Timing of Merger Activity

Mergers and Macroeconomy

Statistical relationships
Nelson (1959, 1966) Studies

Nelson R.L., Merger movements in American Industry, 1895-1956, Princeton, NJ; Princeton University Press, 1959

Nelson R.L., 1966, Business Cycle Factors in the Choice Between Internal and External Growth,” The Corporate Mergers, W.W. Alberts and J.E.Segall, eds. Chicago; University of Chicago Press, 1966.



1959 study

For the period 1897-1954 period, there were 14 cycles in general business activity and 12 merger cycles.

A definite timing relationship to the reference cycle turning points was found in 11 of 12 merger cycles.

The two reference expansions 1911-13, 1921-23 for which there was no corresponding merger expansion were either of short duration or of moderate amplitude. The reference cycle contraction of 1953-54 had no corresponding merger contraction and was one of the mildest contractions in the six-decade period.

The peaks of merger cycle usually preceded the peaks of the reference cycle.

Hoewver, th time sequence for troughs was less consistent than for peaks. Nelson (1959. p.112) suggests that this irregular time sequence of merger activity indicates ‘ that economic forces in a depression are likely to be diffuse and weak, compelling no great uniformity in the response of merger activity

Study of relation between merger activity nad other economic series revealed that merger activity was closely related to stock trading, stock prices and business incorporations.

The peak in merger activity wsa reached one month earlier than stock prices, but its trough lagged the trough in stock prices by three months.

Analysis based on detrended series showed that mergers were more positively correlated to stock pirce changes than to changes in industrial production in periods of high merger activity.

Mergers were more positively correlated to industrial production in periods of low merger activity.

In a follow-up study, Nelson(1966) found that merger activity for the 1919-1961 period peaked on average five months before the peak in stock prices, whereas peaks in plant construction contracts and equipment orders were almost coincident with those in stock prices. Nelson's interpretation for this result was that external growth through mergers was selected by firms early in a stock price rise and before they undertook internal investments. One of the reasons offered by Nelson is that the phenomenon reflects the immediacy with which mergers start to produce revenues and profits. Internal investments may involve a protracted waiting period.

In the same study it was found that a peak in merger activity on an average, came 19 months following the trough in the reference cycle or at about the two thirds point in a reference cycle expansion lasting about 29 months.


Melicher, Ledolter, and D’Antonio (1983 Study) on the relationship between merger activity and macroeconomic variables – Industrial activity, Business failures, Stock prices, and Interest rates

Melicher, Ledolter, and D’Antonio, “A Time Series Analysis of Aggregate Merger Activity,” The Review of Economics and Statistics, 65, August 1983, pp. 423-430.


They used FTC quarterly merger data for 1947 through 1977.
Each times series was transformed into white noise ( that is, uncorrelated random variables or residuals from univariate time series models).

From these prewhitened series correlations were determined to find out lead and lag structures.

Among their findings are:

1. An increase in stock prices followed in a quarter by an increase in merger activity. Since merger negotiations begin on average about two quarters before consummation, merger negotiations may precede stock price movements by about one quarter.

2. Mergers respond inversely to prior changes in bond yields, although this relationship is weaker than the case of mergers and stock prices. Further an increase in bond yields decreases stock prices in the same period. An increase in stock prices leads to an increase in bond yields in the following period.
3. Changes in merger activity and changes in stock prices both lead changes in industrial production.
4. Merger activity precedes business failures by one quarter and the relationship is negative.

Linkages between mergers and macroeconomy have also been studied by Becketti (1986)

Becketti, S., “corporate Mergers and the Business Cycle,” Economic Review, Federal Reserve Bank of Kansas City, May 1986, pp. 13-26


Golbe and White (1987) is another study that examined determinants of merger activity.

Golbe, Devra L., and Lawrence J White, “A time series analysis of mergers and acquisitions in the U S Economy,” mimeo, Presented at the NBER Conference on Mergers and Acquisitions , February 1987.

