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Mergers: the practicalities

Legislation to protect the public interest from monopolies has meant that mergers

within the same industry have sometimes been impossible to achieve. This could leave

businesses that are ambitious to expand with diversification as their only possibility.

It should be noted that, irrespective of the benefits of diversification, the other reasons

for merger could still apply to a particular case involving businesses in different

industries. Even economies of scale, particularly in the administration of the merged

business, could apply.

Synergy

We can see then that, in theory, mergers can bring real benefits to shareholders owing

to genuine increases in positive cash flows and/or risk reduction. These benefits are

often referred to as arising from synergy, a ‘two plus two equals five’ syndrome with

the whole being greater than the sum of the parts.

We should note that these synergy benefits accrue to the shareholders of the

target as well as to those of the bidder. Merger can take place only where target share-

holders are prepared to sell their shares. They will do this only where they are offered

something in excess of what they perceive to be the current value (usually the Stock

Exchange quotation) of those shares. Unless the capital market and the management

of the bidder are basing their valuations on different information from one another,

this excess can only exist due to the synergy benefits perceived by the bidder’s

management.

Going back to Example 14.1, the excess of £5.83 million over the current market

value of the equity of Target is a measure of the value of the synergy benefits. If the

current market value of Target’s equity is as high as £5.83 million then there will be no

synergy benefits of merger and, from a financial viewpoint, it should not take place.

If the market value of Target’s equity immediately before the merger is below

£5.83 million but Bidder has to pay as much as this to persuade the shareholders to

sell, then all of the benefits from synergy would accrue to Target’s shareholders, and

none of it to those of Bidder. It is therefore unlikely that Bidder would offer as much

as the £5.83 million.

14.3 Mergers: the practicalities

Financing mergers

It is important to realise that mergers are basically open market transactions, with one

party (the bidder) buying assets from others (the target’s shareholders). How much

the bidder offers and how it proposes to pay are matters of judgement, which must

be decided by the management. Often, in practice, such decisions are made only after

taking advice from experts, usually merchant bankers. As regards financing, the

bidder must seek a method that is both attractive to the target’s shareholders and

acceptable to itself.

The following are commonly encountered approaches to merger financing.

Cash

Cash has its attractions to the recipients as it gives something that they can use imme-

diately, either for consumption or reinvestment, without having to incur any cost.

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