Mergers and Acquisitions

Mergers and acquisitions (M&A) refers to the consolidation of companies or assets. M&A can
include a number of different transactions, such as mergers, acquisitions, consolidations, tender
offers, purchase of assets and management acquisitions.

Some of the reasons why companies merge with or acquire other companies include:

1. Synergy: The most used word in M&A is synergy, which is the idea that by
combining business activities, performance will increase and costs will decrease. Essentially, a
business will attempt to merge with another business that has complementary strengths and
weaknesses.

2. Diversification / Sharpening Business Focus: These two conflicting goals have been used to
describe thousands of M&A transactions. A company that merges to diversify may acquire
another company in a seemingly unrelated industry in order to reduce the impact of a particular
industry's performance on its profitability. Companies seeking to sharpen focus often merge with
companies that have deeper market penetration in a key area of operations.

3. Growth: Mergers can give the acquiring company an opportunity to grow market
share without having to really earn it by doing the work themselves - instead, they buy a
competitor's business for a price. Usually, these are called horizontal mergers. For example, a
beer company may choose to buy out a smaller competing brewery, enabling the smaller
company to make more beer and sell more to its brand-loyal customers.

4. Increase Supply-Chain Pricing Power: By buying out one of its suppliers or one of the
distributors, a business can eliminate a level of costs. If a company buys out one of its suppliers,
it is able to save on the margins that the supplier was previously adding to its costs; this is known
as a vertical merger. If a company buys out a distributor, it may be able to ship its products at a
lower cost.

5. Eliminate Competition: Many M&A deals allow the acquirer to eliminate future competition
and gain a larger market share in its product's market. The downside of this is that a
large premium is usually required to convince the target company's shareholders to accept the
offer. It is not uncommon for the acquiring company's shareholders to sell their shares and push
the price lower in response to the company paying too much for the target company.

Efficiency explanations
Information theories
Agency problems
Market power
Tax considerations
Diversification
Asset strippers

Hostile Takeovers
Hostile Takeovers The term “Hostile Takeover” is defined as when a company puts a bid on a target firm,
which is being opposed by the management of the targeted company which furthermore advises its
shareholders not to sell to the acquiring firm (Savela, 1999). Also, if a bid is placed for the shares of the
target company without informing its board and is directly aimed to the shareholders, the term hostile
takeover is also applied (Damodaran, 1997). The bid or offer could be suggested towards the
shareholders with or without the consent or negotiations from the management of the targeted firm.
Furthermore, there is a thin line between what is characterized as a hostile bid or a normal bid, since it
sometimes occurs that a friendly or normal bid if you, develops into a hostile bid. However, hostile bids
and offers are generally directly aimed at the shareholders of the targeted company in hope of gaining
control over the company without the consent from the board of directors of the targeted firm (Statens
Offentliga Utredningar SOU, 1990).

The motives behind a hostile takeover in theory, is usually the same as with other acquisitions, except
one additional reason or motive for a hostile bid. It is said that the most effective way of replacing an
ineffective board of directors or management of a targeted firm, is through a hostile takeover. When a
company operates ineffectively even though it has great growth potential or the value of the stock price
doesn’t properly illustrate the real value of the company, the firm is undervalued. The acquiring
company then wishes and aims to replace the old management, in order for the company to achieve its
full revenue and growth potential, thus increasing its stock value. For this reason, companies with a
management that doesn’t seek the best interests for its shareholders are often potential objects for
future acquirements.

A company could during a short period of time have a management that is ineffective, but in theory, if
the market has its way, they will eventually in the long run be replaced. As we have mentioned before,
this could be due to the lack of economic growth potential the management has been able to realize or
perhaps that the strategic plan of the board does not comply with the shareholders view or expectations
(J.M Samuels, et al, 1999).

A hostile takeover could therefore sometimes also be seen as an effective market transaction, which
simply replaces a bad management, in order to gain increased company value for the acquiring company
as well as for the shareholders of the targeted firm (Weston et al, 2004).

