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

2. 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.

3. 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!

4. 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.

5. What are the categories of merger/takeover?
Horizontal
Vertical
Conglomerate
Lateral integration

6. 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.

7. 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.

8. 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.

9. 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!

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

11. 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)

12. 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.

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

14. 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

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

16. 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

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