Mergers and acquisitions (abbreviated M&A) are both aspects of strategic management, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture. Mergers and acquisitions activity can be defined as a type of restructuring in that they result in some entity reorganization with the aim to provide growth or positive value. Consolidation of an industry or sector occurs when widespread M&A activity concentrates the resources of many small companies into a few larger ones, such as occurred with the automotive industry between 1910 and 1940.
The distinction between a "merger" and an "acquisition" has become increasingly blurred in various respects (particularly in terms of the ultimate economic outcome), although it has not completely disappeared in all situations. From a legal point of view, a merger is a legal consolidation of two companies into one entity, whereas an acquisition occurs when one company takes over another and completely establishes itself as the new owner (in which case the target company still exists as an independent legal entity controlled by the acquirer). Either structure can result in the economic and financial consolidation of the two entities. In practice, a deal that is an acquisition for legal purposes may be euphemistically called a "merger of equals" if both CEOs agree that joining together is in the best interest of both of their companies, while when the deal is unfriendly (that is, when the target company does not want to be purchased) it is almost always regarded as an "acquisition".
An acquisition or takeover is the purchase of one business or company by another company or other business entity. Such purchase may be of 100%, or nearly 100%, of the assets or ownership equity of the acquired entity. Consolidation occurs when two companies combine together to form a new enterprise altogether, and neither of the previous companies remains independently. Acquisitions are divided into "private" and "public" acquisitions, depending on whether the acquiree or merging company (also termed a target) is or is not listed on a public stock market. An additional dimension or categorization consists of whether an acquisition is friendly or hostile.
Achieving acquisition success has proven to be very difficult, while various studies have shown that 50% of acquisitions were unsuccessful. The acquisition process is very complex, with many dimensions influencing its outcome. "Serial acquirers" appear to be more successful with M&A than companies who only make an acquisition occasionally (see Douma & Schreuder, 2013, chapter 13). The new forms of buy out created since the crisis are based on serial type acquisitions known as an ECO Buyout which is a co-community ownership buy out and the new generation buy outs of the MIBO (Management Involved or Management & Institution Buy Out) and MEIBO (Management & Employee Involved Buy Out).
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Whether a purchase is perceived as being a "friendly" one or a "hostile" depends significantly on how the proposed acquisition is communicated to and perceived by the target company's board of directors, employees and shareholders. It is normal for M&A deal communications to take place in a so-called "confidentiality bubble" wherein the flow of information is restricted pursuant to confidentiality agreements. In the case of a friendly transaction, the companies cooperate in negotiations; in the case of a hostile deal, the board and/or management of the target is unwilling to be bought or the target's board has no prior knowledge of the offer. Hostile acquisitions can, and often do, ultimately become "friendly", as the acquiror secures endorsement of the transaction from the board of the acquiree company. This usually requires an improvement in the terms of the offer and/or through negotiation.
"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 and/or longer-established company and retain the name of the latter for the post-acquisition combined entity. This is known as a reverse takeover. Another type of acquisition is the reverse merger, a form of transaction that enables a private company to be publicly listed in a relatively short time frame. A reverse merger occurs when a privately held company (often one that has strong prospects and is eager to raise financing) buys a publicly listed shell company, usually one with no business and limited assets.
The combined evidence suggests that the shareholders of acquired firms realize significant positive "abnormal returns" while shareholders of the acquiring company are most likely to experience a negative wealth effect. The overall net effect of M&A transactions appears to be positive: almost all studies report positive returns for the investors in the combined buyer and target firms. This implies that M&A creates economic value, presumably by transferring assets to management teams that operate them more efficiently (see Douma & Schreuder, 2013, chapter 13).
There are also a variety of structures used in securing control over the assets of a company, which have different tax and regulatory implications:
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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 which may or may not become separately listed on a stock exchange.
As per knowledge-based views, firms can generate greater values through the retention of knowledge-based resources which they generate and integrate. Extracting technological benefits during and after acquisition is ever challenging issue because of organizational differences. Based on the content analysis of seven interviews authors concluded five following components for their grounded model of acquisition:
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Preservation of tacit knowledge, employees and documentation are often difficult to achieve during and after acquisition. Strategic management of all these resources is a very important factor for a successful acquisition.
