Mergers, Acquisitions And Corporate Restructuring

Prasad G. Godbole

Copyright 2009 Vikas Publishing House Pvt. Ltd. All rights reserved. Prasad G. Godbole. All rights reserved.

Chapter 4
Mergers and Acquisitions Motives and Synergies

Copyright 2009 Vikas Publishing House Pvt. Ltd. All rights reserved. Prasad G. Godbole. All rights reserved.

CHAPTER 4

M & A is primarily a growth strategy. However, apart from the lure of quantum growth in shortest possible time, there are many other valid motives/ theories for which companies (acquirer companies) resort to M & A.

Lets explore those.

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Merger Motives as summarized by Friedrich Trautwein

Net gains through synergies Merger benefits bidders Merger as a rational shareholders choice Wealth transfer from targets customers Wealth transfer from targets shareholders Net gains through private information

Efficiency Theory Monopoly Theory

Raider Theory

Valuation Theory

Merger benefits bidders managers

Merger as a process outcome Merger as a macroeconomic phenomenon

Empire-building Theory
Process Theory Disturbance Theory

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Merger Motives as summarized by Friedrich Trautwein

Trautwein has classified the first four theories or motives as beneficial to the shareholders of the acquirer company. The fifth one has been classified as beneficial to the managers of the acquirer company and not to its shareholders. In Trautweins view, process theory explains mergers to be an outcome of a process, whereas, by using disturbance theory he tries to explain mergers as a macroeconomic phenomenon.

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Monopoly Theory

This theory explains M&A as being planned and executed to achieve market power, at times including pricing power.

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Monopoly Theory
Monopoly theorys working areas
Market leaders trying to consolidate their position further Profitable and cashrich companies trying to gain market leadership

Example1

Example 2

Mittal Steel acquiring Arcelor

Reliance Industries Limited (RIL) acquiring Indian Petrochemicals Corporation Limited (IPCL) Grasim acquiring Larsen and Toubros (L&T) cement division

Tata steel acquiring Corus

Market entry strategy

Vodafones acquisition of Hutchison Essar

Monster Worldwide acquiring Jobsahead.com

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Efficiency Theory

This theory explains M&A as being planned and executed to achieve synergies, thereby, adding to enterprise valuation.

The rationale here is to create value not hitherto existing by pooling various resources of the acquirer and target companies.

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Efficiency Theory
1. Important points about Synergy Theory:

2.
3.

Revenue generating synergies are far more difficult to achieve than cost reduction synergies. Many a times, even honestly estimated synergies actually fail to materialize. Many a times the acquirers management ends up knowingly overestimating synergies in order to justify the hefty control premium it pays or proposes to pay for the acquisition.

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Efficiency Theory
The synergies are broadly divided into:
(a) Revenue generating synergyRevenue generating synergy can be described as the generation of much higher growth rate and turnover than the individual companies growth rates during independent operations. Example: Merger of ICICI with ICICI bank was to enhance the fee-based income.

(b) Cost reduction synergyIf the combined operations result in cost savings, in any of the areas viz., manufacturing, marketing, operations, manpower, corporate overheads, etc., it would be the case of cost reduction synergy.

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Efficiency Theory

There are five types of synergies:

Synergies

Revenue generating synergies

Cost reduction synergies

Manufacturing Synergy

Operations Synergy

Marketing Synergy

Financial Synergy

Tax Synergy

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Efficiency Theory
(a)

Manufacturing Synergy It involves combining the core competencies of the acquirer company in different areas of manufacturing, technology, design and development, procurement, etc. Examples: Tata Motors acquisition of Daewoos commercial vehicle unit; Synergy: It gave Tata Motors an advantage of producing commercial vehicles in the 200-400 bhp range. Daiichi Sankyo and Ranbaxy deal Synergy: R & D strength of Daiichi was combined with the efficient manufacturing of Ranbaxy.

