Mergers and Acquisitions

A general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

 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

 Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate companies together to form larger ones. When they're not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spinoffs, carve-outs or tracking stocks.

Mergers and Acquisitions: Definition

The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. Two companies together are more valuable than two separate companies - at least, that's the reasoning behind M&A. This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater efficiency. Because of these potential benefits, target companies will often agree to be purchased when they know they cannot survive alone.

Distinction between Mergers and Acquisitions

Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established 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, often of about the same size, 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." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.

 A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition. Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders.

By merging, the companies hope to benefit from the following:

Staff reductions Economies of scale Acquiring new technology Improved market reach and industry visibility

 Staff reductions - As every employee knows, mergers tend to mean job losses. Consider all the money saved from reducing the number of staff members from accounting, marketing and other departments. Job cuts will also include the former CEO, who typically leaves with a compensation package. Economies of scale -Whether it's purchasing stationery or a new corporate IT system, a bigger company placing the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or office supplies - when placing larger orders, companies have a greater ability to negotiate prices with their suppliers.

 Acquiring new technology - To stay competitive, companies need to stay on top of technological developments and their business applications. By buying a smaller company with unique technologies, a large company can maintain or develop a competitive edge. Improved market reach and industry visibility Companies buy companies to reach new markets and grow revenues and earnings. A merge may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones.

Varieties of Mergers
Horizontal merger Vertical merger Market-extension merger Product-extension merger Conglomeration

 Horizontal merger - Two companies that are in direct competition and share the same product lines and markets. Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker. Market-extension merger - Two companies that sell the same products in different markets.

 Product-extension merger - Two companies selling different but related products in the same market. Conglomeration - Two companies that have no common business areas.

 There are two types of mergers that are distinguished by how the merger is financed. Each has certain implications for the companies involved and for investors: Purchase Mergers Consolidation Mergers

Purchase Mergers - As the name suggests, this kind of merger occurs when one company purchases another. The purchase is made with cash or through the issue of some kind of debt instrument; the sale is taxable. Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company. We will discuss this further in part four of this tutorial. Consolidation Mergers - With this merger, a brand new company is formed and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

Acquisitions
An acquisition may be only slightly different from a merger. In fact, it may be different in name only. Like mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhanced market visibility. Unlike all mergers, all acquisitions involve one firm purchasing another - there is no exchange of stock or consolidation as a new company. Acquisitions are often congenial, and all parties feel satisfied with the deal. Other times, acquisitions are more hostile.

 In an acquisition, a company can buy another company with cash, stock or a combination of the two. Another possibility, which is common in smaller deals, is for one company to acquire all the assets of another company. Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Of course, Company Y becomes merely a shell and will eventually liquidate or enter another area of business.

 An acquisition is the purchase of one company by another company. Consolidation is when two companies combine together to form a new company altogether. An acquisition may be private or public, depending on whether the acquire or merging company is or isn't listed in public markets. An acquisition may be friendly or hostile.

Mergers and Acquisitions: Valuation Matters

Both sides of an M&A deal will have different ideas about the worth of a target company: its seller will tend to value the company at as high of a price as possible, while the buyer will try to get the lowest price that he can. There are, however, many legitimate ways to value companies. The most common method is to look at comparable companies in an industry, but deal makers employ a variety of other methods and tools when assessing a target company

Mergers and Acquisitions: Why They Can Fail

The motivations that drive mergers can be flawed and efficiencies from economies of scale may prove elusive. In many cases, the problems associated with trying to make merged companies work are all too concrete. Flawed Intentions The Obstacles to Making it Work

Flawed Intentions
A booming stock market encourages mergers, which can spell trouble. Deals done with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and cheap too. Also, mergers are often attempt to imitate: somebody else has done a big merger, which prompts other top executives to follow suit. A merger may often have more to do with glory-seeking than business strategy. The executive ego, which is boosted by buying the competition, is a major force in M&A, especially when combined with the influences from the bankers, lawyers and other assorted advisers who can earn big fees from clients engaged in mergers. Most CEOs get to where they are because they want to be the biggest and the best, and many top executives get a big bonus for merger deals, no matter what happens to the share price later.

 Globalization, the arrival of new technological developments or a fast-changing economic landscape that makes the outlook uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the management team feels they have no choice and must acquire a rival before being acquired. The idea is that only big players will survive a more competitive world.

The Obstacles to Making it Work

The chances for success are further hampered if the corporate cultures of the companies are very different. When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily overcome.

 For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result can be resentment and shrinking productivity. Merging companies can focus on integration and costcutting so much that they neglect day-to-day business, thereby prompting nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to create value for shareholders

Motives behind M&A

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.

 Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices. 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. Tax minimization strategies include purchasing assets of a nonperforming company and reducing current tax liability under the Tanner-White PLLC Troubled Asset Recovery Plan. Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.

 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 an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise 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. By merging the vertically integrated firm can collect one deadweight loss by setting the downstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.

Why Mergers and Acquisitions in India?

