Merger and Acquisition: Prospect and Retrospect - Essay Example

Merger and Acquisition: Prospect and Retrospect: By the study of economics we know the objective of any agent is the optimization. So, for a privateownership firm the objective is to maximize profit theoretically. That’s why the firm adopts different pricing and production policies to maximise the profit. But in the modern age things have been so much complicated and we see that the concept of entrepreneur has also been changed. In the modern large size firms no single owner exists. The required fund is mainly raised by issuing shares, equities, debentures etc. So the shareholders are the part of the ownership. On the other hand in the level of operation the managers make the decisions. So in the real world the objective and mode of action differ from the theoretically proved ones. So the optimal strategies have also been driven through the modification. So there are different strategies such as merger, acquisition, research and developments etc are adopted. In this text we will discuss the merger and acquisition policies and their effects through some examples in Europe. In the lexicon of economics the word merger refers to the combination of two or more firms to form a single firm. This takes over all the assets and liabilities of the merging firms: shares in the new firm are divided among the shareholders of the original companies on an agreed basis. On the other hand acquisition refers to the situation when one large firm takes over or better we can say purchase of smaller firms for the sake of expansion. If these are unincorporated the owners agree to the terms. If the other business is a company its shares are purchased. Where some, but not all, the shares of other company or companies are purchased, special rules governs the treatment of the existing shareholders those are not willing to sell their share to the purchaser company. Hence we can say that the merger and acquisition are similar as well as dissimilar. In merger the merging companies continue to hold their ownership rights and the right of decision-making regarding the objective of the collaboration. But in the case of acquisition the company, the shares of which have been sold, possesses the ownership right no more. Nor the acquired firm possesses the power to make decision. The entire ownership remains in the hand of a single firm. The similarity between the two is that both of the strategies have the same aim. The main objective is the expansion of firm. The level and range of production would increase. These have some common benefits, which are given below: Economies of Scale: It refers to the factors that make it possible for larger organizations to produce goods or services more efficiently than smaller ones. In other hand when the cost of production diminishes along with expansion of production level the firm is subject to economies of scale. There are different reasons behind such law. a. Division of labour and specialization become more effective when large scale of operation is selected. Consequently the quality and speed of work increase simultaneously. So growing scale can promote both increase in specialization and increase in scale. b. A firm can easily enjoy a discount in the price when it purchases raw material at a larger scale. This will surely decrease the factor cost and hence the cost of production. c. Some technical benefits are generated as the result of technical indivisibilities. It is obvious that a higher dose of capital also makes production more efficient and cost effective. d. With the improved technology of production the labourers involved in the process becomes more efficient. This is known as the concept of learning by doing. The increased efficiency of labour causes farther e. The decrease in cost will enable the firm to adopt more sophisticated technology that would increase the efficiency of the workers. f. The creditworthiness of a large firm is high in the market. So a large firm can get the facility of easy and huge finance. On the other hand shareholders will also be interested in this firm. g. The heavy fund enables research and development of the firm that would enable it to capture market share. Economies of Scope: The benefit from carrying on activities by a firm. When we find that a firm works more cost effectively when it produces more than one products either by product diversification or by producing the by products of any commodity we can say that the firm is subject to the economies of scope. For example if an oil refinery company produces Phenyl, Naphthalene then the average cost of overhead production will be lower. This is the best example of economies of scope. Moreover there are other impacts of the merger and acquisition. In market we can see the merger and acquisition increases the size of the company and makes it more competitive in the market. Sometimes there may be horizontal integration among firms and thereby they take the form of a ‘Multiple Plant Monopolist’. Consequently