Mergers and Acquisitions – What you need to know
Mergers and Acquisitions M&A can be defined as the amalgamation of or getting united by two entities as one single entity. In simple words, mergers and acquisitions take place when two or more businesses combine into one separate entity. This means a newly formed company or the existing company (acquiring company) whenever takes over the assets and liabilities of the old company (acquired company) or the other existing company for a purchase consideration, the mergers and acquisitions take place.
Mergers and acquisitions of companies/business have been one of the most common methods of restructuring. Acquisition of companies can be friendly or hostile. But mergers generally involve the pooling of interest executed by the management team of companies. Most importantly, this can be said that under the Indian context the term mergers are used to denote consolidation of separate legal entities into one single entity through a statutory process of amalgamation.
The motive of M&A are same and both involve the transfer of ownership and control of assets and last but not the least the right to manage corporate cash flows. Thus, it can be said that both these terms are used interchangeably.
Also, the term merger implies merging of two different entities into one and acquisition implies acquiring an old or target company by a new company.
The purchase consideration can be discharged either through cash or through shares and other securities of the purchasing company or through the combination of both. What is known as Mergers in India is known as Amalgamation in the United States of America.
Primarily a merger is executed for deriving the economic benefits or economies of scale in the post merger business of the combined company or if the value of the merged entity exceeds the sum value of the merging entities.
Why do companies do mergers and acquisitions?
The value of a business depends on two factors such as Expected Cash Flows and Cost of Capital. Value of business increases when expected cash flow increases and the cost of capital decreases. Similarly, the value of business decreases when expected cash flows decreases and the cost of capital increases. The following advantages/benefits mainly give rise to the concept of Mergers and Acquisitions.
- Growth Trajectory: The primary motive behind the mergers and acquisitions are the reasons for sustainable growth and improved profitability due to the synergy effect.
- Synergy Effect: Mergers and Acquisitions give rise to additional gains due to synergy effects i.e. additional advantages over and above the individual capabilities which the merger companies gain. Also, synergy gains arise due to intensive production capacity utilisation, distribution network utilisation, research and development and data processing systems.
- Diversification: This refers to the new entry into new products or product line, new markets, new services for obtaining substantial skill, technology and knowledge.
- Tax Advantages: Mergers and Acquisitions help the new entity to take advantage of the tax shield owing to taking over the accumulated losses and accumulated depreciation of the merging entities being a profit-making entity.
- Improved Efficiency: Mergers and Acquisitions help the new firm for best utilisation of resources and due diligence helps in achieving better results with the help of combined resources and maximise capacity utilisation and improved efficiency.
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What are the types of Mergers and Acquisitions ?
- Horizontal merger: A merger is said to be horizontal in nature if it involves two firms operating and competing in the same kind of business activity. Therefore, two or more companies that are in the direct competitive edge in the same product lines and markets, when merging together we can say that a horizontal merger took place. This leads to the economy of scale. Formation of a larger firm may have a benefit of economy of scale. Though it looks very simple in reality, but it is not so easy at all. The work culture between the two competitors may not necessarily be same, who will run the company, egos of each other, who is running the merged company, these sorts of questions keep on popping and these needs to be handled very carefully to derive the synergic benefits. Really it’s going to be a great challenge for the merged entity.
Example: Takeover of Bank of Madura by ICICI bank represented a horizontal merger, Tata Motors acquisition of Jaguar Land Rover, merging of Vodafone and Hutch, acquisition of Compaq by HP in 2011, merging of Lipton India and Brook Bond, Flipkart and Myntra, Amazon and Snapdeal are some of the horizontal mergers examples in the Indian parlance.
- Vertical merger: A merger is said to be vertical in nature if it involves merging of two firms which are at different stages of the manufacturing operation. Thus it means a merger of a customer company with a supplier company. This merger is basically executed so as to ensure smooth supply of raw materials to the acquiring firm. This means the main product manufacturing company can directly source the main ingredients from the merged company without bothering for the other supply chain company.
Example: Acquisition of FLAG Telecom Group by Reliance. Oracle and Sun Microsystems, ArcelorMittal and London Mining Brasil and etc.
In the oil sector, distinctions are made between exploration and production refining and marketing to the end customer. This leads to technological economies such as the elimination of the costs of searching for prices, contracting, payment, collecting and advertising. Also, a shoe producing company S taking over a leather producing company L is another example of a vertical merger. This merger is basically executed to take advantage of the reduced production cost, increased efficiency and profit maximisation.
- Concentric merger: A merger is said to be concentric in nature if it involves the merger of the two firms belonging to the same industry but neither in the same line of business or products. The relationship between the two firms is not even that of a customer and a supplier. This means a company acquires or merges with another company of the same industry but not having the same business operations in place. Thus, a new company is formed to become more competitive and enhance the customer base in the vested industry and this comes with for a suitable compensation under the m&a deals. Statistics have shown previously that this particular type of merger has brought a huge financial benefit to the combined companies in the long term or the companies involved in the said mergers and acquisitions deals.
Example: Citi Group buying Salomon Smith Barney i.e. an investment bank, Axis Bank buying Freecharge, Walmart and Flipkart and etc.
- Conglomerate merger: A merger is said to be conglomerate in nature if it involves the merger of the two firms that have no common business areas or have unrelated business activity. There are two types of conglomerate mergers like Pure conglomerate merger and Mixed conglomerate merger. In case of pure conglomerate merger both the companies have the unrelated business operation and they have nothing in common. On the other hand for mixed conglomerate merger both the companies intend to expand market base or customer base.
Example: L&T and Voltas Ltd., Walt Disney and American Broadcasting co., Microsoft acquired LinkedIn and etc.
- Reverse merger: A merger is said to be reverse in nature if it involves the acquisition of a larger firm by a smaller firm. This concept has been followed successfully for the revival of the sick industries. Generally, a reverse merger is not a hostile one. Under a reverse merger though the smaller company takes over the larger target firm, the management and control vests with the larger company i.e. the acquired firm but not with the smaller company buying the larger one.