Merger Basics

2 MERGER BASICS LEARNING OBJECTIVE After reading this chapter you should be able to: . Understand the basics merger as a form of corporate restructuring . Define and conceptualize the concept of Merger . Understand the different Types of Mergers . Understand the Merger Movements in India and abroad . Spot out the Factors Affecting Merger . Narrate the of Theories of Merger . Point out the Impact of Mergers on Stakeholders In this chapter Introduction, Definition of merger and acquisition, history of merger and acquisition, Types of merger, difference between merger and acquisition, difference between acquisition and takeover, Merger and Acquisition Process, Significance of merger and acquisition, Requirement of merger and acquisition, Motives behind merger and acquisition, Benefits of merger and acquisition, Limitations of merger, Impact of merger and acquisition, Financial accounting for merger and acquisition, Merger and acquisition strategies, Merger and acquisition laws, Merger and acquisition in India, Merger and acquisition in world have been included 2.1 INTRODUCTION As discussed in the previous chapter, a business firm may expand its business by either internally or externally. In internal expansion, the firm grows gradually over time in normal course of business through acquisition of new assets, replacement of the technologically obsolete equipments and the establishment of new lines of products. It is otherwise known as organic growth, the essential feature of which is the reinvestment of the previous years’ retained profit in the existing business, together with finance provided by shareholders. An organic growth provides more corporate control, encourages internal entrepreneurship and protects organisational cultures and core values. It also provides managers with a better understanding of their own firm and assets, and internal investment is likely to be better planned and efficient. However, this type of growth is a slower as compared its counterpart inorganic growth. In external expansion or inorganic growth, a firm acquires a running business and grows overnight through corporate combinations. These combinations are in the form of mergers, acquisitions, amalgamations and takeovers; which have now become important features of corporate restructuring. They have been playing an important role in the external growth of a number of leading companies the world over. They have become popular because of the enhanced competition, breaking of trade barriers, free flow of capital across countries and globalization of businesses. In the wake of economic reforms, Indian industries have also started restructuring their operations around their core business activities through merger, acquisition and takeovers because of their increasing exposure to competition both domestically and internationally. The present era is known as the era of competition and in this era, companies go for merger to avoid the competition and to enjoy sometimes monopoly. Mergers and acquisitions (M & As) have been a very important strategy for entry into a new market as well as for expansion. Corporate India is waking up to the new millennium imperative of mergers and acquisitions in a desperate search for a panacea for facing the global competition. This is hardly surprising as stiff competition is, in a sense, implicit in any bid to integrate the national economy with the global economy. The ongoing process of liberalization has exposed the unproductive use of capital by the Indian corporate both in public and private sectors. Consolidation through mergers and acquisitions (M & As) is considered as one of the best way of restructuring structure of corporate units. The concept of mergers and acquisitions has become very much popular after 1990s, when India entered in to the Liberalization, Privatization and Globalization (LPG) era. The winds of LPG are blowing over all the sectors of the Indian economy but its maximum impact is seen in the industrial sector. It caused the market to become hyper- competitive. As competition increased in the economy, so to avoid unhealthy competition and to face international and multinational companies, Indian companies are going for mergers and acquisitions. 2.2 CONCEPT AND DEFINITION Both the terms “merger” and “acquisition” mean a corporate combination of two separate companies to form one company and they are often used synonymously in practice, but there are slightly different meanings between them. MERGER In a merger activity, it usually takes place when two separate firms which have similar size agree to form a new single company. Then both companies’ stocks will cease to exist and the newly created company’s stock will be issued in its place. This kind of activity is often referred as a “merger of equals” (www.investopedia.com). A typical example of a major merger is the merger between AOL and Time Warner in 2000. In India, the term ‘Merger’ is not defined under any Indian law neither under the Companies Act 1956 nor under the Income Tax Act 1961 even. Simply put, a merger is a combination of two or more distinct entities into one; the desired effect being not just the accumulation of assets and liabilities of the distinct entities, but to achieve several other benefits such as, economies of scale, acquisition of cutting edge technologies, obtaining access into sectors /markets with established players, etc. Generally, in a merger, the merging entities would cease to be in existence and would merge into a single surviving entity. Very often, the two expressions ‘Merger’ and ‘Amalgamation’ are used synonymously. But there is, in fact, a difference. Merger generally refers to a circumstance in which the assets and liabilities of a company (merging company) are vested in another company (the merged company). The merging entity loses its identity and its shareholders become shareholders of the merged company. On the other hand, an amalgamation is an arrangement, whereby the assets and liabilities of two or more companies (amalgamating companies) become vested in another company (the amalgamated company). The amalgamating companies all lose their identity and emerge as the amalgamated company; though in certain transaction structures the amalgamated company may or may not be one of the original companies. The shareholders of the amalgamating companies become shareholders of the amalgamated company. According to the Oxford Dictionary the expression merger or amalgamation means “Combining of two commercial companies into one” and “Merging of two or more business concerns into one” respectively. A merger is just one type of acquisition. One company can acquire another in several other ways including purchasing some or all of the company’s assets or buying up its outstanding share of stock. ACQUISITION While in the case of an acquisition, one company is purchased by another one and no new company is formed subsequently. From a legal point of view, the target company ceases to exist, the acquirer occupies the business of the target firm and the acquirer's stock continues to be traded. In addition, the acquiring firm collects all asset and gains of the target company as well as the liability (www.investopedia.com). An example of a major acquisition is Manulife Financial Corporation's acquisition of John Hancock Financial Services Inc in 2004 (www.investopedia.com). 2.3 TYPES OF MERGERS AND ACQUISITIONS MERGERS There are mainly four types of mergers based on the competitive relationships between the merging parties: 1) Horizontal Mergers 2) Vertical Mergers 3) Conglomerate Mergers (1) Horizontal Merger Horizontal mergers refer to combination of two or more firms that operate and compete in a similar kind of business and are in same stage of industrial process. Horizontal mergers raise three basic competitive issues. The first is the elimination of competition between the merging firms, which, depending on their size, may be significant. The second is that the unification of the merging firm’s operations may create substantial market power and could enable the merged entity to raise prices by reducing output unilaterally. The third problem is that by increasing concentration in the relevant market, the transaction may strengthen the ability of the markets remaining participants to co-ordinate their pricing and output decisions. The fear is not that the entities will engage in secret collaboration but that the reduction in the number of industry members will enhance co-ordination of behaviour. Horizontal merger provides economies of scale from the larger combined unit; eliminates competition, thereby putting an end to price cutting wars, possibility of starting R&D, effective marketing and management. For example in the Aerospace industry, Boeing merged with McDonald Douglass to create the World’s largest aerospace company. Another Compaq acquired Digital Equipment and then itself was acquired by Hewlett Packard (hp). Glaxo Wellcome Plc. and SmithKline Beecham Plc. Mega merger resulted in the largest drug manufacturing company globally. The merger created a company valued at $182.4 billion and with a 7.3 per cent share of the global pharmaceutical market. The two companies have complementary drug portfolios, and the merger helped them pool their research and development funds and the merged company a bigger sales and marketing force. 2) Vertical Mergers Vertical merger is a combination of two or more firms involved in different stages of production or distribution of the same product. For example, the merger of a

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