LV thạc sỹ_Merger and acquisition of listed companies on vietnamese stock exchange

MBA Program
18th Intake (2009 – 2011)

RESEARCH DISSERTATION

“Merger and Acquisition of listed
companies on Vietnamese Stock
Exchange - Reality and
Recommendation”
Author: …

Ha Noi, October


TABLE OF CONTENTS
ABBREVIATION...............................................................................................................................4
CHAPTER I: INTRODUCTION.......................................................................................................5
1.1

Executive summary..........................................................................................................5

1.2

An introduction of the research:.....................................................................................5

1.3

Rationale:...........................................................................................................................5

1.4

Objectives:.........................................................................................................................6

1.5

Research questions:..........................................................................................................6

1.6

Scope of research...............................................................................................................6

1.7

Methodology......................................................................................................................6

1.8

Limitation of the research................................................................................................7

CHAPTER II: THEORETICAL BACKGROUND OF M&A......................................................8
2.1

History of M&A and types of M&A...............................................................................8

2.1.1

History of M&A................................................................................................................8

2.1.2

Types of M&A...................................................................................................................9

2.2

Sample theory of M&A..................................................................................................10

2.3.

General steps in M&A....................................................................................................13

2.3.1.

Developing an Acquisition strategy..............................................................................13

2.3.2.

Choosing a target firm and valuing control, strategy................................................16

2.3.3.

Structuring the Acquisition...........................................................................................19

2.3.4.

Following up on the Acquisition....................................................................................22

2.4

Advantages and Disadvantages of M&A for companies............................................23

2.4.1

Advantages.......................................................................................................................23

2.4.2

Disadvantage...................................................................................................................24

2.5

Experience of M&A in the world..................................................................................24

2.6

Role of the Investment Bank (IB).................................................................................25

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CHAPTER III: M&A ACTIVITIES OF LISTED COMPANIES IN VIETNAM STOCK
EXCHANGES: CURRENT SITUATION AND ANALYSIS.....................................................27
3.1
Steps and Process in M&A of listed companies in Vietnam Stock Exchanges for
an acquirer...........................................................................................................................................
27
3.2

Case study analysis:........................................................................................................27

3.2.1
The merger deal of Mirae joint stock company and Mirae Fiber joint stock

company ...........................................................................................................................................27
3.2.2
The merger between Ha Tien 1 Cement Joint stock company and Ha Tien 2
Cement Joint stock company.........................................................................................................35
3.2.3

Roles of Securities Company in these above case of M&A........................................43

3.3

Limitations, Obstacles and Challenges........................................................................44

3.4

Causes and Reasons........................................................................................................46

CHAPTER IV: SOLUTION...........................................................................................................48
4.1

For listed company.........................................................................................................48

4.2

For Government agencies..............................................................................................48

4.3

For a securities company...............................................................................................48

CONCLUSION.................................................................................................................................50

REFERENCES..................................................................................................................................51
LIST OF TABLE...............................................................................................................................52

3


ABBREVIATION
M&A: Merger and Acquisition
BOD: Board of directors
BOM: Board of managers
DCF: Discounted cash flows
IB: Investment bank
SSC: State securities committee
HNX: Ha Noi stock exchange
HSX: Ho Chi Minh stock exchange
VCSC: Viet Capital securities company
KMR: Code of Mirae joint stock companies on HSX
KMF: Code of Mirae Fiber joint stock companies on HNX
HT1: Code of Ha Tien 1 cement joint stock companies on HSX
HT2: Code of Ha Tien 2 cement joint stock companies on HSX
Vicem: Vietnamese cement corporation
ROC: Return on capital
EBT: Earning before tax
EBIT: Earning before interest and tax
t: Tax ratio
NKD: North Kinh Do joint stock company
KDC: Kinh Do joint stock company
HVG: Hung Vuong joint stock company
AGF: An Giang sea food import and export joint stock company
DVD: Vien Dong medical joint stock company

DHT: Ha Tay medical joint stock company
4


CHAPTER I: INTRODUCTION
1.1 Executive summary
Thesis is a research of M&A activities on Vietnamese stock exchanges. Listed
companies which carried out M&A plan in 2009, 2010 are objectives of the research.
The research is not only the principals and experience from the foreign countries that
Merger and Acquisition (M&A) activities happened for a long time ago, but also the
facts of M&A activities on Vietnamese stock exchange.
Finally, the research dedicated some weak point that M&A activities on Vietnamese
stock exchange such as:


The lack of experts in this sector;



The lack of experiences and training in both consulting companies (securities
companies) and firms;



The lack of standard M&A procedure from government agency (State
securities committee).

In the opinion of a consultant (as me) and a securities companies (like my company –
Agribank securities joint stock company), we need deeply understand M&A activities
in stock exchange in order to encourage and expand these activities on the exchanges

and financial market, which will create an dynamic and competitive economy in
Vietnam now and near future.
1.2 An introduction of the research:
Every company has strategy to expand as large as possible because they can become a
monopolist in market or take advantages of economy of scale to get more and more
profit. On the way to make the ambition come true, company must to invest more and
more and M&A is one of methods that many recent companies use.
In Vietnam, after over 20 years open market and transfer to market economy, our GDP
grows at high level than other ASEAN or ASIA countries. High economic growth
accompanies with more money for investment, there have been a lot of way to
investment in Vietnam and M&A has been a newly, modern stream of investment in
Vietnam.
The research would like to tell a story about M&A activity in Vietnam recently year
and its trend in the near future.
1.3 Rationale:

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In Vietnam, M&A activity appeared a long time ago but it has turn out to be popular
recently and will be a boom in near future.
In recent years, there have been a lot of researches, forums and reports about M&A
activities in Vietnam and Vietnamese stock exchange in particular, which express the
importance of these actions for Vietnamese firms and the develop of Vietnamese
economy.
On the other hand, my current job is a corporate financial consultant in a securities
company, my desire is encouraging M&A consulting in my department in short-term
and generate my Consultant Department act as Investment Banking Department or
Market makers in long-term.
All of these reasons make appearance of this thesis to add more in researches of M&A

activities. Besides, it also develops my knowledge about M&A transactions both in
principal and reality in Vietnam, which is the most important point.
1.4 Objectives:
The research will make an overview about M&A activity on Vietnamese stock
exchange, find out the advantages and difficulties that firms face to. Finally, the
solution to firms will be seek to get benefits as much as possible wherever they want
to operate M&A on Vietnamese stock exchange.
1.5 Research questions:
“How listed enterprises could take effective benefits from M&A on Vietnamese stock
exchange?”
1.6 Scope of research
In this research, I will concentrate only on M&A activity which was done by listed
companies on Ho Chi Minh stock exchange and Ha Noi stock exchange in Vietnam,
Merger and acquire among listed companies
1.7 Methodology

6


1.8 Limitation of the research
Because of the limitation of time, knowledge and experience, the dissertation will
focus only on some subjects that writer consider the main factors with listed company
when operating M&A activity not for all company in Vietnam. Thus, readers will be
not seen the whole-view about M&A in Vietnam. However, writer is looking forward
from financial experts and persons who concern about this topic.

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CHAPTER II: THEORETICAL BACKGROUND OF M&A

2.1 History of M&A and types of M&A
2.1.1

History of M&A

M&A appeared earliest in United State of America in end of 19 th century. Up to now,
M&A has 5 waves following:
First Wave Mergers
The first wave mergers commenced from 1897 to 1904. During this phase merger
occurred between companies, which enjoyed monopoly over their lines of
production like railroads, electricity etc… The first wave mergers that occurred during
the aforesaid time period were mostly horizontal mergers that took place between
heavy manufacturing industries.
End Of 1st Wave Merger
Majority of the mergers that were conceived during the 1st phase ended in failure
since they could not achieve the desired efficiency. The failure was fuelled by the
slowdown of the economy in 1903 followed by the stock market crash of 1904. The
legal framework was not supportive either. The Supreme Court passed the mandate
that the anticompetitive mergers could be halted using the Sherman Act.
Second Wave Mergers
The second wave mergers that took place from 1916 to 1929 focused on the mergers
between oligopolies, rather than monopolies as in the previous phase. The economic
boom that followed the post World war I gave rise to these mergers. Technological
developments like the development of railroads and transportation by motor
vehicles provided the necessary infrastructure for such mergers or acquisitions to
take place. The government policy encouraged firms to work in unison. This policy
was implemented in the 1920s.
The 2nd wave mergers that took place were mainly horizontal or conglomerate in
nature. The industries that went for merger during this phase were producers of
primary metals, food products, petroleum products, transportation equipments and

chemicals. The investments banks played a pivotal role in facilitating the mergers and
acquisitions.
End Of 2nd Wave Mergers
The 2nd wave mergers ended with the stock market crash in 1929 and the great
depression. The tax relief that was provided inspired mergers in the 1940s.
Third Wave Mergers
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The mergers that took place during this period (1965-69) were mainly conglomerate
mergers. Mergers were inspired by high stock prices, interest rates and strict
enforcement of antitrust laws. The bidder firms in the 3rd wave merger were smaller
than the Target Firm. Mergers were financed from equities; the investment banks no
longer played an important role.
End Of The 3rd Wave Merger
The 3rd wave merger ended with the plan of the Attorney General to split
conglomerates in 1968. It was also due to the poor performance of the
conglomerates.Some mergers in the 1970s have set precedence. The most
prominent ones were the INCO-ESB merger; United Technologies and OTIS Elevator
Merger are the merger between Colt Industries and Garlock Industries.
Fourth Wave Merger
The 4th wave merger that started from 1981 and ended by 1989 was characterized
by acquisition targets that wren much larger in size as compared to the 3rd wave
mergers. Mergers took place between the oil and gas industries, pharmaceutical
industries, banking and airline industries. Foreign takeovers became common with
most of them being hostile takeovers. The 4th Wave mergers ended with anti
takeover laws, Financial Institutions Reform and the Gulf War.
Fifth Wave Merger
The 5th Wave Merger (1992-2000) was inspired by globalization, stock market boom
and deregulation. The 5th Wave Merger took place mainly in the banking and

telecommunications industries. They were mostly equity financed rather than debt
financed. The mergers were driven long term rather than short term profit motives.
The 5th Wave Merger ended with the burst in the stock market bubble.
Hence we may conclude that the evolution of mergers and acquisitions has been
long drawn. Many economic factors have contributed its development. There are
several other factors that have impeded their growth. As long as economic units of
production exist mergers and acquisitions would continue for an ever-expanding
economy.
2.1.2

Types of M&A

- Horizontal M&A: Occurring with two companies which compete directly and share
the same market and the same product. The result of this kind of M&A will bring to
an acquirer the chance to spread market share, combine trade mark, reduce fix cost,
enforce the efficiency of distribution channel…Obviously, when 2 competitors cooperate they not only reduce 1 opponent but also create a new strength to fire to
other competitors.

9


- Vertical M&A: Occurring with firms in supply chains, for instance acquisition of firm
and its supplier or its customer. Vertical M&A is divided into 2 group: (a) forward
M&A, a company acquired his costumer, (b) backward M&A, a company acquired his
supplier. Vertical M&A makes an acquirer takes advantages of controlling and
managing the quality of his and his competitors’ input or output.
- M&A to expand market: Applying to companies in the same industry but not the
same geographic market.
- M&A to expand product: Applying to companies which produce different products
but these products related in the same market.

