The company's growth plans: Your approach as an investor.

Good growth is exciting for any company that you own.

Growth can be through organic growth or through mergers and acquisitions.

However, as an investor, you should assign little importance to growth plans of the company in your investing decision.

It is far more important the company sets out the right strategy, since growth will follow in due course.

Many short-term growth targets get in the way of taking the right long-term decisions.

As an investor, you should be willing to ride out patchy results, considering this to be part and parcel of business.

On mergers and acquisitions, the investors should have a very clear stance: it is important to avoid the urge to grow for growth's sake; the focus should be on acquisitions that make sense and not overpaying.  It is important to avoid watering down a quality business with inferior acquisitions.

Mergers and Acquisitions (2)

Acquisitions rarely create value unless they do one or more of the following:

1. improve performance of the target company,
2. remove excess capacity,
3. create market access for the acquirer's or target's products,
4. acquire skills or technologies at a lower cost and/or more quickly than could be done without the acquisition,
5. exploit a business's industry-specific scalability, and
6. pick winners early.

Most of the value of an acquisition goes to the target's shareholders unless one or more of the following hold for the acquirer:

1. it had strong performance before the acquisition,
2. it can pay a low premium,
3. it had fewer competitors in the bidding process, and 
4. the acquired assets were from a private firm or a subsidiary of a large company.

Value Created for Acquirer

The value created for the acquirer is:

Value Created for Acquirer
= (Stand-Alone Value of Target + Value of Performance Improvements) - (Market Value of Target + Acquisition Premium).

Mergers and Acquisitions (1)

Empirical research has shown that acquisitions have come in waves and generally rose when

• stock prices were high, 
• interest rates were low and 
• one or more large deals had already taken place.

Of the mergers and acquisitions:

• 1/3rd of the deals created value for the acquirer,
• 1/3rd destroyed value, and 
• 1/3rd had unclear results.

Cost analysis

Cost savings can create value, but estimating those savings requires a framework.

As an example for a generic drug firm, the analyst might allocate the savings into six categories:

• R&D,
• procurement,
• manufacturing,
• sales and marketing,
• distribution, and 
• administration.

Assumed cost savings should be estimated and categorized in detail to avoid double counting.

It is recommended that those directly involved in the cost-savings process be involved in the estimations of cost savings.



Revenue analysis

Revenue analysis has both explicit and implicit considerations.

Revenue improvements generally have four sources:

• increasing sales to a higher peak level,
• reaching a peak level faster,
• extending the life of products, and 
• adding new products.

Revenue could increase from higher prices, but antitrust regulation can prevent higher prices unless the quality of the products increases.




Stock offer or cash offer

Generally, an acquiring firm's stockholders benefit more if the firm uses stock instead of cash for the acquisition.

Although the stock offering can lead to dilution, it lowers the risk to the acquirer and allocates more risk to the target firm's shareholders.

Research has shown that stock prices react to creation of intrinsic value in an acquisition and that dilution and other accounting issues do not matter.

Mergers and Acquisitions: Types of Mergers

Most mergers fall into three categories:

• Horizontal Merger
• Vertical Merger 
• Conglomerate Merger

Horizontal Merger

This occurs between two companies in the same industry.

For example, two oil companies decide to merge.

They believe they can create efficiencies within the company and thus eliminate costs and improve profitability.

This inevitably causes valuation to increase because profitability is a key driver of valuation.

In doing so, the two companies have achieved some synergy and this type of horizontal merger makes sense.


Vertical Merger

This occurs between two companies involved in different stages of production.

For example, two companies in a media industry decide to merge.

One produces content, and the other owns a network with vast distribution capabilities.

This result in a perfect formula for a successful vertical merger, with content and delivery now offered by one company.

Ultimately, the different stages of production delivery combine to create more efficiency, more productivity, more profitability and of course, more value.


Conglomerate Merger

This occurs between companies in often unrelated industries that seek to create a diversified portfolio of companies intended to hedge against risk.

This type of merger can create some operating efficiencies resulting from the combination of redundant departments.

Merger and Acquisition

M&A continues to be a driving force behind the global economy.

Corporations seeking to fuel growth, boost profits and increase shareholder value are constantly on the lookout for merger opportunities.

Despite the flurry of multi-billion dollar mergers that dominate business headlines these days, we still face the reality that many of those mergers fail to return what was promised to investors.

INVESTMENT MADNESS

INVESTMENT MADNESS

TIM KELLEY March 16, 2015 

Here’s a question for you: what kind of business becomes more attractive as an investment proposition the more expensive it becomes?

The answer – apparently – is just about any business that has a strategy of acquiring other businesses.

Here’s how the logic works. Suppose you are the CEO of a company whose shares trade at a price/earnings of say 20x. That’s a robust multiple and demands a certain amount of growth. If your business doesn’t have the necessary organic growth, you will need to deliver the expected growth via acquisition. The good news is that you can buy companies in the same line of business from private sellers, and the multiples paid in the private market are much lower than 20x; perhaps even in the single digits.

This difference in multiple means that you can issue your own shares to acquire the privately held businesses, and achieve an automatic Earnings Per Share (EPS) uplift. The earnings attached to the shares you issue (at 20x) are much lower than the earnings you acquire in return, and so by the magic of arbitrage, your shareholders have achieved earnings (and presumably value) uplift.

Some acquisitions create value through synergy benefits, but for this strategy it is probably better to avoid that sort of thing. Integrating the acquired businesses and extracting the synergy benefits is troublesome, and likely to distract you from the main game. You are probably better off focusing on acquisitions that don’t require much integrating. That way you can do more acquisitions in a given space of time, and ….. achieve more EPS uplift!

This is advantageous for your strategy, as faster EPS uplift will justify a higher multiple being ascribed to your shares, and this in turn will increase the ratings differential between your shares and the businesses you are acquiring. A higher rating means a more magical arbitrage value.

