MERGERS AND ACQUISITIONS: RESTRUCTURING THE COORPORATE WORLD
Mergers, acquisitions and corporate control have emerged as dominant forces in the modern financial and economic environment. It is a widely held view that a strategic solution to financial distress in corporate organizations is M&As. Firm growth, improved efficiency and profitability are among the key benefits sought from M&As. Thus we can say that M&As have a major impact on the rest of the financial world.
In both Mergers and Acquisitions, there are two companies involved, the target and the acquiring company. There are two main types of M&As that take place. First, where the Acquiring Company buys out the Target Company, that is all the sales and business assets and the Target Company no longer exists. Second, there is M&A taking place through exchange of stocks and equities where the Acquiring Company buys the ownership of the company by buying a major stake at the table of the Target Company.
M&As can take place for various reasons like the Target Company not interested in business anymore or the Target Company being out of business or the Target Company predicting that they might not have a future in the market.
As on the buyer’s side, for the Acquiring Company to grow, they need new business. But sometimes to get into a new market, the Acquiring Company has to buy businesses as it may be tough to get into that specific market.
Investment Bankers are the major players in M&As. They are the ones who actually study the business models of various firms and companies, research if the companies are integrable and compatible, market their respective Target and Acquiring Companies and finally market those companies to come up with potential buyers and sellers.
AFFECT OF M&A ON THE STOCK MARKET:
M&A have quite an impact on the stock market and therefore, ultimately on us. The major factor is how the market reacts to the news of the merger or the acquisition, proving once again that the stock market is fueled by the emotions of the people in the market.
The usual theme during an acquisition is that the stock prices of the Acquiring Company declines and that of the Target Company rise. This is due to the fact that the Acquiring Company has to pay a premium for the acquisition. So people know that they will surely get profited by investing in the Target Company and therefore the stock prices of the Target Company increase.
In case of a Merger, the share prices of the new company that will emerge after the merger takes place is significantly higher than before the merger. This is because of the fact that after a merger takes place, the new company, as a combination of both Target and the Acquiring companies, is expected to have better resources and therefore are expected to perform better in the near future.
So what to do with your stocks? There are probably two scenarios, one where you own the shares of company involved in the M&A and second when you don’t own any shares of either company involved.
§ In case you own the stocks, there are two further scenarios. In an Acquisition, if you own the shares of the Target Company, it is better to sell the shares before the acquisition takes place as the price will lower once the Acquiring Company stops paying the premium involved and negotiated by both the companies. In case you own the shares of the Acquiring Company, the share prices will probably go down for a while but it will rise again once the Acquiring Company gains its momentum again. So it’s entirely up to you if you want to sell or not. In case of a merger, you should probably stay put and hold on to the stocks as the prices will rise.
§ When you don’t own any stocks of either of the companies, then it’s probably the best to stay away from the stocks of the companies involved in an Acquisition before it takes place as the prices may vary drastically depending upon the performance of the Acquiring Company. The best time to invest is just after the Acquisition has taken place as the prices of the Acquiring Company are very low and will most probably increase in the near future.
STEPS INVOLVED IN MERGERS AND ACQUISITIONS:
§ Determination of services by Acquiring Companies: The Acquiring Companies search for new opportunities to expand their business either in the same field or an entirely different market.
§ Identifying the potential Merger or Acquisition candidates: The next step is to find potential candidates that will actually be interested in the merger or the acquisition, here the investment bankers come into play.
§ Financial position and Hit: The risks involved and the consequences of the merger or the acquisition are analyzed.
§ Go or No-Go decision: The corporate leadership then decides whether to proceed with the M&A or not depending upon the risks involved.
§ Conduction of Valuation: The value Target Company is then analyzed by the lawyers and bankers of the Acquiring Company for negotiation.
§ Negotiation of a Definitive Agreement, and Execution of the transaction: The leaders of both the companies officially meet and complete all formalities according to the Securities and Exchange Boards.
§ Implementation of transaction and monitoring ongoing performance: This includes having a ready mechanism to deal with any future problem in the implementation of the deal.
EXECUTION OF PAYMENT:
There are a number of ways the acquiring company can pay like full cash payment, leveraged buyouts, security payments and even shares. Mostly, the transaction involved in M&A is a combination of cash and shares of the acquiring company. A certain amount is paid in cash by the Acquiring Company and rest in terms of shares of the Acquiring Company.
DIFFERENT WAYS TO PAY THE TARGET COMPANY BY SHARES OF THE ACQUIRING COMPANY:
Let’s say that the Target Company is T and the Acquiring Company is A.
Then A has to pay T in shares in terms of a special EXCHANGE RATIO that both the companies agree upon as decided by their lawyers.
Exchange Ratio is basically the parameter on the basis of which the merger occurs. It is defined as the shares of A that T will receive per a specific number of shares that T owns. Exchange Ratio can vary according to the method involved during the valuation of both the companies.
1) Based on Intrinsic Value per share of both the companies:
Exchange ratio is equal to the intrinsic value per share of T divided by the intrinsic value per share of A. Suppose if ER is equal to 1/10, which will mean that T will get 1 share of A per 10 shares that T owns. So we can say that A is valued ten times as higher as T.
2) Based on Earnings per Share of both the companies:
Exchange ratio is equal to the earnings per share of T divided by the earnings per share of A. So if the ER is equal to 1/4, this will mean that T will get 1 share of A per 4 shares that T owns.
3) Based on Market Value per Share of both the companies:
Exchange ratio is equal to the earnings per share of T divided by the earnings per share of A.
4) Exchange ratio can also be equal to a combination of any 2 out of the three methods. For example the ER can be equal to Intrinsic Value per share of T divided by the Market Price per share of A, or Earnings per share of T divided by the Earnings per share of A and so on.
5) Exchange ratio can also be equal to the weighted average of all the methods given above.
All of it depends on the negotiation taking place between the two companies.
WHO BENEFITS FROM M&As:
In a way both the Target and the Acquiring Companies benefit from the Merger or the Acquisition
§ Obtaining quality staff or additional skills, knowledge of the industry or sector and other business intelligence. For instance, a business with good management and process systems will be useful to a buyer who wants to improve their own. Ideally, the business they choose should have systems that complement their own and that will adapt to running a larger business.
§ If a business is underperforming. For example, if a company is struggling with regional or national growth it may well be less expensive to buy an existing business than to expand internally.
§ Accessing a wider customer base and increasing the market share. The target business may have distribution channels and systems the acquirers can use for their own offers.
§ Diversification of the products, services and long-term prospects of their business. A target business may be able to offer acquirers products or services which they can sell through their own distribution channels.
§ Reducing the costs and overheads through shared marketing budgets, increased purchasing power and lower costs in case of a merger.
CONCLUSION:
Mergers and acquisitions are part and parcel of the business operation and functioning and many companies opt for the same in order to provide an upper hand to tier business. This process of merger and acquisition tends to affect the financial aspects of the company in the immediate aftermath and will be based on how the companies tend to perform in the long run. If the company runs in line with its operational goals then it is likely that the stock price will grow with time.
