Merger of Public Limited Companies in the UK - Case Study Example

TOPIC: MERGER OF PUBLIC LIMITED COMPANIES IN UK (Your Name) (Name of institution) Introduction Mergers have continued to increase in the UK for the last 5 years. The region has been hit by a wave of mega deals characterised by high numbers of mergers and acquisitions. However, the main deals are primarily horizontal in nature though diversifying mergers have also been undertaken in the UK’s financial industry where banks and insurance companies have been merged. Most of these mergers have been attributed to globalisation. Within the five years period domestic deals have dominated the M&A market with cross-boarder mergers recording a significant increase. Currently, dozens of companies are operating in the various nationwide and regional energy markets in United Kingdom - everything from local, regional firms to big multinational companies with operations straddling the whole value chain: generation, sales, distribution and trading. Several merged companies also have considerable sales of gas and are dynamically determined to integrate their gas and electricity operations. 1 Conversely, organizations that earlier pursued a multi-utility strategy, such as water/ electricity/ waste collection, are starting to dump this approach following the absence of projected synergies. These merger have seen companies achieve geographical diversification, increase market share, reduce tax, attain resource transfer, cut down the two companies’ expenditure, enjoy economies of scale as well as achieve general economic development, for example, Iberdrola / EDP merger. They have also been used in achieving change in situations where the incumbents have failed. The merger has led to proper use of complementary resources within the two merging companies with the witness of merger gains, this gains include; changing capital requirements, reduced taxes, revenue enhancement, reduced direct and indirect costs. This paper seeks to evaluate and analyse the merger between Iberdrola / EDP in this UK oil industry. It will outline the various reasons that led to this merger, explain the changes that have occurred after the merger as well as examine the potential benefits and losses arising from this mergers. Reasons behind the merger As observed by Alan (2000), the dominating motive behind mergers and acquisition as far as economic and finance literature is concerned has been improving the economic performance of merging companies. As suggested by this economic motive, the two companies have merged following their economic gains prospects i.e. the total value of the two separate companies (CA, CB) is believed to be lower when compared to the sum value of the merged company (CAB). (CA, + CB) < CAB The merger was undertaken in anticipation of reducing variable as well as fixed costs.2 Both companies merged in order to realize some form of savings in terms of costs. This has seen the realization of improved financial performance through the removal of intersecting costs, for instance, administration costs and IT expenditure. However, the prospective of cost reduction is not restricted on the horizontal mergers following its fixed costs nature, it also includes other forms of mergers. Vertical integration has offered unique avenues for cost reduction, for instance, cost reduction has been achieved by shunning the communication and bargaining costs. Where production processes calls for incorporated production sequence, vertical integration have ensured that lower production costs are attained in the merging firms. The bigger size (after the merger) was expected to yield large economies of scale, a thing that will greatly contribute to reduction of costs in the company. Through merging, it is highly expected that the two companies will attain a financial synergy. Most firms have huge investment opportunities but are short of finances whereas some companies have a surplus in their cash flow, merging these two business organisations will no doubt avail some benefits. They will merge following tax advantages accredited to the merger i.e. two merged firms will pay less tax compared to when they are separate. (Alan, 2003) this is the exact scenario in the Iberdrola / EDP merger. This merger was undertaken with an aim of acquiring increased market power whereby, after merging the firm was expected to enjoy monopoly-like positions. This was expected to form a barrier of market entry to most of its potential competitors. The firm will also be in a better position of fixing its prices slightly below the entry level but above the marginal cost. This in return will help gain the control of those resources from the target firm hence putting the merged the firm in a better position as far as production capacity is concerned. The merged company will henceforth administer the supply of vital input while hampering the external uncertainty. The mergers occurred following the need to achieve geographical diversification, reduce tax, cut down the two companies’ expenditure, increase market share, attain resource transfer, enjoy economies of scale as well as achieve general economic development. To achieve change where the incumbent management has failed hostile acquisition has been adapted. There was need to achieve increased revenues sourced from strategic benefits, marketing gains and market power and employing merger was a sure way of achieving this. It’s no doubt that most administrators will constantly struggle to acquire the right in managing the firm’s resources. Therefore, administrators who perform poorly while carrying out their duties are always at a threat of becoming takeover victims thus replacing them with value maximizing managers. The motive of this merger was to replace the non performing managers with a more competent team leading to increased productivity that translates to huge economic gains. Conversely, periods with enormous economic fluctuations may yield considerable distinctions in the present value prospects involving shareholders interested to purchase the company and the serving shareholders. (www.oft.gov.uk) Managerial motives resulted to the merger between the two companies. Corporate managers are agents who act on behalf of the principal owners. When firm management and ownership are separated agency problems are bound to arise. This is due to the fact that, managers and owners will possess varied interests while no perfect contracts between managers and owners can be written. Agency view assumes that managers will maximize their own wealth instead of the shareholders wealth. These management incentives can make the firm to grow into a more favourable size. (www.oft.gov.uk) Changes that has occurred in the merged firms Increased revenues emanating from strategic benefits, marketing gains and market power has been achieved. Marketing gains has been realized following a better mix