Mergers and Acquisitions in E-Commerce

Submitted By: Ami Bajwa Jasraman Sidhu

Definition of Merger and Acquisitions (M&A): Mergers and acquisitions (M&A) are means by which corporations combine with each other. Following a merger, the two corporations cease to exist as separate entities. The less important company loses its identity and becomes part of the more important corporation, which retains its identity. In the classic merger, the assets and liabilities of one corporation are automatically transferred to the other. Mergers may come as the result of a negotiation between two corporations interested in combining, or when one or more corporations target another for acquisition. Combinations that occur with the approval and encouragement of the target company's management are called friendly mergers; combinations that occur despite opposition from the target company are called hostile mergers or takeovers. An acquisition, also known as a takeover or a buyout, is the buying of one company (the target) by another. It is typically used when one company takes control of another. This can occur through a merger or a number of other methods, such as purchasing the majority of a company's stock or all of its assets. In a purchase of assets, the transaction is one that must be negotiated with the management of the target company. Compared to a merger, an acquisition is treated differently for tax purposes, and the acquiring company does not necessarily assume the liabilities of the target company.

History of M&A in E-Commerce: In the latter half of 1990s, the growth of dot.com upstarts provided a big platform for mergers and acquisitions to take place. Between 1996 and 1997, the number of internet service providers (ISPs) increased from 1,500 to 4,000. Because the smaller ISPs were able to serve local markets less expensively than larger rivals, the top contenders in the U.S.A. ISP market began losing their share of the market and they began consolidating in an effort to cut down costs. America Online Inc. (AOL) played a key role with its September 1997 purchase of the consumer online service of CompuServe Corp. from WorldCom Inc. The acquisition boosted AOL's subscriber base to over 10 million which allowed it to lower its prices to better compete with the upstarts. In turn, this prompted several up-starts to join forces in an effort to compete with industry leaders in terms of market share. The other kinds of M&A in the e-commerce world are internet-related acquisitions. The intense competition between World Wide Web browser-makers Microsoft Corp. and Netscape Communications Corp. prompted both companies to seek Internet-related acquisitions as a means of keeping pace with the industry's continually evolving technology. Purchasing new technology meant neither firm had to spend the time and money necessary to develop its own products. In 1998, Netscape watched its share of the Web browser market fall from 62 percent to less than 40 percent. Microsoft's decision in 1995, when Nets-cape's share of the browser market had hovered around 80 percent, to bundle its Internet Explorer browser with its Windows 95

platform had been effective. People who bought new computers used Internet Explorer, simply because it was the browser software already available to them. In November of 1998, America Online (AOL) offered $4.2 billion in stock for the struggling Netscape. Netscape's managers believed a merger with AOL could potentially boost Netscape's share of the browser market, especially if AOL changed its default browser from Internet Explorer to Netscape Navigator. The deal would also increase both firms' positions in the e-commerce industry, which analysts predicted would be worth an estimated $4 billion by 2002. Netscape's Netcenter was already one of the leading full-service Web sites, offering users a gateway to the Internet, as well as online shopping and entertainment services, areas where AOL was looking to expand. Mergers and acquisitions continued to take place as the e-commerce industry matured. Some companies continued to use acquisitions to gain quick access to new technology. For example, KB Toys purchased Brianplay.com in July 1999 rather than build its own online sales operation. Others merged with rivals as a means of gaining increased market share, as was the case with online auction powerhouse eBay, which bought Paris-based iBazar for $112 million in early 2001 to expand its presence in Europe. One of the largest Internet-related mergers, the $183 billion joining of AOL and Time Warner Inc. to form AOL Time Warner Inc., helped to ensure AOL's position as a leading Internet player in the future. However, over the last couple of years, the desire of companies to reach out globally and expand across various countries has ignited the drive for E-commerce M&A. Asian e-commerce firms in particular are expanding their reach into other economies. Japanese e-commerce giant Rakuten acquired French e-tailer PriceMinister for $245 million in June and U.S.-based online retail marketplace Buy.com for $250 million in May. Alibaba.com, a China-based e-commerce firm, also moved into U.S. territory with its acquisition of Vendio, an e-commerce services provider, at the end of June 2010.

Types of M&A: 1) Horizontal Markets Horizontal markets focus on broad categories that cross multiple industries such as software, manufacturing, or utilities. A horizontal M&A takes place between two firms in the same line of business. The two firms are merged across similar products or services. These kinds of mergers are mostly used as a way for company to increase its market share by merging with a competing company. For example, In June 2001, Juno and rival NetZero announced their intent to merge. The $70 million deal was completed three months later. The newly merged firm, named United Online, was the second largest Internet access provider in the U.S., behind AOL. The ISPs announced yesterday they would form one provider called United Online, providing both advertising-paid services and subscriber-paid services. The free services will fall under the NetZero brand, which has been far more successful in attracting advertisers, and the paid services will remain under Junos umbrella. The two companies would combine their respective technologies, which until now were the source of their squabble, and leverage their individual

expertise in the two Internet access models. The only viable free ISP competitor to United Online was Bluelight.com, operated by Kmart Corp., which admitted that the free ISP model was inherently flawed. 2) Vertical Markets A vertical merger/acquisition entails expanding forward or backward in the chain of distribution, toward the source of raw materials or towards the customer. Figure 1 shows the different stages of the production of one good where the output of one business is the input of the other. Here, two firms merge along the value-chain such as a service provider merging with an application developer or a hardware provider merging with a software provider. Vertical mergers take two basic forms: forward integration, by which a firm buys a customer, and backward integration, by which a firm acquires a supplier. This type of merger is used by a firm as a way of gaining competitive advantage.

