The Laws of Mergers and Acquisitions (M&A)

Definition:

Merger and Acquisition is defined as “A general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.” (Investopedia)

Introduction:

Mergers and Acquisitions in other words can be termed as a business phenomenon wherein the senior executives of the companies foresee the market strategies of economic growth, higher revenues and garnering higher synergies by merging to create a higher pie in the market or acquire a company to obtain competitive advantage in the market. This occurrence could appear more valid to the executives of the company due to many factors and situations a company is opposite in present economic situation, few of the forces behind such a decision would be an economic crisis, the dying state of the brand value company and also could be due to financial ill wealth of the company. The basic principle for lining to such decision is more than obvious as to create a higher shareholder values which would be well and over above the two companies.

A company which is being merged or acquired is forced to do so considering following advantages for improving the synergies

* Economies of Scale – This is one of the important elements for executives to decide on the success of Mergers & Acquisitions, it provides the distribution of costs and revenues that in turn affect the cash flows, and companies net present value of investment. The shareholders of both companies will be impacted by the financial transaction which can be considered as a co-efficient of current economic situation.

* Combining Resources – This element suffices companies to merge the best competitive resources in building a more competitive edge in the market. The converged ability of two companies steers the new company in direction of growth and strategic benefits. It’s just not people which will brought together but organization’s best practices and customer base will be combined to be part of much bigger successes.

* Competitive advancement – The converging technologies or a new technology from the acquired company provides a much needed market advancement for the company. Thus eliminating the inefficiencies of a company to construct a market strategy.

* Increase market share – All the above elements in one way or other regulates a merged company to reach more geographical area and markets. It also provides access to each other’s distributors and hence improves the market reach. This ensures new scope in terms of opportunities for sales and investments.

The above elements would surely help the decision makers to opt for a Merger or an Acquisition but does not concrete the success of the same. Due to the complexity involved in Mergers and Acquisitions, the evaluation of such transaction would be difficult, and hence the associated costs and benefits leading to much definitive handling of resultant tax and legal issues.

Consultant Jacalyn Sherriton shares that “In today’s global business environment, companies may have to grow to survive, and one of the best ways to grow is by merging with another company or acquiring other companies”. While McGarvey adds that “Massive, multibillion-dollar corporations are becoming the norm, leaving an entrepreneur to wonder whether a merger ought to be in his or her plans, too.” (Entrepreneur)

In practicality the decision of merging a company or acquiring another firm is relative to capital budgeting decision. It could be differentiated from companies’ investments in five different ways,

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2. The majority factors involved in merger and acquisitions are often unpredictable due to backend strategy.
3. Factor of complexity is more laborious things such as accounting, taxes and legal issues.
4. Danger to the current management positions which is directly dependant on satisfying the stakeholders of two companies.
5. How the market responds to the merger, does it increase the total share price or impedes the increase.
6. History says mergers are often regarded to be Unfriendly.

Differences:

“Although often used synonymously to each other, Mergers and Acquisitions do have differentiating meaning. When one company takes over another and clearly establishes itself as a new owner, the purchase is called an Acquisition. From a legal point of view, the target company ceases to exist, the buyer “swallows” the business and the buyers stock continues to be traded. In the pure sense of the term, a Merger happens when two firms agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred as a “merger of equals”. The firms are often of same size. Both companies’ stocks are surrendered and new company stock is issued in its place. However in practice, actual merger of equals don’t happen very often. Usually one company will buy another and, as part of the deals terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically acquisition. Being bought out often carries negative connotations, therefore, by describing the deal euphemistically as a merger, deal makers and top managers try to make the takeover more palatable.” (Wikipedia)

A Merger:

A Merger in broader terms can be defined as “The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for surrender of their stock.” (Investopedia, p. http://www.investopedia.com/terms/m/merger.asp)

Few Examples:

