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UNIT IIMergers and Acquisitions Q1) What is Mergers and acquisitions? What are the modes of acquiring firm? A1) Mergers and acquisitions (M&A) are defined as consolidation of companies. Differentiating the two terms, Mergers is the combination of two companies to form one, while Acquisitions is one company taken over by the other. M&A is one of the major aspects of corporate finance world. The reasoning behind M&A generally given is that two separate companies together create more value compared to being on an individual stand. With the objective of wealth maximization, companies keep evaluating different opportunities through the route of merger or acquisition. Basic modes of acquiring another firmHorizontal MergersHorizontal mergers happen when a company merges or takes over another company that offers the same or similar product lines and services to the final consumers, which means that it is in the same industry and at the same stage of production. Companies, in this case, are usually direct competitors. For example, if a company producing cell phones merges with another company in the industry that produces cell phones, this would be termed as horizontal merger. The benefit of this kind of merger is that it eliminates competition, which helps the company to increase its market share, revenues and profits. Moreover, it also offers economies of scale due to increase in size as average cost decline due to higher production volume. These kinds of merger also encourage cost efficiency, since redundant and wasteful activities are removed from the operations i.e. various administrative departments or departments such as advertising, purchasing and marketing. Vertical MergersA vertical merger is done with an aim to combine two companies that are in the same value chain of producing the same good and service, but the only difference is the stage of production at which they are operating. For example, if a clothing store takes over a textile factory, this would be termed as vertical merger, since the industry is same, i.e. clothing, but the stage of production is different: one firm is works in territory sector, while the other works in secondary sector. These kinds of merger are usually undertaken to secure supply of essential goods, and avoid disruption in supply, since in the case of our example, the clothing store would be rest assured that clothes will be provided by the textile factory. It is also done to restrict supply to competitors, hence a greater market share, revenues and profits. Vertical mergers also offer cost saving and a higher margin of profit, since manufacturer’s share is eliminated. Concentric MergersConcentric mergers take place between firms that serve the same customers in a particular industry, but they don’t offer the same products and services. Their products may be complements, product which go together, but technically not the same products. For example, if a company that produces DVDs mergers with a company that produces DVD players, this would be termed as concentric merger, and since DVD players and DVDs are complements products, which are usually purchased together. These are usually undertaken to facilitate consumers, since it would be easier to sell these products together. Also, this would help the company diversify, hence higher profits. Selling one of the products will also encourage the sale of the other, hence more revenues for the company if it manages to increase the sale of one of its product. This would enable business to offer one-stop shopping, and therefore, convenience for consumers. The two companies in this case are associated in some way or the other. Usually they have the production process, business markets or the basic technology in common. It also includes extension of certain product lines. These kinds of mergers offer opportunities for businesses to venture into other areas of the industry reduce risk and provide access to resources and markets unavailable previously. Conglomerate MergerWhen two companies that operates in completely different industry, regardless of the stage of production, a merger between both companies is known as conglomerate merger. This is usually done to diversify into other industries, which helps reduce risks. Q2) Explain Synergy effectA2) Synergy is the concept that the combined value and performance of two companies will be greater than the sum of the separate individual parts. Synergy is a term that is most commonly used in the context of mergers and acquisitions (M&A). Synergy, or the potential financial benefit achieved through the combining of companies, is often a driving force behind a merger. Understanding SynergyMergers and acquisitions (M&A) are made with the goal of improving the company's financial performance for the shareholders. Two businesses can merge to form one company that is capable of producing more revenue than either could have been able to independently, or to create one company that is able to eliminate or streamline redundant processes, resulting in significant cost reduction. Because of this principle, the potential synergy is examined during the M&A process. If two companies can merge to create greater efficiency or scale, the result is what is sometimes referred to as a synergy merge. Shareholders will benefit if a company's post-merger share price increases due to the synergistic effect of the deal. The expected synergy achieved through the merger can be attributed to various factors, such as increased revenues, combined talent and technology, and cost reduction. For Example,Let’s say that Company A and Company B decides to go for synergy. Since when we talk about synergy, we talk about mergers and acquisitions; let’s say that Company A and Company B merges with each other because they believe that the decision to combine will enable them to reduce cost as well as to increase profits.The reason they decide to merge with each other is that Company B produces the raw materials Company A uses to prepare the finished products Company A sells.If they merge, Company A doesn’t need to look for a vendor, and sourcing raw materials would be seamless. On the