An Introduction to Mergers & Acquisitions (M&A)
By Joshua Ong:
Aimed at those interested in a summarised and broad overview of the mergers and acquisitions division, the article provides an overview of what mergers and acquisitions are, the types of M&A deals, why companies would want to undergo M&A, and the industry’s recent trends and outlook.
What are Mergers and Acquisitions (M&A)?
In M&A, bankers advise companies and execute transactions on selling or acquiring other companies, or assets or divisions of other companies.
Mergers are usually amalgamations of two companies of similar sizes, whereas acquisitions are usually the purchase of a subsidiary by a parent company. For example, a merger would be between Exxon and Mobil in 1999 to form ExxonMobil, and an acquisition would be Apple acquiring AuthenTec for its TouchID technology.
Bankers in M&A conduct valuations of the target companies, either to sell a company (sell-side) or to advise a company that wants to acquire another company (buy-side). Working in M&A could involve tasks like finding and presenting to potential buyers/sellers, conducting excel-based analysis and deal presentations, and building valuation models.
Strategic Motivations behind M&A
Synergy is the concept that the combined value and performance of two companies will be greater than the sum of their individual parts. The main purpose of M&A would be to increase shareholder value and stimulate growth. Possible synergies include sharing information and technology, supply chain efficiencies, sharing R&D and access to patents. Synergies can be broadly divided into three categories: revenue synergies, cost synergies and financial synergies.
Revenue synergies: Companies can increase their market share and consumer base through a horizontal merger (defined later on), and therefore increase their revenue due to combined sales. An example of this would be Facebook acquiring Instagram in 2012, which connected both apps and increased the audience of both platforms concurrently, thereby increasing advertising sales.
Cost synergies: The combination of companies can reduce their individual costs of production through reducing staff or rent, consolidating suppliers or increasing the utilization of capital assets.
Financial synergies: Reducing the company’s cost of capital through merging with a larger company can lower the lending rate charged by the lender in recognition of its larger balance sheet and cash flows supporting the loan.
A company may wish to expand its offerings of products or services and can do so by acquiring a target company that already produces goods or services in that sector. This would be much faster as compared to the company attempting to make inroads into that sector from scratch, as the target company would have existing infrastructure, technology and experience. Dell acquired 25 companies from 2007 to 2012, in a bid to diversify from PC sales. Dell succeeded in increasing its non-computer revenue by 30% in those 5 years. Diversification has other benefits apart from revenue growth, like reduced operational risks as the acquirer would have more sources of revenue.
Hostile and Friendly Takeovers
A takeover requires a majority vote from shareholders to be approved. A hostile takeover occurs when the acquiring company attempts to take over the target company, without the consent of the target company’s board of directors. In a hostile takeover, the acquiring company usually makes a tender offer (a proposal that an investor makes to shareholders of a publicly listed company, to sell their shares at a specific price at a specific time) to the stockholders of the target company. A hostile acquirer may also attempt to takeover using proxies, where it attempts to persuade shareholders to use their proxy votes to either install new management or take corporate action.
There are a few ways the targeted company can defend against a hostile takeover.
(i) Poison Pill:
One of the most powerful defenses, the target company dilutes its shares such that the hostile bidder cannot obtain a controlling share without incurring large costs. The firm does this by allowing existing shareholders to purchase more shares at a discounted rate. An example would be in 2018 when Papa John’s (PZZA) board adopted the poison pill defense to prevent ousted founder John Schnatter from having a controlling interest. However, although issuing additional shares dilute the shares of the hostile bidder, a poison pill also dilutes the shares of existing shareholders and could potentially be expensive for them as it necessitates additional investment in new shares to maintain their proportion of ownership in the company.
(ii) White Knight:
The target company may look for a friendlier firm to obtain a controlling interest before the hostile company. Unlike a hostile takeover, the current management team would not be ousted. An example of a white knight rescue would be when JPMorgan Chase acquired Bear Stearns to prevent the latter’s insolvency in 2008.
The target company counters by buying back its own shares from the hostile company, and even shares of the hostile company itself. The target company may have to sell off assets or use funding from its “war chest”, in an attempt to scare off the hostile bidder. Porsche attempted to acquire a controlling interest in Volkswagen, but Volkswagen ended up taking over Porsche in the end, exemplifying a successful Pac-man defense.
Friendly takeovers occur when both boards approve of the merger. One company, usually the larger company, acquires the shares and assets of the other company, which ceases to function as a separate entity. Both companies work in tandem in the takeover process, with the acquirer either offering shares or cash.
Types of Mergers
Generally, mergers are categorized into the following categories, with horizontal and vertical mergers being the most common:
(i) Horizontal integration:
Horizontal integration is the acquisition of another business operating at the same level of the value chain in the same industry and sector. In other words: its competitors. Usually done to increase market share, create economies of scale and reduce competition.
Example: Acquisition of Pixar Animation Studios by Disney to form Disney-Pixar in 2006.
(ii) Vertical merger:
A vertical merger is when a company brings previously outsourced operations in-house, through the acquisition of the companies in the same supply chain, mainly to reduce production costs.
Example: Acquisition of AuthenTec by Apple for its TouchID technology.
(iii) Congeneric mergers:
Congeneric mergers are between two businesses that serve the same consumers in different ways but do not offer the same products for an increase in market share, expansion of product lines or synergies.
Example: Merger between Citicorp and Travelers Group to form Citigroup in 1998.
(iv) Market-extension merger:
Market-extension mergers are between two companies that sell the same products in different markets, to ensure that the merging companies can access a larger market and hence a larger consumer base.