they will be able to exploit market power. This is the benefit of merger on the side of the firm. The stocks and share market also changes due to the cases of merger and acquisition. This increases the credibility of the firm. Whenever the credibility of a particular firm increases the shareholders have faith on this company. The shareholders are the optimizers. Their objective is either to maximise the profit subject to risk constraint or to minimize risk subject to profit constraint. So whenever a firm merges with a new one there is some hope in the mind of the shareholders. The common psychology is that an established and giant firm is always trustworthy. Hence the common psychology of the investor supports their tendency to invest in the stocks and shares of such a firm. Now we can use some examples of merger and acquisition through case studies of merger and acquisition on Europe. Case Study- The Daimler-Benz/Chrysler Merger: The merger of two famous automobile companies Daimler-Benz and Chrysler is one of the most famous examples of European merger. The agreement of merger was signed on 7th May, 1998, between these two companies in order to emerge as a single company. According to their expectation that merger was about to generate an annual synergy to the extent of US$ 1.4 billion in 1998 and US$ 3.0 billion in 1999. Moreover it was announced that this merger would not cause any layoffs or plant closing. The merger was declared to be based on pooling of interest method. This merger agreement proposed that the Chrysler stockholders would receive approximately 430 million shares, 43% share of the new company. Daimler Chrysler and Daimler Benz Company stockholders were proposed to receive 570 million shares approximately, the 57% of the total share. Moreover, the Chrysler executives were offered cash and stock option in the newly formed company. According to the agreement the exchange ratio were .6325 share of Daimler Chrysler to be exchanged for shares of Chrysler Company and 1.005 shares of the new company for each share of Daimler Benz Company. By this agreement a new company named Daimler Chrysler was about to be a publicly traded German stock corporation that was incorporated under the rules and regulations of Federal Republic of Germany. It was proposed that the annual stockholders meeting would take place in Germany. The European Commission showed green signal to it on 23rd July 1998. on September 18 of 1998 the 97.5% of the shareholders of the Chrysler and 99.9% of the shareholders of Daimler Benz Company gave their approval for this merger. The stock of Daimler Chrysler €Company started its trading on stock exchanges on November 17 of 1998 under the symbol DCX. The financial performance of the company is given below. In the 1998 financial report we can witness a massive start. Revenue increased up to € 131.8 billion while it was 12% higher than the combined result of 1997. Operating profit increased to € 8.6 billion which was 38% up. Subtracting the extra ordinary one time cost of merger the net income grew to € 5.2 billion, which was 29% up. Earning per share increased by 30%, to € 5.58 billion calculated after exclusion of the extra ordinary cost of merger. The company sold a large numbers of car, light trucks and commercial vehicles and gained huge market share despite enough competition from other companies. In 1998 the stellar performance of the business returned 11.6% of RONA after tax at compared level while it had been 10.2% in the year 1997. Moreover the company had been in track to deliver their synergy target of € 1.3 billion in bottom line profit improvement in 1999. The 1999 report of the CEO announced that 1999 was the year of record sale of their products. Profit growth exceeded the revenue growth beyond anticipation. Net income became 19% up and the company proposed a dividend of € 2.35 per share. Adjusted net income also rose by 16% to € 6.2 billion. This made the Daimler Chrysler Company one of the leading automobile companies earning a mammoth profit. In 1991 the company announced a synergy of € 1.4 billion. The year 2000 was termed as a year of decision in the annual report by the CEO of the corporation. Some crucial decisions were taken and the company had to face some problems in North America as operational challenges. There was a drastic fall in the profit of the Chrysler group. The operating profit of the Chrysler Daimler Company declined from 11 to 9 billion Euros. The operating profit of the Chrysler had a drastic fall from 5 to .5 billion euros. That’s why the management of the Daimler Chrysler group presented a comprehensive turn around plan for the Chrysler Group to the supervisory board, which was later on approved by the group in 2001. The plan was made in terms of decreasing cost and increasing the revenues. The turn around plan was intended to generate additional benefits through and profit movements of € 3.3 billion in 2001, rising to € 5.2 billion in 2002 and € 7.2 billion in 2003.the plan proposed of job