Mergers and Acquisitions (M&A) have been an ongoing phenomenon since the industrial revolution by occurring in cyclical patterns, ‘known as merger waves’. Started in between 1897 to 1904, the international market has seen an unprecedented economic revolution over the seven merger waves till date. With every merger wave, the world economy has encountered the level of enhancement in the infrastructural facilities. From the emergence of heavy industries such as ‘primary metals, petroleum products, chemicals transportation equipment, fabricated metal products, machinery and bituminous coal’ along with the establishment of food manufacturing industry in the first merger wave till the recent mega boom led by the high technological advancement, the world economy has seen it all (P A Gaughan, 2002: p23). And even though research and historical events such as the ‘RJR Nabisco, the attempted merger between Volvo and Renault in 1993, Unum Insurance and Provident insurance in 1999, dramatic failure of AOL and Time Warner, Daimler-Benz and Chrysler, eBay and Skype, to name a few, affirm that less than 50% of mergers and acquisitions succeed, M&A has been a crucial part in corporate finance and also is an ‘essential tool for its growth and development’( Ching, 2018). From filling in the ‘capabilities gaps caused by limited access to strategic resources’, to entering into a new market, from exploiting economies of scale to improve competitiveness and efficiency, to diversification into fast growing market, there are different forms of M&A that take place due to various purposes within in the organisation either in relation to operational motives (cost and revenue synergies) or non-operational motives (finance, tax and management synergies). Mergers, usually between companies of similar sizes and acquisitions, usually between a larger companies acquiring a smaller company promotes exponential growth in the economy. Thus, the increased competition in the global market demands the companies to perform and stand out domestically as well as internationally, making mergers and acquisitions a strategic choice.
The major motive behind any merger and acquisition is “synergy”, ‘the concept that the combined value of two companies would be greater than the sum of the separate, individual companies due to the enhanced cost efficiencies of the new business.’ (Katherine, 2018; p3) However, there are various motives for M&A which can be loosely categorized into; ‘Strategic Motives, Financial Motives and Organizational Motives.’ While for any profit motive organisation, financial aspect is the key to success, closely linked with the ‘investment of surplus funds, higher market capitalization, reducing costs, tax planning/tax benefits, revival of sick units, increasing EPS and creation of shareholder value’, this article will only explore the strategic and operational aspects behind the M&A activities.(Raghunandan,2010). The transactions between ‘Kraft and Cadbury to establish global market leadership in confectionery and access emerging markets’, Google acquiring Motorola for valuable smartphone patents and control over other technologies, the merger of Santander and Abbey to ‘enter new market (UK) for further acquisitions to build market shares’, HMV buyout of MAMA for ‘diversification into fast-growing markets & reduce reliance on retailing’, Tata acquiring JLR to gain ‘economies of scale, expertise, brands, capacity and distribution’ are some of the many examples of the strategic and operational motives of M&A which will be further elaborated below.(Riley, 2012) Touching a base with relation to the motives, theories and synergies of M&A set out by Raghunandan, B.V, the article will distinctively explore the operational and strategic synergies. Additionally, the article further intends to evaluate the different forms of takeovers identified by Ravi M Kishore and analyse the advantages and limitations associated with each of the approaches of the takeover. Subsequently, the various forms of takeovers either cross border or conglomerate in relation to relatedness, size, integration, location and timing will be further explained with reference to Coley and Reinton’s ‘The Hunt for Value (1988), dimensions of merger segmentation.
