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MERGER AND ACQUISITION: CONCEPTUAL FRAMEWORK
The present chapter discusses the conceptual framework of mergers and acquisitions. It focuses on demarcations between various terms like mergers, acquisitions, takeovers, consolidations, reverse mergers, management buyouts etc. The concept of demerger is also introduced. Various Indian laws and statutes having a bearing on merger process have been outlined and trends traced. Few other related procedural issues are also covered. “The decision to invest in a new asset would mean internal expansion for the firm. The new asset would generate returns raising the value of the corporation. Mergers offer an additional means of expansion, which is external, i.e. the productive operation is not within the corporation itself. For firms with limited investment opportunities, mergers can provide new areas for expansion. In addition to this benefit, the combination of two or more firms can offer several other advantages to each of the corporations such as operating economies, risk reduction and tax advantage1.” Today mergers, acquisitions and other types of strategic alliances are on the agenda of most industrial groups intending to have an edge over competitors. Stress is now being made on the larger and bigger conglomerates to avail the economies of scale and diversification. Different companies in India are expanding by merger etc. In fact, there has emerged a phenomenon called merger wave. The terms merger, amalgamations, take-over and acquisitions are often used interchangeably to refer to a situation where two or more firms come together and combine into one to avail the benefits of such combinations and re-structuring in the form of merger etc., have been attempted to face the challenge of increasing competition and to achieve synergy in business operations. 1.1 Corporate Restructuring Restructuring of business is an integral part of the new economic paradigm. As controls and restrictions give way to competition and free trade, restructuring and reorganization become essential. Restructuring usually involves major organizational change such as shift in corporate strategies to meet increased competition or changed market conditions.
Schall, L.D. and Hally C.W., Introduction to financial Management, McGraw Hill Book Company, New York, P.682.
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This activity can take place internally in the form of new investments in plant and machinery, research and development at product and process levels. It can also take place externally through mergers and acquisitions (M&A) by which a firm may acquire another firm or by which joint venture with other firms. This restructuring process has been mergers, acquisitions, takeovers, collaborations, consolidation, diversification etc. Domestic firms have taken steps to consolidate their position to face increasing competitive pressures and MNC’s have taken this opportunity to enter Indian corporate sector. The different forms of corporate restructuring are summarized as follows: Corporate Restructuring
Expansion • Amalgamation • Absorption • Tender offer • Asset acquisition • Joint Venture
Contraction • Demerger + Spin off + Equity carve out + Split off + Split up + Divestitures • Asset value
Corporate Control • Going Private • Equity Buyback • Anti Takeover • Leveraged Buyouts
• Amalgamation: This involves fusion of one or more companies where the companies lose their individual identity and a new company comes into existence to take over the business of companies being liquidated. The merger of Brooke Bond India Ltd. And Lipton India Ltd. Resulted in formation of a new company Brooke Bond Lipton India Ltd. Absorption: This involves fusion of a small company with a large company where the smaller company ceases to exist after the merger. The merger of Tata Oil Mills Ltd. (TOMCO) with Hindustan Lever Ltd. (HLL) is an example of absorption. Tender offer: This involves making a public offer for acquiring the shares of a target company with a view to acquire management control in that company. Takeover by Tata Tea of consolidated coffee Ltd. (CCL) is an example of tender offer where more than 50% of shareholders of CCL sold their holding to Tata Tea at the offered price which was more than the investment price. Mergers & Acquisitions
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Asset acquisition: This involves buying assets of another company. The assets may be tangible assets like manufacturing units or intangible like brands. Hindustan lever limited buying brands of Lakme is an example of asset acquisition. Joint venture: This involves two companies coming whose ownership is changed. DCM group and DAEWOO MOTORS entered into a joint venture to form DAEWOO Ltd. to manufacturing automobiles in India.
There are generally the following types of DEMERGER: Spinoff: This type of demerger involves division of company into wholly owned subsidiary of parent company by distribution of all its shares of subsidiary company on Pro-rata basis. By this way, both the companies i.e. holding as well as subsidiary company exist and carry on business. For example Kotak, Mahindra finance Ltd. formed a subsidiary called Kotak Mahindra Capital Corporation, by spinning off its investment banking division. Split ups: This type of demerger involves the division of parent company into two or more separate companies where parent company ceases to exist after the demerger. Equity carve out: This is similar to spin offs, except that same part of shareholding of this subsidiary company is offered to public through a public issue and the parent company continues to enjoy control over the subsidiary company by holding controlling interest in it. Divestitures: These are sale of segment of a company for cash or for securities to an outside party. Divestitures, involve some kind of contraction. It is based on the principle if “anergy” which says 5-3=3! • Asset sale: This involves sale of tangible or intangible assets of a company to generate cash. A partial sell off, also called slump sale, involves the sale of a business unit or plant of one firm to another. It is the mirror image of a purchase of a business unit or plant. From the seller’s perspective, it is a form of contraction: from the buyer’s point of view it is a form of expansion. For example, When Coromandal Fertilizers Limited sold its cement division to India Cement limited, the size of Coromandal Fertilizers contracted whereas the size of India Cements Limited expanded.
Corporate controls • Going private: This involves converting a listed company into a private company by buying back all the outstanding shares from the markets. Several companies like Castrol India and Phillips India have done this in recent years. A well known example from the U.S. is that of Levi Strauss & company. Mergers & Acquisitions
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Leveraged buyouts: This involves raising of capital from the market or institutions by the management to acquire a company on the strength of its assets.A. and (ii) Amalgamation in the nature of purchase. Generally the company which survives is the buyers which retiring its identity and seller company is extinguished2. This results in reduction in the equity capital of the company. As a result. Anti takeover defenses: With a high value of hostile takeover activity in recent years.• Equity buyback: This involves the company buying its own shares back from the market. • • Merger is a marriage between two companies of roughly same size. AS-14. 1967) Mergers & Acquisitions Page 4 of 93 . In case of amalgamation a new company may came into existence or an old company may survive while amalgamating company may lose its existence. According to Halsbury’s law of England amalgamation is the blending of two or more existing companies into one undertaking. the shareholder of each blending companies becoming substantially the shareholders of company which will carry on blended undertaking. takeover and Amalgamations (London: Sweet and Maxwell Publishers. issued by the Institute of Chartered Accountants of India has defined the term amalgamation by classifying (i) Amalgamation in the nature of merger. It is a legal process by which two or more companies are to be absorbed or blended with another. 2 M. This strengthens the promoter’s position by increasing his stake in the equity of the company. takeover defenses both premature and reactive have been restored to by the companies. There may be amalgamation by transfer of one or more undertaking to a new company or transfer of one or more undertaking to an existing company. It is thus a combination of two or more companies in which one company survives in its own name and the other ceases to exist as a legal entity. The Accounting Standard. the amalgamating company loses its existence and its shareholders become shareholders of new company or the amalgamated company. The survivor company acquires assets and liabilities of merged companies. Amalgamation Amalgamation is an arrangement or reconstruction.Weinberg. Amalgamation signifies the transfers of all are some part of assets and liabilities of one or more than one existing company or two or more companies to a new company.
except that cash may be paid in respect of any fractional shares. after the amalgamation. 2. • • • Amalgamation in the nature of merger is an organic unification of two or more entities or undertaking or fusion of one with another. Amalgamation in the nature of purchase: Amalgamation in the nature of purchase is where one company’s assets and liabilities are taken over by another and lump sum is paid by the latter to the former. It is defined as an amalgamation which satisfies the above conditions3.1. The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity share in the transferee company. by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation. the assets and liabilities of the other company. 2. The business of the transferor company is intended to be carried on.2 (1B) with the following three conditions to be satisfied. immediately before the amalgamation. • • Amalgamation in the nature of merger: As per AS-14. Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein. As per Income Tax Act 1961. No adjustment is intended to be made in the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies. an amalgamation is called in the nature of merger if it satisfies all the following condition: All the assets and liabilities of the transferor company should become. after amalgamation. Mergers & Acquisitions Page 5 of 93 . All the properties of amalgamating company(s) should vest with the amalgamated company after amalgamation. It is defined as the one which does not satisfy any one or more of the conditions satisfied above. 1. All the liabilities of the amalgamating company(s) should vest with the amalgamated company after amalgamation. by the transferee company. merger is defined as amalgamation under sec.
Hindustan Instruments Ltd. In a consolidation. to the existing shareholders of that company. An example of this type of merger is the absorption of Tata Fertilisers Ltd. separate legal entity. c) By purchasing shares of the other company at a stock exchange. but there may be change in control of companies.2. to an entirely new company called HCL Ltd. and Indian Reprographics Ltd. • • Merger through absorption Merger through consolidation Absorption An absorption is a combination of two or more companies into an existing company. liabilities and shares to TCL. and d) By making an offer to buy the shares of other company. all companies are legally dissolved and a new entity is created. an acquired company ( a seller). 1. Laws in India use the term amalgamation for merger. liabilities and shares to the acquiring company for cash or exchange of shares. exchange of shares with 90%of shareholders of amalgamating company is required.. an acquiring company (a buyer). By entering into an agreement with a person or persons holding b) By subscribing new shares being issued by the other company.1 Merger Merger refers to a situation when two or more existing firms combine together and form a new entity. Shareholders holding not less than 75% in value or voting power in amalgamating company(s) should become shareholders of amalgamated companies after amalgamation Amalgamation does not mean acquisition of a company by purchasing its property and resulting in its winding up. An example of consolidation is the merger of Hindustan Computers Ltd. the acquired company transfers its assets. According to Income tax Act. 1. Either a new company may be incorporated for this purpose or one existing company (generally a bigger one) survives and another existing company (which is smaller) is merged into it. TFL transferred its assets. survived after merger while TFL.2 Acquisition Acquisition refers to the acquiring of ownership right in the property and asset without any combination of companies. ceased to exist. Mergers & Acquisitions Page 6 of 93 .3..(TFL) TCL. Acquisition results when one company purchase the controlling interest in the share capital of another existing company in any of the following ways: a) controlling interest in the other company. All companies except one lose their identity in a merger through absorption. Consolidation A consolidation is a combination of two or more companies into a new company .In this type of merger. Thus in acquisition two or more companies may remain independent..
Mergers & Acquisitions Page 7 of 93 . 3. usually by buying all or majority of shares. individual. By Gujarat Ambuja Cement Ltd. Sridharan and P. This is accomplished by an order of Board for Industrial and financial Reconstruction (BIFR) under the provision of Sick Industrial companies Act. 2. N. 4. R. These mergers are motivated and the lead bank takes the initiated and decides terms and conditions of merger. 1. by one company of controlling interest of the other. In India.2 Takeover Acquisition can be undertaken through merger or takeover route. Board for Industrial and Financial reconstruction (BIFR) has also been active for arranging mergers of financially sick companies with other companies under the package of rehabilitation. Takeover is acquisition. The second type of takeover is where ownership of company is captured to merge both companies into one and operate as single legal entity. A third type of takeover is takeover of a sick company for its revival. 1997 issued by SEBI which regulate the bail out takeover. A Takeover may be defined as series of transacting whereby a person. the target firm and the acquiring firm. The fourth kind is the bail-out takeover. either directly by becoming owner of those assets or indirectly by obtaining control of management of the company4.2. H. The recent takeover of Modi Cements Ltd. group of individuals or a company acquires control over the assets of a company. These merger schemes are framed in consultation with the lead bank. 1992). Takeover may be of different types depending upon the purpose of acquiring a company. 1985. Arvind Pandian . was an arranged takeover after the financial reconstruction Modi Cement Ltd. 1.3 . A takeover may be straight takeover which is accomplished by the management of the taking over company by acquiring shares of another company with the intention of operating taken over as an independent legal entity. which is substantial acquisition of shares in a financial weak company not being a sick industrial company in pursuance to a scheme of rehabilitation approved by public financial institution which is responsible for ensuring compliance with provision of substantial acquisition of shares and takeover Regulations. Takeover is a general term used to define acquisitions only and both terms are used interchangeably. Guide to Takeover and Mergers (Nagpur: Wadhwa and co.
M.A. Weinberg, op, cit, pp3 3, 4
Takeover Bid This is a technique for affecting either a takeover or an amalgamation. It may be defined as an offer to acquire shares of a company, whose shares are not closely held, addressed to the general body of shareholders with a view to obtaining at least sufficient shares to give the offer or, voting control of the company. Takeover Bid is thus adopted by company for taking over the control and management affairs of listed company by acquiring its controlling interest. While a takeover bid is used for affecting a takeover, it is frequently against the wishes of the management of Offeree Company. It may take the form of an offer to purchase shares for cash or for share for share exchange or a combination of these two firms. Where a takeover bid is used for effecting merger or amalgamation it is generally by consent of management of both companies. It always takes place in the form of share for share exchange offer, so that accepting shareholders of Offree Company become shareholders of Offeror Company. Types of Takeover Bid There are three types of takeover bid 1. Negotiated bid 2. Tender offer 3. Hostile takeover bid Negotiated bid: It is also called friendly merger. In this case, the management /owners of both the firms sit together and negotiate for the takeover. The acquiring firm negotiates directly with the management of the target company. So the two firms reach an agreement, the proposal for merger may be placed before the shareholders of the two companies. However, if the parties do not reach at an agreement, the merger proposal stands terminated and dropped out. The merger of ITC Classic Ltd. with ICICI Ltd.; and merger of Tata oil mills Ltd. With Hindustan Lever Ltd. were negotiated mergrs. However, if the management of the target firm is not agreeable to the merger proposal, then the acquiring firm may go for other procedures i.e. tender offer or hostile takeover. Tender offer: A tender offer is a bid to acquire controlling interest in a target company by the acquiring firm by purchasing shares of the target firm at a fixed price. The acquiring firm approaches the shareholders of the target firm directly firm to sell their shareholding to the acquiring firm at a fixed price. This offered price is generally, kept at a level higher than the current market price in order to induce the shareholders to disinvest their holding in favor of the acquiring firm. The acquiring firm may also stipulate in the tender offer as to how many shares it is willing to buy or may purchase all the shares that are offered for sale. Mergers & Acquisitions
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In case of tender offer, the acquiring firm does not need the prior approval of the management of the target firm. The offer is kept open for a specific period within which the shares must be tendered for sale by the shareholders of the target firm. Consolidated Coffee Ltd. was takeover by Tata Tea Ltd.by making a tender offer to the shareholders of the former at a price which was higher than the prevailing market price. In India, in recent times, particularly after the announcement of new takeover code by SEBI, several companies have made tender offers to acquire the target firm. A popular case is the tender offer made by Sterlite Ltd. and then counter offer by Alean to acquire the control of Indian Aluminium Ltd. Hostile Takeover Bid: The acquiring firm, without the knowledge and consent of the management of the target firm, may unilaterally pursue the efforts to gain a controlling interest in the target firm, by purchasing shares of the later firm at the stock exchanges. Such case of merger/acquisition is popularity known as ‘raid’. The caparo group of the U.K. made a hostile takeover bid to takeover DCM Ltd. and Escorts Ltd. Similarly, some other NRI’s have also made hostile bid to takeover some other Indian companies. The new takeover code, as announced by SEBI deals with the hostile bids. Takeover and merger “The distinction between a takeover and merger is that in a takeover the direct or indirect control over the assets of the acquired company passes to the acquirer in a merger the shareholding in the combined enterprises will be spread between the shareholders of the two companies”. In both cases of takeover and merger the interests of the shareholders of the company are as follows: 1. Company should takeover or merge with another company only if in doing so, it improves its profit earning potential measured by earning per share and 2. The company should agree to be taken if, and only if, shareholders are likely to be better off with the consideration offered, whether cash or securities of the company than by retaining their shares in the original company. 1.3 Merger through BIFR5 The companies (Amendment) Act, 2001 has repealed the sick Industrial Companies Act (SICA) 1985, in order to bring sick industrial companies within the purview of companies Act 1956 from the jurisdiction of SICA, 1985. The Act has introduced new provisions for the constitution of a tribunal known as the National Company Law Tribunal with regional benches which are empowered with the powers earlier vested with the Board for Industrial and Financial reconstruction (BIFR).
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Board for Industrial and Financial Reconstruction was established by central government under SICA, 1985 for detection of sick and potentially sick industrial units and speedy determination pf their remedial measures and to exercise the jurisdiction and powers and discharge the functioning and duties imposed on the Board by or under the Act. Before the evolution of SICA, the power to sanction the scheme of amalgamation was vested only with the high court. However, sec.18 of the SICA 1985 empowers the BIFR to sanction a scheme of amalgamation between sick industrial company and another company over and above the power of high court as per section 391-394 of companies Act, 1956. The amalgamation take place under SICA have a special place in law and are not bound by the rigour of companies Act, 1956, and Income Tax Act,1961. There is no need to comply with the provisions of sec.391-394 of companies Act,1956 for amalgamation sanctioned by BIFR. The scheme of amalgamation however must be approved by shareholders of healthy company after getting approval from BIFR. Sec.72A of the Income Tax Act has been enacted with a view to providing incentives to healthy companies to takeover and amalgamation with companies which would otherwise become burden on the economy. The accumulated losses and unabsorbed depreciation of the amalgamating company is deemed to loss or allowance for depreciation of the amalgamated company. So amalgamated company gets the advantage of unabsorbed depreciation and accumulated loss on the precondition of satisfactory revival of sick unit. A certificate from specialized authority to the effect that adequate steps have been taken for rehabilitation or revival of sick industrial undertaking has to be obtained to get these benefits. Thus the main attraction for the healthy company to takeover a sick company through a scheme of amalgamation is the tax benefits that may be available to it consequent to amalgamation. The approach usually followed is to quantify the possible tax benefits first and then get an order as part of rehabilitation package from BIFR. Once BIFR is convinced about the rehabilitation benefit it passes an appropriate order to see that benefits of tax concessions properly ensure to the transferee isolation Section 18 of SICA provides for various measures to be recommended by the operating agency in the scheme to be prepared by it for submission to the BIFR concerning the sick industrial unit. Before the amendment, in 1994 under SICA, only normal amalgamation (of sick company with healthy one) was possible and the Act did not provide for reverse merger of a profitable company with sick company. Now the amended Sec.18 of the Act contains provision for effecting both normal and reverse merger. It provides for the amalgamation of • • Sick industrial company with any other company Any other company with the sick industrial company6.
1.4 Types of Merger There are four types of merger are as follows:
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Vertical merger provides a way for total integration to those firms which are striving for owning of all phases of the production schedule together with the marketing network (i. the top management of the company being meted is generally. from the acquisition of raw material to the relating of final products). was a horizontal merger. As horizontal takeovers and mergers involve a reduction in the number of competing firms in an industry. “A takeover of merger is vertical where one of two companies is an actual or potential supplier of goods or services to the other. they tend to create the greatest concern from an anti-monopoly point of view. Horizontal mergers are designed to produce substantial economies of scale and result in decrease in the number of competitors in the industry. the great majority of takeover and mergers have been horizontal. on the other hand horizontal mergers and takeovers are likely to give the greatest scope for economies of scale and elimination of duplicate facilities. If a company takes over its supplier/producers of raw material.. In recent years. with the Hindustan lever Ltd. Forward integration may result if a company decides to take over the retailer or Customer Company. On the other hand. In case of horizontal merger. Weinberg and Blank7 define horizontal merger as follows: “A takeover or merger is horizontal if it involves the joining together of two companies which are producing essentially the same products or services or products or services which compete directly with each other (for example sugar and artificial sweetness).” 2. then it may result in backward integration of its activities. It is a merger with a direct competitor and hence expands as the firm’s operations in the same industry. replaced.e. Vertical merger may result in many operating and financial economies. Horizontal merger: It is a merger of two or more companies that compete in the same industry. The merger of Tata Oil Mills Ltd. Vertical merger: It is a merger which takes place upon the combination of two companies which are operating in the same industry but at different stages of production or distribution system. One potential repercussion of the horizontal merger is that it may result in monopolies and restrict the trade. by the management of the transferee company.1. so that the two companies are both engaged in the manufacture or provision of the same goods or services but at the different stages in the supply route (for example where a motor car manufacturer takes over a manufacturer of sheet metal or a car distributing firm). The transferee firm will get a stronger position in the market as its production/distribution chain will be more integrated than that of the competitors. Here the object is usually to Mergers & Acquisitions Page 11 of 93 .
and associated Glass Ltd. is a Product extension merger and merger between GMM Company Ltd.H.e. In a pure conglomerate. there is some degree of overlap in one or more of this common factors. Mergers & Acquisitions Page 12 of 93 .A. research and development and technology. Conglomerate merger: These mergers involve firms engaged in unrelated type of business activities i. The potential benefit from these mergers is high because these transactions offer opportunities to diversify around a common case of strategic resources8. however. merger between Hindustan Sanitary ware industries Ltd. mergers the acquirer and target companies are related through basic technologies. These mergers represent an outward movement by the acquiring company from its current set of business to adjoining business.. vertical and conglomerate merger.pp. Both these types bear some common elements of horizontal. The acquired company represents an extension of product line.Guide to takeovers and mergers (Nagpur: wadhwa and co. Western and Mansinghka9 classified cogeneric mergers into product extension and market extension types. Arvind Pandian . nor vertically( in the sense of standing towards each other n the relationship of buyer and supplier or potential buyer and supplier). 4. where. sridharan and P.10 Conglomerate mergers are unification of different kinds of businesses under one flagship company. Para 167. marketing. The purpose of merger remains utilization of financial resources. cit.ensure a source of supply or an outlet for products or services.” 3. it defined as product extension merger. When a new product line allied to or complimentary to an existing product line is added to existing product line through merger. Weinberg and M V Blank. Similarly market extension merger help to add a new market either through same line of business or adding an allied field . contains elements of both product extension and market extension merger. there are no important common factors between the companies in production. and Xpro Ltd. The acquiring company derives benefits by exploitation of strategic resources and from entry into a related market having higher return than it enjoyed earlier. In practice. anti-monopoly problems may arise. For example. Co generic Merger: In these. but the effect of the merger may be to improve efficiency through improving the flow of production and 6 N.R. production processes or markets. however there is a degree of concentration in the markets of either of the companies.1992) 7 M. the business of two companies are not related to each other horizontally ( in the sense of producing the same or competing products). op.5 Reducing stock holding and handling costs. market participants or technologies of the acquiring companies.
