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Exam 15: Business Alliances: Joint Ventures, Partnerships, Strategic Alliances, and Licensing

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Question 21

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Business alliances typically use which of the following ways to finance ongoing capital requirements?

A) Request participants to make a capital contribution
B) Issuing additional equity or partnership interests
C) Borrowing without partner guarantees
D) A and B only
E) A, B, and C

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Question 22

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Unlike other legal structures, a corporate structure does not have to be dissolved because of the death of the owners or if one of the owners wish to liquidate their ownership position.

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Question 23

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Which of the following is not a typical characteristic of a licensing arrangement?

Strains Threaten Verizon and Vodafone Joint Venture Vodafone Group, the U.K. based cell phone behemoth wanted to expand geographic coverage in the U.S. In 2000, they teamed up with Verizon Communications to form Verizon Wireless. The profitable business had annual revenues of $20 billion and a coast-to-coast network serving more U.S. customers than any other carrier. However, Vodafone's global ambitions and its buy-out option threatened to put the venture at risk of breaking up. Vodafone executives expressed frustration by the company's lack of control in the U.S., because it owns just 45 percent of the venture. Vodafone seeking to establish its own brand name has been unable to get its name attached to a single product of the joint venture. Moreover, it has been unable to persuade the venture to use a technology compatible with that used by Vodafone in most of the 28 other countries in which it does business. This issue has proven to be particularly irksome since part of the Vodafone strategy is that its European, Asian, and Middle Eastern customers would be able to travel to the U.S. and use their cell phones on Vodafone's network in the U.S. Vodafone also complains that Verizon Wireless has been slow to push next-generation wireless services such as photo and text messaging. Verizon Wireless also receives three times as many customer complaints as the average of Vodafone European units. Vodafone is reduced to be a passive financial investor in the operation. The two partners are also at odds in their strategies for owning wireless assets. Verizon Communications increasingly uses the venture to support its declining land-line telephone business, by bundling wireless at a discount with other services. Vodafone considers landlines as having no future for its strategy. The cloud hanging over Verizon Wireless is the put that Vodafone received as part of its initial investment which gives it the right to sell its interests to Verizon at certain points through 2006. Vodafone can demand that Verizon pay it $10 billion in return for its stake. Mindful of the put, the partners have discussed friendlier ways to alter their relationship. For example, Vodafone could swap part of its stake in the venture for Verizon Communications' interest in Italian wireless operation Omnitel. Anything that reduced Vodafone's interest in Verizon Wireless below 20 percent would free Vodafone from a non-compete clause that precludes the firm from opening up its own operation in the U.S. -To what extent are the problems plaguing the venture today a reflection of failure to? communicate during the negotiations to form the joint venture? What should they have done differently?

Coca-Cola and Procter & Gamble's Aborted Effort to Create a Global Joint Venture Company Coca-Cola (Coke), arguably the world's best-known brand, manufactures and distributes Coca-Cola as well as 230 other products in 200 countries through the world's largest distribution system. Procter & Gamble (P&G) sells 300 brands to nearly 5 billion consumers in 140 countries and holds more food patents than the three largest U.S. food companies combined. Moreover, P&G has a substantial number of new food and beverage products under development. Both firms have been competing in the health and wellness segment of the food market for years. P&G spends about 5 percent of its annual sales, about $1.9 billion, on R&D and holds more than 27,000 patents. The firm employs about 6,000 scientists, including about 1,200 people with PhDs. Both firms have extensive distribution systems. P&G uses a centralized selling and warehouse distribution system for servicing high-volume outlets, such as grocery store chains. With a warehouse distribution system, the retailer is responsible for in-store presentations of the brands, including shelving, display, and merchandising. The primary disadvantage of this type of distribution system is that it does not reach many smaller outlets cost effectively, resulting in many lost opportunities. In contrast, Coke uses three distinct systems. Direct store delivery consists of a network of independently operated bottlers, which bottle and deliver the product directly to the outlet. The bottler also is responsible for in-store merchandising. Coke's warehouse distribution is similar to P&G's and is used primarily to distribute Minute Maid products. Coke also sells beverage concentrates to distributors and food service outlets. On February 21, 2001, Coca-Cola and Procter & Gamble announced, amid great fanfare, plans to create a stand-alone joint venture corporation focused on developing and marketing new juice and juice-based beverages as well as snacks on a global basis. The new company expected to benefit from Coca-Cola's worldwide distribution, merchandising, and customer marketing skills and P&G's R&D capabilities and wide range of popular brands. The new company would focus on the health and wellness segment of the food market. Less than nine months later, Coke and P&G released a one-sentence joint statement on September 21, 2001, that they could achieve better returns for their respective shareholders if they pursued this opportunity independently. Although it is unclear what may have derailed what initially had seemed to the potential partners like such a good idea, it is instructive to examine the initial rationale for the proposed joint effort. Each parent would own 50 percent of the new company. Because of the businesses each partner was to contribute to the JV, the firm would have annual sales of $4 billion. The new firm would be an LLC, having its own board of directors consisting of two directors each from Coke and P&G. Moreover, the new firm would have its own management and dedicated staff providing administrative and R&D services. Coke was contributing a number of well-known brands including Minute Maid, Hi-C, Five Alive, Cappy, Kapo, Sonfil, and Qoo; P&G contributed Pringles, Sunny Delight, and Punica beverages. The new company would have had 15 manufacturing facilities and about 6,000 employees. Although the new firm was to have access to all distribution systems of the parents, it would have been free to choose the best route to market for each product. Although Minute Maid was to continue to use Coke's distribution channels, it also was to take advantage of existing refrigerated distribution systems built for Sunny Delight. Pringles was to use a variety of distribution systems, including the existing warehouse system. The Pringles brand was expected to take full advantage of Coke's global distribution and merchandising capabilities. Minute Maid was to gain access to new outlets through Coke's fountain and direct store distribution system. The new company's sales were expected to grow from $4 billion during the first 12 months of operation to more than $5 billion within two years. The combination of increasing revenue and cost savings was expected to contribute about $200 million in pretax earnings annually by 2005. Specifically, Pringles's revenue growth as a result of enhanced distribution was expected to contribute about $120 million of this projected improvement in pretax earnings. The importance of improved distribution is illustrated by noting that Coke has access to 16 million outlets globally. In the United States alone, that represents a 10-fold increase for Pringles, from its current 150,000 points of outlet. Similarly, improved merchandising and distribution of Sunny Delight was expected to contribute an additional $30 million in pretax income. The remaining $50 million in pretax earnings was to come from lower manufacturing, distribution, and administrative expenses and through discounts received on bulk purchases of foodstuffs and ingredients. P&G and Coke were hoping to stimulate innovation by combining global brands and distribution with talent from both firms in what was hoped would be a highly entrepreneurial corporate culture. The parents also hoped that the stand-alone firm would be able to achieve focus and economies of scale that could not have been achieved by either firm separately. The results of the LLC were not to be consolidated with those of the parents but rather shown using the equity method of accounting. Under this method of accounting, each parent's proportionate share of earnings (or losses) is shown on its income statement, and its equity interest in the LLC is displayed on its balance sheets. The new company was expected to be nondilutive of the earnings of the parents during its first full year of operations and contribute to earnings per share in subsequent years. The incremental earnings were expected to improve the market value of the parents by at least $1.5-2.0 billion (Bachman, 2001). Some observers suggested that P&G would stand to benefit the most from the JV. It would have gained substantially by obtaining access to the growing vending machine market. Historically, P&G's penetration in this market had been miniscule. This perceived disproportionate benefit accruing to P&G may have contributed to the eventual demise of the joint venture effort. Coke may have sought additional benefits from the JV that P&G was simply not willing to cede. Once again, we see that, no matter how attractive the concept may seem to be on the surface, the devil is indeed in the details when comes to making it happen. -What factors may have contributed to the decision to discontinue efforts to implement the joint venture? Consider control, scope, financial, and resource contribution issues.