cuts of 26000 employees and six plants within next two years. The 2001 annual report of the company expressed an operating loss that had accounted euro 1.3 billion while the profit of the previous year had accounted for 9.8 billion euros. The explanation was based on the fact that company had to bear a huge expense required for the measures of restructuring and the market of North America had been competitive enough. In February 2001 a plan was approved by the Supervisory Board of Daimler Chrysler, which aimed at turnaround of Chrysler. This accounted the cost of 3.1 billion euros. The company report accounted that the operating profit of Mercedes Benz at that year was 3.0 billion euros. It was higher than the profit of 2000 by the extent of 0.8 billion euro. But, on the other hand, in the year 2001 the Chrysler accounted for a loss of 5.3 billion euros while the profit margin by Chrysler in the previous year accounted for 0.5 million euros. In this operating loss the cost of the restructuring the company was included and the extent of cost was 3.1 billion euros. The restructuring charges were mainly concerned with workforce reduction, assets write down and the costs of contract cancellation. Causes of failure: If anyone assumes that the merger of the famous Daimler and Chrysler would generate huge positive response in the share market he should not be blamed as a person lacking foresight. But truth is sometimes stranger than fiction. Though in Europe the share market and the shareholders showed positive response towards the new merger in America we could witness a quite different trend, which can be questioned. In mid March 1999 just after the one year of merger of these two companies the percentage of share in the hand of US shareholders showed a sharp decline from 44 percent to 25 percent. If we want to seek the factors responsible behind this typical behaviour of the US investors it is revealed that the origin was the main cause, which had brought about this decline in holding. One main reason behind such decrease can be attributed to the Standard and Poor’s 500 stock indexes. This index excluded the Daimler Chrysler share just because of its origin in Germany. Due to this removal many mutual fund managers had been forced to track the Standard and Poor’s to remover the company’s stock from their portfolio. Some analysts argued that the time difference between the Europe and USA should be made attributable for this disaster faced by the Daimler and Chrysler Company. The Daimler and Chrysler Company’s management makes the public statement about share in the morning in Germany while the US investors remain in bed. That’s why they do not get the proper information in the proper time. This information lag is a main cause of declining percentage of share held by the US investors. DaimlerChrysler share was worth $91.77 on May 7, 1998, Chrysler share was worth $41.43, and the number of Chrysler common shares outstanding at “the date of merger” was 690 million shares, the price and premium paid for acquiring Chrysler Corporation can be determined as follows: Price: 690 x 0.6235 x 91.77 $39,481 million Market value of Chrysler Corporation At the date of merger: 690 x 41.43 27,897 million Premium paid for Chrysler Corporation $11,584 million The amount of premium paid for Chrysler Corp. should be viewed as the price for the expected synergy that will be generated from the merger. According to the synergy theory [Bradley, Desai & Kim, 1988; Seth, 1990], a successful merger generates more earnings and cash flow than the sum total of the earnings and cash flow generated by each entity separately. This cannot be accomplished by generating more revenues given the existing resources or by decreasing expenses as a result of eliminating redundant resources, or both. In a more general term, a merger often fails due to incomplete information, available to the two merged firms. Often, in a frenzy to increase size and the monopoly power, two firms shake their hands and end up getting nothing. Sometimes a firm, in its passion to expand and gain in profit, attempts to risk the diversification of its products by merging with a firm, which has entirely new product category. However after merging, the merger finds out that it lacks the infrastructure for that particular product. This leads to a failure especially when the merger cannot adapt itself well to the changed situation. Increased managerial complicacy and staff problem with the increase in size immediately following a merger often bring a downfall for both the organizations. Reuter Group and Thomson Corporation Collaboration UK based financial information company Reuter Group merged with Thomson Corporation. It assumed that its 2007 trading profit would be higher than anticipated. Reuter expected that 2007 trading profit would account for minimum £ 380 million. Here the trading profit is defined as operating profit obtained by continuing operations excluding one timer. Moreover, the board had its reliance over the attitude of