Summary Financial Management 354: Mergers and Acquisitions
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Course
FINANCIAL MANAGEMENT 354
Institution
Stellenbosch University (SUN)
A summary of The Mergers and Acquisitions: A South African Perspective textbook, along with the lectures and slides studied in the Financial management 354 course offered at Stellenbosch University
Does not contain calculation summaries
Financial Management 354
Mergers and Acquisitions
Summary Notes
In the real world, 90% of all mergers and acquisitions fail. This module will focus on some of
the factors contributing to this, and ways to avoid failures going forward. By the end of this
module, it should be possible to make decisions. For example: Should company A acquire
company B?
Business Day and Money Web are 2 websites where one can find informative investment
articles. Some examples of current mergers and acquisitions are Standard Bank and Liberty,
and Huge Group and Adapt IT.
Mergers and Acquisitions also include corporate restructurings. Earlier this year, Crocs
repurchased some of their shares and issued junk bonds. In these current economic times,
most companies are selling shares rather than repurchasing them. The junk bonds issued by
Crocs will have coupons, which if they don’t pay, will lead to bankruptcy.
PPC cement is selling their lime business. Given the current state of the economy (due to
covid), the construction industry isn’t booming – it has taken quite a knock.
Mergers and acquisitions are an umbrella term and include a range of corporate
restructurings, including share repurchases. Some of these will be covered in later chapters.
Chapter 1: Introduction
Learning Outcomes
Differentiate between a merger and an acquisition
Distinguish between a horizontal, vertical, and conglomerate merger
Explain the rationale behind horizontal, vertical, and conglomerate M&A’s
Distinguish between backwards and forwards integration
Differentiate between a friendly and hostile acquisition
Discuss the reasons why companies undertake business combinations and
restructurings
Describe the 4 stages of the M&A process
Explain what is meant by due diligence investigation
Differentiate between financial and non-financial measures of M&A performance
Discuss 3 behavioral biases that can influence the success of M&A’s
Identify the most important stakeholder in the M&A process
Explain why trade unions are seen as important, albeit indirect, stakeholders in the
M&A process
Mergers
A merger is defined as a transaction that creates a new economic unit from 2 or more
economic units. It is sometimes referred to as an amalgamation of economic units. In most
cases, a merger would look as follows:
,Company A (acquirer/bidder) + Company B (target) = Company C (new merged entity)
This concept applies to both profit and non-profit organizations. In the case of a non-profit,
the Stellenbosch municipality is an example of where a merger took place. It merged with
Pniel and Franschhoek to form today’s Stellenbosch Municipality.
Types of Transactions
Horizontal Merger
In the case of a horizontal merger, competitors in the same industry join forces. This would
be done for a number of reasons, including:
Reduce competition
Form a giant
Improve bargaining powers (thus decreasing output costs) – it’s easier for a bigger
firm to negotiate deals with suppliers and retailers e.g., negotiating rime shelf space
Examples of horizontal mergers are:
o Takealot and Kalahari – Kalahari was the smaller of the 2 businesses, and thus was
the one that lost its name
o Spree and Superbalist – merged in 2018 to form an online retail giant (often a
motivate for mergers)
To protect consumers from monopolies and oligopolies, some transactions may need to be
approved by competition authorities. A monopoly is a situation where 1 player dominates a
market, and an oligopoly are where 2 or 3 firms dominate a market.
A company’s name often reflects the fact that it is the resultant of a merger:
PWC: originally Price Waterhouse and Coopers & Lybrand
Sometimes, the name of the smaller entity disappears, especially if the 2 companies aren’t
the same size. For example, in the Spree and Superbalist merger, Spree lost its name,
despite it being a merger and not an acquisition.
Vertical Merger
This is where companies operating in different levels of a supply chain merge. A supply chain
normally has the following: supplier; manufacturer; distributer; retailer; customer. In the
case of a vertical merger, 2 of these would join forces. Vertical mergers can either be
backward (e.g., manufacturer mergers with supplier – moving away from the customer) or
forward (e.g., manufacturer mergers with distributer – towards consumer). The reason for
this is to gain control over the supply chain. It ensures quality and it keeps the liability of
costs in check.
In 2018, the KFC manufacturer ran out of chicken due to a supply issue, and they had to
close doors in the UK for a few days. This would have been very frustrating for customers
and bad for business (as well as very costly). This could most likely have been prevented had
KFC owned the distribution company that supplied the chicken in order to control the
supply of chicken – it would have ensured a reliable supplier.
Depending on the size of the transaction, regulatory authorities may have to step in.
