Mergers and Acquisition- A conceptual deliberation in Indian Context

Introduction

The merger of the three public sector banks- Bank of Baroda, Vijaya Bank and Dena Bank has raised a lot of curiosity towards consolidation process through mergers like never before. The reason d’êtrebeing  firstly it is directly related to public. All the three banks hold an illustrious history of more than 100 years with billions of people as customers in its fold. Secondly, while mergers and acquisition in corporate sector is a continuous process, the merger of three public sector banks is a major event in banking history in last 50 years after the nationalization of banks in 1969.

Merger & Acquisition- The Indian Context

There has been a continuous process of consolidations in any evolving market. Once a market is allowed to grow, many companies join the bandwagon to take the advantage of business opportunities, however as the market advances to maturity, it discards players with irrelevant business model, competencies and scaling plans. We may see the Indian mobile network market for example. You could probably remember the name of many network providers who entered in the growing Indian market when India embraced wireless communication technology in last decade like- Ericsson, AT&T, Spice, MTS, Virgin, Reliance (Anil Ambani endeavor), Tata Teleservices and so on. These companies today are nowhere on horizon. As Indian mobile network market entered in maturity stage from growing stage, only fewer players with deep pockets, competencies, scaling, technology and eager to serve customers are here to stay, thus now only four players are left in game i.e. Vodafone, Airtel, Reliance Gio and state sponsored BSNL/MTNL. This is exactly the pattern in mature mobile network markets world over where only four or five players are left and operating in any country.

In Indian industry, the pace for mergers and acquisitions activitypicked up in response to various economic reforms introduced by the Government of India since 1991, to facilitate liberalization and globalization. The Indian economy has undergone a major transformation and structural change following the economic reforms, as “size and competence” have become the focus of business enterprises in India. Indian companies realized the need to grow and expand in businesses that they understood well, in order to face the growing competition. Several leading corporate have undertaken restructuring exercises to sell off non- core businesses, and to create stronger presence in their core areas of business interest. Mergers and acquisitions emerged as one of the most effective methods of such corporate restructuring, and became an integral part of the long-term business strategy of corporate sector in India. Over the last decade, mergers and acquisitions in the Indian industry have continuously increased in terms of number of deals and deal value. A survey amongIndian corporate managers in 2006 by “Grant Thornton” found that Mergers & Acquisitions are a significant form of business strategy today for Indian Corporate sectors. Consolidation through mergers and acquisitions is considered as one of the best ways of restructuring structure of corporate units. M&A gives a new life to the existing companies.

What is Merger and Acquisition?

A merger is a combination of two or more companies into one company. It may be in the form of one or more companies being merged into an existing company or a new company may be formed to merge two or more existing companies. The Income tax Act, 1961of India uses the term ‘amalgamation’

for merger.

Thus, Merger or Amalgamation may take any of the two forms:

  1. Merger or Amalgamations through absorption
  2. Merger or Amalgamations through consolidation

Absorption: It is a combination of two or more companies into an ‘existing company. In a merger through absorption, all companies except one go into liquidation and loose their respective separate identity.6 For example, one bank acquires the other. A + B= A: Here, two entities A and B merge such that one , says B loses entity, and other entity A become enlarged one. In this case, A is the acquiring company and B is the target or acquired company. This is generally called as absorption (i.e. B is absorbed by A) or 100% or ‘complete takeover’ of one company by the other.

Consolidation: It is a combination of two or more companies into a ‘new company’. In this form of merger, all companies are legally dissolved and a new entity is created or all the existing companies, which combine, go into liquidation and form a new company with a different entity. Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash or exchange of shares. Consolidation i.e. two or more banks combine to form a new entity. In India the legal term for merger is amalgamation.

There are different types of concept in which merging of the companies take place like, Horizontal Merger, Vertical Merger, Conglomerate Merger, and Reverse Merger.

Acquisition in a general sense means acquiring the ownership in the property. It is the purchase by one company of controlling interest in the share capital of another existing company. Even after the takeover, although there is a change in the management of both the firms, companies retains their separate legal identity. The Companies remain independent and separate; there is only a change in control of the Companies.

