Unit-1 Merger and Acquisition
Content
Mergers and Acquisitions
Unit 1
Unit 1
Introduction to Mergers & Acquisitions
Structure 1.1 Introduction Objectives 1.2 Background 1.3 Meaning Self Assessment Questions 1.4 Motives behind Mergers 1.5 Advantages of Mergers & Acquisitions 1.6 Theories of mergers Operating Financial Managerial synergy of mergers Self Assessment Questions 1.7 Types of Merger Self Assessment Questions 1.8 Value creation of Mergers 1.9 Role of industry Life Cycle Introduction Stage Exploitation Stage Maturity Stage Decline Stage 1.10 Summary 1.11 Terminal Questions 1.12 Answers to SAQ’s & TQ’s
1.1 Introduction
This unit introduces the background of corporate mergers and acquisition and also explains the concept of mergers and acquisition. To start with, you need to know why the corporate go for mergers and the rationale behind such mergers and acquisition. You will also able to understand about the various forms of mergers and acquisition in this unit.
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Objectives After studying this unit, you should be able to Define the concept of mergers and acquisition Discuss the motives behind mergers Describe theories of mergers Discuss about the forms of mergers and acquisition
1.2 Background
Merger and acquisition are the most popular means of corporate restructuring. The current upswing in activity in the domestic market as well as in the global markets proves that strong conceptual and technical skills are required for anyone working in the field. Mergers and acquisitions have happened in history in the last 100 years. Both America and Europe have experienced the spectacular wave of mergers and acquisitions in recent days. In the US, the merger waves started: between 1890-1904 at the end of World War I during later part of II World War and continues to the present day.
As a result of globalization, today the business firms are operating in highly competitive environment. In today’s business world, profitable growth constitutes one of the prime objectives of the business organizations. It can be achieved in two different methods: Internal o Through the process of introducing or developing new products o By expanding or enlarging capacity of the existing product(s). External o By acquisitions of existing business firms in the form of mergers, acquisitions, amalgamations, takeovers, absorption, consolidation etc.
Both of the above methods have their own strengths and weaknesses. In the competitive world, the growth of the firm should be quick and sustainable. The internal growth usually involves a longer implementation period and also entails greater uncertainties. The external growth expedites the pace of growth as the acquired firm already has the facilities or market
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acceptable products. Hence, a growing firm may be in constant search for identifying potential firms which may be merged. The firm will opt for merger if it maximizes the wealth of shareholders. M & A have become universal practice in the corporate world for securing survival, growth, expansion and globalization of the enterprises and achieving multitude of objectives. M & A have started taking place in India in the recent years. A number of mega mergers and hostile takeovers could be witnessed in India now.
1.3 Meaning of Terms
In this section, you will be able to understand various terminologies relating to mergers and acquisitions. These terminologies are frequently used in the later part of this book. 1.3.1 Merger Merger is defined as a combination of two or more companies into a single company where one survives and the others lose their corporate existence. The survivor company acquires the assets as well as liabilities of the merged company or companies. Generally the company which survives is the buyer which retains its identity and Seller Company is extinguished. All assets, liabilities and stock of one company stand transferred to Transferee Company in consideration of payment in the form of Equity, Debt or Cash modes 1.3.2 Amalgamation One or more companies may merge to form a new company. It contemplates a state of things under which two companies are so joined as to form a third entity. One company is absorbed into and blended with another company. The Company Act 1956 vides section 394 and 396A, explains amalgamation which will be discussed separately under legal aspects of merger. However, the term will be used interchangeably with ‘Merger’ whenever the circumstances would so require. 1.3.3 Consolidation Consolidation is Fusion (convergence) of two existing companies into a new company in which both the existing companies extinguish. It is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and ease to exist. In a narrow sense, the term
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amalgamation and consolidation are sometimes used interchangeably. HCL LTD – Hindustan Computers, Hindustan Instruments, Indian Software Company and Indian Reprographics Ltd merged in 1986 to form HCL Ltd. All Assets, Liabilities and Stocks of the Consolidating companies stand transferred to new company for consideration. 1.3.4 Combination It refers to mergers and consolidations as a common term used interchangeably, but carrying legally distinct interpretation. All mergers, acquisitions and amalgamations are business combination. 1.3.5 Holding Company The main criteria of becoming holding company is the control in the composition of the Board of Directors in another company and such control should emerge from holding of equity shares and thereby more than 50% of the total voting power of such company. That is, a Company can obtain the status of a holding company by acquiring shares of other companies. A holding company is a company which holds more than half of the nominal value of the equity capital of another company, called subsidiary company. Both holding and subsidiary companies retain their separate legal entities and maintain their separate books of accounts. 1.3.6 Acquisition Acquisition is an act of acquiring effective control by one company over assets or management of another company, without any combination of companies. Thus, in an acquisition, two or more companies may remain independent, separate legal entity, but there may be change in control of company. An acquisition may be affected by: o Agreement with the persons holding majority interest in a company management (BOD/ Shareholder) o Purchase of shares in open market o To make take-over to the general body of share holders o Purchase of new shares by private treaty o Acquisition of share capital of one company by either all or any of the following forms: cash, insurance of loan capital, and share capital. 1.3.7 Takeover A take-over is acquisition and both the terms are used interchangeably. Takeover is nothing but obtaining of control over management of company
