Merger History

Merger waves tend to be caused by

combination of
Economic, regulatory and technological
shocks and availability of liquidity
Economic - demand
Regulatory - elimination of regulatory barriers
that prevent corporate marriages
Technological - change in industry shapes
No M&A without liquidity

First Merger Wave 1895-1904

Mega
merger
between
Federal
Steel and
Carnegie
Steel
$1b created
US Steel
Also
merged
with 785
separate
firms-75%
of Steel
productio
n of US

1895-1904: Horizontal mergers

Petroleum, food product, bitumen, coal, primary metals, transportation equipments

Created Monopolies.
Law has limited impact of enforcement
GE, Standard Oil (85%), Du-Pont, Kodak, American
Tobacco (90%)

More than 3000 companies disappeared

Regional firms transformed into national firms

Establishment of railway networks created national
markets
Companies facing competition from distant firms went
for local M&A to protect market share
Reach to markets become inexpensive and still is
Northern
is anBuffet
outcome invested
of 390 railroad$26.3b
M&As
SoBurlington
much that
initself
2009
in
between 1850-2000

Problems of the first wave

Supreme
Court in
1895
ruled that
American
Sugar is
not a
monopoly
and did
not
restrain
trade,
despite
the fact it
had 98%
of market
share

Stock Market crash in 1904 and banking panic 1907

Closure of many banks and formation of Federal Reserve - easy
finance ended here
US Administration cracked down on large monopolies
Result: What happened to Standard Oil:
Broken in to 30 Companies
SO of New Jersey named EXXON
SO of New York named MOBIL
SO of California renamed CHEVRON
SO of Indiana renamed AMOCO
Take over became physically hostile
Erie railways 1868: Vanderbilt

The Second Wave (1916-1929)

Oligopolies industry structure
Primary metals, petroleum products, food products,
chemicals
Outside the previously consolidated heavy manufacturing
industries
Product extension merger
Price Fixing
Vertical mergers in the mining and metal industries (1920)
Prominent Corporations:

General Motors, IBM, Union Carbide, John DEERE

Between 1926 & 1930: 4600 mergers happened result
12,000 mining manufacturing, public utility & banking firms disappeared

Radios in homes, entertainment enhanced competition

Mass merchandising, national brand ad

More debt for financing

Firms looked to work together
than competing
The second wave came to an end
when stock market crashed in
October 1929
The 1940s
WW II - merger of small firms
with larger firms
Motive of tax relief

High estate taxes - interfamily

transfer was no longer attractive
5

There were no increased

The Third Wave (1965-1969)

Contrast
with
earlier
waves.
Smaller
firms
acquired
firms
larger in
size

Merger activity at highest level

Economic boom
Conglomerate mergers - 80% diversified
Diversification strategy

ITT acquired - Avis-Rent a Car, Sheraton hotels, Continental Baking, restaurant

chains, credit agencies,
Insurance, construction, airport parking co.

Reason - Anti Trust Enforcement

Federal Gov. adopted stronger antitrust enforcement both with horizontal and
vertical merger hence conglomerate mergers

Management Sciences
Management principles were applied in industries
Management graduates were employed to manage conglomerate mergers
Investment bankers did not finance most of these mergers

Finance for Mergers

Equity financing
As demand for loanable fund for M&As rose, price and interest rates increased that led to
equity funding

Boom in stock market prices: Stock for stock as painless tax free proposal
P/E Ratio
Higher the P/E Ratio, greater is stockholder willingness to pay for such stocks
This process will continue till the firm keeps on acquiring such smaller firms and
same PE ratio principle is applied by the market
A time would come when such targets would be scarce and market will not apply
same PE ratio or the firm acquires a larger firm whose PE ratio deteriorates the
total P/E ratio of combined firm or percentage of such smaller firms becomes
substantial part of the acquirer
And exactly that is what happened in 1960s

