The Great Movement Of Mergers And Acquisitions

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02 Nov 2017

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The chapter presents the overview of the thesis which includes background of the study, objectives of the study, significance of the study, research methodology used and organization of thesis.

Background of the Study

The recession lead to a decrease in the volume of the transactions and companies’ ability to pull of deals, this was due to the lower profits difficulty in finance and also in fulfilling the lenders demands. It also lead to the fall in the equity money a transaction requires further widening the gap between the buyer and the seller. Thus, the M&A transactions fall sharply, changing the structure of the transactions from "stock purchase" to "asset purchase". Some sound companies can strengthen their capabilities and increase their market share by acquisitions.

The Great Movement of Mergers and Acquisitions

The great Merger Movement happened from 1895 to 1905.It was a U.S. business phenomenon. During this period small firms consolidated with the large firms as they had a bigger market share and dominated the small companies. Around 1800 of the firms disappeared in these consolidations. This movement was very big, in the year 1900 the firms that merged had the value as 20% of the GDP,then it decreased in 1990 to 3% ,further leading to a rate of 10-11% of GDP in around 1998-2000.By 1929 smaller competitors joined forces with each other which disintegrate ,this was observed by the organisations that had the greatest share in the market in 1905,growing technological advances of their products, patents and brand recognition by their customers some companies like DuPont,Nabisco,US steel and General Electric have been able to keep their dominance in their respected sectors. The consistent mass producers of homogenous goods were the companies that merged; they could lead to exploiting the efficiencies of the large volume production. Companies with fine products didn’t take part in the Great Movement other than that they earned high profits and margin on the fine products like fine writing paper.

Short Run Factors

The desire to keep the prices high is one of the short run factors in The Great Merger Movement that is why with so many firms the supply of the products remains high with the high prices in the market. In 1893, the demand for the goods declined, thus, according to the classic demand and supply model with the fall in demand the prices of the goods fall. By colluding and manipulating supply to counter the changes in the demand for a good, the firm could avoid the decline in prices. This lead to horizontal integration. Mass production lead to reduction in the unit costs to a lower rate. The new machines were usually financed by bonds, which lead to a panic in 1893 as the interest rate on bond was very high even then no firm agreed to reduce the quantity as they were capital intensive and worked on fixed cost basis.

Long Run Factors

In long run, companies work on reducing the cost thus it was better for the firm to reduce the transportation cost by producing and transporting products from the same location. Also, the technological changes lead to increase in the efficient size of plants which are capital intensive and allow economies of scale. The initial successful mergers were dismantled eventually due to the part of the government and also the competitors. "The US government passed the Sherman Act in 1890 setting rules against price fixing and monopolies." The large companies were attacked for strategizing with others or within the companies with the aim of maximising profits. A great incentive for companies to unite and merge resulting in them not being competitors anymore was created by fixing prices with competitors.

Cross Border Mergers and Acquisitions

The currency of the target corporation appreciates by 1% as compared to the acquirer’s, as a result of the large M&A’s, this being the result of the study done by Lehman brothers in the year 2000.It was observed that after a merger there is a big upward shift in the currency rate, then after fifty days it stabilizes to 1% stronger average rate.

The cross border M&A increased because of the rise in the globalization. There were 2000 cross border M&A’s in the year 1996, these transactions were worth $256 billion. Majority of small and mid-sized firms didn’t consider Cross border intermediation due lacking of significance and strict national mindset.This was the reason that did not let the academic work develop much. This has mostly been unsuccessful because of the broad term. It is a very complex term, where corporate governance, power of average employee, company regulations, political factors and countries culture are the crucial factors that spoil the transactions. The cross border M&A helps in expanding the companies at the global front and create high performing businesses and cultures across national boundaries. Even companies with headquarters in the same country that merge are of this type. Swiss drug makers Sandoz and Ciba-Geigy were a $27 billion merger which is supposedly "single mergers" and was also a cross border merger.

M&A have evolved in five stages in the past, triggered by various economic factors. The factors that play a key role in designing the process of M&A between companies or organisations include the growth in the GDP, interest rates and monetary policies which are a part of macroeconomic environment.

First Wave Mergers :

They commenced from the year 1897 to 1904.Companies that enjoyed monopoly over their lines like electricity, railroad etc. merged during this phase .They were mostly horizontal mergers that took place during the aforesaid time period between heavy manufacturing companies. Most of the mergers during this period resulted in a failure due to inefficiency. The slowdown of the economy in 1903 and the stock market crash in 1904 were the reasons of the failure. Also, the anticompetitive mergers were halted by the Sherman act, thus the legal framework didn’t support it either.

Second Wave Mergers:

The second wave commenced from 1916 to 1929, where it focussed on oligopolies. This wave was a result of the economic boom post world war I. The government policy encouraged firms to work in unison and also lead to technological developments of railroad and transportation by motor vehichles.They were horizontal and conglomerate in nature. Investment banks played a pivotal role in the merger during this phase. This phase ended with great depression and stock market crash in 1929.

