1.0 Introduction
Despite being used as a common phrase, the concept of a merger or merger of equal is often misleading. The phrase creates a perception of equality between two entities-a result that is difficult to achieve in practice, no matter what the companies say in their press releases.
But is it really possible to have a merger? For it to be truly between equals, control of the combined entity must be equally distributed. To drill down to the truth behind the press release, observers must look at the management of the combined entity, the voting power of the shareholders and the location of the headquarters. And also they must look at the elements that may not or cannot be addressed in negotiations or merger documents that may not be apparent until sometime after the consummation of the merger, such as the corporate culture of the combined entity, the location of meetings of the board of directors, succession of power, employee layoffs or compensation issues.
These are the details that often show which company has the upper hand-and it is likely that one company, in essence, acquired the other. Differences in corporate culture, compensation issues or other subtle factors may be less important in determining which company is dominant when the companies operate in the same sector. However, as more technology companies-with their own unique cultures-enter into mergers with non-technology companies-with more traditional corporate cultures-these factors are likely to play an increasingly prominent role. Internal struggles will be intense and will set the tone or attitude of the combined company.
2.0 Problem Statement
The key reasons behind analyzing the fallacies of mergers being acquisitions is to find out if this statement is actually true or not-is it a fact or a fiction? Mergers of equals, mergers and acquisitions are common terms and occur on a daily basis. Any type of merger or acquisition is very critical to the economy of any country due to its undeniable strategic and economic importance. Combining two small or giant corporations into one, can create havoc to the economy if not properly managed. It was with this intention that I decided to undertake this study to examine the fallacies of mergers being acquisitions, within the scope of Pakistan.
3.0 Research Objective
Mergers (of equal or plain), as initially touted or announced, could in fact be acquisitions in disguise. Organisations do not like to be called as 'acquired' or 'taken over'; rather they feel that the word 'merger' sound more peaceful as well as the reputation of the company also remains intact. Where as if 'acquisition' or 'takeover' or 'buyout' types of words used, perceives that the company was not doing that well, hence another organisation had to step in, in order to keep them afloat from sinking or going bankrupt. For this reason, it was very attractive and interesting to pursue this topic, especially when hardly any research had been done in this area. It has always been a fallacy that mergers and mergers of equal are not usually about two firms being engaged in mere merger agreements, just for reason that they are equal or want to merge, but usually, it is the other way around-someone is the acquirer and another a target.
The objective of this research is to investigate whether mergers were actually acquisitions and were being created to give a false perception or were mergers really mergers. The study to be conducted in order to understand the differences and characteristics between mergers and acquisitions led to further scrutinize this fact or fiction by taking into account live case studies within Pakistan. Each of the differences uncovered would be individually assessed and the results then will be further analyzed and appraised as a merger or an acquisition, based on those particular characteristics. The research question-Merger or Acquisition? The Story Behind Pakistani Mergers-will be researched, evaluated and thus proved or disproved. Results will show if there is any kind of fallacy of mergers being acquisitions or not.
4.0 Benefits
My research will be based on the fact that organisations do not like to be called as 'acquired' or 'taken over'; rather they feel that the word 'merger' sound more soothing as well as the reputation of the company also remains intact. Where as if 'acquisition' or 'takeover' or 'buyout' types of words used, perceives that the company was not doing that well, hence another organisation had to step in, in order to keep them afloat from sinking. This fact shall be examined in the research of various Pakistani organizations across the globe. Certain parameters shall be set up in order to then compare and contrast.
The goal of this independent study is to examine the fallacies of mergers being an acquisition, that arises, which was a new topic, and hadn't been investigated before. The aim of this research is to prove that all major Pakistani mergers were acquisitions in disguise and that there was a perception created in the minds of the general public, of them being mergers.
The study shall be conducted to understand the differences and characteristics between mergers and acquisitions that were examined by looking at live cases within Pakistan. This further shall highlight and examined the research question, which I hope to successfully answer. Results shall show that there indeed is a fallacy of mergers being acquisitions and those mergers are actually acquisitions in disguise.
5.0 Scope
Why do so many mergers fail? Merger failure rates are surprisingly unaffected by the strategic relatedness of the merging firms, so the reason is usually not a failure of the acquiring firm to understand the industry of the acquired firm. Nor is the reason usually the failure to build financial plans: After the purchase price has been agreed, cost savings and market power analyses in fact seem to be the chief focus of most mergers in order to justify the purchase price. Nor is the reason usually the failure to plan for the new structures and reporting relationships: That is one of the first things planned, as executives jockey for positions.
