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Why Do Companies Merge With or Acquire Other Companies?

Mergers and acquisitions (M&As) are the acts of consolidating companies or assets, with an eye toward stimulating growth, gaining competitive advantages, increasing market share, or influencing supply chains.

KEY TAKEAWAYS

Mergers and acquisitions (M&As) are the acts of consolidating companies or assets, with an eye toward stimulating growth, gaining competitive advantages, increasing market share, or influencing supply chains.

A merger describes two companies uniting, where one of the companies ceases to exist after becoming absorbed by the other.

An acquisition occurs when one company obtains a majority stake in the target firm, which retains its name and legal structure.

Types of M&A

Merger

A merger describes a scenario where two companies unite, and one of the companies ceases to exist after becoming absorbed by the other. The boards of directors of both companies must first secure approval from their respective shareholder bases.

Acquisition

An acquisition occurs when one company (the acquirer) obtains a majority stake in the target firm, which incidentally retains its name and legal structure. For example, after Amazon acquired Whole Foods in 2017, the latter company maintained its name and continued executing its business model, as usual.

Consolidation

A consolidation results in the creation of an entirely new company, where the stockholders of both companies approve of the consolidation and receive common equity shares in the newly formed entity. For example, in 2018, Harris Corp. and L3 Technologies Inc. joined forces under the new handle L3 Harris Technologies Inc., which became the nation’s sixth-largest defense contractor.

Tender Offer

A tender offer describes a public takeover bid, where an acquiring company (a.k.a. the bidder), directly contacts a publicly traded company's stockholders and offers to purchase a specific number of their shares, for a specific price, at a specific time. The acquiring company bypasses the target company's management and board of directors, which may or may not approve of the deal.

Asset Acquisition

The acquisition of assets occurs when one company acquires the assets of another, with the approval of the target entity's shareholders. This type of event often occurs in cases of bankruptcy, where acquiring companies bid on various assets of the liquidating company.

Management Acquisition

In management acquisitions, which are sometimes referred to as management-led buyouts (MBOs), executives of a company buy a controlling stake in another company, in order to de-list it from an exchange and make it private. But for management acquisitions to occur, a majority of a company's shareholders must approve of the transaction.

Reasons for M&A

Companies merge with or acquire other companies for a host of reasons, including:

Synergies

By combining business activities, overall performance efficiency tends to increase and across-the-board costs tend to drop, due to the fact that each company leverages off of the other company's strengths.

Growth

Mergers can give the acquiring company an opportunity to grow market share without doing significant heavy lifting. Instead, acquirers simply buy a competitor's business for a certain price, in what is usually referred to as a horizontal merger. For example, a beer company may choose to buy out a smaller competing brewery, enabling the smaller outfit to produce more beer and increase its sales to brand-loyal customers.

Increase Supply-Chain Pricing Power

By buying out one of its suppliers or distributors, a business can eliminate an entire tier of costs. Specifically, buying out a supplier, which is known as a vertical merger, lets a company save on the margins the supplier was previously adding to its costs. And by buying out a distributor, a company often gains the ability to ship out products at a lower cost.

Eliminate Competition

Many M&A deals allow the acquirer to eliminate future competition and gain a larger market share. On the downside, a large premium is usually required to convince the target company's shareholders to accept the offer. It is not uncommon for the acquiring company's shareholders to sell their shares and push the price lower, in response to the company paying too much for the target company.