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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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Weinberg. takeover defenses both premature and reactive have been restored to by the companies. Amalgamation Amalgamation is an arrangement or reconstruction.A.• Equity buyback: This involves the company buying its own shares back from the market. Anti takeover defenses: With a high value of hostile takeover activity in recent years. the shareholder of each blending companies becoming substantially the shareholders of company which will carry on blended undertaking. As a result. The survivor company acquires assets and liabilities of merged 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. and (ii) Amalgamation in the nature of purchase. issued by the Institute of Chartered Accountants of India has defined the term amalgamation by classifying (i) Amalgamation in the nature of merger. In case of amalgamation a new company may came into existence or an old company may survive while amalgamating company may lose its existence. 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. AS-14. 1967) Mergers & Acquisitions Page 4 of 93 . • • Merger is a marriage between two companies of roughly same size. 2 M. This strengthens the promoter’s position by increasing his stake in the equity of the company. 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. It is a legal process by which two or more companies are to be absorbed or blended with another. 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. According to Halsbury’s law of England amalgamation is the blending of two or more existing companies into one undertaking. takeover and Amalgamations (London: Sweet and Maxwell Publishers. 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. the amalgamating company loses its existence and its shareholders become shareholders of new company or the amalgamated company. The Accounting Standard.
immediately before the amalgamation. after the amalgamation. The business of the transferor company is intended to be carried on. 1. It is defined as the one which does not satisfy any one or more of the conditions satisfied above. Mergers & Acquisitions Page 5 of 93 . 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. It is defined as an amalgamation which satisfies the above conditions3. All the properties of amalgamating company(s) should vest with the amalgamated company after amalgamation. by the transferee company. after amalgamation. 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. • • Amalgamation in the nature of merger: As per AS-14. merger is defined as amalgamation under sec.2 (1B) with the following three conditions to be satisfied. 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. the assets and liabilities of the other company. by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation. All the liabilities of the amalgamating company(s) should vest with the amalgamated company after amalgamation. except that cash may be paid in respect of any fractional shares. 2.1. 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. • • • 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. 2. As per Income Tax Act 1961.
. An example of this type of merger is the absorption of Tata Fertilisers Ltd. ceased to exist. the acquired company transfers its assets. an acquiring company (a buyer). exchange of shares with 90%of shareholders of amalgamating company is required.. According to Income tax Act. and Indian Reprographics Ltd. Mergers & Acquisitions Page 6 of 93 . but there may be change in control of companies. liabilities and shares to the acquiring company for cash or exchange of shares. c) By purchasing shares of the other company at a stock exchange. to an entirely new company called HCL Ltd. Laws in India use the term amalgamation for merger. Consolidation A consolidation is a combination of two or more companies into a new company . 1. 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.(TFL) TCL. liabilities and shares to TCL. 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. All companies except one lose their identity in a merger through absorption. • • Merger through absorption Merger through consolidation Absorption An absorption is a combination of two or more companies into an existing company. 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. all companies are legally dissolved and a new entity is created. 1. an acquired company ( a seller).2. An example of consolidation is the merger of Hindustan Computers Ltd. TFL transferred its assets. separate legal entity.3. Hindustan Instruments Ltd.In this type of merger. survived after merger while TFL.. Thus in acquisition two or more companies may remain independent. to the existing shareholders of that company. By entering into an agreement with a person or persons holding b) By subscribing new shares being issued by the other company. and d) By making an offer to buy the shares of other company.1 Merger Merger refers to a situation when two or more existing firms combine together and form a new entity.2 Acquisition Acquisition refers to the acquiring of ownership right in the property and asset without any combination of companies. In a consolidation.
3. The recent takeover of Modi Cements Ltd. the target firm and the acquiring firm. 1. N. usually by buying all or majority of shares.2. individual. Takeover is a general term used to define acquisitions only and both terms are used interchangeably. Sridharan and P. A Takeover may be defined as series of transacting whereby a person. Mergers & Acquisitions Page 7 of 93 . These mergers are motivated and the lead bank takes the initiated and decides terms and conditions of merger. R. group of individuals or a company acquires control over the assets of a company. either directly by becoming owner of those assets or indirectly by obtaining control of management of the company4. by one company of controlling interest of the other. The fourth kind is the bail-out takeover. The second type of takeover is where ownership of company is captured to merge both companies into one and operate as single legal entity. Guide to Takeover and Mergers (Nagpur: Wadhwa and co. 4. 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. 1997 issued by SEBI which regulate the bail out takeover. 1992). H. 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 may be of different types depending upon the purpose of acquiring a company. 1. Arvind Pandian . In India. These merger schemes are framed in consultation with the lead bank. 1985.2 Takeover Acquisition can be undertaken through merger or takeover route. Takeover is acquisition. was an arranged takeover after the financial reconstruction Modi Cement Ltd. 2. A third type of takeover is takeover of a sick company for its revival. 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. This is accomplished by an order of Board for Industrial and financial Reconstruction (BIFR) under the provision of Sick Industrial companies Act. By Gujarat Ambuja Cement Ltd.3 .
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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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. Horizontal mergers are designed to produce substantial economies of scale and result in decrease in the number of competitors in the industry.e. In case of horizontal merger. If a company takes over its supplier/producers of raw material. Vertical merger may result in many operating and financial economies. 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. Forward integration may result if a company decides to take over the retailer or Customer Company. was a horizontal merger. the top management of the company being meted is generally. Here the object is usually to Mergers & Acquisitions Page 11 of 93 . One potential repercussion of the horizontal merger is that it may result in monopolies and restrict the trade. with the Hindustan lever Ltd. In recent years. they tend to create the greatest concern from an anti-monopoly point of view. 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. “A takeover of merger is vertical where one of two companies is an actual or potential supplier of goods or services to the other. Horizontal merger: It is a merger of two or more companies that compete in the same industry. replaced. As horizontal takeovers and mergers involve a reduction in the number of competing firms in an industry.. The merger of Tata Oil Mills Ltd. It is a merger with a direct competitor and hence expands as the firm’s operations in the same industry.” 2. on the other hand horizontal mergers and takeovers are likely to give the greatest scope for economies of scale and elimination of duplicate facilities. 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). On the other hand. then it may result in backward integration of its activities. from the acquisition of raw material to the relating of final products). the great majority of takeover and mergers have been horizontal. 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).
In a pure conglomerate. research and development and technology. Western and Mansinghka9 classified cogeneric mergers into product extension and market extension types. The potential benefit from these mergers is high because these transactions offer opportunities to diversify around a common case of strategic resources8.. anti-monopoly problems may arise. and Xpro Ltd. Mergers & Acquisitions Page 12 of 93 . cit. For example. op.ensure a source of supply or an outlet for products or services.H. Weinberg and M V Blank. market participants or technologies of the acquiring companies.1992) 7 M. there is some degree of overlap in one or more of this common factors. Co generic Merger: In these.A. but the effect of the merger may be to improve efficiency through improving the flow of production and 6 N. When a new product line allied to or complimentary to an existing product line is added to existing product line through merger. These mergers represent an outward movement by the acquiring company from its current set of business to adjoining business. however there is a degree of concentration in the markets of either of the companies. marketing.Guide to takeovers and mergers (Nagpur: wadhwa and co. Conglomerate merger: These mergers involve firms engaged in unrelated type of business activities i.10 Conglomerate mergers are unification of different kinds of businesses under one flagship company.pp.5 Reducing stock holding and handling costs. contains elements of both product extension and market extension merger. there are no important common factors between the companies in production. The acquiring company derives benefits by exploitation of strategic resources and from entry into a related market having higher return than it enjoyed earlier. production processes or markets. the business of two companies are not related to each other horizontally ( in the sense of producing the same or competing products). is a Product extension merger and merger between GMM Company Ltd. it defined as product extension merger. In practice. merger between Hindustan Sanitary ware industries Ltd. where. Both these types bear some common elements of horizontal. The purpose of merger remains utilization of financial resources. and associated Glass Ltd. mergers the acquirer and target companies are related through basic technologies. however.” 3. Similarly market extension merger help to add a new market either through same line of business or adding an allied field .e. sridharan and P. nor vertically( in the sense of standing towards each other n the relationship of buyer and supplier or potential buyer and supplier). Para 167. Arvind Pandian .R. 4. The acquired company represents an extension of product line. vertical and conglomerate merger.
Rather. Shriram Industrial Enterprise Ltd. Demerger or spin-off.. A part from core competencies being main reason for demerging companies according to their nature of business. Masinghka.8 P. (ASE) has made ASE big conglomerate which had become unwieldy and cyclic. “Tests of efficiency performance of enlarged debt capacity and also synergy of managerial functions. with Ambalal Sarabhai enterprises Ltd. pursuant to a demerger to a resulting company. liability and management so as to ensure improved results from each of the demerged unit. DCM shriram industries Ltd. according to Section (19AA) of Income Tax Act. so demerger of ASE was done. in some cases. However these transactions are not explicitly aimed at sharing these resources. 9 F.e.Lorange. the desire to perform better and strengthen efficiency. restructuring in the form of demerger was undertaken for splitting up the family owned large business empires into smaller companies. Corporate restructuring in such situation in the form of demerger becomes inevitable. western and K. demerger also occur due to reasons almost the same as mergers i. J. E Kotlarchuk and H Singh. Such demergers are accordingly. As the same suggests. This occurs in cases where dissimilar business are carried on within the same company. and DCM shriram consolidated Ltd. Merger of SG chemical and Dyes Ltd. technologies.S. business interest and longevity and to curb losses. It does not have direct impact on acquisition of monopoly power and is thus favored through out the world as a means of diversification. The historical demerger of DCM group where it split into four companies (DCM Ltd. 1.5 Demerger It has been defined as a split or division. more in the nature of family settlements and are affected through the courts order. synergies or product market strategies. 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. Mergers & Acquisitions Page 13 of 93 .. wastage and competition. “Corporate Acquisitions: A strategic perspective in the management Acquisition”. Thus. it denotes a situation opposite to that of merger. thus becoming unwieldy and cyclical almost resulting in a loss situation.) is one example of family units splitting through demergers. 1961 means the company whose undertaking is transferred. Demerged Company. Undertakings demerge to delineate businesses and fix responsibility. as called in US involves splitting up of conglomerate (multi-division) of company into separate companies.
constituted or formed as a result of demerger. Para 107. While evaluating a merger proposal. From time to time. 1. Approval of the draft amalgamation proposal by the Respective Boards: The draft amalgamation proposal should be approved by the respective boards of directors. copies of all notices.A.Blank op. boards of directors and Company Law Board are required. Weinberg. and M. (including a wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger. Examination of object Clauses: The memorandum of association of both the companies should be examined to check if the power to amalgamate is available. 5. 1956 contain the provisions for amalgamations. The procedure for amalgamation normally involves the following steps: 1. according to Section2(47A) of Income Tax Act.If such clauses do not exists. a notice and an explanatory statement of the Mergers & Acquisitions Page 14 of 93 . The board of each company should pass a resolution authorizing its directors/executives to pursue the matter further.1961 means one 10 M. Intimation to stock Exchanges: The stock exchanges where the amalgamated and amalgamating companies are listed should be informed about the amalgamation proposal.V. 2. 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. Sections 391 to 394 of the companies act. involving fairly complex legal considerations. 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. one should bear in mind the following legal provisions. or more company. 4. resolutions. cit. necessary approvals of the shareholders. and orders should be mailed to the concerned stock exchanges.Resulting company.6 Merger Procedure: A merger is a complicated transaction. the object clause of the amalgamated company (transferee company) should permit it to carry on the business of the amalgamating company (transferor company ) . Further. Application to the National Company Law Tribunal (NCLT): Once the draft of amalgamation proposal is approved by the respective boards. 3. Dispatch of notice to shareholders and creditors: In order to convene the meeting of shareholders and creditors. pp 5 .
Transfer of Assets and Liabilities: After the final orders have been passed by the NCLT. At least 75 percent (in value) of shareholders in each class. all the assets and liabilities of the amalgamating company will. the NCLT is empowered to modify the scheme and pass orders accordingly. 394 of the companies Act. 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. Particulars about transferor and transferee companies Mergers & Acquisitions Page 15 of 93 .meeting. There is no specific form prescribed for the scheme. 1956: 1. 7. 6. after fulfilling the provisions of the law. Petition to the NCLT for confirmation and passing of NCLT orders: Once the amalgamation scheme is passed by the shareholders and creditors. 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. 10. The NCLT will fix a date of hearing. who vote either in person or by proxy. must approve the scheme of amalgamation. should issue shares and debentures of the amalgamated company.6. Holding of Meetings of shareholders and creditors: A meeting of shareholders should be held by each company for passing the scheme of amalgamation. A notice about the same has to be published in two newspapers. the companies involved in the amalgamation should present a petition to the NCLT for confirming the scheme of amalgamation. 9. After hearing the parties the parties concerned ascertaining that the amalgamation scheme is fair and reasonable.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. with effect from the appointed date. 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. 8. as approved by the NCLT. Issue of shares and debentures: The amalgamated company. Important elements of merger procedure are: 1. Likewise. The new shares and debentures so issued will then be listed on the stock exchange. the NCLT will pass an order sanctioning the same. However. have to be transferred to the amalgamated company. in a separate meeting. the creditors of the company must approve of the amalgamation scheme. The notice of the meetings should also be published in two newspapers (one English and one vernacular). should be dispatched by each company to its shareholders and creditors so that they get 21 days advance intimation.
Qualifications attached to the scheme which requires approval of different agencies.2. 8. appointed date of merger 3. Enhancement of borrowing limits of transferee company when scheme coming into effect. Transferor company’s staff. superannuation fund or any other special funds created for the purpose of employees. Share capital of Transferor Company and Transferee Company specifying authorized. Miscellaneous provisions covering Income Tax dues. 9. 13. workmen. 1956 to their respective High court. contingent and other accounting entries requiring special treatment. Treatment of expenses connected with the scheme. Effect of non receipt of approvals/sanctions etc. any condition attached thereto and the fractional share certificate to be issued. Terms and conditions of carrying business by transferor company between appointed date and effective date 7. 11. Proposed share exchange ratio. employees and status of provident fund. 17. Terms of transfer of assets and liabilities from transferor company to transferee company 4. Issue of shares by transferee company 10. issued. 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. Mergers & Acquisitions Page 16 of 93 . Commitment of transferor and Transferee Company towards making an application U/S 394 and other applicable provisions of companies Act. 15. Treatment of specified properties or rights of transferor company 6. Effective date when scheme will came into effect 5. 16. 14. subscribed and paid up capital. 12. Gratuity fund. Description of power of delegates of Transferee Company to give effect to the scheme.
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.1. so arrived at. Ascertainment of liabilities 3.) replacement cost (plant and machinery) or scrap value (obsolete machinery). Broadly there are three(3) methods used for valuation of business: 1. While the past financial performance serves as guide. Yield Value Method This method also called profit earning capacity method is based on the assessment of future maintainable earnings of the business. These net profits are divided by appropriate capitalization rate to get true value of business.preference shares) NAV = Fully diluted equity shares 2. All assets (value by appropriation method all liabilities . real estate etc. Fixation of the value of different types of equity shares. arrears of depreciation etc. borrowing and liabilities including both current and likely contingent liability and preference share capital). is divided by fully diluted equity (after considering equity increases on account of warrant conversion etc. 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. there may be same modifications in this method and fixed assets may be taken at current realizable value (especially investments. The three steps necessary for valuing share are: 1. current assets. Earnings of the company for the next two years are projected (by valuation experts) and simple or weighted average of these profits is computed. Net Value Asset (NAV) Method NAV is the sum total of value of asserts (fixed assets.) to get NAV per share. This figure divided by Mergers & Acquisitions Page 17 of 93 . investment on the date of Balance sheet less all debts. it is the future maintainable profits that have to be considered. 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. The NAV. Deductions will have to be made for arrears of preference dividend. However.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. Valuation of assets 2.6.
