Literature Review | Mergers And Acquisitions

Although they are often uttered in the same breath and were synonymous, the terms “merger” and “acquisition” mean slightly different things. (Peterson, Marcus, 2007)

2.1 MERGERS AND ACQUISITIONS:

A merger occurs when one or more firms establish direct or indirect control over the whole or part of the business or directly or indirectly acquire another firm. Obtaining control of another corporation by purchasing all or a majority of its outstanding shares, or by purchasing its assets is called an acquisition. When two companies combines, corporate mergers occur. When both the companies want to merge, is called an agreed merger.

Situation where one company seeks to control another without its agreement is called a hostile takeover. In case of hostile takeover the target company may seek a ‘white knight’, another company with which it would prefer to merge. http://news.bbc.co.uk/2/hi/business/91472.stm

2.2 ACQUISITION

An acquisition may be only slightly different from a merger. In fact, it’s different in name only. Like mergers, acquisitions are actions through which companies seek efficiencies, economy of scales, and enhanced market visibility. Unlike all mergers, all acquisitions involve one firm purchasing another–there is no exchanging of stock or consolidating as a new company. Acquisitions are often congenial, with all parties feeling satisfied with the deal. At the next moment, acquisitions are more hostile. When a company takes over another one so it becomes the new owner, the purchase is called an acquisition.

There are three basic ways to acquire a company:

Merger or consolidation

Acquisition of stocks

Acquisition of assets

Reverse merger

1. Mergers or Consolidation

A merger refers to the absorption of one firm by another. The acquiring firm retains its name and its identity, and it acquires all of the assets and liabilities of the acquired firm. The acquired firm ceases to exist as a separate business entity after the merger

A consolidation is the same as a merger except that an entirely new firm is created. In consolidation, both the acquiring firm and the acquired firm terminate their previous legal existence and become part of the new firm. However, the rules for consolidation and merger are basically the same. Acquisition by merger and consolidation result in combinations of the assets and liabilities of acquired and acquiring firms.

2. Acquisition of Stock

A second way to acquire another firm is to purchase the firm’s voting stock in exchange for cash. At some point the offer is taken directly to the selling firm’s stockholders. This can be accomplished by using tender offer. A tender offer is a public offer to buy shares of a target firm. One firm makes it directly to the shareholders of another firm.

3. Acquisition of Assets

One firm can acquire another firm by using all of its assets. A formal vote of the shareholders of the selling firm is required. Acquisition of assets involves transferring title to assets. The legal process of transferring assets can be costly.

4. Reverse merger

It is another type of acquisition that enables a private company to get publicly-listed in a relatively short time period. This type of merger occur 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. The private company merges into the public company, and together they become an entirely new public corporation with tradable shares. http://www.investopedia.com/university/mergers/

2.3 MERGER

In the pure sense of the term, a merger happens when two firms, often about the same size, agree to go forward as a new single company rather than remain separately owned and operated. This is called “merger of equals.” Stocks of both the companies are surrendered, and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when they merged, and a new company, DaimlerChrysler, was created. (Peterson, Marcus, 2007)

Mergers happen in waves. Creating shareholder value over and above that of the sum of the two companies is the key principle behind buying a company. Two companies together are more valuable than two separate companies– that’s the reasoning behind M&A.

TYPES OF MERGERS

Financial analysts have typically classified mergers into three types:

Horizontal merger: companies that are in direct competition in the same product lines and markets is called horizontal merger.

Vertical merger: it involves company at different stages of production.

Market-extension merger: Two companies that are selling the same products in different markets.

Product-extension merger: Two companies selling different products but related products in the same market. http://mercantilemergersacquisitions.com/corporate-finance/mergers-strategic-partnerships.html

3. Conglomeration: companies that have no common business areas.

From the perspective of how the merge is financed, there are two types of mergers: purchase mergers and consolidation mergers. Each has certain implications for the companies involved and for investors:

Purchase Mergers – This kind of merger occurs when one company purchases another one. The purchase is made by cash or through the issue of some kind of debt instrument, and the sale is taxable. Companies that are acquiring often prefer this type of merger because it can provide them with a tax benefit.

Consolidation Mergers – With this type of merger, a totally new company is formed and both of the companies are bought and combined under the new entity. The terms of tax are the same as those of a purchase merger. http://mercantilemergersacquisitions.com/corporate-finance/mergers-strategic-partnerships.html

2.4 DISTINCTION BETWEEN MERGERS and ACQUISITIONS

A clear distinction between mergers and acquisitions is required by legal aspects as well.

They are not quite identical phenomena, since they result from two legally different transactions.

