Introduction to M & A

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Meaning of Merger: Merger is defined as a combination two or
more companies into a single company where one survives and
others loose their corporate existence. The survivor acquires the
assets and liabilities of the merged company.
In other words, when the shareholder of more than one company,
usually two, decides to pull the resources of the companies under
a common entity it is called Merger.
 The merger activity can be categorised into:
 Amalgamation: Amalgamation/Triangular Merger: It is a
situation where, usually two companies carrying on similar types
of business comes together and form a new company. In such a
company old companies are liquidated and new company is
formed to takeover the business of liquidated companies.

 Absorption: In case of absorption, usually one company

(usually financially stronger one) acquires or purchases the
business of another company (usually financially weaker one).
Here only one company which has been acquired will lose its
existence.
Dr. Praveen Kr.Sinha, Assocate Professor,
DSATM
Objectives of M & A Deals
 Focus on core strength, operational synergy and efficient
allocation of managerial capabilities and infrastructure.
 Consolidation and economy of scale by expansion and
diversion to use extended domestic and global markets.
 Capital restructuring by appropriate mix of loans and
equity funds to reduce the cost of servicing and
improving return on capital employed.
 Acquiring constant supply of raw materials and access to
scientific research and technological developments.
 Focus of research and development to reap the fruits of
innovation and new technological developments.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Categories or Types of Mergers
Horizontal Mergers and Acquisition
 When two or more corporate firms dealing in similar lines of activity combine
together then horizontal M&A takes place.
 The purpose of horizontal merger is elimination or reduction in competition,
putting an end to price cutting, economies of scale in production, research and
development, marketing and management etc.
 A horizontal M&A is one that takes place between two companies which are
essentially operating in the same market. Their products may or may not be
identical
 The horizontal M&A takes between business competitors who are
manufacturing, selling, distributing the similar type of products or rendering
similar type of service for profit.
 Horizontal M&A results in reduction of competitors in the same industry.
 This type of M&A enables to derive the benefits of economies of sale and
elimination of competition.
 But this may increase the monopolistic tendency in the market.
 Examples:
 Merger of Tata Oil Mill Company Ltd with Hindustan Lever Ltd is a horizontal
merger. Both the companies were operating in the same markets.
 Merger of Centurion Bank and Bank of Punjab
Dr. Praveen Kr.Sinha, Assocate Professor,
 Merger
DSATM of Oriental Bank of Commerce and GTB

 Vertical M&A:
 When a firm acquire its upstream from it to or firms down
stream, then the vertical merger occurs. In the case of
upstream type of merger, it extends to the supplier of raw
materials and in case of down stream type of merger; it
extends to those firms that sell eventually to the
consumer.
 The purpose of such merger is the lower buying cost of
materials, lower distribution costs, assured supplies and
market.
 A vertical merger is one in which the company expands
backwards and forward in the direction of ultimate
consumer.
 Thus in a vertical M&A, there is merging of companies
engaged in different stages of production cycle within the
same industry.
 For example, the merger of Reliance Petrochemicals Ltd with
Reliance industries
Dr. Praveen is anProfessor,
Kr.Sinha, Assocate example of vertical merger with
DSATM
back ward linkage as far as RIL is considered
Conglomerate M&A
 In market contrast, conglomerate M&A is a type of
combination in which an established firm in one industry
combines with another firm in another unrelated industry.
Such M&A moves for diversification of risk constitutes
rationale. In a conglomerate M&A, the concerned
companies are in totally unrelated lines of business.
 For example: Mohta steel industries limited merged with
Vardhaman Spinning Mills Ltd. Conglomerate M&A are
expected to bring about stability of income and profits.
 Bishnauth Tea Co. Ltd. with Eveready Industries Ltd.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Other forms of M&A:

