Competitor- Merger & Acquisition Fundamentals Analysis

A PROJECT REPORT
Submitted by:

Ketan Shivarkar Roll No. 01549

NAME OF THE GUIDE Prof. Hemant Katole

in partial fulfillment for the award of the degree of

MASTER OF BUSINESS ADMINISTRATION

MARKETING

DEPARTEMNT OF MANAGEMENT SCIENCES UNIVERSITY OF PUNE

MAY 2011-13

Competitor- Merger & Acquisition Fundamentals Analysis

A PROJECT REPORT
Submitted by:

Ketan Shivarkar
Roll: 01549 Dec 2012 Project Guide: Prof. Hemant Kalote

Pune University, Executive MBA Program

Competitor- Merger & Acquisition Fundamentals Analysis

UNIVERSITY OF PUNE

CERTIFICATE
Certified that this project report Competitor- Merger & Acquisition Fundamental Analysis is the bonafide work of Ketan Shivarkar who carried out the project work under my supervision.

SIGNATURE Prof. Hemant Katole SUPERVISOR, FACULTY DEPARTEMNT OF MANAGEMENT SCIENCES UNIVERSITY OF PUNE, GANESHKHIND, PUNE 411 007

HEAD OF THE DEPARTMENT DEPARTEMNT OF MANAGEMENT SCIENCES UNIVERSITY OF PUNE, GANESHKHIND, PUNE 411 007

External Examiner

Competitor- Merger & Acquisition Fundamentals Analysis

EXECUTIVE SUMMARY

Student information: Name: Ketan D. Shivarkar Roll No: 01549

Email: ketan.shivarkar@gmail.com

Occupation: Engineering Lead/ Team Manager at Cisco Systems India Pvt. Ltd.

Organization Information: Cisco Systems India Pvt. Ltd. Address: Pride Silicon Plaza 106-A, Ground Floor Senapati Bapat Road Pune - 411016 Maharashtra, India

Industry: Computer Networking/Datacenter Gear and Enterprise Software Title of the Project: Merger & Acquisition Fundamental Analysis. Objective of the Project: Cisco Systems has been known as the serial acquirer over the years, this has been based upon the 148 acquisitions executed over the years in the industry. In this project I plan to analyze the core fundamentals, which constitute to a successful acquisitions and contribute to shareholder value.
Competitor- Merger & Acquisition Fundamentals Analysis

ACKNOWLEDGEMENT
I (Ketan Shivarkar) owe a great many thanks to a great many people who helped and supported me during the research and writing this project report.

I sincerely acknowledge the support and guidance given by our mentor Prof. Hemant Katole, without whom, the project would not have taken shape in the desired direction. Every single bit put in by our mentors is precious in its own way. He has taken pain to go through the project and make necessary correction as and when needed.

The thought and Analysis presented in this project report are materials that I acquired in article, books and published research reports. I make no claim to be comprehensive. A special thanks to the authors mentioned in the bibliography page. Special thanks to Prof. Aswath Damodaran (Professor of Finance at the Stern School of Business at NYU) for sharing this knowledge on valuation principles, which formed the base of the project undertaken.

I would also thank my Institution and my faculty members without whom this project would have been a distant reality. I also extend my heartfelt thanks to my family and well-wishers.

Competitor- Merger & Acquisition Fundamentals Analysis

CERTIFICATE

This is to certify that Mr Ketan Shivarkar, student of 2nd year Executive MBA( Operations), has done his semester project titled CompetitorMerger & Acquisition Fundamentals Analysis at Cisco Systems India Pvt. Ltd., Pune during the academic year 2012-13.

Mr. Dipesh Chheda

Solutions Manager Cisco Systems India Pvt. Ltd., Pune

Place: Pune Date: 26 Dec 2012

Competitor- Merger & Acquisition Fundamentals Analysis

INDEX

Sr. No 1

Particulars Company Profile About Cisco Cisco Acquisition History

Pages

8 -- 11 12 -- 20 21 -- 24

2 3

M & A Industry Wide Analysis Analyzing a Deal Gone Bad The HP-Autonomy Acquisition Acquisition Price Build Up Role Of Investment Bankers Over Confident CEO's & Complaint Boards

26 -- 27 28 -- 31 32 -- 35 36 -- 37 38 -- 45 46

4 5

Creating Value from M&A Deals Bibliography

Competitor- Merger & Acquisition Fundamentals Analysis

COMPANY PROFILE

Competitor- Merger & Acquisition Fundamentals Analysis

ABOUT CISCO
Cisco Systems, Inc. is the worldwide leader in networking for the Internet. Today, networks are an essential part of business, education, government, and home communications. Cisco hardware, software, and service offerings are used to create the Internet solutions that make these networks possible, giving individuals, companies, and countries easy access to information anywhere, at any time. In addition, Cisco has pioneered the use of the Internet in its own business practice and offers consulting services based on its experience to help other organizations around the world. Cisco was founded in 1984 by a small group of computer scientists from Stanford University. This year, the company celebrates 20 years of commitment to technology innovation, industry leadership, and corporate social responsibility. Since the companys inception, Cisco engineers have led in the innovation of Internet Protocol (IP)-based networking technologies. This tradition of IP innovation continues with the development of industryleading products in the core technologies of routing and switching, along with Advanced Technologies in areas such as home networking, IP telephony, optical networking, security, storage area networking, and wireless technology. In addition to its products, Cisco provides a broad range of service offerings, including technical support and advanced services. Cisco sells its products and services, both directly through its own sales force as well as through its channel partners, to large enterprises, commercial businesses, service providers, and consumers. As a company, Cisco operates on core values of customer focus and corporate social responsibility. We express these values through global involvement in educational, community, and philanthropic efforts. At Cisco (NASDAQ: CSCO) customers come first and an integral part of our DNA is creating long-lasting customer partnerships and working with them to identify their needs and provide solutions that support their success.

