The Current Industry Trend - Companies Merging
Posted by Charntel Petersen on
What are the Different Motives for Mergers?
Firstly, what is a Merger?
A merger is a financial transaction in which two companies join each other. Once they have joined, they continue operations as one legal entity. In most cases, mergers can be split into one of five different categories:
- Horizontal merger: Merging companies are direct competitors operating in the same market. The companies involved will offer similar products and/or services.
- Vertical merger: This is where the merging companies operate along the same supply chain line.
- Market-extension merger: This is the case when merging companies offer comparable products. Alternatively, they may have similar services. The key in this instance though is that they operate in different markets.
- Product-extension merger: Here we have a situation where merging companies operate in the same market. They offer products and/or services which are complementary to each other.
- Conglomerate merger: Merging companies offer completely different products and/or services.
The type of merger selected by a company will normally depend on the motives and objectives of the companies involved in the deal.
Companies pursue mergers and acquisitions for a variety of reasons. The most common motives for mergers include the following:
- Value creation
Two companies may consider a merge to increase the wealth of their shareholders. It is expected that the consolidation of two businesses results in synergies that increase the value of one new business. This synergy means that the value of a merged company exceeds the sum of the values of two individual companies. It is recognised that there are two different types of synergies:
- Revenue synergies: Synergies that are intended to improve the company’s revenue-generating ability. For example,
- market expansion,
- production diversification,
- R&D activities
are just a few factors that can create revenue synergies.
- Cost synergies: This is where the synergies will reduce the company’s cost structure. A successful merger may result in larger production results. It may give access to new technologies, and the elimination of certain costs. All these events may improve the cost structure of a company.
Mergers are often undertaken for diversification reasons. For example, a company may use a merger to expand its business operations by entering new markets. It may result in being able to offer new products or services. It is common that the managers of a company may arrange a merger deal to diversify risks relating to the company’s operations.
It may be the case that shareholders are not content with situations where the merger deal is motivated by the objective of risk diversification. In many cases, the shareholders can easily diversify their risks through investment portfolios while a merger of two companies is regarded as a long and risky transaction. Market extension, product extension, and conglomerate mergers are typically motivated by diversification objectives.
- Acquisition of assets
A merger can be motivated by a desire to acquire assets that cannot be obtained any other way. In this type of transaction, it is quite common that some companies arrange mergers to gain access to assets that are unique or to assets that usually take a long time to develop. Access to new technologies is a frequent aim in many mergers.
- Increase in financial capacity
Every company faces a maximum financial capacity to finance its operations through debt or equity markets. If a business finds itself with a low financial capacity, it may choose to merge with another. A merger of this type can result in an entity that will secure a higher financial capacity that can be achieved in further business development processes.
- Tax purposes
If a company generates significant taxable income, it can merge with another company with large carry forward tax losses. After the merger, the total tax liability of the two companies will be much lower than the tax liability of the independent company.
- Incentives for managers
Sometimes, mergers are motivated by the personal interests and goals of the top management of a company. It may be that a company created as a result of a merger guarantees more power and prestige that can be viewed favourably by managers.
The overall aim is easy! It should be to provide products or services that the two companies merged are better than each individual company can offer.
This has been the case with some of the recent mergers in our industry. With some businesses really struggling under the pressures presented by COVID, potential mergers have been a welcome lifeline.
If you have a story about a merger, we would love to hear from you.
You can call us, (07) 3139 1559 or email us at firstname.lastname@example.org.