Description
It describes Evaluation of M&A (Mergers and Acquisitions) of 100 Indian firms
Strategic Management I Project
Strategic Management – Project Mid-Term Submission
Critical Evaluation of the State of M&A of 100 Indian Firms
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TABLE OF CONTENTS Table of Contents
1 INTRODUCTION........................................................................................................4 1.1 Business Environment and need of M&A in current global setup......................4 1.2 The role of M&A in the current Indian Scenario.................................................5 1.3 Here are the top 5 acquisitions made by Indian companies worldwide:............6 2 What is M&A? Classification of Mergers and Classification of Acquisitions ...........10 3 Business Valuation................................................................................................13 3.1 Discounted Cash Flow Valuation method........................................................13 3.2 Relative Valuation Method...............................................................................14 3.3 Asset Valuation Method...................................................................................14 3.4 Control Valuation.............................................................................................14 3.5 Synergy Valuation...........................................................................................15 3.6 Acquisition Value.............................................................................................16 4 Financing an acquisition........................................................................................17 5 Motives of M&A......................................................................................................21 6 Nine reasons why firms go for Merger and Acquisition:.........................................25 1. To affect more rapid growth.............................................................................25 7 Strategy for M&As................................................................................................. 27 8 Nine ways in which merger and acquisition impacts performance of a firm or benefits the firm:...................................................................................................... 34 9 Problems in M&As..................................................................................................36 9.1 Synergy...........................................................................................................36
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1 INTRODUCTION
1.1 Business Environment and need of M&A in current global setup
Merger and acquisition have long been a popular strategy for many firms at the beginning only in North America. But from the fifth merger wave of the twentieth century, the strategy of M&A also became popular in Europe, Asia and Latin America. The growth in merger and acquisition was fed by activity in Europe with firms preparing for the full implementation of the European Union. The enlargement of European market introduced by Euro was a major factor that affected the growth in M&A activities. In 2006, the global M&A market confirmed the recovery seen in 2005, outperforming forecasts made at the start of the year and reaching the peak recorded in 2000 in terms of number of transactions. The equivalent value of transactions on the global M&A market rose 50% on 2005 from Euro 2,583 million to Euro 3,870 million in 2006. Market volumes rose 18%. In 2006, approximately 32,000 transactions were concluded, compared to 27,000 in 2005, which resulted in a new record after the 2000 peak of 30,000 transactions. The geographic areas most affected by M&A activities were the America with 40% of concluded deals, Europe with 34%, Asia with 18% (excluding Japan), Japan with 6%, and Africa and the Middle East with 2%. One difference that can be noted in M&A activities now in the past is that financial markets have ceased to play key roles and present boom in the M&A activities is primarily driven by the strategic choices made by the firms in the light of the opportunities that have been provided by the economic growth.
Mergers and Acquisitions: Causes and Effects Gabriele Carbonara, Rosa Caiazza. Journal of American Academy of Business, Cambridge. Hollywood: Mar 2009. Vol. 14, Iss. 2; p. 188 (7 pages)
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(Ref:http://www-03.ibm.com/industries/global/files/barry_boniface.pdf)
1.2 The role of M&A in the current Indian Scenario
India is the great big oasis most multinational corporations are looking to as they consolidate their position in Indian companies. Also since the start of the new millennium, the news that Indian companies having acquired American-European companies has stopped being a rarity. This is evident in the recent years, where in the year 2001 foreign players accounted for approximately 35% of the value of Indian acquisitions. The telecoms sector dominated the M&A scene accounting for 24% of all deals done in the year 2001. The Batata-- BPL telecom deal ($662 million) represented 10% of all deals done during 2001. Strong and buoyant Indian Economy, Government policies, excess liquid funds with Indian corporates and newly found dynamism in Indian entrepreneurs and corporates have all contributed to this new M&A trend. Recent mergers of like Tata-Corus, Ranbaxy-Daichii, Tata-Jaguar etc have shown the amount of confidence with which Indian corporates are making a mark in the world. While the Indian IT and ITES companies already have a strong presence in foreign markets, other sectors are also now growing rapidly. The
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globalization and its impact on the increasing engagement of the Indian companies in the world markets is an indication of the maturity reached by Indian Industry.
1.3 Here are the top 5 acquisitions made by Indian companies worldwide:
Deal Indian Acquirer Tata Steel Hindalco Target Company Country Corus Group plc Novelis Daewoo Electronics Videocon Corp. Dr. Reddy’s Labs Suzlon Energy Betapharm Hansen Group Germany Belgium 597 565 Korea 729 UK Canada value ($ ml) 12,000 5,982
Indian outbound deals, which were valued at US$ 0.7 billion in 2000-01, increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006. In fact, 2006 will be remembered in India’s corporate history as a year when Indian companies covered a lot of new ground. They went shopping across the globe and acquired a number of strategically significant companies. This comprised 60 per cent of the total mergers and acquisitions (M&A) activity in India in 2006. And almost 99 per cent of acquisitions were made with cash payments. The total M&A deals for the year during January-May 2007 have been 287 with a value of US$ 47.37 billion. Of these, the total outbound cross border
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deals have been 102 with a value of US$ 28.19 billion, representing 59.5 per cent of the total M&A activity in India. The total M&A deals for the period January-February 2007 have been 102 with a value of US$ 36.8 billion. Of these, the total outbound cross border deals have been 40 with a value of US$ 21 billion. Some examples of recent mergers and acquisitions in the India show some interesting trends which are changing the traditional way business is done in India. In banking sector, State Bank of India (SBI) had ambitious plans to integrate many its functions with those of its seven subsidiaries. These functions included treasury operations, ATMs, technology and the intent was to synergize and rationalize its operations as well as reduce costs to result in a steady growth. The bank took a step in this direction by incorporating all its operations in the merger between SBI and State Bank of Saurashtra. The post-merger rationalization is implemented on technology front, asset management, branch banking and seniority. The merger has resulted in some concerns being raised by the employees of SBS and the concerns have been ironed out. It is imminent that such a merger is mandatory in the banking industry once India throws open its doors to foreign banks by 2009 in line with India’s commitment to WTO. Only those banks which are equipped with adequate capital adequacy ratio, latest technology, economy of scale and quality human resources, will be in a position to survive. Moreover a technological update which is very much required both for SBI and the associate banks becomes feasible only once these mergers are started. In the meanwhile, SBI has deferred its merger plans of associate banks with itself in view of the present financial crisis and concentrates more on maintenance of its financial position and overcoming slowdown. The mergers would be initiated once the market conditions are calm.
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Another interesting trend emerging since 2002 is the acquisitions of foreign companies by their Indian counterparts. Other than the already mentioned top 5 Indian acquisitions, some smaller ones show the strategic insights taken by Indian companies to fuel their growth. Recently Punj Lloyd acquired Technodyne International Ltd. on 3rd June, 2008 in terms to form a strategic fit which will further strengthen their existing business range. Technodyne is an engineering, design and consultancy company specializing in large scale cryogenic and high pressure tanks. Technodyne also carries out the basic design and detailed engineering for complete steel and steel plus concrete tanks, including associated piping, instrumentation and electrical systems. The acquired capabilities will enable the group to provide end-to-end solutions for complete delivery of complex cryogenic, high pressure LNG, LPG, ethylene, ammonia and other similar storage tanks, a significant growth area in oil and gas sector. This acquisition is a strategic fit and further strengthens Punj Lloyd’s existing tankage and terminal business. Similarly the Tyre Industry is looking for expansion with both MRF and Apollo looking out for strategic partners and acquisitions. Apollo Tyres acquired the South Africa-based Dunlop Tyres International for around Rs 290 crore ($62 million) in Jan, 2006. The acquisition of Dunlop South Africa made Apollo Tyres Ltd the largest Indian tyre manufacturer in terms of size, reach, technology and range of products with combined capacities touching 900 tonnes per day post acquisition. It is also the first Indian tyre company to undertake an acquisition in the global arena and is expected to be the springboard to position Apollo Tyres Ltd as a global player, and a base for future growth initiatives. The synergies between our two companies have added enormous value to both the partners. Dunlop’s know-how has further boosted Apollo’s R&D and market reach, enabling Apollo to maintain its technology-driven product and market leadership in all the key segments of the tyre market.
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Some other merger trends in India include disinvestment of some profit and loss making Public Sector Units and their merger with keen Industry participants. The Indian metallurgical sector is particularly in focus recently for the disinvestment of Bharat Aluminum Company (BALCO). Sterlite Industries India Ltd. had acquired a stake of 51% in BALCO following a disinvestment offer floated by Govt. of India in March 2001 for around Rs. 551 Crores. Sterlite also approached the Government in the year 2004 for acquiring the remaining 49% residual stake which was followed by a minor legal tussle with Sterlite moving to Delhi High Court in 2006. As of now, the Government’s stand on the selling of the residual 49% stake is confirmed to be negative. But keeping the modest target of disinvestment of atleast 5 PSU’s as announced in the budget and the coming general elections, the balance may tilt on either of the sides. -www.investopedia.com, www.capitalonline.com
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2 What is M&A? Classification of Mergers and Classification of Acquisitions
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. Merger is a combination of two companies into one larger company. Such actions are commonly voluntary and involve stock swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons. Classification 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. 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.
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•
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 - 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 writtenup 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. An acquisition, also known as a takeover, is the buying of one company (the ‘target’) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Another type of acquisition is reverse merger a deal that enables a private company to get publicly listed in a short time period. A
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reverse merger occurs when a private company that has strong prospects and is eager to raise financing buys a publicly listed shell company, usually one with no business and limited assets. Two types of acquisitions are: • The buyer buys the shares, and therefore control, of the target company being purchased. • The buyer buys the assets of the target company.
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.
(Source: www.investopedia.com)
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3 Business Valuation
The valuation of business is a very important component of any merger and acquisition deal. In practice there are various methods of valuation of business in relation to mergers and acquisition. These methods are based on the following approaches to valuation: • • • Income Concept Market Concept Cost concept
The Income Concept uses the Discounting approach of valuation of a firm and the method used is the Discounted Cash Flow Valuation method. The Market Concept uses the Comparables approach and the method of valuation used is the Relative Valuation method. The Cost Concept uses the approach which takes into consideration the underlying asset and uses the Asset Valuation method.
3.1 Discounted Cash Flow Valuation method
This is the most commonly used method of the valuation of a business. In this method, the future cash flows from the forecasted operations, including the residual value of the business at the end of an explicit period (the last year of the forecasted period), are discounted to their present value. If we look at the time perspective, discounted cash flow (DCF) valuation separates free cash flow forecasting into two categories: initial period of explicit forecast and residual value of a going concern at the end of that period. Going concerns would normally operate beyond the explicit period for which it is possible to make a discrete (reasonably accurate) cash flow forecast.
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The residual value of a business as of the end of a discrete projection period is critical to value and is established on the basis of perpetual growth assumptions of future cash flows.
3.2 Relative Valuation Method
The market based concept of valuation seeks to determine the value of a business by comparing the business with the comparable companies. The value is determined relative to the value of other companies. Comparative multiples like price-earning ratio and EBTIDA multiplier can be usefully applied for gauging residual value in discounted cash flow valuation. The other features that can be compared are net earnings, gross revenue and book value of the assets.
3.3 Asset Valuation Method
The principle of substitution is the basis of the asset valuation system and it suggests that no investor would like to pay more for the assets of the business than the cost which is incurred for procuring assets of similar economic utility. In this method, most of the assets are reported in the financial accounts of the subject company at their acquisition value. But the problem lies in the determination of the value of intangible assets. For this reason, in many cases, this method might give results which are less than the fair market value of the business. In case of an acquisition, various other valuations are also required to be taken into consideration:
3.4 Control Valuation
Acquiring companies also normally pay acquisition premiums reflecting the value of control. The value of control is proportional to the value maximization capacity of the target. The rationale behind a value of control lies in expectations of an acquirer to be able to run a company more
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efficiently. Well-managed companies get little or no control premium, as there is hardly any room for operational improvements whereas the case is vice versa for poorly managed companies which get a bigger premium, as there is much room for improvements.
3.5 Synergy Valuation
In acquisition valuation, positive effects on combined value have to be defined in addition to stand-alone valuations of companies involved in the acquisition deal. These positive effects are called synergy. Synergy can thus be defined as increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently. It refers to the combined strength of the companies instead of when they stand alone. Synergy as a valuation input can take different forms, such as increased future growth or reduced costs, etc.
(Ref: “ACQUISITION VALUATION: HOW TO VALUE A GOING CONCERN?” Andrej Bertoncel. Nase Gospodarstvo: NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages))
Synergy can be valued by answering two fundamental questions: (1) What form is the synergy expected to take? Will it reduce costs as a percentage of sales and increase profit margins (e.g., when there are economies of scale)? Will it increase future growth (e.g., when there is increased market power) or the length of the growth period? Synergy, to have an effect on value, has to influence one of the four inputs into the valuation process – cash flows from existing assets, higher expected growth rates (market power, higher growth potential), a longer growth period (from increased competitive advantages), or a lower cost of capital (higher debt capacity).
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(2) When will the synergy start affecting cash flows? –– Synergies can show up instantaneously, but they are more likely to show up over time. Since the value of synergy is the present value of the cash flows created by it, the longer it takes for it to show up, the lesser its value. Once we answer these questions, we can estimate the value of synergy using an extension of discounted cash flow techniques. (www.damodaran.com)
3.6 Acquisition Value
The objective of an acquisition valuation is to provide an indication of value. A professional valuation should establish the fair market value for a willing and informed buyer who would purchase a company in normal open market conditions. Acquisition price is the result of negotiations between a seller and a buyer. It is that level of price where the expectations of both seller and the buyer meet. Thus, acquisition price refers to the final negotiated price. This price is rarely equal to the market value or the intrinsic value. The reason for the same being that it includes something which is called as the acquisition premium. Now, the acquirer company has to define how much acquisition premium is willing to pay to the owners of the target company. Thus, the acquirer company needs to know the exact synergy value they are getting through the acquisition. Also, it needs to decide as to what portion of that value it is willing to share with the shareholders of the target companies. In all, another way of looking at the acquisition premium is that it is the allocation of certain future benefits to the owners of the target company.