Example: Acquisition of Eagle Bancshares Inc by RBC Centura in 2002.
(v) Product-extension merger:
Product-extension mergers are between two companies selling different but related products in the same market. Similarly to market-extension mergers, usually for higher profits from a larger consumer base from the combination of product offerings.
Example: Acquisition of Pizza Hut by Pepsi Co in 1977.
Sell-side vs Buy-side
M&A can be split into two broad categories: Buy-side and Sell-side.
In sell-side deals, you work with sellers who are trying to find a potential buyer for the company. A sell-side investment banker builds valuation models and approaches potential buyers. Bids from potential buyers are collected and winners picked and finally, the purchase agreement is negotiated with the winning bidder.
In buy-side deals, you advise a company that wants to acquire another company or another asset or division, often for synergistic or cost-related reasons, and help to find potential acquisitions. A buy-side investment banker researches potential acquisitions, creates company profiles and presents these to the client company who wishes to acquire another business until a decision is made by the client.
Deals can be further segmented into targeted deals and broad deals.
For targeted deals, the buyer and seller are already in talks, or the acquiring company has a shortlist of potential acquisitions. The work for analysts and associates involved in these deals is more related to analysis on excel and deal presentations as compared to broad buy-side or sell-side work which requires more research.
Broad buy-side deals require more liaising between buyers and sellers, writing the Teaser and Confidential Information Memorandum (CIM) and presenting many potential acquisitions to clients. Broad sell-side deals are where a single company is pitched to many potential buyers. A Teaser is a short one or two slide summary to introduce an acquisition opportunity, and a CIM is a short summary of the company written by the sell-side of the M&A process, including the company’s products, services, financials and broader market.
Key Trends in M&A
1. Global M&A trends
Figure 1: M&A activity globally by deal value and number of deals. Source: PitchBook
In general, the recovery from the Covid-19 pandemic is still going strong with more Initial Public Offerings (IPOs) and increased PE dry powder. There is also a shift towards deals being paid for in stock or a combination of shares and cash, increasing to almost half of all deals compared to 40% in 2020. According to CNN Business, global nonfinancial companies are sitting on nearly US$7 trillion in cash, and PE firms have about US$1.5 trillion in dry powder as of August 2021.
Despite these tailwinds, the recovery of economies from Covid-19 differs greatly by region due to vaccination rates, government responses and supply chain issues.
2. M&A trends in the Asia-Pacific region
M&A activity in the Asia-Pacific region has hit an unprecedented high in the first half of 2021 as markets continue to recover from the Covid-19 pandemic. M&A values targeting the region increased to US$535 billion, up from US$284 billion over the past year. More than 50 deals over US$1 billion targeting the Asia-Pacific region were announced this year, five times more than in 2020. The technology sector accounted for almost one-third of the deal value in this region in this time period.
Figure 2: Deal volume against deal value in the Asia Pacific region. Source: PricewaterhouseCoopers
Chinese domestic M&A deal value totaled US$276.4 billion in the first half of 2021, almost twice that of the same time period in 2020. Most of the largest deals in China were between Chinese companies, such as the mega-merger between Chinese infrastructure companies Sichuan Railway Investment Group and Sichuan Transportation Investment Group valued at US$111.5 billion. Hong Kong also had an increase in domestic activity in H1 of 2021 compared to H1 of 2020.
There were 119 deals targeting tech firms in the region (59.2% YOY increase in value), including the US$4 billion purchase of Shanghai Moonton by ByteDance (who owns TikTok), setting ByteDance up for competition against Tencent.
Yew-Poh Mak, EY Asia-Pacific Strategy and Transactions Leader, says:
“The pandemic has propelled innovation and significant business transformation across all industries. In the tech sphere, M&A activity in Asia-Pacific has been fueled by the emergence of next-gen technological applications, such as industrial Internet of Things (IoT), AI, electric vehicles and sustainable, fuel-efficient technologies. For advanced manufacturers who pursued M&A, the primary activity has been bolt-on acquisitions in the same sector designed to increase market share or transformative deals that would enable a more sustainable business model.”
From the trends observed in the past few years, the Asia-Pacific region looks set to continue having a strong inward focus, with international interest in the high-growth tech sector of the Asian market looking to increase steadily as well.
3. Increased focus on ESG
As consumers become more socially and environmentally aware, environmental, social and governance (ESG) concerns have now become a priority for M&A deals. Globally, there has been a shift towards more ESG-minded deals, as ESG-related deals increased from US$35.7 billion in value in the first half of 2020 to US$96.5 billion in 1H 2021. M&A activity in the renewable energy sector almost tripled in the first half of 2021 compared to 2020. There were also 140 completed low carbon energy transactions in 1H 2021, with each deal worth more than US$50 million.
Investors and directors are increasingly challenging their M&A teams to consider targets that advance the organization’s pursuit of sustainability. BlackRock’s Cameron explains: “The next generation wants to work for companies, buy from companies, and invest in companies that embrace ESG. This is where the economic demand is going and M&A needs to align with this reality.”
Better technology and data allow M&A dealmakers to narrow their targets to sustainability-focused companies, using financial metrics to assign values to ESG factors, like greenhouse gas emissions, increased insurance costs, enhanced demand for goods with positive environmental or social effects and the value of enhanced employee retention and productivity.
With the increasing speed at which deals are being made, the addition of ESG-related analysis will depend on the adoption of digital platforms for deal management. Technology will play an increasingly important role in the analysis of ESG data, from reviewing sensitive personal information in a secure environment during diligence to the application of AI to analyze troves of data.