Why Do Companies Merge With or Acquire Other Companies?

Mergers and acquisitions (M&A) describe the consolidation of companies or assets. M&A can include a number of different transactions that are often in the pursuit of synergy, diversification, growth, competitive advantage, or to influence the supply chain.

A merger occurs when two companies combine when both companies' boards of directors have secured shareholder approval. After the merger, the acquired company ceases to exist and becomes part of the acquiring company. In January 2018, Keurig Dr. Pepper announced it would combine Dr. Pepper, 7UP, Snapple, A&W, and Sunkist with Keurig's franchise of single-serve coffee pods including Green Mountain Coffee Roasters and The Original Donut Shop brands.

An acquisition takes place when the acquiring company obtains a majority stake in the target firm, which does not change its name or legal structure. In 2017, Amazon acquired Whole Foods.

A consolidation creates a new company entirely. The stockholders of both companies approve the consolidation and receive common equity shares in the new firm. Harris Corp. and L3 Technologies Inc. announced a merger in 2018 to create a new L3 Harris Technologies Inc., which will be the nation’s sixth-largest defense contractor.

For a tender offer, one company offers to purchase the outstanding stock of the target firm at a specific price. In this case, the acquiring company bypasses the management and board of directors of the target to deliver the offer directly to the other company's shareholders. Qualcomm announced it would repurchase $10 billion of its shares in 2018 after a failed merger with Dutch semiconductor firm NXP.

The acquisition of assets occurs when one company acquires the assets of another company following the approval of the target's shareholders. This type of event often occurs in cases of bankruptcy where other companies bid for various assets of the liquidating company.

In a management acquisition, also known as a management-led buyout (MBO), company executives of a company buy a controlling stake in a company making it private. Often, these former executives partner with a financier to fund a transaction. The majority of shareholders must approve the management acquisition.

Some of the reasons why companies merge with or acquire other companies include:

1. Synergies: By combining business activities, performance will increase and costs will decrease due to business synergies between the two entities. Essentially, a business will attempt to merge with another business that has complementary strengths and weaknesses.

2. Diversification / Sharpening Business Focus: These two conflicting goals have been used to describe thousands of M&A transactions. A company that merges to diversify may acquire another company in a seemingly unrelated industry to reduce the impact of a particular industry's performance on its profitability. Companies seeking to sharpen their focus often merge with companies that have deeper market penetration in a key area of operations.

3. Growth: Mergers can give the acquiring company an opportunity to grow market share without having to really earn it by doing the work themselves—instead, they buy a competitor's business for a price. Usually, these are called horizontal mergers. For example, a beer company may choose to buy out a smaller competing brewery enabling the smaller company to make more beer and sell more to its brand-loyal customers.

4. Increase Supply-chain Pricing Power: By buying out one of its suppliers or one of the distributors, a business can eliminate a level of costs. If a company buys out one of its suppliers, it is able to save on the margins that the supplier was previously adding to its costs; this is known as a vertical merger. If a company buys out a distributor, it may be able to ship its products at a lower cost.

5. Eliminate Competition: Many M&A deals allow the acquirer to eliminate future competition and gain a larger market share in its product's market. The downside of this is that a large premium is usually required to convince the target company's shareholders to accept the offer. It is not uncommon for the acquiring company's shareholders to sell their shares and push the price lower in response to the company paying too much for the target company.