Acc 825 - Term Paper

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MERGERS AND ACQUISITION –CHALLENGES AND PROSPECTS

Being

A Term Paper on Financial Management

By

OLUSANJO Stephen Gbenga

109021019

Submitted to

DEPARTMENT OF ACCOUNTING

SCHOOL OF POSTGRADUATE STUDIES

UNIVERSITY OF LAGOS

Lecturer in charge

DR. J.O. OTUSANYA

May, 2011

1



ABSTRACTS

Merger and acquisitions (M&A) have been used as instruments for firmgrowth for many years. Engaging in M&A represents an important commitment for any company as it affects every facet of its organisation.

This is because mergers not only bring about two organizations together,it also imposes multiple suppliers and contracts which are critical torunning those organizations; hence, the need to effectively evolvestrategies which reduce complexity associated with pre-merger, duringmerger and post-merger processes so as to achieve quicker and greater profitability.

Growing through mergers has both pros and cons. On one hand, it givesaccess to a larger customer base, induces economies of scale and scope.On the other hand it induces complexity, duplication of people, processesand technology. There are various aspects which if not managed carefully

during a merger can become major pitfalls, for example, issues of managing intellectual property, human resources encompassing culturaldiversity and perspectives, technology platforms, supply chainmanagement, product/service delivery channels, etc.

This term paper examines the challenges and prospects of merger and acquisition decision through a methodological and synthesized review of literature. In approaching the subject matter, key financial ratios werecomputed to evaluate the prospects of post-acquisition business entity.The resulting profitability and investors ratios corroborated existing

studies and researches which establishes that most merger and acquisition fall below expectation i.e. expected shareholders valueaddition and profitability increase.

Key Words: Merger and acquisition, post-acquisition integration, challenges and prospects

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TABLE OF CONTENT

CONTENT PAGE

Title page i

Abstract ii Table of content iii

1.0 Introduction 1

1.1 Problem and Purpose 1

2.0 Literature Review 3

2.1 Mergers and Acquisition Defined 3

2.2 Distinction Between Mergers and Acquisition 3

2.3 Types and Methods of Mergers and Acquisition 42.4 Motives for Mergers and Acquisition 5

2.5 Mergers and Acquisition Processes 7

2.6 Merger and Acquisition Challenges - Why Do M&A Fail?

10

2.7 Due Diligence in Post-Acquisition Processes 12

3.0 Research Methodology 15

4.0 Data Appraisal and Analysis 165.0 Summary and Conclusions 18

References

Appendix I

Appendix II

Appendix III

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1.0 INTRODUCTION

In business today, efforts are being taken in order to grow, while some

firms slowly grow organically others decide to perform a merger or an

acquisition (M&A). Firms performing M&As have a high failure rate and

many times this is caused by a poorly handled post-acquisition process.

Mergers and acquisitions, also known as M&A, are corporate processes of

acquiring new assets by buying, taking over other business or by merging

with them. Due to the emergence of globalization in the industries and

international markets, more and more companies seek to increase

revenue, search for further growth and lower cost through mergers or

acquisition. Gaughan (2002)

By definition, Merger is the combination of two or more companies in

which the assets and liabilities of the selling firm are absorbed by the

buying firm. Although the buying firm may have a considerably different

organization after the merger, it retains its original identity. Acquisition is

the purchase of an asset such as a plant, a division or even the entire

company. For Gaughan (2002), despite the differences between them, the

terms mergers and acquisitions are sometimes used interchangeably.

Mergers and acquisitions have long been performed by companies in the

need to seek growth to gain market shares from competitors, createeconomic profits, and provide returns to shareholders. It is such common

practices that companies which are out of the game are likely to stay

ahead from merged companies. Although there are several obvious

reasons to merge, most authors pointed out the fact that most of mergers

and acquisitions would fail. Many reasons are studied to explain this trend.

In fact empirical studies have treated the question and tried to understand

the reason of this trend over the past decades. The term failure is

understood as not achieving what was expected from the merger andacquisition. (Cassiman & Colombo, 2006)

Like any type of business activity there are pros and cons for both

mergers and acquisitions. Some of the pros include: the potential to add

value to a company's bottom line, the potential to increase a market

share, and the potential to add assets to a company's holdings. While

M&As have several pros, they also have several cons. Some of the cons

include bad public reaction to hostile takeovers, resistance from the

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targeted company and the acquisition of additional liabilities and

problems. (Deans, Kroeger & Zeisel, 2003)

1.1 PROBLEM AND PURPOSE

Much failure than success has been acclaimed in merger and acquisition.It is a fact, that most business acquisitions and mergers fail says InterLINK

Management Consulting. Management desires the gains that

consolidation and economies of scale should bring, but in fact the great

majority of M&As – across all industries do not live up to their promises.

On paper, two plus two should equal five. In fact, two plus two usually

equals three. This has been conclusively shown by dozens of studies

covering hundreds of companies across all industries. Some excerpts:

"70 percent of mergers fail to achieve their anticipated value."

"Most [mergers] fail to add shareholder value-indeed, post-merger, two-thirds of the newly formed companies perform wellbelow the industry average."

By some estimates, 85 percent of failed acquisitions areattributable to mismanagement of cultural issues."

– InterLINK Management

Consulting

A plethora of researches and studies have shown the various failure

factors and main pitfalls changing promising motivations into failed

implementation in the process of merger and acquisition; not much

however has been researched in the Nigerian cases. Although the focus of

this paper is restricted to a synthetic review of various literatures’ findings

of failure factors with possible comparative study of the Nigerian cases, it

strove to evaluate the post-merger prospects (profitability and wealth

maximization prospects) of selected integrated firms.

