Impact Of Mergers And Acquisitions On Corporations Finance Essay
Global economy today requires organisations to adopt strategies of inorganic growth like Mergers & Acquisitions which enable them to improve their competitiveness by gaining larger market share, reduce the business risks through a diversified portfolio of products, allow entry to new markets, and capitalize on economies of scale. The research study was aimed to study the impact of mergers and acquisitions on the performance of corporations which acquired other companies, by analysis of some pre-merger and post-merger financial ratios. The analysis of the results suggests that M&A have a significant impact in making a positive impact on the profitability of the acquiring company, increasing the shareholder value through greater earnings per share; stability in cash flows would provide them with sufficient working capital to meet their operational needs. In order to fund the M&A the acquiring companies will have to increase their debt obligations which will create a risk that the debt financing would outweigh the return that the company obtains from its investments and its operations.
Mergers & Acquisitions are tools to achieve corporate growth. There are several ways in which a firm can grow. The growth can be internal through expansion of its existing activities, increasing the capacity of production or through investment to create a new firm in the current product markets. The external growth of the firm can be through set up of units which deliver a new product or sell products in a new market. A firm can face several problems in the process of its internal growth like government restrictions for capacity enhancement, limited size of the market, and limited growth potential of the product. In order to have the desired growth internally, the firm must have thorough knowledge about the new market/product in order to sustain the competition. Organisations that prefer to grow in a organic manner also tend to take a longer period to establish themselves in the market and yield positive return on their investments.
Organisations in order to grow within a short span of time and obtain higher returns on their investments need to adopt alternative approaches of inorganic growth like Mergers and acquisitions, Joint Ventures or Takeover. These approaches will enable the organisation to use the infrastructure and the resources of the other firm which are already in place. Mergers and Acquisitions provide the firm with significant operational advantages improve the company performance and would also increase the long-term shareholder value.
Mergers enable two separate firms to be combined to a single entity as a result of which the firm obtains operational and structural benefits which would enable it to reduce costs, increase the profits and boost the shareholder value. On the other hand Acquisition of companies may not be done mutually as mergers but can provide the firm with the same benefits as that of a merger. The acquisition of the firm is done by offering a cash price per share to the shareholders of the firm or by using a specified conversion ratio to acquire the firm’s shares.
Organisations tend to adopt such ways of inorganic growth as it provides them with the following advantages:-
Rapid growth through the available infrastructure and resources
Synergistic benefits due to combination of business activities which are derived from cost economies and revenue enhancement
Diversification of the business to make a positive impact on the profitability of the firm
Economies of scale result in lower ordering costs, reduction in the duplication of work in various departments thereby increasing the profits of the company
Increased market share and Revenue
Elimination of competition in the market which would provide the firm with a larger market share in the market.
Acquisition of new technology which would provide the company with a competitive edge and have a sustainable competitive advantage over other players in the market
Procurement of the manufacturing facilities would enable the firm to safeguard the source of obtaining raw material and bring down the purchasing costs.
Expansion of the target market
Financial Synergy would be created through
Reduction in the cost of capital
Increased debt capacity
Ease of raising the capital
Tax Liability of the acquiring firm can be reduced if the target firm is making losses
Globally Mergers and Acquisitions have enabled companies to improve their financial performance and have gained significantly from the technical, diversification and pecuniary synergistic benefits by combining themselves into a single entity. The motivation for pursuing the M&A approach for companies could be similar as they provide similar benefits but the underlying business rationale and the financing methodology used are significantly different.
A merger is a result of mutual decision making done by companies to combine into single entities as a result of which they can succeed in reducing the operational costs which would increase their profitability and create shareholder value. In the process of merger of two organisations, the shareholders exchange their shares with the shares of the merged entity. Mergers make the assets and liabilities of a company vested in another company which would lose its identity and the shareholders would become the shareholders of the newly created single entity. The transfer of the assets, liabilities and the stock is done on the basis of the payment received in the form of Equity shares, debentures, and cash from the transferee company
Types of Mergers
There are mainly 3 types of mergers:-
It is the form of merger which involves firms which are in a similar business. The prime motive of Horizontal mergers is that it would provide economies of scale due to the combination of the two entities. The economies of scale would be obtained through reduction in the costs, elimination of duplicated facilities and providing a diversified product portfolio in the market to obtain a competitive advantage in the market.
