Strategic Management: Corporate Finance Essay

Question:

Write a 2,500-word report critically analysing how the strategy of merger and acquisition has been used in the energy sector during the oil price drop of 2014 to 2016.

The report should include the application of two appropriate academic models. One academic model should focus on internal and external factors. The other model used in the report should focus on strategy.

You should also consider the following when carrying out your research:

The report should include appropriate energy examples of merger and acquisition deals during the oil price drop of 2014 to 2016, and should critically analyse the challenges and benefits of merger and acquisition as a strategy within the energy sector.

The report should not analyse any ongoing merger or acquisition deals.

Answer:

Introduction

During the period of 2014 to 2016, the energy sector suffered due to the drop in the oil price. In order to achieve a balance between the short term viability and also to maintain their long term goals and investments, most of the organizations in the energy sector opt for the strategy of merger and acquisition (Taillard 2013). It has been found that the drop in the oil price has impacted the profits as well as the spending of the firms on their projects. Thus, various companies of the energy sector implemented various strategies in order to stabilize or to improve their financial position by either earning access to resources, technology or new markets. It has been noted that most of the organizations in the energy sector implement the merger and acquisition strategy in order to maintain their financial position in the highly competitive market. In this report, two academic models of merger and acquisition have been discussed – firstly, strategic management model of merger and acquisition in order to focus on strategy and policies of a firm. Secondly, the report focuses on risk management model of merger and acquisition that highlights the both external and internal factors of an organization (Shimizu 2012).

Merger and acquisition

The terminologies “Merger and Acquisition” are generally referred as “M&As” and these are considered as the most important part of the corporate restructuring. Merger is defined as a combination of two organizations that creates a new company. On the other hand, acquisition is defined as the purchase of one firm by another, where no new firm is formed. It has been found that merger and acquisition involve various transactions. These include – acquisitions, mergers, tender offers, consolidations, management acquisitions and purchase of assets (Ross, Westerfield and Jordan 2014). In every case of merger and acquisition, two firms are involved, where the acquiring company offers another company to buy its entire assets or to acquire some of its assets. The basic concept of merger and acquisition is the consolidation of two firms, where by acquiring the assets of another company or by merging two companies; the management of the particular firm intends to earn synergy over the present financial condition of the firms individually. Therefore, the concept and the understandability of both mergers and acquisitions are considered as an important factor, especially in today’s world (Ross, Westerfield and Jordan 2013). It has been noted that in some of the particular sectors, the probability of occurring merger and acquisition is relatively more than other sectors. These include – telecommunications, chemicals, oil, IT, pharmaceuticals and finance. Merger generally takes place between those two companies which are equal in stature and in size along with their cooperation (Ross 2012). Therefore, merger is also known as ‘merger of equals’. On the contrary, it can be said that in case of acquisitions, one firm purchases another, especially the smaller organizations such that they get absorbed within the parent company. the company that is being acquired by another is termed as target company.

Implementation of strategic model

Strategic Management: Merger and Acquisition

At initial level, it has been noted that the mergers and acquisitions were simply the financial transactions that aims to control the target and the undervalued assets of an industry that is much different from the core business of the acquirer. Here, the main aim was to make the cash flows sufficient for the debt repayment. However, as per Hitt, Ireland and Hoskisson (2013), the concept of mergers and acquisitions are totally different in recent days. Thus, during the period of 2014 to 2016, most of the companies in the energy sector opt for the implementation of the merger and acquisition strategy. The reason behind this is that in present days, the typical merger and acquisition of the companies are considered as an operational and strategic in nature. The strategy that has been implemented during the merger and acquisition of energy companies in the time period 2014 – 2016 includes different perceptions of the managers. According to Lynch (2012), during the period of oil price drop, the managers do not justify the action of merger and acquisition as a mere purchase of undervalued assets. Rather, it has been found that the managers of the energy sector consider this activity of merger and acquisition as purchasing of installed customer bases, greater geographical boundaries, better distribution channels, a variety of new talent and organizational competencies. Therefore, it has been found that during the period of oil price drop, most of the companies in energy sector undergo merger and acquisition in order to maintain their profit percentage and long term investment (Raimbault and Barr 2012). All of the acquired factors thus in turn offer much strategic opportunities to the firms such that the organizations in the energy sector can gain an edge over the products and services of the competitors. Thus, it has been found that the organizations of the energy sector are still running successfully in this competitive market even during and after the oil price drop in the year 2014 to 2016.

Opined to Olivas-Lujan and Bondarouk (2013), the strategic planning has been emphasized by the firms as a vital instrument that leads to the success of the business. As per Lasserre (2012), many studies have been conducted in this regard and the outcome of these studies reveals that hardly ever the managers had any strategic rationale for the activities of merger and acquisition. In addition to this, the managers had seldom any idea regarding the impact of these activities that might have on the organizations of the energy sector in the upcoming periods. Nevertheless, the managers of the organizations have recently changed their emphasis from saving cost to using the concept of merger and acquisition as a strategic driver for the growth in the corporations.

