MERGERS AND ACQUISITION –

CHALLENGES AND PROSPECTS

Being

A Term Paper on Financial Management

By

OLUSANJO Stephen Gbenga

109021019

Submitted to

DEPARTMENT OF ACCOUNTING
SCHOOL OF POSTGRADUATE STUDIES
UNIVERSITY OF LAGOS

Lecturer in charge
DR. J.O. OTUSANYA

May, 2011

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ABSTRACTS

Merger and acquisitions (M&A) have been used as instruments for firm
growth for many years. Engaging in M&A represents an important
commitment for any company as it affects every facet of its organisation.
This is because mergers not only bring about two organizations together,
it also imposes multiple suppliers and contracts which are critical to
running those organizations; hence, the need to effectively evolve
strategies which reduce complexity associated with pre-merger, during
merger and post-merger processes so as to achieve quicker and greater
profitability.

Growing through mergers has both pros and cons. On one hand, it gives
access to a larger customer base, induces economies of scale and scope.
On the other hand it induces complexity, duplication of people, processes
and technology. There are various aspects which if not managed carefully
during a merger can become major pitfalls, for example, issues of
managing intellectual property, human resources encompassing cultural
diversity and perspectives, technology platforms, supply chain
management, product/service delivery channels, etc.

This term paper examines the challenges and prospects of merger and
acquisition decision through a methodological and synthesized review of
literature. In approaching the subject matter, key financial ratios were
computed to evaluate the prospects of post-acquisition business entity.
The resulting profitability and investors ratios corroborated existing
studies and researches which establishes that most merger and
acquisition fall below expectation i.e. expected shareholders value
addition and profitability increase.

Key Words: Merger and acquisition, post-acquisition integration, challenges and prospects

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 TABLE OF CONTENT
CONTENT PAGE
Title page i
Abstract ii
Table of content iii
1.0 Introduction 1
1.1 Problem and Purpose 1
2.0 Literature Review 3
2.1 Mergers and Acquisition Defined 3
2.2 Distinction Between Mergers and Acquisition 3
2.3 Types and Methods of Mergers and Acquisition 4
2.4 Motives for Mergers and Acquisition 5
2.5 Mergers and Acquisition Processes 7
2.6 Merger and Acquisition Challenges - Why Do M&A Fail?
10
2.7 Due Diligence in Post-Acquisition Processes 12
3.0 Research Methodology 15
4.0 Data Appraisal and Analysis 16
5.0 Summary and Conclusions 18
References
Appendix I
Appendix II
Appendix III

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1.0 INTRODUCTION
In business today, efforts are being taken in order to grow, while some
firms slowly grow organically others decide to perform a merger or an
acquisition (M&A). Firms performing M&As have a high failure rate and
many times this is caused by a poorly handled post-acquisition process.
Mergers and acquisitions, also known as M&A, are corporate processes of
acquiring new assets by buying, taking over other business or by merging
with them. Due to the emergence of globalization in the industries and
international markets, more and more companies seek to increase
revenue, search for further growth and lower cost through mergers or
acquisition. Gaughan (2002)

By definition, Merger is the combination of two or more companies in

which the assets and liabilities of the selling firm are absorbed by the
buying firm. Although the buying firm may have a considerably different
organization after the merger, it retains its original identity. Acquisition is
the purchase of an asset such as a plant, a division or even the entire
company. For Gaughan (2002), despite the differences between them, the
terms mergers and acquisitions are sometimes used interchangeably.

Mergers and acquisitions have long been performed by companies in the

need to seek growth to gain market shares from competitors, create
economic profits, and provide returns to shareholders. It is such common
practices that companies which are out of the game are likely to stay
ahead from merged companies. Although there are several obvious
reasons to merge, most authors pointed out the fact that most of mergers
and acquisitions would fail. Many reasons are studied to explain this trend.
In fact empirical studies have treated the question and tried to understand
the reason of this trend over the past decades. The term failure is
understood as not achieving what was expected from the merger and
acquisition. (Cassiman & Colombo, 2006)

Like any type of business activity there are pros and cons for both
mergers and acquisitions. Some of the pros include: the potential to add
value to a company's bottom line, the potential to increase a market
share, and the potential to add assets to a company's holdings. While
M&As have several pros, they also have several cons. Some of the cons
include bad public reaction to hostile takeovers, resistance from the

4
targeted company and the acquisition of additional liabilities and
problems. (Deans, Kroeger & Zeisel, 2003)

1.1 PROBLEM AND PURPOSE

Much failure than success has been acclaimed in merger and acquisition.
It is a fact, that most business acquisitions and mergers fail says InterLINK
Management Consulting. Management desires the gains that
consolidation and economies of scale should bring, but in fact the great
majority of M&As – across all industries do not live up to their promises.
On paper, two plus two should equal five. In fact, two plus two usually
equals three. This has been conclusively shown by dozens of studies
covering hundreds of companies across all industries. Some excerpts:

"70 percent of mergers fail to achieve their anticipated value."

"Most [mergers] fail to add shareholder value-indeed, post-
merger, two-thirds of the newly formed companies perform well
below the industry average."
By some estimates, 85 percent of failed acquisitions are
attributable to mismanagement of cultural issues."
– InterLINK Management
Consulting

A plethora of researches and studies have shown the various failure

factors and main pitfalls changing promising motivations into failed
implementation in the process of merger and acquisition; not much
however has been researched in the Nigerian cases. Although the focus of
this paper is restricted to a synthetic review of various literatures’ findings
of failure factors with possible comparative study of the Nigerian cases, it
strove to evaluate the post-merger prospects (profitability and wealth
maximization prospects) of selected integrated firms.

