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AB InBev SABMiller logo

Energy and persistence conquer all things (Benjamin Franklin)

After four unsuccessful bids, it is befitting that the deadline set by the U.K.’s Takeover Panel for beer giant Anheuser-Busch InBev NV to submit a fifth and final offer for SABMiller Plc. was extended to 5 p.m. GMT on 11th November : Armistice Day !

Sabmiller-share-priceRumours that AB InBev were about to bid for SABMiller started over twelve months ago, gaining substance shortly afterwards. What ensued was a succession of bids of ever increasing value to seduce the initially reluctant shareholders of SABMiller – until they surrendered to a staggering offer of USD 107 billion, or £ 71 billion. They can hardly be blamed for grabbing the cash and running, given that SABMiller’s share price at the end of November stands 37% higher than it was on 14th September, as a direct result of AB InBev’s mounting bids. Whilst SABMiller’s share owners might drink to celebrate having realised value growth earlier than expected, many other stakeholders are guaranteed a nasty hangover as a result of the forthcoming merger.

The combined business is set to rake in annual revenues of USD 73 billion, which is more than companies such as Pepsico or even Google. But more importantly, the integration of the two companies aims to generate annual cost synergies of USD 1.4 billion, a significant part of which will come from headcount cuts. With AB InBev employing 155,000 people worldwide, and SABMiller a further 70,000, it is easy to imagine how much duplication there will be at headquarter level as well as in many back-office functions. Having paid 15% more to acquire SABMiller than their initial bid of £ 38 per share, there is no doubt the pressure to realise the cost synergies very fast will be extreme.

A foreseeable domino effect on the beer market

Combined-brandsBeyond the USD 1.4 annual savings, much of the business case underlying the acquisition of SABMiller rests on growth in Africa and Latin America. This is because AB InBev cannot expect much growth in Europe and North America where consumers are beginning to seek product differentiation and thereby generating growth at the other end of the beer market spectrum : micro-breweries or so-called “craft brewers”.

Nonetheless, the combined companies’ market share in North America and the fact that AB InBev own wholesale distributors in several states of the USA might be sufficient to restrain the route to market of many smaller players and this may reduce consumer choice in bars and retail outlets; so this could be bad news for those who have thus far developed well by offering consumers something that differs from the usual mass product.

Global market share of five biggest beer companies

Anheuser-Busch InBev – 20.8%

SABMiller – 9.7%

Heineken – 9.1%

Carlsberg – 6.1%

China Resources Enterprise – 6%

Source: Euromonitor, based on 2014 figures

In spite of SABMiller selling its stake in a venture with Molson Coors for USD 12 billion and thereby letting go of the Coors and Miller brands, the combined AB InBev and SABMiller will be selling one in every three pints of beer worldwide, leaving a huge market share gap between themselves and the next player on the podium. Heineken and Carlsberg must now be furiously re-thinking their strategies; a number of other takeovers and mergers will inevitably happen as the industry seeks a new equilibrium.

According to Bart Watson, chief economist at the Brewers Association, there are already rumours about a Heineken and Molson Coors tie-up as these two companies are now seeing their main competitor become even bigger. Others are likely to follow. Some companies such as Diageo, which is now focusing on its spirits business, could stand to benefit from this new wave of upheaval on the beer market by finding an acquirer prepared to pay over the odds for Guinness as the few remaining global players grapple to keep pace with AB InBev / SABMiller. Interesting times ahead…

Africa : two different interpretations of public health

My thoughts regarding the impact this merger will have on consumer choice have not changed since the blog I published in September 2014 (“Something big could be brewing”), but one new aspect which is now surfacing is the very strong opposition and criticism of the merger which is now emanating from public health circles regarding the African continent, which is a critical growth area in the combined company’s strategy. According to Dr Jeff Collin, director of the Global Public Health Unit at the University of Edinburgh, the AB InBev SABMiller merger aims to “exploit Africa’s low per capita consumption of beer” by targeting low income consumers to generate sales growth.

drunk-300x251In an article published in the British Medical Journal, a team of experts warn of “disturbing implications” relating to the growing alcohol related harm being witnessed in low and middle income countries. And therefore the issue is not specifically African, but also affects other regions targeted in the combined company’s growth plans, notably Latin America and China, the latter being the world’s largest beer market in which SABMiller has a joint-venture producing the country’s Nr 1 beer brand, Snow.

Unsurprisingly, SABMiller see things very differently, stating that more than half of the alcohol consumed on the African continent is what they call “informal”, in other words beverages produced in unregulated facilities, ranging from home made beer brewed in a back yard to dubious distilled beverages containing potentially dangerous by-products such as methylated spirits, reminiscent of the Moonshine that was distilled during the Prohibition in the USA. Based on that premise, SABMiller see their mission as a noble task; as per their spokesperson: “The backbone of SABMiller’s growth strategy in Africa is to ensure the affordability of our beers so that local, low income consumers move from drinking poor quality, and potentially lethal, alcohol to enjoying our high quality beers made with local ingredients.”

Many people will consider that strategy to be a little cynical; but there is one undoubtedly positive element in that statement: “local ingredients”. In the beer industry, the supply chain costs can be a substantial component of the value chain because of the unfavourable weight/volume to value ratio. Consequently, unlike wine and distilled beverages, there is a strong incentive for beer to be produced locally. And that, for emerging economies, is better than burdening the balance of trade with the cost of imported drinks.

Money now vs. safeguarding against a possible longer term threat

Beer on tapAs in the more developed economies, low and middle income economies will see a growing tension between the priorities of their public health programmes and the fiscal requirements of their treasury; migrating the production of beer from back yards and speak-easy environments to a registered and regulated business is a source of corporation tax and possibly some form of alcohol tax as well. This also promotes employment in hygiene conscious factories, which is also important in developing economies.

The authors of the article in the British Medical Journal argue that company’s proposed expansion in low and middle income countries “echoes that of transnational tobacco companies” whilst benefiting from less stringent regulation and controls. That might be the case, but faced with the dilemma of choosing between the certainty of a stream of income and the longer term avoidance of a possible health risk, I will not be surprised if the said low and middle income economies will welcome the growth of AB InBev/SABMiller in their respective countries.

