Acquisitions
An acquisition, also known as a takeover or a buyout or "merger",
is the buying of one company (the ‘target’) by another.
An acquisition may be friendly or hostile. In the former case, the
companies cooperate in negotiations; in the latter case, the takeover
target is unwilling to be bought or the target's board has no prior
knowledge of the offer. 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 or longer established
company and keep its name for the combined entity. This is known as
a reverse takeover. Another type of acquisition is reverse merger,
a deal that enables a private company to get publicly listed in a
short time period. A reverse merger occurs when a private company
that has strong prospects and is eager to raise financing buys a publicly
listed shell company, usually one with no business and limited assets.
Achieving acquisition success has proven to be very difficult. The
acquisition process has many dimensions influencing its outcome.
The buyer buys the shares, and therefore control, of the target
company being purchased. Ownership control of the company in turn
conveys effective control over the assets of the company, but since
the company is acquired intact as a going concern, this form of
transaction carries with it all of the liabilities accrued by that
business over its past and all of the risks that company faces in
its commercial environment. The buyer buys the assets of the target
company. The cash the target receives from the sell-off is paid
back to its shareholders by dividend or through liquidation. This
type of transaction leaves the target company as an empty shell,
if the buyer buys out the entire assets. A buyer often structures
the transaction as an asset purchase to "cherry-pick"
the assets that it wants and leave out the assets and liabilities
that it does not. This can be particularly important where foreseeable
liabilities may include future, unquantified damage awards such
as those that could arise from litigation over defective products,
employee benefits or terminations, or environmental damage. A disadvantage
of this structure is the tax that many jurisdictions, particularly
outside the United States, impose on transfers of the individual
assets, whereas stock transactions can frequently be structured
as like-kind exchanges or other arrangements that are tax-free or
tax-neutral, both to the buyer and to the seller's shareholders.
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 separately listed on a stock
exchange.
It really depends on whether the purchase is friendly or hostile
and how it is announced. In other words, the real difference lies
in how the purchase is communicated to and received by the target
company's board of directors, employees and shareholders. It is
quite normal though for M&A deal communications to take place
in a so called 'confidentiality bubble' whereby information flows
are restricted due to confidentiality agreements (Harwood, 2005).
Distinction between mergers and acquisitions
Although often used synonymously, the terms merger and acquisition
mean slightly different things.
When one company takes over another and clearly establishes itself
as the new owner, the purchase is called an acquisition. From a
legal point of view, the target company ceases to exist, the buyer
"swallows" the business and the buyer's stock continues
to be traded.
In the pure sense of the term, a merger happens when two firms
agree to go forward as a single new company rather than remain separately
owned and operated. This kind of action is more precisely referred
to as a "merger of equals". The firms are often of about
the same size. Both companies' stocks are surrendered and new company
stock is issued in its place. For example, in the 1999 merger of
Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist
when they merged, and a new company, GlaxoSmithKline, was created.
In practice, however, actual mergers of equals don't happen very
often. Usually, one company will buy another and, as part of the
deal's terms, simply allow the acquired firm to proclaim that the
action is a merger of equals, even if it is technically an acquisition.
Being bought out often carries negative connotations, therefore,
by describing the deal euphemistically as a merger, deal makers
and top managers try to make the takeover more palatable. An example
of this would be the takeover of Chrysler by Daimler-Benz in 1999
which was widely referred to in the time.
A purchase deal will also be called a merger when both CEOs agree
that joining together is in the best interest of both of their companies.
But when the deal is unfriendly - that is, when the target company
does not want to be purchased - it is always regarded as an acquisition.
Specialist M&A advisory firms
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 Transition companies, assisting businesses often
referred to as "companies in transition." To perform these
services in the US, an advisor must be a licensed broker dealer,
and subject to SEC (FINRA) regulation. More information on M&A
advisory firms is provided at corporate advisory.
Motives behind M&A
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:
Economy of scale: This refers to the fact that the combined company
can often reduce its fixed costs by removing duplicate departments
or operations, lowering the costs of the company relative to the
same revenue stream, thus increasing profit margins.
Economy of scope: This refers to the efficiencies primarily associated
with demand-side changes, such as increasing or decreasing the scope
of marketing and distribution, of different types of products.
Increased revenue or market share: This assumes that the buyer will
be absorbing a major competitor and thus increase its market power
(by capturing increased market share) to set prices.
Cross-selling: For example, a bank buying a stock broker could then
sell its banking products to the stock broker's customers, while
the broker can sign up the bank's customers for brokerage accounts.