Antitrust regulatory authorities tend to look most favorably on which type of alliances?

The success rate among business alliances is usually much higher than for mergers and acquisitions.

The written contract is the simplest legal structure and most often is used in strategic alliances.

Exxon-Mobil and Russia's Rosneft Create Artic Oil and Gas Exploration Joint Venture ________________________________________________________________ Key Points Contractual commitments in cross-border alliances are effective only to the extent they are enforced by each country's legal system. The success of most alliances ultimately depends on the extent to which each partner needs the capabilities and resources of the other. ______________________________________________________________________________ Exxon-Mobil (Exxon) finalized an agreement with the government-owned Russian oil and gas giant Rosneft on April 16, 2012, to create a joint venture to explore for oil and gas in three designated areas in the Russian portion of the Artic Ocean known as the Kara Sea. The agreement superseded a similar but failed agreement with British Petroleum (BP) earlier in the year. Rosneft's attempt to strike a similar pact with BP in 2011 fell apart because the British company had a joint venture with a separate group of private Russian investors, which blocked the Rosneft deal in an international court. While BP had planned to swap stock, Exxon agreed to give Rosneft assets elsewhere in the world, including some that Exxon owns in the deep waters of the Gulf of Mexico and in Texas. Future investments could total tens of billions of dollars. The final agreement was contingent on Russia's reducing taxes imposed on oil and gas companies. The U.S. Geological Survey estimates that the Artic holds one-fifth of the world's undiscovered, recoverable oil and natural gas. The Kara Sea has an estimated 36 billion barrels of recoverable oil reserves. Total oil and gas reserves are estimated to be 110 billion barrels of oil equivalent, four times Exxon's proven worldwide reserves. Drilling is expected to start in 2015, with Exxon shouldering most of the costs. In exchange for access to these Rosneft properties, the agreement gives Rosneft an option to invest in certain U.S. properties. Rosneft will own two-thirds and Exxon the remainder of the joint venture. The initial commitment by the two companies is to invest $3.2 billion in exploration in the Kara Sea. As a world leader in Artic exploration, Exxon is willing to share its expertise with Rosneft, as well as to transfer technology, in exchange for access to Russia's Artic region. The Russians are particularly interested in learning the latest techniques employed in hydraulic fracturing (so-called "fracking") of underground oil and gas deposits trapped in shale rock. This deal also allows the Russian petroleum industry to diversify internationally. While Russia currently pumps more oil than Saudi Arabia, its onshore oil fields are in decline, threatening a major source of Russian export revenue. Furthermore, Rosneft receives an option to acquire an equity interest in certain Exxon projects in North America, including deep-water drilling in the Gulf of Mexico and fields in Texas. In addition, Rosneft will have an opportunity to invest in Exxon properties and projects outside of the United States. Granting Rosneft options to invest in certain Exxon assets was an important precondition for getting agreement on the joint venture. The Russian government had long demanded reciprocity as part of any deal. This required that in exchange for any ownership in Russian assets, the Russian partner should have the opportunity to invest in assets owned by the other partner. The value of the assets Rosneft would own in the United States would be in proportion to those Exxon would own in Russia. The agreement is risky, in view of Russia's history of reneging on deals with Western oil companies. For example, in 2006, it compelled Royal Dutch Shell to sell 50% of a Sakhalin offshore property to state-owned Gazprom after Shell had spent more than $20 billion of its own money and that of other investors to build the project's infrastructure. British Petroleum and Russia's Rosneft Swap Shares Extending its already close ties with Russia, British Petroleum PLC announced an agreement to exchange shares with Russia's largest oil company, OAO Rosneft, on January 14, 2011. Rosneft is 75% owned by the Russian government. BP and Rosneft also announced the formation of a JV to develop three massive offshore exploration blocks that Rosneft owns in northern Russia. The two firms said they will jointly explore three areas in the South Kara Sea in the Russian Arctic, spending between $1.4 and $2 billion on seismic tests and drilling wells in the initial exploration phase. The JV will be two-thirds owned by Rosneft, with the remainder owned by BP. Reflecting Europe's escalating dependence on Russia for an increasing share of its energy usage, particularly for clean-burning natural gas, the agreement is backed by Britain's prime minister, David Cameron, and Russia's prime minister, Vladimir Putin. Russia holds one-fifth of the