Demerger or spin-off. wastage and competition. As the same suggests. 1961 means the company whose undertaking is transferred. so demerger of ASE was done. business interest and longevity and to curb losses. “Tests of efficiency performance of enlarged debt capacity and also synergy of managerial functions. DCM shriram industries Ltd.) is one example of family units splitting through demergers. more in the nature of family settlements and are affected through the courts order. the desire to perform better and strengthen efficiency. pursuant to a demerger to a resulting company. Demerged Company.e. Rather. It does not have direct impact on acquisition of monopoly power and is thus favored through out the world as a means of diversification. This occurs in cases where dissimilar business are carried on within the same company.. Mergers & Acquisitions Page 13 of 93 . Shriram Industrial Enterprise Ltd. The historical demerger of DCM group where it split into four companies (DCM Ltd. E Kotlarchuk and H Singh. it denotes a situation opposite to that of merger. according to Section (19AA) of Income Tax Act. technologies. the focus of such conglomerate mergers is on how the acquiring firm can improve its overall stability and use resources in a better way to generate additional revenue. Masinghka. J. Undertakings demerge to delineate businesses and fix responsibility. liability and management so as to ensure improved results from each of the demerged unit. synergies or product market strategies. However these transactions are not explicitly aimed at sharing these resources. “Corporate Acquisitions: A strategic perspective in the management Acquisition”. in some cases.S. with Ambalal Sarabhai enterprises Ltd. Such demergers are accordingly.8 P. Corporate restructuring in such situation in the form of demerger becomes inevitable. western and K.. restructuring in the form of demerger was undertaken for splitting up the family owned large business empires into smaller companies. Thus. (ASE) has made ASE big conglomerate which had become unwieldy and cyclic. as called in US involves splitting up of conglomerate (multi-division) of company into separate companies.5 Demerger It has been defined as a split or division. 9 F.Lorange. A part from core competencies being main reason for demerging companies according to their nature of business. 1. demerger also occur due to reasons almost the same as mergers i. thus becoming unwieldy and cyclical almost resulting in a loss situation. and DCM shriram consolidated Ltd. Merger of SG chemical and Dyes Ltd.
copies of all notices. cit.1961 means one 10 M. or more company.Resulting company. Application to the National Company Law Tribunal (NCLT): Once the draft of amalgamation proposal is approved by the respective boards. each company should make an application to the NCLT so that it can convene the meetings of shareholders and creditors for passing the amalgamation proposal. 1956 contain the provisions for amalgamations. Sections 391 to 394 of the companies act.Blank op.A. a notice and an explanatory statement of the Mergers & Acquisitions Page 14 of 93 . boards of directors and Company Law Board are required.If such clauses do not exists. 5. and orders should be mailed to the concerned stock exchanges. the object clause of the amalgamated company (transferee company) should permit it to carry on the business of the amalgamating company (transferor company ) . 3. Weinberg. necessary approvals of the shareholders. Further. From time to time. The procedure for amalgamation normally involves the following steps: 1. resolutions. (including a wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger. Intimation to stock Exchanges: The stock exchanges where the amalgamated and amalgamating companies are listed should be informed about the amalgamation proposal. While evaluating a merger proposal. Approval of the draft amalgamation proposal by the Respective Boards: The draft amalgamation proposal should be approved by the respective boards of directors. Para 107. constituted or formed as a result of demerger.V. 1. Examination of object Clauses: The memorandum of association of both the companies should be examined to check if the power to amalgamate is available. The board of each company should pass a resolution authorizing its directors/executives to pursue the matter further. 4. involving fairly complex legal considerations. and the resulting company in consideration of such transfer of undertaking issues shares to the shareholders of the demerged company and include any authority or body or local authority or public sector company or a company established. Dispatch of notice to shareholders and creditors: In order to convene the meeting of shareholders and creditors. pp 5 . 2.6 Merger Procedure: A merger is a complicated transaction. according to Section2(47A) of Income Tax Act. and M. one should bear in mind the following legal provisions.
An affidavit confirming that the notice has been dispatched to the shareholders/creditors and that the same has been published in newspapers should be filed with the NCLT. who vote either in person or by proxy. in a separate meeting. the NCLT is empowered to modify the scheme and pass orders accordingly. the creditors of the company must approve of the amalgamation scheme. Particulars about transferor and transferee companies Mergers & Acquisitions Page 15 of 93 . must approve the scheme of amalgamation. The new shares and debentures so issued will then be listed on the stock exchange.6.1 Scheme of merger The scheme of any arrangement or proposal for a merger is the heart of the process and has to be drafted with care. A notice about the same has to be published in two newspapers. It is designed to suit the terms and conditions relevant to the proposal but it should generally contain the following information as per the requirements of sec. Transfer of Assets and Liabilities: After the final orders have been passed by the NCLT. 394 of the companies Act. Holding of Meetings of shareholders and creditors: A meeting of shareholders should be held by each company for passing the scheme of amalgamation. 6. The NCLT will fix a date of hearing. 9. Petition to the NCLT for confirmation and passing of NCLT orders: Once the amalgamation scheme is passed by the shareholders and creditors. as approved by the NCLT. After hearing the parties the parties concerned ascertaining that the amalgamation scheme is fair and reasonable. Filing the order with the Registrar: Certified true copies of the NCLT order must be filed with the Registrar of Companies within the time limit specified by the NCLT. At least 75 percent (in value) of shareholders in each class. should be dispatched by each company to its shareholders and creditors so that they get 21 days advance intimation. There is no specific form prescribed for the scheme. after fulfilling the provisions of the law. 1956: 1. with effect from the appointed date. Likewise. Issue of shares and debentures: The amalgamated company. the companies involved in the amalgamation should present a petition to the NCLT for confirming the scheme of amalgamation. However. should issue shares and debentures of the amalgamated company. 8. Important elements of merger procedure are: 1. 10. 7. The notice of the meetings should also be published in two newspapers (one English and one vernacular). the NCLT will pass an order sanctioning the same. have to be transferred to the amalgamated company.meeting. all the assets and liabilities of the amalgamating company will.
Description of power of delegates of Transferee Company to give effect to the scheme. Terms of transfer of assets and liabilities from transferor company to transferee company 4. Qualifications attached to the scheme which requires approval of different agencies. Treatment of expenses connected with the scheme. 16. employees and status of provident fund. Treatment of specified properties or rights of transferor company 6. Gratuity fund. 12. appointed date of merger 3. contingent and other accounting entries requiring special treatment. 8. 1956 to their respective High court. Enhancement of borrowing limits of transferee company when scheme coming into effect. Proposed share exchange ratio. Mergers & Acquisitions Page 16 of 93 . Terms and conditions of carrying business by transferor company between appointed date and effective date 7. 17. any condition attached thereto and the fractional share certificate to be issued. 14. superannuation fund or any other special funds created for the purpose of employees. 15. Issue of shares by transferee company 10. issued. 13. 9. 11. Transferor company’s staff. Effect of non receipt of approvals/sanctions etc. workmen. Commitment of transferor and Transferee Company towards making an application U/S 394 and other applicable provisions of companies Act. Miscellaneous provisions covering Income Tax dues. Effective date when scheme will came into effect 5. Transferor and transferee companies consent to make changes in the scheme as ordered by the court or other authorities under law and exercising the powers on behalf of the companies by their respective boards.2. Share capital of Transferor Company and Transferee Company specifying authorized. subscribed and paid up capital.
The NAV. it is the future maintainable profits that have to be considered. Broadly there are three(3) methods used for valuation of business: 1. This figure divided by Mergers & Acquisitions Page 17 of 93 . Valuation of both companies subject to business combination is required for fixing the consideration amount to be paid in the form of exchange of share. These net profits are divided by appropriate capitalization rate to get true value of business. there may be same modifications in this method and fixed assets may be taken at current realizable value (especially investments. Earnings of the company for the next two years are projected (by valuation experts) and simple or weighted average of these profits is computed.6. All assets (value by appropriation method all liabilities .preference shares) NAV = Fully diluted equity shares 2.1. Net Value Asset (NAV) Method NAV is the sum total of value of asserts (fixed assets. However. Such valuation helps in determining the value of shares of acquired company as well as acquiring company to safeguard the interest of shareholders of both the companies. Valuation is the means to assess the worth of a company which is subject to merger or takeover so that consideration amount can be quantified and the price of one company for other can be fixed. arrears of depreciation etc. real estate etc. so arrived at. current assets. investment on the date of Balance sheet less all debts. Fixation of the value of different types of equity shares. borrowing and liabilities including both current and likely contingent liability and preference share capital). Yield Value Method This method also called profit earning capacity method is based on the assessment of future maintainable earnings of the business.) replacement cost (plant and machinery) or scrap value (obsolete machinery). is divided by fully diluted equity (after considering equity increases on account of warrant conversion etc. Deductions will have to be made for arrears of preference dividend. Valuation of assets 2.2 Valuation in a merger: Determination of share exchange ratio An important aspect of merger procedure relates to valuation of business relates to valuation of business in order to determine share exchange ratio in merger. While the past financial performance serves as guide. Ascertainment of liabilities 3. The three steps necessary for valuing share are: 1.) to get NAV per share.
The gearing of an ordinary share is the ratio of borrowings to equity capital. Hindustan Lever Ltd. The fact that the dividend of one company is better covered than the other is a factor which has to be compensated to same extent. The relative growth prospects of the two companies. 3. stock valuation etc. Also.. (1995)51 as under. is basically an exercise in valuation of shares of two or more of amalgamating company. Profits of both companies’ should be determined after ensuring that similar policies are used in various areas like depreciation. While determining capitalization rate. how many shares of amalgamating company. Market Value Method This method is applicable only in case where share of companies are listed on a recognized stock exchange. 2. It is often difficult to induce a shareholder to agree to a merger if it involves a reduction in his dividend income. past or future profits need to be adjusted for extra ordinary income or loss not likely to recur in future. the determination of share exchange ratio i. Employees union vs. Thus. 6. The cover.equity value gives value per share. 1. The value of net assets of the two companies. These relevant factors has been enumerated by Gujarat High court in Bihari Mills Ltd. The average of high or low values and closing prices over a specified previous period is taken to be representative value per share.e. Mergers & Acquisitions Page 18 of 93 . The relative gearing of the shares of the two companies. due regard has to be given to inherent risk attribute to each business. 3. The problem of valuation has been dealt with by Weinberg and Blank (1971)49 by giving the relevant factors to be taken into account while determining the final share exchange ratio. While determining operating profits of the business. 4. 7. (ratio of after tax earnings to divided paid during the year) for the present dividends of the two companies. The stock exchange prices of the shares of the companies before the commencement of negotiations or the announcement of the bid. and also summarized by the Apex court in the case of Hindustan Levers. The dividends presently paid on the shares of two companies. it must be valued on independent basis without considering benefits on account of merger. 5. a business with established brands and excellent track record of growth and diverse product portfolio will get a lower capitalization rate and consequently higher valuation where as a cyclical business or a business dependent on seasonal factors will get a higher capitalization rate. The voting strength in the company of shareholder of the two companies. Now. are to be exchanged for how many shares of amalgamated company.
if reasonable estimation of future profits and dividend is not possible due to wide fluctuations in profits and uncertain conditions. There are however. • • • • Valuation of shares on book value method is proper and valid mode of valuation of shares.A.. The past history of the prices of two companies.e. Ltd. Often share value cannot be finalized on basis of one parameter only. market value or on net worth basis. Kapoor Co. Mahadeo Jalan (1972) 86 ITR 621 (SC). G. According to Delhi High Court statement. Supreme Court has evolved the following guidelines and aspects which should be considered: • • Regard should be had to price of shares prevailing in stock market Profit earning capacity (yield method) or dividend declared by the company (dividend method) should be considered.8. it cannot be said. company incurring expenses disproportionate to the commercial venture.g. Weinberg and MV Blank. competition. abnormal expenses will be added back to calculate ‘yield’ (e. State of Assam. yield value. Qualitative factors like market fluctuations. pp 1084 ratio in case of amalgamations. break –up value. no rules framed specially for the working out of share exchange 49 51 M. Taxmann 2002. “The valuation of shares is a technical matter which requires considerable skills and expertise.K. possibly to reduce income tax liability) If lower dividend or profits are due to temporary reasons. vs. Para 67 pp5 Bihari Mills Ltd. Valuation can be done on basis of asset value. Law and practice) N.” In CWT vs.D. Majumdar and Dr. In computing yields. break up value method to determine what would be realized in winding up process should be considered. a golden mean should be found. If result of two methods differs. Mergers & Acquisitions Page 19 of 93 . Thus. (1985) cited here from A.Tinsukhia Electric Co. There are bound to be difference of opinion as to what the correct value of the shares of the company is. then estimate of share value before the set-back and proportionate fall in price of quoted shares of companies which have suffered similar reverses should be considered If company is ripe for winding up. final decision depends on judicious consideration of usual methods of valuation i. If it is possible to the value the shares in a manner difference from the one adopted in the given case. that the valuation agreed upon has been unfair. cit. op.K.
When a healthy company merges with a sick or a small company is called reverse merger. it gets advantage of setting off carry forward losses without any conditions. 1 per share and later GSL would be merged with 1 share of GGICL to be allotted to every shareholder of GSL. without following strict norms of listing of stock exchanges. In such cases. If Transferor Company merges with the sick transferee company. This may be for various reasons. One such approved in Shiva Texyarn Ltd.Government policy. 611. reschedule outside loans and also lower interest rate on term loans. All financial Institutions agreed to waive penal interest. The amalgamated company. reverse merger is done. 1. managerial skills are also relevant for the purpose-Sanghi industries Ltd. (with post-merger turnover of Rs. IFCI. Mergers & Acquisitions Page 20 of 93 .77 crores entered into scheme of reverse merger with loss making Gujarat Godrej innovative Chemicals Ltd. However in some cases. The post merger company. Godrej Soaps Ltd. In such case. it is provided that on date of merger.12 crores) restructured its gross profit of 49. (GGICL) (with pre merger turnover of Rs. it gets advantages of listed company.08 crores. this innovative merger which was by way of forward integration in the name of GGICL was completed with the help of financial institutions like IDBI.7 Reverse Merger Normally. Thus. many restrictions are applicable for allowing set off. higher turnover GSC’s pre-merger profits of Rs. 30 crores. b) The transferee company may be listed company. liquidate damages besides finding of interest.The scheme involved reduction of share capital of GGICL from Rs. Thus. Many times. name of Transferee Company will be changed to that of Transferor Company. if Transferor Company merges with the listed company. Thus. ICICI. a small company merges with large company or a sick company with healthy company. 10 per share to Re. (GSL) with pre merger turnover of 436. This capital reduction helps in unity of the accumulated losses and other assets which are not represented by the share capital of the company. a capital reduction aim rehabilitation scheme is an ideal antidote (by way of reverse merger) for sick company. reverse mergers are also accompanied by reduction in the unwieldy capital of the sick company. GGICL reverted back to the old name of amalgamating company. If sick company merges with healthy company. Godrej Soaps Ltd. 60 crores) in 1994. For example Godrej soaps Ltd. outside people even may not know that the transferor company with which they are dealing after merger is not the same as earlier one. Some reasons for reverse merger are: a) The transferee company is a sick company and has carry forward losses and Transferor Company is profit making company. UTI etc.
held by him) would entitle him to more than 5% shares or voting rights in a company. if any. Clause 40B of listing agreement will not apply. 2. as the case may be. 1997. Clauses 40A and 40B of the listing Agreement the company has entered into with stock exchange. 1997. 1997) may be enumerated as follows: i. The salient features of this new takeover code (Regulations.(a) in pursuance of a public issue. to the company which in turn. However. Mergers & Acquisitions Page 21 of 93 .8. SEBI (Substantial Acquisition of shares and takeover) Regulations 1997 Act. The objective of these regulations has been to provide an orderly framework within which substantial acquisitions and takeovers can take place. Takeover and Listing agreement exemption Clauses 40A and 40B of Listing Agreement Clause 40A deals with substantial acquisition of shares and requires the offeror and the offeree to inform the stock exchange when such acquisition results in an increase in the shareholding of the acquirer to more than 10%. the aggregate number of shares held by each such person. Clause 40B deals with takeover efforts. SEBI’s (Substantial Acquisition of shares and Takeover’s) Regulations. or (c) in any other manner not covered by (a) and (b) above. Any person. Any acquirer. On the basis of recommendations of the Committee. who holds more than 5% shares or voting rights in any company. 1997. the SEBI announced on Febuary20. 2.1 Laws applicable to Takeover 1. shall disclose the aggregate of his shareholding or voting rights in that company. to the company within four working days of the acquisition of shares or voting rights. shall within two months of notification of these Regulation disclose his aggregate shareholding in that company. or (b) by one or more transactions. who acquires shares or voting rights which (taken together with shares or voting rights. ii. There is no provision under clause 40B for exemption of non BIFR companies. A takeover offer refers to change in management where there is no change in management. the revised take over code as Securities and Exchange Board of India (Substantial Acquisitions of shares and Takeovers) Regulations.8 Laws statutes in India 1.1. 1. sub clause 13 of amendment of Clause 40B also provides an exemption to the scheme approved by BIFR. shall disclose to all the stock exchanges on which the shares of the company are listed.
(a) the negotiated price under the agreement . held by him or by persons acting in concert with him). unless such acquirer makes a public announcement to acquire shares of such company in accordance with the Regulations. (c) the price paid by the acquirer under a preferential allotment made to him. if any. additional shares or voting rights entitling him to exercise more than 2% of the voting rights. not less than 10% but not more than 25% of the shares or voting rights in a company. unless such acquirer makes a public announcement to acquire shares in accordance with the Regulations. The public offer shall be made to the shareholders of the target company to acquire from them an aggregate minimum of 20% of the voting capital of the company provided that acquisition of shares from each of the shareholders shall not be less than the minimum marketable lot or the entire holding if it is less than the marketable lot. the acquirer(s) who had made the public announcement (s) of the earlier offer(s). during the twelve-month period prior to the date of public announcement. Mergers & Acquisitions Page 22 of 93 . vii. of acquire shares or voting rights which (taken together with shares or voting rights. viii. at any time during the twelve month period up to the date of closure of the offer. Such offer shall be deemed to be a competitive bid. if any. the acquire must send a copy of the draft letter to the target company at its registered office address. for being placed before the Board of Directors and to all the stock exchanges where the shares of the company are listed. shall have the option iv. shall. Upon the public announcement of a competitive bid or bids. in any period of 12 months. ix. No public announcement for an offer or competitive bid shall be made during the offer period except during 21-day period from the public announcement of the first offer. who holds more than 10% shares or voting rights in any company. who is desirous of making any offer. make yearly disclosures to the company. No acquirer holding. (b) average price paid by the acquirer for acquisitions including by way of allotment in a public or rights issue. Within 14 days of the public announcement of the offer. No acquirer shall agree to acquire. vi. Every person. (d) the average of the weekly high and low of the closing prices of the shares of the target company during the 26 weeks proceeding the date of public announcement. entitle such acquirer to exercise 10% or more of the voting rights in a company. v. within 21 days from the end of the financial yea. in respect of his holdings as on 31st March each year. Any person other than the acquirer who had made the first public announcement. within 21 days of the public announcement of the first offer.iii. shall. The minimum offer price shall be the highest of. shall acquire. make a public announcement of his offer for acquisition of some or all of the shares of the same target company. x.
and (e) such circumstances as in the opinion of SEBI merits withdrawal. offer price. xv. the scheme prepared by a financial institutions may provide for acquisition of shares in the financially weak company in any of the following manner (a) outright purchase of shares. xiv. provided that the scheme as far as possible may ensure that after the proposed acquisition. Where the acquirer specifies a minimum level of acceptance and does not want to acquire a minimum 20%. the value of the Escrow Account shall be increased to equal to at least 25% of the consideration payable upon such revision. consequent upon a competitive bid or otherwise. the date of opening of the offer and the period for which the offer shall be kept open. The person acquiring shares from the promoters of the persons in. there is any upward revision of offer. No person shall make a competitive bid for acquisition of shares of the financially weak company once the lead institution has evaluated the bid and accepted the bid of the acquirer who has made the public announcement of offer acquisition of shares from the shareholders other than the promoters. the erstwhile promoters do not own any shares in case such acquisition is made by the new promoters pursuant to such scheme. 100 crores and 10% of the consideration thereafter. In case. shall be withdrawn except under the circumstances mentioned in this regulation. Mergers & Acquisitions Page 23 of 93 . No public offer. the specified date. Such public announcement shall contain relevant details about the offer including the information about the identity and background of the person acquiring shares. xi. being a natural person has died. Irrespective of whether or not there is competitive bid. (d) the sole acquirer. namely-(a) the withdrawals is consequent upon any competitive bid.to make an announcement revising the offer or withdrawing the offer with the approval of the SEBI. xvi. xii. (b) the offer did not receive the minimum level of acceptances.charge of the management of the affairs of the financially weak company or the financial institutions shall make a public announcement of his intention for acquisition of shares from the shareholders of the company. In case of a substantial acquisition of shares in financially weak company not being a sick industrial company. xiii. or (b) exchange of shares. the 50% of the consideration payable is to be deposited in Escrow Account. xvii. once made. number and percentages of shares proposed to be acquired. at any time up to 3 working days prior to the date of the closure of the offer. The acquirer shall deposit in an Escrow Account a sum equivalent to at least 25% of the total consideration payable under the offer up to Rs. to which it was subject to. (c) the statutory approvals(s) required have been refused. any make upward revisions in his offer in respect of the price and the number of shares to be acquired. the acquirer who has made the public announcement of offer. or (c) a combination of both.
or by both these methods” Sec 390(a) As per this section . for the purpose of sections 391 to 393. Sec 390(c) As per this section. or by the division of shares into shares of different classes. their separate meeting is not necessary. The rationale for SEBI’s decision to increase the creeping limit and the threshold limit is difficult to understand. unsecured creditors who have filed suits or obtained decrees shall be deemed to be of the same class as other unsecured creditors. Mergers & Acquisitions Page 24 of 93 . The decision to increase the threshold limit from 10% to 15% is also difficult to be justified. These powers are being transferred to National Company Law Tribunal (NCLT) by companies (second Amendment) Act. The decision to increase the creeping acquisition from 2%to 5% disregards the objective of protection of small shareholders. Sec 390 This section provides that “The expression ‘arrangement’ includes a reorganization of the share capital of the company by the consolidation of shares of different classes. 1956 This has provisions specifically dealing with the amalgamation of a company or certain other entities with similar status. Indian Companies Act.8. Powers in respect of these matters were with High Court (usually called Company Court). SEBI had decided to increase the creeping acquisition limited to 5% from the 25 and the thresh hold limit to 215% from 10%. The Compromise.An amendment to the Regulations. 1. 1998. 2002. The increase in creeping acquisition will bring in quiet acquisition without the trigger of making a minimum offer of 20%. The decision to increase the creeping to 5% and thresh hold limit to 15% appears to be working against the basic spirit of the takeover code. The most common form of merger involves as elaborate but time-bound procedure under sections 391 to 396 of the Act. In fact the 20% offer was to facilitate the market movements and competitive process and also to keep the management on their toes. Arrangement can include reorganization of share capital of company by consolidation of shares of different classes or by division of shares of different classes. 1997 on substantial acquisition of shares and takeovers has been notified on 28. Thus. Sec 390(b) As per this section. arrangement and Amalgamation/reconstruction require approval of NCLT while the sale of shares to Transferee Company does not require approval of NCLT.2 Laws governing merger Various Laws governing merger in India are as follows: 1.’Company’ means any company liable to be wound up under the Act.