Even in the absence of strong political opposition to the merging of the world’s two largest players, implementing the integration of these huge businesses will be a monumental task. Let’s wish them luck (and perseverance), and hope this will not end up with a big hang-over for all those involved. If it does, maybe the other mega-merger which is currently under discussion, namely the USD 160 billion bid by Pfizer to acquire Allegan, will be able to provide the cure to that hang-over!

A bitter saga

Shareholder concerns
A shareholder presentation by Sika’s management illustrates the extent to which the current acquisition offer has destroyed shareholder value both at Sika and Saint-Gobain

Whatever the outcome of the challenged take-over of Sika by Saint-Gobain, which was first announced in December 2014, there will be bitter lessons to be remembered in the future, and other companies whose capital structure includes shares with preferential voting rights might see their value plunge unless they can provide the clarity that is so obviously missing in the case of Sika.

When a minority shareholder holds the majority of the voting rights, that shareholder can unilaterally make decisions that serve self-interest but are seriously detrimental to the interests of the shareholder majority  –  and this is what is happening at Sika, whose founding family’s holding company owns 16% of the shares but 52% of the voting rights, allowing them de facto to do whatever they please.

An inevitable conflict of interest

German magazine BLICK asks how many jobs losses will be caused by what they describe as the Burkard family's appalling greed
German magazine BLICK asks how many job losses will be caused by what they describe as the appalling greed of the Burkard family (pictured above)

Saint-Gobain are offering a 78% premium for the stake of the Burkard family and it is easy to understand why that family is eager to accept the USD 2.9 billion they are being offered.  However, Saint-Gobain have no intention of making an offer on the rest of Sika’s capital; why acquire any more when their proposed acquisition of 16% of the capital will suffice to give them full control of the company.  It is hardly any wonder that the proposed transaction caused an immediate outcry from the remaining shareholders who claim that the deal should not be allowed to proceed unless a public offering is made for the remainder of the share capital.

Saint-Gobain and Sika are today direct competitors.  If the deal goes ahead, Saint-Gobain will only reap 16% of Sika’s future profits, therefore the synergies and any other benefits resulting from the acquisition will be biased to benefit Saint-Gobain far more than Sika, thereby weakening Sika and further undermining the value of the other shareholders’ investment.  These other shareholders include the Bill and Melinda Gates Foundation whose high profile has given the Saint-Gobain Sika deal worldwide exposure.  The Gates trust released a statement declaring that “the proposed transaction makes no strategic sense, is an affront to good corporate governance and is not in the interest of Sika’s business, employees, customers or public bearer shareholders”.  It is obvious from that statement that the Gates trust will fight tooth and nail to block the proposed sale. This is war.

The narrow interpretation of the law

Just like many other Swiss companies, and indeed companies across Europe, Sika’s articles of association contain a number of oddities, in this particular case an “opt out” clause which stipulates that a sale of 33.33% of the company’s voting rights can be made without an open public offer to bid for the rest of the capital.  As the Gates trust rightly states, this clause flies in the face of good corporate governance, but the Swiss federal administrative court confirmed on 1st September the opinion voiced earlier by Switzerland’s M&A Commission (COPA, Commission Suisse des OPA) that Sika’s opt-out clause is legal under Swiss law, according to which opt-out clauses must be challenged within 2 months of being introduced, after which they are binding. The only possibility of removing such a clause after that deadline is to modify the company’s articles of association, which requires a majority vote by the shareholders; quite a challenge when 52% of the votes are in the hands of the Burkard family who argue that investors in the company should have been aware of Sika’s share structure.

Nonetheless, whilst the COPA declared the opt-out clause to be legal, it did not attempt to clarify whether this particular instance the opt-out clause was being invoked in an abusive way.

New creative tactics and a criss-cross of legal challenges

With the opt-out clause confirmed as legal under Swiss law, but in theory still open to challenge as to whether it was being invoked in an abusive manner in this particular instance, the remaining shareholders sought other ways of proving that the Burkard family was serving its own interests to the detriment of the other shareholders and the company as a whole.  This was prompted by the Swiss trust fund ETHOS which requested at a shareholders’ meeting that the controversial opt-out clause be removed; the objective of that request was to prove that by opposing ETHOS’ proposal, the Burkard family was voting in self-interest and more importantly against the interest of the majority of shareholders.

To add to the confusion, it was unclear whether the special shares to be sold by the Burkard family were subject to the restriction requiring sales of more than 5% of the capital to be approved by the Board of Directors.  And in an separate further legal case, as the majority of the Directors are opposed to the transaction, the Burkard family is arguing they were prevented from using their full 52% voting rights to elect new Board Director and remove some of those in place.

In an additional layer of legal complexity, the Bill and Belinda Gates Foundation is now attempting to sue Urs Burkard, who represents the family and is the only member of that family on the Sika Board of Directors, for failing to act in the company’s best interest when he negotiated the sale of his family’s shareholding to Saint-Gobain.  Legal claims against specific members of a Board have a weaker legal basis in Switzerland than they would in the United States, and Urs Burkard’s spokesperson has so far dismissed the threat of such legal action.

So far, the only actors in this dramatic saga to benefit from the current criss-cross of recriminations and court cases have been the lawyers.

The final legal verdict vs. company reputation

Saint-gobainOn 15th September, the Swiss Competition Commission (COMCO) had little other choice than to unconditionally authorise the acquisition by Saint-Gobain of control over Sika, given the favourable ruling on that matter by the European Commission in July and the decisions made earlier by other competition regulators, particularly in China and in the USA.

Done deal? Not yet, mainly because of the on-going legal proceedings, but also because Sika’s directors and shareholders will continue to obstruct this acquisition by every possible means.  Initially, the deadline for closing the deal was set to year end of 2015, but that had to be extended to mid-2016.  A lot can still happen until then.

sika-logoUltimately, what might block the deal is the threat to the reputation of Saint-Gobain’s, whose share capital is largely in the hands of institutional investors who will not be impressed by Saint-Gobain’s contempt for shareholders.  If the deal goes ahead, Sika’s shareholders will forego the opportunity to benefit from the 78% premium being offered to the Burkard family, and face the prospect of future decline of their shares’ value. If the Bill and Belinda Foundation, whose backing of worthwhile causes is acclaimed the world over, is hit financially by the Sika Saint-Gobain transaction, Saint-Gobain may be faced with a well deserve torrent of negative PR.

Can a company hide behind legal court decisions to act unethically?  In theory the answer appears sadly to be yes, but if they do they will have to accept the consequences.

