企业并购中的财务问题,外文文献

RISK FACTORS OF MERGERS AND ACQUISITIONS

Angelika K?dzierska-Szczepaniak

Gdansk University, Poland.

Abstract

Purpose – The world market economy is currently characterized by the tendency to globalization, which means that companies have to cooperate and tighten their relations. Companies working on the local market do not have many possibilities for development, so mergers and acquisitions (M&A) can be a chance for them to cooperate with companies from all over the world. The main goal of this paper is to present the most important risk factors for M&A transactions. It will be based on some famous mergers and acquisitions made all over the worldWhat are the reason(s) for writing the paper or the aims of the research?

Design/methodology/approach – Some research made in Europe and USA show that many of mergers and acquisitions are destined to fail. The data in this paper is based on research of L.Selen, G.Colvin (2003) and S. Jackson, R. Schuler (2002). There were also similar conclusions on the Polish market in 1998-2002. Almost 40% of the transactions were failure. The paper will be a comparison of some mergers and acquisitions made all over the world. Case studies, synthesis and description will be used in this article. Findings – The result of this analysis, that takes into consideration theoretical and practical solutions, shows the main reasons of M&A failure. They lie in the internal and exterior risk factors. Mergers and Acquisitions are the alternative, shorter and cheaper way of development in comparison with the traditional capital investment. On the other hand, they are time-consuming and characterized of high risk.

Research limitations/implications – This research is based on some world M&A processes case-studies. The main focus is on the risk factors of those transactions.

Practical implications - Conclusions of this paper should me helpful for those companies that are interested in brownfield investment. It shows the main threats both on the local and international market.

Social implications (if applicable) - What will be the impact on society of this research? How will it influence public attitudes? How will it influence (corporate) social responsibility or environmental issues? How could it inform public or industry policy? How might it affect quality of life? Not all papers will have social implications.

Originality/value - This paper shows the most important internal and exterior risk factors. The knowledge about those aspects can be very helpful for companies to avoid mistakes in M&A transactions.

Keywords Mergers, acquisitions, risk factors, consolidation, company value, synergy effects, financial risk, operational risk.

Paper type Viewpoint

Introduction

The world market economy is currently characterized by the tendency towards globalization, which means that companies have to cooperate and tighten their relations. Since the beginning of the 20th century the number of mergers and acquisitions has been increasing rapidly not only in the world economy, but also in the Polish one. The first two years of the 21st century brought a decrease in the dynamism of mergers and acquisitions all over the world. In 2003 the value and volume of those transactions started to grow again. Mergers and acquisitions are an alternative, shorter and cheaper way of development in comparison with the traditional capital investment. On the other hand, they are time-consuming and characterized by high risk. Some researches made in Europe and USA show that many of those transactions do not reach the goals and are destined to fail. American research conducted in 2003 shows that almost 70% of mergers and acquisitions do not reach the main goal which is the growth of the company value (Selen, Colvin, 2003). The analysts of AT Kearney came to a similar conclusion that only about 15% of M&A transactions in the United States achieved financial success (Jackson, Schuler, 2002). We could see similar research results on the Polish merger and acquisitions market in 1998-2002 where over 40% of the transactions were destined to fail (Piecek, 2004).

The main goal of this paper is to present the most important risk factors for M&A transactions. It will be based on some famous mergers and acquisitions made all over the world.

Mergers and Acquisitions – Basic Definitions

Mergers and acquisitions of companies are transactions which cause changes in the stock ownership structure and frequently in the main business strategy.

Mergers and acquisitions are similar corporate actions which combine two previously separate companies into a single legal entity. In some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons. In a merger of two corporations, the shareholders usually have their shares in the old company exchanged for an equal number of shares in the merged entity (Brigham, Houston, 2001).

A merger can resemble a takeover but it results in a new company name (often combining the names of the original companies) and in new branding. A takeover, or acquisition, on the other hand, is characterized by the purchase of a smaller company by a much larger one.

An acquisition can produce the same benefits as a merger, but it does not necessarily have to be a mutual decision. A larger company can initiate a hostile takeover of a smaller firm, which essentially means buying the company in the face of resistance from the smaller company's management (Sudarsanam, 2005).

