UPSCpedia: Economedia: Mergers and acquisitions (M&A)

• Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture.
• An acquisition is the purchase of one business or company by another company or other business entity. While merger occurs when two companies combine together to form a new enterprise altogether, and neither of the previous companies survives independently.
• "Acquisition" usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger and/or longer-established company and retain the name of the latter for the post-acquisition combined entity. This is known as a reverse takeover.
• A reverse merger occurs when a privately held company (often one that has strong prospects and is eager to raise financing) buys a publicly listed shell company, usually one with no business and limited assets.
• The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:
  • Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope: This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.
  • Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.
  • Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
  • Synergy: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts.
  • Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company.
  • Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below).
  • Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.
  • Vertical integration: Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power and each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. Following a merger, the vertically integrated firm can collect one deadweight loss by setting the downstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.
  • Hiring: some companies use acquisitions as an alternative to the normal hiring process. This is especially common when the target is a small private company or is in the startup phase. In this case, the acquiring company simply hires the staff of the target private company, thereby acquiring its talent (if that is its main asset and appeal). The target private company simply dissolves and little legal issues are involved.
• Additional motives for merger and acquisition that may not add shareholder value include:
  • Diversification: While this may hedge a company against a downturn in an individual industry it 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.
  • Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.
  • Empire-building: Managers have larger companies to manage and hence more power.
  • Manager's compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders)..
• The economic history has been divided into Merger Waves based on the merger activities in the business world as:                           
  

  Period	Name	Facet
  1897–1904	First Wave	Horizontal mergers
  1916–1929	Second Wave	Vertical mergers
  1965–1969	Third Wave	Diversified conglomerate mergers
  1981–1989	Fourth Wave	Congeneric mergers; Hostile takeovers; Corporate Raiding
  1992–2000	Fifth Wave	Cross-border mergers (Imp for UPSC)
  2003–2008	Sixth Wave	Shareholder Activism, Private Equity, LBO

• CROSS-BORDER MERGER AND ACQUISITION
• Globalization is creating intense business pressures, and for many firms, the quest to survive and prosper in the global market has become the paramount strategic driver of the accelerating boom in cross-border mergers and acquisitions (M&As)
• Cross-border M&As, particularly those involving large firms, vast sums of money and major restructuring of the activities of firms, are among the most visible faces of globalization.
• The new report examines the impact of cross-border M&As on the structure of global business and discusses the concerns of policy makers.
• There are fears that foreign acquisitions can lead to entire industries falling under foreign control, threatening national sovereignty and technological capacity-building. In industries like media and entertainment, for example, the threat to national culture or identity can be a cause for concern.
• It is important that policies be designed to minimize the costs and maximize the benefits of M&As
• Following are the principal changes in the global economic environment of relevance to cross-border M&As:
  • technological changes (rising costs and risks in R&D, new information technology, etc.);
  • changes in the policy and regulatory environment (trade and FDI liberalization, regional integration, deregulation and privatization programmes); and
  • changes in capital markets.
• There is a perception that M&As do not necessarily add productive assets or new jobs to a country.
• Moreover, M&As often lead to employment loss and can be used to reduce competition and strengthen market power.
• The effects of cross-border M&As can be influenced by policies. Policy matters especially when it comes to the risks and negative effects of cross-border M&As. The most important policy concern is competition policy.

 M&A in INDIA: 

The key steps involved in our M&A advisory role are: 

1. Identification of the business to be acquired
2. Strategic planning of acquisition
3. Identifying key targets locally and internationally
4. Valuation
5. Transaction structuring, and negotiation
6. Advice on financing, be it debt, equity or other more complex instruments
7. Supervising due diligence, legal and other issues to work towards a successful completion