The Business Case for Mergers

April 23, 2011

Inorganic Growth – Why?

Fundamentally, acquisitions create value when they enhance the strategic capabilities of both the companies, improving the competitive capabilities of either or both, resulting in improved financial results. There are companies that on their own probably would not be able to make it, but when combined, are able to create a better set of products and services than could have been otherwise provided to the market.

Acquisitions can help grow a company’s market position faster than internal development strategies. It can also provide a way to bring in new capabilities and leverage existing ones that would be difficult without the synergy of an acquisition.

Mergers and acquisitions are being used by firms to strengthen and maintain their position in the market place. They are seen as a relatively fast and efficient way to expand into new markets, and acquire new and useful technologies.

The main objectives for mergers and acquisitions could be summed up as below:-

  • Horizontal mergers for market dominance or economies of scale
  • Vertical mergers for efficient channel control
  • Hybrid mergers for spreading risk, cutting costs, creating synergies, or could also be a defense mechanism to survive against competition
  • Growth for global reach
  • Survival by developing a critical mass
  • Acquisition of cash, deferred taxes, or even excess debt capacity
  • Acquire a bigger asset base to leverage borrowing
  • Top line growth objective, financial gains and personal power
  • Adding a core competency to provide more combinations of products and services
  • To acquire talent, knowledge, and technology (lately, this is becoming a very important reason)

These objectives arise as a consequence of the following changes in the business scenario.

  1. Globalization
  2. Outsourcing
  3. Speed of growth
  4. Shorter product life cycles

Regardless of the reasons companies have for merging, there are some basic assumptions that are being made, and these include:-

  • Mergers and Acquisitions are the fastest and easiest ways to grow
  • Mergers and Acquisitions are likely to fall short of their initial goals
  • Mergers and Acquisitions are difficult to do
  • Creating synergies is a major challenge
  • Shaping and adapting cultures is a major challenge
  • Due diligence is necessary but not sufficient
  • Pre-planning can help increase chances of success

The merger climate is mainly governed by financial, strategic, and psychological motives, and the following specific factors, individually or collectively, can be considered to have facilitated or promoted the current wave of merger activity.

  1. Changing market conditions
  2. Increasing availability of capital
  3. More companies for sale
  4. Easing of regulations
  5. The need to share risk
  6. The existence of complex indivisible problems

Acquisition strategy has been described as an area of corporate strategy where inappropriate mathematical theory and a yearning for greener grass, has prevailed over common sense2.

The objective of a merger and acquisition is to produce advantages for both the buying and selling companies, that is, the resultant entity should be greater than the sum total of the individual entities, that is

Value (A+B) > Value (A) + Value (B)

Motives behind Mergers and Acquisitions

Mergers and Acquisitions are considered to be rational financial and strategic alliances made to benefit the organization and its shareholders. Literature (Napier, 1989) suggests that merger motives are financial (value maximizing) in nature, or, in many cases, managerial (non-value maximizing) too. However, these two are often related. Besides these ways of presenting the benefits to the shareholders, there are some unrecognized psychological motives too, often initiated to satisfy the needs of an individual or a small group of individuals, rather than the long-term benefit to the organization. Some senior managers are motivated to instigate a takeover to be recognized as people with high desires to grow the organization and looking for new opportunities, and as an action against their own fear of obsolescence (Levinson, 1995). Out of a feeling of insecurity of their job, many mergers have thus been instigated. Career moves, egotistical needs to wield power, and empire building attitudes have been other un-stated psychological motives that have prevailed over the rational motives.

Categories of Mergers and Acquisitions

Mergers fall into four general categories – rescue, partnership, adversarial, and hostile takeover. In each category the resistance levels between the people of the two organizations are quite different – from full cooperation to complete resistance.

A rescue is a response to a financial assistance call, and hence the acquiring organization is normally looked upon in a positive light.

A partnership category, where most mergers take place, is when both parties actively desire to combine.

The adversarial situation is when only one firm has a strong inclination in the deal and the two parties invariably want different kinds of deals.

The maximum resistance is faced when there is a hostile takeover, when one party is actively trying not to go ahead with the deal.

The characteristics of the mergers in these different categories are as given below:-

  • Rescue
    • Major weakness in operations or management
    • Top management generally requested to leave
    • Requires tremendous attention by the acquiring firm to retain key employees
    • Cooperation tends to be high between companies
    • Significant issues often overlooked in the negotiations, compromises made later on
    • Management foes not have to sell the benefits of the deal
  • Partnership
    • Surprises or strong hand tactics are scarcely used
    • Goodwill and respect prevails
    • Top management is positive about the deal, but forgets to sell the benefits to the employees
    • Once the financial deal is concluded, management forgets the integration details
    • Communication is the key to the organization’s acceptance of the deal
    • Management packages and agreements with the key employees is critical
  • Adversarial
    • Negotiations become aggressive
    • Typical barrier of one against the other
    • Win-win situation needs both parties to work at it
    • The management of the acquiring company holds a better position
    • Job security issues intensify as uncertainty prevails during negotiations, with talks of layoffs and closures start coming out
    • Productivity drops significantly and resistance rises before the actual closure of the deal
  • Hostile Takeover
    • Communication cannot overcome gossip and internal coffee-table talk
    • Animosity high and left behind by the acquired company
    • Win-lose atmosphere exists
    • Key talent invariably are the first to leave
    • Human resource failures are dominant
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The Business Case for Mergers

April 9, 2011

Inorganic Growth,Why? Fundamentally, acquisitions create value when they enhance the strategic capabilities of both the companies, improving the competitive capabilities of either or both, resulting in improved financial results. There are companies that on their own probably would not be able to make it, but when combined, are able to create a better set of products and services than could have been otherwise provided to the market.

