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3.1 INTRODUCTION

MA-NA6JEMeN -r SEMl[ UN1T

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The corporate world is undergoing a paradigm shift, from expansion and

diversification to ever-increasing mergers and acquisitions (M&As). Merger waves
began in 1883 following the depression that ended that year. The first merger
wave came about due to the economic expansion that occurred at the time (www.
learnmergers.com). The initial trend was dominated by a few 'mega' deals involving
. corporate giants. However, today the whole picture is undergoing a sea change.
Companies have started realizing that in the increasingly competitive, changing,
and challenging environment, M&As can boost the value of their businesses.
Mergers and acquisitions have become a strategic tool that is being effectively
used to acquire established brands and to expand to emerging and often low cost
markets, particularly markets that provide an enormous number of skilled workers.
They help counter competition, acquire new consumers, get a technological
edge, improve bottom lines, etc. It is no wonder then that the corporate world
is fast realizing that M&As are here to stay.

3.2 CONCEPT OF MERGER

A merger is a tool used by companies to increase their long-term profitability
by expanding their operations. Mergers are carried out with mutual consent
between the two companies merging with each other. The company buying the

Mergers and Arquisitions - 81

other company is called the merged or surviving entity, and the one merging
with it is called the merging entity.
A merger is thus a strategy where two or more companies agree to combine their
operations. Once the merger happens, one company survives and the other loses
its corporate identity. The surviving company acquires all the assets and liabilities
of the merging company. It either retains its identity or is re-christened.
The simplest definition of merger is,' a combination of two or more businesses
into one business'. Laws in India use the term 'amalgamation' for merger. The
Income Tax Act, 1961 [Section 2( lA)] defines an amalgamation as the merger
of one or more companies with another, or the merger of two or more compa
nies to form a new company, in such a way that all assets and liabilities of the
amalgamating companies become the assets and liabilities of the amalgamated
company. Shareholders holding not less than nine-tenths in value of the sha.res
in the amalgamating company or companies become shareholders of the amal
gamated company (Income Tax Act, 196l Bare Act).
Thus, as described in the act, mergers or amalgamations may take two forms
(www.business.gov.in), as described in Sections 3.2.1 and 3.2.1.

3.2.1 Merger through Absorption

Absorptiq:qj .<:t combination of two or more companies into an 'existing com
pany'. All companies except one lose their identity in such a merger. For example,
in the absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd (TCL),
TCL, an acquiring company/buyer, survived after the merger whereas TFL,
an acquired company/seller, ceased to exist. Tata Fertilizers Ltd transferred its
assets, liabilities, and shares to TCL.

3.2.2 Merger through Contolidation

Consolidation is a combination ofiwo or more companies into a 'new company'. In
this form of merger, all companies are legally dissolved and a new entity is created.
Here, the acquired comp ny transfers its assets, liabilities, and shares to the acquir
ing company. for cash or exchange of shares. For example, Hindustan Computers
Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd, and Indian
Reprographics Ltd merged into an entirely new company called HCL Ltd.
A fundamental characteristic of mergers, either through absorption or consoli
dation, is that the acquiring company, existing or new, takes over the ownership
of other companies and combines their operations with its own.
As per Accounting Standard 14 issued by ICAI in 1994 (Compendium of
AccouD.ting Standards, Accounting Standard 14), 'amalgamation' means an
amalgamation pursuant to the provisions of the Companies Act, 1956 or any
other statute that may be applicable to companies:
An amalgamation satisfies' all the following conditions:
After amalgamation, all the assets and liabilities of the transferor company
become the assets and liabilities of the transferee company.
Shareholders holding not less than 90% of the face valu e of the equity
.:oh areG o'f the transferor -compaLy (ather than the ec1u'ity :; ha re..; < lready held.

