Home Acquisition A study on mergers and acquisitions and their types

A study on mergers and acquisitions and their types

February 18, 2024

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This article has been written by Riya Puthran pursuing a Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management course from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

Mergers and acquisitions (M&A) are such business transactions where the ownership of companies or organisations is transferred to or consolidated with another company or organisation. Mergers are the combination of two companies to form one single entity, whereas acquisitions are when one company takes over the other. M&A has played a significant role in shaping India’s business landscape. Imagine India in the early 1990s, entering into an era of economic liberalisation. Numerous foreign technologies were brought into India, resulting in corporate sector development.

Types of mergers and acquisitions

Each type of M&A has its own set of pros and cons. Following are the different types of M&A used by business units.

Horizontal integration

Horizontal integration is when a company decides to acquire or merge with a competitor existing in the same industry or market to reduce competition or increase the market share of the company. For example – the acquisition of Instagram by Facebook in 2012 for $1 billion.

Horizontal integration can provide several advantages to the acquiring company, including:

Increased market share: By eliminating a competitor, the acquiring company gains a larger portion of the market, which can lead to increased sales, profits, and market dominance.
Economies of scale: Combining operations and resources with another company can result in cost savings and operational efficiencies. This can be achieved through the sharing of resources, such as manufacturing facilities, distribution networks, and administrative functions.
Enhanced market power: Horizontal integration can strengthen the negotiating power of the acquiring company with suppliers and customers. A larger market share gives the company more leverage in negotiating prices, terms, and conditions, which can lead to improved profitability.
Access to new technologies and capabilities: Acquiring another company can provide the acquiring company with access to new technologies, patents, and expertise. This can enhance the company’s overall capabilities and enable it to offer innovative products or services to its customers.

However, horizontal integration also poses some potential challenges, such as:

Antitrust concerns: Regulators and governments often scrutinise horizontal mergers and acquisitions to ensure they do not result in monopolies or substantially lessen competition in the market. Companies must carefully navigate antitrust laws and regulations to avoid legal complications.
Cultural and operational differences: Merging two companies with different cultures, structures, and processes can be challenging. Integrating the operations and aligning the cultures of the two companies requires careful planning, effective communication, and a strong change management strategy.
Employee redundancies: Horizontal integration can sometimes result in employee redundancies as the acquiring company may have overlapping roles or functions. This can lead to workforce reductions and potential employee morale issues.
Regulatory complexities: Merging two companies can involve complex legal and regulatory requirements, including obtaining regulatory approvals, addressing intellectual property rights, and complying with labour and employment laws.

Vertical integration

Vertical integration is when a company decides to acquire or merge with another company in the same industry but at a different level in the hierarchy. In this type of integration, a company merges with its supplier to improve efficiency or reduce dependency on external factors. Amazon and Apple can be good examples of the above.

There are two types of vertical integration:

Backward integration: This occurs when a company acquires or merges with its suppliers. This can be done to improve efficiency, reduce dependency on external factors, and gain better control over the quality of the inputs. Amazon is a notable example of backward integration. The company started as an online bookseller but has since expanded its operations to include a wide range of products, including electronics, clothing, and household goods. By acquiring or merging with suppliers, Amazon has been able to improve efficiency and reduce costs.
Forward integration: This occurs when a company acquires or merges with its customers. This can be done to increase market share, expand distribution channels, and gain better control over the pricing of the final product. Apple is a good example of forward integration. The company started as a manufacturer of personal computers but has since expanded its operations to include a wide range of products, including smartphones, tablets, and wearables. By acquiring or merging with its customers, Apple has been able to increase market share and expand its distribution channels.

Vertical integration can be a risky strategy, as it can lead to increased costs, reduced flexibility, and decreased innovation. However, when executed successfully, it can also provide a number of benefits, including improved efficiency, reduced costs, increased control over the production process, and improved product quality.

Concentric diversification

Concentric diversification is when a company decides to acquire or merge with another company in a related industry or business. The intention behind such action can be to share resources or to enter new markets.

