Cross-Border Mergers and Acquisitions

The globalization of business over the past decade has spawned a search for competitive advantage that is worldwide in scale. Companies have followed their customers who are going global themselves as they respond to the pressures of obtaining scale in a rapidly consolidating global economy.

 In combination with other trends, such as increased deregulation, privatization, and corporate restructuring, globalization has spurred an unprecedented surge in crossborder merger and acquisition activity.

 Cross border M & As have become a fundamental characteristic of the global business landscape.

 Even mergers of companies with headquarters in the same country while usually not counted as cross-border are very much of this type. After all, when Boeing acquires McDonnell Douglas, the two American companies must integrate operations in dozens of countries around the world.

 This is just as true for other supposedly single country mergers, such as the $27 billion dollar merger of Swiss drug makers Sandoz and Ciba- eigy (now Novartis).

 Hence, understanding the problems and opportunities of cross- order mergers and acquisitions is an essential element in understanding most M&As, and indeed in understanding the nature of global strategy.

 In spite of the huge volume of activity in the cross-border M&A marketplace, an inescapable fact emerges when these deals are examined more closely the majority of cross border M&As are not successful.

 For example, economists David J. Ravenscraft and William F. Long found that most of the 89 acquisitions of American companies by foreign buyers between 1977 and 1990 they studied did not improve operational performance one year after the acquisition. Numerous anecdotal accounts corroborate these results.

 What makes them particularly troublesome in cross-border deals are the inherently greater challenges of melding country cultures, communicating across long distances, dealing with misunderstandings arising from different business norms, and even fundamental differences in management style.

 Why are cross-border mergers and acquisitions so difficult to implement? Consider all that must go right in any (samecountry) acquisition:

 The two companies must reach agreement on which products and services will be offered, which facility or group will have primary responsibility for making this happen, who will be in charge of each of these facilities or groups, where will the expected cost savings come from,

 what will the division of labor look like in the executive suite, what timetable to follow that will best generate the potential synergies of the deal, and myriad other issues that are complex, detailed, and immediate.

 On top of all this the merging companies must continue to compete and serve their customers in a competitive marketplace.

 Why are cross-border mergers and acquisitions so difficult to implement?

Consider all that must go right in any (same-country) acquisition:

 The two companies must reach agreement on which products and services will be offered, which facility or group will have primary responsibility for making this happen, who will be in charge of each of these facilities or groups,

 where will the expected cost savings come from, what will the division of labor look like in the executive suite, what timetable to follow that will best generate the potential synergies of the deal, and myriad other issues that are complex, detailed, and immediate.

 On top of all this the merging companies must continue to compete and serve their customers in a competitive marketplace. Now, take all these challenges, and add a completely new set of problems that arise from the fundamental differences that exist across countries.

 Consider, for example, for all the similarities that a global imperative places on companies, the very real differences in how business is conducted in, say, Europe, Japan, and the United States.

 These differences involve corporate governance, the power of rank and file employees, worker job security, regulatory environments, customer expectations, and country culture all representing additional layers of complexity that executives engaged in cross-border M&As must manage.

 Is it any wonder that cross border mergers are potential minefields that require the utmost care?

What is the strategic logic for the Acquisition

The keys to establishing an effective strategic logic lie in answering questions such as:

How will this merger create value, and when will this value be realized?

Why are we a better parent for this company than someone else?

 Can this merger pass the better-off test will we be able to create more value (by being more competitive, having a stronger cost structure, gaining additional competencies that we can leverage in new ways, etc.) after the deal?

 These are difficult questions that require careful, objective, preacquisition analysis. The tendency for companies in the heat of battle to overstate the real strategic benefits of a deal is a definite problem that must be guarded against.

 Pressures that arise from the desire to close a deal quickly before rival bidders appear, cultural and sometimes language barriers that create uncertainty, and the often emotionally charged atmosphere surrounding negotiations, work against this requirement of objectivity.

 The best solution in this case is to enter the M&A mode with a carefully developed framework that addresses the key questions, and to stick to that framework in evaluating a potential acquisition candidate even when the seemingly inevitable strains arise.