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• Citigroup – Citigroup Inc. is an American multinational financial services company based in New York City. Citigroup was formed from one of the world’s largest mergers in history by combining the banking giant Citicorp and financial conglomerate Travelers Group on April 7, 1998. (Wikipedia)
• Verizon – Verizon communications Inc. is a global broadband and telecommunications company. It was formed because of coming together of Bell Atlantic and GTE.
• ExxonMobil – The Exxon Mobil Corporation, or ExxonMobil, is an American multinational oil and gas corporation. It is a direct descendant of John D. Rockefeller’s standard oil company, and was formed on November 30, 1999, by the merger of Exxon and Mobil. It’s headquartered in Irving, Texas. (Wikipedia)

A merger constitutes current workforce of two separate entities come together to form a single cohesive unit. This newly formed unit is now held responsible for all the liabilities and debts that was previously owned by two separate entities and also by virtue inherits all its assets. This unit also can retain the name one of the entities if it has associated brand value with it, this decision is wholly left to the senior executives or they can go for totally new corporate image. The merger needs to be authorized by stakeholders and board of directors of both the companies. In which case the shareholders are given a choice to continue their holding for new company or option of withdrawing which needs to be paid out only in cash. In non-cash merger, the shares of merged companies will be transformed into shares of new merged firm. In a Cash merger, some shareholders i.e. public shareholders are asked to surrender their shares by the merging companies to generate cash. These stakeholders don’t retain any shares in the new corporation. This is generally termed as freeze-out merger.

Mergers can be further classified depending on the business structures as follows:

* Horizontal Mergers – This kind of merger takes place between two firms which are in direct competition with each other in fields of products lines and markets. Such merger would benefit the combined company to create substantial market power and would entice the firms to maximize the prices at lower production rate.

In which case, all such mergers are subject to Federal laws that prohibit certain actions from taking place during a horizontal merger. Since horizontal merger leads to no competition in market and the merged company enjoys the monopoly in market, this new firm could easily manipulate the prices, for which case Federal laws protect the consumer by prohibiting companies from creating a monopoly.

One such example included the case of “Staples, Inc. a superstore retailer wanted to merge with direct competitor Office Depot, another giant retailer of office supplies. This action would have made Staples the single largest office supply retailer in the market, which would have given them an unfair advantage. Market research showed that Staples would be able to charge the customers at prices 13 per cent higher. The Federal Trade commission (FTC) recognized the cumulative merger output and took measures to forbid such mergers to take place.” (LearnMerger)

* Vertical Merger – A vertical merger involves a corporation to come in direct partnerships with its suppliers and distributors. Such mergers are termed anticompetitive as the supply business demolishes the market of suppliers and distributors.

These kinds of merger involve a manufacturer teaming up with companies’ distributor. Thus the company gaining significant advantage compared to its competitors also this provides significant advantage to suppliers as they no more pay the distributors.

One such merger occurred between “Time warner Incorporated, a major cable operation, and the Turner Corporation, which produces CNN, TBS, and other programming. In this merger, the Federal Trade Commission (FTC) was alarmed by the fact that such a merger would allow Timer warner to monopolize much of the programming in Television. Ultimately, the FTC voted to allow the merger but stipulated that the merger could act in the interests of anti-competitiveness to the point at which the public good was harmed.” (LearnMerger)

* Conglomerate Merger – This kind of merger purely takes place between two businesses which are non-competitive and have no related products or markets. Conglomerate merger does not have any direct implications on the market. The balance between the oligopoly markets is maintained even after the merger takes place.

A conglomerate merger facilitates in reducing overheads for a company and also provides opportunities to improve efficiencies and reduce capital costs. These mergers help increase the demand of firms, hence help entrepreneurs liquidise at an open market price and with a key inducement to form new enterprises.

