Assignment Presentation
Financial Mgt. Applications
Lincoln Business School
University of Lincoln
CONTENT
TABLE OF CONTENT………………………………………………………….1
1.1 INTRODUCTION…………………………………………………………....2
1.2 STATEMENT OF THE PROBLEM…………………………………….....2
1.3 LITERATURE REVIEW…………………………………………………….3
1.4 DEFINITIONS OF MERGERS AND TAKEOVERS……………………..3
1.5 TYPES OF MERGERS……………………………………………………..4
1.6 METHODS OF FINANCING; THEIR ADVANTAGES AND
DISADVANTAGES……………………………………………………………...5
1.7 MOTIVES BEHIND MERGERS…………………………………………...6
1.8 MAJOR THEORIES OF MERGERS AND EVENTS……………………6
I. Synergy…………………………………………………………………………..6
II. Increase Market Share…………………………………………………………8
III. Economies of Scales…………………………………………………………...8
IV. Revenue enhancement through entry into new markets and industries…10
V. Risk diversification or moderation…………………………………………....10
VI. Tax Advantages………………………………………………………………..11
VII. Internalisation of transactions………………………………………………...11
VIII. Talent, knowledge and techniques to enhance revenue…………………..11
IX. Bargain buying…………………………………………………………………12
X. Inefficient management and Re-engineering……………………………….12
XI. Managerial motive……………………………………………………………..12
XII. Free Cash flow, Survival and Empire building……………………………...13
XIII. Hubris……………………………………………………………………………13
XIV. Third party motives…………………………………………………………….14
1.9 WHO BENEFITS IN MERGERS…………………………………………14
2. CONCLUSION………………………………………………………………14
REFERENCES………………………………………………………………...15
Maxine O. Asiedu
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Assignment Presentation
Financial Mgt. Applications
Lincoln Business School
University of Lincoln
Mergers and takeovers
1.1 Introduction
Mergers and takeovers have been in the system for a very long time but their rate has
been on the increase in recent time resulting in numerous regulatory changes. In today’s
world, mergers are taking place even in unrelated businesses and organizations such as
the
pharmaceutical,
banking,
financial
and
communication
industries.
These
organizations normally merge by outright purchase using cash, stocks or a combination
or through pooling of resources or merger of equals (Arnold, 1998). The compelling
factor behind this is said to be both regulatory and business environmental (Spiegal and
Gert, 1996). The theories behind mergers and takeovers are basically derived from
economic and management theories and are analyzed using tools of finance. Some of
these theories are synergy, increase market share, economies of scale, revenue
enhancement, new business opportunities, Hubris, geographic diversification, inefficient
management etc.
1.2 Statement of the problem
The increasing trend in mergers and takeovers has impacted on the bidding price. There
has been a record of huge premium prices for M&A’s and that raises the question as to
why such bidding premiums? The argument has mainly been based on its synestical
effects as (Arnold, 1998) puts it. However many writers and analysts have questioned
whether there are other reasons for the overestimation in potential synergies. This essay
therefore seeks to analyze the theories of mergers and takeovers or acquisitions (M&A)
and relate it to some events and how those events were perceived by investors and
commentators.
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Lincoln Business School
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1.3 Literature Review
Mergers and Takovers as mentioned earlier have been increasing significantly and the
considered value has been a controversial issue. Whilst some researches have argued that
M&A creates value through economies of scale (Baumol 1982; Ross 1980) others have
argued that these transactions are forged by managers who are either self-serving (Fower
and Schmidt 1990) or overconfident (Arnold, 1998; Hayward and Hambrick 1997) and it
often results in loss of vale for the acquirers. Despite this controversy, M&A continues to
be an important way by which wealth can be maximised. In order to account for the view
s of investors and commentators the presentation that follows will be in the following
stages: (a) definition of M&A and the types; (b) motives behind mergers and (c) theories
of M&A and related events.
1.4 Definitions of mergers and takeovers.
Glen (1998) defines merger as the combining of two business entities under common
ownership. Hill and Grant (2007) defines acquisition as when a company uses it capital
resources such stock, debt, or cash to purchase another company but also emphasized that
cash is the most common method of payment except that at the peak of the cycles shares
are the most popular form of consideration. Lubatkin and Shrieves (1986, p.497) had
these to say on mergers and acquisitions they "are used interchangeably to mean any
transition that forms one economic unit from two or more previous ones" They also
described a merger as an agreement between equals to pool their operations and create a
new entity. Undoubtedly there have been a continues increases in mergers and takeovers
over the years and in the most recent wave which peaked in 2000, US firms spent about
1.6 trillion on 11,000 mergers and acquisitions up from $300 billion in 1991 (Hill and
Grant, 2007). UK has also had a merger wave in which it peaked in early 1970s late 80s
and 90s. In 2000 for example it recorded 106,916 million M&A (Financial Statistics
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Lincoln Business School
University of Lincoln
UK, 2000). There are basically three types of mergers and they will be discussed in the
following paragraphs.
