Mergers And Acquisitions
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Introduction
An important, some would say only, the purpose of a business is to create value for the owners or shareholders. Businesses, because of the value represented, are often bought and sold by other businesses. The combining and/or buying of businesses is an industry all its own called mergers and acquisitions. When two companies find compatible reasons to combine their businesses and form a single business unit that is called a merger; when one company buys another company that is called an acquisition. This paper will look briefly at the nature and reasons for businesses merging and acquiring other businesses.
Mergers and acquisitions (M&A) generally deal with the battle for corporate control (Brealey, Myers, & Marcus, 2004, p. 588). Corporate control is exercised by top-level management, hired by the board of directors. The only way to remove these managers is through the board of directors. Often, that means replacing the board and hiring new management. There are essentially four ways to change corporate control: (1) proxy contest, (2) purchase of the company by another (merger or acquisition), (3) leveraged buyout, and (4) divestiture (Brealey et al., 2004, p. 588).
Proxy Contests
Proxy contests are campaigns by shareholders to wield enough power to cause changes in management by garnering enough votes of other shareholders to vote a single way. Obtaining legal permission to vote anothers shares is called a proxy. Proxy contests are difficult, but they have been successful in the past when management or board actions have been perceived to be against the best interests of the shareholders. Shareholders elected the board of directors and shareholders can remove them.
Merger or Acquisition
When a company recognizes a value in owning another company, it may negotiate with the target company to merge and create a single company under the control of the initiating company (merger), or the target company may simply be purchased by tendering an attractive offer for the outstanding shares of the target company or by purchasing the assets of the target company (acquisition) (Brealey et al. 2004, p. 590). Mergers and acquisitions can be friendly, negotiated deals in which all parties see an increased post-sale value, or the effort may be considered a hostile attempt by one company to “take over” another company for reasons of its own, usually because it sees an opportunity to change the management and create more value or realize economies of scale – or several other reasons that will be discussed later.
Leveraged Buyout
The purchase of a company by a group of private investors, usually with considerable borrowed money, is called a leveraged buyout, or LBO. LBOs result in the privatization of the company, and the shares are no longer traded publicly. When the managers of the company are the ones buying the company in this manner, it is called a management buyout, or MBO (Brealey et al., 2004, p. 590).
Divestitures
Another method of exercising management control is to divide a company into smaller logical units. By “spinning off” business units of the parent company, other business units are formed, and the shares of the new company are distributed to the shareholders of the parent company. There are many reasons for divesting a business unit from the parent company, but usually the reasons have a lot to do with realizing improved efficiencies – the new businesses can now focus on a more narrow effort that makes them more valuable as stand-alone units.
Each of the four methods of exercising management control is a powerful and important tool at the disposal of corporations. The exact method used will be determined by the reasons for exercising such control. Next we will briefly examine the motives for M&A activity, whether it is proxy contests, mergers or acquisitions, leveraged buyouts, or divestitures.
Reasons for M&A Activity
Motivation behind M&A activity can be both sensible and dubious. Shareholders are people who act on their perceptions and beliefs about what they think will be best for the value of their interests. Types of M&A activity can be categorized as vertical, horizontal, or conglomerate (Brealey et al., 2004, p. 591). Vertical mergers incorporate two or more companies that have activities at varying levels of production. For example, a beef producer may merge with a fine-dining steakhouse corporation to ensure a market for its beef product. Or, a grocery chain may merge with a distribution company to ensure that its products have a safe and reliable method of being distributed to its stores. Those are vertical mergers. Horizontal mergers are those that take place between two or more companies in the same line of business. For example, two grocery store chains merge to form a larger company that realizes economies of scale and greater buying power. Or, two aircraft companies merge to compliment each others areas of expertise in developing quality aircraft. Conglomerate mergers are the formation of single, larger companies (usually called parent companies) from two or more dissimilar businesses. For example, when a single company buys a restaurant chain, an office supply business, and a fine jewelry chain, a conglomerate is formed.
All these methods of M&A may be sensible or dubious in nature. In any case of merger or acquisition, such activity only makes sense if it adds value or synergies and is worth more together than apart (Brealey et al., 2004, p. 592). Generally, the most sensible reasons for M&A activity are to realize economies of scale, economies of vertical integration, and realization of complimentary expertise and/or resources. Dubious reasons for M&A activity include so-called diversification. Diversification rarely makes any sense because if a shareholder wants to be diversified, he or she can simply invest in shares of a different kind of company. Another dubious reason is so-called boot-strapping in which one company buys another to take advantage of the target companys more attractive profitability; however, the result is usually higher share price without increase in earnings and only temporary benefits.
Methods of M&A Activity
Some mergers and acquisitions are accomplished by tendering cash offers; cash is paid for the shares and/or assets of the target company. Another method is an exchange of shares of the buying company for the shares of the target company. Valuations are calculated and an offer is made. Sometimes, a combination of cash and stock are offered/tendered in exchange for the shares/assets of the target