Third Wave Mergers:

The nature of the mergers during this phase (1965-1969) was conglomerate. They were inspired by high stock prices, interest rates and strict enforcement of antitrust laws. Now, the firms were financed by equities unlike in the case of two wave mergers. The period noticed the poor performance of the conglomerates resulting in the splitting of the merged firms in 1968 with the plan of Attorney General. Mergers like INCO-ESB merger; United Technologies and OTIS Elevator merger and the merger between Colt Industries and Garlock Industries had set precedence in 1970’s.

Fourth Wave Mergers:

This phase commenced from 1981-1989 was characterised by acquisition targets wherein the targets were larger in size than that in the third wave merger. This involved mergers between oil and gas industries, pharmaceutical industries, banking and airline industries. It ended with anti-takeover laws, financial institutions reform and the gulf war.

Fifth Wave Mergers:

The fifth wave phase from 1992-2000 was a result of globalization, stock market boom and deregulation. It involved banking and telecommunications industries. These involved debt finance. There motive was long term profit. This resulted with the burst in the stock market bubble.

Thus, as a conclusion there have been many factors that contributed in the development of the evolution of M&A. Concluding that with the existence of production units the M&A would continue to exist with the expanding economy.

M&A are almost two similar corporate actions involving combining two individual firms into one single entity leading to operational advantages such as improvement in company’s performance and increase of long term shareholder’s funds. An entrepreneur may use internal expansion or external expansion to grow its business.

They are explained as follows:

Internal expansion: In this the firm grows over the time, which includes expansion through acquisition of new assets, by replacing obsolete technological equipment’s and establishing new lines of products.

External expansion: This involves growing through corporate combinations by acquiring another running business.

Combinations like mergers, amalgamations, acquisitions and takeovers are important features of corporate restructuring. These combinations have come into existence because of the enhanced competition, free flow of capital across countries, breaking of trade barriers and globalisation of business. These strategic decisions enhance production and marketing operations which lead to growth of the company. It is a beneficial mean for companies to grow to expand the customer base, gain strength, cut competition or enter a new market or product segment.

1.2. Mergers

According to the Oxford Dictionary "merger" means "combining of two companies into one". Fusion of two or more entities where the identity of one or more is lost. The assets and the liabilities of the companies are vested into another company and the shareholders of both the companies with at least nine-tenth of the shares become shareholders of the new entity formed.

All the assets, stocks and liabilities of one company are transferred to the merged company. Example of a merger is when Daimler-Benz and Chrysler ceased to come together in 1998 to form a new company called Daimler Chrysler, Merger through absorption: Tata Fertilizers Ltd.(TFL) by Tata Chemicals Ltd. (TCL) where the assets and liabilities of TFL were transferred to TCL,Merger through Consolidation:. Merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL Ltd.

1.2.1. Types of Mergers:

Horizontal Mergers: Two companies that share the same product lines and market, in direct competition merge together. Aim of this merger is to achieve the economies of scale by cutting down on duplicated expenses of both the companies.

Examples of horizontal mergers are:

Unilever acquired Lipton tea in 1972

The formation of Brook Bond Lipton India Ltd. through the merger of Lipton India and Brook Bond

The merger of Bank of Mathura with ICICI (Industrial Credit and Investment Corporation of India) Bank in 2001

The merger of BSES (Bombay Suburban Electric Supply) Ltd. with Orissa Power Supply Company

The merger of ACC (erstwhile Associated Cement Companies Ltd.) with Damodar Cement

Vertical Mergers: It refers to a situation where the product manufacturer and the supplier of raw materials or inputs merge to form a new entity. It is beneficial as it makes the company cost efficient by streamlining its production and distribution cost. An example of vertical mergers is:

Time Warner Incorporated, a major cable operation, and the Turner Corporation, which produces CNN, TBS, and other programming. In this merger, the Federal Trade Commission (FTC) was alarmed by the fact that such a merger would allow Time Warner to monopolize much of the programming on television. Ultimately, the FTC voted to allow the merger but stipulated that the merger could not act in the interests of anti-competitiveness to the point at which the public good was harmed.

Market Extension Merger: When two companies that merge together sell same products in different markets.

Example of Market Extension Merger:

The acquisition of Eagle Bancshares Inc. by the RBC Centura. Eagle Bancshares is headquartered at Atlanta, Georgia and has 283 workers. It has almost 90,000 accounts and looks after assets worth US $1.1 billion. Major benefit of this merger was that RBC continued to grow in the North American Market. Further, it could grow in the financial market of Atlanta which is the upcoming leading market in the USA.

Product Extension Merger:

It is merger of two companies dealing in two related products operating in the same market. Example: Mobilink Telecom Inc. acquisition by Broadcom.

Conglomeration: When two companies with uncommon business areas merge. For example: DCM and Modi Industries.

1.3. Acquisitions

It is the purchase of one company by the other either by buying its assets or purchase of its shares. Since 1990, the number of mergers and acquisitions has doubled. Companies choose this way to grow as it increases the number of shares, achieve synergies in operations, access to new technology and a myriad of other reasons. Though it has its own drawbacks as the two companies work culture might clash, key employees might leave and costs of operations might increase rather than fall. The companies making a strategic decision of acquisition have atleast one of these archetypes:

Improving performance of the target company

Removing excess capacity from an industry

Creating market access for products

Acquiring skills or technologies

1.3.1. Types of Acquisitions:

The two kinds of strategies that can be applied in acquisition are as follows:

Friendly Takeover: In friendly takeover, one company acquires the other by cooperating with one another and settling matters mutually.

