Acquisitions, which include mergers and takeovers, are a part of business strategy involving the combination of two or more businesses, with or without the cooperation of all parties. Once a rare occurrence, these maneuvers became a typical part of doing business on a large scale in the 20th century (though the peak came earlier, in the 19th century’s Great Merger Movement). Mergers and acquisitions advisory firms have even developed—sometimes calling themselves transition advisors—although most such guidance is still provided by traditional investment banks.
Mergers and acquisitions (or M&A) are more often referred to collectively than not, but are not synonymous. They simply involve many of the same complications and concerns. Further, many mergers are in actuality acquisitions, but termed mergers in order for the acquired company to save face, a condition frequently included in the written agreement. On the other hand, a hostile takeover, when the purchased company resists being acquired, is never called a merger. At least half of acquisition attempts fail, though companies may try repeatedly, and failed attempts can still leave the attempted acquisitor with significant control of the target company. When NASDAQ abandoned its efforts to acquire the London Stock Exchange (LSE), it sold off the shares of stock it had acquired—nearly a third of the LSE—to the Borse Dubai, a stock exchange holding company of the United Arab Emirates.
When a financial adviser says he is “in mergers and acquisitions,” he usually means he is in corporate advisory, either with an investment bank or with a specialty advisory firm. M&A is the bread and butter of corporate advisory, but the field includes other maneuvers and transactions, such as the privatization of a public company, the spin-off of a portion of a company into a new business, and the management of joint ventures between businesses. The advisers included in such transactions include legal advisers and financial advisers retained by both sides and looking out for the best interests of their respective clients; financiers who arrange funding and attend to other financial concerns of the transaction; and third-party experts, such as consultants specializing in the industry, intellectual property valuation advisors, public relations firms, and so on. The larger the companies involved, the more advisers will generally be called upon, but at a minimum each company will retain legal services, and nearly always at least one financial adviser.
Investment banks like JPMorgan, Goldman Sachs, Morgan Stanley, and Deutsche Bank offer corporate advisory services around the world, and dozens of other investment banks operate regionally or nationally. The strength of an investment bank is its tendency to have fingers in so many pies, a sort of department store of corporate financial services, and although the 2007–08 economic crisis has demonstrated the way in which this becomes a vulnerability, it renders an investment bank’s M&A advice no less useful. But since the end of the 20th century, more and more firms have launched offering corporate advisory services exclusively, and have especially been engaged by businesses concerned about investment banks’ potential conflicts of interest. Most such firms are run by senior executives who have left investment banks and have considerable experience, networking contacts, and professional relationships in the financial industry. They are sometimes hired to supplement the advice of an investment bank rather than to substitute for it.
Corporate advisory firms tend to be smaller, and to operate in a smaller area, than investment banks; in Europe they are in a sense the descendants of the merchant banks like Lazard and Rothschild (both of which continue to offer corporate advisory services). Major corporate advisory firms operating multination ally include Evercore Partners (which advised AT&T on its BellSouth acquisition and managed the separation of Viacom and CBS Corporation) and Greenhill & Co. (in the aftermath of the 2008 credit crisis, one of the few remaining independent investment banks operating on Wall Street), both of them based in New York with operations in Europe and Tokyo.
One of the services offered by advisory firms and investment banks, engaged when considering an acquisition, is business valuation. There are various ways to value a business, and particular methods or information may be more or less valuable in different industries. “Value” itself is not always a straightforward thing, and can be talked about in terms of fair market value (the price an asset would sell for between informed parties on the current market), fair value (largely similar, a term especially used in Generally Accepted Accounting Principles and legal contexts), an intrinsic value, a more subjective measurement that implicitly perceives a flaw or temporariness in the fair market value.
Public companies are in general easier to value than private ones, because the law and their accountability to shareholders has required them to keep financial records that adhere to a certain standard and are audited regularly. Even well-managed private companies may not do so, particularly smaller ones. Further, while it is in the best interest of public companies to emphasize their profits, it is in the best interest of private companies to minimize them to some degree, for the sake of taxes, and financial records will reflect this. Assets of both companies will probably have their original cost and value recorded, rather than their current market values, and valuing the company will thus require reexamining those assets.
