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AFM Unit 4
AFM Unit 4
Quadrant 3 Take the formative assessment for “Unit 4: Mergers and Acquisition”
eAssessment After the live session, repeat the formative assessment for “Unit 4:
Mergers and Acquisition” for self-assessment
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Mergers and Acquisition
Unit : 4
Harsh Singh
M&A as a method of corporate expansion
A merger is the combining of two or more companies
Generally by offering the stockholders of one company securities in the acquiring company
in exchange for the surrender of their stock.
An acquisition normally involves a larger company (a predator) acquiring a smaller
company (a target).
A demerger involves splitting a company into two separate companies which would then
operate independently of each other. The equity holders in the company would continue to
have an equity stake in both companies.
An alternative approach is that a company may simply purchase the assets of another
company rather than acquiring its business, goodwill, etc.
Types of merger
The arguments put forward for a merger may depend on its type:
• Horizontal integration
• Vertical integration
• Conglomerate integration
Reasons for mergers and takeovers
Operating economies
Elimination of duplicate facilities and many other ways.
Management acquisition
Acquisition of competent and go-ahead team to compensate for lack of internal
management abilities.
Diversification
Securing long-term future by spreading risk through diversification.
Reasons for mergers and takeovers
Revenue synergy:
- which result in higher revenues for the combined entity,
- higher return on equity and
- a longer period when the company is able to maintain competitive advantage;
Cost synergy:-
which result mainly from reducing duplication of functions and related costs, and from
taking advantage of economies of scale;
Synergy
Cost synergy:
Sources of which include:
o Economies of scale (arising from eg larger production volumes and bulk buying);
o Economies of scope (which may arise from reduced advertising and distribution costs
where combining companies have duplicated activities);
o Elimination of inefficiency;
o More effective use of existing managerial talent.
Financial synergy:- which result from financing aspects such as the transfer of funds
between group companies to where it can be utilised best, or from increasing debt capacity.
Synergy
Financial Synergy sources of which include:
o Elimination of inefficient management practices;
o Use of the accumulated tax losses of one company that may be made available to the
other party in the business combination;
o Use of surplus cash to achieve rapid expansion;
o Diversification reduces the variance of operating cash flows giving less bankruptcy
risk and therefore cheaper borrowing;
o Diversification reduces risk (however this is a suspect argument, since it only reduces
total risk not systematic risk for well diversified shareholders);
o High PE ratio companies can impose their multiples on low PE ratio companies
(however this argument, known as “bootstrapping”, is rather suspect).
High failure rate of acquisitions
Reasons:
Agency theory suggests that takeovers are motivated by the self-interest of the acquirer's
management.
Poor man-management can be detrimental to successful integration. Lack of
communication of goals and future prospects of employees can lead to employees being
unclear of what is expected of them.
Window dressing can be also a reason for the high failure rate. It is where companies are
not acquired because of the synergies that they may create, but in order to present a better
financial picture in the short term.
Paying too much
Lack of industrial or commercial fit
FORMS OF CONSIDERATION
• Cash
• Share Exchange
• Earn out
Reverse mergers allow a private company to become public without raising capital, which
considerably simplifies the process. It saves time from many months to just a few weeks
The reverse merger only converts a private company into a PLC, so is less dependent on
market conditions (because the company is not proposing to raise capital).
Reverse Takeover
Benefits as a Public Company
• Due diligence needed on shell of the PLC company - no pending liabilities etc
• Risk of current shareholders selling / dumping their shares on the market and the
price falling
• Will there be demand for the shares once public?
• Inexperienced managers in regulatory and compliance requirements of a publicly-
traded company.
Regulatory Framework
At the most important time in the company’s life – when it is subject to a
takeover bid – its directors should act in the best interest of their
shareholders, and should disregard their personal interests.
All shareholders must be treated equally.
Shareholders must be given all the relevant information to make an
informed judgement.
The board must not take action without the approval of shareholders,
which could result in the offer being defeated.
All information supplied to shareholders must be prepared to the highest
with standards of care and accuracy.
The assumptions on which profit forecasts are based and the accounting
polices used should be examined and reported on by accountants.
An independent valuer should support valuations of assets
Conduct of Takeover
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