Business Reorganizations and Restructuring
sondor2012
ac552-case_study_1_.docxCase study 1
Lam research buys Novellus systems to consolidate industry.
Key Points:
· Industry consolidation is a common response to sharply escalating costs, waning demand, and increasing demands of new technologies.
· Customer consolidation often drives consolidation among suppliers
Highly complex electronic devices such as smartphones and digital cameras have become ubiquitous I our everyday lives. These devices are powered by sets of instructions encoded on wafers of silicon called semiconductor chips (semiconductors). Consumer and business demands for increasingly sophisticated functionally for smartphones and cloud computing technologies require the ongoing improvement of both the speed and the capability of semiconductors. This in turn places huge demands on the makers of equipment used in the chip-manufacturing process.
To stay competitive, makers of equipment used to manufacture semiconductor chips were compelled to increase R&D spending sharply. Chip manufacturers resisted paying higher prices for equipment because their customers, such as PC and cellphone handset makers, were facing declining selling prices for their products. Chip equipment manufacturers were unable to recover the higher R&D spending through increasing selling prices. The resulting erosion in profitability due to increasing R&D spending was compounded by the onset of the 2008-2009 global recession.
The industry responded with increased consolidation in an attempt to cut costs, firm product pricing, and gaining access to new technologies. Industry consolidation began among chip manufacturers and later spurred suppliers to combine. In February 2011, chipmaker Texas Instruments bought competitor National Semiconductor for $6.5 billion. Three months later, Applied Materials, the largest semiconductor chip equipment manufacturer, bought Varian.
Semiconductor Equipment Associates for $4.9 billion to gain access to new technology. On December 21, 2011, Lam Research Corporation (Lam) agreed ti buy rival Novellus Systems Inc. (Novellus) for $3.3 billion. Lam anticipates annual cost savings of $100 million by the end of 2013 due to the elimination of overlapping overheads.
Under the terms of the deal, Lam agreed to acquire Novellus in share exchange in which Novellus shareholders would receive 1.125 shares of Lam common stock for each Novellus share. The deal represented a 28% premium over the closing price of Novellus’s shares on the day prior to the deal’s public announcement. At closing, Lam shareholders owned about 51% of the combined firms, with Novellus shareholders controlling the rest.
In comparison to earlier industry buyouts, the purchase seemed like a good deal for Lam’s shareholders. At 2.3 times Novellus’s annual revenue, the purchase price was almost one-half the 4.5 multiple paid by industry leader Applied Materials for Variant in May 2011. The purchase premium paid by Lam was one-half o that paid for comparable transactions between 2006 and 2010. Yet Lam shares closed down 4%, and Novellus’ shares closed up 28% on the announcement date.
Lam and Novellus produce equipment that works at different stages of the semiconductor-manufacturing process, making their products complementary. After the merger, Lam’s product line would be considerably broader, covering more of the semiconductor-manufacturing process. Semiconductor-chip manufacturers are inclined to buy equipment from the same supplier due to the likelihood that the equipment will be compatible. Lam is also seeking access to cutting-edge technology and improved efficiency. Technology exchange between the two firms is expected to help the combined firms to develop the equipment necessary to support the next generation of advanced semiconductors.
Customers of the two firms include such chip makers as Intel and Samsung. By selling complementary products, the firms have significant cross-selling opportunities as equipment suppliers to all 10 chip makers globally. Together, Lam and Novellus are able to gain revenue faster than they could individually by packaging their equipment and by developing their technologies in combination to ensure they work together. Lam has greater penetration with Samsung and Novellus with Intel.
Lam also stated on the transaction announcement date that a 1.6 billion share repurchase program would be implement within 12 months following closing. The buyback allows shareholders to sell some of their shares for cash such that, following completion of the buyback, the deal could resemble a half-stock, half-cash deal, depending on how many shareholders tender their shares during the buyback program. The share repurchase will be funded out of the firms’ combined cash balances and cash flow. Structuring the deal as an all-stock purchase at closing allows Novellus shareholders to have a tax-free deal.
Discussion Question
1. Why did Lam’s shares close down 4% on the news that Lam would buy Novellus? Why did Novellus shares close up 28%?
2. Speculate why Lam used stock rather than some other form of payment
3. Describe how market pressure on semiconductor manufacturers impact chip-equipment makers and how this merger will help Lam and Novellus better serve their customer
4. How do the high fixed costs in the cyclical chip-equipment-manufacturing industry encourage consolidation?
5. Is this deal a merger or a consolidation from a legal standpoint?
6. Is this deal a horizontal or a vertical transaction? Why is this distinction significant?
7. What are the motives for the deal? Discuss the logic underlying each motive you identify.
8. How are Lam and Novellus similar and how are they different? In what way will their similarities and differences help or hurt the long-term success of the merger?
