Mergers and Acquisitions of Companies - Essay Example

?Corporate Finance Introduction Mergers and acquisitions are playing an important role in shaping business activities all over the world, and are oneof the main ways to achieve growth. In recent years we can see the boom in mergers and acquisitions across the world in almost all sectors. Companies go for mergers and acquisitions to expand their business, and try to take over smaller rival companies to grow bigger. Usually, smaller companies look for larger partners in the process of merger and acquisition to gain maximum profit. Stock market movements play an important role in the process of merger and acquisition. At the time of stock market boom, mergers were more appealing. On the other hand, falling share prices can lead to a company being undervalued, and make it an attractive for acquisition. Mergers and acquisitions can either be value destroyers or value creators that depend on factors like company’s cost of capital, its strategies and decisions and cash flows generated from the business operations The performance is not related to the nature of an industry, instead it was driven by the quality and strategy of management. Good strategy by management can produce good results, on the other hand, poor decision and strategies may end with poor performance. For example fall of the company share price since Daimler-Benz's merger with Chrysler Corporation in 1998 is an example for poor management. Later, Dieter Zetsche, ECO, Daimler admitted that the merger was a mistake (Coursework.info, 2011). For any company, money invested today will certainly be worth less in future. In this regard, sound financial management is necessary for its survival and growth as attention should be paid for possible risks and ensures that performance spread remains positive. Shareholders' interest is the paramount objective for any company which will benefit the firm as well as the society at large. Achieving a high share of the market is the highest priority in some industrial sectors (Casper Flugt, 2009). As modern finance theory argues, decision of managers regarding wealth maximisation of shareholders and company's business strategies play important role in building brand value. Adding, managers should engage in merger and acquisition activity only if it gains to the target shareholders. In addition, environmental factors like macro economic conditions and cyclical behaviour of the industry may influence on their performance. The hubris hypotheses formulated by Roll, states that often company managers systematically commit error in evaluating merger opportunities which are due to their excessive self-confidence. So, managerial motives play important role in determining the outcome of the merger and acquisition. In contrast, in some instances even when shareholder wealth is destroyed, executives still seem to gain from mergers and acquisitions, which show that, managers through mergers and acquisition activities may seek to utilise their own utility at the expense of shareholders (Casper Flugt, 2009). Main objectives of merger Companies go for merger and acquisitions to expand their business. By the process they try to develop their companies’ brands. Aim to reduce market competition. Aim to cutting costs by laying off employees, removing management and other related actions. To reduce taxes they go for merger. Aim for ‘empire building’ by acquiring managers and other purposes, they may go for acquisition. It is a strategic move by companies to diversify their business away from their resources. Company managers think that joint company will be able to generate more value than the separate firms. There are many options for payment for a company when it goes for acquiring another firm. It can pay in fully cash, or it may buy targeted shares. It can also choose a combination of loan notes, share and equity, deferred payment. Actually, the payment method is important for several reasons. Payment by means of cash and debt will benefit more for a company than stock acquisitions, as it could be used more efficiently for company’s growth (CXO, 2011). On the other hand, stock acquisitions unlikely to motivate managers to use the resources efficiently. At the same time, a company that has a high cash flow is more likely to make cash offers. On the tax point of view method of payment is important. Cash acquisitions are immediate taxable for the company, and it burdens more on the firm. But, stock acquisitions are generally tax deferrable until the shares are sold (Casper Flugt, 2009). Advantages and disadvantages of merger and acquisitions Merging or acquiring companies outside their home country is becoming a trend among companies in recent years, which is a strategic for corporate growth. It helps to raise required FDI investment and sustain growth for the company. It