 The highest potential crossborder M&As tend to be between firms that share similar or complementary operations in such key areas as production and marketing.

 When two companies share similar core businesses there are often opportunities for economies of scale at various stages of the value chain (e.g., R&D, manufacturing, sales and marketing, distribution, etc.)

 The strategic logic of combining complementary assets can also be compelling.

 These assets, which extend to complementary competencies in technology and know-how, offer great opportunities for companies to create value in the right circumstances Mergers create uncertainty, and people often experience considerable stress during this time.

 There is a real danger that some of the best people in a company will leave as a result of the merger after all, it is usually the best people that have the most attractive outside opportunities and inattention to their personal concerns may be costly.

 Studies indicate that the root cause of employee problems are feelings of mistrust and stress, perceived restrictions in career plans, and attacks on established cultural traditions within the acquired company,

 each of which is exacerbated by the fundamental differences that exist between both merging companies and the countries in which they are based. And these problems do not go away if left untreated.

 Differences among management and workers can sometimes spiral into broader community and political problems.

 Given the importance of integration to acquisition success, how can companies best manage this process? There are several important considerations.

 Understand that most of the value creation in an acquisition occurs after the deal is done. For all the synergies and benefits that are projected to accrue from an acquisition, none can be realized without substantial effort during the integration process.

 Plan for integration before doing the deal. There are many reasons why companies do not do this such as time constraints, insufficient information, lack of awareness of how critical integration really is but the alternative is to essentially guess at the sources of value creation.

 Develop a checklist of key integration issues, assign personal responsibility and a timetable for dealing with these issues, and set targets that will enable the value creation needed to make the deal work.

 Although integration is a process that cannot be completed in a few days, this analysis should yield a blueprint for how to create value from the acquisition.

 Work the details. Some of the confusion and complexity of cross-border mergers can be mitigated by ensuring that executives in an acquiring company learn about differences in accounting standards, labor laws, environmental regulations,

 and norms and regulations governing how business is conducted in the country of the acquired firm early in the process.

 Develop a clear communication plan throughout the entire process. The prospective melding of different country cultures in a cross-border deal can easily compound the uncertainty employees experience in any merger, and must be addressed in a proactive manner.

 In sum, there are two fundamental imperatives that must be underscored in any discussion of cross-border mergers and acquisitions.

 First, companies engage in a merger or acquisition to create value, and that value creation comes about through a combination of synergy realization to cut costs and competitive strategy repositioning to increase revenues and growth.

 And second, both the synergy realization and competitive strategy goals cannot be achieved without significant attention to the challenge of acquisition integration.

 If cross-border M&A strategies are to fulfill their potential, and justify the premium companies typically pay to 6 engage in them, managers will need to fully understand, and embrace, these two imperatives.

 The India story has seen a profound shift in gear and direction during 2006. While in recent years most media references to Indias growth have focused on the subcontinent as a destination for outsourcing and investment,

 this year has seen the arrival of India as a shaping force evident in the powerful new trend towards overseas acquisitions by Indian companies.

 Indian crossborder mergers and acquisitions (M&A) is the search for top-line revenue growth through new capabilities and assets, product diversification and market entry.

 This trend is not driven purely by opportunistic factors: Indian companies are in many cases motivated to look abroad in response to newly competitive, complex or risky domestic markets or to find capabilities and assets that are lacking in India.

 The steep increase in the number of major cross-border transactions in recent years from 40 in 2002 to more than 170 in 2006 - has been facilitated by the relaxation of regulations on overseas capital movements as well as a more supportive political and economic environment,

 including deeper currency reserves, and easier access to debt financing, both at home and from international banks.

 This M&A trend is a key factor helping Indian companies to emerge on the global stage. Six Indian companies feature in the Fortune Global 500 list of the biggest companies in the world.

 These are Indian Oil, Reliance Industries, Bharat Petroleum, Hindustan Petroleum, Oil & Natural Gas, and the State Bank of India. Based on current growth and M&A trends, we would expect this number

 After the Tata-Corus and Vodafone-Hutch mega-deals, conservative estimates by Indian analysts have pegged mergers and acquisitions (M&As), including outbound and inbound deals involving Indian firms, to reach $100 billion in 2007.

