Merger and Acquisitions
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Concepts
• Merger is the combination of two or more firm
maintaining the identity of one of the corporation.
• In other words, merger refers to the combination of
two organizations where one new corporation will
continue to operate and other losses its corporate
existence.
• Various enterprises undergo in the process of merger
and acquisitions in order to make some changes.
The main purpose of merger is to obtain economies
in scale in production and operation by combining
resources and providing higher quality of goods and
services. 2
Cont.
• A Merger or Acquisition (M or A) is a combination
of two companies where one corporation is
completely absorbed by another corporation.
• The less important company loses its identity and
becomes part of the more important corporation,
which retains its identity.
• A merger extinguishes the merged corporation, and
the surviving corporation assumes all the rights,
privileges and liabilities of the merged corporation.
• Consolidation is not a merger. Here two companies
loose their separate identities and unite to form a
completely new corporation.
3
Cont.
• Becoming big is the underlying principle behind the
M&A business strategy.
• Every business strives for survival in the growing
era of core competence and globalization (survival
of the fittest).
• M&A means the change for a business and the
underlying principle is 2+2=5.
• The joining or merging of two companies create
additional value which is called synergy value.
4
Cont.
• An acquisition is the purchase of one company by
another company. This can be public or private.
Acquisition can be friendly or hostile.
• Acquisition usually requires to a purchase of a
smaller firm by a larger one and the process of
acquisition is also very complex with many
dimensions influencing its outcome (tax and
regulatory implications).
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Mergers and acquisitions Definitions
Consolidation Merger with Acquisition
Company
A Company
X
Company Company
C X
Company
Company
B
Y
6
Cont.
• Parties to the acquisitions:
– The target company (or target) is the company being
acquired.
– The acquiring company (or acquirer) is the company
acquiring the target.
• Classified based on endorsement of parties’
management:
– A hostile takeover is when the target company board of
directors objects to a takeover offer.
– A friendly transaction is when the target company
board of directors endorses the merger or acquisition
offer.
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Types of Merger & Acquisitions
Horizontal Merger:
• If two or more corporations in the same area of
business(i.e. two corporations are merged across
similar product and services) are merged together,
then it is called horizontal merger.
• It is used as a way for a corporation to increase its
market share by merging with competing company.
• The purpose of this merger is to obtain economy of
scale in production and operation by eliminating
duplication of facilities, reducing competition,
reduction in cost, increase in stock price and
expansion in market segments. 8
Cont.
Vertical Merger:
• It is the combination of two or more organizations
involved in different stages of production or
distribution of the same product.
• In this merger, two corporations are merged along
with value chain such as a manufacturer merging
with a supplier.
• It is used as a way to gain competitive advantage
within market place.
• The purpose of this merger is to increase profitability.
• Vertical merger are of two types, forward integration
and backward integration. 9
Cont.
Conglomerate Merger:
• It is the combination of two or more corporations
completely engaged in different line of business.
• It is used as a way to smooth out wide fluctuations
in earnings and more consistency in long run
growth.
• The main purpose of this merger is to minimize the
risk
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Motives for merger
• Synergy
• Growth
Creating • Increasing market power
Value • Acquiring unique capabilities or resources
• Unlocking hidden value
• Exploiting market imperfections
Cross- • Overcoming adverse government policy
Border • Technology transfer
• Product differentiation
Mergers • Following clients
• Diversification
Dubious • Bootstrapping earnings
•
Motives •
Managers’ personal incentives
Tax considerations
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Copyright © 2013 CFA Institute
• Becoming big would make you powerful (although
small is beautiful).
• Survival of fittest.
• Synergy value in terms of revenues, expenses, cost
of capital etc. cost can be reduced by eliminating
redundant services in HR, Accounting, IT etc.
• Strategic reasons such as positioning, gap filling,
organizational competencies (through intellectual
capital and innovative ideas).
• Broader market access and risk diversification.
• Improve financial performance through economy of
scale and scope (expansion) as well as through tax
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• Banks can become more stronger through increased
earning capacity, better staff, strengthened capital
base and wider branch network.
• Managerial motives include status, power, empire
building, remuneration, hubris etc.
• Other third party motives are advisors, lawyers,
accountants, regulators etc.
• Suppliers and customers also promote mergers for
their benefits.
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Benefits of Merger & Acquisition
• Reduction in Cost: Corporate resources such as
production facilities, management functions and
management systems can be utilized for large scale of
operation that help to reduce costs.
• Economy in Functional Area: A merged firm can avoid
overlapping functions and consolidate its functional areas
such as manufacturing, marketing, finance, human
resources that help to reduce operational costs of these
functional areas.
• Creation of Synergistic Effect: Synergy refers to the
situation where the merged firm is more valuable than the
sum of individual firms. The managerial capabilities,
creativity and innovativeness enhances merged firm to14
Cont.
• Increase in Market Share: Through M&A, firm
facing problem can increase their market share
merging with large firm.
• Transfer of Resources: With M&A, all the
resources along with technology transferred from
one firm to another firm that increases the
competencies and help firm to get competitive
advantages.
• Benefits of Cross Selling: Mergers and acquisition
involves the benefits of cross selling. Conglomerate
merger provides the benefit of cross selling.
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Problems of M &A
• Difference among shareholders
• Problems in human resource consolidation
• Problems in establishing cultural value
• Problems with top management
Issues concerning M&A in Nepal
• Less confidence among domestic enterprises
• Complex regulation
• Discrepancies in assets valuation and tax incentives
• Legal and tax perspective
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Estimation of Merger Gain & Cost
General Cash & Stock Offer
Economic Gain: The economic gain refers to difference
between value of combined firm and the sum of value of
individual firm. The merger only takes place when there is
economic gain. Thus,
Gain = Annual
PVxyreduction
– (PVx in+costs
PVy) or
Gain = Opportunity costs
Estimating Costs: General Cash Offer
• If the acquiring company offer cash to the acquired company,
then it is known as general cash offer in M&A.
• The cost of acquisition is the difference between cash paid for
acquisition and value of acquired firm as separate entity.
Thus, 17
Cont.
NPV of M&A: It is the difference between economic gain and cost of
merger. The M&A is synergetic only if the NPV is positive. Thus,
NPV= Economic Gain – Cost
Estimating Cost: Stock Offer
• If the acquiring company offer stock to the acquired company to pay
for acquisition instead of cash then it is called general stock offer.
Under stock offer, the cost of merger is determined by the value of
shares in new firm received by the acquired firm’s shareholders.
Cost = N × Pxy – PVy
Where,
N = no. of shares in combined firm
Pxy = price per share of combined firm
PVy = value of acquired firm as separate entity
or, Cost = x × PVxy – PVy
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x= fraction of combined firm’s shares
Strategic Stock Acquisition and Ratio of Exchange
• With a financial acquisition, the underlying idea is to
sell of assets, cut costs, and operate efficiently to
generate higher value than it paid.
• In a strategic acquisition, one company acquires
another as a over all part of strategy resulting into cost
advantages or increase in revenue that arise from
product extension or market dominance of target
company.
• Strategic acquisitions involves both cash and stock
acquisition. Stock acquisition calls for determining
the exchange ratio that indicates the relative value of
the both companies with respect to their earnings and 19
Cont.
Under earning effect, the exchange ratio can be
calculated as follows:
Exchange ratio= MPS offered to acquired firm
MPS of acquiring firm
Under market value effect, the exchange ratio can be
calculated as follows:
Ratio of Exchange = MPS of acquiring firm × Number of shares offered
MPS of acquired firm
MPS = P/E ratio x EPS
EPS = Net income/ No. of shares outstanding
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