Do Mergers Create Value for the Offeror and Offeree - Essay Example

1 Do Mergers Create Value for the Offeror and Offeree? This paper looks critically into the value created by mergers and acquisitions. It attempts to answer the following important questions about this popular practice in corporate management: do mergers actually create value for the offeror and offeree? How can this value be measured? Is it only in the improved share price or otherwise? And what are the criteria responsible for making the process of mergers and acquisitions successful, if undertaken? Empirical facts or information are obtained from peer-reviewed journals to substantiate the information provided in this paper. And the merger of Hewlett-Packard is used as a typical example of a successful mergers and acquisitions that practically add to the shareholders’ value. Theoretically, there are some benefits and merits of mergers and acquisitions. Some of the widely believed benefits of mergers can be synergistically represented by the following formula: Synergy= v.imp (2+2=5), which implies that when two companies merge, they practically bring together their individual resources to expand, grow and become more profitable (Levine and Aaronovitch, 1981). This is why the equation 2+2 does not become 4 as expected. Mergers and acquisitions, M & As are expected to be a value-creating business decision, whereby a newly merged company should be able to outperform its combining parent-companies in sales, revenues, cash-flows and financial performance 2 (Moeller, Schlingemann and Stulz, 2004). It is interesting that values created during mergers can be measured in a number of ways, like evaluating the improvement in the shareholders’ values, increased revenue strategy, better financial performance, and overall performance of all the sections of the newly emerged company (Rau and Vermanclen, 1998). However, most analysts concentrate on the viability of creating shareholders’ values when describing how successful a merger has been. The perennial question is that: do all mergers and acquisitions produce a value that would shoot up the newly formed company’s shares? According to the summary evidence on pages 890 and 891 of Arnold, there were some mergers and acquisitions in the past that had indicated that the processes do not necessarily add values to the newly formed companies. For instance, several studies or researches on this corporate practice carried out by the following researchers (Meeks, 1977; Gregory, 2005; Limmack, 1991; Franks and Harris, 1989; Powell and Stark, 2005; Georgen and Renneboog, 2005; Sudarsanam and Mahate, 2003 etc) reveal that mergers and acquisitions are complex procedures that may yield little or no financial values during its implementation. Some of the findings from the studies confirm that mergers incidentally cause drastic reduction in some companies’ stock value, result in poor post-merger returns, poor financial performance and corresponding decrease in profitability. These problems often raise numerous questions about why firms continue to engage in mergers and acquisitions when empirical information or facts indicate the practice is unproductive. 3 In some cases, merged companies tend to underperform when compared with their individual performances pre-merger. Typical examples of failed mergers include but are not limited to AOL-Time Warner, HSBC-Household, BMW-Rover, Royal Bank of Scotland and ABN Amro, Daimler-Chrysler, French Telecom-Orange etc. In all these cases, the old companies’ stakes were drastically drawn down and the newly formed companies lost an appreciable amount of money—funds that could be saved if mergers had not occurred in the first instance. Due to these colossal failures, several reasons have been put forward to describe how a merger could be successful. One major mistake most companies make when bidding for a takeover or merger is that they entertain unrealistic financial goals (Firth, 1991). Since executives, mainly CEOs and COOs are likely going to bring up the idea of a takeover in the board of directors’ meeting, their reasons are normally based on projected profitability, financial gains and probable organizational expansion. Hence, these untested and possibly unrealistic expectations overtake the minds of their executives that they may reject practical advice offered by their financial consultants (Firth, 1991). Does that mean there are no successful mergers and acquisitions? Findings from past studies indicate that there are actually some success stories (Epstein, 2005). But there are some determinants that are basically essential for achieving this success. Some of these factors that must be decisively dealt with before a merger can be successfully include: 4 (i)efficient synergy evaluation; (ii) great integration project planning; (iii) following due diligence; (iv) selection of the management team; (v) settling cultural issues; (vi) and handling communication well. Better deal selection involves a lot of processes. This entails that the initial synergy evaluation must be properly carried out. It is at this point that more consideration would be given to compatibility of purposes in the companies merging together. That is, are the companies having similar goals? If merged, can they perform together without obvious hitches or problems? (Epstein, 2005). However, companies are separate entities with peculiar characteristics. This indicates that for two or more companies to be successfully merged, there should be a laid-down principle for perfectly integrating all the operations of the merged companies. In other words, a contingent plan for integration is very important for the newly formed company to function seamlessly (Levine and Aaronovitch, 1981). Following the due process in carrying out mergers and acquisitions is the best way to prevent corruption and unfair practices. Due process helps the merging companies to fairly evaluate their values before the merger so as to prevent over-valuation, a problem that could threaten the survival of the new company. Many M & As failed because the acquiring company or merged companies over-or under-value their competitors before the takeover (Rau and Vermaclen, 1998). When the due process is followed, mergers stand a good chance of being successful in any competitive market. 5 Selecting the management team that would manage a new company often poses a great challenge to the newly formed company. This explains why there are changes in companies’ management post-merger so as to reflect a new mentality among the managers. Putting the right and qualified CEOs over new companies tend to be effective and help the new corporations to handle the new challenges facing them. In other words, appointing unqualified managers to handle the new company may lead to unproductive procedure. Another area that often creates hurdles to running a newly formed company is the issue of marrying the different organizational cultures in the merging companies. Each company has its distinctive culture that has been developed for a long period of time. Hence, when such a company merges with another one, there is always a friction in cultural harmony. Workers in the newly formed company mostly adhere to their previous cultural practices. This often threatens smooth performance of operations in the new company. Establishing an efficient inter-departmental communication has been discovered to be a great tool in moving a newly formed company forward. The employees of the new company must work together in a constructive manner in order to break the slow-down that disparate organizational cultures could have caused (Epstein, 2005). A real world example of a successful merger is that of Compaq and Hewlett-Packard. Despite projections from the experts that the deal would fail, it came surprising that the merger has produced something important to all companies that had undergone mergers and acquisitions—creating shareholders’ value (Rosen, 2008). 6 Courtesy: The Huffington Post (Business), 2008. The chart above reveals that the share price of Hewlett-Packard increased considerably almost 5 years after merging with Compaq, beating all expectation. Invariably, in 2008, the stock price of Hewlett-Packard rose by 163% post-merger. This is an outstanding achievement for the new company, Compaq-Hewlett-Packard. This example points to the fact of all other factors are properly managed as described in this paper, it is possible for a newly formed company to achieve its economic or financial projection. 7 In conclusion, companies that want to undertake mergers and acquisitions must take several factors highlighted above into consideration. It is through this approach that a successful merger that adds value to the newly formed company can be achieved. References Epstein, M.J., 2005. The determinants and evaluation of merger success. Business Horizons, 48, 37-46. Firth, M., 1991. Corporate takeovers, stockholder returns and executive rewards. Managerial and Decision Economics, 12, pp. 421-8. Levine, P. and Aaronovitch, S., 1981. The financial characteristics of firms and theories of merger activities. Journal of Industrial Economics, 42, pp. 149-72. Moeller, S. B., Schlingemann, F.P. and Stulz, R.M., 2004. Firm sizes and the gains from acquisitions. Journal of Financial Economics, 73, 201-228. Rau, P.R. and Vermaclen, T., 1998. Glamour, value and post-acquisition performance of acquiring firms. Journal of Financial Economics, 49 (2), pp. 223-53. Rosen, B., 2008. The merger that worked: Compaq and Hewlett-Packard. The Huffington Post (Business), April 9. Read More