Reuters in spite of the then uncertainty in the financial markets. The company assured its strong performance in the year 2007. This was mainly due to the customer investment in business automation, electronic trading, and high value content and new markets. Besides, there was discipline management of transformation activities. The company report says that the 2008 is witnessing a start with strong sales which reflects the vigour of the business. Reuters is anticipating a continued strong underline revenue growth in the first quarter of 2008. This excludes the influences of currency fluctuations, acquisitions and disposal. In May, Thomson Company made a proposal to acquire Reuters in a deal worth £ 8.7 billion or $ 17.2 billion. This acquisition was supposed to provide the world’s one of the largest and leading provider of news and data for personal markets. Recently the deal has been approved. Following the consummation of the conditions of merger the new company would be familiar as Thomson Reuter Corporation. The merger is expected to close on 16th April. On Friday, 19th February 2008 announced his projected dividend schedule for the remaining dividends. Reuter expects its shareholders to receive their second interim dividend as £ 0.0324 per share which is payable on 1st May to the shareholders on record on April 16. Stub dividend represents accrued/pro rated dividends from January 1 throughout April 16 2008, the day before anticipated consummation of the merger. The accrued/pro ration dividend accounts for £ 0.0551 per share. Thomson and Reuter currently assume that the Board of Thomson Reuter would adopt a target dividend payout ratio, which should be compatible with the target payout ratio which exists at Thomson (40% of annual fee cash flow). On the basis the companies anticipate that initial dividend policy of the merged company would pay a quarterly dividend of US $ .27 per share. The board has planned to review the dividend policy at the first quarter of each financial year. The Thomson and Reuters is expected to declare a dividend of US$ 0.22253 per share which will be payable to the stockholders on September 15 of record on August 21, 2008. This dividend is representing the accrued/pro rated dividend from April 17 through June 30 2008 at the rate of US $ 0.27 per share. In December Thomson and Reuters is expected to announce a dividend of US$ 0.27 payable on December 15 to the stockholders of records on November 20 2008. Reuters also announced its financial results for the nine-month period ending September 30. Profit declined to £151 million or 11.9 pence a share from £153 million or 11.5 pence per share in the same period last year. Profit from continuing operations came in at 142 million or 11.2 pence per share, down from £153 million or 11.5 pence per share a year-ago. However, trading profit increased 9% to £269 million from £247 million in the comparable period last year. Adjusted earnings per share advanced 23% to 15.9 pence from last years 12.9 pence. Profit before taxation fell to £183 million from £ 198 million in the corresponding period prior year. Revenue totaled £1.914 billion, compared to £1.908 billion in the same period last year. The merger between Thomson and Reuters would tie up two companies that are strong in two distinct geographical and business areas of the globe. Thomson is stronger in the US but weaker in the other parts of the world while Reuters has its strong base and activities in Europe, Asia, Middle East and Africa. Thomson has its service bias towards the investors who purchase securities commodities and foreign currencies. On the other hand Reuters is keener towards the traders. This type of tie up would help the companies to lead the globe and the shareholders would gradually be benefited. Hence the trend of success would continue for the merger. Conclusion The two cases of merger that we have discussed so far portray the fact that merger can be beneficial for some organizations and can be a failure for others. Merger is an important business approach that is directed towards expanding the business. Merger may help an organization to increase its monolopoly power on one hand, through increasing its economies of scale and scope and on the other, it may complicate its operational procedure and destroy the inter and intra departmental harmony through increasing its size beyond manageable level. Actually merger is not a mathematical cloth that will always yield 2 by the summation of two 1s. Success of merger depends upon extreme managerial proficiency, nature of the product and market as well as the customer’s psychology immediately after the merger. It has been observed that in financial sector, when two banks merge, the credit deposit ratio incurs a set back. It might affect the rate of profit negatively. Therefore, it may be concluded that the outcome of merger is always uncertain and if it fails to generate substantial positive outcome, the stockholders of the respective organization might suffer a loss. Read More