Speeches hit the spotlight as they merge into the largest firm in the industry - Free Essay Example

Sample details Pages: 11 Words: 3320 Downloads: 4 Date added: 2017/06/26 Category Business Essay Type Research paper Did you like this example? Chapter 1 INTRODUCTION: THE MA MANIA Every time you watch the news or read the paper youd be faced with news of the merger mania and leaders discussing their visions and aspirations. Their speeches hit the spotlight as they merge into the largest firm in the industry. The press pushes for more statements, figures and secrets. The lights jump from one big transaction to the other leaving CEOs and their subordinates facing the daily-born challenges of a merger. Time passes and they now know that their jobs are at stakeÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦.. DEFINITION OF MERGERS ACQUISITIONS The term MA is strictly confined to strategically motivated business combinations i.e. transactions that result in the transfer of ownership as well as management and control rights from one company (the target) to another (the acquirer)  [1]  . This can be further described as follows: Acquisition: It occurs when one company takes controlling ownership of another firm or subsidiaries/assets of another firm. This includes spin-offs, divestitures and buy-outs  [2]  . In the course of acquisition process, firm A purchases a controlling interest in firm B. Firm B loses its economic independence. It may, however, remain an independent legal entity. The purchase can be a negotiated deal, in the case of listed corporations, firm A may make a public offer to all shareholders of firm B to buy their shares (tender offer). In case of asset acquisition, firm A purchases assets from firm B. If Firm A purchases all assets, firm B remains a shell corporation which owns only cash. It m ay be dissolved after paying out the cash to its owners. The two different types of acquisition (friendly and hostile takeovers) are further detailed and illustrated in the next section (1.3 The corporate takeover market pg.6). Merger: It is a combination of two or more firms in which all but one legally cease to exist, and the combined organization continues under the original name of the surviving firm  [3]  . Mergers and acquisitions occur in different directions: Horizontal is when both companies are in the same industry. A big example of a horizontal acquisition occurred on July, 2002, Pfizer, Inc. announced the acquisition of Pharmacia, Corp., which would create the largest pharmaceutical company in the world with a projected $48 billion in annual revenue and a research budget of more than $7 billion. Vertical is when a company integrates upstream or downstream their value chain. A big example of a vertical acquisition is that of Internet giant America Online, Inc. (AOL) purchasing media conglomerate Time Warner Inc. in a record setting one-hundred and sixty-five billion dollar deal  [4]  . The merger represented the next generation media company, combining new and old companies into one. Time Warners print publications, cable television lines, and services complemented AOLs online and interactive services and therefore, it is categorized as a vertical acquisition. Conglomerate (diversification) is when companies are from unrelated industries. The products of the two firms are not directly related to each other. With the acquisition, the buyer enters a new market  [5]  . Kelsos acquisition of Nortek is an example of a conglomerate merger. The two companies are totally unrelated. Nortek Inc. is a leading international designer, manufacturer and marketer of building products while Kelso Company, L.P. is a private equity firm based in New York City. Don’t waste time! Our writers will create an original "Speeches hit the spotlight as they merge into the largest firm in the industry" essay for you Create order THE CORPORATE TAKE-OVER MARKET The various tactics that may be used in developing the MA strategy should be viewed as a series of decision points, with objectives and opinions usually well-defined and understood before an MA attempt is initiated. This is illustrated in figure 1 in page 14. Such tactics could be done in a friendly or a hostile strategy. Common objectives for a bidder include: winning control of the target, minimizing transaction costs, facilitating post-MA integrationÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦etc. Friendly takeovers: This type of MA is less costly than aggressive tactics. It retains the key personnel, customers and suppliers during the transaction. It also manages to maintain the targets purchase price and the premerger integration. The primary disadvantage of this approach is the loss of the surprise element  [6]  . On 3 February 2000, UK-based mobile phone group Vodafone AirTouch and the German telecommunications and engineering group Mannesmann AG ended a 3-month takeover negotiations and reached an agreement of a merger. In November 1999, Vodafone had announced its willingness to takeover Mannesmann and later directly addressed its offer to the Mannesmann shareholders. When it became clear that Vodafones attempt at a hostile takeover might succeed, the Mannesmann management agreed to negotiate the terms for a friendly takeover. The agreement defines some terms for the integration of the two companies and their further strategic development. Furthermore, Vodafone confirmed its commitm ent to the Mannesmann employee and that the merger doesnt mean additional job losses, and the rights of the employees, trade unions and works councilors would be fully recognized  [7]  . 