Mergers and acquisitions: For growth and diversification
Mergers and acquisitions are common business practices, particularly in industries like health care, technology, finance and banking
Md. Harun-Or-Rashid
Like all firms, banks can derive considerable benefits from merging, including economies of scale. In addition, there are considerable benefits to financial institutions from merging rather than expanding organically. Over time, banks will have built up a range of low, medium, and high risk borrowers. To expand organically, a bank may have to take on higher risk customers. However, if a bank acquires another bank it will not need to increase its average risk because it will acquire a range of customers of all risks. Banks can also merge to help securing extra liquidity.
Diversification of acquisition is a corporate action whereby a company takes a controlling interest in another company to expand its product and service offerings. In fact, mergers and acquisitions are common business practices, particularly in industries like health care, technology, finance and banking. With the rapid pace of innovation in the modern business world, its important to understand why and how M A occur. In a world dominated by companies of global reach, the big is always beautiful. Business houses like AV Birla Group and Tata demonstrate the power of acquisition led growth strategy. These companies accelerate their growth by acquiring smaller companies, which are either forced to be a part of M A or chose to be.
Earlier, the biggest mergers all of time was the 1999 takeover of Mannesmann by Vodafone Airtouch PLC at $202 billion. Most important among all the M A were the merger between Nations Bank and Bank America and the acquisition of ABN North America and LaSalle Bank by Bank of America. In 2000, America Online (AOL) acquired Time Warner for $164 billion. However, the benefits are accompanied by a multitude of risks as well.
A merger is the consolidation of two or more business organisations into a single entity whereas an acquisition is the transfer of ownership of an entitys stocks, equity interests or assets, sometimes without the consent of another company i.e. hostile takeover. The company acquires 100% or nearly 100% of assets of the acquired company with the objective of increasing market share and plant size, geographic expansion, diversifying product and services, gaining market power, or enjoying benefits of economies of scale. In the former case, new company could be formed by merging but in the latter case, no new company is formed.
Why companies merge? In many cases, synergy is the cause. This term refers to the practice of combining business activities to increase performance while decreasing costs. When two businesses have complementary strengths and weaknesses, merging makes strategic sense. In other cases, mergers occur as a means of diversifying or sharpening the focus of a business.
If so, what makes a company to merge with or acquire another company? The main reason behind this is the desire to compete or survive in the market. Apart from that companies agree to merge in order to gain market strength, to limit the competitors power, to make access to the market in a more effective manner and it also helps companies to lower the costs by using same production facilities and transferring technologies. Sometimes, investors hope to purchase companies whose products are undervalued in the market, in order to increase their values and to add value to their targets.
M A is a very good option for the companies that want to accelerate its growth and expand its business operations by adding product profiles or operations of other company. By merging, companies do have a lot of advantages in the market over other smaller companies whereas acquisition helps as a saver for the company which faces downfall. Also, sometimes ill motives lead to M A in a danger situation.
On the other hand, it seems logical to expect that shareholders of acquiring companies receive positive returns from the mergers, and enjoy significant positive returns while, on average, shareholders of acquiring companies received a zero return. Some of these acquisition activity resulted in negative returns and a trend towards restructuring in many companies.
For instance, Tech giant Microsoft merged with Nokia in an effort to make its position in the smart phone market. Despite the merge of Nokia hardware and Microsoft software, Lumia series continued to lag behind the Apple IOS and Samsung android smart phones. After that Microsoft purchased Nokias smart phone business for $5 billion as well as the companies patents of worth $2.18 billion. Earlier two companies were merged together but after a while, when the Nokia was facing downfall, Microsoft acquired Nokia for a grand total of $7.2 billion.
As the economy changes, so does the spending patterns of the people. Diversification into a number of industries or product line can help create a balance for the entity during these ups and downs. Diversification can boost the growth of the firm thereby leading it towards wealth maximization. However, it can also prove to be a costly failure for certain entities. A detailed analysis of the potential market must be conducted before opting for diversification.
Firms that merge can take advantage of a range of economies of scale, such as cost savings associated with marketing and technology. Economies of scope are also available to firms that merger and are benefits associated with using the fixed assets of one firm to produce output for the other firm. When firms merge, they can share knowledge with each firm benefitting from the knowledge and experience acquired by the other, may be able to allocate more funds to R D and generate new products as a consequence which may increase their competitiveness and profitability in the long run.
Notable, increased concentration and reduced competition are obvious disadvantages of a merger between two dominant firms. Firms that merge may experience diseconomies of scale, such as difficulties with co-ordination and control which will increase average cost in the long run, and reduce profitability.
Higher prices are a likely consequence of a merger because, with less competition, demand is more inelastic and raising price will raise revenue. The economies of scale and scope derived from a merger may increase barriers to entry and make the market less contestable.
Many have observed culture clashes (when two cultural groups get together and differences in their values or beliefs create misunderstandings or other problems) and they are the most common reason for the failure of M A. Many mergers have gone wrong in the past and have faced adverse effects, for instance, merger of AOL and Time Warner is considered the worst failure of all time. The two media giants saw immense opportunities in merging with each other but neither had anticipated the culture clash between the two companies or their fate at the hands of the bubble burst.
The latter forced the American economy into recession and AOL to a goodwill write off of nearly $99 billion in 2002 and subsequently AOL lost numerous subscribers and its share price fell from $226 billion to about $20 billion.
Employees are the core strength of an organisation and if there is no integration among them the organisation is destined to fall apart. Hence, one should check the compatibility of the two companies before the merger. M A pose great scope for growth of companies through expansion and diversification.
The company can mitigate the risks associated with it by prudent planning and compliance management. Remember, a weak or an unsubstantial reason could result in a wrong combination resulting in the huge waste of time and resources.
The writer is a Banker (Appraisal Unit) and a Certified Finance Specialist
