Mergers- in the nature of acquisitions and amalgamations.

types of merger motives behind mergers theories of mergers operating, financial and managerial synergy of mergers value creation in horizontal, vertical and conglomerate mergers internal and external change forces contributing to M & A activities

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 Absorption

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.

An absorption is a combination of two or more companies into an 'existing company'. All companies except one lose their identity in such a merger. For example, absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring company (a buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist. TFL transferred its assets, liabilities and shares to TCL.

Focus on core strength Consolidation and economy of scale 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

Horizontal Mergers and Acquisition Vertical M&A: Conglomerate M&A

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. 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.

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 Merger of Oriental Bank of Commerce and GTB Tata Industrial Finance Ltd. With Tata Finance Ltd.

When a firm acquire its upstream from it to or firms downstream, 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.

For example, the merger of Reliance Petrochemicals Ltd with Reliance industries is an example of vertical merger with back ward linkage as far as RIL is considered Similarly, if a cement manufacturing company acquires a company engaged in civil Construction it will be a case of vertical acquisition with forward linkage.

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.

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 firms stock are less than the value of firms 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.

Tata Steels mega takeover of European steel major Corus for $12.2 billion. The biggest ever for an Indian company. This is the first big thing which marked the arrival of India Inc on the global stage. Vodafones purchase of 52% stake in Hutch Essar for about $10 billion. Essar group still holds 32% in the Joint venture. Hindalco of Aditya Birla groups acquisition of Novellis for $6 billion. Ranbaxys sale to Japans Daiichi for $4.5 billion. ONGC acquisition of Russia based Imperial Energy for $2.8 billion.

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NTT DoCoMo-Tata Tele services deal for $2.7 billion. The second biggest telecom deal after the Vodafone.
HDFC Bank acquisition of Centurion Bank of Punjab for $2.4 billion. Tata Motors acquisition of luxury car maker Jaguar Land Rover for $2.3 billion. Wind Energy premier Suzlon Energys acquistion of RePower for $1.7 billion. Reliance Industries taking over Reliance Petroleum Limited (RPL) for 8500 crores or $1.6 billion.

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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

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.

The following are the synergy in the form of financial benefits available in the case of merger.

Better credit worthiness Reduces the cost of capital Increases the debt capacity Increases the P/E ratio & Value per share Low flotation costs Rising of capital

The strategic motives behind M&A are as follows Expansion and growth Dealing with the entry of MNCs Economies of scale Market penetration: entry into the new market becomes with new and innovative products. Market leadership Backward/Forward integration

New product entry New market entry: Surplus funds Minimum size Risk reduction Balancing the product cycle Arresting downward trend Growth and diversification strategy

Deployment(Arrangement) of surplus funds Funds raising capacity Market capitalisation Tax planning Creation of shareholders value Operating economies Renewal of sick units

Asset stripping: if the market value of shares of a company is quoted below the real and true net worth of a company, it will be a target for acquisition. Under valuation of Target Company Increasing the EPS

Superior management Retention of managerial talent Removal of inefficient management

Growth orientation Access to inputs Unique advantage Defensive strategy Client needs

I. Efficiency theories A. Differential managerial efficiency B. Inefficient management C. Financial Synergy D. Operating synergy E. Pure diversification F. Strategic realignment (shift) to changing environments I. Undervaluation

II. Information and signaling III. Agency problems and managerialism IV. Free cash flow hypothesis V. Market power VI. Taxes VII. Redistribution. VIII. Hubris Hypothesis or Winners Curse X. Q-Ratio X. Other motives

Efficiency theory of mergers suggest that M & A provide mechanism by which capital can be used more efficiently & that the productivity of the firm can be increased through economies of scale. These theories can be further divided as:

It says that more efficiency firms will acquire less efficient firms and realize (understand) gains by improving their efficiency. This implies excess managerial capabilities in the acquiring firm. Ex: if the mgt of firm A is more efficient than the mgt of firm B. If firm A acquires firm B, the efficiency of firm B is brought up to the level of efficiency of firm A, efficiency is increased by merger. This would be a social gain as well as a private gain. Differential efficiency theory is more likely to be a basis for horizontal mergers.

Inefficient mgt is simply not performing up to its potential. Another control group might be able to manage the assets of this area of activity more effectively (i.e., mgt that is unskilled in an absolute sense). Inefficient management theory could be a basis even for mergers b/w firms with unrelated business.

Synergy refers to the type of reaction that occur when two body or factors combine to produce a greater effect together than that with the sum of the two operating independently could account for. It refers to the phenomenon 2+2=5. FINANCIAL SYNERGY The impact of a corporate merger or acquisition on the costs of capital to the acquiring or the combined firm refers to financial synergy.

