Define Merger and Acquisition

Mergers and acquisition is a strategy adopted by the large corporate sector to

consolidate its position and improve its competitive strength vis--vis competitors. It is,
in fact, the least costly method of industrial restructuring. In India, the Mergers and
acquisition activities got a boost after the announcement of the new economic policy
1991 with its focus on liberalization and opening up. The real momentum was gained
after 1994 when the new takeover code was formulated.
Takeovers and Acquisitions are used as synonyms. The meaning of takeover is
that one company acquires another companys total or controlling interest. Subsequent
to
acquisition, the acquired company operates as a part of the acquiring company. Thus,
the
separate identity of the acquired company is lost and it is absorbed within the
administrative framework of the acquiring company.
As against this, in the case of mergers, all combining firms relinquish their
individuality and independence to create a new firm. Thus, in case of merger, there is a
change in both firms and administrative structure of both changes. Mergers generally
occur between firms of smaller size and there is therefore a high degree of cooperation
and interaction between the partners. As against this, in acquisition, firms often tend to
be
of unequal size and the smaller firm is expected to surrender its independence
unilaterally
to the other.
Mergers and Acquisitions are transactions of great significance, not only to the
companies themselves but also to many other communities, such as workers,
managers,
competitors, communities and the economy because it a means by which two
companies
are combined to achieve certain strategies and business objectives. Their success or
failure has enormous consequences for shareholders and lenders and as well as the
constituencies mentioned above. Investments worth billions of dollars are made when a
company goes in for an acquisition.
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It is very crucial for the companies to make the right decision for a merger or an
acquisition because it is the shareholder who might suffer the most in terms of losing
their investments because of some important acquisition made by their companies. An
acquisition is often motivated by the need to bring in efficiency and savings in
production
and other activities.
The Main Idea
One plus one makes Three: This equation is the special alchemy of a merger or
acquisition. The key principle behind buying a company is to create shareholder value
over and above that of the sum of the two companies. Two companies together are
more
valuable than two separate companies--at least, that's the reasoning behind M&A.
This rationale is particularly alluring to companies when times are tough. Strong
companies will act to buy other companies to create a more competitive, cost-efficient
company. The companies will come together hoping to gain a greater market share or
achieve greater efficiency. Because of these potential benefits, target companies will
often agree to be purchased when they know they cannot survive alone.
What is a Merger?
A merger is a term given when companies come together to combine and share
their resources to achieve common objectives whereas an acquisition is when one firm
is
purchasing the assets or shares of another, and with the acquired firms shareholders
ceasing to be owners of that firm
In business or economics a merger is a combination of two companies into one
larger company. Such actions are commonly voluntary and involve stock swap or cash
payment to the target. Stock swap is often used as it allows the shareholders of the two
companies to share the risk involved in the deal. A merger can resemble a takeover but
result in a new company name (often combining the names of the original companies)
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and in new branding; in some cases, terming the combination a "merger" rather than an
acquisition is done purely for political or marketing reasons.
The key principle behind buying a company is to create shareholder value over
and above that of the sum of the two companies. Two companies together are more
valuable than two separate companies- at least, thats the reasoning behind Mergers
and
Acquisition.
Merger is also defined as amalgamation. Merger is the fusion of two or more
existing companies. All assets, liabilities and the stock of one company stand
transferred
to Transferee Company in consideration of payment in the form of:
Equity shares in the transferee company,
Debentures in the transferee company,
Cash, or
A mix of the above modes.
Amalgamation
The term mergers and amalgamation are used interchangeably as forms of seeking
external growth of business by an organization. A merger is a combination of two or
more firms in which only one firm would survive and other would cease to exist, its
assets/liabilities being taken over by the surviving firm. An amalgamation is an
agreement in which the assets/liabilities of two or more firms become vested in another
firm.
The merger/amalgamation of firms in india is governed by the provisions of the
companies act, 1956, it does not define the terms. The income tax act, 1961 stipulates
two
perquisites for any amalgamation through which the amalgamated company against its
future profits u/s 72-A.
