Chapter 3

MERGERS AND ACQUISITIONS

Learning outcomes:
Understand the mergers and different types
of merger
Provide a rationale for mergers and
acquisitions.
Identify the factors in takeover decisions
Understand the strategic approach for the
takeover decisions

Introduction
Mergers and acquisitions evoke a great deal of
public interest and represent the most dramatic facet
of corporate finance.
The merger refers to a combination of two or more
companies into one company.
Merger may be classified into several types:
Horizontal Merger
Vertical Merger
Conglomerate Merger.

Mergers
A horizontal merger represents a merger of
firms engaged in the same line of business.
A vertical merger represents a merger of firms
engaged at different stages of production in
an industry.
A conglomerate merger represents a merger of
firms engaged in unrelated lines of business.

The Reasons for Merger and

Acquisitions
Improving economies of scale: Economies of scale arise when increase in
volume of production leads to a reduction in cost of production per unit.
Operating economics: A combined of two or more firms may result in
reduction of costs due to operating economics.
Market leadership: the merger can enhance value for shareholders of both
companies through the amalgamated entitys access to greater number of
market resources.
Financial benefits: A merger is capable of offering various financial
synergies and benefits such as eliminating financial constraints,
deployment of surplus cash, enhancing debt capacity and lowering the
cost of financing.

The Reasons for Merger and

Acquisitions
Acquiring a new product or brand name: Merger would
provide readymade facilities, which would provide a
quicker entry for enhancing the comparative advantage of
the new product.
Diversifying the portfolio: Diversification implies growth
through the combination of firms in related business..
Synergies: Merger will lead to increase the synergies
effect.
Taxation or investment incentives:. Acquiring or merging
such a company with a highly profitable company would
help make full use of the investment incentives.

Factors in a takeover decision

Price factors
What would the cost of acquisition be?
Would the acquisition be worth the price?
Alternatively, factors (a) and (b) above could be expressed in
terms of: what is the highest price that it would be worth
paying to acquire the business?
The value of a business could be assessed in terms of: Its
earnings; Its assets; Its prospects for sales and earnings growth
How it would contribute to the short term and long term
strategy of the predator company

Other factors
Would the takeover be regarded as desirable by the
predator companys shareholders and (in the case of
quoted companies) the stock market in general?
Are the owners of the target company amenable to a
takeover bid? Or would they be likely to adopt
defensive tactics to resist a bid?
What form would the purchase consideration take? An
acquisition is accomplished by buying the share of
target Company.

Other factors
The purchase consideration might be cash, but the
purchasing company might issue new shares or loan
stock exchanges them for shares in the company
takeover.
How would the takeover be reflected in the published
accounts of the predator company?
Would there be any other potential problems arising
from the proposed takeover, such as:

Future dividend policy

Service contracts for key personnel?

A strategic approach to takeover

A strategic approach to takeovers would imply that
acquisitions are only made after a full analysis of the
underlying strengths of the Acquirer Company, and
identification of candidates strategic fit with its
existing activities.
Possible strategic reasons for a takeover are matched
with suggested ways of achieving the aim in the
following list which specializes in offering advice on
takeovers.