1.3.2 Hostile takeovers: Hostile takeovers, on the other hand, are more challenging. They mainly depend on the factor of surprise which reduces the probability of a leak in the price of the targets stock by arbitrageurs. In the context of MAs, arbitrageurs are speculators who attempt to profit from the difference between the bid price and the target firms current share price  [8]  . An increased pulse in the targets share price can add dramatically to the cost of the transaction. For these reasons, the bidder may choose to go for a hostile takeover. All the above can be simplified in the following figure: Bidder adopts friendly approach Bidder adopts aggressive approach Bear Hug (offer to target board) Initial Query If No, If Yes, If Yes, If No, Negotiate Walk Away Negotiate Proxy Fight Tender Offer Litigation Open Purchase As seen in chart above, the two primary methods of conducting a hostile takeover are the tender offer and the proxy fight: A tender offer is a public bid for a large chunk of the targets stock at a fixed price, usually higher than the current market value of the stock. The purchaser uses a premium price to encourage the shareholders to sell their shares. The offer has a time limit, and it may have other provisions that the target company must abide by if shareholders accept the offer  [9]  . In a proxy fight, the buyer simply tries to convince the shareholders to vote out current management and replace it with a team that supports the acquisition. One of the most famous recent hostile take-over fights was Hewlett-Packards takeover of Compaq. The deal was valued at $25 billion. Hewlett-Packard however spent so much more simply to sell itself to shareholders. 51 percent of shareholders voted in favor of the merger and the deal was executed despite trials to legally halt it.  [10]  . MOTIVES BEHIND MA There are several reasons that pave way to mergers acquisitions. The most significant two are: faster growth and synergy. Proponents of a deal will often point to an ability to grow faster and/or anticipated synergy as the justification for a specific purchase price  [11]  . The following are the strongest prevailing motives of MA: 1.4.1 Operating Synergy: Achieving lower average costs and thus higher profits through an increase in the scale of operation is the main motive for merger activity. Economies of scale refer to spreading of fixed costs over increasing production levels. Scale is defined by fixed costs as depreciation of equipment and amortization of capitalized software, obligations such as interest, lease payments and taxes  [12]  . Accordingly, a merger increases the efficiency of the new firm more than the sum of their parts. Economies of scope refer to using a specific set of skills or an asset currently employed in producing a product or service to produce related products or services. Economies of scope include costs of RD, single brand umbrella to sell several products, selling several products through common distribution channels and so on  [13]  . The utilization of such common capabilities and resources justifies the cost reduction resulting from merging two or more product lines in one firm than to produce them separately. Economies of scope was the motive behind the vast international conglomerates built up in the last two decades. The merger of Travelers Group and Citicorp in 1998, for example, relied on selling the financial products of one by using the sales teams of the other. Citigroup was formed on October 8, 1998, following the merger of Citicorp and Travelers Group to create the worlds largest financial services organization. The history of the company is, thus, divided into the workings of several firms that over time amalgamated into Citicorp, a multinational banking corporation operating in more than 100 countries; or Travelers Group, whose businesses covered credit services, consumer finance, brokerage, and insurance. The merger between Citicorp and Travelers Group was announced to the world, creating a $140 billion firm with assets of almost $700 billion  [14]  . 1.4.2 Financial Synergy: Financial synergy refers to the impact of MAs on the cost of capital (i.e. minimum return required by investors and lenders) of acquiring firm or the newly formed firm resulting from the MA. Theoretically, the cost of capital could be reduced if the merged firms have uncorrelated cash flows, realize financial economies of scale, or result in a better matching of investment opportunities with internally generated funds  [15]  . A good example of mergers achieving financial synergies would be the historical birth of ExxonMobil Corporation formed in 1999 by the merger of the two major oil companies, Exxon and Mobil. It is currently one of the largest publicly traded companies in the world, having been ranked either #1 or #2 for the past 5 years. Exxon Mobils reserves were 72 billion oil-equivalent barrels at the end of 2007 with 37 oil refineries in 21 countries constituting a combined daily refining capacity of 6.3 million barrels. ExxonMobils total reported operating expenses declined by $400 million after the merger. Financial synergies in the merger included efficiency initiatives, spending more than offset, the impacts of new business activity and affiliate reorganizations. During the first year, the new company closed down outdated refineries, slashed seven percent of the workforce and eventually provided consumers with a better and cheaper product. As a result, upstream unit expenses were down 3 percent. Downstream unit expenses were down 1 percent benefiting from both lower overall costs and increased volumes. Furthermore, financial synergy was not simply on expense reduction. It maximized the contribution from all its resources financial assets, property and equipment, people, raw materials, and contracted services making Exxon Mobil the largest refiner in the world now  [16]  . 