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This chapter will discuss about the mergers and acquisition (M&A). Including the motivation of M&A, Choice of payment, benefits of two sides and one case of Wolseley plc acquired DT group.
Wolseley plc’s main strategy of expend their business is through the acquisition way. During year 2007(July 2006- July 2007), the group completed 44 companies acquisitions including the largest ever acquisition, DT GROUP, total Spent reach to £1.7 bn. Merger and acquisition always used by the companies like WOLSELEY as their corporate strategy enhance the size and market weight in order to get a strong position in the competition.
The way by which some companies choose to grow involves getting together with another enterprise and is described using the following terms: merger; takeover, amalgamation, absorption, fusion, integration and agglomeration (uniting of interest). Analytically, it is possible to distinguish between two main ways that firms can get together. The two methods are: (1) acquisition: Also known as ‘takeover’, and where there is a dominant firm and where the owners of the subordinate enterprise give up their interest in exchange for a consideration given by the other enterprise. For example, Firm A takes over Firm B to create an enlarged Firm A. Conventionally, firm A would be the larger of the two. (2) Merger: technically known as a ‘uniting of interest’ or an ‘amalgamation’, where two or more companies, of roughly equal significance, agree to transfer their capital to another company newly formed for the purpose and the old company is dissolved. For example, Firm A merges with Firm B to form Firm C. This is the definition of M&A by Oxford Reference Online .
According to the International Accounting Standard (IAS 22) , merger was defined as a “business combination that results in a new reporting entity, formed from combining entities in which the shareholders come together in partnership for mutual sharing of risks and benefits of the combined entity .In such a transaction no party to the combination obtains control or is dominant whether by share ownership, directors control or otherwise” however the M&A was accounted for as business combination by IFSR 3 Appendix A- A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combinations as that term is used in this IFRS . (IFSR 2008)
4.3 Motivation of mergers and acquisition
The overall goal is to ensure future stability and growth in the market. The most established effects of synergies are profit enhancement, lower taxes, cost reduction and cost of capital. However, on the other hand, it is clear that each company has its own goals which they all hope to get them. Due to mergers which include reduced competition and/or product diversification, the targets are intimately involved with the possible advantages of mergers and acquisitions. Many of the advantages have to do with forming unique research and development skills One of the mainly advantage is through the way of merger, a company could get an opportunities to expand by set up their position in another country. It leads the company to compete in other markets. And moreover, another advantage is that the company does not need waste time and money to develop themselves, because of they could adopt the technology from the other. #p#分頁標題#e#http://www.aleyasingroup.com/Thesis_Tips/Reference/Literature_Review/Through this way, it could cut costs and improve productivity as well. In the long run, this would cut costs and improve productivity. Also many times mergers are used to save a failing business. Economies of scale and scope can be gained with a larger base and with this increased size come many competitive advantages .
But there are some motives are argued by the scholars as wrong reasons for M&A which are diversification and empire building by management o mention only a few from the shareholders viewpoint. Empire building can harm the profitability of shareholder as the management chasing their own interest at the expense of shareholder interests and wealth. Diversification is cited by lot of scholars as a wrong reason because they believe that companies should not try to replicate what shareholders can do for themselves .
A successful M&A expected to produce Vab>Va+Vb ( Vab is the combined firm; Va and Vb are the values of single firms) . The formula shows that the combined firm’s value should be higher than the value of the single firms simply adding together.
4.4 The methods of M&A and Choice of payment
The one way is through merger. Two separate firms combined their entities into one. And the acquirer will undertake all the debts and assets after merger. Also a new firm will exist based on two firms combined. Second way is acquisition of stocks. According to the Stephen A Ross and Westfield’s Corporate Finance, acquisition of stock means purchase the firm’s voting stock in exchange for cash, share of stock, or other securities. And a firm can also acquire another company by buying all of their assets .
There are three ways to complete acquisition, cash payment, stock payment and mix of two. Epstein’s research shows that with the development of stock market in the last decade the stock payment was quite popular. But actually the cash payment is still the main way for companies to complete acquisition . The method of company chose of payment will depends on the truly situation of the capability of acquisition. For example, Franks and Harris finding that stock payment may signal that stock price are overvalued . This research shows that the company which chooses the stock payment may not have the ability to acquisition by cash payment. The following paragraph will discuss the effect which the choice of payment will influence.
