Mergers - Copy

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Chapter # 1 Introduction


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1.1 CONCEPTUAL FRAMEWORK OF MERGERS ACQUISITION

Introduction : -

Mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate

finance and management dealing with the buying, selling, dividing and combining of different

companies and similarentities that can help an enterprise grow rapidly in its sector or location of

origin, or a new field or new location, without creating a subsidiary, other child entity or using a

joint venture. The distinction between a "merger" and an "acquisition" has become increasingly

blurred in various respects (particularly in terms of the ultimate economic outcome), although it has

not completely disappeared in all situations.

Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate finance

world. Every day, Wall Street investment bankers arrange M&A transactions, which bring separate

companies together to form larger ones. When they're not creating big companies from smaller

ones, corporate finance deals do the reverse and break up companies through spinoffs, carve-outs or

tracking stocks.

Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, oreven billions, of dollars. They can dictate the fortunes of the companies involved for years to come.

For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we

hear about so many of these transactions; they happen all the time. Next time you flip open the

newspapers business section, odds are good that at least one headline will announce some kind of

M&A transaction.

Sure, M&A deals grab headlines, but what does this all mean to investors? To answer this question,

this tutorial discusses the forces that drive companies to buy or merge with others, or to split-off or

sell parts of their own businesses. Once you know the different ways in which these deals are

executed, you'll have a better idea of whether you should cheer or weep when a company you own

buys another company - or is bought by one. You will also be aware of the tax consequences for

companies and for investors.
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1.2ACQUISITION :-An acquisition is the purchase of one business or company by another company or other business

entity. Consolidation occurs when two companies combine together to form a new enterprise

altogether, and neither of the previous companies survives independently. Acquisitions are divided

into "private" and "public" acquisitions, depending on whether the acquiree or merging company

(also termed a target) is or is not listed on public stock markets. An additional dimension or

categorization consists of whether an acquisition is friendly orhostile.

Achieving acquisition success has proven to be very difficult, while various studies have shown that

50% of acquisitions were unsuccessful. The acquisition process is very complex, with many

dimensions influencing its outcome.

Whether a purchase is perceived as being a "friendly" one or a "hostile" depends significantly on

how the proposed acquisition is communicated to and perceived by the target company's board of

directors, employees and shareholders. It is normal for M&A deal communications to take place in

a so-called 'confidentiality bubble' wherein the flow of information is restricted pursuant to

confidentiality agreements. In the case of a friendly transaction, the companies cooperate in

negotiations; in the case of a hostile deal, the board and/or management of the target is unwilling to

be bought or the target's board has no prior knowledge of the offer. Hostile acquisitions can, and

often do, ultimately become "friendly", as the acquirer secures endorsement of the transaction fromthe board of the acquiree company. This usually requires an improvement in the terms of the offer

and/or through negotiation.

"Acquisition" usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a

smaller firm will acquire management control of a larger and/or longer-established company and

retain the name of the latter for the post-acquisition combined entity. This is known as a reverse

takeover. Another type of acquisition is thereverse merger, a form of transaction that enables a

private company to be publicly listed in a relatively short time frame. A reverse merger occurs

when a privately held company (often one that has strong prospects and is eager to raise financing)

buys a publicly listed shell company, usually one with no business and limited assets.
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There are also a variety of structures used in securing control over the assets of a company, which

have different tax and regulatory implications: -

The buyer buys the shares, and therefore control, of the target company being purchased.Ownership control of the company in turn conveys effective control over the assets of the

company, but since the company is acquired intact as a going concern, this form of transaction

carries with it all of the liabilities accrued by that business over its past and all of the risks that

company faces in its commercial environment.

The buyer buys the assets of the target company. The cash the target receives from the sell-offis paid back to its shareholders by dividend or through liquidation. This type of transaction

leaves the target company as an empty shell, if the buyer buys out the entire assets. A buyer

often structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and

leave out the assets and liabilities that it does not. This can be particularly important where

foreseeable liabilities may include future, unquantified damage awards such as those that could

arise from litigation over defective products, employee benefits or terminations, or

environmental damage. A disadvantage of this structure is the tax that many jurisdictions,

particularly outside the United States, impose on transfers of the individual assets, whereas

stock transactions can frequently be structured as like-kind exchanges or other arrangements

that are tax-free or tax-neutral, both to the buyer and to the seller's shareholders.

The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where

one company splits into two, generating a second company separately listed on a stock exchange.

As per knowledge-based views, firms can generate greater values through the retention of

knowledge-based resources which they generate and integrate. Extracting technological benefits

during and after acquisition is ever challenging issue because of organizational differences. Based

on the content analysis of seven interviews authors concluded five following components for their

grounded model of acquisition:

1. Improper documentation and changing implicit knowledge makes it difficult to shareinformation during acquisition.

2. For acquired firm symbolic and cultural independence which is the base of technology andcapabilities are more important than administrative independence.

3. Detailed knowledge exchange and integrations are difficult when the acquired firm is largeand high performing.
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4. Management of executives from acquired firm is critical in terms of promotions and payincentives to utilize their talent and value their expertise.

5. Transfer of technologies and capabilities are most difficult task to manage because ofcomplications of acquisition implementation. The risk of losing implicit knowledge is

always associated with the fast pace acquisition.

Preservation of tacit knowledge, employees and literature are always delicate during and after

acquisition. Strategic management of all these resources is a very important factor for a successful

acquisition.

Increase in acquisitions in our global business environment has pushed us to evaluate the key stake

holders of acquisition very carefully before implementation. It is imperative for the acquirer to

understand this relationship and apply it to its advantage. Retention is only possible when resources

are exchanged and managed without affecting their independence.

Acquisitions and Takeovers :-An acquisition may be defined as an act of acquiring effective control by one company over assets

or management of another company without any combination of companies. Thus, in an acquisition

two or more companies may remain independent, separate legal entities, but there may be a change

in control of the companies. When an acquisition is 'forced' or 'unwilling', it is called a takeover. In

an unwilling acquisition, the management of 'target' company would oppose a move of being taken

over. But, when managements of acquiring and target companies mutually and willingly agree for

the takeover, it is called acquisition or friendly takeover.

Underthe Monopolies and Restrictive Practices Act, takeover meant acquisition of not less than

25 percent of the voting power in a company. While in the Companies Act (Section 372), a

company's investment in the shares of another company in excess of 10 percent of the subscribed

capital can result in takeovers. An acquisition or takeover does not necessarily entail full legal

control. A company can also have effective control over another company by holding a minority

ownership.
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1.3 MERGERS OR AMALGAMATIONS.

A 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(1A)] defines amalgamation as

the merger of one or more companies with another or the merger of two or more companies to form

a new company, in such a way that all assets and liabilities of the amalgamating companies become

assets and liabilities of the amalgamated company and shareholders not less than nine-tenths in

value of the shares in the amalgamating company or companies become shareholders of the

amalgamated company.