Strategic and Operational Motives of M&A
Referring to a journal from a corresponding author, Pradeep Kumar Gupta, the approach behind the M&A activity with regards to the strategic motivations as identified by (Raghunandan, 2010), are ‘growth, scale of operations, competition, increase in market share and acquiring size, backward and forward integration, synergy, core competence, diversification, reduction of risk, balancing product cycle, management of recession and entry into new markets/new segment.’ With the increase in globalization there has been an impeccable impact in nature and intensity of the competition around the globe, promoting mergers and acquisitions not only on a national level but also in a global platform. The increase in the ‘cross-border activities accounts for one quarter up to one third of the total transaction volume in worldwide mergers and acquisitions.’ (Kleinert and Klodt, 2001: pp.9-10). In the year 2015, the global M&A held a record by surpassing the volume of $5 trillion(tr) for the first time ever with global cross-border M&A activities reaching a volume of ‘$1.56tr (via 9,490 deals) up from $1.09tr in 2014 and the second highest on record behind 2007 ($1.79tr)’, (Dealogic, 2016). Thus, acquiring capabilities and competencies such as know-how, brand and technology, being able to ‘tap into new markets and customers or sustaining in the existing market’ by improving efficiency and maintaining economies of scale are some of the strategic choices organisations consider while entering into M&A.(Cogman, Jaslowitzer and Rapp, 2015). For example, ‘Google’s takeover of Motorola Mobility in 2011 to gain access and control of a wide variety of patents and other technologies to enable it to support the Android operating ecosystem against Apple and Microsoft/Nokia’,(Riley, 2012), is an illustration of the leading companies thriving to sustain in the market with a competitive advantage. Similarly, the failure of ‘Lenovo's acquisition of IBM’s PC division as a result of the integration issues, substandard services and the exodus of technical employees’ led the Chinese companies to start ‘using overseas takeovers to strengthen the company's position in China, rather than in foreign markets. Instead of acquiring foreign brands, sales networks or goodwill, they would acquire know-how and technology’ to increase their market power and ‘enhance the management of resource dependency’, (Valentina 2015). Moreover, as per Wheelen and Hunger (2001), strategic motives such as integration and diversification can be further classified into concentration strategies (vertical and horizontal integration) and diversification strategies (concentric and conglomerate diversification). As a dominant impact of the ever growing core competency, companies intend to grow vertically in the value chain from extracting raw materials to manufacturing to retailing, known as vertical growth such as the takeover of Pixar Animations Studios by Walt Disney in 2006, and horizontally, around the same location in the value chain either by expanding their product lines or into other geographical location increasing the range of products and services offered to current markets, known as horizontal growth. The integration of Facebook, WhatsApp, Instagram and Messenger is one of the best examples of the horizontal growth in the present times. Similarly, companies seeking growth in the foreseeable future also tend to grow into a related industry with the goal of synergy often referred to as concentric diversification. ‘Coca Cola’s acquisitions of Vitamin Water, Honest Tea, Fuze Beverage and Core Power to provide brand recognition in new categories’ (Wright, 2013) and the ‘addition of tomato ketchup and sauce to the existing "Maggi" brand processed items of Food Specialties Ltd’ are some of the examples of concentric diversification (Thayumanavar, 2016). Another type of diversification is in between the unrelated industry or a conglomerate diversification such as Tata Group, Samsung, and General Electrics, which has a large number of diversified businesses.
Along with the strategic choices that the companies make in relation to M&A, organisational motives are often interlinked with the management decision. With a vision to gain economies of scale through cost and revenue synergies, companies often tend to aim to retain management talents, remove inefficient management, improve the quality of management and emerge as a conglomerate or a diversified business in the long run either to better use the complementary resources or due to the entrepreneur’s personal compulsions. Operational motives also termed as organisational motives or managerial motives are an integral part of the decision making process while entering into a new merger and acquisition contract. As Campbell and Goold (1998) identified, companies save a lot of money by sharing tangible assets and by combining their purchases and different units, they tend to gain a bargaining power and a greater leverage over suppliers, improving the quality of goods they purchase and the coordinated strategies that align to overcome the competitive threat in the market. The historic merger of 1998 between the two giant oil producers in the US, Exxon and Mobil Corp created a ‘superpower’ in the oil industry with consistent low prices and thus the energy company still dominating the market is one of the most successful mergers in history. Linking back to the prior example, Facebook’s acquisition of Instagram in 2012 was also a brilliant play for the company that has dominated the virtual market today. It is thus important to note that the culture and business approach within the merging companies plays a significant role in merger success. The epic merger failure between Unum insurance and Provident insurance, both market leaders in their own portfolios, as a result of the critical differences in the two firms business model is an evident example of how things could go wrong. Moreover, managerial motives can sometimes be ‘focused on the self-interest of the managers and not necessarily in the interest of the shareholders’ (Johnson, Whittington & Scholes, 2011). The preference of some managers in relation to the size of the company and the power and prestige they could behold by sealing the particular M&A deal, more than the actual performance of the company, may lead them to enter into contracts without proper due diligence and inadequate integration planning. Primarily based on the personal interest, ego and goals of the top management, often referred to as ‘empire building’, such deals are generally bad news for the shareholders and often results in significant decline in the shareholders’ value. For example, the cultural clash in the automotive giant Damien Chrysler (worth $37 billion) in 1998 between the “efficient, conservative and safe” approach of Daimler with the “daring, diverse and creating” model of Chrysler led Daimler to sell Chrysler in 2007 for only $7 billion and this was all due to the poor due diligence and lack of integration planning.