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by other. A Company can have effective control over another by holding minority ownership. The process of take over is unilateral and the offeror company decides about the maximum price. Time taken in completion of transaction is less in take-over than in mergers. Under MRTP Act, Takeover means acquisition of not less than 25% of the voting power in a company. Section 372 of the Companies Act 1956 defines the limit of a company’s investment in the share of another company. If a company wants to invest in more than 10% of the subscribed capital of another company, it has to be approved in the shareholders’ general meeting and also by the Central Government. The investment in shares of other companies in excess of 10% of subscribed capital can result into their takeovers. 1.3.8 Restructuring It is re-organizing through changing location of capital investment, use of super technology and displacement of labour altering capital base etc with a view to improve the performance. 1.3.9 De-merger or Corporate Split Or Division It is just opposite to combination. Division of a company takes place when part of its undertaking is transferred to newly formed company or to an existing company. I. Self Assessment Questions 1. State how a business firm can achieve growth internally and externally. _________________________________________________________ _________________________________________________________ 2. Quote the best Indian examples for consolidation. _________________________________________________________ _________________________________________________________ 3. Define Holding Company. _________________________________________________________ _________________________________________________________ 4. Takeover means: _________________________________________________________ _________________________________________________________
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1.4 Motives behind Mergers
The primary objectives of Mergers & Acquisition are diversification, market expansion, improving competitive position etc. Generally, two or more firms have to act for merger. One of them is the buyer and the other is the seller. Both these firms have motives for combination. A different rationale can be assigned at both individual and collective levels which influence sellers and buyers to opt for Mergers and Acquisition. 1.4.1 The Buyers Motives The motivations for buyers are as follows: o To increase the value of the firm’s stock – that is, mergers often lead to increase in stock price and/or Price Earning ratio o To increase the growth rate of the firm o To make a good investment – a firm may make better use of funds by purchasing instead of ploughing the same funds into internal expansion o To improve the stability of the firms’ earnings and sales. This is done by acquiring firm’s whose earnings and sales complement the firm’s peak and valleys o To balance or fill out the product line o To diversify the product line when the current products have reached their peak in the life cycle o To reduce competition by purchasing a competitor o To acquire a needful resource quickly. For eg. High-quality technology or highly innovative management o For tax reasons- it may be desirable to purchase a firm with prior tax losses which will offset current or future earnings o To increase efficiency and profitability, especially if there is synergy between the two companies 1.4.2 The Sellers’ Motives The motivations for sellers are as follows: o To increase the value of the owner’s stock and investment in the firm o To increase the firm’s growth rate by receiving more resources from the acquiring company o To acquire resources to stabilize operations and make them more efficient o For tax reasons – if the firm is owned by a family or an individual, a merger makes it easier to deal with estate tax problems
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o o
To help diversify the owning family’s holdings beyond the present firm To deal with top management problems such as Management Succession for an entrepreneur or dissension among top managers
1.5 Advantages of Mergers & Acquisitions
The most common advantages of mergers and acquisitions are: Maintaining or accelerating profitable growth of a company Enhancing profitability through cost reduction resulting from: o Economies of scale o Operating Efficiency o Synergy Diversifying the risk of the company by the way of acquiring the business of different income streams Reducing tax liability by the way of setting off accumulated losses or unabsorbed depreciation of one company against the profits of another Enhancing the market power of the company
1.6 Theories of Mergers
1.6.1 Operating This theory postulates that the reason for M&A is the resultant operating synergy or operating economies of scale. This theory can be applied to vertical, horizontal and conglomerate M&As. The theory based on operating synergy assumes that economies of scale do exist in the industry and prior to the merger, the firms are operating at levels of activities that fall short of achieving the potentials for economies of scale. Economies of scale arise because of indivisibilities, such as people, equipment and overhead, which provide increasing returns if spread over large no. of units of output. Thus manufacturing operations, heavy investments in plant and equipment typically produce such economies. 1.6.2 Financial This theory postulates that the purpose of mergers and acquisitions is to: Improve liquidity and have direct access to cash resources Dispose of surplus and outdated assets for cash out of combined enterprises Enhance gearing capacity, borrow on better strength and greater assets backing
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Avail of tax benefits Improve Earning Per Share
1.6.3 Managerial synergy of mergers This theory says that if a firm is merged with or taken-over by another firm with better managerial efficiency, the overall managerial efficiency will be improved to the level of the efficient firm. This theory suggests that M & A occurs mostly in respect of firms in similar kinds of business. This would be a social gain as well as private gain. The level of efficiency in the economy would be raised by such mergers. One difficulty in the differential efficiency theory is that, if carried to its extreme, it would result in only one firm in the economy, indeed in the world – the firm with the greatest managerial efficiency. As per this theory, a merger between the two firms will be synergistic since it combines the non-managerial organization capital of the acquired firm with the excess managerial resources of the acquiring firm. II. Self Assessment Questions 1. State important buyer’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 2. State important Seller’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 3. List the economic advantage of mergers and acquisitions _________________________________________________________ _________________________________________________________ _________________________________________________________
