chapter 3_mergers and acquisitions

7/28/2019 Chapter 3_Mergers and Acquisitions

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Oxford University Press 2011. All rights reserved.

Chapter 3


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A strategy where two or more companies agree to combine

their operations with mutual consent

Buying entity is called the Merged or Surviving Entity and

the one merging with it is called Merging Entity.

Under merger one company survives and the other loses its

corporate existence and the Surviving Entity acquires all the

assets and liabilities of the merging company and may

either retains its identity or get re-christened.

Laws in India use the term 'amalgamation' for merger

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Amalgamation as the merger of one or more companies with

another or the merger of two or more companies to form a

new company, in such a way that all assets and liabilities of

The amalgamating companies become assets and liabilities

of the amalgamated company and shareholders not less

than nine-tenths in value of the shares in the amalgamating

company or companies become shareholders of the

amalgamated company

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Merger through Absorption:

Is a combination of two or more companies into an 'existing

company

Here all companies except one lose their identity

For Example:

Absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd (TCL).

TCL, an acquiring company / buyer, survived after merger while TFL, an

acquired company / seller, ceased to exist. TFL transferred its assets,

liabilities and shares to TCL.

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Merger through Consolidation:

Is a combination of two or more companies into a 'new

company

Here all companies are legally dissolved and a new entity is

created.

Acquired company transfers its assets, liabilities, and shares to

the acquiring company for cash or exchange of shares

For Example:Merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian

Software Company Ltd and Indian Reprographics Ltd into an entirely new

company called HCL Ltd.

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Amalgamationmeans an amalgamation pursuant to the

provisions of the Companies Act, 1956 or any other statute,

which may be applicable to companies

Amalgamation in the nature of merger is an amalgamation

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All the assets and liabilities of the transferor company become,after amalgamation, the assets and liabilities of the transferee

company

Shareholders holding not less than 90% of the face value of theequity shares of the transferor company become equity

shareholders of the transferee company by virtue of the

amalgamation

The above to exclude the equity shares already held therein,

immediately before the amalgamation, by the transferee

company or its subsidiaries or their nominees

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The consideration is discharged by the transferee company

wholly by the issue of equity shares in the transferee company

Cash may be paid in respect of fractional shares, if any

The business of the transferor company is intended to be

carried on by the transferee company after amalgamation

No adjustment is intended to be made to 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.

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Merger movements often occur when the economy experiencessustained high rates of growth as it reflects favourable businessprospects

The movements coincide with developments in the businessenvironment

Often result in efficient resource allocation, reallocationprocesses and efficient resource utilization

The waves occur when firms respond to new investment andprofit opportunities arising out of changes in economicconditions and technological innovations ..

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In each of the waves mistakes have been repeated and failures

have been common

Unlike in the past, M & A have become a global phenomenon

and are no longer restricted to the US

A new trend being observed is the rise of emerging market

acquirer.

Research shows that merger waves result from a combination of

economic, regulatory, and technological shocks(Mark Mitchell

and J. H. Mulherin, 1996) .

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Economic shocks deal with economic expansion that

motivates companys to expand in order to meet the ever

growing demand

Regulatory shocks occur when regulatory barriers areeliminated paving the way for corporate communication

Technological shocks represent changes in technology that

not only change the existing industries but also create newones.

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Occurred after the Great Depression of 1883

Peaked between 1898 and 1902 and ended in 1904.

Professor Ralph Nelsons study Industries affected were

primary metals, food products, petroleum, products,chemicals, transportation equipment, fabricated metalproducts, machinery and bituminous coal

Wave saw horizontal mergers and industry consolidationsresulting in near monopolistic market structures.

Giants born during this wave included J.P Morgans U. S. Steel,DuPont Inc., Standard Oil, General Electric, Eastman Kodak,American Tobacco Inc. and Navistar International.

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Oxford University Press 2011. All rights reserved.13

Sherman Act enacted to control creation of suchmonopolies yet mergers continued

Reasons responsible for the growing number of M & As

were: Unwillingness of U.S. Supreme Court to literally interpret the anti monopoly provisions of the Sherman Act

Some States relaxed Corporation Laws that enabled companies to securecapital, create stock in other companies and expand their operationsunabated

Development of U.S transportation system facilitated expansion of markets

Expansion of the firms resulted in economies of scale in production anddistribution and resulted in greater efficiency

A few takeover battles saw judges and elected officialsbeing bribed to violate legal provisions.