 Another recent study by the Institute of International Finance, a Washington-based global association of financial institutions, has predicted that the desire of India Inc to operate in foreign lands will lead to a threefold rise in direct investment flows out of the nation in 2007.

 The figure might appear meager weighed against the frequent investment announcements of hundreds of millions of dollars abroad by Indian majors, because of big foreign financing components or debts.

 In 2006-07, India has already seen mergers worth more than $40 billion that include Tata Steel's acquisition of AngloDutch steel maker Corus ($12.2 billion), Hindalco's buyout of Novelis ($6 billion),

 Suzlon's bid for Germany's REpower ($1.3 billion, a figure likely to go up because of a higher rival bid), besides Vodafone's acquisition of a majority in Hutchison Essar Ltd ($18.8 billion).

 Others could include Reliance Industries' interest in the plastic division of General Electric a deal that could top $5 billion. Comparable figures are being quoted for Ranbaxy and a private-equity firm's interest in German pharmaceuticals major Merck.

 The main factors driving the M&As among Indian companies are surplus funds, globally competitive business practices and a favorable regulatory environment, besides higher margins, revenue, volumes and growth prospects, says the Assocham report.

Why M&A?
Opportunity for growth Need for faster growth Access to capital and brand Gaining complementary strengths Acquire new customers

 Need to enhance skill sets Expand into new areas Widen the portfolio of addressable market Meet end-to-end solution Needs

Acquisitions by major Indian Players

Indian Company Company/Plant acquired/Set-up abroad Located in Size of the deal ($ mn) Amtek Auto Smith Jones Inc. US 20 Amtek Auto GWK Group UK 37 Bharat Forge Carl Dan Peddinghaus GmBH* Germany 116#(euro)

 Sundaram Fasteners Dana Spicer Europe* (Forging unit) UK 2.6 Sundram Fasteners Sundram Fasteners (Zhejiang)** China 5 G. G. Automotive Gears Name not disclosed. US company that manufactures high precision custom gears and planetary gears. US 110

Conclusion
Until the 1990s, not many Indian companies had contemplated spreading their wings abroad. An Indian corporate or group company acquiring a business in Europe or the U.K. seemed possible only in the realm of fantasy.

 The reasons why overseas acquisitions are becoming more common are many. The reform era and the march of globalization have obviously made the environment more conducive. Globalization forever changed the rules of the game.

 Indian entrepreneurs had gained confidence to compete with wellestablished multinationals from abroad in the domestic market place.

 It was only a matter of time before some of them would shift their focus beyond the Indian shores, not just in selling their products but in setting up manufacturing facilities as well.

 A whole range of companies in fields such as pharmaceuticals, automobile ancillaries, IT, banking and steel have ventured abroad. In general, the factors favouring foreign forays in most cases are the availability of affordable human resources, willing to adapt to the global scenario.

 The contribution of economic reform at home to the outward focus of companies can hardly be overstated. For instance, the rupee's exchange rate is market determined and all current account transactions have been freed from controls.

 Indian companies enjoy substantial freedom to invest abroad even though there is no full convertibility of the rupee as yet. Indian businessmen too have, albeit more slowly than those in the West, chosen to invest abroad through acquisitions.

 The good news is that what started as a trickle in the 1990s, has been growing in size. Today outward fund flows from India almost match those coming in from abroad.

C. Identified obstacles to cross-border mergers

I. Legal Barriers a) Execution risks

 1. Cross-border takeover bids are complex transactions that may involve the handling of a significant number of legal entities, listed or not, and which are often governed by local rules (company law, market regulations, self regulations).

 Not only a foreign bidder might be disadvantaged or impeded by a potential lack of information, but also some legal incompatibilities might appear in the merger process resulting in a deadlock, even though the bid would be friendly.

