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7/29/2019 Mergers and Acquisitions From Financial Prospective
http://slidepdf.com/reader/full/mergers-and-acquisitions-from-financial-prospective 1/22
Mergers and AcquisitionsFrom Financial prospective
By Mohamed Khalifa et. al.
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ContentsAbstract ......................................................................................................................................................... 2
Introduction .................................................................................................................................................. 2
Mergers or Acquisitions defining the terms ................................................................................................. 4
Reasons for Mergers and Acquisitions ......................................................................................................... 4
Types of Mergers and Acquisitions ............................................................................................................... 8
Financing the mergers and acquisitions ....................................................................................................... 9
Valuation Matters ....................................................................................................................................... 10
Financial Analysis in Mergers and Acquisitions .......................................................................................... 12
Due Diligence .............................................................................................................................................. 16
The Risk in Trade-Offs between Buyers and Sellers in Mergers and Acquisitions ...................................... 17
Conclusion ................................................................................................................................................... 19
References: ................................................................................................................................................. 21
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Abstract
The consequences of mergers and acquisitions on corporate financial performance, there are
factors that might affect the performance of corporations such as synergies. This paper aims at
reviewing and analyzing these factors on mergers and acquisitions and its effects on the financial
performance. Previous reviews and literatures are using varieties of measures to examine the
impact of mergers and acquisitions on corporate financial performance, this paper concluded that
there are some factors that affect the financial performance, as follows:
1. Methods of payment
2. Methods of valuation.
3. The extent of synergy.
4. Objective of the M&A.
5. Accuracy of Due Diligence.
6. The risk level borne by each party.
Corporate managers should bear in mind such factors and their impact on the post-merger and
acquisition corporate financial performance to evaluate the proposed offers of mergers and
acquisitions accurately and take profitable decisions.
IntroductionMergers and acquisitions (M&A) are an aspect of corporate strategy, finance and management
dealing with the buying, selling, dividing and/or combining of various companies and similar
entities that can aid an enterprise grow faster in its respected sector or geographical location, or a
new market or new location, without creating a subsidiary, other child entity or using a joint
venture. M&A are a large portion of the corporate business world. According to the
investopedia.com website, every day, Wall Street investment bankers operate M&A transactions
that bring companies together to create bigger ones. Deals can be worth hundreds of millions, or
even billions, of dollars. These mergers can record the fortunes of the corporates involved for
years to come.
M&A represent the ultimate in change for a corporate; for the business managers no other event
is more difficult, challenging, or chaotic as a merger and acquisition. It requires that everyone
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involved in the M&A process has a very clear understanding of how, where and when the
process works.1
The term "merger", is used when referring to the merging of two companies forming one new
company that will continue to exist. The term "acquisition" refers to the acquisition of assets by
one company from another one. In some cases of an acquisition, both companies may continue to
exist.1
There is several numbers of motives that may play a role in merger activity. The most general
motive is simply that the acquirers consider the acquisition to be a profitable investment. Firms
will go for acquisitions when it is the most profitable means of enhancing capacity, obtaining
new experience or skills, entering new market or geographic areas, or reallocating assets into the
control of the most effective managers. That’s why; many of the factors that affect the decisionof major investment would also influence merger activity.2
According to the Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA)
analysis in Table 1, The Largest Mergers and Acquisitions Transactions that occurred
worldwide since 01 January 1985 till 19 January 20123
Year Acquirer Target Transaction Value
(in billion USD)
1999 Vodafone AirTouch PLC Mannesmann AG 202.82000 America Online Inc. Time Warner 164.7
2007 Shareholders Philip Morris Intl Inc. 107.6
2007 RFS Holdings BV ABN-AMRO Holding NV 98.2
1999 Pfizer Inc. Warner-Lambert Co. 89.2
1998 Exxon Corp. Mobil Corp 78.9
2000 Glaxo Wellcome PLC SmithKline Beecham PLC 76.0
2004 Royal Dutch Petroleum Co. Shell Transport & Trading Co. 74.6
2006 AT&T Inc. BellSouth Corp 72.7
1998 Travelers Group Inc. Citicorp 72.6
2009 Pfizer Inc. Wyeth 68
2008 InBev Inc. Anheuser-Busch Companies, Inc. 52Table 1
The Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA) analysis,
expressed the announced Mergers & Acquisitions worldwide, 1985-2012 (as of 24 November
2012) in figure 1.3
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Figure 1
Mergers or Acquisitions defining the terms
The terms merger and acquisition are usually unclear or used interchangeably. The difference
between the two is important to be clear. The definition of the words is as follows: 4
• Merger: A combination of two or more companies in which the assets and liabilities of
the target company(s) are absorbed by the buying company. Although the buying
company may be a considerably different organization after the merger, it retains its
original identity.
