Every organization strives to grow in profits, sales and market share. Growth can be either internal or external, whereby internal growth involves developing new products or increasing the capacity of products, while external growth is made possible through mergers and acquisitions. Whereas mergers and acquisitions could open up numerous opportunities for businesses, they could also be the main source of business failure. This essay seeks to critically analyze the reasons for, methods and impact of mergers and acquisitions. Subsequently, this essay will evaluate the arguments for and against mergers and acquisitions, evaluate ‘cash offer’ and ‘share exchange’ as forms of forming the mergers, and critically evaluate the reason for the high rate of failure of mergers.
Arguments for and against the use of mergers and acquisitions as a method of corporate expansion
The use of mergers and acquisitions as a method of corporate expansion is supported by its potential benefits and opportunities. One argument for the use of mergers and acquisitions is that it increases the competitive advantage of the merging companies. According to Triantafyllopoulos and Mpourletidis (2014), some companies merge to help in faster penetration of a new market or increase their market share in a certain market. In some instances, mergers and acquisitions are considered as a strategy to protect the market share in an increasingly concentrated market. To gain competitive advantage or gain a market share in a different market where a company has no operations, a company might acquire another company that already has a market share in that new market. An example of a merger or acquisition that has achieved competitive advantage or increased market share is the purchase of Nycomed, a pharmaceutical company by Takeda.
Another argument for mergers and acquisition for the purpose of corporate expansion is it helps companies that want to diversify their product offerings. According to Triantafyllopoulos and Mpourletidis, mergers could result from the need to differentiate product offering or the business risk of an organization (2014). Diversification could also be necessary when the merging company’s product is facing reducing demand and opts for a merger or acquisition to spread the risk or differentiate products to retain market share and remain profitable amidst the risk. When two companies merge, they can combine their products and services, achieving diversification and gain the competitive advantage over other players in the industry. An example of a merger or acquisition that has achieved diversification is the merger between Bayer and Monsanto. This merger means that two companies will control more than a quarter of the global supply of pharmaceuticals, pesticides, and seeds. This merger brought together a pharmaceutical and a seed and pesticide company, thereby increasing the product diversification of the resulting merger.
Mergers and acquisitions are also good for companies that want to replace leadership if the current leadership is not innovative enough or has not been able to make the business profitable and relevant. According to Allahar (2015), mergers are a good way for companies to enhance their entrepreneurial activity and the current owners cannot find someone capable of enhancing a company’s entrepreneurial activity ad take it to the next level. One such merger or acquisition that has benefited from the change in leadership is the acquisition of Yahoo by At Yahoo, one of her latest and biggest achievements was the successful acquisition of Yahoo by Verizon at the cost of $4.8 billion (Liedke, 2017). Under new leadership or management, Yahoo’s entrepreneurial activity has been increasing. This was a win-win situation for Yahoo’s shareholders and Verizon.
Despite these potential opportunities and benefits of mergers and acquisitions, arguments against mergers suggest otherwise. One argument against mergers and acquisitions is that lack of shared vision and culture could lead to a company losing its market share to competitors or the dominant firm. Whereas some companies come together to increase their market share and competitive advantage, the resulting partnership could negatively impact the market share of one or both of the merging companies. For instance, the merger between Microsoft and Nokia back in 2013 was meant to increase Microsoft’s market share because it was convenient for Microsoft to gain market share in a new market of mobile phone devices. However, the merger failed terribly with Nokia losing its market share from 41% back in 2012 to 3% in 2017.
Another argument against mergers and acquisitions is that the resulting partnership could be hampered by poor governance and weak leadership. Bringing together two independent companies requires clarity on who is to perform what tasks and having a strong leader who will lead the partnership towards its intended vision. However, most mergers fail because of too many wrangles between the leaderships of the two merging companies and lack of clarity on who makes decisions and how decisions are made. In addition, the same wrangles could also lead to conflicts that make the partnerships come to a halt. An example of a merger and acquisition that failed because of poor governance and weak leadership is the Halliburton (HAL) and Baker Hughes (BHI) $103 billion acquisition. After the merger, the two companies could not work together mainly because of antitrust worries between the leaderships of each party (Yaw, 2016).