world's proven reserves of natural gas, and, by some estimates, the South Kara Sea contains some of the largest reserves of oil and gas in the world. The deal comes in the wake of BP's sale of assets to raise funds to cover the costs of the Gulf of Mexico oil spill in mid-2010. Such costs are expected to eventually total $40 billion. Rosneft, which had announced in late 2010 that it was seeking a partner for exploiting its Arctic leases, indicated that BP's experience in dealing with such problems gives it an edge over other potential partners. Rosneft also regards BP's deep-water drilling technology and experience as cutting edge. BP's expertise received another vote of confidence when Australia granted BP licenses to initiate extensive drilling activity off its coast several days after the Rosneft announcement. The share exchange gives Rosneft a 5% interest in BP's voting shares, making it BP's single largest shareholder. In return, BP receives a 9.5% ownership stake in Rosneft. Each stake is valued at about $7.8 billion. Both firms agreed to hold each other's equity for at least two years before selling any stock. BP's shares currently pay a dividend about twice that of Rosneft's. BP and Rosneft have stated publicly that they believe investors have significantly undervalued their firms. The Russian government has a particularly strong interest in seeing the value of its holdings appreciate, since it announced plans to privatize a number of largely state-owned enterprises, including Rosneft, in 2014 in order to raise funds. At the time of the announcement, BP's market capitalization was about $154 billion. With almost 90% of its shares owned by the Russian government and Sherbank, Russia's biggest retail savings bank, the firm's stock trading in public markets tends to be limited and not reflective of Rosneft's true value. However, the terms of the share exchange imply a market capitalization for Rosneft of about $81 billion. The transaction represents the first time there has been a cross-shareholding between major international oil firms and a major government-owned national oil company. Unlike more conventional oil and gas JVs, the Rosneft JV will not own the oil leases but merely the right to develop them. This structure is similar to Russian oil company Gazrpom's agreement with France's Total SA and Norway's Statoil for the development of the Shtokman gas field in early 2008. Rosneft became Russia's leading extraction and refining company after purchasing assets of former privately owned oil giant Yukos at state-sponsored auctions, in which the global community decried what appeared to be the Russian government expropriation of the privately owned assets. In 2006, Rosneft conducted one of the largest IPOs in history by issuing nearly 15% of its shares on the Russian Trading System and the London Stock Exchange. With the shares priced at $7.55 each, the offering raised about $10.7 billion. Most of the proceeds went to the Russian government. BP began its relationship with Rosneft by buying $1 billion in shares in the firm's initial public offering, equivalent to 1.3%. Thus, the recent agreement brings BP's ownership interest in Rosneft to 10.8%. Previous attempts to invest in Russia and to create partnerships between Russian state oil companies and Western oil firms have failed due to outright expropriation by the Russian government or heavy-handed tactics employed by certain Russian billionaires (so-called oligarchs) with close ties to the Russian government. For example, Russian officials forced Shell Oil to sell control of its Sakhalin II oil and gas development to state-owned Gazprom. BP and Gazprom signed a global joint venture in 2007 in which each was to contribute assets valued at $1.5 billion, but it was later dissolved due to disagreements between BP and large Russian investors. TNK-BP, BP's 50 percent-owned JV with a group of Russian billionaire business people, has also had a troubled history. The JV that contributes a quarter of BP's global production and nearly a fifth of its reserves was rocked by a shareholder dispute in 2008 that cost BP some of its control. BP chief executive Bob Dudley had served as chief executive of that JV for five years until he was expelled by BP's Russian partners during the disagreement. On news of the agreement, BP's partners in the TNK-BP JV stated that BP had not notified them adequately and that the Rosneft deal violated their "right of first refusal" as stated in the JV agreement. The partners were successful in getting a court injunction in the United Kingdom to block the implementation of the JV in February 2011. TNK-BP at the time of this writing is considering a legal claim against BP for damages of up to $10 billion for allegedly reneging on its commitment to use TNK-BP as its main vehicle for investment in Russia. These developments raise serious questions about the longer-term viability of the BP-Rosneft JV. -What is the purpose of the 2-year lockup period during which neither partner can sell its stock? How might the lock-up period impact the value of each firm's holdings?

The desire to share risk is a common motive for a business alliance.

