Merger and Acquisition Motives, Types and Strategies
Now- a-days in a corporate finance world, the merger and acquisition plays prominent role. Merger and acquisition refers to corporate finance, corporate strategy and manages deals with buying, selling and combining companies to grow rapidly. They bring different small size companies together to form a larger company.
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Actually large size companies makes dare to buy small or other companies to create competition in market, to purchase shares at low price, to reduce cost and risk to achieve efficiency. The key principal behind the purchasing a company is to create over and above value of shareholders of the company. They may involve a single product with multiple technologies. Mergers and acquisition can be used to increase economies of scale and to reduce competition in the market and to improve share value in the market.
Black Law dictionary defines mergers and acquisitions as the following:
The union of two or more corporations by the transfer of property of all, to one of them, which continues in existence, the others being swallowed or merged
The act of becoming the owner of a certain property.
In the simplest form:
In merger, two firms comes together to run a single company by transfer of property is called merger. In merger, same size of companies merges together and establishes new company.
In acquisition one company takes over the other company and the company holding majority of share becomes the owner of the company and swallows the other company.
Strategic management is concerned with company’s environment, policies and goals of company but also manages operation activities. The strategic planning approach to acquisition implies economy of scale. It helps to recognize risks in management. If the investments exploit risks opportunities and can be used for additional investments with positive net present values, the strategy succeeds.
Motives behind merger and acquisition:
It is cost efficiency. Company funds are properly utilized by establishing various strategies with scale of economy to keep In each and every company transportation takes place on regular basis by acquisition of corporate company we can reduce fright charges by purchasing a supply chain. By purchasing ware house we can reduce ware housing rent. Economics of scale, we need implement new technology for production according to demand and supply. Brand nameattracts customers to purchase a product and they need to fix price lower then competitors. Trend is changed so internet publicity about company, products they produce should be advertised on internet. Integration of operations also reduces the cost of acquisition. Cost low, high profits and automatically it increases share value of shareholders. By merging and acquiring profitable company with company which is in loss in order to offset profits by written off. Manufactures buying out a ware housing chain in order to save on ware housing cost. It helps to reduce competitors by selling products at cheaper rate at good quality. By building strengths to improve the skills, managers need to give more dividends to the share holders and it automatically reduces the risk in management.
Acquisition requires huge investment of capital. We actually invest capital by thinking that benefits of business concern runs for longer period of time by using the principals of accounting as going concern, consistency and accuracy. Acquisition helps to create value for company. Acquisition method helps to recognize value for intangible assets. Therefore financial statement shows relevant information with transparent
Before that we need to study consolidated financial statement of purchasing company related to consideration made by assets, cash or other form of securities. Acquisition process is very complex highly influenced by internal and external factors. We need to secure assets of company by proper control.
Types of mergers and acquisition:
If smaller company acquires the management control of the larger company and keeps its name for the combined entity is called reverse takeover. It takes place when private company with good prospectus and eager to raise finance will acquire public listed company. Horizontal M&A takes place when one company acquires other company from the same line of business. Vertical M&A takes place if one business acquires other related chain of business in the organization. Conglomerate acquisition takes place if acquisition takes place between unrelated businesses. Hostile M&A takes if one of the people is not interested to agree, then the purchasing company purchases from the share stock market and become the owner of that company. A company holding high shares becomes the owner. Friendly M&A takes place when the same size of companies comes together with friendly nature with their willingness and accepted obligation to work.
Sources of finance for business acquisition:
When a company purchases other company the financial sources of current company may falls inadequate. It needs to find the source of finance to pay for acquisition of business. We can raise funds from there internal and external sources.
Shares of company:
By acquiring a company which listed first time in stock market, by issuing shares of this company we can raise funds. Deferred shareholders are going to get dividends after the expiry of certain period this also helps to raise funds. By issuing new shares to existing holder of shares or to the share holders of acquired company on pro-rata manner to keep not affected and it can raise finds easily. Other wise by selling shares in the share market and that money can be paid to the targeted company. Shares are of two types. They are equity shares or ordinary shares and preference share. Issuing of shares depends upon the policies of company.
Debenture holders are known as creditors of the company and they are the first persons to receive interest whether business is running smoothly or not. There will be written acknowledgment containing provision of debt paid and capital need to repay or by selling debentures in the market and we can repay the cash to the targeted company. The principal amount also needs to repay. We can raise finds from this source by taking high risk.
Cash: Cash means liquid amount carried by company. It is a cheap source of finance with high reliability. If the company has enough money to pay for acquisition it is a best choice to reduce risk in management. Company becomes insolvent if there is no enough money to operate business. We need to maintain reserves every year so it helps us whenever we are in need.
By keeping freehold property and other fixed assets as security company can raise funds and receive cash on loan usually repayable after specific period of time.
Retained earnings acts as source of funds by reinvesting profits that could have been paid to the shareholders of company. It is an attractive source of finance. It serves as self financing by giving reasonable dividend to the holders of shares.
Lending is main function of the bank. It issues long term loans, short term loans and medium term loans and it also allows overdraft limited to the transaction with bank. Mortgage act as short term finance. Bank gives loans on turnover of business and credit worthiness of company and interest rate is adjusted with base lending movement rate. This helps to raise funds for acquisition.