1.5 Types of Mergers
In general mergers have been classified into three categories namely: horizontal, vertical,
or conglomerate.

Horizontal merger takes place between two firms in the same line of business. In
a horizontal merger two companies which are engaged in same line or similar
lines of activity are combined. Recent examples include the merger of Royal
Bank of Scotland and Nat West, Morrison and Safeway, Glaxo Wellcome with
Smithkline Beecham, also BP with Amoco Arco and Boeing with McDonald
Douglas etc.

Vertical merger occurs when firms from different stages of production
amalgamate with the belief that some amount of competition is necessary since it
ensures customer value (Arnold, 1998).
There are downstream or backward
vertical merger and upstream or forward vertical merge. A vertical merger entails
expanding forward or backward in the chain of distribution, toward the source of
raw materials or toward the ultimate consumer. For example, an auto parts
manufacturer might purchase a retail auto parts store.

Conglomerate merger is formed through the combination of unrelated businesses
or can be described as the combining of two firms which operates in unrelated
business areas. Example, in 1996 Tomkins bought The gates Corporation (a
manufacturer of power transmission belts, wellington boots and carpet underlay)
for US$ 1,160m and added it to Hovis Bread and the others (Arnold, 1998)
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Financial Mgt. Applications
Lincoln Business School
University of Lincoln
1.6 Methods of Financing, their Advantages and Disadvantages
There are three main options in which mergers are financed and they are the use of cash,
shares and the third option involves the use of debentures, loan stock, convertibles and
preference shares.
Cash is the most preferred means of payment especially where the market is unstable and
allows shareholders to spread their investment through purchase of wide-ranging
portfolio. Mixed bids are also allowed and that is where a variety of financial securities
are used. The advantage of using cash is that the acquirer’s shareholders maintain the
same level of control over their company. The new shareholders will not take ownership
or possession of the right of other shareholders.
Shares are also used to finance mergers and they have two primary advantages. The
capital gains tax can be deferred as the investment gain is not yet realised and also there
is an interest in the combined entity. There is no immediate outflow of cash and does not
put pressure on cash flow in the short run. Secondly the price earning per ratio game can
be played. This is where companies increase their shares (EPS) by acquiring firms with
lower PER’s than theirs. This can bring a rise in share price without any economic value
is created.
The third payment option includes alternative forms of consideration like debentures,
loan stock, convertibles and preferred shares. These are unpopular because of the
difficulty in establishing a rate of return on their securities making it be attractive to
target shareholders. Writers have acknowledged the problem of marketability of
securities and voting rights over the newly merged company.
1.7 Motives behind Mergers
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
Lincoln Business School
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The motive behind horizontal mergers is to achieve economies of scale, the
enhancement of market power resulting from reduction in competition etc. This
type of merger mostly tends to attract the attention of government competition
agencies such as Office of Fair Trading and The Competition Commission in the
United Kingdom.

These vertical types of merger is also said to increase certainty of supply of
market outlay, reduces costs of search, contracting, advertising co-ordination of
production. The advantage with this kind of merger is certainly risk reduction
through diversification, opportunity cost and improved efficiency.
1.8 Major theories of mergers in relation to events
The theories behind M&A are numerous but for the purpose of this essay I will adopt
major theories given by researchers. The major theories that will be discussed here are:
Synergy, increase market share, economies of scale, revenue enhancement, new business
opportunities, Hubris, geographic diversification, inefficient management etc.
i. Synergy
The buzzword synergy has mostly been used as the reason for continues rise in M&A,
that is the idea that a combined entity will have a value greater than the sum of its parts,
or greater value. Theoretically, a company will enter into an acquisition or merger
agreement if they believe that the Net Present Value (NPV) of company A and company
B is greater than NPV of company A and NPV of company B. In a more simplified term,
the economic value of these firms combined is greater than the economic value of these
two firms as separate entities.
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This is expressed mathematically as 2+2= 5 (Lubatkin and Shrieves, 1986, p.497) or
PVab = PVa + PVb + gains (Arnold, 1998). Its characteristics and resulting values before
and after formation have been studied thoroughly in the financial literature (see for
instance, Jensen and Ruback, 1983) and accounted that modern financial theory of M&A
occur in the hope of positive synergistical effects, and many managers have cited synergy
arguments in order to justify their actions and so have many researchers proved this
assertion. This was confirmed by a number of writers (see Friedman and Gibson, 1988;
Maremont and Mitchell, 1988; Porter, 1985).