Many, if not most, mergers fail because the human and operational sides of integration are overlooked: The two merging organizations do not systematically plan how to build on and integrate their people and cultures. Instead of thinking of mergers as marriages where both parties benefit, they are often thought of and spoken of as takeovers, where the acquiring organization's culture or point of view is applied to the acquired organization whether it fits or not. The mind set is often win-lose. The bigger or stronger firm's culture and way of operating win. The smaller firm's culture and operations lose. Naturally, the smaller organization is resentful and does its best to hang on to what it views as its strong points. The larger one pushes harder for change, and a negative spiral can result (Schmalensee, Riddell & Joiner, 2000).
6.0 Research Methodology
Mergers and acquisitions can fail to deliver for literally hundreds of reason, ranging from under-funded pension plans and open workers' compensation claims to unforeseen tax liabilities and poorly managed workforce integration. But there are ways to ensure against all of these liabilities-and many others that most buyers never even imagined. Done the right way, no deals, no matter how big and complex, need to be a gamble.
Mergers and acquisitions have been the subject of considerable research in financial economics. But no one seemed to have analyzed the exact reason as to if mergers are really mergers or acquisitions in disguise, hence this is what I plan on analyzing and needs to be researched.
After researching and uncovering a few characteristics between mergers and acquisitions, it was considered to benchmark them by making certain proxies in order to measure them.
There were many different characteristics that were accumulated between mergers and acquisitions but not all can be used due to-some being similar in nature, some being duplicated and some due to various other limitations. Out of the original 15 characteristics identified, only 10 of them are workable without any constraints. These characteristics have been converted into some form of proxies that are going to be able to ensure that some form of measurable criteria or parameters are identified. After the proxies are created, they shall be tested to our sample merger deals within Pakistan.
In order to test the various characteristics accumulated between mergers and acquisitions, I shall be using a sample size of all the mergers that have occurred in Pakistan, without any restriction in terms of a specific time frame. Once the sample size is selected, further research will go ahead and then various characteristics and their proxies shall be looked into.
Characteristics & Their Proxies
CHARACTERISTICS
PROXIES
Merger
Acquisition
Merger
Acquisition
1
Merging offers succession planning-a way to secure retirement though new ownership.
Acquiring does not offer any secure succession plan.
The CEO & the top management stays on with the company even after 2-3 years.
The CEO & the top management resigns or leaves the company within 2-3 years.
2
Merging also offers reduced work level -a way to share responsibility among more people.
Acquiring does not reduce the work level.
The total productivity or sales reduces by 5% within 3 years. (Compare sales before or the year of the merger with sales in the third year of the merger).
The total productivity or sales does not reduce by 5% within 3 years. (Compare sales before or the year of the merger with sales in the third year of the merger).
3
A merger does not require too much cash.
An acquisition requires a large amount of cash.
0% cash is required.
100% cash is required.
4
A merger allows the shareholders of smaller entities to own a smaller piece of a larger pie, increasing their overall net worth.
An acquisition does not allow the shareholders of smaller entities to own a smaller piece of a larger pie.
There is an increase in the overall net worth from a shareholder value perspective. (Market value of each share, 60 days before and after the merger announcement).
There is a decrease in the overall net worth from a shareholder value perspective. (Market value of each share, 60 days before and after the merger announcement).
5
A merger does not only look at the diversification and delivers value by not diversifying their portfolios at a very high cost.
An acquisition only looks at the diversification and fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much associated with a merger.
Total market value of the combined entity is greater than that separately. (60 days before and after the merger announcement).
Total market value of the combined entity is less than that separately. (60 days before and after the merger announcement).
6
Need for an inter-firm consensus.
No need for inter-firm consensus.
The merger agreement is typically friendly.
The acquisition agreement is generally unfriendly and hostile.
7
Not necessarily a larger commitment to resources.
Larger commitment to resources.
There is an increase in the Book Value after the merger as compared to before. (1 year before and after).
There is a decrease in the Book Value after the merger as compared to before. (1 year before and after).
8
Not always acquires more than is needed
Often acquires more than is needed.
Sold any part or portion of the new business entity within 5 years.
Have not sold any part or portion of the new business entity within5 years.
9
A merger is not at all an owner's hubris-the executives of a company will merge with others because doing so will be beneficial to both the companies involved.
An acquisition is an owner's hubris-the executives of a company will just buy others because doing so is newsworthy and increases the profile of the company.
Profits increase within 3 years. (Compare profits before or the year of the merger with profits in the third year of the merger).
Profits do not increase within 3 years. (Compare profits before or the year of the merger with profits in the third year of the merger).
10
A merger does not lead to bootstrapping.
An acquisition leads to bootstrapping, that is acquiring a competitor with a sole reason of temporarily increasing earnings per share.
No evidence of this occurring just to increase the acquirer's profits. (Not selling the firm within 3 years).
Evidence of this occurring just to increase the acquirer's profits. (Selling the firm within 3 years).
Characteristic 1-Succession Planning
The first characteristic discovered was that 'Merging offers succession planning-a way to secure retirement though new ownership, while an acquisition does not' (Mastracchio & Zunitch, 2002).
