Why Firms Undertake Mergers & Acquisitions

A merger or acquisition may result in the same thing, where two previously separate companies now operate as one, but mergers and acquisitions do differ from each other.

In a merger, two (or more) companies form a single body, in a form of legal consolidation. This is usually through an exchange of shares.

In an acquisition, one company buys another company’s shares or assets. In this situation, the buyer company will still exist in its own form, while taking over the other. There may be circumstances where the buyer retains the name of the acquired company for goodwill reasons.

Broadly speaking, the types of M&A fall into five main categories, which are:

• Horizontal – a company merges with or acquires a direct competitor

• Vertical – the merger or acquisition is with a company that operates in a different part of the supply chain

• Conglomerate – two or more companies merge that are unrelated and different enterprises

• Market extension – the buyer company acquires or merges with a target that operates in a different geographic market

• Product extension – the target company sells different products or services, but to the same customers as the buyer company.

But what are the motives for undertaking these different M&A transactions?

Two companies that merge together may create more value for their shareholders. The concept behind this is synergy. This holds that the combined performance and value of two companies will be greater than the sum of the separate parts.

The idea is that two companies merging together will create a greater economies of scale. This can be through reducing or even eliminating some costs, and accessing fresh talent and new technologies.

There can also be synergies of revenue, through market expansion, diversification of products and increased research and development (R&D).

Synergy goes against the common notion that in M&A, one company is the winner, while the other loses out. What synergy suggests is that both companies involved are winners.

Growth is a popular reason for M&A. Where one company is looking to increase its market share, for example, then an acquisition can offer a way of doing it more rapidly and efficiently.

Companies are constantly aware of their place in the market, and constantly on the lookout for ways to improve their standing in relation to the performance of their peers.

By acquiring another enterprise, a company can gain an improved distribution or marketing network.

Or they may want to expand into new markets, and if a target company already operates in these markets, then it makes sense to acquire it.

As well as accessing a new customer base and capturing an additional market share, M&A provides the means to diversify into other products or services.

If a company buys one of its suppliers or distributors, then it can eliminate a whole area of supply chain costs in one go.

This is a vertical M&A transaction.

Here the buyer company can save on the margins its supplier or distributor had been adding to costs, and instead can ship its goods at a lower cost.

By eliminating competition through M&A, a company can improve its market share.

However, if this an acquisition, rather than a merger, then it can prove costly, if the target company has shareholders who require a large premium to persuade them to sell.

The assets a company seeks to acquire may be unique, such as innovative technology. By going down the M&A route, companies can gain valuable assets that would be hard for them to obtain using other methods.

When it comes to technology, especially, the alternative of developing similar assets internally may take too long, or be too complex if it involves patents and licences.

Expertise is also an asset, and merging with or acquiring another company can improve the resources of a business for its research and development.

It can diversify its products or services, combining what it currently offers with another company to improve its combined competitive edge.

Or it may be looking to branch out with a new business opportunity, in an area of the market it is not currently operating in.

Then there is geographical diversification, where one company can acquire or merge with another to reach an entirely new market, or set of markets, overseas.

A merger or acquisition can be a way for a company to improve its capacity for financing future operations.

A consolidated body of two merged companies may be in a much better position to secure a higher financial capacity for development and expansion.

And acquiring a company for its cash-flow stream is also a common feature of acquisitions involving private equity firms.

Many of the brands we interact with on a daily basis are examples of mergers or acquisitions.

Many of these transactions have made headlines because they involve large amounts of money and household names, and because they have had significant implications for the markets in which they operate.

Some have been successful, others less so.

Disney’s acquisition of Pixar is an example of a transaction with multiple benefits.

It began as a one-off agreement to collaborate on the first Toy Story film. Eventually, Disney acquired Pixar in 2006, through an all-stock transaction worth $7.4 billion.

For Disney, this meant they gained the talent and technology of the world’s most famous animation studio. This also cut down on the competition Disney faced in the animated films market.

For Pixar, it alleviated the pressures of market competition, leaving the company free to focus on its core creative strengths. And it could distribute products through Disney’s established merchandising and home entertainment channels.

Microsoft had a strategic rationale when it bought the VoIP company Skype in 2011. This was to increase the number of daily Skype users to one billion worldwide.

At that time, Skype’s profitability was limited enough for it to be attractive for Microsoft to buy.

The acquisition of Skype was a form of enterprise collaboration, with Skype retaining its own individual brand identity.

However, time has shown that this particular acquisition did not live up to Microsoft’s expectations.

Ultimately, Skype underperformed and Microsoft appears to have undermined its own acquisition by launching its own Teams app. Then the rise of Zoom as a direct competitor caused more damage to Skype’s user rates.

A more successful tech acquisition has been Google’s purchase of the startup company Android in 2005, three years before the launch of Android’s first public version.

Nowadays, Android is the most popular mobile operating system in the world, with a 74.6% market share.

The merger of the accountancy firms Ernst & Whinney with Arthur Young & Co is an example of a merger between equals.

The two firms merged in 1989, with comparative advantages for both. At the time, each of firms had clients in certain sectors, located in geographic regions of the USA. The merger enabled Ernst & Young to both consolidate and expand its business.

Mergers and acquisitions can be complex and costly. Achieving your desired outcome comes from identifying strengths and weaknesses, understanding the detail, and weighing up the risks.

An important part of this is due diligence, including a close scrutiny of those areas which could cause the most amount of risk.

We specialise in company and commercial legal services, covering all aspects of M&A, and we’ve produced our own Guide to Mergers and Acquisitions.