Greenwich School of Management

MBA (Marketing)

Assignment

Takeovers and BP Crisis

Module: Business Environment

Lecturer: Mr Roger Cox

Student: Shahrooz Abbas

Student ID- C10VK0114255FN

University of Wales1

TABLE OF CONTENTS

1 INTRODUCTION......................................................................................................4

1.1 Merger.........................................................................................................................................5

1.2 Acquisition...................................................................................................................................5

2 Reasons for a Takeover........................................................................................5

2.1 Speed of Entry.............................................................................................................................6

2.2 Economies of Scale......................................................................................................................6

2.3 Financial markets.........................................................................................................................8

2.4 Eliminating Competition..............................................................................................................9

2.5 Synergy........................................................................................................................................9

2.5.1 Operating Synergy...............................................................................................................9

2.5.2 Financial Synergy...............................................................................................................10

2.5.3 Diversification....................................................................................................................10

3 Disadvantages of a Takeover...........................................................................11

3.1 Costs of Takeover......................................................................................................................11

3.2 Consumer and Shareholder drawbacks.....................................................................................11

3.3 Effects on Management.............................................................................................................12

3.4 Wages Settlement......................................................................................................................12

4 REASONS AND DISADVANTAGES OF TAKINGOVER BP............................13

4.1 BP Facts......................................................................................................................................13

4.2 Reasons for Takeover................................................................................................................14

4.3 Disadvantages............................................................................................................................14

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4.3.1 Political Effects...................................................................................................................15

4.3.2 Environmental Effects........................................................................................................15

4.3.3 Legal Effects.......................................................................................................................15

4.3.4 Other Disadvantages..........................................................................................................16

5 Conclusion..............................................................................................................17

6 References.............................................................................................................17

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1 INTRODUCTION

BP is one of the largest vertically integrated oil and gas companies in the world. The company’s

operations primarily include the exploration and production of gas and crude oil, as well as the marketing

and trading of natural gas, power, and natural gas liquids. BP is headquartered in London, the UK and

employs about 80,300 people.

British Petroleum, which transformed from a local oil company named Anglo Persian formed

back in 1908 to a global energy group, is one of the world's largest energy companies today,

providing its customers with fuel for transportation, energy for heat and light, retail services and

petrochemicals products for everyday items. BP excelled exponentially in the past century and

today it employs over 80,000 people and operates in over 100 countries worldwide.

On 20th April, 2010, BP came across a deep water rig explosion in the gulf of Mexico which was

caused by what has been described as the worst US ecological disaster ever, wiping more than

$58 billion from the company’s value and causing its share price to drop down more then half

compared to the value before the explosion.

Many analysts are saying that this could trigger a takeover of the business by one of its big

competitors such as Exxon Mobil, Shell or even Petrochina.

In this report, we will discuss the factors and reasons which can result in a takeover of any

company along with the very real disadvantages which a company may face if they do an

acquisition, including those special to an acquisition of BP at this time.

What is Merger and Acquisition stands for?

The term Merger & Acquisition or Takeover refers to the aspect of corporate strategy, corporate

finance and management dealing with the buying, selling and combining of different companies

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that can aid, finance, or help a growing company in a given industry grow rapidly without having

to create another business entity.

Takeovers and mergers are also the reason why today's corporate landscape is a maze of

conglomerations. Insurance companies own breakfast cereal makers, shopping mall outlets are

part of military manufacturing groups, and movie studios own airlines, all because of mergers

and acquisitions.

Although often used synonymously, the terms merger and acquisition mean slightly different

things.

1.1 MergerA merger happens when two firms agree to go forward as a single new company rather than

remain separately owned and operated. It can be described as the mutually agreed decision for

joint ownership between organizations.

When two companies merge, the boards of directors (or the owners, if it is a privately held

company) come to an agreement. The original companies cease to exist, and a new company

forms, combining the personnel and assets of the merging companies. Like any business deal,

this can be straightforward, or incredibly complex. The key is that both companies have agreed

to the merge.

1.2 Acquisition

When one company takes over another and clearly establishes itself as the new owner, the

purchase is called an acquisition. From a legal point of view, the target company ceases to exist,

the buyer "swallows" the business and the buyer's stock continues to be traded.

