As mentioned above, a common method used by corporations to diversify into a new business or new markets is the acquisition of or merger with an existing firm in the target product or market. The primary reason for mergers and acquisitions was that in the western world, the consumption slowed down in the 1980s as a consequence of recessions in the previous decade. Hence, firms were prompted to seek to acquire existing brands that would enable them to rapidly acquire a larger market share while maintaining high levels of control over implementation in terms of costs and time (Faulkner and Campbell, 2006:397).
However, the approach has both advantages and limitations as is given in discussion below. a. Advantages of M&A As a result of merger or acquisition, the acquiring company gains readymade products, markets, know-how and skilled manpower at every level. Mergers and acquisitions are also relatively fast as compared to organic or ground-up operations, obviously because the entire organizational infrastructure exists and hence instant assess to a share of the target market is available. Also this being not an open-ended commitment means that the expenditure is also fixed at the time of transaction (Shim and Siegel, 2001:221).
Mergers are cleaner because the transfer of assets or stock between the acquirer and the target happens automatically by rule of law. If the majority of shareholders, even if it is 51%, approve of the merger, the entire company shareholders are required to sell their shares even if they do not support the transaction. Hence, there is no reason for a hold up by minority shareholders opposing the proposed transaction (DePamphilis, 2007:467). Mergers and acquisitions hence aid in diversification such as reducing cyclical and operational effects.
The effect obtained is overall synergistic, meaning that the whole is usually more than the sum of the individual parts. This is the case especially when the M&A is horizontal, as the tendency here is to eliminate the duplication of facilities. M&A also helps the acquiring company in raising funds, since it would have higher liquid assets and low debt. The market price of stock is generally seen to rise post a merger, which results in a higher P-E ratio (Aswathappa, 2006:342).
b. Disadvantages of M&A
The frequent failure of mergers and acquisitions, however, tell a different story that mergers and acquisitions are not as easy and advantageous as they appear to be. Mergers and acquisitions in general are both difficult to value as well as integrate (Shim and Siegel, 2001:222). Especially in case of cross-border M&As, the situation brings about a class of cultures in the reorganization aspect, and also despite the due diligence, the foreign company is basically unfamiliar with the external competitive forces and consequently does not understand the precise importance of the relevant internal resources and capabilities in order to succeed.
Also adjusting to unfamiliar routine without completely understanding it is both daunting and complex for the top executives of the acquiring organization (DePamphilis, 2007:467). Another problem that arises due to inappropriate valuation is the tendency to pay too much if the target seems attractive enough. Yet another problem appears at the post-acquisition phase. The aftermath of an acquisition is generally characterized by downsizing to gain appropriate economies of scale by optimizing the existing resources. Needless to say, the existing employees of the acquired firm resent such measures.
At times even the local government and other regulatory authorities present difficulties during this phase by intervening in the pricing, financing, job security aspects, by bringing in concepts like nationalism etc. In case of public corporations, the process of mergers can be both costly and time consuming till the actual majority approval has been obtained, including the additional regulations that need to be adhered to such as proxy regulations (Faulkner and Campbell, 2006:397-398). A major problem with the acquisitions and mergers is the due to the dangers of being complacent.
The acquiring company must always remember that even the best of the advantages of the mergers and acquisitions are potential in nature, and that there is no guarantee that the desired results would be obtained merely by merging two companies or by acquiring an attractive portion of a company. A poor choice can transform a potential advantage into an actual disadvantage. Hence, the potential choice needs to be correct not only in terms of financial implications, but also the potential compatibility between the two companies.
Also the cultural and other ramifications must be thought of before undergoing the actual transaction (Aswathappa, 2006:342). 2. 4 Analysis of research already conducted Most of the researchers agree that the Mergers and acquisitions are on a rise in the present business world. According to Vaughn, the reason for his rise is due to increase in competition and a lack of organic growth opportunities, and the trend is expected to continue in the next years to come (2008:35).
The research available on mergers and acquisitions is extensive, and in fact data has been collected for the M&As in the last 100 years. The conclusions is that the mergers and acquisitions over this period of time have had mixed success. A lot has been written about the success and failure of mergers and this has sparked a controversy regarding the long term benefits of M&A, due to which there has been a significant research in the area. Most of the general research on M&A has focus on the long-term benefits on shareholders.
