The ocean is filled with stories of big sharks eating small fish, or smaller fish banding together to protect themselves from a predator. The corporate world is not so different. There is always a larger company trying to acquire a smaller one, or two or more companies combining forces to survive the competition and thrive. While these constant changes affect corporate valuations, what does it actually mean for all the stakeholders and ultimately the stock prices? Check out this blog to understand this in detail and enhance your knowledge of analysing corporate data.
Mergers and acquisitions are a traditional and most tried and tested method that companies use to grow, compete better, or survive in the market. Though they are often mentioned together, a merger and an acquisition are slightly different. The meaning of mergers and acquisitions, popularly known as M&A, and an extension to them, demerger, is explained below.
Mergers - A merger happens when two companies decide to join together and form a single new company. Both companies usually agree to this decision because they believe that together they can do better than alone. For example, imagine two smartphone brands facing tough competition from global companies. If they merge, they can share their resources, technology, and customer base. This makes them stronger in the market. In a merger, both companies may give up their old names and operate under a new name.
Acquisitions - An acquisition is when one company buys another company and takes control of it. The company being bought may continue to run under its original name, or it might be completely absorbed by the buyer. For example, when Tata Motors acquired Jaguar Land Rover from Ford in 2008, Tata became the owner of those global car brands. Tata invested money, brought in new ideas, and helped improve the company’s performance.
Demerger - A demerger happens when a single company splits into two or more separate companies. This is usually done to allow each part of the business to focus on its own goals, operate more efficiently, or unlock better value for shareholders. In most cases, the original company separates one of its business divisions and forms a new, independent company. For example, imagine a large company that runs both a telecom business and a retail business. If it feels that each business will perform better on its own, it may decide to demerge. After the demerger, the telecom business and the retail business will be managed by different companies with their own leadership and strategies. This can help investors, customers, and employees focus more clearly on each business’s strengths. A demerger does not mean that the company is in trouble; rather, it often means the company is restructuring to grow in a smarter way.
M&A can be of many types based on the nature of the deal and the companies that are coming together. The types of mergers and acquisitions are explained below.
This happens when two companies in the same industry and at the same level of production or service merge.
Example - If two mobile network providers in India, like Idea and Vodafone, merge, that is a horizontal merger. They offer similar services and come together to reduce competition and increase market share.
A vertical merger takes place between companies at different stages of the supply chain, like a manufacturer merging with a supplier.
Example - If a textile company merges with a cotton supplier, it helps control costs and improve supply.
This type involves two companies from completely different industries. They merge to diversify their business and reduce risk.
Example - If a food processing company merges with a financial services firm, it is a conglomerate merger. The goal is to grow by entering new markets.
This happens when two companies that sell the same product in different markets combine.
Example - A dairy company in South India merging with a similar company in North India helps them serve a wider customer base.
In a friendly acquisition, the company being bought agrees to the deal. Both sides work together to complete the process smoothly.
Example - Tata Group acquiring Jaguar Land Rover was a friendly acquisition, where both companies worked towards the same goal.
In this case, the acquiring company takes over another company without its full agreement. It often involves buying a large number of shares to gain control. These are less common and more complicated. They usually happen when the target company does not want to be bought.
Here, a private company acquires a public company to enter the stock market without going through a traditional IPO (Initial Public Offering). This helps the private company become publicly listed faster.
The business decision for a merger or acquisition stems from the need to grow and stay ahead of the market curve. However, the reasons for such corporate restructuring can be analysed as under.
To Grow Faster - Two companies combine to expand their size, reach more customers, or enter new markets.
To Reduce Competition - Merging with a competitor can help reduce market rivalry.
To Save Costs - Merged companies can cut down on extra expenses like duplicate staff, offices, or systems.
To Share Resources - They can share technology, employees, and ideas to improve performance.
To Increase Market Power - A bigger company can have more control over pricing and supply.
To Gain New Customers - Acquiring a company with a strong customer base helps grow the business quickly.
To Access New Technology - Buying a company with advanced systems or innovation can boost progress.
To Expand to New Regions - Companies may acquire others in different cities or countries.
To Beat the Competition - Buying a growing competitor can help a company stay ahead in the race.
To Improve Financial Strength - A profitable company can make the acquiring company more valuable.
To Focus on Core Business - Companies may split to give more attention to their main area of work.
To Improve Efficiency - Smaller, independent units can work faster and make better decisions.
