Why Do Companies Merge?

Companies often merge with their competitors or buy a market player. We call these mergers and acquisitions. Ever wondered why companies take these decisions? Why do companies use robust financial resources for these strategic moves? So, I am going to uncover the secrets behind these corporate unions and help you understand how they shape the competitive landscape and drive growth in the business world. Wait till the end of this article, as we will discuss the key benefits of M&As from the very basics to advanced with examples.

What are Mergers and Acquisitions?

Mergers involve two independent companies forming a new legal entity voluntarily. They seek mutual benefits, such as entering new markets, cutting costs, and improving management, ultimately aiming to increase size, scale, and revenue. Investment bankers and corporate lawyers facilitate the process, and funding can be through cash, equity, or both, issuing new stock to shareholders in the new company. [1]

In an acquisition, one company purchases most or all of another company’s shares to gain control, requiring ownership of over 50% of the target firm’s stock and assets. This enables the acquirer to make decisions without the consent of other shareholders. Acquisitions are common in business, involving both willing and unwilling target companies, with the possibility of a no-shop clause during the process. While large company acquisitions dominate headlines, M&A activities are more frequent among small to medium-sized firms. [2]

Why Do Companies Merge with or Acquire Others?

To Achieve Synergy

Mergers and acquisitions (M&A) strive for synergies, where the combined value of two firms surpasses their pre-merger worth. Synergies can arise from cost reductions due to operational efficiencies or increased revenue through expanded market reach and complementary products. Estimating synergies can be done by comparing similar transactions and conducting internal analyses.

Methods to estimate M&A synergies include identifying redundant staff, consolidating vendors, reducing costs, optimizing resources, and exploring cross-selling opportunities. But the thing is, you can’t enjoy synergies immediately. The benefits of synergies can be ripped off after 2 or 3 years. Short-term costs may rise due to integration expenses and culture clashes, potentially hindering synergy realization.

Nonetheless, successful M&A with well-planned synergy realization can create long-term value and strategic advantages for the newly formed company. Careful execution and post-merger integration are crucial to unlock the full potential of synergies and achieve sustained growth in the competitive business landscape.

To Expand and Diversify

If a company wants to diversify further or expand its operations, M&As are a great strategy to undertake. These transactions involve combining two or more firms to achieve specific business objectives that would be challenging to accomplish through organic growth. M&A enables companies to swiftly expand their presence in existing markets or enter new geographic regions by acquiring firms with established operations, expediting market penetration and brand recognition.

Furthermore, M&A facilitates the diversification of product offerings, customer base, and revenue streams. By acquiring businesses in different industries or serving diverse customer segments, companies can spread risks and reduce dependence on a single market, enhancing stability during economic downturns. M&A also provides access to advanced technologies, patents, and intellectual property, giving companies a competitive edge. Economies of scale and cost savings are additional benefits, leading to increased profitability and competitiveness.

To Gain Competitive Edge

Mergers and Acquisitions (M&A) can offer companies a distinctive competitive advantage when treated as a strategic capability rather than isolated transactions. By developing and honing four crucial institutional capabilities, companies can harness the full potential of M&A to outperform competitors in the market. Firstly, engaging in M&A thematically enables companies to create a focused pipeline of potential acquisitions aligned with explicit M&A themes, ensuring strategic objectives are met. Secondly, managing the reputation as an acquirer and being perceived as bold, collaborative, and value-adding enables companies to attract desirable targets and gain a favorable position in the market. Confirming the strategic vision during due diligence ensures that the deal remains in line with the company’s assets and capabilities, maximizing value creation. Lastly, reassessing synergy targets throughout the deal’s life cycle allows companies to adapt and capitalize on new information, capturing additional value and driving growth beyond initial estimates. By mastering these capabilities, companies can leverage M&A as a potent competitive tool, positioning themselves for sustained success and growth. [3]

To Expand Internationally

When a company purchases an already successful business in a new market, it immediately gains access to local knowledge, ways to connect with customers, distribution networks, and an understanding of the rules and regulations. For example, in 2014, Facebook bought WhatsApp. This acquisition of the messaging app was driven by the objective of the international expansion of Facebook. This smart move helped Facebook get more users and quickly expand internationally, especially in new and growing markets where WhatsApp was already popular. Mergers and Acquisitions are great ways for rapid growth and customer acquisitions across the world by companies.

M&A thus acts as a strategic tool that enables companies to expand internationally with reduced risks and faster market penetration, harnessing the strengths of both entities to create a more robust and globally competitive organization.

