How to Merge Two Companies - Essay Example

How to Merge Two Companies? Introduction: The term merger refers to combining two companies into one. In other words, one can state that it is the process of forming a new company by combining two companies. For example, if there are two companies namely company ‘A’ and company ‘B’, both these companies can be combined together to form a new company called company ‘C’. Reasons for Merger: There are a variety of reasons why mergers take place in business. Synergy: Synergy is one of the important reasons for the merger of two companies. Here synergy refers to combining two companies in order to increase their value. For example, if company ‘A’ is merged with company ‘B’, then the resultant company, say company ‘C’, should have the value more than the individual values of the company ‘A’ and company ‘B’. If the merger does not result in increasing the value of the new company, then there is no presence of synergy and the merger will be ineffective. Tax Consideration: A strategic merger can reduce the tax burden by benefiting the statutes and loopholes in law. As there is cash outflow in merger, taxable amount of profit will come down. Another chance of tax saving is that if a company running in losses merges with a profit making company, there will be set off of losses and ultimately it will result in tax saving for the profit making company. Purchase of Assets below their Replacement Cost: Sometimes the replacement cost of an asset may be higher compared to market price. Merger helps in purchasing asset at a price below their cost of replacement. Diversification: Diversification helps in improving the operations of the organization. Sometimes the company may be interested in diversifying its operation to be more profitable and competitive in a highly competitive market place. Managers’ Personal Incentives: Some mergers happen only out of the sole discretion of the managers. In most of the cases merger can result in increasing the value of the new company. That may result in increasing the salary of higher level managers. If they think that they will be monetarily or non-monetarily benefited if the merger happens then they will implement the merger. Break-up Value: If the company a and company b is going to merge into company c then the value of company A and company B if they are taken separately is known as break-up value. If the break-up value is more than market value the merger or acquisition will have a better result. Types of Mergers: There are four types of mergers and they are explained below. Horizontal Merger: If the two companies doing the same business or deal in similar or complimentary products, merge to form a new company, then the merger is called horizontal merger. A soft drink company may merge with a sugar manufacturer for increasing synergy. Vertical Merger: A vertical merger can be explained with the help of an example. If Company ‘A’ is using the finished product of company ‘B’, then the merger of company A with the company ‘B’ to form a new company say Company ‘C’ is called vertical merger. Congeneric Merger: If there is a relationship other than vertical or horizontal between two companies, then the merger of these two companies is called as congeneric merger. Conglomerate Merger: The merger of two companies having no direct or indirect relation with each other, then the merger is called conglomerate merger. Procedure for Merger of Companies: The process of merger involves systematic procedure. A resolution must be passed by the Board of Directors of the companies involved in merger. The resolution includes the companies which are included in merger, what would be the name of the new company, the treatment of the shares of the share holders and any other agreement which the companies entered into…etc. The shareholders of each of the companies to be merged will be called for a meeting for the discussion and approval of the merger. In the meeting if gets approved, then the directors will sign the documents and papers then it will be submitted to the concerned Government authority. After scrutinizing the files if they are satisfied with the papers and documents they will issue a certificate of merger and ultimately the new company comes into existence. “Some statutes permit the directors to abandon the plan at any point up to the filing of the final papers. States with the most liberal corporation laws permit a surviving corporation to absorb another company by merger without submitting the plan to its shareholders for approval unless otherwise required in its certificate of incorporation.” (Methods by Which Corporations Legally Unify Ownership of Assets Formerly Subject to Separate Controls: Corporate Merger Procedures. 2009). In cases the merger involves companies headquartered in different states or countries, the statures of all concerned states and countries will apply. The Future of Mergers and acquisition Though there are a number of factors which influence the merger and acquisition market is the important among them. “The late 1990s saw an unprecedented influx in mergers. In 1999, companies filed a record 4,700 Hart-Scott-Rodino filings, about three times the number received in 1995. The total dollar value of the mergers announced in 1998—$11 trillion—was ten times the amount since 1992.” (Methods by Which Corporations Legally Unify Ownership of Assets Formerly Subject to Separate Controls: The Future of Mergers and Acquisition. 