Mergers & Acquisitions - Essay Example

Mergers & Acquisitions - An Introduction The term 'merger' is often abused, by being loosely applied to refer to any form of business combinations. It has however got a specific connotation. A merger actually refers to a business combination of two or more firms in which only one firm survives and the other firm or firms go out of existence. In a merger, the surviving firm acquires the assets and liabilities of the other firm(s). A relevant example here is the recent merger of HDFC Bank and Times Bank. After the merger, Times Bank will go out of existence and expanded HDFC Bank will continue to exist. A merger takes place when the firms involved in the combination are of unequal size. The larger or stronger firm continues to exist because of its stronger bargaining power and the smaller or weaker firms go out of existence. Four periods of economic history have witnessed very high levels of merger activity, which are called a merger waves. These periods are characterized by cyclical activity i.e. large number of mergers followed by relatively fewer mergers ((ICMR), 2003). The current period is called as the fifth wave. In the first three waves, merger activity was concentrated in the United States of America. The fourth and the fifth waves were global in nature though the impact of the wave is most pronounced in the United States of America. First Wave The first merger wave occurred after the depression of 1883. It peaked between 1898 and1902 though it began in 1897 and ended in 1904. The merger had the greatest impact on eight specific industries i.e. primary metals, bituminous coal, food products, chemicals, machinery, transportation equipment, petroleum and fabricated metal products. These industries accounted for almost two - thirds of the total mergers during these periods. The mergers in the first wave were predominantly horizontal combinations. These resulting industrial consolidations led to creation of large monopolies. For example, US steel founded by J P Morgan merged with Carnegie Steel founded by Andrew Carnegie. The merged firm US Steel also acquired several other smaller steel producers and the resulting giant capture 75% of the steel market of the United States of America. Some of the current corporate leaders like General Electric (GE), Du Pont, Eastman Kodak, and Navistar International are products of the first wave. Second Wave The second merger wave occurred between 1916 and 1929. George Stigler, a winner of the Nobel Prize in Economics, has contrasted the first wave as "merging for monopoly" and the second wave as "merging for oligopoly." The consolidation pattern resulted in the emergence of oligopolistic industrial structures. The second wave was primarily fuelled by the post World War I boom in America Economy and a buoyant capital market. The second merger wave lasted until the Great Depression. The wave ended with the stock market crash on the "Black Thursday" i.e. October 29th of the year 1929, when the stock market witnessed one of the steepest stock price falls in history. Some of the corporate giants like General Motors, International Business Machines (IBM), Union Carbide, and John Deere etc., are a product of this era. Third Wave The third merger wave occurred during 1965 to 1969. This wave featured a historically high level of merger activity. One of the reasons for this factor is that this wave occurred in the background of a booming American Economy. One of the new trends started by this wave was the acquisition of larger companies by smaller companies. In the waves prior to this, the acquirer was always bigger in size than the target. A large proportion of transactions that took place during this wave were conglomerate transactions. The conglomerates formed during this period were highly diversified and simultaneously operated in several unrelated industries. For example, during the sixties ITT acquired such diversified businesses like car rental firms, bakeries, consumer credit agencies, luxury hotels, airport parking firms, construction firms and restaurant chains etc. The bull market in the 1960s drove stock prices higher ad higher. This resulted in the shares of certain companies getting high Price/Earnings multiple. Potential acquirers realized that an acquisition through stock swaps i.e. share of the acquirer given in exchange for the shares of the target company was an innovative way to increase earnings. This led to the famous boot strap game. The boot strap game results in an illusion of wealth creation through financial engineering. Fourth Wave The fourth wave occurred between 1981 and 1989. The most striking feature of this wave is the increasing emergence of hostile takeovers. Although the number of hostile deals is not very high, the figure is significant in terms of value of all Mergers & Acquisitions. The fourth wave can be distinguished from the previous wave by size and prominence of the target firms. Some of the largest firms in the world became the target of acquirers. The average size of deals was substantially higher. The fourth wave also witnesses the emergence of the professional corporate raider. The use of debt to finance acquisitions reached unprecedented proportions during the fourth wave. This was possible due to the emergence of junk bonds. Junk bond refers to the bonds which are rated below investment grade or are unrated. The yields on the junk bonds were significantly higher than that of investment grade bonds. The higher yield resulted in the creation of virtually unlimited appetite for junk bonds. The ready availability of debt financing enabled even small firms to acquire large well established blue chip firms. This gave birth to the phenomenon of leveraged buyouts. Fifth Wave The current merger wave began in 1992. This wave is marked by a large number of mega-mergers and cross-border mergers. The major drivers for the current wave are deregulation, globalization and technology. The increasing levels of deregulation are enabling companies to enter or expand their operations in areas which had significant regulatory barriers. The sectors where the impact of the wave is most visible are telecommunications, entertainment and media, banking and financial services. One such major acquisition