Thus, mergers or amalgamations may take two forms:-

Merger through Absorption:- An absorption is a combination of two or more companiesinto 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.

Merger through Consolidation:- A consolidation is a combination of two or morecompanies into a 'new company'. In this form of merger, all companies are legally dissolved

and a new entity is created. Here, the acquired company transfers its assets, liabilities and

shares to the acquiring company for cash or exchange of shares. For example, merger of

Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd and

Indian Reprographics Ltd into an entirely new company called HCL Ltd.

A fundamental characteristic of merger (either through absorption or consolidation) is that the

acquiring company (existing or new) takes over the ownership of other companies and combines

their operations with its own operations.

Besides, there are three major types of mergers:-
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Horizontal merger:- is a combination of two or more firms in the same area of business.For example, combining of two book publishers or two luggage manufacturing companies to

gain dominant market share.

Vertical merger:- is a combination of two or more firms involved in different stages ofproduction or distribution of the same product. For example, joining of a TV manufacturing(assembling) company and a TV marketing company or joining of a spinning company and

a weaving company. Vertical merger may take the form of forward or backward merger.

When a company combines with the supplier of material, it is called backward merger and

when it combines with the customer, it is known as forward merger.

Conglomerate merger:- is a combination of firms engaged in unrelated lines of businessactivity. For example, merging of different businesses like manufacturing of cement

products, fertilizer products, electronic products, insurance investment and advertisingagencies. L&T and Voltas Ltd are examples of such mergers.

Horizontal and Vertical Mergers


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DISTINCTION BETWEEN MERGERS AND ACQUISITIONS

Although often used synonymously, the terms merger and acquisition mean slightly different

things.This paragraph does not make a clear distinction between the legal concept of a merger (with

the resulting corporate mechanics, statutory merger or statutory consolidation, which have nothing

to do with the resulting power grab as between the management of the target and the acquirer) and

the business point of view of a "merger", which can be achieved independently of the corporate

mechanics through various means such as "triangular merger", statutory merger, acquisition, etc.

When one company takes over another and clearly establishes itself as the new owner, the purchase

is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer

"swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms agree to go forward as a single newcompany rather than remain separately owned and operated. This kind of action is more precisely

referred to as a "merger of equals". The firms are often of about the same size. Both companies'

stocks are surrendered and new company stock is issued in its place.For example, in the 1999

merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist when they merged,

and a new company, GlaxoSmithKline, was created. In practice, however, actual mergers of equals

don't happen very often. Usually, one company will buy another and, as part of the deal's terms,

simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is

technically an acquisition. Being bought out often carries negative connotations; therefore, by

describing the deal euphemistically as a merger, deal makers and top managers try to make the

takeover more palatable. An example of this would be the takeover ofChryslerby Daimler-Benz in

1999 which was widely referred to as a merger at the time.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the

best interest of both of their companies. But when the deal is unfriendly (that is, when the target

company does not want to be purchased) it is always regarded as an acquisition.
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ADVANTAGES OF MERGERS & ACQUISITIONS

The most common motives and advantages of mergers and acquisitions are:-

Accelerating a company's growth, particularly when its internal growth is constrained due topaucity of resources. Internal growth requires that a company should develop its operating

facilities- manufacturing, research, marketing, etc. But, lack or inadequacy of resources and

time needed for internal development may constrain a company's pace of growth. Hence, a

company can acquire production facilities as well as other resources from outside through

mergers and acquisitions. Specially, for entering in new products/markets, the company may

lack technical skills and may require special marketing skills and a wide distribution

network to access different segments of markets. The company can acquire existing

company or companies with requisite infrastructure and skills and grow quickly. Enhancing profitability because a combination of two or more companies may result in

more than average profitability due to cost reduction and efficient utilization of resources.

This may happen because of:-

Economies of scale:- arise when increase in the volume of production leads to a reduction in the

cost of production per unit. This is because, with merger, fixed costs are distributed over a large

volume of production causing the unit cost of production to decline. Economies of scale may also

arise from other indivisibilities such as production facilities, management functions and

management resources and systems. This is because a given function, facility or resource is utilized

for a large scale of operations by the combined firm.

Operating economies:- arise because, a combination of two or more firms mayresult in cost reduction due to operating economies. In other words, a combined firm

may avoid or reduce over-lapping functions and consolidate its management

functions such as manufacturing, marketing, R&D and thus reduce operating costs.For example, a combined firm may eliminate duplicate channels of distribution, or

crate a centralized training center, or introduce an integrated planning and control

system.

Synergy:- implies a situation where the combined firm is more valuable than thesum of the individual combining firms. It refers to benefits other than those related to

economies of scale. Operating economies are one form of synergy benefits. But apart

from operating economies, synergy may also arise from enhanced managerial


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capabilities, creativity, innovativeness, R&D and market coverage capacity due to

the complementarity of resources and skills and a widened horizon of opportunities.

Diversifying the risks of the company, particularly when it acquires those businesses whoseincome streams are not correlated. Diversification implies growth through the combination

of firms in unrelated businesses. It results in reduction of total risks through substantial

reduction of cyclicality of operations. The combination of management and other systems

strengthen the capacity of the combined firm to withstand the severity of the unforeseen

economic factors which could otherwise endanger the survival of the individual companies.

A merger may result in financial synergy and benefits for the firm in many ways:- By eliminating financial constraints By enhancing debt capacity. This is because a merger of two companies can bring

stability of cash flows which in turn reduces the risk of insolvency and enhances the

capacity of the new entity to service a larger amount of debt

By lowering the financial costs. This is because due to financial stability, the mergedfirm is able to borrow at a lower rate of interest.

Limiting the severity of competition by increasing the company's market power. A merger

can increase the market share of the merged firm. This improves the profitability of the firm

due to economies of scale. The bargaining power of the firm vis--vis labour, suppliers andbuyers is also enhanced. The merged firm can exploit technological breakthroughs against

obsolescence and price wars.


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DISADVANTAGES OF MERGERS AND ACQUISITION

Grasping for a company simply because its on the market , or because a competitor wants to

buy it.

Overpayment or misguided purchase.

Inability to integrate well

Diverse Business ;Unmanageable.

Leaping without looking at the value


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MERGERS AND ACQUISITIONS: VALUATION MATTERS

Investors in a company that are aiming to take over another one must determine whether the

purchase will be beneficial to them. In order to do so, they must ask themselves how much the

company being acquired is really worth.

Naturally, both sides of an M&A deal will have different ideas about the worth of a target company:

its seller will tend to value the company at as high of a price as possible, while the buyer will try to

get the lowest price that he can.

