External vs. Internal Growth

Companies have two options to achieve the level of activity or growth pursued by the company:External growth and internal growth.

The company does not acquire other. It growths because of the natural company’s growth.

Eg.: Investing or acquiring more productive assets, hiring more staff or higher qualification, investing more money in R+D+I, company’s development of new or different lines business, etc.

All these options should be financed by the Company. External financing (debt in its various forms: loans, bonds, etc.) or by own funds (capital or increase reserves or retained earnings, mainly).

Internal growth is less risky and usually

less expensive, although it involves more time to do it.

This strategy is one in which the company acquires other companies in its sector, its production lines or

other than the activity of the company sectors.

The finance of the acquisition it is the same as in the internal growth.

External growth through mergers and acquisitions must be done, as we know, only if it creates value to the shareholders (synergy).

The external growth is riskier and usually

more expensive, but means less time to do it.

Pros of a takeover

  • Increase in sales/revenues
  • Venture into new businesses and markets
  • Profitability of target company
  • Increase market share
  • Decreased competition
  • Enlarge brand portfolio
  • Increase in economies of scale
  • Increased efficiency as a result of corporate synergies/redundancies
  • Expand strategic distribution network

Cons of takeover

  • Often paid in excess for the acquisition
  • Culture clashes within the two companies causes employees to be less-efficient or despondent
  • Reduced competition and choice for consumers in oligopoly markets (Bad for consumers, although this is good for the companies involved in the takeover)
  • Likelihood of job cuts
  • Cultural integration/conflict with new management
  • Hidden liabilities of target entity
  • The monetary cost to the company
  • Lack of motivation for employees in the company being bought.

Discussion Questions

Discuss the advantages and disadvantages of the friendly versus hostile takeovers.

Do you believe that takeover defenses are more motivated by the target’s managers attempting to entrench themselves or to negotiate a higher price for their shareholders?

Impact on Shareholder Value

  • Friendly t.ransactions result in average abnormal returns to target shareholders of 20%.
  • Hostile transactions result in average abnormal returns to target shareholders of 30-35%.

En colaboración la Dra. Inés Martín de Santos.