Motivation leading to Mergers & Acquisition

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Motivation leading to Mergers & Acquisition

Motivation leading to Mergers & Acquisition

Motivation- Improving financial performance or reducing risk

The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance or reduce risk. The following motives are considered to improve financial performance or reduce risk:

  • Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope:

    This refers to the efficiencies primarily associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution, of different types of products.

  • Increased revenue or market share:

    This assumes that the buyer will be absorbing a major competitor and thus increase its market power (by capturing increased market share) to set prices.

  • 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. Or, a manufacturer can acquire and sell complementary products.

  • Synergy:

    For example, managerial economies such as the increased opportunity of managerial specialization. Another example is purchasing economies due to increased order size and associated bulk-buying discounts.

  • Taxation:

    A profitable company can buy a loss maker to use the target’s loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to “shop” for loss making companies, limiting the tax motive of an acquiring company.

  • Geographical or other diversification:

    This is designed to smooth the earnings results of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.

  • Resource transfer:

    resources are unevenly distributed across firms (Barney, 1991) and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.

  • Vertical integration :

    Vertical integration occurs when an upstream and downstream firm merge (or one acquires the other). There are several reasons for this to occur. One reason is to internalise an externality problem. A common example of such an externality is double marginalization. Double marginalization occurs when both the upstream and downstream firms have monopoly power and each firm reduces output from the competitive level to the monopoly level, creating two deadweight losses. After a merger, the vertically integrated firm can collect one deadweight loss by setting the downstream firm’s output to the competitive level. This increases profits and consumer surplus. A merger that creates a vertically integrated firm can be profitable.

  • Hiring:

    Some companies use acquisitions as an alternative to the normal hiring process. This is especially common when the target is a small private company or is in the startup phase. In this case, the acquiring company simply hires (“acquhires”) the staff of the target private company, thereby acquiring its talent (if that is its main asset and appeal). The target private company simply dissolves and few legal issues are involved.

  • Absorption of similar businesses under single management:

    Similar portfolio invested by two different mutual funds namely united money market fund and united growth and income fund, caused the management to absorb united money market fund into united growth and income fund.

  • Access to hidden or nonperforming assets (land, real estate).
  • Acquire innovative intellectual property. Nowadays, intellectual property has become one of the core competences for companies. Studies have shown that successful knowledge transfer and integration after a merger or acquisition has a positive impact to the firm’s innovative capability and performance.

Megadeals deals of at least one $1 billion in size-tend to fall into four discrete categories: consolidation, capabilities extension, technology- driven market transformation, and going private.

Other types

However, on average and across the most commonly studied variables, acquiring firms’ financial performance does not positively change as a function of their acquisition activity. Therefore, additional motives for merger and acquisition that may not add shareholder value include:

  • Diversification:

    While this may hedge a company against a downturn in an individual industry it fails to deliver value, since it is possible for individual shareholders to achieve the same hedge by diversifying their portfolios at a much lower cost than those associated with a merger.

  • Manager’s hubris:

    Manager’s overconfidence about expected synergies from M&A which results in overpayment for the target company. The effect of manager’s overconfidence on M&A has been shown to hold both for CEOs and board directors.

  • Empire-building:

    Managers have larger companies to manage and hence more power.

  • 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).

Different types of M & A

By functional roles in market

The M&A process itself is a multifaceted which depends upon the type of merging companies..

A horizontal merger is usually between two companies in the same business sector. An example of horizontal merger would be if a video game publisher purchases another video game publisher, for instance, Square Enix acquiring Eidos Interactive. This means that synergy can be obtained through many forms such as; increased market share, cost savings and exploring new market opportunities.

  • A vertical merger represents the buying of supplier of a business. In a similar example, if a video game publisher purchases a video game development company in order to retain the development studio’s intellectual properties, for instance, Kadokawa Corporation acquiring From Software. The vertical buying is aimed at reducing overhead cost of operations and economy of scale.
  • Conglomerate M&A is the third form of M&A process which deals the merger between two irrelevant companies. The relevant example of conglomerate M&A would be if a video game publisher purchases an animation studio, for instance, when Sega Sammy Holdings subsidized TMS Entertainment. The objective is often diversification of goods and services and capital investment.

By business outcome

The M&A process results in the restructuring of a business’ purpose, corporate governance and brand identity.

  • A statutory merger is a merger in which the acquiring company survives and the target company dissolves. The purpose of this merger is to transfer the assets and capital of the target company into the acquiring company without having to maintain the target company as a subsidiary.
  • A consolidated merger is a merger in which an entirely new legal company is formed through combining the acquiring and target company. The purpose of this merger is to create a new legal entity with the capital and assets of the merged acquirer and target company. Both the acquiring and target company are dissolved in the process.
  1. Arm’s length mergers

An arm’s length merger is a merger:

  1. approved by disinterested directors and
  2. approved by disinterested stockholders:

The two elements are complementary and not substitutes. The first element is important because the directors have the capability to act as effective and active bargaining agents, which disaggregated stockholders do not. But, because bargaining agents are not always effective or faithful, the second element is critical, because it gives the minority stockholders the opportunity to reject their agents’ work. Therefore, when a merger with a controlling stockholder was: 1) negotiated and approved by a special committee of independent directors; and 2) conditioned on an affirmative vote of a majority of the minority stockholders, the business judgment standard of review should presumptively apply, and any plaintiff ought to have to plead particularized facts that, if true, support an inference that, despite the facially fair process, the merger was tainted because of fiduciary wrongdoing.?

  1. Strategic mergers

A Strategic merger usually refers to long term strategic holding of target (Acquired) firm. This type of M&A process aims at creating synergies in the long run by increased market share, broad customer base, and corporate strength of business. A strategic acquirer may also be willing to pay a premium offer to target firm in the outlook of the synergy value created after M&A process.

  1. Acqui-hire

The term “acqui-hire” is used to refer to acquisitions where the acquiring company seeks to obtain the target company’s talent, rather than their products (which are often discontinued as part of the acquisition so the team can focus on projects for their new employer). In recent years, these types of acquisitions have become common in the technology industry, where major web companies such as Facebook, Twitter, and Yahoo! have frequently used talent acquisitions to add expertise in particular areas to their workforces.

  1. Merger of equals

Merger of equals is often a combination of companies of a similar size. Since 1990, there have been more than 625 M&A transactions announced as mergers of equals with a total value of US$2,164.4 bil. Some of the largest mergers of equals took place during the dot.com bubble of the late 1990s and in the year 2000: AOL and Time Warner (US$164 bil.), SmithKline Beecham and Glaxo Wellcome (US$75 bil.), Citicorp and Travelers Group (US$72 bil.). More recent examples this type of combinations are DuPont and Dow Chemical (US$62 bil.) and Praxair and Linde (US$35 bil.).

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