Food for thought …

Similar origins – different trajectories

Ferrero’s bid for Thornton’s marks the end of just over one century of history, as yet another British chocolate household name will be swept up by a foreign group, following in the footsteps of Cadbury in 2009 and Rowntree in 1988.  This will leave the relative newcomer Hotel Chocolat as the only significant specialised independent British owned chocolate manufacturer and retailer.

Thornton shop windowBoth Thornton and Ferrero began as little corner shops; their history is closely associated with their founding families.  But that is probably where the comparison stops.  Whereas Ferrero developed over the years into a formidable marketing machine, a game changer in the chocolate industry, Thornton remained anchored in tradition.  Oddly, it is that traditional image that appears to have attracted Ferrero; the remaining question being whether Ferrero will manage to brush away the “dusty” and “passé” aspects of that tradition, and fully exploit the concept of “authenticity” that underlies tradition.  Given their strong track-record as powerful communicators, transforming the image of Thornton’s is probably not beyond Ferrero’s reach, but it will be quite a task…

Once an up-market purveyor of luxurious chocolates, Thornton’s appears to have dispersed itself over the years, opening its own retail boutiques and diversifying into other categories of indulgent foods, notably ice cream.  In doing so, at no point did Thornton lead or even anticipate consumer trends, thereby missing the shift in taste preferences towards darker and more bitter chocolate compared to what consumers demanded in the 1980s and 1990s, and leaving the door open for the likes of Lindt to occupy that space.

Retail chains – Thornton’s last (and failed) attempt

With sales volumes declining below the critical mass that would be required to profitably run its large Derbyshire plant, and with insufficient cash-flow to justify its large network of retail boutiques, Thornton decided to aim for a step change in sales volumes by entering large retailers, without fully thinking through how their presence in hypermarkets and discount outlets might impact the brand’s already eroded premium image.  Transacting with giants such as Tesco requires a skill set, supply chain efficiencies and ways of working which Thornton appear not to have grasped, and therefore the mass retailer strategy that was supposed to revive Thornton after many years of continued declined turned out to be a failure.

There are only so many successive profit warnings a company can issue before it loses all credibility with its shareholders.  Thornton was getting to that point, and the arrival of Ferrero in that troubled environment can be considered as the deus ex machina  that will hopefully prevent Thornton’s from going into terminal decline.  By the own admission of Thornton’s former Chairman Peter Thornton, grandson of the chocolate maker’s founder, without Ferrero’s offer “The decline in performance would have continued and I think the decline would have been fatal.”

Radical change for Ferrero too

Yes, this stuff really tastes of hazelnuts
Yes, this stuff really tastes of hazelnuts!

The decision to make a significant acquisition to fuel growth marks a radical change in strategy by Giovanni Ferrero, months only after the passing away of his father who founded the company back in the 1940’s and became Italy’s richest citizen.  Until now, the Ferrero empire had grown organically and its acquisitions were focused on increasing production capacity and securing the supply of ingredients: today Ferrero is the world’s biggest consumer of hazelnuts, with 25% of the world’s annual supply used in its production plants. So why depart from such a brilliantly successful strategy?

Ferrero see value in Thornton's where the latter's shareholders had lost confidence (graph source Google finance)
An offer too good to refuse

Giovanni Ferrero argues that the acquisition of Thornton’s will pave the way for Ferrero to rapidly get a strong foothold in Britain, a market where the per capita consumption of chocolate and confectionery in general is high.  However, it did not take any acquisitions for Ferrero to become extremely successful in Germany where the retail scene is harsh and competitive, so why acquire a struggling company to develop in the UK?  Maybe there is an intention to gradually reduce the group’s reliance on Hazelnuts, the price of which has risen steadily in recent years.  That, combined with fluctuating costs of cocoa caused by failed crops and the risk of a global shortage within a decade, means that some diversification may pay dividends over time, branching out in sweets and other types of confectionery.

Seeking the common ground

In the meantime, it will be interesting to observe how the quintessentially British Thornton company will fold into the Ferrero Group which bears the hallmark of its founding family and of Giovanni Ferrero, heir of the Ferrero dynasty, who appears keen to affirm his strong leadership.  Ferrero have stated that the Derbyshire factory will be maintained, but have not commented on how much may change within its walls. However, as the world continues to gobble up ever increasing quantities of Nutella®, Kinder® chocolates and TicTac® sweets, the underused capacity in Derbyshire may be put to good use.

Importantly, no comment has been issued as to where the British company’s management will be located, nor what its remit will be within the Ferrero group.  That was probably wise as it may take a while to determine how much of a shake-up is required to rectify Thornton’s past errors, put the brand back onto a path for success, and use that platform as a Trojan Horse to accelerate the growth of Ferrero’s product portfolio in the UK.

Meanwhile, an imaginative competitor is succeeding where Thornton failed

Hotel Chocolat: a touch of class
Hotel Chocolat: a touch of class

An interesting example that brilliantly illustrates the value and potential of differentiation is the emergence and rapid growth in the UK of Hotel Chocolat since 2003.  Previously named Choc Express (see how some names can project a sense of premium exclusivity and others convey mere convenience), Hotel Chocolat opened its first retail boutique in Watford (not in London’s Bond Street which is more suited to super-premium brand Godiva), and has focused on the premium end of the chocolate market, with strong visual appeal and a packaging that is miles away from the traditional (boring) box of chocolates that can be found on any supermarket shelf.

Thornton's: traditional or "passé"?
Thornton’s: traditional or “passé”?

To further distance itself from mass market chocolate manufacturers, Hotel Chocolat acquired it’s own cocoa plantation on the West Indies island of St Lucia in 2006, on which it opened the Boucan Hotel four years ago.  So yes, there really is a “Hotel” Chocolat and, more importantly, there is a space on the seemingly mature and crowded chocolate and confectionery market in the UK for a new-comer that arrives with fresh, fun ideas and can satisfy the consumers’ desire for self-indulgence.  Hotel Chocolat received the Emerging Retailer of the Year award from Retail Week, and was also nominated as one of Britain’s CoolBrands®, voted for by marketing experts, business professionals and thousands of British consumers whose input was collected by the Superbrands UK panel.

A quick glance above at the illustrations of this year’s Thornton’s and Hotel Chocolat’s summer collections as published on their respective websites leaves no doubt as to which of those two brands has knocked the other off the pedestal of premium chocolate brands.