An increase in acquisitions in the global business environment requires enterprises to evaluate the key stake holders of acquisition very carefully before implementation. It is imperative for the acquirer to understand this relationship and apply it to its advantage. Retention[clarification needed] is only possible when resources are exchanged and managed without affecting their independence.
Corporate acquisitions can be characterized for legal purposes as either "asset purchases" in which the seller sells business assets to the buyer, or "equity purchases" in which the buyer purchases equity interests in a target company from one or more selling shareholders. Asset purchases are common in technology transactions where the buyer is most interested in particular intellectual property rights but does not want to acquire liabilities or other contractual relationships. An asset purchase structure may also be used when the buyer wishes to buy a particular division or unit of a company which is not a separate legal entity. There are numerous challenges particular to this type of transaction, including isolating the specific assets and liabilities that pertain to the unit, determining whether the unit utilizes services from other units of the selling company, transferring employees, transferring permits and licenses, and ensuring that the seller does not compete with the buyer in the same business area in the future.
Mergers, asset purchases and equity purchases are each taxed differently, and the most beneficial structure for tax purposes is highly situation-dependent. One hybrid form often employed for tax purposes is a triangular merger, where the target company merges with a shell company wholly owned by the buyer, thus becoming a subsidiary of the buyer. In a "forward triangular merger", the buyer causes the target company to merge into the subsidiary; a "reverse triangular merger" is similar except that the subsidiary merges into the target company. Under the U.S. Internal Revenue Code, a forward triangular merger is taxed as if the target company sold its assets to the shell company and then liquidated, whereas a reverse triangular merger is taxed as if the target company's shareholders sold their stock in the target company to the buyer.
The documentation of an M&A transaction often begins with a letter of intent. The letter of intent generally does not bind the parties to commit to a transaction, but may bind the parties to confidentiality and exclusivity obligations so that the transaction can be considered through a due diligence process involving lawyers, accountants, tax advisors, and other professionals, as well as business people from both sides.
After due diligence is completed, the parties may proceed to draw up a definitive agreement, known as a "merger agreement", "share purchase agreement" or "asset purchase agreement" depending on the structure of the transaction. Such contracts are typically 80 to 100 pages long and focus on five key types of terms:
The five most common ways to value a business are
Professionals who value 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. 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. While these reports generally get more detailed and expensive as the size of a company increases, this is not always the case as there are many complicated industries which require more attention to detail, regardless of size.
As synergy plays a large role in the valuation of acquisitions, it is paramount to get the value of synergies right. Synergies are different from the "sales price" valuation of the firm, as they will accrue to the buyer. Hence, the analysis should be done from the acquiring firm's point of view. Synergy-creating investments are started by the choice of the acquirer, and therefore they are not obligatory, making them essentially real options. To include this real options aspect into analysis of acquisition targets is one interesting issue that has been studied lately.
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.
Payment in the form of the acquiring company's stock, issued to the shareholders of the acquired company at a given ratio proportional to the valuation of the latter.
There are some elements to think about when choosing the form of payment. When submitting an offer, the acquiring firm should consider other potential bidders and think strategically. The form of payment might be decisive for the seller. With pure cash deals, there is no doubt on the real value of the bid (without considering an eventual earnout). The contingency of the share payment is indeed removed. Thus, a cash offer preempts competitors better than securities. Taxes are a second element to consider and should be evaluated with the counsel of competent tax and accounting advisers. Third, with a share deal the buyer’s capital structure might be affected and the control of the buyer modified. If the issuance of shares is necessary, shareholders of the acquiring company might prevent such capital increase at the general meeting of shareholders. The risk is removed with a cash transaction. Then, the balance sheet of the buyer will be modified and the decision maker should take into account the effects on the reported financial results. For example, in a pure cash deal (financed from the company’s current account), liquidity ratios might decrease. On the other hand, in a pure stock for stock transaction (financed from the issuance of new shares), the company might show lower profitability ratios (e.g. ROA). However, economic dilution must prevail towards accounting dilution when making the choice. The form of payment and financing options are tightly linked. If the buyer pays cash, there are three main financing options:
If the buyer pays with stock, the financing possibilities are:
In general, stock will create financial flexibility. Transaction costs must also be considered but tend to have a greater impact on the payment decision for larger transactions. Finally, paying cash or with shares is a way to signal value to the other party, e.g.: buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.