A merger is a statutory combination of two (or more) companies, either by the transfer of all assets to one surviving company or by joining together of the two firms into a single new enterprise. Therefore, mergers are – at least in principle – co-operative agreements between equal partners, especially, naturally, if an entirely new organization is formed. http://www.investopedia.com/university/mergers/

In contrast, acquisition takes place when one company buys enough shares to gain control over another. It may be defined as friendly or hostile, according to the way it is perceived by the shareholders and the management of the company being acquired. The formal distribution of power is clearer than in the merger case (Gertsen et al., 1998).

When a company takes over another one it becomes the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist and the buyer “swallows” the business, and stock of the buyer continues to be traded. http://www.investopedia.com/university/mergers/

2.5 WHY COMPANIES GO FOR A BUY OR MERGE?

Faster Growth: The most common motive for making an acquisition is to accelerate the growth process and to expand the acquirer’s business in a substantial way with one transaction. There are many potential benefits to such rapid growth. The acquirer may quickly its market share in an existing line of business. Growth may enable the acquiring company to realize substantial economies of scale. Rapid growth through acquisition has many other advantages such as allowing a company to increase its market share and recognition (Joseph M Morris, 1998).

Vertical Integration: Another goal in acquiring a new business may be to achieve vertical integration, for example, when a manufacturer acquires a key supplier or a major distributor. Reasons for vertical integration may include achieving a more stable market on the supply side, the marketing side, or both, providing for greater profits through elimination of the middleman (Joseph M Morris, 1998).

Acquisition of Intangibles and Personnel: Purchasing an operating business is often a way to acquire specific assets, including intangible assets, which might not otherwise be available to the acquiring company. For example, the seller may have technology, a marketing network or other resources which would be very difficult for the buyer to duplicate on its own, and which the buyer hopes to use more profitably than the seller. In many cases, these types of intangible assets are really nothing more than a group of individuals who acquired business-people who have knowledge, training, and experience, which the acquirer needs. In these cases, the key to the acquisition is the ability to be sure that the target personnel can be acquired and retained. This is often accomplished by the use of employment contracts (Joseph M Morris, 1998).

Portfolio Investment: A company may want to invest excess cash at a higher rate of return. In effect, the acquirer becomes a holding company with respect to the acquired business. It does not necessarily seek benefit with regard to its existing business. Instead it looks for the prospect of controlling and profiting from a business which it believes will be a good long-term investment, in which case the operating expertise for the acquired company is often acquired with the business (Joseph M Morris, 1998).

Change in Industries: Another reason for an acquisition may be to gain entry into a totally new industry or industry segment, usually, but not always, an industry, which appears to have some connection with the business of the acquiring company. The buyer may have determined that its own line of business is stagnant or in a decline, and thus chooses to use it resources to expand into an area with more potential. The purchase of an existing business is almost always a faster route to expansion than trying to develop a new operation with the buyer’s existing resources, but this is especially true when the new industry is one with which the purchaser is totally unfamiliar(Joseph M Morris, 1998).

2.6 WHY DO MERGERS FAIL?

Despite having the right intentions, many companies fail in their attempt to successfully complete a merger or acquisition. Often, either a single, consolidated culture is never established, or the integration process itself is not conducted in a focused and expeditious manner, which allows the competition to take advantage of that company’s preoccupation. Following best practices drives a smooth and timely integration, and helps ensure that the M&A processes meet strategic corporate goals and, most importantly, customer needs.

Although companies are aggressively pursuing mergers and acquisitions, recent studies have indicated that 60-80% of all mergers are financial failures when measured by their ability to outperform the stock market or to deliver profit increases. It is true that some of these failures can be largely attributed to market and financial factors, many studies are pointing to the neglect of human resources issues as the main reason for M&A failures. A 1997 PricewaterhouseCoopers global study concluded that lack of attention to people and related organizational aspects contribute significantly to disappointing post-merger results.

A study by Watson Wyatt based on a survey of 1,000 companies revealed that more than two-thirds of companies failed to reach their profit goals following a merger, and only

46% met their cost-cutting goals. Those findings are further supported in a study by A.T

Kearney that shows 58% of mergers failing to achieve their stated goals, and only 42% of global mergers managing to outperform their competitors after two years.

