Merging Companies

Forms of Business Combination

Definition: It is a transaction or other event in which an acquirer obtains control of
one or more businesses.

Three forms of business combination used by firms to restructure include:

1. Merger
2. Consolidation
3. Holding Company

Within the past few years, hardly a day passes without a story in the media about a
merger, consolidation or holding companies. The phenomenon has largely been the
result of industries needing to become more competitive in the world markets.

1. Mergers and Acquisitions

MERGER occurs when one corporation takes over all the operations of another
business entity and that other entity is dissolved.

An ACQUISITION is the purchase of one firm by another.

The main difference between a merger and an acquisition lies in the way in
which the combination of the two companies is brought a bout.

In a merger there is usually a process of negotiate ion involved between the

two companies prior to the combination taking place. In an acquisition the
negotiation process does not necessarily take place.

Acquisitions can be:

Friendly
- In the case of a friendly acquisition the target is willing to be acquired. The
target may view the acquisition as an opportunity to develop into new areas
and use the resources offered by the acquirer. This happens particularly in
the case of small successful companies that wish to develop and expand
but are held back by a lack of capital. The smaller company may actively
seek out a larger partner willing to provide the necessary investment. In this
scenario the acquisition is sometimes referred to as a friendly or agreed
acquisition.

Hostile
- Alternatively, the acquisition may be hostile. In this case the target is
opposed to the acquisition. Hostile acquisitions are sometimes referred to
as hostile takeovers. In most cases the acquirer acquires the target by
 buying its shares. The acquirer buys shares from the targets shareholders
up to a point where it becomes the owner. Achieving ownership may require
purchase of all of the target shares or a majority of them. Different
countries have different laws and regulations on what defines target
ownership.

Despite these two distinct definitions, the two terms, mergers and acquisition,
are often used interchangeably. Typically, in a merger or acquisition the
acquiring firm retains its identity while the target firm ceases to exist. Merger is
said to occur when two or more companies are involved in exchange or
securities and only one company survives. As a result of a merger, one
company survives and the others lose their independent identity.

Motives of Merging

Firms merge to fulfill certain objectives. The main goal actually is the
maximization of the owners wealth as reflected in the acquirers share price.
More specific motives include:

1. Growth or Diversification

Companies desire for rapid growth in size or market share or

diversification in the range of their products. Instead of going through
the time-consuming process of internal growth or diversification the
same way, enter into merger with existing firm. Moreover, when a firm
expands by acquiring another firm, it also removes a potential
competitor.

2. Synergy
It is the main motivation for a merger wherein two firms work together
to produce a combined value that is greater the sum of their individual
values (it is like making 1 + 1 = 3). Thus, lowering combined overhead.
It is most obvious when firms merge with other firms in the same line of
business.
3. Fund-raising
Firms combine to enhance their fund-raising ability. One firm may
combine with another that has high liquid assets and low levels of
liabilities.
4. Increased Managerial Skill or Technology
A firm having good potential that it finds itself is unable to develop fully
because of deficiencies in certain areas of management or an absence of
needed product or product technology.
5. Tax Considerations
 The tax benefit generally stems from the fact that one of the firms has a
tax loss carry over. A company with a tax loss could acquire a profitable
company to utilize tax loss.

6. Increased ownership liquidity

The merger of two small firms or of a small and a large firm may provide
owners of the small firm with greater liquidity.

Types of Merger

a. Horizontal Merger one that combines two companies in the same industry.
Reasons:
1. To meet with more consolidated position at leading, strong third
competitor;
2. To cut on overhead or to avail both companies as one of the top
talent in each; or
3. To expand scope and increase their shares of the market.

Horizontal mergers are carefully scrutinized and regulated by the government

for possible negative effects or restrictions on competition wherein industry
members can go into cartels of monopoly and profits.

Example of Merger:

Another turn-of-the-century drugs merger, Pfizer

created the biggest pharmaceutical company in the
US in 2000 when it gobbled up Warner-Lambert with
the amount of $89 Billion. The tie-up began with a
hostile takeover bid from Pfizer to thwart Warner-
Lamberts attempt to hook up with another pharma company, AHP. Pfizer didnt want
to lose control of the blockbuster statin drug Lipitor, which it had helped Warner-
Lambert bring to market. Post-merger, Lipitor went on to become one of Pfizers best-
selling drugs. Horizontal, in the sense that, they both belong to the pharmaceutical
industry.

b. Vertical Merger Mergers and acquisitions are often used in the pursuit of
vertical integration. In its simplest form, vertical integration is the process of
manufacturers merging with suppliers or retailers. Major production companies
obtain supplies of goods and raw materials from a range of different suppliers.
Vertical integration is basically an attempt to reduce the risk associated with
suppliers.
Reasons:
1. Avoidance or reduction of fixed costs;
 2. Elimination of costs of searching for prices, contracting, payment
collection, advertising and coordination; and
3. Better planning of inventory.

