Merger and Acquisition - Essay Example

 MERGERS AND ACQUISITIONS Introduction In recent years, economies around the globe have been facing frequent mergers, alliances and acquisitions due to rapidly changing needs of customers and markets. These activities usually, are functions of long term corporate strategy, need for diversification or expansion or merely some legal contractual obligations. Similarly, on June 14, 2012, Johnson & Johnson closed its deal of acquisition of Synthes Inc., a Swiss manufacturer of medical equipment used in providing artificial support structure to damaged human body parts. Johnson & Johnson, on the other hand, is one of the biggest names in the health care industry, serving customers around the globe with its baby care products, medical devices, medicines, body nutrition and other day to day consumer products (Jnj.com, 2013). The announcement by Johnson & Johnson had created waves in corporate world; firstly, this marked the biggest acquisition in this industry, and secondly it had multiple-fold effects disturbing many organizations within and outside the industry. Strategic Justification Johnson & Johnson was observed to be laying great emphasis on health care sector in recent years, and wanted to shift its focus from consumer products to healthcare products. Thus, in the words of CEO of Johnson & Johnson, acquisition of Synthes was all part of the big plan for Johnson & Johnson: becoming most wide-range orthopedics and neurologics business, serving customers worldwide in medical industry. This has enabled Johnson & Johnson to be the absolute provider of all related services in supply chain of orthopedics with a comprehensive coverage for all kinds of products and services. Synthes makes substantial profits in developing markets and third world nations. Therefore, the acquisition decision was in line with Johnson & Johnson’s long term strategy to promote well being of public, especially in underdeveloped and developing areas, through innovative and healthier products, putting the company in a stronger position than before. It also provided benefits of economies of scale, synergy and bulk buying to the group as they were engaged in similar businesses and therefore idle capacities and resources could now be better utilized, leading to efficient or full employment of factors of production and fall in unit costs as fixed costs were spread over larger number of units being produced (invertor.jnj.com, 2012). Regulatory implications When deciding on acquisition of Synthes, Johnson & Johnson had to consider all legal complications involved; one of them being prohibition of simultaneous holdings in Synthes and DePuy orthopedics subsidiary. Johnson & Johnson and Synthes have been direct competitors in certain sectors of medical equipment and surgical treatment goods and therefore, Federal Trade Commission intervened to protect public interests (reuters.com, 2012). Antitrust regulations governed by the European Union and U.S. regulators were required to be satisfied and complied with to make due diligence effective. Consequently, it had to divest its stakes from DePuy in order to be able to make acquisition of Synthes legally possible. It accepted offer from Biomet, a company involved in surgical products and instruments to sell the subsidiary for $280 million, receivable in cash (Nj.com, 2013). On part of Synthes, there were past accusations regarding one of its business units, Norian, of conducting trials to promote its product without permission of relevant authorities. The company ended up paying a penalty and damages to another company, amounting to $22 million. It agreed to dispose of its unit which committed offence previously at its acquisition date (Bloomberg, 2013). Apart from mentioned implications, it was very vital to account for the deferred taxation repercussions involved in due diligence activities, including consideration of accumulated tax losses and deferred tax assets that could be utilized for tax avoidance tactics. Target Valuation Johnson & Johnson stated its intentions, a year back from the date of acquisition, to eventually purchase Synthes for value of $21.3 billion at CHF159 per share. However, the deal was finally signed off at $19.7 billion. In 2010, Synthes made sales of $3.87 billion with an increase in net income by 10% from comparative periods. Out of $21.3 billion, $2 billion included cash, liquid marketable securities and near cash equivalent assets. Major part of consideration amounting to $19.3 billion gives a price/earnings ratio of $21.26 based on profits of year 2010, amounting to $908 million. Furthermore, revenue and cash flows generated between the years 2006 and 2010 rose by 11% and 22% per annum respectively, showing positive signs. In the light of computed price/earnings ratio and other financial data mentioned, the company seems highly viable financially with healthy going concern prospects and liquidity-rich metrics (M.gurufocus.com, 2006). At the end of trading in Zurich markets, Synthes stock ticked a high of CHF146.6, making it a $19.75 billion company. Although, due to speculation of investors, stock had not been trading well; yet the premium being paid by Johnson & Johnson depicts that the company seems a profitable addition to the Johnson & Johnson group creating a multiplier effect for group’s consolidated income and global presence in the orthopedics markets (Bloomberg, 2013). Financing Arrangements It was initially