Cross Border Mergers And Acquisitions Finance Essay - Free Essay Example

Merger and acquisition aim at facilitating two companies achieve certain financial objectives. The dissertation aims at giving an insight about the motives of mergers and acquisitions which includes motives that aim at increase or decrease of the shareholders value and also its impact on the shareholders value. The motives of the mergers and acquisitions include synergy, diversification, growth, economies of scale and scope, improvement of managerial efficiency, reduces competition, market expansion and acquiring new technology etc. Further, studying the effect of motives on Mergers and Acquisitions and also providing a deeper knowledge about it and examining them from the point of view of the four approaches involved in the literature review. Lastly, this dissertation includes the study of two cases involving a merger and an acquisition of two companies using the quantitative method i.e. an accounting study which examines the pre and the post MA financial performance of the companies involved. It also includes comparing the post financial performance with a competitive company in the same industry. The two cases studied involved acquisition of BellSouth by ATT and merger of T-Mobile and Orange Mobile with their financial performance being compared with their competitors i.e. Verizon and O2 respectively. According to the findings in the literature review, the company performs better before a merger and acquisition but the acquiring company has to bear loss after the MA. CHAPTER 1: INTRODUCTION MA are almost the same corporate actions. It is a process of combining two previously individual firms into a single entity. To improve companys performance and long term value of the shareholders funds are the significant operational advantages that can be obtained by mergers and acquisitions. A companys motivation to pursue a merger or acquisition benefits from economies of scale; higher revenues and market share in the market, higher tax efficiency and broadened diversification. However the underlying business rationale and financial methodologies are substantially different for mergers and acquisitions. A mutual decision of two equal companies coming together and becoming one entity is called a MERGER. It helps in cutting cost, increasing profits, increasing shareholders value for both the companies shareholders. Therefore, a typical merger involves two equal companies coming together with a goal of forming a company which has a value more than the sum of the two companies individually. In this process the shareholders get the equal amount of shares in the new entity as they had in the old entity. Whereas a takeover or an acquisition is the purchase of a smaller company by a much larger one. Even a non-mutual decision and a concept on unequal can produce many benefits similar to a merger. The larger company can initiate a hostile takeover of a smaller firm and then essentially buy it from the smaller companys management. Unlike in merger, in acquisition, according to the conversion ratio the acquiring firm either offers cash price per share to the shareholders or the acquiring firms shares. 1.1. BACKGROUND OF MERGERS AND ACQUISITIONS THE GREAT MOVEMENT OF MERGER AND ACQUISITIONS The great Merger Movement happened from 1895 to 1905.It was a U.S. business phenomenon. During this period small firms consolidated with the large firms as they had a bigger market share and dominated the small companies. Around 1800 of the firms disappeared in these consolidations. Trust was used as a vehicle. This movement was very big, in the year 1900 the firms that merged had the value as 20% of the GDP,then it decreased in 1990 to 3% ,further leading to a rate of 10-11% of GDP in around 1998-2000.By 1929 smaller competitors joined forces with each other which disintegrate ,this was observed by the organisations that had the greatest share in the market in 1905.Due to growing technological advances of their products, patents and brand recognition by their customers some companies like DuPont,Nabisco,US steel and General Electric have been able to keep their dominance in their respected sectors. The consistent mass producers of homogenous goods were the companies that merged; the y could lead to exploiting the efficiencies of the large volume production. Companies with fine products didnt take part in the Great Movement other than that they earned high profits and margin on the fine products like fine writing paper. SHORT RUN FACTORS The desire to keep the prices high is one of the short run factors in The Great Merger Movement that is why with so many firms the supply of the products remains high with the high prices in the market. In 1893, the demand for the goods declined, thus, according to the classic demand and supply model with the fall in demand the prices of the goods fall. By colluding and manipulating supply to counter the changes in the demand for a good, the firm could avoid the decline in prices. This lead to horizontal integration. Mass production lead to reduction in the unit costs to a lower rate. The new machines were usually financed by bonds, which lead to a panic in 1893 as the interest rate on bond was very high even then no firm agreed to reduce the quantity as they were capital intensive and worked on fixed cost basis. LONG RUN FACTORS In long run, companies work on reducing the cost thus it was better for the firm to reduce the transportation cost by producing and transporting products from the same location. Also, the technological changes lead to increase in the efficient size of plants which are capital intensive and allow economies of scale. The initial successful mergers were dismantled eventually due to the part of the government and also the competitors. The US government passed the Sherman Act in 1890 setting rules against price fixing and monopolies. The large companies were attacked for strategizing with others or within the companies with the aim of maximising profits. A great incentive for companies to unite and merge resulting in them not being competitors anymore was created by fixing prices with competitors. CROSS BORDER MERGERS AND ACQUISITIONS The currency of the target corporation appreciates by 1% as compared to the acquirers, as a result of the large MAs, this being the result of the study done by Lehman brothers in the year 2000.It was observed that after a merger there is a big upward shift in the currency rate, then after fifty days it stabilizes to 1% stronger average rate. The cross border MA increased because of the rise in the globalization. There were 2000 cross border MAs in the year 1996, these transactions were worth $256 billion. Majority of small and mid-sized firms didnt consider Cross border intermediation due lacking of significance and strict national mindset.This was the reason that did not let the academic work develop much. This has mostly been unsuccessful because of the broad term. It is a very complex term, where corporate governance, power of average employee, company regulations, political factors and countries culture are the crucial factors that spoil the transactions. The