Impact of cross-country mergers & acquisitions on operating profit margin

By Ashni walia & Priya Chetty on January 8, 2020

The previous article explained the methodology followed in order to achieve the objectives of this research. The first objective is to compare the pre and post-merger performance of selected cross-country Merger and Acquisition (M&A) deals. The second objective is to examine the impact of the announcement of mergers and acquisitions on the excess returns on the shares. To achieve these objectives, quantitative analysis was carried in a series of articles.

In the previous article four main dependent variables were identified:

  1. operating profit margin,
  2. operating cost margin,
  3. EBITDA (Earnings Before Interest, Taxes, Deductions and Ammortsation) margin, and
  4. current ratio.

This article is based on the first, i.e. operating profit margin. Therefore, the aim of this article is to check the impact of cross-country M&A on the operating profit margin of the businesses.

As explained in the previous article, 100 cross country mergers and acquisitions which occurred in Asian and European countries within the time period of 2000-2017 were selected. In order to test the effect of the mergers and acquisitions on the operating profit, the independent variables that were employed in the study include:

  • size of the business,
  • geographic expansion,
  • R&D innovation and
  • leverage ratio.

Testing the impact of M&A on operating profit

In order to examine the impact of mergers and acquisitions on the operating profit of the businesses, the following hypothesis has been framed.

H0: There is no effect of cross -country mergers and acquisitions on operating profit in the period 2000- 2017.

The dependent variable is operating profit and the set of independent variables include the size of the business, geographical expansion, R&D innovation and the leverage ratio. The data set is divided into two periods. The time period t-1 represents the pre-merger period and the time period t+1 represents the post-merger period. In the post-merger period, the deal size and the industry relatedness are also considered as independent variables. These variables could also impact the profitability of the business after the formation of M&A.

Pre-merger performance

The following table represents the regression results of the acquired business before the M&A, which is represented by t-1. The independent variables included in the pre-merger period are as follows:

  • size of the firm,
  • geographical expansion,
  • R&D innovation and leverage ratio.
Pre-merger performance(t-1) results for checking the impact of the deal on operating profit margin
Figure 1: Pre-merger performance(t-1) results for checking the impact of the deal on operating profit margin

Impact of leverage ratio and size of the firm on operating profit margin

The results clearly indicate that the leverage ratio and the size of the firm of the acquired firm has a significant impact on the operating profit margin of the firm. The coefficient of leverage ratio indicates that with one unit of increase in the leverage ratio, the operating profit increased by about 0.88 units. This means that as the debt of the firm increases, its operating profit also rises. This means that the leverage is positively related to the growth of the firm. This is supported by the study of (Anton, 2017). The study highlighted that firms often increase their debt to finance the assets of the firm. As the firm’s assets increases, the amount of sales of the company also rises which in turn leads to a rise in revenue. The rise in revenue contributes to the long term growth of the firm.

Impact of the size of the firm on operating profit margin

Furthermore, the coefficient for the size of the firm indicates that as the size of the firm increases by 1 unit, the operating profit increased by about 9.5 units. This means that as the firm size expands, it witnesses a rise in profit. This is consistent with the findings of Jo, Durairaj, Driscoll, Enomoto, & Ku (2011). The study highlighted that the firm expands its size in terms of the number of employees and the number of assets. The firm increases its production capacity that leads to a rise in the level of production.

Value of R square and adjusted R Square

Lastly, the R square and the adjusted R squared values are 0.80 and 0.71 respectively. This indicates that the independent variables explain about 71% variation in the dependent variable. This means that the model is good enough to explain variation in the dependent variable. 

Post-merger performance

The following table represents the regression results of the acquired firm after the mergers and acquisitions which is represented by the t-1. The independent variables included in the pre-merger period are as follows:

  • the size of the firm,
  • geographical expansion,
  • R&D innovation and,
  • leverage ratio.
Post-merger performance(t+1) results for checking the impact of the deal on operating profit margin
Figure 2: Post-merger performance(t+1) results for checking the impact of the deal on operating profit margin

Impact of deal size on operating profit margin

The regression results for the post-merger performance are shown in the above table. The results clearly indicate that among all the independent variables, deal size and geographic expansion have a significant impact on the operating profit of the firm. The coefficient for the deal size indicates that with one unit of increase in deal size, the operating profit increased by about .67 units. This means that greater is the amount of deal size of the firm, higher is the level of operating profit for the firm.

