MERGERS AND ACQUISITIONS-SCOPE IMPORTANCE MOTIVE

This article is written by Sarika Kumari student of BALLB 3^rd year, Mewar Law Institute, Ghaziabad.

Keyword

Mergers and acquisitions, consolidations, valuations, acquirer, asset

Abstract

In today’s scenario, we come across great mergers and acquisitions of various companies generally to enhance their financial synergies for lower cost of capital, to improve the company’s performance, and for diversification for higher growth products or markets. In general terms mergers and acquisitions, we mean the consolidations of two or more companies to form one. Although M&A are used interchangeably, they come with different legal meanings, as in mergers, two companies of similar size or so combine to form a new single entity. On the other hand, an acquisition is when a larger company acquires a smaller company, thereby absorbing the business of the smaller company. Moreover, mergers and acquisitions transactions can be differentiated as a horizontal, vertical, conglomerate, etc, or determined in form as a statutory, subsidiary, or consolidations. Valuation being a significant part of M&A is a major point of discussion between the acquirer and the target company.

Mergers & Acquisitions

A merger is described as two firms, of approximately the same size, that joins forces to move forward as a single new entity, rather than remain separately owned and operated. A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both their companies.In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or alter its organizational structure.  

Well-known examples of mergers and acquisitions in 2020-

1. US$21 billion acquisition of Maxim Integrated by Analog Devices

 As the world’s largest manufacturer of semiconductors, Analog (as it’s more commonly referred to) produces the chips and electronics that power some of the most well-known products in the healthcare, automotive, industrial, and consumer segments. Its acquisition of Analog Devices – another all-share deal, reflecting the ongoing pandemic environment in which companies are hoarding cash – strengthens its position as the number one in its industry and with both companies specializing in different industries, the deal is expected to yield synergies of close to US$300 million.

2. US$21 billion acquisition of Speedway gas stations by Seven and I

 Seven and I, the Japanese owner of the ubiquitous 7-Eleven convenience stores, said the acquisition of Marathon Petroleum’s Speedway gas stations allows it to tap into US economic and population growth at a time when Japan’s economy and population are moving in the opposite direction. The deal also means that seven and I will control more than 14,000 gas and convenience stores in North America.

Scope of mergers and acquisitions-

Mergers & Acquisition have gained popularity throughout the world in recent times. They have become popular due to globalization, liberalization, technological developments & intensely competitive business environment. Mergers and acquisitions are a big part of the corporate finance world. This process is extensively used for restructuring the business organization. In India, the concept of mergers and acquisitions was initiated by government bodies. The Indian economic reform since 1991 has opened up a whole lot of challenges both in the domestic and international spheres. The increased competition in the global market has prompted the Indian companies to go for Mergers and Acquisitions as an important strategic choice. The trends of mergers and acquisitions in India have changed over the years. The immediate effects of the mergers and acquisitions have also been diverse across the various sectors of the Indian economy. Mergers and Acquisitions (M&A) have been around for a long time and have experienced waves of popularity during these times and they are very much an important part of today’s business world. They have also become increasingly international which can be due to the rising global competition.

Valuation

In an M&A transaction, the valuation process is conducted by the acquirer, as well as the target. The acquirer will want to purchase the target at the lowest price, while the target will want the highest price. Below are four major valuation methods that are used to value the target:

1. Discounted Cash Flow: DCF is computed by deducting the capital expenditure and change in working capital from the sum of net income and depreciation. It thus interprets the firm’s current value using future cash flows.
2. Enterprise Value to Sales Ratio: The EV/Sales ratio evaluates the enterprise value as a multiple of the revenue generated by the company.
3. Price to Earnings Ratio: The P/E ratio determines the price an acquirer plans to offer. It is represented as a multiple of the target firm’s earnings.
4. Replacement Cost: The acquirer determines the replacement cost of a target firm by identifying a competing target available at the same price.

Importance of valuation in M&A

Irrespective of the purpose for which a merger or acquisition takes place, their main aim is to help entities expand their size and value in the market. After a merger or acquisition takes place, the value of the entities involved equals the sum of their independent values. However, it often happens that mergers and acquisitions tend to have a negative impact on the entities involved due to incorrect estimation of entity value. Though there are precise approaches and methodologies to estimate the value of an entity when they are put to practical use it becomes a complex process. Therefore, it becomes significantly important to determine the right value of entities in mergers and acquisitions with the right approach and methods to avoid financial downfalls. 

Case laws on M&A valuation 

Shreya’s India (P.) Ltd. v. Samrat Industries (P.) Ltd.

 citations: 2007 80 SCL 131

This case dealt with the question of whether a valuation is required for a merger. In this case, an objection was raised by the Regional Director (RD) that no valuation report was filed and the exchange ratio for amalgamation was not estimated by an independent valuator analyst. The High Court of Rajasthan opined that no legal or factual aspect restrained the grant from being sanctioned for the amalgamation. As a result, the objection raised by the regional director was overruled by the said court.

Hindustan Lever Employees’ Union v. Hindustan Lever Ltd and Others

This case dealt with the question of whether a valuation method must be employed for a merger. There is no definite method prescribed for valuation in mergers. But, the High Court of Bombay in this case, accepted the ratio of 2:2:1 as the income, market, and asset-based approach upon which the valuation was done.

Different motives behind mergers & acquisitions

Mergers and acquisitions are regarded as an essential part of strategic management under the envelope of corporate finance. The different motives behind a merger & acquisition can be categorized into the following:

1. Achieve faster growth-It is just simple math when 2 companies combine, then their corresponding assets, as well as market share, are also merged and this widens opportunities for growth. And the increased market power is directly proportional to more yearly turnovers.
2. Attain positive synergy-The concept of synergy states that the combined return of two companies will be greater than the sum of the returns of the companies as individuals. A merger & acquisition process helps to increase the company’s performance for its shareholders.
3. Exploitation of the market-No market is perfect and there are always loopholes that businesses utilize for their own profit. Acquiring or merging of two similar companies help to form a dominant place in the existing market. This allows them to achieve a monopoly over their competitors. acquisition deal also increases the market power of the involved companies by reducing their dependence on other companies for raw materials.
4. Facilitates transfer of technology-When the two companies involved in a merger & acquisition are technology-driven, then a possible motive is the transfer of technology. The companies must be using unique technologies and sharing them could empower them a larger market share. Developing new technologies may require a lot of time and revenue, which may not prove profitable. Through mergers and acquisitions, the development process can be done in an easier and more cost-effective manner.
5. Diversification-Mergers and acquisitions allow companies to attain diversification in their business. There are both risks and profits in acquiring different businesses. Entering into different fields helps the company to maintain a positive impact in the share market.

Conclusion

Mergers and Acquisitions form a major part of the corporate sector. Every company in the market tries to establish itself over the others to gain maximum profits and brand value. Due to the high level of competition in the market, many companies opt for mergers or acquisitions. A merger takes place when two companies come together and form a new company. When one company takes over another company and announces itself as the new owner, it is known as an acquisition. The value of the company is determined based on the purpose for which it is getting merged or acquired. The valuation is done based on income, market, and asset-based approaches. These approaches provide further methods of valuation that serve the purpose of the merger or acquisition. It is not possible for every company to have all the resources and technology required for successful growth. A company agrees to a merger & acquisition, then the main motive is to acquire unique capabilities and resources that best suit its shares in the market.