Takeovers and Mergers - the Language of M&A
Students writing essays about takeovers and mergers need to be familiar with some key terminology. Here are some key terms which are worth understanding and using when writing about M&A:
A vital topic for takeovers and mergers. Government regulators in developed economies such as the UK, USA and Europe are concerned to ensure that businesses do not have excessive market power. Most countries have regulators with the powers to restrain powerful firms or prevent takeovers and mergers that have the potential to create such power. For example, in the UK the Office of Fair Trading (OFT) can investigate whether there is a realistic prospect that a takeover or merger will lead to a substantial lessening of competition. If it decides there are such prospects, the OFT can refer the deal to the Competition Commission (CC). The CC has wide-ranging powers to remedy any competition concerns resulting from a takeover or merger, including preventing the deal from going ahead.
Consolidation refers to the reduction in the number of competitors in a market and the resulting increase in the total market share held by the remaining firms. Takeovers and mergers can be used to consolidate the competitors in an industry which can have several potentially beneficial effects. Firstly, it increases the market power of the acquirer by reducing competition, perhaps enabling the firm to increase prices. Secondly, by putting two competitors together the enlarged business can improve efficiency by reducing surplus capacity or sharing resources.
Cost synergies are the cost savings that a buyer aims to achieve as a result of taking over or merging with another business. These can arise in several ways. For example, integrating two business operations together can allow for reduced headcount, shared services and also the elimination of excess capacity. The enlarged business might also be able to reduce costs by using its greater bargaining power with suppliers, rationalising IT systems and sharing joint expertise to boost efficiency and productivity.
Dis-synergies are negative or adverse effects of a takeover or merger. These are the disruptions that arise from the deal which result additional costs or lower than expected revenues. Good (and common) examples include:
Lower employee productivity during a period of due diligence or arising from the uncertainty of the takeover
Loss of key employees to competitors
Underestimating the time and complexity of merger integration, particularly integrating different systems
Loss of customers who may decide that they wish to reduce the total amount they spend with the two businesses once combined or (worse) switch to a different supplier altogether.
A concept associated with the Ansoff Matrix, diversification involves increasing the range of products or markets served by a business. The extent of diversification depends on the extent to which those products or markets are different from the existing products and markets served by the business. At the extreme, the concept of “conglomerate diversification” involves diversifying into products or services with no relationships to the existing business.
Due diligence is the process undertaken by a prospective buyer of a business to confirm the details (e.g. financial performance, assets & liabilities, legal ownership & issues, operations, market position) of what they expect to buy. Due diligence will look at both the historical record and position of the target business and also the future prospects of the business.
Economies of scale
A common rationale or justification for takeover and mergers. Economies of scale refer to the reduction in unit costs which can arise as the scale of a firm’s operation increases. The concept is closely linked to the strategy of “cost leadership”. Economies of scale are particularly important in industries or markets where businesses have high fixed costs. If a takeover or merger can enable a business to significantly increase its combined scale of operation, then those fixed costs can be spread over a larger output. The mega-mergers in industries such as pharmaceuticals (e.g. the Astra/Zeneca or GlaxoSmithKline mergers) and airline operation (e.g. British Airways / Iberia merger) are good examples of firms looking to M&A to achieve economies of scale.
Horizontal integration occurs when two businesses in the same industry at the same stage of production become one - for example a merger between two car manufacturers (e.g. Daimler & Chrysler) or tour operators (e.g. TUI & First Choice). The key benefits of successful horizontal integration include economies of scale and increased bargaining power (e.g. over suppliers, customers).
A merger is a combination of two previously separate organisations. A merger can be seen as a decision made by two businesses that are broadly “equal” in terms of factors such as size, scale of operations, customers etc. The enlarged business, through the changes made by combining both together, can cut costs, grow revenues and increase profits - which should benefit shareholders of both the original two businesses. What typically happens in a merger is that a new company is formed - and the shares in the new company are distributed to the shareholders of the two original businesses in a suitable split.
The process of bringing two firms together once they have come under common ownership. Often regarded as the most difficult part of any takeover or merger. The integration process needs to cover “hard” areas such as IT systems and marketing strategy as well as “soft” issues such as communication and different business cultures.
Revenue synergies refer to the ability to sell more products and services or raise prices due to the deal. Potential revenue synergies include marketing and selling complementary products; cross-selling into a new customer base and sharing distribution channels.
This important concept is all about the financial returns that are obtained by the shareholders of the business that undertakes a takeover (or both sets of owners in the case of a merger). Shareholder value is created by generating future returns for shareholders which exceed the returns that those shareholders could expect to earn elsewhere. The returns are measured in terms of cash flow, and the cost of capital is used to charge for the use of the capital invested. In essence, the idea is that if you manage your business to add to your shareholder value, then you also improve the value of your shareholders’ investment, and this is consistent with the organisational objective of maximising shareholders’ wealth.
A takeover (sometimes also called an “acquisition”) arises where one business acquires a controlling interest in another business. For a takeover, there is a change of ownership, with the acquiring firm becoming the legal owner of the business that has been sold. The shareholders of the acquired firm agree a price for their shares. Takeovers are much more common than mergers.
Vertical integration refers to the merger of companies at different stages of production and/or distribution in the same industry – and includes backward and forward integration. Backward vertical integration means the merger with input suppliers (e.g. a manufacturer buying a raw material supplier). Forward vertical integration means integration with firms in the output distribution chain (e.g. a manufacturer buying a retailer).
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