Principal Features of Mergers and Acquisitions - Coursework Example

Principal features of Mergers and Acquisitions As a rule, business organisations have to either grow or perish. Those in the growth mode grab market share from competitors, create new markets and generate profits to be passed on to the share holders. Companies that do not grow, will stagnate and lose share holder value. Mergers and Acquisitions (M& A) are short cuts for organisations’ growth and are used to achieve external growth and industry consolidation. The year 2004 witnessed 31,233 M & A deals worth $ 1.9 trillion through out the world as against 28,702 worth $ 1.4 trillion in 2003 registering 39% increase in value. The U.S alone had 8504 deals in 2003 worth $ 841billion. This macro economic activity saw consolidation of industries in energy, power, financial services, and telecommunications sectors involving high technology. M & A s are not an art or science but a process of valuation. To be successful merger or acquisition, it should be properly valued failing which one side wins substantially and the other side loses in an equally substantial manner. A deal is a failure if it does not create share holder value. Hence an M & A transaction must be fair and balanced complementing the requirements of both the buyer and seller. Hence financial statements should be analysed and an appreciation of how the proposed deal will meet the aspirations of both the parties should be done keeping in view the tax, accounting and legal implications. Problems can arise at any stage of the M & A deals. Basics of Mergers and Acquisitions As said earlier a company’s growth for its survival can be organic, inorganic or by external process. Organic growth involves additional employment of marketing professionals, adding new products, or geographical expansion. Inorganic growth is through acquisition of another company in order to gain new products line, new customers or geographical expansion. On the other hand external means are revenue opportunities through franchising, licensing, joint ventures, strategic alliances and overseas distributors. Hence M & A are means of growth for organisations. Merger: It is coming together of two or more firms in which assets and liabilities of the selling firms are taken over by the buying firm. Though the buying firm becomes altogether a new entity post merger, it retains its original identity. Acquisition: It involves purchase of assets of another firm or a division of the same. Procter and Gamble purchased The Gillette Company Inc in 2005 and it was actually an acquisition with an intention to expand its consumer products lines. Distinction: Though the distinction is immaterial because of the end result being the same, its impact on the finance, strategy, culture, and tax will be significant after the merger or acquisition. Mergers are often coming together of two equals while acquisition results in buying of one company by another by payment through cash, securities of the buyer or other assets of value to the seller. In the case of stocks, the seller’s shares are often held separately as a subsidiary company or new division of the seller instead of combining with the existing shares of the buying company. When assets are acquired, they become additional assets of the buying company with the expectation that the value of the assets will appreciate over time which would reflect in increase in share holder value. Many deals are driven by the necessity of spreading the risk and cost of introducing new technologies of communications and aerospace industries, investment on research and development medical discoveries ranging from new medical devices to new drugs, and gaining additional sources of energy such as oil and gas exploration and drilling operations. Globalisation has been an another catalyst to experiment on mergers and acquisitions to gain international presence and market share which is viable alternative to starting overseas operations from the basic levels. M & As are resorted to expand products or service line with a view to remain competitive or to ward off seasonal or cyclical trends. To give one stop-shopping for consumers, deals are initiated in retail, hospitality, food and beverage, entertainment and financial services sectors. They are also resorted to buy brand loyalty and consumer relationship in a less expensive manner rather than building them from the scratch. The buying firm pays premium for acquisition of intangible assets like good will on the seller’s balance sheet. Buyers attach more importance to acquisition existing clientele and other relationships of the seller firm than the machinery and stocks coming along with them. Some times acquisition is made when a business is put up for sale to prevent a new buyer coming into the market so as to avoid competition. Therefore motivation behind A & Ms are varied affecting the nature of transactions, valuation, pricing and capability to get Governmental or third party approvals. Acquisitions: Motivation for sellers: The reasons could be the need for the ownership to retire, its inability to sustain competition in the market, the need to achieve economies of scale or the opportunity for access to the resources of the buying company. Motivation for the buyer: Opportunity to increase in revenue, achieve cost reduction, deployment of under utilised resources, investors’ pressures for growth to the company, the need to cut down competing firms in the market and economies of scales in addition to achievement of vertical and /or horizontal synergies in operations. Besides, to gain new geographic market at a time when current market is overflowing and a desire to diversify. Mergers: Motivation in mergers: Merger is different from acquisition in that it takes place between two equals. Either party of the two equals will have objectives in respect of restructuring industry value chain, responding to competitive pressures such as what happened in the case of HP/Compaq, to enhance process improvements, increasing volume of production, to find additional avenues for the existing management talent, to employ unutilised capital in more profitable or complementary operation and to obtain tax benefits. In a typical merger, there is no buyer and seller. Data collection and due diligence are two way processes and are mutual with each party planning to have strategic positions post merger through equity, management and control. ( Sherman J & Hart A) Conditions under which a buying firm will have chances of gain (ecofine) When NPV (B + T) > [NPV B + NPV T] Where B means bidder, T means target firm and P is price of target firm and NPV is net present value. Shareholder value can be achieved