Module 2 mergers and acquisitions and corporate.pptx
- 1. Module 2 Mergers and Acquisitions Dr. Binoy Mathew
- 2. Merger • Merger refers to combining two or more companies into one company. • It can either be done by merging of one or more companies into the existing company or framing a new company by merging two or more existing company. • The word ‘amalgamation’ is used for merger by Income Tax Act, 1961.
- 3. Bases of Merger • Merger by absorption: combining two or more companies into the existing company. In this case, one company loses its entity and goes into liquidation and all other companies remain the same. • Consolidation: the combination of two or more companies for forming one new company is known as consolidation. This is also called as ‘triangular merger’.
- 4. Acquisition • An acquisition is also known as ‘takeover’. It is when one company buys another company. • When there is stock purchase transaction then the shares of seller are not going to be combined with existing company of the buyer and may be kept separately as the new subsidiary or operating division while in asset purchase transaction, the assets taken by the seller to the buyer becomes an extra asset for the company of buyer.
- 5. Key Differences between Merger vs Acquisition Merger Acquisition Procedure Two or more individual companies join to form a new business entity. One company completely takes over the operations of another. Mutual Decision A merger is agreed upon by mutual consent of the involved parties. The decision of acquisition might not be mutual; in case the acquiring company takes over another enterprise without the latter’s consent, it is termed as a hostile takeover. Name of Company The merged entity operates under a new name. The acquired company mostly operates under the name of the parent company. In some cases, however, the former can retain its original name if the parent company allows it. Comparative Stature The parties involved in a merger are of similar stature, size, and scale of operations. The acquiring company is larger and financially stronger than the target company. Power There is dilution of power between the involved companies. The acquiring company exerts absolute power over the acquired one. Shares The merged company issues new shares. New shares are not issued.
- 6. Types of Mergers • Horizontal Merger • This is the most common type of merger, it happens when companies operating at the same level of the value chain (selling similar products and providing similar services) are direct competitors of each other come together to target a larger market and merge in order to dominate aiming to build higher economies of scale by decreasing market competition. • An example is the acquisition of UberEats by Zomato, where one food delivery business acquired the other dealing exactly at the same level of the value chain. Another example could be, acquisition of Bhushan Steel by Tata Steel.
- 7. • Two businesses that compete in the same market, merge to create an entity with a "supersized" market share. • Increasing the market share and integrating key processes, such as manufacturing, may help to lower overall operating costs. • It's an excellent approach for smaller businesses to access markets in other nations that might not have been previously accessible.
- 8. Vertical Merger • A vertical merger occurs when companies in the same market operate in different stages of production. • This type of merger cuts costs and boosts efficiency across the supply chain, but in business, it reduces flexibility and may also create new complexities. • Imagine a scenario where a cotton supplier supplied cotton to a textile manufacturer for many years. • They realized that their merger could result in reduced costs and an increase in profits. These two entities if merged would be termed as a ‘vertical merger’.
- 9. • An example can be the merger where both entities are at different levels of the production/supply chain would be Zee Entertainment Enterprises Limited Ltd. (ZEEL), a broadcaster, with Dish TV India Limited, a distribution platform operator. • Sometimes, these will be two businesses that aren't technically rivals, but joining forces makes practical sense. • For instance, a car manufacturer and a components supplier might join so that their shared operations can be carried out in close proximity and with more visibility. • The cost of parts is better managed by the automaker, while the parts supplier benefits from a steady flow of customers.
- 10. Congeneric Merger • A congeneric merger (also referred to as a ‘concentric acquisition’ or 'product extension merger') is a type where companies operate in related business segments offering different products or complementary products and have similar target customers. • The merging companies can also be indirect competitors. • The key idea for value creation here is that both companies can create significant cross-selling opportunities through a merger. • An example of this type of merger can be the acquisition of Zomato by Grofers. Both entities are in service to supply food products. • The only difference is that Grofers provides raw material and Zomato delivers cooked food. They have similar target audiences.