Hostile Takeover: In hostile takeover the information on the takeover is unknown to the company bought. Thus, it is a forceful agreement.

1.4. Benefits of Mergers & Acquisitions:

M&A is beneficial to all shareholders, managers and promoters. The main benefits of M&A are:

Greater Value Generations:

M&A often lead to greater value generations for the company, generally it is expected that this phenomenon leads to the shareholder value of the firm to increase which is more than the sum of the shareholder values of the individual parent companies. The concept can be explained as; when the two companies come together they tend to produce at a larger scale leading to increase in the output production. Thus, there are high chances that the cost of production per unit of output gets reduced.

Gaining Cost Efficiency :

M&A also helps in gaining cost efficiency by the implementation of the economies of scale, also a result of the cutting down of the double efforts by both the firms.

Increase in Market Share :

The M&A also leads to increase in market share leading to tax gains and revenue enhancement.

From Managers point of view:

They are concerned with improving the operations of the company, growth of the company providing better deals to raise their status, perks; they might have shares in the company and other fringe benefits. When there’s a guaranteed outcome of the stated things, the managers support the merger.

From Promoters point of view:

Increase the size of the company, financial structures and the financial strength. The closely held private limited companies can get converted into public limited companies due to mergers without contributing much of wealth and promoters losing control over the company.

From consumer’s point of view:

We can measure the benefit of the merger by the increase or decrease of the economic and productive activities which directly affect the degree of welfare i.e. provision of minimal wellbeing of the consumers by changes in the quality of products, price level and after sales service. The aim is not always increasing market growth it can depend on the level life cycle production is at.

1.5. Drawbacks of M&A:

M&A lead to concentration of economic power and these merged entities lead to a dominant position of market power. Also, after merger because of the dominance the entity suffers from deterioration in the performance over the years.

The disadvantages of mergers and acquisitions are as follows:

Monopoly: Two companies that merge together tend to lead to reach the domination position hence create a monopoly in the market.

Corporate debt levels can rise to dangerous levels as it might have a backer and also the amount of loans taken by the company.

Damages the morale and the productivity of the firms.

Managers have to forego long term investments to get short term profits.

It is possible that lesser dividend is given to the shareholders if the company is making losses, also less returns on investments if the company is not making enough profits.

Corporate raiders control to make quick profits, strip assets from the target and destroying company leading to throwing people out of work. It is possible that a company doesn’t throw the people out for example Virgin doing low cost flights to North of England when used to do trains, they instead became unemployed.

1.6. Aim of the Study:

The various aims of the dissertation are as follows:

• Firstly, to know the basic meaning of a merger and an acquisition.

• Secondly, to know why would two companies opt for a merger or an acquisition i.e. the motive behind a merger or an acquisition. This explains the factors that would lead two companies to merge or take over another company. Thus, I will look at the various factors like role of synergy, agency problem, cash flow, and increase in the market power, regulation, economic factors and government influence which influence the managers to merger their company with another company or acquire another one.

• There are different motives like growth, synergy, and economies of scale etc. to shareholders, managers, promoters and customers which are also discussed in this report.

• Also, the effects of the motive of Mergers and Acquisitions on the company post it are also investigated.

• To do the investigation I’ll take into consideration two case studies, which are as follows:

Case study 1:

This includes the study of the acquisition of BellSouth by AT&T.

Case study 2:

This includes the study of the merger of T-Mobile and Orange.

1.7. Research Design:

This section is the blueprint of collection, study and analysis of primary and secondary data, which involves obtaining appropriate answers to the research questions.

The research methodology used in the dissertation is an accounting study, which is explained further. The company’s i.e. T-Mobile, BellSouth, AT&T, O2, Orange Mobile and Verizon’s annual reports and some online data are used for the analysis of the company before and after the merger. This research also involves the study of the changes in financial performance due to Mergers and Acquisitions. Thus, this involves calculation of these three financial ratios i.e. profitability ratios, liquidity ratios and activity ratios and then comparing the company after the merger or acquisition with another company in the same industry; this is done to control the factors like firm specific, industry specific and economic worldwide.

According to Leedy (1997) "research methodology is the foundation of any research project as it directs the research endeavour". Firstly, to become familiar with the research topic the researcher has to have knowledge of the existing published work. The literature review chapter further ensures that the research questions are answered, where the gaps are covered by the further analysis by studying the primary data empirically (Passmore, Dobbie, Parchman & Tysinger, 2002).

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CHAPTER 2: LITERATURE REVIEW

2.1. Motives behind Mergers and Acquisitions:

The past studies and researches done show that Mergers and Acquisitions have various motives, where Andrade et al. (2001) summarised it as " Efficiency-related reasons that often involve economies of scale or other synergies; attempts to create market power, perhaps by forming monopolies or oligopolies; market discipline, as in the case of the removal of incompetent target management; self-serving attempts by acquirer management to over-expand and other agency costs; and to take advantage of opportunities of diversification, like by exploiting external capital markets and managing risk for undiversified managers"

George Coontz’04 states "The motive is to increase profitability and shareholder wealth by an increase in the price of the stock. An increase in price means an increase in the shareholders wealth."

