Mergers and Monopolies
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Wikipedia-Article "Mergers"
The phrase mergers and acquisitions or M&A refers to the aspect of corporate finance strategy and management dealing with the merging and acquiring of different companies as well as other assets. Usually mergers occur in a friendly setting where executives from the respective companies participate in a due diligence process to ensure a successful combination of all parts. Historically, though, mergers have often failed to add significantly to shareholder value.
On other occasions, acquisitions can happen through hostile takeover by purchasing the majority of outstanding shares of a company in the open stock market. In the United States, business laws vary from state to state whereby some companies have limited protection against hostile takeover. One form of protection against hostile takeover is the so-called "poison pill". See Delaware corporations.
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Financing M&A
Technically, what differentiates a merger from an acquisition is how it is financed. Various methods of financing an M&A deal exist:
Merger
A' "merger" or "merger of equals" is often financed by an all stock deal (a stock swap). An all stock deal occurs when all of the owners of stocks of either company get the same amount of stock in the new combined company. The term "demerger" is sometimes used to indicate the effective opposite of a merger, where one company splits into two, the second often being a separately listed stock company if the parent was a stock company.[[Template:ref]]
Acquisition
An acquisition (of un-equals, one large buying one small) can involve a cash and debt combination, or just cash, or a combination of cash and stock of the purchasing entity, or just stock. The Sears-Kmart acquisition is an example of a cash deal. In addition, the acquisition can take the form of a purchase of the stock or other equity interests of the target entity, or the acquisition of all or substantially all of its assets.
High-yield
In some cases, a company may acquire another company by issuing high-yield debt (high interest yield, "junk" rated bonds) to raise funds (often referred to as a leveraged buyout). The reason the debt carry a high yield is the risk involved. The owner can not or does not want to risk his own money in the deal, but third party companies are willing to finance the deal for a high cost of capital (a high interest yield).
The combined company will be the borrower of the high-yield debt and it will be on its balance sheet. This may result in the combined company having a low shareholders' equity to loan capital ratio (equity ratio).
Examples
In a 1985 merger between Pantry Pride and Revlon, Pantry Pride had to issue 2.1 billion dollars of high-yield debt to buy Revlon. The target Revlon was worth 5 times the acquirer.
Motives behind M&A
These motives are considered to add shareholder value:
- Economies of scale: This refers to the fact that the combined company can often reduce duplicate departments or operations, lowering the costs of the company relative to theoretically the same revenue stream, thus increasing profit.
- Increased revenue/Increased Market Share: This motive assumes that the company will be absorbing a major competitor and increasing its power (by capturing increased market share) to set prices.
- Cross Selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
- Synergy: Better use of complementary resources.
- Taxes: A profitable company can buy a loss maker to use the target's tax write-offs.
- Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smooths the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below).
These motives are considered to not add shareholder value:
- Diversification: While this may hedge a company against an downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to acchieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger.
- Overextension: Tend to make the organization fuzzy and unmanageable.
- Manager's hubris: Oftentimes the executives of a company will just buy others because doing so is newsworthy and increases the profile of the company.
- Empire Building: Managers have larger companies to manage and hence more power
- Manager's Compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders); although some empirical studies show that compensation is rather linked to profitablity and not mere profits of the company.
- Bootstrapping: Example: how ITT executed its merger.
M&A and Investment Banking
Historically, Investment Banks (intermediaries which assist companies in selling ownership of themselves as stock or borrowing money directly from investors in the form of bonds) have been closely associated with merger and acquisition activity since a merger or acquisition is a sales opportunity for the Investment Bank. If the company wants to merge with another, it must attain a fair market value for its shares to be swapped which would involve an investment bank. If it wants to buy the other company with borrowed money, it would most likely borrow directly from investors in the form of bonds through a private placement, engineered by the investment bank. Thus, Investment Banks position themselves to act as advisors on mergers and aqusitions and usually charge large fees for doing so.
This system however, gives an incentive to Investment Banks to try to stimulate as much M&A activity as possible, even though the result might not be good for the shareholders of the acquiring company, possibly a conflict of interest. The amount of influence this has is unclear since this activity is usually secret and since the majority of merger proposals do not go through.
M&A marketplace difficulties
No marketplace currently exists for the mergers and acquisitions of privately-owned small to mid-sized companies. Market participants often wish to maintain a level of secrecy about their efforts to buy or sell such companies. Their concern for secrecy usually arises from the possible negative reactions a company's employees, bankers, suppliers, customers and others might have if the effort or interest to seek a transaction were to become known. This need for secrecy has thus far thwarted the emergence of a public forum or marketplace to serve as a clearinghouse for this large volume of business.
