Problems of Merger and Acquisition: Causes of Failures - Essay Example

ADVANCED FINANCIAL REPORTING Table of Contents Introduction 3 Merger & Acquisition Strategy 4 Performance Analysis after Merger & Acquisition 5 Problems of Merger & Acquisition – Causes of Failures 7 Conclusion and Recommendation 10 References 12 Bibliography 14 Introduction In today’s world the primary objective of a firm is to survive the cut-throat competition and one way to do that is to make more profits and add value to shareholders’ wealth. The ladder of success for any firm is ‘growth’ which can be achieved either by expanding existing resources or introduction of new products and services. Another way of achieving growth is through Merger and Acquisition (abbreviated as M&A). The former is also known is organic growth where the firm uses its own resources (retained earnings, reserves and surplus, or equity capital) for financing growth. The later is also known as inorganic growth where the acquirer firm buys the assets and liabilities of the target(s) as on a given date (Sherman, 2010, p.1). Thus, M&A are external growth strategy that gains popularity mainly due to globalization. It has become an important an important way for firms to expand their product portfolios and gaining new markets. M&A also helps the firm’s to acquire knowledge, latest technology and improved management capabilities. In addition, M&A has been found to be extremely successful for specific sectors like pharmaceuticals where extensive Research & Developments are required. R&D does not only require huge capital investment but also requires knowledge in relevant areas so that the target product remains competent on global scale (Kumar and Yadav, 2005, pp.51-63). The main motive for any M&A is to experience a synergy in existing operations as well as profitability of the firms. However, it is also important to note that not all M&A have been successful in the past and thus some failed to maximise values leading to huge capital losses (Frensch, 2007, pp.48-49). In July 2013, TD Travel of Cheshire acquired Hotel scene, the hotel booking agency of Bristol and consequently created a new entity by rebranding called Corporate Travel International. The combined entity is expected to boost revenues for both the companies to over £100 million and also employ more than 160 staff across different units. With reference to the above recent acquisition, the objective of this study is to discuss with reasons as to why such business combination has taken place and also explain the probable consequences or problems that the companies might face in future. Merger & Acquisition Strategy As on July 12, 2013, TD Travel completed the acquisition of Hotel Scene. The acquirer in this case is TD Travel where as the acquired is Hotel scene. The deal was finance and backed by private equity investment firm LDC. The acquisition is expected to create one of the largest and independent corporate travel and booking agent entity of UK. The companies have decided to re-brand the combined business into Corporate Travel International. It is also expected that such M&A will create a synergy that can boost the revenues of the new combined business entity of over £100 million. The companies are also expecting to employ over 160 staffs in different branches located across London, Liverpool, Wilmslow, Bristol, and Hull. From the press release of the company it was found that the director of LDC is very optimistic about the M&A and has recommended the deal. He also believes that the management team of TD Travel is very experienced and motivated and thus holds immense potential to take the new entity to the next level of stimulating growth trajectory. Regarding the financing of the deal, a package of working capital and senior debt facilities was provided by Lloyds Banking Group’s Finance and Acquisition team. The negotiation was primarily led by Relationship Director of TD Travel, Richard Townsend. The responsibilities of lead manager and advisory of the deal was given to BDO LLP which is also one of the most reputed Accountancy and Business advisory firm of UK. According to the views of M&A partner of BDO, the corporate travel sector holds huge potential of generating consistent revenues as the sector is still ripe for consolidation. The transaction is considered by the industry as a great example of strategic fit since the combined business entity will further strengthen TD Travel’s services reach and help it to offer ‘one-stop’ solution to customers. Such business strategy is seemingly quite impressive especially in a competitive business environment. Performance Analysis after Merger & Acquisition The combination of business entities through merger and acquisitions has been witnessed in almost all industries ranging from banking, oil and energy, automobile to aviation. Some of the biggest mergers in automobile sector include Chrysler and Daimler-Benz, AT&T and SBC in telecom sector, KLM and Air France in aviation and these were some M&A that will be remembered for a long time due to the motivation they had created for others in the industry (Stahl and Mendenhall, 2005, p.353). In order to analyse the performance of the companies after M&A a lot of investigation and research has to be conducted. Such research would require the application of knowledge in the field of economics and strategic management. However, one of the most popular and widely used technique to analyse the performance of the acquired and the acquirer after merger is through analysing the shareholder wealth maximisation after M&A. Even the news of M&A has been found to be so sensitive that it holds the potential to immediately impact the share price of the companies involved even months before