FIN703Sem

Mergers and Acquisition

Topic 1: The Takeover Process

&
Forces Affecting Mergers

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 Lecture Objectives
At the end of this topic, you will be able to:
Evaluate the different types of Mergers.
Analyze the pace of Merger activities at present.
Determine the forces driving Merger activities.
Determine the issues regarding Merger activities.
Understand the nature of Tender offers.
Analyze Risk arbitrage in M&A activity

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 Difference Between Merger and Acquisition
Although merger and acquisition are often used as synonymous terms, there is a
subtle difference between the two concepts.
In the case of a merger, two firms together form a new company. After the merger,
the separately owned companies become jointly owned and obtain a new single
identity. When two firms merge, stocks of both are surrendered and new stocks in the
name of new company are issued. Generally, mergers take place between two
companies of more or less same size. In these cases, the process is called Merger of
Equals.
However, with acquisition, one firm takes over another and establishes its power as
the single owner. Generally, the firm which takes over is the bigger and stronger one.
The relatively less powerful, smaller firm loses its existence, and the firm taking over,
runs the whole business with its own identity. Unlike the merger, stocks of the
acquired firm are not surrendered, but bought by the public prior to the acquisition,
and continue to be traded in the stock market.

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 Difference Between Merger and Acquisition
Another difference is, when a deal is made between two companies in friendly
terms, it is typically proclaimed as a merger, regardless of whether it is a buy out. In
an unfriendly deal, where the stronger firm swallows the target firm, even when
the target company is not willing to be purchased, then the process is labeled as
acquisition.
Often mergers and acquisitions become synonymous, because, in many cases, a
bigger firm may buy out a relatively less powerful one and compel it to announce
the process as a merger. Although, in reality an acquisition takes place, the firms
declare it as a merger to avoid any negative impression.
All the merger applications in Fiji and clearance are processed by FCCC under
Section 72 and Section 73 of the Fijian Competition & Consumer Commission
(FCCC) Act 2010.

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 TYPES OF MERGERS
Horizontal mergers
Vertical mergers
Conglomerate mergers

Synergy : where 1+1 = more than 2

Synergy, the idea that the value and performance of two companies combined
will be greater than the sum of the separate individual parts is one of the reasons
companies merger.

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HORIZONTAL MERGERS
A merger occurring between companies in the same industry. Horizontal
merger is a business consolidation that occurs between firms who operate in the
same space, often as competitors offering the same good or service.
Horizontal mergers are common in industries with fewer firms, as competition
tends to be higher and the synergies and potential gains in market share are
much greater for merging firms in such an industry.
Example: A merger between Coca-Cola and the Pepsi beverage division, for
example, would be horizontal in nature.

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 HORIZONTAL MERGERS
Reasons
Economies of scale and scope - The goal of a horizontal merger is to create a new, larger
organization with more market share. Because the merging companies' business operations
may be very similar, there may be opportunities to join certain operations, such as
manufacturing, and reduce costs.
Reduces the competition by reducing the number of companies which are there in the
industry and hence company has to spend less time on taking undue stress about how to
tackle competition and can concentrate more on improving its product and giving the
customer best services by producing good quality product at lowest price.
Achieving Synergies - by combining best practices.
Possible, Government regulation due to potential anticompetitive effects under some
economic theories:
 Fewer firms in industry facilitate collusion
 Potential for market power as competition declines.

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 VERTICAL MERGERS
 A merger between two companies producing different goods or services for one specific
finished product. A vertical merger occurs when two or more firms, operating at different
levels within an industry's supply chain, merge operations. Most often the logic behind
the merger is to increase synergies created by merging firms that would be more efficient
operating as one.
 Affirmative rationale is information and transaction efficiency.
 Key issue: costs of using external market transactions vs. organization costs of internal
transfers.
Example
A vertical merger joins two companies that may not compete with each other, but exist in the
same supply chain.
An automobile company joining with a parts supplier would be an example of a vertical merger.
Such a deal would allow the automobile division to obtain better pricing on parts and have
better control over the manufacturing process. The parts division, in turn, would be guaranteed
a steady stream of business.
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 VERTICAL MERGERS
Why vertical integration may be advantageous

The biggest advantage of vertical merger is that it reduces the company’s dependence on the supplier
of raw material because in vertical merger company is buying the suppliers business and therefore
company has complete control over the supply of raw material and there is no stress of supplier
demanding higher price or late delivery of raw material or any other illegitimate suppliers demand.

It also leads to economics of scale for the company as it reduces the various costs associated with
procurement of raw material like transport cost, transactions cost, labor and so on.

It helps the company in research and development of product because after vertical merger company
has people with knowledge of both raw material and finished product which helps the company in
producing the better product than before at very lower cost leading to higher profits for the company

Affirmative rationale is information and transaction efficiency.

Costs of using external market transactions vs. organization costs of internal transfers.

