Cross-Border Acquisition and Sources of Value Added in Acquisitions - Essay Example

? Mergers and Acquisitions: Cross border acquisition and sources of value added in acquisitions Introduction Lakshmi Mittal’s (an Indian-born entrepreneur) €18.6 billion ($23 billion) hostile bid for Arcelor, Europe's champion steelmaker (formed, in turn, from the champions of France, Spain and Luxembourg in 2002) has became one of the hot topics in the recent past as far as cross border merger and acquisition is concerned (Cross border mergers, 2006). It was absolutely surprising and unbelievable to the Europeans that an Indian entrepreneur was able to acquire one of the most prestigious steel firms in Europe. Globalization and liberalization has brought many opportunities and challenges to the business world. The barriers in establishing business units in overseas countries were diluted as a result of globalization. Moreover, it is possible for larger firms to select their own strategies or mode of entry like merger, acquisition, or joint venture to enter in to the overseas market. Competition is becoming tough in every area of business and it is difficult for even big organizations to survive in the market if they fail to implement suitable business strategies to counter the competition. It is now easy for organizations to do business in any country they want because of globalization. Outsourcing and offshoring are some of the major business strategies adopted by organizations in order to exploit the overseas market. On the other hand, some organizations use merger and acquisition (M & A) based business strategies to spread their wings in to overseas countries. Gaughan (2007) explained M & A as a process in which two corporations combined together to form a single one. Moreover, only one corporation survives after the M & A while the merged corporation goes out of existence after the merger process (Gaughan, 2007, p.12). Domestic mergers and acquisitions were popular prior to globalization; however, cross border mergers were not accepted. Nonetheless, the governments and nations of the current time realized that it is impossible for a country to develop properly through the means of internal resources alone. Most countries are currently doing everything possible to welcome foreign direct investments (FDI) because of the aforementioned awareness. This means cross border mergers have become a reality nowadays. The following chart provides an idea of the size of global merger deals between 2005 and 2007. (Mergers and acquisitions, 2008) “Cross border mergers and acquisitions (M&As) are a main vehicle for foreign direct Investment. Yet despite its quantitative importance, the determinants of cross-border M&As are still not well-understood” (Brakman et al, 2008, p.1). The benefits of cross border alliances or mergers are not limited to the companies alone. Cross border mergers and acquisitions may add more value to the companies and its stakeholders. This paper analyses the cross border merger and acquisition process and the sources of value added to the stakeholders as a result of this business strategy. Since the theories and principles with respect to cross border mergers are extensive, this paper will not discuss anything about negotiation, finance, alternatives etc. | Cross border merger and acquisition Leading financial consultancy Thomson Financial has said that 2006 was a mega-merger year for India: 1,164 deals valued at a total of $35.6 billion as against 1,011 deals worth $21.6 billion in 2005. After the Tata-Corus and Vodafone-Hutch mega-deals, conservative estimates by Indian analysts have pegged mergers and acquisitions (M&As), including outbound and inbound deals involving Indian firms, to reach $100 billion in 2007 (Shankar & Reddy, n. d, p.457) Companies from emerging economies like Brazil, India, Russia and China are currently engaged in acquiring some of the most prestigious companies in America, Europe and Africa (see appendix for some of the statistics of FDI inflows to the host countries as a result of cross border M& A). Recently India’s automobile manufacturer TATA acquired the prestigious Rover and Jaguar group from Britain. The recent global recession has broken the back bone of some of the biggest organizations in the developed regions like America and Europe. Even the biggest organizations in these regions are struggling to survive at present. Bruner (2004) has mentioned Merger and Acquisition (M&A) as the popular mean by which companies respond to changing business conditions (Bruner, 2004, p.3). Organizations have realized that their resources and abilities alone may not be enough to compete effectively in a globalized market. Business strategies are undergoing tremendous changes as a result of the changing world order due to globalization. Galpin and Herndon, (2007) have pointed out that “Today typical merger and acquisition is quite strategic and operational in nature” (Galpin and Herndon, 2007, p.5). Collective growth is the slogan put forward by globalization and it is visible everywhere in the business world. Originally, companies fought for dominance and they used every strategy that was needed to destroy the competitors. At present, even fiercely competing organizations are co-operating with each other, at least in some areas operation, because of their awareness of the necessities of mutual cooperation for mutual growth. Merger mania started in the industrial sector at the beginning of 90’s. Even though most of the mergers in the United States have involved domestic organizations, an increasing number of deals between American and overseas companies are also taking place in America at present. Indeed, when some companies