Acquisitions can help grow a company’s market position faster than internal development strategies. It can also provide a way to bring in new capabilities and leverage existing ones that would be difficult without the synergy of an acquisition.

Mergers and acquisitions are being used by firms to strengthen and maintain their position in the market place. They are seen as a relatively fast and efficient way to expand into new markets, and acquire new and useful technologies.

The main objectives for mergers and acquisitions could be summed up as below:-

  • Horizontal mergers for market dominance or economies of scale
  • Vertical mergers for efficient channel control
  • Hybrid mergers for spreading risk, cutting costs, creating synergies, or could also be a defense mechanism to survive against competition
  • Growth for global reach
  • Survival by developing a critical mass
  • Acquisition of cash, deferred taxes, or even excess debt capacity
  • Acquire a bigger asset base to leverage borrowing
  • Top line growth objective, financial gains and personal power
  • Adding a core competency to provide more combinations of products and services
  • To acquire talent, knowledge, and technology (lately, this is becoming a very important reason)

These objectives arise as a consequence of the following changes in the business scenario.

  1. Globalization
  2. Outsourcing
  3. Speed of growth
  4. Shorter product life cycles

Regardless of the reasons companies have for merging, there are some basic assumptions that are being made, and these include:-

  • Mergers and Acquisitions are the fastest and easiest ways to grow
  • Mergers and Acquisitions are likely to fall short of their initial goals
  • Mergers and Acquisitions are difficult to do
  • Creating synergies is a major challenge
  • Shaping and adapting cultures is a major challenge
  • Due diligence is necessary but not sufficient
  • Pre-planning can help increase chances of success

The merger climate is mainly governed by financial, strategic, and psychological motives, and the following specific factors, individually or collectively, can be considered to have facilitated or promoted the current wave of merger activity.

  1. Changing market conditions
  2. Increasing availability of capital
  3. More companies for sale
  4. Easing of regulations
  5. The need to share risk
  6. The existence of complex indivisible problems

Acquisition strategy has been described as an area of corporate strategy where inappropriate mathematical theory and a yearning for greener grass, has prevailed over common sense.

The objective of a merger and acquisition is to produce advantages for both the buying and selling companies, that is, the resultant entity should be greater than the sum total of the individual entities, that is

Value (A+B) > Value (A) + Value (B)

Motives behind Mergers and Acquisitions

Mergers and Acquisitions are considered to be rational financial and strategic alliances made to benefit the organization and its shareholders. Literature (Napier, 1989) suggests that merger motives are financial (value maximizing) in nature, or, in many cases, managerial (non-value maximizing) too. However, these two are often related. Besides these ways of presenting the benefits to the shareholders, there are some unrecognized psychological motives too, often initiated to satisfy the needs of an individual or a small group of individuals, rather than the long-term benefit to the organization. Some senior managers are motivated to instigate a takeover to be recognized as people with high desires to grow the organization and looking for new opportunities, and as an action against their own fear of obsolescence (Levinson, 1995). Out of a feeling of insecurity of their job, many mergers have thus been instigated. Career moves, egotistical needs to wield power, and empire building attitudes have been other un-stated psychological motives that have prevailed over the rational motives.

Categories of Mergers and Acquisitions

Mergers fall into four general categories – rescue, partnership, adversarial, and hostile takeover. In each category the resistance levels between the people of the two organizations are quite different – from full cooperation to complete resistance.

A rescue is a response to a financial assistance call, and hence the acquiring organization is normally looked upon in a positive light.

A partnership category, where most mergers take place, is when both parties actively desire to combine.

The adversarial situation is when only one firm has a strong inclination in the deal and the two parties invariably want different kinds of deals.

The maximum resistance is faced when there is a hostile takeover, when one party is actively trying not to go ahead with the deal.

The characteristics of the mergers in these different categories are as given below:-

  • Rescue
    • Major weakness in operations or management
    • Top management generally requested to leave
    • Requires tremendous attention by the acquiring firm to retain key employees
    • Cooperation tends to be high between companies
    • Significant issues often overlooked in the negotiations, compromises made later on
    • Management foes not have to sell the benefits of the deal
  • Partnership
    • Surprises or strong hand tactics are scarcely used
    • Goodwill and respect prevails
    • Top management is positive about the deal, but forgets to sell the benefits to the employees
    • Once the financial deal is concluded, management forgets the integration details
    • Communication is the key to the organization’s acceptance of the deal
    • Management packages and agreements with the key employees is critical
  • Adversarial
    • Negotiations become aggressive
    • Typical barrier of one against the other
    • Win-win situation needs both parties to work at it
    • The management of the acquiring company holds a better position
    • Job security issues intensify as uncertainty prevails during negotiations, with talks of layoffs and closures start coming out
    • Productivity drops significantly and resistance rises before the actual closure of the deal
  • Hostile Takeover
    • Communication cannot overcome gossip and internal coffee-table talk
    • Animosity high and left behind by the acquired company
    • Win-lose atmosphere exists
    • Key talent invariably are the first to leave
    • Human resource failures are dominant

– Sanjay Dugar

(E): dugars@dishacv.com