From the desk of Adeel Durvesh

LECTURE 11

FINANCIAL REORGANIZATIONMERGERS & ACQUISITIONS

MERGERS & ACQUISITIONS

Mergers and acquisitions occur when two or more organizations join together all or part of their operations. The difference between them relate mainly to:

--The relative size of individual companies in the business combination

--Ownership of the combined business

--Management control of the combined business

MERGERS

In its broad definition, a merger can refer to any takeover of one company by another, when the businesses of each company are brought together as one

In narrow terms merger exists when:--Neither party is portrayed as the acquirer or the acquired

--Both parties participate in establishing the management structure of the combined business

--Both companies are sufficiently similar in size that one does not dominate the other when combined

--All or most of the consideration involves a share swap rather than a cash payment, etc.

Example

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MERGERS

ACQUISITIONS

An acquisition or takeover, occurs when one company acquires from another company either--A controlling interest in the company’s stocks, or--A business operation and its assets

An acquisition is the straightforward purchase of a “target” company

Example

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EVOLUTION OF MERGERS AND ACQUISITIONS

• First Merger Movement (1893 to 1904)Horizontal mergers took place in steel, oil, telephone and tobacco

• Second Merger Movement (1920s)Vertical mergers associated with the development of the radio and the automobile. It enabled manufacturers to control distribution channels more effectively

• Third Merger Movement (1960s)Most of the companies were aerospace or natural resources. Also food industries diversified drastically which moved away them from their core competencies

• Fourth Merger Movement (1980s)Any company that was not performing up to its potential could be taken over

• Fifth Merger Movement (1993 onwards) It has been characterized by strategic megamergers

TOP 10 MERGERSRank

Acquirer Acquired Announcement Date

Amount ($ Billion)

Industry

1 AOL Time Warner Jan 2000 165.9 Internet/media

2 Exxon Mobil Dec1998 78.9 Oil

3 Travelers Group Citicorp Apr 1998 72.6 Financial Services

4 SBC Comm. Ameritech May 1998 62.6 Telecommunications

5 Nations Bank Bank America Apr 1998 61.6 Financial Services

6 Vodafone Group Air Touch Comm. Jan 1999 60.3 Telecommunications

7 AT&T MediaOne Group Apr 1999 56.0 Telecommunications

8 AT&T Telecommunication Jun 1998 53.6 Telecommunications

9 Total Fina Elf Acquitaine Jul 1999 53.5 Oil

10 Bell Atlantic GTE Jul 1998 53.4 Telecommunications

STRATEGIES FOR GROWTH

BY MERGERS & ACQUISITIONS A M&A strategy for growth can seek to develop products and markets in any of four ways:

--By market penetration, including cross-border acquisitions

--By horizontal diversification

--By vertical integration

--By conglomerate diversification

By Market Penetration, including cross-border acquisitions

Market penetration means developing new and larger markets for a company’s existing products

Pursued within markets that are becoming more international or global esp cross-border M&A

Example

Quebecor Printing, Canada’s largest printer, acquired printing businesses in France and the UK in the mid-1990s, as part of a pan-European expansion strategy

Horizontal DiversificationMergers that take place between two firms in the same line of business are known as horizontal mergers

The company expects to use its existing resources including distribution channels, marketing skills or management skills etc., to improve the performance of acquired companies

Example

A tobacco company might take over a food producer and use common distribution channels such as the acquisition of Kraft and General Foods by Philip Morris, the tobacco company

Vertical IntegrationVertical integration is the combination of a company’s business with the business of a supplier or a customer. There are two types of vertical integration i.e. backward integration and forward integration

Example--A gas supply company might takeover or merge with its own supplier, a gas exploration and development company

--A holiday tour operator might acquire a chain of travel agents

Conglomerate DiversificationConglomerates are the group of companies

that operate in widely diverse industries

Low investment risk for shareholders

Example

In 1980’s Kmart acquired Furr’s Cafetarias, Bishop’s Restaurant, Walden Book Company, Payless Drug Stores Northwest, Makro Wholesale Club, etc..

Develop shared vision and objectivesBuild business and personal relationships

Due diligenceRegulatory clearancePrice and terms

New appointmentsRedundancy announcementsRestructuring Divestment

Fine tuningFurther restructuringJob transfersCultural integration

COURTSHIP EVALUATION/NEGOTIATION

IMMEDIATE TRANSITION

TRANSITION

Pre-merger Post-merger

Identify new leadershipDesign integration and processNext management tier and key employees

Detailed integration planBusiness as usual

STAGES OF MERGER

AVERAGE TIMELINE

4 months 4 months – 1 year 3 – 6 months 6 months – 2 years

MOTIVES OF MERGERS AND ACQUISITIONS

Michael Porter said:“There is a tremendous allure to mergers and

acquisitions. It’s the big play, the dramatic gesture. With the stroke of a pen, you can add

billions to size, get a front page story and create excitement in the market”

Economies of ScaleWhen two or more companies combine, the larger volume of operations of the merged entity results in various economies of scale such as better utilization of combined production capacities, distribution channels, R&D facilities, etc.

MOTIVES OF MERGERS AND ACQUISITIONS Synergy

If company A merges with company B the value of merged entity called AB is expected to be greater than sum of the independent values of A and B V (AB) > V (A) + V (B)Where:V (AB) = Value of the merged entityV (A) = Independent value of Company AV (B) = Independent value of Company B

--Sales synergy: Common distribution channels, sales administration, advertising sales promotion and warehousing

--Operating synergy: Better utilization of facilities and personnel, and bulk-order purchasing to reduce material cost.