Reasons for these synergistrical effects have been offered as gaining fast access to new
technologies or new markets, tapping into sources of know how located outside the
boundaries of the firm, benefiting from economies of scale in research and/or production,
and finally monopoly type advantages. But looking at the successes of M&A from the
past three decades confirms otherwise. If 2+2=5 then have many M&A events failed.
There have been failures in which some resulted in break up of the financial marriages.
The acquisition of between Brooks Brothers by Marks and Spencer, Kellogg’s and
Lender's Bagels, 1990 and even well documented mergers like AOL and Time Warner
2001, AT&T and NCR 1991, Quaker Oats and Snapple all turned out to be failures. The
chance of value in synergy only holds if all things are equal. As much as there are
successes in M&A there are failures but the latter is out number the former significantly.
A recent acquisition of Brooks Brothers, US by Marks & Spencer went disastrous and
investors had to pool back. It was reported the clothing retail shop was recording huge
losses after having paid a premium price of $750m (Management Decision Journal, 1994)
updating the technology and stocking with variety of stock was still under performing.
They had to pull back eventually and this was what the chairman Lord Raynar admitted
they over paid the bid price (Arnold, 2005). M&S was said to have traded in an autocratic
style (ibid) though management was cautioned that the bid price was too high. M&S’s
case is just on out of hundreds of failed M&A. According a survey by KPMG, the value
of M&A deals in US declined by 48%, while European 60% and Asia-Pacific region 10%
(International financial law review, 2001).
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Also between 1996 and 1998 a similar report by KPMG which indication a poor
performance of cross-border mergers and even tried to retrieve it for fear of its receiving
publicity (Arnold, 2005). This reports cast doubts to the effectiveness of M&A. So the
question is if shareholders wealth are not increasing through these consolidation the why
the continuous increase? This some then confirm some issues raised by theorist.
ii. Increase Market Share
Another theory behind M&A is that it increases market shares. Businesses over the world
are interested in increasing their operational efficiencies and monopolistic influence since
it will help them gain market power. Therefore firms of different sizes and from different
area are constantly merging. Whilst larger firms are acquiring smaller firms, there are
some smaller ones acquiring larger ones (Malatesa and walker 1998; Duggal and Millar
1994). This consolidation will give the acquiring firm the ability to exercise some control
over the price of a product and this can be achieved through monopoly or collusion. But
unfortunately there have been few cases of success though research has indicated that
same industry mergers are less risky and more likely to gain market power (Arnold,
2005). Examples of same industry mergers are Travelers/Citicorp and HewlettPackard/Compaq, they have recorded enormous growth since they exercised patience and
negotiated over a long period of time and hence allowed all the parties to develop
realistic expectations. Unpredictably both mergers exceeded their basic goals despite
doubts. Consolidation increases market power for companies but is it mostly helpful for
consumers? Monopoly can be treacherous to consumers.
iii. Economies of Scales:
The theory of economies of scale has been used to justify M&A. Efficiency theory
purports that there are operating, financial and management synergies involved in
merging or takeovers and this will be advantageous to acquirers since larger size of
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production often leads to lower per unit cost of output. There can be economies in
marketing which arise through the use of common distribution channels, administration,
research and development etc. Also development of executives and managers is mostly
better in large firms since there is normally structured form of training programmes and
easy access to wider knowledgeable and experienced colleagues.
In February 2005, EPIC acquired the Siemens Electronics Manufacturing Center
operations in Johnson City in the US known as "JoCy." And is turn out to be successful
since they accepted differences and were opened to themselves. Researchers have raised
questions as to whether friendly bids have positive returns than hostile bids? The post
acquisition business culture should be unifying and so many issues must be address to
ensure success. There have been few success stories like of EPIC and has been confirmed
that achieving cost reductions post synergy is easier than revenue increase(Glen, 2005).
Various surveys of academic research, interviews and financial firms have revealed that it
is much easier to achieve success when the stated goal of a merger is its potential for cost
reduction rather than its potential to increase revenue. For example Kellogg's had a
disastrous acquisition of Lender's it fared much better in the acquisition of the frozen
vegetarian burgers unit of Worthington Foods because they focused on the cost side of
the synergy rather than growth. Likewise, the Hewlett-Packard/Compaq merger was
largely predicated on a consolidation of capacity that could be accurately measured. HP
had established an objective of achieving $1.3 billion in cost savings by November 2003.
