Description
it explains some of the reasons for the failure of M&A. It also lists down a few M&A activities which have taken place in the last few years.
MERGERS AND ACQUISITIONS
Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate companies together to form larger ones. When they're not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spinoffs, carve-outs or tracking stocks. Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, or even billions, of dollars. They can dictate the fortunes of the companies involved for years to come. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time. Next time you flip open the newspaper’s business section, odds are good that at least one headline will announce some kind of M&A transaction.
The Main Idea
One plus one makes three: this equation is the special alchemy of a merger or an acquisition. The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater efficiency. Because of these potential benefits, target companies will often agree to be purchased when they know they cannot survive alone. The Reasons There are a number of reasons that mergers and acquisitions occur. These issues generally relate to business concerns such as competition, efficiency, marketing, product, resource, and tax issues. They can also occur because of some very personal reasons such as retirement and family concerns. It’s more of a corporate greed.
Some of the motives for mergers are as below: 1. Synergy Synergic effect occurs when two substances or factors combine to produce a greater effect together than the sum of those together operating independently. The principle of 2+2 =5, this theory expects that there is really "something out there which creates the merged entity to maximize the shareholders value". To put in other words, synergy is the ability of a merged company to create more shareholders value than standalone entity. • Financial synergy
The resultant feature of corporate merger or acquisition on the cost of capital of the combined or acquiring firm is called as financial synergy. It occurs as a result of the lower cost of internal financing versus external. When the rate of cash flow of the acquirer firm is greater than that of the acquired firm, there is tendency to relocate the capital to the acquired firm and the investment opportunity of the latter increases. • Operating synergy
Economies of scale and economies of scope exist in the industry and before the merger, the activities of the individual firms are insufficient to exploit these. Synergy takes the form of revenue enhancement and cost reduction. The merger of ICICI with ICICI Bank and the reverse merger of IDBI Bank with IDBI served multiple objectives. First, the institutions were strengthened financially. Second, they helped to avoid the complex processes of restructuring the weaker of the units and to foster financial stability. Finally, they have opened the possibilities of actively promoting universal banking. 2. Growth Increasing a company's growth is the most common reason behind merger. Growth can be achieved through investing in capital projects internally or externally by buying out the assets of outside companies. Empirical studies show that the faster growth rates are achieved through external growth by means of mergers and acquisitions. Merging internationally provides an immediate growth opportunity to a firm which was once operating within a single country.
3. Market Power One of the main motives of a merger is to increase the share of a firm in the market. It means to increase the size of the firm and also leading to the monopoly power, hence the firm gets an opportunity to set prices at levels that are not sustainable in a more competitive market. There are three sources by which market power can be achieved. They are product differentiation, overcoming entry barriers and improving market share. 4. Corporate Tax Savings Although tax savings may not be a primary motivation for a combination, it can sweeten the deal. When a purchase of either the assets or common stock of a company takes place, the tender offer less the stock's purchase price represents a gain to the target company's shareholders. Consequently, the target firm's shareholders will usually experience a taxable gain. However, the acquiring company may reap tax savings depending on the market value of the target company's assets when compared to the purchase price. 5. Acquire Needed Resources One firm may simply wish to purchase the resources of another firm or to combine the resources of the two firms. These resources may be tangible resources such a plant and equipment, or they may be intangible resources such as trade secrets, patents, copyrights, leases, etc. , or they may be talents of the target company's employees. One reason given for the mergers in the petroleum industry is that companies wish to acquire the leases of their competitors. 6. Diversification Diversification is another frequently cited reason for mergers. Actually, it was THE reason during the conglomerate merger wave. The idea was to circumvent regulatory restrictions on horizontal and vertical mergers by going outside a company's industry into new markets and to achieve growth there. International mergers provide diversification both geographically and also by product line
Types of Mergers
Here are a few types, distinguished by the relationship between the two companies that are merging:
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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. Conglomeration - Two companies that have no common business areas. 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.
