by Aditya Raj Singh
Purpose and Background
Over time, businesses have diversified into different segments, leading market players to either enter into the same segment or create a new segment designed to establish more healthy competition in the market and give wider choices to end consumers. Traditionally, it has been impossible for a single enterprise to establish its footing in every sector or segment, often requiring complex corporate restructuring in order to expand its scope of operations.
Merger and Acquisitions is not a new concept in the law, but has become an important and strategic style of operating a business. Merger and Acquisition transactions are based on the potential of a segment. In other words, if a sector/segment has high potential and is profitable, corporations try to establish a leg in that sector.
At its most basic roots, merger and acquisitions law contemplates corporate restructuring. A merger is the consolidation of firms, giving birth to a new organization,Vodafone-Idea remains one of the greatest mergers in Indian Telecommunication market. Acquisition, on the other hand is the process of acquiring a firm and making it a subsidy of the parent company. An example of this is Axis Bank acquiring freecharge for Snapdeal.
The fundamental objective of this paper is to analyze how different factors including politics and the law effect the outcomes of merger and acquisition deals, and how corporations deal with these factors to ensure that the related issues do not affect the outcome.
Existing literature already provides abundant information regarding just how these factors impact these transactions. Different authors have different views, but universe of knowledge and ideology is a constant.
This research has helped to develop the importance of these varied factors, as well as how they affect transactions, and the consequences and technicalities involved post-merger. They also consider the impact on the consumers who are benefitting from it.
Methodology
The research methodology adopted is a non-empirical in nature, based on the disparate views of different authors and business analysts. Their views explain the impact of these factors on businesses. In other words, it can best be explained as a circular chain, as the impact of one factor remotely effects the other in a never-ending cycle.
Hypothesis
An analysis of politics, economics, social components, technology, environmental and legal factors in planning for a corporate restructuring as an important aspect of the planning itself. Additionally, to consider minimal post-merger or amalgamation complications arising due to any of such factors.
Keywords
• Mergers and Acquisitions (M&A)
• Factors
• Restructuring
• PESTEL
Introduction
A fundamental objective in establishing a business is to ensure that it continues in perpetuity. Regarding business generally, it is commonly known as the ‘going concern’ principle. To ensure the continuity of businesses, expansion is of paramount importance. Expansion can result from multiple causes. It may be due to the dynamic nature of the industry a company is based in, or it may be due to the emergence of new and potential markets. Mergers and Acquisitions is one way of expanding businesses beyond the boundaries they originally operated in. Mergers and acquisitions are subjected to many internal and external factors, some which may result in making such restructuring a bad decision for the members of the company and the investors. These factors are of great significance and a good businessperson should have proper hold on the analysis of these factors. After proper due diligence, one should decide their best market and structure of organization to avoid unforeseen complications.
This paper focuses on factors that are Political, Economic, Social, Technological, Environmental and Legal (PESTEL) in nature. PESTEL analysis consists of hexagonal analysis of the target market. A proper and complete analysis of these factors will provide a clear picture to potential restructuring corporations, a distinct aid in deciding whether the market they are targeting is beneficial or not.
Political factors are governed by the degree of intervention by the government in an economy. In modern times, economies are divided in three types: socialism, capitalism and a mixed hybrid. In a socialist economy, the control over the economic transactions is assumed by the government, where in capitalist economy, the power is handed over to big corporations and in mixed economy both the government and corporations exercise joint control over the economy. Political factors include government policy, foreign relations, political stability in foreign markets, foreign trade policies, taxation policies, and others. These various political factors affect the conduct and existence of a business to greatly.
Economic factors consist of economic growth, consume income, exchange rates, inflation rates, and the disposable income of both consumers and businesses. These economic factors define the future of an organization in a market where it is willing to invest, helping business organizations in deciding the price of it’s product and services, target consumer, and marketing strategy. Economic factors are of great importance, and must be analyzed thoroughly before moving into a market. For example, in market like India, these factors are of great importance when considering the psychology of buyers, most of which prefer lower prices of commodities irrespective of quality they are offered.
Social factors as the name indicates are in respect of society. It is considered with the consumers who are in the market; it is their taste and preferences, population growth, age distribution, health consciousness, career attitudes and so on. These factors affect the existence of the business as society is the ultimate consumer of the goods or services which a business produce.
Technological factors are a more contemporary challenge that a business encounters in its day to day operations. These factors affect marketing styles, production methods, and management styles of the business. A business must match itself with constantly changing technologies in order to sustain themselves in the market and to ensure the primary objective of profit is achieved through economies of scale.
