Mergers and Acquisitions

Mergers and Acquisitions

Readers of today’s market headlines will note that two of the three stories centered around acquisitions. 

The first discussed rumors of Roku potentially being bought by a larger company like Google or Amazon, which has pushed shares in the connected-device maker up more than 15% so far this week (despite absolutely no concrete evidence emerging). The second focused on the planned acquisition of Fitbit by Google and the regulatory headwinds the deal is facing as it nears completion.

With all of this talk about acquisitions, I thought it would be good to revisit the idea of mergers and acquisitions (M&A for short) for today’s Daily Insight and some of the reasons why they occur.

First thing’s first — the term ‘mergers and acquisitions’ is often used in a broad sense to describe the consolidation of two or more companies into a new entity, but a merger and an acquisition aren’t the same thing, strictly speaking. A merger is when the boards of two companies seek shareholder approval to combine both businesses into a single entity. In most cases, one company will cease to exist entirely and simply become part of the other (usually larger) company. The key members of both organizations are supposed to remain equal partners in a merger deal, but this is not always the case.

An acquisition, however, is when one company buys all the outstanding shares of another company and assumes control over its running. The acquired company might not change its name, but will be entirely under the control of the shareholder owner. The term ‘takeover’ is also sometimes used, although it carries more negative connotations.

Although these are the two most common types of joint ventures that companies pursue, there are other variations. An asset merger, for example, is when one company buys the assets of another (usually bankrupt) company, or a management merger, where the top-level employees in a company buy up all outstanding shares and take it private.

Why Merge?

Every deal struck between two companies will have its own distinct reasons for coming to pass. The complexity of different industries means that it’s important to take a close look at the context surrounding every new merger or acquisition to come on the scene.

That said, there are a few broad categories into which most deals fall into.

A lot of companies see a merger as an opportunity to grow in size and dominance very quickly. By acquiring a smaller company, or joining up with a similar-sized company, a business can rapidly become one of the biggest players in their specific field or industry.  Bigger is better for a few different reasons. Not only will they have more resources and assets available to them after a merger, but they will also benefit in terms of economies of scale. This means that a large company can end up actually saving money on things like production and manufacturing when they’re bigger.

Another advantage of increasing company size is the extent of its market reach. By acquiring an established company in a different state, country, or even continent, a new market and existing customers are inevitably opened up almost immediately. There can be issues around a company getting too big in terms of market dominance and competition, however, which we’ll come to in a moment.

Some mergers and acquisitions take place is because large companies might identify a smaller competitor to be a potential rival in the future or, indeed, that current rivals might snap them up before they do. This preemptive competition mindset quite often inspires large companies like Alphabet and Apple to acquire promising young start-ups and incorporate them into their ecosystem. Then, they can take advantage of all the resources that come with the new company while ensuring they don’t lose out to their rivals. However, a lot of investors don’t like to see this as it could indicate that the company is replacing in-house innovation with spending power.

Finally, and perhaps most cynically, is the fact that some companies can use mergers or acquisitions as a way to manipulate the taxes they pay. In such instances, a company might buy a smaller overseas rival in a country with favorable tax rates. They can then set up the company’s tax base in this location, and avail of cheaper rates on their business transactions.

Why Mergers and Acquisitions Fail

Rumors about potential mergers and acquisitions are quite common, so it’s important not to base any important investment decisions on speculation. But even if a merger looks to have been agreed by both sides, there are still a myriad of things that can prevent its realization.

One of the big things that puts the skids on a merger is regulation. Most countries and governing bodies have laws protecting against anti-competitive practices, which essentially stop companies from becoming too influential. For example, Microsoft was forced to back out of a deal to acquire Intuit in 1995 because the U.S. Justice Department threatened to sue. The government claimed the acquisition would give Microsoft a dominant position in personal finance software and was therefore anti-competitive. Alphabet’s current plan to acquire Fitbit looks likely to face similar obstacles as regulators fear it could damage competition.

Shareholders can also stand in the way. Typically, an individual or group who holds the largest stake in a company is the one that gives the go-ahead for a deal to be struck. However, if a merger or an acquisition goes against the wishes of the majority of other shareholders, they can sometimes band together and block the deal.

Bidding wars can hold up a deal too. If a company has some lucrative product or asset, expect to see numerous companies enter the fray with competing bids. 

And finally, it’s worth mentioning that even if a merger or an acquisition is completed successfully, the long-term success of the deal isn’t assured. “Diworseification” is a term that was coined by Peter Lynch to describe what happens where an ill-fated merger or acquisition ends up doing a company more harm than good. For example, Coca-Cola decided to get into the movie business in the 1980s and bought Columbia Pictures. After clumsily inserting their products into a number of box-office flops, shareholders decided they should stick to selling soda and the great plan was abandoned. Or what about the time Urban Outfitters started selling pizza?

What Happens To My Shares?

When one company buys another, they usually pay in cash or stock — sometimes both.

That means that if you’re a shareholder in a company that’s acquired, you might get cash for your stocks (usually at a premium on their current price), new stocks in lieu of the ones you own, or a bit of both. Every merger and acquisition is different though, so it’s important to look into it and figure out exactly how it affects your standing.

JamesJames

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