The reasons why companies decide to acquire or
merge with other companies are manifold and are as follows:
1. Diversification
especially for cyclicality reduction and to ease regulatory pressures: The idea for
any business is to inject new blood and diversify. Diversity and product range
plays a critical part in any merger or synergy. A buying company therefore may
be able to break from a cyclical or seasonal market by acquiring a company
outside of its product range, thereby diversifying its product range and evading
profitability fluctuations. Similarly a business may operate in a stifling
regulatory environment and might want to acquire a company or a business which
operates in a relatively relaxed regulatory environment. This would allow
greater flexibility in operations.
2. Business
Model: The business
model of the company being acquired may be significantly more attractive. It
may offer fewer benefits or may not be hindered by unions. The acquiring
company may not be in a position to replicate that model and therefore may
choose to acquire it altogether.
3. Intellectual
Property, Licenses and Rights:
A
very good reason for acquisition is usually to acquire intellectual property
and/or licenses and rights that the company being acquired might own or enjoy.
An example of this would be Mobilink’s recent acquisition of Warid which is
being done for the large part to acquire the Warid spectrum which allows for 4G
LTE operations, giving Mobilink an edge. Same holds true for trademarks,
copyrights and patents in other cases.
4. Market Share
and Growth: One of the
major reasons and usually the riskiest one is the attempt to increase market
share through acquisition. This usually happens when the companies are situated
in the same market. A variant of this is to achieve market growth by acquiring
a company in a market that is growing faster. The first of these is risky
because it is open to regulatory challenges including competition
challenges. The second variant is very
similar to diversification explained above.
5. Production
Capacity, Product Range and Product Line: Another
common reason for merger and acquisition is to either increase production
capacity or fill a hole in a product line.
For example a mobile telephony company may seek to acquire a broadband
WLL company to ensure that it can also offer a dongle device as part of its
product range. Similarly a fixed line telephony company may acquire a mobile
telephony company to ensure that it can also cater to the mobile market.
Another related example of this is Microsoft’s acquisition of Nokia. Microsoft
wanted to take over Nokia to fill a hole in its product line i.e. smartphones.
Obviously the acquisition turned out to be a colossal failure in strategy but
nevertheless the idea behind it was sound.
6. Sales
Channels and other synergies: Another
reason may be that a company might have effective sales channels and the other
acquiring company may want to utilize these effective sales channels. It is not
unusual for parent companies and subsidiaries to share sales channels. PTCL for
example uses the sales channels of PTML Ufone which is its 100 percent owned
subsidiary. So synergies in sales channels may actually be a very good reason
for two companies to merge or one company to acquire another.
7. Vertical
integration: A company
may acquire a supplier to ensure its supply lines are secured. This would be an
example of backward vertical integration. In other instances forward vertical
integration is also possible where a company may acquire its customer or a
distributor.
8. Local market
expertise: A foreign
company may want to acquire a local company to enter into the local market.
Numerous such examples exist across the border in India, where companies have
been acquired by foreign companies to acquire expertise and skills to operate
in the Indian market. Such an acquisition or a merger allows a foreign buyer to
acquire instantly the local market skill and expertise including knowledge of
local customs, laws and obstacles germane to language and other cultural
barriers.
9. Defensive
reasons and ulterior motives: Sometimes a
company may acquire another company to become so disproportionately large that
its acquisition by a third company would render it to challenges under the
anti-trust and competition laws of the country. Another reason, usually an
ulterior motive would be, that the management thinks having a larger company
will mean greater executive compensation. This is usually a bad reason to
acquire and often leads to unmitigated disaster. Corporate greed is never a good reason for a
merger or an acquisition.
10. Target
company’s reasons for being acquired:
Equally
important are the reasons for a target company or business (i.e. company that
is being acquired) to allow itself to be acquired. These are:
a.
Anemic Profits and Survival: Usually if a company has little or no
profits it would want to be acquired so as to survive.
b.
Competitive environment and Patent expiration: A
company may want to be acquired because it cannot face the aggressive
competition by its competitors without extra help. Another reason may be that a company may find
itself in a situation where its exclusive patent is expiring and it may not be
able to compete without extra help.
c.
Rapid growth or conversely stalled growth: In both
cases a company may want to be acquired. In the event of rapid growth, to
sustain working capital and in the event of stalled growth to further maximize
profits.
d.
Shareholder pressure: Shareholders may press for acquisition where a
buyer is willing to offer complete liquidity to a group of shareholders.
e.
Technological obsolescence: The technology used by a company may be
obsolete or nearing obsolescence. It may want to be acquired so that the buyer
may use it to convert it to new technology. In some ways we have seen such
acquisitions in the print media market where newspapers have been taken over by
technology companies who then convert existing newspapers into online portals.
The aforesaid reasons do not
constitute an exhaustive list.
There are many reasons, administrative, legal
and others, which may deter a company from acquiring or being acquired. These
are as follows:
1.
Competition law concerns: A merger may lead to anti-competitive and
anti-trust challenges. The newly merged entity may become too big for its own
good and such a merger may not be approved by the competition body or
regulator. An excessively large market share or in Pakistan’s case any
inhibition of competition when the merging parties cross thresholds defined by
the Competition Act 2010 may automatically be challenged and may not be
approved after the two review process.
2.
Regulatory concerns: In certain industries, such as
telecommunication in Pakistan, the regulator plays an important role in
determining pricing structure and the role of a significant market player. For
example the on cards merger/acquisition of Warid by Mobilink is still going to
have to overcome regulatory hurdles and approvals. Failure to get regulatory approvals for
mergers can lead to
3.
Surprises resulting from poor due diligence: This
happens quite often in mergers and acquisitions. Nasty surprises such as an
incomplete audit or failure to get an undertaking or overlooking a key balance
sheet can have its own impact. Accurate due diligence would usually show the
financial and legal health of an entity. An acquiring concern should not touch
an encumbered target with a ten foot pole. It is not in a buyer’s interest to
assume any liabilities which it is unaware of.
4.
Lack of common vision: A lack of
common vision between two managements may be a big deal breaker. A lack of
common vision would mean that a convergence between the two managements would
be impossible and therefore the merger or acquisition would be doomed from the
start.
5.
Complex, Costly and Convoluted: Mergers and
acquisitions are often very complex, are definitely very costly and extremely
convoluted with regulatory codes and rules involved. The entire process
requires a commitment and a spirit of fairness which is often lacking between
two aggressive negotiating entities working at cross purposes.
6.
Value reduction risk: Empirical
evidence suggests that acquisition transaction often destroys value i.e. the
acquiring entity or the merged entity is ultimately valued less than the two
entities previously were in sum. Ultimately it is the opportunity cost of
advantages gained from the merger or acquisition. Would that opportunity cost
be acceptable? Would it be offset by
significant gains? This is ultimately
the call a merging or acquiring entity has to make.
7.
Seller’s acquisition risks: By putting
itself out there for acquisition, a selling target exposes itself. For example
a competitor may enter the bidding process only to be able to conduct due
diligence on key and significant parts of the seller’s operations. It can
obtain pay rates, HR data, proprietary information, key operating and
engineering information, and product ranges both current and in pipeline. Usually a confidentiality agreement is used
to protect against this eventuality but their effectiveness is limited.
8.
Misdirected objectives: An acquiring company
may fail to pinpoint exactly what it wants out of the target acquisition. It
may want the HR culture or work ethic but that may not happen simply because it
takes over an entity. HR culture is not acquired but is embraced.
9.
Alternative of building instead of buying: An acquiring
company may be acquiring a target because it wants to buy innovation and news
ideas. However it may be cheaper for the acquiring company to actually invest
in its own research and development which would lead to more organic innovation
and add value to the company.
10.
Poor Governance, confusion and lack of
leadership: In either merger or acquisition, there comes an extended
period of poor governance because new management is slow in implementation of
the plan or is unable to cope with fast changing situation on the ground. Poor
governance causes confusion and is usually coupled with a lack of leadership.
This is one of the major reasons to avoid a merger or acquisition situation
because the risk is that residual benefits of any such acquisition would be
squandered by either poor governance, infighting or confusion about the chain
of command.
