2. Synergy
1+1=3
• Synergy is derived from two words “synchronous energy”.
• Economies of Scale and Economies of scope are used to achieve
synergies and help companies grow.
• Economies of Scale revolves around reducing the fixed cost per unit.
Suzlon acquired 62% stake in REPower in May 2007 because the
company believed that the high fixed costs in wind turbines business
will get spread over a larger capacity when the two companies scale
up.
• Economies of Scope refers to reducing marketing costs per unit.
Vodafone acquired 74% stake in Hutchison Essar to achieve
economies of scope.
3. Lower Gestation Period
• Capital Intensive industries require high capex and long gestation
periods.
• Harshad Mehta, the controversial big bull of Indian Capital Markets,
firmly propagated the replacement cost theory. He kept buying shares
of ACC stating that the stock price had to reflect the replacement costs
of cement plants.
• One of the main reasons for Tata acquiring Corus was the gestation
period in the steel industry.
• It is believe that it would take Tata Steel at least 10-15 years to
develop the capabilities and market of Corus.
* In case of Idea-Spice merger, according to experts, setting up operations in a new circle requires a breakeven period of nearly three years.
4. Unlocking Value from Sick Units
• Tax Savings are a major reason for many companies merging
with BIFR cases in India.
• Even in the US, companies are allowed to carry forward their
losses up to a period of seven years.
• If a company has a taxable income of 10 crores and it merges a
sick company with with a loss of 6 crores, then its taxable income
comes down to 4 crores giving a tax benefit of 1.8 crores. (3 – 1.2
= 1.8).
• We will take a case study on unlocking value of sick units later in
our lectures.
5. Diversification
• This is a case where a company chooses to spread the risk by
forming a conglomerate through M&A.
• Wipro recently diversified into water purification business by buying
Mumbai-based Aquatech Industries.
• The buy has equipped Wipro with capabilities to provide complete
water treatment solutions including process, plant, equipment and
services for all types of industries.
• Aquatech is also a dominant player in the high purity water segment
for the pharmaceutical industry, which will be an added advantage
for Wipro.
• Wipro, in this case, is spreading its risk by diversifying into water
purification business.
6. Strategic Fit
• Companies use M&A to achieve purely strategic objectives.
• The best example is the recent acquisition of Air Deccan by Kingfisher
Airlines.
• Both had a completely different target market and it was considered a
surprising move considering Vijay Mallya’s flamboyance.
• However, the primary reason for going for the acquisition was the fact
that Air Deccan would get international license much before Kingfisher
Airlines.
7. Horizontal Integration
• Lets first understand the “Rule of 3”.
• The recent acquisition of 40.8% in Spice Communications by Idea Cellular
was done to perform horizontal integration.
• Bharti and Reliance are the top two private telecom operators by market
share.
• With ARPU’s falling and competition increasing, telecom companies in India
are looking to keep capex under control.
• Idea increased its market share to 11.9% and increase its subscriber base
by 17%.
8. Distribution Channels
• M&A can also be used as a tool to develop distribution channels so that the
company can reach its customers in a better way.
• Building new distribution channels can be a time consuming and daunting task.
In a marketing based economy, distribution channels are a critical aspect of
strategic planning.
• Take the case of insurance companies.
• In Feb 2007, AIG Inc.'s American General Life Insurance Co. Unit acquired
stake in Matrix Direct Inc., A Direct Marketer of Term Life Insurance to access
its distribution channels.
• In the case of insurance companies, distribution accounts form the largest
element in insurers’ costs and impact the profitability. .
9. Vertical Integration
• Vertical Integration is all about controlling you value chain.
• The concept of “Vertical Integration” was introduced by Andrew
Carnegie at his steel company towards the end of the nineteenth
century.
• Andrew Carnegie obtained greater efficiency by purchasing the coke
fields and iron-ore deposits that furnished the raw materials for
steelmaking, as well as the ships and railroads that transported these
supplies to his mills.
• Carnegie Steel was merged with several other companies to form the
U.S. Steel company by JP Morgan in 1901.
10. Acquisition of Brands
• Good brands, over a period of time, become an integral part of the
consumers' lives and this goes a long way in adding to the brand
equity of the product.
• Acquisitions of Brands has become an important strategic element for
companies.
• In May 2001, Marico Industries completed the acquisition of two
brands Parachute and Saffola from Bombay Oil Industries. The
acquisition saved Rs 3 crore annually on royalty payments Marico was
making to Bombay Oil, the original owner of the brands.
• In July 2008, Glenmark reached an agreement with Iceland’s Actavis
and its Polish affiliate Biovena to acquire seven pharmaceutical brands
in Poland. The acquisition gives the company access to the Polish
market, touted to be the largest pharma market in Central and East
Europe.
11. Access to talent
• Access to talent can be a major reason for service companies to perform
M&A.
• An interesting observation was made while working on a deal in the IT
sector.
• Minacs Worldwide merged with AB Nuvo at 0.5 times revenues and Kanbay
merged with Capgemini at 6 times revenues.
• The valuations were extreme because Minacs was a call center and Kanbay
was a high end solutions provider.
12. Pure Profits
• Private equity players have been in the news since the 80’s decade of
Reaganomics.
• Private equity players are mostly interested in IRR.
• PE players acquire stakes in companies and de-list them of stock
exchanges to later sell them and make profits.
• Our team worked on a PE deal where in an Indian company was
acquiring stake in a Belgian company. The valuations of the deal
revolved completely around the IRR of the PE player who owned the
company rather than the actual fundamentals of the company.
13. Conclusion
• We have discussed the primary reasons for companies to perform M&A
activities.
• The reasons discussed point towards the fact that M&A is primarily used by
companies as a tool to expand inorganically.
• The critical point to note is that the strategy should be very clear when
performing M&A activity.
• The M&A activity should be a part of the grand strategy of the company.