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2.0 LITERATURE REVIEW

A general view both within business administration and economics

research is that firms exist to grow and that firms seize any possibility to
grow. Growth refers to change in size or magnitude from one period of
time to another. Growth can involve the expansion of existing entities
and/or the multiplication of the number of entities. Growth can also be
obtained by the multiplication of the number of firm controlled by a
particular individual or group of individuals.” By exploring the internal
resources a firm can achieve internal development, by many researchers
referred to as organic growth. Merger and acquisition (M&A) is the
opposite growth strategy where the firm expands by either a merger or an
acquisition with another firm and exploits its competence. (Cooke, 1986)
One plus one makes three: this equation is the special alchemy of a
merger or an 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. (Pomerleano &
Shaw, 2005)

2.1 MERGERS AND ACQUISITION DEFINED

Technically, merger is a combination of two or more companies in which
all but one of the combining companies legally cease to exist and the
surviving company continues in operation under its original name. A
consolidation is a combination in which all of the combining companies
are dissolved and a new firm is formed. “Merger” is used to describe both
types of business combination. (Moyer & McGuigan, 2001)

Acquisition is used interchangeably with merger to describe a business

combination. A term also used is takeover, which can mean a friendly
merger of two companies or a hostile acquisition by tender offer.
However, the term usually is associated with the latter. (Brealey & Myers,
2000)

The acquisition–merger decision is, in essence just another capital

investment decision. Instead of a company deciding whether to buy a
single asset, the decision concerns the acquisition of a ready-made
collection of assets. The decision should be treated in its own right and
separate from the conventional, because it has some particular difficulties

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that are not usually encountered in ‘normal’ investment decisions. (Lumby
& Jones, 2003)

2.2 DISTINCTION BETWEEN MERGERS AND ACQUISITION

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 one company takes over another and clearly established itself
as the new owner, the purchase is called an acquisition. From a legal point
of view, the target company ceases to exist, the buyer "swallows" the
business and the buyer's stock continues to be traded. (Cooke, 1986)
In the pure sense of the term, a merger happens when two firms, often of
about the same size, agree to go forward as a single new 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 (Mcclur, n.d.).
In the 2005 banks consolidation exercise, a good example of a merger is
that between Investment Bank and Trust Company and Chartered Bank to
produce a new company IBTC Chartered.

In practice, however, actual mergers of equals don't happen very often.

Usually, 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, therefore, by describing the deal as a
merger, deal makers and top managers try to make the takeover more
palatable. (Mcclur, n.d.)

A purchase deal will also be called a merger when both CEOs agree that
joining together is in the best interest of both of 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.

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. (Mcclur, n.d.)

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2.3 TYPES AND METHODS OF MERGERS AND ACQUISITION
Mergers and acquisitions are broadly classified into various types. While
the major types are normally considered as horizontal, vertical and
conglomerate, other researchers refer additionally to concentric mergers
as a different type of mergers and acquisitions (Straub, 2007).

Horizontal Merger and Acquisition

The horizontal M&A type is subdivided in two more groups. The first group
covers mergers within the same product line, but allocated to different
countries. Consequently the acquiring firm gains market shares and
power through the merger in new geographical areas. The second type
consists in mergers of companies with slightly different product lines. As a
result, the acquiring firm increases its product line through the merger.
However horizontal mergers are highly controlled by market and
governmental regulations, which limit the value creation in some cases
such as restraining the formation of monopolies (Straub, 2007).

Vertical Merger and Acquisition

On contrast, in a vertical merger, companies do not acquire firms with the
same product line, but firms connected to their own production chain. Also
this type of merger can be subdivided into two different groups; merging
vertical backwards or forwards. The purpose of the forward vertical
acquisition for the acquiring company is to have a sure buyer to which it
can provide its own products. On the other hand, acquiring vertical
backwards means to ensure a constantly guaranteed supply of raw
materials, which are needed for the acquirer’s production. In general a
vertical merger leads to a raise of the acquiring company’s increment
value (Straub, 2007).

Concentric Merger and Acquisition

A concentric M&A affects the knowhow, such as production technology
and delivery service as well as improvement and research capabilities, of
the participating companies. Especially firms from emerging countries
show big interest in the knowhow of enterprises from developed countries.

Conglomerate Merger and Acquisition

An M&A is called conglomerate, if there is no connection, neither in the
production line nor in the production chain, between the involved
companies. This merger can occur mainly because diversified companies

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try to reduce their risk. They aim to build an efficient distribution network
as the fundament for their strategy (Straub, 2007).

2.4 MOTIVES FOR MERGERS AND ACQUISITION

The motivations of M&A are numerous and complex and have been
analysed within different fields as corporate governance, industrial
economics, finance, or fiscal system. Primary motives of the M&A are
discussed in the section following.

Growth
Gaughan (2002) explains that one of the most fundamental motives for
M&A is growth. Growth is when company grow within their own industry.
Indeed, investing in growth through acquisition would create more value
for the companies. In our case study on BNP Paribas a major player in the
bank sector in France, the main motive to this merger was growth. In fact
for the two companies, the M&A was a strategy to acquire opportunities
that meet their profitability criteria and use their existing businesses and
operations to expand in the overall market. Today, the group has adopted
the same strategy to merge with others firms.