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). These companies are sometimes referred to as Merchant Capital Advisors or Advisors, assisting businesses often referred to as "companies in selling." To perform these services in the US, an advisor must be a licensed broker dealer, and subject to SEC (FINRA) regulation.
The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance. The following motives are considered to improve financial performance:
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 acquisition that may not add shareholder value include:
The M&A process itself is a multifaceted which depends upon the type of merging companies.
An arm's length merger is a merger: 1. approved by disinterested directors and 2. approved by disinterested stockholders:
″The two elements are complementary and not substitutes. The first element is important because the directors have the capability to act as effective and active bargaining agents, which disaggregated stockholders do not. But, because bargaining agents are not always effective or faithful, the second element is critical, because it gives the minority stockholders the opportunity to reject their agents' work. Therefore, when a merger with a controlling stockholder was: 1) negotiated and approved by a special committee of independent directors; and 2) conditioned on an affirmative vote of a majority of the minority stockholders, the business judgment standard of review should presumptively apply, and any plaintiff ought to have to plead particularized facts that, if true, support an inference that, despite the facially fair process, the merger was tainted because of fiduciary wrongdoing.″
A Strategic merger usually refers to long term strategic holding of target (Acquired) firm. This type of M&A process aims at creating synergies in the long run by increased market share, broad customer base, and corporate strength of business. A strategic acquirer may also be willing to pay a premium offer to target firm in the outlook of the synergy value created after M&A process.
The term "acqui-hire" is used to refer to acquisitions where the acquiring company seeks to obtain the target company's talent, rather than their products (which are often discontinued as part of the acquisition so the team can focus on projects for their new employer). In recent years, these types of acquisitions have become common in the technology industry, where major web companies such as Facebook, Twitter, and Yahoo! have frequently used talent acquisitions to add expertise in particular areas to their workforces.
Given that the cost of replacing an executive can run over 100% of his or her annual salary, any investment of time and energy in re-recruitment will likely pay for itself many times over if it helps a business retain just a handful of key players that would have otherwise left.
Organizations should move rapidly to re-recruit key managers. It’s much easier to succeed with a team of quality players that one selects deliberately rather than try to win a game with those who randomly show up to play.
Mergers and acquisitions often create brand problems, beginning with what to call the company after the transaction and going down into detail about what to do about overlapping and competing product brands. Decisions about what brand equity to write off are not inconsequential. And, given the ability for the right brand choices to drive preference and earn a price premium, the future success of a merger or acquisition depends on making wise brand choices. Brand decision-makers essentially can choose from four different approaches to dealing with naming issues, each with specific pros and cons:
The factors influencing brand decisions in a merger or acquisition transaction can range from political to tactical. Ego can drive choice just as well as rational factors such as brand value and costs involved with changing brands.
Beyond the bigger issue of what to call the company after the transaction comes the ongoing detailed choices about what divisional, product and service brands to keep. The detailed decisions about the brand portfolio are covered under the topic brand architecture.
Most histories of M&A begin in the late 19th century U.S. However, mergers coincide historically with the existence of companies. In 1708, for example, the East India Company merged with an erstwhile competitor to restore its monopoly over Indian trade. In 1784, the Italian Monte dei Paschi and Monte Pio banks were united as the Monti Reuniti. In 1821, the Hudson's Bay Company merged with the rival North West Company.
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. In 1900 the value of firms acquired in mergers was 20% of GDP. In 1990 the value was only 3% and from 1998 to 2000 it was around 10–11% of GDP. Companies such as DuPont, US Steel, and General Electric that merged during the Great Merger Movement were able to keep their dominance in their respective sectors through 1929, and in some cases today, due to growing technological advances of their products, patents, and brand recognition by their customers. There were also other companies that held the greatest market share in 1905 but at the same time did not have the competitive advantages of the companies like DuPont and General Electric. These companies such as International Paper and American Chicle saw their market share decrease significantly by 1929 as smaller competitors joined forces with each other and provided much more competition. The companies that merged were mass producers of homogeneous goods that could exploit the efficiencies of large volume production. In addition, many of these mergers were capital-intensive. Due to high fixed costs, when demand fell, these newly merged companies had an incentive to maintain output and reduce prices. However more often than not mergers were "quick mergers". These "quick mergers" involved mergers of companies with unrelated technology and different management. As a result, the efficiency gains associated with mergers were not present. The new and bigger company would actually face higher costs than competitors because of these technological and managerial differences. Thus, the mergers were not done to see large efficiency gains, they were in fact done because that was the trend at the time. 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 The Great Merger Movement was the desire to keep prices high. However, high prices attracted the entry of new firms into the industry.
