Mergers and Acquisitions Essay

Mergers and Acquisitions

 

 

1. Introduction

 

 

This paper seeks to analyze and discuss the Factors behind mergers/acquisitions along with along with one case situation of a merger/acquisition implemented within the last five years.  Theories and motives for mergers will be expounded, as well as the phenomenon of merger waves, and any linkages to share prices and situations prevailing in the stock market.  Realistic benefits and costs to both predator and target are spelled out in terms of actual outcomes, along with any legal-cum-regulatory frameworks which govern said takeovers.  This paper will also attempt to relate all this to prevailing business culture in different free-market economies.  Strategies and tactics of both hostile and agreed bids will be covered including other relevant areas such as impacts on share prices, financial objectives/strategies of the firm, and selection of investment projects.  The case chosen for analysis and investigation is from the banking industry involving Bank One and JP Morgan Chase which took place in North America.

 

Merger and acquisition are expansion strategies (Churchill, Jr. and Peter, 1995) of companies which do not want to start from developing new business.  Mergers could be vertical while others horizontal (Brigham and Houston (2000). could  Some well performing companies just look for weaker one with the objective of attaining synergistic effects and hence better profitability.  Mergers are believed to for growth by them could fail as there are also causes of failure (Globusz Publishing, 2005).  This could be best appreciated with the case at hand as to what see happened in the case JP Morgan Chase and Bank One.  Hence, this paper will try to analyze and compare what really happened before and after the merger.

 

1.1 Background of Merger and Acquisition Growth Strategy in the Banking Industry

 

Both JP Morgan Chase and Bank One are part of the banking industry and anybody wanting to see whether they did as planned is to first look at the industry where they play.  Not infrequently, merger or acquisition is resorted by companies to survive the competition in the industry where profits are declining as a result of the diverse economic events and the banking industry is not spared from this economic realities.  Philip Mattera (2003) best articulated the developments in his article, The Free-for-All in Financial Services:  An Overview of The Banking Industry when he said: “Once the epitome of security and stability, the U.S. banking industry has undergone a remarkable transformation over the past three decades.  It has faced a series of crises but managed not to fall into the abyss.  It succeeded in shattering federal regulations that limited its activities, opening the way for banks to morph into financial supermarkets.  The big bank holding companies have been gobbling up their rivals at an amazing rate, while trying to deflect criticism of their policies in poor communities.”

 

Under the same article, Mattera observed the disappearance of the what appeared to be secured and relaxed life of banks in the 1970s, with events such as the collapse of Franklin National Bank and the growing realization that third world countries might not be able to make good on the huge volume of bank loans that had been given them by their by the richer benefactors from economically advanced ones.  He noted too about events in the 1980s regarding the virtual meltdown of the savings and loan industry and of many commercial bank that had become uncontrolled in their real estate and energy lending.  Mattera then attributed the huge bailout given by President Bush administration which according to some experts saved the day for many while rewarding many other companies although the latter had caused the problems in the first place under the banking industry.

Events did not stop there as Mattera continued: “Once the crisis atmosphere was lifted, the banking industry moved full speed ahead in its quest for the holy grail: the abolition of federal regulations barring banks from entering the securities business.  This rule, embodied in the Glass-Steagall Act of 1933, was not an arbitrary exercise of government power.  It was an attempt to restore stability to the financial world after the 1929 stock market crash–the culmination of a speculative boom fuelled in large part by bank lending for margin-account stock purchases.”[1]

 

2. Analysis and Discussion

 