In this way, you should be able to see that the more expensive your company’s shares become, the more effective your growth strategy becomes, and the whole thing becomes a kind of virtuous cycle.

…except that the logic is a tiny bit circular.

If for some reason your ratings were to fall, or private acquisition targets at low multiples were to become scarce, the whole charade might just start to unravel in the same way that it came about. A declining share price could wipe out the value creation potential of your strategy and justify an ever decreasing share price.

Here’s my tip: if you see a broker finding virtue in an elevated price/earnings multiple by pointing out that it facilitates EPS accretive acquisitions, it may be wise to count the seats between you and the exit row.

Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. 


http://www.montinvest.com/

Warren Buffett: Intrinsic Value and Capital Allocation

Intrinsic Value and Capital Allocation

     Understanding intrinsic value is as important for managers as it is for investors.  When managers are making capital allocation decisions - including decisions to repurchase shares - it's vital that they act in ways that increase per-share intrinsic value and avoid moves that decrease it.  This principle may seem obvious but we constantly see it violated.  And, when misallocations occur, shareholders are hurt.     

     For example, in contemplating business mergers and acquisitions, many managers tend to focus on whether the transaction is immediately dilutive or anti-dilutive to earnings per share (or, at financial institutions, to per-share book value).  An emphasis of this sort carries great dangers.  Going back to our college-education example, imagine that a 25-year-old first-year MBA student is considering merging his future economic interests with those of a 25-year-old day laborer.  The MBA student, a non-earner, would find that a "share-for-share" merger of his equity interest in himself with that of the day laborer would enhance his near-term earnings (in a big way!).  But what could be sillier for the student than a deal of this kind?

     In corporate transactions, it's equally silly for the would- be purchaser to focus on current earnings when the prospective acquiree has either different prospects, different amounts of non-operating assets, or a different capital structure.  At Berkshire, we have rejected many merger and purchase opportunities that would have boosted current and near-term earnings but that would have reduced per-share intrinsic value.  Our approach, rather, has been to follow Wayne Gretzky's advice:  "Go to where the puck is going to be, not to where it is."  As a result, our shareholders are now many billions of dollars richer than they would have been if we had used the standard catechism.

     The sad fact is that most major acquisitions display an egregious imbalance: They are a bonanza for the shareholders of the acquiree; they increase the income and status of the acquirer's management; and they are a honey pot for the investment bankers and other professionals on both sides.  They usually reduce the wealth of the acquirer's shareholders, often to a substantial extent.  That happens because the acquirer typically gives up more intrinsic value than it receives.  Do that enough, says John Medlin, the retired head of Wachovia Corp., and "you are running a chain letter in reverse."    Over time, the skill with which a company's managers allocate capital has an enormous impact on the enterprise's value.  Almost by definition, a really good business generates far more money (at least after its early years) than it can use internally.  The company could distribute the money to shareholders by way of dividends or share repurchases.  Often the CEO asks a strategic planning staff, consultants or investment bankers whether an acquisition or two might make sense.  That's like asking your interior decorator whether you need a $50,000 rug.

Mergers and Acquisitions: Why They Can Fail

It's no secret that plenty of mergers don't work. Those who advocate mergers will argue that the merger will cut costs or boost revenues by more than enough to justify the price premium. It can sound so simple: just combine computer systems, merge a few departments, use sheer size to force down the price of supplies and the merged giant should be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice, things can go awry.

Historical trends show that roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market. The motivations that drive mergers can be flawed and efficiencies from economies of scale may prove elusive. In many cases, the problems associated with trying to make merged companies work are all too concrete.

Flawed Intentions
For starters, a booming stock market encourages mergers, which can spell trouble. Deals done with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and cheap too. Also, mergers are often attempt to imitate: somebody else has done a big merger, which prompts other top executives to follow suit.

A merger may often have more to do with glory-seeking than business strategy. The executive ego, which is boosted by buying the competition, is a major force in M&A, especially when combined with the influences from the bankers, lawyers and other assorted advisers who can earn big fees from clients engaged in mergers. Most CEOs get to where they are because they want to be the biggest and the best, and many top executives get a big bonus for merger deals, no matter what happens to the share price later.

On the other side of the coin, mergers can be driven by generalized fear. Globalization, the arrival of new technological developments or a fast-changing economic landscape that makes the outlook uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the management team feels they have no choice and must acquire a rival before being acquired. The idea is that only big players will survive a more competitive world.

The Obstacles to Making it Work
Coping with a merger can make top managers spread their time too thinly and neglect their core business, spelling doom. Too often, potential difficulties seem trivial to managers caught up in the thrill of the big deal.

The chances for success are further hampered if the corporate cultures of the companies are very different. When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily overcome. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result can be resentment and shrinking productivity. More insight into the failure of mergers is found in the highly acclaimed study from McKinsey, a global consultancy. The study concludes that companies often focus too intently on cutting costs following mergers, while revenues, and ultimately, profits, suffer. Merging companies can focus on integration and cost-cutting so much that they neglect day-to-day business, thereby prompting nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to create value for shareholders.

But remember, not all mergers fail. Size and global reach can be advantageous, and strong managers can often squeeze greater efficiency out of badly run rivals. Nevertheless, the promises made by deal makers demand the careful scrutiny of investors. The success of mergers depends on how realistic the deal makers are and how well they can integrate two companies while maintaining day-to-day operations.


Read more: http://www.investopedia.com/university/mergers/mergers5.asp#ixzz2CuCDdkQf


Mergers and Acquisitions: Conclusion


One size doesn't fit all. Many companies find that the best way to get ahead is to expand ownership boundaries through mergers and acquisitions. For others, separating the public ownership of a subsidiary or business segment offers more advantages. At least in theory, mergers create synergies and economies of scale, expanding operations and cutting costs. Investors can take comfort in the idea that a merger will deliver enhanced market power.

By contrast, de-merged companies often enjoy improved operating performance thanks to redesigned management incentives. Additional capital can fund growth organically or through acquisition. Meanwhile, investors benefit from the improved information flow from de-merged companies.

