Costs, Benefits, Taxes and Culture

Mergers are once again filling the headlines of our financial papers and as one who writes a merger blog, there are plenty of things we could discuss.  The Omnicom Publicis merger appears in danger, reportedly due to the resulting tax structure of the deal (although one can suspect other issues as well).  

Taxes also figure in the the $46 billion dollar offer of Valeant for Allergan.  According to an article in the Wall Street Journal, Valeant changed its domicile to Canada after its 2010 merger with Biovail.  As a result, it's tax rate is below 5%, offering a huge competitive advantage over companies in the United States.  Allergan is headquartered in California, so one strategy would be to move the business to Canada.  

But the Valeant Allergan deal is also newsworthy because of the differing cultures of the two companies.  Allergan is more focused on research and development, while Valeant is focused on sales.  Indeed, the planned strategy of Valeant is to reap savings by slashing the R & D spending of Allergan.  Certainly there can be value in R & D and that brings us to the nexus of the items we've talked about.

Consider three aspects of the Valeant, Allergan deal: taxes, culture and strategy.  There are three major claimants on EBITA - bondholders, debt holders and the government.  Reducing taxes increases funds available to the other claimants and can result in significant gains for equity.  

Merging companies with clashing cultures, however, is fraught with problems and can dramatically increase integration costs.  In this case, however, it is clear that Valeant is well aware of the culture/strategy issues and not afraid to confront them.  

So lets consider the pieces: taxes, culture, costs, benefits and strategy.  The value of a company and the value of any deal always come down to the basics - cash flows and risks.  We estimate value by discounting expected cash flows at a rate commensurate with the risks.

And cash flows can be increased in two major ways - growing the revenue or reducing the costs.  Both can be viable strategies and the success of any deal will hinge on the correct estimation of the costs and benefits and implementation of the specific tactics to bring them to fruition.  Both companies have been successful following different paths.  The question here is whether it makes sense for the paths to converge.

The market is predicting a higher, successful bid as the Allergan's stock price on Monday closed well above the $153. value offered by Valeant.  Valeant's stock price rose dramatically as well.  It will be interesting to follow this deal.  

All the best,

Ralph

Deals of the Year for 2013

Deal activity was much higher this year than last, but not at the pace we expected.  See Joe's recent post 'Something is happening here, what it is ain't exactly clear.'  Still, the years is over and we can look back at the highlights.

Investor Place gives a nice tally of the ten biggest deals of the year.  There's an interesting set of stories here, from bankruptcy and regulatory issues (US Air/American Airlines),  private equity (Silverlake and Dell)  Warren Buffett (H. J. Heinz), industry consolidations (Publicis Groupe/Omnicom Group and Applied Materials/Tokyo Electron) and size - the third largest transaction of all time (Verizon and Vodaphone).  See the complete list and more detail here.

All the best,

Ralph

Merger of Equals: A Really Bad Idea?

Last month advertising firms Publicis Groupe (PUG) of France and U.S. based Omnicon (OMC) announced a $35B MOE Merger creating the world’s largest advertising firm .The initial market response was positive with Publicis up 6% while Omnicon increased 7.7%. Synergies of $500MM are expected.

The new firm, Publicis Omnicon Group (POG), will be based in both NYC and Paris. POG will have 14 board members - 7 each from PUG and OMC. POG’s CEO and OMC’s CEO will serve as CO-CEOs of the new combined firm for 30 months. Then OMC CEO will then become CEO as PUG’s Levy is set to step down and become Chairman.

MOE share the following characteristics:

1)     Similar sized firms in the same industry

2)     Substantial portion of the new combined firm is held by each firm’s former

        shareholders

3)     Limited or no premium paid

4)     Stock swap using fixed exchange ratio usually with no caps/floors

5)     Sharing of governance between the two former firms-Co Equal CEOs, etc.

Point # 5 is the issue which causes the most danger in successfully implementing a MOE despite their low premium. The Co Equal structure complicates cultural integration and execution making it difficult to realize the promised synergies. M&A already is a risky activity without adding an additional layer of integration barriers. This is why MOE have a checkered record including:

1)     Daimler-Chrysler

2)     Alcatel-Lucent

3)     Citi-Travelers

4)     Morgan Stanley-Discover

5)     First Union-Wachovia

The integration issues are especially acute when the firms have different business models (e.g. Citi-Travelers) and cultures (e.g. Alcatel-Lucent).This is critical for POG regarding client conflict resolution. For example, Coke is a Publicis client while Pepsi is an Omnicon client. How do you do what is best for the client without upsetting either the Publicis or Omnicom account managers? Another issue is handling the different compensation systems - a U.S. style Omnicon and a Euro Publicis without alienating employees.

Typically, MOE are more symbolic than substantive. They are used get approval for a combinations that otherwise would not occur. For example, General Mills had to incorporate a complex governance sharing structure into its Yoplait yogurt acquisition to get French approval. Usually in a MOE, some parties turn out to be more equal than others.

The basic problem with MOEs is they work in theory but not in practice. The numbers seem to work, but the “soft” issues- people, governance and integration frequently do not work once the deal is closed. You can try to let the lawyers work it out with a detailed memorandum of understanding covering items such as:

 1)     Governance: board size, composition, key committees, management team

         compensation, and management succession.

 2)     Surviving name and HQ Location

 3)     Strategic Plan and Direction

 4)     Capital Structure, Ratings Target and Dividend Policy

 5)     Who Will Be the CFO and What IT Systems Will Be Used

 6)     Professionals: who will be the surviving accountant, lawyers, investment

         bankers, etc.?

 7)     Due Diligence

 8)     Identification and Retention of Key Staff

 9)     Investors Relations Strategy

10)    Detailed Integration and 100 Day Plans

The problem with the lawyer approach is that it inhibits flexibility needed to integrate the two firms. The focus on fairness and balance can interfere with making the right business decision. This can lead to frustration and conflict. The danger is this creates an “us v them” mentality leading to in-fighting. Remember, the two firms were formerly rivals. Thus, some bad blood among the staff is likely to exist. This may make it difficult for them to get along in any event.

I wish the Publicis and Omnicom combination the best of luck. My gut tells me this is going to be a bumpy ride. Co-CEOs and dual HQs, especially with organizations having such different cultures (French v American) raise the odds of a disappointing integration.

j