Validity of Price Paid by the Acquirer and Market Reaction to the Merger Announcement - Literature review Example

Finance and Accounting Finance and Accounting Merger can be described as the purchasing, absorbing or acquiring of two or more companies by an already existing company in the market in order to make business or financial gain (Carey, 2001). A typical merger involves an acquiring and acquired company. An acquiring company is the one that acquires majority of the equity shares of a company while the acquired company is the one that sells its shares to an acquired company (Carleton, 2014). According to Darby (2006) mergers take place when an acquiring company looks to grow and is done on a permanent long term basis. When a merger happens, the acquiring company still exists while the acquired one does not survive. However, the acquired company is led by the merger that has taken place with little or no change in management. The total price paid by the acquirer to the acquired company is based on several factors and have different reasons. Karenfort (2011) explains it all comes down to the value an acquirer places to the business of the acquired and how much the acquired values it. It is obvious that the buyer would want to sell the business at the highest possible price, and the seller would look to buy it at the lowest possible one. However, there are techniques through which the buyer and seller try to penetrate the value of the business so that an agreement could be reached (Harding, 2004). Clark (1985) elucidates that price-earnings ratio is one method to discover the value or worth of a company. The calculations are made considering the earnings of the previous four quarters. Another technique under the same formula calculates earnings for the next four quarters or a year to come. Both training and future price-earnings ratios have their advantages and disadvantages, and the acquirer may opt for the one he wishes. The ratio looks to penetrate an average between market value per share and earnings per share. Price earnings ratio = market value per share / earnings per share So, for example, if a company has a market value of $50 per share and earns $2 per share then the price earnings ratio would amount to $25. If a bigger company is in the market to merge with a smaller company then, it will access all its options. The company that provides them the best earning per share would be the moist preferable option as it would provide them extra earning per unit or share (Harding, 2004). Pritchett (1997) explains another technique known as the replacement cost method through which an acquirer pays an acquired company in terms of the total cost of replacing the identified and targeted company for merger. For example, a company is made up of just equipments and employees. An acquirer would then look to measure how much the equipments (assets) cost and the total wages that are paid to the employees (usually annually). Then the separate costs would be added together, and the acquirer would account this cost as a total replacement cost of the company (Glenlake Publishing Company, Chicago). Based on the equipments and wages of the employees, the acquirer would place an order to the company in order to purchase it. Kruschwitz (2006) believes discounted cash flows are one of the best methods knowing the value of a company in particular. This method regards and makes use of the time value of money concept in business. This method looks to work on the future cash flow (cash inflow and outflow) and looks to penetrate the current market value based on the workings of these cash flows. As this method involves a technique dealing with the future cash flow, it could get tricky at times. Nothing is certain, and assumptions are made to penetrate the right figure (Harding, 2004). However, many mergers rely on this technique for acquisitions. These are the most common types of multiples, direct and discounted cash flow methods in order to find the value for the company. Harding (2004) elucidates when news hits the market that a large company might be interested in acquiring a smaller company, the share price of the smaller or about to acquire firm goes up. It is because when a large firm looks to buy the majority of the shares of a smaller firm then they would have to tempt people to sell it. This temptation comes in the forming of paying more than the share is worth. However, the market comprises of much more than trading in shares. There are emotions and sentiments of people involved that form an important part of every business. Carleton (2004) explains most mergers have failed because the stakeholders reacted in a negative way and could not go with the merger. Merger involves the mixture of two different cultures where employees might not be accustomed to one another but work so the society can benefit and the companies involved can make a profit. Although the merger is involved between two or several companies, it could affect the lives of hundreds and thousands of people involved in consuming the products and services provided by the