Mergers and Acquisitions (M&A): What Are They?

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.

The divisions of financial institutions that participate in such activity are referred to by the name M&A as well.

Important

Although they are frequently used interchangeably, the phrases "mergers" and "acquisitions" have different meanings.

In an acquisition, one business completely buys another.

A merger is the joining of two businesses to create a new legal entity with a single corporate identity.

By comparing companies in the same industry and employing measurements, a company can be appraised objectively.

Understanding about mergers and acquisitions

Although the terms mergers and acquisitions are frequently used synonymously, they actually denote slightly different things.

An acquisition is a takeover in which one business buys another and positions itself as the new owner.

On the other hand, a merger is the coming together of two businesses that are roughly the same size in order to continue forward as one new organisation rather than continuing to be owned and run independently.

This process is referred to as a merger of equals. As an illustration, when the two businesses joined, Daimler-Benz and Chrysler both ceased to exist. Instead, a new corporation called DaimlerChrysler was born.

Stocks of both firms were relinquished, and fresh stock of the combined company was issued 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.

When both CEOs concur that working together is in the best interest of their respective businesses, the purchase agreement is also referred to as a merger.

Acquisitions are always considered to be unfriendly or hostile takeovers in which the target company does not want to be purchased.

Depending on whether the acquisition is friendly or hostile and how it is announced, a transaction can be categorised as either a merger or an acquisition.

In other words, the difference is in the way the board of directors, staff, and shareholders of the target company are informed about the sale.

Various merger and acquisition types

Here are a few frequent transactions that fall under the M&A category.

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, as a result of which Compaq acquired the Digital Equipment Corporation.

Later, in 2002, Compaq and Hewlett-Packard merged to form HP. Prior to the merger, Compaq's ticker symbol was CPQ.

The present ticker symbol was made by combining this with Hewlett-ticker Packard's symbol (HWP) (HPQ)

Acquisitions

In a straightforward acquisition, the acquiring corporation buys the majority of the acquired company, which keeps its name and organisational structure unaltered.

The acquisition of John Hancock Financial Services by Manulife Financial Corporation in 2004 is an illustration of this kind of deal, where both businesses kept their organisational names and identities.

Consolidations

By integrating core companies and doing away with outdated organisational structures, consolidation results in the creation of a new company.

Shares of common ownership in the new company are distributed to shareholders of the two companies who have approved the merger.

As an illustration, the 1998 announcement of the merger between Citicorp and Travelers Insurance Group led to the creation of Citigroup.

Tender Submissions

In a tender offer, one business proposes to buy the other business's outstanding stock for a predetermined amount rather than the going rate. Bypassing management and the board of directors, the acquiring business makes the offer straight to the shareholders of the target company.

For instance, Johnson & Johnson made a $438 million tender offer to buy Omrix Biopharmaceuticals in 2008.

By the end of December 2008, the company had accepted the tender offer, and the transaction had been completed.

Purchasing of Assets

One company directly purchases the assets of another company in an asset acquisition. The shareholders of the company whose assets are being bought must consent.

It is customary during bankruptcy procedures for other businesses to bid on different assets belonging to the bankrupt company, which is then liquidated upon the ultimate transfer of assets to the purchasing businesses.

Business Acquisitions

In a management acquisition, sometimes referred to as a management-led buyout (MBO), executives from one firm buy a majority stake in another, thus taking it private. In an effort to assist fund a deal, these former executives frequently collaborate with a financier or former company leaders.

Such M&A deals often require a large amount of debt financing, and the majority of shareholders must consent. For instance, Michael Dell, the company's creator, stated in 2013 that he had acquired Dell Corporation.

What Structures Mergers Take?

Based on the relationship between the two companies involved in the deal, mergers can be set up in a variety of ways:

1A horizontal merger

is the coming together of two businesses that compete directly and have similar markets and product lines.

2Merging Vertically

a client and a business, or a supplier and a business. Consider the merger of an ice cream producer with a supplier of cones.

3Congeneric Merger

Two companies that provide separate services to the same customer base, like a cable provider and a TV manufacturer.

4Merger with Market Expansion

Two businesses that offer the same goods in various markets. Merger of two businesses selling distinct but related items in the same market.

5Conglomeration

Two businesses with no shared industries.

The following two financing strategies, each with different implications for investors, can also be used to discern between mergers.

Purchase Mergers

This type of merger takes place when one corporation buys another company, as the name implies. Cash is used to make the purchase, or some sort of debt instrument may also be issued. The taxable nature of the sale draws acquiring businesses, who profit from the tax advantages.

Acquired assets can be written up to their actual purchase price, and the difference between their book value and the purchase price can decrease each year, lowering the amount of taxes that the purchasing business must pay.

Consolidation Mergers

With this merger, a whole new company is created, and the two businesses are acquired and merged under the new organisation. Similar tax conditions apply as they would in a buy merger.