Synergy
Synergy refers to the type of reaction that occurs when two substance of
factor combine to produce a greater effect together than which the sum of
the two operating independently could account for. Synergistic gains are
created when there is a mixture of actors that will create a greater value
together than otherwise could have been possible comparing the firms
operation their own. Generally synergies created through a merger will
either reduce costs or increase revenue. Cost synergies can be achieved
through economies of scale. (Gaughan, 2002)

Diversification
Diversification means growing outside a company’s current industry.
Diversification could be in the domestic market or in the cross boarder
one. According to Deans, Kroeger & Zeisel (2003), cross-border M&A
business is growing significantly faster than overall M&A activity, which
also is expanding at a healthy pace. Argue that the managers may regard
the need to diversify the firm’s revenue resource as the reason for
mergers.

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Economies of Vertical Integration
Vertical mergers seek economies in vertical integration. Some companies
try to gain control over the production by expanding back toward the
output of the raw materials and forward to the ultimate consumer. One
way to achieve this is to merge with a supplier or a customer. (Brealey &
Myers, 2000)

Complementary Resources
Many small firms are acquired by large ones that can provide the missing
ingredients necessary for the small firms’ success. The small firm may
have a unique product but lack the engineering and sales organisation
required to produce and market it on a large scale. The firm could develop
engineering and sales talent from scratch, but it may be quicker and
cheaper to merge with a firm that already has ample talent. (Brealey &
Myers, 2000)

Eliminating Inefficiencies
Cash is not the only asset that can be wasted by poor management. There
are always firms with unexploited opportunities to cut costs and increase
sales and earnings. Such firms are natural candidates for acquisition by
other firms with better management. In some instances “better
management” may simply mean that determination to force painful cuts
or realign the company’s operations. Notice that the motive for such
acquisitions has nothing to do with benefits from combining two firms.
Acquisition is simply the mechanism by which a new management team
replaces the old one. A merger is not the only way to improve
management, but sometimes it is the only simple and practical way.
(Brealey & Myers, 2000)

2.5 MERGERS AND ACQUISITION PROCESSES

The M&A process is divided by many authors into different stages, which
may vary depending on the author. Considering different theories about
the merger process, we came upon a model which we believe match the
most with our understanding of the process. However, other merger
processes exist and merging companies do not go compulsorily through
all the stages of the process. We have thus here a model divided in three
different major categories; Pre-merger process, during the merger
activities and post-merger integration. Each of these stages can be

10
subdivided again into two different steps. Hence the M&A process consist
in six main steps

The Merger and Acquisition Process

Research/Decis
Pre‐merger
ion
Process

Strategy
During the

Merger Activiti

M&A
Post Selection
Merger

Integration

Due Diligence

Closing Merger

Post-Merger
Integration
Research and Decision
The pre-merger process is the timeframe before the announcement of the
deal and involves a long process of decision-making. First of all the
decision for an acquisition must be made. This will be done normally by
the CEO of the company in collaboration with the top management team
after thoroughly analyzing the opportunities available (Kusstatscher &
Cooper 2005). But as the game theory of Nash explains, a merger in most
of the cases creates a reaction of the other market players. Therefore, the
top management and the consultancies must be aware of the reaction
following the decision of a M&A deal of the own company. Nevertheless, if
the decision is considered as right, a long list of potential targets will be
created in order to get an overview and more information on the
companies fitting with the acquirer’s strategy (Cassiman & Colombo,
2006).

Strategy

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In this stage a first strategy concept and a business plan will be developed
in order to reduce the number of potential candidates. Due to the same
reason a first valuation of financial and strategic fit will be done.
Additionally, a strategy depending on the complexity of the acquisition,
the strength as well as the ambitions of the target companies and their
managers will be developed in this period. Nevertheless, beside the
importance of the further strategy, the CEO and the negotiation team
should be open-minded for new opportunities and also to be flexible to
react to new problems occurring out of the negotiations with the potential
targets (Kusstatscher & Cooper 2005).

M&A Selection
Ongoing the potential candidates have to be screened and a final group of
maximal five target companies should be selected. This will be done
through two main criteria in addition to a direct contact. The first criteria
regards choosing the final target company depending on the forecasted
benefits of an acquisition of the observed company that could be realized
and the strategic matches in terms of products, markets geographical
position. This stage consists mainly in bidding and negotiating between
the acquiring and the target company. Therefore confidential agreements
are imperative (Kusstatscher & Cooper 2005).

Due Diligence
In the so-called due diligence process the financial shape and the
potential strategic match of the target company will be checked more in
details by a selected team of accountants, consultants and lawyers
(Kusstatscher & Cooper 2005). The biggest problem of the due diligence
process is, that on the one hand the target company wants the acquiring
company to feel comfortable with the postulated price and the quality
offered, but on the other hand the target company does not want to
present all information about financial, marketing or sales aspects for fear
of a late failure of the deal. But exactly because these secret information
are disclosed in the due diligence process, the introduction of an interim
step, in which the acquiring company gets access to certain information
about the target company, can be helpful. There is also the possibility of a
nondisclosure agreement, which protect the secret needs of the involved
company. Nevertheless every time there is not all information honestly
delivered, bad surprises can occur later in the deal.

