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M&A PROCESS

 

The number of merges and acquisitions (M&A) continues to increase, with the international 2006 deal volume 30, 000 breaking the previous record set during the dotcom boom. All signs are that this high level of M&A activity will proceed in 2007 and beyond. In the past, M&As often led to unfavourable results in the form of the reduced shareholder value. Unlike it, today's deals are enjoying greater success at increasing shareholder value, with the deals of the average size often outperforming larger ones1.  

Merges of the companies and acquisition (M&A) and corporate restructuring are a big part of the corporate finance world. The essence of M&A transactions should bring separate companies together to form larger ones. When they do not create the big companies from smaller ones, corporate finance deals do changes and break up companies through spin offs, carve-outs or tracking stocks.

A merger can happen when two companies decide to combine into one entity or when one company buys another. An acquisition always involves the purchase of one company by another.

Three main components of M&A process are the following: internal relatedness, represented by the cultural and organizational fit; the initial conditioning variables, containing the external relatedness and other irreversible realities like acquisition experience, size, and mode of takeover; and the integration process variables, like level and speed of integration, acculturation and autonomy removal. These three components are the bases on which the post-acquisition integration process is performed. The point is that the integration process becomes active after the deal is made. All other factors can be determined before closing the deal2.

1 Richard M. Able, 2007. “The Importance of Leadership and Culture to M&A Success”. Jan 16, pp. 2-6

2 Stahl, G.K. & Voigt, A. (2005), “Impact of cultural differences on merger and acquisition performance: a critical research review and an integrative model”. Advances in Mergers and Acquisitions vol.4. – p.72

 

The main goal of M&A transactions is not only to buy a company, but to

create shareholder value over and above that of the sum of the two companies. Two companies together are considered to be more valuable than two separate existed companies– that is the reasoning behind M&A.

Acquiring companies use various methods to value their targets. Some of these methods are based on comparative ratios - such as the P/E and P/S ratios - replacement cost or discounted cash flow analysis.

When the industry is in consolidation period, and as other competitors consolidate and challenge market position of the company, the fear of being left behind spreads. Companies engage in M&As with the purpose to survive (“bandwagon effect”) 1. Strong companies will try to buy other companies to create a more competitive, cost-efficient company. The companies will unite hoping to receive bigger market share or to achieve greater efficiency. Because of these potential advantages, target companies will often agree to be bought when they know, that they cannot survive alone.

Merges of the companies and acquisitions almost always involve some level of transformational changes and disruptions. Successful post-merger integration demands essential changes both from acquisition and from the acquired organization. The buyer creates boundary disruptions - changes in the established purposes, strategy, ways of doing things and customs. The buyer also should develop control mechanisms to operate transformational change and to reach strategic targets that drove the M&A in the first place. The acquired organization should overcome any troubles about being «absorbed» and learn to unite itself into new corporate procedures and values2. 

The primary motivation for M&A deals is the quest for growth. When internal growth initiatives do not materialize, or there are no other organic growth options, M&A transactions prove to be the only way to create growth.

1 van Wegberg, M., (1994). "Why do Mergers Occur in Waves? Business Cycles, Bandwagons and the Merger for Market Power Paradox." METEOR Discussion Paper

2 Richard M. Able, 2007. “The Importance of Leadership and Culture to M&A Success”. Jan 16, pp. 2-6

External pressure can also force managers to initiate additional M&A transactions. The demand for double-digit growth from analysts and investors becomes hard to satisfy.

An M&A deal can be executed by means of a cash transaction, stock-for-stock transaction or a combination of both. A transaction struck with stock is not taxable.

  For companies the external pressure for more growth can be so immense that it cannot be realized by organic growth through internal projects alone. In this situation, M&A transactions remain the only solution, even if they might have failed in the past.

M&A comes in all shapes and sizes, and investors need to consider the complex issues involved in M&A. The most beneficial form of equity structure involves a complete analysis of the costs and benefits associated with the deals1.

Mergers and acquisitions are often used as synonymous; nevertheless these terms mean slightly different things. Acquisition will take place in the situation, when one company joins with another one and established itself as the new owner.  When two firms, often of about the same size, agree bring together as a single new company rather than remain separately owned and operated, in this case the purchase is called a merge or it can be called a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place.

Regardless of the category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved2.