1.4.3 Diversification: Diversification is the process by which a firm enters a new market, without necessarily leaving its existing one(s), with a product new to the firm but not necessarily to the world. The strategy requires an organizational change and the development of technologies within the firm  [17]  . The best objective for diversification is for a firm to shift from its core product line or market into other lines and markets that have higher growth prospects. If a firm is facing slower growth in its current markets, it may be able to accelerate growth by selling its current products in new markets that are somewhat unfamiliar. Similarly, a firm may attempt to achieve higher growth rates by developing or acquiring new products. The risk is reduced by merging or acquiring a firm already familiar with these new markets or products. Anticipating that the cigarette industry would decline in the future, Philip Morris decided to diversify its product offerings and looked for acquisitions of u nrelated products to decrease dependence on the future of tobacco. In 1970 it acquired Millers Brewing for $ 227 million. Miller was the eight largest U.S. brewer with a 4.4% market share. Philip Morris increased Miller production, introduced new lines of products (Miller Malt Liquor, Milwaukee Ale, Miller Ale), acquired Meister Brau in 1972, and in 1975 introduced Miller Lite. By 1972, under Philip Morris Miller grew to the 3rd largest brewer, behind Schlitz; in 1980, Miller overtook Schlitz to become the second largest brewer. Today Philip Morris Companies is a holding company with a diversified product offering: Miller Brewing, General Foods (acquired, 1985), Kraft, Oscar Meyer (acquired, 1981), and Philip Morris. In 1989, tobacco products accounted for 40% of sales, food products accounted for 51%, and beer accounted for 8%  [18]  . 1.4.4 Strategic Realignment This theory suggests that firms use MAs as ways of rapidly adjusting to changes in their external environments. During the last 15 years, the regulatory environmental and technological changes are what formed a companys opportunities and threats. As the pace of these changes accelerates, MAs are often viewed as a way of rapidly exploiting new products and markets. This is especially because firms often do not have the luxury of time or resources to innovate. Thus, MAs in this case are often considered as a fast and less expensive way to acquire new technologies and propriety know-how to fill gaps in their current product offering  [19]  . An example of a strategic alignment merger would be that of British Telecom BT and MCI Communication Corporation. In June 1994, BT and MCI Communication Corporation, the second largest carrier of long distance telecommunications services in the US, launched Concert Communications Services, a $1 billion merger. This alliance gave BT and MCI a global network for providing end-to-end connectivity for advanced business services. Concert was the first company to provide a single source, broad portfolio of global communications services for multinational customers. On 3 November 1996, BT and MCI announced they had entered into a merger agreement to create a global telecommunications company called Concert plc, to be incorporated in the UK, with headquarters in both London and Washington DC. As part of the alliance BT acquired a 20 per cent holding in MCI. BT thus took an equity stake in MCI and now both companies jointly market and sell each others products and services in Europe and the United States  [20] 1.4.5 Market Power This theory suggests that firms merge to improve their monopoly power to set product prices at levels not sustainable in a more competitive market. According to one study, mergers in the airline industry in the late 1980s did result in higher ticket prices. The argument is based on the premise that the whole is greater than the sum of its parts. That is, when two companies combine, their market growth should out-strip what the companies could achieve independently. The hugest examples of market power mergers are those of the pharmaceutical business. On January 18, UK pharmaceutical companies Glaxo Wellcome and SmithKline Beecham announced that they would be merging their operations. Glaxo SmithKline will be the largest drug company not only in the UK but also outright in the world as well. The merger was closed so accurately leaving no opposition from the monopolies and mergers commission, the government or other regulatory obstacles. The new company-worth some  £130 billio n-will be quoted on both the London and New York stock exchanges. The stock markets had responded favorably to news of talks between the two companies. Glaxo SmithKline are now the worlds biggest producer of prescription drugs and have a market share of more than 7 percent. Glaxo SmithKline also raised global drug sales of  £17 billion, and the combination of their crucial research and development arms saved them  £250 million. The company now has the largest annual research and development budget in the world at  £2.4 billion  [21]  . 