In this context, the various analyses have focused on the pre-transaction performance of the target company and the post-transaction performance of the resulting organization. For doing the analysis, a variety of measures have been used for quantification such as profitability and market measures such as equity values. This would be the method of analysis for this dissertation also; however, in addition to this the concept of organization fit will also be analyzed. The trend for mergers and acquisitions continues to rise meteorically in the present day business world. Read about limitations of Manpower Planning
According to an issue of British Journal of Management in 2006 by Susan Cartwright and Richard Schoenberg titled Thirty Years of Mergers and Acquisition: Recent Advances and Future Opportunities, in the year 2004, 30000 acquisitions were completed globally which is equivalent to one transaction in 18 minutes. McKinsey puts a numerical figure to the mergers and transactions in the year 2004 at USD $2. 0 trillion. In fact the corresponding figures in the years 2006, surpassed the world record 0f 2000, in the first 11 months itself, with a figure of a staggering $4 trillion (Stegmeier, 2008:106).
The reason for the present study is because of multiple studies that show that there is no evidence that the performance of the company resulting after the merger or acquisitions changed after the merger. The most famous study that confirmed this hypothesis was conducted by G. Meeks in 1977 titled Disappointing Marriage: A study of Gains from Merger. Another comprehensive study was conducted in 1987 by David J. Ravenscroft and F. M. Scherer that examined 6000 mergers between 1950 and 1977. The research was titled Mergers, Sell-offs, and Economic Efficiency.
The main objective of the research was to find out how the acquiring companies would fare after an acquisition has taken place. Their results showed that the companies fared quite poorly. In addition, the research also distinguished between pooling and purchase accounting transactions. The result was that the pooling transactions did not perform above the control group, and performed worse than the target company’s pre-merger return. Purchasing transactions too performed poorly. One result that was positive was regarding the mergers, i.
e. transactions between equals, which performed better than their control group and the pre-merger return of both the companies (Hunt, 2004:204-205). The whole period of mergers and acquisition and its overall success of failure were summarized by Damodara. He took the data of the 58 M&As evaluated by McKinsey and company in the period 1972 and 1983 and concluded that 28 of these did not generate a return in excess of the cost of capital, and they did not help the acquiring company in outperforming the competition either.
The follow up study was conducted by McKinsey and Company, who found that 60% of the 115 M&As in United States and United Kingdom during the 1990s earned a return that was less than that of the organization’s cost of capital and actually on 23% of these M&As earned a return that was in excess of the cost of capital. In 1999, KPMG too followed up this research by analyzing 700 of the most expensive acquisitions between 1996 and 1998, and found that only 17% of these created any value for the resulting company. While 30% showed neutral results, a staggering 53% actually destroyed the value.
The approach for failure was approached differently by researchers by enquiring after the number of companies that divested the acquired company after the acquisitions. One of the researches in this genre was conducted by Mitchell and Lehn in 1990, who found that 20. 2% of the acquisitions taking place between 1982 and 1986 were sold by 1988, while Kaplan and Weisbach in 1992 found that 44% of the investments studied by them were divested eventually sometime after the merger (Albarran, Chan-Olmsted and Wirth, 2006:150).
KPMG’s research has also pointed out clearly that 80% of the M&A deals that have been struck over the past 10 years have never created value that the management expected. This result is echoed in more dire terms by McKinsey and company who found that nearly 80% of all the M&A deals failed to recover the costs incurred in the deal. Recently KPMG in 2006 published results of research of all the mergers and acquisitions above US $ 100 million that took place in the period 2002 and 2002.
The results yet again showed that 43% of all the M&As did not create added value to the share holders, though in 31% of the cases the shareholders did benefit, while in 26% of the case the shareholder value actually decreased. Even though in 90% of the cases the companies imagined that the shareholder value increased, 66% of the companies did not find the projected synergy advantages and only 20% of the acquiring companies had an actual plan that explained the advantages.
In fact only 60% of the acquiring companies had a plan to proceed after the official agreement of a merger or an acquisition. The period required for achieving a sense of control was somewhere about 9 months due to differences in culture, financial reporting, rules and measurements and even IT systems (Rodenberg, 2008:52). The results of the researches have not always been overtly negative, however. A study conducted in 1992 by Paul M. Healy, Krishna G. Palepu, and Richard S. Ruback examined the post-acquistion performance of the target company.