actual merger or acquisition takes place. When the information reaches the market, the investors may behave either positive or negative to the news of M&A depending on the fundamental position of the companies. For instance, when the balance sheet of the acquirer firm is already burdened with heavy debt then targeting to acquire another company at such a time might further strain the conditions of the company by increasing financial risk of the firm significantly. In such cases the investors would fear loss of wealth due to merger or acquisition and consequently reach negatively. As a result the share price of the companies would fall rapidly when the news hits market. Conversely, when the investors are expecting growth and synergy from the M&A they are more likely to react positively to the news of M&A leading to increase in the share price of the companies. Hence, from the above discussion it can be said that the perception of information regarding acquisition is such that it tries to project future decrease or increase of cash flow after the merger or acquisition. In the case of TD Travel and Hotel scene, the acquisition is expected to create a synergy and also boost revenues of the new entity, Corporate Travel International, over £100 million. Hence, it is evident that the investors are expecting that the management would be able to increase shareholders’ wealth in future. This will create positive sentiments in the markets and more investors will buy the stocks of the companies leading to consequent rise in share price and increase in shareholders’ wealth. The new combined business entity Corporate Traven International successfully completes over 460,000 transactions per year. According to the CEO of the company, Ian White explains that the real motivation behind such business combination was the integrated travel management services that the new entity would provide as a result of acquisition. Such integration is expected to increase the business heritage of both the companies by bringing together the heritage of two leading hotel and travel booking companies. As a result, the new entity will be able to share extensive knowledge and expertise in the relevant field that will ultimately help CTI to deliver real savings to business operations in UK and the global markets as well. The CEO also added that subsequent to acquisition, CTI will have an exceptionally well-built and differentiated proposition for the corporate travel industry. The combined business entity also plans to launch dedicated online booking and services platform that will help them to further extend their services to global customers that prefer unique ‘best in the class’ experience. The Northern team of LDC which is also one of the most productive private equity investor in the region has invested more than £150 million in 8 businesses during the past two years. It also backed the management buyout of TD Travel in Feb-March 2012. According to the director of LDC, CTI will be able to expand geographically and completely capitalise the needs for growing demand in the market. The company will also be able to save cost through the help of consultant led corporate hotel and travel services. The business is also expected to experience tremendous growth in the coming years and the management team at CTI has the required experience and motivation to take the company’s growth trajectory to the next level. Problems of Merger & Acquisition – Causes of Failures Previous researchers conclude that there may be many causes of failure in merger and acquisition. But one of the most common factors that can be regarded as a generalised cause of failure is overconfidence and poor management decisions. It is also possible that the managers tend to involve in activities that are against the objectives of shareholders’ wealth maximisation and hence ignore the primary motives of M&A. Sometimes however, even good decision, expert management might also back fire due to lack of co-ordination and other strategic reasons (Gertsen, Soderberg, and Torp, 1998, pp.118-119). One of the very common reasons of failure of M&A is over payment. This situation is a consequence of either uninformed urge for growth and expansion or overconfidence. If the acquiring firm pays a hefty premium on M&A deal significantly above the fair market value of the target entity in the form of goodwill, then such over payment may have disastrous consequences. This is because overpayment leads to over-expectation of higher profitability which may actually be practically impossible for the firm to achieve. Thus, excessive payment in the form of goodwill may reduce the profitability of the firm (DePamphilis, 2005, p.23). According to Sadler, “only few business marriages are made in heaven” – implying that successful integration of M&A is rarely seen (Sadler, 2003, p.128). Thus, in order for a merger or acquisition to be successful it is necessary that both the companies which are involved in M&A are also compatible with each other. In addition to this, the business culture, work ethics, traditions, etc. are also important areas that need to be flexible and adjustable. Also, inefficiencies in administrative process create problems that lead to nullifying synergy effects of M&A (Straub, 2007, p.85). Among other reasons, one of the most fatal issues related to failure of M&A is the personal motives of the executives. Hence, it is not uncommon for the managers to enter into M&A deal only to satisfy their own personal needs. Such motives could include higher compensation, fame, building empire, etc. leading to significant increase in agency cost. As a result of personal motives the managers often tend to lose focus on reality and strategic requirements for successful