• Acquisition: The purchase of an asset such as a plant, a division, product line or even an
entire company.
Reasons for Mergers and Acquisitions
Each and every merger transaction has its own unique reasons why. The implicit principle
behind mergers and acquisitions is the simple equation of synergy; as in 1+1 =3. The value of
Company X is $ 2 billion and the value of Company Y is $ 2 billion, but when they merge
together, the total value will be $ 5 billion.1
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Synergy is the additional value created (∆V), as in the following formula: 6
Where:
∆V= VA – T - (VA+ VT)
VT = the pre-merger value of the target firm
VA - T = value of the post-merger firm
VA = value of the pre-merger acquiring firm
The combining of the two firms creates additional value which is called "synergy" value which
can take one of three forms:1
1. Revenues: By joining the two companies, they will realize higher revenues than if they
operate independently.
2. Expenses: By joining the two companies, they will realize lower expenses than if they
operate independently.
3. Cost of Capital: By combining the two companies, they will experience a lower overall
cost of capital.
It would be very unlikely for owners to sell if they would gain more by not selling. Which means
buyers will need to pay more (a premium) if they want to buy the company, In spite of what pre-
merger valuation price. For the sellers, that premium reflects the company's future prospects. For
buyers, the premium reflects part of the post-merger synergy they forecast to be achieved. The
following equation offers a good way to evaluate synergy and how to determine whether a
merger or acquisition transaction makes sense. The equation solves for the minimum required
synergy: 5
The largest source of synergy value is lowering the expenses. Several mergers were driven by the
urge to cut costs. Cost savings always come from the omitting of unnecessary or duplicated
supportive functions, such as HR, Accounting, IT and so on. The ideal mergers might have
strategic reasons for the business combination. These reasons include but not limited to: 1
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New segments talking and Positioning - Taking the benefit of future opportunities that
may be exploited when the two companies are joined.
Fortifying the weakness “Gap Filling” - A company may have an obvious weakness in
distribution and strong finance whereas the second company has strong distribution and
weak finance. By merging these two companies, each company will fills-in a strategic
gap that is crucial for their long-term survival.
Organizational Competencies - Acquiring companies with strong human resources and
or intellectual capital can improve innovative thinking and progress within the first
company.
Fast Market Access – Merging with or acquiring a foreign company will give quick
access to emerging global markets geographically.
Mergers and acquisitions will also be carried out by basic business reasons, such as: 1
Capital investment reduction - It could be cost effective to acquire another company
than to invest internally. Such as if a company is looking for expansion of its
manufacturing facilities. A second company may have a very similar facility that is idle.
It could be more cost effective to just buy this second company with the unused facilities
than building a new facility.
Diversification - It is necessary to increase earnings and get more consistent long-termrevenue growth and profitability. This occurs for companies in very mature industries
such as the pharmaceutical industry where future growth will be questioned.
Short Term Growth – Company management always under the pressure to turnaround
slow growth and profitability. So mergers and acquisitions are the easy way to boost poor
performance.
Undervalued assets - The acquired company’s assets may be undervalued and that’s
why it represents an attractive investment.