- M&A to create groups and holdings: In this case, companies are not the same
industry but they want to diversify their business into other business industries or
areas.
2.2 Sample theory of M&A
Theory of strategy to avoid the overpayment trap in M&A
The theory tells us to take proactive measures to avoid it are essential first steps. It
also provides specific strategies and techniques that we can use to avoid overpaying
for a friendly acquisition.
Obviously, a buyer may overpay by miscalculating their relative negotiating position
and offering a price that is significantly more than the amount a seller would accept.
In addition, a buyer may overpay when the price paid does not provide for an
adequate return on investment. There are two reasons that one buyer is willing to pay
more than the other: (i) a buyer want the company because of the role the acquisition
will play in fulfilling its strategic mission. Such a buyer may pay a significant
premium over Fair Market Value if they are under compulsion to act, unlike the
hypothetical buyer in the definition of Fair Market Value who is not under a
compulsion to act. (ii) A given buyer may be better positioned to maximize returns
from a particular acquisition.
Avoiding the overpayment traps involves for essential business arts: strategy,
negotiation, due diligence and pricing. These four arts must work together.
First, the art of strategy
A company’s strategy is based upon its present position, where it is going and how it
plans to get there. The key question is “will the company’s strategy be best achieved
through organic growth or by means of M&A?”. Our growth objectives and strategy
should define our acquisition.
The basic reasons for making an acquisition are to:


Leverage existing assets and capacity



Acquire needed or desired capacity
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

Acquire a platform company



Acquire a business position (an immediate entry and/or dominant position)
Establish acquisition criteria in writing. Once established, acquisition objectives
should be prioritized and formalized in writing. Of course, the objectives can be
updated and modified to reflect your current strategic thinking, but they should be in
writing. The human brain and ego are powerful forces. Emotion, executive hubris, and
groupthink can obscure reason and result in shoddy decision making. Pursuing the
deal-of-the-moment can waste precious time and resources as following:

 Before entering price negotiations have a “not-to-exceed” amount and a starting price
in mind;
 Build a relationship with the seller(s);
 Learn more about the specific needs of the seller so we can use that information to
add value to our offer;
 Manage expectations and set boundaries early in the process. Flexibility is helpful
along with a problem-solving approach to negotiations. However, unless we establish
boundaries, the seller may push for concessions until the edge of the metaphorical
envelope has been reached;
 Adopt an educative approach when discussing price and valuation issues with the

seller;
 Be wary of auctions;
 Don’t negotiate blindly. Plug deal price, terms and other key assumptions into your
financial model to make sure the numbers meet the investment portion of our
acquisition criteria;
 Be mindful of the power of “No” and don’t be afraid to use it to keep our company
out of the bad deal;
 Don’t underestimate our strength as a buyer and don’t fail to convey strength to the
sellers and the representatives. The degree of assertiveness in negotiations is
dependent upon each party’s perception of their bargaining power, a largely
psychological process.
Second, the art of strategic due diligence
In a typical transaction, buyer and seller indicate their general agreement on price,
terms, deadlines and other basic conditions in a Term sheet or Acquisition contract. A
standard condition is the completion of a due diligence review to the satisfaction of
the buyer. Due diligence requires disclosure by the seller and provides the buyer with
an opportunity to verified the completeness, accuracy and business significance of the
disclosed information. Here are several due diligence strategies we can use to avoid
the overpayment trap:

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 Approach due diligence as an opportunity and spare no effort to thoroughly
understand the company, how it will fit into our plans, and the best way to capture
maximum value while minimizing risk;
 Trust but verify. Trust in our strategic vision, negotiating acumen and valuation
instincts and then take a step back to verify everything. The anticipated economic
benefits rest upon myriad of assumptions. If our assumptions are false, our ROI will
suffer.

 Adopt a cool, analytical and objective approach toward due diligence anf the issue
that are uncovered during the process. Every analyst has their own set of bias. It
comes with being human. Avoid spin, overreaction and the tendency to fit the findings
into a preconceived picture. Use the findings to reach an informed decision as
opposed to using them to rationalize a decision that has already been made;
 Evaluate the implications of all findings that may affect price and related negotiations.
Does the finding have an impact upon such critical areas as:


Markets, customers and revenues



Assumed cost saving and operating expenses



Demands upon cash and credit capacities



Reserves and contingent expenses



Planned assimilation or integration cost



Anything that materially changes our perception of the overall risk of investment.

 Whenever possible, quantify the impact of all findings that relate to valuation and
pricing decisions
 Negotiate with the seller to mitigate the impact of any findings that materially lower
anticipated returns
 Adapt your assimilation and integration plans based upon our findings
 Don’t “stove-pipe” the findings. Make sure that all of the appropriate people in our
organization receive the data and encourage them to carefully evaluate its significance
and adjust plans and expectations as needed
Finally, the art of valuation and pricing
Every business buyer should adopt a formal, disciplined and standardized approach to
valuing and pricing an acquisition target.
When considering models, forecasts and valuations keep a few things in mind:
 Numbers are not the business. Get beyond the numbers. When analyzing historic
financial statements, numbers represent the accounting treatment of transactions.
Keep in mind that every line item is comprised of many individual transactions. Each
individual transaction started with an intention, was then implemented, produced a
12


result and was then reported according to the company’s accounting policies and
competence
 Models can be elegant and simulate the calculated results of a large number of
assumptions and variables. When it comes to valuation and pricing, there are a
number of key assumptions and variables that can be manipulated with dramatic
results. An analyst needs a high degree of intellectual honesty and moral backbone to
simulate numbers that are of true value to the organization.
 Numbers should be used as part of the fact finding, planning and negotiation process
and never manipulated to rationalize or justify and otherwise non-sensible price.
An acquisition is a major business event. Each deal presents a set of unique

challenges and risks. Some risks can be identified and managed. Some risks can catch
a buyer by surprise. These risks and challenges are best faced without the added
burden of overpayment.
By adopting a deal philosophy that integrates strategy, negotiating and due diligence
along with a disciplined approach to valuation and pricing, a buyer can side-step the
overpayment trap.
2.3.

