In: Finance
As part of the financial planning process, a common practice in the corporate finance world is restructuring through the process of mergers and acquisitions (M&A). It seems that on a regular basis, investment bankers arrange M&A transactions, forming one company from separate companies. What are the advantages and the disadvantages of a merger? In your response, provide an example of either - a merger that was successful, or one that was unsuccessful.
Mergers and acquisitions (M&A) is a general term used to describe the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, tender offers, purchase of assets and management acquisitions. The term M&A also refers to the desks at financial institutions that deal in such activity.
The terms "mergers" and "acquisitions" are often used interchangeably, although in actuality, they hold slightly different meanings. When one company takes over another entity, and establishes itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer absorbs the business, and the buyer's stock continues to be traded, while the target company’s stock ceases to trade.
On the other hand, a merger describes two firms of approximately the same size, who join forces to move forward as a single new entity, rather than remain separately owned and operated. This action is known as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. Case in point: both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, Daimler Chrysler, was created. A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies.
Advantages of mergers
Disadvantages of mergers
Examples
1.New York Central and Pennsylvania Railroad
In 1968, the New York Central and Pennsylvania railroads merged to form Penn Central, which became the sixth largest corporation in America. But just two years later, the company shocked Wall Street by filing for bankruptcy protection, making it the largest corporate bankruptcy in American history at the time.
The railroads, which were bitter industry rivals, both traced their roots back to the early- to mid-nineteenth century. Management pushed for a merger in a somewhat desperate attempt to adjust to disadvantageous trends in the industry. Railroads operating outside of the northeastern U.S. generally enjoyed stable business from long-distance shipments of commodities, but the densely populated Northeast, with its concentration of heavy industries and various waterway shipping points, had a more diverse revenue stream. Local railroads catered to daily commuters, longer-distance passengers, express freight service and bulk freight service. These offerings provided transportation at shorter distances and resulted in less-predictable, higher-risk cash flow for the Northeast-based railroads.
Problems had been growing throughout the decade, as an increasing number of consumers and businesses began to favor, respectively, driving and trucking, using the newly constructed wide-lane highways. Short-distance transportation also involved more personnel hours (thus incurring higher labor costs), and strict government regulation restricted railroad companies' ability to adjust rates charged to shippers and passengers, making post-merger cost-cutting seemingly the only way to impact the bottom line positively. Of course, the resultant declines in service only exacerbated the loss of customers.
Penn Central presents a classic case of cost-cutting as "the only way out" in a constrained industry, but this was not the only factor contributing to its demise. Other problems included poor foresight and long-term planning on behalf of both companies' management and boards, overly optimistic expectations for positive changes after the merger, culture clash, territorialism and poor execution of plans to integrate the companies' differing processes and systems.
2.Quaker Oats and Snapple
Quaker Oats successfully managed the widely popular Gatorade drink and thought it could do the same with Snapple's popular bottled teas and juices. In 1994, despite warnings from Wall Street that the company was paying $1 billion too much, the company acquired Snapple for a purchase price of $1.7 billion. In addition to overpaying, management broke a fundamental law in mergers and acquisitions: Make sure you know how to run the company and bring specific value-added skills sets and expertise to the operation.
In just 27 months, Quaker Oats sold Snapple to a holding company for a mere $300 million, or a loss of $1.6 million for each day that the company owned Snapple. By the time the divestiture took place, Snapple had revenues of approximately $500 million, down from $700 million at the time that the acquisition took place.
Quaker Oats' management thought it could leverage its relationships with supermarkets and large retailers; however, about half of Snapple's sales came from smaller channels, such as convenience stores, gas stations, and related independent distributors. The acquiring management also fumbled on Snapple's advertising, and the differing cultures translated into a disastrous marketing campaign for Snapple that was championed by managers not attuned to its branding sensitivities. Snapple's previously popular advertisements became diluted with inappropriate marketing signals to customers.
While these challenges befuddled Quaker Oats, gargantuan rivals Coca-Cola (KO) and PepsiCo: PEP) launched a barrage of competing for new products that ate away at Snapple's positioning in the beverage market.
Oddly, there is a positive aspect to this flopped deal (as in most flopped deals): The acquirer was able to offset its capital gains elsewhere with losses generated from the bad transaction. In this case, Quaker Oats was able to recoup $250 million in capital gains taxes it paid on prior deals, thanks to losses from the Snapple acquisition. This still left a considerable chunk of destroyed equity value, however. (To learn how to offset capital gains at the individual level, read "Seek out Past Losses to Uncover Future Gains.")