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 Fidelity Online Trading
Home > Tutorials
1. Stock Picking
2. Forex Mergers and Acquisitions: Definition
3. Options Trading
4. Credit Crisis
Topics Printer friendly version (PDF format)
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Dictionary Stocks.

Articles The Main Idea

One plus one makes three: this equation is the special alchemy of a merger or an acquisition. The key principle
Exam Prep a company is to create shareholder value over and above that of the sum of the two companies. Two companie
more valuable than two separate companies - at least, that's the reasoning behind M&A.
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Calculators This rationale is particularly alluring to companies when times are tough. Strong companies will act to buy othe
Free create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater
Newsletters to achieve greater efficiency. Because of these potential benefits, target companies will often agree to be purch
know they cannot survive alone.

Distinction between Mergers and Acquisitions

Although they are often uttered in the same breath and used as though they were synonymous, the terms merg
acquisition mean slightly different things.

When one company takes over another and clearly established itself as the new owner, the purchase is called
From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buye
continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forw
single new company rather than remain separately owned and operated. This kind of action is more precisely r
"merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For
Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler,

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another
the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it's tech
acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merge
and top managers try to make the takeover more palatable.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest
companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased -
regarded as an acquisition.
Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friend
how it is announced. In other words, the real difference lies in how the purchase is communicated to and receiv
company's board of directors, employees and shareholders.

Synergy
Synergy is the magic force that allows for enhanced cost efficiencies of the new business. Synergy takes the fo
enhancement and cost savings. By merging, the companies hope to benefit from the following:

• Staff reductions - As every employee knows, mergers tend to mean job losses. Consider all the mone
reducing the number of staff members from accounting, marketing and other departments. Job cuts w
the former CEO, who typically leaves with a compensation package.
• Economies of scale - Yes, size matters. Whether it's purchasing stationery or a new corporate IT syste
company placing the orders can save more on costs. Mergers also translate into improved purchasing
equipment or office supplies - when placing larger orders, companies have a greater ability to negotia
their suppliers.
• Acquiring new technology - To stay competitive, companies need to stay on top of technological deve
their business applications. By buying a smaller company with unique technologies, a large company
develop a competitive edge.
• Improved market reach and industry visibility - Companies buy companies to reach new markets and
and earnings. A merge may expand two companies' marketing and distribution, giving them new sales
merger can also improve a company's standing in the investment community: bigger firms often have
raising capital than smaller ones.

That said, achieving synergy is easier said than done - it is not automatically realized once two companies mer
ought to be economies of scale when two businesses are combined, but sometimes a merger does just the opp
cases, one and one add up to less than two.

Sadly, synergy opportunities may exist only in the minds of the corporate leaders and the deal makers. Where
to be created, the CEO and investment bankers - who have much to gain from a successful M&A deal - will try
an image of enhanced value. The market, however, eventually sees through this and penalizes the company b
discounted share price. We'll talk more about why M&A may fail in a later section of this tutorial.

Varieties of Mergers
From the perspective of business structures, there is a whole host of different mergers. Here are a few types, d
the relationship between the two companies that are merging:

• Horizontal merger - Two companies that are in direct competition and share the same product lines an
• Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merg
cream maker.
• Market-extension merger - Two companies that sell the same products in different markets.
• Product-extension merger - Two companies selling different but related products in the same market.
• Conglomeration - Two companies that have no common business areas.

There are two types of mergers that are distinguished by how the merger is financed. Each has certai
the companies involved and for investors:

• Purchase Mergers - As the name suggests, this kind of merger occurs when one company p
another. The purchase is made with cash or through the issue of some kind of debt instrume
taxable.

Acquiring companies often prefer this type of merger because it can provide them with a tax
 assets can be written-up to the actual purchase price, and the difference between the book v
the purchase price of the assets can depreciate annually, reducing taxes payable by the acq
We will discuss this further in part four of this tutorial.
• Consolidation Mergers - With this merger, a brand new company is formed and both compan
and combined under the new entity. The tax terms are the same as those of a purchase mer

Acquisitions
As you can see, an acquisition may be only slightly different from a merger. In fact, it may be different in name
mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhance
visibility. Unlike all mergers, all acquisitions involve one firm purchasing another - there is no exchange of stock
as a new company. Acquisitions are often congenial, and all parties feel satisfied with the deal. Other times, ac
more hostile.

In an acquisition, as in some of the merger deals we discuss above, a company can buy another company with
combination of the two. Another possibility, which is common in smaller deals, is for one company to acquire al
another company. Company X buys all of Company Y's assets for cash, which means that Company Y will hav
debt, if they had debt before). Of course, Company Y becomes merely a shell and will eventually liquidate or en
of business.

Another type of acquisition is a reverse merger, a deal that enables a private company to get publicly-listed in a
time period. A reverse merger occurs when a private company that has strong prospects and is eager to raise f
publicly-listed shell company, usually one with no business and limited assets. The private company reverse m
public company, and together they become an entirely new public corporation with tradable shares.

Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all mea
synergy that makes the value of the combined companies greater than the sum of the two parts. The success o
acquisition depends on whether this synergy is achieved.

Next: Mergers and Acquisitions: Valuation Matters

Table of Contents
1) Mergers and Acquisitions: Introduction
2) Mergers and Acquisitions: Definition
3) Mergers and Acquisitions: Valuation Matters
4) Mergers and Acquisitions: Doing The Deal
5) Mergers and Acquisitions: Break Ups
6) Mergers and Acquisitions: Why They Can Fail
7) Mergers and Acquisitions: Conclusion

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