Mergers & Acquisitions - Essay Example

?Mergers & Acquisitions Table of Contents Mergers & Acquisitions Table of Contents 2 Introduction 3 Types of Mergers and Acquisition 3 Mergers and Acquisitions in United Kingdom 5 Issues in Cross Border Mergers and Acquisitions: In the light of theory and evidence 6 Human Resources & Cultural Issues 7 Valuation Issues in Mergers and Acquisitions 8 Accounting Issues in Mergers and Acquisitions 11 Conclusion 12 Reference 14 Bibliography 18 Introduction “Mergers and acquisitions represent the ultimate in change for a business. No other event is more difficult, challenging, or chaotic as a merger and acquisition. It is imperative that everyone involved in the process has a clear understanding of how the process works” (Evans, 2000, p.2). Since the past decade, the globalisation of the businesses across the globe has initiated a search for the competitive advantage, worldwide. With the increased competition to fetch the customer satisfaction in a cost effective way, the companies have responded to the pressure of attaining scale in a quickly consolidating global economy. In addition to some other trends, such as privatisation, deregulation and corporate restructuring, globalisation has encouraged an unparalleled surge in the cross border merger and the acquisition activities (Finkelstein, n.d.). Cross border consolidation activities are a significant component of global business operations (Cartwright & Price, n.d.). This report will look into the mergers and acquisitions of companies in the light of current issues. For better understanding, the analysis would be done in the light of relevant theories and applications with the mention of specific examples in the arena of merger and acquisitions. Types of Mergers and Acquisition Through ‘merger’, two companies would join together to create a new company. Acquisition refers to one company taking over the assets of another company. Merger and acquisition can be of three types: Horizontal, Vertical and Conglomerate. In horizontal mergers and acquisitions, two firms, involved, deal across similar products and services. This type of mergers and acquisitions is frequently used as the mean for an organisation to enhance the market share through getting into merger with a competing firm or by acquiring the same. For an instance, consolidation among Mobil and Exxon would allow these companies to attain a large chunk of share in the oil and gas market. Vertical mergers and acquisitions happen when two organisations are merged through the value-chain, such as any manufacturer firm merging with one supplier or a manufacturer acquiring its supplier firm. Vertical consolidation processes are mostly used as significant mean to gain the competitive advantage in the respective marketplace by leveraging on the value chain. For an instance, Merck, a leading pharmaceuticals manufacturer, merged with the leading pharmaceuticals distributor, Medco. This was done to fetch the benefits in products distribution. Consolidations are conglomerate when two firms from entirely dissimilar industries merge. For an instance, a gas pipeline organisation merging with high technology organisation or acquiring the same can be seemed as a conglomerate merger. Conglomerates are mostly used as significant mean to smooth out broad fluctuations in the revenue amount and offer more constancy in the growth in long-term. Typically, organisations in the mature industries which have poor growth prospects would seek to broaden their businesses horizons through mergers and acquisitions. For an instance, General Electric has diversified its business through merger and acquisition activities. GE has got into new segments like television broadcasting and financial services through a number of mergers and acquisitions of the financial services and entertainment organisations. Mergers and Acquisitions in United Kingdom United Kingdom has been the host of a number of mergers and acquisitions. The value of UK domestic acquisitions in the third quarter, 2010, amounted to ?2.6 billion which is slightly up from ?2.1 billion from the previous quarter. In the year 2008, the number of such acquisitions was around 558 leading to a value of ?36.5 billion. However, in the next year, it was drastically reduced to 286 domestic acquisitions. Till the third quarter of 2010, there were 209 such domestic acquisitions took place in UK. A number of cross border acquisitions happened involving the UK companies. The value of acquisitions in the UK by the foreign firms is around ?12.0 billion in the third quarter, 2010. This was an increase from a value of ?2.7 billion in the second quarter 2010. In the year 2008, 252 UK companies were acquired by the foreign companies leading to a value of 52.6. In