Financial Results of Mergers and Takeovers - Essay Example

?This is the new document. everything is perfect but please make sure the real world examples is good example and bad example and please reference them from the times magazine. and in the conclusion you can also talk about review about the empirical evidence and the theory of takeovers and mergers and the examples and on the basis that takeovers and mergers are......Financial Times Advanced Corporate Finance Assignment Name Surname Educational Institution Introduction It was estimated that 55,000 acquisitions valued at $1.3 trillion were materialised in the 1980s. Due to globalisation, the merger and acquisition activities reached $3.44 trillion in 2010. As per Grossman and Hart, takeover and mergers can create synergies or savings to the companies involved. For instance, in 2006, Arcelor of Luxemburg was taken over Mittal Steel of Netherland thereby making Arcelor Mittal, the world’s largest steel company. Some of the compelling reasons for takeover or merger is to expand the market due to the threat from competitors or to penetrate into new markets, to achieve cost synergies like eliminating duplicate functions, to attain higher productivity and to attain increased efficiency from acquired assets or to attain increased revenues and to achieve a higher return on investments for shareholders. Revenue synergy can result in access to the new distribution system, attaining extensions of brand and opening up new geographic markets. A takeover or merger strategy should be employed only when the acquiring company is able to enhance its networth through the positive employment of assets of the acquired company. It was established by previous empirical studies that above-average return is earned by the shareholders of acquired companies whereas the share prices of acquiring company is likely to fall immediately after the acquisition or merger. For instance, when Myogen, a pharmaceutical company is taken over by another pharmaceutical giant Gilead Sciences, there was a decline of 10 percent in Gilead’s stock whereas there was about 50 percent appreciation in Myogen’s stock. (Hoskisson 2008, p. 244). In the majority of the cases, mergers and takeovers had negative results like cost overruns, desertion of key employees, and even may leave black holes in the restructured balance sheet. (Greenblat 2011). Theory Though the merger and the takeover are often employed synonymously, there exists a variance in their economic impact between a takeover and a merger. In takeover, the acquiring company is trying to acquire control over the targeted company by acquiring more than 50% of its shares. In contrast, in merger, as per Hampton (1989), there is a merger of two companies to form a new company. Takeover or merger theories can be explained as below: Agency Theory This theory states that when the share price of a company is low, and then it forces the managers to initiate action either to enhance the share price in the market by performing well or to be taken over by a leader in the industry (DePamphills 2010, p. 41). Efficiency Theory It is divided into two – differential efficient theory which tries to improve the efficiency of a company in the same industry by a dominant company and inefficient theory. As per Copeland and Weston (1988), differential efficiency theory offers an academic base for horizontal takeovers whereas inefficiency theory offers insight on conglomerate takeovers (Lee &Lee 2006, p. 543). Market Power Hypothesis This theory explains that companies combine together to enhance their monopoly authority to quote the prices of the product which is not sustainable at a cutthroat competitive market. However, there is very little empirical support is available for this hypothesis (DePamphills 2010, p. 12). Free Cash Flow Hypothesis It is identical to that of agency theory and as per Jensen (1986), if the cash flow is in excess of that need to finance all takeovers or mergers which have net present values if discounted with the specific cost of capital (Lee &Lee 2006, p. 543). Diversification Hypothesis This theory deals with situation where a company acquires other companies that are engaged in the different business. Diversification helps the company to attain reduced cost of capital and to attain higher growth prospects (DePamphills 2010, p. 8). Bankruptcy Avoidance Hypothesis As per Stallworthy and Kharbanda (1988), if one company is at the verge of bankruptcy, which has very restricted options and will offer itself in the market to be acquired by any company who desires to do so (Lee &Lee 2006, p. 542). Information Hypothesis As per Bradley, Desai, and Kim (1983) information theory of takeover mainly deals with revaluation of assets that would be the main aim of a takeover attempt (Western 2003, p. 164). Tax and Accounting Impacts Takeover or merger decision is also impacted if there is availability of immediate investment tax credits and depreciation deductions that can be only employed by a company which has a substantial taxable income (Auerbach1988, p. 70). Review of empirical evidence Weston, Mitchell and Mulherin (2004) have found that mergers and acquisitions (M&A) had resulted in synergies that offered many advantages both to the consumers and the acquiring company. As per Jensen, (1986), M&A activities can result in agency issues, ending in unexpected optimal returns. Hogarty (1970) reviewed the last fifty years of research and found no major empirical studies which had found that mergers are more profitable than alternative investments. Weston, Mitchell and Mulherin (2004) found that M&A activities have created advantages like value-creating, demonstrating that the synergies of M&A can emanate from a wide range of resources such as an increase in revenues, reduction in costs, access to new markets and products, tax