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During the merger, it is crucial to find the right balance between
emphases to speed and diligence in the decision making process. The
consequences of moving too slow as well as doing the wrong decisions
mean losing a lot of money and reducing shareholder value.

Closing the merger

The timeframe to close the merger may last few hours until a few weeks
depending on the complexity of the deal and the accuracy of the work
done before. Final negotiations about the acquisition price and a binding
letter of intent will be signed together with the closing contracts.
Nevertheless, mistakes can be made during the final meeting, where the
contracts are signed, which may cause delays in the closure or in the
worst case the failure. Hence, there are several points to keep in mind for
the closing meeting: All lawyers and other people involved in the deal,
such as consultants, should be present all the time during the final
meetings, in case of changes through last minute documents.

All time constraints such as desk opening hours of involved banks for
instance, must be taken into consideration and if necessary, in
consultation with them, extended.

Emphasis on speed should not influence the quality. Every single change
made in the closing meeting, caused by late arrival documents or any
other reason, must be thoroughly proved in all layers concerning the deal.
(Kusstatscher & Cooper 2005)

The Integration process

As we mentioned before, each of these six steps is very important and
requires a maximum of concentration to succeed in merging two
companies. Therefore, after closing the merger, the final goal is not
reached yet, and the integration process must be treated with the highest
possible amount of concentration and accuracy. Indeed, mistakes in the
integration process of a M&A are one of the main reasons of failures in
acquisitions. Most time the post-merger integration process executes the
plans that have been done before the integration stage. Consequently
there are different steps which are mainly planned before, but should be
taken into consideration and also controlled to make the acquisition
successful. (Kusstatscher & Cooper 2005)

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2.6 MERGER AND ACQUISITION CHALLENGES - WHY DO M&A
FAIL?

Studies and analysts have allowed shoeing the main reasons why M&A fail
to reach success. Globally the reasons identified appear to be the same
and point out relevant reasons why M&A fail, which we will list in this part.
In fact the due diligence process is supposed to overcome these causes of
failure should it be well done and implemented.

The value of annual global M&A transactions is estimated to be running at

more than $2.2 trillion in 1999 (Thomson Financial Securities Data). In the
view of this enormous economic significance of the transaction numbers
and volume, it is alarming that more of half of all transactions do no lead
to the desired increase in value and higher return on investment for
shareholders. A study by Deans, Kroeger & Zeise (2003) concludes that
70% of M&A fails, KPMG study (1999) showed that 83% of mergers were
unsuccessful in producing any business benefit as regards shareholder
value. For Harvey (1998), the expected synergies for M&A are only
reached in 30 per cent of the cases. Why despite the importance of the
companies involved in the deals and the amount engaged, some M&A
fails?

First of all, it is important to know what failure means. For Rankine (2001),
an acquisition fails if the acquired did not increase shareholder value or
did not achieve the financial, commercial or strategic objectives set at the
time of buying business. Moreover, we point out the fact that there is not
just one reason of M&A fail, but several causes which can lead it. We have
chosen the most relevant ones in the literature review to introduce the
importance of Due Diligence to avoid the failures.

A Wrong or Poor Strategy

A correct strategic analysis is essential in a company decision making
about the type of acquisitions that ought to be considered, how large they
should be, and how quickly they need to be achieved. Indeed, companies
need to create methods of analysing drivers and understanding the
relative impact of the key factors. A survey of European middle to senior
management revealed that only 20 per cent were able to define the key
policies of their organisation the existing level of gross profit or return and
what their company planned to become over the next three year
(Rankine, 2001).

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Misunderstanding what is driving the market is the most basic mistake.
Where companies fail to take proper account of the major forces acting on
the market, then strategic choices and the acquisitions accompanying
them will lead to major failure. Company can have poor goal setting with
the first difficulty will be to setting up the objectives and having high
growth expectations. Rankine (2001) illustrates this case with the
examples of M&A by Exxon (oil producer) with office furniture, General
Motors (auto manufacturer) with missiles or Quarter Oats (cereal
manufacturer) with toys. The chances for success in a transaction
increase when the acquirer company focuses on known industries and
countries.

Over-Estimated the Potential Synergies

“There are some synergies here for sure. I don’t know where
they are yet. To say that now would be an idiot’s game”
(Barry Diller in Noubouss & Beuke,
2008)

An objective of an M&A described before is to increase value of the

shareholder. This incremental value should come from synergies (cost
reduction, sales growth), but often companies makes mistakes in the
estimation of these synergies.

Paying Too Much

Conquering the pressure of price negotiation is a crucial skill. In the worst
case, the acquirer will go bankrupt or so overextend itself as to become a
takeover subject. Bad bidders usually become good targets for other
companies. For Pomerleano & Shaw (2005), about 40 percent of the firms
that fail in the acquisition of a company become targets for other
companies. The bidder has to make a realistic valuation.

Integration Plan not Developed in Advance

Integration planning is essential in the pre-merger process. It must be
planned in advance because the integration plan is integral to the
valuation, implementation of the integration plan should start immediately
once the takeover is completed, and decisions about integration must be
made in advance if resources are to be made available and to make
integration really work.

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KPMG study (1999) enhances that integration project planning goes hand
in hand with synergy evaluation as a key to merger success. It is critical to
work out the mechanics of how synergies will be attained, and also how
the combined business will be stabilised to preserve current value and
ensure that one plus one does not make less than two. The survey
confirms, that the chances of merger success are increased if the process
of working out ‘how’ is started well before the completion of the deal.
Those companies that prioritised pre deal integration project planning
were 13% more likely than average to have a successful deal.