Principle behind any M&A is 2+2=5

Motives behind Mergers and Acquisitions

 

The dominant rationale used to explain merger activity is that acquiring firms seek improved financial performance. The following motives are considered to improvefinancial performance:

  • Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope: Economies of scope are conceptually similar to economies of scale. Whereas economies of scale for a firm primarily refers to reduction in the average cost (cost per unit) associated with increasing the scale of production for a single product type. It refers to lowering the average cost for a firm in producing two or more products. This implies that efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.
  • Increased revenue or market share: Market share is the percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity. This assumes that the buyer will absorb competitor and thus increase its market power (by capturing increased market share) to set prices.
  • Cross-selling: Cross-selling is the action or practice of selling among or between clients, markets, traders, etc. or the action or practice of selling an additional product or service to an existing customer. This article deals exclusively with the meaning. In practice, businesses define cross-selling in many ways. Elements that might influence the definition include the size of the business, the industry sector it operates within and the financial motivations of those, required to define the term. For example, a bank buying a stock broker could then sell its banking products to the stock broker’s customers, while the broker can sign up the bank’s customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
  • Synergy: It is the interaction of multiple elements in a system to produce an effect different from or greater than the sum of their individual effects. Synergy is the magic force that allows enhancing cost efficiencies of the new business. Synergy takes the form of revenue enhancement and cost savings. For example, managerial economies such as the increased opportunity of managerial specialization. Another example is purchasing economies due to increased order size and associated bulk-buying discounts.
  • Taxation: A profitable company can buy a loss maker to use the target’s loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to “shop” for loss making companies, limiting the tax motive of an acquiring company.
  • Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothen the stock price of a company, giving conservative investors more confidence for investing in the company. However, this does not always deliver value to shareholders. Resource transfer: resources are unevenly distributed across firms and the interaction of target and acquiring firm resources can create value either through overcoming information asymmetry or by combining scarce resources.
  • Hiring: some companies use acquisitions as an alternative to the normal hiringprocess. This is especially common when the target is a small private company oris in the startup phase. In this case, the acquiring company simply hires(“acquires”) the staff of the target private company, thereby acquiring its talent (ifthat is its main asset and appeal). The target private company simply dissolvesand little legal issues are involved.

However, on an average, across the most commonly studied variables, acquiringfirms’ financial performance does not positively change as a function of theiracquisition activity. Therefore, an additional motive for merger and acquisition thatmay not add shareholder value includes:

  • Diversification: While this may hedge a company against a downturn in anindividual industry it fails to deliver value, since it is possible for individualshareholders to achieve the same hedge by diversifying their portfolios at a muchlower cost than those associated with a merger.
  • Manager’s hubris: Managerial hubris is the unrealistic belief held by managers inbidding firms that they can manage the assets of a target firm more efficientlythan the target firm’s current management. Managerial hubris is one reason why amanager may choose to invest in a merger that on average generates no profits.Manager’s overconfidence about expected synergies from merger might results inoverpayment for the target company.
  • Empire-building: Empire-Building refers to the tendency of countries and nationsto acquire resources, land, and economic influence outside of their borders inorder to expand their size, power, and wealth. Managers have larger companies tomanage and hence more power.
  • Manager’s compensation: In the past, certain executive management teams hadtheir payout based on the total amount of profit of the company, instead of theprofit per share, which would give the team a perverse incentive to buy companiesin order to increase the total profit while decreasing the profit per share (whichhurts the owners of the company, the shareholders).

Four important considerations should be taken into account:

  1. The company must be willing to take the risk and vigilantly make investments to benefit fully from the merger as the competitors and the industry take heed quickly.
  2. To reduce and diversify risk, multiple bets must be made, in order to narrow down to the one that will prove fruitful.
  3. The management of the acquiring firm must learn to be resilient, patient and be able to adopt to the change owing to ever-changing business dynamics in the industry.
  4. The important being the human amalgamation. The added workforce from the merged / acquired entity must be provided with conducive atmosphere to adapt with the new work culture. Many a time while all financial and other business factors are well rehearsed and managed, HR issues are hanged loosely. This may lead to conflict within work force and demoralization among employees capable enough to ruin all other expected benefits from the consolidation.

Some of the top Merger & Acquisition deals in India

TATA STEEL-CORUS: Tata Steel is one of the biggest ever Indian’s steel company and the Corus is Europe’s second largest steel company. In 2007, Tata Steel’s takeover European steel major Corus for the price of $12.02 billion, making the Indian company, the world’s fifth-largest steel producer. Tata Sponge iron, which was a low-cost steel producer in the fast developing region of the world and Corus, which was a high-value product manufacturer in the region of the world demanding value products. The acquisition was intended to give Tata steel access to the European markets and to achieve potential synergies in the areas of manufacturing, procurement, R&D, logistics, and back office operations.

VODAFONE-HUTCHISON ESSAR: Vodafone India Ltd. is the second largest mobile network operator in India by subscriber base, after Airtel. Hutchison Essar Ltd (HEL) was one of the leading mobile operators in India. In the year 2007, the world’s largest telecom company in terms of revenue, Vodafone made a major foray into the Indian telecom market by acquiring a 52 percent stake in Hutchison Essat Ltd, a deal with the Hong Kong based Hutchison Telecommunication International Ltd. Vodafone main motive in going in for the deal was its strategy of expanding into emerging and high growth markets like India. Vodafone’s purchase of 52% stake in Hutch Essar for about $10 billion. Essar group still holds 32% in the Joint venture.