2009). Now days due to financial crisis, so many mergers, and acquisitions are happening in the world. The main way that corporations look at expansion is through this method. The trouble taken to find new markets and also to build a company from scratch can be avoided thought this practice. The trend was first started in United States of America but it is now spreading all over the world. Initially it affected only big companies but now it started to move to the lower sections of the world economies. The Case Study: The case study given is the merger of the two companies namely Gas Natural SDG, S.A. and Endesa S.A. The merger of two companies is a complicated with regard to the reasons for merger, advantages and disadvantages to the company, shareholders and public. In the case of a merger, a joining or mixing of assets takes place and they include factors like, IT, employees and customers in order to create a stronger and powerful company which will be beneficial to share holders. A merger rises some questions like will it decrease competition, will itn give any benefit to the public. The merger sometimes may result in becoming the position of customers worse in such a way that either there will be increase in the price of the products or decrease in the quality. All these things are analyzed in this case study. These two are not competors, and both belong to different markets in one sense. The complication in this case is that technically, both Gas Natrual and Endesa belong to the energy sector since one the first one is an electricity producer and supplier while the latter is an oil company. The complication mentioned above will rise to the fact that oil can be used to generate power. With regard to theory on mergers and acquisitions, the merger is a vertical one. The merger can be said to be legitimate as per the directives of the European Union. As per 2004 Union directives, the new entity can now do business in both power and gas. Now the issue becomes more complicated since this will classify the merger as having the characteristics of both vertical and horizontal integration. It should be noted that though the two products gas and electricity appear to be quite different, they share certain qualities that make each of them a substitute for the other. In certain cases they are also complimentary to each other. This is because there are electricity generators that use natural gas as fuel. This factor makes both the products complimentary to each other. An instance where they can be called substitutes is also given here. Both gas and electricity can be used to cook food in the kitchen. The two companies had their own justifications regarding the merger. Gas Natural argued that the merger will be beneficial to the consumer since the resulting entity became one of the largest privately owned utility companies in the world. The merger will only result in giving better quality and prices to the end consumer and hence the merger is justified. Endesa who was against the acquisition argued that the merger will result in the new entity focusing only within the geographical boundaries in Spain. This would be against prudent economic policy since it is always advisable for large corporations to expand beyond current markets. Otherwise growth will be compromised. The argument of Endesa was based on the following presumptions of economic theory as put forth by Williamson in his work “Economies as an Antitrust Defence: The Welfare Tradeoffs”. According to him, “There is no presumption in economics against the merger of large gas and electricity companies. Economic theory and evidence do not justify claims suggesting that the combination of two large companies is necessarily bad for consumer welfare.” (Overview. p.1). Gas Natural had made a hostile acquisition bid on Endesa for 22 billion Euro and created a controversy within Spain and the European Union. The bid was approved narrowly by the Spanish regulatory authority CNE, by a margin of one vote, five voting for the deal and four against it. The main concern was with the electricity or power sector rather than the gas sector. Electricity is seen as having inelastic demand. Hence “In order to protect consumers, economic theory recommends that merger control in electricity markets should be more cautious and stringent than in other sectors. That is, the antitrust authorities should be more willing to risk imposing overly-stringent procompetetive remedies (type I errors) than to risk prescribing ineffective remedies (type II errors).” (Leveque and Glachant 2005). In mergers and acquisition theory and regulation, there are three types of errors that may occur. Type I error occurs when regulations are too stringent to allow any sort of merger where benefits to the end consumers may even be overlooked. Type II errors are where a remedy or regulations are too weak to control market activity. Type III error occurs when regulations are made, but are too late to prevent the merger. In this case, economic theory demands that a Type I error should exist in the case of mergers in the electricity or power sector. But the approval of the CNE (even thought narrow) shows that a Type II or even Type III error has occurred. Type II is mentioned because the authority did have the power to stop the takeover bid and Type III is mentioned because even the merger had already been approved. The European Union washed its hands off the whole affair saying that it is an internal matter concerning Spain only and it had no jurisdiction in the case. “In a blow to the board of Spanish power giant Endesa, Gas Natural's hostile takeover bid for the company has been waved through by the European authorities, despite concerns that the alliance will ultimately reduce competition in European energy markets.” (EU Backs Away From Endesa GN Fracas. 