Corporate Finance - Mergers and Acquisitions - Essay Example

Mergers Corporate Finance Mergers and Acquisitions Introduction Profit maximisation is the aim of a business enterprise. It adopts various methods to realise it, and cost reduction is prominent among these methods. The perceived inverse relationship between the scale of a business operation and its cost configuration in its variable components is both a well known theorem in economics and an observed fact in business. Mergers and acquisitions (M&A) are techniques that a business enterprise adopts at some stage of its life to increase the scale of its operations and thereby to reduce its total cost and increase its profits. There are, of course, other reasons too for M&A, such as, to increase the company's market share, to enter a new market, to develop a new product or to achieve management benefits, or to achieve all or most of them. Generally, mergers are brought about in a consensual and cordial environment where the target company helps the purchaser in a 'due diligence' process to ensure that the deal is beneficial to both parties. But acquisitions are sometimes "hostile", in that the acquiring company purchases in the open market a majority of outstanding shares of the target company against the wishes of the target company's board of directors. Value creation 'Mergers and acquisitions should be value creating for the shareholders of both the 'offeror' and the 'offeree' companies'. Value creation is also necessary for further growth. Creating value implies earning a return on invested capital in excess of the cost of capital over time; or earning a strictly positive profit, that is where revenue minus all expenses is greater than zero. Value creators do not have to worry about a capital shortage. They are either flush with internal funds to meet their investment needs, or can attract the needed capital from the markets, which are always in search of profitable investment opportunities. And such companies will also create over time a cadre of managers who have higher standards and better capabilities than the competition. Current state of M&A Many companies have had recourse to M&A as a sure path to fast growth. Operational synergy and economies of scale are the strengths of M&A propelling growth. But the failure of many M&A in the 1990s has actually reduced shareholder value instead of increasing it and as a consequence, both management and investors are now taking a closer look at what makes a merger or acquisition a success or a failure. (K@W, 2003). But there have been some exceptions and one exception has been the recent acquisition of Arcelor by Mittal. The Acquisition of Arcelor by Mittal The rise of Mittal Steel has been a story of growth and expansion through acquisitions, beginning with that of the Iron and Steel Company of Trinidad and Tobago in 1989 and culminating in 2006 in the acquisition of Arcelor, Europe's largest steel producer. Mittal has grown by buying struggling steel plants around the world and knitting them into the world's biggest steel company. It has a strong presence in North America and Europe, but in Asia its operation is confined to Kazakhstan. It is the world's largest and most global steel company, with shipments of 49.2 million tons and revenues of over $28.1 billion in 2005, owning steel-making facilities in 16 countries and employing over 224,000 people. The shares of the company are listed on the New York and Amsterdam stock exchanges. The company produces a broad range of products for the flat and long products markets and has among its customers well known names in the automotive, engineering and appliance sectors. (http://www.mittalsteel.com/company/Profile.htm) Mittal Steel announced its intention to acquire Arcelor on 27 January 2006, for a total of 24 billion euros. Arcelor had been created in 2002 by the merger of Aceralia, Arbed and Usinor, with an intention of mobilizing their technical, industrial, and commercial synergies in a joint venture to create a major player in the steel industry. Arcelor shares are listed on several stock exchanges. (http://www.arcelor.com/index.phplang=en&page=77) Announcing the intention to acquire Arcelor, Lakshmi Mittal, Chairman and CEO of Mittal Steel said in January 2006 that the new company would create sustainable