Merger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.
Such integrations aim to attain production scalability, new market entry, wider consumer base and access to more resources. In mergers, the participating firms enter into an agreement bearing clauses that spell out the terms of the alliance.
- A merger is a business integration process where two or more enterprises join forces to create a new organization by entering into a legal agreement.
- Primarily, it is a company’s expansion strategy. Other benefits include diversification, entry to a new market, availing new resources and increasing market share.
- The different kinds of mergers include – conglomerate, horizontal, vertical, product extension and market extension.
- Mergers and acquisitions (M&As) differ from each other. In the former, a new business entity is created out of two or more enterprises, while acquisitionsAcquisitionsAcquisition refers to the strategic move of one company buying another company by acquiring major stakes of the firm. Usually, companies acquire an existing business to share its customer base, operations and market presence. It is one of the popular ways of business expansion. occur when a firm buys another.
How Does a Merger Work?
A merger in business occurs when two or more firms mutually agree to integrate their assets, resources, and workforce to create a new legal company. Corporates adopt this long-term strategy to attain objectives like reducing competition, capturing a considerable market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors., increasing assets and finances, uplifting stock value, and overcoming entry barriersEntry BarriersBarriers to entry are the economic hurdles that a new entrant must face in order to enter a market. For example, new entrants must pay fixed costs regardless of production or sales that would not have been incurred if the participant had not been a new entrant..
Usually, equal-sized firms with similar business goals come together to create a new entity which is understood as the merger of equals. Many pre-deal assessments are a crucial part of the process. Participating companies go over their existing market valuation, resources, capabilities, costs and revenuesRevenuesRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. before making up their mind.
They undergo integration if they are assured of seamless conduct of joined operations suited to mutual goals. The deal is sealed after the participating firms enter into an agreement bearing clauses that spell out the terms of the alliance. Usually, one party gives up its shares to integrate with another.
Although mergers and acquisitionsMergers And AcquisitionsA merger and acquisitions (M&A) agreement refers to an agreement between two existing companies to merge into a new company, or the purchase of one company by another, which is done generally to benefit from the synergy between the companies, expand research capacity, expand operations into new segments, and increase shareholder value, among other things. (M&A) are both strategic decisions, they are different from each other. The former involves integrating individual entities into a single business organization, and the latter occurs when one company purchases another.
Real-World Merger Examples
Let us look at some real-world examples of mergers that also received news coverage due to their popularity.
Raytheon and United Technologies
In 2020, the Raytheon Corp. and United Technologies Corp formed a new company, Raytheon Technologies Corp. It is considered as a merger of equals since these enterprises are the gems of the aerospace and defence industry. Trading of Raytheon Company’s shares stopped a day prior.
Every share of Raytheon’s common stockCommon StockCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity. was converted into 2.3348 shares of United Technologies’ common stock. It was a rights offering in which existing shareholders are given a choice to buy additional shares. After the completion of the integration, United Technologies became Raytheon Technologies Corporation.
Its common stock shares began to trade on the New York Stock Exchange with the ticker symbolTicker SymbolTicker Symbol is the use of letters to represent shares that are traded on the stock market. It is mainly a combination of two or three alphabets that is unique and easy for investors to identify and buy/sell that particular stock. RTX. The merging firms combined 2019 pro forma net salesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales. of $74 billion and a global workforce of 195000.
Huntington Bancshares (HBAN) and TCF Financial
Bank mergers are also quite common in the business world. For example, in 2020, Huntington Bancshares Incorporated and TCF Financial Corporation, a well-known US regional bank holding company, underwent an all-stock merger. Together they formed a new corporation that had a market worth of $22 billion.
At the time of integration, the market value of Huntington Bancshares was said to be $13.15 billion, while TCF’s stood at $5.3 billion. Also, Huntington was reported to expect an 18% rise in its earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. by 2022.
Types of Mergers
There are broad of five kinds as discussed below:
- Horizontal: When companies that are rivals in the same industry join hands to form a new business enterprise; it falls under the horizontal kind. For instance, the integration of two entertainment channels.
- Vertical: Such collaboration occurs between two or more companies across different product linesProduct LinesProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing. in the same industry. For example, the association of a fabric manufacturing company with a garment manufacturer.
- Congeneric: It is a consumer-centric approach where business entities with the same target market and resources merge to combine a new product. For example, a motion tracker technology provider merges with a digital watch manufacturer.
- Market Extension: Here, the business organizations that offer similar products but serve different markets integrate to trap the potential of a larger market and attract a vast customer base. For instance, an automobile company in the US collaborates with a Dubai based automobile company.
