Mergers and acquisitions make a big part of corporate finance where they are classified as the main forms of corporate restructuring. They are basically meant to bring separate companies together. They mostly target to form large firms by bringing together small ones. These deals are worth billions or hundreds of millions. The main rationale behind mergers and acquisitions is alluring to companies during tough times to make companies cost-effective and more competitive in the market. Mergers and acquisitions enable a growing company in any given industry to accelerate its growth without starting up a new business entity. They entail a restructuring of business entities through selling and buying of different business entities or combining them. For instance, eBay sold 65% of Skype to silver lake partners. eBay retained 35% ownership in skype. 3.1 billion US dollars was paid in the acquisition of Skype in 2005. According to the eBay CEO, John Donahoe, the deal is great and would unlock the long-term and immediate value for eBay and also tremendous potential for Skype.
Merger and acquisition – distinction
These two terms are used as though synonymous but they differ in some respects. Acquisition happens when a company takes over another and the acquired ceases to exist. The acquiring company becomes the new owner of the acquired. Merger on the other hand is said to take place when two companies combine their businesses and agree to operate as one company instead of remaining separately operated and owned Sudarsanam (590). This would be referred to as mergers of equals which do not happen in most cases. No new company is formed in case of acquisition as it is the merger case. For instance, the acquisition of 65% of Skype by silver Lake Partiners did not result into new company formed although Skype became a subsidiary of silver lake partners and remained 35% investment of eBay.
Motives behind mergers and acquisitions
Although the motive behind mergers and acquisitions is to improve the financial performance of the parties and make them more competitive in the market, the following reasons are also key motives. These motives will improve the financial performance of the combined companies.
Firms merge to enjoy economies of scale
This mostly reduces fixed costs by eliminating replica operations and departments. When two companies combine to become one, most of the departments and operations are replicated. The costs related to these departments or profit centers are also lowered and results in increased profit margins. This will improve the overall financial performance of the company by reducing the costs associated with the eliminated revenue stream.
The merging firms also enjoy the increased economy of scope
This is where the merging firms increase their scope of marketing and distribution of products. This is mostly basically associated with demand-side changes reasonably increase (Nieman & Marius 135). The merging firms or the result of acquisition tend to have increased demand and this makes many firms adopt the strategy. The combination of the marketing strategy also would increase the demand for the products.
Market share or revenue
Firms forecast that when they merge, they merge with a major competitor. This would mean that the firm is acquiring a bigger market power and share. It would also have the strength to set competitive prices. The firm will also generate increased revenue. According to Wauters contribution in techcruch.com, the acquisition of Skype by eBay caused great gain. Both the market share and the revenue gained greatly. the market share by 47% and revenue by 44% compared to the previous year.
Cross selling advantage
This happens in cases whereby the merging firms have customers who would consume the products of the other firm. A good example is the merger between a bank and an insurance company. Bank customers would buy insurance policies.
Other motives would include synergy which can take the form of purchasing economies or managerial economies. Purchasing economies is where the firm is able to enjoy higher discounts because of buying in bulk (Nieman and Marius 135). Concerning selling of Skype by eBay, the eBay CEO argued that Skype lacks synergies with eBay e-commerce and online business despite being a strong standalone business. He added that the company would gain compatible synergy with silver lake partners and be able to focus on effective competition in internet business. According to Mapsofworld.com, Finance, a firm acquiring a loss making firm would use that to reduce their tax liability. This is because if a company makes loss, it is not taxed. There is also resource transfer whereby the acquiring firm also acquires resources from the acquired. It may be scarce resources combined and this will increase the profitability of the firm.
Besides the motives behind mergers and acquisitions, there are other benefits that are generally associated with them. Also despite the many advantages, mergers and acquisition have demerits.
Advantages and disadvantages of mergers and acquisitions
The advantages of merger and acquisition are the motives or the reasons that firms strike these deals. We can ascertain the following as benefits:
- Generation of greater value – merged firms as opposed to separate ones, would make greater value. According to Sudarsanam (593), the shareholders value will go up more than for combined companies. An acquisition deal can greatly benefit a firm that is experiencing dangerous times. If a weak company is acquired by another with strong market dominance, the resultant firm can be more cost effective and competitive. The acquired company benefits most.
- Cost efficiency – according to maps of the world.com, combining firms are able to generate cost efficiency because of the resultant economies of scale. The production scale increases and this would translate to per unit cost reduction (Nieman and Marius 135). This improves the overall performance of the resultant company.
When a firm is wishing to enter a new market, merger and acquisition becomes very beneficial. This is mostly the case whereby the targeted company is in the targeted market. It therefore becomes easier for the company to venture into that market.
A firm may also want to strengthen its administration through merger and acquisition. The firm will reap the administration benefits from the acquired company. Other benefits of mergers and acquisitions are associated with the motives discussed in earlier paragraphs. Some of them are waived cost of capital, tax benefits and revenue gains.
Demerits of mergers and acquisitions
According to Nieman and Marius (135) one of the main disadvantages of mergers and acquisitions is that it can be very costly. There are several costs associated with mergers and acquisition; for instance the legal expenses that cannot be evaded. The procedure of mergers and acquisitions must follow a legal procedure because it must be a legal process. There is also cost of takeover which may not be realizable in the short run. There are also intangible costs or miscellaneous.
The opportunity costs are also experienced in the short run. The cost of acquiring another firm and forgo another more profitable investment in the short run (Sudarsanam 593).
There are other disadvantages experienced by the consumers. For instance merging firms may form an oligopoly or a monopoly firm. This would mean that the firm has gained a higher pricing power and may resort to increasing costs to the consumers. The small competing businesses are also suppressed because the resultant firm is big and might scoop the whole market. The prices of shares is also likely to go down.
Mergers and acquisition are very beneficial to a company despite their many disadvantages. When done with valid motives, it can greatly improve the financial performance of a company. EBay financial performance improved in 2008, following the acquisition of Skype in 2005. The financial performance of Skype was also expected to improve after it was sold to Silver Lake Partners. Mergers and acquisition can therefore be very beneficial to the involved firms.
Maps of world.com. “Finance: benefits of mergers and acquisition.” 2009. Web.
Nieman, Gideon and Pretorius, Marius. “Managing growth: a guide for entrepreneurs.” Cape Town. Comet publishing services. 2004
Sudarsanam, Sudi. Creating value from mergers and acquisitions: the challenges. London: prentice hall. 2003
Wauters, Robin. “Confirmed: eBay sells Skype in deal valuing it at $2.75 billion” Tech crunch.com. 2009.Web.