only if Price of T < NPV (B+T) - NPV (B) M & A will have no significance if Price = NPV (B+T) – NPV (B) M & A will result in loss for the owners of the buying firm if: Price > NPV (B+T) - NPV (B) Currently, it is the fifth era of merger and acquisition movements. The First Merger Movement of 1893 to 1904 witnessed formation transcontinental railroad system creating a first common market in Europe. In the U.S horizontal mergers occurred in steel, oil, telephone, and basic manufacturing industries during this period. The second era of 1920 was characterised by vertical mergers with the advent of radio paving way national advertising, automobiles for extended geographic sales and distribution. The vertical mergers helped manufacturers control distribution channels in a more effective manner. The third one of 1960s saw what was called conglomerate mergers as a sequel to reduction in defence expenditures evidenced by part of every conglomerate consisting of aerospace or oil companies. Diversification was the watchword since industries dependent on population growth tended to move away from their core competencies for their survival. In the fourth era of 1980s, companies were bitten by takeover bids as a result of their poor performance. For example Chemical Bank and Disney were the targeted. So in the 1980s, takeovers were encouraged by brute financial strength. It is evident that each era of the mergers were influenced by different set of economic and development forces by distinct group of change factors. The fifth era started in 1993 was full of strategic mega-mergers endured till 2001. Table 1 below shows the mergers in the U.S. over a $50 billions which includes one U.K.acquirer and the 9th largest transaction was between two foreign entities in the U.S. (Fred J 2001) (Table 1 above) (Fred J 2001) The M & A activities slowed down towards the end of 2000. The reasons for the steep growth of M & A activities during the fifth era worldwide were due to ten change forces that have been identified. “Ten change forces are identified: (1) The pace of technological change has accelerated. (2) The costs of communication and transportation have been greatly reduced. (3) Hence markets have become international in scope. (4) The forms, sources, and intensity of competition have expanded. (5) New industries have emerged. (6) While regulations have increased in some areas, deregulation has taken place in other industries. (7) Favourable economic and financial environments have persisted from 1982 to 1990 and from 1992 to mid-2000. (8) Within a general environment of strong economic growth, problems have developed in individual economies and industries. (9) Inequalities in income and wealth have been widening. (10) Valuation relationships and equity returns for most of the 1990s have risen to levels significantly above long-term historical patterns.”(Fred J 2001) Lessons from U.K. In the U.K. as in 1998 there were not much barriers to takeovers. The takeovers serve as a punishment on inefficient managements. This Anglo-Saxon model is therefore considered a prescription for corporate health. Hostile takeovers are not common in other parts of Europe because not all companies are quoted on stock market and even those which are listed in the stock exchanges, things become difficult for potential hostile bidders due to holdings of shares by the Banks or the State, employee rights and vetoing powers. But lately hostile takeovers are slowly becoming widely prevalent in Europe because of offloading of shares owned by the State Governments in companies. In U.K. activists hold the view that takeovers do benefit shareholders and workers because the mergers resulting out of takeovers inject new managerial teams which are more efficient signaling better prospects for share holders and employees. However in practice profitability of merged companies are not any better than the existing companies as found in their research by .Franks J and Meyers C (1996) “This suggests that takeovers are not a mechanism for correcting managerial failure. Even more importantly, the performance of merged companies frequently fails to deliver the expected benefits and, indeed, worse performance more commonly results: one study found that "acquisitions have a systematic detrimental impact on company performance" (Dickerson A, Gibson H and Tsakalotos E1995). If post-merger company performance suffers, a likely outcome is a reduction in job security in the long term. Moreover, takeovers are often followed by significant numbers of redundancies in the short term. In order to convince shareholders that a takeover is in their interests, managers in the bidding firm often promise that cost savings will result from the merger, and shedding staff is a principal way in which this is achieved. Diageo, the food and drinks group formed in December 1997 following the merger of Grand Metropolitan and Guinness, recently announced 850 job losses in the UK with another 1,000 redundancies overseas expected in the next six months. Currently, this pattern is most evident in the financial sector where a wave of mergers is associated with large-scale job losses. As many as 1,600 jobs cuts are planned at the insurance company Eagle Star following the merger of its owner, British American Financial Services with Zurich Insurance. Senior managers at the new group formed as a result of the merger between the Union Bank of Switzerland and the Swiss Bank Corporation recently announced that 13,000 of the 56,000 worldwide workforce would be cut, with nearly 3,000 of these redundancies being in London. (eironline) To conclude, Mergers and Acquisitions are good for a country’s economy if it will result in avoidance wasteful expenditures and healthy GDP besides increasing share holder value of the newly emerging companies. At the same time, it should not result in concentration of power with a few handfuls of companies in order to extract more than reasonable prices from consumers by forming cartels. Works cited List Dickerson A, Gibson H, Tsakalotos E The impact of acquisitions on company performance: Evidence from a large panel of UK firms Canterbury: University of Kent 1995 Ecofine, Mergers & Acquisitions accessed 15 March 2008 http://www.ecofine.com/strategy/mergers.htm Eironline July1998 Corporate mergers and takeovers: lessons from the UK accessed 15 March 2008 http://www.eurofound.europa.eu/ Franks J and Meyers C 1996 Do hostile takeovers improve performance Business Strategy Review, 7. 4 1996 Fred J Weston Mergers & Acquisitions McGraw-Hill Professional Group 2001 Sherman J Andrew and Hart A Milledge, Mergers and Acquisitions From A to Z AMACOM Div of American Management Association, New York 2006 . Read More