We have to know that merger activity is something other than a simple extension of business
investment. Regardless of the main motivations for mergers, there are a few categories of factors
that tends to play a role in a least some mergers. Hereunder are some of these factors; 2
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Efficiencies
Companies might combine their operations through mergers and acquisitions of company
assets to diminish production costs, improve product quality, increase output, gain new
technologies, or provide new products. The efficiency benefits from mergers and
acquisitions include both operating and managerial efficiencies. Operational efficiencies
may arise from economies of scale, production economies of scope, and consumption
economies of scope, improved resource allocation. 2
Moving to an alternative less costly production technology ,enhanced use of information
and expertise, improved focus on core skills of the firm, a more utilized combination of
assets, reductions in transportation costs. The benefits from mergers and acquisitions are
not, however, restricted to little gains to the firms. The tendency of one firm to merge
with another firm or acquire its assets also creates a market for corporate dominancy. 2
Financial and Tax Benefits
Mergers and acquisitions can lead to financial efficiencies. For example, firms may
diversify their earnings by acquiring other firms or their assets with different earnings
flow. 2
Diversification in earnings within firms may minimize the variation in their profitability,
reducing the risk of bankruptcy. Under other conditions, tax benefits may turn out to be
the underlying motive for a merger. Assume when a firm with accumulated losses
mergers with a profit-making firm, tax benefits are utilized better. Because these
accumulated losses can make up for the profits of the profit-making firm. 2
Market Power Effects
Some mergers may end up with market power which pours into the benefit of the
merging firms.2
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Management Greed, Self-Aggrandizement
Some managers may overemphasize growth, or simply make wrong acquisition
decisions. Though self-aggrandizement and greediness by managers may motivate some
mergers and acquisitions, in most cases managers who make poor acquisitions increase
the likelihood that they will, themselves, be an acquisition targets. 2
Utilization of surplus cash:
A firm in a mature industry may generate a lot of cash but may not have profitable
investment opportunities .In such a situation, a merger with another company involving
cash compensation often stands for a more effective utilization of surplus funds. 2
Types of Mergers and Acquisitions
From the business structures point of view, there are different types of mergers, distinguished by
the relationship between the companies that are merging: 5
Horizontal merger - Two firms that are in a direct competition and share the same
product lines and market, as in pharmaceutical industry where the synergy can obtained
by many forms such as; increased market share, cost savings and exploring new market
opportunities.
Vertical merger – Backward or forward vertical merger as in a distributor and
manufacturing company or a supplier and company, major motive will be cost savings
and process efficiency.
Market-extension merger - Two companies that are in the same industry with similar
product but in different markets.
Product-extension merger - Two companies are in different industries but still
related products in the same geographical market.
Conglomeration - Two companies that are working in totally different business areas.
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Classification by how the merger is financed. There are two types, each has certain implications
for the companies involved and for investors: 5
Purchase Mergers - The purchase is made with cash or through the issue of some kind
of debt instrument; the sale is taxable. Acquirers usually prefer this kind of merger
because it can provide them with a tax benefit. Acquired assets can be written-up to the
actual purchase price, and the difference between the book value and the purchase price
of the assets can depreciate annually, reducing taxes payable by the acquiring company.
Consolidation Mergers – A new company is formed and both companies are bought
and combined under the new entity. The tax terms are the same as those of a purchase
merger.
Also there is a type of acquisition which is a reverse merger, which is a deal that enables a
private company to get publicly-listed in somehow short period. A reverse merger take place
when a private company that has a very strong prospects and is seeking to raise financing buys a
publicly-listed shell company, normally a company with no business and limited assets. The
private company reverse merges into the public company, and together they become an entirely
new public corporation with tradable shares.5
Financing the mergers and acquisitionsMergers are identified from acquisitions by the method in which they are financed and also by
the relative size of the companies. Different methods of financing merger or acquisition deal
exist, but they mainly fall under the following category: 6
Cash Transaction - The receipt of cash for shares by shareholders of the target
company. Such transactions are normally called acquisitions rather than mergers because
the shareholders of the target company are removed from the picture and the target
company goes under the (indirect) control of the bidder's shareholders.
Share Transaction - The offer by an acquiring company of shares or a combination of
cash and shares to the target company’s shareholders, in simple words payment in the
form of the acquiring company's stock, issued to the shareholders of the target company
at a given ratio proportional to the valuation of it.
