What was considered a Merger of equals, turned to be a massacre?

There can be a huge problem with internationalization with M&A and companies need a global strategy to manage operations. However implementation can be a challenge, especially when multiple nationalities and countries are involved. Enter Daimler Chrysler. The horizontal $36 billion merger of American carmaker Chrysler and Germany’s Daimler-Benz is a powerful demonstration of the globalization of the world economy.

The first problem that exists here is that both companies aspire fierce national pride in their homelands, which both companies thought could be put aside for progress in a highly competitive car industry. The first question that should be asked with internationalization with M&A is, do we have a global strategy to manage worldwide business leverage? And if so, can we implement it despite there being challenges with differences in nationalities and countries? Though this is a significant issue between the firms, the main problem causing the failed merger or takeover is that the terms of the transaction were misrepresented as a ‘merger of equals’ to close the deal.

When Shrimp went to Bob Eaten (Chrysler CEO) over potential merger, the meeting lasted 18 minutes before an agreement was made. How on earth in an 18-minute meeting could anyone decide on a merger? It takes me 18 minutes to decide on a filling for my sandwich!!! Never mind a $36 billion deal. The answer behind this could be due to the CEO’s overestimating the potential synergies between the firms as well as overestimating their ability to generate returns and as a result, have engaged in a value-destroying merger.

I guess in some cases this merger would be a brilliant idea, as when looking at both corporations they have something huge to offer. Daimler-Benz for instance is a strong luxury German brand with high-end cars, whilst Chrysler targets the low-end consumer in America. Joint together, they could take a large proportion of the market share and become a powerful force in the automobile industry. If only things were that simple. As mentioned above, culture can be the demon in all companies and in order for a successful merger, their needs to be synergies between firms. In order to minimize the culture clash, Schrempp decided to allow both firms to maintain their existing cultures. Can you identify the problem here? At first, it looks as though Chrysler have been given the freedom they want, however within 19 months two American CEO’s were dismissed and German management took over. This looks like complete ignorance if you ask me. Later it was only then that Schrempp admitted that the merger of equals was actually a takeover. Instead of gaining a competitive advantage, the merger was pushed into a deep crisis. This global ambition between he two firms triggered one of the most devastating law suits in corporate history, lasting up to 10 years before being sold for a mere $7.4billion.

  

If we look at how M&A’s has changed today, unlike the Daimler-Benz failure, Deloitte states that 2015’s deals have promised annualised $150-$200 billion in cost savings. Although like the Daimler-Benz merger, synergies are somewhat poorly reported and updates on cost savings may be provided for a year or two, but past this as it dry’s up. The question then, if management were acting in the best interest of shareholders, then shouldn’t M&A’s be successful? Even today, the idea of shareholder value maximisation is a grey area for management because managers are known to act in their own best interests, whether that is for power (Daimler-Benz) or greed. As a result, even today, shareholders are still paying for the deals many years after the event. Managers need to start proving there worth. 

Is human nature the flaw in our financial system?

“There are three ways to make a living in this business: be first, be smarter, or cheat”.

The film Margin Call gives an insider’s look into this unknown Wall Street firm and reveals the human nature of it and the distressing aspect regarding the emotions that drove decisions. The plot really narrows down to an accommodation of factors including; people who were gambling, people who were taking advantage of deregulation and people who were all about the short term rather than the long gain.

I ask the reader, what is the role of emotions in financial decision-making? Do emotions effect how decisions are made? This echoing theme throughout the film explicitly sets out to examine how our emotions, both those which are conscious, and more importantly, those unconscious, play a key role in financial decision making. To me, it seems to be apparent in Margin Call indefinitely as we see how the senior management prepare to do whatever it takes to mitigate the debacle to come even. The reality is, the company held a massive position in an illiquid market, decided to stop chasing profit and were lucky to have cut their losses. At times we find ourselves rooting for the firm's survival despite the fact that its executives are actively promoting worthless assets.

What I found to be a little unrealistic about the movie was the fact that they were able to accomplish the unloading of these illiquid positions as cleanly as they did. In a semi-strong market, you’d assume that regulators would identify this flaw in the formula, although it can be argued that regulators can have an oversight of the big picture here, which relates to my blog regarding Bernard Madoff’s scam. 

Were they acting in the best interest of the shareholders, or even themselves? Most certainly there is a clear indication for delivering shareholder value, although I’d argue at what cost. The bank had insider information regarding its flawed formula and refused to let it bring the company down. Was the bank wrong to sell off its worthless assets? I’d argue not, they’ve implemented a hedge strategy to save their own company from extinction. Ultimately, you’re selling something that you *know* has no value, but quite correctly you are selling to ‘willing’ buyers at the current fair market price. Although the economy may suffer, it’s the markets late reaction, not necessarily the company’s inside knowledge. After all, staying alive is animal instinct, it’s a dog eat dog world. Its human nature to survive, which is why I believe emotions were the basis of decisions making.

On the other hand, could shareholder value be destroyed from potentially losing all their current and future customers from a ruined reputation? The firm may survive from this although they’ll destroy their reputation at the very least, whilst also destroying the economy. One could argue that had they not taken the initiative to sell off their junk, someone else would have. This brings me back to this idea of ‘one man’s gain is another man’s loss.’ The underlying issue here could be the corporate culture of the company, which relates back to my second blog.