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2.0 LITERATURE REVIEW

A general view both within business administration and economics

research is that firms exist to grow and that firms seize any possibility to

grow. Growth refers to change in size or magnitude from one period of

time to another. Growth can involve the expansion of existing entities

and/or the multiplication of the number of entities. Growth can also be

obtained by the multiplication of the number of firm controlled by a

particular individual or group of individuals.” By exploring the internal

resources a firm can achieve internal development, by many researchers

referred to as organic growth. Merger and acquisition (M&A) is the

opposite growth strategy where the firm expands by either a merger or an

acquisition with another firm and exploits its competence. (Cooke, 1986)

One plus one makes three: this equation is the special alchemy of a

merger or an acquisition. The key principle behind buying a company is to

create shareholder value over and above that of the sum of the two

companies. Two companies together are more valuable than two separate

companies - at least, that's the reasoning behind M&A. (Pomerleano &

Shaw, 2005)

2.1 MERGERS AND ACQUISITION DEFINED

Technically, merger is a combination of two or more companies in whichall but one of the combining companies legally cease to exist and the

surviving company continues in operation under its original name. A

consolidation is a combination in which all of the combining companies

are dissolved and a new firm is formed. “Merger” is used to describe both

types of business combination. (Moyer & McGuigan, 2001)

Acquisition is used interchangeably with merger to describe a business

combination. A term also used is takeover, which can mean a friendly

merger of two companies or a hostile acquisition by tender offer.

However, the term usually is associated with the latter. (Brealey & Myers,

2000)

The acquisition–merger decision is, in essence just another capital

investment decision. Instead of a company deciding whether to buy a

single asset, the decision concerns the acquisition of a ready-made

collection of assets. The decision should be treated in its own right and

separate from the conventional, because it has some particular difficulties

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http://www.investopedia.com/terms/m/merger.asp

http://www.investopedia.com/terms/a/acquisition.asp

http://www.investopedia.com/terms/m/merger.asp

http://www.investopedia.com/terms/a/acquisition.asp



that are not usually encountered in ‘normal’ investment decisions. (Lumby

& Jones, 2003)

2.2 DISTINCTION BETWEEN MERGERS AND ACQUISITION

Although they are often uttered in the same breath and used as thoughthey were synonymous, the terms merger and acquisition mean slightly

different things.

When one company takes over another and clearly established itself

as the new owner, the purchase is called an acquisition. From a legal point

of view, the target company ceases to exist, the buyer "swallows" the

business and the buyer's stock continues to be traded. (Cooke, 1986)

In the pure sense of the term, a merger happens when two firms, often of

about the same size, agree to go forward as a single new company rather

than remain separately owned and operated. This kind of action is more

precisely referred to as a "merger of equals." Both companies' stocks are

surrendered and new company stock is issued in its place. For example,

both Daimler-Benz and Chrysler ceased to exist when the two firms

merged, and a new company, DaimlerChrysler, was created (Mcclur, n.d.).

In the 2005 banks consolidation exercise, a good example of a merger is

that between Investment Bank and Trust Company and Chartered Bank to

produce a new company IBTC Chartered.

In practice, however, actual mergers of equals don't happen very often.

Usually, one company will buy another and, as part of the deal's terms,

simply allow the acquired firm to proclaim that the action is a merger of

equals, even if it's technically an acquisition. Being bought out often

carries negative connotations, therefore, by describing the deal as a

merger, deal makers and top managers try to make the takeover more

palatable. (Mcclur, n.d.)

A purchase deal will also be called a merger when both CEOs agree that

joining together is in the best interest of both of their companies. But

when the deal is unfriendly - that is, when the target company does not

want to be purchased - it is always regarded as an acquisition.

Whether a purchase is considered a merger or an acquisition really

depends on whether the purchase is friendly or hostile and how it is

announced. In other words, the real difference lies in how the purchase is

communicated to and received by the target company's board of directors, employees and shareholders. (Mcclur, n.d.)

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http://www.investopedia.com/terms/t/targetfirm.asp

http://www.investopedia.com/terms/c/ceo.asp

http://www.investopedia.com/terms/b/boardofdirectors.asp


http://www.investopedia.com/terms/s/shareholder.asp

http://www.investopedia.com/terms/t/targetfirm.asp

http://www.investopedia.com/terms/c/ceo.asp



http://www.investopedia.com/terms/s/shareholder.asp



2.3 TYPES AND METHODS OF MERGERS AND ACQUISITION

Mergers and acquisitions are broadly classified into various types. While

the major types are normally considered as horizontal, vertical and

conglomerate, other researchers refer additionally to concentric mergers

as a different type of mergers and acquisitions (Straub, 2007).

Horizontal Merger and Acquisition

The horizontal M&A type is subdivided in two more groups. The first group

covers mergers within the same product line, but allocated to different

countries. Consequently the acquiring firm gains market shares and

power through the merger in new geographical areas. The second type

consists in mergers of companies with slightly different product lines. As a

result, the acquiring firm increases its product line through the merger.However horizontal mergers are highly controlled by market and

governmental regulations, which limit the value creation in some cases

such as restraining the formation of monopolies (Straub, 2007).

Vertical Merger and Acquisition

On contrast, in a vertical merger, companies do not acquire firms with the

same product line, but firms connected to their own production chain. Also

this type of merger can be subdivided into two different groups; merging

vertical backwards or forwards. The purpose of the forward vertical

acquisition for the acquiring company is to have a sure buyer to which it

can provide its own products. On the other hand, acquiring vertical

backwards means to ensure a constantly guaranteed supply of raw

materials, which are needed for the acquirer’s production. In general a

vertical merger leads to a raise of the acquiring company’s increment

value (Straub, 2007).

