Economics and Finance
Rationales for Mergers and Takeovers

Mergers and takeovers are both frequently used method to expand a company or to carry out intended corporate restructuring activities. There are many rationales for corporate restructuring activates to be executed. However, among these rationales, controversial and contradicting debates are abundant on which the reasons provided for mergers and acquisitions are grounded (Bogan & Just, 2009).

Economies of scale. Often, one of the most easily understood rationale for merger or acquisition is to achieve substantial economies of scale between the two companies. The two merged companies can share a same production line or manufacturing plant, and substantial cost benefits can be achieved from such a strategic move. Many advantages can be reaped from combining two similar operations, where the cost savings is the biggest advantageous factors.

Synergy. By merging two related companies in an industry or similar industry, both the firms can potentially enjoy synergistic effects from the combined operation. For example, the two companies in the related industry can share the many operation costs from finance, marketing and human resources department. Sometimes, if the two firms are closely located in the value chain, the operational efficiency and effectiveness can be furthered enhanced. Apart from that, very often, the combined firm can cross-sell the other companies products to their existing clients. Overall, instead of 1+1 = 2, the merged firms can achieve an enhanced of value and profitability form a merger deal if the combined firm exhibit the impacts of 1+1 > 2 effects (Brigham & Houston, 2004).

Industry consolidation. In many of the industry, where the market is saturated and the competition among rivalries are intense, merger and acquisition in the industry for consolidation purposes may be a valid reason. After the wave of merger and acquisition, the weaker players may be acquired or merged and the remaining companies able to enjoy high profit margin or greater cost savings (Meigs, Haka, and Bettner , 1999).

Purchase of undervalued assets. Sometimes, a particular firm can be acquired because it is undervalued. The acquirer may simply buy over the undervalued company and to realize the value in the underlying company (Meigs, Haka, and Bettner , 1999).

Purchase of assets below their replacement costs. Sometimes, the bigger companies will also acquire the smaller company in a particular industry because the bigger company believes that the purchase price of the smaller company is justifiable and beneficial, primarily because the purchase price of the assets is below their replacement costs. The acquirer company can then access to the cheaper assets available in the target company.

Diversification. A company may also involve in a merger or acquisition deal because the management wish to diversify the business activities of the organization. The diversification strategy can takes many forms – among them, vertical diversification, horizontal diversification and unrelated diversification. Some experts argued that this is not a valid reason for mergers or acquisition, because the shareholders will be able to diversify with cheaper costs. However, from the management perspective, the managers may believe that a more diversified business base will smoothen the revenue or profitability of the combined firm, or to enlarge the corporate presence in an industry, or simply to increase the company reputation and brand name in the marketplace. Sometimes, in a low growth industry, a company may also diversify into brighter prospect industry to enhance the growth rate of the firm (Brigham & Houston, 2004).

Eliminate inefficiencies. A management may also become motivated to acquire another firm because he believe that the target company is not effectively or efficiently managed, and he believe the acquirer company has the human capital or the relevant skills and experiences in bringing the target firm to greater heights. Thus, the acquirer may just buy over the target firm, fire the existing management team in the target company and place its management team to control and manage the target company. If the many inefficiencies in the target firm is easily manageable and turnaround, there are potentially huge profit to be reaped for the acquirer (Bogan & Just, 2009).

Enlarge the size of balance sheet. Sometimes, two firms may be motivated to merge together because they would like to enlarge the company size or balance sheet. For example, two construction companies may not have the relevant size to bid for an attractive government project, but the combined firm will qualify them to do so (Bogan & Just, 2009).

Tap into larger market shares. Cross nation mergers or acquisition is nothing new since the last decades. As the globalization effects kick in, many ambitious firms are looking at opportunities at oversea. To growth into the foreign countries, one of the best and fastest methods is to acquire or merge with the foreign target company. With this, the acquirer can instantly tap into the market at the foreign nation – and can be beneficial significantly as the company now has larger and deeper access to a new market. If this is done properly, the revenue of net income of the acquirer may increase in a very fast pace.



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