Takeover Mergers Acquisitions Case Study Of British Petroleum Commerce Essay

BP is one of the largest vertically integrated oil and gas companies in the world. The company’s operations primarily include the exploration and production of gas and crude oil, as well as the marketing and trading of natural gas, power, and natural gas liquids. BP has its headquarters in London, United Kingdom and employs about 80,300 people.

British Petroleum, which transformed from a local oil company named Anglo Persian formed back in 1908 to a global energy group, is one of the world’s largest energy companies today, providing its customers with fuel for transportation, energy for heat and light, retail services and petrochemicals products for everyday items. BP excelled exponentially in the past century and today it employs over 80,000 people and operates in over 100 countries worldwide.

On 20th April, 2010, BP came across a deep water rig explosion in the gulf of Mexico which was caused by what has been described as the worst US ecological disaster ever, wiping more than $58 billion from the company’s value and causing its share price to drop down more then half compared to the value before the explosion.

Many analysts are saying that this could trigger a takeover of the business by one of its big competitors such as Exxon Mobil, Shell or even Petrochina.

In this report, we will discuss the factors and reasons which can result in a takeover of any company along with the very real disadvantages which a company may face if they do an acquisition, including those special to an acquisition of BP at this time.

What is Merger and Acquisition stands for?

The term Merger & Acquisition or Takeover 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.

Takeovers and mergers are also the reason why today’s corporate landscape is a maze of conglomerations. Insurance companies own breakfast cereal makers, shopping mall outlets are part of military manufacturing groups, and movie studios own airlines, all because of mergers and acquisitions.

Although often used synonymously, the terms merger and acquisition mean slightly different things.

Merger

A merger happens when two firms agree to go forward as a single new company rather than remain separately owned and operated. It can be described as the mutually agreed decision for joint ownership between organizations.

When two companies merge, the boards of directors (or the owners, if it is a privately held company) come to an agreement. The original companies cease to exist, and a new company forms, combining the personnel and assets of the merging companies. Like any business deal, this can be straightforward, or incredibly complex. The key is that both companies have agreed to the merge.

Acquisition

When one company takes over another and clearly establishes itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer “swallows” the business and the buyer’s stock continues to be traded.

Hostile Takeover: A hostile takeover is an acquisition in which the company being purchased doesn’t want to be purchased, or doesn’t want to be purchased by the particular buyer that is making a bid. The buyer has to gain control of the target company and force them to agree to the sale.

Both acquisitions and mergers typically involve the managers of one organization exerting strategic influence over the other.

Reasons for a Takeover

There are different reasons for developing through a takeover activity. The primary reason being that acquiring firms seek improved financial performance. Another major reason is the need to keep up with the changing environment and to gain opportunities of market growth more quickly than through internal means. Following gives a brief account for the conventional reasons of a takeover.

Speed of Entry

Speed of entry is one of the reasons for a takeover because products and markets nowadays are changing so rapidly that acquisition becomes the only way to successfully enter a market, since the process of internal development is too slow and when speed is important, acquisition is more likely to be used. Most acquisitions are consummated relatively quickly, whereas internal development of new products or services normally takes many months or years. Acquisition may allow the acquiring firm to realize revenue earlier, achieve economies faster, and capture a greater market share. When entry occurs through internal development, a decade or more is often required to fine-tune the business to achieve the profitability of established competitors

Economies of Scale

Economies of scale is an economic term describing a business model where the long-run average cost curve declines as production increases, or in a simple example explaining the principal, where a manufacturing company saves money as it produces higher quantities of its product, as in all business areas, ‘the more you buy, the more you save’. “Economies of scale” is a long run concept and refers to reductions in unit cost as the size of a facility and the usage levels of other inputs increase.

This refers to the fact that the company after takeover can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.

An example is that of a private soft drinks manufacturer. The more orders that the manufacturer receives, the more savings it makes, as it will in turn get cheaper prices for the materials it needs to produce its drinks (e.g. plastic, aluminium, sugar) as it will be buying them in larger quantities and receiving discounts, the manufacturing company in turn would give its customers cheaper prices for the more orders for drinks they make for this very reason, as they will gain the discounts, they can pass a saving onto their customers, making themselves stronger, a more respected company from its suppliers as it is buying in higher volumes and its turnover becomes higher. All these factors contribute to the benefits of economies of scale..