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Founded in 1984 by a small group of computer scientists from Stanford University, Cisco engineers have been leaders in the development of Internet Protocol (IP)-based networking technologies since the company's inception. This tradition of innovation continues with industry-leading products in the core areas of routing and switching, as well as advanced technologies in areas such as Unified Communications, Network Security, Video, Virtualization and Cloud Computing. Innovation is a core part of the Cisco culture and annually $4.5 Billion is invested in R&D; Cisco has more than 22,000 Engineers in more than 10 labs worldwide; more than 4200 patents have been awarded to Cisco inventors. Currently 722 patents have been filed and 420 issued for innovations across all technologies. Cisco Global Facts

Incorporated on December 10, 1984 in California Went public on February 16, 1990. NASDAQ NM: CSCO (Common Stock) Q4 FY'12 Employee Count: 66,639 John T. Chambers is the Chairman and Chief Executive Officer, Cisco FY'12 Revenue: $46.06 billion

Cisco India

With sales and marketing operations spread across key cities in India and a software development centre in Bangalore, Cisco leads the networking market in core technologies of routing and switching, as well as WLAN and network security.

Cisco India Facts

Cisco India commenced operations in 1995 India, as a region, is part of the APAC theater Cisco has 7 Sales Offices in the region - New Delhi, Mumbai, Bangalore, Chennai, Pune, Kolkata and Hyderabad. India headcount is 8700+ including R&D, sales and business support staff
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o

The Cisco Global Development Center is in Bangalore, this is the largest outside of the US. The Cisco ASR 901 Router developed by Cisco's engineering team in India has received the NASSCOM Innovation Award 2012 for innovation in creating a unified platform to serve the needs of 2G/3G/4G mobile backhaul and Carrier Ethernet applications. Joint Development Centers with Wipro Technologies and Infosys Technologies in Bangalore; HCL Technologies in Chennai and Zensar Technologies in Pune.

Cisco's go-to-Market strategy is through partners

o o

2500+ Partners 11 Gold Certified Partners Accenture Services Pvt Ltd, British Telecom India Pvt ltd, Bharti Airtel Services Ltd, Dimension Data India Ltd, HCL Comnet , HCL Infosystems Ltd, IBM, Orange Business Services, AGC Networks, Wipro and TCS 9 Silver Certified Partners Velocis (formerly Integrix), Proactive, Locuz, PC Solutions , Nirmal Datacomm, SK International, Allied Digital Services Ltd, Netplace Technologies Pvt Ltd and Central Data Systems P. Ltd 4 Distributors Ingram Micro, Redington, Compuage and Comstor

Support and Service - Extensive support system for customers with 18 logistics centers (premium depots). Besides that, Cisco is the only vendor to have a support program called ARNBD (advance replacement next business day) for its resellers

Cisco Capital was launched in 2005 to offer flexible leasing and financial services to customers and partners Currently, there are 197 Active Cisco Networking Academies across 23 states & union territories with 22,379 Active Students, 31% of which are women students. Overall these academies have impacted 70,304 students since the program inception in India. India has 18,738 Cisco Certification Ready Course completions through the Cisco Networking Academies.

India Market Share Leadership

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Core Technologies

Router: 71.5%; Switch: 66.4% Total LAN: 68.1% (CY Q2'12, IDC LAN Tracker, Aug 2012)

Advanced Technologies

WLAN: 36.7% (CY Q2'12, IDC, Sep 2012) Security: 34.0% (CY Q2'12, Frost & Sullivan, Sep 2012) Enterprise Telephony: 28.0% (CY Q2'12, Frost & Sullivan, Oct 2012) IP PBX: 43.4% (CY Q2'12, Frost & Sullivan, Oct 2012)

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Cisco Acquisition History

Cisco did not acquire a company for the first seven years of its existence, but on September 24, 1993, Cisco acquired Crescendo Communications, a LAN switching company. Since then, acquisitions have constituted 50% of the company. The company's largest acquisition as of April 2008 is the purchase of Scientific-Atlanta, a manufacturer of cable television, telecommunications, and broadband equipment, for US$6.9 billion. The majority of companies acquired by Cisco are based in the United States. A total of 148 companies have been acquired as of March 2011. Most of the acquired companies are related to computer networking, including several LAN switching and Voice over Internet Protocol companies.