So what’s next?

As a privately owned company, Ferrero does not need to disclose its strategy to the world, and nobody at this stage can be certain of what is going through Giovanni Ferrero’s mind.  Does he really intend to revive the Thornton brand?  Can the Thornton retail outlets be used as a channel for a premium Ferrero/Thornton range whilst Nutella, Ferrero Rocher and Kinder® products continue to flow through high-street shops and retail chains?  How important are the Derbyshire factory and the know-how of some of its staff to Ferrero’s global manufacturing foot-print?

My many years spent at Diageo, and in United Distillers before that, have given me a number of opportunities to see how difficult, painstaking and costly it can be to attempt the revival of a tired brand.  Tired brands often enjoy a high level of notoriety, and many marketers will see this as a fantastic short-cut compared to the time and investment it usually takes to build any awareness of a new brand. But what if a brand is renowned for all the wrong reasons?  Changing well anchored perceptions can be more difficult that building a brand image from scratch.  If Ferrero manage that feat with Thornton’s, they will again have proved their marketing genius.

Meanwhile, let us hope that Thornton’s decline will not be accelerated by the upheaval caused by their integration into the Ferrero group, and that the latter will not get distracted by this integration to the detriment of its sharp marketing and sales focus.  That will depend on how well the post acquisition integration will be planned and orchestrated.

Baked beans on toast for two of the world’s richest men

Kraft-Heinz-Main-BrandsBrazil’s richest man Jorge Paulo Lemann has teamed up with Warren Buffett to engineer a deal to merge with Heinz which will not generate much enthusiasm amongst the gourmet elite of this world.  But the Kraft Heinz merger has everything it takes to get financial markets excited, with the promise of USD 1.5bn annual savings by 2017 and combined sales of USD 29bn, making the future group North America’s third largest food and drink company and the world’s fifth.

Two unknowns remain.  Will the Kraft Heinz Company manage to generate growth beyond the annuity it will derive from savings in overhead costs?  And can it develop new product lines to evolve away from the very 1970’s image that characterizes much of the present range?

Why Oscar Mayer dogs, Mayo®, HP Sauce®, Jell-O®, Philadelphia® and Kool-Aid® can still generate billions

Changing living patterns and the increasing involvement of women in full-time employment created fast growing demand for time-saving foods through the 1950s until the early 1980’s; this was an era of instant coffee and Wonder Mash® which also witnessed the global expansion of fast-food restaurant chains.  But the world has moved on since the days of Macaroni and cheese.  Improvements in Supply Chain efficiency combined with advances in food science now allow supermarkets to offer a broad choice of ready meals of increasing sophistication.  Today, “convenience” also includes anything from fresh ready-to-eat mango salad to ready-to-cook peeled vegetables, as well as meal modules which consumers can combine to produce healthy balanced meals, with a starter, a main course and a dessert if they so desire, that provide the taste, nutrition value and visual appeal of the “real thing” without all the fuss of starting with basic ingredients.

So with every consumer survey telling us that people are now opting for organic or at least more natural foods from sustainable sources, and with the abundance and variety of quality foods on today’s supermarket shelves, how is it that companies such as Kraft and Heinz still manage to achieve sales that combine to USD 29 billion?

Karft-Portfolio
Kraft’s broad portfolio of brands will add to the Heinz range.
Now spot the missing item : the healthy option

Part of the explanation is to be found in the significant price gap between today’s high quality fresh products and run-of-the-mill heavily processed foods.  The average household’s budget priorities have changed over the past decade, with electronic gadgets, leisure and entertainment claiming an increasing share of the consumer’s wallet.  It is tempting for large families or for those on lower income to make savings on food when cheap alternatives can provide the same feeling of satiety at a fraction of the cost of the fancier items beautifully displayed on the supermarket shelves.

Secondly, one also needs to bear in mind that decades of mass-produced processed foods have created a degree of addiction to sugar, fat and salt, so that the consumers who opt for a large plate of French fries smeared with a generous layer of Heinz Ketchup may do so by choice rather than as a result of financial constraints.

There is, however, pressure from all sides to move consumers away from the heavily processed and generally unhealthy types of foods that come off the production-lines of companies such as Heinz and Kraft.  Eating habits do not change overnight, but the change will happen gradually.  Increasingly, the cost saving will become the only justification for buying “junk” food, and when that is the case, consumers guided by the need to make savings might opt for a supermarket’s own brand or a completely generic product rather than “premium branded” processed food.  This is not good news for the future Kraft Heinz Company in the longer term.

Management style will change things faster than eating habits

When Brazilian 3G and Warren Buffet’s Berkshire Hathaway acquired Heinz in 2013 and took the company private, it must clearly have been part of their plan to make another acquisition in that sector to create a paradigm shift within Heinz and change the balance of forces on the market.  Merging with Kraft turns that potential into a reality.  The shake-up is about to begin.

Jorge Lemann
3G’s Jorge Lemann
Warren Buffet
Warren Buffet

3G have acquired a reputation for very aggressive cost cutting, not just the excess or even the frills, but deep cuts everywhere possible whilst also challenging the priorities and seeking solid justification for any capital project or major item of expenditure.  Advertising costs are therefore most likely to be put under close scrutiny.  In my first job in the 1970’s as advertising research executive in one of London’s major advertising firms, my line manager told me “advertising is a unique product: we don’t know how it works, the client cannot tell for sure whether it works or not, and if it doesn’t the client doesn’t get his money back”.  3G surely won’t see it that way and today’s advertising gurus will need to come up with convincing reasons to justify every dollar of advertising spend if they want to retain the Kraft Heinz Company’s account.

Once the fat and duplication has been trimmed off the combined business and further savings are achieved through wiser allocation of sales and marketing funds, let us hope that the Kraft Heinz Company will re-invest some of their USD 1.5 billion annual saving into developing new lines of food to regenerate their portfolio, fuel longer term growth, and preserve the notoriety of those household brand names.

No celebrations for the banks this time

As not all mergers end up being successful, conventional wisdom would say that mergers and acquisitions present shareholders with the potential for value creation, whereas they offer banks and advisers immediate value through fees and financing arrangements.  The deal struck by Warren Buffett and Jorge Paulo Lemann is about to cause a serious dent in that conventional wisdom.