Services

Applications

Middleware

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Hardware

Figure 1 For example, in May this year, Yahoo! acquired Associated Content for a $100 million. By incorporating the online publisher and distributors low-priced CPC-targeted (cost-per-click) model into its network, Yahoo! will be able to produce its own content as opposed to licensing it from third-parties, which should significantly increase its AdSense and search marketing margins. This acquisition is an example of vertical integration since Yahoo! is using Associated Content to reduce its costs and remove redundant non-value adding activities. 3) Conglomerate Markets Conglomerate merger is formed through the combination/acquisition of unrelated businesses. They are usually used as a way to smooth out wide fluctuations in earnings and provide more consistency in long-term growth. Whether a conglomerate merger is pure,

geographical, or a product line extension, it involves firms that operate in separate markets. Therefore, a conglomerate transaction ordinarily has no direct effect on competition. There is no reduction or other change in the number of firms in either the acquiring or acquired firm's market. There are two types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in common, while mixed conglomerate mergers involve firms that are looking for product extensions or market extensions. For example, General Electric (GE) has diversified its businesses through mergers and acquisitions, allowing GE to get into new areas like financial services and television broadcasting.

Reasons for mergers & acquisitions: The foremost reason given by most of the companies for M&A is existence of synergies between the two companies. Such synergies could be the result of firms combined ability to achieve economies of scale, eliminate non value adding processes, share managerial expertise and higher capital. 1) For Horizontal merger: Following are some of the benefits that a firm looks for when aiming to integrate horizontally with another similar firm: Economies of Scale: By selling more of the same product in larger geographic area. Economies of Scope: achieved by pooling resources common to different products also known as synergies. Increased market power over suppliers and downstream members of supply chain.

2) For Vertical merger: Following are some of the benefits that a firm looks for when aiming to integrate vertically with another firm: Avoidance of fixed costs such as heating, storage, transportation. Eliminate cost of searching for prices, contracting, payment collection, communication, advertising and coordination. More efficient information flow and better planning for inventory. Avoid Bull Whip affect by making firm more agile to varying demand.

3) For Conglomerate merger: Conglomerate merger can take place for a number of reasons: In order to allow two unrelated businesses to combine resources to strengthen the position of each company in their respective industries.

To increase presence within a given industry by covering more aspects of that industry. In order to survive shifts in customer tastes, technological advances and political unrest.

Competitive issues/concerns faced during M&A: 1) Horizontal Mergers The three main competitive problems faced during horizontal mergers are: It leads to elimination of competition between the merging firms, which, depending on their size, may be significant. The second is that the unification of the merging firms' operations may create substantial market power and could enable the merged entity to raise prices by reducing output unilaterally. The third problem is that, by increasing concentration in the relevant market, the transaction may strengthen the ability of the market's remaining participants to coordinate their pricing and output decisions. The fear is not that the entities will engage in secret collaboration but that the reduction in the number of industry members will enhance tacit coordination of behavior.

2) Vertical Mergers Vertical integration by merger does not reduce the total number of economic entities operating at one level of the market, but it may change patterns of industry behavior. Whether a forward or backward integration, the newly acquired firm may decide to deal only with the acquiring firm, thereby altering competition among the acquiring firm's suppliers, customers, or competitors. Suppliers may lose a market for their goods, retail outlets may be deprived of supplies, or competitors may find that both supplies and outlets are blocked. This raises the concern that vertical integration will foreclose competitors by limiting their access to sources of supply or to customers. Vertical mergers may also be anticompetitive because their entrenched market power may impede new businesses from entering the market.

3) Conglomerate Mergers Conglomerate mergers, however, may lessen future competition by eliminating the possibility that the acquiring firm would have entered the acquired firm's market independently. A conglomerate merger also may convert a large firm into a dominant company with a decisive competitive advantage or otherwise make it difficult for other companies to enter the market. This type of merger may also reduce the number of smaller firms and increase the merged firm's political power, thereby impairing the social and political goals of retaining independent decision-making centers, guaranteeing small business opportunities, and preserving democratic processes.

