The basic motivation of a merger
should be to add value to a company, thereby enhancing shareholder wealth. That
said, this is not always the case. There is much debate regarding the success
of mergers, with some claiming the majority destroy shareholder value. With
this in mind, the recent announcement of BT’s takeover of EE provided an
interesting read (Roland & Williams, 2015; Thomas, 2015; Williams, 2015; & Hargreaves Lansdown, 2015); would this takeover succumb to the factors that have
previously rendered other mergers disasters? Or would, despite the odds stacked
against the success of mergers, it realise the benefits it anticipates from the
merger?
A merger is typically classed as a
friendly, negotiated deal. So far, the BT-EE merger has been friendly, although
approval is still required from shareholders. There are 3 different types of
mergers; horizontal, vertical and conglomerate. The BT-EE merger takes the form
of a horizontal merger as the two firms are involved in similar business
activity. The horizontal nature of the merger means competition clearance is
required from the UK Competition and Markets Authority. A vertical merger is a
situation in which firms from different stages of the supply chain merge.
Businesses in completely separate industries that unite is known as a
conglomerate merger, although these are quite rare in the UK.
There are various different motives
associated with mergers being undertaken. The neoclassical theory proposes that managers will only engage in takeover activity if it leads to the creation of shareholder wealth. This is likely to be the case with the BT-EE
merger, and most horizontal mergers, as there are various potential synergies from the deal which have the ability to maximise shareholder wealth. Economies
of scale play a large role in this, as a larger sized firm may lead to lower
costs through the utilisation of resources. BT forecast a large cost saving off
the back of the merger, with an expected £360m saved on operating costs and
capital expenditure every year by the fourth full year following the
transaction. This has a net present value of around £3.5bn before integration
costs, falling to £3bn after these costs are taken into account. Spreading costs
over an increased range of products creates economies of scale. As BT is aiming
for a full union of mobile and fixed telecoms, this is likely to result in new
products and services to spread their costs and generate further revenue.
Revenue synergies from the wider range of products are expected to amount to a
net present value of £1.6bn.
Managerial synergy could also have
played a role in the merger, as BT clearly believes they can run EE better than
it is currently being run. Inefficient managers can be replaced and expert
skills transferred between both companies. This can be seen in the takeover
agreement between the two firms, which states Deutsche Telekom, joint owner of
EE, have the right to appoint a director to the BT board. The two companies say
this creates a platform for them to work together, sharing best practice in the
process. These motives behind the BT-EE merger suggest it will generate value
for shareholders. BT seems focused on creating synergies, including higher
revenues and lower costs, as well as working with EE. At first glance, there
does not appear to be any managerial motives, such as higher salaries and
remuneration packages, behind the deal.
An alternative argument suggests managers own personal interests could be the motivations behind mergers. This stems from agency theory, which suggests a difference in goals between managers and shareholders may cause managers to prioritise their own needs as opposed to shareholder wealth maximisation. Factors including increased remuneration and power may encourage such behaviour. Evidence has found managers are rewarded off the back of mergers even if they turn out to be unsuccessful. Alternatively, the manager could suffer from 'hubris', leading them to overestimate their abilities to run the merger on completion. This stems from overconfidence. It may be the case that the managers at BT simply wanted to 'enhance their CV' by running a much larger, more dominant company. If this proves to be the case, it is unlikely to merger will be successful in generating shareholder value.
An alternative argument suggests managers own personal interests could be the motivations behind mergers. This stems from agency theory, which suggests a difference in goals between managers and shareholders may cause managers to prioritise their own needs as opposed to shareholder wealth maximisation. Factors including increased remuneration and power may encourage such behaviour. Evidence has found managers are rewarded off the back of mergers even if they turn out to be unsuccessful. Alternatively, the manager could suffer from 'hubris', leading them to overestimate their abilities to run the merger on completion. This stems from overconfidence. It may be the case that the managers at BT simply wanted to 'enhance their CV' by running a much larger, more dominant company. If this proves to be the case, it is unlikely to merger will be successful in generating shareholder value.
The financing of mergers is most
frequently made up of either cash or shares. BT is paying £12.5bn for EE;
however, the sellers, Deutsche Telekom and Orange, are receiving most of this
in stock. Deutsche Telekom will have a 12% stake in BT, and Orange will have a
4% stake. A major advantage of this is that tax can be avoided
for the time being. It also reduces the amount of cash BT must provide as part
of the deal. However, to achieve this BT
raised £1bn from the sale of 2.2 million new shares at 455p. This will dilute
the position of existing shareholders; not necessarily a popular decision.
Despite this, BT will still have to make use of debt to fund the rest of the
takeover, and take on EE’s existing debt of £2.1bn. This will affect BT's capital structure as gearing would be increased; the company should ensure this would not increase financial distress costs too dramatically as this may destroy shareholder wealth. Cash may be preferred by
the target as it carries a certainty of worth, however, this may be subject to taxation. Despite the limitations
associated with each financing method, it appears to me that BT has funded the
merger in a way that best suits the company. This has allowed them to
strengthen their abilities and improve their free cash flow.
Despite potential synergies and opportunity to maximise shareholder wealth, there has been
widespread criticism of mergers. Grubb & Lamb (2000) claimed that only 20%
of all mergers succeed; hardly enticing odds for shareholders facing the
prospect of a merger. Evidence regarding whether bidding firms generate value through mergers is somewhat ambiguous. Jenson & Ruback (1983) showed share price increased
by 4% on average following a successful bid, and dropped 1% following an unsuccessful
bid. The BT-EE merger certainly follows this proposal, with BT experiencing a
4.5% increase in share price on the day the final terms of the merger were
announced. Shares reached their highest point in 14 years, showing the positive
reaction from the marketplace. However, it remains to be see whether this success will continue once the merger is undertaken. Alternative studies have found successful mergers reduce the wealth of bidding firms shareholders (Firth, 1980). This implies the motivations behind the takeover may play a role in determining whether the merger is successful; it will create shareholder wealth if shareholders interests were prioritised when creating the deal. Target firms seem to benefit from mergers
more; Jenson & Ruback (1983) found shares increased by 30% upon successful bids, dropping
3% for any unsuccessful bids. This led some to claim the increase in wealth of target shareholders is at the expense of bidding shareholders
The forecasts provided by BT of the
synergies expected from the deal seem well thought out. They recognise the cost
of integration and time required to make the merger a success, stating benefits
will be realised in the fourth full year from the transaction. The marketplace
reacted well upon the announcement of the merger and I believe this signals that the deal has the potential to generate shareholder wealth. Having said that, the merger still
requires approval from shareholders and clearance from UK authorities, showing
it is still in its early days. On the basis of this, I am inclined to refrain
from full judgement of the merger, at least for now. Therefore, it remains to
be seen whether the BT-EE merger will relish in the predicted success,
generating value for shareholders, or fall foul to the curse of mergers falling
flat and destroying shareholder value.
References
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Jensen, M. & Ruback, R. (1983). The market for corporate
control: The scientific evidence, Journal
of Financial Economics, 11(1-4), 5-50. doi: 10.1016/0304-405X(83)90004-1
Firth, M. (1980). Takeovers,
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