Source: Booz.Allen & Hamilton
In a merger of equals two firms' managers act cooperatively and strike an agreement without putting either of the firm in play. According to Lambrecht and Myers (2005), both act in their own interests, constrained as usual by the threat of collective action by the investors. According to Wulf (2002) in mergers of equal, the target company Chief Executive Officers frequently strike a deal that benefits them personally but is not always in the best interest of the shareholders.
Characteristic 2-Productivity
The second characteristic uncovered was that 'Merging also offers reduced work level-a way to share responsibility among more people, while an acquisition does not reduce the work level' (Mastracchio & Zunitch, 2002).
McGuckin and Nguyen (1995) and Schoar (2002) find that the productivity of acquiring firms' plants falls and that the productivity of the targets' plants rises following a takeover. Lichtenberg and Siegel (1987) find that plants changing owners had lower initial levels of productivity and higher subsequent productivity growth than plants that did not change hands. This point was further researched by Jovanovic and Rousseau (2004) in relation to mergers being used as asset reallocation.
Characteristic 3-Cash VS Stock
The third characteristic uncovered was that 'A merger does not require too much cash, while an acquisition requires a large amount of cash' (Mastracchio & Zunitch, 2002).
According to Bruner (2005) most of the deals that are share-for-share tend to be worse for buyers than cash deals. Halpern (1973); Yagil (1980); Wansley, Lane and Yang (1982) all observed that cash transactions were associated with higher abnormal returns than transactions based on an exchange of securities. Ellert (1976) observed different abnormal returns for active acquirers and for bidders which had a single large merger; although both groups displayed positive abnormal returns prior to the merger date, they were significant only for the active acquirers.
Characteristic 4-Market Value
The fourth characteristic discovered was that 'A merger allows the shareholders of smaller entities to own a smaller piece of a larger pie, increasing their overall net worth, while this is not possible in an acquisition' (Mastracchio & Zunitch, 2002).
In a merger in which the acquirer's share makes up all or part of a deal's acquisition currency, the acquirer's share price often is subject to significant fluctuations between the deal announcement and the deal closing dates. Given such volatility, the issue arises of how to price share transactions and how to allocate market risk between the acquirer and target shareholders. One way is to use devices called takeover derivatives, which are equity-linked or equity-indexed techniques designed to provide investment protection to the merger parties. These include such techniques as collars, caps, and contingent value rights.
Amobi (1997) in her article recommends all merging firms to use these techniques as they provide protections such as granting the target the option to terminate the transaction if the acquirer's share price falls below a specified level, guaranteeing that the value of the shares is not affected by changes in the acquirer's share price, or allowing the acquirer to request a 'ceiling' on the value of shares it ultimately issues.
Characteristic 5-Market Capitalization
The fifth characteristic revealed was that 'A merger does not only look at the diversification and delivers value by not diversifying their portfolios at a very high cost, while an acquisition only looks at the diversification and fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger' (www.wikipedia.org).
Characteristic 6-Friendly VS Hostile
The sixth characteristic revealed was that 'A merger does require an inter-firm consensus, while an acquisition does not' (Weston & Weaver, 2001).
It is most important to distinguish between a hostile and friendly mergers and acquisitions. In a hostile deal, the acquirer makes a tender offer directly to the target company, without consulting the whole incumbent management. Each shareholder decides individually whether or not to tender their shares. In contrast, a friendly deal has to be approved by both the shareholders and the management.
Schnitzer's (1996) empirical evidence suggests that hostile tender offers are not very attractive. The acquirer has to pay for expensive advertisements and mailings to shareholders in addition to high-cost services of merchant banks and lawyers. To succeed with the offer, the acquirer often has to overcome costly takeover defenses, like poison pills, installed by the management prior to the takeover attempt. Furthermore the acquirer typically ends up paying a high premium to shareholders. But friendly deals too have their drawbacks. It is well know that the separation of ownership and control causes agency problems between the owners and the management of the firm. The management may prevent a merger that would be otherwise profitable to the shareholders if they expect to lose some of their perquisites. From this prospective, a hostile deal could be seen as an alternative procedure that does not depend on the management's consent.
Morck, Shleifer and Vishny (1988) find that targets of hostile deals tend to be older and more slowly growing than targets of friendly mergers. They conclude that friendly deals are motivated by synergy gains whereas hostile deals are used if the intention is to discipline the incumbent management.
Characteristic 7-Book Value
The seventh characteristic uncovered was that 'A merger does not necessarily require a larger commitment to resources, while for an acquisition it does' (Weston & Weaver, 2001).
The relationship between price and book value is much more complex than most investors realize. In practice, analysis often use shortcuts to arrive at Tobin's Q using book value of assets as a proxy or replacement value and market value of debt and equity as a proxy for the market value of assets. In these cases, Tobin's Q resembles the value to book value ratio.
