AHAM NZENWATA
1. INTRODUCTION
Corporate
restructuring includes mergers and acquisitions, amalgamation, takeovers,
spin-offs, leveraged buyouts, buyback of shares, capital reorganization, sale
of business units and assets, etc. mergers and acquisitions are the most
popular means of corporate restructuring or business combinations (Pandey, 2010
).
According
to Arthur and Waya (1963) mergers and acquisitions have played an important
role in the external growth of a number of leading companies the world over. In
the United States, the first merger wave occurred between 1890 and 1904 and the
second began at the end of the World War I and continued through the 1920s. The
third merger wave commenced in the latter part of World War II and continues to
the present day. About two-thirds of the large public corporations in the USA
have merger or amalgamation in their history.
There
are several aspects relating to mergers and acquisitions but they are all
broadly discussed under the concept of corporate restructuring. Corporate
restructuring refers to the changes in ownership, business mix, assets mix and
alliances with a view to enhance the shareholder value (Arthur & Waya 1963).
Hence,
corporate restructuring may involve ownership restructuring, business
restructuring and assets restructuring. A company can affect ownership
restructuring through mergers and acquisitions, leveraged buyouts, buyback of
shares, spin-offs, joint ventures and strategic alliances.
Mergers
and Acquisition as a form of business restructuring involves the reorganization
of business units or divisions. It includes diversification into new businesses,
outsourcing, divestment, brand acquisitions, etc.
The
basic purpose of mergers and acquisition is to enhance the shareholder value.
Companies continuously evaluate their portfolio of businesses, capital mix, and
ownership and assets arrangements to find opportunities for increasing the
shareholder value. They focus on assets utilization and profitable investment
opportunities, and reorganize or divest less profitable or loss-making
businesses/products. In this paper, our focus is on mergers and acquisition and
business reorganization.
2. THE CONCEPT OF MERGERS AND ACQUISITION
2.1 MERGERS
A merger is said to occur when two or
more companies combine into one company. One or more companies may merge with
an existing company or they may merge to form a new company. In a merger, there
is complete amalgamation of the assets and liabilities as well as shareholders’
interests and businesses of the merging companies. In yet another mode of
merger, a company may purchase another company without giving proportionate
ownership to the shareholders of the acquired company or without continuing the
business of the acquired company (ICAI, 2014).
Pandey (2010) defines mergers as the amalgamation
of one or more companies (called amalgamating company or companies) with
another company (called amalgamated company) or the merger of two or more
companies to form a new company in such a way that all assets and liabilities
of the amalgamating company or companies become assets and liabilities of the
amalgamated company and shareholders holding not less than nine-tenths in the
value of the shares in the amalgamating company or companies become
shareholders of the amalgamated company.
According
to Pandey (2010) Mergers may take two forms:
· Merger
through absorption
· Merger
through consolidation
ABSORPTION
Absorption
is a combination of two or more companies into an existing company. All
companies except one lose their identity in a merger through absorption. An
example of this here in Nigeria is the Merger between United Bank for Africa
(UBA) and Standard Trust Bank (STB) in which case UBA retained its identity.
CONSOLIDATION
Consolidation
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. In a
consolidation, the acquired company transfers its assets, liabilities and
shares to the new company for cash or exchange of shares. In a narrow sense,
the terms amalgamation and consolidation are sometimes used interchangeably.
2.2 ACQUISITION
A
fundamena1 characteristic of merger (either through absorption or
consolidation) is that the acquiring or amalgamated company (existing or new)
takes over the ownership of other company and combines its operations with its
own operations. On the other hand, Acquisition may be defined as an act of
acquiring effective control over assets or management of a company by another
company without any combination of businesses or companies.
A
substantial acquisition occurs when an acquiring firm acquires substantial
quantity of shares or voting rights of the target company. Thus, in an
acquisition, two or more companies may remain independent, separate legal
entity, but there may be change in control of companies. An acquirer may be a
company or persons acting in concert for the purpose of substantial acquisition
of shares or voting rights or gaining control over the target company.
An
acquisition or take-over does not necessarily entail full, legal control. A
company can have effective control over another company by holding minority
ownership. If a company wants to invest in more than 10 per cent of the
subscribed capital of another company, it has to be approved in the shareholders’
general meeting. The investment in shares of other companies in excess of 10
per cent of the subscribed capital can result into their takeovers.
2.3 FORMS OF MERGER
There
are three major types of mergers:
Horizontal merger:
This is a combination of two or more firms in similar type of production,
distribution or area of business. Examples would be combining of two book
publishers or two luggage manufacturing companies to gain dominant market
share.
