At the heart of any M&A initiative, there is a desire to gain a competitive advantage in the market. Just as in a marriage, two entities can increase their resources and expect a better future by exploiting the synergy between them.
There might be the financial or non-financial motives for companies engaging in M&A activity.
On the financial front, a merger might allow the acquiring firm to enjoy a potentially desirable portfolio effect by achieving risk reduction while maintaining or increasing the firm's rate of return. For example, the cyclical businesses of two firms can be combined to ensure a steady stream of business throughout the year. Another financial motive may be the tax loss carry-forward if one of the merging companies has sustained a tax loss in recent years.
The non-financial motives for mergers and acquisitions might include the desire to expand management and marketing capabilities as well as the acquisition of new products and technologies. Basically, the firms are trying to gain some synergistic effect. For example, synergies may result from the elimination of overlapping functions in production and marketing.
Let us now look at mergers, its definition, forms, and types.
A merger is said to take place when two or more companies agree to combine, resulting in a new entity or with the resulting firm maintaining the identity of the acquiring company. Most economies prevent mergers between directly competing firms. The rationale is to prevent monopolistic market conditions where the consumer does not have any choice except just one seller. Allegations of monopolistic behavior have plagued Microsoft's operations in Europe.
A merger may take either of the two forms, absorption or consolidation.
The combination of two or more companies into an existing company, where all the companies except one lose their identity is termed as a merger through absorption.
The combination of two or more companies into a new company, where all the companies lose their identity is termed as a merger through consolidation. Here, the acquired company transfers its assets, liabilities and shares to the acquiring company in exchange of cash or shares.
There are three types of mergers, horizontal, vertical, and conglomerate.
Horizontal mergers take place in firms that are large and are complementary to the current business. Pooling complimentary resources will not only ensure that there is no overlap and related inefficiencies between the merged operations, but also help companies harness the synergy better. For example, mergers in the pharmaceuticals industry where research laboratories merge with drug manufacturers. The size also plays a major role because smaller players would not be able to achieve substantial economies of scale by combining production or marketing efforts.
Vertical mergers take place between firms in different stages of production or operations. The basic aim of vertical mergers is to reduce the costs of looking for best prices, contracting, payment collection, communication costs and increase coordinated production. Vertical mergers essentially integrate companies, which operate in various stages in the value chain of a vertical market. They can be of two types, forward and backward integration. Forward integration takes place when the producer of a raw material finds a regular procurer of its products and combines with it. Backward integration takes place when manufacturer finds a supplier of raw materials and takes it over.
Conglomerate mergers are mergers where the merging firms have no relationship and are players in different or unrelated activity. The motive for these kinds of mergers is the firm's need to diversify its business. Conglomerate mergers can be of three types, financial, managerial, and concentric.
Now that we have covered mergers, let us look at acquisition and its types.
Acquisition can be defined as the act of gaining a majority stake in the target firm by an acquiring firm. The target and acquiring companies may remain independent entities, but the control of the company may rest with the acquiring company. There are many factors that might attract an acquiring company to the target company: The acquiring company might be looking to establish a parent-subsidiary relationship, break the target firm and dispose off its assets, or take the target firm private by a small group of investors
A corporate acquisition can be achieved in a friendly or a hostile takeover.
In a friendly takeover, the acquiring firm makes its intentions clear to the management of the target firm. A financial proposal involving either a merger, consolidation or the creation of parent-subsidiary relations is presented to the management. The takeover takes place after the management's approval.
There may be cases where the management of a firm does not wish to merge with another firm. In such cases, the acquiring firm may buy the target firm's stock in exchange for cash, shares or other securities directly from the shareholders, thus bypassing the management. In this way the acquiring firm might buy a majority stake in the target company.
Mergers and acquisitions were perhaps not that relevant in the older closed economies, but in today's world their importance cannot be undermined. In the corporate world, where only the fittest survive, knowledge about the intricacies of M&A is a weapon you can use to save yourself as well as hunt for a better future.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.