Mergers and Acquisitions in Corporate Financial Management

This article discusses the benefits of mergers and acquisitions in corporate expansion, types of M&A, stages involved in M&A, and evaluation of cash offer and share exchange as a form of consideration for M&A. It also provides examples of successful M&A deals. The document type is coursework and the subject is corporate financial management. No course code, course name, or college/university is mentioned.

MERGERS AND
ACQUISITIONS
CORPORATE FINANCIAL MANAGEMENT
COURSE WORK

TABLE OF CONTENTS
INTRODUCTION................................................................................................................................2
CASE STUDY EVALUATION............................................................................................................4
a) Benefits of Mergers and Acquisitions in corporate expansion.........................................................4
b) Evaluation of ‘cash offer’ and ‘share exchange’ as a form of consideration for Mergers and
Acquisition..............................................................................................................................................5
i. Cash Offer...................................................................................................................................5
c. The main reasons for the high failure rate of mergers and acquisitions in enhancing shareholder
value........................................................................................................................................................8
CONCLUSION...................................................................................................................................10
REFERENCES...................................................................................................................................11

INTRODUCTION
Merger is combining of two separate companies, usually of comparable sizes, to form
one new company. Both the two old companies become equal partners. An example to
explain this, when the two firms Daimler-Benz and Chrysler merged, both the firms
ceased to exist, yet a new company, DaimlerChrysler, was formed. Acquisition is the
term used when one company, usually small in size, is taken over or purchased by
another company, usually larger. Through acquisition no new company emerges, rather
the acquired company ceases its existence and its assets become a part of the acquiring
company. Together, Merger and Acquisition (M&A) is defined as a consolidation of
companies. In the world of corporate finance Merger and Acquisition is a major aspect.
Companies decide to take up the route of merger and acquisition with the objective to
maximise wealth (Miller, 2017).
What are the reasons for Mergers and Acquisitions?
There are various reasons why companies decide on mergers and acquisitions such as
improving company’s performance and quicken growth, increasing the market share
and positioning, financial synergy for lower cost of capital, increasing economies of
scale, diversification for higher growth products or markets, giving broader market
access, strategic realignment and technological change, etc. (Bessembinder & Zhang,
2015)
What are the Types of mergers and acquisitions?
Merger, also known as amalgamation, may be done in two ways: merger through
absorption and merger through consolidation (Cooper and Finkelstein, 2007). Looking from
an economic point of view, mergers can be divided into 3 types depending on the
industrial background of the businesses that are forming the combination, such as:
 Horizontal i.e. two business are in the same industry
 Vertical i.e. they are at different production stages or value chain; and
 Conglomerate i.e. dissimilar businesses
How does merger and acquisition take place?

Mergers and Acquisitions can be done by various means such as by buying of assets, by
buying of common shares, by interchanging of shares for assets or shares for shares.
(J.M. Ramanuj, 2012)
What are the Stages involved in any kind of Merger and Acquisition?
Stage 1 Pre-acquisition review
Stage 2 Searching and screening of targets
Stage 3 Target investigation and Valuation
Stage 4 Target Acquisition through negotiation
Stage 5 Post merger integration
These are the stages that take place when two companies agree on a merger and
acquisition (M&A).

