Merger and Acquisitions: Description and Characteristics - Case Study Example

Advance Corporate Finance Theoretically mergers and acquisitions should be value creating for the shareholders of both the offeror and offeree companies. You are required to critically evaluate whether this is the case in practice 1. Introduction The development of commercial activities around the world has led to the need for the creation of various schemes of cooperation among the firms that operate within the global market in order for these firms to face successfully the extremely hard market competition. Regarding this issue, it is noticed by Schraeder et al. (2003, 511) that ‘mergers and acquisitions are becoming a strategy of choice for organizations attempting to maintain a competitive advantage’. From another point of view, Jackson (2007, 40) ‘acquisitions can be a powerful tool to achieve growth, enter new markets and expand the range of a firm's capabilities; but with the highly competitive market for acquisitions and the correspondingly high acquisition prices, all too often transactions fail to create value for shareholders’. Today, mergers and acquisitions have been considered to be the most appropriate strategic scheme for firms around the world in order to enhance their power within their market or increase their value – although these targets are proved often unachievable. Current paper examines a specific issue related with mergers and acquisitions: the value created for the shareholders of the firms that participate in the relevant initiatives. It is proved that in practice mergers and acquisitions should not be considered as a value creating scheme: they could be characterized rather as business choices imposed by the conditions of the market: in this context, the offeror company can have a significant advantage towards the offeree company which has to follow the specific path (merger or acquisition) when its value has been decreased (or it is under threat) because of the increase of the power of its competitors. 2. Merger and acquisitions – description and characteristics 2.1 General overview The role of mergers and acquisitions in the increase of shareholder value in both the companies involved can be easier understood if referring to the context of M&A, i.e. to their main characteristics. In accordance with a description given by the business dictionary of Forbes, the term merger is differentiated by the term acquisition at the following points: ‘when one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition; in the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated’ (Investopedia (Forbes), 2008). In other words, merger requires by the firms – participants the mutual respect of the terms of the relevant agreement. In the case of acquisition the advantage of the transaction is to the buyer’s side who can define the terms and the conditions of the relevant agreement while the seller/ firm acquired should follow these terms without having any particular right to react towards the rules imposed by the buyer/ firm. From a different point of view, it is suggested by Mehta et al. (2004) that M&A can be effectively interpreted if using a series of appropriate theoretical models while the whole procedure can be divided into phases. Referring especially to the M&A in the IT industry the above researchers noticed that the above procedure is influenced by the following factors: ‘(a) the ‘aura’ of the Wall Street — and the ‘promise’ that the merging firms make to Wall Street analysts to achieve extraordinary cost-savings within a restrictive time frame; (b) the acquirer’s influence on the acquired firm, enforcing certain system choices on the acquired people; and (c) the goal to achieve business-IT strategic alignment (Mehta et al., 2004, 8026). In other industries M&A are likely to be influenced by other factors taking into account that the financial power of the firms involved is one of the most significant criteria for the identification of the role of each firm (and its power to impose its views) in the relevant agreement. 2.2 Value created from mergers and acquisitions At a first level it could be noticed that ‘most merger and acquisition activities destroy value; one reason for this is that acquisition premiums tend to be too high in relation to the synergies that motivated the premiums paid’ (Knyphausen et al., 2007, 344). Other explanations have been also given in order to describe the development (or the decrease) of a firm’s value as a result of its involvement in such an agreement. The above fact is also supported by Jackson (2007, 40) who examined the case of ‘Northrop's acquisition of Ryan Aeronautical, a supplier of unmanned aircraft’ and came to the conclusion that ‘if acquirers understand the true strategic value of an asset, measured in terms of stronger SMP and increased revenues, and/or higher profitability for the combined organization, then they can identify situations when the value opportunity will more than offset the premium required to complete the transaction’ (Jackson, 2007, 40). In accordance with the above M&A can lead to the increase of the firm’s value (and the shareholders’ value in general) but only under the terms that the relevant procedure will be appropriately designed and monitored while any business failure will be addressed