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Going Private Transaction (Issuer bid) – it is a special type of acquisition where the
purchaser already owns a majority of the target company shares and wants to fully own it
back again as in the Virgin company example
Table 2 Adapted from reference 4
Valuation Matters
Investors aiming to take over a company should determine whether the deal will be of benefit to
them. In order to do so, investors must ask themselves how much the acquired company is really
worth.5
According to L. Booth and W. Sean Cleary (2007) the Fair market value (FMV) is the highest
price obtainable in an open and unrestricted (free) market between knowledgeable, informed and
prudent parties acting at arm’s length, with neither party being under any compulsion to
transact.6
Normally, the two sides of merger or acquisition deal will have different point of view about the
worth of the target company: the sellers will try to value the company as high as they can, while
the buyer will tend to get the lowest price that they can. There are many direct and clear
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legitimate methods to value companies. The most common way is to look at comparable
companies in the same industry, but there are a variety of other methods and tools to assess a
target company. Such as: 5
1. Comparative Ratios - The following are two methods of many comparative metrics on
which acquiring companies may base their offers:
Price-Earnings Ratio (P/E Ratio) - An acquiring company makes an offer that is a
multiple of the earnings of the target company. By viewing the P/E for all the stocks
within the same industry this will give the buyer company good guidance for what the
target's P/E multiple should be.5
Enterprise-Value-to-Sales Ratio (EV/Sales) - The buyer company makes an offer as a
multiple of the revenues, while being aware of the price-to-sales ratio of other companies
in the same industry. 5
2. Replacement Cost - In some cases, acquisitions are valued based on the cost of replacing
the target company. The value of a company is the sum of all its equipment and staffing costs.
The buyer company can order the target to sell at that price, or it will create a competitor for
them with the same cost. Usually, it takes a long time to create a company. This way of
establishing value of a company definitely wouldn't make much sense in a service industry
where the key assets - people and ideas - are hard to value and develop. 5
3. Discounted Cash Flow (DCF) – It is the key valuation method in mergers and acquisitions;
discounted cash flow analysis determines a company's current value according to its estimated
future cash flows.
Forecasted free cash flows =operating profit + depreciation + amortization of goodwill –
capital expenditures – cash taxes - change in working capital
The forecasted FCF are discounted to a present value using the company's weighted average
costs of capital (WACC).5
Determining fair market value depends on the perspective of the buyer. Some buyers are
more likely to be able to realize synergies than others and those with the greatest ability to
generate synergies are the ones who can justify higher prices.6
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12
2
1
10
)1()1(...
)1(
)1( t
t
t
k
CF
k
CF
k
CF
k
CF V
K= Discount rate CF= Free cash flow t= Time period
Types of buyers and the impact of their perspective on value include: 6
1. Passive investors – use estimated cash flows currently present
2. Strategic investors – use estimated synergies and changes that are forecast to arise
through integration of operations with their own
3. Financials – valued on the basis of reorganized and refinanced operations
4. Managers – value the firm based on their own job potential and ability to motivate
staff and reorganize the firm’s operations.
Reactive Pricing Approaches
Models reacting to general rules of thumb and the relative pricing compared to other
securities. 6
Multiples or relative valuation
Liquidation or breakup values
Proactive Models
A valuation method to determine what a target firm’s value should be based on future
values of cash flow and earnings as the discounted cash flow (DCF) models. 6
Financial Analysis in Mergers and Acquisitions
It is a crucial step for a corporate acquirer’s to assess and analyze the financial statement of an
acquisition or merger candidate, a corporate acquirer usually analyzes the current and potential
financial statements of a target company. This analysis is used in measuring the value of the
shares or the net assets of the target firm. 7
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How to determine value and price of Shares:
The principal determinants of the shares value (or net assets) of a target company are: 7
1. The quantity and timing of probable cash flows that will be generated. This includes
cash flows to be generated by the target company from its operations on a ‘stand-
alone’ basis as well as discretionary cash flows that a buyer anticipates will arise in the
form of post-acquisition synergies;
2. The acquirer’s required rate of return given its perceived risk level of achieving said
cash flows and its perception of the tar get company’s ‘strategic importance.
