COURSE ON MERGERS
Continuing Professional Development, Projects and
Research (CPD) Department in collaboration with RACHIER
& AMOLLO ADVOCATES
Why a Course on Mergers &
■ M & A has become a way of life for today’s business.
■ M & A provides a mechanism for exploiting new financial opportunities created (e.g.
Oraro & Company and HH&M experiment).
■ M & A offers a useful tool for long-term survival in difficult times (Competition may be
too strong, there could be liquidity challenges).
■ M & A as a strategic component for long term growth (A company may use M & A to
build its turnover, or to increase its market share and/or profit).
■ M & A as an effective tool for disposing of unwanted or unprofitable business or
Reasons for Undertaking a Merger
■ The underlying principle behind mergers and acquisitions is the 1+1= 3 rule.
■ The value of company A maybe 1 billion shillings while the value of company B is also 1
billion, but the value of the two companies combined will usually be 3 billion shillings.
By merging or joining up the two companies create additional value called “synergy”.
■ The synergy value takes the following forms:
– Revenue: the joint company will realize lighter revenue than the two companies
– Expenses: by combining the two companies reduces on their operating expenses.
– Cost of Capital: by combining the two companies will experience lower overall cost of
Reasons for Undertaking an Acquisition
■ Reasons for Buying
– Pursuing a growth strategy. Companies use acquisitions to pursue a strategy for
growth in turnover, market share or profits. This may be necessitated by the need to
break entry barriers where competition is strong making start-up entry into the
– Defensive strategy. Companies sometimes use acquisitions to re-organize
themselves within an industry. Acquisition can help eliminate over-capacity or under-
– Financial opportunities. A company can acquire another company to benefit from
financial opportunities that derive from the acquisition, which may include access to
finance at a much cheaper cost or benefiting from the tax losses available in the target
Reasons for Undertaking an Acquisition
■ Reasons for Selling
– The reasons why a company may want to sell of all or some of its business include the
– To raise money and perhaps pay off some of its debt.
– An attractive offer price.
– Desire to sell off the unprofitable part of its business.
– Desire to sell off non-core activities that do not fit commercially or strategically with the
rest of the seller’s business.
– When a business can realize greater value to its shareholders by being sold rather than
– When a company lacks funds to invest in developing the business in which case it becomes
more prudent to sell the business and invest the funds elsewhere.
Key Motives Behind M&A
■ To cut costs. Cost cutting is achieved through elimination of redundant services which
include human resources, accounting, information technology etc.
■ Positioning. Taking advantage of future opportunities that can be best exploited by
the two companies combined.
■ Filing the gap. One company may have a major weakness while the other company
may have some significant strength and vice versa.
■ Organizational competence. Acquiring human resources and intellectual capital can
help improve innovative thinking and development within the company.
Key Motives Behind M&A Cont’d
■ Broader Market Access. Acquiring a foreign company can give a quick access to
emerging global markets.
■ Bargain Purchase. It’s cheaper to buy an existing company an thereafter investing in it
than starting from scratch.
■ Diversification. To smooth out earnings and achieve consistent growth by diversifying
into new products.
■ Short term growth. Management may be under pressure to turn around sluggish
growth and profitability. M & A is therefore made to boost poor performance.
■ Undervalued target. A target company may be undervalued and may therefore
represent good investment.
General Reasons for M&A
■ Market Penetration – developing new and larger markets for the companies goods
e.g. take over ofYU mobile by Safaricom andAirtel.
■ Horizontal Diversification – This happens when a company expands into market for
new products or new brands. The company expects to use its existing resources,
including distribution channels, marketing skills, management skills etc. to improve
performance of the acquired business or is familiar e.g. acquisition of Mashariki
Motors by Simba Colt Motors.
General Reasons for M&A Cont’d
■ Vertical Integration: This happens when a company combines its business with or
acquires the business of its suppliers or customers. For example when a manufacturer
or pharmaceutical products merges with or acquires a company whose main business
is distribution of pharmaceutical products.
■ The motivations for vertical integration include the following:
– To secure a source of supply for key materials, products or services.
– To secure a distribution outlet or a major customer for the company’s products.