Although the conglomerate merger does not impact in perfect competitive markets, but it reduces the future competition by eliminating the possibilities of merged company being an independent player. This type of merger hinders the growth of smaller firms and increases the merged firm’s political power, thus reducing the social and political goals of retaining independent decision-making centers, guaranteeing small business opportunities, and preserving democratic processes. One example of conglomerate merger was the merger between the Walt Disney Company and the American Broadcasting Company. (Wikipedia)

An Acquisition:

An Acquisition can defined as “A corporate action in which a company buys most, if not all, of the target company’s ownership stakes in order to assume control of the target firm. Acquisitions are often made as part of a company’s growth strategy whereby it is more beneficial to take over an existing firms operations and niche compared to expanding on its own. Acquisitions are often paid in cash, the acquiring companies or combination of both.” (Investopedia)

Few examples:

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• Compaq by Hewlett-Packard – Compaq Computer Corporation is an American personal computer founded in 1982. Compaq existed as an independent corporation until 2002, when it was acquired by Hewlett-Packard for $25 billion. (Wikipedia)
• BellSouth by AT&T – Bellsouth Corporation is an American telecommunications holding company based in Atlanta, Georgia. In March 2006 announcement and subsequently executed on December 29, 2006 AT&T Inc. acquired BellSouth for approximately $86 billion. (Wikipedia)
• DoubleClick by Google – DoubleClick was founded in 1996. In March 2008, Google acquired DoubleClick for US$ 3.1 billion.

From the above examples it can be understood clearly, unlike mergers, acquisitions involves a buyout of firm by another firm, i.e. the purchasing firm acquires the assets of the sold firm without merging both entities. The proceeds of the asset sale can be distributed to the selling company’s shareholders as part of dissolution of the corporation. If the acquisition is not in form of totality of assets, the sold entity may decide to continue its corporate existence and to invest the proceeds of the asset sale in a new business. This kind of asset sales in totality must be pre-approved by board of directors and the shareholders of the company being sold. In US not all states require such approval; some states consider the sale of 50% of assets to be a sale of substantially all of the assets.

The main benefits of an acquisition are:

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• Revenue enhancement
• Cost reductions
• Lower taxes
• Changing capital requirements
• Lower cost of capital

Potential increase in revenues due to significant market gains, strategic benefits and market power. Marketing gains arise from more effective advertising, economies of distribution, and a better mix of products. Strategic benefits represent opportunities to enter new lines of business. Finally, a merger may reduce competition, thereby increasing market power. Such mergers, of course, may run afoul of antitrust legislation.

Regulations and Laws:

The business phenomenon of Mergers and Acquisitions has emerged time and again in set of waves in US, with peak of this activity corresponding in succession with periods of strong business growths. These waves can further classified in five phases : The first one at the beginning of twentieth century, the second in 1929, the third in latter of 1960’s, the fourth in the first half of 1980’s and the fifth in the latter of 1990’s.

This last peak, in the final years of the twentieth century, brought very high levels of merger activity. Bolstered by a strong stock market, businesses merged at an unprecedented rate. The total dollar volume of mergers increased throughout the 1990s, setting new records each year from 1994 to 1999. Many of the acquisitions involved huge companies and enormous dollar amounts. Disney acquired ABC Capital Cities for $19 billion, Bell Atlantic acquired Nynex for $22 billion, WorldCom acquired MCI for $41.9 billion, SBC Communications acquired Ameritech for $56.6 billion, Traveler’s acquired Citicorp for $72.6 billion, Nation Bank acquired Bank of America for $61.6 billion, Daimler-Benz acquired Chrysler for $39.5 billion, and Exxon acquired Mobil for $77.2 billion. (Reuters)

The business activity for any Merger and Acquisition to take place in US, it is closely monitored by both state and federal laws. State laws formulates the rules and procedures with a judicial oversight to approve a merger and also to defend the shareholders interest by ensuring fair value are considered or not, by the merging companies. State laws also require the management of companies to be merged or acquired to have clarity over various governing laws to defend themselves from unpredictable hostile takeovers. To demarcate the futility of target companies to preserve their current position, state laws are more deferential to defences. If the management of the target company has already decided to sell or bring about change, in such scenarios court tends to be more sceptical to defences. Since acquisitions are more affective (negative impact) for the employees of target companies, the state allows the directors or board members of target company to defend against the acquisitions. Due to high number of state defences availability, the vast majority of mergers and acquisitions are friendly, negotiated transactions.