1.7 Types of Merger
1.7.1 Vertical Combination It is a process of joining of two or more companies involved in different stages of the production or distribution of the same product or service. That is, two or more companies which are engaged in the production of same goods or services but different stages of production or services join together. Merger of Coal Mining and Railway Company is the best example
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in which new product/services which are complementary to existing product/ services is added. The essential objective of such merger is: To ensure a ready market for the goods & services produced To ensure a source of supply required for production of goods or services To gain a strong position because of imperfect market of intermediary products, scarcity of resources To control over product specification The various types of vertical combination are as explained below: 1. Backward Integration Such combination occurs when the firms acquire or create a company that supplies the firm the raw materials or components and other inputs. 2. Forward Vertical Integration Such combination occurs when the firms acquire or create a company that purchases its products/ services. The above concept of integration of firms can be depicted as below:
Petroleum Exploration
Backward Linkage
Petroleum Production
Backward Linkage
Refining
Original Company
Sales to Wholesaler/Dealers
Forward Linkage
Sales to Retailers Figure 1.1
Forward Linkage
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1.7.2 Horizontal Combination This is the joining of two or more companies in same area of business. In this type of combination, two or more companies which are producing essentially the same product or providing the same services or which are in direct competition with each other join together. The combination of ACC Ltd is the best example to quote here. Such merger results in: Economies of scale Operational economies Elimination of duplication facilities Reduces competition and number of Companies Reduction in investment in working capital, advertisement cost etc To have greater access to channels of distribution
1.7.3 Conglomerate Merger This is joining of two or more companies whose businesses are not related with each other either vertically or horizontally. The companies involved in merger under this mode may be engaged in totally different lines of business. It is like Manufacturing Company acquiring Insurance Company. Eg. Gujarat Gas Ltd & Gujarat Finance Co. Ltd. The basic objectives of conglomerate mergers are: Diversification of Activities Reduction of Risk Economies of Large Scale Operations Financial Stabilities Increase in profits Attain managerial competence
There are various types of conglomerate mergers in practice. They are: 1. Financial Conglomerate: The important features of financial conglomerate is: Provide a flow of funds to each segment of their operations, exercise control Undertake strategic planning but do not participate in operating decisions Serve at least five distinct economic functions: Improve risk-return ratios through diversifications
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Avoid ‘gamblers ruin’ – an adverse run of losses which might cause bankruptcy Establish programme of financial planning & control Improve resource allocation to perform efficiently Divert internal cash flows from the unfavourable areas to more attractive areas
2. Managerial Conglomerate: The managerial conglomerate not only assumes financial responsibility and control, but also plays a role in operating decisions and provides staff enterprise and staff services to the operating entities. By providing managerial counsel and interactions on decision, managerial conglomerates increase the potential for improving performance. General management functions (planning, organizing etc) are in reality transferable to all types of business firms. When any two firms of unequal competence are combined, the total performance of the combined firm will be greater than the sum of the individual part. This defines SYNERGY in its most general forms. These economic benefits are achieved through corporate head quarters. 1.7.4 Concentric Merger Concentric merger is combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. For example, combination of firms producing Television, Washing Machines and Kitchen Appliances come under the concept of concentric merger. The important benefits of concentric mergers are: Reducing of Risks Economies of large scale operations Financial stability Increase in profit Attain managerial competence The important reasons for adopting conglomerate strategy are: Achieve higher growth rate than expansion Effective use of Financial Resources Avail potential opportunities of profitable investments Achieve competitive advantage and stability Improve P/E Ratio and bring out higher market price of shares
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1.7.5 Circular Combination Under this combination, companies producing distinct products seek amalgamation to share common distribution and research facilities so as to obtain economies by elimination of cost on duplication & promoting market enlargement. Acquiring company obtains benefits in the form of economies of resource sharing and diversification. III. Self Assessment Questions 1. Give an example of Vertical Combination _________________________________________________________ 2. Give an example of Horizontal Combination _________________________________________________________ 3. Give an example of Backward and Forward integration _________________________________________________________ 4. List the objectives of Conglomerate mergers _________________________________________________________ _________________________________________________________ 5. Combination of Cement Industry with Chemical Industry is the best example for concentric merger. Yes / No
1.8 Value Creation in Mergers
The value creation in mergers is due to synergic effect. Following are the important synergies that take place in merger and acquisition process if planned strategically. o Marketing Synergy This occurs when products use common distribution channels, sales promotion and sales administration o Operating Synergy Operating synergy is realized by better utilization of facilities, personnel, and economies in purchasing etc o Investment Synergy This can result from the use of same production facilities, technology materials etc o Management Synergy Management synergy exists if the existing managerial expertise of the company will be an added advantage of the new business
