Mergers and acquisition is a regular term in business community. In this article we will try to cover the difference between mergers/acquisitions, types, general issues, advantages/disadvantages, and some important concepts related. In addition, we will have a deeper look for mergers and acquisition from the technology companies perspectives, in addition to some historical background and finally few success and failure cases in the technology domain. Also different techniques and methods for the valuation of small and medium software companies is covered due to the special nature of such companies.

1. Mergers and Acquisitions, Why and Why not? With a focus on High-Tech Industry.
A literature review by: Al-Motaz Bellah Al-Agamawi,
Version One August 2010, Revised Version March 2012.
Email: magamawi@gmail.com, Skype ID: magamawi, Linkedin Profile:
http://www.linkedin.com/in/motazalagamawi, SlideShare Profile: http://www.slideshare.net/magamawi
Contents
Introduction ................................................................................................................................................... 1
What is Merger and Acquisition? ................................................................................................................. 2
The Types of Merger and Acquisition. ......................................................................................................... 2
Why Companies is seeking Merger and Acquisition? .................................................................................. 3
General Companies Valuation Techniques ................................................................................................... 3
Valuation Techniques for Technology Based SMEs .................................................................................... 5
Merger and Acquisition Effect of Venture Capitals ..................................................................................... 6
The History of Merger and Acquisition on National Level .......................................................................... 8
Work Cited:................................................................................................................................................... 9
Keywords: Merger, Acquisition, Vertical Integration, Horizontal Integration, Related Merger, Unrelated Merger, Types of
Mergers, Types of Acquisitions, Motives for Mergers, Motives for Acquisitions, Valuation Techniques, Comparative Ratio,
Discounted Cash Flow, DCF, Replacement Cost, Comparable Transactions, Net Asset Test, Earn outs, COCOMO Model, First
Mover Advantage, GAP Accounting, Blue Chip Accounts, Venture Capitals, High Technology Companies, SMEs, Small and
Medium Enterprises, History of Merger and Acquisition, The great Merger Movement.
INTRODUCTION
Mergers and acquisition is a regular term in business community. In this article we will try to
cover the difference between mergers/acquisitions, types, general issues,
advantages/disadvantages, and some important concepts related. In addition, we will have a
deeper look for mergers and acquisition from the technology companies perspectives, in addition
to some historical background and finally few success and failure cases in the technology
domain.

2. WHAT IS MERGER AND ACQUISITION?
Simply the main idea about both mergers and acquisitions is to increase the performance, one
plus one makes three. This equation is simply simplifying the target behind a merger or an
acquisition between two companies. The idea behind is creating value for shareholders over and
above the sum of the two companies, two companies together are more valuable than two
separate ones (investopedia2010). A merger is when integrating two companies together in
which the two companies will share control and equity with each other. Acquisition is when a
company buys the other company and end up controlling it (Mer101). Usually mergers happens
between two equal size companies who agrees to go forward as a single new company, this kind
of mergers is called “merger of equals”. For example, both Daimler-Benz and Chrysler formed a
new entity named DaimlerChrysler upon merger. Actual mergers of equals are not very often.
Usually, one company will buy another and as part of the deal’s terms, allow the acquired firm to
claim that the action is a merger of equals, even if it is an acquisition, this is because equal
merger usually sound better than acquisition in the market (investopedia2010).
THE TYPES OF MERGER AND ACQUISITION.
From the business perspective, there are many types of business mergers, distinguished based on
the relation between the two companies going in the process. Based on the US Federal Trade
classification mergers types includes: Horizontal mergers which involve companies closely
related from the product or service they produce, Vertical mergers which includes companies
that had a potential or existing buyer-seller relation before merger, and Conglomerate or
unrelated involve essentially companies that unrelated in terms of products-markets in which
they are operating and the main target of this type of mergers is diversifying strategy. Literature
seems to suggest that both Horizontal and vertical mergers are more successful than unrelated
mergers. From a practical perspective, this seems logic, because both horizontal and vertical
mergers are more suspect to benefit from the economy of scale and scope, strategic fit of the
company in terms of relatedness of the product-markets in which they are operating
(DUYSTERS, 2002).

