Economic Environment of Business Lecture Four: Merger, takeover and organic growth

How can firms grow? Retain profits Issue new shares Borrow externally  Internal growth (organic) v merger/ takeover Firms may merge by agreement, or be acquired in a hostile takeover.

What is a merger/ takeover? Mutual agreement of both sets of managers Usually merger of shares into new company e.g. Lloyds TSB Takeover: A makes a direct offer to stockholders of B to gain control. Price usually above market value e.g. HSBC took over Midland – the latter name disappeared!

Why do firms decide to merge? Growth Economies of scale Monopoly power Increased market valuation Reduced uncertainty Opportunity These are explored in detail: Organic growth may be too slow, so firms may decide to merge or takeover competitors These reasons may be appropriate to certain types of merger activity.

What are the categories of merger/takeover? Horizontal (@80%) Vertical (@5%) Conglomerate (@10%) Lateral integration (@5%)

Type of Merger influenced by different motives: Some merger/ takeover activity may be based on speculation, others by the personal ambitions of managers etc. The following slides provide a summary of some of the speculative, costs and managerial motives.

Value Discrepancy Analysis Economic agents operate in a world of: Uncertainty, and Imperfect information As long as Firm A values Firm B greater than Firm B values itself, then A will take over B as long as there is sufficient value added to cover the costs of acquisition. Consider why this may occur: e.g. Rapid changes in technology etc.

Valuation ratio = Market Value/Asset Value   = Market Value/Asset Value = No.Shares x Share Price/Book Value of Sales Targets of asset strippers if share price is low compared to value of its assets. Consider the vulnerability of firms growth via internal funds - e.g. low dividends - low share price etc.

Market Power Theory Companies merge to withstand adverse economic conditions and to increase long term profits: Excess capacity - rationalisation To fight overseas competition Due to tighter laws on collusion Thus a by-product and a cause of increasing market power!

Economies of Scale Lower average costs due to specialisation, and management and research and development economies at the firm level. Synergy 2 + 2 > 4 effects. Strengths of merged firms are complementary In practice, often acquire more plants rather than expanding plant size and synergy difficult to measure.

Managerial theories Growth of firm as an aim of the “Chairman” to warrant: higher salary (33%up, after 2 years) power status job-security (take over less likely)

What are the implications of merger/ takeover activity? The larger firms may operate in a manner deemed to be against the public interest. Legislation and institutions to weigh up costs and benefits to the economy as a whole in terms of: Economic efficiency Economic Welfare See session on Competition Policy Large firms will argue that they can provide the public with more goods/services at lower prices due to scale economies. The counter-argument is that they will exploit their market power.

What type of merger activity is taking place? Consider why Joint Venture is the most common form of merger activity.

What Countries are Involved in Merger Activity? Note the significance of EU merger activity – Would you expect the US to account for a higher percentage of this? Adapted from Griffiths & Wall, p89

Top 5 Sectors Involved in Merger Activity Look in the Times, Guardian or Telegraph for examples of current activity in these sectors

Increasingly, firms expand overseas: Why? Growing similarity between national and EU markets Ability to find a good strategic fit Establishing a market presence overseas ahead of others Obtaining greater growth potential at a lower cost abroad than at home

Overseas Growth Activity: Note the significance of international merger activity within the EU – Links clearly developing between member states.