Chapter 9 : Mergers and Acquisitions
Chapter 9 : Mergers and Acquisitions Take Overs: “Purchase by a company of a controlling interest in the voting share capital of another company” Mergers: “Merger is a business combination that results in the creation of a new reporting entity formed from the combining parties” (Mutual sharing of risks and benefits) Reasons for Mergers/Take Overs: 1. Synergy (1+1=11) 2. Eliminating competition 3. Entry in new market 4. Spread risk (diversification) 5. Acquisition is cheaper than internal expansion 6. Assets backing 7. Management acquisition 8. Operating economies (by eliminating duplicate and competing facilities) 9. Improvement of liquidity and finance-raising ability Deciding factors in a takeover decision: 1. Cost 2. Value a. Earning basis b. Assets basis c. Prospects for sale and growth basis d. Saving brought and additional expenditure basis 3. Will it be desirable for shareholders and stock market 4. What will be form of purchase consideration a. Cash (borrowed) b. Equity shares c. Debentures d. Convertible Loan Stock 5. How takeover would be reflected in published accounts Risks for shareholders of acquiring company in takeover: 1. Decrease in EPS of own company 2. Decrease in Share Price of own company 3. Decrease in Assets backing per share (decrease in net assets) 4. Entry in risky industry When takeover resisted by Target Company: Unwilling to sell Under bidding Unattractive after tax value Terms are poor Opposed by employees Founder appeals loyalty of shareholders Counter steps by Target Company: 1. Issuing a forecast of attractive future profits and dividends. 2. Launching advertising campaign against the takeover bid. 3. Finding a “White Knight”, i.e. a company which will make a welcome takeover bid. 4. Making a counter bid for the predator company. 5. Arranging a management buyout 6. Introducing a “Poison-Pill” , i.e. anti takeover advice Tactics by Acquiring company: Persuading dissatisfied shareholders High prices
Payment Methods Cash Purchase Share exchange Use of convertible loan stock Earn out arrangements Methods are affected by Availability of cash Desired level of gearing Changes in control Changes in structure
Choice of Cash or Paper offer or Both for payment depends on view of parties: Acquiring company and its shareholders: If purchase consideration is in equity shares, EPS might fall. If purchase consideration is in debentures (or cash borrowed elsewhere), it will be cheaper because Interest will be allowable for tax purposes and earnings will not be diluted. Issue of additional loan stock will be unacceptable for parties if company is highly geared. Issuance of large new shares will significantly change controlling structure. Payment in shares preserves cash available. Company might have to increase authorized share capital or borrowing limits. Target Company: If Cash is received, tax on capital gain will become payable immediately. If other consideration is received, it is to be ensured that o Existing income is at least maintained, and o Shares retain their value. If shareholders want to have stake in business, they will prefer shares. Mezzanine Finance: (by biding company; to pay for shares) Lies between equity and debt finance. It is short to medium term, unsecured, high rate of return loan It has option to exchange loan for share after takeover. It is also used in MBO. Earn-out arrangement: When consideration is payable upon the target company reaching certain performance targets. EPS before and after a takeover: Share purchased at higher P/E ratio will give fall in EPS, and vice versa. Company may accept dilution of earnings on acquisition if: There is increase in net assets backing.(from a company having more assets and less earnings) Quality of earnings is superior. Post acquisition integration: (Drucker’s 5 golden rules) 1. There must be common core of unity. 2. Acquirer must ask, “What is in for us” and “ What we can offer” 3. Acquirer must treat product, market and customers of acquired company with respect. 4. Acquirer must provide top management with relevant skills within one year. 5. Cross company promotions should occur within one year. 5 steps of Integration sequence: (C S Jones) 1. Decide and communicate initial reporting relationships 2. Achieve rapid control of key factors which will require access to right, accurate information 3. Human and physical Resource audit to get a clear picture 4. Redefine corporate objectives and to develop strategic plans 5. Revise the organizational structure
Failure of mergers and takeovers: 1. Strategic plan fails to produce expected benefits 2. Over optimism about future market conditions 3. Poor integration management 4. Cultural differences 5. Little or no post acquisition planning 6. Lack of knowledge of target company or industry 7. Little or no experience of acquisition. Impact of mergers and takeovers on stakeholders: On acquiring company’s shareholders EPS may fall especially in equity-financed bids and first time players Cost of mergers exceeds gains. On target company’s share holders Greatest benefit through significant premium over market price. Acquiring company management Increased status and influence Increased salary and benefits Target company management Key personnel will be kept others will be fired Other employees Economies of scale will be achieved by loss of job and eliminating duplication of services. Financial institution Outright winners The more complex, longer and problematic the deal is, the greater their fee income regardless of result.
Joint Ventures Joint ventures: (1st step of acquisition) “ It is an arrangement where two or more firms join forces for manufacturing, financial and marketing purposes and each has a share in both equity and management of business” Advantages: Joint contribution of o Production technology o Corporate expertise o Market knowledge Access to foreign markets Eliminating competition Cheaper than internal expansion Spread risk Suitable for smaller companies Problems: Conflict of interests Where profits will go (in resident company or shareholders of foreign company) Local partners may wish to export to other countries where foreigner is already supplying. Transfer pricing issues (on transfer of expertise, technology and components) Cultural differences e.g. Equal employment opportunity Commercial practices Short term and long term planning Lack of smooth coordination, control and decision making Who will lead Who is responsible Confidentiality issues
Strategic Alliances Strategic Alliance: “ When two or more firms agree to work together to exploit common advantages” e.g. alliance between national airlines to cross-book passengers. Licenses Licenses are very similar to Franchising in their financial aspects, however degree of central control and support is usually less.
