Understanding MERGERS and ACQUISITIONS

Learning Objectives:
After reading the chapter you will be able to
Understand the concept and rationale for merger and acquisition
Understand the types of mergers and the benefits
Understanding the major merger waves
Understanding the merger motives
M&A indices
CONCEPT IN PRACTICE
The worlds first product brand company Procter and Gamble P&G was established in
1837 and it sold candles & soaps. In 1935 the Company expanded its international
presence with the acquisition of the Philippine Manufacturing Company to expand the
Company's first operations in the Far East. In 1957 P&G entered the consumer paper
products business with the acquisition of Charmin Paper Mills, a regional manufacturer
of toilet tissue, towels and napkins. In 1963 P&G entered the coffee business with the
acquisition of Folgers Coffee. the company then wanted to expand into new market on
the eastern side. In 1973 the Company began manufacturing and selling P&G products in
Japan through the acquisition of the Nippon Sunhome Company. The new company was
called Procter & Gamble Sunhome Co. Ltd. In 1982 the company entered into over the
counter and personal health care business. As a result P&G acquired Norwich Eaton
Pharmaceuticals in 1985 the Company significantly expanded its over-the-counter and
personal health care business worldwide with the acquisition of Richardson-Vicks,
owners of Vicks respiratory care and Oil of Olay product lines. By then the company
already had a hold in several markets worldwide. The company next planned to expand to
European market. In 1987 the Company increased its presence in the European personal
care category with the acquisition of the Blendax line of products, including Blend-aMed and Blendax toothpastes. It was the largest international acquisition in Company
history.
The year 1987 and 1988 was a period of consolidation and internal restructuring after a
spree of international acquisitions and merger activity by the company. Hence in this
period P&G announced several major organizational changes with restructuring to
category management and a product supply system that integrated purchasing,
manufacturing, engineering and distribution. In 1988 the Company announced a joint
venture to manufacture products in China. This was the Company's first operation in the
largest consumer market in the world. In 1989 the Company entered the cosmetics and
fragrances category with the acquisition of Noxel and its CoverGirl, Noxzema and
Clarion products. Further in 1990 the Company expanded its presence in the male
personal care market with the acquisition of Shultons Old spice product line.

In 1991 P&G opened its first operation in Eastern Europe with the acquisition of Rakona
in Czechoslovakia. The acquisitions of Max Factor and Betrix further increased the
Company's worldwide presence in the cosmetics and fragrances category. In 1994 P&G
entered the European tissue and towel market with the acquisition of the Germany-based
company, VP Schickedanz.. In 1995 following the lifting of U.S. sanctions against
Vietnam, P&G established a joint venture with the Phuong Dong Company to build a
manufacturing plant in the Song Be Province, just outside of Ho Chi Minh City. In 1996
the Company continued to expand its global reach with acquisitions of the U.S. baby
wipes brand Baby Fresh complementing the Company's global diaper business and its
strong European Pampers Baby Wipes business and Latin American brands Lavan San
household cleaner and Magia Blanca bleach providing a solid foundation for P&G
growth in this important laundry category.
In 1997 P&G expanded its feminine protection expertise into a new global market with
the acquisition of Tambrands. Tampax, its tampon brand, is the market leader
worldwide. In 1999 the Company entered the global pet health and nutrition business by
acquiring the Iams Company, a leader in premium pet foods. Further in the same year
the acquisition of Recovery Engineering Inc. allowed P&G to utilize its understanding of
water treatment by developing home water filtration systems under the brand. In 2001
P&G acquired the Clairol business from Bristol-Myers Squibb Co. Clairol was a world
leader in haircolor and hair care products. In the same year P&G and Viacom Plus
announced a major multimedia marketing partnership. Further Crest SpinBrush was
brought to market in record time following the acquisition of Dr. John's SpinBrush
toothbrushes.
Today P&G has more than 15 billion-dollar brands in its portfolio. These brands
represent more than half of the Company's sales and earnings and include Pampers,
Tide, Ariel, Always, Pantene, Charmin, Bounty, Iams, Crest, Folgers,
Pringles and Downy. Almost all of these brands were acquired by the company. The
company expanded its product lien, business line, markets through mergers and
acquisition. This chapter will help you understand the concept rationale of mergers and
acquisitions. It will further help you to understand the issues and various due diligence
involved in mergers and acquisitions.
CHAPTER OUTLINE
INTRODUCTION
TYPES OF MERGERS
Mergers
Acquisition
Horizontal merger
Vertical merger
Conglomerate merger
MERGER WAVES
First wave
Second wave
Third wave

 Fourth wave
Fifth wave
Sixth wave
MERGER MOTIVES
To eliminate competition and create monopoly
To gain market access i.e. geographical expansion.
To benefit from efficiency gains in form of synergy
To satisfy self ego of managers i.e hubris hypothesis
To benefit from undervaluation
To diversify across industries
To gain access to R&D and technology know-how

INTRODUCTION
Value creation and sound growth prospects underlie the basic existence of every business
enterprise. Every organization is on the lookout for profitable investment opportunities.
Sometimes these opportunities are found within the organization like expansion,
modernization, and new product development etc. and sometimes these opportunities are
part and parcel of the external environment like investment in another companys equity,
in another companys project or by acquiring a profitable established brand, capacity, etc.
The external process has become very popular in the last few years and has contributed
much to the economic development of the countries. The process of acquiring a business,
brand or firm is called mergers and acquisition. It is a form of inorganic growth were the
company purchases growth. The firm avoids growing through Greenfield and Brownfield
projects rather prefers the acquisition mode (see figure 1). Heineken for example in 199900, showed a total increase in its net turnover of 14%. Out of this the new acquisitions
accounted for 8% increase, enhanced sales accounted for 2%, higher sales price mix
accounted for 2%, and improved exchange rates accounted for 2% growth. The
contribution of acquisition to firm growth was maximum. Merger and acquisition can
take many forms like mergers, acquisition, takeovers, absorption, consolidation etc. In
other words we can also call them combination of business enterprises.
Figure 1: Expansion of Sabmiller from an African brewery to international giant
SABMILLER
Was
African brewer Company
Became
International Brewery