– To improve profitability by expanding into the high margin activities of suppliers or
General Reasons for M&A Cont’d
■ Conglomerate diversification: This happens when two or more companies that
operate in diverse fields merge or when one such company acquires the other or
others. This is usually to lower the risks because successful performers balance the
unsuccessful performers and accordingly the annual profits are stabilized and made
more predictable. A company can also buy another company with good prospects at a
lower price, improve its profitability and thereafter sell it off at a much higher profit.
General Definitions Applicable to
■ Broad Definition: Take over of one company by another when the business of the two
companies are brought together as one.
■ Narrow definition: Coming together of two companies of roughly equal size, pooling their
resources into a simple business.
– Shareholders (owners) of both pre-merger companies have a share in the new merged
– Top management of both companies continue to hold positions after the merger.
HowTo Determine If A Merger HasTaken
– Neither company is portrayed as the acquired or acquirer
– Both parties participate in establishing the management structures of the combined
– Both companies are sufficiently similar in size that one does not dominate the other
– All or most of the consideration involves a share swap rather than cash payment (very
little if any cash change hands)
General Definitions Applicable to
■ DEFINITIONOF ACQUISITION
– Take over of the ownership and management control of one company by another
company either by buying the controlling interest in that company’s stocks or by
buying that company’s business operation and its assets often the purchaser
consideration for an acquisition is paid largely or entirely in cash.
Full & Partial Acquisition
– Acquisition of companies can be either full or partial.
– In full acquisition, the acquirer buys all the stocks of the purchased company.
– In partial acquisition the acquirer obtains a controlling interest normally over 50% of
the equity but less than 100%.
M&A and JointVentures
■ DEFINITIONOF JOINTVENTURE (JV)
– Joint Venture is a business partnership in which two or more companies agree to invest
cash or other assets in a particular project or business activity. The partners can
establish a separate company in which they hold stocks in proportion to their
investments in the venture. The main purpose of a joint venture is to create a strategic
alliance between separate companies with a common interest or complementary skills
– JVs therefore differ from mergers and acquisitions.
Stakeholders in the M&ATransactions
■ The stakeholders in the merger and acquisition transactions may be summarized as
1. The Bidding company (acquiring company)
2. The target company (the company to be acquired)
3. The investment banks for both the bidding company and the target company
4. The legal advisors for both the bidding company and the target company
5. Registrars for either or both companies (if they or any of them is a listed company)
6. International attorneys may need to be appointed and/or consulted in a cross border
7. The banks or investment banks for each company may also appoint their own
The Role of Stakeholders in M&A
■ The role of the advisors are to give
independent legal financial or other advise
to the bidding and/or target company. The
shareholders of the bidding company as
well as the target company need
independent advise on the suitability of the
offer and on everything else that
appertains to the transactions. The advisors
will also help both companies in the event
of a hostile takeover to formulate
documents or defense documents.
■ Investment banks advise their clients on
the price, purchase considerations,
strategic and commercial aspects,
identifying targets, assessing their
commercial values, and procedures for
■ Lawyers and attorneys advise on the
contractual and other legal issues
pertaining to the transaction, regulatory
aspects, capital market requirements and
procedures, due diligence exercise and the
preparation of agreements and
memoranda relating to the transaction.
■ Accountants deal with all accounting and
Types of Mergers
■ Horizontal Mergers: Firms dealing in similar products merge to increase their market share (e.g.
Exxon & Mobil or Oraro & HH&M)
■ Vertical Mergers: Firms along a value chain merge to gain a competitive advantage (e.g. a
Pharmaceutical Manufacturer merging with a pharmaceutical distributor – The merger between
Merk & Medeo).
■ Conglomerate Merger: Firms in a completely different industries merge e.g. a merger between
an oil and gas company and a telecommunication company. This is usually to smooth out
fluctuations in earnings, provide consistency for long term growth as well as to promote
diversification e.g. General Electric has diversified its business through mergers and acquisitions
into areas like financial services and television broadcasting.
– In purchase mergers, one company purchases the other company either through cash
or some other from of debt instrument. This type of sale is usually taxable.
