Professional Documents
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ACQUISITION
Historically, mergers have often failed (Straub, 2007) to add significantly to the value of the
acquiring firm's shares (King, et al., 2004). Corporate mergers may be aimed at reducing market
competition, cutting costs (for example, laying off employees, operating at a more
technologically efficient scale, etc.), reducing taxes, removing management, "empire building"
by the acquiring managers, or other purposes which may or may not be consistent with public
policy or public welfare. Thus they can be heavily regulated, for example, in the U.S. requiring
approval by both the Federal Trade Commission and the Department of Justice.
The U.S. began their regulation on mergers in 1890 with the implementation of the Sherman Act.
It was meant to prevent any attempt to monopolize or to conspire to restrict trade. However,
based on the loose interpretation of the standard "Rule of Reason", it was up to the judges in the
U.S. Supreme Court whether to rule leniently (as with U.S. Steel in 1920) or strictly (as with
Alcoa in 1945).
Merger
In business or economics a 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.
Nevertheless, the horizontal mergers do not have the capacity to ensure the market about the
product and steady or uninterrupted raw material supply. Horizontal mergers can sometimes
result in monopoly and absorption of economic power in the hands of a small number of
commercial entities.
Horizontal Monopoly
A monopoly formed by horizontal merger is known as a horizontal monopoly. Normally, a
monopoly is formed by both vertical and horizontal mergers. Horizontal merger is that condition
where a company is involved in taking over or acquiring another company in similar form of
trade. In this way, a competitor is done away with and a wider market and higher economies of
scale are accomplished.
In the process of horizontal merger, the downstream purchasers and upstream suppliers are also
controlled and as a result of this, production expenses can be decreased.
Horizontal Expansion
An expression which is intimately connected to horizontal merger is horizontal expansion. This
refers to the expansion or growth of a company in a sector that is presently functioning. The aim
behind a horizontal expansion is to grow its market share for a specific commodity or service.
Vertical mergers occur when two firms, each working at different stages in the production of
the same good, combine.
Congeneric mergers occur where two merging firms are in the same general industry, but
they have no mutual buyer/customer or supplier relationship, such as a merger between a bank
and a leasing company. Example: Prudential's acquisition of Bache & Company.
Conglomerate mergers take place when the two firms operate in different industries.
A unique type of merger called a reverse merger is used as a way of going public without the
expense and time required by an IPO.
The contract vehicle for achieving a merger is a "merger sub".
The occurrence of a merger often raises concerns in antitrust circles. Devices such as the
Herfindahl index can analyze the impact of a merger on a market and what, if any, action could
prevent it. Regulatory bodies such as the European Commission, the United States Department
of Justice and the U.S. Federal Trade Commission may investigate anti-trust cases for
monopolies dangers, and have the power to block mergers.
Accretive mergers are those in which an acquiring company's earnings per share (EPS)
increase. An alternative way of calculating this is if a company with a high price to earnings ratio
(P/E) acquires one with a low P/E.
Dilutive mergers are the opposite of above, whereby a company's EPS decreases. The
company will be one with a low P/E acquiring one with a high P/E.
The completion of a merger does not ensure the success of the resulting organization; indeed,
many mergers (in some industries, the majority) result in a net loss of value due to problems.
Correcting problems caused by incompatibility—whether of technology, equipment, or corporate
culture— diverts resources away from new investment, and these problems may be exacerbated
by inadequate research or by concealment of losses or liabilities by one of the partners.
2) In the pure sense of the term, 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.
3) In practice, however, actual mergers of equals don't happen very often. Usually, one
company will buy another and, as part of the deal's terms, simply allow the acquired firm
to proclaim that the action is a merger of equals, even if it is technically an acquisition.
Being bought out often carries negative connotations, therefore, by describing the deal
euphemistically as a merger, deal makers and top managers try to make the takeover
more palatable.
4) A purchase deal will also be called a merger when both CEOs agree that joining together
is in the best interest of both of their companies. But when the deal is unfriendly - that is,
when the target company does not want to be purchased - it is always regarded as an
acquisition.
When companies are merging & acquisition they valuate the business.
Business valuation
The five most common ways to valuate a business are
1. Asset valuation,
2. Historical earnings valuation,
3. Future maintainable earnings valuation,
4. Relative valuation (comparable company & comparable transactions),
5. Discounted cash flow (DCF) valuation.
Professionals who valuate businesses generally do not use just one of these methods but a
combination of some of them, as well as possibly others that are not mentioned above, in order to
obtain a more accurate value. These values are determined for the most part by looking at a
company's balance sheet and/or income statement and withdrawing the appropriate information.
The information in the balance sheet or income statement is obtained by one of three accounting
measures: a Notice to Reader, a Review Engagement or an Audit.
