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Home > Mergers and Acquisitions Best Practice > Mergers and Acquisitions: Patterns, Motives, and Strategic Fit

Mergers and Acquisitions Best Practice

Mergers and Acquisitions: Patterns, Motives, and Strategic Fit

by Siri Terjesen

Table of contents

Executive Summary

  • Mergers and acquisitions (M&A) are two broad types of restructuring through which managers seek economies of scale, enhanced market visibility, and other efficiencies.

  • A merger occurs when two companies decide to combine their assets and liabilities into one entity, or when one company purchases another.

  • An acquisition describes one company’s purchase of another—for example, the absorption of a smaller target firm into a larger acquiring firm.

  • The nature and scope of M&A activity has changed over time, with a growing trend to cross-border transactions.

  • M&As are motivated by the expectation of financially rewarding synergies in terms of reduced fixed costs, increased market share, cross-sales, economies of scale, lower taxes, and more efficient resource distribution.

  • At the individual level, executives may pursue M&As because of psychological drivers such as empire-building, hubris, fear, and mimicry.

  • There are five broad types of strategic fit: overcapacity, geographic roll-up, product or market extension, research and development, and industry convergence.

  • M&A execution can be hampered by incompatible corporate cultures, with failure to achieve synergies, high executive turnover, and too much focus on integration at the expense of customers.

  • Before the deal, managers should formulate a clear and convincing strategy, preassess the deal, undertake extensive due diligence, formulate a workable plan, and communicate to internal and external stakeholders.

  • After the deal, managers should establish leadership, manage culture and respect employees, explore new growth opportunities, exploit early wins, and focus on the customer.

Introduction

Mergers and acquisitions are two broad types of restructuring through which managers seek economies of scale, enhanced market visibility, and other efficiencies. A merger occurs when two companies decide to combine their assets and liabilities into one entity, or when one company purchases another. The term is often used to describe a merger of equals, such as that of Daimler-Benz and Chrysler, which was renamed DaimlerChrysler (see case study). The term “acquisition” simply refers to one company’s purchase of another—as when a smaller target firm is bought and absorbed into a larger acquiring firm.

Patterns

The worldwide M&A market topped US$4.3 trillion and over 40,000 deals in 2007. Figure 1 depicts the growth of M&A activity, quarter by quarter, over the last five years.

The nature and scope of M&A activity has changed substantially over time. In the United States, the Great Merger Movement (1895 to 1905) was characterized by mergers across small firms with little market share, resulting in companies such as DuPont, Nabisco, and General Electric.

More recently, globalization has increased the market for cross-border M&As. In 2007 cross-border transactions were worth US$2.1 trillion, up from US$256 billion in 1996. Transnational M&As have seen annual increases of as much as 300% in China, 68% in India, 58% in Europe, and 21% in Japan.1 The regional share of today’s M&A market is shown in Figure 2.

Motives

Mergers and acquisitions are often motivated by company performance, but can also be linked to executive decision-makers’ empire-building, hubris, fear, and tendency to copy other firms.

The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial performance through synergies that enhance revenues and lower costs. The two companies are expected to achieve cost savings that offset any decline in revenues. Then Hewlett-Packard CEO Carly Fiorina justified the merger with Compaq at a launch effort on September 3, 2001: “This is a decisive move that accelerates our strategy and positions us to win by offering even greater value to our customers and partners. In addition to the clear strategic benefits of combining two highly complementary organizations and product families, we can create substantial shareowner value through significant cost-structure improvements and access to new growth opportunities.”2

The formula for the minimum value of the synergies required to protect the acquiring firm’s stockholder value (i.e. to avoid dilution in earnings per share) is:

(Pre-M&A value of both firms + Synergies) ÷ Post-M&A firm number of shares = Pre-M&A firm stock price

Managers may be motivated by the potential for the following synergies:

  • Reduced fixed costs: Duplicate departments and operations are removed, staff often made redundant, and typically the former CEO also leaves.

  • Increased market share: The new larger company has increased market share and, potentially, greater market power to set prices.

  • Cross-sales: The new larger company will be able to cross-sell one firm’s products to the other firm’s customers, and vice versa.

  • Greater economies of scale: Greater size enables better negotiations with suppliers over bulk buying.

  • Lower taxes: In some countries, a company that acquires a loss-making firm can use the target’s loss to reduce liability.

  • More efficient resource distribution: A larger company can pool scarce resources, or might distribute the technological know-how of one company, reducing information asymmetries.

At the individual decision-making level, M&A activity is also linked to the following:

  • Empire-building: M&As may result from glory-seeking, as managers believe bigger is better and seek to create a large firm quickly via acquisition, rather than through the generally slower process of organic growth. In some firms, executive compensation is linked to total profits rather than profit per share, creating an incentive to merge/acquire to create a firm with higher total profits. Furthermore, executives often receive bonuses for completing mergers and acquisitions, regardless of the resulting impact on share price.

  • Hubris: Public awards and increasing praise may lead an executive to overestimate his or her ability to add value to firms. CEOs who are publicly praised in the popular press tend to pay 4.8% more for target firms. Hubris can also lead executives to fall in love with the deal, lose objectivity, and overestimate expected synergies.

  • Fear: Managers’ fear of an uncertain environment, particularly in terms of globalization and technological development, may lead them to believe they have little choice but to acquire if they are to avoid being acquired.

  • Mimicry: If leading firms in their industry have merged or acquired others, executives may be more likely to consider the strategy.

Executives may overpay for a target firm. Microsoft has acquired more than 128 companies, but recently withdrew a US$44.6 billion offer of cash and stock for Yahoo. Microsoft CEO Steve Ballmer commented on the logic of the decision: “Despite our best efforts, including raising our bid by roughly $5 billion, Yahoo! has not moved toward accepting our offer. After careful consideration, we believe the economics demanded by Yahoo! do not make sense for us, and it is in the best interests of Microsoft stockholders, employees, and other stakeholders to withdraw our proposal.”3

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Further reading

Books:

  • Bruner, Robert F. Deals from Hell: M&A Lessons That Rise Above the Ashes. Hoboken, NJ: Wiley, 2005.
  • Galpin, Timothy J., and Mark Herndon. The Complete Guide to Mergers and Acquisitions: Process Tools to Support M&A Integration at Every Level. San Francisco, CA: Jossey-Bass, 2007.
  • Miller, Edwin L. Mergers and Acquisitions: A Step-by-Step Legal and Practical Guide. Hoboken, NJ: Wiley, 2008.
  • Sadtler, David, David Smith, and Andrew Campbell. Smarter Acquisitions: Ten Steps to Successful Deals. Harlow, UK: Pearson Education, 2008.

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