Mergers & Acquisitions (M&A) are often an answer to broader problems during case interviews
Merger & Acquisition cases are best practiced using mock interviews
Many growth strategy case studies eventually lead to M&A questions. For instance, companies with excess funds, searching for ways to grow quickly might be interested in acquiring upstream or downstream suppliers (vertical integration), direct competitors (horizontal integration), complementary businesses or even unrelated businesses to diversify their portfolio. The most important requirement for an M&A is that it must increase the shareholders' value and it must have a cultural fit even when the decision financially makes sense.
Analogous to making a purchase at a grocery store, M&A can be viewed as a "buying decision". In general, we know that a consumer first determines the "need" to buy a product followed by analyzing whether he or she can afford the product. After analyzing the first 2 critical factors, the consumer might look at long/short term benefits of the product. Applying similar logic in M&A cases:
- Why does the company want to acquire ?
- How much is the target company asking for its purchase price & is it fair (see cost-benefit analysis)? Can the acquiring company afford to pay the valuation? Financial valuation will generally include industry & company analysis.
- Benefits - potential synergies.
- Feasibility and risks (cultural and economical).
Key areas to analyze: assets, target, industry, and feasibility
When you are sure that it is an M&A case, proceed with the following analyses after structuring the case as discussed above:
Analyze the client’s company
- Why does the client want to acquire? Potential reasons could be the following:
- (a) Strategic (market position, growth opportunities, diversification of product portfolio)
- (b) Defensive (acquisition by another competitor could make the competitor unconquerable)
- (c) Synergies/value creation (cost saving opportunities such as economies of scale, cross-selling, brand)
- (d) Undervalued (ineffective management, unfavorable market, and the client has the power to bring the target company to its potential value)
- In which industry does the client operate?
- Which other businesses does the client possess? Lookout for synergies?
- What are the client’s key customer segments?
Analyze the target industry
Once it's clear why the client is interested in acquiring a particular company, start by looking at the industry the client wants to buy. This analysis is crucial since the outlook of the industry might overshadow the target's ability to play in it. For instance, small/unprofitable targets in a growing market can be attractive in the same way as great targets can be unattractive in a dying market.
Potential questions to assess are:
- Can the market be segmented and does the target only play in one of the segments of the market?
- How big is the market?
- What are the market’s growth figures?
- What is the focus? Is it a high volume/low margin or a low volume/high margin market?
- Are there barriers to entry?
- Who are the key competitors in the market?
- How profitable are the competitors?
- What are possible threats?
Use Porter's Five Forces as a suitable framework here. You should use it without ever mentioning Porter's name.
Analyze the target company
After analyzing the target industry, understand the target company. Try to determine its strengths and weaknesses (see SWOT analysis) and perform a financial valuation to determine the attractiveness of the potential target. You are technically calculating the NPV of the company but this calculation likely is not going to be asked in the case interview. However, having the knowledge of when it is used (e.g., financial valuation) is crucial. Analyze the following information to determine the market attractiveness:
- The company’s market share
- The company’s growth figures as compared to that of competitors
- The company’s profitability as compared to that of competitors
- How can current businesses from the client leverage revenues and profitability from the business to be acquired (keyword synergies)?
- Does the company possess any relevant patents or other useful intangibles (see Google purchasing Motorola)?
- Which parts of the company to be acquired can benefit from synergies?
- The company’s key customers
Analyze the feasibility of the M&A
Finally, make sure to investigate the feasibility of the acquisition.
Important questions here are:
- Is the target open for an acquisition or merger in the first place? If not, can the competition acquire it?
- Are there enough funds available (have a look at the balance sheet or cashflow statement)? Is there a chance of raising funds in the case of insufficient funds through loans etc.
- Is the client experienced in the integration of acquired companies? Could a merger pose organizational/management problems for the client?
- Are there other risks associated with a merger? (For example think of political implications and risks of failure, like with the failed merger of Daimler and Chrysler.)
You should now be able to evaluate the venture’s financial and qualitative attractiveness for the client. If you conclude that the client should go on with the M&A, make sure to structure your conclusions in the end. Your suggestions should also include:
- potential upsides of the merger
- potential risks and how are we planning to overcome/mitigate them
Keen on cracking an M&A case now? Have a look at Chip equity or General holding
What is Mergers & Acquisitions?
Mergers and acquisitions (M&A) are defined as consolidation of companies. Differentiating the two terms, Mergers is the combination of two companies to form one, while Acquisitions is one company taken over by the other. M&A is one of the major aspects of corporate finance world. The reasoning behind M&A generally given is that two separate companies together create more value compared to being on an individual stand. With the objective of wealth maximization, companies keep evaluating different opportunities through the route of merger or acquisition.
