Cross-Border Merger and Acquisitions

CHAPTER II

GENERAL CONCEPT OF CROSS-BORDER MERGER AND ACQUISITION

II.1. Three Primary Methods of Merger and Acquisition

In corporate capital scheme, there are two ways for a company to raise its capital, through loan and equity. A company can raise its capital by issuing shares on the stock market as the quickest and easiest ways to finance its operation[24]. With this initial reason and based on economic perspectives (market mechanisms)[25], further, the concept of merger and acquisitions (Abbreviation of M&As) is developed.

M&As, in the context of corporate strategy, is an integration of two companies with a certain mechanism in particular business area that ultimately result in a large capitalization in the market economy[26]. The goals to be achieved in the implementation of M&A are the availability of financial aid, other assistances, and to leverage a company’s capital in a rapidly growing industry without having to form a new company from scratch, simply combining two entities to increase opportunities in the given market[27].

Theoretically, there are three primary methods of M&As; those were merger, sale of assets, and tender offer[28]. This thesis will discuss them in detail in sub-sub-chapters based on literature.

II.1.1. Merger and Acquisition

Merger and Acquisitions are usually simply referred to as merger, the condition or process in which a company buys another (the target)[29]. This condition usually can be done in two ways, either friendly or hostile[30]. In the former case, the two companies involved in a negotiation to merger-related matters in terms of the merger itself, in hostile mergers, typically the target company is unwilling to sell its shares to buyer (bidder), or the target’s boards are not known the purchases process made by other entity, and this process usually more complex and even involves the proxy[31] which will play a role in purchasing shares or at any even to influence the shareholders.

Pursuant to article 2:309 BW[32] (Dutch Law), a legal merger is defined as:

“The merger is the juridical (legal) act of two or more legal persons, whereby one acquires the property, rights and interests and the liabilities of the other by universal succession of title or whereby a new legal person, formed or incorporated by them jointly by such juridical (legal) act, acquires their property, rights and interests and the liabilities by general (universal) title.”

According to article above, it says that a merger is the process (universal succession) of transferring assets and liabilities from one company to another and forming a new legal entity by legal framework[33]. Legal act refers to the process of M&As usually consists of 6 (six) process, namely: Meeting of possibly takeover parties, Confidentiality agreement and stand-still agreement, Letter of Intent, due diligence investigation, the Shares Purchases Negotiating Agreement (SPA), and Closing meeting. Further, much literature stated in different terminology for the process related with M&As, but the outcome of the process is relatively similar[34].

II.1.1.1. A Common Merger and Acquisition

The term of M&As sometime used as a pair word (synonymously), however, basically these two words have different meaning and purposes. Pure merger is usually performed between two companies to form a single new company in which both owners have agreed to jointly develop, own, and operate the new company. This is called a merger of equals[35], in which the two companies generally have the same size, and the existing shares merged into one new share in the same stock market. For example, the merger between Glaxo Wellcome and SmithKline Beecham, and ultimately the two companies merged and a new company GlaxoSmithKline was formed[36].

However, in practice, merger of equals is rarely going to happen, and during the process, usually there is a deal between both companies, in which the process of acquiring will be announced as a merger of equals, instead of the process of acquisition, because of the term of an acquisition often refers to as negative connotation[37].

Acquisition is essentially an acquiring of a company by another, where the buyer, based on the legal point of view, buys shares of the target in a majority amount, as a result the target’s shares will be ceased, and consequently, the buyer takes control of the target’s business. In general, the shares value of the buyer company would lead to an increase in the market trading (leveraged recapitalizations)[38], even though the process need to be considered with substantial ownership changes.

II.1.1.2. Consolidation

Merger of equals is an integration of two comparable companies, and the notion of consolidation in the corporate merger means that the two entities will merge into a new company. Further the two companies are dissolved without any prior liquidation process. Consolidation is equated with amalgamation, in which two or more entities are mixed into a new single entity, and the shareholders of both entities are substantially blended into the shareholders of the newly formed entity[39]. Basically, the concept of consolidation and amalgamation relatively the same, in the meaning of the purpose and the entities related, however in practice, the amalgamation concept has mostly been used for blending process of private entities[40], while the consolidation usually refers to public entities.

