Mergers and Acquisition

Meaning of M & A
Merger
• The combination of two firms into a new legal entity
• A new company is created
• Both sets of shareholders have to approve the
transaction.

Acquisition
A transaction where one firm buys another firm with
the intent of more effectively using a core competence
by making the acquired firm a subsidiary within its
portfolio of businesses

Takeover
An acquisition where the target firm did not solicit the
bid of the acquiring firm
 Set of objectives for M & A
• Acquire domain knowledge and technology
• Acquire market share and brand name
• Acquire products or IPR or some other valuable
assets
• Diversify for balance portfolio & less
concentration in a single industry or market
segment
• Competition can be reduced by acquiring your
competitors
• Growth by acquiring additional revenue, profit
and asset base
• Create synergy between different business
areas

– The set of objectives to align with the company’s

long-term plan and the existing operations
 Types of merger
1. Horizontal
• A merger in which two firms in the same industry combine.
• Often in an attempt to achieve economies of scale and/or scope.

2. Vertical
• A merger in which one firm acquires a supplier or another firm that
is closer to its existing customers.
• Often in an attempt to control supply or distribution channels.

3. Conglomerate
• A merger in which two firms in unrelated businesses combine.
• Purpose is often to ‘diversify’ the company by combining
uncorrelated assets and income streams
Motivations for Mergers and Acquisitions
Creation of Synergy Motive for M&As

The primary motive should be the creation of

synergy.

Synergy value is created from economies of

integrating a target and acquiring a company;
the amount by which the value of the
combined firm exceeds the sum value of the
two individual firms.
 Creation of Synergy Motive for M&As
Synergy is the additional value created (∆V) :

[ 15-1] 
VV
AT A
-(V V
T)

Where:
VT = the pre-merger value of the target firm
VA T = value of the post merger firm
VA = value of the pre-merger acquiring firm
 Value Creation Motivations for M&As
Operating Synergies

Operating Synergies
1. Economies of Scale
• Reducing capacity (consolidation in the number of firms in the industry)
• Spreading fixed costs (increase size of firm so fixed costs per unit are
decreased)
• Geographic synergies (consolidation in regional disparate operations to
operate on a national or international basis)
2. Economies of Scope
• Combination of two activities reduces costs
3. Complementary Strengths
• Combining the different relative strengths of the two firms creates a firm
with both strengths that are complementary to one another.
 Value Creation Motivations for M&A
Efficiency Increases and Financing Synergies

Efficiency Increases
– New management team will be more efficient and add
more value than what the target now has.
– The combined firm can make use of unused
production/sales/marketing channel capacity
Financing Synergy
– Reduced cash flow variability
– Increase in debt capacity
– Reduction in average issuing costs
– Fewer information problems
 Value Creation Motivations for M&A
Tax Benefits and Strategic Realignments

Tax Benefits
– Make better use of tax deductions and credits
• Use them before they lapse or expire (loss carry-back, carry-forward
provisions)
• Use of deduction in a higher tax bracket to obtain a large tax shield
• Use of deductions to offset taxable income (non-operating capital losses
offsetting taxable capital gains that the target firm was unable to use)

Strategic Realignments
– Permits new strategies that were not feasible for prior to the
acquisition because of the acquisition of new management skills,
connections to markets or people, and new products/services.
Managerial Motivations for M&As
Managers may have their own motivations to pursue M&As. The two
most common, are not necessarily in the best interest of the firm or
shareholders, but do address common needs of managers
1. Increased firm size
– Managers are often more highly rewarded financially for building a
bigger business (compensation tied to assets/value creation for the firm)
– Many associate power and prestige with the size of the firm.

2. Reduced firm risk through diversification

• Managers have an undiversified stake in the business (unlike
shareholders who hold a diversified portfolio of investments and don’t
need the firm to be diversified) and so they tend to dislike risk (volatility
of sales and profits)
• M&As can be used to diversify the company and reduce volatility (risk)
that might concern managers.
 Theories of Mergers
• Efficiency theories
– Differential managerial efficiency
– Inefficient management
– Operating synergy
– Pure diversification
– Strategic realignment to changing environment
– Undervaluation
 Theories of Mergers
• Information and signaling
• Agency problems and managerialism
– Takeovers as a solution to Agency problems
– Hubris Hypothesis
• Free cash flow hypothesis
– Statements of Hypothesis
– Evidence on the FCFH
• Market power
• Taxes
• Redistribution
 Differential Efficiency
• If the management of firm A is more efficient
than the management of firm B and if after
firm A acquires firm B, the efficiency brought
up to the level of efficiency of firm A
• Excess managerial capacity can be utilized in
acquiring other firms
 The role of the industry life cycle
 There are four stages ;
The development stage
The growth stage
The maturity stage
The decline stage