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Distinction between M&A
Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded. A merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company,
DaimlerChrysler, was created. In practice, however, actual mergers of equals don't happen very often.
Counter Argument: Why companies should not go for Mergers & Acquisitions? M&As have become very popular over the years especially during the last two decades owing to rapid changes that have taken place in the business environment. Business firms now have to face increased competition not only from firms within the country but also from international business giants thanks to globalization, liberalization, technological changes and other changes. Generally the objective of M&As is wealth maximization of shareholders by seeking gains in terms of synergy, economies of scale, better financial and marketing advantages, diversification and reduced earnings volatility, improved inventory management, increase in domestic market share and also to capture fast growing international markets abroad. But astonishingly, though the number and value of M&As are growing rapidly, the results of the studies on the impact of mergers on the performance from the acquirers’ shareholders perspective have been highly disappointing. In this paper an attempt has been made to draw the results of some of the earlier studies while analyzing the causes of failure of majority of the mergers. Causes for Failure of Mergers and Acquisitions Size Issues: A mismatch in the size between acquirer and target is one of the reasons found for poor acquisition performance. Many acquisitions fail either because of ‘acquisition indigestion’ through buying too big targets or by not giving the smaller acquisitions the time and attention it required Diversification: Very few firms have the ability to successfully manage the diversified businesses. Lot of studies found that acquisitions into related industries consistently outperform acquisitions into unrelated. Unrelated diversification has been associated with lower financial performance, lower capital productivity and a higher degree of variance in
performance for a variety of reasons including a lack of industry or geographic knowledge, a lack of focus as well as perceived inability to gain meaningful synergies. Poor Organization Fit: Organizational fit is described as “the match between administrative practices, cultural practices and personnel characteristics of the target and acquirer”. It influences the ease with which two organizations can be integrated during implementation. Poor Strategic Fit: A Merger will yield the desired result only if there is strategic fit between the merging companies. But once this is assured, the gains will outweigh the losses. Mergers with strategic fit can improve profitability through reduction in overheads, effective utilization of facilities, the ability to raise funds at a lower cost, and deployment of surplus cash for expanding business with higher returns. But many a time lack of strategic fit between two merging companies, especially lack of synergies results in merger failure. Strategic fit can also include the business philosophies of the two entities (return on investment versus market share), the time frame for achieving these goals (short-term versus long term) and the way in which assets are utilized (high capital investment or an asset stripping mentality). The absence of strategic fit between the companies may destroy the value for shareholders of both the companies. Poor Cultural Fit: The relationship between cultural fit and acquisition implementation is highly related. It is difficult to undergo a successful implementation without adequately addressing the issues of cultural fit. Merger of Daimler and Chrysler is an example for poor merger performance due to cultural differences. Limited Focus: If merging companies have entirely different products, markets systems and cultures, the merger is doomed to failure. The Tatas for example, sold their soaps business to Hindustan Lever i.e. merger of Tata Oil Mill Company with Hindustan Lever Limited. Failure to Examine the Financial Position: Examination of the financial position of the target company is quite significant before the takeovers are concluded. Areas that require thorough examination are stocks, scalability of finished products, value and quality of receivables, details and location of fixed assets, unsecured loans, claims under litigation, and loans from the promoters. Refuting the counterclaims
The performance of mergers has been gauged in two ways in this paper – by determining whether the long-term post-merger financial performance has changed significantly, and by assessing the wealth gains to shareholders of the acquiring, acquired and the combined firms on the announcement of mergers. It is found that the merged firms demonstrate improvement in long-term financial performance after controlling for pre-merger performance, with increasing cash flow returns post merger. This improved operating cash flow return is on account of improvements in the post-merger operating margins of the firms, though not of the efficient utilization of the assets to generate higher sales. Increase in market power also appears to be driving gains through mergers in India. As far as wealth gains on merger announcement are concerned, only the shareholders of the acquired firms appear to be enjoying significant positive share price returns. The shareholders of the acquiring firms and the combined firms do not seem to be witnessing any significant change in returns. With regard to the strategic factors affecting long-term post-merger financial performance, related mergers seem to be performing lower than unrelated mergers. Both the transfer of corporate control from the acquired firm to the acquiring firm, and the business health of the acquired firm are positively related to the long-term post-merger performance of the firms. The relative size of the acquired firm and the method of payment for the acquired firm do not appear to be playing a role in affecting post-merger performance. In the case of the effect of the strategic factors on the wealth gains on merger announcement, we find that the mergers in which there is no transfer of corporate control seem to be conferring significant positive share price returns to the shareholders of the acquired firms. This is not the case for the shareholders of the acquiring firms and the combined firms. In the case of mergers where there is a transfer of management control, none of these three groups of shareholders witnesses any abnormal returns on announcement of the merger. The wealth gains to acquired firm shareholders on announcement of a merger are positively influenced by the relative size and the pre-merger performance of the acquired firm. The transfer of corporate control from the acquired firm to the acquiring firm is negatively associated with these abnormal share price returns. The level of industry-relatedness of the acquired and the acquiring firms, the method of payment for the acquired firm and the business health of the acquired firm do not appear to be playing a role in affecting the share price returns to the acquired firm shareholders, on announcement of a merger.
