Starbucks M&A in China: from Forbidden to Far and Wide

Starbucks entered China in 1999 and quickly opened a café within the Forbidden City. Chinese were horrified at the image of a U.S. coffee capitalist encroaching on traditional Chinese culture. The site became a lightning rod for controversy and eventually closed.

But Starbucks was sharpening its China vision, focusing on the development of goodwill, brand awareness and strong government relations. Consider a couple of recent moves. In February 2012, Starbucks established a joint venture with the Ai Ni Group, one of Yunnan Province’s most established agricultural companies and coffee operators. The goal is to support local farmers and help them enhance the quality of coffee that can be served within China. And in April, China Starbucks University was created, aiming to “elevate” the company’s China employees, with the noble goal of making Starbucks an employer of choice.

Starbucks intends to make China its second largest market (after the U.S.) by 2014 and plans over 1500 cafés in the country by 2015. There are at present about 600 Starbucks stores in China. The company is currently adding a store about every four days and plans to accelerate this pace.

Given this growth goal, corporate business development is changing in China. Originally, Starbucks entered China largely through minority share licensing agreements or joint ventures with quality corporate partners. Now the company is buying out partners such as Maxim Caterers in areas where Starbucks wants to accelerate growth. Starbucks will have full ownership of cafés in the provinces of Guangdong, Hainan, Sichuan, Shaanxi and Hubei, as well as the province-level municipality of Chongqing. Central, South and Western China is coming under full control of the company.

Starbucks intends to move from forbidden to far and wide.

Research assistance provided by Gaurav Vij

Google's Major Acquisitions

Google's has done over 100 acquisitions over the past ten years. So which deals should we classify as significant? The largest deal by far (Motorola Mobility) involves consideration of about $12.5 billion. (This deal has been approved by U.S and EU antitrust authorities, but is still pending regulatory clearance is China, Taiwan and Israel.) The acquisition of Motorola Mobility is expected to substantially augment Google’s thin patent portfolio of about 2,000 patents, increasing it to 20,000+.

But size of transaction alone does not determine significance. Consider Google's 2005 purchase of Android, rumored to cost a mere $50 million. Android has driven quick adoption of Google's mobile platform, which has augured well for company's broader ad-based business model.

For our take on Google's most significant acquisitions, see the infographic at http://www.trivergence.com/market.asp?MarketID=4105. This visual is destined for change as Google's corporate acquisition machine continues its march forward.

Has Apple Been Too Greedy?

According the Recording Industry Association of America (RIAA), sales of recording music in the US was cut in half over the past decade (from some $14B in 2001 to $7B in 2010). Over this same period, Apple's market capitalization multipled some 30 times. Apple's valuation explosion during this period certainly did not solely derive from its use of the music to sell iPods, but it was music that kick started Apple's value capture momentum. And while Apple flourished, its recording company partners floundered.

Earlier this month, the Wall Street Journal highlighted the leverage that Apple has over telecom providers eager to sell its iPhone. Sprint has apparently committed to buy a staggering $20 billion of iPhones, whether or not the company can sell the devices. Great for Apple to lock in such high-volume orders and then be able to negotiate down its component prices. But is Sprint putting a gun to its head by agreeing to Apple's aggressive terms in the highly competitive smart phone market with Android devices (now) and Windows Mobile phones (soon-to-be) challenging iPhone leadership.

Has Apple been too aggressive, too greedy in dealing with its partners? Has it sucked so much out of key ecosystems (such as music and telecom) that key elements are threatened? Has its valuation gains led to the emaciation of venture relationships? Will Apple's brand continue to be highly valued by consumers, but increasingly loathed by deal partners? Will there be a rising crescendo of push-back by value chain companies who feel that Apple has taken too much off the table for itself?

Not a problem, you say. Apple has $76 billion in cash/cash equivalents on its balance sheet and is on pace to soon be the first company ever to squirrel away over $100 billion given an annual inflow of $15-20 billion of free cash. That means Apple could make numerous major acquisitions, integrating more and more elements of its key market value chains within its own control thereby reducing the need for business development partners. Right?

Hardly. Few companies will now receive more antitrust scrutiny than Apple is likely to face over the next decade. So much currency, but so few choices on what to buy with it. Share buybacks or large dividends, yes. But these latter options while good for shareholders will not support company growth.

Squeezed between potential partner pushback and anticipated antitrust attention, Apple will find its abundance of riches a mixed blessing. Aggressive deal making has paid off, but not without challenging side-effects.

Visualizing M&A Future Moves

I love well-designed business development infographics. Infographics that portray a past story and suggest future direction. M&A infographics particularly excite me. Show me what a company has recently acquired, illustrate the product or service gaps that now exist, and then suggest future M&A activity.

Here's an example -- What's next for HP M&A? This infographic illustrates HP M&A activity for the past ten years by sector and by deal size. Then the author suggests future deals that might fill in gaps.

Of course, predicting future moves is tricky business, especially when it comes to M&A activity. Gap analysis, as useful as it is, is not the only motiviation for M&A. Sometimes management wants to consolidate existing markets -- think AT&T and T-Mobile. At other times, a company may want to move into new markets -- think Berkshire Hathaway and Burlington Northern. Other motivations abound.

Predicting M&A action is no easy chip shot. But visualizing the past provides context. And increases your odds at mapping the future.

Breaking up is hard to do

One of the terms that convinced T-Mobile to accept the offer from AT&T rather than other bidders was the large ($3 billion) breakup fee that accompanied AT&T's $39 billion bid. At 7.7%, this breakup fee is huge by typical deal standards -- such fees tend to be in the 2-3% range. For example, Lubrizol, the industrial lubricants company that recently agreed to be bought by Warren Buffett's Berkshire Hathaway, will pay $200 million (2.2% of the $9 billion deal) if the break the acquisition agreement.

If there is a breakup (termination) fee in a deal structure, more often than not it goes to the acquirer if the target walks away from the deal. This fee is intended to reflect the direct and opportunity costs the acquirer incurs such as advisory expenses and executive time spent on the deal. In one study of 1,100 acquisition agreements, 55% of deals included a target breakup fee, whereas only 21% of the deals had breakup fees for both target and acquirer. Targets apparently have greater incentive to break contracts and seek other "lovers".

Technically the fee to be paid by AT&T (acquirer) to T-Mobile (target) upon deal collapse is deemed a reverse breakup fee. The $3 billion sum is not the largest such fee in history in absolute terms. For example, reflecting the difficult credit environment in 2009, Pfizer would have had to pay Wyeth $4.5 billion if it could not get necessary loan approvals to get the deal done. And AOL was on the hook for $5.4 billion if the company walked away from the Time Warner deal. (Time Warner had a reciprocal breakup fee of $3.9 billion on this deal -- in hindsight Time Warner should have bolted and paid this sum to loose itself from AOL's grip.)

However, on a percentage basis ATT's 7.7% breakup bounty tops both the Pfizer and AOL fees. T-Mobile will walk away with this largess (plus some AT&T spectrum) if regulatory authorities such as the DOJ or FCC nix the deal. AT&T's legendary regulatory team will be put to the test as it attempts to convince a hardened antitrust administration that this deal has merit. T-Mobile executives can be more relaxed as they win no matter the outcome.

M&A integration: not one size fits all

Near the end of Cisco’s acquisition binge of the 1990’s, CEO John Chambers once remarked: “In a merger you can't blend resources and cultures--only one can survive." At that time Chambers’ approach to M&A integration involved pure absorption. The Star Trek/Borg axiom “resistance is futile, you will be absorbed” played center stage. Cisco’s culture would dominate.

By the time Cisco bought Scientific Atlanta (SA) in 2006, Chambers attitude toward M&A was changing. This acquisition would extend Cisco’s domain, not merely strengthen it. And Cisco saw there were certain management processes (including supply chain management) where it could learn a lot from SA. Cisco’s integration approach for this deal would move from absorption to alchemic.

Kent Kresa, former CEO of Northrup Grumman and architect behind many noteworthy Northrup acquisitions, likes to compare M&A integration to New York City in the late 1800’s. While immigrants from countries such as Ireland and Italy would be absorbed into the City, an alchemic process was also working whereby the best of each culture would be amalgamated into a new New York. So it is with M&A combinations where the best of each company should be put forward.

There’s a time for M&A absorption to prevail, especially where the need for autonomy in the target is low while the need for strategic interdependence high. But there’s a time for alchemy to govern, especially where both acquirer and target have distinctive advantages that should be blended.

Furthermore, there’s a time for preservation to triumph, especially where the culture of the target should be allowed to remain intact lest a “buy and crush” dynamic destroy the organization elements that made the target attractive. For example, Warren Buffett’s Berkshire Hathaway is famous for preserving (and then nurturing) its acquisitions.

Finally, hybrid integration approaches at times will be the most effective. Consider Cisco buying a networking component company to complete a solution stack it can offer Cisco customers. While tight product integration demands absorption of the target, there might be a “center of excellence” within the target (say software development) that Cisco should preserve and even enlarge. In this case, both absorption and preservation are employed.

Successful M&A involves the art of integration. But there is not one master template for this art form. Value capture that derives from M&A integration is not a one-size-fits-all proposition.

M&A at a torrid pace

The summer months have certainly not dampened Google's M&A appetite. By my count, the company has done 18 acquisitions this year, with three deals already done so far this August. With the IPO market still somewhat cool, Google is providing a one-stop exit shop for the technology sector. In fact, Google's 18 acquisitions just about equal the number (22) of technology/software companies that have gone public so far this year!

For an infographic of Google 2010 acquisitions, see http://www.trivergence.com/market.asp?MarketID=4087