Retail customers

Forward integration

The acquirer

Backward integration

Raw materials

The concept of vertical integration

Forward integration refers to vertical integration that runs towards the customer
base, whereas backward integration refers to vertical integration that runs
towards the supplier base. Vertical integration offers a number of obvious
advantages. Some of these advantages are listed below.

Combined processes. The production processes of most organizations carry

fixed price overheads. Typical examples include human resources and IT
support. Where integration allows these overhead functions to become
combined, there is, theoretically, the prospect of increased support function
efficiency.

Reduced risk and/or enhanced risk management. Vertical integration

allows some of the risk associated with suppliers to be removed. Obvious
examples are sudden supply price increased and late and/or defective
deliveries. In many ways, the control of supply products and raw materials
passes to the acquirer.

Configuration management. The concept of configuration management is

covered in the EBS text Project Management. Configuration management is
 primarily concerned with the efficient and effective flow of information both
within and outside an organization. Information is generally much more easily
and effectively controlled within an organization and vertical integration,
therefore, acts to enhance the configuration management system operated by a
given organization. Quality management. This is an increasingly important
consideration for most organizations. A fully integrated production system
provides the opportunities for an enterprise wide quality management system
covering everything from raw materials, through production to sales. As with
risk management, quality management is more easily executed where supplies,
production and sales are contained in-house rather than externally.

Reduced negotiation. As suppliers are acquired the necessity for complex

and competitive negotiations decreases. The acquiring company is no longer
required to negotiate the best deals with suppliers as the suppliers become part
of the parent organization. The obvious downside is that the acquired suppliers
may lose their competitive edge as they now have a guaranteed market and no
longer need to compete at the same level.

Proprietary and intellectual property protection. This can be an important

consideration in sectors that are characterized by rapid change and innovation.
Organizations that operate under these circumstances have to give away a
certain degree of their organizational knowledge when specifying exactly what
they want suppliers to produce. In some cases, such specifications can be very
revealing, and an uncontained supplier could re-lease proprietary and
intellectual property to a third party.

Individualization. Complete control of suppliers and customers can lead to a

particular classification of trading known as brand. In order to achieve and
maintain brand status, organizations have to achieve and maintain a close
degree of control over all aspects of production and sales so that quality and
image can be maintained. The evolution of a brand allows organizations to
charge a premium rate for their products.

Example of vertical merger:

Samsung Electronics and Harman International Industries, last
November 14, 2016, announced that they have entered
into a definitive agreement under which Samsung will
acquire HARMAN for $8 billion. HARMAN is the market leader
in connected car solutions, with more than 30 million vehicles currently equipped with
its connected car and audio systems, including embedded infotainment, telematics,
connected safety and security. Since Samsung also manufactures its own cars and
other products that are inclusive of audio system, they just bought their own
producing department of audio systems having acquired their own retailer or
suppliers of such product.

c. Conglomerate Merger combines two companies that have no related products or

markets. The benefit is the ability to reduce risks by merging firms that have
different seasonal or cyclical patterns of sales earnings. Conglomeration can be a
useful approach in spreading business risk across a range of different areas. As
conglomerates grow and expand, however, they run the risk of becoming
unfocused as their senior management team may be unfamiliar with the new
products, services and markets that are introduced as unrelated companies are
acquired. In effect, the risks increase rather than decrease.

Example of Conglomerate merger:

The Walt Disney Company moved to create the world's

most powerful media and entertainment company,
by acquiring Capital Cities/ ABC Inc. for $19
billion in 1995. The American Broadcasting
Company (ABC) is an American commercial broadcast television
network and is quite far-off from the products of the Walt Disney Company, which
products are in the American animation industry and diversifying into live-action film
production, television, and theme parks.

d. Congeneric Merger/Product Extension Merger the acquisition of a firm that is in

the same general industry but is neither in the same line of business nor supplier
or customer. The benefit is the resulting ability to use the same sales and
distribution channels to reach customers of both businesses.

Example of Congeneric merger:

BANKING GIANT Citicorp and financial services titan Travelers Group

yesterday stunned financial markets across the world with plans for the
largest-ever corporate marriage,
creating a $155bn (pounds 93m) global powerhouse.
While both were in the financial services industry, they
had different product lines; Citicorp focused more on investment banking and
financial services while Travelers Group were insurance-inclined.
2. Consolidation
A consolidation is another type of merger in which an entirely new firm is
created. It is closely related means of combination. A consolidation
absorbs both the bidder and target firms to this new firm and the old
firm ceases to exist as separate entities, thus in effect was molded into
one large enterprise.