Forms and Features of takeovers
In addition to benefiting from cost, revenue and financial synergies through consolidation, takeovers also create more competitive entities who are not capable of growing their own brand by simply purchasing another company brand. Moreover, for companies who do not necessarily want to take risks and believe in the better approach of playing safe and efficient, takeovers play a vital role without having to take on the risk, time and expense of starting a new division. And even though takeovers involve high costs, tedious paperwork, integration issues, cultural clashes and the ultimate risk of failure, ‘a well-executed takeover can take a CEO’s career to a higher level’,(Types of Takeover (Corporate) – Definition, 2020), inviting accelerated growth to the business . Nevertheless, there are different kinds of takeovers companies get involved in. As Ravi M Kishore explained, companies can involve in mergers and acquisitions ‘on the basis of lines of business activity such as horizontal, vertical and conglomerate, on the basis of bid of controlling interest ; friendly, hostile and bailout takeovers and on the basis of strategic transactions based on strategic, financial, reverse, downstream, upstream, de facto, cash and short form decisions.’(Kishore, Ravi M.,: 2009, pp. 1067-1096). While the previous section touched some base on the horizontal, vertical and conglomerate forms of mergers, takeovers on the basis of controlling interest are usually registered through the purchase or exchange of shares to an extent to gain control over the target company.
Friendly takeover means an acquisition where both the acquirer and target company willingly negotiate and approve the bid. Stated differently, the management of the existing promoter is informed by the prospective investor ‘about their intention to purchase the company, and the management approves the set purchasing terms’ which is also referred to as negotiated takeover. The friendly takeover bid of Aetna by CVS Health Corp in December 2017 is a relevant example of the resulting company benefiting from the significant synergies of combined capabilities. Contrary to this, a hostile takeover is more of an aggressive and dominant approach whereby the acquiring company unilaterally pursues the acquisition without the consent of the target company. The target company unwilling to agree on the takeover bid, either due to the dissatisfaction in the bid price, undermined company’s prospect and potential or simply not supporting the idea of takeover is persuaded by the acquirer using various tactics, that even with management resistance, acquisition takes place anyway. Hostile takeover can be conducted in several ways, however the two most common strategies acquirers use are tender offer and proxy vote. A tender offer is when the prospective investor makes a public offer to purchase shares of the target company at a fixed price above the current market price, whereas a proxy vote is when the acquiring company persuades the shareholders of the target company to vote out the existing management. In addition, ‘the acquiring company may also decide to make an offer directly without giving the management time to make a decision. This kind of acquisition is what is called a hostile takeover’ (Types of Takeover (Corporate) – Definition, 2020). An example of this type of takeover is when the pharmaceutical giant, Sanofi-Aventis was forced to offer significantly more than the valuation of Genzyme in order to exert control, after Genzyme’s board of directors had issued a unanimous ‘’no’’ verdict. Unlike regular M&As with motives to achieve market power and synergy, bailout M&As on the other hand are resorted to bailout the sick companies, ‘where the government or financially stable company takes over the control of the weak company’ (Bailout Takeover - Understanding How Bailout Takeovers Work, 2020), to allow ‘the company for rehabilitation as per the schemes approved by the financial institutions’ with the goal of helping the latter regain its financial strength (Kishore, Ravi M.,2009, pp. 1067-1096). The rescue of Bear Stearns in the USA following the 2008 crisis, the establishment of Troubled Assets Relief Program (TARP) fund of $700 billion to fund large US companies as a result of subprime mortgage crisis and the recent £1.25 billion bailout plan for venture capital businesses impacted by the Covid-19 crisis in the UK are some of the historic examples of bailout takeovers in the financial industry. Additionally, takeover based on strategic transactions such as downstream, upstream, de facto, cash and short form decisions are likely to occur in between parent and subsidiaries.
