Meaning of Mergers and Acquisitions
Merger and Acquisition (M&A) refers to the process where two companies are combined into single business unit. These are simply business transactions under which ownership of business enterprises, companies or their operating units are consolidated with other entities. Merger and acquisition combine two companies together via distinct types of financial transactions such as mergers, acquisitions, tender offers, consolidations, management acquisitions and purchase of assets. These kind of transactions results in consolidating assets and liabilities of two different companies under one business entity. The main aim behind undergoing such financial transactions is to try and attain synergy- such that whole entity (new company formed) is larger than sum of its components (the former two individual companies).
The term ‘Merger and acquisitions’ in general denotes joining of two companies and are often used interchangeably, but both of them carries different meaning. Merger take place when two separate business unit combine their forces to create new joint enterprise. Acquisition, on the other hand, occurs when one company acquires another company thereby folding it into its operations. The merger transactions typically take place in between the two business units that are of about same size and identifies advantages offered by other with respect to rising sales, capabilities and efficiencies. Also, the merger’s terms are oftenly of friendly nature and mutual agreed among two companies such that they become equal partners in new entity. However, in acquisitions generally the bigger firm take over the smaller firms. The purchase is sometimes friendly while other times it is hostile, depending upon whether the acquired company considers the functioning as operating unit of larger venture better or not. Therefore, the end result of both transaction is overall same but relationship among two entities differs based on whether merger or acquisition has occurred.
Characterizes of Mergers and Acquisitions
Creation of value serve as prime feature of M&A due to which two individual entities come together and form one new venture. The main characteristics during an M&A process are as mentioned below: –
- Communication- Communication is key during the process of merger and acquisitions as they are of very crucial nature. This not only applies to communication in between owner or executives of companies in question but also their employees or subordinates. In case, if employees are not provided with proper information, then they will start looking for other jobs as they may face lack of security here. The low retention of employees during such critical process can really be very harmful for company.
- Growth and Development- The growth and development of business enterprise is main motive behind undergoing merger and acquisition transactions. A business aiming for growth in its operations has generally 2 options available: either start up new project or acquire a company. The growth can not only be made limited to rise in production volume. It can be geographically, demographically and in terms of products too. Business organization can bring up newer products or services that is also termed as product/service expansion. In addition to this,
- Defined goals- Well-defined goals serve as pre-requisite part during the accomplishment of merger and acquisitions. Whenever a company acquires some another company, then pre-designed goals are of utmost importance as they help in well thought of acquisition vision post takeover. After successful completion of merger and acquisition, the sales level gets boosted, patents are acquired, new market is entered and territories also get expanded. The required processes can be initiated at right foot when business objectives are identified during early stages.
- Transparency- Presence of transparency is much required during the process of M&A. It is must to have open and honest communication among concerned parties, right from initial level discussion to the commencement of new firm. For avoiding any type of confusion in future, each and everything need to be made clear. Also, non-disclosure agreement is signed at most of the times for defining the limit of somebody withholding information. It is done among all parties having direct involvement in event for avoiding the unfavourable disclosure of confidential business information.
- Discounted cash flow- A discounted cash flow analysis is prime valuation tool used in M&A for determining the current value of company. The calculation is made on the basis of forecasted cash flows in future. After this, the estimated free cash flows are discounted in comparison to present value utilizing the company’s weighted average cost of capital (WACC). Although such value is quite difficult to compute but with the help of some tools, the overall calculation become very easy.
- Replacement cost- The process of acquisition is in various cases based on replacement cost of target company. Purchasing a right property, property acquirement and assembling of good management is time-taking process. This method is utilized for establishment of certain price but do not make sense in service industry under which ideas and people are prime assets. The costs can be brought down by eliminating the redundancies in staffing.
Types of Mergers and Acquisitions
The organizations will merge together and acquire one another for a variety of reasons. Below mentioned are 4 main ways of companies joining their forces:
- Horizontal Merger/Acquisition- It is one where two companies operating in same market and selling almost similar product join together in order to dominate the market share. The business consolidation take place for expanding market range and it is not necessary that related entities will do anything new after forming a new venture. It is more suitable for companies looking for building economies of scale and reducing the market competition. This type is common in industries having less firms where competition tends to be higher. The potential gain and synergies in share of market are much higher for merging companies in such industry.
For example, Hewlett Packard in 2002 took over Compaq computers for cost of $24.2 billion. The main motive behind it was the creation of dominant personal computer supplier via combining PC products of both companies.
- Vertical Merger/Acquisition- Vertical merger/acquisition involves consolidation of two firms belonging to same industry but operating at distinct stages of production. The merger happens between two companies that provides goods/services for one particular finished product. It is more suitable for streamlining operations, bringing down cost across the supply chain, enhancing efficiencies, but at the same time can reduce flexibility and bring in more complexities for the business enterprise.
For example, a retailer merging with wholesaler and wholesaler merging with manufacturer. This type of deal will enable both wholesaler and retailer to obtain better pricing on product and in turn manufacturer will also be guaranteed of steady business stream.
- Concentric Merger/Acquisition- Under this type of business transaction, both acquirer and target company deal in distinct product/services, both operate in same market and serve same range of customers. Both the companies may be indirect competitors to each other, selling products that are complementary to one another. The consolidating companies share the same channels of distribution, production or technology thereby allowing newer firms for enhancing the market share and expanding their product lines. But at the same time, its downside is that it can limit diversification for both companies as they operate within same industry.
