This can be as much about justifying the spend to their shareholders and the general public as anything else. It also serves to give some insight into the thought process behind the many deals that are closed every week.
The 10 biggest motives are discussed below. Some examples have been provided to give context to each specific motive. This is very common in the airline industry where British Airways has merged with a few different firms over the years to create IAG International Airlines Group , essentially a conglomerate of airlines which has more control over the skies than almost anybody else.
Of course, one issue here is that too much market share attracts the ire of antitrust organizations. In the next decade, as the energy transition continues, we can expect many of the oil and gas majors to begin investing in renewable energy firms, for example. Over the course of the last decade, Google has acquired over 30 artificial intelligence AI startups, acquiring a range of capabilities in a technology which is set to be hugely influential in the years ahead.
As DealRoom blog articles have stated in the past, the scale of synergies are too often exaggerated. But sometimes, the logic, if not the numbers, makes absolute sense. In , when Amazon acquired Whole Foods, it was a clear attempt for Amazon to bring the power of its ecommerce machine to traditional food retail. Clearly, the markets thought it was going to be a success: within hours of the deal, most other food retailers in the US were down by a few percentage points on the news.
Cross selling can be a powerful way to deliver revenue synergies: The idea that two companies have more to offer their customers by being together. What could be more synergistic for revenues than selling tea and coffee together? Now, you can get tea at Starbucks and coffee at Teavana. In some cases, the shareholders of the acquired company can end up owning most of the company that bought their shares.
Companies that pay for their acquisitions with stock share both the value and the risks of the transaction with the shareholders of the company they acquire. The decision to use stock instead of cash can also affect shareholder returns. In studies covering more than 1, major deals, researchers have consistently found that, at the time of announcement, shareholders of acquiring companies fare worse in stock transactions than they do in cash transactions.
Despite their obvious importance, these issues are often given short shrift in corporate board-rooms and the pages of the financial press. Both managers and journalists tend to focus mostly on the prices paid for acquisitions. Price is certainly an important issue confronting both sets of shareholders. But when companies are considering making—or accepting—an offer for an exchange of shares, the valuation of the company in play becomes just one of several factors that managers and investors need to consider.
In this article, we provide a framework to guide the boards of both the acquiring and the selling companies through their decision-making process, and we offer two simple tools to help managers quantify the risks involved to their shareholders in offering or accepting stock. The main distinction between cash and stock transactions is this: In cash transactions, acquiring shareholders take on the entire risk that the expected synergy value embedded in the acquisition premium will not materialize.
In stock transactions, that risk is shared with selling shareholders. More precisely, in stock transactions, the synergy risk is shared in proportion to the percentage of the combined company the acquiring and selling shareholders each will own.
Suppose that Buyer Inc. The market capitalization of Buyer Inc. Seller Inc. The managers of Buyer Inc. They announce an offer to buy all the shares of Seller Inc. The value placed on Seller Inc. The expected net gain to the acquirer from an acquisition—we call it the shareholder value added SVA —is the difference between the estimated value of the synergies obtained through the acquisition and the acquisition premium.
So if Buyer Inc. But if Buyer Inc. The new offer places the same value on Seller Inc. They will own only The rest goes to Seller Inc. The only way that Buyer Inc.
In other words, the new shares would reflect the value that Buyer Inc. But while that kind of deal sounds fair in principle, in practice Seller Inc. In light of the disappointing track record of acquirers, this is a difficult sell at best. One thing about mergers and acquisitions has not changed since the s. In most cases, that drop is just a precursor of worse to come.
And the larger the premium, the worse the share-price performance. But why is the market so skeptical? Why do acquiring companies have such a difficult time creating value for their shareholders? First of all, many acquisitions fail simply because they set too high a performance bar. Even without the acquisition premium, performance improvements have already been built into the prices of both the acquirer and the seller. The rest is based entirely on expected improvements to current performance.
In other cases, acquisitions turn sour because the benefits they bring are easily replicated by competitors.
Competitors will not stand idly by while an acquirer attempts to generate synergies at their expense.
Arguably, acquisitions that do not confer a sustainable competitive advantage should not command any premium at all. Acquisitions also create an opportunity for competitors to poach talent while organizational uncertainty is high. Take Deutsche Bank, for example. After it acquired Bankers Trust, Deutsche Bank had to pay huge sums to retain top-performing people in both organizations. A third cause of problems is the fact that acquisitions—although a quick route to growth—require full payment up front.
By contrast, investments in research and development, capacity expansion, or marketing campaigns can be made in stages over time. Thus in acquisitions, the financial clock starts ticking on the entire investment right from the beginning. Not unreasonably, investors want to see compelling evidence that timely performance gains will materialize.
Thus the price paid may have little to do with achievable value. Finally, if a merger does go wrong, it is difficult and extremely expensive to unwind. Managers whose credibility is at stake in an acquisition may compound the value destroyed by throwing good money after bad in the hope that more time and money will prove them right. The problem, of course, is that the stockholders of the acquired company also have to share the risks. In an all-cash deal, Buyer Inc.
But in a share deal, their loss is only The remaining In many takeover situations, of course, the acquirer will be so much larger than the target that the selling shareholders will end up owning only a negligible proportion of the combined company. It is one of the highest profile takeover stories of the s, and it vividly illustrates the perils of being paid in paper. Boards and shareholders must do more than simply choose between cash and stock when making—or accepting—an offer. There are two ways to structure an offer for an exchange of shares, and the choice of one approach or the other has a significant impact on the allocation of risk between the two sets of shareholders.
Companies can either issue a fixed number of shares or they can issue a fixed value of shares. But the acquisition was not without its risks. First, the Green Tree deal was more than eight times larger than the largest deal Conseco had ever completed and almost 20 times the average size of its past 20 deals.
So investors started to sell Conseco shares. The other way to structure a stock deal is for the acquirer to issue a fixed value of shares.
In these deals, the number of shares issued is not fixed until the closing date and depends on the prevailing price. Mergers and acquisitions are also cost-effective. The acquisition can also increase the supply-chain pricing power. Aside from that, such business restructuring is one way to eliminate possible competitors of the business. However, a business merger and acquisition is a different process and the issues that need to be addressed are different.
Being mindful of those issues may help business owners make the best and most appropriate decisions before jumping into the deal.
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