PART II: IT IS COMPLICATED
This is an
entanglement.
A
complicated corporate relationship status connotes minority acquisitions
(taking less than 50% stakes) in other companies, while the long-term purpose
of stake-building often remains unclear.
In 2008,
Dangote Group, Nigeria’s leading industrial conglomerate, acquired initial
stake of 19.76% (for R350 million of equity funding) in Sephaku Cement, a
leading cement manufacturer in South Africa.
On August
11, 2005, Yahoo! announced it would pay $1 billion in cash and hand over its
China operations to Alibaba.com, China’s e-commerce giant company, in exchange
for 40% stake in Alibaba. The deal would also give Yahoo! 35% voting rights in
Alibaba.com, making it the largest strategic investor in its Chinese partner.
In return, Alibaba would win the exclusive right to use and grow the Yahoo!
brand in China.
A more
complicated relationship occurred on August 6, 1997, when Microsoft invested
$150 million in non-voting Apple stock. The investment served as the lifeline
for Apple’s survival at that period. Yet, then and now, the two companies have
been rivals.
Also, on October
24, 2007, Microsoft acquired 1.6% stake in Facebook for $240 million. This
acquisition came after Zuckerberg frustrated Microsoft’s initial plan for
outright acquisition of Facebook. The small stake also served as lifeline for
Facebook’s survival.
Why all
these minority stakes? The answer is simple – it is complicated.
Acquiring
minority stakes in a company is a notable corporate practice. Such acquisitions
may be for strategic or purely financial investment. And sometimes, it is just
complicated, pure and simple. Because no one really knows why.
·
Strategic Investment
Strategic
investment is one of the two broad methods of investing in the financial world.
The first method involves investment in a company by an individual or another company
with the goal of generating safe, steady returns. The goal is different with
strategic investment.
According
to The
Business Professor, the idea behind strategic investment is to
leverage the invested business, to boost the investor’s market standing. More
than the profits, a strategic investor wants access to the invested business’s
technology, ideas, services, or products, to enhance their own business model.
The Toyota production system
Charles W.
L. Hill, Melissa A. Schilling and Gareth R. Jones write in their book, Strategic Management: An Integrated
Approach, Theory & Cases, 12e, that in contrast to American practice, Toyota
decided, in the 1950s, that, while it would increase in-house capacity for
essential subassemblies and bodies, it would do better to contract out for most
components.
Four
reasons seemed to bolster this strategy:
1. Toyota
wanted to avoid the capital expenditures required to expand capacity to
manufacture a wide variety of components.
2. It
wanted to reduce risk by maintaining a low factory capacity in the event that
factory sales slumped.
3. It
wanted to take advantage of the lower wage scales in smaller firms.
4. Toyota
managers realised that in-house manufacturing offered few benefits if it was
possible to find stable, high-quality, low-cost external sources of component
supply.
They write
that as Toyota evolved during the 1950s and 1960s, its strategy toward its
suppliers had several elements. The company spun off some of its in-house
supply operations into quasi-independent entities in which it took a minority
stake, typically holding between 20 and 40% of the stock. It then recruited a
number of independent companies with a view to establishing a long-term
relationship with them for the supply of critical components. Toyota took a
minority stake in these companies as well.
The
consequences of Toyota’s production system included a surge in labour
productivity, a decline in the number of defects per car, and having the
greatest number of vehicles produced per worker when compared to those at
General Motors, Ford and Nissan between 1965 and 1983.
Taking
minority stakes in a company as a form of strategic investment is employed for several
reasons, which may not be readily obvious.
Outsourcing
R&D
Acquiring
minority stakes can be used for outsourcing research and development (R&D)
from other companies. An article in
Inc. explains R&D is used for obtaining new
knowledge applicable to your business’s needs, which eventually results in new
or improved products, processes, systems, or services that can increase your
business’s sales and profits. R&D can be conducted in-house, under
contract, or jointly with others.
GSK held 18% in Convergence Pharmaceuticals
In life
sciences industry, GlaxoSmithKline (GSK) spun out a group of scientists and
patents involved in experimental drugs for analgesics in 2010, write Faelten et
al. GSK kept 18% of the new business, called Convergence Pharmaceuticals. In
this case, the deal was seemingly designed to cut overheads in R&D for GSK,
boost productivity at the new company and still leave GSK with “skin in the
game”.
According
to Hill et al., although outsourcing non-core activities has many benefits,
there are also risks associated with it, such as holdup and the possible loss
of important information when an activity is outsourced.
