The Risks that UK Coal Can Potentially Face in Undertaking Cross-Border Merger - Case Study Example

Section A You are required to critically evaluate the statement of “By simply acquiring a foreign company we can avoid a whole host of risks and concentrate on creating shareholder wealth” Your answer should display a knowledge of contemporary academic evidence regarding the success or failure of international Mergers and Acquisitions. This report provides a critical analysis of the risks that UK Coal, a FTSE listed company, can potentially face in undertaking cross-border merger and acquisition (M&A) activity. The report will also discuss the impacts foreign direct investment has on the host as well as home countries. Cross-border mergers and acquisitions are complex undertakings packaged with risks and rewards. When two organizations with different internal controls, management styles, corporate cultures and processes attempt to integrate, business risk increases substantially (ACL Services, 2002). Before embarking on M&A journey, it is imperative that all risk factors are considered prior to injecting capital in the host country. UK Coal needs to conduct due diligence so as to ensure that M&A activity fits its long-term strategic objectives. Due diligence identifies, confirms or disputes the business reasons for proposed merger or acquisition transactions. Due diligence demands a thorough data analysis of assets and liabilities, particularly large balance sheet items such as accounts receivable, inventory, and accounts payable to establish fair market value (ACL Services, 2002). It is imperative that a fair value for the business is accurately established so that a reasonable price is paid for the target assets. A careful analysis of the target company’s financial statements avoids incidents of overpaying and mismanaging shareholders’ expectations. Differences in corporate culture, business practices, and institutional layouts can hinder firms from fully realizing their potential. According to a KPMG study, 83 percent of all M&As failed to economically benefit the shareholders and over 50 percent actually destroyed value. A research was conducted involving over 100 senior managers to determine the reason behind this failure which turned out to be the cultural differences (Shimizu, Hitt, Vaidyanath, Pisano, 2004). In pursuing a cross-border M&A, it is vital for an organization to assess the political situation prevailing in the target country. This assessment will not only uncover any potential political risks but also prepare the host company to face them and find appropriate solutions for them. Another potential barrier to a successful M&A activity is lack of knowledge about the target company. Knowledge about the company leads to a successful post-merger integration. Another factor that should be taken into account is the effects of trade impediments on cross border M&A. Academic studies have found that on an aggregate basis, trade costs affect merger activity negatively, though the effect is less pronounced for horizontal mergers, i.e. mergers between firms within the same industry (Hijzen, Gorg, Manchim, 2005). UK Coal needs to ensure that its target company is one which will lead not only to economical but also intercultural synergies between the two companies. To identify an appropriate acquisition target, aforementioned due diligence should be adequately employed. Moreover, UK Coal needs cognizance in matters relating to exchange rates, local accounting standards, foreign government potential trade regulations, etc. (Saavedra-Lim, 1998). UK Coal should have information regarding its local competitors in the host country and their respective market positions. This will lead to reasonable projections and estimates for the business. Expectations of UK Coal from this activity should be realistic and in parity with the overall strategy formulated at the design stage. Regulatory aspects also need attention to avoid any legal risks. Competent professionals (lawyers, accountants) must be hired to provide financial and legal opinions regarding the merger or acquisition transaction. Having conducted the above risk analysis, managers can place themselves in a position to thoroughly understand the value of the M&A activity they are undertaking. Failing to understand these risks can demolish the much-touted synergies of consolidating two entities. Poorly executed mergers and acquisitions can lead to steep declines in the UK Coal’s share prices. Section B You are required to critically discuss, with reference to your chosen company, how an international company can evaluate and prepare for the risks which accompany international investment. International investment requires an examination of inherent risks. These risks can entail foreign exchange, political, regulatory, social, and expropriation risk. Prior to making a significant capital contribution to a foreign country, UK Coal needs awareness of the various risks involved. A proper approach to conducting risk analysis should be employed. For example, a top-down approach which analyses the overall economy, industry group and finally the company. On the other hand, a bottom-up approach starts at the company level and works its way up to industry and the country analysis. Analyzing the risk inherent in a country involves examining the prevailing economic policy and the political environment. Political environment and economic cycle affect overall investment scenario in a country. For example, a politically stable country attracts foreign direct investments. Moreover, an expanding economy is a catalyst for foreign investments. Industry analysis involves analyzing prevailing trends in a particular industry, analyzing competitors, and identifying opportunities and threats in the industry. Analysis at the company level is about product diversity, local experience, and market position. Social risk involves intercultural differences. Employees of companies have professional values and preferences regarding the way activities are carried out (Gitelson, Bing, Laroche, 2001). It is the human factor that can literally lead to the success or failure of a particular organization. So the question arises if two different corporate cultures can successfully amalgamate to maximize shareholder value for the company. Cultural risk in an organization justifies reasons for expenditure on training programs whereby people from different backgrounds are brought together and taught cultural values to boost performance. Foreign exchange matters require attention to reduce losses in revenues that can arise from foreign exchange deterioration (Erb, Harvey, Viskanta, 1996). UK Coal needs to take into consideration foreign exchange risks and make reasonable cash flow projections so as to avoid overestimation and, in turn, overstated revenues. Furthermore, tax risk should also be considered in international investments. Assessing the tax impact of cross-border transactions is a complicated task, however, is significant in terms of establishing revenue projections. For example, high taxes can lead to reduced profits and lower earnings per share for a company’s shareholders. This is the implied cost of cross-border investments and needs to be highlighted at the planning stage. UK Coal, headquartered in the UK, is characterized by a favourable corporate taxation environment. Management of UK Coal should seek geographical diversification in countries characterized by low taxes. Risk related to regulation involves consideration of any potential governance that the country may have on the international investment. To mitigate such risks, services of professionals should be hired for sound guidance on regulatory matters. It would be a good idea to seek reports on the country’s riskiness which would give a fair idea about its political and regulatory environment. Expropriation is another form of risk encountered in international investments whereby a private business is seized from its owner. Though rarely occurring, this risk is enhanced in countries that lack well-defined property laws. Summing the above information, before undertaking international investment it is crucial to examine the risks that can potentially offset the benefits achieved from geographical diversification. REFERENCES ACL Services , 2002. Mergers and Acquisitions www.acl.com. Erb, Claude B., Campbell R. Harvey and Tadas E. Viskanta, 1996, Political Risk, Economic Risk and Financial Risk Financial Analysts Journal. Gitelson, G., Bing, J.W., Laroche, L., 2001. The Impact of Culture on Mergers & Acquisitions CMA Management, 251-266 *Hijzen, A., Gorg, H., Manchim, M., 2005. Cross-Border Mergers and Acquisitions and the Role of Trade Costs. GEP Research Paper 05/17, University of Nottingham. Saavedra-Lim, F., 1998. Mergers and Acquisitions: A Perspective of Associated Risks Credit and Portfolio Management Division, Pitney Bowes Financial Services. Shimizu, K., Hitt, M.A., Vaidyanath, D., Pisano, V., 2004. Theoretical Foundations of Cross-Border Mergers and Acquisitions: A Review of Current Research and Recommendations for the Future. Journal Of International Management J. 10, 307-353 Read More