7. and also summarized by the Apex court in the case of Hindustan Levers. The voting strength in the company of shareholder of the two companies. how many shares of amalgamating company. It is often difficult to induce a shareholder to agree to a merger if it involves a reduction in his dividend income. The dividends presently paid on the shares of two companies.. 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. The cover. The average of high or low values and closing prices over a specified previous period is taken to be representative value per share. Market Value Method This method is applicable only in case where share of companies are listed on a recognized stock exchange. The relative growth prospects of the two companies. Hindustan Lever Ltd. 5. The gearing of an ordinary share is the ratio of borrowings to equity capital. The stock exchange prices of the shares of the companies before the commencement of negotiations or the announcement of the bid. Also. 3. 2. The value of net assets of the two companies.equity value gives value per share. stock valuation etc. the determination of share exchange ratio i. The relative gearing of the shares of the two companies. Profits of both companies’ should be determined after ensuring that similar policies are used in various areas like depreciation. due regard has to be given to inherent risk attribute to each business. Thus. (ratio of after tax earnings to divided paid during the year) for the present dividends of the two companies. 1.e. Employees union vs. Now. These relevant factors has been enumerated by Gujarat High court in Bihari Mills Ltd. (1995)51 as under. past or future profits need to be adjusted for extra ordinary income or loss not likely to recur in future. is basically an exercise in valuation of shares of two or more of amalgamating company. 4. are to be exchanged for how many shares of amalgamated company. 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. While determining operating profits of the business. 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. 3. Mergers & Acquisitions Page 18 of 93 . While determining capitalization rate. 6. it must be valued on independent basis without considering benefits on account of merger.
competition.e.K. If it is possible to the value the shares in a manner difference from the one adopted in the given case. it cannot be said. possibly to reduce income tax liability) If lower dividend or profits are due to temporary reasons. company incurring expenses disproportionate to the commercial venture. 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. The past history of the prices of two companies. G. Law and practice) N.A. yield value.” In CWT vs. Kapoor Co. Ltd. Qualitative factors like market fluctuations. break up value method to determine what would be realized in winding up process should be considered. 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. There are however. Weinberg and MV Blank. Mahadeo Jalan (1972) 86 ITR 621 (SC). a golden mean should be found. (1985) cited here from A. Valuation can be done on basis of asset value. In computing yields. Majumdar and Dr. cit. if reasonable estimation of future profits and dividend is not possible due to wide fluctuations in profits and uncertain conditions. that the valuation agreed upon has been unfair. Thus. Often share value cannot be finalized on basis of one parameter only. State of Assam. • • • • Valuation of shares on book value method is proper and valid mode of valuation of shares. market value or on net worth basis. Para 67 pp5 Bihari Mills Ltd.Tinsukhia Electric Co.K. Mergers & Acquisitions Page 19 of 93 .D. There are bound to be difference of opinion as to what the correct value of the shares of the company is. “The valuation of shares is a technical matter which requires considerable skills and expertise. pp 1084 ratio in case of amalgamations. break –up value..8.g. op. no rules framed specially for the working out of share exchange 49 51 M. If result of two methods differs. abnormal expenses will be added back to calculate ‘yield’ (e. final decision depends on judicious consideration of usual methods of valuation i. vs. Taxmann 2002.
it is provided that on date of merger. Godrej Soaps Ltd. higher turnover GSC’s pre-merger profits of Rs. This may be for various reasons. For example Godrej soaps Ltd. UTI etc. If Transferor Company merges with the sick transferee company. 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. IFCI. One such approved in Shiva Texyarn Ltd. without following strict norms of listing of stock exchanges. it gets advantages of listed company.Government policy. 1 per share and later GSL would be merged with 1 share of GGICL to be allotted to every shareholder of GSL. However in some cases. 60 crores) in 1994. 1. The amalgamated company. ICICI. 611. outside people even may not know that the transferor company with which they are dealing after merger is not the same as earlier one. many restrictions are applicable for allowing set off.The scheme involved reduction of share capital of GGICL from Rs. 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. (GSL) with pre merger turnover of 436. reschedule outside loans and also lower interest rate on term loans. managerial skills are also relevant for the purpose-Sanghi industries Ltd. This capital reduction helps in unity of the accumulated losses and other assets which are not represented by the share capital of the company. Thus. Many times. Godrej Soaps Ltd. If sick company merges with healthy company. a capital reduction aim rehabilitation scheme is an ideal antidote (by way of reverse merger) for sick company. GGICL reverted back to the old name of amalgamating company.08 crores. reverse merger is done. Thus. Mergers & Acquisitions Page 20 of 93 . name of Transferee Company will be changed to that of Transferor Company. (with post-merger turnover of Rs. if Transferor Company merges with the listed company. When a healthy company merges with a sick or a small company is called reverse merger.7 Reverse Merger Normally. Thus. The post merger company.77 crores entered into scheme of reverse merger with loss making Gujarat Godrej innovative Chemicals Ltd. liquidate damages besides finding of interest. (GGICL) (with pre merger turnover of Rs. In such case. b) The transferee company may be listed company. 30 crores. a small company merges with large company or a sick company with healthy company. 10 per share to Re. In such cases. it gets advantage of setting off carry forward losses without any conditions.12 crores) restructured its gross profit of 49. All financial Institutions agreed to waive penal interest. reverse mergers are also accompanied by reduction in the unwieldy capital of the sick company.
The salient features of this new takeover code (Regulations. or (b) by one or more transactions.1 Laws applicable to Takeover 1. SEBI (Substantial Acquisition of shares and takeover) Regulations 1997 Act. who acquires shares or voting rights which (taken together with shares or voting rights.(a) in pursuance of a public issue. shall disclose to all the stock exchanges on which the shares of the company are listed. SEBI’s (Substantial Acquisition of shares and Takeover’s) Regulations. Mergers & Acquisitions Page 21 of 93 . ii. shall within two months of notification of these Regulation disclose his aggregate shareholding in that company. the aggregate number of shares held by each such person. 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%. 1997. 2. The objective of these regulations has been to provide an orderly framework within which substantial acquisitions and takeovers can take place. 1997) may be enumerated as follows: i. the revised take over code as Securities and Exchange Board of India (Substantial Acquisitions of shares and Takeovers) Regulations. Any acquirer. the SEBI announced on Febuary20.8 Laws statutes in India 1. 1. who holds more than 5% shares or voting rights in any company. However. 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. to the company which in turn. sub clause 13 of amendment of Clause 40B also provides an exemption to the scheme approved by BIFR. On the basis of recommendations of the Committee. as the case may be. if any. Any person.1. A takeover offer refers to change in management where there is no change in management. 2. There is no provision under clause 40B for exemption of non BIFR companies. held by him) would entitle him to more than 5% shares or voting rights in a company. 1997. Clause 40B of listing agreement will not apply.8. Clauses 40A and 40B of the listing Agreement the company has entered into with stock exchange. or (c) in any other manner not covered by (a) and (b) above. 1997. Clause 40B deals with takeover efforts.
v. during the twelve-month period prior to the date of public announcement. if any. viii. x. Such offer shall be deemed to be a competitive bid. make yearly disclosures to the company. shall acquire. Within 14 days of the public announcement of the offer. additional shares or voting rights entitling him to exercise more than 2% of the voting rights. shall. vi. unless such acquirer makes a public announcement to acquire shares in accordance with the Regulations. not less than 10% but not more than 25% of the shares or voting rights in a company. if any. the acquire must send a copy of the draft letter to the target company at its registered office address. who is desirous of making any offer. within 21 days from the end of the financial yea. (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.(a) the negotiated price under the agreement . Any person other than the acquirer who had made the first public announcement. held by him or by persons acting in concert with him). Every person. who holds more than 10% shares or voting rights in any company. shall have the option iv. (c) the price paid by the acquirer under a preferential allotment made to him. No acquirer holding. Mergers & Acquisitions Page 22 of 93 . unless such acquirer makes a public announcement to acquire shares of such company in accordance with the Regulations. of acquire shares or voting rights which (taken together with shares or voting rights. for being placed before the Board of Directors and to all the stock exchanges where the shares of the company are listed. within 21 days of the public announcement of the first offer. vii. ix. Upon the public announcement of a competitive bid or bids. 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. make a public announcement of his offer for acquisition of some or all of the shares of the same target company. No acquirer shall agree to acquire. 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. shall.iii. in any period of 12 months. in respect of his holdings as on 31st March each year. (b) average price paid by the acquirer for acquisitions including by way of allotment in a public or rights issue. at any time during the twelve month period up to the date of closure of the offer. the acquirer(s) who had made the public announcement (s) of the earlier offer(s). entitle such acquirer to exercise 10% or more of the voting rights in a company. The minimum offer price shall be the highest of.
xvi. (b) the offer did not receive the minimum level of acceptances. once made. the erstwhile promoters do not own any shares in case such acquisition is made by the new promoters pursuant to such scheme. any make upward revisions in his offer in respect of the price and the number of shares to be acquired. 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. Where the acquirer specifies a minimum level of acceptance and does not want to acquire a minimum 20%. xii. (c) the statutory approvals(s) required have been refused. consequent upon a competitive bid or otherwise. the 50% of the consideration payable is to be deposited in Escrow Account. xiv. Such public announcement shall contain relevant details about the offer including the information about the identity and background of the person acquiring shares. or (c) a combination of both. the specified date. xv. xi. being a natural person has died.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. shall be withdrawn except under the circumstances mentioned in this regulation. 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. xiii. In case of a substantial acquisition of shares in financially weak company not being a sick industrial company. or (b) exchange of shares. 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 acquirer who has made the public announcement of offer. (d) the sole acquirer. provided that the scheme as far as possible may ensure that after the proposed acquisition. the date of opening of the offer and the period for which the offer shall be kept open. No public offer. xvii. and (e) such circumstances as in the opinion of SEBI merits withdrawal. number and percentages of shares proposed to be acquired. the value of the Escrow Account shall be increased to equal to at least 25% of the consideration payable upon such revision. namely-(a) the withdrawals is consequent upon any competitive bid. Irrespective of whether or not there is competitive bid. Mergers & Acquisitions Page 23 of 93 . at any time up to 3 working days prior to the date of the closure of the offer. there is any upward revision of offer. offer price.to make an announcement revising the offer or withdrawing the offer with the approval of the SEBI. to which it was subject to. 100 crores and 10% of the consideration thereafter. The person acquiring shares from the promoters of the persons in. In case.
The most common form of merger involves as elaborate but time-bound procedure under sections 391 to 396 of the Act. or by the division of shares into shares of different classes. arrangement and Amalgamation/reconstruction require approval of NCLT while the sale of shares to Transferee Company does not require approval of NCLT. Mergers & Acquisitions Page 24 of 93 . or by both these methods” Sec 390(a) As per this section .8. 1.An amendment to the Regulations. The rationale for SEBI’s decision to increase the creeping limit and the threshold limit is difficult to understand.’Company’ means any company liable to be wound up under the Act. unsecured creditors who have filed suits or obtained decrees shall be deemed to be of the same class as other unsecured creditors. The decision to increase the threshold limit from 10% to 15% is also difficult to be justified. The Compromise. Indian Companies Act. 2002. for the purpose of sections 391 to 393. 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. Arrangement can include reorganization of share capital of company by consolidation of shares of different classes or by division of shares of different classes. their separate meeting is not necessary. 1956 This has provisions specifically dealing with the amalgamation of a company or certain other entities with similar status. SEBI had decided to increase the creeping acquisition limited to 5% from the 25 and the thresh hold limit to 215% from 10%. The decision to increase the creeping acquisition from 2%to 5% disregards the objective of protection of small shareholders. In fact the 20% offer was to facilitate the market movements and competitive process and also to keep the management on their toes. 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. The increase in creeping acquisition will bring in quiet acquisition without the trigger of making a minimum offer of 20%. Sec 390(c) As per this section. Sec 390(b) As per this section. These powers are being transferred to National Company Law Tribunal (NCLT) by companies (second Amendment) Act. Powers in respect of these matters were with High Court (usually called Company Court). 1998. Thus. 1997 on substantial acquisition of shares and takeovers has been notified on 28.2 Laws governing merger Various Laws governing merger in India are as follows: 1.
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. 392 This section contains the powers of NCLT to enforce compromise and arrangement Sec 392 (1) As per this section. it will have powers to supervise the carrying out of the scheme.g. where NCLT sanctions a compromise or arrangement. 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 (2) As per this sub-section. it will be binding on all creditors or members of that class and also on the company.Sec 391 This section deals with the meeting of creditors/members and NCLT’s sanction to Scheme. Sec 391(6) After an application for compromise or arrangement has been made under the section. the company or any creditor or member of a company can make application to NCLT. 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. application will be made by liquidator. if NCLT sanction. Copy of NCLT order will have to be filled with Registrar of Companies. Sec. NCLT can stay commencement of any suit or proceedings against the company till application for sanction of scheme is finally disposed of. It can give suitable Mergers & Acquisitions Page 25 of 93 . auditor’s report on accounts of the company. 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. Sec 391(1) As per this sub-section. latest financial position. Sec 391(5) In case of default in compliance with provisions of section 391(4). Appeal against NCLT order can be made to National Company Law Appellate Tribunal (NCLAT) where appeals against original order the NCLT lies. On such application. e. NCLT may order that a meeting of creditors or members or a class of them be called and held as per directions of NCLT. Sec 391(4) As per this sub-section. NCLT should also be satisfied that the meting was fairly represented by members/creditors. pendency of investigation of company etc. its liquidator and contributories. If the company is already under liquidation. Sec 391(7) As per this sub-section. the NCLT may sanction the scheme.
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 . or of numbers or any class of members. it can order winding up. 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. the copy of scheme of compromise or arrangement should be furnished to creditor/member free of cost. any director. if he shows that the default was due to the refusal of any other person. if NCLT finds that the scheme cannot work. the company and every officer of the company who is in default. and b) In every notice calling the meeting which is given by advertisement. Sec. 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. managing directors. it is different from the effect on the like interests of other person. Sec 393 (4) Where default is made in complying with any of the requirements of this section. is called under section 391:a) With every notice calling the meeting which is sent to a creditor or member. shall be punishable with fine which may extend to Rs. 50. manager or trustee for debenture holders. Sec 392 (2) As per this section. if the scheme affects rights of debenture holders. Provided that a person shall not be punishable under this sub-section.directions or make modifications in the scheme of compromise or arrangement for its proper working. Sec 393 (2) As per this sub-section. being a director. managing director. Sec 393 This section contains the rules regarding notice and conduct of meeting. and in so far as.393 (1) Where a meeting of creditors or any class of creditors. and in particular stating any material interests of the directors. or manager of the company. 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. Sec 393 (3) As per this sub-section. to supply the necessary particulars as to his material interests. Sec 393 (5) As per this section.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. managing director.
if the transferee company or its nominee holds 90% or more shares in the transferor company. Sec 394 This section contains the powers while sanctioning scheme of reconstruction or amalgamation.the company has to disclose in the statement. Sec 395(2) As per this sub-section. the transferee company will pay the amount payable to transferor company along with the transfer deed duly signed. reconstruction or amalgamation. 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. 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. if NCLT issues such an order. and not only of those attending the meeting.5. Selling shareholders get either compensation or shares of the acquiring company. Sec 394 (2) As per this sub-section. The transferor company will then record name of the Mergers & Acquisitions Page 27 of 93 . The dissenting shareholder can make application within one month of the notice to NCLT. This procedure can be followed only when creditors are not involved in reconstruction and their interests are not affected. This procedure is rarely followed. Sec 394(1) NCLT can sanction amalgamation of a company which is being wound up with other company. if any application is made to NCLT for sanction of arrangement. The transferee company should give notice within one month to dissenting shareholders. Sec 395(1) As per this sub-section. as sanction of shareholders of at least 90% of value of shares is required. the transferee company has to be give notice in prescribed manner to dissenting shareholder that it desires to acquire his shares. Sec 394 (3) As per this sub-section. NCLT shall take into consideration any representation made by Central Government before passing any order. 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. it is entitled to and is also under obligation to acquire remaining shares. Sec 395 This section provides that reconstruction or amalgamation without following NCLT procedure is possible by takeover by sale of shares.000. compromise. Their shares must be acquired within three months of such notice. he is punishable with fine upto Rs. Copy of NCLT order shall be filed with Registrar within 30 days. if shareholders do not submit the transfer deeds. Sec395 (3) As per this section. if he unable to do so. Sec 394A As per this section.500. In case of default. notice of such application must be made to Central Government. The NCLT can order compulsory acquisition or other order may be issued. company as well as every officer who is in default is punishable with fine upto Rs.
