Mergers and Acquisitions have gained substantial importance in today’s corporate world. This process is extensively used for restructuring the business organizations. Some well known financial organizations also took the necessary initiatives to restructure the corporate sector of India by adopting the mergers and acquisitions policies. The Indian economic reform since 1991 has opened up a whole lot of challenges both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for mergers and acquisitions as an important strategic choice. The trends of mergers and acquisitions in India have changed over the years. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy.
The Indian Economy has been growing at the fast rate and emerging as the most promising economy in the world. Be it in IT, R&D, pharmaceutical, infrastructure, energy, consumer retail, telecom, financial services, media, and hospitality etc, there has been a sign of promising boom in the Indian economy. It is the second fastest growing economy in the world with GDP touching 8.9 % in 2010. Investors, big companies, industrial houses view Indian market in a growing and proliferating phase, whereby returns on capital and the shareholder returns are high. Both the inbound and outbound mergers and acquisitions have increased dramatically. According to Investment bankers, Merger & Acquisition (M&A) deals in India will cross $100 billion this year, which is double last year’s level and quadruple of 2005.
India’s merger and acquisitions deal value in year 2010 reached almost US $50 billion which is three times of the deal value last year 2009. There were M&A deals worth about $16 billion in 2009, down from close to US $40 billion in 2008.
Mergers or amalgamation is combination of two or more companies to form as a single new company. In this process no fresh investment is made, however an exchange of shares takes place between the entities. In simple terms, a merger involves the mutual decision of two companies to combine and become one entity. Generally, merger is done between the two entities having similar size.
Varieties of Mergers
Mergers can be of various types. But there are 5 main mergers varieties which are valued most in the corporate world.
Horizontal merger – Two companies that are in direct competition and share the same product lines and markets.
Vertical merger – Two companies which are in the Value Chain.
Market-extension merger – Two companies having same product but different target market.
Product-extension merger – Two companies selling different but related products in the same market.
Conglomeration – Two companies with unrelated business/ industry.
Acquisition means buying the ownership of one company by another company, often as the part of the growth strategy. Unlike in merger, acquisition is generally done by a large company to a small one. Acquisitions can be either friendly or hostile. Like mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhanced market visibility. Acquisition is done either in cash or acquiring the stock of the target company or both.
Distinction between Mergers and Acquisitions
Mergers and Acquisitions are often uttered as one and the same and considered to have the same meaning. But the terms merger and acquisition are two different term meaning.
When one company takes over another independent company and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist and the buyer or the acquirer possesses the full control of the business and the buyer’s stock continues to be traded, then it is acquisition.
Regardless of the type of the strategic alliance they all have one purpose in common. They are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts.
Synergy is the force that is obtained when two or more components meet together to produces an exceptional result which when done solely cannot be achieved. In a business synergy takes the form of enhanced performance, increased profitability and exceptional cost reduction. By merging, the companies hope to benefit from the following:
- Staff reductions
- Economies of scale
- Acquiring new technology
- Improved market reach and industry visibility
Importance of the study
When a company wants to expand, there are various ways its can do. They can achieve the growth either by capturing the market share or by growing through strategic alliances. The main objective of the merger or acquisition is to achieve growth and synergy, economies of scale and capture or expand the market share.
Buzz of merger and acquisition often creates hype in the financial market about the acquirer’s stock price. While most empirical research on merger focus on daily stock return surrounding announcement date, a few studies also look at long term performance of term performance of acquiring firm after merger. essay_footnotecitation"> Not only that, the performance of the company as a whole is also a matter of question mark. Will the company be able to perform better than it is doing or not?
Many firm prior to merger and acquisition have an expectation to create a synergy from merger and acquisition. The main motive behind M&A is to create efficiencies in the business and expansion of the business. But they most of the time ignore the fact that the effect of merger and acquisition has direct correlation with the value of the acquirers company and the stock price. The other problem that is to be considered is the financial risk associated with the M&A.
The objective of this study is to gain the deeper and clear knowledge of the merger and acquisition on the acquiring firm. It also aims at the financial risk that a company may face post merger/ acquisition asa well as the long term performance of the acquirer. The objectives are as follows:
- To examine the effect of EPS myopia on the return of acquiring firms in mergers.
- Evaluate the effect on the stock price of the acquiring company post merger and acquisition.
- Critically evaluating if the shareholders of the acquiring companies experience wealth effect as a result of M&A.
- The expected long term performance of the acquiring firm.
- Study of the financial risk pertaining to the merger and acquisition.
What is the motive behind Merger and Acquisition?
What is the effect on the stock price of the acquirer pre and post M&A?
Does the buzz create the bubble effect on the market or is it long lasting?
What is the wealth effect of the acquirer firm post and pre M&A?
What is the trend of M&A in Indian market?
Drivers of M&A in India
What are the effects of M&A to the competitors?
Effect of the tax to the government post merger and acquisition.
Limitations of the Study
No proper information on the companies is found except for their Balance Sheet and Income Statement.
