SRI SHARADA INSTITUTE OF INDIAN MANAGEMENT -

RESEARCH
(A unit of Sri Sringeri Sharada Peetham, Sringeri)

Approved by AICTE

Plot No. 7, Phase-II, Institutional Area, Behind the Grand Hotel, Vasant Kunj,

New Delhi – 110070

Tel.: 2612409090 / 91; Fax: 26124092

E-mail: [email protected]; Website: www.srisim.org

STRATEGIC MANAGEMENT & BUSINESS POLICY ASSIGNMENT

“MERGER & acquisitions”

A report submitted in partial fulfillment of the requirements of the two-year
full time Post Graduate Diploma in Management.

SUBMITTED TO: Prof. NANDI

Submitted by:

Name: R.VIJAYA RAGHAVAN

Roll No: 20090202

Batch: 2009 – 2011.

 Acknowledgement

We would like to express our gratitude to all those who gave us the
possibility to complete this project. We want to thank SRI SHARADA

INSTITUTE OF INDIAN MANAGEMENT-RESEARCH , NEW DELHI for giving us

an opportunity to work on this project. This project has given us practical
knowledge on various FINANCIAL activities being performed.

We would like to extend our sincere gratitude to

Mr. Prof.NANDI (Faculty) for providing us with an opportunity to work

under them and giving us valuable suggestions and priceless guidance

without which our project would have been incomplete.

It has been a pleasure and wonderful experience to get the opportunity to

be guided by them.
Mergers and acquisitions
The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate
strategy, corporate finance and management dealing with the buying, selling and combining of
different companies that can aid, finance, or help a growing company in a given industry grow
rapidly without having to create another business entity.

Acquisition:-
An acquisition, (the ‘target’) by another. Consolidation is when two companies combine
together to form a new company altogether. An acquisition may be private or public, depending
on whether the acquire or merging company is or isn't listed in public markets. An acquisition
may be friendly or hostile. Whether a purchase is perceived as a friendly or hostile depends on
how it is communicated to and received by the target company's board of directors, employees
and shareholders. It is quite normal though for M&A deal communications to take place in a so
called 'confidentiality bubble' whereby information flows are restricted due to confidentiality
agreements (Harwood, 2005). In the case of a friendly transaction, the companies cooperate in
negotiations; in the case of a hostile deal, the takeover target is unwilling to be bought or the
target's board has no prior knowledge of the offer. Hostile acquisitions can, and often do, turn
friendly at the end, as the acquirer secures the endorsement of the transaction from the board of
the acquire company. This usually requires an improvement in the terms of the offer. Acquisition
usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller
firm will acquire management control of a larger or longer established company and keep its
name for the combined entity. This is known as a reverse takeover. Another type of acquisition
is reverse merger a deal that enables a private company to get publicly listed in a short time
period. A reverse merger occurs when a private company that has strong prospects and is eager
to raise financing buys a publicly listed shell company, usually one with no business and limited
assets. Achieving acquisition success has proven to be very difficult, while various studies have
shown that 50% of acquisitions were unsuccessful.

The acquisition process is very complex, with many dimensions influencing its outcome. There
is also a variety of structures used in securing control over the assets of a company, which have
different tax and regulatory implications:

 The buyer buys the shares, and therefore control, of the target company being purchased.
Ownership control of the company in turn conveys effective control over the assets of the
company, but since the company is acquired intact as a going concern, this form of
transaction carries with it all of the liabilities accrued by that business over its past and all
of the risks that company faces in its commercial environment.
 The buyer buys the assets of the target company. The cash the target receives from the
sell-off is paid back to its shareholders by dividend or through liquidation. This type of
transaction leaves the target company as an empty shell, if the buyer buys out the entire
 assets. A buyer often structures the transaction as an asset purchase to "cherry-pick" the
assets that it wants and leave out the assets and liabilities that it does not. This can be
particularly important where foreseeable liabilities may include future, unquantified
damage awards such as those that could arise from litigation over defective products,
employee benefits or terminations, or environmental damage. A disadvantage of this
structure is the tax that many jurisdictions, particularly outside the United States, impose
on transfers of the individual assets, whereas stock transactions can frequently be
structured as like-kind exchanges or other arrangements that are tax-free or tax-neutral,
both to the buyer and to the seller's shareholders.

The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where
one company splits into two, generating a second company separately listed on a stock exchange.

