Mergers and Acquisition: A short primer - Views on News from Equitymaster

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Mergers and Acquisition: A short primer

Jan 5, 2010

Marico bought Code 10 from Colgate Palmolive. Surprising this acquisition was made in Malaysia. Why are we seeing a sudden spurt of acquisitions by FMCG companies? One reason is that FMCG companies are sitting on a pile of cash. And they don't want to go the whole hog in investing in new product development. Especially at a time when some well known brands are available for cheap. Not to forget the distribution infrastructure they come equipped with. This trend was started by Tata Tea with the big ticket acquisition of Tetley in 2000. Over the years, we have seen several home grown FMCG companies acquiring brands and companies overseas. In this series of articles we will explore what mergers and acquisitions (M&A) are all about.First what is the difference between mergers and acquisitions? Simply put, a merger happens when two companies agree to operate together under the same ownership. Ideally, both companies are of similar size. Both companies in this case surrender their shares and new shares are issued. An acquisition happens when a company takes over a company and establishes ownership over that company. Typically, the company which is acquired or the target company ceases to exist as a separate entity. An example can be Corus which ceased to exist when it was taken over by Tata Steel. Today the company operates as a 100% subsidiary of Tata Steel.

What are the reasons for M&A?

Economies of scale: A company can merge or acquire for achieving economies of scale. This means that a company can lower its costs by removing duplicate departments and processes used in the same product or same service. Moreover, when it comes to buying, size matters. A company placing a larger order is in a position to bargain and can negotiate lower prices for everything from stationary to new IT equipment.

Increase revenue or market share: A company may decide to acquire a competitor company or brand. This will help increase the company's revenues and market share. An example can be Marico's acquisition of Nihar from HUL. HUL was not able to devote sufficient resources to Nihar which is a coconut oil with a strong consumer base in Bihar. Marico being weak in this region was able to acquire this brand and increase its revenue and market share while at the same time eliminating a competitor.

Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by reducing their tax liability. In such a case when the target company is loss making, the accumulated losses get added to the acquirer's profit, resulting in lower effective tax payable.

Geographical diversification: A company may acquire another company to grow in other regions. An eg can be Marico's takeover of Enaleni Pharmaceuticals Consumer Division (Pty) Ltd. in 2007. This company is one of the top players in the hair care segment in South Africa. By acquiring this company, Marico owns an established brand as well as a distribution network to leverage its portfolio.

Vertical integration: Vertical integration is when a company merges or acquires a firm which is upstream or downstream to it. Such integration helps in controlling double margins. Moreover, in case either of the firms is a monopoly and controls the output at a monopolistic level, it results in deadweight loss. Once integrated, the firm's output can be set to competitive levels resulting in increase in profitability for the combined entity.

Knowledge: Today, several products and processes are patented. However, sometimes it so happens that the company owning the patent is not able to exploit its potential as it may be unable to devote proper resources to it. As a result, this firm can be acquired or merged by a larger company which can use this patent and exploit the revenue from it. This can also take place in case of a unique asset. An example can be Tata Tea's takeover of Mount Everest Mineral Water (MEMW). MEMW had an aquifer which is a source of pristine and pure water from the Himalayas. However, they were unable to fully exploit this resource. Tata Tea acquired this company in 2007 and has been able to increase the revenue from this resource.

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