that happened in the United Kingdom is the acquisition of Safeway, Britain's fourth largest supermarket group (Sky News, 2003) by William Morrison Supermarkets which operates in Central London and England (Arla Foods, 2003). Safeway PLC was going through a troubled phase of business and was also struggling to cope up with the competition from the other retail giants in UK. As part of this struggle to compete, Safeway has also started experiencing the decline in its brand equity. All these struggles of Safeway were despite its strong national portfolio of having almost more than 450 outlets all across the United Kingdom. Going ahead, though William Morrison is a regional retail player in the United Kingdom having its strength in Midlands and in Northern Europe. Though William Morrison PLC is a regional player, the main strength of the company is its brand image and reputation in the market. One of the fundamental motives that drive mergers and acquisitions is the growth impulse of firms. Firms that decide to expand have to choose between two generic growth strategies, one is the organic growth and the other being the acquisition driven growth. The former one is a slow, steady process and very often a function of time factor. Acquisitions led growth is an aggressive strategy and is relatively riskier to an organic growth strategy. The second strategy is the one which is evident from the acquisition of Safeway PLC by William Morrison. Another important concept which is relevant to our discussion here is the concept of synergy. This concept is based on the principal that the whole is greater than the sum of the parts. Simply stated, synergy is the phenomenon where 2+2 equals to 5. This concept if related to mergers and acquisitions, translates into the ability of a business combination to be more profitable than the sum of the profits of the individual firms that were combined. The synergy may be in the form of revenue enhancement or cost reduction. Clemente and Greenspan define revenue enhancing synergy as "a newly created or strengthened product or service that is formulated by the fusion of two distinct attributes of the merger partners and which generates immediate and / or long-term revenue growth." Now, if we look at the concept of synergy from the perspective of the acquisition of Safeway PLC by William Morrison, the management of both the companies revealed that this acquisition would result in the evolution of a dynamic national supermarket group the value of which is estimated to be .5.5 Billion. Additionally, the estimated combined sale value of the new group is 12.6 billion with a market share of 16.1%. As the theoretical belief goes, mergers and acquisitions should be value creating for the shareholders of both the offeror and offeree companies. This is evident from the acquisition of Safeway PLC by William Morrison Supermarkets PLC as the later has said that all the shareholders of Safeway would be getting 1.32 new shares of William Morrison for every Safeway share that is held by them. The actual worth of the deal is 277.5 p per Safeway Share. In addition to this, the acquisition leads in combining William Morrison's brand strength with the national portfolio of Safeway. This way the benefit would be for both the companies. The offer price of 277.5 pence per share is a premium of 30.3 per cent over yesterday's closing mid-market price of Safeway shares (Europe.com, 2003). Due Diligence is another important point that needs to be discussed in this context of the acquisition of Safeway PLC by William Morrison Supermarkets PLC. The basic function of due diligence is to assess the benefits and the costs of a proposed acquisition by inquiring into all relevant aspects of the past, present and the predictable future of a business to be purchased. Due Diligence is of vital importance to prevent "unpleasant surprises" after completing the acquisition. The due diligence should be thorough and extensive. Due diligence exercise covers careful study of information in public domain like financial statements, corporate records like minutes of meetings, past prospectuses, share price movements, etc. As part of the deal, the shareholders of both the companies notice that almost 750m of the 1bn debt facility could be used to increase the value of Morrisons' current all-share offer (Fletcher, 2003). Conclusion UK firms bought 365 companies overseas last year and 242 companies in the UK were purchased by firms from abroad. This makes a total of 1,376 company acquisitions involving the UK last year (Lloyds TSB Financial Markets Economic Research Team, 2006). An outflow from the UK of 33bn last year set against the inflow of 50bn. Clearly, this implies that the UK is a magnet for foreign investment at present. Apart from all these factors, the major driving force behind the mergers and acquisitions that are taking place in the United Kingdom is the high level of liquidity available to the companies. The stronger equity market of the United Kingdom is another reason behind this. As the equity market is strong, finance becomes even cheaper and acquisitions even more attractive for companies. References 1. (ICMR), I. C. (2003). Financial Management for Managers. Hyderabad: ICFAI Center for Management Research . 2. Arla Foods. (2003, 12 19). Arla General. Retrieved 01 20, 2008, from Arla Foods: http://www.arlafoods.com/APPL/HJ/HJ202COM/HJ202D01.NSF/O/BF99EBDD3554C652C1257068003EABEE 3. Europe.com. (2003, 01 09). News on FoodMarketing & Retailing. Retrieved 01 20, 2008, from Food & Drink Europe.com: http://www.foodanddrinkeurope.com/news/ng.aspid=16607-after-the-rumours 4. Fletcher, R. (2003, 01 02). Morrisons raises 1bn cash for Safeway bid. Retrieved 01 20, 2008, from Telegraph.co.uk: http://www.telegraph.co.uk/money/main.jhtmlxml=/money/2003/02/02/cnsafe02.xml 5. Lloyds TSB Financial Markets Economic Research Team. (2006, 11 13). Economics Weekly. Retrieved 01 20, 2008, from FXSTREET.COM: http://www.fxstreet.com/fundamental/analysis-reports/economics-weekly/2006-11-13.html 6. Sky News. (2003, 01 09). Sky News. Retrieved 01 20, 2008, from Sky.com: http://news.sky.com/skynews/article/0,,30400-1075872,00.html 7. www.ukbusinesspark.co.uk/bpmerg96.htm 8. www.investmentmarkets.co.uk/20070904-771.html Read More