The risk of failure can be reduced by conducting detailed evaluation of the target company’s business condition by the professionals in the line of business. Detailed examination of the manufacturing facilities, product design features, and rejection rates, marketing net work, profile of key people and productivity of the employees is a pre-requisite for the success of the merger. Decision to acquire the target company should not be influenced by the state of the art physical facilities which include, among other, a good head quarters building, guest house on a beach and plenty of land for expansion. Supporting Reasons and Arguments: There are various factors which provide the benefits for Indian companies to go for Mergers and Acquisitions. Some of them are listed below: ? Opportunity for growth ? Access to capital and brand ? Gaining complementary strengths ? Acquire new customers ? Need to enhance skill sets ? Expand into new areas ? Widen the portfolio of addressable market ? Need for faster growth ? Meet end-to-end solution needs However our major supporting arguments are mainly: The size factor Many companies have undertaken M&A to grow in size by adding manpower and to facilitate overall expansion. The Polaris-OrbiTech merger saw a spurt in the merged entity’s revenues from $60 million to $125 million. The merger also added 1,400 employees to Polaris, taking the total employee strength to 4,000. Similarly, for Bangalore-based vMoksha Technologies, the logic behind the acquisition of two US-based companies, Challenger Systems and X media, was to increase in size by widening its customer base. Pawan Kumar, chairman and CEO of vMoksha Technologies
says, “The size of a company does matter when interacting with customers and clients. These acquisitions added 120 people to our staff.” The acquisition of China-based Navion software helped Mphasis BFL increase its employee strength by 85 people and expand its business in the region. Similarly, when software services giant Wipro acquired BPO player Spectramind, it helped the company expand into the BPO space. In the same vein, Bangalore-based Mascot Systems’ acquisition of US-based eJiva and Hyderabad-based Aqua Regia enhanced the company’s value proposition and made it globally competitive. With the acquisition of eJiva and Aqua Regia, the total employee strength of Mascot Systems increased from 1,700 to 2,000. To gain new customers One likely reason behind M&A has been to gain new customers. Polaris Software had six major customer wins after it acquired the Intellectual Property Rights (IPR) of OrbiTech’s Orbi suite framework of banking solutions. vMoksha also saw a rise in the number of its customers (four new customers) due to acquisitions as it expanded considerably in the US market and leveraged on the existing customer base. Mphasis also added new customers in the Japanese and Chinese markets after the acquisition of Navion. The need for skill set enhancement The need for skill set enhancement seems to be a major reason for companies to merge and make new acquisitions. The Polaris-OrbiTech merger helped in combining skill sets of both companies, which in turn led to growth and expansion of the merged entity. While Polaris Software was looking for a specialised product suite, OrbiTech was looking forward to efficient marketing and service support for its products. Post-merger, Polaris got the Orbi suite framework and combined it with its service expertise to win more customers. After the merger, Polaris has become a large, specialised company in the banking, financial services and insurance (BFSI) space, offering solutions, products and transaction services. Polaris has had some recent post-merger wins, including ABN-AMRO Bank, Kuwait Commercial Bank and Deutsche Leasing.