When a company engages in concentric diversification, it typically seeks to acquire or merge with companies that operate in industries or businesses that are closely related to its core business. By doing so, the company can leverage its existing knowledge, expertise, and assets to enter new markets or expand its product or service offerings.

Key considerations for concentric diversification

Shared resources and synergies

One of the primary benefits of concentric diversification is the opportunity to share resources and create synergies between the acquiring company and the acquired company. This can include sharing manufacturing facilities, distribution networks, research and development resources, or other assets. By combining resources, the companies can achieve cost efficiencies, improve operational effectiveness, and enhance their overall competitiveness.

Market expansion and diversification:

Concentric diversification allows a company to enter new markets or expand its presence in existing markets by offering complementary products or services. By acquiring or merging with a company in a related industry, the company can gain access to new customer segments, distribution channels, and geographic markets. This expansion and diversification help reduce the company’s reliance on a single market or product line, thereby mitigating risk.

Enhanced competitive advantage

Through concentric diversification, a company can strengthen its competitive position by acquiring or merging with companies that possess valuable assets, capabilities, or market share. By combining the strengths of both companies, the resulting entity can achieve a more significant competitive advantage in the industry. This can be particularly beneficial in industries characterised by intense competition.

An example of concentric diversification

Coca-Cola’s launch of Glaceau Smartwater is a classic example of concentric diversification. Coca-Cola, a leading beverage company, expanded its product portfolio by acquiring Glaceau, a producer of premium bottled water. This acquisition allowed Coca-Cola to capitalise on the growing demand for healthier beverage options while leveraging its existing distribution network and marketing expertise.

Conglomerate diversification

Conglomerate diversification is when a company acquires or merges with another company in an unrelated or different industry. The intention behind such a merger or acquisition can be to reduce risks or enter new markets full of opportunities. For example- merger of Amazon and Whole Foods.

The primary intention behind conglomerate diversification is twofold: risk reduction and market expansion. By entering new markets, a company can reduce its reliance on a single industry or product line, thereby diversifying its sources of revenue and mitigating the impact of economic downturns or industry-specific challenges. Moreover, it allows the company to tap into new growth opportunities, leverage its resources and capabilities across different industries, and explore potential synergies between its existing and acquired businesses.

A notable example of conglomerate diversification is the merger between Amazon, an e-commerce and cloud computing giant, and Whole Foods Market, a leading organic supermarket chain. In this case, Amazon sought to expand its reach into the grocery retail sector and leverage its extensive logistics network to enhance the delivery and convenience of fresh and organic food products. This strategic move allowed Amazon to enter a new market, diversify its business portfolio, and gain a competitive advantage in the rapidly growing online grocery market.

Other well-known examples of conglomerate diversification include:

General Electric (GE): GE has diversified its portfolio from its traditional businesses in power generation and aviation into industries such as healthcare, renewable energy, and financial services.
Virgin Group: Founded by Richard Branson, Virgin Group encompasses a diverse range of businesses, including airlines, music, telecommunications, and space tourism.
Berkshire Hathaway: Led by Warren Buffett, Berkshire Hathaway holds a diversified portfolio of companies in various sectors, including insurance, energy, manufacturing, and retail.

Reverse merger

It is said to be a reverse merger when a private company merges with a public company to become a public company without offering an IPO (initial public offering). It is a faster and easier way, with limited compliance, for a private company to become a public company. For example- Godrej Soaps conducted a reverse merger with its subsidiary company, Gujarat Godrej Innovative Chemical.

