GE’s Alstom Acquisition: How Smart is the Move ?

On June 22nd 2014, one of Europe’s fiercest acquisition battles ended. French Government officially supported Alstom’s purchase from General Electric. During the previous two months, Siemens and Mitsubishi also played important roles in the bid. Both strategic and political reasons lie behind the structure of the deal.

On April 30th, Alstom (€21 billion revenues) presented the details of the proposed acquisition from GE (€120 billion revenues): all assets and liabilities related to the Energy activities transferred to GE for an Enterprise Value of 11.4 billion Euros to be paid in cash.

Figure 1

Source: GE Website

Is the deal value fair ? 

By using the comparable method, it emerges that GE has undervalued Alstom. Indeed, GE’s offer implied a EV/EBITDA multiple equal to 7,87, while Damodaran suggesting that a fair multiple for the sector should be equal to 9,78 and Valuemetrics to 10,44.  The main reasons of this undervaluation may be the industry trend and Alstom’s recent performance.  According to an Ernst & Young research of 2012, the M&A trend in the power and utilities industry has been decreasing in terms of value and number of deals. Considering similar transaction multiples of the recent past in the European market, they confirm the trend and are similar to the ones of Alstom’s acquisition. For example, in 2012 Electricite de France acquired Edison International with a EV/EBITDA multiple of 9.7 and Snam was acquired by Cassa Depositi e Prestiti with a multiple equal to 8.7. Moreover, the whole European energy sector has been facing threats due to the raise of energy resource prices.  Alstom has also negatively performed in the last years. In 2013, Net Income fell 28% to €556 million due to higher restructuring costs. Operating Profit fell 3% to €1.4 billion, with Operating Margin dropping from 7.2% to 7% and orders to 10% (€21.5 billion) because of a weak performance in the thermal power division.

The underlying strategy

The strategic rationale behind the deal is to integrate the Alstom energy activities (€14.8 billion revenues and 65.000 employees) within GE to strengthen its development’s prospects. The main sources of synergies are the complementary capabilities among the two firms: GE’s excellence in Gas Turbines and Wind Onshore and Alstom’s superiority in Hydro, Grid, and Steam turbines. Moreover, Alstom could use the cash received to refocus on the transportation sector.

The deal is likely to be very successful due to various elements. It strengthens GE’s position as the most competitive infrastructure Company in the world. Moreover, the type of technology that is going to be acquired is complementary to the existing capabilities of the company, thus increasing the likelihood of benefiting from the potential synergies in the short-term. Indeed, the synergies that GE is going to leverage are concrete and clear because Alstom mostly conducts business in areas where GE is already present, so the learning curve necessary to generate value is not very difficult to be achieved.

The benefits that GE is more likely to achieve are in the power business, especially regarding the production of clean energy. Indeed, the demand of pollution-free energy is likely to increase in the near future, especially from Asian countries like China or India. Thus the acquisition has taken place in an opportune moment in terms of industry cycle and given the huge scale that the company is going to put in place, it will be able to largely satisfy the future demand.

According to estimates provided by GE, the cost synergies opportunities that the company is expected to generate is about $1.2 billion within 2020 (see graph below for a more articulated analysis), a $4 billion increase in operating profits by 2018 and an EPS increase of $.04-.06 within 1 year.

 Another relevant factor is the past success in dealing with acquisitions of France and European companies. Among them we remember Jenbacher, an Austrian company that has been the cornerstone of GE’ global distributed power business and that under GE’s control has increased revenues 3x times. This success ranges also from various industries, not only in the power sector, ensuring that the post-merger integration phase will be conducted appropriately by GE given the previously developed skills.

 What are the Challenges ?

 Although the deal has a huge potential to be very successful, it is not immune to risk. The first important point that GE should be aware of is the strength of the France unions in the context of the France labor market. Any time it will take decisions regarding the firing or the reconversion of the France labor force may be very difficult to be implemented (or may be implemented at higher costs than in other countries of the world).

Another risk factor is the large amount of transactions costs that will be present as soon as the deal will be completed. They mainly derive from the terms of the deal, which require the constitution of three Joint Ventures that were not present in the first bid by GE. Thus, GE will face much more pressure in generating profits given the larger cost structure.

 Figure 2Source: Author’s elaboration on company’s data

Conclusion

 The deal has high chances to turn to be very successful and may be considered as a game changer in the industry. Although the initial terms had to be modified by GE due to the competition that arose from Siemens-Mitsubishi, the benefits are both large and concrete, and very likely to be monetized in the short-term. This is also related to the nature of the estimated synergies. Indeed, they are of the cost-saving type, which have a higher probability to be achieved compared to the growth ones. However, challenges arise from the institutional environment that surrounds GE’s activities in France, where the power of unions is very high as well as the high amount of transactions costs that arose in order to positively conclude the deal.

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Gianmarco Bonaita is a Double Degree student of PGP coming from Bocconi University. He completed his undergraduate degree in Business Administration and Management at Bocconi University. He has been elected city councilman and has worked as a collaborator of journal for 3 months. He has had an internship in an Italian SME. He is passionate about travelling, skiing and photography.

