• DhammikaRanasinghe

Mergers & Acquisitions (Takeovers)

Updated: May 8, 2020


Merger or acquisition is only the first step of a long corporate journey. The ultimate goal is to generate faster revenue growth and maximize shareholder returns.

Key objectives of M&A:

· Benefit by way of synergy

· Market share enhancement and create new markets

· Reduce competition (horizontal integration)

· Economies of scale | reduction of cost | maximize profits

· Benefit over corporate tax

· Optimize utilization of capacity/assets

· Optimize efficiency

· Create investment opportunities

· Combining effect of skills/capabilities

There are many instances that mergers and acquisitions fail, destroying value instead of creating it due to poor planning and execution of the post-deal integration phase. Even the best-planned transactions can fail if a systematic and timely integration strategy is not implemented. Hence the transition period immediately prior to closing and the first 3 months afterward are very decisive.

Not all M&A s are the same:

Many deals that, lawyers, consultants and business people concluded together as mergers and acquisitions actually represent very different strategic approaches activities.

Acquisitions occur for 5 key reasons:

1. To deal with overcapacity through consolidation in mature industries;

Many mergers and acquisitions take place in industries that have substantial overcapacity. These tend to be older, capital-intensive business sectors. Overcapacity accounts for 1/3 of the M&A deals.

From the acquiring company's point of view, the rationale for acquisition is being ‘survival of the fittest’. This kind of deal makes strategic sense, when it can be pulled off. The acquirer closes the less competitive facilities, eliminates the less effective managers, and rationalizes administrative processes. In the end, the acquiring company has greater market share, a more efficient operation, better managers, more clout, and the industry as a whole has less excess capacity. Thousands of deals are done with these objectives in mind. Yet, few of these deals have been judged successful after the deal.

2. To roll-up competitors in geographically fragmented industries;

Geographic roll-ups, which appear at first glance to resemble overcapacity acquisitions, differ substantially in part because they typically occur at an earlier stage in an industry's life cycle. Many industries exist for a long time in a fragmented state. Local businesses stay local, and no company becomes dominant regionally or nationally. Eventually, companies with successful strategies expand geographically by rolling up other companies in adjacent territories. Usually, the operating unit remains local if the relationship with local customers is important. What the acquiring company brings is some combination of lower operating costs and improved value for the customers.

Both overcapacity acquisitions and geographic roll-ups consolidate businesses, yet they can be difficult to tell apart except on a case-by-case basis. They vary in some fundamental ways. For one thing, their strategic rationales differ. Roll-ups are designed to achieve economies of scale and scope and are associated with the building of industry giants. Overcapacity acquisitions are aimed at reducing capacity and duplication. They happen when the giants must be scaled down to fit shrinking world markets.

In geographic roll-ups, it's more important to hold on to key employees and customers than to realize efficiencies quickly

To extend into new products or markets;

The third category is the M&A deal created to extend a company's product line or international reach. Sometimes these are similar to geographic roll-ups; sometimes they involve deals between big companies. They also involve a bigger stretch into a different country, not just into an adjacent city.

It is important to know what you're buying. Be aware of the processes that are considered core may turn out to be very different from those used by the target company. Cultural differences and governmental regulation often interfere with the implementation of core processes.

As a substitute for R&D:

Acquisitions as a substitute for in-house R&D, is related to product and market extensions. From the target company's point of view, an acquisition is often desirable, since it takes a large amount of money to build a sustainable company in technical markets. And potential acquirers can easily crush you if you compete with them directly.

To exploit eroding industry boundaries by inventing an industry:

Executives overseeing each of these activities face different challenges. If an acquisition is made because the specific industry has excess capacity, then it is important to figure out quickly which plants to close and which people to layoff. If, on the other hand, an acquisition is done because it is developing a new technology, your challenge is to hold on to the acquisition's best engineers. These two scenarios explain that acquiring company has to engage in nearly opposite managerial behaviors.

I will turn now to the problems that arise in different types of acquisitions, which I will examine using the resources-processes-values framework. Resources refer to tangible and intangible assets, processes deal with activities that turn resources into goods and services, and values underpin decisions employees make and how they make them. (See the sidebar "Some Order in the Chaos" for more on these terms.)

It entails inventing an industry and a business model based on an unproven hypothesis: that major synergies can be achieved by culling resources from existing industries whose boundaries seem to be disappearing. The challenge to management is even bigger than in the other categories. Success depends not only on how well you buy and integrate but also, and more importantly, on how smart your judgment about industry boundaries.

Successful convergence deals seem to follow a sequence of steps. First, the acquirer's accounting-and-control systems are installed at the target company. Next, the acquirer starts to rationalize the nonessential processes. Finally, the portfolio is pruned of businesses that don't fit the acquirer's strategic objectives.

After those adjustments have been made, subsidiaries are allowed a high degree of freedom. Attempts to integrate the business are driven by specific opportunities to create value, rather than by any perception that symmetrical organizations and systems are important.