Moreover, it is important to note that the above mentioned forms of takeover can occur in any of the either dimensions; horizontal, vertical or conglomerate, depending on the characteristics of the companies involved. Based on a scholarly research summed up by Pondbridge Ltd, ‘relatedness, relative size, horizontal vs vertical, location, Acquisition Purchase Premium (APP) overpayment, hostility and timing in the cycle’ have been identified as the seven salient dimensions in the merger segmentation analysis. In an illustration of the two merger segmentation; business combination type (relatedness) and APP size, Coley & Reinton explained the transition of merger success rate is high when the takeover is between large to small unrelated business as the ‘relative target is easier to understand and integrate’ (Pondbridge Ltd, 2012-2013).The success rate is further improved if small unrelated businesses target potential acquirees in the closely related industry with the same business model. However, it is important to note that M&A success is most probable if the approach to the business model within the companies is similar. For example, HP’s engineering driven culture based on consensus was a poor cultural fit to the sales-driven Compaq culture of rapid decision making, resulting in a loss of an estimated 13 billion dollars in market capitalisation and thus the company had to make significant cultural and leadership changes for the long-term success. Similar to the notion of relatedness, the relative revenue size is another important segment to consider while making hostile acquisition. Given the difference in market value and size of the prospective buyer, it is important to weigh the advantages versus cost, while pursuing a relatively smaller target company. As Azofra et al. (2007, 5) mentioned, ‘those operations in which the size of the acquiring company is much greater than the acquired company’s also show greater returns.’ Notably, such deals are more prominent when the acquiring company is aiming for exponential growth and low risk. The acquisition of DollarShave Club by Unilever, Sekindo by Universal McCann and MyRoll by AVG are some of the stories of smaller companies bought by major names.
Correspondingly, based on the theories set out by Ansoff matrix, Porter's generic strategies and economies of scale, horizontal takeovers are mainly focused on achieving economies of scale and increasing market share whereas, the main purpose of vertical integration both backward and forward is reducing costs. The underlying sense of the latter is ‘depicted by the authors in far less positive terms, as a means of avoiding "market failure”’ and beliefs that set out horizontal business combinations being more successful as its purpose is ‘unambiguously linked to superior performance’ (Ingram et al.,1997,p.197). Contrary to this, another area of diversification that companies seek is in relation to geography. Location plays an appealing role while making takeover decisions by attracting companies in foreign markets as a result of reduced cost, better growth opportunities, less government regulations, diverse market, brand influence and many more. However, in an attempt to diversify and capture a larger market, companies often tend to conceptualize the ‘grass is greener on the other side’ error and suffer from post-merger implementation (PMI) challenges as in the case of NatWest’s acquisition of idiosyncratic Gleacher in 1995 which contributed to its loss of independence and was acquired by RBS in 1999. Furthermore, it is very important to note that merger success is not when the deal is consummated, rather the success or failure is reflected when the shareholders of the acquiring firm experience an improvement in its financial returns. As Clark explained in the merger valuation analytical method of Value Gap (VG), for a deal to be successful, ‘PMI improvements in the new combined company referred to as ‘’Net Realisable Synergies’’ (NRS) should be greater than the APP paid’ (Clark, 2013). Moreover, the APP is also closely related to the timing in the merger wave and influenced by company’s hostility decisions or hubris CEOs. In other words, ‘perceived late phase deals increase the prospect of merger value destruction as eager acquirers overestimate synergies in late periods in order to meet the heightened APP requirement of sellers as the business-merger wave approaches collapse’ (Rhodes-Kropf and & Viswananthan, 2004). The case of Imperial group in 1980 when it paid double the market price to acquire Howard Johnson (HoJo) in order to diversify its business and expand geographically is a prominent example of how over-estimating synergies and lack of market knowledge can lead to the merger failure.
Benefits and Drawbacks of various forms of takeover
So far, we have briefly discussed the strategic, operational and financial motives that lie behind the M&A activities along with the different kinds of takeovers and dimensions of merger segmentation. As the objectives suggest, M&A adds both strengths as well as weakness in an organisation and each form of takeover has its own benefits and limitations. Basically, friendly takeovers enable dynamic firms to turn inefficient firms into more efficient and profitable through economies of scale, shared knowledge and investment opportunities. Stated differently, the takeover generally made via public offer of cash or share, premium per share, shareholder’s approval and regulatory approval are substantially beneficial for both the bidder and target companies as compared to the hostile takeover as ‘it ensures better design of the deal and value delivery to the participating parties’. As the bidder incurs all the reasonable costs associated in the acquisition, target companies in the negotiated takeover deal ‘do not incur costs or erase its value as a result of employing defense mechanisms to prevent a hostile takeover’. This in turn results in the growth prospects and potential synergies for the target company. For example, the acquisition of WhatsApp by Facebook in 2014 is an execution of friendly takeover whereby, ‘WhatsApp retained its brand and continued functioning, as the company’s operations remained independent from the operations of Facebook and additionally WhatsApp’s co-founder and CEO Jan Koum obtained a seat on the board of Facebook’, (Friendly Takeover - Overview, Components, and Advantages, 2020). Correspondingly, according to the Financial Industry Regulatory Authority, hostile takeovers have the potential to improve stock prices for both acquirers and targets. With an aim to ‘secure access to natural resources such as raw materials and energy’, expand in new markets, ‘improve efficiency by accessing production assets such as labor at relatively lower cost’ and benefit from the synergic effect, hostile takeovers result in increased revenue, enhanced efficiency, and lessened competition in the market. (Cogman, Jaslowitzer and Rapp, 2015). Attracted by the strong performance of Cadbury even in times of economic crisis, Kraft’s transformational takeover was the final piece in its strategic jigsaw, making it one of the market leaders in the fast-growing confectionary and snack market.
