What Is an Acquisition?
An acquisition is when one company purchases most or all of another company’s shares to gain control of that company. Purchasing more than 50% of a target firm’s stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company’s other shareholders. Acquisitions, which are very common in business, may occur with the target company’s approval, or in spite of its disapproval. With approval, there is often a no-shop clause during the process.
We mostly hear about acquisitions of large well-known companies because these huge and significant deals tend to dominate the news. In reality, mergers and acquisitions (M&A) occur more regularly between small- to medium-size firms than between large companies.
Key Takeaways
- An acquisition is a business combination that occurs when one company buys most or all of another company’s shares.
- If a firm buys more than 50% of a target company’s shares, it effectively gains control of that company.
- An acquisition is often friendly, while a takeover can be hostile; a merger creates a brand new entity from two separate companies.
- Acquisitions are often carried out with the help of an investment bank, as they are complex arrangements with legal and tax ramifications.
- Acquisitions are closely related to mergers and takeovers.
Understanding Acquisitions
Companies acquire other companies for various reasons. They may seek economies of scale, diversification, greater market share, increased synergy, cost reductions, or new niche offerings. Other reasons for acquisitions include those listed below.
As a Way to Enter a Foreign Market
If a company wants to expand its operations to another country, buying an existing company in that country could be the easiest way to enter a foreign market. The purchased business will already have its own personnel, a brand name, and other intangible assets, which could help to ensure that the acquiring company will start off in a new market with a solid base.
As a Growth Strategy
Perhaps a company met with physical or logistical constraints or depleted its resources. If a company is encumbered in this way, then it’s often sounder to acquire another firm than to expand its own. Such a company might look for promising young companies to acquire and incorporate into its revenue stream as a new way to profit.
To Reduce Excess Capacity and Decrease Competition
If there is too much competition or supply, companies may look to acquisitions to reduce excess capacity, eliminate the competition, and focus on the most productive providers.
To Gain New Technology
Sometimes it can be more cost-efficient for a company to purchase another company that already has implemented a new technology successfully than to spend the time and money to develop the new technology itself.
Officers of companies have a fiduciary duty to perform thorough due diligence of target companies before making any acquisition.
Acquisition, Takeover, or Merger?
Although technically, the words “acquisition” and “takeover” mean almost the same thing, they have different nuances on Wall Street.
In general, “acquisition” describes a primarily amicable transaction, where both firms cooperate; “takeover” suggests that the target company resists or strongly opposes the purchase; the term “merger” is used when the purchasing and target companies mutually combine to form a completely new entity. However, because each acquisition, takeover, and merger is a unique case, with its own peculiarities and reasons for undertaking the transaction, the exact use of these terms tends to overlap in practice.
Acquisitions: Mostly Amiable
Friendly acquisitions occur when the target firm agrees to be acquired; its board of directors (B of D, or board) approves of the acquisition. Friendly acquisitions often work toward the mutual benefit of the acquiring and target companies. Both companies develop strategies to ensure that the acquiring company purchases the appropriate assets, and they review the financial statements and other valuations for any obligations that may come with the assets. Once both parties agree to the terms and meet any legal stipulations, the purchase proceeds.
Takeovers: Usually Inhospitable, Often Hostile
Unfriendly acquisitions, commonly known as “hostile takeovers,” occur when the target company does not consent to the acquisition. Hostile acquisitions don’t have the same agreement from the target firm, and so the acquiring firm must actively purchase large stakes of the target company to gain a controlling interest, which forces the acquisition.
Even if a takeover is not exactly hostile, it implies that the firms are not equal in one or more significant ways.
Mergers: Mutual, But Creates a New Entity
As the mutual fusion of two companies into one new legal entity, a merger is a more-than-friendly acquisition. Mergers generally occur between companies that are roughly equal in terms of their basic characteristics—size, number of customers, the scale of operations, and so on. The merging companies strongly believe that their combined entity would be more valuable to all parties (especially shareholders) than either one could be alone.
Evaluating Acquisition Candidates
Before making an acquisition, it is imperative for a company to evaluate whether its target company is a good candidate.
- Is the price right? The metrics investors use to value an acquisition candidate vary by industry. When acquisitions fail, it’s often because the asking price for the target company exceeds these metrics.