9. Speculate as to why Lam announced a $1.6 billion share repurchase program at the same time it announced the deal.
10. Do you believe this transaction would help or hurt competition among semiconductor-equipment manufacturers?
Case study 2.
The Importance of Timing: The Express Scripts and Medco Merger.
Key points.
· While important, industry concentration is only one of many factors antitrust regulators use in investigating proposed M&As.
· The timing of the proposed Express Scripts-Medco merger could have been the determining factor in its receiving regulatory approval.
Following their rejection of two of the largest M&As announced in 2011 over concern about increased industry concentration, U.S. antitrust regulators approved on April 2, 2012, the proposed takeover of pharmacy benefits manager Medco Health solutions Inc. (Medco) by Express Scripts Inc., despite similar misgivings by critics. Pharmacy benefit managers (PBMs) are third-party administrators of prescription drug programs responsible for processing and paying prescription drug claims. More than 210 million Americans receive drug benefits through PBMs. Their customers include participants in plans offered by Fortune 500 employers, Medicare Part D participants, and the Federal Employees Health Benefits program.
The $29.1 billion Express Scripts-Medco merger created the nation’s largest pharmacy benefits manager administering drug coverage for employers and insurers through its mail order operations, which could exert substantial influence on both how and where patients buy their prescription drugs. The combined firms will be called Express Scripts Holding Company and will have $91 billion in annual revenue and $2.5 billion in after-tax profits. Including debt, the deal is valued at $34.3 billion. Together the two firms controlled 34% of the prescription drug market in the first quarter of 2012, processing more than 1.4 billion prescription; CVS-Caremark is the next largest, with 17% market share. The combined firms will also represent the nation’s third-largest pharmacy operator, trailing only CVS Caremark and Walgreen Co.
The Federal Trade Commission’s approval followed an intensive eight-month investigation and did not include any of the customary structural or behavioral remedies that accompany approval of mergers resulting in substantial increases in industry concentration. FTC antitrust regulators voting for approval argued that the Express Scripts-Medco deal did not present significant anticompetitive concerns, since the PBM market is more susceptible to new entrants and current competitors provide customers significant alternatives. Furthermore, the FTC concluded that Express Scripts and Medco did not represent particularly close competitors and that the merged firms would not result in monopolistic pricing power. In addition, approval may have reflected the belief that the merged firms could help reduce escalating U.S. medical costs because of their greater leverage in negotiating drug prices with manufacturers and their ability to cut operating expenses by eliminating overlapping mail-handling operations.
The FTC investigation also found that most of the large private health insurance plans offer PBM services, as do other private operators. Big private employers are the major customers of PBMs and have proven to be willing to switch PBMs if another has a better offer. For example, Medco lost one third of its business during 2011, primarily to CVS Caremark.
In addition, to CVS Caremark Corp, PBM competitors include UnitedHealth, which has emerged as a recent entrant into the business. Having been one of Medco’s largest customers, UnitedHealth did not renew its contract, which expired in 2012, with Medco, which covered more than 20 million of its pharmacy benefit customers. Other competitors include Humana, Aetha, and Cigna, all of which have their own PB< services competing for managing drug benefits covered under Medicare Part D. With the loss of UnitedHealth’s business, Express Script-Medco’s share dropped from 34% in early 2012 t 29% at the end of that year.
Critics of the proposed merger argued that similar PBM firms often do not have the bargaining power and data-handling capabilities of their larger competitors. Moreover, benefits managers can steer health plan participants to their own pharmacy-fulfillment services, and employers have little choice but to agree, due to their limited leverage. Opponents argue that the combination will reduce competition, ultimately raising drug prices. As the combined firms push for greater use of mail-ordering prescriptions instead of local pharmacies, smaller pharmacies could be driven out of business, for mail-order delivery is far cheaper for both PBMs and patients than dispensing drugs at a store.
Discussion Questions.
1. Why do you believe that U.S. antitrust regulators approved the merger despite the large increase in industry concentration
3. Speculate as to how the Express Scripts-Medco merger might influence the decisions of their competitors to merge?