in an industry merge, others come under pressure to do the same to remain competitive. When two companies are merged together, their monopoly, their market share and competitive power will increase. Such things will create a big headache for other companies in similar business to them and they will also think in terms of merging with some other similar companies in order to increase their competitive power. The telecommunication sector is one of the major business areas in which M & A is taking place quiet widely. The merger between India’s Bharti Airtel and South Africa’s MTN is one of the latest among the cross border merger list. It is not necessary that the merger offers put forward by one organization is always acceptable to the other organization. For example, on November 1999 Vodafone Air Touch announced a Takeover bid on Mannesman AG, a German engineering and Telecommunication group(Vodafone's hostile takeover bid for Mannesmann highlights debate on the German capitalist model, 1999). Vodafone’s efforts were initially blocked effectively by Mannesman who cited various reasons. Even the Mannesman workers (see Appendix for more details) protested against the takeover of their firm by the British telecommunication giant. But Vodafone continued their efforts and made a huge offer directly to the Mannesman shareholders to exchange their shares. In 2000, Mannesman Management, fearing that their shareholders would be canvassed by Vodafone, started negotiations with Vodafone and reached a merger agreement with Vodafone. In short, different strategies are adopted in the cross border merger and acquisition processes in order to achieve a successful end result. “Cross border strategic alliances (CBSA) were motivated by the desire to speed entry into new markets, to develop and commercialize new products, to gain skills or to share costs” (Sudarsanam, 2003, p.232). Coke has recently acquired Thums Up, one of the favourite soft drink manufacturers of India. Coke did so not only to reduce competition from the local manufacturers, but also to counter the threats that were coming from their arch rival Pepsi, more effectively. This situation highlights how cross border mergers will give strategic advantages to the organizations. “Cross border mergers make it easier and cheaper for individual investors to buy and sell foreign shares” (DePamphilis, 2009, p.77). Investors normally welcome cross border mergers or alliances because of the opportunity it provides to exploit investment opportunities in foreign countries. As mentioned in the above example, the Indian investors in Thums Up will get the opportunity to explore the investment markets in America, because of the merger of Thums Up with Coke. “Horizontal mergers occur when two firms in the same line of business merge” (Damodaran, 2001, p.290), whereas vertical mergers occur when two companies producing different goods merge together. In cross border merger alliances, both horizontal and vertical mergers are common. Interestingly, horizontal mergers seem to be more popular than the vertical mergers. The Mittal-Arcelor merger, Coke-Thums Up merger etc are examples of horizontal mergers, whereas the merger between Time Warner Incorporated, (a major cable operation) and the Turner Corporation, (which produces CNN, TBS, and other programming) is an example of vertical merger. “Cross border acquisition do involve knowledge transfer (from the parent to the target company) in the medium term after the acquisition” (Piscitello &Rabbiosi, 2003, p.4). Bertrand et al, (n. d) also expressed similar opinions to those expressed by Piscitello &Rabbiosi. “Restrictions on cross-border acquisitions may be warranted in order to increase technology transfers. The market power coming from monopolizing foreign acquisitions may increase foreign technology transfers” (Bertrand et al, n. d, p.5). Cross border mergers often result in technological transfer between organizations and countries. However, some countries may not like their indigenous technologies to be transferred to foreign soils without adequate returns. For example, the arch rivals China and America may take extreme care while allowing some of their firms to merge with the opposite country’s firms. Cross border mergers depend on the influence of institutions on entry and establishment mode choices in transition countries (Brakman et al, 2008, p.1). In other words, different countries may have different cultures and different political and legal frame works. For example, China is a communist country and America is a democratic country. Both countries have different cultural and legal frame works. In contrast, America and India have a lot of similarities in their administration even though these two countries are culturally different. It is important to note that the strategy used for the mode of entry to China by American companies need not be the same in Indian conditions. Cross-border takeover bids are complex transactions that may involve the handling of a significant number of legal entities, listed or not, and which are often governed by local rules (company law, market regulations, self regulations). Not only might a foreign bidder be disadvantaged or impeded by a potential lack of information, but also, legal incompatibilities might appear in the merger process resulting in a deadlock, even though the bid would be “friendly”. This legal uncertainty may constitute a significant execution risk and act as a barrier to cross-border consolidation (Obstacles to cross-border mergers and acquisitions in the financial sector, 2005, p.2) “If a merger does go wrong, it is difficult and extremely expensive to unwind” (Harvard Business School, 2001, p.99). It