Merger vs. Acquisition
A Merger occurs when two or more companies combine to form one new legal entity.
What is a Merger vs Acquisition?
A Merger occurs when two or more companies combine to form one new legal entity. An Acquisition occurs when one company absorbs another.
Mergers and Acquisitions (M&A) are two terms often used interchangeably. However, there are a few key differences that separate the two.
The easiest way to spot the difference between the two is through the name. When two things merge, they form a new organization. This is true for the business sector; a merger is when two entities combine to become one new business.
Similarly, when one is to acquire something, it becomes that person's own. Thus, an acquisition is when one business absorbs another business into its own.
- A merger combines two companies into a new entity, while an acquisition involves one company taking control of another. Mergers are typically mutual, whereas acquisitions can be friendly or hostile.
- M&A transactions can be horizontal (same industry), vertical (different supply chain stages), conglomerate (unrelated industries), market extension (expanding regions), or product extension (complementary products).
- Companies pursue M&A for synergies (cost savings, efficiency), market share expansion, competitive advantages, and access to new technologies or resources.
- M&A deals are financed through cash, stock, debt, or a combination, with financial modeling techniques used to assess accretion/dilution and overall deal value.
What is a Merger?
A merger is when two or more companies agree to consolidate into one new legal entity. By doing this, all operations, ownership interests, technologies, and resources are now one. All assets and liabilities are combined on the new company's balance sheet.
There are many types of mergers, all of which are used to serve a specific strategy. Some of the key reasons for merging are market expansion, gaining competitive advantages, and synergy.
The biggest objective is to increase the value of the companies.
Why do companies Merge?
Companies have a few different motivations when they choose to merge. The leading reasons to merge are growth, synergy, and gaining a competitive advantage. Merging the two companies should make them more valuable and sustainable than before.
- Synergy: Two companies together will be more effective and valuable than the companies as individuals. Leveraging each other's strengths allows for the new entity to have higher cost savings, revenue, and operational efficiencies than individually combined.
- Market Expansion/Diversification: Merging allows new geographic areas, customers, and verticals to be reached. This, in turn, makes companies less subject to market risk due to an increased market size and expansion of products.
- Competitive Advantage: Companies can gain market share when merging with competitors or complementary businesses. In addition, the new entity has access to more insight and technological edge.
Types of Mergers
There are several different types of mergers, each with its own characteristics and strategic goals. The main types of mergers include:
1. Horizontal
When two companies in the same industry who are often competitors decide to combine into one new company. Benefits include increased market share, synergies, and less competition.
Example: A recent example was between HBO Max and Discovery + on 8 May 23, 2023. The two streaming services became Max; this was part of the much larger deal between Warner Bros and Discovery, now known as Warner Bros. Discovery.
2. Vertical
When two companies at different points of production join as one, this creates an advantage in the supply chain, efficiency, and more.
Example: In 1996, Turner Broadcasting System, a then-media company, merged with Time Warner, a cable company. The deal was valued at $7.5 billion.
3. Conglomerate
When companies merge in a way that is neither vertical nor horizontal. Most of the time, it is between firms that are not in the same industry or geographic location.
Example: In 1998, German luxury automaker Daimler-Benz merged with mass American automaker Chrysler. The deal was valued at $38 billion and formed the company DaimlerChrysler AG. The company would infamously split in 2007.
4. Congeneric
The two companies involved are both in the same industry. However, their products are completely different. Being in the same industry means that much of the distribution, production, technology, and marketing will be the same.
Example: The largest congeneric combination happened in 2015. The deal took place in the food industry.
The players were Kraft and Heinz. Kraft is a food producer known for mayo, lunch meats, salad dressing, and cheeses. Heinz made meat sauces, frozen appetizers, and pasta sauces. The deal resulted in the creation of The Kraft Heinz Company, valued at $100 billion.
5. Market Extension
For this to occur, both companies must be in different markets and in the same industry. The goal is to gain more customers and a larger global market share.
Example: In 2011, British Air agreed to merge with Iberia, the flag carrier of Spain. The deal created the International Airlines Group (IAG). Both companies gained a larger market, having 408 aircraft and 57 million passengers per year as a result of the union.
6. Product Extension
This happens when the two joining companies are in the same industry. Both companies offer products that complement one another. The goal is to gain access to more customers through grouping products.
Example: In 2000, Glaxo Wellcome and SmithKline Beecham merged to create a pharmaceutical giant, GlaxoSmithKline. Glaxo Wellcome was known for its combinatorial chemistry, whereas SmithKline was known for genomics and cell and molecular biology.
What is an Acquisition?
An Acquisition is when one company purchases another company's shares or assets, giving them full ownership and control.
The acquired company may no longer be an independent entity but typically becomes a part of the acquiring company. The company that acquired it has full control over all operations.
It can be a mutually agreed upon transaction. However, they do not require consent from both parties. This makes them much more common than two companies choosing to merge.
What are the reasons for Acquisitions?
