Mergers and Acquisitions

Mergers and Acquisitions

Mergers and acquisitions (M&A) seem to have become common place in the publicly-traded business world and the two terms are often used interchangeably. By definition, an acquisition is the “takeover of a firm by purchase of that firm’s common stock or asset (Brealey, Meyers, Marcus, 2004, p.590), and a merger is defined as “combination of two firms into one, with the acquirer assuming assets and liabilities of the target firm” (Brealey et al, 2004, p. 589). However, mergers between two firms often appear as acquisitions because inevitably, only one management team emerges to lead the new organization forward and these team members typically come from the stronger of the two entities.

There are three ways in which mergers and acquisitions occur: merge the two companies into one organization, one company purchases all of other corporation’s outstanding shares or all the assets of one company are purchased by another. These types of mergers and acquisitions may be categorized as horizontal, vertical or conglomerate. Horizontal mergers take place between competitors in the same line of business, vertical mergers occur between organizations at different levels of the product life cycle, and conglomerate mergers involve companies in completely unrelated businesses.

However they are categorized, the primary motivation of a merger or acquisition should be to enhance shareholder value by creating synergies, leveraging economies of scale, increasing market share, or capitalizing on tax advantages to name a few. Unfortunately, the motivation behind some mergers and acquisitions can be “dubious” from a shareholders point of view. In other words, they add little or no value to the firm. These situations occur when management engages in empire building or acquiring other firms with the sole purpose of gaining additional power, bootstrapping to temporarily raise share prices, or diversification.

When evaluating whether or not to execute a merger, managers of the acquiring company “use various methods to value their targets”:

Some of these methods are based on comparative ratios - such as the P/E and P/S ratios - replacement cost or discounted cash flow analysis. An M&A deal can be executed by means of a cash transaction, stock-for-stock transaction or a combination of both. A transaction struck with stock is not taxable (Investopedia.com, 2006).

The actual mechanics of conducting a merger or acquisition is fraught with risk. Transactions such as these can take months and cost each organization a small fortune. In addition, there are regulatory issues and sometimes anti-trust hurdles to overcome. In the case of a merger or acquisition between organizations headquartered in different countries, regulatory