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Mergers and acquisitions are arguably the bedrock of corporate transactions and movements in the business world.

Some of the largest conglomerates and companies in the world were born out of mergers or acquisitions, from AT&T Inc. (T - Get Report) and Time Warner, Inc. in 2016 to Anheuser-Busch InBev (BUD) and SABMiller in 2015. 

Boiled down to the basics, M&A is employed when two companies are looking to combine into one or when a larger company seeks to control a smaller one. But, what actually are mergers and acquisitions, and what are the different types of M&A? 

Mergers and Acquisitions Definitions

Mergers and acquisitions (or M&A) are transactions of changing ownership between two companies, wherein a merger is a combining of two companies and an acquisition is one company buying another. The end-goal of M&A is to create synergy, which essentially makes the two combined companies worth more or more valuable than the two separate companies. 

Mergers

Two companies can initiate a merger by having the board of directors approve and seek shareholders' approval for the combination of the two separate companies into one company. 

In general, both companies are typically of comparable size, and the two merge into one company, often creating an entirely new company. 

Acquisitions

An acquisition occurs when one company "targets" another company, generally called the target company, and typically obtains a controlling interest in that company. The target company usually ceases to exist once it has been acquired, and there are several ways which a target company can be acquired - both through hostile and friendly takeovers. 

Management Acquisition

A management acquisition, also called a management-led buyout (MBO), is an acquisition that occurs when the executives of one company buy a controlling interest in another company and take it private. The executives in MBOs typically get backed by financial institutions and often leverage the acquisition with a lot of debt - plus, a majority of shareholders must approve the acquisition. 

One big example of a management-led buyout is in 2013 when Michael Dell, the company's chief executive manager, acquired Dell Corporation (DELL) . 

Consolidation 

A consolidation is a transaction where two companies form an entirely new company. The consolidation must be approved by the shareholders of both of the companies involved, who are all offered common equity in the new company. 

Consolidations generally occur between two smaller companies to create a larger one. For example, Citicorp and Traveler's Insurance Group consolidated in 1998 into Citigroup (C - Get Report) . 

Tender Offer

A tender offer is when a company reaches out directly to a company's shareholders and offers to buy the outstanding shares of that company at a certain price. A tender offer is a slightly more unusual form of M&A given that it bypasses executives or upper management when making an offer. 

Acquisition of Assets 

Often occurring during bankruptcy proceedings, an acquisition of assets is when one company acquires the assets of another company, who in turn must get shareholder approval to give up their assets. 

In a bankruptcy situation, it is common for several companies to bid to purchase the assets of the company going bankrupt before that company is liquidated. 

What's the Difference Between Mergers and Acquisitions? 

While the two terms are often used in tandem (or even as substitutes), a merger is the combining of two usually similar-sized companies together to create a new company, while an acquisition is when a company (usually a larger one) acquires or takes control of another company (usually a smaller one). In a merger, both companies hypothetically have equal partnership and control of the new company, while in an acquisition, one company takes control of another. 

Mergers and acquisitions tend to have different connotations in terms of both the scale and consent of the companies involved.

Mergers are generally the combination of equals (or companies of relatively comparable size) into a new company altogether. However, acquisitions are generally initiated by a larger company acquiring a smaller company, which then ceases to exist. Additionally, in some acquisitions, the target company (the one being acquired) may not wish to be acquired. In cases like these, the acquisition is considered a "hostile takeover" - and the company acquiring the other bypasses the company itself and appeals straight to the target company's shareholders. On the other hand, mergers are generally mutually beneficial and consented to by both companies. 

Synergy in Mergers and Acquisitions

Synergy is a key motivator for most M&A deals, and essentially translates to the increased efficiency and revenues resulting from two companies merging together. In other words, either through cost cutting or increasing profits, the two companies together will be worth more or generate more profits than they would separately. 

Synergy, or the predicted financial benefit of merging two companies together, is one of the main factors companies examine when considering an M&A transaction - and it can have several implications.

When two companies consider merging, one of the main benefits of synergy is cutting costs through things like reduced labor force - or, job cuts. While it may be to the employee's chagrin, cutting jobs can save companies huge amounts of money and increase efficiency by eliminating unnecessary positions - which sometimes even include the CEO. 

Additionally, the creation of a new company from two separate companies also entails a wider market base and audience, and consequently, grow sales. By acquiring or merging with a company in a different or wider market, a company can reach further market penetration and increase their visibility.

And by combining forces, companies can also help develop new technology. By acquiring a company building or developing new or unique technology, a company can help stay competitive in a variety of fields through M&A. 

But, while the motivations behind M&A may be similar, what are the types of mergers and acquisitions? 

Types of Mergers and Acquisitions

There are several different types of M&A with different objectives. 

Horizontal Mergers

In horizontal mergers, both companies involved typically sell or produce similar products and services and are in the same industry. The two companies might be competitors, and therefore the objective of horizontal mergers is generally to get rid of competition and increase the company's market share or profits so they don't have to directly compete. 

For this reason, horizontal mergers typically benefit economics of scale because they generally help decrease the cost of production. 

