The Effectiveness of the Mergers and Acquisitions - Essay Example

?Mergers and Acquisitions Part A Mergers and acquisitions have become a new strategy for the organizations in the present competitive world to have afirm stand in the market. Organizations struggling to make a mark in the market often take the help of other large organizations to revive their current situations. On the other hand the company in strong position achieves its expansion policies by such strategic measures. However the overall goal behind mergers and acquisitions often do not yield favorable results. Sometimes it has been noted that the result of the mergers and acquisitions had brought in lots of unanticipated results which had resulted in the total loss of both the participating organizations. The paper here studies the effectiveness of the mergers and acquisitions and also the limitations of the overall process in gaining the profitability of the newly formed company. The role of Merger and acquisition: Most organization incorporates the strategy of the mergers and acquisition only in time of crisis faced by them. As a result the organization entering in to the process fails to critically look in to several issues like the strategic fit, and the risk involved with such strategies. The shareholders value in the firm takes a major setback due to such hasty decision making, from the companies’ behalf. The organizations should critically analyze the role play of such strategies. Generally there are various roles which are carried out by the undertaking of an effective merger and acquisition strategy. (The Boston consulting group, n. d) Mergers and acquisitions can create opportunities for the organizations to lower the respective cost of various expenses incurred. The incorporation of the merger strategies by the organization helps them to establish a new set of business model which can result in gain of productivity of both the organizations concerned. The overall market position can also be improved by the successful implementation of the strategy. Overall the mergers can create opportunities for an organization to gain new capabilities or simply add to their existing skill set. (The Boston consulting group, n. d) The success factor of the mergers and acquisition can lead to a gain of the scale both in measures of scale and scope. A successful merger can lead to the elimination of various risks associated with the execution of the business. The option of leveraging the asset of the acquired organization with that of the other organization provides huge financial benefit for the organizations. A successful merger can also lead to tremendous growth and diversification of the organizations. (Hunt, 2009, p.212,) It has been noted that the recent trend suggests that the organizations are failing to apply the strategy of the mergers and acquisitions in a proper fashion which has contributed to the overall failure. The fine line between the success and the failure of the mergers can be based on significant factors. As the mergers and acquisitions of the organizations leads to a complete restructure of the companies, proper effort form the management is needed to be careful after the implementation. Other than the financial and market factors organizations also needs to be careful regarding the human resource planning. . (Mergers integration, n. d)The failure of the mergers can significantly hamper all levels of the organization. Due to the non achievement of the expected gains of the organization the shareholders are affected at the beginning and it leads to their discontent. The most severe implication of the failure of the mergers can result in the accumulation of more amounts of losses for the organization than the gains which leads to the decline of the value of the shareholders. The failure can lead to a complete business tragedy for the organizations by factors like decrease of productivity, and customer satisfaction and loss of reputations of the brand name. (Mergers integration, n. d) Reasons for failure: The reasons for the failure of the strategy of mergers and acquisition can be attributed to a variety of factor. The most significant causes of the failure of the process can be linked to the payment for the acquired company in a high or over inflated price. Certain organizations also cannot reach the desired economies of scale as lack of financial management. After the merger has taken place the sudden unexpected changes in the financial condition of the market also leads to the failure of the organization. The absence of strategic fit within the organization also contributes significantly towards the failure of the mergers and acquisition practice. Cartwright, n. dpp.1-4) Often organizations enters in to the agreement with another company regarding the issue of the mergers without careful investigation of the partner companies’ capability and deficits. This results in non-attainment of the goals of entering into the merger. Post merger conflicts due to lack of proper assigning of responsibilities also leads to the failure (Cartwright, n. d, pp.1-4) Another study by Watson on a sample size of 1000 companies showed the result that only one third of the organizations were able to meet their profit goals by the merger and 46 percent of the organizations were successful in their cost cutting approach. (Salame, 2006) Empirical study: Researches carried out in deterring the effectiveness of the mergers reflect the results that a small number of organizations have received profitability as a result of such strategic decisions whereas the majority of them have encountered serious problems. However some researchers are of the opinion that mergers generally involve high profitability and a significant amount of gain in the short run share prices. A research conducted over a sample of 386 takeovers in UK between 1985 and 1996 studied the impact of the takeovers. In order to find out the results traditional accounting approach was conducted and the results reflected that organizations involved in the merger came out with high return on equity. (Bild, et al. 2002) Another research by the Boston consulting group studied the impact of the takeovers after a careful investigation of the long term effects on the performance of the firm in the stock markets. The research conducted reached the conclusion after the critical comparison of the return of the total shareholders with the overall return of the business. The research conducted revealed out the result that organizations which has carried at least one acquisition over a period of five to ten years of study conducted in the research, have experienced higher value in the total shareholder return than organizations who have incorporate other strategies. The organizations undergoing mergers and acquisitions, studied in the research have experienced superior performance and had reaped higher profitability over tenure of time. The acquisitions helped the organizations to gain the market shares at a much faster rate and produced higher returns of almost 12.4 percent. However the results of the research conducted by the Boston group could not confer upon the fact that the companies who have experienced higher profitability also have produced higher returns for the shareholders as the results were based on the overall performance and all the companies having higher amount of profitability could not provide higher returns for the share holders. At the time of the acquisition of the company many organizations show a significant gain in the share price. (The Boston consulting group, n. d) The wealth gain experienced goes to the shareholders of the target firms. The improvement in the value of the shareholders is often cited as an example of the anticipation the improvement to be encountered by the organization after the merger happens eventually. However such anticipation is less conclusive to judge the actual post merger effect. A study conducted by Parino and Harris of the 194 US companies reflects some considerable results for some downsizing transactions of mergers between the companies. The results derived showed that the process of acquisitions has also a key role to play in the overall governance of the organization besides the financial benefits. It helps in the monitoring of the performance of the mangers which leads to the overall efficiency of the organization. The research also reflected the fact that the operational performance of the organization reaches a satisfactory level and the industry adjusted cash flow returns was also significantly higher near 2.1 percent. Takeovers involving the transfer of the management also accounted for the positive effect on the operating efficiency of the organization after the occurrence of the merger. The overall result of the research concluded that with the change in the top management of the firms acquired, the organizations tend to exhibit better organizational performance. On an average the companies undergoing the merger process had significant business gains as expected by the stock; however disagreement prevailed regarding the benchmark set for the process of the performance evaluation. Organizations involved in the merger process without a change in the management did not experience a significant change of result after the acquisition was complete. (Parino & Harris, 1999).Many of the mergers involved equity transfer as the mode of payment in the contract between the companies. The transfer of equity was highly valued. Often it was found that overvalued firms proved useful for the shareholders as equity was involved. However mispricing was involved in the mergers and acquisitions. The firms which were overvalued often adopted the methods of stock financing so that they may acquire the assets of the company with high amount of discounts. The discounts they obtain are at expense of the shareholders value in the firm. The reason for the failure of mergers and acquisitions can also be attributed to the fact that the managers often go for the valuation based on the market trends rather than judging the specific value of the firms. As a result of the