The joys and catastrophes of M&A Deals!

“It takes two flints to make a fire.” ~ Louisa May Alcott

So I spent the whole of my first year not understanding the complicated finance jargon, admittedly only learning about M&A this summer! Which is why I have decided to focus more into uncovering the secret language of Investment Bankers. Mergers & Acquisitions are usually said in the same breath, but in fact they mean two completely different things and cannot be said interchangeably. I will briefly talk about the differences in the two terms and also the pros and cons during an M&A deal. The reason behind doing an M&A deal is because when it goes well… it goes really well! In terms of M&A: 1+1 = 3, this is the idea behind synergy, that two separate companies can achieve more than they could individually, you’ll see why this is optimistic…

Mergers

A merger is simply when two companies combine (or ‘merge’) to form one entity. The opposite of a merger is a ‘Demerger’ when one company splits into two different entities, shout outs to Lloyds TSB which split in 2013! A horizontal merger is usually from two firms that are in the same business sector, like competitors. You know what they say, if you can’t beat them… JOIN THEM (quite literally). A vertical merger is when a business combines with a supplier to internalize costs, for example an ice cream producer may join with an ice cream cone producer. Another form of a merger is consolidation, this is when two companies join and become an entirely different company with an entirely different brand.

Acquisitions

 

An acquisition is when one company takes over another and completely establishes itself as the new owner. Essentially this is like an ‘all-or-nothing’ situation where one company takes it all and the other loses everything (except the handsome paycheck of course), usually, it’s a big company that acquires a smaller one. So in October 2014, Facebook acquired Whatsapp, to explain this in terms of the GIF above – the skinny dog on the right is Facebook and the other two are competitors of Facebook (Twitter and Google+). Now they all have the opportunity to ‘merge’ with Whatsapp (food in front of the dogs) but instead the skinny dog named Facebook takes it all, so the opportunity to ‘merge’ is gone for competitors. This skinny dog now gains weight and becomes bigger (maybe bigger than the other dogs) because of the food it gets, in the same sense Facebook grows by acquiring Whatsapp.

Why Take Part In An M&A Deal? 

1. Economies of Scale – this is when outputs increase, long-run costs decrease. When two companies are involved in an M&A deal, you have more staff and therefore more options. With a bigger pool of staff there will be more talent but perhaps there are a lot of staff with the same skill set and traits. To save on costs collectively, the two companies can get rid of staff and rely on the staff of the other company (if they are better) and allocate talent more efficiently.

2. MORE, MORE, MORE! …(and more and more and more) – by merging or acquiring a company can gain more marketing channels, more distribution channels and more diversified products. Also a company can acquire more technology that was previously protected by a patent and more negotiating powers with suppliers due to your enhanced brand. Finally the last ‘more’ is more customers, not only are you merging two companies, to an extent you are merging the two customer pools together as well! 

3. Greater Market Share – if this is an example of horizontal merging or acquiring a competitor, a greater market share will be an added advantage. This can be particularly important when fending off new entrants to your specific market – if you see a honey badger casually strolling on the street, you run a mile right? (watch www.bit.ly/15kONRc if you think honey badgers are cute and innocent – don’t let the name fool you!)

4. Leads to Innovation – successful M&A deals will lead to an increased profit which can be invested in research & development, this could result in a breakthrough.

5. Tax benefits – a profit-making company can buy a loss maker to use the target’s loss to their advantage by reducing their tax liability. Also different regions have different corporate tax, for example, in the US where corporate tax is significantly higher, big companies may want to acquire firms based in lower corporate tax regions and enjoy a lower tax. 

I Got 99 Problems And Here’s Why M&A’s One (or four)

1. Company Culture Clashes – if two companies have completely different ethics and cultures, it will be hard to coexist as one. An example from Tom and Jerry, I’m pretty sure Tom and Jerry, if put in solitude in separate houses, they would carry on with their lives merrily. However, in the same building… you get the idea. 

2. Diseconomies of Scale – you must be thinking… ‘hypocrite much – you just said economies of scale was a benefit!’ I know it seems counter-intuitive but bare with me for a second. When the two firms combine, it is likely that there will be management inefficiencies. Also if the two companies were really niche, then there is a risk that diversifying will ruin their ‘specialist’ brand, so marketing their new brand can also add to the increasing costs.

3. Overvaluation – due to the negative connotations associated with acquisitions (it’s basically a slap in the face and an act of dominance) some tend to be hostile. Hostile acquisitions are usually because the target company doesn’t want to be bought, but the paycheck is too good to refuse! Instead this sly target company might ‘accidentally’ miss out crucial information about its finances leading to an overvaluation on the purchase price. The poor company on the receiving end of a hostile acquisition will inevitably find out all the details when it’s too late.

4. Uncertainties – the idea of globalization and technological developments make a fast-paced economic landscape, this all adds to the risk of an M&A deal.

Conclusion

Angry Drinking animated GIF

There are both ‘joys and catastrophes’ with M&A. But many M&A deals focus too much on cutting costs whilst losing sight of their revenue. Culture differences might spark resentment and limit productivity, and the overvaluation may mean the initial cost is too much to cover, leading to a decrease in profits. Big investment bankers only get involved with over £100 million deals, some say that a few banks may advise based on what might be profitable for them, rather than the client which adds to the uncertainty associated with M&A deals. But if they get it right then 1+1 is actually equal to 3.

Mahad Hassan

Mahad Hassan

Studying a Bachelor's Degree, Mathematics and Economics at the London School of Economics.
Also in charge of Corporate Relations with the LSESU Business Society.