General steps in M&A

There are four basic steps in acquiring a target company as following:
2.3.1.

Developing an Acquisition strategy

There have been different motives for acquisition and coherent acquisition strategy
has to be based on one or another these motives.
One, acquire undervalued firms, firms that are undervalued by financial market can
be targeted for acquisitions by those who recognize this mispricing. The acquirer can
then gain the difference between the value and purchase price as surplus. For this
strategy to work, however, three basic components need to come together:
A capacity to find firms trade at less than their true value: This capacity would
require either access to better information than is available to other investors in the
market or better analytical tools than those used by other market participants.
Access to the funds that will be needed to complete the acquisition: Knowing a firm is
undervalued does not necessarily imply having capital easily available to carry out the
acquisition. Access to capital depends on the size of the acquirer – large firms will
have more access to capital markets and internal funds than smaller firms or
individual – and upon the acquirer’s track record – a history of success at indentifying
and acquiring undervalued firms will make subsequent acquisitions easier.

Skill in execution: If the acquirer, in the process of the acquisition, drives the stock
price up to and beyond the estimated value, there will be no value gain from the
acquisition. To illustrate, assume that the estimated value for a firm is $100 million
and the current market price is $ 75 million. In acquiring this firm, the acquirer will
13


have to pay premium. If that premium exceeds 33% of the market price, the price
exceeds the estimated value and the acquisition will not create any value for the
acquirer.
Although the strategy of buying undervalued firms has a great deal of intuitive appeal,
it is daunting, especially when acquiring publicly traded firms in reasonably efficient
markets, where the premiums paid on market prices can very quickly eliminate the
valuation surplus. The odds are better in less efficient markets or when acquiring
private businesses.
Two, diversify to reduce risk, diversification reduces an investor’s exposure to firmspecific risk. The risk and return models have been built on the presumption that the
firm-specific risk will be diversified away and hence will not be rewarded. By buying
firms in other business and diversifying, the managers of acquiring firms believe they
can reduce earnings volatility and risk, while increasing potential value.
Although diversification has benefits, it is an open question whether it can be
accomplished more efficiently by investors diversifying across traded stocks or by
firms diversifying through acquiring other firms. If we compare the transactions cost
associated with investor diversification with the costs and the premium paid by firms
doing the same, investors in most publicly traded firms can diversify far more cheaply
than firms can.
There are two exceptions to this view. The first is in the case of a private firm, where
the owner may have all or most of his or her wealth invested in the firm. Here, the
argument for diversification becomes stronger, since the owner alone is exposed to all
risk. This risk exposure may explain why may family-owned businesses in Asia, for
instance, diversified into multiple businesses and became conglomerates. The second,

though weaker case, is the closely held firm whose incumbent managers may have the
bulk of their wealth invested in the firm. By diversifying through acquisitions, they
reduce their exposure to total risk, though other investors may not share their
enthusiasm.
Three, create operating or financial synergy, one of the important reasons for
acquisitions is synergy – the potential additional value from combining two firms. It is
probably the most widely used and misused rationale for M&A. There are two types
of synergies: Operating and Financial.
Operating synergies are those synergies that allow firms to increase their operating
income, increase growth or both. Operating synergies can be categorized into four
types:
o Economies of scale that may arise from the merger, allowing the combined
firm to become more cost-efficient and profitable.
o Greater pricing power from reduce competition and higher market share, with
should result in higher margin and operating income.

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o Combination of different functional strengths, as would be the case when a
firm with strong marketing skills acquires a firm with a good product line.
o Higher growth in new or existing markets, arising from the combination of the
two firms. This would be the case when U.S consumer products firm acquires
an emerging market firm, with an established distribution network and brandname recognition, and uses these strengths to increase sales of it products.
o Operating synergies can affect margin and growth, and through these the value
of the firms involved in M&A.
With financial synergies, the payoff can take the form of either higher cash flows and
a lower cost of capital. Included are the following:
- A combination of a firm with excess cash, or cash slack (and limited project
opportunities) and a firm with high-return project (and limited cash) can yield a

payoff in terms of higher value for the combined firm. This synergy is likely to show
up most often when large firms acquire smaller firms or when publicly traded firms
acquire private businesses.
- Debt capacity can increase because when two firms combine, their earnings and cash
flows may become more stable and predictable. This, in turn, allows them to borrow
more than they could have as individual entities, which creates a tax benefit for the
combined firm. This tax benefit can either be shown as higher cash flows, or take the
form of a lower cost of capital for the combined firm.
- Tax benefits can arise either from the acquisition taking advantage of tax laws or
from the use of net operating losses to shelter income. Thus, a profitable firm that
acquires a money-losing firm may be able to use the net operating losses of the latter
to reduce its tax burden. Alternatively, a firm that is able to increase its depreciation
charges after an acquisition will save in taxes and increase its value.
To value synergy from M&A we have this function:
V(AB) > V(A) + V(B)
V(AB) = Value of a firm created by combining A and B (synergy)
V(A) = Value of firm A, operating independently
V(B) = Value of firm B, operating independently
The existence of synergy generally implies that the combined firms will become more
profitable or grow at a faster rate after the merger than will the firms operating
separately.
Four, take over poorly managed firms and change management, some firms are not
managed optimally, and others often believe they can run them better than the current
managers. Acquiring poorly managed firms and removing incumbent management, or
at least changing existing management policy or practices, should make these firms
more valuable, allowing the acquirer to claim the increase in value. This value
increase is often termed the value of control. Although this corporate control story can
15

