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MF 0011Mergers & Acquisitions

Unit 1-Introduction to Mergers and Acquisitions

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Program : MBA

Semester : III

Subject Code : MF 0011

Subject Name : Mergers & Acquisitions

Unit number : 1

Unit Title : Introduction to Mergers and Acquisitions

Lecture Number :

Lecture Title : Introduction to Mergers and Acquisitions

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Introduction to Mergers and Acquisitions

Objectives:

After studying this unit, you should be able to:

Define the meaning of Mergers and Acquisitions (M & A)

Describe the motives behind the M & A

State the advantages and disadvantages of M & A

Classify the types of mergers

Explain the steps to be taken for a successful merger

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Lecture Outline

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Introduction

Meaning: Mergers & Acquisitions Types of Mergers

Motives Behind Mergers

Mergers & Acquisitions: Advantages

Mergers & Acquisitions: Disadvantages

Mergers & Acquisitions: Types Mergers & Acquisitions: Examples

Steps to a Successful Merger

Mergers & Acquisitions: Historical Overview

Summary

Glossary

Check Your Learning

Answers

Case Study

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Introduction: Mergers and Acquisitions

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The hallmark of any successful business is profitable growth.

Making profits and increase in volumes year on year is necessary for growth tobe profitable.

Profitable Growth

Organic Growth

Inorganic Growth

Increase in volumes by the business on itsown, acquiring fresh customers, makingand selling new products and entering newmarkets with its products.

When businesses realise their growth issteady, not spectacular, some businessestake the leap for inorganic growth orgrowth by acquiring businesses. That is,mergers and acquisitions.

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Meaning: Merger & Acquisitions (Cont.)

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Acquisitionrefers to theprocurement of assets by one company fromanother company.

Takeover: In an acquisition, both companies may continue to exist. It is alsoknown as a 'takeover'. It is buying of one company by another. Acquisitionusually refers to a purchase of asmaller firm by a larger one.

Reverse Takeover: Sometimes, a smaller firm will acquire managementcontrol of a larger or longer established company and keep its name forthe combined entity. This is known as a reverse takeover.

The terms demerger, spin-off and spin-out are used to indicate a situationwhere one company splits into two, generating a second company.

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Types of Mergers

Mergers

Absorption: Grouping two or more companiesinto an existing company. All companies except

one lose their identity in a merger throughabsorption.

Consolidation: Known as the fusion of two ormore than two companies into a new companyin which all the existing companies are legally

dissolved and a new company is created.

Examples of Mergers/ Acquisitions: Aditya Birla group, owned HINDALCO acquired NOVELLIS for US$6 billion. TATA MOTORS acquired LANDROVER for $2.3 billion. Takeover of European Steel major CORUS for $12.2 Billion by TATA STEEL, the biggest

ever acquisition by an lndian company.

Example: Merger of TataChemical Ltd (buyer) andTata Fertilisers Ltd (seller),to form Tata Chemical Ltd.

Example: HindustanComputers Ltd, Hindustaninstruments Ltd, IndianSoftware Ltd and Indian Reprographics Ltd was merged toform HCL, a new company.

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Motives Behind Mergers

Sensible Reasons

Strategic ReasonsEconomies of Scale

Economies of Vertical Integration

Complementary Resources

Tax Shield

Utilization of Surplus Funds

Managerial Effectiveness

Dubious Reasons

Diversification

Lower Financing Costs

Earnings Growth

A merger can be rated as sensible when it adds value, i.e., it creates additional

benefit to the parties involved.

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Motives Behind Merger: SensibleReasons (Cont.)

Strategic benefits:

If a firm has decided to enter or expand in a particular industry, acquisition of afirm engaged in that industry, rather than dependence on internal expansion,may offer several strategic advantages. Prevention of a competitor from establishing a similar position in the

industry. Offers a 'timing' advantage since a merger can bypass several stages in the

expansion process May entail less risk and even less cost

Economies of Scale: Helps in Efficient and proper usage of distribution networks, Improved production capacities, Economies in research and development facilities, engineering services, data

processing systems etc. In case of horizontal mergers scope for utilizing resources is greater hence

more prominent economies of scale In case of vertical mergers, benefits include better coordination of activities,

higher market power and lower inventory levels. In conglomerate mergers, there is a possibility of cutting down on overhead

expenses

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Economies of Vertical Integration Achieved when more firms, which are at different levels of production, get

merged. For Example: A oil production company merging with a companyrefining oil and marketing: This will improve the control and co-ordination

In case of companies producing units in-house, vertical merger is not a goodidea. Here, outsourcing with better performing suppliers in the respectivesegments may not be useful.