2.2.1 Are Takeovers Positive or Negative?

The opinions are many in this question and a lot of research has been undertaken. It is still hard to say
whether takeovers are beneficial on the balance and the only thing that is certain is that the beneficial
or negative affects depend highly on from whose angle one is viewing from.
The opinions are many in this question and a lot of research has been undertaken. It is still hard to say
whether takeovers are beneficial on the balance and the only thing that is certain is that the beneficial
or negative affects depend highly on from whose angle one is viewing from.

There is still an unresolved issue in empirical research about corporate control in whether a take-over
actually improves the value of the bidder and the target firm. However, what studies have been able to
show, is that all the gains or positive effects tend to go to the shareholders of the target firm and that
the acquiring firm pays a premium for their company. Furthermore, hostile takeovers in most cases
improve the value for the shareholders of the targeted firm, thus the term hostile is being used to
illustrate the opposition faced by the target firm’s board of directors and not necessarily the
shareholders´. A takeover which takes the shareholders of the target firm in consideration first, in other
words maximizing shareholder value, is called positive (Weston et al, 2004).

2.2.2 Bid Premium

For a hostile bid to take place, an offer has to be made to the shareholders of the target firm. This bid is
very often a lot higher than what the target firm is valued on the market, in order to receive a positive
response from the shareholders and the board of directors of the target firm. The difference between
the bid and what the target company is actually worth is called bid premium. The size of the bid
premium depends on the acquiring company’s willingness to pay for the target company and according
to surveys done in the UK, average bid premiums of hostile takeovers in UK are between 35-45 per cent
higher than the market price of the target company (Schoenberg, 2003).

Defense strategies issued by the targeted company have different purposes. While some strategies are
formulated specifically to prevent the bidder from gaining ownership over the company’s equities or
stocks, other help stagger the bid and even increase it, thus resulting in a higher bid premium received
by the target firm.

2.3 Defense Strategies

All bids that are made between companies are, as mentioned earlier, not always welcomed with open
arms from the target company’s board of directors. In that case the bid is recognized as hostile, also
called unconsolidated bid. This occurs when the acquiring company is trying to acquire the target
company directly through its share holders rather than through a mutual agreement with the target
company’s board of directors. The expression of hostile takeover has its roots in the negative attitude
expressed from the board of directors of the targeted company (Savela, 1999). The reasons for the
targets board of directors’ negative attitude can perhaps be explained by several reasons and not always
related to the valuation of the actual bid. Some of them are; the board of directors’ fears that the
acquisition will have a negative effect on the company’s growth, strategy, revenues or dividend, they
may also experience fear of losing their jobs by being replaced by the biding company’s employees
(Bebchuk, Coates & Subramanian, 2002).

When facing a hostile takeover trough a hostile bid the board of directors will act accordingly to protect
their independence and current management or to ensure that the hostile bidder is pressured to
sweeten their bid further. Often, the main purpose of the chosen defense strategy is to make the
acquisition more costly or time consuming and in such way making the targeted company less attractive
due to the rise in cost which follows. This can be done through several different ways and theses
measures are commonly called defense strategies, shark repellent tactics or antitakeover measures.
These can be used in a reactive approach to fend off a presented hostile bid or be used in a proactive
approach to make sure to that future raids from targeting companies are slows down or even hindered
(Pearce & Robinson, 2004).

There are many different defense strategies to use and are often used in combination with each other to
ensure the effectiveness of the defense. There is no one-situation fit all strategy and therefore the
choice of strategy is dependent on the acquisition strategy used by the acquirer and also what motives
the targeted board of directors have available (Nilsson, 2001).

Hostile Takeover

A hostile takeover occurs when one business acquires control over a public company against the
consent of existing management or its board of directors. Typically, the buying company purchases a
controlling percentage of the voting shares of the target company and, along with the controlling shares,
the power to dictate new corporate policy.