latest financial position. NCLT will make order of sanctioning the scheme only if it is satisfied that company or any other person who has made application has disclosed all material facts relating to the company. Sec 391(4) As per this sub-section. A copy of every order of NCLT will be annexed to every copy of memorandum and articles of the company issued after receiving certified copy of the NCLT order.g. the company or any creditor or member of a company can make application to NCLT. If the company is already under liquidation. Appeal against NCLT order can be made to National Company Law Appellate Tribunal (NCLAT) where appeals against original order the NCLT lies. it will be binding on all creditors or members of that class and also on the company. Copy of NCLT order will have to be filled with Registrar of Companies. Sec 391(3) As per this sub-section. company as well as every officer who is in default is punishable with fine upto Rs 100 for every copy in respect of which default is made. its liquidator and contributories. e. it will have powers to supervise the carrying out of the scheme. Sec. the NCLT may sanction the scheme. On such application. NCLT should also be satisfied that the meting was fairly represented by members/creditors. if NCLT sanction. where NCLT sanctions a compromise or arrangement. NCLT can stay commencement of any suit or proceedings against the company till application for sanction of scheme is finally disposed of. auditor’s report on accounts of the company. pendency of investigation of company etc. If majority in number representing at least three-fourths in value of creditors or members of that class present and voting agree to compromise or arrangement. Sec 391(6) After an application for compromise or arrangement has been made under the section. Sec 391 (2) As per this sub-section. Sec 391(5) In case of default in compliance with provisions of section 391(4). 392 This section contains the powers of NCLT to enforce compromise and arrangement Sec 392 (1) As per this section. Sec 391(7) As per this sub-section. application will be made by liquidator. Sec 391(1) As per this sub-section. NCLT may order that a meeting of creditors or members or a class of them be called and held as per directions of NCLT. It can give suitable Mergers & Acquisitions Page 25 of 93 .Sec 391 This section deals with the meeting of creditors/members and NCLT’s sanction to Scheme.
if NCLT finds that the scheme cannot work. being a director. it can order winding up. managing director. there shall be included either such a statement as aforesaid or a notification of the place at which creditors or members entitled to attend the meeting may obtain copies of such a statement as aforesaid. the copy of scheme of compromise or arrangement should be furnished to creditor/member free of cost. the company and every officer of the company who is in default.000 and for the purpose of this subsection any liquidator of the company and any trustee of a deed for securing the issue of debentures of the company shall be deemed to be an officer of the company. if the scheme affects rights of debenture holders. or manager of the company. it is different from the effect on the like interests of other person. Sec. Sec 393 (4) Where default is made in complying with any of the requirements of this section. there shall be sent also a statement setting forth the terms of the compromise or arrangement and explaining its effect. manager or trustee of debenture holders shall give notice to the company of matters relating to himself which Mergers & Acquisitions Page 26 of 93 . manager or trustee for debenture holders.393 (1) Where a meeting of creditors or any class of creditors. and b) In every notice calling the meeting which is given by advertisement. managing directors. 50. if he shows that the default was due to the refusal of any other person. Sec 392 (2) As per this section.directions or make modifications in the scheme of compromise or arrangement for its proper working. or of numbers or any class of members. Sec 393 This section contains the rules regarding notice and conduct of meeting. any director. shall be punishable with fine which may extend to Rs. managing director. Provided that a person shall not be punishable under this sub-section. Sec 393 (5) As per this section. to supply the necessary particulars as to his material interests. and in particular stating any material interests of the directors. Sec 393 (2) As per this sub-section. Sec 393 (3) As per this sub-section. and in so far as. statement should give details of interests of trustees of any deed for securing the issue of debentures as it is required to give as respects the companies directors. whether in their capacity as such or as members or creditors of the company or otherwise and the effect on those interests of the compromise or arrangement if. is called under section 391:a) With every notice calling the meeting which is sent to a creditor or member.
he is punishable with fine upto Rs. The NCLT can order compulsory acquisition or other order may be issued. NCLT shall take into consideration any representation made by Central Government before passing any order.the company has to disclose in the statement. Sec 395 This section provides that reconstruction or amalgamation without following NCLT procedure is possible by takeover by sale of shares. Sec 395(1) As per this sub-section. notice of such application must be made to Central Government. In case of default. only if Registrar of Companies (ROC) has made a report that affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest. The transferee company should give notice within one month to dissenting shareholders. company as well as every officer who is in default is punishable with fine upto Rs.000. Copy of NCLT order shall be filed with Registrar within 30 days. Sec 394(1) NCLT can sanction amalgamation of a company which is being wound up with other company.500. compromise. The dissenting shareholder can make application within one month of the notice to NCLT. Selling shareholders get either compensation or shares of the acquiring company. if the transferee company or its nominee holds 90% or more shares in the transferor company. Sec 394 (2) As per this sub-section. and not only of those attending the meeting. reconstruction or amalgamation. The transferee company is entitled and bound to acquire those shares on the same terms on which shares of approving share holders are to be transferred to the transferee company. if any application is made to NCLT for sanction of arrangement. Their shares must be acquired within three months of such notice. Sec 394A As per this section. This procedure is rarely followed. the transferee company will pay the amount payable to transferor company along with the transfer deed duly signed. if shareholders do not submit the transfer deeds. it is entitled to and is also under obligation to acquire remaining shares. Sec395 (3) As per this section. as sanction of shareholders of at least 90% of value of shares is required.5. if NCLT issues such an order. The transferor company will then record name of the Mergers & Acquisitions Page 27 of 93 . Sec 394 This section contains the powers while sanctioning scheme of reconstruction or amalgamation. if he unable to do so. NCLT can direct that the property will be vest in the transferee company and that the transfer of property will be freed from any charge. Sec 394 (3) As per this sub-section. This procedure can be followed only when creditors are not involved in reconstruction and their interests are not affected. Sec 395(2) As per this sub-section. the transferee company has to be give notice in prescribed manner to dissenting shareholder that it desires to acquire his shares.
Books and papers of the company which has amalgamated or whose shares are acquired by another company shall be preserved. Sec 396 This section contains the power to Central Government to order amalgamation. Sec 396A This section deals with the preservation of books and papers of amalgamated company. The compensation so assessed shall be paid to the member or creditor by the company resulting from amalgamation. duties and obligations as may be specified in the order. Government can provide the constitution of the single company. Sec395 (4A) When the transferee company makes offer to shareholders of transferor company. powers. decided that “prior Mergers & Acquisitions Page 28 of 93 . in a recent judgment. 1969 (MRTP 1969) Certain Amendments in the MRTP Act were brought about in 1991.transferee company as holder of shares. Before granting such permission. Government may appoint a person to examine the books and papers to ascertain whether they contain any evidence of commission of an offence in connection with formation or management of affairs of the company. the circular of offer shall be accomplished by prescribed information in form 35A. by issuing notification in Official Gazette. These will not be disposed of without prior permission of Central Government. Sec 396(2) The order may provide for continuation by or against the transferee company of any legal proceedings pending by or against Transferor Company. 2.396 (1) As per this sub-section. or its amalgamation or acquisition of its shares. The order can also contain consequential. it can order their amalgamation. if central government is satisfied that two or more companies should amalgamate in public interest. Sec395 (4) As per this section. Sec. Sec396 (3) As per this sub-section. authorities and privileges and such liabilities. Offer should contain statement by Transferee Company for registration before it is sent to shareholders of Transferor Company. with such property. The Supreme Court. even if transfer deed is not signed by dissenting shareholders. The Government has removed restrictions on the size of assets. incidental and supplemental provisions necessary to give effect to amalgamation. he will get compensation assessed by prescribed authority. every member. creditor and debenture holder of all the companies will have same interest or rights after amalgamation. Monopolies and Restrictive Trade practices Act. If the rights and interests are reduced after amalgamation. market shares and on the requirement of prior government approvals for mergers that created entities that would violate prescribed limits. to the extent possible. interest. rights. The sum received by transferor company shall be kept in a separate account in trust for the dissenting shareholders.
if any. However. Foreign Exchange Regulation Act 1973 (FERA 1973) FERA is the primary Indian Law which regulates dealings in foreign exchange. Although there are no provisions in the Act which deal directly with transactions relating to amalgamations. In case of mergers and amalgamations. the benefits under this act are available only if the following conditions mentioned in Section 2 (1B) of the Act are fulfilled: a) All the amalgamating companies should be companies within the meaning of the section 2 (17) of the Income Tax Act. The depreciation charge may be based on the consideration paid and without any revaluation.e. 1961 is vital among all tax laws which affect the merger of firms from the point view of tax savings/liabilities.residents. Income Tax Act. Some of the relevant provisions may be summarized as follows: Depreciation: The amalgamated company continues to claim depreciation on the basis of written down value of fixed assets transferred to it by the amalgamating company. the acquiring firm). unabsorbed depreciation. cannot be assigned to the amalgamated company and hence no tax benefit is available in this respect. and d) The shareholders of not less than 90% of the share of the amalgamating company should become the shareholders of amalgamated company. certain provisions of the Act become relevant when shares in Indian companies are allotted to non. b) All the properties of the amalgamating company (i. c) All the liabilities of the amalgamating company should become the liabilities of the amalgamated company.. 4.approval of the central government for sanctioning a scheme of amalgamation is not required in view of the deletion of the relevant provision of the MRTP Act and the MRTP Commission was justified in not passing an order restraining implementation of the scheme of amalgamation of two firms in the same field of consumer articles”. where the undertaking sought to be acquired is a company which is not incorporated under any law in India. Mergers & Acquisitions Page 29 of 93 . 1961 Income Tax Act. The Act has been amended to facilitate transfer of shares two non residents and to allow Indian companies to set up subsidiaries and joint ventures abroad without the prior approval of the Reserve Bank of India. the target firm) should be transferred to the amalgamated company (i. a number of issues may arise with respect to tax implications. Section 29 of FERA provides that no foreign company or foreign national can acquire any share of an Indian company except with prior approval of the reserve Bank of India..e. 3. However. 1961.
The exchange of old share in the amalgamated company by the new shares in the amalgamating company is not considered as sale by the shareholders and hence no profit or loss on such exchange is taxable in the hands of the shareholders of the amalgamated company. The scheme of amalgamation is approved by a specified authority. The amalgamating company should not be financially viable. and (ii) that the shares are issued in consideration of the shares. 1961 deals with the mergers of the sick companies with healthy companies and to take advantage of the carry forward losses of the amalgamating company. The amalgamation should be in public interest. But the benefits under this section with respect to unabsorbed depreciation and carry forward losses are available only if the followings conditions are fulfilled: I. III.9 Effective Date and Appointed Date Effective Date. IV.A compromise or arrangement takes effect from the date when it is arrived at subject to the sanction of the court (NCLT). 1. in the amalgamated company.Sanction of the NCLT to a compromise has relation back and a scheme or arrangement agreed to by the creditors Mergers & Acquisitions Page 30 of 93 . The amalgamated company should continue to carry on the business of the amalgamating company without any modification Amalgamation Expenses: In case an expenditure is incurred towards professional charges of Solicitors for the services rendered in connection with the scheme of amalgamation. to any shareholder. 1961. not from the date of the sanction but from the date when it was arrived at. If the NCLT refuses sanction. and VI. II. it becomes without effect. Exemption from Capital Gains Tax: The transfer of assets by amalgamating company to the amalgamated company. V. under the scheme of amalgamation is exempted for capital gains tax subject to conditions namely (i) that the amalgamated company should be an Indian Company. Carry Forward Losses of Sick Companies: Section 72A(1) of the Income Tax Act. The amalgamating company is an Indian company. then it is deductible in the hands of the amalgamated company under section 35 of Income Tax Act. If the NCLT grants sanction it takes effect.Capital Expenditures: If the amalgamating company transfers to the amalgamated company any asset representing capital expenditure on scientific research. then such expenses are deductible in the hands of the amalgamated firm. The amalgamation should facilitate the revival of the business of the amalgamating company.
Jindal Ferroy Alloys Ltd. has been merged with ICICI Ltd. ) to get control over DCM Ltd. 1. Pacakaging major Essel Propack which acquired units of the UK’s Arista tubes and Telecon Packaging and turned it around by proper resource allocation. 1969 provided for a cumbersome procedure to get approval for mergers and acquisitions under the Act. acquired Tata Oil Mills from the Tata Group and then merged other group companies i. such as Chabrias. and Ponds (India Ltd.K. Most of the provisions of the MRTP Act. has been merged with Jindal Strips Ltd. has been merged with the latter. and the offer of Sterlite Ltd.) with it. British Gas Company has taken over Gujarat Gas Company. and the reason for this is quite obvious.. also attempted to take over many Indian companies by buying shares of these companies at stock exchanges. Appointed Date.’s offer for Raasi cement Ltd. Volrho Ltd. the concept of mergers. for taking over Indian Aluminum Company have heralded a new era of hostile takeovers in India. which was initially promoted by ICICI Ltd. The regulatory and prohibitory provisions of MRTP Act. even if scheme is sanctioned later by high court (Now NCLT).Appointed date or transfer date is the date on which the property of transferor company vests and is transferred to Transferee Company. India Cement Ltd.of a company becomes operative from the date of the meeting in which it is agreed to and not from the date on which the NCLT sanction is given. Hindujas etc. ITC Classic Ltd. Hindustan Lever Ltd. and Escorts Ltd. India’s increasing “turnaround expert” strategy • • Wockhardt acquired loss making Wallis Laboratories of the U. This can be retrospective. It is usually beginning of financial year..K. During recent years.e. The transfer date specified in the scheme is the date of transfer for purpose of Income Tax assessments.. for convenience of accounting and tax assessments. in 1998 for $8 million and successfully managed to turn it around in a year’s time. Still. Many other Nonresident Indians. Brook Bond Lipton (India) Ltd. there has been a spate of merger moves by various industrial groups. merger in India used to be friendly amalgamation resulting as a consequence of a negotiated deal. Mergers & Acquisitions Page 31 of 93 . have been repealed as a part of economic liberalization drive of the Government of India. 1969.10 Mergers and Takeovers: Indian scene In India. Company like Nicholas Piramal has been built only by mergers and acquisitions. in most of the cases. a loss making company was amalgamated with Voltas Ltd. The SCICI Ltd. acquisitions and takeovers has not been popular and kept a low profile. First. unless 1988 when there was the well-known unsuccessful hostile takeover bid by Swaraj Paul (of Caparo Group of the U.
Aluminiumtechink. Financial and integration maturity Creditability to attract more bank financing Globally Competitive. along with its wholly owned subsidiary. Lakshmi Mittal acquired Arcelor to build the strongest steel venture Mittal Arcelor. Daewoo and made presence in international market with and enhanced product portfolio. Continental engines acquired loss making European remanufactures engines firm vege Motors in June 2005. • • 1.11 The changing scenario • Share of global M&A by MNC’s from developing and transition countries. CDP. (formally Gujrat Heavy Chemicals) acquired a controlling stack of 65 per cent in Romanian Soda ash firm SC Bega Upsom for $ 19. 3. Page 32 of 93 Mergers & Acquisitions .• GHCL Ltd. And the forging major is reaping dividends as a result. GHCL managed to ramp up production by 34%. Imatra Kilsta. 4. Tata motors acquired the bankrupt commercial vehicles units of the Korean group. 5. 1987-4% 2005-13% • Share in Greenfield and expansion projects exceeded 15% in 2005. 2. Tata Group made several significant acquisitions.50 million. The Tata-Corus 1.Scootish Stampings. Mr.and turned it around within six months through better cost control. • • • The Tata’s Journey of M&A • • Tata Tea acquired loss making Tetley of the UK in 2000 and turned it to profits. Bharat Forge has emerged the world’s second largest forging company mainly by way of Mergers and Acquisitions like care Dan Peddinghaus GmbH.debt restructuring exercise that reduced into costs. The $ 11 billion deal in a maker in the ground Pure cash deal confidence and aggressiveness. Daewoo Commercial vehicles and Boston’s Ritz Carlton Hotel. Fedral Forge. A month into the acquisition. Key. such as Us telecom network operator Tyco Global.
up from $96 billion in 2005. Almost 50% of top 50 companies have made at least one overseas acquisition in the past 3 years in varied industries. a deluge with the Birlas now going the Tata’s way. Followed up by pharmaceutical and auto components outfits. Now.8 1.12 Causes of merger: Mergers & Acquisitions (US$ Billion) 13 10. Continental Engines and a host of others. 2000 India has made over 300 overseas acquisitions.9 1.• • • • • • • • • Most important benefit is increased competition. leveraging their recently acquired ability to work in challenging business environment. India’s outward FDI has touched $ 19 million.0 4. The acquisition boom began as a trickle with software companies picking up small information technology companies abroad. making a big ticket acquisition.7 5.4 Page 33 of 93 .TataMotors. This calendar year. Top 10 Indian mergers (1991-97) • Companies involved in Mergers Zee telefilms Power Generators Satyam Infoway Air products Broad com Schoroedel funds Chase manhaltam Reliance Xerox Indian cements 1. More investment abroad implies more the benefits of the home country.6 1.6 1. Wockhardt. Since.3 2.4 1. Esssel Propack. Story vote of confidence in Indian management with such companies as Tata Tea . Strengths the arms of local companies and of the MNC’s to survive in a competitive lieu. BharatFirge.
trade and for advantages in bringing separate enterprise under single control namely: a) b) c) d) Synergy arising in the form of economies of scale. These are generally undertaken to: a) Achieve optimum size b) Improve profitability c) Carve out greater market share d) Reduce its administrative and overhead costs. Achieve optimum size and carve out optimum share in the market. 4. These mergers are generally endeavored to: a) Increased profitability b) Economic cost (by eliminating avoidable sales tax and excise duty payments) c) Increased market power d) Increased size 3. Conglomerate merger: These are mergers between two or more companies having unrelated business. These transactions are not aimed at explicitly sharing resources. synergies or product . technologies. Mergers & Acquisitions Page 34 of 93 . They seek to consolidate operations of both companies.An extensive appraisal of each merger scheme is done to patternise the causes of mergers. b. They are undertaken for diversification of business in other products.They do not have an impact on the acquisition of monopoly power and hence are favored through out the world. Reverse mergers Reverse mergers involve mergers of profir making companies with companies having accumulated losses in order to: a. These hypothesized causes (motives) as defined in the mergers schemes and explanatory statement framed by the companies at the time of mergers can be conveniently categorized based on the type of merger. Risk reduction by avoiding sales and profit instability. Horizontal merger: These involve mergers of two business companies operating and competing in the same kind of activity. Claim tax savings on account of accumulated losses that increase profits. Vertical merger: These are mergers between firms in different stages of industrial production in which a buyer and seller relationship exists. The possible causes of different type of merger schemes are as follows: 1. Cost reduction as a result of integrated operation. Set up merged asset base and shift to accelerate depreciation. 2. Vertical merger are an integration undertaken either forward to come close to customers or backwards to come close to raw materials suppliers.
Eliminate intra-group competition c. Correct leverage imbalances and imprvove borrowing capacity. Cut costs and achieve focus. b. Group company mergers These mergers are aimed at restructuring the diverse unitsof group companies to create a viable unit. Mergers & Acquisitions Page 35 of 93 .5. Such mergers are initiated with a view to affect consolidation in order to: a.
creativity. free flow of capital across countries and globalization of business as a number of economies are being deregulated and integrated with other economies. R&D and market coverage capacity due to the complementarily of resources and skills and a widened horizon of opportunities. breaking of trade barriers. But apart from operating economies. Mergers & Acquisitions Page 36 of 93 .Chapter -2 Motives of Merger The present chapter examines the financial and strategic motives driving the mergers and acquisitions activity and identify them with real life merger cases. innovativeness. A number of motives are attributed for the occurrence of mergers and acquisitions. Synergy refers to benefits other than those related to economies of scale.1 Synergies through Consolidation: Synergy implies a situation where the combined firm is more valuable than the sum of the individual combining firms. Operating economies are one form of synergy benefits. They have become popular in the recent times because of the enhanced competition. 2. Motives of merger: Mergers and acquisitions are strategic decisions leading to the maximization of a company’s growth by enhancing its production and marketing operations. It is defined as ‘two plus two equal to five’ (2+2=5) phenomenon. synergy may also arise from enhanced managerial capabilities.
For example. and thereby can gain by combining these two strength. and Ltd. the fundamental motive for the acquiring firm to takeover a target firm may be the desire to increase the wealth of the shareholders of the acquiring firm. then the merger is beneficial if V (AB)> V (A) +V (B) Where V (AB) V (A) V (B) = Value of the merged entity = Independent value of company A = Independent value of company B A merger which results in meeting the test of increasing the wealth of the shareholders is said to contain synergistic properties. credit monitoring. A major saving may arise from the consolidation of departments involved with financial activities e. The argument is that both firms will be better off after the merger. The sources of synergy of specialized resources will vary depending upon the merger. accounting. However. Operating synergy: The key to the existence of synergy is that the target firm controls a specialized resource that becomes more valuable when combined with the bidding firm’s resources. A firm with a good distribution network may acquire a firm with a promising product line. decide to merge into AB Ltd. When a firm having strength in one functional area acquires another firm with strength in a different functional area. The research and development expenditures will also be substantially reduced in the new set up by eliminating similar research efforts and repetition of work already done by the target firm. since a wider product line may provide larger sales per unit of sales efforts and per sales person. Synergy is the increase in the value of the firm combining two firms into one entity i. marketing and advertisement department can be streamlined. The management expenses may also come down substantially as a result of corporate reconstruction.An under valued firm will be a target for acquisition by other firms. The selling. In case of horizontal merger. synergy may be gained by exploiting the strength in these areas. The firm might be able to reduce the cost of production by eliminating some fixed costs. These are: 1. The marketing economies may be produced through savings in advertising (by reducing the need to attract each other’s customers). This is possible only if the value of the new firm is expected to be more than the sum of individual value of the target firm and the acquiring firm. billing. purchasing etc.e. Mergers & Acquisitions Page 37 of 93 . There are several ways in which the merger may generate operating economies. it is the difference value between the combined firm and the sum of the value of the individual firms. Igor Ansoff (1998) classified four different types of synergies. and also from the advantage of offering a more complete product line (if the merged firms produce different but complementary goods). the synergy comes from some form of economies of scale which reduce the cost or from increase market power which increases profit margins and sales. if A Ltd..g..
