Mergers and Acquisitions

Chapter 17
Mergers and Acquisitions (M&A)

Introduction
 2 ways a firm can expand its operations:
o Acquisition of LT operation assets OR
o Via a takeover

Types of mergers (often divided into 3 broad groups)
 Horizontal mergers
o When 2 firms in the same industry merge
 Example: Shoprite and Checkers

 Vertical mergers
o Occur where firms either expands forward to the customer OR
o Expands backwards to the raw material supplier stage
 Example: merger between a shoe manufacturer and a shoe
retailer

 Conglomerate mergers
o Occur were firms in unrelated lines of business decide to merge

Reasons for mergers:
 A merger should result in synergy benefits
 A merger should take place ONLY if the value of the combined entity is
GREATER THAN the value of the separate entities added together:

V xy >V x +V y

 Operating economies:
o A merger may result in economies in production or distribution such as:
 Lower unit costs through
 Higher production runs

o Operating economies can be effected by the following means: (REC3S)
 Reduction in the number of retail outlets (reduce distribution costs)
 Economies in purchasing
 Combination of production facilities in the number of products
 Combination of IT and administrative functions
 Consolidation of research and development (R&D)programmes
AND
 Standardisation and reduction in number of products

o A merger may result in a reduction in competitive pressures
 Allowing the combined company to raise prices WITHOUT losing
market share

, o Mergers may also be driven by strategic reasons such as:
 Ensuring the supply of key materials AND
 Obtaining sales outlets for the company’s products
    Managerial skills
o A firm with strong management resources
o may decide to take-over a firm currently earning low returns
o to introduce improved management and
o Reap the benefits of expected increased returns

 Use for excess liquidity (H20):
o A company with surplus cash resources may decide to utilise H 2O to
acquire other companies
o Also, a take-over may take place for the acquirer to obtain the benefits
of the strong liquidity position

    Diversification
o A company in a certain business field my decide to enter into an
unrelated business area and
o THEREFORE would obtain the benefits of diversification

 Lower financing costs (LFC):
o Where merged company (P+S) makes better use of it debt capacity
o This (LFC) may also be due to the fact that (P+S) effectively guarantee
each other’s debt
 Thereby reducing the risk to the lender and
 Increasing the risk to the firms

 Replacement costs:
o Where the firms wants to INCREASE production capacity… it may be
cheaper to do so via the acquisition route
 If the value of the target company→ substantially BELOW the→
replacement cost of the target company’s assets

 Products, product pipeline and reserves:
o A merger may be undertaken to obtain access to the target company’s
product range (particularly branded products)

 Tax considerations- tax shields and assessed losses:
o If a takeover is structured as a sale of the business
 Then a company will be able to deduct the interest payments
 Made on the debt used to finance the acquisitions

o If the company is highly leveraged and then starts to incur losses
 These tax shields will be deferred (at best) in the company
reverts back to profitability in future
 Otherwise the tax shields will be LOST as the company will be
accumulating losses

o One reason for undertaking a merger:
 To obtain the benefit of the tax assessed loss of the target
company BUT

,  The acquirer should take note that just because there is an
assessed loss
 DOES NOT automatically mean that the subsidiary will
be able to utilise this assessed loss to protect its future
income from tax


 S103(2) of Income Tax Act:
 Where a change in shareholding has been effected mainly
for utilising assessed loss to avoid taxes
 SARS will disallow the set-off of such income against the
assessed loss


    Technology:
o The acquirer may use the technological expertise of the target
company to improve its own products
o THUS providing a strong incentive to merge


The structuring of takeover offers and taxation
 A may wish to acquire B, so that B → subsidiary of A OR
 A new company C could be formed to hold shares of A and B




Note: if A acquires >50% of the shares of B it maintains majority control

    Financing costs