Several steps that are involved in acquisition valuation are as follows:
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• • • • • • •
Define the rationale of acquisition Select a target company Perform a comprehensive due diligence Define synergy and restructuring costs Define control premium Value a target Define mode of payment
(Ref: “ACQUISITION VALUATION: HOW TO VALUE A GOING CONCERN?”
Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages) )
4 Financing an acquisition
Various methods of financing an M&A deal exist: • Payment by cash: In case of the payment by cash, shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders. A cash deal tend make more sense and better decision making during a downward trend in the interest rates.
•
Financing: Financing capital may be borrowed from a bank, or raised by an issue of bonds. Alternatively, the acquirer's stock may be offered as consideration. Acquisitions financed through debt are known as leveraged buyouts if they take the target private.
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•
Hybrid: Such kind of an acquisition involves a combination of cash and debt, or the financing through the combination of cash and stock of the purchasing entity.
•
Factoring:
Factoring refers to a financial transaction whereby a
business sells its accounts receivable or, in other words the invoices, at a discount.
Various mergers and acquisitions that have taken place in the recent times make use of one or more of these financing and valuation methods. (www.investopedia.com)
•
Merger of HDFC Bank Ltd and Centurion Bank of Punjab:
The merger between these two companies was finalized in the early 2008. At nearly $2 b, it was the largest merger at that time in the Indian banking sector. The mode of financing that was used for the deal was that of share swap where in shares of HDFC Bank Ltd were given as the consideration for financing the deal. There was a share swap in the ratio of 1:29, wherein 1
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equity share each of the HDFC Bank was given for 29 shares held in Centurion Bank of Punjab. In order to arrive at the merger swap ratio, following three methods were applied:
• • •
Net Asset Value Method Income method Market price method
For the market price method, price quotations of both banks on NSE and BSE for last 2 years, last 6 months, last 3 months, and last 2 weeks were considered at that point of time. Also considered were the prices at which both banks had issued fresh capital to institutional investors in the last 6 months under consideration. As per each of these variations of the market price method, swap ratio was coming to around the recommended ratio with 10 per cent range on either side. Again, swap ratio as per NAV method also came close to the recommended swap ratio of 29 shares of Central Bank of Punjab for every one share of HDFC Bank. (Ref: www.hindubsinessline.com)
•
Acquisition of Axon by HCL Technologies:
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This was a $679mn dollar worth deal. Since Axon group is based in UK, it was a cross border merger. The financing of the deal took place via two routes: the first one was through internal accruals to the extent of $116mn. The second was through the issue of ECB, at coupon rate of LIBOR+300 bps (for a period of 1 year), worth $585 mn. (Ref: www.valuenotes.com) In this acquisition, a hint of synergy valuation can be seen as the company HCL bid for Axon to become a significant player in SAP services space. The operational model used by Axon led to synergy and various benefits for HCL and this also explains the premium that HCL Technologies offered in the form of the higher bid to the acquired company.
•
Acquisition of Punjab Tractors Ltd by Mahindra & Mahindra:
Punjab Tractor Ltd., for the purpose of acquisition has been valued at 2,160 crores bye M&M. The deal has been finalized and the financing of the deal will take place by share swap, where for every 3 equity shares of Rs.10 each, one equity share of Rs.10 each.
•
Acquisition of Kinetic Motors Co. by Mahindra & Mahindra:
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The company, Kinetic Motors Co., has been valued by the acquirer company at $137.5 crore. The acquirer company will pay the cash Rs110 crore and 20%stake in new operating company, worth Rs.27.5 crore. Now, here if we use the valuation of assets method, kinetic Motor’s assets have the net value of Rs. 107 crore. So, the valuation is at the premium of about 29%. It’s also a premium of about 30% to trailing 12-month revenues. (Ref: www.livemint.com)
5 Motives of M&A
There are macroeconomic, microeconomic and institutional factors which drive global M&A. In today’s scenario the factor at the macroeconomic level has been continued economic growth. In 2005 prompted institutions, the growth of domestic equity and world real GDP grew by M&A. At the 4.8% (IMF 2006). Favorable conditions in financial and stock markets cross-border led to microeconomic level, a surge of financial flows to collective investment e.g. private funds, massive cross-border investments by these funds. One of the common motives for mergers is growth. Other motives include the pursuit of synergistic benefits and diversification. Certain types of mergers, such as diversifications, tend to yield poor results. Some firms merge to reduce competition. The failing firms avoid bankruptcy by selling to successful firms. In the absence of an antitrust constraint, large firms are more likely than small firms to acquire another competitor. There is also evidence that firms merge to increase market power or to attain economies of scale. Thus there are value-enhancing mergers (conjectured as motivated by synergy) and value-reducing mergers.
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In the case of merger of Punjab National Bank with Nedungadi Bank. One is Private bank and the other public sector banks. Therefore there is diversification involved, and also leading to enhancement of value. In the case of merger of Apollo tyres and Dunlop tyres Apollo used Dunlop tyres’ distribution network to export and enter into African market. Also by this merger it got the manufacturing units in Africa making it the largest tyre manufacturer in India with capacity of 900 tonnes. Moreover it helped in optimizing cost, cutting R&D costs. Classic theories justify mergers and acquisitions on the grounds of increasing market power, leading to additional rent creation and appropriation. More novel theories explain mergers and acquisitions as a function of cognitive traps rooted in unchecked CEO ego (e.g., the "hubris hypothesis" advanced by Hayward and Hambrick [1997]). Asset-based rationales for corporate combinations have a strong and persuasive place: recent acquisitions (e.g., Unilever's purchase of Bestfoods, Kraft Foods purchase of Nabisco, and PepsiCo's acquisition of Quaker Oats) provide compelling evidence that the pursuit of growth in this industry setting will not occur as a function of innovation or pricing power alone. The most important factor in brand acquisition decisions is the positioning/image attribute involved. The objectives of acquiring companies are diverse, including filling critical capability gaps, achieving synergies and economies of scale, acquisition of tax losses and fending off an income trust structure and replacement of management. Sirower (1997) defines synergy as increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently.6 Eccles, Lanes, and Wilson (1999) outline the source of synergies as cost savings, revenue and tax enhancements, process involvements, financial engineering,
benefits. Goold and Campbell (1998) report six forms of synergy including
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shared know-how, shared tangible resources, pooled negotiation power, coordinated strategies, vertical integration, and combined business creation. Studies indicate that the important sources of the merger-related synergy are operating economies, financial economies, differential efficiency, as economies of scale in management, power. As sectors continue to consolidate, there will be another key strategic motive - the acquisition of assets to protect existing revenue base (protection value). From both a theoretical and practical perspective, the acquisition of an asset that can effectively obstruct the entry of a major competitor and prevent the erosion of its market share has significant value. This is particularly true in mature sectors dominated by a handful of players and where top-line growth is constantly challenged and competitors look for a catalyst to break through into each other's geographies to steal business from one another. High-growth targets require companies not only to drive revenue growth and capitalize on opportunities made possible by new technologies but also to defend market position with unprecedented intensity. It is in this competitive context that the concept of protection value is emerging with greater importance. In the case if UTI-Global Trust Bank, the bank had a P/E below 8 on forward earnings, however the motive is to increase the size. However there is costs of merger involved like disgruntled employees, time spent on integrating operations and cultural aspects. The predominant motive for acquiring companies until now was short-term exploitation of market growth opportunities, scale economies, and risk reductions. The new trend is towards the long-term exploration of the target company's capabilities, such as unique employee skills, organizational production and increased market
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routines, superior knowledge and technologies. Synergy rises from the pooling of the two companies' resources be and capabilities. as Acquired of competence-based companies should integrated 'centers
excellences' - and be in charge of innovation processes in connection with specialized products and markets. Cisco Systems, Microsoft and Intel are among companies which have initiated a series of such technology-driven acquisitions in the 1990s (Ranft and Lord, 2002). Likewise, companies like Siemens, ABB, General Electric, DuPont, Nokia, and Nestle have all used acquisitions as a vehicle to gain particular competences they could not create by themselves (Mitchell and Capron, 2002). Despite public commentaries made by CEOs on the non quantifiable, strategic rationales behind their deals, at the board level, quantifiable financial return on investment is a mandatory prerequisite to any deal approval, not only to legitimize the initial offer price but to determine the walk away price.
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6 Nine reasons why firms go for Merger and Acquisition:
1. To affect more rapid growth
The use of M&A to affect more rapid growth is the most important reason / motive behind any type of M&A. Rapid inflation has made the acquisition of another firm not only less costly than building but also much quicker. Relatively low price earning ratios of many firms have attributed to their attractiveness as potential takeover candidates. Most of the executives have consistently stated growth as a primary motive for M&A activity. 2. To gain economies of scale Increasing profitability of operations through economies of scale is a frequently sighted reason for consolidation through M&A activity. 3. To increase market share This is a primary reason cited by executives for horizontal mergers 4. To increase market value of stock: The desire to increase the market value of the stock is also viewed as a major merger motive by executives. This comes as no surprise as the goal of a management should be to maximize the value of the firm’s common stock. 5. Expand product mix:
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Increasing product mix is one of the auxiliary reasons sighted by many executives. 6. To spread risk through diversification: Through diversification of product range, firms try to reduce dependence on few products and thus reduce risk by spreading it over a large product portfolio. 7. To enhance power and prestige of the firm: Many a times M&A activities increase the visibility of firms and thus highlight the influence the firm has in the market. Such firms use M&A activity to 8. To invest in the firm’s idle capital: When bank rates are relatively low, many firms prefer to deploy idle cash in merger and acquisition activities. 9. To gain technical knowledge and expertise and talent: This is an important strategic reason sighted by executives. Technical human resource, patents and machinery are important reasons for M&A
Ref: Reference book of Mergers and Acquisitions (vol 1 chap 3) – Management development institute Library, Gurgaon India
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7 Strategy for M&As
In this section, we will review one set of 'rules of successful acquisition' that
Drucker (1981, 1982) has promulgated. Drucker's rules are the focus of this analysis because his views are often accepted by practitioners. In succeeding paragraphs, supporting and non-supporting evidence, opinions, and arguments are summarized for each rule; inconsistencies in the empirical literature are noted; and the rules are discussed and critiqued. Rule 1: Acquire a company with a 'common core of unity'—either a common technology or markets or in some situations production processes. Financial ties alone are insufficient. The concept of a 'common core of unity' can be defined very narrowly or very broadly. Applying this rule is difficult because of conflicting answers to questions such as: do two firms that provide different products to the same geographically defined market have a common core of unity? Montgomery (1979), Rumelt (1979) and Bettis and Hall (1982) suggest reasons other than relationships among business units for Rumelt's (1974) and Bettis' (1981) findings. These studies suggest that the high economic performance of related business firms is associated with market structure characteristics, e.g. market profitability, market share, market growth and concentration. Apparently, related business firms have tended to grow in
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industries characterized by high levels of return on capital. Market structure characteristics may be a more fundamental determinant of profitability than type of diversification. Also related business firms often have developed skills in product/market areas where product differentiation and market segmentation are possible. These findings suggest that Drucker's rule may be focusing on the wrong strategic variables and hence is a poor guideline to follow. The Anson et al. (1971) study of 93 companies provides minimal support for Drucker's first rule. They found that, with the exception of vertical integrations which were very successful, type of acquisition had little effect on perceived success. Success, however, was perceived to be associated with other factors, e.g. search and planning In conclusion, requiring that an acquired company has a common core of unity with the acquiring company is a very conservative and ambiguous heuristic to use in acquisition decision making. The rule is ambiguous because of problems associated with identifying a 'common core of unity'. Also, identifying a true common core of unity may not be possible prospectively, but rather only retrospectively. This rule may encourage rationalizing of similarities rather than rational analysis. Rule 2: Think through your firm's potential contributions of skills to the acquired company. There must be a contribution and it has to be more than money. Drucker's statement 'think through your firm's potential contributions', is similar to identifying objectives and developing criteria for analysis of alternative companies, then Ansoff et al.'s (1971) results support Drucker. Planning variables in the Ansoff et al. (1971) study correlated with all of the economic performance results measured in the study, except P/E ratio; but
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attainment of synergy had little relationship to most performance variables except stock price growth rate. However, some inconsistency in results was noted by Ansoff et al. (1971); extensive search and planning was not associated with perceived success whereas attainment of synergy was associated with perceived success. This rule can encourage poor planning because it is hard to apply and does not encourage systematic planning. If planning is not systematic, most managers can probably rationalize contributions for any acquisition. Another major problem with this rule is that it seems limited and one-sided because it neglects the potential contribution of the acquired company. Sometimes managers buy a company as much for what it can do for their company as for what they can do for the acquired company. It seems that some modification and much more elaboration of Drucker's second rule is needed for guidance in this areas. We need to consider contributions of 'both' the acquired company and the acquirer. Also, the contributions needed to justify an acquisition may differ in related and unrelated diversification. Rule 3: Respect the products, markets and customers of the acquired company. There must be a 'temperamental fit'. Both the concepts of 'respect' and 'temperamental fit' are ambiguous and hard for managers to apply. According to Drucker, managers in acquiring companies do not feel comfortable with these businesses where there is not a 'temperamental fit' and that eventually they make the wrong decisions. Results that seem to support Drucker come from several resources. Mace and Montgomery (1962) identified conditions of successful acquisition including competent management in the acquiring organization who are
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Strategic Management I Project
motivated to perform well in the new product field. Salter and Weinhold (1979) stress the need for a strong commitment on the part of the acquiring management to exploit the potential benefits of related diversification. Many authors stress the need for co-operation and collaboration between the acquiring firm and the acquired firm. Ansoff et al.'s (1971) conclusion on the effects of integration provides additional insight about the issue addressed in rule 3. Integration had little influence on growth or performance. The strongest statement that could be made was that partial integration tends to produce poorest performance. Thus, it would seem logical that successful acquisition could occur where there was little integration and perhaps little temperamental fit. This rule suggests an attitude that managers should hold to increase the success of an acquisition. Although it does not appear that holding this attitude is either necessary or sufficient for making a successful acquisition, in many cases managers may want to try to adjust their attitudes if they do not respect the product, markets and customers of the acquired company. Rule 4: Within approximately a year, you must be able to provide top management for the acquired company. Drucker believes that it is an elementary fallacy that one can 'buy' management. He feels that managers of the acquired company are likely to go elsewhere for a variety of reasons. In Hayes' (1979) study only 42 per cent of the top managers in acquired companies remained as long as five years following the acquisition. This finding supports Drucker's concern about providing top management, but when Hayes questioned the top managers who left, 82 per cent said that if they had to do it all over again they would not sell at all.
