Mergers
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This article is written by Christopher Manoharan who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (including PE and VC transactions) from LawSikho.

Some of the reasons for Mergers and Acquisitions 

  • Financial synergy for lower cost of capital: Value from synergy is always created by the joining or the merger of two companies. The synergy value can be seen either through the Revenues (higher revenues), Expenses (lowering of expenses) or the cost of capital (lowering of overall cost of capital).
  • Improving company’s performance and accelerate growth: The inflow of assets, manpower and finances from the company acquired or merged with creates increased opportunities for growth and performance.
  • Creating economies of scale: The increased fund flow provides increased opportunities for further consolidation and expansion thus mitigating against any future fund flow constraints.
  • Diversification for higher growth products or markets: Increased diversification leads to reduced overall risk. Its akin to not putting all the eggs in one basket. 
  • Increase in market share and positioning giving broader market access: Increased market share helps create loyal customers and get repeat business.
  • Creating a strategic realignment and technological change: The company merged with or acquired would have technologies which add to the ease of doing business of the organization. This is something that will be of great advantage to the acquiring or merged entity.
  • For Tax considerations: The ability to take advantage of the losses of the entity being acquired or merged into could be tantalizing for any business as it would bring down the losses of that entity.
  • Making pricing gains by purchasing an under-valued target: The acquiring or merging entity could be great value because of the fact that it’s coming cheap.  

Practical reasons for mergers and acquisitions through case study

Google’s acquisition of Motorola Mobility

In Chapter 1, we had analyzed Google’s need for acquiring Motorola Mobility.  

Acquisition of Intellectual Property: Prior to the acquisition, Google had the company had 17,000 patents, with 7,500 patents pending. After the acquisition, Google increased its patent portfolio to over 37,000 patents. This expanded portfolio helped Google defend the viability of its Android Operating System and compete with large competitors like Apple.

Sale of Assets to the Arris Group: On December 19, 2009, Google announced the sale of Motorola’s cable modem and set box business to the Arris Group through a cash and stock deal that saw Google getting richer by USD 2.35 billion.  

Sale of Assets to Lenovo: Google on January 24, 2009 announced the sale of Motorola Mobility to Lenovo in a cash and stock deal which saw the changing in hands of USD 2.91 Billion in cash and USD 750 Million in Stock. 

Sale of Motorola’s factory: This was sold to Flextronics by Google.

Acquisition of Motorola Mobility’s Cash Reserves: By virtue of the acquisition, Google got richer by USD 3.5 billion, which got taken over by Google.

Tax Benefit: Google by virtue of the acquisition also walked away with a tax benefit. As Motorola Mobility suffered a loss and Google was making a profit, the cumulative value of the loss and profit resulted in a decrease in profit which in turn assisted Google to reduce its taxes by $1 billion and a further $ 700 million due to Motorola’s Foreign operating loss.

  

Overall Acquisition Strategy:  

Google’s major reasons to acquire Motorola other than those mentioned above are as follows:

Google was threatened by Samsung’s market share and had to do something. Samsung was tweaking the Android Operating Systems beyond recognition and it was just a matter of time before the cheese would have been moved to Google’s disadvantage. Google was scouting for an opportunity to get even with Samsung and the loss making Motorola Mobility was the perfect decoy since it was one of the largest users of the Android operating system.  

Google acted to purchase Motorola, while declaring that the purchase would not affect it’s relationship with the handset makers. The 7.7. billion USD deal gave Google control over one of the largest manufacturers of mobiles, running, its own Android operating system.  The Motorola mobiles did very well in emerging markets like India and enabled Google to be in a position, strong enough to negotiate with Samsung, a decade long agreement which caused Samsung to tone down the changes in the apps it had made. 

OLA’S Acquisition of Taxi-for-Sure

The rationale for Ola’s acquisition of Taxi-for-Sure (TFS) was four fold:

  1. To obtain efficient operations at a reduced cost. 
  2.  A loyal customer base number 
  3. Better geographical reach. 
  4. Nipping the competition in the bud.

The factors that prompted the acquisition was three fold:

  1. The nimbleness of the smaller entity. The ability to provide services speedily and at a far lower cost was attractive.
  2. Ola and Taxi for sure was operating in the same segment and TFS had registered a very good growth in a short period of time, showing efficiency. It was able to provide services to the customers at a  lower cost.  Had TFS been permitted to grow it out, it would have become the third common name and industry, together with Ola and Uber.  The acquisition proved the twin benefits of securing an efficient division, as well as restricting a growth operator.
  3. TFS had a loyal customer following. The independent operations of TFS were retained.  The TFS customers did not see the acquisition as an intrusion or disturbance to the services. The geographical outreach of TFS was higher. It gave Ola outreach into many geographical markets and a different business space.

