Merger and acquisition (M&A) is the process by which two or more companies combine into a single entity. This article is a detailed guide to M&A that explains the differences between them and their types, as well as answers frequently asked questions.
What are mergers and acquisitions?
To understand what merger (and acquisition) is, let’s explore each of these in more detail. M and A meaning is the process in which two companies combine to form a new one that has all the assets and liabilities of both. This can happen in two ways:
Thus, the main difference is that in a merger, companies come together to form a new one, while in an acquisition, one firm takes over the other, and the acquired company ceases to exist. However, the terms merger and acquisition are often used interchangeably.
Understanding mergers and acquisitions
Now that we know the meaning of M&A, let’s look at some real-world examples. One of the most notable examples of acquisition is the purchase of WhatsApp by Facebook in 2014. An example of the merger can be the union of 21st Century Fox and Disney companies into one corporation.
Now let us look at the key differences between these terms.
Key differences between mergers and acquisitions
In a merger, both the companies involved are on an equal footing. It is usually aimed at achieving synergy between the two. However, in an acquisition, one firm is usually much larger than the other and holds a dominant position.
So in a merger, the companies come together to form a new one, and in an acquisition, one firm takes over the other, and the latter ceases to exist. Despite its seeming brutality, the acquisition helps expand the business by gaining access to new markets or technology.
In a merger, both firms must give up their identity to some extent. This is not the case in an acquisition where the acquiring company maintains its specification.
Types of mergers and acquisitions
Let’s take a look at the different types of mergers and acquisitions.
The purpose of a merger is to create shareholder value by combining two companies or businesses. It can be accomplished through the acquisition of one company by another or through a joint venture. The merged entity typically takes on the name of one of the original companies and continues to operate under that brand.
An acquisition is the purchase of one company by another, as a result of which the acquirer obtains a majority stake in the target firm.
The purpose of an acquisition is to expand:
- Product line;
- Market share;
- The geographic reach.
There are several types of acquisitions. We will discuss them in detail below.
A consolidation is sometimes referred to as a “true merger”. It is a process in which two companies combine to form one that becomes larger and more efficient than them. The new firm will have a stronger market position and be able to take advantage of economies of scale. At the same time, the structures of the two previous organizations cease to exist.
A tender offer is an offer to buy a company’s outstanding stocks at a fixed price. The buyer usually makes the offer public, and the shareholders have a set period to accept or reject it.
If most shareholders accept the offer, the buyer will acquire the company. It will remain independent if the shareholders do not accept the offer.
Acquisition of assets
Acquisition of assets is when a company buys the assets of another. The buyer usually pays with cash, debt, or shares in the buyer’s company. The advantage of this process is that the transaction does not have to be approved by the target company’s shareholders.
Companies most often sell their assets to pay off creditors. This is common during bankruptcy.
Management acquisition, also known as a management buyout (MBO), is a situation where the team buys the company they work for. This decision is due to the fact that managers believe they can run the firm better than anyone else. They also consider that they can make the business more profitable.
The process is usually done with the help of private equity firms: the management team puts up a certain amount of money, and the firm provides the rest.
These occur when one company buys another outright. With a purchase merger, the target organization will cease to exist as a separate entity. And while it might sound like a hostile takeover, it’s not at all. Purchase mergers are usually friendly.
A consolidation merger is when two companies combine to form one. The new business will be a completely new entity with its stock.
Consolidation mergers are usually done to reduce competition or to expand market share. Also, since the two companies are combining, there will likely be some cost savings from economies of scale.
How mergers are structured
The structure of a merger depends on its type. There are six ones:
- Horizontal mergers:
It is when two companies that are in the same business and compete with each other decide to combine. In this type of merger, the firms try to eliminate competition to increase prices.
- Vertical mergers:
It is when two companies in different parts of the same supply chain combine. For example, a company that makes parts for cars and a firm that assembles automobiles could merge.
- Conglomerate mergers:
It is when two companies in completely different businesses combine. For instance, the one that makes soft drinks and a firm that makes airplanes could unite.
- Con-generic mergers:
It is when two companies that offer similar products or services to the same market combine. For example, it could be two banks.
- Market-extension mergers:
It is when two companies that offer the same products or services to different markets combine. For example, a company that makes soft drinks in the United States could merge with one that makes soft drinks in Europe.
