Mergers & Acquisitions (1/2)

In this lesson, you’re expected to learn: 
– the differences between mergers and acquisitions
– types of mergers and acquisitions
– reasons why companies engage in mergers and acquisitions

Many people associate mergers and acquisitions (M&A) with the underhand business practices of the 1980s, when methods such as hostile takeovers and the liquidation of otherwise successful companies came into prominence. This perception isn’t entirely fair though.

Still, the stereotype that the M&A industry is filled with corruption is an idea perpetuated mostly by films such as Oliver Stone’s Wall Street (whose characters become involved in the hostile takeover of an airline with the intention of liquidating all its assets).

If you ask people to define exactly what M&A consists of, what an M&A firm does or why companies pursue M&A (or even what M&A stands for), the chances are that a large percentage of people can’t answer any of these questions correctly.

Mergers and acquisitions are both forms of integration between companies. Although M&A isn’t the only type of corporate integration, the term has entered popular vocabulary to cover a number of corporate integration options, despite referring to only two.

M&A can also refer to the splitting up of companies: selling, stopping or otherwise parting with operations that used to be part of a single company.

Therefore, on the whole, M&A is a field that deals with an odd trait inherent in companies — that is, their ability to combine, divide, become each other, become something else and otherwise interact in a very permeable manner with other organizations.

M&A is a complicated issue that involves a lot of consideration about the potential for a number of different things to integrate well, including the company’s operations, its managementcorporate culture, branding, marketing and distribution, and a great number of other issues.

M&A isn’t purely a financial concern, but these are all secondary considerations for executives, because they determine whether or not a merger is going to work only after they’ve already determined the potential for financial benefit.

In other words, the primary motivation for M&A is always money. After a company establishes that money’s to be made, it does all the extra work to determine whether or not it can make the most of the situation.

Need for Synergy

Having said that, a company can make money through M&A in a number of different ways. Two businesses that are individual from each other don’t stand to benefit if they integrate their two respective organizations only to keep earnings and market share between them unchanged. Some form of gain needs to exist from the synergy between the two companies.

Synergy refers to the idea that the two combined companies can gain benefits beyond what they can produce individually.

Legal Issues

As regards M&A, you have to make one big consideration: the legal position. A lot of legislation around the world says that companies can’t integrate their operations in certain ways, or sometimes at all, if doing so significantly changes competition in the industry.

If two companies decide that they want to merge, but, say, only three companies offer that particular product, the chances are that the government is going to stop them from merging, sometimes fining them for predatory business practices.

The result can be extremely expensive in terms of fines and expenditures on the M&A-in-progress, and so make sure that you assess the legal implications of any M&A before even making the attempt.

The differences between mergers, acquisitions

The differences between mergers, acquisitions and other forms of company integration can be subtle on an operational level and yet still result in significant financial differences in the long run.

These small but crucial variations in integration techniques are, more than anything, legal variances that define exactly who has ownership over what and the assets and resources to which people are entitled, including company profits.

We’ll now look at each of the most common forms of corporate integration, what makes each unique and helps you recognize the different form of corporate integration.

1) Mergers: Joining together

– A merger occurs when two companies ‘become’ each other or, more specifically, both companies cease to exist and a new company is formed out of their operations.

– The shareholders have their shares reorganized under the new company, and all operations fall under a new set of executive management, which usually consists of a combination of the management from the two individual organizations prior to the merger.

– This type of arrangement is usually considered to be a merger of equals, or a combining of companies on equal terms. In reality, though, the larger or more financially healthy company tends to assimilate the other.

Although a merger is, technically, a combination of companies to form a new one, which may imply a level legal playing field in the terms of the merger, the reality isn’t so simple.

Typically mergers tend to occur between companies where one has a dominant place in the market, allowing that company more leverage to maintain managerial control over not only the merger process, but also how operations are run after the merger is complete. This control includes how finances are managed and representation in management.

Mergers happen so frequently because of financial strategy. For companies of all sizes, certain other forms of M&A (such as a vertical acquisition, which is when a company acquires another company — for example, a large construction company may acquire a small, owner-managed builders merchants) carry negative connotations.

Calling an integration a ‘merger’ implies equality in the integration, allowing both companies to maintain a positive image and their shares’ market value. If one company is seen to be ‘acquiring’ the other, investors may infer that the acquired company was in trouble or overvalued, causing the market value of the shares to drop and reducing confidence in the newly integrated entity.

2) Acquisitions: Purchasing a company

– An acquisition differs from a merger because it doesn’t combine two companies. Instead, one company purchases the other as you’d purchase a car.

– Acquisitions are a bit more flexible than mergers in respect of the legal organization of each company, but the true hallmark of an acquisition is that one company then owns another after the acquisition process is complete.

