Merger and acquisation
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This document discusses key concepts related to mergers and acquisitions from an MBA course. It includes types of mergers such as horizontal, concentric, vertical, and conglomerate mergers. It also discusses the steps to a successful merger and the goals of mergers. The document provides details on the merger process, creating synergy between merging companies, reasons for divesture, and rules related to employee stock ownership plans (ESOPs).
Merger and acquisation
- 1. Master of Business Administration – MBA Semester 3 MF0011 – Mergers and Acquisitions - 4 Cred (Book ID: B1732) Assignment – 60 Marks Q1. Write the types of mergers and acquisition. Explain the steps to a successful merger. ANS. Types of mergers and acquisition: 1. Horizontal: It is a merger of two competing firms engaged in the production of similar products or providing similar services. The acquiring firm belongs to the same industry as the target company. The main purpose of such mergers is to obtain economies of scale in production. 2. Concentric: This is a variation of horizontal mergers. It is a combination of two firms that are not in the same industry but operate in related industrial segments. Examples are: INDIAN AIRLINES and AIR INDIA 3. Vertical: When two or more companies, involved in different stages of activities like production or distribution, combine with each other the combination is called a vertical merger. There are two types of vertical combinations: a. Forward integration b. Backward integration 4. Circular combination: Companies engaged in the production of different product seek combination to share common marketing distribution or research facilities in order to generate economies. 5. Conglomerate: This is the combination of companies engaged in unrelated businesses. The basic purpose of such a combination is lowering a cost of capital, optimum utilization of financial resources and enlarging debt capacity. Steps to a successful merger: Mergers need careful planning to achieve financial goals, reduce problems and from profit making. Drop in productivity is expected to be around 50% as people from different workplaces have differences of opinion. Even a successful merger can take three months to their years for completion of recovery prices in an organization Often reduced communication and increased centralization as part of restructuring in companies creates space for rumors and insecurity in employees.
- 2. Q2. Explain the process of merger. Write down the goals of a merger. ANS. Merger Process: The merger process comprises all or most of the following activities: Decision to buy/sell (both buyer and seller) Funding (buyer) Identification of potently and actual target (both) Valuation (both) Preparation of offer/memorandum (seller) Due diligence (both) Bidding (both) Negotiation (both) Paperwork (both) Integration (both) Post-sale restructuring (seller) Some common goals of a merger are: 1. Acquire domain expertise and technology 2. Acquire market share and brand name 3. Acquire technology, products or intellectual property or some such assets 4. Acquire a geographical presence 5. Diversify into different businesses for a balanced portfolio and less concentration in a single industry or market segment 6. Reduce competition by acquiring competitor’s businesses 7. Create a dominant position by sheer size, and thereby reduce overheads and improve profits 8. Achieve growth of revenue profit and assets 9. Create synergy between different business domains 10.Enhance security of sales and supply.
- 3. Q3. What is creating synergy? Explain the prerequisites for the creation of synergy. ANS: Crating synergy: The creation of synergy is not automatic. Synergy requires a great deal of work on the part of managers at the corporate and business levels. Creation of synergy does not require only the material resources of the two companies. It demands effective integration of the combined unit’s human resource, physical assets and operations. The activities that create synergy include combining similar processes, coordinating business units sharing common resources, and resolving conflicts among business units. Prerequisites for the creation of synergy: There are certain requirements which must be met for synergy to be created. When all the four exist then the firm being able to create synergy is substantially higher. 1. Strategic compatibility: Strategic compatibility refers to the matching of organizations strategic capabilities. There are various ways in which capabilities can be matched through a merger. Thus, when combined firms or business organizations are both strong and weak in this same business activities, the newly created combined firm display the same capabilities, although the magnitude of the strength or weakness is greater, and no synergy results. 2. Organizational compatibility: Organizational compatibility occurs when two organizations have similar management process, cultures, systems and structures. Organizational compatibility from an operational point of view suggest that the integration process that are developed and used to combine the operations can be expected to bring about desired results effectively and efficiently. 3. Managerial actions: The third building block for the creation of synergy is related to the actions and initiatives that managers take for their firms to actually realize to competitive benefits. Creation of synergy requires active involvement and participation. 4. Value creation: Value creation is the fourth synergy creation building block. The focus here is or deriving benefits from synergy in excess of the cost to be incurred. The cost associated to be with the following have to be controlled: a. Financing of the transaction b. Premium paid to purchase Premiums sometimes exceed the market value of the target firm by 100% or more. Studies have shown that in the last two decades, premium paid for acquired firms have averaged between 40% and 50%.
- 4. Q4. Give the meaning of divesture. List and explain the reasons for divesture. ANS: Divesture: A transaction through which a firm sells a portion of its assets, product line, a subsidiary or a division to another company for cash or securities is called divesture. Divesture is form of a contraction Mergers, assets purchases and takeovers lead to expansion and are based on the principle of synergy which says 2+2=5. Divesture on the other hand is based on the principle of “reverse synergy” which says 5- 3=3! There are various methods of divesture but the most common are partial, sell off, demerger and equity carve-out. Reasons for divesture: The reasons are 1. Poor fit: The parent company may want to move out of particular line of business which it feels no longer fits into its plans or in which it is unable to operate profitably. Sometimes divestiture follows acquisition: the company that is acquired may have divisions that do not fit the acquirer’s business plans and strategy. 2. Reverse synergy: One motivational factor associated with mergers and acquisitions is synergy. Synergy refers to the additional gains that may be derived when two firms combine. Reverse synergy means that the parts are worth more separately then they are within the parent company’s corporate structure; in other words 4-1=5. In such cases, an outside bidder considers paying more for a division than what the division is worth to the parent company. 3. Cash flow effect: Cash flow in often an immediate benefit of a sell-off. Companies that are under financial distress are often forced to sell valuable assets to enhance cash inflow. 4. Abandoning the core business: The selling of a core business is often motivated by management’s desire to leave an area that it the rare phenomenon though, at best the last resort 5. Reaping the benefits of past successes: Some divestitures take place to benefit from past successful acquisitions. They are often resource sing for using other opportunities. 6. Financing prior acquisitions: Major acquisitions are also followed by a number of divestitures for financing reason. 7. Discouraging takeovers: Many a time, divestitures function as takeover defense by removing the ‘crown jewel’ that causes a takeover threat. 8. Meeting regularity norms: Divestitures often occur in order to comply with government rules and norms. These are called involuntary divestitures.
