Theoretically mergers and acquisitions should be value creating for the shareholders of both the offeror and offeree companies. You are required to critically evaluate whether this is the case in practice. You should refer to at least one real life example in your assignment.
(i) To test your understanding of the theory of mergers and acquisitions.
(ii) To test your ability to critically evaluate the theory of mergers and acquisitions. To help you start this section of your assignment there is a summary of some of the evidence on merger performance in the chapter on mergers in your core text book.
(iii) To test your ability to chose a real life example to support your arguments.
1 understanding of the theory of mergers and acquisitions
2 real life example of mergers or acquisitions that DESTROYS VALUE not create value.
Merger is the joining together of two or more companies where one company will continue to existing a merger the two equally strong firms comes together and form a completely new entity which has a differently new identity. Close to the term merger is the term acquisition which refers to the purchase of assets by one company from another company and both the companies may continue to exist. In a merger the acquired company will cease to exist after the process. The acquired company is referred to as the offeree while the acquiring company becomes the offeror which is sometimes referred to as the predator.
Mergers can take three different forms depending on the companies that are involved the first type of merger is the horizontal merger where two companies at the same production level come together to enjoy the economies of scale by increasing their market share. In this case the firms merge across similar products or services i.e. two firms manufacturing stationery coming together to form a large firm.
Another form of merger is called the vertical merger. In a vertical merger the two or more firms at different levels of production comes together i.e. along a value chain. An example of this kind of merger is the merger between the manufacturer and the supplier where the newly formed company controls both the supply and the production. The objective of this kind of merger is to gain a competitive edge within the industry. The last form of merger is the conglomerate merger where firms at totally different industries combine with the objective of diversification. It is used to smooth the fluctuation in the earnings i.e. should there be poor performance in one production line there will be mitigation from the other production line.
Mergers and acquisitions has taken a common stage in the current business scenario for firms to get into good positioning and to increase the returns to the shareholders. Mergers are important and advantageous to both the offeror and the offeree companies. We will begin by looking aft the advantages of mergers to the offeror.
First synergy implies that the newly formed company will create more value than the value which would be created if the two firms operate independently i.e 1+1=3.the new company will be in a position to perform better than before and thgerefopre increased worth to the shareholders. The synergy will takecthree forms e.g. revenue synergy arising from the increased sales, expenses synergy due to the lower expenses realised and thecost of capital synergy that is realised by the reduction in the costv of obtaining external financing.
Most mergers have strategic reasonsfor the business combination .first therev is the strategy for positioning where the firm takes advantage of the future opportunities that can o=nly be exploited by the two comp[anies combined.the fitrm therefore takes advantage of the emerging new trends in the market.second there is also the desire ton fill the market gap.gap filling implies that the company has the objective of strengthening on ythe weaknesses that have not been controlled by trhe firms.this is for long term survival.again there is the strategic reason for broader market access in which case the acquiring company takes a foreign company to aide the need to go global instantly.the foreign company acquired extends the activities tyo a new political jurisdiction and promotes the speed of ggoing global.the final strategic reason of mergers is the need to have organisational competencies.here the new company acquire the human resopurce and intellects that promotes creativity and innovation in the newly formed company.the new company benefits from the better managerial and competent administration of the company.
Secondly the acquiring company has the advantage of acquiring the offeree at the cheaper cost as it may be cheaper to buy than to build a new facility of the kind.it wilkl alson take short duration to acquire the already existing company than to build a newcompany thereby increasing the shareholders worth.
The offeror also enjoys the advantage of diversification.this is the case for conglomerate merger where two firms at totally different industries join .the objective would be to smooth the earnings that fluctuates with the changes in economic conditions.in a conglkomerate merger one production line may assist in sustaining the other production line that is completely adversely affected by the economic conditions.the firm also increase the lines of revenue hence maximising the owners worth.
Moreover the acquiring firmn also benefits from the undervalued targets.in this scenario the offeror is in a position to buy the firm that is being sold cheaply in order to prevent it from further losses.the cost of purchase is therefore lowewr than both the market and the intrinsic value hence its profitability.
The offeror also realiose the shoprt term growth inm the case whrere it acquires the firm that is in operation. The management will be under the pressure from the shareholders to turn the slow growth into a fast and profitable company.tis boosts the performance and enhance the earnings of the firm created
A company that is making higher p[profits hence paying high taxes may need to buy a loss making firm in a bid to realise tax savings,. The loss making firm will in the short term minimise the earnings reported and hence reduce the tax liability. Companies may also acquire the target in order to have the asset backing. The acquired company will increase the total net assts of the new firm. This will increase the productivity of tyhe new firm by increasing its operation. The ultimate result will be boosted growth and increased earnings hence better worth to the owners.
In mergers thec offeree or the acquired company will also have to defend its acquisition so that the owners also benefits. There are several ways in which thje offeree benefits.
First the company will be shielded fronm realising further losses by disposing the loss making firm to a profitable one.the aim of thios merger is to protect the acquired company from incurring further obligations and increasing claims that would reduce the shareholders value at the end
The offeree also benefits from the reduced cost in merging.as mostof the acquired firms are not realising profirts and their persistence may result into liquidation, the companys prevents itself from thec risk of being declared insolvent and incurring high dissolution expenses.this way the worth of the shareholders is maximised.
Improved liquidity may also be a benefit to the acquired company in circumstances where it disposes only a proportion of its operations for cash.here the firm will diospose the loss making branches but retain its profitable activities.
Another advantage that the offeree obtaions in amerger is that in mergers where there is exchange of shares, the owners of the offeree company will obtain a share of the new firm and therefore will participate in the management and sharing of the earnings from the company.thre can also be the use of convertible securities where the offeree is offered debentures for the price.the ownersof the offeree company will thus gain from the interest payment of theirc loan and the advantage of being able to convert the securities into owenerhip.this also gives the predator the advantage of conserving its cash and hence improves the liquidity.
Again it would be advantageous for the offere being sold at a higher value than its intrinsic value to benefit from the high sales value the worth of the shareholders would have been maximsised by adopting and taking into account the decision that would maximise their wealth the most.this is possible where the offeree is in high demand by the predators.this large number of predators makes the management to be in a better position to bargaoin for a high price.
The offeree also benefits from the process by salvaging the company from the poor management.this situations arise from the fact that after the merger the company will be in apposition to benefit from the efficient utiliosation of the resources and better managemen of the assets of the firm.
An example of a successful merger was between Exxon and mobil in which the two companies horizontally merged to control the market by benefiting from the wide market share.this merger was very productive in the long run when the merged firms took time to change the different corporate cultures in order to realise compatibility in management and the core values.what became categorically noted is that in such kind of mergers the different management must be patient and there must be an element of compromise if successful organisation is to result.
In conclusion, it is worth noting that the various firms that enter into a merger have varying and different objectives that must be well incorporated in the merger agreement for the merger to be successful.various mergers and acquisitions have always stalled due to the poorly controlled process and the ack of total commitment to the agreements. The process therefore requires a sobre and brilliant personnel with pertinent knowledge on how best to overcome the drawbacks that may arise in the process.mergers must therefore be carried out with due diligence for it to thrive.