within a short period of time ensuring that no financial losses will be resulted for the firms involved in the procedure. The performance of the firm in the long term (as a result of its involvement in M&A should be also taken into consideration). The issue of effectiveness of M&A in the increase of the value of the firms’ involved has been examined by Lee et al. (2006, 111) who used as example in order to describe the relation between the shareholder value and the M&A the IT industry. Using a survey conducted across 170 firms of the specific industry, they proved that ‘such strategic alliance announcements create significant gains in firm value; the smaller strategic alliance partners perform better than their larger partners’. The level of increase of the firms’ value (referring to firms that participate in a specific M&A agreement) should be expected to be differentiated across the various industrial sectors in accordance with the conditions of the market (regarding each specific industrial sector), its prospects for the future and the financial strength of the firms involved in order to respond to the needs of such a project (M&A). 2.3 Value of M&A in relation with the shareholders of the offeror and offeree companies In order to understand the relationship between the M&A scheme and the increase of shareholders’ value, it should be necessary to describe primarily the whole procedure (M&A) at least as of its most important parts and then refer to the effects of this procedure on the shareholder value. In accordance with Sirower et al. (2006, 83) ‘when a major acquisition is announced, investors try to understand where the value is going to come from and whether the acquirer has a plan to achieve that value; deals are often brought to market with one big synergy number and a statement that the deal will be “accretive” to earnings’. Regarding the above views which refer especially to the case of acquisition the specific scheme is usually based on unclear plan (at least no specific plan is presented to the firm’s shareholders on time); at a next level the firm’s shareholders cannot estimate the level of their profit; the importance of the relevant agreement in terms of increase of the shareholder value could then be doubted. On the other hand, Chanmugam et al. (2005, 43) accepted that ‘mergers that create maximum value treat the transaction as a complete lifecycle - beginning with pre-deal strategy, progressing through deal execution and continuing with post-merger integration’. In other words, the M&A plan is usually presented to the firm’s shareholders gradually; primarily a general overview of the agreement is presented – not so clear however; during the negotiations between the two firms the rest of the parts of the agreement are explained to their shareholders who are not given the required chance to react and express their opposition to the completion of the particular agreement. Another issue that should be examined is the fact that the various firms that enter a specific M&A scheme tend to use different strategies throughout the progress of the relevant negotiations. In accordance with Gondhalekar et al. (2004, 735) ‘over-invested firms pursue acquisitions more aggressively by paying higher premia while under-invested firms pay less, on average; agency rather than synergistic or hubris effects influence the level of merger premia’. The above findings are in accordance with those of the research made by Delaney et al. (2004) who tried to examine and evaluate the increase of shareholder value of construction firms operating in UK. The above study focuses on the effects of M&A on the increase of shareholder value of the above firms. The findings of the above research prove that ‘related construction mergers create wealth for shareholders of the target firms’ (Delaney et al., 2004, 65). It is clear that all stages of M&A are extremely demanding and for this reason the managers of the firms involved should follow specific strategies in order to ensure the increase of shareholder value by the relevant schemes. The specific issue was examined by Chanmugam et al. (2005, 43) who noticed that ‘top managements in the most successful transactions have relied on four key principles: treat M&A as a holistic process; focus on value creation, not just integration; accelerate merger planning and execution; and use culture as a value-creation tool’. Despite the fact that the above methods can be considered as particularly helpful for the improvement of the performance of the firms that participate in a M&A scheme (as a result of their participation in this agreement) they should be criticized as limited to specific issues leaving other issues with no adequate explanation (e.g. the future of the firms’ employees, the financial administration of the relevant funds and the monitoring of the procedure). 