For example, in 1989 Sony company that produce DVD players brought Columbia Pictures movie studio. Sony was now able to do films production that were played on their own DVD players. This was indeed a key part of strategy for introducing the Sony Blu-ray DVD players.
- Conglomerate Merger/Acquisition- Conglomerate merger/acquisition refers to consolidation or takeover of two companies dealing in totally unrelated business activities. This business consolidation take place for widening the range of product and services. It enables the joining companies in minimizing their cost via combining back-office activities and helps in reducing risk via performing in range of industries. Conglomerate merger is of two types: pure and mixed. The pure conglomerate merger involves 2 companies having nothing in common and mixed conglomerate merger involve companies looking for product and market extensions.
For example, an athletic shoe manufacturer merges with firm producing soft drinks. The resultant new company faces same level of competition in each of its two markets post-merger activity as it was facing individually prior to merger.
Process of Merger and Acquisition
Merger and acquisition process is most critical and challenging task when it comes to corporate restructuring. One wrong move can bring highly negative impacts and therefore this process needs to be performed in adequate manner.
The key steps in process of M&A are explained in points below: –
- Business Valuation- This is the first step in process of merger and acquisition. Business valuation involves evaluation and examination of both present as well as future market value of target company. Detailed research is conducted on company’s history with regarded to capital gain, market share, organizational structure, corporate culture, distribution channel and market credibility. Many other aspects are also conducted in order to find out whether proposed company is suitable or not for doing merger.
- Proposal Phase- Proposal phase is one where a proposal for merger or acquisition is sent by company with full details of deal, comprising of strategies, amount and commitments. At most of the times, the proposal is sent via non-binding offer document.
- Planning Exit- The stage of exit planning needs to be undergone whenever any company wants to sell off its operations. Company needs to make firm decisions with regard to when and how to exit in sorted and profitable manner. During the process, management need to examine every financial and other business issues such as deciding on full or partial sale along with evaluating the numerous reinvestment options.
- Structing the Business deal- Once merger and exit plans are finalized, the takeover company or new entity need to take efforts for marketing and develop innovative plans for improving business and its credibility. The entire focus is on the structuring of business deal during this phase of M&A activity.
- Integration stage- Both firms along with their parameters come together under this stage. Integration stage involves the process of document preparation, signing agreement and deal negotiation. It too defines the future relationship parameters among the two firms.
- Operating the venture- Once agreement is signed and venture is entered, it becomes equally important to operate the venture. It is relatable to meet the said and pre-defined expectations of all companies concerned with process. After the deal, merger and acquisition transaction includes all key activities and measures that work towards fulfilment of desires and requirement of firms involved.
Reasons for Mergers and Acquisitions Activity
The merger and acquisitions activity takes place due to following reasons: –
- Unlocking Synergies- The most common behind every merger & acquisition activity is creation of synergies under which combined company holds more worth than two companies operating on individual basis. It can also be due to reduction in cost and increased revenue level.
Cost synergies are developed because of economies of scale and revenue synergies, on the other hand, are created via cross selling, higher prices or increase in market share. Out of these two, the calculation and quantification of cost synergies is easier.
- Stronger Market Power- A higher market share and more power to influence prices is attained by resulting entity with the help of horizontal merger. The vertical merger also results in high market power, as the entity will have more control over its supply chain, thereby avoiding any external shocks in supply.
- Higher Growth- The merger and acquisition activity enable companies in attaining the inorganic growth faster than growing in an organic manner. A company can reach higher growth via acquiring or merging with entity having latest capabilities instead of taking the risk of developing them internally.
- Diversification- The entities operating in cyclical industries need to diversify their cash flows in order to avoid significant losses during their industry slowdown. A company is able to diversify and reduce its market risk through acquiring the target in non-cyclical industry.
- Tax Benefits- The tax benefits are looked into under which significant taxable income are realized by one company whereas tax loss carry forwards are incurred by another one. An acquirer is able to reduce its tax liability by buying a company having tax losses. On the other hand, mergers are not generally done for avoiding taxes.
Pros and cons of Mergers and Acquisitions
The pros and cons of M&A activity are well-summarized in points given below: –
Pros of Mergers and Acquisitions
- The activity of merger and acquisition is a proven tool for attaining growth. It allows newly formed entity in boosting their market share, enhancing geographical footprint, acquiring new talent, assets and technologies, and overtaking or buying out competitors.
- It is said that two heads are far better than one -merger and acquisition helps companies in realizing valuable synergies and generate more value by operating together instead of operating in individual manner.
- Companies are also able to cut down their costs associated with duplicate roles, license and systems by joining together.
Cons of Mergers and Acquisitions
- It can be a very time-consuming process to perform M&A activity. It is intensive process taking many months or even years to get finalized. Practice of due-diligence is time taking manual work that takes away key plays from their day jobs thereby causing a dip in productivity.
- Merger and acquisition deal carries high degree of risk due to which due diligence is much required. The acquiring company should have proper understanding of target company and due to this only seeking of external services for examining the risk of deal is considered a standard practice.
- It is a very challenging task to integrate two companies with distinct vision and cultures and may even results into problems at integration stage of deal, if in case a proper strategy is not considered while executing the deal.
Examples of Merger and Acquisition
- BMO Financial Group and Bank of the West at $105B
- Walt Disney and 21st Century Fox at $85B
- Microsoft and Activision Blizzard at $70B
- S&P Global and IHS Markit at $44B
- Pfizer and Warner-Lambert at $90B