All mergers or acquisitions are, theoretically, undertaken to grow top-line revenue, expand markets, enter into new markets and/or to reduce costs. Such transactions are often the only viable way for companies to gain market share in constricting industries and in tough economic environments. They also enable the development and strengthening of the core business, thereby allowing for increased efficiencies and economies of scale.
Our designation of an “offensive” or “defensive” transaction is based upon the following:
These types of mergers tend to be proactive events in anticipation of market conditions or market trends and undertaken to address issues that may be arising in an industry. Offensive M&A deals appear to be done to avoid potential challenges in the industry “coming down the pike,” irrespective of what competitors may be doing.
These transactions are generally undertaken to avoid loss in market share, prevent a competitor from purchasing a target company, or as a reaction to industry changes or prior consolidations. The key to these mergers is that they tend to be reactive or in a direct response to the actions of others (mainly competitors) within the industry.
Examples of Recent Offensive and Defensive M&A Transactions
|Date||Offensive (Acquirer/Target)||Value ($ millions)|
|10/01/10||Marfrig Alimentos/Keystone Foods||1,260|
|4/12/10||Hewlett-Packard/3 Com Corp||3,400|
|3/12/10||Stanley/Black & Decker||5,232|
|3/01/10||Nestle USA/North American Frozen Pizza||3,700|
|Date||Offensive (Acquirer/Target)||Value ($ millions)|
We have identified several transactions to better illustrate the differences between offensive and defensive deals in practice.
In the airline industry, two mergers seem to exemplify the opposing transaction types: Delta and Northwest appears to be an example of an offensive transaction — proactively trying to adapt to future industry changes; whereas the recent United and Continental merger appears to be defensive and a direct response to the Delta/Northwest merger.
Delta and Northwest
On multiple occasions after its reorganization from its 2005 bankruptcy filing, Delta attempted to expand its market share and compete more effectively in the ever-evolving passenger airline industry. A previous failure in the discount airline segment, through the creation of the Song brand, caused Delta to return to the proverbial “drawing board” to determine a viable growth strategy. This re-evaluation led to talks, and eventually a merger with Northwest in October 2008 — another airline that scrubbed its balance sheet through the Chapter 11 Bankruptcy process.
Prior to the merger, the airlines were ranked as the third and fifth largest U.S. airlines, respectively, and the “new Delta” is now the largest single U.S. carrier (until such time as the United/Continental deal is finalized).
This offensive merger appears to have resulted in a relatively smooth transition:
1.) Significant routes for each of the airlines did not overlap — Northwest had a significant West Coast and Asia presence versus Delta’s Eastern, Southern and European routes
2.) The majority of Delta’s workforce was not unionized allowing for smoother employee integration with Northwest
3.) The airlines hubs were easily combined, with the more significant hub of each airline surviving (Atlanta for Delta and Detroit for Northwest)
4.) The different aircraft allowed the combined airline to expand services and also allowed for a relatively smooth integration of pilot lists
5.) The customer loyalty programs were seamlessly merged under the Delta Skymiles program
United and Continental Merger
Shortly after the successful merger between Delta and Northwest in 2010, United Airlines and Continental Airlines, in a “defensive” move, renewed their merger discussions. These discussions had previously fizzled out in 2007/2008 when Continental, the healthier of the two airlines, walked away from a consolidation.
Similar to Delta/Northwest, United/Continental has few overlapping hubs and route systems, making the combination attractive as a growth vehicle for both airlines. This combination should enable them to not only protect their current market share, but potentially increase their future market share in the lucrative business travel market. “Continental is strong where United is weak, and United is strong where Continental is weak,” said Continental’s CEO Jeff Smisek. He called the combination “a match made in heaven.”
The merger is not expected to be completed until 2011 or 2012. It is designed to cut costs, boost revenues and increase overall market share. Both United and Continental have lost significant money in prior years and see this merger as the best way to survive in the new airline industry.
COMPUTER SOFTWARE (TECHNOLOGY) INDUSTRY
Another industry that has, for over two decades, been ripe with mergers, partnerships and strategic alliances is the computer software industry. As the dynamics of the industry have shifted, there have been numerous opportunities for both offensive and defensive transactions to respond to the developing corporate landscape. Similar to the airline industry, many computer software and technology companies find themselves in the difficult position of needing to expand their market share, or to build upon already strong foundations to ensure that they maintain a competitive advantage.
The current software industry has seen a shift with the introduction of new protocols for communicating, an increased use of applications as “components” or “capabilities” rather than as distinct units of software, changes in the needed functionality of programs and a shift to larger vendors expanding into what was previously a middle-market sector. Despite these shifts, proactive or offensive transactions can build on the companies underlying strengths and help them become a “powerhouse” in their market.