 The functions of synergy allow for the enhanced cost efficiency of a new entity made from two smaller ones - synergy is the logic behind mergers and acquisitions.

1 Slywotzky, A.J., Wise, R., 2002. "The Growth Crisis - and How to Escape It."  Harvard Business Review 80, pp.72-82

2 van Wegberg, M., (1994). "Why do Mergers Occur in Waves? Business Cycles, Bandwagons and the Merger for Market Power Paradox." METEOR Discussion

The four basic sources of synergy: cost, income, market power, and non-material actives. Cost synergies are often the easiest to document and capture in a merger and acquisition. Income, market power and non-material actives on the other hand are increasingly more difficult to achieve.

A real distinction is in how a purchase is communicated to and received by the target directors’ board of the company, employees and shareholders. Whether a purchase is considered a merge of the companies, or acquisition really depends on whether the purchase is friendly or hostile and how it is announced.

By merging, the companies hope to get advantage from the following: staff reductions, economies of scale, acquiring new technology, and improved market reach and industry visibility. The following equation offers a good way to think about synergy and how to determine whether a deal makes sense.

The equation solves for the minimum synergy:

 

 

The success of a merger is measured by whether the value of the buyer is enhanced by the action1. The practical constraints of mergers often prevent the expected benefits from being fully achieved.

Break up or de-merger strategies can provide companies with opportunities to raise additional equity funds unlock hidden shareholder value and sharpen management focus. De-mergers can occur by means of divestitures, carve-outs spin offs or tracking stocks.

Merges of the companies can fail for many reasons, including a lack of management foresight, the inability to overcome practical challenges and loss of an impulse of the income from a neglect of daily operations.

It's hard for investors to know when a deal is worthwhile. The burden of proof should fall on the acquiring company. To find mergers that have a chance of

1 Robert F. Bruner, Applied Mergers and Acquisitions (Wiley Finance) Wiley, 2004. p.255

 

success, investors should start by looking for some of these simple criteria:

1) A reasonable purchase price. A premium of 10% above the market price seems within the bounds of level-headedness. A premium of 50%, on the other hand, requires synergy of stellar proportions for the deal to make sense.

2) Cash transactions. Companies that pay in cash tend to be more careful when calculating bids and valuations come closer to target.

3) Sensible appetite. An acquiring company should be targeting a company that is smaller and in businesses that the acquiring company knows intimately. Synergy is hard to create from companies in disparate business areas.

When company’s’ top-managers decide, that they wish to make merger or acquisition, they begin with a tender offer. Process typically begins with the acquiring company carefully and cautiously buying up shares in the target company or building a position

The process of M&A consists of the following phases: pre-M&A, M&A, post-M&A phase.

The chronological order of M&A transaction goes hand-in-hand with task complexity. While the first steps are rather easy, later ones become more difficult. The search for the potential targets is rather easy and even the acquisition in comparison with obstacles to be mastered during an actual phase of integration. 

The search and acquisition phases are necessary steps, but are not sufficient to make the entire M&A transaction a success1. Integration takes time and it is painstaking – this is where success can once again be spoiled.  Although the speed of integration is often seen as one of the most critical success factors, the ease of integration is underestimated. It is often predicted that change will be faster and easier than what is realistic2.

1 Shelton, L.M., (1988). "Strategic Business Fits and Corporate Acquisition: Empirical Evidence." Strategic Management Journal 9, pp. 279-287

2 Kruger, J., Dunning, D., (1999). "Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments." Journal of Personality & Social Psychology 77, pp. 1121-1134

The changes which took place during post-merger projects of integration usually only scratch a surface. Within next years the organization remains split in two separate groups – the former employees from company A and those from company B. In the beginning of an integration phase, the acquiring company and their management exercise more power, simple because their company is larger in almost every respect - sales, employees, branches and costs1.

Another approach, rather similar, to differentiate the M&A process is described below.  There considered to be four stages: identifying and selecting acquisition candidates; before the closing (target analysis, first contacts, valuation, pricing, deal structuring and negotiations); negotiations with target and shake holders; and the post-acquisition integration. Their enquiry amongst top managers resulted in a list of problems associated with each of these stages.

1.      Identifying and selecting acquisition candidates:

-          finding candidates with a strong strategic fit

-          <

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