Takeovers, mergers and buyouts

When starting a business, or running it for a long time, you should expect that the structure of the company won’t be the same forever. There are a lot of tendencies, way of its development & among them there is such a phenomena as takeovers & mergers.

When a company wants to introduce new products & services there are two options for it to do it. Large companies have the choice of innovating – developing new products, services or market themselves – or of buying another, smaller company with successful products. If the other company is too big to acquire, another possibility is to merge or amalgamate with it. Another reasons for taking over or combining with other companies include reinforcing your company’s position, reducing competition, diversifying production, as well as rationalizing the use of a plant or invested capital, & also searching for synergy (that means the belief that together the companies will produce more than the sum of the two separate parts).

A company that wants to grow or diversify can launch a raid- in other words, simply buy a large quantity of another company’s shares on the stock exchange. Usually the aim is to persuade enough other shareholders to sell to take control of the company. A “dawn raid” consists of buying shares through several brokers early in the morning, before the market has time to notice the rising price, & before speculators join in. This will immediately increase the share price, & may persuade a sufficient number of other shareholders to sell for the raider to take control of the company.

If a raid is not, or would not be, successful, a predator can make a takeover bid: a public offer to a company’s shareholders to buy their shares, at a particular price during a particular period. A friendly takeover has the consent of the directors of the company whose shares are being acquired; a hostile takeover bid is one undertaken against the wishes of the Board of directors. Defenses against a hostile takeover include the poison pill – a defensive action taken to repel a raider, such as changing the share voting structure or the Board of directors, or spending all the company’s cash reserves. If measures such as these do not work, a company can at least attempt to find a white knight – another buyer whom they prefer.

There are different ways of merging. It can be a horizontal integration when a company takes over other firms producing the same type of goods or services. A vertical integration is a company’s acquisition of either its suppliers or its marketing outlets (wholesalers or retailers). A merger with one’s suppliers is called a backward integration, whereas a merger with one’s marketing outlets is called a forward integration.

There are a lot of arguing in favour & against mergers & integration. Those who like this idea say that a large company will have a stronger position on the market, while entering new markets with new brands is generally slow, risky & expensive. They believe that innovation is more expensive than acquiring or merging with other successful innovative firms, that it’s a good way for a company to reduce competition.

But there are a lot of arguments against mergers. Among them there are such thoughts as conglomerates may become unmanageable & fail to achieve synergy, diversification may dilute a company’s shared values, it’s argued that a company’s optimum market share is rarely very large.

One more indication that the people who warn against takeovers might be right is the existence of leveraged buyouts (LBOs). When in the 1960s a big wave of takeovers in the US created conglomerates, mostly badly-managed, inefficient & underpriced, raiders were able to borrow money, buy them & then restructure, split them up & resell at a profit. Asset-stripping – selling off the assets of poorly performed or under-valued companies- proved to be highly lucrative.

Theoretically, there was little risk of making a loss with a buyout, as the debts incurred were guaranteed by the companies’ assets. The ideal targets for such buyouts were companies with huge cash reserves that enable the buyer to pay the interest on the debt, or companies with successful subsidiaries that could be sold to repay the principal, or companies in fields that are not sensitive to a recession, such as food & tobacco.

So this type of takeovers using borrowed money is called ‘leveraged buyouts’. Leverage means having a large proportion of debt compared to equity capital. (by the way when a company is bought by its existing managers, we talk of a management buyout or MBO). LBOs are often financed by junk bonds, but one can try to get an ordinary loan from a bank. These bonds are considered to be fairly risky, but which pay a high rate of interest. People buy them because the high returns generally compensate the risk of default.

Raiders argue that the permanent threat of takeovers is a challenge to company managers & directors to do their jobs better. The threat of raids forces companies to put capital to productive use. But on the other hand, the permanent expectation of a takeover or a buyout is clearly a disincentive to long-term capital investment, as a company will lose it if a raider tries to break it up as soon as its share price falls below expectations.

LBOs, however, seems to be largely an American phenomenon. German & Japanese managers, for example, seem to consider companies as places where people work, rather than as assets to be bought & sold. Hostile takeovers & buyouts are almost unknown in these two countries, where business tends to concentrate on long-term goals rather than seek instant stock market profits. Workers in these companies are considered to be at least as important as shareholders. The idea of a Japanese manager restricting a company, laying off a large number of workers, & getting a huge pay rise is unthinkable. Lay-offs in Japan are instead a cause for shame for which managers are expected to apologize.