There are, however, many legitimate ways to value companies. The most common method is to

look at comparable companies in an industry, but deal makers employ a variety of other methods

and tools when assessing a target company. Here are just a few of them:

1. Comparative Ratios - The following are two examples of the many comparative metrics onwhich acquiring companies may base their offers:

Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiringcompany makes an offer that is a multiple of the earnings of the target company.

Looking at the P/E for all the stocks within the same industry group will give the

acquiring company good guidance for what the target's P/E multiple should be.

Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring companymakes an offer as a multiple of the revenues, again, while being aware of the price-

to-sales ratio of other companies in the industry.

Replacement Cost - In a few cases, acquisitions are based on the cost of replacing the target

company. For simplicity's sake, suppose the value of a company is simply the sum of all its

equipment and staffing costs. The acquiring company can literally order the target to sell at that

price, or it will create a competitor for the same cost. Naturally, it takes a long time to assemblegood management, acquire property and get the right equipment. This method of establishing a

price certainly wouldn't make much sense in a service industry where the key assets - people and

ideas - are hard to value and develop.

Discounted Cash Flow (DCF) - A key valuation tool in M&A, discounted cash flow analysis

determines a company's current value according to its estimated future cash flows. Forecasted free

cash flows (net income + depreciation/amortization - capital expenditures - change in working

capital) are discounted to a present value using the company's weighted average costs of

capital (WACC).
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SYNERGY: THE PREMIUM FOR POTENTIAL SUCCESS

For the most part, acquiring companies nearly always pay a substantial premium on the stock

market value of the companies they buy. The justification for doing so nearly always boils down to

the notion of synergy; a merger benefits shareholders when a company's post-merger share price

increases by the value of potential synergy.

Let's face it, it would be highly unlikely for rational owners to sell if they would benefit more by

not selling. That means buyers will need to pay a premium if they hope to acquire the company,

regardless of what pre-merger valuation tells them. For sellers, that premium represents their

company's future prospects. For buyers, the premium represents part of the post-merger synergy

they expect can be achieved. The following equation offers a good way to think about synergy and

how to determine whether a deal makes sense. The equation solves for the minimum required

synergy:

In other words, the success of a merger is measured by whether the value of the buyer is enhancedby the action. However, the practical constraints of mergers, which we discuss in part five, often

prevent the expected benefits from being fully achieved. Alas, the synergy promised by deal makers

might just fall short.
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WHAT TO LOOK FOR

It's hard for investors to know when a deal is worthwhile. The burden of proof should fall on the

acquiring company. To find mergers that have a chance of success, investors should start by looking

for some of these simple criteria:

A reasonable purchase price - A premium of, say, 10% above the market price seems withinthe bounds of level-headedness. A premium of 50%, on the other hand, requires synergy of

stellar proportions for the deal to make sense. Stay away from companies that participate in

such contests.

Cash transactions - Companies that pay in cash tend to be more careful when calculatingbids and valuations come closer to target. When stock is used as the currency for

acquisition, discipline can go by the wayside.

Sensible appetiteAn acquiring company should be targeting a company that is smaller andin businesses that the acquiring company knows intimately. Synergy is hard to create from

companies in disparate business areas. Sadly, companies have a bad habit of biting off more

than they can chew in mergers.

Mergers are awfully hard to get right, so investors should look for acquiring companies with a

healthy grasp of reality.


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BUSINESS VALUATION

The five most common ways to valuate a business are

asset valuation, historical earnings valuation, future maintainable earnings valuation, relative valuation (comparable company & comparable transactions), discounted cash flow (DCF) valuation

Professionals who valuate businesses generally do not use just one of these methods but a

combination of some of them, as well as possibly others that are not mentioned above, in order to

obtain a more accurate value. The information in the balance sheet or income statement is obtained

by one of three accounting measures: a Notice to Reader, a Review Engagement or an Audit.

Accurate business valuation is one of the most important aspects of M&A as valuations like these

will have a major impact on the price that a business will be sold for. Most often this information is

expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's

sake. There are other, more detailed ways of expressing the value of a business. While these reports

generally get more detailed and expensive as the size of a company increases, this is not always the

case as there are many complicated industries which require more attention to detail, regardless of

size.
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REGULATIONS FOR MERGERS & ACQUISITIONS

Mergers and acquisitions are regulated under various laws in India. The objective of the laws is to

make these deals transparent and protect the interest of all shareholders. They are regulated through

the provisions of :-

The Companies Act, 1956

The Act lays down the legal procedures for mergers or acquisitions :-

Permission for merger:- Two or more companies can amalgamate only when theamalgamation is permitted under their memorandum of association. Also, the

acquiring company should have the permission in its object clause to carry on the

business of the acquired company. In the absence of these provisions in the

memorandum of association, it is necessary to seek the permission of the

shareholders, board of directors and the Company Law Board before affecting the

merger.

Information to the stock exchange:- The acquiring and the acquired companiesshould inform the stock exchanges (where they are listed) about the merger.

Approval of board of directors:- The board of directors of the individualcompanies should approve the draft proposal for amalgamation and authorise the

managements of the companies to further pursue the proposal.

Application in the High Court:- An application for approving the draftamalgamation proposal duly approved by the board of directors of the individual

companies should be made to the High Court.

Shareholders' and creators' meetings:- The individual companies should holdseparate meetings of their shareholders and creditors for approving the amalgamation

scheme. At least, 75 percent of shareholders and creditors in separate meeting,voting in person or by proxy, must accord their approval to the scheme.

Sanction by the High Court:- After the approval of the shareholders and creditors,on the petitions of the companies, the High Court will pass an order, sanctioning the

amalgamation scheme after it is satisfied that the scheme is fair and reasonable. The

date of the court's hearing will be published in two newspapers, and also, the

regional director of the Company Law Board will be intimated.

Filing of the Court order:- After the Court order, its certified true copies will befiled with the Registrar of Companies.
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Transfer of assets and liabilities:- The assets and liabilities of the acquiredcompany will be transferred to the acquiring company in accordance with the

approved scheme, with effect from the specified date.

Payment by cash or securities:- As per the proposal, the acquiring company willexchange shares and debentures and/or cash for the shares and debentures of theacquired company. These securities will be listed on the stock exchange.