Distinction between mergers and acquisitions

Although often used synonymously, the terms merger and acquisition mean slightly different
things. When one company takes over another and clearly establishes itself as the new owner, the
purchase is called an acquisition. From a legal point of view, the target company ceases to exist,
the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms agree to go forward as a single
new company rather than remain separately owned and operated. This kind of action is more
precisely referred to as a "merger of equals". The firms are often of about the same size. Both
companies' stocks are surrendered and new company stock is issued in its place. For example, in
the 1999 merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist when
they merged, and a new company, GlaxoSmithKline, was created.

In practice, however, actual mergers of equals don't happen very often. Usually, one company
will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that
the action is a merger of equals, even if it is technically an acquisition. Being bought out often
carries negative connotations, therefore, by describing the deal euphemistically as a merger, deal
makers and top managers try to make the takeover more palatable. An example of this would be
the takeover of Chrysler by Daimler-Benz in 1999 which was widely referred to as a merger at
the time.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the
best interest of both of their companies. But when the deal is unfriendly (that is, when the target
company does not want to be purchased) it is always regarded as an acquisition.

Business valuation

The five most common ways to evaluate a business are

 asset valuation,
 historical earnings valuation,
 future maintainable earnings valuation,
  relative valuation (comparable company & comparable transactions),
 discounted cash flow (DCF) valuation

Professionals who valuate businesses generally do not use just one of these methods but a
combination of some of them, as well as possibly others that are not mentioned above, in order to
obtain a more accurate value. The information in the balance sheet or income statement is
obtained by one of three accounting measures: a Notice to Reader, a Review Engagement or an
Audit.

Accurate business valuation is one of the most important aspects of M&A as valuations like
these will have a major impact on the price that a business will be sold for. Most often this
information is expressed in a Letter of Opinion of Value (LOV) when the business is being
evaluated for interest's sake. There are other, more detailed ways of expressing the value of a
business. While these reports generally get more detailed and expensive as the size of a company
increases, this is not always the case as there are many complicated industries which require
more attention to detail, regardless of size.

Financing M&A

Mergers are generally differentiated from acquisitions partly by the way in which they are
financed and partly by the relative size of the companies. Various methods of financing an M&A
deal exist:

Cash:-

Payment by cash. Such transactions are usually termed acquisitions rather than mergers because
the shareholders of the target company are removed from the picture and the target comes under
the (indirect) control of the bidder's shareholders.

Stock:-

Payment in the acquiring company's stock, issued to the shareholders of the acquired company at
a given ratio proportional to the valuation of the latter.

Which method of financing to choose?

There are some elements to think about when choosing the form of payment. When submitting
an offer, the acquiring firm should consider other potential bidders and think strategic. The form
of payment might be decisive for the seller. With pure cash deals, there is no doubt on the real
value of the bid (without considering an eventual earn out). The contingency of the share
payment is indeed removed. Thus, a cash offer preempts competitors better than securities. Taxes
are a second element to consider and should be evaluated with the counsel of competent tax and
accounting advisers. Third, with a share deal the buyer’s capital structure might be affected and
the control of the new co modified. If the issuance of shares is necessary, shareholders of the
acquiring company might prevent such capital increase at the general meeting of shareholders.
The risk is removed with a cash transaction. Then, the balance sheet of the buyer will be
modified and the decision maker should take into account the effects on the reported financial
results. For example, in a pure cash deal (financed from the company’s current account),
liquidity ratios might decrease. On the other hand, in a pure stock for stock transaction (financed
from the issuance of new shares), the company might show lower profitability ratios (e.g. ROA).
However, economic dilution must prevail towards accounting dilution when making the choice.
The form of payment and financing options are tightly linked. If the buyer pays cash, there are
three main financing options:

- Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and may
decrease debt rating. There are no major transaction costs.

- Issue of debt: it consumes financial slack, may decrease debt rating and increase cost of debt.
Transaction costs include underwriting or closing costs of 1% to 3% of the face value.

- Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt.
Transaction costs include fees for preparation of a proxy statement, an extraordinary shareholder
meeting and registration.

If the buyer pays with stock, the financing possibilities are:

- Issue of stock (same effects and transaction costs as described above).

- Shares in treasury: it increases financial slack (if they don’t have to be repurchased on the
market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage
fees if shares are repurchased in the market otherwise there are no major costs.

In general, stock will create financial flexibility. Transaction costs must also be considered but
tend to have a greater impact on the payment decision for larger transactions. Finally, paying
cash or with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock
when they believe their shares are overvalued and cash when undervalued.

