Mergers and Acquisitions - An Overview


By

Manoj Somayaji
Kousar Hamza
Pramod Kadamba
Sunil V Thandi
Management Students
AMC Engineering College
 


Mergers And Acquisitions An Overview

Much of what is called investment is actually nothing more than mergers and acquisitions, and of course mergers and acquisitions are generally accompanied by downsizing.
                                                                                                                     Susan George

Meaning:

A merger or acquisition is a combination of two companies where one corporation is completely absorbed by another corporation. The less important company loses its identity and becomes part of the more important corporation, which retains its identity. A merger extinguishes the merged corporation, and the surviving corporation assumes all the rights, privileges, and liabilities of the merged corporation. A merger is not the same as a consolidation, in which two corporations lose their separate identities and unite to form a completely new corporation.

Definition:

The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.

History of Mergers and Acquisitions:

Tracing back to history, merger and acquisitions have evolved in five stages and each of these are discussed here. As seen from past experience mergers and acquisitions are triggered by economic factors. The macroeconomic environment, which includes the growth in GDP, interest rates and monetary policies play a key role in designing the process of mergers or acquisitions between companies or organizations.

First Wave Mergers:

The first wave mergers commenced from 1897 to 1904. During this phase merger occurred between companies, which enjoyed monopoly over their lines of production like railroads, electricity etc. the first wave mergers that occurred during the aforesaid time period were mostly horizontal mergers that took place between heavy manufacturing industries.

Second Wave Mergers:

The second wave mergers that took place from 1916 to 1929 focused on the mergers between oligopolies, rather than monopolies as in the previous phase. The economic boom that followed the post world war I gave rise to these mergers. Technological developments like the development of railroads and transportation by motor vehicles provided the necessary infrastructure for such mergers or acquisitions to take place. The government policy encouraged firms to work in unison. This policy was implemented in the 1920s.

Third Wave Mergers:

The mergers that took place during this period (1965-69) were mainly conglomerate mergers. Mergers were inspired by high stock prices, interest rates and strict enforcement of antitrust laws. The bidder firms in the 3rd wave merger were smaller than the Target Firm. Mergers were financed from equities; the investment banks no longer played an important role.

Fourth Wave Merger:

The 4th wave merger that started from 1981 and ended by 1989 was characterized by acquisition targets that wren much larger in size as compared to the 3rd wave mergers. Mergers took place between the oil and gas industries, pharmaceutical industries, banking and airline industries. Foreign takeovers became common with most of them being hostile takeovers. The 4th Wave mergers ended with anti takeover laws, Financial Institutions Reform and the Gulf War.

Fifth Wave Merger:

The 5th Wave Merger (1992-2000) was inspired by globalization, stock market boom and deregulation. The 5th Wave Merger took place mainly in the banking and telecommunications industries. They were mostly equity financed rather than debt financed. The mergers were driven long term rather than short term profit motives. The 5th Wave Merger ended with the burst in the stock market bubble.

Hence we may conclude that the evolution of mergers and acquisitions has been long drawn. Many economic factors have contributed its development. There are several other factors that have impeded their growth. As long as economic units of production exist mergers and acquisitions would continue for an ever-expanding economy.

Distinction between mergers and acquisitions:

Although often used synonymously, the terms merger and acquisition mean slightly different things.

When one company takes over another and clearly establishes itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals". The firms are often of about the same size. Both companies' stocks are surrendered and new company stock is issued in its place. For example, in the 1999 merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist when they merged, and a new company, GlaxoSmithKline, was created.

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal euphemistically as a merger, deal makers and top managers try to make the takeover more palatable. An example of this would be the takeover of Chrysler by Daimler-Benz in 1999 which was widely referred to in the time.

Types of Mergers:

Horizontal Mergers:

Horizontal mergers raise three basic competitive problems. The first is the elimination of competition between the merging firms, which, depending on their size, could be significant. The second is that the unification of the merging firms' operations might create substantial market power and might enable the merged entity to raise prices by reducing output unilaterally. The third problem is that, by increasing concentration in the relevant market, the transaction might strengthen the ability of the market's remaining participants to coordinate their pricing and output decisions.

Vertical Mergers:

 Vertical mergers take two basic forms: forward Integration, by which a firm buys a customer, and backward integration, by which a firm acquires a supplier. Replacing market exchanges with internal transfers can offer at least two major benefits. First, the vertical merger internalizes all transactions between a manufacturer and its supplier or dealer, thus converting a potentially adversarial relationship into something more like a partnership. Second, internalization can give management more effective ways to monitor and improve performance.

Conglomerate Mergers:

Conglomerate transactions take many forms, ranging from short-term joint ventures to complete mergers. Whether a conglomerate merger is pure, geographical, or a product-line extension, it involves firms that operate in separate markets. Therefore, a conglomerate transaction ordinarily has no direct effect on competition. There is no reduction or other change in the number of firms in either the acquiring or acquired firm's market.

