Joint Ventures, Partnerships, Strategic Alliances, and Licensing

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• Joint Ventures, Partnerships, Strategic
  Alliances, and Licensing

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Humility is not thinking less of yourself. It is
thinking less about yourself. Rick Warren
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Learning Objectives

• Primary learning objective To provide students
  with a knowledge of how to plan, structure, and
  manage business alliances.
• Secondary learning objectives To provide
  students with knowledge of
• How business alliances represent alternative
  business implementation strategies to MAs
• Motivations for business alliances
• Factors critical to the success of business
  alliances
• Common valuation methodologies
• Alternative legal forms of business alliances
• Key business alliance deal structuring issues and
  challenges and
• Financial performance of business alliances

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Business Alliances as Alternatives to MAs

• Business alliances (as are MAs) are vehicles for
  implementing business strategies. They are not
  themselves business strategies.
• Business alliances may be informal agreements or
  highly complex legal structures
• Alternative forms of business alliances
  (including legal and informal relationships)
• Joint ventures
• Strategic alliances
• Equity partnerships
• Licensing
• Franchising
• Network alliances

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Motivations for Forming Alliances

• Risk sharing
• Sharing proprietary knowledge (e.g., TiVo,
  Sematech, and Wintel)
• Management skills and resources (e.g., Dow
  Chemical/Cordis)
• Gaining access to new markets
• Using another firms distribution channels (e.g.,
  AARP and Hartford Insurance)
• Globalization
• Gaining access to foreign markets where laws
  prohibit 100 foreign ownership or where cultural
  differences are substantial (e.g., China)
• Cost reduction
• Purchaser/supplier relationships (e.g., GM, Ford,
  and Daimler Chrysler online purchasing
  consortium)
• Joint Manufacturing (e.g., major city newspapers)
• Prelude to acquisition or exit (e.g., TRW/Redi,
  Bridgestone/Firestone)
• Favorable regulatory treatment (e.g.,
  collaborative research shared with others)

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Business Alliance Critical Success Factors

• Measureable Synergy (e.g., economies of
  scale/scope access to new products, distribution
  channels, and proprietary know-how)
• Risk reduction (e.g., Verizon and Vodafone share
  network costs to form Verizon Wireless)
• Cooperation (e.g, MCIWorldcom and Telefonica de
  Espana)
• Greatest when partners share similar cultures
• Clarity of purpose, roles, and responsibilities
• Win-win situation (e.g., TRW REDI, Merck and JJ)
• Compatible time frames for partners
• Support from the top
• Similar financial expectations

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Discussion Questions

• 1. Discuss the advantages and disadvantages of a
  partnering arrangement compared to a merger or
  acquisition? Be specific.
• 2. Under what circumstances might it make sense
  to enter into a business alliance with a
  potential merger target before actually proposing
  a merger?
• 3. What do you believe are some of the major
  reasons business alliances often fail to satisfy
  expectations?
• 4. Do you believe that the likelihood of a firm
  achieving its business plan objectives is greater
  through a business alliance than through a
  merger, acquisition, or a solo venture? Explain
  your answer.

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Common Methodology for Valuing Business
Alliances The GE and Vivendi Case

• Step 1 Parties to joint venture agree on a
  measure
• of value (e.g., EBITDA)1
• Step 2 Determine contribution of each party to
  the
• measure of value
• Step 3 Estimate total value of JV by applying
  the
• prevailing industry multiple to the
  measure
• of value
• Step 4 Determine ownership distribution based on
• each partners contribution to the
  JVs total
• asset value
• 1EBITDA is a widely used measure of value,
  because it allows for comparison of businesses
  which may have exhibit different amounts of
  leverage and employ different depreciation
  methodologies.

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Creating NBC Universal in 2003
Vivendi
14 Billion (1/3 of 42 Billion)
General Electric
28 Billion (2/3 of 42 Billion)
Step 1 EBITDA used as the measure of valuing
assets contributed by GE and Vivendi Universal
Entertainment (VUE) to the joint venture which
together generated 3 billion EBITDA Step 2 GE
contributed 2 billion of EBITDA and VUE 1
billion Step 3 Value of combined GE and VUE
assets 42 billion 3 billion x 14
(Comparable entertainment company multiple) Step
4 GE owns 2/3 and VUE 1/3 of NBC Universal based
on the dollar value of their contributed assets
as a percent of total JV assets
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Comcast and General Electric Joint Venture

• Comcast and General Electric (GE)1 announced on
  12/2/09 that they had agreed to form a JV that
  will be 51 owned by Comcast, with the remainder
  owned by GE. Deal closed 1/6/2010.
• GE was to contribute NBC Universal (NBCU) valued
  at 30 billion and Comcast was to contribute TV
  networks valued at 7.25 billion.
• Comcast also was to pay GE 6.5 billion in cash.
  In addition, NBCU was to borrow 9.1 billion and
  distribute the cash to GE.
• GE has an option to sell one-half of its interest
  to Comcast at the end of 3 years and the
  remainder at the end of 7 years.
• 1Reportedly, Comcast was the only bidder for NBCU.

