When most consumers learn that a business has bought a particular brand or corporation, they focus on the cost of the deal and the change in management. This is where M&A in business comes in.
Most individuals need to be aware of the deal’s intricacy, the degree of details involved, and the acquisition strategy.
This post will delve deeper into what M&A is and why businesses use it as a growth strategy.
Table of contents
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Mergers and Acquisitions: An Overview
Even though the terms “mergers” and “acquisitions” are sometimes used interchangeably, they actually refer to two distinct concepts.
An acquisition is a takeover in which one company purchases another and claims ownership.
Contrarily, a merger is the joining of two firms of nearly equal size for them to push ahead as one new entity rather than continuing to be owned and managed independently. This process is called a merger of equals.
For instance, Daimler-Benz and Chrysler both vanished after the two companies merged. Rather, they formed a new corporation called DaimlerChrysler. Stocks of both firms were forfeited, and they issued fresh stock of the combined company in their place.
In February 2022, the business underwent another name change and ticker change to become the Mercedes-Benz Group AG (MBG) as part of a brand makeover.
The acquisition agreement is also referred to as a merger when both CEOs agree that working together is optimal for their respective companies.
Acquisitions are always considered unfriendly or hostile takeovers in which the target company wants to avoid being purchased. Deals can be classified as mergers or acquisitions depending on the nature of the acquisition, whether it is friendly or hostile, and how it is disclosed.
In other words, the distinction lies in how the target company’s board of directors, staff, and shareholders are notified about the sale.
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Why do Companies do M&A?
Have you ever wondered why Disney paid $71 billion to acquire 21st Century Fox?
M&A is an effective weapon that can completely change your company. The main goal is to expand your business with little effort quickly. The primary idea is that the buyer will increase income or reduce costs by purchasing the target company.
The three crucial strategic reasons firms make acquisitions are expansion, a defensive move, and capability acquisition.
The most frequent justifications for acquisitions are to increase market share, expand geographically, or diversify the company’s product offerings. An outstanding illustration of this was in 2014 when Apple decided to purchase Beats.
Apple had never sold headphones before this acquisition, but they were developing one then. Beats was making a lot of money and had a sizable fan base. They obtained product variety and Beat’s market share for upcoming headphones by purchasing Beats.
Defensive considerations are a further justification for buying a company. By purchasing the competition, you can strengthen the business’s market position and eliminate potential threats.
This was perfectly illustrated in 2014 when Facebook bought WhatsApp. Facebook faced a growing challenge from WhatsApp that had the potential to unseat them in some markets.
While WhatsApp could walk away with a sizeable fat check, Facebook purchased WhatsApp to eliminate the competition.
Finally, capability acquisitions refer to when a firm buys a technology or skill that it does not already have and cannot develop but that it can use more effectively than the target company.
Starting from scratch will cost time and money, and you’ll miss out on market chances. At this time, it would be more profitable to buy the capability.
Types of Mergers and Acquisitions
Here are a few frequent business transactions that fall under the M&A category.
Tender Offers
Rather than paying the market price, one company offers to purchase the other company’s outstanding stock in a tender offer for a fixed sum.
The purchasing corporation directly addresses the target company’s shareholders, skipping management and the board of directors in the process.
As an illustration, in 2008, Johnson & Johnson made a $438 million tender offer to acquire Omrix Biopharmaceuticals. The company accepted the tender offer before the end of December 2008 and finalized the deal.
Mergers
The boards of directors of the merging firms accept the union and request shareholder approval. For instance, the Digital Equipment Corporation and Compaq agreed to a merger in 1998, resulting in Compaq acquiring the Digital Equipment Corporation.
Later, in 2002, Compaq and Hewlett-Packard merged. Prior to the union, Compaq’s ticker symbol was CPQ. They made the present ticker symbol (HPQ) with Compaq and Hewlett-ticker Packard’s symbol (HWP).
Acquisitions
A typical acquisition involves the acquiring business acquiring the majority of the acquired business, which keeps its name and organizational structure unaltered.
The 2004 acquisition of John Hancock Financial Services by Manulife Financial Corporation, in which both companies held their identities and administrative frameworks, illustrates this deal.
Consolidations
In the wake of consolidation, a new business is born by combining core businesses and getting rid of outdated organizational structures. The shareholders of the two companies that authorized the merger are given shares of joint ownership in the new business.
For instance, Citigroup was founded as a result of the 1998 announcement of the merger of Citicorp and Travelers Insurance Group.
Acquisition of Assets
One company directly buys the assets of another firm in an asset acquisition. The company’s shareholders whose assets are being purchased must give the agreement.
During bankruptcy proceedings, it is common for other companies to bid on various assets that belong to the bankrupt company. After the assets are ultimately transferred to the acquiring companies, the bankrupt company is liquidated.
Management Acquisitions
In a management purchase, commonly referred to as a management-led buyout (MBO), managers acquire a majority stake in another company and make it private. These former executives frequently work with a financier or former company officers to help fund a deal.
Such M&A transactions, which are usually financed disproportionately with debt, require the approval of a majority of shareholders. For instance, the founder of Dell Corporation, Michael Dell, declared in 2013 that he had acquired the company.
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How Mergers Are Structured
We can put up mergers in a variety of ways depending on the relationship between the two companies participating in the transaction:
- Horizontal merger: Two companies in direct competition share the same product lines and markets.
- Vertical merger: This involves a client, an organization, a supplier, and a business. Think about the merger of an ice cream manufacturer with a cone supplier.