II.1.1.3. Triangular Merger

Triangular merger is a more complex merger process, whereas a parent company is bought another company and combined with its subsidiary[41]. Further, there are several derivative processes related with considerations, for instance, consideration in term of exchange as shares[42], usually offered by cash or debt as a result of a freeze-out transaction[43], in which the ownership of shares in parent company is not affected. But if the shareholders want the ownership of shares in the parent company, then they will become part of the shareholders.

The purpose of this concept is the parent company intended to separate the assets acquired from his existing assets by placing these assets into its subsidiary. It appears because of the different environment of business, so that the separation of assets, liabilities, and incomes become very important. Another possibility is about contingent liabilities[44], for instance, the possibility of tort liabilities must be maintained to remain separate.

In a triangular merger, the acquisition process is conducted by the subsidiary, in which the shareholders of the subsidiary company is represented by the parent company’s boards, thus in decision-making process of the merger, the shareholders have no voting rights[45].

II.1.1.4. Reverse Triangular Merger

In essence, a reverse triangular merger is merely the same with a common triangular merger. However, the difference lies in the surviving company (the company exists after the merger process). This condition derived by several reasons, for instance, if the acquired company has intellectual property rights (IPR)[46] such as copyrights owner, patent rights holder, etc. in which, if the merged company become disappear then the IPR’ rights can not survive.

Therefore, the concept of a reverse triangular merger is widely used by large companies (enterprises) to acquire another company that has the IPR embedded to become their subsidiary. As a consequence, the shareholders of the subsidiary (the boards of parent company) will be converted into shareholders of the new subsidiary, while the initial shareholders would be offered by an exchange of shares or a payment in any other forms of consideration. Thus, the new subsidiary will be wholly owned by parent company.

II.1.2. Sale of Assets

In the M&As, a company can make an acquisition process of assets from other companies under contract of sale, it is marked by the transfer process of its ownership to acquiring company in share purchase agreement regarding the price[47], and way of payment of the assets, further, shareholders of the acquired company is entitled to consideration, such as stocks, cash, securities, options, futures, or any other types of consideration[48]. According to article 122 of Indonesian Company Law No. 40/2007:

(1) Merger and Consolidation shall cause the merging or consolidating Company to legally dissolve.

(2) The dissolution of the Company as referred to in paragraph (1) may occur without any prior liquidation performed.

Further, there are two options related to the existence of the acquired company. First, the company still exists and becomes part of a holding company, in which the prior shareholders still exist. Second, the company is dissolved without any prior liquidation and transfers its ownership to the acquiring company.

Basically, regarding company laws of some countries, the process of buying assets must be approved by the board of directors of both companies, regarding article 123 paragraphs (1) of Indonesian Company Law No. 40/2007 “Both the Board of Directors of the merging Company and the surviving Company shall prepare the Merger plan”.

In the process of sale of assets, especially if it is carried out a substantial assets in the purchase agreement, only the shareholders of the acquired company have vote right to decide such a legal action, while the shareholders of the acquiring company only conducts as control function, because the purchase decision is made by the board of directors.

II.1.3. Tender Offer

In terms of M&As, tender offer is usually equated with the takeover bid[49], in practice, a company (bidder) will make an offer directly to shareholders of another company (target) to buy the shares. Theoretically, the bidder will hold control of the company if the amount of shares exceeds 51%, the control of the company may be held by appointed board of directors[50], and the company automatically become its subsidiary, further if the number of shares purchased up to 100%, then the subsidiary is wholly owned[51]. In the United States, tender offer is regulated by the Williams Act. And SEC Regulation 14E[52], it covers following matters:

(1) The minimum length of time a tender offer must remain open.

(2) Procedures for modifying a tender offer after it have been issued.

(3) Insider trading, in the context related with of tender offers.

(4) Whether one class of shareholders can receive preferential treatment over another.