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The effective implementation of above synergies in merger in turn creates value to the business firms
1.9 Role of industry life cycle
The stage of industry life cycle has an impact on mergers and acquisition process. The influence of various industry life cycles on mergers and acquisitions activities are explained here below: 1.9.1 Introduction Stage In this stage, newly created firms may sell to outside larger firms in a mature or declining industry thereby enabling larger firms to enter a new growth industry. This results in related or conglomerate merger. The smaller firms may wish to sell because they want to convert personal income to capital gain and because they do not want to place large investments in the hands of managers that do not have a long record of success. The horizontal merger between smaller firms may also occur, enabling such firms to pool management and capital resources. 1.9.2 Exploitation Stage Mergers during the exploitation stage are similar to mergers during the introductory stage. The impetus for such mergers is reinforced by the more visible indications of prospective growth and profit and by the large capital requirements of a higher growth rate. 1.9.3 Maturity Stage Mergers in this stage are undertaken to achieve economies of scale in research, production and marketing, in order to match the low cost and price performance of other firms – domestic or foreign. Some acquisition of smaller firms by larger firms takes place for the purposes of rounding out the management skills of the smaller firms and providing them with a broader financial base. 1.9.4 Decline Stage In this stage, horizontal mergers are undertaken to ensure survival. Vertical mergers are also carried out to increase efficiency and profit margins. Concentric mergers involving firms in related industries provide opportunities for synergy and carry over. Conglomerate acquisitions of firms in growth industries are undertaken to utilize the accumulating cash position
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of mature firms in declining industries whose internal flow of funds exceeds the investment requirements of their traditional lines of business. Successful Acquisition process A. Siemens’ acquisition of Plessey Siemens of Germany, in a joint bid with GEC of the UK for the British company Plessey in 1989, acquired Plessey’s electronic system (PES) and air control traffic systems and management (ATM). According to the senior executives of these two Plessey companies, they had been starved of capital investment funds, equipment, and testing and design facilities by Plessey before the acquisition. Plessey also used to operate with a short payback period of only two years. Siemens handled integration with great care. The Plessey companies were given a great deal of autonomy. ATM was made into a world centre. Initially, Siemens used a German consultant on a British cost-reduction project, causing some resentment among the UK managers. Subsequently, however, Siemens allowed the UK companies to choose their own consultants. UK managers were sent to Germany for intercultural training. The British senior executives feel that without Siemens their company would not have survived, and appreciate the greater autonomy and long-term financial support they have received from Siemens.(Financial Times, (13.4.1994). B. Nestle’s takeover of Rowntree: Nestle, the Swiss food and confectionery giant, took over the much respected Rowntree, the York-based confectioner, in a bitter hostile bid in 1988. This bid aroused a great deal of resistance from the Rowntree workforce, and a political storm, with calls for a reference to the Monopolies and Mergers Commission. Nestle approached the integration task with considerable care and sensitivity. Whereas it would normally take two to three years to integrate an acquisition fully, with Rowntree it took four years. Although Nestle assured Rowntree at the time of bid that its global confectionery strategy would be run from York, the assurance was not kept. However, York has become a global research centre for confectionery. There have been heavy capital investments in Rowntree since the takeover. There have been job losses, but there has also been increased productivity. Nestle having neglected the confectionery business of its own, needed Rowntree ‘s
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expertise and brands. It has therefore left Rowntree under the charge of UK managers. Further there has been a flow of managers between Rowntree and the rest of Nestle group, with some of the old Rowntree managers holding global position in Zurich. This two-way flow of managers , the heavy investment the higher profile of Rowntree in Nestle’s global strategy and the degree of autonomy given to Rowntree have all combined to lessen the suspicion and hostility which accompanied the takeover in 1988(Financial Times, 20.4.1994).
1.10 Summary
The growth of a firm can be achieved either internally (new product development or expansion etc) or externally (mergers and acquisition). Merger is the combination of two or more firms into one of the firms whereas an amalgamation involves the combination of two or more firms to form a new firm. Merger could be horizontal, vertical or conglomerate. Merger benefits may result from economies of scale, economies of vertical integration, increased efficiency, tax shields or share resources. Mergers and acquisitions have become universal corporate practice for securing survival, growth, expansion and globalization of the enterprise.
1.11 Terminal Questions
1. How can a business firm achieve growth internally and externally? 2. Explain the concept of Mergers, Acquisition and Amalgamation. 3. What are the different types of mergers? 4. Explain the important theories of merger. 5. What are the motives behind mergers and acquisitions? 6. What are the economic advantages from merger? 7. Differentiate between horizontal and vertical merger. 8. Explain the various types of mergers at different stages of industry life cycle.
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1.12 Answers to SAQs and TQs
SAQs I 1. Refer to Section 1.1 2. HCL Ltd. 3. Refer to Section 1.2.5 4. Refer to Section 1.2.7 II 1. Refer to Section 1.3.1 2. Refer to Section 1.3.2 3. Refer to Section 1.4 Coal Mining and Railway Company ACC Ltd Refer to Section 1.6.1A and 1.6.1B Refer to Section 1.6.3 No
III 1. 2. 3. 4. 5.
