Merger and Acquisition Approaches

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Definition: Merger and Acquisition Approaches

A merger occurs when two or more firms joins together and results in the formation of one firm that has the identity of one of the firm which was a party to the merger. Generally the balance sheet of the smaller firms is merged into those of the larger firms.

There are two approaches to mergers:

1. Horizontal:

When two companies competing in the same industry merge or join together, it is known as horizontal merger. This kind of merger has sometimes very large effect and sometimes very little effect on the resulting company. If two very small companies merge together to form one company the resulting net result is very negligible whereas the effect of two very big companies merging together has a big effect on the resulting company. Suppose when a small grocery store merges with another grocery store, the net effect of this type of merger on the whole grocery store market will be very little and vice versa in the bigger markets.

2. Vertical:

When a company combines with its wholesalers, distributers or supplier, it is said to be a vertical merger. This type of merger can be viewed as anticompetitive because it can often rob supply business from its competition. If a business is receiving material from two different suppliers, and takes over both the firms, this kind of deal will lead to a vertical merger and it could cause the contractor’s competitors to go out of business.

When a firm is purchased by another firm, by either purchasing the shares of the other firm or by purchasing the assets of the other firm is known as acquisition.

There are two kinds of Acquisition:

1. Valuation

The valuation method of acquiring the firm is used when the company wants to acquire an established company; in this case the target companies are valued on the basis of their balance sheets and the company with the highest valuation is picked from the pool of companies to be acquired.

2. Ratios

In ratios approach the most commonly used ratio is P/E ratio i.e. priceearning ratio. It is calculated by dividing the market value per share by its earnings per share. Higher the price earning ratio, higher is the probability of earning in the future. In case of acquiring a company, the company with the higher P/E ratio is selected from the pool of companies from the industry.

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