Mergers and acquisitions framework | Veristrat Inc.

Mergers and Acquisitions
framework

WHAT IS MERGER?
A merger is a combination of two or more companies where one corporation is
completely absorbed by another corporation.
WHAT IS ACQUISITION?
Acquisition essentially means ‘to acquire’ or ‘to takeover’. Here a bigger
company will take over the shares and assets of the smaller company.
Mergers and Acquisitions

MERGER
1. Merging of two organization in
to one.
2. It is the mutual decision.
3. Merger is expensive than
acquisition(higher legal cost).
4. It is time consuming and the
company has to maintain so
much legal issues.
5. Dilution of ownership occurs in
merger.
ACQUISITION
1. Buying one organization by
another.
2. It can be friendly takeover
or hostile takeover.
3. Acquisition is less
expensive than merger.
4. It is faster and easier
transaction.
5. The acquirer does not
experience the dilution of
ownership.
Difference Between Merger And Acquisition:

• Friendly acquisition - Both the companies approve of
the acquisition under friendly terms.
• Reverse acquisition - A private company takes over a
public company.
• Back flip acquisition- A very rare case of acquisition
in which, the purchasing company becomes a
subsidiary of the purchased company.
• Hostile acquisition - Here, as the name suggests, the
entire process is done by force.
Different Types of Acquisitions

• A horizontal merger - This kind of merger exists between two
companies who compete in the same industry segment.
• A vertical merger - A customer and company or a supplier and
company. Think of a cone supplier merging with an ice cream
maker.
• Co-generic mergers - Two businesses that serve the same
consumer base in different ways, such as a TV manufacturer and
a cable company.
- Market-extension merger- Two companies that sell the same
products in different markets.
- Product-extension merger - Two companies selling different but
related products in the same market.
• Conglomerate Mergers - Conglomerate merger is a kind of
venture in which two or more companies belonging to different
industrial sectors combine their operations.
Different Types of Mergers

• Relative Valuation – Analysis of peer groups, examine the different multiples like
Enterprise multiples, Equity multiples etc.
• Discounted Cash Flows (DCF) - A key valuation tool in M&A, discounted cash flow analysis
determines a company's current value according to its estimated future cash flows.
FCFF/FCFE are discounted to a present value using the company's WACC/Cost of equity.
DCF is tricky to get right.
• Replacement cost- In a few cases, acquisitions are based on the cost of replacing the
target company.
•
Valuation Matters

Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant
to create synergy that makes the value of the combined companies greater than the sum of the two parts. The
success of a merger or acquisition depends on whether this synergy is achieved.
Synergy takes the form of revenue enhancement and cost savings. By merging, the companies hope to benefit
from the following:
• Becoming bigger - Many companies use M&A to grow in size and leapfrog their rivals. While it can take years or
decades to double the size of a company through organic growth, this can be achieved much more rapidly through
mergers or acquisitions.
• Preempted competition - This is a very powerful motivation for mergers and acquisitions, and is the primary
reason why M&A activity occurs in distinct cycles.
• Domination - Companies also engage in M&A to dominate their sector. However, since a combination of two
behemoths would result in a potential monopoly, such a transaction would have to run the gauntlet of intense
scrutiny from anti-competition watchdogs and regulatory authorities.
• Tax benefits - Companies also use M&A for tax purposes. This technique involves a U.S. company buying a smaller
foreign competitor and moving the merged entity’s tax home overseas to a lower-tax jurisdiction, in order to
substantially reduce its tax bill.
• Staff reductions - As every employee knows, mergers tend to mean job losses. Consider all the money saved from
reducing the number of staff members from accounting, marketing and other departments. Job cuts will also
probably include the former CEO, who typically leaves with a compensation package.
Why Merge?

• Economies of scale - Whether it's purchasing stationery or a new corporate IT system, a bigger company placing
the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or
office supplies—when placing larger orders, companies have a greater ability to negotiate prices with their
suppliers.
• Acquiring new technology - To stay competitive, companies need to stay on top of technological developments
and their business applications. By buying a smaller company with unique technologies, a large company can
maintain or develop a competitive edge.
• Improved market reach and industry visibility - Companies buy companies to reach new markets and grow
revenues and earnings. A merger may expand two companies' marketing and distribution, giving them new sales
opportunities. A merger can also improve a company's standing in the investment community: bigger firms often
have an easier time raising capital than smaller ones.
Why Merge?

