Mergers and Acquisitions: A beneficial deal or one step towards collapsing?

Mergers and Acquisitions: A beneficial deal or one step towards collapsing?

Mergers and Acquisitions (M&A) play a crucial role in the financial system. Although evidence oppose, as historic data have shown that returns tend to decrease after the merger, companies continue to engage to this kind of activity. In this blog, we are going to discuss about the reasons behind mergers and some issues that appear during the process. Afterwards, two examples will be given, one about a successful M&A and one that ended up as a disaster.

In 2016 the M&A activity reached a value of 3.6 trillion dollars. The main wave of deals derived from China, which completed mergers with both American and European-based firms. These deals engaged despite the geopolitical events that stunned the whole planet; UK’s vote to leave the European Union and Trump’s election in the U.S. .Moreover analyst predicted that this year the M&A market will continue the same trend.

But why are companies so keen to achieve such deals regardless the uncertainty and the obstacles set by the governments?

To begin with, a horizontal merger can lead to a significant increase in the market share. Companies tend to create greater distribution network. In more detail, monopolies can be enforced by M&A activity, thus avoiding problems such as dealing with suppliers and customers with bargaining power. Furthermore, conglomerates can enhance the diversification, mitigating the risk of defaulting .However, journals have underlined that during a financial crisis merger activity should focus on the domestic market and to be more precise on firms which operate in a similar industrial sector. Another potential benefit from M&A activity is the increase in operational performance. Firms can not only diminish managerial inefficiencies through mergers but also gain access to expanded research and development opportunities. Consequently, increased capabilities will provide the company with a competitive advantage. Lastly, the significance of reducing costs through a merger must be pointed out .In more detail, in some industries where economies of scale exist, which means that as sales’ volume increases the product cost decreases, profits can be maximized after an M&A.

Nevertheless, M&A do not always have a positive effect due to multiple factors. Firstly, it is quite common that the managers do not value the companies in a proper way. There is a variety of valuation models such as income based, net asset and stock market valuation , which can give an estimate on the company’s value, only if used in the correct environment. Moreover, CEOs can be the proximate cause of failed mergers. Glory seekers managers, who want to see their face in the cover of some magazines and get a big cheque with their name written on it, form a major force that contributes to rushed decisions regarding M&A.

For the acquisition of Pixar from Disney that was not the case though. When Disney bought Pixar, in 2006, for 7.4 billion dollars most analysts questioned the potential outcomes of this deal. However, looking back now we can see that this was one well executed deal. Disney did benefit from acquiring the world’s most innovative animation studio while Pixar took advantage of Disney’s financial safety. Two completely different cultures managed to be united contributing to the abrupt rise of the stock price. Lastly, this merge increased Disney’s market power, since not only its resources were extended but also since Disney gained the rights over the use of Pixar’s characters

On the other hand, a detrimental case of merger was the one between Lloyds and HBOS.  HBOS had been considered for many years the most vulnerable lender since it had a gap of 198 billion pounds between liabilities and deposits. Thus, in 2008 when Lehman Brothers collapsed it was the first bank in the chain of banks defaulting that needed to be bailed out. Lloyds bought HBOS at a discount (8 billion pounds) to its book value, which was estimated at 19 billion pounds. However, the risks lurking in the balance sheets of HBOS were not carefully analyzed causing Lloyds to lose over £53 billion in three years’ time. Months after HBOS deal Lloyds had to be bailed out by the government with 20 billion pounds due to HBOS toxic loans. In addition, due to the extent of the deal, this merger needed approval by the shareholders. However, it is stated that the information regarding this deal was not properly disclosed in the meeting. Over 8000 investors have sued Lloyds claiming it misled them.

Concluding, my personal opinion is that cooperation between companies can create positive synergies and lead to great benefits. Nevertheless, as it can also have detrimental effects it should be carefully examined and mutually accepted in order to be successful.

Until next time stay safe.