Research Paper on
Acquisition and Mergers
Alagon, Archie De Leon BSA 3-9D
Advance Financial Accounting and Reporting, Part II (ACCO 3083) Prof. Gloria Ardaniel Rante
I. MOTIVES OF ACQUISITION AND MERGERS I.I Synergy According to accountingcouch.com, synergy is often associated with the merger or acquisition of companies. That is, when the sum of the value of the acquirer and the acquiree as a combined company is greater than the two companies valued apart. Most mergers and large acquisitions are justified by the amount of projected synergies. The two categories of synergies are cost synergies and revenue synergies. Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations. For example, closing one corporate headquarters, laying off one set of management, shutting redundant stores, etc. Revenue synergies refer to the ability to sell more products/services or raise prices due to the merger. For example, increasing sales due to cross-marketing, co-branding, etc. Synergy is sometimes described as 1 + 1 = 3. From this we can say that whole is worth more than the sum of the parts. Some mergers create synergies because the firm can either cut costs or use the combined assets more effectively. By merging, the companies hope to benefit from the following: •
Economies of Scale – The cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs. In microeconomics, economies of scale are the cost advantages that enterprises obtain due to size, throughput, or scale of operation, with cost per unit of output generally decreasing with
increasing scale as fixed costs are spread out over more units of output. This is due to lower transaction costs for larger purchases of securities. Often operational efficiency is also greater with increasing scale, leading to lower variable cost as well. •
Removing duplicate department or operation – Also though the process of economies of scale the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
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Cutting Fixed Cost and Elimination of Duplicated Overhead (Staff Reductions) – As every employee knows, mergers tend to mean job losses. Consider all the money saved from reducing the number of staff members from accounting, marketing and other departments. Job cuts will also include the former CEO, who typically leaves with a compensation package.
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Larger Orders-Low Cost – “Size matters”. Whether it's purchasing stationery or a new corporate IT system, a bigger company placing the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or office supplies - when placing larger orders, companies have a greater ability to negotiate prices with their suppliers.
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Cross selling – This is one of the easiest and most effective methods of marketing. In the financial services arena, cross selling can mean selling different types of investments to investors, or even insurance to investors, or tax preparation to retirement planning clients. For example, a bank buying a stock
broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
http://psrcentre.org/images/extraimages/412031.pdf These are generally good reasons for a merger, but in practice, synergies are “easier said than done.� While cost synergies are difficult to achieve, revenue synergies are even harder. The implication is that many mergers fail to live up to expectations and wind up destroying shareholder value rather than create it. And synergy opportunities may exist only in the minds of the corporate leaders.
I.II Growth Opportunities Location and Globalization As the trend toward globalization rises and as globalization's popularity grows worldwide, companies are inclined to develop globally. Cross-border mergers and acquisitions (M&A) becomes more fashionable these days.
Cross-border
acquisitions
are
those
made
between
companies
with
headquarters in different country. Taking on the strategy of a cross-border acquisition has many potential implications. A cross-border M&A may simply be an attempt at value creation as would any domestic M&A be. Still, a cross-border M&A could also offer a way to enter a foreign market whereas a domestic M&A may not provide that opportunity. When predicting performance of a cross-border M&A, we can consider the possibility of better synergies between two companies due to geographic expansion opportunities or sharing of different practices to improve business. Yet, there may be negatives such as conflict of management styles and a turbulent integration process due to significantly different cultures – www.stern.nyu.edu International or cross-border M&As have been a popular strategic tool for multinational firms looking to extend their market reach, develop new manufacturing facilities, develop new sources of raw materials, and tap into capital markets. Crossborder deals have been numerous and large during the 1990s,and are expected to reach new heights due to international privatization trends, reduction in cumbersome industry regulations and red tape, and development of uniform accounting standards by many capital-starved nations. Furthermore, as regional economic agreements continue to emerge, cross-border deals will continue to rise. Diversification Diversification means that an acquirer decides to merge with or acquiree to diversify revenue sources (product diversification) or expand core business overseas
(geographic diversification). Product Diversification focuses on new product markets. On the other hand, Geographic Diversification focuses on new international markets. Companies buy companies to reach new markets and grow revenues and earnings. A merge may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones. For example, in 2008, HP bought EDS to strengthen the services side of their technology offerings (this deal was valued at about US$13.9 billion). Capturing Large Market Shares As the company absorbs a major competitor, it will be able to increase its power (by capturing increased market share) to set prices. – http://www.huntlawgrp.com Companies may decide to merge into order to gain a better distribution or marketing network. A company may want to expand into different markets where a similar company is already operating rather than start from ground zero, and so the company may just merge with the other company. This distribution or marketing network gives both companies a wider customer base practically overnight. One of the things we look for when watching for a market bottom is an increase in merger and acquisition (M&A) activity. This merger, along with several, was a big tip
