Mergers And Acquisitions

The value of mergers and acquisitions remain a topical issue within the contemporary business world. Whether these activities are beneficial to the economy or are simply meant to stifle competition is open to debate. It is crucial though that when this process is put under the spotlight, one must consider the impact on shareholders, creditors, employees, management, and customers of participating companies and competing firms. It is likely that not every group mentioned will benefit from mergers and acquisitions, but a commonly accepted criterion is that the outcome is socially desirable if the benefits exceed the costs.

Several measures have been proposed for analysing the success of mergers and acquisitions. Some mergers and acquisitions simply occur because managers of the acquiring firm may want to see their corporations grow bigger so as to gain control of the company and attain monopolistic power, hubris. Further to the theoretical overview provided in the previous chapter, the literature review covers an overview on mergers and acquisitions and whether the afore-mentioned lead to the creation of shareholder value. This is done by reviewing the literature on the effects of mergers and acquisitions for both the acquiring firm and the target firm's shareholders.The purpose of this study is to explore the field of mergers and acquisitions in South Africa with the aim of evaluating the value that these bring to the economy in terms of wealth creation.

3.2 Value of mergers and acquisitions
It is difficult to make a clear conclusion on whether mergers and acquisitions lead to wealth creation for shareholders. The focus of accounting research questions whether there has been an improvement in the numbers of accounting that follow mergers and acquisitions. Evidences from prior research have been mixed with studies that provide a demonstration that merger and acquisition result in improving the profitability even though most of the studies have concluded that the merger and acquisition do not foster improvements in performance.

Theorists have illustrated that with mergers and acquisitions, there are variations in the stock or share prices of the companies involved (Bild & Guest, 2002). Bild and Guest (2002) go on to note that, within this process, the share price for the acquiring companies generally increases relative to that of the acquired company. This is an important facet to consider bearing in mind that the main role of management in business is to increase the shareholders' wealth. Other authors have argued that the benefits of mergers and acquisitions also include combining complementary organisational resources, enhancing tax advantages, and doing away with activities that prove to be inefficient to the operations of the business (Palich & Cardinal, 2000).

Bild and Guest (2002:47) propagate that 'the other reasons for considering growth through acquisitions include obtaining proprietary rights to products or services, increasing market power by purchasing competitors, shoring up weaknesses in key business areas, penetrating new geographic regions, or providing managers with new opportunities for career growth and advancement'. However, Tchy (2002) believes that at times the reasons behind mergers and acquisitions are overvalued and the figures that are presented during the merger or acquisition process are not necessarily a true reflection of the facts. This becomes less obscure in the long run when companies become less profitable and shareholder wealth is compromised.

Based on a financial theory perspective, Bild and Guest (2002) note that in determining the value that mergers and acquisitions bring to shareholders, it is essential that the present value of the financial gains from these activities are greater than the financial gains of the individual companies before the merger or acquisition process. This however, as most studies have shown, is not an easy feat as the exact costs of the whole process including any synergies are difficult to quantify. Previous studies also fails to provide an explicit account of the cost of the merger and acquisition, the time value of money or gains beyond a limited post-merger period (Bild & Guest, 2002).

A considerable amount of research on mergers and acquisitions exists with diversity in the findings and inconsistent evidence validating the role of mergers and acquisitions in improving firm performance. Studies conducted to review overall merger performance and to identify specific determinants of merger and acquisitions success noted that many mergers and acquisitions fail to live up to post merger expectations (Ramaswamy, 1997). The importance of understanding the factors that contribute to merger success is further explored when the researchers examined the impact of change management as one factor affecting merger outcome. Researchers also indicated that there is a need for a more in-depth investigation of conditions under which these transactions create or destroy value. This results in the possibility that a broader set of factors may influence the outcome of mergers.

