Mergers and Acquisition
Few problems of economic theory and practice cause stronger dispute than problems of mergers and acquisitions. Completely opposite points of view on the appropriateness and effectiveness of such restructurings face within the dispute: some consider mergers as an important source of increasing effectiveness of the company, while others consider mergers as a reflection of the power instincts of managers, whose desire reduces the efficiency of the company.
But no matter what opinions do not exist, mergers and acquisitions are an objective reality, which should be investigated, analyzed and conclusions should be made to avoid repeating mistakes, which have been already completed.
A merger is any association of business entities, which produces a single economic unit of two or more pre-existing structures.
An acquisition can be defined as taking control by one company over another, operation with the purchase of an absolute or partial ownership. An acquisition often can be accomplished by buying up all the shares on a stock exchange. From the legal point of view, there are a number of ways of mergers and acquisition (Tobler 2007, p. 15).
August 28, 2008, Hewlett-Packard has bought 100% of the shares of one of the largest providers of IT services in the world - the U.S. company Electronic Data Systems (EDS). Due to the acquisition of EDS, Hewlett-Packard was able to compete with the world leader of IT services – IBM. The transaction value of $ 13.9 billion showed the largest value of acquisition in the provision of IT services and the second largest in the technology industry after the merger of HP with Compaq in 2002. Total income of both companies has exceeded 38 billion dollars, and the total staff of service units is 210 thousand people in more than 80 countries.
With acquisition of EDS Hewlett-Packard got plenty of competitive advantage. However common basic theories of mergers and acquisitions as the motives of the two companies within this transaction should be considered.
Basic theories of mergers and acquisitions and motives of deal between HP and EDS
Since the late 1980s, theory of pride of hubris theory of Richard Rolle has widely been known, whereby acquisitions often can be explained by the actions of buyers, who are convinced that their actions are right, and the foresight is flawless. As a result, they are paying too high price for achieving their goals (Tobler 2007, p. 22).
The theory of agency costs focuses on the conflict of interests of owners and managers that exists, of course, not only during mergers and acquisitions. The presence of self-interests can produce special management motives of mergers and acquisitions without economic feasibility, against the interests of owners (Baker, Pan & Wurgler 2009, p. 11).
The theory and practice of modern corporate management puts a lot of reasons to explain the merger of HP and EDS. Identifying the motives of mergers is important because they reflect the reasons, for which the both companies together are more expensive than in isolation. A rise of the capitalized value of the combined company and new competitive advantages are the first goals of most mergers and acquisitions (Motis 2007, p.41). There are the following motives for acquisition of HP and EDS:
Gettingsynergy. The main reason for the restructuring of companies in the form of mergers and acquisitions is the effort to gain and strengthen synergetic effect, which is complementary action of the assets of the both companies, the combined effect of which is much greater than the sum of the results of individual actions of these companies. Synergistic effect in general can be due to (Roundy 2009, p. 31):
- the economy of scale;
- the combination of complementary resources (each company has what the other company needs, so their merger may be effective);
- financial savings by reducing transaction costs;
- increased market power due to the reduced competition (monopoly motive - the desire to achieve or enhance its monopoly position. It was the earning the competitive advantages in relation to the IBM);
- complementarity in the sphere of technology.
Improving the quality of governance and elimination of inefficiencies. This merger aimed to achieve the differentiated efficiency, which means that management of the assets of one company was ineffective and after merger the assets of the corporation will be managed more effectively (Weitzel & McCarthy 2009, p. 24).
We can always find the companies, in which the possibility of reducing costs and increasing sales and profits are not fully used, the company, which are suffering from lack of talent or motivation of managers, companies with inefficient management personnel. Such companies are natural candidates to be acquired by firms with more efficient systems of management. In some cases, the "better management" can mean just a painful personnel reduction or reorganization of the company.
Practice proves that the companies with low economic performance tend to be objects of acquisitions. Studies show that in the acquired companies, the actual rate of income was relatively low for several years before their acquisition (DeChesare 2009, p.4).
In some situations, mergers and acquisitions are the most simple and efficient way to improve the quality of governance.
Tax motivation. The current tax law encourages sometimes mergers and acquisitions, which result in lower taxes or tax benefits. For example, a highly profitable company, which carries a high tax burden, may acquire a company with great tax benefits, which will be used to set up on the whole corporation (Motis 2007, p.43).
The company may have the potential to save on tax payments to the budget due to the tax benefits, but the level of its profits is not sufficient to use this advantage.