Deal size leads to major fluctuations in the prices of stock which affects the shareholder’s wealth. The greater amount of deal size could be an indication of the profitable opportunity for investors. These investors display rational behaviour by increasing their investment after the formation of the merger. This rise in the level of investment, in turn, generates huge profits for the firm (Visser & Nazliben, 2017). Here, the shareholder’s wealth is taken ad the proxy for the firm’s operational performance because it is the shareholder’s wealth maximization that translates into maximizing the value of the company as measured by the price of the company’s stock (Osoro & Ogeto, 2014).

Impact of geographical size on operating profit margin

Another variable that has a significant impact on the operating profit of the firm is the geographical expansion. The coefficient value reflects that with one unit increase in the geographical expansion, the operating profit increased by 4.48 units. This means that as the firms expand geographically after the formation of the merger and acquisition, the operating profit of the firm increases. After the formation of the merger, the amount of capital investment in the firm increases. With an increase in the amount of investment, the firm’s capability to expand also increases. As the firm expands its business in different geographic locations, the amount of revenue earned by the firm also rises. This, in turn, increases the prospects for long term growth of the firm (Piedo, 2014). On the other hand, the variables like the size of the firm, industry relatedness, R$D innovation and leverage ratio did not have any impact on the firm operating profit as they have the significant value which was greater than 0.05.

Value of R square and adjusted R square

Lastly, the R square and the adjusted R squared values are 0.71 and 0.70 respectively. This indicates that the independent variables explain about 70% variation in the dependent variable. This means that the model is good enough to explain variation in the dependent variable. 

Thus, the hypothesis H0: There is no effect of cross -country mergers and acquisitions on operating profit margin in the period 2000- 2017 is rejected.

The previous article clearly highlighted that the merger and acquisition activities lead to gain or losses for the shareholders. This gain or loss arising in the form of fluctuations in the stock prices after the announcement of merger and acquisition. These fluctuations post the acquisition can have a long term impact on the operating performance of the firm. Operating performance describes the extent to which efficiency can be generated in the utilization of fixed assets. Enhanced efficiency can contribute to synergies in the form of reduced cost and an increase in revenue. This, in turn, improves the profitability and the performance of the firm.

Operating profit margin is a good indicator of the profitability and efficiency of the firm. A high level of operating profit margin sets a long-term growth pathway for the mergers and acquisitions. When the firm is operating as a single entity, the about of debt raised acts as an indicator for the growth of the company.  A rise in the amount of debt among the cross-country mergers leads to rising operating profit.

This rise is attributed to the increase in the debt-financed investment that raises the capital of the firm. Additionally, the firm’s size is a clear indicator of its production capacity. However, in the post-merger period, geographical expansion and deal size contribute to the rise in the profits of the firm. The amount of deal size acts as a major determinant for the fluctuations in the stock prices. On the other hand, geographical expansion allows firms to improve their production capacity. 

The findings of this article indicate that cross-country mergers and acquisitions do affect the operating profit margins of acquiring firms. The next article will focus on the effect of M&As on the current ratio. The current ratio is one of the measures of the firm performance that shows the firms ability to pay its short-term debts.

References

  • Anton, S. G. (2017). The Impact of Leverage on Firm Growth. Empirical Evidence from Romanian Listed Firms. Review of Economic and Business Studies, 9(2), 147–158. https://doi.org/10.1515/rebs-2016-0039
  • Jo, H., Durairaj, V., Driscoll, T., Enomoto, A., & Ku, J. (2011). Bank mergers: Bank of America-Merrill Lynch vs. Wells Fargo-Wachovia acquisitions. Journal of Case Research in Business and Economics, 3, 1–9.
  • Osoro, C., & Ogeto, W. (2014). Macro-Economic Fluctuations Effects on the Financial Performance of Listed Manufacturing Firms in Kenya. International Journal of Social Sciences, 21(1), 26–40.
  • Piedo, J. (2014). Mergers and Acquisitions in International Business. Mergers and Acquisitions, 43–56.
  • Visser, B., & Nazliben, K. (2017). Post-merger operational performance of M&As and the influence of underlying merger purposes.

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