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mergers and acquisition

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Introduction

1.1 Mergers and acquisitions The phrase mergers and acquisitions refers to the aspect of corporate finance strategy and management dealing with the merging and acquiring of different companies as well as other assets (Wikipedia, 2006). Often many refer a "merger" and an "acquisition" involving two corporate companies, as implying the same thing. However, this is not exactly the case. When a company purchases another company, it is called an acquisition and from a legal point of view, the purchased company ceases to exist and the buyer "swallows" the business, and it continues to be traded (Investopedia, 2006). It declares a merger between two companies, often referred as a "merger of equals" occurs when the shareholders of the existing separate companies agree to go forward as a new single combined company rather than remain separately independent. An actual "merger of equals" rarely occurs, as the shareholders of one of the companies involved have the majority of the equity shareholding in the combined company because of its larger relative size and/or market capitalisation. For example in a merger between company A and company B; company A shareholders received 55% of the combined stock in the newly formed company, and company B shareholder received the remaining 45%. This type of merger is seen as a takeover of one company by another, even though both parties agreed to operate as one combined company. Examples are BP's dominating shareholding merger with Amoco, and AOL's dominating shareholding merger of Time Warner. The term "merger" is used in order to make the takeover more appealing to the shareholders of the smaller company, who have the minority shareholding of the combined company relative to the shareholders of the larger company. ...read more.

Middle

He makes a case that conglomerate mergers and acquisitions can enhance power by forcing suppliers to buy products from its different divisions under the threat that it will stop buying from them if they won't comply. Watson and Head (2004) both argue that an organisation can gain market power through horizontal integration by its ability to earn monopoly profits due to fewer competition, and through vertical integration by having more influence in the raw materials or distribution markets. McLaney (2003) believes that when the bidder and target are in competition for revenue and market share in the industry they compete in, a merger between the two companies will enable the combined company to have a larger market share for their merged assets. He goes on to explain that their combined strength in the marketplace might enable prices to be raised without loss of their combined turnover, which will result an increase in their market revenue. 2.3 Economies of scale Arnold (2005) argues companies can gain from economies of companies through a merger by using its larger size which often leads to lower cost per unit of output. He states the other areas where costs savings can be achieved in a merged entity - advertising, distribution, administration, research and development, and purchasing. He believes that managers and executives benefit from mergers and acquisitions by improving their work at a larger firm with a prepared programme of training and access to a wider range of knowledgeable and experienced colleagues. He believes a combined merged company can also achieve economies of scale financially as well by being able to sell off surplus building, machinery, and making surplus workers redundant in order to cut overcapacity. ...read more.

Conclusion

While the second potential source, they point that by allowing the enlarged company to borrow more through an increase in debt capacity and so thus obtain more interest tax relief. 2.6 Risk diversification Damodaran (2006) does argue diversification reduces an investor's exposure to a company's risk level. He points out that by purchasing companies in other businesses that will help it to diversify, executives of the acquiring company argue they can reduce earnings volatility and spread risks. Besanko, Dranove, Shanley, Schaefer (2001) all believe company shareholders may benefit from diversification if its directors are able to identify other firms that are undervalued by the stock market. Arnold (2005) argues one of the primary reasons for conglomerate mergers is that the overall income of the holding company will be less volatile and more stable, if the cash flows come from a broad diversity of products and markets. He does see a positive in the diversification of unrelated income streams that would improve the situation for the company shareholders where they would obtain a reduction in risk without a decrease in return. He goes on to say that diversification will appeal to the lender as a result of greater stability; hence the merged company will be charged lower interest rates at the time of borrowing. He believes as a result of reduced earnings volatility, a company would avoid defaulting on interest payments on borrowing as there is likelihood of the company producing negative returns is very small. Lumby and Jones (2004) believe another frequently given reason for an acquisition or merger is that it will help diversify a company's existing business and hence reduce a company's risk level. ...read more.

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