The discounted cash flows method of business valuation values assets not according to their cost or their resale value, but their projected cash flows, discounted to the present value. An immature bond that will be worth $20 when it matures is in the present worth less than that, for instance, but nevertheless more than its original cost. The amount by which that future cash flow value is discounted is the discount rate, expressed as a percentage. The example of the bond is a more clear-cut case than most of those faced by the advisors valuing a business: the risk and predictability of return of a bond is very simple compared to that of a restaurant, for instance, or a patent, or a piece of real estate. Two different advisors may come to different conclusions about the discounted cash flow value of an asset, and presenting their reasoning to the prospective buyer is part of the process of considering an acquisition, especially if the acquisition itself will in any way impact that cash flow.
The guideline companies method of business valuation is a benchmark-based method similar to determining the value of an asset like a car or house: the company is compared to other similar companies that have been acquired, with multiples calculated based on differences in areas like price-to-earnings ratio. This has become a more useful method as acquisitions have themselves become more common, as the number of available benchmarks has increased, in some industries more than others.
Intellectual property, like patents and proprietary processes, are especially difficult to value objectively. Various models have been developed, and there are firms that specialize in the valuation of intellectual property, a specialty that has developed principally since the 1990s. In the United States, the most prominent firms in this subfield are Crais Management Group in New Orleans, Ocean Tomo in Chicago, and Intellectual Ventures in Seattle, all of which have supported the treatment of intellectual property as a security-like class of asset, one that could be bought and sold on an exchange, which would strengthen the reliability of intellectual property valuation thanks to the efficiency of the bid/ask system.
Valuing a business generally requires that business’s cooperation, especially if it is a privately-owned company. It is standard for both parties to sign a non-disclosure agreement, though the targeted business could still be at a competitive disadvantage should the other business opt not to go ahead with the acquisition. The valuation report includes an account of the current economic conditions at the time of the valuation date, generally derived from the Federal Reserve’s Beige Book and state and industry publications, followed by a detailed financial analysis that discusses both the current situation and past trends of growth and decline. Data is reported in such a way as to make comparison to other businesses in the industry as easy and accurate as possible, and certain other adjustments are made to the report as circumstances demand: no operating assets (which are assumed to be excluded from the hypothetical sale, such as excess cash) are eliminated from the balance sheet, non-recurring items are adjusted so as not to skew the results of the analysis, and the data of private companies is sometimes adjusted to make it comparable to that of public companies. Executives of private companies often earn a higher salary than those of public companies, for instance.
There are three major business valuation societies in the United States: the American Society of Appraisers, the Institute of Business Appraisers, and the National Association of Certified Valuation Analysts. Each publishes a set of Business Valuation Standards for its accredited members to follow. Common among them are certain minimum requirements for the scope and contents of business valuation reports; the proscription against the appraiser’s fee being contingent on the value of the business appraised; and a requirement of full disclosure of the institutions and individuals participating in the valuation report.
Financing an acquisition is another consideration. If called simply “an acquisition,” the transaction was probably financed with cash, the simple purchase of a smaller company by a larger one; because businesses do not like to restrict their cash flow if they can help it, this is most common when the size discrepancy between the two companies is greatest, i.e., a global corporation acquiring a local independent business and bringing it into the fold. Money can also be raised through bonds or loans from a bank, and it is common to finance an acquisition through some combination of these things.
A leveraged buyout (LBO) is a special type of acquisition, differentiated by the way it is financed. The acquisition—buyout—of another company is financed by loans (leverage), using the assets of the target company as the collateral. The prevalence of junk bonds in the 1980s was due to the number of high-risk leveraged buyouts financed by bond issuance. Over the course of that decade, over $250 billion of leveraged buyouts were made by “corporate raiders” who acquired a total of 2,000 companies.