Tender offer can be made either at public or private companies. The process of tender offer conducted in a public company, usually hold with a more complex mechanism[53], regarding the number of shares traded is usually not 100% it will take a second step of the merger, can be a triangular merger, to acquire the remaining shares that are not acquired at first attempt. Second step process might be a freeze-out merger, in which the remaining shareholders equity will be eliminated by the merger, further, the new owner of the company is formed and the fiduciary duties are raised[54].

Different from the previous tender offer process, in the private companies’ scheme, it is a simpler tender offer, whereas the bidder will directly involve in the sale purchase agreement through a negotiation with the shareholders of a private company (the target company). The bidder requires approval from the board of directors[55], while the target company is not needed, given the offer directly to shareholders and not to the board of directors. On the other hand, shareholders of the bidder usually do not need to have vote for this purpose, whereas for the target company, this offer can be accepted or rejected by the shareholders.

II.1.4 Concept of Cross-Border Merger and Acquisitions

A company in one country can be acquired by an entity (another company) from other countries. The local company can be private, public, or state-owned company. In the event of the merger or acquisition by foreign investors referred to as cross-border merger and acquisitions will result in the transfer of control and authority in operating the merged or acquired company[56].

Assets and liabilities of the two companies from two different countries are combined into a new legal entity in terms of the merger, while in terms of acquisition, there is a transformation process of assets and liabilities of local company to foreign company (foreign investor), and automatically, the local company will be affiliated[57].

Since the cross border M&As involving two countries, according to the applicable legal terminology, the state where the origin of the companies that make an acquisition (the acquiring company) in other countries refer to as the Home Country, while countries where the target company is situated refers to as the Host Country[58].

In corporate merger, the headquarter of the new company can be in two states, for instance, on the merger between the Dutch Royal Shell[59], where the company’s headquarters are in The Hague, Netherlands, with its registered office at the Shell Centre in London, United Kingdom. The headquarter can also be in a state of Home country, such as the merger between Daimler-Benz AG with the American automobile manufacturer Chrysler Corporation (now so called Daimler AG[60]) on October 5th , 2007, where the company headquarter is in Stuttgart, Germany. However, the merger is failed due to any reason and Daimler AG sells his equity shares in Chrysler to private equity house in New York, US. Recently, Chrysler has announced his agreement with the Italian Fiat Auto Group to create a global partnership in the production and distribution of automobiles and other motor vehicles.

II.2. Cross-Border Merger and Acquisition Motives

Underlying motive for Cross Border M&As by large companies today can not be separated from the current globalization. Based on data from World Investment Report between 2000 – 2009, Cross Border M&As is increased in the early 1990 till 2005, while in 2008 it was decreasing both in terms of quantity and value, which is caused by the global economy crisis in the years 2007-2008. However, based on the prospectus World Investment Report 2009, Cross Border M&As in some regions by 2010 tend to be continuously rising, especially in Asia (less impact by the crisis) and this condition also in line with the increasing of global economy. Merger and Acquisitions can be functionally classified as[61]:

o Horizontal M&As (between competing firms in the same industry). They have grown rapidly recently because of the global restructuring of many industries in response to technological change and liberalization. By consolidating their resources, the merging firms aim to achieve synergies (the value of their combined assets exceeds the sum of their assets taken separately) and often greater market power. Typical industries in which such M&As occur are pharmaceuticals, automobiles, petroleum and, increasingly, several services industries.

o Vertical M&As (between firms in client supplier or buyer-seller relationships). Typically they seek to reduce uncertainty and transaction costs as regards forward and backward linkages in the production chain, and to benefit from economies of scope. M&As between parts and components makers and their clients (such as final electronics or automobile manufacturers) are good examples.

o Conglomerate M&As (between companies in unrelated activities). They seek to diversify risk and deepen economies of scope.

Outlined, motives underlay the cross border M&As is to increase profitability or revenue enhancement, cost reduction, market development, and power and efficiency gains[62]. Some literatures take important note by conducting studies on connection of cross border M&As with some indicators as discussed in the following sub-sub chapter.

