M&A and post M&A operations

Types of acquisition

An acquisition can take the form of a purchase of the stock or other equity interests of the target entity, or the acquisition of all or a substantial amount of its assets.

Share purchases – in a share purchase the buyer buys the shares of the target company from the shareholders of the target company. The buyer will take on the company with all its assets and liabilities.

Asset purchases – in an asset purchase the buyer buys the assets of the target company from the target company. In simplest form this leaves the target company as an empty shell, and the cash it receives from the acquisition is then paid back to its shareholders by dividend or through liquidation. However, one of the advantages of an asset purchase for the buyer is that it can “cherry-pick” the assets that it wants and leave the assets – and liabilities – that it does not. This leaves the target in a different position after the purchase, but liquidation is nevertheless usually the end result.

The terms “demerger”, “spin-off” or “spin-out” are sometimes used to indicate the effective opposite of a merger, where one company splits into two, the 2nd often being a separately listed stock company if the parent was a stock company.

Financing M&A

Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:

a. Cash
Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder’s shareholders alone.

b. Financing
Financing cash will be borrowed from a bank, or raised by an issue of bonds. Acquisitions financed through debt are -known as leveraged buyouts -, and the debt will often be moved down onto the balance sheet of the acquired company.

Furthermore, a cash deal would make more sense during a downward trend in the interest rates, i.e. the yield curves are downward sloping. Again, another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. But a caveat in using cash is that it places constraints on the cash flow of the company.

c. Hybrids
An acquisition can involve a cash and debt combination, or a combination of cash and stock of the purchasing entity, or just stock.

Classifications of mergers

Horizontal mergers take place where the two merging companies produce similar product in the same industry.

Vertical mergers occur when two firms, each working at different stages in the production of the same good, combine.

Conglomerate mergers take place when the two firms operate in different industries.

A unique type of merger called a reverse merger is used as a way of going public without the expense and time required by an IPO.

The contract vehicle for achieving a merger is a “merger sub”.

The occurrence of a merger often raises concerns in antitrust circles. Devices such as the Herfindahl index can analyze the impact of a merger on a market and what, if any, action could prevent it. Regulatory bodies such as the European Commission and the United States Department of Justice may investigate anti-trust cases for monopolies dangers, and have the power to block mergers.

Accretive mergers are those in which an acquiring company’s earnings per share (EPS) increase. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E.

Dilutive mergers are the opposite of above, whereby a company’s EPS decreases. The company will be one with a low P/E acquiring one with a high P/E.

The completion of a merger does not ensure the success of the resulting organization; indeed, many mergers (in some industries, the majority) result in a net loss of value due to problems. Correcting problems caused by incompatibility—whether of technology, equipment, or corporate culture— diverts resources away from new investment, and these problems may be exacerbated by inadequate research or by concealment of losses or liabilities at one of the partners. Overlapping subsidiaries or redundant staff may be allowed to continue, creating inefficiency, and conversely the new management may cut too many operations or personnel, losing expertise and disrupting employee culture. These problems are similar to those encountered in takeovers. For the merger not to be considered a failure, it must increase shareholder value faster than if the companies were separate, or prevent the deterioration of shareholder value more than if the companies were separate.