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Merger & Takeover

Merger & Takeovers

Arindam Ghosh Bratati Das

A transaction involving two or more companies in the exchange of securities and

only one company survives is called Merger. Merger and acquisition result in
several advantages in the acquiring company and the target company. There are
three types of Merger. The reasons of Merger are mainly to reduce the competition,
economies of scale, tax advantage, etc.

ny business firm has a prime as 'a transaction involving two or more in production research and
objective i.e. profitable companies in the exchange of development, marketing and
growth. This growth can be securities and only one company management, etc.
achieved internally or externally. survives'. Vertical Merger
Internal growth can be achieved either On the other hand acquisition is "a When a firm acquire its 'upstream'
through the process of introducing or purchase of a company or a part of it from it and or firm's 'down-stream' then
developing new products or by so that the acquired company is Vertical Merger occurs. In the case of
expanding or enlarging the capacity of completely absorbed by the acquiring 'upstream' type of merger' it extends to
existing products. External growth can company and thereby no longer exists the suppliers of raw materials and in
be achieved externally by acquisitions as a business entity". the case of 'downstream' type of merger
of existing business firm. This With the increase in the it extends to those firms that sell
acquisition may take any of the industrialisation and liberalisation, eventually to the consumer. The
following forms :— there is freedom to the corporates to purpose of such merger is the lower
I. Absorption enter or exit the freedom. So the market buying cost of materials, lower
II. Amalgamation has become more dynamic and distribution costs, assured supplies
III. Combinations competitive. As a result the business and market, increasing or creating
IV. Merger firm must strive hard to consolidate barriers to entry for potential
V. Takeover their positions and improve in the competitors.
VI. Demergers. market place. A firm may use mergers Conglomerate Merger
and acquisition to increase In marked contrast, Conglomerate
Although the legal procedure
competitiveness and consolidate its Merger is a type of combination which
involved in these are different, in view
position. a firm established in one industry
of the perspective of economic
consideration these terms are used Types of mergers combines with another firm in another
interchangeably here There are three types of Merger : unrelated industry. Such merger moves
Meaning of terms 1. Horizontal Merger for diversification of risk constitutes
2. Vertical Merger the rationale. Reason for Merger and
Merger is said to occur when two
3. Conglomerate Merger Acquisition. The following are
or more companies combine into one
important reasons for merger and
company. In detail, Merger is defined Horizontal Merger
acquisition of firms :
When two or more corporate firms
Head of the department of Commerce; Economies of Scale:— The
Panihati College,Visiting Lecturer :
dealing in similar lines of activity
combined firm can have larger volume
Bengal College of Management and combine together then Horizontal
the operation than the individual firm.
Media Infotech (Sikim Manipal Merger takes place. The purpose of
University) Thus the combined firm can enjoy
Horizontal Merger is elimination or
Lecturer in Commerce, Panihati economies of scale. The Merger and
reduction in competition, putting an
College, Visiting Lecturer : Media acquisitions help the company to
Infotech (Sikim Manipal University) end to price cutting, economies of sale
produce the goods more economically
Merger & Takeover

