INTRODUCTION

 Merger and acquisitions are part of strategic

management of any business. It involves
consolidation of two businesses with an aim to
increase market share, profits and influence in the
industry. Mergers and Acquisitions are complex
processes which require preparing, analysis and
deliberation. There are a lot of parties who might be
affected by a merger or an acquisition, like
government agencies, workers and managers. Before
a deal is finalized all party needs to be taken into
consideration, and their concerns should be
addressed, so that any possible hurdles can be
avoided.
 MEANING OF MERGER
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.

A merger is a combination of two corporations

in which only one corporation survives and the
merged corporation goes out of existence.
 What is Consolidation?

Which is a business combination whereby two or more

companies join to form an entirely new company

 What's the difference between Merger and Consolidation?

A + B = A, where company B is merged into company A.

Is called Merger.
A + B = C, where C is an entirely new company. Is called
consolidation
 TYPES OF MERGER

Horizontal
Vertical
Conglomerate
 Horizontal Merger
 “Horizontal merger is a business consolidation that
occurs between firms who operate in the same space,
often a competitors offering the same good or
service”.
 A horizontal merger occurs when two competitors
combine. For example, in 1998, two petroleum
companies, Exxon and Mobil, combined in a $78.9
billion merger. If a horizontal merger causes the
combined firm to experience an increase in market
power that will have anticompetitive effects, the
merger may be opposed on antitrust grounds. In
recent years, however, the U.S. government has been
somewhat liberal in allowing many horizontal
mergers to go unopposed.
 Vertical Merger
A merger between two companies producing
different goods and services for one specific
product. A vertical merger occurs when two
or more firms, operating at different levels
within an industry’s supply chain, merge
operations. Most often the logic behind the
merger is to increase synergies created by
merging firms that would me more efficient
operating as one.
For example, in 1993, Merck, the world’s
largest drug company, acquired Medco
Containment Services, Inc., the largest
marketer of discount prescription medicines,
for $6 billion. The transaction enabled Merck
to go from being the largest pharmaceutical
company to also being the largest integrated
producer and distributor of pharmaceuticals.
 Conglomerate Merger
Conglomerate merger, a merger between
firms that are involved in totally unrelated
business activities.

One example would be Philip Morris, a

tobacco company, which acquired General
Foods in 1985 for $5.6 billion,
Conglomerate Merger are of two types:

Pure – The parties have absolutely nothing in

common.
Mixed – The parties seek to expand their
market regions, or to extend product
offerings.
 Product Extension Merger
By merging two companies that provide the same
products or services in the same market, the
resulting company benefits from the combining
of products and service of a greater share of
consumers.
For example , the merger of a company that
manufactures mobile phone handsets and a
company that manufactures Bluetooth hardware
and chipsets would result in higher and profits
for the resulting corporation.
 Market Extension Merger
The combination of two companies that
provide the same products or services, though
in different market regions, is referred to as a
“market extension merger”.
The resulting corporation would benefit from
a larger geographical market area and its
larger consumer base.
 THEORIES OF MERGER
EFFICIENCY THEORIES:

Differential efficiency theory.

Inefficient management theory.
Synergy.
Pure diversification.
Strategic realignment to changing environment.
Undervaluation.
DIFFERENTIAL EFFICIENCY:

 According to this theory if the management of firm

A is more efficient than the firm B and if the firm A
acquires firm B, the efficiency of firm B is likely to
be brought up to the level of the firm A.
 According to this theory, some firms operate below
their potential and consequently have low efficiency.
Such firms are likely to be acquired by other, more
efficient firms in the same industry. This is because,
firms with greater efficiency would be able to
identify firms with good potential operating at lower
efficiency. They would also have the managerial
ability to improve the latter’s performance.
 The theory implies that some firms operate below their
potential and as a result have below average efficiency.

