Mergers and acquisitions are the part of the modern corporate finance world. Theoretically mergers and acquisitions should be value creating for the shareholders of both the offeror and offeree companies. In practice situation is more complicated. In this work I have generalized my knowledge about the mergers, described current trends in corporative business, analyzed the life examples and made my own well-grounded conclusion. Mergers and acquisitions often don't create value for offeree and even for offeror. The main reason is the fast decision on the wave of recent "mergemania" without detailed research and long-term business perspective estimation.
Mergers and acquisitions
Mergers and acquisitions are the part of business strategy, which allow restructing, financing or aiding the growing company through combining two business entities in one.
Merger is "voluntary amalgamation of two firms on roughly equal terms into one new legal entity." (BusinessDictionary.com) http://www.businessdictionary.com/definition/merger.html
Acquisition is "acquiring control of a corporation, called a target, by stock purchase or exchange, either hostile or friendly, also called takeover." (InvestorWorld.com)
The difference between merger and acquisition is simple: merger is the unit of equals, and acquisition is the "ingestion". After the merger the stocks of both or more) companies are surrendered and new company stock is issued in its place, and after the acquisition the target company ceases to exist while the buyer's stock continues to be traded. Thus, after the merger of Daimler-Benz and Chrysler companies new company, DaimlerChrysler, was created.
Acquisition usually is the purchase of a small company by the bigger one, therefore it can be friendly or hostile. Company-buyer can purchase the stocks or the assets of the target company to take it over. The example of recent acquisition is the acquisition of Australian company Felix Resources by China's Yanzhou Coal Mining Dynamic Exports, 2010)
However hostile takeovers or even the friendly acquisition could spoil the reputation of both companies and cause the fall of the buyer's stocks. That is why usually companies proclaim the action as the merger, though it's technically an acquisition. From the other hand, if the boards of unequal companies negotiate the best strategy for both companies, this could be the real merger.
The problem of distinguishing the merger and the takeover becomes more complicated because of different extensions, markets and products of the companies. There are few types of mergers by the relationship between the companies:
- "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.
- 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." Investopedia, 2)
By the type of financing there are two main types of mergers: purchase merger and consolidation merger. Thus, the difference between some types of merger and acquisition is only in name. "In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders." )
Some researchers think that the ratio of mergers and acquisitions depends on global economical situation. Thus, the globalization forced many companies to merger because of high competition in the world trade and the domination of big corporations. Some corporations make such strategic moves for higher rank in a more lucrative global market. The period of economic recession caused the increase of number of mergers. First, corporations have no free finances to provide acquisitions; second, individual organizations are less likely to be able to survive.
Main goals of mergers and acquisitions
The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance: - lowering the fixed costs by removing duplicate departments or operations;
- increasing the scope of marketing and distribution, and other demand-side changes;
- increased revenue or market share;
- reducing tax liability;
- resources distributing across firms;
Theoretically two companies together are more then two separate companies. That is why synergy is the main criteria of the success for every merger or acquisition is the synergy. It makes the value of the combined companies greater than the sum of the two parts.
Thomas Straub shows that M&A performance is a multi-dimensional function. For a successful deal, the following key success factors should be taken into account:
- Strategic logic which is reflected by six determinants: market similarities, market complementarities, operational similarities, operational complementarities, market power, and purchasing power..
- Organizational integration which is reflected by three determinants: acquisition experience, relative size, cultural compatibility.
- Financial / price perspective which is reflected by three determinants: acquisition premium, bidding process, and due diligence.
At the same time, near the half of mergers and acquisitions is not successful. Often the executives of the acquiring company overestimate revenue and cost synergies. That is why they make typical mistakes, described in the "Harvard Business Review" article by Dan Lovallo and others: they rely upon future revenues too much, pay more for target firms than they're worth and ignore the possibilities of future loss. (Lovallo, 2)
"Several studies have found a sharp divergence between market participants' pre-merger expectations about the post-merger performance of merging firms, and the firms' actual performance rates. David Ravenscraft and F. M. Scherer's (1987) large-scale study of manufacturing firms, for example, found that while the share prices of merging firms did on average rise with the announcement of the proposed restructuring, post-merger profit rates were unimpressive. Indeed, they find that nearly one-third of all acquisitions during the 1960s and 1970s were eventually divested. Ravenscraft and Scherer conclude that mergers typically promote managerial "empire building" rather than efficiency, and they support increased restrictions on takeover activity. Michael Jensen, founder of the Journal of Financial Economics, suggests changes in the tax code to favor dividends and share repurchases over direct reinvestment, thus limiting managers' ability to channel "free cash flow" into unproductive."
