Mergers and Acquisitions

What is mergers and acquisitions (M&A)?

Mergers and acquisitions, also known as M&A, is the combining of two companies through some form of financial transaction, such as mergers, acquisitions, tender offers and consolidations.

While the terms mergers and acquisitions are used interchangeably, they have different meanings. Just like its name implies, an acquisition occurs when one company purchases (acquires) another business. Likewise, a merger takes place when two firms unite (merge) to become a new legal entity under a single corporate flag.

Types of mergers and acquisitions

At their core, M&A deals are about adding value to the target company. But not every M&A deal results in success or business growth. That said, you should think about what you will need to give in return for a deal instead of solely focusing on what your company will gain from it. For example, after acquiring another company, you’ll have to dedicate some time and effort to truly understand the new market you’re tapping into. In much the same way you have when starting your original business.

In order to get a better picture about the kinds of deals your company could be aiming for, here’s a rundown of M&A transactions divided by type:

Mergers

What happens in a merger? Behind the scenes are the board of directors for two companies hoping to scale their market power. Luckily, there are multiple ways for these businesses to structure their mergers based on their relationship with one another:

Horizontal mergers are consolidations between two firms that operate in the same market, and who thus are direct competitors. As a result, they can share product lines, rather than competing with one another. This type of merger can help a company gain competitive advantages via combined sales.
Vertical mergers take place between two or more firms that grasp different positions on the supply chain. This allows the merged companies to move up along the supply chain, reducing production costs and increasing efficiency.
Congeneric mergers occur when two businesses, who may not offer the same products or services but do have overlapping distribution channels, come together. This provides synergies for the merger and allows for the expansion of new market share.
Conglomeration is a merger between two firms that are completely different in every way possible. By entering into a conglomerate merger, the companies are able to expand into new and diverse markets and cross-sell their offerings.

Acquisitions

Acquisitions are very common in the business world, whether by large companies like Facebook, or by small-to-medium size firms. The benefits of making acquisitions are manifold, including growth, gaining new technology, greater market share and decreasing competition.

Consolidations

Another type of M&A deal is consolidation, also known as an amalgamation. This refers to the consolidation of smaller companies into a larger one, resulting in a completely new entity. The reasons behind consolidation include elimination of competition, operational efficiency and access to new markets. It can also lead to a bigger customer base. Do keep in mind that this path can become expensive if one of the merging companies is liquidated.

Tender offers

You might have seen tender offers advertised in newspaper ads. That’s because they are public bids to purchase stockholders’ stock in a company. Typically, the stock is set at a higher price than the current stock price. This incentivizes shareholders to sell their shares.

Mergers and acquisitions valuation

These reliable metrics will help either side of a M&A deal understand its value:

Price-earnings ratio (P/E ratio)

P/E ratio = Market value per share/earnings per share

To determine the value, simply divide the current stock price by its earnings per share (see equation above). P/E ratios are used to determine the value of a company’s shares to its earnings per share. A high P/E ratio may imply that the company’s stock is overvalued, and a low P/E ratio means that the stocks may be underpriced.

Enterprise-value-to-sales ratio (EV/sales)

EV/Sales - MC + D - CC/Annual sales

MC = market capital

D = debt

CC = cash and cash equivalents

Here we compare the enterprise value of a company, or its total value, to its annual sales. A lower EV/sales shows that the company may be undervalued, thus becoming a more attractive investment.

Examples of M&A

Facebook and WhatsApp

Following the $1 billion it paid for Instagram, Facebook’s acquisition of WhatsApp was its pricest one yet, valued at a steep $19 billion. What did we learn from this high-profile case? That even Facebook, which set the benchmark for the social media industry, fears irrelevancy in the face of changing market trends.

2. Wix

The leading website builder recently acquired the Miami-based ordering technology provider SpeedETab in a bid to enhance Wix Restaurants. This and the many other acquisition deals by Wix tells us that the company is dedicated to enlisting strong industry players to join its mission of providing the best online platform out there for its clients.