TQs 1. Refer to Section 1.2 2. Refer to Section 1.3 3. Refer to Section 1.7 4. Refer to Section 1.6 5. Refer to Section 1.4 6. Refer to Section 1.5 7. Refer to Section 1.7.1 and 1.7.2 8. Refer to Section 1.9
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Unit 1
Introduction to Mergers & Acquisitions
Structure 1.1 Introduction Objectives 1.2 Background 1.3 Meaning Self Assessment Questions 1.4 Motives behind Mergers 1.5 Advantages of Mergers & Acquisitions 1.6 Theories of mergers Operating Financial Managerial synergy of mergers Self Assessment Questions 1.7 Types of Merger Self Assessment Questions 1.8 Value creation of Mergers 1.9 Role of industry Life Cycle Introduction Stage Exploitation Stage Maturity Stage Decline Stage 1.10 Summary 1.11 Terminal Questions 1.12 Answers to SAQ’s & TQ’s
1.1 Introduction
This unit introduces the background of corporate mergers and acquisition and also explains the concept of mergers and acquisition. To start with, you need to know why the corporate go for mergers and the rationale behind such mergers and acquisition. You will also able to understand about the various forms of mergers and acquisition in this unit.
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Objectives After studying this unit, you should be able to Define the concept of mergers and acquisition Discuss the motives behind mergers Describe theories of mergers Discuss about the forms of mergers and acquisition
1.2 Background
Merger and acquisition are the most popular means of corporate restructuring. The current upswing in activity in the domestic market as well as in the global markets proves that strong conceptual and technical skills are required for anyone working in the field. Mergers and acquisitions have happened in history in the last 100 years. Both America and Europe have experienced the spectacular wave of mergers and acquisitions in recent days. In the US, the merger waves started: between 1890-1904 at the end of World War I during later part of II World War and continues to the present day.
As a result of globalization, today the business firms are operating in highly competitive environment. In today’s business world, profitable growth constitutes one of the prime objectives of the business organizations. It can be achieved in two different methods: Internal o Through the process of introducing or developing new products o By expanding or enlarging capacity of the existing product(s). External o By acquisitions of existing business firms in the form of mergers, acquisitions, amalgamations, takeovers, absorption, consolidation etc.
Both of the above methods have their own strengths and weaknesses. In the competitive world, the growth of the firm should be quick and sustainable. The internal growth usually involves a longer implementation period and also entails greater uncertainties. The external growth expedites the pace of growth as the acquired firm already has the facilities or market
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acceptable products. Hence, a growing firm may be in constant search for identifying potential firms which may be merged. The firm will opt for merger if it maximizes the wealth of shareholders. M & A have become universal practice in the corporate world for securing survival, growth, expansion and globalization of the enterprises and achieving multitude of objectives. M & A have started taking place in India in the recent years. A number of mega mergers and hostile takeovers could be witnessed in India now.
1.3 Meaning of Terms
In this section, you will be able to understand various terminologies relating to mergers and acquisitions. These terminologies are frequently used in the later part of this book. 1.3.1 Merger Merger is defined as a combination of two or more companies into a single company where one survives and the others lose their corporate existence. The survivor company acquires the assets as well as liabilities of the merged company or companies. Generally the company which survives is the buyer which retains its identity and Seller Company is extinguished. All assets, liabilities and stock of one company stand transferred to Transferee Company in consideration of payment in the form of Equity, Debt or Cash modes 1.3.2 Amalgamation One or more companies may merge to form a new company. It contemplates a state of things under which two companies are so joined as to form a third entity. One company is absorbed into and blended with another company. The Company Act 1956 vides section 394 and 396A, explains amalgamation which will be discussed separately under legal aspects of merger. However, the term will be used interchangeably with ‘Merger’ whenever the circumstances would so require. 1.3.3 Consolidation Consolidation is Fusion (convergence) of two existing companies into a new company in which both the existing companies extinguish. It is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and ease to exist. In a narrow sense, the term
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amalgamation and consolidation are sometimes used interchangeably. HCL LTD – Hindustan Computers, Hindustan Instruments, Indian Software Company and Indian Reprographics Ltd merged in 1986 to form HCL Ltd. All Assets, Liabilities and Stocks of the Consolidating companies stand transferred to new company for consideration. 1.3.4 Combination It refers to mergers and consolidations as a common term used interchangeably, but carrying legally distinct interpretation. All mergers, acquisitions and amalgamations are business combination. 1.3.5 Holding Company The main criteria of becoming holding company is the control in the composition of the Board of Directors in another company and such control should emerge from holding of equity shares and thereby more than 50% of the total voting power of such company. That is, a Company can obtain the status of a holding company by acquiring shares of other companies. A holding company is a company which holds more than half of the nominal value of the equity capital of another company, called subsidiary company. Both holding and subsidiary companies retain their separate legal entities and maintain their separate books of accounts. 1.3.6 Acquisition Acquisition is an act of acquiring effective control by one company over assets or management of another company, without any combination of companies. Thus, in an acquisition, two or more companies may remain independent, separate legal entity, but there may be change in control of company. An acquisition may be affected by: o Agreement with the persons holding majority interest in a company management (BOD/ Shareholder) o Purchase of shares in open market o To make take-over to the general body of share holders o Purchase of new shares by private treaty o Acquisition of share capital of one company by either all or any of the following forms: cash, insurance of loan capital, and share capital. 1.3.7 Takeover A take-over is acquisition and both the terms are used interchangeably. Takeover is nothing but obtaining of control over management of company