Sometimes, after the bankruptcy and reorganization, the company may use the right of transfer of incurred losses into taxable income of future periods. But the merger, which was made exclusively for this purpose, the Tax Service of the USA, for example, evaluates as doubtful, and in relation to them the principle of the transfer of losses may be canceled.
Production diversification and the ability to use the excess capacity. The cause of the acquisition is diversification and investment in other businesses. Diversification helps to stabilize the flow of income, which can be profitable for the both companies, employees, suppliers, and consumers (through the expansion of the range of IT services).
Temporarily free resources were also the motive for the merger. The HP company operated in the mature industry, the company created large flows of funds, but had little choice of attractive opportunities for investment. Therefore, such companies often use the generated surplus of cash for acquisitions. Otherwise, they may be acquired by other companies, which will be used excess cash (Tobler 2007, p. 25).
This motivation is associated with hopes for a change of the structure of markets and industries, with a focus on access to important new resources and technologies.
The difference in the market price of the EDS and the cost of its replacement. That was useful because the market value of the property complex of the target company is much smaller than the cost of replacing of its assets. The difference of the market price of the company and the cost of its replacement exists due to mismatch of market and balance value of the acquired company. The market value of the company is based on its ability to generate income, which determines the economic value of its assets. If we talk about a fair assessment, the market value (not a book value ) can reflect the economic value of its assets, but, in practice, the market value is very often less than the book value (due to inflation, functional moral depreciation) (Motis 2007, p. 41).
Farther two motifs that can very often be a reason of mergers and acquisitions were shown. But they are poorly can be regarded as the real motives of the acquisition of HP and EDS.
The difference between the liquidation and the current market value. Otherwise, this motivation can be formulated as the ability to buy cheap company and to sell it as more expensive. Often, the liquidation value of the company exceeds its current market value. In this case, the firm (even if it has been purchased under a slightly higher price than the current market value) can then be sold "separately," in parts, with getting by the seller a substantial income. If the assets of the company can be used more effectively when they were sold in parts to the companies, there is a kind of synergy. In general, if to follow the point of view of expediency, the liquidation should take place when the economic gains outweigh the economic costs.
Personalmotivationof managers. The desire to increase the role of managers. Certainly, business decisions regarding mergers and acquisitions are based on economic feasibility. However, there are some examples, when such decisions are based more on personal motivation of managers than on economic analysis. This is due to the fact that CEOs want power and claim more pay, and the boundaries of power and wages are in a certain relation with the size of the corporation. Thus, the use of stock options as a means of long-term incentives contributes to the desire to increase the sizes of companies. These options can be a significant portion of the payment of managers and can be tied to the cost of capital of the company led by them. In this regard, there are direct incentives to use the profits for purchase of all new assets in all areas of business (Tobler 2007, p. 25).
Analysis of the efficiency factors of the acquisition of HP and EDS
Very often the analysis of a merger or acquisition is begun with a forecast of future cash flows of the company, which is going to purchase. This forecast includes any increase of revenues or costs resulting from the merger or acquisition, and then discounts these amounts and compares the result to the purchase price. In this case, the expected net benefit is calculated as the difference between the discounted cash flow of the acquired company, including the benefits of a merger or acquisition, and the money needed to make this transaction. If the present value of expected cash flow exceeds the price, which the acquiring company can pay for the acquired company, the acquiring company can make a purchase. (Thompson 2013, p. 3).
The above approach does not always provide objective results. Even a well-trained analyst can prevent serious errors in the valuation of the company. It would be better to understand why two or more companies, together, will cost more than separately, to assess possible economic benefits and costs (Cyra 2013, p. 2).
In this case we can reveal some factors of the acquisition.
If we talk about market price of merged companies it should be said that acquisition of EDS allowed Hewlett-Packard to strengthen market position in relation to the IBM Corporation in the field of outsourcing services. According to analyst firm Gartner, in the 2009, global revenue from the provision of computer services grew by 10,5%, reaching 748 billion dollars. IBM in 2009 held the leading position in its segment, controlling 7,2% of the market. EDS ranked second place with the figure of 3%, while the share of HP was 2,2% (fifth place).
Synergetic effect of HP and EDS was in the fact the Technology Solutions Group (TSG) of Hewlett-Packard gave outsourcing services for EDS, as well as some of the functions of consulting and integration. At the same time TSG focused on servers, storage systems, software, and technical services, such as installation, maintenance and repair, design of production systems for customers, as well as consulting and integration services.
Due to the merger of the companies, HP has become one of the leaders in providing technology services and has become able to offer the widest selection of products, services and integrated solutions that help customers to increase business, minimize risk and reduce costs.