Accurate business valuation is one of the most important aspects of M&A (Merger and
Acquisitions) as valuations like these will have a major impact on the price that a business will
be sold for. Most often this information is expressed in a Letter of Opinion of Value (LOV) when
the business is being valuated for interest's sake. There are other, more detailed ways of
expressing the value of a business. These reports generally get more detailed and expensive as
the size of a company increases; however, this is not always the case as there are many
complicated industries which require more attention to detail, regardless of size.
FINANCING M&A
Mergers are generally differentiated from acquisitions partly by the way in which they are
financed and partly by the relative size of the companies. Various methods of financing an M&A
deal exist:
Cash
Payment by cash. Such transactions are usually termed acquisitions rather than mergers because
the shareholders of the target company are removed from the picture and the target comes under
the (indirect) control of the bidder's shareholders alone. A cash deal would make more sense
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, and the debt will often be moved
down onto the balance sheet of the acquired company.
Hybrids
An acquisition can involve a combination of cash and debt, or a combination of cash and stock of
the purchasing entity.
Factoring
Factoring can provide the necessary extra to make a merger or sale work. Hybrid can work as ad
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Taxes: 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.
Vertical integration: Vertical Integration occurs when an upstream and downstream firm
merges (or one acquires the other). There are several reasons for this to occur. One reason is to
internalize 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.
However, on average and across the most commonly studied variables, acquiring firms’ financial
performance does not positively change as a function of their acquisition activity. Therefore,
additional motives for merger and acquisition that may not add shareholder value include:
Diversification: While this may hedge a company against a downturn in an individual industry
it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge
by diversifying their portfolios at a much lower cost than those associated with a merger.
Manager's hubris: manager's overconfidence about expected synergies from M&A which results
in overpayment for the target company.
Empire building: Managers have larger companies to manage and hence more power.
EFFECTS ON MANAGEMENT
A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that
mergers and acquisitions destroy leadership continuity in target companies’ top management
teams for at least a decade following a deal. The study found that target companies lose 21
percent of their executives each year for at least 10 years following an acquisition – more than
double the turnover experienced in non-merged firms.
SHORT-RUN FACTORS
One of the major short run factors that sparked in The Great Merger Movement was the
desire to keep prices high. That is, with many firms in a market, supply of the product remains
high. During the panic of 1893, the demand declined. When demand for the good falls, as
illustrated by the classic supply and demand model, prices are driven down. To avoid this decline
in prices, firms found it profitable to collude and manipulate supply to counter any changes in
The rise of globalization has exponentially increased the market for cross border M&A. In 1996
alone there were over 2000 cross border transactions worth a total of approximately $256 billion.
This rapid increase has taken many M&A firms by surprise because the majority of them never
had to consider acquiring the capabilities or skills required to effectively handle this kind of
transaction. In the past, the market's lack of significance and a more strictly national mindset
prevented the vast majority of small and mid-sized companies from considering cross border
intermediation as an option which left M&A firms inexperienced in this field. This same reason
also prevented the development of any extensive academic works on the subject.
Even mergers of companies with headquarters in the same country are very much of this type
(cross-border Mergers). After all, when Boeing acquires McDonnell Douglas, the two American
companies must integrate operations in dozens of countries around the world. This is just as true
for other supposedly "single country" mergers, such as the $27 billion dollar merger of Swiss
drug makers Sandoz and Ciba-Geigy.
A number of western government officials are expressing concern over the commercial
information for corporate acquisitions being sourced by sovereign governments & state
enterprises.
An ad hoc group of SWF Investment Directors and Managers have now established a database
called SWF Investments and this database provides shared acquisition information to the SWFs.
The SWF website is restricted and it states: "SWF Investments are a resource which has been
established by a number of sovereign wealth funds and state enterprises to produce acquisition
and investment databases and forecasting tools for potential acquisition targets. Subscription to
SWF Investments is by invitation only, and is restricted to government organizations or state
enterprises."
The database seems to be initially concentrating on London Stock Exchange listed companies;
however it is believed that the database will in a matter of weeks be extended to include all the
companies listed on the stock exchanges of most of the developed countries.
Western government are now in a difficult position, as public opinion and the trades unions
prefer the protection and domestic ownership of national companies, however the reality of the
present economic situation suggests that an injection of capital into many of the target company
may in fact save those companies from bankruptcy.