Through
International acquisitions
US, EUROPE, AFRICA, ASIA
INDIA
2000: Narang Breweries : Lucknow
2001: Mysore Breweries Ltd, Rochees Breweries Ltd
2003: Shaw Wallace: Beer Division (Strong Brand Haywards)
2006: Fosters India: Maharashtra
2007 Failed Acquisition Attempt of Mohan Meakin

Merger and acquisition as a strategic tool should result in value creation. It should be able
to create or sustain the competitive advantage of the participating firm. The competitive
advantage comes from product differentiation, low cost or focus strategy. Competitive
advantage is also created when core competence exists in the participating firm. If
competitive advantage and core competence exist before merger they should be able to
sustain it even after merger. If competitive advantage or core competence does not exist
then it has to be created post merger. Competitive advantage puts the merged firm at a
superior position relative to its competitors. A firm with competitive advantage earns
superior profit than its competitors. It makes its network of suppliers, competitors and
customers more meaningful and more productive than without it. The strength of the
merged firm should come from the fact that no one in its network of competitors is able
to replace it correctly and perfectly. Thus mergers and acquisition is an inorganic
strategic tool for corporate restructuring with the objective of value creation.
Mergers offer several advantages to companies as they provide several immediate and
long term benefits to the participating firms. They creates synergy for the merged entity,
Reduce inter trade and intra trade competition, Enhances market potential, Enhances
growth potential, Enhances profitability prospects, Diversification of the company,
Optimum utilization of resources, Enhances management efficiency, Enhances market
value of the company and Increases strategic competitiveness of the company. Thus
mergers and acquisitions enhance the long term value of the company thereby increasing
the market dominance. Apart from increasing the market share the companies also
benefit in the form of operating and financial synergies. For example consolidation may
lead to lowering of total running cost for a company. Here the companies merging are
able to eliminate overlapping activities in a particular region and within the merged
company as a whole.
An economy of scale is also possible when two or more companies merge. Economies of
scale in Mergers are about Increase capacity of merged entity, Increase in sales force and
reduction in overheads, increase in bargaining power from suppliers and Reduction in
production costs due to large volume. Merger should result in decline of the average costs
of the company. As volume of sales pick up average unit cost declines thereby lowering
total cost of the company. Merger also creates economies of scope. Economies of scope

is about broadening the existing product lines, providing one stop shopping for all
services, and obtaining complementary products. Thus merger leads to value addition to
the merged entity meaning thereby the merger creates synergy. Synergy implies that
when 2 or more companies combine together they must be able to create more value than
they individually do i.e., 2+2 = 5 or more than 5.
However, several studies have shown that at most acquisitions dont create value for
acquiring companys shareholders. But still companies continue to make more deals and
bigger deals every year. Recent research shows that acquisitions in the 1990s have an
equal poor record as in the 1970s. The reason could be attributed to
a) Irrational hype about strategic importance of the deal.
b) Unusually high enthusiasm and excitement built up during negotiation.
c) Weak integration of skills and intelligence.
A typical merger and acquisition activity involves proper due diligence i.e. sound
homework prior to execution of merger. Due diligence can take various forms like legal
due diligence, financial due diligence and technical due diligence. Legal due diligence is
concerned with the legal issues of mergers execution. Financial due diligence is
concerned with valuation of target firm, valuation of synergy that determines how much
the acquirer firm need to pay the target. Financial due diligence also deals with deal
structuring i.e. selecting the mode of payment to target companys shareholders. It can be
all cash, all stock or mix of both or simply stock swap or exchange. Technical due
diligence is concerned with the technical feasibility integration of the two firms. This is
very important in technology driven industry like banking, telecomm, internet etc. Finally
some people also focus on human due diligence which is concerned with the human
integration post merger i.e. how well to establish the human compatibility with the
changed environment.
TYPES OF MERGERS
Merger and acquisition is a strategic exercise. It is a tool for quick growth. The merger
and acquisition may take different forms depending on the nature of the business of the
participating companies and mode of payment and deal structuring. Some broad
categories of mergers are discussed in the following para.
MERGERS
Merger is a transaction where two firms agree to integrate their operations on a relatively
coequal basis because they have resources and capabilities that together may create a
stronger competitive advantage. The merged entity may either take an entirely new name
and new identity or the dominant player may completely absorb the smaller players and
retained its own identity.
In India the word merger is not defined under any act. Rather the term amalgamation is
defined in lieu for merger. Section 2(1B) of income tax act defines amalgamation as
Amalgamation, in relation to companies, means the merger of one or more companies
with another company or the merger of two or more companies to form one

company. Here all properties are to be transferred to the amalgamated company.

All liabilities to be transferred to the amalgamated company. The Shareholders holding at
least 3/4th in value of shares of the amalgamating company should become shareholders
of the amalgamated company.
In common parlance, merger means combination of two or more commercial
organizations into one. It can also take the form of absorption where one of the
participating firm survives. Technically Merger can be done by two methods namely,
1.
Merger through Consolidation
2.
Merger through absorption
Merger through consolidation: It results when two or more companies combine to form
an entirely new company. The new combined company is legally a new entity. The
companies, which are acquired, transfer their assets, liabilities and shares to the new
company (acquiring company) and in return get cash or shares of the acquiring company.
Consolidation is generally merger of equals. Here the two firms combine all assets &
liabilities and generally take a new name for the new company formed post merger. For
example JP Morgan and Chase Manhattan becomes JP Morgan Chase, Exxon and Mobil
becomes Exxon-Mobilfor , Guinness and Grand Metropolitan Merge to form entirely
new company Diageo, Sandoz Laboratories and Cieba Geigy merged to form Novartis,
Hindustan Computers Ltd., Hindustan Instruments Ltd. Indian software Company ltd and
Indian Reprographic Ltd. merged to form HCL Ltd, Tata Fertilizer LTD. (TFL) was
absorbed by Tata Chemicals Ltd. (TCL).
Merger through absorption: Here two or more companies combine into any of the
existing participating company. One company is absorbed into another generally in
absorption the dominant player completely absorbs the smaller players and retained its
own identity. For example Philips carbon black limited (PBCL) and RPG company
merged with its wholly owned subsidiary transmission holdings limited (THL), which is
an investment company, HDFC absorbed centurion bank of Punjab, RNRL was absorbed
by Reliance power
ACQUISITION
Acquisition is a business transaction where one firm buys another firm with the intent of
more effectively using a core competence by making the acquired firm a subsidiary
within its portfolio of businesses. In takeover the acquiring firm taking possession of
another business either through share purchase or asset purchases. It is characterized by
the purchase of a smaller company by a much larger one. This results when a company
acquires the ownership/stake in other companies without any combination of the
companies. The acquiring company controls other companies by acquiring their assets or
management. Thus by acquisition the acquiring company takes a hold of the working of
another company. An acquisition becomes a hostile takeover if the target firm does not
solicit the bid of the acquiring firm. For example IBMs acquisition of Lotus in 1995 and
Oracles bid for PeopleSoft in 2003.

