Mergers and Acquisitions

The phrase mergers and acquisitions (abbreviated as M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity [1]. Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisitions mean slightly different things. The below contents will elaborate it in detail.

1.   Mergers

Merger is a decision taken by two companies to combine all operations, officers, structure, and other functions of business. Mergers are meant to be mutually beneficial for the parties involved. In the case of two publicly-traded companies, a merger usually involves one company giving shareholders in the other its stock in exchange for surrendering the stock of the first company [2].

1.1.          Types of Mergers ^[3]

From the perspective of business structures, there is a whole host of different mergers. Here are a few types.

Distinguished by the relationship between the two companies that are merging:

·         Horizontal merger - Two companies that are in direct competition and share the same product lines and markets.

·         Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker.

·         Market-extension merger - Two companies that sell the same products in different markets.

·         Product-extension merger - Two companies selling different but related products in the same market.

·         Conglomeration - Two companies that have no common business areas.

Distinguished by how the merger is financed:

Each has certain implications for the companies involved and for investors:

·         Purchase Mergers - As the name suggests, this kind of merger occurs when one company purchases another. The purchase is made with cash or through the issue of some kind of debt instrument; the sale is taxable.

Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company. We will discuss this further in part four of this tutorial.

·         Consolidation Mergers - With this merger, a brand new company is formed and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

2.   Acquisitions

An acquisitions is the purchase of one company by another company (usually a purchase of a smaller firm by a larger firm), having either a private process or a public process. Achieving acquisitions success has proven to be very difficult as the acquisitions process is very complex, with many dimensions influencing its outcome [1].

2.1.          Types of Acquisitions [1]

·         Friendly takeovers - the companies cooperate in negotiations

·         Hostile takeovers - the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer.

·         Reverse takeovers - a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity

·         Reverse merger - occurs when a private company that has strong prospects and is eager to raise financing buys a publicly listed shell company, usually one with no business and limited assets.

 

3.   Top 5 M&A Deals Worldwide by Value (in mil. USD) From 2000 to 2010 [2]

Rank	Year	Purchaser	Purchased	Transaction value (in mil. USD)
1	2000	Fusion: America Online Inc. (AOL)	Time Warner	164,747
2	2000	GlaxoWellcome Plc.	SmithKline Beecham Plc.	75,961
3	2004	Royal Dutch Petroleum Co.	Shell Transport & Trading Co	74,559
4	2006	AT&T Inc.	BellSouth Corporation	72,671
5	2001	Comcast Corporation	AT&T Broadband & Internet	72,041

Table 2: Top 5 M&A Deals Worldwide

4    Local Acquisitions and Mergers [7]

 

Rank	Company Name	Purchased
1	Richard Pieris & Company PLC - This is one of the largest and most successful diversified business conglomerates based in Sri Lanka.	A valuation was carried out on behalf of Richard Pieris & Co. PLC for the purpose of the acquisition of RPK Management Services (Pvt.) Ltd., the management company of Maskeliya Plantations PLC and Kegalle Plantations PLC.
2	Hayley’s MGT Knitting Mills PLC - This is the second largest knit fabric manufacturer in Sri Lanka.	Hayleys MGT Knitting Mills PLC and Hayleys ADC Textiles Limited employed NDBIB as financial advisors to rationalize its capital structure and to launch a suitable Employee Share Ownership Plan (ESOP) scheme. Two companies merged together.
3	Master Divers (Pvt) Ltd - Company has engaged in many off-shores and harbour based marine activities and maritime construction work in Thailand, Maldives, India, and Singapore and in the Port of Damam, Saudi Arabia.	MDL acquired 53.35% shareholding of Pelwatte Sugar Industries Limited (PSIL) held by the Government of Sri Lanka through a privatization. NDBIB acted as the financial advisor and the arranger of funds for MDL in the above acquisition.
4	Nations Trust Bank PLC and Mercantile Leasing Limited - Considered most customer-centric financial institutions today.	Nations Trust Bank PLC and Mercantile Leasing Limited merged together. The merger was carried out by offering NTB shares to MLL shareholders as consideration based on the share swap ratio recommended by NDBIB.
5	Eagle Insurance Company PLC - This is one of the leading life insurance companies in Sri Lanka. Eagle Insurance is a venture between Aviva International Holdings Ltd, the largest insurer in UK and National Development Bank PLC	NDB through its subsidiary Capital Development & Investment Company PLC (CDIC) acquired 58.44% of Zurich NDB Finance Lanka Ltd., the holding company of Eagle Insurance Company PLC (EICL). NDBIB carried out a valuation of EICL and acted as the financial advisor to NDB in the above acquisition.