Companies usually prefer this type merger or acquisition because the acquired assets
can be written up to the actual purchase price and the difference between the book
price and the purchase price of the said assets can be depreciated annually, thereby
reducing the taxes payable consolidation mergers. In this case, a brand new company
is formed and the new company. The tax terms are the same as those of a purchase
Types of Acquisitions
■ Acquisitions can be typified either in terms of whether the acquisitions effected through purchase of the assets of the
acquired company or the business of the acquired company. Accordingly, there are two main types of acquisitions:
– Purchase Acquisition: where one company acquires all the assets of the other company by cash. The acquired company
then remains only as a shell which will then be liquidated. Is taxable. Enjoys certain tax benefits. Three different sub types
(direct purchase; one company directly purchases either stocks or assets of another company through cash, triangular
forward purchase; occurs when one company wants to purchase another company but does not want to do it directly –
because of tax issues or management issues – so a holding company is registered and acquires the shares of the target
company; triangular reverse purchase/reverse merger- a subsidiary company is registered. The company being acquired
purchases the shares of the subsidiary. This is done for benefits example if it is a listed company it already has its licenses
and if you lose it you will have to apply again and you may not get the license).
– Reverse Merger: this refers to a situation where a private company that is doing much better wishes to take over the
business of a publicly listed company in a relatively short time, with a view to raising capital through capital market. The
private company reverse merges into the public company and together they become an entirely new corporation with
■ These issues are usually outlined in the letter of intent once initial negotiations have
been completed. They include the following:
What is the consideration furnished by each party to the transaction?
What exactly (in legal terms) is being acquired? Is it physical assets, shares or
intellectual property rights?
How is the merger or acquisition to be designed? Will it take the form of an outright
purchase of assets or exchange of stocks?
What is the form of payment? Is it paper payment? Cash payment? Debt payment or a
combination of the above?
What is the estimated time frame for the merger and which law firm will be
responsible for drawing the agreement?
What is the scope of the due diligence?
Whether the target company will be prohibited from “shopping: itself during the
What compensation should the bidding company be entitled to in the event that the
merger leaks out and the target company is “in play” and other companies also make a
bid to acquire the target company.
What restrictions should be imposed on either company during the negotiations.
What regulatory conditions need to be met?
What legal risks exist and how are they to be dealt with?
■ Draw M&AAgreement.
■ Agree on the specific representations (in the form of conditions and warranties) to be
exchanged by each of the parties.
■ What kind of indemnities to be given by each of the parities to the other.
■ What kind of confidentiality agreement should be signed.
■ There are 3 main financial aspects to a merger and/or acquisition.
– Deciding whether the bid will be made for the target company’s shares or assets.
– Deciding on the purchase consideration for the same and the form that it should take.
– Deciding on the financing package to provide the purchase consideration.
WhetherTo PurchaseAssets or Stocks
■ When the bidding company purchases the target company’s shares, it will acquire all
the target company’s rights, liabilities and contingent liabilities.
■ If the target company is a subsidiary company, then there may be outstanding inter-
company loans to be addressed as a condition for the takeover.
■ If the target company has a large amount of money or assets, then there must be an
agreement as to how much of this may be taken up by the target company’s directors
■ Where the bidding company is not purchasing all the assets, then there is need to
agree on which assets are not being purchased.
■ Where the bidding company is not taking all the liabilities of the target company then
there is need to agree on which liabilities are being taken over.
■ The decision whether to acquire only assets or shares may be influenced by tax
implications. When the purchaser buys the entire company then:
– The purchaser company’s tax reliefs are also acquired.
– The purchaser will also take over the tax liabilities.
– The capital gain that is taxable is attributed to the individual shareholders of the vendor
company, and not the vendor company itself.
– When the purchaser buys the assets of the target company, then any tax liability on the
capital gain is attributed to the targets company and not the shareholders of the target
– The company’s management may therefore need to decide whether these capital gains
may be offset to reduce or eliminate its tax liability.
■ The purchase price of the acquired company may take any of the following forms:
– Mixture of cash and paper
■ Paper is usually in the form of shares in the bidding company, but could also take the form
of debenture stock, convertible shares or share warrants.
■ Cash offers could involve shares of the target company being paid out of the bidder’s own
funds. To finance large acquisitions, the bidder may borrow funds from the banks or from
the capital market (by issuing notes, bonds or commercial paper).