A major catalyst behind the Great Merger Movement was the Panic of 1893, which led to a major decline in demand for many homogeneous goods. For producers of homogeneous goods, when demand falls, these producers have more of an incentive to maintain output and cut prices, in order to spread out the high fixed costs these producers faced (i.e. lowering cost per unit) and the desire to exploit efficiencies of maximum volume production. However, during the Panic of 1893, the fall in demand led to a steep fall in prices.
Another economic model proposed by Naomi R. Lamoreaux for explaining the steep price falls is to view the involved firms acting as monopolies in their respective markets. As quasi-monopolists, firms set quantity where marginal cost equals marginal revenue and price where this quantity intersects demand. When the Panic of 1893 hit, demand fell and along with demand, the firm’s marginal revenue fell as well. Given high fixed costs, the new price was below average total cost, resulting in a loss. However, also being in a high fixed costs industry, these costs can be spread out through greater production (i.e. Higher quantity produced). To return to the quasi-monopoly model, in order for a firm to earn profit, firms would steal part of another firm’s market share by dropping their price slightly and producing to the point where higher quantity and lower price exceeded their average total cost. As other firms joined this practice, prices began falling everywhere and a price war ensued.
One strategy to keep prices high and to maintain profitability was for producers of the same good to collude with each other and form associations, also known as cartels. These cartels were thus able to raise prices right away, sometimes more than doubling prices. However, these prices set by cartels only provided a short-term solution because cartel members would cheat on each other by setting a lower price than the price set by the cartel. Also, the high price set by the cartel would encourage new firms to enter the industry and offer competitive pricing, causing prices to fall once again. As a result, these cartels did not succeed in maintaining high prices for a period of more than a few years. The most viable solution to this problem was for firms to merge, through horizontal integration, with other top firms in the market in order to control a large market share and thus successfully set a higher price.
In the long run, due to 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. Low transport costs, coupled with economies of scale also increased firm size by two- to fourfold during the second half of the nineteenth century. 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 Addyston Pipe and Steel Company v. United States, 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.
The economic history has been divided into Merger Waves based on the merger activities in the business world as:
|1897–1904||First Wave||Horizontal mergers|
|1916–1929||Second Wave||Vertical mergers|
|1965–1969||Third Wave||Diversified conglomerate mergers|
|1981–1989||Fourth Wave||Congeneric mergers; Hostile takeovers; Corporate Raiding|
|1992–2000||Fifth Wave||Cross-border mergers|
|2003–2008||Sixth Wave||Shareholder Activism, Private Equity, LBO|
During the third merger wave (1965–1989), corporate marriages involved more diverse companies. Acquirers more frequently bought into different industries. Sometimes this was done to smooth out cyclical bumps, to diversify, the hope being that it would hedge an investment portfolio.
Starting in the fifth merger wave (1992–1998) and continuing today, companies are more likely to acquire in the same business, or close to it, firms that complement and strengthen an acquirer’s capacity to serve customers.
Buyers aren’t necessarily hungry for the target companies’ hard assets. Some are more interested in acquiring thoughts, methodologies, people and relationships. Paul Graham recognized this in his 2005 essay "Hiring is Obsolete", in which he theorizes that the free market is better at identifying talent, and that traditional hiring practices do not follow the principles of free market because they depend a lot upon credentials and university degrees. Graham was probably the first to identify the trend in which large companies such as Google, Yahoo! or Microsoft were choosing to acquire startups instead of hiring new recruits.
Many companies are being bought for their patents, licenses, market share, name brand, research staff, methods, customer base, or culture. Soft capital, like this, is very perishable, fragile, and fluid. Integrating it usually takes more finesse and expertise than integrating machinery, real estate, inventory and other tangibles.
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 local currency.