M&A comes in all shapes and sizes, and investors need to consider the complex issues involved in M&A. The most beneficial form of equity structure involves a complete analysis of the costs and benefits associated with the deals.

Let's recap what we learned in this tutorial:
A merger can happen when two companies decide to combine into one entity or when one company buys another. An acquisition always involves the purchase of one company by another.
The functions of synergy allow for the enhanced cost efficiency of a new entity made from two smaller ones - synergy is the logic behind mergers and acquisitions.
Acquiring companies use various methods to value their targets. Some of these methods are based on comparative ratios - such as the P/E and P/S ratios - replacement cost or discounted cash flow analysis.
An M&A deal can be executed by means of a cash transaction, stock-for-stock transaction or a combination of both. A transaction struck with stock is not taxable.
Break up or de-merger strategies can provide companies with opportunities to raise additional equity funds, unlock hidden shareholder value and sharpen management focus. De-mergers can occur by means of divestitures, carve-outs spinoffs or tracking stocks.
Mergers can fail for many reasons including a lack of management foresight, the inability to overcome practical challenges and loss of revenue momentum from a neglect of day-to-day operations.


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Break Ups (De-mergers): Sell-off, Carve-out, Spin-off and Tracking stocks

Mergers and Acquisitions: Break Ups


As mergers capture the imagination of many investors and companies, the idea of getting smaller might seem counterintuitive. But corporate break-ups, or de-mergers, can be very attractive options for companies and their shareholders.

Advantages
The rationale behind a spinoff, tracking stock or carve-out is that "the parts are greater than the whole." These corporate restructuring techniques, which involve the separation of a business unit or subsidiary from the parent, can help a company raise additional equity funds. A break-up can also boost a company's valuation by providing powerful incentives to the people who work in the separating unit, and help the parent's management to focus on core operations.

Most importantly, shareholders get better information about the business unit because it issues separate financial statements. This is particularly useful when a company's traditional line of business differs from the separated business unit. With separate financial disclosure, investors are better equipped to gauge the value of the parent corporation. The parent company might attract more investors and, ultimately, more capital.

Also, separating a subsidiary from its parent can reduce internal competition for corporate funds. For investors, that's great news: it curbs the kind of negative internal wrangling that can compromise the unity and productivity of a company.

For employees of the new separate entity, there is a publicly traded stock to motivate and reward them. Stock options in the parent often provide little incentive to subsidiary managers, especially because their efforts are buried in the firm's overall performance.

Disadvantages
That said, de-merged firms are likely to be substantially smaller than their parents, possibly making it harder to tap credit markets and costlier finance that may be affordable only for larger companies. And the smaller size of the firm may mean it has less representation on major indexes, making it more difficult to attract interest from institutional investors.

Meanwhile, there are the extra costs that the parts of the business face if separated. When a firm divides itself into smaller units, it may be losing the synergy that it had as a larger entity. For instance, the division of expenses such as marketing, administration and research and development (R&D) into different business units may cause redundant costs without increasing overall revenues.

Restructuring Methods
There are several restructuring methods: doing an outright sell-off, doing an equity carve-out, spinning off a unit to existing shareholders or issuing tracking stock. Each has advantages and disadvantages for companies and investors. All of these deals are quite complex.

Sell-Offs
A sell-off, also known as a divestiture, is the outright sale of a company subsidiary. Normally, sell-offs are done because the subsidiary doesn't fit into the parent company's core strategy. The market may be undervaluing the combined businesses due to a lack of synergy between the parent and subsidiary. As a result, management and the board decide that the subsidiary is better off under different ownership.

Besides getting rid of an unwanted subsidiary, sell-offs also raise cash, which can be used to pay off debt. In the late 1980s and early 1990s, corporate raiders would use debt to finance acquisitions. Then, after making a purchase they would sell-off its subsidiaries to raise cash to service the debt. The raiders' method certainly makes sense if the sum of the parts is greater than the whole. When it isn't, deals are unsuccessful.

Equity Carve-Outs
More and more companies are using equity carve-outs to boost shareholder value. A parent firm makes a subsidiary public through an initial public offering (IPO) of shares, amounting to a partial sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the newly traded subsidiary.

A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is growing faster and carrying higher valuations than other businesses owned by the parent. A carve-out generates cash because shares in the subsidiary are sold to the public, but the issue also unlocks the value of the subsidiary unit and enhances the parent's shareholder value.

The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains some control. In these cases, some portion of the parent firm's board of directors may be shared. Since the parent has a controlling stake, meaning both firms have common shareholders, the connection between the two will likely be strong.

That said, sometimes companies carve-out a subsidiary not because it's doing well, but because it is a burden. Such an intention won't lead to a successful result, especially if a carved-out subsidiary is too loaded with debt, or had trouble even when it was a part of the parent and is lacking an established track record for growing revenues and profits.

Carve-outs can also create unexpected friction between the parent and subsidiary. Problems can arise as managers of the carved-out company must be accountable to their public shareholders as well as the owners of the parent company. This can create divided loyalties.

Spinoffs
A spinoff occurs when a subsidiary becomes an independent entity. The parent firm distributes shares of the subsidiary to its shareholders through a stock dividend. Since this transaction is a dividend distribution, no cash is generated. Thus, spinoffs are unlikely to be used when a firm needs to finance growth or deals. Like the carve-out, the subsidiary becomes a separate legal entity with a distinct management and board.

Like carve-outs, spinoffs are usually about separating a healthy operation. In most cases, spinoffs unlock hidden shareholder value. For the parent company, it sharpens management focus. For the spinoff company, management doesn't have to compete for the parent's attention and capital. Once they are set free, managers can explore new opportunities.

Investors, however, should beware of throw-away subsidiaries the parent created to separate legal liability or to off-load debt. Once spinoff shares are issued to parent company shareholders, some shareholders may be tempted to quickly dump these shares on the market, depressing the share valuation.