deal. The executives may also enter into M&A for purpose satisfying their self-esteem which might lead to failure of mergers. Many merger and acquisitions in the past have not been successful and failed to create any value for the shareholders. A failure in M&A occurs when process of integration does not work properly or gives expected results. When any M&A fails, the wealth of the shareholders deteriorates significantly. This can be understood from the perspective of both the acquirer and the target (acquired). The M&A must be financed from debt capital, equity capital, reserves and surplus or an effective combination of all sources. As discussed earlier, when the balance sheet of the acquirer is highly leveraged, addition of more debt will result into increase in the financial risk of the firm. This will also create negative sentiments among the investors leading to fall in share price and loss of shareholders’ wealth. From the point of view the acquired, it is important that the current management and other employees of the acquired firm cooperate with the new management. If there is any hostile environment after M&A, the resultant entity may experience negative synergy leading to loss of shareholders’ wealth and failure of merger or acquisition. The outcome of failure merger or acquisition may be disastrous for both the acquired and the acquirer. In order to overcome organizational hostility towards changes due to acquisition, many progressive and disciplined steps may be required to be taken by the management create a positive environment after M&A. It is also sometimes important to identify the key personalities needed to monitor the after effect of M&A in future. Hence, good communication between the respective parties is essential for the success of merger or acquisition (Hag, 2003, pp.36-40). The strategic issues behind M&A should not be ignored since the strategic benefits of merger are one of the primary motives. This area might be overlooked by the managers in the sense that managers may have over expected the strategic benefits from M&A where as in reality the outcome may be more humble. Faulty strategic planning is equally harmful to unskilled execution that leads to the failure of M&A (Schuler, Jackson and Luo, 2004, p.84). Conclusion and Recommendation One of the prime cause due to which companies are growing around the world is through merger and acquisition. The companies are motivated to choose this inorganic route as option for growth due to factors including immense competition, thrust to grow big, saturation of domestic markets, and maximisation of shareholders’ wealth. When any business is considering consolidation with another entity there are several issues that need to be addressed so that the M&A produces expected synergies. The issues that might lead to failure of merger or acquisition can occur at any stage during or after the M&A and should be addressed immediately after identification. If proper precaution is not taken timely then the M&A might significantly damage the acquirer firm’s financial resources. There is also a need for expert lawyer, accountant, lead manager(s), etc. so that the analysis of pre-and post-merger is evaluated correctly in the initial stage. All important considerations such as tax benefits, implication of re-branding, consequences of consolidation on parent firm’s balance sheet, etc. should be evaluated at the initial stage so that the M&A do not fail after transaction. Any unanticipated hostility from the target firms’ employees should also be handled tactfully with proper communication so that no disputes arise after acquisition. With reference to the acquisition of Hotel Scene by TD Travel Group, it can be said that the deal is expected to create synergies of over £100 million since the new entity thus formed after acquisition (Corporate Travel International) will employ over 150 employees in different branches. CTI’s transactions are expected to cross over 450,000 per year. The transaction is considered by the industry as a great example of strategic fit since the combined business entity will further strengthen TD Travel’s services reach and help it to offer ‘one-stop’ solution to customers. Such business strategy is seemingly quite impressive especially in a competitive business environment. References DePamphilis, D. M., 2005. Mergers, Acquisitions, and Other Restructuring Activities. 6. United States: Academic Press. Straub, T., 2007. Reasons for Frequent Failure in Mergers and Acquisitions: A Comprehensive Analysis. Germany: Springer. Schuler, R. S., Jackson, S. E., and Luo, Y., 2004. Managing Human Resources in Cross-Border Alliances. London: Routledge. Kumar, B. R. and Yadav, A. K., 2005. Role of Organization Culture in Mergers and Acquisitions. SCMS Journal of Management. 2. Sherman, A. J., 2010. Mergers and Acquisitions from A to Z. United States: AMACOM Div American Mgmt Assn. Frensch, F., 2007. The Social Side of Merger and Acquisition: Cooperation Relationships after Mergers and Acquisitions. Germany: Springer. Stahl, G. K. and Mendenhall, M. E., 2005. Merger and Acquisition: Managing Culture and Human Resource. United States: Stanford University Press. Gertsen, M. C., Soderberg, A. and Torp, J. K., 1998. Culture Dimensions of International Mergers and Acquisitions. Germany: Walter de Gruyter. Hag, F., 2003. Impact of Organizational Culture on Success of Merger and Acquisition: An Analytical Study. United States: ProQuest. Bibliography Hotel scene, 2013. Hotel Scene News – TD Travel Group Acquires Hotel Scene. [Online]. Available at: https://www.hotelscene.co.uk/NewsandResources/HotelsceneNews/TabId/115/ArtMID/572/ArticleID/8031/TD-Travel-Group-Acquires-Hotelscene.aspx. [Accessed on July 27, 2013]. Read More