by issuing notification in Official Gazette. The Supreme Court. it can order their amalgamation. market shares and on the requirement of prior government approvals for mergers that created entities that would violate prescribed limits. The order can also contain consequential. duties and obligations as may be specified in the order. interest. even if transfer deed is not signed by dissenting shareholders. Sec395 (4A) When the transferee company makes offer to shareholders of transferor company. Monopolies and Restrictive Trade practices Act. Government can provide the constitution of the single company. he will get compensation assessed by prescribed authority. Offer should contain statement by Transferee Company for registration before it is sent to shareholders of Transferor Company. powers. Sec 396 This section contains the power to Central Government to order amalgamation. incidental and supplemental provisions necessary to give effect to amalgamation. 2. The compensation so assessed shall be paid to the member or creditor by the company resulting from amalgamation. Sec396 (3) As per this sub-section. to the extent possible. the circular of offer shall be accomplished by prescribed information in form 35A. 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. authorities and privileges and such liabilities. decided that “prior Mergers & Acquisitions Page 28 of 93 . Sec. Sec395 (4) As per this section. These will not be disposed of without prior permission of Central Government. 1969 (MRTP 1969) Certain Amendments in the MRTP Act were brought about in 1991.transferee company as holder of shares.396 (1) As per this sub-section. in a recent judgment. creditor and debenture holder of all the companies will have same interest or rights after amalgamation. If the rights and interests are reduced after amalgamation. 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 sum received by transferor company shall be kept in a separate account in trust for the dissenting shareholders. if central government is satisfied that two or more companies should amalgamate in public interest. with such property. The Government has removed restrictions on the size of assets. Books and papers of the company which has amalgamated or whose shares are acquired by another company shall be preserved. rights. or its amalgamation or acquisition of its shares. Sec 396A This section deals with the preservation of books and papers of amalgamated company. Before granting such permission. every member.
e.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”. However. Income Tax Act. if any. 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. where the undertaking sought to be acquired is a company which is not incorporated under any law in India. cannot be assigned to the amalgamated company and hence no tax benefit is available in this respect.. 3.residents. Foreign Exchange Regulation Act 1973 (FERA 1973) FERA is the primary Indian Law which regulates dealings in foreign exchange. 4. However. Although there are no provisions in the Act which deal directly with transactions relating to amalgamations. 1961 Income Tax Act. the target firm) should be transferred to the amalgamated company (i. and d) The shareholders of not less than 90% of the share of the amalgamating company should become the shareholders of amalgamated company. Mergers & Acquisitions Page 29 of 93 . 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 acquiring firm). 1961. c) All the liabilities of the amalgamating company should become the liabilities of the amalgamated company. certain provisions of the Act become relevant when shares in Indian companies are allotted to non.e.. In case of mergers and amalgamations. 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 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. unabsorbed depreciation. a number of issues may arise with respect to tax implications. b) All the properties of the amalgamating company (i. 1961 is vital among all tax laws which affect the merger of firms from the point view of tax savings/liabilities. The depreciation charge may be based on the consideration paid and without any revaluation.
V. 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. II. 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. 1. and VI.9 Effective Date and Appointed Date Effective Date. IV. and (ii) that the shares are issued in consideration of the shares. then it is deductible in the hands of the amalgamated company under section 35 of Income Tax Act. III. not from the date of the sanction but from the date when it was arrived at. 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. 1961. The amalgamating company is an Indian company. If the NCLT refuses sanction. The scheme of amalgamation is approved by a specified authority. in the amalgamated company. it becomes without effect. to any shareholder. The amalgamation should facilitate the revival of the business of the amalgamating company. The amalgamation should be in public interest.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 . Exemption from Capital Gains Tax: The transfer of assets by amalgamating company to the amalgamated company. 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. Carry Forward Losses of Sick Companies: Section 72A(1) of the Income Tax Act. then such expenses are deductible in the hands of the amalgamated firm. The amalgamating company should not be financially viable.A compromise or arrangement takes effect from the date when it is arrived at subject to the sanction of the court (NCLT). 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. 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.
which was initially promoted by ICICI Ltd.K. It is usually beginning of financial year. Brook Bond Lipton (India) Ltd. unless 1988 when there was the well-known unsuccessful hostile takeover bid by Swaraj Paul (of Caparo Group of the U. even if scheme is sanctioned later by high court (Now NCLT). The regulatory and prohibitory provisions of MRTP Act. ) to get control over DCM Ltd. and Ponds (India Ltd. Hindujas etc.e.) with it. acquisitions and takeovers has not been popular and kept a low profile. has been merged with Jindal Strips Ltd. 1969 provided for a cumbersome procedure to get approval for mergers and acquisitions under the Act. During recent years. a loss making company was amalgamated with Voltas Ltd. has been merged with the latter. the concept of mergers. India Cement Ltd. This can be retrospective. 1. 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. has been merged with ICICI Ltd. Most of the provisions of the MRTP Act. ITC Classic Ltd. and the offer of Sterlite Ltd. First. Jindal Ferroy Alloys Ltd.. British Gas Company has taken over Gujarat Gas Company.’s offer for Raasi cement Ltd. Still. Mergers & Acquisitions Page 31 of 93 . in 1998 for $8 million and successfully managed to turn it around in a year’s time. Appointed Date.. and Escorts Ltd. also attempted to take over many Indian companies by buying shares of these companies at stock exchanges. for taking over Indian Aluminum Company have heralded a new era of hostile takeovers in India. acquired Tata Oil Mills from the Tata Group and then merged other group companies i. and the reason for this is quite obvious. Company like Nicholas Piramal has been built only by mergers and acquisitions. such as Chabrias.Appointed date or transfer date is the date on which the property of transferor company vests and is transferred to Transferee Company. Volrho Ltd. Many other Nonresident Indians.10 Mergers and Takeovers: Indian scene In India. in most of the cases. The transfer date specified in the scheme is the date of transfer for purpose of Income Tax assessments. have been repealed as a part of economic liberalization drive of the Government of India. 1969.. The SCICI Ltd. India’s increasing “turnaround expert” strategy • • Wockhardt acquired loss making Wallis Laboratories of the U. for convenience of accounting and tax assessments.K. Pacakaging major Essel Propack which acquired units of the UK’s Arista tubes and Telecon Packaging and turned it around by proper resource allocation. Hindustan Lever 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.
and turned it around within six months through better cost control. Tata motors acquired the bankrupt commercial vehicles units of the Korean group. • • • The Tata’s Journey of M&A • • Tata Tea acquired loss making Tetley of the UK in 2000 and turned it to profits. • • 1. Lakshmi Mittal acquired Arcelor to build the strongest steel venture Mittal Arcelor. 5.50 million. Continental engines acquired loss making European remanufactures engines firm vege Motors in June 2005. And the forging major is reaping dividends as a result. Key. Daewoo and made presence in international market with and enhanced product portfolio.• GHCL Ltd. Mr. Financial and integration maturity Creditability to attract more bank financing Globally Competitive. The $ 11 billion deal in a maker in the ground Pure cash deal confidence and aggressiveness. 2.debt restructuring exercise that reduced into costs. CDP. The Tata-Corus 1.11 The changing scenario • Share of global M&A by MNC’s from developing and transition countries. Tata Group made several significant acquisitions.Scootish Stampings. Daewoo Commercial vehicles and Boston’s Ritz Carlton Hotel. Aluminiumtechink. 1987-4% 2005-13% • Share in Greenfield and expansion projects exceeded 15% in 2005. 4. GHCL managed to ramp up production by 34%. Imatra Kilsta. (formally Gujrat Heavy Chemicals) acquired a controlling stack of 65 per cent in Romanian Soda ash firm SC Bega Upsom for $ 19. along with its wholly owned subsidiary. 3. Fedral Forge. such as Us telecom network operator Tyco Global. Bharat Forge has emerged the world’s second largest forging company mainly by way of Mergers and Acquisitions like care Dan Peddinghaus GmbH. A month into the acquisition. Page 32 of 93 Mergers & Acquisitions .
Story vote of confidence in Indian management with such companies as Tata Tea . Wockhardt. India’s outward FDI has touched $ 19 million. Now.6 1.TataMotors.0 4.4 Page 33 of 93 . a deluge with the Birlas now going the Tata’s way. up from $96 billion in 2005. Almost 50% of top 50 companies have made at least one overseas acquisition in the past 3 years in varied industries.8 1.• • • • • • • • • Most important benefit is increased competition. leveraging their recently acquired ability to work in challenging business environment. Followed up by pharmaceutical and auto components outfits. This calendar year.9 1.6 1. Strengths the arms of local companies and of the MNC’s to survive in a competitive lieu.12 Causes of merger: Mergers & Acquisitions (US$ Billion) 13 10.7 5. 2000 India has made over 300 overseas acquisitions. 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. Esssel Propack. making a big ticket acquisition. Since. Continental Engines and a host of others.3 2.4 1. The acquisition boom began as a trickle with software companies picking up small information technology companies abroad. BharatFirge. More investment abroad implies more the benefits of the home country.
Risk reduction by avoiding sales and profit instability. They seek to consolidate operations of both companies. Mergers & Acquisitions Page 34 of 93 . Claim tax savings on account of accumulated losses that increase profits. synergies or product . 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. technologies. Conglomerate merger: These are mergers between two or more companies having unrelated business. Horizontal merger: These involve mergers of two business companies operating and competing in the same kind of activity. Achieve optimum size and carve out optimum share in the market. Vertical merger are an integration undertaken either forward to come close to customers or backwards to come close to raw materials suppliers. 2. Vertical merger: These are mergers between firms in different stages of industrial production in which a buyer and seller relationship exists. They are undertaken for diversification of business in other products. These transactions are not aimed at explicitly sharing resources. 4. b. Cost reduction as a result of integrated operation. 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.An extensive appraisal of each merger scheme is done to patternise the causes of mergers. 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. Reverse mergers Reverse mergers involve mergers of profir making companies with companies having accumulated losses in order to: a.They do not have an impact on the acquisition of monopoly power and hence are favored through out the world. Set up merged asset base and shift to accelerate depreciation. The possible causes of different type of merger schemes are as follows: 1.
Cut costs and achieve focus. Correct leverage imbalances and imprvove borrowing capacity.5. Mergers & Acquisitions Page 35 of 93 . Eliminate intra-group competition c. b. Group company mergers These mergers are aimed at restructuring the diverse unitsof group companies to create a viable unit. Such mergers are initiated with a view to affect consolidation in order to: a.
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. Synergy refers to benefits other than those related to economies of scale. creativity.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. Operating economies are one form of synergy benefits. R&D and market coverage capacity due to the complementarily of resources and skills and a widened horizon of opportunities. But apart from operating economies.1 Synergies through Consolidation: Synergy implies a situation where the combined firm is more valuable than the sum of the individual combining firms. It is defined as ‘two plus two equal to five’ (2+2=5) phenomenon. innovativeness. 2. Mergers & Acquisitions Page 36 of 93 . free flow of capital across countries and globalization of business as a number of economies are being deregulated and integrated with other economies. A number of motives are attributed for the occurrence of mergers and acquisitions. breaking of trade barriers. synergy may also arise from enhanced managerial capabilities. They have become popular in the recent times because of the enhanced competition.
The selling. synergy may be gained by exploiting the strength in these areas.g. The management expenses may also come down substantially as a result of corporate reconstruction. since a wider product line may provide larger sales per unit of sales efforts and per sales person. For example. The firm might be able to reduce the cost of production by eliminating some fixed costs. and Ltd. and thereby can gain by combining these two strength. Igor Ansoff (1998) classified four different types of synergies. 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. 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. if A Ltd. it is the difference value between the combined firm and the sum of the value of the individual firms.. Synergy is the increase in the value of the firm combining two firms into one entity i. decide to merge into AB Ltd. accounting. 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. There are several ways in which the merger may generate operating economies. Mergers & Acquisitions Page 37 of 93 . The sources of synergy of specialized resources will vary depending upon the merger. These are: 1.. marketing and advertisement department can be streamlined.e. billing. The marketing economies may be produced through savings in advertising (by reducing the need to attract each other’s customers). When a firm having strength in one functional area acquires another firm with strength in a different functional area. and also from the advantage of offering a more complete product line (if the merged firms produce different but complementary goods). purchasing etc. A firm with a good distribution network may acquire a firm with a promising product line. In case of horizontal merger. A major saving may arise from the consolidation of departments involved with financial activities e. 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. The argument is that both firms will be better off after the merger. credit monitoring. 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. 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.An under valued firm will be a target for acquisition by other firms.
they will be able to produce better results than they were producing as separate entities because of savings various types of operating costs. These resultant economies are known as synergistic operating economies. 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. It may either distribute its surplus cash to its shareholders or use it to acquire some other company. There are many ways in which a merger can result into financial synergy and benefit. SCL also needed to upgrade its technology and increase its production. TSL became the second largest producer of two –wheelers after Bajaj. SCL’s and TCL’s plants were closely located which added to their advantages. (TSL). In a vertical merger. and minimizes uncertainty of supply of inputs and demand for product and saves costs of communication. The combined company has also been enabled to share the common R&D facilities. Financial synergy: Financial synergy refers to increase in the value of the firm that accrues to the combined firm from financial factors. when two firms combine their resources and efforts. manufacturing and marketing –eliminates the need for bargaining (with suppliers and/or customers). The main objective motivation for the takeover was TSL’s need to tide over its different market situation through increased volume of production.Thus.By this merger. Deployment of surplus cash: A different situation may be faced by a cash rich company. (SCL) with TVS-Suzuki Ltd. release the financing constraint. Such merger facilitates better coordination and administration of the different stages of business stages of business operations-purchasing. It may not have enough internal opportunities to invest its surplus cash. Large amount of funds would have been required for creating additional production capacity. 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 . An example of a merger resulting in operating economies is the merger of Sundaram Clayton Ltd. It needed a large manufacturing bas to reduce its production costs. The company can grow externally by acquiring another company by the exchange of shares and thus. 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. a firm may either combine with its supplier of input (backward integration) and/or with its customers (forward integration). 2.
Often a firm. capital gains tax rate. If they sell their shares. obtain bank loan and raise capital in the market easily. can bring stability of cash flows of the combined company. Another allied benefit of a merger may be in the form of greater congruence between the interests of the managers and the shareholders. Financing Cost: The enhanced debt capacity of the merged firm reduces its cost of capital. existing managers will strive continually to improve their performance. cash flows. sales promotion and warehousing. be taken off partially or completely by increase in the shareholders risk on account of providing better protection to lenders. Managerial synergy One of the potential gains of merger is an increase in managerial effectiveness. sales administration. which is performing poorly. The increased borrowing allows a higher interest tax shield which adds to the shareholders wealth. plagued with managerial inadequacies. advertising. Since the probability of insolvency is reduced due to financial stability and increased protection to lenders. A common argument for creating a favorable environment for mergers is that it imposes a certain discipline on the management. If lackluster performance renders a firm more vulnerable to potential acquisition. Debt Capacity: A merger of two companies. another group company to achieve financial synergies. RP Goenka’s ceat tyres sold off its type cord division to Shriram Fibers Ltd. Better credit worthiness: This helps the company to purchase the goods on credit. 4. The company would also be enabled to keep surplus funds and grow through acquisition. but negatively correlated. Issue costs are saved when the merged firm makes a larger security issue. A merged firm is able to realize economies of scale in flotation and transaction costs related to an issue of capital. they would pay tax at a lower. with fluctuating. 3.. Sales synergy These synergies occurs when merged organization can benefit from common distribution channels. This may occur if the existing management team. Mergers & Acquisitions Page 39 of 93 . This advantage may. 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. is replaced by a more effective management team. Another aspect of the financing costs is issue costs. can gain immensely from the superior management that is likely to emerge as a sequel to the merger. however. the merged firm should be able to borrow at a lower rate of interest. in 1996 and also transfer’s its fiber glass division to FGL Ltd.company.
depends upon on the correlation between the earnings of the merging entities. where two firms poorly correlated cash flows merged to create a portfolio of a firms. 2. The extent. The merger of these companies is not necessary for him to enjoy the benefits of diversification. Through the diversification effects. say. to which risk is reduced. there will be some diversification effect as long as the two firm’s earnings are not perfectly correlated (both rising and falling together). and vice-a versa. Smoothing out the earnings of a firm over the different phases of a cycle tends to reduce the risk associated with the firm. his ‘homemade diversification give him far greater flexibility. a shareholder can easily create a diversified portfolio of firms merely by holding the Mergers & Acquisitions Page 40 of 93 . they do not derive any benefits from the proposed merger.2 Diversification A commonly stated motive for mergers is to achieve risk reduction through diversification. if merges with another firm operating primarily in South India. Individually these firms could serve only a limited area. The diversification motive is based on the proposition that if two risky projects are combined. If firm A’s income generally rises when B’s income generally falls. But portfolio of firms in a conglomerate merger is costly as the acquisition of firms is a costly exercise. If investors can diversify on their own by buying stocks of companies which propose to merge. ITC. For example. A firm operating in North India. merger can produce benefits to all firms by reducing the variability of firm’s earnings.e. As a matter of fact. the cyclically prone earnings of firm A would be set off by the counter cyclically prone earnings of firm B. firm A has a product line with a particular cyclical variations and firm B deals in product line with counter cyclical variations. Any investor who wants to reduce risk by diversifying between two companies. 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. the fluctuation of one will tend to set off the fluctuations of the other. While negative correlation brings greater reduction in risk. The greatest benefit from diversification can be obtained by continuing firms from different industries i.The Industrial Credit and Investment Corporation of India Ltd. Individually. can definitely cover broader economic areas.. the earnings of the two firms may fluctuate in line with the cyclical variations. On the other hand. This reduction in overall risk is particularly likely if the merged firms are in different lines of business. may simply buy the stocks of these two companies and merge them into a portfolio. Diversification into new areas and new products can also be a motive for a firm to merge an other with it. products diversification resulting from merger can also help the new firm fighting the cyclical/seasonal fluctuations. conglomerate mergers. if they merge. Moreover. However. then the risk of combination will be less than the weighted average of the risk of these two projects. ABC Company and PQR Company. thus producing a relatively level pattern of combined earnings. (ICICI) acquired Tobaco Company. Thus. positive correlation brings lesser reduction in risk. Classic and Anagram Finance to obtain quick access to a well dispersed distribution network. Indeed.