cross border MA helps in expanding the companies at the global front and create high performing businesses and cultures across national boundaries. Even companies with headquarters in the same country that merge are of this type. Swiss drug makers Sandoz and Ciba-Geigy were a $27 billion merger which is supposedly single mergers and was also a cross border merge r. Based on the merger activities the business world is divided into six merger waves as detailed below: TABLE 1: TYPES OF WAVES PERIOD NAME FACET 1897-1904 First Wave Horizontal mergers 1916-1929 Second Wave Vertical mergers 1965-1969 Third Wave Diversified conglomerate mergers 1981-1989 Fourth Wave Congeneric mergers, Hostile takeovers, Corporate raiding 1992-2000 Fifth Wave Cross border mergers 2003-2008 Sixth Wave Shareholder activism, Private Equity,LBO The table has been taken from (https://en.wikipedia.org/wiki/Mergers_and_acquisitions#1990s) The top merger and acquisition in the 1990s was Vodafone and Mannesmann which had a transaction value of US $183 billion and in 2000 was fusion of AOL with Time warner where the transaction was worth US $164.747 billion. 1.2. MERGERS According to the Oxford Dictionary merger means combining of two companies into one. Fusion of two or more entities where the identity of one or more is lost. The assets and the liabilities of the companies are vested into another company and the shareholders of both the companies become shareholders of the new entity formed. In consideration of the payment of the following: Equity shares in the transferee company Debentures in the transferee company Cash Mix of the above things All the assets, stocks and liabilities of one company are transferred to the transferee company. Example of a merger is when Daimler-Benz and Chrysler ceased to come together in 1998 to form a new company called Daimler Chrysler. 1.2.1. TYPES OF MERGERS: Horizontal Mergers: Two companies that share the same product lines and market, in direct competition. For example. Unilever acquired Lipton tea in 1972; ICICI bank acquired Bank of Madura Limited in all stock deal in 2001. Vertical Mergers: Its when a company and a customer or a supplier and a company merge. For example: 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 Time Warner to monopolize much of the programming on television. Ultimately, the FTC voted to allow the merger but stipulated that the merger could not act in the interests of anti-competitiveness to the point at which the public good was harmed. Market Extension Merger: When two companies that merge together sell same products in different markets. For example: market extension merger i.e. the acquisition of Eagle Bancshares Inc. by the RBC Centura. Eagle Bancshares is headquartered at Atlanta, Georgia and has 283 workers. It has almost 90,000 accounts and looks after assets worth US $1.1 billion. Conglomeration: When two companies with uncommon business areas merge. For example: DCM and Modi Industries. Mergers can be distinguished on the basis of how they are financed. They have implications on the company and the investors involved; which is discussed as follows: Purchase Mergers: This kind of merger occurs when one company purchases another company either by the means of cash or by issuing some debt instrument. Acquiring companies get the tax benefit from this merger, thus prefer it over the rest. The taxes can be reduced annually as the difference between the book value and the purchase value depreciates annually. Consolidation Mergers: In this a brand new entity is formed, where two companies are bought and combined under this. This merger is also taxable. 1.3 ACQUISITIONS Acquiring the ownership in the property is known as acquisition. In business context, an acquisition is one company purchasing the controlling interest in the share capital of another existing company. It is an attempt of one firm to gain majority interest in the other i.e. the target firm and by small group of investors take the target firm private or either disposes off its assets. The target company can be bought by the company either by the means of cash, stock or the combination of both. Whereas it is also possible, common in small deals, that is, when one company acquires all the assets of the other. Factors that affect an acquisition: Purchasing shares in an open market Make takeover to the general body of shareholders Private treaty purchasing new shares Acquisition of share capital by the means on cash, issuance of loan capital or insurance of share capital. Agreement with the members of board, major shareholders commanding voting power, i.e. the people holding the major interest in the companys management. Issue of dividends i.e. had to release as said that it would not pay dividend but released it due to potential threat of acquisition. TYPES OF ACQUISITIONS: There are two kinds of strategies that can be applied in acquisition, they are: FRIENDLY TAKEOVER: A financial proposal made by the acquiring firm to the target firms management board involving consolidation or merger of the two firms, or creation of a parental or subsidiary relationship. HOSTILE TAKEOVER : It is accomplished either by a tender offer or proxy fight. Acquisition of one company by the other company, not through an agreement but by forcing the companys shareholders to replace the companys management. 1.4. Benefits of Mergers and Acquisitions: MA benefit the shareholders in the buying company by offering premium to induce the mergers and acquisitions. This premium increases with the growth of the company. Mergers and acquisitions are a joint decision of the managers, shareholders and the promoters of the combined company. The advantages and the disadvantages of a merger or an acquisition is discussed as follows: From Shareholders point of view : As the owner of the company, shareholders should benefit from the mergers and acquisitions. Shareholders expect that when the companies have merged the investments made by them enhance depends as the shareholders may not precise the other company as a benefit. As they give rise to greater values by sale of shares from one companys shareholders to another and holding investment in shares. Advantages to a shareholder on merger or acquisitions are as follows: Increased face value of the shares if no dilution. Increased return to the shareholders i.e. increasing shareholders wealth. One companys shareholders can sell their shares to another companys shareholders. Better investment opportunities for the shareholders. Expenditure of other companies. Barriers to entry should be using the forecasts. From Managers point of view : They are concerned with improving the operations of the company, growth of the company providing better deals to raise their status, perks; they might have shares in the company and fringe benefits. When theres a guaranteed outcome of the stated things, the managers support the merger. From Promoters point of view : Increase the size of the company, financial structures and the financial strength. The closely held private limited companies can get converted into public limited companies due to mergers without contributing much of wealth and promoters