the year 2009, the number was as less as 112 leading to almost the half the value generation happened in the last year. In the third quarter of 2010, the number of acquisitions in UK by the foreign firms has increased to 51 from 43 in the last quarter and at the same time the value has increased by almost 5 times that the previous quarter figure. UK companies have also acquired a number of foreign companies. Expenditure on the cross border acquisitions by the UK firms increased from ?2.4 billion in second quarter 2010 to ?5.0 billion in the third quarter, 2010, the highest quarterly value since quarter two in the year 2008. There were such 298 cross border acquisitions in 2008. In 2009, the figure was as dimming as 118 leading to a one third value generation of that happened in the previous year. In the quarter three 2010, the number of such acquisitions happened is less than that of previous quarter, however, the value creation was almost twice as that happened in the previous quarter. Among all of these, one of the significant events was the acquisition of subsidiaries of East Resources Inc by Royal Dutch Shell Plc, leading to a value of around ?3.3 billion (Office for National Statistics, 2010) Issues in Cross Border Mergers and Acquisitions: In the light of theory and evidence There can be a number of issues arising in the cross border acquisitions in various countries. There can be structural barriers including statutory, regulatory and infrastructural issues. Strong power of the supervisory boards, the union and worker’s councils can have serious say on the acquisition process and can possess strong redundancy rights. Some countries have discriminatory taxation rules against the foreign acquiring firms. This may impact on the profitability of the consolidated firm. Regulatory issues can emerge from antitrust regulation, stock exchange rules, foreign investment review and professional self regulatory bodies. Infrastructural issues such as absence of legal and investment banking services can create issue in the acquisition process (Sudi, 2003). Apart from this, there can be significant financial and cultural issues in cross border mergers and acquisition processes. According to a KPMG study, "83% of all mergers and acquisitions (M&As) failed to produce any benefit for the shareholders and over half actually destroyed value" (Gitelson, Bing & Laroche, 2001). This has been done taking the responses of more than 100 senior executives who have been involved with around 700 deals in some two-year. This has revealed that the significant reason of the failure has been the human resource and cultural differences. Issues encountered in the mergers and acquisitions are augmented in the cross-cultural situations, when the firms are from various diverse countries. Human Resources & Cultural Issues It is very much important to handle the Human Resource issues with more responsibility and this can only possible when the respective department would have timely access to all the relevant information. However, issues arise when the human resource department is not indulged into the decision making process in cross border acquisitions and thereafter, they are asked to execute the merger and handle all the human related issues. Secondly the target companies may not fully reveal its personal data or even sometimes medium sized businesses do not have meaningful human resource reporting systems. In such a case, the management may face enough difficulty in the integration of the human resource strategy. The issues seem to be arising in the following three stages: Premerger stage, Merger stage and Post merger integration (Bohlin, Daley & Thomson, n.d.). The first step towards any cultural integration is surely carrying out a detailed study of the cultural dimensions of the two countries. The integration of the cultural environment is to work out the strategy for an effective post merger. The human resource team must make a meticulous cultural assessment of the consolidating corporations regarding to the cultural values and practices and at the same time suggest action plan for the firms’ post merger performance (Pinto & Balakrishna, 2006). After the bankruptcy of Lehman Brothers in the end of 2008, Nomura acquired the company’s Asia Pacific and Europe franchise. Lehman Brothers has been one of the leading investment banks in USA, while Nomura is a leading financial institution of Japan. It would not be wrong to say that the cultures of two countries are quite different from one another. As expected, in the transition and post acquisition period, Nomura had to face certain cultural as well as human resource issues. However, Nomura handled it in its own way. Nomura has kept around 8000 former Lehman personnel with the