There are various reasons for mergers and acquisitions, which are as follows:

Growth:

The most common reason for merger is growth. It can be divided into two broadways:

Internal growth:

It is much cheaper and less risky for a company to merge and expand internally. It is much faster to grow by acquisition than internally.

External growth:

Diversification is an external growth strategy. If an organisation operates in a volatile industry then it might opt to hedge the fluctuations by undertaking a merger. This also involves geographical diversification i.e. when one company acquires or merges with another company in some other country or location. It means expansion in the current market and in the new market, increasing the product range and services.

Synergy:

Another reason for merger is synergic benefits. This is the most commonly used word in Mergers and Acquisitions, for increasing performance and reducing cost of operations by combining the business activities. Two businesses merge together if they have complementary strengths and weaknesses i.e. it follows the financial maths 1+1=3. This shows that the value of the two firms combined is much more than the two of them operating independently.

Can be written as,

Val (A+B) > Val (A) + Val (B)

There are two forms of synergies derived from:

Cost economies: They help eliminating duplicate cost factors such as redundant personnel and overhead. These lead to lower per unit costs.

Revenue enhancement: This is when one company’s marketing skills combine with the other company’s research process to significantly increase the combined revenue.

Synergies are positively correlated to Mergers and Acquisition. This means higher the synergy, higher the target gains as well as the acquiring firm’s shareholders benefits (Berkovitch & Narayanan, 1993).

There are three types of synergies:

Operational synergy:

This is achieved by earning operational profits which is done by linking assets of the companies together to be used for various purposes. Operational synergy can be achieved by one company by opting for a merger or an acquisition by eliminating its weakness i.e. for example if a company has a strong production department it can acquire a company with a good supply chain thus resulting in the company to be stronger. As stated in Copeland et al. (2005, p 762) ,"The theory based on operating synergies assumes that economies of scale and scope do exist in the industry and that prior to the merger the firms are operating at levels of activity that fall short of achieving the potential of economies of scale". In other words, operational synergy can be achieved by economies of scale or economies of scope.

Financial synergy:

This includes when two companies after a merger or an acquisition achieve high return on equity, right to use larger and cheaper capital market. Mergers and acquisitions also provide tax benefits, which is a financial synergy. Example of financial synergy: Mitsubishi and Bank of Tokyo. When the capital of two unrelated companies is combined and results in the reduction of cost and a higher cash flow that is also called financial synergy (Fluck & Lynch, 1999; Chatterjee, 1986).It is stated that "financial synergy, on average, tends to be associated with more values than do operational synergies "(Chatterjee, 1986, pg. 120)

Managerial Synergy:

When two companies come together it is possible that one of the company’s has better and well skilled managers than the other company. Thus, the managerial synergy helps in forming a new firm with expertise and thus leading to an improved performance of the company.

Diversification:

Diversification is when that a company goes through a Merger or Acquisition with a company which is from an unrelated industry. This helps in reducing the impact of one particular industry on the profitability of the new entity and also spreads risk in terms of climatic change and consumers tastes. Diversification has not been very successful except for a few companies like General electric, which grew and enhanced the shareholders wealth.

The reason of engaging in M&A is to reduce the top managers’ employment risk, such as the risk of losing job and risk of losing professional reputation (Amihud & Lev, 1981). Many large firms seek to achieve diversification by M&A, rather than internal growth. (Thompson, 1984; Levy & Sarnat, 1970).According to Seth et al. (2000.p 391) " In an integrated capital market, firm level diversification activities to reduce risk are generally considered non-value maximising as individual shareholders may duplicate the benefit from such activities at lower cost."

Economies of scale & Economies of scope :

Size is one of the important factors in M&A. A larger company benefits more from a merger in the form of cost reduction than a small company. The purchasing power and the company’s negotiation power improves after the merger i.e. the larger the company higher the chance to negotiate the price of products with suppliers and to ensure to not spoil the relations with the suppliers although the orders maybe inbuilt. This basically concludes that new entity reduces the duplicate operations lowers costs thus higher profits. The economies of scale refers to the average unit cost of production going down as production unit increases (Brealey et al. ,2006 ;Seth,1990).The economies of scale is the goal of the horizontal and conglomerate M&A.

An economy of scope implies higher the number of products the less is the cost of production. The feature of economies of scope is more suitable for vertical M&A in seeking vertical integration (Brealey et al., 2006). In addition, complementary resources between two firms are also the motive for M&A.It means that smaller firms sometimes have components that larger ones need, so the large company’s acquisition of the small company often take place (Brealey et al., 2006).

Increase market share and revenue:

M&A leading to an increased power of the new entity in the market. This helps in increasing market share. It also improves the investment opportunities of the firm; a bigger firm has an easier time raising capital.eg. Premier and Apollo tyres.

According to Seth (1990, p.101), market power is "The ability of a market participant or group of participants to control the price, the quantity or the nature of products sold, thereby generating extra-normal profits". According to Zheer & Souder (2004) ,increased market power and increased revenue growth are the most common objectives for the firms participating in M&A.They can be achieved through horizontal M&A.Andrade et al.(2001) stated market power may be increased by forming monopolies or oligopolies. Increased power results in being more competitive in the market and increased the revenue growth is achieved by taking the highly elastic products and lowering their prices. New growth opportunities come from the creation of new technologies, products and markets (Sudarsanam, 2003).Thus, these results in strengthening the financial position resulting in an increase in the profitability of the firm along with shareholders’ wealth.

