-amazons-acquisition-of-whole-foods (Links to an external site.) and Petro. G. (2017) ‘Amazon’s Acquisition Of Whole Foods Is About Two Things: Data And Product’, Forbes, August 2 (online) Available at: https://www.forbes.com/sites/gregpetro/2017/08/02/amazons-acquisition-of-whole-foods-is-about-two-things-data-and-product (Links to an external site.))
SOME DETAILS FROM THE COURSE THAT MIGHT BE HELPFUL WHEN COMPLETING THE ORDER.
In this unit, we are going to discuss what drives mergers and acquisitions and we are also going to touch on what makes them successful.
Mergers and acquisitions happen because the combination of two businesses often results in a company (or conglomerate, or holding) which is more than just the sum of the two. If a merger is considered successful, it is usually immediately apparent. If the market capitalisation (the value of all shares on the market) of the companies announcing the merger increases, the market considers the merger a good idea. On the other hand, there was, is and will be many ill-conceived mergers and acquisitions resulting in companies worth less than the sum of their original parts. Let’s take a closer look into the reasons why and how mergers and acquisitions can create value.
The best known reason for M&A is operational synergy. Bigger companies can produce products in larger quantities and more cheaply, which is an operational synergy known as economies of scale. If two companies join forces, they can also cut down on overheads, eliminating duplicate functions in what is known as economies of scope.
A lesser known type of synergy is financial synergy. Bigger companies are often more stable, and their access to capital reflects that. That’s why large companies can often borrow cheaply or issue new equity on more favourable terms.
Another reason for M&A is diversification. Markets change and are exposed to fluctuation in the business cycle. Producing goods in different industries decreases the risk of the whole company being exposed to a sudden change in consumer preferences.
Acquisitions can also be powered by unique capital in the ownership of one of the companies. Unique capital can be production facilities in an area where the company wants to expand, or a specific technology. Often, acquired capital can be social. Technology companies in particular don’t have much physical capital, and all of their value lays in their employees, unique company culture, and ability to produce new innovations.
Market power is yet another reason for M&A. The bigger a company is, the more it can set its own prices (and increase profits), especially if the market in question produces unique products with strong brands. However, there is a fine balance between when company size increase brings new efficiencies, and when it causes damage by decreasing competition. That’s why all market economies have established some form of market oversight to regulate monopolistic behaviour through anti-trust legislation (or competition law, in British and European terminology).
Yet another reason for M&A might be tax consideration, especially in an international context. Tax reasons often also result in companies establishing separate entities to serve various markets, shielding parts of the business from taxation. This trend can be considered opposite to mergers and acquisitions. The opportunity to pay lower taxes stems from differences among taxation systems, most notably residential, used in the U.S. (and Eritrea), and territorial, used everywhere else. At the end of 2017, however, the U.S. was about to change its taxation system to territorial.
And the last reason for M&A which we are going to elaborate on is managerial pride, sometimes referred to as hubris. M&A are often pushed through by overly active managers who over-value the benefits that the combination might bring, simply in order to increase their own prestige.
While there is a lot of legislation regulating corporations, from reporting requirements to accounting standards and the conduct of business, the laws with the most impact on mergers and acquisitions are the ones dealing with excessive market power and tax avoidance (or tax optimisation, as it has become known in corporate new-speak). Market power needs to be regulated because in excess, it damages competition and, though increasing prices, damages both the market and consumers. That’s why most governments have established laws to prevent excessive market power. In the U.S. they are called antitrust laws, while in Britain and Continental Europe they are referred to as competition law.
The success of any merger or acquisition, of course, lies with proper evaluation of its benefits and the proper integration of the two businesses. The action is prone to error, and many mergers that look good on paper fail to deliver on their promise.
Mergers and acquisitions come in waves. In this unit, we are also going to discuss why this happens and we are going to examine, in depth, individual waves which have happened in the past.
Mergers and acquisitions are a fast way to transform any particular industry. Companies can, of course, grow internally, but if an industry has to change rapidly, buying companies or merging with them is simply a much faster way to accomplish the same result.
Waves of mergers and acquisitions come at times when industries need to transform. This might happen when there are significant underlying changes in the economy. A hundred years ago, the market was fractioned because transport was slow and expensive (at least in comparison to the costs and profits at the time). The telephone already existed, but it was also expensive, both to install and to use, and international communication was almost impossible. It is not surprising that the majority of industries were serviced by a large number of small companies. As roads and motorways were gradually built, long distance hauling became cheaper. With telephone adoption throughout the economy, calling became cheaper and more frequently used. With these changes, separate markets integrated and allowed for companies to merge and reap the benefits of economies of scale.