other hand, as a result of the merger, Company B doesn’t need to worry about sales and marketing. All they need to do is to improve their processes to produce better raw materials for Company A.In this case, the sum of Company A and Company B is better than individual Company A and Company B., and that’s why we can call this a synergy in mergers and acquisitions. Q3) Write the Difference between Merger and TakeoverA3)A Merger is a process by which two or more companies make a strategic decision to come together and merge as one company with a new name. Merger helps the company to share information, technology, resources, etc. thereby increasing the overall strengths of the company. The merger also helps in reducing the weakness and gain a competitive edge in the market. Merger always happens on friendly terms as the information is already passed to the directors, employees, etc. Proper planning is done on the structuring of the new company. The acquisition is the process by which one company acquires another company. The financially strong company acquires more than 50% of shares to take over another company. The acquisition doesn’t always happen on friendly terms. It can be a forced move by a company to acquire another company for various reasons like gaining new markets or gaining new customers or reducing competition etc. But acquisition can also happen when one company decides to be acquired by another company without any hostility. In an acquisition, the transition is not always smooth as the company that took over will impose all the decisions on staffing, structure, resources, etc. and thereby creating an air of unease to the company that was acquired and to its employees. One of the key differences is that the merger is the process where two or more companies agree to come together and form a new company; acquisition is the process by which a financially strong company takeovers a less financially strong company by buying more than 50% of its shares. Merger is a strategic decision made after careful discussion and planning between the companies going to be merged. Hence there are fewer chances of a chaotic atmosphere after merging. The acquisition is also a strategic decision, but in most cases, the decision is not mutual. Hence, there is a lot of hostility and chaos after an acquisition has been made. Companies that are merged usually consider each other of equal stature, and hence they help each other out to create a synergy. In the case of an acquisition, the company that acquires imposes its will on the acquired company, and the acquired company is stripped of its freedom and decision-making. The power difference between the acquired and acquiring companies is huge. Since the merger requires a whole new company to be formed, it needs many legal formalities and procedures to be followed. The acquisition doesn’t have many legal formalities and paperwork to be filled as compared to the merger. Q4) What are the advantages of Mergers and Acquisitions?A4) There are many advantages of growing your business through an acquisition or merger. These include:Obtaining quality staff or additional skills, knowledge of your industry or sector and other business intelligence. For instance, a business with good management and process systems will be useful to a buyer who wants to improve their own. Ideally, the business you choose should have systems that complement your own and that will adapt to running a larger business. Accessing funds or valuable assets for new development. Better production or distribution facilities are often less expensive to buy than to build. Look for target businesses that are only marginally profitable and have large unused capacity. Your business underperforming. For example, if you are struggling with regional or national growth it may well be less expensive to buy an existing business than to expand internally. Accessing a wider customer base and increasing your market share. Your target business may have distribution channels and systems you can use for your own offers. Diversification of the products, services and long-term prospects of your business. A target business may be able to offer you products or services which you can sell through your own distribution channels. Reducing your costs and overheads through shared marketing budgets, increased purchasing power and lower costs. Reducing competition. Buying up new intellectual property, products or services may be cheaper than developing these yourself. Organic growth, i.e. the existing business plan for growth, needs to be accelerated. Businesses in the same sector or location can combine resources to reduce costs, remove duplicated facilities or departments and increase revenue. Q5) Which are the main Reasons of companies to offer themselves for sale?A5) Companies merge with or acquire other companies for a host of reasons, including:1. Synergies: By combining business activities, overall performance efficiency tends to increase and across-the-board costs tend to drop, due to the fact that each company leverages off of the other company's strengths.2. Growth: Mergers can give the acquiring company an opportunity to grow market share without doing significant heavy lifting. Instead, acquirers simply buy a competitor's business for a certain price, in what is usually referred to as a horizontal merger. For example, a beer company may choose to buy out a smaller competing brewery, enabling the smaller outfit to produce more beer and increase its sales to brand-loyal customers.3. Increase Supply-Chain Pricing Power: By buying out one of its suppliers or distributors, a business can eliminate an entire tier of costs. Specifically, buying out a supplier, which is known as a vertical merger, lets a company save on the margins the supplier was previously adding to its costs. Any by buying out a distributor, a company often gains the ability to ship out products at a lower cost.4. Eliminate Competition: Many M&A deals allow the acquirer to eliminate future competition and gain a larger market share. On the downside, a large premium is usually required to convince the target company's shareholders to accept the offer. It is not uncommon for