Specialist M&A advisory firms:-

Although at present the majority of M&A advice is provided by full-service investment banks,
recent years have seen a rise in the prominence of specialist M&A advisers, who only provide
M&A advice (and not financing). These companies are sometimes referred to as Transition
companies, assisting businesses often referred to as "companies in transition." To perform these
services in the US, an advisor must be a licensed broker dealer, and subject to SEC (FINRA)
regulation. More information on M&A advisory firms is provided at corporate advisory.

Motives behind M&A:-

The dominant rationale used to explain M&A activity is that acquiring firms seek improved
financial performance. The following motives are considered to improve financial performance:
  Economy of scale: This refers to the fact that 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.
 Economy of scope: This refers to the efficiencies primarily associated with demand-side
changes, such as increasing or decreasing the scope of marketing and distribution, of
different types of products.
 Increased revenue or market share: This assumes that the buyer will be absorbing a major
competitor and thus increase its market power (by capturing increased market share) to
set prices.
 Cross-selling: 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.
 Synergy: For example, managerial economies such as the increased opportunity of
managerial specialization. Another example is purchasing economies due to increased
order size and associated bulk-buying discounts.
 Taxation: A profitable company can buy a loss maker to use the target's loss as their
advantage by reducing their tax liability. In the United States and many other countries,
rules are in place to limit the ability of profitable companies to "shop" for loss making
companies, limiting the tax motive of an acquiring company. Tax minimization strategies
include purchasing assets of a non-performing company and reducing current tax liability
under the Tanner-White PLLC Troubled Asset Recovery Plan.
 Geographical or other diversification: This is designed to smooth the earnings results of a
company, which over the long term smoothens the stock price of a company, giving
conservative investors more confidence in investing in the company. However, this does
not always deliver value to shareholders (see below).
 Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the
interaction of target and acquiring firm resources can create value through either
overcoming information asymmetry or by combining scarce resources.[4]
 Vertical integration: Vertical integration occurs when an upstream and downstream firm
merges (or one acquires the other). There are several reasons for this to occur. One reason
is to internalize an externality problem. A common example is of such an externality is
double marginalization. Double marginalization occurs when both the upstream and
downstream firms have monopoly power; each firm reduces output from the competitive
level to the monopoly level, creating two deadweight losses. By merging the vertically
integrated firm can collect one deadweight loss by setting the downstream firm's output
to the competitive level. This increases profits and consumer surplus. A merger that
creates a vertically integrated firm can be profitable.
 Absorption of similar businesses under single management: similar portfolio invested by
two different mutual funds (Ahsan Raza Khan, 2009) namely united money market fund
and united growth and income fund, caused the management to absorb united money
market fund into united growth and income fund.

However, on average and across the most commonly studied variables, acquiring firms' financial
performance does not positively change as a function of their acquisition activity. Therefore,
additional motives for merger and acquisition that may not add shareholder value include:
  Diversification: While this may hedge a company against a downturn in an individual
industry it fails to deliver value, since it is possible for individual shareholders to achieve
the same hedge by diversifying their portfolios at a much lower cost than those associated
with a merger. (In his book One up on Wall Street, Peter Lynch memorably termed this
"diworseification".)
 Manager's hubris: manager's overconfidence about expected synergies from M&A which
results in overpayment for the target company.
 Empire-building: Managers have larger companies to manage and hence more power.
 Manager's compensation: In the past, certain executive management teams had their
payout based on the total amount of profit of the company, instead of the profit per share,
which would give the team a perverse incentive to buy companies to increase the total
profit while decreasing the profit per share (which hurts the owners of the company, the
shareholders); although some empirical studies show that compensation is linked to
profitability rather than mere profits of the company.

Effects on management:-

A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that
mergers and acquisitions destroy leadership continuity in target companies’ top management
teams for at least a decade following a deal. The study found that target companies lose 21
percent of their executives each year for at least 10 years following an acquisition – more than
double the turnover experienced in non-merged firms. If the businesses of the acquired and
acquiring companies overlap, then such turnover is to be expected; in other words, there can only
be one CEO, CFO, and etcetera at a time...

