1. What are Mergers and Acquisitions?

Overview

This introductory lesson explains what mergers and acquisitions are, and why companies decide to pursue them. We also learn how synergies work and about the qualitative factors that can affect these transactions.

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Summary

  1. Lesson Goal (00:04)

    The goal of this lesson is to explore why mergers occur and the mechanics behind how they work.

  2. Understanding Mergers and Acquisitions (00:29)

    Mergers and acquisitions are transactions in which the ownership of companies is transferred or combined. In a merger, two companies combine to create a single new company. In an acquisition, one company purchases all the stock or assets of another company. The purchased company is dissolved leaving only the purchaser company.

    Mergers and acquisitions are often referred to using the term M&A. Sometimes, the specific terms merger and acquisition will be used interchangeably.

  3. The Benefits of Synergies (01:18)

    When two companies are combined, synergies are created. A synergy is any effect that increases the value of a combined firm above the value of the two separate firms. 

    There are two main types of synergy. The first type is cost synergies, where a combined firm has lower costs than two separate firms would have. For example, a combined firm may need only one office instead of two. Alternatively, they may be able to reduce employee numbers, particularly at a managerial level. The second type of synergy is revenue synergies, where a combined firm can generate more revenue than the firms would generate separately. For example, a combined company may be able to raise prices due to reduced competition in the market. They may also be able to cross-sell products if the individual companies operated in slightly different markets.

    Other types of synergy can exist, depending on the companies and the industry in question. Synergies are only available when one company takes over another. Other investors, such as private equity firms, cannot unlock the value of synergies. As a result, we might expect that M&A transactions should be quite successful. However, other factors other than synergies can affect the success of a merger or acquisition. These can include cultural fit, employee departures, management collaboration, and other factors.

Transcript

Welcome to Kubicle's mergers and acquisitions financial modeling course. As with previous courses, this course will take the form of a case study where one clothing retailer will seek to acquire another.

But before we jump into this case study and begin modeling, this introductory lesson is going to explore why mergers occur and the mechanics behind how they work. Let's start with some definitions. Mergers and acquisitions, or M and A for short, are transactions in which the ownership of companies are transferred or combined. To be specific, a merger is a legal consolidation of company A and company B, which will then create a new company C. An acquisition on the other hand is when company A acquires company B's stock or assets leaving just company A with company B dissolved.

These terms are often combined to the shortened phrase M and A. And in both cases, two companies are combined to form one. You might note that I may use these terms interchangeably during a couple of lessons in this course. Up to now, the acquirers of companies in our courses have been investors. In this course, the buyer is another company, not purely an investor. The buyer is still hoping to get a good return on the asset or company that they are acquiring, however unlike an investor such as a private equity firm, the buyer can unlock synergies. Synergies are defined as any effects that increase the value of a merged firm above the value of the two separate firms. In effect, creating value to the equation one plus one is equal to three.

To understand synergies in more detail, let's take an example of two real estate agents combining. On the left-hand side, we'll first explore some cost synergies.

These include consolidating headquarters into one building and perhaps selling the other building, reducing the employee count, particularly at managerial level, where we only need one chief financial officer and not two for example. Another cost synergy could be reducing sales and marketing expenses, which could again only be possible when the companies are combined. On the right-hand side, we may also have revenue synergies, and these may include price increases because of less competition now that the two companies have merged, but also the cross-selling of different products, particularly if one real estate agent is in commercial property and the other is largely in residential. There are many different types of synergies and they often depend on the types of companies that are merging and the industry in question. However in all cases, the business proposition should be the same, where the cost of company B should not exceed the value of company B plus the synergies.

Given that investors such as private equity funds don't have access to the value creation power of synergies, M and A transactions by their nature should be more successful as a rule. However in addition to the quantitative factors, that determine an M and A deal, there are also qualitative factors that can have a big impact, such as culture fit between the two companies, management team collaboration, employee departures, synergy realizations, and much more.

None of these factors should be discounted when evaluating potential success of a merger or acquisition.