Introduction to Merger
The term “merger” refers to the agreement as per which two entities combine to form a new entity. In other words, it is the amalgamation of two separate entities into a single legal entity. In the corporate world, there are several types of mergers that are completed with the different types of intentions, such as to venture into new segments, expand a company’s reach or gain more market share.
How does Merger work?
- This is the voluntary combination of two entities into one new legal entity, on fairly identical terms. Typically, entities that decide to enter into a merger agreement are approximate of equal size in terms of the scale of operations. As such, it is sometimes known as “merger of equals”.
- Most of these are done to expand to new territories, gain more market share, cutback operating costs, expand top line or boots profitability. Post-merger, the shares of the new merged entity is issued to the existing shareholders of both the merging entities.
- This is done on a cash basis, stock basis or combination of both. In a cash merger, the stocks of the target entity are purchased by the acquiring entity in cash, while in a stock merger, the stocks of the target entity are purchased in exchange for the stocks of the acquiring entity.
Types of Merger
There are five basic types and they are as follows:
- Conglomerate: The merging companies are not from the same line of business (i.e. there is no business in common), but they are usually merged to enhance shareholder’s values.
- Congeneric: Both companies belong to the same line of business and operating in a similar market with overlapping technologies. Such companies intend to leverage by adding one’s product line to another’s product line. In this way, the new merged entity can build larger customer base and reap benefits of the transfer of technical knowledge.
- Market Extension: Both companies are engaged in the sales of similar products but different geography. Such are enable the companies to expand their product’s reach to other geographies resulting in enhanced market reach.
- Horizontal: The merging companies are operating in the same industry selling the same product. Such are intended to draw benefits of synergy and market consolidation. Usually, it results in larger market share, reduction in operating costs and economies of scale.
- Vertical: Both companies operate at a different level of the value chain in the same industry. Such is part of either backward integration or forward integration. It usually results in a reduction in operating costs.
Examples
The examples for the respective types are as follows:
- Conglomerate: The merger of ABC Inc. and Walt Disney Co. in 1995 is an example of a conglomerate. ABC Inc. was engaged in the broadcast television network, while Walt Disney belonged to the entertainment industry.
- Congeneric: The merger of Broadcom and Mobilink Telecom Inc. in 2002 is an example of congeneric. Both the entities were from the electronics industry and so it is allowed them to combine their technical know-how.
- Market Extension: The merger of RBC Centura and Eagle Bancshares Inc. in 2002 is an example of market extension. It allowed RBC to expand its operations in the North American market.
- Horizontal: The merger of Hewlett-Packard (HP) and Compaq in 2001 is an example of a horizontal merger. The merger resulted in the creation of a global technology leader that was valued at over $87 billion.
- Vertical: The merger of Time Warner and AOL in 2000 is an example of a vertical merger. Time Warner was in the information industry through CNN and Time Magazine, while AOL was in the distribution of information over the internet.
Difference between Merger and Acquisition
Mergers and Acquisitions are somewhat different and some of the major differences are as follows:
- This is the process of combining two or more entities to form a new entity, while acquisition is the process in which the financially stronger entity takes over the shares of the financially weaker entity.
- This results in an amicable situation after the process as the decision is taken after rounds of discussion and agreement between the combining entities. On the other hand, acquisition often results in a chaotic atmosphere after the process as in most cases the decision is not mutual, which gives way to hostility and panic.
- Usually, the companies that enter into a merger agreement are of equal stature and hence they can draw the benefits of synergy. In an acquisition, the acquiring company often imposes its will on the acquired company resulting in an apparent power gradient.
Advantages and Disadvantages
Below are the advantages and disadvantages:
Advantages
- In case, of entities that are competing in the same market, the between them helps them to gain a larger market share of having.
- Some companies go for the merger as it offers the benefit of economies of scale that results in a reduction in the cost of operations.
- This results in revenue growth, which at times fits into the objective of some of the companies that want to achieve the inorganic revenue growth.
- For companies that find it difficult to venture to other geographies, this helps them expand their operations to another part of the world without the hassles of setting up itself in a new market or geography.
Disadvantages
- In some of the cases, it has been observed that the growth rate of the newly merged entity is lower than that of the merging entities.
- The process of communication and coordination among the employees of the merging companies can be a challenging task.
- This often results in a larger entity that can potentially engage in monopoly.
Conclusion
So, it can be seen that a merger is a very important business strategy as it is imperative to grow a business, not just organically but also inorganically, to sustain in the constantly evolving market.
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