Brand considerations:-

Mergers and acquisitions often create brand problems, beginning with what to call the company
after the transaction and going down into detail about what to do about overlapping and
competing product brands. Decisions about what brand equity to write off are not
inconsequential. And, given the ability for the right brand choices to drive preference and earn a
price premium, the future success of a merger or acquisition depends on making wise brand
choices. Brand decision-makers essentially can choose from four different approaches to dealing
with naming issues, each with specific pros and cons:
1. Keep one name and discontinue the other. The strongest legacy brand with the best prospects
for the future lives on. In the merger of United Airlines and Continental Airlines, the united
brand will continue forward, while Continental is retired.
2. Keep one name and demote the other. The strongest name becomes the company name and the
weaker one is demoted to a divisional brand or product brand. An example is Caterpillar Inc.
keeping the Bucyrus International name.
3. Keep both names and use them together. Some companies try to please everyone and keep the
value of both brands by using them together. It can create a mouthful, like
PricewaterhouseCoopers
4. Discard both legacy names and adopt a totally new one. The classic example is the merger of
Bell Atlantic with GTE, which became Verizon Communications. Not every merger with a new
name is successful. PricewaterhouseCoopers International tried at one point to rename itself
“Monday:” By changing to YRC Worldwide lost the considerable value of both Yellow Freight
and Roadway Corp.

The factors influencing brand decisions in a merger or acquisition transaction can range from
political to tactical. Ego can drive choice just as well as rational factors such as brand value and
costs involved with changing brands.

Beyond the bigger issue of what to call the company after the transaction comes the ongoing
detailed choices about what divisional, product and service brands to keep. The detailed
decisions about the brand portfolio are covered under the topic brand architecture.

The Great Merger Movement:-

The Great Merger Movement was a predominantly U.S. business phenomenon that happened
from 1895 to 1905. During this time, small firms with little market share consolidated with
similar firms to form large, powerful institutions that dominated their markets. It is estimated that
more than 1,800 of these firms disappeared into consolidations, many of which acquired
substantial shares of the markets in which they operated. The vehicles used were so-called trusts.
In 1900 the value of firms acquired in mergers was 20% of GDP. In 1990 the value was only 3%
and from 1998–2000 it was around 10–11% of GDP. Organizations that commanded the greatest
share of the market in 1905 saw that command disintegrate by 1929 as smaller competitors
joined forces with each other. However, there were companies that merged during this time such
as DuPont, US Steel, and General Electric that have been able to keep their dominance in their
respective sectors today due to growing technological advances of their products, patents, and
brand recognition by their customers. The companies that merged were mass producers of
homogeneous goods that could exploit the efficiencies of large volume production. However
more often than not mergers were "quick mergers". These "quick mergers" involved mergers of
companies with unrelated technology and different management. As a result, the efficiency gains
associated with mergers were not present. The new and bigger company would actually face
higher costs than competitors because of these technological and managerial differences. Thus,
the mergers were not done to see large efficiency gains; they were in fact done because that was
the trend at the time. Companies which had specific fine products, like fine writing paper, earned
their profits on high margin rather than volume and took no part in Great Merger Movement.

Short-run factors:-

One of the major short run factors that sparked in The Great Merger Movement was the desire to
keep prices high. That is, with many firms in a market, supply of the product remains high.
During the panic of 1893, the demand declined. When demand for the good falls, as illustrated
by the classic supply and demand model, prices are driven down. To avoid this decline in prices,
firms found it profitable to collude and manipulate supply to counter any changes in demand for
the good. This type of cooperation led to widespread horizontal integration amongst firms of the
era. Focusing on mass production allowed firms to reduce unit costs to a much lower rate. These
firms usually were capital-intensive and had high fixed costs. Because new machines were
mostly financed through bonds, interest payments on bonds were high followed by the panic of
1893, yet no firm was willing to accept quantity reduction during that period.
Long-run factors:-

In the long run, due to the desire to keep costs low, it was advantageous for firms to merge and
reduce their transportation costs thus producing and transporting from one location rather than
various sites of different companies as in the past. This resulted in shipment directly to market
from this one location. In addition, technological changes prior to the merger movement within
companies increased the efficient size of plants with capital intensive assembly lines allowing for
economies of scale. Thus improved technology and transportation were forerunners to the Great
Merger Movement. In part due to competitors as mentioned above, and in part due to the
government, however, many of these initially successful mergers were eventually dismantled.
The U.S. government passed the Sherman Act in 1890, setting rules against price fixing and
monopolies. Starting in the 1890s with such cases as U.S. versus Addyston Pipe and Steel Co.,
the courts attacked large companies for strategizing with others or within their own companies to
maximize profits. Price fixing with competitors created a greater incentive for companies to unite
and merge under one name so that they were not competitors anymore and technically not price
fixing.