On the other hand the federal government handles corporate amalgamations to render that the combined size of new entity does not dominate or exercise monopolistic power in market as to be unlawful under Sherman Antitrust Act. The federal government also regulates tender offers through the Williams Act, which requires anyone purchasing more than 5 per cent of a company’s shares to identify her and make certain public disclosures, including an announcement of the purpose of the share purchase and of any terms of a tender offer. The act also requires that an acquirer who raises his or her price during the term of a tender offer, raise it for any stock already tendered, that acquirers hold tender offers open for twenty business days, and that acquirers not commit fraud.

(Answers.com – Mergers & Acquisitions)

Federal Antitrust Regulation:

Since the late nineteenth century, the federal government has challenged business practices and mergers that create or may create a monopoly in a particular market. Federal legislation has varied in effectiveness in preventing anticompetitive mergers. (Answers.com – Mergers & Acquisitions)

Sherman Anti-Trust Act of 1890:

“The Sherman Act (15 U.S.C.A. § 1 et seq.) was the first federal antitrust statute. Its application to mergers and acquisitions has varied, depending on its interpretation by the U.S. Supreme Court. In Northern Securities Co. v. United States, 193 U.S. 197, 24 S. Ct. 436, 48 L. Ed. 679 (1904), the Court ruled that all mergers between directly competing firms constituted a combination in restraint of trade and therefore violated section 1 of the Sherman Act. This decision hindered the creation of new monopolies through horizontal mergers.

In Standard Oil Co. of New Jersey v. United States, 221 U.S. 1, 31 S. Ct. 502, 55 L. Ed. 619 (1911), however, the Court adopted a less stringent “rule of reason test” to evaluate mergers. This rule meant that the courts must examine whether the merger would yield monopoly control to the merged entity. In practice this resulted in the approval of many mergers that approached but did not achieve monopoly power.” (Answers.com – Mergers & Acquisitions)

Clayton Anti-Trust Act of 1914:

“Congress passed the Clayton Act (15 U.S.C.A. § 12 et seq.) in response to the Standard Oil Co. of New Jersey decision, which it feared would undermine the Sherman Act’s ban against trade restraints and monopolization. Among the provisions of the Clayton Act was section 7, which barred anticompetitive stock acquisitions.

The original section 7 was a weak anti-merger safeguard because it banned only purchases of stock. Businesses soon realized that they could evade this measure simply by buying the target firm’s assets. The Supreme Court, in Thatcher Manufacturing Co. v. Federal Trade Commission, 272 U.S. 554, 47 S. Ct. 175, 71 L. Ed. 405 (1926), further undermined section 7 by allowing a firm to escape liability if it bought a controlling interest in a rival firm’s stock and used this control to transfer to itself the target’s assets before the government filed a complaint. Thus, a firm could circumvent section 7 by quickly converting a stock acquisition into a purchase of assets.

By the 1930s section 7 was eviscerated. Between the passage of the Clayton Act in 1914 and 1950, only fifteen mergers were overturned under the antitrust laws, and ten of these dissolutions were based on the Sherman Act. In 1950 Congress responded to post-World War II concerns that a wave of corporate acquisitions was threatening to undermine U.S. society by passing the Celler-Kefauver Antimerger Act, which amended section 7 of the Clayton Act to close the assets loophole. Section 7 now prohibited a business from purchasing the stock or assets of another entity if the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.” (Answers.com – Mergers & Acquisitions)

“Congress intended the amended section to reach vertical and conglomerate mergers, as well as horizontal mergers. The U.S. Supreme Court, in Brown Shoe Co. v. United States, 370 U.S. 294, 82 S. Ct. 1502, 8 L. Ed. 2d 510 (1962), interpreted the amended law as a congressional attempt to retain local control over industry and to protect small business. The Court concluded that it must look at the merger’s actual and likely effect on competition. In general, however, the Court relied almost entirely on market share and concentration figures in evaluating whether a merger was likely to be anticompetitive. Nevertheless, the general presumption was that mergers were suspect.

