49 Mergers and takeovers
3.2.2
Theme 3
Key points
1. Reasons for mergers and takeovers.
2. Distinction between mergers and takeovers.
3. Horizontal and vertical integration.
4. Financial risks and rewards.
5. Problems of rapid growth.
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Getting started
FT
In 2014, Swedish-based Spotify, the on-demand music
streaming service, bought The Echo Nest, a Massachusetts-based
music data firm, for a sum thought to be around $100 million.
Spotify bought The Echo Nest for its technology. The Echo Nest’s
core product is a database that stores the characteristics of
millions of songs. The data held by The Echo Nest can be used to
do things such as recognise and name songs by listening to them,
make music recommendations and generate playlists. Spotify
hoped to use this technology to drive its music discovery features
and help its partners to build new music experiences. Daniel Ek,
founder of Spotify, said in the press release, ‘We’ve been fans of
The Echo Nest for a really long time and honoured to have their
talented team join Spotify.’
uying a business is often cheaper than growing internally.
B
A business may calculate that the cost of internal growth is
£80 million. However, it might be possible to buy another
company for £55 million on the stock market. The process
of buying the company might inflate its price, but it could still
work out much cheaper.
Some businesses have cash available which they want to use.
Buying another business is one way of doing this.
Mergers take place for defensive reasons. A business might
buy another to consolidate its position in the market. Also, if a
firm can increase its size through merging, it may avoid being
the victim of a takeover itself.
businesses respond to economic changes. For example,
some businesses may have merged before the introduction of
the euro in 1999 in certain European countries or before the
expansion of the EU in 2004.
Merging with a business in a different country is one way
in which a business can gain entry into foreign markets. It
may also avoid restrictions that prevent it from locating in a
country or avoid paying tariffs on goods sold in that country.
The globalisation of markets has encouraged mergers
between foreign businesses. This could allow a company to
operate and sell worldwide, rather than in particular countries
or regions.
A business may want to gain economies of scale. Firms can
often lower their costs by joining with another firm.
Some firms are asset strippers. They buy a company, sell
off profitable parts, close down unprofitable sections and
perhaps integrate other activities into the existing business.
Some private equity companies have been accused of asset
stripping in recent years.
Management may want to increase the size of the company.
This is because the growth of the business is their main
objective.
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Sources: adapted from www.ft.com, www.spotify.com and
www.techcrunch.com
What do you think is meant by a takeover? Why has Spotify
bought The Echo Nest? Are there any alternatives to taking
over another business in order to grow? What problems might
businesses encounter when taking over another company?
D
Reasons for mergers and takeovers
Mergers and takeovers take place when firms join together and
operate as one organisation. Why do some businesses act in
this way?
●● One of the main motives for integration is to exploit the
synergies that might exist following a merger or takeover.
This means that two businesses joined together form an
organisation that is more powerful and efficient than the
two companies operating on their own. Synergy occurs
when the ‘the whole is greater than the sum of the parts’,
for example when 2 + 2 = 5. Synergies may arise from
economies of scale, the potential for asset stripping, the
reduction of risk through diversification or the potential for
gains by management.
●● It is a quick and easy way to expand the business. For
example, if a supermarket chain wanted to open another
twenty stores in the UK, it could find sites and build new
premises. A quicker way could be to buy a company that
already owns some stores and convert them.
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Distinction between mergers and
takeovers
Both mergers and takeovers are corporate strategies that aim
to improve the performance of a business. However, there is a
clear distinction between the two.
Merger: A merger is where two (or more) businesses join
together and operate as one. Mergers are usually conducted
with the agreement of both businesses. They are generally
Business decisions and strategy
‘friendly’ in nature. The name of the new business is often
formed out of the names of the two original businesses. For
example, one of the biggest mergers that was approved in
2014 was between Swiss-based cement producer Holcim
Ltd and French cement company Lafarge SA, forming
LafargeHolcim. It was widely reported that the new company
would be the world’s largest cement producer with annual
sales over $40 billion. The main reason for this merger was
to help cut costs and cope better with overcapacity and
weak demand.
Once it is known that a takeover is likely, investors scramble
to buy shares, anticipating a quick price rise. Sometimes more
than one firm might attempt to take over a company. This can
result in very sharp increases in the share price as the two
buyers bid up the price.
An example of a takeover in the UK in 2015 was the
purchase of mobile operator O2 by another mobile operator,
Three. It was reported that the cost of the takeover would be
£10.5 billion. The deal would make Three the biggest mobile
operator in the UK with around 32 million customers.
Figure 1 shows the number and value of mergers and
acquisitions in the UK from 1988 to 2013. For example, since
2003 the value of mergers and acquisitions rose sharply up
until 2007 and then fell sharply just after. The financial crisis
followed by the recession was probably responsible for the
rapid decline.
Takeover: A takeover, sometimes called an acquisition,
occurs when one business buys another. Takeovers among
public limited companies can occur because their shares are
traded openly and anyone can buy them. One business can
acquire another by buying 51 per cent of the shares. Some of
these can be bought on the stock market and others might be
bought directly from existing shareholders. When a takeover
is complete, the company that has been ‘bought’ loses its
identity and becomes part of the predator company. Private
limited companies, however, cannot be taken over unless the
majority shareholders ‘invite’ others to buy their shares.
In practice, a firm can take control of another company
by buying less than 51 per cent of the shares. This may
happen when share ownership is widely spread and little
communication takes place between shareholders. In
some cases a predator can take control of a company by
purchasing as little as 15 per cent of the total share issue.
Once a company has bought 3 per cent of another company
it must make a declaration to the stock market. This is a legal
requirement designed to ensure that the existing shareholders
are aware of the situation.
Takeovers of public limited companies often result in a
sudden increase in their share price. This is due to the volume
of buying by the predator and also speculation by investors.
Thinking bigger
R
A
FT
Takeovers can be hostile or friendly. A hostile takeover means that
the victim tries to resist the bid. Resistance is usually co-ordinated by
the board of directors. They attempt to persuade the shareholders that
their interests would be best protected if the company remains under
the control of the existing board of directors. Shareholders then have
to weigh up the advantages and disadvantages of a new ‘owner’. It
was reported in 2014 that a hostile takeover bid was made by the
pharmaceuticals company Pfizer for its UK rival AstraZeneca. The bid,
reported to be worth around £70 billion, was eventually rejected by
AstraZeneca. The board felt that AstraZeneca could get better returns
for the shareholders by remaining an independent company.
Figure 1
A takeover may be invited. A firm might be struggling because it has
cash-flow problems, for example. It might want the current business
activity to continue, but under the control of another, stronger company.
The new company would inject some cash in exchange for control. Such
a company is sometimes referred to as a ‘white knight’.
Source: adapted from www.ft.com
D
Announced mergers and acquisitions in the UK 1988–2013
Number of transactions
Value of transactions (inbil.USD)
1,000
6.000
900
800
700
Key
5.000
Number
Value
4.000
600
500
3.000
400
2.000
300
200
1.000
Source: www.imaa-institute.org
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
100
1988
0
0
Year
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