Acquisition Date September 24, 1993 July 12, 1994 October 24, 1994 December 8, 1994 August 10, 1995 September 6, 1995 October 27, 1995 November 6, 1995 January 23, 1996 April 22, 1996 July 22, 1996 August 6, 1996 Company Newport Systems Solutions Kalpana LightStream Combinet Internet Junction Network Translation Grand Junction Networks TGV Software StrataCom Telebit Nashoba Networks Business Routers LAN switching LAN switching Remote software Gateway Firewalls LAN switching Internet company ATM switching Modems LAN switching $4,000,000,000 $200,000,000 $100,000,000 software desktop Cost $94,500,000 $95,000,000 $204,000,000 $120,000,000 $114,200,000 $5,500,000 $30,000,000 Crescendo Communications LAN switching

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September 3, 1996 October 14, 1996 Dec-96 March 26, 1997 June 9, 1997 June 24, 1997 June 24, 1997 September 2, 1997 December 22, 1997 February 18, 1998 March 10, 1998 March 11, 1998 May 4, 1998 July 28, 1998 August 21, 1998 September 15, 1998 October 14, 1998 December 2, 1998 April 8, 1999 April 8, 1999 April 13, 1999

Granite Systems Netsys Technologies Metaplex Telesend Skystone Systems Global Internet Software Group Ardent Communications Integrated Network LightSpeed International WheelGroup NetSpeed Precept Software CLASS Data Systems Summa Four American Internet Clarity Wireless Selsius Systems Pipelinks Fibex Systems Sentient Networks GeoTel Communications

Computer networking Network simulation Computer networking Broadband access Synchronous networking Firewall Broadband access Digital subscriber line Voice Protocol Computer security Broadband access Internet television Computer networking LAN switching Computer networking Wireless networking Voice Protocol Synchronous networking Digital loop carrier Voice Protocol Voice over over Internet optical over Internet Internet over Internet Internet optical Internet

$220,000,000 $79,000,000 $89,100,000 $40,250,000 $156,000,000 $160,000,000 $124,000,000 $236,000,000 $84,000,000 $50,000,000 $116,000,000 $56,000,000 $157,000,000 $145,000,000 $126,000,000 $250,000,000 $195,000,000

Internet $2,000,000,000

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Protocol April 28, 1999 June 17, 1999 June 29, 1999 August 16, 1999 August 18, 1999 August 26, 1999 August 26, 1999 August 31, 1999 September 15, 1999 September 22, 1999 October 26, 1999 November 9, 1999 November 11, 1999 December 16, 1999 December 17, 1999 December 20, 1999 January 19, 2000 Amteva Technologies TransMedia Communications StratumOne Communications Calista MaxComm Technologies Monterey Networks Cerent IBM Networking Hardware Division COCOM A/S Webline Communications Tasmania Network Systems Aironet Communications V-Bits Worldwide Data Systems Internet Engineering Group Pirelli Optical Systems Compatible Systems Wireless Voice Protocol Gateways Synchronous networking Private exchange Voice Protocol Synchronous networking Synchronous networking Computer networking Cable modems Contact management Web cache Wireless LAN Digital video Information technology consulting Synchronous networking Fiber-optic communication Virtual optical optical optical over Internet branch optical over Internet $170,000,000 $407,000,000 $435,000,000 $55,000,000 $143,000,000 $500,000,000 $6,900,000,000 $2,000,000,000 $65,600,000 $325,000,000 $25,000,000 $799,000,000 $128,000,000 $25,500,000 $25,000,000 $2,150,000,000 private $317,000,000

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networking January 19, 2000 February 16, 2000 March 1, 2000 March 16, 2000 March 16, 2000 March 29, 2000 April 11, 2000 April 12, 2000 May 5, 2000 May 12, 2000 June 5, 2000 July 7, 2000 2001 July 25, 2000 July 27, 2000 August 1, 2000 August 31, 2000 September 28, 2000 September 28, 2000 October 20, 2000 Altiga Networks Growth Networks Atlantech Technologies JetCell infoGear Technology SightPath PentaCom Seagull Semiconductor Arrowpoint Communications Qeyton Systems HyNEX Netiverse AuroraNetics Komodo Technology NuSpeed Internet Systems IPmobile PixStream IPCell Technologies Vovida Networks CAIS Software Virtual networking Chipsets Network management Mobile telephones Information management Content delivery LAN switching Computer networking LAN switching Wavelength-division multiplexing Internet access LAN switching Computer networking Voice Protocol iSCSI Mobile software Media Voice Protocol Voice Protocol Integrated development environment over Internet over player Internet (application software) over Internet $19,000,000 $5,700,000,000 $800,000,000 $127,000,000 $210,000,000 $150,000,000 $175,000,000 $450,000,000 $425,000,000 $369,000,000 $200,000,000 $169,000,000 $170,000,000 private $250,000,000 $355,000,000 $180,000,000 $200,000,000 $301,000,000 $800,000,000

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November 10, 2000 November 13, 2000 December 14, 2000 July 27, 2001 May 1, 2002 May 1, 2002 July 25, 2002 August 20, 2002 October 22, 2002 January 24, 2003 March 19, 2003 March 20, 2003 November 12, 2003 March 12, 2004 March 22, 2004 June 17, 2004 June 29, 2004 July 8, 2004 August 23, 2004 September 9, 2004 September 13, 2004 October 21, 2004 November 17, 2004 December 9, 2004 December 20, 2004 January 12, 2005

Active Voice Radiata ExiO Communications Allegro Systems Hammerhead Networks Navarro Networks AYR Networks Andiamo Systems Psionic Software Okena SignalWorks Linksys Latitude Communications Twingo Systems Riverhead Networks Procket Networks Actona Technologies Parc Technologies P-Cube NetSolve dynamicsoft Perfigo Jahi Networks BCN Systems Protego Networks Airespace

Communication software Wireless networking Wireless networking Virtual networks Computer networking Computer networking Computer networking Data storage Intrusion detection Intrusion detection Echo cancellation Computer networking Web conferencing Computer security Computer security Routers Data storage Routers Service Platform Information technology Communication software Computer networking Network management Routers Network security Wireless LAN Delivery private