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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In India. 16 crores) Ahmadabad cotton Mills merged with Arvind Mils (Rs. management functions and management resources and systems. fixed costs are distributed over a large volume of production causing the unit cost of production to decline. they are subject to capital gain tax rate which is much lower than the ordinary income tax rate. This happens because a given function.34 crores) Alwyn Missan merged with Mahinder and Mahindra Ltd. (Rs. 2. If it combines with a profitable company. Economies will be maximized when it is optimally utilized.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. For example. the high tax rate was the main reason for the post-war merger activity in the USA. particularly when the marginal tax rate is high is a strong motivation for the combination of companies. 1600 crores) When two companies merge through an exchange of shares. The profits arising from the exchange of shares are not taxable until the shares are actually sold. Economies of scale may also arise from other indivisibilities such as production facilities. Merger may help to expand volume of production without a corresponding increase in fixed costs. Also. 3.be in a position to earn sufficient profits in future to take advantage of the carry forward provision. (Rs. Thus. A company establishes management systems by employing enough qualified professionals irrespective of its size. facility or resource is utilized for a large scale of operation. the combined company can utilize the carry forward loss and save taxes with the approval of government. a given mix of plant and machinery can produce scale economies when its capacity utilisation is increased. Similarly. (Rs.47 crores) Hyderabad Alwyn merged with Voltas Ltd. 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.2.3. For example. When the shares are sold. (Rs. reporting and control. tax benefits are responsible for one-third of mergers in the USA12. Economies of scale may also be obtained fro the optimum utilisation of management resource and systems of planning. budgeting. A combined firm with a Mergers & Acquisitions Page 44 of 93 . 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.34 crores) Sidhpur Mills merged with Reliance Industries Ltd. A strong urge to reduce tax liability. The following is the list of some companies along with the amount of tax benefits enjoyed: • • • • • Orrisa synthesis merged with Straw product Ltd. the shareholders of selling company can save tax.
515. For example. 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.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. pp. costs of communicating and co-ordination. Thus.large size can make the optimum use of the management resource and systems resulting in economies of scale. Some of these reasons are technological economies like avoidance of reheating and transportation cost as in the case of iron and steel producer. was also backward integration which helped reduce exchange inefficiencies by eliminating market transactions. these merger help avoid inefficient market transactions and result in reduced exchange inefficiencies. Transactions within a firm might eliminate costs of searching for prices. a leading maker of color picture tube. the merger of a company Mergers & Acquisitions Page 45 of 93 . 1977. when companies engaged at different stages of production or value chain merge. Further. and Brigham. The recent merger of Samtel Electron services (SED) with Samtel Color Ltd. There are many reasons why firms want to be integrated vertically at different stages. (SCL) entailed backward integration of SED which manufactures electronic components required to make picture tubes with SCL. advertising. c) To improve profitability by expanding into high margin activities of suppliers and customers. operator might acquire chain of travel agents and use them to promote his own holiday rather than those of rival tour operators. Thus. economies of vertical integration may be realized. contracting.F. which possesses coffee beans. Dryden Press. Forward integration is where company merges to come close to its customers. So forward or downstream vertical integration involves takeover of customer business. E.F. Tata Tea’s acquisition of consolidated coffee which produces coffee beans and Asian Coffee. Proper planning for production and inventory management may improve due to more efficient information flow within a single firm. 2.. vertical merger may take place to integrate forward or backward. Essentials of Managerial Finance. J. A holiday tour 12 Weston. Backward integration occurs when a company comes close to its raw materials or suppliers.
Vertical integration. and customer finance. 2. 2. 4. Further. They prefer to merge with a local established company which knows behavior of market and has established customer base. So. One such example is Indian market. car purchase. production facilities. Cross border merger are a means of becoming or remaining major players in such markets. Coca Cola while re-entering India market in 1993 acquired Parle. The ICICI. Market penetration strategy is generally pursued within markets that are becoming more global. Anagram had a strong retail franchise. Few instances of MNC’s related mergers are: 1. truck finance. If a company does everything inhouse. this strategy is mainly adopted by MNC’s to gain to new markets. the largest player in market with several established brands and nationwide bottling and marketing network. Rajasthan and Maharastra and a depositor base of over two lakhs depositors. ICICI was therefore attracted by the retail portfolio of Anagram which was active in lease and hire purchase. These acquisitions thus helped ICICI to obtain quick access to well dispersed distribution network. Hence. HLL acquired Dollops. is not always a good idea. a leading financial institution secured a foot hold in retail network through acquisition of Anagram Finance Company and ITC classic. 2. Kwality. brands etc.J.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.engaged in oil exploration and production (like ONGC) with a company engaged in refining and marketing (like HPCL) may improve coordination and control. Heinz entered into India through acquisition of Glato Industries. 3. acquiring companies with good manufacturing and distribution network or few brands of a company gives the advantage of rapid market share. distribution network of over fifty branches in Gujarat. H. however. it may not get the benefit of outsourcing from independent suppliers who may be more efficient in their segments of the value chain. market penetration means developing new and large markets for a company existing products. Whirlpool Corporation’s entry into India by acquiring Kelvinator India.11 Early entry and market penetration An early mover strategy can reduce the lead time taken in establishing the facilities and distribution channels.
To bifurcate business by floating separate products this is referred to as demerger. 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. improve borrowed capital. BIFR motivated Rehabilitation Merger Year April April April April May April 95 95 95 96 96 97 Transferor sick company Tata Keltron Ltd. 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. Taken over by Transferee company Tata Telecom Ltd. merging with it. it also helps to preserve group reputation. Biax Ltd. Some of the group companies which have amalgamated through the BIFR include Mahindra Missan Allwyn with Mahindra and Mahindra. Asian Paints Ltd. Titagarh Steels Ltd. Firstly. Titagarh Papers Mills Ltd. 1961.An important motive for merger is to turn around a financially sick company through the process of merger.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. Universal Steel Alloys Ltd. to revive sickness. Hyderabad. Such mergers within group are also aimed at restructuring their diverse units to create a more viable unit. Powmex Steels Ltd. Bharat Gears Ltd. Example of restructuring and consolidation within the group companies is the case of Nirma Ltd. GKW Ltd. its group companies. Amalgamation taking place under the aegis of Board for Industrial (BIFR) fall under this category. Nirma detergents. Cimmco Birla Ltd. Secondly. 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. Pentasia Chemicals Ltd. Allwyn with Voltas etc. Nirma soaps and Mergers & Acquisitions Page 47 of 93 .
( just like the GEC. Thus. and Alcatel Alsthen. Merger of Videocon groups Videocon Narmada Electronics with its flagship company Videocon International led to operating efficiencies by controlling costs under one head. 2. were merged from Ist April 1992 and changed their name to GEC. and united Distilleries India Ltd. U.K. For instance.detergents.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. In London in Dec. formed by merger of two largest industrial groups The General Electric company plc. Alsthen India Ltd. The objective was to make Nirma a strong and resilient corporate entity capable of facing global competition by restructuring management. 3. 2. Consequent of the merger of Grand plc. Alsthen N. Ltd. By the process of merger. Shina soaps and detergents and Nirma chemicals. The General Electric Company of India Ltd. was 20% before merger. Novartis India (51% of Novartis AG) was formed in India by the merger of Hindustan ciba Giegy and Sandoz India Ltd. the family stake could be consolidated without going through the complications of SEBI guidelines of 4th august 199415. increased their holding by another 20%. The higher stakes helps to ward off takeover bids. 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%. visa. So. Nanda family’s holding in escorts Ltd. sizable reduction in management costs and increased professionalism. their Indian offspring’s IDL Ltd. ‘A’ company which is family owned could be merged with ‘B’ company which is a listed company with family stake in it. and Guiness plc. 2. Similarly. Its merger with Escorts Tractors Ltd. their two Indian counter parts. both liquor companies followed this in India. and The English Electric Company of India Ltd. mergers could be motivated by the need to enhance promoter’s holdings in post.V. in 1996 following the merger of their global parents. 1997.15 Increase Promoter’s stake Another motive for merger could be to increase the stake of promoters.16 Defensive Maneuver Mergers & Acquisitions Page 48 of 93 .merger company. France) 2. As per the dictates of their parent companies. Some instances of such mergers are listed below: 1.
greater market penetration. Cross border mergers and acquisitions are being resorted to such mergers provide opportunities for taking up larger projects. 170 and market capitalization of Rs. On the one hand. The acquisition has brought with it. A merger or acquisition can be used by a company as defensive maneuver to resist takeover by another company. helped improve operating efficiencies and resulted in instant expansion of product lines of Tata tea –Tetley combines. Also the merged company is able to compete more effectively with increased size. European and Asian market have become more receptive to merger and acquisitions. Industries have to increase its capacity. 2. it is able to expand its size. making its acquisition very expensive. 550 crores with the help of swap ratio of forty five Jindal strips for every hundred Jindal Ferro alloy shares. merger of Jindal Ferro Alloys with Jindal Strips helped Jindal Ferro Alloys improve its share price from Rs. European countries face competitive pressures from creation of single Euro currency. 160 crores to Rs. Its size and capacities are small as compared to MNC’s. For example. The recent acquisition of Tetley. 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. induct new technology and development markets. 65 to Rs. 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 . After the pitched Battle against Multi National Company (MNC) in domestic arena. generic market and to acquire global competitive strength.17 Acquire Global Competitive strength With competitive forces resulting from globalization and deregulation. many industries have forced most corporate to consolidate. 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. The globalized business environment thus demands that Indian Industries also restructured. it may consider getting involved in a merger game. The process of globalization and increasing integration of Indian economy with the international market will have its impact sooner or later. on the other hand. the world’s largest Tea brands by Tata tea. Asian crisis has forced most Asian nations to look to the west for technological and capital support. Hence. by increasing market capitalization of the merged company’s threat of takeover can be tackled. Ansoff16 suggested a number of reasons that are attributed to the occurrence of mergers and acquisitions.Merger can be used as shields for protection from raiders. Indian companies have also felt the need of becoming global. If a firm feels that it could be acquired by another firm. In doing so. For instance. To meet the opportunities thrown open by fast growing world. Also. merger are planned to acquire global competitive strength.
al.L. Vanderbilt University Press. et.• • • • • • • • 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.. Mergers & Acquisitions Page 50 of 93 . Manufacturing Firms 1946-65. SEBI (Substantial Acquisition of shares and takeovers) Regulations.S. 1994 15 16 Ansoff H. Acquisitive Behaviour of U. 1971.
who saw potential value in restructuring or breaking up these firms.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. and the accounting consideration involved in merger and acquisition Firms are acquired for a number of reasons. Beatrice and RJR Nabisco were acquired by other firms. Through time. Mergers & Acquisitions Page 51 of 93 . in the form of either higher growth. their own management or wealthy raiders. firms have also acquired or merged with other firms to gain the benefits of synergy. In the 1960s and 1970s. or lower costs. how to develop acquisition strategy. In the 1990s. process of acquisition. as in the Disney acquisition of Capital Cities. In the 1980s. amount paid to the target firm. the matters relating to the valuation of the synergies. corporate giants like Time.
1 Background on Acquisitions When we talk about acquisitions or takeovers. continue the section by providing an overview on the acquisition process and conclude by examining the history of the acquisitions in the United States. In a hostile acquisition. continuing with the identification and valuation of a target firm. a premium of $ 25 over the stock price at the time of the offer. The first is the development of a rationale and a strategy for doing acquisitions. is the price that will be paid by the acquiring firm for each of the target firm’s shares. and whether to use stock or cash.2 The Process of an Acquisition Acquisitions can be friendly or hostile events. AT&T initially offered to buy NCR for $80 per share. how best to raise funds to do it.Acquisitions seem to offer firms a short cut to their strategic objectives. The acquisition price.3 Steps in an Acquisition There are four basic and not necessarily sequential steps. In either friendly or hostile acquisitions. This price may be higher than the initial price offered by the acquirer. 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. 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. AT&T ultimately paid $110 per share to complete the acquisition. 3. The third is the determination of how much to pay on the acquisition. with premiums for the value of control and any synergy. we examine the four basic steps in an acquisition. the managers of the target firm welcome the acquisition and. This decision Mergers & Acquisitions Page 52 of 93 . it is the price at which the acquiring firm receives enough shares to gain control of the target firm. We begin this section by looking at the different forms taken by acquisitions. in acquiring a target firm. seek it out. the difference between the acquisition price and the market price prior to the acquisition is called the acquisition premium. In a tender offer. in the context of mergers and consolidations. 3. The second is the choice of a target for the acquisition and the valuation of the target firm. starting with establishing an acquisition motive. This price is usually based upon negotiations between the acquiring firm and the target firm’s managers. this difference will be recorded as goodwill on the acquiring firm’s books or not be recorded at all. For instance. 3. and the understanding of what the strategy requires in terms of resources. and following up with structuring and paying for the deal. in some cases. The final and often the most difficult step is making the acquisition work after the deal is consummated. we are talking about a number of different transactions. 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 friendly acquisition. 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. In this chapter. in 1991. the target firm’s management does not want to be acquired. but the process has its costs.
Skill in execution: If the acquirer. The acquirer can then gain the difference between the value and the purchase price as surplus. allowing the acquirer to claim the increase in value. The final step in the acquisition. 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. 2. there will be no value gain from the acquisition. In this section. For this strategy to work. These motives were studied in detail in the last chapter. 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. 3. Acquiring poorly managed firms and removing incumbent management. or at least changing existing management policy or practices.1 Developing an Acquisition Strategy Not all firms that make acquisitions have acquisition strategies. should make these firms more valuable. 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. in the process of the acquisition drives the stock price up to and beyond the estimated value. If that premium exceeds 33% of the market price. especially when acquiring publicly traded firms in reasonably efficient markets. 3. 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.has significant implications for the choice of accounting treatment for the acquisition. and the acquisition will not create any value for the acquirer. The odds are better in less efficient markets or when acquiring private businesses. is to make the acquisition work after the deal is complete. In acquiring this firm. however. the acquirer will have to pay a premium. 1. where the premiums paid on market prices can very quickly eliminate the valuation surplus. and not all firms that have acquisition strategies stick with them. assume that the estimated value for a firm is $100 million and that the current market price is $75 million. three basic components need to come together. To illustrate.3. While the strategy of buying under valued firms has a great deal of intuitive appeal. or better analytical tools than those used by other market participants. 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. Mergers & Acquisitions Page 53 of 93 . the price exceeds the estimated value. This value increase is often termed the value of control. and perhaps the most challenging one. as the motives behind merger and motives behind acquisitions are same. it is daunting.
