Mergers and acquisitions is a vague term, though it is a common one within the finance arena. It is rare that there is a merger of equals; usually what is termed a merger is actually one company purchasing another. For all practical purposes, the field is really about one company acquiring another. Generally, the owners of the company for sale want to cash out of their firm, or they want to divest a unit of a larger company, or they want to take a public company private. Purchasers can be another public or private company that wants the market share or expertise of the company, or the buyers can be an investment firm that holds a portfolio of companies that it is improving for later sale.
An example of a successful merger is that of Disney/Pixar. It was no longer Mickey vs Toy Story. Now the two companies could collaborate freely. Did the merger work? Just think of some of the successful films that have been released since: ‘Up’, ‘Brave’, ‘Monsters University’. Think of all the experience Pixar has gained from Disney in terms of advertising & merchandising. The skills and creativity that Disney has aquired from Pixar. A success? Yes!
What about a bad example? Well, staying with the children theme, how about the merger of Mattel/The Learning Company. Mattel has always been a childhood staple for decades, and in 1999, it attempted to tap into the educational software market by scooping up the almost-bankrupt The Learning Company. Less than a year later though, The Learning Company lost $206 million, taking down Mattel’s profit with it. By 2000, Mattel was losing on average $1.5 million a day and its stock prices kept dropping. The Learning Company was sold by the end of 2000, but Mattel was forced to lay off 10% of its employees in order to cut costs. A success? Definitely not!
An investment firm may buy an underperforming company knowing that it has the in-house expertise to take control and turn the asset around. It is similar to value-based stock investments in which the buyer sees potential in an undervalued company. The investment firm may install its own management team or simply provide counsel to the current managers in order to improve operations, reduce costs and increase revenue.
Once the company is turned around, the investment firm has two choices: It can sell the company for a profit or it can hold onto the company, keeping the profits as an annuity. Depending on the economy, the investment firm may decide to hold this company until market valuations are in line with its own valuation of the company’s worth.
The key is for the investment firm to earn a high return on what it paid and the resources it puts into the company after purchase. The firm has its own investors to whom it must return dividends. These dividends can derive from the annual profits thrown off by the portfolio of companies or from the profits earned from the sale of the companies.
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