Mergers and acquisition
What is mergers and acquisition
Mergers refer to the amalgamation of two companies to form a completely new entity whereas acquisition refers to the taking over of one company/firm by another, usually a smaller company by a bigger one. This takeover of one company may be friendly or hostile. Friendly takeovers happen when the board of directors or the management approve of it and encourage the shareholders to vote in favor of it. To motivate the shareholders the acquirer company may offer their shares in exchange of the target shares or make a cash offer.
Hostile takeovers are those in which the board of directors of the target company do not approve of the acquisition and thus discourage the shareholders from voting in favor of the deal. The management rejects the idea and the acquirer has to look for other means to reach their objective. They use strategies such as a tender offer which is an open invitation to all the stockholders to sell their shares for a specific price and within a particular amount of time to them.
They may also employ another method called proxy fight which is basically a contest for control over the organization by urging the shareholders to vote out the existing board of directors and appointing new ones in their place who may be more open to the idea of the acquisition of the company.
Types of mergers/acquisition
There are 4 types
This occurs when the two companies that joined together are involved in the sale of the same or similar type of products and are usually competitors to one another. By merging together they benefit by increasing their profit and market share.
In this, the field of operation of both the companies is within the same industry but they are on different points in the supply chain. By coming together they can ensure continuous supply of the goods without any disruption and also save time and costs involved in production.
Concentric mergers or acquisitions are those companies that serve the same customers but don’t deal in the same kind of products. The products dealt by both the companies may be complementary in nature or go well together. Companies may opt for such an arrangement to provide both the products and the sale of one may lead to a boost in the sales of the other. This will be convenient to the customers and the company can increase its profit margin.
This happens when two companies operating in different industries dealing with unrelated goods decide to come together to diversify the products offered. This helps in having an expanded customer base and also lessens the risk as the better performing sector can compensate for the weaker performing one.
What is the concept of due diligence
Due diligence in M&A refers to the process of researching, verifying and confirming all relevant facts and details regarding the potential deal which allows the buyer to make an informed decision based on the status of the target company. It is considered an essential requirement in M&A and various aspects of the company are looked into to assure the buyer of the state of the company. Some important information that are collected in the process of due diligence include
- Financial matters
- Technology/intellectual property
- Employee Management issues
- Tax Matters
- Antitrust and Regulatory issues
- General Corporate Matters
- Environmental issues
- Production Related Matters
- Marketing Arrangements
- Competitive Landscape
What is the purpose behind M&A
There are several reasons why a company may opt for a M&A. Some of the benefits that may be derived are
Companies may opt for M&A to increase the wealth of the shareholders in both companies. The term synergy refers to the idea that the combined value and earnings of both the companies will be greater than the earnings of the Companies individually.
Economies of scale
Economies of scale are cost advantages that companies benefit from by increasing production and decreasing costs. In an M&A the companies benefit from economies of scale as their production becomes more efficient and since it deals with more products, the higher will be the cost savings.
Increased market shares
This is usually one of the factors taken into consideration when companies opt to merge. A company’s market share of it’s portion of total sales in relation to the market in which it operates. Since two different companies with different customer bases come together it increases their client base thus increasing their market shares.
Merging of two Companies allows it to enter into new markets or offer new products or services and increase its area of business operation. It also allows the company to diversify its risks. Since the company increases its revenue streams through a merger deal, it enables them to spread the risk across those revenue streams rather than concentrating it on one.
Acquisition of assets
One reason for a merger deal is for one company to get access to the assets that they may not be able to acquire through other means. One such important asset is technology that can benefit the consolidated company and increase their profit margin.
Various tax benefits can be derived through M&A deals such as tax loss carry forward. This is a provision that allows a taxpayer to carry over a tax loss to future years. After both companies merge, the tax liability of the consolidated company will be lower than that of the individual company.
Risks involved in M&A
Even though M&A deals sound beneficial for both the companies, this may not always be the case. There are several risks involved in these deals and the companies have to take precautions before closing the deal. Some of the common risks are
Overpaying for the target company
Overpaying for a company destroys shareholders value. Having high hopes on a company only for it to not meet the expected profit levels is a major concern in M&A. It can be a major setback for future financial performance.
Being conservative while estimating synergies is a very important step which must be undertaken as being over optimistic about the merger may cause several problems if synergies created by merging two companies are overestimated.
Weak due diligence practices
As explained above, due diligence is an important process in any M&A. It involves obtaining maximum information about the company such as customer base, financials, insurance which allows the buyer to make an informed decision so that later they are not burdened with unexpected burdens such as litigation or tax matters.
Overall lack of communication and transparency
The company should communicate all important matters such as market share, consumer base, product/service details to the firm so that they are aware of the terms of the deal and can decide accordingly. Lack of transparency and communication leads to discontent within the firm.
The companies should take into account the values, norms and assumptions of each other to increase efficiency. This is one of the major reasons for failure of the consolidated companies. The best way to avoid a failed integration is to carefully plan the integration in detail.
