BBMF 2093CF

TUTORIAL 10 BUSINESS MERGER

1. Why does corporation carry out merger? What are the benefits of merger?

Reasons for merger

a. Economies of scale- merged company will help to reduce per unit

production cost because of larger output

b. Economies of vertical integration – takeover supplier to reduce input cost

c. Combining complementary resources- each of the firm help each other

by filling in the missing resources of the other firm

d. Merger as a use of surplus fund – company can use extra fund to take
over another company

Additional Notes for discussion:

1.(Synergies: By combining business activities, overall performance efficiency tends to
increase and across-the-board costs tend to drop, due to the fact that each company
leverages off of the other company's strengths.

2. Growth: Mergers can give the acquiring company an opportunity to grow market share
without doing significant heavy lifting. Instead, acquirers simply buy a competitor's business
for a certain price, in what is usually referred to as a horizontal merger. For example, a beer
company may choose to buy out a smaller competing brewery, enabling the smaller outfit to
produce more beer and increase its sales to brand-loyal customers.

3. Increase Supply-Chain Pricing Power: By buying out one of its suppliers or distributors,
a business can eliminate an entire tier of costs. Specifically, buying out a supplier, which is
known as a vertical merger, lets a company save on the margins the supplier was previously
adding to its costs. Any by buying out a distributor, a company often gains the ability to ship
out products at a lower cost.

4. Eliminate Competition: Many M&A deals allow the acquirer to eliminate future

competition and gain a larger market share. On the downside, a large premium is usually
required to convince the target company's shareholders to accept the offer. It is not
uncommon for the acquiring company's shareholders to sell their shares and push the price
lower, in response to the company paying too much for the target company.

Benefits of merger
a. Tax benefits – loss making firm combine with profit making firm to
reduce income tax payment

b. Complementary in financial slack- cash poor firm combine with cash

rich company so that the cash poor firm can use the cash to invest in positive NPV
project.
 c. Removal of ineffective managers-after merger, all the ineffective
managers of the target firm will be removed.

d. Increased market powers – after merger, merged company will have

more monopoly power ie more control over pricing

e. Reduction in bankruptcy costs – the combined firm will be financially

stronger, thus reduce the bankruptcy cost and risk

(Case Study for discussion: Sun Pharmaceuticals acquires Ranbaxy:

The deal has been completed: The companies have got the approval of merger
from different authorities.
This is a classic example of a share swap deal. As per the deal, Ranbaxy
shareholders will get four shares of Sun Pharma for every five shares held by them,
leading to 16.4% dilution in the equity capital of Sun Pharma (total equity value is
USD3.2bn and the deal size is USD4bn (valuing Ranbaxy at 2.2 times last 12
months sales).
Reason for the acquisition: This is a good acquisition for Sun Pharma as it will
help the company to fill in its therapeutic gaps in the US, get better access to
emerging markets and also strengthen its presence in the domestic market. Sun
Pharma will also become the number one generic company in the dermatology
space. (currently in the third position in US) through this merger.
Objectives of the M&A:
• Sun Pharma enters into newer markets by filling in the gaps in the offerings of the
company, through the acquired company
• Boosting of products offering of Sun Pharma creating more visibility and market
share in the industry
• Turnaround of a distressed business from the perspective of Ranbaxy
This acquisition although will take time to consolidate, it should in due course start
showing results through overall growth depicted in Sun Pharma’s top-line and
bottom-line reporting.

2. As a manager in a corporation, what are the defensive tactics you can use to prevent
merger?

Refer to lecture notes for detail. Week 10

 a. White knight- white knight is friendly to the target management. White knight
will help the target company by competitive bid by bidding up market price to
prevent takeover.

b. Shark repellent- prevent takeover by making amendment to company charter.

Like requiring acquirer to have 60% share instead of 51%

c. Poison pill – make the target company not attractive for takeover ie load target
company with heavy debt or give out excess cash for managers ie golden
parachute.

d. White squire- a white squire is friendly to target management. The white squire
will purchase enough share of the target to block the takeover. Ie to prevent
acquirer from getting 51% share

3. Contrast spin off and carve outs.

Spin off - the process of a business separating the ongoing operations of a

subsidiary unit and giving the shareholders of the parent firm shares of the
subsidiary unit. The parent and the spin off unit are separate business entities

Carve out – similar to spin off, but the carve out unit issues shares of the new firm to
the public .

4. Describe the parties that will benefit from a merger.

a. Shareholders of the target firm – the shareholders of target firm will have
greater earning because of the competitive bid which raises the share price

b. Lawyers and brokers that carried merger – the lawyers will prepare legal
documents to support the acquisition and merger. Lawyer will have more
business. Broker will be in charge buying share on the behalf of the acquirer

c. The executives of the acquiring firm. The merger firm will become a larger
business entity and executives will have greater responsibilities which translate
to greater pay

5. What are the main features of Leverage Buy Out (LBO)?

The main features of LBO, leverage buy out are.

a. Large portion of the buy out is finance by debt /borrowing
b. Shares of the LBO no longer trade on the open stock market i.e. private
company
6. Oracle Berhad, a dynamic business in microchips makes a bid of 17 shares for every 20
shares of Wizard Berhad, which manufactures electronic hardware. The income
statements of the two firms are as follows:

A concerned shareholder of Wizard Berhad believes that the bid is undervalued and asks for
your advice. You are required to determine:

(a) The bid consideration

(b) The earnings per share of the combined group.

(c) The theoretical post-acquisition price of Oracle shares assuming the price/earning ratio
remains.
17 SHARES OF ORACLES 20 SHARES OF WIZARD

17/20 SHARES OF ORACLES 1 SHARE OF WIZARD

17/20X0.5 M =425 000 0.5M =500,000

425000 SHARES X RM2 = RM850,000