of products from the two firms, economies of distribution and highly effective advertising. This has led to reduced competition thereby rising the market power. Strong cash flows emanating from a focus on energy, coupled with increased energy prices, have put this merged firm in a very encouraging financial position. In addition, this has created favourable financing opportunities making the companies to make greater strides economically. After the merger these companies have attained more market power since they are now enjoying monopoly-like positions. This has formed a market entry barrier to the potential competitors. Due to the large economies of scale this merged company has been fixing its prices above the marginal cost but below the entry level. This has assisted in gaining the control of those resources from the target company thus placing the firm in a better position of raising its production capacity. The merged company has been able to administer the supply of essential input while restricting the external uncertainty. Along with distribution channels, intermediate products and raw materials, resource-seeking motive has been covering know-how acquisition, for instance, geographical, managerial and technological knowledge. As an alternative to developing technology through R&D, these companies have employed merger to be their source of new technology. This has been a very attractive method in achieving specific know how in the United Kingdom. (www.oft.gov.uk) The bigger size has led to large economies of scale, which has greatly contributed cost reductions amongst these firms. Through merging, the two companies have attained a financial synergy. The firm has also replaced the non-performing managers bringing in efficient team. Prior to the merger there were no economies of scale as well as increased revenue to benefit the UK oil industry, The merger has resulted to the better use of complementary resources in the two merging companies with the merger gains being witnessed, this gains include; changing capital requirements, reduced taxes, revenue enhancement, reduced direct and indirect costs. (www.oft.gov.uk) The potential benefits and losses from this merger Electricity and commodity prices usually contain a huge impact on earnings, but they can have a broadly changeable effect depending on the organization’s specific situations. These have been the largest effect on this merged firm since it has its own generation capacity. In times of inflation i.e. the general price rise, this company has been selling its surplus electricity at very good margins. However the company lacks enough capacity for the period of power peaks, which the merged company went through in summer 2006. Their product mix hugely affects the firm’s earnings. Since Iberdola has got fixed-cost generation, such as hydro or nuclear power, the company is not affected by increasing prices of fuels thereby attaining higher margins. The company is not affected by high prices of raw materials since the Iberdrola owns some fuel assets for example; it has got its own coalmines. Much is expected concerning continued rise in Mergers in years to come. A similar scenario applies to capital expenditures level, which must swell so as to help meet the increased demand for transmission and generation capacity. At the same time, the situation is overshadowed by uncertainty about how taxes, demands for ownership unbundling of system activities, environmental directives and political regulation has affected the market. Larger unpredictability in the prices of electricity, gas and oil prices as well as emission allowances shows that trading skills - i.e., access to commodity assets as well as knowledge about the same is increasing. This is expected to benefit the great, diversified organizations, particularly those with incorporated fuel and power handling. According to some energy analysts profit margins in this energy companies is expected to stabilize in the near future. In addition, if the current investment opportunities will not align with the expected rate of returns the firm will have an option of distributing its extra liquidity to the shareholders via share buybacks or special dividends. (www.oft.gov.uk) Electric utilities appear to hedge the merged firm’s future electricity generation in different degrees through selling it under forward contracts. This demands that Iberdrola lock in part of its future generation of electricity at a fixed price for a couple of years forward in time. In line with the widely fluctuating prices of electricity, forward trading will be a good way of balancing and smoothing out the key price risk that is clearly inherent in this business enterprise. However, if the company were to sell all its generation in advance under forward contracts, then the spot price will fail to make major impact on its earnings. Although the total percentage generation hedged through forward contracts will tend to vary sharply from firm to firm and year to year. Those firms that fail to hedge their electricity generation through forward contracts will expose themselves to the fluctuations of prices in the spot market, which can turn out to be exceptionally large resulting to impressive swings in their earnings. (www.oft.gov.uk) Summary and conclusion Mergers have almost proved to be a sure ware of obtaining economic progress in many firms. Through merging, companies have been able to consolidate their resources as well as cut down on their expenses thereby achieving increased revenues. (Gaughan, 2004) The oil industry in UK has benefited most with the merging companies, for instance, Iberdrola and EDP acquiring a wealth of resources thus enabling it to stabilise even in times of oil prices fluctuations. As depicted by the firm’s annual reports the merger has been of great significance since the firm has been able to streamline its management team, cut down on its direct and indirect costs and increase its overall profitability. However, much emphasis on proper management should be put to ensure continued success in merged firms References Alan, J. (2003), Corporate Takeovers, (Chicago: University of Chicago Press) Gaughan, P. (2004), Mergers and Acquisitions. (New York, Harper Collins) Ingham, H. (2002), Mergers and Profitability, (Chicago, University of Chicago Press) Jensen, M. (1998): The Agency cost of Free Cash flow, corporate finance and Takeover, (New York, Prentice hall) Jensen, M. (2005), Takeovers; cause and consequences, Journal of Economic Perspective, 2, 20-58 McGarvey, R. (2003). "Merge Ahead: Before You Go Full-Speed into a Merger, (London, McGraw-Hill) Mergers in UK, available from www.oft.gov.uk (Retrieved November 29, 2007) Palepu, K. and Ruback, L. (1998), Does corporate performance improve after mergers? Journal of Financial Economics, 31(2), 123-138 Porter, M. (1999), Competitive Strategy, (New York, Free Press) Read More