Increase supply chain pricing power:

If a company buys its supplier it helps in reducing the cost of the company to a large extent which is due to the profits of the suppliers being absorbed, increases efficiency only producing products required ("Just in time" process). This is known as a vertical merger and leads to company buying products from the distributors at a lower price.

Eliminate competition:

Mergers and acquisitions eliminate the competition and increases firms’ market share. A drawback is that shareholders need to be paid a huge amount of premium to convince the other company to accept the offer. It is very common that the acquiring company’s shareholders sell their shares which leads to reducing the price the company pays for the target company.

Acquiring new technology:

A large company can buy a small company with unique technologies and develop a competitive edge. This is the need of the competitive market.

Procurement of production facilities:

This is one of the reasons of mergers and acquisitions. It’s a backward integration. When the acquiring firm take the decision of merging with a firm that supplies raw material which helps in safe guarding the sources that supply the goods or the primary products. It helps in reducing the transportation cost and economies in purchase of goods. Example: Videocon takes over Thomson picture in China.

Market expansion strategy:

Mergers and Acquisitions eliminate the competition and protect the existing market. The firm gets a new market to promote its products i.e. existing or obsolete. Example: to increase market in India Lenovo takes over IBM.

Financial synergy:

It may be the reason for a merger or an acquisition; following are the reasons for a financial synergy:

Better credit worthiness :

It helps the company to purchase goods on credit, raise capital in the market or obtain bank loan easily.

Reduces cost of capital:

The cost of capital reduces after mergers because the big firms are safe and they expect lower rate of return on capital.

Increase debt capacity:

Since a merger result in the rise in earnings and cash flows, this leads to increase in the capacity of the firm to borrow funds i.e. debts.

Rising of capital:

Better reputation and credit worthiness with the increase in the size of the company helps in raising the capital easily at any time.

Taxes:

The profitable companies generally buy the companies which are loss making, so that it reduces their tax liabilities. In United States they limit the profitable companies to buy the companies in loss. Example: Ahmedabad cotton mills merged with Arvind mills, Sidapher mills merged with Reliance industry.

2.2. The Effects of Motives on Mergers & Acquisitions:

After studying the various motives of Mergers and Acquisitions, now I further study the effect of the motives on Mergers and Acquisitions, i.e. the post-Merger and Acquisition. According to Burner (2002), there are four approaches (i.e. accounting studies, event studies, survey of executives and clinical studies) to measure post M&A performance. Accounting and event studies are quantitative approaches and survey of executives and clinical studies are qualitative approaches.

2.2.1. Empirical Evidence Based on Accounting Studies

Accounting studies is one of the methods used to examine the changes in the financial performance of the companies before and after a merger or an acquisition. More specifically, the changes of net income, profit margin, growth rates, return on equity (ROE), and return on asset (ROA) and liquidity of the firm are the focus of accounting studies (Bruner 2002; Pilloff, 1996).Dickerson et al. (1997) are the first researchers to study the relationship between M&A and the profitability for the UK firms (1948-1977).According to their findings there is no evidence available to prove that M&A brought any benefits to the financial performance of firms based on the measurement of profitability. Conversely the growth rate and the profitability was lower after the M&A than before M&A.Also, after controlling some uncertain factors that might affect profitability, Dickerson et al.(1997) found that M&A had a negative effect on the acquirer’s profitability by measuring return on assets (ROA) in both the short term and long term period. This is consistent with Meeks (1977), whose studies indicated that the ROA for firms decreased after M&A in the UK.However, Dickerson et al did not investigate the nature of the acquired firm i.e. whether it is horizontal, vertical or conglomerate. Firth (1980), after studying the various other researchers results, concluded that based on accounting studies, generally speaking, acquired companies don’t have great profitability and have low stock market ratings before M&A, but obtain a great deal of profit after engaging in M&A.In contrast, acquiring companies generally have average or above average profitability prior to M&A, whereas they suffer a reduction in profitability after M&A.

Ghosh (1997) is the first researcher to examine the correlation between post-merger operating cash flow and the method of payment used in M&A for the acquiring company for 315 mergers over the period from 1985 to 1995.His research showed that the acquiring firm paid with cash and then it was compared with the company in the same industry, the cash flow increased significantly with an improved asset turnover after the M&A.

2.2.2. Empirical Evidence Based on Event Studies:

According to Bodie, et al. (2005, p381), an event study "Describes a technique of empirical financial research that enables an observer to assess the impact of a particular event on a firm’s stock price". For example study of share and dividend changes. The standard event study includes the use of Sharpe’s (1963) market model and capital asset pricing model (CAPM) [1] (Dimson &Marsh, 1986).Based on event studies , Firth (1980) studied 496 targets and 434 acquirers in the during the period from 1969-1975and the result stated a conflict in terms of shareholders returns to acquiring firms. He found that in the UK after the takeover the share price and the profitability of an acquiring firm declines.Langeteig (1978) used a three factor performance index to measure long term stockholders gains from M&A.He concluded that post-merger the excess returns were insignificantly different from zero and provided no support for mergers. The acquired and the bidder had an average excess return of 12.9% and 6.11% respectively.