Yet within a year, according to Forrester Research, HP had posted savings of $3.7 billion,
and acquired new strength in servers and IT services. In M&A driven solely by
consolidation of capacity in a market or industry, the revenue increase would come from
simple supply-demand dynamics that are much easier to understand.
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iv. Revenue enhancement through entry into new markets and industries
A firm might decide on a merger reasons being that it is interested in a particular market
or industry but lacks the know-how, then that will be an easier means of establishing
itself. A lot of firms have used this reason to explain their interest in M&A. It is believed
that by that means a firm will grow itself organically into the geographical market and
acquire the required skills which would have taken it several years to acquire when on its
own.
Examples of companies that have gained on new market entries are Santander Central
Hispano’s (SCH) and Abbey National, 2004 and as a result of that it attained the position
of the leading retail financial institution in the UK without creating additional capacity.
Many small firms are acquired by large ones for this very reason especially
pharmaceutical companies merged with biotechnology firms so that they can draw
strength from each other example is the Roche and Genentech, AstraZeneca and
Cambridge Antibody Technology (CAT) and one that has raised concerns, Crestor and
Exanta.
v. Risk diversification or moderation
Income stream becoming less volatile has been one major reason for M&A especially
geographic or cross border and conglomerate type. This type of merger normally invests
in a wide variety of products and markets and through that it pools unrelated stream of
income to shareholders. A risk in reduction is received without decrease in return. The
argument posed here is that investors can choose other means of reducing their risk either
than merger. They can simply buy some shares in separately quoted markets. It is a way
of diversifying ones investment so as to avoid putting all eggs into one basket. Cross
borders M&A has also raised significantly firms are constantly seeking for places more
favourable since it will push their profits higher and higher. For example low tax regions
and stable condition will all promote the success of a business.
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vi. Tax Advantages
Tax advantages are also earned by firms that make losses especially when they are in
there is takeover some percentage of relief that is given to the acquiring company. This
help as form of relief or benefit for the acquiring company. Furthermore tax advantages
and reduction in risk may result to an increase in profit which may justify some M&A.
Examples of acquisition made by CarPhone Warehouse may support this. Upon their
takeover of AOL in 2006 their profit increase from £2,355,093 to £3,046,403 (Company
Annual Report, 2006) especially in the US firms that make losses in a particular year can
gain tax reductions in a future date. Tax loss carry-forwards can motivate mergers and
acquisitions.
vii. Internalisation of transactions
The coming together of two firms at different stages of the production chain an acquirer
may achieve more co-ordination from different levels. Here it is believed that cost
advantages can be derived though communication, bargaining, monitoring compliance
and contract enforcement. For example vertical integration ease uncertainties in supply or
prospects of finding outlets. It also takes away the difficulties in hang to bargain with
supplier or customer. This view is more in favour of vertical mergers since a backward
or forward integration will help with raw materials to produce or market the finished
products. Thus corporate diversification will be achieved through reduction in production
or distribution cost.
viii. Talent, knowledge and techniques to enhance revenue
A reason for a firms merger can be because its interest in of apply talent, knowledge and
techniques to the parent company’s existing future product lines in order to gain
competitive advantage. Most Asian companies have this on the agenda and hence take
interest in acquiring western firm’s example Shanghai Automotive Industry Corp merged
with Britain’s MG Rover (Financial Times, 2004).
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Merger is therefore to maximise shareholders wealth but differences might be a problem
just as Sir Richard Branson of Virgin Media Inc and Murdoch's British Sky are also
experiencing difficulties in their merger (Business Week, 2007)
ix. Bargain buying
Bargain buying in terms of potential gains are expected when two firms are combined
another motive explained by managers for mergers. The benefit that a firm can achieve is
enormous therefore there is constant search for companies that are undervalued. There is
the belief that stocks markets on few occasions undervalue shares and spot such
undervalued share can be a niche when acquired.
x. Inefficient management and Re-engineering
Efficiency theory is another reason behind M&A. It is believed that companies which
are under performing can be re-engineered by stronger acquirers but where acquirers
fail the merger only can survive in the short run but cracks will begin to show on
sooner and can lead to a break down. Achieving this is not easy because of
differences that exist in the business cultures. AOL and Time Warner a financial
marriage that took off on a more special note Valentine’s Day 2001 experienced such
difficulties so the merger synergies was abandoned in 2002 the CEO Richard Parsons
announced
that each individual unit would focus on what they are good at
individually. Over emphasizing the potential for collective good is a common mistake
in synergistic mergers and AOL is not alone in misjudging the opportunities. It must
be admitted as a common problem in M&A.