2.1 The Merger of Bank One with J.P. Morgan Chase

For J.P. Morgan Chase & Co. to have bought Bank One Corp for about & US $58 billion caused it to be one of the unprecedented events in the US banking industry.  The merger produced the second largest bank franchise in the United States with company assets combined at $1.1 trillion plus a staggering number of 2,300 branches nationwide.  This effectively put them as one of the top banks which could do almost everything in banking including retail banking and customer lending, credit card servicing, the very lucrative investment banking, asset management, treasury services and the stock market or simply customer securities management.  Expectation before the merger was forecasted cost saving of $2.2 billion to be allocated over a three year period and a combined market capitalization of approximately $130 billion (CNNMoney to Subscribe to Money Magazine, 2005).  If one looks figure as of this writing, market capitalization is already US $ 163.71 billion, which very much above what above the expectation (Yahoo Finance, 2006).  Minus the merger, J.P. Morgan would have fallen to No. 3 after Bank of America Corp.’s $47 billion deal to buy Fleet Boston Financial Corp. is completed.  Bank One, which currently ranks No. 6, complemented the power of J.P. Morgan Chase, making it to reach second highest ranking.  J.P. Morgan’s extended reach through the Midwest and the Southwest, and reduced dependence on investment banking and trading, and benefit from a strong retail and credit card presence present themselves as expectations in the future.  The latter expectation is closely related to the fact that Bank One is world’s largest Visa card issuer (CNNMoney to Subscribe to Money Magazine, 2005).

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2. 2 Did the results of the merger come?

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With every financial oriented person interested with the development, Testimony of the 108th Congress provided: “The evidence shows that increased concentration in the banking industry has not benefited bank customers and has not had a positive effect on the convenience and needs of the communities served by the acquired banks.  The economies of scale that supposedly justify large bank mergers either do not materialize or are not passed on to customers.  For example, large bank mergers often have an adverse effect on consumer deposit pricing and often result in higher fees to consumers.”[2]  The same testimony cited also a Harvard study proving that instances of improved operating results after a large bank merger were attributed mainly to higher re-pricing, not economies of scale.  This therefore suggested the use of increased market power by the large banks to raise prices and not the market forces as some would like to believe.  This as was further proved by the significantly higher fees charged by multi-state banks than those charged by single-state banks as per annual survey of the Federal Reserve.  Hence the Board was urged to examine closely the effect that this merger will have on deposit pricing and fees in areas where the merger partners overlap such as in Texas and Florida, and whether consumers will be adversely impacted by the merger.  (Testimony of the 108th Congress, Merger of Bank One Corporation into J.P. Morgan Chase ; Co.)[3] (Paraphrasing made).

Companies who acquire want advantage of be synergy, believing it can result in the ability to spread fixed costs over a larger number of units produced.  They believe with what textbooks say resulting company may be able to do away with one of its duplicate accounting, personnel, or other staff departments, consolidate a line department, or even share a facility.  When companies combine, people also combine and hence they may have different corporate cultures (Oden, 1997) for which they may aim for cultural integration (Grovewell, n.d.).  An article on Merger Strategy: Reaching for Corporate-Level Goals[4] may have agreed in saying, “If synergy is established, future after-tax earnings and dividends should be higher than for either party alone.  It is here that stockholders benefit from the synergy of a merger.”  How do we then reconcile with the Harvard study that showed that instances of improved operating results after a large bank merger were due primarily to higher re-pricing, not economies of scale, suggesting the use of increased market power by the large banks to raise prices?  Would not the claim of synergy therefore appear to be misplaced in the case of J P Morgan Chase merger with Bank One?  This might make a better subject for future to established what is correct since as confirmed by Yahoo Finance (2006), market capitalization as of now after the merger has exceeded the ; 130 market capitalization.

Normal in merger situation is the charge of violating anti-thrust provisions of law.  An article on Merger Strategy[5]  described anti-trust action as an attempt by one of the various state or federal agencies to block a merger and that state agencies regulate intrastate commerce and have less impact on large firms than on small ones.  It thus said that federal agencies’ jurisdictions are defined by interstate commerce activities and apply to virtually all large firms (and actually to most, if not all, small businesses as well).  Included are the Antitrust Division of the Department of Justice and the Federal Trade Commission (Paraphrasing made).[6]  The government, under Section 7 of the Clayton Act, need to substantiate that a “substantial lessening of competition might occur” because of merger then government could merger.  Not to be forgotten is absence of statute of limitations in antitrust law, allowing dissolution even after a long-standing combination.  This happened in a January 1982 decision requiring AT&T to divest $84 billion worth of local operating subsidiaries (Paraphrasing made).[7]