--Investment synergy: Joint use of plant and equipment, joint search and development efforts, and having common raw materials inventories

--Management synergy: Top management of one of the companies uses their relevant experience and skills to resolve the problems of the other company

MOTIVES OF MERGERS AND ACQUISITIONS

Growth and Diversification

Tax Benefit

Globalization

Avoid unhealthy competition

Higher Debt Capacity

VALUATION AND PRICINGCompanies typically use three methods to value

a company:MARKET MULTIPLE ANALYSIS--Market value of stocks of comparable, publicly traded companies in an industry as a multiple of such companies' earnings and revenues. Those values are then adjusted to account for the size, liquidity and performance differences between target company and those companies.

Difficulty with this analysis is in selecting "comparable" companies and accurately adjusting target company’s value to reflect the differences between target company and such companies.

VALUATION AND PRICING

COMPARABLE TRANSACTIONS--Compare the amount paid in acquisitions for other companies in target company’s industry

DISCOUNTED CASH FLOWS --Determining target company's value by assigning a value in today's rupee to the cash flow to be generated by acquirer’s future operations.i.e. Present values of future cash flows

MAJOR CHALLENGES TO M&ASOME STATISTICS REGARDING M&As A Merger Management Consulting global

survey reveals that only 37% of deals made in the mid 1980s worth $500 million or more outperformed their industry average in shareholder values in the following three years. In 1990s this figure rose to 52%

Cambridge University’s Judge examined 77 large takeovers by British companies between 1990 and 1996. In the two years after the deal, shares in the acquiring companies under-performed by an average of 18%

MAJOR CHALLENGES TO M&A Consultancy’s KPMG 2001 global survey reports that

70% of the combinations studied failed to add value

Large deals are more likely to fail. The Mercer Management reveals that only one-quarter of deals valued more than 30% or more of the acquirer’s annual revenue succeeded in outperforming their industry average

Following are the challenges of M&As:Poor strategy--Strategic approach of M&As should be clear at first to have a positive result of the synergized entities

--When expected synergies do not occur, and the acquired company has a disappointing performance, the cost of the acquisition can be excessive which can damage the financial performance of the group

MAJOR CHALLENGES TO M&A Due Diligence

--The purpose of a due diligence exercise is to confirm or revise the assumptions on which the takeover has been based

CHECKLIST OF DUE DILIGENCEProfit forecasts and cash forecasts

The assumptions on which figures in the forecast are based

Prospects of synergy, economies from pooling resources after the takeover

Actual existence of major customer sales contracts

The existence and the condition of assets, their value and their legal ownership

MAJOR CHALLENGES TO M&AThe target company’s liabilities and potential liabilities

Confirmation that the target company is a going concern, and is operating normally

Confirmation that management and information systems are in place and continue to function properly

Investigation of any recent changes in the target company’s financial structure or cash holdings

Investigation into the current state of the target company’s research and development operations

Environmental audits

MAJOR CHALLENGES TO M&A Implementation

--The firm must have implemented all aspects of efficient operations before it can effectively combine organizations

--Companies should pursue only mergers that further their corporate strategy: strengthening weaknesses, filling gaps, developing new growth opportunities, and extending capabilities

--Poor communication distresses employees so the company should maintain ongoing communication that clearly addresses the concerns of employees

• Poor Performance

--Lack of concentration on the core business

--Watson Wyatt Study confirms the dip in the performance which revealed a drop of 50% in the surveyed companies’ productivity in the first five months of a merger or acquisition

MAJOR CHALLENGES TO M&A

• Resistance to change

--Merger studies reveal that employees need emotional support and practical skills in managing change

-- People can resist change by clinging to old behavior and work practices

--. At worst, employee resistance leads to people leaving the new business

MAJOR CHALLENGES TO M&A

• Cultural Incompatibility

--When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored

--A study of 319 European cross-border deals suggested a success rate of only 57%

MAJOR CHALLENGES TO M&A

DEMERGERS & DISINVESTMENTS• A disinvestment involves a company selling off

some of its businesses

• A demerger, by contrast, is the splitting of one company into two separate independent companies

Company A

Company A Company B

Demerger

Company A retains its stock market listing

New company stock market listing obtained for the shares. Shares issued wholly or mainly to shareholders of Company A

DEMERGERS & DISINVESTMENTS• A modern corporations reveals that 33% to

50% of acquisitions are later divested

• A successful business should grow with a set direction

• To concentrate on core business activities selling divisions has been a common feature of corporate strategy in recent years

Example Unilever has planned to limit their brands to 400 rather than 1600 due to the change of it’s mission statement

WHATS ALTERNATIVE?

OTHER ALTERNATIVE STRATEGIES TO GROWTH

Joint Ventures

Outsourcing

Alliances and Partnerships

Investments

Licensing

Franchising

CONCLUSION

BEFORE MERGER

Kitna maza aayega

Oh! Itna kuch……

PRE MERGER STAGE

Oye Yeh Kia ho gaya?

POST MERGER STAGE

UNSUCCESSFUL MERGER

Oye kidhar phus gaya?

HELP ME PLEASE…….

Kuch to de dete jao mujhe ….

DIVESTMENT