value for all stakeholders and provide the Arcelor shareholders an opportunity to participate in the growth potential of the combined company, "while also receiving a generous cash element". http://www.mittalsteel.com). The merger created the world's first 100 million ton plus steel producer. The initial offer valued each Arcelor share at 28.21 euro which was 27% higher than the closing price of Arcelor shares on 26 January 2006, on Euronext Paris, 31% higher than the volume weighted average price in the preceding month, and 55% higher than the volume weighted average share price in the preceding 12 months. The offer valued Arcelor at an equity value of 18.6 billion euros. The new company would have unprecedented scale, scope and synergies in annual revenues (US$69bn), market capitalisation (US$40 billion); leading position in NAFTA, EU, Central Europe, Africa and South America; expected synergies of US$1 billion from purchasing, marketing and manufacturing efficiencies; a high degree of iron-ore self sufficiency; reduced volatility through geographic and product diversification; low cost profile and high growth prospects; global supply capability; and a dividend policy of about 25% of earnings over the cycle. The offer price to Arcelor shareholders was 4 Mittal Steel shares and cash of 35.25 euro for every 5 Arcelor shares. In addition, they would have the right to receive a cash or stock mix in any proportion they elected, provided that 25% of the aggregate consideration was paid in cash and 75% in stock. (http://www.mittalsteel.com) The Arcelor Board of Directors rejected the 'hostile' bid of Mittal Steel on January 29, 2006, saying that the offer strongly undervalued Arcelor and urged shareholders to preserve the company's independence. It promised an increased 2005 dividend and a 5 billion euro share buyback at a price above the market price in an effort to ward off Mittal. (http://www.arcelor.com/index.phplang=en&page=128). And just a day after formally launching the 'hostile' bid in May, 2006, Mittal increased its total offer by over 6 billion euros to above 24 billion euros ($30.7 billion). Arcelor shares jumped 13 percent and Mittal's declined by 5 percent when their trading began after the new bid was announced. Mittal's new bid valued Arcelor share at 37.7 euros raising it above its market price of 35.50 euros. The Arcelor Board now agreed to consider the Mittal offer. But, instead it announced plans to merge with Russian firm Severstal, in a move aimed at blocking the takeover by Mittal. "I have great confidence that the majority [of shareholders] will accept it", said Mr Dolle, the CEO of Arcelor. But they did not as indicated by the fact that Arcelor shares closed 3% lower at 33.05 euros. So, finally on 25th June, 2006, Arcelor accepted the Mittal offer after Mittal "raised its offer to 40.37 euros per Arcelor share from the previous 37.74 euros per share" (BBC News, 25 June, 2006). The new offer gave the Arcelor shareholders an increased value by 10% in a mixed bag of shares and cash, at 13 Mittal Steel shares and 150.6 euros in cash for 12 Arcelor shares, or 12.55 euros in cash and 1.084 Mittal Steel shares per Arcelor share; or a cash offer of 40.37 euros per Arcelor share; or an exchange offer of 11 Mittal Steel shares per 7 Arcelor shares. This offer represented an improvement of 49% over Mittal Steel's initial offer. The offer ratio implied that the shareholders of Arcelor and Mittal Steel would hold 50.5% and 49.5% respectively of the new merged company of Arcelor-Mittal. The merger benefited both the parties to the contract and provided for 'value addition' to the shareholders. However, there was a caveat: Arcelor would have to pay a $162.7 million penalty to disengage from Severstal, and also to rescue Canada's Dofasco steel plant, which Arcelor had acquired earlier and now placed in a Dutch trust to give financial headache to Mittal in the event he acquired Arcelor. Arcelor had bought Dofasco for 4.0 billion euros (5.1 billion dollars) in January 2006, beating ThyssenKrupp of Germany. Mittal put the total price of the takeover of Arcelor at $33.4 billion. (Stanley Reed. 2006) Merger of Glaxo Wellcome and Smith Kline Beecham On January 31, 1998, Britain's two drug companies, Smith Kline Beecham and Glaxo Wellcome announced that