Mergers and Acquisitions From Financial Prospective

7/29/2019 Mergers and Acquisitions From Financial Prospective

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Mergers and AcquisitionsFrom Financial prospective

By Mohamed Khalifa et. al.



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ContentsAbstract ......................................................................................................................................................... 2

Introduction .................................................................................................................................................. 2

Mergers or Acquisitions defining the terms ................................................................................................. 4

Reasons for Mergers and Acquisitions ......................................................................................................... 4

Types of Mergers and Acquisitions ............................................................................................................... 8

Financing the mergers and acquisitions ....................................................................................................... 9

Valuation Matters ....................................................................................................................................... 10

Financial Analysis in Mergers and Acquisitions .......................................................................................... 12

Due Diligence .............................................................................................................................................. 16

The Risk in Trade-Offs between Buyers and Sellers in Mergers and Acquisitions ...................................... 17

Conclusion ................................................................................................................................................... 19

References: ................................................................................................................................................. 21



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Abstract

The consequences of mergers and acquisitions on corporate financial performance, there are

factors that might affect the performance of corporations such as synergies. This paper aims at

reviewing and analyzing these factors on mergers and acquisitions and its effects on the financial

performance. Previous reviews and literatures are using varieties of measures to examine the

impact of mergers and acquisitions on corporate financial performance, this paper concluded that

there are some factors that affect the financial performance, as follows:

1. Methods of payment

2. Methods of valuation.

3. The extent of synergy.

4. Objective of the M&A.

5. Accuracy of Due Diligence.

6. The risk level borne by each party.

Corporate managers should bear in mind such factors and their impact on the post-merger and

acquisition corporate financial performance to evaluate the proposed offers of mergers and

acquisitions accurately and take profitable decisions.

IntroductionMergers and acquisitions (M&A) are an aspect of corporate strategy, finance and management

dealing with the buying, selling, dividing and/or combining of various companies and similar

entities that can aid an enterprise grow faster in its respected sector or geographical location, or a

new market or new location, without creating a subsidiary, other child entity or using a joint

venture. M&A are a large portion of the corporate business world. According to the

investopedia.com website, every day, Wall Street investment bankers operate M&A transactions

that bring companies together to create bigger ones. Deals can be worth hundreds of millions, or

even billions, of dollars. These mergers can record the fortunes of the corporates involved for

years to come.

M&A represent the ultimate in change for a corporate; for the business managers no other event

is more difficult, challenging, or chaotic as a merger and acquisition. It requires that everyone



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involved in the M&A process has a very clear understanding of how, where and when the

process works.1

The term "merger", is used when referring to the merging of two companies forming one new

company that will continue to exist. The term "acquisition" refers to the acquisition of assets by

one company from another one. In some cases of an acquisition, both companies may continue to

exist.1

There is several numbers of motives that may play a role in merger activity. The most general

motive is simply that the acquirers consider the acquisition to be a profitable investment. Firms

will go for acquisitions when it is the most profitable means of enhancing capacity, obtaining

new experience or skills, entering new market or geographic areas, or reallocating assets into the

control of the most effective managers. That’s why; many of the factors that affect the decisionof major investment would also influence merger activity.2

According to the Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA)

analysis in Table 1, The Largest Mergers and Acquisitions Transactions that occurred

worldwide since 01 January 1985 till 19 January 20123

Year Acquirer Target Transaction Value

(in billion USD)

1999 Vodafone AirTouch PLC Mannesmann AG 202.82000 America Online Inc. Time Warner 164.7

2007 Shareholders Philip Morris Intl Inc. 107.6

2007 RFS Holdings BV ABN-AMRO Holding NV 98.2

1999 Pfizer Inc. Warner-Lambert Co. 89.2

1998 Exxon Corp. Mobil Corp 78.9

2000 Glaxo Wellcome PLC SmithKline Beecham PLC 76.0

2004 Royal Dutch Petroleum Co. Shell Transport & Trading Co. 74.6

2006 AT&T Inc. BellSouth Corp 72.7

1998 Travelers Group Inc. Citicorp 72.6

2009 Pfizer Inc. Wyeth 68

2008 InBev Inc. Anheuser-Busch Companies, Inc. 52Table 1

The Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA) analysis,

expressed the announced Mergers & Acquisitions worldwide, 1985-2012 (as of 24 November

2012) in figure 1.3



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Figure 1

Mergers or Acquisitions defining the terms

The terms merger and acquisition are usually unclear or used interchangeably. The difference

between the two is important to be clear. The definition of the words is as follows: 4

• Merger: A combination of two or more companies in which the assets and liabilities of

the target company(s) are absorbed by the buying company. Although the buying

company may be a considerably different organization after the merger, it retains its

original identity.