The Competition Act, 2002

The Act regulates the various forms of business combinations through Competition

Commission of India. Under the Act, no person or enterprise shall enter into a combination,in the form of an acquisition, merger or amalgamation, which causes or is likely to cause an

appreciable adverse effect on competition in the relevant market and such a combination

shall be void. Enterprises intending to enter into a combination may give notice to the

Commission, but this notification is voluntary. But, all combinations do not call for scrutiny

unless the resulting combination exceeds the threshold limits in terms of assets or turnover

as specified by the Competition Commission of India. The Commission while regulating a

'combination' shall consider the following factors :-

Actual and potential competition through imports; Extent of entry barriers into the market; Level of combination in the market; Degree of countervailing power in the market; Possibility of the combination to significantly and substantially increase prices or

profits;

Extent of effective competition likely to sustain in a market; Availability of substitutes before and after the combination; Market share of the parties to the combination individually and as a combination; Possibility of the combination to remove the vigorous and effective competitor or

competition in the market;

Nature and extent of vertical integration in the market; Nature and extent of innovation; Whether the benefits of the combinations outweigh the adverse impact of the

combination.
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Thus, the Competition Act does not seek to eliminate combinations and only aims to

eliminate their harmful effects.

The other regulations are provided in the:- The Foreign Exchange Management Act, 1999and

the Income Tax Act,1961. Besides, theSecurities and Exchange Board of India (SEBI)has issued

guidelines to regulate mergers and acquisitions. The SEBI (Substantial Acquisition of Shares

and Take-overs) Regulations,1997 and its subsequent amendmentsaim at making the take-over

process transparent, and also protect the interests of minority shareholders
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FINANCING M&A

Mergers are generally differentiated from acquisitions partly by the way in which they are financed

and partly by the relative size of the companies. Various methods of financing an M&A deal exist:

Cash

Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the

shareholders of the target company are removed from the picture and the target comes under the

(indirect) control of the bidder's shareholders.

Stock

Payment in the form of the acquiring company's stock, issued to the shareholders of the acquired

company at a given ratio proportional to the valuation of the latter.

Which method of financing to choose?

There are some elements to think about when choosing the form of payment. When submitting an

offer, the acquiring firm should consider other potential bidders and think strategically. The form of

payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of

the bid (without considering an eventual earnout). The contingency of the share payment is indeed

removed. Thus, a cash offer preempts competitors better than securities. Taxes are a second element

to consider and should be evaluated with the counsel of competent tax and accounting advisers.

Third, with a share deal the buyers capital structure might be affected and the control of the buyer

modified. If the issuance of shares is necessary, shareholders of the acquiring company might

prevent such capital increase at the general meeting of shareholders. The risk is removed with acash transaction. Then, the balance sheet of the buyer will be modified and the decision maker

should take into account the effects on the reported financial results. For example, in a pure cash

deal (financed from the companys current account), liquidity ratios might decrease. On the other

hand, in a pure stock for stock transaction (financed from the issuance of new shares), the company

might show lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards

accounting dilution when making the choice. The form of payment and financing options are tightly

linked. If the buyer pays cash, there are three main financing options:


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Cash on hand: it consumes financial slack (excess cash or unused debt capacity) and maydecrease debt rating. There are no major transaction costs.

It consumes financial slack, may decrease debt rating and increase cost of debt. Transactioncosts include underwriting or closing costs of 1% to 3% of the face value.

Issue of stock: it increases financial slack, may improve debt rating and reduce cost of debt.Transaction costs include fees for preparation of a proxy statement, an extraordinary

shareholder meeting and registration.

If the buyer pays with stock, the financing possibilities are:

Issue of stock (same effects and transaction costs as described above). Shares in treasury: it increases financial slack (if they dont have to be repurchased on the

market), may improve debt rating and reduce cost of debt. Transaction costs include brokerage

fees if shares are repurchased in the market otherwise there are no major costs.

In general, stock will create financial flexibility. Transaction costs must also be considered but tend

to have a greater impact on the payment decision for larger transactions. Finally, paying cash or

with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they

believe their shares are overvalued and cash when undervalued


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MOTIVES BEHIND M&A

The dominant rationale used to explain M&A activity is that acquiring firms seek improved

financial performance. The following motives are considered to improve financial performance:

Economy of scale: This refers to the fact that the combined company can often reduce its fixedcosts by removing duplicate departments or operations, lowering the costs of the company

relative to the same revenue stream, thus increasing profit margins.

Economy of scope: This refers to the efficiencies primarily associated with demand-sidechanges, such as increasing or decreasing the scope of marketing and distribution, of different

types of products.

Increased revenue or market share: This assumes that the buyer will be absorbing a majorcompetitor and thus increase its market power (by capturing increased market share) to set

prices.

Cross-selling: For example, a bankbuying a stock brokercould then sell its banking products tothe stock broker's customers, while the broker can sign up the bank's customers for brokerage

accounts. Or, a manufacturer can acquire and sell complementary products.

Synergy: For example, managerial economies such as the increased opportunity of managerialspecialization. Another example are purchasing economies due to increased order size and

associated bulk-buying discounts.

Taxation: A profitable company can buy a loss maker to use the target's loss as their advantageby reducing their tax liability. In the United States and many other countries, rules are in place

to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax

motive of an acquiring company.

Geographical or other diversification: This is designed to smooth the earnings results of acompany, which over the long term smoothens the stock price of a company, giving

conservative investors more confidence in investing in the company. However, this does not

always deliver value to shareholders (see below).

Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and theinteraction of target and acquiring firm resources can create value through either overcoming

information asymmetry or by combining scarce resources.

Vertical integration: Vertical integration occurs when an upstream and downstream firm merge(or one acquires the other). There are several reasons for this to occur. One reason is to

internalise an externality problem. A common example of such an externality is double
http://en.wikipedia.org/wiki/Economy_of_scalehttp://en.wikipedia.org/wiki/Economy_of_scopehttp://en.wikipedia.org/wiki/Revenuehttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Cross-sellinghttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Stock_brokerhttp://en.wikipedia.org/wiki/Synergyhttp://en.wikipedia.org/wiki/Taxhttp://en.wikipedia.org/wiki/Information_asymmetryhttp://en.wikipedia.org/wiki/Vertical_integrationhttp://en.wikipedia.org/wiki/Externalityhttp://en.wikipedia.org/wiki/Externalityhttp://en.wikipedia.org/wiki/Vertical_integrationhttp://en.wikipedia.org/wiki/Information_asymmetryhttp://en.wikipedia.org/wiki/Taxhttp://en.wikipedia.org/wiki/Synergyhttp://en.wikipedia.org/wiki/Stock_brokerhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Cross-sellinghttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Revenuehttp://en.wikipedia.org/wiki/Economy_of_scopehttp://en.wikipedia.org/wiki/Economy_of_scale


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marginalization. Double marginalization occurs when both the upstream and downstream firms

have monopoly power and each firm reduces output from the competitive level to the monopoly

level, creating two deadweight losses. Following a merger, the vertically integrated firm can

collect one deadweight loss by setting the downstream firm's output to the competitive level.

This increases profits and consumer surplus. A merger that creates a vertically integrated firmcan be profitable.

