Mergers, acquisitions, and other ways companies join forces

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Mergers and acquisitions (known collectively as M&A) are transactions that bring together two businesses. The terms mean different things: A merger is usually the combination of two businesses of about equal strength, while an acquisition is the purchase of one company by another—typically a bigger one buying a smaller one.

If you’re a shareholder in a company that goes through a merger, you may end up receiving shares in the new company. If you own an acquired company, you will either receive cash for the stock you own or shares in the acquiring business. If you own shares in the acquiring company, nothing changes except that the value of your shares might change—for better or worse.

The accounting and legal structures of mergers and acquisitions are complicated. M&A is a major change in corporate strategy that carries big risks and big rewards.

M&A transactions fall into three main strategies:

All three transaction types can help companies grow their market shares, customer bases, and product offerings. They can also lead to reduced costs through economies of scale and supply chain integration while giving some diversification benefits. M&A can help a company enter a new market quickly and offer a faster way to develop technology than doing it in-house. Some companies even use M&A as a way to add key employees from the acquired company.

Mergers and acquisitions are complex. A good transaction starts with a strategic analysis that looks at how the acquisition complements the company’s business in terms of sales, expenses, finances, geographic fit, and cultural fit. Many transactions look great on paper, but the people who need to work together to make the deal work may not get along.

Once a target has been identified, the parties commit to due diligence—an investigative review of financial, legal, and operational issues that’s used to help determine the fair value of the transaction.

Finding and negotiating mergers and acquisitions is difficult. Investment banks and law firms often specialize in this work, but even with experts’ careful analysis, things can go wrong. One party may hide damaging information. Another party may be overly eager to get a deal done. The cultures of the two businesses may be completely different; the new coworkers might not get along, or they may even sabotage the deal. Executives often talk about the synergies that will emerge from an M&A transaction, but unless they can enumerate and value these synergies, the expected benefits may be little more than wishful thinking.

Even when the deal works in terms of business and culture, it can be dragged down by the debt needed to make the acquisition. For example, AT&T (T) acquired Time Warner in 2018, in part paying with borrowed cash and taking on Time Warner’s debt. The deal left AT&T with $180.4 billion in debt, which it struggled to pay down. In 2022, AT&T spun the Time Warner assets off into a new company, Warner Brothers Discovery (WBD), removing some of that debt from its balance sheet.

Most mergers and acquisitions fall short of their stated objectives. Companies often overbid to close a deal, and chief executive officers are often overly confident about their ability to manage culture clashes.

Over the years, there have been numerous M&A deals that took a toll on the companies involved as well as their shareholders. About two decades before AT&T bid for Time Warner, Internet darling America Online—now known as AOL—purchased the legacy media giant for a stunning $350 billion, making it one of the largest merger deals of all time. But the 2001 merger became a case study on failed M&A deals, and in particular, shows how chasing short-term profits and failing to consider corporate culture can result in disaster.

Other notable botched deals include Hewlett-Packard’s 2002 purchase of computer manufacturer Compaq for $25 billion, automaker Daimler-Benz’s $37 billion acquisition of Chrysler in 1998, and the 2004 combination of mass-market retailers Sears and Kmart for $11 billion.

Investment banks specialize in organizing and financing mergers and acquisitions. Among them are Goldman Sachs (GS), Morgan Stanley (MS), and Bank of America (BAC), which work with large companies. Then there are niche players, such as Allen & Company, that work with entertainment companies, or CBRE Group (CBRE), which focuses on real estate. Many hedge funds and private debt funds finance M&A, and private equity funds often organize combinations of their portfolio companies or use M&A as an exit strategy.

In 2023, the largest deals involved companies buying in the same industry. Exxon Mobil (XOM) bought Pioneer Natural Resources; Chevron (CVX) purchased Hess. Pfizer (PFE) purchased Seagen, which develops cancer treatments, and Oracle (ORCL) purchased several businesses, including data analytics company Splunk.

Mergers and acquisitions grab headlines. When the transactions succeed, they lead to new ideas, greater operating efficiencies, and growing profits. When they fail, they destroy businesses and create large shareholder losses.

To ensure success, would-be partners need to think through the strategic and cultural issues before the transaction takes place, and they must be careful not to pay too much.