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Chapter 5

ABSORPTIONS AND MERGERS

 

by josavere

1. BASIC CONCEPTS

A. ABSORPTION: is a negotiation between two companies: one disappearing and the other one which stays keeping its trade name, its administrative structure, increasing its capital and becoming bigger and bigger through external financing or by its own resources. Depending on the terms of the negotiation, the new company can pay to the owners of the disappearing company with shares or with cash.

 

B. MERGER: in this case, a new company is formed to acquire the rights and obligations of the combining companies. This new company acquires rights and obligations of the combining companies having a single patrimony. Thus, gathering efforts, the new company will be able to carry out objectives that would be very difficult for a company by itself to fulfill with the same effectiveness. The merged companies can be paid with shares of the new company.

In general terms, the negotiation is made adding assets and liabilities. In certain situations, it is the best opportunity to solve serious weaknesses of a company taking advantage of   another company’s strengths or vice-verse. For example, a company may possess “The Know How” but not the market, while the other company may have the latter but not the former. If a merger is agreed, upon the new company will have both strengths and will be able to run with the advantages thus obtained.

Structuring the negotiation in itself is very difficult; a stating is required as well as an analysis and a making of decisions by the Board of Directors, because if a company is merged, it is very likely that a group of executive people and other personnel lose their posts, becoming dangerous enemies to the merging; although, this merge could be beneficial for the new company.

To anticipate this reaction by some personnel - quite understandable from a human point of view - is fundamental as a departure point of the discussions, in order to explore alternatives of solution thus turning the first affected employees (in case they deserve it) in supporters of the project, which can be a very valuable asset in the negotiation; although it is not registered in the balance sheet.

 

 

2. GENERAL SITUATIONS IN, WHICH THE MERGER IS RECOMMENDED

A. TO OBTAIN OPERATIVE ECONOMIES: this negotiation could be possible when two companies, which have a production level inferior to their production capacity, could occupy the same premises, thus saving money for fixed expenses (rent, maintenance, supervision, etc.) This situation could be for both companies or for only one of them. The survey made will be guided to calculate the savings to be accomplished using one of the two premises to its maximum capacity and analyzing the benefits of such a decision.

 

B. TO ACQUIRE SKILLFUL PERSONNEL: a lot of literature has been written in administration about the value of the human resource; however, it contrasts with the scarce value it has been given by enterprises - an easy observable phenomenon but completely ignored by the accounting. A calm reflection demonstrates how, in most of the cases, the best resource a company has is its human resource. For other people, the analysis is the contrary: how many years have an employee been working for that company... They calculate the value of his/her indemnity and immediately he/she is turned into a liability.

Good traders know how to take advantage of this situation and sometimes they find in the personnel the best reason for promoting a possible merger or absorption.

 

C. DIVERSIFICATION: when a company is very concentrated in a certain line of products, this characteristic could turn itself in to a weakness, the company can be strengthened by a merger. That diversification can be focused on different forms:

a. Vertical Diversification: is the merger of two companies: one producing raw material or complementary products, approaching the final consumer or supplier, obtaining the biggest capacity in the company and more competitiveness, thus assuring, the existence and yield of the merged companies. It has the disadvantage of increasing the cash flow cycle.

b. Horizontal Diversification: is a merger of companies producing the same type of products or services which look for common benefits that could strengthen themselves in complementary aspects (product distribution, economies of scale, etc.), thus obtaining good commercial and technical benefits, a larger piece of the market, and less production costs, making it a better competitive and profitable company.

This kind of merger is highly recommendable for companies producing stationary demand of goods but with complementary cycles, such as the ones shown in the following graph.

c. Conglomerate Diversification: this is to merger of non- related companies; it dog be an extension of products, complementary businesses, geographic extension, and market.

 

D. GROWTH: it could be the case of a company which does not have either an important infrastructure to do research and development or laboratory or patents or "the know how" or skillful personnel, or very valuable assets and whose development may take a long time. In such circumstances, a growth by absorption, buying a company in crisis that overcomes the weaknesses of the absorbent company or that serves like a bridge to do so could be more rapid and more economic.

