The phrase mergers and acquisitions
) refers to the aspect of corporate strategy, corporate finance and management
dealing with the buying, selling and combining of different companies
that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.
is a tool used by companies for the purpose of expanding their operations
often aiming at an increase of their long term profitability. There are 15 different types of actions that a company can take when deciding to move forward using M&A. Usually mergers occur in a consensual (occurring by mutual consent) setting where executives from the target company help those from the purchaser in a due diligence
process to ensure that the deal is beneficial to both parties. Acquisitions can also happen through a hostile takeover
by purchasing the majority of outstanding shares of a company in the open market
against the wishes of the target's board. In the United States, business laws vary from state
to state whereby some companies have limited protection against hostile takeovers. One form of protection against a hostile takeover is the shareholder rights plan, otherwise known as the "poison pill
Historically, mergers have often failed (Straub, 2007) to add significantly to the value of the acquiring firm's shares (King, et al., 2004). Corporate mergers may be aimed at reducing market competition, cutting costs (for example, laying off employees, operating at a more technologically efficient scale, etc.), reducing taxes, removing management, "empire building" by the acquiring managers, or other purposes which may or may not be consistent with public policy or public welfare. Thus they can be heavily regulated, for example, in the U.S. requiring approval by both the Federal Trade Commission and the Department of Justice.
The U.S. began their regulation on mergers in 1890 with the implementation of the Sherman Act. It was meant to prevent any attempt to monopolize or to conspire to restrict trade. However, based on the loose interpretation of the standard "Rule of Reason", it was up to the judges in the U.S. Supreme Court whether to rule leniently (as with U.S. Steel in 1920) or strictly (as with Alcoa in 1945).
An acquisition, also known as a takeover, is the buying of one company (the ‘target’) by another. An acquisition may be friendly or hostile
. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board
has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover
Types of acquisition
- The buyer buys the shares, and therefore control, of the target company being purchased. Ownership control of the company in turn conveys effective control over the assets of the company, but since the company is acquired intact as a going business, this form of transaction carries with it all of the liabilities accrued by that business over its past and all of the risks that company faces in its commercial environment.
- The buyer buys the assets of the target company. The cash the target receives from the sell-off is paid back to its shareholders by dividend or through liquidation. This type of transaction leaves the target company as an empty shell, if the buyer buys out the entire assets. A buyer often structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and leave out the assets and liabilities that it does not. This can be particularly important where foreseeable liabilities may include future, unquantified damage awards such as those that could arise from litigation over defective products, employee benefits or terminations, or environmental damage. A disadvantage of this structure is the tax that many jurisdictions, particularly outside the United States, impose on transfers of the individual assets, whereas stock transactions can frequently be structured as like-kind exchanges or other arrangements that are tax-free or tax-neutral, both to the buyer and to the seller's shareholders.
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.
is a combination of two companies
into one larger company. Such actions are commonly voluntary and involve stock swap
or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover
but result in a new company name (often combining the names of the original companies) and in new branding
; in some cases, terming the combination a "merger" rather than an acquisition is done purely for political or marketing reasons.
Classifications of mergers
- Horizontal mergers take place where the two merging companies produce similar product in the same industry.
- Vertical mergers occur when two firms, each working at different stages in the production of the same good, combine.
- Congeneric mergers occur where two merging firms are in the same general industry, but they have no mutual buyer/customer or supplier relationship, such as a merger between a bank and a leasing company. Example: Prudential's acquisition of Bache & Company.
- Conglomerate mergers take place when the two firms operate in different industries.
A unique type of merger called a reverse merger is used as a way of going public without the expense and time required by an IPO.
The contract vehicle for achieving a merger is a "merger sub".
The occurrence of a merger often raises concerns in antitrust circles. Devices such as the Herfindahl index can analyze the impact of a merger on a market and what, if any, action could prevent it. Regulatory bodies such as the European Commission, the United States Department of Justice and the U.S. Federal Trade Commission may investigate anti-trust cases for monopolies dangers, and have the power to block mergers.
Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E.
Dilutive mergers are the opposite of above, whereby a company's EPS decreases. The company will be one with a low P/E acquiring one with a high P/E.
The completion of a merger does not ensure the success of the resulting organization; indeed, many mergers (in some industries, the majority) result in a net loss of value due to problems. Correcting problems caused by incompatibility—whether of technology, equipment, or corporate culture— diverts resources away from new investment, and these problems may be exacerbated by inadequate research or by concealment of losses or liabilities by one of the partners. Overlapping subsidiaries or redundant staff may be allowed to continue, creating inefficiency, and conversely the new management may cut too many operations or personnel, losing expertise and disrupting employee culture. These problems are similar to those encountered in takeovers. For the merger not to be considered a failure, it must increase shareholder value faster than if the companies were separate, or prevent the deterioration of shareholder value more than if the companies were separate.
Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things.
When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.
In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals". Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.
In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal euphemistically as a merger, deal makers and top managers try to make the takeover more palatable.
A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition.
Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders. It is quite normal though for M&A deal communications to take place in a so called 'confidentiality bubble' whereby information flows are restricted due to confidentiality agreements (Harwood, 2006).
The five most common ways to valuate a business are
Professionals who valuate businesses generally do not use just one of these methods but a combination of some of them, as well as possibly others that are not mentioned above, in order to obtain a more accurate value. These values are determined for the most part by looking at a company's balance sheet and/or income statement and withdrawing the appropriate information. The information in the balance sheet or income statement is obtained by one of three accounting measures: a Notice to Reader, a Review Engagement or an Audit.
Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. Most often this information is expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's sake. There are other, more detailed ways of expressing the value of a business. These reports generally get more detailed and expensive as the size of a company increases, however, this is not always the case as there are many complicated industries which require more attention to detail, regardless of size.
Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:
Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders alone.
A cash deal would make more sense during a downward trend in the interest rates. Another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. But a caveat in using cash is that it places constraints on the cash flow of the company.
Financing capital may be borrowed from a bank, or raised by an issue of bonds. Alternatively, the acquirer's stock may be offered as consideration. Acquisitions financed through debt are known as leveraged buyouts
if they take the target private, and the debt will often be moved down onto the balance sheet
of the acquired company.
An acquisition can involve a combination of cash and debt, or a combination of cash and stock of the purchasing entity.
can provide the necessary extra to make a merger or sale work. Hybrid can work as ad e-denit
Specialist M&A advisory firms
Although at present the majority of M&A advice is provided by full-service investment banks, recent years have seen a rise in the prominence of specialist M&A advisers, who only provide M&A advice (and not financing). To perform these services in the US, an advisor must be a licensed broker dealer, and subject to SEC (FINRA) regulation. More information on M&A advisory firms is provided at corporate advisory.
Motives behind M&A
The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to add shareholder value:
- Synergy: This refers to the fact that the combined company can often reduce duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit.
- Increased revenue/Increased Market Share: This motive assumes that the company will be absorbing a major competitor and thus increase its power (by capturing increased market share) to set prices.
- Cross selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a manufacturer can acquire and sell complementary products.
- Economies of Scale: For example, managerial economies such as the increased opportunity of managerial specialization. Another example are purchasing economies due to increased order size and associated bulk-buying discounts.
- Taxes: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an acquiring company.
- Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders (see below).
- Resource transfer: resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.
- Vertical integration: Vertical Integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example is of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power, each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. By merging the vertically integrated firm can collect one deadweight loss by setting the upstream firm's output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.
However, on average and across the most commonly studied variables, acquiring
firms’ financial performance does not positively change as a function of their acquisition activity. Therefore, additional motives for merger and acquisiiton that may not add shareholder value include:
- Diversification: While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger.
- Manager's hubris: manager's overconfidence about expected synergies from M&A which results in overpayment for the target company.
- Empire building: Managers have larger companies to manage and hence more power.
- Manager's compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders); although some empirical studies show that compensation is linked to profitability rather than mere profits of the company.
Effects on management
A study published in the July/August 2008 issue of the Journal of Business Strategy suggests that mergers and acquisitions destroy leadership continuity in target companies’ top management teams for at least a decade following a deal. The study found that target companies lose 21 percent of their executives each year for at least 10 years following an acquisition – more than double the turnover experienced in non-merged firms.
M&A marketplace difficulties
currently exists in many states for the mergers and acquisitions of privately owned small to mid-sized companies. Market participants often wish to maintain a level of secrecy about their efforts to buy or sell such companies. Their concern for secrecy usually arises from the possible negative reactions a company's employees, bankers, suppliers, customers and others might have if the effort or interest to seek a transaction were to become known. This need for secrecy has thus far thwarted the emergence of a public forum or marketplace to serve as a clearinghouse for this large volume of business. In some states, a Multiple Listing Service (MLS) of small businesses for sale is maintained by organizations such as Business Brokers of Florida (BBF). Another MLS is maintained by International Business Brokers Association (IBBA).
