Introduction to Merger
The term “merger” refers to the agreement in 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, several types of mergers are completed with different intentions, such as to venture into new segments, expand a company’s reach or gain more market share.
How does Merger work?
- This 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. It is sometimes known as a “merger of equals.”
- Most of these are done to expand to new territories, gain more market share, cutback operating costs, expand the top line, or boost profitability. Post-merger, the shares of the newly merged entity is issued to the existing shareholders of both the merging entities.
- This is done on a cash basis, stock basis, or a 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 have the same line of business and operate in a similar market with overlapping technologies. Such companies intend to leverage by adding one’s product line to another’s. This way, the newly merged entity can build a more extensive customer base and reap the benefits of transferring technical knowledge.
- Market Extension: Both companies are engaged in the sales of similar products but different geography. Such enables the companies to expand their product’s reach to other geographies resulting in enhanced market reach.
- Horizontal: The merging companies operate in the same industry, selling the same product. Such are intended to draw benefits of synergy and market consolidation. Usually, it results in more significant market share, reduced operating costs, and economies of scale.
- Vertical: Both companies operate at different value chain levels in the same industry. Such is part of either backward integration or forward integration. It usually results in a reduction in operating costs.
The examples for the respective types are as follows:
- 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.
- The Merger of Broadcom and Mobilink Telecom Inc. in 2002 exemplifies congeneric. Both entities were from the electronics industry, allowing them to combine their technical know-how.
- 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.
- The Merger of Hewlett-Packard (HP) and Compaq in 2001 is an example of a horizontal merger. The Merger resulted in creating of a global technology leader valued at over $87 billion.
- 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 significant differences are as follows:
- This is combining two or more entities to form a new entity. At the same time, the 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:
- In the case of entities competing in the same market, the between them helps them gain a larger market share.
- Some companies go for the Merger as it offers the benefit of economies of scale that reduces the cost of operations.
- This results in revenue growth, sometimes fitting into some companies that want to achieve 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 themselves up in a new market or geography.
- In some 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 a monopoly.
So, it can be seen that a merger is an essential business strategy as it is imperative to grow a business, not just organically but also inorganically, to sustain in the constantly evolving market.
This is a guide to Merger. Here we discuss an introduction, how it works, examples, types, differences between, and advantages and disadvantages. You can also go through our other related articles to learn more –