There are three ways to take over a public company: vertical acquisition, horizontal acquisition and
conglomerated acquisition. The main reason for the hostile execution of acquisition, at least in theory, is
to remove ineffective management and increase future profits.

Poison Pill Defense

The first poison pill defense was used in 1982, when New York lawyer Martin Lipton unveiled a warrant
dividend plan; these defenses are more commonly known as shareholders' rights plans. This defense is
controversial, and many countries have limited its application. To execute a poison pill, the targeted
company dilutes its shares in a way that the hostile bidder cannot obtain a controlling share without
incurring massive expenses.
A "flip-in" pill version allows the company to issue preferred shares that only existing shareholders may
buy, diluting the hostile bidder's potential purchase. "Flip-over" pills allow existing shareholders to buy
the acquiring company's shares at a significantly discounted price.

Other Defenses

A company might segregate its board of directors into different groups and only put a handful up for re-
election at any one meeting. This staggers the board over time, making it very time-consuming for the
entire board to be voted out. If a board feels like it cannot reasonably prevent a hostile takeover, it
might seek a friendlier firm to swoop in and buy a controlling interest before the hostile bidder. This is
the white knight defense. If desperate, the threatened board may sell off key assets and reduce
operations, hoping to make the company less attractive to the bidder.

Golden parachute

A golden parachute is a clause in a CEO's contract and other management executives of a company, that
will provide them with money or stock options, in the event that the company is being acquired and
executives might be subjected to termination by the acquiring the firm.

This clause in payment is designed to counter the hostile takeover, by making it more expensive, as it
involves paying more than what is usually a lump sum payment to such executives of the target
company.

The strategy is usually implemented along with other takeover defense strategies. The Golden
parachute’s primary function in a hostile takeover is to align incentives between shareholders and the
executives of the target company, as generally there are concerns about executives who face a hostile
takeover while risking loss of their jobs, since they oppose the bid even when it increases the value for
shareholders.

Crown jewel

By using the Crown Jewel strategy, the target company gets the right to sell the company’s most
valuable assets (Crown Jewels) - all or only a few, when it faces a hostile bid. This is done by the target
company, in hope that selling such assets will make them less attractive to the possible acquirers and
may ultimately force a drawback of the bid.

Another way of implementing this type of strategy, by the target company, is to sell its Crown Jewels to
another friendly company (White Knight) and later on, when and if the acquiring company withdraws its
offer, buy back the assets sold to the White Knight at a fixed price agreed in advance.

Lobster trap
The term is derived from the fact that Lobster traps are designed to catch large lobsters but allow small
lobsters to escape. A lobster trap is an anti-takeover strategy used by target firms. In a lobster trap, the
target firm issues a charter that prevents individuals with more than 10% ownership of convertible
securities (including convertible bonds, convertible preferred stock, and warrants) from transferring
these securities to voting stock. This is a prevention measure that makes sure large stakeholders cannot
add to their voting stock and thus reduces facilitating the takeover of the target company.

Selection of the defense system against a hostile takeover is a strategical decision. Careful preparation is
necessary to cut off such unfriendly bids. It is also important to remain flexible in responding to changing
dynamics of takeover techniques. Also, there is no “One size fits all” strategy to make the company full-
proof against such hostile bids. Therefore, a regular review of the takeover environment and events is
essential bring make defense strategies up to date.