1.5 HISTORICAL MA WAVES (1) The 1st MA Wave: 1890s The 2nd MA Wave: 1910s-1920s The 1st MA wave started in 1890s. Its main feature is the horizontal takeover for consolidating industrial production. This period is called the Great Merger Wave but came to an end by the First World War and by the initiation of anti-trust laws like Sherman Act  [22]  . (2) The 3rd Wave: 1950s-1970s The 1930-40s can be said the dark age due to the Great Depression and the subsequent Second World war. The 3rd wave began 1950s and ended in the 1970s when the first oil crisis brought a turmoil in 1973. In this wave, European enterprises pursued horizontal MAs  [23]  . (3) The 4th Wave: 1980s The main turning point in the 4th wave is the recovery of stock markets from recession. Moreover, the fast technological boost led to mergers of worldwide electronics firms to achieve size competitiveness. Hostile MAs were very common and non-related diversifications were cut short. (4) The 5th MA Wave: 1990s The 5th MA wave started 1993 and came to an end with the collapse of equity market in 2000. In both scale and the number of MAs, the 5th wave was unprecedented. During 1993-2001, there were 114,925 MAs in Europe versus 12,729 in the fourth wave. The transaction value in the 5th wave reached $20 trillion, five times greater than the value of the 4th MA wave  [24]  . This is directly associated with the mechanism of international financial market. The main features of the 5th wave could be listed as: 1. cross-border takeovers accounted for a significant portion of total MA deals; 2. deregulation and privatization opened another strategic pathway for cross-border MAs which resulted in the Asian market emerging as an attractive MA target place; 3. the number of hostile MA bids decreased  [25]  . (5) A New Wave Since the mid-2003, the volume of MAs rose by 71% in 2004 compared to 2002. The value of the MAs by European firms amounted to $758 billion compared to $517 billion in 2002. Cross border takeovers are more actively done constituting 43% of the total value of European firms between 2002 and 2005  [26]  . Among industry groups, telecommunication industry is experiencing numerous MAs. For example, at least 10 MAs were completed in the early of 2005 and 8 of them were cross-border takeovers. The decreasing number of hostile MAs is consistent to the MA movement during the 5th wave  [27]  . Table 1: The historical MAs trends Time Period Driving Force(s) Type of MA Activity 1897 1904 Drive for efficiency Technological changes Migration Horizontal consolidation 1916 1929 Entry into WW1 Largely horizontal consolidation 1965 1969 Rising stock market Sustained economic boom Growth of conglomerates 1981 1989 Underperformance of conglomerates vs stock market Favorable foreign accounting practices Rise of hostile take-overs 1992 2000 Economic recovery Booming stock market Internet revolution Globalization reduction in trade barriers Age of strategic mega-mergers 1.6 DO MERGERS AND ACQUISITIONS PAY OFF? The answer to the above posed question seems to depend on for whom and over what period of time. Around the announcement date if transaction, average returns to target firm share-holders, including both friendly and hostile, are about 30%. In contrast, the shareholders of acquiring firms generally returns that range from slightly negative and modestly positive around the announcement date  [28]  . Two approaches have been used to measure the impact of takeovers on shareholder value. The first approach, premerger returns, involves the examination of abnormal stock returns to the shareholders of bidders and targets at time of announcement. The second approach, post merger returns, measures the impact on shareholder value after the merger has been completed. 1.6.1 Returns to Shareholders: This is done by measuring the performance of MAs through accounting and other performance measures, such as cash flow and operating profit, during the 3-5 year period following completed transactions. Unfortunately, studies have shown conflicting evidence about long-term impact of MA activity. Some studies proved that MA create shareholder value and others have found that as many as 50-80% underperform their industry peers or fail to earn their cost of capital  [29]  . 1.6.2 Returns to Bondholders: Recent evidence suggests that investment grade bonds issued by target firms earn average excess returns of 4.3% around the merger announcement date. Moreover, returns to target bonds are even larger when the targets firm credit rating is lesser than the acquirers  [30]  . 1.6.3 Returns to Industry: Studies showed that MAs reflect future efficiencies by transferring assets from those who are not using them effectively to those who can. Studies also proved that MAs dont necessarily increase industry concentration i.e. share of output or value produced by the largest firms in the industry either in manufacturing or in the overall economy  [31]  .