CASE 5: Acquisition of Mannesmann by Vodafone -Jatin Mehta B12085

Case summary
Vodafone AirTouch is UK’s leading cellular service provider. By the late 1980s, the company started expanding its global reach through series of acquisitions, joint-ventures and by 1999 had grown to be the largest mobile company in the world. Sales and operation profits were up by 34% and 17% respectively by September 1999 and Vodafone had captured markets across US, UK and continental Europe. To increase its presence in all-important US market, it acquired AirTouch Communications in January 1999 and later forged a 55-45 partnership with Bell Atlantic.
On the other hand, Mannesmann, formed in 1890 as a producer of seamless steel tubes, entered the telecommunications industry in 1990 by establishing and operating D2, the first private mobile phone network in Germany, and then it quickly became one of Europe’s largest telecommunications companies. By 1999, it had gained a leading position in four of the largest European mobile markets but remained mostly in continental Europe until 2000 when it acquired UK’s third biggest player – Orange and did not look to expand in US or Japan in near terms. It intended to a single supplier of integrated service in terms of fixed lines, wireless and internet activities and hence keep increasing ARPU.
As a whole, the cellular industry itself is expected to see exponential future growth of 45% and above upto 2003. The current penetration levels of 8% globally are extremely low and companies like Vodafone realized the need of robust and aggressive market strategies to capture this growth- Size and global scale are essential in attracting best global content.
In view of these goals, Vodafone is eager to acquire Mannesmann for the reasons as follows. Firstly, the acquisition could help expand the area of business. Mannesmann has the business in the telecommunication equipment, internet service among other things. Vodafone could enter into such areas without taking the risk of entrance. Secondly, the Mannesmann’s big market share in Germany will help Vodafone to ensure the leadership in the European market and even become the biggest operator in the word. Thirdly, the combination will bring Vodafone big synergies from both revenue side and cost saving side. For example, Vodafone could greatly reduce the call cost from Germany to UK as they will be in the same network, while it could attract more users based on this kind of advantage. Besides, the merger reduces the cost of purchasing. The more investment in the oversea markets also reduces the unsystematic risk, and increases the value of the brand Vodafone.

Various levels of problem identified in the case
To start with the initial bid placed by Vodafone was hugely undermined Mannesmann’s own expectations. While Vodafone valued Mannesmann at 138 Bn Euro i.e. 266 Euro/share, laters own assessment was 350 Euro/share.
Mannesmann was itself on trajectory of growth and had future plans under which it acquired Orange PLC. Making things complicated for Vodafone were the facts that Germany has strong laws to protect its companies from takeovers by foreign firms. An interconnected shareholding pattern, with vast amount held by banks ensured a takeover attempt is not an easy task. The principal of codetermination, where worker representatives held half the seats on the supervisory board implied that takeovers that intend to increase the shareholder value would not necessarily be approved by the board and hence despite Vodafone’s assurance of worker’s cause the labor union opposed the merger. Another issue was that under AoA of German companies like Mannesamann, the shareholder was not allowed to have more than 5% of voting rights even if he holds more shares.
Further, Germany has more of ‘stakeholder culture’ rather than UK’s ‘shareholder culture’, so while in former mangers work in tandem with labor unions, institutional shareholders, suppliers and dealers etc., in the later, top managers are given company’s stock options to incentivize them to work towards enhancing shareholders value and were also given golden parachutes if required to be pushed out of the firm for control. Hence, in this environment an acquisition of firm and future control would be difficult.
There was also concern about response to such a large level cross-country bid and ensuing political debates across Europe, with leaders of both UK and German government already expressing their support for their local companies. In such a case if the transaction fails, the political repercussions of the same would be huge.

Details of background knowledge required for solving the problem

The case primarily requires to assess the value of Mannesmann hence the premium that Vodafone should finally offer at given the potential synergy that the combined entity can create. Vodafone’s CEO Gent and Mannesmann’s CEO Esser had entered in to talks to explore potential synergies in various business areas but those talks didn’t yield any result and instead Mannesmann went on to acquire Orange- the hid biggest player in UK. These incidents led Vodafone to make a hostile bid for Mannesmann. Vodafone was of the view that the combined group would yield a synergy of 500 Mn £, and will on increasing in successive years. Vodafone’s advisors Goldman Sachs also estimated that the combined entity’s synergy in data business would yield a perpetual cost synergies of 4% and savings on capital expenditure till 2006. While various estimates pegged Mannesmann’s valuation from 174 €/share to 250 €/share, Vodafone’s offer was 232 €/share valuing the firm at 138 Bn € but Mannesmann’s own valuation was way ahead at 350 €/share. This offer contained an exchange of 43.7 Vodafone shares in for each Mannesmann’s share and was then revised to 53.7 shares. This would had given Mannesmann shareholders a control of 47.2% stake in combined entity and a 20% premium on their current value of stock as on 19 November 1999.
Mannesmann intended to spin off its engineering and steel business into separate entity and become a telecommunications pure-play which was acceptable to Vodafone as well.

List of alternative solutions to the identified problems
Arguments in favor of Mannesmann accepting the deal:
As the combined firm will be a much bigger and hence powerful entity in Europe and elsewhere, it will help plans of both the companies to grow and dominate the world telecommunication market. On the other hand, a failed deal at such a large level would jeopardize the prospects of both firms and would also impact the existing joint holdings of the firm in France, Italy and Germany.

Given %P as premium paid for the firm R as revenue, π as profit %SynC and SynR are the cost synergy % and revenue synergy % respectively and given by,
%SynC = %P*R*π /R*(1-π)
%SynC = π*(%P-%SynR)/(1-π)
Using these two equations and the following exhibit we can arrive at a premium value to be paid for Mannesmann stock. | Vodafone | Mannesmann | Value of tele-communication business pre-merger | 116361 | 71387 | Equity stake | 52.80% | 47.20% | | | | As per exhibit 10 | | Revenue Synergy | 1.70% | | Cost Synergy | 7.80% | | Operating Profit | 5.70% | | | | |
Assuming it to be consistent through future years from 2000 onwards, one may use the above formula to calculate %P , i.e. the premium Vodafone should pay for acquisition. i) %P= 7.8% *(1-.057)/.057 = 12.91% ii) %P= 12.91%+1.7% =14.61%
Hence this should be the premium Vodafone should offer to Mannesmann over current valuation

Final conclusion and Recommendations
Hence, based on above analysis it is proposed that Vodafone should bid an offer of ____ €/share for Mannesmann. Considering the vast power that comes with the firm as big as that of merged entity and the attempt to secure the future growth of firm’s employees, Mannesmann should go ahead with the deal. Moreover, Vodafone should allay the stakeholders fear at Mannesmann and wrap the deal into a friendly takeover rather than a hostile one. Acquisition of such a large magnitude would not be a success unless and until the stakeholders of incoming company agree to work for the common good, reduce friction among themselves and work towards common cause. Moreover, as the Vodafone offers 47.2% stake in the combined entity is an attractive deal for the Mannesmann shareholders.