It may either distribute its surplus cash to its shareholders or use it to acquire some other company. Such merger facilitates better coordination and administration of the different stages of business stages of business operations-purchasing. a firm may either combine with its supplier of input (backward integration) and/or with its customers (forward integration). (TSL). These resultant economies are known as synergistic operating economies. An example of a merger resulting in operating economies is the merger of Sundaram Clayton Ltd. manufacturing and marketing –eliminates the need for bargaining (with suppliers and/or customers). The company can grow externally by acquiring another company by the exchange of shares and thus. SCL also needed to upgrade its technology and increase its production. Large amount of funds would have been required for creating additional production capacity. (SCL) with TVS-Suzuki Ltd. SCL’s and TCL’s plants were closely located which added to their advantages.By this merger. TSL became the second largest producer of two –wheelers after Bajaj. Their wealth may increase through an increase in the market value of their shares if surplus cash is used to acquire another Mergers & Acquisitions Page 38 of 93 . Financial synergy: Financial synergy refers to increase in the value of the firm that accrues to the combined firm from financial factors. release the financing constraint. they will be able to produce better results than they were producing as separate entities because of savings various types of operating costs. It may not have enough internal opportunities to invest its surplus cash. It needed a large manufacturing bas to reduce its production costs. and minimizes uncertainty of supply of inputs and demand for product and saves costs of communication. In a vertical merger. Deployment of surplus cash: A different situation may be faced by a cash rich company. The shareholders may not really benefit much if surplus cash is returned to them since they would have to pay tax at ordinary income tax rate. when two firms combine their resources and efforts. There are many ways in which a merger can result into financial synergy and benefit. A merger may help in: • • • • • Eliminating financial constraint Deployment surplus cash Enhancing debt capacity Lowering the financial costs Better credit worthiness Financial Constraint: A company may be constrained to grow through internal development due to shortage of funds. 2. The main objective motivation for the takeover was TSL’s need to tide over its different market situation through increased volume of production.Thus. The combined company has also been enabled to share the common R&D facilities.
cash flows. Sales synergy These synergies occurs when merged organization can benefit from common distribution channels. another group company to achieve financial synergies. but negatively correlated. be taken off partially or completely by increase in the shareholders risk on account of providing better protection to lenders. RP Goenka’s ceat tyres sold off its type cord division to Shriram Fibers Ltd. can gain immensely from the superior management that is likely to emerge as a sequel to the merger. plagued with managerial inadequacies. The stability of cash flows reduces the risk of insolvency and enhances the capacity of the new entity to service a larger amount of debt. A merged firm is able to realize economies of scale in flotation and transaction costs related to an issue of capital. Financing Cost: The enhanced debt capacity of the merged firm reduces its cost of capital. existing managers will strive continually to improve their performance. in 1996 and also transfer’s its fiber glass division to FGL Ltd. If they sell their shares. sales promotion and warehousing. The increased borrowing allows a higher interest tax shield which adds to the shareholders wealth. obtain bank loan and raise capital in the market easily. Another allied benefit of a merger may be in the form of greater congruence between the interests of the managers and the shareholders. is replaced by a more effective management team. Since the probability of insolvency is reduced due to financial stability and increased protection to lenders. Managerial synergy One of the potential gains of merger is an increase in managerial effectiveness. can bring stability of cash flows of the combined company. advertising. Better credit worthiness: This helps the company to purchase the goods on credit. 4. capital gains tax rate. however. Often a firm. with fluctuating. This may occur if the existing management team. Another aspect of the financing costs is issue costs. Issue costs are saved when the merged firm makes a larger security issue. 3.company. Debt Capacity: A merger of two companies. Mergers & Acquisitions Page 39 of 93 . sales administration. which is performing poorly. If lackluster performance renders a firm more vulnerable to potential acquisition. The company would also be enabled to keep surplus funds and grow through acquisition. A common argument for creating a favorable environment for mergers is that it imposes a certain discipline on the management.. they would pay tax at a lower. the merged firm should be able to borrow at a lower rate of interest. This advantage may.
thus producing a relatively level pattern of combined earnings. On the other hand. Any investor who wants to reduce risk by diversifying between two companies. Classic and Anagram Finance to obtain quick access to a well dispersed distribution network. (ICICI) acquired Tobaco Company. However. The extent. The merger of these companies is not necessary for him to enjoy the benefits of diversification. Thus. Diversification into new areas and new products can also be a motive for a firm to merge an other with it. A firm operating in North India.The Industrial Credit and Investment Corporation of India Ltd. As a matter of fact. While negative correlation brings greater reduction in risk. products diversification resulting from merger can also help the new firm fighting the cyclical/seasonal fluctuations. may simply buy the stocks of these two companies and merge them into a portfolio. conglomerate mergers. Individually. his ‘homemade diversification give him far greater flexibility. if merges with another firm operating primarily in South India. ABC Company and PQR Company. Through the diversification effects.e. firm A has a product line with a particular cyclical variations and firm B deals in product line with counter cyclical variations. The diversification motive is based on the proposition that if two risky projects are combined.. For example. ITC. there will be some diversification effect as long as the two firm’s earnings are not perfectly correlated (both rising and falling together). they do not derive any benefits from the proposed merger. then the risk of combination will be less than the weighted average of the risk of these two projects. merger can produce benefits to all firms by reducing the variability of firm’s earnings. The greatest benefit from diversification can be obtained by continuing firms from different industries i. He can contribute the stocks of ABC Company and PQR Company in any proportion he likes as he is not confronted with a ‘fixed’ proportion that result from the merger. Indeed. where two firms poorly correlated cash flows merged to create a portfolio of a firms. say. If investors can diversify on their own by buying stocks of companies which propose to merge. positive correlation brings lesser reduction in risk. a shareholder can easily create a diversified portfolio of firms merely by holding the Mergers & Acquisitions Page 40 of 93 . This reduction in overall risk is particularly likely if the merged firms are in different lines of business. and vice-a versa. Moreover.2 Diversification A commonly stated motive for mergers is to achieve risk reduction through diversification. Smoothing out the earnings of a firm over the different phases of a cycle tends to reduce the risk associated with the firm. to which risk is reduced. the earnings of the two firms may fluctuate in line with the cyclical variations. can definitely cover broader economic areas. If firm A’s income generally rises when B’s income generally falls. Individually these firms could serve only a limited area. if they merge. the cyclically prone earnings of firm A would be set off by the counter cyclically prone earnings of firm B. depends upon on the correlation between the earnings of the merging entities. But portfolio of firms in a conglomerate merger is costly as the acquisition of firms is a costly exercise. 2. the fluctuation of one will tend to set off the fluctuations of the other.
shares of diversified companies. This is much easier and cheaper than creating a portfolio of firms in conglomerate merger. Thus, firms diversify to achieve: • • • • Sales and growth stability Favorable growth developments Favorable competition shifts Technological changes
2.3 Accelerated Growth Growth is essential for sustaining the viability, dynamism and value-enhancing capability of company. A growth- oriented company is not only able to attract the most talented executives but it would also be able to retain them. Growing operations provide challenges and excitement to the executives as well as opportunities for their job enrichment and rapid career development. This helps to increase managerial efficiency. Other things being the same, growth leads to higher profits and increase in the shareholders value. A company can achieve its growth objective by: • • Expanding its existing markets Entering in new markets.
A company may expand and/or diversify its markets internally or externally. If the company cannot grow internally due to lack of physical and managerial resources, it can grow externally by combining its operations with other companies through mergers and acquisitions. Mergers and acquisitions may help to accelerate the pace of a company’s growth in a convenient and inexpensive manner. Internal growth requires that the company should develop its operating facilitiesmanufacturing, research, marketing etc. Internal development of facilities for growth also requires time. Thus, lack or inadequacy of resources and time needed for internal development constrains a company’s pace of growth. The company can acquire production facilities as well as other resources from outside through mergers and acquisitions. Specially, for entering in new products/markets, the company may lack technical skills and may require special marketing skills and/or a wide distribution network to access different segments of markets. The company can acquire existing company or companies with requisite infrastructure and skills and grow quickly. Mergers and acquisitions, however, involve cost. External growth could be expensive if the company pays an excessive price for merger. Benefits should exceed the cost of acquisition for realizing a growth which adds value to shareholders. In practice, it has been found that the management of a number of acquiring companies paid an excessive price for acquisition to satisfy their urge for high growth and large size of their companies. It is necessary that price may be carefully determined and negotiated so that merger enhances the value of shareholders.
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For example, RPG Group had a turnover of only Rs.80 crores in 1979. This has increased to about Rs. 5600 crores in 1996. This phenomenal growth was due to the acquisitions of a several companies by the RPG Group. Some of the companies acquired are Asian cables, ceat, Calcutta Electricity Supply and company, SAE etc. 2.4 Increased Market power A merger can increase the market share of the merged firm. The increased concentration or market share improves the profitability of the firm due to economies of scale. The bargaining power of the firm with labour, suppliers and buyers is also enhanced. The merged firm can also exploit technological breakthroughs against obsolescence and price wars. Thus, by limiting competition, the merged firm can earn super normal profit and strategically employ the surplus funds to further consolidate its position and improve its market power. The acquisition of Universal Luggage by Blow Plast is an example of limiting competition to increase market power. Before the merger, the two companies were competing fiercely with each other leading to a severe price war and increased marketing costs. As a result of the merger, Blow Plast has obtained a strong hold on the market and now operates under near monopoly situation. Yet another example is the acquisition of Tomco by Hindustan Lever. Hindustan Lever at the time of merger was expected to control one-third of three million tonne soaps and detergents markets and thus, substantially reduce the threat of competition. Merger is not only route to obtain market power. A firm can increase its market share through internal growth or ventures or strategic alliances. Also, it is not necessary that the increased market power of the merged firm will lead to efficiency and optimum allocation of resources. Market power means undue concentration which could limit the choice of buyers as well as exploit suppliers and labour. 2.5 Purchase of assets at bargain price Mergers may be explained by the opportunity to acquire assets, particularly land, mined rights, plant and equipment at lower cost than would be incurred if they were purchased or constructed at current market prices. If market prices of many stocks have been considerably below the replacement cost of the assets they represent, expanding firm considering constructing plants developing mines, or buying equipment. Often it has found that the desired asset could be obtained cheaper by acquiring a firm that already owned and operated the asset. Risk could be reduced because the assets were already in place and an organization of people knew how to operate them and market their products. Many of mergers can be financed by cash tender offers to the acquired firm’s shareholders at price substantially above the current market. Even, so, the assets can be acquired for less than their current cost of construction. The basic factor underlying this is that inflation in construction costs not fully reflected in stock prices because of high interest rates and
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limited optimism (or downright pessimism) by stock investors regarding future economic conditions. 2.6 Increased external financial capability Many mergers, particularly those of relatively small firms into large ones, occur when the acquired firm simply cannot finance its operations. This situation is typical in a small growing firm with expanding financial requirements. The firm has exhausted its bank credit and has virtually no access to long term debt or equity markets. Sometimes the small firms have encountered operating difficulty and the bank has served notice that its loans will not be renewed. In this type of situation, a large firm with sufficient cash and credit to finance the requirements of the smaller one probably can obtain a good situation by making a merger proposal to the small firm. The only alternative the small firm may have is to try to interest two or more larger firms in proposing merger to introduce completion into their bidding for the acquisition. The smaller firm’s situation might not be so bleak. It may not be threatened by nonrenewable of a maturing loan. But its management may recognize that continued growth to capitalize on its markets will require financing beyond its means. Although its bargaining position will be better, the financial synergy of the acquiring firm’s strong financial capability may provide the impetus for the merger. Sometimes the financing capability is possessed by the acquired firm. The acquisition of a cash rich firm whose operations have matured may provide additional financing to facilitate growth of the acquiring firm. In some cases, the acquiring firm may be able to recover all or part of the cost of acquiring the cash-rich firm when the merger is consummated and the cash then belongs to it. A merger also may be based upon the simple fact that the combination will make two small firms with limited access to capital markets large enough to achieve that access on a reasonable basis. The improved financing capability provides the financial synergy. 2.7 Increased managerial skills Occasionally, a firm will have good potential that it finds itself unable to develop fully because of deficiencies in certain areas of management or an absence of needed product or production technology. If the firm can not hire the management or develop the technology it needs, it might combine with a compatible firm that has the needed managerial personnel or technical expertise. Any merger, regardless of the specific motive for it, should contribute to the maximization of owner’s wealth. 2.8 Reduction in tax liability Under Income Tax Act, there is a provision for set-off and carry forward of losses against its future earnings for calculating its tax liability. A loss making or sick company may not Mergers & Acquisitions
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reporting and control.34 crores) Alwyn Missan merged with Mahinder and Mahindra Ltd. In India. When the shares are sold. economies in the use of the marketing function can be achieved by covering wider markets and customers using a given sales force and promotion and advertising efforts. particularly when the marginal tax rate is high is a strong motivation for the combination of companies. The profits arising from the exchange of shares are not taxable until the shares are actually sold. (Rs. budgeting.9 Economies of Scale Economies of scale arise when increase in the volume of production leads to a reduction in the cost of production per unit. Economies of scale may also be obtained fro the optimum utilisation of management resource and systems of planning. This happens because a given function. a given mix of plant and machinery can produce scale economies when its capacity utilisation is increased. facility or resource is utilized for a large scale of operation. (Rs. If it combines with a profitable company. A strong urge to reduce tax liability. they are subject to capital gain tax rate which is much lower than the ordinary income tax rate. For example. the high tax rate was the main reason for the post-war merger activity in the USA. 2. Similarly. For example. Thus. Economies will be maximized when it is optimally utilized. tax benefits are responsible for one-third of mergers in the USA12. 3. fixed costs are distributed over a large volume of production causing the unit cost of production to decline. Also.34 crores) Sidhpur Mills merged with Reliance Industries Ltd. A company establishes management systems by employing enough qualified professionals irrespective of its size. the combined company can utilize the carry forward loss and save taxes with the approval of government. A number of companies in India have merged to take advantage of this provision. a profitable company is allowed to merge with a sick company to set-off against its profits the accumulated loss and unutilized depreciation of that company. the shareholders of selling company can save tax. (Rs. A combined firm with a Mergers & Acquisitions Page 44 of 93 . (Rs. management functions and management resources and systems.47 crores) Hyderabad Alwyn merged with Voltas Ltd. 16 crores) Ahmadabad cotton Mills merged with Arvind Mils (Rs.be in a position to earn sufficient profits in future to take advantage of the carry forward provision. The following is the list of some companies along with the amount of tax benefits enjoyed: • • • • • Orrisa synthesis merged with Straw product Ltd.2.3. Merger may help to expand volume of production without a corresponding increase in fixed costs. Economies of scale may also arise from other indivisibilities such as production facilities. 1600 crores) When two companies merge through an exchange of shares.
c) To improve profitability by expanding into high margin activities of suppliers and customers. The recent merger of Samtel Electron services (SED) with Samtel Color Ltd. vertical merger may take place to integrate forward or backward. 2. Thus. when companies engaged at different stages of production or value chain merge. J.. these merger help avoid inefficient market transactions and result in reduced exchange inefficiencies.10 Vertical Integration Vertical integration is a combination of companies of companies business with the business of a supplier or customer generally motivated by a pure desire: a) To secure a source of supply for key materials or sources b) To secure a distribution outlet or a major customer for the company’s products. The real gain can be achieved by integrating backward if raw material market is not perfectly competitive and firm has to buy raw materials at monopolistic prices hence merge to obtain control of supplies. and Brigham. Tata Tea’s acquisition of consolidated coffee which produces coffee beans and Asian Coffee. the merger of a company Mergers & Acquisitions Page 45 of 93 . A holiday tour 12 Weston. So forward or downstream vertical integration involves takeover of customer business. Essentials of Managerial Finance. contracting. economies of vertical integration may be realized. Forward integration is where company merges to come close to its customers. Some of these reasons are technological economies like avoidance of reheating and transportation cost as in the case of iron and steel producer. (SCL) entailed backward integration of SED which manufactures electronic components required to make picture tubes with SCL. advertising. was also backward integration which helped reduce exchange inefficiencies by eliminating market transactions. There are many reasons why firms want to be integrated vertically at different stages. E. which possesses coffee beans. Backward integration occurs when a company comes close to its raw materials or suppliers. Thus. pp. Proper planning for production and inventory management may improve due to more efficient information flow within a single firm. For example. 1977.F. Transactions within a firm might eliminate costs of searching for prices.large size can make the optimum use of the management resource and systems resulting in economies of scale. costs of communicating and co-ordination.515. operator might acquire chain of travel agents and use them to promote his own holiday rather than those of rival tour operators. Dryden Press. a leading maker of color picture tube. Further.F.
If a company does everything inhouse. H. The ICICI. So. Vertical integration.12 Revival of sick companies Mergers & Acquisitions Page 46 of 93 . Milk food to gain an entry into ice cream market with the help of their marketing networks. truck finance. however. 3. a leading financial institution secured a foot hold in retail network through acquisition of Anagram Finance Company and ITC classic. Whirlpool Corporation’s entry into India by acquiring Kelvinator India. Anagram had a strong retail franchise. production facilities. acquiring companies with good manufacturing and distribution network or few brands of a company gives the advantage of rapid market share.11 Early entry and market penetration An early mover strategy can reduce the lead time taken in establishing the facilities and distribution channels. market penetration means developing new and large markets for a company existing products. it may not get the benefit of outsourcing from independent suppliers who may be more efficient in their segments of the value chain. One such example is Indian market. These acquisitions thus helped ICICI to obtain quick access to well dispersed distribution network. Hence. They prefer to merge with a local established company which knows behavior of market and has established customer base. Rajasthan and Maharastra and a depositor base of over two lakhs depositors. Further. Heinz entered into India through acquisition of Glato Industries.engaged in oil exploration and production (like ONGC) with a company engaged in refining and marketing (like HPCL) may improve coordination and control. Coca Cola while re-entering India market in 1993 acquired Parle. is not always a good idea. Cross border merger are a means of becoming or remaining major players in such markets. Market penetration strategy is generally pursued within markets that are becoming more global. 2. the largest player in market with several established brands and nationwide bottling and marketing network.J. car purchase. Kwality. distribution network of over fifty branches in Gujarat. 2. this strategy is mainly adopted by MNC’s to gain to new markets. 2. brands etc. and customer finance. ICICI was therefore attracted by the retail portfolio of Anagram which was active in lease and hire purchase. 4. Few instances of MNC’s related mergers are: 1. HLL acquired Dollops.
To bifurcate business by floating separate products this is referred to as demerger. improve borrowed capital. Firstly. Example of restructuring and consolidation within the group companies is the case of Nirma Ltd. GKW Ltd.An important motive for merger is to turn around a financially sick company through the process of merger. Allwyn with Voltas etc. Such mergers within group are also aimed at restructuring their diverse units to create a more viable unit. Amalgamation taking place under the aegis of Board for Industrial (BIFR) fall under this category. Taken over by Transferee company Tata Telecom Ltd. BIFR motivated Rehabilitation Merger Year April April April April May April 95 95 95 96 96 97 Transferor sick company Tata Keltron Ltd. Hyderabad. merging with it. the purpose is to revive a group of sick companies by merging it with groups of healthy company by obtaining concessions from financial institution and government agencies and obtaining benefits of tax concessions u/s 72A of Income Tax Act. BIFR found revival of ailing companies through the means of their with healthy company as the most successful route for revival of their financial wealth. Asian Paints Ltd. Powmex Steels Ltd. to revive sickness. its group companies. 1961.13 Consolidation at Group level Group company mergers are generally initiated with a view to affect consolidation to derive critical mass to cut costs in order to achieve focus and eliminate competition. 2. Titagarh Papers Mills Ltd. Secondly. Pentasia Chemicals Ltd. Cimmco Birla Ltd. Biax Ltd. Nirma detergents. it also helps to preserve group reputation. Universal Steel Alloys Ltd. Titagarh Steels Ltd. There are few other micro economic reasons to decide on mergers with group consideration as their sole consideration: • • • To achieve economies of scale To reduce cost of administration and management expenses in companies within same group. Nirma soaps and Mergers & Acquisitions Page 47 of 93 . Bharat Gears Ltd. Some of the group companies which have amalgamated through the BIFR include Mahindra Missan Allwyn with Mahindra and Mahindra.
and Guiness plc. The higher stakes helps to ward off takeover bids. Ltd. 2. Its merger with Escorts Tractors Ltd. visa. were merged from Ist April 1992 and changed their name to GEC. Some instances of such mergers are listed below: 1. The General Electric Company of India Ltd.( just like the GEC. formed by merger of two largest industrial groups The General Electric company plc. 2. In London in Dec. U. their two Indian counter parts. Alsthen India Ltd. For instance. 1997. 2. Alsthen N.14 Following Parent’s Footsteps Some of mergers in India belonging to Multinational giants take place as a result of direct fall out of mergers of their parent companies taking place in their home countries. Consequent of the merger of Grand plc. and Alcatel Alsthen.16 Defensive Maneuver Mergers & Acquisitions Page 48 of 93 . and The English Electric Company of India Ltd. The objective was to make Nirma a strong and resilient corporate entity capable of facing global competition by restructuring management. So. mergers could be motivated by the need to enhance promoter’s holdings in post. in 1996 following the merger of their global parents. Merger of Videocon groups Videocon Narmada Electronics with its flagship company Videocon International led to operating efficiencies by controlling costs under one head.V. Novartis India (51% of Novartis AG) was formed in India by the merger of Hindustan ciba Giegy and Sandoz India Ltd. their Indian offspring’s IDL Ltd. the family stake could be consolidated without going through the complications of SEBI guidelines of 4th august 199415. and united Distilleries India Ltd. Thus. merger of Reliance Polythylene and Reliance Polypropylene into Reliance Industries swap ratio of 100: 30 and 100:25 respectively resulted in an increase in Ambani’s stake from 23% to 37%. sizable reduction in management costs and increased professionalism. ‘A’ company which is family owned could be merged with ‘B’ company which is a listed company with family stake in it. Nanda family’s holding in escorts Ltd.15 Increase Promoter’s stake Another motive for merger could be to increase the stake of promoters. Similarly. both liquor companies followed this in India. By the process of merger. France) 2. As per the dictates of their parent companies.merger company.detergents. Shina soaps and detergents and Nirma chemicals.K. 3. increased their holding by another 20%. was 20% before merger.
