Merger vs. Acquisition
Former refers to the combination of two separate businesses into a new legal entity whereas the latter is the absorption of one company by another.
Mergers and Acquisitions (M&A) are often mistaken by many to be similar but have a few key differences that tend to set them apart.
Looking into the definition of mergers: it is the combination of two separate businesses into a new legal entity. In reality, it is often rare to find true mergers, as there are rarely two identical companies that stand to benefit from combining resources and synergies mutually.
Acquisitions do not result in the formation of a new company. Instead, the purchased company gets fully absorbed by the acquiring company.
This leads to the acquired company getting liquidated and operating under the acquiring company's name.
Over the past few decades, the M&A sector has seen immense growth and changes. As a result, it has become more prominent in the modern world and has played a key role in many corporate finance, advisory and consulting roles.
The most common transactions occur when a seller hires an investment bank or financial advisor to help facilitate the M&A transaction to ensure that the acquired company receives a fair value.
What is a Merger
Summary of the concept
As mentioned, it combines two separate businesses into a new legal entity. Both the acquiring and acquired firms change their legal names to be part of a new entity.
It can be broken down into three main types:
Horizontal
Vertical
Conglomerate
1. Horizontal:
This occurs when two competitors in the same industry combine. A prominent example of this was in 1998 when two of the largest oil and gas companies, Exxon and Mobil, merged to form Exxon Mobil.
The two firms combined their 75.3 billion in assets. This helps combine firm experience, resources, and synergies and increases the combined market share.
Governments often discourage mergers of such scale, as it creates a monopolistic possibility. The U.S. government tends to be more lenient and allows transactions of such size to take place, allowing many horizontal integrations to go unopposed.
While in comparison with Europe, the European Commission has traditionally been stricter in allowing such large scaled transactions to take place that may have anticompetitive effects on prominent European companies.
2. Vertical:
Vertical integrations merge companies at different levels of the supply chain, as these companies have a buyer-seller relationship.
An example of such an integration in the U.S. was within the eyeglass industry. An Italian manufacturer (Luxottica) expanded into the U.S. market through acquisitions such as Avant-Garde Optics Inc and Lenscrafters.
Given the size and scale of the transaction, it was surprising to some that the company was allowed by regulators to assume such a big market share in the U.S. eyeglasses market.
3. Conglomerate:
A conglomerate integration occurs when the companies are not competitors and do not have a buyer-seller relationship.
This often allows companies to diversify and enter new markets faster than building a new company. But unfortunately, these are the rarest forms of transactions because of their limited financial benefit and lesser market efficiency.
A prominent example of this was Philip Morris, a tobacco company, which acquired General Foods in 1985 for $5.6 billion, Kraft in 1988 for $13.44 billion, and Nabisco in 2000 for $18.9 billion.
The company later changed its name in early 2003 to Altria, allowing it to move out of being a domestic tobacco company to more of an international food conglomerate.
The reason for the transition out of the tobacco industry was because the U.S. tobacco industry has been declining at a much faster rate than the international tobacco business.
Are there any more types of mergers?
The different types are:
1. Congeneric:
It is similar to a horizontal merger to the extent that both the acquiring company and the target company are in the same industry. However, the only difference is that the companies have different product lines while catering to customers in the same market.
Such companies can benefit from sharing distribution channels, raw materials, marketing, and technology costs.
The most prominent example was the formation of Citigroup in 1998. This was when Citicorp and Travelers Group merged to form Citigroup.
In the Citigroup case, although both firms operated in the same industry (financial services), they had different product offerings: Travelers Group specialized in insurance and brokerage services, whereas Citicorp worked on banking services and credit card offerings.
2. Product Extension:
This occurs between two business organizations that deal with products related to each other and operate in the same market. In some cases, they may also be competitive with one another.
This allows the companies to group their product lines and reach a larger consumer base. It ensures that the company earns higher profits at lower costs, as they can take advantage of each other's resources and synergies.
A historical example of this was when PepsiCo acquired Pizza Hut in 1977. Pepsi Co. took advantage of Pizza Hut's nationwide customer base and popularity, allowing them to sell Pepsico products to Pizza Hut's customers.
The Pizza Hut transaction was so successful that within the same year, sales from the Pizza Hut Brand exceeded $436 million, and Pizza Hut opened a new headquarters in Kansas valued at $10 million.
3. Market Extension:
This transaction occurs when two companies with the same products operate in separate markets and merge. Such a merger often occurs to ensure that the acquiring company can access a larger market through the acquiring firm.
An example of a market extension strategy was within the financial services industry when RBC Centura acquired Eagle Bancshares Inc.