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Mergers and Acquisitions

therein, immediately before the amalgamation, !Jy the

transferee company, its subsidiaries, or their nominees)
become equity shareholders of the _trans feree company
by virtue of the amalgamation.
The consideration for the amalgamation receivable by those
equity share
holders of the transferor company who agree to become
equity shareholders of the transferee company is
discharged by the transferee company wholly by the
issue of equity shares in the transferee company,
except that cash
may be paid in respect of any fractional shar s.
The business of the transferor company is intended to be
carried on, after
the
amalgamation,
by
thetransferee corr.pany. _
No adjustment is intended to be made to the book
values of the assets and liabilities of the transferor
company when they are incorporated in the financial
statements of the transferee company, except to ensure
uniformity of accounting policies.
The principal idea behind M&As is to create shareholder
value that is over and above the sum of the two merging
companies. This is achieved by creating a more competitive
and cost-efficient company by gaining greater market
share.

3.6 CONCEPT OF ACQUISITION

D cquisition is an attempt made by one firm to gi!l

a_m.aj.o.rity_in.te.t:est...i.FHtFH)ther jirm. ll:ieiirnr
atternpt1ngrogatrnrmajority1-;;terest is called the acquiring firm
anatlR-other .fim is called the target firm. Once the acquisition is completed ,

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Mergers and Acquisitions

93

the acquiring firm becomes the legal owner and controller

of the business of the target firm. The acquiring firm pays
for the net assets, goodwill, and brand name of the
company bought.
Acquisitions are actions through which companies seek
to achieve economies of scale, increased efficiency, and
enhanced market visibility. In an acquisition, unlike in a
merger, there is no exchange of stock or consolidation as a
new com pany even though it involves one company
purchasing another.
Some prominent acquisitions include the following:
Google's largest acquisition in March 2008 when it
acquired DoubleClik, an advertising company
I\1ahindra & Mahindra's acquisition of 90% stake
in German company
Schoneweiss
Acquisition of Mumbai-based Ambit RSM by
PricewaterhouseCoopers' (PwC)
It is important to note that acquisitions may
lead to the following:
A subsequent merger
Establishment of a parent-subsidiary relationship
A strategy of breaking up the target firm and
disposing off part or all its assets
Conversion of the target firm into a private firm

3.1 0 DISTINCTION BETWEEN MERGERS AND ACQUISITIONS

People very often talk of mergers and acquisitions in the same breath and treat
them as synonyms. However, the two terms are slightly different. The differ
ences between a merger and an acquisition are important to value, negotiate,
and structure a client's transaction. Both mergers and acquisitions involve one
or multiple companies purchasing all or part of another company. The main
distinction between a merger and an ac(p.Jisition is how they are financed.
When a company takes over another company and establishes itself as a new
entity, the process is called acquisition. Here the target company ceases to exist
while the buyer company continues.
A merger, on the other hand, is a process where two entities agree to move
forward as a single entity as against remaining separately owned and operated
entities. Mergers are typically more expensive than acquisitions, with the parties
incurring higher legal costs.
The stock of the acquiring company continues to be .traded in an acquisition,
whereas in case of a merger, the stocks of both the entities are surrendered and
the stocks of the new company are issued in its place.
In reality, one entity buys another and allows the acquired firm to proclaim
that the action is merger and not acquisition. This is done to ward off the nega
tivity often associated with acquisitions.
Very often, it is noticed that companies prefer mergers over acquisitions though
it may sound unusual. Some of the more frequently encountered reasons are as
follows (Mastracchio and Zunitch 2002):
A merger does not require cash.
A merger may be accomplished tax-free for both parties.

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Mergers and Acquisitions

A merger lets the target company realize the appreciation potential of th:.
merged entity, instead of being limted to sales proceeds.
A merger allows the shareholders of smaller entities to own smaller piece
of a larGe r pie, increasing their overall net worth.
A merger of a privately held company into a publicly held company allows
the target company shareholders to receive a public company's stock.
A merger allows the acquirer to avoid many of the costly and time-consuming
aspects of asset purchases, such as the assignment of leases and bulk-sales
notifications.
Merger is of consid rable importance when there are minority stockholders.
The transaction becomes effective and dissenting shareholders are obliged
to go along once the buyer obtains the required number of votes in support
of the merger.