II.2.1. Foreign Direct Investment Motive

Over the past few decades, economic development has become globalised, and some trends indicate progress toward the development of international networks in all spheres[63]. One of the trends is an increasing of Foreign Direct Investment (abbreviation of FDI). FDI is a long-term active participation from foreign country to other countries usually in the form of management participation, joint ventures, or transfer technology and know-how[64]. FDI is divided into two types, namely inward and Outward FDI, both of which will result in net FDI inflow. Basically, the flow of FDI into a country can be done in two ways, through green-field investment, or by making mergers and acquisitions of local companies[65].

The relation between net FDI inflow with Cross Border M&As, is reflected by the complexity of companies in adoption with regional strategies and intricate network structures that have facilitated intra-regional economic interdependency. This condition might become one of the region’s attractiveness to international investors upon the growth of net FDI inflow. Afterward, it is important to build intergovernmental efforts towards creating the appropriate environment for the companies following the huge net FDI inflow. According to UNCTAD data of inward stock flow 2009, total inward stock is increased across all regions. Thus, the increasing of net FDI inflow could be followed by several cross border activities, for example, Cross Border M&As in term of investment, and the expansion of operations[66].

II.2.2. Financial Motive

The main motivation of doing Cross Border M&As is related to financial performance. In most cases, financial motive is more visible than other motives. It is related to the purpose of doing mergers and acquisitions, in which the decision is based on interests of the shareholders and the board of directors. In practice, financial motive is done by private equity, for instance, when they propose management buyouts (MBO)[67] or sell the merged companies in the next couples of years in order to take advantage from the margin of increasing company’s value[68].

There are several activities underlying this motive[69]:

§ Economy of scale:

This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.

§ Increased revenue or market share:

This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.

§ Resource transfer:

resources are unevenly distributed across firms[70] and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.

§ Geographical or other Diversification:

This is designed to smooth the earnings results of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.

From these perspectives, financial motive arise as efficiency gains increased because Cross Border M&As intensify synergies between firms that in turn leverages economy of scale or scope[71]. Furthermore, the diversification creates an opportunity for investors to develop their business in a larger scale, geographically or by type of business. Thus economically, this circumstance might create gain in value and efficiency.

II.2.3. Strategic Motive

Strategic motive is a more complex motive behind Cross Border M&As, it might change the market structure and as such have an impact on companies profits, moreover, it might even be reduced to zero, this is the so-called merger paradox[72]. In general, the aim of this motive is to eliminate double activities in integrated companies due to enlarge economics of scale, for instance, by creating new supply chains or diversity of product, and extending market share. Practically, this motive can be as follow[73]:

§ Cross-sel

l, for example, a bank buying a stock broker could then sell its banking products to the stock broker’s customers, while the broker can sign up for the bank’s customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.

§ Synergy:

For example, managerial economies such as the increased opportunity of managerial specialization. Another example is purchasing economies due to increased order size and associated bulk-buying discounts.

Strategic perspective of Cross Border M&As is derived by technological, regulatory, and to some extent also financial consideration[74], it can be explained by the fact that most of this motive is conducted through horizontal merger of companies[75], whereas integrated functions (eliminating double activities, i.e. in Research and Development function) are an important factor in companies’ decisions to engage such merger or acquisitions.

II.3 International Growth in Relation with Cross Border Mergers and Acquisitions

The most fundamental motives to conduct cross border M&As is growth. Companies who seeking for expand have two options and should choose between internal growth and M&As growth. In the former case, if a company seeks to expand within its own business, the company could face that internal growth is not reluctant to be a satisfaction alternative. For instance, the company may find difficulty in maximising the opportunity because of a limited period of time, whereas internal growth may not suffice. As the company grows slowly, the competitors could respond very quickly and might be taken as dominant in given market share that a company may have dissipated over time by the actions of competitors[76].

Thus to balance this condition, a company could choose M&As growth by acquiring company which has the resources, such as facilities, well established managements, and other resources available for additional competition purpose in the market.

