A merger or an acquisition results in creation of a larger entity. But that cannot be the raison d'etre for shareholders to be gung-ho about the deal. The success of a merger depends upon whether the deal will be able to generate additional returns for shareholders in the long run. Therefore, shareholders need to look out for the following factors in order to avoid getting trapped in corporate mergers and acquisitions.
Excessive valuations: Sometimes a promoter company may place high valuation on merger with listed or unlisted subsidiary in order to pocket in higher gains from its stakes in the target company. This can erode wealth for existing shareholders. In such a case, shareholders can choose to vote against the deal.
Lack of transparency: In the absence of adequate disclosures on the exact nature of the structure of the deal, assessing the potential of the deal can be difficult and subject to risks.
Leveraged buyout: When an acquisition is funded through debt, shareholders need to ensure that it does not stretch the company's balance sheet too much. Otherwise there is a possibility of company's profitability and cash flows getting impacted in the long run.
Business synergies: Companies use the merger and acquisition route for inorganic expansion and growth. It may be either for the purpose of backward integration such as a power or cement company acquiring mining assets or vertical integration for gaining access to a new technology, products or markets. Such deals are expected to be value accretive through better synergies. But when a merger between two companies with unrelated business takes place, then it should be analyzed more critically to ensure against destruction of shareholder's wealth in the long term.
Past track record: Many a times, distressed companies are acquired at discounted valuations. In such cases it is imperative to look at the past track record of the acquirer company in turning around the fortunes of the target company before arriving at an investment decision.
A company undertaking a merger or acquisition shows a possibility of better growth prospects. But whether it translates in higher returns is something that shareholders need to be certain while arriving at an investment decision.