gains, etc. As per Singh (1971), in UK, about 75% of corporate failures were happened due to imprudent takeovers over the periods of 1954-1960. As per Alkhafaji (2001), when a firm acquires another firm where there is stiff resistance from the target company, then it is known as hostile takeover and when if the target company is in consensus of the acquisition, then it is known as friendly takeover (Hildebrandt 2007, p. 4). Gregoriou & Renneboog are of the view that despite the fact that various research studies have found that there is an increase in stock price performance immediately after the takeovers and mergers, the empirical corroboration on changes in the operating performance in the post-takeover period is comparatively meagre and their findings are conflicting. Gregoriou & Renneboog had investigated the long-run profitability after the takeover of 155 companies from Europe between 1997 and 2001 and found that the profitability of merged companies declined noticeably immediately after the takeover. They also found that performance of those companies which engaged in hostile takeovers had deteriorated significantly. As per Jensen (1986), companies with substantial cash reserves experience acute cash flow issues and are more probable to make poor acquisitions (Gregoriou & Renneboog 2007, p. 113). According to James, shareholders of the targeted company are benefitted from mammoth benefits in a successful acquisition than compared to a tender offer. In the case of an unsuccessful takeover attempt, there is a decline in share price to the pre-offer stage unless accompanied by subsequent bid (James 202, p. 730). Real world examples The merger of Mobil and Exon in 1999 , two giant oil companies, the $81 billion merger, was the best example of how a merger can bring success to the business. ExonMobil earned about $129 billion in cash alone since merger and shareholders received a bounty of $47 billion. In the last five years , the amount that ExonMobil shareholders received have surpassed about 98% of the market capitalisation of companies listed in the NYSE. (Business Week 2004). Merger between Travelers and Citicorp in 1998 was said to be planned to initiate an era of big financial institutions that could offer a wide variety of financial services’ products anywhere in the world. Nine years later, the merger was failed to sail smoothly, and Citicorp finally had to divest its insurance arm. Citicorp met many setbacks, mainly due to the regulatory obstacles in Japan, Europe and US and its investors found fault on the ability of the Citicorp’s management team to manage such a wide and diverse business.(Larsen 2007). Conclusion Empirical evidence carried over by Mitchell and Mulherin (2004), Jensen, (1986), Hogarty (1970) ,Weston, Mitchell and Mulherin (2004) have established that (M&A) had resulted in synergies . On the other hand , Singh (1971), Alkhafaji (2001), Gregoriou & Renneboog found that majority of mergers have failed to bring any value addition. Various theories of mergers suggest that a business can expand its operation and performance through mergers. No doubt, M&A helps to expand the market due to the threat from competitors or to penetrate into new markets, to achieve cost synergies like eliminating duplicate functions, to attain higher productivity and to attain increased efficiency from acquired assets or to attain increased revenues and to achieve a higher return on investments for shareholders. Likewise, Revenue synergy can result in access to a new distribution system, attaining extensions of brand and opening up new geographic markets. Weston, Mitchell and Mulherin (2004) found that M&A activities have created advantages like value-creating, demonstrating that the synergies of M&A can emanate from a wide range of resources such as an increase in revenue, reduction in costs, access to new markets and products, tax gains, etc. Gregoriou & Renneboog found that the profitability of merged companies declined noticeably immediately after the takeover. They also found that performance of those companies which engaged in hostile takeovers had deteriorated significantly. However, in the majority of the cases, mergers and takeovers had negative results like cost overruns, desertion of key employees, and even may leave black holes in the restructured balance sheet. \ List of References Auerbach, AJ 1998, Merger and Acquisitions, University of Chicago Press, Chicago. Businessweek, 2004,Online Extra:Why ExxonMobi Makes Bets Early, viewed 3 December, 2012 DePamphills, D 2011, Merger, Acquisitions and Other Restructuring Activities, Elsevier, New York. Greenblat, E 2011, Your Gun on the Street Markets, Wiley-Blackwell, Berth. Gregoriou, GN & Renneboog, L 2007, International Mergers and Acquisitions Activity since 1990, Elsevier, New York. Hildebrandt, A 2007, Corporate Restructuring, GRIN Verlag, New York. Hogarty, TF 1970, ‘The profitability of corporate mergers’, Journal of Business, vol. 3, pp. 317–327. Hoskisson, RE 2008, Competing for Advantages, Cengage Learning, New York. James, VHC 2007, Financial Management & Policy, 12/E, Pearson Publishing India, New Delhi. Jensen, MC 1986, ‘Agency costs of free cash flow: corporate finance, and takeovers’, American Economic Review, vol. 76, pp. 323-329. Larsen,PT,2007.Global , Universal ,Unmanageable? Viewed 3 December 2012 < http://www.ft.com/intl/cms/s/0/403af614-dd92-11db-8d42-000b5df10621.html#axzz2DweNaefC> Lee C & Lee F 2006, Encyclopaedia of Finance, Springer, London. Riley, J 2012, Factors influencing the success of takeovers and mergers, viewed 17 October, 2012 . Weston, JF 2008, Takeovers, restructuring and corporate governance, Pearson Education India, New Delhi. Weston, JF, Mitchell, M & Mulherin L 2004, Takeovers, restructuring, and corporate governance, Prentice Hall, Englewood Cliffs, New Jersey. Read More