'Mergers and Acquisitions is a general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.

What Are Mergers and Acquisitions?

Mergers and acquisitions are both changes in control of companies that involve combining the operations of multiple entities into a single company.

In a merger, two companies agree to combine their operations into a single entity.

In an acquisition, one company purchases another company, and has the right to sell off operations, merge them into similar groups in the purchasing company, or close facilities or cancel products altogether.

Why Merge? 

Companies would choose to merge together for different reasons:

v  The combined entity would be larger, and have corresponding larger resources for marketing, product expansion, and obtaining financing. This could help them better compete in the marketplace.

v  The combined entity could merge similar operations to reduce costs. Corporate and administrative functions, such as human resources and marketing, are often targets for combinations. They might also combine the production areas if the companies produce similar products and reduce costs by having fewer plants or facilities in operation.

v  The combined entity might have less competition in the marketplace. If the products of the two companies competed for customers, they could combine their offerings and use resources for improving the product, rather than marketing against each other.

v  The combined entity might have synergy in operations. Synergy is when combined operations show lower costs or higher profits than would be expected by just adding their financial information together on paper. This could be due to economies of scale, where costs are lower due to higher volume of production, or due to vertical integration, where greater control over the production process is achieved due to owning more steps in the production process.

Why Acquire?

Acquisitions are undertaken for strategic reasons. For example:

v  A company might acquire another company to obtain a specific product. It can be less expensive to purchase a company offering a product you'd like to sell than building the product yourself. Software companies often purchase smaller companies that offer extensions to their product line if they become popular with customers, so they can add the functionality to their primary offering.

v  A company might acquire other companies to increase its size. A larger company may have more visibility in the marketplace, and also better access to credit and other resources.

v  A company might acquire another to obtain control over a critical resource. For example, a jewelry company might acquire a gold mine, to ensure they have access to gold without market price fluctuations.

Issues in Combining Companies:- 

It can be difficult to combine companies, whether they are merging or one is acquiring the other.

Combining operations means that some people will lose their jobs, since the company might only need, say, one Director of Human Resources but they have 2 currently available.

Companies may have different systems for managing information, including production information, financial information, and even communications, such as email systems. There can be a significant effort required to merge the systems into a single system, in order to take advantage of the synergies of combined operations.

Companies may have very different cultures, and be unable to work together. 

Definition of Demergers:-

The act of splitting off a part of an existing company to become a new company, which operates completely separate from the original company. Shareholders of the original company are usually given an equivalent stake of ownership in the new company. A demerger is often done to help each of the segments operate more smoothly, as they can now focus on a more specific task. opposite of merger.

Business combinations, commonly referred to as mergers and acquisitions, can take many forms. The most important distinction among them is the method of payment: (i) cash or cash and shares or (ii) 100% in shares.

All-share deals can take several forms: -

·         legal merger: two or more companies are combined to form a single company. In general, one company is dissolved and absorbed into the other;

·         contribution of shares: the shareholders of company B exchange their shares for shares of company A;

·         asset contribution: company B transfers a portion of its assets to company A in exchange for shares issued by company A.

·         The economics of the business combination are independent of the financial arrangements. That said, in an all-share deal the resources of the two entities are added together, increasing the merged company's financial capacity, compared with what it would have been after the conclusion of a cash deal. Also, in an all-share deal, all the shareholders of the resulting group share the risks of the merger. When the deal is negotiated, the companies are valued and the relative value ratio and exchange ratio are set. The exchange ratio is the number of shares of the acquiring company that will be exchanged for the tendered shares of the acquired company. The relative value ratio determines the position of each group of shareholders in the newly merged group.

The higher a company's P/E ratio is, the more tempted it will be to carry out acquisitions by issuing shares, because its earnings per share will automatically increase. But be careful! No value is automatically created. The increase in EPS is only a mathematical result deriving from the difference between the P/E ratios of the acquirer and the acquiree. At the same time, the P/E ratio of the new entity declines, because the market capitalisations of the new group should theoretically correspond to the sum of the market capitalisation of the two companies prior to the merger. Sometimes the new company's P/E ratio stays the same as the acquiring company's P/E ratio. We call this the “magic kiss” effect, because it implies that the company has only to “wake up” the “sleeping beauty” it has acquired. In each case, the value of the merger synergies is added to the value of the new company. How they are shared by the two groups of shareholders determines the premium the acquiring company will pay to the target's shareholders to persuade them to participate in the deal.

A demerger is a simple concept. A diversified group decides to separate several business divisions into distinct companies and to distribute the shares of the new companies to shareholders in return for shares of the parent group. It is often an answer to too low a valuation for a group with too far-flung activities.

The value created by a demerger can be analysed as follows:

Ø  Unlocking the value trapped in the conglomerate discount (efficient markets hypothesis);

Ø  Increasing the motivation of the managers of the newly independent company (agency theory).

Ø  A demerger results in companies being more exposed to takeover bids.

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