What were the issues which forced Ola to shut down TFS?

  • They were integration issues. The operating systems were diverse and could not be integrated or merged. This gave rise to coordination issues and efficiency and inefficiency seeping into the business.
  • The acquirer would have to be able to foot the bills of the combined entity and the acquired entity should be generate it’s own profits and run separately on its own.  If this was not happening, it would have to be shut down or it would be sold off to someone else.
  • The acquirer loses key employees right after the acquisition, this would affect the smooth functioning of the business. Getting new people or training existing people could result in an additional cost.
  • Ola faced all the above issues after it acquired TFS eventually saw Ola shutting down the TFS operations. Acquisition for immediate benefits without a long-term plan for success, resulted in this sad situation.  

Flipkart’s acquisition of Myntra and later Jabong

Acquiring entities, operating in the same sector, could be a risky game. It could be akin to putting all your eggs in the same basket. But where the target is a market leader for niche products. consolidating the market might mean benefits for both. 

Some of the key reasons for the acquisition were:

  • Positioning: Flipkart could position itself as having access to key fashion apparel and exploit a market, which was not earlier available to Flipkart before the acquisition.  
  • Bargain Purchase: Flipkart showed that it was cheaper to acquire another company, than to invest internally. Flipkart, got access to Myntra’s unused facilities, Myntra being cash strapped as it was, rather than to go out and build new facilities on its own.
  • Diversification: Flipkart’s intention to diversify into fashion was an outcome of the realization that further growth in an already mature industry was highly unlikely.  Flipkart realised that  diversification was essential to achieve more consistent long term growth and profitability. 

Lead over competitors: Myntra was clearly ahead in the fashion sector and this acquisition placed Flipkart ahead of Amazon and Snapdeal.  

  • Prior to the merger Myntra had a share of 30% of the online fashion apparel market, however post acquisition Flipkart acquired a 50% share in the segment that was clocking nearly 100% annualised growth. Flipkart by virtue of the deal was able to acquire a market leader in the online fashion industry and diversify its inventory.
  • Flipkart took advantage of beaten down interest rates and acquired an undervalued cash strapped target at a competitive price. Myntra in order to strengthen its fund position was considering other alternatives, including an initial public offering. But in the end, the merger made the most sense.  
  • As regards Jabong, it was approached by Flipkart at a time when Myntra was not opened up for sale. Jabong had also received investor interest and it was approached by the likes of Reliance Industries, the Birla group as well as  Snapdeal, but Jabong which was No.2 in the market place was clearly interested in merging with Myntra the No.1 in the market place. 

What lead to the success of the Flipkart – Myntra deal?

The key reasons were:

  • Win-win scenario:  

Flipkart saw entry into a new market while Myntra saw the advantages of gaining access to Flipkart’s logistic network. 

  • Common Investors:  

Flipkart and Myntra had common investors, Accel Partners and Tiger Global who both supported the deal, as it meant increasing the returns from for them with a lower investment.  Flipkart acquired Myntra through a 100% acquisition for an estimated 2000 crore in lieu of cash and stock. The acquisition was undertaken through a shared swap between the shareholders of Myntra and Flipkart, leaving the early shareholders of Myntra, millionaires in the process.

  • Respect to the management of the Target Company: 

The founders of Flipkart saw Mukesh Bansal the founder of Myntra as a mentor and guide and treated him with respect.  He was invited to join the Flipkart board, and got involved in the Flipkart fashion business.   Flipkart and Myntra were to remain as two separate entities, but people holding stock options in Myntra will hold the same in Flipkart.  The same management team was to be retained at Myntra.  Employee roles and the company’s road map was to remain the same.

  • Employees of the target company were given a similar or better offer:

Myntra employees holding stock options were provided similar options in Flipkart, which was clearly beneficial to them, which is why the deal was supported by the employees,

  • Consolidation as a successful strategy:  

The consolidation that Flipkart achieved through the back to back acquisitions of Myntra and Jabong, clearly gave Flipkart a headway. This is clearly understood from Walmart valuation of Flipkart at US 21 billion included a high valuation of Myntra and Jabong between 5.5 to 6.5 billion which had been purchased only at USD 400 million (Myntra: 330 billion and Jabong: 70 billion).

Conclusion

As the reader would notice, the reasons for mergers and acquisitions are many. In the case of Google’s acquisition of Motorola Mobility, it was a strategy to retain market relevance by getting Samsung to the table. In the case of Ola’s acquisition of Taxi for sure it was an acquisition that went awry and the only benefit was to shut out a competitor. In the case of Flipkart’s acquisition of Myntra, it lead to huge consolidation and was a win-win situation for both parties. The last was a very positive outcome.


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