Strategies and plans of both companies
HP was planning to create a new business group under the brand «EDS-an HP company. Its headquarters according to plan was in Plano, Texas, the previous place of head office of EDS. According to HP's plans management of new business group was carried by Ronald A. Rittenmeyer, current at that time the chairman, president and CEO of EDS, who was to join the executive board of HP and report directly to Mark Hurd, chairman and CEO of HP. According to the plan the two companies had become a stronger business partner, providing customers with the most competitive and extensive portfolio of products and services in the industry, supporting customers by providing the latest technology for business transformation and achieving the best results. Consolidation strategy has yielded positive results for shareholders, because it would greatly increase the shareholder value of the company. Acquisition of EDS according to the plan was another step in the expansion of the range of HP's services. The combined company had provided the following services: IT outsourcing, including data center services, workplaces, networks and security management; outsourcing of business process, including the administrative resources for health care and work with the applications of patients, financial processes, work with the client databases and outsourcing of HR; applications, including the development, modernization and management, consulting and integration, technical services. Merged company offered an expanded package of solutions and specialized expertise in areas such as healthcare, manufacturing, financial services, energy, transport, communications, light industry, retail and the public sector.
Brief description ofthe most significant wavesofmergersand acquisitions
Historically, economists could see very interesting waves of mergers and acquisition of the companies engaged in different kinds of business (conglomerate mergers). The boom of the large diversified companies (conglomerates), was in the 60 years of XX century, though large conglomerates were created at the beginning of it. It should be emphasized again that the economic benefits of the merger arise only when the market value of the company which is created by the merger or acquisition is higher than the sum of the market values of its constituent companies before aggregation (Matthews 2013, p. 3).
1887-1904 years. The majority of mergers were based on the principle of horizontal integration. Most of all sectors of industry were dominated by monopolies next to the enterprise, which can be considered as the forerunners of modern vertically integrated corporations came. The difersified nature was a distinctive feature of most mergers: at least five companies have been involved in 75% of the total number of mergers; more than 10 companies participated in 26% of mergers. Sometimes, a few hundred firms were consolidated (Kahl 2005, p. 33).
1916-1929 years. Due to the antimonopoly legislation mergers in industries led to the domination of oligopolies. This wave is characterized by strong vertical mergers and diversification.
1960-1970 years. This phase is characterized by a wave of conglomerate mergers. According to the Federal Trade Commission of the U.S., from 1965 to 1975, 80% of mergers led to the formation of conglomerates. Number of conglomerate mergers has increased from 10,1%, to 45.5%. Concerning tough antitrust limited horizontal and vertical integration, the number of horizontal mergers has decreased from 39% to 12% (Kahl 2005, p. 35).
1980-1985 years. During this period, the share of conglomerate mergers declined. Moreover, the creation of new associations was accompanied by the destruction of previously created conglomerates. The trend of hostile takeovers was notable. Considering mitigation of antitrust policy in this period, horizontal mergers were the most common.
The second half of the 1990’s years. Horizontal integration was the most popular type of merger. Mergers and acquisitions in the financial sector have a huge scale (Kahl 2005, p. 37).
Modern period is characterized by the increasing number of mergers and acquisitions with the small decline in 2001-2004 years. Quite a few mergers were in the IT-sector. Experts claim that the deal between HP and EDS has spurred a wave of mergers in the IT-sector, because after appearance of the merged company smaller firms have become less competitive, and mergers and acquisitions have become the only way for them to stay afloat.
It should not be forgotten that slowdown of the global economy affects companies of this sector not the best way, because many customers have started to reduce their costs. Only some companies such as, IBM and Accenture, have overcome the contraction of global GDP in 2008, but, hard times definitely came for such companies as Infosys and Wipro. Therefore, mergers and acquisitions have become so spread in the IT sector. Otherwise, these companies would have been simply unable to compete, especially considering the emergence of the new merged company HP-EDS. Analysts say that farther Indian companies are the most likely candidates for M & A deals in the sector. They try to cope with a sharp increase of production costs and declining sales in foreign markets.
Therefore, large companies seek additional sources of expansion. Mergers and acquisitions can be one of the most popular among them. The deal between HP and EDS can be an example of acquisition in the IT sector. Post capitalized value of the combined company was the goal of the merger. Merger or acquisition is economically justified if the synergetic effect arises and manager can proceed to the evaluation of the costs of its implementation (Matthews 2013, p. 2). . Benefits of the merger represent a synergistic effect and a lot of new competitive advantages. Analyzing the global experience and systematizing its theories, we put up some motives and factors of the deal. The main waves of mergers and acquisitions have been considered including the latest wave in the IT sector.