Eagle Bancshares Inc. was headquartered in Atlanta, Georgia, and looked after assets worth $1.1 billion. This allowed RBC (One of Canada's largest banks based on market capitalization) to benefit from Eagle Bancshares North American presence and grow its business presence in the region while diversifying its operations base.
4. Consolidations:
Consolidations are slightly different from mergers, though they have one key difference: in a consolidation, two or more businesses merge to form an entirely new company. All the combining companies are dissolved, and only the new entity operates.
For example, in 1996, two Swiss pharmaceutical companies (Sandoz and Ciba-Geigy) merged to become Novartis, now one of the largest pharmaceutical companies in the world.
We can look into why they occur and how they gained popularity. Companies often decide to merge to expand their reach into new markets, reduce operational costs, and increase company profits.
Why do companies merge?
The two companies looking to merge often stand to benefit from the operational capacity and reach of the other. However, it also leads to sacrificing specific individual company power to balance out the two companies' synergies.
Can shareholders oppose a transaction?
Shareholders often have the ability to vote on opposing crucial deals and transactions depending on their long-term and short-term goals and objectives for the company.
Many companies leverage a proxy vote, a right given by the shareholder of a company to allow the management to vote on behalf of their shares.
Much voting within large public corporations is often done via a proxy vote, as it allows management and board of directors to pursue business opportunities that shareholders may not deem necessary.
However, the shareholders that chose not to give up their proxy vote can attempt to replace management by electing enough directors who believe in their goals.
This results in a battle between management and shareholders, which can often disincentivize firms from merging due to poor management.
What is an Acquisition
Summary of the concept
An acquisition is the absorption of one company by another. Unlike in a merger, the acquiring firm in an acquisition keeps its name and identity and gains all the assets and liabilities of the target firm.
After the acquisition, the firm ceases to exist as a separate business entity and operates under the parent firm.
Acquisitions can also be broken into three different types:
Horizontal
Vertical
Conglomerate
1. Horizontal Acquisition
It is when both the acquiring company and the target company are in the same industry.
The purpose is to gain market share and reduce competitive pressure. Therefore, horizontal acquisitions often focus on companies that acquire other firms that offer similar products to theirs.
One of the most well-known transactions was when Meta acquired Instagram for a reported $1 billion. As per Bloomberg's 2018 Intelligence Report, the transaction yielded a 100% return in just six years, with both companies operating within the social media industry.
2. Vertical Acquisition
It involves firms at different steps of the production process or falls on a different level of the supply chain.
This allows the company to be more independent of the changes in market trends and gives a reliable source for raw materials and services as they do not rely on outside vendors. It is also cheaper and faster to buy an established company than to build from the ground up.
The solar panel industry has seen a large number of vertical integrations. For example, in 2014, SolarCity, the largest U.S. rooftop solar installer, acquired Silevo, a high-efficiency photovoltaic module manufacturer.
The transaction helped SolarCity achieve a breakthrough in solar power pricing because of massive benefits from economies of scale.
3. Conglomerate Acquisition
A conglomerate acquisition involves acquiring several firms that are unrelated to each other and are across different industries.
These are very popular in the technology sector, allowing companies to diversify their operations and venture into new businesses.
An example of this is when Amazon acquired Wholefoods in 2017. Amazon spent more than $13 billion to buy an organic and well-established supermarket chain to expand its digital grocery capabilities and grow into a lucrative industry.
Reason for acquisition
A common reason amongst firms is synergies. Synergy is the concept where the value and performance of two companies combined are greater than that of them as two different firms before the integration.
Another reason is that it can create the appearance of earnings growth and increase investor and market sentiment by leading them to believe that the firm is worth more than its actual price.
This can hold for the acquiring firm as it shows the company has the financial ability to acquire another firm, and this can hold for a target firm as they can be bought at a higher price than what they are currently traded at.
Firms acquire other companies to grow market power and reduce competition. In such scenarios, with lesser competition, the prices of goods and services can be increased, generating monopoly profits.
However, if such a transaction reduces competition in the market, they do not benefit society and the U.S. Accordingly, the Department of Justice often discourages such monopolistic firms from existing.
Cost reduction is another reason firms are involved in an M&A transaction. The combined firm may operate more efficiently than two separate firms by using lesser resources and taking advantage of each other's technology and distribution channels.
A merger increases operating efficiency by taking advantage of Economies of Scale, which is essentially the reduced average cost as production increases.
Technology is another prominent reason for firms to merge, as it can help the acquiring company improve the quality and efficiency of its product lines. This technology transfer was the motivation behind Google merging with Android.
How are the acquisitions financed?
Acquisitions are often financed through unused debt and leveraged recapitalizations by banks, private equity firms, or private investors.
A prominent example of this is Elon Musk's 44 billion dollar offer to buy out Twitter which would be financed through 13 billion in debt financing, which Morgan Stanley is leading.