$266,000,000 $295,000,000 $155,000,000 $181,000,000 $173,000,000 $85,000,000 $113,000,000 $2,500,000,000 $12,000,000 $154,000,000 $13,500,000 $500,000,000 $80,000,000 $5,000,000 $39,000,000 $89,000,000 $82,000,000 $9,000,000 $200,000,000 $128,500,000 $55,000,000 $74,000,000 $16,000,000 $34,000,000 $65,000,000 $450,000,000

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April 14, 2005 April 26, 2005 May 23, 2005 May 26, 2005 June 14, 2005 June 27, 2005 July 22, 2005 July 26, 2005 September 30, 2005 November 18, 2005 November 29, 2005 March 7, 2006 June 8, 2006 June 8, 2006 July 6, 2006 August 21, 2006 October 10, 2006 October 25, 2006 November 13, 2006 December 15, 2006 January 4, 2007 February 9, 2007 February 21, 2007 March 5, 2007

Topspin Communications Sipura Technology Vihana FineGround Networks M.I. Secure Corporation Netsift KISS Technology Sheer Networks Nemo Systems Scientific-Atlanta Cybertrust SyPixx Networks Metreos Audium Meetinghouse Arroyo Video Solutions Ashley Laurent Orative Greenfield Networks Tivella IronPort Five Across Reactivity Utah Street Networks

LAN switching Voice Protocol Semiconductors Network security Virtual networks Computer networking Entertainment technology Service management Computer networking Digital cable Information gathering Surveillance Voice Protocol Voice Protocol Computer security Video on demand Gateways Mobile software Semiconductors Digital signage / IPTV Computer security Social service Web services Social networking over Internet over Internet private over Internet

$250,000,000 $68,000,000 $30,000,000 $70,000,000 $13,000,000 $30,000,000 $61,000,000 $97,000,000 $12,500,000 $6,900,000,000 $14,000,000 $51,000,000 $28,000,000 $19,800,000 $43,700,000 $92,000,000 $31,000,000 $830,000,000 $135,000,000

networking

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service March 13, 2007 March 15, 2007 March 28, 2007 May 21, 2007 September 18, 2007 September 27, 2007 October 23, 2007 November 1, 2007 April 8, 2008 June 10, 2008 July 23, 2008 August 27, 2008 September 19, 2008 January 27, 2009 March 19, 2009 May 1, 2009 October 27, 2009 November 2, 2009 December 18, 2009 April 18, 2010 May 18, 2010 NeoPath WebEx SpansLogic BroadWare Technologies Cognio Latigent Navini Networks Securent Nuova Systems, Inc. DiviTech A/S Pure Networks, Inc. PostPath Jabber, Inc. Richards-Zeta Intelligence Pure Digital Technologies Tidal Software ScanSafe Set-top box business of DVN Starent Networks Tandberg MOTO Data storage Web conferencing Computer networking Surveillance Mobile software Business WiMAX Digital management Computer networking Digital management Computer software Email Presence Building Building systems Digital video Intelligent Application Management SaaS Web Security Provider Cable System Evolution Videoconferencing Development Product design Architecture management service rights performance management $3,200,000,000 $330,000,000 $100,000,000 $678,000,000 $120,000,000 $215,000,000 $590,000,000 $105,000,000 $183,000,000 $2,900,000,000 $3,300,000,000

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Group May 20, 2010 August 26, 2010 September 2, 2010 December 1, 2010 CoreOptics ExtendMedia Arch Rock Corporation LineSider Technologies Digital processing Video Smart Grid Network Software Network Configuration January 26, 2011 Pari Networks and Adaptive February 4, 2011 Inlet Technologies (ABR) [Cisco Bit digital Change Rate media $95,000,000 Management (NCCM) Management signal

processing platforms March 29, 2011 August 21, 2011 August 29, 2011 October 20, 2011 March 15, 2012 newScale Inc. AXIOSS Talent Versly BNI Video NDS Group Software Intelligent Automation for Cloud] and IT Service Management Software Integrated Software Video Conditional Access $31,000,000 $99,000,000 $5,000,000,000

The buy pillar of the company's three pillars of innovation: build, buy, and partner. Cisco focuses on acquisitions that capitalize on new technologies and business models. Cisco's growth strategy is based on identifying and driving market transitions. Corporate Development focuses on acquisitions that help Cisco capture these market transitions. Cisco segments acquisitions into three categories: market acceleration, market expansion, and new market entry. The target companies might bring different types of assets to Cisco, including great talent and technology, mature products and solutions, or new go-

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to-market and business models. Cisco particularly seeks acquisitions with the potential to reach billion dollar markets. Integration is essential to successful acquisitions. Our overall business development effort includes engaging from the early diligence phase through to mainstream business, by investing in dedicated integration resources across the company at the corporate and functional levels. We have a long history of integration, achieving best practices through continuous learning and deep experience with a process that challenges all companies who repeatedly make acquisitions. Leaders in IT and other markets frequently seek Cisco's advice on acquisition integration. Our integration process starts with the entire acquisition strategy. Cisco seeks acquisitions where there is not only a strong business case but also a shared business and technological vision, and where compatibility of core values and culture foster an environment for success.