- 11. Conglomerate Merger • A conglomerate merger is a merger between companies whose businesses and industries are entirely different from each other. • The aim of this merger is to achieve a big size company. • There are almost zero synergy benefits for conglomerate mergers but there is an opportunity for business risk diversification . • It can be especially challenging to integrate dissimilar companies, raising the risk of culture clashes and lost efficiency due to disrupted business operations. • A famous example of this type of merger is the merger between the Walt Disney Company and the American Broadcasting Company. • Ultimately, mergers like this can be about portfolio diversification. When a product or sector performs poorly, it is hoped that other products or sectors can make up for the losses.
- 12. • Types of conglomerate mergers • Product Extension Merger: The merger happens among the firms which are selling different products but has same production process or market channel is known as product extension merger. • Market Extension Merger: When there is merger among the company selling the same products, but have different market for selling a product is known as market extension merger • Pure Merger: In pure merger, the merger happens among different firms.
- 13. • Reverse Merger: In the reverse merger, a profit earning company merges into the loss bearing company and the identity of profit earning company is lost. • It is the easy method of going public without any expenditure and less time is required as in case of raising the IPO and it also helps in taking use of the provision of IT Act which lets the company carry forward the losses to set off against the profit.
- 14. Notable Merger deals: • 1. Merger of Bank of Rajasthan with India’s largest private sector bank in an all share deal valued at about Rs. 30.41 billion in May 2010 which gave ICICI Bank sustainable competitive advantage over its customers in Indian banking. • 2. RNLR born out of demerger of Dhirubai Ambani’s Reliance in 2005 merged with Reliance Power in a mega Rs. 50,000 crore deal in July 2010. The combined entity had over 60 lakh shareholders-the largest for any entity in the world. • 3. In a biggest ever merger in the Indian Pharmaceutical Industry, Sun Pharmaceuticals acquired Ranbaxy from its Japanese parent Daiichi Sankyo in a deal valued at $4 billion. • 4. Tata Fertilisers Ltd. (TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring company (a buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist.
- 15. • 5. Hindustan Computers Ltd, Hindustan Instrument Ltd, Indian Software Company Ltd and Indian Reprographics Ltd. in 1986 to an entirely new company called HCL Ltd. • 6. Trends emerging now clearly shows the strategic shift in the behavioural pattern of Indian entrepreneurs, who are now more willing to sell a part or whole of their stake to exit their business to foreign players i.e. focus of deal activity shifting from outbound to inbound. • The reason for all such trend reversal is the weak Indian rupee which has made Indian businesses on international market. • Attractive valuations from foreign entities, given significant growth openings in India are prompting Indian entrepreneurs to evaluate exits. • Moreover, there is significant shift in attitude and behaviour of Indian entrepreneurs who focus with open mind to evaluate strategic buyers, and to exit their age-old businesses and this trend is expected to continue. • Few successful exits in the recent past by the Indian promoters include Daiichi- Ranbaxy and Abott-Piramal.
- 16. Motives of Merger • Motive 1: Acquire New Technology/Expertise • Industries change and if companies don’t, they don’t survive. That’s why companies are often on the lookout to acquire other companies which give them new technologies and expertise. • Examples: • Over the course of the last decade, Google has acquired over 30 artificial intelligence (AI) startups, acquiring a range of capabilities in a technology that is set to be hugely influential in the years ahead. • (https://dealroom.net/blog/acquisition-examples)
- 17. • Motive 2: Economies of Scale • Bigger is often better. • That’s the thinking behind acquiring for the economies of scale motive. Larger companies enjoy cost savings and competitive advantages that smaller companies usually don’t. • Examples: • This is very common in the airline industry where British Airways has merged with a few different firms over the years to create IAG (International Airlines Group), essentially a conglomerate of airlines which has more control over the skies than almost anybody else.
- 18. • Motive 3: Market Share • Market share may be the most common motive of all for M&A transactions; companies are constantly looking at where they stand in their industries relative to their peers so market share acquisitions are never far from the thoughts of CEOs. • Of course, one issue here is that too much market share attracts the ire of antitrust organizations. • Examples: • Virtually every big retail bank you know has become big through the acquisition of smaller regional retail banks, giving them a power that famously makes them ‘too big to fail’.
