The subject of mergers and acquisition (M&A) is a complex one especially considering the numerous cases that has evolved in the past two decades. Thus, M&A present a firm with potentially larger market share and market diversity as it is increasingly becoming the repeatedly used method of growth for companies in recent times (Sofya, 2005). However, the summary of the M&A concept lies in the fact that when the target's firm's value increases, then M&A is considered successful. This paper elaborate on the factors and theories behind M&A, the benefits and costs involved in venturing on such move. Also, the strategies used, and impacts on share prices and financial objectives amongst others. This paper cited a case study to buttress the understanding of the subject on focus, like the merger occurring between Boots (UK) and Alliance UniChem (France) forming Boot Alliance company.
Featured cares study:
UK: Boots and Alliance UniChem
The two companies, Boots, a British company which had previously begun to expand internationally, and Alliance Unichem, established as Unichem in the UK in the 1930s and merged in 1997 with the French company Alliance Santé, announced a merger in October 2005. The companies eventually merged in July 2006, naming the extended company Alliance Boots. Alliance Boots is a large multinational group with a strong presence in the UK. Before the merger, Alliance UniChem had expanded through a series of acquisitions into a number of other European counties, including, the Czech Republic, Germany, Greece, Italy and Spain, as well as outside of Europe into Egypt, Morocco and Turkey, while Boots had expanded into the US and Russia.
The principal activities of the two companies before the merger were in the wholesale of pharmaceuticals and health and beauty products in the case of Alliance UniChem and in the retailing and manufacture of the same kinds of product in the case of Boots, which has a chain of over 3,000 retail pharmacies and 380 distribution depots.
The merger, which was accomplished through the issue of new shares, split almost equally between Boots and Alliance UniChem shareholders, created a company with a value of about €10 billion at the time and employing some 101,000 employees, 55% working in Boots.
Reasons for merger
Alliance Unichem justified the merger at the time by stating that it would enable the enlarged company to 'enhance (its) offering to the independent (retail) chemist', according to the Executive Deputy Chair of Alliance UniChem, Stefano Pessina. For Boots, it reduced the company's reliance on retail outlets at a time when cheap healthcare products were increasingly being offered by large supermarkets. In addition, the merger created the potential for cost savings in the form of 1,000 job cuts or 1% of the total workforce announced initially.
The main reason for the merger was that it was expected to generate gains from the larger scale of operations and would allow the company to widen its product range.
What is Mergers and Acquisition?
As globalization continues to strive in our modern world, companies have continue to seek better ways to enhance their business processes and survive the test of growing market competitions that lie at the mercy of rapid change of how the market place has evolved in recent times. Hard works and tactics to beat competitors have become a core strategic value in companies to ensure optimal knowledge is gained against rivals to achieve growth and supremacy. This growing industrial impetus has seen to the rise of hostile merging and acquisitions/takeovers of firms across the global (Sofya, 2005)
Sofya (2005) defined mergers and acquisition as the "combination of the assets and liabilities of two firms to form a single business entity", (Hoang and Lapumnuaypon, 2008) further defined merger as the "combination of two or more companies in creation of a new entity or formation of a holding company" while "acquisition is the purchase of shares or assets on another company to achieve a managerial influence". According to Dimitrios et al (2006), "Corporate merger is when two or more companies are terminated in the purpose of forming a combination of companies that will create as a rule, a larger and more powerful financial unit".
In addition, merger by absorption implies the combination of two approximately equal firms. The exchange or buying of stocks is often a feature of this combination. However, when two or more firms are merged into a newly created one and the combining firms in the merger are dissolved this is known as merger by establishment or acquisition/ takeover, (Sofya (2005), Hoang and Lapumnuaypon, 2008). The acquired firm in this regard is called the target firm.
Factors behind M&A
The past one decade has witness remarkable mergers activities with the advent of the internet and its boundless applications in modern day business like the use of the internet to speed post ideas and decisions. Reliance on traditional post office mailing service has been stepped up with courier service coming into light. The result of this is an increase in efficient and faster mergers and acquisitions transactions as senior managerial decisions convey at the medium of the countless wireless form of communications and interactions. Thus, fast advances in technology, financing efficiency, and favourable regulatory settings are the three main factors driving mergers, (Sofya, 2005). With these factors playing a huge role in growing economies around the world, there have emerged four economic factors which seriously affect the acceptance of merger across industries. For instance, static efficiency represents mergers of companies resulting in economies of scale with cost reduction. Dynamic efficiency which concerns increment of profits of merging companies which are used for new products research and development and innovation, this creates dynamic efficiency with provision of funds for long term capital investments.
The awarding of companies delivering on promising products and service and punishing of those that don't is also a factor that increases the survival of the fittest which in turn prompts companies to merge or acquire. The rise of competition in free markets increases growth of interest that can initiate merging movements. However, the risk of monopolies is an economic argument that can lead to mergers been rejected.