be used to justify large premium over the market price, the potential for its success
rests on the following:
- The poor performance of the firm being acquired should be attributable to the
incumbent management of the firm rather than to market or industry factors that are
not under management control.
- The acquisition has to be followed by a change in management practices and the
change has to increase value. Actions that enhance value increase cash flows from
existing assets, increase expected growth rates, increase the length of the growth
period, or reduce the cost of capital.
- The market price of the acquisition should reflect the status quo, that is, the current
management of firm its poor business practices. If the market price already has the
control premium built into it, the acquirer has little potential to earn the premium.
Five, cater to managerial self-interest, in most acquisitions, it is the managers of the
acquiring firm who decide whether to carry out the acquisition and how much to pay
for it, rather than the stockholders of the same firm. Given these circumstances, the
motive for some acquisition may not be stockholder wealth maximization but
managerial self-interest, manifested in any of following motives for acquisitions:
- Empire building: Some top managers interests’ seem to lie in making their firms the
largest and most dominant firms in their industry or even in the entire market.
- Managerial ego: Some acquisitions, especially when there are multiple bidders for
the same firm, become tests of machismo for the managers involve. Neither side
wants to lose the battle, even though winning might cost their stockholders billions of
dollars.
- Compensation and side benefits: In some cases, M&A can result in the rewriting of
management compensation contracts. If the potential private gains to the managers
from the transaction are large, it might blind them to the costs created for their own
stockholder.
2.3.2. Choosing a target firm and valuing control, strategy
Once a firm has an acquisition motive, two key questions need to be answered. The
first relates to how to best identify a potential target firm for an acquisition. The

second is the more concrete question of how to value a target firm.
Choosing a target firm: Once a firm has identified the reason for its acquisition
program, it has to find the appropriate target firm.
- If the motive for acquisition is undervaluation, the target firm must be undervalued.
How such a firm will be identified depends on the valuation approach and model
used. With relative valuation, an undervalued stock is one that trades at a multiple (of
earnings, book value, or sales) well below that of the rest of the industry, after
controlling for significant differences on fundamentals. Thus, a bank with a price to
book value ratio (P/B) of 1.2 would be an undervalued bank if other banks have
16


similar fundamentals (ROE, growth and risk) but trade at higher price to book value
ratios. In discounted cash flow valuation approaches, an undervalued stock is one that
trades at a price well below the estimated discounted cash flow value.
- If the motive for acquisitions is diversification, the most likely target firms will be in
businesses that are unrelated to and uncorrelated with the business of the acquiring
firm. Thus, a cyclical firm should try to acquire countercyclical or, at least, noncyclical firms to get the fullest benefit from diversification.
- If the motive for acquisition is operating synergy, the typical target firm will vary
depending on the source of the synergy. For economies of scale, the target firm should
be in the same business as the acquiring firm. Thus, the acquisition of Security Pacific
by Bank of America was motivated by potential cost savings from economics of scale.
For functional synergy, the target firm should be strongest in the functional areas
where the acquiring firm is weak. For financial synergy, the target firm will be chosen
to reflect the likely source of the synergy – a risky firm with limited or no stand-alone
capacity for borrowing if the motive is increased debt capacity, or a firm with
significant net operating losses carried forward if the motive is tax benefits.
- If the motive for the merger is control, the target firm will be poorly managed firm
in an industry where there is potential for excess returns. In addition, its stock-holding
will be widely dispersed (making it easier to carry out the hostile acquisition), and the

current market price will be based on presumption that incumbent management will
continue to run the firm.
- If the motive is managerial self-interest, the choice of a target firm will reflect
managerial interest rather than economic reasons.
Valuing the target firm: The valuation of an acquisition is not fundamentally different
from the valuation of any firm, although the existence of control and synergy
premiums introduces some complexity into the valuation process. Given the
interrelationship between synergy and control, the safest way to value a target firm is
in steps, starting with a status quo valuation of the firm, and following up with a value
for control and a value for synergy.
We start our valuation of the target firm by estimating the firm value with existing
investing, financing and dividend policies. This valuation, we term the status quo
valuation, provides a base from which we can estimate control and synergy premiums.
In particular, the value of the firm is a function of its cash flows from existing assets,
the expected growth in these cash flows during a high-growth period, the length of
high-growth period and the firm’s cost of capital.
Value of control: Many hostile takeovers are justified on the basic of the existence of
a market for corporate control. Investors and firms are willing to pay large premiums
over the market price to control the management of firms, especially those that they
perceive to be poorly run. This section explores the determinants of the value of
corporate control and attempts to value it in the context of an acquisition.