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Importance of Intellectual Property in Mergers and Acquisitions

Last month, Google astonished quite a few analysts when it announced the acquisition of Motorola Mobility for $12.5 billion. The hefty amount meant that the software giant parted away with nearly a third of its $39 billion cash reserves. It also meant that Google deviated from its earlier M&A strategy of acquiring small companies with superior technologies which it could easily integrate into itself as it did with Android in 2005. It also signified a major upheaval in its operating strategy because now they have not only increased their headcount by 66% but they have also entered a space which they have relatively very little experience in and one whose dynamics are way different than the one they are used to. The question is despite such large differences, why did they take such a decision? While some may argue Google is trying to go the Apple way by making its own hardware and software (which if true, might take some time coming), the reality lies in Motorola’s intangible assets – patents and 24,500 of those (17,000 approved and 7,500 pending approval). Google believes that this portfolio can be used as a leverage to ward off the increasing number of patent litigations from Apple and Microsoft against the Android-based phone manufacturers like HTC and Samsung and thus build confidence in these manufacturers to continue using them.

Technology-Driven M&A Deals
Welcome to the world where the M&A transactions transcends the boundaries of products and customers and enters into intellectual property (IP) as a huge value addition prospect. In this knowledge economy where innovation is touted to be one of the supreme drivers of growth, IP protection takes centre stage because this model has been widely successful in encouraging innovation. So, when an M&A acquisition involves parties which are technology-driven, IP is bound to be a key asset whose importance will influence the deal in a big way.
When we talk of technology-driven M&A, we are talking of huge numbers. According to PwC, the total value of the technology deals i.e. in internet, IT services, hardware and software in US alone was $77 billion in 2008 (yes, this was the year when the world faced an economic downturn!), $53 billion in 2009 and $107 billion in 2010. If one takes the pharmaceutical sector alone where patents are considered to be the backbone of any company, there have been 1345 deals in the last 10 years with a cumulative deal size of $694 billion. When one comes to think of patents being at the heart of these companies, it’s difficult to ignore the value it can play in an M&A deal. According to Nader Mousavi, a leading IP transactional lawyer who has worked with big law firms like Sullivan & Cromwel and Wilmer Cutler Pickering Hale & Dorr in the US, “IP as a percentage of deal value in M&A has been growing over the last 30 years. IP rights have gone from, as a percentage of overall value of S&P 500 companies, in the teens to 85 % or more.”

Significance of IP in M&A Strategy
Reducing Pressure on Internal R&D – In this knowledge economy, more and more companies are turning to an open innovation process in which they buy or license innovations to supplement and even replace their internal R&D. With the increasing emphasis on innovation and decreasing technology life-cycles, it’s imperative that a company looks into the ROI of its internal R&D. This will not only help them manage their R&D expenses better but also increase the number of innovation available to them and increase the speed of their product introductions. For this, it’s essential that the companies study the patent landscape and implement strategic analyses. These analyses will help them in identify the target which is active in the desired technology domain.
Bridging the Technology Gap in the Core Business – Companies are always looking at ‘synergy’ in any M&A deal. Many a times this synergy can be derived from complementary technologies. The addition of this technology to their portfolio would mean end-to-end integration of all components required to launch the product in the market. Take the case of the acquisition of SwitchOn networks by PMC-Sierra for $ 450 million. SwitchOn was a pioneer in wirespeed packet classification and inspection technology. It provided standard semiconductor and software components to enable applications such as QoS, Load Balancing, URL Switching Firewalling, etc. at wire speeds exceeding OC-48. It also had a patent pending on this technology, which on being granted would provide it the right to exclude any other company from using this technology. PMC-Sierra, on the other hand had expertise in broadband communications and has worldwide technical and sales support network. The addition of SwitchOn’s packet classification expertise was complementary to PMC-Sierra’s broadband communications strategy. With SwitchOn’s acquisition, it also acquired its patent which helped it achieve the strategic leverage in its domain.
Mitigating IP Litigation Risks – In a recent survey of Wall Street professionals conducted by CRA International, 75% of respondents indicated that patent litigation exposure was “important” or “very important” in valuing investment opportunities. Well, who could be in a better position to vouch for this than our beloved Google! In order to protect itself from the barrage of patent litigations involving Android, the count of which had reached 37 by March this year, it was no less than desperate to look for a strong patent portfolio. After the Nortel loss, when it bid an amount of $‘Pi’ billion for 6000 patents, it would have realized the actual seriousness which surrounds such patents not only in terms of money but also the business sense that they make. Its acquisition of Motorola Mobility is testament to the fact that a sound patent portfolio is one of the best cushions to have in the technology space.
Patent Trolls – Strong patent portfolios have been the targets of several non-practicing entities (NPE) also referred to as trolls. These NPEs acquire companies having strong patents but are in either in distress or are ready to be acquired (read: sell their patents) for the amounts offered by the NPEs. However, the NPEs do not develop any products around those patents. They initiate patent litigations against the practicing companies with the sole intention of receiving generous settlement amounts. While the jury is still out on the ethical part of this business model, as far as it legal, a few companies continue to do it and successfully so. Firms like Intellectual Ventures, MOSAID, Tessera etc. have portfolios running into thousands of patents. All they do is find a hot patent and assert it against large companies.