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Purchase Price Determination and Resulting
Control Premium and Minority Discount
NBC Universal Joint Venture (NBCU) Valuation1 37.25 billion
Comcast Purchase Price for 51 of NBC Universal JV Cash from Comcast paid to GE Cash proceeds paid to GE from NBCU borrowings2 Contributed assets (Comcast network) Total 6.50 9.10 7.25 22.85 billion
GE Purchase Price for 49 of NBC Universal JV Contributed assets (NBC Universal) Cash from Comcast Paid to GE Cash proceeds paid to GE from NBCU borrowings Total 30.00 (6.50) (9.10) 14.40 billion
Implied Control / Purchase Price Premium ()3 Implied Minority/Liquidity Discount ()4 20.3 (21.1)
1Equals the sum of NBCU (30 billion) plus the
fair market value of contributed Comcast
properties (7.25 billion) and assumes no
incremental value due to synergy. These values
were agreed to during negotiation. 2The 9.1
billion borrowed by NBCU and paid to GE will be
carried on the consolidated books of Comcast,
since it has the controlling interest in the JV.
In theory, it reduces Comcasts borrowing
capacity by that amount and should be viewed as a
portion of the purchase price. In practice, it
may reduce borrowing capacity by less if lenders
view the JV cash flow as sufficient to satisfy
debt service requirements. 3The control premium
represents the excess of the purchase price paid
over the book value of the net acquired assets
and is calculated as follows 22.85 / (.51 x
37.25 -1. 4The minority/liquidity discount
represents the excess of the fair market value of
the net acquired assets over the purchase price
and is calculated as follows 14.40/(.49 x
37.25) -1.
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Discussion Questions

1. Suppose two firms, each of which was generating
   operating losses, wanted to create a joint
   venture. The potential partners believed that
   significant operating synergies could be created
   by combining the two businesses resulting in a
   marked improvement in operating performance. How
   should the ownership distribution of the JV be
   determined?
2. Discuss the advantages and disadvantages of your
   answer to question one.
3. Should the majority owner always be the one
   managing the daily operations of the business?
   Why? Why not?

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Legal Form Follows Business Strategy

• Business strategy provides direction
• If management determines a business alliance is
  best way to implement strategy, an appropriate
  legal form must be selected.
• Legal form affects
• taxes,
• limitations on liability,
• control,
• duration,
• ease of transferring ownership, and
• ease of raising capital

Why do partners often spend more time on
developing a legal structure than a business
strategy?
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Alternative Legal Forms of Business Alliances
Corporate Structures

• Generalized C Corporation
• Advantages Continuity of ownership, limited
  liability, provides operational autonomy,
  facilitates funding facilitates tax-free merger
• Disadvantages Subject to double-taxation,
  inability to allocate losses to shareholders
  relatively high setup costs
• Sub-Chapter S Corporation
• Advantages Avoids double taxation limited
  liability
• Disadvantages Maximum of 100 shareholders,
  excludes corporate shareholders, must distribute
  100 of earnings can issue only one class of
  stock, lacks continuity difficult to raise large
  sums of money

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Alternative Legal Forms of Business Alliances
Partnerships

• General Partnerships
• Advantages Profits/losses and responsibilities
  allocated to partners avoids double taxation as
  long as one partner (usually the general partner)
  has unlimited liability
• Disadvantages Partners have unlimited liability,
  partners jointly/severally liable, each partner
  has authority to bind partnership to contracts,
  lacks continuity partnership interests illiquid
• Private limited partnerships
• Advantages Profits/losses allocated to partners,
  liability limited if one partner has unlimited
  liability avoids double taxation
• Disadvantages Lacks continuity, interests
  illiquid lacks financing flexibility as limited
  to 35 partners (Note Public LPs can have an
  unlimited number of partners)

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Alternative Legal Forms of Business Alliances
Limited Liability Companies

• Limited Liability Companies
• Advantages Offers limited liability, owners can
  be managers without losing limited liability
  protection, avoids double taxation, allows
  unlimited number of members (owners), allows
  corporate shareholders, can own more the 80 of
  another firm and offers flexibility in
  allocating investment, profits, losses
• Disadvantages Structure lacks continuity,
  ownership shares illiquid as transfer subject to
  approval of all members members must be active
  participants in the firm

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Alternative Legal Forms of Business Alliances
Other

• Franchise alliances
• Advantages Allows repeated application of a
  successful business model, minimizes start-up
  expenses facilitates communication of common
  brand and marketing strategy.
• Disadvantages Royalty payments (3-7 of revenue)
• Equity partnerships
• Advantages Facilitates close working
  relationship limits financial risk, potential
  prelude to merger may not require financial
  statement consolidation
• Disadvantages Limited tactical and strategic
  control
• Written contracts
• Advantages Less complex no separate legal
  entity established potential prelude to merger
• Disadvantages Limited control, may lack close
  coordination potential for limited commitment

