Mergers & Acquisitions
Mergers and Acquisitions, or M&A for short, generally refers to two businesses combining in some manner. Many companies use M&A activities as a way to achieve growth, while others may use M&A to diversify their businesses.
In any case, Mergers & Acquisitions activities are one of the most controversial topics in finance and are associated with complex legal, tax, and synergistic issues. A casual reading of the headlines indicates that mergers and acquisitions take a variety of forms (e.g., friendly or hostile), but almost always someone is left unhappy (usually the managers that are removed, or workers that will be laid off). Although Mergers and Acquisitions is often used as a generic term that refers to any business combination.
We can differentiate between mergers and acquisitions. An acquisition refers to one company buying only part of another company. A typical acquisition transaction may involve the purchase of assets or a distinct business segment (e.g., subsidiary) from another company. If the acquirer absorbs the entire target company, the transaction is considered a merger.
Once a merger is completed, only one company will remain, and the other will cease to exist. Whether a transaction is called a merger or an acquisition, the initiator of the venture is referred to as the bidder Company, or acquirer Company, while the opposite side of the transaction is known as the target Company.
Post-Merger Value of an Acquirer
In any merger that makes economic sense, the combined firm will be worth more than the sum of the two separate firms. This difference is the gain or Profit , which is a function of synergies created by the merger and any cash paid to shareholders as part of the transaction.
In equation form, we can denote the post-merger value of the combined company as:
VAT = VA + VT + S − C
Where: VAT = post-merger value of the combined company (acquirer + target)
VA = pre-merger value of acquirer
VT = pre-merger value of target
S = synergies created by the merger
C = cash paid to target shareholders
Once again, remember that the pre-merger value of the target should be the price of the target stock before any market speculation causes the target’s stock price to jump.
Gains/Profit Accrued to the Acquirer
In most merger transactions, acquirers must pay a takeover premium to entice the target Company’s shareholders to approve the merger. The target company’s management will try to negotiate the highest possible premium relative to the value of the target company. From the target Company’s perspective, the takeover premium is the amount of compensation received in excess of the pre-merger value of the target’s shares, or:
Gain Target = TP = PT − VT
where:
Gain Target = gains accrued to target shareholders
TP = takeover premium
PT = price paid for target
VT = pre-merger value of target
In most merger transactions, acquirers must pay a takeover premium to entice the target Company’s shareholders to approve the merger. The target company’s management will try to negotiate the highest possible premium relative to the value of the target company. From the target Company’s perspective, the takeover premium is the amount of compensation received in excess of the pre-merger value of the target’s shares, or:
Gain Target = TP = PT − VT
where:
Gain Target = gains accrued to target shareholders
TP = takeover premium
PT = price paid for target
VT = pre-merger value of target