Why Economies of Scale Happen: An In Depth Look

Corporations incur fixed costs when buying heavy machinery, buildings, or other large purchases. A fixed cost is called ‘fixed’ because when production increases in the short run, new buildings and machines are not immediately needed. Because fixed costs are not tied to production, firms have an incentive to produce as much as possible (assuming they can sell their product). Intuitively, a large factory should produce a large number of units to minimize its fixed cost per unit. Say that an automobile factory costs 1 million dollars. If it only produces 1000 cars, then its Fixed Cost Per Unit is 1 million dollars divided by 1000 cars, or $1000/Car.

If the factory produces 8000 cars, however, its Fixed Cost Per Unit is 1 million dollars divided by 8000 cars, or $125 per car. By producing 7000 more cars, the firm gets an 88% fixed cost reduction per car.

This graph illustrates that increased production reduces fixed costs per unit.

Figure 1

With fewer fixed costs per unit, firms can afford to lower per unit prices. If fixed costs are very significant to a particular firm’s industry, then firms who mass produce efficiently can cut costs, extract revenues, lower prices, and therefore capture market share. Higher market share and higher revenues mean more money to spend on machinery, and expand the firm. This in turn allows further cost cutting, higher production, and the development of better products. In the long run, firms which effectively mass produce take over industries dominated by high fixed costs.

Figure 2

Financial markets

Financial markets may provide conditions that motivate acquisitions. If the share value or price/earnings (P/E) ratio of a company is high, it may see the opportunity to acquire a firm with a low share value or P/E ratio. Indeed, this is a major stimulus for the more opportunistic acquisitive companies. An extreme example is asset stripping, where the main motive is short-term gain by buying up undervalued assets and disposing of them piecemeal.

Eliminating Competition

A buyer company, when absorbs a major competitor, eliminates the major competition and thus increases it revenue or market share. This motive of takeover comes into play when companies want to increase their market power which results in an increased share value and overall monopoly.

Synergy

Synergy is the potential additional value from combining two firms. It is probably the most widely used and misused rationale for takeovers.

Operating Synergy

Operating synergies are those synergies that allow firms to increase their operating income, increase growth or both. Operational synergy is deemed to be the main motive of the takeover when the bidder takes over a target in the same industry. We would categorize operating synergies into four types.

1.     Economies of scale that may arise from the takeover, allowing the combined firm to become more cost-efficient and profitable.

2.     Greater pricing power from reduced competition and higher market share, which should result in higher margins and operating income.

3.     Combination of different functional strengths, as would be the case when a firm with strong marketing skills acquires a firm with a good product line.

4.     Higher growth in new or existing markets, arising from the combination of the two firms. This would be case when a UK consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products.

Operating synergies can affect margins and growth, and through these the value of the firms involved in the takeover.

Financial Synergy

With financial synergies, the payoff can take the form of either higher cash flows or a lower cost of capital (discount rate). Included are the following.

1. A combination of a firm with excess cash, (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm. The increase in value comes from the projects that were taken with the excess cash that otherwise would not have been taken. This synergy is likely to show up most often when large firms acquire smaller firms, or when publicly traded firms acquire private businesses.

2.      Debt capacity can increase, because when two firms combine, their earnings and cash flows may become more stable and predictable. This, in turn, allows them to borrow more than they could have as individual entities, which creates a tax benefit for the combined firm. This tax benefit can take the form of either higher cash flows or a lower cost of capital for the combined firm.

3.      Tax benefits can arise either from the acquisition taking advantage of tax laws or from the use of net operating losses to shelter income. Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden. Alternatively, a firm that is able to increase its depreciation charges after an acquisition will save in taxes and increase its value.

Diversification

Companies takeover different product line companies to diversify their product or service range and to protect themselves against downturns in the core markets. This calls for a very well thought and specific policy keeping in mind the future steps and goals of a company. Moreover, can really help if there is a downfall in the core market and company shares of a particular product.