Key advantages of a reverse merger include:

Expediency: Compared to a traditional IPO, a reverse merger can be completed much more quickly, often within a matter of months instead of years. This is because it eliminates the need for the lengthy and complex procedures associated with an IPO, such as regulatory approvals, due diligence, and marketing the offering to investors.
Cost-effectiveness: Reverse mergers are generally less expensive than IPOs as they do not require the underwriting fees, legal expenses, and other costs associated with an IPO. This can be particularly advantageous for smaller companies with limited resources.
Reduced regulatory compliance: Reverse mergers are subject to fewer regulatory requirements compared to traditional IPOs. This is because the private company is already a reporting company, having met the SEC’s reporting requirements as a public company. As a result, the reverse merger process typically involves less regulatory scrutiny and paperwork.

History of mergers and acquisitions (M&A)

During 1897-1904, most mergers used to take place between competitors who wanted to extend their hold or dominance over the market. No action was taken against such anti-competition agreements as competition law was not introduced back then, a result of which some organisations found merging as a tool to manage the prices of their products in the market. The concept of M&A was introduced early in developed nations such as the US in 1895 and Europe in the 1920s. However, in India, it was recently introduced that economic reforms were the reason behind active M&A undertakings in the country.

History of mergers and acquisitions (M&A) in India

In 1931, the merger of Tata Oil Mills Company with Lever Brothers India Limited was one of the early mergers in India, which gave birth to Hindustan Unilever Limited (HUL), India’s largest fast-moving consumer goods company with a revenue of more than 597 billion Indian rupees. The British entered India in the name of business with their East India Company, which also merged with its rival at that moment to gain control or hold over the Indian market. Today, business units, be they in energy, telecommunications, or pharmaceuticals, are realising that M&As have firmly established their presence and are going to be even more significant in the future. With the removal of restrictive arrangements such as monopolies, India is developing more and more towards M&A.

Evolving legal and regulatory framework

Companies Act 2013

The Companies Act 2013 provided a standardised procedure to undergo a merger or an acquisition by replacing the Companies Act of 1956. The Companies Act 2013 also made it easy for small or subsidiary organisations to undergo a merger or acquisition by introducing fast-track mergers. Fast-track mergers make it easy for small or subsidiary organisations to merge or acquire a company by reducing the amount of paperwork and procedures. The Act also introduced the National Company Law Tribunal (NCLT), which is a platform where various corporate matters, including M&As, are discussed. NCLT makes sure that the companies are following the procedures prescribed and also resolves disputes between the companies.

SEBI Regulations

The Securities Exchange Board of India is the regulatory authority for the securities market in India. SEBI regulations promote fairness and transparency in the transactions of companies undergoing mergers or acquisitions in order to protect the interests of shareholders. According to SEBI, a company shall announce its merger or acquisition to the shareholders, and then later on, the shareholders may decide whether to exit or stay in the company. SEBI has issued a code of conduct in order to prevent insider trading during M&A. The SEBI (Prohibition of Insider Trading) Regulations of 2015 prevent any sensitive information from being misused during M&A.

Key provisions:

Insider trading prohibition: The regulations prohibit insiders, such as company directors, officers, employees, and anyone with access to unpublished price-sensitive information, from trading in the company’s shares or communicating such information to others for the purpose of trading.
Definition of insider: Insiders are defined as individuals who have regular access to unpublished price-sensitive information due to their position or association with the company. This includes promoters, directors, senior management, employees with access to sensitive information, and persons with a substantial shareholding.
Price-sensitive information: The regulations define price-sensitive information as any information that is not generally available and could significantly affect the market price of a company’s shares. Examples include financial results, business plans, mergers and acquisitions, regulatory approvals, and material contracts.
Trading restrictions: Insiders are prohibited from trading in the company’s shares during specific periods, known as “prohibited periods.” These periods typically occur before the announcement of price-sensitive information, such as during the preparation of financial results or negotiations for a merger.
Disclosure requirements: Insiders are required to promptly disclose any changes in their shareholding or any other information that may be considered price-sensitive. Failure to do so can result in penalties and other legal consequences.
Penalties: Violations of the insider trading regulations can lead to significant penalties, including fines, imprisonment, and disgorgement of profits. SEBI, the Indian securities regulator, has the authority to investigate and enforce these regulations.