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Strategic Management I Project
A number of questions must be asked about this rule. What does it mean to say you are able to provide top management? How do you know you have this capability or, prior to the acquisition, that you can develop it? How does this differ from rational staffing policy for a firm? Can top management talent be recruited successfully? These questions suggest that following this rule may be difficult and unnecessary. For example, some companies currently use recruiters to find top management talent. In many cases the acquired company wants to retain management and in these cases Hayes' findings are especially relevant. According to Parsons and Baumgartner (1970), 'most experienced buyers, such as chief executives of conglomerates, say that what they are really acquiring is a going organization. Generally they want a company that is fully staffed, with a general manager and able functional heads and, since it takes three to five years to develop a good operating team, they want assurance that these key people will stay-on the job.' Efforts to retain top management are probably more important than preparation to replace those who leave. Following from Levinson's (1970) analysis of merger failure, if the acquiring company has rules or attitudes like Drucker's rule 4, that rule and its attendant attitude may actually create the potential problems it is intended to remedy. Managers in the acquired companies can often sense the attitudes of managers at corporate headquarters and become concerned or worried about their jobs. Rule 4 and the next one may lead to a vicious circle of managerial turnover and poor performance in an acquired company. In conclusion, top management can be successfully retained and potential loss of managers in acquired companies should probably be handled by standard personnel procedures rather than singled out for special concern or action. Adopting a rule that emphasized good human relations during and
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Strategic Management I Project
following an acquisition may help reduce rather than induce the problem of unintended turnover. Rule 5: Within the first year of a merger, a large number of managers of both companies should receive substantial promotions from one of the former companies to the other. According to Drucker (1981), the goal of this rule is to convince managers in both companies that the merger offers them personal opportunities. Salter and Weinhold's (1979) analysis suggests a refinement for this rule; they conclude, as previously mentioned, that for economic value to be created in related diversifications either party needs to possess functional or industry related skills that can be transferred to the other company. Presumably these transfers would be personal opportunities for substantial promotion. According to Barmash (1971) in Welcome to Our Conglomerate, mergers create job insecurity that may harm individuals and the acquired companies. This type of acquisition policy may only increase the turmoil in the acquired company. The human relations issues in mergers are certainly very important. Marks (1982) reviews research on merging human resources and concludes that the importance of organizational and human dynamics in mergers on financial performance cannot be precisely determined, but neither can it be denied. Drucker's rules 4 and 5 address human resource issues in mergers, but these issues are not adequately addressed. More sophisticated and positive prescriptions for specific acquisitions situations can probably be developed. In conclusion, there are currently no rules that will invariably lead to a successful acquisition. Drucker's rules may be applicable in some situations, but those situations have not been clearly identified. The rules are conservative and the problems they attempt to avoid may not be inherent
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given good management practices. There are potentially highly rewarding acquisition strategies for aggressive firms that violate his rules. Ideas other than those of Drucker's are currently tempting many aggressive managers. So, although there are risks associated with all acquisitions, following Drucker's rules probably does not significantly reduce these risks and following them may create long-run competitive problems.
Ref: Merger Strategy: An Examination of Drucker's Five Rules for Successful Acquisitions Paine, Frank T., Power, Daniel J. Strategic Management Journal. Chichester:Apr/Jun 1984. Vol. 5, Iss. 2, p. 99 (12 pp.)
1-Focus 7-Step Model 1-Focus 7-Step process has been adapted to address the specific and unique concerns of mergers and acquisitions. Training on specialized activities and various large scale interventions is offered across all levels and functions at various stages. Beginning at the pre-merger stage, the 1-Focus 7-Step process drives the integration from a Top Down - Bottom Up approach in an organic, collaborative process. Pre Merger Cultural DNA Due Diligence: Collaborating on an integration strategy Culture of Engagement framework Step I Involvement and Engagement: Dreaming the dream of the future New Identity formulation Step II Shared Vision: Expanding the vision from mine to ours and giving it life Step III Analysis: Evaluation of current reality in line with strategy Step IV Action: Cascading the process by creating ownership in the process
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Step V Implementation: Building and creating momentum Step VI Maintenance: Focusing direction and energy of corporate New Identity Step VII Renewal: Re-evaluation and re-creation REPEAT Step I Integrated Organization: Dreaming the dream of the new future together
Ref: SEVEN STEPS TO MERGER EXCELLENCE Sandy Weiner, Roberta Hill. Ivey Business Journal Online. London:Sep/Oct 2008. Vol. 72,Iss. 5, (1 pp.)
8 Nine ways in which merger and acquisition impacts performance of a firm or benefits the firm:
1. The most important impact of M&A is that on the management of the target firms. Research shows that there is a break in continuity of leadership in the target firms causes degradation in the organizational performance of the target firm in the early stages. 2. Aftermath of mergers and acquisitions impact the employees or the workers the most. It is a well known fact that whenever there is a merger or an acquisition, there are bound to be lay offs. In the event when a new resulting company is efficient business wise, it would require less number of people to perform the same task. Under such circumstances, the company would attempt to downsize the labor force. 3. Technical know how and research activities in a firm benefit the most through M&A activities of a firm. However the firms have to be operating in overlapping technological domains for this to happen.
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4. Economies of scale are achieved through M&A only if the integration of the operations of the two entities is achieved. Integration of operations is the most important challenge in an M&A activity and it is seen that it helps in the long run for the merged entity. 5. Gaining entry into new markets by using the brand name of the target firm is a benefit obtained by the acquiring firm. Many times a merger gives access to markets which were previously unexplored by the acquiring firms. 6. M&A activities provide companies the chance to gain competitive advantage in the market. This has been observed mainly in oligopolistic markets. 7. Mergers have led to cultural conflicts between employees of the two merging entities. Organizational change caused due to mergers is sudden and may create an atmosphere of instability in the workforce. 8. Growth in costumer confidence is a benefit seen by the new company formed. It has been observed that after consolidation the costumer confidence levels have improved for both the firms merging. 9. Streamlined process in the two firms are exchanged through M&A. This may give development of the new merged firm a head-start in terms of efficiency in many domains. However, the processes sometimes are tailored by the merging entities to make them suitable for the new merged entity.
Ref: Reference book of Mergers and Acquisitions (vol 1 chap 3) – Management development institute Library, Gurgaon India
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9 Problems in M&As
Historically, half of all M&A activities have failed to create lasting shareholder value. Findings in a ten-year A.T. Kearney study on stock performance after mergers reveals that since 1990, in the two years after their deals closed, nearly 50 percent of the biggest mergers and acquisitions failed to produce total shareholder returns greater than their industry peers[1]. Only 30 percent outperformed their industry peers (by 15 percent or more) and had earned a penny more in profitability two years later. After five years, 70 percent of the survivors were still chronic under performers in their industries.
Ref: Mergers and acquisitions: Reducing M&A risk through improved due diligence Jeffery S Perry, Thomas J Herd. Strategy & Leadership. Chicago: 2004. Vol. 32, Iss. 2; p. 12 (8 pages)
9.1 Synergy
Many observers and many independent studies question whether M&As truly add value. Executives also point to the unfulfilled realization of synergies. Only half of the senior executives polled in a 2006 Accenture/Economist
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Intelligence Unit survey believed that their companies had achieved the revenue synergies they had expected from their M&A activities, and just 45 percent affirmed that expected cost synergies had been captured. Although acquirers are getting better at identifying and capturing synergies, many deals still do not recover their acquisition premiums and others fail to achieve the long list of benefits touted by management as the rationales for doing the deals in the first place. Some of those failures are clearly the result of overpaying for targets. But others are due to an incorrect understanding of what exactly synergies are and how they should be captured. There are several factors that are easy to overlook, or under-appreciate, when deal-making emotions are running high.
Ref: Where has all the synergy gone? The M&A puzzle Kristin Ficery, Tom Herd, Bill Pursche. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 5; p. 29
9.2 Information Asymmetry
The fundamental problem lies in two inherent features of many M&As: the acquiring company’s struggle to value the target’s resources and the need for the parties involved to agree on a price. The process of due diligence provides a useful starting point for obtaining detailed and reliable information about the quality of the resources to be acquired, yet often fails to unearth the sort of deep, and often tacit, knowledge about the target’s resources that can ultimately determine the success or failure of an acquisition. Moreover, time pressures, organizational complexity, unfamiliar product or geographic markets and the challenges surrounding the appraisal of intangibles can hamper a suitor’s valuation and negotiation efforts. Sellers often face problems in conveying the true value of their resources and capabilities to a buyer in a credible fashion. This is because sellers have
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natural incentives to inflate their representation of the quality of the offering in order to command a higher sale price, while acquirers already assume that sellers are presenting their best face. When such information asymmetries exist across bidders and sellers, attractive deals may simply fall through; but for those deals that are completed, acquirers are likely to overpay. In other words, acquirers run the risk of adverse selection, or winding up with a “lemon.”
Ref: Avoiding Lemons in M&A Deals Jeffrey J. Reuer. MIT Sloan Management Review. Cambridge: Spring 2005. Vol. 46, Iss. 3; p. 15
9.3 Frauds
Preventing employee fraud, regardless of industry, is a thorny problem for businesses during normal times. But it is doubly difficult when companies choose to merge, and those involved in any kind of merger or acquisition should closely monitor the company store to guard against the theft, shrinkage, scams and other kinds of employee dishonesty that becomes an even greater temptation while the entire organization redefines itself. Companies would be wise to heed the M&A red flag, as the combination of two companies often creates an environment that is ripe for fraud. Here is why. * Slow implementation of internal controls. Audit procedures and checkcashing policies need to be integrated. In addition, there should be a separation of duties for financial oversight. If these issues are not addressed early on, the confusion and uncertainty of merging operations will contribute to criminal losses from theft, fraud and abuse. * Inconsistent systems. Purchasing companies need to be aware of the differences between their internal controls and those of the company that
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they are buying. The corporate cultures of the two organizations need to mesh. One company, for example, suffered four crime losses from the same acquisition within a short period of time from the same outlet. That should be an intolerable level of employee theft. * Surprises after the fact. Globally dispersed organizations and
conglomerates have unique problems. Acquired companies may have locations that the acquirer never knew existed, with no internal controls in place to prevent theft. In effect, the remote location becomes a rogue operation. Conglomerates can face losses as they attempt to merge a new line of business with their current operations and are unsure of existing internal controls. * Ethical lapses. Employees who are both prone to steal in the first place and bitter about a merger that may leave them unemployed are a bad combination. The merger period creates a gray area in which anxiety rises and shrinkage increases. Quickly implementing internal controls against theft is an imperative.
Ref: The Hidden Costs of Mergers and Acquisitions Michael Klein. Risk Management. New York: Mar 2006. Vol. 53, Iss. 3; p. 42 (1 page)
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10 Cross border M&A Trends
The rise of globalization has increased the market for cross border M&A. In the past, a more national mindset prevented the vast majority of small and mid-sized companies from considering cross border intermediation as an option.
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(Source: “Global financial turmoil and new opportunities” Alsuhaibani, S. Investment Research. Saudi Arabia: Dec 2008; p. 7)
Due to the complicated nature of cross border M&A, the vast majority of cross border actions have unsuccessful results. Cross border intermediation has much more complexity to it than regular intermediation; viz. issues pertaining to corporate governance, the power of the average employee, company regulations, political factors customer expectations, and countries' culture are all crucial factors that could spoil the transaction. However, with the soft economies in a number of countries around the world, we are today seeing more cross-border bargain hunting as top companies seek to expand their global footprint.
(Source: “Global financial turmoil and new opportunities” Alsuhaibani, S. Investment Research. Saudi Arabia: Dec 2008; p. 7)
Even mergers of companies with headquarters in the same country are very much of this type (cross-border mergers), as the companies must integrate operations in dozens of countries around the world. E.g. Boeing’s acquisition of McDonnell Douglas and the merger of Sandoz and Ciba-Geigy (now Novartis).
(Source: “Safe ways to cross the merger minefield” Finkelstein, S. Financial Times Mastering Global Business. London: 1999; p. 123)
Interestingly, financial variables and other institutional factors appear to play a significant role in M&A flows. In particular, the size of financial markets, as measured by the stock market capitalization to GDP ratio, has a strong positive association with domestic firms investing abroad. This result points to the importance of domestic financial conditions in stimulating international investment during the boom years of 1990s, and accords with the significant drop in cross-border M&As at the turn of the millennium.
