Mergers and Aqusitions

What are the main benefits assumed to flow from a merger or takeover? Why do so many mergers and takeover fails to deliver improved financial performance? Illustrate your answer with relevant financial case study?

A takeover is when one company takes over another and clearly establishes itself as the new owner. This purchase is known as an acquisition, the target company ceases to exist and the buyers stock continues to be traded from a legal point of view. Now a merger is when two companies (they are often about the same size and have factors in common in terms of product) agree to go on forward as a new company rather than remaining separately owned and operated. Both the company stocks are surrendered and a new company stock is issued in its place.

For example Daimler-Benz and Chrysler no longer exist when they merged but now a new company “DaimlerChrysler” was created ,(McClure in investopidia)

A purchased deal can also be called a merger when both CEO's agree that joining together will be the interest of both company ,as Vos & Kellerher.,2000 stated that theoretically a company will enter an acquisition or merger if they believed that the Net Present Value combined is greater than when separated, and also the economic value combined is greater than when the firm is separated, but if the deal is unfriendly that is if the target company does not want to be purchased it is referred to as an acquisition. Firms are acquired for a number of reasons.

In the 1960s and 1970s, firms such as Gulf and Western and ITT built themselves into conglomerates by acquiring firms in other lines of business. The main reasons why merger and takeover occur are to create shareholder value over and above that of the sum of the two companies. The reasoning behind this idea is that two companies together are more valuable than two separate companies. This idea is especially appealing to companies when times are tough. Strong companies will buy other companies to create a more competitive, more efficient market.

They will come together hoping to gain greater market share and to achieve higher efficiency and because of these potential benefits smaller companies will often agree to be purchased when they know they cannot survive alone. From the perspective of business structures different mergers exist such as: Horizontal merger, vertical merger, Market-extension merger and Product-extension merger. ,(McClure in investopidia).

According to Haslam(20074/8) mergers will generate synergies since one firm is weak the other that is stronger will provide strength. Synergy is the magic force that allows for enhanced cost efficiencies of the new business. It takes the form of revenue enhancement and cost savings Synergy is a stated motive in many mergers and acquisitions. Bhide (1993) examined the motives behind 77 acquisitions in 1985 and 1986, and reported that operating synergy was the primary motive in one-third of these takeovers.

More benefits of mergers are economies of scale, a bigger company placing the orders can save more on cost. The company’s purchasing power will be increased, buying in bulk (such as equipment or office supplies or raw materials can help the company have greater ability to negotiate prices and getting bulk discounts).

There will be staff reductions as every employee knows that mergers tend to mean job losses but the company will save more cash reducing the number of staff. Merging companies may acquire new technologies because to stay competitive they need to be on top of technological developments and their business application. By buying a smaller company with certain unique technology the bigger company may maintain or develop a competitive advantage.

Haslam(2007/8) further explained that mergers will increase the market dominance of the firm meaning it will improve their market reach and industry visibility, a merge may expand two companies marketing and distributions, giving them new sales opportunities, it can also improve a company’s standing in the investment community, bigger firms often has easier time raising capital than smaller firms.

Moreover the debts capacity of a company may increase because when two companies join together their earnings and cash flow may become more stable and predictable. This will allow the company to borrow more money in terms of loans as an example. Now tax benefits may also arise due to acquisition taking advantage of tax laws or from the use of net operating losses to shelter income.

Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden. Although there are all these possible benefits with mergers and takeover, many still fails to bring up their performance after merging. Why do so many mergers and takeover fails?

“The amount of time and energy needed to successfully merge two sophisticated organizations is more likely to resemble the planning and execution of the invasion of Normandy, accompanied by the resultant clash of cultures from many elements attempting to work together towards one end. This corporate failure to consider and plan for the long-term consequences can result in financial problems, loss of employee loyalty, lowered employee morale and reduced productivity.” Salame(2006).

In recent years cross-border mergers has increased mainly due to globalization for example Daimler-Chrysler deal, Exxon-Mobil and Alcoa-Reynolds. However although mergers and takeover are aggressively being undertaken by companies, recent studies have indicated that 60-80% of all mergers are financial failures when measured by their ability to outperform the stock market or to deliver profit increases.