■ When a company has sufficient cash to finance an offer the takeover is usually done very
fast and at low costs, the fees for the lawyers, accountants and other advisers will be
settled with relative case.
■ Financing Cash Offers. If the company wishes to finance the takeover with cash but does
not have the money, then it can finance itself in the following manner:
– Borrow money from the bank.
– Enter into a syndicated loan arrangement
– Enter into a cash underwriting arrangement whereby the vendors accept stocks in the
purchasing company which are then immediately with institutional investors who have
agreed to give cash for the shares.
■ EQUITY BASED PAPER OFFERS
■ In paper offers the shareholders of the target
company are asked to give up ownership of their
shares in the target company and instead take up
new shares in the bidding company. This is also
known as share for share swap. A share for share
swap arrangement will only work if:
– It’s attractive for the vendors to hold equity in the
– The vendors intend to sell the shares in the stock
market after the merger transaction is over
– The vendors are willing to sell all the assets and the
company will remain only a shell which is the reason
why they are keen to receive only a paper offer.
■ DEBT-BASED PAPER OFFERS
■ Debt-based paper offers include the following:
– Convertible securities
– Share warrants
Cash or Paper Alternative
■ In deciding whether to make a cash or paper offer the following considerations are
i. The bid premium.
ii. Liquidity or marketability of the bidder’s shares.
iii. Speed and confidentiality
iv. Tax issues (where stocks are sold for a higher price than what they were originally paid for
then there is a capital gain tax payable).
v. Legal and regulatory issues.
vi. Market conditions.
vii. Competition from rival bidders.
Evaluate the condition of the physical plant and equipment as well as other tangible and
intangible property to be included in the transaction
Analyze the potential antitrust issues that may prohibit the proposed merger or acquisition
Determine compliance with relevant laws and disclose any regulatory restrictions on the
proposed transaction; and
Discover liabilities or risks that may be deal breakers.
Stages in the Conduct of Due Diligence
in Mergers & Acquisitions (M&A)
■ Pre-offer due diligence
■ Post-offer due diligence
■ Post M&A due diligence
■ US Securities Act of 1933;
• Transferred responsibility onto securities dealers and brokers to fully disclose to potential
investors any material information related to the securities or instruments that they were
• The consequence for failing to disclose such information made them liable for criminal
• Making full disclosure a legal requirement also meant that the securities dealers and
brokers would be left vulnerable to unfair prosecution if they failed to disclose some
material fact that they did not have, or could not reasonably have had prior knowledge on.
• Hence, to provide protection to the dealers and brokers the Act included a legal defense
which they called the ‘due diligence’ defense.
■ Due diligence simply means the orderly investigation of a variety of matters
pertaining to business. It is part of the preparatory work for a M&A transaction
■ Due diligence also implies that the person conducting the investigation has made a
‘diligent’ effort to obtain all the relevant and meaningful information pertaining to
the matter under investigation and has disclosed all of that information in a dutiful and
■ Due diligence in mergers and acquisitions transactions is a vital activity and may
require several months of intense analysis.
■ Deal making is glamorous; due diligence is not (merging or acquiring firm has to
assemble large teams and spend pots of money). A deal may look so good on the face
of it but you may not be aware of the hidden flaws.
Importance of Due Diligence:
The Case of Safeway Acquires Dominick’s
■ Safeway was a leading American grocery chain with a string of successful mergers.
■ In 1998 Safeway acquired Dominick’s. Dominick’s was also a grocery company in the Chicago area. It
had 11% of the market share and Safeway wanted to tap into this 11% market share. Within 5 weeks
the deal was sealed. Safeway did not conduct due diligence.
■ After the acquisition, Safeway found out that:
a. Dominick’s focus was more on prepared foods, in store cafes and their products did not fit with
Safeway’s emphasis on store brands and cost discipline
b. Dominick’s employees were part of a strong trade union that resisted Safeway’s aggressive cost
c. Customers within the Chicago area were unwilling to buy Safeway’s private label goods
■ Safeway in Chicago lost the 11% market share to rival Jewel. A thorough due diligence process
would have certainly revealed these problems.