Merger waves:-

The economic history has been divided into Merger Waves based on the merger activities in the
business world as:

Period Name Facet

1889–1904 First Wave Horizontal mergers

1916–1929 Second Wave Vertical mergers

1965–1989 Third Wave Diversified conglomerate mergers

1992–1998 Fourth Wave Congeneric mergers; Hostile takeovers; Corporate Raiding

2000 - Fifth Wave Cross-border mergers

Deal Objectives in More Recent Merger Waves:-

During the third merger wave (1965-1989), corporate marriages involved more diverse
companies. Acquirers more frequently bought into different industries. Sometimes this was done
to smooth out cyclical bumps, to diversify, the hope being that it would hedge an investment
portfolio.

Starting in the fourth merger wave (1992-1998) and continuing today, companies are more likely
to acquire in the same business, or close to it, firms that complement and strengthen an acquirer’s
capacity to serve customers.
Buyers aren’t necessarily hungry for the target companies’ hard assets. Now they’re going after
entirely different prizes. The hot prizes aren’t things—they’re thoughts, methodologies, people
and relationships. Soft goods, so to speak.

Many companies are being bought for their patents, licenses, market share, name brand, research
staffs, methods, customer base, or culture. Soft capital, like this, is very perishable, fragile, and
fluid. Integrating it usually takes more finesse and expertise than integrating machinery, real
estate, inventory and other tangibles.

Cross-border M&A:-

In a study conducted in 2000 by Lehman Brothers, it was found that, on average, large M&A
deals cause the domestic currency of the target corporation to appreciate by 1% relative to the
acquirers.

The rise of globalization has exponentially increased the necessity for MAIC Trust accounts and
securities clearing services for Like-Kind Exchanges for cross-border M&A. In 1997 alone, there
were over 2333 cross-border transactions, worth a total of approximately $298 billion. Due to the
complicated nature of cross-border M&A, the vast majority of cross-border actions have
unsuccessful anies seek to expand their global footprint and become more agile at creating high-
performing businesses and cultures across national boundaries.

Even mergers of companies with headquarters in the same country are very much of this type
and require MAIC custodial services (cross-border Mergers). After all, when Boeing acquires
McDonnell Douglas, the two American companies must integrate operations in dozens of
countries around the world. This is just as true for other supposedly "single country" mergers,
such as the $29 billion dollar merger of Swiss drug makers Sandoz and Ciba-Geigy (now
Novartis).

Major M&A:-

1990s

Top 10 M&A deals worldwide by value (in mil. USD) from 1990 to 1999:

Transaction value (in mil.

Rank Year Purchaser Purchased
USD)

Vodafone Air touch

1 1999 Mannesmann 183,000
PLC

2 1999 Pfizer Warner-Lambert 90,000

3 1998 Exxon Mobil 77,200

4 1998 Citicorp Travelers Group 73,000

 5 1999 SBC Communications Ameritech Corporation 63,000

Air Touch
6 1999 Vodafone Group 60,000
Communications

7 1998 Bell Atlantic GTE 53,360

8 1998 BP Amoco 53,000

9 1999 Qwest Communications US WEST 48,000

10 1997 WorldCom MCI Communications 42,000

2000s

Top 10 M&A deals worldwide by value (in mil. USD) from 2000 to 2009:

Transaction value (in

Rank Year Purchaser Purchased
mil. USD)

Fusion: America Online Inc.

1 2000 Time Warner 164,747
(AOL)

2 2000 Glaxo Wellcome Plc. SmithKline Beecham Plc. 75,961

Shell Transport & Trading

3 2004 Royal Dutch Petroleum Co. 74,559
Co

4 2006 AT&T Inc. BellSouth Corporation 72,671

AT&T Broadband &

5 2001 Comcast Corporation 72,041
Internet Svcs

6 2009 Pfizer Inc. Wyeth 68,000

Spin-off: Nortel Networks

7 2000 59,974
Corporation

8 2002 Pfizer Inc. Pharmacia Corporation 59,515

9 2004 JP Morgan Chase & Co Bank One Corp 58,761

Anheuser-Busch
10 2008 Inbev Inc. 52,000
Companies, Inc
M&A in Popular Culture:-

In the novel American Psycho the protagonist Patrick Bateman, played by Christian Bale in the
film adaptation, works in mergers and acquisitions, which he occasionally refers to as 'murders
and executions' to his unwitting victims. The character also enjoys Genesis albums and
competing with colleagues on who has the best business card.