That is just one example where technological and economic transformation ushered in a wave of mergers and industry integration.
Another trigger for a wave of mergers and acquisitions can be a change in the regulatory environment. An example of this could be abolishing the law in the U.S. which prevented banks from operating in multiple states. A wave of mergers and acquisitions in the banking industry followed this liberalisation. But regulation can work both ways. Recent regulations requiring systemically important banks to have higher capital buffers have caused divestment in the segment of large banks, which is, by definition, the opposite process to a wave of mergers.
Merger waves also have to coincide with an expansion phase of the economy. The reason why mergers and acquisitions occur in waves closely relates to how deals are financed. A company considering the purchase of another firm has to have the capability to issue new stock, sell debt, or have enough profits to re-invest – or, more often, all of these options combined. In the case of issuing new stock, the company prints out a large quantity of new shares, sells them to new investors, and uses the received cash to purchase the target company from its original owners. For acquisitions to be possible, a company needs to be in the position to sell new stocks and borrow money. This means that investors have to believe in its sustainability and profitability. Only then will they be willing to buy its shares or bonds. And that is much more likely to happen when times are good. That is why many more acquisitions happen when the economy is expanding than during recessions.
But this cyclical nature of M&A comes with caveats. While there are plenty of companies for sale and not enough buyers during recessions, during economic expansion the situation is reversed – companies are able to invest, while there are not enough opportunities. This drives up the price of target companies and makes the deals less beneficial. The deals closed at the highest point of the business cycle are often very profitable for the target company owners, but less so for the purchasing company.
The wave of mergers is usually triggered by a combination of the above-mentioned factors. But, it is usually not a coincidence that these happen at the same time. Major expansion in the economy tends to coincide with or be caused by improvement in technology, which is the main reason why productivity grows. And because the business cycle is uneven, we go through periods where the economy consolidates and nothing much is happening. These periods are usually followed by periods of rapid transformation.
In this unit’s videos, we will talk about individual waves of mergers and acquisitions, how they changed the markets and the economy, what their triggers were, and how regulation changed over time to keep up with the developments.
This unit covers material applicable to learning outcomes 1 and 2:
Identify and critically analyse the relative importance of different types of drivers of M&A and Private Equity.
Identify value creation and critically assess the success or otherwise of a range of M&A transactions and Private Equity.
Here are some keywords to use when you are conducting further research on this unit:
Operational synergy, economies of scale, economies of scope, financial synergy, diversification, unique capital, market power, anti-trust legislation, competition law, tax consideration, managerial pride, hubris, merger waves, equity financing, debt financing, monopoly, oligopoly, vertical integration, horizontal integration, acquisition premium
Unit 1 Reading List
Sudarsanam, P. S. (2003) Creating value from mergers and acquisitions: the challenges: an integrated and international perspective. Harlow, Essex: FT Prentice Hall, Chapters 1,2 and 3.
Rosenbaum, J. and Pearl, J. (1981- 2013) Investment banking: valuation, leveraged buyouts, and mergers & acquisitions. Second edition. Hoboken, New Jersey: Wiley, Chapter 7.
Dutordoir, M., Roosenboom, P., and Vasconcellos, M. (2010). ‘Synergies disclosure in mergers and acquisitions’. Erasmus University Working Paper, Social Science Research Network, 17 May [online]. Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.375.6569&rep=rep1&type=pdf (Links to an external site.)
Ahern, K. and Harford, J. (2010) ‘The Importance of Industry Links in Merger Waves’, Ross School of Business, AFA 2011; Denver Meetings Paper. Available at: http://cear.gsu.edu/files/2013/03/Seminar_2010_0205_The_Importance_Of_Industry_Links_In_Merger_Waves.pdf (Links to an external site.)
Duchin, R. and Schmidt, B. (2013) ‘Riding the merger wave: Uncertainty, reduced monitoring, and bad acquisitions’, Journal of Financial Economics, 107, 69–88. Available at: http://schwert.ssb.rochester.edu/f423/JFE13_DS.pdf (Links to an external site.)
Misamore, B. (2017) ‘CREATING VALUE: AMAZON’S ACQUISITION OF WHOLE FOODS’, Business Insights, June 26 (online) Available at: https://online.hbs.edu/blog/post/creating-value-amazons-acquisition-of-whole-foods (Links to an external site.) (Accessed January 21 2020)
Petro. G. (2017) ‘Amazon’s Acquisition Of Whole Foods Is About Two Things: Data And Product’, Forbes, August 2 (online) Available at: https://www.forbes.com/sites/gregpetro/2017/08/02/amazons-acquisition-of-whole-foods-is-about-two-things-data-and-product (Links to an external site.) (Accessed January 21 2020)