Implementing the Growth Strategy

An article to be referred to

Growth Through Acquisitions: A Fresh Look. By: Anslinger, Patricia L.; Copeland, Thomas E..
Harvard Business Review,
Jan/Feb96, Vol. 74 Issue 1, p126-135, 10p, 1 graph, 2bw;

Acquisitions - Agency and Resource perspectives

The agency theory perspective is very popular in explaining why firms engage in ineffective M&A. The agency logic predicts that manager-controlled industrial firms will pursue conglomerate diversification. A firm's managers may benefit from the increase in firm size in that these firms are less likely to fail and executive pay is often linked to firm size. Bank managers have an incentive to improve their employment stability through acquisition since governments are reluctant to close large troubled banks because the failure of a large bank would create severe problems throughout the banking system.

From the resource-based perspective, the firm is composed of a bundle of tangible and intangible resources. Resources do not create value statically or independently and their value comes from their interactions with other resources (Gupta and Roos, 2001). If complementary resources are not under its ownership control, the firm has difficulty in realizing the true potential of its resources. Consequently, the firm has an incentive to merge or acquire other firms that own complementary resources. Hagedoorn and Dysters (2002) suggest that M&A can be one of the alternatives that firms have to exploit external sources of innovative competencies to protect their core businesses. Firms can also pursue non-synergistic acquisitions to grow dramatically and maintain sustained returns at the same time. The resource-based scholars tend to emphasize how a firm that has heterogeneous scarce, valuable and inimitable resources can lead to sustainable competitive advantage (Barney, 1991).

The agency logic predicts that manager-controlled industrial firms will pursue conglomerate diversification. A firm's managers may benefit from increases in firm size in that these firms are less likely to fail.



Barney, J.B. (1991), "Firm resources and sustained competitive advantage", Journal of Management, Vol. 17 pp.99-120.



Barney, J.B., Zajac, E.J. (1994), "Competitive organisational behaviour: Toward an organisationally-based theory of competitive advantage", Strategic Management Journal, Vol. 15 pp.5-9.


Gupta, O., Roos, G. (2001), "Mergers and acquisitions through an intellectual capital perspective", Journal of Intellectual Capital, Vol. 2 No.3, pp.297-309.


Hagedoorn, J., Dysters, G. (2002), "External sources of innovative capabilities: the preference for strategic alliances or mergers and acquisitions", Journal of Management Studies, Vol. 39 No.2, pp.167-88.

Mergers and Acquisitions Course - 2008

Topics/chapters to be covered from Fred Weston/Mitchell/Mulherin

Ch. 1 The Takeover process

Ch.2 The legal and Regulatory Framework - Instead of the material in the chapter Indian framework on mergers and SEBI regulations on take overs will be discussed.

Ch. 3 Accounting for M&As - Instead of material in the chapter, Indian Accounting Standard AS-14 will be discussed.
Book to be referred - Maheshwari and Maheshwari Advanced Accounting Volume 2, Chapter on Amalgamations

Ch. 4 Deal Structuring: Some Indian legal issues may he discussed

Ch 5. strategic Issues

Ch 6. Theories of Merges and Tender offers

Ch. 7. The Timing of Merger Activity

Ch. 8 Empirical Tests of M&A Performance

Ch. 9 Alternative Approaches of valuation

Ch. 10 Increasing the value of the organization

Ch. 11 Coproate Restructuring and divestitures

Ch. 12 empirical tests of Corporate Restructuring and Diverstitutes

Ch. 16 Going private and leveraged buyouts

Ch. 17 International Takeovers and Restructuring

Ch.22 Implementation and Management Guides for M&A s
-----Duel Diligence
-----Integration

Acquisition and Strategic Planning - 1

Strategic Planning for Growth

According to Boston Consulting Group, of all the factors contributing to the fundamental value of a business, by far the most important is profitable growth. They estimate that it is responsible for between two-thirds and three-fourths of a company's TSR over the long term.

To support companies in planning for profitable growth, BCG helps companies determine the precise role that growth should play in their corporate strategies, identify the most promising growth opportunities, and set the appropriate balance between organic growth and growth by acquisition.

http://www.bcg.com/impact_expertise/practice_area.jsp?practice=38




What actually is (successful) growth?


