 Hello and welcome to this session in which we'll discuss the concepts of mergers and acquisition. Oftentimes, these terms are used interchangeably. In this session, we'll kind of define them a little bit more and dive into the different types of mergers and acquisition. What is a merger? It's a business strategy that involves combining two or more businesses into one entity. So we have two businesses and they combine together into one entity. An acquisition is a corporation action with one company, the acquirer or the purchaser. You have one company that's the purchaser. Purchases most of all the company's target. You have a target or if you have an acquirer, you have an inquiry. You're acquiring someone else. How? By buying dossiers to gain control. So an acquisition is when one company buys another company. That's what an acquisition is. An example will be Facebook buying Instagram or Microsoft buying LinkedIn. That's an acquisition. Mergers when two companies merge together and they form a single entity. Most commonly, why do companies do this? Why do they perform mergers and acquisition? Usually to expand the company's reach, expand into a new segment, gain market share, reduce costs. And we're going to look at different reasons by looking at different type of mergers and acquisition. Which are horizontal combination. We could have a vertical combination, horizontal, vertical. We could have circular. We could have diagonal combination. We also will talk about tender offer and purchase of asset as form of acquisition. As you might know, every time we have a list with Farhat, we're going to go through each concept separately. I'm going to talk about what's a horizontal combination. Give you a real-world example, advantages and disadvantages of each. One of them including tender offer and purchase of asset. Let's go ahead and start with horizontal combination. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead. Start your free trial today. Horizontal combination is also known as horizontal merger or horizontal integration. It's a strategy where a company acquires or merge with another company that operates at the same level in the industry. Typically, this kind of combination happens between two firms that are direct competitors that are offering similar goods and services. You might be saying, why would you do that? The primary objective of that is to achieve economies of scale. Basically produce more at a much harder level, at a much larger level. Reduce competition. When you have two companies merging together, they become a large company. They can have more market share. They can expand product or service lines. They can increase market share. And this is why you will do that. A classic example is the horizontal integration merger of Exxon and Mobile in 1999. They were both where oil companies operating in the same industry and directly competing with each others. After the merger, it becomes Exxon Mobile, creating one of the world's largest companies. Now we're going to talk about advantages and disadvantages for each type of merger starting with horizontal combination. Advantages, obviously economies of scale. We talked about this. It means you also could reduce cost. When you operate and produce more with the same fixed cost, your operating cost goes down, lower cost. And lower cost can be quoted as a reason or as an advantage for all type of merger, if you would like to. Lower cost, increased market share. That's the reasons you could always quote. Or you could always use as a reason for the merger. Increase market power. Here you want more market power. Two companies, they're combining together. They become a larger company. Reduce the level of competition and give the merge entity greater power over pricing, which can lead to increase profitability. Because remember, once you are monopoly or quasi monopoly, you could increase your profit. You could have synergy by combining resources, skills, technologies. R&D companies can achieve synergy that result in improved operational efficiency and innovation. Simply put, you have now two companies, basically two brains working together. Diversification, horizontal combination can help companies diversify their product or services. Why? Because you could have services that the other company don't have and vice versa. Reducing their dependency on a single product or market. There are disadvantages for horizontal combination. One of them is regulatory oversight. Horizontal merger often face significant regulatory due to antitrust laws. Antitrust laws is monopolies laws where they are designed to prevent the creation of monopolies and maintain competitive advantage. A lot of time, two companies, they try to merge and the SEC and the government says, no, you won't do it because it becomes a monopoly. There could be integration challenges. Merging two companies can be complex and challenging. Different culture, different accounting information system, different information system, computer information system. It involves integrating different corporate culture, system and processes which can lead to employee dissatisfaction and reduce productivity. The risk of reduced competition while increased market share can be an advantage. It can be disadvantage for consumer leading to higher prices and less choices because now you have the bargaining power as with the company, not with the buyer. Potential job losses. To achieve economies of scale and you might have to eliminate certain redundancies because of the same position of both companies and you combine, well, guess what? You're going to lay off some people. So it could lead to job losses. We could have social and economic consequences and it could reduce the morale at people who are staying because they don't want to see that their coworkers, their friends leaving the company. This is horizontal combination. Let's talk about vertical combination. Vertical combination or vertical integration is a business where a company takes control of multiple stages of the production process. Now the production process could start with R&D, then you can manufacture, then you have to supply it, then you have to, you know, there's a payment system, so on and so forth. So there's a series of steps. This could mean a company acquires another business operating at a different level in the industry supply