Staggered board approach

Golden parachutes
Greenmail
Crown jewel
Poison pill
White knight
Attacking the logic of the bid
Litigation
A number of considerations affect the dividend policy of company. The major factors are:

a. Stability of Earnings. The nature of business has an important bearing on the

dividend policy. Industrial units having stability of earnings may formulate a more
consistent dividend policy than those having an uneven flow of incomes because
they can predict easily their savings and earnings. Usually, enterprises dealing in
necessities suffer less from oscillating earnings than those dealing in luxuries or
fancy goods.
b. Liquidity of Funds. Availability of cash and sound financial position is also an
important factor in dividend decisions. A dividend represents a cash outflow, the
greater the funds and the liquidity of the firm the better the ability to pay dividend.
The liquidity of a firm depends very much on the investment and financial decisions
of the firm which in turn determines the rate of expansion and the manner of
financing. If cash position is weak, stock dividend will be distributed and if cash
position is good, company can distribute the cash dividend.
c. Needs for Additional Capital. Companies retain a part of their profits for
strengthening their financial position. The income may be conserved for meeting
the increased requirements of working capital or of future expansion. Small
companies usually find difficulties in raising finance for their needs of increased
working capital for expansion programmes. They having no other alternative, use
their ploughed back profits. Thus, such Companies distribute dividend at low rates
and retain a big part of profits.
d. Trade Cycles. Business cycles also exercise influence upon dividend Policy.
Dividend policy is adjusted according to the business oscillations. During the
boom, prudent management creates food reserves for contingencies which follow
the inflationary period. Higher rates of dividend can be used as a tool for marketing
the securities in an otherwise depressed market. The financial solvency can be
proved and maintained by the companies in dull years if the adequate reserves have
been built up.
e. Government Policies. The earnings capacity of the enterprise is widely affected
by the change in fiscal, industrial, labour, control and other government policies.
 Sometimes government restricts the distribution of dividend beyond a certain
percentage in a particular industry or in all spheres of business activity as was done
in emergency. The dividend policy has to be modified or formulated accordingly in
those enterprises.

f. Taxation Policy. High taxation reduces the earnings of he companies and

consequently the rate of dividend is lowered down. Sometimes government levies
dividend-tax of distribution of dividend beyond a certain limit. It also affects the
capital formation. N India, dividends beyond 10 % of paid-up capital are subject to
dividend tax at 7.5 %.
g. Legal Requirements. In deciding on the dividend, the directors take the legal
requirements too into consideration. In order to protect the interests of creditors and
outsiders, the companies Act 1956 prescribes certain guidelines in respect of the
distribution and payment of dividend. Moreover, a company is required to provide
for depreciation on its fixed and tangible assets before declaring dividend on shares.
It proposes that Dividend should not be distributed out of capita, in any case.
Likewise, contractual obligation should also be fulfilled, for example, payment of
dividend on preference shares in priority over ordinary dividend.
h. Past dividend Rates. While formulating the Dividend Policy, the directors must
keep in mind the dividend paid in past years. The current rate should be around the
average past rat. If it has been abnormally increased the shares will be subjected to
speculation. In a new concern, the company should consider the dividend policy of
the rival organisation.
i. Ability to Borrow. Well established and large firms have better access to the
capital market than the new Companies and may borrow funds from the external
sources if there arises any need. Such Companies may have a better dividend pay-
out ratio. Whereas smaller firms have to depend on their internal sources and
therefore they will have to build up good reserves by reducing the dividend payout
ratio for meeting any obligation requiring heavy funds.
Bird in Hand Theory of Dividend Policy

What does 'Bird In Hand' mean

Bird in hand is a theory that postulates investors prefer dividends from a stock to potential capital gains
because of the inherent uncertainty of the latter. Based on the adage a bird in the hand is worth two in
the bush, the bird-in-hand theory states investors prefer the certainty of dividend payments to the
possibility of substantially higher future capital gains.

Dividend vs. Capital Gains Investing

Investing for capital gains is predicated largely on conjecture. An investor may gain an advantage in
capital gains by conducting extensive company, market and macroeconomic research, but ultimately,
the performance of a stock hinges on a host of factors completely out of the investor's control.

For this reason, capital gains investing represents the "two in the bush" side of the old adage. Investors
chase capital gains because of the possibility of those gains being large and making the investor rich, but
the possibility is just as real that capital gains are nonexistent or, worse, negative.