Cultural Difference
Another criterion identified as part of challenges and relevant causes of
failure is the cultural differences of two businesses combining. Culture
difference refers to the way the decisions are taken in the acquirer and
acquired companies, since each company has its own organizational
culture with which employees identify. Indeed the companies’
organizational culture may be very different and then cause poor efficient
communication.

A lack of concern for the cultural factors forms a major obstacle to success
of international M&A. Noubouss & Beuke, (2008) suggest that cultural
incompatibility between the target and acquiring firm has significant
impact on why M&A operations sometimes fail to achieve the pre-defined
goals. In most of transactions, the acquirer company imposes its culture
to the acquired company and will put the employee with different
education backgrounds, different working attitude and habit even
different value together. Although this strategy can work sometimes, most
of the times this is a perfect way of destroying value.

Problem Areas not Identified in Due Diligence

Due Diligence (DD) aims to ensure that the acquirer does not get any
nasty surprises after taking control of business. Relying on the last audit
of the target company and a chat with its management is now recognised
as at best problematic or, worst, a patently disastrous route to
familiarising the buyer with the potential problem it is likely to face. There
are much more demanding than corporate acquirers because, as outsiders
to the industry they are investing in, investors start with less basic
knowledge of the markets in the first place.
There are three principal reasons why due diligence disappoints or fail:

16
 • The question were not asked in the first place: when the acquirer
company management is overconfident about its knowledge of the
target company

• If the question were asked, satisfactory answers neither were nor

obtained: the target company provide restricted answers, or claims
to be bound by ‘commercial confidentiality’ or shelter behind a lack
of effective record keeping, the risks soar.

• The deal process hampered the completion of effective due

diligence: several deals constraints can happens as hostile
acquisition, auction, time pressure, sensitivity of the seller.

It is up to the team involved in the due diligence to analyse, identify and

resolve potential key elements necessary to avoid the M&A fail.

2.7 DUE DILIGENCE IN POST-ACQUISITION PROCESSES

Due Diligence Defined

Due diligence as it applies to mergers corporate acquisition is understood
to mean an investigation into the company acquired in various aspects
previously defined. The term is commonly used when it comes to mergers
and acquisition processes. In other words it is simply trying to ascertain
and find information which can be relevant in deciding whether or not to
proceed the M&A. (Noubouss & Beuke, 2008)

In fact the idea is for the buyer to make sure that it knows what it is
investing in and uncover possible relevant elements which might be
critical for the M&A success and know more about what it is buying.
Because the notion of due diligence often vary between the different
professionals involved, there might be different definitions of the term
influenced by their own role in the process. (Cassiman & Colombo, 2006)

For Harvey (1998) due diligence is all the inquiries and investigations
made by a prospective buyer in advance of the acquisition of a company
to determine whether the acquisition should go ahead and upon what
terms.

Basic Due Diligence Scope

The basic due diligence scope is composed of the financial and the legal
aspect mainly. Moreover historically, the role of due diligence has been to
document the financial background of a potential candidate and compile

17
legal information on the firm being acquired, such as incorporation
documentation, stockholders and potential lawsuits (Harvey, 1998).

In the financial due diligence, the focus is on the validation of historical

information, the review of management and systems. The goal is to
confirm underlying profit and provide a basis for valuation.

In the Legal due diligence, the focus is on contractual agreements mainly

and the goal is to uncover warranties and indemnities as well as validate
all existing contracts, sale and purchase agreements.

Emerged Elements
Here is some other due diligence areas which have emerged during the
last decades. Even though the most commonly applied due diligence prior
to conducting a merger and acquisition are the Financial and Legal
aspects, the due diligence process may concern various other fields such
as legal, environmental, commercial, corporate culture, systems/IT,
pension, fiscal, insurance, human resources, and various other aspects.

In fact experts have begun to re-examine the traditional due-diligence

process of the past several decades to determine how to enhance its
value. The complexity of M&A transactions, the financial instruments used
in the transactions and increased government regulation have stimulated
a renewed interest in due diligence (Harvey, 1998)

The Commercial due diligence is based on the investigation of market

dynamics, the target's competitive position and commercial prospects.
The goal is to assess the sustainability of future profits and formulate the
strategy for the combined business

The Human resources and culture due diligence goal is to make up

the workforce, the terms and conditions of employment, the level
commitment and motivation as well as the organizational culture. The
goal is to uncover any employment liabilities, assess the potential human
resources costs and risks of doing the deal, prioritizing the HR issues that
need to dealt with during integration, assess cultural fit, costing and
planning the post-deal HR changes

Environmental due diligence can be defined as the systematic

identification of environmental risks and liabilities associated with an
organization's properties and operations. In fact there is an increasingly

18
stringent movement of the regulatory framework in many developed
countries towards the 'polluter pays' principle, with greater emphasis now
being placed on environmental issues across all industries in order to
manage potential risks associated with poor environmental performance
or impact on the natural environment. It is all about assessing the
environmental risk associated with a merger and acquisition

Pension due diligence may be performed if the purchaser is acquiring

the pension scheme as part of the transaction. Purchasers will not want to
have to make large, one-off contributions to the scheme, the biggest
concern, therefore, will be funding deficits. The idea is to minimize the risk
of underfunding due to the various pension plans and plan valuations.