 Strategic M&A: A strategic acquisition involves operating

synergies i.e. tow firm are more profitable than combined.
 Financial M&A: the bidder usually believes that the prices of
the firm’s stock are less than the value of firm’s assets.
 Downstream M&A : Merger of a parent company with its
subsidiary is called Down Stream merger.
 Up Stream Merger: Merger of subsidiary company with its
parent company is called Up Stream merger.
 Short-form Merger: Merger of a subsidiary company with its
parent company where the parent owns substantially all of the
shares of the subsidiary. It is less expensive and less time
consuming than the normal type of merger.
 Cash Merger: A merger in which certain shareholders are
required to accept cash for their shares while other shareholders
receive shares.
Dr. Praveen Kr.Sinha, Assocate Professor,
DSATM
Motives for M&A
The M&A activities are as a result of factors and
strategies, which are classified under the following four
heads.
 Synergy
 Strategic motives
 Financial motives
 Organisational motives

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
Synergy
If the resources of one company are being capable of merging with the
resources of another company effortlessly, resulting in higher productivity
in both the units, it is a case of synergy. The combined effect of two or
more courses of action is greater than the sum of individual companies.
For example, if the technical manpower in one unit can exploit the modern
machines in another organisation, it will be fruitful to both the
organisations. Symbolically the synergy can be stated as follows
 
{V (A) +V (B)<V (AB)
Where V (A) = independent value of company A
 V (B) = independent value of company B
 V (AB) = value of the merged entity.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
Strategic Motives:
Expansion and growth: If allowed by the government, expansion and growth through M&A is
less time consuming and more cost effective.
Dealing with the entry of MNCs: Merger or joint venture is a possible strategy for survival
with the arrival MNCs. It may be very difficult to beat the MNCs without strategically aligning
with them.
Economies of scale: The bigger is always thought to be better in the industrial era. Pooling of
the resources definitely bring about the economies of scale.
Market penetration: entry into the new market becomes with new and innovative products.
New product entry: entering into a new product market is a time consuming effort.
Companies with adequate resources will do well in new product market through M&A.
New market entry: advertisements and promotional activities will be more cost effective if the
organisation has presence in many places. Taking away a new market from a competitor will be
costly affair. M&A may provide this advantage.
Balancing the product cycle: combining with a complementary industry to compensate for the
fluctuation in a product life cycle might be good strategy. If the main product is seasonal – say
sugar- it will be beneficial to add another non-seasonal product say ceramics in the
organisation’s fold.
Arresting downward trend: if the trend in the industry is pointing a downward trend when
projected for the next five years, it is prudent to takeover the business belonging to a young and
potential industry.
Growth and diversification strategy: many companies look for takeover or merger with a
Dr.to
view Praveen
achieve Kr.Sinha, Assocate Professor,
growth, diversification and stability.
DSATM
Financial Motives:
Deployment(Arrangement) of surplus funds: The cash rich companies always
look around to takeover cash strapped companies with a view to arrange surplus
funds in investable projects.
Funds raising capacity: the increase in fixed assets and current assets base will
improve the funds raising capacity and more working capital finance can be sought
from the banks and financial institutions.
Market capitalisation: the rise in income of the target company increases the
earnings per share as well as market value of the share. This will result in increase of
market capitalisation.
Tax planning: the provisions of the corporate income tax might subsidise the M&A
activities and it may be possible to acquire a sick but potential company
economically.
Creation of shareholders value: the M&A transactions are resorted to create
shareholder value and wealth by optimum utilisation of the resources of both
companies.
Operating economies: the combinations will affect savings in overheads and other
operating costs and will help in increasing the profitability of the organisation.
Renewal of sick units: If a viable unit becomes sick, a healthy company may like to
merge it so as to reap the hidden benefits of the hidden potentials of the sick unit.
Dr. Praveen Kr.Sinha, Assocate Professor,
DSATM
Organisational motives:
 Superior management: By combining together the managerial
skills are also poled together.
 Retention of managerial talent: Human resources are considered
essential and important. To assure growth to the senior
management personnel in order to retain the management talent, it
may be required to attempt M&A.
 Removal of inefficient management: M&A is a quick remedy to
replace inefficient management from an organisation which has,
say, high product strength.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Theories of Firm

