Mergers and Acquisitions

Mergers and acquisitions (M&A) is a general term that refers to the consolidation of companies or assets. The key principle behind M&A is that two companies together are more valuable than two separate companies. For all intents and purposes, M&A simply means the buying and selling of companies.

A merger is the voluntary fusion of two companies on broadly equal terms into one new legal entity. In a merger two or more entities has an equal stake in the new enterprise and each merging entity has a very clearly defined role in the new entity. This combination is also known as “merger of equals”, because the firms that agree to merge are roughly equal in terms of size, customers, scale of operations, etc. There are two types of mergers based on how the merger is financed.

The first one is purchase mergers. This kind of merger occurs when one company purchases another. The purchase is made with cash or through the issue of some kind of debt instrument and the sale is taxable. Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company. The second one is consolidation mergers. With this merger, a brand new company is formed and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

An acquisition is a corporate action in which a company buys most or all, of another firm's ownership stakes to assume control of it. An acquisition occurs when a buying company obtains more than 50% ownership in a target company. In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or legal structure.

We can see that the two terms have a lot in common. That’s why most of the times these two terms are used interchangeably and simply both are used together as M&A. Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly (merger) or hostile (acquisition) 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.

Types of mergers and Acquisitions

• Horizontal merger

Horizontal mergers occur when two companies sell similar products to the same markets. The goal of a horizontal merger is to create a new, larger organization with more market share. Horizontal mergers are often used by companies that are in direct competition and share the same product lines and markets.

Horizontal mergers help companies gain advantages over competitors. For example, if one company sells products similar to the other, the combined sales of a horizontal merger give the new company a greater share of the market. If one company manufactures products complementary to the other, the newly merged company may offer a wider range of products to customers. Merging with a company offering different products to a different sector of the marketplace helps the new company diversify its offerings and enter new markets.

A horizontal merger of two companies already excelling in the industry may be a better investment than putting a lot of time and resources into developing the products or services separately. A horizontal merger can increase a company’s revenue by offering an additional range of products to existing customers. The business may be able to sell to different geographical territories if one of the pre-merger companies has distribution facilities or customers in areas not covered by the other company. A horizontal merger also helps reduce the threat of competition in the marketplace. In addition, the newly created company may have greater resources and market share than its competitors, letting the business exercise greater control over pricing.

Horizontal mergers raise three basic competitive problems. The first is the elimination of competition between the merging firms, which, depending on their size, could be significant. The second is that the unification of the merging firms' operations might create substantial market power and might enable the merged entity to raise prices by reducing output unilaterally. The third problem is that, by increasing concentration in the relevant market, the transaction might strengthen the ability of the market's remaining participants to coordinate their pricing and output decisions. The fear is not that the entities will engage in secret collaboration but that the reduction in the number of industry members will enhance tacit coordination of behavior.

• Vertical merger

A vertical merger is a merger occurs when two or more firms, operating at different levels within an industry's supply chain, merge operations. Two firms are merged along the value-chain, such as a manufacturer merging with a supplier. Vertical mergers are often used as a way to gain a competitive advantage within the marketplace. It happens between two companies that operate at separate stages of the production process for a specific finished product. A vertical merger, also known as a vertical integration, is a merger between a manufacturer and a supplier within the same industry. These types of mergers or integrations occur when a company seeks to reduce operating costs and increase efficiency to realize higher profits. Combining the operations of two companies allows a parent company to control the entire production cycle of a product by incorporating two businesses as a single business entity. The initial benefit is the reduction in supplier costs that leads to an increase in profitability. The second benefit is an expansion in revenue streams that also increases the bottom line.

There are two types of vertical merger strategies, backward integration and forward integration that move vertically up or down the supply chain to achieve a vertical integration. A backward integration normally occurs when a manufacturer moves up the supply chain to own the supplier of its raw materials. For example, an intermediate manufacturer that wants to reduce the costs of production can merge or acquire a supplier of materials. A forward integration happens when a company within the supply chain moves down to eliminate the middleman and get closer to the end customer. In these situations, a manufacturer normally acquires or integrates with wholesalers or distributors to control the direct sales to consumers. If, for example, the tire manufacturer wanted to increase B2B sales by selling directly to auto dealerships, it could acquire or merge with the logistics company that supplies auto dealers with the manufacturer's tires. This type of integration also reduces costs and increases profitability.

• Congeneric mergers

Congeneric mergers are those where two companies are in the same or related markets or industries but do not offer the same products. In congeneric mergers, the two companies share the same consumer base in different ways with complimentary goods. A congeneric merger can allow the two involved companies to take advantage technology or production processes in order to expand their product line or increase their market share.

• Conglomerate Mergers

A conglomerate merger occurs between two companies that are involved in totally unrelated business activities. There are two types of conglomerate mergers: a) pure and b) mixed.

Pure conglomerate mergers involve companies with nothing in common, while mixed conglomerate mergers involve companies that are looking for market extensions and product extensions. In a conglomerate merge, the two involved companies together as one entity are stronger than two separate companies. When these types of deals occur, it can upset some of the market, because it could allow a monopoly in a certain market.

There are many advantages and disadvantages of these types of mergers. To begin with advantages, the two involved companies reach a large target audience. Before the merger, the two companies were able to target only their own areas of the market, while now they can cooperate and share a bigger market share. Additionally, the risk is less because we have risk diversification. Although we have risk diversification, this can be a downfall for some companies because they can spread themselves across too many areas. Furthermore, the companies merging together have no past experience about the functionalities of each other and this can lead to mismanagement in the organization.