Merger

Dev Bhargava db9101@stud.asb.dk SMBA Industrial Economics IA-5 IA 5.1 (max 2 page) What are the major forces behind mergers from an Industrial Economics point of view. Carefully distinguish the perspectives of the various players involved (e.g. the merging firms). Briefly discus the effects and possible objections that other players in the industry, policy makers or the public may fear' Mergers :- When two (or more companies)combine to form a separate business entity, it is called a merger. In a sense, it is a legalized form of collusion. The major forces behind mergers from the perspective of the merging firms involved are: 1. Reduction of Cost -Due to the reorganization of the firm structure, there should be a more efficient use of assets , leading to a more efficient post merger firm thereby reducing cost 2. Market performance- A more efficient post merger firm will have better productivity and a better market performance(for both homogenous and heterogeneous product)/market share(for a homogenous product) in comparison to the pre merger firms. 3. Financial stability- An inefficient company would want to merge with a more profitable and efficient company in an effort to improve its financial stability. For example, Jaguar and Land Rover(JLR) was struggling financially and on the verge of dying out. So it decided to merge with Tata motors as Tata had shown an interest (horizontal merger). This deal gave JLR a new lease of life and has now helped it to improve its market performance. 4. Diversification- A firm that is looking to diversify its business interest would want to merge with a company involved in the production of that good (heterogeneous product merger/vertical merger) 5. Strengthening – A merger can help the firm in integrating its product and thereby improve product performance. For eg- Ebay and paypal are different products but a combination of the two has improved the final product, making it better for the consumers and helping Ebay and PayPal to improve its performance. 6. Branding- Mergers can help in establishing a brand name. Again taking the Tata JLR example, the deal has helped Tata Motors( Indian car company ) in enhancing its brand value and establishing a worldwide presence. 7. Tax write off- One company can use the other company’s losses as a tax write off. Effects:A merger may have a positive effect in that it increases the efficiency of the firm or a negative effect if it leads to greater single firm or joint non-cooperative exercise of market power. A more efficient will able to sell at a lower cost leading to lesser deadweight loss, benefitting consumers. A post merger firm is likely to have higher market share leading to more monopolistic conditions (not applicable if both merging companies are small) This will lead to higher concentration, lower consumer surplus, higher deadweight loss and higher mark up power(Lerner index) 1 Dev Bhargava db9101@stud.asb.dk SMBA Industrial Economics IA-5 Impact on shareholders- For smaller firm; beneficial, as the larger firm usually tends to pay higher than actual value. For the larger firm, initially it is not as beneficial as the firm has to use its cash reserves, take up loans/debt. Objections for :1. Policy makers- Regulation 839/2004 of the European deals with merger rules and regulations. Assessment done on market definition-product and geographic market. a.) The focus of EU merger policy is dominance [Article 2(3)]- whether the new firm will impede effective competition or not or if there would be restrictions on new firms entering this market because of the merged firm. b.) If the new merger/collusion will lead to price rise/discrimination. c.) If there is less choice for business customers and consumers d.) If the new market share is monopolistic. e.) If the new firm tends to tie in consumer to their product (anti-competitive) f.) If the new merger can dominate the market in collusion with other firms 2. Other players in the industrya.) The fear of a new dominant/ monopolistic post merger firm is the biggest objection for other players in the industry b.) Anti-competitive behavior- whether the creation of a new firm will create entry barriers for a another firm to enter the market. c.) If a merged firm has higher efficiency, competitors would advocate a market definition that shows the market share of the merged firm to be large. d.) Objections for other firms will be similar to the ones of the policy makers. 