In India the word acquisition is not used rather we use the term takeover. According to
the earlier monopolies and restrictive trade practices ( now the MRTP act has been
replaced by competition act 2002) takeover means acquiring at least 25% of the voting
power in a company. Sometimes acquisition of even 10% of the subscribed capital can
result in takeover/control of the company, hence Indian Companies Act states that if a
company intends an acquisition of 10% or more in another company, it has to seek
approval in the shareholders general meeting and also by the central government.
Generally a hostile acquisition is called a takeover. A takeover is always resisted by the
acquired company. Thus unwilling, induced, and forced acquisitions are termed as
takeovers. A holding company is the company that owns around 50% or more of the
share value in a company (subsidiary company). But holding company as well as
subsidiary company are different entities and maintain separate accounting reports.
Business snapshot
On November 18 2001. Grasim bought 2-5 crore shares of Larsen and Tourbo (L&T).
From Reliance (RIL) at Rs. 306.60 per share amounting to 10% of equity capital of L&T.
`On 24th November 2001 Kumar Birla and Mrs. Rajshree Birla are inducted on board of
L&T. On 27th December, 2001 SEBI asked for details of Grasim and RIL deal on L&T.
On 13th October 2002. Grasim made an open offer rom 20% of L&T stake at Rs. 190 per
share. On 20th October 2002 SEBI took note of investors Complaining on the offer price
by Grasim. On 18th November 2002. Sebi directed NV Birla Group to put open offer on
hold. In the first major consolidation in the Rs. 700 crore Nylon. Yarn industry, Thapar
Group Company JCT Limited is expected to take over nylon yarn plant of Baroda Rayon
in Surat. After this take over JCT will become the largest nylon textile yarn
manufacturers in India. JCT has entered into a long term agreement with Baroda Rayon
to run its nylon plant shut for over 2 years now. JCT will run the plant on a conversion
basis (i.e., run the plant and pay a fee). The RM, FGs will be JCTs. The Assets and
liabilities will continue to remain with Baroda Rayon (for Baroda Rayon the plant will
start running, earning a fee).
th

Merger can be categorized into following types:1.

Horizontal Merger
2.
Vertical Merger
3.
Conglomerate Merger.

Horizontal merger
A typical Horizontal merger involves two firms that operate in same business line and
compete each other in the same industry. In a horizontal merger the merging companies
are engaged in same type of business, distribution of business. For example merger of
HP and COMPAQ, Vodafone and hutch etc. it results in the consolidation of firms that
are direct rivals i.e. competitors. i.e. sell substitutable products within overlapping
geographical markets. Horizontal mergers result in increase in market power of the
acquiring firm as well as increase in efficiency gain through economies of scale,
economies of scope and rationalization. For example BP & Amoco expected to save $2

bn p.a. from operations. However in a typical horizontal merger there exists huge
challenge of integration like in Exxon & mobile, Helene-Curtis and unilever.
Electrolux acquired Voltas white goods division for Rs. 160 crore. Voltas had a
manufacturing capacity of 50,000 refrigerators and 2, 00,000 washing machines per
annum along with 2 brands namely Voltas & Allwyn. Electrolux Further Acquired
Kelvinator (see figure 2).

Figure 2: Electrolux M&A

Electrolux AB

Position Allwyn in low end segment, phase out

Voltas brand, rebuild Kelvinator brand.

55% Maharaja
International

Manufacture only Kelvinator

fridges & import high-end
Electrolux fridges

Increase the
capacity of the
company

74% Intron

Manufacture front loading

Electrolux machines (washing)

Increase the capacity

of the company

80% Electrolux Voltas

Manufacture Voltas, Allwyn,

Kelvinator fridges & Electorlux
W.M.

Increase the capacity

of the company

Horizontal mergers realize economics of scale. It expands the existing business

geographically into new territories by offering similar products and services to layer
customer base. It does not involve additional products or services. When markets reach
saturation point the best option for the firm is to expand through horizontal merger.
Organic growth in a saturated market like hiring sales force and managers, developing
efficient sales and marketing channel and developing effective, customer relationship
management practices does not seem a lucrative business decision. However, the basic

strategy for growth is a saturated market is to organize a competing firm in some market
or in distant geographic markets. Organic expansion involve large amount of money
and time to hire and train people for new markets, new system and new processes.
Sometimes it may become an added burden on the organization. Acquiring a firm in
distant geographic market does away with such establishment and set up costs. It is an
established business already running operation and delivering goods or services. Hence
buying firm starts earning from day one.
Horizontal merger between two large players has large effect on confirmed firm as well
as market. When horizontal merger is between two small players the impact may be very
little. Large horizontal mergers are generally considered anti-competitive. Large
consolidation through horizontal merger may lead to unfair market practices by the
involved players to take advantage over its competitors. Horizontal mergers are more
common than vertical and conglomerate mergers. Generally, the players are involved in
same industry and in same stage of production. Horizontal mergers create consolidation
in the industry. Horizontal merger achieves economies of scale in the production process
through doing away with duplicate resources, decreasing working capital and certain
fixed expenses, reducing advertising and promo expense, eliminating competition.
Economics of scale in simple microeconomics terms refer to cost advantage that a firm
derives due to expansion (merger) (figure 3). The average cost per unit falls as scale of
output increase. The horizontal merger enhances capacity and scale of output by
1)
Reducing cost of purchase due to back buying of inputs and hence enhanced
bargaining power with suppliers.
2)
Reducing cost of advertising & promotion over complete set of products,
brand combined together.

