Supervisor:
Abstract
In modern business world characterized with competition, acquisition and mergers are dominating main company’s games. In fact, major companies in such as food sectors and banks are acquiring smaller firms in order to ensure that control competition and assets are strengthened. Just like numerous other decisions, there is need for careful prognosis and study before taking this important step in analysis of assets in a company, business performance, and acquisition overall viability. Embry Investment Group is a company that is exploring for a company to qualify for acquisition. This report is aimed at gaining a deeper comprehension on the viability and feasibility of McDonald’s as the company being targeted for acquisition. This purpose is enhanced by detailing a comprehensive study of McDonald’s performance for the last 10 years together with its future trends. From the report, McDonalds is qualified as a candidate for acquisition by EIG.
Executive summary
In every CEO or company’s board’s strategy, growth is one of the highly valued business strategies which define not only the current performance but the business future direction. Growth is apparently signaled by increasing profits and obviously results in better rewards for the employees, investors, stakeholders in addition to enhancing increased financial investment in the company’s next financial year. In order to achieve this growth, acquisition is favored as one of the key move. However, these acquisitions have not always defined a company’s success based on the fact that there are many times when this decision has been accompanied by high failure rates. This is why before any decision on merger, a comprehensive evaluation of the company of acquisition and other factors should take place to determine if the decision is feasible.
Based on the fact that acquisition is a decision likely to pose conflicting results (success of failure), it is important to evaluate and have a clear insight of the company aspiring to make this important decision. As Ji-Yub and Jerayr (2011) study established, 34 percent of all the Australian companies’ acquisition deals heightened stakeholders’ value, 30 percent resulted in reduction of stakeholder value while 36 percent of these deals did not yield any effect. This was however an improvement based on the fact that a year earlier, more failure than success resulted from acquisition. Based on the fact that research portray conflicting results, this organizational approach to growth apparently require a review. In this article, the researcher comprehensively examines whether EIG decision to merge with McDonald’s is viable or not. In order for this study to make a final recommendation, it comprehensively examines McDonald’s as the company which EIG hopes to acquire. McDonald’s analysis covers the company’s background, current and future performance. This process enhances examination of acquisition process due diligence.
Background on acquisition and merger
The year 2004 was characterized by more than 45 percent increase in mergers and acquisition activities with financial profits of more than $1.98 trillion being made as a result of the highest level of acquisitions ever made since the year 2000. This is a very important and notable activity growth based on the fact that from research, it is approximated that more than half of acquisitions and mergers had failed. A study by Harding and Rovit (2004) examined more than 1,500 acquisitions, incorporating 250 Chief Executive Officers (CEOs) in the interviews.
In the study, Harding and Rovit observed that only a few of the interviewed CEOs had formulated a strategic rationale that would eventually result in a successful acquisition. Moreover, this study observed that 55 percent of companies that had formulated a clear acquisition rationale eventually concluded, after unsuccessful acquisition, that they had formulated a wrong rationale.
EIG is a company contemplating on signing acquisition business deal with McDonalds. In this acquisition process, EIG is seeking to expand the rapid growth and expansion of the already established and expanded investment portfolio. Apparently, EIG has a good acquisition track of record mixed with bad track. For instance, acquisition of power proved futile when the company failed to appropriately incorporate the company’s management trend, resulting to years of dwindling performance. The initial transaction period of this acquisition was also characterized with a dump period of transition.
In its decision to enter into acquisition, EIG should be guided by Ji-Yub and Jerayr (2011) which highlights various reasons that have undeniably proved to justify acquisition and merge. According to Ji-Yub and Jerayr, acquisition enables development of synergies, cost savings, economies of scale, rationalized channels of distribution and increased production. These authors highlight the focus of companies on potential capital return on their decision to merge or acquire another company. According to Ji-Yub and Jerayr, one of the main reasons why companies acquire one another is to enhance acquisition of customers. They add that as a result of the CEOs mounting pressure on utilization of the cash while increasing earnings, such companies have a high probability of embarking on acquisition even if an appropriate strategy is not followed. As Komlenovic and Mamun (2011) highlights, reasoning of the needs behind acquisition should incorporate a strategic approach as opposed to being a strategy of utilizing the excess capital. Komlenovic and Mamun has thus highlighted various strategic reasons that will acquire justified acquisition: (i) acquisition of new products, skills and capabilities, (ii)consolidation with an industry that is more mature, (iii) extension of the geographical outreach and, (iv) creation of a new industry of transforming of the already existing.
