Page 21 - CIMA SCS Workbook February 2019 - Day 2 Suggested Solutions

CIMA FEBRUARY 2019 – STRATEGIC CASE STUDY

Acquisition is a complex process. A suitable target has to be identified, then valued. Then the
directors of the bidding company and the target company have to negotiate and finally there are
complex legal procedures to follow as the shares of the target company are purchased. Vita’s
directors have no experience of acquisition, so they would have to appoint advisors such as
accountants and lawyers to help (potentially expensive).
Organic growth can be planned very carefully to fit in exactly with the company’s objectives.
Sometimes when a new business is acquired, it may have some operations in different regions or
industries which the acquiring company did not plan to enter.
Conclusion
Vita has only ever grown organically in the past, but perhaps the time is approaching where an
acquisition might be a good idea. If the directors can identify a suitable target company and find a
competent (and relatively inexpensive!) team of advisors to guide them through the process, an
acquisition could deliver instant benefits to Vita’s shareholders.

SYNERGIES
Introduction

Synergy is the extra value created when two companies combine. It is sometimes referred to as
the “2+2=5 effect”.

There are several reasons why synergistic gains arise. These are:
operating economies, such as economies of scale and elimination of inefficiency,

financial synergy, such as the reduced risk caused by diversification,

other synergistic effects, such as market power.
I have explained below what sort of specific gains could be generated if Vita decided to acquire
another company in the same industry.
Operating economies
Economies of scale - Horizontal combinations (acquisitions of a company in a similar line of
business) can reduce costs and therefore increase profits due to economies of scale. As
mentioned above, this will be a key factor in the consumer electronics industry where overheads
(especially research and development) are so large.
Complementary resources - by combining the strengths of two companies a synergistic gain can
be obtained. For example, Vita has been successful in the past at introducing new products, but
only a small proportion of its sales are made directly to customers. Acquiring a firm that has
experience in online retailing could give Vita an additional competitive advantage.
Elimination of inefficiency - If the victim company is badly managed, its performance and hence
its value can be improved by the elimination of inefficiencies. Improvements could be obtained
particularly in the areas of research and innovation, where Vita has traditionally been very strong.

Financial synergy
Diversification - Diversification normally reduces risk, so even if the earnings of the combined
companies stay the same (i.e. no operating economies are obtained), there could still be an
increase in value of the company due to the lower risk and lower cost of capital.
Diversification and financing - If the future cash flow streams of the two companies are not
perfectly positively correlated (i.e. if they are forecast to fluctuate in different ways) then, by
combining the two companies, the variability of their operating cash flow may be reduced. A
more stable cash flow is more attractive to creditors and this could lead to cheaper financing.

80 KAPLAN PUBLISHING