CASE

REPORT

BACKGROUND
The telecommunications industry was broadly dened to include the transmission of a wide range of information, from traditional phone-to-phone communications to broadband media. The industry grew rapidly during the 1990s and it was forecast that there would be even faster growth in the coming years. However, this growth was accompanied with an intense consolidation procedure within the industry. In this report, one of such consolidations concerning Vodafone Air Touch from UK and Mannesmann from Germany will be analyzed in detail.

With operations spread over 24 countries and 31million equity subscribers, Vodafone Air Touch, based in the UK, was one of the leading international mobile telecommunications companies, and by 1999, it had grown into the largest mobile companies in the world. Starting from 1988, Vodafone expanded its business outside UK into other European countries and later into other parts of the world. For instance, in order to penetrate the US market, in January of 1999, Vodafone acquired Air Touch Communications and changed its name to Vodafone Air Touch; later that year, Vodafone combined its wireless assets with those of Bell Atlantic Corporation in a joint venture. The aggressive merger and acquisition strategy pursued by Vodafone rightly reected the frequent and intense consolidations in the whole telecommunication industry back in 1990s.

At that time, Mannesmann, a German telecommunication company who entered the industry in 1990, pursued the same consolidation strategy. In October 1999 Mannesmann had agreed to buy UK mobile operator, Orange, for $31 billion. Orange's main shareholder, Hutchison Whampoa, agreed to sell only 10 days after they had rst been contacted by Mannesmann. The reaction of Vodafone Air Touch was just as quick, mounting a counter-bid for the Mannesmann within a few weeks led by Chris Gent, CEO of Vodafone Air Touch. This move was widely predicted as Vodafone now saw its own strategic interests seriously threatened by Mannesmann's move. The success of Vodafone's bid, however, was far from assured, not least because of Germany's stringent takeover rules. The reality fell right into the expectation. After a vigorous defense by Mannesmann; the deal was struck, making it the rst everhostile takeover of a German company by a foreign outt. The New York Times (4/2/2000) saw it as "a watershed in European corporate behavior".

To complete this takeover, Gent would have to re-evaluate the probability of success of the unprecedented and historical takeover bid. The following report will analyze the pro side of the takeover and the con side of the takeover.

BENEFITS OF TAKEOVER
Greater Value Generation Mergers and acquisitions often lead to an increased value generation for the company. It is expected that the shareholder value of a rm after mergers or acquisitions would be greater than the sum of the shareholder values of the parent companies. Typically, the target companys shareholders gain from the M&A while the bidder companys shareholders get zero gain or loss from the M&A. Nevertheless, when a company buys out another, it expects that the newly generated shareholder value will be higher than the value of the sum of the shares of the two separate companies. The market capitalization of the two company directly reect the expectation from the market for the possible synergy in the future, and therefore, shareholders normally consider this as a sign for whether they should support the deal or not.

Value Vodafone 17 dec = sharesVodafone*priceVodafone = 154186.4042 Value Mannesmann 17 dec = sharesMannesmann*price Mannesmann = 121188.6 Value combine 17 dec = 275375.0042

Value Vodafone 21 oct = sharesVodafone*priceVodafone = 130206.9767 Value Mannesmann 21 oct = sharesMannesmann*price Mannesmann = 75276.765 Value combo 21 oct = 205483.7417 Indicated synergies = (275375.0042 - 205483.7417) / 0.6 = 116485.44

We divided the difference in combined shareprices by 0.6, as the shareprices only reect 60% of the synergies. That means the indicated synergies are 116 billion. Mergers and acquisitions generally succeed in generating synergies from both cost efciency and revenue enhancement. A cost synergy refers to the opportunity of a combined corporate entity to reduce or eliminate expenses associated with running a business. Cost synergies are realized by eliminating positions that are viewed as duplicate within the merged entity and through the implementation of economies of scale. A revenue synergy refers to the opportunity of a combined corporate entity to generate more revenue than its two predecessor stand-alone companies would be able to generate. Revenue synergy is realized through market share gain. Companies go for Mergers and Acquisition from the idea that, the joint company will be able to generate more value than the separate rms. And in the following chart, the operating synergy and capital expenditure synergy from the acquisition of Mannesmann are calculated:

In millions Total Operating Prot Prot after Tax PV Capex Synergy Saving in Capital PV Total Synergy

2000 0

2001 90

2002 246

2003 688

2004 984

2005 1221

2006 Cont V 1489 41361.1

Total

0 0 0 0

58.5 54.37 60 55.76

159.9 138.11 147 126.97

447.2 359.0 360 288.98

639.6 477.15 420 313.33

793.65 550.26 469 325.17

967.85 26884.7 623.64 17323.4 19525.84 506 326.04 0 0 1436.25

To use the new WACC, the calculation is shown as: Cost of debt = 7% ; Cost of equity= 5.5 % + 1.1 * 7.7% = 13.97% ; New WACC: 0.05 * 7% + 0.95 * 13.97% = 13.62% In millions Total Operating Prot Prot after Tax PV Capex Synergy Saving in Capital PV Total Synergy 2000 0 2001 90 2002 246 2003 688 2004 984 2005 1221 2006 Cont V 1489 15478.2 Total

0 0

58.5 51.49

159.9 123.86

447.2 304.89

639.6 383.79

793.65 419.14

967.85 10060.8 449.86 4676.32

7072.83

0 0

60 52.81

147 113.87

360 245.44

420 252.02

469 247.68

506 235.19 1147.01

To determine whether they should support for the takeover, shareholders of Vodafone should evaluate the three possible synergies against the price premium Vodafone pay to acquire Mannesmann. The offered condition is that each Mannesmann share would receive 53.7 Vodafone shares, so that in aggregate Mannesmann shareholders would own 47.2% of the equity of the newly combined rm. This offer valued Mannesmann at 232 per share, Internal Rate of Return 20000 15000 10000 5000 0 -5000 -10000 -15000 -20000 40000 30000 20000 10000 0 Break Even Analysis

2000 2001 2002 2003 2004 2005 2006 Synergy (Low Cost)

2000 2001 2002 2003 2004 2005 2006 Premium Paid Accumulated Synergy (High Cost) Accumulated Synergy (Low Cost)

Synergy (High Cost)

roughly a 20% premium over the price that day. The total premium of the offer accounts for: (232-194)*517.9m= 19680.2 million

When compare the possible synergies anticipated in the two scenarios (WACC equals 7.6% or 13.62%) above to the price premium Vodafone intents to pay for Mannesmann, it shows that Vodafone shareholder will lose in the rst scenario when synergy is calculated in a market price basis and in the third scenario when the cost of capital rise to 13.62%. Therefore, there is a risk for the Vodafone shareholders that they will lose in the takeover. However, for the Mannesmann shareholders, they are receiving a high premium from the takeover no matter what. Therefore, in the hostile takeover, Mannesmann shareholders gain more that the Vodafone shareholders. Benets from market expansion The merger, coming as it did shortly after the takeover of One2One by Deutsche Telekom, revealed the rapid pace of the consolidation among the principal operators within the European mobile network layer. The consolidation strategy of Vodafone required it to takeover Mannesmann to complete its European market penetration and defend its UK market share after Mannesmann acquire Orange. At stake for Vodafone and Mannesmann was the dominance of the European and world telecommunications industry, the two companies were competing to be one of the top four to ve operators in the world. If Vodafone Air Touch succeeded in acquiring Mannesmann, the resulting company would be the global leader in the industry, which operates in 25 countries and 42 million equity subscribers. The new combined company will also gain much competitiveness against its global competitors such as DoCoMo and TIM. Danger triggered by the failure of the takeover If the Vodafone AirTouch bid were unsuccessful, the fate of the two rms would be at stake. A failed bid would make Mannesmann a direct competitor in the UK and negatively impact the joint holdings in Germany, Italy, and France. It might also make both Mannesmann and Vodafone potential targets of companies such as MCI Worldcom, SBC, Bell Atlantic, and NTT DoCoMo. This is because that after unsuccessful bid, the market capitalization of both rms will shrink, and this provides a perfect timing for the other competitors to acquire the companies with a lower price. Besides, taking-over either Vodafone or Mannesmann would provide the bidder company a broad market expansion in Europe. And whats was, such a takeover would destroy the prospect of an European telecommunication champion. If taking these consequences into consideration, the shareholders and management from Mannesmann would be less against the takeover from Vodafone.