they were in merger talks in order to form the world's largest pharmaceutical group, with 16.2bn ($26.6bn) in combined annual revenues, with the Glaxo shareholders owning 59.5% of the equity of the combined company and SmithKline shareholders, the remaining 40.5%. Analysts saw the deal as creating a company with significant shareholder value when the stocks of both companies surged in price. (http://news.bbc.co.uk/english/business/default.htm/). However, on February 24, 1998 the merger talks collapsed, with Smithkline citing "insurmountable differences." The news was a dampener for the London Stock Exchange with the FTSE-100 Index tumbling 110 points in the opening minutes of trading, wiping 20bn off the value of leading shares. The City recovered some of its composure by the close, ending down 51.8 points at 5,651. Glaxo Wellcome and SmithKline Beecham saw their stock market values plunge by more than 8bn and 4bn respectively, with Glaxo share price down by 247p to 16.57 and SmithKline by 83p to 724p. The merger talks were revived in January 2000, for the merger to be finalised in July 2000. The merger was to be implemented by the acquisition of Glaxo and SmithKline by a newly formed holding company, GlaxoSmithKline (GSK), under section 425 of the Companies Act whereby the two companies would become wholly-owned subsidiaries of GlaxoSmithKline when the Scheme became effective. News that the company had resumed talks after a two-year hiatus sent the stock prices surging. Glaxo went up 4% at 1808 pence and SmithKline was up 7% at 837.5 pence in London trading. In the pre-opening hours in New York, SmithKline was up 2 3/4, or 4%, to 69 1/2, according to Instinet. Glaxo was unchanged from the previous close of 58. However, the next day Glaxo was down 3.5% at 1755 pence and Smith Kline was down 7.1% at 786.5 pence, mostly on profit-taking after the companies rose 4.5% and 7.1% respectively on the previous day, following the news that the talks were back on. (The Street.com: Glaxo, Smithkline Renew Merger Talks, at (http://www.thestreet.com/brnews/biotech/86179.html/) The merger rationale was in response to the forces responsible for change in the pharmaceutical industry, namely: "rapid advances in science and technology, the growing importance of marketing power and the emergence of patients as consumers". Short term merger benefits were seen as combined cost savings, enhanced marketing power and leadership position in key therapeutic areas, while medium term benefits were envisaged as enhanced consumer marketing skills, strong portfolio of core products, and increased resource for key pipeline products. The long term growth ambition was to emerging as a world leader in research. These measures were expected to add much value to the shares to the shares of the company. Under the terms of the merger, Glaxo Wellcome Shareholders and SmithKline Beecham Shareholders will receive, respectively: for each Glaxo Wellcome Share 1 GlaxoSmithKline Share for each SmithKline Beecham Share 0.4552 GlaxoSmithKline Shares Holders of Glaxo Wellcome ADRs and holders of SmithKline Beecham ADRs will receive, respectively: for each Glaxo Wellcome ADS 1 GlaxoSmithKline ADS for each SmithKline Beecham ADS 1.138 GlaxoSmithKline ADS Based on the number of shares outstanding as at the 31st December 1999, upon the merger becoming effective, 3,640,804,312 GlaxoSmithKline Shares would be issued to Glaxo Wellcome Shareholders and 2,556,309,411 GlaxoSmithKline Shares would be issued to SmithKline Beecham Shareholders, representing approximately 58.75 per cent and 41.25 per cent respectively of the issued ordinary share capital of GlaxoSmithKline. The current market price, as on 18 November, 2006 on the LSE was 1374.00 pence and on the NYSE, 51.70 USD. However, the avowed objective of the merger had been to achieve strong growth through research and development in the highly competitive environment of the pharmaceutical industry world-wide, rather than to create ostensible value addition to shareholders. In the recent years GSK has been buying back its shares, so that after its purchase of 575,000 of its Ordinary shares of 25 pence each ("shares") on 17 November 2006 at a price of 1371.33 pence per share, the Company holds 222,164,678 of its shares in Treasury and has 5,767,158,511 shares in