Merger vs Acquisition: What You Should Know

merger and acquisition

A merger and acquisition are general terms used to explain the coming together of two or more commercial entities that necessitate a rearrangement of their corporate structure. They seek to improve internal synergies within the company in order to boost competence and productivity. However, there are important distinctions between an acquisition vs a merger in terms of beginning, process, and conclusion.

For starters, when two or more organizations decide to combine forces to form a new company, this is known as a merger. Conversely, an acquisition occurs when a bigger, more financially secure firm buys out a smaller one. The latter ceases to exist, and the larger corporate enterprise takes over all of its activities and assets.

Merger vs Acquisition: Overview

It is not uncommon for two businesses to collaborate in the business world. Mergers and acquisitions are the two most common methods for businesses to merge with other businesses. It’s useful to understand how each transaction functions and how they differ from one another if you work in business or are a part of a company that might participate in a merger or acquisition. In this article, we define mergers and acquisitions and examine a number of distinctions between the two kinds of business transactions.

What Exactly Are Mergers and Acquisitions?

Given that the main goal of both transactions is to combine two businesses, acquisitions and mergers can have many similarities in their fundamental operations. For one or both of the enterprises involved in the trade, these kinds of transactions can expand their market reach and profitability. Having stock in a company that combines with another successful company can improve the value of their shares, so this can be extremely beneficial to shareholders.

The most obvious distinction between an acquisition and a merger is the rationale for the use of each type of transaction. When two businesses decide to combine with mutual understanding and agreement, the situation is referred to as a merger. An acquisition, on the other hand, illustrates a scenario in which one corporation acquires another company, oftentimes, for financial reasons.

Merger Definition

A merger occurs when two or more separate firms combine to establish a new company. The merged company typically adopts a new name, ownership, and management team made up of staff from both businesses. And since the merging companies combine their resources to seek specific gains, even at the expense of reducing their respective strengths, the choice to merge is always consensual. Generally, no money is exchanged.

Mergers may be done to grow market share, break into new markets, cut operational costs, boost revenue, and increase profit margins. The size and scope of activities of the parties to the contract are generally comparable, and they treat one another on an equal footing. New shares are issued by the combined business, and existing owners of both parent companies receive a proportionate share of the new shares.

In 2000, Glaxo Wellcome and SmithKline Beecham, two pharmaceutical firms, merged to establish the British global corporation GlaxoSmithKline.

Acquisition Definition

An acquisition involves one company buying the assets of another. Gaining complete control over the target company requires the acquirer to own at least 51% of its equity. A financially stronger organization typically acquires a smaller, comparably weaker one when it happens between two enterprises of different sizes.

Meanwhile, a hostile takeover occurs when a firm takes over the operations of another without the latter’s approval. The choice need not be mutual.

Under the name of the larger corporation, the smaller business continues to operate. The staff of the purchased company may be kept on by the acquirer or terminated. Only in rare circumstances does the purchased firm get to keep its original name; in most cases, the acquired company stops existing under its former name and begins operating under the name of the acquiring corporation. There are no new shares issued.

Similar reasons exist for mergers and acquisitions. The main objective is to pool resources with another business in order to acquire a stronger competitive edge.

The American supermarket business Whole Foods Inc. was purchased by e-commerce behemoth Amazon in 2017 for $13.7 billion. The latter is still operated by its original CEOs, John Mackey and Walter Robb, and still goes by its original name, but all of its activities are under the exclusive authority of parent corporation Amazon.

Merger vs Acquisition: Types

Some frequent deals that fall under the M&A category include the following:

#1. Mergers

The boards of directors of the merging firms accept the union and request shareholder approval. For instance, the Digital Equipment Corporation and Compaq agreed to a merger in 1998, as a result of which Compaq acquired the Digital Equipment Corporation. Later, in 2002, Compaq and Hewlett-Packard merged to form HP. Prior to the merger, Compaq’s ticker symbol was CPQ. The present ticker symbol (HPQ) was made by combining this with Hewlett-ticker Packard’s symbol (HWP).

#2. Acquisitions

In a straightforward acquisition, the acquiring corporation buys the majority of the acquired company, which, sometimes, keeps its name and organizational structure unaltered. The acquisition of John Hancock Financial Services by Manulife Financial Corporation in 2004 is an example of this kind of deal, where both businesses kept their organizational names and identities.

#3. Consolidations

By integrating core companies and doing away with outdated organizational structures, consolidation results in the creation of a new company. Shares of common ownership in the new company are distributed to shareholders of the two companies who have approved the merger. As an example, the 1998 announcement of the merger between Citicorp and Travelers Insurance Group led to the creation of Citigroup.