Horizontal mergers can enable firms to engage themselves in anti-competitive practices and have a monopoly in the market
This form of merger involves combination of firms which belong to different stages of the production or the supply chain. The firms which choose to adopt such a strategy have their main motive to expand their operation through forward or backward integration. Through the merger of the two entities, the company can reduce the inventory and finished goods can be supplied according to the prevailing demand in the market. Vertical mergers lead to integration of the production processes which would result in reduction in cost of obtaining raw materials so that the firm can capitalize on the demand for the product. Companies are often forced to have vertical mergers when they have scarcity of resources or are not in a strong position in the market.
These mergers are between firms which are involved in unrelated businesses. The primary purpose for these mergers is the utilization of financial resources which provides stability to the acquiring company. It also leads to creation of a diversified product portfolio which would reduce the probability of inconsistency of cash flows for the company. Conglomerate mergers can be categorized into 3 types:-
Product extension mergers which occur between firms involved in related business activities, mainly done to create a diversified product portfolio.
Geographic market extension mergers are between firms in geographically distinct areas
Pure conglomerate mergers involve merger of firms which are in unrelated businesses. They are not done with a motive to extend the product offering or expand the market.
Procedure of a Merger
Searching for a partner for the Merger: - It is the first step in the merger process where the top management can identify the various probable companies in the same or diversified business activities which could become better merger partners. This process of identification is normally based on information obtained from various public and private sources.
Agreement between the two Firms: - The actual merger process begins with the agreement which should be sanctioned by the court under section 391 of companies act 1956. The sanction would make the transaction legal.
Scheme of Merger: - It should be prepared by the companies who have mutually taken the decision to merge into a single entity. The scheme should contain the following information :-
Information regarding the companies getting merged
Terms of transfer of assets and liabilities
Terms of conducting business
Specifications about authorized, paid-up and issued capital
Terms for dividend payment
Status about the employees of the companies getting merged
Accounting entries and provisions covering income tax and other contingencies
Board of Directors approval for the scheme :- The board of directors of the two companies must approve the scheme
Approval from Financial institutions: - It is mandatory for the companies to get approval from the financial institutions who have guaranteed the funding. Also Reserve Bank approval is mandatory.
Court Approval: - The court has to decide on the approval of the scheme prepared for the merger. Once approved by the court, the companies can be merged.
Transfer of Assets and Liabilities
Allotment of Shares
Stock Exchange Intimation :- The firms need to intimate the stock exchange for listing the new shares to the shareholders
Public Announcement: - Under SEBI regulations the public announcement of the merger is mandatory. The announcement should have all the details, terms & conditions under which the deal has been made.
Acquisition is the purchase of a company by another company with a motive to have a controlling interest in the share capital of the other company. It is an attempt by a firm to gain a majority interest in another form through payment in the form of cash, stock or a mix of both. The process of acquisition can be done through:-
Members of the board and persons holding majority interest in the company can have an agreement to give the majority of the voting power
The shares of the company can be purchased in the open market
Takeover offer can be put forward to the general body of the shareholders
Acquiring share capital through cash, loan or a mix of both.
The strategies adopted in corporate acquisitions are:-
Friendly Takeover: - This form of acquisition involves the acquiring firm making a financial proposal to the management and board of the target firm. The proposal may result in a parent/subsidiary alliance, merger of the two firms or consolidation of both the entities
Hostile Takeover :- This form of takeover provides the suitor with the control of the target company whose management in not willing to agree for a merger or a takeover. This type of takeover occurs when the board of the target company rejects the offer, but the bidder tries to pursue it. The bidder can also make the offer after announcing its intention to make the offer of acquisition.
Reverse Takeover: - This type of takeover involves a private company acquiring a public company. The primary purpose for these kind of approach is that the private company would save the expense and the time required to launch a conventional IPO
Backflip Takeovers:- In this type of takeover the acquiring company makes it a subsidiary of the purchased company.
Financing of Takeovers
Funds for financing the takeovers are obtained by the company through bank borrowing or raising capital through the issue of bonds in the market
Public companies having cash offers allow the shareholders to take their consideration in “loan notes” which does not make them liable for capital gain tax.
Takeovers can also be financed through all share deals.