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The value of wresting control of a firm from incumbent management is inversely
proportional to the perceived quality of that management and its capacity to maximize
firm value. In general, the value of control will be much greater for a poorly managed
firm that operates at below optimum capacity than for a well managed firm. The value
of controlling a firm comes from changes made to existing management policy that

can increase the firm value. Assets can be acquired or liquidated, the financing mix
can be changed, the dividend policy reevaluated, and the firm restructure to maximize
value. If we can identify the changes that we would make to target firm, we can value
control. The value of control can then be written as:
Value of control = Value of firm, optimally managed – Value of firm with current
management.
The value of control is negligible for firms that are operating at or close to their
optimal value since a restructuring will yield little additional value. It can be
substantial for firms operating at well below optimal, since a restructuring can lead to
a significant increase in value.
Valuing Synergy: There is a potential for operating synergy, in one form or the other,
in many takeovers. Some disagreement exists, however, over whether synergy can
valued and, if so, what that value should be. One school of thought argues that
synergy is too nebulous to be valued and that any systematic attempt to do so requires
so many assumptions that it is pointless. If this is true, a firm should not to be willing
to pay large premiums for synergy if it cannot attach the value to it.
Although valuing synergy requires us to make assumptions about future cash flows
and growth, the lack of precision in the process does not mean we cannot obtain an
unbiased estimate of value. Thus, we maintain that synergy can be valued by
answering two fundamental questions:
o What form is the synergy expected to take? Will it reduce costs as a
percentage of sales and increase profit margins? Will it increase future
growth or the length of the growth period?
o When will the synergy start affecting cash flows? Synergies can show
up instantaneously, but they are more likely to show up over time.
Since the value of synergy is the present value of the cash flows
created by it, the longer it takes for it to show up, the lesser it value.
Once we answer these questions, we can estimate the value of synergy using an
extension of discounted cash flows techniques. First, we value the firms involved in
the merger independently by discounting expected cash flow to each firm in the

merger independently by discounting expected cash flows to each firm at the
weighted average cost of capital for that firm. Second, we estimate the value of the
first step. Third, we build in the effects of synergy into expected growth rates and cash
flows, and we value the combined firm with synergy. The difference between the
value of the combined firm with synergy and the value of the combined firm without
synergy provides a value for synergy.
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Financial synergy: Synergy can also be created from purely financial factors. We will
consider three legitimate sources of financial synergy: a greater “tax benefit” from
accumulated losses and tax deductions; an increase in debt capacity and therefore firm
value; and better use for “excess” cash or cash slack. Managers may reject profitable
investment opportunities if they have to raise new capital to finance them. Since
managers have more information than investors about prospective projects, leading to
the rejection of good projects and to capital rationing for some firms. It may therefore
make sense for a company with excess cash and no investment opportunities to take
over a cash-poor firm with good investment opportunities, or vice versa. The
additional value of combining these two firms is the present value of the projects that
would not have been taken if they had stayed apart but can now be taken because of
the availability of cash. Cash slack can the potent rationale for publicly traded firms
that have more access to capital and want to acquire small, private firms that have
capital constraints. It may also explain why acquisition strategies concentrating on
buying smaller, private firms have worked fairly well in practice. Several possible tax
benefits accrue from takeovers. If one of the firms has tax deductions that it cannot
use because it is losing money, whereas the other firm has income on which it pays
significant taxes, combining the two firms can result in tax benefits that the two firms
can share. The value of this synergy is the present value of the tax savings that result
from this merger. In addition, the assets of firm being taken over can be written up to
reflect new market values in some forms of mergers, leading to higher tax saving from

depreciation in future years.
2.3.3.

Structuring the Acquisition

Once the target firm has been identified and valued, the acquisition moves forward
into the structuring phase. There are three interrelated steps in this phase. The first is
the decision on how much to pay for target firm, given that we have valued it, with
synergy and control built into the valuation. The second is the determination of how to
pay for the deal, that is, whether to use stock, cash or some combination of the two,
and whether to borrow any of the funds needed. The final step is the choice of
accounting treatment of the deal because it can affect both taxes paid by stockholders
in the target firm and how the purchase is accounted for in the acquiring firm’s
income statement and balance sheets.
Deciding on an Acquisition price
In the last section, we explained how to value a target firm, with control and synergy
considerations built into the value. This value represents a ceiling on the price that the
acquirer can pay on the acquisition rather than a floor. If the acquirer pays the full
value, there is no surplus value to claim for the acquirer’s stockholders and the target
firm’s stockholders get the entire value of the synergy and control premiums. This
division of value is unfair if the acquiring firm plays an indispensable role in creating
the synergy and control premiums.

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Consequently, the acquiring firm should try to keep as much of premium as it can for
it stockholders. Several factors, however, will act as constraints. They include the
following:
 The market price of the target firm, if it is publicly traded, prior to the

acquisition: Since acquisitions have to be based on the current market price,
the greater the current market value of equity, the lower the potential for gain
to the acquiring firm’s stockholders. For instance, if the market price if a
poorly managed firm already reflects a high probability that the management
of the firm will be changed, there is likely to be little or no value gained from
control.
 The relative scarcity of the specialized resources that the target and the
acquiring firm bring to the merger: Since the bidding firm and the target firm
both contribute to the creation of synergy, the sharing of the benefits of
synergy among the two parties will depend in the large part on whether the
bidding firm’s contribution to the creation of the synergy is unique or easily
replaced. If it can be easily replaced, the bulk of the synergy benefits will
accrue to the the target firm. If it is unique, the benefits will be shared much
more equitably. Thus, when a firm with cash slack acquires a firm with many
high-return projects, value is created. If there are a large number of firms with
cash slack and relatively few firms with high-return project, the bulk of the
value of synergy will accrue to the latter.
 The presence of other bidders for the target firm: When there is more than one
bidder for a firm, the odds are likely to favor the target firm’s stockholders.
Payment for a target firm
Once a firm has decided to pay a given price for a target firm, it has to follow up by
deciding how it is going to pay for this acquisition. In a particular, a decision has to be
made about the following aspects of the deal:
 Debt versus equity: A firm can raise funds for an acquisition from either debt
or equity. The mix will generally depend on the excess debt capacities of both
the acquiring and the target firm. Thus, the acquisition of a target firm that is
significantly under-levered may be carried out with a larger proportion of debt
than the acquisition of one that is already at its optimal debt ratio. This, of
course, is reflected in the value of the firm through the cost of capital. It is also
possible that the acquiring firm has excess debt capacity and that is uses its

ability to borrow money to carry out the acquisition. Although the mechanics
of raising the money may look the same in this case, the cost of capital used in
valuing the acquisition should not reflect this debt raise. The additional debt
has nothing to do with the target firm, and building it into the value will only
result in the acquiring firm paying a premium for a value enhancement that
rightfully belong to its own stockholders.