A merger of the magnitude of Heinz and Kraft’s would normally be toasted with champagne by the investment banks whose names invariably pop-up each time a deal is struck.  But in this particular case, the only toast will be the one covered in humble Heinz baked beans, because the two giants behind the deal are sitting on huge cash reserves and will not need big financing.  This means that Wall Street’s major banks will all miss out on their share of what is currently being tagged as the biggest M&A deal of 2015.

Oh well, we’ve only just reached the end of Quarter 1, there is still some time for other big guys to spark off a few more “biggest M&A deals of 2015” during the coming nine months.

How can two world-renowned business leaders commit first-time-beginner mistakes ?

Told you so …

Some critics, journalists and experts from all walks of life relish in pointing out how accurately they had predicted a business failure many months before it occurred.  One year exactly after Publicis and Omnicom announced their plan to merge, I don’t take much pride in having spelt out at the time what would happen to their phantasm of becoming the world’s largest marketing services company:  John Wren and Maurice Levy’s proposed scheme contained all the misconceptions and glaring mistakes one can possibly make in a merger or acquisition.  A real beginners’ job.  It is actually quite shocking to see two internationally respected businessmen totally ignoring some of the basic rules they could have found in the introduction of “Mergers and Acquisitions for Dummies”, which is easily available from Amazon alongside my own “Perfect M&As – The Art of Business Integration”.

Visualising the end game

Before and After : Publicis's Maurice Levy, all smiles as the merger project was announced.
Before and After : Publicis’s Maurice Levy, all smiles as the merger project was announced.

The Publicis-Omnicom proposed deal did not rest on a compelling business case, and in the absence of a clear and credible statement of the benefits the merger will

provide, one cannot expect to have the drive and motivation to overcome the many hurdles and challenges that need to be resolved as two organisations blend to become one.  Who is the individual that will set the tone? What will the resulting merged company look and feel like considering the two companies each have a strong but very different culture?   How well will Wren and Levy agree on key decisions?  The answer to this last point became blatantly obvious: not being able to agree on the nomination of the CFO is just so basic one struggles to understand how Messrs Wren and Levy allowed themselves to reveal with such enthusiasm and optimism a plan for which the first elementary steps had not even been thought through.

By Omnicom’s chief executive’s own admission : “There was no clear finish line in sight”.  How is it conceivable that such senior and supposedly experienced business leaders could ignore the most basic prerequisites of a successful business integration?

Preparation, preparation, preparation

Maurice Levy has to recognize the glaring shortfalls of the Publicis - Omnicom merger plan
Maurice Levy has to recognize the glaring shortfalls of the Publicis – Omnicom merger plan

It will take a good autopsy of this failed merger to reveal how much (or how little) advice the two companies had requested and received and considered prior to announcing their merger plan to the world.  Was there really that little due diligence prior to the announcement, or did the two businessmen simply ignore any warning signs they might have been given? Were they blinded by the prospect and thrill of becoming the world’s number one agency, bigger, better and bolder than Sir Martin Sorrell’s WPP? When Publicis and Omnicom announced their intention to merge, my article referred to “The obsession with size”.  Was this finally just about two over-inflated egos, or was there truly a cogent business rationale which failed to materialise?

How is it that nobody had anticipated that tax considerations would invalidate the complex structure on which the proposed combined company was due to be set-up?  Last year, in writing “shareholders vote by raising their hand, but clients can vote with their feet”,  I was wondering how forcing fierce global rivals such as Coca-Cola/Pepsi, Nestlé/Mars or Microsoft/Google to deal with one combined agency would not run into regulatory problems or result in some of those key clients seeking other options.  Now it transpires that amidst the difficulties to keep the merger on track, talent and client retention also became a big challenge: is that at all surprising?

Maintaining focus

Any book or “how to” manual on M&A will tell you that one of the big challenges during the merger process is to manage the dual focus of keeping day-to-day business on track whilst maintaining the integration drive.  Publicis already had a few problems of its own to resolve prior to the merger announcement, and attempting a complex merger in that state is like covering rust with glossy paint that will not take long to peel off.  In the absence of clear succession plans in Publicis Maurice Levy had already postponed his retirement before the merger proposal was on his radar screen, so by what miracle would the key pieces of the puzzle all fall beautifully into place in a combined Publicis-Omnicom organisation if Publicis could not figure out how to organise itself as a stand-alone entity?

Predictably, the uncertainty and lack of unity of vision that rapidly emerged after the merger announcement proved a huge distraction to the business.  Now the engagement is over, and the bruised fiancée is licking her wounds.  Publicis’s shares have dropped 16% since the beginning of the year, wiping off EUR 1.8 billion of the company’s value, with a drop in net income and further margin erosion,  whilst Omnicom announces a healthy rise in revenue.

After such a poor performance, Maurice Levy had better return to his desk and thrash out a coherent succession plan to restore clarity within Publicis, as many shareholders will feel he has reached the end of his shelf-life.

 

A month of intense courtship ends in rejection

When Pfizer, the inventor of Viagra, announced on 28th April its interest in acquiring AstraZeneca,  the latter’s shares jumped by more than 14% and kept investors on the edge of their seats during a whole month as they watched the bid rise higher and higher, but not enough for AstraZeneca’s leadership to surrender to such courting.

Whereas AstraZeneca’s shares were worth £37.81 in mid-April, Pfizer’s £55.00 final offer was still deemed not attractive enough, and one may wonder what makes AstraZeneca’s boss Pascal Soriot so confident that his company is worth more than the 45% premium Pfizer was prepared to pay.  Now, it’s “game over”, this dramatic game of poker saw AstraZeneca’s shares climb to £43.28, and they have continued to hover within the £42.50 to £43.00 space since rejecting the Pfizer offer. 

So is this a realisation by investors that AstraZeneca is worth more than the market had rated until a month ago or, as would appear far more likely,  could this just be the consequence of Chairman Leif Johansson’s admission, after Pfizer had declared their £55.00 bid to be “final”, that a £58.85 bid might be considered?

Growth projections or bluff?

Worldwide, the levels of investment and effort in bioscience have reached dizzy heights, and major breakthroughs are expected that will revolutionise the treatment of cancer, diabetes, Alzheimer’s and other threatening illnesses.  In this race to find the Holy Grail, whoever is first in commercialising these revolutionary drugs wins the prize.  AstraZeneca have argued strongly that they are on the verge of releasing that breakthrough, particularly in the area of cancer treatments, but competitors such as Novartis, Merck or Roche are also in that race and it will be tough.