Disadvantage of Takeovers
Reduced Competition and choices for customers
Conflicts with the management
Impacts of Mergers and Acquisitions on the Company
Mergers and acquisitions allow the acquiring company an opportunity to grow their market share through utilisation of the resources and assets of the acquired company. The acquiring company pays a premium price to acquire the necessary resources which would enable it to attain its competitive goals. The growth that the companies would achieve through M&A would be significantly higher than the growth it would achieve if it would adopt a strategy of growing organically
The firms would become more valuable entities through the combination than the value of each of them if they were operating as separate entities
Mergers and Acquisitions allow companies to diversify their businesses and reduce their dependence on the performance of a single industry
M&A would also improve the purchasing power of the companies, increase their ability to negotiate which would lower the costs to the company thereby increasing its profits
Companies merge with other companies so that they have access to new markets and can grow their revenues and earnings manifold
The companies can also use their prowess to optimize their supply chain and as a result reduce the costs required to manufacture finished goods.
M&A allows elimination of the competition in the market which would allow it to gain a larger market share. But in order to acquire the target company, the acquiring company has to pay a large premium in order to convince the shareholders to accept the offer
The acquiring company can adopt new innovative technologies from the acquired company which would enable it to have a competitive advantage in the market
M&A also allows companies to use the manufacturing facilities and the available infrastructure in order to ramp-up the production to cater the demand of goods in the market
M&A may also improve the credit-worthiness of the company which would enable it to raise capital from the market easily
With the Increase in the size of the firm due to M&A, the expectations would expect lower rate of return for the invested capital due to reduced risk
M&A activities by the firm can stabilize the cash flows of the firm and increase its stability
Companies can also use M&A to reduce their tax liabilities
Impacts of Mergers and Acquisitions on the Shareholders
Shareholders of the acquired company gain significant return on the amount of holding they have in the company as a premium price per share is offered to the company for accepting the offer of the acquiring company. The price offered is much more than the book value of the shares.
Shareholders of the acquiring company obtain returns in the long term with the growth of the company.
Shareholders of the company are benefited as the face value of the share would be increased and also they will get more return on the investments made by them in the firms which are getting combined
Financing of Mergers and Acquisitions
The various methods of financing M&A deals include:-
Cash Payment: - these forms of transactions take place mainly in acquisitions where the entire control of the company is transferred to the shareholders of the acquiring company.
Financing: - Funds required for the merger or acquisition of another company can be obtained in the form of loans from banks or raised through the issue of bonds. M&A one through debt come under “leveraged buy-out”. However, cash deals provide an advantage to the firm as it would not have to dilute its Earnings per share (EPS) in order to acquire another company
Hybrid Financing: - This form of financing involves a combination of cash, debt or the stock of the purchasing entity.
Valuation of Mergers and Acquisitions
Investors and stakeholders of a company who aim to acquire another company must analyse the benefits that the acquisition would provide to them. Organisations must critically analyse the worth of the company that they are willing to acquire. It is a natural tendency that both the parties involved in the transaction would try to obtain the maximum possible benefits in terms of the value and cost to be paid up for the company. The buyer would try to get the lowest price possible and the seller would tend to try to sell at the highest possible price. Deal makers in order to assess the various prospective companies use a variety of methods for their assessment. The following are the methods used in the valuation of the M&A process:-
Comparative Ratios: - Companies tend to use these ratios in order to get the measure of the target companies through which they may base their offers.
Price-Earnings Ratio (P/E Ratio) :- It is the ratio which provides the valuation of a company’s share price in the market with respect to its earnings per share. On the basis of this ratio the acquiring company proposes a price which would be multiple of the earnings of the company.
Enterprise-Value to Sales Ratio: - On the basis of this ratio, the company makes an offer which would be multiple of the revenues of the target company.
Replacement Cost: - Valuation of acquisitions can also be done on the basis of the cost of replacing the company’ assets as it will take a long time for the acquiring company to set up a whole new firm with the right equipment and good management. This method of valuation cannot be used in the service industry as it involves human capital and ideas as its main assets which are difficult to value.
Discounted Cash Flow: - It provides the estimation of the current value of the company on the basis of forecasted future cash flows. The forecasted cash flows are brought down to a present value using WACC.
Participants in the Mergers and Acquisitions Process
The M&A process require highly qualified and skilled personnel who have their specialities in every aspect of M&A transactions. The various advisors involved in the process are:-
Investment Bankers who charge fees for their advisory services provide assistance to the company which wants to acquire another company of a particular industry. The financing for M&A transactions is provided by investment banks.
Lawyers take care of the legal framework of the transaction and perform the legal proceedings required.