Disadvantages of a Takeover

The reasons for takeover are kept under account while targeting a company, but calculating the disadvantages associated with it are analysed with more precision and taking all situations under consideration. Companies mostly come up with the following disadvantages while acquiring other companies

Costs of mergers and acquisitions

Mergers and acquisitions can be costly due to the high legal expenses, and the cost of acquiring a new company that may not be profitable in the short run. This is why a merger or acquisition may be more of strategic corporate decision than a tactical maneuver. Moreover, if a poison pill unknowingly emerges after a sudden acquisition of another company’s shares, this could render the acquisition approach very expensive and/or redundant.

• Legal expenses

• Short-term opportunity cost

• Cost of takeover

• Potential devaluation of equity

• Intangible costs

M&A activity can also be exacerbated by the short-term cost of opportunity or opportunity cost. This is the cost incurred when the same amount of investment could be placed elsewhere for a higher financial return. Sometimes this cost does not prevent or deter the acquisition because projected long-term financial benefits outweigh that of the short-term cost.

Consumer and shareholder drawbacks

In some cases, acquisitions may not only disadvantage the shareholders but consumers as well. In both cases, this may happen when the newly formed company becomes a large oligopoly or monopoly. Moreover, when higher pricing power emerges from reduced competition, consumers may be financially disadvantaged. Some of the potential disadvantages facing consumers in regard to mergers are the following.

• Increase in cost to consumers

• Decreased corporate performance and/or services

• Potentially lowered industry innovation

• Suppression of competing businesses

• Decline in equity pricing and investment value

Shareholders may also be disadvantaged by corporate leadership if it becomes too content or complacent with its market positioning. In other words, when takeover activity reduces industry competition and produces a powerful and influential corporate entity, that company may suffer from non-competitive stimulus and lowered share prices. Lower share prices and equity valuations may also arise from the merger itself being a short-term disadvantage to the company.

Effects on management

A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that mergers and acquisitions destroy leadership continuity in target companies’ top management teams for at least a decade following a deal. The study found that target companies lose 21 percent of their executives each year for at least 10 years following an acquisition – more than double the turnover experienced in non-merged firms. If the businesses of the acquired and acquiring companies overlap, then such turnover is to be expected; in other words, there can only be one CEO, CFO, etc at a time.

Wages Settlement

This could also be a problem if the acquiring company gives less wages to its employees then the acquired company. This may result in overpaying the new employees of acquired company or increasing the wages of its previous employees. This can really unsettle the budget and administration of the company.

REASONS AND DISADVANTAGES OF TAKING OVER BRITISH PETROLEUM

The idea of BP being taken over by anyone would have sounded crazy before the gulf of Mexico disaster, but it is now becoming commonplace to suggest that the UK oil major might even fall into the hands of rivals like Exxon Mobil, Shell or even Petrochina.

The about turn has been extraordinary. Before its money and reputation began bleeding away in the Gulf of Mexico, the oil giant was considered the safest of blue chip companies, because its debts were so low and its income so high.

BP’s failure to stop an oil leak from spewing millions of gallons of crude into the Gulf of Mexico may leave the biggest oil and gas producer in the U.S. in a fight to stay independent.

BP Facts

Clean-up:

Cost to date: $3.1bn approx

Escrow account promise: $20bn

Shares:

Share price on 20 April (before leak began): 656p

Share price lowest point (on 25 June): 296p (55% fall)

2009 profits: £10bn

2010 dividend: £1.8bn in Q1; Q2-4 cancelled, saving £5.4bn

Debt:

Total debts: £17bn, of which £4.9 due by end-2011

2009 cashflow: £21bn

Credit ratings: A2/A (Moodys/S&P)

Credit default swap spread (5 years): 4.1% per annum

Strategic investors:

Market capitalisation: £65bn (at 345p current share price)

Kuwait shareholding: 1.75%

China shareholding: 1.1%

(Data: Bloomberg as of 6 July 2010)

Reasons for Takeover

In addition to being the largest oil and gas producer in the U.S, BP is the biggest operator in the Gulf of Mexico, where it holds more than 500 leases and pumps 450,000 barrels of oil a day. The company plans 10 projects in the Gulf during the next five years, more than other regions of the world, according to a BP presentation. A takeover of BP will result in the acquisition of all these projects ultimately increasing the growth of the acquiring company.