Concentric Merger and AcquisitionA concentric M&A affects the knowhow, such as production technology

and delivery service as well as improvement and research capabilities, of

the participating companies. Especially firms from emerging countries

show big interest in the knowhow of enterprises from developed countries.

Conglomerate Merger and Acquisition

An M&A is called conglomerate, if there is no connection, neither in the

production line nor in the production chain, between the involved

companies. This merger can occur mainly because diversified companies

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try to reduce their risk. They aim to build an efficient distribution network

as the fundament for their strategy (Straub, 2007).

2.4 MOTIVES FOR MERGERS AND ACQUISITION

The motivations of M&A are numerous and complex and have been

analysed within different fields as corporate governance, industrial

economics, finance, or fiscal system. Primary motives of the M&A are

discussed in the section following.

Growth

Gaughan (2002) explains that one of the most fundamental motives for

M&A is growth. Growth is when company grow within their own industry.

Indeed, investing in growth through acquisition would create more value

for the companies. In our case study on BNP Paribas a major player in the

bank sector in France, the main motive to this merger was growth. In fact

for the two companies, the M&A was a strategy to acquire opportunities

that meet their profitability criteria and use their existing businesses and

operations to expand in the overall market. Today, the group has adopted

the same strategy to merge with others firms.

Synergy

Synergy refers to the type of reaction that occurs when two substance of factor combine to produce a greater effect together than which the sum of

the two operating independently could account for. Synergistic gains are

created when there is a mixture of actors that will create a greater value

together than otherwise could have been possible comparing the firms

operation their own. Generally synergies created through a merger will

either reduce costs or increase revenue. Cost synergies can be achieved

through economies of scale. (Gaughan, 2002)

Diversification

Diversification means growing outside a company’s current industry.

Diversification could be in the domestic market or in the cross boarder

one. According to Deans, Kroeger & Zeisel (2003), cross-border M&A

business is growing significantly faster than overall M&A activity, which

also is expanding at a healthy pace. Argue that the managers may regard

the need to diversify the firm’s revenue resource as the reason for

mergers.

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Economies of Vertical Integration

Vertical mergers seek economies in vertical integration. Some companies

try to gain control over the production by expanding back toward the

output of the raw materials and forward to the ultimate consumer. One

way to achieve this is to merge with a supplier or a customer. (Brealey &

Myers, 2000)

Complementary Resources

Many small firms are acquired by large ones that can provide the missing

ingredients necessary for the small firms’ success. The small firm may

have a unique product but lack the engineering and sales organisation

required to produce and market it on a large scale. The firm could develop

engineering and sales talent from scratch, but it may be quicker and

cheaper to merge with a firm that already has ample talent. (Brealey &

Myers, 2000)

Eliminating Inefficiencies

Cash is not the only asset that can be wasted by poor management. There

are always firms with unexploited opportunities to cut costs and increase

sales and earnings. Such firms are natural candidates for acquisition by

other firms with better management. In some instances “better

management” may simply mean that determination to force painful cutsor realign the company’s operations. Notice that the motive for such

acquisitions has nothing to do with benefits from combining two firms.

Acquisition is simply the mechanism by which a new management team

replaces the old one. A merger is not the only way to improve

management, but sometimes it is the only simple and practical way.

(Brealey & Myers, 2000)

2.5 MERGERS AND ACQUISITION PROCESSES

The M&A process is divided by many authors into different stages, which

may vary depending on the author. Considering different theories about

the merger process, we came upon a model which we believe match the

most with our understanding of the process. However, other merger

processes exist and merging companies do not go compulsorily through

all the stages of the process. We have thus here a model divided in three

different major categories; Pre-merger process, during the merger

activities and post-merger integration. Each of these stages can be

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subdivided again into two different steps. Hence the M&A process consist

in six main steps

The Merger and Acquisition Process

Pre‐merger

Process

During the

Merger Activiti

Post Merger

Integration

Research and Decision

The pre-merger process is the timeframe before the announcement of the

deal and involves a long process of decision-making. First of all the

decision for an acquisition must be made. This will be done normally by

the CEO of the company in collaboration with the top management team

after thoroughly analyzing the opportunities available (Kusstatscher &

Cooper 2005). But as the game theory of Nash explains, a merger in most

of the cases creates a reaction of the other market players. Therefore, the

top management and the consultancies must be aware of the reaction

following the decision of a M&A deal of the own company. Nevertheless, if

the decision is considered as right, a long list of potential targets will be

created in order to get an overview and more information on the

companies fitting with the acquirer’s strategy (Cassiman & Colombo,

2006).

Strategy

11

Research/Decision

Strategy

M&A Selection

Due Diligence

Closing Merger

Post-Merger

Integration



In this stage a first strategy concept and a business plan will be developed

in order to reduce the number of potential candidates. Due to the same

reason a first valuation of financial and strategic fit will be done.

Additionally, a strategy depending on the complexity of the acquisition,

the strength as well as the ambitions of the target companies and their

managers will be developed in this period. Nevertheless, beside the

importance of the further strategy, the CEO and the negotiation team

should be open-minded for new opportunities and also to be flexible to

react to new problems occurring out of the negotiations with the potential

targets (Kusstatscher & Cooper 2005).

M&A Selection

Ongoing the potential candidates have to be screened and a final group of

maximal five target companies should be selected. This will be done

through two main criteria in addition to a direct contact. The first criteria

regards choosing the final target company depending on the forecasted

benefits of an acquisition of the observed company that could be realized

and the strategic matches in terms of products, markets geographical

position. This stage consists mainly in bidding and negotiating between

the acquiring and the target company. Therefore confidential agreements

are imperative (Kusstatscher & Cooper 2005).

