Mergers And Acquisitions

Prof. Preeti Kumari

Mergers And Acquisitions

The key principle behind buying a company is to create

shareholder value over and above that of the sum of the two
companies.

The reasoning behind M&A is that two companies together

are more valuable than two separate companies.

Acquisition

When the target company does not want to be

purchased - it is regarded as an acquisition.
A corporate action in which a company buys most, if not
all, of the target company's ownership stakes in order to
assume control of the target firm.
Acquisitions are often made as part of a company's growth
strategy whereby it is more beneficial to take over an
existing firm's operations and niche compared to expanding
on its own.

Acquisitions

Acquisitions are often paid in cash, the acquiring company's stock

or a combination of both.
Acquisitions can be either friendly or hostile.
Friendly acquisitions occur when the target firm expresses its
agreement to be acquired. If the company's board of directors feels that
accepting the offer serves the shareholders better than rejecting it, it
recommends the offer be accepted by the shareholders.

If the target company's board rejects the offer, but the Acquiring firm
continues to pursue it, a takeover is considered "hostile. Acquiring
firm needs to actively purchase large stakes of the target company in
order to have a majority stake.

Merger

A merger is a Voluntary amalgamation of two or

more corporations, agree to go forward as a single new
company rather than remain separately owned and operated.

Both companies' stocks are surrendered and new company

stock is issued in its place.

Owners of each pre-merger firm continue as owners, and

the resources of the merging entities are pooled for the
benefit of the new entity.

Synergy

Synergy, or the potential financial benefit achieved

through the combining of companies, is often a driving force
behind a merger.
The concept that the value and performance of two
companies combined will be greater than the sum of the
separate individual parts.
A synergistic merger occurs when the postmerger earnings
exceed the sum of the separate companies premerger
earnings.

Sources of Synergy

The expected synergy achieved through the merger can be

attributed to various factors

Staff reductions As every employee knows, mergers tend to mean job losses.
Economies of scale - A bigger company placing the orders can save more on
costs. When placing larger orders, companies have a greater ability to
negotiate prices with their suppliers.
Acquiring new technology - By buying a smaller company with unique
technologies, a large company can maintain or develop a competitive edge.
Improved market reach and industry visibility - A merge may expand two
companies' marketing and distribution, giving them new sales opportunities.
Standing in the investment community: bigger firms often have an easier
time raising capital than smaller ones.

Example

For example, when the Proctor & Gamble Company

acquired Gillette in 2005, a P&G news release cited that "The
increases to the company's growth objectives are driven by the
identified synergy opportunities from the P&G/Gillette combination.
The company continues to expect cost synergies of approximately
$1 to $1.2 billionand an increase in the annual sales run-rate of
about $750 million by 2008." In the same press release, then P&G
chairman, president and chief executive A.G. Lafley stated, "We
are both industry leaders on our own, and we will be even stronger
and even better together." This is the idea behind synergy - that by
combining two companies the financial results are greater than what
either could have achieved alone.

Varieties of Mergers

From the perspective of business structures, there is a whole

host of different mergers. Here are a few types,
distinguished by the relationship between the two
companies that are merging:

Horizontal merger

Two companies that are in direct competition and share the

same product lines and markets.
Example:

A merger between Coca-Cola and the Pepsi beverage division, for

example, would be horizontal in nature. The goal of a horizontal
merger is to create a new, larger organization with more market
share. Because the merging companies' business operations may
be very similar, there may be opportunities to join certain
operations, such as manufacturing, and reduce costs

Vertical Merger

A merger between two companies producing different goods

or services for one specific finished product.
A vertical merger occurs when two or more firms, operating at
different levels within an industry's supply chain, merge operations
In vertical mergers, by directly merging with suppliers, a company
can decrease reliance and increase profitability.
An example of a vertical merger is a car manufacturer purchasing a
tire company. Such a vertical merger would reduce the cost of tires
for the automaker and potentially expand business to supply tires to
competing automakers.