The dramatic escalation of Pfizer’s bids and AstraZeneca rebuffs has now placed self-inflicted pressure on the latter’s management; substantiating its self-assessed value assumes that AstraZeneca’s revenues will grow by 75% over the next eight years.  This will require not just one but several breakthrough drugs and those hopes could be dashed if competitors come up with similar drugs within that same timeframe.

Call in the politicians for some emotional debate

In retrospect, it is also possible that Pfizer may have chosen a bad time to launch its bid. Beyond the mere question of money (which in itself was not negligible as AstraZeneca proudly declined the industry’s largest ever deal), much of the debate will have focused on the future of bioscience and Britain’s role as a worldwide centre of excellence in that field.

Having that debate whilst European parliament and local elections in Britain were taking place gave politicians from every party a golden opportunity to voice their thoughts, each of them pledging to be defending the national interest.  This will have almost certainly boosted AstraZeneca’s confidence in its pursuit of continued independence.

Wait three months, or seek a less demanding bride?

Now that the courting has failed, British law requires a minimum three month wait before Pfizer is allowed to attempt luring AstraZeneca again.  How big will the diamond ring need to be this time?

Whereas many analysts are skeptical about AstraZeneca’s ability to achieve anything close to the very ambitious goals it has set itself to justify the high premium over its current share price, Pfizer’s offer of £ 55.00 assumes that such a bold plan could indeed be achieved, but then one should wonder how Pfizer could hope to generate even more value beyond that point to derive any benefit from this massive acquisition.

Once the current excitement and frustration have cooled off, Pfizer might be glad they have not over-stretched themselves in acquiring a major competitor at its maximum price.  If mergers and acquisitions are about creating value rather than just becoming the biggest guy in one’s industry, I think there could be some benefit in seeking out smaller pharmaceutical companies whose product pipeline could complement Pfizer’s declining R&D productivity and which could benefit from Pfizer’s scale and commercial presence: that would constitute a real win-win.

She loves me, she loves me not …

Several of AstraZeneca’s significant shareholders would have been happy to take the money and run when Pfizer offered them £ 55.00, cashing in today instead of waiting for value which is being promised to them in the future based on a very uncertain plan.  But human nature is such that no one can face the embarrassment of a U-turn, coming back on a “final offer” or saying “oh why not” after having said “no”.

Many analyst still expect Pfizer to come back to the negotiating table in some months from now. However if that does not occur, some powerful and very frustrated shareholders will be holding Pascal  Soriot to ransom in delivering his ambitious plans and revealing those miracle drugs we are being promised.  There could be difficult times ahead.

… in the meantime, the elections are over and bioscience has abruptly fallen off the radar screen of the politicians who only two weeks earlier were desperately arguing in favour or against the Pfizer deal in typical cacophony.  Maybe the three month cool-off period will do them some good too.

Two European giants with global reach

Holcim and Lafarge, confident of making the (b)right choice in cementing their future together
Holcim and Lafarge, confident of making the (b)right choice in cementing their future

For a change, this month’s mega-merger announcement does not involve American or Asian heavyweight players, but rather two giants in “old Europe”.  It is not about social media, high-tech or software, and will instead rock an industry which has none of that glitz and glamour  : cement.

Having flirted together but failed to reach a deal 18 months ago, the world’s two biggest cement producers (by value) are set to blend, in what is described as a merger of equals (after all, cement is cement …) as Holcim intends to acquire Lafarge and become a global giant with an annual turnover of 32 billion Euros.

A feast for the anti-trust regulators

Once combined, Holcim and Lafarge would have operations in 90 countries.  This would not be the first time an industry’s two largest players are allowed to merge after letting go of some assets, as did Guinness and GrandMet in 1997 to form Diageo, but the approval of that merger required some seven months of deliberations by regulators across the world.

Holcim and Lafarge expect to be under scrutiny in at least 15 countries.  This is unlikely to be a casual routinely exercise, because the cement industry has a long history of collusion and price fixing, acting as a cartel in many countries, and both Holcim and Lafarge are among the cement producers being probed under an investigation launched by the European Commission in 2010 which is still open.  In that context, important concessions will need to be made to the regulators if the deal wants to have the remotest chance of closing by the beginning of 2015 as Holcim and Lafarge predicted in their announcement.

Those sacrifices are already part of the merger scenario; a Lafarge spokesperson confirmed that up to 15% of the new group’s assets might be divested to secure the anti-trust authorities approval of the deal.   Two-thirds of those disposals are likely to occur in Western Europe where the overlap between the two merging companies is the most significant.  Compared to shutting down plants, selling production plants to competitors avoids massive lay-offs and also reinforces competition on the market: this is evidently something that will be perceived as positive by European authorities.

However, Western Europe is the area where cement over-capacity is at its worst and the market’s growth prospects are dull.  In that context, the pair’s disposals might only fetch a very low price, and if that divestment programme does not generate the projected 5 billion Euros, the business case of the merger could be quite seriously affected.

An ambitious business case

Some of the rationale for the Holcim-Lafarge merger makes eminent sense, but other components of the business case will require a real tour de force to be achieved.  The merger announcement failed to cause much excitement on the markets, even though the share price rise both Holcim and Larfarge have experienced – oscillating mostly between 5 and 12% – reveals a degree of interest from investors.

Holcim-1Cement is bulky, heavy and of low value relative to its weight. The market catchment area for any given production plant is therefore quite limited as transport costs rapidly outweigh economies of scale.  The positive side of this is that cement is one sector in which mature economies are not likely to be invaded by Chinese production, even if China now accounts for more than half of the world’s cement consumption.  A producer’s geographical spread is therefore a key factor.  In that sense, Holcim and Lafarge complement each other particularly well in the fast growing economies, as the former is strong in Latin America and Asia whilst the latter is well positioned in Africa and the Middle East.  The pair believe that the lower risk and business fluctuations resulting from better geographical spread will reduce their borrowing costs, thereby generating annual savings of some 200 million Euros.

Holcim and Lafarge believe they can save an annual 1.4 billion Euros three years after merging, which together with to the above-mentioned saving in financing costs would include 340 million on procurement and 250 million on sales costs, to mention just the key savings areas.  If they can manage that it will be quite a remarkable achievement considering their heavy involvement in France and Germany, two notoriously inflexible labour markets in which change can be slow and costly to implement.