Up to this time no dissolution on J.P. Morgan and Bank One’s merger has happened after approval of the merger by the Federal agencies.  However, the possibility of happening is always there especially in the light of the Harvard findings that the increase in profits was not through economies of scale but of higher prices and therefore detrimental to the economy and pursuant to the power of the State under the police power in political law.  The would-be companies planning to be part of merger and acquisition have this warning of state’s power under the anti-trust laws.[8]  To guide every predator, if any of the following conditions is met by a merger, the merger is illegal:[9]

(1) Substantial actual or potential competition exists between the proposed buyer and seller,

(2) Vertical merger would prevent competitors from access to supply or customer markets or otherwise lessen competition between firms in buyer-seller related industries, and,

(3) Potential reciprocal dealing exists such that the merged firms could force a supplier to buy from one of them under threat of cancellation of purchases from it.

Nevertheless, the residual power of the state to dissolve anti-trust companies with violations afterwards remains a challenge for every corporation.

 

2.3 Further Analysis of Other Results of the Merger

 

Table I (See Appendix A) shows that the profitability ratio expressed in net income to revenues of JP Morgan before and after the merger. The claim for synergy hence higher possibility is not very evident at this point using the Table.  The merger got approved in January, 2004 and effects should be after that date.  Before the merger the net profit margin in December, 2003 above is already 15 % and in December, 2004, the year of the merger, it even declined to .08, hence no apparent evidence of synergy.  The ready answer would seen no because  quarterly rates starting March 31, 2005 to June 30, 2006  showed an increasing trend in net profit margin from 8% to 10%, then 13%, 13%, 13% and 15% for each of the consecutive quarters respective.  Assuming that some adjustments happened in 2004 and those benefits of combined business will come into play after the adjustment; the highest net profit margin was 15% which is almost the same before the merger.  Could we now reconcile the figures given the Harvard Study?

 

2.4 Effect of merger on the stock price

 

Another way to confirm result is by the stock price.  Data as per Appendix B showed that stock prices have been increasing since the merger was approved in January, 2004, seeming to prove a successful merger involving JP Morgan and Bank One.

 

3. Conclusion and Recommendation

 

The factors that brought banks to merger or acquisition is just like those in other industries, the need to survive if not for growth because of the  increasing competition in the industry driving profitability lower.  As to whether the JP Morgan and Bank One merger into one organization is likely a successful one appears to be confirmed in the stock price increase after the merger.  Profit margin wise, the evidence seems not obvious.  In any case, it has survived the games of competition with no charge of violation of anti-trust through such growth strategies.  As competition continues, the company’s survival will depend on how it will face the challenges of competition that have been driving other mergers in the industry and the rules of the game on possible action or anti-trust.  The approval to merge by Federal agencies is in perpetuity as it will be still under regulation.  It must be stated however that with efficient operation as a result of merger, it could mean lower cost for doing business which will cause better prices for customers since they would pay less interest in borrowing from banks and this is good for the any economy in the world whether market oriented or not.

 

4. Recommendation

 

JP Morgan made it well after the merger in terms of higher stock prices and at least maintained profitability.  The possibility of anti-trust violation however hangs on wall waiting to fall in case of violation.  Hence, the company is advised to play the rules.  Although not all mergers are successful, there is basis not to disregard the claims of synergy in the case of merger.