agreed that purchase prices shall comprise two components; one paid in common stock and remainder in cash. Johnson & Johnson shall buy securities of Synthes for CHF55.65 per share in cash, forming 35% of purchase price and allot its own stock at CHF103.35 per share which makes 65% of total consideration. It was provided that the weighted average market price of Johnson & Johnson’s stock shall be strictly fluctuating not below a floor of CHF52.54 and above a ceiling of CHF60.45 during a period of 10 days prior to closing of deal. As a result, each shareholder of Synthes shall receive 1.717 (not more than 1.9672 but not less than 1.7098) shares in Johnson & Johnson and $57.96 in cash for each of his share in Synthes. Key decision makers of Johnson & Johnson made an efficient decision with the proportions set for the purchase price since this would not tie up their funds and would keep liquidity free for flexible running of its operations. Moreover, this would maintain their credit ratings since this deal would not affect its current ratios and acid test ratios; it would be still in position to settle its liabilities and debts in the same manner (M.gurufocus.com, 2006). Defense Tactics When the initial price was offered by Johnson & Johnson to owners of Synthes, it was not performing as good as the offer made, and apparently Synthes was getting more than it deserved. However, they were aware of the qualitative measures as well as forecasted benefits from Johnson & Johnson’s point of view. On the other hand, the mode of purchase appeared attractive and appealing to shareholders of Synthes to get stake in a highly reputable listed entity such as Johnson & Johnson. Also, in that period of time, there was a common belief in stock markets that shares of Johnson & Johnson have been undervalued. Therefore, members of Synthes would view it to be a profitable venture since they might speculate their investments in Johnson & Johnson to increase in value within a short period of time. Synthes’ market value, at the time of acquisition, was no more than $18 billion and therefore the price being offered contained a substantial amount of premium to recognize the hard work and effort put in making Synthes a successful operation. Therefore, there was no question of inadequacy of purchase consideration or need for negotiation on Synthes’ key management’s part. The nomenclature of shareholdings in Synthes is not that scattered since its chairman alone owns 48% of the total equity and therefore there was not much unrest on part of shareholders since they did not have much at stake. The chairman, nevertheless, was convinced with the decision and offered price and thus no complexities were faced during negotiation phase. As a matter of fact, rumors had it that the chairman merely used the offer to comfortably retire with a fortune and had no interests in persuading high bids for his company, which in turn got excessive criticisms by other shareholders and the general public (Intelligence, 2011). Implementation In current scenario, Johnson & Johnson has areas which need radical alterations for good; while allocating its resources therein, catering another acquired concern seems like quite impracticable. The decision shall make the operations of group more complex and hard to manage due to extent of scattered operations around the globe and level of diversification in its production portfolio. Nevertheless, since Synthes deals in similar industry as to that of Johnson & Johnson therefore it can be comfortably assumed that the acquisition shall provide benefits outweighing the problems that come as part and parcel of it. The group can now have a competitive edge in the industry by exploiting its production facilities and capacity, having more efficient employment of resources and by getting nurtured through synergetic effects and economies of scale. Also, the infrastructure and culture of both entities shall bear great resemblance and it might not be problematic to integrate them both to work collectively since Johnson & Johnson already has decades of experience in dealing within same industry and tackling the same nature of obstacles. The pivotal issue lies in the fact that Synthes is already a profitable venture which has created its own presence and goodwill in markets and pressure to maintain its reputation and financial figures shall add greatly to responsibility of Johnson & Johnson (Law, 2011). A major challenge for Johnson & Johnson shall be to mitigate the possibilities of corrosion of earnings per share for its existing shareholders resulting from the implementation of acquisition process. It was forecasted that the earnings per share in 2012 shall fall by $0.10 following the acquisition decision. Johnson & Johnson needs to find different techniques to combat against this negative impact foreseen to be baggage of its decision. It may focus on cost controlling measures to enhance its profitability in other direction to offset the effects coming in from investments side. Moreover, it can, as a last resort, decide to engage a shares buyback programme in order to reduce number of ordinary public shareholders and, in turn, mitigate the possibilities of dilution of earnings per share (Croc, 2012). Evaluation of Risk It can be generally assumed that majority of due diligence decisions adversely affect or dilute the shareholder value of existing shareholders and therefore is often faced with resentment, criticisms and