If you follow the news, you’ve probably heard the words “mergers” and “acquisitions” thrown around quite a bit lately. This is especially true if you’ve been following this year’s news, because mergers have happened at a record pace in the first half of 2018. In fact, Anil Chaturvedi, who has worked as an investment banking executive for several decades, said there’s never been a year like 2018 in terms of mergers and acquisitions. This year, AOL and Yahoo have merged, Time Warner and AT&T became one, and—as of this writing—Disney is working on closing a deal to buy part of Fox. Many more have merged and many more deals are in the works.
To be sure, it’s been a crazy year for mergers and acquisitions, but if you don’t have years of experience in this field, like Anil Chaturvedi, you may have a few questions. For example, why do companies merge or acquire each other? How does it happen? Why are investment bankers involved; what role do they play?
In this article, with the help of Anil Chaturvedi’s years of experience in the investment banking industry, we’ll answer all your questions (and more) about mergers and acquisitions.
Why do Companies Merge or Acquire?
The most simple answer for why companies merge is that the companies involved want to create more value for their shareholders, and a merger or acquisition is the best way for them to do that. The merge may create value in a variety of ways, but the important thing to remember is that whether the company is merging with another one, or purchasing it, the goal is always to create more value and more wealth. This makes sense, as no company will do a deal or make an investment that doesn’t somehow make them and/or their investors richer.
While creating wealth is always the primary reason, there are multiple ways that a merger can help generate more wealth. Therefore, there are multiple reasons that one company or another may pursue a merger or acquisition. A few of those reasons are as follows:
1. Lower Supply Costs
Just about every company has a supply chain and a distribution network. Take Apple for example. Apple works with several companies to deliver their products to the end consumer. Analog Devices, Inc. provides Apple with touchscreen controllers needed for Apple’s iPhone and watch. Qualcomm Inc. provides semiconductors and several different types of electronic parts for Apple.
Other Apple suppliers include Samsung, STMicroelectronics, Nidec Corp., and many more. Each of these companies provides supplies to Apple and charges Apple a certain margin on the sales of those supplies. If Apple were to buy out one of its suppliers, Apple wouldn’t have to pay that margin anymore; they’d get the parts at cost. The same thing can happen with distributors; if a company buys out its distributor, it may be able to ship products more cost effectively.
2. Mitigating Risk Through Diversification, Eliminating Competition
Whether Anil Chaturvedi is advising a wealthy individual or a large corporation on their investment choices, a key consideration is always diversification. And that’s one of the reasons many companies choose to merge. For example, Facebook may want to merge with a startup that provides photo sharing capabilities, like Instagram, to eliminate the risk that Instagram has an impact on Facebook’s profitability. In fact, Facebook bought out Instagram for $1 billion in 2012.
3. Increase Market Share
If you pay attention to mergers, you may notice that they often involve at least one large company. The reason for this is that, generally, very large companies are more mature and once a company has reached maturity, it becomes more difficult to increase market share. One way that large, mature companies can grow is through mergers.
4. Better Performance at Lower Cost
Whenever you hear of two or more companies merging, you’re bound to hear the word, “synergy.” And while veteran banking executives like Anil Chaturvedi have seen this term abused and misused, it’s still very relevant for mergers and acquisitions. In just about any merger, the two companies that are joining together do so—at least in part—to combine their complementary competitive advantages.
Moreover, every company needs their own accounting, marketing, and payroll team. However, when two companies merge, there’s no need for two of these teams, so many employees are rendered redundant. And while this is unpleasant for the employees that get let go, it saves a lot of money for the companies involved without losing any productivity.
What Role Do Investment Bankers Play in Mergers and Acquisitions?
On the Buy Side
Over the years, as world markets have become increasingly globalized, investment bankers like Anil Chaturvedi have become even more valuable to companies looking to engage in mergers and acquisitions. Large companies are always looking for ways to grow or become more efficient, and mergers and acquisitions allow them to do that.
