Friday, September 16, 2005

Mergers and acquisitions

Mergers and acquisitions

The phrase mergers and acquisitions (M&A) refers to the aspect of business strategy and management dealing with the merging and/or acquiring of different companies.

Usually these occur in a friendly setting where officers in each company involved come together to go through a due diligence process to ensure a successful marriage between all the parties involved. Historically however, this process has failed, with the majority of mergers and acquisitions failing to add shareholder value.

On other occasions, acquisitions can happen through hostile takeover via absorbing the majority of outstanding shares in the open stock market. In the United States, business laws vary from state to state; some companies have limited protection against hostile takeover. See Delaware corporations.

Financing M&A

Technically, what differentiates a merger from an acquisition is how it is financed. Various methods of financing an M&A deal exist:

  • Merger:- A stock swap involves issuing stock to exchange for the shares of the other company.
  • Acquisition:- A cash deal involves buying a target company with cash.
  • In some cases, a company may acquire another company by issuing junk bonds to raise funds. In a 1985 merger between Pantry Pride and Revlon, Pantry Pride had to issue 2.1 billion dollars of Junk bonds to buy Revlon. The target Revlon was worth 5 times the acquirer.

Motives behind M&A

These motives are thought to be good for shareholders:

  • Economy of scale: This refers to the fact that the combined company can often reduce duplicative departments or operations, lowering the costs of the company relative to theoretically the same revenue stream, thus increasing profit.
  • Increased revenue (due to lack of competition): This motive assumes that the company will be getting rid of a major competitor and increasing its power to set prices.
  • Increased revenue (due to "revenue synergies" aka "cross-selling"): For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts
  • Synergy (better use of complementary resources)
  • Taxes (a profitable company can buy a loss maker to exploit the target's tax shield
  • Geographical or other diversification: This is designed to smooth the earnings results of a company, which over the long term smooths the stock price of a company, giving conservative investors more confidence in investing in the company

Bad for shareholders

  • Diversification (tend to be unprofitable due to conflict of interest)
  • Overextension (tend to make the organization fuzzy and unmanageable)
  • Manager's hubris: Oftentimes the executives of a company will just buy others because doing so is newsworthy, and increases the profile of the company.
  • Manager's Compensation: In the past, certain executive management teams had their payout based on the total amount of profit of the company, instead of the profit per share, which would give the team a perverse incentive to buy companies to increase the total profit while decreasing the profit per share (which hurts the owners of the company, the shareholders)
  • Bootstrapping (example: how ITT executed its M&A)

posted by TBlog @ 12:08 PM