Mergers and acquisitions are most common in the health care, technology and retail.
• Healthcare - Many small and medium-sized companies find it difficult to compete in the marketplace with the
handful of behemoths in the field. A rapidly changing landscape in the health-care industry, with government
legislation leading the way, has posed difficulties for small and medium companies that lack the capital to keep up
with these changes. Moreover, as health-care costs continue to skyrocket, despite efforts from the government to
reign them in, many of these companies find it nearly impossible to compete in the market and resort to being
absorbed by larger, better capitalized companies.
• Technology - The technology industry moves so rapidly that, like health care, it takes a massive presence and huge
financial backing for companies to remain relevant. When a new idea or product hits the scene, industry giants
such as Google, Facebook and Microsoft have the money to perfect it and bring it to market. Many smaller
companies, instead of unsuccessfully trying to compete, join forces with the big industry players. These firms
often find it more lucrative to be acquired by one of the giants for a huge payday.
• Retail - The retail sector is highly cyclical in nature. General economic conditions maintain a high level of influence
on how well retail companies perform. When times are good, consumers shop more, and these firms do well.
During hard times, however, retail suffers as people count pennies and limit their spending to necessities. In the
retail sector, much of the merger and acquisition activity takes place during these downturns.
M&A- Prone Industries

• The Opening Offer - CEO and top managers of a company decide that they want to do a merger or acquisition,
they start with a tender offer. The process typically begins with the acquiring company carefully and discreetly
buying up shares in the target company, or building a position.
• The Target's Response - Once the tender offer has been made, the target company can do one of several things:
1. Accept the Terms of the Offer- If the target firm's top managers and shareholders are happy with the terms of
the transaction, they will go ahead with the deal.
2. Attempt to Negotiate - The tender offer price may not be high enough for the target company's shareholders to
accept, or the specific terms of the deal may not be attractive. In a merger, there may be much at stake for the
management of the target (particularly, their jobs). If they're not satisfied with the terms laid out in the tender offer,
the target's management may try to work out more agreeable terms that let them keep their jobs or, even better,
send them off with a nice, big compensation package.
3. Execute a Takeover Defense or Find Another Acquirer
• Closing the Deal - Finally, once the target company agrees to the tender offer and regulatory requirements are
met, the merger deal will be executed by means of some transaction.
Doing The Deal

The three main reasons for a merger or acquisition deal to fail are a lack of funding by the acquirer to close the
deal, the difference in valuation estimates by the two parties and government intervention due to regulations.
• Adequate funding is necessary for a successful merger. In late 2008, for example, automotive giants General
Motors and Chrysler, two of the so-called Big Three of the U.S. auto industry, were deep in talks to merge. Before
the year ended, the merger talks collapsed after GM admitted it was running out of money following a huge $4.2
billion quarterly loss.
• One year after the failed merger between GM and Chrysler, social media sites Facebook and Twitter were in
discussions to join forces, with the former attempting to acquire the latter for $500 million. Disagreements over
Facebook’s valuation could not be overcome by the two camps, resulting in the end of what could have been the
single most dominant player in global social media.
• One instance of regulation: the case of United Airlines and US Airways, with the former offering to take over the
latter for a combined infusion of $11.6 billion in cash and assumption of debt. The talks began in late 2000 and
ended one year later when the then-Bush administration raised doubts that the merger would be approved by
federal regulators. (Ironically, United acquired Continental Airlines in 2010, and US Airways merged with American
Airlines in 2013).
Why Mergers Don’s Go Through?