The research was titled Does Corporate Performance Improve after Performance Mergers, and examined the performance of the largest 50 mergers that occurred in United States between 1979 and 1984. The researchers recognized that the eventual stock price of the acquiring company could be influenced by multiple factors. Hence, they focused on the cash flow generated by both the companies post transaction, which is also the method chosen for this dissertation. The research produced several results.
The cash flow results of both the companies were evaluated pre and post mergers. The evaluated cash flow returns were found by dividing the operating cash flow with the market value of the assets of the firm at the beginning of the period. The results showed an increase in the cash flow returns for the merged companies which would result in asset productivity related to the company’s industry. In addition, the result also compares the increase in cash flows with the returns in the merger and found that there was a correlation between the two.
The expectation of an improvement in cash flows led to abnormal stock returns (Hunt, 2004:204-205). Another study was conducted in Jeannette Switzer between 1967 and 1987 and studied 324 combinations during this period. The study, which was titled Evidence on Real gains in Corporate Acquisitions, studied the changes in operating performance of the merged companies post transactions. The results of the study showed that the operating cash flow returns for the involved companies were larger than what would have been expected if the two companies had not been merged.
There was both an improvement in the operating cash flow margin and the asset utilization of the merged companies. The attitude of the merger too produces mixed results in the post take over performance of the companies, as was demonstrated by Kennedy and Limmack in their study conducted in 1996 (Hunt, 2004:205). A major study was conducted by Ronan Powell in 1997, consisting of 411 target companies and another 532 firms that were less likely to be taken over between the period 1984 and 1991. The idea behind the research was to model the effect of various factors on the mergers and acquisitions.
The result of his studies led him conclude that there are a large number of factors that determine whether a company is likely to be a takeover target. The factors include the size of the firm, growth, leverage, and poor stack price performance. Some other factors significantly affecting the possibility of takeover were liquidity and free cash flow. The research also determined the interrelationship between these factors. For instance, it was demonstrated that if a firm is smaller, then its free cash flow will be larger as will be its likelihood for a takeover.
In addition to this, Powell also analyzed the hostile and friendly takeovers separately. He found that the companies that were subjected to hostile takeovers were more likely to be larger in size, having lower liquidity and also lower profitability. In contrast, the firms that were subjected to friendly takeovers were more likely to be smaller in size and having higher leverage. Another recent study conducted in this area was conducted in United Kingdom by Paul Barnes analyzing the performance of stockholders of acquiring companies at the time of mergers and acquisitions.
The study was titled Why do Bidders do badly out of Mergers? Some UK evidence, and showed that the target company’s stock prices increased by 31. 5% on average during the period surrounding the announcement of a transaction while the stock price of the acquirer typically only increased by 1%. The results according to Powell were because of the eagerness of the acquiring management team to make the acquisition rather than enhancing the shareholder value (Hunt, 2004:206).
An often quoted study by a prominent financial economist Michael Jenson showed that share holders of the target firms often earn above average returns from the acquisitions, however, the shareholders of the acquiring firm earn return on an average close to zero. There have been several other studies that agree with this viewpoint. For instance, a study by McKinsey found that approximately 60% of the acquisitions they researched failed to earn returns greater than the annual cost of capital required to finance the acquisitions, while only 23% were successful.
Some studies also showed that because of this reason a high percentage i. e. 30-45% of the acquisitions are later sold and often at prices that produce a loss to the initial investment. Because of this many acquired businesses are spun off into independent companies such as the MCR spin-off by AT&T (Hitt, Harrison and Ireland, 2001:5). In addition, there are several acquisitions that have performed poorly. An example is that of the acquisition of Snapple beverage Co. by Quaker Oats for US $ 1. 7 billion in 19994, which was sold a mere three years later in1 997 for only US $ 300 million i.
e. a loss of US $ 1. 4 billion. Another example is that of Novell’s, a computer network company, acquisition of WordPerfect Corp. that resulted in a loss of US $ 700 million or 50% of the acquisition price within an year. Yet another example is of the acquisition of McDonnell Douglas Corp. by Boeing Co. in 1997. Three years prior to the said acquisition, the stock of McDonnell Douglas has quadrupled in value. However, in the months following its acquisition, the Boeing stock declined in value by 15%.