Market Extension Mergers

A market extension merger takes place between two companies that

deal in the same products but in separate markets.
Access to a bigger market and that ensures a bigger client base.
Example:

Acquisition of Eagle Bancshares Inc by the RBC Centura. Eagle Bancshares is headquartered at
Atlanta, Georgia and has 283 workers. It has almost 90,000 accounts and looks after assets
worth US $1.1 billion.
Eagle Bancshares also holds the Tucker Federal Bank, which is one of the ten biggest banks in
the metropolitan Atlanta region as far as deposit market share is concerned. One of the major
benefits of this acquisition is that this acquisition enables the RBC to go ahead with its growth
operations in the North American market.
With the help of this acquisition RBC has got a chance to deal in the financial market of
Atlanta , which is among the leading upcoming financial markets in the USA. This move would
allow RBC to diversify its base of operations.

Product Extension Mergers

A product extension merger takes place between two business

organizations that deal in products that are related to each other and operate in
the same market.
allows the merging companies to group together their products and get access to
a bigger set of consumers. This ensures that they earn higher profits.
Example:

The acquisition of Mobilink Telecom Inc. by Broadcom is a proper example of product

extension merger. Broadcom deals in the manufacturing Bluetooth personal area network
hardware systems and chips for IEEE 802.11b wireless LAN.
Mobilink Telecom Inc. deals in the manufacturing of product designs meant for handsets
that are equipped with the Global System for Mobile Communications technology. It is also
in the process of being certified to produce wireless networking chips that have high speed
and General Packet Radio Service technology. It is expected that the products of Mobilink
Telecom Inc. would be complementing the wireless products of Broadcom.

Conglomerate Merger

A merger between firms that are involved in totally unrelated

business activities.
There are two types of conglomerate mergers: pure and mixed.

Pure conglomerate mergers involve firms with nothing in common, while

mixed conglomerate mergers involve firms that are looking for product
extensions or market extensions.

Example:

A leading manufacturer of athletic shoes, merges with a soft drink firm. The
resulting company is faced with the same competition in each of its two markets
after the merger as the individual firms were before the merger.

Cross-border mergers

One of the main reasons why foreign firms are interested in

buying U.S. companies is to gain entrance to the U.S.
market.

Defensive mergers

A defensive merger is one where the firm's managers decide

to merge with another firm to avoid or lessen the possibility
of being acquired by a third company.

Defensive tactics

Firms use defensive tactics to fight off undesired mergers.

A company seeking to fight off a hostile takeover might

employ the services of an investment banking firm to
develop a defensive strategy.

Poison pills

A strategy used by corporations to discourage hostile

takeovers. With a poison pill, the target company attempts
to make its stock less attractive to the acquirer.
3 procedures used to defend against hostile takeovers.

Borrowing funds on terms that would require immediate

repayment of all loans if the firm is acquired,

selling off at bargain prices the assets that originally made the
firm a desirable target,

Poison pills

3 procedures used to defend against hostile

takeovers.

and granting huge golden parachutes that open if the firm is

acquired

Substantial benefits given to a top executive (or top executives) in the

event that the company is taken over by another firm and the executive is
terminated as a result of the merger or takeover. Golden parachutes are
contracts given to key executives and can be used as a type of
antitakeover measure taken by a firm to discourage an unwanted takeover
attempt. Benefits include items such as stock options, cash bonuses,
generous severance pay or any combination of these benefits.

white knight

The white knight is the "savior" of a company in the midst of a

hostile takeover.
A white knight is a company (the "good guy") offers the target firm a way
out with a friendly takeover that is facing a hostile takeover from another
party (a "black knight").
Unlike a hostile takeover, current management typically remains in place
in a white knight scenario, and investors receive better compensation for
their shares.
Often a white knight is sought out by company officials - sometimes to
preserve the company's core business and other times just to negotiate
better takeover terms.

Raising antitrust issues.

This is an effort to have the justice department intervene.