There's a fourth major reason an acquisition doesn't go through: the target firm doesn't want to be acquired,
forcing the would-be buyer has to launch a hostile takeover. While there are examples of hostile takeovers
working, they are generally tougher to pull off than a friendly merger. Types of hostile takeovers include:
• Dawn Raid - During a dawn raid, a firm or investor aims to buy a substantial holding in the takeover-target
company's equity by instructing brokers to buy the shares as soon as the stock markets open. By getting the
brokers to conduct the buying of shares in the target company (the "victim"), the acquirer (the "predator") masks
its identity and thus its intent. The acquirer then builds up a substantial stake in its target at the current
stock market price. Because this is done early in the morning, the target firm usually doesn't get informed about
the purchases until it is too late, and the acquirer now has controlling interest. In the U.K., there are now
restrictions on this practice.
• Saturday Night Special - A Saturday night special is a sudden attempt by one company to take over another by
making a public tender offer. The name comes from the fact that these maneuvers used to be done over the
weekends. This too has been restricted by the Williams Act in the U.S., whereby acquisitions of 5% or more of
equity must be disclosed to the SEC.
• Tender Offer – A method by which a hostile acquirer renders an offer to the shareholders of a company in an
attempt to gather a controlling interest in the company. Generally, the potential acquirer will offer to buy stock
from shareholders at a much higher value than the market value.
.
Hostile Takeovers

A tender offer is an offer to purchase some or all of shareholders' shares in a corporation. The price offered is
usually at a premium to the market price
A tender offer is when an investor proposes buying shares from every shareholder of a publicly traded company for
a certain price at a certain time. The investor normally offers a higher price per share than the company’s stock
price, providing shareholders a greater incentive to sell their shares. For example, a stock’s current price is $10 per
share. An investor wanting to take over the company issues a tender offer for $12 per share on the condition he
acquires at least 51% of the shares.
Hostile Takeovers (Cont..)

If a company doesn't want to be taken over, there are many strategies that management can use. Almost all of
these strategies are aimed at affecting the value of the target's stock in some way.
 Golden Parachute - A golden parachute measure discourages an unwanted takeover by offering lucrative
benefits to the current top executives, who may lose their jobs if their company is taken over by another firm.
Benefits written into the executives' contracts include items such as stock options, bonuses, liberal severance
pay and so on. Golden parachutes can be worth millions of dollars and can cost the acquiring firm a lot of money,
therefore becoming a strong deterrent to proceeding with their takeover bid.
 Macaroni Defense - In this tactic, the target company issues a large number of bonds that come with the
guarantee that they will be redeemed at a higher price if the company is taken over. It's a highly useful strategy
but the target company must be careful it doesn't issue so much debt that it cannot make the interest payments.
 People Pill - Management threatens that in the event of a takeover, the management team will resign at the
same time in mass. This is especially useful if they are a good management team; losing them could seriously
harm the company and make the bidder think twice.

Defensive Maneuvers

 Poison Pill - With this strategy, the target company aims at making its own stock less attractive to the acquirer. There are two types of
poison pills.
- The 'flip-in' poison pill allows existing shareholders (except the bidding company) to buy more shares at a discount. This
type of poison pill is usually written into the company’s shareholders rights plan. The goal is to dilute the shares held by the bidder
and make the takeover bid more difficult and expensive.
- The 'flip-over' poison pill allows stockholders to buy the acquirer's shares at a discounted price in the event of a merger. If
investors fail to take part in the poison pill by purchasing stock at the discounted price, the outstanding shares will not be diluted
enough to ward off a takeover.
An extreme version of the poison pill is the "suicide pill" whereby the takeover-target company may take action that may lead to its
ultimate destruction.
 Sandbag - With the sandbag tactic the target company stalls with the hope that another, more favorable company (like "a white
knight") will make a takeover attempt. If management sandbags too long, however, they may be getting distracted from their
responsibilities of running the company.
 White Knight - A white knight is a company (the "good guy") that gallops in to make a friendly takeover offer to a target company that
is facing a hostile takeover from another party (a "black knight"). The white knight offers the target firm a way out; although it will
still be acquired, it will be on more favorable terms – or at least, terms more to its liking.
Defensive Maneuvers