losing control over the company. From consumers point of view: We can measure the benefit of the merger by the increase or decrease of the economic and productive activities which directly affect the degree of welfare i.e. provision of minimal wellbeing of the consumers by changes in the quality of products, price level and after sales service. The aim is not always increasing market growth it can depend on the level life cycle production is at. Advantages to a consumer from mergers and acquisitions are: Lower price and better quality goods : The economic benefits that a company get from mergers and acquisitions lead to low price, also the promotional changes and better quality goods for consumers. Improved standard of living of the consumers : Low price of products and improvement in quality automatically improves the standard of living of the consumers. DRAWBACKS: MA lead to concentration of economic power and these merged entities lead to a dominant position of market power. Also, after merger because of the dominance the entity suffers from deterioration in the performance over the years. The disadvantages of mergers and acquisitions are as follows: Monopoly: Two companies that merge together tend to lead to reach the domination position hence create a monopoly in the market. Corporate debt levels can rise to dangerous levels as it might have a backer and also the amount of loans taken by the company. Damages the morale and the productivity of the firms. Managers have to forego long term investments to get short term profits. It is possible that lesser dividend is given to the shareholders if the company is making losses, also less returns on investments if the company is not making enough profits. Corporate raiders control to make quick profits, strip assets from the target and destroying company leading to throwing people out of work. It is possible that a company doesnt throw the people out for example Virgin doing low cost flights to North of England when used to do trains, they instead became unemployed. 1.6. Aim of the dissertation; The various aims of the dissertation are as follows: Firstly, to know the basic meaning of a merger and an acquisition. Secondly, to know why would two companies opt for a merger or an acquisition i.e. the motive behind a merger or an acquisition. This explains the factors that would lead two companies to merge or take over another company. Thus, I will look at the various factors like role of synergy, agency problem, cash flow, and increase in the market power, regulation, economic factors and government influence which influence the managers to merger their company with another company or acquire another one. There are different motives like growth, synergy, and economies of scale etc. to shareholders, managers, promoters and customers which are also discussed in this report. Also, the effects of the motive of Mergers and Acquisitions on the company post it are also investigated. To do the investigation Ill take into consideration two case studies ,which are as follows : Case study 1: This includes the study of the acquisition of BellSouth by ATT. Case study 2: This includes the study of the merger of T-Mobile and Orange. 1.7. RESEARCH METHODOLOGY The research methodology used in the dissertation is an accounting study, which is explained further. The companys i.e. T-Mobile, BellSouth, ATT, O2, Orange Mobile and Verizons annual reports and some online data are used for the analysis of the company before and after the merger. This research also involves the study of the changes in financial performance due to Mergers and Acquisitions. Thus, this involves calculation of these three financial ratios i.e. profitability ratios, liquidity ratios and activity ratios and then comparing the company after the merger or acquisition with another company in the same industry; this is done to control the factors like firm specific, industry specific and economic worldwide. CHAPTER 2: LITERATURE REVIEW 2.1. Motives behind Mergers and Acquisitions: The past studies and researches done show that Mergers and Acquisitions have various motives, where Andrade et al. (2001) summarised it as Efficiency-related reasons that often involve economies of scale or other synergies; attempts to create market power, perhaps by forming monopolies or oligopolies; market discipline, as in the case of the removal of incompetent target management; self-serving attempts by acquirer management to over-expand and other agency costs; and to take advantage of opportunities of diversification, like by exploiting external capital markets and managing risk for undiversified managers George Coontz04 states The motive is to increase profitability and shareholder wealth by an increase in the price of the stock. An increase in price means an increase in the shareholders wealth. There are various reasons for mergers and acquisitions, which are as follows: Growth: The most common reason for merger is growth. It can be divided into two broadways: Internal growth: It is much cheaper and less risky for a company to merge and expand internally. It is much faster to grow by acquisition than internally. External growth: Diversification is an external growth strategy. If an organisation operates in a volatile industry then it might opt to hedge the fluctuations by undertaking a merger. This also involves geographical diversification i.e. when one company acquires or merges with another company in some other country or location. It means expansion in the current market and in the new market, also by increasing the product range and services. Synergy: Another reason for merger is synergic benefits. This is the most commonly used word in Mergers and Acquisitions, for increasing performance and reducing cost of operations by combining the business activities. Two businesses merge together if they have complementary strengths and weaknesses i.e. It follows the financial maths 1+1=3. This shows that the value of the two firms combined is much more than the two of them operating independently. Can be written as, Val (A+B) Val (A) + Val (B) There are two forms of synergies derived from: Cost economies: They help eliminating duplicate cost factors such as redundant personnel and overhead. These lead to lower per unit costs. Revenue enhancement: This is when one companys marketing skills combine with the other companys research process to significantly increase the combined revenue. Synergies are positively correlated to Mergers and Acquisition. This means higher the synergy, higher the target gains as well as the acquiring firms shareholders benefits (Berkovitch Narayanan, 1993). There are three types of synergies: Operational synergy: This is achieved by earning operational profits which is done by linking assets of the companies together to be used for various purposes. Operational synergy can be achieved by one company by opting for a merger or an acquisition by eliminating its weakness i.e. for example if a company has a strong production department it can acquire a company with a good supply chain thus resulting in the company to be stronger. As stated in Copeland et al. (2005, p 762) ,The theory based on