Characteristic 8-Sold a Part of the New Business
The eighth characteristic revealed was that 'A merger does not always acquire more than is needed, while for an acquisition it often does' (Weston & Weaver, 2001).
Perry & Lee (2001) in their article state that the goal of acquiring or buying a company is to purchase assets and property that the acquirer believes can be put to productive use and thereby produce value at least equal to or greater than the price the buyer is willing to pay. Among the most coveted assets and properties that the buyer seeks are rights to intellectual property in the form of licenses that the target either holds or grants.
Characteristic 9-Profits
The eleventh characteristic uncovered was that 'A merger is not at all an owner's hubris-the executives of a company will merge with others because doing so will be beneficial to both the companies involved, while an acquisition is an owner's hubris' (www.wikioedia.org).
The overall performance of mergers in terms of profits is mixed. The extent to which mergers enhance profitability is a subject of debate. But we do know that mergers can increase profitability by enhancing not only efficiency but also market power.
Characteristic 10-Bootstrapping
The twelfth characteristic revealed was that 'A merger does not lead to bootstrapping that is acquiring a competitor with a sole reason of temporarily increasing earnings per share, while in an acquisition this bootstrapping occurs' (www.wikioedia.org).
Some mergers and acquisitions that offer no evident economic gains nevertheless produce several years of raising their earnings per share. Poor growth prospects, decrease in stock prices and earnings low, show that the merger produces no economic benefit and so the firms should be worth exactly the same together as they are apart. The market value after the merger should be equal to the sum of the separate values of the two firms. This is called the bootstrap effect because there is no real gain created by the merger and no increase in the two firms combined value. Since the stock price is unchanged, the price earning ratio also falls (Brealey, Myers & Allan, 2006).
Financial manipulators sometimes try to play the bootstrap or chain letter game, to ensure that the market and investors do not understand the deal. In bootstrap game, the earnings growth is generated not from capital investment or improved profitability, but from the purchase of slowly growing firms with low price-earnings ratios. If this fools investors, the financial manager may be able to puff up the stock prices artificially. But to keep fooling investors, the firm has to continue to expand by merger at the same compound rate. Clearly, this cannot go on forever; one day expansion must slow down or stop. At this point of time, the earnings growth will fall dramatically and the house of cards will collapse.
7.0 Literature Review
This topic does not have much in line of research done from other authors and researchers as this is an absolutely new topic, never undertaken before. There is nothing from which, any sort of empirical studies or comparisons can be undertaken, hence this research will be under un-chartered waters.
Every researcher talks about mergers and acquisitions to be either-exploit synergies and growth opportunity or efficiency through layoffs, consolidation and disinvestments. Some researchers also go on to talk about mergers and acquisitions increasing market power; bidders paying too much for the target companies; and shareholder benefits from acquisitions. Few have even tackled the issues as to why major mega-marriages tend to fail in the long-run.
We know surprisingly little about mergers and acquisitions, despite the buckets of ink spilled on the topic. In fact, our collective wisdom could be summed up in a few short sentences. Acquirers usually pay too much. Friendly deals done using stock often perform well. Chief Executive Officers fall in love with deals and do not walk away when they should. Integration's hard to pull off, but a few companies do it well consistently. Given that we are in the midst of the biggest merger boom of all times, the collective wisdom seems inadequate, to say the least.
The popular view of merger and acquisition is that merger and acquisition is a loser's game. The following excerpt from a recent book by Grubb & Lamb, (2000) says:
"the sobering reality is that only about 20% of all mergers really succeed…most mergers typically erode shareholder wealth…the cold, hard reality that most mergers fail to achieve any real financial returns…very high rate of merger failure…"
8.0 Limitations of the Study
As it was a new topic, not much information shall be available in the form of research papers or literature reviews. Also there are so many more characteristics between mergers and acquisitions, that could have been explored further but due to lack of information, it shall be just not possible. Data collection also shall prove to be very difficult as the University is not subscribed to any mergers and acquisition databases and not all information shall be easily available on the internet and to the general public.
Another limitation that might arise is the fact that some of the companies that shall be chosen in the sample will be quite old and that might proved to be very difficult to gather historical data. After a merger, the target company is taken over, and then there is no information or data available, before the completion of the merger. It might be very hard to find any sort of websites on the internet that may provide the required historical data.
9.0 Tentative Schedule
Submission of Research Proposal: August 28, 2010
Mid Semester Draft: November, 2010
Submission of Final Report: December, 2010
10.0 Tentative Table of Contents
Title Page
Acknowledgements
Introduction
Background & Literature Review
Evolution of Mergers & Acquisitions
Methodology & Criteria Benchmark
Data Collection & Findings
Conclusion
References/ Bibliography
Appendices