HINDALCO-NOVELIS: The HindalcoNovelis merger marks one of the biggest mergers in the aluminum industry. Hindalco industries Ltd. is an aluminum manufacturing company and is a subsidiary of the Aditya Birla Group and Novelis is the world leader in aluminum rolling, producing an estimated 19percent of the world’s flat-rolled aluminum products. The Hindalco Company entered into an agreement to acquire the Canadian company Novelis for $6 billion, making the combined entity the world’s largest rolled-aluminum Novelis operates as a subsidiary of Hindalco.

RANBAXY-DAIICHI SANKYO: Ranbaxy Laboratories Limited is an Indian multinational pharmaceutical company that was incorporated in India in 1961 and Daiichi Sankyo is a global pharmaceutical company, the second largest pharmaceutical company in Japan. In 2008, Daiichi Sankyo Co. Ltd., signed an agreement to acquire the entire shareholders of the promoters of Ranbaxy Laboratories Ltd, the largest pharmaceutical company in India. Ranbaxy’s sale to Japan’s Daiichi at the price of $4.5 billion.

ONGC-IMPERIAL ENERGY: Oil and Natural Gas Corporation Limited (ONGC), national oil company of India. Imperial Energy Group is part of the India National Gas Company, ONGC Videsh Ltd (OVL). Imperial Energy includes 5 independent enterprises operating in the territory of Tomsk region, including 2 oil and gas producing enterprises. Oil and Natural Gas Corp. Ltd (ONGC) took control of Imperial Energy UK Based firm operating in Russia for the price of $1.9 billion in early 2009. This acquisition was the second largest investment made by ONGC in Russia.

MAHINDRA & MAHINDRA- SCHONEWEISS: Mahindra & Mahindra Limited is an Indian multinational automobile manufacturing corporation headquarters in Mumbai, India. It is one of the largest vehicles manufacturer by production in India. Mahindra & Mahindra acquired 90 percent of Schoneweiss, a leading company in the forging sector in Germany. The deal took place in 2007, and consolidated Mahindra’s position in the global market.

STERLITE- ASARCO: Sterlite is India’s largest non-ferrous metals and mining company with interests and operations in aluminum, copper and zinc and lead. Sterlite has a world class copper smelter and refinery operations in India. Asarco, formerly known as American Smelting and Refining Company, is currently the third largest copper producer in the United States of America. In the year 2009, Sterlite Industries, a part of the Vedanta Group signed an agreement regarding the acquisition of copper mining company Asarco for the price of $ 2.6 billion. The deal surpassed Tata’s $2.3 billion deal of acquiring Land Rover and Jaguar. After the finalization of the deal Sterlite would become third largest copper mining company in the world.

TATA MOTORS-JAGUAR LAND ROVER: Tata Motors Limited (TELCO), is an Indian multinational automotive manufacturing company headquartered in Mumbai, India and a subsidiary of the Tata Group and the Jaguar Land Rover Automotive PLC is a British multinational automotive company headquarters in Whitley, Coventry, United Kingdom, and now a subsidiary of Indian automaker Tata Motors. Tata Motors acquisition of luxury car maker Jaguar Land Rover was for the price of $2.3 billion. This could probably the most ambitious deal after the Ranbaxy won. It certainly landed Tata Motors in a lot of troubles.

SUZLON-REPOWER: Suzlon Energy Limited is a wind turbine supplier based in Pune, India and RePower systems SE (now Senvion SE) is a German wind turbine company founded in 2001, owned by Centerbridge Partners. Wind Energy premier Suzlon Energy’s acquisition of RePower for $1.7 billion.

RIL-RPL MERGER: Reliance Industries Limited (RIL) is an Indian Conglomerate holding company headquartered in Mumbai, India. Reliance is the most profitable company in India, the second-largest publicly traded company in India by market capitalization. Reliance Petroleum Limited was set up by Reliance Industries Limited (RIL), one of India’s largest private sector companies based in Ahmedabad. Currently, Reliance Industries taking over Reliance Petroleum Limited (RPL) for the price of 8500 crores or $1.6 billion.

Conclusion:

M&A’s are considered as important change agents and are a critical component of any business strategy. The known fact is that with businesses evolving, only the most innovative and nimble can survive. That is why, it is an important strategic call for a business to opt for any arrangements of M&A. Once through the process, on a lighter note M&A is like an arranged marriage, partners will take time to understand, mingle, but will end up giving positive results most of the times.