Different challenges to managers:

Rapid strategic change is a necessity for most companies in these days of globalization, competition, and accelerated technological change. Accomplishing change through acquisition appeals to a great many managers. My conclusion is that acquisitions come in several distinct flavors, and that each type presents managers with different challenges.

Stock value;

In cash mergers or takeovers, the acquiring company agrees to pay a certain amount for each share of the target company's stock. The target's share price would rise to reflect the takeover offer. However, the X share price could initially fall if investors are unconvinced about the strategic value of the merger

Structuring an M&A deal:

One of the most complicated steps in the M&A process is properly structuring the deal. There are many factors to be considered, such as antitrust laws, securities regulations, corporate law, rival bidders, taxes, accounting issues, contacts, market conditions, forms of financing, and specific negotiation points in the M&A deal itself. Important documents when structuring deals are the Term Sheet (used for raising money) and a Letter of Intent (LOI).

Two types of acquirers in M&A:

In M&A deals there are typically two types of acquirers strategic and financial. Strategic acquirers are other companies, often direct competitors or companies operating in adjacent industries, such that the target company would fit in nicely with the acquirer’s core business. Financial buyers are institutional buyers such as private equity firms that are looking to own, but not directly operate the acquisition target. Financial buyers will often use leverage to finance the acquisition, performing a leveraged buyout.

Tax management in M&A:

Making an acquisition, disposing of a business, going through a merger, entering into a joint venture, planning for IPO, planning for a public to private transaction, restructuring a business, reassessing management incentive plans or refinancing, tax risks need to be managed and net cash flows optimized.

Tax planning at an early stage can add significant value to every transaction, whether by minimizing transaction tax costs, managing long term sustainable tax rates and cash flows, and ultimately planning ahead for a tax efficient exit.

Rival bidders in M&A

The vast majority of acquisitions are competitive or potentially competitive. Companies normally have to pay a “premium” to acquire the target company, and this means having to offer more than rival bidders. To justify paying more than rival bidders, the acquiring company needs to be able to do more with the acquisition than the other bidders in the M&A process can.

Analyzing a M&A

One of the biggest steps in the M&A process is analyzing and valuing acquisition targets. This usually involves two steps: valuing the target on a standalone basis and valuing the potential synergies of the deal.

When it comes to valuing synergies, there are two types of synergies to consider, hard and soft. Hard synergies are direct cost savings to be realized after completing the merger and acquisition process. Hard synergies, also called operating or operational synergies, are benefits that are virtually sure to arise from the merger or acquisition such as payroll savings that will come from eliminating redundant personnel between the acquirer and target companies. Soft synergies, also called financial synergies, are revenue increases that the acquirer hopes to realize after the deal closes. They are “soft” because realizing these benefits is not as assured as the “hard” synergy cost savings.

Post M&A issues:

Management styles not being ideal

· Not correctly identifying the new entity’s goals

· Absence of social and cultural fit

· Lack of (immediate) finance and liquidity

· Pressure created through reverse synergy

· Negative pricing policies

· Lack of expertise in management

· Improper matching between scares resources

· Inability to meet the targets (financial and non-financials)

· HR and other issues

Mergers and Acquisition in Sri Lanka and Takeovers and Mergers Code:

Securities & Exchange Commission (SEC) functions as the administrator of the Code formulated under the provisions of the Securities & Exchange Commission Act. The target of the Code is listed public companies focusing on protection of shareholders in takeover and merger transactions.

Key regulated activities of the code are

1. The voluntary offer:

· The offeror must forward the offer to Board of Directors of the offeree company and prohibits the offeror from making offers to any shareholders of the target company

· Board of Directors of the target company is reasonably trust that a firm unconditional offer, will be made, and that the offeror is in a position to implement the offer in full, the Board will make an announcement.

· Within 28 days of the announcement of the offer the offeror shall forward the ‘offer document’ to the Board of Directors and every shareholder of the offeree

· After the offeror has satisfied all the conditions of the specified period, the offer becomes and is declared unconditional.

2. The mandatory offer.

Sri Lankan Code compels a purchaser acquiring 30 per centum or more of voting rights in a company to make a cash offer to all other shareholders at the highest price paid by such purchaser in the previous 12 months.

* An announcement should also be made immediately when a person or persons acting in concert acquires, by a series of transactions over a period of time or otherwise, shares carrying 30 per centum or more of the voting rights of a company, or while holding between 30% and 50% of the voting rights of a company acquires in any period of 12 months, additional shares carrying more than 2% of the voting rights in the same company

* The Code prevents the appointment of a nominee of the offeror or person acting in concert with the offeror to the Board of Directors of the offeree company or the transfer or exercise of voting rights in the company by such offeror or person acting in concert until the offer document is forwarded to the Board of the offeree company.

End of article………..

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