• Acquisition: The purchase of an asset such as a plant, a division, product line or even an

entire company.

Reasons for Mergers and Acquisitions

Each and every merger transaction has its own unique reasons why. The implicit principle

behind mergers and acquisitions is the simple equation of synergy; as in 1+1 =3. The value of

Company X is $ 2 billion and the value of Company Y is $ 2 billion, but when they merge

together, the total value will be $ 5 billion.1



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Synergy is the additional value created (∆V), as in the following formula: 6

Where:

∆V= VA – T - (VA+ VT)

VT = the pre-merger value of the target firm

VA - T = value of the post-merger firm

VA = value of the pre-merger acquiring firm

The combining of the two firms creates additional value which is called "synergy" value which

can take one of three forms:1

1. Revenues: By joining the two companies, they will realize higher revenues than if they

operate independently.

2. Expenses: By joining the two companies, they will realize lower expenses than if they

operate independently.

3. Cost of Capital: By combining the two companies, they will experience a lower overall

cost of capital.

It would be very unlikely for owners to sell if they would gain more by not selling. Which means

buyers will need to pay more (a premium) if they want to buy the company, In spite of what pre-

merger valuation price. For the sellers, that premium reflects the company's future prospects. For

buyers, the premium reflects part of the post-merger synergy they forecast to be achieved. The

following equation offers a good way to evaluate synergy and how to determine whether a

merger or acquisition transaction makes sense. The equation solves for the minimum required

synergy: 5

The largest source of synergy value is lowering the expenses. Several mergers were driven by the

urge to cut costs. Cost savings always come from the omitting of unnecessary or duplicated

supportive functions, such as HR, Accounting, IT and so on. The ideal mergers might have

strategic reasons for the business combination. These reasons include but not limited to: 1



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New segments talking and Positioning - Taking the benefit of future opportunities that

may be exploited when the two companies are joined.

Fortifying the weakness “Gap Filling” - A company may have an obvious weakness in

distribution and strong finance whereas the second company has strong distribution and

weak finance. By merging these two companies, each company will fills-in a strategic

gap that is crucial for their long-term survival.

Organizational Competencies - Acquiring companies with strong human resources and

or intellectual capital can improve innovative thinking and progress within the first

company.

Fast Market Access – Merging with or acquiring a foreign company will give quick

access to emerging global markets geographically.

Mergers and acquisitions will also be carried out by basic business reasons, such as: 1

Capital investment reduction - It could be cost effective to acquire another company

than to invest internally. Such as if a company is looking for expansion of its

manufacturing facilities. A second company may have a very similar facility that is idle.

It could be more cost effective to just buy this second company with the unused facilities

than building a new facility.

Diversification - It is necessary to increase earnings and get more consistent long-termrevenue growth and profitability. This occurs for companies in very mature industries

such as the pharmaceutical industry where future growth will be questioned.

Short Term Growth – Company management always under the pressure to turnaround

slow growth and profitability. So mergers and acquisitions are the easy way to boost poor

performance.

Undervalued assets - The acquired company’s assets may be undervalued and that’s

why it represents an attractive investment.

