Mergers and Acquisitions: An Overview

Mergers and Acquisitions: An Overview

What are mergers? What are acquisitions?

When one company takes over another company and clearly established itself as the new owner of the larger entity, this is called an acquisition. The swallowed-up entity has officially and legally ceased to exist. During an official merger, both companies' stocks are surrendered and new company stock is issued to shareholders, although quite often, rather than a merger of equals, one company dominates the other company during and after the merger. ("Mergers and Acquisitions: Definition," 2006, Investopedia)

Benefits and costs of mergers and acquisitions

These deals are embarked upon, usually, to generate what is called a process of 'synergy,' throughout the company. Ideally, the new, larger entity is stronger than the two previously existing organizations. Synergy is achieved through enabling staff reductions to occur, by enabling the leaner but larger company to better deploy economies of scale during production, and by combining the strengths of the two entities, such as the technological strengths of one firm with the brand recognition of another firm. (For example, the talent of the small, cutting-edge Pixar animation company and the Disney Corporation)

Less quantifiably, a merger or an acquisition can expand the national or international market base of both companies and raise overall industry visibility. "Companies buy companies to reach new markets and grow revenues and earnings. A merger may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones." ("Mergers and Acquisitions: Definition," 2006, Investopedia)

Sensible" and "dubious" reasons for mergers and acquisitions

Generating such synergy through cost cuts, making outreaches to new markets, and combining strengths are all good reasons for embarking upon a merger or an acquisition. However, merely generating better standing in the investment community, and gaining good press for the company are transient, rather than long-lasting benefits, and will quickly ebb away if the new company does not turn a profit. "Mergers are often attempt to imitate: somebody else has done a big merger, which prompts other top executives to follow suit," and such moves are motivated by "glory seeking" rather than long-term, sound strategic plans. ("Mergers and Acquisitions: Why They Can Fail," 2006, Investopedia)

Financing: Cash vs. Stock

One of the gauges of a merger's success is if the merger deals primarily in cash transactions. "Companies that pay in cash tend to be more careful when calculating bids and valuations come closer to target. When stock is used as the currency for acquisition, discipline can go by the wayside," in terms of the actual value of the acquired company. ("Mergers and Acquisitions: Valuation matters," 2006, Investopedia)

The truth is, that if an analyst wished to improve his or her track record for accurate prediction, he or she would do well to predict the failure of a merger, any merger. Roughly two-thirds of all mergers fail, and lose value on the stock market. Creating an economy of scale can prove difficult, and the new, larger entity can be unwieldy. Again, using stock to finance the deal can be its downfall "a booming stock market encourages mergers...Deals done with highly rated stock as currency are easy and cheap, but the strategic thinking behind them may be easy and cheap too." ("Mergers and Acquisitions: Why They Can Fail," 2006, Investopedia)

Financial risks of merging with or acquiring an organization in another country and how those risks could be mitigated

Globalization," defined as "the arrival of new technological developments or a fast-changing economic landscape that makes the outlook uncertain are all factors that can create a strong incentive for defensive mergers. Sometimes the management team feels they have no choice and must acquire a rival before being acquired. The idea is that only big players will survive a more competitive world." ("Mergers and Acquisitions: Why They Can Fail," 2006, Investopedia) Also, the general trend towards globalization offers an additional incentive to seek to merge with a company with a developed market in an international outpost that the other company wishes to make inroads into -- but there is no guarantee that the corporate culture created by the merger will be equally as successful, or have an equal thumb on the local pulse as the smaller, original company.

Furthermore, local governments can be difficulty to deal with, financing the larger company may be difficult, and a global company is more subject to the uncertainty of worldwide political events. A devalued currency because of fears of internal uprisings, conflicts with government officials, and a clash of corporate cultures, or the culture of the company's home nation and the nation of the firm can all create friction and generate financial losses.