is not necessary that cross border mergers always end up in successes. “Survey evidences show that cross border acquisitions are successful in more than half the cases” (Sudarsanam, 2003, p.214). However, Berry (2010) has pointed out that mergers can create complications ranging from employee bonuses and added debt (Berry, 2010). Daniel (2002) has pointed out that more than half of all mergers are essentially financial failures in the sense that the combined entity produces less shareholder value than the two individual pre-merger companies (Daniel, 2002, p.3). FINKELSTEIN (n. d) has also expressed similar opinions. He has pointed out that “most of the 89 acquisitions of American companies by foreign buyers between 1977 and 1990 they studied did not improve operational performance one year after the acquisition” (FINKELSTEIN n. d., p.1) As in the case of other business strategies, the failure rate in the merger process, especially in the cross border merger process is very high. In the cross border merger process, two culturally different companies are entering the agreement. If both the companies fail to understand the cultural parameters of each other, such a tie up may end in failure. The major reasons for the failures of merger and acquisition are the over estimation about the outcome of the merger, lack of business strategy, and lack of communication and management strategies, poor business plan etc. The offeror and offeree may expect and set unrealistic expectations which may not always materialise. The failure to achieve over exaggerated outcomes may develop dissatisfaction among both the offeror and offeree which may result in a lack of communication between them and subsequent management failures. Royal Bank of Scotland's deal for ABN Ambro is acknowledged as a shocker. According to academics however, it seems the situation was not such a shock. Indeed, mergers and acquisitions seldom live up to their promise of delivering strategic benefits, easy growth and a boost in the value of the acquirer's shares. For certain, some do work and according to academics, as many as 35 per cent do. But that still means that more than 60 per cent of deals fall flat chasing the elusive goal that is reached by a minority (Robbins, 2009) “The stakeholders in acquiring firms do not seem to share the enthusiasm for mergers and acquisitions that their managers have because of the stock prices of the bidding firms decline on the takeover announcements” (Damodaran, 2001, p.21). Mergers and acquisitions can be beneficial to the employees of the smaller organization since they will get their salary structure revised in most of the cases. However, merging can cause fears of job loss. It is not necessary that all the employees would be retained after the merger process. Moreover, the takeover announcements may decrease the share prices of the bidding firms which is not good for the share holders. The major disadvantage associated with merger and acquisition is to the offeree. The offeree will lose their corporate identity and brand value because of their merger with another company. Whatever the advantages the offeree had in the market, developed by them facing stiff challenges, would be the wealth of the offeror after the merging process. Some of the workers of the offeree may lose their jobs while some others may be forced to shift their positions in the new company. The freedom and work benefits enjoyed by the workers in the offeree company need not be preserved in the offeror company. Sources of value added in acquisitions Mergers and acquisitions always result in mutual growth and synergistic benefits both for the offeror and the offeree. Increased market share, lower cost of production, higher competitiveness, acquired research and development, know how and patents, financial leverage, improved profitability etc are some of the advantages M & A can bring to a company (Berry, 2009). Moreover, Gaughan, (2001) has mentioned that the combination of two firms will yield a more valuable entity than the value of the sum totals of the individual entities. In other words, in his opinion, Value (A + B) > Value (A) + Value (B) (Gaughan, 2001, p.5). When two companies compete in a market, they are knowingly or unknowingly destroying some of the opportunities of the other. If they merge together, the destructive elements will completely be vanished and the constructive elements will be increased. In other words, these companies will spend more of their efforts in the constructive sphere because of the absence of destructive elements and their value will be increased. The effects of mergers and acquisitions on small business organizations depend on the type of M&A, size of institutions involved, intrastate versus interstate nature, and many other factors. In some cross border mergers, small organizations may get prominent places in the decision making process whereas in some other cases, they will assume the lesser role in the new organization. In some particular cases, the ownership of the organization has shifted to distant locations and the smaller organizations have become junior partners in larger organizations. The offeror and the offeree can increase their customer base through merger and acquisition. For example, consider the recent merger deal between two telecommunication giants, India’s Bharti Airtel and South Africa’s MTN. According to this cross border merger deal, MTN and its shareholders would acquire around 36 per cent economic interest in Bharti Airtel, while Bharti Airtel would acquire a 49 per cent stake in South African telecom giant MTN (India's 11 largest M&A deals, 2009). The above deal helped both the companies to exploit opportunities