Mergers and Acquisitions
The moment you hear the word M&A, there are numerous questions which may arise in your mind-
- What is the process of M&A?
- How exactly does it take place?
- What happens to the companies undergoing M&A?
- How the deal does take place?
- What happens to the shareholders of both the company?
Mergers and Acquisitions definition-
Both Mergers and acquisitions are prominent aspects of corporate strategy, corporate finance and management. The process of M&A deals on the ways of buying, selling, dividing and combining of different companies. The process may help the involved entities to grow rapidly in its sector or location, or it may also help it flourish in a new field.
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The process of merger involves combining of two companies as a single company. In merger, both the companies mutually agree to merge themselves.
The process of merger is generally adopted for business growth and it is done on a permanent basis. Generally, merger takes place between two companies. However, more than two companies can also participate in the process.
There are two important concepts in merger-
It is a single existing company which purchases the majority of equity shares of another company
It surrenders its majority of equity shares to the acquiring company.
Types of Mergers-
There are various types and forms of mergers. Some of them are listed below-
- Horizontal merger
Merger of two companies that are in direct competition. Such companies share the same product lines and markets.
- Vertical merger
Merger of a customer and company or a supplier and company.
Example- Merger of a cone supplier with an ice cream maker.
- Market-extension merger
This includes the merger of two companies that sell the same products in different markets.
- Product-extension merger
This is the merger of two companies selling different but related products in the same market.
This is the merger of two companies that have no common business areas.
Some examples of well-known Mergers are-
- British Salt (UK) merged with TATA Chemicals (India)
- Zain Telecommunications (Africa) and Bharti Airtel (India)
- ICICI bank (India) and Bank of Rajasthan (india)
Acquisition Definition / Acquisition meaning –
In the process of acquisition, one company buys majority of the company ownership stakes of the target company in order to obtain control over the same.
Acquisitions often form a vital part of a company’s growth strategy. For such firms, it is more beneficial to take over an existing firm’s operations rather than expanding its own operations.
Acquisitions can be both, friendly or hostile. In Friendly acquisitions, the target firm offers its agreement to get acquired. Whereas in hostile acquisitions the target firm does not give any agreement, thus the acquiring firm purchases a large stakes of the target company in order to have a majority stake in it.
M&A Hostile Defense Strategies-
- Shareholder rights plan (poison pill)
- White Knight bidder
- Management Buyout (MBO)
- Stagger board
- Delay annual shareholder’s meeting
- Trigger acceleration of debt repayment
Mergers and Acquisitions Jobs and Roles-
Here the banker goes for executing the deals. Here the banker takes his client to potential buyers and tries to convince the buyer about his clients.
- Executing the Sell-Side M&A Deals
Here the client comes to the investment banker for help; the client proposes his intention to sell his company and asks the investment bank to help him.
- Executing the Buy-Side M&A Deals
Here the client comes to the investment bank with an intention of buying a company. Here the clients need help in either finding such company or helping the financing activity.
M&A Entry Qualifications
The openings to enter mergers and acquisitions are aimed at people with a degree. Employers will require candidates to be proficient, but will typically graduates with a MBA finance degree. Employers may specify their academic requirement and subject. One usually joins the firm as analysts, progressing to M&A associates. Gaining higher experience, one may move into M&A transactional negotiations and project managing deals.
MA& Tasks may involve
- Investigating market conditions and expansions.
- Developing M&A strategies, recognizing sectors and groupings of companies that might be possible business targets for clients.
- Directing investigations into the financial and commercial state of corporations subject to a particular transaction.
- Financial modeling.
- Developing and presenting suitable financial solutions to clients.
- Constructing business ‘pitch book’
- Managing the operation of a M&A proposition.
- Working with corporate finance coworkers to provide advice on capital structure.
- Project managing transactions, overseeing the negotiation of terms and developing proposals to raise funds
- Making new takeover timetables.
- Giving instructions to other colleagues and professionals, such as lawyers.
- Making sure that all the regulatory aspects of a transaction have been taken into consideration.
M&A Job skill requirements
- Relationship management skills
- Analytical skills
- Numerical skills
- Commercial and economic awareness
- Understanding of the financial markets
- Sense of integrity and business ethics
- Communication and interpersonal skills
- Negotiation skills
- Project management skills
- Ability to work within a regulated environment.
