Mergers & Acquisitions
Contents
Mergers & Acquisitions
• Differential Efficiency & Financial Synergy: Theory of Mergers
• Operating Synergy & Pure Diversification: Theory of mergers
• Costs and Benefits of Merger
• Evaluation of Merger as a Capital Budgeting Decision
• Calculation of Exchange Ratio
Mergers & Acquisitions
When two or more companies agree to combine their operations, where one company survives and the other loses its corporate existence, a merger is affected. The surviving company acquires all the assets and liabilities of the merged company. The company that survives is generally the buyer and it either retains its identity or the merged company is provided with a new name.
Types of Mergers
1. Horizontal Mergers
2. Vertical Mergers
3. Conglomerate Mergers
Horizontal Mergers
This type of merger involves two firms that operate and compete in a similar kind of business. The merger is based on the assumption that it will provide economies of scale from the larger combined unit.
Example: Glaxo Wellcome Plc. and SmithKline Beecham Plc. megamerger
The two British pharmaceutical heavyweights Glaxo Wellcome PLC and SmithKline Beecham PLC early this year announced plans to merge resulting in the largest drug manufacturing company globally. The merger created a company valued at $182.4 billion and with a 7.3 per cent share of the global pharmaceutical market. The merged company expected $1.6 billion in pretax cost savings after three years. The two companies have complementary drug portfolios, and a merger would let them pool their research and development funds and would give the merged company a bigger sales and marketing force.
Vertical Mergers
Vertical mergers take place between firms in different stages of production/operation, either as forward or backward integration. The basic reason is to eliminate costs of searching for prices, contracting, payment collection and advertising and may also reduce the cost of communicating and coordinating production. Both production and inventory can be improved on account of efficient information flow within the organization.
Unlike horizontal mergers, which have no specific timing, vertical mergers take place when both firms plan to integrate the production process and capitalize on the demand for the product. Forward integration take place when a raw material supplier finds a regular procurer of its products while backward integration takes place when a manufacturer finds a cheap source of raw material supplier.
Example: Merger of Usha Martin and Usha Beltron
Usha Martin and Usha Beltron merged their businesses to enhance shareholder value, through business synergies. The merger will also enable both the companies to pool resources and streamline business and finance with operational efficiencies and cost reduction and also help in development of new products that require synergies.
Conglomerate Mergers
Conglomerate mergers are affected among firms that are in different or unrelated business activity. Firms that plan to increase their product lines carry out these types of mergers. Firms opting for conglomerate merger control a range of activities in various industries that require different skills in the specific managerial functions of research, applied engineering, production, marketing and so on. This type of diversification can be achieved mainly by external acquisition and mergers and is not generally possible through internal development. These types of mergers are also called concentric mergers. Firms operating in different geographic locations also proceed with these types of mergers. Conglomerate mergers have been sub-divided into:
• Financial Conglomerates
• Managerial Conglomerates
• Concentric Companies
Financial Conglomerates
These conglomerates provide a flow of funds to every segment of their operations, exercise control and are the ultimate financial risk takers. They not only assume financial responsibility and control but also play a chief role in operating decisions. They also:
• Improve risk-return ratio
• Reduce risk
• Improve the quality of general and functional managerial performance
• Provide effective competitive process
• Provide distinction between performance based on underlying potentials in the product market area and results related to managerial performance.
Managerial Conglomerates
Managerial conglomerates provide managerial counsel and interaction on decisions thereby, increasing potential for improving performance. When two firms of unequal managerial competence combine, the performance of the combined firm will be greater than the sum of equal parts that provide large economic benefits.
Concentric Companies
The primary difference between managerial conglomerate and concentric company is its distinction between respective general and specific management functions. The merger is termed as concentric when there is a carry-over of specific management functions or any complementarities in relative strengths between management functions.
ACQUISITIONS
The term acquisition means an attempt by one firm, called the acquiring firm, to gain a majority interest in another firm, called target firm. The effort to control may be a prelude
• To a subsequent merger or
• To establish a parent-subsidiary relationship or
• To break-up the target firm, and dispose off its assets or
• To take the target firm private by a small group of investors.