General Electric and Comcast Join Forces Joint ventures are sometimes created if a business cannot be sold outright. Such JVs are viewed as a way of improving a firm’s operations enabling the parent to exit the business eventually at a higher value. In an effort to shore up its big finance business, severely weakened during the 2008 financial crisis, and to focus more on its manufacturing and infrastructure operations, General Electric (GE) sought to sell its media and entertainment business, NBCUniversal. GE’s decision to sell also reflected the deteriorating state of the broadcast television industry and a desire to exit a business that never quite fit with its industrial side. NBC has been mired in fourth place among the major broadcast networks, and the economics of the broadcast television industry have deteriorated in recent years amid declining overall ratings and a reduction in advertising. In contrast, cable channels have continued to thrive because they rely on a steady stream of subscriber fees from cable companies such as Comcast. Moreover, while NBCUniversal was profitable in 2009, it was expected to go into the red in subsequent years. Unable to find a buyer for the entire business at what GE believed was a reasonable price, GE sought other options, including combining the operation with another media business. After extended discussions, GE and Comcast announced a deal on December 2, 2009, to form a joint venture consisting of NBCUniversal and selected Comcast assets. Comcast is primarily a cable company and provider of programming content, with 24.3 million cable customers, 16.1 million high-speed Internet customers, and 7.8 million voice customers. Comcast hopes to diversify its holdings as it faces encroaching threats from online video and more aggressive competition from satellite and phone companies that offer subscription TV services, by adding more content on its video-on-demand offerings. Furthermore, by having an interest in NBCUniversal’s digital properties, such as Hulu.com, Comcast expects to capitalize on any shift of its cable customers to viewing their favorite TV programs online by owning the program content. Comcast’s strategy is to integrate vertically by owning the content it distributes through its cable operations. Previous attempts to do this, such as AOL’s acquisition of Time Warner in 2001, have ended in failure, largely because the cultures of the two firms did not mesh. Some media companies have merged successfully —for example, Time Warner’s merger with Turner Broadcasting. Having learned from AOL’s rush to achieve synergy, Comcast is allowing the NBCUniversal JV to operate independent of the parents and is sharing the risk with GE. This joint venture transaction is noteworthy for its potential impact on limiting competition in the entertainment industry, its complex financial engineering, and its multifaceted organizational structure and as an exit strategy for GE from the media and entertainment business. Each of these considerations is discussed next. The announcement raised significant concerns within the media and entertainment industry about the potential for limiting access to both content and distribution by increasing industry concentration. After receiving significant concessions, regulators approved the creation of the joint venture media giant on January 17, 2011. The U.S. Federal Communications Commission and the Department of Justice required Comcast and NBCUniversal to relinquish voting rights and board representation to Hulu, although they could continue to remain part owners. Furthermore, Comcast has to ensure what the FCC called “reasonable access” to its programming for its competitors, and the firm may not discriminate against programming that competes with its own offerings. The deal reflected complicated financial engineering, involving both parties contributing assets to create a joint venture, agreeing on the total value of the endeavor, determining the value of each party’s contributed assets to determine ownership distribution, and finally determining how GE would be compensated. The joint venture transaction based on the value of the assets contributed by both parties was valued at $37.25 billion, consisting of GE’s contribution of NBCUniversal, valued at $30 billion, and Comcast’s contribution of cable network assets valued at $7.25 billion. The ownership interests were determined based on the value of the contributed assets and cash payments made to GE as described in Figure 15.1. In exchange for contributing NBCUniversal operations valued at $30 billion to the JV, GE received $15.6 billion in cash ($6.5 billion from Comcast + $9.1 billion borrowed by the NBCUniversal JV) + a 49% ownership interest in the NBCUniversal JV). In exchange for contributing $7.5 billion in cable network assets to the JV and paying GE $6.5 billion in cash, Comcast received a 51% interest in the NBCUniversal JV. NBCUniversal Joint Venture at Closing. Organizationally, the two parties own NBCUniversal indirectly through their ownership in a holding company (see Figure 15.2). As part of the deal, NBCUniversal Inc. was converted to a limited liability company (NBCUniversal Media LLC), which is a wholly owned subsidiary of NBCUniversal Holdings Inc., a corporation in which Comcast owns 51% of the outstanding shares and GE the remainder. NBCUniversal Holdings is the sole member (owner) in NBCUniversal Media LLC. By having the right to designate the majority of the board members of NBCUniversal Holdings, Comcast effectively controls the holding company and, in turn, NBCUniversal Media LLC. To maintain its status as a pass-through organization for tax purposes, NBCUniversal Media makes quarterly distributions to the holding company, which has no independent source of income, to meet its cash requirements. Among other things, these obligations include making cash distributions to Comcast and GE so that they can pay taxes due on the income generated by NBCUniversal Media. As long as GE retains at least a 20% ownership interest in the combined firms, it has certain approval rights over acquisitions, mergers, dissolution, bankruptcy, material expansion of the business, dividend payouts, new equity issues or repurchase, additional borrowing in excess of working capital requirements, loan guarantees, and other actions that could affect the value of its investment. NBCUniversal Postclosing Organization Finally, the deal enables General Electric to pursue a staged exit of NBCUniversal over a number of years. In doing so, GE hopes that the potential synergy with Comcast will increase substantially the value of its share of the joint venture. GE has redemption rights (a put option) during the six months beginning January 28, 2014, to redeem one-half of its interest in NBCUniversal Holdings. In the six months beginning on January 28, 2018, GE can redeem its remaining interest. Comcast is committed to funding $2.9 billion for each of the two redemptions, payable in cash and stock up to $5.8 billion to the extent NBCUniversal Media cannot fund the redemptions. The purchase price to be paid with any redemption by GE will be 120% of the “public market trading value” of NBCUniversal Holding, to be determined by an appraisal if the business is not yet publicly traded, less 50% of the “public market trading value” greater than $28.4 billion. After January 28, 2014, GE may transfer its interest to a third party, subject to Comcast’s having the right of first offer (first refusal). Comcast has a call option to buy out GE after the same dates designated for GE’s put option at the same price required under the put option. In 2011, NBCUniversal Media had revenue of $19.3 billion, earnings before interest and taxes of $2.3 billion, and net income of $1.7 billion. While the financial outlook for the business has stabilized, the deal continues to be subject to the criticism that there is little overlap between Comcast and NBCUniversal Media’s businesses to provide significant cost savings. Moreover, big media deals have a poor track record, as illustrated by the AOL Time Warner debacle. Comcast is placing a big bet that it will be able to combine content and distribution successfully and to grow the value of the consolidated businesses. In contrast, General Electric may be more intent on exercising its option to sell its interests unless the fortunes of NBCUniversal Media improve dramatically in the coming years. -What are the likely challenges Comcast and GE will have in integrating the various businesses that comprise the joint venture? Be specific.

Empirical studies show that the business alliance announcements seldom have any impact on the market value of their parent firms.