through the full utilisation of plant take advantage of tax benefits. Even to borrow more funds.
capacities. the sick company with accumulated * Increases the P/E ratio and value
Synergy :— Synergy is simply losses may be merged with a profitable per share: The liquidity and
defined as 2+2=5 phenomenon. The company and take advantage of marketability of the security increases
value of the company formed through income tax benefits with the approval after the merger. The growth rate as well
merger will be more than the sum of the of Government. The following is the list as earnings of the firm will also increase
value of the individual companies just of some companies along with the due to various economies after the
merged. amount of tax benefits enjoyed : merged company. All these factors help
Symbolically Ex:— Orissa Synthesis merged with the company to enjoy higher P/E in the
V (A) + V (B ) < V ( AB ) straw product Ltd.( Rs =16 crores) market.
V(A) = value of A Ltd. *Ahmadabad Cotton Mills Merged * Low floatation cost: Small
V (B) = value of B Ltd. with Arvind Mills ( Rs =3.34 crores) etc. companies have to spend higher
* Sidhaper Mills merged with percentage of the issued capital as
V (AB) = value of merged company.
Reliance Industries Ltd.(Rs. 3.34 crores) floatation cost when compared to a big
Diversification of risk
* Alwyn Nissan merged with firm.
When a company produce single
Mahinder and Mahindra Ltd. (Rs. 2.47 * Rising of capital: After the merger
product then the company's profits and
crores) due to increase in the size of the
cash flows fluctuate widely. This
* Hyderabad Alwyn merged with company and better credit worthiness
increase the risk of a firm.
Voltas Ltd. (Rs. 1,600 crores) and reputation, the company can easily
Diversification reduces the risk of the
* Orissa Synthesis with Straw raise the capital at any time.
firm. So a company whose earnings are
Products Ltd. (Rs. 16 crores). Corporate restructuring
of different nature. The merger of
companies whose earnings are To increase market power and to kill As M.B. Athreya says "Earlier,
negatively correlated will bring stability competition buying was considered hostile and
in the earnings of the combined firm. Merger help the company to reduce predatory behaviour and selling was
So diversification reduces the risk of competition in the market. It also help regarded as week-kneed failure. But
the firm. to increase the market power. now buying and selling businesses has
become psychologically more
Growth Ex:- TOMCO and HLL Merger,
acceptable. These are early responses
This is possible in two ways— Premier and Apollo Tyres,
to market friendly policies, and more
external and internal. Mergers and Blow Fast and Universal of this is bound to happen." Arun
acquisition help the company to grow Luggage Industries, Bharat Ram echoes a similar view "A
quickly without any gestalion period. Associated Cement Companies company may feel that it is not possible
Example etc. to continue in every business that it
RPG group had a turnover of only Financial synergy has been in the past, and so it must
Rs. 80 crores in 1979, which has The following are the financial divest intelligently. And there will be
increased to about Rs.5600 crores in synergy available in the case of other companies who will want to buy
1996. This phenomenal growth was due mergers : these business. So restructuring by
to the acquisitions of several * Better credit worthiness: This way of mergers, acquisitions and
companies by the RPG group. Some of helps the company to purchase the divestments will accelerate".
the companies acquired are Asian goods on credit, obtain bank loan and Corporate restructuring can occur in a
Cables, Ceat, Calcutta Electricity raise capital in the market easily. myriad ways. Business firms resort to
Supply and Company, SAE, etc. a variety of activities that lead to
* Reduces the cost of capital: The
Reduction in tax liability inverstors consider big firms as safe expansion, sell off and change in
Under Income-tax act there is a and hence they expect lower rate of ownership and control. Though the
provision for set off and carry for-ward return for the capital supplied by them. classification is some what arbitrary, it
of losses. A sick company may not be So the cost of capital reduces after the helps in clarifying the emphasis of
in a position to earn sufficient profits merger. various restructuring practices. The
in future to take advantage of the carry * Increases the debt capacity: After very objective of corporate
forward position. So a sick company the merger the earnings and cash flows restructuring is to fight competition
with accumulated losses may like some become more stable than before. This and to conduct the business in an
profitable company to merger with it to increases the capacity of the company efficient and effective manner, so as to
consolidate the position of the
Merger & Takeover

business. alternative route to profitable growth. valuing the firm particularly in the
Financial considerations in merger Shortly the major economic cases of large listed corporate firms.
and acquisitions advantages of mergers are: The EPS is an important criterion for
A merger can financed by cash or economies of scale, merger decisions.
exchange of shares or combinations of synergy, However, the worth of a firm should
cash, shares and debentures. tax benefits, not be determined on the basis of a
Cash offer single approach and a single figure, but
diversification, etc.
Here the shareholder of the largest within a range on the basis of a
The scheme and legal procedure for
company are paid cash in exchange of consideration of all the alternative
mergers and tax aspects of mergers are
their shares in the target company. approaches. The second aspect of
also described. The focus of the
merger is the mode of financing. In the
Share exchange analysis of mergers and acquisitions is
case of a firm having a high P/E ratio,
Here the acquiring company issues on the financial framework covering
issue of equity shares is advantageous
shares to the shareholders of the target three major as-pects: (1) determining the
both to the acquiring and acquired
company in exchange. firm's value, (2) financing technique in
firms. To meet the investment needs of
Exchange ratio merger and (3) merger as a capital
different types of investors,
The determination of the exchange budgeting decision.
convertible securities can also be
ratio is based on the value of shares of Determining the worth of a firm is issued. Yet another form of financing
the companies involved in the merger. the first step. It is a difficult task also. merger is the deferred-payment plan.
The basic objective of financial In estimating the value of a firm, several
The tender offer is another alterna-
management is to maximise the factors are considered in conjunction
tive to acquire firms. The purchasing
shareholder's wealth even the merger with one another. The book value
firm directly approaches the sharehold-
decision is to be taken in the light of although not an effective measure by
ers of the target firm. This approach
wealth maximisation. itself, is useful in specific situations.
may be cheaper provided that the man-
Conclusion The appraisal value mayor may not be
agement of the target firm does not at-
This section summarises the main a good indicator to be paid for a
tempt to block it. The capital budget-
points of the discussion relating to company. Its merit depends upon the
ing framework can also be applied to
mergers and acquisitions as an approach taken and nature of business.
evaluate merger decisions.
The market value is a key element in