Hiring: some companies use acquisitions as an alternative to the normal hiring process. This isespecially common when the target is a small private company or is in the startup phase. In this

case, the acquiring company simply hires the staff of the target private company, thereby

acquiring its talent (if that is its main asset and appeal). The target private company simply

dissolves and little legal issues are involved.

Absorption of similar businesses under single management: similar portfolio invested by twodifferent mutual funds (Ahsan Raza Khan, 2009) namely united money market fund and united

growth and income fund, caused the management to absorb united money market fund into

united growth and income fund.

However, on average and across the most commonly studied variables, acquiring firms' financial

performance does not positively change as a function of their acquisition activity. Therefore,

additional motives for merger and acquisition that may not add shareholder value include:

Diversification: While this may hedge a company against a downturn in an individual industryit fails to deliver value, since it is possible for individual shareholders to achieve the same

hedge by diversifying their portfolios at a much lower cost than those associated with a merger.

(In his bookOne Up on Wall Street, Peter Lynch memorably termed this "diworseification".)

Manager's hubris: manager's overconfidence about expected synergies from M&A which resultsin overpayment for the target company.

Empire-building: Managers have larger companies to manage and hence more power.

Manager's compensation: In the past, certain executive management teams had their payoutbased on the total amount of profit of the company, instead of the profit per share, which would

give the team a perverse incentive to buy companies to increase the total profit while decreasing

the profit per share (which hurts the owners of the company, the shareholders).
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BRAND CONSIDERATIONS

Mergers and acquisitions often create brand problems, beginning with what to call the company

after the transaction and going down into detail about what to do about overlapping and competing

product brands. Decisions about what brand equity to write off are not inconsequential. And, given

the ability for the right brand choices to drive preference and earn a price premium, the future

success of a merger or acquisition depends on making wise brand choices. Brand decision-makers

essentially can choose from four different approaches to dealing with naming issues, each with

specific pros and cons:

1. Keep one name and discontinue the other. The strongest legacy brand with the bestprospects for the future lives on. In the merger of United Airlines and Continental Airlines,

the United brand will continue forward, while Continental is retired.2. Keep one name and demote the other. The strongest name becomes the company name and

the weaker one is demoted to a divisional brand or product brand. An example is Caterpillar

Inc. keeping the Bucyrus International name.[13]

3. Keep both names and use them together. Some companies try to please everyone and keepthe value of both brands by using them together. This can create a unwieldy name, as in the

case ofPricewaterhouseCoopers, which has since changed its brand name to "PwC".

4. Discard both legacy names and adopt a totally new one. The classic example is the mergerof Bell Atlantic with GTE, which became Verizon Communications. Not every merger with

a new name is successful. By consolidating into YRC Worldwide, the company lost the

considerable value of both Yellow Freight and Roadway Corp.

The factors influencing brand decisions in a merger or acquisition transaction can range from

political to tactical. Ego can drive choice just as well as rational factors such as brand value and

costs involved with changing brands.

Beyond the bigger issue of what to call the company after the transaction comes the ongoing

detailed choices about what divisional, product and service brands to keep. The detailed decisions

about the brand portfolio are covered under the topic brand architecture.
http://en.wikipedia.org/wiki/United_Airlineshttp://en.wikipedia.org/wiki/Continental_Airlineshttp://en.wikipedia.org/wiki/Caterpillar_Inc.http://en.wikipedia.org/wiki/Caterpillar_Inc.http://en.wikipedia.org/wiki/Bucyrus_Internationalhttp://en.wikipedia.org/wiki/Mergers_and_acquisitions#cite_note-Httpmerriamassociatescomcaterpillarnewlegsacquiringthebucyrusinternationalbrand-12http://en.wikipedia.org/wiki/Mergers_and_acquisitions#cite_note-Httpmerriamassociatescomcaterpillarnewlegsacquiringthebucyrusinternationalbrand-12http://en.wikipedia.org/wiki/Mergers_and_acquisitions#cite_note-Httpmerriamassociatescomcaterpillarnewlegsacquiringthebucyrusinternationalbrand-12http://en.wikipedia.org/wiki/PwChttp://en.wikipedia.org/wiki/GTEhttp://en.wikipedia.org/wiki/Verizon_Communicationshttp://en.wikipedia.org/wiki/YRC_Worldwidehttp://en.wikipedia.org/wiki/Yellow_Freighthttp://en.wikipedia.org/w/index.php?title=Roadway_Corp.&action=edit&redlink=1http://en.wikipedia.org/wiki/Brand_architecturehttp://en.wikipedia.org/wiki/Brand_architecturehttp://en.wikipedia.org/w/index.php?title=Roadway_Corp.&action=edit&redlink=1http://en.wikipedia.org/wiki/Yellow_Freighthttp://en.wikipedia.org/wiki/YRC_Worldwidehttp://en.wikipedia.org/wiki/Verizon_Communicationshttp://en.wikipedia.org/wiki/GTEhttp://en.wikipedia.org/wiki/PwChttp://en.wikipedia.org/wiki/Mergers_and_acquisitions#cite_note-Httpmerriamassociatescomcaterpillarnewlegsacquiringthebucyrusinternationalbrand-12http://en.wikipedia.org/wiki/Bucyrus_Internationalhttp://en.wikipedia.org/wiki/Caterpillar_Inc.http://en.wikipedia.org/wiki/Caterpillar_Inc.http://en.wikipedia.org/wiki/Continental_Airlineshttp://en.wikipedia.org/wiki/United_Airlines


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THE GREAT MERGER MOVEMENT

The Great Merger Movement was a predominantly U.S. business phenomenon that happened from

1895 to 1905. During this time, small firms with little market share consolidated with similar firms

to form large, powerful institutions that dominated their markets. It is estimated that more than

1,800 of these firms disappeared into consolidations, many of which acquired substantial shares of

the markets in which they operated. The vehicle used were so-called trusts. In 1900 the value of

firms acquired in mergers was 20% ofGDP. In 1990 the value was only 3% and from 19982000 it

was around 1011% of GDP. Companies such as DuPont, US Steel, and General Electric that

merged during the Great Merger Movement were able to keep their dominance in their respective

sectors through 1929, and in some cases today, due to growing technological advances of their

products, patents, and brand recognitionby their customers. There were also other companies that

held the greatest market share in 1905 but at the same time did not have the competitive advantages

of the companies like DuPont and General Electric. These companies such as International Paper

and American Chicle saw their market share decrease significantly by 1929 as smaller competitors

joined forces with each other and provided much more competition. The companies that merged

were mass producers of homogeneous goods that could exploit the efficiencies of large volume

production. In addition, many of these mergers were capital-intensive. Due to high fixed costs,

when demand fell, these newly-merged companies had an incentive to maintain output and reduce

prices. However more often than not mergers were "quick mergers". These "quick mergers"

involved mergers of companies with unrelated technology and different management. As a result,

the efficiency gains associated with mergers were not present. The new and bigger company would

actually face higher costs than competitors because of these technological and managerial

differences. Thus, the mergers were not done to see large efficiency gains, they were in fact done

because that was the trend at the time. Companies which had specific fine products, like fine writing

paper, earned their profits on high margin rather than volume and took no part in Great Merger

Movement.