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VERTICAL MERGERS
Why vertical integration may be advantageous
 Asset specialization requires common ownership through vertical integration
to avoid expropriation by one party at the expense of another.
 If markets for a product like crude oil are not efficient, vertical integration of
exploration, production, refining, and marketing may avoid supply flow
interruptions.
 Avoids the necessity for haggling in small numbers of bargaining along the
value chain.
 May contribute to more efficient information flows for planning production
and inventory levels.
 When critical knowledge is gained in producing product components, this
learning process can be internalized to avoid losing it to outside firms.

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 VERTICAL MERGERS
When vertical integration may be less efficient than the use of markets

Market transactions are low cost

E-commerce reduces information and transactions costs, so likely to

lead to less vertical integration

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 CONGLOMERATE MERGERS
 A merger between firms that are involved in totally unrelated business activities.

 There are two types of conglomerate mergers: pure and mixed.

 Pure conglomerate mergers involve firms with nothing in common

 Mixed conglomerate mergers involve firms that are looking for product extensions
or market extensions.
Example
A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting
company is faced with the same competition in each of its two markets after the merger as
the individual firms were before the merger. 

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 CONGLOMERATE MERGERS
 Conglomerate mergers seem to attract special attention for two
reasons.
 First, this is virtually the only kind of significant merger activity the
very largest firms can engage in, and the conduct of these firms is
always top news.
 Second, the conglomerate merger does not "fit" as neatly into
antitrust doctrine as other mergers do, and hence, there is a good
deal of mystery about what the operating rules are or should be. 

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 CONGLOMERATE MERGERS
Why do conglomerate mergers occur?
A desire to diversify - which in itself can have several motivations.
A firm that has grown large and profitable in a particular product line may wish to continue its growth but,
because of the antitrust laws or other considerations, may be unable to grow horizontally or vertically.
Or a firm tied to a single product or class of customer (the Government, for example) may be concerned
about its vulnerability if, for reasons unrelated to the firm's competence, the single product should suddenly
be made obsolete or the single customer class should cut back its purchases.
Conglomerate mergers between firms in related product lines also create opportunities for increased
efficiencies through the meshing of production or marketing facilities or methods, and for the introduction of
new and aggressive management into a stagnating industry.
Access to available capital or tax loss advantages can also stimulate mergers of all types, but principally those
of the conglomerate variety.
Companies diversify with imperfectly correlated securities to reduce portfolio risk where Professional
management aids selection among investment alternatives.

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 Financial and Managerial Conglomerate & Concentric Company
Financial Conglomerates
 Internal capital markets: provide flow of funds to each segment of operations; ultimate financial risk bearer.
 Perform strategic planning and exercise control, but do not participate in operating systems.
 A financial conglomerate is a company that combines different types of financial institutions under one roof:
Banking, Insurance and Asset Management.
Managerial Conglomerates
 Includes characteristics of financial conglomerates.
 Also provides general management functions.
 Some argue that management is transferable over a variety of industries.
 Provides managerial counseling and interactions on decisions.
 Increases the potential for improving operating performance.
Concentric Company (refer to next slide)

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 CONCENTRIC COMPANIES
Concentric diversification involves adding new products or services that are related to your
current offerings -either because they appeal to the same market or because they can be offered
without much investment in new resources (or both.)
Start with focused core activities, combine with firms in less related activities to broaden market
potentials; End result may be large multiproduct, multiplant firms in related activities
You can achieve concentric diversity with acquisitions, but often it's a natural outgrowth of what
you're already doing.
Example
•If you own a bakery, for example, you might do an addition and start serving sandwiches.
•If you produce table linens, you might start making curtains.
•If you clean carpets for commercial customers, you might add services for the residential market.

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 CONCENTRIC COMPANIES
Advantages
Concentric diversity aims for synergy - using your experience and strengths in one
area to gain a foothold in another area.
You use what you know about your bakery customers to sell them sandwiches, or
you use the same equipment to make both napkins and curtains, or you take your
commercial carpet cleaning experience and apply it to homes.
Concentric diversification can also provide a gainful use for excess capacity. With
conglomerate diversification, the advantage is the diversification itself -spreading
the market risk across more sectors. If the hardware store business falls, the car
wash business may be able to carry the company. This kind of advantage applies to
concentric diversity, too.

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 CONCENTRIC COMPANIES
Disadvantages
Although diversification is supposed to reduce market risk, it carries dangers of its own. With
conglomerate diversity, there's no guarantee that the businesses will be a good fit. A hardware
store owner can buy a car wash, but if you don't know anything about how to run one, you'll have
problems. And even if you hire someone to run it, you may not be able to tell with confidence if it's
being run well.
Dangers of concentric diversity include line overextension - diluting the value of your brand by
trying to do too much.
If your new products or services don't measure up to the quality of your current offerings, that
could hurt your existing sales as customers lose faith.
And with both types, there is always the possibility that the diversification will just be a poor
investment –if you misread the market, you will end up offering something that customers don't
want.

