Mergers and Acquisitions – Everything the Indian retail Investors need to know about mergers and acquisition to Invest wisely
Mergers and acquisitions are part and parcel of any business. So we see so many ongoing mergers and acquisitions in the market.
They are very healthy for the market as more prominent companies either acquire the smaller ones to consolidate or merge to form a larger entity to do much better business.
It is not surprising in 2020 when we hear about the immense numbers of corporate restructurings taking place.
As an investor, let us understand what is a merger and how it differs from an acquisition. Moreover, how an investor should build their position for an M&A.
What is a Merger?
In business or economics, a merger is to combine two or more companies into one larger company.
Such actions are commonly voluntary and involve a stock swap or cash payment to the target.
A stock swap is often used as it allows the two companies’ shareholders to share the risk involved in the deal.
The best example of a merger is Vodafone and Idea, when both the companies merged to form Voda-Idea or VI. Both the companies had a tough time standing against JIO, so they joined hands to create a new company.
The profit-sharing, investment, and other such ratios can vary depending on the new entity’s shareholding pattern.
Types of Mergers
There are majorly three types of mergers. Let me explain each in a very simplistic way.
- Horizontal mergers – It takes place where the two merging companies produce a similar product in the same industry and want to become a more significant entity. The best example is VodaIdea, where each was a similar telecom operator before the merger.
- Vertical mergers – When two firms, each was working at different stages in producing the same goods, combine to use the supply chain of the final product entity efficiently.
- Conglomerate mergers take place when the two firms operate in different industries. It typically happens when a company wants to foray into a separate vertical and merge with another industry player.
The main reason for M&A is faster growth and improvement of the profit margins. However, there are other reasons like
- Enhance the productivity cycle by enhancing supplies with an adequate supply of raw material.
- Elimination of competition
- Moving into other areas of expertise.
Who benefits from a merger?
A merger is a mutual decision for two or more entities to join forces. So ideally, both companies benefit from a merger.
However, depending on the type of merger, one entity may benefit slightly more over the other. But broadly, both companies do benefit.
What is an Acquisition?
An acquisition is the buying of one company (the “target” company) by another. However, in some cases, the acquisition is for only part of the business instead of a complete company acquisition.
A recent example of acquisition is Pidilite Industries acquiring the US-based Huntsman Group’s Indian arm – Huntsman Advanced Materials Solutions Private Ltd (HAMSPL). The acquirer gets the Indian subcontinent business of HAMSPL and the trademark license for exporting the same products to the Middle East, Africa, and ASEAN (Association of Southeast Asian Nations) countries.
Acquisition usually refers to the purchase of a smaller firm by a larger one.
Types of Acquisitions
There are two types of acquisition – friendly and hostile.
- Friendly Acquisition – The acquiring company offers a price to the target company that they can’t refuse and are willing to sell the company. The target company often negotiate for a better price for itself.
- Hostile Acquisition or takeover – The target company is not willing to sell. Still, the acquirer takes most of the shares from the open market to forcibly acquire the target company. Often the promoters are not the majority shareholders, so other shareholders may be willing to let the company be taken over for a better price. Mindtree was a hostile takeover by the L&T group.
Who benefits from an acquisition?
Unlike mergers, acquisitions can be beneficial to either one of the two companies, which depends on how the acquisition takes place.
In an acquisition, the acquirer can pay a very high price for the target company to be more beneficial to the target company than the acquiring company.
The WhatsApp takeover by Facebook was seen like Facebook paid a very high price for the acquisition.
Similarly, the acquiring company can get a better deal from the target company to make the acquisition very lucrative for the acquiring company.
Finally, in a hostile takeover, it is often the target company’s non-promoter shareholders that benefit the most.
How to Invest amid mergers and acquisitions?
Finally, after understanding mergers and acquisitions in detail, the most crucial aspect for an equity market investor is to know how one can invest amidst M&A.
We know both the company’s benefits in a merger. However, if we look at Vodafone and Idea’s merger, it was a forced merger due to JIO.
They were tough competitors prior but couldn’t survive the JIO wave. The only option left with them was to go out of business or merge and try to survive the wave. They chose the latter.
So in a merger, one has to understand if the company will make a lot more money than what it is making right now. If you think it will, it is worth investing but not otherwise.
Similarly, in an acquisition, everything depends on the price. Tata Steel acquiring Corus was not a very lucrative deal, but the same company acquiring Bhushan steel is a good deal.
So again, in an acquisition, the one thing one should look at is how the company will pay for the acquisition. If it means adding too much debt, then it may not be an excellent deal. However, if the company can acquire from the cash on the books and very little debt, it may be a very fruitful acquisition.
The best way to invest in a company amid mergers and acquisitions is valuation.
The price will reveal a lot. Both the companies involved in an acquisition will price the target company differently. The seller will price the company higher, while the buyer will try to lower the price.
So invest in companies that want to boost growth with acquisition at a reasonable price.