II. 3. 1. International Growth of Economy

Cross border M&As may become one alternative for companies who have been successful in their product within national market to expand revenue and profit[77]. Whereas cross border M&As facilitates the companies with opportunities of tapping new market rather than pursuing further growth in internal market. For instance, cross border deals may enable companies to utilise country specific know how of the acquired companies, the staff, and also the distribution network they might have, these will provide more advantages for acquiring companies. Carrying this condition, the key element to be considered is whether such cross border M&As provide opportunity cost relate with the risk adjusted return. Opportunity cost is reflected by what can be achieved to the next base use of the invested capital[78].

In European Union (EU), since the development of many areas of regulations to reduce cross countries barriers, cross border deals (including M&As) become significantly increased. In certain Asian markets, cross border deals is still secluded because of the resistance of some countries to foreign acquirers, however, there are signs that this condition will be changed rapidly[79].

Within 1970-2000, according to many research and studies in global investments, international growth in economy has considerably effected by globalized world on corporations. The fastest way to achieve growth is through cross border M&As by acquiring other markets in international scope. Although, to enter new markets will certainly create additional risks for investors, many companies that have previously been involved in cross border deals (M&As’ waves) may become references for those who conduct such deals to reduce the risks. International growth of economy is marked by significant activities in many areas of industry such as automobile, telecommunication, and other corporate matters[80].

II. 3. 2. Operating Synergy of Company Combinations

The purpose of company combinations through merger is to enhance its revenue or to reduce its cost through synergies. Revenue enhancing may be more difficult than cost reducing to achieve. However, the company combinations through revenue enhancements can produce new opportunity, for instance, sharing of marketing by enabling cross-marketing by each merger partner’s products with a broader line of markets, whereas each company could sell more products and services. This condition may lead to the comparative advantage between the two merged companies as a result the exchange from their conducts[81].

Cross-marketing also provides the opportunity to enable faster growth in revenue enhancement of each merger partner rather than exploiting their own market[82]. Even though the sources of revenue enhancements are huge, but to achieve such enhancements is not an easy way. That was why, cost related synergies through cost reductions also become a very important in making a plan for merger deals. In general, the merger of two companies may have certain specific facilities and those are duplicative, for example, if both companies have their own distribution networks and research development division that could create similar result. These activities maybe pointed to be eliminated and build more effective and efficient synergy through company combinations’ scheme.

Operating synergy in company combinations tend to look for cost-reduction synergies as a main source than revenue-enhancement. The reason lays on the fact that cost-reduction may come to decrease as a result of an increased of the size/scale of companies operations. Whereas revenue enhancements are vaguely referred to as merger benefits, but these enhancements usually are not clearly defined and companies sought to these purpose may find hardly quantified objectives.

[24] Supra, note 10, pp. 564-566

[25] Supra, note 10, p.654

[26] See wikipedia at: http://en.wikipedia.org/wiki/Merger#Motives_behind_M.26A

[27] Fred J. Weston, Kwang S. Chung, and Juan A. Siu, ` Takeovers, Restructuring, And Corporate Governance – Preliminary`, ISBN 0-13-889163-X, The Anderson School, University of California, Los Angeles, 1998, p.87

[28] Pinto, Arthur R. and Branson, Douglas M., Understanding Corporate Law (Third Edition), ISBN-1422429598-781422429594 Lexis-Nexis, (September 10, 2009), pp.143-150

[29] Supra, note 28, p.143

[30] Supra, note 28, p.145

[31] Supra, note 28, p.177

[32]See Burgerlijk Wetboek (Dutch Civil Code), available at: http://files.shareholder.com/downloads/RANJF/0x0x205097/E5437DE6-E4A8-4C03-AD8B-4B3CADE7D624/0805_MergerProposal_full.pdf

[33] Supra, note 27, p.8

[34] Patrick A. Gaughan, Mergers, Acquisitions, and Corporate Restructurings, ISBN-13: 978-0471705642, Wiley; 4th edition (February 2, 2007).