Coca-Cola and Procter & Gamble's Aborted Effort to Create a Global Joint Venture Company Coca-Cola (Coke), arguably the world's best-known brand, manufactures and distributes Coca-Cola as well as 230 other products in 200 countries through the world's largest distribution system. Procter & Gamble (P&G) sells 300 brands to nearly 5 billion consumers in 140 countries and holds more food patents than the three largest U.S. food companies combined. Moreover, P&G has a substantial number of new food and beverage products under development. Both firms have been competing in the health and wellness segment of the food market for years. P&G spends about 5 percent of its annual sales, about $1.9 billion, on R&D and holds more than 27,000 patents. The firm employs about 6,000 scientists, including about 1,200 people with PhDs. Both firms have extensive distribution systems. P&G uses a centralized selling and warehouse distribution system for servicing high-volume outlets, such as grocery store chains. With a warehouse distribution system, the retailer is responsible for in-store presentations of the brands, including shelving, display, and merchandising. The primary disadvantage of this type of distribution system is that it does not reach many smaller outlets cost effectively, resulting in many lost opportunities. In contrast, Coke uses three distinct systems. Direct store delivery consists of a network of independently operated bottlers, which bottle and deliver the product directly to the outlet. The bottler also is responsible for in-store merchandising. Coke's warehouse distribution is similar to P&G's and is used primarily to distribute Minute Maid products. Coke also sells beverage concentrates to distributors and food service outlets. On February 21, 2001, Coca-Cola and Procter & Gamble announced, amid great fanfare, plans to create a stand-alone joint venture corporation focused on developing and marketing new juice and juice-based beverages as well as snacks on a global basis. The new company expected to benefit from Coca-Cola's worldwide distribution, merchandising, and customer marketing skills and P&G's R&D capabilities and wide range of popular brands. The new company would focus on the health and wellness segment of the food market. Less than nine months later, Coke and P&G released a one-sentence joint statement on September 21, 2001, that they could achieve better returns for their respective shareholders if they pursued this opportunity independently. Although it is unclear what may have derailed what initially had seemed to the potential partners like such a good idea, it is instructive to examine the initial rationale for the proposed joint effort. Each parent would own 50 percent of the new company. Because of the businesses each partner was to contribute to the JV, the firm would have annual sales of $4 billion. The new firm would be an LLC, having its own board of directors consisting of two directors each from Coke and P&G. Moreover, the new firm would have its own management and dedicated staff providing administrative and R&D services. Coke was contributing a number of well-known brands including Minute Maid, Hi-C, Five Alive, Cappy, Kapo, Sonfil, and Qoo; P&G contributed Pringles, Sunny Delight, and Punica beverages. The new company would have had 15 manufacturing facilities and about 6,000 employees. Although the new firm was to have access to all distribution systems of the parents, it would have been free to choose the best route to market for each product. Although Minute Maid was to continue to use Coke's distribution channels, it also was to take advantage of existing refrigerated distribution systems built for Sunny Delight. Pringles was to use a variety of distribution systems, including the existing warehouse system. The Pringles brand was expected to take full advantage of Coke's global distribution and merchandising capabilities. Minute Maid was to gain access to new outlets through Coke's fountain and direct store distribution system. The new company's sales were expected to grow from $4 billion during the first 12 months of operation to more than $5 billion within two years. The combination of increasing revenue and cost savings was expected to contribute about $200 million in pretax earnings annually by 2005. Specifically, Pringles's revenue growth as a result of enhanced distribution was expected to contribute about $120 million of this projected improvement in pretax earnings. The importance of improved distribution is illustrated by noting that Coke has access to 16 million outlets globally. In the United States alone, that represents a 10-fold increase for Pringles, from its current 150,000 points of outlet. Similarly, improved merchandising and distribution of Sunny Delight was expected to contribute an additional $30 million in pretax income. The remaining $50 million in pretax earnings was to come from lower manufacturing, distribution, and administrative expenses and through discounts received on bulk purchases of foodstuffs and ingredients. P&G and Coke were hoping to stimulate innovation by combining global brands and distribution with talent from both firms in what was hoped would be a highly entrepreneurial corporate culture. The parents also hoped that the stand-alone firm would be able to achieve focus and economies of scale that could not have been achieved by either firm separately. The results of the LLC were not to be consolidated with those of the parents but rather shown using the equity method of accounting. Under this method of accounting, each parent's proportionate share of earnings (or losses) is shown on its income statement, and its equity interest in the LLC is displayed on its balance sheets. The new company was expected to be nondilutive of the earnings of the parents during its first full year of operations and contribute to earnings per share in subsequent years. The incremental earnings were expected to improve the market value of the parents by at least $1.5-2.0 billion (Bachman, 2001). Some observers suggested that P&G would stand to benefit the most from the JV. It would have gained substantially by obtaining access to the growing vending machine market. Historically, P&G's penetration in this market had been miniscule. This perceived disproportionate benefit accruing to P&G may have contributed to the eventual demise of the joint venture effort. Coke may have sought additional benefits from the JV that P&G was simply not willing to cede. Once again, we see that, no matter how attractive the concept may seem to be on the surface, the devil is indeed in the details when comes to making it happen. -In your opinion, what were the motivating factors for the Coke and P&G business alliance?

In what way can the Comcast/GE JV created in 2011 be viewed as a phased entry strategy into owning content for Comcast and as a phased exit strategy for GE?

JV and alliance agreements often limit how and to whom parties to the agreement can transfer their interests. These limitations include which of the following mechanisms?

Major motivations for business alliances include risk sharing as well as gaining access to new markets and skills.

In late 1999, General Motors (GM), the world's largest auto manufacturer, agreed to purchase 20% of Japan's Fuji Heavy Industries, Ltd., the manufacturer of Subaru vehicles, for $1.4 billion. Why do you believe that General Motors may have wanted to limit initially its investment to 20%?