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Efficiency Theory
(b) Operations Synergy

It involves rationalizing the combined operations in such a manner that through sharing of facilities such as warehouses, transportation facilities, software and common services, etc., duplication is avoided and logistics are improved leading to quantum cost saving. Examples: Kingfisher Airlines acquired Deccan Airways Synergy: To achieve substantial savings through rationalization of routes, reduction in the combined number of flights on the same routes, sharing of commercial and ground handling staff, reduction in the combined number of airplanes in use, etc. Cont.

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Efficiency Theory

Oriental Bank of Commerces (OBC) takeover of Global Trust Bank (GTB) Synergy: From OBCs strong branch network in the north and GTBs strong network and franchise in the western and southern part of India. Videsh Sanchar Nigam Limited (VSNL) acquired Tyco Synergy: On the basis of bandwidth and technology

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Efficiency Theory
(c) Marketing Synergy

It involves using either the common sales force or distribution channel or media to push the products and brands of both the acquirer and target companies at lower costs than the sum total of costs that they would incur in independent marketing operations. Involves leveraging on the brand equity of one of the two companies to push the sale of the second companys products. Can involve acquiring better pricing power on account of two companies coming together.

Cont.

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Efficiency Theory

Examples: Hindustan Lever Limited (HLL) acquired Lakmes brand and business Synergy: Aimed at using HLLs vast distribution network to leverage on the strong brand equity of Lakme in the womens cosmetics business. Dilip Piramal acquired Universal Luggage Synergy: To use the common distribution channel and sales force to push both the companies products. Also to gain improved pricing power.

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Efficiency Theory
(d) Financial Synergy

It involves combining both the acquirer and target companies balance sheets to achieve either a reduction in the weighted average cost of capital or a better gearing ratio or other improved financial parameters.

In this, one has to effect the target companys merger with the acquirer company.

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Efficiency Theory
(e) Tax Synergy

It involves merging a loss-making company with a profitable one so that the profitable company can get tax benefits by writing off accumulated losses of the loss-making company against the profits of the profit making company.

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Valuation Theory
This theory explains the M&A as being planned and executed by the acquirer who has better information about the valuation of the target company than the stock market as a whole and who estimates the real intrinsic value to be much higher than the present market capitalization of the company. Such an acquirer is ready to pay premium over the present market price to acquire control over the target company.

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Valuation Theory

Efficient Markets Theory argues that stock markets are perfect and efficient when it comes to determining the right of any company. Then, how is it possible that the market capitalization is much below the true intrinsic value of the company?

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Valuation Theory

This theory is in sharp contrast to the Efficient Markets TheoryIf the acquirer becomes privy to information gaps, costs and also critical inside information of the markets, he will find the intrinsic value of the company to be much higher than the market capitalization. The acquirer may have the same information about the company as the stock market, but has a different view on the future cash flows based on his own reading of the future course of economy or the company.

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Valuation Theory

In case of the companies having substantial off-balance sheet assets, the acquirer may put much more value to the company than the stock market. A cash-rich company planning to acquire competitors can find undervalued companies at the end of a prolonged recessionjust before the boom. In case of underperforming companies having strong brand (s), the acquirer may be confident of leveraging on such brands and generating growth and cash flows and hence, may put a much higher value to the company than the stock market.

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Raider Theory

Raider Theory explains the M&A activity in specific context of PE funds, where the acquirer acquires non controlling but influential stake in cash needy companies at much lower valuation than potential valuation or even present valuation, just to transfer the wealth from existing shareholders to themselves without any strategic intent of running these companies themselves. In India, so far as the unlisted companies are concerned, it would be possible for PE funds to acquire equity shares at a price that is even below the present intrinsic value of the company. The Raider theory does not work in case of listed companies in India.

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Empire Building Theory

Empire Building Theory tries to explain M&A as being planned and executed by the managers for expanding their own empire rather than creating wealth for shareholders.