The M&A Way

There are a number of motives for companies which adopt a strategy of Mergers and Acquisitions (M&A’s).  M&A’s generate synergies that can, in turn, foster corporate growth, increase market power, boost profitability, and improve shareholder wealth (Alexandridis, Petmezas and Travlos 2010).  Other benefits may be incremental cash flows and reductions in the cost of capital (Antoniou, Arbour & Zhao, 2008). 

Recently it was announced that two food giants, namely Kraft and Heinz have agreed to merge.  The deal was struck by Heinz’s owners, the Brazilian investment firm 3G Capital, and the billionaire investor Warren Buffett’s Berkshire Hathaway (BBC News, 2015).  Buffett is no stranger to the business world through his opinions and actions, his name having occurred frequently in my previous blog posts.

When the news of the merger was publicly released, Buffett commented, ‘This is my kind of transaction, uniting two world-class organisations and delivering shareholder value.’  This may be the case in terms of this particular merger as Kraft shareholders will receive a special cash dividend of $16.50 per share as part of the deal, (BBC News, 2015) and on the day of the news announcement the share price surged by 36% to $83.17 (the significance of which is shown in figure 1), its highest since 2012 (Cimilluca, Mattioli & Dulaney, 2015).

Yes, the shareholders of Kraft may have benefited already as there has been a significant rise in share price and the guarantee of a special cash dividend but can there be any guarantee that this merger is going to lead to corporate growth, increased market power and profitability?  Only time will tell.  This leads to a more fundamental question, namely how successful mergers and acquisitions have been in reaching their goals.

Considering that 20 percent of mergers worth more than $10 billion announced in the last two years have collapsed and of those deals that failed, $278 billion of the total and $784 billion in announced deal was lost (Bloomberg, 2015), some people may say that Buffett and 3G have made a brave move in engineering the merger between Kraft and Heinz. 

There are a number of possible reasons for the failure of mergers and acquisitions.  The market for corporate control of public companies is extremely competitive.  As a result, acquirers tend to bid more aggressively and offer hefty premiums for target firms which could result in a value-destroying merger and aquistion deal.  (Antoniou, Arbour & Zhao, 2008).  This is known as Roll’s (1986) Hubris hypothesis.  This is also related to the Agency problem (Jenson and Meckling, 1976) discussed back in Blog 1 where I discussed how managers can act in self-interest at the expense of shareholders which results in the destruction of shareholder value.

Competitiveness between CEOs to acquire control of public companies can become marked as we have witnessed with some recent comments made by one CEO in relation to a failure of a merged company which took place a year ago.  Siemens CEO Josef Kaesar, who lost out to US rival GE in a bid to acquire the energy assets of Alstrom, was quoted by a media outlet as saying that his company was at a disadvantage because Alstrom CEO Patrick Kron ‘declared on several occasions that he felt resentment towards Germany and Siemens’ (Rosemain & Webb, 2015).  These are strong comments to make, especially from a CEO of a leading organisation.  This shows that company management are willing to go to extreme lengths to compete with other companies when it comes to mergers and acquisitions which explains why some CEO’s may overpay for acquisitions, thereby damaging shareholder value.

Mergers and Acquisitions are also not as ‘plain sailing’ as stakeholders may think.  Take the recent Lafarge/Holcim merger discussions.  The initial terms and management line-up became a significant area of debate between the boards of both companies after Lafarge’s results had lagged behind Holcim.  Lafarge CEO Bruni Lafont, who has been designated as CEO of the merged company, has lost out as a result of Holcim managers coming out to say that they did not want him to become CEO of the merged group because of Lafarge’s recent lacklustre performance (Financial Times, 2015).

In conclusion, there are a number of arguments both for and against mergers and acquisitions.  I find it difficult to argue with someone as successful as Warren Buffett who seems very confident that the recent merger in which he has been involved is going to enhance shareholder value.  However, it is quite clear to see that there are a number of barriers to overcome in order to ensure the success of a merger or acquisition.  There therefore needs to be a very effective integration process to ensure that as many synergies as possible are achieved in order to reduce overhead costs of the merged companies and thereby create a solid basis for shareholder value. 

Alexandridis, G., Petmezas, D., & Travlos, N. (2010). Gains from Mergers and Acquisitions Around the World: New Evidence. Financial Management, 39(4), 1671-1695. doi:10.1111/j.1755-053x.2010.01126.x

Antoniou, A., Arbour, P., & Zhao, H. (2008). How Much Is Too Much: Are Merger Premiums Too High?. European Financial Management, 14(2), 268-287. doi:10.1111/j.1468-036x.2007.00404.x

BBC News,. (2015). Kraft shares soar on Heinz merger. Retrieved 26 March 2015, from http://www.bbc.co.uk/news/business-32050266

Cimilluca, D., Mattioli, D., & Dulaney, C. (2015). Kraft, Heinz to Merge, Forming Food Giant. WSJ. Retrieved 26 March 2015, from http://www.wsj.com/articles/kraft-foods-h-j-heinz-to-merge-1427278332

