We’ve been taught philosophies such as “There’s synergy in collaboration” since our childhood. And of course the usual habit of the corporate world is to modify the definitions and add money to it. In this blog post, we’ll study one such modification which is Mergers and Acquisitions shortly called M&A. The global M&A market is estimated to have around market transaction volumes of around $3.5 trillion in the year 2018, with such a huge huge market it’s necessary for us to discuss the What,Why and How of M&A.
What is M&A?
The basic definition of Mergers and acquisitions (M&A) is the consolidation of companies or assets through various types of financial transactions. Let’s understand with an example:
Let’s suppose there’s a company A in India which manufactures hardware of communication devices such as phones, and a company B in USA which primarily makes software and other applications. Logically both of the companies have complementary products and when collaborated gives us a good Mobile phone. Now the services of company A can be outsourced by company B working as two different individual companies. But, when both the companies consolidate to a single company, ceteris paribus the profit should ideally be much more than working as 2 different companies because of many reasons such as Tax benefits for FDI in emerging nations, Economies of scale, increase in inventory turnover, increased distribution capabilities etc.
Mergers occur when two companies consolidate into a single legal entity. Such transactions generally happen between two businesses that are about the same size and which recognize advantages the other offers in terms of increasing sales, efficiencies, and capabilities.
A+B=C
Example: Vodafone merges with Idea to form Vodafone Idea Ltd
Acquisitions occur when one company buys or attains a majority stake in another company and there’s no change in the legality of identity. A+B=A Example: Facebook acquires Instagram.
The end result of both processes is the same, but the relationship between the two companies differs based on whether a merger or acquisition occurred.
Why M&A?
The motive of any M&A deal is Synergy. In layman terms Synergy is defined as 2+2=5, where the merged company is more efficient than the accumulation of unmerged companies.
Synergy can be classified into 4 types:
Capex Synergy: The cost savings and cost avoidance of the Capital expenditure to undertake new investments by the firms. Capex synergy can take the following forms.
Example.1: The merger of Exxon and Mobil both being Oil and Gas companies had a lot of common infrastructure which reduced the costs
Example.2: The merger of Vodafone and Idea where there were a lot of overlapping spectrum.
Opex Synergy: The savings of Operational Expenditure which is the investment needed to run the business and for daily activities where synergy can be found such as lot of employment redundancies, economies of scale etc.Example.1: Nokia’s merger with Siemens Network had a lot of Opex synergies where the proprietary technology of one company would benefit the other company as well
Financial Synergy: Tax benefits are one of the main reasons for mergers these days, If one of the firms involved has previously sustained net losses, the merged entity will have tax benefits such as Tax- loss carry forwards. Another major corporate M&A scheme involves a company in a high-corporate-tax-rate state or country merging with another corporation in a low-corporate-tax-rate state or country.Ancillary Opportunities: A major number of M&A’s happen for the opportunities in future and many other prospects such as improving the brand visibility, improving governance in the target companies etc.
How do M&A deals happen?
The M&A process has many steps and can often take anywhere from 6 months to several years to complete. It starts with the acquiring company finding its appetite or target company finding the value of the whole business. Here comes the intermediaries such as Investment Banks which help in Valuation to Making the deals. Once the appetite of Acquiring company is found, the search for target company at that value starts. The target company is selected in such a way that, it fits the budget and gives the maximum synergy. Once the target is found the deal proceeds for “How much to pay”. In a transaction, valuation is essentially the price that one party will pay for the other, or the value that one side will give up to make the transaction work. Valuations are often a negotiated number, because the %growth in future is totally uncertain and valuation completely depends on Cash flows, Future growth and the time value of money.
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