Accountants provide advisory services on financial structuring, optimal tax structure and also perform the audit of the financial statements and operation of the target company
Valuation Experts use models based on various assumptions to determine the value of the target company
Institutional investors include banks, mutual funds who have invested money in the firm can collectively influence the decision making.
Evaluating Post Merger Impact and Performance
Mergers and Acquisitions and strategic alliances are significantly important corporate strategies for organisations that are striving for growth and trying to sustain the intense competition in the industry. Organisations continuously need to adopt methodologies for cost reduction, obtain benefits of economies of scale, use innovative technology to optimize business processes and diversify the business in order to improve the shareholder value. Considering the M&A activities globally there has been a significant increase in the number of the deals and the value of the deals that have been taking place.
The Indian M&A industry has experienced the first wave of M&A activity (1990-95), when the Companies in India were facing stiff competition from foreign companies. During the second wave (1995-200) the companies in India felt the growing competition of the multi-national corporations in the country. The third wave (2000-present) has witnessed Indian companies venturing in developed countries and has been making acquisitions. With the passage of time the size of the acquiring and the target firm has also increased to a large extent.
Considering the present status of M&A activities, there has been a significant increase on the mergers and acquisitions of companies. India also has experience a rise in the number of M&A Deals. The economic slowdown did impact the overall M&A activity globally but India, Japan, China are the countries in the Asia Pacific region where there have been the highest number of M&A deals in 2010. India is one of the most lucrative markets for M&A deals.
Data & Findings
The study provides analysis of the financial data of firms that have merged in the period of 2000-2008. The evaluation of the financial performance of the firms is done on a long term basis i.e for a period of three years. The period undertaken to study the various M&A deals in India is from 2003-05 in order to compare the financial performance of those firms before and after the merger. The data for the study has been obtained from CMIE database PROWESS and other finance journals.
Considering the period of study, 491 mergers took place considering all the industries. But the sample undertaken for study includes the financial data of 5 companies collected in the period of 6 years. Out of the span of 6 years, data for three years would be before the merger and the data for the other three years would be post merger. The data has been obtained from the Centre for Monitoring Indian Economy (CMIE)-Prowess Database.
The study of the impact of the merger has been done on the basis of the following parameters:-
Return on Equity
Return on Net worth
Earnings per Share
Debt to Equity Ratio
Profit before tax
Return on Income (NPBT/Total Income)
In order to analyse the profitability of the companies the ratios of return on net worth and earnings per share provide with a clear understanding of the financial viability of the company, its efficiency and its ability to provide returns on the investments done by the shareholders.
Return on Net Worth
Return on net worth provides us with the understanding of efficiency with which the company is utilizing the funds to generate profits. Considering the Data of the companies analysed their net worth of the post merger period was higher than their worth before the merger.
Observations Related to Net Worth
Out of the 5 companies which merged with other companies of the industry, 4 showed an increase in the return on net worth and 1 showed a decrease in the return on net worth. Also the overall net worth of 4 of the 5 merged firms increased and the net worth of 1 company decreased after the merger.
Earnings per Share
The accurate idea of the return on investment can be provided to the shareholders through the Earnings per share and not on the basis of the dividend paid out by the company. The greater the EPS better are the prospects and the performance of the company.
Observations Related to Earnings per Share
Out of the 5 companies which merged 4 companies indicated an increase in the EPS and only 1 company had a decrease in the EPS.
Majority of the companies had a significant increase in the EPS.
Liquidity ratios measure the ability of the firm to pay-off its short term obligations. Current ratio can be used to measure the liquidity of the firm. Ideally the current ratio of a firm should be 2. A very high current ratio would indicate idle funds and a very low ratio would indicate scarcity of working capital
Observations Related to Current Ratio
Among the 5 firms, 3 companies showed an increased in the current ratio and the other 2 companies showed a decrease in the current ratio
Solvency of a firm would indicate its ability to meet its long term obligations for which debt to equity ratio can be used. Higher the debt to equity ratio riskier would be the financial position of the firm and vice versa.
Observations Related to Debt to equity ratio
Out of the 5 firms analysed there has been an increase in the debt to equity ratio of all 5 firms which means that the amount of debt has increased.
Overall Efficiency Analysis
A measure of the profitability of the firm would be the perfect indicator for the efficiency of the firm. In order to measure the efficiency of the merged companies the profit before tax and the return on income in measured
Observations for Profit before tax
Among all the 5 firms analysed for the efficiency, the profit before tax of all the 5 firms had increased which can be interpreted as a positive impact of the merger of the companies.