Another argument against mergers and acquisitions is regulatory and legal issues. In some instances, mergers and acquisitions are smooth, especially when they happen within a common jurisdiction. The problem occurs when the two merging companies come from different jurisdictions or when the country in which the merger or acquisition is occurring imposes regulatory restrictions that are beyond the merging companies. One such merger that fell apart because of these regulatory issues is the deal between Allergan (AGN) and Pfizer (PFE). The vision to merge the two companies faltered when the U.S. regulators imposed deeper restrictions.
The use of ‘cash offer’ and ‘share exchange’ as a form of consideration for mergers and acquisitions
The method of financing mergers and acquisitions include cash offering, securities or stock offerings and cash and stock combined.
- The cash offer
This occurs when the acquirer uses cash from his or her reserves or from creditors to acquire a company. A cash offer involves the acquiring company taking the entire risk of the expected synergy value. If the bidding company has no surplus cash, it has to finance the acquisition through debt. Debts are mostly sought from financial institutions, and this type of cash is subject to capital and interest payments. The cost of borrowing is one of the potential debt problems that bidding company has to deal with. Once the purchase is made, the post-acquisition capital structure of the bidding company is likely to be negatively affected as the most liquid assets would have already been used to finance the acquisition (Rappaport & Sirower, 1999).
When it comes to the shareholders of the bidding company, debt capacity is influenced by tangible assets and growth on earnings. This implies that forms with more tangible assets can easily borrow huge amounts to finance mergers and acquisitions than firms with few tangible assets. However, debt financing also comes with a financial risks for the shareholders of the bidding company as the tangible assets are used as collateral. In case the combined company defaults in repaying the debt, the tangible assets could be lost to the lenders resulting in a loss to the bidding company.
In addition, debts come with interest rates and other obligations such as fines in case of defaults. In other words, the shareholders of the bidding company could end up spending all their liquid assets. The shareholders of the bidding company therefore have to incur this risk. The cash transaction also attracts greater tax liabilities for the shareholders of the bidding company compared to when the deal is financed through stocks. On the positive side, debt financing is good for a bidding company that wants to preserve corporate control as the shares are maintained (Bouzgarrou, 2014).
The cash offer could be a good deal for the target company’s shareholders because they get the cash in exchange of company ownership instead of stocks. In addition, the target company’s shareholders maintain corporate control when they obtain shares in exchange of their company. Stock offers also do not come with increased tax obligations as no cash is involved. However, stock can fluctuate in value, and if this value depreciates after the acquisition or merger, the target company’s shareholders incur a loss. Such an instance is highly risky if the target company’s shareholders want to recover the value of the company. If stocks depreciate, then the target company’s shareholders would have sold their company for a less amount than if they were paid in cash. The target company’s shareholders therefore have to incur this stock fluctuation risk.
- Share exchange or stock offering
Also known as securities offering, this involves an acquirer offering shares of common stock or common stock to the shareholders of the company that is being acquired. In the stock transaction, the risk is spread in different ratios among the acquiring company, the selling shareholders and the combined company (Rappaport & Sirower, 1999).
The main advantage of stock offering is that it is fast and easy, and the acquirers can quickly concentrate their resources on the financial growth of the new investment. This option also provides the freedom of not being bound to the obligations of debts and loans. With share exchange, investors or acquirers only risk their shares in case the financial condition of the selling company worsens. Another benefit of share exchange for the bidding company is that there is no loss of liquid asset and this puts the bidding company at a financial advantage. One challenge of the share exchange for the bidding company is stocks fluctuation. If stocks change in value after the acquisition, then the bidding company stands a chance to gain or lose. For instance, if the bidding company paid for the acquisition through its own stock and the share prices increase after the purchase, the bidding company would have paid more in share exchange than if the transaction was in cash. Another challenge of stock exchange is that the bidding company stands a chance to lose its corporate control to the target company. This is because the target company shareholders will gain more stocks and the corporate power that come with the shares (Sehgal, Banerjee & Deistin, 2012).
While the main benefit of share exchange for the target company and its shareholders is that they retain some form of ownership control, the main challenge or disadvantage of share exchange is that the there is a threat of being bought out by the investors. According to Vladimir and Vyacheslav, the main fear of selling companies is facing aggressive investors who want to buy shares to protect the dominant company (2013). The bidding company shareholders could be targeting to buy out the target company to control ownership and management. There is also the risk of capital washout whereby the share capital preservation has not been provided and the risk of increased corporate control from the shareholders who want to control the management of the combined company.