Some significant E-commerce M&A: 1) Vertical M&A: EBay acquires PayPal In summer of 2002 eBay, online auction marketplace, announced that it is acquiring online payments company PayPal for sum of $1.5 billion. This marriage of two companies is a natural fit according to eBay executives, since bulk of customers of PayPal come through eBay and 75% of eBay customers preferred PayPal as payment method over eBays own payment method, Billpoint. With this acquisition, eBay gained control over electronic payment service favored by many of its customers. This kind of integration is known as backward integration, according to which a firm acquires a supplier, in this case eBay is the firm and PayPal is the supplier. This is also a vertical acquisition. PayPal is a Customer-to-Business company, C2B, whereas eBay is a Customer-toCustomer company, C2C. PayPal offers features superior to eBay Payments for example, sellers can use it as a merchant bank account, to hold cash or invest in money market funds, and share in revenue from debit transactions. In 2002, PayPal announced it planned to sell 3 million shares of stock. This news drove down PayPals stock price enough for EBay to respond with their $1.5 billion deal. EBay stock went down quite a bit on the PayPal news, probably because of the high price tag. 2) Horizontal M&A: Salesforce acquires Jigsaw In April, Salesforce.com acquired Jigsaw, a user-generated B2B business contact community, for $142 million. By buying Jigsaw Salesforce is trying to strengthen its cloud computing platform, SalesForce.com, by leveraging Jigsaws cloud based model for acquiring, completing, and cleansing business contact data on a subscription basis over the Internet. The general theme is that Jigsaw will enable Salesforce customers to improve the accuracy of contact information. This is a typical example of horizontal acquisition or integration. The transaction is expected to reduce SalesForce.com's earnings by about 20 cents to 22 cents per share for fiscal year 2011, but this is common in fast-growing markets. Salesforce.com is aiming at $3 billion market opportunity after this acquisition. Over the past year, the computing company's stock price has more than doubled and it has raised $575 million in debt financing. 3) Conglomerate M&A: Time Warner and AOL
2001-America Online, Inc. and Time Warner Inc. today announced that they have completed their merger to create AOL Time Warner Inc. (NYSE: AOL)-the world's first Internet-powered media and communications company-which will connect, inform and entertain people everywhere in innovative ways that enrich their lives. AOL Time Warner now becomes the premier global company delivering the world's most highly respected and valuable entertainment, news and Internet brands across rapidly converging media platforms. The Company's unique combination of businesses, consumer relationships and growth opportunities transcend traditional categories, spanning interactive services, cable systems, publishing, music, cable networks and filmed entertainment. These unmatched

assets position AOL Time Warner to speed the development of the interactive medium and capitalize on such transformational opportunities as digital music, interactive television and broadband Internet services. The Company also provides unparalleled opportunities to advertisers and marketers to creatively enhance their relationships with their customers. Steve Case, Chairman of AOL Time Warner, said: "This is a historic moment for consumers everywhere, and a tremendous step toward our goal of becoming the world's most respected and valued company. AOL Time Warner will lead the convergence of the media, entertainment, communications and Internet industries, and provide wide-ranging, innovative benefits for consumers. Our brands, services and technologies already touch hundreds of millions of people and, by closely integrating our assets, we will embed the AOL Time Warner experience more deeply into their everyday lives. At the same time, our company is deeply committed to the communities in which we live and work, and through our philanthropic initiatives, we will explore ways to use the power of media, communications and information technologies to serve the public interest and strengthen society." Jerry Levin, Chief Executive Officer of AOL Time Warner, said: "AOL Time Warner's scale, scope and reach will enable us to capitalize on the digital revolution that is shaping global media, entertainment and communications on behalf of consumers worldwide. With today's closing, all our planning and preparations over the past year start to pay off. We are hitting the ground running with a clear road map for creating value for our customers, business partners, shareholders and employees. Our unprecedented range of businesses will enable AOL Time Warner to launch new platforms for growth and to empower consumers in new and exciting ways. Above all, it gives us the resources and expertise to strengthen and expand the unique journalistic heritage that is at the core of our company." As a result of the merger, Time Warner and America Online stock will be converted to AOL Time Warner stock at fixed exchange ratios. The Time Warnershareholders will receive 1.5 shares of AOL Time Warner for each share of Time Warner stock they own. America Online shareholders will receive one share of AOL Time Warner stock for each share of America Online stock they own. The merger has been effected on a tax-free basis to shareholders. America Online's shareholders own approximately 55% and Time Warner's shareholders own approximately 45% of the new Company. The new Company's stock will be traded under the symbol AOL on the New York Stock Exchange. Digital files of the new AOL Time Warner logo are available at http://www.aoltimewarner.com/corpid/ About AOL Time Warner Inc. AOL Time Warner (NYSE:AOL) is the world's first Internet-powered media and communications company, whose industry-leading businesses include interactive services, cable systems, publishing, music, cable networks and filmed entertainment. Caution Concerning Forward-Looking Statements This document includes certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are naturally subject to uncertainty and changes in circumstances. Actual results may vary materially from the expectations contained herein due to changes in economic, business, competitive, technological and/or regulatory factors and factors affecting the integration of the businesses of Time Warner Inc. and America Online, Inc. More detailed information about those factors is set forth in filings by AOL Time Warner, Time Warner and America Online with the Securities and Exchange Commission, including AOL Time Warner's registration statement on Form S-4, Time Warner's most recent quarterly report on Form 10-Q and America Online's most recent annual report on Form 10-K. AOL Time Warner is under no obligation to (and expressly disclaims any such obligation to) update or alter its forwardlooking statements whether as a result of new information, future events or otherwise