170 and market capitalization of Rs.Merger can be used as shields for protection from raiders. A merger or acquisition can be used by a company as defensive maneuver to resist takeover by another company. 160 crores to Rs. many industries have forced most corporate to consolidate. The process of globalization and increasing integration of Indian economy with the international market will have its impact sooner or later. Industries have to increase its capacity. helped improve operating efficiencies and resulted in instant expansion of product lines of Tata tea –Tetley combines. European and Asian market have become more receptive to merger and acquisitions. After the pitched Battle against Multi National Company (MNC) in domestic arena. it may consider getting involved in a merger game. the world’s largest Tea brands by Tata tea. merger are planned to acquire global competitive strength. Its size and capacities are small as compared to MNC’s. Hence. If a firm feels that it could be acquired by another firm. European countries face competitive pressures from creation of single Euro currency. Cross border mergers and acquisitions are being resorted to such mergers provide opportunities for taking up larger projects. The acquisition has brought with it. induct new technology and development markets. generic market and to acquire global competitive strength. it is able to expand its size. on the other hand. The recent acquisition of Tetley. Also.17 Acquire Global Competitive strength With competitive forces resulting from globalization and deregulation. by increasing market capitalization of the merged company’s threat of takeover can be tackled. greater market penetration. Ansoff16 suggested a number of reasons that are attributed to the occurrence of mergers and acquisitions. Indian companies have also felt the need of becoming global. The globalized business environment thus demands that Indian Industries also restructured. Asian crisis has forced most Asian nations to look to the west for technological and capital support. it is suggested that mergers and acquisition are intended to: • • • Limit competition Utilize under-utilization market power Overcome the problem of slow growth and profitability in one’s own industry Mergers & Acquisitions Page 49 of 93 . the world’s largest integrated tea company has been driven by the fact that Tetley fits perfectly into Tata tea’s globalization drive and could be a perfect launch vehicle to achieve greater synergies in global arena. Also the merged company is able to compete more effectively with increased size. making its acquisition very expensive. merger of Jindal Ferro Alloys with Jindal Strips helped Jindal Ferro Alloys improve its share price from Rs. To meet the opportunities thrown open by fast growing world. 550 crores with the help of swap ratio of forty five Jindal strips for every hundred Jindal Ferro alloy shares. For example. On the one hand. Globalization has thus resulted in major implications for industrial competitiveness by lowering the cost of labour and opening markets to a great number of producing firms. For instance. 2. In doing so. 65 to Rs.
L. Vanderbilt University Press. et.. Mergers & Acquisitions Page 50 of 93 . 1994 15 16 Ansoff H.• • • • • • • • Achieve diversification Gain economies of scale and increase income with proportionately less investment Establish a transnational bridgehead without excessive start-up costs to gain access to a foreign market Utilize under-utilized resources-human and physical and managerial skills Displace existing management Circumvent government regulations Reap speculative gains attendant upon new security issue or change in P/E ratio Create an image of aggressiveness and strategic opportunism empire building and to amass vast economic powers of the economy. 1971. SEBI (Substantial Acquisition of shares and takeovers) Regulations. Manufacturing Firms 1946-65. al.S. Acquisitive Behaviour of U.
In the 1990s. Mergers & Acquisitions Page 51 of 93 . how to develop acquisition strategy. and the accounting consideration involved in merger and acquisition Firms are acquired for a number of reasons. firms have also acquired or merged with other firms to gain the benefits of synergy. process of acquisition. their own management or wealthy raiders. In the 1960s and 1970s. who saw potential value in restructuring or breaking up these firms. corporate giants like Time. Through time. in the form of either higher growth. In the 1980s. Beatrice and RJR Nabisco were acquired by other firms. the matters relating to the valuation of the synergies. or lower costs. amount paid to the target firm.Chapter-3 ACQUISITIONS This chapter covers the historical background of acquisition. firms such as Gulf and Western and ITT built themselves into conglomerates by acquiring firms in other lines of business. we saw a wave of consolidation in the media business as telecommunications firms acquired entertainment firms and entertainment firms acquired cable businesses. as in the Disney acquisition of Capital Cities.
3. There is one final comparison that can be made and that is between the price paid on the acquisition and the accounting book value of the equity in the firm being acquired. we examine the four basic steps in an acquisition. this difference will be recorded as goodwill on the acquiring firm’s books or not be recorded at all. AT&T ultimately paid $110 per share to complete the acquisition. and whether to use stock or cash. The final and often the most difficult step is making the acquisition work after the deal is consummated. it is the price at which the acquiring firm receives enough shares to gain control of the target firm. starting with establishing an acquisition motive. In either friendly or hostile acquisitions. is the price that will be paid by the acquiring firm for each of the target firm’s shares. seek it out. Depending upon how the acquisition is accounted for. The acquiring firm offers a price higher than the target firm’s market price prior to the acquisition and invites stockholders in the target firm to tender their shares for the price. We begin this section by looking at the different forms taken by acquisitions. the managers of the target firm welcome the acquisition and. in acquiring a target firm. This price is usually based upon negotiations between the acquiring firm and the target firm’s managers. and the understanding of what the strategy requires in terms of resources. 3.3 Steps in an Acquisition There are four basic and not necessarily sequential steps. in the context of mergers and consolidations. continuing with the identification and valuation of a target firm. In a tender offer. in some cases.2 The Process of an Acquisition Acquisitions can be friendly or hostile events. In a friendly acquisition. These transactions can range from one firm merging with another firm to create a new firm to managers of a firm acquiring the firm from its stockholders and creating a private firm. how best to raise funds to do it. the target firm’s management does not want to be acquired. if there are other firms bidding for the same target firm or if an insufficient number of stockholders tender at that initial price. In a hostile acquisition. The first is the development of a rationale and a strategy for doing acquisitions. This decision Mergers & Acquisitions Page 52 of 93 . The acquisition price.1 Background on Acquisitions When we talk about acquisitions or takeovers. we are talking about a number of different transactions. This price may be higher than the initial price offered by the acquirer. a premium of $ 25 over the stock price at the time of the offer. For instance. In this chapter. 3. and following up with structuring and paying for the deal. The second is the choice of a target for the acquisition and the valuation of the target firm. AT&T initially offered to buy NCR for $80 per share. the difference between the acquisition price and the market price prior to the acquisition is called the acquisition premium. with premiums for the value of control and any synergy.Acquisitions seem to offer firms a short cut to their strategic objectives. but the process has its costs. in 1991. The third is the determination of how much to pay on the acquisition. continue the section by providing an overview on the acquisition process and conclude by examining the history of the acquisitions in the United States.
assume that the estimated value for a firm is $100 million and that the current market price is $75 million. Acquiring poorly managed firms and removing incumbent management. 3. and perhaps the most challenging one. and the acquisition will not create any value for the acquirer. 3.has significant implications for the choice of accounting treatment for the acquisition. These motives were studied in detail in the last chapter. While the strategy of buying under valued firms has a great deal of intuitive appeal. Access to the funds that will be needed to complete the acquisition: Knowing a firm is undervalued does not necessarily imply having capital easily available to carry out the acquisition. however. the price exceeds the estimated value. the acquirer will have to pay a premium. especially when acquiring publicly traded firms in reasonably efficient markets. where the premiums paid on market prices can very quickly eliminate the valuation surplus. The acquirer can then gain the difference between the value and the purchase price as surplus. three basic components need to come together. we consider a number of different motives for acquisitions and suggest that a coherent acquisition strategy has to be based on one or another of these motives.3. The odds are better in less efficient markets or when acquiring private businesses. Skill in execution: If the acquirer. there will be no value gain from the acquisition. as the motives behind merger and motives behind acquisitions are same. or better analytical tools than those used by other market participants. and not all firms that have acquisition strategies stick with them. To illustrate. For this strategy to work.1 Developing an Acquisition Strategy Not all firms that make acquisitions have acquisition strategies. it is daunting. This value increase is often termed the value of control. should make these firms more valuable. Access to capital depends upon the size of the acquirer – large firms will have more access to capital markets and internal funds than smaller firms or individuals – and upon the acquirer’s track record – a history of success at identifying and acquiring under valued firms will make subsequent acquisitions easier. In this section. allowing the acquirer to claim the increase in value. is to make the acquisition work after the deal is complete. A capacity to find firms that trade at less than their true value: This capacity would require either access to better information than is available to other investors in the market. In acquiring this firm. Firms that are undervalued by financial markets can be targeted for acquisition by those who recognize this mispricing. Acquire poorly managed firms and change management Some firms are not managed optimally and others often believe they can run them better than the current managers. 1. If that premium exceeds 33% of the market price. in the process of the acquisition drives the stock price up to and beyond the estimated value. The final step in the acquisition. or at least changing existing management policy or practices. 2. Mergers & Acquisitions Page 53 of 93 .
As noted in the last chapter. • Mergers & Acquisitions Page 54 of 93 .3. the target firm must be under valued. With relative valuation. given the motives. if other banks have similar fundamentals (return on equity. 3. The first relates to how to best identify a potential target firm for an acquisition. If the motive for acquisitions is diversification. The acquisition has to be followed by a change in management practices.e. 3.2 Choosing a Target firm and valuing control/synergy Once a firm has an acquisition motive. i. and risk) but trade at much higher price to book value ratios. The market price of the acquisition should reflect the status quo. Choosing a target firm Once a firm has identified the reason for its acquisition program. noncyclical firms to get the fullest benefit from diversification. increase the length of the growth period. the potential for its success rests on the following. at least. The poor performance of the firm being acquired should be attributable to the incumbent management of the firm. • If the motive for acquisitions is under valuation. book value or sales) well below that of the rest of the industry. In the last two decades. Thus. an under valued stock is one that trades at a multiple (of earnings. 1. the current management of the firm and their poor business practices. In discounted cash flow valuation approaches. rather than to market or industry factors that are not under management control. Thus. The second is the more concrete question of how to value a target firm. How such a firm will be identified depends upon the valuation approach and model used. a cyclical firm should try to acquire counter-cyclical or. If the market price already has the control premium built into it. it has to find the appropriate target firm. the most likely target firms will be in businesses that are unrelated to and uncorrelated with the business of the acquiring firm. actions that enhance value increase cash flows from existing assets. an under valued stock is one that trades at a price well below the estimated discounted cash flow value. increase expected growth rates. growth. 2. corporate control has been increasingly cited as a reason for hostile acquisitions. there is little potential for the acquirer to earn the premium. a bank with a price to book value ratio of 1. or reduce the cost of capital.2 would be an undervalued bank.Prerequisites for Success While this corporate control story can be used to justify large premiums over the market price. after controlling for significant differences on fundamentals. and the change has to increase value. there are two key questions that need to be answered.
provides a base from which we can estimate control and synergy premiums. if the motive is tax benefits. Status Quo Valuation We start our valuation of the target firm by estimating the firm value with existing investing. This section explores the determinants of the value of corporate control and attempts to value it in the context of an acquisition. For economies of scale. the expected growth in these cash flows during a high growth period. This valuation. the target firm will be chosen to reflect the likely source of the synergy – a risky firm with limited or no standalone capacity for borrowing. especially those that they perceive to be poorly run. the target firm will be a poorly managed firm in an industry where there is potential for excess returns. Determinants of the Value of Corporate Control Mergers & Acquisitions Page 55 of 93 . In addition. although the existence of control and synergy premiums introduces some complexity into the valuation process. the typical target firm will vary depending upon the source of the synergy. In particular. starting with a status quo valuation of the firm. the target firm should be strongest in those functional areas where the acquiring firm is weak. • • Valuing the Target Firm The valuation of an acquisition is not fundamentally different from the valuation of any firm. Investors and firms are willing to pay large premiums over the market price to control the management of firms. For functional synergy. If the motive for the merger is control. the safest way to value a target firm is in steps. For financial synergy. the target firm should be in the same business as the acquiring firm. the acquisition of Security Pacific by Bank of America was motivated by potential cost savings from economies of scale. which we term the status quo valuation. a. Given the inter-relationship between synergy and control.• If the motive for acquisitions is operating synergy. b. financing and dividend policies. the choice of a target firm will reflect managerial interests rather than economic reasons. If the motive is managerial self-interest. the length of the high growth period and the firm’s cost of capital. or a firm with significant net operating losses carried forward. if the motive is increased debt capacity. Thus. and following up with a value for control and a value for synergy. the value of the firm is a function of its cash flows from existing assets. The Value of Corporate Control Many hostile takeovers are justified on the basis of the existence of a market for corporate control. its stock holdings will be widely dispersed (making it easier to carry out the hostile acquisition) and the current market price will be based on the presumption that incumbent management will continue to run the firm.
and the firm can be restructured to maximize value. The value of control can then be written as: Value of Control = Value of firm. in one form or the other. One school of thought argues that synergy is too nebulous to be valued and that any systematic attempt to do so requires so many assumptions that it is pointless. Some disagreement exists. over whether synergy can be valued and. the longer it takes for it to show up.g. Mergers & Acquisitions Page 56 of 93 . the value of control will be much greater for a poorly managed firm that operates at below optimum capacity than for a well managed firm. or a lower cost of capital (higher debt capacity).The value of wresting control of a firm from incumbent management is inversely proportional to the perceived quality of that management and its capacity to maximize firm value. if so. a longer growth period (from increased competitive advantages). It can be substantial for firms operating at well below optimal. While valuing synergy requires us to make assumptions about future cash flows and growth. when there is increased market power) or the length of the growth period? Synergy. to have an effect on value. Thus we maintain that synergy can be valued by answering two fundamental questions. higher growth potential). Since the value of synergy is the present value of the cash flows created by it. a firm should not be willing to pay large premiums for synergy if it cannot attach a value to it. what that value should be. If this is true. when there are economies of scale)? Will it increase future growth (e. optimally managed . however. c.Value of firm with current management The value of control is negligible for firms that are operating at or close to their optimal value. since a restructuring can lead to a significant increase in value. the lack of precision in the process does not mean we cannot obtain an unbiased estimate of value.. The value of controlling a firm comes from changes made to existing management policy that can increase the firm value. we can value control. the lesser its value. the financing mix can be changed and the dividend policy reevaluated..g. Valuing Operating Synergy There is a potential for operating synergy. Assets can be acquired or liquidated. since a restructuring will yield little additional value. higher expected growth rates (market power. If we can identify the changes that we would make to the target firm. In general. (1) What form is the synergy expected to take? Will it reduce costs as a percentage of sales and increase profit margins (e. (2) When will the synergy start affecting cash flows? –– Synergies can show up instantaneously. but they are more likely to show up over time. in many takeovers. has to influence one of the four inputs into the valuation process – cash flows from existing assets.
Deciding on an Acquisition Price The value determined in consideration of synergy and control represents a ceiling on the price that the acquirer can pay on the acquisition rather than a floor. if the acquiring firm plays an indispensable role in creating the synergy and control premiums. Second.3. Third. the greater the current market value of equity. if it is publicly traded. we value the firms involved in the merger independently.. we can estimate the value of synergy using an extension of discounted cash flow techniques. by adding the values obtained for each firm in the first step. They include: 1. We will consider three legitimate sources of financial synergy . by discounting expected cash flows to each firm at the weighted average cost of capital for that firm.e. Several factors.a greater “tax benefit” from accumulated losses or tax deductions. the acquiring firm should try to keep as much of the premium as it can for its stockholders. which though a widely used rationale for mergers. Consequently. with diversification. we estimate the value of the combined firm. there is likely to be little or no value gained from control. if the market price of a poorly managed firm already reflects a high probability that the management of the firm will be changed. Valuing Financial Synergy Synergy can also be created from purely financial factors. and whether to borrow any of the funds needed. is not a source of increased value by itself. whether to use stock. synergy and control built into the valuation. 3. The final step is the choice of the accounting treatment of the deal because it can affect both taxes paid by stockholders in the target firm and how the purchase is accounted for in the acquiring firm’s income statement and balance sheets. the acquisition moves forward into the structuring phase. Mergers & Acquisitions Page 57 of 93 . an increase in debt capacity and therefore firm value and better use for “excess” cash or cash slack. This division of value is unfair. If the acquirer pays the full value. The first is the decision on how much to pay for the target firm. First. the lower the potential for gain to the acquiring firm’s stockholders. with no synergy. however. prior to the acquisition: Since acquisitions have to base on the current market price. The market price of the target firm. there is no surplus value to claim for the acquirer’s stockholders and the target firm’s stockholders get the entire value of the synergy and control premiums. however. d. cash or some combination of the two. There are three interrelated steps in this phase.Once we answer these questions. For instance. i. we build in the effects of synergy into expected growth rates and cash flows and we value the combined firm with synergy. The second is the determination of how to pay for the deal. The difference between the value of the combined firm with synergy and the value of the combined firm without synergy provides a value for synergy. We will begin the discussion.3 Structuring the Acquisition Once the target firm has been identified and valued. will act as constraints.
Debt versus Equity: A firm can raise the funds for an acquisition from either debt or equity. Bradley. the benefits will be shared much more equitably. where the payment is structured in terms of a stock swap – shares in the acquiring firm in exchange for shares in the target firm. The first is to use cash balances that have been built up over time to finance the acquisition. Although the mechanics of raising the money may look the same in this case. raise cash and use the cash to pay for the acquisition. Thus. Mergers & Acquisitions Page 58 of 93 . The third is to offer stock as payment for the target firm. value is created. the sharing of the benefits of synergy among the two parties will depend in large part on whether the bidding firm's contribution to the creation of the synergy is unique or easily replaced. the acquisition of a target firm that is significantly under levered may be carried out with a larger proportion of debt than the acquisition of one that is already at its optimal debt ratio. The question of which of these approaches is best utilized by a firm cannot be answered without looking at the following factors. a decision has to be made about the following aspects of the deal. The mix will generally depend upon both the excess debt capacities of the acquiring and the target firm. Payment for the Target Firm Once a firm has decided to pay a given price for a target firm. If there are a large number of firms with cash slack and relatively few firms with high-return projects. The presence of other bidders for the target firm: When there is more than one bidder for a firm. when a firm with cash slack acquires a firm with many high-return projects. 1.33% in contested takeovers. Desai. it is important that the value of the target firm not reflect this additional debt.2. Thus. It is also possible that the acquiring firm has excess debt capacity and that it uses its ability to borrow money to carry out the acquisition. In particular. They estimated the market-adjusted stock returns around the announcement of the takeover for the successful bidder to be 2% in single bidder takeovers and -1. the odds are likely to favor the target firm’s stockholders. The second is to issue stock to the public. the bulk of the synergy benefits will accrue to the target firm. The additional debt has nothing to do with the target firm and building it into the value will only result in the acquiring firm paying a premium for a value enhancement that rightfully belongs to its own stockholders. If it is unique. 1. and Kim (1988) examined an extensive sample of 236 tender offers made between 1963 and 1984 and concluded that the benefits of synergy accrue primarily to the target firms when multiple bidders are involved in the takeover. The relative scarcity of the specialized resources that the target and the acquiring firm bring to the merger: Since the bidding firm and the target firm are both contributors to the creation of synergy. the bulk of the value of the synergy will accrue to the latter. Cash versus Stock: There are three ways in which a firm can use equity in a transaction. it has to follow up by deciding how it is going to pay for this acquisition. 3. is reflected in the value of the firm through the cost of capital. of course. This. If it can be easily replaced.
and that is the accounting treatment. we describe the accounting choices and examine why firms choose one over the other. seems to play a disproportionate role in the way in which acquisitions are structured and in setting their terms. The goodwill is then written off (amortized) over a period of 40 years. the option of using cash on hand is available only to those firms that have accumulated substantial amounts of cash. The premium paid over market value is not shown on the acquiring firm’s balance sheet. the stockholders in the target firm may be able to defer capital gains taxes on the exchanged shares. The stockholders in the target firm are also aware of this and may demand a larger premium when the payment is made entirely in the form of the acquiring firm’s stock. Mergers & Acquisitions Page 59 of 93 . Purchase versus Pooling There are two basic choices in accounting for a merger or acquisition. While this amount is generally based upon the market price at the time of the acquisition. On the other hand. with the more overpriced firm gaining at the expense of the more under priced (or at least. reducing reported earnings in each year. The perceived value of the stock: When stock is issued to the public to raise new funds or when it is offered as payment on acquisitions. In purchase accounting. the potential tax gains from a stock swap may be large enough to offset any perceived disadvantages. The final aspect of a stock swap is the setting of the terms of the stock swap. the book values of the target and acquiring firms are aggregated. since what they gain on the acquisitions can be more than what they lost in the stock issue. firms that believe their stocks are overvalued are much more likely to use stock as currency in transactions. the number of shares of the acquired firm that will be offered per share of the acquiring firm. If an acquisition qualifies for pooling. managers who believe that their stock is trading at a price significantly below value should not use stock as currency on acquisitions. the acquiring firm’s managers are making a judgment about what the perceived value of the stock is. In other words. Since this benefit can be significant in an acquisition. A fairer ratio would be based upon the relative values of the two firm’s shares. Accounting Considerations There is one final decision that. less overpriced) firm. In this section. the ratio that results may be skewed by the relative mispricing of the two firm’s securities. in our view.. Tax factors. i. The amortization is not tax deductible and thus does not affect cash flows.The availability of cash on hand: Clearly. when an acquisition is a stock swap. the entire value of the acquisition is reflected on the acquiring firm’s balance sheet and the difference between the acquisition price and the restated value of the assets of the target firm is shown as goodwill for the acquiring firm.e.
