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1. What are Mergers and Acquisitions?
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.
Mergers and Acquisitions
- Mergers and Acquisitions are transactions in which the ownership of companies are transferred or combined
- A Merger is a legal consolidation of Company A and Company B, creating a new Company C
- An Acquisition occurs when Company A acquires Company B's stock, leaving just Company A
- Emerge when the combined value of two companies is higher than the pre-merger value of both combined
- Can be either cost synergies or revenue synergies
- Cost synergies are much easier to accurately estimate than revenue synergies
- Only available in M and A, not available to pure investors such as Private Equity firms
Qualitative factors that affect Mergers and Acquisitions
- Culture fit
- Managment team collaboration
- Employee departures
- Synergy realisations
- Lots more!
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.