Hostile Takeover: A hostile takeover is an acquisition in which the company being purchased

doesn't want to be purchased, or doesn't want to be purchased by the particular buyer that is

making a bid. The buyer has to gain control of the target company and force them to agree to the

sale.

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Both acquisitions and mergers typically involve the managers of one organization exerting

strategic influence over the other.

2 Reasons for a Takeover

There are different reasons for developing through a takeover activity. The primary reason being

that acquiring firms seek improved financial performance. Another major reason is the need to

keep up with the changing environment and to gain opportunities of market growth more quickly

than through internal means. Following gives a brief account for the conventional reasons of a

takeover.

2.1 Speed of Entry

Speed of entry is one of the reasons for a takeover because products and markets nowadays are

changing so rapidly that acquisition becomes the only way to successfully enter a market, since

the process of internal development is too slow and when speed is important, acquisition is

more likely to be used. Most acquisitions are consummated relatively

quickly, whereas internal development of new products or services normally

takes many months or years. Acquisition may allow the acquiring firm to

realize revenue earlier, achieve economies faster, and capture a greater

market share. When entry occurs through internal development, a decade or

more is often required to fine-tune the business to achieve the profitability of

established competitors

2.2 Economies of Scale

Economies of scale is an economic term describing a business model where the long-run average cost

curve declines as production increases, or in a simple example explaining the principal, where a

manufacturing company saves money as it produces higher quantities of its product, as in all business

areas, 'the more you buy, the more you save'. "Economies of scale" is a long run concept and refers to

reductions in unit cost as the size of a facility and the usage levels of other inputs increase.

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This refers to the fact that the company after takeover can often reduce its fixed costs by

removing duplicate departments or operations, lowering the costs of the company relative to the

same revenue stream, thus increasing profit margins.

An example is that of a private soft drinks manufacturer. The more orders that the manufacturer

receives, the more savings it makes, as it will in turn get cheaper prices for the materials it needs

to produce its drinks (e.g. plastic, aluminium, sugar) as it will be buying them in larger quantities

and receiving discounts, the manufacturing company in turn would give its customers cheaper

prices for the more orders for drinks they make for this very reason, as they will gain the

discounts, they can pass a saving onto their customers, making themselves stronger, a more

respected company from its suppliers as it is buying in higher volumes and its turnover becomes

higher. All these factors contribute to the benefits of economies of scale..

Why Economies of Scale Happen: An In Depth Look

Corporations incur fixed costs when buying heavy machinery, buildings, or other large

purchases. A fixed cost is called 'fixed' because when production increases in the short run, new

buildings and machines are not immediately needed. Because fixed costs are not tied to

production, firms have an incentive to produce as much as possible (assuming they can sell their

product). Intuitively, a large factory should produce a large number of units to minimize its fixed

cost per unit. Say that an automobile factory costs 1 million dollars. If it only produces 1000

cars, then its Fixed Cost Per Unit is 1 million dollars divided by 1000 cars, or $1000/Car.

If the factory produces 8000 cars, however, its Fixed Cost Per Unit is 1 million dollars divided

by 8000 cars, or $125 per car. By producing 7000 more cars, the firm gets an 88% fixed cost

reduction per car.

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This graph illustrates that increased production reduces fixed costs per unit.

Figure 1

With fewer fixed costs per unit, firms can afford to lower per unit prices. If fixed costs are very

significant to a particular firm's industry, then firms who mass produce efficiently can cut costs,

extract revenues, lower prices, and therefore capture market share. Higher market share and

higher revenues mean more money to spend on machinery, and expand the firm. This in turn

allows further cost cutting, higher production, and the development of better products. In the

long run, firms which effectively mass produce takeover industries dominated by high fixed

costs.

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Figure 2

2.3 Financial markets

Financial markets may provide conditions that motivate acquisitions. If the share value or

price/earnings (P/E) ratio of a company is high, it may see the opportunity to acquire a firm with

a low share value or P/E ratio. Indeed, this is a major stimulus for the more opportunistic

acquisitive companies. An extreme example is asset stripping, where the main motive is short-

term gain by buying up undervalued assets and disposing of them piecemeal.