Companies choose to acquire another company for many reasons. By acquiring companies, they should become stronger than before. This can happen through a larger market share, synergy, and new technologies.
- Market share: Through Acquisition, companies can gain more customers through a larger market reach. This will also eliminate competition, increasing the acquiring company's slice of the pie.
- Synergy: When complementary products and services are combined. The acquiring company will then save on costs and become more operationally efficient.
- New Technologies: The acquiring company will oftentimes look for a target that can offer them innovation. This is through tech, intellectual property, talent, or any other resources that lift the competitive advantage.
Types of Acquisitions
There are several types of acquisitions, each with its own characteristics and strategic objectives. The main types of acquisitions include:
1. Vertical
When a company purchases another company that operates in a different production line stage.
Example: In 2017, Amazon acquired Whole Foods for $13.7 billion. This allowed Amazon to move into a new stage of the supply chain, one in which it had control over the distribution of food products.
2. Horizontal
Occurs from acquiring a business or competitor who operates in the same industry at the same stage of the supply chain.
Example: In 2012, Facebook, now Meta, purchased rival social media company Instagram. The deal cost $1 billion in cash and Facebook shares. This gave Facebook all of Instagram’s employees.
3. Conglomerate
The purchase of another company completely outside of the buying companies industry. These transactions commonly occur to diversify a business's portfolio.
Example: Berkshire Hathaway, a multinational conglomerate Holding company, obtained Dairy Queen in 1997. Dairy Queen was valued at $585 million and paid for in cash and stock.
4.Friendly
A deal that is approved by management and the board of directors of the targeted company.
Example: On June 13th, 2016, Microsoft acquired LinkedIn. The board of directors of each company unanimously approved the deal. Microsoft bought LinkedIn at $196 a share, totaling $26.2 billion in an all-cash transaction.
5. Hostile Takeover
This happens when the target company's management does not want to be purchased. The bidding company will typically go straight to shareholders to either place a proxy vote to change to supporting management or make a tender offer.
Example: In 2010, Kraft successfully took over Cadbury. Cadbury's board of directors rejected offers, stating they were too low. Eventually, Kraft was able to raise the offer price to $21.8 billion, a number that the board recommended to shareholders.
6. Product Extension
This happens when a company obtains another company in the same industry. These two companies do not make the same products but rather products that complement one another. This allows for a larger share of customers.
Example: A famous example is PepsiCo getting into the restaurant industry. PepsiCo first acquired Pizza Hut in 1977, followed by Taco Bell and later KFC. This made it so that people who ate at those restaurants had to drink Pepsi products.
7. Market Extension
A strategic move to acquire another company to gain access to a new market. The target company is in the same industry but in a different global region.
Example: In 2014, Facebook successfully acquired WhatsApp for $16 billion. This brought Facebook 2 billion new users and stronger access to Europe, Latin America, and Asia.
8. Congeric
The acquiring and target companies are in the same industry. However, the products of both companies are not at all similar. This gives the acquiring company more distribution, production, and marketing abilities.
Example: When Google purchased Nest Labs in 2014. This deal gave Google, a tech company focused on search engines, access to a smart home company. This allowed Google to break into a new segment of tech.
Key Differences between Merger vs Acquisition
It is important to know what mergers and acquisitions are and their different types. In addition, understanding the motivation behind the corporate transaction is valuable. This gives all the details to understand the key differences between the two.
The two differ in terms of name, structure, legality, purpose, control, and financing.
| Component | Merger | Acquisition |
|---|---|---|
| Name | The company that emerges takes on a new name that is different from that of the combined companies. Ex: Heinz and Kraft merged to create the Kraft Heinz Company | The acquired company takes on the name of the company that acquired it. In some instances, the acquired company keeps its name. Ex: Instagram and Whatsapp |
| Structure | Usually occurs between two equal-sized companies. Both companies must agree to merge. | The acquirer is usually much larger than the target company. A target company can be acquired without wanting to. |
| Legality | Both companies lose their legal status, forming a new legal entity. | The acquirer keeps its legal status. The target company is either dissolved or can keep its legal status for brand recognition. |
| Purpose | Companies believe that combining will create a stronger, more efficient company. | The acquirer wants to gain market share, competitive advantages, and diversify. |
| Control | Power is shared between the merging companies | Acquiring company takes control of the target company |
| Financing | Assets and Stocks are exchanged equally between companies | Acquiring companies often pay more than the real value of a company to acquire it. |
To learn more about M&A, watch this video explaining the key differences:
It is also important to note that many articles refer to acquisitions as mergers. This is due to the negative connotation associated with acquisitions. When reading the details of an M&A deal, make sure to look at all the components.
How are M&A deals financed?
M&A deals can be financed in numerous different ways. The companies involved in the deal must analyze their financial health before choosing a method. Most deals use a combination of financing methods.
- Cash: Cash may be used to fund a deal. This cash typically comes from the buyer's balance sheet.
- Debt: Companies may also borrow cash from a third party to finance a deal. The fees paid on the debt are considered the transaction cost. Interest paid will also affect earnings.