An early famous example was the Gibson Greetings acquisition, in which a greeting card company was acquired in 1982 for $80 million, only $1 million of which was contributed by the acquiring group; the other $79 million was easily paid back 16 months later when the company went public with an initial public offering (IPO) of $290 million. It was the sort of success story that launched a thousand ships, at the start of a decade that would soon become known for its bottom-line attitude and glorification of greed. The raider label was as likely to be used by businessmen as the media, as these investors would often—or often enough to feed the perception—embark on a hostile takeover of a company, strip its assets, lay off its employees, and restructure the remains, as much like a virus or group of convert-or-die missionaries as like the Vikings and pirates the label invoked.
The 1987 Oliver Stone movie Wall Street combines aspects of investors like Carl Icahn and Michael Milken into the corporate raider Gordon Gekko, played by Michael Douglas; his “greed is good” speech, in turn, was inspired by an address by arbitrageur Ivan Boesky, whose defense of greed in 1986 summarized and polarized much of the decade. Gekko’s plans to acquire an airline he promises to restructure, but intends only to liquidate by selling it off piecemeal, are likewise emblematic of much of the corporate raiding activity of the time, even to the choice of an airline as his target. Icahn was best known for his 1985 hostile takeover of Trans World Airlines (TWA) and subsequent reduction of wages and benefits, liquidation of assets, and sale of profitable gates to other competing airlines, while relocating the corporate offices to a building he owned in Westchester County.
The LBO boom peaked with the takeover of RJR Nabisco in 1989, a buyout that cost $31.1 billion—$109 a share, after a prolonged bidding war involving (in one capacity or another) Morgan Stanley, Goldman Sachs, Salomon Brothers, and Merrill Lynch, the most prominent investment banks of the era. When adjusted for inflation, no buyout has been larger, and it was the last of its kind for the era; buyouts slowed, and even the RJR Nabisco deal had to be recapitalized a year later. Milken’s firm, Drexel Burnham Lambert, had raised the largest amount of money for the decade’s flurry of buyouts, leading the way in the securitization of high-yield debt, for which Milken was called “the junk bond king.”
The era symbolically ended shortly after the RJR Nabisco deal, when the firm pleaded no contest to six federal felony charges related to stock manipulation and misdeeds, paying a $650 million fine, the largest ever paid for securities violations. Milken left the firm when he was indicted individually on 98 charges of racketeering and securities fraud (insider trading), for which he was eventually sentenced to ten years in prison. Drexel Burnham Lambert declared bankruptcy less than a year later.
The 21st century saw a rebirth of leveraged buyouts, as lending standards became lax, interest rates declined, and the Sarbanes-Oxley Act altered the regulations affecting public companies. Though no buyout equaled RJR Nabisco’s when adjusted for inflation, there were more multibillion-dollar buyouts, totaling significantly more money, in the first decade of the 21st century than in the 1980s. 2006 alone saw 654 companies bought for $375 billion.
The high-yield-debt market enabling this was affected by the subprime mortgage crisis that rippled across the other sectors of the economy in 2007–08; no bankruptcy or indictment was needed to end the boom this time, just general economic malaise and its attendant risk aversion. Many of the buyouts of this recent wave were funded with “cov-lite” loans— covenant light loans, loans with fewer clauses in their agreements protecting the rights of the lender, something more and more banks offered at a time when it was a borrowers’ market and lenders had to compete for attention.
It is a mistake to conflate leveraged buyouts with the corporate raiding associated with the 1980s; even most buyouts in that decade did not result in negligent handling or opportunistic dismantling of the acquired companies. Management buyouts (MBOs), for instance, are leveraged buyouts instigated by the management of a company, when those managers want to take control of the company—usually, but not always, in order to take the company private. The reasons for this vary, but often management may have a plan for the company that is not going to return a profit to the shareholders quickly, or involves a risk shareholders are not willing to take.
The problem with MBOs when they become a common corporate maneuver is the temptation that is presented for mismanagement: Corporate officers planning an MBO will have to raise less money to buy out the company if they can reduce its worth first.
