Cross Border Mergers and Acquisitions - Essay Example

?Cross Border Mergers and Acquisitions Table of Contents Table of Contents 2 Introduction 3 Factors motivating cross border acquisition 3 Factors affecting cross border acquisition 7 Examples of Recent Successful Cross Border Acquisition 10 Acquisition of Zain By Bharti Airtel 10 Acquisition of Lehman Brothers by Nomura 11 Conclusion 12 Reference 13 Introduction The international acquisitions lead to internationalisation of intangible and tangible resources that requires time to build up through internal means and are often difficult to achieve through market based transactions. It has been seen that the value created is high for the target firms present in advanced institutional and economic environments. The advanced economies refer to the countries that possess resources of high quality. Aulakh et al (2000) have shown the modus operandi of the domestic firms that take part in the international resources acquisition. A study conducted by UNCTAD (2006) shows that 17 percent of the FDI in the world comprise South-North and South-South flows and of this the cross-border acquisitions occupy a significant proportion. This project would look into the cross border acquisitions with an insight into the reasons driving the acquisitions and influential factors impacting such acquisitions. Factors motivating cross border acquisition Various theories have been developed that explain the significance of the mergers and acquisitions. According to Efficiency theories the main motive behind such deals is to exploit the benefits arising out of synergies or economies of scale. Market power theories highlight that acquisitions lead to oligopoly benefits. Agency theories state that the acquisition and acquisition deals mitigate agency problems like removing the inefficient managerial staff. This theory also states that it may also give rise to agency problems such as imprudent managerial decisions solely guided by the motive of empire building. Besides this the acquisition deals are also guided by the advantages arising from the ‘benefits of diversification’. Though there is no single theory on mergers and acquisitions however these theories have garnered empirical support. Studies have shown that the shareholders of the target firm benefit the most in such deals whereas the shareholders of the bidder firm do not derive any immediate benefit from the deal. The abnormal return that that the bidders can enjoy is either slightly negative or zero. The combined return of the bidder-target firm is found to be universally positive indicating that the acquisition deals lead to value creation. It has also been seen that the stock price of the target firms’ exhibit higher returns in the case of cash offers as compared to the stock offers; hostile takeovers as compared to friendly takeovers; and multiple bidder as compared to contests by single bidders (Gregoriou & Neuhauser, 2007, p. 1). The success associated with the M&A deals has eluded many corporations. Marks & Mirvis (1998) state that the failure rates of such deals is around 50 to 75 percent. Despite the uncertainties associated with the deal the acquisition and acquisition deals are on the rise. The various benefits arising out of the deal include managerial synergies, cost synergies, market synergies etc. The sources of synergies include consolidated purchases, production, administration, marketing, market power, cross-selling, acquisition of technical expertise, patent, knowhow of the target, market expansion etc. In the horizontal acquisitions that involve integration of two companies belonging to the same sector the main motive is gaining market share of the target firm. This happens in the case of matured industries where the opportunities of growth are nearly exhausted, presence of excess capacity etc. Horizontal acquisitions result in enhanced revenue, savings in cost and better growth opportunities (Hitchner, 2006, p.106). The acquiring firm also gets a control over the customer base of the target firm thereby raising the total revenue base of the bidder firm. It may also be possible that the target firm has a good market reputation and therefore, the acquisition of the target firm will enable the bidder to capitalise on the name of the acquired firm. Even though this is the prime reason behind such deals the realisation of the ultimate benefits has been a matter of concern. As per the study conducted by Sherer & Ross regarding the link between market power and horizontal acquisitions the resulting gains are not very significant. In fact competitor reaction, regulatory restraints on monopolistic acquisitions and adoption of similar strategies by the rivals has raised serious doubts about the success of such deals in the context of the recent economic environment. The horizontal acquisitions also enable an access to the patents and exclusive privileges enjoyed by the target firm. Like the target firm may have a well developed research facility. In the event of an integration of the two companies the research facility of the two companies can be integrated thereby lowering the research related expenses. Other than this the resources and capabilities of the target firm may be one of the attractions of the acquisition. The valuable resources often make a company a soft target for hostile acquisition. To thwart this attempt the management of the company being targeted designs an anti-takeover strategy referred as ‘Crown jewel’ By way of this the target company can sell-off its prized assets in the event of a takeover bid making it unattractive in the eyes of the acquiring company (Monks & Minow, 2008, p.278; Chandra, 2008, p.891) The management personnel of the target company may be highly efficient and skilled. By taking over the target company the bidder firm can take advantage of the skilled manpower of the target company. But this too is laden with some limitations. This may be advantageous in the case of ‘friendly takeovers’ but in the case of ‘hostile takeovers’ the managerial synergies may not be realised. The big companies have designed strategies that thwart such takeover bids. Usually what happens is that the acquiring companies want to get a managerial control in the target company. This results in a number of lay-offs. For this reason the target firm’s management design a ‘Golden Parachute’ strategy. As per this strategy if the bidder firm terminates any of the management personnel of a company it has to pay a huge amount as ‘severance pay’. This raises the cost of the deal making the investment unattractive. This