Challenges in the Conduct of Due
■ A survey of 250 international mergers and acquisitions on the exercise of due diligence
conducted by Bain & Company revealed that the due diligence process:
i. Had failed to uncover major problems since half of the companies surveyed found
that their targets had been dressed up to look better for the deals
ii. Had led to an overestimation of the synergies available from their acquisitions
■ What then can firms do to improve their due diligence?
Pre – Offer Due Diligence in M&A
■ Firms need to investigate at the onset the following 4 basic questions;
1. What are we buying?
2. What is the target’s stand alone value?
3. Where are the synergies – and the skeletons?
4. What’s our walk away price?
1.What are we buying?
■ The merging or acquiring firm must:
a. Develop a mental image of the target company by drawing on its public profile and its
reputation within the business community
b. Build its own bottom up view of the target and its industry, gather information about
customers, suppliers and competitors in the field
c. Investigate around the 4C’s of competition: Customers, Competitors, Costs and
■ Good due diligence practitioners begin by drawing a map of their target’s market,
sketching out its size, its growth rate and how it breaks down by geography, product
and customer segment.
■ You must ask questions such as:
a. Has the target fully penetrated some customer segments but neglected others?
b. What is the target’s track record in retaining customers?
c. What channels does the target use to serve its customers?
Approach the customers directly, do not rely on what the target tells you.
■ Good due diligence practitioners always examine the target’s industry presence. How does it compare to its
rivals in terms of market share, revenues, and profits by geography, product and segment
■ Look at the pool of available profits and try to determine whether the target is getting a fair share of
industry profits compared with its rivals.
■ Ask yourself:
a. Where in the value chain are the profits concentrated?
b. Is there a way to capture more?
c. Is the target underperforming operationally?
d. Are its competitors?
e. Is the business correctly defined?
f. How will competitors react to the acquisition and how that might affect the business?
■ Seek independent advice. Do not rely on what the target tells you.
■ Successful due diligence teams always ask the following questions about costs:
1. Do the target competitors have cost advantage?
2. Why is the target performing above/below expectations given its relative market positon?
3. What is the best cost position the acquirer could reasonably achieve?
4. How is the target using its experience in the market to drive down costs?
5. What are the benefits of sharing costs?
6. How to allocate costs going forward?
7. Which products and customers really make the money, and which ones should be
■ You are not just buying a P&L and a balance sheet but also capabilities such as
■ Competencies will determine how well a company will be able to pursue its post acquisition
■ Ask yourself:
a) What special skills or technologies does the target have that create definable customer
b) How can it leverage those core competencies?
c) What competencies can the company do without?
■ Assessing capabilities also involves looking at which organizational structures will enable
the business to implement its strategy most effectively.
The Case of Bridgepoint
■ In 2000, a company called Bridgepoint wanted to buy a fruit company. This fruit
company was a leading producer of the fruit mixtures that were used to flavor yogurt.
The market was growing for flavored yogurt globally. This company was posting
profits and had won praise for its innovativeness and its excellence in R&D and
■ There was nothing suspicious about the company. Bridgepoint wanted to buy this
company and expand its business to include ice cream and baked goods.
■ 4 weeks of discussions between Bridgepoint and the fruit company ensued and the
deal was called off.
The Case of Bridgepoint Cont’d
■ During those 4 weeks of due diligence it was discovered that:
1. While the market for flavored yogurt was growing, profitability in many markets was
2. Consumers surveyed told Bridgepoint that they would be unlikely to tolerate
3. Bridgepoint researchers found that the fruit company was highly dependent on sales
to only 2 large yogurt producers, both of which seemed intent on achieving control
over the entire production process
2.What is the target’s stand alone value
■ You must rigorously analyze the target’s books not just to verify the reported numbers
and assumptions but to also determine the business’s true value as a stand alone
Is itWorth It?
■ Be aware of financial trickery:
Treating as market sales many of the products the target sells to distributors which
may not represent recurring sales
Some companies scatter the marketing function among field offices and maintain just
a coordinating crew at headquarters, which hides the true overhead
A company may use the restructuring of a sales network as a way to declare bad
receivables as a onetime expense
A manufacturer may decide to postpone its machine renewals a year or two so those
figures won’t be immediately visible in the books. But the manufacturer will overstate
free cash flow and possibly mislead the investor about how much regular capital a
The Case of Cinven
■ Cinven before acquiring Odeon Cinemas in the UK got analysts to look into local
demand patterns and competitor activities, data on attendance, revenues, operating
costs, capital expenditure that would be required over the next 5 years.