Wipro acquired GE Medical Systems Information Techno-logy (India) to leverage its specialisation in the health science domain. The intellectual property that Wipro acquired from the medical systems software company provided it with a platform to expand its offerings in the Indian and the Asia-Pacific healthcare IT market. Similarly, when Wipro acquired the global energy practice of American Management System and the R&D divisions of Ericsson, it acquired skilled professionals and a strong customer base in the areas of energy consultancy and telecom R&D. vMoksha Technologies’ acquisition of two US-based companies helped it to increase its size, and leverage on the expertise of the acquired companies. Says Kumar, “One of the acquired companies is very strong in banking and we leveraged this factor to gain some good banking customers.” Likewise Bangalore-based Mascot Systems was benefited by the technical expertise of eJiva and Aqua Regia, the two companies it recently acquired. The acquisition also helped Mascot to extend its offerings through a portfolio of complementary services, technologies and skills. Expand their market reach into new geographies Many Indian companies have carried out acquisitions and mergers to expand their reach in international markets and to spread across different geographies. Mphasis BFL, through its acquisition of Navion software wants to expand its operations into the Chinese and Japanese markets. Ravi Ramu, Mphasis BFL’s group chief financial officer of says, “The need for developing a near-shore centre for the Japanese market triggered this acquisition. Besides this, we plan to tap the skilled labour force in China to improve our prospects in the region. We also plan to tap the local market at a later stage and use the Chinese base as an alternative centre for our offshore services in the region.” Similarly, vMoksha Techn-ologies after acquiring the two US-based companies has cemented its base in the US market and plans further expansions from here. Adds Kumar, “With the acquisitions, we also expanded our reach in the US market besides India. Since the majority of workforce in the acquired companies was Indian, integration was much easier and smooth”
Following is a snapshot of some of the Mergers and Acquisitions by Indian companies post 2000 and in short reasons for doing so : Mergers & Acquisitions Company Polaris Wipro Merged with/Acquired Merged with OrbiTech Acquired Spectramind Reason/Benefits Acquired IPR of OrbiTech's range of Orbi Banking product suite. Aimed at expanding in the BPO space,the acquisition gave Wipro an opportunity to run a profitable BPO business. Wipro Acquired practice Wipro Wipro global of energy It acquired skilled professionals and a strong American customer base in the area of energy consultancy.
Management Systems Acquired the R&D divisions It acquired specialised expertise and people in of Ericsson GE Medical Systems (India) telecom R&D. It acquired IP from the medical systems company, which in turn gave it a platform to expand its offerings in the Indian and Asia Pacific healthcare IT market. vMoksha Challenger Systems & X Primarily aimed at expanding its customer base. media The company also leveraged on the expertise of the companies in the BFSI space.
Mphasis
Acquired Navion software
China-based Expanded its presence in the Japanese and the Chinese markets. It also plans to use it as a redundancy centre for its Indian operations.
Mascot Systems Acquired US-based eJiva and Expanded in size and leveraged on technical Hyderabad-based Aqua Regia expertise of the acquired companies. Acquisitions have helped the company in offering multiple services and expanding its customer base considerably.
Conclusion We restate our argument and state that the dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:
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Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins. Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices. Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products. Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts. Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company. Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below). Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources. Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur.
One reason is to internalise an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.
References:
http://www.investopedia.com/university/mergers/ http://insightory.com/view/133//strategic_alliances_vs._mergers_and_acquisitions _-_are_indian_companies_making_the_right_choice%3F
http://www.businessweek.com/globalbiz/content/jun2009/gb2009061_356464.ht m
http://www.indianmba.com/Faculty_Column/F1799/fc79.html
http://www.economywatch.com/mergers-acquisitions/india.html
doc_410716534.doc
it explains some of the reasons for the failure of M&A. It also lists down a few M&A activities which have taken place in the last few years.