2.2.3. Empirical Evidence Based on Clinical Studies:

It provides a blueprint for comparing the discounted value of cash flows and divestiture to the pre-acquisition value. They originate from anthropology, sociology and clinical methods in the 1920’s.It is also called a case study, which is an in- depth study by one person through field interviews with executives and knowledgeable observers and is a form of quantitative descriptive research (Bruner, 2002).

2.2.4. Empirical Evidence Based on Surveys of Executives Studies:

The surveys of executives in the form of a questionnaire, asking questions regarding motives of M&A or whether they are beneficial for shareholders or not. The post-merger performance can be inferred from the questionnaire (Bruner, 2002).As in CFERF( Canadian financial executive research foundation) executive research report, "Finance executives have shown in this study that organizations can improve their chances of successfully merging firms by incorporating people related risks into the evaluation, due diligence and deal structuring phases of M&A activity". In Ingham et al. (1992), where they surveyed 146 of UK’s top 500 companies during the period from 1984-1988 on the basis of a questionnaire. However in case of the profitability of acquiring firms, whether it increased or not post M&A, they found different results. From the short term point (0-3years), 77% of the managers claimed that short term profitability increased whereas long term i.e. over 3 years, 68% said the profitability increased. There is one problem in this survey, which is that it considers only private companies other than the other financing companies.

TABLE 1. COMPARISON AMONG EACH RESEARCH REPORT

STRENGTHS

WEAKNESSES

EVENT STUDIES

It is a direct forward looking measure creating value for investors, where the expected future cash flow is the present stock price.

There are various assumptions made regarding the functioning of the market, rationality, absence of restriction on arbitrage which is not unreasonable for most of the stocks on an average over time as a result of the researches.

Some companies are vulnerable to specific events, researchers and large numbers of people deal with this problem.

ACCOUNTING STUDIES

It is the certified and audited accounts which are used by investors as an indirect measure of economic value creation.

Different reporting practices.

Different time period

Principles and regulations different for different companies.

In case of historic cost approach, inflation and deflation is a sensitive issue.

Inadequate disclosure of the accounts by the companies.

Different accounting practices in different countries.

SURVEY OF MANAGERS

It gives an insight of the success of the acquisition that may not be known in the stock market.

Includes the study of managers whose area of interest is not focused on the creation of economic value.

Historical results are not good predictors

Participation is very low i.e. 2-10% which makes them vulnerable to criticisms.

CASE STUDIES

Inductive research to examine new patterns and behaviour by restructuring an actual experience.

The research reports can be difficult to abstract large implications from numerous reports where hypothesis testing limits the researches ability to increase the size of the research

Source: "Does M & A Pay? A survey of evidence for the decision maker" (Bruner, 2002, p.16).

CHAPTER 3: RESEARCH METHODOLOGY

3.1. Overview of an Accounting Study – Research Methodology

A company taking over other company will need to evaluate the company to determine whether it is beneficial or not. The main idea is to find the worth of the company; both the companies will have different ideas to evaluate the merger. Naturally, the seller would value the company at the highest price as possible, whereas the buyer will value it at the lowest price possible. The company’s operations need to be valued by taking some of the accounting procedures into account; it also helps in knowing the impact of mergers and acquisitions on the cost, revenues, profits etc. of both the companies. [2] 

Firstly, I will consider the company’s financial statements, balance sheet, profit and loss accounts and the content in the annual reports. Using this data I will calculate the financial ratios i.e. profitability ratios (net profit margin, gross profit margin, return on asset and return on equity), liquidity ratios (current ratio and liquid ratio) and activity ratios (total asset turnover and inventory turnover).These financial ratios help in analysing the company’s performance and various other factors indicating the progress.

There are many appropriate ways to value the company, it can be by either comparing two companies in the same industry or there are some more ways of valuing the companies which are discussed as follows:

1. Profitability Ratios:

It is to measure the overall performance of the company; the success of a company and the goal is to obtain sufficient profit in the end. It is used for the analysis of the trend, the operating profitability and efficiency is observed by the gross profit margin ratio and also the return on assets and equity analyses the manager’s efficiency in manufacturing and purchasing costs, it also reflects the perspective of the shareholders. It also helps in knowing the return on sales using the figures of net profit margin, this is used for two companies in the same industry in different years, also tells the profit earned in respect to the sales.

2. Liquidity Ratios:

It consists of current ratio and liquidity ratio. These ratios measure the liquidity of the firm i.e. how they meet their creditor’s demands. Liquidity arises when the cash inflow is not the same as cash outflow. Example: If cash inflow from sale is unequal to the cash paid to the employees or suppliers etc. then the problem of liquidity arises. Also, in calculation of quick ratio, inventory is not included as it is the least liquid current asset.

3. Activity Ratios:

It measures the efficiency of the company to use the assets. Total asset turnover ratio helps understanding how efficiently different companies use its assets whether in the same industry or taking into account two different years. The inventory turnover ratio tells how efficient the working capital management is as it indicates both liquidity and operational efficiency.