operating synergies assumes that economies of scale and scope do exist in the industry and that prior to the merger the firms are operating at levels of activity that fall short of achieving the potential of economies of scale. In other words, operational synergy can be achieved by economies of scale or economies of scope. Financial synergy: This includes when two companies after a merger or an acquisition achieve high return on equity, right to use larger and cheaper capital market. Mergers and acquisitions also provide tax benefits, which is a financial synergy. Example of financial synergy: Mitsubishi and Bank of Tokyo. When the capital of two unrelated companies is combined and results in the reduction of cost and a higher cash flow that is also called financial synergy (Fluck Lynch, 1999; Chatterjee, 1986).It is stated that financial synergy, on average, tends to be associated with more values than do operational synergies (Chatterjee, 1986, pg. 120) Managerial Synergy: When two companies come together it is possible that one of the companys has better and well skilled managers than the other company. Thus, the managerial synergy helps in forming a new firm with expertise and thus leading to an improved performance of the company. Diversification: Diversification is when that a company goes through a Merger or Acquisition with a company which is from an unrelated industry. This helps in reducing the impact of one particular industry on the profitability of the new entity and also spreads risk in terms of climatic change and consumers tastes. Diversification has not been very successful except for a few companies like General electric, which grew and enhanced the shareholders wealth. The reason of engaging in MA is to reduce the top managers employment risk, such as the risk of losing job and risk of losing professional reputation (Amihud Lev, 1981). Many large firms seek to achieve diversification by MA, rather than internal growth. (Thompson, 1984; Levy Sarnat, 1970).According to Seth et al. (2000.p 391) In an integrated capital market, firm level diversification activities to reduce risk are generally considered non-value maximising as individual shareholders may duplicate the benefit from such activities at lower cost. Economies of scale Economies of scope : Size is one of the important factors in MA. A larger company benefits more from a merger in the form of cost reduction than a small company. The purchasing power and the companys negotiation power improves after the merger i.e. the larger the company higher the chance to negotiate the price of products with suppliers and to ensure to not spoil the relations with the suppliers although the orders maybe inbuilt. This basically concludes that new entity reduce the duplicate operations lowers costs thus higher profits. The economies of scale refers to the average unit cost of production going down as production unit increases (Brealey et al. ,2006 ;Seth,1990).The economies of scale is the goal of horizontal and conglomerate MA. An economy of scope implies higher the number of products the less is the cost of production. The feature of economies of scope is more suitable for vertical MA in seeking vertical integration (Brealey et al., 2006). In addition, complementary resources between two firms are also the motive for MA.It means that smaller firms sometimes have components that larger ones need, so the large companys acquisition of the small company often take place (Brealey et al., 2006). Increase market share and revenue: MA leading to an increased power of the new entity in the market. This helps in increasing market share. It also improves the investment opportunities of the firm; a bigger firm has an easier time raising capital.eg. Premier and Apollo tyres. According to Seth (1990, p.101), market power is The ability of a market participant or group of participants to control the price, the quantity or the nature of products sold, thereby generating extra-normal profits. According to Zheer Souder (2004) ,increased market power and increased revenue growth are the most common objectives for the firms participating in MA.They can be achieved through horizontal MA.Andrade et al.(2001) stated market power may be increased by forming monopolies or oligopolies. Increased power results in being more competitive in the market and increased the revenue growth is achieved by taking the highly elastic products and lowering their prices. New growth opportunities come from the creation of new technologies, products and markets (Sudarsanam, 2003).Thus, these results in strengthening the financial position resulting in an increase in the profitability of the firm along with shareholders wealth. Increase supply chain pricing power: If a company buys its supplier it helps in reducing the cost of the company to a large extent which is due to the profits of the suppliers being absorbed, increases efficiency only producing products required (Just in time process). This is known as a vertical merger and leads to company buying products from the distributors at a lower price. Eliminate competition: Mergers and acquisitions eliminate the competition and increases firms market share. A drawback is that shareholders need to be paid a huge amount of premium to convince the other company to accept the offer. It is very common that the acquiring companys shareholders sell their shares which leads to reducing the price the company pays for the target company. Acquiring new technology: A large company can buy a small company with unique technologies and develop a competitive edge. This is the need of the competitive market. Procurement of production facilities: This is one of the reasons of mergers and acquisitions. Its a backward integration. When the acquiring firm take the decision of merging with a firm that supplies raw material which helps in safe guarding the sources that supply the goods or the primary products. It helps in reducing the transportation cost and economies in purchase of goods. Example: Videocon takes over Thomson picture in China. Market expansion strategy: Mergers and Acquisitions eliminate the competition and protect the existing market. The firm gets a new market to promote its products i.e. existing or obsolete. Example: to increase market in India Lenovo takes over IBM. Financial synergy: It may be the reason for a merger or an acquisition; following are the reasons for a financial synergy: Better credit worthiness : It helps the company to purchase goods on credit, raise capital in the market or obtain bank loan easily. Reduces cost of capital: The cost of capital reduces after mergers because the big firms are safe and they expect lower rate of return on capital. Increase debt capacity: Since a merger result in the rise in earnings and cash flows, this leads to increase in the capacity of the firm to borrow funds i.e. debts. Rising of capital: Better reputation and credit worthiness with the increase in the size of the company helps in raising the capital easily at any time. Taxes: The profitable companies generally buy the companies which are loss making, so that it reduces their tax liabilities. In United States they limit the profitable companies to buy the companies in loss. Example: Ahmedabad cotton mills merged with Arvind mills, Sidapher mills merged with Reliance industry. 