CASE STUDY EVALUATION
a) Benefits of Mergers and Acquisitions in corporate expansion
Mergers and acquisitions help a business to grow without having to wait for years for
the marketing and sales strategy to pay off. Companies go for merger and acquisition
primarily to secure an opportunity to achieve growth in its current line of business and
expand in the area of product or service line in a new market that the business currently
does not serve. The benefits of Merger and Acquisition are as follows: , . .
 Growth and expansion: When a business tries to expand internally, it would require to
make heavy investment in the marketing and sales channels, which actually locks the
money of the business, making it difficult for the business to operate. This method of
growth would take years to have a moderate growth. Thus, it is more favourable to buy
a business that is small in size but doing well in its line of product/service, thus costing
less and also expanding quicker. (Yaghoubi, Locke and Gibb, 2013).
 Capital, Cash and Credit: It is a difficult task to get credit and loans from banking
institutions. Merging can make it easier for any company to get the loan approved as
merging increases the value of the company.
 Diversification: Sometimes in merger and acquisition, the company or entity that has
been acquired has a different line of product or service that the acquiring entity. This
allows the acquiring entity to diversify its line of product which is also complimentary
for the business.
 Entering global market: The international Merger and Acquisition gives the
opportunities to quickly enter foreign market where the company was not present
before. The company acquired have been present and have gain recognition and
goodwill in the country. By the help of merger and acquisition the acquiring company
also becomes a part of the foreign market very easily, which, if tried to achieve through
marketing and sales would have taken years since it is quite a challenge to penetrate a
market that the company has no experience with. (Ghosal and Sokol, 2013)
 Increase in revenue: The business offering two products may offer 5 after the merger
and acquisition. Thus the revenue earning will increase
 Reducing competition: When the market share and territory of a business increases, it
becomes harder for others in the same market to compete. Thus there is an elimination
of competition. They will either have to manage with very small share in the market,
cease their operations or become a part of the big company as another acquired
company.
 Access to trained and quality staff: With merger and Acquisition, the management
and employees of the acquired company also becomes a part of the asset sale of the

acquiring company. Therefore, there is an inflow of a pool of talent with experience and
knowledge of the industry or operating sector or foreign market.
These are some of the benefits that a successful merger and acquisition offers to a
company which takes up merger and acquisition as an opportunity to expand its
business (Soongswang, 2011).
Some examples where merger and acquisition helped businesses to grow and expand:
1. Sherwin-Williams agreed to reduce its competition by taking over Valspar for $11.3
billion. The deal gave Sherwin-Williams the access to places where Valspar already had
a good presence. The merger would also accelerate Sherwin-William’s growth in
foreign markets such as Asia, Europe and the Middle East.
2. Canadian utility operator Fortis Inc. buys Novi-Michigan Based ITC holdings in $11.4
billion. The acquisition would give Fortis a foothold in the Midwest and give the
combined company an opportunity to expand.
3. Microsoft bought social networking company LinkedIn for $26.2 billion in an all-cash
deal. This merger took LinkedIn’s stock up by 47% in trading and accelerate the growth
of LinkedIn and Microsoft Office 365 and Dynamics.
b) Evaluation of ‘cash offer’ and ‘share exchange’ as a form of consideration for Mergers
and Acquisition
i. Cash Offer
1. The Meaning of Cash offer, its advantages and disadvantages:
In case of merger and acquisition, Cash Offer means an offer to buy a publicly traded
company in exchange for cash. It differs from other types of takeover offers that
may buy the company in exchange for stock and/or debt.
The Advantages of Cash Offer:
The advantage of using Cash Offer is that the purchase price will be certain and fixed. It
is a less risky transaction for both the companies as the value of cash does not fluctuate
like stocks do. Using cash gives the advantage of a guaranteed purchase price over the
fluctuating price of stock. Another advantage of using cash offer for merger and
acquisition is that is prevents dilution of ownership of company. A cash acquisition
gives the advantage that the ownership stays with the company. (rodek, 2017)
The disadvantage of Cash Offer:
The disadvantages of Cash Offer is that the cash reserve will be used up, which is the
most liquid asset. Therefore, there is a loss of liquid asset. The fixed assets of the
company are difficult to convert to cash in the short run. Another problem with Cash
Offer is that it can result in debt problems in case the Cash offer is made with the help
of bank loans. The more the amount of debt the company holds the higher will be the