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(Source: “What drives capital flows? The case of cross-border M&A activity and financial deepening” Julian di Giovanni. Journal of International Economics. Amsterdam: Jan 2005. Vol. 65, Iss. 1; p. 6)
Cross border mergers and acquisitions activity again started booming in the middle of the current decade. In 2005, Europe saw a 58% surge in transnational deals; in Japan, cross-border M&A jumped 21%, and in India the rise was a staggering 68%. It is not hard to see why. After years of restructuring, companies were once again cash-rich and confident. Credit became cheap and plentiful. And as industry consolidation reduces the number of viable M&A opportunities at home, more and more companies started looking abroad for acquisition targets or merger partners to help them meet their growth aspirations. Yet for most, the prospect of acquiring or merging with a company in an unfamiliar market is daunting. The pursuit of economies of scale-based cost savings is usually the biggest driver for national deals. But cross border acquisitions are more often about growth. Ready-made access to customers, products, brands, distribution channels and market knowledge all make acquisitions an appealing option for geographic expansion. Opportunities for revenue growth can arise from the cross selling of products, the exchange of knowledge about markets or technology, or the ability to offer existing customers more comprehensive global coverage.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
The greatest risks in cross-border transactions arise from the failure to understand the culture, regulatory structure or competitive environment – and sometimes all three considerations – in the target market. These oversights can lead to overly optimistic (or pessimistic) assumptions about revenue growth or cost-savings opportunities. In many cases, acquiring
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companies assume that their detailed knowledge of their own market will translate directly to the target market, and they therefore see little reason to invest in upfront fact-finding. In other cases, where a market is undergoing rapid development, acquirers may decide that there is too much uncertainty for a detailed investigation of the current state of play to be relevant. Or if an acquirer feels pressure to act because a herd mentality takes over, it may decide there simply is not time to do its homework. Assuming that customers in new markets are fundamentally the same as those at home is another classic mistake. Whatever the reason, the failure to do homework on an acquisition can lead to critical, costly, and sometimes irreparable mistakes.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
Proper due diligence can expose these challenges. The right level of investment in due diligence needs to be tailored to the specific situation. A straightforward investigation of local rules and regulations may be all that is required. But for more complex situations, local advisors who can help explain critical differences in customer needs, competitive behaviour or cultural factors will typically repay the investment in their services many times over. The successful integration of an acquired management team also requires sensitivity and careful attention to the cultural gaps that exist between acquirer and target, or between merging partners in a cross border deal.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
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Following is a discussion on some recent major cross border M&A deals 1. Tata Steel – Corus In Jan 2007, Tata Steel acquired Corus plc, the Anglo-Dutch steel giant. After nine rounds of bidding, Tata Steel emerged victorious over the nearest suitor, Brazil’s CSN. This, till date, is the biggest ever cross border acquisition by an Indian company. The merger made Tata Steel the world’s 5th biggest steel manufacturer in terms of installed capacity and also gave it the strategically significant strong distribution network that Corus enjoys in Europe. The synergic advantages went beyond - Corus' enjoys a reputation in making the grades of steel used in automobiles and aerospace industries, which could boost Tata Steel's supplies to the Indian market. On the other hand, Corus was expected to benefit from Tata Steel's expertise in low cost manufacturing processes. However, as we saw in the theory that cross border M&A transactions are often fraught with risks pertaining to over-optimism or overpessimism. In this case, some analysts contend that the price paid by Tata Steel (608 pence per share of Corus) for the acquisition was too high. Despite the up-cycle in the commodities markets, Corus had been facing tough times, logging a considerable drop in profit after tax for the year 2006. Experts are still divided in their verdict as to whether the deal would bring home worthwhile benefits to Tata Steel.
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Also, it was an all-cash deal, with the funding done through internal accruals, debt and equity (Rights Issue), and analysts believe that the transaction would be a financial albatross around Tata Steel’s neck for some time to come. 2. HCL Tech – Axon Group Another closely contested cross-border deal was that for Axon Group plc, with HCL Technologies pipping Infosys Technologies to the post as recently as 2 months ago. Strategically, this would have been a first major acquisition by either company. At the core of the rationale was SAP package implementation business in Europe, seen by many experts as a cash cow, more so in current times of financial turmoil and currency risk. The deal, though nowhere near the Tata-Corus deal size, still is the biggest M&A transaction carried out by in the Indian IT sphere ever. As per Mr Vineet Nayar, CEO of HCL Tech, “Axon represents that right capability for us. It is the right stepping stone to respond to the economic slowdown…Together, we can provide seamless end-to-end services”. In the past, one of the major concerns for the Indian IT industry considering cross border inorganic growth used to be dilution of profitability. But more recently, even Indian IT companies’ margin juggernaut has halted and subsided closer to global levels, which makes them willing to be on the lookout for greener pastures. 3. Hindalco – Novelis Hindalco’s acquisition of Canadian rival Novelis, the world’s largest aluminium cans maker, was another big ticket cross border acquisition,
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in fact the second biggest, after Tata-Corus deal. Post-merger, the entity is the world’s largest player in aluminium rolling. In the words of Mr Kumar Mangalam Birla, chairman of the Aditya Birla Group, “It (the deal) is in line with our long-term strategies of expanding our global presence across various businesses and is consistent with our vision of taking India to the world.” In the words of Mr Debu Bhattacharya, MD of Hindalco, Novelis is a strategic fit for Hindalco, which had ambitions to grow upstream to ensure sustainable profits. Hindalco was faced with a tricky proposition to venture by itself, as the technology could still be developed, but customer acceptance doesn’t come as naturally. Further, the product portfolio got widened as a result of the merger, leading to better hedge of sorts against the volatility in aluminium prices. Getting into the nitty-gritties, the energy efficiency focus at Novelis’ plants was of a much higher level vis-à-vis Hindalco. However, as with Tata-Corus deal, experts differ in their opinion over the pricing of the deal vis-à-vis the benefit. Novelis was a loss-making company, and the unified entity is having a tough time fighting the dropping demand faced by Novelis more recently.
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11 Research Methodology
We intend to study and conduct a cross-sectional exploratory analysis of the M&A-related activities in the top 100 firms in India in recent times. Generally, we would limit our focus on those transactions – accomplished or otherwise – where the deal size was in excess of US$ 20 mn (approx. Rs 100 Cr). We intend to study in depth i. ii. the trends prevalent in the transactions, the strategic benefits or intentions behind the transactions,
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iii. iv. v. vi. vii.
the mode of financing, the strategies adopted to carry out the transactions, the problems faced during and after the deal was struck, the fallout of the transaction on the parties involved, the road ahead in normal circumstances as well as in a more pertinent recessionary environment, and
On the basis of the above, we will try to figure out the commonalities and the differences at various levels and compare, contrast and understand as to why a particular approach was adopted at a particular juncture.
12 Company Analysis
The appendix to this document contains the Excel tables which document 100 companies and their M&A activities. There are 5 sheets in the excel document. Sheet 1 gives the analysis of whether a given company adopts M&A as a strategy or not. Sheet 2 gives the analysis of what sort of M&A activity (for example: merger, acquisition, buyout, strategic stake etc) is done by a given company. Sheet 3 contains analysis of reasons given by executives of various firms for using merger and acquisition. Sheet 4 gives analysis of performance impact of M&A activity on a given company and
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Sheet 5 gives the future preferences of a company for merger and acquisition activities. The analysis shows the prominence of M&A as an effective strategy for inorganic growth with 47 of the given 100 companies going for merger and acquisition activity. Most of the companies go for merger or acquisition when they have enough cash. However there are few like the ones owned by Tata group and HCL which go for merger and acquisition as a strategy based on available opportunity and have gone for leveraged buyouts to fulfill their strategic needs. Some companies like Bhushan Steel have gone for foreign acquisitions to increase their global presence while on the other hand companies like Cipla has divested its South African subsidiary to improve its efficiency.
M&A us (47% ed ) M&A not us (53% ed )
The 53 companies not going for merger and acquisition are the ones which mostly prefer organic growth and have to allocate resources (both cash as well as loans) in buying strategic assets like land. Many of these firms prefer to go for joint ventures on individual projects. 27 of them are Public Sector companies which are thus under Government of India’s supervision when it comes to mergers, acquisitions and disinvestments. While 12 of the companies have been involved in pure mergers, 18 have been involved in pure acquisitions. On top of these, 8 companies have
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named the process Mergers and Acquisitions (M&A) in their Annual Reports thus maintaining a little ambiguity. Tata Sons has been involved in a reverse merger/takeover being the holding company of the Tata Group. There have been 6 instances of pure takeovers amongst the companies. 2 companies have been involved in taking up strategic stakes.
20 15 10 5 0
Mergers
Acquisitions
M&A
Takeover
C teg a orisa tion
Strategic Stake
Reverse Merger
22 out of 47 companies say that that one reason for M&A activity is fast growth. Fast growth is also a major reason given by executives of firms going for merger and acquisition. This means that the companies which seek growth in terms of revenues/turnover have used M&A as a strategic tool for expansion. Firms like Tata chemicals have aggressively used M&A and have ended up being world’s 2nd biggest firm in their domain in terms of revenue and production capacities. 22 out of 47 companies say that increase in market share/control is a major deciding factor for Merger and acquisitions. The next most important (19/47) reason sighted was improvement in efficiencies. 12 companies have gone for M&A to gain competitive advantage.
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Stock Market New Assets New markets Synergy Diversification Competitive Advantage Improvement in efficiency Increase market share Fast Growth
0
5
10
K R s for M&A ey ea ons
15
20
25
39 of the 47 have reported significant improvement in their performance because of the M&A activity. The reasons cited for the improvement range from stronger distribution networks, increased production and capacity, geographical and product diversification, higher agility etc.
40 35 30 25 20 15 10 5 0 S n ig ifican t Not S n ig ifican t
Im provem in P ent erforma e nc
40 Companies out of 53 who haven’t gone for M&A wont do it in future. The rest 13 may go for M&A in future. 25 out of 47 who have gone for M&A will continue the same way while 8 of them will discontinue in the future. 14 will do more M&A in the future.
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M&A Done
40 20
Wont Do in future No M&A Done Will Continue Will Do More
0
No M&AD one
M&AD one
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References
?
“What drives capital flows? The case of cross-border M&A activity and financial deepening”
Julian di Giovanni. Journal of International Economics. Amsterdam: Jan 2005. Vol. 65, Iss. 1; p. 127
?
“Cross-Border Mergers and Acquisitions: Do Strategy or Post-Merger Integration Matter?”
H Donald Hopkins. International Management Review. Marietta: 2008. Vol. 4, Iss. 1; p. 5 (7 pages)
?
“Transnational mergers and acquisitions: how to beat the odds of disaster”
Caroline Firstbrook. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53
?
“Mergers and Acquisitions: Causes and Effects”
Gabriele Carbonara, Rosa Caiazza, Journal of American Academy of Business: 2009, Vol. 14; p. 188 (7 pages)
?
“ACQUISITION VALUATION: HOW TO VALUE A GOING
CONCERN?” Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages)
?
“India: Legal and tax considerations in cross-border M&A”, Deanne
D'Souza-Monie, 2002
?
“The Hidden Costs of Mergers and Acquisitions”
Michael Klein. Risk Management. New York: Mar 2006. Vol. 53, Iss. 3; p. 42 (1 page)
?
“Avoiding Lemons in M&A Deals”
Jeffrey J. Reuer. MIT Sloan Management Review. Cambridge: Spring 2005. Vol. 46, Iss. 3; p. 15
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Strategic Management I Project
?
“Where has all the synergy gone? The M&A puzzle”
Kristin Ficery, Tom Herd, Bill Pursche. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 5; p. 29
?
“Mergers and acquisitions: Reducing M&A risk through improved due
diligence” Jeffery S Perry, Thomas J Herd. Strategy & Leadership. Chicago: 2004. Vol. 32, Iss. 2; p. 12 (8 pages)
?
“Seven Steps to Merger Excellence”
Sandy Weiner, Roberta Hill. Ivey Business Journal Online. London: 2008. Vol. 72, Iss. 5
?
“Merger Strategy: An Examination of Drucker's Five Rules for
Successful Acquisitions” Paine, Frank T., Power, Daniel J., Strategic Management Journal: 1984. Vol. 5, Iss. 2; p. 99 (12 pages)
?
“Merger Motives and Target Valuation: A Survey of Evidence from
CFOs” Tarun K Mukherjee, Halil Kiymaz, H Kent Baker, Journal of Applied Finance: 2004, 14(2), p. 724
?
“The Determinants Of Horizontal Acquisitions: Evidence” Tremblay, Victor J., Tremblay, Carol Horton, The Journal of Industrial Economics:
1988, 37(1), p. 21.
?
“Marketing-Related Motives in Mergers & Acquisitions: The
Perspective of the U.S. Food Industry” Douglas Reid, Academy of Marketing Science. Journal: 2004, 32(1), p. 98-99.
?
“Access to competence: an emerging acquisition motive”
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Jens Gammelgaard, European Business Forum: 2004, (17), p. 44-47
?
“Merger motives “
David C Lam, Michael Chiu, CA Magazine: 2005, 138(2), p. 41-42
?
“Merger Strategy: An Examination of Drucker's Five Rules for Successful
Acquisitions” FRANK T PAINE & DANIEL J POWER; Strategic Management Journal (pre-1986); Apr-Jun 1984; 5, 2; ABI/INFORM Global; pg. 99
?