Insurance due diligence investigates in the present, future and most

importantly past exposures of the business – the structure and cost of the
existing program.

19
3.0 RESEARCH METHODOLOGY

Empirical research on the performance of mergers and acquisition can be

classified into two elements. First, studies have been undertaken using
share prices to establish the distribution of gains and losses to
shareholders. Naturally, evidence collected on share-price performance
surrounding a merger event will have implications for capital market
theory. Secondly, assessments have been undertaken in terms of
managerial performance measures of profitability using accounting
figures. For some studies, however, other researchers have opted for
cases study and analyses.

For this paper, the research methodology has been approached in two
ways. First, a synthetic review literature on mergers and acquisition in
order to establish a warnings and signals pointing out the main pitfalls
changing promising motivations into failed implementation in the process
of Merger & Acquisition is carried out. In evaluating the profitability and
shareholders’ value addition prospects, accounting ratios – most
especially the profitability and investors ratios will be evaluated for both
pre-merger and post-merger financial periods of selected firms.

The Sampled two (2) banks used for the financial appraisal were selected
with the prior object of excluding the effect of the recent financial bubble
burst of banks, hence the use of judgmental random sampling techniques.
Also, the financial ratios calculated covered periods between 2005 and
2007 in order to alienate the effect of the global meltdown on findings and
conclusions drawn in relation to profitability and shareholders’ wealth
maximization prospects of mergers and acquisition process. The banks
are First Bank Plc and United Bank for Africa Plc.

The consolidation exercises led to the emergence of twenty-five (25)

banks which were before the consolidation, eighty-nine (89). In attempt to
meet up with the recapitalization direction, First Bank Plc acquired
Merchant Bank Corporation International, FBN (Merchant) Bankers
resulting into a recapitalization base of N48.7 billion. The United Bank for
Africa on the other hand merged with Standard Trust Bank resulting into a
recapitalization base of N50 billion

20
21
4.0 DATA APPRAISAL AND ANALYSIS

In evaluating the post-acquisition prospects of selected banks, four ratios

have been identified and computed – two key profitability ratios and two
key investors’ ratios. The results are presented below in summary. For the
profitability ratios, appendix III contains the calculations of the financial
ratios presented in the table while reference should be made to appendix I
and appendix II for the investors’ ratios.

Table 1: Pre-Acquisition and Post-Acquisition Status – First Bank

Plc
Pre-Acquisition Post-Acquisition

2004 2005 2006 2007

Return on capital 36.52% 33.90% 31.78% 22.22%

employed
Profit margin 31.26% 30.61% 31.65% 27.87%

Earnings per share N3.81 N3.08 N2.69 N1.56

Dividend per share N0.90 N1.05 N0.26 -

Table 2: Pre-Acquisition and Post-Acquisition Status – United

Bank for Africa Plc
Pre-Acquisition Post-Acquisition

2004 2005 2006 2007

Return on capital 26.15% 32.20% 25.67% 13.75%

employed
Profit margin 23.44% 24.46% 14.54% 22.58%

Earnings per share N1.64 N1.52 N1.86 N2.41

Dividend per share N0.60 N0.60 N1.00 -

The comparative result of computed financial ratios for the pre-acquisition

and post-acquisition periods of the two banks reveals that there was no

22
significant improvement in the financial performance of the banks after
the acquisition of other entities. For example, the return on capital
employed of First Bank Plc fell from 33.9% at acquisition in 2005 to
22.22% in 2007 post-acquisition financial year. The fall in ROCE which is
the same for United Bank for Africa Plc (dropped from 24.46% at
consolidation to 22.58% in 2007 post-acquisition financial year) was
further explained by a decline in the net profit margin in 2007 for both
banks.
The results could probably result from excessive unutilized capital
accumulated from the consolidation process or exercise. In other words,
there could be a degree or some level of inefficiencies in utilizing capital
employed in generating earnings. The decline in net profit margin could
also be attributable to expenses resulting from post-acquisition
integration processes.
The decline in profitability led directly to a decrease in earnings per share
for First Bank Plc. The earnings per share dropped from N3.08 at
acquisition to N1.56 post-acquisition. This, however, was not the same for
the second bank – United Bank for Africa Plc whose earnings per share
moved from N1.64 in 2004 pre-acquisition period to N2.41 in 2007 post-
acquisition period. This dividend payment followed this same trend as
earnings per share. No dividend was however paid in 2007 by both banks
probably a resultant effect of the dawning of the economic recession by
late 2007 which was to become more vicious and corrosive in following
financial periods.
The stands or findings analysed above is further corroborated by studies
such as InterLINK Management Consulting (2004) which concluded most
mergers and acquisition produce marginal benefits i.e. lower profitability
prospects than expected; while only 17% provided substantial returns to
shareholders." About these figures, one expert said: "That's a staggering
number. That means those organizations were better off before they
merged than after they merged." (www.interlinkconsulting.com) A KPMG
study (1999) showed that 83% of mergers were unsuccessful in producing
any business benefit as regards shareholder value.
Boyd and Runkle (1993) find that larger banks are more highly leveraged
and less profitable in terms of asset returns. Secondly, their findings
established that efficiency improvements as a result of the consolidation
exercise are unlikely to be experienced in the short term. Though the

23
twenty-five megabanks are large banks having the capital to generate
jumbo returns, these returns are not likely to match the capital and asset
strength of the banks.