The ultimate unsatisfying conclusion of Margin Call is that there may be no final fix for the problem; that, to a large extent, the financial crises is unavoidable and will continue to happen in any economy that resembles free market capitalism. The message is conclusive: Human nature does not change and the crisis will happen again. The question is not whether we should reform our financial and economic system to prevent another crisis. The question is whether we can at all.

CALL OF DUTY meets Candy Crush!

How long before you can judge the company you have acquired? That will be the question going into 2016 for Activision Blizzard CEO Bobby Kotick who has bought King Digital Entertainment for ……hold on I think I have my sources wrong….HOW MUCH?? $5.9billion, are you mad! Considering that Candy Crush has been on the decline for the last few quarters and that mobile phone games have one of the shortest lifespans in the world, was it worth it? Arguably to a certain extent I can agree because the app rakes in $1 million a day in micro transactions, which although has gone sown slightly, still is huge cash inflows. Activisions current business model is based around hit based games such as the COD titles and World of Warcraft selections, which although are huge profit makers, do not bring in a steady inflow. This is where King can help. Activision need to be balanced around regular steady streams of income, which is why Blizzard bought King and the deal is expected to increase Activision Blizzard expected revenue in 2016 by 30%. A huge motive behind this venture would be society’s addiction to mobile phones, which has progressed immensely over the years. Furthermore, with Blizzard controlling already a huge part of the console market, it makes sense to invest into the app industry in order to diversify the business and sustain its competitive advantage.

Having played Candy Crush, though addictive for the first week or so, I can’t see how the valuation is at $6 billion. Part of me wants to believe this is due to CEO overconfidence from both companied and maybe even complete arrogance in taking over something just because the funds are there to do so. With a transaction this big, I’d expect thorough due diligence to have been taken when completing this overall valuation figure. Firstly, if the market were efficient, it would be safe to say that the market valuation represents a true intrinsic value of the firm. In determining whether the investment is likely to return a profit, it is worth also noting that King produced cash flows of $600 million in cash last year. Considering the value of the company is said to be higher than its cash flows, its definite good news for the gaming brand.

Despite the valuation, I would have said that the company itself has been over evaluated big time, with the biggest contributor to this being management resistance to sell for less. 

BHP Billiton - Progressive Dividend FLOP

 "Big business should re-balance demands of shareholders with wider issues"

BHP made 61% less in pre-tax profits, yet still made decision to increase dividends by 2%. Why, despite the fact that BHP didn’t make as much profit as it thought it had, would the company increase dividends by 2%?  The words I’m looking for here are ‘progressive dividend policy’, which involves management committing to a rising dividend year-on-year for the company. The company plans to do so by accelerating cuts in operating and capital spending to ensure this pay-out, although I question whether this pay-out would be sustainable in the future and secondly, is it wise cutting spending. BoE’s chief economist Andy Haldane argues that if BHP commits itself to this policy, is the company potentially running the risk of eating its own business by not being able to invest in new products and services. In this article, he also accuses business leaders for “serving the short-term interest of shareholders at the expenses of the wider economy.”

Looking back at MM’s theory of dividend irrelevance (Residual Dividends Policy) dividends should be paid from retained earnings after meeting investment needs from positive NPV projects, MM argued that if all projects can’t be met, then a company should alter its capital structure to finance these projects (i.e. bank loans) but ultimately, TAKE ON MORE DEBT. This was apparent in their theory against an optimal capital structure which I discussed in my previous blog on American Apparel.

So the question remains, does dividend policy help to maximise shareholder wealth? 

Not surprisingly, the finance literature poses considerable debate on whether dividend policy plays a role in achieving this goal and whether it affects firm value. One view, attributed to Miller and Modigliani (1961) and echoed in Black (1976), suggests that dividends are irrelevant for firm value and possibly value-destroying, which is evident in BHP’s case because the company is serving the short-term interests of shareholders. BHP have a progressive policy of dividends, however is willing to decrease investment in growth to fulfil its yearly claim. While dividend policy may not maximise shareholder wealth, it can certainly destroy it. So, should BHP drop its dividends? I would say so, as dividends should relate to performance increases in profits, rather than temporary. With the money returned from dividends, this should mitigate their loss.

Another perspective, represented in the classic works of Williams (1938), Lintner (1965), and Gordon (1959), considers dividends as an important determinant of firm value. Arguably, I would also agree with this statement because to an investor, dividend pay-outs can be seen as a way of assessing the company’s performance, for example; BHP’s sustaining dividend increase is to signal to shareholders that the drop in earnings is only temporary, which is a reason why share price has increased, because more people are buying the shares, and perhaps the best time to. Although I believe if the company would reinvest, likelihood that investors would still prosper from new project and therefore also increased share price.

No universal set of factors is appropriate for all firms because dividend policy is sensitive to numerous factors including firm characteristics, market characteristics, and substitute forms of dividends. The Dividend Puzzle remains an important topic in modern finance. Despite extensive research, considerable debate exists on whether dividend policy plays a vital role in achieving shareholder value.

I had my thoughts on the topic….what’s yours?