misinterpretation of the value of the firm, the firms often accept offers which are overvalued. (Savor & lu, 2009, pp. 1061-1063) The concept of the overvaluation often influences the decision of the firms in relation of the acquisition process. As a result of the mispricing the firms entering into the contract of merger and acquisition often gets engaged in less profitable ventures. However overvalued firms have the greatest benefit of entering into the acquisition until and unless their mispricing is being highlighted in the market. It is quite debatable regarding the benefits the shareholders of the company receives as a result of the value driven acquisitions. The real benefit however could only be determined after the study of the performance of the shareholders in the absence of such mergers. (Savor & lu, 2009, pp. 1061-1063) The accounting studies involved in studying the performance of the mergers and takeovers studies the overall significant giant in reaching to a conclusion. A lot of studies conducted also relate the fact that the shareholders of the organizations lose a lot because of the acquisition strategies taken by the organizations. In 2004 a research conducted on 79 UK organizations highlight the fact that the shareholders lose up to 12 percent in the following two years post mergers. A sample size of 155 European organizations involved in the mergers and acquisitions over the period of 1997 and 2001 showed that more than 80 companies have experienced a decrease in the operational performance for a period of over three years after the process of merger have taken place. Research carried out by Craninckx and Huyghebaert in the period of 1997 to 2006 on a sample of European firms showed that nearly 50 percent of the shareholders value was destroyed as an impact of the merger. The evaluation of the combined effect of the stock of the firm and the operational efficiency after two years of the merger also did not showed any considerable improvement. The study also reflected crucial findings that owing to the failure of the strategy of the merger more than 10 percent of the companies were further sold after the deal of the contract lapsed. The results evolved supported the idea that in case of the privately held target, the investors fails to predict the failure of the mergers and acquisitions due to the reduced scope of accessing the relevant information regarding the failure of the organizations. (Craninckx and Huyghebaert, 2011, pp.11-13) Overall it can be concluded that through mergers and acquisitions are good strategic measures but they can prove fatal if not implemented under proper planning by the organization. Part B Merger between Procter and Gamble and Gillette: In 1999 P&G, the leading brand in fast moving consumer products aimed to enter in a merger with Gillette. However the merger between Procter and Gamble and Gillette was effected in the year of 2005. Both the organizations entering into merger had similar set of traditions and history. Moth Procter and Gamble and Gillette were in the market for over hundred years, both the organization was a leading brand in the market and they lead the way for market innovation. . The merger was effected due to the joint collaboration of both the companies. However financial analysts were concerned regarding the risk undertaken by P& G in the process of the merger, as it was one of the largest ventures undertaken in the history of the company (The Procter & Gamble (P&G)-Gillette Merger, n. d) Before the merger both the companies were well established and they were earning considerable amount of profit. The main aim behind the merger was to create a biggest brand in the fast moving consumer goods section. (Rizvi, 2008) The deal between the two organizations was a good idea as it helps the two brands to be one of the greatest brands dealing with the consumer goods. The effect of the merger will bring in a portfolio of 21 billion dollar brands and the newly formed company will constitute the two thirds of the total market sale. The merger can enable both the companies to leverage the capabilities in the market and help in building retail partnerships. The merger was aimed to create a strong sustained growth in the market. The price of the deal was also a fair valuation as the level of performance of the combined organization was expected to soar higher. The merger would have provided an attractive cost and synergy for the combined deal, besides both the brand had their reputation in product innovation. Considering the ample opportunity arising from the merger, the immense amount of the merger value paid to the acquired company seemed pretty fair. (P&G/ Gillete, n. d).After the merger P&G expected a considerable amount of market capitalization with nearly about $200 billion. The merger took place as Procter and Gamble acquired Gillette by a massive $54 billion bid. As a result of the deal it gave .975 shares of P& G in respect of every share for Gillette, which increased the value of the share of Gillette at $ 54.05 per share. Table 1 Merger Terms Merger