What are mergers and acquisitions (M&A)?
In general, M&A (mergers and acquisitions) are transactions between two companies that combine in some form. These transactions include , for example, mergers, takeovers, consolidations,takeover bids, assetpurchases and management takeovers. The term M&A also refers to the departments of financial institutions that deal with such activities. Although the terms “merger” and “acquisition” are often used interchangeably, they have different legal meanings. In a merger, two companies, usually of a similar size, come together to form a new entity. A takeover, on the other hand, is when a larger company acquires a smaller company and thus absorbs the business of the smaller company. Takeovers can be friendly or hostile, depending on whether the board of the target company agrees.
Types of M&A
The following explains some of the transactions that fall under the term M&A.
Mergers
When companies merge, the process is decided by the Board of Directors. The merger requires the approval of the shareholders. The merging companies are often of a similar size. A new company is created and new shares are issued. In other words, a merger is an agreement that combines two existing companies into one new company. Mergers are usually carried out to increase a company’s reach, expand into new segments or gain market share. All of this is done to increase the value of the company.
Example: Both Daimler-Benz and Chrysler ceased to exist when the two companies merged and a new company, DaimlerChrysler, was formed. The shares of both companies were returned and new company shares were issued in their place.
Acquisitions/takeovers
A takeover occurs when a company acquires most or all of the shares in another company in order to gain control of that company. The acquisition of more than 50% of the shares and other assets of a target company allows the acquirer to make decisions about the newly acquiredassets without the consent of the company’s other shareholders. Takeovers, which are very common in business, can take place with the consent of the target company or despite its rejection. In the case of consent, there is often a no-shop clause during the process. A no-shop clause is a clause in an agreement between a seller and a potential buyer that prevents the seller from soliciting a purchase offer from another party.
Consolidation
Consolidation involves the creation of a new company by merging the core businesses and abandoning the old corporate structures. The shareholders of both companies must approve the consolidation and receive ordinary shares in the new company following approval.
Tender offers
A tender offer is an offer to buy some or all of a company’s shares. Tender offers are usually made publicly and invite shareholders to sell their shares at a certain price and within a certain time window. The price offered is usually a premium to the market price and often depends on a minimum or maximum number of shares sold.
An offer is an invitation to submit bids for a project or the acceptance of a formal offer, e.g. a takeover bid. An exchange offer is a special type of takeover offer in which securities or other non-cash alternatives are offered in exchange for shares.
Example: On April 13, 2022, Elon Musk offered to acquire all of Twitter’s common stock at a price of $54.20 per share in order to launch a hostile takeover bid that valued the company at $43 billion. Twitter’s board responded with a shareholder rights plan that provides for dilution of Musk’s ownership if he acquires more than 15% of the company’s common stock.
Management buyout
A management buyout (MBO) is a transaction in which the management team of a company acquires the assets and operations of the company it manages. A management buyout is attractive to professional managers because, as owners of the company, they have more opportunities and control than employees.
Acquisition of assets
In an asset acquisition strategy, a company acquires another company by purchasing its assets, as opposed to a traditional acquisition strategy, which involves the purchase of shares. The company whose assets are to be acquired must obtain the approval of its shareholders. The acquisition of assets is typical in bankruptcy proceedings where other companies bid for various assets of the bankrupt company, which is liquidated after the assets are finally transferred to the acquiring companies.
The structure of mergers
Mergers can be structured in different ways depending on the relationship between the two companies involved:
- A horizontal merger takes place between two companies that operate in similar sectors. The companies can be in competition, but this does not necessarily have to be the case.
- A vertical merger takes place between a company and its supplier or a customer along its supply chain. The company wants to move up or down in its supply chain and thus consolidate its position in the industry.
- Congeneric mergers: Two companies that operate in the same industry but have different businesses serving the same customer base in different ways, e.g. a television manufacturer and a cable provider. It is therefore a company in the same industry but with different product lines.
- Conglomerate: In contrast to a congeneric merger, the two companies in a conglomerate do not have similar business activities. Theoretically, the companies have no overlaps and are therefore not in competition. However, the companies do have something in common, for example in terms of technology, production or research.
- Merger for market expansion: Two companies that sell the same products in different markets.
- Merger for product expansion: Two companies that sell different but related products on the same market.
Reasons for M&A
Mergers and acquisitions (M&A) can take place for various reasons, e.g:
- Synergy effects: The merged company is worth more than the two individual companies. Synergies can be achieved through cost reductions or higher revenues. Cost synergies result from economies of scale, while revenue synergies usually arise from cross-selling, increasing market share or higher prices.
- Growth: Inorganic growth through M&A is usually a faster way for a company to achieve higher revenues than organic growth. A company can benefit by acquiring or merging with a company with the latest capabilities without having to take the risk of developing them internally.
- Market power and competition: In a horizontal merger, the resulting company achieves a higher market share and gains the power to influence prices. Vertical mergers also lead to greater market power, as the company can better control its supply chain and thus prevent external supply shocks.
- Diversification: Companies operating in cyclical industries need to diversify their cash flows to avoid significant losses in the event of a downturn in their industry. By acquiring a company in a non-cyclical industry, a company can diversify and reduce its market risk.
- Tax advantages: Tax advantages are examined if a company generates a high taxable income while another company has tax loss carryforwards. Acquiring the company with the tax losses allows the acquirer to use the tax losses to reduce its tax liability. However, mergers are usually not only carried out to avoid taxes.
The payment of M&A
There are two types of payment – shares and cash. In many cases, however, a combination of both is used in mergers and acquisitions, which is known as a mixed offer.
In a share offer, the acquirer issues new shares that are paid to the shareholders of the target company. The number of shares received is based on an exchange ratio that is determined in advance due to share price fluctuations.
In a cash offer, the acquirer simply pays cash in return for the shares of the target company.
Another form of acquisition, known as a reverse merger, allows a private company to go public in a relatively short period of time. Reverse mergers take place when a private company that has good prospects and is seeking financing buys a publicly traded shell company with no legitimate operations and limited assets. The private company merges with the listed company and together they become an entirely new public company with tradable shares.
The impact of M&A activities on shareholders
In general, the shareholders of the acquiring company will see a temporary drop in share value in the days leading up to a merger or takeover. At the same time, the shares of the target company usually increase in value. This is often due to the acquiring company having to spend capital to acquire the target company at a premium to pre-acquisition share prices. After a merger or acquisition has officially become effective, the share price usually exceeds the value of the respective company in the pre-acquisition phase. If favorable economic conditions prevail, the shareholders of the merged company usually benefit from favorable long-term performance and dividends.
It should be noted that the shareholders of both companies may experience a dilution of their voting rights due to the increased number of shares released during the merger process. This phenomenon occurs primarily in share mergers when the new company offers its shares in exchange for shares in the target company at an agreed exchange price. The shareholders of the acquiring company only lose a small amount of voting rights, while the shareholders of a smaller target company may experience a significant erosion of their voting rights in the relatively larger pool of stakeholders.