Conversely, takeovers usually involve very high costs and the process always comes with disruptions annoying the clients and customers involved. In addition to the high premium price, friendly takeovers are subject to regulatory approval. In other words, even if the buyout term is approved by both the parties involved, a rejection from the regulators and shareholders will mean that the deal did not go through. Regulatory rejections are subject to the factors such as putting the new company in a monopolistic position. ‘Since takeover involves new management assuming control over a target company, there is some element of incompatibility in terms of management styles, structure, and culture’ (Types of Takeover (Corporate) – Definition, 2020), often resulting in integration issues and delayering due to overlapping functionalities. Moreover, the ‘lack of international experience and insufficient knowledge of overseas commercial and legal environments’ can be a great challenge for the cross-border mergers and acquisitions (Ping, 2018). Additionally, since hostile takeovers are un-welcomed by the target company, it can use various defense mechanisms such as poison pill, golden parachute, macaroni defense, scorched earth policy, staggered board of directors, supermajority, dual-class stock, greenmail and white knight defense in order to avoid the takeover bid. For example, Airgas Inc’s attempt to deter the acquisition by Air Products & Chemicals Inc. using a defense strategy of poison pill turned out to be successful for the company. Notably, these types of defense strategies can create a situation of war between companies and leak confidential information of the target company.
Contrastingly, unlike friendly and hostile takeovers, bailout takeovers help to ‘turn around the operations of the target company without liquidating its assets. By developing a rescue plan and appointing a manager to spearhead the recovery while protecting the interests of the investors and shareholders, bailout takeovers are beneficial for those whose collapse of bankruptcy would be detrimental to the industry’ or economy as a whole. However, such takeovers promotes the concept of moral hazard creating a sense of doom in the economic environment. Further, it also discourages competition which ultimately can be harmful for the economy. (Bailout Takeover - Understanding How Bailout Takeovers Work, 2020).
Conclusion from Analysis
To summarise, technological change, core competency, competitive advantage, investment in emerging economies, market share, product development, market development, market penetration, access to wider network and diversification are some of the key strategic drivers of M&A activity. In order to improve productivity and profitability and to achieve cost, revenue and financial synergies through combined resources, companies focus on improving and developing the business by making the best use of the available financial resources. With a motive to extend the customer base and business activity, change competitive structure and improve business capabilities or to achieve personal ambitions and gain financial rewards, companies can involve in M&A activities to strengthen its market position in various ways. Using different approaches either via negotiation or persuasion, businesses acquire other companies either in the same industry, along the value chain or in diversified industries. Based on the dimensions of merger segmentation, takeovers are often influenced by factors such as relatedness, organisation size, geography, premium price and industry shocks. The takeover of Kraft and Cadbury as mentioned above is a form of horizontal hostile takeover and the takeover of AOL over Time Warner is an example of vertical hostile takeover. Similarly, the takeover of Crucell by Johnson and Johnson is an example of vertical friendly takeover and the takeover of YouTube by Google is a live example of conglomerate integration. While it is noted that mergers and acquisitions reduces risks, enables efficiency, overcomes barriers to entry and promotes revenue growth and cost saving opportunities, the involvement of high costs, problems in valuation, cultural clashes, questionable motives, job losses and diseconomies of scale cannot be neglected. And while bailout plans by the government or financial institutions strengthen weak companies to regain their financial capabilities, it creates a sense of moral hazard in the economy promoting rash decisions. Thus, even though mergers and acquisition are an essential component of economic growth, going beyond a normal limit can be harmful for the economy giving rise to monopolistic markets, price wars and unhealthy competition.
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