Mergers & Acquisitions
This article focuses on mergers and acquisitions (M&A). Mergers and acquisitions are common and in some cases necessary for a business to survive in the current global economy. There are a number of factors involved in mergers and acquisitions and they often require the involvement of various advisors, such as investment bankers, lawyers, accountants, and deal managers. Mergers and acquisitions can have far-reaching affects on the business community, the companies involved, and the companies’ employees, investors, and consumers. This article provides an overview of various factors involved in mergers and acquisitions and includes a discussion of the pros and cons of M&A activity.
Keywords Acquisition; Advisors; Consolidation; Contingent Liabilities; Due Diligence; Junk Bonds; Leveraged Buyout; Merger; Private Equity; Sarbanes-Oxley; Yield Curve
Mergers and acquisitions are a common strategy for growing a business. A merger occurs when two companies combine to form one entity, while an acquisition results from one business taking over and absorbing another. An acquisition can either be friendly where both parties want the deal to happen or can result in what is commonly known as a hostile takeover. In this scenario, a company that is not interested in making a deal becomes the target of another entity or group of investors (Ojala, 2005). These transactions are driven by many factors. For example, M&A activity can be the result of a business looking to form a strategic alliance with another company or vendor in the same industry.
One potentially lucrative and increasingly popular strategy for M&A activity has emerged from large pools of private equity money being used for leveraged buyouts, or LBOs. Essentially, an LBO is the buyout of a company with borrowed money, where the target company's assets act as collateral (Barron's, 2006). In industry parlance, the term "leverage" refers to debt, and the borrowed money increases the buyer's purchasing power. In a private equity transaction, companies such as the Blackstone Group and Kohlberg, Kravis, Roberts & Co. (KKR) use their own money in addition to debt to finance the merger or acquisition of other companies. In many cases, these private equity buyers restructure the target company and then sell their holdings when the value of the merged company increases to a level where the buyer can make a large profit. In short, private equity buyers with vast financial resources have a major influence on merger activity.
Another factor influencing M&A activity is the general trend toward consolidation in certain industries, such as the frenzy surrounding technology companies during the boom of the 1990s. "Consolidations are slightly different from mergers in that the resulting company is a new entity" (Ojala, 2005, p. 27). In the early 2000s, the banking industry saw a good deal of M&A activity. This was partly the result of the interest rate environment; long-term interest rates were producing lower yields than short-term rates. Because of this, banks were making less profit on long-term loans such as mortgages. Therefore, in order to grow in this type of interest rate environment, a bank will look to acquire another entity's assets, such as deposits. These deposits, or assets, can then be used for other investments. The ongoing M&A activity in this industry resulted in a great deal of consolidation, and many smaller community and regional banks no longer exist. Of note, there were three mergers in 2006 that accounted for $50 billion in deal value: Capital One's acquisition of North Fork Bank; Wachovia's acquisition of Golden West, and the Regions Financial acquisition of AmSouth Bancorp (McCune, 2006).
In regard to the energy sector, a contributing factor to M&A activity is the fact that the cost of buying a company is far less than starting new lines of production. According to the independent research firm Wall Street Access Corporation, large oil companies such as Marathon Oil and Hess can potentially make large gains in takeovers and will likely see lots of M&A activity. "Whether it's private equity players driving the deals or companies that see the virtue of joining together, the activity is likely to be bustling in lots of sectors" (Weber, 2006, p. 73).
Mergers and acquisitions can have far-reaching effects on a business sector as well as on the investors and shareholders of companies in a particular sector. While a number of studies have shown how M&A deals can "destroy shareholder value … companies with a strong history of deals earn higher returns than those who do few or none at all" (Corbett, 2005, p. 58). There are a number of ways that mergers and acquisitions can create value for shareholders. One key factor in this regard is for a company to enhance its core business by entering into transactions with entities in the same sector rather than buying ownership interests in target companies merely to expand the buyer's scope.
Logistics of M
Mergers do not occur overnight and sometimes take years to be fully implemented. Preliminary work involves a great deal of legal and other activity, and much of the effort in the early stages focuses on due diligence. This means that the buyer and the seller, as well as their advisors, need to do their homework. The buyer needs to learn as much as possible about the target company in order to adequately determine the appropriate purchase price. The buyer also needs to be familiar with the condition of the target company as well as any potentially bad financial situations, managerial problems, pending lawsuits, sales forecasts, and contingent liabilities (Parr, 2006). These are liabilities that will be incurred only when assets are sold, and these include costs for assets or income tax on capital gains realized through the sale of assets. In short, contingent liabilities are potential liabilities that are not listed on a company's balance sheet but recorded only as footnotes because they may never become due or payable (Barron's, 2006).
While the buyer needs to rely on the information being provided by the seller and any other information that might be otherwise available, sellers also need to perform due diligence before they provide information to prospective buyers and "the seller should control the information flow" (Parr, 2006, p. 232). In order to do so, the seller needs to know as much as possible about the target company so that there are no surprises during the negotiation and to ensure that material information is not concealed from the buyer. If a buyer uncovers onerous information about a target that was not provided by the seller, a potential merger transaction can quickly unravel (Parr, 2006).
A deal can also unravel if confidential information finds its way to the public. In the course of performing due diligence, a great deal of information is exchanged and it is often the case that this information is confidential and may not be available to the public. Moreover, the parties involved in an M&A transaction need to be mindful that M&A activity can trigger the buying and selling of stock on the various exchanges. In such cases, the buyer and seller need to agree that the terms of a pending M&A transaction will remain confidential and that the parties involved will not share information disclosed in the course of due diligence to the public or with other parties not directly involved in the transaction. Finally, successful deal-making also requires the merging companies to share the same core values and this is as important as their desire for a strategic alliance. While the merger might make sense in terms of products, technologies, and numbers, companies that do not share the same values ultimately will be not be able to survive a merger. Finally, a successful merger is one that is priced correctly. This requires that a buyer avoid the "negotiating frenzy" that sometimes arises in a competitive merger market and this ultimately rests on a buyer having performed sufficient due diligence (Welch, 2006).
According to Alistair Corbett, a partner of Bain and Company, an example of a dealmaker that has been successful in creating shareholder value is Power Financial. The company has frequently made M&A deals but has selected companies that are close to its core business, performed extensive due diligence, and, through its experience, has been able to integrate quickly. In the end, a company looking to grow its business has a greater chance for success by pursuing deals that expand a company's base "by adding new customers, products, markets or channels" (Corbett, 2005, p.58).
Advisement for M
While there are many factors that shape M&A activity, these transactions often require merging companies to rely on various advisors such as deal managers, investment banks, lawyers, and accountants. Such advisors have a network of contacts that can make the M&A process more efficient. Further, advisors have knowledge of various dynamics affecting a particular merger market, and they are familiar with techniques that contribute to structuring the finance and determining the correct price of a transaction (Holliday, 2006).
While companies like the Blackstone Group and KKR act as private equity buyers in some merger transactions,...
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