What is growth? We can measure corporate growth with statistics about

· Revenue

· Profits

· Number of staff

· Number of subsidiaries.



There are several strategic options, how organizations can grow:

· Internal growth (e.g. entry in new markets, launch of new products)

· Mergers and acquisitions

· Joint ventures

· Leveraging (licensing, development of a network of franchise partners).





Successful growth fulfils the following criteria:

A growing organization should always generate value. Successful growth can be measured by the criteria of sustainability, profitability and shareholder value generation.



· Growth does not necessary generate shareholder value.

· Successful corporate growth needs focus on and leadership in some core businesses.

· Success of failure in growth is not a matter of industry or size of the organization. It is, however, a matter of managerial decisions.



That sounds simple, but it is not. According to a study of Bain & Company, only a one out of seven organization manages to grow successfully.



Barriers to Growth

Barriers to successful corporate growth are complex. The main reason is a lack of a growth strategy – or failure to implement one. A poll from ADL and Fortune revealed that only about 25% of all respondents finally realized their intended strategies.

This allows two conclusions:

· Parts of the management have deficits, which prevent realization of the strategy. These deficits may base in communication or the inability to translate the overall vision and strategy into smaller steps and projects for particular divisions.

· In some companies, the whole planning process is little more than rubbish, since they fail to analyze their environment correctly and hence to develop appropriate projections and scenarios.



Moreover, there may be barriers to growth on operational levels:

· Lack of financial means or insufficient access to outside capital

· Lack of qualified staff / expertise

· Lack of preparation to take risks

· Lack of willingness and ability to change (“we always did it that way”)

· The “this is not invented here”-syndrome – the lack of willingness to take on external knowledge





Preconditions for Growth

The most important thing an organization should have is a strong core business. Such a core business has the following characteristics:

· It is a unique, profitable combination of strategic assets (e.g. equipment, intellectual property rights), skills and abilities (e.g. expert knowledge of workforce), products/services, and relations to external environment.

· It distinguishes the organization from its competitors.

· It enables the organization to serve a particular market segment with a perceived value added.

· It may be a single line of business or a combination of several divisions.

· It is the long-lasting major source of growth and value generation.

· It does not necessary contribute the largest proportion of revenues, but it does contribute the largest proportion of profits (A-product)



These characteristics of a core business reveal which further preconditions are needed in order to achieve growth:

· Development and implementation of a (growth)strategy

· Sound financial basis

· Ownership or development of two to three profitable core businesses

· Market leadership with these core businesses (even if it is in a narrow niche market)

· Management focus on these core businesses

· Continuous monitoring of external environment, early realization of and reactions to changes in the market

· Avoidance of unnecessary diversification into unknown businesses



The last point needs some explanation. Diversification into new businesses is not wrong in itself. Changes in the external environment may force the organization to explore new products in new markets. Management should however avoid looking for better prospects in unknown territory (here: business) only because they are not successful in their traditional fields.



The general message for corporate growth is:

Start with the exploitation of your existing competitive advantages.

http://www.themanager.org/Strategy/ManagingGrowthII.htm

Acquisition and Strategic Planning - 2

Growth Strategy Implementation

Alternatives and their advantages and disadvantages

Build (organic growth)

Adv:
Control

Dis:

Capital/expense requirements
Speed

Partner
Alternatives possible
- Marketing/distribution alliance
- Joint venture
- License
- Franchise

Adv:
Limited capital and expense requirment

Dis:
lack of or limited control
Potential for diverging objectives
Potential for creating a competitor

Minorty Stakes in other companies

Adv.
Limited capital and expense requirment

dis:
High risk of failure
lack of control



Acquire

Adv.
Speed
Control

Dis:
Capital expense requirements
Potential earnings dilution


Swap assets

Adv:
Limited use of cash
No earnings dilution
Limits tax liability if assets base does not change

Dis:
Finding willing parties
Reaching agreement onf assets to be exchanged

According to standard theory, the decision ot choose among alternative options should be made based upon the discounting of the cash flow stream to the firm resulting from each option.

