Acquisitions and takeovers

When analyzing investment decisions, we did not consider in any detail the largest investment decisions that most firms make, i.e., their acquisitions of other firms. Boeing’s largest investment of the last decade was not a new commercial aircraft but its acquisition of McDonnell Douglas in 1996. At the time of the acquisition, Boeing's managers were optimistic about the merger, claiming that it would create substantial value for the stockholders of both firms. What are the principles that govern acquisitions?

Should they be judged differently from other investments? Firms are acquired for a number of reasons. In the 1960s and 1970s, firms such as Gulf and Western and ITT built themselves into conglomerates by acquiring firms in other lines of business. In the 1980s, corporate giants like Time, Beatrice and RJR Nabisco were acquired by other firms, their own management or wealthy raiders, who saw potential value in restructuring or breaking up these firms. In the 1990s, we saw a wave of consolidation in the media business as telecommunications firms acquired entertainment firms, and entertainment firms acquired cable businesses.

Through time, firms have also acquired or merged with other firms to gain the benefits of synergy, in the form of either higher growth, as in the Disney acquisition of Capital Cities, or lower costs. Acquisitions seem to offer firms a short cut to their strategic objectives, but the process has its costs. In this chapter, we examine the four basic steps in an acquisition, starting with establishing an acquisition motive, continuing with the identification and valuation of a target firm, and following up with structuring and paying for the deal. The final, and often the most difficult, step is making the acquisition work after the deal is consummated.

Prof. Aswath Damodaran