At present, the process by which a company is bought or sold can prove difficult, slow and expensive. A transaction typically requires six to nine months and involves many steps. Locating parties with whom to conduct a transaction forms one step in the overall process and perhaps the most difficult one. Qualified and interested buyers of multimillion dollar corporations are hard to find. Even more difficulties attend bringing a number of potential buyers forward simultaneously during negotiations. Potential acquirers in industry simply cannot effectively "monitor" the economy at large for acquisition opportunities even though some may fit well within their company's operations or plans.
An industry of professional "middlemen" (known variously as intermediaries, business brokers, and investment bankers) exists to facilitate M&A transactions. These professionals do not provide their services cheaply and generally resort to previously-established personal contacts, direct-calling campaigns, and placing advertisements in various media. In servicing their clients they attempt to create a one-time market for a one-time transaction. Many but not all transactions use intermediaries on one or both sides. Despite best intentions, intermediaries can operate inefficiently because of the slow and limiting nature of having to rely heavily on telephone communications. Many phone calls fail to contact with the intended party. Busy executives tend to be impatient when dealing with sales calls concerning opportunities in which they have no interest. These marketing problems typify any private negotiated markets.
The market inefficiencies can prove detrimental for this important sector of the economy. Beyond the intermediaries' high fees, the current process for mergers and acquisitions has the effect of causing private companies to initially sell their shares at a significant discount relative to what the same company might sell for were it already publicly traded. An important and large sector of the entire economy is held back by the difficulty in conducting corporate M&A (and also in raising equity or debt capital). Furthermore, it is likely that since privately-held companies are so difficult to sell they are not sold as often as they might or should be.
Previous attempts to streamline the M&A process through computers have failed to succeed on a large scale because they have provided mere "bulletin boards" - static information that advertises one firm's opportunities. Users must still seek other sources for opportunities just as if the bulletin board were not electronic. A multiple listings service concept has not been applicable to M&A due to the need for confidentiality. Consequently, there is a need for a method and apparatus for efficiently executing M&A transactions without compromising the confidentiality of parties involved and without the unauthorized release of information. One part of the M&A process which can be improved significantly using networked computers is the improved access to "data rooms" during the due diligence process.
Levels and flows
Worldwide Completed Mergers & Acquisitions reported by Thomson Financial ([1]) ($ trillion)
- 2004: 1.516 (Q4 2004 report)
- 2003: 1.149 (Q4 2003 report)
- 2002: 1.337 (Q4 2003 report) 1.316 (Q4 2002 report)
- 2001: 2.186 (Q4 2002 report)
Worldwide Announced Mergers & Acquisitions
- 2004: 1.949 (Q4 2004 report)
- 2003: 1.333 (Q4 2003 report)
- 2002: 1.207 (Q4 2003 report) 1.230 (Q4 2002 report)
- 2001: 1.701 (Q4 2002 report)
Merger
In business or economics a merger is a combination of two companies into one larger company. Such actions are commonly voluntary and involve stock swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons.
Classifications of mergers
- Horizontal mergers take place where the two merging companies produce similar product in the same industry.
- Vertical mergers occur when two firms, each working at different stages in the production of the same good, combine.
- Conglomerate mergers take place when the two firms operate in different industries.
A unique type of merger called a reverse merger is used as a way of going public without the expense and time required by an IPO.
Issues
The occurrence of a merger often raises concerns in anti-trust circles. Devices such as the Herfindahl index can analyze the impact of a merger on a market and what, if any, action could prevent it. Regulatory bodies such as the European Commission and the United States Department of Justice may investigate anti-trust cases for monopolies dangers, and have the power to block mergers.
The completion of a merger does not ensure the success of the resulting organization; indeed, many (in some industries, the majority) mergers result in a net loss of value due to problems. Correcting problems caused by incompatibility—whether of technology, equipment, or corporate culture— diverts resources away from new investment, and these problems may be exacerbated by inadequate research or by concealment of losses or liabilities at one of the partners. Overlapping subsidiaries or redundant staff may be allowed to continue, creating inefficiency, and conversely the new management may cut too many operations or personnel, losing expertise and disrupting employee culture. These problems are similar to those encountered in takeovers. For the merger to not be considered a failure, it must increase shareholder value faster than if the companies were separate, or prevent the deterioration of shareholder value more than if the companies were separate.
Major Mergers & Acquisitions since 1990
Acquirer and target, announcement date, deal size, share and cash payment.