“ACQUISITION VALUATION: HOW TO VALUE A GOING
CONCERN?” Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 10 pages
? ? ? ? ? ? ? ? ? ? ? ?
http://www-03.ibm.com/industries/global/files/barry_boniface.pdfhttp://www.ibef.org www.investopedia.com www.tatasteel.com www.corusgroup.com www.hindalco.com www.novelis.com www.hcltech.com www.hcl-axon.com www.thehindubusinessline.com www.alacrastore.com www.economictimes.com
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doc_396908065.doc
It describes Evaluation of M&A (Mergers and Acquisitions) of 100 Indian firms
Strategic Management I Project
Strategic Management – Project Mid-Term Submission
Critical Evaluation of the State of M&A of 100 Indian Firms
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TABLE OF CONTENTS Table of Contents
1 INTRODUCTION........................................................................................................4 1.1 Business Environment and need of M&A in current global setup......................4 1.2 The role of M&A in the current Indian Scenario.................................................5 1.3 Here are the top 5 acquisitions made by Indian companies worldwide:............6 2 What is M&A? Classification of Mergers and Classification of Acquisitions ...........10 3 Business Valuation................................................................................................13 3.1 Discounted Cash Flow Valuation method........................................................13 3.2 Relative Valuation Method...............................................................................14 3.3 Asset Valuation Method...................................................................................14 3.4 Control Valuation.............................................................................................14 3.5 Synergy Valuation...........................................................................................15 3.6 Acquisition Value.............................................................................................16 4 Financing an acquisition........................................................................................17 5 Motives of M&A......................................................................................................21 6 Nine reasons why firms go for Merger and Acquisition:.........................................25 1. To affect more rapid growth.............................................................................25 7 Strategy for M&As................................................................................................. 27 8 Nine ways in which merger and acquisition impacts performance of a firm or benefits the firm:...................................................................................................... 34 9 Problems in M&As..................................................................................................36 9.1 Synergy...........................................................................................................36
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Strategic Management I Project 9.2 Information Asymmetry...................................................................................37 9.3 Frauds............................................................................................................. 38 10 Cross border M&A Trends....................................................................................40 11 Research Methodology........................................................................................47 12 Company Analysis...............................................................................................48 References...............................................................................................................53 Appendix..................................................................................................................52
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1 INTRODUCTION
1.1 Business Environment and need of M&A in current global setup
Merger and acquisition have long been a popular strategy for many firms at the beginning only in North America. But from the fifth merger wave of the twentieth century, the strategy of M&A also became popular in Europe, Asia and Latin America. The growth in merger and acquisition was fed by activity in Europe with firms preparing for the full implementation of the European Union. The enlargement of European market introduced by Euro was a major factor that affected the growth in M&A activities. In 2006, the global M&A market confirmed the recovery seen in 2005, outperforming forecasts made at the start of the year and reaching the peak recorded in 2000 in terms of number of transactions. The equivalent value of transactions on the global M&A market rose 50% on 2005 from Euro 2,583 million to Euro 3,870 million in 2006. Market volumes rose 18%. In 2006, approximately 32,000 transactions were concluded, compared to 27,000 in 2005, which resulted in a new record after the 2000 peak of 30,000 transactions. The geographic areas most affected by M&A activities were the America with 40% of concluded deals, Europe with 34%, Asia with 18% (excluding Japan), Japan with 6%, and Africa and the Middle East with 2%. One difference that can be noted in M&A activities now in the past is that financial markets have ceased to play key roles and present boom in the M&A activities is primarily driven by the strategic choices made by the firms in the light of the opportunities that have been provided by the economic growth.
Mergers and Acquisitions: Causes and Effects Gabriele Carbonara, Rosa Caiazza. Journal of American Academy of Business, Cambridge. Hollywood: Mar 2009. Vol. 14, Iss. 2; p. 188 (7 pages)
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(Ref:http://www-03.ibm.com/industries/global/files/barry_boniface.pdf)
1.2 The role of M&A in the current Indian Scenario
India is the great big oasis most multinational corporations are looking to as they consolidate their position in Indian companies. Also since the start of the new millennium, the news that Indian companies having acquired American-European companies has stopped being a rarity. This is evident in the recent years, where in the year 2001 foreign players accounted for approximately 35% of the value of Indian acquisitions. The telecoms sector dominated the M&A scene accounting for 24% of all deals done in the year 2001. The Batata-- BPL telecom deal ($662 million) represented 10% of all deals done during 2001. Strong and buoyant Indian Economy, Government policies, excess liquid funds with Indian corporates and newly found dynamism in Indian entrepreneurs and corporates have all contributed to this new M&A trend. Recent mergers of like Tata-Corus, Ranbaxy-Daichii, Tata-Jaguar etc have shown the amount of confidence with which Indian corporates are making a mark in the world. While the Indian IT and ITES companies already have a strong presence in foreign markets, other sectors are also now growing rapidly. The
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globalization and its impact on the increasing engagement of the Indian companies in the world markets is an indication of the maturity reached by Indian Industry.
1.3 Here are the top 5 acquisitions made by Indian companies worldwide:
Deal Indian Acquirer Tata Steel Hindalco Target Company Country Corus Group plc Novelis Daewoo Electronics Videocon Corp. Dr. Reddy’s Labs Suzlon Energy Betapharm Hansen Group Germany Belgium 597 565 Korea 729 UK Canada value ($ ml) 12,000 5,982
Indian outbound deals, which were valued at US$ 0.7 billion in 2000-01, increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006. In fact, 2006 will be remembered in India’s corporate history as a year when Indian companies covered a lot of new ground. They went shopping across the globe and acquired a number of strategically significant companies. This comprised 60 per cent of the total mergers and acquisitions (M&A) activity in India in 2006. And almost 99 per cent of acquisitions were made with cash payments. The total M&A deals for the year during January-May 2007 have been 287 with a value of US$ 47.37 billion. Of these, the total outbound cross border
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deals have been 102 with a value of US$ 28.19 billion, representing 59.5 per cent of the total M&A activity in India. The total M&A deals for the period January-February 2007 have been 102 with a value of US$ 36.8 billion. Of these, the total outbound cross border deals have been 40 with a value of US$ 21 billion. Some examples of recent mergers and acquisitions in the India show some interesting trends which are changing the traditional way business is done in India. In banking sector, State Bank of India (SBI) had ambitious plans to integrate many its functions with those of its seven subsidiaries. These functions included treasury operations, ATMs, technology and the intent was to synergize and rationalize its operations as well as reduce costs to result in a steady growth. The bank took a step in this direction by incorporating all its operations in the merger between SBI and State Bank of Saurashtra. The post-merger rationalization is implemented on technology front, asset management, branch banking and seniority. The merger has resulted in some concerns being raised by the employees of SBS and the concerns have been ironed out. It is imminent that such a merger is mandatory in the banking industry once India throws open its doors to foreign banks by 2009 in line with India’s commitment to WTO. Only those banks which are equipped with adequate capital adequacy ratio, latest technology, economy of scale and quality human resources, will be in a position to survive. Moreover a technological update which is very much required both for SBI and the associate banks becomes feasible only once these mergers are started. In the meanwhile, SBI has deferred its merger plans of associate banks with itself in view of the present financial crisis and concentrates more on maintenance of its financial position and overcoming slowdown. The mergers would be initiated once the market conditions are calm.
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Another interesting trend emerging since 2002 is the acquisitions of foreign companies by their Indian counterparts. Other than the already mentioned top 5 Indian acquisitions, some smaller ones show the strategic insights taken by Indian companies to fuel their growth. Recently Punj Lloyd acquired Technodyne International Ltd. on 3rd June, 2008 in terms to form a strategic fit which will further strengthen their existing business range. Technodyne is an engineering, design and consultancy company specializing in large scale cryogenic and high pressure tanks. Technodyne also carries out the basic design and detailed engineering for complete steel and steel plus concrete tanks, including associated piping, instrumentation and electrical systems. The acquired capabilities will enable the group to provide end-to-end solutions for complete delivery of complex cryogenic, high pressure LNG, LPG, ethylene, ammonia and other similar storage tanks, a significant growth area in oil and gas sector. This acquisition is a strategic fit and further strengthens Punj Lloyd’s existing tankage and terminal business. Similarly the Tyre Industry is looking for expansion with both MRF and Apollo looking out for strategic partners and acquisitions. Apollo Tyres acquired the South Africa-based Dunlop Tyres International for around Rs 290 crore ($62 million) in Jan, 2006. The acquisition of Dunlop South Africa made Apollo Tyres Ltd the largest Indian tyre manufacturer in terms of size, reach, technology and range of products with combined capacities touching 900 tonnes per day post acquisition. It is also the first Indian tyre company to undertake an acquisition in the global arena and is expected to be the springboard to position Apollo Tyres Ltd as a global player, and a base for future growth initiatives. The synergies between our two companies have added enormous value to both the partners. Dunlop’s know-how has further boosted Apollo’s R&D and market reach, enabling Apollo to maintain its technology-driven product and market leadership in all the key segments of the tyre market.
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Some other merger trends in India include disinvestment of some profit and loss making Public Sector Units and their merger with keen Industry participants. The Indian metallurgical sector is particularly in focus recently for the disinvestment of Bharat Aluminum Company (BALCO). Sterlite Industries India Ltd. had acquired a stake of 51% in BALCO following a disinvestment offer floated by Govt. of India in March 2001 for around Rs. 551 Crores. Sterlite also approached the Government in the year 2004 for acquiring the remaining 49% residual stake which was followed by a minor legal tussle with Sterlite moving to Delhi High Court in 2006. As of now, the Government’s stand on the selling of the residual 49% stake is confirmed to be negative. But keeping the modest target of disinvestment of atleast 5 PSU’s as announced in the budget and the coming general elections, the balance may tilt on either of the sides. -www.investopedia.com, www.capitalonline.com
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2 What is M&A? Classification of Mergers and Classification of Acquisitions
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. Merger is a combination of two companies into one larger company. Such actions are commonly voluntary and involve stock swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons. Classification 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. 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.
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•
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 - 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 writtenup 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. An acquisition, also known as a takeover, is the buying of one company (the ‘target’) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Another type of acquisition is reverse merger a deal that enables a private company to get publicly listed in a short time period. A
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reverse merger occurs when a private company that has strong prospects and is eager to raise financing buys a publicly listed shell company, usually one with no business and limited assets. Two types of acquisitions are: • The buyer buys the shares, and therefore control, of the target company being purchased. • The buyer buys the assets of the target company.
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.
(Source: www.investopedia.com)
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3 Business Valuation
The valuation of business is a very important component of any merger and acquisition deal. In practice there are various methods of valuation of business in relation to mergers and acquisition. These methods are based on the following approaches to valuation: • • • Income Concept Market Concept Cost concept
The Income Concept uses the Discounting approach of valuation of a firm and the method used is the Discounted Cash Flow Valuation method. The Market Concept uses the Comparables approach and the method of valuation used is the Relative Valuation method. The Cost Concept uses the approach which takes into consideration the underlying asset and uses the Asset Valuation method.
3.1 Discounted Cash Flow Valuation method
This is the most commonly used method of the valuation of a business. In this method, the future cash flows from the forecasted operations, including the residual value of the business at the end of an explicit period (the last year of the forecasted period), are discounted to their present value. If we look at the time perspective, discounted cash flow (DCF) valuation separates free cash flow forecasting into two categories: initial period of explicit forecast and residual value of a going concern at the end of that period. Going concerns would normally operate beyond the explicit period for which it is possible to make a discrete (reasonably accurate) cash flow forecast.
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The residual value of a business as of the end of a discrete projection period is critical to value and is established on the basis of perpetual growth assumptions of future cash flows.
3.2 Relative Valuation Method
The market based concept of valuation seeks to determine the value of a business by comparing the business with the comparable companies. The value is determined relative to the value of other companies. Comparative multiples like price-earning ratio and EBTIDA multiplier can be usefully applied for gauging residual value in discounted cash flow valuation. The other features that can be compared are net earnings, gross revenue and book value of the assets.
3.3 Asset Valuation Method
The principle of substitution is the basis of the asset valuation system and it suggests that no investor would like to pay more for the assets of the business than the cost which is incurred for procuring assets of similar economic utility. In this method, most of the assets are reported in the financial accounts of the subject company at their acquisition value. But the problem lies in the determination of the value of intangible assets. For this reason, in many cases, this method might give results which are less than the fair market value of the business. In case of an acquisition, various other valuations are also required to be taken into consideration:
3.4 Control Valuation
Acquiring companies also normally pay acquisition premiums reflecting the value of control. The value of control is proportional to the value maximization capacity of the target. The rationale behind a value of control lies in expectations of an acquirer to be able to run a company more
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efficiently. Well-managed companies get little or no control premium, as there is hardly any room for operational improvements whereas the case is vice versa for poorly managed companies which get a bigger premium, as there is much room for improvements.
3.5 Synergy Valuation
In acquisition valuation, positive effects on combined value have to be defined in addition to stand-alone valuations of companies involved in the acquisition deal. These positive effects are called synergy. Synergy can thus be defined as increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently. It refers to the combined strength of the companies instead of when they stand alone. Synergy as a valuation input can take different forms, such as increased future growth or reduced costs, etc.
(Ref: “ACQUISITION VALUATION: HOW TO VALUE A GOING CONCERN?” Andrej Bertoncel. Nase Gospodarstvo: NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages))
Synergy can be valued by answering two fundamental questions: (1) What form is the synergy expected to take? Will it reduce costs as a percentage of sales and increase profit margins (e.g., when there are economies of scale)? Will it increase future growth (e.g., when there is increased market power) or the length of the growth period? Synergy, to have an effect on value, has to influence one of the four inputs into the valuation process – cash flows from existing assets, higher expected growth rates (market power, higher growth potential), a longer growth period (from increased competitive advantages), or a lower cost of capital (higher debt capacity).
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(2) When will the synergy start affecting cash flows? –– Synergies can show up instantaneously, but they are more likely to show up over time. Since the value of synergy is the present value of the cash flows created by it, the longer it takes for it to show up, the lesser its value. Once we answer these questions, we can estimate the value of synergy using an extension of discounted cash flow techniques. (www.damodaran.com)
3.6 Acquisition Value
The objective of an acquisition valuation is to provide an indication of value. A professional valuation should establish the fair market value for a willing and informed buyer who would purchase a company in normal open market conditions. Acquisition price is the result of negotiations between a seller and a buyer. It is that level of price where the expectations of both seller and the buyer meet. Thus, acquisition price refers to the final negotiated price. This price is rarely equal to the market value or the intrinsic value. The reason for the same being that it includes something which is called as the acquisition premium. Now, the acquirer company has to define how much acquisition premium is willing to pay to the owners of the target company. Thus, the acquirer company needs to know the exact synergy value they are getting through the acquisition. Also, it needs to decide as to what portion of that value it is willing to share with the shareholders of the target companies. In all, another way of looking at the acquisition premium is that it is the allocation of certain future benefits to the owners of the target company.