 

E. DEBTS DUE TO TAXES TO BE PAID: occasionally, a company with sufficient financial capacity can buy another one, which has accumulated losses to be absorbed, in such a case the purchase is subsidized by the government.

 

G. TRADING OF SHARES: eventually, it could be a sufficient reason for a company, which has not easily found a buyer, to purchase another one whose shares are being sold in the stock market. It is possible to make the negotiation paying the owners with shares so that they can sell them in the market. These are very easy negotiations for the economic groups.

 

H. FINANCING: this is a factor, which can be dominant for a company with many cash surpluses. Buying another unsettled but profitable company, it can balance its corporative finances in order to make a profitable and reasonably unsettled company.

The survey should emphasize in the flows of individual funds and in the combined flow, bringing them to the current net value to calculate the benefit of the negotiation.

 

I. OTHERS: if they are advantageous to generate any value such as the spreading of a geographic cover, complementing of a distribution network, access to financing sources, diversification of services, better use of an administrative team, assurance of the supplying of raw materials, etc.

 

 

3. SYNERGY

A basic principle: it is the effect that arises from the merger of two companies by the reduction of costs and expenses they would have to pay if they were working alone.

It is the typical case of the managers, important executives, members of Boards of Directors, and advisers, in addition to premises expenses, such as rent, profits, publicity, etc.

In a graphical form, it is said that A+ B = C

C > A + B

Being the plus (+), the proportion in which the new company resulting from the merger or the absorption is increased according to the case, because the collective benefits derived from the merge of forces are bigger than the ones which could be obtained if they were not merged.

Not always synergy occurs from the moment of the negotiation; in some cases, it is necessary to wait for a while to obtain the reduction of expenses and the possible benefits by economies of scale, which are easily analyzed by the increase of the profits of the merged company, as they integrate in the search of their objectives.

  • A report of the meeting of partners and results of the voting.

  • Approval of the merger agreement.

  • An estimate of the contributions in goods that the new company or the absorbent one is to receive.

  • Publication in an official newspaper of wide national circulation in which the legal representatives of the companies, taking part in the process, inform the public about balance sheets, methods of valuation, fulfillment of the legal obligations, and consolidated financial statements, with their corresponding notes.

The consolidated balance sheet should show the integration of the patrimonies with extraordinary financial statements of/ or the absorbed companies, previous elimination of the common accounts (debts, credits, investments, capital) that the new or the absorbent company should receive.

The balance sheet should be accompanied by technical studies processed to define the price of the selling of assets classified in properties, real state, and equipment, and the same requirement in the case of intangible assets such as patents, trademarks, copyrights, mercantile credit, and exemptions.

Example:
Merger of Banco de Colombia with Banco Industrial Colombiano
The process began in August 1997 and was authorized by the Superintendence of Values on November 7, 1997. The merger took place from January 25, 1999 on, and Bancolombia -- as a new bank in the country arose.

When the announcement of the merger was made, the shares of Bank de Colombia had a price of $491 and those of  BIC $4,450 in the stock market of the country.

According to a report published by SUVALOR, the process was made based on the figures as follows:

Numbers of the Balance

BIC Banco de Colombia Bancolombia Participation within the System
Gross portfolio 1.182.545 1.922.496 3.105.041 16.60%
Non pay portfolio 31.064 111.635 142.699 13.10%
Overcome portfolio 18.948 60.570 79.518 16.00%
Net portfolio 1.163.597 1.861.926 3.025.523 15.80%
Total assets 2.105.190 3.261.520 5.702.530 18.60%
Total deposits - bonds 1.072.112 1.914.074 2.986.186 16.70%
Current account 284.226 428.604 712.830 15.60%
Accounts of saving 225.949 691.379 917.328 20.00%
CDT´s 461.113 522.577 983.690 18.60%
Bonds 0 170,156 170,156 8.20%
Liabilities Total 1,699,111 2,781,669 4,770,280 19.00%
Total patrimony 406,079 479,851 932,250 16.70%
GAINS Y LOST
Operational income 255,054 424,982 680,036
Operational utility 53,033 14,996 68,029
No operational income 647 11,197 11,844
Utility before adjustments 53,680 26,193 79,873
Adjustments by inflation -22,688 -7,514 -30,202
Utility before taxes 30,992 18,679 49,671
Taxes 8,534 334 8,868
Net utility 22,458 18,345 40,803
INDICATORS
Quality of the portfolio 2.60% 5.80% 4.60%
Cover of the portfolio 61.00% 54.30% 55.70%
Percentage commercial portfolio 71.40% 77.70% 75.70%
Percentage portfolio consumption 28.60% 22.10% 24.60%
Percentage portfolio 0.00% 0.20% 0.10%
Patrimony / active totals 19.30% 14.70% 16.30%
ROA – annual 2.10% 1.10% 1.40%
ROE – annual 11.40% 7.80% 8.90%
INDICATORS OF THE SHARES
SHARES IN  CIRCULATION 163,470,255 1,065,628,148
New emission of shares BIC 50,000,000
Convert. 49% shares B of Col. 54,445,393
New Shares in  circulation 213,470,255 54,445,393 267,915,648
Present price (august 28/97) 4,567 489
VL 2,484 450 3,480
P/VL 1.8 1.1

Based on these figures, BIC paid the “owners” of Bank de Colombia a relation P/VL, a book value, equal to 1.98 times; to the minority stockholders, it was recognized the   relative value equivalent to 0.10427 shares of BIC for each share of Bank de Colombia; it shows a relation: P / VL = 1.2 times (0.78 times less), or said in another form, 9.59 shares of  Bank de Colombia were exchanged by a share of Bancolombia.

The price in books of the new Bancolombia Company to June 30/97 was $3,480, according to a report from SUVALOR, dated Sept. 10/97; on this same date, the intrinsic value of every share of Bank de Colombia was $450.29.

In Dic. / 98 in a special edition of NOTES FOR BANCOLOMBIA’S SHAREHOLDERS, the president of the bank informed about over costs for 83,000 (million Colombian pesos) explaining why in Sept./98  the bank had a loss of 2,863 (million Colombian pesos). In that it report, he expressed satisfaction by the long- term perspectives based on the extension of branches, leadership, consolidation of economies of scale, diversity of products and services, better quality of securities, and reduction of the cost of funds. At the end of the taxable year, 1998, the new bank had losses for 17,464 million (million Colombian pesos) and stopped the dividend; on October 30, 1999 the losses for the taxable year amounted $107,572 (million Colombian pesos).

In November 1999, the share of Bancolombia was quoted at $1,150 in the stock market and its intrinsic price was $2,954. At the closing of the taxable year, the losses amounted $ 197,228 (million Colombian pesos). It is important to continue observing the evolution to analyze the results in the long term.

 

 

4. GENERAL CONSIDERATIONS

Although mergers imply a deep financial survey, it is urgent and determining to have a complement of an administrative type so that real benefits can be attained. It demands the processing of a programmed evolution plan which includes its implications, the possibilities of expansion and the feasibility studies; besides, a clear vision of the merged company analyzed like an individual company with the fundamental changes and the possible risks is required.  For the activities to be fulfilled, it should be established an order of priorities with a sequence properly analyzed and structured by means of a plan of value generation.

The constitution of an interdisciplinary team that includes all the levels and is concentrated to guide the integration plan, specially in the companies which have been merged to form a new one - whose result should be a high dose of synergy - is recommended. It should be insisted on the permanent communication to all the members of the merged company, observing a right deal with the employees.

Special attention must be given to the personnel in their psychological aspect, in its economic aspect at an individual level as a result of the wages, pensions, and severance regime of the organizations involved in the process and concerning the agreed collective conventions with the unions, if they exist.

 

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