3. Non-operating assets that are acquired as part of the transaction.
The actual price that a corporate acquirer might be prepared to pay for the shares (or net assets)
of the target company may be higher or lower than its estimate of fair market value. This is due
to such things as the negotiating positions of the parties involved, the number of acquirers
interested in such Company at that time, and several other factors that take place during the
course of negotiations. 7
Prospective Discretionary Cash Flow
Any Business is usually valued based on its ability to prospectively generate cash flow.Discretionary cash flow is defined as cash flow from operations (Earnings before interest,
taxes, depreciation, and amortization ‘EBITDA’) less income taxes, capital expenditure
and working capital requirements. 7
Discretionary cash flow represents the amount of money available to the providers of
capital of a business (debt holders and shareholders) that can be withdrawn without
affecting the existing operations of the business, or its ability to generate its forecast
operating results.7
An estimate of prospective discretionary cash flow to be generated by a business normally
involves an assessment of the historical operating results of the target company and any
financial projections that have been prepared. In addition, an assessment of the prospective
discretionary cash flows to be generated normally includes those of the target company
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itself, and those that the acquirer anticipates will be realized in the form of post-acquisition
synergies. 7
Historical operating results
Recent historical operating results (normally the past five years) are considered when
estimating prospective operating results. The quantum of weight afforded to historical
operating results depends on whether and to what extent they are believed to represent
what the target company prospectively is capable of generating on a stand-alone basis. For
example, If the target company has made significant changes in the recent years (e.g.
Product lines extension, capacity, the dynamics of the industry in which it operates, etc.),
then historical operating results may not be indicative of future expectations. 7
Moreover, an analysis of the historical financial statements of an acquisition target normally
involves the calculation of various financial ratios that can generally be categorized as: 7
Profitability Ratios (e.g. profit margin, Basic earning power, return on assets) that
indicate the proportion of revenues retained by the company at different levels, and the
company’s sensitivity to fluctuations in revenues.
Asset Management Ratios (e.g. days at hand and inventory turnover) which assist a
buyer in assessing incremental working capital requirements that will be needed to
support prospective revenues, and in evaluating management efficiency
Liquidity Ratios (e.g. the current ratio and quick ratio), which measure the short term
financial strength of the business, and whether the buyer will be required to make a
capital injection to support the operations of the target company.
Debt management Ratios (e.g. Debt ratio and times interest earned) which measure
target company’s ability to accommodate interest bearing debt. This may in turn affect
the acquirer’s cost of capital, and its required rate of return
Operating Ratios (e.g. sales per employee and average selling price per unit sold), which
help a buyer in assessing the resource and capacity requirements of a target company.
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These mentioned above ratios can provide a buyer with insight into the reasons for a target
company’s historical performance. However, ratio analysis must be moderated by taking into
consideration the changes in accounting policies, management practices, and so on, which may
alter such analysis. In addition, when analyzing the historical financial statements of the target
company, it is important to consider the status of the economy and the industry at the time those
results were achieved.. Prior to selling a business, many owners and managers will take steps to
reflect the best possible financial results, knowing that those results often are a key element in
negotiations with prospective acquirers. Thus, owners and managers sometimes reduce spending
in discretionary accounts such as advertising, research and development, and so on, to increase
short-term profitability. However, these actions may have serious long term consequences to the
vendor’s business.7
One more thing should be taken into consideration is that analysis of historical financial
statements involves the identification of unusual or non-recurring items. This is because, by
definition, historical unusual and non-recurring items are not indicative of prospective operating
results. Sellers normally are quick to point out unusual and non-recurring items that negatively
impacted historical results. However, a buyer should consider whether these things truly are
nonrecurring. For example, while a costly strike may be unusual, it may recur in the future, and
hence should be considered either through a reduction of prospective discretionary cash flows, or
in the level of risk of achieving those cash flows. Just because an item is classified as ‘unusual’
or ‘extraordinary’ in the financial statements does not necessarily mean that it will not reappear.