Unlike in a merger, in an acquisition, the acquiring firm usually offers a cash price per share to the target firm's shareholders or the acquiring firm's shares to the shareholders of the target firm according to a specified conversion ratio. Either way, the buyer essentially finances the purchase of the target company, buying it outright from its shareholders.

Merger involves the mutual decision of two companies to combine and become one entity. In business and economics it is a combination of two companies into one larger company. The activity of those companies is voluntary and unanimous. The partners usually have a similar position on the market (Lewandowski, 1998). The merger can proceed in two different ways. First, both companies that merge are dissolved and quite a new company comes into being. The shareholders of merged firms receive shares of the new company in exchange for the previous one. This kind of merger is called consolidation (unification) (Dobbins, Fr?ckowiak, Witt, 1992). The second type is merger made through acquisition, i.e. incorporation. In this case one of the companies is attached to the other one. The company that is incorporated loses its legal personality and the shares are replaced by the new shares of the attaching company.

The definition shows that in a merger at least one company loses its legal entity, which means that two companies combine and become one larger entity.

The term acquisition (takeover) usually means the act of one company taking control over another company. It can be done by means of buying shares of the company being acquired, privatization, tenancy, joint venture or buying assets of this company (Fr?ckowiak, 1998). As a result, the company that was taken over is a part of the bigger company (e.g. it is a part of a capital group). When it happens the company loses its independence and is controlled by the new owner. On the other hand, the company that was acquired does not lose its entity.

The differences between mergers and acquisitions are often conventional. It is very difficult to clearly distinguish between the two notions and make sure that we are dealing with either of the two. In literature those words are often used interchangeably.

Restrictions and risk in mergers and acquisitions

The major risk in M&A processes results from the fact that they are complex and time-consuming. The effects of a merger or acquisition can be felt for several years. Moreover, mergers and acquisitions are very often connected with very high operating costs which result from the organizational and personal changes, severance pay for dismissed workers, technical and technological changes, training workers, etc. Barriers and the limitations which can appear before, during or after the consolidation process can be divided into internal which have their source in the enterprise itself and external on which the company only has limited influence.

The internal limitations, which include workers’ resistance to changes or gaining funds for transactions, can be eliminated by proper actions undertaken by the management, such as preliminary research about the company’s financial possibilities and informing employees about planned changes.

The realization of M&A process depends especially on such economic factors as the economic situation, GDP, legal and administrative solutions, the level of interest rate as well as non-economic factors such as political tensions. These factors can be rated among external limitations whose elimination or moderation is more difficult and very often impossible.

Since the beginning of the fifth wave of M&A advisory and consulting firms have been conducting research that should characterize risk factors connected with mergers and acquisitions. The main risk groups which according to the respondents’ opinions play the main role in taking decisions about mergers or acquisitions of European companies, are presented in Chart 1. The research was carried out by Goldsmith Agio Helms on the representative sample of American private equity funds.

Main risk aspects in M&A transactions.

Chart l.

The difference in management styles of both companies is one of the most important risk factors in M&A transactions. Such risk concerns primarily the international connections where the mentality and culture of transaction’s participants can be different. The purchase of a biotechnological company Hyberitech by one of the largest pharmaceutical firms - the Eli Lilly in 1986 was an example of an acquisition which failed due to different management styles. There was an informal style of management in Hyberitech as opposed to an authoritarian style applied in Eli Lilly. As a result of misunderstandings, many managers of Hyberitech left their jobs. Eli Lilly sold the Hyberitech for less than 5% price of purchase in 1995 (Hooke, 1997).

The second important risk factor o in this research is due diligence analysis. This results from the fact that due diligence is often limited only to the verification of the financial reports of the acquired company (Cullinan, Roux, Weddigen, 2004). While it is a very important element of the whole assessment of the company, the managers cannot forget about strategic analysis which takes into consideration not only the financial results but also the logic of the planned acquisition and potential profits for the buyer. The example of the transaction which failed as a result of excessively optimistic expectations and inaccuracy in due diligence analysis was the acquisition of Siemens Mobile by BenQ in June 2005. Managers of BenQ wanted to strengthen the market position of the brand. This strategy, however, did not produce the desired effect,

because the acquired company, Siemens Mobile, was in a very difficult financial situation. The transaction proved unsuccessful and the new company BenQ-Siemens announced the bankruptcy of its factories in Europe and changes in company strategy.

