Question

(a) Explain the major justifications likely to be put forward to explain the following types of acquisitions:

(i) horizontal acquisitions;

(ii) vertical backwards and forwards acquisitions;

(iii) conglomerate acquisitions.

(b) Discuss reverse takeovers under the following headings:

i. meaning

ii. advantages

iii. disadvantages

(c) Discuss the use of the price/earnings ratio and dividend growth methods of determining the value of a target company.

(d) Explain why a company may wish to divest part of its operations.

(e) Discuss the use of the price/earnings ratio and dividend growth methods of determining the value of a target company.

Answer 1

Horizontal acquisitions means that when one company acquires another company operating in the same industry and working at same production level i.e., both companies produce or provide same class of goods or services so that the resultant new merged company is in a better competitive position due to increased market share and enjoy more economies of scale. Examples food processing industry .Vertical backwards acquisition happens when one company purchases another company which is a supplier of inputs to the acquiring company can be explained with help of an example a car manufacturing company purchases a input manufacturer company say tires it ensures that acquiring company is having steady supply of tires production is not held up. Vertical forward acquisition means that a company decides to purchase or take control over the post production process I.e., buying or acquiring a business ahead of it's own supply chain.for example a clothes manufacturing company buying a retail outlet or dealership so that the acquiring company is in a position to reach final customers of its products and profits are increased. Conglomerate acquisition means merger of two firms belonging to different industries or between firms operating in different geographical locations I.e., a merger of firms who are producing unrelated products or business activities example TATA is classic example for this from salt to software, cars etc. Usually companies do this for expansion of business,product range etc. Reverse takeovers means acquisition or takeover of a public company by a private company through buying majority of their shares thereby obtaining major controlling power without resorting to intial public offers and avoiding all the complex procedures, formalities but in some cases a private company is also acquired by public company through asset swap or share issue whatever may be the case but it typically involves reorganization of capitalisation of the acquiring company. Advantages of reverse takeovers 1) no need for registration since the private company has acquired public company through bulk or mass buying of shares in the shell company so registration is not required unlike in case of IPO's. 2) less time consuming in case of IPO's registration and listing involves months or years time but in reverse takeovers it happens in weeks time.3) cost effective since reverse takeovers avoids registration and listing process there respective cost is saved disadvantages of reverse takeovers 1) liquidity problems often it is experienced by lawsuits due to various reasons many shareholders who are anxious dumping their shares results in low share price and investors are not willing to lend money in such business 2)it some times leads to reverse stock splits and reduction in the number of shares. 3)inefficient and lack of skilled management because private company managers do not know the functioning the operations of a public companies they lack efficiency and thereby poor management. Divesture or disinvestment means withdrawing of funds invested or sale of one the business unit or operations The reason for why a company may divest a part of its operations 1)if it is non core activity for the main business. 2) if it is required by agreements of mergers or other regulatory authorities. 3)if the company has become bankrupt then it will sell part of its business operations to obtain funds and stability in working.4)if one of the subsidiaries company is underperforming or making continuously losses it will be sold by the parent company. The uses of price earning ratio (PE ratio) and dividend growth models in determining value of target company 1) PE ratio indicates how much price the market is willing to pay for the stock today based on past and future earnings   PE ratio = market price/earnings per share A high PE ratio indicates that stock price is highly relative to earnings therefore stock is overvalued in the market and investors are expecting high growth for the company. Low PE ratio indicates that stock price is relatively lower to earnings so the stock is undervalued. helps in decision making process by indicating price for the stocks 2)dividend growth model it also helps in ascertaining value of a stock assuming the dividend growth at a stable rate in perpetuity or different rate for a given period in hand. As it calculates true value of stock based on dividend payments it shows efficiency,liquidity etc to judge and acquire a target company.