Chapter: Three: Merger & Acquisitions

What is a 'Merger'
A merger is a deal to unite two existing companies into one new company. There are several
types of mergers and also several reasons why companies complete mergers. Most mergers unite
two existing companies into one newly named company. Mergers and acquisitions are
commonly done to expand a company’s reach, expand into new segments, or gain market share.
All of these are done to please shareholders and create value.

Definition of Merger

The definition of merger in general and in finance can be stated as follows:

In General, "Merger is an absorption of one or more companies by a single existing company."
In Finance, "Merger is an act or process of purchasing equity shares (ownership shares) of one
or more companies by a single existing company."

Meaning of Merger

Acquiring company is a single existing company that purchases the majority of equity shares of
one or more companies.
Acquired companies are those companies that surrender the majority of their equity shares to an
acquiring company.
Merger is a technique of business growth. It is not treated as a business combination.
Merger is done on a permanent basis. Generally, it is done between two companies. However, it
can also be done among more than two companies. During merger, an acquiring company and
acquired companies come together to decide and execute a merger agreement between them.
After merger, acquiring company survives whereas acquired companies do not survive anymore,
and they cease (stop) to exist. Merger does not result in the formation of a new company.
The management of acquiring company continues to lead (direct) the merger.

What is an 'Acquisition'
An acquisition is a corporate action in which a company buys most, if not all, of another firm's ownership
stakes to assume control of it. An acquisition occurs when a buying company obtains more than 50%
ownership in a target company. As part of the exchange, the acquiring company often purchases the target
company's stock and other assets, which allows the acquiring company to make decisions regarding the
newly acquired assets without the approval of the target company’s shareholders. Acquisitions can be
paid for in cash, in the acquiring company's stock or a combination of both.

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Example of Merger

Consider the example of merger shown in the following diagram.

In the above example, Company 'A' and Company 'B' are operating (existing) in the market.
Company 'A' is an acquiring company, and Company 'B' is getting acquired by Company 'A'. In
other words, Company 'B' gets merged with Company 'A'.

In this example of merger, Company 'A' will purchase the majority of equity shares (ownership
shares) of Company 'B'. Company 'A' will take over the assets and liabilities of the Company 'B'.
The shareholders of the Company 'B' will be given the shares of Company 'A'. The acquiring
Company 'A' will continue to operate (function) by its erstwhile (former) name.

Some recent examples of well-known mergers are as follows:

British Salt operating in UK merged with TATA Chemicals based in India.
Zain Telecommunications operating in Africa merged with Bharti Airtel Limited based in India.
Bank of Rajasthan operating in India merged with ICICI Bank (India).

Types of Mergers
There are five main types of company mergers:

• Conglomerate: A conglomerate is a corporation that is made up of a number of different,

seemingly unrelated businesses. In a conglomerate, one company owns a controlling stake in a
number of smaller companies, which conduct business separately. Each of a

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conglomerate's subsidiary businesses runs independently of the other business divisions, but the
subsidiaries' management reports to senior management at the parent company.

• Horizontal: A horizontal merger is a merger or business consolidation that occurs between

firms that operate in the same space, as competition tends to be higher and the synergies and
potential gains in market share are much greater for merging firms in such an industry. This type
of merger occurs frequently because of larger companies attempting to create more
efficient economies of scale, such as the amalgamation of Daimler-Benz and Chrysler.
Conversely, a vertical merger takes place when firms from different parts of the supply
chain consolidate to make the production process more efficient or cost effective.

For example, if one company sells products similar to the other, the combined sales of a
horizontal merger give the new company a greater share of the market. If one company
manufactures products complementary to the other, the newly merged company may offer a
wider range of products to customers. Merging with a company offering different products to a
different sector of the marketplace helps the new company diversify its offerings and enter new
markets.

• Market Extension Mergers

A market extension merger takes place between two companies that deal in the same products
but in separate markets. The main purpose of the market extension merger is to make sure that
the merging companies can get access to a bigger market and that ensures a bigger client base.

Example

A very good example of market extension merger is the acquisition of Eagle Bancshares Inc by
the RBC Centura. Eagle Bancshares is headquartered at Atlanta, Georgia and has 283 workers. It
has almost 90,000 accounts and looks after assets worth US $1.1 billion.