Culture and people challenges
People are the biggest assets in any company and should be taken into consideration before closing the deal. The values and ideas of the people should be taken into account. Cultural clashes are a common occurrence in M&A and it’s important to equip the new employees with skills needed in the company.
Laws pertaining to M&A
The Companies Act 2013
Section 230 to 240 of The Companies act 2013 covers the provisions governing M&A involving companies and their members and creditors. All corporate transactions such as mergers, primary/secondary acquisitions or PE funding must be implemented with regards to the provisions given in the Companies act 2013.
The Foreign exchange Management Act 1999(FEMA) and FDI Policy
In M&A transactions, FEMA regulations provide guidelines and conditions on issuance of shares or securities by an Indian entity to a person residing outside India or any transfer of security from or to such person. It deals with issue and acquisition of shares after merger or demerger of Indian Companies. The department of Industrial policy and promotion issues detailed guidelines on foreign direct investment in India through the FDI Policy.
Securities and Exchange Board of India(SEBI)
The securities market in India is governed by the regulations and guidelines issued by the securities and exchange board of India(SEBI) which is the market regulator for publicly listed companies. The SEBI regulations 2011 control the M&A transactions which involve the acquisition of a major stake in the company.
The insolvency and bankruptcy code 2016(IBC)
The IBC was enacted as a comprehensive code to consolidate laws relating to reorganisation and insolvency resolutions of corporates, partnerships as well as individuals. The entire process begins from the institution of proceedings until approval of a resolution plan or liquidation. The Code is intended to revive Sick Corporates as far as possible and if the revival is not possible, then to liquidate the same.
The Competition Act 2002
The law of M&A and Competition Law are intrinsically bound with each other as any combination including merger and acquisition has to undergo the regulatory guidelines as enumerated under the Competition Act, 2002. It was enacted with an objective of promoting competition and protecting the interest of consumers.
The Income Tax Act 1961
Income Tax Act defines ‘amalgamation’ as merger of one or more companies with another company or merger of two or more companies to form one company. The Indian Income Tax Act, 1961 (ITA) contains several provisions that deal with the taxation of different categories of mergers and acquisitions. In the Indian context, M&As can be structured in different ways and the tax implications vary based on the structure that has been adopted for a particular acquisition.
Vodafone and Mannesmann
This acquisition consisted of the takeover of Mannesmann by Vodafone. It was the largest Acquisition and was worth $203 Billion. Vodafone was based in the United Kingdom and was a mobile operator whereas Mannesmann was a German owned industrial conglomerate company.
Verizon and Vodafone acquisition
In 2013, Verizon Communications paid $130 Billion to buy Vodafone out of its wireless business and gave the company control over its wireless division.
Disney and 21st century fox
In 2019 Disney took over 21st century Fox including 20th century Fox film and television studios as well as U.S cable/satellite channels for $85 billion.
Dell and EMC corporation
This deal was the largest ever acquisition in the technology sector. It was valued at $74 billion and this Dell EMC acquisition was later named Dell Technologies and it went on to become the number one seller of storage systems in the world.
Walmart acquisition of Flipkart
Walmart acquired a 77 per cent stake in Flipkart for $16 Billion which was the biggest ever e-commerce deal.. Walmart stated that Flipkart will leverage Walmart’s diverse retail expertise, merchandise, supply chain knowledge and financial strength, while Flipkarts ” talent, technology, customer insights and agile and innovative culture” will benefit Walmart.
America online and Time Warner
In 2000, America online(AOL) had announced that it would pay $182 Billion in stock and debt for Time Warner. It was the largest corporate merger in U.S history. The reason for failure was that the expected synergies failed to become a reality and the value of AOL stock went from $226 Billion to about $20 Billion.
Google and Motorola
Google acquired Motorola mobility for $12.5 Billion. After less than 2 years ,Google sold Motorola to Lenovo for $2.91 Billion. This merger failed as Motorola failed to innovate after being acquired by Google.
Microsoft and Nokia
Microsoft acquired Nokia’s mobile phone business for about $7.2 Billion and is considered one of the biggest mistakes of the company. This acquisition failed and Microsoft had to write down about $ 7.5 Billion related to this transaction and cut 7800 jobs.
eBay and Skype
In 2005 eBay acquired Skype for $2.6 Billion. It failed because eBay estimated its customers’ demand for Skype products to be higher than what it was. This was a case of unnecessary technical Integration and Skype’s tech did not appeal to eBay’s customers.
This article discusses the basic details regarding merger and acquisition deals and their types and purpose behind it as well as the concept of due diligence which is a very essential task in any merger or acquisition. It also discusses the risks and laws pertaining to mergers and acquisitions in India as well as giving examples of a few successful and unsuccessful mergers and acquisitions.
Author: Diya Manikoth,
3rd year BA LLB