Methods of Acquisition Financing

A business can acquire another business using cash, equity, the assumption of debt, or any combination of the three. One corporation frequently buys the whole asset portfolio of another company in smaller transactions. Company X pays cash for all of Company’s Y assets, leaving Company Y with nothing except cash (and debt, if any). Of course, Company Y degenerates into a mere shell and eventually liquidates or expands into other industries.

Reverse mergers, a different type of purchase arrangement, allow a private business to become public relatively quickly.

Reverse mergers happen when a private company with promising future prospects that is desperate to get financing buys a publicly traded shell company with scant assets and no real business operations.

The public firm and the private company reverse merger, creating a new public corporation with marketable shares.

How Acquisitions and Mergers Are Valued

The target firm will be valued differently by the two corporations involved on either side of an M&A deal. Naturally, the buyer will try to purchase the company for the least amount of money while the seller will value it as highly as they can.

Fortunately, a company can be appraised objectively by looking at similar businesses in the same sector and relying on the following indicators.

P/E ratio (price-to-earnings ratio)

An acquiring business makes an offer that is a multiple of the earnings of the target company 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.

Ratio of Enterprise Value to Sales (EV/Sales)

The acquiring corporation uses an enterprise-value-to-sales ratio (EV/sales) to make an offer that is a multiple of revenues while being cognizant of the price-to-sales (P/S ratio) of rival firms in the sector.

Discretionary Cash Flow (DCF)

A company's present value is established using a discounted cash flow (DFC) analysis, a crucial valuation method in mergers and acquisitions.

Forecasted free cash flows are discounted to a present value using the company's weighted average cost of capital, which is calculated as net income plus depreciation/amortisation (capital expenditures) change in working capital (WACC). Although DCF might be challenging to use correctly, few tools can compete with it as a valuation technique.

Cost of Replacement

Acquisitions are occasionally determined by the cost of replacing the target company. Let's assume for the purpose of argument that a company's value is equal to the total of its personnel and equipment expenses.

The acquiring corporation can really demand that the target sell at that price, or else it will build a rival business at the same price.

Naturally, the process of assembling competent management, acquiring property, and investing in the appropriate machinery is lengthy.

In a service industry where the key assets (people and ideas) are difficult to evaluate and develop, this form of pricing wouldn't make much sense.

Frequently Asked Questions

What Distinguishes Mergers From Acquisitions?

The term "acquisition" typically refers to a deal when one company buys out another company through a takeover. When the buying and target companies come together to form a totally new entity, the word "merger" is employed.

Use of these phrases frequently overlaps since each combination is a special circumstance with its own features and motivations for carrying out the transaction.

Why Do Businesses Keep Using M&A to Acquire Other Businesses?

Growth and competition are two of capitalism's primary forces. A business must innovate while cutting expenses when it faces competition. Buying rival companies is one way to make them less of a threat.

By acquiring additional product lines, intellectual property, human resources, and customer bases, businesses also use M&A to expand. Businesses could also search for synergy.

Combining business operations usually results in improved overall performance efficiency and decreased overall costs as one company makes use of the advantages of the other.

What Is a Hostile Takeover?

Most frequently, friendly acquisitions take place when the target company consents to be purchased, the target company's board of directors and shareholders authorize the transaction, and these combinations frequently work to both parties' advantages.

Hostile takeovers, sometimes referred to as unfriendly acquisitions, happen when the target company objects to the purchase.

Hostile acquisitions don't have the same consent from the target company; thus the acquiring firm must aggressively buy significant holdings in the target company to obtain a controlling position, which compels the acquisition.

How Are Shareholders Affected by M&A Activity?

In general, shareholders of the acquiring company will experience a brief decline in share value in the days preceding a merger or acquisition. At the same time, the value of the target company's stock often increases.

This is frequently because the acquiring corporation will have to invest money to buy the target company at a price above the pre-takeover share values.

The stock price typically rises above the pre-takeover value of each underlying company after a merger or acquisition formally takes place.

Shareholders of the amalgamated firm often experience positive long-term performance and dividends in the absence of unfavorable economic conditions.

Be aware that the increased number of shares released during the merger procedure may result in a dilution of voting power for the shareholders of both firms.

When the new firm offers its shares in exchange for shares in the target company, at an agreed-upon conversion rate, this occurrence is significant in stock-for-stock mergers.

While shareholders of a smaller target firm may incur a severe erosion of their voting power in the relatively bigger pool of stakeholders, shareholders of the acquiring company only experience a slight loss of voting power.

What Sets a Vertical Merger or Acquisition Apart from a Horizontal One?

Companies adopt the competitive strategies of horizontal and vertical integration to strengthen their position against rivals. The acquisition of a similar company is known as horizontal integration.

When a business chooses horizontal integration, it will buy a rival business that competes at the same industry value chain level. One such acquisition was made by Marriott International, Inc. of Starwood Hotels & Resorts Worldwide, Inc.

The process of purchasing business operations within the same industrial vertical is referred to as vertical integration.

A business that chooses vertical integration assumes total control over one or more phases of a product's manufacture or distribution.

For instance, Apple purchased AuthenTec, the company behind the touch ID fingerprint sensor technology.