Outline
This paper discusses the process that a firm goes through during a merger-and-acquisition event, the reasons why companies take this business solution, why M&A sometimes fails, and what happens when an M&A fails to achieve the desired results. First, M&A is defined as a process that may be undertaken together or separately.
If it is only a merger, this refers to the joining of two companies such that only one new company will emerge and continue to exist. When the term “acquisition” is applied, one company only acquires the assets of another company, and both companies continue to exist. Altogether, M&A is defined as a business transaction in which one company acquires another company. Thus, the acquiring company remains in business while the acquired company is integrated into the former, ceasing to exist after the M&A. With globalization and a more competitive business environment everywhere, the paper reports that M&A has become a normal event for businesses that want to ensure their long-term survival. Every major company in developed economies like the US has gone through a merger and acquisition process at some stage of its operation.
Introduction
The term merger-and-acquisition (M&A) suggests a crisis in which a losing business enterprise needs to merge and be acquired by another more profitable company. As such, M&A is a last-resort measure taken by desperate companies to salvage a profit from their dying business. This could be the case in previous decades when the business competition was limited to a few players, but not anymore under today’s highly competitive business climate. With globalization and a more competitive business environment everywhere, M&A has become a normal event for businesses that want to ensure their long-term survival. Every major company in developed economies like the US has gone through a merger and acquisition process at some stage of its operation (Lajoux, 2005). An M&A occurs in increasing frequency even among equally profitable companies as part of the strategy to generate long-term growth.
Some companies are even built for short-term gains, to sell them for a profit later on through an M&A process. Whether all merger-and-acquisition undertakings are successful is another matter.
All studies on M&A agree that no business event is more challenging such that if undertaken with less attention to details and less understanding of the process, M&A can be a failure for the companies involved. This paper discusses the process that a firm goes through during a merger-and-acquisition event, the reasons why companies take this business solution, why M&A sometimes fails, and what happens when an M&A fails to achieve the desired results.
Definition
Merger and acquisition is a business activity on the same level as divestments, joint ventures, spin-ins and spin-outs, and strategic partnerships. All are business transactions outside a firm’s normal course of business. The terms merger and acquisition mean different things although customarily referred to as one and synonymous (Evans, 2009). This means that a merger can happen between two companies without one acquiring the other’s assets. If a merger takes place, the assets of two companies are only joined and both may continue to exist. In an acquisition, one company purchases and takes over another company, and the buyer emerges as the new owner with the acquired company ceasing to exist. This means that the acquired company is swallowed by the buyer (Laroux, 2005). Ordinarily, mergers occur between two firms of about the same size, which they agree to operate as a single new company rather than remain separately owned. If the companies involved are publicly listed, they surrender their stocks during the merger, after which a new set of a single stock is created for the merger. This was what happened to Glaxo Wellcome and SmithKline Beecham in 1999, both of which ceased to exist after they merged. The merged companies became GlaxoSmithKline, whose newly created stock replaced those of the two companies.
Mergers fall under three categories
Horizontal – this happens when a merger involves two companies dealing in the same products and services. In effect, the firms are competitors in the same market and want to merge to increase market share. An example of this type of merger is that between Exxon and Mobil, after which both companies were rewarded with a bigger share of the gas and oil market (Laroux, 2005).
Vertical – an example of a vertical merger is the one between Merck and Medco. Both are engaged in pharmaceuticals but one is a manufacturer while the other is a distributor, which means that a manufacturer merges with a supplier. The objective of this merger along the value chain is to gain a competitive advantage since the merged companies cornered two different phases of the marketplace.
Conglomerate – this type of merger involves two companies in totally different industries to achieve more consistency in future growth. For example, a high-technology firm may merge with a gas pipeline company when the former feels that growth in the technology industry has bottomed out. By merging with a gas company, the technology firm can diversify into gas distribution which remains a high-growth industry. General Electric has engaged in this type of activity by merging with companies in such industries as financial services and broadcasting.
