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Mergers & Acquisition

Merger
A transaction where two firms agree to
integrate their operations because they
have resources and capabilities that
together may create stronger competitive
advantage.
The term merger refers to a combination
of two or more companies into a single
company and this combination may be
either through consolidation or absorption.
A consolidation is a combination of two or more
companies into a third entirely new company
formed for the purpose. The new company
absorbs the assets, and possibly liabilities, of
both original companies which cease to exit.
When two firms merge, stock of both are
surrendered and new stocks in the name of new
company are issued. Generally merger takes
place between two companies of more or less
same the size.
In case of absorption, one company
absorbs another company i.e. it purchases
either the assets or shares of that
company. The merger by absorption is
always friendly in nature i.e. both the
companies agree to the terms of
absorption.
Types of Merger

1. Horizontal
A merger in which two firms in the same industry combine.
Often in an attempt to achieve economies of scale and/or scope.
2. Vertical
A merger in which one firm acquires a supplier or another firm that is
closer to its existing customers.
Often in an attempt to control supply or distribution channels.
3. Conglomerate
A merger in which two firms in unrelated businesses combine.
Purpose is often to diversify the company by combining uncorrelated
assets and income streams
4. Cross-border (International) M&As
A merger or acquisition involving a Indian and a foreign firm it, could
be either the acquiring or target company.
Horizontal Merger
A horizontal merger results in the
consolidation of firms that are direct rivals
i.e. sells substitutable products within
overlapping geographic markets. This
form of merger results in the expansion of
a firms operation in a given product line
and at the same time eliminates
competition.
Horizontal Mergers have a flip side too:-
They result in creation of large entities that cause ripple
effects in the sector and sometimes throughout the
economy.
Large horizontal mergers are perceived as anti-
competitive, for they give the new entity an unfair
competitive advantage over its competitors.
Most countries regulate large horizontal mergers by
enacting competition acts. This does not mean that
horizontal mergers are always bad. They are
encouraged when the resulting benefits outweigh the ill
effects of reduction in competition.
Vertical Merger
When two firms working in different stages of
production or distribution of the same product
join together, it is called Vertical Merger.
A Vertical Merger is one in which the buyer
expands backward and merges with the firm
supplying raw material or expands forward in the
direction of the ultimate consumer. The
economic benefits of this type of merger stem
from the firms increased control over the
acquisition of raw material or the distribution of
finished goods.
Vertical Mergers are usually mergers of non- competing companies
where ones product is a necessary component or complement of
the others.
Such mergers can achieve pro- competitive efficiency benefits.
Vertical integration can lower transaction costs, lead to synergistic
improvements in design, production and distribution of the final
output/ product and thus enhance competition.
The basic objective of a vertical merger is to eliminate cost of
searching for vendors, contracting prices, payment collection,
advertising and communication and coordinating production. Such a
merger can have a very positive impact on production and inventory
since information flows efficiently within the organisation.
Conglomerate Merger

A Conglomerate Merger involves two firms in


totally unrelated activities. A conglomerate is a
firm that has external growth through a number
of mergers of companies whose business are
not related either horizontally or vertically.
A conglomerate may have operations in
manufacturing, electronics, banking, fast food
restaurants and other unrelated businesses.
This form of business results in the expansion of
firms operations in different unrelated lines of
business with an increased sense of operating
synergies.
By purchase of assets

The assets of company Y may be sold to


company X. Once this is done, company Y is
then legally terminated and company X survives.
By purchase of common shares

The common share of company Y may be


purchased by company X. When company X
holds all the shares of company Y, it is
dissolved.
By exchange of shares for assets

Company X may give its shares to the


shareholders of company Y for its net assets.
Then company Y is terminated by its
shareholders who now holds shares of company
X.
Exchange of shares for shares

Company X gives its shares to the shareholders


of company Y and then company Y is
terminated.
Stakeholder Groups in the M & A Activities

