Mergers & Acquisitions

Mergers and Acquisitions

• Merger:
• is where two companies come together to combine and share resources and
integrate operations on a relatively coequal basis to achieve a common
objectives
• Under merger the combining firms remain
• joint owners
• new company is created

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Mergers and Acquisitions
• Acquisition:
• one firm purchase the assets of another, with the acquired firm ceasing to be
the owners of that firm. Often it is the larger company which acquires a
smaller one
• Hostile Takeover
• Special type of acquisition wherein the target firm does not solicit the
acquiring firm’s bid. Unfriendly acquisition

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Reasons for Acquisitions
• Increased Market Power
• Overcoming Entry Barriers
• Cost of new product development and increased speed to Market
• Lower risk in developing new products
• Increased Diversification
• Reshaping competitive scope
• Learning and Developing new capabilities

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 Increased Market Power
• Factors increasing market power
• When there is the ability to sell goods or services above competitive
levels
• When costs of primary or support activities are below those of
competitors
• When a firm’s size, resources and capabilities gives it a superior ability
to compete
• Market power is increased by:
• Horizontal acquisitions
• Vertical acquisitions
• Related acquisitions

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Market Power Acquisitions
Horizontal Acquisitions

• Acquisition of a company in the same industry in which the acquiring firm

competes increases a firm’s market power by exploiting:
– Cost-based synergies & Revenue-based synergies
• Acquisitions with similar characteristics result in higher performance than those
with dissimilar characteristics

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Market Power Acquisitions
Vertical Acquisitions

• Acquisition of a supplier or distributor of one or more of the firm’s

goods or services
– Increases a firm’s market power by controlling additional parts of the value
chain
–

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Market Power Acquisitions
Related Acquisitions

• Acquisition of a company in a highly related industry

– Because of the difficulty in implementing synergy, related acquisitions are
often difficult to implement

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Overcoming Entry Barriers

• Factors associated with the market or with the firms currently

operating in it that increase the expense and difficulty faced by new
ventures trying to enter that market
• Economies of scale of current players –
• Cross-Border Acquisitions

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Cost of New-Product Development & Increased Speed to Market

• Internal development of new products is costly when the firms does

not have expertise and developing internally will take time
• Acquisitions allow a firm to gain access to new and current products that are
new to the firm

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 Lower Risk Compared to Developing New Products

• An acquisition’s outcomes can be estimated more easily and accurately

than the outcomes of an internal product development process
• Managers may view acquisitions as lowering risk
•

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 Reshaping the Firm’s Competitive Scope
• An acquisition can:
• Reduce the negative effect of an intense rivalry on a firm’s financial
performance
• Reduce a firm’s dependence on one or more products or markets
• Reducing a company’s dependence on specific markets alters
the firm’s competitive scope

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 Learning and Developing New Capabilities
• An acquiring firm can gain capabilities that the firm does not currently
possess:
• Special technological capability
• Broaden a firm’s knowledge base
• Reduce inertia
• Firms should acquire other firms with different but related and
complementary capabilities in order to build their own knowledge base

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Other Motives of M & A
• Managerial motive
• to avoid being taken over (job security)
• to pursue growth in size, status and higher remuneration
Removal of inefficient Management
-to remove managers who failed to maximise shareholder
wealth

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Unrelated Mergers
• Diversification to reduce risk in original business
• Owner-Manager’s ambition
• To deploy the excess money
• value creation due to efficiencies from an internal capital market
• value creation due to the exploitation of a conglomerate discount
• a corporate raider who buys and restructures firms

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 Problems in Achieving Success

• Analysis suggests
• 20% of all mergers and acquisitions are
successful
• 10 % produce average results
• 50% produce disappointing results
• 20% are clear failures

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Problems in Achieving Success Too large

Managers overly
focused on
Acquisitions acquisitions

Integration Too much

difficulties diversification

Inadequate evaluation Large or extraordinary Inability to achieve

of target debt synergy

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 Integration Difficulties
•Integration challenges include:
• Melding two disparate corporate cultures
• Linking different financial and control systems
• Building effective working relationships (particularly when
management styles differ)
• Resolving problems regarding the status of the newly acquired firm’s
executives
• Loss of key personnel weakens the acquired firm’s capabilities and
reduces its value

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 Inadequate Evaluation of the Target
• Due Diligence
• The process of evaluating a target firm for acquisition
• Ineffective due diligence may result in paying an excessive premium for the target
company
• Evaluation requires examining:
• Financing of the intended transaction
• Differences in culture between the firms
• Tax consequences of the transaction
• Actions necessary to meld the two workforces

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 Large or Extraordinary Debt
•High debt can:
• Increase the likelihood of bankruptcy
• Lead to a downgrade of the firm’s credit rating

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Inability to Achieve Synergy
• Synergy exists when assets are worth more when used in
conjunction with each other than when they are used
separately
• Firms experience transaction costs when they use acquisition
strategies to create synergy
• Firms tend to underestimate indirect costs when evaluating a
potential acquisition