The one-time expense is not tax deductible and has no cash flow consequences. Firms seem to be willing to accept these constraints. Here. In early 1999. 3. pooling is not allowed when one of the firms is a subsidiary or division of another firm in the two years prior to the merger. another accounting choice has entered the mix. discount rates and value is making such a difference in whether acquisitions get done. It is revealing of managers’ obsession with reported earnings that a provision that has no effects on cash flows. Some firms will not make acquisitions if they do not qualify for pooling. No transactions that benefit only a group of stockholders are allowed. firms are constrained in what they can do after the merger. or they will pay premiums to ensure that they do qualify. The question whether an acquisition will qualify for pooling seems to weigh heavily on the managers of acquiring firms. such as restricting stock buybacks and major asset divestitures. In-process R&D In the last few years. claiming that many acquisitions that were viable now would not be in the absence of this provision. Stock buybacks or any other distributions that change the capital structure prior to the merger are prohibited.4 Final Considerations Mergers & Acquisitions Page 60 of 93 . In acquisitions such as Lotus by IBM and MCI by Worldcom. The potential to reduce the dreaded goodwill amortization with a one-time charge is appealing for many firms and studies find that firms try to take maximum advantage of this option. The net effect is that the firm takes a one-time charge at the time of the acquisition that does not affect operating earnings12.3. Only voting common stock can be issued to cover the transaction.For an acquisition to qualify for pooling. other than duplicate facilities or excess capacity. the top executives at high technology firms fought back. especially for acquisitions in the technology sector. Lev (1998) documented this tendency and also noted that firms that qualify for this provision tend to pay significantly larger premiums on acquisitions than firms that do not. Each of the combining firms has to be independent. The combined firm cannot sell a significant portion of the existing businesses of the combined companies. and it eliminates or drastically reduces the goodwill that needs to be amortized in subsequent periods. Furthermore. as the conditions for pooling make clear. the merging firms have to meet the following conditions. firms that qualify can follow up an acquisition by writing off all or a significant proportion of the premium paid on the acquisition as in process R&D. as both the accounting standards board and the SEC sought to crack down on the misuse of in-process R&D. just to qualify for pooling. the in-process R&D charge allowed the acquiring firms to write off a significant portion of the acquisition price at the time of the deal. the issue of preferred stock or multiple classes of common stock is not allowed.
In particular.global acts governing mergers and acquisitions . just to qualify for favorable accounting treatment. even when accounting choices have little or no effect on cash flows. the results can be expensive for stockholders in the acquiring firm. The Hart-Scott-Rodino Act of 1976 was amended on December 21. When accounting choices weigh disproportionately in the outcome. 2000. Firms will overpay on acquisitions. consequences of changed forces. The abolition of the pooling method of accounting appears to be Mergers & Acquisitions Page 61 of 93 . merger movements. regulations of tender offers .It also describes the merger performance during the 1980’s and the factors affecting mergers and acquisitions and the cross border mergers. This behavior is rooted in a fear of how much financial markets will punish firms that report lower earnings. Given the transparency of this write off (firms report earnings before and after goodwill amortization). But overcapacity in a number of industries will predictably result in consolidation mergers. largely as a consequence of the write off of goodwill. Mergers and restructuring activities accelerated through the first quarter of 2000. firms will often acquire entire firms rather than the divisions that they are interested in and defer asset divestitures that make economic sense. The rules of the games are changing as well.The managers of acquiring firms clearly weigh in the accounting effects of acquisitions. The volume of deal activities declined quarter by quarter through the first quarter of 2001. Chapter – 4 Change forces and Mergers This chapter deals with the changed forces affecting mergers. To meet the requirements for pooling. Firms will reject some good acquisitions simply because they unable to meet the pooling test or because in-process R&D cannot be written off. we believe that this fear is misplaced and the empirical evidence backs us up.
The average dollar volume of M&A activity in the United States for the years 1998 through 2000 was slightly more than $1.1.5 trillion. as shown in Table 4. All these mergers are greater than $50 billion. For both segments of the world.1 Announced M&A Activity ($ Billion) Mergers & Acquisitions Page 62 of 93 .Merger activity leveled off in 2000. As shown in Table 4. and have occurred since 1998. The Vodafone–Air Touch transaction involved a foreign (United Kingdom) acquirer. but from unusually high levels. and stock prices continued to decline during the fourth quarter.3 trillion. Merger activity in the United States and worldwide rose to unprecedented levels in 1998 and 1999. So while the pace of M&A activities may decline from the torrid levels of the late 1990s. The ninth largest transaction involved foreign T A B L E 4.2 lists the top 10 mergers in all history through January 2001. they continue to represent a major force in the financial and economic environment.likely.1. for the rest of the world the corresponding figure was somewhat more than $1. The stock market indexes reached their peak in March 2000. The rules for writing off goodwill and other intangibles are being changed. The current merger activity is a part of what has been called the fifth merger movement. the year 2000 represented a leveling off of worldwide M&A activity. the percentage increases compared with average levels in 1995 to 1997 were approximately 157 percent. This was associated with a decline in merger activity toward the end of the year. which began in 1993 and has been characterized by strategic mega-mergers. Table 4.
S. The largest of all was AOL and Time Warner. two in oils and financial services.2 Source: Thomson Financial Securities Data. To understand the reasons for the strong growth of M&A activity worldwide in recent years and whether the slowing toward the end of 2000 will continue requires some historical perspective.3 157. combining the new and old economies. T A B L E 4. Firms on both sides of the deal.2 Top 10 Merger Rank Acquirer Acquired Announcement Amount Page 63 of 93 Industry Mergers & Acquisitions .U.3 157. Domestic Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 95–97 98–00 $ Totals %Change $201 205 2 214 4 356 66 306 –14 172 –44 133 –23 132 –1 219 66 310 42 404 30 564 40 811 44 1480 82 1436 –3 1661 16 $593 1526 Worldwide $Totals $237 260 312 503 556 430 339 322 435 527 825 1003 1497 2302 3072 3180 $1108 2851 %Change 10 20 61 11 –23 –21 –5 35 21 57 22 49 54 33 4 Rest of the World $Totals %Change $36 55 53 98 78 147 50 250 70 258 3 206 –20 190 –8 216 14 217 0 421 94 439 4 686 56 822 20 1636 99 1519 –7 $515 1326 157. Five of the ten were in telecommunications. which will be placed in the Internet/media category.
9 Internet/media December 1998 78.Final May 2002) ($25 billion) () (2) Procter & Gamble buy Gillette (2005. 2001 . announced July 2006.9 Oil April 1998 72. and intensity of competition have expanded. acquiring Dreamworks for $3. announced January 2006. Ten change forces are identified: 1. $54 billion) () (3) Paramount.1 billion (4) The Walt Disney Company.6 Financial services May 1998 62. Hence markets have become international in scope. 5. sources. The pace of technological change has accelerated. Nations Bank Vodafone group AT&T AT&T Total Fina Bell Atlantic Time Warner Mobil Citicorp Ameritech Bank America Air Touch Communication Media One Group Telecommunications Elf Acquitaine GTE date ($Billion) January 2000 $165. Mergers & Acquisitions Page 64 of 93 .3 Tele communication April 1999 56. $7 billion Microsoft and Wininternals Inc. The costs of communication and transportation have been greatly 3.5 Oil July 1998 53.1 THE CHANGE FORCES The increased pace of M&A activity in recent years has reflected powerful change forces in the world economy.6 Tele communication July 1999 53.0 Tele communication June 1998 53. 4. with Compaq (Announced Sept.4 Tele communication Major Mergers & Acquisitions 2000-2006 (1) Hewlett-Packard.. The forms. 2. reduced. New industries have emerged. 4.6 Tele communications April 1998 61.6 Financial Services January 1999 60.1 2 3 4 5 6 7 8 9 10 AOL Exxon Travelers Group SBC Comm. acquiring Pixar.
Dell Computers. and the many advances in information systems. Mergers to catch up technologically are illustrated by the series of acquisitions by AT&T. Another major force stimulating M&A and restructuring activities comprises changes in industry organization. and other related activities. and medical services. 7. PC software. The next set of factors relates to efficiency of operations. Within a general environment of strong economic growth. 10. in turn. Valuation relationships and equity returns for most of the 1990s have risen to levels significantly above long-term historical patterns. The economic and financial environments have also been favorable for deal making. Andrew Grove at Mergers & Acquisitions Page 65 of 93 . computer services. including the Internet. which include personal computers. created further dynamism in industrial activities. Economies of scope refer to cost reductions from operations in related activities. Economies of scale spread the large fixed cost of investing in machinery or computer systems over a larger number of units. rising stock prices and relatively low interest rates have favored internal growth as well as a range of M&A activities. servers. the Internet. In the information industry. Inequalities in income and wealth have been widening. these would represent economies of activities in personal computer (PC) hardware. The growing forces of competition have produced deregulation in major industries such as financial services. Examples are Bill Gates at Microsoft. deregulation has taken place in other industries. has been very successful concentrating on PC sales with only limited activities in the many other segments of the value chain of the information industry. Another efficiency gain is achieved by combining complementary activities. 9. server hardware. Improvements in communication and transportation have created a global economy. software. Overriding all are technological changes. for example. problems have developed in individual economies and industries. An example is the shift in the computer industry from vertically integrated firms to a horizontal chain of independent activities. Favorable economic and financial environments have persisted from 1982 to 1990 and from 1992 to mid-2000. While regulations have increased in some areas. server software. for example. Nations have adopted international agreements such as the General Agreement on Tariffs and Trade (GATT) that have resulted in freer trade. Strong economic growth. combining a company strong in research with one strong in marketing. Individual entrepreneurship has responded to opportunities and.6. airlines. 8.
The forces in Europe have been similar to the factors in the earlier merger movements in the United States. Real-time financial planning and control information requirements have increased. Industry boundaries have become increasingly blurred. Second Merger Movement—1920s Mergers & Acquisitions Page 66 of 93 . so the merger forces in Europe are very strong.3 MERGER MOVEMENTS The foregoing describes M&A activities beginning in 1993. The knowledge and organizational capital components of firm value have increased. These impacts have expanded opportunities and risks. Distribution and marketing methods have changed. Growth opportunities among product areas are unequal. but increased in others. 4. Economic activity has shifted from manufacturing to services of increasing sophistication. The value chain has deconstructed in the sense that more activities are performed by specialist firms. Forces for vertical integration have diminished in some areas. The technological requirements for firms have increased.S. The four previous merger movements in the United States can be briefly summarized: First Merger Movement—1893 to 1904 The merger movement at the turn of the century was associated with the completion of the transcontinental railroad system. In relation to the gross domestic product (GDP). among the many. John Chambers at Cisco Systems.Intel. New industries have been created. economy. The forms and number of competitors have been increasing. and the basic manufacturing industries at the time. Changes in the organization of industries have taken place. A wide range of adjustment processes have been used by firms in response to their increasingly changing environment. oil. It created the first common market. this merger movement in the United States has thus far been of greater magnitude than any others. not just in the U. New growth opportunities have attracted such large flows of resources that unfavorable sales-to-capacity relationships have developed. Europe is experiencing similar forces from its effort at integration. telephone.2 CONSEQUENCES OF THE CHANGE FORCES The change forces are having major impacts. In the United States. The pace of product introductions has accelerated. The requirements for human capital inputs have grown relative to physical assets. 4. major horizontal mergers took place in steel. the fifth major merger movement—the era of strategic megamergers. even in new industries such as telecommunications and e-commerce. Jack Welch at General Electric. Strategy formulation and revisions are more important. The decline and failure rates of firms in some sectors have accelerated. This M&A activity exists worldwide. and Bernie Ebbers at MCI WorldCom.
Fourth Merger Movement—1980s Financial innovations. too” drugs and generics. but this is eroded by “me. Changes in the Page 67 of 93 • • Mergers & Acquisitions . which made national advertising possible. newspapers): Technological changes have impacted the relationship between the content and delivery segments. forest). Chemical Bank and Disney were both almost taken over. Chemicals. with the new planning literature. commercial banks. Also influencing this was the idea that a good manager. pharmaceuticals: Both require high amounts of R&D. Also at this time. the identity of the industries has varied at different time periods. and the automobile. It is an attractive and glamorous industry (attracted Japanese investors beginning in late 1980s). Media (movies. insurance companies). In every sample of conglomerates. A distinct group of change factors propelled each movement. However. could manage anything. So the availability of high-risk financing strongly propelled the 1980s and there was some dismantling of the diversification of the 1960s. Each of the merger movements in the United States was driven by a different set of economic and development forces. records. diversified. There is potential overlap in the content of different media outlets. Chemicals become commodities. Vertical mergers enabled manufacturers to control distribution channels more effectively. at least one-half of the companies were aerospace or natural resource–depleting companies (oil. but suffer rapid imitation. Financial (investment banks. magazines. junk bonds.This period was characterized by an increase in vertical mergers. These were associated with the development of the radio. But these movements did not occur randomly. which permitted more effective geographic sales and distribution organizations. industries like the food industries. Pharmaceuticals enjoy a limited period of patent protection. made all firms vulnerable to a takeover bid. Any company that was not performing up to its potential could be taken over. In the fifth merger movement described above. Third Merger Movement—1960s The conglomerate mergers of the 1960s represented in part an adjustment to the slowdown in defense expenditures. Globalization of industries and firms requires financial services firms to go global to serve their clients. hoping to avoid their growth being tied down to population growth. Much of the diversification at this time was ill advised as companies moved away from their core competencies. more than 50 percent of the M&A activity in a given year has been accounted for by five or six industries. The industry characteristics related to strong M&A pressures can be summarized as follows: • • Telecommunications: Technological change and deregulation in the United States and abroad (particularly Europe) have stimulated efforts to develop a global presence.
Section 13(d) of the Williams Act of 1968 required that any person who had acquired 10 percent or more of the stock of a public corporation file a Schedule 13D with the SEC within 10 days of crossing the 10 percent threshold. the quarterly report. industrial machinery: All face unique difficulties that give advantages to size. The Securities Act of 1933 has primary responsibility for recording information.4 REGULATION OF TENDER OFFERS The regulation of tender offers stems from the original Securities Acts of 1933 and 1934. Food. Autos face global excess capacity. Williams Act The Williams Act. (2) Form 10-Q. and (3) Form 8-K. the annual report. Food consumption will only grow at the rate of population growth. Section 12(j) empowers the SEC to revoke or suspend the registration of a security if the issuer has violated any provisions of the 1934 act. • • • 4. Its stated purpose was to protect target shareholders from swift and secret takeovers in three ways: (1) by generating more information during the takeover process that target shareholders and management could use to evaluate outstanding offers. • Autos. the current report for any month in which specified events occurred. (2) by requiring a minimum period during which a tender offer must be held open. The act was amended in 1970 to increase the SEC powers and to reduce the trigger Mergers & Acquisitions Page 68 of 93 . 1968. Expanding internationally offers opportunities to grow in new markets. Utilities: Deregulation has created opportunities for economies from enlarging geographic areas. and (3) by explicitly authorizing targets to sue bidding firms. Section 5 prevents the public offering and sale of securities without a registration statement. timber: Both face exhausting sources of supply. oil and gas. Problems exist in matching raw material supplies with manufacturing capacity. thus delaying the execution of the tender offer. stimulating M&A to achieve critical mass. the SEC has the power to request more information or to issue a stop order. in the form of various amendments to the Securities Exchange Act of 1934.technology of basic research and increased risks due to competitive pressures have created the stimulus for larger firms through M&As. Oil faces the uncertainty of price and supply instability due to actions of the OPEC cartel. retailing: It is hampered by slow growth. However. The basic reports are (1) Form 10-K. Section 8 provides for registration and permits the statements to automatically become effective 20 days after it is filed with the SEC. became law on July 29. New kinds of competitive forces have created needs for broadening managerial capabilities. which delays the operation of the 20-day waiting period. The SEC imposes periodic disclosure requirements under Section 13. It is the Securities Exchange Act of 1934 (SEA) that provides the basis for the amendments that were applicable to takeover activities. Natural resources.
Section 14(d) applies only to public tender offers but applies whether the acquisition is small or large. The suit against IBM. Section 13(d) provides management and the shareholders with an early warning system. The 5 percent trigger rule also applies under Section 14(d). This was the basis on which the DOJ stopped the merger between Staples and Office Depot. two are of particular interest. HART-SCOTT-RODINO ACT OF 1976 The Hart-Scott-Rodino Act of 1976 (HSR) consists of three major parts. so its coverage is broader. The Microsoft case illustrates the policies of the Department of Justice under Section 2 of the Sherman Act. An acquiring firm must disclose in a Tender Offer Statement (Schedule 14D-1) its intentions and business plans for the target as well as any relationships or agreements between the two firms. SEA Section 14(c) prohibits misrepresentation. deceptive. which had gone on for 10 years. nondisclosure. The suit against AT&T resulted in divestiture of the operating companies effective in 1984. CLAYTON ACT OF 1914 The Clayton Act created the Federal Trade Commission for the purpose of regulating the behavior of business firms. Companies made asset acquisitions to avoid the prohibition against acquiring stock. Section 5 gives the FTC power to prevent firms from engaging in harmful business practices. Basically. the DOJ turned its attention to Microsoft during the decade of the 1990s.point for the reporting obligation under Section 13(d) from 10 to 5 percent. antitrust actions were usually taken after completion of a Mergers & Acquisitions Page 69 of 93 . Under Section 2. Section 2 is directed against firms that had already become dominant in their markets in the view of the government. The FTC can block mergers if it perceives a tendency toward increased concentration—that the share of industry sales of the largest firms appeared to be increasing. Both firms were required to sign consent decrees in 1956 restricting AT&T from specified markets and requiring that IBM sell as well as lease computer equipment. or any fraudulent. any group making solicitations or recommendations to a target group of shareholders that would result in owning more than 5 percent of a class of securities registered under Section 12 of the Securities Act must first file a Schedule 14D with the SEC. SHERMAN ACT OF 1890 This law contains two sections. The 1950 amendment gave the FTC the power to block asset purchases as well as stock purchases. IBM and AT&T were sued again in the 1970s. Among its sections. or manipulative acts or practices in connection with a tender offer. As enacted in 1914. Parallel to DOJ’s suits against IBM during the 1970s. This was the basis for actions against IBM and AT&T in the 1950s. Section 1 prohibits mergers that would tend to create a monopoly or undue market control. Section 7 made it illegal for a company to acquire the stock of another company if competition could be adversely affected. Before HSR. Its objective was to strengthen the powers of the DOJ and FTC by requiring approval before a merger could take place. The amendment also added an incipiency doctrine. Thus. was dropped in 1983. Section 7 involves mergers.
The HSR process should be viewed as an educational endeavor to provide the necessary information to the government staff attorneys. The presentation should demonstrate how the industry dynamics Mergers & Acquisitions Page 70 of 93 . In the Microsoft case. The state itself does not need to be injured by the violation. Title II is a premerger notification provision.” Under Title I. In the interest of maintaining the same HSR revenue levels the amendment increases the filing fees. It is expected that the amendment will cut the number of reportable transactions in half. emphasizing the industry dynamics that make the transaction imperative for the preservation of the client as a viable entity for providing high quality products to its customers at fair prices. so it was difficult to “unscramble the omelet.000.transaction. By the time a court decision was made. The amendment increases the minimum threshold that requires filing from $15 million to $50 million and eliminates the alternative 15 percent of target voting stock threshold. A successful suit with triple damages can augment the revenues of the states. the fee will become $280.000 fee. The amendment was designed to reduce the number of transactions that require HSR notification and to increases the fees for large transactions. Title III is the Parens Patriae Act—each state is the parent or protector of consumers and competitors. it can require firms to provide internal records that can be searched for evidence. Some deals that currently are not covered would become reportable (firms with assets below the $10 million threshold that have an acquisition price over $200 million would become reportable).000. The staff attorney’s should be contacted with an offer to voluntarily provide additional information. From $100 million to $500 million. 2001. the DOJ has the power to issue civil investigative demands in an antitrust investigation. The HSR amendment increases the amount of time the reviewing agency has from 20 to 30 days. On December 21. It became effective February 1. We have seen cases in which firms were required to provide literally boxcar loads of internal files for review by the DOJ under Title I. 2000. There will now be a three-tier fee system in place of the old $45.000. The transaction threshold will be annually adjusted to follow GNP. the fee will increase to $125. Companies should follow a proactive strategy during the 30-day review period. Under the guidance of attorneys. the fee is $45. the merged firms had been operating for several years. The idea here is that if the DOJ suspects a firm of antitrust violations. It expands the powers of state attorneys general to initiate triple damage suits on behalf of persons (in their states) injured by violations of the antitrust laws. the attorneys general of 22 states joined in the suit filed by the DOJ. For transactions under $100 million. The overriding approach should be for the lawyers and executives to convey a factual. high-level business executives should be made available for informal presentations or staff interviews. For transactions that are valued at more than $500 million. This gives the individual states the incentive to increase the budgets of their state attorneys general. an amendment to Title II was signed into law by President Clinton. A briefing package should fully develop the business reasons for the merger. logical story.
supplemented by proxy statements to shareholders soliciting approval of transactions. 4. Somewhat more—47 percent of the firms—were targets of friendly takeovers. the spirit of the regulatory authorities was altered.require the transaction to enable the firm to fulfill its responsibilities to consumers. the event return results could differ also. 1999). The stock market adjustment that began in July 1998 dampened new M&A deal announcements. and its owners and creditors. THE ANTITRUST GUIDELINES In the merger guidelines of 1982. The sample accounted for about 40 to 45 percent of total deal value in most years. The selection criteria began with all M&A in which the price paid for the target exceeded $500 million. they found significant differences in the rate of M&A activity as well as in the timing of the activity. 4. The information was obtained from the Mergerstat database. the economics of industry were taken into account. 1998.” November 23. the third quarter of 1998 was still high because of deals initiated earlier. They found that in their sample of 1064 firms. Mitchell and Mulherin (1996) studied industrylevel patterns of takeover and restructuring activity during the 1982 to 1989 period. By 1997.6 INDUSTRY INFLUENCES ON M&A ACTIVITY In an in-depth analysis of industry effects. this annual number became so large that the cutoff was raised to $1 billion or more. with 11 major deals totaling $65 billion announced on “Merger Monday. The study summarized deal structure patterns and calculated event returns. employees. increasing to almost 69 percent for the first half of 1998. the courts and the antitrust agencies began to be less rigid in their approach to antitrust. The stock market began to recover in mid-October and was associated with resumption in an active M&A market. concentration tests were applied somewhat mechanical the internationalization of competition and other economic realities. the communities in which it has its plants and offices. The study ended with transactions announced through June 1998. The results reflect large transactions whose patterns are different from those of smaller transactions. In addition to the concentration measures. 57 percent were the object of a takeover attempt or experienced a major restructuring during the 1980s. The remaining 13 percent of the firms engaged in defensive asset restructuring or financial recapitalization. Of the firms involved in takeovers or restructuring. 40 percent were hostile takeover targets. The exploding number of blockbuster transactions is consistent with these data. the study captures a distinctive cycle of M&A activity. Among their 51 sample industries. Thus. For completed transactions. In the merger guidelines of 1968. 1992. Most of the M&A activity occurred in Mergers & Acquisitions Page 71 of 93 . and successively in 1987.5 MERGER PERFORMANCE DURING THE 1990s This study used a sample of 364 transactions that accounted for almost one-half of the total M&A values between 1992 and mid-1998 (Weston and Johnson. and 1996. however.
agency costs. 2. and market power. and lower leverage. coal. and drops to. like internal investment.7 percent for the United States.5 percent for the rest of the world. Their evidence supports an impact of industry shocks. hostile M&A activity is relatively small. Their basic economic finding is that mergers. This is measured by changes in the import penetration ratio. acquiring firms appear to be those with better performance. The industries with the largest change in import penetration ratios were shoes. The asset reallocation results in improved efficiency. The bidder in hostile takeovers is often referred to as a raider. Their broader framework also measures the role of other influences— synergy. and trucking industries. The number rises to 3. diversification. In contracting industries. The ability to use public markets for leveraged financing increased both the rate of takeovers and the size of takeover targets. Table 4.3 Mergers & Acquisitions Page 72 of 93 . apparel. office equipment and supplies. lower capacity utilization. 4. entertainment. broadcasting. autos and auto parts. Table 4. Many large and well-publicized hostile episodes have taken place. Their data set is based on Value Line companies and industry groupings covering the period 1970 to 1994. These shocks affected not only the oil industry but also the structure of industries in which energy represented 10 percent or more of input costs. Mitchell and Mulherin conclude that the interindustry patterns in takeovers and restructuring reflect the relative economic shocks to the industries.relatively few industries. The industries most directly affected were integrated petroleum. One major force was deregulation. owing to identifiable major shocks defined as factors causing a marked change in overall industry structure and corporate control activity.7 HOSTILE TAKEOVERS When the management and the board of directors resist the takeover attempt by bidders. which had a major impact on the air transport. A third major factor was foreign competition. natural gas. Andrade and Stafford (1999) extend the Mitchell and Mulherin results. machine tools. Their results support the view that a major influence on the takeover activity of the 1980s was a combination of broad underlying economic and financial forces. natural gas. are a response to favorable growth potentials. They find a dual role in that own-industry mergers are used in industries with excess capacity to achieve consolidation. A fourth major influence was innovations. we have hostile takeovers. tires and rubber. construction equipment. the ratio of imports to total industry supply. and steel. A second major factor was the oil price shocks that occurrence in 1973 and 1979. and trucking. air transport.3 percent. The median level of hostile M&A activity to the total worldwide value of transactions is 3.3 shows that as a percent of total value of transactions.
