Mergers and Acquisitions

Kushni Ulapane analyses the benefits and risks of mergers and acquisitions. 

What are mergers and acquisitions (M&A)?

– A merger occurs when two companies combine business operations and become one entity.

– An acquisition occurs when one company becomes a majority shareholder in another, such that it can take control of the business.

Benefits

M&A allows companies to combine and expand their presence and reach in a market. As well as this, companies can enter new sectors if the two companies merging are in different industries. This enables them to establish a larger presence in different markets, which means that they will be able to reach more consumers and increase profits. Companies may then use profits to invest into research and development, allowing them to improve and innovate their products.

Another benefit to M&A is that companies will be able to gain economies of scale, which will help them become more efficient and more profitable. This is due to lower average costs that firms will experience, as a result of the increase in output from being a larger firm. For example, firms may experience buying economies of scale, as they will be able to bulk buy raw materials and receive discounts, reducing the cost of production. They may also experience financial economies of scale, as larger firms are usually rated by financial markets to be more “credit worthy”, so they will be able to borrow at lower interest rates. This can further help companies invest into research and development.

Companies that are a part of M&A deals have the benefit of accessing new resources and competencies, expanding their knowledge about the market, and providing them with more facilities that may help improve their product. In addition to this, M&A gives companies the opportunity to improve their infrastructure, which means that they will be able to increase revenue, as a result of a higher output. This will lead to further financial gains, encouraging more investment.

Risks

A risk of mergers and acquisitions is the potential for firms to increase their market share beyond what the Competitions and Market Authorities would class as ‘monopoly’. The percentage share for this is around 25% and would grant the firm price setting power such that it can set prices above a socially optimum level. Therefore, consumers may be faced with higher prices as a result.

Larger firms may also experience diseconomies of scale as a result of the increase in the size of the firm. For example, they may face difficulties with communication and coordination when working with a larger number of employees, as they will not be able to motivate workers. This will lead to inefficiencies thus increasing the cost of production, which in turn would decrease profits. Inefficiencies may also be present as a result of culture clashes between firms. This will lead to further disagreements between employees, creating an environment of stress for the workers.

Job losses may occur in the case of an aggressive takeover by an asset stripping company – they may get rid of under-performing sectors of the target firm. Although this may boost efficiency of the firms, this will have a negative impact on the economy as this will increase unemployment and have further financial implications on the government.

M&A during COVID-19

The market for M&A has contracted rapidly, as a result of the COVID-19 pandemic. Accenture revealed that the deal volume in the first quarter of 2020 has dropped 33% from the year before. The changes in stock prices, as a result in changes in consumer behaviour and market structure, has caused issues within M&A deals. For example, UK’s Cineworld’s acquisition of Cineplex (Canada-based competitor) was approved in February 2020, however, the share prices in both companies have drastically collapsed due to the crisis. This shows that the changes in share prices that COVID-19 has had on companies may change the confidence of the involved companies.

Material Adverse Change (MAC) clauses in transaction documents may be negotiated more frequently, during the crisis. This will allow buyers to have the opportunity to walk away from a transaction before closing, during events that are detrimental to the target business. This shows that M&A deals may be less desirable to enter, due to uncertainty and lack of confidence in associating with companies that may be negatively affected by Coronavirus. They may also consider undertaking a more detailed due diligence on certain areas of a target company, to see how the company is coping with the pandemic and how it may affect the company in the future.

Nevertheless, there have been mergers that have successfully continued such as Virgin Media and O2 (announced 7th May 2020). Allen & Overy have shown that it is possible to deliver a deal during a time like this, by having a hand in this £31 billion merger. Therefore, despite the presence of the pandemic, it is clear that a merger (or an acquisition) can be carried out, successfully.

By Kushni Ulapane.