Short-run factorsOne of the major short run factors that sparked The Great Merger Movement was the desire to keep

prices high. However, high prices attracted the entry of new firms into the industry who sought to

take a piece of the total product. With many firms in a market, supply of the product remains high.

A major catalyst behind the Great Merger Movement was the Panic of 1893, which led to a major

decline in demand for many homogeneous goods. For producers of homogeneous goods, when
http://en.wikipedia.org/wiki/Trust_(19th_century)http://en.wikipedia.org/wiki/GDPhttp://en.wikipedia.org/wiki/DuPonthttp://en.wikipedia.org/wiki/US_Steelhttp://en.wikipedia.org/wiki/General_Electrichttp://en.wikipedia.org/wiki/Patentshttp://en.wikipedia.org/wiki/Brand_recognitionhttp://en.wikipedia.org/wiki/DuPonthttp://en.wikipedia.org/wiki/General_Electrichttp://en.wikipedia.org/wiki/International_Paperhttp://en.wikipedia.org/wiki/American_Chiclehttp://en.wikipedia.org/w/index.php?title=Fine_products&action=edit&redlink=1http://en.wikipedia.org/wiki/Panic_of_1893http://en.wikipedia.org/wiki/Panic_of_1893http://en.wikipedia.org/w/index.php?title=Fine_products&action=edit&redlink=1http://en.wikipedia.org/wiki/American_Chiclehttp://en.wikipedia.org/wiki/International_Paperhttp://en.wikipedia.org/wiki/General_Electrichttp://en.wikipedia.org/wiki/DuPonthttp://en.wikipedia.org/wiki/Brand_recognitionhttp://en.wikipedia.org/wiki/Patentshttp://en.wikipedia.org/wiki/General_Electrichttp://en.wikipedia.org/wiki/US_Steelhttp://en.wikipedia.org/wiki/DuPonthttp://en.wikipedia.org/wiki/GDPhttp://en.wikipedia.org/wiki/Trust_(19th_century)


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demand falls, these producers have more of an incentive to maintain output and cut prices, in order

to spread out the high fixed costs these producers faced (i.e. lowering cost per unit) and the desire to

exploit efficiencies of maximum volume production. However, during the Panic of 1893, the fall in

demand led to a steep fall in prices.

Another economic model proposed by Naomi R. Lamoreaux for explaining the steep price falls is to

view the involved firms acting as monopolies in their respective markets. As quasi-monopolists,

firms set quantity where marginal cost equals marginal revenue and price where this quantity

intersects demand. When the Panic of 1893 hit, demand fell and along with demand, the firms

marginal revenue fell as well. Given high fixed costs, the new price was below average total cost,

resulting in a loss. However, also being in a high fixed costs industry, these costs can be spread out

through greater production (i.e. Higher quantity produced). To return to the quasi-monopoly model,

in order fora firm to earn profit, firms would steal part of another firms market share by dropping

their price slightly and producing to the point where higher quantity and lower price exceeded their

average total cost. As other firms joined this practice, prices began falling everywhere and a price

war ensued.

One strategy to keep prices high and to maintain profitability was for producers of the same good to

collude with each other and form associations, also known as cartels. These cartels were thus able to

raise prices right away, sometimes more than doubling prices. However, these prices set by cartelsonly provided a short-term solution because cartel members would cheat on each other by setting a

lower price than the price set by the cartel. Also, the high price set by the cartel would encourage

new firms to enter the industry and offer competitive pricing, causing prices to fall once again. As a

result, these cartels did not succeed in maintaining high prices for a period of no more than a few

years. The most viable solution to this problem was for firms to merge, through horizontal

integration, with other top firms in the market in order to control a large market share and thus

successfully set a higher price.

Long-run factorsIn the long run, due to desire to keep costs low, it was advantageous for firms to merge and reduce

their transportation costs thus producing and transporting from one location rather than various sites

of different companies as in the past. Low transport costs, coupled with economies of scale also

increased firm size by two- to fourfold during the second half of the nineteenth century. In addition,

technological changes prior to the merger movement within companies increased the efficient sizeof plants with capital intensive assembly lines allowing for economies of scale. Thus improved
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technology and transportation were forerunners to the Great Merger Movement. In part due to

competitors as mentioned above, and in part due to the government, however, many of these

initially successful mergers were eventually dismantled. The U.S. government passed the Sherman

Act in 1890, setting rules against price fixing and monopolies. Starting in the 1890s with such cases

as Addyston Pipe and Steel Company v. United States, the courts attacked large companies forstrategizing with others or within their own companies to maximize profits. Price fixing with

competitors created a greater incentive for companies to unite and merge under one name so that

they were not competitors anymore and technically not price fixing.

Merger wavesThe economic history has been divided into Merger Waves based on the merger activities in the

business world as

Period Name Facet

18971904 First Wave Horizontal mergers

19161929 Second Wave Vertical mergers

19651969 Third Wave Diversified conglomerate mergers

19811989 Fourth Wave Congeneric mergers; Hostile takeovers; Corporate Raiding

19922000 Fifth Wave Cross-border mergers

20032008 Sixth Wave Shareholder Activism, Private Equity, LBO

Deal objectives in more recent merger waves

During the third merger wave (19651989), corporate marriages involved more diverse companies.

Acquirers more frequently bought into different industries. Sometimes this was done to smooth out

cyclical bumps, to diversify, the hope being that it would hedge an investment portfolio.

Starting in the fourth merger wave (19921998) and continuing today, companies are more likely to

acquire in the same business, or close to it, firms that complement and strengthen an acquirers

capacity to serve customers.

Buyers arent necessarily hungry for the target companies hard assets. Some are more interested in

acquiring thoughts, methodologies, people and relationships. Paul Graham recognized this in his

2005 essay "Hiring is Obsolete", in which he theorizes that the free market is better at identifying

talent, and that traditional hiring practices do not follow the principles of free market because they
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MERGERS AND ACQUISITIONS: DOING THE DEAL

Start with an Offer

When the CEO and top managers of a company decide that they want to do a merger or acquisition,

they start with a tender offer. The process typically begins with the acquiring company carefully

and discreetly buying up shares in the target company, or building a position. Once the acquiring

company starts to purchase shares in the open market, it is restricted to buying 5% of the total

outstanding shares before it must file with the SEC. In the filing, the company must formally

declare how many shares it owns and whether it intends to buy the company or keep the shares

purely as an investment

Working with financial advisors and investment bankers, the acquiring company will arrive at an

overall price that it's willing to pay for its target in cash, shares or both. The tender offer is then

frequently advertised in the business press, stating the offer price and the deadline by which the

shareholders in the target company must accept (or reject) it

The Target's Response

Once the tender offer has been made, the target company can do one of several things:

Accept the Terms of the Offer - If the target firm's top managers and shareholders arehappy with the terms of the transaction, they will go ahead with the deal.

