People often use the terms mergers and acquisitions interchangeably. Both refer to popular corporate restructuring strategies further confused by the modern corporate transaction called a Merger and Acquisition (M&A) deal instead of a merger or an acquisition, leading to the erosion of the differences between the two.
Even though both mergers and acquisitions aim to achieve better synergies within companies and increase the organization’s efficiency and competence, each of these corporate restructuring strategies has specific applications.
Knowing the factors that differentiate between mergers and acquisitions helps one make informed company restructuring decisions. These factors include:
Decision and Initiation
The Merger
A merger is a process that occurs when two or more companies of similar size and scope combine forces and create a new organization. The new corporate entity believes that the combined companies can improve performance and synergies and gain a competitive advantage.
The merged companies consolidate into a new entity with a new name, new ownership, and a new management structure, usually comprised of members from each firm. The CEOs of the consolidating companies foresee mutual benefits in this corporate restructuring strategy and agree to relinquish some individual authority to realize these advantages.
The terms of a merger are friendly as the directors, employees, and other key people in the firms involved are aware and in agreement with this corporate strategy.
Merger Case Study
Exxon Corp. and Mobil Corp., the top two oil producers, respectively, in the industry, merged in 1999 after obtaining approval from the Federal Trade Commission. The FTC demanded an extensive restructuring of the combined organization under the name Exxon Mobil Corp. and asked that over 2,400 gas stations across the United States be sold in this largest retail divestiture in the FTC’s history.
The Acquisition
An acquisition occurs when a financially strong company acquires a firm smaller in scope and size, usually within the same general industry. The acquiring company aims to create shareholder value by expanding its customer reach or by gaining market share. Sometimes a smaller company approaches a larger, stronger one and proposes the acquisition.
Reasons for acquisition vary. The acquiring company may purchase a supplier’s firm to increase production and lower per-unit costs to improve economies of scale. A financially strong company might also seek to increase its market share, reduce costs, and expand into new product lines by adopting the acquisition strategy. Sometimes companies engage in acquisitions to obtain the target company’s technology to save years of capital investment costs and research and development.
A new company does not emerge in an acquisition transaction. Instead, the larger company absorbs the smaller company, which then ceases to exist. The smaller company transfers all its assets to the larger company and starts functioning under it.
An acquisition transaction does not always happen on friendly terms. At times, the financially strong or acquiring company forces the decision on another company to accomplish its goals, such as gaining new markets, expanding its customer base, reducing competition in the industry, etc.
The acquisition transaction might not go through smoothly. Usually, the acquiring company takes over all decisions for the target company concerning staffing, structure, resources, etc., which creates a sense of uneasiness among its employees.
An acquisition transaction, also called a takeover, carries a negative connotation. Most companies prefer calling corporate restructuring a merger to facilitate a smooth transition, even when it is a takeover or acquisition.
Acquisition Case Study
AT&T Inc. completed its acquisition of Time Warner Inc. in June 2018. However, the US government intervened to block the deal, and the case went to court. Finally, an appeals court cleared AT&T’s takeover of Time Warner Inc in February 2019. AT&T Inc. expected the combined entity to realize cost savings of $1.5 billion and revenue synergies of $1 billion within three years of closing the $42.5 billion acquisition.
In reality, merger transactions happen less frequently than acquisition transactions. Due to the negative perception of takeovers, contemporary corporate restructuring methods blend both terms and use them in conjunction with one another to call it an M&A deal.
Procedure and Payment
A merger transaction usually does not require cash. However, this corporate restructuring strategy dilutes the individual power of each firm involved in the transaction. The companies involved in the merger surrender their shares to the newly formed joint company, which issues new shares to the shareholders of the consolidated organization.
Shareholders of the merged companies receive shares of the new company in the same value as they held previously. For instance, if a shareholder-owned $5,000 worth of shares in one of the merging companies, after the merger, they will receive shares of the newly formed company amounting to $5,000. The number of shares the shareholder owns before and after the merger could change, but the value of shares remains the same.
Companies often, similar in size, scope, and capability come together. A merger transaction is also called the merger of equals. However, rarely are the modern merger transactions the merger of equals. Larger companies often acquire smaller organizations and let them call the acquisition a merger to preserve their reputation.
Case Study
Two pharmaceutical companies, Glaxo Wellcome and SmithKline Beecham, merged in 2000 to create the largest pharmaceutical company in the world with a market capitalization of $186.65 billion and a global market share estimated at 7.3%. The two firms described the new entity, GlaxoSmithKline, as a merger of equals, even though the shareholders of Glaxo Wellcome owned 58.75% of the consolidated company.
The acquiring company pays in stock, cash, or both to buy the target firm. Usually, the acquiring company buys all shares or majority interest. If the acquisition transaction takes place on all cash terms, there is no change to the equity portion of the acquiring company’s balance sheet.
Suppose a larger company purchases a majority stake that is less than 100 percent in the form of shares of the target company. In that case, its balance sheet will show the minority interest in the liabilities section.
The acquiring company provides shares of its organization to the target firm’s shareholders per a predetermined ratio. For example, suppose a shareholder owns 500 shares in the target company, and the terms of the acquisition are a 1:1 all-stock deal. In that case, that person receives 500 shares in the acquiring company after the transaction. The value of the shares allotted to the shareholders of the target company is reflected in the acquiring company’s financial statements.
The target company ceases to exist in its previous name and continues to operate under the name of the acquiring organization. The parent company has the right to either retain or lay off the staff of the acquired company. Occasionally, the target company retains its original name after the acquisition.
Case Study
Amazon acquired American supermarket chain Whole Foods Inc. for $13.7 billion in 2017. The target company continues to operate in its original name, and the original CEOs, John Mackey and Walter Robb run it. However, the parent company Amazon controls all its operations.
Related: Benefits of M&A.
A Common Purpose
The most common corporate restructuring strategies–mergers and acquisitions–differ on several significant points:
- procedure,
- mutual decision,
- name of the new company,
- comparative stature of the combining companies,
- the share of power among the merging firms, and
- the shareholding ratio of each company.
The purpose of both mergers and acquisitions is to achieve better synergies, cut costs, increase profits, expand operations, reduce competition, and enhance market share.
Be it a merger or an acquisition, the critical point for business owners to consider is the smooth integration of companies. In many cases, the firms combine on paper, but in reality, face immense hurdles conducting joint operations.
Challenges arise from differences in the corporate cultures, diverse management opinions, or conflicting procedures and processes, which adversely affect the consolidation goals. Often management fails to combine the companies and eliminate what does not work.
The consolidating companies must conduct thorough due diligence before the transaction, discover the key strengths and weaknesses, and have a well-defined plan to facilitate smooth integration and restructuring.