Mergers & Acquisitions can take place:
• by purchasing assets
• by purchasing common shares
• by exchange of shares for assets
• by exchanging shares for shares
Types of Mergers and Acquisitions:
Merger or amalgamation may take two forms: merger through absorption or merger through consolidation. Mergers can also be classified into three types from an economic perspective depending on the business combinations, whether in the same industry or not, into horizontal ( two firms are in the same industry), vertical (at different production stages or value chain) and conglomerate (unrelated industries). From a legal perspective, there are different types of mergers like short form merger, statutory merger, subsidiary merger and merger of equals.
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Reasons for Mergers and Acquisitions:
• Financial synergy for lower cost of capital
• Improving company’s performance and accelerate growth
• Economies of scale
• Diversification for higher growth products or markets
• To increase market share and positioning giving broader market access
• Strategic realignment and technological change
• Tax considerations
• Under valued target
• Diversification of risk
Principle behind any M&A is 2+2=5
There is always synergy value created by the joining or merger of two companies. The synergy value can be seen either through the Revenues (higher revenues), Expenses (lowering of expenses) or the cost of capital (lowering of overall cost of capital).
Three important considerations should be taken into account:
• The company must be willing to take the risk and vigilantly make investments to benefit fully from the merger as the competitors and the industry take heed quickly
• To reduce and diversify risk, multiple bets must be made, in order to narrow down to the one that will prove fruitful
• The management of the acquiring firm must learn to be resilient, patient and be able to adopt to the change owing to ever-changing business dynamics in the industry
Stages involved in any M&A:
Phase 1: Pre-acquisition review: this would include self assessment of the acquiring company with regards to the need for M&A, ascertain the valuation (undervalued is the key) and chalk out the growth plan through the target.
Phase 2: Search and screen targets: This would include searching for the possible apt takeover candidates. This process is mainly to scan for a good strategic fit for the acquiring company.
Phase 3: Investigate and valuation of the target: Once the appropriate company is shortlisted through primary screening, detailed analysis of the target company has to be done. This is also referred to as due diligence.
Phase 4: Acquire the target through negotiations: Once the target company is selected, the next step is to start negotiations to come to consensus for a negotiated merger or a bear hug. This brings both the companies to agree mutually to the deal for the long term working of the M&A.
Phase 5:Post merger integration: If all the above steps fall in place, there is a formal announcement of the agreement of merger by both the participating companies.
Reasons for the failure of M&A – Analyzed during the stages of M&A:
Poor strategic fit: Wide difference in objectives and strategies of the company
Poorly managed Integration: Integration is often poorly managed without planning and design. This leads to failure of implementation
Incomplete due diligence: Inadequate due diligence can lead to failure of M&A as it is the crux of the entire strategy
Overly optimistic: Too optimistic projections about the target company leads to bad decisions and failure of the M&A
Example: Breakdown in merger discussions between IBM and Sun Microsystems happened due to disagreement over price and other terms.
Recent Mergers and Acquisitions
Mergers and Acquisitions Case Study:
Case Study 1: Sun Pharmaceuticals acquires Ranbaxy:
The deal has been completed: The companies have got the approval of merger from different authorities.
This is a classic example of a share swap deal. As per the deal, Ranbaxy shareholders will get four shares of Sun Pharma for every five shares held by them, leading to 16.4% dilution in the equity capital of Sun Pharma (total equity value is USD3.2bn and the deal size is USD4bn (valuing Ranbaxy at 2.2 times last 12 months sales).
Reason for the acquisition: This is a good acquisition for Sun Pharma as it will help the company to fill in its therapeutic gaps in the US, get better access to emerging markets and also strengthen its presence in the domestic market. Sun Pharma will also become the number one generic company in the dermatology space. (currently in the third position in US) through this merger.
Objectives of the M&A:
• Sun Pharma enters into newer markets by filling in the gaps in the offerings of the company, through the acquired company
• Boosting of products offering of Sun Pharma creating more visibility and market share in the industry
• Turnaround of a distressed business from the perspective of Ranbaxy
This acquisition although will take time to consolidate, it should in due course start showing results through overall growth depicted in Sun Pharma’s top-line and bottom-line reporting.
Case Study 2: CMC merges with TCS:
This is an example where there is a merger in the same industry (horizontal). It was done to consolidate the IT businesses. The objective of this merger, as indicated by the management of CMC, was that the amalgamation will enable TCS to consolidate CMC’s operations into a single company with rationalised structure, enhanced reach, greater financial strength and flexibility. Further it also indicated that, it will aid in achieving economies of scale, more focused operational efforts, standardisation and simplification of business processes and productivity improvements.
M&A’s are considered as important change agents and are a critical component of any business strategy. The known fact is that with businesses evolving, only the most innovative and nimble can survive. That is why, it is an important strategic call for a business to opt for any arrangements of M&A. Once through the process, on a lighter note M&A is like an arranged marriage, partners will take time to understand, mingle, but will end up giving positive results most of the times.
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