3. WHY COMPANIES IS SEEKING MERGER AND ACQUISITION?
Companies in different industries are seeking mergers and acquisitions for many reasons and
motives but in general, companies are looking forward to increase profits and rapid growth.
Motives to increase financial performance includes: Economy of scale and scope, increase both
revenue and market share, cross selling, synergy to increase managerial specialization or
purchasing economies, taxation when a profitable company buys a loss one to use the loss in its
benefit, geographic diversification, business diversification, resources and knowhow transform
vertical integration of products or technologies, absorption of similar business under the same
management, and competition elimination (wikipedia10). When it comes to High-tech industry,
in addition to the above motives, companies are looking forward to: joint or complimentary
R&D programs, integrating both upstream and downstream partners, integration of users can
help to identify market need for new technology and for large technology companies they are
always looking forward to acquire new innovative ideas to guarantee leadership in their markets
(DUYSTERS, 2002). For SMs- small and medium size technology companies, acquisition can
provide strategic, operating and financial benefit. Also large companies carrying the acquisition
of small/medium companies benefits. Strategic acquisition can benefit SMs shareholders with
earlier liquidity than IPO, with less risk and dilution. It also can provide SMs with immediate
leverage of large companies established distribution and manufacturing infrastructure, without
the required time and risk of internal development. Large companies benefit from the ownership
of new products and technologies necessary to maintain its competitive advantage, growth rate
and profitability (Mergers & Acquisitions: A Strategy for High Technology Companies, 2003).
GENERAL COMPANIES VALUATION TECHNIQUES
Company valuation is always a very important part in closing either a merger or an acquisition
deal, especially when it comes to high-tech companies and in particular when a small or a
medium size company is involved in the process. There are many type and techniques for
companies valuation, we will try to summarize the most standard and well none valuation types.
First widely used technique is comparative ratio either price earning ration or enterprise-value-
to-sales ratio. Price earning ration is simply apply a standard industry multiple for the earning of
the target company, then company valuation will be equal its earning multiplied by a multiple.

4. Looking at the Price/ Earnings for all the stocks within the same industry group will give the
acquiring company good guidance for what the target's P/E multiple should be. Enterprise-value-
to-sales ration is very close to Price earnings ratio, valuation will be equal to a multiple to the
revenue.
Second valuation technique is discounted cash flow DCF; discounted cash flow analysis
determines a company's current value according to its estimated future cash flows. Forecasted
free cash flows (net income + depreciation/amortization - capital expenditures - change in
working capital) are discounted to a present value using the company's weighted average costs of
capital.
Third valuation technique is, Replacement Cost - In a few cases, acquisitions are based on the
cost of replacing the target company. For simplicity's sake, suppose the value of a company is
simply the sum of all its equipment and staffing costs. The acquiring company can literally order
the target to sell at that price, or it will create a competitor for the same cost (investopedia2010).
Comparable Transactions is another way of determining a company. Valuation is determined as a
comparison of the amount paid in acquisitions for other companies in some industry. Purchase
Price Denomination is another way, when a large company pays cash for smaller company, large
company will express the purchase price in dollars.
In an acquisition where large company issues stock to pay for smaller company, large company
may express its offered purchase price in any of the following ways: as a dollar value of its
shares, fixed number of shares, or a percentage of combined entity.
Net Asset Test is a technique in which, if either large company or smaller company believes that
the balance sheet is likely to become significantly weaker or stronger between the date the
definitive agreement is signed and the closing date, it may suggest that the purchase price be
adjusted to reflect a change in the net assets.
Earn outs is another technique. In an "earn out," some portion of small company’s purchase price
will be paid by large company only if small company achieves negotiated performance goals
after the closing. Parties typically use an earn out when they agree that a higher valuation would