[35] Supra, note 26

[36] See at: http://en.wikipedia.org/wiki/GlaxoSmithKline

[37] Supra, note 26

[38] Fred J. Weston, Ph.D., and Samuel C. Weaver, Ph.D., Mergers and Acquisitions: ‘tax accounting guidelines, legal and regulatory frameworks, guidelines for post-merger integration’, ASIN: B000OFQGEK, McGraw-Hill (2001). p.188.

[39] See at: http://en.wikipedia.org/wiki/Halsbury%27s_Laws_of_England

[40] Supra, note 26

[41] Supra, note 28, p. 144

[42] Supra, note 28, p.145

[43] Supra, note 28, p.145

[44] Supra, note 28, p.146

[45] Supra, note 28, p.112

[46] See at: http://en.wikipedia.org/wiki/Intellectual_property_rights

[47] Harvard Business Review on Merger and Acquisitions, Strategy and General, ISBN 1-57851-555-6, Harvard Business School Press, Boston 2001-MA 02163, pp.74-78

[48] Regarding the Securities Exchange Act of 1934 in the United States of America. The Act, 48Stat.881 (enacted June 6, 1934), codified at 15 U.S.C.§78a et seq., was a sweeping piece of legislation.. Securities mean stocks, bonds, and debentures.

[49] See at: http://en.wikipedia.org/wiki/Tender_offer

[50] General Rules and Regulations promulgated under the Securities Exchange Act of 1934, Rule 14f-1 — Change in Majority of Directors; “If, pursuant to any arrangement or understanding with the person or persons acquiring securities in a transaction subject to section 13(d) or 14(d) of the Act, any persons are to be elected or designated as directors of the issuer, otherwise than at a meeting of security holders, and the persons so elected or designated will constitute a majority of the directors of the issuer,…..”

[51] See at: http://en.wikipedia.org/wiki/Wholly_owned

[52] Supra, note 49, William act. and SEC Regulation 14E sections.

[53] Supra, note 28, pp.149-150

[54] Supra, note 28, p.215

[55] Supra, note 28, p.149

[56] Supra, note 22, p.183-184

[57] Supra, note 28, p.146

[58] See at: http://en.wikipedia.org/wiki/Merger#Cross-border_M.26A

[59] Supra, note 58, Royal Dutch Shell, at: http://en.wikipedia.org/wiki/Royal_Dutch_Shell

[60] Supra, note 58, Daimler AG, at: http://en.wikipedia.org/wiki/Daimler_Chrysler

[61] United Nations Conference on Trade and Development, ‘World Investment Report 2000, Cross-border Mergers and Acquisitions and Development’, UNITED NATIONS Publication, ISBN 92-1-112490-5 Switzerland, 2000, p.101

[62] Supra, note 61, p.102

[63] Supra, note 11, p.51

[64] See at: http://en.wikipedia.org/wiki/Foreign_direct_investment

[65] Supra, note 22, p.183

[66] Supra, note 11, p.7

[67] Brakman, Steven, Garretsen, Harry and Van Marrewijk, Charles, Cross-Border Mergers and Acquisitions: On Revealed Comparative Advantage and Merger Waves (November 2005). CESifo Working Paper Series No. 1602. Available at SSRN: http://ssrn.com/abstract=870389, pp.

[68] Supra, note 34, p.145

[69] See at: http://en.wikipedia.org/wiki/Merger#Motives_behind_M.26A

[70] Jay Barney, Firm Resources and Sustained Competitive Advantage, Journal of Management, Vo.17, No.1, Texas A&M University, 1991, pp.99-120

[71] Supra, note 34, pp.126-135

[72] Supra, note 61, p.1

[73] Supra, note 62

[74] Supra, note 61, p.5

[75] Supra, note 61, p.7

[76] Supra, note 34, p.117

[77] Supra, note 34, p.120

[78] Supra, note 10, p.20

[79] Supra, note 34, p.121, and also pursuant to World Investment Prospect Survey 2009-2011, pp.44-46

[80] Supra, note 34, pp.121-125

[81] Supra, note 34, p.127

[82] Supra, note 34, p.129, and Supra, note 61, p.140