This paper analyzes whether mergers and acquisitions involving UK companies create shareholder value in practice. Value creation to shareholders is the principal reason behind mergers and acquisitions which is why M&As purport to be expedient. However, the periodic statistical decrease of M&As involving UK companies in span of 10 years (National Statistics, 2010) indicates that M&As tend to emerge ineffective in the process. Most of them failed to render pre-merger goals and as such, resulted in financial failures. Indeed, there had been a lag in merger activity since the start of the decade (Hay Group, 2007). Still, M&A activity continues to be the only trend to grow. The cases for BP Amoco and GlaxoSmithKline are taken as examples for evaluating whether value had been created to shareholders after the consolidation.
Theories on M&A
Theoretically, mergers and acquisitions create shareholder value by assisting companies in the exploitation of new resources like technological advances; increasing the knowledge base, thus capacity and so many other perceived benefits. Statistically and historically however, mergers and acquisitions destroy shareholder value rather than otherwise. Several independent sources have accounted conflicting evidences as to the actual value created by M&A transactions; although most of them indicated that M&As destroy more than create shareholder value nearly all in terms which are cultural and structural by nature (Hay Group, 2007). McCann (2004) states that a merger proposal alone could radically reduce the value of the bidding firm while target firms realize positive gains on the average. Cole et al. (2006) replicate this finding. They further state that in horizontal merger proposals, firms could experience outstanding negative cumulative returns and rarely recoup as bids conclude.
Berkovitch and Narayanan (1993) forward three critical motivational hypotheses behind mergers and acquisitions: synergy; hubris; agency. These rationales create an impact to both the target's and bidder's shareholder wealth. In a synergistic view, firms expect to create strategically, operating (e.g. gaining access to new markets, economies of scale and economies of scope), and financial synergies (e.g. reduction of the variability in the cash flow, increase debt capacity). Views regarding the manager's hubris relate to something more personal, leading to overpayment instead. Agency views are associated with agency costs from efficiency loss influenced by information asymmetries. With agency theory, takeovers happen in effort to make a firm more efficient by re-aligning skewed information (Bruner, 2004).
McCann (2004) explains how these three hypotheses remain the major impelling forces behind M&A transactions involving UK firms -- synergy, being the most dominant motive. Table 1 shows the total value created by M&As to both targets and acquirers (Berkovitch & Narayanan, 1993).
Table 1 Aggregate Value Created by M&A
Theories
Total Value
Gains to Target
Gains to Bidder
Synergy
positive
positive
positive
Agency
negative
positive
negative
Hubris
none
positive
negative
In synergistic M&As, the target and the bidder expect to that the value a merged company could yield may outweigh the aggregate value when the company operates independently (standalone company) at a certain performance level (McCann, 2004). There is a proportionate relationship between target gain and bidder gain (McCann, 2004). Synergistic mergers have been known to yield positive shareholder value as opposed to mergers motivated by agency views and managerial hubris. In agency views, the acquirer extracts value from the target but will ultimately be dispersed between the target's shareholders and the bidder's management (McCann, 2004). With managerial hubris, the bidder's value will be transferred to the target's, thus a negative relationship between the two (McCann, 2004).
M&A Activity Involving UK Companies
Table 2 Percentage Decrease within 10 Years
Transaction
Number
Value
M&As abroad by UK companies
79%
94%
M&As in the UK by foreign companies
51%
51%
Table 2 depicts the decrease in the number and value of mergers and acquisitions transactions involving UK companies. Although there can be several indicators to this effect such as the poor overall economy, and etc., the figures may also imply that companies no longer regard M&As transactions as profitably effective than theorized. The biggest known factor to this decreased activity is the reduction of market of corporate regulations (Capron & Kaiser, n.d.).