Tracking Stock
A tracking stock is a special type of stock issued by a publicly held company to track the value of one segment of that company. The stock allows the different segments of the company to be valued differently by investors.

Let's say a slow-growth company trading at a low price-earnings ratio (P/E ratio) happens to have a fast growing business unit. The company might issue a tracking stock so the market can value the new business separately from the old one and at a significantly higher P/E rating.

Why would a firm issue a tracking stock rather than spinning-off or carving-out its fast growth business for shareholders? The company retains control over the subsidiary; the two businesses can continue to enjoy synergies and share marketing, administrative support functions, a headquarters and so on. Finally, and most importantly, if the tracking stock climbs in value, the parent company can use the tracking stock it owns to make acquisitions.

Still, shareholders need to remember that tracking stocks are class B, meaning they don't grant shareholders the same voting rights as those of the main stock. Each share of tracking stock may have only a half or a quarter of a vote. In rare cases, holders of tracking stock have no vote at all.


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Mergers and Acquisitions: Valuation Matters

Investors in a company that are aiming to take over another one must determine whether the purchase will be beneficial to them. In order to do so, they must ask themselves how much the company being acquired is really worth.

Naturally, both sides of an M&A deal will have different ideas about the worth of a target company: its seller will tend to value the company at as high of a price as possible, while the buyer will try to get the lowest price that he can.

There are, however, many legitimate ways to value companies. The most common method is to look at comparable companies in an industry, but deal makers employ a variety of other methods and tools when assessing a target company. Here are just a few of them:
Comparative Ratios - The following are two examples of the many comparative metrics on which acquiring companies may base their offers:
Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes an offer that is a multiple of the earnings of the target company. Looking at the P/E for all the stocks within the same industry group will give the acquiring company good guidance for what the target's P/E multiple should be.
Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company makes an offer as a multiple of the revenues, again, while being aware of the price-to-sales ratio of other companies in the industry.
Replacement Cost - In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity's sake, suppose the value of a company is simply the sum of all its equipment and staffing costs. The acquiring company can literally order the target to sell at that price, or it will create a competitor for the same cost. Naturally, it takes a long time to assemble good management, acquire property and get the right equipment. This method of establishing a price certainly wouldn't make much sense in a service industry where the key assets - people and ideas - are hard to value and develop.
Discounted Cash Flow (DCF) - A key valuation tool in M&A, discounted cash flow analysis determines a company's current value according to its estimated future cash flows. Forecasted free cash flows (net income + depreciation/amortization - capital expenditures - change in working capital) are discounted to a present value using the company's weighted average costs of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival this valuation method.

Synergy: The Premium for Potential Success
For the most part, acquiring companies nearly always pay a substantial premium on the stock market value of the companies they buy. The justification for doing so nearly always boils down to the notion of synergy; a merger benefits shareholders when a company's post-merger share price increases by the value of potential synergy.

Let's face it, it would be highly unlikely for rational owners to sell if they would benefit more by not selling. That means buyers will need to pay a premium if they hope to acquire the company, regardless of what pre-merger valuation tells them. For sellers, that premium represents their company's future prospects. For buyers, the premium represents part of the post-merger synergy they expect can be achieved. The following equation offers a good way to think about synergy and how to determine whether a deal makes sense. The equation solves for the minimum required synergy:



In other words, the success of a merger is measured by whether the value of the buyer is enhanced by the action. However, the practical constraints of mergers often prevent the expected benefits from being fully achieved. Alas, the synergy promised by deal makers might just fall short.



What to Look For
It's hard for investors to know when a deal is worthwhile. The burden of proof should fall on the acquiring company. To find mergers that have a chance of success, investors should start by looking for some of these simple criteria:
A reasonable purchase price - A premium of, say, 10% above the market price seems within the bounds of level-headedness. A premium of 50%, on the other hand, requires synergy of stellar proportions for the deal to make sense. Stay away from companies that participate in such contests.
Cash transactions - Companies that pay in cash tend to be more careful when calculating bids and valuations come closer to target. When stock is used as the currency for acquisition, discipline can go by the wayside.
Sensible appetite – An acquiring company should be targeting a company that is smaller and in businesses that the acquiring company knows intimately. Synergy is hard to create from companies in disparate business areas. Sadly, companies have a bad habit of biting off more than they can chew in mergers.
Mergers are awfully hard to get right, so investors should look for acquiring companies with a healthy grasp of reality.


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Mergers and Acquisitions: Doing The Deal

Start with an Offer
When the CEO and top managers of a company decide that they want to do a merger or acquisition, they start with a tender offer. The process typically begins with the acquiring company carefully and discreetly buying up shares in the target company, or building a position. Once the acquiring company starts to purchase shares in the open market, it is restricted to buying 5% of the total outstanding shares before it must file with the SEC. In the filing, the company must formally declare how many shares it owns and whether it intends to buy the company or keep the shares purely as an investment.

Working with financial advisors and investment bankers, the acquiring company will arrive at an overall price that it's willing to pay for its target in cash, shares or both. The tender offer is then frequently advertised in the business press, stating the offer price and the deadline by which the shareholders in the target company must accept (or reject) it.

The Target's Response
Once the tender offer has been made, the target company can do one of several things:
Accept the Terms of the Offer - If the target firm's top managers and shareholders are happy with the terms of the transaction, they will go ahead with the deal.
Attempt to Negotiate - The tender offer price may not be high enough for the target company's shareholders to accept, or the specific terms of the deal may not be attractive. In a merger, there may be much at stake for the management of the target - their jobs, in particular. If they're not satisfied with the terms laid out in the tender offer, the target's management may try to work out more agreeable terms that let them keep their jobs or, even better, send them off with a nice, big compensation package.