While some of problems were due to the manufacturing inefficiencies within Boeing, the company nevertheless had to eliminate several unprofitable airplanes from the McDonnell Douglas line. In addition, Boring also had to shut down bout 27 million square feet of its own production line by 2003. The guarantee for a success of merger cannot be given even for mega mergers. One of the examples of this was the acquisition of Waste management by USA Waste resulting in a performance that was 80% below the average of S&P-500.
Another example was the Walt Disney’s acquisition of Capital Cities/AMC, which resulted in a performance that was 80% below the average of S&P-500. This is not always the case however. There are many acquisitions that produce excellent positive results. The best example of this is Citigroup, a merger between Travelers and Citicorp, which has performed 75% above the average of S&P-500, since he completion of the merger in the year 1998 (Hitt, Harrison and Ireland, 2001:6). A study conducted in 2001 by Susan Trimbath, Halina Frydman, and Roman Frydman analyzed the Fortune 500 companies for at least a year between 1980 and 1997.
The study titled Cost Inefficiency, Size of Firms and Takeovers analyzed the determinants and effects of takeovers. Analysis echoes one of the results of the research conducted by Ronan Powell that a company would be at a higher risk of being acquired if it is inefficient. The result also demonstrated that most companies showed an increase in efficiency post merger or being acquired. In the same year i. e. 2001, Mary Zey and Tami Swenson analyzed the history com Fortune 500 companies in 1976 between the time period 1981 and 1995, for finding out the reasons that prompted M&A activities.
They concluded that one of the main reasons why many companies go in for mergers and acquisitions is when they can no longer accumulate adequate capital at an appropriate rate, and such an activity is mainly driven by external forces such as the change in tax laws such as the Tax reform Act of 1986 (Hunt, 2004:207-208). KPMG’s report of 1999 titled Unlocking Shareholder Value: The Keys to success in M&A, identified selecting the management team, resolving cultural issues and integration project planning as three of the six critical keys to successful mergers and acquisitions.
The results of the study also pointed out that the management of the integrations stage of the M&A is the key to achieving post-acquisition success. KPMG’s study also pointed out that 26% of the mergers and acquisitions are more likely to be successful if the acquiring company and its management teams focus on identifying the cultural issues. The details of the study are shown in detail in the Figure- 3 below. Figure – 3, Pre-deal activities and the increased chances of success (Howson, 2003:5)
However, the results of a 2002 survey conducted by KPMG itself showed that two-thirds of the companies brought between 1996 and 1998 still needed to be properly integrated. (Young and Scott, 2004:94). This entire exercise shows the importance of organization fit in mergers and acquisitions, an issue that will be discussed in detail in the present dissertation. The KPMG research study also reveled that the UK-US deals, that account for about half of all the cross-border deals are 45% more likely to succeed that the average, whereas the US-Europe deals were 11% less likely to succeed than average.
In fact the most frequent reason for the failure of the mergers and acquisitions is usually the differences in culture between the merging organizations. However, the latest study published by KPMG in January 2007, showed that this argument cannot be considered entirely accurate and is an oversimplification. The actual reason might be attributed to the failure of the management in integrating the culture but not the actual differences in the cultures themselves.
This is because the results of the KPMG research show that 80% of the respondent admitted that there were not well prepared for the integration of the organizations. The result echoes an earlier comment by Frits Grotenhuis in the year 2001, who stated that the impact of the cultural differences in mergers and acquisitions are significant but they are not insurmountable and can be managed (Rodenberg, 2008:53). 2. 5 Summary of chapter and key findings The literature review done in this chapter served to understand the basics of mergers and acquisitions, the differences between them and the different types that are possible.
In addition to this the advantages and disadvantages of M&As also helped in understanding the various risks associated with the transactions. However, the main part of the literature review was applying these concepts in understanding the important researches conducted in this area and the results obtained thereof. The crux of the chapter is that mergers and acquisitions are extremely risky strategic options that have become extremely necessary in recent times. Most of the M&A deals have either failed miserably or have failed to live up their expectations.
The management of the acquiring company must hence understand the necessity of the deal in enhancing their current position and the exact plan of achieving the same. In addition to this, the resulting M&A deal will be successful only when the post-acquisition integration is planned and executed properly. This means that the organization fit and means to achieve the same are an important part of the mergers and acquisition deals. These two form the basic hypothesis for the present dissertation which will be analyzed using various case studies in the chapters that follow.