One very often finds that sometimes the deal is very unfriendly- the
acquiring company manipulates events and forcefully takes over the target.
Such a deal is called a hostile takeover. It would therefore not be wrong to say
that a purchase is considered a merger or an acquisition on the basis of
whether the purchase is friendly or hostile, and how it is announced. However,
the fact remains that M&As are strategies targeted at synergy.

3.11 MOTIVES BEHIND MERGERS AND ACQUISITIONS

While one often hears CEOs saying that M&As are inspired by a desire to diversify
or achieve higher growth rate, the reasons could be varied. Some of the com
monly identified reasons are as follows:

3.11.1 Synergy
Synergy \s the most essential component of mergers. In mergers, synergy
between t'he participating firms determines the increase in value of the com
bined entity. In other words, it refers to the difference between the value of
the combined firm and the value of the sum of the participants (Damodaran
Aswath 1997). Synergy accrues in the form of revenue enhancement and cost
savings. For example, if firms A and B merge and the value of the combined
entity- V(AB)- is expected to be greater than (VA+ VB), the sum of
the independent values of A and B, the combined entity is said tbe
benefitting through synergy.
Synergy can take the following forms:
This refers to the cost savings that'come through economies
. of scale - -::>r i creased sales and profits. It leads to the overall growth of the firm
(Damodaran 1997).
Operating synergy

This is the direct result of financial factors such as lower

taxes, higher debt capacity or better use of idle cash (Damodaran 1997). When a
firm with accumulated losses or unabsorbed depreciation merges with a profitable
Financial synergy

Mergers and Acquisitions

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firm and the combined firm can set off such losses against its profits, a
financial synergy, kn as tax sh_ield, occurs. The following are some
examples:
'" en HUL acquired Lakme, it helped HUL to enter the cosmetics
market
-"' through an established brand.
When Glaxo and Smithkline Beecham merged, they not only gained
market share, but also eliminated competition between each other.
Tata Tea acquired Tetley to leverage Tetley's international
marketing strengths.

3.11.2 Acquiring
Technology

New

To remain competitive, companies need to constantly upgrade their

technology and business applications. To upgrade technology, a company
need not always acquire technology. By buying another company with
unique technology, the buying company can maintain or develop a
competitive edge. A good example is a merger of a logistics company
such as a land transport entity with an air line cargo company. Another
example is a merger between Blackberry and Treo which can
incorporate cell phone capability and email connectivity in one
device; palm pilots and tablet laptops can provide benefits to both
the entities.

3.11.3
Improved
Profitability
Companies explore the possibilities of a merger when they anticipate that
it wili improve their profitability. The results of the International
Business Owners Survey, 2004, carried out by Grant Thompson,
conducted across 26 countries in E rope, Africa, Asia-Pacific, and the
US, showed that 34 /o of businesses use M&A to maintain or improve
profitability. For example, European Media Group Bertelsmann, Pearson,
and others have driven their growth by expanding into the US through
M&As.

3.11.4 Acquiring
Competency

Companies also opt br M&As to acquire a competency or capability that

they do not have, and which the other firm does. For example, the
ICICI-II_9 alliance made the retailer network and depositor base
available to t'tl'e" ging entity. Similarly, IBM merged with Daksh for
acquiring competencies that thlatter possessed.

3.11.5 Entry into New

Markets
Mergers are often looked upon as a tool for hassle-free entry into new
markets. Under normal conditions, a company can enter a new market,
but may have to face stiff competition from the existing companies and
may have to battle out for a share in the existing market. However, if the
merger route is adopted, one can enter the market with gpeater ease and
avoid too much competition. For example, the merger of Orange, Hutch,
c.nd Vodafone took place to achieve this objer.tive.

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Mergers and Acquisitions

3.11.6 Access to Funds

Often a company finds it difficult to access funds from the capital market. This
weakness deprives the company of funds to pursue its growth objec tives effec
tively.Jn such cases; a Company may decide to merge with another company
that is viewed as fund-rich. For example, TDPL merged with Sun Ph;:rrmasince
TDPCdid not have funds to launch new produ cts.

