FINANCIAL

MANAGEMENT
MERGERS

INTRODUCTION
The words Mergers and Acquisitions are often used as an interchangeable term, a convenient but
inaccurate usage. Mergers refer to deals where two or more companies take virtually equal stakes
in each others businesses, whereas an acquisition is the straightforward purchase of a target
company by another company.
Merger:
A "merger" or "merger of equals" is often financed by an all stock deal (a stock swap). An all
stock deal occurs when all of the owners of the outstanding stock of either company get the same
amount (in value) of stock in the new combined company. The terms "demerger," "spin-off" or
"spin-out" are sometimes used to indicate the effective opposite of a merger, where one company
splits into two, the second often being a separately listed stock company if the parent was a stock
company. Merger is a legal process and one or more of the companies lose their identity.

High-yield
In some cases, a company may acquire another company by issuing high-yield debt (high interest
yield, "junk" rated bonds) to raise funds (often referred to as a leveraged buyout). The reason the
debt carry a high yield is the risk involved. The owner cannot or does not want to risk his own
money in the deal, but third party companies are willing to finance the deal for a high cost of
capital (a high interest yield).
The combined company will be the borrower of the high-yield debt and it will be on its balance
sheet. This may result in the combined company having a low shareholders' equity to loan capital
ratio (equity ratio).
Consolidation
Technically speaking consolidation is the fusion of two existing companies into a new company
in which both the existing companies extinguish.

Merger and Consolidation can be differentiated on the basis that, in a merger one of the two
merged entities retains its identity whereas in the case of consolidation an entire new company is
formed.
Takeovers
A takeover bid is the acquisition of shares carrying voting rights in a company with a view to
gaining control over the management. The takeover process is unilateral and the offer or
company decides the maximum price.
Demerger
It means hiving off or selling off a part of the company. It is a vertical split as a result of which
one company gets split into two or more.
Amalgamation
Halsburys Laws of England describe amalgamation as a blending of two or more existing
undertaking into one undertaking, the shareholders of each blending company becoming
substantially the shareholders in the company which is to carry on the blended undertaking.

CLASSIFICATIONS OF MERGERS
Mergers are generally classified into 5 broad categories. The basis of this classification is the
business in which the companies are usually involved. Different motives can also be attached to
these mergers. The categories are:

Horizontal Merger:
It is a merger of two or more competing companies, implying that they are firms in the same
business or industry, which are at the same stage of industrial process. This also includes some
group companies trying to restructure their operations by acquiring some of the activities of other
group companies.
The main motives behind this are to obtain economies of scale in production by
eliminating duplication of facilities and operations, elimination of competition, increase in
market segments and exercise better control over the market.
There is little evidence to dispute the claim that properly executed horizontal mergers
lead to significant reduction in costs. A horizontal merger brings about all the benefits that accrue
with an increase in the scale of operations. Apart from cost reduction it also helps firms in
industries like pharmaceuticals, cars, etc. where huge amounts are spent on R & D to achieve
critical mass and reduce unit development costs.
Vertical Mergers
It is a merger of one company with another, which is involved, in a different stage of production
and/ or distribution process thus enabling backward integration to assimilate the sources of
supply and / or forward integration towards market outlets.
The main motives are to ensure ready take off of the materials, gain control over product
specifications, increase profitability by gaining the margins of the previous supplier/ distributor,
gain control over scarce raw materials supplies and in some case to avoid sales tax.
Conglomerate Mergers
It is an amalgamation of 2 companies engaged in the unrelated industries. The motive is to
ensure better utilization of financial resources, enlarge debt capacity and to reduce risk by
diversification.
It has evinced particular interest among researchers because of the general curiosity
about the nature of gains arising out of them. Economic gain arising out of a conglomerate is not
clear.

Much of the traditional analysis relating to economies of scale in production, research,

distribution and management is not relevant for conglomerates. The argument in its favor is that
in spite of the absence of economies of scale and complimentary, they may cause stabilization in
profit stream.
Even if one agrees that diversification results in risk reduction, the question that arises is
at what level should the diversification take place, i.e. in order to reduce risk should the company
diversify or should the investor diversify his portfolio? Some feel that diversification by the
investor is more cost effective and will not hamper the companys core competence.
Others argue that diversification by the company is also essential owing to the fact that
the combination of the financial resources of the two companies making up the merger reduces
the lenders risk while combining each of the individual shares of the two companies in the
investors portfolio does not. In spite of the arguments and counter- arguments, some amount of
diversification is required, especially in industries which follow cyclical patterns, so as to bring
some stability to cash flows.
Concentric Mergers
This is a mild form of conglomeration. It is the merger of one company with another which is
engaged in the production / marketing of an allied product. Concentric merger is also called
product extension merger. In such a merger, in addition to the transfer of general management
skills, there is also transfer of specific management skills, as in production, research, marketing,
etc., which have been used in a different line of business. A concentric merger brings all the
advantages of conglomeration without the side effects, i.e., with a concentric merger it is
possible to reduce risk without venturing into areas that the management is not competent in.
Consolidation Mergers:
It involves a merger of a subsidiary company with its parent. Reasons behind such a
merger are to stabilize cash flows and to make funds available for the subsidiary.
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.