The next factor that is crucial for the success of mergers and acquisitions is the legal system in different countries, especially in the field of antimonopolistic legislation. Moreover, particularly in Central and Eastern European (CEE) countries, the state is often a co-owner of the company and has influence on both changes within the company and the changes connected with planned mergers and acquisitions.

According to J. C. Hooke the risk in mergers and acquisitions processes can be divided into three basic groups: operating risk, financial risk and overpaying risk (Hooke, 1997). Operating risk concerns the fact that the new company may not generate the expected results, which will be responsible for low advantages of scale. That can be connected with unsuccessful restructuring, entering new areas of business activity or job resignations on the part of the highly qualified managers of the acquired company. The risk is smaller when the acquiring company broadens its product range or increases the market share only. An example of low operating risk was the merger of Vistula S.A. and Wólczanka S. A. in 2006. Before the merger the two companies did not compete against each other but produced complementary goods, so the merger resulted in a wider range of products.

The financial risk is connected with the method of financing the transaction. Companies usually use borrowed capital in financing. Apart from that, they have to take over the liabilities and debts of the candidate to purchase. Using the loan capital in the transaction can result in better profitability and better financial ratios for shareholders, but on the other hand, the general debt of the company grows, and consequently, the financial costs and the changeability of net profit grow as well. A transaction connected with a high financial risk is exemplified by the acquisition of Brewpole B.V. with the dependent companies (Le?ajsk Ltd, Elbrewery Ltd, Warka Ltd) by the ?ywiec Group S.A.1 Before the connection ?ywiec Group S.A. was characterized by a stable financial situation. Brewpole BV and the dependent companies, on the other hand, were characterized by a high degree of financial leverage and liquidity problems. In 1999, less than twelve months after the acquisition, the financial costs of the whole group increased from PLN 8 million to PLN 120 million, and in 2001 they grew to nearly PLN 200 million (Zywiec Group, 1998-2006). The consistent restructuring activity contributed to the improvement of the financial situation and decrease in the financial risk for the ?ywiec Group.

The risk of overpaying is connected with the price which the acquiring company has to pay to the stockholders of the acquired company. Sometimes the synergy effect and the increase in revenues are estimated too optimistically by the buyer. The estimation of synergy effects before the completion of the transaction is very difficult or sometimes even impossible. When the bonus is too high, the costs may exceed the advantages resulting from the transaction and lead to a failure.

The management of acquiring companies tend to forget that the cost of a transaction is not only the real price paid to the shareholders of the acquired company, but also many other costs connected with the transaction. High bonuses for the control are not common on the Polish capital market due to its lower competitiveness. On the Warsaw Stock Exchange several companies seldom compete to acquire the same enterprise. One of the most interesting examples of a “fight” on the Warsaw Stock Exchange were the attempts to acquire Polfa Kutno S. A. by an Italian concern Recordati and American Ivax Corporation in 2004. When Italian Recordati noticed the call of Polfa Kutno S.A. shares, the managers of Ivax Corporation raised their offer by about 10%. The price of Polfa Kutno shares grew by over 40% when both firms tried to buy it. Finally, the company was acquired by Ivax Corporation and replaced on the Stock Exchange by the buyer.

It also happens that the bonus for control does not exist. Such a situation takes place when the buyer already has the majority of shares in the acquired company.

Failure may also have its roots in the motives themselves. N. Rodriguez lists three basic doubtful premises of M&A processes:(Rodriguez, 2005):

?building of empire;

?aspirations for short-term enlargement of profits;

?incorrect conception of diversification - building the conglomerates.

1Called Browary ?ywiec S.A. till 2004, later it became ?ywiec Group S.A.

