Mergers & Acquisitions: Reasons and Considerations
This section discusses all sides of why mergers and acquisitions (M&A) happen, including key factors in mergers, advantages and disadvantages of mergers, M&A strategy considerations etc.
There are three common ways in which companies get together in order to obtain competitive advantages in their markets:
- Vertical merger. A company merges with a supplier or a customer. An example is when a wholesaler mergers with retailers.
- Horizontal merger. Two companies in a similar business merge. An example is the merging of two grocery stores.
- Conglomerate merger. Two companies in unrelated industries merge their operations, such as an automotive company mergers with a publishing company.
Reasons and objectives for Mergers and Acquisitions (M&A)
Common reasons for corporate mergers and acquisitions are:
- Market considerations. One frequent merger objective is to capture a greater share of the market which the company serves. A merger may make it possible for the company to offer a complete product line for the first time, or it may expand the geographic area in which the company sells its goods. Foreign acquisitions are frequently made for this latter reason.
- Distribution economies: creating a single distribution system (including salesmen, jobbers, dealers, retail outlets, and transportation facilities) which can handle two products having common, or similar, markets and distribution channels at a lower unit cost.
- Product and geographic diversification: entering new product and international markets, which will enable companies to avoid the adverse impact of negative conditions in a particular market, and/or to participate in new growth markets.
- Improved operations through strengthening weaknesses, eliminating overcapacity, and reducing overhead costs. Also seasonal problems can be solved as well.
- Research and development (R&D) needs: reducing the R&D cost per unit of production.
- Financial reasons: securing higher earnings per share (EPS) and as a result a higher price/earnings (P/E) ratio and/or achieving greater financial stability and security.
- Complexity and automation. Small and medium enterprises (SMEs) may seek a merger with a larger companies in order to use their resources for automation. Similarly, two SMEs may join to create an organization of sufficient size to compete with larger corporations.
Advantages and disadvantages of Mergers and Acquisitions (M&A)
Advantages of Mergers and Acquisitions
- Increases market share and expands product lines.
- Provides a good return on investment when the market value of the acquired business is significantly less than its replacement cost.
- Provides something that acquirer misses such as superior management and research capabilities.
- Helps the company in financing internal expansion by purchasing a business already possessing required capital facilities.
- Attains an operational synergistic effect: increased efficiency through economies of scale in production, marketing and purchasing and cost savings through eliminating overlapping administrative functions.
- Achieves financial synergy since the cost of issuing debt and/or equity securities is lower for larger firms.
Disadvantages of Mergers and Acquisitions
- Reverse synergies – reducing the net value of merged companies due to costs of servicing acquisition debt, incompetence of acquired company management etc.
- Undesirable financial effects due to inability to materialize the anticipated benefits such as expected cost reductions.
- Antitrust procedures delaying or preventing the proposed merger.
- Problems caused by violating the minority stockholders rights.