In the
context of outsourcing, they explain, holdup refers to the risk of your company
becoming too dependent upon the specialist provider of an outsourced activity
and the specialist using this fact to raise prices beyond some previously
agreed-upon rate. However, the risk of holdup can be reduced by outsourcing to
several suppliers and pursuing a parallel sourcing policy.
As regards the
risk of loss of important competitive information and forfeited learning
opportunities, they write that ensuring there is appropriate communication
between the outsourcing specialist and your company can be effective in
mitigating the risk. At Dell, for example, a great deal of attention is paid to
making sure that the specialist responsible for providing technical support and
onsite maintenance collects and communicates all relevant data regarding
product failures and other problems to Dell, so that Dell can design better
products.
Access to
greater information
Minority
acquisitions can facilitate access to greater information about a target,
allowing the acquiring company to better assess the value of the target and
expected synergies before committing to purchasing a majority stake in the
target. This is particularly common where uncertainty surrounds expected result
from a full-blown merger.
In this
instance, the holder of minority stakes gets the opportunity to monitor the
target firm and participate in its management.
Malcolm glazer acquired Manchester United
Faelten et
al. write that in 2003, Manchester United was one of the most successful
football teams in Europe with a history that gave the club a uniquely popular
global fan base. It was a time when a number of outside investors saw the UK
football market as an attractive investment for either prestige or money.
As the
strategy to acquire Man United, Malcolm Glazer swept the market for available
shares of the company and started purchasing them. By November 2004, he had
acquired 28% stake of the company’s shares. He then demanded and received three
board seats in the company.
At this
stage, Mr. Glazer realised that in order to acquire majority stakes in the
company, he had to find a way to buy the 29% stake belonging to the second
biggest shareholder of the company, Cubic Expression. Combining his stake with
Cubic’s would give him more than 50% of the club – certainly enough for control
and also sizeable enough to try to force out small investors.
In May
2005, Mr. Glazer finally secured Cubic’s stake, giving them a majority of the
company’s shares. Only at this point – confident that they could squeeze out
the remaining shareholders as would be possible under UK takeover regulations –
did the Glazer family launch a formal bid for Man United.
Mr. Glazer
bought United for £790 million in a highly leveraged deal by putting in £270
million of their own cash (34% of the borrowed money).
READ ALSO: Salami Tactic in Negotiation: How Malcolm Glazer Acquired Manchester United
Expanding
into foreign market
Minority
acquisition can also be used as a scout before extending your tentacles across
foreign markets. Like Warren Buffett advises, do not test the depth of the
river with both your feet while taking a risk. And a foreign market river may
be far deeper than the ocean.
Expanding
into a new geographic location is challenging in various aspects. For you to
operate effectively, you need local relationships, not only with customers but
also with suppliers, partners, regulators, and a host of other parties. A
bigger challenge is understanding and operating within a new local culture. As
a result, taking a minority stake in your potential target helps you to better
assess those challenges, and minimise risks.
Yahoo!-Alibaba deal
Recounting
what went down with Yahoo! minority stake in Alibaba and reasons for the
success of the investment, Sue Decker, Yahoo! President at the time, writes in an article
in Harvard Business Review that, “A second critical
principle that contributed to our success in China was the realisation that we
had to be willing to loosen the reins of control. This runs counter to the
behaviour of most corporations and counter to our earlier attempts. In the
media and internet industries, it turns out to be very important when operating
in China.
“So with
Alibaba, we realised we needed to be willing to give up all operating control.
Practically speaking, this meant forgoing our previous desire to own more than
50% of the local operations. It also meant we would leave all employee issues to
our partner and allow our code to be used by people with no previous connection
to the company. Scary.”
Risks
attached to expanding into an international market include operating, valuation
and integration risks. Majority acquisition effectively transfers majority
control to the acquirer, along with the primary incentive and responsibility to
manage and operate the target company. On the other hand, not assuming primary
responsibility for operations of the target company through minority
acquisition shields the minority acquirer from operating risks arising out of
liability of foreignness.
Furthermore,
access to more information about the target company through minority
acquisition gives the minority acquirer strategic advantage over other bidders.
You are able to determine better and more quickly the correct value of the
target, and you are aware of the various issues to be ironed out in the due
diligence process. Valuation risks are therefore better managed through the minority
acquisition.
Integration
risks associated with post-acquisition can also be mitigated by acquiring
minority stakes. When you learn about the target, you identify potential
bottlenecks to post-acquisition integration. You will be able to identify key
managers with essential knowledge of the target company, the local market
linkages that you must retain, and other factors that you must incorporate in
your post-acquisition plans.