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M & A Industry Wide Analysis

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The evidence suggests that a growth strategy built around acquisitions, especially of other publicly traded firms, is more likely to fail than succeed. To back this statement, you can look at three pieces of evidence a) The behavior of the acquiring company's stock price, around the announcement of an acquisition b) The post-deal performance (stock price & profitability) of firms after acquisitions c) The overall track record of acquisition-based growth strategies, relative to other growth strategies

When an acquisition of a publicly traded company is announced, the attention is generally on the target firm and its stock price, but the market's reaction to the event is better captured in what happens to the acquiring firm's stock price. In the figure below, take a look at the target and acquiring firm stock behavior in the twenty days before and after the acquisition announcement across hundreds of acquisition announcements:

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The winner in public company acquisitions is easy to spot and it is the target company stockholders, who gain about 18% over the 41 days. On average, bidding company stockholders have little to show in terms of price gains; the stock price for acquiring firms drops about 2% during the announcement period and about 55% of all acquiring firms see their stock prices go down. Note that while the percentage price drop is small (relative to the price increase for the target firm), acquiring firms are typically much larger than target firms and the absolute value that is lost by acquiring firm stockholders from acquisitions can be staggering. A study of 12,023 acquisitions by large market cap firms from 1980 to 2001 estimated that their stockholders lost $218 billion in market value because of these acquisitions. While this number was inflated by some especially bad deals done between 1998 and 2000, they illustrate the potential for massive value losses from acquisitions and the reality that one big, bad deal can undo decades of careful value creation in a company.

Post-deal stock price performance: KPMG studied the 700 biggest mergers between 1996 and 1998 and compared the stock price performance for a year after the deal was closed to that of the peer group to conclude that 83% of the companies underperformed after acquisitions. Thus, the negative reaction to acquisition announcements does not seem to dissipate over longer periods. In some good news, KPMG has updated its M&A study five more times since its 1999 study and reports that there has been some improvement between 1999 and 2011. While only 31% of deals made in the last study (looking at 2007-2009 deals) were value adding, that is an improvement over the 17% from the 1999 study

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ANALYSING A DEAL GONE BAD

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THE HP-AUTONOMY ACQUISITION

Hewlett Packard (HP) had a terrible day on November 20 2012. In a surprise announcement, the company announced that it was taking a write off of $8.8 billion of the $11.1 billion that it paid to acquire Autonomy, a UK based technology company, in October 2011, and that a large portion of this write off ($ 5 billion) could be attributed to accounting improprieties at Autonomy. Even by the standards of acquisition mistakes, which tend to be costly to acquiring company stockholders, this one stood out on three dimensions: 1. It was disproportionately large: While there have been larger write offs of acquisition mistakes, this one stands out because it amounts to approximately 80% of the original price paid. 2. The preponderance of the write off was attributed to accounting manipulation: Most acquisition write offs are attributed either to over optimistic forecasts at the time (the investment banker made us do it) of the merger or changes in operations/markets after the acquisition (it was not our fault). HP's claim is that the bulk of the write off ($5 billion of the 8.8 billion) was due to accounting improprieties (a polite word for fraud) at Autonomy. 3. The market was surprised: Most acquisition write offs, which take the form of impairments of goodwill, are non-news because they lag the market and have no cash flow effects. In other words, by the time accountants get around to admitting a mistake from an acquisition, markets have already admitted the mistake and moved on. In HP's case, the market was surprised and HP's stock price dropped about $ 3 billion (12%) on the announcement. Put differently, the market had priced in an acquisition mistake of $5.8 billion into the value already and was surprised by the difference.

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The blame game

Meg Whitman, the current CEO of HP, blamed the prior top management at the company, and said that "(t)he two people that should have been held responsible are gone ". Leo Apotheker, the prior CEO who orchestrated the acquisition, claimed to be shocked at the "accounting improprieties" at Autonomy. Michael Lynch, the founder of Autonomy, said that two major auditors had performed "due diligence" on the financial statements and had found no improprieties at the company. Deloitte LLP, the auditor for Autonomy, denied all knowledge of accounting misrepresentations and claimed to be cooperating with authorities. The advisers on the deal (Perella Weinberg & Barclay's Capital for HP, Quatalyst, UBS, Goldman Sachs, Chase & BofA for Autonomy) have all been mysteriously silent, though none have offered a refund of their advisory fees.

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BUILDING UP THE ACQUISITION PRICE

Before we look at the numbers, it is worth reviewing the history of the two companies involved. Autonomy was a company founded at the start of the technology boom in 1996, which soared and crashed with that boom and then reinvented itself as a business/enterprise technology company that grew through acquisitions between 2001 and 2010. Hewlett Packard, with a long and glorious history as a pioneer in computers/technology, had fallen on lean times as its PC business became less competitive/profitable and due to top management missteps. On August 18, 2011, HP's then CEO, Leo Apotheker (who had worked at SAP) announced his intent to get out of the PC business and expand the enterprise technology business by buying Autonomy. While the deal making began on his watch, the actual deal was officially completed on October 3, 2011, with Meg Whitman as CEO. If she was a reluctant participant in the deal, it was not obvious in the statement she released at the time where she said "the exploding growth of unstructured and structured data and unlocking its value is the single largest opportunity for consumers, businesses and governments. Autonomy significantly increases our capabilities to manage and extract meaning from that data to drive insight, foresight and better decision making." One of the perils of assessing "big" merger deals is that the fog of deal making, composed of hyperbole, buzzwords and general uncertainty, obscures the facts. So, lets stick with the facts that were available at the time the deal was done (a time period that stretched from August 18, 2011, to October 3, 2011): 4. Acquisition Price: While there have been varying numbers reported about what HP paid for Autonomy, partly reflecting when the story was written (between August & November) and partly because of exchange rate movements (HP paid 25.50/share), the actual cost of the deal was $11.1 billion.