24
5.0 SUMMARY AND CONCLUSIONS

Organic growth can be seen as an alternative to acquisition-led growth.

Acquisition led-growth is however advantageous because the synergistic
process – at the heart of the merger and acquisition (M&A) decision is
characterized with rapid strategy implementation; allows companies to
immediately achieve the critical mass required to gain the same operating
scale economies as those enjoyed by competitor; allows the company to
fund growth by issuing new equity rather than with cash and enable
companies to acquire both hard assets and the intellectual capital
required to propel rapid growth.

However, M&A processes induce considerable degree of complexities. This

is because the process is sometimes unknown or underestimated since
the executives sometimes want the deal to be closed as soon as possible,
and neglect some critical factors which can be important to get a true
vision of the target and therefore increase the chance of success of the
deal in future. In the view of the enormous economic significance in M&A
transactions numbers and volume, it is alarming that more of half of all
transactions do not lead to the desired objectives.

From the critical review of literatures embarked upon and the result of the
financial appraisal; some prominent conclusions drawn relative to the
challenges and prospects of the merger and acquisition decision:
(i) Growth by merger and acquisition remains a good alternative to
organic organisation growth if managed adequately and
efficiently.
(ii) Researches have underlined the high rate of failure among M&A,
and the difficulty to achieve expected results and synergies.
(iii) Reasons of failure, many analysts have pointed out include a
wrong or poor strategy, over-estimated the potential synergies,
paying too much and deficient integration plan.
(iv) Mismanagement of cultural issues especially in cross-border
merger poses difficulties to M&A expertise. Owing to the
challenge and impact culture integration poses in the M&A
processes, firms have been seen to prefer centralization of power
and unicultural organization, and in most cases a congruence
concerning culture have occurred.
(v) Laxity in due diligence is key challenging area in especially
post-merger integration. This is evident in the post-consolidation
events that ensued in the Nigerian banking sector where for lack

25
of due diligence, the 2005 recapitalisation exercise became
partly a curse. The banks were not ready for the gift hoisted upon
them. The rapid accumulation of capital outstripped each bank’s
ability to manage it since there existed a dearth gap and
deficiency in due diligence during the merger-acquisition
processes.

26
 REFERENCES
TEXTBOOKS
Brealey, R.A. and Myers, S.C. (2000) Principles of Corporate Finance (6th
ed). United States of America: McGraw-Hill
Cassiman, B. and Colombo, M.G. (2006) Mergers and Acquisitions: The
Innovative Impact. Massachusetts, USA: Edward Elgar Publishing Inc
Cooke, T.E. (1986) Mergers and Acquisition. New York, USA: Basil
Blackwell Inc.
Deans, G.K., Kroeger, F. and Zeisel, S. (2003) Winning the Merger
Endgame: A Playbook for Profiting from Industry Consolidation. New
York: McGraw-Hill
Gaughan, P. A. (2002). Mergers, Acquisitions and Corporate
Restructurings. (3rd ed) New Jersey: John Wiley and Sons.
Kusstatscher, V. & Cooper, C. L. (2005). Managing Emotions in Mergers
and Acquisitions. Masachusetts: Edward Elgar Publishing.
Lumby, S. & Jones, C. (2003) Corporate Finance, Theory and Practice (7th
ed) edition. London: Thomson Learning
Moyer, R.C. and McGuigan, J.R. (2001) Contemporary Financial
Management (8th ed) United States of America: Thomson Learning.
Pomerleano, M. & Shaw, W. (2005) Corporate Restructuring: Lessons from
Experience. Office of the World Bank: Washington D.C, USA
Rankine D. (2001) - Why Acquisition Fail? Practical Advice for Making
Acquisitions Succeed. Pearson Education Limited (p.xxi).
Straub, T. (2007). Reason for Frequent Failure in Merger and Acquisitions.
Wiesbaden: Deutscher Universitats‐Verlag.

JOURNALS
Boyd, J.H. and Runkle, D.E. (1993) “Size and Performance of Banking
Firms: Testing the Predictions of Theory”. Journal of Monetary
Economics, 31, pp. 47-67.
Harvey M. (1998) - Beyond traditional due diligence in the 21st century”
Journal Article Excerpt, Review of Business, Vol. 19.

INTERNET FILES
InterLINK Management Consulting (2004) Mergers Integration. Retrieved
April 24th, 2011 from
www.interlinkbusiness.com/service/merger_acquisition
Mcclur, B. ( n.d.) Merger and Acquisition: Introduction. Retrieved April 24,
2011 from www.investopedia.com/contributors/default.aspx?id=49
Noubouss & Beuke, (2008) Due Diligence: Learn From The Past, But Look
Toward The Future. Retrieved April 24, 2011 from http://ssrn.com

27
KPMG survey (1999): Unlocking shareholder value: the keys to success,
Global Research Report.

28
APPENDIX I

29
 APPENDIX II

UB
A
Profit And Loss Account for the year ended
31st March
2005 2004

N’Million N’Million

GROSS EARNINGS 25,506 23,928

Interest and discount income 14,456 15,155

Interest expenses (3,490) (3,107)

10,966 12,048

.
Loan loss and other provision (761
(40)
)
Net Interest Margin
10,926
11,287
Other banking income
11,050
8,773
21,976
20,060
Depreciation
(1,402)
(1,353)
Other operating expenses
(14,335)
(13,089)

PROFIT BEFORE TAXATION

6,239
5,608
Income taxation
(1,619)
(1,204)
Deferred taxation .