Advantages

1. Both constitute permanent forms of combination which lead to the

desirable effect of management obtaining complete and full control
of the business.
2. Same as holding company.

Disadvantages

1. Lack attribute of flexibility

2. It is always necessary to obtain approval and consent of the
stockholders of each corporation involved in either a merger or
consolidation, which is not always easy.
3. If often times give rise to personnel problems especially with respect
to top executives of several companies, a factor has deferred the
formation of mergers and consolidation in number of instances.

Example:

Perhaps one of the most obvious examples of industry consolidation can be seen in
the evolution of public accounting over the twenty years. In 1986, nine large
accounting firms dominated the industry. But in 1987, Klynveld Main Goerdeler (KMG)
merged with Peat Marwick Mitchell to create KPMG Peat Marwick, reducing the
number of top-tier players to the "Big Eight." Then in 1989, Ernst & Whinney merged
with Arthur Young, and Deloitte Haskins & Sells merged with Touche Ross, further
consolidating the industry to the "Big Six." In 1998, the merger of Price Waterhouse
and Coopers & Lybrand created the "Big Five," and the dissolution of Arthur Andersen
in 2002 left the "Big Four."

3. Holding Company
It is a corporation whose objective is to obtain or hold enough shares of
stocks in other corporations in order to exercise control over them. In a
considerable number of instances, a holding company is purely a
 financial enterprise which does not produce any goods itself. The
amazing feature of the holding company is that it brings about
maximum amount of combination and control with a minimum
expenditure for stocks.

Advantages

1. It does not require the formal consent of stockholders. Neither would

it be necessary to pay off dissenting minority of cash, as may be
evident in the case of merger and consolidations.
2. It does not result to loss of goodwill with either public or employees.
3. There is no assumption or guaranty of a subsidiarys liabilities.
4. Any enterprise which has been operating profitable for quite some
time may be eased out from the whole.

Disadvantages

1. Overcapitalization of the holding company may become inevitable.

2. In case where the subsidiaries are only partly owned, the possibility
of troubles arising from minority stockholder is probable.
3. Holding companies are frequently overburdened with the expense of
creating and maintaining separate corporate organizations.

During dull periods, the inability of the subsidiaries to maintain income receipts as
much as it used to prevent the holding companies from receiving any income from
them.

Example:

Mahindra & Mahindra, the market leader in utility vehicle

and tractors, bought 60 percent stake in Classic
Legends (CLPL), a company engaged in manufacturing and
marketing two-wheelers.

Terms in Business Combination

Acquiree is the business or businesses that the acquirer obtains control of in a

business combination.

Acquirer is the entity that obtains control of the acquire

*However, in a business combination in which a variable interest entity is

acquired, the primary beneficiary of that entity always is the acquirer.
Acquisition Date is the date on which the acquirer obtains control of the acquire.

Business is an integrated set of activities and assets that is capable of being

conducted and managed for the purpose of providing a return in the form of
dividends, lower costs, or other economic benefits directly to investors or other
owners, members, or participants.

Business Combination is a transaction or other event in which an acquirer obtains

control of one or more businesses.

*Transactions sometimes referred to as true mergers or merger of equals

also are business combinations.

Contingent Consideration usually is an obligation of the acquirer to transfer additional

assets or equity interests to the former owners of an acquire as part of the exchange
for control of the acquire if specified future events occur or conditions are met.
However, contingent consideration also may give the acquirer the right to the return
of previously transferred consideration if specified conditions are met.

Control is the power over the investee or the power to govern the financial and
operating policies of an investee as to obtain benefits.

Equity Interests means ownership interests of investor-owned entities and owner,

member, or participant interests of mutual entities.

Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement
date (FASB Statement No. 157, Fair Value Measurements, paragraph 5).

Goodwill is an asset representing the future economic benefits arising from other
assets acquired in a business combination that are not individually identified and
separately recognized.

An asset is identifiable if it is either:

1. Separable, that is, capable of being separated or divided from the entity
and sold, transferred, licensed, rented, or exchanged, either individually or
together with a related contract, identifiable asset, or liability, regardless of
whether the entity intends to do so; or
2. Arises from contractual or other legal rights, regardless of whether those
rights are transferrable or separable from the entity or from other rights and
obligations.

Intangible Asset is an asset (not including a financial asset) that lacks physical
substance. As used in this SFAS No. 141, the term intangible asset excludes goodwill.
Mutual Entity is an entity other than an investor-owned entity that provides dividends,
lower costs, or other economic benefits directly to its owners, members, or
participants.

*For example, a mutual insurance company, a credit union, and a cooperative

entity are all mutual entities.

Non-controlling Interest is the equity in a subsidiary not attributable, directly or

indirectly to a parent.

Owners include holders of equity interests of investor-owned entities and owners

members of, or participants in, mutual entities.