 This legal uncertainty may constitute a significant execution risk and act as a barrier to cross-border consolidation

 2. The financial sectors of some Member States include institutions with complex legal setup resulting in opaque decision making processes. An institution based in another Member State might only have a partial understanding of all the parameters at stake,

 some of them not formalized. Such a situation might constitute a significant failure risk, as a potential bidder might not have a clear understanding of who might approve or reject a merger or acquisition proposal.

 3. In some cases, legal structures are not only complex but also prevent, de jure or de facto, some institutions to be taken over or even merge (in the context of a friendly bid) with institutions of a different type.

 Such restrictions are not specific to cross-border mergers, but could provide part of the explanation of the low level of cross-border M&As,

 since consolidation is possible within a group of similar institutions (at a domestic level) whereas it is not possible with other types of institutions (which makes any cross-border merger almost impossible).

 4. In some Member States, the privatization of financial institutions has sometimes been accompanied by specific legal measures aimed at capping the total participation of non-resident shareholders in those companies or imposing prior agreement from the Administration (i.e. golden shares).

 Some of such measures were clearly discriminatory against foreign institutions, when it came to consolidation.

 5. In some Member States, company law allows the company boards to set up defence mechanisms, such as double voting rights and poison pills, to prevent any hostile bids.

 Such asymmetries in company law might distort the level playing field within the EU, and protect national markets, sometimes to the benefits of participants in these markets.

 6. Even if an acquisition is successful, there may exist impediments to effective control, i.e. there may be a risk that the acquiring company does not acquire proportionate influence in the decision making process within the acquired company while being exposed to disproportionate financial risks.

 This can be explained notably by the existence of special voting rights, ineffective proxy voting or use of the Administrative office by a foreign acquirer. Also barriers (or restrictions) to sell shares could hamper the process.

 7. Differences in national reporting schemes, notably as regards accounting systems, may result in difficulties to assess the financial situation of a potential target.

b) One-off costs
8. The national laws of some countries might include restrictions on the type of offers that can be executed (i.e. cash only vs. exchange of shares).

 Even though such measures are not in themselves discriminatory to cross-border mergers, they might constitute a barrier to cross-border consolidation, given that the different features of such mergers (notably in terms of size) could call for a specific type of offer.

c) Ongoing costs
9. Differences in employment legislation across the EU may also create barriers for efficient and flexible (re)organization.

 In particular, the procedures to move staff within a pan-European group remain very complex (furthermore in some cases, prudential rules impose constraints on the location of staff.

 Those differences may also result in higher legal costs to deal with the different legal systems, as well as complex processes and different timelines when trying to introduce changes on a crossborder basis.

 10. The different accounting systems across the EU have also required companies to set up adapted IT, specific personnel and reporting systems.

 This limits the scope of possible cost synergies when two institutions merge across the border, where as such synergies do exist when two institutions.

 11. The consumer protection rules are very different from one Member State to another. This heterogeneity translates into the necessity of country-customized financial products compliant with those rules, and therefore also specific IT systems that handle those products and consumer relationship.

 For instance, this has been evidenced in the mortgage credit sector in the report recently published by the mortgage credit forum group set up by the Commission.

 Furthermore, those different rules are often based on the general good provisions and consequently potential abuses aimed at protecting the national markets are difficult to challenge in court.

 12. Differences in national implementations of the Directive on data protection may also interfere with an optimal organization of businesses within merged companies. Indeed, it can have a strong impact on IT systems and limit back-office rationalization.

 13. More generally, differences of approaches in private law, sometimes explained by historical or cultural factors, may impose a country-by-country approach for some products or services (especially in the insurance sector), with the same results as differences in consumer protection rules.

 Those differences include notably liability and bankruptcy rules, with the implied difficulties of enforcing crossborder collateral arrangements, as well as differences in legal rules for securities.

a) Execution risks
14. As mentioned earlier, mergers and acquisitions are complex processes.

II. Tax barriers

 Despite some harmonized rules, taxation issues are mainly dealt with in national rules, and are not always fully clear or exhaustive to ascertain the tax impact of a cross-border merger or acquisition.

 This uncertainty on tax arrangements sometimes requires seeking for special agreements or arrangements from the tax authorities on an ad hoc basis, whereas in the case of a domestic deal the process is much more deterministic.