Agency
Agency problem
problem and
and
Efficiency Theories Managerialism
Managerialism
Free
Free Cash
Cash Flow
Flow hypothesis
hypothesis

Information
and Signaling
Synergy
Synergy Benefits
Benefits
Agency Problems
Market
Market Share
Share
Agency Problems

Differential Efficiency
Tax
Tax motives
motives
Diversification reason Managerialism
Diversification reason Managerialism

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Efficiency Theories

1. Differential Efficiency: Some firms operate below their potential. Such firms
are suitable to acquisition by other firms which are more efficient. For
example if the management of firm X is more efficient than the management
of the firm Y, and if firm X acquires firm Y, the efficiency of firm Y is likely to be
brought up to the level of firm X. However, a limitation is that it may result in
to the acquiring firm paying too much premium for the acquired firm due to
over optimism about improving the performance of the acquired firm.
2. Synergy benefits:It is based on the assumption that the value of a combined
firm is worth more than the value of the firms taken separately. (i.e. 2 + 2 = 5)
VAB = VA + VB + X
VA = Value of acquiring firm before merger
VB = Value of target firm before merger
VAB = Value of combined firm after merger
X = Present value of cash benefits resulting from merger
Types of Synergies:
 Operating Synergy
 Financial Synergy
Dr. Praveen Kr.Sinha, Assocate Professor,
 Managerial Synergy
DSATM
o Operating synergy is when the value and performance of
two firms combined is greater than the sum of the separate
firms apart and, as such, allows for the firms to increase
their operating income and achieve higher growth.
Operating economies are maximum in Horizontal merger
due to the reasons that duplicate facilities can be eliminated.
o Financial synergy: Impact of merger or acquisition on the
reduced cost of capital of acquiring firm or the newly formed
firm. A merged firm is able to take the advantage of new
financial opportunities because of the firm’s increased size of
capital base.
o Managerial Synergy (Theory of Managerial Efficiency):
Impact of merger or acquisition on the reduced cost of
managing the firm. Some mergers/acquisitions are benefited
due to the fact that the acquirer’s management can better
manage the target’s resources.
 It is based on the assumption that two firms have different
levels of managerial competence.
Dr. Praveen Kr.Sinha, Assocate Professor,
 InDSATM
the case of conglomerate merger, economies are
3. Firms indulge in diversification to overcome concentration risk (risk due to being
in one business).
 It helps to stabilize the firms earnings
 Greater the combination of the firms of independent business, the higher will be
the reduction in the business risk and greater will be the benefit of diversification
and vice versa.
 Merger between two unrelated firms would tend to reduce business risk, which in
turn, reduces the discount rate / required rate of return (i.e. K e) of the firm’s
earnings (as investors are generally risk averse) and thus, increases the market
value.
 Diversification benefit is found in conglomerate type of merger.
 Diversification into unrelated products in which the firm has no competitive
advantage should be avoided.
Example: Several investment banks (exposed to vagaries of stock market and have
highly volatile earnings) acquired asset management firms (having stable stream of
earnings) to reduce volatility of the earnings stream.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
Information and Signalling
The announcement of merger negotiations or a
tender offer may convey information or signals to
market participants that future cash flows are likely to
increase and that future values will increase.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
 Agency Problem and Managerealism
1. Agency Problems and Mismanagement: Mergers are undertaken to
correct situation where thee is a divergence between the goals of
management and owners.
2. Managerialism: Managers may increase the size of the firm through
mergers in the belief that their compensation determined by size. But in
practice management compensation is determined by profitability. The
basic premise of managerialism theory emphasizing size is in doubt.
3. Hubris Hypothesis or Winners Curse: Hubris is an animal with spirit of
arrogance and pride. Hubris hypothesis states that even though current
market value of the target firm reflects its true economic value, the bidder
believe that their own valuation of target firm is superior and tend to
overpay. The winner is cursed in the sense that he paid more than the
company’s worth. Excess premium paid for the target company benefits
its shareholder but the shareholders of the acquiring company suffer a
reducing
Dr. PraveeninKr.Sinha,
their wealth.
Assocate Professor,
DSATM
 Free Cash Flow hypothesis

