Mergers and Acquisitions are the legal commercial transactions under Companies Act that are largely governed under Section 230-240, Chapter 15 of the Act in which the ownership of companies/firms/businesses, or their operating units are transferred or consolidated with other companies/entities. Mergers and acquisitions can be a strategic move, it can help businesses to grow or shrink, change the nature and scale of business, or improve the competitive position of both the businesses. There are also provisions of other laws that govern Mergers and Acquisitions.

A merger is a legal merging of two business/commercial entities into one, whereas an acquisition is when one entity acquires the share capital, equity interests, or assets of another entity. These types of transactions, from a commercial and economic standpoint, result in the consolidation of assets and liabilities under one organisation, making the distinction between a “merger” and an “acquisition” less obvious.

A transaction structured as an acquisition may result in the indirect ownership of one party’s firm by the shareholders of the other party, but a merger may result in each party’s shareholders having partial ownership and control of the combined enterprise. When managements and shareholders of both the equal companies agree that partnering is in the best interests of both companies, the agreement is referred to as a “merger of equals”.

Types of commercial deals:

Mergers:

Merger is when the boards of directors of two companies agree to merge and seek shareholders’ approval and they approve it. The international examples are: in 1998, the Digital Equipment Corporation and Compaq agreed to merge their companies and Compaq absorbed the Digital Equipment Corporation. In 2002, Compaq merged with Hewlett-Packard. CPQ was Compaq’s pre-merger ticker symbol. The present ticker symbol was created by combining this with Hewlett-(HWP) Packard’s ticker symbol (HPQ).

Acquisitions:

In an acquisition, the acquiring company acquires a majority stake in the acquired company, which retains its name and organisational structure. An international examples is: Manulife Financial Corporation’s acquisition of John Hancock Financial Services in 2004 is an example of this type of deal, in which both companies kept their identities and organisational structures.

Consolidations:

Consolidation establishes a new corporation by merging core functions and discarding prior organisational structures. Both companies’ stockholders must approve the merger, after which they will get common equity shares in the new company. The international examples are: Citicorp and Travelers Insurance Group, announced a merger in 1998, resulting in Citigroup.

Tender Submissions:

A tender offer is when one firm offers to buy the outstanding stock of another company for a set price rather than the market price. The purchasing firm informs the other business’s shareholders directly, bypassing management and the board of directors. The international example is Johnson & Johnson, made a $438 million tender offer to purchase Omrix Biopharmaceuticals in 2008. Most tender offers culminate in mergers, even if the acquiring business may continue to exist (especially if there are a few dissenting shareholders).

Purchase of Assets:

In an asset purchase, one company buys the assets of another company’s business out rightly and the corporation/company whose assets are being purchased must obtain its shareholder approval. During bankruptcy procedures, other companies bid on various assets of the bankrupt company, which is liquidated when the assets are transferred to the acquiring firms.

Acquisitions in Management:

A management acquisition, often called a management-led buyout, occurs when a business’ leaders buy a majority share in another company and take it private. In order to assist fund a deal, these former executives frequently team up with a financier or former company officers. The majority of shareholders must approve such merger and acquisition transactions, which are often financed disproportionately with debt. The international example is Dell Corporation, stated in 2013 that it had been acquired by its founder, Michael Dell.

How Mergers and Acquisitions are valued?

The target company will be valued differently by both parties participating in merger and acquisition transaction. The seller will almost likely try to sell the company for the highest price feasible, while the buyer will try to buy it for the lowest price possible. Fortunately, a company’s value may be determined objectively by examining comparable companies in the same industry and using the following metrics:

  • Price-to-Earnings Ratio (P/E Ratio): An acquiring business uses a price-to-earnings ratio (P/E ratio) to make an offer that is a multiple of the target company’s earnings. The acquiring business can obtain a reliable idea of what the target’s P/E multiple should be by looking at the P/E for all the companies in the same industry group;
  • EV/Sales (Enterprise Value to Sales Ratio): With an enterprise-value-to-sales ratio (EV/sales), the acquiring business makes an offer based on a multiple of revenues while keeping in mind the industry’s price-to-sales (P/S) ratio;
  • Cash Flow Discounted (DCF): A discounted cash flow (DFC) analysis is a significant M&A valuation tool that assesses a company’s current value based on its expected future cash flows. Forecasted free cash flows are discounted to present value using the company’s weighted average cost of capital (net income + depreciation/amortization – capital expenditures – change in working capital) (WACC). Although DCF is difficult to master, few tools can compare to this method of valuation;
  • Cost of Replacing: The cost of replacing the target company is sometimes a factor in acquisitions. Assume that a company’s worth is simply the sum of all of its equipment and personnel costs for the sake of simplicity. The acquiring business has the power to order the target to sell at that price, or it can build a competitor at the same price. Naturally, assembling strong management, acquiring property, and purchasing the necessary equipment takes time. In a service industry where the key assets (people and ideas) are difficult to evaluate and develop, this way of determining a price makes little sense.

Why do companies acquire through Mergers & Acquisitions?

The fair competition and growth are two of capitalism’s most important forces to drive it. When faced with competition, a corporation must decrease costs while also innovating like most of the corporations have done in COVID 19 pandemic situation. There are number of strategies formulated by corporates all over the world. One strategy is to purchase competitors and all start-ups so that they are no longer a threat. Mergers and Acquisitions are also viewed by businesses & corporations to expand their product lines, Intellectual property, human resources, and consumer bases. Synergies may also be sought by businesses which mean the net addition of all the resources and performance is more than individual performance. Integrating corporate activities, total performance efficiency improves and overall costs decrease as one company capitalises on the strengths of the other and that’s the idea of Synergism.

Types of Transactions:

Horizontal: A horizontal merger occurs when two companies in similar industry, whether direct competitors or not, join together as a unit;

Vertical: A vertical merger occurs when a company and its supplier or client merge along the supply chain. By moving up or down its supply chain, the company hopes to strengthen its position in the industry;

Conglomerate: This sort of transaction is frequently done for the purpose of diversification and involves companies from different industries.

Mergers and Acquisitions are preffered by Companies for:

Unlocking synergies: Mergers and acquisitions are frequently utilised to create synergies that increase the value of the merged company beyond the value of the two companies individually. Synergies might emerge as a result of cost-cutting or increased revenue or sharing resources. The cost synergies are achieved through economies of scale, whereas revenue synergies are achieved through cross-selling, expanding market share, or boosting prices. The cost synergies are the easier to quantify and calculate of the two options;

Increased growth: Organic growth is preferred by the companies most of the times as this type of growth is perceived permanent. Inorganic growth through mergers and acquisitions is usually a faster way for a company to increase revenue than organic growth. Instead of taking risk and creating talents internally, a company can gain from acquiring/merging with another company that already has cutting-edge capabilities needed in the business;

Increased market power: A horizontal merger will give the new organization a larger market share and the ability to influence prices. Vertical mergers also provide a corporation more market power since it has more control over its supply chain and can prevent external supply disruptions;

Diversification: Companies in cyclical industries feel obligated to diversify their cash flows to prevent suffering from significant losses during a downturn. By acquiring a target in a non-cyclical industry, a company can diversify and reduce market risk;

Tax advantages: When one company has a lot of taxable income and another has a lot of tax loss carry forwards, the tax benefits can be considered. The acquirer can use the tax losses to reduce its tax liability by acquiring the company with the tax losses. Mergers, on the other hand, are rarely done only to save money on taxes.

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