Not surprisingly, highly sought-after target companies that are the object of several bidders will have greater latitude for negotiation. Furthermore, managers have more negotiating power if they can show that they are crucial to the merger's future success.
Execute a Poison Pill or Some Other Hostile Takeover Defense – A poison pill scheme can be triggered by a target company when a hostile suitor acquires a predetermined percentage of company stock. To execute its defense, the target company grants all shareholders - except the acquiring company - options to buy additional stock at a dramatic discount. This dilutes the acquiring company's share and intercepts its control of the company.
Find a White Knight - As an alternative, the target company's management may seek out a friendlier potential acquiring company, or white knight. If a white knight is found, it will offer an equal or higher price for the shares than the hostile bidder.
Mergers and acquisitions can face scrutiny from regulatory bodies. For example, if the two biggest long-distance companies in the U.S., AT&T and Sprint, wanted to merge, the deal would require approval from the Federal Communications Commission (FCC). The FCC would probably regard a merger of the two giants as the creation of a monopoly or, at the very least, a threat to competition in the industry.

Closing the Deal
Finally, once the target company agrees to the tender offer and regulatory requirements are met, the merger deal will be executed by means of some transaction. In a merger in which one company buys another, the acquiring company will pay for the target company's shares with cash, stock or both.

A cash-for-stock transaction is fairly straightforward: target company shareholders receive a cash payment for each share purchased. This transaction is treated as a taxable sale of the shares of the target company.



If the transaction is made with stock instead of cash, then it's not taxable. There is simply an exchange of share certificates. The desire to steer clear of the tax man explains why so many M&A deals are carried out as stock-for-stock transactions.

When a company is purchased with stock, new shares from the acquiring company's stock are issued directly to the target company's shareholders, or the new shares are sent to a broker who manages them for target company shareholders. The shareholders of the target company are only taxed when they sell their new shares.

When the deal is closed, investors usually receive a new stock in their portfolios - the acquiring company's expanded stock. Sometimes investors will get new stock identifying a new corporate entity that is created by the M&A deal.


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Should you cheer or weep when a company you own buys another company?

Mergers and Acquisitions: Introduction

By Ben McClure


Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate companies together to form larger ones. When they're not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spinoffs, carve-outs or tracking stocks.

Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, or even billions, of dollars. They can dictate the fortunes of the companies involved for years to come. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time. Next time you flip open the newspaper’s business section, odds are good that at least one headline will announce some kind of M&A transaction.

Sure, M&A deals grab headlines, but what does this all mean to investors? To answer this question, this tutorial discusses the forces that drive companies to buy or merge with others, or to split-off or sell parts of their own businesses. Once you know the different ways in which these deals are executed, you'll have a better idea of whether you should cheer or weep when a company you own buys another company - or is bought by one. You will also be aware of the tax consequences for companies and for investors


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Mergers and Acquisitions: Definition

The Main Idea
One plus one makes three: this equation is the special alchemy of a merger or an acquisition. The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. Two companies together are more valuable than two separate companies - at least, that's the reasoning behind M&A.

This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater efficiency. Because of these potential benefits, target companies will often agree to be purchased when they know they cannot survive alone.

Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things.

When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it's technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the takeover more palatable.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition.

Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders.

Synergy
Synergy is the magic force that allows for enhanced cost efficiencies of the new business. Synergy takes the form of revenue enhancement and cost savings. By merging, the companies hope to benefit from the following:
Staff reductions - As every employee knows, mergers tend to mean job losses. Consider all the money saved from reducing the number of staff members from accounting, marketing and other departments. Job cuts will also include the former CEO, who typically leaves with a compensation package.
Economies of scale - Yes, size matters. Whether it's purchasing stationery or a new corporate IT system, a bigger company placing the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or office supplies - when placing larger orders, companies have a greater ability to negotiate prices with their suppliers.
Acquiring new technology - To stay competitive, companies need to stay on top of technological developments and their business applications. By buying a smaller company with unique technologies, a large company can maintain or develop a competitive edge.
Improved market reach and industry visibility - Companies buy companies to reach new markets and grow revenues and earnings. A merge may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones.

That said, achieving synergy is easier said than done - it is not automatically realized once two companies merge. Sure, there ought to be economies of scale when two businesses are combined, but sometimes a merger does just the opposite. In many cases, one and one add up to less than two.

Sadly, synergy opportunities may exist only in the minds of the corporate leaders and the deal makers. Where there is no value to be created, the CEO and investment bankers - who have much to gain from a successful M&A deal - will try to create an image of enhanced value. The market, however, eventually sees through this and penalizes the company by assigning it a discounted share price. We'll talk more about why M&A may fail in a later section of this tutorial.

Varieties of Mergers
From the perspective of business structures, there is a whole host of different mergers. Here are a few types, distinguished by the relationship between the two companies that are merging:
Horizontal merger - Two companies that are in direct competition and share the same product lines and markets.
Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker.
Market-extension merger - Two companies that sell the same products in different markets.
Product-extension merger - Two companies selling different but related products in the same market.
Conglomeration - Two companies that have no common business areas.

There are two types of mergers that are distinguished by how the merger is financed. Each has certain implications for the companies involved and for investors:
Purchase Mergers - As the name suggests, this kind of merger occurs when one company purchases another. The purchase is made with cash or through the issue of some kind of debt instrument; the sale is taxable.

Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company.

Consolidation Mergers - With this merger, a brand new company is formed and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.


Acquisitions
As you can see, an acquisition may be only slightly different from a merger. In fact, it may be different in name only. Like mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhanced market visibility. Unlike all mergers, all acquisitions involve one firm purchasing another - there is no exchange of stock or consolidation as a new company. Acquisitions are often congenial, and all parties feel satisfied with the deal. Other times, acquisitions are more hostile.

In an acquisition, as in some of the merger deals we discuss above, a company can buy another company with cash, stock or a combination of the two. Another possibility, which is common in smaller deals, is for one company to acquire all the assets of another company. Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Of course, Company Y becomes merely a shell and will eventually liquidate or enter another area of business.