Due Diligence

In the so-called due diligence process the financial shape and the

potential strategic match of the target company will be checked more in

details by a selected team of accountants, consultants and lawyers

(Kusstatscher & Cooper 2005). The biggest problem of the due diligence

process is, that on the one hand the target company wants the acquiring

company to feel comfortable with the postulated price and the quality

offered, but on the other hand the target company does not want topresent all information about financial, marketing or sales aspects for fear

of a late failure of the deal. But exactly because these secret information

are disclosed in the due diligence process, the introduction of an interim

step, in which the acquiring company gets access to certain information

about the target company, can be helpful. There is also the possibility of a

nondisclosure agreement, which protect the secret needs of the involved

company. Nevertheless every time there is not all information honestly

delivered, bad surprises can occur later in the deal.

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During the merger, it is crucial to find the right balance between

emphases to speed and diligence in the decision making process. The

consequences of moving too slow as well as doing the wrong decisions

mean losing a lot of money and reducing shareholder value.

Closing the merger

The timeframe to close the merger may last few hours until a few weeks

depending on the complexity of the deal and the accuracy of the work

done before. Final negotiations about the acquisition price and a binding

letter of intent will be signed together with the closing contracts.

Nevertheless, mistakes can be made during the final meeting, where the

contracts are signed, which may cause delays in the closure or in the

worst case the failure. Hence, there are several points to keep in mind for

the closing meeting: All lawyers and other people involved in the deal,

such as consultants, should be present all the time during the final

meetings, in case of changes through last minute documents.

All time constraints such as desk opening hours of involved banks for

instance, must be taken into consideration and if necessary, in

consultation with them, extended.

Emphasis on speed should not influence the quality. Every single change

made in the closing meeting, caused by late arrival documents or any

other reason, must be thoroughly proved in all layers concerning the deal.

(Kusstatscher & Cooper 2005)

The Integration process

As we mentioned before, each of these six steps is very important and

requires a maximum of concentration to succeed in merging two

companies. Therefore, after closing the merger, the final goal is not

reached yet, and the integration process must be treated with the highestpossible amount of concentration and accuracy. Indeed, mistakes in the

integration process of a M&A are one of the main reasons of failures in

acquisitions. Most time the post-merger integration process executes the

plans that have been done before the integration stage. Consequently

there are different steps which are mainly planned before, but should be

taken into consideration and also controlled to make the acquisition

successful. (Kusstatscher & Cooper 2005)

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2.6 MERGER AND ACQUISITION CHALLENGES - WHY DO M&A

FAIL?

Studies and analysts have allowed shoeing the main reasons why M&A fail

to reach success. Globally the reasons identified appear to be the same

and point out relevant reasons why M&A fail, which we will list in this part.

In fact the due diligence process is supposed to overcome these causes of

failure should it be well done and implemented.

The value of annual global M&A transactions is estimated to be running at

more than $2.2 trillion in 1999 (Thomson Financial Securities Data). In the

view of this enormous economic significance of the transaction numbers

and volume, it is alarming that more of half of all transactions do no lead

to the desired increase in value and higher return on investment forshareholders. A study by Deans, Kroeger & Zeise (2003) concludes that

70% of M&A fails, KPMG study (1999) showed that 83% of mergers were

unsuccessful in producing any business benefit as regards shareholder

value. For Harvey (1998), the expected synergies for M&A are only

reached in 30 per cent of the cases. Why despite the importance of the

companies involved in the deals and the amount engaged, some M&A

fails?

First of all, it is important to know what failure means. For Rankine (2001),

an acquisition fails if the acquired did not increase shareholder value or

did not achieve the financial, commercial or strategic objectives set at the

time of buying business. Moreover, we point out the fact that there is not

just one reason of M&A fail, but several causes which can lead it. We have

chosen the most relevant ones in the literature review to introduce the

importance of Due Diligence to avoid the failures.

A Wrong or Poor Strategy

A correct strategic analysis is essential in a company decision making

about the type of acquisitions that ought to be considered, how large they

should be, and how quickly they need to be achieved. Indeed, companies

need to create methods of analysing drivers and understanding the

relative impact of the key factors. A survey of European middle to senior

management revealed that only 20 per cent were able to define the key

policies of their organisation the existing level of gross profit or return and

what their company planned to become over the next three year

(Rankine, 2001).

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Misunderstanding what is driving the market is the most basic mistake.

Where companies fail to take proper account of the major forces acting on

the market, then strategic choices and the acquisitions accompanying

them will lead to major failure. Company can have poor goal setting with

the first difficulty will be to setting up the objectives and having high

growth expectations. Rankine (2001) illustrates this case with the

examples of M&A by Exxon (oil producer) with office furniture, General

Motors (auto manufacturer) with missiles or Quarter Oats (cereal

manufacturer) with toys. The chances for success in a transaction

increase when the acquirer company focuses on known industries and

countries.

Over-Estimated the Potential Synergies

“There are some synergies here for sure. I don’t know wherethey are yet. To say that now would be an idiot’s game”

(Barry Diller in Noubouss & Beuke,

2008)

An objective of an M&A described before is to increase value of the

shareholder. This incremental value should come from synergies (cost

reduction, sales growth), but often companies makes mistakes in the

estimation of these synergies.

Paying Too Much

Conquering the pressure of price negotiation is a crucial skill. In the worst

case, the acquirer will go bankrupt or so overextend itself as to become a

takeover subject. Bad bidders usually become good targets for other

companies. For Pomerleano & Shaw (2005), about 40 percent of the firms

that fail in the acquisition of a company become targets for other

companies. The bidder has to make a realistic valuation.