Complementary resources Sensible to merge companies with complementary resources

For Example: A company bringing in a new product will need the help of acompany with good engineering capabilities and better marketing network:Easier for manufacturing and marketing the new product. The complementaryresources will improve the new worth more than they are separately.

Tax Shield:When a company with unabsorbed depreciation and/or accumulated lossesmerges with a better performing company, tax shields can be utilized.In case of its merger with a profit-making company, its accumulated lossesand/or absorbed depreciation can be set off against the profits of the profit-making firm and tax benefits can be realised faster.


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Utilization of surplus fundsA merger through cash compensation with other companies is helpful insituations where a company is generating good revenue but has no investingopportunities. In such situations, the firms need to distribute higher dividendsand even has to buy back it shares. Managements however prefer furtherinvestments, thought they may or may not be profitable, hence effectivelyutilizing the surplus funds.

Managerial Effectiveness Increases managerial efficiency when a poor-performing team is replaced

with a better-performing one Greater similarity between shareholders and managers, leading to creation

of a disciplined and better work environment In cases where managers feel that poor performance of their firm may lead

to a merger, they would work for better performance Firm plagued with managerial inadequacies can gain immensely from the

superior management that is likely to merge as a consequence of merger


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Diversification:

Risk reduction by diversification: The degree of risk will depend on thecorrelation of earnings of both the entities.

This value is questionable, because any investor who wants to reduce riskcan create a portfolio by diversifying two companies. The merger is notnecessary for the investor to get benefitted by positives of diversification.

The company's home-made diversifications offers better flexibility

Lower Financing Costs Many believe that the consequence of larger size and greater earnings

stability is to reduce the cost of borrowing for the merged firm: Creditorsof the merged firm enjoy better protection than independent firms

Example:If two firms A and B merge, the creditors of the merged firm are

protected by equities of both A and B. This reduces the cost of debt, and itimposes an extra burden on the shareholders since shareholders of firm Amust support the debt to firm B and vice versa.In an efficient market, the benefit to the shareholders from lower cost ofdebt would be set off by the additional risk borne by them, and there wouldbe no net gain.

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Motives Behind Merger: DubiousReasons

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Earnings Growth

A merger may create appearance of growth in earnings stimulating a priceincrease if the investors are fooled.

Example: Company A acquired Company B. The pre-merger financial positionshows that A has superior growth prospects and commands a price earnings(P/E) multiple of 20, while B has an inferior growth prospects and has priceearnings of 10. The merger is not expected to create any additional value. Theexchange ratio is fixed at 1:2 that is 1 share of A is given in exchange for twoshares of B.

Situation l - The market is 'smart': The financial position of A after the mergeris better and the earnings per share rises, but the market recognises that thegrowth prospect of the combined firm will not be as bright as that of A alone. Sothe market price per share remains unchanged and the P/E ratio falls. Here the

market value of the combined company is simply the sum of the market valuesof the merging companies.

Situation 2 - The market is 'foolish': It may regard the increase in earnings pershare of A as reflection of true growth and so the market price of A will rise andthe P/E ratio will stay the same.

Motives Behind Merger: DubiousReasons (Cont.)

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Mergers & Acquisitions: Advantages

Economies of scale helps in lowering the costsTo Shareholders

Promoters get the advantage of restructuring thecompany

To Promoters

Managers often look forward to mergers as an opportunityto enhance their status financially and otherwise.

To Managers

The benefits of mergers get passed to the consumers inthe form of better products and services.

To Consumers

For detailed explanation on theadvantages of mergers and

acquisitions to various sectionsof the society, Click here

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Mergers & Acquisitions : Examples

Merger of Phoenix Electric (India) and Phoenix Lamps (India) (ConcentricCombination)

Merger of Videocon Narmada Electronics and Videocon International Ltd(Concentric Combination)

Merger of bank of Madura and ICICI (Concentric Combination) Acquisition of Blue Dart to DHL Worldwide (Concentric Combination)

Acquisition of Thomson SA of France by Videocon India in a deal worth$290million (Concentric Combination) Indian Airlines and Air India (Concentric Combination) Standard Equity Fund and Dr. Reddys Laboratories (Circular Combination) Karnataka Scooters and Brooke Bond (India) Ltd (Circular Combination)

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Steps to Successful Merger

Mergers need careful planning to achieve financial goals, reduce problemsand for profit-making. For employees, possibility of changes and uncertainty

at work place can create stress. This affects judgments, perceptions, andinterpersonal relationships.