We have to know that merger activity is something other than a simple extension of business

investment. Regardless of the main motivations for mergers, there are a few categories of factors

that tends to play a role in a least some mergers. Hereunder are some of these factors; 2



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Efficiencies

Companies might combine their operations through mergers and acquisitions of company

assets to diminish production costs, improve product quality, increase output, gain new

technologies, or provide new products. The efficiency benefits from mergers and

acquisitions include both operating and managerial efficiencies. Operational efficiencies

may arise from economies of scale, production economies of scope, and consumption

economies of scope, improved resource allocation. 2

Moving to an alternative less costly production technology ,enhanced use of information

and expertise, improved focus on core skills of the firm, a more utilized combination of

assets, reductions in transportation costs. The benefits from mergers and acquisitions are

not, however, restricted to little gains to the firms. The tendency of one firm to merge

with another firm or acquire its assets also creates a market for corporate dominancy. 2

Financial and Tax Benefits

Mergers and acquisitions can lead to financial efficiencies. For example, firms may

diversify their earnings by acquiring other firms or their assets with different earnings

flow. 2

Diversification in earnings within firms may minimize the variation in their profitability,

reducing the risk of bankruptcy. Under other conditions, tax benefits may turn out to be

the underlying motive for a merger. Assume when a firm with accumulated losses

mergers with a profit-making firm, tax benefits are utilized better. Because these

accumulated losses can make up for the profits of the profit-making firm. 2

Market Power Effects

Some mergers may end up with market power which pours into the benefit of the

merging firms.2



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Management Greed, Self-Aggrandizement

Some managers may overemphasize growth, or simply make wrong acquisition

decisions. Though self-aggrandizement and greediness by managers may motivate some

mergers and acquisitions, in most cases managers who make poor acquisitions increase

the likelihood that they will, themselves, be an acquisition targets. 2

Utilization of surplus cash:

A firm in a mature industry may generate a lot of cash but may not have profitable

investment opportunities .In such a situation, a merger with another company involving

cash compensation often stands for a more effective utilization of surplus funds. 2

Types of Mergers and Acquisitions

From the business structures point of view, there are different types of mergers, distinguished by

the relationship between the companies that are merging: 5

Horizontal merger - Two firms that are in a direct competition and share the same

product lines and market, as in pharmaceutical industry where the synergy can obtained

by many forms such as; increased market share, cost savings and exploring new market

opportunities.

Vertical merger – Backward or forward vertical merger as in a distributor and

manufacturing company or a supplier and company, major motive will be cost savings

and process efficiency.

Market-extension merger - Two companies that are in the same industry with similar

product but in different markets.

Product-extension merger - Two companies are in different industries but still

related products in the same geographical market.

Conglomeration - Two companies that are working in totally different business areas.



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Classification by how the merger is financed. There are two types, each has certain implications

for the companies involved and for investors: 5

Purchase Mergers - The purchase is made with cash or through the issue of some kind

of debt instrument; the sale is taxable. Acquirers usually prefer this kind of merger

because it can provide them with a tax benefit. Acquired assets can be written-up to the

actual purchase price, and the difference between the book value and the purchase price

of the assets can depreciate annually, reducing taxes payable by the acquiring company.

Consolidation Mergers – A new company is formed and both companies are bought

and combined under the new entity. The tax terms are the same as those of a purchase

merger.

Also there is a type of acquisition which is a reverse merger, which is a deal that enables a

private company to get publicly-listed in somehow short period. A reverse merger take place

when a private company that has a very strong prospects and is seeking to raise financing buys a

publicly-listed shell company, normally a company with no business and limited assets. The

private company reverse merges into the public company, and together they become an entirely

new public corporation with tradable shares.5

Financing the mergers and acquisitionsMergers are identified from acquisitions by the method in which they are financed and also by

the relative size of the companies. Different methods of financing merger or acquisition deal

exist, but they mainly fall under the following category: 6

Cash Transaction - The receipt of cash for shares by shareholders of the target

company. Such transactions are normally called acquisitions rather than mergers because

the shareholders of the target company are removed from the picture and the target

company goes under the (indirect) control of the bidder's shareholders.

Share Transaction - The offer by an acquiring company of shares or a combination of

cash and shares to the target company’s shareholders, in simple words payment in the

form of the acquiring company's stock, issued to the shareholders of the target company

at a given ratio proportional to the valuation of it.



