Mergers and Acquisitions

Mergers and acquisitions involve two separate companies combing to make one company. As the names suggest, a merger relates to two companies often of similar size combining to make one bigger company. Acquisitions on the other hand involves one company taking over another company which will then cease to exist. There have been several notable mergers and acquisitions in the past, and M&A activity often finds itself in the news headlines. But is the process of making a bigger company by combining two smaller companies always a good thing? Most mergers and acquisitions take place with the aim of increasing total revenue by combining two companies together and also reduce expenditure. Savings can be found in the form of reducing the total wage bill by decreasing staff numbers as many job roles will have two people fulfilling them since two companies have now become one. It is also hoped that the newly formed, bigger company will have more purchasing power and therefore be able to negotiate lower prices from suppliers, again a form of cost cutting. Such economies of scale are perceived as being a significant benefit of merging with or acquiring another company. Additionally this process could allow for a greater share in the market for the new, bigger company which now might find it has significant competitive advantage as one large entity. Furthermore, merging or acquiring a new company is often used a method of gaining access to new markets. For example, in 1998 Tesco purchased the Lotus chain of supermarkets from the Charoen Pokphand group to create Tesco Lotus, Tesco's first Asian Venture. This is an example of one method of Foreign Direct Investment (FDI) as mentioned in the previous blog, and allowed Tesco to quickly establish itself in the Thai food retailing market.

So the advantages of M&A seem plentiful but at what cost? Financially speaking, the cost of acquiring another company can astronomical. Typically a company wishing to buy another company will pay a 30% premium on the share price. Examples of large deals include the acquisition of Mannesmann by Vodafone in 2000 for around $185 billion and America Online (AOL) acquiring Time Warner in 2001 for over $180 billion. Following the acquisition of Mannesmann, Vodafone's share price dropped quite noticeably. Taking into account the general theme of these blogs, the maximisation of shareholder wealth, it could be argued that an M&A activity that decreases the value of a company's share price is certainly not in the interest of increasing shareholder wealth and therefore a bad idea. It has been argued that acquisitions have occurred based on a number of different decisions not related to increasing shareholder wealth. The status of the management of the acquiring company is likely to improve following an acquisition, and this fact alone may be enough of an incentive for a CEO to orchestrate a takeover. Although this may benefit the CEO personally, making him a better known business leader, acquiring a company for this reason alone is certainly not considering the interests of the shareholders. CEOs of smaller companies may also decide to acquire another company in the hope that this will prevent their own company being subject to a takeover. Being acquired by another company is likely to lead to the dismissal of much of the existing management, on average within two years of being taken over. Although it is easy to identify motive for acquiring another company to avoid being taken over yourself, this again is not in the interests of the shareholder. Such conflicts of interest  can allow for acquisitions to occur for the 'wrong reasons' in the eye of perhaps everyone other than the CEO of the company!

Quite often mergers and acquisitions are seen as anti competitive processes and are prevented from occurring by governing bodies. In a recent case, the purchase of airline BMI by IAG (who also own British Airways) came under scrutiny for being potentially anti-competitive. Rival airline Virgin argue that the deal will create a monopoly especially on routes between Heathrow and Scotland and north-western England. Virgin say that such dominance over these routes will result in increased prices and reduced services which will be against the interests of consumers. In response to the deal, the UK's Office of Fair Trading (OFT) has announced that it will not make a review and that the European Commission will be left with the decision of whether or not to approve it.

So overall it appears that M&A activity is not necessarily always a good thing. It can result it job losses, decreased competition, higher prices for the consumers and a reduction in shareholder wealth for investors. The desire to create a bigger company purely to become more powerful is not the right reason to conduct a merger or acquisition in my opinion. With so many other stakeholders being affected, it is crucial that such activity takes place for the right reasons.