In United States v. General Dynamics, 415 U.S. 486, 94 S. Ct. 1186, 39 L. Ed. 2d 530 (1974), the Court changed direction. It rejected any antitrust analysis that focused exclusively on market share statistics, cautioning that although statistical data can be of great significance, they are “not conclusive indicators of anticompetitive effects.” A merger must be viewed in the context of its particular industry. Therefore, the Court held that “only a further examination of the particular market — its structure, history, and probable future — can provide the appropriate setting for judging the probable anticompetitive effect of the merger.” This totality-of-the-circumstances approach has remained the standard for conducting an antitrust analysis of a proposed merger.” (Answers.com – Mergers & Acquisitions)

Federal Trade Commission Act of 1975

“Section 5 of the Federal Trade Commission Act (15 U.S.C.A. § 45), prohibits “unfair method[s] of competition” and gives the Federal Trade Commission (FTC) independent jurisdiction to enforce the antitrust laws. The law provides no criminal penalties and limits the FTC to issuing prospective decrees. The Justice Department and the FTC share enforcement of the Clayton Act. Congress gave this authority to the FTC because it thought an administrative body would be more responsive to congressional goals than the courts.” (Answers.com – Mergers & Acquisitions)

Hart-Scott-Rodino Antitrust Improvements Act of 1976

“The Hart-Scott-Rodino Antitrust Improvements Act (HSR) (15 U.S.C.A. § 18a) established a mandatory premerger notification procedure for firms that are parties to certain mergers. The HSR process requires the merging parties to notify the FTC and the Justice Department before completing certain transactions. In general, an HSR premerger filing is required when (a) one of the parties to the transaction has annual net sales (or revenues) or total assets exceeding $100 million and the other party has annual net sales (or revenues) or total assets exceeding $10 million, and (b) the acquisition price or value of the acquired assets or entity exceeds $15 million. Failure to comply with these requirements can result in the rescission of completed transactions and can be punished by a civil penalty of up to $10,000 per day.

HSR also established mandatory waiting periods during which the parties may not “close” the proposed transaction and begin joint operations. In transactions other than cash tender offers, the initial waiting period is thirty days after the merging parties have made the requisite premerger notification filings with the federal agencies. For cash tender offers, the waiting period is fifteen days after the premerger filings. Before the initial waiting periods expire, the federal agency responsible for reviewing the transaction can request the parties to supply additional information relating to the proposed merger. These “second requests” often include extensive interrogatories (lists of questions to be answered) and broad demands for the production of documents. A request for further information can be made once, and the issuance of a second request extends the waiting period for ten days for cash tender offers and twenty days for all other transactions. These extensions of the waiting period do not begin until the merging parties are in “substantial compliance” with the government agency’s request for additional information.

If the federal government decides not to challenge a merger before the HSR waiting period expires, a federal agency is highly unlikely to sue at a late date to dissolve the transaction under section 7 of the Clayton Act. The federal government is not legally barred from bringing such a lawsuit, but the desire of the federal agencies to increase predictability for business planners has made the HSR process the critical period for federal review. However, the decision of a federal agency not to attack a merger during the HSR waiting period does not preclude a lawsuit by a state government or a private entity. To facilitate analysis by the state attorneys general, the National Association of Attorneys General (NAAG) has issued a Voluntary Pre-Merger Disclosure Compact under which the merging parties can submit copies of their federal HSR filings and the responses to second requests with NAAG for circulation among states that have adopted the compact.” (Answers.com – Mergers & Acquisitions)

Due Diligence:

In general terms it can be defined as “An investigation or audit of a potential investment. Due Diligence serves to confirm all material facts in regards to sale. It refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.” (Investopedia)

Before a merger or an acquisition takes place, certain companies would like to involve itself into analysing the businesses they are merging with or acquiring for financial position and market health. This critical investigation is often termed as Due Diligence. Some managers and business owners who want to proceed with such investigation would rely on information from in-house team set up for this particular program or external outsourced firm. Depending on how convincing the Due Diligence report is managers conform to the decision of either to go ahead with a merger/acquisition or not. The probable use of such program is to unearth any traps or hidden drawbacks that are associated with the business under consideration.

