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FINANCIAL STRATEGY

CHAPTER 10
STRATEGIC IMPLICATIONS
OF ACQUISITIONS
Learning Outcomes

 Evaluate the financial and strategic implications of


proposals for an acquisition, merger or divestment,
including taxation implications.

Strategic Implications of Acquisitions 2


1 Mergers and Takeovers

 Relevant definitions:
– A takeover is the acquisition by an entity of a
controlling interest in the voting share capital of
another entity, usually by the purchase of a
majority of the voting shares.
[CIMA Official Terminology]
– A reverse takeover is when a smaller entity takes
over a larger one, so that the predator entity has
to increase its equity by over 100% to complete
the takeover.

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1 Mergers and Takeovers

 Relevant definitions:
– A merger is a business combination that results in
the creation of a new reporting entity formed from
the combining parties, in which the shareholders
of the combining entities come together in a
partnership for the mutual sharing of the risks and
benefits of the combined entity, ....
[CIMA Official Terminology]
– Synergy is the positive incremental net gain
associated with the combination of the entities
through a merger or acquisition (i.e. 1 + 1 = 3).
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1 Mergers and Takeovers

 Horizontal integration:
– Results when 2 entities in the same line of business
combine (i.e. Barclays & ABSA, RAU & TWR, Adidas
& Reebok, SABMiller & AB Inbev).
– List some of the entities currently involved in merger
talks.
 Vertical integration:
– Results from the acquisition of one entity by another
which is at a different level in the supply chain (i.e.
attempt by Sasol and Engen to merge was disallowed
by Competition Commission).
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1 Mergers and Takeovers

 Concentric diversification:
– Occurs when an entity seeks to add new products
that have technological and/or marketing
synergies with the existing product line.
 Conglomerate diversification:
– Consists of making entirely new products for new
classes of customers.

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1 Mergers and Takeovers

 The main reason for merging should be to maximise


shareholder value.
 Other reasons for mergers and takeovers include:
– Operating economies (by avoiding duplication);
– Management acquisition (acquire strong team);
– Diversification (can be debatable though);
– Asset backing (acquire substantial assets);
– Quality of earnings (less risky earnings);
– Finance and liquidity (improve liquidity);
– Growth (cheaper than internal expansion);
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1 Mergers and Takeovers

 Reasons for mergers and takeovers include:


– Tax reasons (be careful if only reason is for tax);
– Defensive reasons (to prevent being taken over);
– Strategic opportunities (for strategic ‘fit’);
– Increased market share (market power);
– Combining complementary needs (in which both
entities gain);
– Using surplus cash (to acquire other entities);
– Asset stripping as well as big data access; and
– Reduced competition (beware of Competition
Commission).
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1 Mergers and Takeovers

 Big Data
– Big data is data that requires a lot of computer
power to analyse;
– And is too large and complex to analyse using
traditional database management tools;
– If you can analyse the data on your personal
computer then it is not regarded as big data;
– Companies may want to gain access to another
company’s big data and this may therefore be a
reason to merge.
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1 Mergers and Takeovers

 Advantages of mergers as an expansion strategy:


– Speed;
– Lower cost;
– Acquisition of intangible assets; and
– Access to overseas markets.

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1 Mergers and Takeovers

 Disadvantages of mergers as an expansion


strategy:
– Exposure to business risk;
– Exposure to financial risk;
– Acquisition premium;
– Managerial competence; and
– Integration problems.

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1 Mergers and Takeovers

 Types of synergy:
– Revenue synergies;
– Cost synergies;
– Management synergies; and
– Financial synergies.
 Revenue synergies
– Exist when the acquisition will result in higher
revenues, higher return on equity or a longer
period of growth for the acquiring company.