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Going Private Transaction (Issuer bid) – it is a special type of acquisition where the

purchaser already owns a majority of the target company shares and wants to fully own it

back again as in the Virgin company example

Table 2 Adapted from reference 4

Valuation Matters

Investors aiming to take over a company should determine whether the deal will be of benefit to

them. In order to do so, investors must ask themselves how much the acquired company is really

worth.5

According to L. Booth and W. Sean Cleary (2007) the Fair market value (FMV) is the highest

price obtainable in an open and unrestricted (free) market between knowledgeable, informed and

prudent parties acting at arm’s length, with neither party being under any compulsion to

transact.6

Normally, the two sides of merger or acquisition deal will have different point of view about the

worth of the target company: the sellers will try to value the company as high as they can, while

the buyer will tend to get the lowest price that they can. There are many direct and clear



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legitimate methods to value companies. The most common way is to look at comparable

companies in the same industry, but there are a variety of other methods and tools to assess a

target company. Such as: 5

1. Comparative Ratios - The following are two methods of many comparative metrics on

which acquiring companies may base their offers:

Price-Earnings Ratio (P/E Ratio) - An acquiring company makes an offer that is a

multiple of the earnings of the target company. By viewing the P/E for all the stocks

within the same industry this will give the buyer company good guidance for what the

target's P/E multiple should be.5

Enterprise-Value-to-Sales Ratio (EV/Sales) - The buyer company makes an offer as a

multiple of the revenues, while being aware of the price-to-sales ratio of other companies

in the same industry. 5

2. Replacement Cost - In some cases, acquisitions are valued based on the cost of replacing

the target company. The value of a company is the sum of all its equipment and staffing costs.

The buyer company can order the target to sell at that price, or it will create a competitor for

them with the same cost. Usually, it takes a long time to create a company. This way of

establishing value of a company definitely wouldn't make much sense in a service industry

where the key assets - people and ideas - are hard to value and develop. 5

3. Discounted Cash Flow (DCF) – It is the key valuation method in mergers and acquisitions;

discounted cash flow analysis determines a company's current value according to its estimated

future cash flows.

Forecasted free cash flows =operating profit + depreciation + amortization of goodwill –

capital expenditures – cash taxes - change in working capital

The forecasted FCF are discounted to a present value using the company's weighted average

costs of capital (WACC).5

Determining fair market value depends on the perspective of the buyer. Some buyers are

more likely to be able to realize synergies than others and those with the greatest ability to

generate synergies are the ones who can justify higher prices.6



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K= Discount rate CF= Free cash flow t= Time period

Types of buyers and the impact of their perspective on value include: 6

1. Passive investors – use estimated cash flows currently present

2. Strategic investors – use estimated synergies and changes that are forecast to arise

through integration of operations with their own

3. Financials – valued on the basis of reorganized and refinanced operations

4. Managers – value the firm based on their own job potential and ability to motivate

staff and reorganize the firm’s operations.

Reactive Pricing Approaches

Models reacting to general rules of thumb and the relative pricing compared to other

securities. 6

Multiples or relative valuation

Liquidation or breakup values

Proactive Models

A valuation method to determine what a target firm’s value should be based on future

values of cash flow and earnings as the discounted cash flow (DCF) models. 6

Financial Analysis in Mergers and Acquisitions

It is a crucial step for a corporate acquirer’s to assess and analyze the financial statement of an

acquisition or merger candidate, a corporate acquirer usually analyzes the current and potential

financial statements of a target company. This analysis is used in measuring the value of the

shares or the net assets of the target firm. 7



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How to determine value and price of Shares:

The principal determinants of the shares value (or net assets) of a target company are: 7

1. The quantity and timing of probable cash flows that will be generated. This includes

cash flows to be generated by the target company from its operations on a ‘stand-

alone’ basis as well as discretionary cash flows that a buyer anticipates will arise in the

form of post-acquisition synergies;

2. The acquirer’s required rate of return given its perceived risk level of achieving said

cash flows and its perception of the tar get company’s ‘strategic importance.