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 SHORT-FORM MERGER
Also known as a parent-subsidiary merger
It is a merger between a parent company and its substantially (but not necessarily
wholly) owned subsidiary, with either the parent company or the subsidiary
surviving the merger.
A short-form merger does not require approval of the stockholders of the
subsidiary. The requirements of a short-form merger are dictated by state statute.
If a buyer acquires less than 100% (but generally at least 90%) of a target company's
outstanding stock, it may be able to use a short-form merger to acquire the
remaining minority interests.
The merger allows the buyer to acquire those interests without a stockholder vote,
thereby purchasing all of the target company's stock. This merger process occurs
after the stock sale closes, and is not a negotiated transaction.

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 THE PACE OF MERGER ACTIVITY
Number & Value of M&A Worldwide
Since 2000, more than 790’000 transactions have been announced worldwide
with a known value of over 57 trillion USD. In 2018, the number of deals has
decreased by 8% to about 49’000 transactions, while their value has increased
by 4% to 3.8 trillion USD.
https://imaa-institute.org/mergers-and-acquisitions-statistics/

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CHANGE FORCES DRIVING MERGERS
Technological change
Efficiency of operations – economies of scale, scope, complementarity, need to
catch up technologically
Globalization and freer trade
Changes in industry organization
New industries
Deregulation and regulation.
Favorable economic and financial conditions.
Negative trends in certain industries and economies.
Widening inequalities in income and wealth.

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Issues – M&A Activity

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 Issues – M&A Activity
In Favor
Critical to healthy expansion of business firms
Increase value and efficiency
Move resources to optimal uses

Opposed
No improvements subsequent to the acquisition
Redistribution of wealth from labor and other stakeholders to shareholders
Speculative activity

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MERGER AND TENDER OFFER TERMINOLOGY

 Merger
• Negotiated deals that meet certain technical, legal requirements.
• Mutuality of negotiations.
• Mostly friendly but one firm may be stronger and dominate the transaction.

 Tender offers
• One firm or person makes offer directly to the shareholders to buy their shares
at specified prices.
 Hostile when an offer is made to the shareholders without approval of the board of
directors
 Restructuring — changes in organization, operations, policies and strategies to
enable the firm to achieve its long-term objectives

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 THE NATURE OF TENDER OFFERS
 Bidder seeks target firm's shareholders approval — may aim for 50% or more of the target
shares
 Minority shareholders
1. Law not clear on whether merger doctrine applies
2. Terms may be "crammed down" on the minority shareholders when bidder has obtained control
3. If acquirer decides not to complete the buyout, minority may be subject to the decisions of the
majority holders — "freeze-in"
4. Minority has the right to bring legal action

5. Many recent minority squeeze outs

◦ Usually reversing an equity carve-out
◦ Courts have ruled that majority holders can make takeover bid without demonstrating that offer is
a fair price
◦ Recently, minority shareholders have done well – parent corporations probably seeking to avoid
shareholder litigation

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 KINDS OF TENDER OFFERS AND PROVISIONS
Conditional or unconditional — offer may be contingent on obtaining a certain percentage of the
shares
Restricted versus unrestricted — restricted offer prespecifies the number or percentage of shares
the bidder will take
◦ In restricted offer, oversubscription may result in prorationing by the bidder
◦ Law requires a 20-day waiting period for the target shareholders to make their decision to offer
their shares
"Any-or-all" tender offer — an unconditional and unrestricted offer
Contested offer — other bidders compete with the first bidder
◦ When new tender offer is made, the stockholders of the target have 10 business days to
consider the new offer
◦ Initial offer period is extended by 10 days
Two-tier offer
◦ First tier — cash offer to obtain 50% or more of target's stock
◦ Second tier — smaller value may be offered since control has been already established. Second
tier is often paid with debt instead of cash or equity of the bidder.
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 RISK ARBITRAGE IN M&A
ACTIVITY
In M&A, risk arbitrage refers to the practice of taking a position for short-term resale at a
profit
Risk arbitragers take a position in target firms, essentially betting that the merger deal will
be completed
(Target firms shares are usually selling at a discount – below purchase price-so an investor
buys at a lower price in the hope of selling it at a higher price to the acquirer).

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 NATURE OF THE ARBITRAGE
BUSINESS
Information gathering and analysis is the principal raw material in the
arbitrage business
In recent years, arbitragers attempt to anticipate takeover bids to establish
their stock positions before any announcement
Arbitragers respond to announced takeover bids by evaluating the offer and
assess its possibility of success
Arbitragers must act early enough to capture the gains inherent in the
transaction

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 ARBITRAGE FUNDS
Primary goal is eliminating market risk
Fund buys stock of target (and shorts buyer in stock transactions)
Funds seek to spread deal risk over a portfolio of well researched deals
Performance of merger arbitrage funds is often high
However, funds are exposed to the risk of market crashes, which if happens
will lead to deals being canceled, and funds will end up losing most of their
capital and could go out of business.

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THE END

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