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by other. A Company can have effective control over another by holding minority ownership. The process of take over is unilateral and the offeror company decides about the maximum price. Time taken in completion of transaction is less in take-over than in mergers. Under MRTP Act, Takeover means acquisition of not less than 25% of the voting power in a company. Section 372 of the Companies Act 1956 defines the limit of a company’s investment in the share of another company. If a company wants to invest in more than 10% of the subscribed capital of another company, it has to be approved in the shareholders’ general meeting and also by the Central Government. The investment in shares of other companies in excess of 10% of subscribed capital can result into their takeovers. 1.3.8 Restructuring It is re-organizing through changing location of capital investment, use of super technology and displacement of labour altering capital base etc with a view to improve the performance. 1.3.9 De-merger or Corporate Split Or Division It is just opposite to combination. Division of a company takes place when part of its undertaking is transferred to newly formed company or to an existing company. I. Self Assessment Questions 1. State how a business firm can achieve growth internally and externally. _________________________________________________________ _________________________________________________________ 2. Quote the best Indian examples for consolidation. _________________________________________________________ _________________________________________________________ 3. Define Holding Company. _________________________________________________________ _________________________________________________________ 4. Takeover means: _________________________________________________________ _________________________________________________________
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1.4 Motives behind Mergers
The primary objectives of Mergers & Acquisition are diversification, market expansion, improving competitive position etc. Generally, two or more firms have to act for merger. One of them is the buyer and the other is the seller. Both these firms have motives for combination. A different rationale can be assigned at both individual and collective levels which influence sellers and buyers to opt for Mergers and Acquisition. 1.4.1 The Buyers Motives The motivations for buyers are as follows: o To increase the value of the firm’s stock – that is, mergers often lead to increase in stock price and/or Price Earning ratio o To increase the growth rate of the firm o To make a good investment – a firm may make better use of funds by purchasing instead of ploughing the same funds into internal expansion o To improve the stability of the firms’ earnings and sales. This is done by acquiring firm’s whose earnings and sales complement the firm’s peak and valleys o To balance or fill out the product line o To diversify the product line when the current products have reached their peak in the life cycle o To reduce competition by purchasing a competitor o To acquire a needful resource quickly. For eg. High-quality technology or highly innovative management o For tax reasons- it may be desirable to purchase a firm with prior tax losses which will offset current or future earnings o To increase efficiency and profitability, especially if there is synergy between the two companies 1.4.2 The Sellers’ Motives The motivations for sellers are as follows: o To increase the value of the owner’s stock and investment in the firm o To increase the firm’s growth rate by receiving more resources from the acquiring company o To acquire resources to stabilize operations and make them more efficient o For tax reasons – if the firm is owned by a family or an individual, a merger makes it easier to deal with estate tax problems
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o o
To help diversify the owning family’s holdings beyond the present firm To deal with top management problems such as Management Succession for an entrepreneur or dissension among top managers
1.5 Advantages of Mergers & Acquisitions
The most common advantages of mergers and acquisitions are: Maintaining or accelerating profitable growth of a company Enhancing profitability through cost reduction resulting from: o Economies of scale o Operating Efficiency o Synergy Diversifying the risk of the company by the way of acquiring the business of different income streams Reducing tax liability by the way of setting off accumulated losses or unabsorbed depreciation of one company against the profits of another Enhancing the market power of the company
1.6 Theories of Mergers
1.6.1 Operating This theory postulates that the reason for M&A is the resultant operating synergy or operating economies of scale. This theory can be applied to vertical, horizontal and conglomerate M&As. The theory based on operating synergy assumes that economies of scale do exist in the industry and prior to the merger, the firms are operating at levels of activities that fall short of achieving the potentials for economies of scale. Economies of scale arise because of indivisibilities, such as people, equipment and overhead, which provide increasing returns if spread over large no. of units of output. Thus manufacturing operations, heavy investments in plant and equipment typically produce such economies. 1.6.2 Financial This theory postulates that the purpose of mergers and acquisitions is to: Improve liquidity and have direct access to cash resources Dispose of surplus and outdated assets for cash out of combined enterprises Enhance gearing capacity, borrow on better strength and greater assets backing
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Avail of tax benefits Improve Earning Per Share
1.6.3 Managerial synergy of mergers This theory says that if a firm is merged with or taken-over by another firm with better managerial efficiency, the overall managerial efficiency will be improved to the level of the efficient firm. This theory suggests that M & A occurs mostly in respect of firms in similar kinds of business. This would be a social gain as well as private gain. The level of efficiency in the economy would be raised by such mergers. One difficulty in the differential efficiency theory is that, if carried to its extreme, it would result in only one firm in the economy, indeed in the world – the firm with the greatest managerial efficiency. As per this theory, a merger between the two firms will be synergistic since it combines the non-managerial organization capital of the acquired firm with the excess managerial resources of the acquiring firm. II. Self Assessment Questions 1. State important buyer’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 2. State important Seller’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 3. List the economic advantage of mergers and acquisitions _________________________________________________________ _________________________________________________________ _________________________________________________________