- 19. • Motive 4: Synergies (“Value Creation”) • As DealRoom blog articles have stated in the past, the scale of synergies is too often exaggerated. • But sometimes, the logic, if not the numbers, makes absolute sense. In 2017, when Amazon acquired Whole Foods, it was a clear attempt for Amazon to bring the power of its eCommerce machine to traditional food retail. • Clearly, the markets thought it was going to be a success: within hours of the deal, most other food retailers in the US were down by a few percentage points on the news.
- 20. • Motive 5: Geographical Diversification • Geographical diversification has been a huge value-driver in M&A over the years and this stands to reason: • Why build a company from scratch in a foreign country when you can acquire a cash-generating entity that already exists and use it as a platform for your own company’s growth in that country? • Examples: • An example could be a merger between Habyt, the biggest European co- living company, and Hmlet, the biggest Asia Pacific player in communal living. After this merge Habyt became the largest co-living player worldwide. • Arguably the most successful example of this has been the Spanish bank Santander, which has acquired banking chains in 9 countries outside of Spain to become one of the world’s largest retail banking institutions.
- 21. • Motive 6: Vertical Integration • Vertical integration involves a company acquiring different parts of the value chain; typically, this begins with a company that has grown to a certain size buying its own distribution so that it doesn’t need to hire third-party distribution.
- 22. • Motive 7: Cross-selling • Cross-selling can be a powerful way to deliver revenue synergies: The idea that two companies have more to offer their customers by being together. • Examples: • One recent example of a cross-selling deal is provided by Starbucks’ acquisition of Teavana for $750 million in 2017. • What could be more synergistic for revenues than selling tea and coffee together? Now, you can get tea at Starbucks and coffee at Teavana. Everyone’s a winner.
- 23. • Motive 8: Taxation • Perhaps unsurprisingly, tax is one area where companies are loath to admit that they’ve undertaken M&A to avoid taxes (note: avoid, not evade). • It doesn’t play well with consumers knowing that a company is openly avoiding taxes but be assured: this is one of the most common motives for M&A. • But also one of the least mentioned as the explicit motive. The idea is that a cash flow-positive company acquires a firm with carry forward tax losses to reduce its own tax burden.
- 24. • Motive 9: The Financial Motive • Until now, the motives have been largely strategic in nature. • But what about when a company is being bought essentially for its stream of cash flows? • This is usually the case when a private equity firm is involved in an acquisition. US investment bank William Blair used DealRoom when it was advising the management of TaskUs Inc. on a sale to private equity giant, Blackstone. Blackstone acquired TaskUs Inc. for a fee in excess of $500 million.
- 25. • Motive 10: Opportunism • Companies aren’t always looking for an acquisition when one lands on their doorstep. • “Opportunistic” is a word that CEOs are keen to play up as it suggests that the transaction is a sort of ‘once-in-a- lifetime deal.’ • Really what’s at play in an opportunistic deal is buying a company below its intrinsic value. JP Morgan’s 2008 ‘fire sale’ deal for BearStearns, which it acquired at a supposedly knockdown price, is an example of a deal that found a company rather than the other way around.
- 26. Theories of Mergers • (1)Efficiency Theories: • Differential Managerial Efficiency/managerial synergy: Higher efficient firms will acquire lower efficient firms and realize gains by improving their efficiency. • It would be most likely to be a factor in mergers between firms related industries where the need for improvement could be more easily identified.
- 27. • Inefficient Management Theory: The target companies management is so inefficient that virtually any management could do better, and hence could be an explanation for mergers between firms in unrelated industries. • This theory's main limitation is its implication, agency costs are so high that shareholders have no way to discipline managers, sort of costly merger.
- 28. • Pure diversification Theory: Pure diversification as a theory of mergers differs from shareholder portfolio diversification. • Shareholders may efficiently spread their investment and risk amongst industries, so there does not exist any need for firms to diversify for the sake of their shareholders. • Managers and other employees, however, are at greater risk if the only industry in which their firm operates should fail their firm specific human capital is not transferable. • Therefore, firms /may not diversify to encourage firm specific human capital investments which makes their employees more valuable and productive, and to increase the probability that the organization and reputation capital of the firm will be preserved by transfer to another line of business owned by the firm in the event its initial industry declines
- 29. • Operating Synergy Theory: Economies of scale or of scope and those mergers help achieve levels of activities at which they can be obtained. • It includes the notion of complementary of capabilities. For example, one firm might be strong in R&D but weak in marketing while another has a strong marketing department without the R&D capability. • Merging the two firms would result in operating synergy.