MERGERS AND ACQUISITIONS
Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate companies together to form larger ones. When they're not creating big companies from smaller ones, corporate finance deals do the reverse and break up companies through spinoffs, carve-outs or tracking stocks. Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, or even billions, of dollars. They can dictate the fortunes of the companies involved for years to come. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time. Next time you flip open the newspaper’s business section, odds are good that at least one headline will announce some kind of M&A transaction.
The Main Idea
One plus one makes three: this equation is the special alchemy of a merger or an acquisition. The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater efficiency. Because of these potential benefits, target companies will often agree to be purchased when they know they cannot survive alone. The Reasons There are a number of reasons that mergers and acquisitions occur. These issues generally relate to business concerns such as competition, efficiency, marketing, product, resource, and tax issues. They can also occur because of some very personal reasons such as retirement and family concerns. It’s more of a corporate greed.
Some of the motives for mergers are as below: 1. Synergy Synergic effect occurs when two substances or factors combine to produce a greater effect together than the sum of those together operating independently. The principle of 2+2 =5, this theory expects that there is really "something out there which creates the merged entity to maximize the shareholders value". To put in other words, synergy is the ability of a merged company to create more shareholders value than standalone entity. • Financial synergy
The resultant feature of corporate merger or acquisition on the cost of capital of the combined or acquiring firm is called as financial synergy. It occurs as a result of the lower cost of internal financing versus external. When the rate of cash flow of the acquirer firm is greater than that of the acquired firm, there is tendency to relocate the capital to the acquired firm and the investment opportunity of the latter increases. • Operating synergy
Economies of scale and economies of scope exist in the industry and before the merger, the activities of the individual firms are insufficient to exploit these. Synergy takes the form of revenue enhancement and cost reduction. The merger of ICICI with ICICI Bank and the reverse merger of IDBI Bank with IDBI served multiple objectives. First, the institutions were strengthened financially. Second, they helped to avoid the complex processes of restructuring the weaker of the units and to foster financial stability. Finally, they have opened the possibilities of actively promoting universal banking. 2. Growth Increasing a company's growth is the most common reason behind merger. Growth can be achieved through investing in capital projects internally or externally by buying out the assets of outside companies. Empirical studies show that the faster growth rates are achieved through external growth by means of mergers and acquisitions. Merging internationally provides an immediate growth opportunity to a firm which was once operating within a single country.
3. Market Power One of the main motives of a merger is to increase the share of a firm in the market. It means to increase the size of the firm and also leading to the monopoly power, hence the firm gets an opportunity to set prices at levels that are not sustainable in a more competitive market. There are three sources by which market power can be achieved. They are product differentiation, overcoming entry barriers and improving market share. 4. Corporate Tax Savings Although tax savings may not be a primary motivation for a combination, it can sweeten the deal. When a purchase of either the assets or common stock of a company takes place, the tender offer less the stock's purchase price represents a gain to the target company's shareholders. Consequently, the target firm's shareholders will usually experience a taxable gain. However, the acquiring company may reap tax savings depending on the market value of the target company's assets when compared to the purchase price. 5. Acquire Needed Resources One firm may simply wish to purchase the resources of another firm or to combine the resources of the two firms. These resources may be tangible resources such a plant and equipment, or they may be intangible resources such as trade secrets, patents, copyrights, leases, etc. , or they may be talents of the target company's employees. One reason given for the mergers in the petroleum industry is that companies wish to acquire the leases of their competitors. 6. Diversification Diversification is another frequently cited reason for mergers. Actually, it was THE reason during the conglomerate merger wave. The idea was to circumvent regulatory restrictions on horizontal and vertical mergers by going outside a company's industry into new markets and to achieve growth there. International mergers provide diversification both geographically and also by product line
Types of 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. Conglomeration - Two companies that have no common business areas. 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.
