What is Mergers and Acquisition – Valuation

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Mergers and Acquisition: Are we better off buying a new capability, market entry, customer base, earning opportunity and so on, or attempting to build it ourselves? A company always revolves around such question when it has desire for expansion and growth.  Corporate restructuring can be considered, when there is expansion strategy is in place with company.

Mergers can be defined as combination of two or more companies into a single company where the survivor acquires assets as well as liabilities of merged companies and other loses their corporate existence. And Acquisition is purchase of one company of controlling interest in the share capital of another company.  Acquisition is basically but acquiring ownership in the property of others.

What is Mergers and Acquisition

Mergers and Acquisition: Objectives behind process

  • Economies at large scale: operating cost advantage is one of biggest motive behind any corporate restructuring. Due to higher level of operation the average cost can be reduced. In operational terms real economies may arise from the production activities, research and development activities, administrative activities like storage, transportation etc.
  • Improving revenues and hence profitability: Merged firm can have huge market share. So sales potential of new entity can improve due to expanded market.
  • Faster growth in scale and quicker time to market: Merger and acquisition can give wider market. It will give quick accessibility to new market. New need not to go for market research as one of the company has already established in that particular segment. No need of establishment of new plant and building.
  • Acquisition of new technology or competence: One of the important objectives behind mergers and acquisition is technology up gradation and achieving operational competency.
  • Elimination of competition: If there is Merger and Acquisition takes place within same line of industry. It cut down and reduces the competition. Thus it gives a larger market share to the new company.
  • Tax shield: there will be definitely tax befit in merger and acquisition deal. Tax benefit in the form of set-off and carry forward of losses. If there is any loss of target firm it set off and carried forward with acquiring firm.

Types of Merger and acquisition

  • Horizontal  Merger
  • Vertical Merger
  • Conglomerate Merger

Horizontal merger

Horizontal merger involves two firms operating and competing in the same kind of business activity. This type of acquisition is also known as buying a market place. Motive behind horizontal merger is as follows.

  1. Elimination or reduction in competition
  2. Putting an end to price cutting
  3. Economies of scale in production
  4. Research and development
  5. Marketing and management.

Vertical merger

Vertical merger Vertical mergers or vertical integration happens when the acquiring firm buys buyers or sellers of goods and services to the company. In other words, a vertical merger is usually between a manufacturer and a supplier. Vertical mergers adopted by firm to increase efficiency along the supply chain which, in turn, increases profits for the acquiring company. It can occur in two ways. One when a firm acquires supplier it is known as backward integration or ‘Upstream’ from it.  When firm acquires customer, it is known as forward integration or ‘downstream’ from it.

Merits:

  1. As there is integration with supplier there will be low buying cost of materials.
  2. Forward integration helps ready market which leads to lower distribution costs.
  3. Assured supplies and market. So Business operation does not get affected.
  4. Increasing or creating barriers to entry for potential competitors.
  5. Placing them at a cost disadvantage.

Conglomerate merger

Conglomerate merger represents a merger of firms engaged in unrelated lines of business.

Types of Conglomerate merger:

  • Product-extension mergers broaden the product lines of firms. These are mergers between firms in related business activities and may also be called concentric mergers.
    Ex: P&G acquires Gillette to expand its product offering in the household sector and smooth out fluctuations in earning.
  • A geographic market-extension merger involves two firms whose operations have been conducted in non overlapping geographic areas.
    Ex: Darden Inc, A chain of restaurants.

Pure conglomerate mergers involve unrelated business activities. These would not qualify as either product-extension or market extension. It allows a company to introduce new and different product and new territories to operate.

 

A conglomerate merger helps company to diversify in different line of business. This type of merger also helps a company to reduce its risk exposure. If one line of business does not do well at least other line of business can generate wealth.