WAYS OF HANDLING A MERGER

There are 4 ways in which a merger can be handled
1 ) Friendly merger
A merger whose terms are approved by the management of both companies. Usually such
mergers have a high probability of success
2 ) Hostile merger
A merger in which the target firms management resists the acquisition or merger.
3 ) Tender offer
The offer of one firm to buy the stock of another by going directly to the stockholders,
frequently (but not always) over the opposition of the target companys management
4 ) Proxy Fight
An attempt to gain control of a firm by soliciting stockholders to vote for a new management
team.

Terms like "dawn raid", "poison pill", and "shark repellent" might seem like they belong in
James Bond movies, but there's nothing fictional about them - they are part of the world of

mergers and acquisitions (M&A). Owning stock in a company means you are part owner, and as
we see more and more sector-wide consolidation, mergers and acquisitions are the resultant
proceedings. So it is important to know what these terms mean for your holdings.
Mergers, acquisitions and takeovers have been a part of the business world for centuries. In
today's dynamic economic environment, companies are often faced with decisions concerning
these actions - after all, the job of management is to maximize shareholder value. Through
mergers and acquisitions, a company can develop a competitive advantage and ultimately
increase shareholder value.
There are several ways that two or more companies can combine their efforts. They can partner
on a project, mutually agree to join forces and merge, or one company can outright acquire
another company, taking over all its operations, including its holdings and debt, and sometimes
replacing management with their own representatives. Its this last case of dramatic unfriendly
takeovers that is the source of much of M&As colorful vocabulary.

HISTORY OF MERGERS IN THE 20TH CENTURY

In 1998 there were a large number of blockbuster mergers and acquisitions that made past
mergers and acquisitions look small by comparison. For example, the largest announced mergers
in 1998 were the marriage between Citicorp and Travelers Group estimated at $77 billion in
value and Exxons acquisition of Mobil for an estimated $79 billion. Closely following were
transactions between SBC and Ameritech values at approximately $61.8 billion and between
Nations Bank Corp and BankAmerica Corp. valued at approximately $60 billion. AT&T
announced the acquisition of Tele-Communications, Inc., valued at approximately $43 billion.
One of the largest industrial mergers and acquisition was between Chrysler Group and Daimler
Benz AG Valued at $45.5 billion, was also announced. These were all larger than the acquisition
of MCI by WorldCom announced in 1997 and characterized as a megamerger by many at
approximately $37 billion.

The size and number of M&A transactions continue to grow worldwide. For example one of the
largest mergers in history was announced in 1999 MCI WorldCom and Sprint agreed to a merger
values by analyst at $ 115 billion and $129 billion. But it did not receive regulatory approval and
the respective boards of directors called off the merger agreement in July 2000. Had the merger
been completed it would have been the second largest global telecommunications company
behind only AT&T.

IMPORTANCE OF MERGERS AND ACQUISITIONS

The 1980s produced approximately 55,000 mergers and acquisitions in the United States alone.
The value of the acquisitions during this decade was approximately $1.3 trillion as impressive as
these figures are; they are small in comparison to the merger wave that began in the earlier
1990s approximately in 1993. The number and value of mergers and acquisitions have grown
each year since 1993. For example in 1997 there were approximately 22,000 mergers and
acquisitions roughly 40% of the total acquisitions during the whole decade of the 1980s. Perhaps
more significant, the value of these mergers in 1997 was $1.6 trillion. In other words, the
acquisitions completed in 1997 were valued at $300 billion more than the value of acquisitions
during the 1980s. Interestingly 1980s was often referred to as the decade of Merger Madness.
The year 1998 was no different, as noted by the huge Merger and Acquisitions transactions listed
earlier; it was predicted to be another record year. Interestingly the 6,311 domestic mergers and
acquisitions announced in 1993 had a total value of $234.5 billion for an average $37.2 million,
whereas the mergers and acquisitions announced in 1998 had an average value of $168.2 million
for an increase of 352% over those of 1993. Approximately $2.5 trillion in mergers were
announced in 1999, continuing the upward trend.
The merger and acquisitions in the 1990s represent the fifth merger wave of the twentieth
century and their size and numbers suggest that the decade of 1990s might be remembered for

the megamerger mania. With five merger waves throughout the twentieth century, we must
conclude that mergers and acquisitions are an important, if not dominant. Strategy for twenty
first century organizations

THE MOTIVE BEHIND MERGERS

The strategic Goals of mergers and acquisitions
1 ) Economies of Scale
2 ) Consolidation: Media buyers are now consolidating to increase ad rates
3 ) Globalization: For Example Kerry Group an Irish milk processor and dairy cooperative has become a global
player after a string of acquisitions in the food and ingredients business.
4 ) Create or gain access to distribution channels: A lack of distribution has been one of the main hindrances to growth of the wine companies.
They are overcoming this by a string of acquisitions for example Fosters.
5 ) Gain access to new products and technologies: Pooling resources helps pharmaceutical companies to speed up research and development of new
drugs and also to share the risks and place a number of bets on emerging technologies. In the
1990s 23 pharmaceutical merger to form the top ten players.

