Merger and Acquisition Analysis Key Terms

Delve into merger and acquisition analysis with these important key words

To properly analyze a merger, it is critical to know some of the basic characteristics of each merger. In analyzing mergers and acquisitions, the focus is on one question: does the merger create value? Focusing on the appropriate features of each merger or acquisition is critical to answering that question. The type of merger is very important. For example, a hostile takeover or a stock swap can have important side effects in terms of the success of the merger and the total value created. The payment method, whether stock or cash, is also a critical element of the value creation process.

Hostile takeover

Professionals label an acquisition a hostile takeover when the management of the target firm is opposed to the takeover. Hostile takeovers are more likely to fail, meaning the acquirer will not be able to buy the target firm. When a deal fails, the target's share price often drops and the trader will earn negative returns.

Stock swap

A stock swap is a merger or acquisition in which the purchased-or target-firm's shareholders trade their shares for shares in the acquiring firm. The trade is usually not one-for-one. The acquiring firm makes an offer to the target firm (based on the relative value of thet firm) and bases the stock swap offer on that value. This offer ratio is called the swap ratio. For example, if the swap ratio is 1:2, then for every two shares of the target firm, the shareholder gets one share in the acquiring firm.

Horizontal merger

A horizontal merger occurs when two firms that compete in the same industry merge. If the two firms merging are large, then a horizontal merger can trigger an antitrust investigation. Antitrust investigations can put a merger in jeopardy, so this type of merger is often perceived as riskier than other types.

Vertical merger

A firm buys another firm either above the acquirer or below the acquirer in the supply chain, creating a vertical merger. For example, if a firm that refines oil were to purchase a chain of gas stations, then that would be a vertical merger. Vertical mergers are more likely to be completed successfully than horizontal mergers because there is less of an antitrust concern.

Conglomerate merger

When two unrelated firms merge with each other, a conglomerate merger occurs. This is different from a horizontal merger because the firms are in different industries, and it is different from a vertical merger because the firms aren't related by the supply chain. Typically, a conglomerate merger creates the least value for the firms' shareholders in the long-run.

Acquisition premium

The acquisition premium is a critical driver of value creation. The premium is the value offered to the target firm's shareholders on top of the current market value of the target firm's shares. Often, the management and shareholders of the target firm will hold out for high premiums, so it is in the interest of the acquirer to carefully analyze the target ahead of time and ascertain a maximum price to pay for the target firm's shares.

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