is an additional advantage for a company to gain management skills, common governance, technology, marketing and production skills, patents, and many more (MapXL Inc, 2011). The main disadvantage of cross border acquisition for a company is lack of country and company specific knowledge of the foreign target firm which would lead to wrong valuation of foreign targets (Casper Flugt, 2009). Many a times, mergers and acquisitions were beneficial for companies as they can generate cost efficiency, and value for them. They may help the company to increase revenue through gain in market, and they can even generate tax gains. Shareholders expected that, their share value increases than their parent companies after mergers or acquisitions. These are beneficial procedure for companies to overcome their tough time. When a company facing problems in the market and is struggling to overcome difficulties, it may go for a merger deal. On the other hand, a company, which has a strong market presence, may go to acquire a weak firm. Generally, small firms agree to be acquired by large firms as they benefit more and get a chance to accumulate larger market share. A. Helps to increase market share Mergers and acquisitions help the companies to increase their market share. When a financially strong company acquires a weak company, the new group can experience a substantial increase in their market share. Company can avails some administrative benefits after merger or acquisition. For instance, Standard Chartered PLC, a London based company went through a series of acquisitions over the years in its successive path, and creates value for its shareholders as well as for society. It is a multinational bank with operations in more than 70 countries. Being a constituent of FTSE 100 Index, it operates in consumer, corporate and institutional banking and treasury services. In 2004, Standard Chartered and Astra International, Indonesia based company took over Permata Bank, which is now a second largest branch network of Standard Chartered in Indonesia. Bank acquired Korea First Bank in 2005, and in another acquisition, in 2006, it acquired 81% stake in Union bank of Pakistan, which helps the bank to extend its business to new region. Now, Standard Chartered Bank is Pakistan’s sixth largest bank (Rediff Moneywiz, 2011). Standard Chartered PLC.Profitability ratios. Current ratio 2. 25 Quick ratio 3.42 Earning retention ratio 100.00 Financial charges coverage ratio 2.47 Fin. charges cov.ratio (post tax) 1.75 Margin (%) Gross profit 67.30 Total debt/equity 10.38 Fixed assets turnover ratio 4.79 Current ratio (inc. st loans) 0.71 Operating margin (%) 68.98 Source: Rediff Moneywiz. In 2006, Taiwan based Hsinchu International Bank merged with Standard Chartered bank, and now it is the largest foreign bank in Taiwan in terms of branch network. Prior to merger Hsinchu had suffered extensive losses on defaulted credit card debt. In 2008, bank acquired American Express Bank Ltd in a fully cash deal. B. Beneficial for entering new market After merger or acquisition, a new company can increase its production which in turn cost of production per unit of output gets reduced. These are beneficial for companies to enter new market, and to introduce new products through research and development. It helps to gain higher competitiveness, and financial leverage. BHP Billiton, profitability ratios. Source: Stock Analysis on net 100 NYSE Leaders. If we take BHP Billiton as an instance, we can notice that company achieved the success through the process of mergers and acquisitions. Now it is world's largest mining, and third largest company by market capitalisation. The company is one of the largest constituents of the FTSE 100 Index. In 2005, company went for an acquisition of WMC resources, another mining company, and the deal gives 100% ownership right for BHP Billiton on WMC resources. In 2010, in a 320 million US dollar deal, Athabasca Potash was merged with BHP Billiton, which could be a valuable deal as it helps the company to produce approximately 15% of the world demand of potash by 2020 (Stock Analysis on net 100 NYSE Leaders, 2011). C. Helps to build brand value Mergers and acquisitions help the companies to build their brand value which in turn become value creator. In 1998, in one of the biggest deal, US oil giant Amoco decided to merge with British Petroleum (BP) which was a 110 billion US dollar deal. After the deal BP Amoco has emerged as Britain's biggest oil and Gas Company. London based BP Amoco is now third largest oil company in the world. Being a sixth or seventh largest company, BP has now a major worldwide presence. In the new group, 60% shares were held by BP shareholders, and the remaining 40% share holders were by Amoco. Market welcomed the news, and shares of both the companies surged in the stock market soon