There are broadly two kinds of strategies that can be employed in corporate acquisitions. These include:
Friendly Takeover
The acquiring firm makes a financial proposal to the target firm’s management and board. This proposal might involve the merger of the two firms, the consolidation of two firms, or the creation of parent/subsidiary relationship.
Hostile Takeover
A hostile takeover may not follow a preliminary attempt at a friendly takeover. For example, it is not uncommon for an acquiring firm to embrace the target firm’s management in what is colloquially called a bear hug.
Differential Efficiency & Financial Synergy: Theory of Mergers
Differential Efficiency
According to the differential efficiency theory of mergers, if the management of firm A is more efficient than the management of firm B and if after firm A acquires firm B, the efficiency of firm B is brought up to the level of firm A, then this increase in efficiency is attributed to the merger.
According to this theory, some firms operate below their potential and consequently have low efficiency. Such firms are likely to be acquired by other, more efficient firms in the same industry. This is because, firms with greater efficiency would be able to identify firms with good potential operating at lower efficiency. They would also have the managerial ability to improve the latter’s performance.
However, a difficulty would arise when the acquiring firm overestimates its impact on improving the performance of the acquired firm. This may result in the acquirer paying too much for the acquired firm. Alternatively, the acquirer may not be able to improve the acquired firm’s performance up to the level of the acquisition value given to it.
The managerial synergy hypothesis is an extension of the differential efficiency theory. It states that a firm, whose management team has greater competency than is required by the current tasks in the firm, may seek to employ the surplus resources by acquiring and improving the efficiency of a firm, which is less efficient due to lack of adequate managerial resources. Thus, the merger will create a synergy, since the surplus managerial resources of the acquirer combine with the non-managerial organizational capital of the firm.
When these surplus resources are indivisible and cannot be released, a merger enables them to be optimally utilized. Even if the firm has no opportunity to expand within its industry, it can diversify and enter into new areas. However, since it does not possess the relevant skills related to that business, it will attempt to gain a ‘toehold entry’ by acquiring a firm in that industry, which has organizational capital alongwith inadequate managerial capabilities.
Financial Synergy
The managerial synergy hypothesis is not relevant to the conglomerate type of mergers. This is because, a conglomerate merger implies several, often successive acquisitions in diversified areas. In such a case, the managerial capacity of the firm will not develop rapidly enough to be able to transfer its efficiency to several newly acquired firms in a short time. Further, managerial synergy is applicable only in cases where the firm acquires other firms in the same industry.
Financial synergy occurs as a result of the lower costs of internal financing versus external financing. A combination of firms with different cash flow positions and investment opportunities may produce a financial synergy effect and achieve lower cost of capital. Tax saving is another considerations. When the two firms merge, their combined debt capacity may be greater than the sum of their individual capacities before the merger.
The financial synergy theory also states that when the cash flow rate of the acquirer is greater than that of the acquired firm, capital is relocated to the acquired firm and its investment opportunities improve.
Operating Synergy & Pure Diversification: Theory of Mergers
Operating Synergy
The operating synergy theory of mergers states that economies of scale exist in industry and that before a merger takes place, the levels of activity that the firms operate at are insufficient to exploit the economies of scale.
Operating economies of scale are achieved through horizontal, vertical and conglomerate mergers. Operating economies occur due to indivisibilities of resources like people, equipment and overhead. The productivity of such resources increases when they are spread over a large number of units of output. For instance, expensive equipment in manufacturing firms should be utilised at optimum levels so that cost per unit of output decreases.
Operating economies in specific management functions such as production, R&D, marketing or finance may be achieved through a merger between firms, which have competencies in different areas. For instance, when a firm, whose core competence is in R&D merges with another having a strong marketing strategy, the 2 businesses would complement each other.
Operating economies are also possible in generic management functions such as, planning and control. According to the theory, even medium-sized firms need a minimum number of corporate staff. The capabilities of corporate staff responsible for planning and control are underutilised. When such a firm acquires another firm, which has just reached the size at which it needs to increase its corporate staff, the acquirer’s corporate staff would be fully utilised, thus achieving economies of scale.
Vertical integration, i.e. combining of firms at different stages of the industry value chain also helps achieve operating economies. This is because vertical integration reduces the costs of communication and bargaining.