■ This analysis revealed that the initial market valuation that was given by the target
■ Estimated of sales growth at the national level were not justified by the local trends.
As a result, Cinven was able to negotiate to pay 45 million pounds less than the
original asking price.
3.Where are the synergies – and the
■ The due diligence process under this head helps to distinguish between the different
kinds of synergies and then to estimate both their potential value and the probability
that they can be realized.
■ Consider what are the easiest synergies to be achieved. Creating a map of synergies
can be of assistance.
What about the skeletons in the closet?
■ The due diligence team also needs to look out for the skeletons in the closet of every
■ For instance, seeing more competition for promotions, talented employees may leave,
sometimes taking customers with them or due to the distractions of a merger,
management pays less attention to the core business undermining its results.
■ Example 1:The merger between Southern Pacific and the Union Pacific railroads
■ Example 2:The merger between Kellogg and biscuit maker Keebler
The merger between Southern Pacific and
the Union Pacific railroads
■ In 1996 Southern Pacific and the Union Pacific railroads merged. Incompatibilities in
the company’s information systems combined with other operating conflicts created
massive disruptions in rail traffic throughout western United States leading to delayed
and misrouted shipments and irate customers.
The merger between Kellogg and biscuit
■ In 2001 Kellogg merged with Keebler. The merged companies got distracted by the
merger and planning of the post merger business. This resulted in the loss of potential
4.What’s our walk away price?
■ This is the final leg of a sound pre-offer due diligence process.
■ It is about the price you are willing to pay and to stick to it.
■ There are a variety of methods and principles that are used during the exercise of due
■ Firms that do a lot of M&A transactions often develop their own in house M&A due
diligence expertise, whereas firms that pursue occasional M&A transactions often
engage outside professionals to assist them with this highly complex and risky activity.
Post – Offer Due Diligence in M&A
■ Post – offer due diligence is conducted after the acquisitive company or the company
making the offer has access to internal company information about the target
■ Checklist as a guide.
(should contain the following categories to
base due diligence on)
■ Employee benefits
■ Financial results
■ Cost Structure
■ Intellectual property
■ Fixed assets and facilities
The Legal Opinion
M&A transactions have an economic and a legal aspect to it (confine yourself to the
Dependent on the type of M&A transaction and the industry
Discuss the legal and taxation aspects
Legal Opinion Cont’d
Set out the facts of the M&A transaction
Discuss the type of sale that will be taking place (share sale or sale of assets and their
Set out and explain the applicable and governing laws
State the regulations to be complied with
Legal Opinion Cont’d
Analyses of any valuations done
Indicate the approvals to be sought and the procedure and timelines
Identify any restrictions in transfer of ownership
Discuss what legal risks exist (squatter issues)
Legal Opinion Cont’d
Review the company’s previous and current legal history (lawsuits, contracts,
proprietary interests and encumbrances)
Liability post the M&A transaction (who is to pay for the purchase price of property
negotiated before the merger?)
Termination of agreement
Issue shares and float them at the capital markets and for this you need the assistance of an investment bank. The role that such banks play in mergers and acquisitions. In these instances, shares are being acquired. You do not just give out the shares. You give them out to the investment bank instead. Kenya RE will for example release their shares to Dyer and Blair and the acquiring company will release its shares as well and then the account will be settled.
As you acquire the stake in another company you need to consider the effect of all this on the business and hence the role of the bank is critical. Will such a transaction impact positively or negatively on the shares and for this reason a report will have to be produced by the investment bank and which report must be approved by the regulator.
Undertaking letter to be given during the negotiation stage.
Sign the non disclosure agreement/confidentiality (this could be part of the undertaking letter). Whether the merger succeeds or fails, this must be there to protect business interests. Consequences of violations of the agreement must also be stated in the UL.
UL comes from the acquiring company. Then comes the non disclosure that both the companies will sign.
Length of time depends on many factors, especially the kind of transaction one is dealing with.