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Known as Period of Merging for Oligopoly

Saw consolidation of several industries and growth of

oligopolistic industry structure

Wave produced fewer monopolies, more oligopolies

and many vertical mergers

Period also saw mergers between many unrelated industries

creating first large-scale conglomerates.

Period saw disproportionate number of mergers in primary

metals, petroleum products, food products, chemicals andtransportation equipment

Corporations born during this wave General Motors, IBM, John

Deere and Union Carbide

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Decade saw large companies taking over smaller firms withthe motive of getting tax relief

Firms encouraged to sell businesses to outsiders since the

estate taxes were very high and it was very expensive sellingbusinesses within the family

Mergers did not result in concentration of economic powersince most of them held very insignificant portion of the

industrial assets

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Celler-Kefauver Act passed to prevent or prohibit theanticompetitive acquisition of a firms assets

Made horizontal and vertical mergers tougher resulting information of conglomerates for expansion

Wave continued until 1968 when Litton Industries announcedthat its quarterly earnings had declined first time in fourteenyears

Market turned sour to conglomerates and the selling pressure

on stock prices increased

Anti-trust lobby was hell bent upon preventing mergers for theybelieved they are anti competitive and result in abuse ofmonopoly power.

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Known as era of Hostile Takeovers

Saw a dramatic decline in the number of mergers

Decade saw some trendsetting events such as: A change in the acceptable takeover behaviour Hostile takeover of major established companies started For Example:

INCO (International Nickel Companys) attempt to takeover ESB, the largestbattery maker

United Technologies bid for Otis Elevator Colt Industries attempt of hostile takeover move of Garlock Industries

Sanctioning of aggressive advances by investment Banks

Investment Bankers started offering consultancy services in anti-takeoverdefences

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Known as Wave of Megamergers

Hostile takeovers increased dramatically

Large firms became acquisition targets

Mergers seen in oil and gas industry, drugs, medicalequipments, banking and petroleum industry.

Leading megamergers included: Chevron and Gulf Oil

Philip Morris and Kraft Texaco and Getty Oil

DuPont and Conoco British Petroleum and Standard Oil of Ohio U.S. Steel and Marathon Oil Kohlberg Kravis and Beatrice

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Megadeals often financed with large amounts of debt. ForExample: Leveraged Buyouts

Conflicts between The Federal and State Governmentsincreased as State Governments started passing anti-

takeover legislations at the behest of local companies whichwas seen by Federal Government as infringement ofinterstate commerce

Deals motivated by Non U.S. companies that desired toexpand into larger and more stable U.S market.

Different sectors responded to deregulation differently. ForExample: Response of broadcasting sector quicker than airtransport

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Period saw a major economic transition such as increase inaggregate demand, longest post-war expansion of companiesand rise in stock market values

Phase saw large megamergers happening, few hostile deals

and more strategic mergers

Fad of financing merger deals through debt also got erodedand increased use of equity financing noticed.

Roll ups became popular i.e. fragmented industriesconsolidated through large scale acquisition of companies

Trend very common in industries such as funeral printing, officeproducts and floral products

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Examples: Mittal takeover of Arcelor Dubai based Ports World takeover of Peninsular and

Oriental Navigation Company

Tata Steel takeover of Corus Group

European nations started erecting barriers to impede takeoverof national champions.

Examples:

Merger of Suez SA and Gaz De France SA by the French Government tofend away Italian utility Enel SpA;

Spain enforced a new law to prevent German E.On AGs takeover bid ofSpanish utility Endesa SA

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Horizontal Merger Two companies that are in direct competition and sharing the same

product lines and markets combine

Based on the assumption that it will provide synergy and allow

enhanced cost efficiencies to the new business.

Examples of Synergistic Benefits: staff reduction and reductions in

related costs, economies of scale, opportunity to acquire technologies

unique to the target company and increased market reach and

industry visibility.

For Examples: Daimler Benz and Chrysler, Glaxo Wellcome Plc.

and SmithKline Beecham Plc., Exxon and Mobil, Volkswagen and Rolls

Royce and Lamborghini, Ford and Volvo and so on.

