Classification of Mergers and Acquisitions

The financial and operational consequences of mergers and the motive for the mergers are key aspects that management and analysts need to understand.

An acquisition occurs when a company purchases a portion or all of another company’s shares, effectively controlling it. A merger occurs when a company absorbs another company. Mergers are categorized by the form of integration.

Statutory Merger

In a statutory merger, one of the companies will no longer exist, and all its assets and liability are transferred to the purchasing company.

$$\text{Company A} + \text{Company B} = \text{Company A}$$

Subsidiary Merger

In a subsidiary merger, the target company becomes a subsidiary of the acquirer. The subsidiary merger occurs when the target company has a good brand among consumers, and the acquirer would like to keep it.

$$\text{Company A} + \text{Company B} = (\text{Company A} + \text{Company B})$$

Horizontal Merger

A horizontal merger occurs when companies in the same business merge. Horizontal mergers increase market power, and companies that execute horizontal mergers often want to experience economies of scale.

Vertical Merger

In a vertical merger, a target company is bought by an acquirer in the same production chain. The benefit of vertical mergers is that they give better control of the production process and cost savings. Backward integration occurs when an acquirer buys a target that is ahead of their value chain. In a forward integration, an acquirer buys a target that is a distributor.

Conglomerate Merger

In a conglomerate merger, an acquirer purchases a target that is not related to its core business. The motivation behind a conglomerate merger is company-level diversification to reduce the volatility of its cash flows.

Question

AMC is a steel manufacturer that is looking to acquire Dura, an iron ore mining company. If the merger is successful, this will most likely be an example of a:

1. Vertical merger and backward integration.
2. Vertical merger and forward integration.
3. Conglomerate merger.

Solution

The correct answer is A.

Because AMC and Dura are in the same production chain of manufacturing steel, and Dura is a supplier of iron ore used to make steel.

B is incorrect. While AMC and Dura in the same production chain, Dura acts as a supplier and not a distributor; hence there is no forward integration.

C is incorrect. This type of merger is vertical, not horizontal.

Reading 18: Mergers and Acquisitions

LOS 18 (a) Classify mergers and acquisitions(M&A) activities based on forms of integration and relatedness of business activities.