Investigate the Impact of Acquisition on Shareholders’ Wealth a Case Study of Western Digital Corporation and SanDisk Corporation
This paper assesses the merger and acquisition that happened between Western Digital Corporation and SanDisk Corporation on 21 October 2015. The research investigates the pre-merger and post-merger performance of the firm.
1.0 Introduction
Mergers and acquisition is one of the most applied by companies to achieve the needed resources and capacities to enhance the company earning capacity. Mergers and acquisition promote operation efficiency as a result of consumption and production economy of scale, improved resource allocation, improved application of expertise and information, enhanced marketing synergy, improved use of brand name capital and more effective asset combination. M&A promote corporate synergies which may result in more improved production method, more efficient management and improved market power.
New-classical economic theory assumes that the main role of the organization management is to maximize shareholders wealth. M&A is considered an instrument through which corporate replace their inefficient management team. This help in the redeployment of capital in the organization. Hence, if shareholders wealth maximization policies are followed by companies then shareholder should not suffer loss in the acquisition process. In additional competitive environment make the bidder corporates to increase the premiums which are paid to the target firms hence increasing the earnings and returns of the shareholders after the acquisition. Therefore the process of M&A is considered as zero net present value investment decision. Also, acquisition destruction or shareholders wealth creation is considered to be contingent on the economic environment during the acquisition period. Hence the process of merger and acquisition is very important in wealth maximization. The current disruption in the global financial market has impacted the economic condition of many businesses hence making firm with financial muscles to increase their opportunity to acquire the firm which is struggling. The businesses which are not able to endure the global financial crisis are acquired by the strong companies.
1.2 background of the study
In the past decade, Mergers and Acquisition (M&A) have continued to receive much public attention as most of the major mergers and acquisition have affected the value of companies. Several mergers and acquisition have taken place globally. To have insight into global mergers and acquisition, this section will highlight mergers and acquisition activities that have happened in the last decade.
Whether mergers and acquisition affects the shareholder wealth is a matter of continuous debate among scholars and researchers. Mergers and acquisition enhance cost-efficient through increased managerial efficiency, scope efficiency and economy of scale. Maranga (2010) found that companies that engage in the acquisition of target has no significant influence on post-merger cost efficiency. However, some companies, that engage in mergers and acquisition demonstrated a decrease in cost efficiency. Study on the effect of M& A on Malaysia by Sufian (2004) indicated that the overall average post-merger efficiency was still higher. The share capital of the company is the amount of money described to shareholders as the one who invest in the company. The shareholder expects a return for the investment they make in the organization. The ability of the company to join in strategic merger and acquisition is based on the company cash flows.
The study will focus on the merger that took place between Western Digital Corporation and SanDisk Corporation. The main aim is to investigate how merger and acquisition influenced the shareholders of both acquiring and the target company. The merger and acquisition between Western Digital Corporation and SanDisk Corporation were announced on 21 October 2015. In this acquisition, Western Digital Corporation acquired all the outstanding shares of SanDisk for a total equity value of $19B in cash and stock. The merger and acquisition was considered as one of the largest acquisition in the hard disk drive and storage industry. However, in September 2015, Unisplendour announced that it would spend $3.78 billion to purchase 15% of WD and become the largest shareholder of WD. In this case, both deals would be likely to be closely scrutinized by U.S. regulators because of national security concerns, but in February 2016, Unisplendour withdrew its plan to invest in WD which allowed the acquisition to go through. This study aims to investigate the impact of the acquisition on shareholders’ wealth and also to explore the reason that WD considers SanDisk as an appropriate acquisition target. Furthermore, the researcher examines the influence and development of storage component business after WD buys SanDisk. The researcher found that motivations could be the following: firstly, WD and SanDisk have complementary product lines. WD is one of the leading manufacturers of hard disk drives. To remain competitive, it is necessary to acquire SanDisk who operates as a leading provider of flash-based drives. Secondly, the combination enables WD to vertically integrate into NAND, which gives WD a foothold in securing long-term access to solid-state technology at a lower cost.
According to Arikan and Stulz (2016), there could be a different situation in mergers and acquisition, in the short-term; all shareholders would get benefits and results in a win-win situation. But the situation would be reversed if we take the long-term view. Also, several works of literature have implied that the combination of the two brands is a value creation strategy since it gives WD access to the solid-state drives market and then become the largest provider of persistent storage. Therefore, in this study, the main hypotheses are the merger creates value for both Western Digital and SanDisk.
2. Literature Review
This section presents the introduction to mergers and acquisition and conclusion of empirical studies on how mergers and acquisition influence shareholder wealth maximization. Further, several indicators will be used to test how M & A affect corporate value.