Underlying merger and acquisition literature do not combine to form one base theory and consistently centers on merger motivations related to efficiency theory, agency theory and resource theory. With the considerable amount of research done on mergers and acquisitions, diversity exists in the findings with inconsistent evidence validating the role of mergers and acquisitions of improving firm performance. Due to the inconsistency the findings by Palich& Cardinal (2000) indicate that there was a need for more in-depth investigation into merger and acquisition factors that create or destroy value. The net effect of mergers and acquisitions remains unclear despite the number of research studies done.

3.2.1 Cross-border mergers and acquisitions
Pehon (2006) summarises JP Neary's (2003) economic model which expands beyond the standard explanations to explore motivations for cross-country mergers and acquisitions. Rationalisation of cross-border merger and acquisitions transaction requires an in-depth explanation of the cross-border aspect of the transaction. The research from Brakman, Garretsen and van Marrewijk (2001), emphasises that strategic motives is one of the key reasons that triggers most cross-border merger and acquisition deals. Buying a firm outside of one's own sector might be motivated by an efficiency motive since it can be profitable to control a larger part of the value chain. In this instance, both motives increase profits after the take-over (Palich &Cardinal, 2000).

Additionally, Brakman et al (2001) argues that since most cross-border merger and acquisition activities belong to the category of an economic concept known as Foreign Direct Investment (FDI). Research analysing the determinants and causes of international bank mergers by Buch and DeLong (2001) concluded that economies of scale and scope is one of the major motives to increase the need and trend of international mergers. Neary (1981) studied international cross-border bank mergers between 1985 and 2005, and utilised a theoretical framework proposed by Pehon (2006) that categorised bidders into strategic market-asset and efficiency-seekers. As an example, Schmautzer (2006), in his framework indicates that banking mergers and acquisitions are motivated as market-seekers to aim for financial synergies through geographic diversification, motivated as asset-seekers to aim for (financial) product diversification, and motivated as efficiency-seekers to be primarily interested in operational synergies.

According to Jagersma (2005), the decision to make an acquisition is first and foremost a strategic one, and to a much lesser extent a financial one. Jagersma (2005) offered six reasons which included; economies of skills, expansion, economies of scale, market entry, geographic risk spreading and financial. Rossi and Volpin (2004) completed a study on determinants of mergers and acquisitions and focused on the differences in laws and regulations across countries. They concluded that the volume of mergers and acquisitions was significantly larger in countries with better accounting standards and stronger shareholder protection.

According to Marks and Mirvis (2001), there are many factors that can account for merger failure. These include buying the wrong company for the wrong price, executing the wrong deal structure, or even making the right deal at the wrong time. Consistent with Epstein's observations as reported by Marks and Mirvis (2001), they observed that the primary reason for failure among mergers is a poorly designed and executed integration process. Some strategic management studies emphasise the role of management, or other social factors, such as personnel, the environment or culture.

Despite the research on failures of mergers and acquisitions, there is some evidence that cross border mergers and acquisitions are successful, and therefore do add value. For example, Armour (2002) found success in the ability to maximise shareholder value through the setting of specific and tangible goals by doubling the value of the company every four years by achieving certain profit levels. Bert et al., (2003) specified success of mergers and acquisitions as meeting or exceeding the financial analysts' expectations by earning positive shareholder returns within the first two years after the change of control (Pehon, 2006). Consistent with Datta (1991), Homburg and Bucerius (2006) defined success as the new merged firms' return on sales after the merger, as compared to the target and acquirer returns before the merger. Antoniou, Arbour and Zhao (2006), defined a successful or value-creating merger as one that exhibits forms of cash flow, margin, asset productivity, profitability and/or efficiency improvement. Furthermore, Andrade et al. (2001) indicated that when assessing performance in the context of the accounting research, success is defined as the merged company performing better than the parties would have done in the absence of the merger.