in India and South Africa more judiciously for the mutual benefits. Bharti Airtel will get the assistance from MTN for their operations in South Africa whereas MTN would get assistance from Bharti Airtel for their operations in India. The understanding of business climate and formalities in these countries can be exchanged for mutual benefits through this merger. In other words, both the offeror and the offeree got mutual benefits of diversifying their business portfolios for mutual benefits. It is evident that both MTN and Bharti Airtel can increase their competitive power across the world, and moreover both of them can take benefit out of the research and development done by each of them. MTN would have more awareness and data about the South African market whereas Airtel may have more awareness about Indian conditions. The culture, politics, economic conditions, legal requirements, social norms etc might be different in these countries and both MTN and Airtel can exchange these data for their mutual benefit and collective growth. Sharma (2001) has mentioned; Accelerate product development,??Spread risk/share resources, ?Access to new markets, Expand customer base, Increased market presence, ?Provide added value to customers, ?Access knowledge and expertise outside of your company,?Strengthen reputation – credibility etc as some of the major advantages of a cross border merger deal (Sharma, 2001, p.17). The collective financial capabilities, technical abilities and resources of a firm after the merging with another firm would be immense compared to the resources of the independent firms before the merger. The supply chain networks of the two firms in the merging process would help the new company to reach even more distant territories or distant countries. Miller (2008) has mentioned that Edwin L. Miller (Author) › Visit Amazon's Edwin L. Miller Page Find all the books, read about the author, and more. See search results for this author Are you an author? Learn about Author Central Mergers and Acquisition (M&A) will help organizations to diversify into other areas (Miller, 2008, p.12). Competition is getting stiff in every field of business and it is difficult for an organization to stick with a single business portfolio alone. Diversification helps business groups to survive in a market, even if they face a set back in business portfolio. It is not possible for an organization to stick with a single business portfolio at present because of the rapid changes in business fields. For example, Sony Corporation has established ties with Ericsson to make mobile phones as part of their business diversification. Sony has realized that even though they are supposed to be the leaders in the electronic goods manufacturing industry, especially for audio and video equipments, they are not so in areas such as mobile phone manufacturing. Mobile phones are one of the rapidly moving consumer goods today and Ericsson has all the necessary technologies needed for mobile phone manufacturing. Sony was able to exploit its tie up with Ericsson and doing well in the mobile phone market at present. Conclusions Cross border Merger and Acquisition are popular in the current business world because of the introduction of globalization in the last two decades. Most of the prominent business groups are currently trying to explore the possibilities in overseas markets and they often adopt cross border merger and acquisition strategies as their mode of entry to foreign countries. Synergistic benefits and growth prospects are the major benefits of a merger. The combined resources and capabilities would help both the offeror and the offeree to extend their wings and increase their control over the global market more effectively. At the same time, a substantial number of merger attempts result in failure because of the unrealistic goals set by the offeror and the offeree. Over estimated expectations, improper management and business plan, lack of communication etc are the major reasons for the failure of mergers. To conclude, cross border merger and acquisition is beneficial to the offeror and the offeree if and only if both parties are able to forecast the market trends well and set realistic targets. References 1. Berry AW. (2009), Advantages and disadvantages of acquisitions and mergers, [Online] Available at: http://www.helium.com/items/1561489-mergers-and-acquisitions [Accessed on 28 February 2011] 2. Bertrand O. Hakkala K and Norback P.J. (n.d) Cross-Border Acquisition or Greenfield Entry: Does it Matter for Affiliate R&D? [Online] Available at: http://www.biceps.org/files/bertrand_hakkala_norback_1.pdf [Accessed on 28 February 2011] 3. Brakman S. Garretsen H. & van Marrewijk C ( 2008). 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[Online] Available at: http://www.eurofound.europa.eu/eiro/1999/11/feature/de9911220f.htm [Accessed on 28 February 2011] Appendix Basic figures for Mannesmann AG (1998) Sales Earnings Employees Division EUR million % EUR million % Number % In total 19,076 100 1,453 100 114,625* 100 Engineering 6,602 35 229 16 45,503 40 Automotive 5,482 29 216 15 42,849 37 Telecommunications 4,654 24 982 68 14,081 12 Tubes 2,338 12 26 2 12,192 11 * The total number of employees in 1998 was 116,247, including other companies and Mannesmann administrative headquarters. (Vodafone's hostile takeover bid for Mannesmann highlights debate on the German capitalist model, 1999). Cross-border M&A investments (percent of FDI inflows to the host countries) 1987-91 1992-94 1995-97 1998-2001 World 66.29 44.75 60.18 76.23 Developed countries 77.49 64.93 85.39 88.96 Developing and transition economies 21.94 15.49 25.79 35.74 (Brakman et al, 2008, p.5) Read More