Non-Technology Driven Deals
All the technology-driven M&A deals would tend to focus on the patent portfolio which is at stake. However, there are other forms of IP like copyrights and trademark, which can figure in the strategic objectives of a company. Here are a few reasons which would cause IP to influence a company’s M&A strategy:
Improve Distribution Channels – The merger of AOL and Time-Warner was one which involved equals in their respective industries. Time-Warner had a huge collection of copyrighted entertainment media including content magazines, movies, books, music and programming. However, with the increasing penetration of internet it was looking at alternate distribution channels to reach out to its audience. Thus, the decision to merge with AOL, which had become a huge brand in the internet space made a lot of sense.
Build a Brand Presence – When Indian tea-maker Tata was faced with the decision of expanding its foothold in the lucrative US and European market, acquiring a famous brand in these regions was the obvious answer. Thus, the acquisition of Tetley saw the light of the day. The deal catapulted Tata Tea into the global arena, as Tetley is an international brand with a presence in over 44 countries. Tetley has a presence in India, Canada, the US, Australia and Europe, and is the world’s second largest tea brand. The acquisition helped Tata to cash on the widely recognized Tetley trademark and use its expertise and infrastructure in sourcing teas worldwide for the Indian market too.

IP Related Issues in M&A
Valuation – There has already been a paradigm shift in the IP due diligence process which is currently being undertaken by firms that identify IP as central to their long term objectives. They look at it from a value addition perspective rather than the traditional transactional perspective and thus, conduct a comprehensive due diligence using the latest tools and analyses. However, valuation still remains the trickiest part. This is so because IP valuation has no fixed model and is largely contextual. Risks, timing, cash flows, option value, alternatives and intended use (e.g., defensive, offensive) of specific IP assets form the pillars on which the valuation may be based. At the same time, CFOs are confronted with an ever-changing landscape of tax, financial and regulatory reporting requirements that impose differing and sometimes ambiguous standards for valuing IP.
Anti-trust Regulations – Most anti-trust laws prohibit M&A which will significantly ‘lessen’ the competition or lead to a monopoly in the market. Such issues are more serious when it comes to patents, as they by nature provide the holder the right to exclude anyone from practicing the patent.
With the growing importance of a knowledge-economy in today’s context it is beyond doubt that IP will be a key consideration for the companies as they carve out their strategic objectives. IP will thus, play an increasing role in fuelling the future M&As especially in the technology-intensive industries.

Role of consulting in M&A

It is a statistically proven and a widely known fact, that only 3 in 10 big mergers and acquisitions create meaningful value for shareholders, while 5 out of 10 actually destroy value. In spite of the oddly skewed statistics, mergers and acquisitions continue to be a popular way for organizations to grow – horizontally, vertically, across the border- and to diversify – synergistically or unrelated.

When a firm decides on starting the process of merger and acquisition with another firm, it hires a gamut of outside professionals – investment bankers, consultants, valuation experts, accountants, attorneys. These professionals help with various steps of the M&A process right from scouting for firms to acquire or merge with, to aiding in the post-merger integration of firms. This article concentrates on the role of consultants in the process.

The first stage at which consultants are involved, is the M&A strategy phase. Consulting firms do a lot of projects with companies to formulate their growth strategy. Hence, the M&A strategy work is an extension of the same. Consultants are hired to form a detailed M&A program that consists of conceptualising the goals, areas to grow in, kind of partnership vehicle to be preferred (M&A, Joint venture, Alliance etc.) etc. The next stage is the screening of acquisition targets. This includes generating a list of potential targets based on criteria decided by the M&A strategy, creating profile and investment thesis for targets, and then developing an approach plan for the targets. The third stage at which consultants enter is strategic due diligence. Strategic due diligence involves detailed study of the target to confirm the investment thesis, establishment of possible synergies, forecasting of market trends etc. The fourth stage, which is also the most crucial stage because of its high contribution to failure or success of the merger, is the merger integration. In this stage, value from the merger needs to be extracted, but with as less friction as possible. Apart from the operational decisions that need to be taken, a lot of cultural issues need to be sorted out in a speedy manner – organization structure, a shared decision-making system etc. A consulting firm may aid the company through all four stages or may make an entrance at any intermediate stage of the process.

M&A activity had taken a hit in the initial phase of recession, but now private equity players are back in the game and the credit and equity markets are again financing M&A deals. This will boost the M&A activity in the near future, which spells good news for the consulting industry.

Source: http://www.bain.com/bainweb/Consulting_Expertise/capabilities_detail.asp?capID=9