On the other hand, and as mentioned earlier, Brouthers, Hastenburg and Ven (1998) noted that since mergers have multiple motives, merger studies that measure success by examining a single financial measure of performance will undervalue goals of the merger, and hence performance may be inaccurately measured. The authors suggest that since there have not been alternative performance measures other than financial ratios or stock measures, a better indicator of performance would be the achievement or non-achievement of the predetermined objectives of the merger. Furthermore, the methodology for assessing merger success should entail the use of multiple measures of performance, such as financial and non-financial measures in order to capture the true performance of the merger (Ramaswamy, 1997).

3.2.2 Value creation with the use of key parameters
According to DePamphilis (2008), merger and acquisition activities increase the value of the firms in terms of their growth. Further to that, it also has a positive impact on the profits earned by the shareholders selling around merger and acquisition announcement dates and after the trading activities occurs in the future. The merger and acquisition activities also lead to improvement in the value by increasing the long-term performance of the firms that have merged or acquired. Further studies found that in terms of value, cash deals are much cheaper than the deals occurring from the stocks of the firm. However, acquirers tend to pay excessive premiums for growth companies.

Bruner (2004) states that the valuation of the merged and acquired companies as a result of these activities, are as a result of value conserved, value created and value destroyed. Value conserved occurs as a result of merger and acquisition activities when investment returns are equal to the required returns. As a result, investors are able to get their returns before the deal occurs. Secondly, value is created as a result of merger and acquisition activities when the level of investment increases more than the amount of returns required by the investors. Similarly, the returns earned by the investors are more than their expectations even before the deal is completely implemented. On average, smaller acquirers realise higher abnormal returns than larger acquirers (Moeller, Schlingemann and Stulzrm, 2004). Thirdly, according to Bruner (2004), value destruction also occurs when the return on investment reduces the required returns amount, here the investor is unable to get the returns as expected before the deal occurs.

The impetus for businesses to pursue between a sale and a merger may involve estate planning, a need to diversify its investments, an inability to finance growth independently, or a simple need for change. In addition, some businesses find that the best way to grow and compete against larger firms is to merge with or acquire other businesses. It is important to note that for a merger to be successful and beneficial to the parties involved each side should add value so that together the two are much stronger. Smith (2006) points out that many mergers fail to work. He identifies overpaying for the acquisition as a common mistake because of an incomplete valuation model. It is thus essential to develop a complete valuation model, including analysis under different scenarios with recognition of value drivers. Only then can the value of an acquisition be better realised.

In general, value is created in a merger and acquisition when the following key parameters are addressed. These parameters determine whether the merger will improve the strategies of both companies, if there is sufficient resources allocated for integrating the two companies, if integrations takes place by design and not by chance, whether both companies have prepared for integration in advance through due diligence, if human and cultural issues are directly addressed as part of integration, and if the integration process is viewed as evolutionary with several concurrent projects going on in trying to integrate the two companies as quickly as possible (Smith, 2006).
According to DePamphilis (2008), work covered by other authors on whether mergers and acquisitions create value or not, can be summarised as follows:
' Acquirers overpay for growth companies (excessive premium)
' Shareholders profit by selling around announcement dates
' Long-term performances of combined companies improve
' The method of payment affects long-term returns i.e. cash deals are cheaper than acquiring stock

3.3 Types of mergers and acquisitions
Mergers and acquisitions can also be described as a consolidation of companies. In a merger, two companies combine to form a new entity, whereas during an acquisition, one company seeks to purchase another. In an acquisition, the acquiring company is making the purchase and the target company is being bought.

According to Cavallaro (2011), a merger can be statutory, where the target company is fully integrated into the acquirer and thereafter no longer exists. A merger can also be a consolidation, where two companies join to become a new company or a merger can be subsidiary, where the target company becomes a subsidiary of the acquiring company.

