Maximization of Wealth
Mergers and acquisitions, or M&A, pertain to transactions that are incurred between two firms or businesses who are joining forces to become one form. For such transactions, two different companies come together to create more value. The primary objective behind M&A is the maximization of wealth, which acts as a route to evaluate the efficiency and value of various opportunities.
What Are Acquisitions?
Though the two terms are often used interchangeably, they differ when it comes to their legal meanings.
An acquisition is when a company buys a majority of, or all, of the shares of another company. Purchasing over 50% of the stock, as well as other assets of a target firm, gives the acquirer control of the entity. They are then free to make decisions related to finance and assets without receiving approval from the target company's shareholders. If someone is looking to sell their business, an acquisition is often a beneficial option to exit.
Most of the time, acquisitions that are publicized concern well-known and large companies. Due to their size and popularity, these deals dominate the news. However, mergers occur quite regularly between medium and small-sized firms.
Types of Acquisitions
There are various classifications concerned with acquisitions. The sector in which the two relevant businesses operate forms the basis of the most common type of classification.
This strategy pertains to acquiring a firm in the same sector, industry, or business. The acquisition of WhatsApp by Facebook is a real-life example of this kind of deal. Though WhatsApp retains its name, Facebook is its owner, and the two operate in the same industry. However, both yield the benefits that come with the other’s expertise.
The process of vertical acquisition involves a firm acquiring its supplier of materials or the distributor of its products. This could also involve the acquirer gaining control of a firm that sells its products.
For example, a garment company could acquire the source that supplies it with cotton. This is usually done to ensure a greater amount of control of the supply chain. This impacts the receipt of raw materials, as well as the delivery of goods. In turn, the timeline of outsourcing the materials and delivering the product to the end-user is influenced.
This strategy involves firms acquiring another company that operates in a completely different sector, industry, or business. Deals like these are usually made to reap the benefits of diversification. An example of a conglomerate acquisition would be a food company purchasing a clothing company to access a new market.
The congeneric acquisition takes place when companies that share a similarity decide to join hands. This could be related to anything, either a similar distribution channel or production technology. However, the production activity of the two firms is not connected in any way.
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Why Are Companies Acquired?
When a company is looking to be acquired, it will hire a sell-side M&A professional to help it seek out opportunities for a profitable buyout. On the other hand, an acquirer will consult with a buy-side M&A expert for the most profitable businesses out there that will serve its objectives. There are several reasons why acquisitions take place.
Economies of Scale:
Bigger is often considered better. There is no denying that larger firms enjoy competitive benefits, as well as cost savings that smaller companies do not have the opportunity to take advantage of. This is quite common in the airline industry, such as Canadian Airlines being acquired by Air Canada in the 2000s.
Acquiring competition to retain or increase market share is a strategy most firms employ, especially when their other tactics have failed. Studies have revealed time and time again that companies constantly review where they stand in the market relative to their peers. This enables them to be proactive with problems and solutions to protect their market share.
Acquire New Technology:
Industries are constantly evolving, which is why companies are always finding innovative ways survive. Firms often seek out businesses that incorporate unique products and services, and look for distinct or valuable expertise and technologies along with it. For example, the next decade is predicted to bring in acquisitions of various renewable energy firms by gas and oil majors.
Studies have revealed that geographical diversification is a major value driver in M&As. Firms reason that there is no need to build from the ground up in a foreign country when a cash-generating entity can simply be acquired. They believe that an already existing firm can be used as a platform to ensure growth.
As aforementioned, this type of acquisition allows the company to purchase different parts of a value chain. This is done to have greater control over the supplies or the delivery of the product and to minimize the costs being paid out to vendors. Through acquisitions, firms seek to eliminate the need to hire a third party for any function in the value chain.
The Advantages and Disadvantages of Acquisitions
Reduced Barriers of Entry:
Acquiring another company, especially one operating in a different sector, allows expansion into new product lines and markets. In addition, if a brand is already well-known and has a good existing client base and reputation, market barriers can easily be overcome. Even small businesses can use the acquisition to minimize research and development expenses and the time given to building a substantial client base.
Access to Experts:
When large and small businesses come together, their new business model allows greater and easy access to various specialists. These could belong to a wide range of fields and experts, such as a human resource consultant, a lawyer, and an auditor, to name a few.
Access to Capital:
Once the deal for an acquisition goes through, the new company is granted greater access to capital. Small business owners generally invest their own funds into the growth of their business because they cannot attain large loan funds.
However, acquirers open new doors for these businesses, enabling them to raise additional capital without digging into their own pockets.
Though acquisitions are a great way to grow a business, they pose some challenges.
Every company has its own unique culture, which it nurtures and develops after its inception. If the two firms involved in acquisition have conflicting cultures, then it can pose several problems. Managers and employees, as well as their activities, may be unable to integrate and work in cohesion.
The two firms involved in the acquisition process may have different objectives and may be in different phases of growth. For example, where one company may be looking to expand its operations into new markets, the other may be looking for ways to cut costs. This could bring about resistance if both companies have different objectives.
Example of Recent Top Acquisitions
There have been several major acquisitions in the Canadian market lately.
One of these occurred when Flutter Entertainment, an Ireland-based company, acquired the online gaming company, The Stars Group Inc. (TSG). The former purchased all the shares of TSG and decided to create a combined operation, which would generate a yearly revenue of $4.7 billion.
Another example of a recent and big acquisition was when a consortium, Ontario Teachers’ Pension Plan Board, along with AlpInvest Partners, acquired one of the cybersecurity units of Dell Technologies Inc., RSA. The tech giant had been seeking to streamline its business, keep up with dynamic industry trends, and pay off its down debt, which is why it sought to sell off RSA.