- 30. • Financial Synergy Theory: Hypothesis complements between merging firms, not in terms of management capabilities, but in the terms of availability of investment possibility in internal cash flow. • Most of firms in a declining industry will produce large cash flows since there are very few attractive investment possibilities whereas a growth industry has more investment opportunities than cash. • The merged firm will have a lower cost of capital because of the lower cost of internal funds as well as possible risk reduction including savings in flotation costs, and improvements in capital allocation.
- 31. • Theory of Strategic Alignment to changing environment: External acquisitions of needed capabilities by a firm, allow such firms to adapt more quickly and with less risk than developing capabilities internally.
- 32. • Undervaluation Theory: Mergers occur when the market value of target firm stock for some reason does not reflect it true of potential value. • Firms acquire assets for expansion more cheaply by buying the stock of existing firms than by buying or building the assets when the target's stock price is below the replacement cost of its assets.
- 33. (2)Information and Signaling Theory • The information or signaling theory attempts and explains why target shares seem to be permanently revalued upward in a tender offer irrespective of it being successful or unsuccessful. • The hypothesis says that the tender offer sends a signal to the market that the target shares are undervalued, or alternatively, the offer signals information to target management, which inspires them to implement a more efficient strategy on their own. • Another school holds that the revaluation is not really permanent, but only reflects the likelihood that another acquirer will materialize for a synergistic combination. • Other aspects of takeovers may also be interpreted as signals value, including the means of payment and target management's response to the offer.
- 34. • (3) Agency Theory: • (i) Agency Problem: Agency problems may result from a dissent of interest between managers and shareholders or between shareholders and debt holders. • A number of organization and market mechanisms serve to discipline self serving managers, and takeovers are viewed as the discipline of last resort. • (ii) Managerialism: On the other hand managerialism, views, takeovers as demonstration of the agency problem rather than its solution. It suggests that self-serving managers make ill-conceived combinations solely to increase firm size and their own compensation. • (iii) Hubris Theory: The hubris theory is another variant on the agency's cost theory; it implies that an acquiring firm managers commit errors of over optimism (winner's curse) in bidding for targets.
- 35. • (iv) H.Jensen's Free Cash Flow Theory: Generally takeovers take place because of the existing conflicts between managers and shareholders over the payout of free cash flows. • The hypothesis points that free cash flows (that is, in excess of investment needs) should be paid out to shareholders, reducing the power of management and subjecting managers to the scrutiny of the public capital markets in less intervals. • Debts for stock exchange offers are viewed as a means of bonding the mangers. Promise to pay out future cash flows to shareholders.
- 36. • (5)Market Power Theory: Market power advocates claim that merger gains are the result of rapid increasing concentration leading to collusion and monopoly effects. • Empirical evidence on whether industry concentration causes reduced competition is not conclusive. • There is much evidence that concentration is the result of vigorous and continuing competition which causes the composition of the leading firms to change over time.
- 37. • (6)Tax Effects Theory: Tax effects theory do not play a major role in explaining M&A activity overall. • Carryover of net operating losses and tax credits, stepped up asset basis, and the substation of capital gains for ordinary income (less important after the Tax Reform Act of 1986) are among the tax motivations for mergers. • Emerging inheritance taxes may also motivate the sale of privately held firms with aging owners. • A final theory of the value increases to shareholders in takeovers is that the gains come at the expense of other stakeholders in the firm. • Expropriated stakeholders under the redistribution hypotheses may include bondholders, the government (in the case of tax savings), and organized labour.
- 38. Mergers and Industry Life Cycle • (1) Introduction Phase • The introduction, or startup, phase involves the development and early marketing of a new product or service. Innovators often create new businesses to enable the production and proliferation of the new offering. • Information about the products and industry participants is often limited, so demand tends to be unclear. During this stage, consumers of the goods and services need to learn more about them, while the new providers are still developing and honing the offering.