Eagle Bancshares also holds the Tucker Federal Bank, which is one of the ten biggest banks in
the metropolitan Atlanta region as far as deposit market share is concerned. One of the major
benefits of this acquisition is that this acquisition enables the RBC to go ahead with its growth
operations in the North American market.

With the help of this acquisition RBC has got a chance to deal in the financial market of Atlanta ,
which is among the leading upcoming financial markets in the USA. This move would allow
RBC to diversify its base of operations.

Product Extension Mergers

A product extension merger takes place between two business organizations that deal in products
that are related to each other and operate in the same market. The product extension merger

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allows the merging companies to group together their products and get access to a bigger set of
consumers. This ensures that they earn higher profits.

Example

The acquisition of Mobilink Telecom Inc. by Broadcom is a proper example of product

extension merger. Broadcom deals in the manufacturing Bluetooth personal area network
hardware systems and chips for IEEE 802.11b wireless LAN.

Mobilink Telecom Inc. deals in the manufacturing of product designs meant for handsets that are
equipped with the Global System for Mobile Communications technology. It is also in the
process of being certified to produce wireless networking chips that have high speed and General
Packet Radio Service technology. It is expected that the products of Mobilink Telecom Inc.
would be complementing the wireless products of Broadcom.

• Vertical Merger: Two companies that make parts for a finished good combine. A vertical
merger is a merger between two companies that operate at separate stages of the production
process for a specific finished product. A vertical merger occurs when two or more firms,
operating at different levels within an industry's supply chain, merge operations. Most often, the
logic behind the merger is to increase synergies created by merging firms that would be more
efficient operating as one.

An example of a vertical merger is a car manufacturer purchasing a tire company. Such a vertical
merger reduces the cost of tires for the automaker and potentially expands its business by
allowing it to supply tires to competing automakers. This example shows how a vertical merger
can be twice as beneficial to the company conducting the integration. The initial benefit is the
reduction in supplier costs that leads to an increase in profitability. The second benefit is an
expansion in revenue streams that also increases the bottom line.

Comparison between Merger and Acquisition:

  Merger Acquisition

Merger is considered to be a An acquisition occurs when

process when two or more one company or corporation
Definition companies come together to takes control of another
expand their business company and rules all its
operations. business operations.

They are considered as They are considered as

Terms
amicable. hostile.

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 Stocks New stocks are issued. No new stocks are issued.

The companies of same size The larger companies

Companies
join hands together. acquire smaller companies.

Both the companies are The company that is

Power
treated as equal. stronger gets the power.

The two companies of same

The two companies of
size combine to increase
different sizes come
Challenges their strength and financial
together to combat the
gains along with breaking
challenges of downturn.
the trade barriers.

A buyout agreement is A buyout agreement is

known as a merger when
both owners mutually
Agreement
decide to combine their
business in the best interest
of their firms.
known as an acquisition
when the agreement is
hostile, or when the target
firm is unwilling to be
bought.

Disney and Pixar merged Google acquired Android

Examples together to collaborate for $50 million in August
easily and freely.   2005.

Mergers & Acquisitions can take place:

• by purchasing assets
• by purchasing common shares
• by exchange of shares for assets
• by exchanging shares for shares

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Reasons for Merger
Reason # 1. Economies of Scale:
An amalgamated company will have more resources at its command than the individual
companies. This will help in increasing the scale of operations and the economies of large
scale will be availed. These economies will occur because of more intensive utilisation of
production facilities, distribution network, research and development facilities, etc.

These economies will be available in horizontal mergers (companies dealing in same line
of products) where scope of more intensive use of resources is greater.

The economies will occur only upto a certain point of operations known as optimal point.
It is a point where average costs are minimum. When production increases from this
point, the cost per unit will go up.

The optimal point of production is shown with the help of a diagram also:

Reason # 2. Operating Economies:

A number of operating economies will be available with the merger of two or more
companies. Duplicating facilities in accounting, purchasing, marketing, etc. will be
eliminated. Operating inefficiencies of small concerns will be controlled by the superior
management emerging from the amalgamation. The amalgamated companies will be in a
better position to operate than the amalgamating companies individually.

Reason # 3. Synergy:

Synergy refers to the greater combined value of merged firms than the sum of the values
of individual units. It is something like one plus one more than two. It results from

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benefits other than those related to economies of scale. Operating economies are one of
the various synergy benefits of merger or consolidation.

The other instances which may result into synergy benefits include, strong R &D
facilities of one firm merged with better organised production facilities of another unit,
enhanced managerial capabilities, the substantial financial resources of one being
combined with profitable investment opportunities of the other, etc

Reason # 4. Growth:

A company may not grow rapidly through internal expansion. Merger or amalgamation
enables satisfactory and balanced growth of a company. It can cross many stages of
growth at one time through amalgamation. Growth through merger or amalgamation is
also cheaper and less risky.

A number of costs and risks of expansion and taking on new product lines are avoided by
the acquisition of a going concern. By acquiring other companies a desired level of
growth can be maintained by an enterprise.

Reason # 5. Diversification:

Two or more companies operating in different lines can diversify their activities through
amalgamation. Since different companies are already dealing in their respective lines
there will be less risk in diversification. When a company tries to enter new lines of
activities then it may face a number of problems in production, marketing etc.

When some concerns are already operating in different lines, they must have crossed
many obstacles and difficulties. Amalgamation will bring together the experiences of
different persons in varied activities. So amalgamation will be the best way of
diversification.

Reason # 6. Utilisation of Tax Shields:

When a company with accumulated losses merges with a profit making company it is
able to utilise tax shields. A company having losses will not be able to set off losses
against future profits, because it is not a profit earning unit.

On the other hand if it merges with a concern earning profits then the accumulated losses
of one unit will be set off against the future profits of the other unit. In this way the
merger or amalgamation will enable the concern to avail tax benefits.

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Reason # 7. Increase in Value:
One of the main reasons of merger or amalgamation is the increase in value of the
merged company. The value of the merged company is greater than the sum of the
independent values of the merged companies. For example, if X Ld. and Y Ltd. merge
and form Z Ltd., the value of Z Ltd. is expected to be greater than the sum of the
independent values of X Ltd. and Y Ltd.

Reason # 8. Eliminations of Competition:

The merger or amalgamation of two or more companies will eliminate competition
among them. The companies will be able to save their advertising expenses thus enabling
them to reduce their prices. The consumers will also benefit in the form of cheap or
goods being made available to them.

Reason # 9. Better Financial Planning:

The merged companies will be able to plan their resources in a better way. The collective
finances of merged companies will be more and their utilisation may be better than in the
separate concerns. It may happen that one of the merging companies has short gestation
period while the other has longer gestation period.

The profits of the company with short gestation period will be utilised to finance the
other company. When the company with longer gestation period starts earning profits
then it will improve financial position as a whole.

Reason # 10. Economic Necessity:

Economic necessity may force the merger of some units. If there are two sick units,
government may force their merger to improve their financial position and overall
working. A sick unit may be required to merge with a healthy unit to ensure better
utilisation of resources, improve returns and better management. Rehabilitation of si.ck
units is a social necessity because their closure may result in unemployment etc.

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10-Step M&A Process

A typical 10-step M&A deal process includes:

1. Develop an acquisition strategy – Developing a good acquisition strategy revolves around the
acquirer having a clear idea of what they expect to gain from making the acquisition – what their
business purpose is for acquiring the target company (e.g., expand product lines or gain access to
new markets)

2. Set the M&A search criteria – Determining the key criteria for identifying potential target
companies (e.g., profit margins, geographic location, or customer base)

3. Search for potential acquisition targets – The acquirer uses their identified search criteria to
look for and then evaluate potential target companies

4. Begin acquisition planning – The acquirer makes contact with one or more companies that meet
its search criteria and appear to offer good value; the purpose of initial conversations is to get
more information and to see how amenable to a merger or acquisition the target company is

5. Perform valuation analysis – Assuming initial contact and conversations go well, the acquirer
asks the target company to provide substantial information (current financials, etc.) that will

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 enable the acquirer to further evaluate the target, both as a business on its own and as a suitable
acquisition target

6. Negotiations – After producing several valuation models of the target company, the acquirer
should have sufficient information to enable it to construct a reasonable offer; Once the initial
offer has been presented, the two companies can negotiate terms in more detail

7. M&A due diligence – Due diligence is an exhaustive process that begins when the offer has been
accepted; due diligence aims to confirm or correct the acquirer’s assessment of the value of the
target company by conducting a detailed examination and analysis of every aspect of the target
company’s operations – its financial metrics, assets and liabilities, customers, human resources,
etc.

8. Purchase and sale contract – Assuming due diligence is completed with no major problems or
concerns arising, the next step forward is executing a final contract for sale; the parties make a
final decision on the type of purchase agreement, whether it is to be an asset purchase or share
purchase

9. Financing strategy for the acquisition – The acquirer will, of course, have explored financing
options for the deal earlier, but the details of financing typically come together after the purchase
and sale agreement has been signed

10. Closing and integration of the acquisition – The acquisition deal closes, and management
teams of the target and acquirer work together on the process of merging the two firms

Mergers and Acquisitions Case Study:

Case Study 1: Sun Pharmaceuticals acquires Ranbaxy:

The deal has been completed: The companies have got the approval of merger from different
authorities.

This is a classic example of a share swap deal. As per the deal, Ranbaxy shareholders will get four shares
of Sun Pharma for every five shares held by them, leading to 16.4% dilution in the equity capital of Sun
Pharma (total equity value is USD3.2bn and the deal size is USD4bn (valuing Ranbaxy at 2.2 times last
12 months sales).

Reason for the acquisition: This is a good acquisition for Sun Pharma as it will help the company to fill
in its therapeutic gaps in the US, get better access to emerging markets and also strengthen its presence in
the domestic market. Sun Pharma will also become the number one generic company in the dermatology
space. (currently in the third position in US) through this merger.

Objectives of the M&A:

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• Sun Pharma enters into newer markets by filling in the gaps in the offerings of the company, through the
acquired company

• Boosting of products offering of Sun Pharma creating more visibility and market share in the industry

• Turnaround of a distressed business from the perspective of Ranbaxy

This acquisition although will take time to consolidate, it should in due course start showing results
through overall growth depicted in Sun Pharma’s top-line and bottom-line reporting.

Case Study 2: CMC merges with TCS:

This is an example where there is a merger in the same industry (horizontal). It was done to consolidate
the IT businesses. The objective of this merger, as indicated by the management of CMC, was that the
amalgamation will enable TCS to consolidate CMC’s operations into a single company with rationalised
structure, enhanced reach, greater financial strength and flexibility. Further it also indicated that, it will
aid in achieving economies of scale, more focused operational efforts, standardisation and simplification
of business processes and productivity improvements.

Problems:

1. Are the following hypothetical mergers horizontal, vertical or conglomerate?

a. IBM acquires Dell Computer.
b. Dell Computer acquires Stop & Shop (a supermarket chain)
c. Stop & Shop acquires Campbell Soup
d. Coca cola acquires Pepsi division .

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 e. Compbell Soup acquires IBM.
2. Cisluner Foods is considering acquisition of a smaller food company, Tergetco. Cislunar
is all of proposing to finance the deal by purchasing all of Target co’s outstanding stock
for $ 19 per share.

Cisluner Foods Targetco Combined

Companies
Revenues $ 150 $20 $172 (+2)
Operating costs 118 16 132 (-2)
Earnings 32 4 40 (+4)
Cash 55 2.5
Other assets book value 185 17
Total assets 240 19.5
Price per share 48 16
Number of shares 10 2.5
Market value 480 40

a) Why would Cisluner and Targetco be worth more together than apart?
b) What are the terms of the Merger? What is the cost to Cislunar and its shareholder/
c) What is the Merger NPV for Cisluner?

3. Sweet Cola Crop (SCC) is bidding to take over SDP company. SCC has 3000 share
outstanding , selling at $50 per share. SDP has 2000 shares outstanding. Selling at
$17.50 a share. SCC estimates the economic gain from the merger is $15000.
a) If SDP can be acquired for $20 a share what is the NPV of the merger to SCC?
b) What is the post merger value of SCC.

https://www.slideshare.net/ravirockaditya/mergers-and-acquisition-ppt

https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma-process/

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