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Motives for Mergers

The most common reasons for M&A deals

What are the Different Motives for Mergers?

Companies pursue mergers and acquisitions for several reasons. The most common motives for mergers include the following:

 

1. Value creation

Two companies may undertake a merger to increase the wealth of their shareholders. Generally, the consolidation of two businesses results in synergies that increase the value of a newly created business entity. Essentially, synergy means that the value of a merged company exceeds the sum of the values of two individual companies. Note that there are two types of synergies:

  • Revenue synergies: Synergies that primarily improve the company’s revenue-generating ability. For example, market expansion, production diversification, and R&D activities are only a few factors that can create revenue synergies.
  • Cost synergies: Synergies that reduce the company’s cost structure. Generally, a successful merger may result in economies of scale, access to new technologies, and even elimination of certain costs. All these events may improve the cost structure of a company.

 

Motives for Mergers

 

2. Diversification

Mergers are frequently undertaken for diversification reasons. For example, a company may use a merger to diversify its business operations by entering into new markets or offering new products or services. Additionally, it is common that the managers of a company may arrange a merger deal to diversify risks relating to the company’s operations.

Note that shareholders are not always content with situations when the merger deal is primarily 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 typically a long and risky transaction. Market-extension, product-extension, and conglomerate mergers are typically motivated by diversification objectives.

 

3. Acquisition of assets

A merger can be motivated by a desire to acquire certain assets that cannot be obtained using other methods. In M&A transactions, 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 internally. For example, access to new technologies is a frequent objective in many mergers.

 

4. Increase in financial capacity

Every company faces a maximum financial capacity to finance its operations through either debt or equity markets. Lacking adequate financial capacity, a company may merge with another. As a result, a consolidated entity will secure a higher financial capacity that can be employed in further business development processes.

 

5. Tax purposes

If a company generates significant taxable income, it can merge with a company with substantial carry forward tax losses. After the merger, the total tax liability of the consolidated company will be much lower than the tax liability of the independent company.

 

6. Incentives for managers

Sometimes, mergers are primarily motivated by the personal interests and goals of the top management of a company. For example, a company created as a result of a merger guarantees more power and prestige that can be viewed favorably by managers. Such a motive can also be reinforced by the managers’ ego, as well as his or her intention to build the biggest company in the industry in terms of size. Such a phenomenon can be referred to as “empire building,” which happens when the managers of a company start favoring the size of a company more than its actual performance.

Additionally, managers may prefer mergers because empirical evidence suggests that the size of a company and the compensation of managers are correlated. Although modern compensation packages consist of a base salary, performance bonuses, stocks, and options, the base salary still represents the largest portion of the package. Note that the bigger companies can afford to offer higher salaries and bonuses to their managers.

 

Mergers

 

What is a Merger?

A merger is referred to as a financial transaction in which two companies join each other and continue operations as one legal entity. Generally, mergers can be divided into five different categories:

  1. Horizontal merger: Merging companies are direct competitors operating in the same market and offer similar products and/or services.
  2. Vertical merger: Merging companies operate along the same supply chain line.
  3. Market-extension merger: Merging companies offer comparable products and/or services but operate in different markets.
  4. Product-extension merger: Merging companies operating in the same market offer products and/or services complementary to each other.
  5. Conglomerate merger: Merging companies offer completely different products and/or services.

Note that the type of merger selected by a company primarily depends on the motives and objectives of the companies participating in a deal.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

  • Acquisition Structure
  • Financial Synergy
  • M&A Considerations and Implications
  • Merger Consequences Analysis

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