In today’s competitive world, when globalization has taken the front seat in almost all parts of the world, the companies have to face enormous amount of competition. It helps organizations to avoid investing considerable amount of money in combating the competition. For avoiding unnecessary blockage of money into things, which do not lay any output for the firms, the companies these days resort to corporate restructuring processes.
Corporate restructuring involve mergers and acquisitions. On the bigger picture, the mergers and acquisition leave lasting effects on the performance and fate of the company.
A merger is the coming together of two companies to form one larger company. Such actions in the business world are normally voluntary and they will involve cash payment to the company that is targeted or even stock swap. There may be a stock swap, which is mostly used by many companies since it always has the provision of allowing the shareholders from both companies to share all the involved risks in the business deal. The merger often has effect on the earnings of the company as well as on their market goodwill. Hence, the price of the share is also affected.
Whenever any company goes through phases of restructuring, the expected output could be either negative or positive. In a way, a merger may be similar to acquisition but in merging companies, the resulting company will always have a new name, which may be a combination of the companies’ names. Branding of the resulting company will purely depend on the marketing and political reasons.
Thus as time continues to pass and competition tightens between companies competing for the same markets, the drive to merge will continue taking precedence. It should be remembered that the management of the companies plays a key role in the discussion of choosing a merger as a right strategy. It has been noted that a key element in mergers is to increase the competitiveness of the new organization and bring about better fortunes.
Major force driving this acquisition of merger between Merck’s and Medco
Mergers increase shareholder value and attract accrual of gains to the target company. Among the benefits, include the benefits of economies of scale, attempts by companies to form oligopolies and monopolies thereby creating market power, and need for diversification.
In essence, formation of mergers is attributed to waves in an industry, prompting different companies to react by uniting and clustering to enhance their survival. The failure of the efficient market hypothesis gives rise to acquisitional takeovers, in which companies strive to increase their market power by accumulating material, financial, and human resources.
Mergers are largely associated with increased shareholder value and company profitability, usually through expansions, diversifications, and cost savings (Gugler, Mueller, Yurtoglu and Zulehner, 2003).
By using share values for the merged companies before and after the mergers, the researchers report that most of such mergers result in increased share value, implying that the wealth of the shareholder and the value of the company in the eyes of investors have increased. However, the value of shares of the acquiring firm and those of the target firm differ in relation to market conditions and public perceptions regarding the merger (Hunt, 2009 pp. 5).
Returns on the mergers differ from company to company, with value firms reporting higher returns on average compared to growth firms (Frankel, 2005, pp. 153). The variations in returns on the mergers result from varying degrees of risks, and investor forecasts in relation to previous company performance. Similarly, the researchers attribute differences in company profitability following the mergers to different accounting and reporting practices, and the variation in industrial shock waves necessitating the mergers.
Identifying the actual benefits resulting from mergers is challenging, since it is difficult to identify underlying sources of gains from mergers, and studies suggest that all benefits associated with the mergers accrue to the target firm shareholders (Andrade, Mark and Erik, 2001 pp. 106). As such, it would be difficult to establish the actual benefits resulting from mergers.
Companies form mergers to increase their competitiveness by accessing a wider market, new skills, and technologies. With globalization, it is extremely difficult for a pharmaceutical company to succeed on its own. By forming mergers, companies can access new markets, new products, and extra finances.
However, mergers are not always successful unless both parties are benefitting. An effective merger must ensure that both parties derive benefits from it. Once a company enters into a merger, it may loose its sovereignty. This means that the company cannot get out of the merger in the future even if it has resolved its financial difficulties. It is therefore important to maintain independence so that if the merger fails to succeed, the companies can part ways and continue their operations as independent companies.
Negotiators must always act in the best interest of the shareholders because it is their responsibility to ensure that they maximize the profits of the shareholders. If only one party is benefitting, the losing party should then not sign the deal. The parties should instead go back to the negotiating table and create a deal that increases the net value of both parties.
The most general reason for the success of merger and acquisition is that many firms try to overcome concentration risk. Firms, which are excessively dependent on a single product, are exposed to the risk of the market for that product. Diversification by way of merger and acquisition reduces such risk.
In addition, firms often use merger and acquisition as a strategy to enter into new market or a new territory. This gives them ready platform on which they can further build their operations. Tax shield is one another aspect of consideration. Tax shields play an important role.
Firms in distress have accumulating past losses and unclaimed depreciation benefits on their books. A profit making taxpaying firm can derive benefit from these tax shields. They can reduce or eliminate their tax liability by benefiting from a merger of these firms. In some countries, tax laws do not permit passing of such tax shields to the acquiring firm except under specific circumstances (DePamphilis, 2009).
From the case, the merger was meant to provide market for their products. The Executive Vice President, Sales & Marketing believed that a merger was going to open up new markets that are in the managed health care market. Medco’s had kept marketing database which was going to be used to l create market expansion opportunities.
However, the Chief Operating Officer did not consider benefits but thought of effects of cultural and operational differences. The merger was the right strategy because it would solve the problems that the two companies were facing. Merging the two companies would create a company that transcended national borders thus increasing sales. A merger is the most efficient way to enter a new market or increase distribution line.
The company can respond to competitive cost pressures through economies of scale. For Merck & Company, the merger would reduce marketing cost by $1billion and expand sales while Medco would be able to penetrate the American market and gain financial support. However, the merger failed to materialize because the two companies could not agree on the terms of control.
