Merger and its Wave

Guru Prasad Paudel Deputy Director, NRB

Background
Business organizations can combine with each other in a various ways. One of the most common approach is Mergers and Acquisition (M&A), which combine independent firms under common control, and joint ventures and strategic alliances, which enhance inter-firm cooperation without combining separate entities (G-10, 2001). M&A is increasingly used by corporate or business organization to strengthen and maintain their market place. M&As continue to be a dominant growth strategy for companies worldwide (Jarrod et al., 2005). It is the global phenomenon. According to Thomson Financial, in the main industrialized countries there were 34,147 M&As between 1996 and 2001, compared with 19,996 between 1990 and 1995. The total value of transactions rose from $1390 billion in the rst six-year period to $8135 billion in the latter period. M&A activity was especially pronounced in the financial sector. According to Amel (2002) more than 8000 bank consolidations occurred globally between 1990 and 2001 and the total value of the deals reached about $1,800 billion. In USA, there were 15000 banks in 1982, 9000 banks were merged each other still 2003. International business is growing rapidly. Growth is required not only to give better service but also to meet growing competition. Growth is also a sign of how well their customer base is being served. Nonetheless, there are so many alternative ways for a financial firm to grow. One of the significant alternatives for securing growth in this modern era is through Merger and Acquisition. ILO study reports (2001) quotes Jacques Attali, former President of the European Bank for Reconstruction and Development in 20 years, there will be no more than four or five global firms in each sector. Alongside, there will be millions of small temporary enterprises subcontracted by the large ones. Further, David Komansky, CEO of Merrill Lynch, is cited to have contended that only six to eight global banks will soon be competing on the world's financial markets, with regional entities, notably in Europe and Asia, existing side by side with these big international players. European Central bank report, 2011 explains financial integration is part of the Euro-system's mission statement (www.ecb.europa.eu)

Definition of M&A
Definitely, there are so many dissimilarities between Merger and Acquisition. Merger is the operation by which two companies join together to form a single one. This enables the consolidation and increasing competitive capacity of enterprises. In a merger transaction is where both parties agree to combine their businesses, and for this purpose form a new company that issues shares which replace the shares of both businesses. In general merger is used as equals different entities. There are also mergers between unequal. The acquisition is a business combination in which one entity obtains control of the net assets and operations of another, in exchange for a transfer of assets, employment, debt or issuing shares. From a legal point of view, the target company ceases to exist. In many cases Mergers, acquisitions and business combinations used as if they are the same. This consolidation terminology is used as same in many literatures. In this paper, after a large literature review the consolidation term 'merger' & acquisition' (M&A) is used interchangeably. (1)

Why Mergers:
In Business organization consolidation is very familiar facts. Two or more organizations take the consolidation decision influencing by various motives. Behind the Merger there are so many motives. The major reasons of mergers are as follows: Horizontal merger (i.e. merger between same groups) is for market dominance; to be giant organization and be economies of scale. Vertical mergers (i.e. merger between producer and wholesaler group organization) is for channel control Conglomerate merger (i.e. merger between different group organizations) is for diversify of business, risk spreading, cost cutting To get synergy effect. To grow and be a world-class leading organization and global reach In the unfavourable situation, merger is for Survival, to save from cut-throat competition. To be Flexible To adopt high class technologies To get more talented, knowledge people.

Lighting the importance of M&As Harding and Rovit (2004) describes, it has become virtually impossible, in fact, to create a world-class company through organic growth alone. Any organization may grow either by its internal extension or by external expansion. In case of internal extension a firm grows gradually over time in the normal course of the business, through procurement of new assets. Furthermore, in this method the major funding sources is either reinvesting the earned profit or reinjection by its' existing shareholders. But in case of external expansion, a firm acquires a running business and grows at once through corporate combinations. These combinations are in the form of mergers, acquisitions, amalgamations and takeovers and have now become important features of corporate restructuring. They have been playing an important role in the external growth of a number of leading companies the world over. They have become popular because of the improved competition, breaking of trade barriers and globalization of businesses. M&A is a strategic decision taken for maximization of a company's growth by enhancing its production and marketing operations. So M&A is a business strategy. In the wake of economic reforms, many corporate houses have also started restructuring their operations around their core business activities through acquisition and takeovers because of their increasing exposure to competition both domestically and internationally.

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Bank merger activities in different Economies

Country USA Literatures Activities From 1990 through 1998, the number of banks has dropped Frohlick from 12,347 to 8,774 banks resulting in a 28.9% decline. &Kavan, (2000) During this same period, there have been 4,625 unassisted mergers with only 569 failures This study examines patterns in the 3,517 mergers Steven J. P. consummated during the ten years from 1994 to 2003; (2004) these transactions involved the acquisition of about $3.1 trillion in assets, $2.1 trillion in deposits, and 47,300 offices. Thomson Report The value of global mergers and acquisitions (M&A) (2011) totalled US$2.4 trillion during the full-year 2010, a 22.9% increase from comparable 2009 levels and the strongest fullyear period for M&A since 2008. Thomson, 3rd In 1985, when China's economy began opening up to the qtr 2008 world and one of the first M&A transactions was completed, transactions values totalled a mere US$ 124 million that year. More than 20 years later, transaction values in China topped US$ 160 billion. Thomson China's outbound M&A activity recorded a 64.4% growth, Reuters, 2008 totalling US$ 47.8 billion 2008 up from a total of US $ 29.1 billion in 2007. Shanmugam, In addition to the inherent weakness in the banking system 2003 detected during the financial crisis, there was an urgent need to accelerate the merging of the banking system in the face of a more competitive and globalized business environment. Badreldin & Through the analysis, sufficient evidence to conclude that Kalhoefer, 2009 mergers and acquisitions have clear effects on the profitability of banks in the Egyptian banking sector was not found.

USA

Global

China

China

Malaysia

Egypt

Why M&A is Important in Nepalese Banking sector:

The banking sector of Nepal is considered as a booming sector and the soundness of the banking system has been imperative for the development of the countrys economy. The number of Nepalese Commercial Banks (CBs) and financial Institutions (FIs) has enormously increased but they are not large capital based entities. Nepal Rastra Bank (NRB) has already made the first move the consolidation process by way of direction to increase their capital that could be possible only by way of merging some of these CBs and FIs. These are the some facts, so we need Merger strategy in our financial system: Mushrooming Banks and Financial Institutions having low capital based is the major reason for consolidation. According to NRB website, till to date (2011 mid July) there are nearly 30 plus commercial banks, 80 plus developments banks, around 80 finance companies and 20 plus microfinance development banks. In Nepal, We have still no (3)

single CB to fall within criteria of 'The Banker' magazine which includes worldwide 1000 big Banks on the basis of their Core Capital(CC) whereas the banks in comparable economy of Pakistan and least economy Myanmar have been included in the list of 1000 banks. In this context we need large bank which is possible through M&A. It has been internationally practices, M&As introduced when there in the system has small banks having low capital. Nepalese financial sector is facing severe problems in these days. One after another Financial Institutions have been broken and this has led to loss the public confidence towards the banking system as a whole. To restore the public confidence in the banking system and thus to avoid the losses to depositors it is necessary to be sound FIs, for that purpose merger is the best alternatives. According to Ravichandran et al. (2010) same strategy has been adopted by RBI in 1960 while 45 banks were pushed into mergers. Regarding the Indian banking system Ravichandran et al. (2010) explains in 1960s, several private banks were found to be operating on a very low capital. As a result, several banks have failed and this has led to loss of confidence of the public towards the banking system as a whole. To restore confidence in the banking system and thus to avoid losses to depositors, 45 banks were pushed into mergers. Most of these mergers were between failed private banks and public sector banks. The GON, public statement of income and expenditure of 2010/11has outlined the Merger and acquisition of Banks and financial institutions. Realizing the need of merger of BFIs to cope with the emerging financial problems, NRB has recently unveiled a byelaw to facilitate this process. This byelaw includes some regulatory waives as well some regulatory directives to merge BFIs. Sometimes it will be controversy that we have not still sufficient financial inclusion; however NRB is leading towards the merger of banks and financial institutions. The reason is, NRB is seeking sound and healthy banks which can control large numbers of branches and to help the financial inclusion. To develop the infrastructure, hydro-power, cable-car needs large amount. Small capital based banks and FIs can't meet the Single Obligor Limit (SOL), Large Capital based entities are necessary which is possible through M&A.