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DEFINITION OF AMALGAMATION UNDER THE INCOME TAX ACT, 1961:
Section 2(1B) of the Income Tax Act, 1961 defines the term amalgamation as
follows:
amalgamation, in relation to companies, means the merger of one or more companies
with another company or the merger of two or more company (the company or
companies
which so merge being referred to as the amalgamating company or companies and the
company with which they merge or which is formed as a result of the merger, as the
amalgamated company) in such a manner that
(i) All the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company by virtue of the
amalgamation
(ii) All the liabilities of the amalgamating company or companies immediately before the
amalgamation become the liabilities of the amalgamated company by virtue of the
amalgamation;
(iii) Shareholders holding not less than 14(three-fourths) in value of the shares in the
amalgamating company or companies (there than shares already held therein
immediately
before the amalgamation by, or by a nominee for, the amalgamation by, or by a
nominee
for, the amalgamated company or its subsidiary) become shareholders of the
amalgamated company by virtue of the amalgamation, otherwise than as a result of the
acquisition of the property of one company by another company pursuant to the
purchase
of such property by the other company or as a result of the distribution of such property
to the other company after the winding up of the first-mentioned company.
It will be noticed that the definition uses the expression amalgamating company and
amalgamated company to refer to the expressions Transferor Company and
Transferee Company respectively. An important issue that arises in the case of
amalgamation is that of capital gains arising from the transfer of shares or any kind of
capital gains arising with respect to taxation of the capital gains. However the company
may also stand to lose in cases of amalgamation as mergers in the Indian context are
viewed as a tax planning measure. The deductibility has to be seen in the hands of the
transferee company.
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To constitute amalgamation under the Income Tax Act, there must be satisfied the
three
conditions specified clauses(i) , (ii) and (ii) of the definition.
Acquisition:
Acquisition in general sense is acquiring the ownership in the property. In the
context of business combinations, an acquisition is the purchase by one company of a
controlling interest in the share capital of another existing company.
Methods of Acquisition:
An acquisition may be affected by
(a) agreement with the persons holding majority interest in the company management
like members of the board or major shareholders commanding majority of voting
power;
(b) purchase of shares in open market;
(c) to make takeover offer to the general body of shareholders;
(d) purchase of new shares by private treaty;
(e) Acquisition of share capital through the following forms of considerations viz.
means of cash, issuance of loan capital, or insurance of share capital.
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TYPES OF ACQUISITIONS
The term acquisition means an attempt by one firm, called the acquiring firm, to
gain a majority interest in another firm, called target firm. The effort to control may be a
prelude
To a subsequent merger or
To establish a parent-subsidiary relationship or
To break-up the target firm, and dispose off its assets or
To take the target firm private by a small group of investors.
There are broadly two kinds of strategies that can be employed in corporate
acquisitions.
These include:
1. Friendly Takeover
The acquiring firm makes a financial proposal to the target firms management and
board.
This proposal might involve the merger of the two firms, the consolidation of two firms,
or the creation of parent/subsidiary relationship. In this takeover, the management of the
acquired and acquiring companies agrees mutually for the takeover.
2. Hostile Takeover
A hostile takeover may not follow a preliminary attempt at a friendly takeover. In this an
aggressive firm (known as a raider) tries to acquire a firm against the latters desire.
Hostile takeovers are generally linked with poor management and performance. If a firm
functions inefficiently resulting in its poor performance, its share price tumbles down.
The raider then buys out its shares at a low price and gains control over the
management
of this firm. The raider replaces the inefficient management by an efficient team of
managers. For example, it is not uncommon for an acquiring firm to embrace the target
firms management in what is colloquially called a bear hug.
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Pros and Cons of Takeover
Pros and cons of a takeover differ from case to case but still there are a few worth
mentioning.
Pros:
1. Increase in Sales / Revenues (e.g. Procter & Gamble takeover of Gillette)
2. Venture into new businesses and markets
3. Profitability of target company
4. Increase market share
Cons:
1. Reduced competition and choice for consumers in oligopoly markets
2. Likelihood of price increases and job cuts
3. Cultural integration/conflict with new management
4. Hidden liabilities of target entity.
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Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were
synonymous, the terms "merger" and "acquisition" mean slightly different things.
