Business Combination-Merger & Takeover
A “merger” refers to a situation where 2 firms of similar size combine (or merge ) willingly, while an “acquisition” or take-over implies that there is a dominant, bigger (predator) company taking over a smaller (target) company. Take-overs can either be agreed (friendly take-over) or contested (hostile take-over) by the target company.
We can further classify mergers into different types:
- Vertical mergers where two firms are in different stages of production of a product, e.g. a crude oil producer and an oil refining company
- Horizontal mergers where two firms are in the same line of business
- Conglomerate mergers where the firms are in unrelated line of business
- Concentric mergers where the firms are involved in different but related line of business
- Reverse take-over where the bigger firm acquires a smaller firm through share swaps and the smaller firm ends up controlling (taking over) the bigger company.
OBJECTIVE of Merger or Acquisition:
Both Merger or Acquisition shares the same goal namely to combine two previously separate firms into a single legal entity so as to reap economies of scales and other synergies ultimately leading to the enhancement of shareholder value in the long term..
CHARACTERISTICS OF MERGER:
For a merger, the characteristics are:-
- Normally involves two relatively equal companies, which combine to become one legal entity
- In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for an equal number of shares in the merged entity.
- A merger normally requires mutual decision amongst the two parties.
CHARACTERISTICS OF ACQUISITION OR TAKEOVER:-
Whilst for TAKEOVER, or acquisition, it is characterized by the following:
- There is no mutual decision amongst the two parties
- Normally the purchase of a smaller company is by a much larger one. The larger company normally initiates a hostile takeover which meets with resistance from the smaller company’s management.
In an acquisition, the acquiring firm usually offers a cash price per share to the target firm’s shareholders or the acquiring firm’s share’s to the shareholders of the target firm according to a specified conversion ratio. Either way, the purchasing company essentially finances the purchase of the target company, buying it outright for its shareholders.
WHY DO WE HAVE MERGER & ACQUISITION:
Possible rationales include:
- Economies of scale as fixed costs are shared over a larger output and common costs may be reduced;
- Economics of vertical integration-through vertical mergers, large manufacturing companies can gain control over the production process by expanding back towards the output of the raw materialsand forward to the ultimate customer. One way to achieve this is to merge with a supplier or a customer. Vertical integration makes co-ordination and administration easier,
- Strength in size where complementary resources may be pooled together for more effective competition;
- Liquidity, where a company with surplus cash may make acquisitions to produce growth and synergy, or a company may acquire another company which is cash-rich through share swaps to gain control and use the surplus cash; or
- Growth which is substantially higher than organic growth.
- Unused Tax shelter
- Diversification program to broaden their earning base and reduce risk.
During the course of M & A exercise, we often encounter the needs to value the securities of the acquired company.
As we know there are various methods of valuing securities and the more common ones are as follows:
- Based on stock market quotation;
- Net assets or Balance Sheet basis;
- Yield bases ( both dividend and earning yield)
- Revenue or earning capacity basis
The method employed will depend on the particular securities being valued and the purpose of the valuation. Furthermore, there is a need to be cautious that the various method might overlap.
However, before even we discuss the value set upon the securities, we need to consider some of the other following factors that can influence the final price which are:
- Dividend yield;
- Earning yield or
- Price –earning;
- Prospects of the company;
- Value of the company’s net assets;
- Company’s capital commitments and any expansion programme contemplated;
- Industrial or commercial prospects of the company’s field of operation;
- Position and prospects of subsidiary or other companies in which the company has made investments;
- Budget, or estimated budget changes;
- Composition of the company’s board of management;
- Prospect of foreign action likely to affect the company’s trading prospects and
- Political and economic scenario of the country in which the company resides.