2005). This is despite the fact that the Unions opinion sided with the stand taken by Endesa. According to the Union, this was in violation of the principles of the Union and that the deal did not have a community dimension. The European Union also was of the view that the deal had created a duopoly in the country which was contrary to the policies of free trade practices. In effect the deal would create barriers of entry for new entrants into the field which may turn out to be detrimental to the consumers. There have been several studies on this particular acquisition since it was controversial and not many precedents have taken place in this regard. One example is a study titled “The Acquisition of Endesa by Gas Natural: An Anti-trust perceptive”. According to the authors François Lévêque and Jean-Michel Glachant the study was based on the opinions of economic professors and experts and raises three questions with regard to the merger. The first one was whether such acquisitions in the energy sector (and electricity in particular) was beneficial to the consumers. The answer given here was in the negative and gives three reasons why it may prove so. Any market in the modern world and especially in the Union should be considered free and should not create barriers for entry for new players. Only a market that has enough competition will provide real benefits (like decreased cost and increased efficiency) to the service. This deal has effectively created barriers to entry due to the existence of duopolistic tendencies in the market. Such entities may find the current market very attractive and hence will not have the initiative to move beyond national barriers into international arenas. This could reduce the operational efficiency of the entity due to complacency. It also appears that the holding of Endesa in other European markets were subject to divestiture. Such precedence will create suspicion among member states with regard to ethics. This will lead to lower levels of cooperation among member states whereas the need of the hour and the future is otherwise. High cooperation is required to be an efficient energy producer and manage. The second question was with regard to stringency of laws, a practice which is looked on with disfavour in the Union and in many markets of the world. As mentioned earlier in this paper, electricity demand is extremely inelastic and hence a monopoly organization can run increase power tariffs without a resulting decrease in demand. Moreover the Type I error (stringent laws against mergers that may ultimately prevent increased efficiency) will not be a factor here since increased efficiency through mergers is very difficult in the case of the electricity sector. Moreover, a type II error (which probably can happen here) due to not stopping the merger could prove detrimental to the consumers. The third question was with regard to factors detrimental to competition due to the merger. It should be noted here that an agreement between Endesa and Iberdola (another power utility) to transfer assets of the former to the latter had resulted in the formation of two powerful companies. This was the duopoly situation mentioned by the European Union in the earlier section of this paper. The answer to this question was that it could be detrimental to competition in the market. A collision between the merged company and Iberdola can result in excessive power to the companies which can prove damaging to the consumers who will have no alternative sources of power. The paper also gives more reasons why the merger is bad for the market and the consumer. “The market power of generators depends on whether for a given time (especially in peak hours) and a given place (in load pockets) a generator is indispensable to serve demand and to balance the system. Therefore, the unilateral effect of the merger greatly depends on the redistribution of plants.” (Leveque and Glachant 2005). On the whole the paper establishes that the merger was in contravention of anti-trust principles and hence could prove detrimental to consumers through increased costs and lack of alternatives. More articles and opinions echo some of the sentiments and opinions given in the above study especially with regard to market entry. According to an article in the Energy Business Review, “New foreign entrant would be deterred, as the regulated retail market in Spain given companies little ability to create an effective structural hedge.” (Gas Natural: Endesa Acquisition Approved But With Conditions. 2005). It would be worthwhile to see whether the merger would take place had it been under the jurisdiction of the European Union and not under the Spanish authorities. The fact that the Union had not approved of the deal even though it kept its hand off it has already been mentioned in the paper. But the situation can be analysed to other similar situations of merger though it does not deal with the power sector. But many of the other factors are present and hence a comparative study will be effective here. Three case studies that had various decisions will be taken into consideration. The first one involves the pharmaceutical sector. “Two large mergers in the pharmaceutical sector were notified to the European Commission: Sanofi /Synthélabo and Pfizer/Pharmacia. The European Commission concluded that both mergers could have an adverse impact on competition, limiting the choice of certain drugs available to patients.” (Examples of Mergers Examined By The European Commission. 