- Conglomerate: The association of firms which belong to completely different industries or business lines are considered a conglomerateConglomerateA conglomerate in business terminology is a company that owns a group of subsidiaries conducting business separately, often in distinct industries. It reflects diversification of operations, product line and market to allow business expansion.. For instance, a telecom company joining hands with an electronics manufacturing firm.
It is an opportunity of increasing the market share on one hand and decreasing the level of competition on the other. Companies with limited capital can expand and scale up their business operations by merging with another enterprise.
When a merger involves a market extension, companies can cross-sellCross-sellCross-sell is a marketing strategy used by a company to convince an existing customer to buy related or supplementary products and services in addition to the primary purchase. in different markets, whether domestic or global, thus catering for a more extensive clientele. Conglomerates expand their empire using M&As, bringing them diversification and enhanced profits.
Duplication of operations and resources like machines and technology can be eliminated to ensure cost-effectiveness. Other advantages include exposure to better technology, process, and resources.
Also, the share prices often go high, yielding better returns to the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares., giving rise to the merger arbitrageMerger ArbitrageMerger Arbitrage, also known as risk arbitrage, is an event-driven investment strategy that aims to exploit uncertainties that exist between the period when the M&A is announced and when it is successfully completed. This strategy, mainly undertaken by hedge funds, involves buying and selling stocks of two merging companies to create risk-free profit.. The strategy of merger arbitrage involves stock markets traders making the most out of price fluctuations that are common once an integration announcement is made.
Criticisms of Mergers
- Many collaborations fail due to inadequate due diligence and over-expectations from each other. Sometimes, the firms have entirely different objectives, plans, work culture and policies, making it difficult for them to work together. Also, in cross-border mergers, employees face communication barriers, cultural diversity and geographical constraints.
- While such an association of companies also impacts the economy, many employees are laid off due to overlapping responsibilities in the new firm.
- Moreover, it promotes monopoly when a single entity such as a conglomerate gains access to many markets by M&As. At times, they set unreasonable prices, heavy on consumers’ pockets.
- Business integrations do not always work as desired by the companies, they may end up in demergers or spin-offs. Companies sometimes disintegrate or fall into terrible losses when they aren’t compatible to work together.
- Demerges usually occurs within a conglomerate as corporate restructuring. The parent company breaks the business into smaller units to either sell them off or for specialized focus. Corporates typically try to break away from a loss-making business using demergers.
Real-World Failed Merger
One such failed integration was of Daimler Benz and Chrysler. These two pioneers of the automobile industry integrated to form DaimlerChrysler in November 1998. The collaboration didn’t turn out as fruitful.
The company’s market capitalization came down to $53 billion in 2000 (while earlier, Daimler-Benz AG alone had a $57 billion market capitalization). In 2007, Daimler allocated Chrysler to Cerberus Capital Management by paying a certain amount.
Laws Protecting Investors
Federal laws govern the rights of consumers from adverse effects like high product prices and poor quality after the merger. For example, section 7 of the Clayton Act restricts certain M&As which intent on bringing monopoly or subsiding competition within an industry.
In addition, the Horizontal Merger Guidelines issued by the Federal Trade Commission (FTC) and Department of Justice (DOJ) also provides for agencies’ analytical framework to keep a check over antitrust issues. Moreover, the premerger actions taken by the antitrust agencies under the Hart-Scott-Rodino Act include the pre-examination of such deals and their possible effects on the consumers.
Also, such authorities look into the complaints regarding the harmful effects of various mergers on the customers. As per the Securities and Exchange Commission (SEC), if a company that is subjected to the SEC reporting obligations, should inform the shareholders about the integration. Shareholders can find merger fillings of the company from SEC’s database by looking for the proxy statement or information statement.
A merger is the voluntary association of two or more business entities to form a single, more prominent firm. In January, a highly significant example in the US was America Online (AOL) and Time Warner, which was announced in 2000. AOL compensated Time Warner with $182 billion for the latter’s stocks and debt. While AOL held 55% shares in the new firm, 45% went to Time Warner. However, the association didn’t sustain, and in 2009, the company spun off.
M&A buzz often results in high volatility of the corporate stock prices. Thus, if you are an investor who trades on the market expectation, you may avail yourself of the opportunity of huge returns by buying stocks before integration and selling it off at a high price later.
The four types are conglomerate, horizontal, vertical, product extension and market extension.
This article has been a Guide to what is a Merger and its definition. Here we discuss Top 5 types of mergers along with examples, advantages, and disadvantages. You can learn more about M&A from the following articles –