Conglomerate Mergers
This is where there are a bunch of different businesses with no common market merge
together. The term comes from geology – rocks made up of smaller stones – different and
distinct parts. An example of this would be the Virgin franchise. They have airlines, gyms,
,music, and money. Bidvest is also an example. It is essentially companies in different and
unrelated industries coming together to create a bigger company.
This is done to:
Enter new markets (especially if there are high barriers to entry – such as the
pharmaceutical industry)
It can be costly and time consuming to do research and development, and is often
easier for a company to merge with another company that has done all the dirty
work
Expand product and service offerings
The first thing they teach you in investment courses is not to keep all eggs in 1 basket. It is
important to diversify. For example, due to covid, virgin airlines suffered losses, but other
virgin businesses have done okay. Weak performance in one industry could be offset by
strong performance in another. This is done to stabilize losses.
However, it is very difficult to manage widely divergent businesses effectively. The Tata
group own a number of businesses, including steel, beverages, telecom, cars, power, and
chemicals. All of these will have different customer bases, different technologies,
independent research, and development costs, and they will each be at different stages in
the business lifecycles.
Acquisitions
This is a transaction in which an acquirer (A) obtains the controlling interest (50%+) in a
target (B):
A+B=A
B usually disappears as it becomes the subsidiary, and example being SAM and ABInBev –
their products (e.g., Castle Lager) is a well-known, established brand that remains on the
market, but the name of the establishment disappears. SAB is no more.
As with mergers, acquisitions can be either horizontal, vertical, or conglomerate. They are
usually considered to be either takeovers or buyouts and can be friendly or hostile. In the
case of friendly, the target’s (B’s) board accepts the proposal made by A and they call on the
approval of shareholders. If it is hostile, the target’s board will reject the offer, and the
acquirer will go straight to the shareholders to seek their approval. This is what happened in
the case of Huge Group and Adapt IT.
Reasons for Mergers and Acquisitions
Companies want to grow, be it in the same or in different industries and/or
countries. Going across borders does, however, add complexity
Synergies: 2 + 2 = 5, meaning that the outcome is more than the sum of the
components. In such a case, there is something extra that is unlocked.
o Operational: there is an increase in revenue, increase in sales, reduction in
costs, etc.
o Financial: in the case of conglomerate, you reduce the risk of offsetting
returns. If there is less risk, it means the WACC will also be lower, ultimately
resulting in higher cash flow
Restructure the way the business is organized: this could be either changing the
structure of the firm or changing the capital structure. Examples would be PPC
selling their lime business, and Crocs repurchasing shares.
To expand into unrelated industry (locally or internationally)
, To achieve economies of scale
To reorganize the ownership structure of the firm
Companies undertake M&A to access the technologies of other companies and gain
access to expertise that have been built up in targets over time.
There may also be tax related reasons
Standard Bank and Liberty
Standard Bank and Liberty’s collaboration goes back many years. In 1991, they engaged in a
joint venture, known as Stanlib Asset Management, and by 1994, Standard Bank had
acquired 54% of shares in Liberty, meaning they had the controlling interest.
Liberty Insurance is currently not doing very well. There are a lot of other large insurance
companies, such as OUTsurance, which creates a lot of competition for them. So, for
Standard Bank, the next logical transaction for them to follow was full integration with
Liberty. Their goal is to create the largest financial services platform in Africa. When a bank
and an insurance company come together, it is referred to as a Bancassurance. Seeing as
Stannard Bank and Liberty or not direct competitors, but are not operating in entirely
different markets, this merger would be known as co-generic.
Standard Bank are paying a 40% premium for this transaction to take place, meaning they
are paying 40% more than what Liberty were worth on July 14 th. This is good news for the
Liberty shareholders, but not so good for the Standard Bank shareholders. This is because
wealth is being transferred from the SBK shareholders to the Liberty shareholders. This
would cause the share price of Liberty to increase.
The Merger and acquisition Process
This is a generic process that is applicable to both profit and non-profit organizations but
may not be exactly as is in all businesses. This is just a standard procedure that business
should, and generally do follow. The steps are:
1. Plan the deal
2. Finalize the merger agreement
3. Integrate entities
4. Analyze the success of the transaction
1. Plan the Deal
As previously stated, around 90% of mergers and acquisitions fail and this can be attributed
to the lack of planning towards the proposed deal. In many cases, the target company does
not appeal to the competitive strategy of the acquirer. There are four main strategies:
a) Cost Leadership
b) Differentiation
c) Focus
i. Cost Leader – Here, the goal is to provide products at the lowest possible
price (e.g., Pep). They target the mass market (NB: the mass market is every
consumer in the market)
ii. Differentiation – Here, they want to offer something special and unique (this
could be a brand image). This may not necessarily be the cheapest option,
but the mass market is also targeted. These are things like technology, brand
image and innovation, and include examples such as: KFC (special recipe),
apple
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