2.1 Merger and Acquisition
Merger and acquisition refer to the transaction that involves two or more companies where stocks are transferred allowing only one corporate entity to survive. This means that one company is acquired by the other one hence the two firms operate as one company and under one name. mergers and acquisition are categorized into three classes that’s conglomerate, vertical merger and horizontal merger.
2.2. Theories of Acquisitions
This section presents the theories that explain the relationship between M&A versus shareholders wealth maximization. The main goal of merging corporate is to create synergy. Firms merge and acquire with main objective to have a competitive advantage over other companies. Companies merge to increase the available offer, reduce operation cost and content positively. Mergers and Acquisition promote the positive performance of the organization. Several theories have been used to explain the effect of merger and acquisition on wealth maximization of a firm.
Several empirical studies have been done to access the performance of mergers and acquisition in the short-term. This study will predominantly evaluate the effect of mergers and acquisition on shareholders of the acquiring firms. The literature review primary focus will be on studies analyzing the implication of mergers and acquisition on acquirer shareholders wealth.
The Theory of Efficiency
The efficiency theory indicates mergers take place when two companies expect to generate sufficient synergies for the benefits of both parties. The theory suggests that the merger should be accepted if its purpose is for mutual benefit. In case the target company is not positive about the deal there is a likelihood of the merger taking place. According to Klein (2001), the main objective of the merger is to create value for the shareholders of the company. However, it is necessary to differentiate between efficiency theory synergy achieved through collusive synergies or allocate synergies and economy of scale that is experienced as a result of the improved ability of the company and the market power. The role of every indicator of performance should be computed to know what contribution of mergers and acquisition is in value creation. According to research by (Devos 2008), it is observed that most gain on shareholders wealth is associated with operating synergies however market power play a significant role in the performance of a merger. The positive performance of the firm is also attributed to allocative synergy. All factors kept constant the price of the stock is influenced by the market power. Several studies have found different results from mergers and acquisition. Mergers and acquisition have been evidenced as the main contributor of allocative synergy and market power (Cefis, 2008) merger and acquisition play a critical role in promoting market power, efficiency and synergy.
Theory of corporate control
This theory suggests that there will always be a company willing to acquire the non-performing company and remove those managers who do not promote efficiency in the company. The managers who are considered to over the highest value to the firm shareholder will be retained until the company identify a strong team that can create more wealth.
The theory is partly based on the efficient market theory, however, there exist two different theories of corporate control does not recognize the existence of the synergy of the corporate asset of both the acquiring and the firm been acquired but instead the synergy between the acquiring managerial ability and the assets of the target company. Therefore, the theory suggests the efficiency of managers from the reallocation of under-utilized capital. The theory also suggests that the management of the target company will resist takeover as they believe that the inefficiency is the key reason behind under-performance. In most cases, bidders are private companies with an efficient management system. They are also key competitors in the industry.
Hurbis Theory
The merger and acquisition have been associated with the positive performance of the company. However, this is not always the case. Puranam and Singh, 1999 suggest that 80% to 60% of M&A does not create value for the company. It is assumed that the management of the acquiring companies are not rational and hence they make mistakes which result in companies incurring losses as a result of limited information. The acquiring firms are also assumed that they maximize on private utility function hence resulting to the negative performance of the company.
Hurbis Theory suggests that managers intention may be good but high confidence leads to an overestimation of their potential to enhance synergies. In most cases overconfidence the chance of overpayment which may later result in losses (Malmendier and Tate, 2008). Güner, Malmendier, and Tate, (2008) found strong evidence of Hubris in European context while Berkovitch and Narayanan (1993) found the same in the US takeover. According to several studies, it was evidenced that a third of larges take over in the last decade suffered losses as a result of overconfidence. However, most of the optimistic managers were able to increase the wealth of their shareholders as a result of mergers and acquisition. According to the theory of managerial discretion by Jensen, ‟s (1986) unproductive acquisition does not result from over-confidence but instead the presence of excess free cash flow (FCF) or liquidity.
Firms with excess internal funds are more likely to engage in strategic decision compared to the companies with less free cash flow. A higher level of liquidity triggers managers to engage in strategic mergers to increase the company market power (Martynova and Renneboog, 2008).
