Accompanied with the development of economy, there are a lot of examples on mergers and acquisitions (M&A). There are many theories support the view that M&A can create value for the offeror and offeree. Synergy view suggests that a company can acquire economies of scale after M&A, which means that the new company will operate with a lower cost than before. The new company can make use of the advantage of each other and operate with less competition, which also contributes to the development of new company. This effect is often called "2+2=5". However, agency theory suggests that the agency problem between the owner of the company and the manager may result in failure of the M&A (Kim & Finkelstein, 2009). M&A will destroy value and the offeror and offeree will not benefit from the M&A. Last, this article introduces an example and analyzes the effect of M&A. The combination of American Online and Time Warner destroyed value. It can be seen that most of M&A will create value, but if the manager wants to enlarge the company without considering the benefit of shareholders M&A may destroy value.
Analysis of M&A
The theory of M&A
Mergers and acquisitions promote the development of some companies. The most famous results of earliest effort were the huge corporate mergers which produced the Standard Oil Trust and General Motors. There are some motives for mergers and acquisition. First, a company can acquire synergy after the progress. The result of mergers is "2+2=5", which is synergy effect. Before M&A one of the company or both do not operate at a level which is economies of scale, the situation changes after M&A. A company can make use of the advantage of the other company in order to create more value than the situation that they are separated. The 2+2=5 also is true in other transactions except for economies of scale. These types of transaction are buying the competition, strategic deals and leveraged buyouts (Sara et al., 2005). Buying the competition means that both of the participants of M&A will be benefit from efficiencies and less competition which are introduced by M&A. The strategic deals mean that if the participants can make use of the skill and resources of each other. The leveraged buyouts mean that the performance of both sides will be better through management incentives. Second, the speed of innovation and production can increase. Through mergers and acquisitions the market share increase, the production and innovation also speed up (Ronan, & Andrew, 2005). Thirdly, M&A can eliminate the barriers to entry one country. In some circumstances, one country may limit the entrance of the companies from other countries in order to protect domestic industry. M&A will not destroy the domestic company, which will reduce the resistance to entry the market. Fourthly, M&A is less risky than organic growth. One company may come across a lot of difficulties in the progress of market extension. However, the company can make use of the original marketing channel of the offeree. The innovation of new products is another aspect. If one company wants to develop a new product itself, it will meet with a lot of risk like the failure on the innovation. These uncertainties will not exist if the company merges with another company who is successful in the innovation of that product. Fifthly, the undervaluation of target company's stocks will also induce the formation of M&A. Once the stocks of a company are undervalued heavily, these stocks will become investment tools that some companies favorite in. If this company is related to the offeror, M&A will probably form between these companies. Last, one company can operate on some aspects through M&A. More and More companies operate in several industries, which maybe relevant with the major aspect or not. Through this progress the companies will acquire the profits of risk diversification. The risk of one industry may be offset by other industries.
The offeror and offeree can benefit from the progress of M&A theoretically. Base on the analysis above, the offeror can enlarge the market share of its products through M&A, which will bring more profits than before (Laamanen, 2007). The offeror can operate in several aspects, which will reduce the risk when operate in single product. Through M&A one company can develop with less risk because it can make use the technology which belongs to the offeree. All of these will increase the value of the offeror, which will lead to the increase on profit and earnings per share. The offeree will also benefit from M&A. The offeree can make use of the technology of the offeror, which is more advanced generally. The inefficient management of offeree will improved through M&A, which will bring more profits than before. The shareholder of the target company will acquire the bid premium in the progress of M&A. Study shows that the premium can be high (Richard, 2009). This is a kind of direct income to the owner of the target company.
Mergers destroy value
Except for the theoris that M&A can create value for offeror and offeree, some examples shows that M&S may destroy value. There is less theoretical reason support the view that mergers will create value when the mergers occur between two companies that engaged in different business. This kind of mergers is called conglomerate mergers. Agency theory suggests that some mergers like conglomerate mergers will destroy value. This maybe results from the conflicts between the managers and the owner of the companies (Ronan, & Andrew, 2005). The object for the owner of the companies is the maximization of their equities. But the object for the manager of the companies is the scale of the companies and the risk of the companies, because the incomes of the manager are directly relevant to the size of the company. The mangers are more willing to merge with other companies or acquire other companies, which may reduce the wealth of the stockholders (Andrade et al., 2001). Through mergers the operation risk of the company reduces in that the company can operate in some irrelevant business. The cash flow of the company is more stable after mergers and the probability that company falling into financial distress declines.
Based on the synergistic view, horizontal and vertical M&A may create value for the company then the owner of the company will benefit from the progress. But the result may be different when conglomerate mergers happen. The agency view suggests that mergers will destroy value (Ronan & Andrew, 2005). This view suggests that conglomerate mergers will destroy value more likely. The mergers that offerors performing well and with a lot of free-cash flow may destroy value, either. A lot of studies found that the offeror will acquire negative returns after mergers. All of these are support by the agency theory.
An example of M&A
This article will analyze a real example and investigate whether the offeror and offeree can be benefit from the merger in the next. The example illustrates the combination between American Online and Time Warner. The data of the two companies are shown in table 1.
Table 1 data of American Online and Time Warner
American Online(before M&A)
Time Warner (before M&A)
After M&A
Stock price
$73
$90
$50
P/E
77.3Ã-
300Ã-
106.4Ã-
EPS
$0.94
$0.3
$0.47
(Source: David, R.K et al. (2004) 'Meta-Analyses of Post-Acquisition Performance: Indications of Unidentified Moderators', Strategic Management Journal, 25(2), pp.187-200.)
It can be seen from the table that before combination the stock price of the two companies are $73 and $90, respectively. The combination completed in 2001 by the scheme that each share of American Online exchange for one share of new company and each share of Timer Warner exchange for 1.5 share of new company. The average stock price of the new company is $50 in the half year after combination. The original shareholder of American Online is benefit from the merger in that the P/E ratio is higher than before. The original shareholder of Time Warner is not benefit from the combination. The stock price of the new company decline to $20 in 2002, the shareholder of the two companies both cannot be benefit from the combination. The merger of American Online and Time Warner destroy the value.
However, there are a lot of successful examples of M&A. The income of the new company also will be affected by some factors. The economic environment is not same after combination. The economy depression in 2002 affected the operation of the new company in a large extent.
Conclusion
According to the analysis above, it can be seen that there are many motives which promote M&A. Based on synergy theory, both sides of M&A can benefit from the progress. After M&A the company can operate on a new level in which economies of scale will occurs. The new company can create more value than the situation that they operate alone, which means that the shareholders will be benefit from M&A. However, agency theory suggests that M&A may destroy value. The conflicts between the owner of the company and the manager may induce some unsuccessful M&A. The value of the company will decline in this kind of M&A. An example is cited to illustrate the effect of M&A, it can be seen that both sides are not benefit from the merger. The failure in the example may be result from the changing economic environment. M&A is not the only factor that contributes to the failure of new company.