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5. Market Price prior: Autonomy's market cap a few days prior to the deal being announced was approximately $5.9 billion. 6. Pre-deal accounting book value: The book value of Autonomy's equity, prior to the deal, was estimated to be $2.1 billion. (Source: Autonomy's balance sheet from its annual report for 2010) 7. Post-deal accounting book value: After acquisitions, accountants are given a limited mission of reappraising the value of existing assets and this appraisal led to an adjusted book value of $ 4.6 billion for Autonomy. (Source: HP's 2011 annual report, page 99) The advantage of working with these numbers is that differences between them are revealing. In the figure below, I attempted to deconstruct the $11.1 billion paid by HP into its constituent parts:

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Acquisition Price Build Up

You can see the build up to the price paid by HP as a series of premiums: 1. The accounting "write up" premium for book value: One of the residual effects of the changes that have been made to acquisition accounting is that accountants are allowed to reassess the value of a target company's existing assets to reflect their "fair" value. For technology companies such as Autonomy, this becomes an exercise in putting values to technology patents and other intangible assets and that exercise added $2,533 million to the original book value of equity.

2. The pre-deal "market" premium over book value ($1.3 billion over post-deal book value): Even if accountants write up the value of assets in place to fair value,

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markets may still attach a premium for growth potential and future investments. As with any market number, this number can be wrong, too high for some companies and too low for others. Prior to the HP deal, the market was attaching a value of $6.2 billion to Autonomy, $3,833 million higher than the original book value of equity and $1.3 billion more than the post-deal accounting book value of equity.

3. The acquisition premium ($5.2 billion): To justify this premium, HP would have to had to believe that one or more of the following held: (i) (ii) The market was undervaluing Autonomy, i.e., that the true value of Autonomy was much higher than the $ 5.9 billion, There are synergies between HP and Autonomy that have value, i.e., that there are value-enhancing actions that the combined firm (HP+Autonomy) can take that could not have been taken by the firms independently and/or (iii) That Autonomy was badly run and that changing the way it was run could make it more valuable, i.e., there is a control premium.

Even without the benefit of hindsight, neither undervaluation nor the control premium seemed to fit as motives in this acquisition. The market was pricing Autonomy richly in August 2011; the market cap of $ 5.9 billion was roughly 6 times revenues and 15 times earnings and neither number looked like a bargain. The reaction to the deal was negative, at the time that it was done. The analysts and experts were generally down on the deal, but more importantly, the markets voted against the deal by pushing down HP's stock price.

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ROLE OF INVESTMENT BANKERS

HP paid $30.1 million in advisory fees to Perella Weinberg and Barclays Capital for guidance on how much to pay for Autonomy and whether the deal made sense. So why did they not spot the accounting manipulation or recognize that synergy would be elusive? In general, why, if acquiring firms pay so much for "expert" advice, do so many deals go bad?

Conflicting roles:

The answer can be seen in an imperfect analogy. Asking an investment

banker whether a deal makes sense is analogous to asking a plastic surgeon whether there is anything wrong with your face. After all, if either party says No, they have no business to transact and no revenues to generate. Allowing the dealmaker (the investment banker) to also be the deal analyst (provide advice on whether the deal is a good deal) is a recipe for bad deals and we have no shortage of those. The solution is simple in the abstract but transitioning to it may be difficult. The deal making has to be separated from the deal analysis. Put differently, investment bankers should do what they do best, which is to manage the mechanics of the deal, and be paid for the service. There should be a third party, with absolutely no stake in the deal's success or failure, whose job it is to assess the deal to see if it makes sense, with compensation provided just for that service. Why has this common sense change not happened yet? First, many acquiring companies want affirmation of decisions that they have already made (to acquire), rather than good advice. Second, the same entity (say, Goldman Sachs or Morgan Stanley) cannot slip back and forth between being a deal maker on one deal and a deal analyst on another, since there will be a shared and collusive interest then in shirking the deal analyst role. You would need credible entities whose primary business is valuation/appraisal and not deal making.

The Deal Table: In many businesses, companies measure their success based upon market
share and revenues. M&A bankers are no different and their success is often measured by where they fall in the deal table rankings. Here, for instance, is the latest deal table from Bloomberg, listing the top bankers for M&A globally, in 2011 and 2012.

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Note that the rankings are based upon the dollar value of deals done, and that there are no extra columns for good deals and bad deals. Consequently, a banker who does a $11 billion bad deal will be ranked more highly than one who does a $4 billion good deal. There are three implications that follow. 1. When a big deal surfaces, bankers line up to be part of that deal, willing to bear almost any cost to get involved. 2. The bigger the deal, the worse the advice you are likely to get; the conflict of interest that we mentioned earlier gets magnified, as the deal gets larger. 3. Individual bankers will be judged on their capacity to get deals done and not on the quality of their deal advice or valuation expertise. Thus, it is not surprising that the biggest stars in the M&A firmament are the dealmakers.

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In fact, it is interesting that Perella Weinberg is listed as one of HPs advisors on the Autonomy deal. Joe Perella, co-founder of the firm has a long history in the acquisition business that goes back almost four decades to his position as co-head of M&A at First Boston in the 1970s. He left the firm; with the other co-hear of the First Boston M&A team, (Bid 'em up) Bruce Wasserstein, to create Wasserstein Perella, a lead player in the some of the biggest acquisitions of the 1980s. He returned to head M&A at Morgan Stanley for a few years before leaving again to found Perella Weinberg. Through all the years, it seems that the singular skill that he possesses is not his capacity to value target companies but that he can get any deal done. So what can we do to change this focus on deal making? We do have to begin by changing the way we compensate bankers in deals but we also have to follow up on deals. I would like to see some entity generate deal tables that track the largest deals from five years ago and report how much those deals have made (or lost) for stockholders in the acquiring firms. It would be interesting to see the list of the top 10 bankers in terms of value creating and value destructive deals.