Several empirical research work indicates that the impact of abnormal return in stock price merger and acquisition by cash-rich predator declining and negative in the cash flow amount held by the acquiring firm. Further, it is suggested that the company shareholder will trust the management to make acquisition decisions on their behalf on basis of subjective and fuzzy concept like current and past high cash flows, intuition and gut feeling and managerial instincts. Hence, the hubris theory suggests that well-intentioned managers make irrational decisions because of their decision quality are less challenge compared to the decision of managers will be limited to liquidity. The self-interest of managers also play a critical role in merger and acquisition and hence in most time, it results in making bad decisions (Martynova and Renneboog, 2009). Empirical studies suggest that acquirer returns are also affected by the size of the company being acquired. Companies acquiring large firms enjoy higher returns as companies acquiring small firms. This indicates that the manager focuses on acquisition when they are financially stable. Also, this supports the managerial and agency cost theories of a firm which suggest that management engages in the self-serving acquisition and as a result, the company suffers loss in terms of customer value.
Empirical studies
Different empirical researches on company mergers and acquisition have put more focus on the effect of mergers and acquisition on company operations. This is based on the account M& A has been a key element for companies police to promote efficiency. Various studies on mergers and acquisition have presented different conclusions and discovery. Most researchers’ interest has been to investigate the effect of merger and acquisition announcement on the performance of the stock price. For example, Pandey, (2001) evaluated the impact of mergers and acquisition between 1990 to 1996. The study suggested that during the mergers and acquisition event window the acquiring firm was associated with a positive and negative significant abnormal return of 2.83% (0.58%) respectively. The researcher noted that the CAR of the target company were a bit higher but also demonstrated both successful and unsuccessful significance ranging from 20.58% to 18.96% respectively. This was different from the research findings of Dodd (1980) who analyzed 80 unsuccessful mergers and 71 successful mergers in the period between 1972-1977. and came up with the conclusion that shareholders of the acquired companies have a more positive abnormal return (AR) above 13 per cent from official merger and acquisition announcement event.
In contrary, for the shareholders in acquiring companies, the cumulative abnormal returns were 5.5% for unsuccessful and 7.22% for successful bidders. Research by Jensen and Ruckback (1983) on the effect of the merger to the stock price concluded that successful mergers and takeover contributed 20-30% of abnormal return to the company being taken over (shareholders), however, he observed that the acquiring company have a very insignificant abnormal return. The result was in line with the results of Jarrell, Tichy, (2001)who found that most of the merger deal was more beneficial to the target firms as compared to the bidding companies.
Similarly, other studies that were based on successful and unsuccessful defended the mergers and acquisition bid. The study by Yang, and Branch, (2001) demonstrated a statically significant positive CAR of 47.84% gained by the stakeholders in the acquired firms in the event window and the trend was sustained for two years. Stakeholders in the acquiring companies obtained positive impact of 7.9%. Same results were also reached by Wong and ’Sullivan, (2001) in their signalling model on the repurchase of stock as a defence take over. It observed that the takeover had a positive effect on the acquiring companies and hence influence the wealth of the stakeholders.
Research by Loderer and Martin (1992) his investigation on 155 acquisition and 304 mergers documented a negative through insignificant statistical abnormal return over the period after the mergers took place and positive through insignificant abnormal return for the takeover. Applying moving average model for estimating beta using the market model through application of the average method, Andre and L’her, (2004) found the insignificant positive abnormal return of 0.01% for over three years after the announcement of the bid by investigating 129 unsuccessful bids and 434 successful bids in the United Kingdom for the period ranging from 1965 to 1975. However, the results were contrasted by Jean-Francois (2004) who found that there existed a negative and significant announcement event abnormal return post-mergers and acquisition.
In the case of long-term predator performance, negative post-merger performance was evidenced. Research by Agrawal, Jaffe and Mandelker (1992) found negative and abnormal returns over 60 months after the takeover. Andre, Kooli, and Jean-Francois (2004) suggested statistically significant earnings of 16% for holding and buying the sharing of the acquiring firms for 60 months post-merger. The study also indicated significant returns for Canadian bidders over 36 post-event period. Research by Healy, Palepu and Ruback (1992) on taking over performance for fifty largest United State merger evidenced that merger and acquisition promote the productivity in the market, resulting to increased operating cash flow return.
Other scholars investigated global or international mergers and takeover and similarly mixed findings were evidenced. Research by Carnes and Jandik (2001) demonstrated a negative and significant return on United State bidders during 3 and 5 years cross mergers. Cross-merger takeover results in the decreased market value of the bidder companies five years after the mergers and take over the period (Gugler, Mueller, Yurtoglu and Zulehner 2008). However, these results were contrasted by Guest and Hughes (2001) who did not find results to prove the negative post-takeover for the cross-border takeover.
The impact of mergers and acquisition on the size of the firm was also studied by Moeller, Schlingemann, and Stulz (2004) the study focused on more than 12,000 takeovers from 1990-2000 found that takeover by smaller companies resulted to statistically significant abnormal return compared to the larger companies acquisition. It is projected that the larger companies pay a premium price on their takeover which in results to the loss in net worthy of the shareholders.