United States
- AOL Time Warner; America Online and Time Warner (US$166 billion excluding debt, Stock: 100%, Cash: 0%) (PBS coverage, CNN)
- ExxonMobil; Exxon and Mobil Oil (Dec. 1998, $77 billion, Stock: 100%, Cash: 0%) (Suns Online, CNN)
- Citigroup; Citicorp and Travelers Group (1999, $73 billion, Stock: 100%, Cash: 0%) (Cornell, Citigroup FAQ)
- J.P. Morgan Chase, Bank One (announced January 14, 2004) ($59 billion, Stock: 100%, Cash: 0%) (SNL)
- Procter & Gamble buy Gilette (2005, $54 billion) ([2])
- Bank of America; with FleetBoston Financial (2003, $47 billion) ([3])
- MCI Communications; with WorldCom; created MCI WorldCom (1997) ($44 billion, Stock: 100%, Cash: 0%) (Department of Justice, MCI.com)
- ChevronTexaco; Chevron and Texaco ($35 billion) ([4])
- DaimlerChrysler; Daimler Benz and Chrysler (Announced May 1998 - Final 1998) ($35 billion) ([5])
- Vivendi Universal; Vivendi and Seagram (agreed 19 June 2000) ($32 billion, Stock: 100%, Cash: 0%) (The Tocqueville Connection, Law firm)
- Hewlett-Packard; with Compaq (Announced Sept. 2001 - Final May 2002) ($25 billion) ([6])
- Walt Disney Company; with Capital Cities/ABC (1995) ($19 billion)
- Kmart; with Sears, Roebuck (Announced Nov. 17, 2004) ($11 billion, 55% stock, 45% cash) (Investorguide)
- Monsanto; with Pharmacia & Upjohn
- NBC Universal; NBC and Universal
- Pfizer; with Warner-Lambert
- Total; with Petrofina, and Elf Aquitaine
- JDS Uniphase; with SDL
- Union Pacific Railroad; with Southern Pacific Railroad
- Sprint; with Nextel
- Verizon; Bell Atlantic, GTE, and AirTouch Cellular
- G4; with TechTV, purchased for $300 Million by Comcast.
- Paramount; acuiring Dreamworks
Europe
- Vodafone; with Mannesmann (completed February 2000) ($130 billion) ([7])
- BP; with Amoco (completed August 1998) ($110bn)
Japan
See also
- Wikiversity:Mergers and Acquisitions: The Wikiversity Graduate Level Department offering courses on Mergers and Acquisitions
- Divestiture
- Multiple voting rights
- Poison pill
- Takeover
- Spin off (the opposite of a merger)
Accounting
Data
Lists
External links
Academic Research Institutions
Blogs
Merger Direct
European Union market
- FT.com / World / US - EU agrees rules to ease cross-border mergers - November 26 2004
- EU Approves Rules For Cross-Border Mergers - November 25, 2004
- CEPS Articles - The Challenge of the 13th
Legislation in American and European Jurisdictions
- - Article on Austrian Merger Control law
- Control Premiums and Minority Discounts in Mergers and Acqusitions
Notes and references
- ^ Demerger. Finance Glossary. URL accessed on October 23, 2005.
Wikipedia-Article "Monopolies"
- This article is about the state of a player in economics. For the Parker Brothers board game see Monopoly (game).
In economics, a monopoly (from the Greek monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a kind of product or service. Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods.
Monopoly should be distinguished from monopsony, in which there is only one buyer of the product or service; it should also, strictly, be distinguished from the (similar) phenomenon of a cartel. In a monopoly a single firm is the sole provider of a product or service; in a cartel a centralized institution is set up to partially coordinate the actions of several independent providers (which is a form of oligopoly).
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Forms of monopoly
Monopolies are often distinguished based on the circumstances under which they arise; the main distinctions are between a monopoly that is the result of coercion (coercive monopoly); or one that arises from the cost structure of the industry (natural monopoly) due to e.g. sole access to a resource or consistently outcompeting all other firms.
Legal monopoly
A monopoly based on laws explicitly preventing competition is a legal monopoly or de jure monopoly. When such a monopoly is granted to a private party, it is a government-granted monopoly; when it is operated by government itself, it is a government monopoly or state monopoly. A government monopoly may exist at different levels of government (eg just for one region or locality); a state monopoly is specifically operated by a national government.
An example of a "de jure" monopoly is AT&T, which was granted monopoly power by the US government, only to be broken up in 1982 following a Sherman Antitrust suit.
Natural monopoly
Main article: Natural monopoly
A natural pool is a monopoly that arises in industries where economies of scale are so large that a single firm can supply the entire market without exhausting them. In these industries competition will tend to be eliminated as the largest (often the first) firm develops a monopoly through its cost advantage. In these industries monopoly may be more economically efficient than competition, although because of potential dynamic efficiencies this is not necessarily clear-cut.
