Chapter 14 • Corporate restructuring
l combining administration and accounting activities leading to savings in the asso-
ciated costs; and
l raising and servicing finance being on a larger scale and therefore possibly cheaper.These economies of scale would tend to give rise to decreased total cash outflows.Access to some aspect of the target that the bidder considers
underutilised
Assets considered to be underutilised might include:
l particular tangible assets, including land, plant and cash, that are not fully ex-
ploited; and
l particular intangible assets such as standing in some market, perhaps an export
market or a particular contract; or technological expertise, which could be better
exploited.Underutilisation of assets suggests poor management, and bidders will sometimes
be attracted to such targets where they have an abundance of management skills
themselves. Businesses must seek ways of promoting rising management talent, and
expansion through merger with mismanaged businesses provides an excellent means
of creating opportunities for promotion. Underutilisation of assets implies the pos-
sibility of acquiring assets at a discount on their potential economic value.
The overall effect of such mergers would be expected to be an increase in positive
cash flows, through stronger management skills being brought to bear on the target’s
assets. They may also decrease uncertainty about the cash flows – in other words, they
may reduce risk.
Underutilisation of assets is likely to be the reason for a potential target to attract
the interest of a private equity fund. The fund would see that there is the possibility
of managing the business more effectively than had recently been the case. By doing
this, the fund would expect to add value that it could then realise, probably through
reselling the revitalised target.Risk spreading and reduction through diversification
Merging two businesses with different activities will reduce risk since the returns from
the different activities are unlikely to be perfectly positively correlated with one another.
Although this factor is frequently put forward as the justification for such mergers,
in the context of maximisation of shareholders’ wealth it could well be invalid. This is
because, as we saw in Chapter 7, such diversification could be, and probably is, under-
taken by individual shareholders at little or no cost. Having this done for them may
not increase their wealth. The evidence on the success of mergers in practice, which
we shall review later in the chapter, seems to indicate that ‘diversifying’ mergers are
not successful.
As we saw in Chapter 2, this provides us with an example of possible conflict of
interests between shareholders and managers – an agency problem. Shareholders are
unlikely to benefit from the merger because they will typically have undertaken such
risk-reducing diversification on a ‘homemade’ basis.
The managers, on the other hand, do not hold portfolios of employments, so the
only way that they can achieve this risk reduction is through diversification within
the business. A popular way to diversify is through merger, though this would by no
means be the only way.