As noted in the last chapter. a cyclical firm should try to acquire counter-cyclical or. Choosing a target firm Once a firm has identified the reason for its acquisition program. the potential for its success rests on the following. The market price of the acquisition should reflect the status quo. a bank with a price to book value ratio of 1. 1. • If the motive for acquisitions is under valuation.2 Choosing a Target firm and valuing control/synergy Once a firm has an acquisition motive. i. Thus. 2.Prerequisites for Success While this corporate control story can be used to justify large premiums over the market price. 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. noncyclical firms to get the fullest benefit from diversification. If the market price already has the control premium built into it. an under valued stock is one that trades at a price well below the estimated discounted cash flow value. after controlling for significant differences on fundamentals. With relative valuation. actions that enhance value increase cash flows from existing assets.2 would be an undervalued bank. the most likely target firms will be in businesses that are unrelated to and uncorrelated with the business of the acquiring firm. the current management of the firm and their poor business practices. 3.3. corporate control has been increasingly cited as a reason for hostile acquisitions. growth. Thus. The first relates to how to best identify a potential target firm for an acquisition. there are two key questions that need to be answered. it has to find the appropriate target firm. In discounted cash flow valuation approaches. If the motive for acquisitions is diversification. the target firm must be under valued. at least. rather than to market or industry factors that are not under management control. book value or sales) well below that of the rest of the industry. if other banks have similar fundamentals (return on equity. • Mergers & Acquisitions Page 54 of 93 . and the change has to increase value. and risk) but trade at much higher price to book value ratios. The acquisition has to be followed by a change in management practices. In the last two decades. increase the length of the growth period. or reduce the cost of capital. given the motives. increase expected growth rates.e. 3. an under valued stock is one that trades at a multiple (of earnings. there is little potential for the acquirer to earn the premium. The poor performance of the firm being acquired should be attributable to the incumbent management of the firm.
Status Quo Valuation We start our valuation of the target firm by estimating the firm value with existing investing. the target firm should be in the same business as the acquiring firm. For functional synergy. Thus. For financial synergy. 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. If the motive is managerial self-interest. starting with a status quo valuation of the firm. Given the inter-relationship between synergy and control. a. Investors and firms are willing to pay large premiums over the market price to control the management of firms. This section explores the determinants of the value of corporate control and attempts to value it in the context of an acquisition. b. In particular.• If the motive for acquisitions is operating synergy. This valuation. For economies of scale. the value of the firm is a function of its cash flows from existing assets. the safest way to value a target firm is in steps. provides a base from which we can estimate control and synergy premiums. If the motive for the merger is control. if the motive is increased debt capacity. the typical target firm will vary depending upon the source of the synergy. especially those that they perceive to be poorly run. 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. which we term the status quo valuation. financing and dividend policies. the choice of a target firm will reflect managerial interests rather than economic reasons. although the existence of control and synergy premiums introduces some complexity into the valuation process. or a firm with significant net operating losses carried forward. the target firm will be a poorly managed firm in an industry where there is potential for excess returns. and following up with a value for control and a value for synergy. The Value of Corporate Control Many hostile takeovers are justified on the basis of the existence of a market for corporate control. the length of the high growth period and the firm’s cost of capital. In addition. the target firm should be strongest in those functional areas where the acquiring firm is weak. Determinants of the Value of Corporate Control Mergers & Acquisitions Page 55 of 93 . if the motive is tax benefits. • • Valuing the Target Firm The valuation of an acquisition is not fundamentally different from the valuation of any firm. the expected growth in these cash flows during a high growth period. the acquisition of Security Pacific by Bank of America was motivated by potential cost savings from economies of scale.
the financing mix can be changed and the dividend policy reevaluated. a longer growth period (from increased competitive advantages). If this is true. optimally managed . (1) What form is the synergy expected to take? Will it reduce costs as a percentage of sales and increase profit margins (e. we can value control. or a lower cost of capital (higher debt capacity). c.g. in one form or the other. 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.g. Assets can be acquired or liquidated. and the firm can be restructured to maximize value. Mergers & Acquisitions Page 56 of 93 . when there is increased market power) or the length of the growth period? Synergy.Value of firm with current management The value of control is negligible for firms that are operating at or close to their optimal value. If we can identify the changes that we would make to the target firm.. over whether synergy can be valued and. a firm should not be willing to pay large premiums for synergy if it cannot attach a value to it. if so. The value of controlling a firm comes from changes made to existing management policy that can increase the firm value. In general. what that value should be. Some disagreement exists. in many takeovers. since a restructuring will yield little additional value.. Thus we maintain that synergy can be valued by answering two fundamental questions. the lesser its value. (2) When will the synergy start affecting cash flows? –– Synergies can show up instantaneously. higher growth potential). the longer it takes for it to show up. the lack of precision in the process does not mean we cannot obtain an unbiased estimate of value. The value of control can then be written as: Value of Control = Value of firm. While valuing synergy requires us to make assumptions about future cash flows and growth. but they are more likely to show up over time. higher expected growth rates (market power. has to influence one of the four inputs into the valuation process – cash flows from existing assets.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. when there are economies of scale)? Will it increase future growth (e. since a restructuring can lead to a significant increase in value. Valuing Operating Synergy There is a potential for operating synergy. Since the value of synergy is the present value of the cash flows created by it. 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. to have an effect on value. It can be substantial for firms operating at well below optimal. however.
. by adding the values obtained for each firm in the first step. The first is the decision on how much to pay for the target firm. d. We will begin the discussion. with no synergy. Several factors. will act as constraints. The market price of the target firm. an increase in debt capacity and therefore firm value and better use for “excess” cash or cash slack. The second is the determination of how to pay for the deal. which though a widely used rationale for mergers. however. cash or some combination of the two. This division of value is unfair. 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. there is likely to be little or no value gained from control. whether to use stock. Mergers & Acquisitions Page 57 of 93 . the acquiring firm should try to keep as much of the premium as it can for its stockholders. we value the firms involved in the merger independently. the acquisition moves forward into the structuring phase. Third. prior to the acquisition: Since acquisitions have to base on the current market price. For instance. 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. They include: 1. i. We will consider three legitimate sources of financial synergy . Second. There are three interrelated steps in this phase. First. 3. if the market price of a poorly managed firm already reflects a high probability that the management of the firm will be changed.3. we build in the effects of synergy into expected growth rates and cash flows and we value the combined firm with synergy. and whether to borrow any of the funds needed. we estimate the value of the combined firm.Once we answer these questions. if it is publicly traded. the greater the current market value of equity. the lower the potential for gain to the acquiring firm’s stockholders.3 Structuring the Acquisition Once the target firm has been identified and valued.a greater “tax benefit” from accumulated losses or tax deductions. is not a source of increased value by itself. Consequently. if the acquiring firm plays an indispensable role in creating the synergy and control premiums. however. synergy and control built into the valuation. 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.e. we can estimate the value of synergy using an extension of discounted cash flow techniques. If the acquirer pays the full value. Valuing Financial Synergy Synergy can also be created from purely financial factors. 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. by discounting expected cash flows to each firm at the weighted average cost of capital for that firm. with diversification.
Mergers & Acquisitions Page 58 of 93 . 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. a decision has to be made about the following aspects of the deal. 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. 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.33% in contested takeovers. Desai. In particular. Debt versus Equity: A firm can raise the funds for an acquisition from either debt or equity. Although the mechanics of raising the money may look the same in this case. 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. raise cash and use the cash to pay for the acquisition. The mix will generally depend upon both the excess debt capacities of the acquiring and the target firm. Thus. Bradley. the benefits will be shared much more equitably. The question of which of these approaches is best utilized by a firm cannot be answered without looking at the following factors. the odds are likely to favor the target firm’s stockholders. 3. The first is to use cash balances that have been built up over time to finance the acquisition. 1. This. of course. 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.2. it has to follow up by deciding how it is going to pay for this acquisition. 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 second is to issue stock to the public. when a firm with cash slack acquires a firm with many high-return projects. Payment for the Target Firm Once a firm has decided to pay a given price for a target firm. The presence of other bidders for the target firm: When there is more than one bidder for a firm. If it is unique. 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. Thus. is reflected in the value of the firm through the cost of capital. Cash versus Stock: There are three ways in which a firm can use equity in a transaction. it is important that the value of the target firm not reflect this additional debt. the bulk of the synergy benefits will accrue to the target firm. the bulk of the value of the synergy will accrue to the latter. 1. where the payment is structured in terms of a stock swap – shares in the acquiring firm in exchange for shares in the target firm. If there are a large number of firms with cash slack and relatively few firms with high-return projects. The third is to offer stock as payment for the target firm. If it can be easily replaced.
the acquiring firm’s managers are making a judgment about what the perceived value of the stock is. the book values of the target and acquiring firms are aggregated. Tax factors. The amortization is not tax deductible and thus does not affect cash flows. the ratio that results may be skewed by the relative mispricing of the two firm’s securities. and that is the accounting treatment. the potential tax gains from a stock swap may be large enough to offset any perceived disadvantages. seems to play a disproportionate role in the way in which acquisitions are structured and in setting their terms. Purchase versus Pooling There are two basic choices in accounting for a merger or acquisition. firms that believe their stocks are overvalued are much more likely to use stock as currency in transactions. 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 our view. Mergers & Acquisitions Page 59 of 93 . While this amount is generally based upon the market price at the time of the acquisition. 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. the stockholders in the target firm may be able to defer capital gains taxes on the exchanged shares. i. If an acquisition qualifies for pooling. less overpriced) firm.e. we describe the accounting choices and examine why firms choose one over the other. In other words. In purchase accounting. the option of using cash on hand is available only to those firms that have accumulated substantial amounts of cash. The goodwill is then written off (amortized) over a period of 40 years. Since this benefit can be significant in an acquisition. when an acquisition is a stock swap. In this section. with the more overpriced firm gaining at the expense of the more under priced (or at least.The availability of cash on hand: Clearly. The premium paid over market value is not shown on the acquiring firm’s balance sheet. reducing reported earnings in each year. since what they gain on the acquisitions can be more than what they lost in the stock issue. 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. the number of shares of the acquired firm that will be offered per share of the acquiring firm. A fairer ratio would be based upon the relative values of the two firm’s shares.. managers who believe that their stock is trading at a price significantly below value should not use stock as currency on acquisitions. The final aspect of a stock swap is the setting of the terms of the stock swap. On the other hand. Accounting Considerations There is one final decision that.
In acquisitions such as Lotus by IBM and MCI by Worldcom. 3. Each of the combining firms has to be independent. The one-time expense is not tax deductible and has no cash flow consequences. The question whether an acquisition will qualify for pooling seems to weigh heavily on the managers of acquiring firms. 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. such as restricting stock buybacks and major asset divestitures. and it eliminates or drastically reduces the goodwill that needs to be amortized in subsequent periods. Furthermore. 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. discount rates and value is making such a difference in whether acquisitions get done. Stock buybacks or any other distributions that change the capital structure prior to the merger are prohibited. claiming that many acquisitions that were viable now would not be in the absence of this provision. The combined firm cannot sell a significant portion of the existing businesses of the combined companies. Here. the top executives at high technology firms fought back. Some firms will not make acquisitions if they do not qualify for pooling. In early 1999. No transactions that benefit only a group of stockholders are allowed. It is revealing of managers’ obsession with reported earnings that a provision that has no effects on cash flows. just to qualify for pooling. or they will pay premiums to ensure that they do qualify.For an acquisition to qualify for pooling. 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. as both the accounting standards board and the SEC sought to crack down on the misuse of in-process R&D.4 Final Considerations Mergers & Acquisitions Page 60 of 93 . 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. Only voting common stock can be issued to cover the transaction. The net effect is that the firm takes a one-time charge at the time of the acquisition that does not affect operating earnings12. firms are constrained in what they can do after the merger. as the conditions for pooling make clear. the issue of preferred stock or multiple classes of common stock is not allowed. In-process R&D In the last few years. other than duplicate facilities or excess capacity. Firms seem to be willing to accept these constraints. another accounting choice has entered the mix.3. 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. the merging firms have to meet the following conditions.
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. When accounting choices weigh disproportionately in the outcome. To meet the requirements for pooling.global acts governing mergers and acquisitions . The volume of deal activities declined quarter by quarter through the first quarter of 2001. Mergers and restructuring activities accelerated through the first quarter of 2000. The rules of the games are changing as well. firms will often acquire entire firms rather than the divisions that they are interested in and defer asset divestitures that make economic sense. Given the transparency of this write off (firms report earnings before and after goodwill amortization). the results can be expensive for stockholders in the acquiring firm. consequences of changed forces. we believe that this fear is misplaced and the empirical evidence backs us up.The managers of acquiring firms clearly weigh in the accounting effects of acquisitions. But overcapacity in a number of industries will predictably result in consolidation mergers. The abolition of the pooling method of accounting appears to be Mergers & Acquisitions Page 61 of 93 .It also describes the merger performance during the 1980’s and the factors affecting mergers and acquisitions and the cross border mergers. In particular. Firms will overpay on acquisitions. merger movements. even when accounting choices have little or no effect on cash flows. The Hart-Scott-Rodino Act of 1976 was amended on December 21. just to qualify for favorable accounting treatment. Chapter – 4 Change forces and Mergers This chapter deals with the changed forces affecting mergers. 2000. regulations of tender offers . This behavior is rooted in a fear of how much financial markets will punish firms that report lower earnings. largely as a consequence of the write off of goodwill.
The average dollar volume of M&A activity in the United States for the years 1998 through 2000 was slightly more than $1.1 Announced M&A Activity ($ Billion) Mergers & Acquisitions Page 62 of 93 . So while the pace of M&A activities may decline from the torrid levels of the late 1990s. but from unusually high levels. For both segments of the world.5 trillion.1. As shown in Table 4.likely.Merger activity leveled off in 2000. they continue to represent a major force in the financial and economic environment. The rules for writing off goodwill and other intangibles are being changed.1. which began in 1993 and has been characterized by strategic mega-mergers.3 trillion. the year 2000 represented a leveling off of worldwide M&A activity. and have occurred since 1998. and stock prices continued to decline during the fourth quarter.2 lists the top 10 mergers in all history through January 2001. This was associated with a decline in merger activity toward the end of the year. The ninth largest transaction involved foreign T A B L E 4. The Vodafone–Air Touch transaction involved a foreign (United Kingdom) acquirer. The stock market indexes reached their peak in March 2000. the percentage increases compared with average levels in 1995 to 1997 were approximately 157 percent. The current merger activity is a part of what has been called the fifth merger movement. as shown in Table 4. All these mergers are greater than $50 billion. Table 4. Merger activity in the United States and worldwide rose to unprecedented levels in 1998 and 1999. for the rest of the world the corresponding figure was somewhat more than $1.
combining the new and old economies.3 157. The largest of all was AOL and Time Warner.3 157. T A B L E 4. Five of the ten were in telecommunications. two in oils and financial services.U. Firms on both sides of the deal. 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.2 Source: Thomson Financial Securities Data.2 Top 10 Merger Rank Acquirer Acquired Announcement Amount Page 63 of 93 Industry Mergers & Acquisitions . 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. which will be placed in the Internet/media category.S.
9 Internet/media December 1998 78. acquiring Dreamworks for $3.5 Oil July 1998 53.9 Oil April 1998 72. 4.1 THE CHANGE FORCES The increased pace of M&A activity in recent years has reflected powerful change forces in the world economy. 2001 .3 Tele communication April 1999 56.6 Tele communications April 1998 61. reduced.1 2 3 4 5 6 7 8 9 10 AOL Exxon Travelers Group SBC Comm. Hence markets have become international in scope.0 Tele communication June 1998 53. announced July 2006.1 billion (4) The Walt Disney Company. Nations Bank Vodafone group AT&T AT&T Total Fina Bell Atlantic Time Warner Mobil Citicorp Ameritech Bank America Air Touch Communication Media One Group Telecommunications Elf Acquitaine GTE date ($Billion) January 2000 $165.4 Tele communication Major Mergers & Acquisitions 2000-2006 (1) Hewlett-Packard. New industries have emerged.6 Financial services May 1998 62. The forms.. announced January 2006. acquiring Pixar. The costs of communication and transportation have been greatly 3.6 Tele communication July 1999 53. Ten change forces are identified: 1. and intensity of competition have expanded. sources. 2. with Compaq (Announced Sept. $54 billion) () (3) Paramount. Mergers & Acquisitions Page 64 of 93 .Final May 2002) ($25 billion) () (2) Procter & Gamble buy Gillette (2005. 5. 4. The pace of technological change has accelerated. $7 billion Microsoft and Wininternals Inc.6 Financial Services January 1999 60.