At present, the process by which a company is bought or sold can prove difficult, slow and expensive. A transaction typically requires six to nine months and involves many steps. Locating parties with whom to conduct a transaction forms one step in the overall process and perhaps the most difficult one. Qualified and interested buyers of multimillion dollar corporations are hard to find. Even more difficulties attend bringing a number of potential buyers forward simultaneously during negotiations. Potential acquirers in an industry simply cannot effectively "monitor" the economy at large for acquisition opportunities even though some may fit well within their company's operations or plans.
An industry of professional "middlemen" (known variously as intermediaries, business brokers, and investment bankers) exists to facilitate M&A transactions. These professionals do not provide their services cheaply and generally resort to previously-established personal contacts, direct-calling campaigns, and placing advertisements in various media. In servicing their clients they attempt to create a one-time market for a one-time transaction. Stock purchase or merger transactions involve securities and require that these "middlemen" be licensed broker dealers under FINRA (SEC) in order to be compensated as a % of the deal. Generally speaking, an unlicensed middleman may be compensated on an asset purchase without being licensed. Many, but not all, transactions use intermediaries on one or both sides. Despite best intentions, intermediaries can operate inefficiently because of the slow and limiting nature of having to rely heavily on telephone communications. Many phone calls fail to contact with the intended party. Busy executives tend to be impatient when dealing with sales calls concerning opportunities in which they have no interest. These marketing problems typify any private negotiated markets. Due to these problems and other problems like these, brokers who deal with small to mid-sized companies often deal with much more strenuous conditions than other business brokers. Mid-sized business brokers have an average life-span of only 12-18 months and usually never grow beyond 1 or 2 employees. Exceptions to this are few and far between. Some of these exceptions include The Sundial Group, Geneva Business Services and Robbinex.
The market inefficiencies can prove detrimental for this important sector of the economy. Beyond the intermediaries' high fees, the current process for mergers and acquisitions has the effect of causing private companies to initially sell their shares at a significant discount relative to what the same company might sell for were it already publicly traded. An important and large sector of the entire economy is held back by the difficulty in conducting corporate M&A (and also in raising equity or debt capital). Furthermore, it is likely that since privately held companies are so difficult to sell they are not sold as often as they might or should be.
Previous attempts to streamline the M&A process through computers have failed to succeed on a large scale because they have provided mere "bulletin boards" - static information that advertises one firm's opportunities. Users must still seek other sources for opportunities just as if the bulletin board were not electronic. A multiple listings service concept was previously not used due to the need for confidentiality but there are currently several in operation. The most significant of these are run by the California Association of Business Brokers (CABB) and the International Business Brokers Association (IBBA) These organizations have effectivily created a type of virtual market without compromising the confidentiality of parties involved and without the unauthorized release of information.
One part of the M&A process which can be improved significantly using networked computers is the improved access to "data rooms" during the due diligence process however only for larger transactions. For the purposes of small-medium sized business, these datarooms serve no purpose and are generally not used.
Reasons for frequent failure of M&A was analyzed by Thomas Straub in "Reasons for frequent failure in mergers and acquisitions - a comprehensive analysis", DUV Gabler Edition, 2007.
The Great Merger Movement
The Great Merger Movement was a predominantly U.S. business phenomenon that happened from 1895 to 1905. During this time, small firms with little market share consolidated with similar firms to form large, powerful institutions that dominated their markets. It is estimated that more than 1,800 of these firms disappeared into consolidations, many of which acquired substantial shares of the markets in which they operated. The vehicle used were so-called trusts
. To truly understand how large this movement was—in 1900 the value of firms acquired in mergers was 20% of GDP
. In 1990 the value was only 3% and from 1998–2000 is was around 10–11% of GDP. Organizations that commanded the greatest share of the market in 1905 saw that command disintegrate by 1929 as smaller competitors joined forces with each other. However, there were companies that merged during this time such as DuPont, Nabisco, US Steel, and General Electric that have been able to keep their dominance in their respected sectors today due to growing technological advances of their products, patents, and brand recognition by their customers. These companies that merged were consistently mass producers of homogeneous goods that could exploit the efficiencies of large volume production. Companies which had specific fine products, like fine writing paper, earned their profits on high margin rather than volume and took no part in Great Merger Movement.