The first cause is connected with lack of suitable preparation and analysis prior to the completion of the transaction. This happens when ambitious enterprise owners purchase another enterprise with no strategic reason. One example of this solution is Vivendi Universal which started acquiring various companies (including MP3 or Vizzavi) in December 2001 . Thanks to those acquisitions, it became the second media concern in the world. The debts of the company exceeded €25 billion at the end of 2003. In order to save the company from bankruptcy a decision was made at the beginning of 2004 to sell up parts of the newly purchased enterprises .

Another example is the merger of Daimler - Benz AG (Germanys) and Chrysler Corporation (USA) in 1998 resulting in a new connected company: DaimlerChrysler AG. The new corporation was supposed to become a global motor concern. However, a number of acquisitions proved to be misconceived and economically groundless. In 2004 the market value of the whole company was over half lower than the accumulated value of both companies before the merger. As a result, after a few years’ experience, a decision was made to divide the company again (Brors, Freitag, Student, 2007).

The second doubtful premise is the pressure on the part of the stockholders who are interested in quick return on the invested capital. If the motivational system for managers is misconstructed, they can make decisions which will prove unfavourable for the company in the long term while at the same time generating short-term profits and consequently bonuses for the management.

The third inappropriate reason for mergers and acquisitions which can contribute to their failure is the acceleration of growth and the diversification of risk at all costs. Entering new areas of activity can cause clear damages for the company’s brand, which is exemplified by the acquisitions made by Walt Disney Company (McMurdy, 1995). As a result of those acquisitions a diversified entertainment oligopoly was created, which led to a decrease in brand loyalty and in profitability. It was only the connection with Pixar, a smaller company from the same sector, which improved the image of the whole company.

Summary

The barriers of mergers and acquisitions processes characterized above are significant for the success of the whole transaction. It is important to recognize and attempt to eliminate or reduce them before the completion of the project. Once it is done, there is a chance that, in spite of many obstacles, the transaction will prove successful.

In some cases, however, contrary to expectations and despite eliminating internal barriers, a merger or acquisition proves to be unsuccessful. The reasons for failure stem from the fact the this kind of transaction is unique and takes place in several stages. A takeover of another company is a very complicated process where the potential investor has no possibility of foreseeing all possible threats. To a large extent, the risk of failure results from the process of companies’ connection (Jemison, Sitkin, 1986).

An analysis of barriers shows that there are various causes of failures which can be either rational or random resulting from unfavourable changes in the surroundings. Mistakes are frequently made and dangers disregarded already in the preparation phase. It manifests itself in a superficial analysis of the acquired company, overestimation of the expected synergy effects or overestimation of the share price of the acquired company (Zarz?dzanie na ?wiecie, 1998).

The knowledge which factors are crucial for the successful transaction is an important element of a successful merger or acquisition.

The basis of a successful undertaking is its thorough preparation as well as careful consideration of the following factors: the time of transaction, the method of connection, obtaining funds, integration of companies, etc. (Lewandowski, 1998).

Even though success factors have been identified, many mergers and acquisitions still fail. However, it does not always mean that the transaction was conducted incorrectly. The reasons for failure could be purely coincidental.

It should be remembered that one of the crucial factors contributing to the successful transaction is incorporating the transaction in the company’s strategy and implementing it consistently. However, the safest transaction which is most likely to succeed seems to be a small one made by a strong company within its own sector in order to make a full use of the synergy effect.

References

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Dobbins, R., Fr?ckowiak, W., Witt, S.F.(1992), Praktyczne zarz?dzanie kapita?ami firmy, Wydawnictwo Paanpol, Poznań

Fr?ckowiak, W. (1998), Fuzje i przej?cia przedsi?biorstw, Wydawnictwo PWE, Warszawa.

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Biographic notes:

Angelika K?dzierska-Szczepaniak is a lecturer at Gdansk University, Faculty of Management, Finance Department since 2002; Ph.D. in economics science in January 2008, Ph.D. dissertation title: Financial Aspects of Mergers and Acquisitions of companies quoted on the Warsaw Stock Exchange; Dean’s Representative for European Programmes since 2008.