Average cost
in long run
Average
Cost

minimum cost

Output
Figure 3: economies of scale
Horizontal merger also enhances economies of scope. Where economies of scale means
reduction in average cost per unit due to increase in scale of production economies of
scope implies reduction in average cost of producing multiple products.
The portfolio of products and brands becomes more efficient as number of products
promoted increases along with increase in people reached due to cross selling of the
product bundle into the market of new players and effective combination of distribution
channel. Example of Horizontal Merger; Lipton India and Brook Bond merge to form

Brook Bond Lipton India Ltd., Bank of Mathura with ICICI Bank, HDFC Bank and
Centurion Bank of Punjab, Bombay Suburban Electric Supply Ltd. (BSES) Ltd. with
orissa Power Supply Co., ACC (Associated Cement Companies Ltd.) with Damodar
Cement.
Vertical merger
Vertical Merger happens when two companies in different stages of production or
distribution or value chain combine. Generally, it involves companies upstream and
another is downstream. Vertical mergers neither change market shares in a relevant
market nor eliminate a direct source of competition. Vertical mergers make the merged
firm cost-efficient by streamlining its distribution and production costs. It ideally leads to
optimal utilization of resources.
Thus Vertical merger takes two forms namely
Backward vertical merger
When a firm integrates with its supplies it is known as backward integration. Here post
merger the company controls inputs used in its production operations. For example a
steel industry may acquire iron ore mines, Sugar Mill acquires sugarcane farm,
automobile company acquires tire or spare part manufacturer, coca cola integrated
vertically backward when it bought its franchises and bottlers and Merck-medco
Forward vertical merger
When the company acquires a firm forward like distribution dealer and , retailers it is
known as forward vertical integration. For example Chevrons oil- gulf oil, America
online- map quest. Reliance Petroleum could integrate forward if it decides to sell its
entire output through its own petrol pumps instead of through Indian Oil, Disneys
acquisition of American Broadcasting Company. (ABC). Vertical integration reduces
transportation costs of production, supplies and distribution system are in close
proximity and at the same time enhances supply chain activity coordination. It may also
leads to creation or expansion of core competency and competitive advantage of firm
vertical merger does not directly create monopoly but creates entry barriers to new
players and competitors.
Conglomerate merger
Here the merging companies are engaged in diverse business activities. Thus merger
happen between companies that have no common business link and are completely
unrelated. The participating firms may sell related products, share marketing &
distribution channels & production processes, or they may be wholly unrelated. Pure
diversified mergers, diversify the risk of business portfolio of the parent firm.
Diversification of a firm into different business lines that are having low or negative
correlation tends to reduce the overall risk of the conglomerate grant firm (parent firm).
The diversification helps the firm to diversify away the business specific risk and hence
reduce the fluctuation in operating profit (EBIT) of the parent firm. The volatility in
operating profits (EBIT) i.e. business risk is high in individual business and hence

10

diversification across low or uncorrelated business us reduced in a portfolio of business

for parent firm. Parent firms volatility in operating profit reduces due to diversification.
This helps the parent firm to go for greater diversification. For example, diversified
firms like Reliance Industries, Aditya Birla Group, NUVO. Kelsos acquisition of Nortek
Where Nortek Inc. is a international designer manufacturer and marketer of building
products while Kelso & Company LP is a private equity firm
For example Reliance Industries Ltd. merged with Reliance Petroleum Ltd, aditya birla
group acquired idea cellular , Ciba-Geigy (contact lens, Ritalin, Maalox) and
Sandoz(Gerber Baby Food, Ovaltine) merged to form Novartis, US steel- marathon oil
merged to form USX, AOL merged with time Warner, PepsiCo merged with pizza hut,
Citicorp merged with travelers insurance, P&G merged with clorox and Cardinal
healthcare merged with allegiance, AT&T merged with Hartford insurance, Bankcorp of
America merged with Hughes electronics, R J Reynolds merged with burmah oil & gas.
Business Snapshot
Savlon was sold by Imperial chemical Industry, as a part of over the counter - OTC
product sell off to Johnson and Johnson. Savlon was clinically proven to be better
antiseptic than Dettol and hence there were few doubts regarding the success of Savlon in
India. In India Dettol is produced and marketed by Reckitt & Benckieser- Piramal (A
joint Venture between Reckitt & Benckieser and Nocholas Piramal ). In 1998 Hindustan
lever acquired all rights to savlon brand in the medicated soap segment From J&J. In turn
they agreed to pay a fixed percentage on brand turnover. HLL with Savlon soap intended
to compete in medicated soap category against its rival Dettol soap. After four years of
the marketing alliance with J&J HLL called it off in 2003. It decided to launch Lifeboy
soap to fight against Dettol.

HLL (2003)
Called off the alliance

SAVLON
Clinically proven
better antiseptic than
Dettol

HLL (1998)
Savlon soap marketing
rights from J&J

Imperial Chemical
Industry ltd (ICI ltd)

Sold OTC brands

Johnson &
Johnson (J&J)

11

MERGER WAVES
Merger activity started from the mid 80s and has since evolved along with industry
growth and capital market growth. Merger activity has shown specific cycle patterns
along with capital market and industrial production cycles. For a better understanding we
group merger acquisition activity into six cycles called waves (table 1).
Table 2: characteristic of the merge waves
Merger waves
Period
Particulars
First wave
1893-1904
Horizontal merger
Second wave
1916-1929
Vertical merger
Third wave
1950-1970
Diversified mergers
Fourth wave
1980-1989
Hostile mergers, corporate
raider, LBOs
Fifth wave
1990-2000
Cross border mega mergers
Sixth wave
2003-2008
Private equity, shareholder
awareness
Source : york university
First wave: 1898-1904
The first merger wave occurred between 1989-1904. this merger wave witnessed peak
M&A activity across united states in US economy Also witnessed consolidation across
sectors during the period. Evolution of railroad transportation system fuelled the
consolidation spree. Firms merged horizontally creating monopoly, eliminating
competition and became leading market shareholders. From individual units of ownership
giant firms emerged like US steel, Du Pont, standard electric, Eastman Kodak etc. The
urge to consolidate was so strong among companies that on an average 300 firms
disappeared annually during the period (table 2). Merger activity was concentrated in the
industry where transportation cost was high relative to the price of the product . Majority
of mergers activity occurred in eight industries namely food products, chemical products,
petroleum products, primary metals metal products, transportation equipment and coal
mining. The economy moved towards monopoly. Major industries that saw consolidation
were capital and labour intensive that had high fixed costs.
Table 2: Firm disappearance by merger and merger
capitalization 1895-1920
Year
Firm disappearance Merger
by merger
capitalization

