Basics of Mergers and acquisitions (M&As)
Businesses, in their need to survive in competitive times, explore various options. There are two major ways to expand a business – by setting up new production facilities or through mergers and acquisitions. Because of the increasing globalization of all the business, mergers and acquisitions have become a fact of life. The statistics of the mergers and acquisitions in recent times have risen dramatically. In United States alone, the number of mergers and acquisitions rose from 3600 in 1991 to 8700 in 1999, according to the US Federal Trade Commission.
Employing mergers and acquisitions as a business strategy is clearly the emerging trend (Halibozek and Kovacich, 2005: 40). Cross border mergers and acquisitions too are on a rise and have become a common and important occurrence in the international business scenario. A main reason for this is the trade liberation measures adopted by the governments in many countries due to the pressures of globalization. However, mergers and acquisitions are still relatively less important in developing countries despite obvious exceptions in case the government decides to privatize certain industries.
A recent example for this is the activities taking place in South America and in a few African countries (Halibozek and Kovacich, 2005: 42).
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Wubben in his book gives explained the concept of M&A as given by COPELAND and WESTON as “traditional subject of M&A has been expanded to include takeovers and related terms of corporate restructuring, corporate control, and changes in ownership structure of times” (2007:5). Moving further from this broad definition, Wubben has given the different areas of mergers and acquisitions in the form of a figure, which is given in Figure – 1 below.
Figure – 1, Areas of M & A activity in a broad sense (Wubben, 2007:6) a. Mergers Sherman and Hart define merger in their book as “a combination of two or more companies in which the assets and liabilities of the selling firms are absorbed by the buying firms” (2006: 11). They further clarify that even thought he buying firm might be a totally different organization prior to the merger, it retains its original identity even after the merger has taken place.
Halibozek and Kovacich in their book give the definition of merger as given in the Black’s law dictionary as “the union of two or more corporations by the transfer of property at all, to one of them, which continues in existence, at others being swallowed up or merged therein” (2005:3). That is to say a merger is a generic term employed for a full and final coming together of two previously separate corporations or commercial interests. Mergers are generally conducted between equal partners and are something akin to a business combination.
In case of a merger, however, the two companies form a single entity and the buying firm assumes all the liabilities and receives all the assets of the disappearing company. The shareholders of both the organizations come together to share the resources of the enlarged organization, and both sides become shareholders in the new organization. An example of a merger is between Sprint and Nextel (Campbell, Stonehouse and Houston, 2002: 214-215). b. Acquisitions Sherman and Hart define acquisition in their book as “the purchase of an asset such as a plant, a division, or even an entire company” (2006: 11).
Halibozek and Kovacich in their book give the definition of acquisition as given in the Black’s law dictionary as “the act of becoming an owner or a certain property” (2005:3). That is to say an acquisition is an addition to an established entity or group. Acquisitions are generally conducted between unequal partners, as here one of the party buys subsumes another party and the target company is integrated into the corporate group of the acquirer. Initially the legal existence of the target remains unchanged The shareholders of the smaller organizations, i. e. Also read what are the three main types of bank transactions?
the one being bought, cease to be the owners of the resulting enlarged organization unless payment to the shareholders is paid partly in shares of the acquiring company. To all intents and purposes, however, the shares of the smaller organization are completely bought by the larger. An example of an acquisition of The Gillette Company Inc. by Procter & Gamble in 2005, to extend its market in the consumer product industry (Campbell, Stonehouse and Houston, 2002: 214-215). c. Categories of mergers and acquisitions As is mentioned earlier, the mergers and acquisitions have various expressions that are interchangeably used in different countries.
Some common terms used for expressing the M&A activities are “takeover, transaction, consolidation, concentration, fusion, amalgamation, business combination, tender and sell-off” (Wubben, 2007:5). Needless to say the different terms are used in different contexts, and are based on the reasons why a particular merger or acquisition takes place. Hence, the M&As can be divided used various criteria which are shown in detail in the Figure – 2 below. Figure – 2, Criteria for categorizing mergers and acquisitions (Wubben, 2007:7) Each of the criteria for the categorization of mergers and acquisitions will be discussed below.
i. Based on strategic direction – Based on the strategic direction of the company i. e. the company’s focus on the business sector, product segment, it might decide to go in for mergers and acquisitions which can be divided into the following: ?. Horizontal – This type of transaction occurs between two companies who operate in the same lines of business. The expansions that result are into similar or related product lines. Usually the companies that opt for such a transaction are competitors of each other and have an aim to achieve greater market coverage by consolidating the resources.
This implies that the strategic behaviors of the merging companies can be coordinated. An aim behind the mergers is also reducing the intensity of competition. This is even more important if there are already entry barriers in the business (Green, 1990:18-19). The horizontal merger can be further divided into two: market extension mergers, which involve the same products but in a different geographical region and the product extension merger which consists of merging with a company that manufactures a similar but not identical product.
An example of horizontal merger is the trend in the bank and building society mergers and between Chevron and Texaco (Weston and Weaver, 2004:12). ?. Vertical – This type of transaction occurs when one entity is acquired by another. Both the companies are usually at a different level in the supply chain. Usually the aim behind vertical transactions is to reduce uncertainty and transaction costs in forwards and backward linkages in the supply chain. That is to say vertical transactions usually involve companies that are both supplier and producer or producer or retailer.
