merger

1. Merger Strategy
One plus one makes three is the main idea behind a
Merger or an Acquisition.
The key principle behind buying a company is to create
shareholder value over and above that of the sum of
the two companies. Two companies together are more
valuable than two separate companies.
Especially, when times are tough, strong companies
will act to buy other companies to create a more
competitive and cost-efficient company. The companies
will come together hoping to gain a greater market
share or to achieve greater efficiency. Target
companies will often agree to be purchased when they
know they cannot survive alone.

2. Merger Strategy
 This chapter focuses on the strategic motives and
determinants of mergers and acquisitions (M&As). It begins
with a discussion of two of the most often cited motives for
mergers and acquisitions—Growth and Synergy.
 Synergy is the magic force that allows for enhanced cost
efficiencies of the new business. Synergy takes the form of
revenue enhancement and cost savings.
 The different types of synergy:
 Operating and Financial synergy
 Operating synergy has the most economically sound basis.
Financial synergy is a more questionable motive for a merger
or an acquisition.

3.  Companies often merge in an attempt to diversify
into another line of business. The history of
mergers is replete with diversification transactions.
The track record of these diversifications, with
notable exceptions, is not very impressive.
However, certain types of diversifying transactions,
those that do not involve a movement to a very
different business category, have a better track
record.
 Companies experience greater success with
horizontal combinations, which result in an
increase in market share, and even with some
vertical transactions, which may provide other
economic benefits. Unfortunately, a less noble
motive such as hubris, or pride of the management
of the bidder, also may be a motive for an

4. I. Growth
 One of the most fundamental motives for M&As is growth.
Companies seeking to expand are faced with a choice
between internal or organic growth and growth through
M&As. Internal growth may be a slow and uncertain process.
 Growth through M&As may be a much more rapid process,
although it brings with it its own uncertainties.
 If a company seeks to expand within its own industry they
may conclude that internal growth is not an acceptable
alternative. For example, if a company has a window of
opportunity that will remain open for only a limited period of
time, slow internal growth may not suffice.
As the company grows slowly through internal expansion,
competitors may respond quickly and take market share.

5. Advantages that a company may have can dissipate over
time. The only solution may be to acquire another company
that has the resources, such as established offices and
facilities, management, and other resources, in place. There
are many opportunities that must be acted on immediately
lest they disappear.
Eg.1. It could be that a company has developed a new product
or process and has a time advantage over competitors. Even
if it is possible to patent the product or process, this does not
prevent competitors from possibly developing a competing
product or process that does not violate the patent.
Eg. 2. Another example would be if a company developed a new
merchandising concept. Being first to develop the concept
provides a certain limited time advantage. If not properly
taken advantage of, it may slip by and become an opportunity
for larger competitors with greater resources.

6. Case study 1
 An American multinational medical devices, pharmaceutical and
consumer packaged goods manufacturer founded in 1886
 A manufacturer and marketer of a wide range of health care
products
 Over 1995- 2005, it engineered over 50 acquisitions as part of its
growth through acquisitions strategy
 It sought to pursue those companies who had developed successful
products in order to not waste time and resources in unsuccessful
internal development attempts
 In 1996, it acquired Cordis but it failed to place it in the lead in the
market
 In 2005, it resorted to M&A again by bidding for market leader
Guidant for $ 25.4 billion (initially). It would have been the largest
deal in its long history of M&A but then Guidant’s litigation liabilities
became known and then it was outbid by Boston Scientific. Then it
acquired Pfizer’s consumer products division for $ 16 billion.

7.  Throughout, it acquired following businesses:
1. Alza for drug delivery
2. Depuy for orthopedic devices
3. Neutrogena for skin and hair care
4. Peninsula pharmaceuticals for life threatening infections etc.
 B. Another example of growth strategy is when a company wants to
expand to another geographic region. It can be another region of the
same country or another country or continent. Incase of international
expansion, the company needs to understand the new market,
recruit new personnel and encounter other hurdles like language
and culture barriers. Then, mergers, acquisitions or JVs may be the
fastest and lowest risk alternative.
 Interestingly, exchange rates play an important role in international
deals. When the currency of a bidder appreciates relative to that of a
target, a buyer holding the more highly valued currency may be able
to afford a higher premium which would be attractive for the target.
 Eg. A sample from 1970- 1987 shows that foreign acquirers paid
10% higher premiums.

8.  Diversification
 Diversification means growing outside a company’s current
industry category. This motive played a major role in the
acquisitions and mergers that took place in the third merger
wave—the conglomerate era. During the late 1960s, firms
often sought to expand by buying other companies rather
than through internal expansion. This outward expansion was
often facilitated by some creative financial techniques that
temporarily caused the acquiring firm’s stock price to rise
while adding little real value through the exchange. The
legacy of the conglomerates has drawn poor, or at least
mixed, reviews. Indeed, many of the firms that grew into
conglomerates in the 1960s were disassembled through
various spinoffs and divestitures in the 1970s and 1980s. This
process of deconglomerization raises serious doubts as to
the value of diversification based on expansion.
 Although many companies have regretted their attempts at
diversification, others can claim to have gained significantly.
One such firm is General Electric (GE). Contrary to what its
name implies, for many years now GE is no longer merely an
electronics-oriented company. Through a pattern of
acquisitions and divestitures, the firm has become a
diversified conglomerate with operations in insurance,
television stations, plastics, medical equipment, and so on.