Vertical Mergers 

On the other hand, a vertical merger is when two companies that are in the same industry along different stages of the supply chain for the same product merge together. For instance, a vertical merger could occur between a Tupperware-type company and a plastics manufacturer, where both companies contribute to the same product on the same supply chain.

Vertical mergers are key in helping companies cut costs and inefficiencies by keeping the flow of supply steady and cutting down on extra expenses. 

Concentric Mergers

While vertical mergers are between companies on different stages of supply, concentric mergers are between two companies in the same industry at the same level of production, but with slightly different products that are often complements to one another. Concentric mergers occur between two companies that serve the same customer base but provide different, or even complementary, products.

Conglomerate Mergers

A conglomerate merger is one between two companies in completely different industries into one company. The two companies generally service different business areas and markets.

Leveraged Buyout

A leveraged buyout (LBO) occurs when management or another company uses debt, mostly in the form of borrowed funds or outside capital, to finance an acquisition of another company - typically using 90% debt and 10% equity. Because of the high ratio of debt, the bonds in these transactions are often deemed "junk bonds," and LBOs are often used to take public companies private or spin off part of the company by selling it. 

Hostile vs. Friendly Takeovers

In general, acquisitions come in two forms - hostile and friendly takeovers. 

In a hostile takeover, as the name suggests, the target company being acquired doesn't want to be acquired - or, namely, the board of directors do not approve the acquisition. In this kind of takeover, the company doing the acquiring appeals straight to the shareholders of the target company and not the board of directors or executives. If the shareholders approve the acquisition, the target company may be acquired by the acquiring company without the consent of upper management. Often, a hostile takeover is facilitated by a tender offer or a proxy fight - the latter of which is a strategy that appeals to the target company's shareholder's proxy votes in order to pass the acquisition.

A friendly takeover is one where the target company's board of directors approves the acquisition. 

Valuation

Valuation is a key component of all M&A deals and helps determine the right price of the target company (or, the company getting acquired or merged with). Valuation will obviously be different for each company, but there are several factors companies use to help determine the value appropriate for any given M&A transaction. 

Most companies will use similar companies in the industry to help determine the multiple they will pay for the target company, but there are also a myriad of other factors and tools companies use to find just the right price for their M&A deal. 

Price-to-Earnings Ratio (P/E ratio) 

One of the biggest components to determining a company's value is the price-to-earnings ratio, or P/E ratio.

The P/E ratio is simply the current price of the company's shares divided by the annual earnings per share. In M&A, a company will typically look at some multiple of the target company's P/E ratio and will often compare it to P/E ratios of similar companies within the same industry. This comparison can help the company decide what multiple to put on the P/E ratio of the target company. 

Discounted Cash Flow

In addition to the P/E ratio, companies also examine the target company's discounted cash flow - which determines a company's current value by way of their future (estimated) cash flows. 

The discounted cash flow (DCF) helps companies determine what multiple it should use for the target company by examining the target company's free cash flows and discounting them with the company's weighted average costs of capital (WACC), which gives it the present value

Essentially, by using equations, companies discount the future free cash flows of a company by a certain value every year to help determine its present value. 

Enterprise-Value-to-Sales Ratio (EV/sales)

With an enterprise-value-to-sales ratio, or EV/sales ratio, the company doing the acquiring looks at the target company's revenues to find the multiple it should pay for it, while also looking at the price-to-sales ratio of other similar companies in the same industry. 

Pre-merger Stock Price

The pre-merger stock price of a target company is a method used to determine the synergy needed for a company to merge with another. The pre-merger stock price can be found by the following equation: 

Pre-merger stock price equals the pre-merger value of both firms plus synergy divided by post-merger number of shares. 

Mergers and Acquisitions Examples

What are some real-world examples of M&A? 

In 2015, beer company Anheuser-Busch InBev acquired SABMiller in 2015 to create the world's largest beer company. The deal reportedly went down for $107 billion. 

Just a year later in 2016, one of the biggest deals between two communications companies was initiated - the acquisition of Time Warner Cable Inc. by AT&T Inc. The acquisition was reportedly worth some $85 billion. However, the deal was challenged by the U.S. Justice Department over antitrust issues, although the challenge didn't ultimately succeed in stopping it. 

Additionally, over the summer of 2017, online retail giant Amazon (AMZN - Get Report)  acquired grocery store Whole Foods for some $13.7 billion. 

What's happening this year in the world of M&A? 

Mergers and Acquisitions News

For starters, a mega-fintech M&A deal reportedly is going down between payments companies Fiserv (FISV - Get Report) and First Data (FDC - Get Report) , announced early in 2019. The two fintech companies would create a combined $22 billion company. 

Additionally, the Wall Street Journal reported this week that McGraw-Hill and Cengage are set to merge in an all-stock deal to become the world's second-largest college textbook and educational materials company in the U.S. According to reports, the combined company would generate some $3.16 billion in annual revenues. 

And in the health space, HealthEquity Inc. (HQY - Get Report) has reportedly propositioned WageWorks Inc. (WAGE - Get Report) with a buyout, with a roughly 17.3% premium. HealthEquity reportedly proposed a $2 billion offer to the employee benefits administer. 

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