The rise of globalization has exponentially increased the necessity for agencies such as the Mergers and Acquisitions International Clearing (MAIC), trust accounts and securities clearing services for Like-Kind Exchanges for cross-border M&A. In 1997 alone, there were over 2,333 cross-border transactions, worth a total of approximately $298 billion. Due to the complicated nature of cross-border M&A, the vast majority of cross-border actions are unsuccessful as companies seek to expand their global footprint and become more agile at creating high-performing businesses and cultures across national boundaries. Nonetheless, the current surge in global cross-border M&A has been called the “New Era of Global Economic Discovery.”
Even mergers of companies with headquarters in the same country can often be considered international in scale and require MAIC custodial services. For example, when Boeing acquired McDonnell Douglas, the two American companies had to integrate operations in dozens of countries around the world (1997). This is just as true for other apparently "single-country" mergers, such as the 29 billion-dollar merger of Swiss drug makers Sandoz and Ciba-Geigy (now Novartis).
Despite the goal of performance improvement, results from mergers and acquisitions (M&A) are often disappointing compared with results predicted or expected. Numerous empirical studies show high failure rates of M&A deals. Studies are mostly focused on individual determinants. A book by Thomas Straub (2007) "Reasons for frequent failure in Mergers and Acquisitions" develops a comprehensive research framework that bridges different perspectives and promotes an understanding of factors underlying M&A performance in business research and scholarship. The study should help managers in the decision making process. The first important step towards this objective is the development of a common frame of reference that spans conflicting theoretical assumptions from different perspectives. On this basis, a comprehensive framework is proposed with which to understand the origins of M&A performance better and address the problem of fragmentation by integrating the most important competing perspectives in respect of studies on M&A. Furthermore, according to the existing literature, relevant determinants of firm performance are derived from each dimension of the model. For the dimension strategic management, the six strategic variables: market similarity, market complementarities, production operation similarity, production operation complementarities, market power, and purchasing power were identified as having an important impact on M&A performance. For the dimension organizational behavior, the variables acquisition experience, relative size, and cultural differences were found to be important. Finally, relevant determinants of M&A performance from the financial field were acquisition premium, bidding process, and due diligence. Three different ways in order to best measure post M&A performance are recognized: synergy realization, absolute performance, and finally relative performance.
Employee turnover contributes to M&A failures. The turnover in target companies is double the turnover experienced in non-merged firms for the ten years following the merger.
Top 10 M&A deals worldwide by value from 1990 to 1999:
|Rank||Year||Purchaser||Purchased||Transaction value (in USD)|
|1||1999||Vodafone Airtouch PLC||Mannesmann||202,000,000,000|
|5||1999||SBC Communications||Ameritech Corporation||63,000,000,000|
|6||1999||Vodafone Group||AirTouch Communications||60,000,000,000|
|9||1999||Qwest Communications||US WEST||48,000,000,000|
Top 10 M&A deals worldwide by value from 2000 to 2010:
|Rank||Year||Purchaser||Purchased||Transaction value (in USD)|
|1||2000||Fusion: AOL Inc. (America Online)||Time Warner||164,747,000,000|
|2||2000||Glaxo Wellcome Plc.||SmithKline Beecham Plc.||75,961,000,000|
|3||2004||Royal Dutch Petroleum Company||"Shell" Transport & Trading Co.||74,559,000,000|
|4||2006||AT&T Inc.||BellSouth Corporation||72,671,000,000|
|5||2001||Comcast Corporation||AT&T Broadband||72,041,000,000|
|7||2000||Spin-off: Nortel Networks Corporation||59,974,000,000|
|8||2002||Pfizer Inc.||Pharmacia Corporation||59,515,000,000|
|9||2004||JPMorgan Chase & Co.||Bank One Corporation||58,761,000,000|
|10||2008||InBev Inc.||Anheuser-Busch Companies, Inc.||52,000,000,000|
Other notable M&A deals from 2010 to 2014 include:
|Year||Purchaser||Purchased||Transaction value (in USD)|
|2013||Berkshire Hathaway||H. J. Heinz Company||28,000,000,000|
|2013||Microsoft Corporation||Nokia Handset & Services Business||7,200,000,000|
|2014||Comcast||Time Warner Cable||45,200,000,000|