P/E Ratio
Assumptions:
Acquiring firm is larger than target firm
Larger firm has PE Ratio of 25:1
Annual earnings are Rs. 1,000,000
1,000,000 shares are outstanding
Target firm has PE Ratio of 10:1
Annual earnings are Rs. 100,000
100,000 shares are outstanding
Offer from large firm stock-for-stock, one share of acquirer for two shares
of target
Large firm issues 50000 shares to finance the purchase
Acquisition causes EPS of higher P/E firm to rise
1 share was earning Rs. 1. Now 1 share is earning Rs.1.05
( 1100000/1050000)
Assuming that PE ratio of combined firm remains same. Stock price will
rise to Rs. 26.25 ( 25*1.05)
This way large firm can continue to offer small firm significant premium
while its EPS and stock price rises

Other accounting manipulations became visible

Bootstrap effect
Issue of convertible debts in exchange of common stock. EPS rises after merger as
profit of both firms is pooled but outstanding stocks remain same as new firms stocks
are in Convertible Debts whose value keeps on rising
If same P/E ratio is applied it become very attractive and stock prices rise in market

Book profit rose rather than assets

Many conglomerate merger failed
60% of conglomerate acquisitions between 1970 and 1982 were divested by 1989
Conglomerates represent an era away from specialization - a common story

The Fourth Wave (1981-1989)

Recession in 1974-75
Hostile merger became popular

If board of target firm accepts, it is friendly, if not, hostile

INCO V/s ESB and United Tech V/s OTIS

Great mergers in

Oil and gas industry

Drugs and medical equipment industries due to deregulation in some industries
Deregulation of airline industries
Banking industry

Even hostile take over attempt became source of income for attempting firms
Corporate Raiders: Bilzerian Singer (Green mail)

Investment bankers played aggressive role - risk free advisory fee: Drexel Bank
- Junk Bonds
M&A advisory services became lucrative source of income for investment
bankers
Anti takeover defenses and takeover strategies

Junk Bonds
Junk bonds are risky investments but have
speculative appeal because they offer
higher yields than safer bonds
Companies that issue junk bonds typically
have poor credit ratings and there is a
strong possibility they may not be in a
position to honor the bond at maturity
Investors demand superlative returns as
compensation for the risk of investing in
them

The Fifth Wave (1992-2001)

Managers promised themselves mistakes of 4th
wave will not be repeated and instead of highly
leveraged deals will focus on strategic deals
US and global economy went in prolonged
postwar expansion and firms responded to
demands by inorganic growth rather than internal
Firms relied on equity rather than on debt for
financing hence less pressure to sell in short run to
repay debt and reduce the pressure of debt service
12

Societal perspective
Did the gains of target shareholders more than offset losses of
acquirers - did not come even closer and why acquirer (one firm)
should care for society $135b losses

Stock markets went up

Managers became hubris filled
High valuations are result of my managerial excellence rather than
anything else
Board can not refuse M&A proposal of such a CEO who has
shown result

Oligopoly Market Structure

Competition took a different shape in many industries
Very few competitors
Coke 44.5%, Pepsi-31.4%, Cadbury Schweppes -14.4%
Boeing and Airbus 98% share among themselves
Wal-Mart , Tesco, Costco and Carrefour

Globalisation
Cross border M&As

Not confined to US companies

Mittal -Arcelor
Tata - JLR and Corus
Lenovo - IBM
Sawrisi (Egypt) - Part of Enel Telcom, Italy

Protectionism by Govts.
French Govt.

The Sixth Wave (2001- Cont.)

Recession ends - great economic activity
Low Fed rates after 9/11 to boost economy
persisted longer than necessary
Low rates
Provided fuel for sub prime real state loans
Gave rise to pvt. equity for financing M&As - low
interest debt

Markets boom hence equity also available, easy

to raise fund from market

M&A In India
License era - Unrelated diversification
Conglomerate merger
Friendly take over and hostile bids by buying equity shares
Swaraj Paul raided Escorts & DCM 1983 - failed
13 crore

The Hindujas raided and took over Ashok Leyland and Ennore
Foundaries 1987 Rs. 55cr
Chhabria Group acquired Shaw Wallace, Dunlop and Falcon Tyres

Goenka group took over Ceat tyres

The Oberoi - Pleasant hotels of Rane group
1989 - Tata Tea acquired 50% of the equity shares of Consolidated
Coffee Ltd from resident shareholders