Merger Waves
The rise of competitive advantages with mass productions and transportations innovated in the eighties and nineties as well as the changes in regulations and tax system increased the technological and economic changes in modern market places creating an increase in financial activity which results in an imbalance in the marketplace of products creating a financial turbulence strong enough to cause merger wave, (Dimitrios et al, 2006). (Michael and Ashfaqul, 2003), with (Jarrad, 2004), further elaborated that industry's economic shocks, technological or regulatory environment create a merger wave that result in large scale reallocation of assets. In his research on M&A, (Jarrad, 2004) tagged this phenomenon with his neoclassic hypothesis. However, (Michael and Ashfaqul, 2003), further commented that this shock is not enough adding that capital liquidity which correlates with high assets values must be present for the shock to produce a wave. (Jarrad, 2004) also denoted that merger wave can occur when there is a relaxation in financial constraints which brings fundamental values closer to prices caused by a simultaneous increase in cash flows.
(Jarrad, 2004) second theory of behavioural hypothesis further explained that merger waves can also occur when assets of lower-valued firms are bought by managers using overvalued stock as criteria. Thus, the following predictions are made by the behavioural hypothesis: "Merger waves will occur following periods of abnormally high stock returns or market-to-book ratios, especially when dispersion in those returns or ratios is large".
Merger wave is prompted by the need for competitive advantages and hence creates a cycle of such since competitors don't sit back when leading companies advance to merging arrangements. A merger wave comprise of recipient country or target firm and a sending or acquiring firm. The wave spans through national and international borders as, for instance, more companies from developed countries like the US,UK, Germany, France, and Canada, dominate M/A activity, accounting for about 89% of outward M&A flows in the past two decades, (Michael and Ashfaqul, 2003). Thus, in a dynamic global market place, business and firms are restructuring in some way in response to shocks caused by internal or external competitive threats. This is the beginning and sustenance of merger waves resulting in some form of aggregate merger wave with time.
Motives for M&A
There have been researches in the aspect of why mergers movements are ventured on by many companies? There are many complex reasons for M&A which vary for various transactions between parties involved; hence a single theory cannot justify the motives for M &A. On a broader view companies go into merging and acquisitions for the reason of privatization. For instance, companies usually foreign owned can merge or buyout government own business in order to develop its potential and products, etc. Again, firms go into M&A in order to expand market share and saving a company that is struggling to rise up in a concentrated competitive market. In turn the acquiring company gains a larger market share and brand. For instance, the formation of the new company Alliance Boot, which came as a result of a merging transaction between Boots (UK), and Alliance UniChem (France). This increased the international presence of the company. Lastly, companies just have the motive of taking over another company and incorporating it into its own operations. For instance, the underperformance of Dutch bank for many years prompted its takeover by a syndicate comprising the Banco Santander of Spain, Royal Bank of Scotland (RBS), and the Belgian-Dutch bank Fortis.
Thus, in M&A deals it should be noted that at goodwill, real assets and intangible assets are been purchased by the acquiring companies, (Michael and Ashfaqul, 2003). This is in turn an advantage of M&A and hence a benefit for both predator and target firms.
Thus, a summary is giving by Hoang and Lapumnuaypon (2008), as below:
"(1) M&A is considered as a means for firms to grow quickly;
(2) M&A firms hope to experience economic gains as a result of economies of scale or scope;
(3) a larger firm as a result of M&A may have a better access to capital market, which later leads to a lower cost of capital, i.e., financial benefits; and
(4) M&A is aimed at anticipated gains which a firm may experience when applying its superior management skills to the target's business."
Types and Classification of Mergers and Acquisition
The classification of M&A depends on many factors depending on the deal which can be the strategy employed and targets of the buying companies, the basic features and activities of the bought out, and the social economic conjecture of the geographic location. Depending on degree of implementation M&A can be classified as horizontal, vertical or conglomerate. Horizontal merger relates to companies acquiring and target companies that belong to the same industry, produce similar products. In response to technological changes and liberalization in recent years, horizontal M&A has grown speedily especially in automobiles, pharmaceuticals, telecommunications and banking industries, (Hoang and Lapumnuaypon, 2008, Dimitrios et al 2006). Vertical merger relates to client-supplier or buyer-seller combinations. The motive is to "reduce uncertainty and transaction costs by upstream and downstream linkages in the value chain and to benefit from economies of scope",(Hoang and Lapumnuaypon, 2008). Promiscuous or conglomerate merger relates to the combination of firms of unrelated business fields. The motivation for this can be to diversify risks. Lastly, M&A can span through national boundaries into what is known as cross-border M&A transaction, which is when companies from different geographical location or countries engage in merging activities.
Thus, according to (Dimitrios et al, 2006), distinguishing M&A can also be done
"Depending on the position taken by the company's administration: Friendly buyout: where the Administration of the bought out company successfully cooperates for the implementation of the buyout. Hostile buyout: where the Administration of the bought out company rejects the buyout proposal in order to avoid or delay the buyout and takes to defensive tactics."