There are various reasons regarding mergers and acquisitions to be justified. The companies under the energy sector that have undertaken such deals of merger and acquisition can either be a complete failure or can be a gain from them. Therefore, the alignment of the strategic plans of the organizations with their plans regarding merger and acquisition is considered as an important factor (Pitt and Koufopoulos 2012). The reason behind this is that this alignment of the strategic plans with the plans of merger and acquisition of an organization can only make the activity of merger and acquisition of the firm effective and successful. This can be done by the help of an effective instrument i.e. due diligence which involves the screening of all the acquisition targets and the potential mergers.

Implementation of Risk management model

The risk management model is the most suitable one that helps the organizations of the energy sector to focus on internal as well as external factors in order to analyze the process by which the strategy of merger and acquisition is used in the energy sector. It has been found that during the period of 2014 to 2016 i.e. during the period of oil price drop; this particular risk management model has been applied and implemented to better understand the strategy of merger and acquisition within the energy sector. The merger and acquisition risk management model has been proposed for considering the risk factors that are present within the activities of merger and acquisition. The objective of this model is to maximize the scope of success in the activities of merger and acquisition by reducing and managing the related risks. According to Oskooe (2012), there are various types of theories and models within the risk management model of merger and acquisition. However, the primary approach of the merger and acquisition risk management model is composed of two steps. These include – firstly, risk identification of the organization with the help of fish bone method and secondly, risk quantification with the help of Fuzzy-AHP method. It has been found that most of the organizations in the energy sector use the merger and acquisition risk management model in order to identify as well as manage the risks due to the process of merger and acquisition (Parrino, Kidwell and Bates 2014). It also helps to maximize the profitability of the particular firms. As per the model, the first step is to identify the associated risks based on internal and external factors of the organizations of energy sector. The fishbone diagram helps to identify various possible causes for each problem (Parrino, Kidwell and Bates 2012). Additionally, this structure can also be used for arranging a session of brainstorming and also to sort ideas into useful categories immediately. Therefore, it can be said that for the organizations of the energy sector, the fishbone diagram acts as a tool that analyzes the process of dispersion.

Figure 1: General structure of Fishbone Diagram

(Source: Parrino, Kidwell and Bates 2012)

On the other hand, most of the organizations of energy sector adopt the Analytic Hierarchy Process (AHP) with the merger and acquisition risk management model in order to quantify the risk factors that have been identified. This model acts as a useful and powerful tool for systematic analysis that ranks the relative factors and also indicates its importance. This AHP helps to link between the qualitative and quantitative methods and it also helps to solve the problems of the organization of the energy sector regarding its decision making (Parnell 2014). Therefore, it can be said that the implementation of this risk management model to the organizations of the energy sector will help to resolve all the complex problems by implementing the right strategies based on the internal and external factors of the firm.

Examples of merger and acquisition in energy sector

During the period of 2014 – 2016, many organizations under the energy sector have undergone the activities of merger and acquisition, the reason behind this being the oil price drop. However, it has been found that most of the mergers and acquisitions have provided positive results contrary to what was expected. For example – INEOS has successfully acquired the U.K. North Sea Gas Fields from Deutsche Erdoel AG, Schlumberger has successfully acquired Fluid Inclusion Technologies Inc. and NuEnergy Gas Ltd has also acquired Dart Energy (Indonesia) Holdings Pte Ltd successfully (Ogfj.com 2016). Additionally, it has been found that Ameresco has successfully acquired all the assets of U.K. Energy Services Provider Energyexcel LLP during the period of oil price drop (Ameresco.com 2016). Moreover, the organization Camin Cargo Control Inc has also acquired Quantum Control Services during this period (Ogfj.com 2016). Therefore, from all these examples it can be said that merger and acquisition play a vital role in the organizations of energy sector during the period of oil price drop.

Benefits of merger and acquisition in energy sector

It has been found that there are various advantages regarding the implementation of the activities merger and acquisition within an organization, especially in the energy sector. Some of the advantages of merger and acquisition are as follows:

Firstly, the mergers and acquisitions help to pave the ways for the organizations in the energy sector to enter into the new markets. This activity also helps the organizations in the energy sector to add new product lines to the existing one of the firm (David 2013). Additionally, it also helps the firm to increase its distribution channel or distribution reach as this activity of merger and acquisition helps to gain a core competence to do more combinations.

Secondly, the implementation of merger and acquisition to the firms of the energy sector help the management to enhance or increase the value of its shareholders.

Thirdly, the value of the shareholders of an organization can be enhanced by implementing the activities of merger and acquisition by reducing the costs that are obtained due to the combination of operations, departments and trimming the employees of the firm (Brealey, Myers and Marcus 2012). Therefore, this reduction in cost in turn leads to the increase in the profitability amount of the firms in the energy sector.

Fourthly, the implementation of merger and acquisition activities within the organizations of energy sector helps to increase the revenue of the firm by the process of the absorption of a major competitor. This in turn increases the market share of the organizations in the energy sector.