Several steps that are involved in acquisition valuation are as follows:
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• • • • • • •
Define the rationale of acquisition Select a target company Perform a comprehensive due diligence Define synergy and restructuring costs Define control premium Value a target Define mode of payment
(Ref: “ACQUISITION VALUATION: HOW TO VALUE A GOING CONCERN?”
Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages) )
4 Financing an acquisition
Various methods of financing an M&A deal exist: • Payment by cash: In case of the payment by cash, shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders. A cash deal tend make more sense and better decision making during a downward trend in the interest rates.
•
Financing: Financing capital may be borrowed from a bank, or raised by an issue of bonds. Alternatively, the acquirer's stock may be offered as consideration. Acquisitions financed through debt are known as leveraged buyouts if they take the target private.
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•
Hybrid: Such kind of an acquisition involves a combination of cash and debt, or the financing through the combination of cash and stock of the purchasing entity.
•
Factoring:
Factoring refers to a financial transaction whereby a
business sells its accounts receivable or, in other words the invoices, at a discount.
Various mergers and acquisitions that have taken place in the recent times make use of one or more of these financing and valuation methods. (www.investopedia.com)
•
Merger of HDFC Bank Ltd and Centurion Bank of Punjab:
The merger between these two companies was finalized in the early 2008. At nearly $2 b, it was the largest merger at that time in the Indian banking sector. The mode of financing that was used for the deal was that of share swap where in shares of HDFC Bank Ltd were given as the consideration for financing the deal. There was a share swap in the ratio of 1:29, wherein 1
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equity share each of the HDFC Bank was given for 29 shares held in Centurion Bank of Punjab. In order to arrive at the merger swap ratio, following three methods were applied:
• • •
Net Asset Value Method Income method Market price method
For the market price method, price quotations of both banks on NSE and BSE for last 2 years, last 6 months, last 3 months, and last 2 weeks were considered at that point of time. Also considered were the prices at which both banks had issued fresh capital to institutional investors in the last 6 months under consideration. As per each of these variations of the market price method, swap ratio was coming to around the recommended ratio with 10 per cent range on either side. Again, swap ratio as per NAV method also came close to the recommended swap ratio of 29 shares of Central Bank of Punjab for every one share of HDFC Bank. (Ref: www.hindubsinessline.com)
•
Acquisition of Axon by HCL Technologies:
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This was a $679mn dollar worth deal. Since Axon group is based in UK, it was a cross border merger. The financing of the deal took place via two routes: the first one was through internal accruals to the extent of $116mn. The second was through the issue of ECB, at coupon rate of LIBOR+300 bps (for a period of 1 year), worth $585 mn. (Ref: www.valuenotes.com) In this acquisition, a hint of synergy valuation can be seen as the company HCL bid for Axon to become a significant player in SAP services space. The operational model used by Axon led to synergy and various benefits for HCL and this also explains the premium that HCL Technologies offered in the form of the higher bid to the acquired company.
•
Acquisition of Punjab Tractors Ltd by Mahindra & Mahindra:
Punjab Tractor Ltd., for the purpose of acquisition has been valued at 2,160 crores bye M&M. The deal has been finalized and the financing of the deal will take place by share swap, where for every 3 equity shares of Rs.10 each, one equity share of Rs.10 each.
•
Acquisition of Kinetic Motors Co. by Mahindra & Mahindra:
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The company, Kinetic Motors Co., has been valued by the acquirer company at $137.5 crore. The acquirer company will pay the cash Rs110 crore and 20%stake in new operating company, worth Rs.27.5 crore. Now, here if we use the valuation of assets method, kinetic Motor’s assets have the net value of Rs. 107 crore. So, the valuation is at the premium of about 29%. It’s also a premium of about 30% to trailing 12-month revenues. (Ref: www.livemint.com)
5 Motives of M&A
There are macroeconomic, microeconomic and institutional factors which drive global M&A. In today’s scenario the factor at the macroeconomic level has been continued economic growth. In 2005 prompted institutions, the growth of domestic equity and world real GDP grew by M&A. At the 4.8% (IMF 2006). Favorable conditions in financial and stock markets cross-border led to microeconomic level, a surge of financial flows to collective investment e.g. private funds, massive cross-border investments by these funds. One of the common motives for mergers is growth. Other motives include the pursuit of synergistic benefits and diversification. Certain types of mergers, such as diversifications, tend to yield poor results. Some firms merge to reduce competition. The failing firms avoid bankruptcy by selling to successful firms. In the absence of an antitrust constraint, large firms are more likely than small firms to acquire another competitor. There is also evidence that firms merge to increase market power or to attain economies of scale. Thus there are value-enhancing mergers (conjectured as motivated by synergy) and value-reducing mergers.
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In the case of merger of Punjab National Bank with Nedungadi Bank. One is Private bank and the other public sector banks. Therefore there is diversification involved, and also leading to enhancement of value. In the case of merger of Apollo tyres and Dunlop tyres Apollo used Dunlop tyres’ distribution network to export and enter into African market. Also by this merger it got the manufacturing units in Africa making it the largest tyre manufacturer in India with capacity of 900 tonnes. Moreover it helped in optimizing cost, cutting R&D costs. Classic theories justify mergers and acquisitions on the grounds of increasing market power, leading to additional rent creation and appropriation. More novel theories explain mergers and acquisitions as a function of cognitive traps rooted in unchecked CEO ego (e.g., the "hubris hypothesis" advanced by Hayward and Hambrick [1997]). Asset-based rationales for corporate combinations have a strong and persuasive place: recent acquisitions (e.g., Unilever's purchase of Bestfoods, Kraft Foods purchase of Nabisco, and PepsiCo's acquisition of Quaker Oats) provide compelling evidence that the pursuit of growth in this industry setting will not occur as a function of innovation or pricing power alone. The most important factor in brand acquisition decisions is the positioning/image attribute involved. The objectives of acquiring companies are diverse, including filling critical capability gaps, achieving synergies and economies of scale, acquisition of tax losses and fending off an income trust structure and replacement of management. Sirower (1997) defines synergy as increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently.6 Eccles, Lanes, and Wilson (1999) outline the source of synergies as cost savings, revenue and tax enhancements, process involvements, financial engineering,
benefits. Goold and Campbell (1998) report six forms of synergy including
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shared know-how, shared tangible resources, pooled negotiation power, coordinated strategies, vertical integration, and combined business creation. Studies indicate that the important sources of the merger-related synergy are operating economies, financial economies, differential efficiency, as economies of scale in management, power. As sectors continue to consolidate, there will be another key strategic motive - the acquisition of assets to protect existing revenue base (protection value). From both a theoretical and practical perspective, the acquisition of an asset that can effectively obstruct the entry of a major competitor and prevent the erosion of its market share has significant value. This is particularly true in mature sectors dominated by a handful of players and where top-line growth is constantly challenged and competitors look for a catalyst to break through into each other's geographies to steal business from one another. High-growth targets require companies not only to drive revenue growth and capitalize on opportunities made possible by new technologies but also to defend market position with unprecedented intensity. It is in this competitive context that the concept of protection value is emerging with greater importance. In the case if UTI-Global Trust Bank, the bank had a P/E below 8 on forward earnings, however the motive is to increase the size. However there is costs of merger involved like disgruntled employees, time spent on integrating operations and cultural aspects. The predominant motive for acquiring companies until now was short-term exploitation of market growth opportunities, scale economies, and risk reductions. The new trend is towards the long-term exploration of the target company's capabilities, such as unique employee skills, organizational production and increased market
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routines, superior knowledge and technologies. Synergy rises from the pooling of the two companies' resources be and capabilities. as Acquired of competence-based companies should integrated 'centers
excellences' - and be in charge of innovation processes in connection with specialized products and markets. Cisco Systems, Microsoft and Intel are among companies which have initiated a series of such technology-driven acquisitions in the 1990s (Ranft and Lord, 2002). Likewise, companies like Siemens, ABB, General Electric, DuPont, Nokia, and Nestle have all used acquisitions as a vehicle to gain particular competences they could not create by themselves (Mitchell and Capron, 2002). Despite public commentaries made by CEOs on the non quantifiable, strategic rationales behind their deals, at the board level, quantifiable financial return on investment is a mandatory prerequisite to any deal approval, not only to legitimize the initial offer price but to determine the walk away price.
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6 Nine reasons why firms go for Merger and Acquisition:
1. To affect more rapid growth
The use of M&A to affect more rapid growth is the most important reason / motive behind any type of M&A. Rapid inflation has made the acquisition of another firm not only less costly than building but also much quicker. Relatively low price earning ratios of many firms have attributed to their attractiveness as potential takeover candidates. Most of the executives have consistently stated growth as a primary motive for M&A activity. 2. To gain economies of scale Increasing profitability of operations through economies of scale is a frequently sighted reason for consolidation through M&A activity. 3. To increase market share This is a primary reason cited by executives for horizontal mergers 4. To increase market value of stock: The desire to increase the market value of the stock is also viewed as a major merger motive by executives. This comes as no surprise as the goal of a management should be to maximize the value of the firm’s common stock. 5. Expand product mix:
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Increasing product mix is one of the auxiliary reasons sighted by many executives. 6. To spread risk through diversification: Through diversification of product range, firms try to reduce dependence on few products and thus reduce risk by spreading it over a large product portfolio. 7. To enhance power and prestige of the firm: Many a times M&A activities increase the visibility of firms and thus highlight the influence the firm has in the market. Such firms use M&A activity to 8. To invest in the firm’s idle capital: When bank rates are relatively low, many firms prefer to deploy idle cash in merger and acquisition activities. 9. To gain technical knowledge and expertise and talent: This is an important strategic reason sighted by executives. Technical human resource, patents and machinery are important reasons for M&A
Ref: Reference book of Mergers and Acquisitions (vol 1 chap 3) – Management development institute Library, Gurgaon India
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7 Strategy for M&As
In this section, we will review one set of 'rules of successful acquisition' that
Drucker (1981, 1982) has promulgated. Drucker's rules are the focus of this analysis because his views are often accepted by practitioners. In succeeding paragraphs, supporting and non-supporting evidence, opinions, and arguments are summarized for each rule; inconsistencies in the empirical literature are noted; and the rules are discussed and critiqued. Rule 1: Acquire a company with a 'common core of unity'—either a common technology or markets or in some situations production processes. Financial ties alone are insufficient. The concept of a 'common core of unity' can be defined very narrowly or very broadly. Applying this rule is difficult because of conflicting answers to questions such as: do two firms that provide different products to the same geographically defined market have a common core of unity? Montgomery (1979), Rumelt (1979) and Bettis and Hall (1982) suggest reasons other than relationships among business units for Rumelt's (1974) and Bettis' (1981) findings. These studies suggest that the high economic performance of related business firms is associated with market structure characteristics, e.g. market profitability, market share, market growth and concentration. Apparently, related business firms have tended to grow in
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industries characterized by high levels of return on capital. Market structure characteristics may be a more fundamental determinant of profitability than type of diversification. Also related business firms often have developed skills in product/market areas where product differentiation and market segmentation are possible. These findings suggest that Drucker's rule may be focusing on the wrong strategic variables and hence is a poor guideline to follow. The Anson et al. (1971) study of 93 companies provides minimal support for Drucker's first rule. They found that, with the exception of vertical integrations which were very successful, type of acquisition had little effect on perceived success. Success, however, was perceived to be associated with other factors, e.g. search and planning In conclusion, requiring that an acquired company has a common core of unity with the acquiring company is a very conservative and ambiguous heuristic to use in acquisition decision making. The rule is ambiguous because of problems associated with identifying a 'common core of unity'. Also, identifying a true common core of unity may not be possible prospectively, but rather only retrospectively. This rule may encourage rationalizing of similarities rather than rational analysis. Rule 2: Think through your firm's potential contributions of skills to the acquired company. There must be a contribution and it has to be more than money. Drucker's statement 'think through your firm's potential contributions', is similar to identifying objectives and developing criteria for analysis of alternative companies, then Ansoff et al.'s (1971) results support Drucker. Planning variables in the Ansoff et al. (1971) study correlated with all of the economic performance results measured in the study, except P/E ratio; but
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Strategic Management I Project
attainment of synergy had little relationship to most performance variables except stock price growth rate. However, some inconsistency in results was noted by Ansoff et al. (1971); extensive search and planning was not associated with perceived success whereas attainment of synergy was associated with perceived success. This rule can encourage poor planning because it is hard to apply and does not encourage systematic planning. If planning is not systematic, most managers can probably rationalize contributions for any acquisition. Another major problem with this rule is that it seems limited and one-sided because it neglects the potential contribution of the acquired company. Sometimes managers buy a company as much for what it can do for their company as for what they can do for the acquired company. It seems that some modification and much more elaboration of Drucker's second rule is needed for guidance in this areas. We need to consider contributions of 'both' the acquired company and the acquirer. Also, the contributions needed to justify an acquisition may differ in related and unrelated diversification. Rule 3: Respect the products, markets and customers of the acquired company. There must be a 'temperamental fit'. Both the concepts of 'respect' and 'temperamental fit' are ambiguous and hard for managers to apply. According to Drucker, managers in acquiring companies do not feel comfortable with these businesses where there is not a 'temperamental fit' and that eventually they make the wrong decisions. Results that seem to support Drucker come from several resources. Mace and Montgomery (1962) identified conditions of successful acquisition including competent management in the acquiring organization who are
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Strategic Management I Project
motivated to perform well in the new product field. Salter and Weinhold (1979) stress the need for a strong commitment on the part of the acquiring management to exploit the potential benefits of related diversification. Many authors stress the need for co-operation and collaboration between the acquiring firm and the acquired firm. Ansoff et al.'s (1971) conclusion on the effects of integration provides additional insight about the issue addressed in rule 3. Integration had little influence on growth or performance. The strongest statement that could be made was that partial integration tends to produce poorest performance. Thus, it would seem logical that successful acquisition could occur where there was little integration and perhaps little temperamental fit. This rule suggests an attitude that managers should hold to increase the success of an acquisition. Although it does not appear that holding this attitude is either necessary or sufficient for making a successful acquisition, in many cases managers may want to try to adjust their attitudes if they do not respect the product, markets and customers of the acquired company. Rule 4: Within approximately a year, you must be able to provide top management for the acquired company. Drucker believes that it is an elementary fallacy that one can 'buy' management. He feels that managers of the acquired company are likely to go elsewhere for a variety of reasons. In Hayes' (1979) study only 42 per cent of the top managers in acquired companies remained as long as five years following the acquisition. This finding supports Drucker's concern about providing top management, but when Hayes questioned the top managers who left, 82 per cent said that if they had to do it all over again they would not sell at all.