In such deals, banks target an ongoing private transaction, increase their debt, and take some of the debt proceeds as a dividend.
The acquired corporation then has a levered capital structure that, in turn, provides tax benefits to the corporation in return for having a higher risk profile for the company.
What is a Hostile Takeover?
Acquisitions do not require two companies to be well off from the transaction, as not all acquisitions are friendly.
The target firm's management can also resist merging, wherein the acquirer can decide whether or not to pursue the deal and, if so, what tactics to use.
This could lead to the acquiring firm using a toehold strategy, which is a strategy where the acquiring firm purchases some of the target stock in secret to gain control of the company without alerting secondary stakeholders.
Key Differences
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- Comparative stature
| Titles | Mergers | Acquisition |
|---|---|---|
| Two or more individual companies agree to form a new separate business entity. | One company takes over the resources and synergies and operates it under the acquiring company. |
| It is an agreement by mutual consent of the involved parties. Therefore, these types of transactions are generally considered friendly and planned. | An acquisition may not always be mutual, as it can happen without the target firm's consent, which could be deemed a hostile takeover. |
| The emerged entity operates under a new name. Ex: JP Morgan + Chase Bank of America = JP Morgan Chase | The acquired entity operates under the same name as the acquiring company. However, there are a few exceptions where the target company is allowed to keep its original name. Ex: Tata Motors' acquisition of Land Rover and Jaguar led to acquiring companies retaining their name |
| The parties involved in an ideal scenario tend to have similar stature, size, and scale of operations. | The acquiring company during an acquisition is often larger and financially stronger than the target company. |
| There is a dilution of power between the involved companies. | The parent company has complete power over the target company. |
| Post integration, the new company issues new shares. | There are no new shares that are issued |
| When two or more companies consider each other on equal terms, they usually merge. | The acquiring company is larger than the target company and wants to increase its market share. |
How are they facilitated?
They are facilitated by:
Tender Offers
Tender offers are when an acquiring firm first announces to all the target firm's stakeholders that it is looking to buy a fixed number of shares at a specified price. Then, the offer is communicated to the target firm's shareholders through a public announcement.
Factors to consider in M&A transactions:
During stock acquisition, shareholder meetings and a vote are not required. If the target firm's shareholders dislike the offer, they are not required to accept it and need not tender their shares from the offer.
The acquiring firm can deal directly with the shareholders of a target firm via a tender offer. This allows the acquiring firm to bypass the firm's management and board of directors.
Frequently, a minority of shareholders will not agree to the conditions and price of the tender offer, in which case the target firm cannot be completely absorbed. After the acquiring company reaches a high percentage of stock and establishes a majority control, this leads to a formal acquisition.
How does one value M&A deals?
The valuation of a business during a merger or acquisition is both a subjective and objective process.
This is due to the variability in which companies are valued based on different market sentiment factors subjective to an individual. This is because one individual may believe that the stock price is underpriced while another believes that the stock is overpriced.
On the objective side, one has to look at the business model, past performance, competitors, and other macro insights to value the business.
What are some of the different deal valuation metrics
The metrics are:
1. Floor value
When the buyer and seller disagree on the price, the price set is the minimum value the acquiring company is willing to sell at in the market.
The floor value clears the intention of the seller that they are not willing to sell below a certain price, and it allows the buyer to understand the stock's underlying value better.
2. Book value
The per-share dollar value would be received if the assets were liquidated for the value at which the assets are kept on the company's current financial statements, minus the money that must be paid to liquidate the liabilities and preferred stock.
Book value is sometimes referred to as shareholders' equity, net worth, or net asset value. However, a company's book value may not accurately measure its market value, as it merely reflects the values at which the assets are held on the books.
Suppose the historical balance sheet values contradict the true value of the company's assets (including intangible assets, such as goodwill, intellectual properties, and brand recognition). In that case, book value will not be as relevant to the company's valuation.
One use of the book value is that it helps provide a floor value, with the company's true value being higher.
There may be companies that are worth less than the current book value. Though this is not common, a company may have many uncertain liabilities, such as pending litigation, which makes its value less than the book value.
3. Equity value
It is the value of an ownership interest in a business. For a corporation, this value is often represented by its stock value.
It is the value of the entire business and is also defined as the market value of equity claims, which reflects the combined value of the claims from equity holders and debt holders.
5. Liquidation
It is another type of benchmark of the company's floor value. It is defined as the measure of the per-share value that would be derived if the firm's assets were liquidated and all liabilities and preferred stock, as well as the liquidation costs, were paid.
6. Discounted future cash flow
The approach to valuing a business is projected by understanding the magnitude of future monetary benefits that a business will generate.
These annual benefits, defined in earnings or cash flows, are then discounted back to present value to determine the current value of the future benefits.