- Examine the debt load. A target company with an unusually high level of liabilities should be viewed as a warning of potential problems ahead.
- Undue litigation. Although lawsuits are common in business, a good acquisition candidate is not dealing with a level of litigation that exceeds what is reasonable and normal for its size and industry.
- Scrutinize the financials. A good acquisition target will have clear, well-organized financial statements, which allows the acquirer to exercise due diligence smoothly. Complete and transparent financials also help to prevent unwanted surprises after the acquisition is complete.
The 1990s Acquisitions Frenzy
In corporate America, the 1990s will be remembered as the decade of the internet bubble and the megadeal. The late 1990s, in particular, spawned a series of multi-billion-dollar acquisitions not seen on Wall Street since the junk bond fests of the roaring 1980s. From Yahoo!’s 1999 $5.7-billion purchase of Broadcast.com to AtHome Corporation’s $7.5-billion purchase of Excite, companies were lapping up the “growth now, profitability later” phenomenon. Such acquisitions reached their zenith in the first few weeks of 2000.
Example of Acquisitions
AOL and Time Warner and AT&T
AOL Inc. (originally America Online) was the most publicized online service of its time, and had been extolled as “the company that brought the internet to America.” Founded in 1985, by the year 2000 AOL had grown to become the United States’ largest internet provider. Meanwhile, the legendary media conglomerate, Time Warner, Inc. was being labeled an “old media” company, given its range of tangible businesses like publishing, and television, and an enviable income statement.
In 2000, in a masterful display of overweening confidence, the young upstart AOL purchased the venerable giant Time Warner (TWX) for $165 billion; this dwarfed all records and became the biggest merger in history. The vision was that the new entity, AOL Time Warner, would become a dominant force in the news, publishing, music, entertainment, cable, and Internet industries. After the merger, AOL became the largest technology company in America.
However, the joint phase lasted less than a decade. As AOL lost value and the dot-com bubble burst, the expected successes of the merger failed to materialize, and AOL and Time Warner dissolved their union:
- In 2009, AOL Time Warner dissolved in a spin-off deal.
- From 2009 to 2016, Time Warner remained an entirely independent company.
- In 2015, Verizon Communications, Inc. (NYSE: VZ) acquired AOL for $4.4 billion.
Then, in October 2016, AT&T (NYSE: T) and Time Warner (TWX) announced a deal in which AT&T will buy Time Warner for $85.4 billion, morphing AT&T into a media heavy-hitter. In June 2018, after a protracted court battle, AT&T completed its acquisition of Time Warner.
Certainly, the AT&T-Time Warner acquisition deal of 2018 will be as historically significant as the AOL-Time Warner deal of 2000; we just can’t know exactly how yet. These days, 18 years equals numerous lifetimes—especially in media, communications, and technology—and much will continue to change. For the moment, however, two things seem certain:
- The consummation of the AT&T-Time Warner merger already has begun to reshape much of the media industry.
- M&A enterprise is still alive and well.
What Are the Types of Acquisition?
Often, a business combination like an acquisition or merger can be categorized in one of four ways:
- Vertical: the parent company acquires a company that is somewhere along its supply chain, either upstream (such as a vendor/supplier) or downstream (a processor or retailer).
- Horizontal: the parent company buys a competitor or other firm in their own industry sector, and at the same point in the supply chain.
- Conglomerate: the parent company buys a company in a different industry or sector entirely, in a peripheral or unrelated business.
- Congeneric: also known as a market expansion, this occurs when the parent buys a firm that is in the same or a closely-related industry, but which has different business lines or products.
What Is the Purpose of an Acqusition?
Acquiring other companies can serve many purposes for the parent company. First, it can allow the company to expand its product lines or offerings. Second, it can cut down costs by acquiring businesses that feed into its supply chain. It can also acquire competitors in order to maintain market share and reduce competition.
What Is the Difference Between a Merger and an Acquisition?
The main difference is that in an acquisition, the parent company fully takes over the target company and integrates it into the parent entity. In a merger, the two companies combine, but create a brand new entity (e.g., a new company name and identity that combines aspects of both).