Latest M&As In India

2014 deals US$33b
2015 deals US$20b
2016 expected US$ 30b
American Tower Corporation (ATC) acquired 51% of Viom Networks, which
had 42,200 towers and 200 indoor distributed antenna systems across India
Lupin acquired Gavis Pharma and Novel Laboratories for $880 m
Birla acquired two cement units of Lafarge India for Rs 5,000 cr
M&As worth $17b in the first 7 months of 2016
Sun Pharma acquisition of Ranbaxy $4b
Reliance Infrastructure acquisition of Pipavav Defence and Offshore
Engineering Rs.2085 cr
Adani acquisition of Dhamra Port $932m
Reliance - Network18 $678m

MBO
Springfield Remanufacturing Corp. of Navistarwas
purchased by its managers
New Look (UK) was subject to MBO in 2004 byTom Singh,
who had floated it in 1998 backed by private equity houses
Apaxand Permira
Virgin Grouphas undergone several MBOs
Virgin Megastoreswas sold off as part of a MBO (2007) now
known asZavvi
Virgin Comicsunderwent a MBO (2008) now known as Liquid
Comics
Virgin Radiounderwent similar process and becameAbsolute
Radio

PE firm Blackstone Group agreed to buy Indian back-office

EBO
450 employees of Penn Central purchased
Mobile Tool International, Colorado (aerial
lift trucks co. sales $70m) from its owners
National Forge Company owners sold 78%
of Pennsylvania Forger (sales $75m) to its
employees for $45m
U.S. Office of Personnel Management sold
background investigative unit which is
now
a
100%
employee-owned
independent company - Sales-$65 m

Market Power
Firms ability to maintain prices above competitive levels
In competitive markets, in long run firms earn normal
return, not the economic rent
In such situations firms set costs at equal to marginal
cost
Learner Index measures market power by difference
between price and marginal cost
In monopoly, this ratio is equal to the reciprocal of the
price elasticity of demand

Learner index = (P-MC)

P
P = Price and MC = Marginal Cost
Index ranges from 1 to 0. 1 implies greatest market power. For a perfectly
competitive firm (where P = MC), Li = 0, such a firm has no market power
If the price of a product is Rs.15/unit and mc Rs.10/unit than the value of
the index of monopoly power shall be = 15-10/15 = 5/15= 0.33 and
when the price is equal to Rs. 20/unit than the value of the index of
monopoly power shall be = 20-10/20 = 10/20= 0.50
Only having a positive difference between price and marginal cost does
not guarantee profit, fixed costs could be very high which will result in
losses

Separation of Ownership and

Managerial Control
Historically, firms managed by founder-owners and descendants
Separation of ownership and managerial control allow shareholders to purchase
stock, entitling them to income (residual returns Income after all expenses)
Shareholder value reflected in price of stock
It implies that they take risk also - should the expenses be more than revenue

Small firms managers are high percentage owners, which implies less
separation between ownership and management control (even in US S&P 500
firms majority are family owned WalMart, Ford, Cargill, Comcast) India Reliance, Hero, AirTel, Bajaj, Birla
Family-owned businesses face two critical issues

1. As they grow, they may not have access to all needed skills to manage the
growing firm and maximize returns, so may need outsiders to improve
management
2. May need to seek outside capital (whereby they give up some ownership
control)

 Agency relationships
Relationships between business owners (principals) and
decision-making specialists (agents) hired to manage
principals' operations and maximize returns on investment
Principals are specialists Risk Bearers and Agents
(Professional Managers) are specialist Decision Makers
This presents best combination for highest returns for
owners
Managerial Opportunism - seeking self-interest with guile
(i.e., cunning or deceit)
Opportunism: an attitude and set of behaviors
Stockholders dont know which agent will enact managerial
opportunism

Principals establish governance and control

mechanisms to prevent agents from acting
opportunistically

 Agency problems: M&A

Can result in two managerial benefits shareholders dont enjoy
1. Increase in firm size
2. Firm portfolio diversification which can reduce top executives
employment risk (i.e., job loss, loss of compensation, loss of power and loss
of managerial reputation)

M&A reduces these risks because a firm and its managers are less
vulnerable to the reduction in demand associated with a single or
limited number of product lines or businesses

Agency problems: Firms free cash flow

Resources remaining after the firm has invested in all projects that
have positive net present values within its current businesses
Available cash flows
Managerial inclination to overdiversify
Shareholders may prefer distribution as dividends, so they can control how
the cash is invested