companies. Gaughan (2005) believes that consumers, employees and the government are a major part of the market and its ongoing activities and are equally affected by it. Jarillo (2007) gives the example of the Novell and WordPerfect merger and how it was destroyed as a result of internal conflicts. WordPerfect was the best software company in the USA in the 1980s. It was so strong that any competition felt week in front of it. In 1994 when the company was fighting with Microsoft for market share it merged up with Novell, which was a software multinational giant. Novell paid a huge amount to acquire the services of WordPerfect, and it was thought that the company would grow much larger in size compared to Microsoft, its biggest rival at the time. Surprisingly, when the merger was taking place the management of Novell penetrated that the attitude of employees working for the two companies could be a stumbling block in the success of the merger. The research showed that employees would not be willing to work with one another as both the companies had a different approach towards their work. The research discovered that the experienced managers were not ready to give up their styles of working. Before the merger took place, the employees had declared that they would not be able to settle with the employees of the other company. The research was not taken too seriously (Jarillo, 2007). When the two companies merged, some of the employees came to work under one roof. It was devastating for the company. The employees of the once two separate companies could not comply with each other. Jarillo (2007) points out that both the groups started a blaming game. When errors in the business started to show up, the managers started blaming employees of the other management. There were two divisions under the same building working against the interest of each other and the merger was getting affected in a very negative way. Finally, the company fired managers from both the sides hoping it would help to resolve problems between the two companies. It did not happen as the employees still failed to work with each other. Even under new management, the employees showed less interest towards each other and productivity was at its worst. Jarillo (2007) explains the merger between Novell and WordPerfect took place so that the software company could bring in more experts to work under one roof and to drive competition out of the market. However, the exact opposite happened. Instead of driving competition out, the merger strengthened Microsoft and forced Novell to sell WordPerfect for a loss of $1 billion. In the above case, the market had already reacted in a negative way. The merger would only be successful if Novell had worked on a strategy to make the employees work together before going and buying out WordPerfect. It was not to be, and the company suffered huge losses. Wolf (2007) reveals one other example of a merger that shouted for a big no from the consumers when it was announced was between the German auto manufacturers Daimler-Benz and Chrysler Merger. The merger came to be known as the Daimler and Chrysler merger. People did not even know how to pronounce the name of the company when the merger took place. Majority of the people failed to recognize the merger and refused to buy a car on the basis of this notion. If they could not say what car they were driving then, there was no purpose to buy it. To the people in the USA, this merger did not make any sense from the engineering point of view. Wolf (2007) believes that Daimler-Benz was recognized as something classier while Chrysler Merger a bit bolder. The public totally disapproved of a car that was somewhere in between. They were not curious to know what would be the result of a less conservative in style Daimler-Benz merger with the chic Chrysler Merger. It did not make any sense at all. On top of that, both the cars were known to be of the same engineering style. If Ferrari were involved in the merger then, it would have made some sense. A fast sports car buying a classic or modern, bold car would have appealed to people in some way or the other. This merger was the type in which both the companies used more or less the same type of engine and thus this is the reason it could not offer anything new to the people. The merger ignored the shouts of the people at the announcement. The company should have at least looked to meet some of the demands of the people. The idea of combining a modern to a classic car looked dull from the beginning, and it proved to be as boring and unsuccessful as the people thought it would be (Wolf, 2007). Kumar (2012) talks about one very important merger that the involved government was the merger of Cadbury and Kraft. In 2012, it was announced that Kraft had successfully managed to purchase Cadbury. It added too much speculation by the government of the UK. Cadbury was not just a confectionary company in the UK, but it was also the pride of the country. It represented UK and selling it would mean disassociating with it. Kumar (2012) explains that the company was so