that the bull market was likely to re-emerge. Similarly, when deal-activity begins to slow it is a signal that prices in the market may begin to move lower. M&A activity is common at a market bottom because lower stock prices are attractive to potential acquirers as they look to consolidate competitors and grab more market share. Elimination of Competition or Potential competitor The importance of potential competition as a constraint on market power has been recognized in the industrial organization literature. Subsequent economic theory has formalized the relationship between firms not currently producing in an industry and market performance, and considerable empirical evidence confirms the role of such firms. Indeed, merger policy has elevated entry conditions to co-equal status with concentration among incumbent firms as factors determining competitive effects and likely policy: A merger or acquisition between firms in a concentrated market may well be permitted if the prospects for entry into the industry can be shown to be timely, likely, and sufficient to restore the pre-merger degree of competition. This concern is most acute where the participants are direct rivals, because courts often presume that such arrangements are more prone to restrict output and to increase prices. The fear that mergers and acquisitions reduce competition has meant that the government carefully scrutinizes proposed mergers. We should note at the outset two quite different versions of the doctrine of potential competition. The first involves the case where the non-incumbent is perceived to be a possible entrant and, as such, it constrains the behavior of incumbent firms. The elimination of that potential competitor therefore confers greater pricing discretion on
incumbents, and does so whether or not the firm actually would or might enter.. The second version of this doctrine entails a firm that objectively is likely to enter the market, even if not so perceived. Its elimination by merger prevents future entry that would have led to deconcentration of the market and the strengthening of competition.
I.III Improved Business Capabilities Technology Integration – To stay competitive, companies need to stay on top of technological developments and their business applications. By buying a smaller company with unique technologies, a large company can maintain or develop a competitive edge. Stimulating Innovation – The rapid technological change, growing technological complexity and the shortening of product life cycles add new dimensions to an already complex scenario and increasingly force firms to source technologies externally. Though occurrence of M&A has grown dramatically in the last years, academic research on the relationship between innovation and M&A has not kept pace with the changes. In spite of the vast and rapidly growing body of literature on M&A, empirical evidence which has explored this relationship is rather limited and often inconclusive. The literature on the technological effects of M&A shows contradictory implications. On the one hand, M&A may build up competencies and foster innovation
for a number of reasons. M&A can reduce high transaction costs related to the transmission of knowledge between firms. – Bresman et al., 1999 Furthermore, in fast moving markets with abbreviated product life cycles, firms may perceive that they do not have the time to develop the required skills and knowledge internally, and therefore, turn outward to M&A. In this sense, M&A may offer a quick access to knowledge assets. Moreover, M&A may extend the technological base of firms involved allowing them to achieve greater economies of scale and scope through more efficient deployment of knowledge resources. In addition, the integration of complementary knowledge may also increase innovation through M&A leading to more advanced technologies being developed. Finally, by exchanging the best practices on innovation management within the combined entity, firms may employ efficient technology integration. Acquired Managerial Skills, Leadership and Communication Capacities •
Strong verbal and written communication skills
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Excellent project management skills; comfortable managing multiple projects and driving initiatives through a complex organization
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Ability to identify core issues quickly
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Ability to build relationships with colleagues at all levels
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Independent and self-starter
The involvement of communications professionals from an early stage continues to prove instrumental in helping achieve two strategic goals: 1) Proactively and successfully communicate the M&A objectives; and 2) Help avoid the potential costs and loss of credibility often associated with a failed merger. Improve Probability and EPS Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E. Dilutive mergers are the opposite of above, whereby a company's EPS decreases. The company will be one with a low P/E acquiring one with a high P/E. Increased Liquidity Due to the high liquidity of publicly traded stock, public firms may more easily use their shares as M&A currency. Acquiring a more liquid firm increases the liquidity of the new combined entity. – http://phd.insead.edu/ In this case, liquidity becomes a fundamental variable in the choice of the target, and its importance depends on the types of the shareholders. Public shareholders value liquidity. This is due to different reasons. First, public shareholders – particularly shareholders with a short horizon – value the ability to exit with low price impact or to
rebalance their portfolio cheaply. Investors who rebalance their portfolio more often – short horizon investors – have a higher preference for liquidity because they can turn over their portfolio and sell to face withdrawals without moving the market. Second, liquidity makes stock prices more informative. This helps to assess the value of future investment opportunities, but also to increase the accuracy of management compensation and, as a result, the alignment of incentives.