2.4 Eliminating Competition

A buyer company, when absorbs a major competitor, eliminates the major competition and thus

increases it revenue or market share. This motive of takeover comes into play when companies

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want to increase their market power which results in an increased share value and overall

monopoly.

2.5 Synergy

Synergy is the potential additional value from combining two firms. It is probably the most

widely used and misused rationale for takeovers.

2.5.1 Operating Synergy

Operating synergies are those synergies that allow firms to increase their operating income,

increase growth or both. Operational synergy is deemed to be the main motive of the takeover

when the bidder takes over a target in the same industry. We would categorize operating

synergies into four types.

1.     Economies of scale that may arise from the takeover, allowing the combined firm to become more

cost-efficient and profitable.

2.     Greater pricing power from reduced competition and higher market share, which should result in

higher margins and operating income.

3.     Combination of different functional strengths, as would be the case when a firm with

strong marketing skills acquires a firm with a good product line.

4.     Higher growth in new or existing markets, arising from the combination of the two firms.

This would be case when a UK consumer products firm acquires an emerging market firm,

with an established distribution network and brand name recognition, and uses these

strengths to increase sales of its products.

Operating synergies can affect margins and growth, and through these the value of the firms

involved in the takeover.

2.5.2 Financial Synergy

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With financial synergies, the payoff can take the form of either higher cash flows or a lower cost

of capital (discount rate). Included are the following.

1. A combination of a firm with excess cash, (and limited project opportunities) and a firm

with high-return projects (and limited cash) can yield a payoff in terms of higher value for

the combined firm. The increase in value comes from the projects that were taken with the

excess cash that otherwise would not have been taken. This synergy is likely to show up most

often when large firms acquire smaller firms, or when publicly traded firms acquire private

businesses.

2.      Debt capacity can increase, because when two firms combine, their earnings and cash flows

may become more stable and predictable. This, in turn, allows them to borrow more than

they could have as individual entities, which creates a tax benefit for the combined firm. This

tax benefit can take the form of either higher cash flows or a lower cost of capital for the

combined firm.

3.      Tax benefits can arise either from the acquisition taking advantage of tax laws or from the

use of net operating losses to shelter income. Thus, a profitable firm that acquires a money-

losing firm may be able to use the net operating losses of the latter to reduce its tax burden.

Alternatively, a firm that is able to increase its depreciation charges after an acquisition will

save in taxes and increase its value.

2.5.3 Diversification

Companies acquire different product line companies to diversify their product or service range

and to protect themselves against downturns in the core markets. This calls for a very well

thought and specific policy keeping in mind the future steps and goals of a company. Moreover,

can really help if there is a downfall in the core market and company shares of a particular

product.

3 Disadvantages of a Takeover

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The reasons for takeover are kept under account while targeting a company, but calculating the

disadvantages associated with it are analysed with more precision and taking all situations under

consideration. Companies mostly come up with the following disadvantages while acquiring

other companies

3.1 Costs of Takeover

Takeovers can be costly due to the high legal expenses, and the cost of acquiring a new company

that may not be profitable in the short run. This is why a takeover may be more of strategic

corporate decision than a tactical manoeuvre. Moreover, if a poison pill unknowingly emerges

after a sudden acquisition of another company's shares, this could render the acquisition

approach very expensive and/or redundant.

• Legal expenses

• Short-term opportunity cost

• Cost of takeover

• Potential devaluation of equity

• Intangible costs

Takeover activity can also be exacerbated by the short-term cost of opportunity or opportunity

cost. This is the cost incurred when the same amount of investment could be placed elsewhere

for a higher financial return. Sometimes this cost does not prevent or deter the acquisition

because projected long-term financial benefits outweigh that of the short-term cost.

3.2 Consumer and Shareholder drawbacks

In some cases, acquisitions may not only disadvantage the shareholders but consumers as well.

In both cases, this may happen when the newly formed company becomes a large oligopoly or

monopoly. Moreover, when higher pricing power emerges from reduced competition, consumers

may be financially disadvantaged. Some of the potential disadvantages facing consumers in

regard to takeovers are the following.