Environmental factors question the conduct of a business in whether they are doing their activity in an environmentally friendly manner, as well as if and how they abiding to the various environmental legislation. Consumers have become aware of trends towards the protection of the environment, and businesses makes sure that technology used does not negatively affect the environment.
The law is another consequential factor, as it directs the way in which a corporation ought to work under the guise of legislation. Business organizations must comply with the laws that the legislature has laid down for its conduct, from prohibition of workplace harassment of employees to labor laws. Conduct of every business in different countries is subject to different laws of their respective jurisdiction. As such, it is important for the businesses to follow the legislation.
Mergers and Acquisitions, commonly known as M&A, is an area of law that describes any transaction where companies combine to form a new company or a company acquires another company. Going through this type of restructuring, companies create a pool of resources and also get access to each others market. Merger and acquisitions are often done by companies which are located in different locations, commonly known as cross border mergers and acquisitions. Such M&A gives a business an opportunity to expand its business to a new target market while using the reputation of its partner and vice versa. It can be the ultimate win-win situation.
To properly proceed through an M&A transaction, businesses commonly complete a full PESTEL analysis so as to continue its conduct. Examples of cross border mergers and acquisitions are Bhart-Airtel, Vodafone-Idea, and Walmart Flipkart. These are concrete examples of mergers and acquisitions which have taken place in India.
Mergers and Acquisitions Include:
1. Mergers
2. Acquisitions
3. Consolidation
4. Tender offer
5. Acquisitions of Assets
6. Management Acquisitions
Research Methodology
The research methodology adopted for this paper comes from secondary sources, such as:
1. Interviews of people holding positions in top management of big investing groups and corporate houses;
2. Previously done researches on the same topic; and
3. Newspaper articles.
Such methodology was chosen because it gives actual perceptions of people who are involved in such transactions making our contentions concrete.
Political Influence on Mergers and Acquisitions: As previously stated, political factors are triggered by the relation with foreign government, political stability, and government intervention in economy. These factors affect mergers and acquisitions as companies will not risk its existence by entering into a country which has an unfavorable political environment or into a country where governmental intervention in business activities is more than desirable. Here are the views of people who touched upon impact of political system on potential mergers and acquisitions:
1. Christopher Darbyshire (Chief Investments Officer at Seven Investment Management) very clearly said in its interview with Bloomberg quoting the example of a Pfizer-Allergan merger worth $160 billion because of the political risk. Pfizer decided to terminate the deal due to change of tax regime under the new U.S. Treasury Rules preventing companies from shifting their business to lower tax countries, in this case Ireland. It was a political stunt to ensure the government has cash reserves.
2. The New York Times also gave a reason for failure in merger and acquisitions deals involving political risks it stated in its article:
Mergers and acquisitions bankers and lawyers have attributed the slowdown concerns about mergers being blocked by antitrust regulators after some prominent deals fell apart for that reason. There is added pressure because any deal that is signed now will have to gain regulatory approval under a new administration, and the outcome of the presidential election is far from certain.
3. It is clear that the business houses are very concerned with the political atmosphere surrounding any merger or acquisition. Specifically, anti-merger sentiments on the part of key political actors/institutions such as the president and the executive bureaucracy (e.g., the Antitrust Division of the Justice Department and the Federal Trade Commission) should be a focus of corporate compliance.
4. The determinants of FDI or acquisition mode include policy-perspective (e.g., openness, product-market regulation, corporate tax rates and infrastructure) and non-policy perspective (e.g., market size, distance, factor proportions, political stability and economic stability).
Notably, Japanese investors tend to respond more strongly to decreases than to increases in intra-nation conflict. However, these decreases result in improved political relations, benefiting investors while maintaining corporate goals.
Thereby, I conclude that political factors play a significant role in the integration of world economies, whether it be through Foreign Direct Investment (FDI) or M&A. The political factors, therefore, drive the psychology of the potential investors and makes them wisely choose the economy which is most politically stable, as well as favoring the interest of the investors in pre and post merger situations.
Economic factors effecting Mergers and Acquisitions:
Economic factors are directly related to the financial position of a host country, their economic stability, financing rates, and most of all, the market in which they will be dealing in. These factors contemplate the financial condition and spending psychology of the people.
This factor is the most significant factor when deciding whether a potential restructuring will be successful or not. There have been cases in the past where this factor led to the closure of big corporate houses which underwent mergers and acquisitions. A Singapore newspaper gave statistics of closure of different sectors of business as result of tough economy. It showed a cessation rate of companies from 7.3% in 2014 to 7.8% in 2016. The design of the financial system plays a key role in macroeconomic policies, especially capital markets and their regulatory framework.
