Understanding Mergers and Acquisitions

Jan 01, 2024 By Susan Kelly

Although the terms mergers and acquisitions are frequently used interchangeably, they can have different meanings. An acquisition is when one company acquires another and becomes the new owner.

A merger combines two companies that are approximately equal in size. They join forces to create a new entity and move forward. This is called a merger between equals. This is an example: Chrysler and Daimler-Benz both ended up dead when they merged. DaimlerChrysler was formed. Stocks of both companies were given up, and new stock was issued. The company was renamed and changed to the Mercedes-Benz Group AG in February 2022 as a part of a brand refresh.

When both CEOs agree to merge their companies, a purchase deal is also called a merger. Acquisitions are any deals that target companies don't want to be bought or are hostile or unfriendly. A deal can be classified as a merger or an acquisition, depending on how it is announced. The difference is in how the deal is communicated and how it is received by the target company's employees, shareholders, board of directors, and employees.

Why Do Companies Engage In M&A?


M&A is a common way for companies to increase their size and surpass their competitors. Increasing a company's size through organic growth can take many years or even decades.


This strong motivation is the main reason M&A activity happens in distinct cycles. A strong desire to acquire a company with a large portfolio of assets before its rivals often leads to a frenzy in hot markets. Examples of frenetic M&A activity within specific sectors include telecoms and dot-coms in the late 90s, commodity and oil producers in 2006-07, and biotechnology companies from 2012-14.


Companies can also merge to take advantage of economies of scale and synergies. When two businesses with similar businesses merge, synergies can be created. They can consolidate or eliminate duplicate resources such as branch offices and manufacturing facilities. Every million dollars saved or fraction thereof goes directly to the bottom line, increasing earnings per share and making M&A transactions "accretive."


Companies also undertake M&A to control their industry. A combination of two giants could result in a monopoly. Such a transaction would need to be subjected to intense scrutiny by anti-competition watchdogs and regulatory authorities.

Tax Purposes

M&A can also be used by companies for tax purposes, though this could be an implicit motive rather than an explicit one. Corporate inversion is a technique where a U.S. corporation buys a smaller foreign competitor and moves the tax home of the merged entity overseas to a lower tax jurisdiction to reduce its tax bill significantly.

M&A Effects

Capital Structure

M&A activity has more long-term implications for the acquiring or dominant entity in a merger than for the target firm in an acquisition or the company that is subsumed by a merger. An M&A transaction offers the opportunity for shareholders to cash out at a substantial premium, particularly if it is an all-cash transaction. The target company's shareholders get a stake and a vested right in its long-term success if the acquirer pays part in cash and some in stock.

The deal size and company size will determine the magnitude of the M&A transaction's impact on the acquirer. The acquirer is exposed to greater risk if the target is larger than it is. While a company might be able to handle a small acquisition's failure, a large purchase could severely impact its long-term success.

Depending on the terms of the M&A transaction, the acquirer's capital structure may change once the M&A transaction is closed. All-cash deals will significantly reduce the cash reserves of acquirers. All-cash deals are usually financed with debt, as most companies don't have enough cash to pay the full amount. This can increase a company's debt, but the extra cash flows from the target firm may justify the increased debt load.

Market Reaction

Market reactions to the news of an M&A transaction will vary depending on market participants' perceptions of its merits. The target company's stock will rise to an amount close to the acquirer's offer price, provided that the offer is significantly higher than the target's prior stock price. If the target believes that the acquirer has made a low-ball offer and is forced to increase it or that the target is highly sought after enough to attract a competitor bid, then the target shares could trade higher than the offer price. In certain situations, the target company might trade below the offer price. When part of the acquisition consideration is paid in acquirer's shares, the stock drops when the deal is announced.

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