In last week’s blog I touched on the fact companies carry out mergers and acquisitions as part of FDI. However, I did not go into too much detail about the benefits and drawbacks of such an activity. This blog will focus on such issues and discuss the case of Glencore International plc. and Xstrata plc.
Generally speaking it is well known that companies which acquire other companies lose money. So that begs the question why do companies go about doing such an activity when their aim should be to maximise shareholder value? It could be a number of reasons such as: Taking control of a key supplier, the quest for growth or getting quick access to a market.
The factors just described could also be reasons for mergers. Arnold (2008) however, sets out the following motives for why two companies may merge: Synergy, bargain buying, managerial motives and third party motives. Another factor to why companies may merge or acquire a company is hubris, another word for arrogance, it states managers may become over optimistic causing them to make errors. The fundamental principle of any merger and acquisition however, is: ‘Are we maximising shareholder wealth?’ If the answers no, then investors should be asking why not?
All over the news in the past few months has been the possible merger of Glencore and Xstrata. These two companies are leaders in the commodities market focusing primarily on non-renewable resources. If the companies do merge then we would describe it as a horizontal merger. Due to the fact the two companies are engaged in similar lines of activities. Mentioned in a previous post they both have their HQ’s in Barr, Switzerland and both chief executives are from South Africa. The merger sounds perfect yet the two companies are still trying to win over investors.
Speculation of the possible merger began surfacing in early February and the share price for both companies shot up. The diagrams below show this.
Glencore share price
Xstrata Share Price
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RECOMMENDED ALL-SHARE MERGER OF EQUALS OF
GLENCORE INTERNATIONAL PLC AND XSTRATA PLC
TO CREATE UNIQUE $90 BILLION NATURAL RESOURCES GROUP
The above statement states a merger of equals however; Xstrata earns almost double the EBITDA of Glencore at $6.4bn. This is somewhat surprising given Glencore’s revenue is over five times that of Xstrata standing at $186bn. Clearly Glencore is a bit more inefficient than Xstrata. If the merger takes place and the integration of the company’s goes smoothly then profits could sky rocket. Xstrata’s greater efficiency would help to turn Glencore’s massive revenues into more profit. A global mining and commodities powerhouse would be created.
Glencore has offered Xstrata shareholders a merger ratio of 2.8 New Glencore Shares for every Xstrata Share held. Clearly if it’s a merger of equals then why does Glencore have to pay such a premium? To the Xstrata shareholders however, they feel this figure undervalues the company and are therefore holding out. This is one of the fundamental problems with mergers and acquisitions. The agreement on the right price! The bidding company usually pays over the odds.
Will the merger of Xstrata and Glencore take place? Probably unless the regulatory bodies intervene seeing the merger as a limit of competition. Will the merger benefit shareholders? Time will tell. Hopefully increased profits will occur resulting in a higher share price and an increase in dividends. On the other hand the merger could turn out to be a disaster. Different attitudes and cultures could cause friction in the boardroom and with this will come failure.
Sources Used: Arnold: Corporate Financial management (2008), FT, The Guardian, http://www.glencore.com/, http://www.xstrata.com/, investopedia
Sources Used: Arnold: Corporate Financial management (2008), FT, The Guardian, http://www.glencore.com/, http://www.xstrata.com/, investopedia
You mentioned conflicting attitudes and cultures creating a possible disaster from this merger, what other problems generally can arise from mergers/acquisitions?
ReplyDeleteThe merger or acquisition can turn into a disaster if no planning has been done after the acquisition stage. This ultimately leads to bad management and bad decision making which may eventually lead to the failure of the merger or acquisition. Overestimating the initial value of the M&A can also lead to problems. It will mean the return on the investment will be higher and if targets are not met shareholders are likely to be disgruntled.
ReplyDeleteApparently there has been a reduction in M&A deals over the past few years, can you give an explanation why?
ReplyDeleteObviously the risk involved in carrying out such deals has increased due to the international financial crisis we find ourselves in. Companies are less inclined to take risk when the market is so unstable. This is probably why M&A activity has reduced in recent times. Many studies have been carried out questioning the value M&A add to a business so this could be another reason for the decline.
ReplyDelete