Before making this strategic decision, IEG needs to have an understanding of the reason for failure of various acquisitions despite formulation of clearly labeled acquisition rationale. In a study by Kowitt (2011), numerous reasons for failure have been highlighted. For instance, Kowitt observes that due to the overemphasis of the short term legal and financial issues, most companies have a tendency of neglecting strategic direction that a company should take. This neglect is inclusive of failing to make a clarification of the pertinent issues encompassing leadership, and lack of a clearly established communication with the stakeholders during the process of a merger or acquisition.
According to Harding and Rovin (2004), acquisition failure is usually caused by varying reasons. They observe that overemphasis on the short term legal and financial issues are one of the reasons likely to trigger failure. As a result of this diversion, companies tend to ignore the overall strategic direction that forms the basis of establishment. Laamanen and Keil (2008) add failure of clarification of the leadership issues, together with generally failing to establish a viable communication linkage with the stakeholders during the process of acquisition. In other studies, the reasons for acquisition failure have specifically been detailed. For instance in Komlenovic and Mamun (2011), five reasons fueling acquisition failures have been highlighted: (a) poor rationale in the acquisition strategy, (b) cultural mismatch, (c) communication and leadership difficulty in the company to be acquired, (d) poor execution and integration planning and, (e) parting with too much money for the company to be acquired. Based on the fact that McDonalds is apparently a highly developed company having continually developed its investment portfolio through market expansion, it is obvious that EIG should not under approximate the amount of financial commitment required to successfully acquire this company. Therefore, this acquisition challenges EIG to set aside a huge capital that can successfully enhance acquisition agreement between the two companies. Before gaining a more comprehensive understanding on acquisition, let us understand McDonalds, the company whose EIG acquisition strategy is based on.
McDonald’s company background
McDonald’s is a company that EIG is contemplating on acquiring. Signing an acquisition deal with McDonald’s is a good decision and a major move in this company’s capital growth investment. This is based on the fact that the acquisition will be secured in one of the most successful companies in the food industry. McDonald’s has developed a strong business standing history, having built a loyal customer base with the continued dedication to customer service by the company. This devotion has been reflected with the inventory turnover which has continuously remained above the competitors and market average.
McDonalds inventory turnover in comparison to competitors
Basically, food industry presents one of the most competitive fields. However, this challenge has encouraged McDonalds to target continued dedication on the customers that it humbly seeks to serve. This approach to business has enabled McDonalds to maintain a leadership position as a leader in market capitalization; its market capital being $39.38 billion (Kowitt, 2011). While massive amount of this company’s investment has been devoted on capital, McDonalds’ asset has been managed with a high inventory turnover while sustaining cost adeptness. Moreover, much of McDonald’s success is attributed to the Company’s strategy of product development that has apparently been in conformation with the changing customer needs. The company’s Gross Profits Margins relative to the competitor is detailed in the table 2 below
Table 2: McDonalds gross profit margins
Demand drivers in McDonald’s food industry
The much of the growth in the food industry is mainly attributed to global sales continuous growth complied with the even increasing company revenue. Recently, McDonalds made an announcement of its first quarter earnings per share of 0.57. When an adjustment is made for a one-time settlement of tax amounting to $178 million –equivalent of $per every company share-, the resulting EPS was $0.44: this amount is in agreement with the consensus that was initially estimated at $0.45 (Tschoegl, 2007). The result is a 10 percent growth in the adjusted earnings over the same period of the year as a result of increasing comparable global sales by 4.5%, which resulted to a (per cent increase in revenue). The Relevance of McDonalds to the United States customers is mainly attributed by their ”friendly” prices, menus, variety, choices and reputable customer services from the global angle, McDonalds has successfully been able to cater and adapt to varying societies and cultures while still ensuring that they are provided with a similar experience based on which the company’s reputation is built.
Based on the fact that substantial ration of McDonalds sales are derived from global stores, foreign dominated sales are expected to continue generating additional earnings leverage based on the fact that the US dollar is weakening against other major currencies. Most importantly, McDonald is also a company that has previously successfully undertaken the move being currently contemplated by EIG acquisition. Some of the companies that McDonalds has successfully acquired are Chipolte Mexican Grill and Boston Market. After efficacious acquisition deals, this company has embarked on a focused growth platform that has been geared towards yielding long term benefits and growth to McDonald’s.