Integration Plan not Developed in Advance

Integration planning is essential in the pre-merger process. It must be

planned in advance because the integration plan is integral to the

valuation, implementation of the integration plan should start immediately

once the takeover is completed, and decisions about integration must be

made in advance if resources are to be made available and to make

integration really work.

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KPMG study (1999) enhances that integration project planning goes hand

in hand with synergy evaluation as a key to merger success. It is critical to

work out the mechanics of how synergies will be attained, and also how

the combined business will be stabilised to preserve current value and

ensure that one plus one does not make less than two. The survey

confirms, that the chances of merger success are increased if the process

of working out ‘how’ is started well before the completion of the deal.

Those companies that prioritised pre deal integration project planning

were 13% more likely than average to have a successful deal.

Cultural Difference

Another criterion identified as part of challenges and relevant causes of

failure is the cultural differences of two businesses combining. Culture

difference refers to the way the decisions are taken in the acquirer and

acquired companies, since each company has its own organizational

culture with which employees identify. Indeed the companies’

organizational culture may be very different and then cause poor efficient

communication.

A lack of concern for the cultural factors forms a major obstacle to success

of international M&A. Noubouss & Beuke, (2008) suggest that cultural

incompatibility between the target and acquiring firm has significantimpact on why M&A operations sometimes fail to achieve the pre-defined

goals. In most of transactions, the acquirer company imposes its culture

to the acquired company and will put the employee with different

education backgrounds, different working attitude and habit even

different value together. Although this strategy can work sometimes, most

of the times this is a perfect way of destroying value.

Problem Areas not Identified in Due Diligence

Due Diligence (DD) aims to ensure that the acquirer does not get any

nasty surprises after taking control of business. Relying on the last audit

of the target company and a chat with its management is now recognised

as at best problematic or, worst, a patently disastrous route to

familiarising the buyer with the potential problem it is likely to face. There

are much more demanding than corporate acquirers because, as outsiders

to the industry they are investing in, investors start with less basic

knowledge of the markets in the first place.

There are three principal reasons why due diligence disappoints or fail:

16



• The question were not asked in the first place: when the acquirer

company management is overconfident about its knowledge of the

target company

•If the question were asked, satisfactory answers neither were norobtained: the target company provide restricted answers, or claims

to be bound by ‘commercial confidentiality’ or shelter behind a lack

of effective record keeping, the risks soar.

• The deal process hampered the completion of effective due

diligence: several deals constraints can happens as hostile

acquisition, auction, time pressure, sensitivity of the seller.

It is up to the team involved in the due diligence to analyse, identify andresolve potential key elements necessary to avoid the M&A fail.

2.7 DUE DILIGENCE IN POST-ACQUISITION PROCESSES

Due Diligence Defined

Due diligence as it applies to mergers corporate acquisition is understood

to mean an investigation into the company acquired in various aspects

previously defined. The term is commonly used when it comes to mergers

and acquisition processes. In other words it is simply trying to ascertainand find information which can be relevant in deciding whether or not to

proceed the M&A. (Noubouss & Beuke, 2008)

In fact the idea is for the buyer to make sure that it knows what it is

investing in and uncover possible relevant elements which might be

critical for the M&A success and know more about what it is buying.

Because the notion of due diligence often vary between the different

professionals involved, there might be different definitions of the term

influenced by their own role in the process. (Cassiman & Colombo, 2006)

For Harvey (1998) due diligence is all the inquiries and investigations

made by a prospective buyer in advance of the acquisition of a company

to determine whether the acquisition should go ahead and upon what

terms.

Basic Due Diligence Scope

The basic due diligence scope is composed of the financial and the legal

aspect mainly. Moreover historically, the role of due diligence has been todocument the financial background of a potential candidate and compile

17



legal information on the firm being acquired, such as incorporation

documentation, stockholders and potential lawsuits (Harvey, 1998).

In the financial due diligence, the focus is on the validation of historical

information, the review of management and systems. The goal is toconfirm underlying profit and provide a basis for valuation.

In the Legal due diligence, the focus is on contractual agreements mainly

and the goal is to uncover warranties and indemnities as well as validate

all existing contracts, sale and purchase agreements.

Emerged Elements

Here is some other due diligence areas which have emerged during the

last decades. Even though the most commonly applied due diligence prior

to conducting a merger and acquisition are the Financial and Legal

aspects, the due diligence process may concern various other fields such

as legal, environmental, commercial, corporate culture, systems/IT,

pension, fiscal, insurance, human resources, and various other aspects.

In fact experts have begun to re-examine the traditional due-diligence

process of the past several decades to determine how to enhance its

value. The complexity of M&A transactions, the financial instruments used

in the transactions and increased government regulation have stimulateda renewed interest in due diligence (Harvey, 1998)

The Commercial due diligence is based on the investigation of market

dynamics, the target's competitive position and commercial prospects.

The goal is to assess the sustainability of future profits and formulate the

strategy for the combined business

The Human resources and culture due diligence goal is to make up

the workforce, the terms and conditions of employment, the levelcommitment and motivation as well as the organizational culture. The

goal is to uncover any employment liabilities, assess the potential human

resources costs and risks of doing the deal, prioritizing the HR issues that

need to dealt with during integration, assess cultural fit, costing and

planning the post-deal HR changes

Environmental due diligence can be defined as the systematic

identification of environmental risks and liabilities associated with an

organization's properties and operations. In fact there is an increasingly

18



stringent movement of the regulatory framework in many developed

countries towards the 'polluter pays' principle, with greater emphasis now

being placed on environmental issues across all industries in order to

manage potential risks associated with poor environmental performance

or impact on the natural environment. It is all about assessing the

environmental risk associated with a merger and acquisition

Pension due diligence may be performed if the purchaser is acquiring

the pension scheme as part of the transaction. Purchasers will not want to

have to make large, one-off contributions to the scheme, the biggest

concern, therefore, will be funding deficits. The idea is to minimize the risk

of underfunding due to the various pension plans and plan valuations.