When a company takes over another one and clearly becomes the new owner, the
purchase is called an acquisition. From a legal point of view, the target company ceases
to exist and the buyer "swallows" the business, and stock of the buyer continues to be
traded.
In the pure sense of the term, a merger happens when two firms, often about the
same size, agree to go forward as a new single company rather than remain separately
owned and operated. This kind of action is more precisely referred to as a "merger of
equals." Both companies' stocks are surrendered, and new company stock is issued in
its
place. For example, both Daimler-Benz and Chrysler ceased to exist when the two
firms
merged, and a new company, DaimlerChrysler, was created.
In practice, however, actual mergers of equals don't happen very often. Often, one
company will buy another and, as part of the deal's terms, simply allow the acquired firm
to proclaim that the action is a merger of equals, even if it's technically an acquisition.
Being bought out often carries negative connotations. By using the term "merger,"
dealmakers and top managers try to make the takeover more palatable.
A purchase deal will also be called a merger when both CEOs agree that joining
together
in business is in the best interests of both their companies. But when the deal is
unfriendly--that is, when the target company does not want to be purchased--it is always
regarded as an acquisition. So, whether a purchase is considered a merger or an
acquisition really depends on whether the purchase is friendly or hostile and how it is
announced. 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.
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TYPES OF MERGERS
1. Horizontal Mergers
2. Vertical Mergers
3. Conglomerate Mergers
4. Circular Mergers
1. Horizontal Mergers
This type of merger involves two firms that operate and compete in a similar kind
of business. The merger is based on the assumption that it will provide economies of
scale from the larger combined unit. The objective here is to improve the competitive
strength in the market and increase the bargaining power in the industry.
Example: Glaxo Wellcome Plc. and SmithKline Beecham Plc. mega merger
The two British pharmaceutical heavyweights Glaxo Wellcome PLC and
SmithKline Beecham PLC early this year announced plans to merge resulting in the
largest drug manufacturing company globally. The merger created a company valued at
$182.4 billion and with a 7.3 per cent share of the global pharmaceutical market. The
merged company expected $1.6 billion in pretax cost savings after three years.
2. Vertical Mergers
Vertical mergers take place between firms in different stages of
production/operation, either as forward or backward integration. The basic reason is to
eliminate costs of searching for prices, contracting, payment collection and advertising
and may also reduce the cost of communicating and coordinating production. Both
production and inventory can be improved on account of efficient information flow
within the organization.
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Unlike horizontal mergers, which have no specific timing, vertical mergers take
place when both firms plan to integrate the production process and capitalize on the
demand for the product.
Example: Merger of Usha Martin and Usha Beltron
Usha Martin and Usha Beltron merged their businesses to enhance shareholder
value, through business synergies. The merger will also enable both the companies to
pool resources and streamline business and finance with operational efficiencies and
cost
reduction and also help in development of new products that require synergies.
3. Conglomerate Mergers
Conglomerate mergers are affected among firms that are in different or unrelated
business activity. Firms that plan to increase their product lines carry out these types of
mergers. Firms opting for conglomerate merger control a range of activities in various
industries that require different skills in the specific managerial functions of research,
applied engineering, production, marketing and so on. This type of diversification can be
achieved mainly by external acquisition and mergers and is not generally possible
through internal development. These types of mergers are also called concentric
mergers.
Firms operating in different geographic locations also proceed with these types of
mergers. Conglomerate mergers have been sub-divided into:
Financial Conglomerates
These conglomerates provide a flow of funds to every segment of their operations,
exercise control and are the ultimate financial risk takers. They not only assume
financial
responsibility and control but also play a chief role in operating decisions. They also:
Improve risk-return ratio
Reduce risk
Improve the quality of general and functional managerial performance
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Provide effective competitive process
Provide distinction between performance based on underlying potentials in the
product market area and results related to managerial performance.