Government grants cash and other subsidies to companies with an aim to develop economy by expanding stability in economy by establishing high standards of technology to provide employment opportunities. Government helps the company by providing various fund to takeover other company if it is going to develop economy.
Various methods to calculate cost of acquisition:
Calculation of acquisition is very difficult task and it is related to capital investment. We need to estimate and evaluate the costs and benefits of acquisition over a period of years; the most suitable method for this will be capital budgeting analysis. Most often we approach stock analysis because we purchase company with cash or securities for consideration. The audit report of acquired company helps acquiring company to take decisions. Acquisition of company requires huge amount of investment. So I suggest acquiring company to implement investment framework regarding various policies and procedures to be followed to reduce cost of acquisition and various tools to predict financial analysis. Therefore by keeping all this matters under consideration there are various methods to calculate cost of acquisition.
If the acquiring company purchases the assets of the company more than the face value. The difference is called goodwill. Goodwill appears in the financial statements on assets side. In this method we need to revaluate the net assets. We can acquire a company by making payment by cash, securities and combination of two.
Pooling of interest method:
In this method, we combine the balance sheets of both the companies at book value. This method doesn’t effects the company by acquiring the assets and liabilities. Therefore this method is no more exists.
Analysis to estimate profitability of acquisition:
Ratios analysis method:
Ratio analysis plays a vital role while calculating profitability, working capital and to estimate share values of company. Mostly we use this method to calculate to know available funds. For calculation of acquisition cost price-to earnings ratio (P/E). It calculates market value per share by it s earning per share of Transferee Company. If it is most profitable then acquiring company can acquire it.
Price to sales ratio helps us by dividing current price of stock with its revenue per share.
Cash flow analysis:
Net present value analysis method is used to calculate present value of both companies and also jointly. It shows the present value of all future cash flows discounted at the cost of capital on present investment. Marginal value of an acquisition helps to know present value of shareholders. This will help us to calculate price and value of benefits.
This are the various methods used to calculate cost of acquisition. I think cash flow analysis is best one to know whether the project is profitable or not. Different methods are used by different companies according to their operational and financing strategies.
Why and which source of finance is better to reduce cost of acquisition:
Mostly we acquire a business by cash, issue of shares or by debt instruments. They can be issued purely by cash, by share or by debt instruments or by combining any of them it is company choice.
By issue of cash, it is cheaper source of finance with high reliability. If the company is having enough money then it can repay it fully by cash. There will be no interference in management. It helps to reduce risk of the management. The company becomes insolvent if there is no enough cash to operate.
By issue of stock, we can raise money. But if we issue shares to the targeted company we need to pay dividend. They also interference in management and interrupts the smooth going work. If we issue huge shares the value of the shares comes down.
By issue of debt stock, we need to pay interest with principal amount with in a period of time. I think it is not a good source to reduce cost of acquisition.
According to me, I think combined issue of stock and cash will be the good source of finance. By issuing limited shares with cash we are going to own the targeted company. No interest rate. No interference in management. By keeping sum amount of cash aside for operating the business to runs smoothly and by issuing limited shares we can raise share value of company.
In 2005, NEWS CORP owned by Rupert Murdoch acquired MY SPACE social networking site. NEWS CORP acquired MY SPACE for $580 million. At the time acquisition MY SPACE is fifth most visited internet. NEWS CORP acquired MY SPACE by seeing the demand for Google site in internet. It is conglomerate acquisition because they are from different industries. MY SPACE played a dominate role in social networking as well as in cybercafe. In 2007, NEW CORP revenue exceeded $28 million which hold news paper, magazines and television, radio and sports franchises. News Corp is one of the largest media with revenue exceeding $28 million in 2007 which holds books, news papers, magazines, and television, radio and sports franchises. MY SPACE revenue stood at $525 million in ads. In 2008, MY SPACE became a fast growing website in the world. After acquisition MY SPACE continued with its own culture and also empowered with additional resources in order to further growth. Therefore it is one of the successful business combinations. BY acquiring my space, News Corp. possessed new sales and advertising channels and it is able to provide operational and financial resources. It became possible only by implementing proper corporate strategy to reduce cost of acquisition. I think they provided cash flow analysis to calculate cost of acquisition to know the net present value for future inflows on investment.
Through this example, I conclude that proper strategic implementation helps the acquiring organization to succeed. Acquisition is capital budgeting process so firstly to acquire a company we need to check the credit worthiness of business through various sources of funds. I think sources of funds from the share holder and bank loans are best suitable to raise funds and I suggest that cash flow analysis is the best way to calculate cost of acquisition because this analysis helps us to find the net present values for investments and also internal rate of return on investment. An acquisition is said to be effective only when firm maintains financial flexibility and adaptability in management. Buying firms with assets helps to face competitiveness. They need to maintain additional finance not to forgone profitability project.
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Synergistic gains from corporate acquisition and their division between the stockholders of target and acquiring firms,” journal of financial economics, 21, 1988.
Gaughan, Patrick A. Mergers and Acquisitions. New York: Harper Collins, 1991.
Carney, William J. Mergers and Acquisitions. New York: Foundation Press, 2000.