Assessing McDonald’s future performance
When assessing McDonald’s future performance, it is important to examine the company’s past efforts that have resulted in increased growth within the last one decade. This past growth enhances projection to evaluate if the growth in the company can be sustainable in the coming ten years. Back in the year 2003, McDonalds initiated the revitalization plan with the main focus being centered on growth in its existing restaurants and clearing the debts that had previously been accumulated in bad financial performance times. After initiation of this plan, McDonalds experienced sales growth that was approximated at 11.26%. With this information, it is possible to conclusively project a high likelihood of sustainable growth in the next ten years; a growth that may result in a decline after the ten years. At this time, acquiring McDonalds would be progressive business decision which leaves the management with a free ride of implementing the initiatives of al an already drafted plan.
If EIG adopts this plan, positive results are mainly likely to be attributed to the changes initiated by McDonalds in the year 2002. The company (EIG) should fully be confident that McDonalds can successfully be able to continue adapting to the changes according to the customers desires. In addition, acquisition move is viable at this time when McDonalds is at the saturation point at United States market. This is evident from the first quarter international sales registered in the year 2009. In this year, global sales increased by 4.8%; a move that assisted the company in boosting total revenue up 8 percent in comparison to the first quarter of the previous year.
Analysis of the acquisition methodology
When evaluating the viable approach in acquisition, IEG will be guided by a clear understanding of the several acquisition approaches. Acquisition takes various approaches as summarized in the figure below.
As Harding and Rovin (2004) explain, acquisition can bring hostile or friendly events. If an acquisition process friendly, McDonalds Company managers will openly welcome the acquisition. However incase the acquisition turns hostile, McDonald’s firm managers have a high likelihood of refusing to be acquired. In such an instance, IEG can offer a price that is slightly higher than McDonald’s market price before acquisition and this target firms stakeholders are invited to have their shares tendered for the shares. Whichever the approach, hostile or friendly, the premium price will rule out whether the process is eventually viable to the two companies. In the context of consolidation and merger, the acquisition price will have to be paid by the acquiring firms for each of shares belonging to the target firm. This price will mainly be centered on the negotiation trend between the target firm’s managers and acquiring forms.
In a tender offer, the acquiring firm should most importantly gather enough to ensure that it can control the target firm (McDonalds). There is a high likelihood that this price will exceed the price primarily presented by the acquirer , if additional firms are making bids for the same firm or if the initial price attract limited number of stockholders. For example back in the year 1990, AT&T made an initial offer of buying NCR for $81 per share, a premium that was $25 above the stock price when this offer was being initiated. Eventually, the company was forced to increase its offer to $110 per share in order for this acquisition to be successful.
Another requirement that EIG should importantly fulfill before making this acquisition is comparison between the incoming book value and the price that will eventually have to be made to validate this acquisition. Depending on accounting for the acquisition, this variance will be documented as a good will on the books of EIG. The acquisition price is detailed in the figure 1 below based on various parts.
Figure 2: Acquisition price details
Acquisition price of the targeted company
The prevailing target firm market price before acquisition
Target firm equity book value
Conclusion
Acquisition will apparently take various forms and its occurrence will be triggered by numerous reasons. Categorization of acquisition may be based on what happens after the acquisition to the target firm. This article seeks reasons to validate EIG acquisition of McDonalds. As this article provides, EIG may opt to consolidate the target form into a merge, initiate a new entity in addition to acquiring the target firm or even opt for a buyout which will enhance remaining independent. In order to gain a clear insight on whether IEG acquisition of McDonalds is justified, this article has detailed acquisition reasons. The article also draws emphasis on choosing a firm with characteristics that best qualifies it for acquisition. The firm is then valued with an assumption that the existing management will continue managing the company. In conclusion, this report indeed justifies that McDonalds is a good target to acquisition by EIG based on its portrayal of steady growth in capital. Acquisition of this company provides IEG an opportunity to rapidly increase its capital based on the fact that McDonalds is already performing well although in a competitive industry.
References
Harding, D. and Rovin, S. (2004). Mastering the merger: four critical decisions that make or
break the deal. Harvard Business Press.
Ji-Yub, K. and Jerayr, J. (2011). When Firms Are Desperate to Grow via Acquisition: The Effect
of Growth Patterns and Acquisition Experience on Acquisition Premiums, Administrative
Science Quarterly, 56 (1): 26-60.
Komlenovic, S. and Mamun, A. (2011). Business cycle and aggregate industry mergers. Journal
of Economics & Finance, 35 (3): 239-259.
Kowitt, B. (2011). Why Mcdonald's Wins in any Economy. Fortune, 164 (4): 70-78.
Laamanen, T. and Keil, T. (2008). Performance of serial acquirers: toward an acquisition
program perspective. Strategic Management Journal, 29 (6): 663-672.
Tschoegl, A. (2007). McDonald's : Much Maligned, But an Engine of Economic Development.
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