June 16, 2015
Mergers and acquisitions (M&A) are defined as consolidation of companies. Differentiating the two terms, Mergers is the combination of two companies to form one, while Acquisitions is one company taken over by the other. M&A is one of the major aspects of corporate finance world. The reasoning behind M&A generally given is that two separate companies together create more value compared to being on an individual stand. With the objective of wealth maximization, companies keep evaluating different opportunities through the route of merger or acquisition.
• by purchasing assets
• by purchasing common shares
• by exchange of shares for assets
• by exchanging shares for shares
Merger or amalgamation may take two forms: merger through absorption or merger through consolidation. Mergers can also be classified into three types from an economic perspective depending on the business combinations, whether in the same industry or not, into horizontal ( two firms are in the same industry), vertical (at different production stages or value chain) and conglomerate (unrelated industries). From a legal perspective, there are different types of mergers like short form merger, statutory merger, subsidiary merger and merger of equals.
• Financial synergy for lower cost of capital
• Improving company’s performance and accelerate growth
• Economies of scale
• Diversification for higher growth products or markets
• To increase market share and positioning giving broader market access
• Strategic realignment and technological change
• Tax considerations
• Under valued target
• Diversification of risk
There is always synergy value created by the joining or merger of two companies. The synergy value can be seen either through the Revenues (higher revenues), Expenses (lowering of expenses) or the cost of capital (lowering of overall cost of capital).
• The company must be willing to take the risk and vigilantly make investments to benefit fully from the merger as the competitors and the industry take heed quickly
• To reduce and diversify risk, multiple bets must be made, in order to narrow down to the one that will prove fruitful
• The management of the acquiring firm must learn to be resilient, patient and be able to adopt to the change owing to ever-changing business dynamics in the industry
Phase 1: Pre-acquisition review: this would include self assessment of the acquiring company with regards to the need for M&A, ascertain the valuation (undervalued is the key) and chalk out the growth plan through the target.
Phase 2: Search and screen targets: This would include searching for the possible apt takeover candidates. This process is mainly to scan for a good strategic fit for the acquiring company.
Phase 3: Investigate and valuation of the target: Once the appropriate company is shortlisted through primary screening, detailed analysis of the target company has to be done. This is also referred to as due diligence.
Phase 4: Acquire the target through negotiations: Once the target company is selected, the next step is to start negotiations to come to consensus for a negotiated merger or a bear hug. This brings both the companies to agree mutually to the deal for the long term working of the M&A.
Phase 5:Post merger integration: If all the above steps fall in place, there is a formal announcement of the agreement of merger by both the participating companies.
Poor strategic fit: Wide difference in objectives and strategies of the company
Poorly managed Integration: Integration is often poorly managed without planning and design. This leads to failure of implementation
Incomplete due diligence: Inadequate due diligence can lead to failure of M&A as it is the crux of the entire strategy
Overly optimistic: Too optimistic projections about the target company leads to bad decisions and failure of the M&A
Example: Breakdown in merger discussions between IBM and Sun Microsystems happened due to disagreement over price and other terms.
The deal has been completed: The companies have got the approval of merger from different authorities.
This is a classic example of a share swap deal. As per the deal, Ranbaxy shareholders will get four shares of Sun Pharma for every five shares held by them, leading to 16.4% dilution in the equity capital of Sun Pharma (total equity value is USD3.2bn and the deal size is USD4bn (valuing Ranbaxy at 2.2 times last 12 months sales).
Reason for the acquisition: This is a good acquisition for Sun Pharma as it will help the company to fill in its therapeutic gaps in the US, get better access to emerging markets and also strengthen its presence in the domestic market. Sun Pharma will also become the number one generic company in the dermatology space. (currently in the third position in US) through this merger.
Objectives of the M&A:
• Sun Pharma enters into newer markets by filling in the gaps in the offerings of the company, through the acquired company
• Boosting of products offering of Sun Pharma creating more visibility and market share in the industry
• Turnaround of a distressed business from the perspective of Ranbaxy
This acquisition although will take time to consolidate, it should in due course start showing results through overall growth depicted in Sun Pharma’s top-line and bottom-line reporting.
This is an example where there is a merger in the same industry (horizontal). It was done to consolidate the IT businesses. The objective of this merger, as indicated by the management of CMC, was that the amalgamation will enable TCS to consolidate CMC’s operations into a single company with rationalised structure, enhanced reach, greater financial strength and flexibility. Further it also indicated that, it will aid in achieving economies of scale, more focused operational efforts, standardisation and simplification of business processes and productivity improvements.
M&A’s are considered as important change agents and are a critical component of any business strategy. The known fact is that with businesses evolving, only the most innovative and nimble can survive. That is why, it is an important strategic call for a business to opt for any arrangements of M&A. Once through the process, on a lighter note M&A is like an arranged marriage, partners will take time to understand, mingle, but will end up giving positive results most of the times.