Attempt to Negotiate - The tender offer price may not be high enough for the targetcompany's shareholders to accept, or the specific terms of the deal may not be attractive. In

a merger, there may be much at stake for the management of the target - their jobs, in

particular. If they're not satisfied with the terms laid out in the tender offer, the target's

management may try to work out more agreeable terms that let them keep their jobs or, even

better, send them off with a nice, big compensation package.

Not surprisingly, highly sought-after target companies that are the object of several bidderswill have greater latitude for negotiation. Furthermore, managers have more negotiating

power if they can show that they are crucial to the merger's future success.

Execute a Poison Pill or Some Other Hostile Takeover DefenseA poison pill schemecan be triggered by a target company when a hostile suitor acquires a predetermined

percentage of company stock. To execute its defense, the target company grants all

shareholders - except the acquiring company - options to buy additional stock at a dramatic
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discount. This dilutes the acquiring company's share and intercepts its control of the

company.

Find a White Knight - As an alternative, the target company's management may seek out afriendlier potential acquiring company, orwhite knight. If a white knight is found, it will

offer an equal or higher price for the shares than the hostile bidder.

Mergers and acquisitions can face scrutiny from regulatory bodies. For example, if the two biggest

long-distance companies in the U.S., AT&T and Sprint, wanted to merge, the deal would require

approval from the Federal Communications Commission (FCC). The FCC would probably regard a

merger of the two giants as the creation of a monopoly or, at the very least, a threat to competition

in the industry.

Closing the Deal

Finally, once the target company agrees to the tender offer and regulatory requirements are met, the

merger deal will be executed by means of some transaction. In a merger in which one company

buys another, the acquiring company will pay for the target company's shares with cash, stock or

both.

A cash-for-stock transaction is fairly straightforward: target company shareholders receive a cash

payment for each share purchased. This transaction is treated as a taxable sale of the shares of the

target company.

If the transaction is made with stock instead of cash, then it's not taxable. There is simply an

exchange of share certificates. The desire to steer clear of the tax man explains why so many M&A

deals are carried out as stock-for-stock transactions.

When a company is purchased with stock, new shares from the acquiring company's stock areissued directly to the target company's shareholders, or the new shares are sent to a broker who

manages them for target company shareholders. The shareholders of the target company are only

taxed when they sell their new shares.

When the deal is closed, investors usually receive a new stock in their portfolios - the acquiring

company's expanded stock. Sometimes investors will get new stock identifying a new corporate

entity that is created by the M&A deal
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MERGERS AND ACQUISITIONS: BREAK UPS

As mergers capture the imagination of many investors and companies, the idea of getting smaller

might seem counterintuitive. But corporate break-ups, orde-mergers, can be very attractive options

for companies and their shareholders.

Advantages

The rationale behind a spinoff, tracking stock or carve-out is that "the parts are greater than the

whole." These corporate restructuring techniques, which involve the separation of a business unit or

subsidiary from the parent, can help a company raise additional equity funds. A break-up can also

boost a company's valuation by providing powerful incentives to the people who work in the

separating unit, and help the parent's management to focus on core operations.

Most importantly, shareholders get better information about the business unit because it issues

separate financial statements. This is particularly useful when a company's traditional line of

business differs from the separated business unit. With separate financial disclosure, investors are

better equipped to gauge the value of the parent corporation. The parent company might attract

more investors and, ultimately, more capital.

Also, separating a subsidiary from its parent can reduce internal competition for corporate funds.

For investors, that's great news: it curbs the kind of negative internal wrangling that can

compromise the unity and productivity of a company.

For employees of the new separate entity, there is a publicly traded stock to motivate and reward

them. Stock options in the parent often provide little incentive to subsidiary managers, especially

because their efforts are buried in the firm's overall performance.

Disadvantages

That said, de-merged firms are likely to be substantially smaller than their parents, possibly making

it harder to tap credit markets and costlier finance that may be affordable only for larger companies.

And the smaller size of the firm may mean it has less representation on major indexes, making it

more difficult to attract interest from institutional investors. Meanwhile, there are the extra costs

that the parts of the business face if separated. When a firm divides itself into smaller units, it may

be losing the synergy that it had as a larger entity. For instance, the division of expenses such as

marketing, administration and research and development (R&D) into different business units may

cause redundant costs without increasing overall revenues
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Restructuring Methods

There are several restructuring methods: doing an outright sell-off, doing an equity carve-out,

spinning off a unit to existing shareholders or issuing tracking stock. Each has advantages and

disadvantages for companies and investors. All of these deals are quite complex.

Sell-Offs

A sell-off, also known as a divestiture, is the outright sale of a company subsidiary. Normally, sell-

offs are done because the subsidiary doesn't fit into the parent company's core strategy. The market

may be undervaluing the combined businesses due to a lack of synergy between the parent and

subsidiary. As a result, management and the board decide that the subsidiary is better off under

different ownership.

Besides getting rid of an unwanted subsidiary, sell-offs also raise cash, which can be used to pay off

debt. In the late 1980s and early 1990s, corporate raiders would use debt to finance acquisitions.

Then, after making a purchase they would sell-off its subsidiaries to raise cash to service the debt.

The raiders' method certainly makes sense if the sum of the parts is greater than the whole. When it

isn't, deals are unsuccessful.

Equity Carve-Outs

More and more companies are using equity carve-outs to boost shareholder value. A parent firm

makes a subsidiary public through an initial public offering (IPO) of shares, amounting to a partial

sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the

newly traded subsidiary.

A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is growing

faster and carrying higher valuations than other businesses owned by the parent. A carve-outgenerates cash because shares in the subsidiary are sold to the public, but the issue also unlocks the

value of the subsidiary unit and enhances the parent's shareholder value.

The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains

some control. In these cases, some portion of the parent firm's board of directors may be shared.

Since the parent has a controlling stake, meaning both firms have common shareholders, the

connection between the two will likely be strong.
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That said, sometimes companies carve-out a subsidiary not because it's doing well, but because it is

a burden. Such an intention won't lead to a successful result, especially if a carved-out subsidiary is

too loaded with debt, or had trouble even when it was a part of the parent and is lacking an

established track record for growing revenues and profits.