appointment of three non-Japanese managers as Senior Managing Directors. Nomura did not promote only the Japanese bankers; rather, it put its effort to choose the right person for the right position (Cassim et.al., 2009). Valuation Issues in Mergers and Acquisitions One of the significant issues arising out of the acquisition planning and implementation is surely the valuation issues. It is pretty significant for the bidding company to have a fair idea about the financial state as well as the valuation of the company. The valuation is complicated because of the synergy issues which are pretty unique to the transactions. Another significant factor is the complex nature of the acquisition process and many stakeholders in there. According to the ‘Stakeholder Model’, a stakeholder is n individual or an organisation or institution which has a concern in the success of a business. The main stakeholders in a cross border acquisition include shareholders, customers, management, suppliers, employees, the local community and the regulatory or government agencies. The interest of the investors may be different from that of the employees. In such a case, it is pretty significant to find out ways to satisfy the various stakeholder interests and hence, it would be considerably important for the success of any consolidation process (Bized, 2006). One of the significant factors to consider in the preparation of the merger and acquisition valuation is surely the rationale for the transaction. This fundamental factor lays the groundwork for the valuation and would surely demand the identification of the value drivers, right from its beginning. There are certain reasons which drive the transactions. To create the value through the synergy of the consolidated firms. To diversify the business in order to minimize the risk To create value through restructuring and establishing better management processes The target firm is required to be valued according to the purposes behind the acquisition process and with the same the valuation methodology would also change respectively. For an instance, if the transaction is intended to create value through the synergy of the consolidated firms, then the target company must explore the operating and financial synergies of the combine firms. On the other side, if the target firm is considered as good investment, then the same must be assumed to be a standalone entity and it must be compared to its market value or else it could be compared to its per share price on the public exchange. If the bidding firm is seeking to broaden its horizons to diversify the risk, then the cost of capital of the target firm would be investigated for the effect on the consolidated firms (Hunt, 2009). In a number of cases, the valuation technique for the mergers and acquisitions is pretty similar to the other valuation methodologies for a number of purposes. Influential factors which can create the valuation issues are standard of value in any transaction, acquisition premiums versus control premiums, value of synergy, cost of capital in any transaction, accounting issues in the consolidated businesses and fair price analysis (Ferguson, 2003). Certain theories are discussed here to understand the valuation issues in the cross border acquisition processes. Undoubtedly, calculation of the fair market value of target firm is going to be tough as the target firm would have more knowledge than the bidding firm. Despite of all these facts the fair market value is assumed to be the standard value in any transaction. To reach at the fair value, certain assumptions are required to taken into account. However, it is pretty important that the assumptions must be appropriate to the condition of the respective firm (Reilly & Schweihs, 1999). Another value which is considered in the mergers and acquisition is the firm’s intrinsic value. The intrinsic value estimation is done through a discounted cash flow analysis and comparing the same with publicly traded price of the company. Realising the intrinsic value of the target can help the bidding firm to decide on the price of the transaction while placing an initial offer (Rezaee, 2001). There is another value, ‘Investment value’ which is also an important concept in the valuation of mergers and acquisitions. The investment value is realised based on the individual investment requirements and the expectations. Investment value is pretty different from both the fair value and the intrinsic value. This is due to the fact that the calculation of investment value takes benefits particular to the specific transactions into account. Under the investment value, the synergies fetched from the transaction itself are taken into account while determining the value of the target firms (Gole & Morris, 2007). One of the complex but significant concept in the mergers and acquisition is the estimation of potential value of synergies, resulting in enhanced cash flow more than the two firms could have been able to generate individually. Another significant difficulty is to determine the appropriate cost of capital to value the target entity. A number of large and successful bidding firms prefer the internal benchmark rate of return or the hurdle rate as the estimated cost of capital. There is key rationale behind such assumption. The rationale is that the hurdle rate is the rate of return, which is required by the bidding firm’s shareholders to increase shareholders’ wealth. However, the estimation of cost of capital in the pricing of the target firms must reflect the relative risk of the target firms rather than the risk of the bidding firms (Hitcher, 2003). Accounting Issues in Mergers and Acquisitions A number of accounting issues in the mergers and acquisitions may arise when a company acquires a firm in any foreign location. These issues arise due to the requirements of aligning the company’s business in accordance to the local accounting standards. The issues may also arise due to the differences in the accounting standards of the two countries. For an instance, if a UK Company acquires an US firm, financial reporting in case of business combinations and other intangible assets is required to be taken into account. According to US accounting standards, the purchase method of accounting is considered; however, the pooling of interest would no longer be allowed. In the process, goodwill would no longer be amortized (Appraisal Economics Inc, 2011). There are many research papers have been introduced taking the data of the UK companies. A research was done to evaluate whether the takeovers can create enough value for the acquiring company. The research has been carried out using the residual income approach of valuation. The methodology considers this by employing residual income approach to the valuation and by comparing present value of the bidding firm’s future profits prior to acquisition with the results following the acquisitions. The cost of the acquisition, the earnings and the bidding firms’ cost of capital which are introduced beyond sample period are taken into consideration. A comprehensive sample of 386 acquisitions happened during the period 1985-1996 (Bild, Guest, Cosh & Runsten, 2002). Using traditional accounting method, researchers have found out that acquisition activities result in significant enhancement in the acquiring firm’s profitability. However, the research has also discovered that on an average, acquisition processes destroy around 30 percent of pre-acquisition value of the bidding firm. It was also found that the merger has significant positive effect on return on equity of the firm. The difference in the pre and post acquisition period is not driven by reduced returns on equity. However, it is driven by the subtraction of goodwill expenditure, which has not been capitalized at the acquisition time (Bild, Guest, Cosh & Runsten, 2002; Capron & Shen, 2007). Tata Motors acquired Jaguar Land Rover in the year 2008. Once the acquisition was over, Tata Motors found itself with a huge debt burden. Earlier to that, Tata Motors had pretty low debt amount. However, following the acquisition, the company was in a liquidity issue with a considerable amount of debt in its portfolio. However, Tata is quite hopeful regarding the deal as it thinks inclusion of JLR would help the organization to enhance its cash flow in the coming future (Sood, Seth & John, 2010). Conclusion Although, there are a number of issues leading to a significant number of merger and acquisition failure. However, that does not mean that merger and acquisition success is not possible. However, to be the part of few companies, which succeed rather than major chunk which fails to deliver, would demand enough insight into the relevant factors and environmental considerations. The success of consolidation process is based on concentration, acceleration and adaption to the changing environment, be it political, economic, social, technological, legal or environmental. The merger and acquisition transactions are primarily financial including the valuation of assets, deciding on the due diligence and price before the merger. However, there is high possibility that the financially driven event would become a transaction of human resource filled with anguish, disturbance and survival behaviour. There are a number of pitfalls of merger and acquisition events. All the pitfalls of such events would throw a challenge to the leaders towards an enhanced standard of managing the changes. The situation demands the strategy to be