What are Mergers and Acquisitions (M&A)? All about their structure and types

Merger and acquisition (M&A) is the process through which two or more companies come together to form a single entity. This article serves as a comprehensive guide to M&A, explaining the distinctions between mergers and acquisitions, as well as providing answers to commonly asked questions.

What are mergers and acquisitions?

To understand the concept of mergers and acquisitions, let’s delve deeper into each term. M&A refers to the process in which two companies merge to create a new entity that assumes both their assets and liabilities. This can occur in two ways:

• Acquisition: One company purchases another.
• Merger: Two companies combine to form a new entity.

The primary difference lies in the fact that a merger involves the formation of a new entity, while an acquisition results in one company taking over another, causing the acquired company to cease to exist. However, the terms “merger” and “acquisition” are often used interchangeably.

Understanding mergers and acquisitions

Now that we have defined M&A, let’s examine some real-world examples. A notable acquisition example is Facebook’s purchase of WhatsApp in 2014. On the other hand, the merger between 21st Century Fox and Disney serves as an example of two companies joining forces to become one corporation.

Key differences between mergers and acquisitions

In a merger, both companies involved are on equal footing, aiming to achieve synergy. In contrast, an acquisition typically involves one larger firm acquiring a smaller one, holding a dominant position.

In a merger, companies come together to form a new entity, while in an acquisition, one company takes over another, leading to the latter’s dissolution. Despite the perception of being aggressive, acquisitions help expand businesses by gaining access to new markets or technology.

In a merger, both companies must relinquish some of their identity, whereas in an acquisition, the acquiring company maintains its distinctiveness.

Types of mergers and acquisitions

Let’s explore the various types of mergers and acquisitions.

Merger

The purpose of a merger is to create value for shareholders by combining two companies or businesses. This can be achieved through the acquisition of one company by another or through a joint venture. The resulting entity typically adopts the name of one of the original companies and continues operating under that brand.

Acquisition

An acquisition involves one company purchasing another, resulting in the acquirer obtaining a majority stake in the target firm. The objective of an acquisition is to expand the product line, market share, or geographic reach.

There are several types of acquisitions, which we will discuss in detail below.

Consolidations

A consolidation, often referred to as a “true merger,” occurs when two companies combine to form a larger and more efficient entity. The new firm gains a stronger market position and can leverage economies of scale. Additionally, the structures of the previous organizations cease to exist.

Tender offers

A tender offer is a public offer to purchase a company’s outstanding stocks at a fixed price. Shareholders have a specific period to accept or reject the offer. If the majority of shareholders accept the offer, the buyer acquires the company. If not, the target company remains independent.

Acquisition of assets

In an asset acquisition, a company purchases the assets of another company. Payment is typically made in cash, debt, or shares of the buyer’s company. This type of acquisition does not require approval from the target company’s shareholders. Asset acquisitions are often used by companies to settle debts or during bankruptcy.

Management acquisitions

A management acquisition, also known as a management buyout (MBO), occurs when the management team purchases the company they work for. This decision is driven by the belief that the managers can run the business more effectively and make it more profitable. Private equity firms often assist in the process, with the management team contributing a portion of the funds and the firm providing the rest.

Purchase mergers

Purchase mergers take place when one company acquires another entirely. In this scenario, the target organization ceases to exist as a separate entity. Despite the name, purchase mergers are typically friendly transactions.

Consolidation mergers

Consolidation mergers involve two companies merging to form a completely new entity with its own stock. These mergers are often pursued to reduce competition or expand market share. Additionally, cost savings can be achieved through economies of scale resulting from the combination of the two companies.

How mergers are structured

Mergers can be structured in different ways depending on the type of merger. There are six main types:

1. Horizontal mergers:

This occurs when two companies in the same business and competing with each other decide to combine. The purpose of this merger is to eliminate competition and potentially increase prices.

2. Vertical mergers:

This type of merger involves two companies in different parts of the same supply chain coming together. For example, a company that manufactures car parts merging with a company that assembles automobiles.