Another type of acquisition is a reverse merger, a deal that enables a private company to get publicly-listed in a relatively short time period. A reverse merger occurs when a private company that has strong prospects and is eager to raise financing buys a publicly-listed shell company, usually one with no business and limited assets. The private company reverse merges into the public company, and together they become an entirely new public corporation with tradable shares.

Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved.


Read more: http://www.investopedia.com/university/mergers/mergers1.asp#ixzz2Ctzq6VA5

Wall Street Prep Lessons: Cash Flow, DCF, WACC, LBO, M&A, Trading and Transactions

Latexx Partners says Navis has sufficient funds for takeover

Latexx Partners says Navis has sufficient funds for takeover
Written by Joseph Chin of theedgemalaysia.com
Wednesday, 02 February 2011 08:49


KUALA LUMPUR: LATEXX PARTNERS BHD [], which received a takeover offer from Navis Asia VI Management Company Ltd, has vouched that the fund management’s RM852.03 million offer would not fail as it has sufficient resources.

In reply to a query from Bursa Malaysia, Latexx said on Wednesday, Feb 2 that Navis confirmed that it had sufficient financial resources to undertake the acquisition as it currently has over US$3 billion in capital under management and had sufficient unutilised funds for the acquisition.

On Monday, Navis Asia offered RM852.03 million to acquire all of Latexx’s assets and liabilities for RM852.03 million or RM3.10 per share, which was 30 sen above the last traded price of RM2.80.

Latexx also said the takeover was in the best interest of of the company as the offer price was a premium of about 20% over the pre-disturbance closing price of RM2.58 per share (that is closing market price on Jan 26) and about 19.7% over the five-day volume weighted average market price up to Jan 26.

“The offer price represents a premium of approximately 189% over the unaudited consolidated net assets per share of the company as at Sept 30, 2010 of RM1.07 and a premium of approximately 260% over the audited consolidated net assets per share of the company as at Dec 31, 2009 of 86 sen,” it said.

Latexx added the acquiror’s track record reflected their ability to grow the business after the acquisition.

“After having considered the factors above, the board believes that the disposal is in the best interest of Latexx. The board will be appointing a principal adviser and an independent adviser to advise the shareholders on the fairness and reasonableness of the proposal,” it said.

It added the board does not intend to maintain the listing status of Latexx and the company will be delisted after the distribution of the cash and/or securities to shareholders and warrantholders.

A Winning Stock Strategy: Sell on the Rumor

MARKETS & FINANCE
January 13, 2011, 5:00PM EST

A Winning Stock Strategy: Sell on the Rumor
Companies named as acquisition targets typically deliver disappointing returns for investors

By Tara Lachapelle

The surest way to profit from takeover speculation in the stock market is to bet it's wrong.

Bloomberg examined 1,875 rumors about pending buyouts of 717 companies from 2005 to 2010 and found a total of 104 of those companies were acquired. While stocks that were the subject of takeover speculation initially jumped, they tended to decline over ensuing weeks. An investor who sold such stocks short—selling borrowed shares in hopes of buying them back at a lower price later—would have earned average profits of 1.2 percent over the next month, an annualized gain of 14 percent.

It's a strategy John S. Orrico has used. "We see it as an opportunity to sell if we think the rumor is false or ridiculous, which in most cases" it is, says Orrico, who focuses on mergers and acquisitions at New York-based Water Island Capital, which oversees about $2.2 billion.

Opportunities to employ the strategy are increasing as the stock market climbs and merger activity picks up. The number of unconfirmed stories about possible mergers surged to 611 last year, a 71 percent increase from 2009, data compiled by Bloomberg from more than 50 news providers and brokerages show.

Stocks tracked by Bloomberg gained 2.9 percent on the day they were mentioned in a takeover story. They fell 0.2 percent, 0.6 percent, and 1.2 percent, on average, in the day, week, and month following a reported rumor. The Standard & Poor's 500-stock index rose 0.03 percent, 0.2 percent, and 0.5 percent, on average, during the same periods. That makes sense to Todd Salamone, an equity analyst at Schaeffer's Investment Research in Cincinnati, who says that by the time market chatter is publicly reported, it's been passed around trading desks via instant messages and e-mail and is usually old news. While "the rumors tend to create a pop," he says, "it's a very short-term event."

Akamai Technologies (AKAM) has been the subject of more buyout rumors than any other U.S. company since the beginning of 2005, Bloomberg research found. The provider of computing services that speed delivery of Internet content remains independent after being named 21 times. The most recent instance was Dec. 16. After rallying 1.7 percent when the speculation was reported, shares of the Cambridge (Mass.) company lost 3.8 percent in the next week, while the S&P 500 gained 1.1 percent. Spokesmen for all the companies in this story mentioned as takeover targets either declined to comment or did not respond to requests for comment.

NetList (NLST), a computer memory systems maker, rose 1.9 percent, to $5.52, when rumors were reported on Dec. 28, 2009 that Microsoft (MSFT) might buy it. The shares declined 2.2 percent a day later, 9.4 percent a week later, and 31 percent in 30 days. "NetList makes memory modules that go into servers, so Microsoft is not the type of company that would want to go and buy them," says Richard Kugele, an equity analyst at Needham & Co. "There's a difference between hardware companies and software companies, and it's just completely outside the bounds of what they do."

Even when they coincide with other bullish signals, rumors usually don't prove accurate. The volume of call options in Jefferies Group (JEF)—giving the holder the right to purchase the stock at a certain price—jumped amid unconfirmed takeover reports on Feb. 27, 2008. A deal never occurred, and Jefferies stock plummeted 3.4 percent the next day and 10 percent the next week. It had fallen a total of 20 percent 30 days later.


Some stocks are acquired after years of speculation. OSI Pharmaceuticals (OSIP) was the subject of takeover talk nine times from 2005 to 2009, and the shares slipped on eight of those occasions. The stock jumped 52 percent on Mar. 1, 2010, the day Tokyo-based Astellas Pharma said it would begin a hostile offer. There's no record of any takeover rumors in the days leading up to the announcement. Astellas bought OSI on June 9.