Vertical merger:
This is a combination of two or more firms involved in different stages of
production or distribution. For example, joining of a TV manufacturing
(assembling) company and a TV marketing company or the joining of a wool
spinning company and a weaving company. Vertical merger may take the form of
forward or backward merger. When a company combines with the supplier of
material, it is called backward merger and when it combines with the customer,
it is known as forward merger.
Conglomerate:
This is a combination of firms engaged in unrelated lines of business activity.
A typical example is merging of different businesses like manufacturing of
cement products, fertilizers products, electronic products, insurance
investment and advertising agencies. Transcorp Nigeria PLC with interests in
Hotels, Oil and Gas, Telecommunications etc is a good example of a conglomerate
company.
2.4 MOTIVES AND BENEFITS OF M&A
Ansoff
et al (1971) believes that mergers and acquisitions are strategic decisions
leading to the maximization of a company’s growth by enhancing its production
and marketing operations.
Mergers
and acquisitions have become popular in the recent times because of the
enhanced competition, breaking of trade barriers, free flow of capital across
countries and globalization of business as a number of economies are being
deregulated and integrated with other economies.
A
number of reasons are attributed for the occurrence of mergers and acquisitions.
All of them are not real benefits. Based on the empirical evidence and the
experiences of certain companies, the most common motives and advantages of
mergers and acquisitions are explained below:
Accelerated Growth
Growth
is essential for sustaining the viability, dynamism and value-enhancing
capability of a company. A growth- oriented company is not only able to attract
the most talented executives but it would also be able to retain them. Growing
operations provide challenges and excitement to the executives as well as
opportunities for their job enrichment and rapid career development. This helps
to increase managerial efficiency. All things being equal, growth leads to
higher profits and increase in the shareholders’ value. A company can achieve
its growth objective by:
· Expanding
its existing markets
· Entering
in new markets
A
company may expand and/or diversify its markets internally or externally. If
the company cannot grow internally due to lack of physical and managerial
resources, it can grow externally by combining its operations with other
companies through mergers and acquisitions. Mergers and acquisitions may help
to accelerate the pace of a company’s growth in a convenient and inexpensive
manner.
Internal
growth requires that the company should develop its operating
facilities—manufacturing, research, marketing, etc. Internal development of
facilities for growth also requires time. Thus, lack or inadequacy of resources
and time needed for internal development constrains a company’s pace of growth.
The
company can acquire production facilities as well as other resources from
outside through mergers and acquisitions. Specially, for entering in new
products/markets, the company may lack technical skills and may require special
marketing skills and/or a wide distribution network to access different
segments of markets. The company can acquire existing company or companies with
requisite infrastructure and skills and grow quickly.
Enhanced Profitability
The
combination of two or more companies may result in more than the average
profitability due to cost reduction and efficient utilization of resources.
This may happen because of the following reasons:
· Economies
of scale
· Operating
economies
· Synergy
Economies of scale
arise when increase in the volume of production leads to a reduction in the
cost of production per unit. Merger may help to expand the volume of production
without a corresponding increase in fixed costs. Thus, fixed costs are
distributed over a large volume of production causing the unit cost of
production to decline. Economies of scale may also arise from other
indivisibilities such as production facilities, management functions, and
management resources and systems.
This happens because a given function,
facility or resource is utilized for a larger scale of operation. For example,
a given mix of plant and machinery can produce scale economies when its
capacity utilization is increased. Economies will be maximized when it is
optimally utilized. Similarly, economies in the use of the marketing function
can be achieved by covering wider markets and customers using a given sales
force and promotion and advertising efforts. Economies of scale may also be
obtained from the optimum utilization of management resource and systems of
planning, budgeting, reporting and control.
In addition to economies of scale, a
combination of two or more firms may result in cost reduction due to operating economies. A combined firm
may avoid or reduce overlapping functions and facilities. It can consolidate
its management functions such as manufacturing, marketing, R&D and reduce
operating costs. For example, a combined firm may eliminate duplicate channels
of distribution, or create a centralized training centre, or introduce an
integrated planning and control system.
Synergy implies
a situation where the combined firm is more valuable than the sum of the
individual combining firms. It is defined as ‘two plus two equal to five’ (2 +
2 = 5) phenomenon. Synergy refers to benefits other than those related to
economies of scale. Operating economies are one form of synergy benefits
(Weston and Brigham, 1977). But apart from operating economies, synergy may
also arise from enhanced managerial capabilities, creativity, innovativeness,
R&D and market coverage capacity due to the complementarities of resources
and skills and a widened horizon of opportunities (Weston and Brigham, 1977).