Secondly, since the absolute ratios don’t have any meanings the major point is to observe the changes in the ratio from one country to another or comparisons among various companies.

Lastly, the profitability of the company is affected by various factors like firm-specific, industry-specific and economic-wide factors. The profitability change of the acquiring company and the benchmark group i.e. the post-merger and long term data is available to the acquirers as the target companies are de-listed after the M&A (Sudarsanam, 1995).

In the dissertation, I take the benchmark groups as the top two competitors of the company. It involves calculating the financial ratios and analysing them, this is one of the easiest tools to compare two companies, also during the observation period the benchmark group is not acquired or made large.

Table 2: Formulas of key financial ratios

Key growth rates

Turnover

Changes in turnover

Net profit

Profitability ratios

Net profit margin= net profit after tax/sales

Gross profit margin = gross profit /sales

Return on Asset (ROA) = net profit before interest /sales

Return on equity (ROE) = net profit after tax/equity

Liquidity ratios

Current ratio = current assets/current liabilities

Quick ratio = (current assets-inventories)/current liabilities

Activity ratios

Total asset turnover = sales / total assets

Inventory turnover = cost of sales / inventories

3.2. Source of Data:

The data i.e. the financial reports of the companies including the balance sheet, profit and loss account and the cash flow statement is compiled from the reports available online on the company’s website. These statements are used to know the financial performance of the company before and after a merger or an acquisition.

3.3. Limitations of the Study:

Since the data is collected from the secondary sources i.e. the financial reports of the companies so it is possible that they are bias because of the accounting techniques. Also, there can be some limitations related to the some aspects of financial reports not being analysed properly despite of studying and analysing all the key ratios. The results of other studies like clinical study, survey study, event study when compared to the accounting studies results have different conclusions about the effect of M&A.For example: while studying a clinical study, one of the factors that could affect the changes in production and performance can be organizations managerial and mechanism practices (kalpan, et al., 1997) which is not a factor that is examined in accounting studies.

CHAPTER 5: CONCLUSION, LIMITATIONS AND

RECOMMENDATION OF THE STUDY

5.1. Conclusion

With an increasing trend of mergers and acquisitions and the increasing competition and the development of globalization aiming at achieving certain strategic and financial motives.

The dissertation is about the overall review by studying the empirical literature including the motives of mergers and acquisitions which could be categorised into three parts:

Increase shareholders value is one of the major motives which include synergy, increased market power, increased revenue growth, economies of scale, scope and managerial efficiency.

Secondly, the motives that decrease the shareholders’ value like agency motive, free cash flow and managerial hubris.

Thirdly, motives that have an uncertain impact on the shareholders i.e. diversification.

Then is the effect of the motives of mergers and acquisitions. There are four methods which can be used for this empirical study, they are:

Accounting studies,

Event studies,

Survey of executives and

Clinical studies

Also, the findings of the Mergers and Acquisitions from US and UK are also explained in the literature review.

The method used in the dissertation report is the accounting method followed by the pre-merger and acquisition analysis with a final post-merger and acquisition comparison of the company with its competitors.

To study the motives, effects and the literature review completely there is a need to examine the empirical evidence which was done by taking the following:

Acquisition of BellSouth by AT&T

Merger of T-Mobile and Orange forming "Everything Everywhere"

In case of the acquisition of BellSouth by AT&T, AT&T purchased BellSouth with the motive of growth and diversification with the increase in the managerial skills. But after analysing the pre and post-acquisition conditions of both the companies, it is observed that the companies had better financial position did improve after acquisition but its competitor Verizon had a better financial status than AT&T after acquiring BellSouth. The financial performance of AT&T was compared to Verizon, the telecommunication company to control firm specific, industry-specific, economic wide factor that may affect the financial performance of the firms involved.

The revenue synergy and the diversification motive were met as the services were spread all over the world covering 22 states. It is observed that the firm is achieving profits after the acquisition but the return on asset and to the shareholders of AT&T is less as compared to that of Verizon. Hence, the results of the two companies post-acquisition are consistent to the findings stated in the literature review by Dickerson et al.(1997),Meeks(1977),and Caves (1989) which stated that the profitability of the acquiring company after the M&A is lower than that it was before the M&A.

In case of the merger between T-Mobile and Orange, it is observed that it has a similar pattern as that of the acquisition between AT&T and BellSouth. Where the financial status of the company was better before the merger. Thus proving the financial findings in the empirical literature review are consistent.

5.2. Recommendation of the Further Study

The dissertation concentrates on the post M&A and to examine the further scope by comparing with a competitive firm in the same industry. The performance can be measured by four methods including accounting method, event study, clinical study and the survey of executives where only the accounting method is used to study the motives and effects of M&A, thus there can be different results obtained by using the other three methods. Also there can be various factors that affect a M&A are the accounting methods, impact on M&A (friendly or hostile),size effect, type of target (public or private or subsidiary) etc. that need to be studied. Thus, there can be a deeper investigation of this topic taking into consideration a different method and various factors affecting it.

APPENDIX

APPENDIX 1.1: DEFINITION OF CAPM

The model used for the pricing of risky securities, explaining the relationship between risk and the expected return is known as CAPM i.e. Capital Asset Pricing Model.

