The Delicate Balancing Act of Mergers and Acquisitions: Strategic Acquisitions and Unforeseen Post-Transaction Challenges
Mergers and Acquisitions (M&A) are strategically very crucial decisions taken by any business considering their long-term impact on not only the revenue of the combined entity but also the returns for investors/shareholders of all the businesses. Considering its importance, M&A processes are carried out cautiously by the top management of the businesses, investment bankers, lawyers and due diligence teams whose expertise lies in smoothly closing the M&A transaction (M&A is referred to as a transaction because either cash and/or shares are exchanged for the shares and/or assets of another company). Despite the presence of so many experts, all deals are subject to post-transaction risks which could manifest in many ways such as legal issues, reputational disasters, the combined company’s failure to deliver the results and many more. One of the most interesting and live case studies regarding this risk is the Microsoft-Activision Blizzard transaction which is facing scrutiny by regulators across the world. In this article, we will discuss the M&A process, in particular – the strategic acquisition process, and post-transaction risks where we discuss the Microsoft-Activision Blizzard case briefly.
All M&A transactions in general go through 3 phases: (1) Strategising, (2) Executing, and (3) Closing and Integrating
As the titles clearly explain, the first strategising phase involves taking the decision whether or not to go ahead with an M&A transaction. Based on the acquirer’s stage of the business lifecycle, current cash balance, value of shares (if traded publicly) and the ability of the company to independently generate future revenue and cash at historical growth levels, a decision is made by the top managers whether a merger or an acquisition will be a good option or not. Ideally, if a company is heavy in cash balance or has shares which are trading at an overpriced rate (not true for all cases but most of the cases), they would prefer going for an acquisition of another company. The rationale for such a decision is that, if a company is holding a high cash balance, then they have to pay corporate tax on that cash (the corporate tax rate differs from country to country but is usually around 20%). And if the shares are overpriced, the company may want to exploit it for acquiring a company with lower PE (price to earnings) ratio to make the transaction and hence, the value of the combined company higher. This may sound confusing at first but the concept is very simple. Let us understand this with an example:
Acquiring company A, with a $100 profit, has a share price of $20 and 500 outstanding shares. Its PE ratio is 20/100=0.2. It is aiming to acquire company B, with a $100 profit, a share price of $10 and 500 outstanding shares (PE ratio: 10/100=0.1). If company A acquires company B then, in simplest terms, the combined company’s profit will be 100+100=$200, outstanding shares will be 500+500=1,000, and the share price should be that of company A which is $20 because company B is now a part of company A. However, the price of shares is determined by shareholders. If they perceive this acquisition positively, they might price in the future growth possibilities. In this case, the share price for the combined company will be pushed higher than $20 going to say $25. Now, if we calculate the market value of the three companies, we understand how Company A has exploited its high share value and Company B’s acquisition to increase the overall value of the combined company. Market Value of A: $20×500 shares=$10,000; Market Value of B: $10×500 shares=$5,000; Market Value of A+B at $20 share price: $20×10,00 shares=$20,000; Market Value of A+B at $25 share price: $25×1,000 shares=$25,000. The combined company’s value is clearly higher by $5,000. Let us also see how the PE ratio changes. PE of A: 0.2; PE of B: 0.1; PE of the combined company at $20 share price: 20/200=0.1; PE of the combined company at $25 share price: 25/200=0.125. Hence, in reality, this transaction is slightly beneficial for Company B’s shareholders but not Company A’s shareholders because their PE will fall from 0.2 to 0.125 or 0.1.
The above example is super simplified for concept clarity. In reality, every acquisition is made to generate high profits or revenue (the idea is 1 plus 1 should be more than 2 and not 2).
Strategising will involve considerations such as growth, future plans, return to investors, exit for financial investors, brand image, etc. In this stage, a decision is made on what is the best course of action – M&A, LBO, fundraising, etc.