strategy is widely used by the companies in America. Important example includes Citigroup Inc’s John Reed’s severance pay of USD 30 million and USD 5 million every year for life (Kokot, 2006). O’Shaughnessy & Flanagan (1998) state an extensive study has been conducted with respect to R&D expenditures, motives, stock price reaction of the target etc. Jensen and Ruback et al (1983) have highlighted that the empirical studies conducted have revealed that the target firms capture the majority of the benefits arising from the deal. According to King et al (2004) the scientific evidences clearly signify that the mere purchase of the assets of a firm does not indicate a rise in the value of the acquiring firm. As per their study most of the deals may at best yield ‘break-even results’ as a majority actually destroy the value of the firm. As per Brito (2003) in the real world the acquisition announcements invites an unfavourable reaction from the firms who respond by either preventing the deal or by becoming an insider to the acquisition deal (Clougherty & Duso, n.d.). From the strategic point of view the more the similarity in the nature of business operations of the firms the greater is the synergy potential. The greatest advantage arises from the horizontal acquisition deals as this leads integration of two competing entities that have a common set of operations. Such overlapping often result in redundancies of certain functions. As a result of this the costs are trimmed in the newly formed combined entity. These synergies are not limited to the economies of similarity. In contrast to the horizontal acquisitions the conglomerate acquisitions that involve integration of two companies belonging to two different industries the value addition synergies vary to a great extent. This offers low potential as two completely unrelated businesses are combined together. The findings of Larsson and Finkelstein (1999) revealed that complementarities and strategic similarities formed important determinants of realisation of synergy (Pablo, et al., 2004, p.5). The overseas acquisition is done with a motive to acquiring an access to the strategic resources. As per Capron et al (1998) and Ethiraj & Levinthal (2004) international acquisitions act as a significant form of internationalisation that empower the firms in the emerging economies to acquire an access to the ‘critical assets’ needed for strategic renewal and solving complex problems (Gubbi, et al. 2009). Hence the value addition from the acquisition activity arises from cost reduction, increase in the market share, entry into new markets, etc. Other than this the bulk purchase of raw materials for additional production allows the company to negotiate favourable deals with the suppliers. On account of bulk purchase of goods the company can avail huge discounts thereby lowering the production costs. This enables the firms to keep the prices competitive. Factors affecting cross border acquisition There are a number of factors which can affect the cross border acquisitions. The cross border acquisitions have various structural issues like statutory, infrastructural and regulatory issues. Certain regulatory issues like antitrust rules, foreign investment regulations and the stock exchange rules can emerge as barriers to get indulged into the cross border acquisitions (Sudi, 2003). In the last few years the transition and developing countries have shown an inclination towards ‘investment liberalisation’. Though these countries are eager to invite foreign investors there have been various concerns about the impact of these acquisitions on the development. An important issues is that the equity markets of these economies is not yet fully developed thereby enabling the foreign firms to acquire the domestic companies at a very low value. Besides it is believed that cross-border merger and acquisition deals unlike the Greenfield FDI, that involves investment of new capital, does not boost productive capacity and may lead to termination of employees in the future and shut down of some of the business activities. To thwart a foreign takeover some countries have imposed restrictions on the acquisition by foreign companies in specified sectors (Norback & Persson, 2002). The cross-border acquisitions face a number of legal and tax barriers that often discourage this form of integration. Like a rise in the number of cross-border acquisitions in the banking sector raises serious concerns about financial stability. This form of merger highlights the gaps present in the regulatory framework that may lead to inordinate delays owing to the uncertainty faced by the regulators. The requirement of multiple reporting coupled with the ambiguity in definitions and requirements burdens the cross border entity with administrative issues. An overseas merger calls for additional reporting requirements on the part of the merging entities. Unlike the ‘cost synergies’ created in the case of domestic mergers the cross-border deals involve additional costs. It is pretty significant to handle the employee issues with appropriate care and more responsibility. To achieve the human resource management department is required to have access to all the relevant information. However, it has been noticed that in most of the cases, no or less involvement of human resource department is there in the decision making in cross border acquisitions and later on they are asked to take care of the human related issues, which can create a problem in the absence of relevant data, information and processes. In such situation, the management of the bidding firm may have to experience difficulties in integrating both the organisations (Bohlin, Daley & Thomson, n.d.). Apart from that there can be accounting and valuation issues in the acquisition process which can emerge as influential factors in the cross border acquisitions. The value of a target company in a merger and acquisition deal is done using the discounted cash flow technique. This involves discounting the future cash flows of the company. As the life of a corporation is considered to be infinite, the analysis comprises two parts: terminal value and forecast period. The forecast period varies between five to ten years. The value of the anticipated free cash flows after the forecasted period is measured by ‘terminal value’. This value is estimated at the end of the forecasting period and is an accumulation of the free cash flows arising beyond the period of forecast. This is based on assumptions of equal required rate of return and no abnormal growth opportunities. The free cash flows