Top 10 M&A deals worldwide by value (in mil. USD) from 1990 to 1999:
Rank Year Purchaser Purchased Transaction value
(In mil. USD)
1. 1999 Vodafone Air Touch PLC Mannesmann 183,000
2. 1999 Pfizer Warner-Lambert 90,000
3. 1998 Exxon Mobil
77,200
4. 1999 Citicorp Travelers Group
73,000
5. 1999 SBC Communications Ameritech Corporation 63,000
6. 1999 Vodafone Group Air Touch Communications
60,000
7. 1998 Bell Atlantic GTE 53,360
8. 1998 BP Amoco 53,000
9. 1999 Qwest Communications US WEST 48,000
10. 1997 World com MCI Communications 42,000
Top 9 M&A deals worldwide by value (in mil. USD) since 2000:
Rank Year Purchaser Purchase Transaction value
(in mil. USD)
1. 2000 Fusion: America Online Inc. (AOL) Time Warner
164,747
2. 2000 Glaxo Welcome Plc. SmithKline Beecham Plc.
75,961
3. 2004 Royal Dutch Petroleum Co. Shell Transport & Trading Co
74,559
While most mergers and acquisitions increase the operational efficiency of business firms some
can also lead to a building up of monopoly power. The anti-competitive effects are achieved
either through coordinated effects or unilateral effects. Sometimes mergers and acquisitions tend
to create a collusive market structure.
However, free and fair competition is seen to maximize the consumers' interests both in terms of
quantity and price.
The remaining percentages of firms usually have a substantially long gestation period for getting
the legal approval. These cases are relatively complex and need a close examination of the
various aspects by the regulatory bodies.
It may be noted that the 'Competition Network' mentioned above is actually an association of
international competition authorities.
As per the law, the compulsory period of waiting for applicants can either be 210 days starting
from the day of notice filing or receipt of the Commission's order, whichever occurs earlier.
The threshold limits for firms entering business combinations are substantially high under the
Indian law. The threshold limits are set either in terms of the asset value or or in terms the firm's
turnover. Indian threshold limits are greater than those for the EU. They are twice as high when
compared with UK.
The Indian law also provides for the modern day phenomenon of merger and acquisitions, which
are cross border in nature. As per the law domestic nexus is a pre-requisite for notification on
this type of combinations.
It can be noted that Competition Act, 2002 has undergone a recent amendment. This has replaced
the voluntary notification regime with a mandatory regime. Of the total number of 106 countries,
which possess competition laws only 9 are thought to be credited with a voluntary notification
regime. Voluntary notification regimes are generally associated with business uncertainties.
In case of an Indian merger when transfer of shares occur for a company they are entitled to a
specific exemption from the capital gains tax under the “Indian I-T tax Act”. These companies
can either be of Indian origin or foreign ones.
A different set of rules is however applicable for the 'foreign company mergers'. It is a situation
where an Indian company owns the new company formed out of the merger of two foreign
companies.
It can be noted that for foreign company mergers the share allotment in the merged foreign
company in place of shares surrendered by the amalgamating foreign company would be termed
as a transfer, which would be taxable under the Indian tax law.
Also as per conditions set under section 5(1), the 'Indian I-T Act' states that, global income
accruing to an Indian company would also be included under the head of 'scope of income' for
the Indian company.
One of the most important certified merger and acquisition advisory programs is the Certified
Valuation Manager Program offered by the American Academy of Financial Management
(AAFM). The American Academy of Financial Management is also hosting a number of
Certified Valuation Manager Training Conferences throughout the year.
The certified mergers and acquisitions agencies help commercial enterprises or business
corporations in acquiring or taking over other companies and also in significant issues related to
mergers and acquisitions. These agencies also help business entities regarding management
In this modern-day world, the power of globalization, market liberalization and technological
advancement has contributed towards the formation of a increasingly competitive and active
commercial world, where mergers and acquisitions are more and more utilized for achieving
optimization of firm value and competitive benefits.
In the United States, the Alliance of Merger & Acquisition Advisors (AM&AA) is a principal
global institution, which offers specialized services related to the academic and resource
requirements in the profession of merger and acquisition advisory services. It has more than 500
members and has attained the position of a market leader in the educational domain of mergers
and acquisitions. The members are merger and acquisition professionals offering transactional
support and mediator services. The majority of the members have qualifications like MBA, CPA,
or JD. The merger and acquisition training program offered by the Alliance of Merger &
Acquisition Advisors is known as CM&AA certification.
The certified mergers and acquisition advisory services can be broadly categorized into the
following types:
1. Business Valuation Services
2. Funding Services (Acquisition financing, recapitalizations, financial reconstruction)
3. Asset Disposal Services
4. Acquisition Lookup
5. Management Buyouts (MBOs)
6. Certified Equipment and Machinery Estimation
The Sarbanes-Oxley Act plays a major role in the mergers and acquisitions that take place in the
United States. It was introduced in the year 2002 and is also called as the Public Company
Accounting Reform and Investor Protection Act of 2002. One of the principal objectives behind
the promulgation of this act is to maintain transparency in the mergers and acquisitions
transactions and protect the investors.