Motives behind M&A:

The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:

  • Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope: This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.
  • Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
  • Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts.
  • Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company.
  • Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.
  • Vertical integration: Vertical integration occurs when upstream and downstream firms merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalize an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses.
  • Diversification: While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger. (In his book One Up on Wall Street, Peter Lynch memorably termed this "diworseification".)
  • Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.
  • Empire-building: Managers have larger companies to manage and hence more power.

Failure of M&A:

A book by Prof. Dr. Thomas Straub (2007) "Reasons for frequent failure in Mergers and Acquisitions" develops a comprehensive research framework that bridges rival perspectives and promotes a modern understanding of factors underlying M&A performance. The first important step towards this objective is the development of a common frame of reference that spans conflicting theoretical assumptions from different perspectives. On this basis, a comprehensive framework is proposed with which to understand the origins of M&A performance better and address the problem of fragmentation by integrating the most important competing perspectives in respect of studies on M&A Furthermore according to the existing literature relevant determinants of firm performance are derived from each dimension of the model. For the dimension strategic management, the six strategic variables: market similarity, market complementarities, production operation similarity, production operation complementarities, market power, and purchasing power were identified having an important impact on M&A performance. For the dimension organizational behavior, the variables acquisition experience, relative size, and cultural differences were found to be important. Finally, relevant determinants of M&A performance from the financial field were acquisition premium, bidding process, and due diligence. Three different ways in order to best measure post M&A performance are recognized: Synergy realization, absolute performance and finally relative performance.

Case Study on Mergers and Acquisitions:

Case I: Milk Company

In a given country milk is produce by small and large producers in thousands of installations. These producers are organized in cooperatives of production. Some of these cooperatives got together and started a company, Unimilk that buys and transports milk from the farms into some regional processing units to be stabilized. Unimilk has a national market share of 80% of fresh milk and covers almost all regions except for the South East where 3 other companies with a national share of 15% buy fresh milk and Unimilk has only a regional share of 10% in that region. The company, Unimilk, also owns some production units that use that milk to produce milk UHT, Pasteurized and yogurts, butter and cheese. Unimilk has a market share in these products of 40, 30, 15 and 5%. Unimilk has submitted a merger notification to the Competition Authority asking to buy one of those regional companies, SouthEast1.

Case II: Petroleum terminal in a port

In a given country there is no production of oil. There is only one refining company, Fina and there are other 3 wholesale companies with some retail networks for petroleum products. The main port of entry for these petroleum products, either crude oil or derivatives is the port of Smirna, with 70% of imports of these products. About 85% of the oil used in the country is imported as crude oil and refined by Fina and then distributed by Fina (40% market share at wholesale level) and sold to other companies (each one has an equal remaining share of the wholesale market). Petroleum prices are not regulated. There is only one terminal for taking these products from the tankers that arrive in the country and store them. This terminal has been the property of the Port Company of Smirna, a public company that has contracts with each of the big oil companies for the use of the terminal. The terminal is subject to regulation by the Port Authority of Smirna. The Port Company of Smirna decided to sell the terminal to Fina. The Competition Authority receives a notification proposing the acquisition of the terminal by Fina.

Latest Mergers and Acquisitions:

  • Sun Pharma takes control of Taro
  • Malaysian firm to buy 49% stake in NDTV Lifestyle
  • Elder Pharma to buy UK's NeutraHealth for $19.1 mn
  • Aqua Logistics to buy Star Distribution
  • KEC Intl buys US-based SAE Towers for $95 mn
  • Google acquires social games website Social Deck.
  • Reliance turns white knight, buys EIH stake
  • PwC buys Diamond Management for $378 mn
  • Google buys visual search engine Like.com
  • Nokia Siemens buys Motorola network biz for $1.2 bn.

Conclusion:

One size doesn't fit all. Many companies find that the best way to get ahead is to expand ownership boundaries through mergers and acquisitions. For others, separating the public ownership of a subsidiary or business segment offers more advantages. At least in theory, mergers create synergies and economies of scale, expanding operations and cutting costs. Investors can take comfort in the idea that a merger will deliver enhanced market power.

By contrast, de-merged companies often enjoy improved operating performance thanks to redesigned management incentives. Additional capital can fund growth organically or through acquisition. Meanwhile, investors benefit from the improved information flow from de-merged companies.

M&A comes in all shapes and sizes, and investors need to consider the complex issues involved in M&A. The most beneficial form of equity structure involves a complete analysis of the costs and benefits associated with the deals.

Reference links:

  • www.economywatch.com Mergers and Acquisitions
  • finance.mapsofworld.com/merger-acquisition/history.html - United States
  • en.wikipedia.org/wiki/Mergers_and_acquisitions
  • www.investopedia.com Tutorials
  • legal-dictionary.thefreedictionary.com/Mergers+and+Acquisitions
  • www.acpc-rs.org/pdf/Case-study-on-mergers.pdf
  • www.livemint.com/SectionPages/Mergers-Acquisitions.aspx?...3...
     


Manoj Somayaji
Kousar Hamza
Pramod Kadamba
Sunil V Thandi
Management Students
AMC Engineering College
 

Source: E-mail October 22, 2010

 

           

 

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