Mergers and Acquisition Process
According to Hoang and Lapumnuaypon (2008), the process involve in a typical M&A transaction are divided in three phases: planning, implementation and integration. The planning concerns itself with the overall transaction plan including operational, managerial and legal techniques and optimization. The implementation phase relates to sealing of agreements, conclusion of the M&A deal and contracts. The integration phase deals with post implementation of the M&A deal.
Mergers and Acquisition Advisory Firms
As stated before, venturing on M&A transaction is a complex process that requires carefulness. Thus, companies transacting in M&A do not deal with just the aspect of finance, but social and technological cost are also determinant in the final outcome of the deal, (Dimitrios et al, 2006). As such, due to the rise in M&A in recent times, external consultants have emerged to offer expertise in various levels of the M&A process and help in sealing M&A deals. This consultants are known as the merger & acquisition advisory firms, and are often employed by acquiring or targeting companies to offer assistance in conducting the M&A transactions. According to Hoang and Lapumnuaypon (2008), M&A advisors firms can be "investment banks, corporate lawyers, accountants, stockbrokers, strategy consultants, investor relations and public relations consultants, and environment consultants". The primary role of M&A advisory firms is acting as match makers i.e. linking acquiring and target companies together, carry out business evaluations, business marketing, resolving issues encountered during the process, and providing skills and insights in negotiations and strategy for clients.
Mergers and Acquisition Regulations
M&A advisory firms, together with promising acquirers and target firms, all play or are seriously tie by strict national and international regulations or laws to avoid monopolies. For instance, in the US, the Federal Deposit Insurance Corporation (FDIC) enacted a Bank Merger Act (Section 18(c) of the Federal Deposit Insurance Act) which ensures that the FDIC scrutinizes all M&A transactions to avoid approving one that has the potential of creating market monopoly which is a threat to free market. Also, in UK, the Monopolies and Mergers Commission, established in 1948, monitors or investigates reports on monopolies by businesses. There is also the Fair Trading and the Competition acts which are enacted to check unlawful trading and promote healthy competitions. The Broadcasting Act helps to protect private information from the public thereby restricting the disclosure of private information regarding mergers and acquisitions through public means of public information distribution, (Hoang and Lapumnuaypon, 2008).
Mergers and Acquisition and Stock Prices, Exchange Rate and Interest Rate
The evolution of globalization has created three variable impact on M&A activities especially merger transactions across countries. Changes in exchange rate, for instance, create elastic price effects that affect investment flows. M&A activities are also positively affected by stock market index while it has been seen that M&A activities are negatively affected by interest rates. Thus, according to Michael and Ashfaqul (2003), "The most important metric of financial capacity for the acquiring firm is often its stock price because M/As are often accomplished through issuance of stock by the acquiring firm. The greater the capitalization of the acquiring firm, the greater capacity they have for purchasing other firms".
The significance of higher stock market index (stock price increment) portents the strength of the country's economy thereby making companies in such country target country as companies are apt to acquirer corporations in countries with strong currency. However, high stock price increase M&A cost, but it also indicates national economic prospects and company profitability. Thus, M&A transactions increase by 4% as a country's currency appreciation by 1%, (Michael and Ashfaqul, 2003). Also, a fall in a foreign country's stock prices results in depreciation of its exchanges, the implication of this is that its companies become potential targets to foreign buyers as the cost of M&A transaction at this point will be low. M&A has the potential of increasing shareholders benefits in the long run.
Mergers and Acquisition Impact on Economy
The economic effect on a country is of major concern especially with regards as to how M&A has contributed in the improvement of the performance of the concerned sector. M&A activities have a great tendency of improving the growth of a company and the country at large as stock prices can soar making the country's foreign exchange stronger. However, one of the effects of M&A is job losses and job growth as well. Job loss tend to be a frequent occurrence following M&A especially when companies of same industry merge. Thus, duplicate job role can be cut as fewer staffs can handle some specific tasks as in the case of privatisation. For instance, the acquisition of Schering by Bayer resulted in the cut of about 5350 jobs of which 3150 of them are in Europe. As reported by European Restructuring Monitor (ERM) over the period of 2002-2007, 6.5% or about 240,000 jobs of approximately 3.7 million job losses arose from M&A activities. The table below gives a summary:
Jobs losses from restructuring involving mergers or acquisitions, 2002-2007 (%)
2002
2003
2004
2005
2006
2007
2002-2007
6.6
2.9
3.8
5.3
11
9.9
6.5
Source: Author's estimates based on cases reported in the ERM
In spite of job losses as a result of M&A, yet in the long term the financial and market position of enlarged company can result in job creation as well. Employment increase in by 40% was recorded in Czech Republic as a result of insurance companies' merger. Also, 30% increase of job growth occurred in the merge of TSB in Ireland despite earlier loss of jobs.
Again, M&A impact on branding "The higher the acquirer's marketing capability, the higher is the target firm's brand portfolio value" and the "The higher the acquirer's brand portfolio diversity, the higher is the target firm's brand portfolio value", .For example, Jones Apparel Group acquired Barneys New York in order "to enter the high-growth, resilient luxury goods market" (Cem et al, 2008).
