Corporate Finance Environment - Essay Example

and Section # of INTRODUCTION: The current recessionary period that has engulfed most part of the world, has had its implications on the businesses all over. Some of them have suffered massive losses and others are thriving. In short, there are beneficiaries as well as beneficiary as well as losers in this deal. Recession has also triggered some of the most important mergers and acquisitions of recent times. The success rate of these mergers or acquisitions is questionable relating to different cases. Also, vertical mergers may occur when the organizations are feeling the heat of decreased gross profits due to lower revenues; they may acquire vertical firms in the supply chain to decrease costs. However, there are a number of reasons why mergers and acquisitions have been triggered in the recent recession of the economic cycle. Also, one needs to understand how and when the bid price is set. Since both the parties in the deal want to safeguard their interest in the deal whether it is a merger or an acquisition, they would want to reduce costs as well as increase profitability of the venture. Therefore, a dilemma occurs at reaching a consensus of the bid price. There are various methods of financing as well (Deepak, 1990). This paper provides a brief overview of mergers and acquisitions, outlining the major characteristics of these activities. The implications and reasons for this increase in mergers and acquisitions will then be discussed keeping in mind two important examples; the acquisition of Cadbury by Kraft and the merger of British Airways and Iberia of Spain. Furthermore, this paper also defines the major ways through which these acquisitions or mergers are financed and how the concerning parties have been able to come to a consensus on a bid price; providing a solid conclusion in the end. MERGERS AND ACQUISTIONS Mergers and Acquisitions are a very important part of corporate finance. Throughout the history, organizations have merged together to form bigger ones so that they are able to leverage out their revenues and decrease costs through various means. Usually, these deals involve huge amounts of money; as they are instrumental in shaping the future of the firm which is being formed as a result. However, there are various implications of these actions which shall be discussed (William, 2007). In the science of mergers and acquisitions, one plus one makes three. This equation may not hold true in mathematical circumstances but it sure does in the science of financial options. One of the major rationales behind such corporate actions is to allow the value creation above and beyond the value that the two separate companies were providing their stakeholders; a synergy should be created that is more than the sum of its parts added. This can be termed as a driving force for either a friendly merger or a forced acquisition. This rationale increases three-folds during times of recession; as companies start losing their value, they might group up with similar companies to gain a bigger market share, or strong companies may buy out their struggling counterparts in a cost efficient manner (Micheal, 2001). Mergers and Acquisitions, though used simultaneously, are very different in nature. When a company takes over another company and develops itself as the owner of the other firm, it is an acquisition. Acquisitions might be friendly as well as forceful. Another way to explain an acquisition is that the buyer company consumes the selling company and integrates both the businesses together. The selling companies do not exist anymore; the buyer’s stocks continue to trade in the market (Jeffery, 2001). On the other hand, a merger is the joining together of two comparable (in size) businesses in order to take advantage of a bigger firm in the market. The stocks of both the companies are dissolved and a new stock is issued of the resulting company. However, usually, mergers of equals don’t happen in reality; hence some mergers are technically acquisitions resulting in a consensus between the two parties to call it a merger, as the concept of being bought brings negative undertones to the market. M&A-CHARACTERISTICS AND TYPES The resultant of mergers and acquisitions is usually a creation of ‘synergy’; this aspect also serves as the major reasons for mergers and acquisition. For simplicity purposes, mergers and acquisitions will not be referred to as M&A. Synergy allows organizations to increase revenues and decrease the costs associated with the business; through staff reductions, increasing economies of scales as size of the company increases, through acquisition of new technology that may result in a M&A. It may also increase the market visibility of the resulting firm, which is equally important as they have a better chance of raising capital and increasing marketing and sales opportunities. A dilemma that exists in the real world is that a M&A may not result in synergy creation. It is a theoretical concept which may not hold true always. When such a disaster happens, the concerned stakeholders develop a perception of increased shareholder value. However, market fundamentals then force the company’s share price to go down. There are many types of mergers and acquisitions; there are few which