3. Non-operating assets that are acquired as part of the transaction.

The actual price that a corporate acquirer might be prepared to pay for the shares (or net assets)

of the target company may be higher or lower than its estimate of fair market value. This is due

to such things as the negotiating positions of the parties involved, the number of acquirers

interested in such Company at that time, and several other factors that take place during the

course of negotiations. 7

Prospective Discretionary Cash Flow

Any Business is usually valued based on its ability to prospectively generate cash flow.Discretionary cash flow is defined as cash flow from operations (Earnings before interest,

taxes, depreciation, and amortization ‘EBITDA’) less income taxes, capital expenditure

and working capital requirements. 7

Discretionary cash flow represents the amount of money available to the providers of

capital of a business (debt holders and shareholders) that can be withdrawn without

affecting the existing operations of the business, or its ability to generate its forecast

operating results.7

An estimate of prospective discretionary cash flow to be generated by a business normally

involves an assessment of the historical operating results of the target company and any

financial projections that have been prepared. In addition, an assessment of the prospective

discretionary cash flows to be generated normally includes those of the target company



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itself, and those that the acquirer anticipates will be realized in the form of post-acquisition

synergies. 7

Historical operating results

Recent historical operating results (normally the past five years) are considered when

estimating prospective operating results. The quantum of weight afforded to historical

operating results depends on whether and to what extent they are believed to represent

what the target company prospectively is capable of generating on a stand-alone basis. For

example, If the target company has made significant changes in the recent years (e.g.

Product lines extension, capacity, the dynamics of the industry in which it operates, etc.),

then historical operating results may not be indicative of future expectations. 7

Moreover, an analysis of the historical financial statements of an acquisition target normally

involves the calculation of various financial ratios that can generally be categorized as: 7

Profitability Ratios (e.g. profit margin, Basic earning power, return on assets) that

indicate the proportion of revenues retained by the company at different levels, and the

company’s sensitivity to fluctuations in revenues.

Asset Management Ratios (e.g. days at hand and inventory turnover) which assist a

buyer in assessing incremental working capital requirements that will be needed to

support prospective revenues, and in evaluating management efficiency

Liquidity Ratios (e.g. the current ratio and quick ratio), which measure the short term

financial strength of the business, and whether the buyer will be required to make a

capital injection to support the operations of the target company.

Debt management Ratios (e.g. Debt ratio and times interest earned) which measure

target company’s ability to accommodate interest bearing debt. This may in turn affect

the acquirer’s cost of capital, and its required rate of return

Operating Ratios (e.g. sales per employee and average selling price per unit sold), which

help a buyer in assessing the resource and capacity requirements of a target company.



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These mentioned above ratios can provide a buyer with insight into the reasons for a target

company’s historical performance. However, ratio analysis must be moderated by taking into

consideration the changes in accounting policies, management practices, and so on, which may

alter such analysis. In addition, when analyzing the historical financial statements of the target

company, it is important to consider the status of the economy and the industry at the time those

results were achieved.. Prior to selling a business, many owners and managers will take steps to

reflect the best possible financial results, knowing that those results often are a key element in

negotiations with prospective acquirers. Thus, owners and managers sometimes reduce spending

in discretionary accounts such as advertising, research and development, and so on, to increase

short-term profitability. However, these actions may have serious long term consequences to the

vendor’s business.7

One more thing should be taken into consideration is that analysis of historical financial

statements involves the identification of unusual or non-recurring items. This is because, by

definition, historical unusual and non-recurring items are not indicative of prospective operating

results. Sellers normally are quick to point out unusual and non-recurring items that negatively

impacted historical results. However, a buyer should consider whether these things truly are

nonrecurring. For example, while a costly strike may be unusual, it may recur in the future, and

hence should be considered either through a reduction of prospective discretionary cash flows, or

in the level of risk of achieving those cash flows. Just because an item is classified as ‘unusual’

or ‘extraordinary’ in the financial statements does not necessarily mean that it will not reappear.

Conversely, non-recurring and unusual items that favorably affected historical operating results

often are buried as part of revenues or expenses from ongoing operations. Examples include non-

recurring property tax refunds, a significant one-time sale, and the recovery of assets that had

previously been written down. The detection of these things requires careful analysis of the

historical financial statements, including ratios and so on. 7

The analysis of historical financial statements should not be limited to annual results. Quarterly

and monthly results also should be considered as these can provide insight as to seasonality and

short-term performance. 7



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Forecast operating results

When getting a business for sale, the owners, managers or sellers may prepare forecast

operating results. Where forecasts are prepared, they normally are for a period of 3 to 7

years. Where meaningful forecasts are available, a buyer typically will estimate the value of

the target company’s equity using a ‘discounted cash flow’ methodology as discussed

earlier.7

Due Diligence

There is a shared lead that runs throughout most of the mergers and acquisitions deals. It is the

Due Diligence. This is a very detailed and extensive evaluation of the proposed deal. An

important question is - Will this merger work? And to answer this question, it is a must to

determine what kind of "synergy" exists between the two companies. This includes: Investment

synergy - What financial resources will be required, what level of risk fits with the new

organization, and many questions that should be answered before doing the deal.1

Strategic synergy - What management strengths will be brought together through this

deal? Both parties must bring unique experience to the table to create synergies.