To Reduce Regulatory Tax

Sometimes, Mergers and auctions are used as a technic to reduce a company’s regulatory tax. By structuring the deal appropriately, acquiring companies may benefit from a step-up in the tax basis of the target company’s assets, enabling higher depreciation and amortization deductions. Additionally, utilizing the target company’s Net Operating Losses (NOLs) can offset future taxable income, resulting in reduced tax obligations. In cross-border deals, access to foreign tax credits earned by the target company can help offset taxes on foreign income, thereby lowering the overall tax burden. Taking advantage of tax structures like tax-free exchanges can result in tax savings. However, navigating the complex landscape of tax laws and regulations requires careful tax planning and expert consultation to ensure the M&A deal is tax-efficient and complies with the relevant rules. By doing so, companies can maximize the potential benefits of the transaction and optimize their financial outcomes.

Business Merger Examples of Three Companies

Here are the world’s most prominent mergers took place in the business history of USA.

The Merger of Kraft and Heinz

A merger is an agreement that is made to unite two existing companies to form a new company. And one of the most significant examples of a merger is the merger of Kraft and Heinz. Founded in Chicago in 1923, Kraft Food Inc. merged with 152 years old Pennsylvanian company Heinz forming a new company, Kraft and Heinz, in 2016. This merger made the new company the third-largest food company in the USA and The fifth-largest food company globally. According to the CEO of Berkshire Hathaway Inc. (co-owner of Heinz), the reason for this merger was to increase the value of shareholders through the expansion of business in the global arena. Utilizing Heinz’s worldwide reach and Krafts big-name products, the company managed a better opportunity for bargaining with retail outlets, restaurants, and food companies and expanded.

The Merger of AT&T with Time Warner

In 2018 the biggest telecommunication company globally, AT&T, merged with Time Warner, a film, television, and cable operation company. The merger plan was announced back in 2016 by AT&T. Later, the merger plan was halted by a lawsuit filed by the United States Justice Department. Fearing it could lead to too much concentration of industrial power in the hands of a few persons because of the size of two companies and their broad reach in different areas of the service sector. This merger is for mutual benefits that the executive chairman of AT&T described in a statement. He mentioned a significant customer pain in not accessing paid content on multiple devices, and the merger of AT&T and Time Warner will allow US citizens to access all the Time Warner premium content through AT&T networks.

The Merger of Exxon and Mobil

In 1999 two giant oil companies of the USA made a merger agreement of 81 billion dollars. The newly merged organization is now called ExxonMobil Corporation. At the time of the merger, the organization had become the third-largest business organization globally. The apparent reason for this merger was to cope with fields such as: earning stability, falling oil price, and increasing competitive advantage in long-term gains. Through this merger, Exxon focused on discovering potential oil and gas fields, using the rich experience of Exxon’s deep-water exploration. The union was supposed to gain 2.8 billion dollars in revenue in 2 years. The merger between these two giants was supposed to achieve significant cooperation in Research and Development for Exxon.

Bottom Line

Mergers and acquisitions (M&A) are like magical business unions. Companies join forces to get benefits of course. But there are thousands of instances where companies went bankrupt because of these decisions! Do you know why? Because the overestimated outcome and the expense exceeded the benefits. This is the reason why companies involve analysts, consultants, and top executives to make such moves. Usually, merger and acquisition decisions come from the top of the management. But the whole company faces the outcome good or bad. Another hassle is the differences between the companies create a lot of issues while merging. Both parties need to adapt to a new situation and cultivate a culture of cooperation. But if they’re done right, M&As will bring opportunities for growth. I hope this article helped you understand this particular landscape.

References

1. https://www.theforage.com/blog/skills/merger
2. https://www.investopedia.com/terms/a/acquisition.asp
3. https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/m-and-a-as-competitive-advantage
4. dummies.com/business/corporate-finance/mergers-and-acquisitions/the-reasons-for-mergers-and-acquisitions/
5. answers.google.com/answers/threadview?id=57377
6. smallbusiness.chron.com/advantages-company-mergers-22476.html
7. boundless.com/finance/textbooks/boundless-finance-textbook/mergers-and-acquisitions-20/reasons-for-business-combinations-131/reasons-for-combining-businesses-541-5678/
8. thebalance.com/why-do-companies-merge-mergers-and-acquisitions-explained-392847
9. investopedia.com/ask/answers/06/mareasons.asp