The Saudi government continues, with conviction, in its persistent efforts to encourage the industrial growth in the Kingdom. In the process, several comprehensive studies and projections have been made by government agencies designated to analyze all pertinent data available to guide future growth in the industrial sector. The experience and status of small-to-medium private companies that have enjoyed the substantial growth opportunities of the eighties becomes somewhat a subject worth exploring in light of increased competition from new companies preparing to enter and expand in this century.
The past two decades have witnessed remarkable restructuring in the economic, business and financial sectors. The implementation of the Saudization plans adopted by the government was indeed a major feat to achieve during that period and many companies have reaped great benefits from the boom years during which the Saudi government participated rather actively.
It was that participation that had helped to create industrial strategies supported by low-cost capital loans, industrial estates, infrastructure, and other incentives. That was the platform for the industrial sector to take off in a manner of unprecedented proportions. While the industrial growth has been so rapid and impressive, it has reached a point today where some companies are, understandably, experiencing difficulties. It could be because too many of them started in the oil boom years of the eighties — thus reaping full advantage of elastic demand and supply — and operated their factories and production facilities at maximum output.
Many companies in Saudi Arabia are becoming aware that if they want to compete nationally, regionally and internationally, they must slim down, improve their style of management and focus on a narrower range of businesses.
How would the Kingdom respond to this phenomenon and what recommendations would it make to revitalize the industrial sector and put it back on the right track? In some circles, mergers are considered as an option and a possible panacea.
Generally speaking, companies grow in two ways: First, internally by acquiring specific assets and financing them by foregoing dividends and/or external financing and second, externally by merging with or acquiring of other companies. The objective of either type of acquisitions (assets or companies) is primarily to maximize the capital value and profit dynamics of the company.
The reasons for a merger are many and complex and more than one usually is involved. But, in general terms, they include: Operating economies, management acquisitions, diversifications and growth. Operating economies can eliminate duplicate facilities while marketing, purchasing, and other operations can be consolidated. With an industrial company merger, a company with a product that complements an existing product line can fill out that line and hopefully increase the total overall demand for the products of the acquiring company. Under operating economies, three types of mergers exit: Horizontal, Vertical and Conglomerate. The type of merger that is most commonly used and recommended for Saudi companies is Horizontal in which two companies in the same line of business are combined and management acquisition is closely related to these operating economies.
If a Saudi company that is unable to employ top-quality management and that it has no one coming up through the ranks, it may seek to link-up with another company that has aggressive and competent management, thus improving its prospects for stability and growth.
Diversification is the motive in some mergers. By acquiring a company in a different line of business, a company may be able to reduce cyclical instability in earnings. One must however recognize that diversification through mergers will enhance the owners’, or shareholders’, wealth only if it was thoroughly studied and effectively implemented.
The growth factor for a merger is when a Saudi company finds itself unable to grow at a fast or balanced enough rate through internal expansion, and management decides that its only way of achieving a desired growth is by merging with another company. The cost of growth by mergers may well be cheaper than the real cost of internal growth, i.e. the numerous costs, and risks, involved in developing and embarking upon a new product may be avoided through acquisition of a going concern.
From an accounting standpoint, a merger of two companies is treated as a pooling of interests and is usually quite popular and widely used in a Horizontal merger. In a pooling of interests, the balance sheet of the two companies are combined, with assets and liabilities simply added together.
Large accounting firms are experts in this field and must be involved from the outset in any merger negotiations, along with adequate legal representation by specialized lawyers. In the final analysis, companies should indeed take full advantage of the existing free-market economic framework in Saudi Arabia and seriously consider the consolidation of their businesses through whatever best available means, including mergers with other companies in similar lines of business.
The government should also play a major role in guiding and encouraging local companies to achieve their objectives and to acquire the benefits from mergers. In general, companies can benefit from mergers by improving capacity utilization, making better use of existing sales force, reducing managerial staff, gaining access to new suppliers, distributors and banking facilities, and by utilizing new technologies. To succeed, companies must control and protect the resources of the local industry, implement effective management methods, and adapt down-to-earth realistic policies aimed at improving the return on investment.
Finally, merging weak companies into stronger and healthier ones is an option worth considering to respond effectively to the future industrial and economic growth potential in the Kingdom.
(Habib F. Faris is vice president at Clariden Bank, London.)
(The information contained here in is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information.)