Marketing synergy – Does the products and services complement each other? Will the

various components of marketing fit together – promotion programs, brand names,

distribution channels, customer mix?

Operating synergy - Will the different business units and production facilities fit

together and how? How do labor force, technologies, and production capacities, fit

together?

Management synergy - What expertise and talents do both sides bring to the merger?

How well do leadership styles, strategic thinking, ability to change, and culture fit

together?

Financial synergy – Will the financial elements fit together and how?

Due diligence should be a cooperative and patient process between the buyer’s and seller’s. Any

trial to keep out or manipulate data will lead to risks and problems in the future.



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Misrepresentations of data or omissions will lead to post-closing litigation, which is expensive

and time consuming for both sides.4

Due diligence is very wide and deep, extending well beyond the functional areas (finance,

production, human resources, and marketing.). Due diligence must expose all of the major risk

associated with the proposed merger or acquisition. These risk areas that need to be investigated

are (Market - Customer - Competition - Legal) 1

The Risk in Trade-Offs between Buyers and Sellers in Mergers and

Acquisitions

In about most of all acquisitions, the acquirer’s stock price falls instantly after the deal is

announced. In most cases, that drop is a sign of worse to come. The market’s routinely negative

response to M&A announcements reflects investors’ skepticism about the likelihood that the

acquirer will be able both to maintain the original values of the businesses in question and to

achieve the synergies required to justify the premium.8

Reasons behind this are mainly the following: 8

First of all, many acquisitions fail simply because they set too high performance bar. Even

without the acquisition premium, performance improvements have already been built into the

prices of both the acquirer and the seller.

In other cases, acquisitions turn sour because the benefits they bring are easily replicated by

competitors. Competitors will not stand idly by while an acquirer attempts to generate synergies

at their expense. 8

Third reason of problems is the fact that acquisition – though it is a quick route to growth – it

requires full payment ahead. By contrast, investments in research and development, capacity

expansion, or marketing campaigns can be made in stages over time. So in acquisitions thefinancial clock just starts ticking on the whole investment just from the beginning. 8

The main difference between cash and stock transactions is that: In cash transactions, acquiring

shareholders take on the whole risk that the expected synergy value involved in the acquisition

premium won’t materialize. In stock transactions, that risk is shared with selling shareholders.



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More specifically, in stock transactions, the synergy risk is shared in proportion to the percentage

of the combined company the acquiring and selling shareholders each will own. 8

How Risk Is Distributed Between Acquirer and Seller

The risk is distributed between the buyer and the seller based on the way an acquisition is

paid for. An acquirer who pays mainly in cash, for example, presumes all the risk that the

price of its shares will drop between the announcement of the deal and its closing. The

acquirer also assumes all the operating risk after the deal closes. By contrast, an acquirer who

pays the seller a fixed number of its own shares minimizes its risk from a drop in share price

to the percentage it will own of the new, merged company. The acquirer that pays a fixed

value of shares assumes the entire pre-closing market risk but minimizes its operating risk to

the percentage of its post-closing ownership in the newly acquired company.

8

Table 3 Adapted From reference 8

Tax Consequences of Acquisitions

The way an acquisition is paid for whether cash or stock affects the tax bills of the

shareholders involved., a cash purchase of shares is the most tax-favorable way for the

acquirer to make an acquisition as it offers the opportunity to revalue assets and hence to

increase the depreciation expense for tax purposes. On the other hand, shareholders in the

selling company will face a tax bill for capital gains if they receive cash. They are therefore

likely to bargain up the price to compensate for that cost, which may offset the acquirer’s tax

benefits. After all, if the selling shareholders suffer losses on their shares, or if their shares

are in tax-exempt pension funds, they may favor cash rather than stock.8



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By contrast, the tax treatments for stock financed acquisitions appear to favor the selling

shareholders because they allow them to receive the acquirer’s stock tax-free. In other

words, selling shareholders can defer taxes until they sell the acquirer’s stock. 8