3. Conglomerate mergers:

In this type of merger, two companies from completely different industries combine. For instance, a soft drink manufacturer merging with an airplane manufacturing company.

4. Con-generic mergers:

This merger occurs when two companies offer similar products or services to the same market. For example, two banks merging.

5. Market-extension mergers:

This type of merger involves two companies that offer the same products or services but to different markets. For example, a soft drink company in the United States merging with one in Europe.

6. Product-extension mergers:

This merger occurs when two companies that offer different products or services to the same market combine. For example, a soft drink company merging with a bottled water company.

How acquisitions are financed

Acquisitions are typically financed through a combination of cash and debt. For example, if a company wants to acquire another company for $2 billion and has $1 billion in cash, it would need to borrow the remaining $1 billion.

Financing can be done through issuing bonds, which would be paid back over time using the acquired company’s profits. If borrowing is not sufficient, the acquiring company may need to sell assets, such as property or another subsidiary it owns.

Another financing option is using stock. For instance, Company A can offer its stock in exchange for acquiring all the stock of Company B.

How mergers and acquisitions are valued

When valuing a company during an acquisition, several methods are commonly used:

1. Price-to-earnings ratio (P/E ratio):

This method values a company based on its earnings. For example, if Company A has a P/E ratio of 10 and earned $10 million last year, it would be valued at $100 million.

2. Discounted cash flow (DCF):

This method looks at a company’s projected future cash flows and discounts them back to their present value. It considers the total value of all future cash flows.

3. Enterprise-value-to-sales ratio:

This method compares a company’s market value to its sales. For example, if Company A has a market value of $100 million and sales of $50 million, its EV/S ratio would be 2.

4. Replacement cost:

This method estimates the cost of replacing a company’s assets. For example, if it would cost $100 million to replace Company A’s assets and the company has a market value of $150 million, the replacement cost is 66.7%.

Frequently Asked Questions

To further understand mergers and acquisitions, let’s address some frequently asked questions:

How do mergers differ from acquisitions?

The main difference is that a merger creates a new company, while an acquisition involves one company taking over another. In a merger, two companies come together to form a new entity, often to expand product lines or geographic reach.

Why do companies keep acquiring other companies through M&A?

Companies may seek to acquire other firms for various reasons, including expanding product lines or geographic reach, gaining access to new technology or intellectual property, achieving economies of scale, eliminating competition, or diversifying their business portfolios.

What is a hostile takeover?

A hostile takeover occurs when a company tries to acquire another without the approval of the target firm’s board of directors. It can involve bidding wars, proxy fights, and lawsuits. The hostile company aims to gain control of the target business by buying up its shares or making a tender offer. This type of takeover can result in a loss of control and potentially lead to job losses.

How does M&A activity affect shareholders?

M&A activity has a significant impact on shareholders. When a company is being acquired, the shareholders of that company usually experience a substantial increase in the value of their shares. This occurs because the shares of the target firm become more valuable after the merger takes place.

Conversely, shareholders of the acquiring company typically see a decrease in the value of their shares. This is because the company must take on a significant amount of debt to finance the merger.

In some instances, shareholders of both companies may experience a decrease in the value of their shares. This can happen if the merger does not go as planned, resulting in the new company being less valuable than the two separate companies were before the merger.

What is the difference between a vertical and horizontal merger or acquisition?

In a vertical merger or acquisition, the businesses involved operate in the same industry but at different stages of the production process. For example, a tire manufacturing company may merge with a vehicle manufacturing company.

On the other hand, a horizontal merger or acquisition involves businesses in the same industry and at the same stage of production. For instance, two tire manufacturing companies may decide to merge.

Conclusion

M&A stands for Mergers and Acquisitions, which are terms commonly used interchangeably in the business world. However, there is a distinction between the two. A merger occurs when two companies combine to form one, while an acquisition refers to one firm taking over another.

Companies employ M&A strategies and activities to foster growth in their businesses. The primary objectives behind these activities include expanding market share, diversifying the product line, and entering new markets.