xi. Managerial motive behind mergers is another issue that needs to be questioned. Is
it always for the rational reasons they claim? Maximising shareholders wealth rather
management personal interest. It have been questioned whether it is not the idea of
being paid more? Higher remuneration status, prestige, power are said to be
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a motive M&A. Sometimes mergers happen with the aim of management satisfying
their wants such as gained in managing hundreds and thousands of people in big titles
CEO, Director etc. People by nature want to be known by influential positions they
have held. For example the man who has headed so many big businesses around the
world and for that matter will do anything in their power enter into M&A. Their
experiences in such situations will never be questioned. A typical example is the case
of M&S acquisition of Brooks brothers sited earlier.
xii. Free Cash flow, Survival and Empire building
These are all reasons behind the increase in merger activities. Firms in theory must retain
their money within the firm and invest in any project which will in turn produce greater
returns. Managers use this idea of investing for greater returns to justify actions. What is
interesting is that both small and large firms are engaging in merger activities.
Management believes that the best way to avoid a takeover and dominate is to grow large
themselves the idea of eat or be eaten. Management in order to avoid being vulnerable
merge for their survival but, not because of their claim maximise shareholders wealth.
This technique will not only ensure the survival of the business but more a way to
achieve empire building.
xiii. Hubris is another reason that has been raised to explain the increase in mergers
activities since there has not been a insignificant increase in growth in M&A. The reason
could also be what was referred to as Hubris hypothesis by Roll, 1986. According to Roll
managers may commit errors of over-optimism in evaluating merger opportunities due to
excessive pride or faith in their own abilities. Some acquires do not learn from their
mistakes let alone that of others. So was it the case that the resources of M&S couldn’t
have contained Brooks Brother but still went ahead and acquired it.
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I believe that management of M&S had worthy intension of maximising the shareholders
wealth but made a mistake by not doing their homework well. Acquirers should learn to
follow procedures since it will help avoid problems.
xiv. Third party motives are also the reason why some mergers take place. For M&A to
take place the services of professionals like financial advisers, accountant, lawyers etc are
sort and they charge some fees for providing those services. The intension of third parties
can be that the more deals they negotiate the higher their take home can also be the
reason increase M&A. this could be why despite considerable failure M&A are still
happening. Advisers for example charge fees are charged for bidding, advising,
identifying targets, etc Therefore advisors, accountants and lawyers may be keen on
markets to merge. The press and tabloids to specialist publications will also spice up the
marriage (financial) by portraying the glamorous sides of it. Just recently a Private equity
group by name Terra Firma and medical charity (Wellcome Trust) have confirmed they
are considering a rival takeover bid for Alliance Boots, UK. For the bid battle to be
possible their offer will have to be above £10bn, 1,040p-a-share bid tabled by Kohlberg
Kravis Roberts (KKR) and Italian Stefano Pessina the group, which was created in a
£7bn tie-up with chemist chain Alliance Unichem last year, a company that supplies more
than 125,000 pharmacies, health centres and hospitals (BBC, 2007) it must be
emphasized that the reporter raised question what the effects of a private equity
acquisitions might have on a pharmaceutical gaint Boot on the UK market but was it
enough to send a message to shareholers?
1.9 Who benefit in mergers and public impression
Who benefits from mergers? In terms of economies of scale it has been argued that goods
are produced at lower cost therefore society will benefit but there will be less competition
meaning two offsetting outcomes. Those who benefit are mainly directors of the
acquiring companies, financial institutions. M&A is profitable for targets firms
(chatterjee, 1986; Lubukin, 1987; Pinches et al, 1992) but insignificant (Singh and
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Montgomery 1987; Zollo and Singh 2001) some also argued its negative consequence for
the buyer Hayward and Hambrick, 1997.
It also can lead to job losses (Arnold, 1998) to the target. Public impressions on merger
events vary depending on the group one belongs. Those benefiting are likely to be
content and vice versa.
2. Conclusion
From the above discussion, it can be concluded that though M&As have not led to
significant enhancement of value of shares (Sirower,1997; Singh and Montegomery,
1987; Manedalkor,1992; Arnold, 2001p.1062.) they have the potential to create value for
shareholders when well organised. In order to achieve good results from M&A, acquirers
must be cautious, follow due procedures and avoid rush and over optimism in mergers.
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References
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http://www.hemscott.com/companies/company-chart.do?companyId
http://fame.bvdep.com/version
http://global.facitiva.com
http://academic.mintel.com/?logon&ath_user=hum.da73d00&athk%3CRkppCKPEVO%
2BZxcUr1g%3E
http://www.ft.com/home/uk
http://proquest.umi.com/pqdweb?RQT=504&CERT=QXRoZW5zVXNlck
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