Question 11.Qfr.1: Explain the major justifications likely to be put forward to...

(a) The major justifications put forward to explain horizontal takeovers centre on the fact that the merging companies are in the same industry and so are likely to benefit from economies of scale. They may also benefit from synergy between operations as well. Horizontal takeovers can also be justified as a way of breaking into new geographical markets. Market share can also be a viable reason, so that companies can earn monopoly profits, but the bidder must beware of referral to the Competition Commission. There may be financial gains and tax benefits, but increasing EPS is not a valid justification.

(b) In vertical backward or forward takeovers the major justification is that a company can either secure control of vital raw materials or guarantee an outlet for, and control the distribution of, its product. This helps companies to reduce the power of suppliers or to decrease the revenue lost to distributors. Economies of scale or synergy are less likely to occur than with horizontal takeovers.

(c) It is very difficult to see the rationale for conglomerate mergers as there will be few economies of scale or synergy due to the unrelated nature of the merging businesses. The merger cannot be justified from the point of view of risk reduction as shareholders are likely to hold diversified portfolios. Nor can it be justified as the acquisition of a bargain since, if capital markets are efficient, the target’s share price will reflect its true value.