The Various Types of M&a Activity Explained

As we have discussed in some detail in various members-only Knowledge Base articles, mergers and acquisitions (M&A) are strategic business activities that involve the consolidation, combination, or acquisition of companies to achieve objectives such as growth, diversification, synergy, and market dominance.

In this unlocked Covering the Bases article, we instead search into the most common types of M&A activity, providing insights into their characteristics, benefits, and potential challenges; and then seek to compile a list of the most common calculations used to decide the suitability of of a business for investment.

CONGLOMERATE M&A

Conglomerate M&A refers to the merger or acquisition of companies that operate in unrelated industries. The primary motive behind this type of M&A is diversification, allowing companies to expand their presence into new markets and reduce risk by not relying solely on a single industry or sector.

Conglomerate M&A can offer synergistic benefits through the sharing of resources, knowledge transfer, and the potential for cross-selling opportunities.

This said, managing diverse business units and ensuring effective integration may present operational challenges; and that should be taken into consideration.

HORIZONTAL M&A

Horizontal M&A occurs when two companies operating in the same industry and at the same stage of the value chain merge or acquire one another.

This type of M&A aims to achieve economies of scale, increased market share, and enhanced competitiveness. By joining forces, companies can reduce redundant costs, streamline operations, and leverage combined resources to gain a stronger foothold in the market.

It is worth noting that this type of activity may mean larger corporates facing increased antitrust concerns due to the potential for reduced market competition.

VERTICAL M&A

Vertical M&A involves the consolidation of companies operating at different stages of the same industry’s value chain. For example, a manufacturer acquiring a supplier or a distributor merging with a retailer. Vertical integration allows for better control over the supply chain, improved coordination, cost efficiencies, and reduced dependence on external suppliers or customers.

Vertical M&A activity also poses challenges such as increased regulatory scrutiny, potential conflicts of interest, and the need for effective integration of different processes.

MARKET EXTENSION M&A

Market extension M&A involves the acquisition of a company operating in the same industry but in a different geographic market. By entering new markets through M&A, companies can rapidly expand their customer base, distribution network, and brand presence.

This kind of M&A activity offers significant growth potential and the ability to leverage existing expertise and products in untapped markets.

On the negative side, it is worth considering culture and values. Cultural differences, regulatory complexities, and market-specific challenges must be carefully navigated to ensure successful integration.

PRODUCT-BASED M&A

Product extension M&A occurs when a company acquires or merges with another company that offers complementary products or services.

This type of M&A allows for diversification within the same industry and enables companies to expand their product portfolio, gain access to new technologies or intellectual property, and achieve cross-selling opportunities. By the two entities combining product offerings, they can enhance their competitive position, potentially capture a larger market share, and in-turn drive revenue growth.

However, integrating different product lines, aligning branding strategies, and managing customer expectations can be significant integration challenges.

Within product, asset purchases are often used an an alternative to a full-blown corporate acquisition as it is often a far simpler transaction.

FORMULA’S OF NOTE

Below is list of the (approximately) 50 most common calculations used when deciding whether a business is a suitable candidate for M&A activity:

• Enterprise Value (EV) = Market Capitalisation + Total Debt – Cash and Cash Equivalents
• Equity Value = Enterprise Value – Total Debt + Cash and Cash Equivalents
• Price-Earnings (P/E) Ratio = Market Price per Share / Earnings per Share (EPS)
• Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) = Net Income + Interest + Taxes + Depreciation + Amortisation
• Debt-to-Equity Ratio = