Chapter - 4

Mergers and Acquisitions

Expansion: Growth is always essential for the existence of a business concern. A concern is bound
to die if it does not try to expand its activities, there may be a number of reasons which are
responsible for the expansion of business concerns.

Reasons for Expansion:

1. Existence: Expansion is essential for the existence of the firm otherwise it may result into
failure & may out of business.
2. Advantage of large scale: A large scale of business enjoys a number of economies in
production, finance, marketing & management. All these economies enable a firm to keep
its costs under control & have a upper hand over its competitors.
3. Use for higher profits: Every businessman aspire to earn more & more profits. The
volume of profits can be increased by the expansion of business activities.
4. Monopolistic ambition: Monopolistic ambition of business leaders help in control in the
same line so that they may be able to dictate their terms.
5. Better management: A bigger concern can afford to use the services of experts. Various
managerial functions can be efficiently managed by the persons who are qualified for such
jobs.
6. Natural urge: As everybody wants to go higher & higher in their private life & this is
applicable to a business concern too. Every businessman wants to expand its activities in a
natural way.

Types of Mergers:

Merger types can be categorized based on the nature of the businesses involved, their strategic
objectives, and how they integrate their operations. Here are some common types of mergers:

1. Horizontal Merger:
o Involves two companies that are direct competitors operating in the same industry
and market.
o The aim is to achieve economies of scale, increase market share, and reduce
competition.
o Example: Two telecommunications companies merging to consolidate resources
and expand their customer base.
2. Vertical Merger:
o Occurs between companies operating at different stages of the production or supply
chain.
o Typically involves a supplier and a customer or a manufacturer and a distributor.
 o Aims to improve efficiency, control costs, and integrate operations across the
supply chain.
o Example: A car manufacturer merging with a tire producer to streamline production
and reduce dependency on external suppliers.
3. Conglomerate Merger:
o Involves companies that operate in unrelated industries or markets.
o The merger aims to diversify risk, expand market presence, or capitalize on
management expertise or distribution channels.
o Example: A media conglomerate acquiring a food and beverage company to enter
new markets and diversify revenue streams.
4. Market Extension Merger:
o Involves companies that operate in the same industry but in different geographic
markets.
o Aims to expand market reach, access new customers, and achieve economies of
scale in distribution or marketing.
o Example: A regional retail chain merging with another chain in a different region
to create a larger national presence.
5. Product Extension Merger:
o Involves companies that offer related but non-competing products or services.
o Aims to diversify product offerings, cross-sell to existing customers, and leverage
complementary technologies or capabilities.
o Example: A software company merging with a hardware manufacturer to offer
integrated solutions and expand their market share.
6. Congeneric Merger:
o Involves companies that serve the same customer base with different products or
services.
o Aims to consolidate resources, reduce costs, and enhance market penetration
through cross-selling opportunities.
o Example: A pharmaceutical company merging with a biotechnology firm to
enhance research capabilities and broaden product development pipelines.

Reasons for Mergers & Acquisitions:(Importance or merits)

1. Market Expansion and Growth: One of the primary reasons for mergers is to achieve
accelerated growth by expanding into new markets or increasing market share in existing
markets. Merging with another company allows access to a larger customer base,
distribution networks, or geographic regions.
2. Economies of Scale: Merging companies can achieve cost efficiencies and economies of
scale by consolidating operations, eliminating duplicate functions, and reducing overall
costs. This can lead to improved profitability and enhanced competitiveness in the industry.
 3. Diversification: Mergers enable companies to diversify their business portfolios, reducing
reliance on a single product line, market segment, or geographic area. Diversification can
mitigate risks associated with economic downturns, industry cyclicality, or changes in
consumer preferences.
4. Access to New Technologies and Capabilities: Acquiring or merging with another
company can provide access to new technologies, intellectual property, research and
development capabilities, or innovative processes. This enhances the acquirer’s ability to
innovate and remain competitive in a rapidly evolving market.
5. Strategic Realignment: Mergers allow companies to strategically realign their business
focus or reshape their competitive strategy. This could involve shifting towards higher-
growth sectors, consolidating to achieve a stronger market position, or responding to
industry trends and disruptions.
6. Enhanced Financial Performance: Mergers can lead to improved financial performance
through increased revenue opportunities, enhanced profitability, and stronger cash flows.
This can create value for shareholders and stakeholders of both merging entities.
7. Access to Talent and Management Expertise: Mergers often involve acquiring skilled
management teams, talented employees, and industry experts. This strengthens leadership
capabilities, enhances organizational talent pool, and fosters a culture of innovation and
excellence.
8. Strategic Alliances and Partnerships: Mergers can facilitate strategic alliances and
partnerships between companies, enabling them to leverage complementary strengths,
share resources, and collaborate on mutually beneficial projects or initiatives.

PE Ratio:

The Price-to-Earnings (P/E) ratio is a key financial metric used to evaluate the valuation of a
company's stock. It is calculated by dividing the market price per share of the company's stock by
its earnings per share (EPS). PE ratio helps to determine whether a stock overvalued or
undervalued. A company PE ratio can also be benchmarked against other stocks in the same
industry or against the broder market.

Formula

Market Price Per Share

P/E Ratio = Earnings Per Share

Capitalization:

Capitalization refers to the total value of a company's outstanding shares in the stock market. It is
a key metric used to understand the size and financial health of a company.

Market Capitalization:
Market capitalization (market cap) is the total market value of a company's outstanding shares of
stock. It is calculated by multiplying the current share price by the total number of outstanding
shares.

Market Capitalization = Price Per Share × Number of Outstanding Shares

Methods of Valuation of Firms:

1. Net Asset Value Approach: This is most commonly used method for valuation of firms.
The Net Asset Value (NAV) approach is a method used to determine the value of a
company, investment fund, or any other entity with a collection of assets and liabilities.
NAV is the total value of an entity's assets minus its liabilities. It represents the net worth
or equity value of the entity. The NAV approach is a fundamental valuation method,
especially useful in finance for assessing the value of entities with easily measurable and
marketable assets and liabilities. The formula is:

NAV = Total Assets − Total Liabilities

2. Earnings approach (EPS): The Earnings Approach, also known as the Income Approach
or Earnings Valuation Method, is a widely used method for valuing a company based on
its ability to generate future earnings. This approach is particularly useful for businesses
where income generation is the primary driver of value.

𝐄𝐏𝐒 𝐨𝐟 𝐓𝐚𝐫𝐠𝐞𝐭 𝐂𝐨𝐦𝐩𝐚𝐧𝐲

Exchange Ratio = 𝐄𝐏𝐒 𝐨𝐟 𝐀𝐪𝐮𝐢𝐫𝐢𝐧𝐠 𝐂𝐨𝐦𝐩𝐚𝐧𝐲

3. Market Value Approach (MPS): The Market Value Method, also known as the Market
Approach, is a valuation method that determines the value of a company, asset, or security
based on the current market prices of similar or comparable entities. The market price is
affected by the factors like demand and supply position in the stock market.

𝐌𝐚𝐫𝐤𝐞𝐭 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐓𝐚𝐫𝐠𝐞𝐭 𝐂𝐨𝐦𝐩𝐚𝐧𝐲

Exchange Ratio = 𝐌𝐚𝐫𝐤𝐞𝐭 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐀𝐪𝐮𝐢𝐫𝐢𝐧𝐠 𝐂𝐨𝐦𝐩𝐚𝐧𝐲

Demerge of merger
 It is method of corporate restructuring where a single company gets dividend into two or
more then two undertakings to be operated on their own. Demerge is basically opposite to
the merger.
 The merger consolidates two different firms whereas demerge splits a single firm into
different components.
Leverage buyouts:
A leveraged buyout occurs when an investor, typically financial sponsor, acquires a
controlling interest in a company's equity and where a significant percentage of purchase price is
financed through leverage borrowing. The assets of the acquiring company are used as collateral
for the borrowed capital. Sometimes with assets of the acquiring company. Typically, leveraged
buyout uses a combination of various debt instruments from bank and debt capital markets.
Management buyout:
The most common buyout agreement is the management buyout. In this corporate arrangement,
the company's management teams and/or executives agree to buyout or acquire a large part of the
company, subsidiary, or divisions from the existing shareholders. Due to the fact that this finance
compromise requires a considerable amount of capital, the management team often employs the
assistance of venture capitalists to finance this endeavor.