In principle, mergers and acquisitions can occur separately, but in practice, the two terms often go together. It is called a merger when the agreement on the transaction specifies that the companies will be joined together for their mutual interests. However, when the deal is unfriendly or the company being purchased exhibits some resistance to the deal, it is always regarded as an acquisition (Evans, 2009). The purchase then is considered a merger or an acquisition depending on whether the purchase is friendly or unfriendly as well as how the transaction is announced. In effect, the circumstances on how the intention to buy is communicated to the board of directors, shareholders, and employees of the target company and the way the communication is received make a difference on whether the transaction can be described as a merger or an acquisition.
Reasons
The basic reason for every M&A is expressed in the equation: 2 plus 2 equals 5. This means that if two companies valued at $2 billion each go through an M&A process, the result is a new company with a book value of $5 billion. Thus, the M&A creates what is called synergy value.
This additional value created by an M&A may come in the form of higher revenues, lower expenses, and lower cost of capital. The merger realizes higher revenues for the two companies when they combine their resources and customer base. Lower operating expenses and cost of capital, on the other hand, become possible because the two firms no longer operate separately (Evans, 2009). By far the biggest consideration in most M&As is the value created on lower expenses because it answers the need of today’s companies to cut costs under the current difficulties in the business environment.
Once the departments of both companies are streamlined, such as those on human resources and accounting, considerable savings can be realized from the M&A.
Other than these practical reasons, there are also at least four strategic reasons that distinguish the most successful mergers. Positioning is one of these reasons, which will allow a company to take advantage of market support in areas where it is weak. For example, a telecommunications firm can improve its future position if it merges and acquires a broadband service company (Straub, 2007). Another strategic reason is gap-filling, which intends to merge with a company that could supplement a weakness of another company. Thus, if a manufacturer has a poor distribution network it can fill this gap by merging with a large distributor. The third strategic reason that underpins an M&A is the need to strengthen a firm’s organizational competencies. By merging with another company, a poorly staffed firm can improve its organizational competencies through the acquisition of a new set of human resources and intellectual capital that can boost innovative thinking and productivity.
The fourth and final strategic reason is broader market access, which gives preference to a company with an overseas presence as an M&A target. This means that if an exclusively domestic firm acquires a foreign company, it gains access to emerging markets (Horan, et al., 2007).
Basic business reasons also drive many M&As.
These include bargain purchase, the need to diversify, short-term growth, and undervaluation of an M&A target company. A bargain purchase happens when a company targets for M&A a competitor whose facilities suddenly turn idle because of financial problems. This company aims to expand by building fabrication facilities similar to those of the competitor that become idle, but instead of doing so, it acquires the facilities of the losing competitor and gets a bargain in the process. On diversification as a business reason for M&A, the acquisition of a company in another line of business enables certainly firms to expand their reach.
As for short-term growth, it becomes a reason when a company needs to immediately improve its performance.
This can be done by acquiring a highly profitable firm. The final business reason is the undervalued target, which refers to a company whose stock value may be undervalued and thus represents a good investment (Zafar, 2009).
Process
The M&A process starts with a diligent review to decide if it is viable and ends with a careful post-merger integration to ensure the long-term success of the merger and acquisition. Here are the five phases involved in M&A:
- Pre-Acquisition Review – this is the first step that determines if it is wise for a company to engage in an M&A. If the review found that the days ahead for the company will be rough in terms of sales, market share, return on investment, and competences, then an M&A is in order. The basis of this review is the capability of the firm to achieve its growth target for the next three years as well as a determination if it is undervalued. If the review shows that the firm cannot achieve its growth target on its own, it proceeds to devise a growth plan under an M&A. As for the valuation, this is included in the pre-acquisition stage because if a firm is undervalued it could find itself the target of an M&A.