How do you Build an M&A Model?
A typical M&A model includes these four key steps:
1. Making assumptions: Assumptions are essential as they help clarify the extent to which various factors are considered. For example, considering how the merger will be financed, several new shares to be issued, and synergies, among other factors.
2. Making projections: From the company's financial statements and assumptions, we can make predictions about income and growth rates using the valuation techniques used above for each company.
3. Combining financials: After making projections, we combine both companies' income statements, adding revenue and operating expenses and adjusting for debt or cash used to finance the deal and look at the company as a whole.
4. Calculating accretion/dilution: Combining the income statements of both companies and dividing by the number of outstanding shares yields the earnings per share of the combined companies. If earnings per share are higher than pre-merger, the deal is accretive; if they are lower, it is dilutive. An accretive deal means that the transaction will be beneficial as the acquiring firm's earnings per share (EPS) would increase after the deal goes through
Everything You Need To Master M&A Modeling
To Help You Thrive in the Most Prestigious Jobs on Wall Street.
Merger Examples
Examples are:
1. Vodafone and Mannesmann
In February 2000, Britain's Vodafone AirTouch PLC merged with Mannesmann AG in a historic deal that reshaped the mobile telecom marketplace.
This transaction was the largest cross-border transaction at the time and was the largest M&A transaction in history, valued at more than US$190 billion.
2. Exxon and Mobil
In November 1998, Exxon and Mobil merged into a deal valued at $81 billion. The merged entity became the third-largest company in the world at the time of its announcement, behind General Electric and Microsoft, with a market capitalization of $237.53.
The merged company, ExxonMobil Corp., created one of the world's preeminent oil companies with revenues of $200 billion and worldwide production of 2.5 million barrels of oil a day.
3. American Online and Time Warner
In January 2000, America Online merged with Time Warner in a deal valued at a stunning $350 billion. It was the largest M&A deal in American business history at the time.
Though not all mergers are successful, in this case, in the subsequent years of the transaction, the company experienced countless job losses, investigations by the Securities and Exchange Commission and the Justice Department, and countless executive upheavals.
Acquisition Examples
Examples are:
1. Amazon buys Whole Food
In June 2017, Amazon agreed to buy the upscale grocery chain Whole Foods for $13.4 billion, in a deal that transformed the grocery shopping experience and made it a bigger player in the food and beverages market.
The company's initial attempts to sell groceries online failed to make a major dent in the market. However, acquiring Wholefoods allowed them to better position themselves against Walmart, which was the largest grocery retailer in the United States at the time.
2. Intel acquires Mobileye
In March 2017, the computing giant Intel acquired Mobileye, a leader in computer vision for autonomous driving technology, for $15.3 billion.
Mobileye covers a range of technology and services, including sensor fusion, mapping, front- and rear-facing camera tech, and driving policy intelligence underlying driving decisions. This deal made Intel a more prominent player in the autonomous driving market.
3. Disney Buys 21st Century Fox
In March 2019, Disney acquired 21st Century Fox Company in one of the most complicated transactions of one media company to another in history.
Before the acquisition by Disney, Fox was a powerhouse in the entertainment industry, one of the six major studios and the 4th largest media conglomerate in the world.
The deal included 20th Century Fox Studios, both film and television divisions, which included rights to The Simpsons, Planet of the Apes, Alien, and Die Heart franchises, amongst many others.
Disney would also get Fox's 30% share of Hulu, giving Disney a controlling share of Hulu as it already owned a 30%, gaining a stronger market position in the online streaming industry.
Which are the best M&A Companies to work for?
Top 5 leading banks by M&A transactions in 2021 by deal volume as per Statista:
Top 5 leading M&A consulting companies in the world:
. PWC
. KPMG
. McKinsey
FAQ's
As mentioned above, the fundamental difference between mergers and acquisitions is that a merger combines two organizations into an entirely new entity. While, in an acquisition, the company absorbs another, but no new organization is created.
Some of the most notable Mergers include Vodafone and Mannesmann in 2000, Exxon and Mobil in 1998, American Online and Time Warner in 2000.
Some of the most notable Acquisitions include Amazon buying Whole Foods in 2017, Disney buying 21st Century Fox in 2019, and Intel buying Mobileye in 2017.
Making assumptions
Making projections
Combining financials
Calculating accretion/dilution
Acquisitions are often financed through unused debt and leveraged recapitalizations by banks, private equity firms, or private investors.
A common reason amongst firms is synergies. Synergy is the concept where the value and performance of two companies combined are greater than that of them as two different firms before the integration.
We can look into the details behind why they occur and how they gained popularity. Companies often decide to merge to expand their reach into new markets, reduce operational costs, and increase company profits.
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