Introduction
In the business world, growth is essential for survival. There are a few ways to achieve growth, but one of the most common and effective is through mergers and acquisitions (M&A). M&A can be defined as “a general term used to describe the consolidation of companies or assets through various types of financial transactions.”
M&A can be an effective way to grow a company quickly. When done correctly, it can add new products or services, new technologies, new talent, and new customers. It can also help a company enter new markets or expand its footprint in existing markets. And while there are risks associated with M&A, such as overpaying or integrating two cultures that clash, the potential rewards make it a strategy that is often worth pursuing.
For CEO’s, M&A can be an attractive option because it allows them to make transformative changes to their companies without having to go through the time-consuming and often difficult process of organically growing their businesses. Additionally, M&A can help CEO’s boost their stock prices and increase shareholder value.
Common Reasons for Pursuing M&A
There are many reasons why companies pursue M&A transactions. Some common reasons include:
1. To enter new markets
2. To expand into adjacent markets
3 .To acquire complementary products or services
4 .To acquire technology or other intellectual property
5 .To gain access to new talent
6 .To boost growth
7 .To enhance shareholder value
8 .To increase market share
9. To achieve economies of scale
10.To reduce competition
11.To diversify revenue sources
12.To hedge against macroeconomic trends
In addition to the reasons above, there are often more personal motivations for why CEO’s pursue M&A. For example, some CEO’s may feel pressure to grow their companies quickly in order to meet the expectations of shareholders or board members. Others may view M&A as a way to make a “transformational” change to their company that will help it better compete in the future. Additionally, some CEO’s may simply feel that M&A is the best way to grow their company given the current market conditions.
Types of M&A Transactions
The following are some common transaction types that fall under the M&A umbrella.
1. Mergers: A merger occurs when two companies combine to form a new company. The shareholders of each company receive shares in the new company in exchange for their shares in the old company.
2. Acquisitions: An acquisition occurs when one company buys another company. The shareholders of the acquired company receive cash or shares in the acquiring company in exchange for their shares in the old company.
3. Consolidations: A consolidation occurs when two or more companies combine to form a new company, but unlike a merger, the shareholders of the old companies do not receive any equity in the new company. Instead, they receive cash or debt instruments.
4. Divestitures: A divestiture occurs when a company sells all or part of its business through an asset sale, share sale, spin-off, or some other type of transaction.
5. Tender Offers. In a tender offer, one business offers to buy the other company's outstanding shares for a fixed price rather than the market price. The purchasing business makes the offer directly to the shareholders of the other company, bypassing management and the board of directors.
6. Asset Acquisition. In an asset acquisition, one business directly acquires the assets of another. The corporation whose assets are being acquired must gain shareholder approval. During a bankruptcy case, other businesses bid on different assets of the bankrupt company, which is liquidated following the ultimate transfer of assets to the purchasing corporations.
7. Management Acquisitions. A management acquisition, also known as a management-led buyout (MBO), occurs when a business's leaders acquire a majority share in another company and take it private. In order to assist finance a deal, these former executives often collaborate with a financier or former corporate officials. Such mergers and acquisitions are often funded disproportionately with debt, and they must be approved by a majority of shareholders. For example, Dell Corporation announced in 2013 that it had been acquired by its founder, Michael Dell.
The type of transaction that makes sense for a given situation depends on a variety of factors such as the strategic objectives of the companies involved, regulatory considerations, tax implications, and shareholder preferences.
How Mergers Are Structured
Mergers may be arranged in a variety of ways, depending on the connection between the two firms participating in the transaction:
Horizontal merger: A merger between two firms that compete in the same product lines and marketplaces.
A vertical merger involves a client and a firm, or a supplier and a company. Consider an ice cream manufacturer acquiring a cone provider.
Congeneric mergers include two companies that service the same customer base in different methods, such as a TV maker and a cable provider.
A market-extension merger occurs when two firms offer the same items in separate markets.
A product-extension merger occurs when two firms offer distinct but related items in the same market.
Conglomeration: Two firms with no common business sectors.
How Are Acquisitions financed?