The countries that have policies restricting financial openness, should, as a result, experience a reduced volume of cross-border M&A activity. The authors stated that an increased level of financial openness will open doors for international expansion, which I believe would be an opportunity to bring in new cash flow and help capital move around much easier thanks to “the cleverness of investors and global financial markets.”
Overpayments are also the result of failed mergers and acquisitions. If Company A is unduly bullish about Company B’s prospects and wants to forestall a possible bid for Company B from a rival it may offer a very substantial premium for Company B. Once it has acquired company Company B, the best-case scenario that Company A had anticipated may fail to materialize. For instance, a key drug being developed by Company B may turn out to have unexpectedly severe side-effects, significantly curtailing its market potential. Company A’s management (and shareholders) may then be left to rue the fact that it paid much more for Company B than what it was worth. Such overpayment can be a major drag on future financial performance.
Additionally, GDP, exchange rate, interest rate and share prices have significant impact on the level of outward U.K. cross border M&As. On the other hand, GDP, money supply and share price have statistically significant impact on the U.K. cross borders M&As inflows.
The best example of how economic factors can affect business is ABN Amro-Royal Bank of Scotland merger. This deal was signed off for 71 billion British Pounds (approximately $100 billion USD). This deal led to the demise of two out of the three buying consortiums who decided to buy in a bidding war for ABN Amro, a Dutch bank. But the global crisis intensified from the summer of 2007, resulting in the amount paid being three times ABN’s book value. That value later diminished and subsequently led to the collapse of RBS stock prices of RBS, forcing the British government to intervene with a 48 billion Pound bailout. The other member of the buying consortium, Belgian-Dutch Bank Fortis also had to be nationalized by the Dutch government in 2008, when it was on the verge of bankruptcy.
As such, economic factors, irrespective of the size of business, play a very important role. It is an important consideration when a cross border investment is contemplated, and one has to be cautious to allocate its resources so that the business remains profitable.
Social factors effecting Mergers and Acquisitions:
Many authors and critics argue that social factors are environmental factor by a different name. As such, these will be discussed later. Environmental factors are a much more widely used term and primarily focuses on the living environment available to the society in which businesses carry on their operations.
On the other hand, social factors relate to the cultural differences or similarities of people, including literacy rates. This factor generally becomes visible when the restructuring is done and the day to day operations begin to proceed. Businesses often fail to notice or consider this factor at an earlier stage, as the initial primary focus is to maximize wealth.
In a study done by Deloitte, social factors or say cultural issues have been shown to affect mergers and acquisitions. The above picture is a glimpse of that very study. Culture has been one of the major country-specific characteristics that affect the whole M&A cycle: pre-merger decision-making, negotiation and deal structuring, and post-merger integration.
As a social factor, the number of patents registered has a significant and positive correlation with the mergers and acquisition market. A high number of patents represent a smart and well prepared population, typically preferred by investors. Combined with the effect of literacy rate, we can conclude that the financial decision to invest in economies with good social indicators is preferred by all investors. Even if there can be opportunities in countries with low stage of development in terms of social issues, investors will, in many cases, choose the more safer environment of a socially developed country.
In a survey-based paper, the impact of national culture distance on acquisition management, using survey report of 142 top executives involved in international M&As was discussed. The author suggested that national cultural differences significantly influenced both deal completion phase and post-merger integration phase. Therefore, acquiring firm managers should pay more attention to due diligence and to use of professional advisors in pre-acquisition phase.
When a merger or acquisition unexpectedly heads south, the costs are painfully clear. Morale drops. Synergies fail to materialise. Key people—those you planned to keep—start heading for the exits. A likely cause of the trouble is culture clash. In a Bain survey of executives who have managed through mergers, this was the No. 1 reason for a deal’s failure to achieve the promised value. In a culture clash, the companies’ fundamental ways of working are so different and so easily misinterpreted that people feel frustrated and anxious, leading to demoralisation and defections. Productivity flags, and no one seems to know how to fix it.
To avoid these cultural differences some tools were defined:
1. Set the cultural integration agenda. To wit, a company’s culture is all the shared values, beliefs and behaviours that determine how people do things in an organisation. Three key elements in combination define the culture: The behavioural norms exhibited by everyone from senior leaders to frontline employees; The critical capabilities and decisions about where and how to compete, as defined by the company’s strategy; and the operating model of the company—the structure, accountabilities, governance mechanisms and ways of working that make up the blueprint for how work gets done.
2. Diagnose the differences that matter. In many cases, there are significant differences between the acquirer’s culture and the other party. But it can be difficult to pinpoint where, and how substantial, the differences are. Diagnostics can identify and measure the differences among people, units, geographical regions and functions.
Thereby, I conclude that even though social factors may be ignored due to their relative unimportance, post merger realities confirm this factor as the greatest reason for the failure of a restructuring. Therefore, it is the duty of the top management to do a due diligence over this factor to avoid looses to the company and the employees associated with it.
Technological factors:
Technological factors are significant factors in an organisation’s day to day operations. These are important tools for improving an organisation’s operations and functions. Development in technology over the past decade has boosted the economy, but contains some pitfalls as well. Technology impacts operations of businesses as much as the historical transition from manual labour to machine labour and have impacted the marketing strategies massively. To illustrate, from a newspaper advertisement to advertising on websites like YouTube, Facebook and many others. These technologies, like the development of the internet, have helped the companies to be located as a search result of the consumer, and install and track cookies of a user.
Technology such as IOT (Internet of Things), Artificial intelligence, and Machine learning are only a few examples that businesses have used to expand their operations across the globe to reduce their cost. Technology factors are related to economic factors in that technology is not cheap. In a country like The United States, obtaining new technology is very expensive for companies, where businesses in India and China can access the same technology at a relatively lower cost. This helps the companies to achieve their ultimate goal of profit maximisation.
Technology in merger and acquisitions:
As per a research by Accenture strategic research, 41 percent of the companies see technologies as a disruption to their businesses. Yet the same research found that nearly half (47 percent) of executives are turning this threat into an opportunity by putting technology and mobility at the core of their future growth strategies.
In the area of mergers and acquisitions (M&A) in particular, two roles for technology are coming into sharp focus : The Catalyst and The Enabler.
As a Catalyst
Technology disruption—whether it takes the form of digital, cloud, analytics, the Internet of things (IoT) or artificial intelligence—is introducing new business models and forcing traditional communications, media and technology companies to up their game. For established players, staying ahead of industry innovators and new agile startups is critical—and harder than ever. Fortunately for them, M&A can level the playing field and open the door to future game-changing transformations.
Forward-thinking communications, media and high-tech companies have caught on. They are acquiring companies with technological expertise they can then use to develop new offerings, redefine industry boundaries and drive top-line growth. One telecommunications client, for example, used M&A to acquire IoT and analytics capabilities in order to enter the automotive market. In addition to driving new revenue streams, the company estimates its acquisition of new technologies will enable it to grow its customer base by over 70 percent within two years. 42 percent of executives now see the need for acquiring next-generation technology as a trigger for M&A.
As an enabler
According to 58 percent of executives, technology is a key enabler to unlocking merger synergies and challenging new market entrants. The quality of the resulting IT environment also plays a critical role in the success of future transformations that M&A deals might enable. Unfortunately, many communications, media and high-tech companies still run systems for billing, provisioning, customer service, production or countless other functions that are decades old. For them, integrating first and modernising later is usually not a winning strategy. That’s because cloning or merging outdated legacy systems during M&A come with considerable risk. The older the systems, the more difficult it will be to integrate effectively or achieve future synergies and transformation goals. Upgrading systems before or during M&A integration is one way to avoid the legacy technology trap. But this approach may not always be best. For every dollar spent to upgrade systems, an additional $1.30 to $1.50 is usually spent during later transformation efforts.
To accelerate merger integrations and post-merger transformations, leading companies are adopting three principles:
• At the outset of the restructuring they make critical investments to update the technology. They start with a modern approach rather than conventional of integrating first and modernising later.
• Transition to future platforms that enable vertical and horizontal integration. Using cloud, analytics, virtualisation, master data harmonisation and as-a-service technologies can increase integration speeds and reduce costs by up to 30 percent.
• Don’t go it alone. Integrating platforms with business partners is more critical than ever to provide seamless end-to-end customer experiences. More than 80 percent of executives agree that partnerships are required for modern technology adoption. Forward-thinking leaders bring in partners early during M&A integration to share platform costs, spread risks and accelerate transformation timelines.
I conclude that technological factor is a very crucial factor for M&A. Though not very prominent, they play a significant role in M&A activity and are the most ascertained factor in M&A where technology plays a prominent role in post merger activity of the business. The Dell EMC merger was the most prominent merger in the history of global technology industry. While some may not agree, technology played an important role in this merger. With this merger, Dell got access to the data storage market, a key activity of EMC, and with the upgrade to cloud storage, Dell also entered that segment. It depicts how technology played a key role for Dell.
Environmental factors
Environmental factors in the context of PESTEL are related to all types of physical environment, such as climate, climate change, weather, renewable energy, non-renewable energy, types of goods available, and the environmental laws which a business has to abide by to carry on its activity. Although environmental laws are part of the legal factor, it is concerned with environment, so it has been put under environmental factor for the purposes of this paper.
Environmental factors have been given huge importance, as any misconduct on the part of business would have a negative impact on the environment and ultimately, society itself. The physical environment such as climate, weather, climate change are uncontrollable factors, and thereby, a business has to do a proper analysis of target market’s environmental factor and make a direct link between the segment they will be dealing in and the direct impact on it due to environment.
Environmental factors also involve geographical location of a business, direct linked to the profitability and the management of the business. Scholars found that physical distance between two countries affect the cross-border acquisition performance. The conditional logit is the most frequently used method when examining location choices. It is based on MacFadden’s model of multinomial logit.
I conclude that environment plays a very significant role in Merger and Acquisition. The objective of business is achieved by carrying on its task in that very environment and the business must very carefully assess the elements of this factor to avoid any post merger or acquisition hindrances.
Legal factors
Legal as the name suggests is related to the law. Legal factors are of utmost significance as this factor ultimately decides the fate of the business which has been restructured as a new entity. This factor requires due diligence on the part of parties involved in the transaction and requires parties to carry out through research in the market they are entering. It involves antitrust laws, taxation policies, corporate social responsibility, intellectual property rights law, consumer protection laws. These laws have to be ascertained and understood before any restructuring can be contemplated.
Legal factors have a direct relation to political factors. The latter’s stability would ultimately be considered profitable for the company. As far as stability is concerned, the dynamic nature of this factor can result in closure of the business if politics fail the legal aspects.
The Foreign Direct Investment (“FDI”) regime in India has progressively liberalised business law, and the Government of India recognises the key role of FDI in the economic development of a country. With very limited exceptions, foreign entities can now invest directly in India, either as wholly owned subsidiaries or as a joint venture. In an international joint venture, any proposed investment by a foreign entity/individual in an existing entity may be brought in either through equity expansion or by purchase of the existing equity. Every country has laws covering mergers and acquisitions. In India, mergers and acquisitions are governed under sections 230 to 240 Chapter XV of The Companies Act, 2013.
Following is the example and reasons of failed mergers and acquisitions:
• HDFC and Max life
This merger of the HDFC insurance sector and Max life insurance failed due to non approval by the authorities like sectoral, Insurance Regularity and Development Board(IRDB). Section 35 of Insurance Act bars the merger of insurance company with non insurance companies.
• IDFC and Shriram finance
Some of the investors from IDFC demanded 60 percent premium on fear of diminution of their holdings in the swap. IDFC Ltd could not lessen below the 40% shareholding and therefore could not give a good value to Shriram Transport. The shareholders of Shriram feared Holding Company Discount. The structure and valuation were not mutually acceptable to both the parties.
The RBI stance was critical for Piramal Enterprise Limited to hold more than 5% in IDFC whereas it held a reasonable stake in Shriram and its subsidiaries.
The reason for calling off the merger was-
1. Disagreement in Share swap Ratio.
2. Zero value for Shareholders.
• RCOM and Aircel Merger
✴Opposition from Creditors like Ericsson and (CDB) China Development Bank who objected before NCLT.
✴The procedure was time-consuming as a lot of permissions had to be sought from courts and authorities like DOT.
✴High taxation, the charge levied by the centre on the use of spectrum through auction.
The deal was called off mutually by both the parties.
The above-mentioned instances explicitly depict how legal aspects effect the M&A transactions and how this very aspect of PESTEL need to be properly ascertained, to avoid heavy legal fees. Parties should do due diligence before getting into the transaction of the other party’s books, assets, liabilities legal issues in past and pending ones. Such analysis would give a business a better idea that whether the objective behind this merger or acquisition is duly met or not.
Conclusion
Every business seeking to expand its activity within a territory or across borders must complete their due diligence, including an analysis of various significant factors. I have put my primary focus on political, economical, social, technological, environmental and legal (PESTEL), and once the business entities analyze these factors and other significant factors, the objective of their merger or acquisition is duly achieved without any negative post merger or acquisition impacts and it would carry out its key activities in a better way, the ultimate goal.
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