To Unlock Value - Sometimes, the separate companies are worth more than the combined one.
To Attract Investment - Investors may prefer to invest in focused businesses.
To Reduce Conflict - Different divisions may have different goals, and splitting can solve this.
To Gain Control of a Valuable Company - The buyer sees growth potential in the target company, even if the target disagrees.
To Use the Target's Assets or Brand - The buyer may want the land, factories, patents, or brand name.
To Enter a New Market Quickly - Buying an established company is faster than starting from scratch.
To Fix a Poorly Managed Company - The buyer believes they can run the target company better and make profits.
To Eliminate a Threat - The buyer may see the target company as future competition and wants to stop it early.
We have seen the meaning and the reason for such capital restructuring above. Let us now focus on the key differences between them for better understanding.
Mergers, acquisitions, demergers, and hostile takeovers are all forms of corporate restructuring, specifically capital restructuring. These processes involve significant changes to a company's ownership, structure, or financial setup. However, their impact is seen directly on the corporate valuations and ultimately the share prices. This impact is explained hereunder,
A merger is when two companies come together to form a single, larger company. For both companies involved, this is often seen as a way to become stronger, reduce costs, and increase profits. When the market sees that the merger can bring better performance, it usually responds positively. This may result in a rise in the stock prices of both companies, especially if investors believe the combined company will do better than the individual ones.
For companies, a merger can increase overall valuation because it may now have more customers, better resources, and stronger market control. However, if the merger is not planned properly or if the two companies fail to work well together, the stock price might fall. This happens because investors get worried about management problems, cultural differences, or financial risks.
Example - When Vodafone India merged with Idea Cellular, the hope was to compete better against Jio. But over time, the merged company faced financial struggles, which affected its valuation and stock performance.
In an acquisition, one company buys another. The company being bought (the target) usually sees a rise in its stock price because the buyer pays a higher price (called a premium) to take control. This benefits the shareholders of the target company.
For the company making the purchase (the acquirer), the stock market reaction can go either way. If investors believe that the acquisition will lead to growth, increase profits, or give access to valuable technology or markets, the acquiring company’s stock price may go up. But if the buyer pays too much or takes on too much debt, the stock price may drop, and the valuation can suffer.
Example - When Tata Motors acquired Jaguar Land Rover from Ford in 2008, some investors were unsure at first. But later, as JLR performed well and became profitable, Tata Motors' valuation and global reputation improved significantly.
A demerger happens when a company splits into two or more separate businesses. This is usually done so that each new company can focus better on its core area. For investors, this is often seen as a positive move, especially when the original company is involved in very different businesses that don’t fully benefit from being together.
In most cases, a demerger helps unlock hidden value. The stock market can now value each company based on its actual performance. Investors usually get shares in the new company, and both stocks may perform well if the businesses are managed properly.
Example - In 2023, Reliance Industries demerged Jio Financial Services. This allowed Reliance to focus more on its energy and retail businesses, while Jio Financial could develop as a separate financial company. Investors were given shares in both, and the market viewed this move positively, leading to better valuations.
A hostile takeover is when a company tries to take control of another company without its approval. This usually involves buying large amounts of shares directly from the market or from existing shareholders. The stock price of the target company often goes up in the short term because the buyer is offering a high price to attract shareholders.
However, hostile takeovers can also create tension and uncertainty. Employees and management of the target company may resist, and this can affect the company’s day-to-day operations. For the acquiring company, it may be expensive and risky, which can lead to a drop in its valuation. If the deal fails, both companies might see their stock prices fall.
Example - One known case is Larsen & Toubro’s (L&T) hostile takeover of Mindtree in 2019. L&T gradually bought shares from the open market and other investors, even though Mindtree’s management was against it. The stock prices moved sharply during this period due to market uncertainty.
Mergers and acquisitions are quite common in the corporate world. These are essential changes for optimising resources and taking advantage of the changing market conditions. While it is a challenging process, it can have a powerful impact on a company’s valuation and stock prices, which can be positive or negative, depending on how well they are planned and executed. Furthermore, it can be a good opportunity for investors to tap into unexplored opportunities; however, not without the risks involved.
This article was a detailed analysis of key corporate restructuring tools and their impact on companies and investors alike. Let us know your thoughts on this topic or if you need further information on the same, and we will address them.
Till then, Happy Reading!
Read More: Corporate Actions and Their Impact on Share Prices
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
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