Microsoft Partners with Yahoo!-An Alternative to Takeover? Business alliances sometimes represent a less expensive alternative to mergers and acquisitions. This notion may have motivated Microsoft when the firm first approached Yahoo! about a potential partnership in November 2006 and again in mid-2007. Frustrated with their inability to partner with Yahoo!, Microsoft initiated a hostile takeover bid in 2008 valued at almost $48 billion or $33 per share, only to be spurned by Yahoo!. Following the withdrawal of Microsoft's offer, Yahoo!'s share price fell into the low to mid-teens and remained in that range throughout 2010. Reflecting the slumping share price and a failed effort to create a search partnership with Google, Yahoo!'s cofounder, Jerry Yang, was replaced by Carol Bartz in early 2009. The U.S. Justice Department had threatened to sue to block the proposed partnership between Yahoo! and Google on antitrust grounds. Microsoft again approached Yahoo! with a partnering proposal in mid-2009, which resulted in an announcement on February 18, 2010, of an Internet search agreement between the two firms. As a result of the agreement, Yahoo! transferred control of its Internet search technology to Microsoft. Microsoft is relying on a ten-year arrangement with Yahoo! to help counter the dominance of Google in the Internet search market. By gaining access to each other's Internet users, both firms hope to be able to attract more advertising dollars from companies willing to pay for links on Microsoft's and Yahoo!'s websites. With Microsoft's search technology believed to be superior to Yahoo!'s, users requesting searches through Yahoo!'s site will be implemented using Microsoft's search software. Regulatory agencies in both the United States and the European Union had no trouble approving the proposal because the combined Yahoo! and Microsoft Internet search market share is dwarfed by Google's. Google is estimated to have about two-thirds of the search market, followed by Yahoo! at 7% and Microsoft with about 3%. Yahoo! could profit handsomely from the deal, since it will retain 88% of the revenue from search ads on its website during the first five years of the ten-year contract. Microsoft will pay for most of the costs of implementing the partnership by giving Yahoo! $150 million to defray its expenses. Microsoft also agreed to absorb about 400 of Yahoo!'s nearly 14,000 employees. Ironically, Microsoft may get much of what it wanted (namely Yahoo!'s user base) at a fraction of the cost it would have paid to acquire the entire company. Garmin Utilizes Supply Agreement as Alternative to Acquiring Tele Atlas Following an aggressive bidding process, Garmin Ltd., the largest U.S. maker of car-navigation devices, withdrew its bid for the Netherlands-based Tele Atlas NV on November 16, 2007. Tele Atlas provides maps of 12 million miles of roads in 200 countries. The move cleared the way for TomTom NV to buy the mapmaker for $4.25 billion. Both Garmin and TomTom are leading manufacturers of global positioning systems (GPSs), which enable users to navigate more easily through unfamiliar territory. The most critical component of such navigation systems is the map. In lieu of acquiring Tele Atlas, Garmin entered into a six-year deal with an option to extend for an additional four years to obtain maps from Tele Atlas's competitor Navteq Corp. In doing so, Garmin avoided the EPS-dilutive effects of owning money-losing Tele Atlas. Garmin can focus on building traffic information and business listings into its products without having to own the underlying maps. An acquisition would have diluted Garmin's profit until 2010. Building maps comparable to those owned by Tele Atlas could take up to 10 years and cost $1 billion. By owning the maps, TomTom is seeking to become more of a service provider than simply a manufacturer of GPS devices. Such devices are widely used in the automotive industry, as well as aviation and boating. The biggest growth opportunity is the increased use of GPS tracking capabilities in the market for mobile phones. This application is expected to dwarf the transportation and sports markets for GPS devices. Because it will own the underlying maps, TomTom may be able to more easily combine the data with navigation devices and add traffic, gas station, and restaurant information. In contrast, Garmin will have to obtain proprietary data from others. Garmin may also have to pay more for maps or even lose access after the contract (including the option to extend) expires. -Describe the advantages of the supply agreement to Garmin compared to outright acquisition of Tele Atlas?