Empirical evidence found the Capital gains in cash offer are usually taxed for the target firm shareholders. However the taxes for stock exchange are delayed until the stocks are sold . In another word, the cash payments for the tax tend to be more at a premium level. Although the acquirer can write up the acquired assets to market value in order to offset the premium, the earning will be decrease because of the goodwill amortisation .#p#分頁標題#e#
When relate to the abnormal earning, the research shows through the way of cash offers is higher than other two methods for both bidder and target firms. Gains to the acquired companies in UK, US and France were provided to be much higher in cash payment than in stock payment by Espen Eckbo.B and Karin S.Thorburn; also Huang.Y and R.A Walkling. In acquirer position, ‘positive returns in cash and negative returns in stock exchange for the bidding firms’ this standpoint is supported by Travolos.
Chart 3 abnormal returns and payment methods
This chart shows the influences of method of payment changes the operating performance and the result reflects the cash offer bring the highest change. On average, the cash offers do better than stock payment .
Generally speaking, there is a certain risk of threaten original shareholders’ continued control of acquirer firm by choosing the stock payment. There is a lot of authors support this point of view. Shleifer. A. Vishny says that the corporate governance is quite important after acquisition, management of the acquirer firm when use cash payments instead of stock payments in order to preserve control power . With adding by Moeller, when acquiring firm regard their share price as undervalue, they will choose to finance the acquisition by cash . Therefore, the profit of stock price will only benefit the original shareholders of the acquirer but not the target firm’s shareholders in the future. ‘On the other hand, when a shareholder has supermajority voting rights, stock financing is unlikely to threaten her continued control. In this case, any reluctance to issue stock in an acquisition is greatly weakened.’ From the point view of Marafaccio, Ronald W. Masulis, this argument is also been agreed.
From a view of capital structure point, most evidences agree that the shareholder would choose cash payment than the stock payment because the operating performance will be better for both sides. However, if the performance of management is related to cash flows due to the big mounts of cash will be spent on the acquisitions the management of acquirer will prefer to use stock acquisition. Variance of firms’ earning reduction and liability capability rising was found by Travlos in most acquisitions including the wealth will be transfer from shareholder to bondholders if there is no capital restructuring .
4.5 Cash offer by Wolseley plc for the acquisition of DT group
Wolsey has officially completed the acquisition of DT Group on 26 September 2006. Their first announced was on 25 July 2006. Cash consideration of Euro1,498 million (£1,023 million) representing the equity value of DT Group has been agreed which including the assumption of net debt as at 30 June 2006 of Euro484 million (£330 million), gives an enterprise value of Euro1,982 million (£1,353 million) . The dividend was increased by 5p to 29.4p and company’s shares price fell 5% to 1105p on that day .#p#分頁標題#e#
The acquisition was financed using debt (placed 59.5 million new shares, or just under 10 per cent of out-standing shares, at pounds 11 apiece to raise pounds 655m). The purchase of DT Group is Wolseley’s largest acquisition to date. The deal gives the company a major presence in the Nordic region and significantly broadens its European reach. The group hope to take advantage of combined strength of DT Group's existing scale and Wolseley's resources represent a significant opportunity for Wolseley to continue its bolt-on acquisition strategy, to maintain its position as one of the leading consolidators in the http://www.aleyasingroup.com/Thesis_Tips/Reference/Literature_Review/European market .
Additional benefits are expected from initiatives in conjunction with Wolseley on purchasing and sourcing, reducing working capital, cost savings in IT and indirect spend, all contributing to enhanced trading margins. The combined effect of all these initiatives is expected, over time, to generate additional pre-tax earnings in excess of 2% per annum of DT Group's existing revenues.
The return on gross capital employed (ROGCE) is expected to exceed Wolseley's pre-tax weighted average cost of capital (WACC) in the first full year following the acquisition and exceed Wolseley's normal hurdle rate for a strategic acquisition, being an incremental 5% over pre-tax WACC by year five following the acquisition. The acquisition of DT Group will take Wolseley's gearing to approximately 128% with pro-forma interest cover (before amortisation of intangibles) in excess of 7 times .
According to the Interim Results report in January 2008, DT Group’s revenue (13% of total revenue), including acquisitions, was DKK10,920 million (£1,035 million) compared to DKK6,878 million (£621 million) for the period of Wolseley’s ownership in the prior year (25 September 2006 to 31 January 2007). DT achieved good organic growth of 3.9% for the four-month comparative period. Its gross margin improved as it focused on improving its relationship with the key small and mid-sized contractors and craftsmen, combined with the strategy of targeting the RMI market. Trading profit increased from DKK338 million (2007: £31 million) to DKK688 million (£65 million). Trading margin was 6.3% and it was able to reduce working capital further from an already excellent low level .
Despite the market recession, the progress which DT group hard made is quite impressive among all the subsidiaries which provided it was a quite successful acquisition the group had made.
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