- 39. • (2) Growth Phase • In this second phase, consumers have come to understand the value of the new offering, business, or industry. Demand grows rapidly. • A handful of important players usually becomes apparent, and they compete to establish a share of the new market. Immediate profits usually are not a top priority as companies spend on research and development or marketing.
- 40. • (3) Maturity Phase • The maturity phase begins with a shakeout period, during which sales growth slows, focus shifts toward expense reduction, and consolidation occurs (as companies begin to merge or acquire each other). • Some firms attain economies of scale, hampering the sustainability of smaller competitors. Growth can continue. • As maturity is achieved, barriers to entry become higher, and the competitive landscape becomes more clear. Market share, cash flow, and profitability become the primary goals of the remaining companies now that growth is relatively less important. • Price competition becomes much more relevant as product differentiation declines with consolidation.
- 41. • (4) Decline Phase • The decline phase marks the end of an industry's or business' ability to support growth. Obsolescence and evolving end markets (end users) negatively impact demand, leading to declining revenues. This creates margin pressure, forcing weaker competitors out of the industry. • Further consolidation is common as participants seek synergies and further gains from scale. The decline phase often signals the end of viability for the incumbent business model, pushing industry participants into adjacent markets. • As with the maturity phase, the decline phase can be delayed with large-scale product improvements or repurposing. However, these tend simply to prolong the decline and ultimate market exit.
- 42. Reasons for failure of M&A • 1. Unclear goals and timelines • According to a survey conducted by Statista in 2021, most respondents indicate that a clear M&A strategy is the most important factor for achieving a successful M&A in the U.S. • Thus, lack of proper strategic planning is the most common reason why most mergers and acquisitions fail. • Sometimes, companies rush an M&A deal when there’s an opportunity to acquire a competitor or to gain a bigger market share. However, rushing often results in unrealistic expectations and, thus, a failed transaction. Before entering into a transaction, both companies should clearly understand the acquisition objectives and assess the potential synergies it can bring.
- 43. • 2. Poor due diligence • Sloppy or careless due diligence processes is another common reason why the majority of mergers and acquisitions fail. • According to Bain’s 2020 Global Corporate M&A Report, more than 60% of executives indicate that poor due diligence is the main reason for deal failure. • Due diligence is an integral part of the M&A process that allows an acquiring company to investigate the documentation, legal aspects, and internal processes of the to-be-acquired company to help avoid surprises. On the other hand, due diligence is also a great chance for target companies to ensure they’re fully prepared for the acquisition.
- 44. • 3. Overpaying • The McKinsey & Company analysis of about 2,500 deals conducted between 2013 and 2018 showed that the larger the transaction, the more likely it is to fail. • Often, companies become too focused on the potential benefits a deal may bring and overlook its real value. This often results in a failed transaction and financial loss.
- 45. • 4. Lack of proper communication • This relates to poor communication both between the two companies engaging in the deal and between the senior management and key team members. • Communication breakdowns between the sell- and buy- side lead to different visions of the deal objectives. Additionally, poorly communicated deal objectives by the senior executives leaves key team members confused and might lead to misunderstanding of the combined company’s goals. This, in turn, results in executing the wrong goals.
- 46. • 5. Cultural clashes • When two companies have completely different cultures, it might be difficult to gain a cultural fit during post-merger integration. • 6. Operational difficulties • Just like with culture, the operational styles of two companies entering a transaction also matter. • When two companies have different approaches to operations, it can lead to operational inefficiencies and M&A challenges.
- 47. • 7. Lack of management involvement • Often, company senior managers and leadership teams choose to let professional advisors oversee the transaction and address the deal issues. • However, management involvement helps a company to close a deal successfully. This is because company owners and senior managers have a better understanding of the deal objectives and, thus, build an atmosphere of trust throughout the company teams actively engaged in the integration process.