retaliation by them. However, with goodwill created by both the companies, the acquirer Johnson & Johnson and the acquire Synthes, created a positive impact on the stock markets after announcement of the decision. Initially, while announcing its intentions, the management of Johnson & Johnson projected the resolution to dilute current earnings by 22 cents per share. However, due to speculative trading, its shares market price rose by 1.7% in the following period. According to Brown, Johnson & Johnson has not been coping well in stock markets as compared to its rivals but this decision definitely gave it a boost. Thus, it shall be only fair to claim that risks of damage to existing shareholders and their investments were eliminated (brown, 2012). Other risks include possibilities of corporate failures which often occur subsequent to mergers and acquisitions. The acquiring company and group, Johnson & Johnson, is highly prone to failing to manage the new addition to its own overall benefit and to run it in better or atleast the same way as before. A successfully running operation has its established set of norms, standards, attitudes and corporate environment. Johnson & Johnson might find it extremely difficult to blend it in its own culture and enforce its own standards therein. Integration might be found by existing key employees of Synthes as demoralizing and unacceptable and may lead to retaliation, frictional pressures and ultimately employee turnover. Though, the management was confident that they shall succeed in ensuring smooth operations of both entities, giving independence and authoritative control to its management to tolerable extents, still the risks of mismanagement and loss of control must be considered since it not only shall affect operations of Synthes but also become source of serious damages and injuries to the group’s reputation and its employees’ morale. Conclusion Johnson & Johnson needs to take steps to improve its reputation and performance statistics that have deteriorated in past years as compared to its competitors in industry. Therefore, acquisition of Synthes seems like a good call to do the same. The major benefit that Johnson & Johnson would be able to reap from this strategic due diligence decision is the lessening of competition, giving it a stronger footing in the industry and increasing its overall profitability in the long run. The decision, in long term, shall prove out to be very beneficial for Johnson & Johnson as the industry for surgical and medical instruments is blooming and is expected to increase by $71 billion by 2015 (Croc, 2012). From Synthes’ point of view, apart from number game as mentioned in the paper, it could benefit through achievement of a sense of belonging, getting an opportunity to become part of a prestigious group which has better systematic procedures and learning opportunities. In general, public at large will also be in an advantageous position since now they can get the same good at a better price and of a better quality and brand name. However, it may backfire in this regard too: decrease in competition may create opportunity for establishing a monopoly in surgical goods industry, charging unreasonably high prices and consequently causing the customer to suffer. References Bloomberg (2013) Johnson & Johnson Buys Synthes for $21.3 Billion to Boost Trauma Products. [online] Available at: http://www.bloomberg.com/news/2011-04-27/j-j-agrees-to-buy-synthes-for-21-3-billion-in-cash-stock.html [Accessed: 25 Apr 2013]. Bloomberg (2013) Synthes Investor Suits Over J&J Takeover Dismissed. [online] Available at: http://www.bloomberg.com/news/2012-08-20/synthes-investor-suits-over-j-j-takeover-thrown-out-by-judge.html [Accessed: 25 Apr 2013]. Brown, A. (2012) Johnson & Johnson's $19.7B Synthes Deal: A Surprise Earnings Boost - Forbes. [online] Available at: http://www.forbes.com/sites/abrambrown/2012/06/13/johnson-johnsons-19-7b-synthes-deal-a-surprise-earnings-boost/ [Accessed: 25 Apr 2013]. Croc, S. (2012) Johnson & Johnson: A Lucrative Buy On Synthes Acquisition. [online] Available at: http://seekingalpha.com/article/682701-johnson-johnson-a-lucrative-buy-on-synthes-acquisition [Accessed: 25 Apr 2013]. Intelligence, S. (2011) J&J to land Synthes for $20bn?. [online] Available at: http://www.pharma-share.com/jj-land-synthes-20bn [Accessed: 25 Apr 2013]. Investor.jnj.com (2012) Johnson & Johnson Announces Completion of Synthes Acquisition (NYSE:JNJ). [online] Available at: http://www.investor.jnj.com/releasedetail.cfm?releaseid=683098 [Accessed: 25 Apr 2013]. Jnj.com (2013) Johnson & Johnson. [online] Available at: http://www.jnj.com/connect/ [Accessed: 25 Apr 2013]. Law, A. (2011) Will a Synthes implant improve J&J’s standing? - Bizmology. [online] Available at: http://bizmology.hoovers.com/2011/04/28/will-a-synthes-implant-improve-jj’s-standing/ [Accessed: 25 Apr 2013]. M.gurufocus.com (2006) Untitled. [online] Available at: http://m.gurufocus.com/news_read.php?id=129888 [Accessed: 25 Apr 2013]. Reuters (2012) Johnson & Johnson wins US approval to buy Synthes. [online] Available at: http://www.reuters.com/article/2012/06/11/us-jj-synthes-approval-idUSBRE85A1EO20120611 [Accessed: 25 Apr 2013]. The Star-Ledger - NJ.com (n.d.) Johnson & Johnson divests DePuy trauma business to clear way for Synthes deal. [online] Available at: http://www.nj.com/business/index.ssf/2012/04/johnson_johnson_divests_depuy.html [Accessed: 25 Apr 2013]. Read More