Mergers typically fail for the following key reasons (http://www.emergeinternational.com/7_reasons.html)

Lack of Communication

Poor business fit

Management’s failure to integrate

Loss of Key People and Talented Employees

Corporate Culture Clash

Power Politics

10 Inadequate Planning

2.7 EFFECT OF GLOBALIZATION ON MERGERS

Globalization surely encompasses the international trade and commerce of the past, coupled with the global acquisitions and mergers that are creating new corporate giants with the capability of spreading their corporate DNA globally. In an increasingly global environment, it is the need of the day to expand operations globally. An acquisition, in this fast-paced, high-tech world, tends to be much faster and it is an effective way to penetrate a foreign market, with its different national tastes. In this global environment mergers are no more problematic due to trade liberalization, innovation and deregulation which have caused markets to open and expand entry barriers to fall and enabled more foreign firms to provide meaningful competition. Technology has improved and have brought down the costs of transportation and communication dramatically, making cross-border trade and investment more feasible. The trade negotiations have opened up markets by removing not only tariff barriers but also non-tariff barriers in both goods and now services. Also deregulation and privatization have opened up former monopolies, state-owned enterprises and other limited entry markets, increasing firms’ competitive opportunities.

One of the most important reasons why some kind of competition policy for developing countries has become imperative is the huge merger wave, which has gripped the world economy in the 1990s. The merger boom of the 1990s is of course not entirely an event. Earlier it is indicated that, it is in part caused by liberalization and globalization, closer integration of world markets through finance and trade, and the creation of the European single market, among other factors that is, international trade has likely increased competition. An example is the auto industry – what was once a domestic oligopoly of The Big Three back in the 1970s is now a more fragmented international market where European, Japanese, US and other players sell and source across borders and vie for market share.

In 1980s the mergers were largely financed through ‘leveraged buy-outs’–borrowed money–and acquired firms were often cannibalized. Mergers of today involve stock swaps rather than cash transactions. Values of bloated stock market have made deals of previously unimagined size possible. The mergers current cascade is also sustained by the broad trend toward privatization of state-owned companies and public infrastructure, deregulation, and the liberalization of trade, investments, and capital markets. In an era of globalization, the size and geographical reach of a firm are seen as ever more crucial to success. Increasingly, firms either achieve this objective by observing others, or competitors swallow them up. According to Securities Data Corporation, there were more than 2000 announced cross-border acquisitions in 1996 worth over $252 billion. While this represents 54% more acquisitions than in 1991, the increase in dollar value has been even more remarkable, tripling during this time period. Clearly cross- borders M&As have become a fundamental characteristic of the global business.

Cross-border mergers have also been the main driving force of foreign direct investment (FDI) in recent years. This indicates that a considerable portion of private capital flows goes simply to changing ownership of existing factories and other businesses. Some of the acquisitions imply a long-term investment commitment, others may be little more than a prelude to asset stripping–retaining the most valuable parts of a company and closing or selling off other parts.

The cross-border merger implies that transnational corporations (TNCs), particularly the largest ones, will continue to expand their already strong role in world trade.

2.8 THE STATE OF THE AUTO INDUSTRY

The factors behind the great wave of M&As in the auto industry sector can be identified as; increasing innovation costs which have pushed automakers to look for new business and markets and restructuring of their operations; rapid technological development augmenting technological interrelatedness; new communications and cross-border restructuring; and regulatory changes. M&As in the motor vehicle industry was also necessitated by excess installed production capacity, which required rationalization and associated efficiency gains.

In terms of the value of deals, the industry’s peak year of the M&A wave was 1998, when most of the deals arose from cross-border M&As. The most important of these deals was the one concluded between Daimler-Benz and Chrysler, followed by a series of other M&As: Volkswagen took over Rolls Royce, Ford took over Volvo’s car division, and Nissan concluded an alliance with Renault.

Although the motor vehicle market is notably rather concentrated, the new M&A wave can be seen as occurring in a somehow new global environment, characterized by market liberalization and by new countries entering the industry. This has raised the need for spatial reorganization in order to access new markets and to sustain a decrease in costs. Besides the industry structure other factors should be taken into account. As anticipated above, new communications and cross-border restructuring have changed the ways of doing business as the transaction and information costs of customers are removed or, at least, reduced. Similarly, technological changes have added new pressures to competitiveness in the light of the cost and risks involved in developing the next generation of cars. Regulatory changes have also played their role in this industry as a consequence, for instance, of the removal of selective distribution arrangements or restrictions. In addition, the Asian crisis has ameliorated the growing problem of excess capacity.

The past ten years can be described as the merger and acquisition age for the auto industry. This wave is not only affecting auto manufacturers but parts suppliers and even car dealership that are trying to create dealership chains. The most recent deal among auto manufacturers is the proposition of GM and FIAT to acquire the troubled DAEWOO motors. Observers believe that this trend will continue in the future and there will be no more than eight significant manufacturers in the twenty-first century. The key catalysts for this consolidation are manufacturing overcapacity, the pressure to improve shareholders returns and the increasing consumer power. (http://www.american.edu/carmel/km2214a/industry.htm)