What is Mergers and Acquisitions?
Mergers and Acquisitions or M&A is a financial transaction in which one company merges with one or more companies to form a new entity, or one company acquires another company.
Merger
A merger occurs when one company merges with one or more companies to form a new entity.
For example, when America Online Inc. merged with Time Warner Inc. at the height of the Internet bubble in 2000 in a $182 billion all-stock transaction to form a new entity called AOL Time Warner worth $350 billion, this was a merger as both companies combined to form a new company.
The merger was characterized by both companies as a merger of equals even though AOL, with its high-priced Internet stock, was technically using its AOL stock to acquire Time Warner stock. AOL shareholders would own 55% of the new AOL Time Warner company and Time Warner shareholders would own 45% of the new AOL Time Warner company.
Acquisition
An acquisition occurs when one company acquires another company.
For example, when Amazon.com, Inc. acquired Whole Foods, Inc. for $13.7 billion in 2017, this was an acquisition as Amazon and Whole Foods remained two separate companies. The corporate names and organizational structure of each entity stayed the same.
Friendly Combination or Hostile Takeover
Most mergers and acquisitions transactions involve two companies that want to engage in some combination. These are friendly combinations.
But sometimes a target company does not want to merge with or be acquired by another company. These are hostile takeovers. The potential acquirer normally has to buy a significant stake in the target company and seek to convince or force the Board of Directors or shareholders of the target company to agree to the combination.
The acquirer makes a tender offer for the target company.
Tender Offer
A tender offer involves the acquiring company making a formal offer to buy the outstanding shares of the target company at a specific price and terms.
The tender offer is presented directly to the shareholders of the target company. The Board of Directors and management of the target company are required to decide on whether to accept or reject the offer. And they are required by law to act in the best interests of the company.
Board and Shareholder Approval
In a merger or acquisition, the management of each company presents the transaction to their respective Boards of Directors. Each Director is elected by the shareholders to act as a fiduciary for the company and must make a decision based on what is in the best interests of the company.
The Board of Directors typically vote to decide on the transaction. If the majority of Directors vote against the transaction, it does not receive Board approval and cannot move forward. If the majority of Directors vote in favour of the transaction, it receives Board approval and the deal can move forward.
Next, if the the company is registered in a jurisdiction that requires shareholder approval, or if the company by-laws require shareholder approval, a shareholder meeting is called by the company in order for the shareholders to vote for or against the transaction.
If the majority of voting shareholders vote against the transaction, it does not receive shareholder approval and cannot move forward. If the majority of voting shareholders vote in favour of the transaction, it receives shareholder approval and the transaction can be completed.
M&A Deal Structures
Share Purchase
Most mergers and acquisitions involve the purchase or exchange of shares in the two companies.
In a consolidation, the merger combination creates a new entity with its own new organizational and legal structure. The shareholders of each company receive new shares in the new company.
In a simple acquisition, the companies remain separate entities with each company retaining its own legal structure. The shareholders of the target company receive shares, cash, or other financial instruments from the acquiring company.
Asset Purchase
In an asset purchase, instead of a share transaction, one company purchases the assets of the other company.
The acquirer may acquire the assets of the target company in order to select specific assets that it desires and discard any unwanted assets or debt and other liabilities. An asset purchase is more common in the acquisition of small and medium-sized businesses. It is not common in transactions involving public companies.
Management Buyout
The management team of a company may decide to acquire the company from its shareholders. This is called a management buyout (MBO).
The management team of a public company could raise financing to buy out shareholders of the company. In this case, the management engages in a leveraged buyout (LBO). The managers borrow money secured by the assets of the company in order to fund their acquisition.
The Board of Directors and shareholders must approve the management’s offer.
Reverse Merger
A reverse merger generally involves a smaller private company merging into a public shell company that has no operations and little assets.
This is usually effected in a stock exchange in which the shareholders of the private company sell their company to the public company and receive shares in the public company as compensation. As such, the private company owners become major shareholders of the public company.
Thus, the private company goes public quickly by merging into the public company. The public company may also change its name to a name that better describes its new business operations. With the private company as part of its business operations, the public company can raise additional financing to grow its operations.
Types of Mergers and Acquisitions
There are a number of different methods in which mergers can be structured. The type of merger normally depends on the purpose of the merger or the deal structure of the merger. Types of mergers include:
Conglomerate
Conglomerates were very popular in the 1960s but are less common today. Conglomerates involve a merger or acquisition transaction between 2 companies that have nothing in common.
Ling-Temco-Vought
Ling-Temco-Vought (LTV) founded by entrepreneur James Ling was a huge conglomerate based in Dallas, Texas. It existed from 1961 to 2000 and acquired businesses in aerospace, airlines, electronics, steel manufacturing, sporting goods, and meat packing.
In 1970, LTV was ranked number 14 in the Fortune 500 largest companies in America. It had revenues of over $3.7 billion and more than 120,000 employees in 1970.
Horizontal Merger and Acquisition
A horizontal merger involves the combination of two companies that are direct competitors. These companies operate in the same markets and product lines.
T-Mobile and Sprint
In April 2020, Sprint Corporation merged with T-Mobile US in a $26 billion all-stock deal. They were direct competitors in the wireless carrier industry.
T-Mobile and Sprint both offered similar products to the same markets. The objective of the merger was to increase the customer base of the new company in order to be more competitive against rivals like AT&T and Verizon. And the new company could speed up the development of its 5G technology to serve its customers better.
T-Mobile, which was considered the acquirer in this merger transaction, discontinued the Sprint brand and the new entity emerged as the T-Mobile brand. The merger would create a new company with 100 million customers.
Vertical Merger and Acquisition
A vertical merger involves the combination of two companies that operate at different levels in the same supply chain.
For instance, a customer may merge with its supplier. The customer company usually acquires the supplier company in order to control the volume and quality of its supplies.
Walt Disney and Pixar
In 2006, Walt Disney acquired animation studio Pixar in a deal worth $7.4 billion. This transaction was not a merger. It was a vertical acquisition in which Pixar was purchased by Disney. Pixar became a subsidiary of Disney.
Prior to the acquisition, Pixar, which was founded and run by Steve Jobs, had released its films through Disney’s distribution channels. Thus, Disney would own Pixar’s innovative animation studio and films and receive a steady supply of new Pixar characters and films for the Disney audience. And Pixar would receive guaranteed financial backing and distribution from its new parent company Disney.
Product Extension Merger
A product extension merger involves the combination of two companies that sell different but related products in the same market.
EMC and Data General
In 1999, EMC Corporation acquired Data General Corporation in a $1.1 billion stock swap transaction.
EMC, which is today called Dell EMC, sold enterprise-class storage devices to its customers. Data General sold fibre-channel storage technology, Windows NT and UNIX storage systems and software, and server products to its customers. The combination would add Data General’s products to EMC’s product line. And Data General would benefit from the global distribution and sales reach through EMC’s sales team.
Market Extension Merger
A market extension merger involves the combination of two companies that sell the same or similar products but operate in different markets.
TD Bank and First Horizon Bank
In 2022, New Jersey-based TD Bank, which is a member of TD Bank Group and a subsidiary of The Toronto-Dominion Bank in Canada, acquired First Horizon Corporation in an all-cash transaction valued at $13.4 billion.
The goal of the acquisition was to enable TD Bank to accelerate the growth of its U.S. banking operations into the southeastern market of the United States.
Congeneric Merger
A congeneric merger involves the combination of two companies in the same or related industries or markets but that do not offer the same products.
Heinz and Kraft
In 2015, Kraft Foods merged with H.J. Heinz in a $100 billion transaction. Kraft was a major producer of mayonnaise and cheese. Heinz was a major producer of pasta sauce, meat sauce and frozen appetizers. The merger created a new entity called Kraft-Heinz, which was the fifth-largest food and beverage company in the world.
M&A Valuation
How are the companies valued in an M&A transaction?
Valuation is both an art and a science. The mathematical value of the assets or shares of the companies involved are usually skewed by human emotions that can cloud logical judgment in a transaction.
Valuations are normally performed by the investment bankers involved in the transaction. Each company involved in the transaction engages its own investment bankers and attorneys to represent its company in the transaction.
Here are a few common valuation methods used:
Stock Price Premium
The most common and simplest method used to value a target company involves simply valuing the target company or making a tender offer for the target company at a price that is a specific percentage above its most recent stock price.
For example, if the target company is trading at $60 per share, the acquirer could make a tender offer at 10% above this stock price, by offering to buy its stock at $66 per share.
Generally, when an acquirer makes an offer above the current stock price, this attracts interest in the stock of the target company and new demand for the stock increases the stock price to that tender offer price.
On the other hand, the stock price of the acquirer will generally fall since the acquirer will have to pay out some of its cash or shares to the target company.
Price to Earnings Ratio
An acquirer could offer to pay a multiple of the earnings of the target company. This multiple is the Price to Earnings ratio.
The acquirer could use the P/E ratios of comparable companies in the target company’s industry to decide on the multiple to offer to purchase the target company.
Enterprise Value to Sales Ratio
An acquirer could offer to pay a multiple of the revenues of the target company. This multiple is the Enterprise Value to Sales ratio.
The acquirer could use the Enterprise Value to Sales ratios of comparable companies in the target company’s industry to decide on the multiple to offer to purchase the target company.
Discounted Cash Flow
A discounted cash flow (DCF) analysis calculates a company’s current value based on its estimated future cash flows.
The DCF mathematical formula can be helpful in determining a value for a company.
M&A Financing
Once a transaction has been approved, how does the acquirer pay for the target company?
A company can buy another company with cash, shares, other financial instruments, assumption of debt, or a combination of financing methods. As mentioned in the LBO section, an acquirer may use the assets of the target company as collateral to raise debt funding and acquire the target company.
The investment bankers of the acquirer normally handle the task of raising money to fund the acquisition. They raise the funds from institutional investors such as hedge funds, pension funds, and banks, as well as from wealthy individuals.