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Attained mainly by external acquisition and mergers and is

not generally possible through internal development

Are also called concentric mergers

Firms operating in different geographic locations also prefer

conglomerate mergers

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Has to bear capital gains tax on difference betweenbases in assets sold and purchase price allocated to

such assets which could be substantial if assets are

heavily depreciated

If the target company desires to use the proceeds of

the asset sale for paying dividend to the stockholders,

dividend would be subject to an additional tax, thus

increasing the burden on the target company

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The acquirer purchases the entire outstanding equityof the target company

Acquirer purchases the entire company and all assets

and liabilities of the business that come with it

Stock purchase does not cause any disruption in the

operations which can continue as usual.

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Closings are simplified

Fewer contract consents and very little paper work is

required to transfer specific assets.

All employees and employee benefits are transferred

with the stock sale.

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Cannot pick and choose assets and liabilities. Also it has toinherit everything, including unknown liabilities such as

sellers contracts, employees, etc.

The tax basis in the assets purchased does not get steppedup.

Potential of larger capital gains tax on a future sale of

heavily depreciated assets although lower depreciationprovision reduces the tax liability.

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Dogs: Businesses that have a very small share in the market and have a very

low growth potential i.e. they do not hold much future economic

promise and are on the verge of dying. Investing in such divisions

reflects a narrow view of the business having no future except high

risk. Are cash traps and can only eat into the profits of the company.

Acquirer should avoid acquiring such companies as they would not

add any value and would result increased losses and turn out to be a

bad buy decision.

If the company owns any such unit or division it is better to divest sucha division as soon as possible or else it would keep accumulating losses

and affect the overall profitability of the group

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Include: Market growth

Market size

Competitive intensity and

Capital requirements.

When factors are assessed collectively it implies that greater

the market growth, the larger the market, the lesser the

capital requirements and less the competitive intensity, the

more attractive the industry will be.

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The matrix suggests that: Acquirer should invest in winners and questions marks where the

industry attractiveness and competitive position are both favourable;

Maintain the market position of average businesses and profit

producers where industry attractiveness and competitive position is

average and Sell losers, in case it owns any.

For Example: Unilever undertook a major exercise of assessing its

business portfolio and based on the results decided to sell off several

speciality chemical units that were not contributing to the firmsprofitability. The resources generated through such divestitures were

used to acquire related businesses like Ben and Jerry, Homemade and

Slim-fast

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Based on the logic that a corporate strategy should be able

to counter the opportunities and threats prevailing in the

organizations external environment.

Especially true in case of the competitive strategy which the

argument states should be based on the understanding of

industry structures and the way they change.

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Supplier concentration Importance of volume to supplier

Differentiation of inputs

Impact of inputs on cost differentiation

Switching costs of firms in the industry Presence of substitute inputs

Threat of Forward integration

Cost relative to total purchases in industry

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Merger is a process where two entities agree tomove forward as a single entity as against

remaining separately owned and operated entities.

Mergers are typically more expensive than

acquisitions, with the parties incurring higher legal

costs.

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A merger does not require cash. A merger may be accomplished tax-free for both parties.

A merger lets the target company realize the appreciation potential of the

merged entity, instead of being limited to sales proceeds.

A merger allows the shareholders of smaller entities to own a smaller piece

of a larger pie, increasing their overall net worth.

A merger of a privately held company into a publicly held company allows

the target company shareholders to receive a public companys stock.

A merger allows the acquirer to avoid many of the costly and time-

consuming aspects of asset purchases, such as the assignment of leases and

bulk-sales notifications.

Merger is of considerable importance when there are minority stockholders.The transaction becomes effective and dissenting shareholders are obliged

to go along once the buyer obtains the required number of votes in support

of the merger.

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Synergy Operating synergy

Financial synergy

Examples:

When HUL acquired Lakme, it helped them to enter the cosmetics market

through an established brand.

When Glaxo and Smithkline Beecham merged, they not only gained

market share but also eliminated competition between each other.

Tata tea acquired Tetley to leverage Tetleys international marketing

strengths.

Acquiring new technology: For example: Mergers amongst logistics companies such as a land

transport entity with an airline cargo company

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Improved profitability For example, European Media Group Bertelsmann, Pearson, etc. have

driven their growth by expanding into US through M & A.

Acquiring a Competence: For example: Similarly IBM merged with Daksh for acquiring

competencies that the latter possessed.

Entry into new markets

For example: The merger of Orange, Hutch and Vodafone was carriedout to achieve this objective.

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Tax benefitsFor example: Ashok Leyland Information Technology (ALIT)

was acquired by Hinduja Finance, a group company, so that

it could set off the accumulated losses in ALITs books against

its profits.

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chapter 3_mergers and acquisitions

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