This article is written by Muskan Khandelwal, pursuing a Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from Lawsikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho), Ruchika Mohapatra (Associate, LawSikho), and Indrasish Majumder (Intern at LawSikho).
This article has been published by Shoronya Banerjee.
Table of Contents
Introduction
Mergers and acquisitions (hereinafter referred to as “M&A”) are deals in which two or more firms merge in some way. Even though the terms mergers and acquisitions (M&A) are sometimes used interchangeably, they have distinct legal definitions. Two firms of equal size unite to establish a distinct single company in a merger. A merger occurs when the board members of two firms agree to merge and request necessary approvals from the shareholders. For instance, in 1998, the Digital Equipment Corporation and Compaq agreed to merge, with Compaq absorbing the Digital Equipment Corporation. An acquisition, on the contrary, occurs when a larger corporation buys a smaller corporation and absorbs the smaller corporation’s operations. M&A transactions can be amicable or hostile, based on the target company’s board of directors’ consent. In a straightforward acquisition, the purchasing corporation acquires a majority interest in the acquired company, which retains its name and organizational structure. Manulife Financial Corporation’s acquisition of John Hancock Financial Services in 2004 is an instance of this sort of deal, in which both firms kept their identities and organizational structures.
Types of M&A
For several objectives, businesses will combine and purchase one another. Here are four of the most common methods for businesses to collaborate:
1. Horizontal merger / acquisition
A horizontal merger occurs when two firms are in direct competition with one another. Horizontal mergers are used to gain market share, create economies of scale, and take advantage of merger synergies. Compaq Computers was purchased by Hewlett Packard in 2002 for $24.2 billion. By integrating the PC products of both firms, the goal was to establish the leading personal computer provider.
2. Vertical merger / acquisition
A vertical merger occurs when two firms that operate in a similar supply chain combine forces. A vertical merger is the joining of firms in a company’s manufacturing and distribution processes. Higher quality control, greater circulation of knowledge along the supply chain, and merger synergies are all reasons for a vertical merger.
In the year 2000, America Online and Time Warner merged vertically for the first time. Because of each company’s various activities in the supply chain – Time Warner supplied information through CNN and Time Magazine, while AOL delivered information via the internet – the transaction was classified as a vertical merger.
3. Conglomerate merger / acquisition
To increase their variety of services and goods, two firms in different industries combine forces or one takes over the other. By merging back-office tasks and functioning in a variety of sectors, this method may help cut costs and risk.
4. Concentric merger / acquisition
Two firms may share consumers yet provide distinct services in specific instances. Sony, for example, is a DVD player manufacturer that also owns the Columbia Pictures film studio, which it purchased in 1989. Sony could now make movies that could be played on its DVD players. Furthermore, this was a crucial component of Sony’s Blu-Ray DVD player launch plan.
Reasons for M&A
There are numerous reasons behind an M&A deal. The most common reasons are mentioned below:
1. Unlocking Synergies
Mergers and acquisitions (M&A) are commonly used to produce synergies that make the merged firm worth more than the two enterprises separately. Synergies can occur as a result of cost savings or increased income.
Cost synergies are achieved through economies of scale, whereas revenue synergies are achieved by cross-selling, expanding market share, or boosting pricing. Cost synergies are easier to quantify and estimate of the two.
2. Higher growth
When opposed to organic growth, inorganic growth from mergers and acquisitions (M&A) is typically a speedier technique for a firm to obtain bigger sales. A corporation can benefit from purchasing or merging with a corporation that has cutting-edge capabilities rather than risk cultivating those skills organically.
3. Stronger market power
A horizontal merger will provide the new organization with a larger market share and the ability to affect prices. Vertical mergers also provide a corporation with more market power since it has more control over its supply chain and can prevent outside supply disruptions.
4. Diversification
Companies in cyclical sectors feel compelled to diversify their cash flows to prevent severe losses during a downturn. A corporation can diversify and decrease market risk by buying a company in a non-cyclical sector.
5. Tax benefits
When one firm has a lot of taxable income and another has a lot of tax-loss accruals, the tax incentives are investigated. The acquirer can use the tax losses to reduce its tax burden by acquiring the firm with the tax losses. Mergers, on the other hand, are rarely done only to save money on taxes.
M&A effects
1. Capital structure
M&A activity has longer-term consequences for the acquiring business or the prevailing organization in a merger than for the target firm in a merger or the organization that is swallowed in a merger.
An M&A deal provides the acquired corporation’s shareholders with the option to cash out at a high premium, — particularly if the acquisition is all-cash. The target firm’s investors get a share in the acquirer and hence have a real stake in its long-term performance if the acquirer pays half in cash and half in its own shares.
The consequence of an M&A deal on the buyer is determined by the deal size concerning the corporation’s size. The danger to the buyer increases as the prospective target grows greater. A corporation may be capable of surviving a small-scale acquisition catastrophe, but a large-scale acquisition failure might risk the corporation’s long-term viability.
