Two companies that produce similar products and/or services
A horizontal merger occurs when companies operating in the same or similar industry combine together. The purpose of a horizontal merger is to more efficiently utilize economies of scale, increase market power, and exploit cost-based and revenue-based synergies.
When companies undergo a horizontal merger, the underlying principle is to create value. A successful merger should create value in which combining the companies would be worth more than if each company were under independent ownership. In a horizontal merger, 1 + 1 (referring to two independent companies) should be greater than 2 (the merged company).
Reasons for merging horizontally:
Although there are many benefits to a horizontal merger, they may not be fully realized and the merger may not actually create added value. Merging companies face problems such as:
Though one is often confused with the other, there is a distinct difference between the two types of mergers.
The diagram below shows the difference between the two:
Assuming Clothing Store A, B, and C are competitors. If Clothing Store A merges with Clothing Store B or Clothing Store C, it is a horizontal merger.
The production process: Textile Producer A → Shirt Manufacturer A → Clothing Store A. If Clothing Store A merges with Shirt Manufacturer A or Textile Producer A, it is a vertical merger.
Consider a famous horizontal merger: HP (Hewlett-Packard) and Compaq in 2011. The structure was a stock-for-stock merger with an exchange ratio of 0.63 HP share per Compaq share, valued at approximately US$25 billion. The new company would be held 64% by HP and 36% by Compaq shareholders.
The rationale behind the horizontal merger of HP and Compaq was based on the following points:
The merger created a US$87 billion global technology leader offering the most comprehensive set of IT products and services for businesses and consumers. The new HP became the top global player in IT services, imaging and printers, and access devices. Cost and revenue synergies were established, creating substantial shareholder value and providing new growth opportunities.