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Motives for Mergers and Acquisitions• DIVERSIFICATION:
• Growing outside a company’s current industry category. This motiveplayed a major role in the M & A that took place in the 3rd mergerwave- the CONGLOMERATE era.
• Many of the firms that grew into conglomerates in the 1960s weredisassembled through various spin-offs and divestitures in the1970s and 1980s. This process of deconglomerisation raises seriousdoubts as to the value of diversification based on expansion.
• Eg. General Electric (GE) is a case of successful diversification.Through a pattern of acquisitions and divestitures, the firm has
become a diversified conglomerate with operations in insurance,television stations, plastic, medical equipment and so on.
During the 1980s and 1990s, when the firm was acquiring anddivesting various companies, earnings rose significantly. The marketresponded favourably to these diversified acquisitions by followingthe rising pattern of earnings.
Part of the reasoning behind GE’s successful diversification strategy hasbeen the types of companies it has acquired. GE sought to acquireleading positions in the various industries in which it owned
business.
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• By expanding through the acquisition of a number of firms,
the acquiring corporation may attempt to achieve some of the
benefits that investors receive by diversifying their portfolio of
assets.
• One reason behind management’s decision to opt for
diversified expansion is its desire to enter industries that are
more profitable. Eg. The parent company’s industry has
reached the mature stage, the competitive pressures withinthe industry preclude the possibility of raising prices to a level
where extraordinary profits can be enjoyed etc.
• Economic theory implies that in the long run, only industries
that are difficult to enter will have above- average returns.
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Financial benefit of Diversification
Coinsurance effect:
If the covariance between earnings of two potential mergercandidates is negative, there might be an opportunity to derive
coinsurance benefits from their combination.
Related vs Unrelated DiversificationDiversification does not mean conglomerization.
Related diversification: Eg. Merck purchased Medco (1994)
Merck- one of the largest pharmaceutical companies in the world
Medco- largest marketer of pharmaceuticals in the US.
The track record of related acquisitions is significantly better than that
of unrelated acquisitions.
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Other Economic Motives
• Horizontal integration:
Increase in market share and market power, resulting fromacquisitions and mergers of rivals.
• Vertical integration:
Merger or acquisition between companies having buyer-seller
relationship.
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Horizontal integration:
• Two extreme forms of market structure:
__________________ and _________________
Horizontal integration involves a movement from thecompetitive end of the spectrum towards the monopoly end.
eg. Exxon merger with Mobil in 1998, Chevron bought Texacoin 2000 etc.
Market power: or monopoly power
Three sources of market power:
1. Product differentiation2. Barriers to entry
3. Market share: can be increased by horizontal integration.
Roll- up acquisitions: ?
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Vertical Integration:
Vertical integration involves the acquisition of firms that are
closer to the source of supply or to the ultimate consumer.Eg. Chevron acquired Gulf Oil (1984): a case of backward
integration motive by Chevron to augment its reserves.
Eg. Mobil bought Sperior Oil: Mobil was strong in refining and
marketing but low on reserves and Superior had large oil andgas reserves but lacked refining and marketing operations.
Forward integration: ?
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Motives for Vertical Integration:
1. Dependable source of supply: supply availability, quality
maintenance, timely delivery etc.
2. Lower transactions costs: avoiding disruptions, avoiding
renegotiations etc.
3. Need for specialized inputs: custom-designed materials or
machinery etc.
Eg. Automobile manufacturers have long realized that they may
need to provide potential buyers with financial assistance, in
the form of less expensive and more readily available credit.
GM formed GMAC (General Motors Acceptance Corporation)
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Other motives
1. Improved management
2. Improve R & D
3. Improve distribution4. Tax motives ?
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DIVESTITURES
• The most common form of divestiture involves the sale of a
division of the parent company to another firm. The process is
a form of contraction for the selling company but a means of
expansion for the purchasing corporation.
Involuntary vs Voluntary Divestitures
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Reasons for Voluntary Divestitures
1. Poor fit of division: divestitures become part of an efficient
market process that reallocates assets to those who will
allow them to reach their greatest gain.
2. Reverse Synergy:
3. Poor performance: the division could fail to pay a rate of
return that exceeds the parent company’s hurdle rate- the
minimum return threshold that a company will use to
evaluate projects or the performance of parts of the overall
company.eg, cost of capital.
4. Capital market factors: pure plays help complete the market.
5. Cash flow factors:
6. Abandoning the core business: less common reason.
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Reverse Synergy
The parts are worth more separately than they are within the
parent company’s corporate structure.
In such cases, an outside bidder might be able to pay more for
a division than what the division is worth to the parent
company.
Eg. A large parent company is not able to operate a division
profitably, whereas a smaller firm, or even the division by
itself, might operate more efficiently and therefore earn a
higher rate of return.
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DIVESTITURE PROCESSEach divestiture is unique.
Step 1: Divestiture decisionInvolves financial analysis of the various alternatives
Step 2: Formulation of a restructuring plan
Involves breakdown of the asset disposition, retention of
employees, etc.
Step 3: Approval of the plan by the shareholders
Depending upon the significance of the transaction
Step 4: Registration of Shares
Step 5: Completion of the deal
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