This study is based on secondary database, so errors in the data could affect the results of the study.
External factors such as economic conditions, regulatory changes etc are not taken into consideration.
An overview of the Study
This dissertation is divided into five chapters. The first chapter deals with the background information, problem statement, objective of the study, importance of study, research question & limitation of the study.
The second chapter deals with literature review. This chapter indicates the theoretical framework of the valuation method of Merger and Acquisition. It shows the detail description of the past research that has been done on the topic and discusses the outcome of the study.
The third chapter deals with the research methodology of the dissertation. It deals with the Research method used for the data and information collection. It includes sample selection/design procedure, data collection and data analysis tools used in the dissertation. In this part assumptions had been made where there is lack of appropriate data and information.
The fourth chapter deals with analysis and interpretation of the financial data that are used to achieve the objectives of the dissertation. This section mainly deals with the findings from the study and also focuses on the analysis and its results.
The fifth and the last chapter of this dissertation present the findings of the study, recommendation of the study to the investors, financial managers & regulators. It also concludes the suggestions for future research.
Review of the Literature
2. Literature Review
Many authors and writers have written lot about merger and acquisition and its impact on the performance of the company as well as on the economy. A great deal of research has been carried out on the performance of the corporations involved in the merger and acquisition. When a company wants to jump start a long term growth or boost up the corporate performance, M&A may seem to be the best option. Yet study after study puts the success rate of M&A lies just between 20% and 30%. A lot of researcher had tried to explain the abysmal statistics, usually by analyzing the attributes of the deals that worked and those that didn’t. What is lacking is the robust theory that identifies the causes of those success and failures. essay_footnotecitation">
2.1 Merger and Acquisition: Conceptual Review
Farlex Financial Dictionary essay_footnotecitation"> has defined ‘A decision by two companies to combine all operations, officers, structure, and other functions of business. Mergers are meant to be mutually beneficial for the parties involved. In the case of two publicly-traded companies, a merger usually involves one company giving shareholders in the other its stock in exchange for surrendering the stock of the first company’
Pratap G. Subramanyam (2005) has stated merger as in the term associated with the integration of one company into another. The merging company should exist thereafter and all its assets and liabilities get legally vested in the merged company. This means that the merger means amalgamation of the assets of the two or more companies to form a new company serving the similar or different purpose.
2.1.1 Recognition of amalgamation (merger) by Indian Statutory Bodies
The Company Act of India does not define an amalgamation or a merger. Therefore, the term are being interpreted as being included in the term ‘arrangement’ as defined in Section 390(b). This is vindicated by the fact that Section 394 talks about arrangement that are in nature of amalgamation of two or more companies. It is possible under Companies Act for two or more companies to amalgamate using the shareholder approval route under Section 293(1)(a) though such route is never adopted. The more appropriate route is to get court order under Section 394 of the Act, which has been specifically enacted to enable amalgamations.
Section 390 This section provides that ‘The expression ‘arrangement’ includes a reorganization of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes, or by both these methods’
Section 394 This section contains the powers while sanctioning scheme of reconstruction or amalgamation.
Under the Income Tax(IT) Act, 1961 Section 2(1B) the word amalgamation in relation to companies means the merger of one or more companies to another company or the merger of two or more companies to form one company so that:
All the property of the amalgamating company or companies before the amalgamation becomes the property of amalgamating company by virtue of the amalgamation.
All liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of amalgamating company by the virtue of amalgamation.
Accounting Standard AS-14 defines amalgamations as those pursuant to the provisions of the companies Act or any other statute, which may be applicable to the companies. Therefore, it applies to all transactions that come under the purview of Section 391-394 of the Companies Act that relate to integration of two or more companies. AS-14 categorizes amalgamation into two categories: (a) amalgamation in nature of merger (b) amalgamation in nature of purchase.
An amalgamation fall into former category if:
All assets and liabilities of transferor company become after amalgamation, the assets and liabilities of the transferee company.
Shareholders holding not less than 90% of the face value of the equity share of transferor company (excluding the shares held by the transferee company), become the equity shareholder of the transferee company by virtue of the amalgamation.
The consideration for the amalgamation, receivable by those equity shareholders of the transferor company who agree to become the equity shareholder in the transferee company, is discharged wholly by issue of shares (except for fractional shares that may be settled in cash).
The business of the transferor company is intended to be carried on by the transferee company.
Acquisition is the mechanism by which companies change hands and through transfer of ownership of share or transfer of control. Acquisition means the purchase of or getting access to significant stakes in a company, often making such acquirer a major shareholder or force in the company.
According to Dictionary of Financial Term essay_footnotecitation"> ‘If a company buys another company outright, or accumulates enough shares to take a controlling interest, the deal is described as an acquisition.’ For example, if Corporation A buys 51% or more of Corporation B, then Corporation B becomes a subsidiary of Corporation A, and the activity is called an acquisition. A single investor may buy out a publicly-traded company; one calls this “going private.” Acquisitions occur in exchange for cash, stock, or both.
