M&A

MOTIVES AND RATIONALES

Why do companies resort to M & A?

M & A is a powerful strategy of instantaneous

quantum growth.
 Growth Strategy Model

Ansoff’s Product Market Matrix

Ansoff’s Product Market Matrix

Present products New products

Present Market Product

markets penetration development

New Market Diversification

markets development
 Classes of Growth Opportunities and M & A
Market Penetration

Market Development 1. Intensive Growth

Product Development

Backward Integration

Forward Integration 2. Integrative Growth

Horizontal Integration

Concentric Diversification

Horizontal Diversification 3. Diversification Growth

Conglomerate Diversification
 Classes of Growth Opportunities and M & A

I. Intensive Growth
(a) Market penetration
 It involves a company seeking increased sales for its present products in the
present markets through more aggressive marketing efforts.
 It involves activities like expanding the dealer and retailer network, getting
bigger and prime shelf space from the retailers, launching attractive dealer
and consumer incentive/gift schemes, launching heavy advertisement
campaigns, etc.
 The ones who are market leaders already also need to maintain their
position and if possible expand the degree of market penetration so as to
enhance their leadership stature.
 It is achieved in an organic manner.
 Example: Marketing war between Pepsi and Coke or between Hindustan
Unilever Limited (HUL) and Procter & Gamble (P&G)
Classes of Growth Opportunities and M & A

(b) Market development

 It consists of a company seeking increased sales by taking its existing
products into new markets.
 When a regional company launches its products in another region or a
company which was hitherto operating in a domestic market starts
exporting its products, it is said to be following a market development
strategy.
 It can be either organic or inorganic.

 Example: China Inc

 Classes of Growth Opportunities and M & A

(c) Product development

 It consists of a company seeking

increased sales by developing improved
products for its present markets.
 Sometimes, companies phase out the
older products in this process, whereas,
at times the older products continue
along with the newer ones, both catering
to different sub segments of a market
segment.
 Example: Nokia launches a new model
of mobile phone every six months. Thus,
Nokia creates a huge replacement
demand by luring consumers with better
features and conveniences of the latest
models.
Classes of Growth Opportunities and M & A
II. Integrative Growth
(a) Backward integration
 It consists of a company seeking ownership or increased control of its supply
system.
 It could be organic or inorganic.

 Example: Reliance Industries Limited is the most impressive example of

backward integration.
Starting with Vimal range of fabrics, RIL went backward into manufacture of
polyester fiber and yarn, followed by intermediate chemicals, polymers, refinery
and finally oil exploration. With this, RIL has become a fully integrated company
across the entire value chain.
Classes of Growth Opportunities and M & A

(b) Forward integration

 It consists of a company seeking ownership or increased control of

its distribution system.
 It could be organic or inorganic.

 Example: A refinery getting into petrol pumps (like RIL) or a film

production house getting into distribution and subsequently, into
running of cinema halls.
 Classes of Growth Opportunities and M & A

(c) Horizontal integration

 It consists of a company seeking

ownership or increased control of its
competitor (s).
 This means acquisition.
 It, by its definition itself, is an inorganic
growth strategy.
 Example: Tata Steel acquiring Corus,
Mittal Steel acquiring Arcelor and Jet
Airways acquiring Sahara Airlines
Classes of Growth Opportunities and M & A

IMPORTANT

Concept of integration whether backward, forward or horizontal does

not mean that there has to be a merger of the target company
( acquired company) with the acquirer company.

It is sufficient that the acquirer acquires control over the target

company such as in case of Grasim- Ultra Tech.
Classes of Growth Opportunities and M & A

III. Diversification Growth

(a) Concentric diversification
 It consists of a company seeking to add new
products that have technological or
marketing synergies with the existing
products. These products would normally
appeal to new classes of customers.

 Example- if a cosmetics company that has

hitherto been manufacturing and marketing
only women’s cosmetics launches the men’s
range, it would be an example of concentric
diversification.
Classes of Growth Opportunities and M & A

(b) Horizontal Diversification

 It consists of a company seeking to

add new products that could
appeal to its present customers
though, technically unrelated to its
present product line.
 Example- The cosmetic company
that has been manufacturing and
marketing women’s cosmetics, if
this company enters women’s
garments business, it would be a
case of horizontal diversification.
Classes of Growth Opportunities and M & A

(c) Conglomerate Diversification

 It consists of a company seeking to

add new products for new classes of
customers, with no relationship to the
company’s current technology,
products or markets.