Steps in M&A Process
The step-by-step process of a M&A deal is as follows:
1. Company and buyer analysis –
During this process it is important to consider potential synergies, restructuring needs, risks involved, Capital structure etc.
2. Analysis of pricing mechanism-
The various issues that need to be considered here are Cash or equity, various Pricing mechanisms, Terms and conditions etc.
3. Share data analysis-
At this stage it is important to determine if the company is listed or not listed, who were the minority shareholder, determine the status of share certificate.
4. Management presentation and meeting-
Here the buyer and the sellers, all meet the management.
5. Letter of intent-
The issues to consider at this stage are the letter of intent, confidentiality agreement.
6. Process of due diligence-
This includes review of public registers, Annual reports and financial statements.
Issues that are important here are Preparation of applications and filings.
The share transfer certificate plays an important role here.
Here the Submission of applications and filings to Competition Authority and to Financial Supervisory Authority has to be done for approval.
Closing memorandum, purchase price payments are the important steps at this stage of the process.
Concept of Synergy/ Synergy Meaning
Synergy is the concept that stresses upon the fact that the value of the two companies together will be more than that of the individual companies.
By merging, the companies hope to yield from the following factors:
- Staff reductions
Mergers may lead to losing jobs. Thus the money is saved from reducing the number of staff members from various departments.
- Economies of scale
Yes the size of the business matters. Mergers also lead into improved purchasing power to buy equipment or other office supplies.
- Acquiring new technology
To stay competitive, companies need to stay on top of technological development process. By buying smaller companies with unique technologies, a big company can maintain its competitive edge.
- Improved market reach and industry visibility
Companies can reach new markets and grow revenues and earnings. A merge may expand marketing and distribution, giving the two companies new sales opportunities.
Sources of Synergy
- Revenue enhance
- Marketing gains
- Strategic benefits
- Market or monopoly power
- Cost reduction
- Economies of scale
- Economies of vertical integration
- Complementary resources
- Elimination of inefficient management
- Tax Gains
- Net operating losses
- Unused debt capacity
- Surplus fund
- The cost of capital
Importance of Valuation in M&A
Investors of a company which has the intention to take over another one must determine if the purchase will be beneficial to them. Hence they must ask themselves the question that – “How much the company being acquired is really worth?”
The answer to this is valuation of the company. There are many ways of company Valuation. The most common method is to look for comparable peer companies in an industry. But the deal makers employ a variety of other methods and tools for assessment.
Let’s understand a few of them:
1. Comparative Ratios –
The following are two examples of the many comparative metrics on which acquiring companies may base their offers:
- Price-Earnings Ratio (P/E Ratio) –
An acquiring company makes an offer which is a multiple of the earnings of the target company.Analyzing the P/E for all the stocks of the same industry group gives the acquiring company a good picture of what the target’s P/E multiple should be.
- Enterprise-Value-to-Sales Ratio (EV/Sales) –
Here the acquiring company makes an offer as a multiple of the sales.
2. Replacement Cost –
Sometimes acquisitions cost is the cost of replacing the target company. For example the value of a company is the sum of all its equipment and staffing costs. Then acquiring company can direct the target company to sell at that price.
3. Discounted Cash Flow (DCF) –
Discounted cash flows help in determining company’s current value according to its estimated future cash flows.Predicted free cash flows are discounted to a present value using the company’s weighted average costs of capital (WACC).
Free cash flows are calculated by the following formula-
Operating profit + depreciation + amortization of goodwill – capital expenditures – cash taxes – change in working capital.
Financing methods for M&A-
Various methods of financing an M&A deal exist:
Such dealings are usually termed acquisitions rather than mergers. This is because the shareholders of the target company are removed from the big picture while the target comes under the control of the bidder’s shareholders (indirectly).
Here the Payment is often in the form of the acquiring company’s stocks. These stocks are issued to the shareholders of the acquired company.
Motive behind M&A/ Objectives of M&A
- Economy of scale
- Economy of scope
- Transfer of resources
- Vertical integration
The concept of Break-up Fee
A break-up fee is paid if a transaction is not completed. This may happen if a target company walks away from the transaction. This may happen after a merger agreement or stock purchase agreement is signed.
This fee is designed in such a way that it discourages other companies from making bids for the target company.
In case if the acquiring company walks away from a transaction after signing the agreement a reverse breakup fee is paid.
The reverse breakup fees are usually 2-4% of the target company’s equity value. But this is also subject to negotiation between the two companies.