company’s annual interest payment which will eventually create cash flow problems.
This would also make the acquiring company seem riskier to the lenders. (rodek, 2017)
2. Due to lack of cash reserve, effects of having to source funds through rights issue
(Equity) and borrowing (Debt) to finance the Merger & acquisition:
Right shares (Equity):
The key difference between a Cash Deal and Equity deal can be understood clearly from
the resultant balance sheet, where in all cash deal the capital balance is not affected.
However in case of “all equity” deal the capital balance of the resultant balance sheet is
affected. In simpler words the equity portion of the balance sheet of the parent company
remains unchanged. Whereas in case of an all-stock deal it is a direct contrast where the
equity portion of the balance sheet in the resultant company gets affected. (Alsharairi,
Black & Hofer, 2015)
Looking at the trends, in 1988, 60% of all mergers were paid in cash and these were not
just small value but had huge sum of money involved. Only 2% of the deals were made
through stock exchange. A decade later this scenario has completely reversed. Almost
50% of the total deals made were by exchange of stock and cash mergers kept as low as
15%. This is purely because; in case of stock exchange the liquidity position of the
parent and the resulting company remains healthy. In today’s world a healthier liquidity
is of utmost importance as a cash rich company is preferred more.
Funding a merger and acquisition is through exchange of equity shares has become the
most common practice of funding mergers. Making right offering to the existing
shareholders can also finance mergers and acquisitions. A ‘right offering’ is an offer
made to the existing shareholders, to purchase additional shares, at a price, generally
discounted, known as the exercise price or subscription price. A right will give the
existing shareholders the right to purchase new shares at a discount rate as compared to
the market price on a future date. That is the company is giving its existing shareholders
a chance to increase their shareholding, at a discounted price on a future date. Further
between the date of right issue and issue of equity shares, the shareholders who has
exercised the right can transfer the rights subscribed. This feature off transfer ability
makes right issue as an option of dividend payout. As right shares are issued at a
discount, shareholders always have the chance to trade off the right shares subscribed at
the prevailing market rate. (Ringe, 2016).
Right shares are a very good option for the shareholders but when it is used as an
instrument to fund mergers and acquisitions, the same can prove to be challenging. The
risk of under subscription, at a discounted price, and transfer-ability can affect the
funding of merger and acquisition adversely. Further adding to the risk is the market
volatility. Once the news of a merger hits the market, movement of stock prices
becomes inadvertent. No matter how well an existing company does pre-and post-

merger, there is always a risk of drop in stock prices. Shareholders may feel nervous
and trade off shares. These risks become challenges to funding mergers and acquisition.
(Gregoriou & Neuhauser, 2007)
A merger or an acquisition has a determined purchase price by value, now if the per unit
share price of the right shares drops then there is always a risk of short funding. Further
the transfer ability of right shares keeps the resulting company in doubt about the final
shareholders of the company.
The year 2016 has been a bad year for stock finished merger and acquisition
transactions. The S&P 500 has moved by 1%, 16 times during the first 26 sessions of
2016. There was only one merger and acquisition deal over $1 billion that got financed
entirely through stock. (Kwoka, 2014).
Risk-taking shareholders will prefer rights shares to cash. Right shares can turn out to
be a preferable option for the shareholders of the bidding company. The reason behind
is that right shares will be offered at a discounted price. Hence there is a straight away
surplus in the hands of the shareholders. Also as right shares are easily transferable, a
shareholder always has the option to move out of the resultant or the merged company if
situations turn out to be not as expected. Thus the risk of the shareholders of the bidding
company is safely covered in case of rights shares. But when compared to an all cash
deal of Merger and acquisition, Right Share as a source of funding M&A turns out to be
riskier. A Cash deal is risk free, but others are not. (Fridolfsson and Stennek, 2000).
Borrowings:
External borrowing as a source to fund mergers and acquisitions is a costly affair. A loan comes
with a fixed financial charge, better known as interest. Even if the interest rate keep low, the
total cost can add up during a million merger and acquisition deal. An external borrowing can
be cheaper than the equity boring when the interest rates are lower than the rate of return of
capital employed. An external borrowing will affect the financial leverage position of a
company and where cost of debt is lower than cost of equity, financial leverage will be
favorable, Vice versa.
External borrowings will increase the gearing ratio of a company that is a company is gearing
ratio will increase. Highly geared capital structure is a situation where the company has a huge
portion of debt capital and lower proportion of equity capital. A highly geared capital can give
favourable financial leverage results when cost of debt is lower than cost of equity. But the
scene is a pain when the company is operating profit is not sufficient to fund the interest
portions of the borrowed capital. This may lead to capital erosion. Mergers and acquisitions
funded through external borrowings will generally have a higher capital gearing, which if not
balanced adequately with the market situations can result in an unsuccessful merger or
acquisition (FAULÍ-OLLER, SANDONÍS and SANTAMARÍA, 2011).
Though an external borrowing will come with a fixed cost of capital, and also a tax shield but
the same is also a fixed financial burden that has to be met compulsorily. This is known as the
financial risk.