#4. Offers to Bid

In a tender offer, one business proposes to buy the other business’s outstanding stock for a predetermined amount rather than the going rate. Bypassing management and the board of directors, the acquiring business makes the offer straight to the shareholders of the target company. For instance, Johnson & Johnson made a $438 million tender offer to buy Omrix Biopharmaceuticals in 2008. By the end of December 2008, the company had accepted the tender offer, and the transaction had been completed.

#5. Acquisition of Assets

A company directly purchases the assets of another company in an asset acquisition. The shareholders of the company whose assets are being bought must consent. It is customary during bankruptcy procedures for other businesses to bid on different assets belonging to the bankrupt company, which are then liquidated upon the ultimate transfer of assets to the purchasing businesses.

#6. Management Acquisitions

A company’s leaders buy a majority interest in another business, taking it private, in a management acquisition, also known as a management-led buyout (MBO). In an effort to help fund a deal, these former executives often collaborate with a financier or former company leaders. The majority of shareholders must consent to such M&A transactions, which are mostly financed disproportionately with debt. For instance, Michael Dell, the company’s creator, stated in 2013 that he had acquired Dell Corporation.

Merger vs Acquisition: Structure

The following explains what structures look like when it comes to mergers and acquisitions.

How Mergers Are Structured

Depending on the relationship between the two companies involved in the transaction, mergers can be set up in a variety of ways:

  • Horizontal Merger: A horizontal merger is the coming together of two businesses that compete directly and have similar markets and product lines.
  • Vertical Merger: This is a merger between a client and a business or between a business and a supplier. Imagine a cone provider and an ice cream manufacturer merging.
  • Congeneric Merger: Congeneric mergers involve two companies that provide the same clientele in various ways, like a TV manufacturer and a cable provider.
  • Market-extension merger: Merger of two businesses that sell the same goods in various markets.
  • Product-extension merger: Merger of two businesses selling distinct but related items in the same market.
  • Conglomeration: A conglomeration is a grouping of two distinct businesses.

Two different financing strategies, each with different implications for investors, can potentially be used to discern between mergers.

How Acquisitions Are Financed

A business can acquire another business using cash, equity, the assumption of debt, or any combination of the three. One corporation often buys the whole asset portfolio of another company in smaller transactions. For example, company X pays cash for all of Company Y’s assets, leaving Company Y with nothing except cash (and debt, if any). Of course, Company Y degenerates into a mere shell and eventually liquidates or expands into other industries.

Reverse mergers, a different type of purchase arrangement, allow a private business to become public relatively quickly. Reverse mergers happen when a private company with promising future prospects that is desperate to get financing buys a publicly traded shell company with scant assets and no real business operations. The public firm and the private company reverse merger, creating a new public corporation with marketable shares.

How Acquisitions and Mergers Are Valued

The target firm will be valued differently by each of the companies involved in an M&A acquisition. Naturally, the buyer will try to purchase the company for the least amount of money while the seller will value it as highly as they can. Fortunately, a company may be assessed objectively by looking at similar businesses in the same sector and relying on the following metrics:

#1. Price-to-Earnings Ratio (P/E Ratio)

An acquiring business makes an offer that is a multiple of the earnings of the target company using a price-to-earnings ratio (P/E ratio). The acquiring business will receive sound advice on what the target’s P/E multiple should be by looking at the P/E for all the companies in the same industry group.

#2. Enterprise-Value-to-Sales Ratio (EV/Sales)

The acquiring corporation uses an enterprise-value-to-sales ratio (EV/sales) to make an offer that is a multiple of revenues while being cognizant of the price-to-sales (P/S ratio) of rival firms in the sector.

#3. Discounted Cash Flow (DCF)

A company’s present value is established using a discounted cash flow (DFC) analysis, a crucial valuation method in mergers and acquisitions. Using the company’s weighted average cost of capital, forecasted free cash flows (net income plus depreciation and amortization, capital expenditures, and changes in working capital) are discounted to a present value. Although DCF might be challenging to use correctly, few tools can compete with it as a valuation technique.

#4. Replacement Cost

Acquisitions are occasionally determined by the cost of replacing the target company. Let’s assume, for argument’s sake, that a company’s value is equal to the total of its personnel and equipment expenses.

The acquiring corporation can demand that the target sells at that price, or else it will build a rival business at the same price. Generally, the process of assembling competent management, acquiring property, and investing in the appropriate machinery is lengthy. Moreso, in a service industry where the key assets (people and ideas) are difficult to evaluate and develop, this form of pricing wouldn’t make much sense.