It's no secret that plenty of mergers don't work. Those who advocate mergers will argue that the merger will cut
costs or boost revenues by more than enough to justify the price premium. It can sound so simple: just combine
computer systems, merge a few departments, use sheer size to force down the price of supplies and the merged
giant should be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice, things can go
awry. Different systems and processes, dilution of a company's brand, overestimation of synergies and lack of
understanding of the target firm's business can all occur, destroying shareholder premium and decreasing the
company's stock price after the transaction.
• Flawed Intentions - For starters, a booming stock market encourages mergers, which can spell trouble. Deals done
with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and
cheap too. A merger may often have more to do with glory-seeking than business strategy.
• The Obstacles to Making it Work - The chances for success are hampered if the corporate cultures of the
companies are very different. When a company is acquired, the decision is typically based on product or market
synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily
overcome. For example, employees at a target company might be accustomed to easy access to top management,
flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem
significant, but if new management removes them, the result can be resentment and shrinking productivity.
Why Mergers Fail?

And sometimes, the expected advantages of acquiring a rival don't prove worth the price paid. Say pharma
company A is unduly bullish about pharma company B’s prospects – and wants to forestall a possible bid for B from
a rival – so it offers a very substantial premium for B. Once it has acquired company B, the best-case scenario that
A had anticipated doesn't materialize: A key drug being developed by B may turns out to have unexpectedly severe
side-effects, significantly curtailing its market potential. Company A’s management (and shareholders) may then be
left to rue the fact that it paid much more for B than what it was worth.
More insight into the failure of mergers is found in a highly acclaimed study from McKinsey, a global consultancy.
The study concludes that companies often focus too intently on cutting costs following mergers, while revenues,
and ultimately, profits, suffer. Merging companies can focus on integration and cost-cutting so much that they
neglect day-to-day business, thereby prompting nervous customers to flee. This loss of revenue momentum is one
reason so many mergers fail to create value for shareholders.
Why Mergers Fail?

• Continuous communication – employees, stakeholders, customers, suppliers and government
leaders.
• Transparency in managers operations
• Capacity to meet new culture higher management professionals must be ready to greet a new or
modified culture.
• Talent management by the management
How to Prevent the Failure

• America Online and Time Warner - The consolidation of AOL Time Warner is perhaps the most prominent
merger failure ever. In 2001, America Online acquired Time Warner in a megamerger for $165 billion— the
largest business combination up until that time. Respected executives at both companies sought to capitalize on
the convergence of mass media and the Internet.
Shortly after the megamerger, however, the dot-com bubble burst, which caused a significant reduction in the
value of the company's AOL division. In 2002, the company reported an astonishing loss of $99 billion, the largest
annual net loss ever reported by a company, attributable to the goodwill write-off of AOL. Around this time, the
race to capture revenue from Internet search-based advertising was heating up. AOL missed out on these and
other opportunities, such as the emergence of higher-bandwidth connections due to financial constraints within
the company. At the time, AOL was the leader in dial-up Internet access; thus, the company pursued Time Warner
for its cable division as high-speed broadband connection became the wave of the future. However, as its dial-up
subscribers dwindled, Time Warner stuck to its Road Runner internet search provider rather than market AOL.
With their consolidated channels and business units, the combined company also did not execute on converged
content of mass media and the Internet. Additionally, AOL executives realized that their know-how in the Internet
sector did not translate to capabilities in running a media conglomerate with 90,000 employees. And finally, the
politicized and turf-protecting culture of Time Warner made realizing anticipated synergies that much more
difficult. In 2003, amidst internal animosity and external embarrassment, the company dropped "AOL" from its
name and simply became known as Time Warner.
Biggest Merger and Acquisition Disasters

• Quaker Oats Company and Snapple Beverage Company – (Due to management intention & not well planned)
• Sprint and Nextel Communications - (Due to cultural differences. Management was not handled the things well
planned, so top management & other employees left the company)
Biggest Merger and Acquisition Disasters

• Learn from mistakes of others
• Define your objectives clearly
• Complete strategy to achieve goal.
• SWOT analysis for the merged business - a must
• Conservative attitude necessary at evaluation desk strong arguments to support project
• Pick holes in strategy to get the best
• Will merged units be able to work at efficient / ideal level?
• Acquire expertise to interpret changes
Conclusion

Mergers and acquisitions framework | Veristrat Inc.

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