12

1895
1897
1898
1899
1900
1901
1902
1905
1906
1910
1911
1916
1919
1920

43
69
303
1208
340
423
379
226
128
142
103
117
171
206

(million $usd)
40.8
119.7
650.6
2262.7
442.4
2052.9
910.8
243
377.8
257
210.5
470
981.7
1088.6

Ralph nelson, the merger movements in American industry,

1895-1956; national bureau of economic research, UMI,
1959, ISBN 0-87014-065-5

During demand decline period and price competition that followed the great depression in
US these firms readily absorbed each other to become giants in their respective sectors .
As sectors consolidated giants were created from small widely distributed firms.
Consolidation helped firms take advantage of economies of scale and economies of
scope. .Horizontal consolidation of such mega nature witnessed in the first wave lead to
reduced production costs and manipulation of prices to strengthen sales and create
demand. Simultaneous development of the capital market augmented the consolidation
spree. The growing capital market provided the much required support in the form of
large size securities issue that financed the deals. Although the first merger wave is
symbolic to US however Great Britain experienced simultaneous merger wave. The
divers for the first merger wave were economic depression of US, new state legislations
on incorporations, development of stock exchange (NYSE). Main reasons for the
consolidation were reduction of price competition and cost reduction. This wave ended
with crash of equity market.
Second wave: 1916- 1929
The second wave began with World War II and ended with stock market crash of 1929.
Enactment of antitrust laws created ground for second merger wave. This period also
marked consolidation and emergence of new giants like general motors, IBM, union
carbide etc. The period witnessed emergence of oligopoly rather than monopoly. Along
with merger activity the stock prices also gained momentum running parallel with
industrial production and growth. However when stock market crashed in 1929 the merge
activity suffered a decline.
To discourage monopoly creation as witnessed in first wave merger Sherman antitrust act
was created and enforced with vigour. It lead to discouragement of monopoly creation

13

lead to creation of oligopoly. Clayton act 1914 discouraged monopolies and

uncompetitive mergers hence the period witnessed more vertical mergers occurred
relative to horizontal mergers. Cost reduction though economies of scale and scope were
main motives for the merger.
Third merger wave ( 1946-1970)
This period began a decade after World War II and was marked by economic surplus and
growth in US economy. Merger happened in unrelated businesses. The M&A activity
was more concentrated around 5 years 46, 47, 54, 55, 56. In 1968 around 25000 merges
took place and declined in latter part. Unlike the fist and second merger waves this period
was marked by diversified mergers that happened amongst unrelated businesses and gave
birth to an era of creation of conglomerate business empires.
The strong regulatory reforms that discouraged monopoly and anticompetitive sprit along
with strong antitrust policy lead to diversification. In US during the period the M&A
activity focused on diversification and conglomerate creation while In UK the M&A
activity focused on horizontal integration. Third merger wave ended with the oil crisis
followed by global recession
Fourth wave (1980-1989)
This era was highlighted by friendly as well as hostile mergers. The term corporate raider
was coined. This wave gave birth to the concept of leverage buyouts LBOs and more and
more companies were bought by debt financing. This period was also market by foreign
takeovers across countries especially hostile mergers. However few mega hostile deals
like RJ Nabisco bought by KK ( Kohlbeg, Kavis, & Roberts) for $25 million, indictment
of Michael Milken and his investment bank Drexel Burnham Lambert shook the financial
world. This wave of LBOs reached an end as markets for junk bonds which is used for
financing LBOs collapsed. The period saw enactment of anti-takeover code of conduct.
The main divers fo M&A activity during this period were deregulation of financial
service sector, creation of new financial instruments and advancements in technology
know how. Taking lessons from the third merger wave the companies diversified and
focused on core competencies rather than on non core assets.
Fifth merger wave ( 1990-2000)
This was an era of bill Clinton. The world economies flourished especially India and
china. This wave also marked revival of LBOs although not of the magnitude as
witnessed in 4th wave. This period was marked by overvaluation and overpayment, high
profile mega mergers, dominance of equity deals over LBOs and wealth transfer from
acquirer to target company shareholders. The merger activity was more pronounced by
control mania where acquirer pursued companies aggressively for control and created
overpayment. For example BP and amco, Exxon/ Mobil, Citicorp/ travelers, chase
Manhattan and J P Morgan, Compaq and digital equipment, HP and Compaq,
Mannesmann and Vodafone, Daimler Benz and Chrysler etc.

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Stock market boom supported the wave and ran parallel to the wave. Further
deregulation, globalization and liberalization of banking and telecom industry marked the
wave peak of 98-2000. Revival of equity financing was witnessed as LBOS took a back
seat. Consolidation of industries and globalization was the key buzzword. This wave ran
parallel to the IT Boom. Many high profile mergers failed like AOL-Time Warner, While
Pfizers Acquisition of Lambert (lipitor) for $100 bn and Exxon Mobil were mega
successful deals (table 3). However in early 2000 as stock market bust and dot.com era
sagged the M&A spree came to a halt.