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 Cash versus stock: A firm can use equity in a transaction in three ways. The
first is to use cash balances that have been built up over time to finance the
acquisition. The second is to issue stock to the public, raise cash, and use the
cash to pay for the acquisition. The third is to offer stock as payment for the
target firm, where the payment is structured in term of stock swap – shares in
the acquiring firm in exchange for shares in the target firm. The question of
which these approaches a firm should use cannot be answered without looking
at the following factors:
-

The availability of cash on hand: The option of using cash on hand is
available only to those firms that have accumulated substantial amounts of
cash.

-

The perceived value of the stock: When stock is issued to the public to
raise new funds or when it is offered as payment on acquisitions, the
acquiring firm’s managers are making a judgment about what the
perceived value of the stock is. In other words, managers who believe that

their stock is trading at a price significantly below value should not use
stock as currency on acquisitions because what they may gain on the
acquisitions van be more than lost in the stock issue. On the other hand,
firms that believe their stocks are overvalued are much more likely to use
stock as currency in transactions. The stockholders in the target firm are
also aware of this and may demand a larger premium when the payment is
made entirely in the form of the acquiring firm’s stock.

-

Tax factors: When an acquisition is a stock swap, the stockholders in the
target firm may be able to defer capital gains taxes in the exchanged
shares. Since this benefit can be significant in an acquisition, the potential
tax gains from a stock swap may be large enough to offset any perceived
disadvantages.

The final aspect of a stock swap is the setting of the term of the stock swap, that is,
the number of shares of the acquired firm that will be offered per share of the
acquiring firm. Although this amount is generally based on the market price at the
time of acquisition, the ratio that results may be skewed by the relative mispricing of
the two firms’ securities, with the more overpriced firm gaining at the expense of the
more underpriced (or at least, less overpriced) firm. A fairer ratio would be based on
the relative value of two firms’ shares as the following illustration shows.
Accounting considerations
There are two basic choices in accounting for a merger or an acquisition – one final
decision seems to play a disproportionate role in the way in which acquisitions are
structured and setting their terms.
In purchase accounting, the entire value of the acquisition is reflected on the acquiring
firm’s balance sheet, and the difference between the acquisition price and the restated
value of the assets of the target firm is shown as goodwill for the acquiring firm. The

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goodwill is one of amortization which is generally not tax deductible and thus does
not affect cash flows. If an acquisition for pooling, the book values of the target and
acquiring firms are aggregated. The premium paid over market value is not shown on
the acquiring firm’s balance sheet.
For an acquisition to qualify for pooling, the merging firms have to meet the
following conditions:
-

Each of the combining firms has to be independent; pooling is not allowed
when one of the firms is a subsidiary of another firm in the two years prior to
the merger.

-

Only voting common stock can be issued to cover the transaction; the issue of
preferred stock or multiple classes of common stock is not allowed;

-

Stock buybacks or any other distributions that change the capital structure
prior to the merger are prohibited;

-

No transactions that benefit only a group of stockholders are allowed;

-

The combined firm cannot sell a significant portion of the existing businesses
of the combined companies, other than duplicate facilities or excess capacity.

The question of whether an acquisition will qualify for pooling seems to weigh
heavily on the managers of acquiring firms. Some firms will not make acquisitions if
they do not qualify for pooling, or they will pay premium to ensure that they do
qualify. Furthermore, as the conditions for pooling make clear, firms are constrained
in what they can do after merger. Firms seem to be willing to accept these constraints,
such as restricting stock buybacks and major asset divestitures, just to qualify for
pooling.
2.3.4.

Following up on the Acquisition

In this section, there are both evidences on the success and failure of merger at
enhancing value and the reasons many mergers do not work.
The post-deal performance of merged companies: Several studies examine the extent
to which mergers and acquisitions succeed or fail after the firm combine. Most studies
conclude that many mergers fail to deliver on their promises of synergy, and even
those that deliver seldom create value for the acquirer’s stockholders.
Some studies are for example such as: McKinsey and Co. examined 58 acquisition
programs between 1972 and 1983 for evidence on two questions: (1) Did the return on
the amount invested in the acquisitions exceed the cost of capital? (2) Did the
acquisitions help the parent companies outperform the competition? They concluded
that 28 of the 58 programs failed both tests and that six more failed at least one test. In
a follow up study of 115 mergers in the United Kingdom and the United States in
1990s, McKinsey concluded that 60% of transactions earned returns on capital less
than the cost of capital and that only 23% earned excess return. In 1999, KPMG
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examined 700 of the most expensive deals between 1996 and 1998 and concluded that
only 17% created value for the combined firm, 30% were value neutral, and 53%
destroy value.
In summary, the evidence on mergers adding value is murky at best and negative at
worst. Considering all contradictory evidence contained in different studies,
concluding that:
 Mergers of equals (firms of equal size) seem to have a lower probability of
succeeding than acquisitions of a smaller firm by much larger firm.
 Cost-saving mergers, whereby the cost savings are concrete and immediate,
seem to have a better chance of delivering on synergy than mergers based on
growth synergy.
 Acquisition programs that focus on buying small private businesses for
consolidations have had more success than acquisition programs that
concentrate on acquiring publicly traded firms.
 Hostile acquisitions seem to do better at delivering improved post-acquisition
performance than friendly mergers.
Why do mergers fail? There are several reasons cause mergers fail, such as:
 Lack of post-merger plan to deliver on synergy and control: Firms in many
mergers seem to believe that the value enhancements associated with synergy
and control will arise on their own. In reality, however, firms must plan for
and work at creating these benefits. The absence of planning can be attributed
to the fact that firms are seldom concrete about what form synergy will take
and do not try to quantitatively estimate the cash flows associated with
synergy.
 Lack of Accountability
o Culture shock
o Failure to consider external constraints
o Managerial Egos

