Introduction
Restructuring is a common business practice that organizations use to enhance their competitiveness and expand market share. Mergers and acquisitions (M&As) are common restricting strategies, and a merger involves two or more firms forming a larger organization (Corporate Finance, 2021). On the other hand, an acquisition involves a firm purchasing another company’s shares to form a larger organization (Garside & Farrell, 2014). There are various factors motiving organizations to restructure, such as long-term survival in competitive markets.
It is important to be able to properly address the question at hand by understanding the intricacies in different markets. In the United States, more than 325,000 M&As with a combined value of approximately $34.9 trillion have been announced since 1985 (Corporate Finance, 2021). Over the same period, the UK has experienced the announcement of more than 103,070 M&As with a combined value of approximately £5.688 trillion (Corporate Finance, 2021). Carphone Warehouse and Dixons Retail merged on August 7, 2014, to form a combined Dixons Carphone Group.
The organization claims to have acquired more products, knowledge, and advice to help the customers navigate the complex technical world (Dixons Carphone, 2021). Operating through 900 stores and fourteen brands in eight countries, the company is a leading retailer of technology and services. This paper evaluates the Dixons Carphone merger, considering the merits, drawbacks, and implications for critical stakeholders.
Merits
M&A processes can occur at full, moderate, and minimal levels. Under the full arrangement, the companies merge all the functional areas, such as operations, finance, marketing, and human resources, to leverage the best practices (Corporate Finance, 2021). Moderate merging involves combining some activities, such as production, centralizing strategic decisions in one company, and making operational activities autonomous. The minimal approach involves merging selected personnel to reduce redundancies.
Strategic and operational decisions remain decentralized and autonomous. The firms in question agreed to a full equal merger of £3.8bn, forming an electrical retailer specializing in various products and gadgets, such as fridges and phones, and services (Garside & Farrell, 2014). The new company Dixons Carphone brought household names, such as Carphone Warehouse, PC World, and Currys, under one roof (Garside & Farrell, 2014). The arrangement can help to leverage the practices of the two firms.
In order to properly understand the merger process, it is important to understand the underlying weighted average cost of capital or WACC. The term can be defined as “the cost of capital for any particular business or project is the rate of return required by the providers of capital (both debt and equity) having regard to the risk characteristics inherent in the project” (PWC, 2017, para. 1). The cost of capital is understood as the income that investments must bring in order for them to justify themselves from the investor’s point of view.
The cost of capital of these companies is expressed as a percentage of the amount of capital invested in any business, which the investor should pay during the year to use his capital. The investor can be a creditor, owner or shareholder of the enterprise, or the enterprise itself. In the latter case, the enterprise invests its own capital, which was formed during the period preceding the new capital investments and, therefore, belongs to the owners of the enterprise. In any case, one has to pay for the use of capital, and the cost of capital is the measure of this payment.
Repackaging a firm’s securities cannot create value in capital markets. Similarly, an M&A adds no value if it does not affect the merging firms’ after-tax cashflows (Corporate Finance, 2021). The desire to go beyond the sale of phones, household appliances, and computers motivated the desire to form the merger. For instance, the company was determined to venture into new areas, such as domestic heating, lighting, and security services controlled via mobile phones. Other benefits included greater buying power, growth options, and increased savings of at least £80m per annum within three years of operation (Garside & Farrell, 2014).
More revenues would be generated by retailing the combined pay-TV, broadband, and phone services offered by various operators, such as BT and Virgin. The company would also earn commissions from music services or supermarkets for pre-installing their mobile applications on smartphones (Garside & Farrell, 2014). The outcome would be increased after-tax cash flows, thus adding value to the two companies.
In addition, it is of paramount importance to understand the implications of perfect capital markets. The key characteristics of such a market are manifested in its key five properties. These include the notion that participants possess equal expectations, there is equivalent access to information, there are no tax inclusions and transactional costs, and there is a large number of sellers and buyers (ORDNUR, 2021). Therefore, under the given financial theory, where the non-essential noise is reduced, the merger process can be considered an appealing deal for the firms.
The Carphone’s Greek Squad technical support teams would support road rescue groups, such as the RAC and the AA, by providing an end-to-end service, addressing sales, insurance, service, and repairs and recycling (Garside & Farrell, 2014). The CEO, Sabastian James, said that the merger was founded on core strategic principles, not mere cost cuts (Garside & Farrell, 2014). He also said that the companies were doing adjacent things, which indicated the need for a merger to converge in response to market conversion.
As competitors, the firms hoarded information from each other to acquire a competitive edge. The merger reduced information asymmetry in the two firms because working together provided an opportunity to share crucial information relating to their various businesses. As such, they were strategically positioned to address competition and acquire a higher market share. The combined capital gives the new company the financial strength to deal with hard economic times. With the combined managerial expertise, the firms can better approach risks and respond adequately to market and economic shocks.
The merger helped to deal with competition and enhance the organizations’ capabilities to deal with competition and emerging technologies. For instance, electrical retailers at the time were at the risk of extinction as book and record stores. Before the merger, Carphone had already failed to diversify by selling electricals through Best Buy (Garside & Farrell, 2014). Simultaneously, mobile networks were selling more through their shops to pay less commission to carphones, while Apple was selling iPhones easily through its retail outlets.
The stiff competition in the outlets in which the firms operated indicated the need to restructure as a survival strategy. Working together would provide numerous benefits, such as economies of scale. Those are benefits accruing to a firm as it enlarges or increases production. For instance, the combined company is likely to have lower marginal costs compared to the initial companies. Cost-saving is a competitive advantage because it increases margins, helping a company stay ahead of its rivals. The firms seeking to sell products directly to deny the Carphone commission are already taking a cost leadership approach to gain a competitive advantage. By levering scale economies, the new company can address the competition issue from a cost-saving perspective.
Investment analyst reports indicated that shares of the two companies were plummeting. For instance, Carphone’s share was down more than 7 percent to £303, while Dixons’ share was down by approximately 10 percent to £46p (Garside & Farrell, 2014). The situation indicates that the two companies needed an urgent strategy to salvage their financial situations. An organization must ensure that its stock is gaining value (Corporate Finance, 2021). The Modigliani-Miller Theorem (M&M) indicates that a firm’s market value depends on the underlying assets and the present value of future earnings.
Drawbacks
Not all M&As succeed because of the numerous challenges the merging firms face in rationalizing their activities. Statistics indicate that approximately 50 percent to 90 percent of M&As fail (Corporate Finance, 2021). The rate of failure of M&As is similar to the rate of divorce in marriages. The reasons for the collapse of M&As are similar to those of failed marriages, such as poor communication, cultural mismatch, and financial difficulties. In restructuring organizations, the expected synergy values may not be realized, leading to failure. Poor strategic fit in which the merging firms have contrasting goals and objectives may also cause challenges. Cultural and social differences in the restructuring firms have caused the failure of numerous M&As. Inadequate due diligence in the M&A may also contribute to failure. Therefore, the merging firms must evaluate each other to determine the issues that may emerge after signing the deal.
Evidently, the drawbacks can also include potential bankruptcy costs since such a deal can be associated with certain risks. According to the Modigliani-Miller theory of capital structure, a firm’s value is solely and independently rooted in risks of assets and its ability to generate revenue regardless of financing and profit distribution (Brusov, Filatova, Orekhova & Eskindarov, 2018). Thus, debt can be considered an appealing option in the process of a merger since it can be more valuable due to debt usage.
There were concerns that the emphasis on the merger’s equality would create competition over who needed to control the emerging business’ operations. The merging firms agreed to cut their combined workforce by approximately 2 percent to reduce labor costs but add 4 percent to leverage growth opportunities, leading to a 2 percent net increase (Garside & Farrell, 2014). Although there seem to be a strategic fit between the two companies, cultural and social differences appeared different, which caused the delay in formalizing the M&A.
Stakeholders’ Implications
Both companies’ shareholders owned 50 percent of the combined group, indicating equal ownership and decision-making rights. All Dixons’ outlets were required to have Carphone concessions under the new arrangement (Garside & Farrell, 2014). Carphone’s chairman and founder, Sir Charles Dunstone, led a 14-strong board, including two deputy chairs, a CEO, a deputy CEO, and a senior non-executive director (Garside & Farrell, 2014).
Dixon’s CEO, Sabastian James, became the CEO deputized by Andrew Harrison of Carphone Warehouse. Although the M&A seems to have succeeded in forming an inclusive leadership team between the two companies, significant challenges can emerge. For instance, the two companies’ leadership styles may differ, leading to regular conflicts among managers and increasing agency costs (Corporate Finance, 2021). Some leaders may also fail to balance all stakeholder interests when making decisions, creating an agency problem.
Dixons’ market capitalization was approximately £1.87 bn, while that of Carphone was approximately £1.9 bn during the merger (Garside & Farrell, 2014). The new company was expected to join the FTSE 100 index. Under the new capital structure for the combined company, Dixons’ shareholders received 0.155 of a share of the new company to forfeit a Dixons’ share (Garside & Farrell, 2014). On the other hand, Dunstone’s 23.5 percent share in Carphone would decline to 11.75 percent in Dixons Carphone. An agreeable capital structure is a critical process in ensuring the success of an M & M&A. It is also essential to apply stakeholder theory in the management of an M&A to ensure that all critical stakeholders’ interests are addressed. Aggrieved stakeholders may bring issues later, leading to the collapse of the M&A.
Conclusion
In summary, Carphone Warehouse and Dixons Retail agreed to form an equal full merger of £3.8bn on August 7, 2014. The new business, Dixons Carphone Group, would specialize in retailing technology and services, leveraging the two companies’ best practices. The need to address growing competition in the retail sector, especially the technology and service segment, necessitated the restructuring strategy. The merger creates value by increasing after-sales cash flows for the two companies. They also combined tangible and intangible assets, leading to economies of scale and other benefits, such as enhanced managerial skills. Information asymmetry is reduced in the new company because the managers can no longer hoard information from each other.
Instead, they complement each other, leading to better decision-making, risk management, and strategy formulation and implementation. A larger market share helps the company deal with competition from the other companies, focusing on maximizing sales in their stores to deny Carphone Warehouse or Dixons Retail commissions.
References
Brusov, P., Filatova, T., Orekhova, N., & Eskindarov, M. (2018). Modern corporate finance, investments, taxation and ratings. ResearchGate. Web.
Corporate Finance. (2021). Lecture 4: Corporate restructuring: Mergers and acquisitions. Web.
Dixons Carphone. (2021). About Us. Dixons Carphone. Web.
Garside, J., & Farrell, S. (2014). Carphone Warehouse and Dixons agree £3.8bn mergers. The Guardian. Web.
ORDNUR. (2021). Perfect capital market. ORDNUR. Web.
PWC. (2017). What is WACC used for? PWC. Web.