3. Conclusion - Recommendations Mergers and Acquisitions have been considered as ideal schemes for firms that need to enhance their power towards their competitors. In accordance with the data presented in Figure 1 M&A were in a phase of extreme growth in 2000 while in the years that followed presented a trend for decline (being in 2004 less than 300,000 compared to the 800,000+ of 2000). The reason for the decline in the application of these two schemes the last years may be the fact that the whole procedure is not appropriately designed and monitored and is usually led in failure. Indeed, the study of Ficery et al. (2007, 29) showed that ‘the six most common mistakes that acquiring executives make are: defining synergies too narrowly or broadly; missing the window of opportunity; incorrect or insufficient use of incentives; not having the right people involved in synergy capture; mismatch between culture and systems; and using the wrong process’. Other mistakes made by managers involved in these agreements can be also considered as being the reasons for the decrease in using M&A as a tool for financial support or expansion (depending on the role of each firm in the above agreements). On the other hand, it has been proved that ‘for companies who have an active M&A growth strategy, a speeded up merger integration allows for the early capture of M&A deal value’ (Chanmugam et al., 2005, 43). Moreover, certain indicators can be used in order to estimate the potential success of a specific M&A scheme. Regarding this issue, it is supported by Sirower et al. (2006, 83) that ‘negative stock price reactions are a fairly reliable predictor of future disappointing operating performance and, in many cases, further stock-market underperformance’. Other factors can also have an important role in the success of a specific M&A plan. More specifically, Lin et al. (2006, 95) found that ‘ethical conduct in M&A is significantly correlated with employee job performance’. The importance of employees’ participation in the success of an attempted M&A plan has been already highlighted above. In fact, both firms’ employees have a significant role in all phases of such a plan; for this reason, appropriate HR strategies should be applied throughout the development of M&A scheme. From another point of view Glenn et al. (2002, 169) support that ‘for the discourse of shareholder value to be significant and effective, there needs to be an institutional structure which supports it’. The structure of this institutional structure will be depended on the characteristics of the industrial sector involved but also the characteristics of the firms that participate in the specific scheme. Various types of M&A plan can be applied as it can be seen in Figure 2 (the theoretical framework of acquisition is presented analytically in Figure 3) where the Horizontal merger is found to be the most common form of mergers globally. Other types of mergers (as well as acquisitions) can be met within each specific market taking into account the financial, political and cultural characteristics of this market. In most cases when a M&A plan is applied within the international market (or the local one) the increase of the shareholders’ value is set as a priority; however most commonly this increase is limited while other targets (like the expansion of a firm or firms (in case of merger) within its market) is primarily pursued by the managers that administer the whole project. References Delaney, F., Wamuziri, S. (2004) The impact of mergers and acquisitions on shareholder wealth in the UK construction industry. Engineering, Construction and Architectural Management, 11(1): 65-73 Ficery, K., Herd, T., Pursche, B. (2007) Where has all the synergy gone? The M&A puzzle. Journal of Business Strategy, 28(5): 29-35 Glenn, M., Yuko, T. (2002) Shareholder value in the Japanese Context. Competition and Change, 6(2): 169-191 Gondhalekar, V., Sant, R., Ferris, S. (2004) The price of corporate acquisition: determinants of cash takeover premia. Applied Economics Letters, 11(12): 735-739 Investopedia (Forbes), 2008, available at http://www.investopedia.com/university/mergers/mergers1.asp Jackson, S. (2007) Creating value through acquisitions. Journal of Business Strategy, 28(6): 40-41 Knyphausen, D., Koeppen, J., Schweizer, L. (2007) Identifying synergies ahead of mergers and acquisitions. International Journal of Financial Services Management, 2(4): 344-360 Lee, S., Kim, L. (2006) The impact of M& A and joing ventures on the value of IT and non-IT firms. Review of Quantitative Finance and Accounting, 27(2): 111-123 Lin, C., Wei, Y. (2006) The Role of Business Ethics in Merger and Acquisition Success: An Empirical Study. Journal of Business Ethics, 69(1): 95-109 Mehta, M., Hirschheim, R. (2004) A Framework for Assessing IT Integration Decision – Making in mergers and acquisitions. Proceedings of the 37th Annual Hawaii International Conference on System Sciences, p. 8026 (4C) http://doi.ieeecomputersociety.org/10.1109/HICSS.2004.1265631 Schraeder, M., Self, D. (2003) Enhancing the success of mergers and acquisitions: an organizational culture perspective. Management Decision, 41(5): 511-522 Sirower, M., Sahni, S. (2006) Avoiding the ‘Synergy Trap’: Practical Guidance on M&A Decisions for CEOs and Boards. Journal of Applied Corporate Finance, 18(3): 83-95 Appendix Figure 1 – Mergers and Acquisitions (value by industry, 1988-2004), source: Global Policy Forum, http://www.globalpolicy.org/socecon/tncs/tables/mergesector.htm) Figure 2 – Number of cases by merger type, source: Competition Commission, http://www.compcom.co.za/annualreportbook2/pages/02_mergers.htm) Figure 3 – Theoretical framework of acquisitions, source: http://www.12manage.com/methods_haspeslagh_acquisition_integration_approaches.html) Read More