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Strategic Management I Project
A number of questions must be asked about this rule. What does it mean to say you are able to provide top management? How do you know you have this capability or, prior to the acquisition, that you can develop it? How does this differ from rational staffing policy for a firm? Can top management talent be recruited successfully? These questions suggest that following this rule may be difficult and unnecessary. For example, some companies currently use recruiters to find top management talent. In many cases the acquired company wants to retain management and in these cases Hayes' findings are especially relevant. According to Parsons and Baumgartner (1970), 'most experienced buyers, such as chief executives of conglomerates, say that what they are really acquiring is a going organization. Generally they want a company that is fully staffed, with a general manager and able functional heads and, since it takes three to five years to develop a good operating team, they want assurance that these key people will stay-on the job.' Efforts to retain top management are probably more important than preparation to replace those who leave. Following from Levinson's (1970) analysis of merger failure, if the acquiring company has rules or attitudes like Drucker's rule 4, that rule and its attendant attitude may actually create the potential problems it is intended to remedy. Managers in the acquired companies can often sense the attitudes of managers at corporate headquarters and become concerned or worried about their jobs. Rule 4 and the next one may lead to a vicious circle of managerial turnover and poor performance in an acquired company. In conclusion, top management can be successfully retained and potential loss of managers in acquired companies should probably be handled by standard personnel procedures rather than singled out for special concern or action. Adopting a rule that emphasized good human relations during and
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Strategic Management I Project
following an acquisition may help reduce rather than induce the problem of unintended turnover. Rule 5: Within the first year of a merger, a large number of managers of both companies should receive substantial promotions from one of the former companies to the other. According to Drucker (1981), the goal of this rule is to convince managers in both companies that the merger offers them personal opportunities. Salter and Weinhold's (1979) analysis suggests a refinement for this rule; they conclude, as previously mentioned, that for economic value to be created in related diversifications either party needs to possess functional or industry related skills that can be transferred to the other company. Presumably these transfers would be personal opportunities for substantial promotion. According to Barmash (1971) in Welcome to Our Conglomerate, mergers create job insecurity that may harm individuals and the acquired companies. This type of acquisition policy may only increase the turmoil in the acquired company. The human relations issues in mergers are certainly very important. Marks (1982) reviews research on merging human resources and concludes that the importance of organizational and human dynamics in mergers on financial performance cannot be precisely determined, but neither can it be denied. Drucker's rules 4 and 5 address human resource issues in mergers, but these issues are not adequately addressed. More sophisticated and positive prescriptions for specific acquisitions situations can probably be developed. In conclusion, there are currently no rules that will invariably lead to a successful acquisition. Drucker's rules may be applicable in some situations, but those situations have not been clearly identified. The rules are conservative and the problems they attempt to avoid may not be inherent
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given good management practices. There are potentially highly rewarding acquisition strategies for aggressive firms that violate his rules. Ideas other than those of Drucker's are currently tempting many aggressive managers. So, although there are risks associated with all acquisitions, following Drucker's rules probably does not significantly reduce these risks and following them may create long-run competitive problems.
Ref: Merger Strategy: An Examination of Drucker's Five Rules for Successful Acquisitions Paine, Frank T., Power, Daniel J. Strategic Management Journal. Chichester:Apr/Jun 1984. Vol. 5, Iss. 2, p. 99 (12 pp.)
1-Focus 7-Step Model 1-Focus 7-Step process has been adapted to address the specific and unique concerns of mergers and acquisitions. Training on specialized activities and various large scale interventions is offered across all levels and functions at various stages. Beginning at the pre-merger stage, the 1-Focus 7-Step process drives the integration from a Top Down - Bottom Up approach in an organic, collaborative process. Pre Merger Cultural DNA Due Diligence: Collaborating on an integration strategy Culture of Engagement framework Step I Involvement and Engagement: Dreaming the dream of the future New Identity formulation Step II Shared Vision: Expanding the vision from mine to ours and giving it life Step III Analysis: Evaluation of current reality in line with strategy Step IV Action: Cascading the process by creating ownership in the process
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Step V Implementation: Building and creating momentum Step VI Maintenance: Focusing direction and energy of corporate New Identity Step VII Renewal: Re-evaluation and re-creation REPEAT Step I Integrated Organization: Dreaming the dream of the new future together
Ref: SEVEN STEPS TO MERGER EXCELLENCE Sandy Weiner, Roberta Hill. Ivey Business Journal Online. London:Sep/Oct 2008. Vol. 72,Iss. 5, (1 pp.)
8 Nine ways in which merger and acquisition impacts performance of a firm or benefits the firm:
1. The most important impact of M&A is that on the management of the target firms. Research shows that there is a break in continuity of leadership in the target firms causes degradation in the organizational performance of the target firm in the early stages. 2. Aftermath of mergers and acquisitions impact the employees or the workers the most. It is a well known fact that whenever there is a merger or an acquisition, there are bound to be lay offs. In the event when a new resulting company is efficient business wise, it would require less number of people to perform the same task. Under such circumstances, the company would attempt to downsize the labor force. 3. Technical know how and research activities in a firm benefit the most through M&A activities of a firm. However the firms have to be operating in overlapping technological domains for this to happen.
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4. Economies of scale are achieved through M&A only if the integration of the operations of the two entities is achieved. Integration of operations is the most important challenge in an M&A activity and it is seen that it helps in the long run for the merged entity. 5. Gaining entry into new markets by using the brand name of the target firm is a benefit obtained by the acquiring firm. Many times a merger gives access to markets which were previously unexplored by the acquiring firms. 6. M&A activities provide companies the chance to gain competitive advantage in the market. This has been observed mainly in oligopolistic markets. 7. Mergers have led to cultural conflicts between employees of the two merging entities. Organizational change caused due to mergers is sudden and may create an atmosphere of instability in the workforce. 8. Growth in costumer confidence is a benefit seen by the new company formed. It has been observed that after consolidation the costumer confidence levels have improved for both the firms merging. 9. Streamlined process in the two firms are exchanged through M&A. This may give development of the new merged firm a head-start in terms of efficiency in many domains. However, the processes sometimes are tailored by the merging entities to make them suitable for the new merged entity.
Ref: Reference book of Mergers and Acquisitions (vol 1 chap 3) – Management development institute Library, Gurgaon India
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9 Problems in M&As
Historically, half of all M&A activities have failed to create lasting shareholder value. Findings in a ten-year A.T. Kearney study on stock performance after mergers reveals that since 1990, in the two years after their deals closed, nearly 50 percent of the biggest mergers and acquisitions failed to produce total shareholder returns greater than their industry peers[1]. Only 30 percent outperformed their industry peers (by 15 percent or more) and had earned a penny more in profitability two years later. After five years, 70 percent of the survivors were still chronic under performers in their industries.
Ref: Mergers and acquisitions: Reducing M&A risk through improved due diligence Jeffery S Perry, Thomas J Herd. Strategy & Leadership. Chicago: 2004. Vol. 32, Iss. 2; p. 12 (8 pages)
9.1 Synergy
Many observers and many independent studies question whether M&As truly add value. Executives also point to the unfulfilled realization of synergies. Only half of the senior executives polled in a 2006 Accenture/Economist
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Intelligence Unit survey believed that their companies had achieved the revenue synergies they had expected from their M&A activities, and just 45 percent affirmed that expected cost synergies had been captured. Although acquirers are getting better at identifying and capturing synergies, many deals still do not recover their acquisition premiums and others fail to achieve the long list of benefits touted by management as the rationales for doing the deals in the first place. Some of those failures are clearly the result of overpaying for targets. But others are due to an incorrect understanding of what exactly synergies are and how they should be captured. There are several factors that are easy to overlook, or under-appreciate, when deal-making emotions are running high.
Ref: Where has all the synergy gone? The M&A puzzle Kristin Ficery, Tom Herd, Bill Pursche. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 5; p. 29
9.2 Information Asymmetry
The fundamental problem lies in two inherent features of many M&As: the acquiring company’s struggle to value the target’s resources and the need for the parties involved to agree on a price. The process of due diligence provides a useful starting point for obtaining detailed and reliable information about the quality of the resources to be acquired, yet often fails to unearth the sort of deep, and often tacit, knowledge about the target’s resources that can ultimately determine the success or failure of an acquisition. Moreover, time pressures, organizational complexity, unfamiliar product or geographic markets and the challenges surrounding the appraisal of intangibles can hamper a suitor’s valuation and negotiation efforts. Sellers often face problems in conveying the true value of their resources and capabilities to a buyer in a credible fashion. This is because sellers have
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natural incentives to inflate their representation of the quality of the offering in order to command a higher sale price, while acquirers already assume that sellers are presenting their best face. When such information asymmetries exist across bidders and sellers, attractive deals may simply fall through; but for those deals that are completed, acquirers are likely to overpay. In other words, acquirers run the risk of adverse selection, or winding up with a “lemon.”
Ref: Avoiding Lemons in M&A Deals Jeffrey J. Reuer. MIT Sloan Management Review. Cambridge: Spring 2005. Vol. 46, Iss. 3; p. 15
9.3 Frauds
Preventing employee fraud, regardless of industry, is a thorny problem for businesses during normal times. But it is doubly difficult when companies choose to merge, and those involved in any kind of merger or acquisition should closely monitor the company store to guard against the theft, shrinkage, scams and other kinds of employee dishonesty that becomes an even greater temptation while the entire organization redefines itself. Companies would be wise to heed the M&A red flag, as the combination of two companies often creates an environment that is ripe for fraud. Here is why. * Slow implementation of internal controls. Audit procedures and checkcashing policies need to be integrated. In addition, there should be a separation of duties for financial oversight. If these issues are not addressed early on, the confusion and uncertainty of merging operations will contribute to criminal losses from theft, fraud and abuse. * Inconsistent systems. Purchasing companies need to be aware of the differences between their internal controls and those of the company that
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Strategic Management I Project
they are buying. The corporate cultures of the two organizations need to mesh. One company, for example, suffered four crime losses from the same acquisition within a short period of time from the same outlet. That should be an intolerable level of employee theft. * Surprises after the fact. Globally dispersed organizations and
conglomerates have unique problems. Acquired companies may have locations that the acquirer never knew existed, with no internal controls in place to prevent theft. In effect, the remote location becomes a rogue operation. Conglomerates can face losses as they attempt to merge a new line of business with their current operations and are unsure of existing internal controls. * Ethical lapses. Employees who are both prone to steal in the first place and bitter about a merger that may leave them unemployed are a bad combination. The merger period creates a gray area in which anxiety rises and shrinkage increases. Quickly implementing internal controls against theft is an imperative.
Ref: The Hidden Costs of Mergers and Acquisitions Michael Klein. Risk Management. New York: Mar 2006. Vol. 53, Iss. 3; p. 42 (1 page)
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10 Cross border M&A Trends
The rise of globalization has increased the market for cross border M&A. In the past, a more national mindset prevented the vast majority of small and mid-sized companies from considering cross border intermediation as an option.
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(Source: “Global financial turmoil and new opportunities” Alsuhaibani, S. Investment Research. Saudi Arabia: Dec 2008; p. 7)
Due to the complicated nature of cross border M&A, the vast majority of cross border actions have unsuccessful results. Cross border intermediation has much more complexity to it than regular intermediation; viz. issues pertaining to corporate governance, the power of the average employee, company regulations, political factors customer expectations, and countries' culture are all crucial factors that could spoil the transaction. However, with the soft economies in a number of countries around the world, we are today seeing more cross-border bargain hunting as top companies seek to expand their global footprint.
(Source: “Global financial turmoil and new opportunities” Alsuhaibani, S. Investment Research. Saudi Arabia: Dec 2008; p. 7)
Even mergers of companies with headquarters in the same country are very much of this type (cross-border mergers), as the companies must integrate operations in dozens of countries around the world. E.g. Boeing’s acquisition of McDonnell Douglas and the merger of Sandoz and Ciba-Geigy (now Novartis).
(Source: “Safe ways to cross the merger minefield” Finkelstein, S. Financial Times Mastering Global Business. London: 1999; p. 123)
Interestingly, financial variables and other institutional factors appear to play a significant role in M&A flows. In particular, the size of financial markets, as measured by the stock market capitalization to GDP ratio, has a strong positive association with domestic firms investing abroad. This result points to the importance of domestic financial conditions in stimulating international investment during the boom years of 1990s, and accords with the significant drop in cross-border M&As at the turn of the millennium.