HURDLES OF TAKEOVER
Pressure from Mannesmann There are two major protestors in Vodafones bid from the Mannesman side. First, the executives of Mannesman led by Klaus Esser, CEO of the company, would be against the takeover. He believes the value of Mannesman was underestimated by Vodafone. In the i offer Vodafone suggested 266 per share based on prices on December 17, 1999, which indicated a total value of 138 billion. Executives of Mannesmann rejected the offer. Despite the facet that this price was a premium of 14 over the Mannesmann price that day, and that Mannesmann had offered shares at around 157.8 only a few weeks earlier when they acquire Orange. Besides, whats complicating Vodafones takeover is Governance structures of Mannesmann, which is different from Vodafones, The principal of codetermination in Germany means that the board should maximize the value for all stakeholders including the employees, whereas UK corporates focus on the maximization of Shareholders value. In addition, because of the executive compensation rule in Germany, Esser owned no options and little share and therefore, had little or no incentives to support the bid. In his own defense, Esser claimed that 90% of shareholders believed that Mannesmann had better long term prospects as an independent company. Another difculty facing the takeover is the protest from Mannesmann employees. German employee unions have comparative more inuence on corporate decisions. After the public announcement of the takeover plans, representatives from the IG Metall and the Mannesmann group works council immediately rejected Vodafone's bid as unacceptable. If the takeover is completed, Vodafone is very likely to discharge workers of Mannesmann to realize cost saving synergy. This potential threat directly lead to the interest conicts between the bidder and target companys employee representatives. Another concern from the IG Metall union and workers of Mannesmann is that the co-determination culture at Mannesmann will be overwhelmed by predator capitalism from Vodafone. They claimed that the takeover is very shortsighted and unhealthy for long-term development of Mannesmann. Political Interferences On 22 November 1999, the American trade union confederation AFL-CIO stated its opposition publicly against the takeover. AFL-CIO has an inuence on the company through collectively-bargained benet funds, which control about 13% of Mannesmann shares. Its president John Sweeney claimed that "the managers of worker capital have a responsibility to invest those funds in the long-term interests of their beneciaries. The AFL-CIO believes value is created over the long-term by partnerships among all a corporation's constituents -- workers, investors, customers, suppliers and communities. Mannesmann, and the European model of corporate governance under which it is structured, has allowed just those kinds of value-creating partnerships to ourish. Worker capital, the savings of America's working families, should support value-creating partnerships like those at Mannesmann. Only then will the global economy be able to deliver sustainable, equitable prosperity. On the other hand, attitudes of governments of Germany and UK toward the takeover are quite complicated. Due to the risk of losing thousands of jobs and the intension to protect domestic rm, German Chancellor Gerhard Schroeder, initially criticized the hostile bid. Labor union has huge political force in Germany, hostile bid may lead to radically political resistance. Takeover was welcomed by Prime Minister Tony Blair, his spokesman said: "The Prime Minister welcomes the proposed merger as very good news and a demonstration of how Britain can be a world leader in the knowledge-driven economy." Nevertheless, to fulll regulations in UK, Vodafone would have to promise to spin-off Orange once the takeover is succeeded. The acquisition of a whole Mannesmann will bring the risk of violating laws against monopoly in UK since together with the market share of Orange in UK, Vodafone would dominate over half of the UK telecommunication market share.

External Risks Acquisition is complex and takes time to complete, in Vodafones case timing is signicant for a good price. The process of takeover takes from weeks to months. The timing of negotiation may signicantly affect pricing. Interest rates uctuate over time, variation of cost of capital during the takeover is risky for the bidder. At the same time, it is an international acquisition, exchange rate also affects the price of bid. The longer Vodafone waits, the more the may pay since Euro tends to appreciate against Pound at the time of consolidation. GBP / EUR 1.600 1.525 1.450 1.375 1.300 Exchange Rate Throughout 1999