are distinguished by the relationship of the two companies which are merging, there are few which are distinguished by the way they are financed. By relationship, there are vertical mergers when a company buys a supplier or a customer, example an FMCG acquiring a distribution company. There is a horizontal take over when companies competing against each other in similar markets. Then there are conglomerates in which two entirely different companies merge together. Through methods of financing, there are purchase mergers which happen when one company purchases another company. In such deals, the companies which are acquiring other companies, prefer this kind of acquisition; as this allows them to enjoy a tax benefit in accounting. When purchase occurs, the assets of the purchased company can be written down at the purchased price and any difference between the purchase and the book value can be depreciated annually, providing a consequent tax benefit. In the case of Kraft acquiring Cadbury, Kraft will be able to enjoy tax benefits on the basis of difference between the net asset value. With consolidation mergers, a new company forms and the companies which were involved are now one entity. M&A: RECESSION TRIGGERS M&A ACTIVITY The recessionary period that the world is engulfed in, will greatly affect the number of mergers and acquisitions that are taking place. It is understandable that some organizations will be severely hit in times of recession. Due to lowering revenues and increasing costs, as consumerism goes down, the organizations are bound to face tough times in recession. Under such circumstances, it is becomes impossible for some organizations to sustain at their current level. Mergers and acquisitions are considered an easy way out in this scenario. As it is said, mergers and acquisitions are supposed to create synergies of higher level so that it adds value to new organization. However, the success of M&A is subjected to the actual increase in shareholder value, and not the perceived increase (Samuel, 2004). Size has become an important variable, to survive in recession times today. It has been observed that organizations need a considerable size to sustain operations in front of multinationals operating in their industry; else they will be swallowed by competition. To ensure that organizations survive business today, they are merging with other related or competing organizations in order to increase their leverage in the market that comes from increased market share (Barry, 1992). Also, the general increase in business failures due to recession pave way for acquisitions and buy-outs in order to rescue the firm from bankruptcy; leverage buy-outs can become the ultimate rescue tool for some. Although, the success of the buy-out depends upon the buyers financial and management competency that may help the organization to come out of trouble and become leverage for the organization (Mike, 2010). With the help of research, it was accessed that during the last recessionary period of the 1990s, major re-structuring took place in organizations. According to Mark Wright, 64% had new directors appointed, and 34% had problems with their cash flows before they were bought. All in all, it is evident, that recessionary period activates activities that take place to save the organizations from bankruptcy, increase the leverage by increasing size, taking up organizations in trouble etc. All this is done through different types of mergers and acquisitions (George, 1990). The paper will now discuss the two important happenings of the corporate world; the acquisition of Cadbury by Kraft and the merger of British Airways with Iberia of Spain. M&A- CASES AT HAND: a) Cadbury’s and Kraft With this acquisition, Kraft will be become the No. 1 confectionary company The acquisition of Cadbury and Kraft is a competitive buy-out between two consumer good organizations; they specialize in confectionary and packaged goods. This provides them with an advantage, of pooling in their human resources together so that they are able to build leverage for the organization. However, there have been issues relating to this acquisition. Firstly, according to a study, M&A of this scale are not known to develop synergy for the organization. According to the research conducted by RHR International, 70% of acquisitions of this sort fail to develop the expected results (Guy, 2010). There are other iconic issues related to this acquisition as both the companies hold iconic positions in their respective markets and countries. This acquisition can be considered a purchase buyout, where the organizations will be sharing their resources and their expertise so that the total firm has a significant position in the market place. With this acquisition Cadbury will become the world no 1 in confectionary business; this will help them merge their marketing/management resources and take advantage of the leverage that the resulting company will create (Munya, 2010). It is also being said, that Kraft is paying a 40% premium to Cadbury shareholders to make this deal work; this is a cause of concern for Kraft shareholders. Warren Buffet, a 10% shareholder of Kraft, has recently said that he will vote against this Acquisition (Guy, 2010). The basic leverage that these organizations