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Major deterrents to mergers and acquisitions

The whole process of merger in Pakistan is tedious, time consuming and complex and can take between three months to one year

By Wasif Ijlal
Feb 05 - 11, 2001

In developed free economies, corporate mergers and acquisitions not a phenomenon but a regular feature. It was estimated that the global mergers and acquisitions market in 1999 was worth $2.9 trillion.

All of the top ten deals in the US in 1999 had a combined transaction value of more than $35 billion. Not only its business on a big scale, its also captures the attention of the world's media because of the size and stature of the players involved, be it the high profile international investment banks like Morgan Stanley or Goldman Sachs or the huge companies involved in the mergers like Time, Exxon or Warner.

In Pakistan, the take-over and merger activity is still in its infancy stage and the total deals done are negligible compared to developed countries and even countries in South East Asia.

Corporate acquisitions represent part of a corporate/business strategy used by many firms to achieve various objectives. Acquisitions can be used to penetrate into new markets and new geographic regions, gain technical/management expertise and knowledge, or allocate capital. In order to survive and grow, business organisations often utilise mergers and acquisitions strategically.

There can be a number of motives for a company to pursue a strategy of merger or acquisition. In their book, "Acquisition Behaviour of U.S. Manufacturing Firms", Ansoff, Brandenburg, Portner, & Radosevich identified thirteen general motives for engaging in acquisitions, which are listed:

  • A desire to limit competition or achieve monopoly benefits

  • A desire to utilize unutilized market power

  • A response to shrinking opportunities for growth and/or profit in one's own industry due to shrinking demand or excessive competition

  • A desire to diversify to reduce the risks of business

  • A desire to achieve a large enough size to realize an economical scale of production and/or distribution

  • A desire to overcome critical lacks in one's own company by acquiring the necessary complementary resources, patents, or factors of production

  • A desire to achieve sufficient size to have efficient access to capital markets or inexpensive advertising

  • A desire to utilize more fully particular resources or personnel controlled by the firm, with particular applicability to managerial skills

  • A desire to displace an existing management

  • A desire to utilize tax loopholes not available without merging

  • A desire to realize the promotional or speculative gains attendant upon new security issues, or changed price earnings ratios

  • A desire of managers to create an image of themselves as aggressive managers who recognize a good thing when they see it

  • A desire of managers to manage an ever-growing set of subordinates.

The acquisition process involves a wide variety of information, tasks, and manpower in analyzing, synthesizing, and evaluating both conceptual and technical details.

Major barriers to the M&A activity in Pakistan

No significant synergistic operating economies: When two undertakings combine their resources and efforts they expect to produce better results than two separate undertakings because of savings in operating costs like combined sales offices, staff facilities, plants management, etc. which lower the operating costs. The resultant economies are known as synergistic operating economies.

In Pakistan, the cost of debt and inflation is currently hovering around the 18% and 11% mark respectively. A combination of two entities also means an increase in the overhead costs, and in cases where the financing has been done externally, a subsequent rise in the cost of debt in the balance sheet of the acquiring company. This may negate any synergy or benefit that may arise as a result of the merger.

It is usually the practice for an acquiring company to reduce the manpower by some degree as a measure of post- merger integration. This is done primarily to streamline the entire operations of the merged unit and ensure that work is performed more efficiently. In some cases this can be a problem in Pakistan as the prospect of any significant layoffs may prompts the workers to go on a strike resulting in a losses of efficiency and profits in the post merger period.

Lack of motivation from the standpoint of shareholders

One of the motivations from the standpoint of the shareholders in a potential merger situation is their belief that Investment made by them in the companies subject to merger would enhance in value. The sale of shares from one company's shareholders to another and holding investment in shares should give rise to greater values i.e. the opportunity gains in alternative investments. In fact in countries where mergers are regular phenomena, it's often the pressure of shareholders that can lead to a potential acquisition opportunity.

In Pakistan, where owner-entrepreneurs hold the majority of the shares in listed companies, general shareholders do not have a big part to play in initiating a merger activity. With owners of the companies holding 51% or more of the shareholding through direct or indirect investment, minority shareholders do not have a significant say in the affairs of the company. The high and mighty attitude of the management in "doing what is good for the company" is a major deterrent to merger activity.

Small industrial base

Mergers and acquisitions are motivated with the objective to diversify the activities and to obtain the advantage of joining the resources for enhanced debt financing and better serviceability to shareholders. Such amalgamations result in creating conglomerate undertakings.

There is limited opportunity for diversification given the relative small industrial base in the country. Nearly all the major sectors such as Textiles, Cement and Sugar are in the midst of crises that have sapped the liquidity of these sectors. There is neither liquidity nor any visible urge for companies to merge in these sectors for the purpose of diversification.

