What are Mergers and Acquisitions – M&A?
Mergers and Acquisitions (M&A) is a generic term that describes the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, takeover bids, asset purchases, and management takeovers.
The term M&A also refers to the desks at financial institutions engaged in such activities.
The central theses
- The term mergers and acquisitions (M&A) generally refers to the process of merging a company.
- In an acquisition, one company buys the other directly. The acquired company does not change its legal name or structure, but is now owned by the parent company.
- A merger is the combination of two companies that then form a new legal entity under the banner of a company name.
- M&A deals generate significant profits for the investment banking industry, but not all mergers or acquisitions close.
- After the merger, some companies find great success and growth, while others fail spectacularly.
The essence of fusion
The terms “mergers” and “acquisitions” are often used interchangeably, although in reality they have slightly different meanings. When a company takes over another company and establishes itself as new owner, the purchase is known as an acquisition. From a legal perspective, the target company ceases to exist, the buyer takes over the business, and the buyer’s shares continue to trade while the target company’s shares are no longer traded.
A merger, on the other hand, describes two companies of roughly the same size that join together to move forward as a single new entity rather than staying and operating separately. This action is known as a “merger of equals”. The shares of both companies will be returned and new company shares will be issued in their place. Case in point: Both Daimler-Benz and Chrysler ceased to exist when the two companies merged and a new company, Daimler Chrysler, was founded. A purchase agreement is also known as a merger when both CEOs believe that a merger is in the best interests of both companies.
Unfriendly (“hostile takeover”) businesses where target companies do not want to be bought are always considered acquisitions. A deal can therefore be classified as a merger or an acquisition depending on whether the acquisition is friendly or hostile and how it is announced. In other words, the difference is in how the deal is communicated to the board of directors, employees, and shareholders of the target company.
Types of mergers and acquisitions
Here is a quick overview of some common transactions that fall under the M&A umbrella:
In the event of a merger, the boards of directors of two companies approve the merger and obtain approval from the shareholders. After the merger, the acquired company no longer exists and becomes part of the acquiring company. For example, there was a merger between Digital Computers and Compaq in 1998, in which Compaq Digital Computers took over. Compaq later merged with Hewlett-Packard in 2002. The ticker symbol prior to the Compaq merger was CPQ. This was combined with the Hewlett-Packard ticker symbol (HWP) to create the current ticker symbol (HPQ).
In the case of a simple acquisition, the acquiring company receives the majority stake in the acquired company, which neither changes its name nor its legal structure and often retains the existing stock symbol. An example of this transaction is the acquisition of John Hancock Financial Services by Manulife Financial Corporation in 2004, with both companies retaining their names and organizational structures. Acquisitions can be made by exchanging shares in one company for the other, or by buying the target company’s shares for cash.
The consolidation creates a new company by combining core businesses and abandoning the old company structures. The shareholders of both companies must agree to the consolidation and, upon approval, receive common shares in the new company. For example, Citicorp and Traveler’s Insurance Group announced a consolidation in 1998 that resulted in Citigroup.
In a takeover bid, one company offers to buy the other company’s outstanding shares at a price rather than a market price. The acquiring company will inform the shareholders of the other company of the offer directly, bypassing the management and the board of directors. For example, in 2008 Johnson & Johnson made an offer to acquire Omrix Biopharmaceuticals for $ 438 million. While the acquiring company may continue to exist – especially if there are certain dissenting shareholders – most takeover bids result in mergers.
Acquisition of assets
When one company acquires assets, it directly acquires another company’s assets. The company whose assets are being acquired must obtain approval from its shareholders. The purchase of assets is typical of bankruptcy proceedings where other companies bid for various assets of the bankrupt company that will be liquidated upon the final transfer of assets to the acquiring companies.
In a management acquisition, also known as a management-led buyout (MBO), the executives of one company acquire a majority stake in another company and take it privately. These former executives often work with a financier or former senior executive to help finance a transaction. Such M&A transactions are usually disproportionately financed with debt, and the majority of shareholders must approve this. For example, Dell Corporation announced in 2013 that it had been taken over by its managing director Michael Dell.
The structure of mergers
Mergers can be structured in a number of ways based on the relationship between the two companies involved in the deal.
- Horizontal fusion: Two companies that are in direct competition and share the same product lines and markets.
- Vertical fusion: A customer and a company or a supplier and a company. Imagine a cone supplier merging with an ice cream maker.
- Generic fusions: Two companies serving the same consumer base in different ways, e.g. B. a TV manufacturer and a cable company.
- Market expansion merger: Two companies selling the same products in different markets.
- Merging of product extensions: Two companies selling different but related products in the same market.
- Conglomerate: Two companies that have no common business areas.
Mergers can also be distinguished by two funding methods – each with its own consequences for investors.
- Mergers: As the name suggests, this type of merger occurs when one company buys another company. The purchase is made in cash or by issuing a debt security. The sale is taxable, which attracts the acquiring companies who enjoy the tax benefits. Acquired assets can be depreciated to the actual purchase price and the difference between the book value and the purchase price of the assets can be depreciated annually, thereby reducing the taxes payable by the acquiring company.
- Consolidation Mergers: With this merger, a brand new company is created and both companies will be purchased and combined under the new entity. The tax conditions correspond to those of a merger.
A company can buy another company with cash, stock, underwriting, or a combination thereof. In smaller transactions, it is also common for one company to acquire all of the assets of another company. Company X buys all of Company Y’s assets for cash, which means Company Y only has cash (and possibly debt). Of course, Company Y will just become a shell and will eventually liquidate or move into other businesses.
Another takeover agreement known as a “reverse merger” enables a private company to go public in a relatively short period of time. Reverse mergers occur when a private company that has good prospects and wants to raise funding buys a publicly traded shell company with no legitimate business operations and limited assets. The private company reverses the merger with the stock corporation and together forms a completely new stock corporation with tradable shares.
Both companies involved in either side of an M&A deal will rate the target company differently. The seller will obviously value the company at the highest possible price while the buyer will try to buy it at the lowest possible price. Fortunately, a company can be assessed objectively by examining comparable companies in an industry and using the following metrics:
- Comparative ratios: The following are two examples of the many comparison metrics that acquiring companies can base their offers on:
- Price-performance ratio (P / E): With this ratio, an acquiring company makes an offer that is a multiple of the profit of the target company. By examining the P / E for all stocks within the same industry group, the acquiring company gets good guidance on the P / E of the target.
- Ratio of company value to sales (EV / sales): With this ratio, the acquiring company makes an offer as a multiple of the turnover, being aware of the price-performance ratio of other companies in the industry.
- Replacement costs: In some cases, acquisitions are based on the cost of replacing the target company. For simplicity, let’s say the value of a company is simply the sum of all of its equipment and labor costs. The acquiring company can literally ask the target to sell at that price, or it will create a competitor for the same cost. Of course, it takes a long time to build good management, acquire real estate, and buy the right equipment. This method of pricing would certainly not make much sense in a service industry where key assets – people and ideas – are difficult to evaluate and develop.
- Discounted Cash Flow (DCF): Discounted cash flow analysis, an important valuation tool in mergers and acquisitions, determines the current value of a company based on its estimated future cash flows. The projected free cash flows (net income + depreciation – investments – change in working capital) are discounted to present value using the company’s weighted average cost of capital (WACC). While it’s difficult to get DCF right, few tools can compete with this valuation method.