Lee Copeland states that “The Due Diligence process involves everything from reading the fine print in corporate legal and financial documents such as equity vesting plans and patents to interviewing customers, corporate officers, and key developers.” (Computerworld – Due Diligence)

“The term Due Diligence first came into common use as a result of the United States’ Securities Act of 1933. This Act included a defense at Sec. 11, referred to as the ‘Due Diligence’ defense, which could be used by broker-dealers when accused of inadequate disclosure to investors of material information with respect to the purchase of securities. So long as broker-dealers exercised ‘Due Diligence’ in their investigation into the company whose equity they were selling, and disclosed to the investor what they found, they would not be held liable for nondisclosure of information that was not discovered in the process of that investigation.” (Wikipedia – Due Dilligence)

Due Diligence plays a comprehensive role in case of Mergers and Acquisitions. In such scenarios the previous track record of the operations and finer prospects for future existence provides collective information needed to make decisions. The advent of Information technology has added to complexity of the process, as the integrating data from all sources require formidable system to be in place which is time consuming. The information derived involves thorough analysis of wide area of businesses in consideration from balance sheets, cash flows, product stocks, assets, inventories, tax situation, investments to new age ordinances of intellectual property rights, environmental practices and background check of some key executives and personnel. Thus Due Diligence paves way for a more formidable and trusted approach in acquiring or merging with businesses, the risks taken now would be rewards benefitted for future. The success of a merger or an acquisition strategy in totality depends on structure and depth of Due Diligence process.

Cases of Mergers and Acquisitions:

Below are few cases of failed Mergers and Acquisitions with subsequent reasons:

1. Microsoft acquisition of Intuit (1994-1995)

“In 1994, Microsoft (MSFT) proposed what would have been the software industry’s largest acquisition, a $2 billion bid for financial software firm Intuit (INTU). Microsoft saw an opportunity in Intuit’s recurring fees for processing online check-writing transactions, a specialty of Intuit’s Quicken financial software. But Microsoft already had a financial program called Money, and together the two products accounted for 90% of the market. The U.S. Justice Dept. in April 1995 sued to block the deal, arguing the combination could have led to higher prices and less competition. Microsoft and Intuit cancelled the deal a month later.” (Bloomberg)

2. Bell Atlantic merger with TCI (1993-1994)

“In 1993, in what was then the largest planned corporate merger, Bell Atlantic, a phone company serving north-eastern U.S. states, agreed to pay $33 billion for the nation’s largest cable-TV company, Tele-Communications. The deal collapsed in early the next year as John Malone, then-CEO of TCI, and Raymond W. Smith, head of Bell Atlantic, found their corporate cultures clashed. Bell Atlantic is now part of Verizon Communications (VZ). TCI was ultimately was acquired by AT&T (T) in 1999 and sold to Comcast (CMCSA) in 2001.” (Bloomberg)

3. General Electric bid for Honeywell (2000-2001)

“ Upon learning in October 2000 that defense contractor United Technologies (UTX) planned to make an offer for aviation electronics giant Honeywell (HON), General Electric (GE) CEO Jack Welch lined up his own bid. Placing calls from his car, Welch convened his board and had a $45 billion offer within 45 minutes. GE’s offer arrived by fax before Honeywell’s board had even met to consider UTX’s proposal. Antitrust regulators in the European Union said the deal would stifle competition and quashed it by the following summer” (Bloomberg)