Merger & Acquisition
In this corporate world, there is a very important and hot topic called merger and acquisition. The main motive for integration is to accelerate the growth and expand the acquirer business. But there is a question i.e. why do merger create? To answer this question firstly take a look on whether the merger create value, and if it so then for whom. By making an acquisition it affects on firm return as well as change it risk.
Takeover can be in the form of merger, proxy contest and tender offer. When merging is happened the acquirer offering to buy the target company stock but at higher price which is excess to the previous market value of offeree company. When successful or an unsuccessful (M&A) take place in the market it effect immediately on the share prices of both the acquirer and target. When there is successful merger then the shareholder might benefit substantially from acquisition. If takeover is unsuccessful, the share prices fall to pre offer level. Some studies show that when the offer is successful the target firms experience green light in stock exchanges mean get abnormal gain. When the acquirer's bid successfully accepted by the target company then the evidence shows that takeover create value.As said by Mandelker’s
“Stockholders of acquiring firms seem to earn normal from mergers as from mergers other investment production activities with commensurate risk levels stockholders of acquired firms earn abnormal return of approximately 14% on the average in the 7 months preceding the mergers.” Mandelker’s (1974)
According to above quote the successful target firm gain significant increase in stock prices this is because the acquiring company pay the premium to the target firm by bidding more than its past value.
“ acquiring firm shareholders on average earn about 4% in the hostile takeovers and roughly zero in mergers”Jensen(1970)
“Jarrell and Poulsen find that successful bidder may be decline in the profit. Jarrell and Poulsen find that there was significant abnormal return of 5% to acquiring firm in the 60s, 2.2% in 70s and insignificantly abnormal loss in 80s.”Jarrell and Poulson (1984)
According to the above quotation the successful bidder company in successful takeover is sometime do not get increase in return but some time it stay red in stock market. The reason is that acquirer donot know what he is going to buy it may be risk that is why its share prices going down. But instead of this acquiring firm talk about synergies (increase productivity and reduce cost).
As we can see in Exxon and Mobil takeover the Exxon is a bidder who bid for Mobil company. When the target company accept the bid the share price of Exxon is plunge slightly. Exxon gives target shareholder $1.32 for Mobil shares.
“Acquisition motive may be defined in terms of the acquirer’s corporate and business strategy objectives.” Sudarsanam (199, p.13)
Synergies play an important role in (M&A). Pre-deal evaluation of synergies is helpful to enhancement of success to 28%. Productive efficiency is an ability of company to get higher output by utilising less input. When two companies merge it create a value which is more than the value as separate. This surge in value comes from the increase in revenue and decrease in cost. When there is integration it means the labour skills and market outlet come across to sell more goods. The value is created when gain is greater than the transaction cost. As a basic sense in M&A that synergies is eliminating the weakness and create the strength. For example if a company is strong in product line and weak in sales. The competitor may be strong in sale and vice versa. If these two firms combine (M&A) properly then the combination will eliminate the potential weakness and bring more key strength for both the companies. One real life example is thatin 2001the success of Kellogg’s acquisition with Keble which made cookies. As Kellogg’s realised that there is decline in cereal so with this Kellogg’s made cereal bars and put this on the supermarket shelf’s which help them to increase there profit. And Kellogg’s eliminate its weakness and come up with strength to increase the shareholder value. From merging the companies have to reduce their staff to cut the cost and maximizing company growth.
The main ingredient is to increase the market power. This is because it helps to control over the price of the products. This power can be gain from monopoly or de facto cooperation. When there is (M&A), the market power of acquiring company will be increase by merging. This market power can be achieve by monopoly, collusion or de facto cooperation. If a firm has large scale in the market then it may be able to push the price of goods sold because the customer do not have choice because this is the only firm who can supply this good in the market.
The main important ingredient of synergy is economies of scale. For example, the larger size of company may be good in sale efficiency and one more advantage is that the cost per unit output is low. Economies in marketing benefited in as by advertising jointly to reduce cost. For example, Kraft wanted to take over Cadbury because it wanted to take control of the valuable channel of Cadbury. Multi products can be joining together such as wool and meat the common input is sheep. In economies of scale we can reduce the input cost and we get better output. Merger can also looking for new technologies as if a target company good in new technology which help them to maximising companies growth then acquirer can bid on that to get new Research & Development. Merger companies can take advantage of tax by merging with other countries companies. As we know that tax, system of UK is very strict. Mostly companies want to merge with other countries companies to reduce their tax after profit.
If the cash flow is coming from wide range of products and markets then the overall income stream will be less volatile. For example if a merging company has a wide range of products to sell in the market then it will help to reduce the risk. However, the shareholders are going to invest in those products where there is high return. In theory firm should save money to invest in future money which will produce greater return than the investor opportunity cost of capital. When cash is in surpluses then it will give back to shareholder. But it does not happen in real world because managers are going to invest this cash to merge with other company to gain more in future.
“A conglomerate rate merger generally leads, through the diversification effect to reduced risk for the combined entity.” Amihud & Lev (1981)
BP and Amoco US oil giant merged in 1998. When they merged the share price of BP will soared by 15%. For Amoco the share price also increase from $40 to $46. In this takeover the 60% of shareholder will be BP and rest of them are from Amoco. With this merger 6000 job will lay off worldwide.
“shows that the stockholders of bidding firms either gain a small statistically insignificant amount.”Langetieg (1978)
From above example we see that when the takeover takes place there was surge in share prices of both the companies. As above quotation it seems legal that acquirer also gains from merging. This is horizontalmerger. Instead of takeover surge in share prices there are other reason which affects the company such as synergy, economies of scale and risk diversification. From this takeover BP want to increase its strength in US market. This alliance will help BP to take a lot of profit from Amoco oil reservoir.The main important aspect is synergies mean increase productivity with reduce cost.BP announced to cut 6000 jobs worldwide to reduce cost.BP knows how about oil industry market which is a great advantage for them. It also help to eliminate the monopoly in US because Amoco was 4thlargestoil company in US. BP also gets the advantage of Amoco different channel of distribution.
From the above discussion it concluded that merger can create value. When the target accepts the bid and acquirer do not lose, so the evidence shows that takeovers create value. As acquiring firm is large than the target, the total return of target and acquiring company return do not measure the gain to the merging firms. As we know that “the dollar value of small percentage losses for bidders could exceed the dollar value of large percentage gains to targets.” At the time of merging many studies shows that target company get increase in share prices then acquirer. For acquirer there are other factor where they can measure there company values such as synergies and Economies of scale etc. Synergies increases the merger efficiencyby reducing cost and it increase the productivity because 1+1=3.
Bibliography:
Arnold, Glen; Arnold; Glen, 2010. Handbook of Corporate finance: a business companion to financial markets, decision & techniques Harlow: FT Prentice Hall
Gregory, Alan; Cooper, Cary L, 2000. Advances in Mergers & Acquisitions London: JAI
Morris, Joseph M; Brendel, James N 2000 Mergers and Aquisition: Business strategies for accountants Newyork; Chichester: Wiley
North-Holland Publishing Company; Smith, Clifford W. 1990 Modern Theory of Corporate Finance New York; London: McGraw-Hill