 15. The uncertainty on VAT regime applicable to financial products and services may put at risk the business model or envisaged synergies. The EU's VAT legislation in this area is badly in need of modernization and because of its inadequacies, there is an increasing tendency to resort to litigation.

 The outcome can often be uncertain and as a result tax implications may place a question mark over otherwise sound business strategies.

 16. In recent years, the number of significant ECJ cases on VAT and financial services has increased steadily.

 Individual judgment may indeed clarify the law in particular circumstances but often at the cost of consequences which may not always be compatible with overall Community policy objectives.

Ongoing costs
17. The issue of transfer pricing is a complex one for a group operating in several countries.

 As was evidenced in the Commissions Communication Towards an Internal Market without tax obstacles - A strategy for providing companies with a consolidated corporate tax base for their EU-wide.

 18. A group operating across several Member States may wish to centralize support functions to increase operating efficiency.

 But in many cases the result will include creating a VAT penalty on the inter group supply of services (e.g. legal services or other back technical operations) to another Member State.

 19. Given that in the financial services sector VAT is at best only partially recoverable, this represents significant additional costs that penalized cost synergies to expect from a crossborder merger when compared to a national merger.

 This tax penalty on cross-border shared service operations is in addition to the general bias towards vertical integration which is widely perceived as a barrier to efficiency in the existing VAT provisions.

 20. Specific domestic tax breaks may favour specific, nonharmonized products or services, with the result that every institution has to provide this service or product if it wants to remain competitive.

 In such a situation, a merger between two entities located in that domestic market may yield synergies of scale, whereas it will be more difficult to exploit comparable synergies for a foreign institution taking over a domestic one, while not being entitled to the tax break in their home state.

 21. In some cases, there may be discriminatory tax treatments for foreign products or services, i.e. products or services provided from a Member State different from the one where it is sold.

 22. Therefore, a cross-border group will be disadvantaged when trying to centralize the industrial functions (e.g. asset management functions) over a domestic group since the latter may keep all its value chain within the country and still benefit from synergies.

 23. A cross-border merger may highlight gaps or imperfections in the regulatory framework which may make regulators feel uncertain how to proceed, leading to delay, the imposition of specific measures or a veto of the proposed merger.

 24. In the banking sector, for example, the emergence of large cross-border groups might raise local supervisors concerns regarding financial stability (e.g. the ongoing discussions on deposit guarantee schemes).

 In other sectors such as exchanges which had traditionally operated within one national market, regulators may be unclear how to operate in a cross-border context.

 25. The complexity of the numerous supervisory approval processes in the case of a crossborder merger can also pose a risk to the outcome of the transaction as some delays must be respected and adds to the overall uncertainty.

 In particular, in the case of a merger between two parent companies with subsidiaries in different countries, indirect change of control regulations may require that all the national supervisors of all the subsidiaries must approve the merger.

 26. Despite a common regulatory framework, there might be significant divergences in supervisory practices at the level of institutions.

 Such divergences might be explained by optionally in the harmonized rules, including provisions taken at national level that exceed the harmonized provisions (super equivalent measures), or lack of coherence in enforcement of common rules.

 27. The consequence is a limit on homogeneous approaches, and therefore synergies, of risk control and risk management within a cross-border group.

IV. Economic barriers

a) Execution risks b) One-off costs

 28. The fragmentation of the European equity markets may impose additional transaction cost on a cross-border merger. For instance, the exchange of share mechanism can be complex, and more expensive, when the two entities involved are listed on different stock exchanges.

 The additional costs might also influence the bidder on the type of deals (i.e. cash vs. exchange of shares).

c) Ongoing costs
29. Independently of the legal frameworks or tax incentives.

 30. The absence of critical size in some market segments (e.g. investment banking) may incite institutions to enter into a niche strategy, where the advantages of cross-border mergers that create large players is less evident from an economic point of view.

 31. Indeed, not only it would be difficult to find synergies between two niche players, but also absolute size would not necessarily be an advantage if an institution wants to maintain its competitive advantage in its niche market.

