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Introduction to Mergers & Acquisitions
Structure 1.1 Introduction Objectives 1.2 Background 1.3 Meaning Self Assessment Questions 1.4 Motives behind Mergers 1.5 Advantages of Mergers & Acquisitions 1.6 Theories of mergers Operating Financial Managerial synergy of mergers Self Assessment Questions 1.7 Types of Merger Self Assessment Questions 1.8 Value creation of Mergers 1.9 Role of industry Life Cycle Introduction Stage Exploitation Stage Maturity Stage Decline Stage 1.10 Summary 1.11 Terminal Questions 1.12 Answers to SAQ’s & TQ’s
This unit introduces the background of corporate mergers and acquisition and also explains the concept of mergers and acquisition. To start with, you need to know why the corporate go for mergers and the rationale behind such mergers and acquisition. You will also able to understand about the various forms of mergers and acquisition in this unit.
Sikkim Manipal University
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The external growth expedites the pace of growth as the acquired firm already has the facilities or market Sikkim Manipal University Page No. The internal growth usually involves a longer implementation period and also entails greater uncertainties.Mergers and Acquisitions Unit 1 Objectives After studying this unit.: 2 . In today’s business world. It can be achieved in two different methods: Internal o Through the process of introducing or developing new products o By expanding or enlarging capacity of the existing product(s). Both of the above methods have their own strengths and weaknesses. acquisitions. Mergers and acquisitions have happened in history in the last 100 years. In the competitive world. The current upswing in activity in the domestic market as well as in the global markets proves that strong conceptual and technical skills are required for anyone working in the field. amalgamations. takeovers. In the US. absorption. As a result of globalization. Both America and Europe have experienced the spectacular wave of mergers and acquisitions in recent days. the growth of the firm should be quick and sustainable. profitable growth constitutes one of the prime objectives of the business organizations. the merger waves started: between 1890-1904 at the end of World War I during later part of II World War and continues to the present day. you should be able to Define the concept of mergers and acquisition Discuss the motives behind mergers Describe theories of mergers Discuss about the forms of mergers and acquisition 1. External o By acquisitions of existing business firms in the form of mergers. consolidation etc. today the business firms are operating in highly competitive environment.2 Background Merger and acquisition are the most popular means of corporate restructuring.
2 Amalgamation One or more companies may merge to form a new company. expansion and globalization of the enterprises and achieving multitude of objectives. One company is absorbed into and blended with another company. The survivor company acquires the assets as well as liabilities of the merged company or companies.3. liabilities and stock of one company stand transferred to Transferee Company in consideration of payment in the form of Equity. Generally the company which survives is the buyer which retains its identity and Seller Company is extinguished. you will be able to understand various terminologies relating to mergers and acquisitions.3 Consolidation Consolidation is Fusion (convergence) of two existing companies into a new company in which both the existing companies extinguish. 1.3. In a narrow sense. The firm will opt for merger if it maximizes the wealth of shareholders.: 3 . 1.1 Merger Merger is defined as a combination of two or more companies into a single company where one survives and the others lose their corporate existence. All assets. M & A have become universal practice in the corporate world for securing survival. These terminologies are frequently used in the later part of this book. A number of mega mergers and hostile takeovers could be witnessed in India now. growth. It is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and ease to exist. It contemplates a state of things under which two companies are so joined as to form a third entity. However.Mergers and Acquisitions Unit 1 acceptable products. the term Sikkim Manipal University Page No. a growing firm may be in constant search for identifying potential firms which may be merged. The Company Act 1956 vides section 394 and 396A. 1. explains amalgamation which will be discussed separately under legal aspects of merger. the term will be used interchangeably with ‘Merger’ whenever the circumstances would so require.3 Meaning of Terms In this section. Hence.3. M & A have started taking place in India in the recent years. Debt or Cash modes 1.