- Search and Screen Targets – the next step for an acquiring company is to search for the best M&A target. To meet the criteria for this selection, a company targeted for the takeover must be a good strategic fit with the acquiring firm. This means that the performance of the target firm is driven by factors that complement rather than overlap with those of the acquiring company. Compatibility and fit should be assessed across a range of criteria that include relative size, type of business, capital structure, organizational strengths, core competencies, and market channels.
- Investigate and Value the Target – this involves a more detailed analysis of the target company. The acquiring company wants to ascertain that the target firm fits with its organization, so the process is characterized by a more thorough review of operations, strategies, financials, and other aspects of the target company. In M&A parlance, this detailed review is called “due diligence,” to identify all the values that can be generated from the M&A.
Acquiring companies often commission investment bankers to assist in this valuation process. Laroux (2005) provides an example of how such valuation is conducted:
- Value of acquiring company……… …………….$560M
- Value of target company……………………………..$176M
- Value of synergies per phase…………………….$38M
- Less M&A costs (legal, investment bank, etc.)…($9M)
- Total Value of Combined Company……..$765M
Acquire through Negotiation – the negotiation process starts, based on a plan that seeks to satisfy such key questions as What are the benefits to be derived from the target company? How much resistance will the acquiring firm encounter from the target company? What is the best bidding strategy and how much to offer in the first round of bidding? The most common approach to acquiring another company is for both companies to reach an agreement on whether to negotiate the M&A. This is called “bear hug” in M&A language in which both parties agree to the buyout arrangement. When the target shows some resistance, the acquiring firm resorts to an action called “toehold position” in which it puts pressure on the target to negotiate without necessarily causing panic (Evans, 2009). In this action, a so-called tender offer is made by the acquiring company and presented directly to the shareholders, which deliberately bypasses management. The tender offer has the following characteristics: 1) it sets a price above the prevailing market price for the target; 2) it applies to a big part if not all of the target’s outstanding shares of stock; and 3) it is open for a limited period (DePamphilis, 2008).
Announcement of M&A Agreement – the two companies announced an agreement on the final M&A agreement, which sets such terms as the acquisition price, whether the controlling interest was acquired or just the physical assets, the form of payment, time frame for the merger and similar details. This announcement is followed by the actual integration of the two companies, which is considered more challenging than the initial stages of the M&A.
Active M&A Center
The United Arab Emirates has emerged as the most active center for M&A in the Middle East with 50 such transactions being reported from the country alone between 1996 and 2001 (Zafar, 2009). This is based on a study commissioned by Abraaj Capital to assess the prospects for private equity in the region and the market forces that drive M&A activity.
During the period under study, a total of 266 M&A transactions occurred in the Middle East. Of this number, 91 M&As involved a total amount of $8.7 billion. Most of the recent M&A activity has taken place in the banking sector with progressive players like the Ahli United Bank and Mashreqbank leading the way. The two banks have set their growth strategy precisely on acquisitions.
In recent years before the global recession that started in mid-2008, banks in the Middle East as a whole experienced unprecedented growth, with many of them still reporting moderate profits in 2008. Between 2002 to 2007, banks in UAE posted a 34 percent increase in total assets and a 39 percent increase in net profits. The banking sector has so far shunned major mergers and acquisitions, but changing conditions in the global and regional financial industry have created unique opportunities for a long-predicted wave of mergers and acquisitions (Gulfnews, 2009).
For the whole Middle East and North Africa (MENA) region, M&A activities dropped by 66 percent in May 2009 but only because of the global recession. The figure is expected to increase again when the recession is over.