Lack of leveraged buyouts (LBO's)

The management of company itself can also initiate the acquisition of a company. This phenomenon is known as a management buyout. This practice is common in USA for over 25 years and quite in vogue in UK. Management may raise capital from the market or institutions to acquire the company on the strength of its assets, known as leveraged buyouts.

The financial institutions in Pakistan are riddled with non-performing loans and banks defaults. The cost of capital is high and banks are very cautious in advancing loans. The lack of financing alternatives plus an alarming shortage of liquidity makes an acquisition by the management or a LBO a very remote possibility.

Inside trading

Insider trading has been recognized as unfair trade practice at Stock Market throughout the world because the access to price sensitive information gives undue advantage to the insider over the common investors who have no knowledge of it and are subjected to exploitation for lack of such information in buying and selling of the shares of the concerned company.

The concept of insider trading is based on the availability of unpublished strategic information about a company, which is highly sensitive to share price of such company in the stock market. Use of such information by the persons having access to it for trading in the stocks for purpose of making personal gains is called 'Insider Trading'.

In take-over bids, insider trading is highly detrimental to the interest of the company.

Inside trading has become a harsh reality in Pakistan. Although there are a lot of effective checks on paper, in practice the trend of inside trading is still on the rise.

Persons who have access to such information are usually closely associated with the company either as:

(1) Promoters or directors and their associates;

(2) Persons working in institutions like financial institutions dealing with the company and in normal course of such dealings possess such price sensitive information;

(3) Persons manning the firms having business relationship with the company having access to confidential information of the affairs of the company.

(4) Persons not having connections with the company but having price sensitive information about the company's affairs through other companies having dealings with such company

In U.K., there is a self-regulatory code known as City Code to curb this corporate malaise. Securities (Insider Dealing) Act, 1985, regulates insider trading. A person connected with the company in any capacity is prohibited to deal with securities at Stock Exchange. Such person may be a director, employee or other person standing in professional or business relationship with the company or related company whose relationship gives him price sensitive information

The information constraint

Determining the value of a business is one of the most difficult aspects of any transaction, since every business is unique.

To establish a market value, "hard" figures such as historical earnings, cash flows, assets, and liabilities, are used. But "soft" or subjective figures such as projected earnings and cash flows, and the value of intangibles (such as patents, brands, know-how, the quality of management, and leases at below-market rates) are also considered. Subjective matters or "soft figures" also include such factors as current market conditions, industry popularity, number of potential buyers, acquisition structure, tax attributes, and the objectives of the seller or buyer. With all this subjectivity, market value can at best be only a range of estimates.

It is generally observed that for any potential buyer or seller in Pakistan, the following constraints exists which greatly affects the valuation of the company.

  • The information memorandum used by the seller is mainly used for window dressing and contains incomplete information.

  • Due to the weakness in the financial reporting system, the authenticity of the information about the company is hard to verify.

  • The system of financial reporting in Pakistan is in a very primitive stage. There is an acute dearth of timely and accurate financial information. Since the valuation conducted by analysts is primarily based on published annual reports, the lack of details in financial statements considerably reduces the usefulness of the exercise. This state of affairs also makes it difficult to make comparison among companies in the same industry. This makes the valuation of a business from the point of view of an acquisition nearly impossible.

  • There has been more than one instance where the balance sheet of the selling company was manipulated and inflated by over valuation of the company's asset base.

  • The only reliable source of data available on important economic indicators are the government publications, which are hard to understand and not user friendly.

  • Problems involving the buyer and sellers

  • There are a lot of cultural idiosyncrasies that curb the trend of merger in the corporate sector.

  • Most of the companies listed on the equity markets in Pakistan are family dominated and their sellers are unrealistic about the price they want for their business. They may be sincere about "wanting" to sell, but they are unable to be realistic about how the marketplace will value the business.

  • In some cases, sellers fail to be honest about their business or its situation. They may be hiding the fact that new competition is entering the market, that the business has serious problems or some other reason the business is not saleable under existing circumstances. Even worse, some sellers do not disclose that there is more than one owner and that they are not all in agreement about selling the business.

  • One of the most observed case are the one where a seller decides to wait until a buyer is found and then check with their outside advisors about the tax and/or legal consequences. At this point, the terms of the deal have to be altered, and the buyers do not agree.

  • The cost of credit is high in Pakistan. With interest rates touching a range of 18-20%, a buyer has to have enough liquidity to purchase the business without making the transaction too much debt-laden. Unfortunately, with a prolonged recession, there are only a number of high net worth individuals who have the ability to keep the transaction relatively low leveraged. Most of the minority shareholders back off as they cant afford to pay the high cost of debt needed for acquiring a business.