3. called subsidiary company.7 Takeover A take-over is acquisition and both the terms are used interchangeably. 1. separate legal entity. HCL LTD – Hindustan Computers. but carrying legally distinct interpretation. a Company can obtain the status of a holding company by acquiring shares of other companies. Liabilities and Stocks of the Consolidating companies stand transferred to new company for consideration. but there may be change in control of company.: 4 .Mergers and Acquisitions Unit 1 amalgamation and consolidation are sometimes used interchangeably. Thus. Takeover is nothing but obtaining of control over management of company Sikkim Manipal University Page No. two or more companies may remain independent. and share capital. in an acquisition.4 Combination It refers to mergers and consolidations as a common term used interchangeably. without any combination of companies.6 Acquisition Acquisition is an act of acquiring effective control by one company over assets or management of another company. 1. Indian Software Company and Indian Reprographics Ltd merged in 1986 to form HCL Ltd. 1. All mergers.3. insurance of loan capital. An acquisition may be affected by: o Agreement with the persons holding majority interest in a company management (BOD/ Shareholder) o Purchase of shares in open market o To make take-over to the general body of share holders o Purchase of new shares by private treaty o Acquisition of share capital of one company by either all or any of the following forms: cash. Hindustan Instruments. acquisitions and amalgamations are business combination. A holding company is a company which holds more than half of the nominal value of the equity capital of another company. All Assets.3. 1.5 Holding Company The main criteria of becoming holding company is the control in the composition of the Board of Directors in another company and such control should emerge from holding of equity shares and thereby more than 50% of the total voting power of such company.3. That is. Both holding and subsidiary companies retain their separate legal entities and maintain their separate books of accounts.
Quote the best Indian examples for consolidation. If a company wants to invest in more than 10% of the subscribed capital of another company. I. _________________________________________________________ _________________________________________________________ 4. 1. Time taken in completion of transaction is less in take-over than in mergers.3. _________________________________________________________ _________________________________________________________ 2. Define Holding Company. 1. The process of take over is unilateral and the offeror company decides about the maximum price. State how a business firm can achieve growth internally and externally. Self Assessment Questions 1. A Company can have effective control over another by holding minority ownership. use of super technology and displacement of labour altering capital base etc with a view to improve the performance.8 Restructuring It is re-organizing through changing location of capital investment.: 5 . The investment in shares of other companies in excess of 10% of subscribed capital can result into their takeovers. it has to be approved in the shareholders’ general meeting and also by the Central Government. _________________________________________________________ _________________________________________________________ 3. Section 372 of the Companies Act 1956 defines the limit of a company’s investment in the share of another company.9 De-merger or Corporate Split Or Division It is just opposite to combination. Division of a company takes place when part of its undertaking is transferred to newly formed company or to an existing company. Takeover means acquisition of not less than 25% of the voting power in a company.Mergers and Acquisitions Unit 1 by other. Under MRTP Act.3. Takeover means: _________________________________________________________ _________________________________________________________ Sikkim Manipal University Page No.
it may be desirable to purchase a firm with prior tax losses which will offset current or future earnings o To increase efficiency and profitability.1 The Buyers Motives The motivations for buyers are as follows: o To increase the value of the firm’s stock – that is. This is done by acquiring firm’s whose earnings and sales complement the firm’s peak and valleys o To balance or fill out the product line o To diversify the product line when the current products have reached their peak in the life cycle o To reduce competition by purchasing a competitor o To acquire a needful resource quickly. For eg.Mergers and Acquisitions Unit 1 1. Both these firms have motives for combination. A different rationale can be assigned at both individual and collective levels which influence sellers and buyers to opt for Mergers and Acquisition.4. Generally. especially if there is synergy between the two companies 1.4 Motives behind Mergers The primary objectives of Mergers & Acquisition are diversification.2 The Sellers’ Motives The motivations for sellers are as follows: o To increase the value of the owner’s stock and investment in the firm o To increase the firm’s growth rate by receiving more resources from the acquiring company o To acquire resources to stabilize operations and make them more efficient o For tax reasons – if the firm is owned by a family or an individual. mergers often lead to increase in stock price and/or Price Earning ratio o To increase the growth rate of the firm o To make a good investment – a firm may make better use of funds by purchasing instead of ploughing the same funds into internal expansion o To improve the stability of the firms’ earnings and sales.4. High-quality technology or highly innovative management o For tax reasons. a merger makes it easier to deal with estate tax problems Sikkim Manipal University Page No. One of them is the buyer and the other is the seller. 1. improving competitive position etc. two or more firms have to act for merger.: 6 . market expansion.
2 Financial This theory postulates that the purpose of mergers and acquisitions is to: Improve liquidity and have direct access to cash resources Dispose of surplus and outdated assets for cash out of combined enterprises Enhance gearing capacity. horizontal and conglomerate M&As.: 7 .6. the firms are operating at levels of activities that fall short of achieving the potentials for economies of scale. borrow on better strength and greater assets backing Sikkim Manipal University Page No.6. Economies of scale arise because of indivisibilities. Thus manufacturing operations. equipment and overhead.Mergers and Acquisitions Unit 1 o o To help diversify the owning family’s holdings beyond the present firm To deal with top management problems such as Management Succession for an entrepreneur or dissension among top managers 1. which provide increasing returns if spread over large no.1 Operating This theory postulates that the reason for M&A is the resultant operating synergy or operating economies of scale. such as people. of units of output. The theory based on operating synergy assumes that economies of scale do exist in the industry and prior to the merger.6 Theories of Mergers 1.5 Advantages of Mergers & Acquisitions The most common advantages of mergers and acquisitions are: Maintaining or accelerating profitable growth of a company Enhancing profitability through cost reduction resulting from: o Economies of scale o Operating Efficiency o Synergy Diversifying the risk of the company by the way of acquiring the business of different income streams Reducing tax liability by the way of setting off accumulated losses or unabsorbed depreciation of one company against the profits of another Enhancing the market power of the company 1. This theory can be applied to vertical. heavy investments in plant and equipment typically produce such economies. 1.
if carried to its extreme. a merger between the two firms will be synergistic since it combines the non-managerial organization capital of the acquired firm with the excess managerial resources of the acquiring firm. State important buyer’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 2.1 Vertical Combination It is a process of joining of two or more companies involved in different stages of the production or distribution of the same product or service. Self Assessment Questions 1. II.7. The level of efficiency in the economy would be raised by such mergers. State important Seller’s motivation behind mergers _________________________________________________________ _________________________________________________________ _________________________________________________________ 3. Merger of Coal Mining and Railway Company is the best example Sikkim Manipal University Page No. This would be a social gain as well as private gain.3 Managerial synergy of mergers This theory says that if a firm is merged with or taken-over by another firm with better managerial efficiency.: 8 .7 Types of Merger 1. two or more companies which are engaged in the production of same goods or services but different stages of production or services join together. That is. List the economic advantage of mergers and acquisitions _________________________________________________________ _________________________________________________________ _________________________________________________________ 1. As per this theory.Mergers and Acquisitions Unit 1 Avail of tax benefits Improve Earning Per Share 1. This theory suggests that M & A occurs mostly in respect of firms in similar kinds of business. it would result in only one firm in the economy.6. One difficulty in the differential efficiency theory is that. indeed in the world – the firm with the greatest managerial efficiency. the overall managerial efficiency will be improved to the level of the efficient firm.
2. Forward Vertical Integration Such combination occurs when the firms acquire or create a company that purchases its products/ services. scarcity of resources To control over product specification The various types of vertical combination are as explained below: 1. The essential objective of such merger is: To ensure a ready market for the goods & services produced To ensure a source of supply required for production of goods or services To gain a strong position because of imperfect market of intermediary products. Backward Integration Such combination occurs when the firms acquire or create a company that supplies the firm the raw materials or components and other inputs.Mergers and Acquisitions Unit 1 in which new product/services which are complementary to existing product/ services is added.: 9 .1 Forward Linkage Sikkim Manipal University Page No. The above concept of integration of firms can be depicted as below: Petroleum Exploration Backward Linkage Petroleum Production Backward Linkage Refining Original Company Sales to Wholesaler/Dealers Forward Linkage Sales to Retailers Figure 1.
The companies involved in merger under this mode may be engaged in totally different lines of business.: 10 . Ltd.2 Horizontal Combination This is the joining of two or more companies in same area of business. advertisement cost etc To have greater access to channels of distribution 1. Financial Conglomerate: The important features of financial conglomerate is: Provide a flow of funds to each segment of their operations.3 Conglomerate Merger This is joining of two or more companies whose businesses are not related with each other either vertically or horizontally. exercise control Undertake strategic planning but do not participate in operating decisions Serve at least five distinct economic functions: Improve risk-return ratios through diversifications Sikkim Manipal University Page No. two or more companies which are producing essentially the same product or providing the same services or which are in direct competition with each other join together. In this type of combination. Such merger results in: Economies of scale Operational economies Elimination of duplication facilities Reduces competition and number of Companies Reduction in investment in working capital. It is like Manufacturing Company acquiring Insurance Company.Mergers and Acquisitions Unit 1 1. They are: 1. Eg.7. The combination of ACC Ltd is the best example to quote here. Gujarat Gas Ltd & Gujarat Finance Co. The basic objectives of conglomerate mergers are: Diversification of Activities Reduction of Risk Economies of Large Scale Operations Financial Stabilities Increase in profits Attain managerial competence There are various types of conglomerate mergers in practice.7.
but also plays a role in operating decisions and provides staff enterprise and staff services to the operating entities. Managerial Conglomerate: The managerial conglomerate not only assumes financial responsibility and control. managerial conglomerates increase the potential for improving performance. These economic benefits are achieved through corporate head quarters. When any two firms of unequal competence are combined.4 Concentric Merger Concentric merger is combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. 1. This defines SYNERGY in its most general forms.Mergers and Acquisitions Unit 1 Avoid ‘gamblers ruin’ – an adverse run of losses which might cause bankruptcy Establish programme of financial planning & control Improve resource allocation to perform efficiently Divert internal cash flows from the unfavourable areas to more attractive areas 2. combination of firms producing Television.: 11 . the total performance of the combined firm will be greater than the sum of the individual part. The important benefits of concentric mergers are: Reducing of Risks Economies of large scale operations Financial stability Increase in profit Attain managerial competence The important reasons for adopting conglomerate strategy are: Achieve higher growth rate than expansion Effective use of Financial Resources Avail potential opportunities of profitable investments Achieve competitive advantage and stability Improve P/E Ratio and bring out higher market price of shares Sikkim Manipal University Page No. General management functions (planning. For example. By providing managerial counsel and interactions on decision. Washing Machines and Kitchen Appliances come under the concept of concentric merger.7. organizing etc) are in reality transferable to all types of business firms.
Self Assessment Questions 1.: 12 . personnel. Following are the important synergies that take place in merger and acquisition process if planned strategically. Combination of Cement Industry with Chemical Industry is the best example for concentric merger.8 Value Creation in Mergers The value creation in mergers is due to synergic effect.Mergers and Acquisitions Unit 1 1. Acquiring company obtains benefits in the form of economies of resource sharing and diversification. technology materials etc o Management Synergy Management synergy exists if the existing managerial expertise of the company will be an added advantage of the new business Sikkim Manipal University Page No. companies producing distinct products seek amalgamation to share common distribution and research facilities so as to obtain economies by elimination of cost on duplication & promoting market enlargement. III. List the objectives of Conglomerate mergers _________________________________________________________ _________________________________________________________ 5. Give an example of Horizontal Combination _________________________________________________________ 3.5 Circular Combination Under this combination. Yes / No 1.7. o Marketing Synergy This occurs when products use common distribution channels. Give an example of Vertical Combination _________________________________________________________ 2. and economies in purchasing etc o Investment Synergy This can result from the use of same production facilities. sales promotion and sales administration o Operating Synergy Operating synergy is realized by better utilization of facilities. Give an example of Backward and Forward integration _________________________________________________________ 4.
2 Exploitation Stage Mergers during the exploitation stage are similar to mergers during the introductory stage. This results in related or conglomerate merger.Mergers and Acquisitions Unit 1 The effective implementation of above synergies in merger in turn creates value to the business firms 1. The horizontal merger between smaller firms may also occur.4 Decline Stage In this stage. Vertical mergers are also carried out to increase efficiency and profit margins. production and marketing.9. Conglomerate acquisitions of firms in growth industries are undertaken to utilize the accumulating cash position Sikkim Manipal University Page No.9.3 Maturity Stage Mergers in this stage are undertaken to achieve economies of scale in research.9.9 Role of industry life cycle The stage of industry life cycle has an impact on mergers and acquisition process. horizontal mergers are undertaken to ensure survival. 1. 1.1 Introduction Stage In this stage. in order to match the low cost and price performance of other firms – domestic or foreign. enabling such firms to pool management and capital resources. The impetus for such mergers is reinforced by the more visible indications of prospective growth and profit and by the large capital requirements of a higher growth rate. newly created firms may sell to outside larger firms in a mature or declining industry thereby enabling larger firms to enter a new growth industry. 1. The smaller firms may wish to sell because they want to convert personal income to capital gain and because they do not want to place large investments in the hands of managers that do not have a long record of success. Some acquisition of smaller firms by larger firms takes place for the purposes of rounding out the management skills of the smaller firms and providing them with a broader financial base. Concentric mergers involving firms in related industries provide opportunities for synergy and carry over.: 13 .9. The influence of various industry life cycles on mergers and acquisitions activities are explained here below: 1.