 32. Domestic mergers can contribute to increase market power, and therefore increased profitability even without any cost synergies (i.e. raising the income while maintaining the costs at a constant level).

 33. Since most of the retail markets are still organized on a national basis, cross-border mergers yield very few, if any, increased market power.

 34. Differences in economic cycles across the different Member States may also play a role, in that the economic environment has a strong effect on bank profitability.

V. Attitudinal barriers

a) Execution risks

35. Openly or not, some Member States may promote a national industrial policy, aiming at the creation of national champions.

 Among possible justifications, some may argue that such a policy may ensure adequate financing of the national economy. Political considerations may also play a role with recently privatized companies or institutions that have received public money.

 This political interference may block a cross-border merger, even though such this transaction is compatible with the existing rules. Such interference might not require formal powers or rules to materialize.

 Indeed, as evidenced in the previous sections, there are many obstacles to overcome to carry through a cross-border merger that it is realistic to think that no cross-border merger can be achieved if there is a strong political opposition.

 In addition, such a policy may lead to tolerance of high levels of concentration at a domestic level, allowing (or even encouraging) domestic consolidation over cross-border consolidation and making it even more difficult to accept a foreign takeover of a national institution with a significant market share.

 36. Employees reluctance within the target company of a crossborder deal might also pose a threat to the successful outcome of the transaction. Indeed, employees may not accept to be managed from another country.

 A public opposition to the project may influence analysts assessment. Also employees may play a role if they have a participation in the company.

 37. Cross-border mergers may imply a change in the place of quotation, or even in the currency of quotation.

 Shareholders acceptance of quotation changes may be limited, even all risks or tax impacts are eliminated. Indeed, the place of quotation may have an important symbolic value.

 38. Given that cross-border mergers are complex and need to overcome a number of execution risks (as evidenced in this document), there might be an impact on shareholders and analysts apprehension of failure risk when it comes to crossborder mergers.

 b) One-off costs c) Ongoing costs

 39. Interference with political considerations may also have consequences in the structures put in place after a cross-border merger.

 Such political concessions (e.g. guarantees of level of employment, no headquarter moves, protection of the local brand) may help in getting the merger through the different obstacles,

 but constrain the resulting cross-border entity in realizing the full potential of the merger as options may be severely limited.

 40. Consumers may mistrust foreign entities, meaning that all parameters being equal, a local incumbent may have an advantage over a competitor identified as foreign.

 This explains why foreign institutions often prefer to keep a local brand, even though it might impede synergies across certain functions (e.g. marketing) or slow down the integration process (transition from one brand to another over a long period of time).

Summary
I. Legal Barriers II. Tax barriers III. Implications of supervisory rules and requirements IV. Economic barriers V. Attitudinal barriers

a) Execution risks
1. Legal uncertainty 2. Opaque decision making processes 3. Legal structures

 4. Limits or controls on foreign participations 5. Defence mechanisms 6. Impediments to effective control 7. Difficulties to assess the financial situation

 14. Uncertainty on tax arrangements 15. Uncertainty on VAT regime 23. Concerns regarding financial stability 24. Misuse of supervisory powers 25. Supervisory approval processes

 35. Political interference 36. Employees reluctance 37. Shareholders acceptance of quotation changes 38. Shareholders and analysts apprehension of failure risk

b) One-off costs
8. Restriction on offers 16. Exit tax on capital gains 28. Fragmentation of the European capital markets

c) Ongoing costs
9. Employment legislation 10. Accounting systems 11. Divergent consumer protection rules

12. Data protection 13. Differences in private law 17. Transfer pricing 18. Inter-group VAT 19. No homogeneous loss compensation

 20. Specific domestic tax breaks 21. Discriminatory tax treatments 22. Taxation on dividends 26. Divergences in supervisory practices 27. Multiple reporting requirements

 29. Different product mixes 30. Non-overlapping fixed costs 31. Lack of middle-size institutions 32. Absence of critical size 33. Market power

 34. Differences in economic cycles 39. Political concessions 40. Consumer mistrust in foreign Entities