 Example- ITC Limited is a classic

case of conglomerate diversification.
ITC is into many unrelated
businesses, from cigarettes to hotels
and paper and paperboards to biscuits
and atta (flour).
M & A is primarily a growth strategy. However,
apart from the lure of quantum growth in shortest
possible time, there are many other valid motives/
theories for which companies (acquirer
companies) resort to M & A.

Lets explore those……………….

Merger Motives as summarized by Friedrich Trautwein

Net gains through

Efficiency Theory
synergies
Wealth transfer
from target’s Monopoly Theory
Merger benefits customers
bidder’s
shareholders Wealth transfer
Merger as a rational from target’s Raider Theory
choice shareholders
Net gains through
Valuation Theory
private information

Empire-building
Merger benefits bidder’s managers
Theory

Merger as a process outcome Process Theory

Disturbance
Merger as a macroeconomic phenomenon
Theory
 Merger Motives as summarized
by Friedrich Trautwein

 Trautwein has classified the first four theories or

motives as beneficial to the shareholders of the
acquirer company.
 The fifth one has been classified as beneficial to
the managers of the acquirer company and not to
its shareholders.
 In Trautwein’s view, process theory explains
mergers to be an outcome of a process, whereas,
by using disturbance theory he tries to explain
mergers as a macroeconomic phenomenon.
 Monopoly Theory
This theory explains M&A as being planned and
executed to achieve market power, at times including
pricing power.
 Monopoly Theory
Monopoly theory’s Example1 Example 2
working areas

Reliance Industries Limited

Market leaders trying to
Mittal Steel acquiring (RIL) acquiring Indian
consolidate their position
Arcelor Petrochemicals
further
Corporation Limited (IPCL)

Profitable and cash-rich

Grasim acquiring Larsen
companies trying to
Tata steel acquiring Corus and Toubro’s (L&T) cement
gain market
division
leadership

Vodafone’s acquisition of Monster Worldwide

Market entry strategy
Hutchison Essar acquiring Jobsahead.com
 Efficiency Theory

• This theory explains M&A as being planned and

executed to achieve synergies, thereby, adding to
enterprise valuation.

• The rationale here is to create value not hitherto

existing by pooling various resources of the
acquirer and target companies.
 Efficiency Theory

 Important points about Synergy Theory:

1. Revenue generating synergies are far more difficult to

achieve than cost reduction synergies.
2. Many a times, even honestly estimated synergies
actually fail to materialize.
3. Many a times the acquirer’s management ends up
knowingly overestimating synergies in order to justify the
hefty control premium it pays or proposes to pay for the
acquisition.
 Efficiency Theory
The synergies are broadly divided into:

(a) Revenue generating synergy-

Revenue generating synergy can be
described as the generation of much
higher growth rate and turnover than
the individual companies’ growth
rates during independent operations.
Example: Merger of ICICI with ICICI
bank was to enhance the fee-based
income.
(b) Cost reduction synergy-
If the combined operations result in
cost savings, in any of the areas viz.,
manufacturing, marketing, operations,
manpower, corporate overheads, etc.,
it would be the case of cost reduction
synergy.
 Efficiency Theory
There are five types of synergies:

Synergies

Revenue generating
Cost reduction synergies
synergies

Manufacturing Operations Marketing Financial Tax

Synergy Synergy Synergy Synergy Synergy
 Efficiency Theory
(a) Manufacturing Synergy
It involves combining the core competencies of the acquirer
company in different areas of manufacturing, technology,
design and development, procurement, etc.

Examples:
➨ Tata Motors acquisition of Daewoo’s commercial vehicle
unit;
Synergy: It gave Tata Motors an advantage of producing
commercial vehicles in the 200-400 bhp range.

➨ Daiichi Sankyo and Ranbaxy deal

Synergy: R & D strength of Daiichi was combined with the
efficient manufacturing of Ranbaxy.
 Efficiency Theory
(b) Operations Synergy

 It involves rationalizing the combined operations in such a

manner that through sharing of facilities such as
warehouses, transportation facilities, software and common
services, etc., duplication is avoided and logistics are
improved leading to quantum cost saving.