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• Increase in cost to consumers

• Decreased corporate performance and/or services

• Potentially lowered industry innovation

• Suppression of competing businesses

• Decline in equity pricing and investment value

Shareholders may also be disadvantaged by corporate leadership if it becomes too content or

complacent with its market positioning. In other words, when takeover activity reduces industry

competition and produces a powerful and influential corporate entity, that company may suffer

from non-competitive stimulus and lowered share prices. Lower share prices and equity

valuations may also arise from the takeover itself being a short-term disadvantage to the

company.

3.3 Effects on Management

A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that

mergers and acquisitions destroy leadership continuity in target companies’ top management

teams for at least a decade following a deal. The study found that target companies lose 21

percent of their executives each year for at least 10 years following an acquisition – more than

double the turnover experienced in non-merged firms. If the businesses of the acquired and

acquiring companies overlap, then such turnover is to be expected; in other words, there can only

be one CEO, CFO, etc at a time.

3.4 Wages Settlement

This could also be a problem if the acquiring company gives less wages to its employees then the

acquired company. This may result in overpaying the new employees of acquired company or

increasing the wages of its previous employees, which can really unsettle the budget of the

company.

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4 REASONS AND DISADVANTAGES OF TAKINGOVER BP

The idea of BP being taken over by anyone would have sounded crazy before the gulf of Mexico

disaster, but it is now becoming commonplace to suggest that the UK oil major might even fall

into the hands of rivals like Exxon Mobil, Shell or even Petrochina.

The about turn has been extraordinary. Before its money and reputation began bleeding away in

the Gulf of Mexico, the oil giant was considered the safest of blue chip companies, because its

debts were so low and its income so high.

BP's failure to stop an oil leak from spewing millions of gallons of crude into the Gulf of Mexico

may leave the biggest oil and gas producer in the U.S. in a fight to stay independent.

4.1 BP Facts

Clean-up:

Cost to date: $3.1bn approx Escrow account promise: $20bn

Shares:

Share price on 20 April (before leak began): 656p Share price lowest point (on 25 June): 296p (55% fall)

2009 profits: £10bn

2010 dividend: £1.8bn in Q1; Q2-4 cancelled, saving £5.4bn

Debt:

Total debts: £17bn, of which £4.9 due by end-2011 2009 cashflow: £21bn

Credit ratings: A2/A (Moodys/S&P)

Credit default swap spread (5 years): 4.1% per annum

Strategic investors:

Market capitalisation: £65bn (at 345p current share price)

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Kuwait shareholding: 1.75%

China shareholding: 1.1%

(Data: Bloomberg as of 6 July 2010)

4.2 Reasons for Takeover

In addition to being the largest oil and gas producer in the U.S, BP is the biggest operator

in the Gulf of Mexico, where it holds more than 500 leases and pumps 450,000 barrels of

oil a day. The company plans 10 projects in the Gulf during the next five years, more

than other regions of the world, according to a BP presentation. A takeover of BP will

result in the acquisition of all these projects ultimately increasing the growth of the

acquiring company.

A takeover by Anglo-Dutch shell looks likely because synergies of $9bn had been

estimated by former BP chief Lord Browne and it is revealed that merger of these

companies were tried before in 1995 and 2004. These synergies will give the combined

company the power to take advantage from economies of scale and great pricing power.

If Exxon Mobil acquires BP that would be a combination of the first and second biggest

gas producers in the US which will result in the monopoly of the whole oil market in the

hands of the acquirer. If this happens, the joined company can dictate the stock market

and gain other advantages as well.

Chinese oil giant Petrochina which is not a major oil producer but an avid consumer of

oil can divert scarce oil supplies of BP towards china to satisfy its needs rather than those

of the west. This will not only give Petrochina access to BP’s international oil and gas

reserves, but also the expertise and latest technology which will result in higher value and

growth of the combined company.

The takeover will eliminate a fierce competition between the oil giants of the world as the

acquiring company will absorb a major competitor in the form of BP. Thus increasing

overall market power and share value.

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4.3 Disadvantages

The huge and indeterminate cost of the oil spill cleanup, as well as damages, fines and

compensation analysts forecast of the cash cost to BP have ranged up to about $40 bn, could

spiral into tens of billions.

4.3.1 Political Effects

Technically any of Exxon Mobil, Shell or Petrochina can afford to buy BP, but in an industry

which is already fraught with regulatory and political risk, it is a difficult to cope up with all the

arising situations.