33 (21
PROFIT AFTER TAXATION 9)

30
 4,653 4,185

APPROPRIATION:

Statutory Reserve

Small Scale Industries reserve 697 628

Bonus issue reserve 624 561

General reserve - 255

1,211
Dividend - proposed 1,496
1,530
1,836
4,185
4,653

Earnings Per Share

1.64
Earnings Per Share – Adjusted 1.52
1.37
Dividend Per Share 1.52
0.60
Dividend Per Share - Adjusted 0.60
0.50
0.60

UBA
BALANCE SHEET AS AT MARCH 31,
2005 MARCH 31, 2004

2005 2004

31
 NMillion NMillion

ASSETS

Cash and short term funds 109,716 89,820

Government securities 58,444 40,497

Investments 2,835 2,387

Loans and Advances 67,610 56,136

Other assets 4,169 13,603

Fixed assets 6,154 6,363

TOTAL ASSETS 248,928 208,806

LIABILITIES

Deposit and current accounts 205,110 151,929

Other liabilities 20,876 32,051

Taxation 2,494 2,279

Deferred taxation 1,070 1,103

229,550 187,362

BORROWING 1,676 3,385

CAPITAL AND RESERVES 5,748 1,275

Share capital 16,172 16,784

Other reserves 17,702 18,059

SHAREHOLDERS’ FUNDS 248,928 208,806

32
33
 UBA
Profit And Loss Accounts for the year
ended 30th September
2007 2006

N’Million N’Million

GROSS EARNINGS 101,106 86,079

Interest and discount income 68,575 57,207

Interest expenses (26,531) (24,879)

Net Interest Margin 42,044 32,328

Loan loss and other provision (3,163 (5,164)

)
27,164
38,881
Other income 28,872
32,531
Operating income 56,036
71,412
Operating expenses (43,522)
(44,424)
Profit before taxation and exceptional item 12,514
26,988
Exceptional items .
-
(4,161)
12,514
22,827
Taxation (1,046)
(2,996)
Profit on ordinary activities after taxation and exceptional item 11,468
19,831
Minority Item .
-
.
-
11,468
19,831

34
APPROPRIATION:

Transfer to statutory reserve (2,975) (1,720)

Reserve for Small Scale Industries - (1,147

)
Proposed dividend .
-
(7,06
Retained profit transferred to general reserve 16,856 0) .

1,541

Earnings Per Share (Kobo) - Basic 241

186

35
 UBA
BALANCE SHEET AS AT SEPTEMBER 30,
2007

2007 2006

NMillion NMillion

ASSETS

Cash and short term funds 102,724 72,920

Due from other banks and Financial Institutions 415,577 391,185

Treasury bills and government bonds 149,472 201,992

Investments in subsidiaries and associated companies 5,807 5,554

Long term investments 21,907 7,122

Loans and Advances 320,229 107,194

Other assets 38,419 33,048

Fixed assets 48,213 32,226

TOTAL ASSETS 1,102,348 851,241

LIABILITIES

Deposit and current accounts 897,651 757,407

Managed funds - -

Other liabilities 33,749 35,118

36
Taxation payable 3,959 1,359

Deferred taxation 991 1,499

Dividend payable 42 7,102

Term loan 1,135 1,135

937,527 803,620

CAPITAL AND RESERVES

Share capital 5,748 3,530

Share premium 119,066 23,209

Other reserves 28,776 9,651

Core capital 153,590 36,390

Fixed assets revaluation reserve 11,231 11,231

SHAREHOLDERS’ FUNDS 164,821 47,621

Minority Interest .
- .
-

TOTAL LIABILITIES 1,102,348 851,241

37
 APPENDIX III

Computation of Return on Capital Employed (ROCE)

ROCE = Profit before interest and
taxation
Capital employed

Year First Bank Plc United Bank for

African Plc
2004 = 14,106,000,000 x = 5,608,000,000 x
100 100
38,621,000,000 21,444,000,000
1 1
= 36.52% = 26.15%
2005 = 15,145,000,000 x = 6,239,000,000 x
100 100
44,672,000,000 19,378,000,000
1 1
= 33.90% = 32.20%
2006 = 19,381,000,000 x = 12,514,000,000 x
100 100
60,980,000,000 48,756,000,000
1 1
= 31.78% = 25.67%
2007 = 22,097,000,000 x = 22,827,000,000 x
100 100
99,452,000,000 165,956,000,000
1 1
= 22.22% = 13.75%

Computation of Net Profit Margin

Profit Margin = Profit before interest and
taxation
Gross Earnings

Year First Bank Plc United Bank for

African Plc
2004 = 14,106,000,000 x = 5,608,000,000 x
100 100
45,121,000,000 23,928,000,000
1 1
= 31.26% = 23.44%
2005 = 15,145,000,000 x = 6,239,000,000 x
100 100
49,475,000,000 25,506,000,000

38
 1 1
= 30.61% = 24.46%
2006 = 19,381,000,000 x = 12,514,000,000 x
100 100
61,243,000,000 86,079,000,000
1 1
= 31.65% = 14.54%
2007 = 22,097,000,000 x = 22,827,000,000 x
100 100
79,299,000,000 101,106,000,000
1 1
= 27.87% = 22.58%

39