Insurance due diligence investigates in the present, future and mostimportantly past exposures of the business – the structure and cost of the

existing program.

19



3.0 RESEARCH METHODOLOGY

Empirical research on the performance of mergers and acquisition can be

classified into two elements. First, studies have been undertaken using

share prices to establish the distribution of gains and losses to

shareholders. Naturally, evidence collected on share-price performance

surrounding a merger event will have implications for capital market

theory. Secondly, assessments have been undertaken in terms of

managerial performance measures of profitability using accounting

figures. For some studies, however, other researchers have opted for

cases study and analyses.

For this paper, the research methodology has been approached in two

ways. First, a synthetic review literature on mergers and acquisition inorder to establish a warnings and signals pointing out the main pitfalls

changing promising motivations into failed implementation in the process

of Merger & Acquisition is carried out. In evaluating the profitability and

shareholders’ value addition prospects, accounting ratios – most

especially the profitability and investors ratios will be evaluated for both

pre-merger and post-merger financial periods of selected firms.

The Sampled two (2) banks used for the financial appraisal were selected

with the prior object of excluding the effect of the recent financial bubble

burst of banks, hence the use of judgmental random sampling techniques.

Also, the financial ratios calculated covered periods between 2005 and

2007 in order to alienate the effect of the global meltdown on findings and

conclusions drawn in relation to profitability and shareholders’ wealth

maximization prospects of mergers and acquisition process. The banks

are First Bank Plc and United Bank for Africa Plc.

The consolidation exercises led to the emergence of twenty-five (25)banks which were before the consolidation, eighty-nine (89). In attempt to

meet up with the recapitalization direction, First Bank Plc acquired

Merchant Bank Corporation International, FBN (Merchant) Bankers

resulting into a recapitalization base of N48.7 billion. The United Bank for

Africa on the other hand merged with Standard Trust Bank resulting into a

recapitalization base of N50 billion

20



21



4.0 DATA APPRAISAL AND ANALYSIS

In evaluating the post-acquisition prospects of selected banks, four ratios

have been identified and computed – two key profitability ratios and two

key investors’ ratios. The results are presented below in summary. For theprofitability ratios, appendix III contains the calculations of the financial

ratios presented in the table while reference should be made to appendix I

and appendix II for the investors’ ratios.

Table 1: Pre-Acquisition and Post-Acquisition Status – First Bank

Plc

Pre-Acquisition Post-Acquisition

2004 2005 2006 2007

Return on capital

employed

36.52% 33.90% 31.78% 22.22%

Profit margin 31.26% 30.61% 31.65% 27.87%

Earnings per share N3.81 N3.08 N2.69 N1.56

Dividend per share N0.90 N1.05 N0.26 -

Table 2: Pre-Acquisition and Post-Acquisition Status – United

Bank for Africa Plc

Pre-Acquisition Post-Acquisition

2004 2005 2006 2007

Return on capital

employed

26.15% 32.20% 25.67% 13.75%

Profit margin 23.44% 24.46% 14.54% 22.58%

Earnings per share N1.64 N1.52 N1.86 N2.41

Dividend per share N0.60 N0.60 N1.00 -

The comparative result of computed financial ratios for the pre-acquisition

and post-acquisition periods of the two banks reveals that there was no

22



significant improvement in the financial performance of the banks after

the acquisition of other entities. For example, the return on capital

employed of First Bank Plc fell from 33.9% at acquisition in 2005 to

22.22% in 2007 post-acquisition financial year. The fall in ROCE which is

the same for United Bank for Africa Plc (dropped from 24.46% at

consolidation to 22.58% in 2007 post-acquisition financial year) was

further explained by a decline in the net profit margin in 2007 for both

banks.

The results could probably result from excessive unutilized capital

accumulated from the consolidation process or exercise. In other words,

there could be a degree or some level of inefficiencies in utilizing capital

employed in generating earnings. The decline in net profit margin could

also be attributable to expenses resulting from post-acquisition

integration processes.

The decline in profitability led directly to a decrease in earnings per share

for First Bank Plc. The earnings per share dropped from N3.08 at

acquisition to N1.56 post-acquisition. This, however, was not the same for

the second bank – United Bank for Africa Plc whose earnings per share

moved from N1.64 in 2004 pre-acquisition period to N2.41 in 2007 post-

acquisition period. This dividend payment followed this same trend as

earnings per share. No dividend was however paid in 2007 by both banks

probably a resultant effect of the dawning of the economic recession by

late 2007 which was to become more vicious and corrosive in following

financial periods.

The stands or findings analysed above is further corroborated by studies

such as InterLINK Management Consulting (2004) which concluded most

mergers and acquisition produce marginal benefits i.e. lower profitability

prospects than expected; while only 17% provided substantial returns to

shareholders." About these figures, one expert said: "That's a staggering

number. That means those organizations were better off before they

merged than after they merged." (www.interlinkconsulting.com) A KPMG

study (1999) showed that 83% of mergers were unsuccessful in producing

any business benefit as regards shareholder value.