Or, a manufacturer can acquire and sell complementary products.
Synergy: For example, managerial economies such as the increased
opportunity of managerial specialization. Another example are purchasing
economies due to increased order size and associated bulk-buying
discounts.
Taxation: A profitable company can buy a loss maker to use the
target's loss as their advantage by reducing their tax liability.
In the United States and many other countries, rules are in place
to limit the ability of profitable companies to "shop"
for loss making companies, limiting the tax motive of an acquiring
company. Geographical or other diversification: This is designed
to smooth the earnings results of a company, which over the long
term smoothens the stock price of a company, giving conservative
investors more confidence in investing in the company. However,
this does not always deliver value to shareholders (see below).
Resource transfer: resources are unevenly distributed across firms
(Barney, 1991) and the interaction of target and acquiring firm
resources can create value through either overcoming information
asymmetry or by combining scarce resources. Vertical integration:
Vertical integration occurs when an upstream and downstream firm
merge (or one acquires the other). There are several reasons for
this to occur. One reason is to internalise an externality problem.
A common example is of such an externality is double marginalization.
Double marginalization occurs when both the upstream and downstream
firms have monopoly power, each firm reduces output from the competitive
level to the monopoly level, creating two deadweight losses. By
merging the vertically integrated firm can collect one deadweight
loss by setting the downstream firm's output to the competitive
level. This increases profits and consumer surplus. A merger that
creates a vertically integrated firm can be profitable. 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:
Diversification: While this may hedge a company against a downturn
in an individual industry it fails to deliver value, since it is
possible for individual shareholders to achieve the same hedge by
diversifying their portfolios at a much lower cost than those associated
with a merger. Manager's hubris: manager's overconfidence about
expected synergies from M&A which results in overpayment for
the target company. Empire-building: Managers have larger companies
to manage and hence more power.
Manager's compensation: In the past, certain executive management
teams had their payout based on the total amount of profit of the
company, instead of the profit per share, which would give the team
a perverse incentive to buy companies to increase the total profit
while decreasing the profit per share (which hurts the owners of
the company, the shareholders); although some empirical studies
show that compensation is linked to profitability rather than mere
profits of the company. Effects on management A study published
in the July/August 2008 issue of the Journal of Business Strategy
suggests that mergers and acquisitions destroy leadership continuity
in target companies’ top management teams for at least a decade
following a deal. The study found that target companies lose 21
percent of their executives each year for at least 10 years following
an acquisition – more than double the turnover experienced
in non-merged firms.
The Great Merger Movement
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. To truly
understand how large this movement was—in 1900 the value of
firms acquired in mergers was 20% of GDP. In 1990 the value was
only 3% and from 1998–2000 it was around 10–11% of GDP.
Organizations that commanded the greatest share of the market in
1905 saw that command disintegrate by 1929 as smaller competitors
joined forces with each other. However, there were companies that
merged during this time such as DuPont, US Steel, and General Electric
that have been able to keep their dominance in their respected sectors
today due to growing technological advances of their products, patents,
and brand recognition by their customers. The companies that merged
were mass producers of homogeneous goods that could exploit the
efficiencies of large volume production. 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.
Short-run factors
One of the major short run factors that sparked in The Great Merger
Movement was the desire to keep prices high. That is, with many
firms in a market, supply of the product remains high. During the
panic of 1893, the demand declined. When demand for the good falls,
as illustrated by the classic supply and demand model, prices are
driven down. To avoid this decline in prices, firms found it profitable
to collude and manipulate supply to counter any changes in demand
for the good. This type of cooperation led to widespread horizontal
integration amongst firms of the era. Focusing on mass production
allowed firms to reduce unit costs to a much lower rate. These firms
usually were capital-intensive and had high fixed costs. Because
new machines were mostly financed through bonds, interest payments
on bonds were high followed by the panic of 1893, yet no firm was
willing to accept quantity reduction during that period.
Long-run factors
In the long run, due to the 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. This resulted in shipment directly
to market from this one location. 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 U.S. versus Addyston Pipe and Steel Co., 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.
Merger waves
The economic history has been divided into Merger Waves based on
the merger activities in the business world as:
Period Name Facet
1889 - 1904 First Wave Horizontal mergers
1916 - 1929 Second Wave Vertical mergers
1965 - 1989 Third Wave Diversified conglomerate mergers
1992 - 1998 Fourth Wave Congeneric mergers; Hostile takeovers; Corporate
Raiding
2000 - Fifth Wave Cross-border mergers
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