PC software. and the many advances in information systems. Strong economic growth. Economies of scale spread the large fixed cost of investing in machinery or computer systems over a larger number of units. The next set of factors relates to efficiency of operations. these would represent economies of activities in personal computer (PC) hardware.6. and medical services. which include personal computers. Andrew Grove at Mergers & Acquisitions Page 65 of 93 . Another efficiency gain is achieved by combining complementary activities. rising stock prices and relatively low interest rates have favored internal growth as well as a range of M&A activities. Individual entrepreneurship has responded to opportunities and. Another major force stimulating M&A and restructuring activities comprises changes in industry organization. The growing forces of competition have produced deregulation in major industries such as financial services. Examples are Bill Gates at Microsoft. server hardware. in turn. including the Internet. Improvements in communication and transportation have created a global economy. 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. 9. problems have developed in individual economies and industries. Within a general environment of strong economic growth. combining a company strong in research with one strong in marketing. Dell Computers. In the information industry. for example. server software. Nations have adopted international agreements such as the General Agreement on Tariffs and Trade (GATT) that have resulted in freer trade. 8. for example. created further dynamism in industrial activities. 7. An example is the shift in the computer industry from vertically integrated firms to a horizontal chain of independent activities. Mergers to catch up technologically are illustrated by the series of acquisitions by AT&T. and other related activities. servers. Valuation relationships and equity returns for most of the 1990s have risen to levels significantly above long-term historical patterns. Favorable economic and financial environments have persisted from 1982 to 1990 and from 1992 to mid-2000. 10. computer services. While regulations have increased in some areas. Inequalities in income and wealth have been widening. deregulation has taken place in other industries. Economies of scope refer to cost reductions from operations in related activities. The economic and financial environments have also been favorable for deal making. the Internet. Overriding all are technological changes. software. airlines.
Forces for vertical integration have diminished in some areas. Industry boundaries have become increasingly blurred. The value chain has deconstructed in the sense that more activities are performed by specialist firms. Jack Welch at General Electric. Growth opportunities among product areas are unequal.2 CONSEQUENCES OF THE CHANGE FORCES The change forces are having major impacts. This M&A activity exists worldwide.S. among the many. The decline and failure rates of firms in some sectors have accelerated. New industries have been created. New growth opportunities have attracted such large flows of resources that unfavorable sales-to-capacity relationships have developed. and the basic manufacturing industries at the time. telephone. Changes in the organization of industries have taken place. Real-time financial planning and control information requirements have increased. 4. The forces in Europe have been similar to the factors in the earlier merger movements in the United States. In relation to the gross domestic product (GDP). Strategy formulation and revisions are more important. It created the first common market. 4. John Chambers at Cisco Systems. Distribution and marketing methods have changed. and Bernie Ebbers at MCI WorldCom. A wide range of adjustment processes have been used by firms in response to their increasingly changing environment. Second Merger Movement—1920s Mergers & Acquisitions Page 66 of 93 . In the United States. not just in the U. Europe is experiencing similar forces from its effort at integration. even in new industries such as telecommunications and e-commerce. major horizontal mergers took place in steel. The forms and number of competitors have been increasing. the fifth major merger movement—the era of strategic megamergers.3 MERGER MOVEMENTS The foregoing describes M&A activities beginning in 1993. The knowledge and organizational capital components of firm value have increased. economy.Intel. 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. These impacts have expanded opportunities and risks. The technological requirements for firms have increased. The pace of product introductions has accelerated. but increased in others. this merger movement in the United States has thus far been of greater magnitude than any others. The requirements for human capital inputs have grown relative to physical assets. Economic activity has shifted from manufacturing to services of increasing sophistication. so the merger forces in Europe are very strong. oil.
Chemicals become commodities. In the fifth merger movement described above. Any company that was not performing up to its potential could be taken over. So the availability of high-risk financing strongly propelled the 1980s and there was some dismantling of the diversification of the 1960s. which permitted more effective geographic sales and distribution organizations. Vertical mergers enabled manufacturers to control distribution channels more effectively. Pharmaceuticals enjoy a limited period of patent protection. and the automobile. could manage anything. but suffer rapid imitation. Chemical Bank and Disney were both almost taken over. Globalization of industries and firms requires financial services firms to go global to serve their clients. It is an attractive and glamorous industry (attracted Japanese investors beginning in late 1980s). A distinct group of change factors propelled each movement. 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. In every sample of conglomerates. Much of the diversification at this time was ill advised as companies moved away from their core competencies. made all firms vulnerable to a takeover bid. which made national advertising possible. commercial banks. at least one-half of the companies were aerospace or natural resource–depleting companies (oil. Also influencing this was the idea that a good manager. Changes in the Page 67 of 93 • • Mergers & Acquisitions . Each of the merger movements in the United States was driven by a different set of economic and development forces. forest). Media (movies. Financial (investment banks. Chemicals. newspapers): Technological changes have impacted the relationship between the content and delivery segments. the identity of the industries has varied at different time periods. with the new planning literature. magazines. Third Merger Movement—1960s The conglomerate mergers of the 1960s represented in part an adjustment to the slowdown in defense expenditures. industries like the food industries. junk bonds. but this is eroded by “me. Also at this time. too” drugs and generics. Fourth Merger Movement—1980s Financial innovations. diversified. There is potential overlap in the content of different media outlets. hoping to avoid their growth being tied down to population growth. These were associated with the development of the radio. But these movements did not occur randomly. However.This period was characterized by an increase in vertical mergers. more than 50 percent of the M&A activity in a given year has been accounted for by five or six industries. pharmaceuticals: Both require high amounts of R&D. records. insurance companies).
The SEC imposes periodic disclosure requirements under Section 13. The Securities Act of 1933 has primary responsibility for recording information. and (3) Form 8-K. 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. Section 8 provides for registration and permits the statements to automatically become effective 20 days after it is filed with the SEC. Williams Act The Williams Act. Autos face global excess capacity. Section 5 prevents the public offering and sale of securities without a registration statement. Expanding internationally offers opportunities to grow in new markets. industrial machinery: All face unique difficulties that give advantages to size. and (3) by explicitly authorizing targets to sue bidding firms. • • • 4. Food. The act was amended in 1970 to increase the SEC powers and to reduce the trigger Mergers & Acquisitions Page 68 of 93 . oil and gas. Natural resources. became law on July 29. the annual report. Oil faces the uncertainty of price and supply instability due to actions of the OPEC cartel. in the form of various amendments to the Securities Exchange Act of 1934. 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. the quarterly report. New kinds of competitive forces have created needs for broadening managerial capabilities. However. the current report for any month in which specified events occurred. timber: Both face exhausting sources of supply. 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. stimulating M&A to achieve critical mass. • Autos. retailing: It is hampered by slow growth.4 REGULATION OF TENDER OFFERS The regulation of tender offers stems from the original Securities Acts of 1933 and 1934. 1968. Utilities: Deregulation has created opportunities for economies from enlarging geographic areas. thus delaying the execution of the tender offer. (2) by requiring a minimum period during which a tender offer must be held open.technology of basic research and increased risks due to competitive pressures have created the stimulus for larger firms through M&As. The basic reports are (1) Form 10-K. Food consumption will only grow at the rate of population growth. the SEC has the power to request more information or to issue a stop order. Problems exist in matching raw material supplies with manufacturing capacity. which delays the operation of the 20-day waiting period. It is the Securities Exchange Act of 1934 (SEA) that provides the basis for the amendments that were applicable to takeover activities. (2) Form 10-Q.
Section 7 involves mergers. 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. Before HSR. Parallel to DOJ’s suits against IBM during the 1970s. This was the basis on which the DOJ stopped the merger between Staples and Office Depot. SEA Section 14(c) prohibits misrepresentation. The amendment also added an incipiency doctrine. HART-SCOTT-RODINO ACT OF 1976 The Hart-Scott-Rodino Act of 1976 (HSR) consists of three major parts. 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.point for the reporting obligation under Section 13(d) from 10 to 5 percent. CLAYTON ACT OF 1914 The Clayton Act created the Federal Trade Commission for the purpose of regulating the behavior of business firms. was dropped in 1983. As enacted in 1914. Section 14(d) applies only to public tender offers but applies whether the acquisition is small or large. SHERMAN ACT OF 1890 This law contains two sections. 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. antitrust actions were usually taken after completion of a Mergers & Acquisitions Page 69 of 93 . 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. which had gone on for 10 years. IBM and AT&T were sued again in the 1970s. The 5 percent trigger rule also applies under Section 14(d). Section 13(d) provides management and the shareholders with an early warning system. The suit against IBM. Section 2 is directed against firms that had already become dominant in their markets in the view of the government. or any fraudulent. Under Section 2. Basically. deceptive. The suit against AT&T resulted in divestiture of the operating companies effective in 1984. 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. nondisclosure. Thus. Among its sections. or manipulative acts or practices in connection with a tender offer. so its coverage is broader. The 1950 amendment gave the FTC the power to block asset purchases as well as stock purchases. The Microsoft case illustrates the policies of the Department of Justice under Section 2 of the Sherman Act. the DOJ turned its attention to Microsoft during the decade of the 1990s. Its objective was to strengthen the powers of the DOJ and FTC by requiring approval before a merger could take place. two are of particular interest. Section 7 made it illegal for a company to acquire the stock of another company if competition could be adversely affected. 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.
The transaction threshold will be annually adjusted to follow GNP. logical story. an amendment to Title II was signed into law by President Clinton. the fee will increase to $125.000. 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 fee. It became effective February 1. Under the guidance of attorneys. the attorneys general of 22 states joined in the suit filed by the DOJ. the fee is $45. 2000. Title III is the Parens Patriae Act—each state is the parent or protector of consumers and competitors. 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 fee will become $280.” Under Title I. 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. The idea here is that if the DOJ suspects a firm of antitrust violations. For transactions that are valued at more than $500 million. It is expected that the amendment will cut the number of reportable transactions in half. the merged firms had been operating for several years. The amendment was designed to reduce the number of transactions that require HSR notification and to increases the fees for large transactions. A successful suit with triple damages can augment the revenues of the states. There will now be a three-tier fee system in place of the old $45. The HSR process should be viewed as an educational endeavor to provide the necessary information to the government staff attorneys. Title II is a premerger notification provision. A briefing package should fully develop the business reasons for the merger. From $100 million to $500 million. In the Microsoft case. For transactions under $100 million. This gives the individual states the incentive to increase the budgets of their state attorneys general.transaction. Companies should follow a proactive strategy during the 30-day review period. The overriding approach should be for the lawyers and executives to convey a factual. 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. The HSR amendment increases the amount of time the reviewing agency has from 20 to 30 days. 2001. 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. The presentation should demonstrate how the industry dynamics Mergers & Acquisitions Page 70 of 93 .000. high-level business executives should be made available for informal presentations or staff interviews.000. so it was difficult to “unscramble the omelet. the DOJ has the power to issue civil investigative demands in an antitrust investigation. By the time a court decision was made. On December 21. The state itself does not need to be injured by the violation. The staff attorney’s should be contacted with an offer to voluntarily provide additional information. In the interest of maintaining the same HSR revenue levels the amendment increases the filing fees. it can require firms to provide internal records that can be searched for evidence.
Mitchell and Mulherin (1996) studied industrylevel patterns of takeover and restructuring activity during the 1982 to 1989 period. The results reflect large transactions whose patterns are different from those of smaller transactions.” November 23. the third quarter of 1998 was still high because of deals initiated earlier. The exploding number of blockbuster transactions is consistent with these data. the courts and the antitrust agencies began to be less rigid in their approach to antitrust. THE ANTITRUST GUIDELINES In the merger guidelines of 1982. 4. 4. and its owners and creditors. the event return results could differ also. the economics of industry were taken into account. 1999). the spirit of the regulatory authorities was altered. 40 percent were hostile takeover targets. The sample accounted for about 40 to 45 percent of total deal value in most years. In addition to the concentration measures. For completed transactions. 1998. the study captures a distinctive cycle of M&A activity.require the transaction to enable the firm to fulfill its responsibilities to consumers. 1992. concentration tests were applied somewhat mechanical the internationalization of competition and other economic realities. The information was obtained from the Mergerstat database. Most of the M&A activity occurred in Mergers & Acquisitions Page 71 of 93 . The selection criteria began with all M&A in which the price paid for the target exceeded $500 million. Somewhat more—47 percent of the firms—were targets of friendly takeovers. The study summarized deal structure patterns and calculated event returns. employees. supplemented by proxy statements to shareholders soliciting approval of transactions. they found significant differences in the rate of M&A activity as well as in the timing of the activity. and successively in 1987. and 1996. with 11 major deals totaling $65 billion announced on “Merger Monday. Of the firms involved in takeovers or restructuring. increasing to almost 69 percent for the first half of 1998. The remaining 13 percent of the firms engaged in defensive asset restructuring or financial recapitalization.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. the communities in which it has its plants and offices. By 1997. Among their 51 sample industries. The study ended with transactions announced through June 1998. this annual number became so large that the cutoff was raised to $1 billion or more. They found that in their sample of 1064 firms. however. 57 percent were the object of a takeover attempt or experienced a major restructuring during the 1980s.6 INDUSTRY INFLUENCES ON M&A ACTIVITY In an in-depth analysis of industry effects. Thus. In the merger guidelines of 1968. The stock market began to recover in mid-October and was associated with resumption in an active M&A market. The stock market adjustment that began in July 1998 dampened new M&A deal announcements.
the ratio of imports to total industry supply. A second major factor was the oil price shocks that occurrence in 1973 and 1979.7 HOSTILE TAKEOVERS When the management and the board of directors resist the takeover attempt by bidders. Their evidence supports an impact of industry shocks. and lower leverage. They find a dual role in that own-industry mergers are used in industries with excess capacity to achieve consolidation. which had a major impact on the air transport. autos and auto parts. The asset reallocation results in improved efficiency. Their broader framework also measures the role of other influences— synergy. hostile M&A activity is relatively small. apparel. This is measured by changes in the import penetration ratio. The number rises to 3. A fourth major influence was innovations. The industries with the largest change in import penetration ratios were shoes. natural gas. lower capacity utilization. Many large and well-publicized hostile episodes have taken place. office equipment and supplies.relatively few industries. The median level of hostile M&A activity to the total worldwide value of transactions is 3. and drops to. owing to identifiable major shocks defined as factors causing a marked change in overall industry structure and corporate control activity.3 percent. In contracting industries. coal. entertainment. Table 4. are a response to favorable growth potentials. construction equipment. 2. A third major factor was foreign competition. The bidder in hostile takeovers is often referred to as a raider. and trucking industries. 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. broadcasting. Andrade and Stafford (1999) extend the Mitchell and Mulherin results. One major force was deregulation. agency costs. air transport. 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. machine tools. acquiring firms appear to be those with better performance. Their basic economic finding is that mergers. The ability to use public markets for leveraged financing increased both the rate of takeovers and the size of takeover targets. and market power. Table 4.5 percent for the rest of the world. and trucking. The industries most directly affected were integrated petroleum. 4. diversification.3 Mergers & Acquisitions Page 72 of 93 .3 shows that as a percent of total value of transactions. Mitchell and Mulherin conclude that the interindustry patterns in takeovers and restructuring reflect the relative economic shocks to the industries. Their data set is based on Value Line companies and industry groupings covering the period 1970 to 1994. we have hostile takeovers. tires and rubber. natural gas. like internal investment.7 percent for the United States. and steel.