are then discounted using the weighted average cost of capital to obtain the value of the enterprise. The free cash flow is equal to total post-tax earnings, plus non-cash charges like depreciation, minus any capital expenditure and investment in working capital. The terminal value represents the long term prospects of the enterprise and therefore requires careful attention (University of Virginia Darden School of Business, n.d; Gaughan, 2005, p.171). The government regulation of merger and acquisition deal includes a straightaway prohibition of such activities, levy of heavy amount as fines and high clean-up costs. The Hart-Scott-Rodino Antitrust Improvement Act of 1976 has formulated procedures facilitating a review of potential monopolistic transactions by the government. This essentially requires the bidder company to inform about its prospective acquisition to the Department of Justice (DoJ) and Federal Trade Commission (FTC) in some situations. Based on an examination, if a transaction appears to eliminate competition, then the government can bring the acquisition to a halt by filing an injunction (Bragg, 2008, p.265). Examples of Recent Successful Cross Border Acquisition Acquisition of Zain By Bharti Airtel The acquisition of Zain Telecom has established Bharti Airtel as the fifth largest mobile operator in the world. Towards the middle of 2010 the telecom company announced the completion of its acquisition deal of Zain Telecom’s African operations. The value of the deal has been reported as $10.7 billion. This has enabled the Indian telecom giant to spread its operations in the African region. The subscriber base of the company has reached 180 million in Asia and Africa. This is a form of horizontal merger as both the companies are in similar businesses though at different stages of maturity. Sunil Mittal, the Chairman of Bharti Group, said that this deal is the largest ever cross-border in an emerging economy. This is expected to generate combined revenues of approximately of $13 billion. In fact this is the primary motive behind all merger deals. By acquiring the target firm the acquirer aims to raise the market share. This is evident in the case of Bharti’s acquisition of Zain as well. This will entitle the company to make a foray in the African markets thereby opening up a new source of revenue for the company. The deal materialised after a failure of the merger negotiations with MTN. However the MTN merger would have yielded lesser benefits as this would give the company mere board control without any management control and brand change option. The merger with Zain will give Bharti Group a total control over Zain’s business operations. The latter will now function as Bharti International’s 100 percent subsidiary. The MTN deal would have led tro some compromises whereas Zain’s acquisition will entitle the company to complete control and a new brand. The company expects to achieve revenues worth $5 billion from this strategy by 2010-13. The completion of the deal has cost the company $7.9 billion and the remaining amount of $400 million was agreed to be paid before the completion of some of the formalities (The Hindu, 2010). Bharti has also taken over debts worth $1.7 billion of the target company as at the end of December 2009. The completion of this deal manifests the approval of the regulators and government of the involved nations. This implies that the on the political and legal front the telecom giant did not have to pass through extensive formalities. The amount paid to Zaoin has been raised as debt from a group of foreign banks and State Bank of India. Standard Chartered acted as the lead advisor and lead arranger contributing the major portion of the deal with Barclays coming second by contributing $900 million. The other advisors include BNP, ANZ, Credit Agricole CIB, DBS, HSBC, Credit Agricole CIB, Bank of America-Merrill Lynch and Sumitomo Mitsui Banking Corporation. State Bank of India contributed an amount of nearly $1 billion in terms of Indian currency (Bennett, Coleman & Co. Ltd., 2010). This will give Bharti Group an opportunity to establish itself in the global sphere. Acquisition of Lehman Brothers by Nomura In the month of September, 2008, Lehman Brothers filed for bankruptcy. At that time, The company had $600 billion in the assets and debts. The event was followed by the acquisition of Lehman’s Asia Pacific and Europe franchises by Nomura, a Japanese financial institution. The culture of both the organisations has been pretty different. Nomura realised its responsibilities towards the integration of human resource management. The company does not want to have issues in the management of human issues and cultural management. To handle the situation, in the month of October, Nomura hired earlier fixed income employees of Lehman Brothers. The new workforce consists of about 8000 people from Lehman Brothers. At the first phase, Nomura has offered jobs to the Lehman employees. In the next phases, the acquirer integrated the infrastructural, financial, operational and organisational management structures. According to the new management structure, Nomura appointed three non-Japanese managers as the Senior Managing Directors. Adding to it, the company attempts to promote right people for the suitable jobs rather than promoting only the Japanese bankers (Cassim & et. al, 2009). This helped Nomura to minimise the human resource and cultural issues in the acquisition process. Conclusion The merger and acquisition deals gain momentum in times of low market valuations. This enables the company to acquire an ownership in another company with a view to capture market, reduce market competition, acquiring access to target company’s valuable resources etc. The merger and acquisition deals create a number of potential benefits such as managerial synergies; cost synergies, technical synergies etc. However, the acquisition may not necessarily translate into ‘value creation’ as evidences have shown that the shareholders of the acquirer are losers in the deal whereas the target firm’s shareholders take away the majority of the benefits. Reference Bennett, Coleman & Co. Ltd. 2010. Business. Bharti completes acquisition of Zain's Africa biz for $10.7bn. Available at: http://timesofindia.indiatimes.com/business/india-business/Bharti-completes-acquisition-of-Zains-Africa-biz-for-107bn/articleshow/6023848.cms [Accessed on February 22, 2011). Bohlin, N., Daley, E. & Thomson, S. No Date. Successful Post-Merger Integration: Realizing the Synergies. [Pdf]. 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