A study in 1997 at PricewaterhouseCoopers global study concluded that the main reasons of merger and takeover failures are because of the lack of attention to people and related organizational aspects contribute significantly to disappointing post-merger results. A study by Watson Wyatt based on a survey of 1,000 companies revealed that more than two-thirds of companies failed to reach their profit goals following a merger, and only 46% met their cost-cutting goals

So based on the research of Salame(2006) mergers failed because of these following human resource reasons, first is the lack communication. Poor communication between people at all levels of the organization, and between the two organizations that are merging, is one of the principal reasons why mergers fail. There is also the fact that managers tend to withhold information from employees which can cause major problem because it will contribute to confusion, uncertainty and a loss of trust and loyalty on the part of the employees.

Another cause to the failure would be a lack of training, not only for employees but senior managers and HR professionals who are supposed to oversee the merger process. Loss of Key People and Talented Employees is another reason why mergers failed. “An increase in the turnover rate of productive employees is one of the greatest prices of corporate mergers.” Salame(2006).

Lastly but not least from R.Salame(2006) the reasons for failure is because of Corporate Culture Clash. Business International states that poor communications and inability to manage cultural differences are the two main causes of failed mergers. Cultural differences that cannot be resolved affect communications, decision-making, productivity and employee turnover at all levels of the organization. An example of a failed merger is The DaimlerChrysler Merger.

On May 7th, 1998, Eaton announced that Chrysler would merge with Daimler-Benz. Thanks to a $37 billion stock-swap deal, the largest trans-Atlantic merger ever, Chrysler would not "do it alone" any longer. Daimler-Benz CEO Jürgen Schremp hailed the union as "a Merger of equals, a merger of growth, and a merger of unprecedented strength" In 2001, three years after a "merger of equals" with Daimler-Benz, the outlook is much bleaker.

DaimlerChrysler's market capitalization stands at $44 billion, roughly equal to the value of Daimler-Benz before the merger and Chrysler Group's share value has declined by one-third relative to pre-merger values. Its key revenue generators –the minivan, the Jeep SUV, and the supercharged pickup truck – have all come under heavy competition from Toyota, Honda, General Motors and Ford.

So why did the merger failed: Culture clash

Although DaimlerChrysler's Post-Merger Integration Team spent several million dollars on Cultural sensitivity workshops for its employees on topics such as "Sexual Harassment in the American Workplace" and "German Dining Etiquette," the larger rifts in business practice and management sentiment remain unchanged.

The dislike and distrust ran deep, with some Daimler-Benz executives publicly declaring that they "would never drive a Chrysler". With such words flying across public news channels, it seemed quite apparent that culture clash has been eroding the anticipated synergy savings. Much of this clash was not good to a union between two companies which had such different wage structures, corporate hierarchies and values.

Furthermore, Chrysler and Daimler-Benz's brand images were founded upon diametrically opposite premises.Chrysler's image was one of American excess, and its brand value lay in its assertiveness and risk-taking cowboy aura, all produced within a cost-controlled atmosphere. Also distribution and retail sales systems had largely remained separate as well, owing generally to brand bias.

Another main reason why the merger failed was because of mismanagement. During 1998-2001, Chrysler was neither taken over nor granted equal status. It floated in a no man's land in between. The managers had built Chrysler's "cowboy bravado" were no more. Some remained on staff, feeling withdrawn, ineffective and eclipsed by the Germans in Stuttgart. Others left for a more promising future at G.M. or Ford. The American dynamism faded under subtle German pressure, but the Germans were not strong enough to impose their own managers.

So we have seen that culture is the main reason for merger and acquisitions failure. Synergy savings are only achieved when two companies can produce and distribute their wares more efficiently than when they were apart. Owing to culture clash and a poorly integrated management structure, DaimlerChrysler is unable to accomplish what its forbears took for granted three years ago: profitable automotive production so that’s why it was a failed merger

Referencing

People.stern.nyu.edu/adamodar/pdfiles/papers/acquisitions.pdf Accessed date:21/02/2013

C.Haslam(2007/8) “business analysis and decision making”p.143- university of London 2007

Rita Salame(2006) “Key strategy”pdfiles-www.keystrategy.com

http://www.ehow.com/about_5569053_different-types-mergers.html Accessed date:21/02/2013

http://www.investopedia.com/university/mergers/mergers1.asp#axzz2Mb6VjgjK Accessed date:21/02/2013

http://www.wsws.org/en/articles/1998/05/mzzg-m08.html Accessed date:21/02/2013