Merger vs Acquisition: Examples in the Real World

The following are two of the most notable mergers and acquisitions over the years, however, there have been many.

Merger: Exxon and Mobil

Following the Federal Trade Commission’s permission, Exxon Corp. and Mobil Corp. completed their merger in November 1999. (FTC).

Prior to the merger, Exxon and Mobil were the top two oil producers in the sector. The combined company underwent a significant restructuring as a result of the merger, which included selling more than 2,400 petrol stations around the country.

Exxon Mobil Corp. (XOM) continues to be the name under which the joint venture trades on the New York Stock Exchange (NYSE).

Acquisition: Time Warner and AT&T

According to AT&T’s website, the acquisition of Time Warner Inc. by AT&T Inc. (T) was finalized on June 15, 2018.

The acquisition, however, was challenged in court as a result of U.S. government interference to thwart the transaction, but in February 2019, an appeals court upheld AT&T’s acquisition of Time Warner Inc.

Within three years of the transaction’s closing, the $42.5 billion acquisition is anticipated to result in cost savings for the combined business of $1.5 billion and revenue synergies of $1 billion.

AT&T announced on May 17, 2021, that it would spin off its WarnerMedia division and combine it with Discovery.

Merger vs Acquisition: Why Do Businesses Keep Using M&A to Acquire Other Businesses?

Growth and competition are two of capitalism’s primary forces. A business must innovate while cutting expenses when it faces competition. Buying rival companies is one way to make them less of a threat.

Businesses also use M&A to expand, half the time, by acquiring additional product lines, intellectual property, human resources, and customer bases. Businesses could also search for synergy.

Merging business operations usually results in improved overall performance efficiency and decreased overall costs as one company makes use of the advantages of the other.

What is a Hostile Takeover?

The most regular acquisitions are friendly ones, which take place when the target company consents to be purchased. The board of directors and shareholders authorize this acquisition, and these mergers often work to both parties’ advantage.

Hostile takeovers, also referred to as unfriendly acquisitions, on the other hand, happen when the target company rejects the acquisition. In contrast to friendly acquisitions, hostile acquisitions require active participation on the part of the acquiring firm in order to acquire a controlling position in the target company and force the acquisition.

Merger vs Acquisition: How Are Shareholders Affected by M&A Activity?

In general, shareholders of the acquiring company will see a brief decline in share value in the days preceding a merger or acquisition. At the same time, the value of the target company’s stock often increases.

This is mostly because the acquiring corporation will have to invest money to buy the target company at a price above the pre-takeover share values.

The stock price typically rises above the pre-takeover value of each underlying company after a merger or acquisition formally takes place.

Shareholders of the amalgamated firm often experience positive long-term performance and dividends in the absence of unfavorable economic conditions.

Meanwhile, be aware that the increased number of shares released during the merger procedure may result in a dilution of voting power for the shareholders of both firms. When the new firm offers its shares in exchange for shares in the target company, at an agreed-upon conversion rate, this occurrence is significant in stock-for-stock mergers.

While shareholders of a smaller target firm may incur a severe erosion of their voting power in the relatively bigger pool of stakeholders, shareholders of the acquiring company only experience a slight loss of voting power.

What Sets a Vertical Merger or Acquisition Apart from a Horizontal One?

Companies adopt the competitive strategies of horizontal and vertical acquisition to strengthen their position against rivals. The acquisition of a similar company is known as horizontal. When a business chooses horizontal acquisition, it will buy a rival business that competes at the same industry value chain level, such as when Marriott International, Inc. acquired Starwood Hotels & Resorts Worldwide, Inc.

The process of purchasing business operations within the same industrial vertical is referred to as vertical acquisition. A business that chooses vertical acquisition assumes total control over one or more phases of a product’s manufacture or distribution. For instance, Apple purchased AuthenTec, the company that develops the touch ID fingerprint sensor technology used in its iPhones.

Merger vs Acquisition FAQs

How Do Mergers Differ From Acquisitions?

The term “acquisition” generally refers to a deal when one company buys out another company through a takeover. When the buying and target companies come together to form a totally new entity, the word “merger” is employed. The use of these phrases tends to overlap because each combination is a unique situation with its own features and motives for carrying out the transaction.

Why Do Companies Keep Acquiring Other Companies Through M&A?

Combining business operations usually results in improved overall performance efficiency and decreased overall costs as one company makes use of the strengths of the other.

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