MF0011 Mergers and Acquisitions

Q1. Write the types of mergers and acquisitions. Explain the steps to a successful merger. Ans. There are 5 types of Mergers and Acquisitions. 1. Horizontal: It is a merger of two competing firms engaged in the production of similar products or providing similar services. The acquiring firm belongs to the same industry as the target company. The main purpose of such mergers is to obtain economies of scale in production by eliminating duplication of facilities, widening the product line, reduction in investment, elimination of competition in product market, increase of market share, reduction in advertising costs etc. 2. Concentric: This is a variation of horizontal mergers. It is a combination of two firms that are not in the same industry but operate in related industrial segments. For instance a company with a chain of restaurants may acquire a hotel company. The major difference here is that the merging companies are not competitors. 3. Vertical: When two or more companies, involved in different stages of activities like production or distribution, combine with each other the combination is called a vertical merger. An example can be the combination of a car manufacturing company and piston (that is generally bought and used by the car manufacturing company) manufacturing company. The acquiring company attempts to reduce inventories of raw material and finished goods, implements its production plans as per the objectives and economises on working capital requirements. There are two types of vertical combinations. a) Forward Integration: In this kind of vertical combination a manufacturer combines with its customer. For example, TV manufacturer merges with TV marketing company. b) Backward Integration: In this kind of vertical combination a manufacturer combines with the supplier of input material. For example, the combination of a car manufacturing company with a piston manufacturing firm.

4. Circular combination: Companies engaged in the production of different products seek combination to share common marketing, distribution or research facilities in order to generate economies. The acquiring company obtains benefits of resources sharing. Another major advantage is achievement of diversification. A variation of circular combination is managerial conglomerates, which denote combination of general managerial talent of two different companies across all functions.

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5. Conglomerate: This is the combination of companies engaged in unrelated businesses. The basic purpose of such a combination is lowering of cost of capital, optimum utilisation of financial resources and enlarging debt capacity. Conglomerates are used to smooth out fluctuations in the earnings of different businesses. The idea is to diversify and minimise the overall risk. A typical example would be the merging of a cement company, an electronics company, a finance company and a garment manufacturing company. A real life example is Voltas Ltd. Steps to a Successful Merger Mergers need careful planning to achieve financial goals, reduce problems and for profitmaking. Drop in productivity is expected to be around 50% as people from different workplaces have differences of opinion. Even a successful merger can take three months to three years for the completion of recovery process in an organisation. For employees, possibility of changes and uncertainty at workplace can create stress. This affects judgments, perceptions, and interpersonal relationships. Often reduced communication and increased centralisation as part of re-structuring in companies creates space for rumours and insecurity in employees. During these times, employees do not have much access to senior level managers. Active intervention is necessary to maintain the level of productivity and to assure employees. Some suggestions for a smoother restructuring and transition are: Circulate a consistent message in the combining entities from top down. Maintain consistent accountability and compensation throughout the company for similar positions. Find out new ways of structuring the company to bridge corporate culture differences. Establish gaugeable objectives, especially in areas, which will be working together for a common goal. Revamp the compensation plan to recognise the additional work required by transition. Plan different ways for people to get to know each other.

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Q2.Explain the process of merger. Write down the goals of a merger. Ans. Process of Merger The merger process comprises all or most of the following activities: decision to buy/sell (both buyer and seller) funding (buyer) identification of potential and actual target (both) valuation (both) preparation of Offer/Memorandum (seller) due diligence (both) bidding (both) negotiation (both) paperwork (both) integration (buyer) post-sale restructuring (seller)

The Goals Of A Merger 1. 2. 3. 4. 5. acquire domain expertise and technology acquire market share and brand name acquire technology, products or intellectual property or some such assets acquire a geographical presence diversify into different businesses for a balanced portfolio and less concentration in a single industry or market segment 6. reduce competition by acquiring competitors businesses 7. create a dominant position by sheer size, and thereby reduce overheads and improve profits 8. achieve growth of revenue, profit and assets 9. create synergy between different business domains 10. enhance security of sales and supply

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Q3. What is creating synergy? Explain the prerequisites for the creation of synergy. Ans. Creating Synergy The creation of synergy is not automatic. Synergy requires a great deal of work on the part of managers at the corporate and business levels. Creation of synergy does not require only the material resources of the two companies. It demands effective integration of the combined units human resource, physical assets and operations. The activities that create synergy include combining similar processes, coordinating business units sharing common resources, and resolving conflicts among business units. Managers often underestimate the magnitude of problems that arise in integration efforts, resulting in a situation where creation of synergy becomes very difficult.