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Distinction between M&A
Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded. A merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company,
DaimlerChrysler, was created. In practice, however, actual mergers of equals don't happen very often.
Counter Argument: Why companies should not go for Mergers & Acquisitions? M&As have become very popular over the years especially during the last two decades owing to rapid changes that have taken place in the business environment. Business firms now have to face increased competition not only from firms within the country but also from international business giants thanks to globalization, liberalization, technological changes and other changes. Generally the objective of M&As is wealth maximization of shareholders by seeking gains in terms of synergy, economies of scale, better financial and marketing advantages, diversification and reduced earnings volatility, improved inventory management, increase in domestic market share and also to capture fast growing international markets abroad. But astonishingly, though the number and value of M&As are growing rapidly, the results of the studies on the impact of mergers on the performance from the acquirers’ shareholders perspective have been highly disappointing. In this paper an attempt has been made to draw the results of some of the earlier studies while analyzing the causes of failure of majority of the mergers. Causes for Failure of Mergers and Acquisitions Size Issues: A mismatch in the size between acquirer and target is one of the reasons found for poor acquisition performance. Many acquisitions fail either because of ‘acquisition indigestion’ through buying too big targets or by not giving the smaller acquisitions the time and attention it required Diversification: Very few firms have the ability to successfully manage the diversified businesses. Lot of studies found that acquisitions into related industries consistently outperform acquisitions into unrelated. Unrelated diversification has been associated with lower financial performance, lower capital productivity and a higher degree of variance in
performance for a variety of reasons including a lack of industry or geographic knowledge, a lack of focus as well as perceived inability to gain meaningful synergies. Poor Organization Fit: Organizational fit is described as “the match between administrative practices, cultural practices and personnel characteristics of the target and acquirer”. It influences the ease with which two organizations can be integrated during implementation. Poor Strategic Fit: A Merger will yield the desired result only if there is strategic fit between the merging companies. But once this is assured, the gains will outweigh the losses. Mergers with strategic fit can improve profitability through reduction in overheads, effective utilization of facilities, the ability to raise funds at a lower cost, and deployment of surplus cash for expanding business with higher returns. But many a time lack of strategic fit between two merging companies, especially lack of synergies results in merger failure. Strategic fit can also include the business philosophies of the two entities (return on investment versus market share), the time frame for achieving these goals (short-term versus long term) and the way in which assets are utilized (high capital investment or an asset stripping mentality). The absence of strategic fit between the companies may destroy the value for shareholders of both the companies. Poor Cultural Fit: The relationship between cultural fit and acquisition implementation is highly related. It is difficult to undergo a successful implementation without adequately addressing the issues of cultural fit. Merger of Daimler and Chrysler is an example for poor merger performance due to cultural differences. Limited Focus: If merging companies have entirely different products, markets systems and cultures, the merger is doomed to failure. The Tatas for example, sold their soaps business to Hindustan Lever i.e. merger of Tata Oil Mill Company with Hindustan Lever Limited. Failure to Examine the Financial Position: Examination of the financial position of the target company is quite significant before the takeovers are concluded. Areas that require thorough examination are stocks, scalability of finished products, value and quality of receivables, details and location of fixed assets, unsecured loans, claims under litigation, and loans from the promoters. Refuting the counterclaims
The performance of mergers has been gauged in two ways in this paper – by determining whether the long-term post-merger financial performance has changed significantly, and by assessing the wealth gains to shareholders of the acquiring, acquired and the combined firms on the announcement of mergers. It is found that the merged firms demonstrate improvement in long-term financial performance after controlling for pre-merger performance, with increasing cash flow returns post merger. This improved operating cash flow return is on account of improvements in the post-merger operating margins of the firms, though not of the efficient utilization of the assets to generate higher sales. Increase in market power also appears to be driving gains through mergers in India. As far as wealth gains on merger announcement are concerned, only the shareholders of the acquired firms appear to be enjoying significant positive share price returns. The shareholders of the acquiring firms and the combined firms do not seem to be witnessing any significant change in returns. With regard to the strategic factors affecting long-term post-merger financial performance, related mergers seem to be performing lower than unrelated mergers. Both the transfer of corporate control from the acquired firm to the acquiring firm, and the business health of the acquired firm are positively related to the long-term post-merger performance of the firms. The relative size of the acquired firm and the method of payment for the acquired firm do not appear to be playing a role in affecting post-merger performance. In the case of the effect of the strategic factors on the wealth gains on merger announcement, we find that the mergers in which there is no transfer of corporate control seem to be conferring significant positive share price returns to the shareholders of the acquired firms. This is not the case for the shareholders of the acquiring firms and the combined firms. In the case of mergers where there is a transfer of management control, none of these three groups of shareholders witnesses any abnormal returns on announcement of the merger. The wealth gains to acquired firm shareholders on announcement of a merger are positively influenced by the relative size and the pre-merger performance of the acquired firm. The transfer of corporate control from the acquired firm to the acquiring firm is negatively associated with these abnormal share price returns. The level of industry-relatedness of the acquired and the acquiring firms, the method of payment for the acquired firm and the business health of the acquired firm do not appear to be playing a role in affecting the share price returns to the acquired firm shareholders, on announcement of a merger.
