Merging Companies - Essay Example

Omesh Madan Order: 172431 Economics Merging Companies Introduction Mergers and acquisitions are one of the popular topics in business today, since they characterize the new economy, pressure of global competition, development of technology and disappearance of country boundaries. Companies are merging not only to cut costs but also to gain access to new technology, new markets and new skills in order to survive in globally competitive environment. Mergers and acquisitions have had an important impact on the business environment for over 100 years. The first merger wave lasted from 1897 to 1904 with the main motive of monopoly. The second merger wave came in 1916 soon after the First World War. It was a merger for oligopoly. It lasted till 1929. 1940 saw the mergers due to tax relief. The next wave came in the wake of booming economy and rising stock prices and lasted as conglomerate merger from 1965 to 1969. The fourth merger wave was of mega merges from 1981 to 1989 due to expanding economy, technical developments and international competitions. The strategic restructuring wave lasted from 1992 to 2000. It was again due to the expanding economy, rising stock prices, technical developments and globalization. An understanding of the market structure and the consumer behavior along with the motives for merger, the issues involved, valuation matters, the human resource angle and other related subjects will dictate the correct path to mergers and acquisitions. Understanding Mergers and Acquisitions Both mergers and acquisitions are synonymous, however they have different implications. An acquisition takes place when one company takes over another company and becomes the new owner. The target company does not exist thereafter. The buyer runs the business, whose stocks continue to be traded. In a merger, two firms often of the same size decide to become one single new company; it is a merger of equals. In a merger the stocks of both the companies are surrendered and a new company stock is issued. A purchase deal will also be called a merger. If a purchase is hostile and the target company does not want to be purchased, it becomes an acquisition. The various types of mergers are given below. Horizontal mergers. Vertical mergers. Conglomerate mergers. Reverse mergers. Accretive mergers. Dilutive mergers. Why Mergers Happen Mergers take place due to variety of reasons. However it is primarily the growth, which dictates further strategy. A company can grow internally, but it is a slow and ineffective method. A faster method is to merge or acquire. The decisions are taken with the object of maximizing the wealth of the firm's shareholders. The motives for mergers are as given below. Growth Synergy Diversification Eliminate competition. Economies of scale. Acquisition of new technology. Improved market reach and industry visibility. Cutting costs Reducing taxes. Empire building. Oligopolies. Monopoly. Valuation Matters A company aiming to take over a target company must determine the worth of the company being acquired. Both sides will have a different prospect of the worth of the company. Target company will value at higher price. Purchasing company will value at lower price. The following seven steps will help in evaluation. Step 1. Analyze historical performance. Step 2. Forecast performance. Step 3. Estimate the cost of capital. Step 4. Estimate the cost of equity financing. Step 5. Arbitrage pricing model. Step 6. Estimating the continuing value. Step 7. Calculating and interpreting results, calculating and testing results and interpreting the results with in the decision context. Some of the methods that can be used to evaluate the company are as given below. Comparative Ratio. Price/Earning Ratio (P/E Ratio). Enterprise Value to Sales Ratio (EV/Sales). Replacement Cost. Discounted Cash Flow. Balance Sheet Valuation Model. Dividend Discount Model. Making Acquisitions Work A plenty of mergers do not work. The successful mergers are distinguished from failed ones in a number of dimensions ranging from pre acquisition planning to post acquisition integration management. Historical trends show that two third of mergers disappoint on own terms; they lose value on stock market. An analysis of the barrier to success leads to the following points. Flawed Intention Merger initiated only due to booming stock market. Mergers done to imitate others or for the sake of seeking glory. Incompatibility of the top management. Not doing enough homework on acquiring business. Ego- on either or both sides. Misreading your own operational strengths and weaknesses. Time pressure or constraints. Inadequate patience in negotiations. Corporate cultures are different. Mistake to realize the importance of human relation problems. Intense focusing on integration and cutting costs, thus neglecting day-to-day business resulting in loss of revenue. The loss of revenue momentum is one of the reasons for failure to create value for shareholders. Some of the aspects which must be considered towards the achievement of successful mergers are as given below. Detailed integration plans. Clarity of purpose of acquisition. Good cultural fit. A high degree of cooperation between the two companies. Knowledge of the target company. Anticipation of problems. HR Issues The importance of HR in the complete cycle of mergers must not be ignored. This has been the major cause of the failure of mergers in more than two third of the cases. The issues and the implications of HR have been identified for each stage and are given below. Stage 1. Pre-merger. Issues Identifying reasons for the merger. Forming a team leader for the merger process. Searching and selecting a potential partner. Planning for managing the process of merger. Planning to learn from the process. Implications Dissemination process for knowledge and understanding. Leadership needs to be in place. Systematic pre-selection and selection. Cultural assessment. Planning for merger, which minimizes problems at later stage. Planning of training for learning and knowledge transfer. Stage 2. Merger Stage Issues Selection of integration manager. Designing and selection of team. Creating new strategies. Identification and retention of key employees. Managing the change process. Deciding on HR policies. Implications Selecting the appropriate manager. Creating team design and nominating members. Communicating the benefits of merger. Selection and firing of company personnel. Establishing a new culture, structure and HR policies. Stage 3. Solidification Stage Issues Assessment of new strategies and structure. Assessing the new culture. Assessing the new HR policies. Solidifying the leadership and staffing. Learning from the process. Implications Effective leadership and staffing of new entity. Creating and evaluating a new structure. New entity must learn. Assessment revision for molding two cultures. Conclusion Acquisitions are financial decisions that should be consistent with the company's goal of shareholder wealth maximization. Sound and thorough financial analysis should be part of any acquisition. Acquisitions are also strategic decisions that should be consistent with the mission of acquiring company and fit into the overall strategic plan. The 1990's have brought another period of record levels of acquisitions. With increasing pressure on companies to operate efficiently and maximize shareholder value, the necessity of careful planning and evaluation of acquisition opportunities is paramount. Acquisition can take on variety of forms, including mergers, consolidations etc. These may be hostile or friendly. 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