Sixth merger wave ( 2003-2008)

This wave started three years post IT bubble bust. IT bubble bust that marked the end of
fifth wave lead to credit crunch, global liquidity tightness and loss of investor trust. Fear
prevailed in capital market. Gradually as economies revived general macro and micro
economic scenarios eased. With evolution of corporate governance practices and
strengthening of capital market yielded more fundamental valuation figures. These
drivers lead to growth in M&A activity. It peaked in 2006 when M&A deals crossed
around 1$ trillion mark. In mid 2007 the financial crisis started and liquidity crunch
creped in which had rippling effect across markets worldwide. Unlike the 5th wave in the
sixth wave along with equity payment cash payment formed substantial part of the deals.
The cash surplus of corporate and high liquidity in the market was instrumental in
creating the sixth merge wave. The corporate control mania that emerged in the 5th wave
subsided in this merger wave and overpayments educed thus reducing the acquisition
premium and wealth transfer. Managerial hubris softened paving way to more
fundamental strategic reasons for acquisitions.
Enactment of Sarbanes Oxley act created improved corporate governance practice
resulting in improved valuations and better premium justifications. Sixth wave
predominantly streamlined the acquisition process in terms of fewer premiums, premium
justification, less wealth transfer clear-cut strategic rationale for acquisitions and fading
of myopic vision of acquirers acquisition bid.
Emergence of sixth wave was driven by cheap funds. The deals were debt financed and
cash financed. The wave was marked by more friendly takeover in America and more
hostile side in Europe and Asia. Asia witnessed deregulation liberalization and
globalization and Europe integration ( euro), low interest rates and weak dollar were
drives of the fourth merger wave. Sixth wave ended with subprime mortgage crisis and
credit crunch that lead to high costs of funds.

The first two merger waves were unique to US third wave incorporated merger wave of
UK as well. The fourth wave included merger wave of Europe. Fifth and sixth merger
wave was more a global phenomenon.. Many reasons have been cited by academicians

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and researchers justifying the occurrence of such waves. We now discuss the major
reasons for mergers across globe.
Table 3: Top 20 deals by value in the last decade ($USD BN)
1999
2000
2007
2007
1999
1998
2000

Vodafone AirTouch PLC

Mannesmann AG
Time Warner
Philip Morris Intl Inc
ABN-AMRO Holding NV
Warner-Lambert Co
Mobil Corp
SmithKline Beecham PLC

202.80
164.70
107.60
98.20
89.20
78.90
76.00

AT&T Inc
Travelers Group Inc
Comcast Corp
Pfizer Inc
SBC Communications Inc
NationsBank Corp,Charlotte,NC

Shell Transport & Trading Co

BellSouth Corp
Citicorp
AT&T Broadband & Internet Svcs
Wyeth
Ameritech Corp
BankAmerica Corp

74.60
72.70
72.60
72.00
67.30
62.60
61.60

2006

Gaz de France SA

Suez SA

60.90

1999
2004
2008
1999
2000

Vodafone Group PLC

Sanofi-Synthelabo SA
InBev NV
Total Fina SA
Pacific Century CyberWorks Ltd

AirTouch Communications Inc

Aventis SA
Anheuser-Busch Cos Inc
Elf Aquitaine
Cable & Wireless HKT

60.30
60.20
52.20
50.10
37.40

2004
2006
1998
2001
2009
1998
1998

America Online Inc

Shareholders
RFS Holdings BV
Pfizer Inc
Exxon Corp
Glaxo Wellcome PLC
Royal Dutch Petroleum Co

REASONS FOR M&A

Firm merge for several reasons. But all reasons culminate in creating strategic benefit to
the merged entity in the long run. The merger of the resources owned by the companies
are required to yield competencies that create advantage to the acquiring firms in the long
run. The acquired should be placed at an advantageous position post M&A in the industry
structure vis--vis its peers. The merger and acquisition process for whatever reasons
leads to combination of the complimentary and supplementary resources of the two
companies. The acquirer gets new supplementary resources that create added advantage
for the merged entity. At the same time the acquirer combines its resources effectively
with the acquired resources similar in nature i.e. complimentary resources. The resources
include all tangible and intangible assets, firm processes, firm attributes and capabilities

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and the knowledge and information the firm controls and generates1. These resources
combine to generate competencies that yield advantage to the merged entity in the
industry structure vis--vis its peers. The acquirer should derive strength and gains by
acquiring the target company. Post M&A the acquirer should be better placed in the
industry structure as compared to its peers. The M&A should yield competencies in form
of competitive advantage through physical resources2 like plant equipment, geographical
location, technology know-how etc, though human resources3 like experience, judicious
judgment, intelligence , foresight and skills of managers. Also though organizational
resources4 like hierarchical structures, span of control, divisional boundaries and product
diversification etc.
The broad reasons for M&A across sectors and economies can be listed as follows.

To eliminate competition and create monopoly

To gain market access i.e. geographical expansion.
To benefit from efficiency gains in form of synergy
To satisfy self ego of managers i.e hubris hypothesis
To benefit from undervaluation
To diversify across industries
To gain access to R&D and technology know-how

To eliminate competition and create monopoly

Horizontal and vertical integration eliminate competition. Typically horizontal mergers
eliminates direct competitors and consolidate the industry. Horizontal merger of firms in
same business line, in same geographical location and close substitute products call for
consolidation. As markets become slimmer and players reduce the merged entity enjoys
the monopoly status. Anti-competitive laws across globe aim at reducing the monopoly
creation through horizontal mergers. Horizontal mergers directly hamper the competition
and eliminate weak players that are acquired (figure 4).
Vertical merger creates foreclosure of rivals by blocking supplier or distributor for
competitors. The supplier may force the firm ( vertical backward integration) to buy all
its inputs from the supplier. In vertical merger competition may be blocked by tying as
well. In tying the customers are required to buy all inputs with the one they want from the
supplier. In tying the supplier agrees to sell its customer one product (tying item) only if
the customer buys remaining items from the supplier. This creates anti competitive
environment in the industry structure.

Daft R 1983 organizational theory and design new york west.