The 1980s made hostile takeover such a common phrase that it can be easy to forget there is any other Acquisitions, Takeovers, and Mergers sort. While it is true that a friendly takeover is more likely to be referred to as an acquisition, this is simply a matter of labeling.
A hostile takeover is any acquisition performed without the cooperation of the company—which can mean that the company actively resisted the acquisition (by rejecting initial offers) or can simply mean that its cooperation was not sought. There are different strategies of hostile takeovers, from gathering up enough stock to own a controlling stake in the company to persuading existing shareholders to vote the current management out in favor of managers who will approve the takeover. Hostile takeovers are riskier, insofar as without the cooperation of the targeted company, the business valuation will be less well-informed, and potentially inaccurate.
A reverse takeover is one in which a private company acquires a public company without taking it private—in other words, the private company bypasses the usual process of going public by buying and merging with a public company, which can turn it public in weeks rather than the year or more that a standard IPO usually takes. US Airways, for instance, was acquired by America West Airlines, putting the company in the hands of US Airways’ creditors, with the goal of rescuing it from bankruptcy.
In a merger, two companies join to form a larger company. There is usually a new name and brand identity for the resulting company, but not always. Mergers may be horizontal—involving companies that produce similar products in an industry, such as Pepsi and Coca-Cola—or vertical, involving two companies involved with different stages of production of the same good or service, like a movie studio and a television network. Conglomerate mergers involve companies from completely separate industries.
Mergers can raise a lot of antitrust red flags, and the busiest period of merger activity in the United States contributed to the speed with which antitrust legislation was adopted. The “great merger movement” took place from 1895 to 1905, a period during which there was a significant national trend toward moving operations and consciousness from the regional level to the national level. For instance, during this same Progressive Era—which historian Robert Wiebe has called the organizational period—the country’s major nationwide professional guilds (such as the American Medical Association and American Legal Association) developed, as did its national labor unions, several of its religious organizations, and a great many of its media organizations. There was a general and pronounced trend since the end of the Civil War to treat institutions in the United States as American institutions first, Alabaman and Iowan and Pennsylvanian institutions second, an attitude adopted so successfully that it is taken for granted a century later.
In business, the effect of this trend was for more companies to want to operate nationally rather than in a single state or region. State laws sometimes made this difficult, and trusts were created in order to create legal entities which could then own or merge with smaller regional entities, which would then all be operated uniformly. Hardware stores in 30 states, for instance, could merge into a nationwide hardware chain.
That is not to say that the motivation of the great merger movement was simply to participate in the spirit of cultural change that presided over the day. Economic concerns were foremost. The Panic of 1893 had driven demand and prices down, and mergers allowed costs to come down in order to keep profits stable, or on the increase. When those costs came down because of vertical or horizontal integration, all was well. But when the mergers resembled a form of collusion, with companies joining together in order to keep prices high by removing the need to compete, that is when antitrust legislation had to be enacted in order to limit the circumstances in which mergers could occur, and set out the sorts of companies that, in plain English, are not allowed to exist under American law—companies that represent such a large part of their industry that the industry is rendered noncompetitive.
As an illustration of just how much merging was occurring, in 1900—right in the middle of this period—the value of firms involved in mergers that year was equal to 20 percent of the country’s gross domestic product. By contrast, in an ordinary year, it is closer to 5 percent or less.
- Bryan Burrough and John Helyar, Barbarians at the Gate: The Fall of RJR Nabisco (Harper & Row, 1990);
- Susan Cartwright and Richard Schoenberg, “Thirty Years of Mergers and Acquisitions Research: Recent Advances and Future Opportunities,” British Journal of Management (v.17, 2006);
- Donald DePamphilis, Mergers, Acquisitions, and Other Restructuring Activities (Elsevier Academic Press, 2008);
- Robert F. Reilly and Robert P. Schweihs, The Handbook of Advanced Business Valuation (McGraw-Hill Professional, 1999);
- Thomas Straub, Reasons For Frequent Failure in Mergers and Acquisitions: A Comprehensive Analysis (Deutscher Universitatsverlag, 2007).
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