Mergers and Acquisition:
It’s a term which refers to the consolidation of the companies or assets; it can include a number of transactions such as mergers, acquisition, consolidations, purchase of assets, tender offers and management acquisitions. M&A also refers to the department at financial institutions which deals with mergers and acquisitions.
Transactions of M&A:
In merger, boards of directors for two companies approve the combination and seek for shareholder’s approval. After the merger, the acquired company ceases to exist and becomes a part of the acquiring company.
The acquiring company obtains the majority stake in the acquired firm, which doesn’t change any name or legal structure.
A consolidation creates a new company and the stockholders of both the companies must approve the consolidation. They receive the common equity shares in the new firm subsequent to the approval.
One company offers to purchase the outstanding stock of other firm at a specified price. The acquiring company can communicate directly to the other company’s shareholders through the management and the board of directors.
Acquisition of assets:
While purchasing the assets, one company acquires the assets of another company. The acquired company must obtain approval from its shareholders. Such kind of purchasing of assets is typical during bankruptcy proceedings, where other companies bid for various assets of the bankrupt company, which has been liquidated upon the final transfer of assets while during acquiring the firm.
In a management acquisition also known as “Management-Led-Buyout”, the executives of the company purchases a controlling stake in a company, making it as private. To help fund a transaction, the former executive partner with a financier or corporate officers. Such Mergers and acquisition transaction is typically financed disproportionately with debt and the majority of shareholders need to approve it.
Difference between “Merger and Acquisition”?
Although we use these together and even it used as synonymous, the mergers and acquisition mean slightly different things.
A Merger occurs when two separate entities combines the forces to create a new joint organisation in which theoretically both are equal partners.
An acquisition refers to the purchase of one entity by another (usually a small firm is acquired by a larger one). A new company doesn’t emerge from an acquisition rather the acquired company is often consumed and ceases to exist and the assets become the part of the company.
Acquisition sometimes can be called as takeovers – It generally carries more negative meanings than mergers especially if the target firm shows resistance to being sought.
Even technically it is not, many acquiring companies refer to an acquisition as a merger.
When legally speaking, merger requires two companies to consolidate into a new entity with a new ownership and a management structure.
When one company takes the operational management decision of another one, then there the acquisition takes place. The common interpretive distinction rests on whether the transaction is friendly (merger) or hostile (acquisition).
Friendly mergers of equals would not take place very frequently. It’s very uncommon that two companies would benefit due to the combining forces and two different CEOs agree to give up some authority to realise those benefits. When it happens, the stocks of both the companies are surrendered and the new stocks will be issued under the name of the new business entity.
Since the mergers are very uncommon and takeovers being viewed in a derogatory light, the two terms become increasingly conflated and used in conjunction with one another. Contemporary corporate restructuring are usually referred as mergers and acquisition transaction rather than simply a merger or acquisition. The actual difference between the two terms got eroded slowly by the new definition of M&A deals. The real difference lies how the purchase has been communicated to and received by the target company’s board of directors, shareholders and the employees.
What are the kinds of mergers?
As from the business perspective, there is a whole host of different mergers. Here are few types which are distinguished by the relationship between the two companies that are merging:
Two companies which are in direct competition and sharing the same product lines and markets.
This kind of merge is between the customer and a company or a supplier and a company. For e.g. Ice cream maker can be merge with the cone supplier.
Two companies sell the same products in different markets.
Two companies selling the different products but the related products are in the same market.
Two businesses serve the same consumer base in different ways. For e.g. TV manufacturer and the cable operator.
Two companies which doesn’t have any common business areas. There are two types of mergers which can be distinguished by how the merger is financed. Each one has certain implications for the companies being involved and for the investors.
As the name suggests, this occurs when one company purchases another. The purchases are made with the form of cash or a kind of debt instrument; the sale is taxable. Acquiring companies prefer this kind of companies often because it provides them with a tax benefits. Acquired assets can written up to the actual purchase price and the difference between the purchase price and the book value of the assets can depreciate annually, reducing taxes which are payable by the acquiring company.
Details of acquisition:
In an acquisition, as in some mergers, one company can buy another company with stock, cash or a combination of two. Another possible thing in smaller deals is for one company to acquire all the assets of another company.
For example, if a company X buys all the company assets of Y for cash. Then the company Y will have only cash obviously Y becomes merely a shell and eventually liquidate or enter another form of business.
Another type of acquisition is a reverse merger, which is a deal that enables a private company to get listed publicly in a very short time period. A reverse manager occurs when a private company has strong prospects and very eager to acquire financing which buys a publicly listed shell company that is usually with limited assets and with no business. The private company reverse merges into the public company and when see together it becomes an entirely a new public corporation with tradable shares.
Naturally both sides of an Mergers and acquisition deals would have different ideas about the worth of the target company. Seller will tend to value the company at higher price as possible while the buyer try to get for the lower price that he can.
Many legitimate values are to value the companies, the most common method is to look at the comparable companies in the particular industry, but deal makers employ so many methods and tools while assessing a target company. Few of them are listed below:
The two comparative metrics are there by which the acquiring companies may base their offers:
Price Earnings Ratio (P/E RATIO):-
An acquiring company makes an offer that is a multiple of the earnings of the target company. Looking at the price earnings ratio for all the stocks within the same industry group might give you good guidance for the acquiring company.
Enterprise-value-to-sales ratio (EV/sales):-
An acquiring company makes an offer as a multiple of the revenues again, while being aware of the price to sales ration of other companies in the industry.
- Replacement cost:
Acquisitions are based on the cost of replacing the target company. The acquired one can literally order the targeted one to sell at that price or it may create a competitor for the same cost. All it takes a long time to assemble a good management, acquiring the property and get the right equipment. This method of establishing the price wouldn’t make any sense in the service industry and the key assets like people and ideas are very hard to value and develop.
- Discounted Cash Flow (DCF):
A key valuation tool in Mergers and Acquisition, discounted cash flow analysis determines the company’s current value according to its estimated future cash flows. Foretasted free cash flows (net income + depreciation – Capital expenditures – change in working capital) are discounted to a present value by using the company’s weighted average costs of capital (WACC). Discounted cash flow is little bit tricky to get right, but there are some tools can rival this kind of valuation method.
Acquiring companies nearly always pay a substantial premium on the stock market value of the companies they buy. The justification for doing that always boils down to the notion of synergy, a merger benefits the shareholders when a company’s post-merger share prices increases by the value of potential synergy.
It may be unlikely for rational owners to sell if they would benefit more by not selling. Buyers need to pay the premium if they hope to acquire the company irrespective of what pre-merger valuation tells them. For sellers, the premium represents the company’s future prospects. For buyers, the premium represents as the part of the post-merger synergy which they expected and that can be achieved. The following equation offers a good way to think about the synergy and to determine whether a deal makes any sense. This equation solves for the minimum required synergy:
Success of a merger is measured based on whether the value of the buyer got enhanced by an action.
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