Natural monopoly arises when there are large capital costs relative to variable costs, which arises typically in network industries such as electricity and water. It should be distinguished from network effects, which operate on the demand side and do not affect costs. Counter-intuitively, the case of a monopolization of a key source of a natural resource is not considered a natural monopoly, because it is based on the running down of natural capital rather than the amortization of an investment in physical or human capital.
Whether an industry is a natural monopoly may change over time through the introduction of new technologies. A natural monopoly industry can also be artificially broken up by government, although (eg electricity liberalization, eg Railtrack) the results are at best mixed. Advocates of free markets, such as libertarians, assert that a natural monopoly is a practical impossibility, and, given that a monopoly is a persistent rather than a transient situation, that there is no historical precedent of one ever existing. They say that the idea of "natural monopoly" is mere theoretical abstraction to justify expanding the scope of government, and that it in the case of nationalization or deprivatization it is the government intervention itself that creates a monopoly where one did not actually exist.
Local monopoly
A local monopoly is a monopoly of a market in a particular area, usually a town or even a smaller locality: the term is used to differentiate a monopoly that is geographically limited within a country, as the default assumption is that a monopoly covers the entire industry in a given country. This may include the ability to charge (to some extent) monopoly pricing, for example in the case of the only gas station on an expressway rest stop, which will serve a certain number of motorists who lack fuel to reach the next station and must pay whatever is charged.
Monopolistic competition
Main article: Monopolistic competition
Industries which are dominated by a single firm may allow the firm to act as a near-monopoly or "de facto monopoly", a practice known in economics as monopolistic competition. Common historical examples arguably include corporations such as Microsoft and Standard Oil (Standard's market share of refining was 64% in competition with over 100 other refiners at the time of the trial that resulted in the government-forced breakup). Practices which these entities may be accused of include dumping products below cost to harm competitors, creating tying arrangements between their products, and other practices regulated under antitrust law.
Large corporations often attempt to monopolize markets through horizontal integration, in which a parent company consolidates control over several small, seemingly diverse companies (sometimes even using different branding to create the illusion of marketplace competition). Such a monopoly is known as a horizontal monopoly. A magazine publishing firm, for example, might publish many different magazines on many different subjects, but it would still be considered to engage in monopolistic practices if the intent of doing this was to control the entire magazine-reader market, and prevent the emergence of competitors.
A monopoly arrived at through vertical integration is called a vertical monopoly. A common example is vertical integration of electricity distribution with electricity generation, which is common because it reduces or eliminates certain costly risks.
Coercive monopoly
Main article: coercive monopoly
A coercive monopoly is one that arises and whose existence is maintained as the result of any sort of activity that violates the principle of a free market and is therefore insulated from competition which would otherwise be a potential threat to its superior status. The term is typically used by those who favor laissez-faire capitalism.
Economic analysis
Primary characteristics of a monopoly
- Single Seller
- A pure monopoly is an industry in which a single firm is the sole producer of a good or the sole provider of a service. This is usually caused by a blocked entry.
- No Close Substitutes
- The product or service is unique in ways which go beyond brand identity, and cannot be easily replaced (a monopoly on water from a certain spring, sold under a certain brand name, is not a true monopoly; neither is Coca-Cola, even though it is differentiated from its competition in flavor).
- Price Maker
- In a pure monopoly a single firm controls the total supply of the whole industry and is able to exert a significant degree of control over the price, by changing the quantity supplied (an example of this would be the situation of viagra before competing drugs emerged). In subtotal monopolies (for example diamonds or petroleum at present) a single organization controls enough of the supply that even if it limits the quantity, or raises prices, the other suppliers will be unable to make up the difference and take significant amounts of market share.
- Blocked Entry
- The reason a pure monopolist has no competitors is that certain barriers keep would be competitors from entering the market. Depending upon the form of the monopoly these barriers can be economic, technological, legal (basic patents on certain drugs), or of some other type of barrier that completely prevents other firms from entering the market.
Monopolistic pricing
In economics a company is said to have monopoly power if it faces a downward sloping demand curve (see supply and demand). This is in contrast to a price taker that faces a horizontal demand curve. A price taker cannot choose the price that they sell at, since if they set it above the equilibrium price, they will sell none, and if they set it below the equilibrium price, they will have an infinite number of buyers (and be making less money than they could if they sold at the equilibrium price). In contrast, a business with monopoly power can choose the price they want to sell at. If they set it higher, they sell less. If they set it lower, they sell more.