The final selection may depend on such nonquantifiable factors as the senior manager's risk profile, patience and ego.

Developing the Acquisition Plan - 1

An acquisition plan is required if the firm decides that an acquisition is needed to implement the firm's business strategy.

The plan delineates key management objectives for the takeover, resource constraints and appropriate strategies for implementing the proposed transaction.

the acquisition plan provides appropriate guidance to those charged with successfully completing the transaction by providing critical inputs into all subsequent phases of the acquisition process.

the acquisition plan defines the criteria, such as size, profitability, industry, and growth rate used to select potential acquisition candidates.

The plan specifies the roles and responsibilities of team members, including outside consultants, and sets the team budget. It indicates management's preference for the form of payment.

Search for Acquisition Candidates - 1

To start the search for acquisition candidates, the search team or the manager must have preset primary screening or selection criteria. At the initial stage the criteria can be a small number. They include the industry, size of transaction,some valuation criteria like P/E, or P/B multiples.

The search team may go through various databases and director services like Dun and Bradstreet, Standard and Poors, Thomas' Register and Million Dollar Directory to identify potential targets.

The search team can contact firm's law, banking and accounting firms.

Investment banks, M&A brokers and leveraged buyout firms are fertise sources of candidates. But they may require an advisory or finder's fee.

Some firms do advertise its interest in acquiring a particular type of firm in various businss dailies and periodicals.

Making an Initial Offer to the Target - 1

A common first step in a transaction is to negotiate a bilateral confidentiality agreement and letter of intent.

The acquirer has an incentive to avoid signing a letter of intent. But the target company or an interested seller is often unwilling to proceed without a written offer.



Letter of intent

The letter of intent lays out the principla areas of agreement between the two parties.

The letter of intent formally stipulates the reason for the agreement, major terms and conditions, the responsibilities of both parties while the agreement is in force, a reasonable expiration date, and how fees associated with the transaction weill be paid.

Major terms and conditions include a brief outline of the proposed structure of the transaction.

The proposed purchase price may be expressed as a specific dollar figure, as a range, or as a multiple of some measure of value. The letter of intent also specifies the types of data to be exchanged and the duration and extent of the initial due diligence

Due Diligence - 1

Buyer due diligence is the process of validating assumptions underlying valuation.

The primary objectives are to identify and to confirm "sources of value" and to mitigate real or potential liability by looking for fatal flaws that reduce value.

Due diligence involves three primary reviews.

1. A strategic/operational/marketing due diligence conducted by senior operatons and marketing managers.

2. A financial due diligence conducted by financial and accounting personnel to ascertain the value of assets and liabilities that are being acquired.

3. A legal due diligence to ensure that there are no hidden legal liabilities to any outside party.

A rigorous due diligence is done based on comprehensive checklists.

The strategic and operational review has focus on th seller's management team, operations as well as marketing and sales strategies. An assessment of customer's viewpoint regarding the company's products and people is an essential component of this review.

The financial review examines the accuracy, timeliness, and completeness of thes seller's financial statements.

Legal due diligence concentrates on corporate records, management and employee issues, material contracts and obligations of the seller, litigations and claims.

Integration - 1

the major activities in integration can be described in the following sequence.

Premerger planning
Addressing communication issues
Defining the new organization
Developing staffing plans
Functinal and departmental integration
Building a new corporate culture

Premerger planning

By doing premerger integration planning, the buyer will have an opportunity to insert into agreement the apprpriate representations and warranties as well as conditions that facilitate postmerger integration process. The planning process creates a blueprint for a post merger integration organization that will be assembled immediately after the closing.

Part of the integration planning exercise is carried as a part of the due diligence exercise. One responsibility of the due diligence team is to identify ways in which assets, processes and other resources can be combined in order to realize cost savings, productivity improvements, or other perceived synergies. Valuation of the target involves estimating the rate at which the expected synergies may be realised. This step needs that how and over what time period the integration will be implemented has to be thought of as a plan to give numerical estimates of magnitude and timing of the cash flows of the combined companies