chain. Either upstream or it's just called backward. Basically you can buy your supplier or raw material producer or you can buy companies what's called downstream or forward, basically by a distributor or retailer that's going to sell your product. You have the product done. Now you are going to sell it downstream or forward. You will buy it. Example is Apple computers. Apple designs, manufacture, market and sells its product directly to consumer through Apple owned retail stores and online. That's a vertical combination. This integration from product conception to consumer sales allow Apple a high degree of control over its supply chain quality, cost and customer experience. Apple is a good example. It's a classic example for a successful vertical combination. There are always advantages and disadvantages. Again, we talked about the advantages, control over the supply chain, guaranteeing distribution outlet, controlling cost, controlling quality. That's good. Always cost efficiency is a reason by owning different stages of the supply chain. You can eliminate the need to mark out of other firms leading to cost saving to the consumer quality control. You're in charge of the whole process. You have a direct oversight. Apple would have direct oversight from R&D until the product reaches the consumer's hand. So therefore they can learn a lot about their mistakes through the process, resulting in improved product and better customer service. Better coordination because now it's the same company. So vertical integration lead to better coordination between different stages of the production and distribution. They can communicate with each other, respond very quickly. There are also disadvantages. One is reduced focus. Not Apple is a great company, but that's not how vertical integration work. I'll give you the best example. Sometime what happened, expanding into different stages of the supply chain may spread the company's resources and management. Why? Because now they have to worry about the production, the supply, the retail, leading to less focus on its core competency. So whatever they do the best. Now they can't focus on that because they have to focus on different things, which is you're no longer specialized. Increased risk. Owning more stages of the supply chain can expose a company to business risk. Now you have another risk to worry about, such as volatility in raw material prices or industry specific risk at different stages. Now you own that risk. You cannot go somewhere else because you're the company, you're the supplier, limited flexibility. Being tied to its own upstream and downstream, the company may find it challenging to adapt the changes. Let's assume another company can do the same work either upstream or downstream at a much lower cost because they're better at it. Well, you're stuck. Now you own your own company. You can just switch. You have to sell your company. We'll talk about that later. Large investment required. When you do vertical integration, you need a capital investment. You need a lot of money to either buy or acquire or establish those operations. And this is going to cost money, time, resources, your employees. You'll have to send them to train other people to learn the process. So it's a large investment required. Another combination is called circular combination or conglomerate merger occur when companies operating in a different industries or completely unrelated businesses come together to form a single entity to form a single entity under one management. The main objective is to diversify business operation, reduce risk and exploit potential synergies between the two operation. A classic example is the merger of Walt Disney and ABC television in 1995, which is basically just two different businesses. Disney, a leading player in the entertainment industry and ABC was a television network operate in different yet related industries. The merger allowed Disney to diversify its operation into television broadcast and ABC to access Disney's extensive content library. This is a circular combination. They're not related in any way, not vertical, not horizontal. It's a circular. They're under the same management. Again, you could always quote. Now they have they need only one top management, right? Advantages. Diversification. We talked about this. Cross promotion. That's really good. Cross promotion is really good. You can leverage cross promotion opportunities. For example, Disney can promote their movies through ABC television creating synergies between the two entities. Financial efficiencies, a.k.a. cost saving. You have a better access to capital and can allocate resources more efficiency across businesses based on the profitability and growth prospect. Again, cost reduction. It's a good thing. It could always good for combinations. Disadvantages. Well, complex management. Now management. They're used to either running Disney or ABC. Now they have to run both companies at the same time. Making it conglomerate can be challenging due to due to the diversity of operation industries and market because now you have to know you have to have knowledge in both companies in both industries. The complexity of managing multiple unrelated businesses can result in inefficiencies and mistakes. Also, you could you could have regulatory issues because conglomerate in some countries they're not well liked lack of focus. Again, which companies am I focusing on more? Is it ABC or is it Disney? Maybe you lose focus on the core business due to the diversified interest. Also, you could have that thing could blow up in your face, you know, potential for negative synergy. Well, the goal is to create positive synergy. Sometimes the diverse nature of operation can result in negative where the whole is less than the sum of its part. Okay, so simply put management time and attention of management can be divided or resources may be inefficiently allocated due to the lack of understanding of different businesses. You thought it's a good synergy, but it's really not. Let's talk about diagonal combination or integration occur when a company acquires or merge with another company that provides related but different services related but slightly different services or operates in a related but different stage of the supply chain. So either or either or this form of integration is a