After
considering all these challenges and risks, and you observe that the market or
the target company is unattractive, and therefore decide to exit, the lower
commitment through minority acquisition helps to reduce the costs and risks of
exit.
What happened to Dangote’s 19.76% stake in Sephaku
Cement (Pty) Limited
After
acquiring 19.76% in Sephaku Cement, by October 15, 2010, Dangote Industries
Limited increased its stake in Sephaku Cement to 64% for R779 million. The
further investment follows the initial R350 million of equity funding concluded
in March 2008, bringing the total investment to R1.129 billion. The transaction
was reported to be the largest ever foreign direct investment (FDI) by an
African company into South Africa.
What happened to Yahoo!’s 40% stake in Alibaba
Following
years of assumptions, by September 2012, Yahoo! completed the sale of as much
as half of its 40% stake (523 million shares) in Alibaba for $7.6 billion after
a series of negotiations, through a buyback. The deal, which contained a
payment of $7.1 billion in cash and stock, and another $550 million paid to
Yahoo! under a revised technology and patent licencing agreement with Alibaba, would
provide a much-needed cash injection for Yahoo at that time.
CBS News
reports that, “Struggling internet Yahoo! Inc.
has secured a lifeline after agreeing to sell half of its prized stake
in Chinese e-commerce group Alibaba for about $7.1 billion, with most of the
cash going to shareholders.”
The
Guardian reports that the deal would generate “a windfall
that could help ease the pain of Yahoo! shareholders who have endured the
company’s foibles during the past few years.”
Commenting
on the deal, Marissa Mayer, Yahoo! President and CEO at the time said, “This
yields a substantial return for investors, while retaining a meaningful amount
of capital within the company to invest in future growth.”
·
Pure Financial Investment
Berkshire Hathaway minority holdings
Berkshire
Hathaway Inc., an American multinational conglomerate holding company, has
minority holdings in several companies. 10 notable companies among them
include:
|
Company |
Ownership % |
|
1. American
Express |
18.7% |
|
2. Apple |
5.7% |
|
3. Bank
of America |
10.7% |
|
4. Bank
of New York Mellon |
9.0% |
|
5. Coca-Cola |
9.3% |
|
6. Delta
Airlines |
11.0% |
|
7. J.P.
Morgan Chase |
1.9% |
|
8. Moody’s |
13.1% |
|
9. U.S.
Bancorp |
9.7% |
|
10. Wells
Fargo |
8.4% |
These
minority holdings serve as financial investment vehicles for Berkshire
Hathaway’s shareholders, generating and maximising their financial returns periodically.
“It is
certain that Berkshire’s rewards from these 10 companies as well as those from
our many other equity holdings, will manifest themselves in a highly irregular
manner. Periodically, there will be losses, sometimes company-specific,
sometimes linked to stock-market swoons. At other times – last year was one of
those – our gain will be outsized,” Warren Buffett, the chairman and CEO of
Berkshire Hathaway, writes in his 2020 letter to the company’s shareholders.
Taking
minority stake in a company purely to generate financial returns is a usual
business practice. This practice is common among private equity firms, venture
capital firms, sovereign wealth funds, hedge funds, family offices, and high
net worth individuals.
·
It is Just Complicated
Microsoft investments in Facebook and Apple
After
Microsoft’s failed attempt to buy Facebook, Microsoft reached an agreement for
$240 million cash injection into Facebook (1.6% stake) that allowed Zuckerberg
to keep control of the business. Under the terms of the agreement, Microsoft would
be the exclusive advertising platform for Facebook. The motivation for the minority
acquisition came after intense competition between Microsoft and Google for a
stake in Facebook. Microsoft won the race to invest in Facebook against Google,
even if that effort was costly.
Microsoft’s
4.5% minority acquisition in Apple was needed because, ironically, Microsoft did
not want to lose Apple, its competitor. Microsoft believed if it were to lose
yet another competitor, the US government would come down harder on its own
dominant position in software. The investment was a result of the strong
disposition of the US to antitrust law in the country.
The terms
of the deal contained agreement between the two companies to settle all
outstanding litigation and cross-license patents, while making Microsoft Office
available for the Macintosh, and making Internet Explorer the default browser –
but not the only one – on the Mac.
Acquiring minority stakes in another company is a complicated corporate status. Because the motivation for such relationship may be for a different million reasons. Often, all we are left with are speculations, while waiting for time to tell.
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