There are different types of mergers: horizontal, vertical, conglomerate and congeneric. In a horizontal merger, a competitor or a related business is acquired. Here the acquirer is looking to achieve cost synergies, economies of scale and gain market share. An example of this is the merger between Daimler-Benz and Chrysler. A vertical merger is an acquisition of a company along the production chain. An example here would be a car company purchasing a tyre manufacturer. In a conglomerate merger, a company completely outside of the acquirer's scope of core operations is purchased. A congeneric merger is a type of merger where two companies are in the same or related industries but do not offer the same products (Goldsmith 2007). In a congeneric merger, the companies may share similar distribution channels providing synergies for the merger.

An acquisition is an activity where an entire takeover of the organisation takes place and one company targets to buy another company. Changes in corporate control can happen because of a hostile bid which is contested by the target's board and management, or friendly takeover of a target company, or because of a proxy contest started by unhappy shareholders. According to Morck, Shleifer, and Vishny (1988b), there are many theories that explain why managers resist a takeover attempt. The management entrenchment theory is one such theory which suggests that managers use a variety of takeover defenses to ensure their longevity with the company. Hostile takeovers, or the threat of such takeovers, have historically been useful for maintaining good corporate governance by removing bad managers and replacing them with better ones. The shareholder interest theory is used to increase the purchase price to the benefit of the target company's shareholders while the proxy contest theory is applied when a dissident group of shareholders attempt to gain representation on the company's board of directors or change management proposals (Ertimur, Ferri, and Stubben 2008).

3.3.1 Friendly takeovers
Under friendly takeover conditions, a negotiated agreement is possible without the acquirer resorting to aggressive tactics. Here the potential acquirer initiates an informal dialogue with the target's top management, and the acquirer and target reach agreement on key issues early in the process. Examples of such friendly takeovers involving South African companies are: Japanese telecommunications operator Nippon Telegraph's acquisition of South African information technology services provider Dimension Data, valued at R22-billion, and Walmart's 51% acquisition of Massmart, valued at R16,8-billion (Polity Focus).

3.3.2 Hostile takeovers
According to the Thomson Reuters database, hostile takeovers of U.S. firms peaked at about 14 percent of all takeovers in the 1980s. There are several types of hostile takeover tactics, including the bear hug, proxy contest, and tender offer. With the bear hug tactic, the acquirer mails a letter that includes an acquisition proposal to the target company's CEO and board of directors. The letter arrives with no warning and demands a quick response, to move the board to a negotiated settlement. The bear hug also involves a public announcement as well. Directors who vote against the proposal may be subjected to lawsuits from target shareholders, especially if the offer is at a substantial premium.

In a proxy contest, dissident shareholders attempt to win representation on the board of directors. The dissidents then initiate a proxy fight to remove management due to poor corporate performance. By replacing board members, proxy contests can be won by gaining control without owning 50.1 percent of the voting stock. Instituting a proxy contest to replace a board is costly, which explains why there are so few. During the period 1996 and 2004, an average of 12 companies annually faced contested board elections (The Economist, 2006).

A hostile tender offer tactic is a deliberate effort to go around the target's board and management to reach the target's shareholders directly with an offer to purchase their shares.
Potential bidders often purchase stock before a formal bid to accumulate stock at a price lower than the eventual offer price. Tender offers can be cash, stock, debt or some combination of the three.

According to DePamphilis (2008), there are quite a few advantages to hostile takeovers. One is that the friendly approach surrenders the element of surprise. Even a few days warning gives the target management time to take defensive action. The friendly approach allows for negotiations to raise the likelihood of a leak and that will lead to a hike in the target's share price which would then add to the cost of the transaction. Successful hostile takeovers depend on the premium offered to target shareholders, the board's composition and the composition and sentiment of the target's current shareholders.

3.4 Cost of mergers and acquisitions
According to (2014), mergers and acquisitions are strategic business deals that are executed only after comparing its cost with the potential benefits to know the viability of the proposition. In an acquisition deal, the acquiring company estimates the cost of acquiring the other company to gauge how profitable the takeover will be in the long-run. In most instances both sides of a merger and acquisition deal will have different ideas about the worth of a potential target company. Smith (2006) point out that those sellers tend to value the company as high as possible, while the buyer will try to get the lowest price. There are, however, many legitimate ways to value companies. The most common method is to look at comparable companies within an industry however deal makers employ a variety of other methods and tools when assessing a target company.