Investors in a company thatareaiming to take over another one must determine whether the purchase will be beneficial to them. In order to do so, they must ask themselves how much the company being acquired is really worth.
Does merger create value for offeror and offeree?
Historical trends show that roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market. The motivations that drive mergers can be flawed and efficiencies from economies of scale may prove elusive. In many cases, the problems associated with trying to make merged companies work are all too concrete.
For starters, a booming stock market encourages mergers, which can spell trouble. Deals done with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and cheap too. Also, mergers are often attempt to imitate: somebody else has done a big merger, which prompts other top executives to follow suit.
A merger may often have more to do with glory-seeking than business strategy. The executive ego, which is boosted by buying the competition, is a major force in M&A, especially when combined with the influences from the bankers, lawyers and other assorted advisers who can earn big fees from clients engaged in mergers. Most CEOs get to where they are because they want to be the biggest and the best, and many top executives get a big bonus for merger deals, no matter what happens to the share price later.
On the other side of the coin, mergers can be driven by generalized fear. Globalization, the arrival of new technological developments or a fast-changing economic landscape that makes the outlook uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the management team feels they have no choice and must acquire a rival before being acquired. The idea is that only big players will survive a more competitive world.
The Obstacles to Making it Work
Coping with a merger can make top managers spread their time too thinly and neglect their core business, spelling doom. Too often, potential difficulties seem trivial to managers caught up in the thrill of the big deal.
The chances for success are further hampered if the corporate cultures of the companies are very different. When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily overcome. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result can be resentment and shrinking productivity.
More insight into the failure of mergers is found in the highly acclaimed study from McKinsey, a global consultancy. The study concludes that companies often focus too intently on cutting costs following mergers, while revenues, and ultimately, profits, suffer. Merging companies can focus on integration and cost-cutting so much that they neglect day-to-day business, thereby prompting nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to create value for shareholders.
ous, and strong managers can often squeeze greater efficiency out of badly run rivals. Nevertheless, the promises made by deal makers demand the careful scrutiny of investors. The success of mergers depends on how realistic the deal makers are and how well they can integrate two companies while maintaining day-to-day operations.
The example of the contradictory merger
At the end of last century Compaq Company, that was the largest supplier of personal computing systems in the world at that time, began the aggressive expansion in domestic market. In 1997 Compaq acquired through a stock-for-stock transaction two related companies, Tandem Computers Incorporated and Microcom, Inc. year later Compaq company completed its $9.1 billion acquisition of Digital Equipment Corporation, the number four computer maker in the United States. Immediately after acquisition annual revenues of Compaq increased to more than $37 billion, and raised the position of the company as the world industry leaders. "The company was number one worldwide in desktop computers, number three in portable computers, number three in workstations, number one in both PC servers costing less than $25,000) and entry servers (less than $100,000), and number six in midrange servers ($100,000 to $1 million). In computer services, Compaq was suddenly number three, behind IBM and EDS."
However the integration suddenly appeared to be difficult and costly. Besides, the Compaq CEO Eckhard Pfeiffer did not have the clear strategy of joint company development. That is why, after some varied-successful attempts to keep the position of Compaq, it was engaged in a merger with Hewlett-Packard in 2002. Many HP shareholders opposed the deal and the merger was approved only after the narrowest of margins. This merger was not very profitable too. Fiorina Carly was forced from the position of HP SEO in 2005, because under her leadership HP's stock price lost over 60% of the stock's value, from $52 per share in 1999 to $21 per share in 2005. The merger HP-Compaq was characterized as failure, and Fiorina Carly was included into the list of "The 20 Worst American CEOs of all time," by business magazine web site Cond Nast Portfolio. In 2009 HP sold the part of former Compaq assets for scanty price.
Analyzing the system of mergers and acquisitions, I concluded that the potential profit of merger or acquisition to create value for shareholders from both sides could easily be overestimated. The positive impact of merger or acquisition can be very short-termed, and then the problems of integration and further business operation. Mergers and acquisitions obviously have the advantages, but investors have to scrutinize the promises of deal-makers carefully.