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Too Much Diversification
• Diversified firms must process more information of
greater diversity
• Scope created by diversification may cause managers
to rely too much on financial rather than strategic
controls to evaluate business units’ performances
• Acquisitions may become substitutes for innovation

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 Managers Overly Focused on Acquisitions
• Managers invest substantial time and energy in acquisition
strategies in:
• Searching for viable acquisition candidates
• Completing effective due-diligence processes
• Preparing for negotiations
• Managing the integration process after the acquisition is completed

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 Too Large
• Additional costs of controls may exceed the benefits of the
economies of scale and additional market power
• Larger size may lead to more bureaucratic controls
• Formalized controls often lead to relatively rigid and
standardized managerial behavior
• Firm may produce less innovation
•

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Mergers and Acquisition Process
Three stages
1. Planning
2. Valuation & Deal Structuring
3. Post Merger Integration
Planning
• Identifying the right company to fill the gap
• Start preliminary talks and sign MoU
• Conduct Due diligence
• Valuation Negotiations
Due Diligence
Process through which a potential buyer evaluates a target or its assets
for acquisition.

Helps in negotiation and valuation

Due Diligence
• Financial Performance and Records
• Organizational Structure and process
• Competitive Challenges in the market
• Organizational Culture
• Management style and decisions
• Legal and Tax issues
• Information Systems
Valuation in M&As
• Fair Value - Approaches & Suitability
• Asset Based
• Cash Flow Based
• Market Based
• Premiums/ discounts
• Control premium/ minority discount
• Strategic premium
Fair Value
Fair value is the amount for which an asset could be exchanged
between knowledgeable, willing parties (i.e. neither party is in a
distressed situation to participate in the transaction) in an arm’s length
transaction
Fair Value

KEY REQUIREMENTS OF FAIR VALUATION

Willing No Compulsion
Willing Information
to transact
Buyer Seller Symmetry
M&A valuations can depart from fair
values ..
•Buyers/ Sellers leverage:
• Competitive Positioning
• Distress Sale Vs. Desperate Buy

Same target can have different value in the hand of different

acquirers.
Key Constituents of Valuations
Tangible Assets Intangible Assets
• Land & Building • Brand
• Plant & Machinery • Distribution Network
• Current Assets • IPRs
• Other Tangible Assets • Licenses and Permits
• Collaboration/ Tie-ups for
technology, etc
• Performance Track record
• Other intangible assets

On-going business operations

Synergies post the Merger

 Fair Valuation Methodologies
Asset Based Cash Flow Based Market Based

• Book Value • Free Cash Flow • Quoted Market Price

• Replacement Cost • Discounted Cash Flow • Comparable Listed

• Quotation Based Multiples
• RBI Indices
• Comparable Transaction
Multiples

Applicability of a particular methodology guided by

On whose behalf? – buyer vs seller; one buyer vs another buyer

•For what purpose? –of

Applicability strategic acquisition,
a particular financial reporting,
methodology guided restructuring
by various factors
When? – distress situation, industry downturn
Due Diligence
Process through which a potential buyer evaluates a target or its assets
for acquisition.

Helps in negotiation and valuation

Due Diligence
• Financial Performance and Records
• Organizational Structure and process
• Competitive Challenges in the market
• Organizational Culture
• Management style and decisions
• Legal and Tax issues
• Information Systems
Negotiation
• Both buyer and seller need to understand each other’s motive before
coming to the negotiating table
• Price is not everything
• Know your walk-away number
• Know who’s on the other side of the table
• Concede small victories – and let them be known.
• Try to seek win-win situation
Decision Issues
1. Price
2. Mode of Transaction – Cash & Stock
3. Transaction Vehicle – Holding company, Integration with acquirer
4. Management Issues
Post Merger Integration
• The phase where the operations of the acquired entity are
merged with buyer’s existing operations / or merged entities
operations are integrated
• The companies spend time in pulling off the deal. But ignore
the importance of PMI
• Lack of attention to PMI leads to failure of most of the M&As
PMI – Consideration
• Acquisition Integration is not a discrete phase of a
deal and does not begin after documents are signed -
It is a process that begins with due diligence and runs
through the ongoing management of the new
enterprise
• Integration management is a fulltime job and needs to
be recognized as a distinct business function, like
Operations, Marketing, Finance or HR -Have a full-
time Integration Manager
PMI – Consideration
• Decisions about management structure, key roles, reporting
relationships, layoffs, restructuring and other career affecting aspects
of the integration should be made, announced and implemented as
soon as possible after the deal is signed. Creeping changes,
uncertainty and anxiety that last for months are debilitating and
immediately start to drain value from acquisition
• A successful integration melds not only the various technical aspects
of the business, but also the different cultures -The best way to do so
is to get people working together quickly to solve business problems
and accomplish results that could not have been achieved before