EDGAR Online and UBMatrix
Another example of an offensive merger was the deal announced in June 2010 between EDGAR Online (a leading provider of U.S. SEC public company filings through the use of XBRL data) and UBMatrix (the leading provider and inventor, of XBRL software to both domestic and foreign corporations).
This merger vertically integrated two of the corporate leaders in the XBRL technology, which is rapidly expanding to become the uniform source for all public company filings. The combined entity will become a leader in the international market. The two companies have a strong market share in the translation of the language and reporting of data (EDGAR) and the underlying creation of data to be reported (UBMatrix), but together will be able to provide comprehensive services for the global market. In addition, many of the banking, tax and financial regulatory bodies of the major economic powers, in an attempt to provide greater uniformity in reporting, have started to adopt the language as the required reporting language for regulatory filings.
RENTAL CAR INDUSTRY
AVIS and Dollar Thrifty
The recent battle for Dollar Thrifty is a good example of a defensive M&A transaction. Both Hertz and Avis Budget were battling each other to acquire Dollar Thrifty, the fourth largest car rental company in the U.S., to obtain a bigger stake in the vacation market. Dollar Thrifty was the latest deal announced in the car rental industry (Avis bought Budget in 2002 and Enterprise acquired Alamo and National in 2007).
The transaction would have given Hertz one-third more sites worldwide, raising its total to 9,800 sites. Since Hertz was already the largest car rental company by locations, Hertz pursued this deal to increase its leisure business. Dollar Thrifty would also have helped Hertz in its rivalry with Avis and strengthened its position against Enterprise, which has 7,600 Enterprise, Alamo and National sites.
Avis was determined not to allow Hertz to obtain Dollar Thrifty. As a result, in September 2010, it ultimately outbid Hertz to win the battle to purchase Dollar Thrifty. Avis has agreed not to commence an exchange offer as the parties work cooperatively to obtain anti-trust clearance for the proposed transaction.
Potential Pitfalls for Offensive or Defensive Deals
Irrespective of the underlying driver propelling a M&A transaction, each deal shares a multitude of the same potential pitfalls and key questions impacting the ultimate success of the combination:
- Can the transaction truly expand a market or build on a market already served by the parties?
- Can management effectively implement plans for growth by overcoming:
- Different operational structures?
- Varying and often conflicting corporate cultures?
- Labor and employee integration issues (e.g., workforce reductions or labor issues)
- Does the combined company have the resources to effectively grow and is the projected growth precipitated on an increase in operational efficiencies, revenues, etc?
- Can an integration of IT systems be done smoothly?
- Are growth and cost saving targets reasonable and achievable?
- United/Continental expect to achieve $1.2 billion in revenues and cost savings through their merger by 2013, despite having experienced significant losses for several quarters prior to 2010.
- Have potential regulatory and anti-trust issues been addressed?
For example, history has shown that the integration of two airlines is a difficult challenge, often due to nasty labor battles and damaging service problems. Support of the pilots is critical in determining whether any airline merger is ultimately successful as well as the ability of the combined company to merge two distinct corporate cultures and customer service reputations. Labor disputes after America West and US Airways combined, for example, delayed the combined carrier from fully integrating staff.
As such, the United/Continental merger, as any merger, may not ultimately succeed despite the success of Delta/Northwest. The potential pitfalls include: necessary workforce reductions, union disputes, pilot disputes, conflicting aircraft configurations for similar routes, reservation system integrations, regulatory issues about gate spaces and hubs and, likely most important, the need for the combined carriers to be profitable.
Only time will reveal how the United/Continental and Avis/Dollar Thrifty mergers will turn out. When industry challenges come your way or market share is at stake, the natural response is to leap to action, but before you do, consider all the potential pitfalls you may face with both types of M&A. In either instance, proper transaction due diligence should steer your course.
David Berliner, CPA, CIRA, CTP, is a partner in the business restructuring services practice at BDO Consulting, a division of BDO, USA, LLP. He is based in New York and can be reached at firstname.lastname@example.org.
Michele Michaelis, CPA, CIRA, CTP, is a director in the business restructuring services practice at BDO Consulting, a division of BDO, USA, LLP. She is based in New York and can be reached at email@example.com.
 United emerged from a three-year bankruptcy in 2006 with morale problems because its unions had to agree to wage and benefit cuts.
2 XBRL data — eXentisble Business Reporting Language — is a primary language for business and financial data utilized by a significant portion of U.S. governmental, and foreign governmental oversight bodies.