Many rumors are losers from the start. MetroPCS Communications (PCS), the wireless network, lost 1 percent on Sept. 21, 2009, after a news service reported chatter about a potential bid. The stock fell 34 percent over the next month and 49 percent for all of 2009, when the shares posted the fourth-biggest retreat in the S&P 500.

"The question that remains unanswered is: Where does the takeover story originate?" says Michael McCarty, managing partner at Differential Research in Austin, Tex. "It's most likely from someone who's interested in selling." Deliberately spreading false rumors may violate securities laws, especially if the intent is to sway prices, says James D. Cox, a professor at Duke University School of Law. Proving a market manipulation case is difficult, according to Peter J. Henning, a law professor at Wayne State University and a former federal prosecutor. "You might be able to see a unicorn before you see a market manipulation case established based on rumors," he says, adding that it is difficult to prove that someone started a rumor and then traded on it. "You get lots of investigations announced and very few cases brought," he says.

Overall, Bloomberg found that companies mentioned in takeover rumors were no more likely to be acquired than any other company. The safest strategy might be to avoid investing on gossip entirely. "Don't chase rumor stocks," says Michael Vogelzang, chief investment officer at Boston Advisors. "You never know where you are in the chain, whether you're the first to hear it or the last. You're just playing with fire."

The bottom line: Stocks that are the subject of takeover rumors jump, then fall, making short sales a winning strategy. Ignoring rumors works, too.

Lachapelle is a reporter for Bloomberg News.

http://www.businessweek.com/magazine/content/11_04/b4212036681349.htm?link_position=link1

US Supreme Court Addresses "Fair Price" and "Fair Value" in Appraisal Proceedings

Posted on December 31, 2010 by Francis G.X. Pileggi

Supreme Court Addresses "Fair Price" and "Fair Value" in Appraisal Proceedings; Declines to Adopt Bright Line Rules for Appraisal Proceedings

In affirming the Court of Chancery’s finding of fair value in an appraisal proceeding, the Delaware Supreme Court in Golden Telecom, Inc. v. Global GT LP, declined to adopt two bright line rules urged by the parties on appeal. Slip op. No. 392, 2010 (Del. Supr. Dec. 29, 2010). Read opinion here. Instead, the Supreme Court held that: (1) in an appraisal proceeding pursuant to 8 Del. C. § 262, the Court of Chancery must take into account all relevant factors and need not defer, either conclusively or presumptively, to the merger price as indicative of fair value; and (2) companies subject to an appraisal proceeding are not bound by the data in their proxy materials. The Supreme Court also held that the abuse of discretion standard of review for appraisal cases is a formidable standard wherein the Supreme Court will defer to the Court of Chancery even where the Supreme Court may have independently reached a different decision.

This summary was prepared by Kevin F. Brady and Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.

The Merger and the Petition for Appraisal

In early 2007, Open Joint Stick Company Vimpel-Communications (“Vimpel-Com”) notified Golden Telecom, Inc. (“Golden”) that Vimpel-Com was interested in acquiring Golden. Because the two largest shareholders of Golden were also the two largest shareholders of Vimpel-Com, Golden formed a special committee of independent directors. After nearly three months of negotiations, the special committee ultimately recommended and the Board approved the merger at $105 per share. Golden and Vimpel-Com executed a merger agreement with a cash tender offer and a backend merger. Global GT LP and Global GT Ltd. (collectively “Global”) declined to tender its shares and sought appraisal. The Court of Chancery held that the fair value of Golden as of the date of the merger was $125.49.

Golden and Global Appeal

Golden appealed arguing that, among other things, the Court: (i) should have deferred to the merger price because it was an arms length transaction with an “efficient market price;” (ii) should have given some weight to market evidence; (iii) erred in considering a blended beta; and (iv) erred in accepting Global’s expert and its long term growth rate in its discounted cash flow analysis. Global cross appealed contending that the Court used the incorrect tax rate.

Fair Value Requires Independent Evaluation Not Deference to Merger Price

Relying on the language of § 262, the Supreme Court, stated that “fair value” is to be determined by “all relevant factors” valuing the corporation as a “going concern, as opposed to the firm’s value in the context of an acquisition or other transaction.” The Supreme Court also reasoned that “[s]ection 262(h) unambiguously calls upon the Court of Chancery to perform an independent evaluation of ‘fair value’ at the time of the transaction” and that “[r]equiring the Court of Chancery to defer—conclusively or presumptively—to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent.”

Court Refuses to Adopt Bright Line Rule

Global contended that in the appraisal proceeding, Golden should not have been permitted to walk away from the tax rate set forth in the fairness opinion. While the Court agreed that the primary purpose of fairness opinions is to convince shareholders that a merger price is fair, it declined to set forth a bright line rule because: (i) the appraisal process is a flexible process with the Court of Chancery having significant discretion in the factors it considers; (ii) section 262 does not require the Court to bind the parties to previously prepared data, but on the contrary requires consideration of “all relevant factors;” and (iii) “public companies distribute data to stockholders to convince them that a tender offer price is fair[;] [i]n the context of a merger, this ‘fair’ price accounts for various transactional factors such as the synergies between the companies.” The Court emphasized the distinction between valuation at the tender offer stage seeking “fair price” under the circumstances of the merger and valuation at the appraisal stage seeking “fair value” of the company as a going concern.

While the Supreme Court held that corporations subject to an appraisal proceeding may deviate from data in their proxy materials, the Court of Chancery “can—and generally should—consider and weigh inconsistencies in data advocated by a company.” In this case, the Court of Chancery had a “rational basis” for accepting the tax rate Golden relied upon in the appraisal proceeding, but not in its proxy.