Financial Times,. (2015). Holcim and Lafarge: A merger of egos - FT.com. Retrieved 26 March 2015, from http://www.ft.com/cms/s/0/41d317c8-d14e-11e4-98a4-00144feab7de.html#axzz3VWkDRKhD

Inc, K. (2015). KRFT:NASDAQ GS Stock Chart - Kraft Foods Group Inc. Bloomberg. Retrieved 26 March 2015, from http://www.bloomberg.com/quote/KRFT:US/chart

Roll, R.,  (2008). ‘The hubris hypothesis of corporate takeovers’, Journal of Business, Vol. 59, 1986, pp. 197-216.  Retrieved 21^st March 2015 from http://www.jstor.org/stable/2353017

Rosemain, M., & Webb, A. (2015). Battle for Alstom Lives on via Executive Barbs After GE Deal. Bloomberg.com. Retrieved 26 March 2015, from http://www.bloomberg.com/news/articles/2015-03-11/alstom-ceo-rebuffs-siemens-overtures-of-possible-train-merger

The Dividend Debate

Dividend policy is a firm’s policy with regards to paying out earnings as dividend versus retaining them for reinvestment in the firm.  It is the division of profit between payments to shareholders and reinvestment in the firm (Hussainey, Oscar Mgbame & Chijoke‐Mgbame, 2011).

Dividends act as ‘conveyors’ of information about the company.  An unexpected change in dividend is a good indication of how the directors view the future prospects of the company (Arnold, 2013).  For example Lloyds bank recently announced that it will resume paying dividends to shareholders, after it reported full-year statutory profits of £1.8bn.  Lloyds had not paid dividends to shareholders since the 2008 financial crisis (BBC News, 2015).  Lloyd’s shareholders could interpret this decision to pay dividends as meaning Lloyds bank directors are optimistic about the future of the bank, having recovered significantly from the financial crisis.  When this information on dividend payments was released, the share price rose by 0.6%.  This can be interpreted as confirming the theory set out in my 2^nd Blog which talked about Stock Market Efficiency where shares rationally reflect all available information.

However as Arnold (2013) states, it is risky for managers to increase the dividend above the regular growth pattern if they are not expecting improved business prospects.  An example of this could be WM Morrison PLC where the company has increased dividends for the past 5 years (see figure 1), despite the company having a very poor year for fiscal year ending 2014 (see figure 2).  It is reasonable to suggest that Morrison’s shareholders may have been misled by the company’s directors as increasing its dividend may have given shareholders the impression that the company is performing well, despite its struggles performing against the ‘discounters,’ namely Aldi and Lidl.  However in saying this, Morrisons had been committed to a dividend payment policy of a certain level for the past number of years, the final dividend of which is due to be paid this year.

Opposition to paying dividends came from Miller and Modigliani (MM Theory) in 1961 who stated in their academic paper that dividend policy is irrelevant to shareholder wealth.  One of the main arguments they advanced was that firms are able to finance projects which have a positive NPV from retained earnings or by issuing new shares at the same cost which would have otherwise have been paid out to shareholders in the form of dividends (Arnold, 2013).  An example of the MM Theory in practice is the recent case of Vodafone.  On the 6^th March 2015, Vodafone’s share price fell dramatically to a 2 month low, following speculation of a dividend cut.  Analysts at Nomura, the financial services group, cited reasons such as necessary acquisitions which were draining Vodafone’s free cash flow (Elder, 2015).  This supports the MM Theory as Vodafone have been investing in projects (taking on acquisitions), most likely with a positive NPV and therefore have chosen to cut dividends in order to fund these worthwhile investments.

I think Miller and Modigliani’s theory that dividend policy is irrelevant is difficult to support.  Although, arguably, they have reason to suggest that cash should be retained to be invested in positive NPV projects, I believe that this can be applied to only one of many different investor classes or ‘clientele’ as referred to by Arnold (2013).  Other investor classes may want a high and stable dividend yield immediately and therefore do not want to wait for a dividend which is declared years down the line as a result of investment by the company in positive NPV Projects.

Arnold, G. (2013). Corporate financial management. Harlow, England: Financial Times/Prentice Hall.

BBC News,. (2015). Lloyds to resume dividend payments. Retrieved 8 March 2015, from http://www.bbc.co.uk/news/business-31655343

Hussainey, K., Oscar Mgbame, C., & Chijoke‐Mgbame, A. (2011). Dividend policy and share price volatility: UK evidence. The Journal Of Risk Finance, 12(1), 57-68. doi:10.1108/15265941111100076

Elder, B. (2015). Vodafone stumbles on dividend payout fears. The Financial Times. Retrieved from http://www.ft.com/cms/s/0/d71f85b0-c423-11e4-9019-00144feab7de.html#axzz3TibguTE2

Markets.ft.com,. (2015). WM Morrison Supermarkets PLC, MRW:LSE financials - FT.com. Retrieved 8 March 2015, from http://markets.ft.com/research/Markets/Tearsheets/Financials?s=MRW:LSE