- Product-extension mergers:
It is when two firms that offer different products or services to the same market combine. For example, a business that makes soft drinks could merge with a company that makes bottled water.
How acquisitions are financed
Acquisitions are usually financed with a combination of cash and debt. For example, if a company that wants to buy a company for $2 billion has $1 billion in cash, it would have to borrow $1 billion.
It could be done by issuing bonds. They would be paid back over time with the money that the business makes from the acquired company. If the firm can’t borrow enough money, it may have to sell some of its assets, such as property or another company that it owns.
Acquisitions can also be financed with stock. For example, if Company A wants to buy Company B, it could offer to exchange some of its stock for all of Company B’s one.
How mergers and acquisitions are valued
There are several methods used to value a company that’s being acquired. The main ones are:
- Price-to-earnings ratio (P/E ratio):
This is the most common way to value a company. It simply states that a firm is worth the years of earnings it has in the bank. For example, if Company A has a P/E ratio of 10. And it earned $10 million last year; then it’s valued at $100 million.
- Discounted cash flow (DCF):
This valuation method looks at a company’s projected cash flows and discounts them back to present value. The idea is that a business is only worth the total of all its future cash flows. So it makes sense to discount them back to present value.
- Enterprise-value-to-sales ratio:
This method looks at a firm’s market value and compares it to its sales. For example, if Company A has a market value of $100 million and sales of $50 million. Then it has an EV/S ratio of 2. If Company B has a market value of $200 million and sales of $100 million, it also has an EV/S ratio of 2.
- Replacement cost:
It estimates what it would cost to replace assets. For example, replacing Company A’s assets would cost $100 million, and the firm has a market value of $150 million. Then the replacement cost is 66.7%.
Frequently Asked Questions
To understand the topic even better, let’s look at questions that are often asked when studying mergers and acquisitions.
How do mergers differ from acquisitions?
The main difference between a merger and acquisition strategies is that:
- A merger results in the creation of a new company, while an acquisition results in one firm taking over another. The business that is acquired ceases to exist as a separate entity; that is, the acquiring company absorbs its assets and liabilities.
- In a merger, two companies come together to form a new company. This is often done to expand the product line or geographic reach of the companies involved.
Why do companies keep acquiring other companies through M&A?
There are several reasons why companies may seek to acquire other firms through M&A:
- To expand the product line or geographic reach of the companies involved.
- To gain access to new technology or intellectual property.
- To achieve economies of scale.
- To eliminate a competitor.
- To diversify the business portfolio.
What is a hostile takeover?
A hostile takeover is when a company tries to acquire another without the approval of the board of directors of the target firm. It can be a very contentious and messy process that often involves multiple rounds of bidding, proxy fights, and lawsuits.
The hostile company tries to buy up enough shares of the target business to take control, or it can make a tender offer. Also, hostile firms try to replace the board of directors of the target one with its people.
A hostile takeover is a very dangerous thing for a company because it can result in the loss of control of the business and lead to the loss of jobs.
How does M&A activity affect shareholders?
The merger and acquisition process affects the shareholders of both firms. The shareholders of the company being bought out usually see a big increase in the value of their shares. This is because the target firm’s shares become more valuable after the merger.
On the other hand, shareholders of the business that is doing the buying usually see a decrease in the value of their shares. This is because the company has to pay a lot of debt to finance the merger.
In some cases, shareholders of both firms may see a decrease in the value of their shares. For example, this can happen if the merger does not go as planned and the new company is less valuable than the two ones before the merger.
What is the difference between a vertical and horizontal merger or acquisition?
In a vertical merger or acquisition, the businesses are in the same industry but at different stages of the production process. For example, a company that makes tires may merge with one that makes vehicles.
In a horizontal merger or acquisition, the businesses are in the same industry and at the same stage of production. For example, two companies that make tires may merge.
M&A’s full form is Mergers and Acquisitions. They are two terms often used interchangeably in the business world. However, there is a difference between the two. A merger is when two companies combine together to form one. And acquisition is a term used to describe the situation when one firm takes over another.
Companies use M&A strategies and activities to grow their businesses. The main motive behind these activities is to increase market share, expand the product line, and enter new markets.