5 4. a bidder needs to understand the difficulties likely to be encountered and have a well-formulated plan that has a reasonable probability of success. The outcome of hostile bids is shown in Table 4. All these challenges are magnified in hostile mergers. Differences in cultural factors.7 Worldwide 14.2 1.6 5.7 22.1 1.7 6. and problems in implementing the combination of two different organizations are formidable.S.2 1.5 Source: Thomson Financial Securities Data Schwert (2000) shows the difficulty of distinguishing between hostility versus strategic efforts to increase bidder or target gains from a potential transaction.2 0. The hostile bids succeed in somewhat more than one-third of the attempts.4 1.9 0.1 7.3. the target company is sold to a third party.9 6.1 22.5 17.4 2.7 2.1 0.0 2.0 5.9 1.7 3. These factors can be broadly summarized into two categories: Mergers & Acquisitions Page 73 of 93 .3 Rest of the World 27. Considerable animosity is likely to be encountered in combining the two organizations.3 6.3 4.2 7. In somewhat under 40 percent of the cases.9 4.8 Factors affecting merger There are several factors that motivate the mergers and acquisitions.8 0.0 2.4 1. The target will not cooperate in providing information. Domestic 11.5 15.7 3.9 1.9 1.5 9.2 0.2 3. The probability of success of a hostile bid is low.1 0.5 0.4 3.2 3. the company remains independent.8 6.3 0. Given the evidence.9 3. combining companies is difficult. All empirical studies find that the returns to bidders in hostile takeovers are negative.6 6.6 4.3 3. 4.8 12.0 0.2 5. differences in information systems.3 0.8 0.Percent of Hostile M&A Activity to Total Value of Transactions Year 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Mean Median U. At best.1 3. In somewhat less than one-third of the efforts.
licenses and business restrictions to cure problems. The “big is bad” concept has been abandoned. the FASB is proposing that purchase accounting replace pooling but that goodwill should not be automatically written down. Mergers & Acquisitions Page 74 of 93 . will be a bit less restrictive. are a major factor in merger activity. Fluctuations in currencies have an impact on cross-border mergers and current conditions in the foreign exchange markets have contributed to the slowdown in merger activity. but instead should be subjected to a periodic impairment test. undoubtedly acted as a stimulant for some mergers. At this time it appears that the EU has become a bit more restrictive and the U. Arbitrageurs.. at the beginning of 2001. The availability of pooling accounting for mergers has been a significant factor in the 1990s merger activity. Now. The overall situation can be summarized: Current antitrust enforcement policies will not unduly restrain mergers in 2001. The sharp decline in the Euro during 2000 was a deterrent to European acquisitions of U. first at the end of 2000 and then in the first-half of 2001.S. with a change in administration. Currencies. a factor in assuring the shareholder vote necessary to approve a merger. companies in Asia. They have recognized that markets are global and have accepted divestitures.1. Exogenous Factors Affecting Mergers: Accounting. Antitrust. Thus. The strong dollar and weak Asian currencies led to a significant increase in acquisitions by U. Government policy can promote. retard or prohibit mergers and is a major factor affecting mergers. This method of accounting could be even more favorable for mergers than pooling in that it will avoid amortization of goodwill and not saddle the merged companies with the restrictions against share repurchases and asset dispositions that encrust the pooling rules. and the EU have been reasonably receptive to mergers. but it is not possible to gauge accurately how many deals were undertaken in 1999 and 2000 to beat the deadline. However. They will continue to be a force both facilitating and promoting mergers. An impairment charge would be taken when the fair value of goodwill falls below its book value.S. By accumulating large amounts of stock of a company to be acquired.S. They sometimes band together to encourage a company to seek a merger and sometimes to encourage a company to make an unsolicited bid for a company with which they are dissatisfied. The uncertainty as to the U. As pooling came under increasing pressure from the SEC and the FASB. Pooling avoids dilution of earnings brought about by the recognition and mandatory amortization of goodwill when a merger is accounted for as a purchase. they can be. neither significantly stimulating nor restraining mergers. companies. The recent strength in the Euro has not had time to become a factor in mergers. together with hedge funds and activist institutional investors.S. Arbitrage. and frequently are. its impending demise. The antitrust regulators in the U. accounting will basically be a neutral factor in 2001 and the foreseeable future.S. the new purchase accounting will make hostile exchange offers practical for the first time in the United States and therefore might be a greater stimulant to merger activity than presently thought.
S. With the demise of the financially motivated bust-up bids of the 1970s and 1980s. major companies have been willing to make hostile bids. The concomitant change in attitude toward cross-border mergers has had a similar effect. valuing and executing mergers has been a significant factor. Receptive equity and debt markets are critical factors in merger activity. Hostile Bids.S. utilities and radio and television in the U. employee resistance to mergers will not be meaningful. The willingness of continental European governments to step back and let the market decide the outcome of a hostile bid has opened the door and led to a significant increase in European hostile bid activity.S. Deregulation. As long as there is a vibrant job market. Experts. the U. analyzing. The general prosperity and full employment in the U. Markets. So too the availability of specialized lawyers. – has also contributed to an increase in mergers. trade deficit and the strength of the dollar portend at best slow growth of cross-border acquisitions of U. Deregulation of specific industries – like financial institutions. Labor. In the U. AT&T. The development of experts in conceiving. IBM. In addition there has been a dramatic increase in hostile bids in Europe.economy. Pfizer. in the 1990s resulted in weakened resistance to mergers by the employees of acquired companies.S. it in fact dates to the turn of the 20th Century when JP Morgan merged the Carnegie steel interests with a number of others to create U. these funds have the capability of doing major deals and will continue to be an important factor. Wells Fargo and Norfolk Southern are some of the companies that have done so. Johnson & Johnson. media and technology stocks and for five years these sectors led merger volume to new heights. With tens of billions of dollars of equity to support leverage of two to three to one.S. It should be noted that the present debate in the EU with respect to the long-pending merger legislation revolves around a last-minute attempt to require company boards to consider employees as well as shareholders prior to effectuating a merger and to authorize target companies to adopt takeover defenses. The worldwide movement to market capitalism and privatization of state controlled companies has led to a significant increase in the number of candidates for merger. and the shift to strategic transactions. LBO Funds. companies. This Mergers & Acquisitions Page 75 of 93 . consultants and accountants to provide backup and support to the managements and directors of merging companies has been a merger stimulant. The fact that global investment banks are calling merger opportunities to the attention of all the major companies in the world is a merger stimulant. The $202 billion record-setting bid by Vodafone for Mannesmann being the prime example.S. While some consider this to be phenomenon of the 1980s. Prior to mid 2000 the equity markets were very favorable for telecommunications. Steel. the success rate for strategic hostile bids by major companies has similarly led to an increase in activity. The growth of LBO funds from a humble beginning in the 1970s to the megafunds of the 1990s has been a significant factor in acquisitions. General Electric.
has dampened the merger ardor of many companies. media and technology mergers. both at attractive interest rates. Outside of the telecommunications. With the NASDAQ down more than 50% from its early 2000 highs and many telecommunications. Starting with the 19th Century railroad and oil mergers. media and technology stocks down even more. with concern that the landing will be hard rather than soft. media and technology sectors. Many of today's acquisitions involve a company with a favorable operating margin acquiring a company with a lower operating margin. that restraint on mergers will be ameliorated. While they basically determine whether a particular merger is doable at a particular time. the pending change in German tax law – to facilitate banks selling their significant stakes in German companies – is viewed as a potential stimulant to mergers in Germany. New Companies. What are the autogenous businesses reasons driving merger activity? There is no single or simple explanation and again no ranking in importance is possible. but the uncertainty as to the economy. Sharing the benefits of an improved operating margin through reduction of operating costs. Just as the explosive formation of new companies in the latter part of the 19th Century fueled the first and second merger waves. The junk bond market has virtually dried up and banks have tightened their lending standards. Autogenous Factors Affecting Mergers: The foregoing external factors are essentially beyond the ability of companies to control or even to influence significantly. a prime motivation for merger has been to gain and increase market power. merger activity has been less impacted by the decline in the securities markets.same period saw an active. Left unrestrained by government regulation it would be a natural tendency of businesses to seek monopoly power. The recent actions of the Federal Reserve in twice reducing interest rates may change market psychology and stem the fall of the equity markets. For example. media and technology stocks is that there are now many good companies with low stock market values and a need for fresh capital that may be met only through merger with a stronger company. they do not explain why companies want to merge. Experience indicates that one or more of the following factors are present in all mergers: Obtaining market power. This has resulted in a reduction of cash acquisitions. If so. growing junk bond market and ready availability of bank loans. stock mergers in these sectors are no longer readily doable and at this time there is little prospect of a return to conditions conducive to telecommunications. Taxes. A special feature of the collapse in the telecommunications. The general worldwide reduction in capital transaction taxes has lifted a restraint on mergers. the recent formation of thousands of new companies in the technology areas has fueled the fifth wave and will be a major factor in merger activity in the future. The 19th Century Interstate Commerce Act and Sherman Antitrust Act were the governmental response to the creation of trusts to effectuate railroad and oil mergers. By improving the acquired company's Mergers & Acquisitions Page 76 of 93 .
However. and joint-venture consolidation of refining and marketing operations by. Currently it has a poor record in media and entertainment. Acquiring firms may reallocate or redeploy assets of the acquired firm to more efficient uses. Over the years vertical integration has had a mixed record. and the cross-border utility mergers following the relaxation of state utility regulation. transportation and utilities are industries that have experienced mid1990s mergers as a result of deregulation. vertical integration continues to be a motivation for a significant number of acquisitions. The usual and generally least risky means of increasing global market penetration is through acquisition of. cross-border merger and acquisition activity has been steadily increasing. Response to deregulation. oil and gas companies is another example of an effort to reduce costs by eliminating overcapacity. Due to the increased globalization of product markets. Response to the global market. or joint venture with.S. healthcare. Examples are the acquisition of investment banks and insurance companies by commercial banks following the relaxation of restrictions on activities by commercial banks. insurance.S. as noted below. companies have become global in scope. Concentration of management energy and focus. The mega-mergers of. Banking. The Defense Department encouraged the consolidations to assure that its suppliers remained healthy. Additionally. and. particularly where "hardware" companies have acquired "software" companies. Integrating back to the source of raw material or forward to control the means of distribution. The acquisition of Time Warner by AOL is an example. This factor is particularly significant in the aerospace/aircraft and pharmaceutical industries. intra-industry consolidating acquisitions provide opportunities to reduce costs by spreading administrative overhead and eliminating redundant personnel. A similar situation has resulted in a large number of mergers of suppliers to the automobile manufacturers. is being widely pursued as a response to the Internet. a local partner. Sharing the costs and benefits of eliminating excess capacity. The need to spread the risk of the huge cost of developing new technology.operations. U. The advantage or necessity of having a more complete product line in order to be competitive. the acquirer creates synergies that pay for the acquisition premium and provide additional earnings for the acquirer’s shareholders. This is particularly the case for companies such as suppliers to large retail chains that prefer to deal with a limited number of vendors in order to control costs of purchasing and carrying inventory. The 1990s witnessed a recognition by corporate management that it is frequently not possible to manage efficiently more than a Mergers & Acquisitions Page 77 of 93 . The sharp reductions in the defense budget in the early 1990s resulted in defense contractors consolidating in order to have sufficient volume to absorb fixed costs and leave a margin of profit. telecommunications. money management. Many of the most important and largest product markets for U. The pressure to control healthcare costs has had a similar impact in the healthcare industry.
Current examples of industries experiencing significant consolidation are banking. information.P. The receptivity of both the equity and debt markets to large strategic transactions. advertising and oil and gas. When a series of consolidations takes place in an industry. Less management resistance to takeovers. there has been recognition that a spinoff can result in the market valuing the separate companies more highly than the whole. Response to changes in technology. the AOL and Time Warner merger is premised on convergence of media and the Internet. Institutional investors and other shareholder activists have had considerable success in urging (and sometimes forcing) companies to restructure or seek a merger. software. Larger companies have significantly higher multiples than smaller companies with the same growth rate. but spinoffs have continued as a frequently used means of focusing on core competencies. In other cases. Rapid and dramatic technological developments have led companies to seek out acquisitions to remain competitive. entertainment and shopping. So too the Mergers & Acquisitions Page 78 of 93 . When debt financing for acquisitions is also readily available at attractive interest rates. Morgan shows that size has a major impact on a company’s price earnings multiple. shareholder pressure has been the impetus for growth through acquisitions designed to increase volume. These factors resulted in the spinoff or sale of non-core businesses by a large number of companies. cable and media companies designed to place them in a position to compete in an era of high-speed Internet access via cable in which people interact with the World Wide Web for news. A recent study by J. Similarly. Banking is another example where rapid changes in technology have sparked a significant number of mergers. The recognition by boards of directors that it is appropriate to provide incentive compensation. Cogent examples are the acquisitions by telephone. companies will try to create value by using what they view as an overvalued currency. Response to industry consolidation. there is pressure on companies to not be left out and to either be a consolidator or choose the best partner. AT&T’s acquisition of cable companies reflected its strategy to use cable lines to form a network for local phone and internet services. resulting in divestitures of non-core businesses and sales of entire companies in some cases. Boards have responded by urging management to take actions designed to maximize shareholder value. The amendment to the tax law eliminating new Morris Trust spinoff/merger transactions had a dampening effect on the level of spinoff/merger activity. expand product lines or gain entrance to new geographic areas. The enhanced ability of shareholders to communicate among themselves and to pressure boards of directors has had a significant impact. For instance. Pressure by institutional shareholders to increase shareholder value. Similarly. When equity investors are willing to accept substantial amounts of stock issued in mergers and encourage deals by supporting the stock of the acquirer. companies will similarly use what they view as cheap capital to acquire desirable businesses. significant stock options and generous severance benefits has removed much of the management resistance to mergers.limited number of businesses. forest products. food.
the landscape of mergers and acquisitions from an international perspective is changing. including economic and capital raising ones. it is quite unlikely that any future waves will be dominated by US companies as they were in the past.2 trillion in 2000 from $322 billion about a decade previously. In addition. Since global scale is often necessary to boost earnings. With disparate political interests involved. From a regulatory perspective. European companies tended to conduct merger activity ‘‘in market’’ (i. At the beginning of this merger wave.ability of management to obtain a significant equity stake through an LBO has been a stimulant to these acquisitions. and European companies increasingly are looking for targets outside Europe. As the pace of European deals continues unabated. As a result. even the most routine merger or acquisition seems to have a transnational component. accounting. the growth of international transactions has created a greater need for – and has forced some – global harmonization in the legal and accounting areas. Both large and small companies must now think of global competition and cannot merely focus on their neighboring competitors. Cross-border merger and acquisition activity has been steadily increasing and is expected to continue for many years. companies often find themselves an unwilling target. The worldwide volume of mergers and acquisitions reached $3. the globalization of their clients has led to expansion of US investment bankers. was between two non-US firms. United States As more US companies engage in operations outside the US. Not only is the sheer volume of deals on the rise. As US companies realize that many of their brethren are being bought by companies outside the US. Based on the trends in the marketplace. Many of the more notable transactions have either involved parties entirely outside the United States or have involved at least one non-US party. 4. the number and size of European mergers and acquisitions had climbed gradually. some commentators predict that Mergers & Acquisitions Page 79 of 93 . they increasingly seek to penetrate local markets through acquisitions or joint ventures. they seek to acquire non-US companies to enhance the likelihood that they can compete with these non-US giants in the future. The relative importance of the US is in a steady decline based on any number of factors. Below is a brief analysis of how it is impacting various regions of the world. many mergers are intended to have worldwide implications. this is no small feat.9 THE CHANGING INTERNATIONAL M&A LANDSCAPE This is the first merger wave that can truly be called an international one. Without a global perspective. within the same country). cross-border transactions are quite common within Europe. the $180 billion Vodafone-Mannesmann transaction.e. but almost every aspect is dramatically evolving – from the viewpoints of the regulators to the corporate strategies employed. As many of the product markets for larger companies become global in scope. This is most clearly exemplified by the fact that the largest deal in history. and law firms. Now. Europe Even before it received a boost from the use of a single currency in the late 1990s.
from a valuation perspective. the Asian economic crisis caused a blip in this trend. currencies.e. undertaking a crossborder transaction is more complex than those conducted ‘‘in market’’ because of the multiple sets of laws. but by 1999 activity had rebounded. reflecting slower economic recovery and a general unwillingness to encourage foreign acquisitions. Historically. How should the transaction be financed? The financial structure of the transaction might be impacted by which country the target is in. FACTORS TO CONSIDER IN A CROSS-BORDER TRANSACTION Although the basic merger or acquisition is the same worldwide.10 Cross border mergers Cross border mergers and acquisitions are playing an important role in the growth of international production. Although this Directive was rejected by the European parliament due to the objections of a few countries. Now these political impediments are falling. In 1998.the European level of merger and acquisition activity during 2002 may surpass that of the US1. mainly as a function of the limited number of sizable companies in those continents. and as the trend to transition from control by family-owned enterprises to professional managers continues. cultures. the level of South American mergers and acquisitions activity has fallen. ``Not only they dominate FDI flows in developing countries. customs. For example. In Europe. this activity should grow as regulators recognize that elimination of restrictions on foreign investment is necessary to provide capital for their countries’ economies. 4. there has been an unprecedented sharp increase in the number of hostile takeovers during the past few years. it reflects the deregulatory attitude of many regulators and should continue to boost the level of deal activity. the level of Asian mergers and acquisitions activity has increased steadily. they have also begun to take hold as a mode of entry into developing countries and economies in transition. Other types of considerations include the change in the Mergers & Acquisitions Page 80 of 93 . As rapid economic growth continues. Other areas In 2001. Asia During the past decade. and other factors that impact the process. Acquisition activity in Australia and Africa is relatively low compared with the rest of the world. stock ‘‘flowing’’ back to the acquiror’s home jurisdiction). as reflected by the mid-2000 European Union Takeovers Directive that was loosely patterned on the takeover friendly British and US regulatory framework. hostile takeovers have been politically difficult in most European countries (with the notable exception of Britain). ‘‘flowback’’ can have a negative impact on the acquiror’s stock price and cause regulatory problems (i.
» If the transaction involves issuing stock. how will the acquiror’s stockholder base be composed? How many shares are held by cross-border investors? Does the new composition shift stockholder power dramatically? Will any of the new stockholders cause problems? » If the transaction involves debt. particularly if one is based on a code system and the other is common law. This may require disclosure of financial information to which the target’s investors are accustomed. one from the country of each party. or even a third-party country with established merger laws like the US. investors will want pro forma information to understand how the combined company will operate going forward. or to the target’s stockholders? Is the acquiror prepared to be subject to the laws of the target’s country if it issues stock in the transaction. foreign tax credit is useless to US tax-exempt investors). but which is new for the acquiror. such as those promulgated by the Federal Reserve Board in the US? How are the customs and cultures of the parties different? Before contemplating the transaction. communities. secured. and the possible change in the tax treatment of dividends that encourages the sale of the stock (e. as well as with its own shareholders. In comparison.g. the acquiror should be able to express a clear vision of how the target will be operated and funded. such as a tender offer. From a financial perspective. This will be necessary to share with the target and its employees and shareholders. How do the applicable laws govern the transaction? If the transaction is public. can the acquiror comply with any applicable margin requirements.The following are issues for an acquiror to address when structuring the transaction.’’ or whether it will be part of a regional center or managed solely from the acquiror’s headquarters. and if so. If two sets of laws are involved. it is common for both the acquiror and target to have two sets of advisors. One cultural issue is whether the target will still be managed ‘‘in country. where will the debt be issued. the parties generally must abide by the law of the country where the offer will be made. Mergers & Acquisitions Page 81 of 93 . the parties can choose which law governs if the transaction is private. and shareholders. unsecured. from ‘‘in country’’ or cross-border? What type of debt will be issued – senior. will the stock be common or preferred stock. will cash be raised by raising capital in the public markets.nature of the investments held by institutional investors caused by a stock exchange merger – these investors may be compelled under their own investment guidelines to sell newly acquired stock in the acquiror. particularly the financial disclosure laws? » After issuing stock. It is also fairly routine for non-US parties to have their own US investment banker and law firm as advisors in a transaction – even if neither party is from the US. Public relations are important in winning the hearts of the target’s employees. or mezzanine? » If the transaction involves cash. and will the stock be issued directly to the target the transaction. They can select ‘‘ground rules’’ that are the laws from either of the home countries. in which market will the stock be issued? If cash financing is obtained in the target’s country. Employees worry about overseas managers and communities wonder about loss of jobs.