5. be justified if acquired company were to meet forecasted performance goals (Mergers &
Acquisitions: A Strategy for High Technology Companies, 2003).
VALUATION TECHNIQUES FOR TECHNOLOGY BASED SMES
Always there is a dilemma when it comes to merger or acquisition of a small or medium
software company. One problem in selling a small technology company is that they do not have
any of the brand names, distribution, or standards leverage that the big companies possess.
Therefore, on their own, they cannot create this profitability leverage. The acquiring company,
however, does not want to compensate the small seller for the post acquisition results that are
directly attributable to the buyer's market presence. This is what we refer to as the valuation gap.
To solve such valuation gap there are some techniques and methods but practically some of them
are very hard to apply on the practical ground and other needs specialized professionals to apply.
Those techniques includes:
Cost for the buyer to write the code internally, this technique could be applied through
developing a constructive cost model for projecting the programming costs for writing computer
code, COCOMO model.
Also first mover advantage from a competitor or, worse, customer defections, there is a real cost
of not having your product today, this could be by justifying the entire purchase price based on
the number of client defections the acquisition would prevent.
Another technique is restating historical financials using the pricing power of the brand name
acquirer. The end-user customer's perception of risk is usually greater with the small company.
We can literally double the financial performance of small company on paper and present a
compelling argument to the large company buyer that those economics would be immediately
available to him post acquisition. It certainly not GAP Accounting, but it is as effective as a tool
to drive transaction value.
Another component is for any contracts that extend beyond one year. We take an estimate of the
gross margin produced in the firm contract years beyond year one and assign a five X multiple to
that and discount it to present value.

6. In addition, another method is trying to assign a value for miscellaneous assets that the seller is
providing to the buyer. Do not overlook the strategic value of Blue Chip Accounts. Those
accounts become a platform for the buyer's entire product suite being sold post acquisition into
an installed account. It is far easier to sell add-on applications and products into an existing
account than it is to open up that new account. These strategic accounts can have huge value to a
buyer.
Finally, you can use a customer acquisition cost model to drive value in the eyes of a potential
buyer by calculating the 100% sales person yearly quota salary, divide it by the typical number
of deals which could be closed per year, you will have the cost of new customer acquisition, then
multiply it by the number of clients you have, by this you will know your company valuation
based on your customer base and this could be one of the methods used in valuation and
negotiation (Kauppi, 2008).
MERGER AND ACQUISITION EFFECT OF VENTURE CAPITALS
Finally, we would like to confer with the effect of merger and acquisition on venture capitals in
the high-tech markets. The uncertain nature of technological innovation and a potential
misunderstanding of the complexities of high tech operations can lead to much speculation about
the true worth of high tech firms. This valuation uncertainty is expected to heighten the
information sensitivity of investors in high tech industries. Investors in industry-related firms are
highly sensitive to merger announcements involving high-tech targets and that the industry
responses are even stronger in takeovers with high information impact factors (KOHERS, 2004).
Growth is important because companies create shareholder value through profitable growth. Yet
there is powerful evidence that once a company’s core business has matured, the pursuit of new
platforms for growth entails daunting risk. Roughly, one company in ten is able to sustain the
kind of growth that translates into an above-average increase in shareholder returns over more
than a few years. Too often, the very attempt to grow causes the entire corporation to crash. Even
expanding firms face a variant of the growth imperative.
No matter how fast the growth treadmill is going, it is not fast enough. The reason: Investors
have an annoying tendency to discount into the present value of a company’s stock price
whatever rate of growth they foresee the company achieving. Thus, even if a company’s core

7. business is growing vigorously, the only way its managers can deliver a rate of return to
shareholders in the future that exceeds the risk-adjusted market average is to grow faster than
shareholders expect. Changes in stock prices are driven not by simply the direction of growth,
but largely by unexpected changes in the rate of change in a company’s earnings and cash flows.
A company must deliver the rate of growth that the market is projecting just to keep its stock
price from falling. It must exceed the consensus forecast rate of growth in order to boost its share
price. This is a heavy, omnipresent burden on every executive who is sensitive to enhancing
shareholder value. In most cases companies fall in a trap by following this behavior and strategy
without considering the other parameters related to merger and acquisition.
A relative case is AT&T. In the space of a little over ten years, AT&T had wasted about $50
billion and destroyed even more in shareholder value, all in the hope of creating shareholder
value through growth. The first AT&T attempt arose from a widely shared view that computer
systems and telephone networks were going to converge. In 1991, AT&T acquires NCR, at the
time the world’s fifth-largest computer maker, for $7.4 billion. AT&T lost another $2 billion
trying to make the acquisition work. AT&T finally abandoned this growth vision in 1996, selling
NCR for $3.4 billion. In 1994, the company bought McCaw Cellular, at the time the largest
national wireless carrier in the United States, for $11.6 billion, eventually spending $15 billion in
total on its own wireless business. When Wall Street analysts subsequently complained that they
were unable to properly value the combined higher-growth wireless business within the lower-
growth wireline company, AT&T decided to create a separately traded stock for the wireless
business in 2000. This valued the business at $10.6 billion, about two-thirds of the investment
AT&T had made in the venture. In 1998, it embarked upon a strategy to enter and reinvent the
local telephony business with broadband technology. Acquiring TCI and MediaOne for a
combined price of $112 billion made AT&T Broadband the largest cable operator in the United
States. Then, more quickly than anyone could have foreseen, the difficulties in implementation
and integration proved insurmountable. In 2000, AT&T agreed to sell its cable assets to Comcast
for $72 billion.
We could cite many cases of companies’ similar attempts to create new-growth platforms after
the core business had matured. They follow an all-too-similar pattern. When the core business
approaches maturity and investors demand new growth, executives develop seemingly sensible