Not all acquisitions are considered bad. When a smaller company (the target) is being acquired by a much larger company (the bidder), the latter quite frequently appreciates the value of the smaller company, especially for businesses that are already known to be in financial trouble and whose share price has dropped in value as a result.

In this case, even rumors of an acquisition can raise the price of the company’s shares, because investors believe that being acquired by a company with more assets or better management may give the struggling company the jump start it needs to be more successful, as well as the fact that for those staff in the target company who manage to survive the acquisition, it can lead to greater opportunities.

Here are two of the possible options that may influence an acquisition:

i) Organizational sovereignty: Refers to whether or not the acquired company remains a company in its own right. Remember that companies can own other companies and the acquiring company has the option merely to make the acquired company a single branch or division of its other operations as opposed to allowing it to stay an independent entity.

So, in many cases, a company may just purchase a controlling share of the acquired company’s equity (usually more than 50 per cent to gain control), giving it the ability to manage the acquired company from a distance but never fully integrating the two organisations. On the other hand, the acquired company may simply cease to exist, becoming a single division of the acquiring company.

ii) Partial acquisition: The acquiring company is required to purchase more than 50 per cent of the equity in the acquired company. This amount gives the acquiring company a controlling shareholding, allowing it to manage the acquired business however it wants. A partial acquisition does, however, limit the acquiring company’s ability to integrate completely the company’s operations, because private shareholders still remain (sometimes called minority shareholders or non-controlling interests).

In other words, in partial acquisitions, the acquired company remains a business. In a full acquisition, the acquiring company purchases the total value of the acquired company and has the option to make that company a part of its own operations.

3) Buyouts: Taking control 

A buyout occurs when one company buys a controlling shareholding in another. A buyout is very similar to the partial acquisition approach. In fact, some people argue that no difference exists, which isn’t surprising because the difference is subtle.

The primary difference between a buyout and other forms of M&A is that a controlling shareholding is used, rather than a share swap, purchase of other forms of equity or other possibilities of acquisition. So, in a buyout, a controlling share of equity is purchased.

Another subtle nuance occurs when that controlling share is purchased by borrowing more money or by having an Initial Public Offering (IPO). When a company raises additional money for the sole purpose of controlling another company, it’s called a leveraged buyout.

The use of the buyout is popular among venture capitalists (a company or third party who provides capital to high-potential, high risk or new companies) and investors, and is used for gaining control and expanding one’s operations very quickly without the intention of ever integrating those additional operations.

A buyout is sort of an arm’s-length approach, where the purchased company is expected to maintain the high degree of autonomy it always had, but the purchasing entity intends to take advantage of the increased reach or earnings potential after the buyout because it will have access to more business through more customers and more contacts.

Considering other forms of integration

At the core of all M&A is the idea of corporate integration, but companies can make corporate integration happen in several ways that aren’t technically mergers or acquisitions. To use a phrase we heard from Kent Kedl of Technomic Asia, M&A has been extended to ‘M,A&A: Mergers, Acquisitions and Alliances’.

1) Hostile Takeover

A hostile takeover is really the same thing as a regular buyout or acquisition except that it occurs without the consent of the management of the acquired company.

A hostile takeover occurs in a few ways:
– A proxy fight occurs whereby a majority of shareholders of the target company are convinced to vote out the current board of directors and replace it with a board that agrees to the takeover.
– A company buys up a controlling share of equity on the secondary market (the financial market in which previously issued shares are bought and sold).
– A company purchases the debt of a troubled company and gains control over its assets through liquidation.

In any case, the end result of a hostile takeover is the same as a normal acquisition or buyout, but it’s done by force.
2) Factoring

Factoring is a much less integrated way to integrate. It’s a one-time deal (which can be repeated in the future, but each deal takes place only once rather than being ongoing) that’s relatively short term and keeps both organizations totally independent of each other.

Factoring works by one company selling its sales ledger (that is, the record of all customers who owe the company money) to another at a discount. So, in essence, the acquiring company (known as the factoring company) is only acquiring the future cash flows on the acquired company’s trade debtors (customers who owe the business money because they’ve bought goods or services on credit), meaning that it’s purchasing part of the company’s future revenues.

Usually, the purchase price on such a deal is only 5-20% of the total value, depending on the quality of the trade debtors, trade debtor days (days the customers take to pay eventually) and other variables.

In this way, one company can acquire another’s specific operations and within a limited timeframe, instead of carrying out a permanent and total acquisition.

3) Joint ventures and partnerships

Sometimes companies want to work together on a specific operation but don’t want to merge their other operations. These joint ventures and partnerships come in several different forms.

What does matter is that the exact nature of the contributions to these agreements, as well as the allocation of earnings, are established during the contract negotiations to form the agreement.

Joint ventures and partnerships tend to be far more popular than any other form of corporate integration — usually because it gives an opportunity to go into another market and in some cases it may even be the only way in which local regulations allow you to operate in that market — but they’re also less involved in finance and more in corporate management.
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