The risk of failure can be reduced by conducting detailed evaluation of the target company’s business condition by the professionals in the line of business. Detailed examination of the manufacturing facilities, product design features, and rejection rates, marketing net work, profile of key people and productivity of the employees is a pre-requisite for the success of the merger. Decision to acquire the target company should not be influenced by the state of the art physical facilities which include, among other, a good head quarters building, guest house on a beach and plenty of land for expansion. Supporting Reasons and Arguments: There are various factors which provide the benefits for Indian companies to go for Mergers and Acquisitions. Some of them are listed below: ? Opportunity for growth ? Access to capital and brand ? Gaining complementary strengths ? Acquire new customers ? Need to enhance skill sets ? Expand into new areas ? Widen the portfolio of addressable market ? Need for faster growth ? Meet end-to-end solution needs However our major supporting arguments are mainly: The size factor Many companies have undertaken M&A to grow in size by adding manpower and to facilitate overall expansion. The Polaris-OrbiTech merger saw a spurt in the merged entity’s revenues from $60 million to $125 million. The merger also added 1,400 employees to Polaris, taking the total employee strength to 4,000. Similarly, for Bangalore-based vMoksha Technologies, the logic behind the acquisition of two US-based companies, Challenger Systems and X media, was to increase in size by widening its customer base. Pawan Kumar, chairman and CEO of vMoksha Technologies
says, “The size of a company does matter when interacting with customers and clients. These acquisitions added 120 people to our staff.” The acquisition of China-based Navion software helped Mphasis BFL increase its employee strength by 85 people and expand its business in the region. Similarly, when software services giant Wipro acquired BPO player Spectramind, it helped the company expand into the BPO space. In the same vein, Bangalore-based Mascot Systems’ acquisition of US-based eJiva and Hyderabad-based Aqua Regia enhanced the company’s value proposition and made it globally competitive. With the acquisition of eJiva and Aqua Regia, the total employee strength of Mascot Systems increased from 1,700 to 2,000. To gain new customers One likely reason behind M&A has been to gain new customers. Polaris Software had six major customer wins after it acquired the Intellectual Property Rights (IPR) of OrbiTech’s Orbi suite framework of banking solutions. vMoksha also saw a rise in the number of its customers (four new customers) due to acquisitions as it expanded considerably in the US market and leveraged on the existing customer base. Mphasis also added new customers in the Japanese and Chinese markets after the acquisition of Navion. The need for skill set enhancement The need for skill set enhancement seems to be a major reason for companies to merge and make new acquisitions. The Polaris-OrbiTech merger helped in combining skill sets of both companies, which in turn led to growth and expansion of the merged entity. While Polaris Software was looking for a specialised product suite, OrbiTech was looking forward to efficient marketing and service support for its products. Post-merger, Polaris got the Orbi suite framework and combined it with its service expertise to win more customers. After the merger, Polaris has become a large, specialised company in the banking, financial services and insurance (BFSI) space, offering solutions, products and transaction services. Polaris has had some recent post-merger wins, including ABN-AMRO Bank, Kuwait Commercial Bank and Deutsche Leasing.