Many methods are available to calculate the cost of mergers and acquisitions. However, the common ones are the Replacement Cost Method (RCM) and the Discounted Cash Flow Method (DCFM). The Replacement Cost Method is ideally used for manufacturing firms that have a number of by-products. These by-products like machinery, furnaces, tools, etc. can be re-used by the acquiring company in the course of business. Therefore, the total cost of the by-products is compared with the cost of replacing them with the new ones at market price to determine the profitability of the deal. However, this method is unsuitable for human resource-intensive firms.

The discounted cash flow method analysis is a key evaluation tool and determines a company's current value in relation to its estimated future cash flows. The discounted cash flow method also discounts future cash flow projections from the newly formed company to its present value. In general this method helps evaluators determine if the deal is worth proceeding with. Decisions are taken on calculated present values of the deal depending on what the 'acquiring' entity considers to be beneficial.

3.5 Cash, Securities or mixed offering payment methods
A company can be purchased using cash, stock or a mix of the two. Stock purchases are the most common form of acquisition. Firms have to take many factors into consideration when an offer is put together: potential presence of other bidders, the target's payment preference, tax implications, and transaction costs if stock is issued.

The greater the perceived benefits of an acquisition as realised by management, the higher the preference for them to pay for stock in cash, (Cavallaro, 2011). This is mainly due to their belief that shares will eventually be worth more after synergies are realized from the merger. Similarly, the target company will want to be paid in stock, so that they can be partial owner in the acquirer and will also be able to benefit from the expected synergies.

When an acquirer's shares are overvalued, management prefers to pay for the acquisition with exchange of stock-for-stock. The stocks are considered a form of currency. Since the shares are deemed to be priced higher than what they are actually worth (based on market perception, due diligence, third party analysis, etc.) the acquirer is getting more value. If the acquirer's shares are considered undervalued, management may prefer to pay for the acquisition with cash. The payment method of choice is a major signaling effect from management. It is a sign of strength when an acquisition is paid for with cash. Stock payment reflects management's uncertainty regarding possible synergies from a merger.

3.6 Winners and Losers in Mergers and Acquisitions
According to (2014), not all companies will openly embrace mergers. This creates a paradox in the process in which ultimately while there will be winners, the acquired company would be seen to be the 'loser'. Latief (2009) points out that there are some risk factors associated with post-merger integration that companies need to consider when they are involved in merger and acquisition activities. These include the level of integration companies need to implement, the type and number of key personnel to retain as well as the kinds of conflict and competition the companies should anticipate during the integration.

The biggest disadvantage of acquisitions is that they fail because of cultural mismatches. However, the resultant of both merger and acquisition activities is increase in the stability of the companies, increase in the profitability, enhancement in the performance and lead towards growth in the entire organisation.

To illustrate the impacts of mergers and acquisitions in relation to its winners and losers, the case involving the horizontal merger transaction between AT&T and T-Mobile USA as reported by Sorkinet al (2011) is briefly discussed. AT&T announced the purchase of T-Mobile USA from Deutsche Telekom AG for $39 billion in cash and stock. AT&T and its shareholders were clear winners as the stock went up by 10% since the deal was announced. By conducting this deal, AT&T eliminated one of its large competitors in the wireless business. The losers in this case were the consumers as there was now a less choice of providers.

In April 2011, Chesapeake Energy purchased Bronco Drilling at $11 per share in a cash deal worth approx. $315 million. Bronco Drilling is a land oil driller that owns 22 rigs operating in various onshore areas of the United States. Here the winners were clearly Chesapeake Energy and its shareholders as Chesapeake paid only 6% premium on the day the deal was announced. Chesapeake also got the additional rigs to add to its Nomac Drillling subsidiary which owned 95 rigs. The losers were Bronco Drilling's shareholders as they only received 6% premium. This is typically an example of vertical integration.