 

Appendices

Appendix A- Table I

Table I

JP Morgan

Per Quarter
Net profit  Margin
30-Jun-06

0.15
31-Mar-06

0.13
31-Dec-05

0.13
30-Sep-05

0.13
30-Jun-05

0.10
31-Mar-05

0.08
31-Dec-05

0.13
31-Dec-04

0.08
31-Dec-03

0.15
source: extracted from
http://finance.yahoo.com/q/is?s=JPM

Appendix B- Stock Price from 200 to Present

 

STOCK PRICES
 

Date
Open
High
Low
Close
Avg Vol
Adj Close*
Oct-06
46.96
48.57
46.69
47.99
11,881,000
47.99
Dec-05
38.52
40.56
38.32
39.69
9,972,704
39.04
Dec-04
37.80
39.48
37.25
39.01
9,770,709
36.92
Dec-03
35.61
36.84
34.50
36.73
6,907,554
33.58
Dec-02
24.01
24.15
23.61
24.00
9,910,150
21.21
* Close price adjusted for dividends and splits.

 

46.96   48.57   46.69   47.99   11,881,000      47.99
Reference: http://finance.yahoo.com/q/hp?s=JPM&a=11&b=30&c=2002&d=11&e=30&f=2006&g=m

 

Bibliography:

 

 

Brigham and Houston (2000), Fundamentals of Financial Management,  Thomson South-Western,  United Kingdom
Churchill, Jr. and Peter (1995), Marketing, creating values for Customers, Irwin, Sydney, Australia
CNNMoney to Subscribe to Money Magazine, {www document} URL http://money.cnn.com/2004/01/14/news/deals/jpmorgan_bankone/, (2005), Accessed on October 17, 2006.
Globusz Publishing (2005),  6 Causes of failure, {www document} URL http://www.globusz.com/ebooks/Mergers/00000014.htm#38
Grovewell (n.d.) , International M & A Integration, {www document} URL http://www.grovewell.com/intl-M&A-integration.html, October, 17, 2006
6.      Joy, O.M., Introduction to Financial Management, Homewood, Ill.: Irwin, (1980)

Mattera, Philip, February, The Free-for-All in Financial Services:  An Overview of The Banking Industry,  Corporate Research E – Letter No.9, (2003) [On line] available: <http://www.corp-research.org/archives/feb01.htm> , Accessed on October 17,2006
Merger Strategy: Reaching For Corporate-Level Goals, no date,[On line] available: <http://www.cba.uri.edu/Faculty/Comerford/Text/Appendix3-1.html> (n.d.) , Accessed on October 17, 2006
Oden, H. (1997) Managing Corporate Culture, Innovation, and Intrapreneurship;  Quorum Books
10.  Van Horne, James C., Financial Management and Policy, Englewood Cliffs, N.J.: Prentice-Hall, (1960)

Yahoo Finance, (2006), Statistics on Stocks {www document} URL http://finance.yahoo.com/q/hp?s=JPM&a=11&b=30&c=2002&d=11&e=30&f=2006&g=m, Accessed on October 17,2006
Yahoo Finance, JP Morgan Chase ,{www document) URL, (2006) http://finance.yahoo.com/q/is?s=JPM>  (Accessed on October 17,2006)
[1]  Mattera (2003) <http://www.corp-research.org/archives/feb01.htm>
[2] <http://www.icba.org/advocacy/testimonydetail.cfm?sn.itemnumber=1699&itemnumber=533&pf=1>
[3] Ibid, Paraphrasing made
[4]  < http://www.cba.uri.edu/Faculty/Comerford/Text/Appendix3-1.html >
[5] Article on Merger Strategy, <http://www.cba.uri.edu/Faculty/Comerford/Text/Appendix3-1.html> citing M. Joy Introduction to Financial Management (Homewood, Ill.: Irwin, 1980), pp.  510-511
[6] Article on Merger Strategy, <http://www.cba.uri.edu/Faculty/Comerford/Text/Appendix3-1.html> citing O.M. Joy Introduction to Financial Management (Homewood, Ill.: Irwin, 1980), pp.  510-511
[7] Ibid
[8] Article on Merger Strategy, citing James C. Van Horne, Financial Management and Policy, (Englewood Cliffs, N.J.: Prentice-Hall, 1960), p. 666
[9] Article on Merger Strategy, citing See Joy, Introduction to Financial Management, p. 521

 

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