Fifthly, the implementation of the merger and acquisition leads to the cross-selling of the services and products provided or served by the organizations of the energy sector.

Sixthly, it has also been found that the savings of tax can also be obtained by the organizations of the energy sector, especially when a highly profitable organization gets merged with or takes over a money-loser company.

Seventhly, the implementation of the activities merger and acquisition lead to diversification that can also stabilize the earnings of the organizations of the energy sector and can also boost up the confidence level of the investors of the firms (Berk, DeMarzo and Harford 2012).

Eighthly, it has been found that some of the mergers and acquisitions take place within an organization of the energy sector, especially when the management of a business distinguishes the requirement of altering the identity of the corporate.

Ninthly, the activities of merger and acquisition also help to reduce the risk of an organization or it can also be said that these activities also help to spread the risk among other organizations of the energy sector, such that it can be handled well.

Tenthly, the acquisitions of the organizations under the energy sector are considered to achieve the horizontal and vertical operational synergies. These synergies signify that the entire one is greater than the different parts.

Lastly, it has also been found that some of the activities of merger and acquisition occur due to the market dominance and also to reach the economies of scale. This helps the organizations of the energy sector to run profitably.

Challenges of merger and acquisition in energy sector

It has been found that there are several advantages of the implementation of merger and acquisition. However, close analysis indicates that there are also some challenges regarding implementation of merger and acquisition within the organizations of the energy sector. These include – communication challenges, cultural challenges, employee retention challenges, flawed intentions, obstacles to making it work, accessing the corporate cultures, differences, legal and issues (Berk 2013).

Recommendation

On the basis of the above analysis it can be recommended that the steps taken by the firms to merge at the time of crisis is best suited to the situation and should be applied henceforth too. The past method of viewing mergers as scaling down competition at times of need has now changed. There is an improved perception among the managements that such a step would in fact help in mitigating the situation by improving customer sales, cutting down costs and by going beyond logistical or geographical boundaries. Such a step would surely benefit a firm to return to a much better position once the crisis is over, and as such is highly recommended.

Conclusion

Therefore, it can be rightly concluded on the basis of the above analysis and observations that mergers have resulted in firms mitigating untoward crises like a sudden and prolonged drop in oil prices, contrary to the belief that it would only aid in reducing competition. The various models like strategic and risk mitigation, to name a few, have further strengthened the notion that mergers have helped in the past and if conducted judiciously would benefit in the future too. Since risk factors like drop in prices or change in demand patterns are unpredictable, such actions should be planned in advance so that the firm itself does not collapse.

References

Ameresco.com. 2016. Ameresco | Ameresco Acquires Substantially All Assets of UK Energy Services Provider Energyexcel LLP to Further Expand its Comprehensive Energy Efficiency and Renewable Energy Solutions to International Customers. [online] Available at: [Accessed 26 Jul. 2016].

Berk, J. 2013. Fundamentals of corporate finance. Toronto: Pearson.

Berk, J., DeMarzo, P. and Harford, J. 2012. Fundamentals of corporate finance. Boston: Prentice Hall.

Brealey, R., Myers, S. and Marcus, A. 2012. Fundamentals of corporate finance. New York: McGraw-Hill/Irwin.

David, F. 2013. Strategic management concepts. Boston: Pearson.

Hitt, M., Ireland, R. and Hoskisson, R. 2013. Strategic management. Mason, OH: South-Western Cengage Learning.

Lasserre, P. 2012. Global strategic management. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan.

Lynch, R. 2012. Strategic management. Harlow, England: Pearson.

Ogfj.com. 2016. Home. [online] Available at: [Accessed 26 Jul. 2016].

Olivas-Lujan, M. and Bondarouk, T. 2013. Social media in strategic management. Bingley, UK: Emerald.

Oskooe, S. 2012. Oil price shocks and stock market in oil-exporting countries: evidence from Iran stock market. OPEC Energy Review, 36(4), pp.396-412.

Parnell, J. 2014. Strategic management. Los Angeles: SAGE.

Parrino, R., Kidwell, D. and Bates, T. 2012. Fundamentals of corporate finance. Hoboken, NJ: Wiley.

Parrino, R., Kidwell, D. and Bates, T. 2014. Essentials of corporate finance. Hoboken, NJ: J. Wiley & Sons.

Pitt, M. and Koufopoulos, D. 2012. Essentials of strategic management. London: SAGE.

Raimbault, C. and Barr, A. 2012. Emerging risks. Farnham, Surrey: Gower.

Ross, S. 2012. Fundamentals of corporate finance. New York: McGraw-Hill.

Ross, S., Westerfield, R. and Jordan, B. 2013. Fundamentals of corporate finance. New York, NY: McGraw-Hill/Irwin.

Ross, S., Westerfield, R. and Jordan, B. 2014. Essentials of corporate finance. New York, NY: McGraw-Hill Irwin.

Shimizu, K. 2012. The cores of strategic management. New York: Routledge.

Taillard, M. 2013. Corporate finance for dummies. Hoboken, N.J.: John Wiley & Sons, Inc.

How to cite this essay: