Mergers and acquisitions (M&A) have become a popular business strategy for companies looking to expand into new markets, add capabilities and talent, or consolidate to reduce costs. But why exactly do companies pursue M&A? What are the strategic reasons and benefits that make these deals so appealing?
Let’s examine the key drivers behind mergers and acquisitions benefits.
Overview of Mergers and Acquisitions
A merger occurs when two companies combine together into one entity. An acquisition refers to one company purchasing another company to take control of its assets, operations, and management.
The main types of M&A deals include:
- Horizontal M&A – Two companies in the same industry and at the same stage of production merge. This allows them to consolidate overlapping operations and reduce costs. For example, the merger between HDFC Bank and Times Bank in 2020 consolidated their retail banking businesses.
- Vertical M&A – A company merges with or acquires its supplier or distributor to control the supply chain. This provides economies of scale. For instance, Tata Steel’s acquisition of raw material provider TS Alloys in 2022 gave it greater control over costs.
- Conglomerate – Companies in totally unrelated industries merge. This leads to diversification into new markets and products. For example, Tata Group operates in diverse sectors like automobiles, steel, and information technology through acquisitions.
- Concentric – Companies in related industries with synergies merge. This provides economies of scope. For instance, Birla Cellulose acquired Grasim Industries to leverage synergies between viscose staple fiber and the pulp business.
- Acquisition of majority interest – One company acquires a controlling stake in another company. For example, Walmart acquired a majority stake in Flipkart to enter the Indian ecommerce market.
- Acquisition of assets – A company acquires only selected assets of another company. For instance, Mahindra & Mahindra acquired 100% of Ford India’s manufacturing plant and key assets to expand capacity.
- Takeover – A company gains control of another company by acquiring majority shares. Like Nirma’s takeover of Lafarge India by purchasing its 100% equity stake and assets.
Strategic Benefits and Advantages of M&A
There are several benefits of mergers and acquisitions that make them a popular growth strategy for companies across industries:
1. Gain Capabilities and Talent
Companies can use M&A to acquire skills, technology, and human talent that would take years to develop internally. Acquiring a company with critical capabilities provides them quickly to boost competitive advantage.
For example, HCL Technologies has made several acquisitions to gain expertise in areas like cybersecurity, digital consulting, and cloud services. This allowed it to expand offerings for clients rapidly.
Similarly, acquisitions allow Indian pharmaceutical companies to gain expertise in new drug development and innovative delivery mechanisms. Buying biotech startups expands their research capabilities and product pipelines quickly compared to in-house R&D.
2. Expand into New Markets
M&A provides a rapid route for companies to enter new markets and geographies. Instead of building operations from scratch, companies can acquire or merge with an established player in the target market for an instant footprint.
For instance, Facebook expanded into India by acquiring a local social media company called Jio Platforms. This provided Facebook with access to Jio’s millions of telecom subscribers as potential Facebook users.
Similarly, Flipkart’s acquisition of eBay India helped it instantly gain market share in the growing Indian ecommerce industry. eBay India already had an established reputation, customer base and supply chain network.
3. Increase Economies of Scale
By combining operations, mergers lead to increased efficiency and lower costs through economies of scale and elimination of duplicate roles and processes. A merged entity can negotiate better terms with suppliers and spread fixed costs over a larger revenue base.
For example, the merger of Vodafone India and Idea Cellular created synergy benefits by reducing overlapping infrastructure costs. Their combined scale gave them increased bargaining power with equipment suppliers to lower capital spending.
Similarly, industry consolidation helps merged steel companies in India optimize production capacity and distribution reach. This lowers their overall costs and makes them more competitive.
4. Gain Market Share
Companies can use acquisitions to quickly capture a larger share of the market and reduce competitive pressures. Consolidating the market through M&A deals enables pricing power and higher profitability.
For example, HDFC Bank became the largest private sector bank in India through the acquisition of Centurion Bank and other smaller banks over the years. The M&A strategy added to its customer base and branch network rapidly.
Similarly, acquisitions helped Dabur expand its share of the Ayurvedic medicine and natural consumer products market in India by merging competing brands.
5. Diversify Business
Conglomerate mergers allow companies to diversify into unrelated products and services, spreading risk across multiple revenue streams. Diversification provides more stable revenues for the merged entity compared to relying on a single market.
For instance, Tata Group operates in diverse sectors like automobiles, steel, and information technology through acquisitions. This diversification reduces overall risk, as weakness in one industry can be offset by strength in another.
6. Utilize Excess Cash
Companies often accumulate excess cash reserves or debt capacity over time. This spare borrowing capacity can be utilized to acquire other companies and provide returns higher than just holding cash or buying back shares.
For example, Reliance Industries has made major acquisitions like Network18 using its strong cash flows and low debt position. This allowed Reliance to enter the rapidly-growing media and entertainment sector.
7. Gain Synergies
Companies with synergistic assets and operations can merge to gain performance improvements. Supply chain integration, shared distribution, and combined research provide cost efficiencies that benefit both companies.
The merger of Dena Bank and Bank of Baroda allowed them to consolidate branches and improve operational efficiency. Combining their IT systems and teams helped save costs through economies of scale.
8. Acquire Undervalued Assets
Acquiring underperforming companies or assets at a discount can create value for the buyer through turnarounds. The acquirer can inject better management and restructure operations to improve performance.
For instance, Tata Motors’ acquisition of Jaguar Land Rover (JLR) from Ford provided it access to a global luxury brand at an attractive valuation. Under Tata’s ownership, JLR made a successful turnaround and became highly profitable.
9. Increase Shareholder Value
M&A can unlock higher market valuation for shareholders of both companies by combining assets and increasing revenues and profits. Investors often reward mergers through higher multiples.
The merger of HDFC and HDFC Bank is expected to lead to value creation for their shareholders owing to business synergies, larger assets, and cross-selling opportunities.
10. Gain Tax Advantages
There can be tax benefits associated with M&A deals, especially when the acquirer can utilize the target company’s accumulated losses to offset its profits and reduce taxes. It could utilize the losses of these steel assets to lower its taxable income.
Key Takeaways on Mergers and Acquisitions Benefits
Mergers and acquisitions offer strategic advantages for companies looking to grow quickly, enter new markets, add capabilities, consolidate fragmented industries, and provide better shareholder returns. M&A deals provide rapid access to resources and capabilities that would otherwise take years to build organically.
However, successful integration and realization of synergies are critical to achieve the anticipated benefits. Companies must have robust post-merger integration plans to bring together disparate cultures, systems, and processes. Deep due diligence and careful valuation are also needed for deals to pay off.
When done right, mergers and acquisitions can create tremendous value for stakeholders and provide companies with a competitive edge. The Indian economy has seen an increasing trend of M&A deals across sectors as firms pursue strategic expansion and growth.