prestigious to the people and government of the UK that Prime Minister Gordon Brown also came out and said that the company should not be sold and gathered massive support from consumers and trade unions. There were also some protests made. This reluctance to sell only raised the value for Cadbury. Negotiations had started $16.2 billion and agreed and ended at $18.9 billion. The shareholders benefited from protests and disapproval of people to sell it (Carleton, 2014). Kumar (2012) believed the merger was expected to cut jobs in the UK and so it did. After the merger, it had closed some factories in the UK immediately cutting jobs. It was expected from the company to do so as it has heavily borrowed some $8 billion from an English bank. It was an example of a merger that the public and government, to some extent, were against but the shareholders sold the company for their personal interest. Carleton (2014) believes there are also other organizations, financial institutes and stakeholders that are related to the well-being of a business. The Wall Street, for example, indicated to Quaker Oats not to expand operations by buying Snapple Beverage Company. The Wall Street had anticipated and acted quickly when the announcement of a merger between the two ran out into the market. According to the research presented by Wall Street, More than 50% of the sales of the company were because of gas stations and small convenience stores. The company was more popular among smaller retailers rather than the bigger ones. Quaker Oats had decided to merge with Snapple Beverage Company because it had good links with large supermarkets and departmental stores. It did not realize that it did not have a demand in such superstores. The Wall Street was smart to point this out to the company that completely refused to agree to this fact. Quaker Oats had been successful in the past when they had bought Gatorade drink and thought they could repeat the same this time. It was not to be the case, and the company suffered in millions. There is another case of identical nature (Carleton, 2014). Ebay decided to purchase Skype, and so it did for $2.6 billion. Wall Street gave the indication that such it was a futile deal as it would never be able to materialize. EBay’s aim was to build a video commodity selling website in the near future. What it learned harshly was that it was very difficult to manage accounts that way. There were concerns over privacy plus availability of the seller at the time when buyer needed to make a purchase. A few years later eBay sold Skype for a loss of $700 million (Carleton, 2014). All these examples are of companies that failed to consider the demands of the stakeholders. Mergers are useless if they do not turn out to be planned acquisitions. For a merger to be successful, it has to meet the demands of the people. It is possible for a company to place good value and purchase another business through merger, but nothing is guaranteed how the market would react. There are quite a few stakeholders and sentiments of the stakeholders involved in the merger. It is very important to see how the market reacts and then respond in a similar fashion. If the market responds are negatively booing the effort of the company in order to purchase the product then its best to walk away without hurting the sentiments of people. There are always other options for a company to consider, and it should always be considered keeping stakeholders in mind. List of References Achieving Post-Merger Success2014San FranciscoJohn Wiley & Sons Carey, D. (2001). Harvard Business Review on Mergers and Acquisitions. Boston: Harvard Business School Press. Carleton, J. R. (2004). Achieving Post-Merger Success: A Stakeholders Guide to Cultural Due Diligence. San Francisco: John Wiley & Sons. Clark, J. J. (1985). Business merger and acquisition strategies: a handbook for entrepreneurs and managers. New York: Prentice-Hall. Darby, J. B. (2006). Practical Guide to Mergers, Acquisitions and Business Sales. Chicago: CCH Publication. Gaughan, P. A. (2005). Mergers: What Can Go Wrong and How to Prevent It. New Jersey : John Wiley & Sons. Glenlake Publishing Company. (Chicago). Mergers and Acquisitions. 2000: Global Professional Publishing . Jarillo, J.-C. (2007). Reasons for Frequent Failure in Mergers and Acquisitions: A Comprehensive Analysis. London: Springer Science & Business Media. Karenfort, S. (2011). Synergy in Mergers & Acquisitions: The Role of Business Relatedness. London: BoD – Books on Demand. Kruschwitz, L. (2006). Discounted Cash Flow: A Theory of the Valuation of Firms. Chichester: John Wiley & Sons. Kumar, B. R. (2012). Mega Mergers and Acquisitions: Case Studies from Key Industries. Basingstoke: Palgrave Macmillan. Mastering the Merger: Four Critical Decisions That Make or Break the Deal2004New YorkHarvard Business Press Pritchett, P. (1997). After the Merger: The Authoritative Guide for Integration Success . New York: McGraw Hill Professional. Wolf, T. (2007). The DaimlerChrysler Merger - One Company, Two Cultures. 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