Conclusion

Our conclusion is that there are some major factors that affect the financial performance of a

corporate post-merger and acquisition, as follows:

1. Methods of payment from a taxation prospective - The way an acquisition is paid for

whether cash or stock affects the tax bills of the shareholders involved, a cash purchase of shares

is the most tax-favorable way for the acquirer to make an acquisition as it offers the opportunity

to revalue assets and hence to increase the depreciation expense for tax purposes.

2. Methods of valuation - We have concluded that to value the target company it is better to use

the comparative ratios method along with the discounted cash flow method as the first gives a

bigger picture versus the market and industry while the other method gives a snapshot on the

future estimated financial status of the post merge transaction in order to reach the ideal buying

price

3. The extent of synergy - The combining of the two firms creates additional "synergy" value

which can take one of three forms: Revenues, Expenses or Cost of Capital and the most likely

to bring highest synergy value is lowering the expenses due to omitting of unnecessary or

duplicated supportive functions, such as HR, Accounting, IT and so on

4. Objective of the M&A - There are various types of reasons and objectives for mergers and

acquisitions, accordingly the relative importance of the reasons is a major determinant of the

success of the M&A and the financial performance of the company post-merge, Overcapacity

deals and product-line extensions were the most common reasons, geographic expansions comes

third.

5. Accuracy of Due Diligence - Due diligence should expose all of the major risk associated

with the proposed merger or acquisition. These risk areas that need to be investigated are

(Market - Customer - Competition - Legal), any trial to keep out or manipulate data will lead

to risks and problems in the future and will lead to post-closing litigation, which is expensive and



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time consuming for both sides. The extend on how accurate the due diligence the more

successful the transaction and will impact positively on the financial performance of the

corporate

6. The risk level borne by each party – Distributing the risk between the buyer and the seller is

based on the way an acquisition is paid for. The buyer that pays mainly in cash presumes all the

risk that the price of its shares will drop between the announcement of the deal and it’s closing.

The buyer also assumes all the operating risk after the deal closes. By contrast, the buyer that

pays the seller a fixed number of its own shares minimizes its risk from a drop in share price to

the percentage it will own of the new, merged company. The buyer that pays a fixed value of

shares assumes the entire pre-closing market risk but minimizes its operating risk to the

percentage of its post-closing ownership in the newly acquired company

Corporate managers should bear in mind such factors and their impact on the post-merger and

acquisition corporate financial performance to evaluate the proposed offers of mergers and

acquisitions accurately and take profitable decisions.



21 | P a g e

References:1- Matt H. Evans; Mergers & Acquisitions (Part 1); Excellence in Financial Management; March 2000

2- Paul A. Pautler; Evidence on Mergers and Acquisitions ; Bureau of Economics, Federal Trade

Commission; September 25, 2001

3- Thomson Financial, Institute of Mergers, Acquisitions and Alliances (IMAA) analysis, extracted on 3

January 2013 on http://www.imaa-institute.org/statistics-mergers-acquisitions.html

4- Andrew J. Sherman and Milledge A. Hart; Mergers & Acquisitions from A to Z; 2nd edition;

American Management Association 2006

5- The Basics Of Mergers And Acquisitions; Investopedia.com, 2010,

http://www.investopedia.com/university/mergers/

6- Laurence Booth and W. Sean Cleary; INTRODUCTION TO CORPORATE FINANCE; Chapter 15 –

Mergers and Acquisitions; 2007 John Wiley & Sons Canada, Ltd.

7- Howard E. Johnson; Financial Statement Analysis in Mergers and Acquisitions;

Campbell Valuation Partners Limited publication; (www.campbellvaluation.com) ;

January 1, 20018- Alfred Rappaport and Mark L. Sirower; Stock or Cash? The Trade-Offs for Buyers and Sellers in

Mergers and Acquisitions; Harvard business review November –December 1999, Reprint 99611

http://www.imaa-institute.org/statistics-mergers-acquisitions.html





http://www.campbellvaluation.com/






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