Williamson O 1975, markets and hierarchies , new york : free press.
3
Tomer J F 1987 organizational capital, the path to higher productivity and well being, new York: praeger.
4
Becker G S 1964, human capital, new york: Columbia.
2

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figure 4: monopoly creation in horizontal and vertical merger

To gain market access i.e. geographical expansion.
Companies choose merge and acquisition for expansion in new markets. Geographical
expansion through M&A involves better understanding of market as the local target is
operating in that market. For example coke came to India it bought thums up, limca and
gold spot owned by Mr AMESH Chauhan. All three strong brands holding about 70% of
the soft beverage market in India was sold to coke which received a readymade market in
India. Till date thums up contributes more to the bottom line of coke India than coke
itself. Similarly Vodafone entered India by acquiring hutch., daiichi entered Indian
pharma sector by acquiring ranbaxy etc.out-bound deals help companies expand in new
markets, new geographic locations and hence garner new revenues though new
customers. Acquirers get a readymade market and readymade product and distribution
system all at one place.
Geographical expansion pursued to add new brands, products and business lines to that of
existing ones. This adds directly to the existing revenues and gives synergy gains to the
acquirer. The acquirer can now cross sell and take advantage of multiple, brands, product
portfolios. Geographical expansion benefits from local specialization , higher utilization
of capacity and more technical efficiency gains. However new geographical expansion
also poses risk which is domestic country specific. In any geographical expansion the
acquirer takes time to adjust to local benefits and the market.
To benefit from efficiency gains in the form of synergy

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All mergers and acquisition are pursued with an ulterior motive of synergy gains. The
acquirer understands that post acquisition the acquirer would not only get the target but
also added value derived from integration of the two. Synergy gains occur both in
horizontal as well vertical merges. Synergy gains are derived from combination of
supplementary and complimentary resources.
Typically Horizontal mergers result in elimination of competitor. The industry gets
consolidated with horizontal mergers. Large scale consolidation lead to monopoly
creation as competition is eliminated and acquirers dominance on pricing and distribution
enhances. As Horizontal mergers occur between firms engaged in similar business,
similar markets, close substitute products, it provides greater market power to the
acquirer. Incentive to merge horizontally not only eliminates competition but also creates
large cost savings for the acquirer. The cost savings come from economies of scale and
economies of scope.
An economy of scale is derived by larger production output leading to reduced fixed
costs as well as variable production costs. Post merger acquirer is in a position to
manage the vendor(s) better and that helps to reduce cost of inputs as the acquirer gets
into a better bargaining position with large purchase orders. The large combined
production facilities help in elimination of overlapping resources and activities thus
lowering the fixed costs. Elimination of duplicate, overlapping and redundant resources
saves time, effort and money thus reducing overall costs. In the post merger scenario the
merged entity may shift or reallocate production processes among facilities that were
owned separately pre-merger with the aim of reducing marginal cost of production. At
the same time large capacities may result in specialization in processes, division of labour
resulting in reduced costs. The merged entity gains from combining their complementary
and supplementary resources, technology, know-how, skills and even administrative
abilities.
Economies of scope occur as cost of production for the combined portfolio of brands and
products reduces post merger. The combined entity has a widely diversified bouquet of
brands, product offerings with lesser cost associated with their production, marketing and
distribution. After merger the cross selling happens across the client base of both the
companies. After adjusting for cannibalization the cross selling of brands and products
across the two markets help in enhancing revenues and reducing distribution costs. Large
firms as a result of merger benefits from spreading their advertisement and promotional
budget over larger bouquet of brands and products. Large firms with broader array of
assets are able to borrow more funds and maybe at lower costs if the quality of assets
improve post merger.
Apart from horizontal mergers, vertical mergers also create efficiency gains. The vertical
merger combines firms which operate in different stages of value chain activity of the
firm. Backward vertical integration helps in streamlining procurement process thereby
reducing the cost of inputs and backward supply chain. For example when steel industry
purchases iron ore mines, sugar manufacturer purchases sugarcane farms, flour and
baking company purchases wheat farms etc reduce their cost of raw material and

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procurement. Forward vertical mergers happen when firms purchase entity involved with
distribution of the end product and services. This again helps the acquirer to reduce the
distribution cost and enjoy efficiency gains from such front end loaded deals.

To satisfy self ego of managers i.e hubris hypothesis

Many merger and acquisition happen due to the self ego of the acquirer. The CEO self
concept and his ego. Hubris implies that the acquirer lands up paying too much for the
acquisition of the target. This is mainly linked to the ego and overconfidence of the
acquirer. The overvaluation and overpayment due to aggressive biding leads to wealth
transfer from acquirer to target shareholders, and also high debt financing raising the cost
of money to eth acquirer.
Ideally target should have same value to all bidders. The winner is the one who
overvalues the target. Managers pay huge premium with the impression that they are
correct in their judgments of spotting the synergy gains and future growth opportunities5.
This is due to their overconfidence and rigidity. And later post merger the whole
company pays a price and looses on value in the long run due to overpayment.
Technically hubris hypothesis discusses the myopic vision of the acquirer during bidding
process and final acquisition.
To benefit from undervaluation
M&A is pursued by firms when the target company is available at undervalued price. The
undervaluation is in context of the fundamental value of the target company assets. Such
companies may be termed as sick or poor in performance. Sometimes undervaluation is
also in context of the market share price. A stock may loose more than 50% of its value
and remain at its new low price consistently like Satyam, Bear Stearns etc. This eroded
market value may be due to investors distrust, loss of market confidence or erosion of
brand value.
The main issue is that the acquirer should be able to spot the undervaluation in time and
the cost of integration should not be more than the benefit of undervaluation. Otherwise
the benefit of undervaluation buyout is defeated. The acquisition premium is generally
not paid when the target is bought with undervaluation as motive.
To diversify across industries
M&A is pursued across unrelated business and sectors when the acquirer intends to
diversify and become a conglomerate. A conglomerate operates in multiple businesses
5

Mukherjee TK, Kiymaz H, Baker HK. 2004. Merger Motives and Target Valuation: A Survey of Evidence from CFOs.
Journal of Applied Finance 14: 7-24.