6 ) Enhance or increase products and/or services: Mergers between large banks specializing in different sectors for example when Allianz AG
acquired Dresdner Bank.
7 ) Increase market share or access to new markets: Car manufacturers turn to mergers and acquisition for this reason. For example when Daimler
Benz and Chrysler Group merged, when Ford acquired Jaguar.
8 ) Diversification
9 ) To offset threatened loss of market
10)

To increase the rate of growth

11)

To improve cyclical and seasonal stability

STAGES OF A MERGER
1 ) COURTSHIP: 2 ) EVALUATION AND NEGOTIATION: 3 ) PLANNING: 4 ) THE IMMEDIATE TRANSITION: 5 ) THE TRANSITION PERIOD : DISADVANTAGES OF MERGERS
1 ) All liabilities assumed (including potential litigation)
2 ) Two thirds of shareholders (most states) of both firms must approve
3 ) Dissenting shareholders can sue to receive their fair value
4 ) Management cooperation needed

5 ) Individual transfer of assets may be costly in legal fees

6 ) Integration difficult without 100% of shares
7 ) Resistance can raise price
8 ) Minority holdouts
9 ) Technology costs - costs of modifying individual organizations systems etc.
10)

Process and organizational change issues every organization has its own culture

and business processes

11)

Human Issues Staff feeling insecure and uncertain.

12)

A very high failure rate (close to 50%).

WHY MERGERS DO NOT SUCCEED?

Despite the popularity and importance of mergers and among large and small firms, many
mergers do not produce the benefits that are expected or desired by the buying firm. Some of the
reasons could be:

1) High cost of financing

A study conducted by McKinney shows that 60% of the acquisitions examined failed to earn
returns greater than the annual cost of capital required to finance the acquisitions.
2 ) The potential for managerial hubris

This may preclude an adequate analysis of the target firm or may produce substantial
premiums paid for the firm that is acquired. In such a case the mergers may not be for the
benefit of the company. An e.g. is Sonys $5 billion takeover of Columbia Studios in which
Walter Yetnikoff, the CEO of Sony paid almost $800 million to acquire two producers from
their contract at the Warner Bros. This was a part of the battle with the Warner Bros CEO,
Steven Ross. Yetnikoff convinced his superiors at Sony that the producers would earn
millions of $ for them. Unfortunately both of them set records for underachievement.

3) Failure to integrate
Diverse cultures, structures and operating systems of the two firms.
4 ) Failure to do proper due diligence
During the pre-merger or acquisition stage.

5) Bankruptcy of strategy
There is a strong belief that mergers and acquisitions indicate a bankruptcy of strategy, an
inability to innovate. CEOs in order to defend their merger plans are often quoted saying
Only the biggest survive. This rationale is largely spacious; size does not inoculate a
company from rule-busting innovation. Thus lack of innovation is another reason for mergers
floundering.
6 ) Employees of the organization
1 ) The sought-after benefits of greater size and efficiency are nullified by increased losses
related to top-heavy organizations which mean that the people increase as a result the benefits
etc provided to the top management also substantially increase.
2 ) There are problems of: reduced job security, increased workloads, anxiety and stress all of
which have a negative effect on the morale of the employees which in turn affects their
productivity.

3 ) If the employees and the culture of the companies are not integrated then this can be a major
reason for the failure of the merger and acquisition

HR ISSUES IN MERGERS & ACQUISITIONS

People issues like staffing decision, organizational design, etc., are most sensitive issues in
case of M&A negotiations, but it has been found that these issues are often being overlooked.

Before the new organization is formed, goals are established, efficiencies projected
and opportunities appraised as staff, technology, products, services and know-how
are combined.

But what happens to the employees of the two companies? How will they adjust to
the new corporate environment? Will some choose to leave?

When a merger is announced, company employees become concerned about job

security and rumors start flying creating an atmosphere of confusion, and
uncertainty about change.

Roles, behaviors and attitudes of managers affect employees' adjustment to M&A.

Multiple waves of anxiety and culture clashes are most common causes of merger
failure.
CONCLUSION
Corporate restructuring refers to changes in ownership, business mix, assets mix and
alliances with a motive to increase the value of shareholders. The economic
considerations in terms of motives and effect of business combinations are similar but
the legal procedures involved are different. A merger refers to a combination of two or
more companies into one company. One or more companies may merge with an
existing company or they may merge to form a new company. Mergers may be of three
types (i) horizontal, (ii) vertical and (iii) conglomerate merger. The advantages of
merger are economics of scale, synergy, strategic benefits, tax benefits and utilization

of surplus funds. The process of financial evaluation begins with determining the value
of the target firm. The different approaches may be undertaken to assess the value of
the target firm namely valuation based on assets, earnings, dividend, cash flows etc.
After the value of a firm has been determined the next step is the choice of the method
of payment to the acquired firm. The payment take the form of either cash or securities
i.e., ordinary shares, convertible securities, deferred payment plans and tender offers.