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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

Documents

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