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and business lines that are not related to each other. Diversification happens when the
acquirer and target are on unrelated businesses and post Merger the acquirer is diversified
into businesses that are having low correlation with each other. Due to low correlation the
businesses are able to reduce the business risk of fluctuating operating profit. The
fluctuation in the operating profit of the acquirer reduces as the M&A adds unrelated
businesses and becomes stable. Stable operating profits call for high debt repaying
capacity and hence more debt and less cost of capital. However there are no distinct
synergy benefits in pure diversified merger and hence ideally acquisition premium is not
justified.
Diversified mergers into new products new business lines yield less synergy gains. as
witnessed in the third wave which was dominantly known as diversified merger wave,
Almost all deals that created conglomerate gains in this wave reported weak performance
in the long run. Many could not survive and were sold off. They were found to destroy
shareholders value in the long run6. Diversified mergers lead to high control and
coordination costs from the acquirer7, information asymmetries and production
inefficiencies. The managerial bottlenecks magnify with diversification and destroy value
in the long run.
To gain access to R&D and technology know-how
Firm with lucrative R&D investment are tempting targets. R&D does not assure revenue
till it is in the process. Only when R&D yield innovations which garner a market and
create surplus it is termed commercially successful. Acquiring company high on R&D
assures control over future innovation market. R&D intensive industries would call for
more M&A as R&D are secretive in their research initiative and activities and
innovations of new products. M&A grants directs control over &D and hence more
dominance in the market. Several firms pursue M&A to acquire firms with strong
innovation centres. These are R&D intensive firms that reap on commercial success of
their r&d developments. Microsoft is a company that has aggressively pursued smaller
entrepreneurial ventures based on r&d and innovation like forethought which had
developed a presentation software now known as PowerPoint. P&G acquired innovation
based firm Gillette and so on.
In March 2009 a pharmaceutical giant Roche completed its acquisition of biotechnology
firm Genentech for $ 46.8 billion8. Roche had earlier acquired a substantial stake in
Genentech in 1999 bys pending $2.1 billion due to TPA a clot busting drug developed by
Genentech. Genentech established in 1976 carries a legacy of innovative culture and
strong R&D laboratory (gRED). Roche agreed to provide the autonomy to R&D at
Genentech to retain its strong culture of highly successful innovation. Roches best

Weston FJ, Mitchell ML, Mulherin HJ. (2004) Takeovers, Restructuring and Corporate Governance. Pearson Prentice
Hall: Upple Saddle River, New Jersey
7 Rajan, R., H. Servaes, L. Zingales, 2000, The Cost of Diversity: The DiversificationDiscount and Inefficient
Investment, The Journal of Finance, Vol 55, Issue 1, pp 35-80
8
http://www.nytimes.com/2009/03/13/business/worldbusiness/13drugs.html

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selling drugs cancer medicines avastin, herceptin, rituxan came from Genentech9. In
2012 july Roche faced problems with its R&D cell ( Roche pharma research and early
development laboratory pRED). As a result Roche initiated drastic job cuts and shutting
down of the Nutley NJ research site. Roche lab faced several high profile expensive
failures like heart drug dalcetrapib. Genetechs R&D successes are several and have
outshined the Roches lab performance since the merger. This has forced Roche to retain
the autonomy of the target firm i.e. Genetechs R&D lab.
Post merger as competition reduces and industry consolidates the players tend to invest
less in R&D. Synergies in R&D take longest time to realize. The creativity, innovation,
and free thinking gets curbed which coupled with licensing procedures and regulatory
requirements In R&D testing and commercialization de-motivated the acquirer to pursue
R&D. Pfizer was founded in 1849 in USA and became household name by 1942 with its
blockbusting drug penicillin. It entered into merger fro the first time in 2000 by
acquiring Warner Lambert due to its drug lipitor for $100 billion. Lipitor became
blockbusting drug and Pfizer has grown since. In 2003 added pharmacia to become one
of the leading R&D oriented pharmaceutical company. It diversified itself by acquiring
Wyeth in 2009 to become worlds leading biopharmaceutical company. However post
expiry of patent of lipitor its best selling drug contributing significantly to its bottom-line,
Pfizer has shunned away from R&D investment. Pfizer is cutting down its costs by
cutting R&D investment. The R&D spend of Pfizer was about USD$ 9.4 billion in 2010
and has reduced to USD$ 7 billion in 2012. Pfizer has closed its R&D sites in catama,
italy, Aberdeen, Gasport UK. It closed down its R&D site Ann Arbor which was most
productive R&d lab and where Lipitor was discovered. Pfizer seems to have shifted its
corporate strategic focus away from R&D. and with this shift it calls for aggressive
pursuit of M&A fro growth. If Pfizer cannot make it it should buy it. Further Pfizer is
also selling off non-core non-pharmaceutical businesses like capsugel (gelatin capsule
manufacturing unit to KKR) and nutrition business unit to Nestle.

KEY TERMS
Due diligence
Takeover
Subsidiary
Vertical

Merger
Consolidation
Conglomerate
Backward integration

Acquisition
Amalgamation
Horizontal
Forward integration

SUMMARY

Every organization in on the lookout for profitable investment opportunities.

Sometimes the opportunities are found within the organization like expansion,

9 http://www.genengnews.com/keywordsandtools/print/4/27737/

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modernization and new product development, etc. The acquisition can take many
forms like mergers, acquisition, takeovers, absorption, consolidation.
Mergers: Here 2 or more companies combine to form either a new company or
one of the combining companies.
Acquisition: This results when a company acquires the ownership/stake in other
companies without any combination of the companies.
Takeover: Takeover means acquiring at least 25% of the voting power in a
company.
Holding Company: A company is termed as a holding company if it owns around
50% or more of the shared value in a company.
Horizontal Merger: Here the merging companies are engaged in same type of
work, distribution of business.
Vertical Merger: Here the merging companies are engaged in different stages of
production or distribution. IT MAY BE Backward vertical merger OR Forward
merger
Conglomerate: Here the merging companies are related in diverse business
activities.
Merger Creates synergy for the merging companies, Reductions of inter trade and
intra trade competition, Enhances market potential, Diversification of the
company, Optimum utilization of resources and Increases strategic
competitiveness of the company
The cost of the merger is the amount of funds (cash and cash equivalent) paid by
the acquiring firm to the acquired firm.
Variables of successful merger can be elimination by overlapping activities, cost
savings from mergers economies of scale, increased borrowing capacity of post
merger company.
Variables of failures of mergers can be due to merged company becomes too large
to handle, profits of one company are used to compensate for others losses,
companies in diverse business are merged for financial gains.

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