Merger Waves
Merger waves, which give the knowledge regarding the incremental trends and stages of M&As. The merger history has been divided into Merger Waves based on the merger activities in the business world. The merger movement in banking has been widely documented and highly arguable topics. Economists and historians refer to five waves of mergers in the U.S.A starting in distress the 1890s. But L. Martin (2006) argues sixth waves of Merger; the last one has started since 2003. The starting date and duration of each of these waves are not specific, although the ending dates for those that ended in wars or financial disasters, like the 1929 crash or the bursting of the millennium Bubble, are more definite. According to L. Martin, 2006, six merger waves are as follows: First Period (1893 to 1904): In the historical Mergers this was the time of the major horizontal mergers creating the principal steel, telephone, oil, mining, railroad and other giants of the basic manufacturing and (4)

transportation industries in the U.S. The Panics of 1904 and 1907, a U.S. Supreme Court decision in 1904 making the recently enacted antitrust laws1 applicable to horizontal mergers, and then the First World War are pointed to as the causes of the end of the first wave, which some view as continuing beyond 1904. Very giant industry has been formed in this period, so the monopolies created during the first merger wave and had driven the criticism. The USA Justice Department charged a number of the large monopolies with violating the Sherman Antitrust Act (1890). Second Period (1919 to 1929): After the first wave, this period led to the vertical integration. The second merger wave began during World War I and continued until the stock market crash of 1929. The major automobiles manufacturers introduced in this period. Ford, for example, was integrated from the finished car back through steel mills, railroads and ore boats to the iron and coal mines. The Great Depression, 1929 abolished and ended this wave. Overall, mergers of the second wave were characterized by oligopolies rather than monopolies. There were more vertical mergers than horizontal merger. Third Period (1955 to 1969-73): In this period the conglomerate mergers have been adopted. This period has put the major contribution to build giant and diversify organization. Acquirers more frequently bought into different industries. Major conglomerates like IT&T (Harold Geneen), LTV (Jimmy Ling), Teledyne (Henry Singleton) and Litton (Tex Thornton) were created. Many major established companies accepted the concept and diversified into new industries and areas. The conglomerate stocks crashed in 1969-70 and the diversified companies never achieved the benefits thought to be derived from diversification. Fourth Period (1974-80 to 1989): Generally referred to as the merger wave, or takeover wave, of the 1980s and frequently said to be the period from 1984 to 1989. This is generalization wave period. Most of economies have been adopted M&As as a business tool in this era. Mergers of the fourth merger wave were larger than those of earlier periods. Mergers in the billion-dollar range became common. Debt was more widely used to finance mergers. However, its antecedents reach back to 1974 when the first major-company hostile bid was made by Morgan Stanley on behalf of Inco (the same Inco that has been involved in the four-way takeover struggle that has now ended with its takeover by Vale) seeking to take over ESB. This successful hostile bid opened the door for the major investment banks to make hostile takeover bids on behalf of raiders. In addition to hostile bids, this period was noted for junk bond financing and steadily increasing volume and size of LBOs.
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The United States antitrust law is the body of laws that prohibits anti-competitive behaviour (monopoly) and unfair business practices. Antitrust laws are intended to encourage competition in the marketplace (Sullivan Arthur & Steven M. Sheffrin (2003). These laws make illegal certain practices deemed to hurt businesses or consumers or both, or generally to violate standards of ethical behavior. Competition agencies along with private litigants, apply the antitrust and Consumer protection laws in hopes of preventing market failure. The term antitrust was originally formulated to combat "business trust", now more commonly known as Cartels. Other countries use the term "competition law" (http://en. wikipedia. org/ wiki/ United _States _antitrust _law# cite_note-0). In the history of this law first time the Federal legislation passed in 1890 "Sherman Antitrust Act" and this Law was supplemented by the Clayton antitrust act in 1914. (http://wiki.answers.com/ Q/ What_ is_ the_ sherman_antitrust)