Franchising This gives limited right to franchisee (e.g. in a geographical area) to exploit patent product or production process, brands, manufacturing know how and/or technical advice and assistance. e.g. KFC, McDonald Mechanism: Franchiser grants permission. Franchisee pays for permission and assistance. Franchisee is responsible for day to day running of franchise. Franchiser may impose Quality Control Measures to ensure that goodwill is not damaged. Franchisee supplies capital, personal involvement and local market knowledge. Benefits to Franchiser: Rapid expansion (franchisee provides capital). Local knowledge. Economies of scale. Problems to Franchiser: Limited control over quality. Conflicts of interest. Franchisee may become competitor.
Key Financial management decisions:
Strategic Tactical
Operational
Investment Selection of products and markets Required level of profitability Fundamental fixed assets Efficient and effective use of resources Pricing Working capital management
Financing Target debt/equity mix
Dividend Capital growth or high dividend payout
Lease Vs. Buy
Scrip or dividend
Working management
capital
------
cash
Payment Methods Cash Purchase Share exchange Use of convertible loan stock Earn out arrangements Methods are affected by Availability of cash Desired level of gearing Changes in control Changes in structure
Choice of Cash or Paper offer or Both for payment depends on view of parties: Acquiring company and its shareholders: If purchase consideration is in equity shares, EPS might fall. If purchase consideration is in debentures (or cash borrowed elsewhere), it will be cheaper because Interest will be allowable for tax purposes and earnings will not be diluted. Issue of additional loan stock will be unacceptable for parties if company is highly geared. Issuance of large new shares will significantly change controlling structure. Payment in shares preserves cash available. Company might have to increase authorized share capital or borrowing limits. Target Company: If Cash is received, tax on capital gain will become payable immediately. If other consideration is received, it is to be ensured that o Existing income is at least maintained, and o Shares retain their value. If shareholders want to have stake in business, they will prefer shares. Mezzanine Finance: (by biding company; to pay for shares) Lies between equity and debt finance. It is short to medium term, unsecured, high rate of return loan It has option to exchange loan for share after takeover. It is also used in MBO. Earn-out arrangement: When consideration is payable upon the target company reaching certain performance targets. EPS before and after a takeover: Share purchased at higher P/E ratio will give fall in EPS, and vice versa. Company may accept dilution of earnings on acquisition if: There is increase in net assets backing.(from a company having more assets and less earnings) Quality of earnings is superior. Post acquisition integration: (Drucker’s 5 golden rules) 1. There must be common core of unity. 2. Acquirer must ask, “What is in for us” and “ What we can offer” 3. Acquirer must treat product, market and customers of acquired company with respect. 4. Acquirer must provide top management with relevant skills within one year. 5. Cross company promotions should occur within one year. 5 steps of Integration sequence: (C S Jones) 1. Decide and communicate initial reporting relationships 2. Achieve rapid control of key factors which will require access to right, accurate information 3. Human and physical Resource audit to get a clear picture 4. Redefine corporate objectives and to develop strategic plans 5. Revise the organizational structure
Failure of mergers and takeovers: 1. Strategic plan fails to produce expected benefits 2. Over optimism about future market conditions 3. Poor integration management 4. Cultural differences 5. Little or no post acquisition planning 6. Lack of knowledge of target company or industry 7. Little or no experience of acquisition. Impact of mergers and takeovers on stakeholders: On acquiring company’s shareholders EPS may fall especially in equity-financed bids and first time players Cost of mergers exceeds gains. On target company’s share holders Greatest benefit through significant premium over market price. Acquiring company management Increased status and influence Increased salary and benefits Target company management Key personnel will be kept others will be fired Other employees Economies of scale will be achieved by loss of job and eliminating duplication of services. Financial institution Outright winners The more complex, longer and problematic the deal is, the greater their fee income regardless of result.
Joint Ventures Joint ventures: (1st step of acquisition) “ It is an arrangement where two or more firms join forces for manufacturing, financial and marketing purposes and each has a share in both equity and management of business” Advantages: Joint contribution of o Production technology o Corporate expertise o Market knowledge Access to foreign markets Eliminating competition Cheaper than internal expansion Spread risk Suitable for smaller companies Problems: Conflict of interests Where profits will go (in resident company or shareholders of foreign company) Local partners may wish to export to other countries where foreigner is already supplying. Transfer pricing issues (on transfer of expertise, technology and components) Cultural differences e.g. Equal employment opportunity Commercial practices Short term and long term planning Lack of smooth coordination, control and decision making Who will lead Who is responsible Confidentiality issues
Strategic Alliances Strategic Alliance: “ When two or more firms agree to work together to exploit common advantages” e.g. alliance between national airlines to cross-book passengers. Licenses Licenses are very similar to Franchising in their financial aspects, however degree of central control and support is usually less.
Franchising This gives limited right to franchisee (e.g. in a geographical area) to exploit patent product or production process, brands, manufacturing know how and/or technical advice and assistance. e.g. KFC, McDonald Mechanism: Franchiser grants permission. Franchisee pays for permission and assistance. Franchisee is responsible for day to day running of franchise. Franchiser may impose Quality Control Measures to ensure that goodwill is not damaged. Franchisee supplies capital, personal involvement and local market knowledge. Benefits to Franchiser: Rapid expansion (franchisee provides capital). Local knowledge. Economies of scale. Problems to Franchiser: Limited control over quality. Conflicts of interest. Franchisee may become competitor.
Key Financial management decisions:
Strategic Tactical
Operational
Investment Selection of products and markets Required level of profitability Fundamental fixed assets Efficient and effective use of resources Pricing Working capital management
Financing Target debt/equity mix
Dividend Capital growth or high dividend payout
Lease Vs. Buy
Scrip or dividend
Working management
capital
------
cash
