The term mergers and acquisitions (M&A) refers to the consolidation of companies or their major business assets through financial transactions between companies. A company may purchase and absorb another company outright, merge with it to create a new company, acquire some or all of its major assets, make a tender offer for its stock, or stage a hostile takeover.
M&A activities are also indicative of divisions within financial institutions that deal in such undertakings.
Key Takeaways
- The terms “mergers” and “acquisitions” are often used interchangeably, but they differ in meaning.
- In an acquisition, one company purchases another outright.
- A merger is the combination of two firms to form a new legal entity under one corporate name.
- Objective valuation of a company can be achieved by studying industry comparables and using financial metrics.
Understanding Mergers and Acquisitions
What is an Acquisition?
In an acquisition, one company takes over another and establishes itself as the new owner. This results in the dissolving of the target company’s corporate structure.
What is a Merger?
A merger involves two companies of approximately equal size joining forces to move forward as a single new entity. This is often referred to as a merger of equals. For example, when Daimler-Benz and Chrysler merged, the new entity was named DaimlerChrysler.
Hostile or unfriendly takeover deals, where the target company resists the acquisition, are considered acquisitions in contrast to friendly mergers. The distinction usually depends on how the deal is communicated to the target company’s board of directors, employees, and shareholders.
Types of Mergers and Acquisitions
Mergers
In a merger, the boards of directors for two companies approve the combination and seek shareholders’ approval. For instance, the merger between the Digital Equipment Corporation and Compaq, whereby Compaq absorbed Digital Equipment, eventually combining with Hewlett-Packard in 2002.
Acquisitions
In acquisitions, the acquiring company obtains a majority stake in the acquired firm. An example is Manulife Financial Corporation’s 2004 acquisition of John Hancock Financial Services.
Consolidations
Consolidation involves creating a new company by combining core businesses and abandoning prior corporate structures, like the Citicorp and Travelers Insurance Group consolidation, resulting in Citigroup.
Tender Offers
In a tender offer, a company offers to purchase outstanding stock of the other firm at a set price directly to shareholders, bypassing management and the board of directors. Example: Johnson & Johnson’s 2008 tender offer to acquire Omrix Biopharmaceuticals.
Acquisition of Assets
One company directly acquires the assets of another with shareholder approval. This often occurs in bankruptcy proceedings.
Management Acquisitions
Also known as management-led buyouts (MBOs), the company’s executives purchase a controlling stake in another company, taking it private. Example: Dell Corporation’s 2013 buyout by its founder Michael Dell.
How Mergers Are Structured
Mergers can be distinguished by their structure and financing:
- Horizontal merger: Between companies in direct competition with similar product lines and markets.
- Vertical merger: Between a customer and a company or a supplier and a company.
- Congeneric mergers: Between businesses serving the same consumer base in different ways.
- Market-extension merger: Between companies selling the same products in different markets.
- Product-extension merger: Between companies selling different but related products in the same market.
- Conglomeration: Between companies with no common business areas.
Purchase Mergers
Occurs when one company purchases another, often with cash or debt. The sale is taxable, benefiting acquiring companies via tax benefits.
Consolidation Mergers
A brand-new company is formed, combining both companies under a new entity. Tax terms are similar to those in purchase mergers.
How Acquisitions Are Financed
Financing an acquisition can include cash, stock, assumption of debt, or combinations thereof. Financing may sometimes be facilitated by an investment bank involved in the transaction.
In smaller deals, it’s common for one company to acquire all another company’s assets, resulting in the target becoming a shell and eventually liquidating or entering new business areas.
Reverse Merger
A private company acquires a publicly listed shell company to become publicly listed within a short period.
How Mergers and Acquisitions Are Valued
Valuing an M&A target involves different metrics:
Price-to-Earnings Ratio (P/E Ratio)
An acquirer makes an offer based on a multiple of the target’s earnings by examining P/E ratios within the same industry.
Enterprise-Value-to-Sales Ratio (EV/Sales)
Offer made as a multiple of revenues, noting the price-to-sales ratio among industry companies.
Discounted Cash Flow (DCF)
Determines a company’s current value based on projected future cash flows.
Replacement Cost
Valuation based on how much it would cost to replicate the target company’s infrastructure and business operations.
Frequently Asked Questions (FAQs)
How Do Mergers Differ From Acquisitions?
An acquisition involves one firm absorbing another via a takeover, whereas a merger describes a mutual combination to form a new entity.
Why Do Companies Keep Acquiring Other Companies Through M&A?
Motivations include eliminating competition, obtaining new product lines, intellectual property, human capital, customer bases, and achieving synergies for greater efficiency and lowered costs.
What Is a Hostile Takeover?
A hostile takeover occurs when the target company resists the acquisition, prompting the acquiring firm to actively purchase stakes to gain control.
How Does M&A Activity Affect Shareholders?
Shareholders of the acquiring firm might see a short-term drop in stock value, while shareholders of the target firm might experience gains.
What Is the Difference Between a Vertical and Horizontal Merger or Acquisition?
Horizontal integration: Absorbing a related business.
Vertical integration: Taking control over one or more stages in the supply chain, such as acquiring suppliers or distributors negligently.
Related Terms: merger, acquisition, hostile takeover, friendly acquisition, horizontal merger, vertical merger.
References
- Daimler. “Company History”.
- Mercedes-Benz Group. “Daimler Embarks on a New Era as Mercedes-Benz Group”.
- McKinsey & Company. “Done Deal? Why Many Large Transactions Fail to Cross the Finish Line”.
- U.S. Securities and Exchange Commission. “Compaq Computer Corporation, Form Q-10, For the Quarterly Period Ended September 30, 1999”. Page 6.
- Hewlett-Packard Company Archives. “A Pact With Compaq”.
- Manulife Financial. “Manulife Financial and John Hancock Complete Merger Creating North America’s Second Largest Life Insurance Company”.
- Federal Reserve System. “Federal Reserve Press Release, September 23, 1998”.
- U.S. Securities and Exchange Commission. “Tender Offer”.
- U.S. Securities and Exchange Commission. “Offer to Purchase for Cash All Outstanding Shares of Common Stock of Omrix Biopharmaceuticals, Inc. at $25.00 Net per Share by Binder Merger Sub, Inc., a Wholly-Owned Subsidiary of Johnson & Johnson”.
- Fierce Biotech. “Johnson & Johnson Completes Acquisition of Omrix Biopharmaceuticals, Inc”.
- Dell. “Open Letter to Shareholders From Michael Dell”.
- Marriott International. “Marriott International Completes Acquisition of Starwood Hotels & Resorts Worldwide, Creating World’s Largest and Best Hotel Company While Providing Unparalleled Guest Experience”.
- U.S. Securities and Exchange Commission. “AuthenTec, Inc., Form 8-K, July 26, 2012”.