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In Europe in the latter half of the 1980s companies sought to prepare for the Common Market through cross-border horizontal mergers. In the U.S. this was the period that saw corporate raiders like Boone Pickens run rampant with two-tier, front-end-loaded, boot-strap, bust-up, junk-bond, hostile tender offers until the playing field was leveled by the poison pill in the mid1980s. However, even after the poison pill, merger activity increased through the latter part of the 1980s, pausing for only a few months after the October 1987 stock market crash. It ended in 1989-90 with the $25 billion RJR Nabisco LBO and the collapse of the junk bond market, along with the collapse of the savings and loan banks and the serious loan portfolio and capital problems of the commercial banks. Fifth Period (1993 to 2000) : This was the era of the mega-deal. It ended with the bursting of the Millennium Bubble and the great scandals, like Enron, which gave rise to the revolution in corporate governance that is continuing today. During the fifth wave companies of exceptional size and global sweep were created on the assumption that size matters, a belief encourage by market leaders premium stock-market valuations. High stock prices simultaneously emboldened companies and pressured them to do deals to maintain heady trading multiples. Sixth Period (2000 to onwards): In this wave, merger activity has increased tremendously. Thousand of mergers cases having a total of trillions dollar happened by the end of 2006. The principal factors are globalization, encouragement by the governments of some countries (for example, France, Italy and Russia) to create strong national or global champions, the rise in commodity prices, the availability of lowinterest financing, hedge fund and other shareholder activism and the tremendous growth of private equity funds with a associated increase in management-led buyouts. In conclusion, we can say that M&A is essential for business growth. Like Harding and Rovit (2004) describes, it is almost impossible to create a world-class company through natural growth alone. However, sometimes M&A is applied to address the crisis. If the economy faces troubles, so many countries applied M&A strategy to overcome from the crisis. After observing its waves, it will be clear how M&A has increased tremendously. Because a company has only two options i.e. grow or die. M&A leads to grow. Overall, with the probability of continued M&A activity around the world for the next several coming years, its future seems bright.

References:
Carson D., Gilmore A., Perry C. & Gronhaug K. (2001). Qualitative Marketing Research, Sage Publication, pp.114-115. Cheryl Frohlich C. & Kavan C. Bruce (2000). An examination of bank merger activity: A strategic framework content analysis. Harding, D. and Rovit, S. (2004). Building Deals on Bedrock. Harvard Business Review, 82 (9): 121-128 Jarrod McDonald, Max Coulthard, and Paul de L. (2005). Planning for a successful Merger or Acquisition: Lessons from an Australian Study. Journal of Global Business and Technology, Volume 1, Number 2, Fall 2005 (6)

K. Ravichandran, Fauzias Mat-Nor, Rasidah Mohd-Said. (2010). Market Based Mergers in Indian Banking Institutions. International Research Journal of Finance and Economics. Issue 37 (2010) Martin L. (2006). Merger Waves in the 19th, 20th and 21st Centuries. Nepal Rastra Bank (2011). Bank and Financial Institutions Merger Byelaw, 2011. OECD (2000). Mergers in Financial Services. Paris: OECD Thomson Financial and SDC P. (2001). Mergers and acquisitions in the main industrial countries. Thomson Reuters, 3rd quarter 2008, Financial Advisors.

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