A merger is a combination of two or more companies into one company. Generally, the motives of mergers are to enhance the competitiveness of new combined entity in the form of synergies, growth etc. It is generally achieved through stock swap or outright payment to other company. Both mergers are very common and are done for consolidating businesses. The reasons behind consolidating the business are varied and may range from an increased market share to international expansion. Every business combination is guided by a strong reason.
Motives behind Mergers
The following are the motivations behind any merger that occurs between the companies:
This is the most common reason for a merger. It is expected that when two companies merge to form a new bigger company, the value of the new entity will be more than the combined value of two separate companies. Generally, there are two types of synergies that are aimed for:
Synergies that reduce costs through the economies of scale in various divisions of the company, viz. research and development, procurement, sales and marketing, manufacturing, distribution and general administration.
Synergies that increase the overall revenue through expanded markets, products cross-selling and an increase in prices.
Generally, any company has two options to grow, viz. organic growth and external growth. Organic growth is achieved by an increase in sales by making internal investments. External growth is achieved by an increase in sales by buying external resources through mergers and acquisitions. Often, companies prefer to grow externally, especially the ones in a mature industry as the industry offers limited opportunities for growth. It is less risky to have external growth.
A horizontal merger in a small industry will definitely help in increasing the market share. An increased market share will, in turn, give the power to influence prices. In fact, monopoly is an extreme example of a horizontal merger. A vertical merger can also increase the market power by reducing the dependence on external suppliers.
Not every company can have all the resources or strengths required for a successful growth. There will come a time when the company wants to acquire the competencies and resources that it lacks. This can easily be done through mergers and acquisitions in a very cost-effective way as compared to developing the capabilities internally.
Diversification of the company’s total cash flows is a reason argued by managers for the mergers. However, shareholders are not convinced by this reason as they can easily diversify their investments themselves at the portfolio level. This is cheaper and less painful than the company going through the process of merging with another company to achieve synergies created by diversification.
A merger deal might have a bootstrapping effect on the company’s EPS. This occurs when the acquiring company’s shares are trading at a higher P/E ratio than the P/E of the target company and the P/E does not decrease even after the merger. Such an effect increases the current EPS of the company at the expense of decreased future EPS and decreased growth prospects.
Personal Incentives for Managers
The executives of a company might want the merger to satisfy their personal goals rather than maximize the shareholder value. A post-merger bigger company translates into more prestige and greater power for them. Even the compensation increases in a bigger company. Thus, the managers will prefer the merger to increase the size of their company.
A company with a large taxable income will look at merging with a company with large carry forwards tax losses. By doing so, the acquiring company can lower the tax liability. A merger purely for reducing tax liabilities will not be approved by regulators, however, companies can hide this reason under other strong motivations to merge.
Unlocking Hidden Value
A struggling company may be bought by an acquirer to unlock its hidden value. The acquiring company may believe that by making some improvements in management and organizational structure and adding more resources, it can make the company perform better. Of course, the acquirer will pay a lower price than the market price.
International mergers and acquisitions have become more common and important in today’s business world. Like with mergers in one’s own country, these international deals are also motivated by the above-mentioned reasons. However, there are several reasons specifically for international mergers as follows:
- Unique products can be marketed in new markets.
- Transfer of technology to new markets.
- Exploiting market inefficiencies.
- Overcoming disadvantageous policies of the government.
- Continued support to international clients.
Thus, the reasons for mergers are varied and may be single or multiple ones. It is important to understand the exact reason behind a merger to evaluate the resulting synergies and increased margins. A weak or an unsubstantial reason could result in a wrong combination resulting in the huge waste of time and resources.1,2