This paper provides the framework for a cost-benefit analysis of mergers which, when combined with empirical evidence, form guidelines for maximizing the profits from mergers. Mergers are examined as a means to achieve economies of scale, to utilize unused tax shelters, and to diversify. The cost of the takeover is then examined in terms of its components: the acquisition premium, the market value, and the value of the company as a separate entity. From this Framework two basic merger strategies can be developed to identify sources of potential profits. The sharing of these profits between the buyer and the seller is then examined using empirical evidence.
The oil industry is in the midst of a massive restructuring in which integrated and independent oil companies are being reorganized through mergers. The recent wave of takeover activity will have long term effects on the industry and will change many of our careers. As a result, a Framework for understanding merger activity is needed to gain a perspective on the industry that provides our livelihood.
History shows that oil companies have been notoriously poor in their choice of acquisition partners and in their judgment of value. A recent survey (Orans Field, 1984) in the united states found that four 0 F the seven worst mergers of the decade 1974–1984 involved oil companies diversifying into new business sectors. Table I summarizes this data by comparing actual 1983 earnings per share to estimated earnings per share if the money spent on the acquisition had been used to repurchase the company's stock.
Table 1 available in full paper
As Table 1 shows, mergers can severely affect the profitability of a company. Nine years after the takeover of Marcor, Mobil had earnings per share (EPS) that were estimated to be 40 percent lower than if the money been spent to repurchase the company's stock. In the case of Exxon, only its size prevented a larger reduction in EPS. On average these four large companies suffered an estimated 22 percent reduction in their earnings.
A similar survey of Canadian mergers (The Perils of Takeovers. 1984) concluded that six of the ten worst takeovers in 1981 involved ail companies. While the American survey contained companies who tried to diversify by buying unrelated companies, the Canadian survey contained oil companies which acquired similar firms.
A merger will generate an economic gain if the combined firm is worth more than the sum of the separate firms. The benefit or value added is equal to the value of the merged firm (VAB), less the standalone value of the separate companies (VA,VB). The increase in value of the overall firm is the reward for the improved ability of the combined company to efficiently produce goods and/or services.
Benefit = V = VAB - VA - VB