Often reduced communication and increased centralisation as part of re-structuring in companies creates space for rumours and insecurity inemployees.

Circulate a consistentmessage in the

combining entitiesfrom top down.

Maintain consistentaccountability andcompensationthroughout the

company for similarpositions.

Find out new ways ofstructuring the

company to bridgecorporate culture

differences.

Establish gaugeableobjectives, especiallyin areas, which willbe working togetherfor a common goal.

Revamp thecompensation plan torecognise the

additional workrequired bytransition.

Plan different waysfor people to get toknow each other.


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Stats: The United States Federal Trade Commission reports that the number of filings

in 1999 was almost three times the number received in 1993. This same trendis being experienced worldwide. Web property deals tripled from 140 in 1998 to450 in 1999 with an incredible increase of 700% in dollar spending from 1998to 1999.

Facts and Figures: Acquisition of Time Warner by America Online was the highest acquisition in

terms of amount spent. This being more than three times the total spent in1998/1999.

Mergers are not just between the internet-related businesses, but acrossindustries.

Late 1990s to 2000 Mergers and Acquisitions were at an all-time high

Till 2005 M & A slowed down due to economic slowdown.companies did not have the cash to buy other companies.

2004-05 Economy revived, businesses had cash. The end of 2004saw many deals: Sprint combining with Nextel K-Mart Holding Corp buying Sears

Mergers & Acquisitions: HistoricalOverview

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A merger or amalgamation should be considered only after careful

examination of the merits and demerits, and ensuring overall positivevalue addition.

Merger is defined as a combination where two or more than twocompanies combine into one company.

Mergers may happen for various reasons - Sensible Reasons like:Economies of Scale, Economies of Vertical Integration, Complementary

Resources, Tax Shield, Utilization of Surplus Funds or ManagerialEffectiveness, and dubious Reasons like: Diversification, Lower FinancingCosts, Earnings Growth.

M & A offers a bunch of advantages to its shareholders, promoters,managers and consumers in different ways.

There are 5 types of mergers: Horizontal, Concentric, Vertical, circularCombination and Conglomerate mergers.

Summary

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Merger:Merger is a grouping of two or more companies into one company.

Acquisition: The term acquisition refers to the acquisition of assets by onecompany from another company.

Spin-off:An independent company carved out of another company (of whichit was a part) through a sale.

Conglomerate: Combination of companies engaged in unrelated businesses

Glossary

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Check Your Learning

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11.A company may use a specific _______________ or assets to widen thescope of its activities.

12.Acquisitions and mergers are strategic decisions. (True/False)

13.The decision of M & A requires approval by one-third of shareholders voting.(True/False)

14.Under _____________ the acquiring firm belongs to the industry of the

target company.

15.Conglomerate merger is the combination of companies engaged in_________________.

16.Combination of two or more companies involved in different stages ofactivities is called _____________.

17.Vertical combination is of two types _________________ and backwardintegration.

18.Combinations of companies engaged in the production of different productsare called ______________.


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Check Your Learning

19.Web property deals increased three-fold from 140 in 1998 to 450 in 1999with an incredible increase of 700%. (True/False)

20.America Online's acquisition of Time Warner was valued at more than threetimes the total 1998/1999 M & A spending. (True/False)

21.For the success of a merger ______________ among the mergingbusinesses is very important.

22.Productivity drops by as much as _________________ have been reported.

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Answers

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1. True.

2. True.

3. True.

4. False.

5. True.

6. False.

7. True.

8. Horizontal mergers.

9. Risk reduction.

10. Managerial effectiveness.11. Set of skills.

12. True.

13. False.

14. Horizontal merger.

15. Unrelated businesses.

16. Vertical merger.

17. Forward integration.18. Circular combination.

19. True.

20. True.

21. Cultural integration.

22. 50%.

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Case Study

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Click on the icon besides, toanalyze the case on Corporate

Restructuring

Answer the following questions, based on thegiven case:

QuestionDiscuss the case given above.

Hint answer:The deal will bring a lot of opportunities for thecompany and strengthen Subexsposition in therevenue maximisation space of telecom sector.

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