Prerequisites for the creation of synergy 1. Strategic compatibility: Strategic compatibility refers to the matching of organisations strategic capabilities. There are various ways in which capabilities can be matched through a merger. Thus, when combined firms or business organisations are both strong and/or weak in the same business activities, the newly created combined firm displays the same capabilities (or lack of capabilities), although the magnitude of the strength or weakness is greater, and no synergy results. 2. Organisational compatibility: Organisational organisations have similar management processes, Organisational compatibility from an operational point processes that are developed and used to combine the about desired results effectively and efficiently. compatibility occurs when two cultures, systems and structures. of view suggests that the integration operations can be expected to bring

3. Managerial actions: The third building block for the creation of synergy is related to the actions and initiatives that managers take for their firms to actually realise the competitive benefits. Creation of synergy requires active involvement and participation of the management. Managers must recognise the importance and magnitude of integration issues and the need to involve human resources in implementing a combination. 4. Value creation: Value creation is the fourth synergy creation building block. The focus here is on deriving benefits from synergy in excess of the costs to be incurred. The costs associated with the following have to be controlled: (a) Financing of the transaction (b) Premium paid for purchase.

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Q4. Give the meaning of Divesture. List and explain the reasons for divesture. Ans. Meaning Of Divesture A transaction through which a firm sells a portion of its assets, a product line, a subsidiary or a division to another company for cash or securities is called divesture. Divestiture is a form of contraction. Mergers, asset purchases and takeovers lead to expansion and are based on the principle of synergy which says 2 + 2 = 5. Divesture on the other hand is based on the principle of reverse synergy which says 5 3 = 3!

Reasons for divesture Divestures show that the companies make continuous efforts to adjust to the changing economic, political and legal environment. The reasons and rationale for divesture are: Poor fit The parent company may want to move out of a particular line of business which it feels no longer fits into its plans or in which it is unable to operate profitably. The buying firm, with greater expertise in the line of business, will presumably manage the division's assets more profitably. Sometimes divestiture follows acquisition: the company that is acquired may have divisions that do not fit the acquirers business plans and strategies. For example: Sale of IBM product centres to Nynex: In 1986 IBM sold 81 IBM Product Centres, its retailing operations in US, to Nynex, one of the regional telephone companies created in the AT&T court-directed divesture. In 1988 IBM sold most of its US copier business to Eastman Kodak. Reverse synergy One motivational factor associated with mergers and acquisitions is synergy. Synergy refers to the additional gains that may be derived when two firms combine. Reverse synergy means that the parts are worth more separately than they are within the parent company's corporate structure; in other words, 4 1 = 5. In such cases, an outside bidder considers paying more for a division than what the division is worth to the parent company. Cash flow effect Cash inflow is often an immediate benefit of a sell-off. Companies that are under financial distress are often forced to sell valuable assets to enhance cash flows. Facing the threat of bankruptcy in the early 1980s, Chrysler Corporation was forced to sell off its coveted tank division in an effort to ward off bankruptcy. International Harvester sold its profitable Solar Turbines International Division to Caterpillar Tractor Company to realise immediate proceeds of $505 million. These funds were used to cut Harvester's short-term debt in half.
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Abandoning the core business The selling of a core business is often motivated by management's desire to leave an area that it believes has matured and presents few growth opportunities. This is a rare phenomenon though, at best the last resort. An example of the sale of a core business was by Greyhound which sold its business in 1987. The firm in such a case usually diversifies into other more profitable areas, and the sale of the core business helps finance the diversification. Reaping the benefits of past successes Some divestitures take place to benefit from past successful acquisitions. They are often encouraged by favourable market conditions. The purpose of such divestitures is ensuring the availability of financial and managerial resources for using other opportunities. Such divestitures denote successes rather than failures (or mistakes). Hanson PLC is said to make a business of this activity. Other examples are sale of hotel by Hilton and Marriott. Financing prior acquisitions Major acquisitions are also followed by a number of divestitures for financing reason. Campeau Corp., which acquired Allied Stores in 1986, declared that 16 Allied divisions will be sold out to pay down bank debt. Similarly, after its $6.5 billion acquisition of Federated Department Stores, Campeau engaged in the activity of divestitures beginning in late 1988. Discouraging takeovers Many a time, divestitures function as takeover defence by removing the crown jewel that causes a takeover threat. For example the Brunswick Corp. selling off its medical division in 1982 to American Home Products this was done as Brunswick faced a takeover threat from Whittaker. The earning of Brunswick from the sale of the division was $100 million more than what Whittaker had offered for the entire company. In a similar situation, when Whittaker faced a threat of being taken over in 1989, it sold its chemical and technology operations. Meeting regulatory norms Divestitures often occur in order to comply with government rules and norms. These are called involuntary divestitures. In USA Santa Fe had merged with Southern Pacific Railway Systems (Southern) in 1983. The combined railway was operated together while awaiting an antitrust analysis and ruling from the ICC (Interstate Commerce Commission) which had antitrust jurisdiction for such kinds of merger.