 However, a difficulty would arise when the acquiring

firm overestimates its impact on improving the
performance of the acquired firm. This may result in the
acquirer paying too much for the acquired firm.
Alternatively, the acquirer may not be able to improve
the acquired firm’s performance up to the level of the
acquisition value given to it.
INEFFICIENT MANAGEMENT THEORY:

 The managerial synergy hypothesis or inefficient theory

is an extension of the differential efficiency theory. It
states that a firm, whose management team has greater
competency than is required by the current tasks in the
firm, may seek to employ the surplus resources by
acquiring and improving the efficiency of a firm, which
is less efficient due to lack of adequate managerial
resources. Thus, the merger will create a synergy, since
the surplus managerial resources of the acquirer
combine with the non-managerial organizational capital
of the firm.
 When these surplus resources are indivisible and
cannot be released, a merger enables them to be
optimally utilized. Even if the firm has no
opportunity to expand within its industry, it can
diversify and enter into new areas. However, since it
does not possess the relevant skills related to that
business, it will attempt to gain a ‘toehold entry’ by
acquiring a firm in that industry, which has
organizational capital alongwith inadequate
managerial capabilities.
SYNERGY

 Synergy refers to the type of reactions that occur

when two substances or factors combine to
produce a greater effect together than that which
the sum of the two operating independently could
account for.
 The ability of a combination of two firms to be
more profitable than the two firms individually.
 There are two types of synergy:
 Financial synergy.
 Operating synergy.
FINANCIAL SYNERGY:

 The managerial synergy hypothesis is not

relevant to the conglomerate type of mergers.
This is because, a conglomerate merger implies
several, often successive acquisitions in
diversified areas. In such a case, the managerial
capacity of the firm will not develop rapidly
enough to be able to transfer its efficiency to
several newly acquired firms in a short time.
Further, managerial synergy is applicable only
in cases where the firm acquires other firms in
the same industry.
 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 effect and achieve lower cost of
capital. Tax saving is another considerations. When
the two firms merge, their combined debt capacity
may be greater than the sum of their individual
capacities before the merger.

 The financial synergy theory also states that when the

cash flow rate of the acquirer is greater than that of
the acquired firm, capital is relocated to the acquired
firm and its investment opportunities improve.
 OPERATING SYNERGY

 The operating synergy theory of mergers states that

economies of scale exist in industry and that before a
merger takes place, the levels of activity that the firms
operate at are insufficient to exploit the economies of
scale.
 Operating economies of scale are achieved through
horizontal, vertical and conglomerate mergers.
Operating economies occur due to indivisibilities of
resources like people, equipment and overhead. The
productivity of such resources increases when they
are spread over a large number of units of output. For
instance, expensive equipment in manufacturing
firms should be utilised at optimum levels so that cost
per unit of output decreases.
 Operating economies in specific management
functions such as production, R&D, marketing or
finance may be achieved through a merger between
firms, which have competencies in different areas.
For instance, when a firm, whose core competence
is in R&D merges with another having a strong
marketing strategy, the 2 businesses would
complement each other.
PURE DIVERSIFICATION:

 Diversification provides several benefits to

managers, other employees and owners of the
firm as well as to the firm itself. Moreover,
diversification through mergers is commonly
preferred to diversification through internal
growth, since the firm may lack internal
resources or capabilities required. The timing of
diversification is an important factor since there
may be several firms seeking to diversify through
mergers at the same time in a particular
industry.
 Employees: - The employees of a firm develop firm-
specific skills over time, which make them more
efficient in their current jobs. These skills are
valuable to that firm and job only and not to any other
jobs. Employees thus have fewer opportunities to
diversify their sources of earning income, unlike
shareholders who can diversify their portfolio.
Consequently, they seek job security and stability,
better opportunities within the firm and higher
compensation (promotions). These needs can be
fulfilled through diversification, since the employees
can be assigned greater responsibilities.
 Owner-managers: - The owner-manager of a firm is
able to retain corporate control over his firm through
diversification and simultaneously reduce the risk
involved.
 Firm: - A firm builds up information on its employees
over time, which helps it to match employees with jobs
within the firm. Managerial teams are thus formed
within the firm. This information is not transferred
outside and is specific to the firm. When the firm is
shut down, these teams are destroyed and value is lost.
If the firm diversifies, these teams can be shifted from
unproductive activities to productive ones, leading to
improved profitability, continuity and growth of the
firm.
 Goodwill: - A firm builds up a reputation over time in
its relationships with suppliers, creditors, customers
and others, resulting in goodwill. It does this through
investments in advertising, employee training, R&D,
organizational development and other strategies.
Diversification helps in preserving its reputation and
goodwill.
 Financial and tax benefits: - Diversification through
mergers also results in financial synergy and tax
benefits. Since diversification reduces risk, it
increases the corporate debt capacity and reduces the
present value of future tax liability of the firm.
STRATEGIC REALIGNMENT TO CHANGING
ENVIRONMENT

 It suggests that the firms use the strategy of M&As as

ways to rapidly adjust to changes in their external
environments. When a company has an opportunity of
growth available only for a limited period of times low
internal growth may not be sufficient.
 Sometimes the firm may have limited period of growth.
Adjustment through internal adjustment may take time.
So, external acquisition will help to reduce time
involved.
 Otherwise, competitors may exploit the situation
Undervaluation

Undervaluation theory states that mergers

occur when the market value of the target firm
stock for some reason does not reflect its true
or potential value or its value in the hands of
alternative management.
Firms may be able to acquire assets for
expansion more cheaply by buying the stocks
of existing firms than by buying or building
assets when the target’s stock price is below the
replacement cost of its assets
 HUBRIS AND THE WINNER’S CURSE

Hubris hypothesis explains why mergers occur

even if the current market value of the target
firm reflects its true economic value. Instead of
accepting market’s valuation, managers and
bidders believe that their own valuation of
target firm is superior and tend to over pay.
Bidders get caught in hubris, an animal like
spirit of arrogance and pride where they are
over optimistic in evaluating potential
synergies.
 The desire to win can drive the purchase price of a
company well in excess of its economic value. In
an auction environment the winning bid is often
in excess of estimated value of the target
company and is likely to represent a positive
valuation error. The positive valuation error
represents the winners curse. 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 shareholders but the
shareholders of the acquiring company suffer a
decrease in wealth.
 SYNERGY
 What is critical is how the extra gains are to
be achieved?

 Synergy refers to the type of reactions that

occur when two substances or factors combine
to produce a greater effect together than that
which the sum of the two operating
independently could account for.
 TYPES OF SYNERGY

Operating synergy
Financial synergy
Managerial synergy
Operating synergy:

• Operating synergy or operating economies may

be involved in horizontal and vertical mergers. For
horizontal mergers the source of operating
economies must represent a form of economies of
scale. The economies, in turn, may reflect
indivisibilities and better utilization of capacity
after the merger.
• Another area in which operating economies
may be achieved is vertical integration.
Combining firms at different stages of an
industry may achieve more efficient
coordination of the different levels. Costs of
communication, and various forms of
bargaining and opportunistic behaviour can
be avoided by vertical integration.
Financial synergy;

• The motive of the merger is to capture investment

opportunities available in the acquired firm’s
industry by lowering the costs of capital of the
combined firm through the merger and also
utilizing lower-cost internal funds of the acquiring
firm. The opportunity for utilizing the cash flows
of the acquiring firm will be enhanced if the cash
flow of the acquired firm is low.
• The decrease in bankruptcy probability may
decrease the expected value of bankruptcy costs
and increase the expected value of tax savings
from interest payments for premerger debts, and
thus increase the value of the combined firm by
lowering its cost of capital.
• Internal funds do not involve transaction costs of
the flotation process and may have differential
tax advantages over external funds.
• The acquiring firms may supply lower-cost
internal funds to the combined firm. Further, the
acquired firms will typically have low free cash
flows because high expected demand growth in
their industries requires greater investments. The
low free cash flows of the acquired firms provide
synergistic opportunities in financing.

• Economies of scale in floatation and transaction

costs of securities are another potential source of
financial synergy.
 Managerial synergy:

• Now imagine a production process employing four

factor inputs ---- generic managerial capabilities,
industry-specific managerial capabilities, firm-specific
non managerial human capital and capital investment.