Wipro acquired GE Medical Systems Information Techno-logy (India) to leverage its specialisation in the health science domain. The intellectual property that Wipro acquired from the medical systems software company provided it with a platform to expand its offerings in the Indian and the Asia-Pacific healthcare IT market. Similarly, when Wipro acquired the global energy practice of American Management System and the R&D divisions of Ericsson, it acquired skilled professionals and a strong customer base in the areas of energy consultancy and telecom R&D. vMoksha Technologies’ acquisition of two US-based companies helped it to increase its size, and leverage on the expertise of the acquired companies. Says Kumar, “One of the acquired companies is very strong in banking and we leveraged this factor to gain some good banking customers.” Likewise Bangalore-based Mascot Systems was benefited by the technical expertise of eJiva and Aqua Regia, the two companies it recently acquired. The acquisition also helped Mascot to extend its offerings through a portfolio of complementary services, technologies and skills. Expand their market reach into new geographies Many Indian companies have carried out acquisitions and mergers to expand their reach in international markets and to spread across different geographies. Mphasis BFL, through its acquisition of Navion software wants to expand its operations into the Chinese and Japanese markets. Ravi Ramu, Mphasis BFL’s group chief financial officer of says, “The need for developing a near-shore centre for the Japanese market triggered this acquisition. Besides this, we plan to tap the skilled labour force in China to improve our prospects in the region. We also plan to tap the local market at a later stage and use the Chinese base as an alternative centre for our offshore services in the region.” Similarly, vMoksha Techn-ologies after acquiring the two US-based companies has cemented its base in the US market and plans further expansions from here. Adds Kumar, “With the acquisitions, we also expanded our reach in the US market besides India. Since the majority of workforce in the acquired companies was Indian, integration was much easier and smooth”
Following is a snapshot of some of the Mergers and Acquisitions by Indian companies post 2000 and in short reasons for doing so : Mergers & Acquisitions Company Polaris Wipro Merged with/Acquired Merged with OrbiTech Acquired Spectramind Reason/Benefits Acquired IPR of OrbiTech's range of Orbi Banking product suite. Aimed at expanding in the BPO space,the acquisition gave Wipro an opportunity to run a profitable BPO business. Wipro Acquired practice Wipro Wipro global of energy It acquired skilled professionals and a strong American customer base in the area of energy consultancy.
Management Systems Acquired the R&D divisions It acquired specialised expertise and people in of Ericsson GE Medical Systems (India) telecom R&D. It acquired IP from the medical systems company, which in turn gave it a platform to expand its offerings in the Indian and Asia Pacific healthcare IT market. vMoksha Challenger Systems & X Primarily aimed at expanding its customer base. media The company also leveraged on the expertise of the companies in the BFSI space.
Mphasis
Acquired Navion software
China-based Expanded its presence in the Japanese and the Chinese markets. It also plans to use it as a redundancy centre for its Indian operations.
Mascot Systems Acquired US-based eJiva and Expanded in size and leveraged on technical Hyderabad-based Aqua Regia expertise of the acquired companies. Acquisitions have helped the company in offering multiple services and expanding its customer base considerably.
Conclusion We restate our argument and state that the dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:
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Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins. Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices. Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products. Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts. Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company. Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below). Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources. Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur.
One reason is to internalise an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.
References:
http://www.investopedia.com/university/mergers/ http://insightory.com/view/133//strategic_alliances_vs._mergers_and_acquisitions _-_are_indian_companies_making_the_right_choice%3F
http://www.businessweek.com/globalbiz/content/jun2009/gb2009061_356464.ht m
http://www.indianmba.com/Faculty_Column/F1799/fc79.html
http://www.economywatch.com/mergers-acquisitions/india.html
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