Similarly. In addition to access to all financial information. banking. and if so.Even if the parties do not use the target’s country’s laws as the ‘‘ground rules. » Will the acquisition have to be approved by the target’s shareholders. or a pure US agreement? What level of due diligence is appropriate? Due diligence is critical in a cross-border transaction since there is a greater likelihood for undesirable surprises to surface after an agreement has been reached initially. will these customs be used as a shield to stall or prevent a transaction? » How difficult will it be to obtain complete financial information? Are there laws that prohibit disclosure or enable the target to share data that are not reliable? » What is the role of regulators in the target’s country? Do they have tools to effectively stall or prevent a transaction. to determine whether any benefits may be lost due to the pending change in control. without an initial tender offer)? » How will the formal merger or acquisition agreement be drafted? Will it be local to the acquiror or the target. there could be laws that pose substantial obstacles to consummating a deal.e. any other major agreements should be reviewed. There are more than a few instances of cross-border bids that have failed because the target’s government blocked the transaction to stop a company from falling into the hands of another country. It is important to establish in the formal agreement what type of due diligence is permitted and what the consequences are of finding certain types of surprises. defense contracting. in the US. For example. constitute an event of default so as to accelerate outstanding indebtedness). such as restrictions on ownership. such as licensing and joint venture agreements. will the regulatory delays make it appropriate for the acquisition to take the form of a one-step merger (i. Australia. Mergers & Acquisitions Page 82 of 93 .g.g. the President of the United States has the power to block the acquisition or to render it void after it has been completed. under the Exon-Florio provisions of the Trade Act. and if so. such as Canada. that makes the transfer of those subsidiaries difficult so that they will have to be forcibly divested to consummate the deal? » Is the target or any of its subsidiaries in a heavily regulated industry (e. or Germany. or a US agreement with one of the local laws governing. The acquiror should ensure that it has adequate access to the target’s documentation and personnel to facilitate the due diligence process. and other employee agreements to see if the target’s change in control would impose any previously undisclosed costs or obligations (e. such as requisite governmental approval under exchange control or national security laws? For example. and does the target’s country have laws that make this difficult? » Does the target have subsidiaries or do business in countries other than its home country.’’ an acquiror must consider the laws of the target in deciding whether to pursue a combination. The following are issues for an acquiror to address before a deal is struck with a target. or insurance) that requires regulatory approval. the acquiror should review the target’s loan agreements. severance plans. » Will the target insist on ‘‘in market’’ customs.
Overall. If the target is involved in operations out of its home country. and should structure the transaction accordingly. the acquiror should determine whether the target has a shareholder rights plan or poison pill. Even if a significant antitrust problem is not present. or vice versa? Are there any significant tax or currency issues? The acquiror should structure the transaction with a complete understanding of the tax implications. more than 70 countries have their own competition laws. the European Union has become quite aggressive (e. the acquiror should conduct a review of the relevant antitrust laws.e. or has a provision that requires a super-majority vote to approve mergers.The target’s charter and bylaws should be checked to see if they have any peculiar provisions that might make it more difficult for the acquiror to gain full control of the target. and there are a number of regional economic organizations that have competition law frameworks.g. dividends) or capital gain. the Hart-Scott-Rodino Antitrust Improvements Act requires a notice and waiting period unless the transaction is below specified minimal levels. blocking the General ElectricHoneywell merger). If it cannot tolerate the currency risk that is involved in the target’s operations. it may desire current income (i. In the US. Are there any significant antitrust or non competition issues? Although the US generally has the most aggressively enforced antitrust laws in the world. The following are issues for an acquiror to address before pursuing a target. This requires an analysis of the interplay of local law and tax treaties as well as the expectation of where future revenues and deductions will be derived. » To what extent do the acquiror and target compete in a line of business? » Will the acquisition substantially lessen competition in any line of business in any particular country? » What products or services does the acquiror sell to the target now. Based on the acquiror’s own tax preferences. Chapter -5 Post-Closing Challenges Mergers & Acquisitions Page 83 of 93 . The acquiror must also take care to consider the volatility of any currencies that are implicated in the transaction and ensure that it has adequate protection from downward swings in them before the transaction is closed. it may be necessary to report the acquisition in advance to a governmental agency. For example. the acquiror should consider the ongoing impact of a volatile currency after the transaction is complete.
The consequences of a weak or ineffective transition plan are the buyer’s inability to realize the transaction’s true value. A Time of Transition Post-closing challenges raise a wide variety of human fears and uncertainties that must be understood and addressed by both buyer and seller. The seller can be so accustomed to managing the business that he/she may not be open to changes in strategies or policies implemented by the buyer. And even if there is a plan.’’ particularly when the seller remains on-site in a consulting capacity or even as a minority owner. It is a time of fear. particularly for the buyer. and in some cases. Mergers & Acquisitions Page 84 of 93 . and related matters are often the most difficult part of completing a merger or acquisition. seller.The focus of this chapter is on understanding and anticipating the nature and types of post-closing challenges faced by both buyer and seller after the deal is completed. stress and frustration for most of the employees who were not on the deal team and may only have limited amounts of information regarding their roles in the post-closing organization. well they don’t always work out as anticipated. The buyer must have procedures in place to prevent the seller from undermining these transitional efforts and assume control of the company—also without ego. The need to quickly integrate the two corporate cultures also raises personal and psychological issues that must be addressed. and their respective advisors. The integration of human resources. wasted time and resources devoted to solving post-closing problems. otherwise. the accounting methods and financial practices. or politics. Many of the fears experienced by the employees of both buyer and seller result from expectations of downsizing to cut costs. the employees’ stress and distraction will affect the seller’s performance and the viability of the transaction. Estimates are as high as three out of every five M&A deals results in an ineffective plan for the external integration of the two companies. and achieve the economies of scale potential provided by the transaction. has just begun. Often one of the greatest challenges for the buyer is the postclosing integration of the two companies. The closing of a merger or acquisition usually brings a great sigh of relief to the buyer. But the term closing can be misleading in that it suggests a sense of finality. emotion. the uncertainty associated with the change will likely lead to widespread insecurity and fear of job loss at all levels of the organization. Once word of a deal leaks out to employees. Post-closing challenges may arise in a wide variety of subject areas. emotion. avoid duplication. when in truth the hard work. even litigation. the operating and management information systems. Everyone has worked hard to ensure that the process went smoothly and that all parties are happy with the end result. Another common problem is the psychological consequences of ‘‘seller’s remorse. the corporate cultures. The fear of the unknown experienced by the employees of the seller must be addressed and put to rest. The seller must facilitate smooth transition of ownership and management to the buyer’s team without ego. or politics.
An April 2005 report published by Challenger. This is the greatest source of employee fear and is the fuel that powers the rumor mill. Management is often party to employment contracts. while staff can be protected by union contracts and/or federal or state employment laws. The biggest cuts came in the telecom and high tech industries. Management In many ways. These sellers often want the benefit of the bargain but seem unwilling to accept the burden of the bargain and relinquish control of the company. In attempting to realize the true value of a merger or acquisition. This should have been examined during the due diligence process and worked into the pricing for the transaction. if the terms dictate that the acquired firm is to maintain its independence. it is more likely that earnings projections will be met or exceeded. and other issues. Not consideration of all candidates fairly may result in a lower return on the investment. places. The first step in determining staffing levels is to divide the workforce into management and staff/labor. On the one hand. management staffing is a much easier problem to resolve. Important issues that need to be managed fall into three areas—people. if the acquired firm is absorbed into the acquirer. But some of these fears are valid.1 Staffing Levels and Other People Problems One of the primary areas that an acquiring company looks to in order to realize the projected return on its investment is the new company’s level of staffing. and in what positions. If a certain number of employees can be eliminated. it is much more difficult to reduce staffing levels. These problems are particularly common in mergers where the management and flow of the deal may be one of shared objectives and values as opposed to an acquisition that more clearly has a designated quarterback. staff cutbacks are probably appropriate and healthy.000. These two groups must be distinguished because the terms of employment are often quite different. the chances for for not fully realizing success are greatly increased. and who goes. Most require forethought in order to anticipate potential pitfalls. The hard part is deciding who stays. but it is not a bad idea to involve the acquired company as well. and things.The seller undermines the buyer’s efforts or contradicts its authority. The primary task of resolving the level of management staffing is to determine where there are redundancies and who the most qualified candidates are. over six times the rate of the last quarter of 2004 and three times the rate of the first quarter of 2004. stock options. 5. Some issues are addressed in the closing documents. the buyer must coordinate a smooth and efficient post-closing process. Mergers & Acquisitions Page 85 of 93 . Only in this way can a true evaluation be made. Such a process is normally driven by the acquiring company. Most employment agreements and/or management benefits can be quantified to determine the cost of such decisions. On the other hand. The bottom line is that if the buyer doesn’t plan to address the following issues. Gray & Christmas recommended that job cuts following M&A deals in the first quarter of 2005 soared to nearly 77. Much of this depends on the nature of the acquisition. and receives deferred compensation.
employees on matters of wages. Make sure that the applied criteria are documented and objective and are supported by a performance evaluation and that any review of personnel files and performance evaluations is confidential. or sex discrimination for which the buyer may be held accountable under civil rights legislation. While change can be difficult. Be honest. which protects the rights of union. Mergers & Acquisitions Page 86 of 93 . The buyer shortchanges itself by not doing so. which may or may not be consistent with staffing plans after the acquisition. • Employees on family leave workers ’ compensation. a formal evaluation of all candidates can lead to a stronger. it should not prevent the buyer from evaluating all employees.All candidates must be evaluated objectively. Once the selections are made. The same rules apply to evaluating labor as to evaluating management. the buyer gains a much better sense of the quality of the workforce that does ultimately remain. This limits the options available when deciding who should stay and who should go. as well as nonunion. • Union contracts that could fall under the National Labor Relations Act (NLRA). which must be sent 60 days in advance by the seller to its employees if there is a plan to close facilities. • Race. Be objective. Labor Labor is often protected by union contracts and labor laws. • WARN (Worker Adjustment and Retraining Notification) notices. This may require the formation of a review committee made up of representatives from each organization to ensure that the terminations occur according to agreed upon procedures. which has certain rights to comparable positions upon their return to work. choosing the incumbent management team is an easy decision. However. and working conditions. The following is a list of legal considerations to be examined: • Employment agreements that may contain conditions that are unacceptable to the buyer or conditions that may be triggered in the event of a merger or acquisition. religion. more diverse team. It is often difficult to do so because emotions often cloud the judgment of the evaluators. which protects workers against changes in the workforce or changes in benefit plans that would discriminate against workers over 40 or make age-based distinctions. By evaluating first and then worrying about possible protections. or disability. they must be examined from a legal point of view. • Whistle-blowers who could bring claims of wrongful discharge. Be balanced. However. For the acquiring company. even if claims are filed based on events that occurred before the acquisition. hours. it is necessary to embrace the change inherent in acquisitions to enhance your chances of success. Develop a selection methodology by targeting certain employees for layoff or retention based on performance and experience. • Age discrimination under the Age Discrimination in Employment Act (ADEA) and/or Older Workers Benefit Protection Act (OWBPA).
there is a limit to the amount of losses that make financial sense. As a result. one of the most valuable assets is the customer base. It makes little sense to keep a customer if it is not possible to make a profit on the relationship. is for the seller to transfer the goodwill of its customers to the buyer. is a distinction between essential and nonessential duties and a review of property leases to determine who is responsible (the lessee or the lessor) for renovations required under the ADA. • Whether state law counterparts to federal employment laws have precedence. requires a review of job descriptions to ensure that there. A disgruntled employee can very quickly destroy this goodwill and perhaps jeopardize a significant income stream on which the value of the acquisition was based. This entails all manner of documents related to such issues. especially concerning the determination of exempt versus nonexempt positions. • Lack of compliance with the Drug-Free Workplace Act and various government contract laws can lead to suspended payments or terminated contracts for a seller that is a federal government contractor. even in these cases. thereby enabling other customers to be profitable. • To ensure that the employees being acquired are legally able to work in the United States. the customer may be a direct competitor of the buyer or of one of the buyer’s customers. In addition. it is important to evaluate the seller’s customer base. among other things. • Problems that could develop under the Occupational Health and Safety Act (OSHA) if current compliance is not verified and the cost of future compliance is not factored into operating results. the burden of compliance is on the employer under the Immigration Reform and Control Act (IRCA). The bottom line is that the buyer needs to conduct a thorough labor and employment review. However. unless the customer enables the merged company to penetrate a new market or if the customer helps achieve scale economies. • Violations of the Fair Labor Standards Act (FLSA) or Equal Pay Act. a violation in this area could lead to substantial payments to current and former employees for overtime worked but not paid. which. It may be necessary to discount the value of the acquisition to account for a customer base that is unprofitable or duplicative and that provides little additional strategic value. however. Perhaps more important. One of the post-closing challenges is to determine the profitability of the customers. The key steps to transferring this goodwill are: • • • Personal introductions to customer contacts Social events to acquaint customers with the new owners Letters from both the seller and buyer that thank customers for their business and announce the new management and plans for the merged entity Mergers & Acquisitions Page 87 of 93 . Often the acquired company has legacy customers that they have been unwilling or unable to terminate if the customer is unprofitable or difficult to manage.• Compliance with the Americans with Disabilities Act (ADA). The acquirer should review all customers for profitability and sustainability. Each transaction is unique in that the above issues will apply in differing degrees. Customers When a buyer acquires a business.
there must also be human considerations. and lawyers. Since this is often true. Of special importance are suppliers that provide professional services—in particular. subject to any potential conflicts of interests being resolved. In addition. the bankers may not have the appropriate expertise. Essential vendors are a key component of the continued success and uninterrupted operations of a company. there are certain suppliers whose replacement would cause significant disruption. As a result. When examining the space requirements of the combined entity. The accountants of the seller may be providing outsourcing of certain tasks for which it may not be practical to change immediately. The space should be evaluated to determine if the rent is more or less expensive than other company space and if the amount of space is more than is needed. After all. This will go a long way toward helping to cut expenses in order to reach the target return. we can reduce the staff by x percent. rent and/ or lease payments are a natural place for a buyer to focus on when evaluating the efficiencies to be gained by a merger. total square footage can be reduced by x percent. These factors should be considered carefully before any key relationships are terminated. bankers. accountants. If a buyer is purchasing a business in a different industry. the staff has x percent more square footage per employee than our company. However. it is certainly helpful to consider the square footage. But very few decisions in a merger or acquisition can be resolved with a simple mathematical equation. it is necessary for the buyer to conduct a thorough review of the existing suppliers to ensure that the seller is getting the best prices and terms. This can occur in situations where there is only one supplier of a given product or service. 5. thereby saving $x. This has to be accounted for when looking at space. or if the supplier is an integral part of a just-in-time inventory system. Ultimately. any vendor can easily be replaced. The legal counsel of the seller may be better suited to deal with certain local matters or be more cost-effective. just as much as when examining staffing levels. The standard assumption is that the combined company will use the buyer’s professional suppliers. but this may not always be desirable or feasible. However. it may be best to continue to use both firms for certain purposes.Vendors Suppliers are much more often overlooked than customers. and with people come emotions and unpredictability. There usually are people involved. which means that we need x percent less of square footage in which to work. It would seem to be an easy issue to resolve: In acquiring this company. How long have the employees been in this space? How does the commute compare to where they might be relocated? How much interaction is required between the staff being relocated and staff in a different location? How much reconfiguration of the office and facilities of each company will be required to accommodate additional staff or functions? How much productivity can be expected from these people during the course of the move? Mergers & Acquisitions Page 88 of 93 .2 Problems Involving Places Often one of the larger expenses on the income statement.
Most. industry group identification. A corporate identity defines what makes a corporation unique. The company name and logo are merely manifestations of that identity. there are many legal and administrative tasks that must be accomplished by the acquisition team to complete the transaction. it may be important to consider a new corporate identity in the form of the company name and/or logo. and how it is different from other corporations. it only stands to reason that the merged entity is different from what existed before. 5. In an asset acquisition. management Mergers & Acquisitions Page 89 of 93 . and direction. This may seem obvious. it must be determined what the corporation stands for. employees. Location is a factor that can effect the overall integration of the buyer by the seller and can lead to significant turnover. Since there is essentially a new company. The key is to identify what changes have occurred and respond to them by shaping the image or identity that is communicated to the public. of these aspects are altered in some way as the result of a merger or acquisition. It is taken very personally by many employees. There are several aspects of a corporation that go into its identity. and suppliers • Adjustments to bank accounts and insurance policies In addition to the above. Yet this is a point that can often be forgotten when it comes to corporate identity.3 Corporate Identity Now that the two companies have become one. depending on the size and type of the financing method selected by the purchaser. Only then does it make sense to put a name on it and identify an image with it. Our suggestion is to take steps to maximize your efficiency of space and property but to do so considering the human elements of the changes. distributors. The parties to any acquisition must be careful to ensure that the jubilation of closing does not cause any post-closing matters to be overlooked.4 Legal Issues Following the closing of the transaction. a stock acquisition may also include the following: • Filing articles of amendment to the corporate charter or articles of merger • Completion of the transfer of all stock certificates • Amendments to the corporate bylaws • Preparation of all appropriate post-closing minutes and resolutions Such actions require legal counsel familiar with the issues of corporate governance and intellectual property.Non-consideration of these and other related questions can open up a can of worms. customer base. customers. if not all. 5. These include market share. While the buyer’s legal counsel attends to these matters. Before such issues can be decided. where it is going. The nature and extent of these tasks will vary. these post-closing tasks typically include the following: • Final verification that all assets acquired are free of liens and encumbrances • Recording of financing statements and transfer tax returns • Recording of any assignments of intellectual property with the Library of Congress or Patent and Trademark Office • Notification of the sale to employees. but the real issue goes much deeper.
This means that you want to first communicate that information that affects people directly. and reporting structure. of course. a lack of communication typically means a lack of success. Well. It is a bit disconcerting to walk the halls in an organization and not know people. It also helps in the socialization process among the employees. As with any relationship. There will be fear on the part of employees. Information should be communicated in the order of its importance. works best. is more difficult as organizations grow larger. that’s how it feels for all the employees of an acquired company. especially who is staying and who is leaving • Reporting structures • Job descriptions and responsibilities • Title. along with an important person from the buyer’s side. If possible. The next most important information is the introduction of the new management team and the transition to new managers and employees. have the prior manager make some kind of handover to the new. A trusted person from the seller’s side. This will assist in the transition and add credibility to the process. is communication. In a merger. By making an effort to introduce the key players. Finally. think of the amount of communication that is necessary in the first few weeks and months of such a relationship. 5. If a merger is thought of as the beginning of a marriage.can more readily focus on the other aspects of the business combination for which they are better qualified and more effective. as relates to such things as job security. They can place a name with a face and know who is being referred to in discussions. the person doing the communicating is also important. Think of how it feels on the first day of a new job. This can help overall efficiency because employees will be focusing on doing their job rather than wondering who someone is and how that person might affect their career. people are more comfortable. compensation. As a result. which in turn contributes to efficiency! This. the two keys to effective communication are to determine (1) the importance of the information and (2) who should communicate it.5 Minimizing the Barriers to Transition No matter how hard you try and how well you anticipate the issues that need to be addressed. workplace location. it is important to be aware of the various aspects of change management and address them as well. communicate the new reporting structure and have individual managers introduce the two sides when there will be day-today interaction. The primary emotion that will be encountered in dealings with various groups will be fear. But you may also have to deal with fear on the part of customers (the buyer may discontinue a product line) and suppliers (the buyer may already have someone to supply that good). including changes in: • The organization. and many of the other emotions that surface during the course of acquisition transition. Communication The primary tool for dealing with fear. Some kind of Mergers & Acquisitions Page 90 of 93 . and benefits • Job location and operating procedures As a result of the importance of this information. the natural response of most people is to avoid change.
as viewed by the seller’s employees. which needs to be defined and communicated early. it is often helpful to give the task force a set life at its beginning—60 or 90 days—and to evaluate the situation at that time. The task force can also be used to organize the information that needs to be communicated to the new employees. The role of the task force is best kept simple. and procedures. Once its work is completed. Creating the dialogue and organizing the information serve to help reduce or eliminate the fear.6 Post-Merger Task Force One of the tools through which communication can be made more effective is a postmerger task force. The amount of information to be communicated can be overwhelming. The first sign that the end of the task force’s life is near is when all the information deemed to be important in relation to the merger has been disseminated. Failure to do so will limit its effectiveness and call into question the resolve of the new organization. Such an entity should be composed of a representative group from both sides of the transaction and should be formed after the due diligence process. can go a long way in making everyone more comfortable with the new faces. people will not take the task force seriously. Mergers & Acquisitions Page 91 of 93 . and resolve post-merger problems. and the way it is communicated can also cause problems. This is easier said than done. especially those that interact regularly. the CEO should probably avoid making him or herself a member. as it is much easier to say when the merger activity begins than to define when it is over. Nonetheless. The composition of the task force has a bearing on its effectiveness and the integrity of the buyer. If one of the members from the seller’s side is an employee who is not respected by the majority of the workforce. The importance of effectively communicating the role of the task force cannot be emphasized enough. The task force can serve to communicate the issues in order of importance and to address them accurately. This helps prevent the grapevine from disseminating erroneous information. 5. when it is determined that the value of the task force has been expended and it is now time to get to work to realize the true value of the combination. is to uncover. In this way. a dialogue can be opened and people will get the impression that actions are being taken to address concerns. the task force must be dissolved. An additional indication is the amount of information flowing back from the employees to the task force has significantly waned. In a very real sense this is the first operating decision to be seen by the seller’s employees and thus it will greatly influence the new employees’ perception of the acquiring organization.group meeting or social gathering among the employees of various departments. evaluate. functions. The final call will come from the CEO. The role of such a group. An honest assessment of those being considered for the task force will go a long way toward establishing its credibility. As a result. It can serve as a conduit from labor to management to resolve problems that arise during the course of the merger.
and picking the right people for the job. 1967) Mergers & Acquisitions Page 92 of 93 . By planning properly. But the importance of these issues in the success of a business combination cannot be overemphasized. This will require assembling a team with proven implementation skills and a desire to see the transaction work.A. paying attention to the details. a buyer will gain confidence in its ability to successfully integrate the seller into its operations. This will serve to encourage further growth through mergers and acquisitions. The sheer number of issues that need to be addressed can seem overwhelming at first glance.The importance of a well-planned and smooth post-closing transition cannot be emphasized enough. Without the proper attention to these matters. the value of the transaction may never be realized. Weinberg. takeover and Amalgamations (London: Sweet and Maxwell Publishers. BIBLIOGRAPHY M.
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