Terms Shares P&G Stock Price Value per share Total Value (billions) P&G Shares 965.25 $55.44 $54.05 $53.513 Gillette stock value ( 2005) $45.00 Premium 20% Ratio analysis of Procter and Gamble in the year 2006 Profitability Ratios: Return on Assets (ROA) = (Net Income / Average Total Assets) (Siddiqui, 2006, p.647-657) Therefore, ROA for 2006 is: ROA = (8,684 /135,695) = 6.40% Return on Equity (ROE) The Return of Equity for Procter & Gamble can be calculated using following equation: Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) Therefore, ROE for 2006 is: ROE = (8,684 /62,908) = 13.80% Profit Margin A profit margin indicates how much profit a company can obtain from a certain amount of sales. The profit margin for Procter & Gamble can be calculated using following equation: Profit Margin = (Net Income / Sales) Therefore, Profit Margin for 2006 is: Net Profit Margin = (8,684 /68,222) = 12.73% Liquidity Ratios Current Ratio The ratio shows company’s short-term responsibility over its debts. A higher number indicates that the company is liquid / has a larger capability to pay its short-term debts. The current ratio for Procter & Gamble can be calculated using following equation: Current Ratio = (Current Assets/ Current Liabilities) Therefore, Current Ratio for 2006 is: Current Ratio = (24,329/19,985) = 1.217 Net Working Capital Ratio The Net Working Capital Ratio for Procter & Gamble can be calculated using following equation: Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) Therefore, Net Working Capital Ratio for 2006 is: Net Working Capital Ratio = ((24,329 – 19,985)/ 135,695) = 3.20% Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds. =62908/ 35976 =1.748 (2006 Annual Report) Ratio analysis of Procter and Gamble in the year 2007 Return on Assets (ROA) = (Net Income / Average Total Assets) =103408/138014 =.749 Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) =10340/66760 =.154 Profit Margin = (Net Income / Sales) 10340/76476 =.135 Current Ratio = (Current Assets/ Current Liabilities) 24031/30717 =0.782 Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) =(24031-30717)/138014 =.048 Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds =66760/23375 =2.85 Ratio analysis of Procter and Gamble in the year 2004 Profitability Ratios: Return on Assets (ROA) = (Net Income / Average Total Assets) Therefore, ROA for 2004 is: = 6481/ 57048= 11.3% Return on Equity (ROE) The Return of Equity for Procter & Gamble can be calculated using following equation: Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) Therefore, ROE for 2004 is: 6481/ 17278 =37.5 % Profit Margin = (Net Income / Sales) 6481/51407= 12.6% Liquidity Ratios Current Ratio Current Ratio = (Current Assets/ Current Liabilities) 17115/22147 =.772 Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) = (17115-22147)/57048 =0.88 Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds. =17278/12554 = 1.376 (Annual Report, 2004) Ratio analysis of Procter and Gamble in the year 2008 Return on Assets (ROA) = (Net Income / Average Total Assets) 12075/143992 =0.83 Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) 12075/69494 =.173 Profit Margin = (Net Income / Sales) =12075/83503 .144 Current Ratio = (Current Assets/ Current Liabilities) 24515/30958 =.79 Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds. 69494/23581 =2.94 Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) (24515-30958)/143992 =0.044 Ratio analysis of Procter and Gamble in the year 2009 Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) (21905-30901)/134833 =.066 Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds. 63099/20652 =3.05 Current Ratio = (Current Assets/ Current Liabilities) 21905/30901 =.708 Profit Margin = (Net Income / Sales) 13436/70029 =.191 Return on Assets (ROA) = (Net Income / Average Total Assets) = 13436/134833 =0.9 Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) =(13436/63099) =.212 Ratio analysis of Gillette in the year 2004 Return on Assets (ROA) = (Net Income / Average Total Assets) 1385/9955 = 13.9% Return on Equity (ROE) = (Net Income / Average Shareholder’s Equity) = 1385/2224 = 62.2 % Profit Margin = (Net Income / Sales) 1385/ 9252 =14.9% Liquidity Ratios Current Ratio Current Ratio = (Current Assets/ Current Liabilities) =3650/ 3658 =.99 Net Working Capital Ratio = ((Current Assets – Current Liabilities)/Total Assets) (3650-3658)/9955 =.0008 Capital Gearing Ratio = Equity Share Capital /Fixed interest bearing funds. (Barrow, 2011) =2224/2453 =.906 (Exhibit, 10(i)) All the ratios calculated are summarized in the table below. Procter and Gamble 2009 2008 2007 2006 2004 Return on Asset (ROA) 9% 8.3% 7.49% 6.40% 11.3% Return on Equity (ROE) 21.2 17.3% 15.4 13.80% 37.5% Net Profit Margin 19.1% 14.4% 13.5% 12.73% 12.6% Current Ratio .708 .79 .782 1.21 .772 Net Working Capital Ratio .66 .044 .48 3.20 .88 Capital Gearing Ratio 3.5 2.94 2.85 1.748 1.76 Gillette Return on Asset (ROA) 13.9% Return on Equity (ROE) 62.2% Net Profit Margin 14.9% Current Ratio .99 Net Working Capital Ratio .0008 Capital Gearing Ratio .906 As