Failure Risk In M&A

The failure risk in M&A

Abstract: With the development of business and regulation, more and more companies seek to increase revenue, search for further growth and lower cost through merger or acquisition. There are many motives behind the M&A activity. But according to in depth analysis of studies conducted from 1979 to 2000, About 14 of 24 studies report positive combined returns, it means about 40% combination didn’t bring positive returns for acquiring companies’ shareholders. In this article, I will illustrate why the acquirer didn’t perform well after the purchase and why some M&A activity didn’t come true.

Key words: Merger and acquisition, Synergies, Valuation, People, Value;

в... An introduction to M&A

Companies choose merger and acquisition activities for many reasons. Briefly speaking, the companies use merger and acquisition to achieve growth, or diversify their business. They can change current operation condition through merger or acquisition. The first major spurt of mergers occurred around the 1895-1905 period and primary involved horizontal mergers . M&A generally refers to two businesses combination. And there is a distinction between acquisition and mergers. An acquisition is the purchase of some portion of one company by another. It might refer to the purchase of assets from another company, the purchase of a subsidiary. If the company buys the entire target company, the takeover should be regarded as a merger. And a merger is a combination of two companies into one larger company. So after the merger, only one company will remain and the other will no longer exist as an entity. A merger offer is referred to as either friendly or hostile. If the companies cooperate in negotiations, the offer is regarded as friendly; And if the takeover is opposed by the target company’s management team and it is unwilling to be bought. The merger offer is hostile. Whether a merger is friendly or hostile is important because the target company’s management team will defend the merger if they consider it as a hostile offer and the takeover process will be more complicated and longer. Generally, merger usually refers to a purchase of a smaller firm by a larger one, but that is not always the case.

в...Ў Motives behind M&A

Dominant company managers may consider a lot of reasons for mergers and acquisitions, such as the search for economies of scale or cost saving through integration.

Synergies; Among the most common motives for a merger is that it will create synergies. It means that whole of the combined company will be worth more than the two companies would be worth if operating separately. Generally speaking, synergies created through a merger will either reduce costs or increase revenue. Cost synergies can be achieved through economies of scale. Revenue synergies are typically created by cross-selling products, expanding market share, or raising prices to take advantage of reduced competition. Managers often turn to merger and acquisition to grow their companies’ revenues. Merger and acquisition is especially common in mature industries and it is considered less risky way to merger with an existing company than developing an unfamiliar market. Acquisitions can also create tax advantages that investors can not gain on their own. A profitable company can buy a loss maker to use the target's loss to reduce their tax liability. However, in the United States and many other countries, regulators are limiting the tax motive of an M&A activity. They do not approve mergers that are carried out purely for tax advantage. Synergy estimates should be the most important factor in M&A analysis because it determines the value of transaction and the value added to the acquirer’s shareholders. Therefore it also determines whether the M&A is successful.

Diversification; There are many motives are considered to not add shareholder value. Managers may regard the need to diversify the firm’s revenue resource as the reason for mergers. Diversification through merger and acquisition has a high risk of failure. Managers need a very professional analysis on the corporate financial condition and business culture to seek for a success in diversification. It means the acquirer interested in diversifying should have understanding of the industry it is entering and its current strength. So the dominant company should better have the ability to transfer its current skills. An acquirer can focus on one or two fields for its goal of business diversification other than several areas with which it is not familiar. In fact, research has revealed that conglomerates trade at a discount relative to the sum of the value of individual business. It means the whole is less than the sum of the individual parts.

Manger’s compensation; It is the motive that do not add shareholder value. The executive management teams will get their payout based on the profit of the company, this strategy would give the team an incentive to buy companies to increase the company profit. But because the total outstanding of shares will also increase after the business combination, the profit per share perhaps won’t increase. So it doesn’t add value to shareholders and it hurts the owners of the company but benefit the managers. If it does happen, we will consider it as an unsuccessful M&A strategy. Synergies transaction can create value for shareholders that they would unable to create on their own or through internal investment.

в...ў Measures of M&A success

Success in merger and acquisition is driven by both the structure of the merger and acquisition deal and the conduct by which one pursues it. The structure of the M&A environment refers to economics, strategy, organization, brand, Law and ethics. The conduct in merger and acquisition activity refers to the management of the process. Measures of M&A Success are generally the creation of market value, financial stability, improved strategic position, organizational Strength, enhanced brand and observance of letter and spirit of ethical norms and laws. A merger or acquisition is more likely to be successful if the dominant company has a clear strategy. The opportunity will benefit the person who has good preparation. And sometimes, many companies do not have a profound investigation on the target company, and they have no clear purchase strategy or business concept after the merger activity. They just subjectively believe that this is an attractive opportunity according to current economic environment. Typically, merger or acquisitions