Conversely, non-recurring and unusual items that favorably affected historical operating results
often are buried as part of revenues or expenses from ongoing operations. Examples include non-
recurring property tax refunds, a significant one-time sale, and the recovery of assets that had
previously been written down. The detection of these things requires careful analysis of the
historical financial statements, including ratios and so on. 7
The analysis of historical financial statements should not be limited to annual results. Quarterly
and monthly results also should be considered as these can provide insight as to seasonality and
short-term performance. 7
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Forecast operating results
When getting a business for sale, the owners, managers or sellers may prepare forecast
operating results. Where forecasts are prepared, they normally are for a period of 3 to 7
years. Where meaningful forecasts are available, a buyer typically will estimate the value of
the target company’s equity using a ‘discounted cash flow’ methodology as discussed
earlier.7
Due Diligence
There is a shared lead that runs throughout most of the mergers and acquisitions deals. It is the
Due Diligence. This is a very detailed and extensive evaluation of the proposed deal. An
important question is - Will this merger work? And to answer this question, it is a must to
determine what kind of "synergy" exists between the two companies. This includes: Investment
synergy - What financial resources will be required, what level of risk fits with the new
organization, and many questions that should be answered before doing the deal.1
Strategic synergy - What management strengths will be brought together through this
deal? Both parties must bring unique experience to the table to create synergies.
Marketing synergy – Does the products and services complement each other? Will the
various components of marketing fit together – promotion programs, brand names,
distribution channels, customer mix?
Operating synergy - Will the different business units and production facilities fit
together and how? How do labor force, technologies, and production capacities, fit
together?
Management synergy - What expertise and talents do both sides bring to the merger?
How well do leadership styles, strategic thinking, ability to change, and culture fit
together?
Financial synergy – Will the financial elements fit together and how?
Due diligence should be a cooperative and patient process between the buyer’s and seller’s. Any
trial to keep out or manipulate data will lead to risks and problems in the future.
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Misrepresentations of data or omissions will lead to post-closing litigation, which is expensive
and time consuming for both sides.4
Due diligence is very wide and deep, extending well beyond the functional areas (finance,
production, human resources, and marketing.). Due diligence must expose all of the major risk
associated with the proposed merger or acquisition. These risk areas that need to be investigated
are (Market - Customer - Competition - Legal) 1
The Risk in Trade-Offs between Buyers and Sellers in Mergers and
Acquisitions
In about most of all acquisitions, the acquirer’s stock price falls instantly after the deal is
announced. In most cases, that drop is a sign of worse to come. The market’s routinely negative
response to M&A announcements reflects investors’ skepticism about the likelihood that the
acquirer will be able both to maintain the original values of the businesses in question and to
achieve the synergies required to justify the premium.8
Reasons behind this are mainly the following: 8
First of all, many acquisitions fail simply because they set too high performance bar. Even
without the acquisition premium, performance improvements have already been built into the
prices of both the acquirer and the seller.
In other cases, acquisitions turn sour because the benefits they bring are easily replicated by
competitors. Competitors will not stand idly by while an acquirer attempts to generate synergies
at their expense. 8
Third reason of problems is the fact that acquisition – though it is a quick route to growth – it
requires full payment ahead. By contrast, investments in research and development, capacity
expansion, or marketing campaigns can be made in stages over time. So in acquisitions thefinancial clock just starts ticking on the whole investment just from the beginning. 8
The main difference between cash and stock transactions is that: In cash transactions, acquiring
shareholders take on the whole risk that the expected synergy value involved in the acquisition
premium won’t materialize. In stock transactions, that risk is shared with selling shareholders.
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More specifically, in stock transactions, the synergy risk is shared in proportion to the percentage
of the combined company the acquiring and selling shareholders each will own. 8
How Risk Is Distributed Between Acquirer and Seller
The risk is distributed between the buyer and the seller based on the way an acquisition is
paid for. An acquirer who pays mainly in cash, for example, presumes all the risk that the
price of its shares will drop between the announcement of the deal and its closing. The
acquirer also assumes all the operating risk after the deal closes. By contrast, an acquirer who
pays the seller a fixed number of its own shares minimizes its risk from a drop in share price
to the percentage it will own of the new, merged company. The acquirer that pays a fixed
value of shares assumes the entire pre-closing market risk but minimizes its operating risk to
the percentage of its post-closing ownership in the newly acquired company.
