Mergers and Acquisitions: Concepts that you must Know

25 Jan 2020 Read 271 Views

Business is an unpredictable business. People do it; some become successful empires, some others perish in the dust, and rest merge or acquire. The merger and acquisition is a very old phenomenon. In fact, in India, small British companies merged with the East India Company in 1708.

The question arises, what drives these mergers or acquisitions? Why are they different? Is it a science that has a specific formula, or is it an art, to each its own? The next few minutes will acquaint you with the most exciting part of finance news.

The Jargons

The merger or acquisition requires at least two companies. When the buyer company buys assets and shares of a company, it is called as 'acquisition.' The company continues to work in its original name. When the buyer company absorbs the target company such that the target company does not exist anymore, it is called a 'merger.' This is the fundamental difference.

A vertical acquisition is the one where the target belongs to the primary business domain of the buyer, but a different production level. Say a car company buys a tyre company. The car company now no more depends on other tyre companies. It is like Amazon buying TouchCo, leading to better development of Kindle.

A horizontal acquisition is where the buyer company and the target companies are at the same production level. Say a car company buys another car company. It is like Facebook buying Instagram or WhatsApp.

The Driving Force

The driving forces are clear. A company wants to buy another company when it sees the synergy. The buying company thinks that buying the target would help enhance productivity than both companies doing it individually. If the efficiency could really work out, it would save money and provide opportunities to scale.

The target company, too, might be losing steam or might be burdened with ballooning debt. Such reasons tempt them on a good offer.

In many fields, especially Information Technology, it helps in extending new services. When Google acquired Waze, it revolutionized Google Maps by integrating the ‘Traffic’ feature. Cab services might have been unimaginable without this.

Sometimes, it also helps in adding in previous clients of the target company.

A few other times, there is a 'defensive M&A.' Microsoft went on to buy LinkedIn for $26.2bn because it feared that Google might buy it. In that case, Google would have acquired LinkedIn's talent pool, its clients, and maybe integrated Gmail to LinkedIn, ultimately wiping out Microsoft Outlook!

Timing to Acquire the Target

There is no specific timing to buy a company. Nevertheless, buyer companies prefer the targets that are in the development or growth phase. The development phase is the start-up stage. In this stage, the companies are bought for their innovation. Jio bought the AI solutions start-up, Haptik.

The growth phase is when a company is profitable. Disney buying Pixar Studios is one such example. In the mature stage, mostly competitor companies come together to eliminate challenges. Vodafone-Idea merger is the same story. Some companies begin to decline; even then, they are bought for their assets and brand name. Microsoft bought Nokia and Verizon Media bought Yahoo!

The Payments

The target would want it to be in cash. A buyer would want to buy in exchange for its equity. In most cases, it is a combination of both. Though companies like Microsoft and Apple sit on a huge pile of cash and they can buy their targets in a go, most companies do not have this luxury.

Either they have to take debt for cash payments, or they have to issue fresh stocks or both. Each has its own cost.

Sometimes, when ask price (quoted by target) and bid price (quoted by buyer) have less difference, there may be some 'earn-out.' Earn-out is the additional payment that takes place after the M&A. For example, if the profit of the target exceeds 20% in the first year (post-M&A), the target firm will get ₹ 100 crores more from the buyer.

Types of Buyers

There can be two kinds of buyers in the M&A. One is 'Corporate Buyers.' They want to get in the business, look to get in new avenues, or expand their current domain, and they have a long-term engagement with the company.

On the other hand, there are 'Financial Buyers.' These buyers worry only about income and profits. They want to invest, earn profits, and then sell the ownership and exit. Venture Capitalists, Private Equity Funds, Mutual Funds, and other such institutions do the same.

Types of Targets

Targets can be of only two types. Either the company is listed on a stock exchange, or it is not. If someone wants to buy a listed company, all he needs is to get enough shares of the company and then claim to own it. If someone wants to buy the unlisted company, he will need the approval of the target company.

In all our discussions, we assumed that the buyer and the target company are mutually involved, but what if this was not the case. What would happen if the deal did not work out or that target did not want to approve the acquisition?

If the company is unlisted, it has complete control of whether it wants to be sold or not. This does not have many complications. However, in the other case, it is shareholders who own the listed companies. These shareholders instate a board of directors for the governance of the firm.

If the company is listed, the buyer company needs to buy enough shares to take over control. It may buy this through the market by paying a premium over market price.

However, we must know that no public company puts all its shares on the stock exchange. How can he get more shares? Even if the buyer gets the required number of shares, what would happen if the promoters and the board refuse to take over? Can the buyer still pull off a ‘hostile takeover’? Is there no defence for the target, or is it?

Winding Down

Mergers and Acquisitions play a vital role in the world economy. Everything comes to a passé, so does a company. Every year we would see some companies faring better than others do. In this process, they buy, sell, or perish.

However, one aspect of M&A is still untouched. Can somebody buy the target against its will? Is there a way that ‘hostile takeover’ may take place? On the other hand, can the target firm save itself in this event? All these answers need a separate discussion.
Read: Hostile Takeovers: Defence and Takeover Strategies for knowing answers to the above questions.

About the Author: Vivek Tiwari | 46 Posts

Vivek Tiwari is a Software Engineer and a Data Scientist who hopelessly fell for Economics. His plans to move to Finance might now save mankind from his IITJEE selection story.

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