Examples:
➨ Kingfisher Airlines acquired Deccan Airways
Synergy: To achieve substantial savings through rationalization of
routes, reduction in the combined number of flights on the same
routes, sharing of commercial and ground handling staff, reduction
in the combined number of airplanes in use, etc.
Cont.
 Efficiency Theory

➨Oriental Bank of Commerce’s (OBC) takeover of Global Trust

Bank (GTB)
Synergy: From OBC’s strong branch network in the north and
GTB’s strong network and franchise in the western and southern part
of India.

➨Videsh Sanchar Nigam Limited (VSNL) acquired Tyco

Synergy: On the basis of bandwidth and technology
 Efficiency Theory
(c) Marketing Synergy

• It involves using either the common sales force or distribution

channel or media to push the products and brands of both the
acquirer and target companies at lower costs than the sum total of
costs that they would incur in independent marketing operations.

• Involves leveraging on the brand equity of one of the two

companies to push the sale of the second company’s products.

• Can involve acquiring better pricing power on account of two

companies coming together.

Cont.
 Efficiency Theory

Examples:
➨ Hindustan Lever Limited (HLL) acquired Lakme’s
brand and business
Synergy: Aimed at using HLL’s vast distribution network to
leverage on the strong brand equity of Lakme in the
women’s cosmetics business.

➨ Dilip Piramal acquired Universal Luggage

Synergy: To use the common distribution channel and
sales force to push both the companies’ products. Also to
gain improved pricing power.
 Efficiency Theory
(d) Financial Synergy

• It involves combining both

the acquirer and target
companies’ balance sheets
to achieve either a reduction
in the weighted average cost
of capital or a better gearing
ratio or other improved
financial parameters.

• In this, one has to effect the

target company’s merger
with the acquirer company.
 Efficiency Theory
(e) Tax Synergy
• It involves merging a loss-making company with a profitable
one so that the profitable company can get tax benefits by
writing off accumulated losses of the loss-making company
against the profits of the profit making company.
 Valuation Theory
• This theory explains the M&A as
being planned and executed by
the acquirer who has better
information about the valuation
of the target company than the
stock market as a whole and
who estimates the real intrinsic
value to be much higher than
the present market capitalization
of the company.

• Such an acquirer is ready to pay

premium over the present
market price to acquire control
over the target company.
 Valuation Theory

Efficient Markets’ Theory argues that stock markets are

perfect and efficient when it comes to determining the
right of any company.
Then, how is it possible that the market capitalization is
much below the true intrinsic value of the company?
 Valuation Theory

This theory is in sharp contrast to the Efficient

Markets’ Theory-
 If the acquirer becomes privy to information gaps, costs and
also critical inside information of the markets, he will find
the intrinsic value of the company to be much higher than
the market capitalization.

 The acquirer may have the same information about the

company as the stock market, but has a different view on
the future cash flows based on his own reading of the future
course of economy or the company.
 Valuation Theory
 In case of the companies having substantial off-balance
sheet assets, the acquirer may put much more value to the
company than the stock market.

 A cash-rich company planning to acquire competitors can

find undervalued companies at the end of a prolonged
recession—just before the boom.

 In case of underperforming companies having strong brand

(s), the acquirer may be confident of leveraging on such
brands and generating growth and cash flows and hence,
may put a much higher value to the company than the stock
market.
 Raider Theory

 Raider Theory explains the M&A activity in specific context of

PE funds, where the acquirer acquires non controlling but
influential stake in cash needy companies at much lower
valuation than potential valuation or even present valuation,
just to transfer the wealth from existing shareholders to
themselves without any strategic intent of running these
companies themselves.

 In India, so far as the unlisted companies are concerned, it

would be possible for PE funds to acquire equity shares at a
price that is even below the present intrinsic value of the
company.

 The Raider theory does not work in case of listed

companies in India.
 Empire Building Theory

 Empire Building Theory

tries to explain M&A as
being planned and
executed by the
managers for expanding
their own empire rather
than creating wealth for
shareholders.