Public Customers

Stakeholders Employees
Shareholders

Board of Directors State Institutions Industry Analysts


Public- The publics need for extensive general
information places demands on the company.
They are concerned with the retention of
workplaces at a given site in the post-merger
period.
Shareholders- As owners of the company, the
shareholders are primarily interested in the post-
merger increase of the enterprise value. This
depends on the significance of related factors
such as turnover and growth, capital structure
and profit, tax rate and investments and the like.
Board of Directors- The Board of Directors is
primarily concerned with the control of the
business management on the basis of company
information at their disposal.
State institutions- The claim of state institutions
concern levying taxes and contributions, the
upkeep of existing legal norms as well as the
maintenance of competition.
Customers- For the customer stakeholder group,
the satisfaction of their needs is the main
demand on the company. Their expectations
focus on the price and the quality of the goods
as well as the services offered to them.
Employees- The principal interest of the
employees is, even after a merger, the quality of
the work they have. This is measured by their
income, job security, working condition and the
possibilities of participative management.
Industry analysts- The analysts of the large
investment banks give immediate
recommendations to investors and stakeholders
who are looking for capital investment
opportunities. Additionally, through these
recommendations, they have an influence on the
business analysts and thus also indirectly have
an effect on companies.
There are other stakeholders who include
suppliers, external investors, competitors,
business associations, press and so on. They
play important roles in M&A decisions and post-
merger integration.
Identifying Value Drivers in Mergers and
Acquisitions
A merger is a game of drawing synergy.
The acquiring firm, which wants to
optimize value gains, attempts to increase
synergy and minimize the premium that it
has to pay to the target company.
Value created through M & A = Increase in
synergy- Decrease in premium
Increase in Synergy
Synergy is the result of increase in efficiency of the
combined entity. The efficiency gains accrue on account
of the following:
Improvement in style of management so that
administratively the company becomes stronger.
Improvements in financials by restructuring the capital
structure to reduce cost and increase possibilities of
efficient deployment of financial resources.
Improvements in operational efficiency with the objective
of increasing productivity, reducing or eliminating
rejections and wastages.
Changes in the ability to control risk.
Reduction in inefficiencies existing before the merger
took place.
The synergies can be exploited only when
the value of the combined entity exceeds
the sum of its parts. To attain this
objective, the combined entity should be
able to increase its revenue, reduce the
volatility in its earnings, or even reduce its
costs.
Decrease in Premium
Paying a comparatively lower price for the target
company is another way of increasing the net
gain from a deal.
The acquiring company should identify market
imperfections while valuing the target company.
These imperfections should then be indexed
against other player in the industry so that the
appropriate price of the shares the target
company can be determined. This is where the
acquirer can ascertain the appropriate amount
payable for the target and avoid paying high
premium for the target.
Value Creation Motivations for M&As

Operating Synergies
1. Economies of Scale
Reducing capacity (consolidation in the number of firms in
the industry)
Spreading fixed costs (increase size of firm so fixed costs
per unit are decreased)
Geographic synergies (consolidation in regional disparate
operations to operate on a national or international basis)
2. Economies of Scope
Combination of two activities reduces costs
3. Complementary Strengths
Combining the different relative strengths of the two firms
creates a firm with both strengths that are complementary
to one another
Efficiency Increases
New management team will be more efficient and add
more value than what the target now has.
The combined firm can make use of unused
production/sales/marketing channel capacity
Financing Synergy
Reduced cash flow variability
Increase in debt capacity
Reduction in average issuing costs
Fewer information problems
Tax Benefits
Make better use of tax deductions and credits
Use them before they lapse or expire (loss carry-back, carry-forward
provisions)
Use of deduction in a higher tax bracket to obtain a large tax shield
Use of deductions to offset taxable income (non-operating capital
losses offsetting taxable capital gains that the target firm was unable
to use)
New firm will have operating income to make full use of available
CCA.
Strategic Realignments
Permits new strategies that were not feasible for prior to the
acquisition because of the acquisition of new management skills,
connections to markets or people, and new products/services.
Managerial Motivations for M&As

Managers may have their own motivations to pursue


M&As. The two most common, are not necessarily in
the best interest of the firm or shareholders, but do
address common needs of managers
1. Increased firm size
Managers are often more highly rewarded financially for building a
bigger business (compensation tied to assets under administration for
example)
Many associate power and prestige with the size of the firm.
2. Reduced firm risk through diversification
Managers have an undiversified stake in the business (unlike
shareholders who hold a diversified portfolio of investments and dont
need the firm to be diversified) and so they tend to dislike risk
(volatility of sales and profits)
M&As can be used to diversify the company and reduce volatility
(risk) that might concern managers.
Reasons for buying a business

Pursuing a growth strategy


Defensive reasons
Financial opportunities
Reasons for selling a business

To raise money, perhaps to pay off debts or to


raise cash for future acquisitions.
An attractive offer price.
The desire to sell off non- core activities that do
not fit commercially or strategically with the rest
of the sellers businesses.
A wish to sell off non- core activities that do not
fit commercially or strategically with the rest of
the sellers businesses.
Opportunity for realizing a greater value to
stockholders if the company is sold rather than
retained.
Lack of funds to invest in developing the
businesses and a consequent willingness to sell
to a buyer who wishes to invest funds for the
business needs.
A company that runs into financial difficulties and
seeks refinancing from its banks could be forced
to agree, as a condition of the refinancing, to
sell- off businesses to raise cash for repaying
some of the loans.
National and state governments of many
countries have sold off (or disinvested or
privatized) businesses to private buyers to raise
cash for the development of the social sectors.

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