Chapter 3MERGERS AND ACQUISITIONS

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

IntroductionMergers 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 MergerVertical MergerConglomerate Merger.

MergersA 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 AcquisitionsImproving 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 AcquisitionsAcquiring 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 decisionPrice factorsWhat 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 growthHow it would contribute to the short term and long term strategy of the predator company

Other factorsWould 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 factorsThe 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 policyService contracts for key personnel?

A strategic approach to takeoverA 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.

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