  • Some buyers, like sellers, have very unrealistic expectations regarding the price of businesses. They are also uneducated about the nature of small business in general.

  • It's a common occurrence in Pakistan to have property disputes, so its no surprise that a small thing like transferring a lease to a new owner may become the source of a legal or even a personal vendetta that takes months to settle.

  • Buyers and/or sellers may receive wrong advice from outside advisors, usually attorneys or management consultants. The main problem is relying too much on outside help is that in their zeal to represent their clients, consultants forget that the goal is to put the deal together. In some cases, they erect so many roadblocks that the deal can only fall apart.

The complex procedure for mergers and takeovers

There are no specific guidelines or codes on takeovers and mergers in Pakistan. The mergers and acquisitions activity that takes place in Pakistan is governed through the Companies Ordinance 1984.

There is no Take-over Code that would govern the mergers and acquisitions activities in the corporate sector. The whole process of merger in Pakistan is tedious, time consuming and complex and can take between three months to one year.

The beginning to a merger in Pakistan can be made through common agreement between the transferor and the transferee, but a simple agreement would not provide a legal cover to the transaction unless it carries the sanction of the court for which the procedure laid down under section 283- 287 of the companies ordinance 1984 should be followed.

The procedure is quite complex and a number of tedious steps have to be taken to enforce a scheme of merger.


Effective due diligence can lead to a deliberate acquisition strategy for the acquirer. Through the due diligence process, acquiring firms gain an invaluable opportunity to collect comprehensive information about the target's operations before the execution of acquisition.

Ernst & Young summarised due diligence as, 'Due diligence is a process that, in short, involves learning as much as possible about a seller's business, finances, and operations. "The buyer needs to confirm the benefits of the acquisition and to ensure that there are no unrecorded liabilities or unidentified risks that could materially impact the business after the deal is consummated".

Due diligence is a strategic and not a purely accounting exercise. It is aimed to understanding the business of the Target Company and business that it is pursuing, not merely a stock taking exercise.

In Pakistan, the process of due diligence is carried out in the same way as an accounting audit with too much focus on hard data. The result in many cases is a document, which may provide wrong signals to the acquiring company.

What can be done to remove these barriers?

The wave of mergers and acquisition has radically changed the competitive structure of all industries. A number of industries have benefited from the resulting synergies that result from merging with another partner. It is apparent that the merger activity in Pakistan is suffering due to the various regulatory, processes, information and transaction related constraints.

In the humble opinion of the author, the following steps should be taken on an immediate basis to encourage the M&A activities in Pakistan.

  • There should be a clear takeover code, which would lay out the ethical and social responsibilities of the parties involved in a merger.

  • The stakeholders of a company needed to be better educated about the process of merger. Right now there is a huge apprehension towards the whole process of merger and its perceived as something that is detrimental to the overall health of the organisations and its various stakeholders.

This apprehension can only be removed if the various stakeholders are better educated about the underlying motives and synergistic benefits that a merger has to offer. The responsibility has to be taken up by the various government institutions that govern the area of mergers and acquisitions and the large private institutions that need to play their role in promotion of healthy merger activity in the country.

  • Inside Trading is another major barrier to the promotion of merger activities in the country. Again, the importance of a proper code of conduct cannot be stressed more and more importantly; the regulatory authorities that enforce the code should be dedicated and honest to the task.

  • The Financial reporting system needs to be revamped so that clear, consistent and transparent data is available to all parties to a merger. There should not be any secret aims to information which does not come into the parameter of inside information. The help of chartered accountants can be taken in this regard by the government so that a consistent basis of financial reporting is established within a stipulated time frame.

  • The whole regulatory process of merger needs to be made easier and investor friendly. The current process is complex and time consuming and is a major de-motivation for companies that are pursuing the strategy of merger.

  • In order to seize synergy through acquisitions, its is vital that accurate evaluation of the acquired firm is done through a proper process of due diligence. Mergers are driven by strategic intent and not by pure accounting logic and as such the exercise should not be purely accounting based. The major crux of the due diligence exercise should be the estimation of the proposed synergy between the acquiring firm and the acquired firm based upon realistic assumptions.

  • A comprehensive study sponsored by the Ministry of Finance, Government of Pakistan should be carried out in collaboration with investment banking professionals, business schools, management consultants and related merger and acquisition specialists. The study should address the regulatory, legal and other constraints to the merger process in Pakistan in detail and provide recommendation, including the various regulatory amendments that are necessary for making the process less complex.