2.2. THE EFFECTS OF MOTIVES ON MERGERS AND ACQUISITIONS After studying the various motives of Mergers and Acquisitions, now I further study the effect of the motives on Mergers and Acquisitions, i.e. the post-Merger and Acquisition. According to Burner (2002), there are four approaches (i.e. accounting studies, event studies, survey of executives and clinical studies) to measure post MA performance. Accounting and event studies are quantitative approaches and survey of executives and clinical studies are qualitative approaches. 2.2.1. EMPERICAL EVIDENCE BASED ON ACCOUNTING STUDIES Accounting studies is one of the methods used to examine the changes in the financial performance of the companies before and after a merger or an acquisition. More specifically, the changes of net income, profit margin, growth rates, return on equity (ROE), and return on asset (ROA) and liquidity of the firm are the focus of accounting studies (Bruner 2002; Pilloff, 1996). Dickerson et al. (1997) are the first researchers to study the relationship between MA and the profitability for the UK firms (1948-1977).According to their findings there is no evidence available to prove that MA brought any benefits to the financial performance of firms based on the measurement of profitability. Conversely the growth rate and the profitability was lower after the MA than before MA.Also, after controlling some uncertain factors that might affect profitability, Dickerson et al.(1997) found that MA had a negative effect on the acquirers profitability by measuring return on assets (ROA) in both the short term and long term period. This is consistent with Meeks (1977), whose studies indicated that the ROA for firms decreased after MA in the UK.However Dickerson et al did not investigate the nature of the acquired firm i.e. whether it is horizontal, vertical or conglomerate. Firth (1980), after studying the various other researchers results, concluded that based on accou nting studies, generally speaking, acquired companies dont have great profitability and have low stock market ratings before MA, but obtain a great deal of profit after engaging in MA.In contrast, acquiring companies generally have average or above average profitability prior to MA, whereas they suffer a reduction in profitability after MA. Ghosh (1997) is the first researcher to examine the correlation between post-merger operating cash flow and the method of payment used in MA for the acquiring company for 315 mergers over the period from 1985 to 1995.His research showed that the acquiring firm paid with cash and then it was compared with the company in the same industry, the cash flow increased significantly with an improved asset turnover after the MA. 2.2.2. EMPERICAL EVIDENCE BASED ON EVENT STUDIES: According to Bodie, et al. (2005, p381), an event study Describes a technique of empirical financial research that enables an observer to assess the impact of a particular event on a firms stock price. For example study of share and dividend changes. The standard event study includes the use of Sharpes (1963) market model and capital asset pricing model (CAPM) (Dimson Marsh, 1986).Based on event studies , Firth (1980) studied 496 targets and 434 acquirers in the during the period from 1969-1975and the result stated a conflict in terms of shareholders returns to acquiring firms. He found that in the UK after the takeover the share price and the profitability of an acquiring firm declines.Langeteig (1978) used a three factor performance index to measure long term stockholders gains from MA.He concluded that post-merger the excess returns were insignificantly different from zero and provided no support for mergers. The acquired and the bidder had an average excess return of 12.9% and 6. 11% respectively. 2.2.3. EMPERICAL EVIDENCE BASED ON CLINICAL STUDIES: It provides a blueprint for comparing the discounted value of cash flows and divestiture to the pre-acquisition value. They originate from anthropology, sociology and clinical methods in the 1920s.It is also called a case study, which is an in- depth study by one person through field interviews with executives and knowledgeable observers and is a form of quantitative descriptive research (Bruner, 2002). 2.2.4. EMPERICAL EVIDENCE BASED ON SURVEYS OF EXECUTIVES STUDIES: The surveys of executives in the form of a questionnaire, asking questions regarding motives of MA or whether they are beneficial for shareholders or not. The post-merger performance can be inferred from the questionnaire (Bruner, 2002).As in CFERF( Canadian financial executive research foundation) executive research report, Finance executives have shown in this study that organizations can improve their chances of successfully merging firms by incorporating people related risks into the evaluation, due diligence and deal structuring phases of MA activity. In Ingham et al. (1992), where they surveyed 146 of UKs top 500 companies during the period from 1984-1988 on the basis of a questionnaire. However in case of the profitability of acquiring firms, whether it increased or not post MA, they found different results. From the short term point (0-3years), 77% of the managers claimed that short term profitability increased whereas long term i.e. over 3 years, 68% said the profitability i ncreased. There is one problem in this survey, which is that it considers only private companies other than the other financing companies. TABLE 1. COMPARISON AMONG EACH RESEARCH REPORT STRENGTHS WEAKNESSES EVENT STUDIES It is a direct forward looking measure creating value for investors, where the expected future cash flow is the present stock price. There are various assumptions made regarding the functioning of the market, rationality, absence of restriction on arbitrage which is not unreasonable for most of the stocks on an average over time as a result of the researches. Some companies are vulnerable to specific events, researchers and large numbers of people deal with this problem. ACCOUNTING STUDIES It is the certified and audited accounts which are used by investors as an indirect measure of economic value creation. Different reporting practices. Different time period Principles and regulations different for different companies. In case of historic cost approach, inflation and deflation is a sensitive issue. Inadequate disclosure of the accounts by the companies. Different accounting practices in different countries. SURVEY OF MANAGERS It gives an insight of the success of the acquisition that may not be known in the stock market. Includes the study of managers whose area of interest is not focused on the creation of economic value. Historical results are not good predictors Participation is very low i.e. 2-10% which makes them vulnerable to criticisms. CASE STUDIES Inductive research to examine new patterns and behaviour by restructuring an actual experience. The research reports can be difficult to abstract large implications from numerous reports where hypothesis testing limits the researches ability to increase the size of the research Source: Does M A Pay? A survey of evidence for the decision maker (Bruner, 2002, p.16). CHAPTER 3: RESEARCH METHODOLOGY 3.1. OVERVIEW OF AN ACCOUNTING STUDY RESEARCH METHODOLOGY A company taking over other company will need to evaluate the company to determine whether it is beneficial or not. The main idea is to find the worth of the company; both the companies will have different ideas to evaluate the merger. Naturally, the seller would value the company at the highest price as possible, whereas the buyer will value it at the lowest price possible. The companys operations need to be valued by taking some of the accounting procedures into account; it also helps in knowing the impact of mergers and acquisitions on the cost, revenues, profits etc. of both the companies. Firstly, I will consider the companys financial statements, balance sheet, profit and loss accounts and the content in the annual reports. Using this data I will calculate the financial ratios i.e. profitability ratios (net profit margin, gross profit margin, return on asset and return on equity), liquidity ratios (current ratio and liquid ratio) and activity ratios (total asset turnover and inventory turnover).These financial ratios help in analysing the companys performance and various other factors indicating the progress. There are many appropriate ways to value the company, it can be by either comparing two companies in the same industry or there are some more ways of valuing the companies which are discussed as follows: 1. Profitability Ratios: It is to measure the overall performance of the company; the success of a company and the goal is to obtain sufficient profit in the end. It is used for the analysis of the trend, the operating profitability and efficiency is observed by the gross profit margin ratio and also the return on assets and equity analyses the managers efficiency in manufacturing and purchasing costs, it also reflects the perspective of the shareholders. It also helps in knowing the return on sales using the figures of net profit margin, this is used for two companies in the same industry in different years, also tells the profit earned in respect to the sales. 2. Liquidity Ratios: It consists of current ratio and liquidity ratio. These ratios measure the liquidity of the firm i.e. how they meet their creditors demands. Liquidity arises when the cash inflow is not the same as cash outflow. Example: If cash inflow from sale is unequal to the cash paid to the employees or suppliers etc. then the problem of liquidity arises. Also, in calculation of quick ratio, inventory is not included as it is the least liquid current asset. 3. Activity Ratios: It measures the efficiency of the company to use the assets. Total asset turnover ratio helps understanding how efficiently different companies use its assets whether in the same industry or taking into account two different years. The inventory turnover ratio tells how efficient the working capital management is as it indicates both liquidity and operational efficiency. Secondly, since the absolute ratios dont have any meanings the major point is to observe the changes in the ratio from one country to another or comparisons among various companies. Lastly, the profitability of the company is affected by various factors like firm-specific, industry-specific and economic-wide factors. The profitability change of the acquiring company and the benchmark group i.e. the post-merger and long term data is available to the acquirers as the target companies are de-listed after the MA (Sudarsanam, 1995). In the dissertation, I take the benchmark groups as the top two competitors of the company. It involves calculating the financial ratios and analysing them, this is one of the easiest tools to compare two companies, also during the observation period the benchmark group is not acquired or made large. Formulas of key financial ratios Key growth rates Turnover Changes in turnover Net profit Profitability ratios Net profit margin= net profit after tax/sales Gross profit margin = gross profit /sales Return on Asset (ROA) = net profit before interest /sales Return on equity (ROE) = net profit after tax/equity Liquidity ratios Current ratio = current assets/current liabilities Quick ratio = (current assets-inventories)/current liabilities Activity ratios Total asset turnover = sales / total assets Inventory turnover = cost of sales / inventories SOURCE OF DATA: The data i.e. the financial reports of the companies including the balance sheet, profit and loss account and the cash flow statement is compiled from the reports available online on the companys website. These statements are used to know the financial performance of the company before and after a merger or an acquisition. LIMITATIONS OF THE STUDY: Since the data is collected from the secondary sources i.e. the financial reports of the companies so it is possible that they are bias because of the accounting techniques. Also, there can be some limitations related to the some aspects of financial reports not being analysed properly despite of studying and analysing all the key ratios. The results of other studies like clinical study, survey study, event study when compared to the accounting studies results have different conclusions about the effect of MA.For example: while studying a clinical study, one of the factors that could affect the changes in production and performance can be organizations managerial and mechanism practices (kalpan, et al., 1997) which is not a factor that is examined in accounting studies. CHAPTER 4 CASE STUDY ANALYSIS 4.1. Overview of ATT acquisition of BellSouth Corporation BellSouth was acquired by ATT on 29th December 2006 with an aim to control more than half of the telephone and the internet services in the U.S.It was approved by Federal Communications System (FCC), and was worth $ 86 billion approximately (or 1.325 shares of ATT for each share of BellSouth on the close of trading date).This resulted in ATT being the nations largest provider of business voice, data /internet and wireless services. Thus, it leads to own both yellowpages.com and Cingular wireless, leading to the expansion of the telephone and the data network all over the country covering 22 states. 4.1.3. The motives of ATT acquisition of BellSouth ATT provides smartphones, next-generation TV services and also sophisticated solutions for multi-national businesses. It aims at providing innovative, reliable, high quality products and services prioritising the customers satisfaction and bringing them together even if they are at different parts of the world. It achieves its aim by using innovative ideas in the communications and entertainment industry. It fulfils the growth motive as it lead to providing the nations fastest mobile broadband network, providing large coverage for U.S. wireless carrier and also the largest Wi-Fi network in United States.Also,its the only 100 per cent IP-based national U.S. television service provider. It has a three-screen strategy that provides services across the mobile device, TV and the PC.More than 1200 ATT real yellow pages are published and distributed annually. It also fulfils the motive of diversification as it was ranked No.4 on the DiversityInc top 50 lists in 2011 for its diversity and inclusion initiatives and it was also ranked as no.2 for suppliers diversity in the same year. It is also No.1 among 75 American companies which were awarded for exceptional learning and development programs. It was also awarded various awards for recognising women talents in different fields. Also, was recognised for its exemplary achievements as the corporation of the year including Asian, Black, Hispanic and native American-owned provider in its supply chain. It was also awarded for its emphasis in managing its technology. 4.1.4. Consequences of ATT acquisition of BellSouth: Financial Performance Figure 1: Key figures and ratios of BellSouth from 2004-2005 (in $ millions) 2004 2005 Sales 20,300 20,547 PBIT 5,289 4,670 Changes in sale 247 PAT 4,758 3,294 Gross Profit 12,780 12,480 Equity 23,066 23,534 Total Asset 59,339 56,553 Retained Earnings 19,267 20,383 Gross profit Margin 0.629 0.607 ROE 0.206 0.1399 ROA 0.0873 0.07607 Total asset turnover 0.342 0.363 Current Asset 5,613 4,209 Current Liability 10,370 11,286 Current Ratio 0.54 0.37 Analysis: The key indicators of the growth rate are sales, net profit and the changes in the turnover. As in the figure 1 the sales increase from the year 2004 to 2005 by $247 million but there is a decrease in the profits of the company where profit before interest and tax and profit after tax both decrease by $619 million and $1465 million respectively. The profitability can be studied by looking at the gross profit margin, ROE (Return on equity) and ROA (Return on asset), all the figures are decreasing from the year 2004 to 2005, thus showing that the company suffers losses. This ratio indicates the effect of changes in sales, equity and assets on the gross profit, PBIT and PAT respectively. According to Walton Aerts (2006), the margin ratios are used to study the trend analysis and to do comparisons among companies and also helps in studying the operating profitability and efficiency. Hence the figure shows inefficient operating profitability and efficiency. The liquidity ratio i.e. the current ratio studies how a company meets its creditors demands. There is a decrease in the current ratio from 0.54 to 0.37 .the ideal current ratio is 2:1, thus by a decrease in this ratio we observe that the company is unable to meet its short term debt i.e. the demand of the creditors which is due to the decrease in the current asset and an increase in the current liability from the year 2004 to 2005. The activity ratio which is the total asset turnover ratio is increasing from 0.342 to 0.363, thus showing that the companys assets are used efficiently by the management. To summarize, BellSouth didnt perform good financially before the merger. Figure 2: Key figures and ratios of ATT from 2004-2007 (in $ millions) 2004 2005 2006 2007 Sales 40,733 43,764 63,055 1,18,928 PAT 5,887 4,786 7,356 11,951 PBIT 5,901 6,168 10,288 20,404 Changes in sale (1,101) 2,570 55,273 Gross Profit 23,372 24,755 35,706 72,873 Equity 40,504 54,690 1,15,540 1,15,367 Total Asset 1,10,265 1,45,632 2,70,634 2,75,644 Retained Earnings 28,806 29,106 30,375 33,297 Gross profit Margin 0.57 0.565 0.566 0.613 ROE 0.145 0.087 0.206 0.103 ROA 0.0535 0.0423 0.038 0.074 Total asset turnover 0.369 0.301 0.233 0.431 Current Asset 9,962 14,654 25,553 24,686 Current Liability 20,355 25,418 40,482 39,274 Current Ratio 0.4894 0.577 0.631 0.629 Quick Ratio 0.613 0.60 Inventory 756 1,119 Analysis: The key indicators of growth rate are sales, change in inventory and the net profit. Looking at the figure 2, it can be seen that sales increase steadily from 2004 to 2005 which is a remarkable increase from 2005 to 2006 i.e. after the acquisition and then leading to a major increase of 87.66% .Also the profit and the changes in inventory increase remarkably indicating that it was beneficial for the firm to acquire BellSouth. The gross profit margin, ROE and ROA figures from the above table indicate that the increasing trend of the gross profit margin shows an improvement in the operating efficiency over the years. The ROE tells the benefit to the shareholders it had an increasing trend from 2004 to 2005 with a great hike in the year 2006,but further lead to a decrease in 2007 from 0.206 to 0.103 ,thus showing a slight decrease in the profitability. The ROA shows a significant increase over the years thus showing that the company managed its assets quite well. The liquidity ratio, the current ratio and the quick ratio measures the companys ability to meet its creditors demands. The figures in the above table indicate that the company is able to meet its creditors demands sufficiently with an increase in it over the years. The activity ratio, i.e. the total asset turnover ratio indicates how well the assets are managed, thus the figures indicate a good management of assets over the year 2004 to 2007. Thus, the figure 1 and figure 2 show an improvement in the profitability, efficiency and managing skills of the companies over the years. 4.1.5. Comparison of ATT with its competitor post acquisition: Verizon Verizon Communications Inc., known as Verizon provides a global broadband and telecommunication service. It originated in 1983 as Bell Atlantic in New York City. In 2000, after acquiring the independent phone company GTE it continued to run by the name of Verizon. It is one of the top competitors to ATT in the telecommunication industry. Figure 3a. Key growth of Verizon from 2006-2009 Year Turnover ($ million) Net Profit ($ million) Gross Profit PBIT 2006 88,182 6,197 52,873 8,154 2007 93,469 10,358 55,922 14,545 2008 97,354 12,583 58,347 15,914 2009 1,07,808 10,358 63,509 11,568 Source: Compiled from Verizons annual reports from 2006-2009 Figure 3b. Key growth of ATT from 2006-2009 Year Turnover ($ million) Net Profit ($ million) Gross Profit PBIT 2006 63,055 7,356 72,873 10,288 2007 1,18,928 11,951 72,127 20,404 2008 1,24,028 12,867 74,472 23,063 2009 1,23,018 12,535 72,613 21,492 Source: Compiled from ATTs annual reports from 2006-2009 The data of the key growth of Verizon (Fig.3a) shows an increasing turnover from the year 2006 to 2009 from $88,182 million to $1,07,808million.In the case of ATT (Fig.3b) shows that the key indicator of growth the turnover of the company is steadily increasing from the year 2006 to 2008 with an insignificant fall in the year from $1,24,028 million in 2008 to $12,30,18 million in 2009.Both the companies show a consistent increase in the revenue over the years where the revenue growth of Verizon is 22.25% and of ATT is 95.096 % respectively. Thus, ATT has better growth rate over the six years; hence it achieves the revenue synergy. With regard to the net profit , both Verizon and ATT have increasing net profits over the four years, where the net profit of both the companies decrease insignificantly in the year 2009 from 2008 ,with ATT having more profit than Verizon. Therefore, ATT maintains a steady net profit over the years. Figure 4a.Profitability Ratios of Verizon from 2006-2009 Year Net profit Margin Gross profit margin Total Assets Equity ROA ROE 2006 0.070 0.599 1,88,804 48,535 0.043 0.128 2007 0.1108 0.598 1,86,959 50,581 0.288 0.204 2008 0.129 0.599 2,02,352 78,905 0.202 0.159 2009 0.096 0.589 2,27,251 84,367 0.137 0.123 Source: Compiled from Verizon annual reports from 2006-2009 Figure 4b. Profitability Ratios of ATT from 2006-2009 Year Net Profit Margin Gross Profit margin Total Assets Equity ROA ROE 2006 0.116 1.156 2,70,634 1,15,926 0.038 0.0635 2007 0.1005 0.606 2,75,644 1,15,747 0.074 0.1032 2008 0.104 0.600 2,65,245 96,750 0.087 0.1329 2009 0.102 0.590 2,68,752 1,02,325 0.079 0.1225 Source: Compiled from ATT annual reports from 2006-2009 Comparing the net profit margin and the gross profit margin of the two companies over the four years, the average net profit margin of Verizon and ATT is 0.101 and 0.106 respectively and the average gross profit margin is 0.596 and 0.738 respectively. Thus showing that companies make profits on the total assets and shareholders equity possessed. Thus, ATT has a better market strategy than Verizon. At the same time the ROA and the ROE of the two companies were positive with an increasing trend. Though the average ROA is 0.167 and 0.0695 respectively showing the return on asset of ATT is not as good as that of Verizon. The financial position of ATT Company has a positive indication but the financial status after the acquisition is poor as that of the competitor company. Figure 5a.Liquidity Ratios of Verizon from 2006-2009 Year Current asset Current liability Inventories Current Ratio Quick Ratio 2006 22,538 32,280 1,514 0.698 0.65 2007 18,698 24,741 1,729 0.756 0.686 2008 26,075 25,906 2,092 1.007 0.926 2009 22,608 29,136 2,289 0.776 0.697 Source: compiled from Annual reports of Verizon from 2006-2009 Figure 5b. Liquidity Ratios of ATT from 2006-2009 Year Current asset Current liability Inventories Current ratio Quick ratio 2006 2,553 40,482 756 0.063 0.044 2007 24,686 39,274 1,119 0.629 0.601 2008 22,556 42,290 862 0.533 0.513 2009 24,334 36,705 885 0.663 0.639 Source: compiled from Annual reports of ATT from 2006-2009 From the prospective of the Liquidity, the current ratio and the quick ratio followed an increasing trend for both Verizon and ATT from 2006-2009 , where the average current ratio of the respective companies is 0.81 and 0.472 respectively and the average quick ratio being 0.74 and 0.45 respectively. From the year 2006-2009, the current assets of Verizon is the almost the same of the year 2006 and 2009, whereas the current liability has decreased. In case of ATT, his current assets increased majorly in 2007 leading to a steady increase till the year 2009 whereas the current liabilities have decreased by 9.33% over the four years. As the average ratios of Verizon are better than that of ATT, the short term liquidity of the company was worse than its competitor after the acquisition. Figure 6a.Activity Ratios of Verizon from 2006-2009 Year Total Asset Turnover 2006 0.467 2007 0.499 2008 0.481 2009 0.474 Figure 6b. Activity Ratios of ATT from 2006-2009 Year Total Asset Turnover 2006 0.233 2007 0.431 2008 0.367 2009 0.401 From the above figures 6a and 6b, it is observed that the total asset turnover ratio of both the companies Verizon and ATT are steadily increasing with an average total asset turnover to be 0.48 and 0.35 respectively.However the average of ATT was lower than that of Verizon thus proving that ATT did not utilize its total assets efficiently after the acquisition. Summary According to the Verizons annual report, there is a good operating and financial discipline seen in the business, with maximising the cash flow and the return to the shareowners. Also, by the end of this year there is an extraordinary growth seen by introducing video sharing, conferencing and 4G connections. According to the ATT annual report, the company did improve increasing the efficiencies over the board, adjusting cost structure, increasing cash flow and raising dividends as compared to the last year. By comparing the various financial performance indicators of ATT with its competitor Verizon, it has been concluded that ATT did not show a commendable performance after the acquisition. It has a consistent revenue growth, net profit margin and gross profit margin, but it underperformed its competitor in ROE, ROA, liquidity ratios and total asset turnover. Thus proving the results of Dickerson et al. (1997), Meeks (1977), Firth (1980) and Caves (1989) to be consistent as in the empirical literature review claiming that the profitability of the acquiring company is lower after the MA than before the MA. 4.2. T-MOBILE AND ORANGE MOBILE MEGER AN OVERVIEW In December 2009, Consumer Focus and the Communications Consumer Panel had sent a joint letter to the Competition Commissioner, Neelie Kroes asking for the merger by the authorities in the UK.On 1st March 2010, the European Commission approved the merger with a condition that the combined company sells the 25% of the spectrum it owns on the 1800 MHz radio band and amend a network sharing agreement with smaller rival. In 2010, Deutsche Telekoms T mobile and Orange mobile combined together by becoming a part of the joint venture with France Telecoms UK mobile network provider. They merged under the new parent company called Everything Elsewhere on 11th may 2010, which was announced on the British High Streets. Despite the merger they continued to co-exist in the UK market. This took place on the 1st April 2010.On 8th September 2009 the BBC news stated that It would be UKs largest provider overtaking the Telefonicas O2, with about 37% of the mobile market. According to the financial times The mobile phone operator formed by the merger of Orange and T-Mobile two years ago has been forced to sell the spectrum by European competition authorities. It covers around 30million customers, i.e. more than half of the UKs adult population. The CEO of the company Tom Alexander said that This is the first major consumer benefit of the merger between Orange and T-Mobile, and it delivers an unrivalled and unique experience that no other operator can offer. 4.2.3. The motives of T-Mobile and Orange Mobile merger The main aim behind the merger was to create the countrys largest mobile phone operator covering 37% of the market, leapfrogging rivals Vodafone and O2.This deal lead to unemployment as the two companies rationalised their networks. Also, it helped in cost saving by closing down the high street retail stores worth 3.5bn. France Telecoms chief financial officer Gervais Pellissier said the deal would on the one hand fundamentally change our respective positions in the UK and on the other hand bring substantial benefits to consumers in the UK. His opposite number at Deutsche Telekom, Timotheus Httges, added that the merger was the first step towards creating the new mobile champion in the UK. On August 21, 2012, according to the financial times, 4G mobile broadband will reach Britain the next month and also the company aims at providing 4G mobile and phones broadband devices in UK by the next year The deal helped the T-Mobile to be at par with its competitors and helps Orange to improve its margins by pooling its wireless assets with T-Mobile. Prior to