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(Source: “What drives capital flows? The case of cross-border M&A activity and financial deepening” Julian di Giovanni. Journal of International Economics. Amsterdam: Jan 2005. Vol. 65, Iss. 1; p. 6)
Cross border mergers and acquisitions activity again started booming in the middle of the current decade. In 2005, Europe saw a 58% surge in transnational deals; in Japan, cross-border M&A jumped 21%, and in India the rise was a staggering 68%. It is not hard to see why. After years of restructuring, companies were once again cash-rich and confident. Credit became cheap and plentiful. And as industry consolidation reduces the number of viable M&A opportunities at home, more and more companies started looking abroad for acquisition targets or merger partners to help them meet their growth aspirations. Yet for most, the prospect of acquiring or merging with a company in an unfamiliar market is daunting. The pursuit of economies of scale-based cost savings is usually the biggest driver for national deals. But cross border acquisitions are more often about growth. Ready-made access to customers, products, brands, distribution channels and market knowledge all make acquisitions an appealing option for geographic expansion. Opportunities for revenue growth can arise from the cross selling of products, the exchange of knowledge about markets or technology, or the ability to offer existing customers more comprehensive global coverage.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
The greatest risks in cross-border transactions arise from the failure to understand the culture, regulatory structure or competitive environment – and sometimes all three considerations – in the target market. These oversights can lead to overly optimistic (or pessimistic) assumptions about revenue growth or cost-savings opportunities. In many cases, acquiring
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companies assume that their detailed knowledge of their own market will translate directly to the target market, and they therefore see little reason to invest in upfront fact-finding. In other cases, where a market is undergoing rapid development, acquirers may decide that there is too much uncertainty for a detailed investigation of the current state of play to be relevant. Or if an acquirer feels pressure to act because a herd mentality takes over, it may decide there simply is not time to do its homework. Assuming that customers in new markets are fundamentally the same as those at home is another classic mistake. Whatever the reason, the failure to do homework on an acquisition can lead to critical, costly, and sometimes irreparable mistakes.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
Proper due diligence can expose these challenges. The right level of investment in due diligence needs to be tailored to the specific situation. A straightforward investigation of local rules and regulations may be all that is required. But for more complex situations, local advisors who can help explain critical differences in customer needs, competitive behaviour or cultural factors will typically repay the investment in their services many times over. The successful integration of an acquired management team also requires sensitivity and careful attention to the cultural gaps that exist between acquirer and target, or between merging partners in a cross border deal.
(Source: “Transnational mergers and acquisitions: How to beat the odds of disaster” Firstbrook, C. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53)
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Following is a discussion on some recent major cross border M&A deals 1. Tata Steel – Corus In Jan 2007, Tata Steel acquired Corus plc, the Anglo-Dutch steel giant. After nine rounds of bidding, Tata Steel emerged victorious over the nearest suitor, Brazil’s CSN. This, till date, is the biggest ever cross border acquisition by an Indian company. The merger made Tata Steel the world’s 5th biggest steel manufacturer in terms of installed capacity and also gave it the strategically significant strong distribution network that Corus enjoys in Europe. The synergic advantages went beyond - Corus' enjoys a reputation in making the grades of steel used in automobiles and aerospace industries, which could boost Tata Steel's supplies to the Indian market. On the other hand, Corus was expected to benefit from Tata Steel's expertise in low cost manufacturing processes. However, as we saw in the theory that cross border M&A transactions are often fraught with risks pertaining to over-optimism or overpessimism. In this case, some analysts contend that the price paid by Tata Steel (608 pence per share of Corus) for the acquisition was too high. Despite the up-cycle in the commodities markets, Corus had been facing tough times, logging a considerable drop in profit after tax for the year 2006. Experts are still divided in their verdict as to whether the deal would bring home worthwhile benefits to Tata Steel.
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Also, it was an all-cash deal, with the funding done through internal accruals, debt and equity (Rights Issue), and analysts believe that the transaction would be a financial albatross around Tata Steel’s neck for some time to come. 2. HCL Tech – Axon Group Another closely contested cross-border deal was that for Axon Group plc, with HCL Technologies pipping Infosys Technologies to the post as recently as 2 months ago. Strategically, this would have been a first major acquisition by either company. At the core of the rationale was SAP package implementation business in Europe, seen by many experts as a cash cow, more so in current times of financial turmoil and currency risk. The deal, though nowhere near the Tata-Corus deal size, still is the biggest M&A transaction carried out by in the Indian IT sphere ever. As per Mr Vineet Nayar, CEO of HCL Tech, “Axon represents that right capability for us. It is the right stepping stone to respond to the economic slowdown…Together, we can provide seamless end-to-end services”. In the past, one of the major concerns for the Indian IT industry considering cross border inorganic growth used to be dilution of profitability. But more recently, even Indian IT companies’ margin juggernaut has halted and subsided closer to global levels, which makes them willing to be on the lookout for greener pastures. 3. Hindalco – Novelis Hindalco’s acquisition of Canadian rival Novelis, the world’s largest aluminium cans maker, was another big ticket cross border acquisition,
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in fact the second biggest, after Tata-Corus deal. Post-merger, the entity is the world’s largest player in aluminium rolling. In the words of Mr Kumar Mangalam Birla, chairman of the Aditya Birla Group, “It (the deal) is in line with our long-term strategies of expanding our global presence across various businesses and is consistent with our vision of taking India to the world.” In the words of Mr Debu Bhattacharya, MD of Hindalco, Novelis is a strategic fit for Hindalco, which had ambitions to grow upstream to ensure sustainable profits. Hindalco was faced with a tricky proposition to venture by itself, as the technology could still be developed, but customer acceptance doesn’t come as naturally. Further, the product portfolio got widened as a result of the merger, leading to better hedge of sorts against the volatility in aluminium prices. Getting into the nitty-gritties, the energy efficiency focus at Novelis’ plants was of a much higher level vis-à-vis Hindalco. However, as with Tata-Corus deal, experts differ in their opinion over the pricing of the deal vis-à-vis the benefit. Novelis was a loss-making company, and the unified entity is having a tough time fighting the dropping demand faced by Novelis more recently.
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11 Research Methodology
We intend to study and conduct a cross-sectional exploratory analysis of the M&A-related activities in the top 100 firms in India in recent times. Generally, we would limit our focus on those transactions – accomplished or otherwise – where the deal size was in excess of US$ 20 mn (approx. Rs 100 Cr). We intend to study in depth i. ii. the trends prevalent in the transactions, the strategic benefits or intentions behind the transactions,
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iii. iv. v. vi. vii.
the mode of financing, the strategies adopted to carry out the transactions, the problems faced during and after the deal was struck, the fallout of the transaction on the parties involved, the road ahead in normal circumstances as well as in a more pertinent recessionary environment, and
On the basis of the above, we will try to figure out the commonalities and the differences at various levels and compare, contrast and understand as to why a particular approach was adopted at a particular juncture.
12 Company Analysis
The appendix to this document contains the Excel tables which document 100 companies and their M&A activities. There are 5 sheets in the excel document. Sheet 1 gives the analysis of whether a given company adopts M&A as a strategy or not. Sheet 2 gives the analysis of what sort of M&A activity (for example: merger, acquisition, buyout, strategic stake etc) is done by a given company. Sheet 3 contains analysis of reasons given by executives of various firms for using merger and acquisition. Sheet 4 gives analysis of performance impact of M&A activity on a given company and
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Sheet 5 gives the future preferences of a company for merger and acquisition activities. The analysis shows the prominence of M&A as an effective strategy for inorganic growth with 47 of the given 100 companies going for merger and acquisition activity. Most of the companies go for merger or acquisition when they have enough cash. However there are few like the ones owned by Tata group and HCL which go for merger and acquisition as a strategy based on available opportunity and have gone for leveraged buyouts to fulfill their strategic needs. Some companies like Bhushan Steel have gone for foreign acquisitions to increase their global presence while on the other hand companies like Cipla has divested its South African subsidiary to improve its efficiency.
M&A us (47% ed ) M&A not us (53% ed )
The 53 companies not going for merger and acquisition are the ones which mostly prefer organic growth and have to allocate resources (both cash as well as loans) in buying strategic assets like land. Many of these firms prefer to go for joint ventures on individual projects. 27 of them are Public Sector companies which are thus under Government of India’s supervision when it comes to mergers, acquisitions and disinvestments. While 12 of the companies have been involved in pure mergers, 18 have been involved in pure acquisitions. On top of these, 8 companies have
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named the process Mergers and Acquisitions (M&A) in their Annual Reports thus maintaining a little ambiguity. Tata Sons has been involved in a reverse merger/takeover being the holding company of the Tata Group. There have been 6 instances of pure takeovers amongst the companies. 2 companies have been involved in taking up strategic stakes.
20 15 10 5 0
Mergers
Acquisitions
M&A
Takeover
C teg a orisa tion
Strategic Stake
Reverse Merger
22 out of 47 companies say that that one reason for M&A activity is fast growth. Fast growth is also a major reason given by executives of firms going for merger and acquisition. This means that the companies which seek growth in terms of revenues/turnover have used M&A as a strategic tool for expansion. Firms like Tata chemicals have aggressively used M&A and have ended up being world’s 2nd biggest firm in their domain in terms of revenue and production capacities. 22 out of 47 companies say that increase in market share/control is a major deciding factor for Merger and acquisitions. The next most important (19/47) reason sighted was improvement in efficiencies. 12 companies have gone for M&A to gain competitive advantage.
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Stock Market New Assets New markets Synergy Diversification Competitive Advantage Improvement in efficiency Increase market share Fast Growth
0
5
10
K R s for M&A ey ea ons
15
20
25
39 of the 47 have reported significant improvement in their performance because of the M&A activity. The reasons cited for the improvement range from stronger distribution networks, increased production and capacity, geographical and product diversification, higher agility etc.
40 35 30 25 20 15 10 5 0 S n ig ifican t Not S n ig ifican t
Im provem in P ent erforma e nc
40 Companies out of 53 who haven’t gone for M&A wont do it in future. The rest 13 may go for M&A in future. 25 out of 47 who have gone for M&A will continue the same way while 8 of them will discontinue in the future. 14 will do more M&A in the future.
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M&A Done
40 20
Wont Do in future No M&A Done Will Continue Will Do More
0
No M&AD one
M&AD one
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References
?
“What drives capital flows? The case of cross-border M&A activity and financial deepening”
Julian di Giovanni. Journal of International Economics. Amsterdam: Jan 2005. Vol. 65, Iss. 1; p. 127
?
“Cross-Border Mergers and Acquisitions: Do Strategy or Post-Merger Integration Matter?”
H Donald Hopkins. International Management Review. Marietta: 2008. Vol. 4, Iss. 1; p. 5 (7 pages)
?
“Transnational mergers and acquisitions: how to beat the odds of disaster”
Caroline Firstbrook. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 1; p. 53
?
“Mergers and Acquisitions: Causes and Effects”
Gabriele Carbonara, Rosa Caiazza, Journal of American Academy of Business: 2009, Vol. 14; p. 188 (7 pages)
?
“ACQUISITION VALUATION: HOW TO VALUE A GOING
CONCERN?” Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 (10 pages)
?
“India: Legal and tax considerations in cross-border M&A”, Deanne
D'Souza-Monie, 2002
?
“The Hidden Costs of Mergers and Acquisitions”
Michael Klein. Risk Management. New York: Mar 2006. Vol. 53, Iss. 3; p. 42 (1 page)
?
“Avoiding Lemons in M&A Deals”
Jeffrey J. Reuer. MIT Sloan Management Review. Cambridge: Spring 2005. Vol. 46, Iss. 3; p. 15
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Strategic Management I Project
?
“Where has all the synergy gone? The M&A puzzle”
Kristin Ficery, Tom Herd, Bill Pursche. The Journal of Business Strategy. Boston: 2007. Vol. 28, Iss. 5; p. 29
?
“Mergers and acquisitions: Reducing M&A risk through improved due
diligence” Jeffery S Perry, Thomas J Herd. Strategy & Leadership. Chicago: 2004. Vol. 32, Iss. 2; p. 12 (8 pages)
?
“Seven Steps to Merger Excellence”
Sandy Weiner, Roberta Hill. Ivey Business Journal Online. London: 2008. Vol. 72, Iss. 5
?
“Merger Strategy: An Examination of Drucker's Five Rules for
Successful Acquisitions” Paine, Frank T., Power, Daniel J., Strategic Management Journal: 1984. Vol. 5, Iss. 2; p. 99 (12 pages)
?
“Merger Motives and Target Valuation: A Survey of Evidence from
CFOs” Tarun K Mukherjee, Halil Kiymaz, H Kent Baker, Journal of Applied Finance: 2004, 14(2), p. 724
?
“The Determinants Of Horizontal Acquisitions: Evidence” Tremblay, Victor J., Tremblay, Carol Horton, The Journal of Industrial Economics:
1988, 37(1), p. 21.
?
“Marketing-Related Motives in Mergers & Acquisitions: The
Perspective of the U.S. Food Industry” Douglas Reid, Academy of Marketing Science. Journal: 2004, 32(1), p. 98-99.
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“Access to competence: an emerging acquisition motive”
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Strategic Management I Project
Jens Gammelgaard, European Business Forum: 2004, (17), p. 44-47
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“Merger motives “
David C Lam, Michael Chiu, CA Magazine: 2005, 138(2), p. 41-42
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“Merger Strategy: An Examination of Drucker's Five Rules for Successful
Acquisitions” FRANK T PAINE & DANIEL J POWER; Strategic Management Journal (pre-1986); Apr-Jun 1984; 5, 2; ABI/INFORM Global; pg. 99
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“ACQUISITION VALUATION: HOW TO VALUE A GOING
CONCERN?” Andrej Bertoncel. Nase Gospodarstvo : NG. Maribor: 2006. Vol. 52, Iss. 5/6; p. 116 10 pages
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