The aftermath of M&A

Impact on operational effectiveness of acquiring company

Operational synergy

One of the main objectives of any company acquiring another company or business organisation is to achieve synergies. To achieve synergy by way of acquiring or merging with another business means to produce a greater profit together as compared to the sum of their individual profits. Acquiring or merging with another company results in huge financial expenditure; therefore, every acquiring company aims to achieve profit by way of cost reduction, entry into new markets, or sharing resources post M&A.

Employee engagement

Employee engagement is another area in which many companies face difficulties. Communication plays an important role in dealing with this issue. The acquiring company should communicate with the employees as soon as the M&A procedure is finalised. The company should provide them with the necessary training about the new system, make them aware of the new work culture, and make them feel relevant even in the new company. Similarly, senior management should also be trained for new systems and provided with increased remuneration if necessary.

Economies of scale

Post M&A combined resources and facilities lead to economies of scale. This results in a reduction in per-unit costs and production efficiency. It should be noted that not all M&As are successful. Some achieve success, while others go through rough patches and eventually fail.

Cultural integration

The coming together of two different companies with two different work cultures can only work if both cultures are blended to boost employee morale. Cultural integration plays a significant role in the success of the merger. If the employees are content with the new work atmosphere, it will positively affect production efficiency.

India’s top mergers and acquisitions

Tata Steel and Bhushan Steel

The financial crisis of 2008 was a huge disaster for Bhushan Steel, and after some time it declared bankruptcy. Tata Steel acquired Bhushan Steel for Rs 35,200 crore in 2018. The acquisition of Bhushan Steel by Tata Steel was a strategic decision aimed at enhancing Tata Steel’s market position. This merger led to increased production efficiency for Tata Steel.

Sun Pharmaceuticals and Ranbaxy Laboratories

The merger aimed to create a pharmaceutical giant. The acquisition of Ranbaxy Laboratories by Sun Pharmaceuticals was a landmark case in the pharmaceutical sector of the country. Ranbaxy was facing regulatory issues and stopped making any profits. As a result, Sun Pharma acquired it for $4 billion in April 2014. The integration was indeed successful, as it became India’s largest and the world’s fifth-largest drugmaker.

Zomato Blinkit

Zomato acquired Blinkit (formerly known as Grofers) for Rs 4,447 crore in June, and about 97% of shareholders voted in favour of the deal. With this acquisition, Zomato entered the quick commerce space. Blinkit was facing a liquidity crisis after rebranding itself from Grofers. It also delayed the payment made to vendors as a result and agreed to the acquisition.

Tata Group and Air India

Tata Group acquired Air India for a value of $2.4 billion, or Rs 18,000 crore. On January 27, 2022, the ownership of Air India was officially given to Tata Group. Incompetent people at the top level, arrogance towards customers, and poor management were some of the reasons behind the airline’s failure. Later on, Tata also announced the merger of Air India with Vistara.

Recent trends and predictions

According to Business Standard, there has been a fall in the number of M&A deals in 2023. At the end of August 2023, almost 21,500 M&A deals were announced, valued at $1.18 trillion. This shows a 14% decline in the number of M&A deals. Numerous geopolitical issues and recession fear contributed to this decline.

However, M&A activities can be seen stabilising now, and people are waiting for 2024, which looks more hopeful for M&As. “We’re relatively optimistic about the outlook for 2024, as deal activity shows promising signs of recovery. That said, challenges for dealmakers remain—in particular, a higher cost of capital, which will push companies to consider large or transformational deals with an even higher level of scrutiny,” said Jens Kengelbach, BCG’s global head of M&A.

Conclusion

So here we studied how mergers and acquisitions impact the operational effectiveness of a company, sometimes positively and sometimes negatively. It’s not just about merging or acquiring a company that can add to the revenue of our company; post-merger/acquisition steps also play a significant role in determining the success of the M&A. Today, the corporate sector in India has realised that M&As are crucial to expanding your business as well as staying relevant in the market in the long run.