Acquisitions may be friendly or hostile; a friendly acquisition occurs when the board of directors supports the acquisition and a hostile acquisition occurs when it does not.
2.1.2 The Acquisition and Takeover Code in India
After the advent of the SEBI, introduced in 1994, there was a concerted attempt at formulation of a comprehensive framework under which acquisition and takeover could be made in existing listed companies. However the takeover code does not apply to unlisted companies and continue to be regulated by the provision of the Company Act. Listed companies are currently governed by the provision of Takeover Code, clause 40A and 40B of the Listing Agreement of the stock exchange and Section 108B and 108D of the Companies Act as regards acquisition and takeovers.
Under the provision of Section 108B, corporate under the same management holding whether singly or in aggrete.10% or more of the nominal value of the subscribed equity share capital of the any other company shall, before transferring one or more such shares, give to the central government an intimation of its proposal to do with the prescribed details. Section 108D provides the similar provision wherein the Central Government can act suo moto of any transfer of a block share in a company. All the Sections under 108 are backed by Section 108G.
Section 108G Applicability of the provisions of sections 108A to 108F.”The provisions of sections 108A to 108F (both inclusive) shall apply to the acquisition or transfer of shares or share capital by or to, an individual firm, group, constituent of a group, body corporate or bodies corporate under the same management, who or which”
(a) is, in case of acquisition of shares or share capital, the owner in relation to a dominant undertaking and there would be, as a result of such acquisition, any increase”
(i) in the production, supply, distribution or control of any goods that are produced, supplied, distributed or controlled in India or any substantial part thereof by that dominant undertaking, or
(ii) in the provision or control of any services that are rendered in India or any substantial part thereof by that dominant undertaking; or
(b) would be, as a result of such acquisition or transfer of shares or share capital, the owner of a dominant undertaking; or
(c) is, in case of transfer of shares or share capital, the owner in relation to a dominant undertaking.
The SEBI Takeover Code brought in several new features into acquisition law which were not present in Clause 40A and 40B. The basic theme of the code is to provide for fair play and transparency in acquisition and takeover but at the same time to ensure that they are not stifled into extinction.
2.2 Differentiation of Merger and Acquisition
In general Mergers and Acquisitions are used interchangeably, but they have a subtle differentiation in there meaning. Weston and Copeland (1992) distinguished merger and acquisition: merger as a transaction between more or less equal partners, while acquisitions are used to denote a transaction where a substantially bigger firm takes over a smaller firm. Their basis of distinguish was the size. But there are other factors apart from size that denotes the differences between merger and acquisition.
Asquith & Mullins (1986) define mergers and acquisitions on basis of share distribution. When two firms merge, shares of both are surrendered and new shares in name of the new firm will be issued. Unlike in merger, shares of the acquiring firm are not surrendered but traded in the market prior to the acquisition and continue to be traded by the public after the acquisition. The shares of the target firm cease to exist publicly.
Motives behind Merger and Acquisition
There are three major motives for the mergers and takeovers: Synergy, Agency, Hubris
Synergy motive means that the sum total return/value from the integration of two or more companies should be greater than that from the individual company. Elazar Berkovitch (1993) suggests that the takeovers occur because of economic gains that results by merging the resources of the two firms. They even concluded that total gains from M&A are always positive and thus can say that synergy appears.
The agency motive suggests that takeovers occur because they enhance the acquirer management’s welfare at the expense of acquirer shareholders.
Elazar Berkovitch and M. P. Narayanan (1993) suggested three major motives for mergers and acquisitions: synergy, agency and hubris. The synergy motive suggests that the takeovers occur because of economic gains that results by merging the resources of the two firms. The agency motive suggests that takeovers occur because they enhance the acquirer management’s welfare at the expense of acquirer shareholders. The hubris hypothesis suggests that managers make mistakes in evaluating target firms, and engaged in acquisitions even when there is no synergy.
Khemani (1991) states that there are multiple reasons, motives, economic forces and institutional factors that can be taken together or in isolation, which influence corporate decisions to engage in M&As. It can be assumed that these reasons and motivations have enhanced corporate profitability as the ultimate, long-term objective. It seems reasonable to assume that, even if this is not always the case, the ultimate concern of corporate managers who make acquisitions, regardless of their motives at the outset, is increasing long-term profit. However, this is affected by so many other factors that it can become very difficult to make isolated statistical measurements of the effect of M&A’s on profit.
The “free cash flow” theory developed by Jensen (1988) provides a good example of intermediate objectives that can lead to greater profitability in the long run. This theory assumes that corporate shareholders do not necessarily share the same objectives as the managers. The conflicts between these differing objectives may well intensify when corporations are profitable enough to generate “free cash flow,” i.e., profit that cannot be profitably re-invested in the corporations. Under these circumstances, the corporations may decide to make acquisitions in order to use these liquidities. It is therefore higher debt levels that induce managers to take new measures to increase the efficiency of corporate operations. According to Jensen, long-term profit comes from the re-organization and restructuring made necessary by takeovers.