- 48. • 8. Regulatory issues • McKinsey & Company research shows that out of 345 large M&A deals announced between 2013 and 2020, 47 of them (14%) were canceled because of antitrust or regulatory reasons. As of 2023, there were 3 merger complaints filed due to the antitrust laws so far, according to Bloomberg. • These are the external factors that greatly impact a deal’s success. However, thorough due diligence and prior analysis help to avoid regulatory difficulties.
- 49. • 9. Poor post-merger integration • After a deal’s closure, the integration process begins. Often, companies underestimate the importance of post-merger integration, which results in poor post- acquisition management and poor execution of the deal’s objectives. • Instead, an acquiring firm and a target company should have a clear integration plan, which specifies how the companies’ workforce, projects, products, and internal processes will be distributed and shared.
- 50. • 10. High recovery costs • The complexity of the post-merger integration process typically leads to high recovery costs, which are sometimes beyond the companies’ capacity. As a result, the deal fails. • When assessing the transaction and building a strategy, companies should take into account the post-merger integration period and the costs it might incur. This is because a newly formed company might need to invest in new processes or systems. Additionally, there might also be layoffs that could lead to higher costs.
- 51. • 10. High recovery costs • The complexity of the post-merger integration process typically leads to high recovery costs, which are sometimes beyond the companies’ capacity. As a result, the deal fails. • When assessing the transaction and building a strategy, companies should take into account the post-merger integration period and the costs it might incur. This is because a newly formed company might need to invest in new processes or systems. Additionally, there might also be layoffs that could lead to higher costs.
- 52. • 11. Synergy overestimation • Overestimated synergies go together with overpaying and are what leads to the latter. • Often, companies become too focused on the potential synergies a deal can bring without proper analysis and, thus, might not notice certain issues a target company lacks. This results in overpaying and possible deal failure.
- 53. Synergy • Synergy is a concept that the combined value and performance of two companies after their integration will increase compared to the sum of the separate entities. • By achieving synergies, merged firms can profit by realizing results such as increased revenue and market share, a reduced tax burden, or combined technology.
- 54. Types of Synergies • (1) Operating /Business Synergies • Economies of scale • Economies of scope • Multi-plant economies • (2) Financial Synergies • Reduced cost of capital procurement • Higher market valuation
- 55. • (3) Managerial Synergies • (4) Market Synergies • Market power synergies • Market expansion synergies
- 56. Value creation in M&A • Strategic Alignment: At the heart of value creation in M&A lies strategic alignment between the acquiring and target companies. Whether it's expanding into new markets, diversifying product offerings, or enhancing operational efficiency, strategic alignment forms the foundation for value creation.
- 57. • Synergy Realization: Synergies represent the additional value that can be unlocked through M&A by combining resources, reducing costs, and leveraging economies of scale. Identifying and realizing synergies is a critical component of value creation, encompassing areas such as revenue enhancement, cost savings, and operational efficiencies.
- 58. • Cultural Integration: Cultural integration plays a pivotal role in M&A success, yet it is often overlooked. Merging organizations with divergent cultures can lead to friction, resistance, and ultimately, value destruction. Effective cultural integration involves fostering open communication, building trust, and aligning values and behaviors across the organization.
- 59. • Talent Management: People are the lifeblood of any organization, and talent management is a key driver of value creation in M&A. • Retaining top talent, nurturing leadership pipelines, and aligning employee incentives are essential for maintaining productivity and morale during periods of transition.
- 60. • Customer Focus: A customer-centric approach is paramount in value creation through M&A. Understanding and anticipating customer needs, preferences, and behaviors is essential for delivering superior products, services, and experiences.
- 61. • Risk Management: M&A transactions inherently involve risks, ranging from integration challenges to market volatility and regulatory hurdles. Effective risk management is crucial for safeguarding value and minimizing potential downside impacts.
- 62. • Post-Merger Integration: The success of an M&A transaction hinges on effective post-merger integration (PMI). • PMI involves aligning systems, processes, and structures to ensure seamless operations and maximize synergies. • From IT integration to organizational restructuring and change management, a well-executed PMI strategy is instrumental in realizing the anticipated value of the transaction. • Timely communication, strong leadership, and a clear roadmap are key enablers of successful PMI.