clear, concentrate, accelerate and adapt. Apart from that, in the cross border acquisitions, the cultural differences must be taken into account. The financial, cultural and human issues which differentiate among the successful and the remaining are not based on the abstract values, rather on the strong reality of productivity, sustained growth and enhanced economic value. Reference Appraisal Economics Inc. 2011. Goodwill and Other Impairment. [Online]. Available at: http://www.appraisaleconomics.com/goodwill_imp.html [Accessed on March 07, 2011]. Barbradozier. No Date. Mergers and Acquisitions: Daimler AG & Chrysler Group. [Online]. Available at: http://barbradozier.wordpress.com/2010/05/28/mergers-and-acquisitions-daimler-ag-chrysler-group/ [Accessed on March 04, 2011]. Bild, M. Guest, P. Cosh, A. & Runsten, M. December, 2002. Do Takeovers Create Value? A Residual Income Approach on U.K. Data. [Pdf]. Available at: http://www.cbr.cam.ac.uk/pdf/WP252.pdf [Accessed on March 01, 2011]. Bized. December, 2006. Mergers and Acquisitions: In whose interest?. [Online]. Available at: http://www.bized.co.uk/current/mind/2006_7/041206.htm [Accessed on March 01, 2011]. Business World. August, 2004. The road to Gunsan Tata Motors' acquisition of the Daewoo plant in Korea is more than just a deal. It is a stepping stone to global markets. Here's how India's biggest automotive player is going places. [Online]. Available at: http://www.tata.com/company/Media/inside.aspx?artid=nSv1PBMj0ns= [Accessed on March 07, 2011]. Capron, L. & Shen, C. J. 2007. Acquisitions of Private vs. Public Firms: Private Information, Target Selection, and Acquirer Returns. [Pdf]. Available at: http://www.insead.edu/facultyresearch/faculty/personal/lcapron/research/documents/acquisitionsofprivatevspublicfirms.pdf [Accessed on March 07, 2011]. Cassim, F., Rivera, K., Rebib, R., Reuber, T. & Wannaprapa, K. May, 2009. The Bankruptcy of Lehman Brothers and its Acquisition by Nomura. [Pdf]. Available at: http://n.ethz.ch/student/rebibr/projects/Lehman-Nomura.pdf [Accessed on March 10, 2011]. Cartwright, S. & Price, F. No Date. Managerial preferences in International Merger and Acquisition Partners Revisited: How Are They Influenced? [Pdf]. Available at: http://www.xs4all.nl/~karhen/Papers/2/Managerial%20preferences%20in%20international%20mergers%20and%20acquisition%20partners%20revisited%20-%20how%20are%20they%20influenced.pdf [Accessed on March 01, 2011]. Evans, H. M. March, 2000. Course 7: Mergers & Acquisitions (Part 1). [Pdf]. Available at: http://www.exinfm.com/training/pdfiles/course07-1.pdf [Accessed on March 01, 2011]. Ferguson, S. 2003. Financial analysis of M&A integration. McGraw-Hill Professional. Finkelstein, S. No Date. Cross-Border Mergers and Acquisitions. [Pdf]. Available at: http://mba.tuck.dartmouth.edu/pages/faculty/syd.finkelstein/articles/Cross_Border.pdf [Accessed on March 01, 2011]. Gitelson, G. Bing, J. & Laroche, L. 2001. The Impact of Culture on Mergers & Acquisitions. [Online]. Available at: http://www.itapintl.com/facultyandresources/articlelibrarymain/the-impact-of-culture-on-mergers-a-acquisitions.html Accessed on March 01, 2011]. Gole, J. W. & Morris, M. J. 2007. Mergers and acquisitions: business strategies for accountants. John Wiley and Sons. Hitcher, J. 2003. Financial valuation: applications and models. John Wiley & Sons. Hunt, A. P. 2009. Structuring mergers & acquisitions: a guide to creating shareholder value. Aspen Publishers Online. Office for National Statistics. December, 2010. Mergers and acquisitions involving UK companies. [Pdf]. Available at: http://www.statistics.gov.uk/pdfdir/ma1210.pdf [Accessed on March 01, 2011]. Pinto, P. & Balakrishna. December, 2006. Mergers and Acquisitions. [Pdf]. Available at: http://dspace.scmsgroup.org/bitstream/handle/10562/573/article%20.pdf?sequence=1 [Accessed on March 01, 2011]. Reilly, F. R. & Schweihs, P. R. 1999. Valuing intangible assets. McGraw-Hill Professional. Rezaee, Z. 2001. Financial institutions, valuations, mergers, and acquisitions: the fair value approach. John Wiley and Sons. Sood, V., Seth, S. & John, S. November 14, 2010. How Tata Motors turned JLR around. [Online]. Available at: http://www.livemint.com/2010/11/14211117/How-Tata-Motors-turned-JLR-aro.html [Accessed on March 10, 2011]. Sudi, S. 2003. Creating Value from Mergers and Acquisitions. Pearson Education. Bibliography Arnold, G. 2002. Corporate Financial Management, 2nd Edition. Prentice Hall Brealey, R.A. and Myers, S.C. 2000. Principles of Corporate Finance, 6th Edition. McGraw-Hill International Damodaran, A. 2001. Corporate Finance: Theory and Practice, 2nd Edition. John Wiley & Sons. Sudarsanam, S. P. 2003. Creating Value from Mergers and Acquisitions, 1st Edition. FT Prentice Hall. Read More