General Electric and Comcast Join Forces Joint ventures are sometimes created if a business cannot be sold outright. Such JVs are viewed as a way of improving a firm’s operations enabling the parent to exit the business eventually at a higher value. In an effort to shore up its big finance business, severely weakened during the 2008 financial crisis, and to focus more on its manufacturing and infrastructure operations, General Electric (GE) sought to sell its media and entertainment business, NBCUniversal. GE’s decision to sell also reflected the deteriorating state of the broadcast television industry and a desire to exit a business that never quite fit with its industrial side. NBC has been mired in fourth place among the major broadcast networks, and the economics of the broadcast television industry have deteriorated in recent years amid declining overall ratings and a reduction in advertising. In contrast, cable channels have continued to thrive because they rely on a steady stream of subscriber fees from cable companies such as Comcast. Moreover, while NBCUniversal was profitable in 2009, it was expected to go into the red in subsequent years. Unable to find a buyer for the entire business at what GE believed was a reasonable price, GE sought other options, including combining the operation with another media business. After extended discussions, GE and Comcast announced a deal on December 2, 2009, to form a joint venture consisting of NBCUniversal and selected Comcast assets. Comcast is primarily a cable company and provider of programming content, with 24.3 million cable customers, 16.1 million high-speed Internet customers, and 7.8 million voice customers. Comcast hopes to diversify its holdings as it faces encroaching threats from online video and more aggressive competition from satellite and phone companies that offer subscription TV services, by adding more content on its video-on-demand offerings. Furthermore, by having an interest in NBCUniversal’s digital properties, such as Hulu.com, Comcast expects to capitalize on any shift of its cable customers to viewing their favorite TV programs online by owning the program content. Comcast’s strategy is to integrate vertically by owning the content it distributes through its cable operations. Previous attempts to do this, such as AOL’s acquisition of Time Warner in 2001, have ended in failure, largely because the cultures of the two firms did not mesh. Some media companies have merged successfully —for example, Time Warner’s merger with Turner Broadcasting. Having learned from AOL’s rush to achieve synergy, Comcast is allowing the NBCUniversal JV to operate independent of the parents and is sharing the risk with GE. This joint venture transaction is noteworthy for its potential impact on limiting competition in the entertainment industry, its complex financial engineering, and its multifaceted organizational structure and as an exit strategy for GE from the media and entertainment business. Each of these considerations is discussed next. The announcement raised significant concerns within the media and entertainment industry about the potential for limiting access to both content and distribution by increasing industry concentration. After receiving significant concessions, regulators approved the creation of the joint venture media giant on January 17, 2011. The U.S. Federal Communications Commission and the Department of Justice required Comcast and NBCUniversal to relinquish voting rights and board representation to Hulu, although they could continue to remain part owners. Furthermore, Comcast has to ensure what the FCC called “reasonable access” to its programming for its competitors, and the firm may not discriminate against programming that competes with its own offerings. The deal reflected complicated financial engineering, involving both parties contributing assets to create a joint venture, agreeing on the total value of the endeavor, determining the value of each party’s contributed assets to determine ownership distribution, and finally determining how GE would be compensated. The joint venture transaction based on the value of the assets contributed by both parties was valued at $37.25 billion, consisting of GE’s contribution of NBCUniversal, valued at $30 billion, and Comcast’s contribution of cable network assets valued at $7.25 billion. The ownership interests were determined based on the value of the contributed assets and cash payments made to GE as described in Figure 15.1. In exchange for contributing NBCUniversal operations valued at $30 billion to the JV, GE received $15.6 billion in cash ($6.5 billion from Comcast + $9.1 billion borrowed by the NBCUniversal JV) + a 49% ownership interest in the NBCUniversal JV). In exchange for contributing $7.5 billion in cable network assets to the JV and paying GE $6.5 billion in cash, Comcast received a 51% interest in the NBCUniversal JV. NBCUniversal Joint Venture at Closing. Organizationally, the two parties own NBCUniversal indirectly through their ownership in a holding company (see Figure 15.2). As part of the deal, NBCUniversal Inc. was converted to a limited liability company (NBCUniversal Media LLC), which is a wholly owned subsidiary of NBCUniversal Holdings Inc., a corporation in which Comcast owns 51% of the outstanding shares and GE the remainder. NBCUniversal Holdings is the sole member (owner) in NBCUniversal Media LLC. By having the right to designate the majority of the board members of NBCUniversal Holdings, Comcast effectively controls the holding company and, in turn, NBCUniversal Media LLC. To maintain its status as a pass-through organization for tax purposes, NBCUniversal Media makes quarterly distributions to the holding company, which has no independent source of income, to meet its cash requirements. Among other things, these obligations include making cash distributions to Comcast and GE so that they can pay taxes due on the income generated by NBCUniversal Media. As long as GE retains at least a 20% ownership interest in the combined firms, it has certain approval rights over acquisitions, mergers, dissolution, bankruptcy, material expansion of the business, dividend payouts, new equity issues or repurchase, additional borrowing in excess of working capital requirements, loan guarantees, and other actions that could affect the value of its investment. NBCUniversal Postclosing Organization Finally, the deal enables General Electric to pursue a staged exit of NBCUniversal over a number of years. In doing so, GE hopes that the potential synergy with Comcast will increase substantially the value of its share of the joint venture. GE has redemption rights (a put option) during the six months beginning January 28, 2014, to redeem one-half of its interest in NBCUniversal Holdings. In the six months beginning on January 28, 2018, GE can redeem its remaining interest. Comcast is committed to funding $2.9 billion for each of the two redemptions, payable in cash and stock up to $5.8 billion to the extent NBCUniversal Media cannot fund the redemptions. The purchase price to be paid with any redemption by GE will be 120% of the “public market trading value” of NBCUniversal Holding, to be determined by an appraisal if the business is not yet publicly traded, less 50% of the “public market trading value” greater than $28.4 billion. After January 28, 2014, GE may transfer its interest to a third party, subject to Comcast’s having the right of first offer (first refusal). Comcast has a call option to buy out GE after the same dates designated for GE’s put option at the same price required under the put option. In 2011, NBCUniversal Media had revenue of $19.3 billion, earnings before interest and taxes of $2.3 billion, and net income of $1.7 billion. While the financial outlook for the business has stabilized, the deal continues to be subject to the criticism that there is little overlap between Comcast and NBCUniversal Media’s businesses to provide significant cost savings. Moreover, big media deals have a poor track record, as illustrated by the AOL Time Warner debacle. Comcast is placing a big bet that it will be able to combine content and distribution successfully and to grow the value of the consolidated businesses. In contrast, General Electric may be more intent on exercising its option to sell its interests unless the fortunes of NBCUniversal Media improve dramatically in the coming years. -Speculate as to why the partners chose to operate NBCUniversal Media through a holding company.