- 5. Q5. Explain the key rules of employees stock ownership plan. Discuss the two types of ESOPs. ANS: Employees stock ownership plans: Employee- owned corporations are corporations owned wholly or in part by the employees. Employees are usually given a share of the corporation of the corporation after a certain length of employment or they can buy shares at any have its shares sold on the public stock markets. Employee-owned in corporations are shared with the employees. These types of corporations also often have boards of directors elected directly by the employees. Rules of employee stock ownership (ESOPs): An ESOP is a type of an employee benefit plan. It is a similar to a profit-sharing plan in some ways. A company sets up a trust fund in an ESOP into which new shares of its own stock or cash is contributed in order to buy existing shares. The ESOP can also borrow money to buy new or already present shares, with the company contributing cash to the plan enabling it to repay the loan. Irrespective of hoe the stock is acquired by the plan, the contributions made by the company to the trust are tax-deductible, within certain limits. The key rules of ESOPs are as follows: 1. Vesting: Before an employee’s requires entitlement to ESOP, he must work for a certain period, which is referred to as the vesting period. If an employee’s leaves before vesting, he loses the right. An ESOP must comply with minimum schedules for vesting, called as cliff vesting or graded vesting. 2. Distribution after termination: Distribution of vested benefits with retirement, disability or death, takes places during the following plan year. The following are the expectations to this rule: a. If the termination occurs for reasons other than the ones stated above, the distribution must commence no later than the sixth plan year following termination. b. Repayment of the loans that have been taken against the ESOP benefits must be done. Distribution occurs in the plan year after repayment. 3. Distribution during employment: Cash or stock can be received directly by employees by diversifying their accounts. Dividends may be paid by the employer to a participant who is at least a 5% owner beyond the age of 70, although still working in the company.
- 6. 4. Put option: A put option is offered by some companies, for opinion, the employee can sell their company stock back to the employer within 60 days after distribution and within 60 days during the following plan year. 5. Taxation: No tax is required to be paid by the employees on stock until they receive distributions. Payments are subject to applicable taxes, and an additional 10% excise tax will be levied. Dividends that have to be paid directly to participants on stock are taxable. Types of ESOPs: There are two types of ESOPs – leveraged and non- leveraged. 1. Non- leveraged ESOPs: Anon- leveraged ESOPs is a stock bonus plan, identified as an ESOP in the plan document that invest primarily in company stock and meets certain legal requirements. The sponsoring employer contributes newly issued or treasury stock and cash to buy stock from existing owners. 2. Leveraged ESOPs: A leveraged ESOP borrows money on the credit of the employer or other related parties to buy company stock. It is only a qualified employee benefit plan that can do this. The loan can be towards the ESOP itself to the employer to then lend the money to the ESOP. The loan from the company to the ESOP does not have to be on the same terms, provided its terms are the equivalent of an arm’s length transaction. Q6. Explain the following with examples: 1. Exchange rates 2. External advantages in different products 3. Rule of government policies ANS: Exchange rates: Foreign exchange rates affect international mergers in a number of ways. The advantages of the domestic versus foreign currency can affect a company’s economic factors such as the cost of the acquisition, the financing expenses of running the firm and the repatriated profits’ value to the parent. Currency translation profits and losses in financial reporting can occur due to accounting conventions. Example: The acquisitions by Union Pacific Resources and the CIT Group of Canadian firms were facilitated by the decline in the value of the Canadian dollar in 1998 and 1999.
- 7. External advantages in differential products: A strong correlation exists between globalizing and product differentiation. A company that has earned the reputation for producing better - quality goods in the domestic market will possibly find acceptance for the products in foreign markets too. Example: In the 1920s (the early days of the US automobile industry) were exported to Europe in large numbers. This was before the auto industry was developed in European countries. The advantages of the US mass production facilities and knowhow made American cars cheaper despite the higher foreign tariffs and this motivated foreign direct investments. The tables were the turned. First, Volkswagen came from Germany to the US. Then cars from Japan became widely accepted in the US. Later manufacturing operations were established by foreign makers in the US. Role of government policies: Government policies, regulations, tariffs and quotas can affect international mergers and acquisition in a number of ways. Exports are particularly vulnerable to tariffs and quotas erected to protect domestic industries. Even the threat of such restrictions can encourage international mergers, especially when the market to be protected is too large. Japan’s huge export surplus, which led to voluntary export restrictions coupled with threats of more binding restrictions, was a major factor in increased direct investment by Japan in the United States. Example: The Deutsche Telekom acquisition of one2one is n example of the many influences of government policy. Deutsche Telekom had been a monopoly protected by the German government. German deregulation created competition from international and German firms. Similarly, Deutsche Telekom acquired ono2one because of the possibility of purchasing a coveted mobile phone license from the British government. The influence of government policy also is reflected in the European Union’s decision to open previously regulated industries, such as electric utilities, to competiotion.