8
Table 3 Adapted From reference 8
Tax Consequences of Acquisitions
The way an acquisition is paid for whether cash or stock affects the tax bills of the
shareholders involved., a cash purchase of shares is the most tax-favorable way for the
acquirer to make an acquisition as it offers the opportunity to revalue assets and hence to
increase the depreciation expense for tax purposes. On the other hand, shareholders in the
selling company will face a tax bill for capital gains if they receive cash. They are therefore
likely to bargain up the price to compensate for that cost, which may offset the acquirer’s tax
benefits. After all, if the selling shareholders suffer losses on their shares, or if their shares
are in tax-exempt pension funds, they may favor cash rather than stock.8
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By contrast, the tax treatments for stock financed acquisitions appear to favor the selling
shareholders because they allow them to receive the acquirer’s stock tax-free. In other
words, selling shareholders can defer taxes until they sell the acquirer’s stock. 8
Conclusion
Our conclusion is that there are some major factors that affect the financial performance of a
corporate post-merger and acquisition, as follows:
1. Methods of payment from a taxation prospective - The way an acquisition is paid for
whether cash or stock affects the tax bills of the shareholders involved, a cash purchase of shares
is the most tax-favorable way for the acquirer to make an acquisition as it offers the opportunity
to revalue assets and hence to increase the depreciation expense for tax purposes.
2. Methods of valuation - We have concluded that to value the target company it is better to use
the comparative ratios method along with the discounted cash flow method as the first gives a
bigger picture versus the market and industry while the other method gives a snapshot on the
future estimated financial status of the post merge transaction in order to reach the ideal buying
price
3. The extent of synergy - The combining of the two firms creates additional "synergy" value
which can take one of three forms: Revenues, Expenses or Cost of Capital and the most likely
to bring highest synergy value is lowering the expenses due to omitting of unnecessary or
duplicated supportive functions, such as HR, Accounting, IT and so on
4. Objective of the M&A - There are various types of reasons and objectives for mergers and
acquisitions, accordingly the relative importance of the reasons is a major determinant of the
success of the M&A and the financial performance of the company post-merge, Overcapacity
deals and product-line extensions were the most common reasons, geographic expansions comes
third.
5. Accuracy of Due Diligence - Due diligence should expose all of the major risk associated
with the proposed merger or acquisition. These risk areas that need to be investigated are
(Market - Customer - Competition - Legal), any trial to keep out or manipulate data will lead
to risks and problems in the future and will lead to post-closing litigation, which is expensive and
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time consuming for both sides. The extend on how accurate the due diligence the more
successful the transaction and will impact positively on the financial performance of the
corporate
6. The risk level borne by each party – Distributing the risk between the buyer and the seller is
based on the way an acquisition is paid for. The buyer that pays mainly in cash presumes all the
risk that the price of its shares will drop between the announcement of the deal and it’s closing.
The buyer also assumes all the operating risk after the deal closes. By contrast, the buyer that
pays the seller a fixed number of its own shares minimizes its risk from a drop in share price to
the percentage it will own of the new, merged company. The buyer that pays a fixed value of
shares assumes the entire pre-closing market risk but minimizes its operating risk to the
percentage of its post-closing ownership in the newly acquired company
Corporate managers should bear in mind such factors and their impact on the post-merger and
acquisition corporate financial performance to evaluate the proposed offers of mergers and
acquisitions accurately and take profitable decisions.
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References:1- Matt H. Evans; Mergers & Acquisitions (Part 1); Excellence in Financial Management; March 2000
2- Paul A. Pautler; Evidence on Mergers and Acquisitions ; Bureau of Economics, Federal Trade
Commission; September 25, 2001
3- Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA) analysis, extracted on 3
January 2013 on http://www.imaa-institute.org/statistics-mergers-acquisitions.html
4- Andrew J. Sherman and Milledge A. Hart; Mergers & Acquisitions from A to Z; 2nd edition;
American Management Association 2006
5- The Basics Of Mergers And Acquisitions; Investopedia.com, 2010,
http://www.investopedia.com/university/mergers/
6- Laurence Booth and W. Sean Cleary; INTRODUCTION TO CORPORATE FINANCE; Chapter 15 –
Mergers and Acquisitions; 2007 John Wiley & Sons Canada, Ltd.
7- Howard E. Johnson; Financial Statement Analysis in Mergers and Acquisitions;
Campbell Valuation Partners Limited publication; (www.campbellvaluation.com) ;
January 1, 20018- Alfred Rappaport and Mark L. Sirower; Stock or Cash? The Trade-Offs for Buyers and Sellers in
Mergers and Acquisitions; Harvard business review November –December 1999, Reprint 99611