2006). The decision was that the merged entities should transfer the rights to manufacture and sell of some products to competitors so that a balance will be restored. The second case involved a merger in the consumer goods sector. In the case of a proposed merger between Unilever and Bestfoods, the Commission came to the conclusion that certain food items like soups, pasta, jams, and other food items would face reduced competition as a result. The directive was the same as in the above two mergers in the pharmaceutical sector mentioned above. The merged entity was required to transfer approximately a billion dollars of existing business of the two companies to competitors. The case of a acquisition by Proctor & Gamble of a company called Wella also resulted in a situation where the Commission found that there could be reduced competition in certain hair care products in markets of Ireland, Sweden and Norway. The only difference here when compared to the above cases was that Proctor & Gamble on its own initiative agreed to sell some of its products to competitors which was agreed to by the Commission and the acquisition becoming approved. The third case involved the merger of two petroleum companies. The companies in question were two French giants, TotalFina and Elf Aquitaine. It was estimated that the merged entity would effectively control nearly sixty percent of the market share of automobile fuel and a majority control of liquefied petroleum gas. The same solution as in the case of the pharmaceutical case was followed here also. “This allowed the European Commission to give conditional clearance to the merger while ensuring that the French fuel markets remained competitive and that consumers continued to be charged fair prices.” (Examples of Mergers Examined By The European Commission: Merger of French Petroleum Companies. 2006). Substituting the case of the Gas Natural acquisition of Endesa into the Union context, the Commission would have probably approved the merger by directing that the company sell off some of its existing business to competitors as in the cases mentioned above. It should be noted that sale of assets of Endesa to a competitor Iberdola was done in the above case also. But the Commission would not have approved that as being satisfactory since the situation only resulted in the creation of an oligopoly as opposed to a monopoly. This situation is not better off to consumers since competition was not possible even then. Hence the Commission would have required Gas Natural to divest of some area of business to a larger number of competitors rather that to another single large entity. Conclusion: The merger or acquisition of Endesa by Gas Natural had been approved by the Spanish agency NCE to the dismay and protestation of the latter. The type of merger could be classified as vertical in this case. In all probability the acquisition would have been approved by the Supreme Court also. It was a decision that surprised many including the European Union. The general opinion of many studies, reviews and articles on this controversial issue have all come to the conclusion that the merger would be detrimental to the interests of the consumers and to the market. There would result a considerable threat to entry of competitors which is against the principles of free trade followed by the Union. In an era of globalization and open markets, such a merger of two companies would not have been acceptable in many countries and would have been approved only if conditions like the one mentioned about in the other case studies have been complied with. Bibliography EU Backs Away From Endesa GN Fracas. (2005). [online]. Goliath: Business Knowledge on Demand. Last accessed 11 January 2009 at: http://goliath.ecnext.com/coms2/gi_0199-5120493/EU-backs-away-from-Endesa.html Examples of Mergers Examined By The European Commission. (2006). [online]. Competition: Directorate General. Last accessed 11 January 2009 at: http://ec.europa.eu/competition/mergers/mergers.pdf Examples of Mergers Examined By The European Commission: Merger of French Petroleum Companies. (2006). [online]. Competition: Directorate General. Last accessed 11 January 2009 at: http://ec.europa.eu/competition/mergers/mergers.pdf Gas Natural: Endesa Acquisition Approved But With Conditions. (2005). [online]. Energy Business Review. Last accessed 11 January 2009 at: http://www.energy-business-review.com/article_feature.asp?guid=F51EBC02-1651-49EA-A943-AF820F806C28 LEVEQUE, Francois., and GLACHANT, Jean Michael. (2005). The Acquisition of Endesa by Gas Natural: An Antitrust Perspective. [online]. Microeconomix. Last accessed 11 January 2009 at: http://www.microeconomix.com/component/docman/doc_details/25-the-acquisition-of-endesa-by-gas-natural-an-antitrust-perspective.html Methods by Which Corporations Legally Unify Ownership of Assets Formerly Subject to Separate Controls: Corporate Merger Procedures. (2009). [online]. The Free Dictionary. Last accessed 11 January 2009 at: http://legal-dictionary.thefreedictionary.com/Corporate+merger Methods by Which Corporations Legally Unify Ownership of Assets Formerly Subject to Separate Controls: The Future of Mergers and Acquisition. (2009). [online]. The Free Dictionary. Last accessed 11 January 2009 at: http://legal-dictionary.thefreedictionary.com/Corporate+merger Overview. 1. Last accessed 11 January 2009 at: http://www.iaee08ist.org/DownloadAbstract.php?PI=125&T=1 Read More