issue excluding Treasury shares. (www.gsk.com/financial/quarterly_results_2006.htm) Number of words: 2006. References Amit, R. and Schoemaker, P. 1993 "Strategic Assets and Organizational Rent," Strategic Management Journal, 14, (): 33-46. Favaro, Ken, 1998, Marakon Associates, Put Value Creation First, at http://www..favaro.net/publications/pvcf/ken_pvcf.html Glaxo Smthkline Merger, 2000, The Pharmaceutical Journal, Vol.264, No.7080 p. 125, January 22, 2000. at http://www.pharmj.com/editorial/20000122/business/glaxosmithkline.html/ Grant, R. 1991, "The Resource-based Theory of Competitive Advantage: Implications for Strategy Formulation," California Management Review, 33, Issue 3 (:1991) 114-135. R. C Higgins, 1977. "How Much Growth Can a Firm Afford," Financial Management, Fall 1977. Knowledge@Wharton (K@W), 2003, Written for GE Corporate Financial Services at http://www.gelending.com/Clg/Resources/PDF/Whitepapers/ Knowledge@Wharton, Written for GE Corporate Financial Services at http://www.gelending.com/Clg/Resources/PDF/Whitepapers/ M. Miller and F.Modigliani, 1961. "Dividend Policy Growth and the Valuation of Shares," Journal of Business, October 1961. Randy Myers, 1997. "Measure for Measure," CFO Magazine, November 1997. Stanley Reed (2006), Business Week, What price Mittal's Victory, June 26, 2006 The Street.com: Glaxo Smithkline Renew Merger Talks, at http://www.thestreet.com/brnews/biotech/86179.html/ Appendix 1 Arcelor Share price on 11/6/2006. 11/16/2006 Time Price D/D-1 Paris 17:39:13 42.70 +0.23% Brussels 17:07:01 42.56 0% Madrid 17:18:24 42.43 -0.05% Lux 16:00:31 41.875 +0.3% Stock market information (Arcelor) 2002 2003 2004 2005 Highest price (euro) 16.05 13.37 17.16 21.27 Lowest price (euro) 8.12 7.61 12.60 15.12 Average price over the year (euros) 12.82 10.61 14.50 17.97 Price at year end (euro) 11.34 13.37 16.97 20.95 Number of shares at year end 532,366,409 533,040,796 639,774,327 639,774,327 Market capitalisation at year end (in millions of euros) 6,037 7,1276 10,857 11,497 Daily mean volume traded during the year 2,206,021 2,562,938 4,037,819 4,137,036 Net earnings per share (euro) -0.25* 0.54 4.26 6.26 Arcelor 2006 Appendix 2 GLAXOSMITHKLINE PLC Currency Code: USD Price:55.04 Change:.7300 %Change:1.34 Open: 54.72 Yesterday Close: 54.31 High: 55.15 Low: 54.61 Volume: 1,565,000 52-Week High: 58.40 52-Week Low: 48.98 Charting and all data (except Forbes 2000 data where applicable) provided by Financials & Ratios Book Value/Share ($) NA Current Ratio (MRQ) 1.56 Div/Yield % 3.0 Earn/Shr ($) 2.95 Earn/Shr Est 3.78 Ex-Div Amt. ($) 1.64 Ex-Div Date 08/02/06 Interim Earnings Period 3 Mo Mar Market Cap 163,588.94 P/E 18.41 Shares Out 6,024,266 GlaxoSmithKline: share prices on 18 Nov 2006 LSE 1374.00p +1.00 19 Nov 2006 closed NYSE 51.90 -0.07 19 Nov 2006 closed Issued: 26th October 2006, London, UK Results announcement for the third quarter 2006 Strong GSK performance continues: Q3 EPS 24.7p up 21% CER (16% reported) Earnings guidance raised; Dividend increased; New share buy-back programme GlaxoSmithKline plc (GSK) today announces its results for the third quarter ended 30th September 2006. The full results presented under 'Income Statement' are summarised below. FINANCIAL RESULTS* Q3 2006 Q3 2005 Growth 9 months 2006 9 months 2005 Growth m m CER% % m m CER% % Turnover 5,642 5,471 7 3 17,266 15,753 9 10 Operating profit 2,023 1,783 19 13 6,108 5,241 16 17 Profit before tax 2,022 1,753 21 15 6,089 5,126 18 19 Earnings per share 24.7p 21.3p 21 16 74.5p 62.8p 18 19 Q3 2006 SUMMARY* 2006 Earnings guidance raised to mid-teens EPS percentage growth (in CER terms) Q3 dividend of 12p (2005: 10p). Expected full year dividend increased to 48p (2005: 44p) New share buy-back programme of 2 billion per year; 6 billion expected over next 3 years Top of Form Top of Form GlaxoSmithKline plc Bottom of Form Real-time quotesGSK quote (on 17 Nov, 2006 ) 52.00 lunch Previous Close 52.00 Bid NA Open NA Bid Size NA High NA Ask NA Low NA Ask Size NA Volume NA 52 Week Range 48.98-58.40 GSK Intraday Chart 5d 1m 3m 1y 3y 5y 10y Market Cap. 149.96 Bil Total Shares Out. 2.88 Bil Avg. Daily Volume 1.44 Mil P/E 14.80 Forward P/E 14.70 Earnings/Share 3.52 Return on Equity 66.18 Current Dividend Yield 3.50% Last trade 11/17/2006 04:03 PM ETFinancial data in U.S. dollars Read More