This feature is a continuation of an earlier publication on various financial theories propounded to explain factors underlying mergers and acquisitions. Discussions in the previous write-up ended on the Herfindahl index (H index) and the agency problems and managerialism related to mergers and acquisitions.
Types of Mergers and Acquisitions
The quest for expansion and growth influences most organisations to combine with, or acquire another firm. A merger occurs when the economic resources of two or more firms are combined to emerge with one firm. Copeland and Weston (1983) and Weston and Copeland (1992) identify three major forms of mergers: Vertical merger, conglomerate merger, and horizontal merger.
A vertical merger occurs during different stages in the lives of firms in given industries. For example, the marketing department of pharmaceutical Company A may decide to merge with its counterpart in pharmaceutical Company B to ensure effective marketing of its finished products.
In the case of conglomerate merger, two or more firms from different firms pool resources together to emerge with one unit. Conglomerate mergers can be grouped into three. These include product extension merger, geographic market extension merger, and pure conglomerate merger.
A product extension merger expands the product lines of companies. Suppose General Electric (GE) merges with Walgreens in the United States of America, and Aluworks merges with Kinapharma in Ghana. These mergers would increase GE’s product lines to include drugs and stationery, among others; and increase Aluworks’ product lines to include drugs.
Geographic market extension mergers relate to two companies whose operating activities are concentrated in unrelated geographic locations. To illustrate, a firm situated in the Northern Region of Ghana with no branches beyond the Northern Region may decide to merge with a company located in the Central Region of Ghana with no branches beyond the Central Region. Similarly, a firm incorporated in the State of New York with branches limited to New York State may decide to merge with an organisation incorporated in the State of California.
In some cases, a merger may not be borne out of the desire to enjoy geographic market extension or product extension; the decision may be borne out of the firms’ intention to pool capital resources together. This is known as a pure conglomerate merger. Thus, a pure conglomerate merger occurs when Ernest Chemists, a pharmaceutical company in Ghana, merges with Nestlé Ghana, a cocoa-based beverage company, neither with the primary intention to create a geographic market extension nor to enjoy a product extension, but to combine their capital and intellectual resources to enhance production and service delivery to customers.
A horizontal merger relates to the combination of economic resources of companies in the same industry. An example is the merger between Walgreens and Duane Reade in the United States of America; and a merger between M & G Pharmaceuticals and Tobinco Pharmaceuticals in Ghana. The data on combinations are generally segmented into acquisitions and mergers. Due to the importance attached to merger and acquisitions, most organisations, especially financial institutions, have a department designated to the activities related to takeover activities. Table 8 illustrates some significant mergers in recent years. The combination of Beecham Group and SmithKline Beckman at a market value of $16.1 billion makes the major headline among the list of combined firms. The least among the mergers is the combination of Schering and Plough at a market value of $1.4 billion. The values of combined firms such as Keegan Resources and PMI Gold; and Access Bank and Intercontinental Bank are not known.
The combined market values of the merged firms are not known
Table 9 provides an illustration of some major acquisitions that are pending, completed, or unsuccessful. The transaction (acquisition) values between Chevron and Gulf ($13.3 billion); and between Philip Morris and Kraft ($13.1 billion) dominate all the transaction values in Table 9. The values of all acquisitions with the dash (-) sign in Table 9 are not known. Usually, the acquisition process begins with a tender offer. Copeland and Weston (1983) and Weston and Copeland (1992) provide a concise account for how the tender offer is initiated. The tender offer commences with the acquiring firm making its intentions to have a controlling interest in the target company, known to its board of directors and management. The acquiring firm then contacts the shareholders to sell their shares in the target firm. Alternatively, the acquiring firm could utilise a strategy known as the bear hug.
Under the bear hug strategy, management of the acquiring firm formally writes to the board of the acquired firm to announce its takeover intentions. The acquiring company usually mails the letter and expects the directors (of the acquired firm) to reply within a given period of time. The directors’ timely decision on the bid permits the acquiring company to decide on the next line of action. Sometimes, the directors object to proposed bid. When the acquiring firm finds it difficult to gain the approval of the directors, it may appeal directly to the shareowners of the target firm through a tender offer. The decision to contact the shareowners of the target company may be rescinded if the directors and managers have a majority interest.
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Values of the acquired firms are not known
The method of appealing directly to the shareowners is often described as Saturday night special. The method is so named because shareowners’ approval would afford the acquiring company the opportunity to replace the directors of the target firm who were uncooperative in the acquisition process. This strategy is also known as a hostile takeover. Directors and management of the target company usually welcome a hostile takeover with fierce resistance; they are more likely to seek alternative firm(s) to compete with the acquiring company in the bidding process. In most cases, the directors and management of the target firm throw their weight behind the alternative firm. This is referred to as a white knight. The use of tender offers in mergers and acquisitions increased dramatically after 1965, even though their usage extends to a considerable period of time.
Merger and acquisition activities could also be explained in terms of purchase and pooling of interests. From an accounting perspective, we could distinguish between pooling of interests and purchase. In pooling of interests, two companies combine their economic resources and engage in operations under their respective trade names to a considerable extent. Generally, the size of firms involved in the pooling of interests is closely equal, that is, the combining firms are not significantly different in terms of size. A purchase involves the acquisition and absorption of a relatively smaller company into the acquiring company. An example is the recent acquisition of North Fork Bank by Capital One Bank National Association (NA) in the United States of America; and the acquisition of ProCredit Ghana by Fidelity Bank in Ghana. North Fork Bank was a relatively small bank with branches in the states of New York, New Jersey, and Connecticut. The acquisition of ProCredit helped Fidelity Bank to increase its customer base to over 700,000; have over 300 agencies; operate over 96 automated teller machines (ATMs); and operate about 80 networked branches across Ghana.
The findings of a scientific research conducted by comment and Jarrell (1987) revealed that, in about 50 percent of mergers, the acquiring company negotiates an agreement with the directors and management of the target firm. Negotiated agreements usually result in friendly tender offers or takeovers. It is worth noting a takeover could also be a friendly one, even without a pre-negotiated agreement. An example of such takeovers is the one made in heaven in which the price is correctly determined and all parties are expected to share in the benefits to be derived thereof. The success of most mergers is pivoted around mutual consent. The basic source of payment for mergers is stock; and the acquisition process is usually initiated by one bidder. Management tends to be hostile to bidding firms when its ownership in the target firm is low.
Conversely, the bidding process is characterised by friendliness when management’s ownership in the target firm is relatively high. Management ownership in large corporations has witnessed a significant increase in recent years, although it was originally low. In most cases, the operating performance of the target company in a hostile bid falls short of the industry average; the cost of replacing its assets exceeds the market value of its securities. Contrarily, the operating performance of the target company in a friendly bid is usually above the industry average; the cost of replacing its assets is less than the market value of its securities.
Merger and acquisition activities could also be explained in terms of purchase and pooling of interests.
Ebenezer M. Ashley (PhD)
Fellow & Council Member, ICEG