Execution involves actions such as identifying and reaching out to target companies for acquisition, evaluating the valuation of combined companies, synergies, etc. Once the valuation has been fixed and the buyer and target are both interested to go forward with the transaction, due diligence is conducted (due diligence involves financial, tax, commercial, and legal due diligence) to ensure all information is correct, within the state laws where the companies are based, valuation is correct, no violation of any rule, etc.
Once all the nitty gritty is checked, the transaction has to be closed. In this stage, the regulators are informed of the transaction, approvals are taken and finally, the public is made aware of the transaction through press releases. But the transaction does not end here.
In the end, the two companies are integrated at the ground level where logos are changed, internal systems are merged, etc.
Closing and integrating are one of the MOST IMPORTANT phases of the transaction because a failure at this phase can have disastrous consequences. The reputation gets affected, the share price might plummet, governance issues may lead to a future collapse of the combined company and many more consequences.
No banker or lawyer wants to deep down face a post-announcement failure of a transaction because it not only affects the banker’s or lawyer’s reputation but also impacts their fees in some cases. Hence, closing and integration are also closely watched and executed by the entire M&A team including the top management of the two businesses.
Microsoft-Activision Blizzard Transaction case study
The Microsoft-Activision Blizzard transaction gives us a live example of the regulatory hiccups that may come after the announcement of a transaction. Let us briefly understand what is happening with this transaction. In January 2022, Microsoft announced its $69bn acquisition of Activision Blizzard, a gaming studio business. The transaction was one of the biggest in the gaming space for Microsoft. Hence, it grabbed the attention of global media. But it also came into the radar of regulators around the world. Video gaming is a relatively newer and less regulated area. Hence, some regulations are vague in certain jurisdictions. This complicated the post-transaction announcement process for Microsoft and Activision Blizzard. If we keep the transaction rationale and importance aside and only focus on how regulatory scrutiny is delaying the final closing of the transaction, we understand how crucial the closing and integrating phase is. The following summary of the challenges faced by Microsoft from regulators across post-announcement:
- The Competition and Markets Authority (CMA) of the UK requested the court to halt this transaction since it was scrutinising Microsoft’s anti-competition motives through this transaction.
- The US Federal Trade Commission (FTC) submitted a lawsuit to block this transaction considering Microsoft’s history of acquiring gaming studio businesses and then making the games exclusive on Xbox (Microsoft-owned) and not other platforms owned by other providers. This violates competition laws. Although Microsoft put out a statement they do not intend to make Activision’s games such as Call of Duty exclusive to Xbox but also set on PlayStation if that’s the case, they have to go through the scrutiny.
- European Commission also started investigating the transaction from the viewpoint of whether the price of games would increase for competitor’s consoles or whether games will be released late in other consoles.
These investigations have delayed the complete closing and integration of the two companies by almost 1.5 years now. There were many instances where it felt the transaction would fall apart which hurt the share price of the two companies. But now it seems they will get approval from regulators soon but only time will tell.
In conclusion, M&A is a very complicated process which involves strategic decision-making, experts from all dimensions and careful execution to make it a success. From the company’s point of view, careful evaluation of the impact and consequences of the transactions are to be considered. Strong risk management must also be set up to avoid massive mishaps. From an investor’s or shareholder’s point of view, a careful evaluation must be made of any transaction announcement before making a buy or sell decision-based solely on sentiment. While market sentiment tracing so to say is profitable for the short term for some expert traders, vouching on valuations and event studies (tracking the share price of the two companies for a certain time before and after the transaction announcement) is crucial to avoid substantial losses.
Disclaimer: The information provided in this article is for educational and informational purposes only. It does not constitute financial or investment advice, and readers are encouraged to consult with their own financial advisors or professionals before making any investment decisions. The examples and case studies discussed are simplified for illustrative purposes and may not reflect the complexities involved in actual M&A transactions. The article highlights the importance of careful evaluation, risk management, and due diligence in M&A processes while acknowledging the inherent uncertainties and potential risks associated with post-transaction outcomes. The Microsoft-Activision Blizzard case study is used to exemplify regulatory challenges in M&A, but its specific details and future developments may evolve beyond the scope of this article.
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