A corporation may purchase another firm using cash, stock, debt assumption, or a mix of the three. In smaller transactions, it is also usual for one firm to purchase all of the assets of another company. Company X purchases all of Company Y's assets for cash, leaving Company Y with just cash (and debt, if any). Of course, Company Y becomes a shell and will ultimately liquidate or explore other markets.
A reverse merger is another kind of acquisition arrangement that allows a private firm to become publicly traded in a very short amount of time. Reverse mergers occur when a private corporation with promising prospects and a strong need for finance acquires a publicly traded shell company with no actual business activities and little assets. The private firm reverses its merger with the public company, and the two companies combine to form an entirely new public corporation with marketable shares.
How are mergers and acquisitions valued?
Both firms on either side of an M&A transaction will place a different value on the target company. The seller will undoubtedly value the firm at the greatest possible price, while the buyer will want to purchase it at the lowest feasible price. Fortunately, a firm may be objectively valued by researching similar companies in a sector and depending on the measures listed below.
P/E Ratio (Price-to-Earnings Ratio)
An acquiring business uses a price-to-earnings ratio (P/E ratio) to make an offer that is a multiple of the target company's earnings. Examining the P/E multiples for all companies in the same industry group will provide the acquiring business with a solid indication of what the target's P/E multiple should be.
Enterprise-Value-to-Sales (EV/Sales) Ratio
The purchasing corporation uses an enterprise-value-to-sales ratio (EV/sales) to make an offer as a multiple of revenues while keeping in mind the price-to-sales (P/S ratio) of competing companies in the industry.
Discounted Cash Flow (DCF)
A discounted cash flow (DFC) analysis, a major valuation method in M&A, calculates a company's present value based on its expected future cash flows. Forecasted free cash flows are discounted to present value using the company's weighted average cost of capital (net income + depreciation/amortization (capital expenditures) change in working capital) (WACC). To be sure, DCF is difficult to master, but few tools can compete with it.
Replacement Cost
Acquisitions are often predicated on the cost of replacing the target firm. Assume that the value of a corporation is just the sum of its equipment and personnel expenses. The purchasing business may essentially command the target to sell at that price, or it will develop a competition at the same cost.
Naturally, assembling strong management, acquiring land, and purchasing the necessary equipment takes time. This approach of determining a price makes little sense in a service business when the essential assets (people and ideas) are difficult to value and grow.
Frequently Asked Questions
How Do Mergers Differ From Acquisitions?
In a merger, two companies come together to form a new company. The shareholders of each company receive shares in the new company in exchange for their shares in the old company. In an acquisition, one company buys another company. The shareholders of the acquired company receive cash or shares in the acquiring company in exchange for their shares in the old company.
What Is the Difference Between a Vertical and Horizontal Merger or Acquisition?
Horizontal and vertical integration are competitive techniques used by businesses to strengthen their position among rivals. The acquisition of a similar firm is an example of horizontal integration. A firm that chooses horizontal integration will purchase another company that works at the same level of an industry's value chain, such as when Marriott International, Inc. acquired Starwood Hotels & Resorts Worldwide, Inc.
Vertical integration is the acquisition of company activities within the same industrial vertical. Vertical integration means that a corporation has total control over one or more stages of a product's manufacturing or distribution. Apple, for example, purchased AuthenTec, which manufactures the touch ID fingerprint sensor technology used in iPhones.
What Is the Difference Between a Tender Offer and an Asset Acquisition?
In a tender offer, one business offers to buy the other company's outstanding shares for a fixed price rather than the market price. The purchasing business makes the offer directly to the shareholders of the other company, bypassing management and the board of directors. In an asset acquisition, one business directly acquires the assets of another. The corporation whose assets are being acquired must gain shareholder approval. During a bankruptcy case, other businesses bid on different assets of the bankrupt company, which is liquidated following the ultimate transfer of assets to the purchasing corporations.
What Is a Management Acquisition?
A management acquisition, also known as a management-led buyout (MBO), occurs when a business's leaders acquire a majority share in another company and take it private. In order to assist finance a deal, these former executives often collaborate with a financier or former corporate officials. Such mergers and acquisitions are often funded disproportionately with debt, and they must be approved by a majority of shareholders. For example, Dell Corporation announced in 2013 that it had been acquired by its founder, Michael Dell.