4. however. Successful Acquisition process A. Initially.1994). This bid aroused a great deal of resistance from the Rowntree workforce. Nestle having neglected the confectionery business of its own. in a bitter hostile bid in 1988. According to the senior executives of these two Plessey companies. but there has also been increased productivity. Plessey also used to operate with a short payback period of only two years. (13. with Rowntree it took four years. Siemens’ acquisition of Plessey Siemens of Germany. There have been job losses. Nestle approached the integration task with considerable care and sensitivity. Whereas it would normally take two to three years to integrate an acquisition fully. The British senior executives feel that without Siemens their company would not have survived.(Financial Times. B. Siemens used a German consultant on a British cost-reduction project. There have been heavy capital investments in Rowntree since the takeover. and a political storm. and appreciate the greater autonomy and long-term financial support they have received from Siemens.Mergers and Acquisitions Unit 1 of mature firms in declining industries whose internal flow of funds exceeds the investment requirements of their traditional lines of business. the York-based confectioner.: 14 . Although Nestle assured Rowntree at the time of bid that its global confectionery strategy would be run from York. Siemens allowed the UK companies to choose their own consultants. they had been starved of capital investment funds. However. UK managers were sent to Germany for intercultural training. in a joint bid with GEC of the UK for the British company Plessey in 1989. equipment. ATM was made into a world centre. Subsequently. and testing and design facilities by Plessey before the acquisition. acquired Plessey’s electronic system (PES) and air control traffic systems and management (ATM). Nestle’s takeover of Rowntree: Nestle. The Plessey companies were given a great deal of autonomy. needed Rowntree ‘s Sikkim Manipal University Page No. the Swiss food and confectionery giant. the assurance was not kept. causing some resentment among the UK managers. took over the much respected Rowntree. York has become a global research centre for confectionery. with calls for a reference to the Monopolies and Mergers Commission. Siemens handled integration with great care.
Mergers and Acquisitions Unit 1 expertise and brands. 3. economies of vertical integration. Mergers and acquisitions have become universal corporate practice for securing survival. growth. What are the economic advantages from merger? 7. the heavy investment the higher profile of Rowntree in Nestle’s global strategy and the degree of autonomy given to Rowntree have all combined to lessen the suspicion and hostility which accompanied the takeover in 1988(Financial Times. Explain the various types of mergers at different stages of industry life cycle. vertical or conglomerate. Merger could be horizontal. Explain the concept of Mergers.1994). This two-way flow of managers . expansion and globalization of the enterprise. 1. What are the motives behind mergers and acquisitions? 6. Merger is the combination of two or more firms into one of the firms whereas an amalgamation involves the combination of two or more firms to form a new firm. It has therefore left Rowntree under the charge of UK managers.: 15 . 5. increased efficiency. Differentiate between horizontal and vertical merger. tax shields or share resources. What are the different types of mergers? 4. with some of the old Rowntree managers holding global position in Zurich.4. 1. Sikkim Manipal University Page No. Merger benefits may result from economies of scale. How can a business firm achieve growth internally and externally? 2.11 Terminal Questions 1. 20. 8. Acquisition and Amalgamation. Further there has been a flow of managers between Rowntree and the rest of Nestle group.10 Summary The growth of a firm can be achieved either internally (new product development or expansion etc) or externally (mergers and acquisition). Explain the important theories of merger.
1B Refer to Section 1. Refer to Section 1.1 and 1.6. Refer to Section 1. 3. 4.3.2 2.5 7.3 3.6. Refer to Section 1.12 Answers to SAQs and TQs SAQs I 1. Refer to Section 1. 5.6 5.1A and 1.7 II 1. Refer to Section 1. Refer to Section 1. Refer to Section 1. Refer to Section 1.3. Refer to Section 1. Refer to Section 1. Refer to Section 1.2.6. Refer to Section 1. HCL Ltd.2 3.5 4.4 6.7 4. Refer to Section 1. TQs 1.2. 2. Refer to Section 1.1 2.4 Coal Mining and Railway Company ACC Ltd Refer to Section 1.Mergers and Acquisitions Unit 1 1. 3.7.3 No III 1.1 2.9 Sikkim Manipal University Page No.7.: 16 .2 8.
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