(2)-Mergers and Acquisitions – Creating Synergies – Part II

This is part II of the article Mergers and Acquisitions – Creating Synergies – Part I. Please start reading this article from the first part, before proceeding with this part.

However, though it is easy to quote examples as above, but synergy is highly subjective and abstract term. How do you actually quantify the value in terms of numbers, say, for e.g. the reduction in poaching of air pilots? And it is not necessary that the M&A transaction always produce positive synergy. The result can be negative also. For e.g. today Jet and Kingfisher have acquired a majority of Indian skies. Suppose tomorrow government gives nod to overseas airlines to come and serve internal Indian routes. In that case, there will be a fierce competition and the M&A that is appearing to be of a positive synergy, it may turn out to be negative and even the acquirers of today may be acquired tomorrow by bigger fishes that may come to the sea.

How does this M&A business work and how do companies decide which business to acquire?

You may be working for a big reputed MNC having offshore center in India, but the fact is that the founder of this Indian unit will be earning hefty money at the billing hour rate model, for each hour you work, while you are given a fixed salary.

Nothing in this world works without commission or brokerage. The same thing goes with M&A. Investment Banks keep on looking for clients who are willing to acquire or merge with others, or clients who want to be acquired for the need of money. These investment banks have dedicated teams that keep visiting some or the other companies and tell them that if they merge with or acquire someone, how their business will grow OR if they sell themselves, how much money they can raise. Once the companies are fine with the proposal of the investment bank advisors, the investment bank advisors start looking for counterparty. They read the balance sheet and financial reports of both the firms, attempt to do all kinds of nasty calculations and finally make a transaction summary, informing the “fair value” of the company to be acquired. At this point of time, the company that is willing to sell itself will have to decide that it needs more or is it fine with the valuation. In case the news spreads out that so and so company is up for sale, other interested companies will start making offers for them. The competition begins like bidding, and the highest bidder wins the game. For e.g. Tata had competition from a Brazilian steel company for Corus, while Mittal faced stiff competition from other steel giants while grabbing Arcelor. Ultimately, the highest bidder wins. The most important thing to note is that in the process of bidding, the acquiring company may end up paying a much higher price than expected, for the synergy the acquisition may create. It sometimes becomes a prestige issue for the acquiring company, if it fails to acquire, even if the company has to pay a hefty price.

Whatever be the case, the investment advisors from investment banks make a high level of commission, which may range anywhere from 2% to 10%. When the deal is worth billions of dollars, who would not love to get a piece of cake? So the motivation factor of the valuation and bidding process becomes “GET THE DEAL DONE” – whatever may be the final outcome for the acquiring company (and the shareholders)– who cares as long as I am getting my commission.

For Arcelor Mittal deal, there was no single investment bank offering advice to Mittals, but a consortium of 3 or 4 banks comprising big names like Goldman Sachs, Morgan Stanley, etc. Same was the case on the Arcelor side, there was a joint team of 3 banks. At the end of the deal, each got a BIG piece of cake for their “valuable valuation”. Hence, the reason for M&A deal may not be just the case of a foresight of a positive synergy. It can as well be for prestige issue for the bidding companies or the misguidance by the investment banking advisors or similar such reasons.

The world is full of examples where the 2 companies joining hands have created high level of positive synergies. It is equally true for the negative synergies also. The world is equally full of examples where companies ended up in big losses for M&A transactions.

The impact can come in any form – directly or indirectly- and can affect anyone and everyone. For e.g. the reputed financial services organization ADP based in US, lost its major clients when the client was acquired by another competitor firm of ADP. Result, ADP lost its business. ADP had nothing to do with the M&A deal that was going on with its clients. Instead, the deal went through smoothly. Suddenly, one fine day the news came in that the clients will not be using the ADP products any further. Who can make guesses or predictions about this kind of business impact?

Looks like this article has now grown lengthy enough to continue further. I have lot more to tell on M&A, but for the moment, I believe this should be sufficient for introduction to M&A, the reason for M&A and what drives the M&A transactions.
Tomorrow, I will touch the real issue: How are stock prices affected by such M&A deals or even with M&A news or rumors. Keep visiting!

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You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.