9. Other Economic Motives
 In addition to economies of scale and
diversification benefits, there are two other
economic motives for M&As: horizontal integration
and vertical integration. Horizontal integration
refers to the increase in market share and market
power that results from acquisitions and mergers of
rivals. Vertical integration refers to the merger or
acquisition of companies that have a buyer–seller
relationship.

10.  Horizontal Integration
 Combinations that result in an increase in market share may
have a significant impact on the combined firm’s market
power. Whether market power actually increases depends on
the size of the merging firms and the level of competition in
the industry. Economic theory categorizes industries within
two extreme forms of market structure.
 On one side of this spectrum is pure competition, which is a
market that is characterized by numerous buyers and sellers,
perfect information, and homogeneous, undifferentiated
products. Given these conditions, each seller is a price taker
with no ability to influence market price.
 The monopolist may or may not earn a profit, depending on
the magnitude of its costs relative to revenues at the optimal
“profit-maximizing” price-output combination. Within these two
ends of the industry structure spectrum is monopolistic
competition, which features many sellers of a somewhat
differentiated product. Closer to monopoly, however, is
oligopoly, in which there are a few (i.e., 3 to 12) sellers of a
differentiated product. Horizontal integration involves a
movement from the competitive end of the spectrum toward
the monopoly end.

11. By merging, the companies hope to
benefit from the following:
 Staff reduction: mergers tend to mean job losses, mostly from
reducing the number of staff members from accounting, marketing or
other support functions. Job cuts may also include the CEO, who
would typically leave with a compensation package.
 Economies of scale: 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: a merger may expand
two companies’ marketing and distribution, giving them new sales
opportunities. Due to improved financial standing, bigger firms have
an easier time raising capital than smaller ones.

12.  Overcoming the entry barriers: Mergers and acquisitions is
one of the ways for smooth market entry, as the goodwill of
the other company and the brand gets transferred to new
entities without initial hurdles. These costly barriers to entry,
otherwise would make start-ups economically unattractive.
 Eliminating the cost of new product development: buying
established business reduces risk of start-up ventures.
 Low risk as compared to developing new products.
 Increased feasibility and speed of diversification. It is a quick
way to move into businesses when the firm lacks experience
and depth in the industry.
 Acquisition is intended towards avoiding excessive
competition and improve competitive balance of the industry
and thereby increased market power. Acquisition is also used
to restrict the dependence of the firm on a single or a few
products or markets.

13. Synergy
 The word “SYNERGY” is derived from ancient Greek words
SUNERGIA and SUNERGOS which mean COOPERATION and
WORKING TOGETHER.
 In business environment, it signifies that the combined efforts of two
or more agents create such effects which are greater than the sum
of their individual effects. Technically, Synergy is the ability of the
merged company to generate higher shareholders’ wealth than the
standalone entities. Economically, it is the ability of the combined
entity to further limit the competitors’ abilities to contest against their
or the targets’ current input markets, processes or output markets.
Failure to achieve this will result in the failure of the acquisition.
 Synergies create the following benefits to justify a particular M&A:
1. Cost reduction
2. Tax benefits
3. Unused debt capacity
4. Surplus funds
5. Asset write-ups

14. 1. Cost reduction: economies of scale and economies of
vertical integration
2. Tax benefits: unabsorbed losses of the target company can
be written off.
3. Unused debt capacity: if the target firm has lower debt-
equity ratio than the bidding firm, combining can lead to
incremental tax shields.
4. Surplus funds: excess funds in the target firm may be
turned into positive NPV in the combined organisation.
5. Asset write-ups: assets of the target firm may be revalued
at higher market value and the resulting incremental
depreciation may produce a tax shield.

15. Operating Synergy
 The operating synergy theory of mergers states that
economies of scale exist in industry and that before a merger
takes place, the levels of activity that the firms operate at are
insufficient to exploit the economies of scale.
 Operating economies of scale are achieved through
horizontal, vertical and conglomerate mergers. Operating
economies occur due to indivisibilities of resources like
people, equipment and overhead. The productivity of such
resources increases when they are spread over a large
number of units of output. Eg., expensive equipment in
manufacturing firms should be utilised at optimum levels so
that cost per unit of output decreases.
 Operating economies in specific management functions such
as production, R&D, marketing or finance may be achieved
through a merger between firms, which have competencies in
different areas. For instance, when a firm, whose core
competence is in R&D merges with another having a strong
marketing strategy, the two businesses would complement

16.  Operating economies are also possible in generic
management functions such as, planning and control.
According to the theory, even medium-sized firms need a
minimum number of corporate staff. The capabilities of
corporate staff responsible for planning and control are under-
utilized. When such a firm acquires another firm, which has
just reached the size at which it needs to increase its
corporate staff, the acquirer’s corporate staff would be fully
utilized, thus achieving economies of scale.
 Vertical integration, i.e. combining of firms at different stages
of the industry value chain also helps achieve operating
economies. This is because vertical integration reduces the
costs of communication and bargaining.