1.7 Types of Merger
1.7.1 Vertical Combination It is a process of joining of two or more companies involved in different stages of the production or distribution of the same product or service. That is, two or more companies which are engaged in the production of same goods or services but different stages of production or services join together. Merger of Coal Mining and Railway Company is the best example
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in which new product/services which are complementary to existing product/ services is added. The essential objective of such merger is: To ensure a ready market for the goods & services produced To ensure a source of supply required for production of goods or services To gain a strong position because of imperfect market of intermediary products, scarcity of resources To control over product specification The various types of vertical combination are as explained below: 1. Backward Integration Such combination occurs when the firms acquire or create a company that supplies the firm the raw materials or components and other inputs. 2. Forward Vertical Integration Such combination occurs when the firms acquire or create a company that purchases its products/ services. The above concept of integration of firms can be depicted as below:
Petroleum Exploration
Backward Linkage
Petroleum Production
Backward Linkage
Refining
Original Company
Sales to Wholesaler/Dealers
Forward Linkage
Sales to Retailers Figure 1.1
Forward Linkage
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1.7.2 Horizontal Combination This is the joining of two or more companies in same area of business. In this type of combination, two or more companies which are producing essentially the same product or providing the same services or which are in direct competition with each other join together. The combination of ACC Ltd is the best example to quote here. Such merger results in: Economies of scale Operational economies Elimination of duplication facilities Reduces competition and number of Companies Reduction in investment in working capital, advertisement cost etc To have greater access to channels of distribution
1.7.3 Conglomerate Merger This is joining of two or more companies whose businesses are not related with each other either vertically or horizontally. The companies involved in merger under this mode may be engaged in totally different lines of business. It is like Manufacturing Company acquiring Insurance Company. Eg. Gujarat Gas Ltd & Gujarat Finance Co. Ltd. The basic objectives of conglomerate mergers are: Diversification of Activities Reduction of Risk Economies of Large Scale Operations Financial Stabilities Increase in profits Attain managerial competence
There are various types of conglomerate mergers in practice. They are: 1. Financial Conglomerate: The important features of financial conglomerate is: Provide a flow of funds to each segment of their operations, exercise control Undertake strategic planning but do not participate in operating decisions Serve at least five distinct economic functions: Improve risk-return ratios through diversifications
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Avoid ‘gamblers ruin’ – an adverse run of losses which might cause bankruptcy Establish programme of financial planning & control Improve resource allocation to perform efficiently Divert internal cash flows from the unfavourable areas to more attractive areas
2. Managerial Conglomerate: The managerial conglomerate not only assumes financial responsibility and control, but also plays a role in operating decisions and provides staff enterprise and staff services to the operating entities. By providing managerial counsel and interactions on decision, managerial conglomerates increase the potential for improving performance. General management functions (planning, organizing etc) are in reality transferable to all types of business firms. When any two firms of unequal competence are combined, the total performance of the combined firm will be greater than the sum of the individual part. This defines SYNERGY in its most general forms. These economic benefits are achieved through corporate head quarters. 1.7.4 Concentric Merger Concentric merger is combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. For example, combination of firms producing Television, Washing Machines and Kitchen Appliances come under the concept of concentric merger. The important benefits of concentric mergers are: Reducing of Risks Economies of large scale operations Financial stability Increase in profit Attain managerial competence The important reasons for adopting conglomerate strategy are: Achieve higher growth rate than expansion Effective use of Financial Resources Avail potential opportunities of profitable investments Achieve competitive advantage and stability Improve P/E Ratio and bring out higher market price of shares
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1.7.5 Circular Combination Under this combination, companies producing distinct products seek amalgamation to share common distribution and research facilities so as to obtain economies by elimination of cost on duplication & promoting market enlargement. Acquiring company obtains benefits in the form of economies of resource sharing and diversification. III. Self Assessment Questions 1. Give an example of Vertical Combination _________________________________________________________ 2. Give an example of Horizontal Combination _________________________________________________________ 3. Give an example of Backward and Forward integration _________________________________________________________ 4. List the objectives of Conglomerate mergers _________________________________________________________ _________________________________________________________ 5. Combination of Cement Industry with Chemical Industry is the best example for concentric merger. Yes / No
1.8 Value Creation in Mergers
The value creation in mergers is due to synergic effect. Following are the important synergies that take place in merger and acquisition process if planned strategically. o Marketing Synergy This occurs when products use common distribution channels, sales promotion and sales administration o Operating Synergy Operating synergy is realized by better utilization of facilities, personnel, and economies in purchasing etc o Investment Synergy This can result from the use of same production facilities, technology materials etc o Management Synergy Management synergy exists if the existing managerial expertise of the company will be an added advantage of the new business