In case of a forward integration in the supply chain, the acquiring firm attempts to ensure a continuous demand for its product, an example being the acquiring of stationery firms or publishing firms by a paper producer to guarantee a market for its end product. In case of a backward integration in the supply chain, the acquiring firm attempts to eliminate the vagaries associated by depending on any particular supplier thus ensuring continuous supply of raw materials, an example being the acquiring of textile mills by a clothing manufacturer to guarantee continuous input for its product (Green, 1990:19).
As can be seen, mainly such deals aim to improve the client-supplier or buyer-seller relationships. The acquiring company’s aim is usually to increase its control over more sources of supply and distribution. An example of a vertical transaction is the of UL breweries who have moved with full vigor towards the distribution of their products via public houses, and between AOL and Time Warner (Weston and Weaver, 2004:12). ?. Conglomerate – A conglomerate of companies is formed when two companies in unrelated in business combine. The main aim behind such mergers is to benefit from economies of scope and to diversify risk.
Such transactions were popular in the 1980s, but they have not been so much popular post 1990s as the companies have had an increasing tendency to shift their focus back on their core businesses to cope up with the increasing international competition (Green, 1990:20). A variation of this type of merger is the concentric transactions where the acquired company operated in the same market as the acquiring firm but has a product of technology portfolio that is total unrelated to that of the acquiring firm i. e. market concentric, or has a similar product of technology portfolio but in an unrelated market i.
e. technology concentric. For e. g. the acquisition activities of Tyco international (Weston and Weaver, 2004:12). ii. Based on Acquisition structure – Acquisition structure is probably one of the most fundamental issues while structuring an acquisition. There are two types of deals that may emerge are given below: ?. Purchase of assets – This type of deal happens when the target is a division of an already existing corporate group and not a separate legal identity, also when the deal involves only a part of the business not an entire product line.
At times such a deal might also result when a company wishes to avoid taking on all the liabilities of the target company. Assets can be tangible e. g. plant, equipment etc. or intangible e. g. intellectual property, corporate name etc. (Swartz and Lee, 2007:7). In case of asset purchase there is the possibility that the acquiring company can purchase only as much of the company as it desires, and in addition the acquiring company usually does not inherit the previous liabilities of the target company. Even the loss making operations can be selectively absorbed to use them for tax purposes.
However, such transaction are usually time consuming because of asset identification process and the acquiring company usually pays more for the part of the company, than it would in case of a share deal (Schneeman, 2002:415). ?. Purchase of shares – Purchasing shares or stock is the most common form of merger or acquisition. Such a transaction involves purchasing all or substantially all of the outstanding stocks of a corporation either by an individual, a group of individuals or more commonly another corporation.
The target corporation usually becomes a subsidiary of the acquiring company or it is merged in to the acquiring company (Swartz and Lee, 2007:7). The main advantage of this type of transaction is the lower capital outlay and hence it is more attractive to the shareholders. However, here the acquiring company is liable for any previous claims or liabilities of the acquired company. The transaction also becomes difficult in case the number of shareholders is large (Schneeman, 2002:415).
iii. Based on status of target – The legal status of target, given below, has a significant impact on the acquisition process especially when the transaction is a share deal. ?. Publicly owned – If the target company is publicly owned, the acquisition of shares requires compliance with federal and state securities laws and is potentially vulnerable to competing offers from third parties. Hence, such a transaction is more complicated (Wubben, 2007:10). ?.
Privately owned – Privately owned companies have a possibility of much smoother M&A transaction, because the legalities involved are significantly lesser. However, there are certain additional contractual provisions that apply to shareholders of a privately held company such as warranties and indemnifications or earn-out provisions etc (Wubben, 2007:10). iv. Based on attitude – This differentiation comes into existence when the merger or usually acquisition is sought by the acquiring company, and is as given below: ?.
Friendly transaction – Such types of transactions usually start with negotiations between both acquiring and potentially acquired companies and typically end in a letter of intent signed by both the parties and the approval of a board of directors (Wubben, 2007:10). ?. Hostile transaction – This type of transactions are usually an offer to buy the shares of a public company without prior knowledge and consent of the target company’s board of directors. Hence, the transaction is usually against the wishes of the target company.
It is usually observed that the price premium paid during a hostile takeover is higher than in case of a friendly transaction, usually as a means to transform the hostility of the target into at least a reluctant acceptance (Wubben, 2007:10-11). v. Based on form of payment – Mergers and acquisitions can be paid for in the form of either cash or securities i. e. shares of the acquiring company as a kind of exchange offer. The most common motivation behind selecting either type of transaction is the tax implications.
Cash is usually taxable so many a times the target company’s shareholders might prefer stocks of the acquiring company. Another reason for offering a stock is also to ensure the interest and responsibility of the former company’s shareholders in the acquiring company’s growth and prosperity. On the other hand payment in the form of cash might be preferable in case the former shareholders desire a clean break, in addition to the fact that such transactions are usually simple (Wubben, 2007:11). vi.
Based on Financing – The above mentioned for of payment is also dependent on the financing possibilities that the acquiring company has and the corresponding implications on taxation for both the parties. If the preferable transaction payment is in the form of cash, the same might be generated either internally or externally in the form of borrowed cash. In case of stocks and securities, the offers are paid by either offering existing treasury shares or by issuing new shares. Payment for a business can be wholly or partially with debt and is usually known as seller financing (Shea, 1999: 37).
vii. Based on geographical focus – Another common way of categorizing mergers and acquisitions is based on geographical focus. The transactions can be either domestic or cross-border, based on whether the acquiring company and its target company have home operations in the same country or not. In case the transaction is a cross-border transaction, the complexity of deal increases with regards to both the legal aspects of the deal as well as the post-closing integration between the two companies because of the cultural barriers (Wubben, 2007:11).