Table 3: Local M&A Examples

5.     Statistics on M&A

The 1990s featured the most intense period of mergers and acquisitions in U.S. economic history. This period is now recognized as the fifth merger wave in U.S. history. Merger waves are periods of unusually intense merger and acquisition activity.  There have been five such periods since the start of the twentieth century, with the previous one occurring in the 1980s. This wave featured many record-breaking mergers. When it ended in the late 1980s, many thought that there would be an extended period of time before another one began. However, after a short hiatus, an even stronger merger wave took hold, far eclipsing that of the 1980s [8].

The merger wave of the 1990s was path breaking due to the dollar value of the transactions and the unusually high number of deals (see Fig: 1, Fig: 2). While the fourth wave of the 1980s was known for both its megamergers and its colorful hostile deals, the fifth wave has featured far larger deals, as well as a good supply of hostile transactions [8].

Fig. 1: Merger and Acquisition Transaction, 1980–2000

Fig: 2: Dollar Value of U.S. Acquisitions of Foreign Companies, 1980–2000

6.     Discussion

Mergers and Acquisitions have been very common incidents since the turn of the 20th century. These are used as tools for business expansion and restructuring. Through mergers the acquiring company gets an expanded client base and the acquired company gets additional lifeline in the form of capital invested by the purchasing company. Recent mergers and acquisitions authenticate such a view [4].

There are many good reasons for growing your business through an acquisitions & merger [5]. These include:

• Obtaining quality staff or additional skills, knowledge of your industry or sector and other business intelligence. For instance, a business with good management and process systems will be useful to a buyer who wants to improve their own. Ideally, the business you choose should have systems that complement your own and that will adapt to running a larger business.
• Accessing funds or valuable assets for new development. Better production or distribution facilities are often less expensive to buy than to build. Look for target businesses that are only marginally profitable and have large unused capacity which can be bought at a small premium to net asset value.
• Your business underperforming. For example, if you are struggling with regional or national growth it may well be less expensive to buy an existing business than to expand internally.
• Accessing a wider customer base and increasing your market share. Your target business may have distribution channels and systems you can use for your own offers.
• Diversification of the products, services and long-term prospects of your business. A target business may be able to offer you products or services which you can sell through your own distribution channels.
• Reducing your costs and overheads through shared marketing budgets, increased purchasing power and lower costs.
• Reducing competition. Buying up new intellectual property, products or services may be cheaper than developing these yourself.
• Organic growth, ie the existing business plan for growth, needs to be accelerated. Businesses in the same sector or location can combine resources to reduce costs, eliminate duplicated facilities or departments and increase revenue.

It is interesting to note that a number of acquisitions and mergers are currently taking place in Sri Lanka. A couple of years back SLT (Sri Lanka Telecom) acquired Mobitel, JKH (John Keells Holdings) has acquired Asian Hotels and Phoenix and Jewel knit have merged to form a group of their own by the name of Brandix. When HNB attempted to acquire Sampath Bank, a lot of publicity was given to the fact. The acquisitions failed eventually, because of stiff resistance from the target.

In many cases, companies resort to mergers or acquisitions because they believe that it is the easiest and fastest way to growth. Even though this view is acceptable to a certain extent, many acquisitions do not produce the expected results. This is because there are problems of post-acquisitions integration and failure to achieve the results projected. Vanik had bad experiences in integrating some of its acquisitions. On a global scale the merger between AOL and Time Warner Group proved to be a flop.

Acquisitions and mergers are also forms of fulfilling managerial egos as they lead to the creation of large corporate empires. One wonders whether the building of such empires serve any purpose to the shareholder, if shareholder value is not enhanced, as a result of these changes.

The impact of an acquisitions or merger is ultimately borne by the shareholders. The concern that the shareholders of JKH are likely to share today would be as to what the projected earnings of Asian Hotels for the next quarter will be, and its influence on the earnings of JKH. If an acquisitions increases the earnings of the company and also boosts confidence, it would be reflected by the PE (Price: Earnings) ratios.