Compensation: The third factor that contributes to the deterioration of deal advice is
the way in which the deal advisors get compensated for their services. In most deals, the deal advisors get paid for getting the deal done and there is no accountability for deal performance. Neither Perella Weinberg nor Barclays Capital will have to return any of the advisory fees that they received for the HP/Autonomy deal, even though the advice that was offered was atrocious. I think that there is a solution, even within the existing system. Rather than tie the entire fee to getting the deal done, a significant portion should be contingent on post-merger performance. Thus, if the acquiring firms stock price or profitability fails to beat the peer groups stock price performance or profitability in the years (two, three or five) that follow, the bankers will either not get a large portion of their fee or be forced to return a proportion of the fees that they have already been paid. Bankers will complain that this puts them at the mercy of macroeconomic shifts and mismanagement of the post-merger integration, but those are variables that they should be considering when assessing whether a deal should get done.

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In closing, though, acquiring firms are quick to blame bankers for bad advice. I think that the ultimate blame has to lie with the top managers of the acquiring firms. No acquirer is ever forced to do an acquisition at the wrong price and if they chose to do so, they should be held responsible.

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Over Confident CEOs & Compliant Boards

Given the manpower, data power and model power that are brought into the acquisition process. How can all these smart people working with sophisticated models and updated data be so wrong so often? The answer lies in a simple fact: in most acquisitions, the decision to acquire is made first and the analysis follows, and all too often, the decision is not only made at the top of the organization, but at the very, very top by the CEO. That is not the way organizations are supposed to work. Big ideas, no matter who originates them, are supposed to be discussed honestly and openly, analyzed fully and then vetted by an independent, well informed board of directors to make sure that stockholder interests are being served. That may still happen in some organizations, but consider this alternate reality. In a moment of inspiration (insanity) or brilliance (lunacy), the CEO decides to do an acquisition of a target firm for strategic (empire-building) reasons. The managers around him or her, recognizing that the die has been cast, choose not to voice their opinions, get bulldozed when they do, or decide to join the CEO in pronouncing the acquisition a great idea. An investment banker is found to affirm that the deal is, in fact, a great deal and the rest as they say is history. If the acquisition process is prone to failure, as the evidence suggests that it is, there are many potential culprits that you can blame. The investment bankers who facilitate the deals for huge advisory fees are an easy target and the accountants/auditors who dress up the books are a close second, but the primary culprit has to be the top management (and particularly the CEO) of the acquiring firm. After all, once a CEO gets set on doing a deal, he can go about picking the facilitators (the investment bankers and accountants) to make the deal look good. As we bring behavioral finance into play, the evidence suggests that over confident CEOs play a key role in greasing the skids for large (bad) acquisitions. To measure confidence, Malmendier and Tate, who have a series of interesting papers on how over confident CEOs manage, developed two measures.

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They looked at a sample of 394 large US firms and found that over confident CEOs were 65% more likely to do acquisitions than cautious CEOs, though they were also less likely to draw on external financing; their over confidence led them to believe that the market was underpricing their stock and thus made them more reluctant to use stock in acquisitions. They were also more like to acquire just to diversify, and the market reaction to their acquisitions is more negative than to acquisitions by cautious CEOs. Can no one stop a headstrong CEO? There is a counterweight built into the system, the board of directors, and it can act as a restraint on a CEO embarking on a valuedestructive path. Unfortunately, one common feature shared by value-destroying acquirers is a compliant board, which shirks its responsibility to protect shareholder interests. It is not surprising that it HP, which has had issues with corporate governance and board oversight, was the ill-fated acquirer of Autonomy.

In summary, then, a headstrong, over confident CEO, combined with a compliant board creates a decision making process where there are no checks on hubris and large, value destroying actions often follow. If investors want to prevent their firms from embarking on deals like the HP/Autonomy deal, they need to pay attention to corporate governance, and not just at the surface level. After all, the board at HP met all the Sarbanes/Oxley requirements for a "good" board and may even have scored high on the corporate governance scores in 2010. The problem with corporate governance watchdogs, legislation and scores is that they are far too focused on what the board looks like and far too little on what it does. In my view, it matters little whether a board is small or large, whether it is filled with luminaries or unknowns, experts or novices and whether it meets the criteria for independence. It does matter whether the board acts as a check on the dreams and acts of imperial CEOs.

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CREATING VALUE FROM M&A DEALS

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Go where the odds favor you

While acquisitions in the aggregate, and on average, have not been good news for acquirers, there are some subsets of acquisitions where acquiring company stockholders do much better. a) Small versus Large acquisitions: Acquiring smaller companies seem to provide much better odds of success than mergers of equals. In the graph below, for instance, take a look at the returns to acquirers around acquisition announcements of targets, with the targets classified based upon their size in market cap terms, relative to the acquiring company. Markets are much more welcoming of small deals than big ones, justifiably wary of the integration costs and culture clashes that mergers of equal inevitably bring.