The main reasons for the high failure rate of mergers and acquisitions in enhancing shareholder value
Whereas mergers and acquisition are common for companies that want to achieve corporate expansion, many of them fail because of various reasons. The first reason for the failure of mergers and acquisitions is clash in corporate culture. Mergers involve two companies with different cultures coming together for strategic reasons and to survive as one entity, the cultures have to unite. One way of doing this is to set aside the cultures of two companies and starting a new culture that will incorporate the values of both companies. However, most mergers and acquisitions do not consider this critical factor leading to poor management, and ultimately, the deal is nullified.
One major merger that has failed due to a clash in corporate culture is the merger between the American Omnicon and the French Publicis (Canina & Kim, 2010). The two advertising companies came together to increase their market share in the advertising industry and also beat competition. However, the deal fell apart following internal clashes in the corporate culture as well as power struggles between the management of the two companies. The strong corporate cultures between the two companies, as well as employees and managers feeling threatened, have been a major source of failure for even the largest mergers. Another example of a merger and acquisition that has failed due to poor corporate blending or clash in corporate culture is the merger between Sprint and Nextel Communications that was worth $35 billion. However, shortly after the acquisition, employees started leaving the company citing cultural clashes and incompatibility between the two companies.
Some mergers also fail because of miscalculation of real value or paying too much. In such instances, the acquiring company tends to make the purchase in order to beat the competition. However, the mistake is realized when the resulting merger cannot recoup the investment. An example of such a failed partnership is the merger between eBay and Skype in an acquisition that was worth $2.6 billion. This was a considerable high price to pay for a company whose assets were not worth over $7 million. After stakeholders and critics questioned the high price that eBay was paying for Skype, the then eBay justified the move citing that Skype had the potential to improve its auction site. However, the merger was not well received by eBay customers who rejected the platform altogether. Following this miscalculation, Skype lost its value, and after two years, eBay was forced to reevaluate the value of Skype, and the value was written down by more than $900 million. The merger between eBay and Skype failed because of miscalculation of the real value of Skype by eBay (Hassan & Ghauri, 2014).
Another major reason for the failure of mergers and acquisitions is regulatory pressure. Regulatory pressure and restrictions make it difficult for companies to merge and conduct business smoothly. A merger that has failed due to regulatory pressure is the merger between Allergan (AGN) and Pfizer (PFE). Following more regulatory and tax restrictions, the two pharmaceutical companies could not realize their potential and vision for the mergers. Another merger that has failed because of regulatory pressure and restrictions is the merger between MCI WorldCom and Sprint. The partnership fell apart mainly because of increased regulatory pressure interns if meeting standards and other restrictions.
Another reason that has led to the failure of many mergers and acquisitions is poor integration. While mergers are a good option to increase market share and gain competitive advantage, they can only be successful if the two merging companies integrate their assets and operations. However, some mergers come together without a proper plan for business integration, and this is a key recipe for failure. An example of a merger that has failed due to poor integration is the partnership between Bank of America and Merrill Lynch. Whereas the merger could put the two companies ahead of their competitors in the finance industry, the companies had a poor integration plan and took forever to integrate their assets and operations (Hassan & Ghauri, 2014). In addition, the two companies took too long to decide on who should do what and as a result many customers of the two banks left. The loss of clients diluted the purpose of the merger leading to the failure of the partnership.
The acquisition of Nextel Communications by Sprint also failed due to poor integration, particularly when it came to business functions. There was a lack of trust and rapport between the two companies making it very difficult to integrate operations and business functions. In the end, the merger failed, and the $35 billion investment did not pay off.
In summary, mergers and acquisitions provide numerous opportunities to companies that want to achieve corporate expansion. Mergers and acquisitions help in increasing market share, facilitate market penetration, attain competitive advantage and achieve diversification. However, arguments against mergers point out to lack of a shared vision and culture, poor governance and regulatory issues as the main challenges of mergers. To finance mergers and acquisitions, the bidding companies can opt for cash offers, share exchange or both. While the cash offer enables investors to retain corporate power, debt financing comes with its own risks. The share exchange option is ideal for investors who want to redirect resources elsewhere. The main reasons for the failure of mergers and acquisitions include class in culture, poor integration, financial miscalculation and regulatory pressure. However, with a proper plan in place, mergers and acquisitions can be very successful.