This would result in a positive impact on the share price, which in turn will tend to rise. Shareholders will also be concerned about the funding of an acquisition. If it is in the form of debt capital it could lead to an increase in the financial risk. On the other hand, issue of new shares or a rights issue can also fund an acquisition. A new issue will dilute the shareholding whereas a rights issue will not. However if an increase in market value is not significant, both can result in a decline in the price per share.

From the shareholders' point of view, an acquisition would be successful only if the management team of the acquirer is able to integrate the organizations successfully and achieve the benefits of synergy.

No acquisitions can be successful without the support of the employees. HNB's attempt to take over Sampath Bank failed because of opposition from the employees. On the other hand, the employees of Mobitel were keen about the takeover by SLT since they expected better growth opportunities under the new parent. The acquirer will have to win the employees to its side since their support is essential in order to understand the business as well as to implement new strategies. Any redundancies, which arise, should be dealt with quickly, and payments should be generous, if funds permit, since this will boost the morale of the retained employees.

It is important to understand the drawbacks of mergers and acquisitions to understand public or regulatory interest. These changes could result in a monopoly or a near monopoly situation, which could be detrimental to the interests of consumers. Large firms might get the opportunity to adopt anti-competitive practices, which may prevent the development of new as well as existing competitors in the market.

A merger or an acquisition goes against public interest if it is in a position to control and dominate the market for goods or services. In such situations, the Fair Trading Commission is empowered to investigate a merger. For example in Europe, EU regulators prevented GE's proposed merger to Honeywell, because they feared it would create the world's largest manufacturer of aircraft engines.

There are also situations where acquisitions and mergers are opposed on grounds of nationalism. When Nestle attempted to acquire Rowntree in the UK, a newspaper published the headline: " Help! The Swiss are Coming For Our Smartees". Acquisitions and mergers are a must as they can help to ensure that firms enjoy economies of scale as well as minimize unnecessary competition. Mergers such as Brandix can help to build strong Sri Lankan firms, which can be competitive internationally.

With the development of the open economy the Sri Lankan mindset may change, and there will be more openness towards acquisitions and mergers in the future. There may be a situations arising where foreign organizations might acquire local companies. An interesting deal to look out for would be the privatization of the People's Bank [6].

7.     Conclusion

One size doesn't fit all. Many companies find that the best way to get ahead is to expand ownership boundaries through mergers and acquisitions. For others, separating the public ownership of a subsidiary or business segment offers more advantages. At least in theory, mergers create synergies and economies of scale, expanding operations and cutting costs. Investors can take comfort in the idea that a merger will deliver enhanced market power.

M&A comes in all shapes and sizes, and investors need to consider the complex issues involved in M&A. The most beneficial form of equity structure involves a complete analysis of the costs and benefits associated with the deals.

8.     References

[1]     Mergers and acquisitions. [Online]. Viewed 2011 March 2.

Available: http://en.wikipedia.org/wiki/Mergers_and_acquisitions

[2]     Mergers. [Online]. Viewed 2011 March 2.  

Available: http://financial-dictionary.thefreedictionary.com/Mergers

[3]     Mergers and Acquisitions: [Online]. Viewed 2011 March 2.

Available: http://www.investopedia.com/university/mergers/mergers1.asp

[4]     Recent Mergers and Acquisitions: [Online]. Viewed 2011 March 2.  

Available: http://www.economywatch.com/mergers-acquisitions/international/recent.html

[5]     Benefits of a merger or acquisition: [Online]. Viewed 2011 March 2.

Available: http://www.businesslink.gov.uk/bdotg/action/detail?itemId=1074409301&type=RESOURCES

[6]     Mergers and acquisitions: the way forward? [Online]. Viewed 2011 March 2.

Available: http://sundaytimes.lk/031012/ft/11.htm

[7]     Local M&A examples, [Online]. Viewed 2011 March 3.

Available: http://www.ndbib.com/productpage.aspx?loadid=11&product=Mergers%20and%20Acquisitions

[8]     Mergers and Acquisitions: An Overview By Patrick A. Gaughan, Ph.D. , College of Business, Fairleigh Dickinson University, Economatrix Research Associates, Inc. (0471414379.pdf) Viewed 2011 March 3.