Failures
The post-merger integration is considered critical to the success of an M&A in terms of human resource management. In turn, the human resource function plays a critical and strategic role in supporting a successful M&A. Because of possible clashes in corporate cultures, this period is the most difficult phase in the M&A process ((Straub, 2007). The reason is that companies have differences in culture, information systems, strategies, and other aspects of business operation. When two companies with different cultures combine, sparks are expected to fly. According to Horan, et al. (2007), cultural integration is a major impediment to the success of an M&A because every organization has a unique business culture. Some may be freewheeling and entrepreneurial while other firms expect their people to do things by the book. One firm has a culture of paternalism while another is democratic and participative. Bringing together two such different cultures can create frictions on the people’s side of the business. To overcome this problem, M&A analysts suggest that companies acquiring other firms must anticipate the challenge and then implement change management when the M&A deal is done. The necessity of change should be communicated to employees, emphasizing how the new setup will work for their benefit. If the firm can afford it, incentives may be provided to break through the employees’ resistance to change. In many post-M&A integration scenarios, companies help employees let go of the past and embrace the present and future. According to the HR managers of Pricewaterhouse (online), the growth of firms that went through the M&A process is not being constrained by a lack of financial capital but by a shortage of human capital.
The report said International M&A activity especially calls for a broader range of skills and talents. In planning for change during an M&A event, firms are advised to take action much earlier in the process to identify the people in the company that can be key to the success of the project. Steps are then taken to keep these people.
The integration process is usually done at three levels: full, moderate, and minimal. The process is done in full measure if all the functional aspects of the two companies are merged, such as the operations, marketing, finance, and human resources departments. In this case, the new company that emerged from the M&A uses the best practices gleaned from the two companies. The effort is moderate if only certain key functions or processes are merged.
Consequently, minor day-to-day decisions remain as they were except for strategic matters which become centralized.
In a minimal integration, only selected personnel from the two companies are joined together. Strategic decisions remain centralized and operating decisions stay autonomous (DePamphilis, 2008).
Lack of due diligence in M&A review, negotiation, and integration can be harmful to the companies involved. For example, if an announced merger is suddenly called, the reputation of the acquiring company can be severely damaged ((Evans 2009). This was shown in the merger between Rite Aid and Revco, which failed to anticipate anti-trust actions that required selling off retail stores. As a result, the expected synergy of values could not be realized. Another classic case of an M&A gone wrong is the merger between HFS Inc. and CUC International. Four months after the merger was announced, it was disclosed that there were significant accounting irregularities. Because of these reports, the newly formed company Cendant lost $ 14 billion in market value. Later, the firm’s chairman resigned, investors filed over 50 lawsuits, and nine of 14 directors from CUC resigned. In 2000, Ernst & Young was forced to settle with shareholders for $335 million (Straub, 2007).
Due diligence is therefore essential for uncovering potential problem areas, exposing risk and liabilities, and helping to ensure that there are no surprises after the merger is announced (Gulfnews, 2009). In today’s fast-paced business environment, however, some companies decide to pass due diligence and make an offer based on competitive intelligence and public information, which is very risky in an M&A (King, et al., 2004).
References
De Pamphilis, D. (2008). “Mergers, Acquisitions and Other Restructuring.” New York: Elsevier.
Evans, Matt H. (2000). “Excellence in Financial Management.”
Gulfnews (2009). “Mergers and Acquisitions in MENA Down 66 percent.” Al Nisr Publishing.
Horan, P., Lee, S.H., Muravota, L., Singa, S. & Wang, B.X. (2007). “M&A in Emerging Markets: The Human Capital Challenge.” Marsh & McLennan Co.
King, D.R., Dalton, D.R., Daily, C.M. & Covin, J.G. (2004). “Meta-Analyses of Post- Acquisition Performance.” Strategic Management Journal 25 (2).
Laroux, Alexandra Reed (2005). “The Art of Merger and Acquisition Integration.” McGraw-Hill: 2d edition.
PricewaterhouseCoopers. “Talent and M&A.” Webpage design (online). 2009. Web.
Scott, Andy (2008). “Mergers and Acquisitions in China.” China Briefing.
Straub, Thomas (2007). “Reasons for Frequent Failure in Mergers and Acquisitions: A Comprehensive Analysis.” Wiesbeden: Deutscher University.
Zafar, Azhar (2009). “Mergers and Acquisitions in the Middle East.” Ernst & Young Middle East.