In most real markets, the drop in demand associated with a price increase is due partly to losing customers to other sellers and partly to customers who are no longer willing or able to buy the product. In a pure monopoly market, only the latter effect is at work, and so, particularly for inflexible commodities such as medical care, the drop in units sold as prices rise may be much less dramatic than one might expect.
If a monopoly can only set one price it will set it where marginal cost (MC) equals marginal revenue (MR) as seen on the diagram on the right. This can be seen on a supply and demand diagram for the firm. This will be at the quantity Qm; and at the price Pm;. This is above the competitive price of Pc and with a smaller quantity that the competitive quantity of Qc. The profit the monopoly gains is the shaded in area labeled profit.
As long as the price elasticity of demand (in absolute value) for most customers is less than one, it is very advantageous to increase the price: the seller gets more money for less goods. With an increase of the price the price elasticity tends to rise, and in the optimum mentioned above it will for most customers be above one. A formula gives the relation between price, marginal cost of production and demand elasticity which maximizes a monopoly profit: 
(known as Lerner Index).
The economy as a whole loses out when monopoly power is used in this way, since the extra profit earned by the firm will be smaller than the loss in consumer surplus. This difference is known as a deadweight loss.
Calculating monopoly output
The single price monopoly profit maximisation problem is as follows:
The monopoly's profit is its total revenue less its total cost. Let the price it sets as a market response be a function of the quantity it produces (Q) P(Q) and let its cost function be as a function of quantity C(Q). The monopoly's revenue is the product of the price and the quantity it produces. Hence its profit is:
Taking the first order derivative with respect to quantity yields:
Setting this equal to zero for maximisation:
i.e. marginal revenue = marginal cost, provided
(the rate of marginal revenue is less than the rate of marginal cost, for maximisation).
This procedure assumes that the monopolist knows exactly which is the demand function. For a discussion on a monopolist who does not know it, see http://www.economicswebinstitute.org/essays/monopolist.htm where a free software is available as well.
===Monopoly and efficiency===In standard economic theory (see analysis above), a monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price. Assuming that costs stay the same, this does not lead to an outcome which is inefficient in the sense of Pareto efficiency; no-one could be made better off by shifting resources without making someone else worse off. However, total social welfare declines compared with perfect competition, because some consumers must choose second-best products.
It is also often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they don't have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of efficiency can raise the potential value of a competitor enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives. The theory of contestable markets argues that in some circumstances (private) monopolies are forced to behave as if there were competition, because of the risk of losing that monopoly to new entrants, or because of the availability in the longer-term of substitutes in other markets. For example, a canal monopoly in the late eighteenth century United Kingdom was worth a lot more than in the late nineteenth century, because of the introduction of railways as a substitute.
Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can then be dealt with via regulation. (This is a rather optimistic view of how effectively regulation can substitute for competition.) When monopolies are not broken through the open market, often a government will step in to either regulate the monopoly, turn it into a publicly-owned monopoly, or forcibly break it up (see Antitrust law). Public utilities, often being natural monopolies and less susceptible to efficient breakup, are often strongly regulated or publicly-owned. AT&T and Standard Oil are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able to compete effectively in the long-distance phone market and started to take phone traffic from the less efficient AT&T.
Historical examples
Salt
Until common salt (sodium chloride) was mined in quantity in comparatively recent times, its availability was subject to the vagaries of climate and environment. A combination of strong sunshine and low humidity or an extension of peat marshes was necessary for winning salt from the sea - the most plentiful source - by solar evaporation or boiling. Mines and inland salt springs being scarce and often located in hostile areas like the Dead Sea or the salt mines in the Sahara desert, they required well-organised security for transport, storage and highly monopolised distribution. Changing sea levels flooded many of these sources during certain periods and caused salt "famines" and communities were left to the mercy of those who monopolised these few inland sources. The "Gabelle", a notoriously high tax levied upon salt, played a role in the start of the French Revolution and is possibly the most cruel example in recent history. Anyone was allowed to purchase salt; however, strict legal controls were in place over who was allowed to sell and distribute salt. Advocates of laissez-faire capitalism, such as the Austrian school, maintain that a salt monopoly would never develop without such government intervention.
External link: Salt and the evolution of monopoly (salt.org.il)
See also
- Market form, Duopoly, Triopoly
- Perfect competition
- Monopsony
- Oligopoly
- Free market
- United States v. Microsoft
- Long tail
- Price discrimination
- List of economics topics
External Links
- Monopoly by Elmer G. Wiens: Online Interactive Models of Monopoly (Public or Private) and Oligopoly