Synergistic Horizontal Mergers: Example-Based Evaluation
Successful Merger. British Petroleum (BP) is a UK-based gas and oil company while Amoco, is the latter's small American competitor. In 1998, the BP-Amoco merger became one of the largest cross-border takeovers involving a UK firm, with an approximate amount of $120 billion. The merger put BP Amoco as the third largest oil and gas company in the world behind Exxon Corp., and Royal Dutch/Shell. Upon the announcement, BP's share prices rose by 15% as each Amoco common stock shareholders were "offered 3.97 BP shares for each Amoco common stock" ("BP and Amoco," 1998). A 60, 40 share of the merged company was awarded to BP's and Amoco's shareholders, respectively ("BP and Amoco," 1998). Likewise upon the merger, BP Amoco reported $140 billion in market capitalization -- approximately 21% higher than with both the companies' pre-merger market caps combined (Kim & Kim, 2006). The merger yielded $108 billion in revenues per year; $6.4 billion in yearly profit; and $132 billion in market value while significantly cutting costs and enhancing financial, operational, and strategically efficiencies (Kim & Kim, 2006). Through pooling-of-interest accounting, goodwill was not created, hence the high reported earnings. However, the company did not earn as much as desired but the prices of stock remained high, consequently creating shareholder value. The BP Amoco merger was in fact a very timely and ideal fusion - complimenting each other's assets (Kim & Kim, 2006). Like the case for BP Amoco merger, synergistic mergers for the most part, yield shareholder value.
The main reason to such a successful merger was the effective integration of two diversified management structures (Allen, 2002). The merger was carefully laid out and positioned leading a smooth merging transition (Allen, 2002).
Failed Merger. Another large synergistic merger was between Glaxo Wellcome, the second largest pharmaceutical & Healthcare Company worldwide, and SmithKline Beecham, another pharmaceutical company, within 1997 and 2001. Both companies proposed a $76 billion merger under the name GlaxoSmithKline (Azam et al., n.d.). Upon the union, the nominal value of issued shares was £1.556 million while the market value was 119 billion (azam et a., n.d.). From this point, the shareholders did not get the full value of their investment. The merger was dubbed to be a convenient merger but Glaxo Wellcome was experiencing sluggish growth prior to the consolidation. While the cost savings reached £1.8 billion with a profit margin 35%, the merged company underperformed the FTSE All-Share Index, from 5,592.3 to 5481.8; and the Bloomberg 500 European Index (Lynn, 2002). Share prices in both companies decreased: Glaxo Wellcome's by 303p to £16.10 while SmithKline Beechams, by 92p to 715p ("Failed merger triggers,"1998). By 2003, the price per share was £13 which is merely higher than the average (Azam et al., n.d.). Until 2004, it went through sever underperformance, thus yielding no significant shareholder value. As what seemed to ensue, the shareholders were not giving their due. They perceived the inadequate management quality as the reason behind this failed merger.
Discussion: Why M&As Fail or Succeed
From the two examples above, the success and failure of merger lies in the management integration. In a 2007 Hay Group study of more than 200 large European M&As, ninety-one percent of corporate M&As failed to achieve the goals initially planned before the merger. Failure rate for UK companies was even higher, accounting for approximately 97%.
Reasons for the Failure. Business executives tend to compromise the intangible assets indispensable for the merger process (human resources, business culture, company structure and corporate governance) as they focus instead on the systemic and financial concerns (Hay Group, 2007). Another factor (which the GlaxoSmithKline failed to perform) is the poor execution of due diligence in a way of comprehensively understanding, then learning the corporate cultures and most importantly, the human capital of both participating companies (Hay Group, 2007). Finally, a lack of effective post-merger integration which could improve the management and workforce structures in terms of flexibility (Hay Group, 2007).
Reasons of Success. To make an M&A transaction successful, Hay Group (2007) consultancy recommends that there must be an optimal investment on both tangible and intangible assets, that is, in understanding the interconnectedness among intercultural diversity (human capital) and organizational capital.
Conclusion
There can be several factors that determine the success or failure of a merger. These factors may significantly change overtime in a way that it may change its influence towards the same. Some mergers may have failed in its first few years but may significantly yield value in the long run as the market changes become favourable to the merged company. Thus, determining whether M&A transactions create or destroy shareholder value cannot be entirely generalized to create a paradigm. In most cases, mergers and acquisitions fail because of the lack of foresight and religious adherence to pre-merger plans. Factors like these can be manipulated and constantly exercised which in turn, will assist in yielding shareholder value and competitive advantage.