Boyd and Runkle (1993) find that larger banks are more highly leveraged

and less profitable in terms of asset returns. Secondly, their findings

established that efficiency improvements as a result of the consolidationexercise are unlikely to be experienced in the short term. Though the

23



twenty-five megabanks are large banks having the capital to generate

jumbo returns, these returns are not likely to match the capital and asset

strength of the banks.

24



5.0 SUMMARY AND CONCLUSIONS

Organic growth can be seen as an alternative to acquisition-led growth.

Acquisition led-growth is however advantageous because the synergistic

process – at the heart of the merger and acquisition (M&A) decision is

characterized with rapid strategy implementation; allows companies to

immediately achieve the critical mass required to gain the same operating

scale economies as those enjoyed by competitor; allows the company to

fund growth by issuing new equity rather than with cash and enable

companies to acquire both hard assets and the intellectual capital

required to propel rapid growth.

However, M&A processes induce considerable degree of complexities. This

is because the process is sometimes unknown or underestimated sincethe executives sometimes want the deal to be closed as soon as possible,

and neglect some critical factors which can be important to get a true

vision of the target and therefore increase the chance of success of the

deal in future. In the view of the enormous economic significance in M&A

transactions numbers and volume, it is alarming that more of half of all

transactions do not lead to the desired objectives.

From the critical review of literatures embarked upon and the result of the

financial appraisal; some prominent conclusions drawn relative to the

challenges and prospects of the merger and acquisition decision:

(i) Growth by merger and acquisition remains a good alternative to

organic organisation growth if managed adequately and

efficiently.

(ii) Researches have underlined the high rate of failure among M&A,

and the difficulty to achieve expected results and synergies.

(iii) Reasons of failure, many analysts have pointed out include a

wrong or poor strategy, over-estimated the potential synergies,

paying too much and deficient integration plan.

(iv) Mismanagement of cultural issues especially in cross-border

merger poses difficulties to M&A expertise. Owing to the

challenge and impact culture integration poses in the M&A

processes, firms have been seen to prefer centralization of power

and unicultural organization, and in most cases a congruence

concerning culture have occurred.

(v) Laxity in due diligence is key challenging area in especially

post-merger integration. This is evident in the post-consolidationevents that ensued in the Nigerian banking sector where for lack

25



of due diligence, the 2005 recapitalisation exercise became

partly a curse. The banks were not ready for the gift hoisted upon

them. The rapid accumulation of capital outstripped each bank’s

ability to manage it since there existed a dearth gap and

deficiency in due diligence during the merger-acquisitionprocesses.

26



REFERENCESTEXTBOOKS

Brealey, R.A. and Myers, S.C. (2000) Principles of Corporate Finance (6th

ed). United States of America: McGraw-Hill

Cassiman, B. and Colombo, M.G. (2006) Mergers and Acquisitions: TheInnovative Impact. Massachusetts, USA: Edward Elgar Publishing Inc

Cooke, T.E. (1986) Mergers and Acquisition. New York, USA: BasilBlackwell Inc.

Deans, G.K., Kroeger, F. and Zeisel, S. (2003) Winning the MergerEndgame: A Playbook for Profiting from Industry Consolidation. New

York: McGraw-Hill

Gaughan, P. A. (2002). Mergers, Acquisitions and CorporateRestructurings. (3rd ed) New Jersey: John Wiley and Sons.

Kusstatscher, V. & Cooper, C. L. (2005). Managing Emotions in Mergersand Acquisitions. Masachusetts: Edward Elgar Publishing.

Lumby, S. & Jones, C. (2003) Corporate Finance, Theory and Practice (7 th

ed) edition. London: Thomson Learning

Moyer, R.C. and McGuigan, J.R. (2001) Contemporary FinancialManagement (8th ed) United States of America: Thomson Learning.

Pomerleano, M. & Shaw, W. (2005) Corporate Restructuring: Lessons fromExperience. Office of the World Bank: Washington D.C, USA

Rankine D. (2001) - Why Acquisition Fail? Practical Advice for Making

Acquisitions Succeed. Pearson Education Limited (p.xxi).

Straub, T. (2007). Reason for Frequent Failure in Merger and Acquisitions.Wiesbaden: Deutscher Universitats‐Verlag.

JOURNALS

Boyd, J.H. and Runkle, D.E. (1993) “Size and Performance of BankingFirms: Testing the Predictions of Theory”. Journal of Monetary Economics, 31, pp. 47-67.

Harvey M. (1998) - Beyond traditional due diligence in the 21st century” Journal Article Excerpt, Review of Business, Vol. 19.

INTERNET FILES

InterLINK Management Consulting (2004) Mergers Integration. RetrievedApril 24th, 2011 fromwww.interlinkbusiness.com/service/merger_acquisition

Mcclur, B. ( n.d.) Merger and Acquisition: Introduction. Retrieved April 24 ,

2011 from www.investopedia.com/contributors/default.aspx?id=49

Noubouss & Beuke, (2008) Due Diligence: Learn From The Past, But Look Toward The Future. Retrieved April 24, 2011 from http://ssrn.com

27

http://www.interlinkbusiness.com/service/merger_acquisition

http://www.investopedia.com/contributors/default.aspx?id=49

http://ssrn.com/

http://www.interlinkbusiness.com/service/merger_acquisition

http://www.investopedia.com/contributors/default.aspx?id=49

http://ssrn.com/



KPMG survey (1999): Unlocking shareholder value: the keys to success,Global Research Report.