Diversification of Risk
Diversification
implies growth through the combination of firms in unrelated businesses. Such
mergers are called conglomerate mergers. It is difficult to justify
conglomerate merger on the ground of economies, as it does not help to
strengthen horizontal or vertical linkages. It is argued that it can result
into reduction of total risk through substantial reduction of cyclicality of
operations. Total risk will be reduced if the operations of the combining firms
are negatively correlated (Pandey, 2010).
In
practice, investors can reduce non-systematic risk (the company-related risk)
by diversifying their investment in shares of a large number of companies.
Systematic risk (the market, related risk) is not diversifiable. Therefore,
investors do not pay any premium for diversifying total risk via reduction in
non-systematic risk that they can do on their own, cheaply and quickly.
The
reduction of total risk is advantageous through combination since the
combination of management and other systems strengthen the capacity of the
combined firm to withstand the severity of the unforeseen economic factors that
could otherwise endanger the survival of individual companies. Conglomerate
mergers can also prove to be beneficial in the case of shareholders of unquoted
companies since they do not have the opportunity for trading in their company’s
shares (Pandey, 2010).
Reduction in Tax Liability
In
a number of countries, a company is allowed to carry forward its accumulated
loss to set-off against its future earnings for calculating its tax liability.
A loss-making or sick company may not be in a position to earn sufficient
profits in future to take advantage of the carry-forward provision. If it
combines with a profitable company, the combined company can utilize the
carry-forward loss and save taxes.
Financial Benefits
There
are many ways in which a merger can result in financial synergy and benefits. A
merger may help in:
· Eliminating
the financial constraint
· Deploying
surplus cash
· Enhancing
debt capacity and
· Lowering
the financing costs
Financing constraint:
A
company may be constrained to grow through internal development due to shortage
of funds. The company can grow externally by acquiring another company by the
exchange of shares and thus release the financing constraint.
Surplus cash:
A cash-rich company may face a different situation. It may not have enough
internal opportunities to invest its surplus cash. It may either distribute its
surplus cash to its shareholders or use it to acquire some other company. The
shareholders may not really benefit much if surplus cash is returned to them
since they would have to pay tax at ordinary income tax rate. Their wealth may
increase through an increase in the market value of their shares if surplus
cash is used to acquire another company. If they sell their shares, they would
pay tax at a lower, capital gains tax rate. The company would also be enabled
to keep surplus funds and grow through acquisition.
Debt capacity:
A merger of two companies, with fluctuating, but negatively correlated, cash flows,
can bring stability of cash flows of the combined company. The stability of
cash flows reduces the risk of insolvency and enhances the capacity of the new
entity to service a larger amount of debt. The increased borrowing allows a
higher interest tax shield which adds to the shareholders wealth.
Increased Market Power
A
merger can increase the market share of the merged firm. The increased
concentration or market share improves the profitability of the firm due to
economies of scale. The bargaining power of the firm vis-à-vis labour,
suppliers and buyers is also enhanced. The merged firm can also exploit
technological breakthroughs against obsolescence and price wars. Thus, by
limiting competition, the merged firm can earn super-normal profit and strategically
employ the surplus funds to further consolidate its position and improve its
market power.
3. CONCLUSION
Companies
undertake corporate restructuring in order to enhance shareholders values.
Corporate restructuring take the form of ownership restructuring, business
restructuring and assets restructuring. Mergers and acquisitions result in change
in ownership and enhanced shareholders value. There are huge benefits that are
likely to accrue to companies that engae in corporate restructuring through
mergers and acquisitions. However, such benefits compe accompanied by related
costs. Therefore, a careful analyses and understanding of the prevailing
business industry specific and business environment factors is necessary for
the benefits of mergers and acquisition to be realized.
REFERENCES
Ansoff, H. L. et al (1971) Acquisitive
Nature of US Manufacturing Firms 1946-1965, Vanderbilt University Press, New
York
Arthur, R. H. & Waya, H. (1963) A
Critical Study of Accounting for Business Combination, Accounting Research
Study, American Institute of Certified Public Accountants, New York.
ICAI, Statements of Accounting
Standards (2014) Accounting for Amalgamation, New Delhi, http://www.icai.org/resource.as14.html
Pandey, I. M. (2010) Financial
Management, 10th Edition, Vikas Publishing House Pvt Ltd, India
Weston, J. F. and Brigham, E. F.
(1977) Essentials of Managerial Finance, Dryden Press, P. 515
For comments,
observation or other feedback or if you need assistance with your research
projects/papers, you can contact the author via E-mail: researchmidas@gmail.com
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