3.11.7 Tax Benefits

Merge rs are also adopted to reduce tax liabiliti es. By merging w t _l()SS-making
e ntity, a compy with a high tax liability tan set off the acc umulated losses of
the target ag;J'nst its profits, gaining tax befits. F.or exa mple, Ashok -Leyland
InforJTiation Teclih6iogy-(ALIT) was acquired by Hinduja Finance, a group
company, so that it could set off the accumulated losses in ALIT's books against
its profits.

3.13 REASONS FOR FAILURE OF MERGERS AND ACQUISITIONS

While there is often a great hype when a merger or acquisition is announced, the
end result is not always positive. Quite often, M&As destroy rather than add value
to the acquirer's business. The most common reasons for failure are as follows. -

(.::\"" } 3.13.1 Unrealistic Price Paid for Target

........_:,.,; The process of M&A involves valuation of the target company and paying a
price for taking over the assets of the company. Quite often, one finds that the
price paid to the target company is much more than what should have been paid.
While the shareholders of the target company stand benefited, the shareholders
of the acquirer end up on the losing side. This is because they have to carry the
burden of the overpriced assets of the target company which dilutes the future
earnings of the acquirer. Having bid over-enthusiastically; the buyer may find
that the premium paid for the acquired company's shares (the so-called 'winner's
curse') wipes out any gains made from the acquisition (HenrY2002).
This phenomenon is generally noticed in the later years when the acquirer has
to revalue the assets and write of goodwill booked at the time of l\1&A.

3.13.2 Difficulties in Cultural Integration

Every merger involves combining of two or more different entities. These enti
ties tef1ect different corporate cultures, styles of leadership, differing employee
expectations and functional differences. If the merge r is implemented in a way
that does not deal sensitively with the companies ' p eople and their different
corporate cultures, the process may turn out to be a disaster. There may be
acute contrasts between the attitudes and values of the two companies, especially

I 14 Mergers and Acquisitions

if the new partnership crosses national boundaries.

While the process is being executed,
these
differences are known but often ignored. As years
pass by and the combined entity tries to synergize
the operations, these differences surface and often
lead to failure of the merger. For example, the
merger of Daimler Benz with Chrysler. While
Daimler-Benz's culture stressed on a more formal
and structured management style, Chrysler favoured
a more relaxed, freewheel ing style.

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Mergers and acquisitions are looked upon as an

important instrument of creating synergies through
inoreased revenue, reduced costs, reduction in net
working capital and improvement in the investment
intensity. Overestimation of these can lead to failure
of mergers.

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Companies very often face integration difficulties,
i.e., the combined entity has to adapt to a new set of
challenges given the changed circumstances. To

dothis, the company prepares plans to integrate the

operations of the combining enti ties. If the
information available on related issues is inadequate
or inaccurate, integration becomes difficult.

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Mergers and acquisitions that are driven by sound business

strategies are the

ones that succeed. Entities that fail to assess the
strategic benefits of mergers face
failure. It is therefore important to understand the
strategic intent. This has been discussed later in the
chapter.

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Mergers and acquisitions also fail when the products
or services of the merging entities do not n,aturally fit
into the acquirer's overall business plan. This delays
efficient and effective integration and causes failure. For example,
the decision
3.
of HUL to take over the
business
of
Modern
Bakery.

3.1
3.1
Ina
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Due
Dili

gen
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Due diligence is a crucial component of the M&A
process as it helps in detecting financial and business
risks that the acquirer inherits from the target
company. Inaccurate estimation of the related risk
can result in failure of the merger.

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One of the ost crucial. elements of an effective
acquisition strategy is planning how one intends to
finance the deal through an ideal capital
structureThe acquirer may decide to acquire the
target through cash. To pay the price of
acquisition, the acquirer may borrow heavily from
the market. This creates a very high leveraged
structure and increases the interest burden of the
company.