The target will not cooperate in providing information.5 15. Domestic 11.1 0.5 4. the target company is sold to a third party.4 1.8 0.9 1.8 0.6 4. The hostile bids succeed in somewhat more than one-third of the attempts. These factors can be broadly summarized into two categories: Mergers & Acquisitions Page 73 of 93 .8 6.6 6.2 5.9 4. Considerable animosity is likely to be encountered in combining the two organizations.8 Factors affecting merger There are several factors that motivate the mergers and acquisitions.9 1.9 1. differences in information systems.8 12. and problems in implementing the combination of two different organizations are formidable.1 7.1 22. 4.0 2.3 4.S.3 0. In somewhat less than one-third of the efforts.5 0.3 6.5 9.3 Rest of the World 27.0 2.4 2.2 1.4 3.2 3. In somewhat under 40 percent of the cases.6 5.1 1.2 7.7 22.1 3. the company remains independent.3 0.9 3. The probability of success of a hostile bid is low.0 0.3 3.7 2. Differences in cultural factors.1 0. All these challenges are magnified in hostile mergers.3. a bidder needs to understand the difficulties likely to be encountered and have a well-formulated plan that has a reasonable probability of success.2 0.7 Worldwide 14.9 0.2 0.2 1.2 3.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.0 5.7 6. combining companies is difficult.4 1. The outcome of hostile bids is shown in Table 4.7 3.9 6.5 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. At best. Given the evidence. All empirical studies find that the returns to bidders in hostile takeovers are negative.7 3.5 17.
they can be. at the beginning of 2001. The uncertainty as to the U. but it is not possible to gauge accurately how many deals were undertaken in 1999 and 2000 to beat the deadline. Pooling avoids dilution of earnings brought about by the recognition and mandatory amortization of goodwill when a merger is accounted for as a purchase. 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. companies. Arbitrageurs. will be a bit less restrictive. The strong dollar and weak Asian currencies led to a significant increase in acquisitions by U. undoubtedly acted as a stimulant for some mergers. are a major factor in merger activity. The “big is bad” concept has been abandoned. Antitrust. neither significantly stimulating nor restraining mergers. retard or prohibit mergers and is a major factor affecting mergers.S. An impairment charge would be taken when the fair value of goodwill falls below its book value. the FASB is proposing that purchase accounting replace pooling but that goodwill should not be automatically written down. The availability of pooling accounting for mergers has been a significant factor in the 1990s merger activity. Thus. together with hedge funds and activist institutional investors. Government policy can promote. first at the end of 2000 and then in the first-half of 2001. Currencies. They will continue to be a force both facilitating and promoting mergers.S. accounting will basically be a neutral factor in 2001 and the foreseeable future. licenses and business restrictions to cure problems. companies in Asia. By accumulating large amounts of stock of a company to be acquired. However. The antitrust regulators in the U. Now. a factor in assuring the shareholder vote necessary to approve a merger. Arbitrage. and the EU have been reasonably receptive to mergers.1. 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. They have recognized that markets are global and have accepted divestitures. Mergers & Acquisitions Page 74 of 93 . its impending demise. The sharp decline in the Euro during 2000 was a deterrent to European acquisitions of U.S.S. with a change in administration. 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. The overall situation can be summarized: Current antitrust enforcement policies will not unduly restrain mergers in 2001. As pooling came under increasing pressure from the SEC and the FASB. 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. and frequently are.. Exogenous Factors Affecting Mergers: Accounting. The recent strength in the Euro has not had time to become a factor in mergers. At this time it appears that the EU has become a bit more restrictive and the U. but instead should be subjected to a periodic impairment test.
IBM. The development of experts in conceiving. Steel. Labor. – has also contributed to an increase in mergers. 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 worldwide movement to market capitalism and privatization of state controlled companies has led to a significant increase in the number of candidates for merger.S. As long as there is a vibrant job market. In addition there has been a dramatic increase in hostile bids in Europe. Pfizer. In the U. and the shift to strategic transactions. major companies have been willing to make hostile bids.S.economy. Wells Fargo and Norfolk Southern are some of the companies that have done so. General Electric. 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. Receptive equity and debt markets are critical factors in merger activity. Hostile Bids. Experts.S. trade deficit and the strength of the dollar portend at best slow growth of cross-border acquisitions of U. Deregulation.S. analyzing. The general prosperity and full employment in the U. these funds have the capability of doing major deals and will continue to be an important factor. 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. With the demise of the financially motivated bust-up bids of the 1970s and 1980s. While some consider this to be phenomenon of the 1980s. valuing and executing mergers has been a significant factor. 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. Prior to mid 2000 the equity markets were very favorable for telecommunications. 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.S. The $202 billion record-setting bid by Vodafone for Mannesmann being the prime example. The concomitant change in attitude toward cross-border mergers has had a similar effect. employee resistance to mergers will not be meaningful. Markets. consultants and accountants to provide backup and support to the managements and directors of merging companies has been a merger stimulant.S. With tens of billions of dollars of equity to support leverage of two to three to one. Deregulation of specific industries – like financial institutions. AT&T. So too the availability of specialized lawyers. utilities and radio and television in the U. This Mergers & Acquisitions Page 75 of 93 . companies. the success rate for strategic hostile bids by major companies has similarly led to an increase in activity. LBO Funds. media and technology stocks and for five years these sectors led merger volume to new heights. Johnson & Johnson. the U. in the 1990s resulted in weakened resistance to mergers by the employees of acquired companies.
With the NASDAQ down more than 50% from its early 2000 highs and many telecommunications. media and technology sectors. Left unrestrained by government regulation it would be a natural tendency of businesses to seek monopoly power. Many of today's acquisitions involve a company with a favorable operating margin acquiring a company with a lower operating margin. 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. with concern that the landing will be hard rather than soft. Just as the explosive formation of new companies in the latter part of the 19th Century fueled the first and second merger waves. Starting with the 19th Century railroad and oil mergers. Sharing the benefits of an improved operating margin through reduction of operating costs. While they basically determine whether a particular merger is doable at a particular time. both at attractive interest rates. merger activity has been less impacted by the decline in the securities markets. has dampened the merger ardor of many companies. The junk bond market has virtually dried up and banks have tightened their lending standards. 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. What are the autogenous businesses reasons driving merger activity? There is no single or simple explanation and again no ranking in importance is possible. that restraint on mergers will be ameliorated. media and technology stocks down even more. New Companies. By improving the acquired company's Mergers & Acquisitions Page 76 of 93 . 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. 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. 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. but the uncertainty as to the economy. 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. This has resulted in a reduction of cash acquisitions. Experience indicates that one or more of the following factors are present in all mergers: Obtaining market power. The general worldwide reduction in capital transaction taxes has lifted a restraint on mergers. The recent actions of the Federal Reserve in twice reducing interest rates may change market psychology and stem the fall of the equity markets. media and technology mergers. For example. growing junk bond market and ready availability of bank loans. Outside of the telecommunications. they do not explain why companies want to merge. If so. Taxes.same period saw an active. A special feature of the collapse in the telecommunications.
companies have become global in scope. Examples are the acquisition of investment banks and insurance companies by commercial banks following the relaxation of restrictions on activities by commercial banks. healthcare. Currently it has a poor record in media and entertainment. Additionally. the acquirer creates synergies that pay for the acquisition premium and provide additional earnings for the acquirer’s shareholders. transportation and utilities are industries that have experienced mid1990s mergers as a result of deregulation. cross-border merger and acquisition activity has been steadily increasing. Due to the increased globalization of product markets. intra-industry consolidating acquisitions provide opportunities to reduce costs by spreading administrative overhead and eliminating redundant personnel. money management. and the cross-border utility mergers following the relaxation of state utility regulation. telecommunications. Concentration of management energy and focus. insurance. and joint-venture consolidation of refining and marketing operations by. is being widely pursued as a response to the Internet. This factor is particularly significant in the aerospace/aircraft and pharmaceutical industries.S. Response to deregulation. 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. 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 . vertical integration continues to be a motivation for a significant number of acquisitions. A similar situation has resulted in a large number of mergers of suppliers to the automobile manufacturers. oil and gas companies is another example of an effort to reduce costs by eliminating overcapacity. Sharing the costs and benefits of eliminating excess capacity. The need to spread the risk of the huge cost of developing new technology. and. Acquiring firms may reallocate or redeploy assets of the acquired firm to more efficient uses. 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 advantage or necessity of having a more complete product line in order to be competitive. Banking. The acquisition of Time Warner by AOL is an example.operations. as noted below. However. a local partner. The pressure to control healthcare costs has had a similar impact in the healthcare industry. The usual and generally least risky means of increasing global market penetration is through acquisition of. Many of the most important and largest product markets for U. The Defense Department encouraged the consolidations to assure that its suppliers remained healthy.S. Integrating back to the source of raw material or forward to control the means of distribution. Response to the global market. or joint venture with. The mega-mergers of. particularly where "hardware" companies have acquired "software" companies. U. Over the years vertical integration has had a mixed record.
These factors resulted in the spinoff or sale of non-core businesses by a large number of companies. 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.P. Larger companies have significantly higher multiples than smaller companies with the same growth rate. When equity investors are willing to accept substantial amounts of stock issued in mergers and encourage deals by supporting the stock of the acquirer. Morgan shows that size has a major impact on a company’s price earnings multiple. there is pressure on companies to not be left out and to either be a consolidator or choose the best partner. Pressure by institutional shareholders to increase shareholder value. When a series of consolidations takes place in an industry. Response to industry consolidation. resulting in divestitures of non-core businesses and sales of entire companies in some cases. Cogent examples are the acquisitions by telephone. companies will try to create value by using what they view as an overvalued currency. AT&T’s acquisition of cable companies reflected its strategy to use cable lines to form a network for local phone and internet services. The recognition by boards of directors that it is appropriate to provide incentive compensation. forest products. Current examples of industries experiencing significant consolidation are banking. software. but spinoffs have continued as a frequently used means of focusing on core competencies. there has been recognition that a spinoff can result in the market valuing the separate companies more highly than the whole. The enhanced ability of shareholders to communicate among themselves and to pressure boards of directors has had a significant impact. food. entertainment and shopping. For instance. Similarly. So too the Mergers & Acquisitions Page 78 of 93 . expand product lines or gain entrance to new geographic areas. 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. Institutional investors and other shareholder activists have had considerable success in urging (and sometimes forcing) companies to restructure or seek a merger. A recent study by J.limited number of businesses. Less management resistance to takeovers. Response to changes in technology. Rapid and dramatic technological developments have led companies to seek out acquisitions to remain competitive. the AOL and Time Warner merger is premised on convergence of media and the Internet. shareholder pressure has been the impetus for growth through acquisitions designed to increase volume. Banking is another example where rapid changes in technology have sparked a significant number of mergers. In other cases. Boards have responded by urging management to take actions designed to maximize shareholder value. information. advertising and oil and gas. The amendment to the tax law eliminating new Morris Trust spinoff/merger transactions had a dampening effect on the level of spinoff/merger activity. When debt financing for acquisitions is also readily available at attractive interest rates. The receptivity of both the equity and debt markets to large strategic transactions. Similarly.
and law firms. accounting.9 THE CHANGING INTERNATIONAL M&A LANDSCAPE This is the first merger wave that can truly be called an international one. Since global scale is often necessary to boost earnings. they seek to acquire non-US companies to enhance the likelihood that they can compete with these non-US giants in the future. it is quite unlikely that any future waves will be dominated by US companies as they were in the past. but almost every aspect is dramatically evolving – from the viewpoints of the regulators to the corporate strategies employed. Many of the more notable transactions have either involved parties entirely outside the United States or have involved at least one non-US party. From a regulatory perspective. As the pace of European deals continues unabated. many mergers are intended to have worldwide implications. this is no small feat. As US companies realize that many of their brethren are being bought by companies outside the US. including economic and capital raising ones. This is most clearly exemplified by the fact that the largest deal in history. even the most routine merger or acquisition seems to have a transnational component. Based on the trends in the marketplace. European companies tended to conduct merger activity ‘‘in market’’ (i. the landscape of mergers and acquisitions from an international perspective is changing.e. some commentators predict that Mergers & Acquisitions Page 79 of 93 . Cross-border merger and acquisition activity has been steadily increasing and is expected to continue for many years. Europe Even before it received a boost from the use of a single currency in the late 1990s. the growth of international transactions has created a greater need for – and has forced some – global harmonization in the legal and accounting areas. The relative importance of the US is in a steady decline based on any number of factors. The worldwide volume of mergers and acquisitions reached $3.ability of management to obtain a significant equity stake through an LBO has been a stimulant to these acquisitions. United States As more US companies engage in operations outside the US. As a result. At the beginning of this merger wave. Below is a brief analysis of how it is impacting various regions of the world.2 trillion in 2000 from $322 billion about a decade previously. Now. companies often find themselves an unwilling target. As many of the product markets for larger companies become global in scope. the $180 billion Vodafone-Mannesmann transaction. With disparate political interests involved. within the same country). 4. and European companies increasingly are looking for targets outside Europe. the globalization of their clients has led to expansion of US investment bankers. was between two non-US firms. In addition. they increasingly seek to penetrate local markets through acquisitions or joint ventures. cross-border transactions are quite common within Europe. Both large and small companies must now think of global competition and cannot merely focus on their neighboring competitors. the number and size of European mergers and acquisitions had climbed gradually. Without a global perspective. Not only is the sheer volume of deals on the rise.
the Asian economic crisis caused a blip in this trend. Acquisition activity in Australia and Africa is relatively low compared with the rest of the world. currencies. reflecting slower economic recovery and a general unwillingness to encourage foreign acquisitions. ``Not only they dominate FDI flows in developing countries. the level of Asian mergers and acquisitions activity has increased steadily. ‘‘flowback’’ can have a negative impact on the acquiror’s stock price and cause regulatory problems (i. Asia During the past decade. Other types of considerations include the change in the Mergers & Acquisitions Page 80 of 93 . undertaking a crossborder transaction is more complex than those conducted ‘‘in market’’ because of the multiple sets of laws.the European level of merger and acquisition activity during 2002 may surpass that of the US1. and as the trend to transition from control by family-owned enterprises to professional managers continues. How should the transaction be financed? The financial structure of the transaction might be impacted by which country the target is in. Other areas In 2001. Now these political impediments are falling. In 1998. from a valuation perspective. Historically. In Europe. but by 1999 activity had rebounded. and other factors that impact the process. as reflected by the mid-2000 European Union Takeovers Directive that was loosely patterned on the takeover friendly British and US regulatory framework. FACTORS TO CONSIDER IN A CROSS-BORDER TRANSACTION Although the basic merger or acquisition is the same worldwide. For example. Although this Directive was rejected by the European parliament due to the objections of a few countries.e.10 Cross border mergers Cross border mergers and acquisitions are playing an important role in the growth of international production. they have also begun to take hold as a mode of entry into developing countries and economies in transition. As rapid economic growth continues. stock ‘‘flowing’’ back to the acquiror’s home jurisdiction). 4. mainly as a function of the limited number of sizable companies in those continents. customs. the level of South American mergers and acquisitions activity has fallen. 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. cultures. hostile takeovers have been politically difficult in most European countries (with the notable exception of Britain). this activity should grow as regulators recognize that elimination of restrictions on foreign investment is necessary to provide capital for their countries’ economies.
g. and if so. » If the transaction involves issuing stock. 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. In comparison. investors will want pro forma information to understand how the combined company will operate going forward. This may require disclosure of financial information to which the target’s investors are accustomed. and shareholders. but which is new for the acquiror. secured. the parties can choose which law governs if the transaction is private. From a financial perspective. 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. If two sets of laws are involved. or even a third-party country with established merger laws like the US. the parties generally must abide by the law of the country where the offer will be made. one from the country of each party. How do the applicable laws govern the transaction? If the transaction is public. 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. such as a tender offer. the acquiror should be able to express a clear vision of how the target will be operated and funded.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. and will the stock be issued directly to the target the transaction. 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. particularly if one is based on a code system and the other is common law. 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 the financial disclosure laws? » After issuing stock. Public relations are important in winning the hearts of the target’s employees.’’ or whether it will be part of a regional center or managed solely from the acquiror’s headquarters.The following are issues for an acquiror to address when structuring the transaction. Mergers & Acquisitions Page 81 of 93 . foreign tax credit is useless to US tax-exempt investors). or mezzanine? » If the transaction involves cash. can the acquiror comply with any applicable margin requirements. will the stock be common or preferred stock. unsecured. 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. as well as with its own shareholders. from ‘‘in country’’ or cross-border? What type of debt will be issued – senior. This will be necessary to share with the target and its employees and shareholders. will cash be raised by raising capital in the public markets. communities. and the possible change in the tax treatment of dividends that encourages the sale of the stock (e. They can select ‘‘ground rules’’ that are the laws from either of the home countries. where will the debt be issued.