However, finding the right companies to target, determining the right price to buy them for, structuring the deal, and sourcing the funds to finance the deal are all complicated, but extremely important tasks. Most—if not all—companies have neither the expertise nor experience to handle all those tasks, so they work with investment bankers.
Companies that want to buy another company use an investment banker for buyer representation. Buyers will usually have a harder time finding a target company to buy because most companies are not ready to sell.
On the Sell Side
From an investment banker’s perspective, being approached by a company that wants to sell is much more attractive. When an investment banker represents a seller, he or she is doing many of the same things as they would be if they were representing a buyer. The only difference is that investment bankers representing sellers are looking for potential buyers.
Valuation and Advisory Services
Regardless of the type of client that an investment banker like Anil Chaturvedi is representing, the duties are fairly similar. One of the most critical things that investment bankers do is to figure out how much a business is worth. Whether a company is looking to buy or sell, this is a very important service. For the company looking for another firm to buy, an investment banker’s valuation service helps that company identify good deals.
This is critical because, while a certain company may be a very attractive target for an acquiring company, if the price is too high to justify the potential value of the new, merged company, the deal won’t work. Similarly, companies that are looking to sell want to capture the highest sales price possible. An investment banker can provide valuations that make the case for the selling company’s sales price.
Moreover, seasoned investment bankers like Anil Chaturvedi understand other market dynamics that may give their clients more leverage. In this way, an investment banker can help their client demand (and receive) a higher sales prices than they could on their own.
Most investment bankers don’t sit back and wait for clients to walk in their door. Instead, they closely follow the market and research potential mergers and acquisitions. Then, they approach companies that, based on their research, will benefit from a certain merger or acquisition. Investment bankers can approach companies in a variety of ways.
For example, they might approach two companies that would mutually benefit from a merger. Or, they might approach a seller who may benefit from executing a sale. In any case, as experts on mergers and acquisitions, the investment banker will approach a company (or companies) with their ideas about potential deals. Investment bankers do this, and often make deals by doing so, because large companies are often not aware of potentially lucrative mergers and/or acquisitions.
Financing the Deal
As mentioned earlier, mergers and acquisitions often involve large companies, which means they often involve huge sums of money. Even if the acquiring company has the financial wherewithal to acquire another company, they may not have the cash on hand to make the purchase.
In this scenario, an investment banker like Anil Chaturvedi is indispensable. The investment banker may offer new securities to the market, whether its debt or equity, to raise funds for the acquiring company to make the deal.
Structuring the Deal
Something most people who aren’t investment bankers don’t really think about is the structure of mergers and acquisitions. However, for any acquisition or merger, the structure of the deal is extremely important. Investment bankers and their clients have to consider the impact of financing, regulations, taxes, accounting rules, market dynamics, and more.
Things you might not think about, like what’s going to happen to the target company’s management team, can derail a deal, so they’re vital to consider. After all, when one company takes over another, they’re not going to have two CEOs. The target company’s CEO may want assurance that he or she will have a job when the deal is done. Or, as often happens, he or she may want a generous severance package.
Either way, the point is that there are tons of seemingly small details that must be worked out in the structure of the deal for a merger or acquisition to actually happen.
How Do Mergers and Acquisitions Work?
So far we’ve covered most of the activity involved in a merger and acquisition before any offers, cash, or stock changes hands. In reality, the work done before offers are made is just as—if not more—important than the work that’s done to make the deal happen. The stuff that grabs headlines, though, is when the gears of the deal start to set in motion.
Once all the due diligence is done, the acquiring company will buy the target company in one of two ways. They will either purchase all the target company’s outstanding shares or they will purchase a portion of the target company’s assets.
When the acquirer wants to purchase all the outstanding shares, they will issue what’s called a “tender offer.”