A takeover by Anglo-Dutch shell looks likely because synergies of $9bn had been estimated by former BP chief Lord Browne and it is revealed that merger of these companies were tried before in 1995 and 2004. These synergies will give the combined company the power to take advantage from economies of scale and great pricing power.

If Exxon Mobil acquires BP that would be a combination of the first and second biggest gas producers in the US which will result in the monopoly of the whole oil market in the hands of the acquirer. If this happens, the joined company can dictate the stock market and gain other advantages as well.

Chinese oil giant Petrochina which is not a major oil producer but an avid consumer of oil can divert scarce oil supplies of BP towards china to satisfy its needs rather than those of the west. This will not only give Petrochina access to BP’s international oil and gas reserves, but also the expertise and latest technology which will result in higher value and growth of the combined company.

The takeover will eliminate a fierce competition between the oil giants of the world as the acquiring company will absorb a major competitor in the form of BP. Thus increasing overall market power and share value.

Disadvantages

The huge and indeterminate cost of the oil spill cleanup, as well as damages, fines and compensation analysts forecast of the cash cost to BP have ranged up to about $40 bn, could spiral into tens of billions.

Political Effects

Technically any of Exxon Mobil, Shell or Petrochina can afford to buy BP, but in an industry which is already fraught with regulatory and political risk, it is a difficult to cope up with all the arising situations.

There is already a statutory limit under US law for oil spill costs of a mere $75m, but BP long ago waived this limit, as hiding behind it would have been politically untenable.

The oil firm could take more active steps to limit its liability, for instance through a selective bankruptcy of its US business.

But this would almost certainly be unpalatable to the company’s board, as it would enrage US politicians, including President Barack Obama, and probably cut off the entire US market to BP.

So the political reality is that BP’s liability in the Gulf of Mexico remains unlimited, and this continues to weigh down the company’s share price.

A takeover of BP in such a scenario will result in an unlimited liability for the acquiring company. Moreover, it may probably cutoff from the U.S market where BP is the biggest oil and gas provider.

Environmental Effects

The environmental threats after Mexico oil spills are still in account and acquiring companies will feel the effects of it for a long time. The cost of oil cleanup is indeterminate and in case of an acquisition, those cleanups and its effects will become the liability of the acquiring company and if they fail to clear them in a particular set of time, then the acquired company can feel the heat as well.

Legal Effects

The damages, fines and compensation forecasts of the spill are very unclear and there is no exact account of the litigations which BP will face. BP has crossed the $368 million mark till now in paying companies and individuals as a result of after-effects of the oil spill. Still there is a long way to go and no one wants to pay an unquantifiable liability.

Other Disadvantages

If Shell makes a move, then it will ace serious competition issues that would force divestments in Europe and the US. A combined company will be very difficult to manage and to sustain growth.

Petrochina will be in a risk of overpaying the employees of BP as labour is cheap in Chinese companies and this could really effect the management and workforce from top to bottom.

In case of Exxon Mobil, Most combinations of assets would have to be downsized for competition reasons. The overlapping management will lose their jobs and the old management will have to fit in the shoes of the BP management and become familiar with their systems and ways which will take time and incur cost.

The costs of oil projects are set to soar as governments insist on tougher environmental safety standards in the wake of the spill. Already the Kazakhstan energy ministry has forced Shell to tighten up plans at its Kashagan development, meaning that the current $136bn budget dedicated for the project is likely to be busted. The result could be that smaller companies, that don’t have market values in excess of $100bn – might pull out of deep-water activities. Only the big boys of the industry would remain in the waters.

Conclusion

There are many likely motives to takeover BP but it carries a lot of dips and drops. If a buyer does try to overcome all these enormous hurdles, it would still need to agree a deal. At the moment, there is no sign of BP to surrender. Takeover talks are likely to keep swirling, but the chances are that BP will emerge with its independence intact.