Mergers and acquisitions

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"Merger" redirects here. For the legal doctrine, see Merger doctrine. For other uses of the word "merger", see merge.

The phrase mergers and acquisitions or M&A refers to the aspect of corporate finance strategy and management dealing with the merging and acquiring of different companies.

Contents

[edit] Overview

Mergers are a tool used by companies for the purpose of expanding their operations and increasing their profit.

Usually mergers occur in a consensual 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". See Delaware corporations.

Historically, mergers have often failed 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), reducing taxes, removing management, "empire building" by the acquiring managers, or other purposes which may not be consistent with public policy or public welfare. Thus they can be heavily regulated, requiring, for example, approval in the U.S. 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 to rule either lenient (as with U.S. Steel in 1920) or strict (as with Alcoa in 1945).

[edit] Types of acquisition

An acquisition can take the form of a purchase of the stock or other equity interests of the target entity, or the acquisition of all or a substantial amount of its assets.

  • Share purchases - in a share purchase the buyer buys the shares of the target company from the shareholders of the target company. The buyer will take on the company with all its assets and liabilities.
  • Asset purchases - in an asset purchase the buyer buys the assets of the target company from the target company. In simplest form this leaves the target company as an empty shell, and the cash it receives from the acquisition is then paid back to its shareholders by dividend or through liquidation. However, one of the advantages of an asset purchase for the buyer is that it can "cherry-pick" the assets that it wants and leave the assets - and liabilities - that it does not. This leaves the target in a different position after the purchase, but liquidation is nevertheless usually the end result.

The terms "demerger", "spin-off" or "spin-out" are sometimes used to indicate the effective opposite of a merger, where one company splits into two, the 2nd often being a separately listed stock company if the parent was a stock company.

[edit] Financing M&A

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:

[edit] All share deals

A "merger" or "merger of equals" is often financed by an all stock deal (a stock swap), known in the UK as an all share deal. Such deals are considered mergers rather than acquisitions because neither company pays money, and the shareholders of each company end up as the combined shareholders of the merged company. There are two methods of merging companies in this way:

  • one company takes ownership of the other, issuing new shares in itself to the shareholders of the company being acquired as payment, or
  • a third company is created which takes ownership of both companies (or their assets) in exchange for shares in itself issued to the shareholders of the two merging companies.

Where one company is notably larger than the other, people may nevertheless be wary of calling the deal a merger, as the shareholders of the larger company will still dominate the merged company.

[edit] Cash

A company acquiring another will frequently pay for the other company 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.

The cash can be raised in a number of ways. The company may have sufficient cash available in its account, but this is unlikely. More often the cash will be borrowed from a bank, or raised by an issue of bonds. Acquisitions financed through debt are known as leveraged buyouts, and the debt will often be moved down onto the balance sheet of the acquired company.

[edit] Hybrids

An acquisition can involve a cash and debt combination, or a combination of cash and stock of the purchasing entity, or just stock. The Sears-Kmart acquisition is an example of a cash deal.

[edit] Examples

In a 1985 merger between Pantry Pride and Revlon, Pantry Pride had to issue 2.1 billion dollars of high-yield debt to buy Revlon. The target Revlon was worth 5 times the acquirer. The purchasing company issues debentures to the public and money received on issue of debentures is paid to the selling company

[edit] Motives behind M&A

These motives are considered to add shareholder value:

  • Economies of scale: This refers to the fact that the combined company can often reduce duplicate departments or operations, lowering the costs of the company relative to theoretically 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 double 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.
  • Synergy: Better use of complementary resources.
  • Taxes: A profitable company can buy a loss maker to use the target's tax write-offs. 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.

These motives are considered to not add shareholder value:

  • 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.
  • Overextension: Tend to make the organization fuzzy and unmanageable.
  • 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 rather linked to profitability and not mere profits of the company.
  • Bootstrapping: Example: how ITT executed its merger.
  • Vertical integration: Companies acquire part of a supply chain and benefit from the resources.

[edit] M&A Advisors

[edit] M&A marketplace difficulties

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No marketplace currently exists 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.

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 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. 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.

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 has not been applicable to M&A due to the need for confidentiality. Consequently, there is a need for a method and apparatus for efficiently executing M&A transactions 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.


[edit] Merger

In business or economics a merger 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.

[edit] The Great Merger Movement

The Great Merger Movement is the period from 1895 to 1905. During this time of restructuring, small firms with little market share consolidated with similar firms to form large, powerful institutions that could compete with the market dominators of the time. 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.

[edit] Short Run Factors

One of the major short run factors that sparked 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. Horizontal integration is when multiple firms responsible for the same service or production process join together. As a result of merging, this involved mass production of cheap homogeneous output that exploited efficiencies of volume production to earn profits on volume. Focusing on mass production allowed firms to reduce unit costs at a much lower rate. These firms usually were capital-intensive and had high fixed costs. Due to the fact of new machines were mostly financed through bonds, interest payments on bonds were high followed by the panic of 1983, yet no firm was willing to accept quantity reduction during this period.

[edit] Long Run Factors

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 government over time grew weary of big businesses merging and created the Sherman Act in 1890, setting rules against price fixing(Section I) and monopolies(Section II). In the modern era, everyone knows of the controversy over Microsoft, but starting in the 1890s with such cases as U.S. versus Addyston Pipe and Steel Co. the courts attacked such companies for strategizing with others or within their own companies to maximize profits. Ironically, such acts against 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. The Sherman Act is still under debate to this day, ranging from broad to strict to mixed interpretations. There are many varied opinions on whether it is acceptable to dominate a market based on size and resources, and we must wait and see what the courts of the future will conclusively decide.

[edit] 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.
  • 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 and the United States Department of Justice 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 at 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.

[edit] Major mergers & acquisitions in the 1990s

Acquirer and target, announcement date, deal size, share and cash payment.

[edit] United States

[edit] Europe

[edit] Japan

[edit] Major mergers & acquisitions 2000-2006

[edit] United States

[edit] Europe

[edit] Japan

[edit] Multinational

[edit] See also


[edit] Lists

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