There is already a statutory limit under US law for oil spill costs of a mere $75m, but BP long

ago waived this limit, as hiding behind it would have been politically untenable.

The oil firm could take more active steps to limit its liability, for instance through a selective

bankruptcy of its US business.

But this would almost certainly be unpalatable to the company's board, as it would enrage US

politicians, including President Barack Obama, and probably cut off the entire US market to BP.

So the political reality is that BP's liability in the Gulf of Mexico remains unlimited, and this

continues to weigh down the company's share price.

A takeover of BP in such a scenario will result in an unlimited liability for the acquiring

company. Moreover, it may probably cutoff from the U.S market where BP is the biggest oil and

gas provider.

4.3.2 Environmental Effects

The environmental threats after Mexico oil spills are still in account and acquiring companies

will feel the effects of it for a long time. The cost of oil cleanup is indeterminate and in case of

an acquisition, those cleanups and its effects will become the liability of the acquiring company

and if they fail to clear them in a particular set of time, then the acquired company can feel the

heat as well.16

4.3.3 Legal Effects

The damages, fines and compensation forecasts of the spill are very unclear and there is no exact

account of the litigations which BP will face. BP has crossed the $368 million mark till now in

paying companies and individuals as a result of after effects of the oil spill. Still there is a long

way to go and no one wants to pay an unquantifiable liability.

Figure 3

4.3.4 Other Disadvantages

If Shell makes a move, then it will ace serious competition issues that would force

divestments in Europe and the US. A combined company will be very difficult to manage

and to sustain growth.

Petrochina will be in a risk of overpaying the employees of BP as labour is cheap in

Chinese companies and this could really effect the management and workforce from top

to bottom.

In case of Exxon Mobil, Most combinations of assets would have to be downsized for

competition reasons. The overlapping management will lose their jobs and the old

management will have to fit in the shoes of the BP management and become familiar

with their systems and ways which will take time and incur cost.

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The costs of oil projects are set to soar as governments insist on tougher environmental

safety standards in the wake of the spill. Already the Kazakhstan energy ministry has

forced Shell to tighten up plans at its Kashagan development, meaning that the current

$136bn budget dedicated for the project is likely to be busted. The result could be that

smaller companies, that don't have market values in excess of $100bn – might pull out of

deepwater activities. Only the big boys of the industry would remain in the waters.

5 Conclusion

There are many likely motives to takeover BP but it carries a lot of dips and drops. If a buyer

does try to overcome all these enormous hurdles, it would still need to agree a deal. At the

moment, there is no sign of BP to surrender. Takeover talks are likely to keep swirling, but the

chances are that BP will emerge with its independence intact.

6 References

1. Johnson, Scholes, Whittington., 2008. Exploring Corporate Strategy. 8th Edition. London: Prentice Hall.

2. Biggadike., 1979. Corporate Diversification: Entry, Strategy and Performance.

Cambridge: Harvard University Press.

3. Vos, E and Kelleher, B., 2001.Mergers and Takeovers: A Memetic Approach. Hamilton: University of Waikato, Department of Finance

4. Hughes, Bravo., 2010, BP more likely to survive intact, but the takeover talk goes on. The daily telegraph.

5. Saigol, Johnson, Cooks., 2010. Talk of takeover swirls around BP. Financial Times.

6. Rosing, 2008, Merger and Acquisition is not strategy.

Available from: http://leadershipperformance.blogspot.com/2008_12_01_archive.html

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7. Good, Kahn., Economies of Scale.

Available from: http://www.wikinvest.com/wiki/Economies_of_scale

8. Berry., Advantages and Disadvantages of Acquisitions and Mergers.

Available from: http://www.helium.com/items/1561489-mergers-and-acquisitions

9. Knight., 2010, Which way forward for BP. BBC news

Available from: http://www.bbc.co.uk/news/10520619

10. Whitener., 2010, M&A Services.

Available from: http://www.whitenercpa.com/accounting.htm

11. Swint, Reed., 2010, BP becoming a takeover target as shares slip. London: Bloomberg Business week.

Available from: http://seattletimes.nwsource.com/html/businesstechnology/2012016758_bptakeover03.html

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