Mergers & Acquisitions

INTRODUCTION

Profitable growth constitutes one of the prime objectives of most business firms. It can be achieved 'internally', either through the process of introducing/developing new products or by expanding the capacity of existing products the firm is engaged in. Alternatively, growth can be facilitated 'externally' by mergers and acquisitions of existing business firms.

Internal expansion enables a firm to retain control with itself and also provides flexibility in choosing equipment, technology, location etc., which are compatible with existing operations. However, internal expansion usually involves a longer period of implementation and greater uncertainties, and sometimes, raising adequate funds is problematic. A merger or an acquisition obviates, in most of the situations, finance problems as payments are normally made in the form of shares of purchasing company. Further, it also expedites growth, because the merged/ acquired company already has the products or facilities that are required.

Merger-mania has struck Wall Street. Nearly every sector of the world economy has been affected by the recent wave of mega-mergers, which have included NATIONS BANK, BANK OF AMERICA, BOEING, McDONNEL-DOUGLAS, AOL, TIME WARNER, EXXON and MOBIL to name a few. Last year alone, mergers involving American companies totaled a record of $1 trillion. In India, in 1999, there were nearly 12,000-crore-rupees-worth of mergers and acquisitions.

MERGERS, ACQUISITIONS AND TAKEOVERS

Some inefficient companies keep afloat because of management obstinacy where as some simply by default. One method of weeding them out is to get them liquidated, but in many cases that also implies wastage or destruction of valuable assets, established brand equity and even a good team. Mergers, acquisitions and takeovers are modern methods of preventing asset-destruction and systemic decay.

MERGER: The incorporated company acquires all existing assets and liabilities of the two companies. A merger must be distinguished from a 'consolidation' which is a combination of two companies whereby an entirely new company is formed. Both cease to exist and shares of their common stock are exchanged for shares in the new company. When two companies of approximately the same size combine, the term consolidation applies. When there is significant difference in size, 'merger' is a more appropriate term.

ACQUISITION/TAKEOVER: An acquisition/takeover happens when one company purchases the assets or shares, wholly or partially, of another company. The payment is in cash or in shares or other securities. The acquired company is not dissolved and it continues to exist as a separate entity.

CERTAIN STRATEGIC CONSIDERATIONS: Consider a company that is trading profitably in an area it knows well. Why should it consider either merging with or even acquiring another company? Why should it not just continue to do what it has proved it can do well-- just expand its core business. This is so as it may not be possible for a company to develop its traditional business (often known as 'organic growth') fast enough to meet corporate objectives. Rather, it may decide to develop into new business areas. The examples are vertical, horizontal, related, geographical and conglomerate.

VERTICAL DIVERSIFICATION occurs when a company diversifies into a new area one step removed from the traditional. This may either be "backwards" or "forwards". Vertical Diversification Backwards occurs when a company enters an area traditionally catered to by one of its suppliers. Consider a dairy company that has always bought milk from a number of farms in order to convert it into bottled milk, butter, cheese and other dairy products. If that dairy company were to purchase the farms (and thus become its own supplier), it would have diversified vertically backwards. Equally the dairy company could acquire the retail outlets that it has traditionally supplied, and have diversified vertically forwards.

HORIZONTAL DIVERSIFICATION occurs when a company seeks an acquisition or merger that enables it to undertake more of its traditional business. Thus, if one dairy company acquired others, it would have diversified horizontally.

RELATED DIVERSIFICATION occurs when a company uses its goodwill and reputation in a particular business to diversify into new areas where that good name and reputation will be recognized and translated into strategic advantage. An example is that of Wilkinson Sword. It was an old company with a good reputation in the manufacture of ceremonial military swords. Clearly, the market for these products was limited and declining. The company decided, very profitably, to diversify into the manufacture of disposable razor blades-- a market previously dominated by Gillette.

GEOGRAPHICAL DIVERSIFICATION is a form of the Horizontal that occurs when a company seeks to expand its traditional business into a different area of the country or internationally. An example is that of the " Manchester Guardian", a newspaper which was traditionally centered on the north-west of England, which evolved into a national newspaper ("The Guardian") which sought to appeal to readers in the whole of the United Kingdom. More recent examples would include breweries that had, traditionally, only supplied outlets in particular localities; they had decided to launch their beers nationally.

CONGLOMERATE DIVERSIFICATION A company may decide that its strength lies in its ability to manage subsidiary companies--its managerial excellence being its distinguishing factor, the exact business area being largely irrelevant. Such a company may build a portfolio of subsidiary companies in diverse business areas, linked only by its perceived management ability. Such a company would be described as having adopted a strategy of Conglomerate Diversification.

REASONS FOR DIVERSIFICATION Apart from the need to accelerate business growth (and, in particular, profit growth), there are several other reasons for strategic diversification. Some of them are: the need to secure supplies of raw materials, a firm customer base, eliminate a competitor, the opportunity of managing a business more profitably than its present management and synergistic advantages, the possibility of utilizing assets in a business more advantageously than its present management, the availability of a strong management team and cash position.

THE RATIONALE BEHIND MERGERS AND ACQUISITIONS

The major economic advantages of mergers and acquisitions are as follows:

1. ECONOMIES OF SCALE: Reduction in the average cost of production and hence in the unit cost when output is increased is known