Observations for Return on Income
Among the 5 firms analysed, all 5 firms showed an increase in the ratio.
Analysis of Mergers & Acquisitions in various Industry Sectors
ICICI Bank & Bank of Madura
ICICI bank acquired Bank of Madura at the swap ratio 2:1 which meant that two shares of ICICI would be equivalent to each share of Bank of Madura. The number of branches of the merge entity increased from 97 to 378 and also provided ICICI with the rural presence. Also the fee income of ICICI increased from 87 Crores to 171 Crores. ICICI also gained 1.2 million accounts of customers and got an entry in the small and medium customer segment. Through the merger ICICI bank had the combined asset base of 1600 crores which gave it the capability of greater resource mobilization
Mean Pre-merger and Post-merger Ratios for ICICI
Due to the merger all the ratios except the operating profit margin, net profit margin and debt to equity ratio have declined. Due to the increase in the debt ratio which shows that ICICI has taken more debt to fund the merger and its operations would be affected if the cost of debt exceeds the earnings. The profitability of ICICI has increased but the Return on net worth and Return on capital employed has decreased which shows that the firm is not able to generate profits after the merger. The merger between the firms did not prove to be successful as expected due to the following reasons:-
Lower Capital adequacy ratio of the merged entity due to the non performing assets of Bank of Madura
Nicholas Piramal and Pfizer’s Morpeth Unit
Nicholas Piramal India acquired Pfizer’s unit in UK through the purchase of its assets. The deal between the two entities involved the agreement of supplying of products totalling to revenues above $350 million, assets and various other current assets. Through the acquisition the company made a global footprint and diversified its product portfolio
Mean Pre-Merger and Post-Merger ratios of Nicholas Piramal
The merger has resulted in the increase of the operating margin and the net profit which shows that the firm has made greater profits per dollar of revenue obtained. Also the return on the net worth, liquidity ratio has improved which shows that the firm’s greater ability to pay its short term obligations. Also the reduced debt to equity ratio signifies that it has used equity to finance the M&A transaction. The growth of the firm within such a short span of time indicates that it is a successful merger.
Jet Airways & Air Sahara
The acquisition of Air Sahara by Jet Airways took place for 1450 Crore. The main motive behind the deal was to reduce the capital and operational expenditure.
Mean Pre-Merger and Post Merger Ratios for Jet Airways
The above ratios indicate that the profitability of the company has reduced drastically. Due to the increased leverage used by Jet Airways there has been a significant reduction in the Return on Equity, Return on invested capital and liquidated ratios which show that the financial health of the firm had deteriorated. One of the Primary reasons for the failure of the deal was that Jet had over-valuated Sahara’s assets and hence wanted a discount on the original price to be paid for the deal which as not acceptable to Sahara.
Analysis & Conclusion
Considering the large number of M&A taking place in the Indian industry, according to the sample data analysed majority of the firms produced an improved financial performance after the merger. The study of the data showed the following facts:-
Earnings per Share and Debt to Equity witnessed a significant change in the financial position of the company.
Analysis of the study shows that most of the acquiring firms were able to attain their desired growth rates in the long run.
Due to M&A the firms were successful in generating higher cash flows, reducing the costs and obtaining a greater market share.
With the increase in the financial performance of the firm, also increased the debt obligations of majority of the firms since they had chosen debt financing to obtain funds for M&A.
M&A also created a significant positive impact on the profitability of the firm.
The following aspects need to be taken care of before making the deal with the company getting acquired:-
Pre- merger planning through effective communication during the integration
Commitment & Competency of the Leadership
In-depth Financial Analysis of the firm need to be done
Cultural & People Issues need to be taken into consideration
Adequate importance should be given for improving risk management ability of the firm
Firms should implement the best practices obtain the maximum from the transaction.
Mergers and Acquisitions by Indian Companies
Table 1. Data on Return on Net worth
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Table 2. Data on Earnings Per Share
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Table 3. Data on Current Ratio
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Table 4. Data on Debt to Equity Ratio
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Table 5. Data on Profit before Tax
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Table 6. Data on PBT/Total Income
Bank of Baroda
Bank of India
IDFC Co. Ltd.
L & T Finance
Number & Value of M&A Transactions Gloabally
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