Does the “value magic” reside in transforming the industry?

Beyond the promise of operational and financing savings, two components of the rationale for the Holcim-Lafarge merger are quite hypothetical at this stage but are potentially the most significant generators of economic value in the longer term.

Firstly, it takes a real mammoth to fight the growing competition in some of the world’s rapidly growing markets, such as China where Anhui Conch became the world’s largest cement maker last year (by volume, not by value), or Mexico’s Cemex, currently the world’s Nr 6 but growing on the fast lane to overtake its rivals.

Secondly, and this is the more exciting aspect of the merger, the pair’s combined marketing nous and R&D capability has the potential to revolutionise the market with the launch of innovative products which would transform the image of the industry, until now only too similar to the physical attributes of the product : rigid, grey and dusty …  Maybe cement can really be more than cement: Lafarge in particular has developed products whose improved specifications justify higher pricing and elevate cement above its current commodity status, such as fast drying cement or even cement which can set under water.  Variations in tone, texture and appearance are also on the cards, and with this comes the potential  – and the expectation as far as Holcim and Lafarge are concerned –  to play an active role in the evolution of architectural design and advise architects in their choices of these innovative materials.

Lafarges-Roberta-Plant-Calera-UsaConceptually and intellectually, this is quite an appealing and exciting challenge, but it is difficult to imagine such transformation within the next three to five years in two companies which until now have relied mostly on size and hegemony (and some times price-fixing when the going became too tough) rather than being agile and capable of re-inventing themselves by adding a service veneer over their heavy industry core.

Another fascinating business case commences for future business school students.  Let’s watch the next moves and allow three to five years before the jury delivers its verdict. We may be in for a good surprise.

IBM Servers and now Motorola Mobility : China’s two biggest technology deals in the space of two weeks

Whilst the jury of bloggers is still out debating whether Google’s sale of Motorola Mobility to Lenovo for just under $ 3bn is a smart move or the admission of a terrible flop less than two years after buying that company for $ 12.5bn, Lenovo’s double acquisition clearly signals an aggressive growth strategy, and yesterday’s move is intended to propel the company to become one of the leading global players in mobile technology.

Two consecutive acquisitions of this magnitude by one same Chinese giant are likely to have a non negligible impact on the American psyche.  The regulators will be having an interesting time sifting through the pros and cons before allowing Lenovo to walk off with their new prized possessions, although it is difficult to see on what grounds these two deals could be blocked.

Good Feng Shui Will Be Needed to Repeat the ThinkPad® Magic

Last week’s acquisition by Lenovo of IBM’s low end server business made obvious sense, in the footsteps of the very positive development of the ThinkPad® range since acquiring it on from IBM in 2005.  However, Motorola might be a different case, because the brand’s eroded equity had only recently been revived by Google after years of decline, and this was achieved by reinforcing the brand’s American identity and heritage, which had a very positive impact on Motorola’s market share in North and South America but did little for the brand’s performance elsewhere.

Manufacturing mobile sets in Texas might strike the right chord for American consumers, but poses a challenge in terms of production costs when the competitors’ operations moved to China or other low cost countries years ago… In that context, it is hardly surprising that Motorola’s losses were worsening year-on-year.

Lenovo will certainly leverage their manufacturing capability to generate significant cost synergies, but the determining factor for success once the issue of manufacturing costs has been addressed will be one of sales volume rather than margin per unit: will Motorola maintain its image in North America under Lenovo’s ownership and have the talent required to develop products capable of leading the category in terms of design and features?  The payback on Lenovo’s investment to shoehorn itself into the Americas’ large and lucrative mobile market assumes that the magic that occurred with the ThinkPad® can be repeated with the Motorola brand.  Let’s watch this pace during the next two or three years…

The Simplistic View

Some indiscriminate commentators are comparing in a rather crude way the $12.5bn paid by Google in May 2012, its largest ever acquisition, with the $2.9bn “bargain price” at which Motorola Mobility is now being sold to Lenovo.  This totally overlooks the fact that Google’s interest in Motorola was based on the many thousands of valuable patents owned by that company, the most important of which Google will retain, whereas Lenovo needs the equity of a strong brand to break into the American market.  Of course, we shall need a few years to determine with certainty whether this was a win-win deal, but it clearly has the potential to be one.

Considering the magnitude of Motorola’s losses, which add to the cost Google paid for that company in 2012, many will argue that the price paid for Motorola’s patents was too high.  But if we look at this from the other angle, what would have happened if Google had failed to acquire the patents they needed to ring-fence their Android platform which was being increasingly challenged in the courts?

Google Not So Dumb After All

I cannot be the only one to believe that these patents have a far greater strategic value in terms of securing Google’s future than they would have if they were sold and dispersed across other players on the market: a 50% rise in the share price over the past 10 months shows that in spite of the proliferation of comments and blogs ranting about Google’s senior management being out of touch with reality, there nonetheless seems to be a general consensus within the serious investment community that Google know their stuff and continue to be incredibly successful.  A corporation the size of Google is bound to suffer glitches here and there, or even a big knock on the chin; what really matters is that they are strong and resilient enough to overcome those challenges and continue their formidable progression.

Google ended 2013 with revenue up 22% on the previous year’s figure and could afford to acquire Nest Labs inc. for $3.2bn in cash two weeks ago, partly financed by shedding off Motorola Mobility.

By retaining the key patents in the Motorola deal and jettisoning the loss-making hardware side of the business which Lenovo has the scale to possibly turn around, Google is no longer a competitor to other manufacturers whose devices use Android, and can therefore focus on developing the broadest possible usage of its Android software.  Not such a bad idea for a company which has built its reputation and fortune on developing remarkable software …

 

Business Case and Hypotheses – Science and Beliefs

Literature on mergers and acquisitions tells us that M&A is all about growth, either by gaining clout, entering new markets, new channels, new product lines, acquiring know-how, licences, intellectual property, or a combination of the above.  In spite of all the rigour, methodology and risk mitigation that go into choosing the right candidate for a merger or acquisition, some of the assumptions underlying the business case will always remain an act of faith.  My view of the future is unlikely to be identical to yours.

At a corporate level, we see the likely end-result of such gaps between expectations and reality in the acquisition of SANYO by PANASONIC as recently as 2009 (late 2008 to be precise).