3. Public a.) For the people working in the merging companies , the biggest fear is that of a lay off as when firms restructure their organization , they will probably downsize . b.) Consumers would want to block a merger that increases the firms market power/dominance as this collusion could increase the cost for the consumer References: 1 Martin, Stephen . Industrial Organization , A European Perspective(2001) 2 Dev Bhargava db9101@stud.asb.dk SMBA Industrial Economics IA-5 IA 5.2 The case that I am going to discuss is the Arcelor Mittal merger case (horizontal merger). Arcelor S.A., based in Luxembourg, was the largest steel producer in Europe and created through the merger of Aceralia, Arbed and Usinor in February 2002. Mittal Steel N.V, controlled by the Mittal family with its base in Netherland was the world’s largest steel producer. The two companies merged in June 2006 to form Arcelor Mittal with its base in Luxembourg. This deal created the world’s first 100 million plus steel producer. The initial bid offer by Mittal for Arcelor shares was $23.3 billion , which was later increased to $34 billion .This bid was accepted by Arcelor . Under the new ownership conditions, Arcelor shareholders would own 50.5% while the Mittal family would own 43.5% of the capital and voting rights, with Mr. Lakshmi Mittal becoming the Chairman and CEO of the group. This was one of the most controversial mergers in recent history, while now it has become one of the most successful. The motives behind the merger :1. Price cyclicality- Lakshmi Mittal wanted to smoothen out price fluctuations in the steel industry. He felt that this could happen if there was consolidation in the steel industry i.e. have a few large producers instead of having a large number of producers. 2. Market power- Mittal wanted to gain market power over suppliers and customers and lower risk for the steel industry. 3. Consolidation-The main motive for the two companies was consolidation; improving their sourcing of raw material ( as both were steel producers) and more productivity.(increase in economy of scale) 4. Access to more markets- Both companies wanted to extend their reach to more markets. Arcelor could tap into Mittal’s strong areas in Eastern and Central Europe, Africa while Mittal could have a presence in Arcelor’s stronghold of Western Europe/North and South America. 5. New markets- The combined firm has the leverage to enter new markets in India, China, Indonesia etc. 6. Efficiency- The merger would lead to more efficient use of assets, reducing costs and improve market performance 7. Market Share- The deal made ArcelorMittal control 10% of the world’s steel production, largest steel producer in the world (concentration of top 10 companies =40%, top 50=73%) .This is a heavily fragmented and competitive market. 8. Market leader- ArcelorMittal became the market leader in major markets like automotive, construction, household appliances and packaging 9. Share price- Arcelor got a good deal, Mittal after an initial offer of $23.3 billion increased it to$32.4 billion ($47.34 per share) and eventually to $34 billion. ($50.68 per share or 40.74euro ,compared to the actual share price of 25 euro) Pre and post merger competitive situation:The steel market both pre and post merger is highly competitive and fragmented. Though not a perfect competition as entering this market is extremely tough (high fixed cost, raw material). Pre merger, the two firms 3 Dev Bhargava db9101@stud.asb.dk SMBA Industrial Economics IA-5 were the top 2 steel companies in the world ( Market share -5%,Mittal;4% Arcelor). Post merger even though ArcelorMittal produces more than twice the quantity of the next competitor (BAOSTEEL) ( 77.5 mmt to 31 mmt), it still has only 10% of the world market indicating the competitive concentration of the sector. The market leader has little mark up in this sector. This merger led to more consolidation/mergers in the industry (Tata-Corus etc). Competition policy issues :The EU Commission did an assessment on the basis of product and geography and saw that Arcelor was majorly active in Western Europe , South and North America, while Mittal was active in Central and Eastern Europe, Africa and North America. Each had a minor presence in each other’s principal active region. In terms of product, Arcelor was active in stainless/specialty steel and flat products (plates, coils) while Mittal was active in sales of long products (bars , beams, rods) . A merger would not lead to competitive issues for these products as there were a number of sizeable competitors for these products and a merger would have a limited increase in the market share for Arcelor Mittal. But the only exception was in the market for heavy section beams /long carbon steel product. A merger would give Arcelor Mittal a huge market share of the total EEA (European Economic Area) production capacity with limited options for customers. The proposal offered by Mittal to rectify these concerns was to divest two Arcelor heavy and medium section steel mills (Unterwellenborn, Germany and Pallenzano, Italy) and a Mittal section and bar mill in Poland along with related commercial and distribution assets. This would reduce production share by 10% for heavy section products in EEA and remove the overlap between Arcelor and Mittal in terms of sale. The Commission accepted this proposal and passed the merger between Arcelor and Mittal as it felt that now the merger would not impede on the competitiveness of the market despite the fact that these companies were already the top two steel companies in the world. References 1. http://europa.eu/rapid/pressReleasesAction.do'reference=IP/06/725 2.http://www.arcelormittal.com/index.php'lang=en&page=539\ 3.http://www.domainb.com/companies/companies_a/Arcelor_Mittal/20080523_mega_merger.html 4