• A merger is in essence the pooling of interests by two business entities which results in common ownership.
• An acquisition normally involves a larger company (a predator) acquiring a smaller company (a target).
• Generally both referred to as mergers for PR reasons:
  • It portrays a better message to the customers of the target company.
  • To appease the employees of the target company.
• An alternative approach is that a company may simply purchase the assets of another company rather than acquiring its business, goodwill, etc.

The arguments put forward for a merger may depend on its type:

• Horizontal integration.
• Vertical integration.
• Conglomerate integration.

Horizontal integration

• Two companies in the same industry, whose operations are very closely related, are combined,
• e.g. Glaxo with Welcome and the banks and building societies mergers, e.g. Lloyds TSB and HBOS.
• Main motives: economies of scale, increased market power, improved product mix.
• Disadvantage: can be referred to relevant competition authorities.

Vertical integration

• Two companies in the same industry, but from different stages of the production chain merger.
• e.g. major players in the oil industry tend to be highly vertically integrated.
• Main motives: increased certainty of supply or demand and just-in-time inventory systems leading to major savings in inventory holding costs.

Conglomerate integration

• A combination of unrelated businesses, there is no common thread and the main synergy lies with the management skills and brand name,e.g. General Electrical Corporation and Tomkins (management) or Virgin (brand).
• Main motives: risk reduction through diversification and cost reduction (management) or improved revenues (brand).

Organic growth is internally generated growth within the firm.

 Advantages of organic growth (disadvantages of growth by acquisition)

• Organic growth allows planning of strategic growth in line with stated objectives.
• It is less risky than growth by acquisition - done over time.
• The cost is often much higher in an acquisition - significant acquisition premiums.
• Avoids problems integrating new acquired companies - the integration process is often a difficult process due to cultural differences between the two companies.
• An acquisition places an immediate pressure on current management resources to learn to manage the new business.

Advantages of growth by acquisition (disadvantages of organic growth)

• Quickest way is to enter a new product or geographical market.
• Reduces the risk of over-supply and excessive competition.
• Fewer competitors.
• Increase market power in order to be able to exercise some control over the price of the product, e.g. monopoly or by collusion with other producers.
• Acquiring the target company's staff highly trained staff - may give a competitive edge.

Whilst the potential for synergy is a key reason given for growth by acquisitions other motives do exist:

• Entry to new markets and industries.
• To acquire the target company's staff and know-how.
• Managerial motives - conscious pursuit of self-interest by managers.
• Arrogance factor / Hubris hypothesis.
• Diversification.
• A defence mechanism to prevent being taken over.
• A means of improving liquidity.
• Improved ability to raise finance.
• A reduction of risk by acquiring substantial assets (if the predator has a high earnings to net asset ratio and is in a risky business).
• To obtain a growth company (especially if the predator's growth is declining).
• To create a situation where rationalisation (which would otherwise be shirked) may be carried out more acceptably.

Reasearch suggests that, with hindsight, many acquisitions are viewed as a mistake and erode shareholder value.

Reasons advanced for the high failure rate of combinations are:

• Over-optimistic assessment of economies of scale. Such economies can be achieved at a relatively small size; expansion beyond the optimum results in disproportionate cost disadvantages.
• Once a company has been bought, management move on to identify the next target rather than ensuring that predicted synergy is realized. The post-acquisition management phase is often critical.
• Inadequate preliminary investigation combined with an inability to implement the amalgamation efficiently.
• Insufficient appreciation of the personnel problems which will arise.
• Dominance of subjective factors such as the status of the respective boards of directors.
• Difficulty of valuation.
• Arguments given as justification for merger or acquisition are suspect.
• Laziness of management in looking for alternatives.
• Winners curse - where two or more predators bid to buy a target the winner has often had to pay an excessive premium to secure the deal.

The regulation of takeovers varies from country to country but focuses primarily on controlling the directors. Typical factors include the following:

• At the most important time in the company's life - when it is subject to a takeover bid - its directors should act in the best interest of their shareholders, and should disregard their personal interests.
• All shareholders must be treated equally.
• Shareholders must be given all the relevant information to make an informed judgement.
• The board must not take action without the approval of shareholders, which could result in the offer being defeated.
• All information supplied to shareholders must be prepared to the highest with standards of care and accuracy.
• The assumptions on which profit forecasts are based and the accounting polices used should be examined and reported on by accountants.
• An independent valuer should support valuations of assets.

The acquisition of quoted companies is circumscribed by the City Code on Takeovers and Mergers, which is the responsibility of the Panel on Takeovers and Mergers.

• This code does not have the force of law.
• It is enforced by the various City regulatory authorities, including the Stock Exchange, and specifically by the Panel on Takeovers and Mergers (the Takeover Panel).
• Its basic principle is that of equity between one shareholder and another.
• It sets out rules for the conduct of such acquisitions.

The Stock Exchange Yellow Book also has certain points to make in these circumstances:

• Details of documents to be issued during bids for quoted companies.
• Such documents to be cleared by the Stock Exchange.
• Timely announcement of all price sensitive information.

The Office of Fair Trading (OFT) regulates the monopoly aspects ofbids. Many bids, because of their size, will require review by the OFT,and a limited number will subsequently be referred to the Competition Commission under the Fair Trading Act if the OFT thinks that a merger might be against the public interest (i.e. constraining of competition).

As a rule of thumb the Competition Commission may investigate an acquisition if it will result in the combined entity acquiring 25% or more of market share.

Their investigations may take several months to complete during which time the merger is put on hold. Thus giving the target company valuable time to organise its defence. The acquirer may abandon its bid as it may not wish to become involved in a time consuming Competition Commission investigation.

The Commission may simply accept or reject the proposals or accept them subject to certain conditions, e.g. on price. There has been a recent surge in the level of merger activity within Europe due to reduction of barriers to overseas ownership and a desire by multinational companies to enter the European market. These are subject to regulation by the European Commission in Brussels.

In addition, if the offer gives rises to a concentration (i.e. a potential monopoly) within the EC, the European Commission may initiate proceedings. This can result in considerable delay, and constitutes grounds for abandoning a bid.

• Every company (but especially quoted ones) is potentially subject to takeover.
• There will be a price at which the owners (shareholders) may be induced to sell their shares.
• If a bid is received, then the directors should consider it from the shareholders' perspective - if it will increase shareholder wealth, then the directors should recommend accepting the offer.
• A problem arises where a publicly quoted group, with a widely spread shareholding, receives an unwelcome ("predatory") bid, with the clear objective of buying the group at a price below the value that management put on it.
• Shareholders need to determine the management's motives in defending the bid.
• The purpose of corporate defence is either to obtain a full and satisfactory price from an unwelcome bidder, or to ward off the bid, and remain independent.

It is important to emphasise that this is a management, as opposed to shareholders', view, since presumably the latter, if they are induced to sell, will be happy with the transaction, on the "willing buyer, willing seller" assumption.

It is also important to determine management's motives in defending a bid strongly. The intention may genuinely be to obtain the best price for the shares, and prevent them being sold below their intrinsic value. However, the intention may merely be to maintain the group's independence at any price - which may not be the best solution for shareholders.

The circumstances under which a predator may seek to buy a group at less than full value are usually as follows:

• The share price is depressed. This can usually be identified by:
  • the group's market value being below the net value of its shareholders' funds; or
  • the group's price/earnings ratio being below, or its yield being above that for its sector.

In this case, however, the predator may believe that under its management the group can recover and perform much better financially than under existing management.

• The group's prospects are better than the share price would indicate. A period of fluctuating profits may be about to be followed by a good recovery. A predator might recognise this before it became apparent to the stock market as a whole, and seek to capitalise on the opportunity.
• The group occupies a strong position in one or more markets. The predator may see the acquisition of the group as a unique opportunity to purchase a major market share, and wish to do so without paying the market premium which should, in theory, attach to such a one-off situation.

Strategic defences

The principal aim of strategic defence is to try to eliminate, as far as possible, the attractions of the group to a would-be predator.

Defences can be split into pre- and post-bid defences.

Pre-bid defences

• Eternal vigilance

  Maintain a high share price by being an effective management team and educate shareholders.

• Communicate

  Investors may be told of any good research ideas within the company and of the management potential or merely be made more aware of the company's achievements.

• Clearly defined strategy

  Communicate the strategy effectively to ensure that it is well understood, this will reassure shareholders and tend to maintain the share price.

• Cross shareholdings

  Your company buys a substantial proportion of the shares in a friendly company, and it has a substantial holding of your shares.

• Strong dividend policy

  The level of cash dividend is often held to influence share price.

Post-bid defences

• Attack the logic of the bid.
• A White Knight Strategy - Find a friendlier bidder instead.
• Improve the image of the company - this can be done through revaluation, profit projections, dividend promises and public relation consultants.
• Refer to regulatory authorities (e.g. Competition Commission).
• Encourage unions, the local community, politicians, customers and suppliers to lobby on your behalf.

Other potential defences

The following tactics are likely to be frowned upon by the Takeover Panel in the UK but are used in the USA:

(1) PacMan defence - (Reverse takeovers)

(2) Poison Pill Strategy

(3) Crown Jewels

(4) Scorched Earth

(5) Golden Parachutes

(6) Fatman

Any board recognises that there is a point at which an offer becomes irresistible:

• Offer strong and logical resistance right up to this point.
• Decision based primarily on price.
• Other important considerations being the interests of employees and customers.
• Directors recommending acceptance of a bid clearly have a duty to make sure that the price is the best available in the circumstances and that independence is still not a better course, bearing in mind longer term considerations.