By: Vansh Ved
Mergers, the amalgamation or blending of two equal-sized companies, or one economically weaker with another stronger, or one holding strong distribution network with a weaker one, or any other possible permutation of two distinct entities coming together to form a whole new identity and corporation. This amalgamation is generally done for either financial purposes or strategic ones. An acquisition on the other hand is a takeover or acquiring of one entity by another which either occurs as a friendly or a hostile transaction. A company takes over majority stake and/or resources of the target company and makes its decisions with the goal to forward the acquiring company’s interests.
A company thinks of merging or acquiring for a plethora of reasons: Growth of the business, Financial inadequacy for bigger operations, monopolizing the market, acquiring patented innovation or technology, or even tax evasions and benefits. A merger or acquisition is generally an expensive process to go through for any party to a merger. Accountancy, taxes, finances, shares, permissions, legalities, dues, etc. are a part of this tedious procedure. Yet, companies choose to merge. The principle of 2+2 = 5 attracts the idea of joining forces and making the best product of the two companies that are doing fairly well but probably not growing. India, has seen a boom of these mergers and acquisitions in the past couple of decades since governments liberalized laws regarding monopolies and restrictive trade practices. The years 2014, 2016 and 2018 particularly stood out in terms of the value of M&A transactions across India. The total value of the mergers in 2018 even crossed the 100-billion-dollar mark.
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Private players, quite obviously look to maximize profits through M&A transactions and it’s been proven statistically that quite often they achieve their goals. But there is another aspect or perspective of viewing this transaction too; the market’s perspective. Not just the market’s perspective, but the timing, the situation, the impact, the share and its future is important for the simple reason that the economy is directly affected by it. We will cover, in this article, the economic analysis of mergers and acquisitions.
The economic perspective of Mergers and Acquisitions
A merger of two giant organizations has either of the two consequences; wiping out of the competition completely, or marginalizing it so much by the power of the two companies’ technology, customer base, financial resources etc. that it goes out of business or enters a lower rung of the competition soon. This monopolization of a market has many consequences of its own too. Price mark ups, price manipulation, complete control over output and supply, and lack of substitutes are a part of the market once a monopoly like situation is established. The corporation and its shareholders might be the ones making the profit but it is generally the consumer who faces the music of such deals. The amalgamated new entity is powerful enough to increase the prices, control the supply as well as the demand as the entire customer base depends on it. However, a monopoly resulting from a merger can also have a positive impact on the costs and finances on which the companies used to function. If regulated by the government through supportive and at the same time, restrictive laws, monopolies can result in efficient production at fair prices, which is a key boosting factor of a country’s economy.
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Mergers can lead to economies of scale, i.e., lower average costs and other cost reductions and benefits which occur as a consequence of large-scale operations which tend to make production more efficient. It can also lead to increased research and operations in the direction of growth of the industry which is enabled by the additional funds generated by the combined profits. It prevents an unprofitable yet potentially strong business from shutting down.
A Merger can also be seen as a transfer of resources. A transfer from one, lesser capable and profitable to the more independent, firm and profitable one. This allocation of resources and avoidance of the wastage of a certain amount of manpower, machinery, product line or even talent, is a highly economical transaction. Some critics of acquisitions say that it “creates” unemployment. This couldn’t be more far from the truth as what is actually happening is that when the target company is on the verge of failing and shutting down completely, the acquirer in fact takes over the control of the target company hence saving the total loss accompanied with a 100% layoff which would’ve taken place had the acquired company been running with the same obsolete resources and weaker financial support.
Apart from a scenario where a merger or amalgamation results in a monopoly, when two good players of the market merge, the competitiveness of the market automatically tenses up. This often results in a drop in prices due to more competition and even higher productivity. Consumers benefit highly due to such a situation. India is going through a phase of unemployment as never seen before. M&A deals can help a corporation grow and set up multiple offices and operations in all parts of India and thus aid in creating more skilled employment.
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A huge potential of the Indian Economy gets wasted when foreign firms enter the Indian markets and acquire Indian companies, through either friendly or hostile takeovers, which are going through a financially and economically tough time. Mergers of two Indian companies or acquisition of a foreign firm by an Indian company can drastically improve the condition and situation of Indian firms in the international markets. Consequently, our position in the foreign exchange also improves due to a bigger market share and more exports, due to better production.
An ideology to keep in mind while counting the benefits of M&A deals is that the Indian Economy is massive in its scale and is always looking for investments in sectors such as textile, agriculture, education, clothing, technology and automobiles. When two firms of the same industry merge, or either one of them acquires the other, it aids in a bigger investment in research and development, technology, machinery and retail (marketing as well as sales). When two corporations from different industries merge or acquire, it is generally purely a search for an investment opportunity and an amalgamation of any type gives the opportunity to find a credible investment which even diversifies their business and enables boosting of the other industry by infusing more capital.