Capital Asset Pricing Model (CAPM)

The risk free rate represents the time value of money, which is compensation on the investment for the investors over a period of time. Where the other half of the formula represents the risk i.e. the additional risk to the investor, β representing the risk measure which helps in analysing the returns to asset to the market over a period of time and also to the market premium.

APPENDIX 1.2: PROCEDURE OF MERGER

1. Searching for merger partner:

The first step is to search for merger partners which involves using the public and the private sources to analyse the company, this is done by the top managers, where the company to be merged with can be in the same industry on in a diversified field.

2. Agreement between the two companies:

The merger starts with the agreement between the two companies involved which involves the transaction to be legally sanctioned by the court under section 391 of Companies Act 1956.

3. Scheme:

The scheme is to be prepared by the companies before they decide to merge. Different companies have different merging schemes. Some of the things involved in a merger are as follows:

Merging company’s statistics.

Terms of transfer of assets and liabilities from transferor to transferee.

Conditions involved for conducting the business after the merger.

Information about the share capital of the companies going to merge i.e. capital, paid up capital and issued capital. .

The profit sharing ratios of the companies and the conditions attached to it.

The composition of the employees of the company and the funds for the employees like gratuity funds, provident funds etc.

Treating the debit balance of the companies getting merged.

Income tax dues, contingencies or any other accounting entries.

4. Approval by the board of directors:

Both the companies going to merge, i.e. the transferor or the transferee, there board of directors must approve to all the terms and conditions for them to merge.

5. Approval of scheme by financial Institutions:

After the scheme has been approved by the financial institutions, debenture holders, banks the board of directors approves the scheme as they are used to raise the funds.

6. Application to the court:

After the approval by the financial institutions the next step is to send an application to the court, the application sent is made under some laws for example: under section 39(1) of Indian companies act 1956 to the high court for the decision of the merger of the two companies.

7. Approval by the court:

When the court receives the application then the final decision is made whether to approve the scheme of the merger or not.

8. Transfer of assets and liabilities:

The high court can give the orders to transfer assets from one company to the other. By this the assets and liabilities of the transferor company shall automatically get transferred to the transferee company.

9. Allotment of shares to shareholders of the transferor company:

After the virtue of the scheme, according to the profit sharing ratio decided in the agreement the shares of the transferor company get transferred to the transferee company.

10. Suggestion to stock exchanges:

After the merger becomes effective the company should apply to list the new shares on the stock exchange; this is done by the company which takes over the assets and liabilities of the transferor company.

11. Public announcement:

Public announcement are mandatory in mergers. For example if it’s India, then the announcement is to be made under SEBI regulations.

APPENDIX 1.3. Historical development of AT&T

Telephone was invented by Alexander Graham Bell in the year 1876, it was the foundation of the best and the most reliable telephone service brand which was named as AT&T.Then in 1984, the SBC communication Inc.(formerly known as Southwestern Bell corp.) was born through an agreement between AT&T and the U.S. department of Justice.

Twenty one years later, SBC communication Inc. led to be the global communications provider by acquiring Telesis Group (1997), Southern New England Telecommunications (1998) and Ameritech Corp. (1999), this was due to the dramatic changes that triggered due to the Telecommunications Act of 1996.Then by 2005, SBC Communications Inc. acquired AT&T Corp., thus forming the new AT&T. (www.att.com)

APPENDIX 1.4. Historical development of BellSouth Corporation

It is an American Telecommunication company based in Atlanta, Georgia formed in 1983. After the U.S. department of Justice forced the American Telephone and Telegraph Company to divest itself of its regional telephone companies on January 1, 1984 it was one of the seven original Regional Bell operating companies. In 1992, this company was formed by combining two companies, Southern Bell based in Atlanta and South Central Bell based in Birmingham, Alabama. Services provided include telephone and DSL/Dial-Up internet services in states of Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina and Tennessee. It provided satellite television with the DirecTV and cable television was provided in limited markets as BellSouth Entertainment Americast.It began as the 12th largest corporation in the United States, with $11billion in assets, 13.4 million telephone lines and 131500 employees.

APPENDIX 1.5. Historical Development of T-Mobile

T-Mobile is a mobile network and a mobile broadband operator in the UK. It was started by the now-defunct Mercury Communications which was named as Mercury One2One, a GSM mobile network. Later it was known as One2One, which was then purchased by Deutsche Telekom in 1999 and was rebranded as T-Mobile in year 2002.It offers both pay as you go and pay mobile contract phones. (www.wikipedia.com)

APPENDIX 1.6. Historical Development of Orange Mobile

It originated in the UK in 1990 with the formation of "Microtel Communications Ltd." In July 1991, the Hong Kong based conglomerate –Hutchison Whampoa through a stock swap deal with BAe, acquired 65% of the controlling stake in Microtel.

On 28th April 1994, the orange brand was launched in the UK mobile phone market. In April 1996 it was listed on the London Stock Exchange and NASDAQ,being the youngest company to enter the FTSE 100.In 1999, it was launched in Austria, Belgium and Switzerland and was licensed to various operators in Hong Kong,Israel,Austria and India.

It represents the flagship brand of the French telecom group for mobile, landline and internet businesses and is known as a French multinational telecom company with 226 million customers as of December 2011.



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