There are many reasons for companies wanting to acquire other companies. These reasons include the pursuit of a growth strategy, the defence of hostile action from another would-be acquirer, and financial opportunities. However, the commonest reason is that the merger will result in substantial trade advantage or greater profits than the combined profits of the two companies working separately. There is also the element of synergy.
More generally, motivation for takeovers and mergers may arise from the fact that cost of production would be less in a larger entity combined with enlarged operational capacity and reduction of duplications (the economies of scale). Mergers and acquisitions may enable a company acquire a competitor which poses substantial threat to it, or a company which supplies its raw materials or provides it with market outlets with the aim of assuring, improving these services, or ensuring that these companies are not taken-over by a competitor. Again, the motivation may be
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diversification of enterprises with a view to ensuring stability of earnings;
and it may be to acquire the much-needed technology or managerial expertise of another company. Large combines have more obvious financial advantages than small companies. There is an enlarged capital base, loan capacity, accelerated growth and increased earnings.
There are reasons for going the route of mergers, which have been considered to primarily add to shareholder value. They are as follows: -
(a) Economies of Scale: This refers to the fact that the combined company can often reduce duplicate units or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit.
Economies of scale that would result in a reduction in costs and utilization of the synergies between the two merging entities to streamline operation was also cited as one of the reasons for the merger between Dangote Cement Plc and Benue Cement Plc.
(b) Increased Revenues/ Increased Market Share: This motive assumes that the company will be absorbing a major competitor and thus increase its power (by capturing increased market share) to set prices.
(c) Cross Selling: For example, a bank buying a stock broker could then sell its banking products to the stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts, or a manufacturer can acquire and sell complementary products.
(d)Synergy: Better use of complementary resources. Excluding any synergies resulting from the merger, the total post-merger value of
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the two firms is equal to the pre-merger value. However, the post-merger value of each individual firm likely will be different from the pre-merger value because the exchange ratio of the shares probably will not exactly reflect the firms' values with respect to one another.
The exchange ratio is often skewed because the target firm's shareholders are paid a premium for their shares.
Synergy takes the form of revenue enhancement and cost savings.
When two companies in the same industry merge, such as two banks, combined revenue tends to decline to the extent that the businesses overlap in the same market and some customers become alienated. For the merger to benefit shareholders, there should be cost saving opportunities to offset the revenue decline; the synergies resulting from the merger must be more than the initial lost value.
(e) Taxes: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In the United States and many other countries, rules are in place to limit the ability of profitable companies to "shop" for loss-making companies, limiting the tax motive of an acquiring company.
(f) Geographical or other diversification: This is designed to smooth the earnings results of a company, which over a long term, smoothens the share price of a company, giving conservative investors more confidence in investing in the company. However, this does not always deliver value to shareholders.
(g)Resource Transfer: Resources are unevenly distributed across firms and the interaction of target and acquiring firm resources can create
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value through either overcoming information asymmetry or by combining scarce resources.
(h) Increased market share which can increase market power: In an oligopoly, increased market share generally allows companies to raise prices. Note that while this may be in the shareholders' interest, it often raises antitrust concerns, and may not be in the public interest.
The reasons for a merger could also be appreciated from the perspective of the seller. The reasons include –
(a) The seller could be approaching retirement or getting ready for an exit out of the business.
(b) The need for competent management or managers that could lead the business to the next level i.e. sustain it.
(d) The business could require substantial investment in new technology and business processes to enhance its competiveness.
(e) The need for access to the target’s resources coupled with the need for liquid assets to augment working capital, and meet critical obligations of the company.
The reasons for merging could also be appreciated from the buyer’s perspective. The reasons would include –
(a) The need to enhance revenues, and reduce the operation costs relative to the revenues. In essence to increase the earnings per share (EPS). Mergers in which the acquiring company's earnings per
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share (EPS) increases is known as “accretive mergers”. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E. The corollary of accretive mergers is “dilutive mergers”, whereby a company's EPS decreases.
The company will be one with a low P/E acquiring one with a high P/E.
(b) Backward or vertical integration (vertical or horizontal operational synergies) or economies of scale.
(c) The need to acquire new technologies, business processes, production capacity and management capabilities.
(d)Strengthening management capabilities.
(e) Change in the overall direction of the business.