the acquiring company's shareholders to sell their shares and push the price lower, in response to the company paying too much for the target company. Q6) Note the Reasons for failure of Mergers and Reverse Merger.A6) Here are six common reasons that M&A deals fail: Inaccurate Data and Valuation MistakesOverly idealistic valuations and lofty projections are frequent culprits in a deal’s demise. Granted, the parties to a prospective deal want to do everything possible to make it happen. Unfortunately, this often means that the financial matters are calculated and analyzed rather “creatively” to make them as enticing as possible. Although it is understandable that parties want to present the numbers assuming the best case scenario, when it becomes evident that reality is well below what was presented, it could prove fatal. Insufficient Owner InvolvementDuring the negotiations, it is quite common for seasoned professionals to oversee most of the key issues. Some leaders may stay involved in the process, but plenty are so busy running the company and thus allow the experts to handle most of the work. The problem with this is that once those experts are out of the equation and it is time for the newly formed entity to move forward, the leadership may not have adequate insight with respect to existing circumstances and expectations. Integration ObstaclesMerging entities on paper is often far easier than merging them operation, culture, and personnel-wise. Things can get particularly dicey if there is not a concrete plan in place for the integration and/or there is inadequate communication from the higher ups to middle management. The uncertainty of a merger or acquisition often erodes morale, which can easily disrupt productivity and efficiency. These sorts of integration obstacles have to be evaluated beforehand and must be handled delicately. Resource LimitationsThere has to be sufficient resources available, both human and financial capital, for a newly formed entity to overcome the challenges of integrating the two distinct companies and cultures. There will likely be a need for new staff, updated policies and procedures, extra real estate space, and so much more, the additions of which will no doubt require the investment of quite a bit of time and money. Hopefully, this is something that is considered and planned for well in advance, but unfortunately, that is not always the case. Unexpected Economic FactorsEven the best laid plans can go awry if the economy experiences sudden, drastic changes that affect stock prices and interest rates. A negative economic climate will undoubtedly interfere with the success of mergers and acquisitions, regardless of how well they were expected to perform. Lack of Planning and StrategyFor the most part, the aforementioned issues that are often responsible for a deal’s failure can be avoided, at least in part, with proper planning and the creation and execution of a coherent strategy. For many M&A deals, the main focus is on getting the deal closed, but not enough attention is paid to preparing for the aftermath. This lack of foresight makes it far more likely for even the smallest of issues to get in the way of the deal’s true potential. Q7) What are the Commonly Used Bases for determining the Exchange Ratio?A7) The commonly used bases for establishing the exchange ratio are: earnings per share, market price per share, and book value per share. Earnings per share: Suppose the earnings per share of the acquiring firm are Rs 5.00 and the earnings per share of the target firm Rs 2.00. An exchange ratio based on earnings per share will be 0.4 that is (2/5). This means 2 shares of the acquiring firms will be exchanged for 5 shares of the target firm. While earnings per share reflect prime facie the earnings power, there are some problems in an exchange ratio based solely on current earnings per share of the merging companies because it fails to take into account the following:* The difference in the growth rates of earnings of the two companies* The gains in earnings arising out of merger* The differential risks associated with the earnings of the two companiesMoreover, there is the measurement problem of defining the normal level of current earnings. The current earnings per share may be influenced by certain transient factors like a windfall profit, or an abnormal labor problem, or a large tax relief. Finally, how can earnings per share, when they are negative, be used? Market Price per share: The exchange ratio may be based on the relative market prices of the shares of the acquiring firm and the target firm. For example, if the acquiring firm’s equity share sells for Rs 50 and the target firm’s equity share sells for Rs 10 the exchange ratio based on the market price is 0.2 that is (10/50). This means that 1 share of the acquiring firm will be exchanged for 5 shares of the target firm. When the shares of the acquiring firm and the target firm are actively traded in a competitive market, market prices have considerable merit. They reflect current earnings, growth prospects and risk characteristics. When the trading is meager market prices, however, may not be very reliable. In the extreme case market prices may not be available if the shares are not traded. Another problem with market prices is that they may be manipulated by those who have a vested interest. Book value per share: The relative book values of the two firms may be used to determine the exchange rate. For example, if the book value per share of the acquiring company is Rs 25 and the book value per share of the target company is Rs 15, the book value based exchange ratio is 0.6 =(15/25). The proponents of book value contend that it provides a very objectives basis. This however is not convincing argument because book values are influenced by accounting policies which reflect subjective judgments. There are still serious objections against the use of the book value.1. Book values do not reflect changes in purchasing power of money.
2. Book values often are highly different from true economic values.
2. Book values often are highly different from true economic values.
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