The tender offer will consist of a proposal to purchase the stock of the target company. The proposal will include the price that the acquirer is willing to pay for the target; this payment may be in the form of cash, stock, or a combination of both.
The acquirer makes this offer to the shareholders of the target company and the shareholders must decide whether to reject or accept the offer. Obviously, price and the terms of payment are extremely important to the target company, which is why an investment banker like Anil Chaturvedi is so valuable to the acquiring company. In some cases, a tender offer is made before the acquiring company attempts a hostile takeover. However, tender offers can also lead to cooperative mergers between the two firms.
After the offer is made and communicated to shareholders, the target company can accept, deny, try to negotiate, find another buyer, or execute what’s called a “poison pill scheme.”
As you might expect, the market conditions and the state of the target company play a role in how they react to a tender offer.
While a share purchase gives the acquiring company full control of the target company, an asset purchase does not. That’s because, in an asset purchase, the acquiring company will only purchase certain parts of the target company. For example, a company that sells printers may want to buy just the distribution centers of another company. In this example, the target company would retain ownership of its stock and any other assets it has and just sells off its distribution centers.
In fact, Uber did this type of sale when it sold its operations in China to the Chinese firm, Didi Chuxing. Companies often do this sort of thing to get out of ventures that are losing money or to redirect their focus and investment to other units within the company.
Mergers and acquisitions often happen across international borders, which can complicate things. This is also a reason that investment bankers with international experience, like Anil Chaturvedi, are instrumental in facilitating these types of transactions. In the United States, for example, most transactions that are proposed are reviewed by the Federal Trade Commission (FTC) and the Department of Justice.
In this review, the transacting parties wait for the preliminary review before they close the deal. According to the FTC’s website, depending on what the agency finds during a review, it can do one of three things:
- End the waiting period, allowing the deal to proceed.
- Allow the waiting period to end, again allowing the deal to proceed.
- Extend the time period for the review for more time to review information about the transaction.
Ultimately, the FTC has final say over whether the deal can proceed. However, if the FTC wants to block the deal, they have to take legal action. For the most part, though, the FTC allows deals to go through.
As you might imagine, when multiple regulatory authorities from different countries are involved—which is often the case—regulatory approval may slow down the deal considerably. This is especially true in the case of especially large companies because regulators are generally very concerned about preventing anticompetitive behavior.
One such example of a recent merger that has required extensive regulatory approval is the Time Warner and AT&T deal. In fact, earlier this month, the Department of Justice filed an appeal of a federal judge’s decision to let the deal go through on the grounds that Time Warner would have anti competitive bargaining power over TV distributors.
In essence, what the DOJ is worried about is that the merged companies will have an unfair advantage over other companies like Comcast and Dish. As you can see, in complicated deals such as this, the regulatory process can be dragged out significantly. AT&T and Time Warner actually got approval, yet even after that they had additional hurdles to get over.
Many Ways to Go Wrong and a Few to Go Right
As you can see from this primer on mergers and acquisitions, making these deals is no walk in the park. From sourcing deals, raising funds, conducting due diligence to making an offer, negotiating, and jumping through regulatory hoops, it’s virtually a gauntlet of things that could go wrong. However, as mentioned earlier, there are precious few ways for a mature company to grow more efficiently than through mergers and acquisitions.
After all, mature companies are generally large and they usually have lots of free cash flow. Mergers make sense for them because instead of investing tons of money into an uncertain outcome, they can buy a smaller company that has already taken the risk. Of course, the acquiring company might have to pay a premium, but there’s a lot of value in purchasing a known quantity rather than taking the risk yourself, especially as a large public company with lots of shareholders to please.
Still, even a simple deal is no easy task. Fortunately for corporations, there are investment bankers who do much of the legwork for them. And since these mergers and acquisitions can result in significantly more profitable companies, successful investment bankers like Anil Chaturvedi are very valuable to their clients.
Want more from Anil Chaturvedi? Read our last article here.