Mergers and Acquisitions: Definitions, Process, and Objectives
Chapter 13: Mergers & Acquisitions
Definitions
Acquisitions: Purchase of property rights by a buyer of a company, by means of transferring the majority of the shares to the buyer, where the buyer obtains control of the target. Usually, the target company loses legal independence.
Merger: Two firms decide on joint operation and ownership. Often, stocks are withdrawn, and new stocks are issued in their place. True equal mergers are rare. There are several types of mergers:
- Horizontal: The buyer operates in the same markets as the target.
- Vertical: The buyer and the target operate on different levels of the supply chain.
- Conglomerate: Neither the criteria of horizontal nor vertical mergers are met in an acquisition process.
Process of an Acquisition
An acquisition can be initiated by the buyer or the target. Steps:
- Acquisition yes/no? Type of acquisition?
- Search for targets.
- Negotiations.
- Financing.
- Closing the contract.
- Ratification by the board of directors and shareholders.
- Implementation.
Aspects to Classify Acquisitions
Similarity of business, attitude of target company management, number of prospective buyers, relative size of buyer or target, financing, and tax impact.
Buyer’s Objectives
- Competition-related objectives: Increasing company valuation, growth, reducing competitive threats, investment funds.
- Production-oriented goals: Economies of scale, economies of scope, decreasing dependence on suppliers, access to new technologies.
- Market-related objectives: Completion of product ranges, increase of market share, access to new markets, acquisition of brand image.
- Increasing management’s power.
- Tax optimization.
- Increasing target market valuation.
Seller’s Objectives
- Company-related objectives: Solve financial problems, procure funds for investments, strong partner for further expansion, initiate restructuring of the company.
- Management: Cash out, solve disagreements among shareholders, organize succession.
Odds of Success
75% did not achieve stated objectives, and 30% did not increase shareholder wealth. There are several obstacles to success often underestimated, such as cultural differences, demotivation of employees, distraction from routine business, and loss of customers.
The Winner’s Curse
The winner tends to overpay, then the acquisition may fail commercially. Assumptions: N >= 2 prospective buyers bid for company C. Each bidder has their own belief about C’s economic value. The true value V is the same for all bidders. The higher bidder buys C. Effect: the higher N, the more likely that Vh > V and the higher on average the excess valuation Vh > V.
The Process of Valuation
Data collection: retrieval of data on the condition of acquisition and object, market conditions, abilities of buyer and seller. Forecast: development of scenarios on future profit streams/cash flows.
Negotiations
One negotiation variable: If the willingness to pay by the buyer and the willingness to accept by the seller do not overlap, no deal is possible. If the seller values the merger lower than the buyer, the contract is possible. If the seller values the merger higher than the buyer, the contract is not possible.
One negotiation variable differing expectations: The valuations Vs and Vb may depend on the differing estimations of probabilities. The solution is to do a contingency contract with P = Po (due in any case) + Pc (due only if the merger happens).
Determinants of Negotiation Strength
Negotiation positions and skills determine how the gain is divided. The determinants are the: alternatives, time constraints, knowledge of the opponent, restricted negotiation power, commitment, and threats.