Broad stock market indices such as the Dow Jones Industrial Average (DJIA) and the Standard & Poor's
(S&P) 500 have averaged 9 to 10% in annual returns over the long term. It is very difficult to find
dividends that high. Even stocks in notoriously high-dividend industries such as utilities and
telecommunications tend to top out at 4 to 5%. However, if a company has been paying a dividend yield
of, say, 5% for many years, receiving that return in a given year is much more of a sure thing than
earning 9 or 10% in capital gains.

Disadvantages of the Bird in Hand

Legendary investor Warren Buffett once opined that in investing, what is comfortable is rarely
profitable. Dividend investing at 4 to 5% per year provides near-guaranteed returns and security, but
over the long term, the pure dividend investor has earned far less money than the pure capital gains
investor. Moreover, during some years, such as the late 1970s, dividend income, while secure and
comfortable, has been insufficient even to keep pace with inflation.
Making Sense Of Stock Market Anomalies
In the non-investing world, an anomaly is a strange or unusual occurrence. In financial markets,
anomalies refer to situations when a security or group of securities performs contrary to the notion of
efficient markets, where security prices are said to reflect all available information at any point in time.

With the constant release and rapid dissemination of new information, sometimes efficient markets are
hard to achieve and even more difficult to maintain. There are many market anomalies; some occur
once and disappear, while others are continuously observed. (To learn more about efficient markets,
see What Is Market Efficiency?)

Can anyone profit from such strange behavior? We'll look at some popular recurring anomalies and
examine whether any attempt to exploit them could be worthwhile.

Calendar Effects

Anomalies that are linked to a particular time are called calendar effects. Some of the most popular
calendar effects include the weekend effect, the turn-of-the-month effect, the turn-of-the-year effect
and the January effect.

Weekend Effect: The weekend effect describes the tendency of stock prices to decrease on Mondays,
meaning that closing prices on Monday are lower than closing prices on the previous Friday. For some
unknown reason, returns on Mondays have been consistently lower than every other day of the week.
In fact, Monday is the only weekday with a negative average rate of return.

Years Monday Tuesday Wednesday Thursday Friday

1950-2004 -0.072% 0.032% 0.089% 0.041% 0.080%

Source: Fundamentals of Investments, McGraw Hill, 2006

Turn-of-the-Month Effect: The turn-of-the-month effect refers to the tendency of stock prices to rise on
the last trading day of the month and the first three trading days of the next month.
Years Turn of the Month Rest of Days

1962-2004 0.138% 0.024%

Source: Fundamentals of Investments, McGraw Hill, 2006

Turn-of-the-Year Effect: The turn-of-the-year effect describes a pattern of increased trading volume and
higher stock prices in the last week of December and the first two weeks of January.

Years Turn of the Year Rest of Days

1950-2004 0.144% 0.039%

Source: Fundamentals of Investments, McGraw Hill, 2006

January Effect: Amid the turn-of-the-year market optimism, there is one class of securities that
consistently outperforms the rest. Small-company stocks outperform the market and other asset classes
during the first two to three weeks of January. This phenomenon is referred to as the January effect.
(Keep reading about this effect in January Effect Revives Battered Stocks.)

Occasionally, the turn-of-the-year effect and the January effect may be addressed as the same trend,
because much of the January effect can be attributed to the returns of small-company stocks.

Why Do Calendar Effects Occur?

So, what's with Mondays? Why are turning days better than any other days? It has been jokingly
suggested that people are happier heading into the weekend and not so happy heading back to work on
Mondays, but there is no universally accepted reason for the negative returns on Mondays.

Unfortunately, this is the case for many calendar anomalies. The January effect may have the most valid
explanation. It is often attributed to the turn of the tax calendar; investors sell off stocks at year's end to
cash in gains and sell losing stocks to offset their gains for tax purposes. Once the New Year begins,
there is a rush back into the market and particularly into small-cap stocks.
Announcements and Anomalies

Not all anomalies are related to the time of week, month or year. Some are linked to the announcement
of information regarding stock splits, earnings, and mergers and acquisitions.