after the deal was announced. BP shares were up 15% after the deal was announced. Amoco shareholders received 3.97 BP shares for each share of Amoco plus a 25% premium on BP shares. But employees feel the pinch as the new group took action to cut 6,000 jobs worldwide to minimise the cost (Forbes.com, 2011). In February 2011, BP signed for partnership with Reliance Industries, Indian oil and Gas Company owned by Mukesh Ambani, and takes 30% stake in a new joint-venture. Company was aimed to improve the quality and capability of its manufacturing portfolio through the process of mergers and acquisitions. Their marketing strategy, supported by world-class manufacturing facility along with quality products helped them to generate customer, and brand value. BP PLC., Profitability ratios. (For the year 2011, upto September). Gross Profit Margin 16.2 % Current Ratio 1.2 Current P/E Ratio 5.8 Leverage Ratio 2.7 Receivables Turnover 9.6 Asset Turnover 1.3 12 Month Normalized P/E Ratio 5.3 Book Value per Share $34.58 Price/Book Ratio (Price/Equity) 1.23 Revenue to Assets 1.2 Quick Ratio 0.7 Source: Forbes.com. D. Helps to build capital Mergers and acquisitions also help the companies to build its capital. For example, HSBC Holdings plc, a London based bank is engaged in financial services and is now said to be world’s second largest bank, which has a presence in nearly 87 countries across America, Europe, Asia, and Africa. Bank goes through series of acquisitions which help to build its capital and brand value. In 2003, it acquired Polski Kredvt Bank SA of Poland for $ 7.8 million, and in 2004, it expanded its business into China buying 19.9% of the Bank of Communications of Shanghai. On the same year it acquired Marks and Spencer Retail Financial Services Holdings LTD in a cash deal. In 2007, it acquired the Chinese bank in Taiwan, and in 2008 it acquired Indian retail broking firm, IL&FS investment (Forbes.com, 2011). HSBC, profitability ratios. (5 Year Average) Return on Equity 9.8% Return on Assets 0.5% Return on Invested Capital 3.2% Total Debt/Equity Ratio 2.15 Debt/Equity Ratio 2.08 Average P/E Ratio 18.4 Source: Forbes.com. Conclusion In the present competitive market companies are looking for mergers and acquisitions to expand their business to a newer region. Most of the mergers and acquisitions resulted in value creation. Especially, in case of big companies it is true. There is some perception that nearly 50-70% of mergers fail to deliver shareholder value. In many occasions employees feel the pinch as the new group goes to cut jobs to reduce cost to the company. But, ultimately performance is not related to the nature of an industry, instead it was driven by the quality and strategy of management. Sound financial management along with other favourable factors is necessary for value creation, its survival and growth for any company. Reference Casper Flugt, (2009). Shareholder wealth effects of mergers and acquisitions: An empirical investigation of short-term performance in the European market, [Online], Available: http://pure.au.dk/portal-asb-student/files/8464/217003.pdf [18 November 2011]. Coursework.info, (2011). Mergers and acquisitions can be a value creators or value destroyers, [Online], Available: http://www.coursework.info/AS_and_A_Level/Business_Studies/Structures__Objectives___External_Influences/Mergers_and_acquisitions_can_be_value_cr_L811504.html [16 November 2011]. CXO, (2011). Don’t fear the merger, [Online], Available: http://www.cxo.eu.com/article/Dont-fear-the-merger/ [19 November 2011]. Forbes.com, (2011). BP PLC (NYSE:BP); Ratios and Returns, [Online], Available: http://finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=bp [17 November 2011]. Forbes.com, (2011). HSBC Holdings PLC (NYSE:BP); Ratios and Returns, [Online], Available: http://finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=hbc [17 November 2011]. HSBC Holdings plc, (2011). HSBC Holdings plc 2011 interim results-highlights, [Online], Available: http://www.hsbc.com/1/2/newsroom/news/2011/interim-results-2011 [16 November 2011]. Magnus Bil, Paul Guest, Andy Cosh & Mikael Runsten, (2002). DO Takeovers create value? A residual income approach on U.K. Data, [Online], Available: http://www.cbr.cam.ac.uk/pdf/WP252.pdf [16 November 2011]. MapXL Inc, (2011). Benefits of Mergers and Acquisitions, [Online], Available: http://finance.mapsofworld.com/merger-acquisition/benefits.html, [16 November 2011]. Rediff Moneywiz, (2011). Standard Chartered PLC. - Research Center, [Online], Available: http://money.rediff.com/companies/standard-chartered-plc/14030270/ratio [18 November 2011]. Stock Analysis on net 100 NYSE Leaders, (2011). BHP Billiton Ltd. (BHP); Profitability Ratios, [Online], Available: http://www.stock-analysis-on.net/NYSE/Company/BHP-Billiton-Ltd/Ratios/Profitability, [16 November 2011]. Read More