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Alliance Deal Structuring Issues

• Defining scope in terms of included/excluded
  products, geographic coverage, and duration
  (Amgen and JJ litigation over who has rights to
  future products)
• Determining control and management (how are
  decisions made?steering or joint management
  committee, majority/minority, equal division of
  power, or majority rules framework.
• How are resources to be contributed (form and
  value)? How is ownership determined?
• Tangible contributions (cash or cash commitments
  and assets required by the business)
• Intangible contributions (services, patents,
  brand names, and technology)

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Alliance Deal Structuring Issues Continued

• Governance (protecting stakeholder
  interests)--board or partnership committee
• Profit/loss and tax benefits allocation and
  dividend determination
• Dispute resolution and termination (Who owns
  assets following dissolution?)
• Financing ongoing capital requirements (What
  happens if additional capital is needed? Can the
  alliance borrow? Target debt/equity ratio?)
• Performance criteria (How is performance to plan
  measured and monitored?)

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Empirical Studies of Business Alliances

• Abnormal returns to business alliance partners
  average about 2 during the 60 days preceding the
  alliances announcement.
• Partner share prices often increase prior to
  announcement for alliances involving firms within
  the same industry as well as in different
  industries
• However, the increase is greatest for firms to
  the same industry involving technical knowledge
  transfer.
• Alliances often account for 6-15 of the market
  value of large firms.
• While the number of alliances is growing rapidly,
  about two-thirds fail to meet participant
  expectations.
• Financial returns on investment tend to be higher
  for those firms with significant experience in
  forming alliances.

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Discussion Questions

• Why should the development of a business strategy
  precede concern about the form of legal
  arrangement (e.g., corporation, limited liability
  company, partnership, etc.)?
• Discuss the circumstances under which it might
  make more sense to use a C-Corporation rather
  than a partnership as a acquisition vehicle or
  post-closing organization? Be specific.
• Why is defining the scope of a business alliance
  critical before legal agreements are signed? Be
  specific.

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Application Overcoming Political Risk in
Cross-Border Deals

• Cross-border transactions often are
  subject to considerable political risk. In
  emerging countries, this risk reflects the
  potential for expropriation of property or civil
  strife. However, as Chinese efforts to secure
  energy supplies in recent years have shown,
  foreign firms have to be highly sensitive to
  political and cultural issues in any host
  country, developed or otherwise.
• In addition to a desire to satisfy
  future energy needs, the Chinese government has
  been under pressure to tap its domestic shale gas
  deposits due to the clean burning nature of such
  fuels to reduce its dependence on coal. However,
  China does not currently have the technology for
  recovering gas and oil from shale.
• To gain access to the needed technology
  and to U.S. shale gas and oil reserves, China
  National Offshore Oil Corporation (CNOOC) Ltd. in
  October 2010 agreed to invest up to 2.16 billion
  in selected reserves of U.S. oil and gas producer
  Chesapeake Energy Corp (Chesapeake), a leader in
  shale extraction technologies and an owner of
  substantial oil and gas shale reserves in the
  southwestern U.S.

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Application Questions

• The deal grants CNOOC the option of
  buying up to a third of any other fields
  Chesapeake acquires in the general proximity of
  the fields the firm currently owns. The terms of
  the deal call for CNOOC to pay Chesapeake 1.08
  billion for a one-third stake in a South Texas
  oil and gas field. CNOOC could spend an
  additional 1.08 billion to cover 75 percent of
  the costs of developing the 600,000 acres
  included in this field. Chesapeake will be the
  operator of the JV project in Texas, handling all
  leasing and drilling operations, as well as
  selling the oil and gas production.
• Discussion Questions
• 1. Describe some of the ways in which
  CNOOC could protect its rights as a minority
  investor in the joint venture project with
  Chesapeake? Be specific.
• 2. What strategic flexibility do the terms of
  this deal offer CNOOC?

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Things to Remember

• Alliances often represent attractive alternatives
  to MAs.
• Motivations for forming alliances include risk
  sharing, gaining access to new markets,
  accelerating new product introduction, technology
  sharing, cost reduction, globalization, a desire
  to acquire or exit a business, or their perceived
  acceptability to regulators.
• Alliances may assume a variety of different
  structures from highly formal to highly informal,
  handshake agreements.
• As is true for MAs, a business plan should
  always precede concerns about how the transaction
  should be structured.
• Business alliance deal structuring focuses on the
  fair allocation of risks, rewards, resource
  requirements, and responsibilities of
  participants.
• While business alliances are expected to remain
  highly popular, their success rate in terms of
  meeting participants expectations is about the
  same as MAs.