Pure Diversification
Diversification provides several benefits to managers, other employees and owners of the firm as well as to the firm itself. Moreover, diversification through mergers is commonly preferred to diversification through internal growth, since the firm may lack internal resources or capabilities required. The timing of diversification is an important factor since there may be several firms seeking to diversify through mergers at the same time in a particular industry.
Employees: - The employees of a firm develop firm-specific skills over time, which make them more efficient in their current jobs. These skills are valuable to that firm and job only and not to any other jobs. Employees thus have fewer opportunities to diversify their sources of earning income, unlike shareholders who can diversify their portfolio. Consequently, they seek job security and stability, better opportunities within the firm and higher compensation (promotions). These needs can be fulfilled through diversification, since the employees can be assigned greater responsibilities.
Owner-managers: - The owner-manager of a firm is able to retain corporate control over his firm through diversification and simultaneously reduce the risk involved.
Firm: - A firm builds up information on its employees over time, which helps it to match employees with jobs within the firm. Managerial teams are thus formed within the firm. This information is not transferred outside and is specific to the firm. When the firm is shut down, these teams are destroyed and value is lost. If the firm diversifies, these teams can be shifted from unproductive activities to productive ones, leading to improved profitability, continuity and growth of the firm.
Goodwill: - A firm builds up a reputation over time in its relationships with suppliers, creditors, customers and others, resulting in goodwill. It does this through investments in advertising, employee training, R&D, organizational development and other strategies. Diversification helps in preserving its reputation and goodwill.
Financial and tax benefits: - Diversification through mergers also results in financial synergy and tax benefits. Since diversification reduces risk, it increases the corporate debt capacity and reduces the present value of future tax liability of the firm.
Costs and Benefits of Merger
When a company ‘A’ acquires another company say ‘B’, then it is a capital investment decision for company ‘A’ and it is a capital disinvestment decision for company ‘B”. Thus, both the companies need to calculate the Net Present Value (NPV) of their decisions.
To calculate the NPV to company ‘A’ there is a need to calculate the benefit and cost of the merger. The benefit of the merger is equal to the difference between the value of the combined identity (PVAB) and the sum of the value of both firms as a separate entity. It can be expressed as Benefit = (PVAB) – (PVA+ PVB)
Assuming that compensation to firm B is paid in cash, the cost of the merger from the point of view of firm A can be calculated as
Cost= Cash - PVB
Thus NPV for A = Benefit –Cost
= (PVAB – (PVA + PVB)) – (Cash – PVB)
the net present value of the merger from the point of view of firm B is the same as the cost of the merger for ‘A’. Hence,
NPV to B = (Cash - PVB)
NPV of A and B in case the compensation is in stock
In the above scenario we assumed that compensation is paid in cash, however in real life compensation is paid in terms of stock. In that case, cost of the merger needs to be calculated caarefully. It is explained with the help of an illustration –
Firm A plans to acquire firm B. Following are the statistics of firms before the merger –
A B
Market price per share Rs.50 Rs.20
Number of Shares 500,000 250,000
Market value of the firm Rs.25 million Rs.5 million
The merger is expected to bring gains, which have a PV of Rs.5 million. Firm A offers 125,000 shares in exchange for 250,000 shares to the shareholders of firm B.
MAJOR ACQUISITION IN INTERNATIONAL MARKET
TATA STEEL’S ACQUISITION OF CORUS
India inc. is on a foreign acquisition spree and tata steel is leading the pack. The India steel major has successfully bagged quite a few companies in asia. Recently, it has aquired corus, the biggest steel company in the uk.
Corus was formed after the merger between british steel and dutch group hoogovens in the year 1999. corus is the ninth largest steel company globally and leads the market position in construction and packaging in Europe.
Tata steel initially offered $7.64 bn in cash for the acquisition of the uk’s largest steel company. But corus has accepted the deal at euro 4.3bn [$8.1bn]. tata has offered 455 pence per share and pledged to contribute euro126 mn to the corus pension fund as part of the deal. They will also increase the annual contributions to the british steel fund.
There are a few risks in this deal. The foremost risk is that tata steel will have to pay off huge debt of euro bn ,if there is an economic downturn in future. Tata group have taken euro1bn of the debt for buying corus.