Acquiring a high-value business is an effective strategy, but it is extremely expensive. Sourcing acquisition finances requires a solid strategy.
Debentures or Bonds:
Acquirers often opt for bonds and debentures because it gives issuers the flexibility to personalize the bond contract as per their needs.
There have been instances when the company being acquired will provide funds for the deal. In return, they require an annuity payment, which includes an interest over a predetermined timeline. However, this is done only when the owner of the target company is sure that the cash flow generated will be enough to cover the annuity payments.
Banks and Non-Banking Financial Firms:
If the company acquired has a promising cash flow stream and is predicted to continue with the same trend for the foreseeable future, then acquisition finance can be obtained through loans. These loans can come from various banks, as well as lending organizations. They may also be lent out by non-banking financial firms, which offer an affordable rate of interest.
What Are Mergers?
Mergers and consolidation are defined as a voluntary fusion of multiple firms, usually two, which turn into a new legal entity. The organizations that agree to come together and become one are roughly equal in terms of customers, scale of operations, and size.
Most commonly, the objective of a merger is to benefit the shareholders of a firm. This includes increasing the market share, expanding into new territories, reducing operations costs, growing revenues, uniting common products, and increasing profits.
Once deals of mergers go through, the shares of the new firm are distributed to the already existing shareholders of both the original businesses.
Types of Mergers
A merger occurring between two firms that conduct completely unrelated business activities is categorized as a conglomerate merger. There are two kinds of conglomerate mergers, namely mixed and pure. The former involves firms seeking market and product extensions, whereas the latter pertains to firms with nothing in common.
This type of merger is concerned with companies operating in the same sector. This deals with firms operating in the same space as their competitors, usually offering the same goods and services. These are prevalent in industries with a small number of firms, where competition is higher, and the potential benefits of merging are greater.
Market Extension Mergers:
This kind of merger takes place between two firms that are involved with the same product but operate in different markets. The primary aim of a market extension merger is to ensure that the companies coming together receive access to a larger market and a greater client base.
Product Extension Mergers:
A product extension merger occurs between two firms that deal in related products and conduct business in the same market. It allows merging firms to group their offerings together and gain access to a bigger client base.
One such example is that of the merger between Reuters Group PLC and Thomson Corporation in the year 2007, which was the fifth-largest deal in the history of Canada. The information company and the international news organization came together to become one of the largest financial news providers across the globe.
When two companies that produce different goods and services for a particular finished product merge together, a vertical merger takes place. The merging firms are usually at different levels of the supply chain and fuse to enhance synergies and efficiency.
The Benefits and Drawbacks of Mergers
The Pros of Mergers:
It is important to know the value of a business before entering into a deal. This is because the individual valuation is an indication of whether the business will thrive after joining forces. For this reason, you must also be familiar with the benefits and costs of merging. Here are some pros of mergers.
In various industries, the laws of customer satisfaction dictate that firms will need to provide a national network to appease them. This means that there are important economies of scale, and the efficiency of coming together as one will enhance the chances of providing a national network and platform.
Research and Development:
A merger is often executed to access new avenues of research and development in a cost-effective way. This is especially important for companies operating in industries like drug research, where there are various failed strategies that an organization needs to deal with.
Two firms coming together boost their value, and the combined entity is worth more than either of the individual organizations. Duplication is reduced, and efficiency is enhanced. The result usually brings about an increase in the overall revenue.
The Cons of Mergers:
Distress Amongst Employees:
Merging with another firm can cause an employee base to feel distressed. There is an imminent chance of layoffs, which gives rise to uncertainty. Until the entire deal goes through, and the new entity comes into being, the productivity and efficiency of each business may take a hit.
The balance sheet debt of the new company could be increased if either one or both are heavily financed by external sources. It can have an impact on credit lines and hinder the chances of borrowing additional funds. Therefore, it is advised to hire an analyst to go through the financial statements of a potential merging firm.
Example of Recent Top Mergers
Back in 2020, a merger occurred between Canadian rivals Husky Energy and Cenovus Energy, which was estimated to have a total worth of around $3.8 billion. The former is controlled by a billionaire in Hong Kong, Li Ka Shing, whereas the latter is based in Calgary. The merger dictated that once the deal was complete, the billionaire would control a quarter of the new company.
Another example of a merger that is being classified as one of the greatest domestic mergers deals in Canada in the last decade is that of Rogers Communications Inc. and Shaw Communications Inc. The transaction has a value of around $26 billion.
The two examples mentioned above are of recent mergers in Canada, which were both undertaken to reduce competition in highly competitive markets.
Differences Between Mergers and Acquisitions
While mergers and acquisitions are usually used synonymously, they have several subtle differences.
A merger involves the formation of a new company, after which the two separate entities become one. The process of such deals entails the surrender of stocks of these firms, and new ones are issued. Mergers usually take place between organizations of similar sizes.
On the other hand, an acquisition refers to the takeover of one firm by another and, thereby, the establishment of a single owner. Commonly, it is a bigger company which gains control of the smaller one.
Where a merger is quite often a friendly deal occurring between two firms, even if a buyout is involved, an acquisition is deemed to be more of a hostile takeover. However, friendly acquisitions are common, and hostile mergers are possible.
- A non-binding letter of intent
- Exclusivity agreement
- Standstill provision
- Confidentiality agreement
- Due diligence checklist
- Acquisition screening criteria
Even though the pandemic severely impacted the economy, the country has still seen many M&A deals. The domestic deal volume saw a rise of 49% in the first six months of 2021. Choosing to pursue these types of business transactions can result in a successful journey to development and growth, but it will require a lot of thought, planning, and legal and financial advice.
If you need more guidance on the process of M&A deals, or have any questions related to buying or selling a business, feel free to contact us for assistance.