Financial synergy occurs as a result of the lower costs of internal financing versus external financing. A combination of firms with different cash flow positions and investment opportunities may produce a financial synergy and achieve lower cost of capital.

This theory assumes that economies of scale do exist in the industry and that prior to the merger, the firms are operating at levels of activity that fall short of achieving the potentials for economies of scale. Ex: one firm might be strong in cash but weak in marketing while another has strong marketing department without the R&D capability. Merging the two firms would result in operating synergy. Vertical integration is one area in which operating economies may be achieved.

Impact of merger or acquisition on the reduced cost of managing the firm. Some mergers/acquisitions are benefited due to the fact that the acquirers management can better manage the targets resources. It is based on the assumption that two firms have different levels of managerial competence. In the case of conglomerate merger, economies are realized only through management efficiency.

Diversification of shareholders wealth through mergers along with the employees & managers of the company is termed as the pure diversification. Diversification of the firm provide managers and other employees with job security & opportunities for promotion and, other things being equal, results in lower labour costs. i.e., Firm-specific investment.

Diversification can increase corporate debt capacity and decrease the present value of future tax liability. Diversification can be achieved through internal growth as well as mergers

It says that mergers take place in response to the environmental changes. External acquisitions of needed capabilities allow firms to adopt more quickly and with less risk than developing capabilities internally. Strategic planning is concerned with the firms environments and population, not just operating decisions.

The strategic planning approach to mergers implies either the possibilities of economies of scale or tapping an under used capacity in the firms present managerial capabilities. By external diversification the firms acquirers mgt skills form needed augmentation (increase) of its present capabilities.

Undervaluation states that mergers occur when the market value of target firm stock for some reason does not reflect its true or potential value or its value in the hands of an alternative mgt. One cause of under valuation may be that mgt is not operating the co up to its potential. Second possibility is that the acquirers have inside information. Another aspect of under-valuation theory is the difference b/w the market value of assets and their replacement costs.

It attempts to explain why target shares seem to be permanently re valued ---- in a tender offer whether or not it is successful. The information hypothesis says that the tender offer sends a signal to the market that the target shares are undervalued or alternatively the offer signals information to target mgt., which inspires them to implement a more efficient strategy on their own.

It may result from a conflict of the interest b/w managers & shareholders or b/w shareholders & debt holders. A number of organisatin & market mechanisms serve to discipline self-serving managers & takeovers are viewed as the discipline of last resort.

It says that takeover take place because of the conflicts b/w managers & shareholders over the pay out of free cash flows. Hypothesis assumes that free cash flow should be paid out to share holders reducing the power of mgt & subjecting managers to the security of the public capital markets more frequently.

It claims that merger gains are the result of increased concentration leading to involvement & monopoly effects. 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. Merger or acquisition is effected (resulted) to enter into new market or territory. Example: Whirlpool entered into Indian market through acquiring controlling stake of 51% in

Hubris is an animal with spirit of overconfidence 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 companys worth. Excess premium paid for the target company benefits its shareholder but the shareholders of the acquiring company suffer a reducing in their wealth.

Q ratio is defined as the ratio of the market value of the acquiring firms stock to the replacement cost of its assets. Mergers are undertaken when the market value of the company is less than the replacement cost of its assets. Generally the increasing inflation rate causes the replacement of the assets too costlier. In such a situation mergers or acquisition is the cheapest route of possessing the assets

Personal reasons: Mergers and acquisition may also take place out of personal feeling, whims and fancies of the controllers of large concern. An entrepreneur desiring to build up an empire may go for merger. Compulsion by the Government: Government imposes compulsion on some companies to merge with other firms in the interest of public u/s 396 of the Companies Act, 1956. Surplus liquidity: A cash surplus company can invest in another company by way of acquiring controlling stake in it.

Regulatory Change: Deregulation enabled to remove all artificial barriers in the industries such as financial services, telecommunications etc. and resulted in to increased competition. Such increased competition made the firms to effect mergers or acquisitions.

Technological changes (technological requirements of firm has increased) Economies of scale and complimentary benefits (growth opportunities among product areas are unequal) Opening up of economy or liberalization of economy Global economy (increase in competition) Deregulation New industries were created. Negative trends in some economies.

Favorable economic & financial conditions (real time financial planning and control information requirements have increases). Widening inequalities in income & wealth High valuation on equities. Requirement of human capital has grown relative to physical assets. Increase in new product line. Distribution and marketing methods have changed.

Declining sales or earning An uncertain future Owens do not find successor in sight Desire to maximize growth under the umbrella of a large company Lack of adequate financial and management skills To concentrate time and effort on what it can do best.

Poor integration strategies Key employees leaving Lack of compelling strategic rationale Acquiring company did not do sufficient due diligence Poor internal and / or external communications Corporate culture clashes Premium paid for the company was too high Unrealistic expectation of possible synergies