8. strategies to generate it (Raynor, 2003). Merger and acquisition has many benefits but the most
important is wise evaluation for the decision and the clear strategy and motive behind such
attempt. Going through the process just and only for the sake of growth cause failure in many
cases, other parameters as increasing competency, fostering innovation capabilities, capitalizing
on market share and increasing efficiency and decreasing costs must be included among other to
increase the success probability of mergers and acquisitions.
THE HISTORY OF MERGER AND ACQUISITION ON NATIONAL LEVEL
On the national level, there are more than one case for a wave of merger and acquisitions mainly
in the USA and UK.
At the turn of the twenties century the United States have witnessed the largest manufacturing
mergers and acquisition in its economy, this mergers named as “The Great Merger Movement in
American Business”. Between 1895 and 1904 over 1800 firm disappeared into horizontal
combination, many of which acquired a substantial share of the markets in which they operated.
There are many opinions related to main motives and reasons behind such merger movement, but
we can summarize the widely agreed upon reasons as follows:
the development of capital-intensive mass-production manufacturing technique in the late 19th
century, the very rapid growth experienced by many capital-intensive industries after 1887 and
the deep depression which dominated the mid 1890s. One of the opinions argues that the
movement was not a result from the rise of large-scale manufacturing but it was an attempt by
entrepreneurs to escape severe price competition. This argument stress on the importance of
market control motive in favor of the drive of efficiency motive, it suggest that in the period of
rapid growth, new firms with extensive capital investments, high fixed charges, and no
established pattern of marketing, suffered from considerable price warfare and formed
consolidations. Once established, this consolidations, whatever their level of efficiency, were
able to control the competitive environment in the short run. Nevertheless, in the long run most
of these giant enterprises encounter higher costs and could not retain their dominance unless they
created barriers to entry through such means as controlling the supply of raw materials or
massive spending on advertisements (Ulen, 1987).

9. On the other hand, the emergence of large firm in Great Britain started in 1870 to 1914. In 1905,
following and largely the result of the first great merger movement in the United States, a
number of very large enterprises with capitalizations exceeding £2 million had come into being
in UK. Yet this increase does not appear to have been on a scale comparable with that
experienced in the United States. The biggest of these possessed assets far in excess of the
largest British concerns, appear to have achieved a far greater share of their respective markets,
and covered a far broader range of manufacturing and mining activity than did the biggest British
enterprises (Payne, December 1967).
One of the very important technological merger and acquisition is the British computer industry.
In 1968, with the blessing of the British, Industrial Reorganization Corporation, English electric
Computers Ldt., Plessey Computer division and International Computers and Tabulators joined
together to form the only existing British computer company of any size, International
Computers Ldt., known as ICL. There had been also considerable earlier merger activities in the
industry, involving Elliott Automation, Leo Computer Ltd., Ferranti, and General Electric in just
the post of 1960 period. The main justification for 1968 merger was on the ground of
technological progressiveness. It was felt that only as a merger industry could British computer
manufacturing compete with its US rivals on a technological level. In addition, the existence of
increasing returns to scale in computer manufacturing which coupled with IBM’s world market
share of approximately 70% makes the chance of any small company using price-cutting as a
successful competitive weapon very remote. One can argue that if the British computer industry
was to make inroads into the US position of supremacy the it must be based on the technology
superiority. To evaluate this case, studies shows that the number of British computer patients was
almost equal to IBM within the period after the acquisition, British computer industry market
share have increased but we do not have an accurate figure to measure it against US market
share, but finally we can confirm that the British computer industry has at least been able to hold
its own against the US companies (Stoneman, 1978).
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