Factors to consider surrounding Mergers and Acquisitions

Factors to consider surrounding Mergers and Acquisitions 

Welcome to my final blog. Here, I hope to truly understand the issues of mergers and acquisitions (M&A), as billion dollar takeovers will surely cause a range of implications throughout the process. M&A can certainly generate wealth. The true extent of gained value is a result of managerial alignment. This is where majority shareholder interest versus managerial enrichment (Sudarsanam, 1996). It is suggested that M&A usually occurs in waves, with each wave having a different component (Kummer et al. 2008). These waves are demonstrated in the below graph.

(Kummer et al. 2008).
These graph above shows the waves of M&A activity in the US from 1887- 2005. The compacts discussed relate to business cycles, corporate fads of globalisation of markets. However, M&A has historically halted when there is a major economic shock to the financial system as shareholders question where value is generated. The huge M&A boom in the 1990's is attributable to the '.com bubble'. This occurred as a result of 'fad-based investing'. Investors ignored traditional valuation methods, instead freely bought shares in any company associated with '.com' in the hope that they would become profitable (Jorn Madslien, 2010). However, most either failed completely or at least lost the majority of it's share valuation. (If your interested in shareholder valuations, please see my other blog, 'The good and the bad to shareholder valuation methods').

Why should you merge?

Money is the answer. Successful mergers will bring further economic benefits too two companies performing well. General costs decline, only one taxation bill is due and firms can streamline economy of scope by merging existing products. Furthermore, superior management can eliminate inefficiencies in semi-strong or strong markets, while eliminating the weak members of a team.

A takeover can to take place, the target and acquiring company must approve a deal, which can be either friendly, or hostile. Friendly takeovers occur as the board of the target company support a deal, believing it will create sufficient shareholder value and actually ask shareholders to vote in favour of a deal.
On the other hand, a hostile takeover occurs if an entity has purchased a large proportion of shares in the target company and can either force a shareholder vote, or replace the board of directors. This method is known as corporate raider.
Another method of a hostile takeover, is through golden parachutes. This effectively avoids managerial disfunction and instead, a board is likely to be receptive of a bid by agreeing to be let go in order to receive lucrative severance packages.

How to merge?

There are various types of mergers. Firstly, conglomerate mergers involve unrelated business activity. An example here can be seen with Tata Steel, who operate in a wide variety of industries. Secondly, vertical mergers can involve companies in the same industry, but at different stages. The benefit here is avoiding government regulations through transaction cost reduction and the transfer of information that could be beneficial to the market. 
Horizontal mergers involve businesses with similar operations within the same industry. Here, managers generate wealth, using methods such as; operational, financial and managerial synergy and increased monopoly power (Sudarsanam, 1996).This can be seen with Pfizer's attempted takeover of AstraZeneca. 
Financing a merger through cash is the most simple, as it means the acquiring shareholders retain the same level of control they had previously. However, this could put huge strain on cash flow, if there is not enough cash reserve to pay their obligations,
Alternatively, the merge can be financed through shares, which means there is no instant cash outflow. However, this could result in the dilution of existing shareholders positions, which would not be well received.

The potential issues.

As discussed, it is often the case that an acquiring company will streamline a target companies existing management team. However, this is not always going to prove successful. It can be argued that that management is what made the target company a success, and if the new management are as successful or efficient, it can result in a loss of clients. Without the customer, all value could be removed form the company, essentially rendering the existing company worthless.
Furthermore, if no improvements are made following a merger, it can be difficult to see where value has been generated. A merger must take place on all levels of the company meaning it can be complicated to ensure all employees understand their role. This confusion may cause inefficiency and reduce effective output (Forbes, 2013).


The effects of mergers.

Firstly, shareholders of the target company are likely to benefit from a takeover, as it is usual that any bid will be paid at a premium, above market value. Studies suggest that the shares of a target company grow be an average of 30% (Jensen & Reuback, 1983). Unfortunately, history shows that the acquiring companies shareholders see either no gains, or even make losses in the short term. It is argued that rather than creating wealth, it is simply transferred to this new merger. 

Secondly, while the acquiring company will see benefits, if it seeks increased monopoly power, the market it operates in may be worse off, due to less competition. For example, if an airline takeover occurs, it may streamline operations and close flight lines, meaning customers will actually be worse off.

Thirdly, it is argued that retained management retain their roles for an average of 3-5 years, before being forced out of the company. Employees of the target company also have an uncertain future as potential changes and cut backs could result in job losses. On the other hand, the acquiring companies management are likely to see rewards with increase power and security.
 

Summary.

Clearly, there are many complications to M&A. M&A must create shareholder wealth, but following apparent booms will not guarantee this. Merging can decrease operating costs and streamline management, however, this can bring issues of uncertainty and reduced efficiency. Furthermore, an appropriate method of financing must be used. This could possibly be achieved through mixing cash and share takeovers, creating value, while delaying some payments. Finally, the effects of a merger should always be geared toward shareholder benefits, which is seen through the target company. However, this should be weighed against the potential value reduction in the acquiring company and the potential negative effect to the market itself.

References

Forbes (2013). 30 key lessons learned from mergers and acquisition transactions. Retrieved from http://www.forbes.com/sites/allbusiness/2013/06/17/30-key-lessons-learned-from-ma-transactions/

Jensen and Ruback (1983). The market for corporate control. Journal of Financial Economics, 11(1), 5-50. Retrieved from http://www.wiggo.com/mgmt8510/Readings/Readings10/Jensen1983jfe.pdf 

Jorn Madslien (2010). Dotcom bubble burst: 10 years on. Retrieved from http://news.bbc.co.uk/1/hi/business/8558257.stm 

Kummer, C., & Steger, U. (2008). Why merger and acquisition (M&A) waves reoccur: the vicious circle from pressure to failure. Strategic Management Review, 2(1), 44-63. Retrieved from https://www.imd.org/research/publications/upload/Steger_Kummer_WP_2007_11.pdf

Sudarsanam, S., Holl, P., & Salami, A. (1996).  Shareholder Wealth Gains In Mergers: Effect Of Synergy And Ownership Structure. Journal Of Business Finance & Accounting, 23(5/6), 673-698. Retrieved from http://search.ebscohost.com/login.aspx?direct=true&AuthType=cookie,ip,shib,uid&db=buh&AN=9611102530&site=ehost-live&scope=site