What Is a Reverse Merger?
A reverse merger is the process by which a private company acquires a public company so that the private company can become public without going through an initial public offering (IPO). In a reverse merger, the shares of the private company are exchanged for the shares of the public company, and the resulting entity is typically renamed. The management team of the private company usually remains in place following the transaction.
What Are Some Examples of Recent Biggest Acquisitions?
Some notable acquisitions that have occurred in recent years include:
- In 2022, Elon Musk's SpaceX acquired Starlink, a subsidiary of Satellite industry for $73 Billion.
- In 2020, Google's acquisition of Looker, a data analytics company, for $2.6 Billion
- In 2019, Salesforce's acquisition of Slack, a messaging platform used by businesses, for $27.7 Billion
- In 2018, Walt Disney Company's acquisition of 21st Century Fox, a media conglomerate, for $71.3 Billion.
What Are Some Criticisms of Mergers and Acquisitions?
Mergers and acquisitions can be controversial. Some believe that they lead to monopolies, while others argue that they help businesses become more efficient. There are also concerns that companies may use mergers and acquisitions to avoid regulation or hide financial problems. Additionally, some workers may lose their jobs as a result of a merger or acquisition.
What Is a Hostile Takeover?
A hostile takeover is an unsolicited offer to buy a company. The offer is made by a bidder that is not favored by the target company's management. A hostile takeover can be accomplished through a tender offer or by going directly to the target company's shareholders. In order to succeed, the bidder must gain the support of a majority of the target company's shareholders. Hostile takeovers often occur when the target company's stock price is undervalued. They can also occur when the bidder believes that it can improve upon the target company's management and operational efficiencies.
What Is a White Knight?
A white knight is a friendly acquirer that comes to the aid of a target company in order to fend off an unwanted hostile takeover bid. A white knight may be another company or a group of investors that have friendly relations with the target company. White knights often offer a higher price for the target company than the hostile bidder. In addition, a white knight's offer is usually more favorable to the target company's management and shareholders.
What Is a Poison Pill?
A poison pill is a tactic used by a target company to make itself less attractive to a potential acquirer. Poison pills are typically used in situations where a hostile takeover is feared. There are two types of poison pills:
-The shareholder rights plan, also known as a "flip-in" provision, gives existing shareholders the right to buy additional shares at a discount if an outsider acquires a certain percentage of the company's shares. This dilutes the ownership stake of the hostile bidder and makes an acquisition more difficult and expensive.
-The board rights plan, also known as a "flip-over" provision, entitles shareholders to buy shares of the acquirer at a discount if the hostile takeover is successful. This makes an acquisition more expensive for the bidder.
What Is a Golden parachute?
A golden parachute is a severance package that is typically given to a company's top executives in the event of a change in control of the company. Golden parachutes usually include generous severance payments and other benefits, such as continuation of health insurance coverage. They are often used to discourage hostile takeovers. Golden parachutes can also be used to entice executives to stay with a company during a period of transition or uncertainty.
What Is Greenmail?
Greenmail is a premium that a potential acquirer pays to a target company in order to persuade the target to agree to be acquired. Greenmail can also refer to the payment that a target company pays to an unwanted bidder in order to dissuade the bidder from pursuing an acquisition. Greenmail payments are often seen as controversial because they can discourage other potential bidders from making offers for the company. In addition, greenmail payments can be used to entrench existing management and discourage shareholder activism.
What Is a Tender Offer?
A tender offer is an offer to buy a certain number of shares of a company's stock at a fixed price. Tender offers are often used in hostile takeover situations. Tender offers must be registered with the SEC and are subject to numerous regulations. In order to be successful, a tender offer must be accepted by a majority of the target company's shareholders.
What Is a Proxy Fight?
A proxy fight is a contested election for a corporation's board of directors. Proxy fights are often used as a tactic in hostile takeover situations. In order to win a proxy fight, the bidder must persuade a majority of the target company's shareholders to vote for its slate of directors. Proxy fights can be costly and time-consuming, and they often result in negative publicity for the companies involved.