- Congeneric mergers: This has to do with two companies that provide separate services to the same customer base, like a cable provider and a TV manufacturer.
- Market-extension merger: This has to do with two businesses that offer the same goods in different markets.
- Product-extension merger: This involves two firms competing in the same market with various but similar items.
- Conglomeration: This involves two businesses that do not share any industry sectors.
The following two financing strategies, each with different implications for investors, can also be used to differentiate between mergers.
Purchase Mergers
As the name suggests, this merger happens when one firm purchases another business. The purchase is made using cash, though they could also issue a debt instrument. The sale’s taxable character attracts acquiring companies since they can benefit from the tax incentives.
With the ability to write down purchased assets to their actual purchase price, the gap between their book value and the sales price can narrow over time, reducing the amount of taxes the acquiring corporation must pay.
Consolidation Mergers
This merger results in the creation of an entirely new firm that acquires and unites the two businesses. Similar to a purchase merger, the tax conditions apply.
How Are Acquisitions Financed?
A company can use cash, equity, the assumption of debt, or any combination of the three to purchase another company. One corporation frequently buys the whole asset portfolio of another company in smaller transactions.
Company A pays cash for all of Company B’s assets, leaving Company B with nothing except money (and debt, if any). Of course, Company B degenerates into a mere shell and eventually liquidates or moves into other fields.
A new purchasing deal called a “reverse merger” enables a private company to go public quickly. In a reverse merger, a private company with excellent prospects for the future scrambling to secure financing purchases a publicly traded shell organization with few assets and no actual commercial operations.
A reverse merger between public and private companies results in forming a new public corporation with tradeable shares.
How Mergers and Acquisitions Are Valued
The businesses on either side of an M&A deal will value themselves differently from the target firm. Naturally, the seller will try to sell the business for the highest possible price, while the buyer will attempt to purchase it for the lowest price.
They may evaluate a business objectively by examining competitors in the same industry and relying on the following indicators.
Price-to-Earnings Ratio (P/E Ratio)
An acquiring organization makes an offer that is a multiple of the target company’s earnings using a price-to-earnings ratio (P/E ratio).
The acquiring business will get good advice on what the target’s P/E multiple should be by looking at the P/E for all the companies in the same industry group.
Enterprise-Value-to-Sales Ratio (EV/Sales)
To present a bid more remarkable than the revenue while being aware of the price-to-sales (P/S ratio) of competing enterprises in the industry, the acquiring organization utilizes an enterprise-value-to-sales ratio (EV/sales).
Discounted Cash Flow (DCF)
A discounted cash flow analysis (DFC), a crucial valuation technique in mergers and acquisitions, determines the present worth of a company.
Forecasted free cash flows are discounted to a present value using the firm’s weighted average cost of capital, which is determined by adding net income to depreciation/amortization (capital expenditures) change in working capital (WACC). Only some tools can match DCF as a valuation technique, even though it can be tricky to utilize appropriately.
Replacement Cost
The cost of replacing the target company can occasionally influence an acquisition. To make a point, let’s say that a company is worth exactly what it pays for employees and equipment.
The purchasing company has the right to demand that the target sells at that price, or else it will launch a competing operation at the same price.
Naturally, it takes time to assemble a capable management team, acquire property, and invest in the right gear. This type of pricing wouldn’t make much sense in a service industry where the essential assets (people and ideas) are challenging to assess and develop.
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When to do M&A?
When do businesses approach M&A? There are two categories of acquirers: proactive buyers and reactive buyers, to keep things straightforward.
It is usual for large public corporations to look for expansion prospects constantly. These proactive purchasers continually search for chances to acquire businesses to achieve inorganic growth. These businesses frequently have a lot of cash and heavily rely on M&A as part of their overall strategy.
The core element of an acquisition is that it may take months or years for a technology or a concept to mature and realize all the possibilities of that specific opportunity.
You run the danger of missing out on present market opportunities and failing to establish that business. It is better to buy an existing organization rather than construct it yourself if it already delivers the same capacity or product that you are aiming for.
Additionally, chances can appear out of nowhere. These are reactive purchasers who merely happen across a business acquisition opportunity.
For many reasons, sellers may suddenly decide to sell their business, which could be a desirable purchase for the buyer’s business.
A private company’s owner is often prepared to retire and leave the business when it decides to sell. They might also be seasoned businesspeople going on to their next project. In any event, this will cause the buyer to respond and consider buying the company.
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FAQs
M&A refers to corporate finances, management, and strategy that deals with buying or combining with other businesses. When two firms merge, they usually adopt a new name and create a new company.
M&As are the processes of combining businesses or assets to promote growth, gain competitive advantages, boost market share, or impact supply chains.
The merger of Exxon and Mobile (a great example of a successful horizontal merger), Disney’s acquisition of Pixar and Marvel, and Google’s acquisition of Android are a few of the most well-known and successful Mergers and Acquisitions that have taken place in recent years.
Since you spend so much time updating market slides and working on memos in ECM and DCM rather than performing in-depth financial modeling, M&A and industry groups are seen as “more technical” than capital markets.
Conclusion
The term “mergers and acquisitions” (M&A) refers to the merging of businesses or their key financial assets through business-to-business financial transactions.
A business can completely buy out and absorb another business, combine with it to form a new business, take over some or all of its key assets, make a tender offer for its stock, or launch a hostile takeover. They are all M&A activities.
The divisions of financial institutions that participate in such activity are also referred to by the name M&A.
References
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