General Electric and Comcast Join Forces Joint ventures are sometimes created if a business cannot be sold outright. Such JVs are viewed as a way of improving a firm’s operations enabling the parent to exit the business eventually at a higher value. In an effort to shore up its big finance business, severely weakened during the 2008 financial crisis, and to focus more on its manufacturing and infrastructure operations, General Electric (GE) sought to sell its media and entertainment business, NBCUniversal. GE’s decision to sell also reflected the deteriorating state of the broadcast television industry and a desire to exit a business that never quite fit with its industrial side. NBC has been mired in fourth place among the major broadcast networks, and the economics of the broadcast television industry have deteriorated in recent years amid declining overall ratings and a reduction in advertising. In contrast, cable channels have continued to thrive because they rely on a steady stream of subscriber fees from cable companies such as Comcast. Moreover, while NBCUniversal was profitable in 2009, it was expected to go into the red in subsequent years. Unable to find a buyer for the entire business at what GE believed was a reasonable price, GE sought other options, including combining the operation with another media business. After extended discussions, GE and Comcast announced a deal on December 2, 2009, to form a joint venture consisting of NBCUniversal and selected Comcast assets. Comcast is primarily a cable company and provider of programming content, with 24.3 million cable customers, 16.1 million high-speed Internet customers, and 7.8 million voice customers. Comcast hopes to diversify its holdings as it faces encroaching threats from online video and more aggressive competition from satellite and phone companies that offer subscription TV services, by adding more content on its video-on-demand offerings. Furthermore, by having an interest in NBCUniversal’s digital properties, such as Hulu.com, Comcast expects to capitalize on any shift of its cable customers to viewing their favorite TV programs online by owning the program content. Comcast’s strategy is to integrate vertically by owning the content it distributes through its cable operations. Previous attempts to do this, such as AOL’s acquisition of Time Warner in 2001, have ended in failure, largely because the cultures of the two firms did not mesh. Some media companies have merged successfully —for example, Time Warner’s merger with Turner Broadcasting. Having learned from AOL’s rush to achieve synergy, Comcast is allowing the NBCUniversal JV to operate independent of the parents and is sharing the risk with GE. This joint venture transaction is noteworthy for its potential impact on limiting competition in the entertainment industry, its complex financial engineering, and its multifaceted organizational structure and as an exit strategy for GE from the media and entertainment business. Each of these considerations is discussed next. The announcement raised significant concerns within the media and entertainment industry about the potential for limiting access to both content and distribution by increasing industry concentration. After receiving significant concessions, regulators approved the creation of the joint venture media giant on January 17, 2011. The U.S. Federal Communications Commission and the Department of Justice required Comcast and NBCUniversal to relinquish voting rights and board representation to Hulu, although they could continue to remain part owners. Furthermore, Comcast has to ensure what the FCC called “reasonable access” to its programming for its competitors, and the firm may not discriminate against programming that competes with its own offerings. The deal reflected complicated financial engineering, involving both parties contributing assets to create a joint venture, agreeing on the total value of the endeavor, determining the value of each party’s contributed assets to determine ownership distribution, and finally determining how GE would be compensated. The joint venture transaction based on the value of the assets contributed by both parties was valued at $37.25 billion, consisting of GE’s contribution of NBCUniversal, valued at $30 billion, and Comcast’s contribution of cable network assets valued at $7.25 billion. The ownership interests were determined based on the value of the contributed assets and cash payments made to GE as described in Figure 15.1. In exchange for contributing NBCUniversal operations valued at $30 billion to the JV, GE received $15.6 billion in cash ($6.5 billion from Comcast + $9.1 billion borrowed by the NBCUniversal JV) + a 49% ownership interest in the NBCUniversal JV). In exchange for contributing $7.5 billion in cable network assets to the JV and paying GE $6.5 billion in cash, Comcast received a 51% interest in the NBCUniversal JV. NBCUniversal Joint Venture at Closing. Organizationally, the two parties own NBCUniversal indirectly through their ownership in a holding company (see Figure 15.2). As part of the deal, NBCUniversal Inc. was converted to a limited liability company (NBCUniversal Media LLC), which is a wholly owned subsidiary of NBCUniversal Holdings Inc., a corporation in which Comcast owns 51% of the outstanding shares and GE the remainder. NBCUniversal Holdings is the sole member (owner) in NBCUniversal Media LLC. By having the right to designate the majority of the board members of NBCUniversal Holdings, Comcast effectively controls the holding company and, in turn, NBCUniversal Media LLC. To maintain its status as a pass-through organization for tax purposes, NBCUniversal Media makes quarterly distributions to the holding company, which has no independent source of income, to meet its cash requirements. Among other things, these obligations include making cash distributions to Comcast and GE so that they can pay taxes due on the income generated by NBCUniversal Media. As long as GE retains at least a 20% ownership interest in the combined firms, it has certain approval rights over acquisitions, mergers, dissolution, bankruptcy, material expansion of the business, dividend payouts, new equity issues or repurchase, additional borrowing in excess of working capital requirements, loan guarantees, and other actions that could affect the value of its investment. NBCUniversal Postclosing Organization Finally, the deal enables General Electric to pursue a staged exit of NBCUniversal over a number of years. In doing so, GE hopes that the potential synergy with Comcast will increase substantially the value of its share of the joint venture. GE has redemption rights (a put option) during the six months beginning January 28, 2014, to redeem one-half of its interest in NBCUniversal Holdings. In the six months beginning on January 28, 2018, GE can redeem its remaining interest. Comcast is committed to funding $2.9 billion for each of the two redemptions, payable in cash and stock up to $5.8 billion to the extent NBCUniversal Media cannot fund the redemptions. The purchase price to be paid with any redemption by GE will be 120% of the “public market trading value” of NBCUniversal Holding, to be determined by an appraisal if the business is not yet publicly traded, less 50% of the “public market trading value” greater than $28.4 billion. After January 28, 2014, GE may transfer its interest to a third party, subject to Comcast’s having the right of first offer (first refusal). Comcast has a call option to buy out GE after the same dates designated for GE’s put option at the same price required under the put option. In 2011, NBCUniversal Media had revenue of $19.3 billion, earnings before interest and taxes of $2.3 billion, and net income of $1.7 billion. While the financial outlook for the business has stabilized, the deal continues to be subject to the criticism that there is little overlap between Comcast and NBCUniversal Media’s businesses to provide significant cost savings. Moreover, big media deals have a poor track record, as illustrated by the AOL Time Warner debacle. Comcast is placing a big bet that it will be able to combine content and distribution successfully and to grow the value of the consolidated businesses. In contrast, General Electric may be more intent on exercising its option to sell its interests unless the fortunes of NBCUniversal Media improve dramatically in the coming years. -Speculate as to the potential circumstances in which either Comcast or GE would be likely to exercise their call or put options? Which party do you believe is likely to exercise their options first and why?