The fast changing global steel industry is witneesing the increasing trend of consolidation and this take over is done at the right time with the right partner for right terms.
ARCELOR
Arcelor was formed on February 19,2001 with the merger of the three European group: the French usinor, Spanish aceralia and the Luxembourg arbed. It is registered in Luxembourg and listed on various stock exchanges on February 18,2002. in order to maximize the generation of cash and to ensure the sustained profitability,it designed it’s businees model by mainly focusing on building position in high margin products.
WITHIN four year of its establishment, arcelor has not only crossed its targets but also bolstered its position in the fieldof production and supply of high value-added steel. It became the lead supplier of steel to the automotive, house appliances, construction, packaging sector and general industries. It has strengthened its position in carbon steel,especially more so in automotive steel. The key strategy of arcelor in international development is to maintain balance between high growth emerging markets and supporting multinational clients.
INDUSTRY BACKGROUND
More than a hundred year old steel industries has grown strongly and steadily through the decades steel industry witnessed a significant restructuring in the last 15 years mainly due to decline in the demand from the central and eastern Europe. During the 1990s, the industry observed restructuring with the marked regional consolidation among European union producers.
The saga of arcelor-mittal merger
On January 27,2006 mittal stunned the global steel industry with the launch of a surprise bid for its nearest rival arcelor with an unsolicited offer of euro18.6bn. mittal made an offer of 4 mittal shares plus 35.25cashfor every five shares of arcelor. The alternative offer were stock offer of 16 mittal shares for 15 arcelor shares or cash offer 28.21 for each arcelor share and the proration of aggregate consideration was 25%cash and 75% stock. Mittal kept few conditions in his offer that there should be a minimum accepted of more than 50%and also no change in the arcelor substance during the offer. In addition to these condition, mittal also wanted to sell dofasco to thyssenkrupp for 3.8 bn. Mittal was ready to reimburse the payment of break fee by arcelor to dofasco and the earning of dofasco before its sale will be transferred to the combined group.
The latest bid offers 13Mittal shares plus 150.6 cash for 12 Arcelor share with an option to recive more cash or shares subject to 13 % cash and 69% stock in aggregate. However ,both the companies have not yet come to a consent regarding Canadian steel maker Dafosco that arcelor acquired in January 2006.
Under the agreement, the marged firm will be called “Arcelor Mittal” . Arcelir investors retain 50.5% ownership . Mittal family, which held875 share capital and a lock-upperod of five years, subject to certain exceptions.
Regardless of holding period, all the shareholders will have identical voting and economic rights,i.e. one vote for one share. Kinsch of arcelor will becom the chairman and LN Mittal will be the president of the arcelor Mittal wherein, LN Mittal will be from Mittal Steel, three representatives of Arcelor shareholders and three representatives of employees. After three years, the shareholders will be elacting thair Bord of directors. The management board will be comprised of seven executive among which, four executives will be from Arcelor, three executives will be frome Mittle Steel and the chairman of the new company will propose the CEO.
The Best Combination
Arcor is the number one steel number one steel company by revenue whereas Mittal is the number one steel company in terms of shipments . the combination of thease two top companies leades the consoldination to new to new level making Arcelor Mittal as the Numero Uno. The combaind company will immediatelyachive industry ledership by dwarfing other steel makers with the production capacity of over 120 million tons ayear whish is approximately 10% of globle steel production . It will produse three times more than capitalization of $46 bn. The new company with ites 61 plantes in 27 countries will lead the major markets like North America , South America, Western Europe,Estern Europe and Africa.
Mittal Steel and Arcelor are quite complimentary in their business leading to a minimal overlap in geographic and product fit.In the US Mittal steel is the leading supplier to the packaing, appliances and automotive sector with strong R&D and in the European market arcelor enjoys the similar position . Mittal Steel’s mills produse lower-quality steel that is generally sold in open market while Arcelor focuse on high-quality steel for long-term costomers.
Conclusion
From the above project we conclude that: The merger of Mittal Steeland Arclor is bound to bring a steel change in the consolidation of steel industry. The combination is expected to offer unparalleled scale of production coupled with strong globle presence, thus providing unigue platform for groth and value creation.
Last edited by a moderator:
