Last week I discussed foreign direct investment and how that can benefit the company and inevitably the shareholders. But this week is centred around companies merging together or a company acquiring a company. Mergers and acquisitions (M&As).
So what’s the difference between a merger and an acquisition? Well the difference isn’t clear in the business world as sometimes it can be called a merger when really a company is taking over another or vice versa. But the simple way to think of a merger is two companies agreeing to combine into one. And an acquisition is a company buying another. For the purpose of this blog we can use merger and acquisition interchangeably.
There are several different types of M&As all of which have recent news stories to give real context to the theory. Firstly there is a horizontal merger, this can be seen in the recent news surrounding the two mining and commodity giants Glencore and Xstrata who are companies in similar lines of activities, which I will discuss in detail later. Another type of merger is the vertical merger, which means buying up parts of the supply and production chain, Greggs is a good example of this, they own the bakeries that supply their retail stores. The advantages being it can reduce costs for Greggs, it also allows greater degrees of product control and faster product alterations, which should give Greggs a competitive advantage over other rival retailers, boosting shareholder wealth. The final type of merger is when a conglomerate is formed, where the two companies are unrelated in their activity but see some commercial gains in merging.
The deal between Glencore and Xstrata hasn’t gone through yet but they would form a giant $90billion company that would have huge power in the commodity and mining markets.
So what are the main benefits for the companies and their shareholders? Well the companies sell a lot of their products such as copper, zinc and aluminium to China for manufacturing purposes. Merging creates less competition in the market which allows prices to rise, and if they charge more money, they make more money! The idea of synergy is also key when discussing a merger of this size, the shareholders and managers should be expecting the combination of the two sets of assets to produce “gains” which is extra value from the same asset base. Other synergy benefits would possibly include tax bill reductions (which have been discussed in one of my previous blogs). The economies of scales the two companies could benefit from could be immense, by sharing suppliers they could negotiate even larger discounts, which would be eye watering for the supplier but would decrease costs for Glencore and Xstrata. Other than the obvious economical reasons for the merger, why else would the executives make this move? Business men like large businesses and want to be the biggest and the best! The idea of empire building is a reality, fuelled with a dangerous mix of status, hubris and power struggles of the top executives and if the opportunity arises to combine to make the world’s largest company, do you think the power hungry execs could turn it down?
Is this merger really going to be the perfect synergy, or will it all end in tears? No matter how rose tinted your glasses are, you must realise that this merger won’t be as simple as plugging the two companies together and value will instantly be created. The steps involved in merging are huge and ridiculously expensive, a company will have to broker the deal and they will be taking between 2-5% of the deal which is over $4billion. Which is $4billion instantly wiped off shareholder value. The ability for the two management teams to fuse together is critical to the mergers success, if they don’t resolve cultural, dominance and personal differences at the top of the firm it will quickly destroy the merger as they management will tear the companies apart from the inside. There is also the question as to whether anyone other than the management and shareholder benefit from this deal? If the merger happens successfully, I’m sure the executives will be very happy with their increased salaries and bonuses and the shareholders will be very happy with an increase in dividends and share prices, but what about the rest of the stakeholders? Will society actually benefit from this? As consumers would a company with the ability to control commodity prices be good? Probably not, because any increase in price will be passed on directly to us. As a driver for the company, would you be pleased when they manage to reduce transportation costs by 10% causing you to lose your job? Probably not. As a supplier would you be pleased when Glenstrata knock on the door demanding a 20% drop in price? Probably not. M&As can be great for shareholders and executives but do the largest really help anyone other than the select few?
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