Carve-outs can also create unexpected friction between the parent and subsidiary. Problems can

arise as managers of the carved-out company must be accountable to their public shareholders as

well as the owners of the parent company. This can create divided loyalties.

Spinoffs

A spinoff occurs when a subsidiary becomes an independent entity. The parent firm distributes

shares of the subsidiary to its shareholders through a stock dividend. Since this transaction is a

dividend distribution, no cash is generated. Thus, spinoffs are unlikely to be used when a firm needs

to finance growth or deals. Like the carve-out, the subsidiary becomes a separate legal entity with a

distinct management and board.

Like carve-outs, spinoffs are usually about separating a healthy operation. In most cases, spinoffs

unlock hidden shareholder value. For the parent company, it sharpens management focus. For the

spinoff company, management doesn't have to compete for the parent's attention and capital. Once

they are set free, managers can explore new opportunities.

Investors, however, should beware of throw-away subsidiaries the parent created to separate legal

liability or to off-load debt. Once spinoff shares are issued to parent company shareholders, some

shareholders may be tempted to quickly dump these shares on the market, depressing the share

valuation.

Tracking Stock

A tracking stock is a special type of stock issued by a publicly held company to track the value of

one segment of that company. The stock allows the different segments of the company to be valued

differently by investors.

Let's say a slow-growth company trading at a low price-earnings ratio (P/E ratio) happens to have a

fast growing business unit. The company might issue a tracking stock so the market can value the

new business separately from the old one and at a significantly higher P/E rating.
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Why would a firm issue a tracking stock rather than spinning-off or carving-out its fast growth

business for shareholders? The company retains control over the subsidiary; the two businesses can

continue to enjoy synergies and share marketing, administrative support functions, a headquarters

and so on. Finally, and most importantly, if the tracking stock climbs in value, the parent company

can use the tracking stock it owns to make acquisitions.

Still, shareholders need to remember that tracking stocks are class B, meaning they don't grant

shareholders the same voting rights as those of the main stock. Each share of tracking stock may

have only a half or a quarter of a vote. In rare cases, holders of tracking stock have no vote at all.
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MERGERS AND ACQUISITIONS: WHY THEY CAN FAIL

It's no secret that plenty of mergers don't work. Those who advocate mergers will argue that the

merger will cut costs or boost revenues by more than enough to justify the price premium. It can

sound so simple: just combine computer systems, merge a few departments, use sheer size to force

down the price of supplies and the merged giant should be more profitable than its parts. In theory,

1+1 = 3 sounds great, but in practice, things can go awry.

Historical trends show that roughly two thirds of big mergers will disappoint on their own terms,

which means they will lose value on the stock market. The motivations that drive mergers can be

flawed and efficiencies from economies of scale may prove elusive. In many cases, the problems

associated with trying to make merged companies work are all too concrete.

Flawed Intentions

For starters, a booming stock market encourages mergers, which can spell trouble. Deals done with

highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be

easy and cheap too. Also, mergers are often attempt to imitate: somebody else has done a big

merger, which prompts other top executives to follow suit.

A merger may often have more to do with glory-seeking than business strategy. The executive ego,

which is boosted by buying the competition, is a major force in M&A, especially when combined

with the influences from the bankers, lawyers and other assorted advisers who can earn big fees

from clients engaged in mergers. Most CEOs get to where they are because they want to be the

biggest and the best, and many top executives get a big bonus for merger deals, no matter what

happens to the share price later.

On the other side of the coin, mergers can be driven by generalized fear. Globalization, the arrival

of new technological developments or a fast-changing economic landscape that makes the outlook

uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the

management team feels they have no choice and must acquire a rival before being acquired. The

idea is that only big players will survive a more competitive world.
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The Obstacles to Making it Work

Coping with a merger can make top managers spread their time too thinly and neglect their core

business, spelling doom. Too often, potential difficulties seem trivial to managers caught up in the

thrill of the big deal.

The chances for success are further hampered if the corporate cultures of the companies are very

different. When a company is acquired, the decision is typically based on product or market

synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues

are easily overcome. For example, employees at a target company might be accustomed to easy

access to top management, flexible work schedules or even a relaxed dress code. These aspects of a

working environment may not seem significant, but if new management removes them, the result

can be resentment and shrinking productivity.

More insight into the failure of mergers is found in the highly acclaimed study from McKinsey, a

global consultancy. The study concludes that companies often focus too intently on cutting costs

following mergers, while revenues, and ultimately, profits, suffer. Merging companies can focus on

integration and cost-cutting so much that they neglect day-to-day business, thereby prompting

nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to

create value for shareholders.

But remember, not all mergers fail. Size and global reach can be advantageous, and strong

managers can often squeeze greater efficiency out of badly run rivals. Nevertheless, the promises

made by deal makers demand the careful scrutiny of investors. The success of mergers depends on

how realistic the deal makers are and how well they can integrate two companies while maintaining

day-to-day operations.


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Specialist M&A advisory firms

Although at present the majority of M&A advice is provided by full-service investment banks,

recent years have seen a rise in the prominence of specialist M&A advisers, who only provide

M&A advice (and not financing). These companies are sometimes referred to as Transition

companies, assisting businesses often referred to as "companies in transition." To perform these

services in the US, an advisor must be a licensed broker dealer, and subject to SEC (FINRA)

regulation. More information on M&A advisory firms is provided at corporate advisory.

Cross-border M&A

In a study conducted in 2000 by Lehman Brothers, it was found that, on average, large M&A deals

cause the domestic currency of the target corporation to appreciate by 1% relative to the acquirers.

The rise of globalization has exponentially increased the necessity for MAIC Trust accounts and

securities clearing services for Like-Kind Exchanges for cross-border M&A. In 1997 alone, there

were over 2333 cross-border transactions, worth a total of approximately $298 billion. Due to the

complicated nature of cross-border M&A, the vast majority of cross-border actions have

unsuccessful anies seek to expand their global footprint and become more agile at creating high-

performing businesses and cultures across national boundaries.[18]

Even mergers of companies with headquarters in the same country are very much of this type and

require MAIC custodial services (cross-border Mergers). After all, when Boeing acquires

McDonnell Douglas, the two American companies must integrate operations in dozens of countries

around the world. This is just as true for other supposedly "single country" mergers, such as the $29

billion dollar merger of Swiss drug makers Sandoz and Ciba-Geigy (now Novartis).

M&A in popular culture

In the novel American Psycho the protagonist Patrick Bateman, played by Christian Bale in the film

adaptation, works in mergers and acquisitions, which he once referred to as "murders and

executions" to a potential victim.

In the film The Thomas Crown Affair, Thomas Crown is the CEO of a fictional mergers and

acquisitions firm, called Crown Acquisitions.
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