evident from the study of the ratio analysis that the Procter and Gamble received a huge boost in the financial performance post merger. Their overall profitability increased considerably and a decrease in considerable amount of the Capital gearing ratio was observed in the immediate first two years after merger. The overall result of the return on Asset was also achieved higher results. It signified that the financial goals of Procter and gamble were achieved after the merger. The company has also received significant growth in terms of total sales figure. The overall increase in sales figure of the next four years suggest that the \main objective of entering the market , to become a leader in the fast moving consumer goods sector was on the right track and the merger proved to be successful and well strategized. Competition with Unilever Though the aims and objectives of Procter and Gamble were achieved on the course of merger, yet the competition from Unilever posed considerable amount of threat for the company. Unilever was also advancing in the market with latest strategies and products. In 2006 Unilever posted a profit of US $ 6 billion and had accounted a turnover of US$ billion dollar. Unilever aimed at achieving more and provided a stiff competition in the market Procter and gamble. The competition from Unilever also suggest that though it had not undertaken any merger still it had the potential of being a leading player in the market. (.The figure of current ratio of the firm in year in 2006 was 0.68 whereas that of Procter and gamble was 1.21 which showed that in the year post merger Procter and gamble was in a much more good financial state than Unilever (Unilever Annual Report and Account, 2006) References Bild, et al, (2002), Do take overs create value, repec, available at: http://ideas.repec.org/p/cbr/cbrwps/wp252.html (accessed on November 23, 2011) Craninckx, K& Huyghebaert, N (2011), Can Stock market predict M&A failure, European financial management , Vol,17, No 1, pp.9-45 Parino, J,D & Harris, R, S, (n. d), Takeovers, Mangement Replacement, and Post acquisition Operating Performance, Journal of Applied Corporate Finance, Vol,11, No,4 Savor, P, G& Lu, Q, (2009), Do Stock mergers Create Value for Acquirers, Journal of Finance, Vol, LXIV, No,3 The Boston Consulting Group, (n. d), Successful M& A : Method in the Madness, BCG Hunt, P, (2009), Structuring Mergers & Acquisitions:  A Guide to Creating Shareholder Value, Aspen Publishers Online Mergers integration, (n. d), interlinkbusiness, available at: http://interlinkbusiness.com/mergers.html (accessed on November 23, 2011) Salame, R (2006), Why do mergers Fail, peoplemix, available at: http://www.peoplemix.com/documents/articles/Why%20Do%20Mergers%20Fail.pdf (accessed on November 23, 2011) Catwrigh, S, (n. d), Why Mergers Fail and How to Prevent It, qfinance, available at: http://www.qfinance.com/contentFiles/QF02/g1xtn5q6/12/1/why-mergers-fail-and-how-to-prevent-it.pdf (accessed on November 23, 2011) 2006 Annual Report, (n. d) PG available at:http://www.pg.com/en_US/downloads/investors/annual_reports/2006/pg2006annualreport.pdf (accessed on November 23, 2011) 2004 Annual Report, (n. d) PG, available at: http://www.pg.com/en_US/downloads/investors/annual_reports/2004/pg2004annualreport.pdf (accessed on November 23, 2011) Exhibit 10(i), n.d, edgaronline, available at: http://sec.edgar-online.com/gillette-co/10-k-annual-report/2004/03/01/Section28.aspx (accessed on November 23, 2011) P&G/ Gillete, (n. d), PG , available at: http://www.pg.com/images/homepage/pg_gillette_faq.pdf (accessed on November 23, 2011) Rizvi, Y, (2008), ‘Picking the flowers’; Acquisition strategy as a tool for survival and growth. A case analysis of the acquisition of Gillette India Limited by Procter & Gamble, iitk, available at : http://www.iitk.ac.in/infocell/announce/convention/papers/Marketing,%20Finance%20and%20International%20Strategy-08-Yasmeen%20Rizvi%20draft.pdf (accessed on November 23, 2011) The Procter & Gamble (P&G)-Gillette Merger, (n. d), icmrindia, available at: http://www.icmrindia.org/casestudies/catalogue/Business%20Strategy/The%20Procter%20and%20Gamble-P&G-Gillette%20Merger-excerpts1.htm (accessed on November 23, 2011) Unilever Annual Report and Account, (2006), Unilever, available at: http://www.unilever.com/images/Annual%20Report%20and%20Accounts%202004_tcm13-11940.pdf (accessed on November 23, 2011) Isidore, C, (2005), P&G to buy Gillette for $57B, cnn money, available at: http://money.cnn.com/2005/01/28/news/fortune500/pg_gillette/ (accessed on November 23, 2011) Siddiqui, S, A, 2006), Managerial Economics and Financial Analysis, Liguria: New Age International Barrow, C, (2011), Starting and Running a Business All-in-One For Dummies, New Jersey: John Wiley & Sons Appendix Consolidated financial statement of P&G (Premerger) Financial Statement Procter and Gamble 2004(Post Merger ) Financial Statement Gillette (2004) (Post merger) Amount Net sales $ 9252 Net Income $ 1385 Equity Share capital 2224 Income per common share 1.35 Diluted 1.34 Read More