The factors responsible for making the merger and acquisition deals favorable in India are: Dynamic government policies Corporate investments in industry Economic stability ready to experiment attitude of Indian industrialists Sectors like pharmaceuticals, IT, ITES, telecommunications, steel, construction, etc, have proved their worth in the international scenario and the rising participation of Indian firms in signing M&A deals has further triggered the acquisition activities in India.

Difference Between Mergers and Acquisitions

Merger
The case when two companies (often of same size) decide to move forward as a single new company instead of operating business separately. The stocks of both the companies are surrendered, while new stocks are issued afresh. For example, Glaxo Wellcome and SmithKline Beehcam ceased to exist and merged to become a new company, known as Glaxo SmithKline.

Acquisition
The case when one company takes over another and establishes itself as the new owner of the business. The buyer company swallows the business of the target company, which ceases to exist. Dr. Reddy's Labs acquired Betapharm through an agreement amounting $597 million.

Ten biggest Mergers and Acquisitions deals in India

Tata Steel acquired 100% stake in Corus Group on January 30, 2007. It was an all cash deal which cumulatively amounted to $12.2 billion. Vodafone purchased administering interest of 67% owned by Hutch-Essar for a total worth of $11.1 billion on February 11, 2007. India Aluminium and copper giant Hindalco Industries purchased Canada-based firm Novelis Inc in February 2007. The total worth of the deal was $6-billion.

 Indian pharma industry registered its first biggest in 2008 M&A deal through the acquisition of Japanese pharmaceutical company Daiichi Sankyo by Indian major Ranbaxy for $4.5 billion. The Oil and Natural Gas Corp purchased Imperial Energy Plc in January 2009. The deal amounted to $2.8 billion and was considered as one of the biggest takeovers after 96.8% of London based companies' shareholders acknowledged the buyout proposal.

 In November 2008 NTT DoCoMo, the Japan based telecom firm acquired 26% stake in Tata Teleservices for USD 2.7 billion. India's financial industry saw the merging of two prominent banks - HDFC Bank and Centurion Bank of Punjab. The deal took place in February 2008 for $2.4 billion. Tata Motors acquired Jaguar and Land Rover brands from Ford Motor in March 2008. The deal amounted to $2.3 billion. 2009 saw the acquisition Asarco LLC by Sterlite Industries Ltd's for $1.8 billion making it ninth biggestever M&A agreement involving an Indian company. In May 2007, Suzlon Energy obtained the Germanybased wind turbine producer Repower. The 10th largest in India, the M&A deal amounted to $1.7 billion.

Top 10 Mergers & Acquisitions in India for 2010

Tata Chemicals buys British salt Tata Chemicals bought British Salt; a UK based white salt producing company for about US $ 13 billion. The acquisition gives Tata access to very strong brine supplies and also access to British Salts facilities as it produces about 800,000 tons of pure white salt every year Reliance Power and Reliance Natural Resources merger This deal was valued at US $11 billion and turned out to be one of the biggest deals of the year. It eased out the path for Reliance power to get natural gas for its power projects Airtels acquisition of Zain in Africa Airtel acquired Zain at about US $ 10.7 billion to become the third biggest telecom major in the world. Since Zain is one of the biggest players in Africa covering over 15 countries, Airtels acquisition gave it the opportunity to establish its base in one of the most important markets in the coming decade

 Abbotts acquisition of Piramal healthcare solutions Abbott acquired Piramal healthcare solutions at US $ 3.72 billion which was 9 times its sales. Though the valuation of this deal made Piramals take this move, Abbott benefited greatly by moving to leadership position in the Indian market GTL Infrastructure acquisition of Aircel towers This acquisition was worth about US $ 1.8 billion and brought GTL Infrastructure to the third position in terms of number of mobile towers 33000. The money generated gave Aircel the funds for expansion throughout the country and also for rolling out its 3G services

 ICICI Bank buys Bank of Rajasthan This merger between the two for a price of Rs 3000 cr would help ICICI improve its market share in northern as well as western India JSW and Ispat Ki Kahani Jindal Steel Works acquired41% stake at Rs 2,157 cr in Ispat Industries to make it the largest steel producer in the country. This move would also help Ispat return to profitability with time Reckitt Benckiser goes shopping Reckitt acquired Paras Pharma at a price of US $ 726 million to basically strengthen its healthcare business in the country. This was Reckitts move to establish itself as a strong consumer healthcare player in the fast growing Indian market

 Mahindra goes international Mahindra acquired a 70% controlling stake in troubled South Korea auto major Ssang Yong at US $ 463 million. Along with the edge it would give Mahindra in terms of the R & D capabilities, this deal would also help them utilise the 98 country strong dealer network of Ssang Yong Fortis Healthcare acquisitions Fortis Healthcare, the unlisted company owned by Malvinder and Shivinder Singh looks set to make it two in two in terms of acquisitions. After acquiring Hong Kongs Quality Healthcare Asia Ltd for around Rs 882 cr last month, they are planning on acquiring Dental Corp, the largest dental services provider in Australia at Rs 450 cr As you see in the list, the M & As have happened across industries and sectors like banking, automotive, healthcare, FMCG, telecom etc. This shows that this really has been the dream year of Indian industry.