ADVANTAGES OF ACQUISITION
Acquisition provides the following advantages to the
companies which are merged:
1) Economies of scope the notion of economies of scope resemble that of economies of
scale. Economies of scale principally denote effectiveness related to alterations in the
supply side, for example, growing or reducing production scale of an individual form of
commodity. On the other hand, economies of scope denote effectiveness principally
related to alterations in the demand side, for example growing or reducing the range of
10) A company that has earned profits may find value in the tax losses of a target
corporation that can be used to offset the income it plans to earn. A merger may not,
however, be structured solely for tax purposes. In addition, the acquirer must continue to
operate the pre-acquisition business of the company in a net loss position. The tax
benefits may be less than their "face value," not only because of the time value of money,
but also because the tax loss carry-forwards might expire without being fully utilized.
11) Tax advantages can also arise in an acquisition when a target firm carries assets
on its books with basis, for tax purposes, below their market value. These assets could be
more valuable, for tax purposes, if they were owned by another corporation that could
increase their tax basis following the acquisition. The acquirer would then depreciate the
assets based on the higher market values, in turn, gaining additional depreciation benefits.
13) A firm with surplus funds may wish to acquire another firm. The reason is that
distributing the money as a dividend or using it to repurchase shares will increase income
taxes for shareholders. With an acquisition, no income taxes are paid by shareholders.
14) Acquiring firms may be able to more efficiently utilize working capital and fixed
assets in the target firm, thereby reducing capital requirements and enhancing
profitability. This is particularly true if the target firm has redundant assets that may be
divested.
15) The cost of debt can often be reduced when two firms merge. The combined firm
will generally have reduced variability in its cash flows. Therefore, there may be
circumstances under which one or the other of the firms would have defaulted on its debt,
but the combined firm will not. This makes the debt safer, and the cost of borrowing may
decline as a result. This is termed the coinsurance effect.
17) Obtaining quality staff or additional skills, knowledge of your industry or sector
and other business intelligence. For instance, a business with good management and
process systems will be useful to a buyer who wants to improve their own. Ideally, the
business you choose should have systems that complement your own and that will adapt
to running a larger business.
18) Accessing funds or valuable assets for new development. Better production or
distribution facilities are often less expensive to buy than to build. Look for target
businesses that are only marginally profitable and have large unused capacity which can
be bought at a small premium to net asset value.
19) Business underperforming. For example, if you are struggling with regional or
national growth it may well be less expensive to buy an existing business than to expand
internally.
20) Accessing a wider customer base and increasing your market share. Your target
business may have distribution channels and systems you can use for your own offers.
21) Diversification of the products, services and long-term prospects of your business.
A target business may be able to offer you products or services which you can sell
through your own distribution channels.
22) Reducing costs and overheads through shared marketing budgets, increased
purchasing power and lower costs.
24) Organic growth, i.e. the existing business plan for growth, needs to be
accelerated. Businesses in the same sector or location can combine resources to reduce
costs, eliminate duplicated facilities or departments and increase revenue.
SWOT (strengths, weaknesses, opportunities and threats) analysis to assess your business.
Analysing your results carefully will show you how to build on strengths, resolve weaknesses,
An acquisition could become expensive if you end up in a bidding war where other parties are
equally determined to buy the target business.
A merger could become expensive if you cannot agree terms such as who will run the combined
business or how long the other owner will remain involved in the business.
Both mergers and acquisitions can damage business performance because of time spent on the
deal and a mood of uncertainty.
Different legal issues can arise at different stages of the acquisition process and require separate
and sequential treatment. Diligence is the process of uncovering all liabilities associated with the
purchase. It is also the process of verifying that claims made by the vendors are correct.
Directors of companies are answerable to their shareholders for ensuring that this process is
properly carried out.
A written statement from the seller that confirms a key fact about the business is known as a
warranty. You may require warranties on the business' assets, the order book, debtors and
creditors, employees, legal claims and the business' audited accounts. A commitment from the
seller to reimburse you in full in certain situations is known as an indemnity. You might seek
indemnities for unreported tax liabilities, for example.
CROSS-BORDER MERGERS
The Companies (Cross-Border Mergers) Regulations 2007 came into force on 15 December
2007 and govern mergers between UK and overseas companies. The regulations introduced a
framework which removed legislative barriers and made it easier for UK companies to engage in
mergers with other companies from within the European Economic Area. Read information on
the regulations governing cross-border mergers on the Department for Business, Enterprise and
Regulatory Reform (BERR) website- Opens in a new window. If you are contemplating a cross-
border merger, make sure you take appropriate professional advice from the start.
Advisers can provide valuable guidance in areas such as valuing the business, financing the deal,
terms and contracts, reviewing legal aspects and specialist valuation of specific areas of the
business.