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Q5. Explain the key rules of Employee Stock Ownership Plans. Discuss the two types of ESOPs. Ans. The key rules of ESOPs are as follows: 1. Vesting: Before an employee acquires entitlement to ESOP, he must work for a certain period, which is referred to as the vesting period. If an employee leaves before vesting, he loses the right. An ESOP must comply with minimum schedules for vesting, called as cliff vesting or graded vesting. 2. Distributions after termination: Distribution of vested benefits with retirement, disability or death, takes places during the following plan year. 3. Distribution during employment: Cash or stock can be received directly by employees by diversifying their accounts. Dividends may be paid by the employer to a participant who is at least a 5% owner beyond the age of 70, although still working in the company. 4. Put Option: A put option is offered by some companies, for company stock bought via the ESOP benefits plan. In this option, the employee can sell their company stock back to the employer within 60 days after distribution and within 60 days during the following plan year. 5. Taxation: No tax is required to be paid by the employees on stock until they receive distributions. Payments are subject to applicable taxes, and an additional 10% excise tax will be levied. Dividends that have to be paid directly to participants on stock are taxable. Types of ESOPs 1. Non-leveraged ESOPs: A non-leveraged ESOP is a stock bonus plan, identified as an ESOP in the plan document that invests primarily in company stock and meets certain legal requirements. The sponsoring employer contributes newly issued or treasury stock and/or cash to buy stock from existing owners. Contributions generally may equal 15% of the covered payroll (which usually is the combined payroll of all employees eligible for participation) or, if the ESOP includes a money purchase pension plan in which the employer commits to contribute a set percentage of covered payroll per year in cash or stock, 15% plus the money purchase pension plan contribution percentage (from 1% to 10%) up to a maximum of 25% of covered payroll. 2. Leveraged ESOPs: A leveraged ESOP borrows money on the credit of the employer or other related parties to buy company stock. It is only a qualified employee benefit plan that can do this. The loan can be towards the ESOP itself or to the employer who then lends the money to the ESOP (lenders generally prefer the latter). The loan from the company to the ESOP does not have to be on the same terms, provided its terms are the equivalent of an arm's length transaction.

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Q6. Explain the following with examples : Exchange rate, External advantages in different products, Role of government policies Ans. Exchange rates Foreign exchange rates affect international mergers in a number of ways. The advantages and disadvantages of the domestic versus foreign currency can affect a companys economic factors such as the cost of the acquisition, the financing, expenses of running the firm and the repatriated profits value to the parent. Currency translation profits and losses in financial reporting can occur due to accounting conventions Example The acquisitions by Union Pacific Resources and the CIT Group (both US companies) of Canadian firms were facilitated by the decline in the value of the Canadian dollar in 1998 and 1999. External advantages in differential products A strong correlation exists between globalising and product differentiation. A company that has earned the reputation for producing better-quality goods in the domestic market will possibly find acceptance for the products in foreign markets. Example In the 1920s (the early days of the US automobile industry) cars were exported to Europe in large numbers. This was before the auto industry was developed in European countries. The advantage of the US mass production facilities and knowhow made American cars cheaper despite the high foreign tariffs and this motivated foreign direct investments. Role of government policies Government policies, regulations, tariffs and quotas can affect international mergers and acquisitions in a number of ways. Exports are particularly vulnerable to tariffs and quotas erected to protect domestic industries. Even the threat of such restrictions can encourage international mergers, especially when the market to be protected is large. Japan's huge export surplus, which led to voluntary export restrictions coupled with threats of more binding restrictions, was a major factor in increased direct investment by Japan in the United States. Example The Deutsche Telekom acquisition of One2One is an example of the many influences of government policy. Deutsche Telekom had been a monopoly protected by the German government. German deregulation created competition from international and German firms.

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