- Stock: Oftentimes, stock is issued to pay for deals. The price of the stock issued is equivalent to the current market price. This causes dilution to the issuing company.
- Combination: Using Stock, Debt, and Cash is quite common to finance a deal. Using other securities, such as warrants and options, causes further dilution.
Oftentimes, banks, lenders, and private equity groups will help finance M&A deals.
How are M&A deals Valued?
The purpose of valuation and modeling is to make a deal to ensure that a fair market price occurs. Companies use both relative and intrinsic methods when valuing companies.
- Relative Valuation Methods
- Comparable Transaction Analysis(CTA): Analyzes key financial metrics from recent M&A deals with similar industries, size, and operations.
- Comparable Company Analysis(CCA): Compares the financial metrics like industry, business operations, structure, and revenue of similar public companies.
- Intrinsic Valuation Method
- Discounted Cash Flow (DCF): Calculates the present value of a company's expected future cash flows.
Building the Model
The process of building an M&A model can be divided into five main parts. The first step is making assumptions, followed by projections, valuation, combining pro formas, and finally, accretion or dilution.
- Assumptions: First key assumptions must be made about both companies' financial and operational aspects. Assumptions can be made for revenues, operating expenses, capital expenditures, working capital, and more.
- Projections: Use the three financial statements (Income Statement, Balance Sheet, Statement of Cash Flows) of both companies to project key assumptions.
- Valuation: Choose a valuation method and apply it to find the fair market value price of the target.
- Combined Pro Forma: The process of combining the two companies' three financial statements. When doing so, one must consider the changes in synergy, cost savings, and more.
- Accretion or Dilution: The model will lead to either accretion or dilution. Accretion is when the new earnings per share is more than the original. Dilution is when earnings per share are less than the original.
Are there any regulations for M&A deals?
Companies are not allowed to merge with or acquire other companies whenever they want. For a company to merge or acquire, it must gain shareholders' approval. Shareholders can either vote for or against or abstain from voting.
Even if shareholders approve an M&A deal, it still might not come to fruition. Laws have been established to block M&A deals that can eliminate competition. One such law was the Clayton Act.
The Clayton Act of 1914 was made to stop monopolistic behavior. It also addresses various antitrust laws, protects consumers, regulates price discrimination, and regulates exclusive dealings.
A recent example of this was the case of JetBlue and Spirit Airlines. In 2022, JetBlue agreed to buy Spirit. However, the deal was blocked on Jan 17th, 2024, due to monopolistic elements.
A company can be split into two?
M&A involves the elimination of companies. After the deal is over, there are fewer companies in total. The opposite of that is a carveout. A carveout is when a business sells a segment of itself, forming a new company.
A famous example of this was the 2014 merger between eBay and PayPal. eBay allowed for PayPal to separate. This deal gave shareholders one share of PayPal for every share of eBay they owned. This allowed each business to focus on its growth and strategy.
Ironically, ten years later, in 2024, eBay had a market cap of 21.5 Billion, whereas Paypal had a market cap of 69.85 Billion.
Conclusion
M&A deals are complex corporate transactions that constantly occur and impact the economy. Although the two phrases are often used interchangeably, it is important to remember they are two vastly different deals.
Mergers are the consolidation of two companies into one new entity. On the other hand, an acquisition is when one company takes over another, gaining full ownership and control. The overarching motivation behind these deals is to increase shareholder value.
M&A deals can be financed through various methods, including stocks, debt, and cash, with a specific mix depending on the circumstances of each deal.
Common methods for valuing M&A deals include Comparable Transaction Analysis (CTA), Comparable Company Analysis (CCA), and Discounted Cash Flow (DCF), among others.
M&A deals do follow a process before being approved. First off, they must be approved by shareholders. Even with shareholders' approval, deals do not always come to fruition due to the Clayton Act.
It is important to understand the key differences between mergers and acquisitions, their types, their reasons, and how they are valued. Being informed about the M&A market puts shareholders in a strategic position.
Merger Vs. Acquisition FAQs
Investment banks are responsible for arranging M&A deals. Some examples of Investment Banks are Morgan Stanley, JP Morgan Chase, and Goldman Sachs.
Mergers involve two companies agreeing to become one new legal entity. An acquisition happens when one company purchases another, gaining full control.
Companies merge to expand their market, increase efficiency, and become more valuable.
Companies acquire other companies to become stronger than before. A successful deal should lead to less competition, synergy, and new technologies.
The steps are:
- Assumptions: Make assumptions on each company's key operating and financial aspects.
- Projections: Use each company's three financial statements to make projections
- Valuation: Choose a valuation method (DCF, CTA, CCA) and apply it to find a fair market value.
- Combined Pro Forma: Combine the two companies' financial statements, factor in cost savings, and synergy.
- Accretion or Dilution: The model will show whether the deal is in accretion or dilution. Accretion is a higher EPS after the deal is done, whereas Dilution is a lower earnings per share after the deal is done.
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