• The firm-specific non-managerial human capital can

only be supplied by a long-term learning effort or by
merging with existing firms in the same industry. The
industry-specific managerial resources can be obtained
by internal learning or by merging with a firm in the
same or related industries.
• Suppose that a firm, call It B has ‘excess capacity’
in industry specific resources and that another
firm in a related industry, call it T experiences
‘shortages’ in these resources.

• The acquisition of T by B will make the firms

realize more balanced factor proportions between
industry-specific and firm-specific resources by
transferring the excess capacity of B in the
industry-specific capabilities to T’s operation.
• An example of the T-type firm will be an R&D
oriented firm lacking marketing organizations
and being acquired by a B-type firm with
strong marketing capabilities in related fields
of business.
 VALUE CREATION

Value creation is the primary objective of any

business entity. It is obvious that most
successful organizations understand that the
purpose of any business is to create value for
its customers, employees, investors as well as
its shareholders.
Value creation in:

• Horizontal,
• Vertical and
• Conglomerate mergers
Horizontal merger:

A horizontal merger is one that takes place

between two companies that are essentially
operating in the same market. The horizontal
merger takes place between business
competition who are manufacturing, selling
and distributing the similar type of service for
profit.
• Horizontal merger results in reduction of competitors in
the same industry. This, type of merger enables to
derive the benefit of economies of scale & elimination
of competition. But it leads to increase in monopolistic
tendency in the market.

• For example, merger of Tata Oil Mills Company Ltd.

with Hindustan Lever Ltd. is a horizontal merger. Both
the companies have similar products.
Vertical Merger:

• A vertical merger is one in which the company

expands backwards by merging with a company
supplying raw material or expands forward in the
direction of the ultimate consumer. Thus in a
vertical merger, there is a merging of companies
engaged at different stages of the production
cycle within the same industry.
• The vertical merger will bring the firms together who
are involved in different stages of production, process
or operation. A vertical merger allows for smooth flow
of production, reduced inventory, and reduction in
operating cost, increase in economies of scale,
elimination of bottlenecks etc.
• For example, the merger of Reliance Petrochemicals
Limited with reliance industry limited is an example of
vertical merger with backward linkage as far as RIL is
concerned.
Conglomerate Merger:
• In a conglomerate merger, the concerned
companies are in totally unrelated lines of
business. This type of merger involves the
integration of companies entirely involve in a
different set of activities, products or services.
The merging companies are neither
competitors nor complementary to each other.
• This form of merger is resorted to increase economic
power, profitability , diversification of activities.
• For example, Mohta Steel Industries Limited merged
with Vardhaman spinning mills Ltd.
• Conglomerate mergers are expected to bring about
stability of income & profits, since the two units
belong to different industries.
 CHANGING FORCES CONTRIBUTING
TO M&A ACTIVITIES
 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
 Internal and external
change forces contributing to M & A
activities
Internal Factors:

High Cost
Less Profit
Shortage of Inputs
Excess Resources
Low Growth
Low Price
• External Factors:

 Globalization- widened challenges and

opportunities
 Technology- complexity and criticality of
processes and methods
 Awakened customer- customer rules the business
Stringent government norms- environment,
labour, taxation, quality etc.
 Innovation-creative destruction- reduced product
life cycle.
 More Competition
Impact of mergers and acquisitions on
shareholders:

We can further categorize the shareholders into

two parts:
The Shareholders of the acquiring firm
The shareholders of the target firm.
Shareholders of the acquired firm:

• The shareholders of the acquired company benefit

the most. The reason being, it is seen in majority
of the cases that the acquiring company usually
pays a little excess than it what should. Unless a
man lives in a house he has recently bought, he
will not be able to know its drawbacks. So that
the shareholders forgo their shares, the company
has to offer an amount more than the actual
price, which is prevailing in the market. Buying a
company at a higher price can actually prove to
be beneficial for the local economy.
Shareholders of the acquiring firm:

• They are most affected. If we measure the

benefits enjoyed by the shareholders of the
acquired company in degrees, the degree to
which they were benefited, by the same
degree, these shareholders are harmed. This
can be attributed to debt load, which
accompanies an acquisition.