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APPENDIX I

29



APPENDIX II

UB

A

Profit And Loss Account for the year ended

31st March

GROSS EARNINGS

Interest and discount income

Interest expenses

Loan loss and other provision

Net Interest Margin

Other banking income

Depreciation

Other operating expenses

PROFIT BEFORE TAXATION

Income taxation

Deferred taxation

PROFIT AFTER TAXATION

2005

N’Million

25,506

14,456

(3,490)

10,966

.

(40)

10,926

11,050

21,976

(1,402)

(14,335)

6,239

(1,619)

.

33

2004

N’Million

23,928

15,155

(3,107)

12,048

(761

)

11,287

8,773

20,060

(1,353)

(13,089)

5,608

(1,204)

(21

9)

30



APPROPRIATION:

Statutory Reserve

Small Scale Industries reserve

Bonus issue reserve

General reserve

Dividend - proposed

Earnings Per Share

Earnings Per Share – Adjusted

Dividend Per Share

Dividend Per Share - Adjusted

4,653

697

624

-

1,496

1,836

4,653

1.52

1.52

0.60

0.60

4,185

628

561

255

1,211

1,530

4,185

1.64

1.37

0.60

0.50

UBA

BALANCE SHEET AS AT MARCH 31,

2005 MARCH 31, 2004

2005 2004

31



ASSETS

Cash and short term funds

Government securities

Investments

Loans and Advances

Other assets

Fixed assets

TOTAL ASSETS

LIABILITIES

Deposit and current accounts

Other liabilities

Taxation

Deferred taxation

BORROWING

CAPITAL AND RESERVES

Share capital

Other reserves

SHAREHOLDERS’ FUNDS

NMillion

109,716

58,444

2,835

67,610

4,169

6,154

248,928

205,110

20,876

2,494

1,070

229,550

1,676

5,748

16,172

17,702

248,928

NMillion

89,820

40,497

2,387

56,136

13,603

6,363

208,806

151,929

32,051

2,279

1,103

187,362

3,385

1,275

16,784

18,059

208,806

32



33



UBA

Profit And Loss Accounts for the year

ended 30th September

GROSS EARNINGS

Interest and discount income

Interest expenses

Net Interest Margin

Loan loss and other provision

Other income

Operating income

Operating expenses

Profit before taxation and exceptional item

Exceptional items

Taxation

Profit on ordinary activities after taxation and exceptional item

Minority Item

2007

N’Million

101,106

68,575

(26,531)

42,044

(3,163

)

38,881

32,531

71,412

(44,424)

26,988

(4,161)

22,827

(2,996)

19,831

-.

19,831

2006

N’Million

86,079

57,207

(24,879)

32,328

(5,164)

27,164

28,872

56,036

(43,522)

12,514

-.

12,514

(1,046)

11,468

-.

11,468

34



APPROPRIATION:

Transfer to statutory reserve

Reserve for Small Scale Industries

Proposed dividend

Retained profit transferred to general reserve

Earnings Per Share (Kobo) - Basic

(2,975)

-

-.

16,856

241

(1,720)

(1,147

)

(7,06

0) .

1,541

186

35



UBABALANCE SHEET AS AT SEPTEMBER 30,

2007

ASSETS

Cash and short term funds

Due from other banks and Financial Institutions

Treasury bills and government bonds

Investments in subsidiaries and associated companies

Long term investments

Loans and Advances

Other assets

Fixed assets

TOTAL ASSETS

LIABILITIES

Deposit and current accounts

Managed funds

Other liabilities

2007

NMillion

102,724

415,577

149,472

5,807

21,907

320,229

38,419

48,213

1,102,348

897,651

-

33,749

2006

NMillion

72,920

391,185

201,992

5,554

7,122

107,194

33,048

32,226

851,241

757,407

-

35,118

36



Taxation payable

Deferred taxation

Dividend payable

Term loan

CAPITAL AND RESERVES

Share capital

Share premium

Other reserves

Core capital

Fixed assets revaluation reserve

SHAREHOLDERS’ FUNDS

Minority Interest

TOTAL LIABILITIES

3,959

991

42

1,135

937,527

5,748

119,066

28,776

153,590

11,231

164,821

-.

1,102,348

1,359

1,499

7,102

1,135

803,620

3,530

23,209

9,651

36,390

11,231

47,621

-.

851,241

37



APPENDIX III

Computation of Return on Capital Employed (ROCE)ROCE = Profit before interest and

taxationCapital employed

Year First Bank Plc United Bank forAfrican Plc

2004 = 14,106,000,000 x100

38,621,000,0001= 36.52%

= 5,608,000,000 x100

21,444,000,0001= 26.15%

2005 = 15,145,000,000 x10044,672,000,000

1= 33.90%

= 6,239,000,000 x10019,378,000,000

1= 32.20%

2006 = 19,381,000,000 x100

60,980,000,0001= 31.78%

= 12,514,000,000 x100

48,756,000,0001= 25.67%

2007 = 22,097,000,000 x100

99,452,000,0001= 22.22%

= 22,827,000,000 x100

165,956,000,0001= 13.75%

Computation of Net Profit MarginProfit Margin = Profit before interest and

taxationGross Earnings

Year First Bank Plc United Bank forAfrican Plc

2004 = 14,106,000,000 x100

45,121,000,0001= 31.26%

= 5,608,000,000 x100

23,928,000,0001= 23.44%

2005 = 15,145,000,000 x100

49,475,000,000

= 6,239,000,000 x100

25,506,000,000

38



1= 30.61%

1= 24.46%

2006 = 19,381,000,000 x100

61,243,000,0001= 31.65%

= 12,514,000,000 x100

86,079,000,0001= 14.54%

2007 = 22,097,000,000 x100

79,299,000,0001= 27.87%

= 22,827,000,000 x100

101,106,000,0001= 22.58%

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