Merger is an important business approach that is directed towards expanding the business (Gugler, Mueller, Yurtoglu and Zulehner, 2003). Merger may help an organization to increase its monopoly power on one hand, through increasing its economies of scale and scope and on the other, it may complicate its operational procedure and destroy inter and intra departmental harmony through increasing its size beyond manageable level.
Actually, merger is not a mathematical cloth that will always yield two by the summation of two one. Success of merger depends upon extreme managerial proficiency, nature of the product and market as well as the customer’s psychology immediately after the merger.
It has been observed that in financial sector, when two banks merge, the credit deposit ratio incurs a set back. It might affect the rate of profit negatively. Therefore, it may be concluded that the outcome of merger is always uncertain and if it fails to generate substantial positive outcome, the stockholders of the respective organization might suffer a loss.
Synergies of the merger
The merger agreement was expected to provide an opportunity to Merck & Company to increase market share in the industry as a leader and the highest revenue earner and with the highest market capitalization. Market growth was a major ground behind this acquisition the company wanted to ensure an increasing share in the managed care. This will ensure the growth of company earnings. There may be elimination of overlapping management and consolidation of business support functions.
The benefits of the merger are witnessed through the company’s ability to adjust to market demands and the large market share attained through the merger. In the long term, the merger is likely to be beneficial to the companies due to the increment in revenues and overall cost saving.
Merging makes it cheaper for companies to access materials from suppliers, and can get such materials at a discount due to the economies of scale. This is beneficial in the long-term performance of the company since it leads to more savings, hence more investment and overall increased profitability.
The benefits of mergers are usually traced to shareholders and company performance, and these are derived from the value of shares. The merger turned company into one of the largest employers and is expected to increase the company’s revenue both in the short term and in the long term.
Following the positive changes in the company’s share value, the merger supports the existing literature on the claim that mergers increase shareholder value and company profitability. Additionally, the merger follows the observation that investors use a company’s previous performance record to predict a merger’s future performance (DePamphilis, 2009).
The ratio of exchange
When a firm trades its stock for the shares of another firm, the number of shares of the acquiring firm must be determined. The first requirement, of course, is that of the acquiring company have sufficient authorized and unissued and/or treasury stock ordered to complete the transaction. Often the repurchase of shares, is necessary in order to obtain sufficient shares for the transaction.
Since the acquiring firm is generally larger and has a market for its shares, the acquiring firm offers a certain amount for each share of the acquired firm.
This amount is generally greater than the current market price of publicly traded shares. The actual ratio of exchange is merely the ratio of the amount paid per share of the acquired firm to the market price of the acquiring firm pays the acquired firm in stock, which has a value equal to its market price. However, price has been stated of $ 6.6billion for acquisition of Medco Containment Services Incorporated.
Benefits of merger
The two companies will experience exponential growth in market share, since they end up dealing with a bigger organization than they did before. They also gain from an expanded network, which literally means dealing with more people and thus gaining more contacts with Medco’s database.
This is a good prospect for business expansion. The benefit in the long run to the shareholders is that they can gain when the merged company does grow as profit margins increase. This happens when the new firm finally settles into business and gains new ground by benefiting from the cost cutting measures.
Among the gains of the employees are that those who survive usually end up working for higher wages once the merger picks up and the gains begin to be seen. Higher pay packages are offered them, they experience, and exciting career growth provided that the merger is successful.
This offers them greater opportunities and personal development prospects than they had before. There is a better prognosis for career advancement. Promotion means handling more people over a larger scope. This increases the gains that go with career advancement (DePamphilis, 2009).
Even then, loyal consumers, especially the corporate ones are always considered when major decisions are being made. They are the ones who keep the companies going in the lean times, and with time, the companies learn that rubbing such customers the wrong way is economic suicide. Therefore, they do not emerge as losers even in a merger.
The main advantage to consumers is the improvement in quality that results from the outstanding features of each individual company’s products being consolidated into one better whole. Apart from that, the consumer benefits from wide ranging products over and above what they had in the individual company before, especially in areas where only one of the partner companies was represented.
Competitive reactions to Merck’s acquisition of Medco
After Merck announced intention to merge with Medco competitors reacted quickly by merging with companies, which were vertically in their supply chain. British drug maker SmithKline Beecham planned to merge with Diversified Pharmaceutical Services Incorporated, at $2.3 billion while Roche Holdings Limited announced plans acquire Syntax Corporation. One year later Eli Lilly and Company intended to acquire PCS Health Systems from McKesson Corporation for $4 billion.
Mergers may have some economies of sale and scope, it is not materialized in every case, and hence there may be failures. Again, the benefits or synergies may take some time to reflect and it is usually reflected first in the value of the combine firm as against the sum of values of independent firms. In case of acquisitions, it is important for the bidding firm, which is the combined firm after the deal is complete, to perform well and show an improvement in valuation.
Andrade, G., Mark M. and Erik S. (2001). “New Evidence and Perspectives on Mergers.” Journal of Economic Perspectives 15, no. 2 (2001): 103–120.
DePamphilis, D., (2009). Mergers, Acquisitions, and Other Restructuring Activities: An Integrated Approach to Process, Tools, Cases, and Solutions. London: Academic Press.
Frankel, M. (2005). Mergers and acquisitions basics: the key steps of acquisitions, divestitures, and investments. San Francisco: John Wiley and Sons.
Gugler, K., Mueller, D., Yurtoglu, B. & Zulehner, C. (2003). “The effects of mergers: an international comparison.” International Journal of Industrial Organization 21, no. 2003 (2003): 625-653.
Hunt, P. (2009). Structuring Mergers & Acquisitions: A Guide to Creating Shareholder Value. New York: Aspen Publishers Online.