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The effective implementation of above synergies in merger in turn creates value to the business firms
1.9 Role of industry life cycle
The stage of industry life cycle has an impact on mergers and acquisition process. The influence of various industry life cycles on mergers and acquisitions activities are explained here below: 1.9.1 Introduction Stage In this stage, newly created firms may sell to outside larger firms in a mature or declining industry thereby enabling larger firms to enter a new growth industry. This results in related or conglomerate merger. The smaller firms may wish to sell because they want to convert personal income to capital gain and because they do not want to place large investments in the hands of managers that do not have a long record of success. The horizontal merger between smaller firms may also occur, enabling such firms to pool management and capital resources. 1.9.2 Exploitation Stage Mergers during the exploitation stage are similar to mergers during the introductory stage. The impetus for such mergers is reinforced by the more visible indications of prospective growth and profit and by the large capital requirements of a higher growth rate. 1.9.3 Maturity Stage Mergers in this stage are undertaken to achieve economies of scale in research, production and marketing, in order to match the low cost and price performance of other firms – domestic or foreign. Some acquisition of smaller firms by larger firms takes place for the purposes of rounding out the management skills of the smaller firms and providing them with a broader financial base. 1.9.4 Decline Stage In this stage, horizontal mergers are undertaken to ensure survival. Vertical mergers are also carried out to increase efficiency and profit margins. Concentric mergers involving firms in related industries provide opportunities for synergy and carry over. Conglomerate acquisitions of firms in growth industries are undertaken to utilize the accumulating cash position
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of mature firms in declining industries whose internal flow of funds exceeds the investment requirements of their traditional lines of business. Successful Acquisition process A. Siemens’ acquisition of Plessey Siemens of Germany, in a joint bid with GEC of the UK for the British company Plessey in 1989, acquired Plessey’s electronic system (PES) and air control traffic systems and management (ATM). According to the senior executives of these two Plessey companies, they had been starved of capital investment funds, equipment, and testing and design facilities by Plessey before the acquisition. Plessey also used to operate with a short payback period of only two years. Siemens handled integration with great care. The Plessey companies were given a great deal of autonomy. ATM was made into a world centre. Initially, Siemens used a German consultant on a British cost-reduction project, causing some resentment among the UK managers. Subsequently, however, Siemens allowed the UK companies to choose their own consultants. UK managers were sent to Germany for intercultural training. The British senior executives feel that without Siemens their company would not have survived, and appreciate the greater autonomy and long-term financial support they have received from Siemens.(Financial Times, (13.4.1994). B. Nestle’s takeover of Rowntree: Nestle, the Swiss food and confectionery giant, took over the much respected Rowntree, the York-based confectioner, in a bitter hostile bid in 1988. This bid aroused a great deal of resistance from the Rowntree workforce, and a political storm, with calls for a reference to the Monopolies and Mergers Commission. Nestle approached the integration task with considerable care and sensitivity. Whereas it would normally take two to three years to integrate an acquisition fully, with Rowntree it took four years. Although Nestle assured Rowntree at the time of bid that its global confectionery strategy would be run from York, the assurance was not kept. However, York has become a global research centre for confectionery. There have been heavy capital investments in Rowntree since the takeover. There have been job losses, but there has also been increased productivity. Nestle having neglected the confectionery business of its own, needed Rowntree ‘s
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expertise and brands. It has therefore left Rowntree under the charge of UK managers. Further there has been a flow of managers between Rowntree and the rest of Nestle group, with some of the old Rowntree managers holding global position in Zurich. This two-way flow of managers , the heavy investment the higher profile of Rowntree in Nestle’s global strategy and the degree of autonomy given to Rowntree have all combined to lessen the suspicion and hostility which accompanied the takeover in 1988(Financial Times, 20.4.1994).
1.10 Summary
The growth of a firm can be achieved either internally (new product development or expansion etc) or externally (mergers and acquisition). Merger is the combination of two or more firms into one of the firms whereas an amalgamation involves the combination of two or more firms to form a new firm. Merger could be horizontal, vertical or conglomerate. Merger benefits may result from economies of scale, economies of vertical integration, increased efficiency, tax shields or share resources. Mergers and acquisitions have become universal corporate practice for securing survival, growth, expansion and globalization of the enterprise.
1.11 Terminal Questions
1. How can a business firm achieve growth internally and externally? 2. Explain the concept of Mergers, Acquisition and Amalgamation. 3. What are the different types of mergers? 4. Explain the important theories of merger. 5. What are the motives behind mergers and acquisitions? 6. What are the economic advantages from merger? 7. Differentiate between horizontal and vertical merger. 8. Explain the various types of mergers at different stages of industry life cycle.
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1.12 Answers to SAQs and TQs
SAQs I 1. Refer to Section 1.1 2. HCL Ltd. 3. Refer to Section 1.2.5 4. Refer to Section 1.2.7 II 1. Refer to Section 1.3.1 2. Refer to Section 1.3.2 3. Refer to Section 1.4 Coal Mining and Railway Company ACC Ltd Refer to Section 1.6.1A and 1.6.1B Refer to Section 1.6.3 No
III 1. 2. 3. 4. 5.
TQs 1. Refer to Section 1.2 2. Refer to Section 1.3 3. Refer to Section 1.7 4. Refer to Section 1.6 5. Refer to Section 1.4 6. Refer to Section 1.5 7. Refer to Section 1.7.1 and 1.7.2 8. Refer to Section 1.9
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