One of the major short run factors that sparked in The Great Merger Movement was the desire to keep prices high. That is, with many firms in a market, supply of the product remains high. During the panic of 1893, the demand declined. When demand for the good falls, as illustrated by the classic supply and demand model, prices are driven down. To avoid this decline in prices, firms found it profitable to collude and manipulate supply to counter any changes in demand for the good. This type of cooperation led to widespread horizontal integration amongst firms of the era. Focusing on mass production allowed firms to reduce unit costs to a much lower rate. These firms usually were capital-intensive and had high fixed costs. Because new machines were mostly financed through bonds, interest payments on bonds were high followed by the panic of 1893, yet no firm was willing to accept quantity reduction during this period.
In the long run, due to the desire to keep costs low, it was advantageous for firms to merge and reduce their transportation costs thus producing and transporting from one location rather than various sites of different companies as in the past. This resulted in shipment directly to market from this one location. In addition, technological changes prior to the merger movement within companies increased the efficient size of plants with capital intensive assembly lines allowing for economies of scale. Thus improved technology and transportation were forerunners to the Great Merger Movement. In part due to competitors as mentioned above, and in part due to the government, however, many of these initially successful mergers were eventually dismantled. The U.S. government passed the Sherman Act
in 1890, setting rules against price fixing
and monopolies. Starting in the 1890s with such cases as U.S. versus Addyston Pipe and Steel Co.
, the courts attacked large companies for strategizing with others or within their own companies to maximize profits. Price fixing with competitors created a greater incentive for companies to unite and merge under one name so that they were not competitors anymore and technically not price fixing.
In a study conducted in 2000 by Lehman Brothers
, it was found that, on average, large M&A deals cause the domestic currency
of the target corporation to appreciate by 1% relative to the acquirer's. For every $1-billion deal, the currency of the target corporation increased in value by 0.5%. More specifically, the report found that in the period immediately after the deal is announced, there is generally a strong upward movement in the target corporation's domestic currency (relative to the acquirer's currency). Fifty days after the announcement, the target currency is then, on average, 1% stronger.
The rise of globalization has exponentially increased the market for cross border M&A. In 1996 alone there were over 2000 cross border transactions worth a total of approximately $256 billion. This rapid increase has taken many M&A firms by surprise because the majority of them never had to consider acquiring the capabilities or skills required to effectively handle this kind of transaction. In the past, the market's lack of significance and a more strictly national mindset prevented the vast majority of small and mid-sized companies from considering cross border intermediation as an option which left M&A firms inexperienced in this field. This same reason also prevented the development of any extensive academic works on the subject.
Due to the complicated nature of cross border M&A, the vast majority of cross border actions have unsuccessful results. Cross border intermediation has many more levels of complexity to it then regular intermediation seeing as corporate governance, the power of the average employee, company regulations, political factors customer expectations, and countries' culture are all crucial factors that could spoil the transaction. However, with the weak dollar in the U.S. and soft economies in a number of countries around the world, we are seeing more cross-border bargain hunting as top companies seek to expand their global footprint and become more agile at creating high-performing businesses and cultures across national boundaries.
Even mergers of companies with headquarters in the same country are very much of this type (cross-border Mergers). After all,when Boeing acquires McDonnell Douglas, the two American companies must integrate operations in dozens of countries around the world. This is just as true for other supposedly "single country" mergers, such as the $27 billion dollar merger of Swiss drug makers Sandoz and Ciba-Geigy (now Novartis).
Major M&A in the 1990s
Top 10 M&A deals worldwide by value (in mil. USD) from 1990 to 1999:
||Transaction value (in mil. USD) |
||Vodafone Airtouch PLC
Major M&A from 2000 to present
Top 9 M&A deals worldwide by value (in mil. USD) since 2000:
||Transaction value (in mil. USD) |
||Fusion: America Online Inc. (AOL)
||Glaxo Wellcome Plc.
||SmithKline Beecham Plc.
||Royal Dutch Petroleum Co.
||Shell Transport & Trading Co
||AT&T Broadband & Internet Svcs
||Spin-off: Nortel Networks Corporation
||JP Morgan Chase & Co
||Bank One Corp
- DePamphilis, Donald (2008). Mergers, Acquisitions, and Other Restructuring Activities. New York: Elsevier, Academic Press.
- Cartwright, Susan; Schoenberg, Richard (2006). "Thirty Years of Mergers and Acquisitions Research: Recent Advances and Future Opportunities". British Journal of Management 17 (S1): S1–S5.
- Harwood, I. A. (2006). "Confidentiality constraints within mergers and acquisitions: gaining insights through a 'bubble' metaphor". British Journal of Management 17 (4): 347–359.
- Straub, Thomas (2007). Reasons for frequent failure in Mergers and Acquisitions: A comprehensive analysis. Wiesbaden: Deutscher Universitätsverlag.