Stock Split Effect: Stock splits increase the number of shares outstanding and decrease the value of each
outstanding share, with a net effect of zero on the company's market capitalization. However, before
and after a company announces a stock split, the stock price normally rises. The increase in price is
known as the stock split effect.

Many companies issue stock splits when their stock has risen to a price that may be too expensive for
the average investor. As such, stock splits are often viewed by investors as a signal that the company's
stock will continue to rise. Empirical evidence suggests that the signal is correct. (For related reading,
see Understanding Stock Splits.)

Short-Term Price Drift: After announcements, stock prices react and often continue to move in the
same direction. For example, if a positive earnings surprise is announced, the stock price may
immediately move higher. Short-term price drift occurs when stock price movements related to the
announcement continue long after the announcement.

Short-term price drift occurs because information may not be immediately reflected in the stock's price.

Merger Arbitrage: When companies announce a merger or acquisition, the value of the company being
acquired tends to rise while the value of the bidding firm tends to fall. Merger arbitrage plays on
potential mispricing after the announcement of a merger or acquisition.

The bid submitted for an acquisition may not be an accurate reflection of the target firm's intrinsic
value; this represents the market anomaly that arbitrageurs aim to exploit. Arbitrageurs aim to take
advantage of the pattern that bidders usually offer premium rates to purchase target firms. (To read
more about M&As, see The Merger - What To Do When Companies Converge and Biggest Merger and
Acquisition Disasters.)

Superstitious Indicators

Aside from anomalies, there are some nonmarket signals that some people believe will accurately
indicate the direction of the market. Here is a short list of superstitious market indicators:

The Super Bowl Indicator: When a team from the old American Football League wins the game, the
market will close lower for the year. When an old National Football League team wins, the market will
end the year higher. Silly as it may seem, the Super Bowl indicator was correct more than 80% of the
time over a 40-year period ending in 2008 . However, the indicator has one limitation: It contains no
allowance for an expansion-team victory.

The Hemline Indicator: The market rises and falls with the length of skirts. Sometimes this indicator is
referred to as the "bare knees, bull market" theory. To its merit, the hemline indicator was accurate in
1987, when designers switched from miniskirts to floor-length skirts just before the market crashed. A
similar change also took place in 1929, but many argue as to which came first, the crash or the hemline
shifts.

The Aspirin Indicator: Stock prices and aspirin production are inversely related. This indicator suggests
that when the market is rising, fewer people need aspirin to heal market-induced headaches. Lower
aspirin sales should indicate a rising market. (See more superstitious anomalies at World's Wackiest
Stock Indicators.)

Why Do Anomalies Persist?

These effects are called anomalies for a reason: they should not occur and they definitely should not
persist. No one knows exactly why anomalies happen. People have offered several different opinions,
but many of the anomalies have no conclusive explanations. There seems to be a chicken-or-the-egg
scenario with them too - which came first is highly debatable.

Profiting From Anomalies

It is highly unlikely that anyone could consistently profit from exploiting anomalies. The first problem lies
in the need for history to repeat itself. Second, even if the anomalies recurred like clockwork, once
trading costs and taxes are taken into account, profits could dwindle or disappear. Finally, any returns
will have to be risk-adjusted to determine whether trading on the anomaly allowed an investor to beat
the market. (To learn much more about efficient markets, read Working Through The Efficient Market
Hypothesis.)

Conclusion

Anomalies reflect inefficiency within markets. Some anomalies occur once and disappear, while others
occur repeatedly. History is no predictor of future performance, so you should not expect every Monday
to be disastrous and every January to be great, but there also will be days that will "prove" these
anomalies true!

Read more: Making Sense Of Market Anomalies

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