Shall I drown you – or do we both die together ?

Panasonic, for whom Sanyo was a rival in many segments of consumer entertainment electronics such as video cameras and sound systems, was expecting to gain significant market share by acquiring that household brand, and more specifically to enter the lithium ion batteries and solar panel markets which they believed to have brilliant future with the emergence of portable electronic devices and growing focus on renewable energy.

Only four years later, with the powerful but rather unhelpful benefit of hindsight, we can contemplate the extent to which Panasonic’s underlying hypotheses turned out to be wrong.  The combined impacts of a strong yen, a slump in the sale of digital appliances after the amazing year-on-year growth fuelled by smart-phones, strong competition from Korea in the lithium ion batteries industry and China churning out solar panels almost at the speed of the solar rays with will capture, Panasonic finds itself today having acquired a sinking ship.  The Japanese government may be driving a policy aimed at reducing the value of the yen, but it would require far more to put Sanyo on a firm footing on the global market.

Whereas it would in the past have taken many years, possibly a couple of decades, for a large industrial conglomerate to decline and disappear from the market’s radar screen, we now see the extent to which the cycles of corporate growth or decline have accelerated.  The acquisition target which seemed so attractive only four years ago is now a burden.  Panasonic plan to cut 90% of Sanyo’s global workforce over the next three years: with that kind of pruning, it is likely the Sanyo name will disappear altogether.

Since the ill-fated acquisition of 2009, Panasonic has already attempted to refocus and simplify its business by selling all its non-Japan and China white-goods operations to Haier of China.  The divisions producing domestic electrical appliances are to be sold to Whirlpool.  The once almighty Sanyo corporation is being sold bit by bit, just as one deconstructs a castle made of Lego.

What was thought to be a great business case initially has turned out to be a nightmare for Panasonic’s leadership.  The business case built in 2008 and due diligence based on the “as is” valuation evidently failed to consider the robustness of the underlying assumptions regarding future growth, competitor activity and the evolution of the global economy.

And so as the two brands struggle to keep their heads above the water, it seems that one of them will push the other below the water-line to remain above the surface. I wonder what the Sanyo’s founder Toshio Iue, who at one point through family ties had come close to joining the lead at Matsushita, would think today of the epilogue of his legacy.

Not a brilliant story, but definitely one from which learnings need to be captured.

Yahoo! chief executive Marissa Mayer’s move to acquire the blogging website Tumblr for an astonishing $ 1.1 bn is indeed a bold one.  As a former Google executive Ms Mayer hopefully knows things about what makes a website “cool” and fashionable which we other mortals ignore : how else could one explain the rationale behind paying a premium of $ 300 million above the previous valuation of Tumblr ?

Flickr-homepage

I felt some reassurance reading Ms Mayer’s statement declaring that Tumblr would continue to operate independently so as “not to screw it up”.  More importantly Tumblr’s co-founder and 26 year-old chief executive Mark Karp will remain at the helm of Tumblr – or that is at least the initial intention.  Indeed, the huge challenge in this deal will be to insure that Tumblr with its young boss and 125 strong team who probably revere him as an icon – quite justifiably – can maintain the buzz, energy, creative enthusiasm and ability to “break the conventional rules” which characterize the most successful companies of the internet age.

The colour purple – will it run in the wash ?

Yahoo-homepage

I don’t subscribe to the view of those who believe that every bubbly creative exciting entrepreneurial company is doomed to becoming a boring fat corporation if it grows much larger, victims of its own success.  Huge companies such as Apple and Google are proof to the contrary, as is Virgin Group if we look beyond the frontiers of the technology sector; but it is true that those iconic companies are the exception rather than the rule.

Unsurprisingly, Tumblr’s users are sceptical, as evidenced by tweets of “No, no, no, nooooooo!” and “Tumblr is about to suck”.  Young Mark Karp is trying to reassure them, stating that “We’re not turning purple”.  I like the analogy, and personally I would be weary of mixing bright vivid colours with dark purple in a same wash-load …

When a high buzz “cool” company is united with another that has become lacklustre over the years, does the former’s “coolness” revive the dull company, just as an antibiotic gets rid of an infection, or will it gradually dilute and fade away?  This is indeed the $ 1.1 billion question in the acquisition of Tumblr by Yahoo!

Solid business case or act of faith ?

If Yahoo! and Tumblr continue to operate and appear on the internet as totally distinct platforms, one fails to see what it is about Tumblr that will attract traffic to Yahoo!  It is hard to believe that the look and feel of Yahoo! would appeal to Tumblr users, and loading Tumblr with links to drive viewers to Yahoo! might cause frustration and irritation …  Tumblr is on the rise, Yahoo! is in decline, so it is quite clear which of the two is in urgent need of profound transformation.

“Coolness” is the outcome of a specific style, flair and contagious energy of the person or team at the helm of a business, which must percolate through the entire company.  What is it that makes a restaurant or bar “the” fashionable place to go to in a city?  There is no recipe for coolness and trendiness, and remaining on top of the “cool” wave requires an ability to constantly come up with something new as competitors are fast to copy whatever they believe consumers find so attractive.

There might be some transfer of knowledge and consumer insights from Tumblr to Yahoo! but $1.1bn is a high price to pay for that learning experience, if indeed it does occur.  For a start, it would not have cost much to redesign the Yahoo! interface as we all know that cluttered screens are a total turn-off for most audiences.  If that transformation does not occur fast, Yahoo! will be left with the continuing issue of declining audiences and the benefits case of the Tumblr acquisition will rest entirely on the ability to massively increasing income from advertising.  Whether Yahoo!’s current advertisers will want to associate their brands and services with some of the more politically controversial or sexually explicit content of the Tumblr platform remains to be seen.

Yahoo!’s track record in M&A is a mixed one; GeoCities which was acquired in 1999 was canned 10 years later.  A wave of further acquisitions in 2004-2005, notably that of Flickr, failed to infuse the “coolness” Yahoo! was seeking, but that was before the days of Marissa Mayer.  Yahoo!’s board and shareholders have made an act of faith in believing that Ms Mayer is the charismatic leader who will send a positive shockwave through the company, put the negativity of years of decline behind and turn Yahoo! into a stylish platform.  Let’s hope they are right.

This kind of act of faith feels similar to wearing a new prototype of mechanical wings whilst standing on the edge of a cliff.  And then you jump : Yahoooooooooooo !