3. Advantages and disadvantages of cash offer on target companies shareholder:
Paying with cash is a favorable alternative in case of mergers and acquisitions. Shareholders of
the target company always have higher preference of cash deals rather than the other than cash
deals. Cash transactions are instant, free of any mess and complication and do not require any
management complications as in the case of stock exchange transactions. (Emott, 2011)
Further more the value of cash is not volatile and it does not depend on how the company is
performing or is expected to perform in the future. Cash transactions are quick, easy; free of
complications and for the same it is highly preferred by the receiving shareholders. (Schade,
2014)
Only one exception that can come to cash offers is when the buying company has to pay the
selling company shareholders in multiple currencies. Here different currencies have different
exchange rates, and the same are market driven. This exchange rate risks is the only risk that is
associated with cash transactions. Currency exchange fees can also add up as an extra cost to
multinational acquisitions or mergers.
c. The main reasons for the high failure rate of mergers and acquisitions in enhancing
shareholder value
Merger and acquisition can be valuable means to increase the scale of operations,
broaden the portfolio, enter into new market zone, improve existing products or
services, acquire talented employees, scale up the brand value and create value to the
shareholders. The shareholders can determine whether the process of merger and
acquisition is adding value or not only after considering all the necessary measures and
doing a valuation of the target company. However, not in all situations the merger helps
to create value. In certain situations there is a failure in creating shareholder value or
there is a devaluation. This success or failure in creating the value depends on the initial
planning and the execution of the merger and acquisition. If the right approach is
followed to execute the targeted plan then there will be an addition to the value, on the
other hand, if the approach is not correctly followed, no addition in the value will be
achieved (Ceil, 2013).
Reasons for the failure of merger and acquisition to add value:
Overvaluation: Sometimes, fraudulent accounting practises are the causes of
overvaluation of an acquisition. At times, simple misjudge or false assumption of the
market or trend may raise the valuation of the acquisition.
Intervention: Even if two companies agree to the terms and conditions of a merger or
acquisition, third parties may interfere with ulterior motives, adding restrictions that
prevent a merger from becoming final or achieving its intended goals. Those third
parties are governments in most cases.

Fear and greed: sometimes, merger takes place between companies, solely, due to fear
in decline, rising in the cost, dramatic changes required or due to the greed for higher
revenue. These are entirely wrong reasons and they pursue companies to merge. In these
cases, valuation of shares do not happen.
Cultural differences: The work culture and the people in a business are familiar to a
certain kind of work environment. When the businesses merge, cultural differences
might occur since people take time to adjust to new environments. Mergers or
acquisitions in many cases bring together people who have been competing against each
other for many years of their working lives.
Some examples to explain the failure in enhancing the shareholder value is as follows:
Hewlett-Packard (HP) acquired the Compaq Computers and the Palm Inc. in the early
2000 so as to compete against Dell Computer and Apple. But with the acquisition of
Compaq, the market trend for HP computers started declining, and it went completely
against the market leader with the acquisition of Palm Inc. The stock kept falling ever
since the acquisition had taken place.
Bank of America (BAC) acquired the Countrywide Financial (CF). But BAC being
conservative as a banking culture was not able to blend well with the aggressive culture
of CF. Due to the cultural differences, the shares kept falling, expected revenue failed to
pick and hence losses were faced.
Proper planning was missing in the acquisition of Sterling Chemicals by Eastman
Kodak. The amount that Eastman Kodak paid to acquire Sterling Chemicals did not
match with the core idea of the business. Since then, the stock of the two company has
been falling.
This proves that Merger and Acquisition is not always in the favour of shareholders,
especially if merger and acquisition takes place without proper planning and execution.

CONCLUSION
There are numerous ways of funding mergers and acquisitions. It should be noted that
cash versus stock decision is only relevant to strategic buyers. A strategic buyers refers
to a company who is operating in the same industry and a merger or acquisition will
help in expansion of market share or dealing with competition.
Hence the method of funding should be driven by a number of factors. When liquidity is
important for the resultant company to operate or fight threats, cash dealings should be
avoided. Instead of making a choice between cash or stock of merger and acquisition
can also be funded by both. Are part of the consideration decided can be funded by cash
and the rest can be done by exchange of equity shares. In this case both the advantages
and disadvantages will neutralize and come down to a situation which is acceptable to
all.

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