combination of horizontal and vertical integration. It's a bunch of things. The main aim of this type, this type of combination is the leverage of the synergies created by combining different but related operation and to gain a competitive edge. An example would be Amazon acquiring whole food. What's the purpose of this Amazon? The primary purpose is to for Amazon, which is an online retail platform to expand into the brick and mortar grocery business by acquiring whole food. They can start from the beginning, but they really want whole food as brick and mortar where they could also get their product of the online selling to the consumer. Well, both businesses are in the retail industry. They operate in distinct but related segment. All Amazon is known for its online whole food is brick and mortar a physical store. So they this is a diagonal combination. Amazon leverage this merger to expand its grocery delivery services combining its expertise in online retail with whole food physical retail presence and supply chain. Advantages and disadvantages. Leveraging synergies, of course, diversification. Now you have more than one business. You have online business and brick and mortar, which is, you know, diversify your revenue stream, competitive advantage by integrating a company can often create unique competitive advantage. Everybody wants to buy from Amazon because also if you buy from Amazon, you have access to your grocery or if you go to a whole food, you'll just buy from Amazon and pick up your stuff at whole food. Disadvantages, integration challenges, bringing together related but different operation can be complex. And we saw that and may face difficulties in blending different corporate cultures, operations processes, accounting information system, computer system and business models. Risk of distraction, which is lack of focus expanding into the into the new but related areas can distract company from its own core business, which is Amazon online selling potentially leading to underperformance in its operation. Increased complexity, managing a broader range of operation can increase the complexity of the business requiring more sophisticated management skills and system and that's why management is very important when you look at a company. How well is management regulatory hurdles similar to other type of combination you could face regulatory hurdle and what's the problem too much power too much power means monopoly. You could have significant market power, which is government don't like this. Let's talk about when one company wants to buy another company, how else can they acquire it acquisition they can do what's called the tender offer. What is a tender offer. It's a formal public proposal public proposal made by an entity usually company to buy a specified number of shares of another company directly though from the shareholders. So you're not asking management to make a decision whether they want to sell themselves or not, you go to the shareholders and look, I'm willing to pay you this much usually at a fixed price. This is typically strategy used in takeover attempt, especially in cases where management of the target company is resistant to the takeover. The purpose is to directly appeal to shareholder bypassing the target company's management and board of directors. If the shareholder find it attractive, they can decide to tell with the cell, which is the tender that's what's called their shares to the entities making the making the offer. If enough shareholders accept the entity can gain control over the target company. Well, let's see what happened here. Microsoft, they wanted to take over Yahoo in 2008. They proposed a tender offer for the total of 44 billion to buy Yahoo looking to strengthen its position in internet search, which is they could have been a bad idea. Then Microsoft created Bing. And that's also wasn't that good as well. Microsoft offered to buy Yahoo share at a premium of 60% above their market price at that time. Aiming to incentivize Yahoo shareholders to sell their shares. The management refused the offer believing it's undervalued the company and the deal ultimately did not go through because most of the shares were in the hands of the management of the founder of Yahoo. That's why it doesn't go through. So it's not they have to go through management. Management owned the share. Also, you can do an acquisition rather than buying the stocks of a company by owning the company, owning. What you can do is you can purchase the asset. You can pick and choose which asset, which division you want to buy. You're not buying the whole company. You're buying pieces of it. And an asset purchase, the buying company requires only certain asset of another company, not the company itself. They can choose which asset it wants to buy, therefore avoiding unwanted assets or liabilities. Assets include physical asset or intellectual property like brand name, customer list. A good example, Microsoft bought Nokia devices and services division in 2013. They essentially perform an asset purchase buying specific asset and leave in the rest of Nokia intact. We don't want you just want that specific division asset. Advantages, ability to pick and choose what you want, which assets and liabilities to acquire can be structured to limit the legal liabilities associated with the purchase of assets because you don't want the liabilities. It can often be less expensive. You're not buying the whole company income less complicated than a full acquisition. Disadvantage, transferring asset can be complex, especially when dealing with intangible asset or asset with liens, with loans. You may not receive the full benefit of an integrated business because you're only buying part of the business. Employees contract and licenses may automatically transfer with the asset and may require additional agreement, which is additional headaches. This is when you do an acquisition. You can just purchase an asset in the assets owned by the whole company. What should you do now? Go to the FARHAT lectures to learn about this mergers and acquisition and do what? Work additional MCQs that's going to help you understand the difference between mergers, acquisition, the different type of mergers that you learn about, horizontal, vertical, circular, so on and so forth. Good luck, study hard and of course stay safe.