o The market price hurdle
2.4 Advantages and Disadvantages of M&A for companies

2.4.1

Advantages

Merger and acquisition will bring to acquiring firms the advantages from both cost
savings and increase in revenues.

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In term of cost savings, firms after M&A may get the reduction in labor cost because
of well organized in producing or layoff workforces that are not necessary; reduction
in Over Head cost including costs related to marketing and distribution; better
recruitment strategy; better human resource management; reduction in after sales
service cost; better and and efficient information technology service and savings in
purchasing cost (strong purchasing power).
In term of increase in revenues, acquiring firm would has better product mix
(applying with the firm mergers and acquires its suppliers); improvement in brand
image; better range of product and services; more effective pricing policy and lower
competition.
2.4.2

Disadvantage

On the other hand, M&A will still bring some disadvantages for firms. First, it makes
the disturbance in organization and management. M&A forces target firms or even
acquiring firms have to change in organization and management. The process of

changing puts firms into the chaos then effects to enterprise’s operation. Second, the
threat of monopoly, merger and acquisition of firms in the same industry would
generate a bigger competitor for other firms. That new firm may take control in both
supply and distribution channels and then destroys the competitive business
environment of this industry. Although there have been many anti-monopoly laws and
regulations issued recently, M&A is still a threat for new market economy.
2.5 Experience of M&A in the world
Lesson learn from the successful M&A deal: Time Warner and Turner
Broadcasting system – 1995
The merger between Time Warner (TW- an US media and entertainment corporation)
and Turner Broadcasting System (TBS -the company managing the collection of cable
networks such as CNN, HLN, Cartoon network, TBS….) has been a greatest
successful deal all the time. Two Managing Directors, Gerald Levin for Time Warner
and Ted Turner for TBS, made surprised to everyone when they were partners in the
deal that nobody thought it had a happy-ending. In the time of merger, TBS was in
serious financial situation. After acquiring MGM in 1986, TBS fell in to debt burden.
TBS also depended the distributions system of two cable companies (Telecommunication and TW). With TW, it had to face to competition from merger of Walt
Disney and Capital cities/ABC.
When merger announced, all experts were doubt about the success of deal and
someone thought that Levin and Turner could not integrate. Two companies have a
huge difference of management style. TBS was controlled by experiences while TW
was controlled by scientific methods. In the first time, managers of TBS felt
uncomfortable because their decisions were analyzed strictly by others. When time
went by, two parties realized many benefits from consolidation such as: Cable
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Television system could buy content from film producers and sponsor back to
publishing activities like Time and Sport Illustrated. Some products as Batman might
be used in film systems, publishing and cable television…These products were known

more and more people and created a lot of revenues.
With the abilities of both content and distribution of media products, company after
merger has took advantages from these sides to make profit. In the past, film was
shown on cable television too late, about 6-8 years from they were released. In other
way, cable TV is the last period of film life cycle. Because of the strength of
distribution, TW now can bring film on cable TV faster. This help to create number of
cable TV users and revenues from advertising.
More and more investors took care about this merger. TW has been develop to a
simple of biggest media and entertainment Inc on publishing, film and music
production, cable TV…Strategy of using many media channel in order to introduce
the same content has been effective.
Lesson learn from the fail M&A deal: The collapse of Indiainfo.com
The case of Indiainfo.com (an Indian software company) is the typical one which
refer to risk in M&A and reckless investment. In the period from December 1999 to
February 2000, Indiainfo.com began its business by strategy of massive advertising,
which was spent 11 – 15 billion Rupee and this company also said that he would catch
up the top company named Rediff.com. When Mr. Raj Koneru – the company’s
founder – recruited some professional managers, some adventure funds were
interested in. Believing in an ambitious future of company, Morgan Stanley decided to
invest 11.5 billion US dollar to take 7% of capital of company. However, it is difficult
to manage a rapid growth company. The culture conflict between Ryan’s old
management style and professional management style came from Morgan Stanley
pushed company in bad situation. Mr. Raj Koneru participated deeper and deeper in to
merger and acquisition deal without discussing with his managers. In many deal, cash
was used for payment. For instance, the acquisition VSNL – a leader Indian internet
supplier – worth 200 billion Rupee (45 million US dollar), the purpose of this
acquisition was website of Indiainfo.com would open when a person used VSNL. All
Indiainfo.com managers knew this deal when they were in press conference.
All M&A deal that Raj Koneru carried out would spend one billion. Koneru also
made mistake when he postponed IPO plan. This delay may come from the M&A that

took a huge of money and time. The large number of advertising cost, salary and
M&A cost was over 30 billion Rupee in September 2000. This situation dedicated an
early bankruptcy.
2.6 Role of the Investment Bank (IB)
The Investment banks play an important role in the M&A operations because:
 The acquiring company and the target company normally appoint an IB as an
adviser in the operation. (Because they are professional)
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