Why Does M&A Happen?
With M&A deals consistently covering the front pages of financial news, it is integral to understand the reasoning behind them. Not only is it necessary to know why a deal is in the works, but also whether the deal is friendly or hostile (which can often be difficult to decipher as an outsider). This article will explore why some firms choose to merge or acquire one another before looking at the nature of a hostile takeover.
Why Do Firms Merge?
There are countless reasons as to why firms would choose to merge. Having said that, it could be argued that the overarching motivation is to benefit from the synergies that arise by combining the two firms. Synergy is where the value of the combined firm is greater than the sum of the two individual firms. In corporate finance, the idea of synergies is sometimes characterised as ‘1+1=3’ to emphasise the additional benefit of the two companies combining to form one entity. There are three main sources of synergy: revenue-based, cost-based and financial-based.
A revenue-based synergy arises from there being the potential for more revenue as a result of the merger or acquisition. One way that this could occur is via strategic benefits. These are potential avenues for growth in the future that would otherwise have not occurred if the merger had not gone ahead. For example, if a motor vehicle producer merged with a sustainable energy company, there is the potential to use the expertise of both companies and produce a sustainably powered vehicle (e.g. an electric car). The production and sale of this new product adds another revenue stream for the combined firm.
In addition to that, if the merger occurs within the same industry, it will create a single entity with a larger market share. Providing that the market share is sufficient for there to be some level of control, the new entity may be able to charge higher prices for consumers. In turn, these higher prices would boost the revenue of the combined firm. The fear of higher prices was the reason given by the Competition and Markets Authority (CMA) in the UK for blocking the proposed merger between Sainsbury’s and Asda.
A cost-based synergy is where there is the possibility of reducing costs within the new entity. Economies of scale, the fall in average costs as production increases, are a main factor in cost-based synergies. These benefits from growing larger (such as access to cheaper financing, bulk-buying, reduced risk etc.) enable costs to fall without having to sacrifice revenue. Consequently, the new firm can enhance profitability.
It is not just economies of scale that can lead to cost-based synergies though. Technology transfer from one firm to the other can increase overall efficiency within the firm as ideas and processes are shared. Additionally, the merging of two entities puts management in the spotlight. This opens the door to the removal of any inefficient managers who are performing inferiorly relative to their peers. A synergy will occur as there will be less money and resources wasted by the inefficient management as they are no longer employed by the new entity. It could be said that this removal of inefficient management would not have occurred had the merger not gone ahead.
Financial-based synergies are the benefits to the general financial health of the new entity arising from the merger or acquisition. One of the most prominent financial-based synergies would be those related to tax. Mergers and acquisitions can be used to decrease the amount of tax paid by shifting moving the company headquarters from a region of high corporate taxes to a region with low corporate taxes. This is known as tax inversion. The merger of Medtronic (a US medical technology company) and Covidien Plc (an Irish medical technology companies) in 2015 for approximately $49.9bn was the biggest tax inversion in history. With that said, there has been a crackdown on tax inversions in recent time.
Whilst mergers and acquisitions can often go swimmingly, there are certainly some instances where the negotiations aren’t as simple. More specifically, there are some scenarios where a company wants to acquire another but has its approach rejected. Despite this rejection, if the company still wants to forgo a takeover, there are various measures that can be deployed to form what is known as a ‘hostile takeover’. Experts predict that the UK could experience an increase in the number of hostile takeovers in the coming years.
The first method which may be used would be a tender offer, where the hopeful acquirer makes an offer directly to the shareholders at a premium to the market value. There is usually a period for which the tender offer is valid before it closes. At this point, the acquirer will review how many shareholders have accepted the offer and determine whether they have sufficient control. American conglomerate Kraft used a tender offer when they launched a hostile bid for British confectioner Cadbury in 2009. It should be noted here that a firm looking to takeover another does not necessarily need 100% of equity in the new business; having enough shares to elect the majority of board members would suffice.
An alternate means to take control of another company would be via what is known as a ‘proxy fight’. This is where the acquirer looks to influence the board of the target company by convincing existing shareholders to vote out the current senior management team and replace them with recommendations of the acquirer. If they succeed in gaining control of the board, the acquirer will consequently gain control of the firm.
Whilst there are arguably an infinite number of reasons behind mergers and acquisitions, the majority can be characterised as looking to capture the synergies that can arise from the transaction. With global M&A volumes hitting an all-time high in 2021, it will be interesting to see how the reasons behinds these transactions change over time. Adding on to that, what the future holds for the nature of M&A activity (whether it being friendly or hostile) will also be pivotal to follow.