II IMPACT OF MERGERS AND ACQUISITION Impact of Mergers and Acquisitions on Workers or Employees New resulting company during acquisition and merger, wisely, would require less number of people to perform the same task. So, there will be an attempt to downsize the work force. If the employees who have been laid off possess sufficient skills, they may in fact benefit from the lay off and move on for greener pastures. But it is usually seen that the employees those who are laid off would not have played a significant role under the new organizational set up. This accounts for their removal from the new organization set up. These workers in turn would look for re-employment and may have to be satisfied with a much lesser pay package than the previous one. Even though this may not lead to drastic unemployment levels, nevertheless, the workers will have to compromise for the same. If not drastically, the mild undulations created in the local economy cannot be ignored fully. Some impacts on employees’ morale include:
Stress – Change is often difficult for employees, especially if they were not directly involved in decisions that impact their jobs. During mergers and acquisitions, change can be especially difficult and can lead to stress which can have a negative impact on morale if not handled effectively. Fear of Job Loss – When two or more organizations come together, culture clash is inevitable. Rarely do two organizations have the same culture. This fear can negatively impact productivity and may even result in employees leaving the company to seek jobs elsewhere. Competitiveness – When employees are concerned about their own job security they are more likely to become competitive with others and this competitiveness can result in conflict--sometimes even violence. Impact of Mergers and Acquisitions on Management at the top Impact of mergers and acquisitions on top level management may actually involve a "clash of the egos". There might be variations in the cultures of the two organizations. Under the new set up the manager may be asked to implement such policies or strategies, which may not be quite approved by him. When such a situation arises, the main focus of the organization gets diverted and executives become busy either settling matters among themselves or moving on. If however, the manager is well equipped with a degree or has sufficient qualification, the migration to another company may not be troublesome at all. The Impact of the Merger or Acquisition on the New Organization
Mergers and acquisitions immediately impact organizations with changes in ownership, in ideology, and eventually, in practice. Cohesion is most often the critical asset in the eventual success or failure of the overall deal and the one that impacts the extent to which qualitative talent retention can be attained. Despite the fact that it is increasingly common these days for companies to publish their cultural traits or values, what is listed does not always reflect the actual culture of the place. Anthropologists have long known that the task of learning about a specific group’s culture does not start by asking members themselves to identify the specific traits. In fact, cultural traits are not readily identified by the members of a social group. Impact of Mergers and Acquisitions on Shareholders Shareholders of the acquired firm: The shareholders of the acquired company benefit the most. The reason being, it is seen in majority of the cases that the acquiring company usually pays a little excess than it what should. Unless a man lives in a house he has recently bought, he will not be able to know its drawbacks. So that the shareholders forgo their shares, the company has to offer an amount more then the actual price, which is prevailing in the market. Buying a company at a higher price can actually prove to be beneficial for the local economy. Shareholders of the acquiring firm: They are most affected. If we measure the benefits enjoyed by the shareholders of the acquired company in degrees, the degree to which they were benefited, by the same
degree, these shareholders are harmed. This can be attributed to debt load, which accompanies an acquisition.
III. ISSUES AND PROBLEMS IN MERGERS AND AQUISITIONS Integration Difficulties •
Complexity of financial and control systems
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Difference in culture and working relationships (discussed on Part II. Impact of M&A)
Inadequate evaluation of target •
Inappropriate valuation can result in paying excessive premium for target company
Large or extraordinary debt •
Financing option(junk bonds) whereby risky acquisitions are financed with money (debt) that provides a large potential return to lenders (bondholders)
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High debt can negatively affect the firm o Increases the likelihood of bankruptcy o Can lead to a downgrade in a firm’s credit rating o May preclude needed investment in other activities that contribute to a firm’s long-term success
Inability to achieve synergy •
Firms tend to underestimate costs and overestimate synergy
Too much diversification •
Firms can become over-diversified which can lead to a decline in performance. They must process more information of greater diversity
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Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate performance of business units
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Acquisitions may become substitutes for innovation
References accountingcouch.com Bresman et al., 2011 huntlawgrp.com investopedia.com/university/mergers/mergers1.asp phd.insead.edu/ illus. – http://psrcentre.org/images/extraimages/412031.pdf stern.nyu.edu