Especially from a long-term perspective, corporate mergers or acquisitions can have a huge influence on companies’ growth and overall outlook. Yet even though the transformation of the acquiring company can happen in a very short term, mergers and acquisitions are considered to have significant risks because, statistically, only 30% or less of them turn out to be successful.
Usually, companies that undertake M&A transactions look for the growth of their business or want to beat the competition. However, they also encounter some risks such as paying too much or not being able to integrate two companies well.
Reasons for M&As
The main reasons for companies to engage in mergers and acquisitions are the following:
- Growth – sometimes it can take years to double the size of the company in an organic way. M&A can be used to grow quickly.
- Competition – this is what leads to craziness in hot markets – companies urge to purchase a firm with an attractive asset portfolio before any of its rivals does.
- Synergies – the goal is to eliminate or consolidate duplicate resources of two companies with similar businesses. The result is taking advantage of synergies and economies of scale.
- Domination – M&A would help two companies dominate their market unless they are big enough to create a monopoly. In this case, their activities would be limited and persecuted.
Effects of M&As
This part presents the most common ways of M&As affecting a company. Firstly, we should analyze the change in the capital structure. M&A activity has a long-term influence on the capital structure of both the acquiring company and the target company. An M&A transaction allows the shareholders of the target company to cash-out a big premium or a stake in the dominant entity.
When it comes to the acquirer, the deal size affects the impact of an M&A transaction directly – the bigger the potential target, the bigger the risk. While a failure of a small acquisition can “shake but not break” the acquirer, a big-sized failure can affect its long-term success immensely.
At the moment when a deal is closed, the acquirer’s capital structure changes and it depends on the design of the M&A deal. If the transaction is processed in cash, the acquirer’s cash holdings drop significantly. However, not every company has enough cash prepared for such huge transactions. That is why most of them take out loans which inevitably increases their indebtedness.
Another way of designing the M&A transaction is financing it through the acquirer’s stock. To start, the shares must often be premium-priced for an acquirer to use the stock as currency. Not to forget that the management of the target company needs to be convinced that it is beneficial to accept stock instead of cash.
Secondly, it is important to take into consideration the possible market reaction to news of an M&A as it can be favorable or unfavorable. It completely depends on how market participants perceive the merits of the deal. Typically, the shares of the target company will come close to the acquirer’s offer. And not only: the shares of the target company can be traded above the offer price if the target company is considered attractive enough for a rival bid.
On the other hand, the target’s shares can be traded below the offer price. It usually happens when the purchase should be processed partly in the acquirer’s shares. Then the stock falls once they announce the deal publicly. The stock may plummet because market participants view the price for the deal as too high or do not find the deal accretive to earnings per share.
COREDO can help you with planning and performing your M&A transactions step by step. Contact us to arrange a personal consultation.