As a general rule, mergers and acquisitions (M&A) are value destructive for shareholders. Demergers or spin-offs are value accretive. In simple English, that means, avoid the shares of an acquiring company. But there may be money making opportunities in the companies being demerged or spun off. There is a difference between a merger and an acquisition. Mergers are rare, as they happen between two companies that are equal in size and reach. Both companies lose their individual identities, and a third company is formed.
An acquisition, or a takeover, happens when a bigger company buys out a smaller company, with or without the smaller company’s cooperation or willingness to be acquired. The usual motivations are economies of scale, killing a competitor, gaining market share and reach. The biggest disadvantage of acquisitions is that they fail because of cultural mismatches. Every company is shaped over the years by the vision and background of its promoters or management.
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This is called ‘company culture’ – the way they project themselves in the market place, how they treat customers, employees, suppliers and shareholders, their social responsibilities, integrity and commitment, innovating capabilities. No two companies do business the same way, even within the same sector. When one company acquires another, the cultural differences become very difficult to overcome. This leads to key personnel of the acquired company quitting and leaving with priceless intellectual property and customer relationships built up over many years.
Reverse takeovers, when a smaller company acquires a larger one, are even worse. Like Tata Steel buying Corus or Tata Motors buying Jaguar-Land Rover. In both cases, the ambition was to become global companies in quick time. But the prices paid in both cases were too high, and the timing was wrong. The shares of both companies tanked while they scrambled to raise money to cover the huge acquisition debt. For shareholders of the company being acquired, an advantage could be a bidding war between two or more potential acquirers.
This is currently happening with Great Offshore (earlier demerged from Great Eastern Shipping). Without any change in the fundamentals, the share price is going up as two likely acquirers are bidding up the offer price. Opto Circuits is a notable example of an Indian company that has successfully used the acquisition route to grow its sales and profits quickly. Probably because they have shrewdly targeted companies with complementary products and geographical each that were not doing well financially. Demergers and spin-offs happen due to two main reasons: 1. Getting rid of an unwanted or less profitable division or subsidiary – like Larsen & Toubro did with its cement business, and ICI has done with its non-paint subsidiaries. Profitability and share prices of both companies increased significantly. 2. Spinning off a division or subsidiary into a stand-alone company because it has grown in size and value.
Mahindra & Mahindra has done this a few times, with its financial services, information technology, holiday resorts subsidiaries. Investors would do well to look out for companies that have ‘hidden assets’ in the form of profitable subsidiaries. Sooner or later, these subsidiaries will get demerged or spun off. With reforms in the financial sector a top priority of the Government, I would keep a close watch on companies with asset management (read, ‘Mutual Funds’) and insurance subsidiaries. Pros and cons of mergers and acquisitions A number of reasons provide sanction for a corporate merger and acquisition, not all of which are necessarily financial in nature. Moreover, M is within the scope of the Board of Directors to pursue (1) and the company executives to initiate and execute. Since board members may also be subject to political, social, and personal interests, decisions seemingly in favor of the shareholders may also become quagmire with additional factors. According to Investopedia. om, an estimated 66% of mergers and acquisitions are not successful because of M intent. Of the 33% that are considered successful, the mergers and acquisitions achieved a net gain from the M with our without bad M intent. A number of reasons for the majority of failures exist in addition to the failures themselves indicating a potential disadvantage of M activity is a relatively high risk of failure. This is further illustrated in an article from a 2005 article in the Journal of Global Business on M preparation. 6) Moreover, the article that refers to numerous M case studies and research sources states the reasons for M failures include 1) bad basis for decision making on the part of the company leadership, 2) failure to consider and/or incorporate the new company, 3) bad management and 4) overestimating the valuation of the acquired corporation. the reasons some M’s fail, mergers and acquisitions, regulations of such and their circumstances may harness the characteristics of the decision makers for the net economic advantage despite possible conflicts of interest, short-term financial and consumer disadvantages.
In other words, in theory, mergers and acquisitions may be economically beneficial in terms of reducing complexity of regulatory oversight, increasing global corporate competitiveness, and adding to shareholders net wroth. This is verified by the M&A activity that is successful through increases in equity valuations, larger market share, improved operational efficiency, higher industrial capacity etc.