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NBFCs in India are going through a rather difficult time and they are in need of some radical changes. Mergers could help them in several ways, ease in taxation being one of them. A bigger corporation formed as a result of two struggling non-banking companies merging, is a stronger entity, gets tax benefits and has more resources. Mergers can help boost the economy in several ways such as this. In such cases, it is a solution to lack of resources, limited supply and reach and a sort of a legitimate cheat code against heavy taxations.
Types of Mergers and the difference in their impacts
There are several different types of mergers and acquisitions. Conglomerate, concentric, reverse mergers etc., friendly or hostile takeovers and several types of other combinations, like leveraged buyouts, divestitures, consolidations, etc. Some of the best ways to combine businesses are as follows:
Conglomerate mergers:
These mergers occur between two companies whose lines of business are completely different. They run their business in completely different industries and merge or acquire either of them to diversify their line of business for more profit as well as security. In today’s market, the predictability of the success of any industry is close to impossible due to a plethora of factors affecting the market. Hence, having a running business in a whole another area, sometimes proves to be a boon for a single industry business. Reliance Industries as well tata is a prime example of diversification of business through acquiring several companies and growing their outreach as well ensuring profitability in some or the other industry. Such mergers are also a blessing to the economy as it helps entities grow and diversify their business thereby ensuring they do not run out of resources or suffer due to lack of variety in their line of products. It also builds a solid brand name, possibly globally. L&T (an engineering firm) and Voltas (an air conditioning company) is a great example of a conglomerate merger.
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Vertical Mergers:
This type of a merger occurs between two entities working in the same industry per se but at fundamentally different levels. An example of this kind of a merger could be the merger of a clothing brand and a textile factory. This way, the manufacturer and the seller could come together as one and improve the flow and communication of the business. Sometimes, even manufacturers of fast-moving consumer goods acquire a company with a good distribution channel to facilitate a good flow of products and to improve marketing. Vertical mergers are good for the companies merging as well as the economy. They give a sense of stability to a company’s quality, raw material supply and distribution. Reliance (a multi-billion-dollar group of industries) and FLAG Telcom (a communication service provider) is a vertical merger where Reliance acquired the latter to get bigger into the telecommunications business and thus gain a stable source of network transport.
However, some types of mergers have proved to be detrimental for the economy and are rarely encouraged. An example of such mergers is a horizontal merger.
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Horizontal mergers occur between companies operating in the same line of business as well as at the same level in the chain. A recent example of a merger of this kind is Lipton Tea India and Brooke Bond. An article by Harvard Business review [1] showed that horizontal mergers usually end up creating a monopoly-like market which has more downsides than benefits for the economy.
The review suggests that the effects of a horizontal merger are much more than any other kind. They often lead to price markups which are mostly arbitrary and have a negative impact on fair pricing for the customer base. Statistics have also shown that two firms of the same industry merging have evidently not shown any improvements in either productivity or economy of the market around them.
The most relevant as well as recent merger that helped save two companies and at the same time was effective in improving competition in the Telcom industry in India, was the Vodafone-Idea merger. Vodafone, formerly India’s second largest telecommunications company was under a debt close to 9000 crores in the year 2017. Idea, formerly the third largest player in the industry was also under a huge debt around the same time. The moment Reliance Jio entered the market, both companies were about to lose their assets and were on the verge of bankruptcy. Had they gone bankrupt; it would have created a semi-monopoly like situation for Airtel and Jio. This would have made calling and internet services in India, more expensive than ever. But both companies decided to merge. The Vodafone-Idea merger was valued at about $12.5 billion. This merger avoided a possible monopolistic market from existing and kept in control prices of Telcom services.
Indian firms in the last 5 years have been bold in acquiring several foreign companies, thus growing rapidly internationally too. Byju’s acquired Osmo, OYO rooms acquired the Leisure Group, Zomato took over UrbanSpoon and many other such Acquisitions have taken place recently. Tata Motors’ acquisition of Range Rover and Jaguar was probably one of the most remarkable acquisitions in India’s automobile industry’s history. Tata Motors, a mid-segment car company with adequate finance, took over two premium car brands and put itself back on the map in the automobile industry. Such acquisitions have massively helped in coping with unemployment in this industry. These foreign companies also bring a huge potential for technological development with them.
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A good merger can boost the economy of an industry as well as the market in ways it never can. Employment, R&D, increased capital flow, increased returns to shareholders and endless opportunities of growth. Mergers and acquisitions have proved to be a blessing to the companies struggling to stay in the market without totally selling out to the big players who have big pockets. A merger helps raise more capital and hence encourages the longevity of such businesses. All in all, a merger’s positive effects on the Indian Economy, far outweigh the ill effects of it in the long run.
[1] https://hbr.org/2016/11/mergers-may-be-profitable-but-are-they-good-for-the-economy