1. Market Share: Mergers are undertaken to improve ability to set and maintain
prices above competitive level. Increase in the size of the firm is expected to result
in market power.
2. Tax motives
 Benefit of carry forward and set-off of unabsorbed business losses and depreciation u/s
72A
 Exemption of capital gain arising on the transfer of shares by the transferor company to
the transferee company u/s 44.
 Exemption from sales tax on the transfer of goods within the company.

Example:
 Absorption of Ahmedabad Cotton Mills Ltd. (ACML) by Arvind Mills (in 1979) resulted
into a tax benefit of Rs.2 crores in the next two years after merger. The ACML was closed
in 1977 due to labour problems and it had an accumulated losses of Rs.3.34 crores.
 Takeover of Sidhpur Mills by Reliance (in 1979) also resulted into tax benefit. Reliance
got the benefit of carry forward and setting-off of the accumulated losses of
Rs.2.47crores.
Dr. Praveen Kr.Sinha, Assocate Professor,
DSATM
MERGERS AND INDUSTRY LIFE CYCLE

Industry life cycle concept is used as a framework for indicating when

different types of mergers may have an economic basis at different stages of
an industry’s development.
Stage of Type of Merger
Industry Life
Cycle
Introduction Newly created firms may sell to outside larger firms in a
Stage mature or declining industry, thereby enabling larger
firms to enter a new growth industry. These result in
related or conglomerate mergers. The smaller firms
may wish to sell because they want to convert personal
income to capital gain and because they do not want to
place large investments in the hands of managers that
do not have a long record of success. Horizontal
mergers between smaller firms may also occur,
enabling such firms to pool management and capital
resources.
Exploitation Mergers during the exploitation stage are similar to
Stage mergers
Dr. Praveen Kr.Sinha, during
Assocate the introductory stage. The impetus for
Professor,
DSATM
such mergers is reinforced by the more visible
Stage of Industry Type of Merger
Life Cycle

Maturity Stage Mergers are undertaken to achieve economies of scale in

research, production, and marketing in order to match the low
cost and price performance of other firms, domestic or foreign.
Some acquisition of smaller firms by larger firms takes place for
the purposes of rounding out the management skills of the smaller
firms and providing them with a broader financial base.

Decline Stage Horizontal mergers are undertaken to ensure survival. Vertical

mergers are carried out to increase efficiency and profit margins.
Concentric mergers involving firms in related industries provide
opportunities for synergy and carry-over. Conglomerate
acquisitions of firms in growth industries are undertaken to utilize
the accumulating cash position of mature firms in declining
industries whose internal flow of funds exceeds the investment
requirements of their traditional lines of business

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM
Mergers & Acquisitions – a strategic
perspective
M&A activities should take place within the framework of long
range planning by business undertakings. M&A are the most popular
means of corporate restructuring or business combination. It is
believed that M&A are strategic decision leading to the maximisation
of company’s growth by enhancing its production and marketing
operations. The reasons why M&A activities are considered to be
strategic are:
 It includes huge amount of investment and the benefits are long term in nature.
 It concerned with maintaining or accelerating company’s growth.
 Enhancing profitability through cost reduction resulting from economies of scale,
operating efficiency and synergy.
 Diversifying the risks of the company, particularly when it acquires those businesses
whose streams are not considered.

Dr. Praveen Kr.Sinha, Assocate Professor,

DSATM