can work on is working on the talent that both have, as they were leaders in their respective countries (Barry, 1992). Also, with their increased market share, Cadbury and Kraft will be dominating the confectionary industry, increasing economies of scale and increasing barriers to entry for other organizations to jump into the industry. (Gunter, 2005) When it comes to financing, Kraft is feeling the heat from its investors is it is paying a premium of over 40% to the Cadbury shareholders in the acquisition; therefore, it has become a fight of finance and not brands (Renee, 2009). Also, Kraft has taken a huge amount of debt to finance this issue; hence they may face problems in this area in the days to come. Analysts have also said that Kraft can finance this deal by selling of its frozen pizza business and some of the securities worth $9.2 billion from its investors (Reuters, 2010) b) British Airways and Iberia Another important British M&A Activity is the friendly merger of British Airways and Iberia of Spain. Under this activity, both the organizations will have to seek permission from the European Commission and their respective shareholders, and the deal is expected to be completed by the end of 2010. Both the organizations will work under their own brand names. The resultant airline will become the biggest in the area to compete with Lufthansa and Air France directly. With the help of this deal too, one can see, that they are creating synergy and expect the size to create leverage for the new organization. Under this agreement, the CEO of British Airways will stay at his position, whereas the CEO of Iberia would become the chairman for the newly formed company (The Transnational, 2010). One of the biggest reasons for this merger, apart from synergy creation, would be cost cutting. Recession and terrorism has struck the airline industry for the worse. With lesser revenues, the airline industry is looking for ways to reduce costs and increase efficiencies. This seems a sensible way for both the airline companies to reduce costs and increase efficiencies as both are working in the same area of the world (Julia, 2009). A sensible deal, it will provide the consumers with more options as routes will be combined, and there should be no increased in fares expected. The British Airways customers can find themselves exposed to greater world locations due to Iberias network. After a lot of negotiations, this deal has finally taken place, as there were issues related to share splitting of the new company which ultimately went into British Airways favour. This merger has been considered as a merger of equals (Dan, 2009). Issues related to the merger of the two airlines were many; a cause of concern for Iberia was British Airways mounting pension debt. However, it is expected that finance will be taken care of in due course of time as for Iberia this would mean increased channeled resources and they would be ready to raise debt to finance this deal. The strategic position that both these organizations will create for themselves will help them in increasing value for the organization. British Airways has also been facing issues related to labor unions in the past and this has come as a breath of fresh air after two years of negotiation (TehranTimes, 2010) Reaching the Bid Price: When it comes to reaching the proper bid price, in theory, it should be simple. The buyer company will access the value of the target company and then analyze if the organization will be able to buy it out at the price that they have reached or a lower price. The target company should be happy with a bid price which is better than their own assessment of their company. However, there are various issues related to the mergers and acquisitions in real life, concerning perceived shareholder value and the right bid price, the division of shares between the share holders of the two companies. When it comes to Kraft and Cadbury, they are facing issues regarding the bid price, as the shareholders of Kraft think that the management is paying a huge premium to the shareholders of Cadbury. They are unhappy with the decision of the payment of 850 pence per share to Cadbury, as opposed to 759 pence before. On the other hand, Cadbury shareholders are fairly happy with the decision as they are making profits. (Reuters, 2010) No such financial issue has been faced by British Airways and Iberia. This shows the difference between a perceived merger which is actually an acquisition (Kraft and Cadbury) when compared to a merger. CONCLUSION In conclusion, I would believe that mergers and acquisitions can become a great tool of either increasing shareholder value or saving organizations from bankruptcy. However, it is not necessary that such M&A will translate into synergy. The strategic importance of M&A will be different from case to case and organizations should rather focus on integrating the culture, the human resource and the management in order to create synergy. All concerned stakeholders should be satisfied for a fruitful merger or an acquisition. BIBLIOGRAPHY Weston, J., Weaver, S. (2004) Mergers and Acquisitions. McGraw Hill Professional Bruner, R. (2004) Mergers and Acquisitions. John Wiley and Sons. Stahl, G., Mendenhall, M. 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