Motivations that Triggers M&A Transactions – 1

Every company review its own resources before taking the decision of investment. In case a company has surplus value, it has the opportunity of making new investments. However, taking a decision of investment is not only related with the surplus value. Investments are generally driven by strategic planning of companies. For example, some companies would like to invest other companies to obtain the revenue leap that they have been missing for years. Others might want to invest in another industry to prove the world that they are able to success. On the other hand, another company may want to decrease its costs related with the supplier payments.

All in all, as people have different motivations while spending their money, so do the companies. In case you are one of those companies who are planning to invest, it is better to take into account those motivations with your strategies in order to improve your decision making processes.

Let’s have a look at the most common motivations together.

The most common motivation behind an M&A transaction is of course to obtain a growth. A company might obtain a growth either by “organic way” (with internal resources) or by “external resources” as merging with another company.

Sometimes, it would be hard for a company to continue its growth with its internal resources. Especially for those companies who are in a perfect completion markets, as times goes by it become harder to harder to keep their pace of growth. We should always remember that within perfect competition markets, windows of opportunity appear for a small portion of time and who ever touch it will going to keep it. In such conditions, shareholders might create the intended growth by acquiring another company. What makes this method useful is that instead of building a new web of customer portfolio or production facility, the acquirer can directly benefit from those already created by the acquired company.

World’s famous Johnson & Johnson had followed this approach between 1995 and 2016. Within these 20 years, it acquired more than 70 companies. After all those M&A deals, the company obtains approximately 200 subsidiary and becomes an economy of scale.

Another reason to follow this method can be to obtain geographical expansion. Many times, it might take too much time and effort for a company to develop proper sales and distribution chain in a country/region in which the company is newly established. The fastest possible solution might be the acquiring a company who has already resources that are meet with the expectations. 

Maybe at that point we should underline some problematic topics that might occur after a cross-country investments. Those problems can be arise from cultural, linguistic or geographical differences between the countries. For example, many of the Mediterranean countries enjoy relax siesta comparing the Northern European countries. Having expecting a focused working hours from those countries can be demoralizing.

Another example might be the business habits. German companies, for example, are used to have systematic business agreements with defined rights and obligations in written form. On the other hand, Turkish Businessmen appreciate interpersonal trust more than written agreements. Although this would allow dynamic and fast business relations, it might be also confusing for many of the Germany companies. Within this context, it is possible for a German and Turkish companies to have integration problems after any possible M&A transaction.

Let’s look at another important topic for German companies which create confusion when they acquire a Turkish company, economic situation. One of the chronic problem of the Turkish economy is hyperinflation and fluctuating f/x rates. In some cases, those factors hit financial statements so hard that German companies and their financial analysts have hard times to deal with the dramatic changes on the financial statements over time.

Synergy is more of a chemistry concept. Synergy is commonly defined as the effect of two or more substances working in combination that is greater than the expected additive effect of said substances. Actually, it is more or less the same in business terminology. Synergy is the point in which 2 + 2 makes 5. That is to say, it is the point in which two sides of the merger create greater value than their own potentials.

It might arise from two different way: a- By operational synergy, b- By financial synergy.

We are familiar with the operational synergy in general. When two company merge, they bring their own revenues that create revenue enlargement. Also, this transaction can create cost cutting effects. 

Pricing power occurs when two rival company agrees to merge. In case you can able to merge correct two rivals, you can have an oligopolistic market and obtain the pricing power. Of course although theoretically it seems easy, in real life, regulating authorities (e.g. Competition Authority) let your enthusiasm die. 

Nevertheless, interestingly researches proves that what makes synergy special is not pricing power but the positive effect on efficiency which can be called as cost-cutting effect.

Functional combination is the other operational synergy concept. What you should expect by functional combination is that merging parties are completing each other as if they are puzzle pieces. Pharmaceutical companies tend to search their targets with this motivation. 

For example, let’s say you have a huge pharmaceutical production facility with cutting edge technology. However, you have no R&D Department and that is why you can only produce mouthwash.  Thus, you prepare your budget and start to search for a company who has a qualified R&D department in Pharmaceutical Industry.

Let’s say you are operating in frozen food industry and losses of inventory during the transportation between locations leaves you in floods of tears. What might change the situation is to find and acquire a small logistics company that already has quite good refrigerated truck fleet. With the help of new family member, you can decrease the losses caused by logistic problems. Also think about the logistics cost. As you have your own logistics company, costs will also decrease.

General tendency of M&A Professionals towards operational synergy is to find cost-cutting items that will be arisen after transaction. Of course one of the main drivers of this tendency is to upgrade the company so that efficiency of the company increase and so cost per unit will decrease.

Production companies, especially the ones whose assets are crowded, might deal with huge costs per units in case the production volume is low. Depreciations, rental fees, maintenance costs and so might become nightmare. However, if you can acquire a company with well-organized distribution chain who generally sells you rival’s product, you can turn the table.  Now you have new customers, new backlog orders and your machines start to process relentlessly. Voila! As the cost per unit drops, you increase your profitability without a single dime price increase to your customers. 

Another cost-cutting synergy might arise when a merger happened between excellent combination two companies. Imagine that you are a company who is process aluminium profile, and you are consuming 30% of the aluminium profile that is produced by the market.  For the suppliers, you might be another headache customer since you are not so special with the amount you are buying. However, in case you can merge with a company who is ordering another 30% of the market, your market share become 60% and every single aluminium profile producer would wait your words to serve you. With this big demand power, now you can force your suppliers to drop the prices.

We have already written that the operational synergy is not the only synergy coming from M&A transactions. The other synergy that a company enjoy after an M&A transaction would be the financial synergy. What you should expect from financial synergy is to decrease the cost of capital. But how?

Financial institutions do not like companies with weak financial structure.  You should gain their trust by lovely financial statements and charming equity position. As a young talented software engineer, imagine that you establish a company for a new kind of software that can change the world forever. But in order to gain a seat within the market, you give long payment dues to your clients. But of course you are a newbie so your suppliers open a credit lines as extended as you are giving to your clients. As time goes by, your cash reserves start melt. You need a loan to pay your debts. But with little reputation and problematic cash flow of yours, either financial institutions implement short maturities with high interest rates, or they even laugh at your application. 

However, finding a company who is reputable in the industry with strong financial background to merge with you can reach appetising loans with nice maturities and low interest rates. As we all know, the words of reputable companies are more trustworthy and prevailing. Thereby it is easy for them to find useful loans that decrease the cost of capital. As a newbie, you can enjoy the financial synergy of this M&A transaction.

In our upcoming essay, you will going to read another two most common motivations that trigger an M&A transaction. Do not think that you have no appetize for an M&A transaction before reading that one. Maybe you have already motivated but you haven’t know it yet.