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Note that the biggest successes are with target firms that are small, with market caps, less than 6% of the acquiring firm's market cap and returns get progressively worse as target firm size increases. b) Cash versus Stock: There is no consensus finding here, but looking at the figure above, paying with stock seems to deliver higher returns for small acquisitions, but paying with cash seems deliver better returns with larger acquisitions. Perhaps, target company stockholders recognize the propensity of acquiring companies to pay with "overpriced' stock and demand higher premiums. c) Private versus Public targets: Acquirers who focus on buying privately owned businesses rather than public companies earn much more positive returns, mostly because they dont have to pay premiums over a market price that already incorporates much of what they are paying for. In fact, looking at the figure below, the very best targets are divisions of public companies, often divested at bargain basement prices by CEOs who want to get rid of high profile failures.

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d) Cost synergies versus growth synergies: While it is good to be skeptical about promised synergies in acquisitions, companies seems to be much better at delivering cost synergies than growth synergies, as evidenced in the figure below. This phenomenon may reflect the fact that cost synergies are easier to plan for and deliver than amorphous growth synergies.

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Do your valuation, before you make your offer and value all the "good" stuff I believe that the biggest problem with an acquisition based strategy remains the price paid. If you pay too much for a target company, no matter how well matched that company may be to yours, you have a bad deal. The key to a successful acquisition strategy then becomes doing your homework in valuing not only the target company but all of the other goodies that you see coming with the deal, control and synergy being foremost. It is also critical that this valuation not be outsourced to bankers or consultants. They may be well intentioned, but it is not their money that is being spent. Here is the three-step process for valuing an acquisition:

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Step 3: Value Synergy

Value the combined firm with synergy built in. This may include a. A higher growth rate in revenues: growth synergy b. Higher operating margins, because of economies of scale c. Lower taxes, because of tax benefits: tax synergy d. Lower cost of debt: financing synergy e. Higher debt ratio because of lower risk: debt capacity Subtract the value of the target firm (with control premium) + value of the bidding firm (pre-acquisition). This is the value of the synergy.

Step 2: Control Premium

Value the company as if optimally managed. This will usually mean that investment, financing and dividend policy will be altered: Investment Policy: Higher returns on projects and divesting unproductive projects. Financing Policy: Choose a financing mix/ type that reduces your cost of capital Dividend Policy: Return unused cash, especially if you are punished for it. Value of control = Target company value with optimal management Status quo target company value from step 1.

Step 1: Status Quo Value (Target firm)

Value the target company as is, with the existing managements investment, financing and dividend policy (even if it is optimal or efficient)

Each of these steps will require estimates and forecasts, but that is true for any investment. In fact, I would wager that many companies spend far more time making these assessments with small capital budgeting projects than they do with multi-billion dollar acquisitions. Managers will also claim that synergy is too qualitative and fuzzy to
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value, which would be fine if they were paying with qualitative dollars, but they are not.

Get a Share of the Spoils

Just because you have valued control and synergy in a merger does not mean that you should offer to pay that amount as a premium. If you do, target company stockholders walk away with the spoils of your hard work (in delivering control and synergy value) and your stockholders get nothing. Thus, a key step in acquisition is negotiating for a fair share of both the control and synergy values. That fair share will depend upon how integral the acquiring company is to generating these additional values; the more important the role of the acquirer, the greater the share of the premium it should demand. In fact, if bankers are true deal makers, this is where they should earn their fees.

Have a plan to deliver the good stuff

While many acquirers seem to view getting the deal done as the climax of the process, it is really the beginning of a long (and often tricky) process of integration. Good acquirers not only have clear plans for what they will do after the acquisition but they also set aside the resources (people, funds) to put those plans into operation. When mergers work, it is almost never by accident. The KPMG surveys of global mergers over the years have emphasized this planning and post-deal integration as a key component to deal success.

Hold decision makers accountable

If you want acquisitions to deliver value, you have to hold everyone in the process accountable. I would start with the managers in the acquiring firm but I would also include the bankers and consultants to the acquiring company. In particular, I think that management compensation and deal fees should have clawback provisions that are conditioned on the performance of the merged firm (in stock prices and profitability).

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Be ready to walk away

You have to be willing to walk away from a deal, if it does not make sense for you. In too many deals, the objective for the acquiring firm becomes getting the deal done, rather than getting a good deal done. In addition to staying disciplined, i.e., not going back and fudging the valuation numbers to make a deal look good, there is another simple rule that acquirers should consider following. If you get into a bidding war over a target firm, walk away. In fact, while you may nominally be labeled the loser in the bidding war, it is far better for your stockholders to be the loser rather than the winner, as evidenced by the figure below:

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BIBLOGRAPHY
http://www.cisco.com/web/about/doing_business/corporate_development/acquisitions/ab out_cisco_acquisitions.html http://www.hp.com/hpinfo/newsroom/press/2011/111003xb.html http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irolnewsArticle&ID=1760639&highlight= http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=AUT NF&dataset=balanceSheet&period=A&currency=native http://www.stern.nyu.edu/%7Eadamodar/pc/blog/HP2011annual.pdf http://emlab.berkeley.edu/%7Eulrike/Papers/OCmergers_19_05_06_Final_Tables.pdf http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1340514 http://en.wikipedia.org/wiki/Main_Page http://emlab.berkeley.edu http://www.kpmg.com/global/en/pages/default.aspx http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1573395 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=385023 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1340514 www.imaa-institute.org/docs/m&a/kpmg_01_Unlocking%20Shareholder%20Value%20%20The%20Keys%20to%20Success.pdf http://www.globoforce.com/gfblog/2012/6-big-mergers-that-were-killed-by-culture/

Competitor- Merger & Acquisition Fundamentals Analysis