Leveraged recapitalization strategy

A corporate strategy in which a company takes on significant

additional debt with the intention of paying a large cash dividend to
shareholders and/or repurchasing its own stock shares.
The result is asset and/or liability restructuring, where the company's
liabilities are increased and where equity is reduced.
This strategy is an intentional antitakeover measure used to make the
corporation less attractive to potential acquirers.
In mergers and acquisitions, strategies, these are often called "shark
repellents," since they are intended to fend off unwanted or hostile
takeover attempts. Also called leveraged recap.

Joint venture

A joint venture involves the joining together of parts of

companies to accomplish specific, limited objectives.
Joint ventures are controlled by the combined management
of the two (or more) parent companies.
A corporate or strategic alliance is a cooperative deal that
stops short of a merger.

Merger analysis

Since the primary rationale for any operating merger is

synergy, in planning such mergers the development of accurate pro
forma cash flows is the single most important task.

Only if a target firm's value is greater to the acquiring firm than its
market value as a separate entity will a merger be financially
justified.

The value of the target firm is calculated by discounting residual

cash flows that belong to the acquiring firm's shareholders at the
target's cost of equity reflecting any changes to its capital structure
as a result of the merger.

Leveraged buyouts - LBO

The acquisition of another company using a significant amount of

borrowed money (bonds or loans) to meet the cost of acquisition.
the assets of the company being acquired are used as collateral for the
loans in addition to the assets of the acquiring company.
The purpose of leveraged buyouts is to allow companies to make large
acquisitions without having to commit a lot of capital.
In recent years, an increasing number of firms have been acquired by
private equity firms.
Private equity firms raise capital from wealthy individuals and look for
opportunities to make profitable investments.

Divestiture

Divestitures are a way for a company to manage its

portfolio of assets.
As companies grow they may find they are trying to focus
on too many lines of business, and that they must close
some operational business units in order to focus on more
profitable lines.
The partial or full disposal of a business unit through sale,
exchange, closure or bankruptcy.

Divestiture

Divestiture may result from a management decision to no

longer operate a business unit because it is not part of a core
competency.
It may also occur if a business unit is deemed redundant after a
merger or acquisition, if jettisoning a unit increases the resale value
of the firm or if a court requires the sale of a business unit to
improve market competition.
For example, an automobile manufacturer that sees a significant and
prolonged drop in competitiveness may sell off its financing division
in order to pay for the development of a new line of vehicles.

Spinoff

It is a type of divestiture.

Businesses wishing to streamline their operations often sell less

productive or unrelated subsidiary businesses as spinoffs.

For example, a company might spin off one of its mature business
units that is experiencing little or no growth so it can focus on a
product or service with higher growth prospects.

Motivation for mergers

Why do companies merge with or

acquire other companies?

Synergy: The most used word in M&A is synergy, which is the idea
that by combining business activities, performance will increase and
costs will decrease.

Diversification / Sharpening Business Focus: A company that

merges to diversify may acquire another company in a seemingly
unrelated industry in order to reduce the impact of a particular
industry's performance on its profitability. Companies seeking to
sharpen focus often merge with companies that have deeper market
penetration in a key area of operations.

Why do companies merge with or acquire other

companies?

Growth: Mergers can give the acquiring company an opportunity to grow

market share without having to really earn it by doing the work themselves instead, they buy a competitor's business for a price.

Increase Supply-Chain Pricing Power: By buying out one of its suppliers or

one of the distributors, a business can eliminate a level of costs. If a company
buys out one of its suppliers, it is able to save on the margins that the supplier
was previously adding to its costs. If a company buys out a distributor, it may
be able to ship its products at a lower cost.

Eliminate Competition: Many M&A deals allow the acquirer to eliminate

future competition and gain a larger market share in its product's market.

Functions of Bank Advisers/Investment Bankers

in Mergers

Arranging mergers
Assisting in defensive tactics
Establishing a fair value
Financing mergers

Do mergers really create value?

The evidence strongly suggests:

Acquisitions do create value as a result of economies of scale,

other synergies, and/or better management.

Shareholders of target firms reap most of the benefits, because

of competitive bids.