Based on how the M&A deal was structured, the acquirer’s capital structure will fluctuate when the deal closes. An all-cash transaction will significantly decrease the acquirer’s cash reserves. However, few corporations have enough cash on hand to pay for an acquired company in full, all-cash mergers are frequently funded through debt. While this raises a company’s debt, the increased cash flows generated by the acquired corporation may justify the greater debt load.
Several M&A deals are funded in part with the acquirer’s shares. An acquirer’s shares must frequently be premium-priced, to begin with, if it is to be used as payment for an acquisition; otherwise, making acquisitions would be excessively dilutive. In addition, the target company’s managers must be persuaded that taking the acquirer’s shares rather than actual money is a sensible option.
2. Market reactionÂ
Market reaction to the announcement of an M&A deal can be positive or negative, based on market people’s perceptions of the deal’s characteristics. Usually, the target’s shares will climb to a value near that of the acquirer’s bid, given that the acquirer’s bid is a large premium to the target’s prior share price. Indeed, the target’s stock may trade above the initial offer if it is believed that the buyer has undervalued the target and will be obliged to increase it, or if the target firm is prized enough to draw a competing bid.
In some cases, the target firm may trade at a lower price than the offer price. This usually happens when a portion of the acquisition price is paid in the acquirer’s stock, and the stock drops when the acquisition is publicized. Assume that Targeted ABC Co.’s acquisition price of Rs. 25 per share is made up of two stocks of an acquirer for Rs. 10 each and Rs. 5 in cash. Targeted ABC Co. will most probably be valued at Rs. 21 rather than Rs. 25 if the acquirer’s stock is only worth Rs. 8.
Whenever a buyer publishes an M&A acquisition, its stock may drop for a variety of factors. Perhaps market players believe that the buying price is too high. Alternatively, the transaction may be viewed as being not advantageous to earnings per share (EPS). Alternatively, investors may feel that the buyer is trying to take on too much indebtedness to fund the deal.
The purchases that an acquirer undertakes should preferably improve the acquirer’s economic capabilities and earnings. Because a succession of acquisitions can disguise degradation in a firm’s core sector, investors and analysts frequently look at the company’s “organic” revenue and operating margin growth rate, which eliminates the influence of M&A.
When a buyer makes a hostile offer for a target firm, the latter’s executives may suggest that the purchase be rejected by its stakeholders. Amongst the most prevalent causes for such refusal is that the acquirer’s offering is significantly undervalued by the target’s leadership. However, as the famous Yahoo-Microsoft example demonstrates, rejecting an unexpected offer can occasionally backfire.
M&A : an important instrument for business expansion and boosting purchasing capacity
M&A may be a powerful tool for boosting purchasing power, establishing scale, boosting a target’s productivity, and reducing surplus industry resources, as well as fueling long-term, profitable expansion. By analysing the reason for M&A and its effect, we deduce that M&A transactions lead to the growth of the company which boots its purchasing capacity. It increases its revenue and thus, leads to an increase in purchasing capacity.
The market reaction, if favorable to the company, also boosts its purchasing capacity. M&A should be considered as a key arrow in the business bow, ready to be released when needed, because of its multiple economic advantages. The attraction of M&A is enhanced by the slow rate of global economic expansion. In reality, the most popular motivations given by CEOs for investing in M&A are to increase purchasing capacity, acquire access to new client bases, enter more geographic marketplaces, and enhance goods and services.
When two companies merge, by consolidating marketing expenditures, it may lower its costs and overhead. Due to the huge number of purchases, the company will have more purchasing power and reduced purchasing expenses. As a result, the more money the company has, the simpler it is for the company to save money. Another benefit of M&A is that larger order size and accompanying bulk-buying discounts result in purchasing economies.
Conclusion
In this article, we have critically analysed what are the reasons for M&A and what are its effects. We can finally conclude that it has a significant impact on the purchasing capacity of the company. It boosts the company’s purchasing power tremendously. Reasons for the boost are an increase in revenue and growth, purchasing economies, discounts, synergies, etc. M&As are one of the best tools for growth and increased purchasing capacity.
References
- https://www.investopedia.com/articles/investing/102914/how-mergers-and-acquisitions-can-affect-company.asp
- https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-ma-making-the-deal-work-strategy.pdf
- https://www.docurex.com/en/the-main-types-of-mergers-and-acquisitions/Â
- https://www.investopedia.com/terms/m/mergersandacquisitions.asp#:~:text=Mergers%20and%20acquisitions%20(M%26A)%20is,of%20assets%2C%20and%20management%20acquisitions.
- https://www.investopedia.com/ask/answers/why-do-companies-merge-or-acquire-other-companies/
- https://www.incorp.asia/blog/driving-business-growth-through-mergers-and-acquisitions/
Students of Lawsikho courses regularly produce writing assignments, and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:
Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.