Another example is Wal-Mart's purchase of Kosmix which is social media company in 2005. Undisclosed sources said that Wal-Mart paid Kosmix in the vicinity of $300 million. The winners in this case were clearly the two Kosmix owners. This was not their first venture as they also sold their search engine Junglee to Amazon in 1998. Although not stated, the losers in this case could be Kosmix, as the corporate culture of large companies like Wal-Mart is quite different to the smaller company.

Global merger and acquisition activities also impacted several developing and emerging countries such as in the case of South Africa, which prior to 1995 had several trade and economic sanctions as a result of race based apartheid legislation. This is further unpacked in the following section.

3.7 Mergers and Acquisitions in the South African Mining Industry
The removal of economic sanctions in 1995 and South Africa's inclusion in the global economic framework there has been a great increase in mergers and acquisitions in South Africa. This was further enhanced by Broad Based Black Economic Empowerment (BBBEE) legislation such as BBBEE Act of 2003. Figure 1 gives us an indication of the BBBEE contribution in mergers and acquisitions between 1995 and 2007.

Figure 1: BEE contribution to Mergers and Acquisitions in South Africa

Source: DTI, 2008
As mentioned in Chapter 2 (Theoretical Overview), the data included for the study concentrates on the period 2003 to 2008. This is due to the availability of data. The reason for this is because after the year 2003 merger and acquisition activities increased drastically as a result of the enhancements in the mining industry of South Africa. During the year 2003 till 2008, there are about 130 deals that took place in different markets of mining industry like in gold, platinum, coal and etc.

In the South African mining industry, the main reasons for mergers and acquisitions were driven by legislation compliance, operational and financial synergies and strategic re-alignment. In some cases, managerial pride, misevaluation and tax considerations could be the motivating factors. The reason for a merger or an acquisition is very important, as it offers clarity on purpose throughout the process of target acquisition. It would also help in clarifying the non-financial benefits and any dangers to the merger objective. The most important step in any deal process is most likely to be the post-merger integration step. This is because when companies merge, they do not only merge income statements, balance sheets and cash flows, but also people, cultures, systems and procedures, which normally take a while to integrate. The post-merger integration has a major impact on how much of the value expected is actually derived and how long it would take.

According to DePamphilis (2008), during the acquisition of Harmony, in addition to assets from the old Harmony and Evander, the company acquired assets from Randfontein, Elandskraal, Freegold and ARMgold. Within about three years between 2000 and 2003, the cultures of JCI, Anglogold and ARMgold had to be merged into the existing culture, organisational structures etc. The psychological and emotional impacts of such changes are traumatic and must be handled carefully to ensure the intended benefits are realised.
Figure 2 below shows the number and value of mergers and acquisitions in South Africa during 1991 to 2013.

Figure 2: Announced Mergers and Acquisitions South Africa, 1991-2013

Source: Thomas Financial Institute of Mergers, Acquisitions and Alliances (IMAA) analysis

3.8 Conclusion
The literature reviewed indicates that evidence from both the accounting-based and event studies is mixed. Whilst some suggest that mergers and acquisitions lead to the creation of shareholder wealth, others argue that mergers and acquisitions do not result in the creation of shareholder wealth. Most studies however, conclude that mergers and acquisitions do not result in shareholder wealth creation. There is a need for further research that will determine more adequate methods of studying the impact of mergers and acquisitions.

Studies have shown various reasons and factors that are considered by decision makers particularly in the mining industry when taking the decision to decide on either a merger or an acquisition while operating in the South African economy. It is anticipated that the different views that support or oppose mergers and acquisitions will form the basis on which this study will be undertaken.

Source: ChinaStones -

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