What Is a Golden Share?
A golden share is a special class of stock that gives the holder veto power over certain corporate actions. Golden shares are often used by governments to protect strategic industries from being acquired by foreign investors. Golden shares can also be used by controlling shareholders to entrench their position and discourage takeover bids. Golden shares typically have limited voting rights and do not entitle the holder to receive dividends.
What Is a White Knight?
A white knight is a potential acquirer that is welcomed by the target company. White knights are often seen as more favorable acquirers than hostile bidders because they typically offer better terms to the target company. In addition, white knights are usually less threatening to the target company's management and employees. White knights are often used as a tactic to ward off hostile takeover bids.
What Is a Pac-Man Defense?
A Pac-Man defense is a tactic that is used to ward off hostile takeover bids. In a Pac-Man defense, the target company initiates its own bid for the acquirer. This has the effect of making the target company less attractive to potential acquirers and discourages hostile bids. Pac-Man defenses are often seen as controversial because they can result in the overpayment for the acquirer.
What Is a Lockup Agreement?
A lockup agreement is a contract that restricts the ability of shareholders to sell their shares. Lockup agreements are often used in initial public offerings (IPOs) to prevent shareholders from selling their shares immediately after the IPO. Lockup agreements typically last for 180 days or more. After the lockup period expires, shareholders are free to sell their shares.
What Is a Standstill Agreement?
A standstill agreement is a contract between two companies that limits the ability of one company to take certain actions. Standstill agreements are often used in takeover situations. In a standstill agreement, the target company agrees not to take certain actions, such as issuing new shares or selling assets. Standstill agreements typically last for a period of one to three years.
What Is a Poison Put?
A poison put is a defensive tactic that is used to make a company less attractive to potential acquirers. A poison put gives the holders of a particular class of shares the right to sell their shares back to the company at a predetermined price. Poison puts are often used in hostile takeover situations.
What Is an Auction Process?
An auction process is a method of selling a company that is used in takeover situations. In an auction process, potential acquirers submit sealed bids to the target company. The target company then selects the highest bidder and enters into exclusive negotiations with that bidder. Auction processes are often used in hostile takeover situations.
What Is a Sandbag?
A sandbag is a tactic that is used to make a company less attractive to potential acquirers. A sandbag generally involves the target company taking on debt or issuing new shares. This has the effect of making the target company less attractive to potential acquirers and discourages hostile takeover bids. Sandbagging is often seen as a controversial tactic because it can result in the overpayment for the target company.
What Is a Targeted Share Repurchase?
A targeted share repurchase is a program whereby a company buys back shares from selected shareholders. Targeted share repurchases are often used in takeover situations. In a targeted share repurchase, the target company buys back shares from shareholders that it believes are supportive of the company. This has the effect of making the target company less attractive to potential acquirers and discourages hostile takeover bids.
What Is a White Knight?
A white knight is a company that comes to the rescue of a target company in a hostile takeover situation. A white knight generally offers to buy the target company at a price that is higher than the hostile bidder's offer. This has the effect of making the target company less attractive to potential acquirers and discourages hostile takeover bids. White knights are often seen as friendly acquirers because they typically have the support of the target company's management.
What Is a Crown Jewel Defense?
A crown jewel defense is a tactic that is used to make a company less attractive to potential acquirers. A crown jewel defense generally involves the target company spinning off or selling its most valuable assets. This has the effect of making the target company less attractive to potential acquirers and discourages hostile takeover bids. Crown jewel defenses are often seen as controversial tactics because they can result in the overpayment for the target company.
Conclusion
Mergers and acquisitions (M&A) are significant events in the life of any public company—and they should be given careful consideration by CEO’s before proceeding. There are many reasons why companies pursue M&A transactions, but not all deals are created equal—an acquisition that doesn’t align with a company’s overall strategy is unlikely to be successful and could even jeopardize the future of the business.
CEOs should carefully consider their motivations for pursuing M&A before moving forward with any particular deal—an acquisition that doesn’t align with a company’s overall strategy is unlikely to be successful and could even jeopardize the future of the business.