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1 Mergers and Takeovers

 Cost synergies
– Result from economies of scale;
– As scale increases, marginal cost falls and this will
be manifested in greater operating margins for the
combined entity.
 Management synergies
– Result from sharing competencies / technology.
 Financial synergies
– Include sources such as diversification and tax
benefits.
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1 Mergers and Takeovers

 Factors to consider in the merger and takeover


decision include:
– Cost of acquisition (i.e. price factors based on the
valuation of the entity (assets, earnings etc.));
– Reaction of shareholders (both entities);
– Form of purchase consideration (shares or cash);
– Existence of service contracts for key personnel;
– Future dividend policy;
– Reaction of the stock market; and
– Possible effect on the cost of capital.
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1 Mergers and Takeovers

 Taxation issues:
– Some countries allow tax losses of a target
company to be offset against profits of the parent
company, however, some countries disallow this.
– Local taxes such as withholding taxes on interest,
dividends and royalties need to be taken into
account – the impact is reduced if a double
taxation agreement (DTA) is in place.
– Companies can exploit different tax rules and tax
rates by merging with an overseas company and
re-incorporating in a low tax regime (tax inversion).
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2 Conduct of a Takeover

 The process and conduct of a takeover may


depend on:
– The support from the bidding entity’s shareholders
to the takeover;
– The resistance (or lack of) from the target entity;
– Whether the directors of the target entity want to
contest the takeover offer; and
– Measures put in place to resist or thwart an
unwelcome offer.

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2 Conduct of a Takeover

 Defences before a bid (proactive measures)


include:
– Communicate effectively with shareholders in
terms of forecast future profits and dividends;
– Revalue non-current assets;
– Implement a ‘poison pill’ (i.e. preference shares
which convert to equity (ordinary) shares on a
takeover bid);
– Introduce a ‘shark repellent’ (super majority is
required to approve takeover (i.e. 80% approval);
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2 Conduct of a Takeover

 Defences before a bid (proactive measures):


– Improve performance of the entity;
– Increase dividends (to acquire shareholder
loyalty);
– Undertake a share split (making the shares more
marketable and widely held); and
– Introduce contracts for key personnel (which make
large lump sum payments in the event of
termination of employment – a.k.a. “golden
parachutes”).
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2 Conduct of a Takeover

 Defences after a bid (reactive measures):


– Issue a rejection letter;
– Revise profit forecasts (can’t be too optimistic);
– Lobby the Competition Commission (seek Competition
Commission intervention);
– Attack the bidder (overall strategy, management style,
dubious accounting policies, etc.);
– Find a ‘white knight’ (seek a new, more acceptable
bidder); and
– Launch a counter bid (known as a Pac-man defence).

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3 Regulation of Takeovers

 General takeover regulations include:


– All shareholders (of the same class of share) must
be treated similarly;
– All shareholders must be furnished with the same
information;
– Shareholders must be given sufficient information
and advice to make a decision;
– Directors of a target entity, may not delay or hamper
a takeover bid;
– Any acquisition that may lead to a substantial
lessening of competition will be investigated by a
country’s competition authorities.
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4 Impact of Mergers on
Stakeholders
 The following stakeholders should be considered
when evaluating the benefits of a merger:
– Acquiring company shareholders (i.e. predator);
– Target company shareholders;
– Acquiring company management (i.e. predator);
– Target company management;
– Other employees; and
– Financial institutions.

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Trends in Merger Activity

 Recent mergers and acquisitions include:


– Woolworths’ acquisition of David Jones (Australian
Department Store) in 2014;
– Vodacom’s proposed acquisition of Neotel in 2015
(Telkom and Cell C object to the acquisition) and
eventually Vodacom walked away from the
acquisition;
– SABMiller and AB Inbev’s merger of US$ 107 billion
in 2016; and
– Steinhoff’s (SA company) acquisition of Poundland
(UK discount retailer) and Mattress Firm (US
bedding company) in 2016.
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Trends in Merger Activity

 Acquisition is one of the main ways of carrying out


foreign direct investment (FDI) (i.e. Vodafone and
Vodacom).
 Hostile bids both locally and overseas, have
become more prevalent in recent times (i.e. Curro
Holdings made a bid for Advtech in 2015).
 Private Equity is a recent trend in mergers,
acquisitions and buyouts. Private Equity is where a
large private equity entity (i.e. Bain & Co.) invests in a
listed entity and then takes it private (i.e. Edcon).

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QUESTIONS?