Managerial Conglomerates
Managerial conglomerates provide managerial counsel and interaction on
decisions thereby, increasing potential for improving performance. When two firms of
unequal managerial competence combine, the performance of the combined firm will be
greater than the sum of equal parts that provide large economic benefits.
Concentric Companies
The primary difference between managerial conglomerate and concentric
company is its distinction between respective general and specific management
functions.
The merger is termed as concentric when there is a carry-over of specific management
functions or any complementarities in relative strengths between management
functions.
4. Circular mergers
Companies producing distinct products seek amalgamation to share common
distribution and research facilities to obtain economies by elimination of cost on
duplication and promoting market enlargement. The acquiring company obtains benefits
in the form of economies of resource sharing and diversification.
Reverse Merger
Process
In a reverse takeover, shareholders of the private company purchase control of the
public shell company and then merge it with the private company. The publicly
traded corporation is called a "shell" since all that exists of the original company
is its organizational structure. The private company shareholders receive a
substantial majority of the shares of the public company and control of its board
of directors. The transaction can be accomplished within weeks. If the shell is an
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SEC-registered company, the private company does not go through an expensive
and time-consuming review with state and federal regulators because this process
was completed beforehand with the public company.
The transaction involves the private and shell company exchanging information
on each other, negotiating the merger terms, and signing a share exchange
agreement. At the closing, the shell company issues a substantial majority of its
shares and board control to the shareholders of the private company. The private
company's shareholders pay for the shell company by contributing their shares in
the private company to the shell company that they now control. This share
exchange and change of control completes the reverse takeover, transforming the
formerly privately held company into a publicly held company.
Benefits
In addition, a reverse takeover is less susceptible to market conditions.
Conventional ipos are risky for companies to undertake because the deal relies on
market conditions, over which senior management has little control. If the market
is off, the underwriter may pull the offering. The market also does not need to
plunge wholesale. If a company in registration participates in an industry that's
making unfavorable headlines, investors may shy away from the deal. In a reverse
takeover, since the deal rests solely between those controlling the public and
private companies, market conditions have little bearing on the situation.
The process for a conventional IPO can last for a year or more. When a company
transitions from an entrepreneurial venture to a public company fit for outside
ownership, how time is spent by strategic managers can be beneficial or
detrimental. Time spent in meetings and drafting sessions related to an IPO can
have a disastrous effect on the growth upon which the offering is predicated, and
may even nullify it. In addition, during the many months it takes to put an IPO
together, market conditions can deteriorate, making the completion of an IPO
unfavorable. By contrast, a reverse takeover can be completed in as little as thirty
days.
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For a conventional IPO, it can cost as much as $200,000 just to release a
preliminary prospectus. A reverse merger, however, can be done for $95,000 to
$150,000.
Additionally, many shell companies carry forward what is known as a tax-loss.
This means that a loss incurred in previous years can be applied to income in
future years. This shelters future income from income taxes. Since most active
public companies become dormant public companies after a string of losses, or at
least one large one, it is more likely that a shell company will offer this tax
shelter.
It is highly unusual to preserve any benefit from the tax loss carry forward in a
shell company. The tax regulations normally reduce the loss carry forward by the
percentage of the change in control. In a well structured reverse merger, the
private company should end up with 95% or more of the stock after the merger,
thus reducing the tax loss carry-forward by this amount.
Drawbacks
Reverse Takeovers always come with some history, and some shareholders.
Sometimes this history can be bad, and manifest itself in the form of unseen
liabilities, sloppy records, lurking lawsuits (lying in wait for the company to gain
assets which to pursue), and other skeletons in the closet. Additionally, these
shells may sometimes come with angry or deceitful shareholders who are anxious
to "dump" their stock at the first chance they get. Possibly the biggest caveat is
that most CEO's are naive and inexperienced in the world of pubicly traded
companies, and are not playing with fire, but playing with atomic power. Due
dilligence and experienced advisors can overcome all of these drawbacks. RTO's
can be explosive vehicles for corporate growth, but they are not to be taken
lightly.
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