banking. and if so. will the regulatory delays make it appropriate for the acquisition to take the form of a one-step merger (i.’’ an acquiror must consider the laws of the target in deciding whether to pursue a combination. 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. Australia. such as Canada. The following are issues for an acquiror to address before a deal is struck with a target. such as restrictions on ownership. Mergers & Acquisitions Page 82 of 93 . 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. there could be laws that pose substantial obstacles to consummating a deal. In addition to access to all financial information. 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. 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. under the Exon-Florio provisions of the Trade Act.g. Similarly. The acquiror should ensure that it has adequate access to the target’s documentation and personnel to facilitate the due diligence process. defense contracting. any other major agreements should be reviewed.Even if the parties do not use the target’s country’s laws as the ‘‘ground rules. to determine whether any benefits may be lost due to the pending change in control.g. For example. the President of the United States has the power to block the acquisition or to render it void after it has been completed. severance plans. and if so. » Will the acquisition have to be approved by the target’s shareholders. in the US. 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. such as licensing and joint venture agreements. such as requisite governmental approval under exchange control or national security laws? For example. or insurance) that requires regulatory approval. » Will the target insist on ‘‘in market’’ customs. the acquiror should review the target’s loan agreements. and other employee agreements to see if the target’s change in control would impose any previously undisclosed costs or obligations (e. or Germany. or a US agreement with one of the local laws governing. 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. constitute an event of default so as to accelerate outstanding indebtedness). 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.e.
it may desire current income (i. blocking the General ElectricHoneywell merger). the Hart-Scott-Rodino Antitrust Improvements Act requires a notice and waiting period unless the transaction is below specified minimal levels. The following are issues for an acquiror to address before pursuing a target. Based on the acquiror’s own tax preferences. Are there any significant antitrust or non competition issues? Although the US generally has the most aggressively enforced antitrust laws in the world. dividends) or capital gain. or has a provision that requires a super-majority vote to approve mergers. Overall. the acquiror should determine whether the target has a shareholder rights plan or poison pill.e. it may be necessary to report the acquisition in advance to a governmental agency. If the target is involved in operations out of its home country. and there are a number of regional economic organizations that have competition law frameworks.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. the European Union has become quite aggressive (e. 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. Even if a significant antitrust problem is not present. » 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. the acquiror should consider the ongoing impact of a volatile currency after the transaction is complete. For example. more than 70 countries have their own competition laws. 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.g. 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. In the US. and should structure the transaction accordingly. If it cannot tolerate the currency risk that is involved in the target’s operations. Chapter -5 Post-Closing Challenges Mergers & Acquisitions Page 83 of 93 . the acquiror should conduct a review of the relevant antitrust laws.
The need to quickly integrate the two corporate cultures also raises personal and psychological issues that must be addressed. 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. 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. particularly for the buyer. or politics. or politics. has just begun. 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. Post-closing challenges may arise in a wide variety of subject areas.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. the uncertainty associated with the change will likely lead to widespread insecurity and fear of job loss at all levels of the organization. The seller must facilitate smooth transition of ownership and management to the buyer’s team without ego. It is a time of fear. the accounting methods and financial practices. Often one of the greatest challenges for the buyer is the postclosing integration of the two companies. The integration of human resources. when in truth the hard work. 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 in some cases. well they don’t always work out as anticipated. wasted time and resources devoted to solving post-closing problems. emotion. and achieve the economies of scale potential provided by the transaction. 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. even litigation. Another common problem is the psychological consequences of ‘‘seller’s remorse. Mergers & Acquisitions Page 84 of 93 . otherwise. the employees’ stress and distraction will affect the seller’s performance and the viability of the transaction. The fear of the unknown experienced by the employees of the seller must be addressed and put to rest. Many of the fears experienced by the employees of both buyer and seller result from expectations of downsizing to cut costs. The consequences of a weak or ineffective transition plan are the buyer’s inability to realize the transaction’s true value. The closing of a merger or acquisition usually brings a great sigh of relief to the buyer. emotion. and related matters are often the most difficult part of completing a merger or acquisition. avoid duplication.’’ particularly when the seller remains on-site in a consulting capacity or even as a minority owner. seller. 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. But the term closing can be misleading in that it suggests a sense of finality. Once word of a deal leaks out to employees. the corporate cultures. and their respective advisors.
and other issues. On the one hand. If a certain number of employees can be eliminated. the buyer must coordinate a smooth and efficient post-closing process. if the terms dictate that the acquired firm is to maintain its independence. while staff can be protected by union contracts and/or federal or state employment laws. 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. 5. The hard part is deciding who stays. and who goes. Most require forethought in order to anticipate potential pitfalls. Not consideration of all candidates fairly may result in a lower return on the investment. stock options.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. Management is often party to employment contracts. and receives deferred compensation. the chances for for not fully realizing success are greatly increased. Management In many ways. Most employment agreements and/or management benefits can be quantified to determine the cost of such decisions. Such a process is normally driven by the acquiring company. and in what positions. Some issues are addressed in the closing documents. staff cutbacks are probably appropriate and healthy. On the other hand. Only in this way can a true evaluation be made.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. Much of this depends on the nature of the acquisition. This is the greatest source of employee fear and is the fuel that powers the rumor mill. management staffing is a much easier problem to resolve. Gray & Christmas recommended that job cuts following M&A deals in the first quarter of 2005 soared to nearly 77. places. it is more likely that earnings projections will be met or exceeded. but it is not a bad idea to involve the acquired company as well. Important issues that need to be managed fall into three areas—people. The bottom line is that if the buyer doesn’t plan to address the following issues. The first step in determining staffing levels is to divide the workforce into management and staff/labor. over six times the rate of the last quarter of 2004 and three times the rate of the first quarter of 2004. In attempting to realize the true value of a merger or acquisition.000. The biggest cuts came in the telecom and high tech industries. it is much more difficult to reduce staffing levels. But some of these fears are valid. 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. These two groups must be distinguished because the terms of employment are often quite different. An April 2005 report published by Challenger. and things. Mergers & Acquisitions Page 85 of 93 . if the acquired firm is absorbed into the acquirer. This should have been examined during the due diligence process and worked into the pricing for the transaction.
it should not prevent the buyer from evaluating all employees. • Employees on family leave workers ’ compensation. or disability. • Race. 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. 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. However. it is necessary to embrace the change inherent in acquisitions to enhance your chances of success.All candidates must be evaluated objectively. For the acquiring company. which may or may not be consistent with staffing plans after the acquisition. • Whistle-blowers who could bring claims of wrongful discharge. which protects the rights of union. more diverse team. Mergers & Acquisitions Page 86 of 93 . However. Develop a selection methodology by targeting certain employees for layoff or retention based on performance and experience. It is often difficult to do so because emotions often cloud the judgment of the evaluators. Labor Labor is often protected by union contracts and labor laws. religion. which must be sent 60 days in advance by the seller to its employees if there is a plan to close facilities. • Age discrimination under the Age Discrimination in Employment Act (ADEA) and/or Older Workers Benefit Protection Act (OWBPA). Be honest. Be objective. While change can be difficult. 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. employees on matters of wages. the buyer gains a much better sense of the quality of the workforce that does ultimately remain. 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. The same rules apply to evaluating labor as to evaluating management. Once the selections are made. which has certain rights to comparable positions upon their return to work. Be balanced. The buyer shortchanges itself by not doing so. or sex discrimination for which the buyer may be held accountable under civil rights legislation. • WARN (Worker Adjustment and Retraining Notification) notices. they must be examined from a legal point of view. • Union contracts that could fall under the National Labor Relations Act (NLRA). By evaluating first and then worrying about possible protections. This limits the options available when deciding who should stay and who should go. as well as nonunion. and working conditions. hours. even if claims are filed based on events that occurred before the acquisition. a formal evaluation of all candidates can lead to a stronger. choosing the incumbent management team is an easy decision.
the customer may be a direct competitor of the buyer or of one of the buyer’s customers. even in these cases. This entails all manner of documents related to such issues. • 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. One of the post-closing challenges is to determine the profitability of the customers. 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. • Violations of the Fair Labor Standards Act (FLSA) or Equal Pay Act. among other things. it is important to evaluate the seller’s customer base. However. which. The acquirer should review all customers for profitability and sustainability. • Whether state law counterparts to federal employment laws have precedence. • 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. one of the most valuable assets is the customer base. Perhaps more important. 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. there is a limit to the amount of losses that make financial sense. Each transaction is unique in that the above issues will apply in differing degrees. the burden of compliance is on the employer under the Immigration Reform and Control Act (IRCA). As a result.• Compliance with the Americans with Disabilities Act (ADA). especially concerning the determination of exempt versus nonexempt positions. It makes little sense to keep a customer if it is not possible to make a profit on the relationship. unless the customer enables the merged company to penetrate a new market or if the customer helps achieve scale economies. thereby enabling other customers to be profitable. requires a review of job descriptions to ensure that there. In addition. 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. The bottom line is that the buyer needs to conduct a thorough labor and employment review. however. Customers When a buyer acquires a business. is for the seller to transfer the goodwill of its customers to the buyer. 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 . • To ensure that the employees being acquired are legally able to work in the United States. 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. a violation in this area could lead to substantial payments to current and former employees for overtime worked but not paid.
After all. This will go a long way toward helping to cut expenses in order to reach the target return. any vendor can easily be replaced. Since this is often true. 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. there are certain suppliers whose replacement would cause significant disruption. But very few decisions in a merger or acquisition can be resolved with a simple mathematical equation. The standard assumption is that the combined company will use the buyer’s professional suppliers.Vendors Suppliers are much more often overlooked than customers. 5. 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. just as much as when examining staffing levels. This can occur in situations where there is only one supplier of a given product or service. However. we can reduce the staff by x percent. or if the supplier is an integral part of a just-in-time inventory system. As a result. However. accountants. the bankers may not have the appropriate expertise. 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. it is certainly helpful to consider the square footage. thereby saving $x. This has to be accounted for when looking at space. it may be best to continue to use both firms for certain purposes. The legal counsel of the seller may be better suited to deal with certain local matters or be more cost-effective. It would seem to be an easy issue to resolve: In acquiring this company. Essential vendors are a key component of the continued success and uninterrupted operations of a company. There usually are people involved. but this may not always be desirable or feasible. total square footage can be reduced by x percent. and with people come emotions and unpredictability. which means that we need x percent less of square footage in which to work. bankers. The accountants of the seller may be providing outsourcing of certain tasks for which it may not be practical to change immediately. In addition. Of special importance are suppliers that provide professional services—in particular. When examining the space requirements of the combined entity. These factors should be considered carefully before any key relationships are terminated. Ultimately. there must also be human considerations. subject to any potential conflicts of interests being resolved. If a buyer is purchasing a business in a different industry. and lawyers. 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. the staff has x percent more square footage per employee than our company.
management Mergers & Acquisitions Page 89 of 93 . Before such issues can be decided.Non-consideration of these and other related questions can open up a can of worms. employees. A corporate identity defines what makes a corporation unique. customers. it may be important to consider a new corporate identity in the form of the company name and/or logo. distributors. 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. of these aspects are altered in some way as the result of a merger or acquisition. Yet this is a point that can often be forgotten when it comes to corporate identity. Location is a factor that can effect the overall integration of the buyer by the seller and can lead to significant turnover. if not all. The company name and logo are merely manifestations of that identity.4 Legal Issues Following the closing of the transaction. Only then does it make sense to put a name on it and identify an image with it. There are several aspects of a corporation that go into its identity. industry group identification. Since there is essentially a new company. and how it is different from other corporations. depending on the size and type of the financing method selected by the purchaser. These include market share. The nature and extent of these tasks will vary. 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. It is taken very personally by many employees. 5. there are many legal and administrative tasks that must be accomplished by the acquisition team to complete the transaction. 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. While the buyer’s legal counsel attends to these matters. In an asset acquisition. 5. it must be determined what the corporation stands for. where it is going. Most. it only stands to reason that the merged entity is different from what existed before. but the real issue goes much deeper. This may seem obvious. and suppliers • Adjustments to bank accounts and insurance policies In addition to the above. customer base. and direction. 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.3 Corporate Identity Now that the two companies have become one. 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.
compensation. As a result. workplace location.can more readily focus on the other aspects of the business combination for which they are better qualified and more effective. of course. the person doing the communicating is also important. The next most important information is the introduction of the new management team and the transition to new managers and employees. and reporting structure. think of the amount of communication that is necessary in the first few weeks and months of such a relationship. and benefits • Job location and operating procedures As a result of the importance of this information. as relates to such things as job security.5 Minimizing the Barriers to Transition No matter how hard you try and how well you anticipate the issues that need to be addressed. a lack of communication typically means a lack of success. There will be fear on the part of employees. They can place a name with a face and know who is being referred to in discussions. If a merger is thought of as the beginning of a marriage. 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). It also helps in the socialization process among the employees. The primary emotion that will be encountered in dealings with various groups will be fear. 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. Well. It is a bit disconcerting to walk the halls in an organization and not know people. This means that you want to first communicate that information that affects people directly. the natural response of most people is to avoid change. This will assist in the transition and add credibility to the process. especially who is staying and who is leaving • Reporting structures • Job descriptions and responsibilities • Title. Information should be communicated in the order of its importance. If possible. Communication The primary tool for dealing with fear. is more difficult as organizations grow larger. and many of the other emotions that surface during the course of acquisition transition. By making an effort to introduce the key players. people are more comfortable. A trusted person from the seller’s side. along with an important person from the buyer’s side. which in turn contributes to efficiency! This. works best. have the prior manager make some kind of handover to the new. communicate the new reporting structure and have individual managers introduce the two sides when there will be day-today interaction. 5. is communication. As with any relationship. Finally. that’s how it feels for all the employees of an acquired company. In a merger. Some kind of Mergers & Acquisitions Page 90 of 93 . it is important to be aware of the various aspects of change management and address them as well. Think of how it feels on the first day of a new job. including changes in: • The organization. the two keys to effective communication are to determine (1) the importance of the information and (2) who should communicate it.
is to uncover. As a result. a dialogue can be opened and people will get the impression that actions are being taken to address concerns. and the way it is communicated can also cause problems. people will not take the task force seriously. as it is much easier to say when the merger activity begins than to define when it is over. especially those that interact regularly. the CEO should probably avoid making him or herself a member. 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 composition of the task force has a bearing on its effectiveness and the integrity of the buyer. The importance of effectively communicating the role of the task force cannot be emphasized enough. The task force can also be used to organize the information that needs to be communicated to the new employees. can go a long way in making everyone more comfortable with the new faces. An honest assessment of those being considered for the task force will go a long way toward establishing its credibility. The task force can serve to communicate the issues in order of importance and to address them accurately. If one of the members from the seller’s side is an employee who is not respected by the majority of the workforce. 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. evaluate. Failure to do so will limit its effectiveness and call into question the resolve of the new organization. and resolve post-merger problems. 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. as viewed by the seller’s employees. the task force must be dissolved. and procedures. Mergers & Acquisitions Page 91 of 93 . In this way. The amount of information to be communicated can be overwhelming. The role of the task force is best kept simple. 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. This helps prevent the grapevine from disseminating erroneous information. It can serve as a conduit from labor to management to resolve problems that arise during the course of the merger. Once its work is completed. 5. functions.6 Post-Merger Task Force One of the tools through which communication can be made more effective is a postmerger task force.group meeting or social gathering among the employees of various departments. The final call will come from the CEO. which needs to be defined and communicated early. Creating the dialogue and organizing the information serve to help reduce or eliminate the fear. The role of such a group. Nonetheless. This is easier said than done. An additional indication is the amount of information flowing back from the employees to the task force has significantly waned. 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.
This will require assembling a team with proven implementation skills and a desire to see the transaction work.The importance of a well-planned and smooth post-closing transition cannot be emphasized enough. BIBLIOGRAPHY M. and picking the right people for the job. the value of the transaction may never be realized. 1967) Mergers & Acquisitions Page 92 of 93 . paying attention to the details. Weinberg. This will serve to encourage further growth through mergers and acquisitions. But the importance of these issues in the success of a business combination cannot be overemphasized. a buyer will gain confidence in its ability to successfully integrate the seller into its operations. By planning properly. The sheer number of issues that need to be addressed can seem overwhelming at first glance.A. Without the proper attention to these matters. takeover and Amalgamations (London: Sweet and Maxwell Publishers.
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