Court of Chancery Did Not Abuse Its Discretion in the Valuation

The Court described the “abuse of discretion standard of review” as a “formidable standard” predicated on the Court of Chancery’s expertise in appraisal proceedings. Even where the Supreme Court might independently reach a different conclusion, the Court of Chancery’s decision will not be dismissed unless the factual findings are not supported by the record or the valuation is “clearly wrong.” The Supreme Court affirmed the Court of Chancery in this case because it “addressed each of these findings of fact and valuation methods, and [it] followed an orderly and logical deductive process in arriving at [the Court’s] conclusions . . . .”


http://www.delawarelitigation.com/2010/12/articles/delaware-supreme-court-updates/supreme-court-addresses-fair-price-and-fair-value-in-appraisal-proceedings-declines-to-adopt-bright-line-rules-for-appraisal-proceedings/

STRATEGY & INNOVATION May 26, 2010, 4:40PM EST

How to Succeed at M&A

All too often, mergers and acquisitions fail dismally. That, says Innosight's Mark Johnson, is because executives don't understand what they're really buying

By Mark W. Johnson

Companies constantly seek new growth opportunities, but organic new growth is far from a sure bet. While business model innovation is a powerful path to sustained, robust growth, new businesses can take years to mature. The skills needed to conceive and incubate them present a unique set of challenges that many companies find difficult to overcome. "A large enterprise has trouble making an investment in innovation," says Brad Anderson, the recently retired CEO of electronics retailer Best Buy (BBY). "It's in part because Wall Street has trouble imagining a new way to operate but, more important, because people inside the company can't see the value of a new idea and so won't allocate the resources and support the new initiative needs to succeed."

But organic growth is not the only option available to companies seeking transformational growth. Though most of my book Seizing the White Space: Business Model Innovation for Growth and Renewal is dedicated to developing new business models within incumbent organizations, I don't mean to imply that incumbent companies shouldn't seek to achieve transformative growth and exploit opportunities in their white space through mergers and acquisitions—they should. Building models in-house is not the only option for companies seeking transformational growth. Corporations can transform their business models through acquisitions as well. When Anderson took over Best Buy, in fact, he led the company through a series of strategic acquisitions that helped it grow beyond a pure retail sales model.

But it's no news to point out that acquisitions, at the best of times, are tricky. Study after study finds that acquisitions tend to disappoint, variously estimating that half to as many as 80 percent fail to create value. The high-profile struggle of AOL (AOL) after its $180 billion acquisition of Time Warner (TWC) is one obvious example of an acquisition gone bad. But there are others: Daimler/Chrysler, Sprint/Nextel, and Quaker Oats/Snapple, to name only a few. Quaker Oats paid $1.7 billion for the Snapple brand in 1994 but sold it to Triarc three years later for a mere $300 million.

BUSINESS MODEL DEVELOPMENT

I believe many M&A disappointments stem from a failure to understand the fundamentals of business model development. When one company buys another, what it's really purchasing is the target company's business model—its customer value proposition, its profit formula, its resources, and its processes. The new company's resources can be folded into the core of the acquiring company, but new business models resist such integration. Consequently, successful acquisitions tend to fall into one of two camps. 

• An acquirer can buy a company solely for its resources, which it would then fold into its own business model, while jettisoning the rest. The bulk of Cisco's (CSCO) acquisitions follow that pattern. 
• Alternatively, a company can seek to acquire another company's business model, which it then needs to keep separate, but can strengthen by injecting into it its own resources. That's what Best Buy did with Geek Squad.

Johnson & Johnson (JNJ) has understood this, buying business models at an early stage and then keeping them separate. For example, its Medical Devices & Diagnostics (MD&D) division bought three business models that were fundamentally new to its respective markets: Vistakon (disposable contact lenses), LifeScan (at-home diabetes monitoring), and Cordis (artery stents used in angioplasty procedures). J&J bought these companies young and incubated them into the larger enterprise, where they became the growth engine of the MD&D division for many years.

All too often, attempts to fold an acquired business into the core can kill what made it unique in the first place. Video game maker Electronic Arts (ERTS) learned this the hard way. Propelled by investor expectations, rising development costs, and an industry consolidation trend, EA aggressively bought up small companies led by creative teams that had found success in the market. To profit from anticipated economies of scale, it built up a standardized technical infrastructure and imposed streamlined production processes on its new acquisitions.

The results were abysmal. EA fell into a pattern of producing mediocre products based on movie licenses and sports franchises, which were updated each year. Forcing creative teams to follow core processes was killing their innovative spirit. Luckily, CEO John Riccitiello saw the writing on the wall and announced a sea change in EA's operations: Independent creative studios would operate as "city-states" within the EA corporate structure.

ACQUIRED MODEL TAKES WHAT IT NEEDS

Most of the principles that govern the incubation, acceleration, and transition of homegrown new business models apply to acquired ones as well. Equally important is leadership's ability to allow a newly acquired business model to pull what it needs from the core, rather than having elements of the core model pushed onto it. Best Buy's Brad Anderson expressed this idea succinctly when, referring to the Geek Squad deal, he said, "Geek Squad bought Best Buy, not the other way around."

Anderson knew that the new model would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad's 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer's bottom line.

As Vijay Govindarajan and Chris Trimble noted in Ten Rules for Strategic Innovators, a newly acquired business based on a model distinct from the core should decide what it can borrow from the parent, what it should forget (or forget about), and what it will do or learn that is completely new. The key to understanding what to forget and what to learn lies in the business model. You must understand both your own business model and the new company's model completely, so you won't throw away the most valuable thing you bought—the very thing that will help your company grow.

Mark W. Johnson is Chairman and Co-Founder of innovation consulting and research firm, Innosight. He is the author ofSeizing the White Space: Business Model Innovation for Transformative Growth and Renewal, (Harvard Business Press, February 2010) and a co-author of The Innovator's Guide to Growth (Harvard Business Press, July 2008).

http://www.businessweek.com/innovate/content/may2010/id20100525_156769.htm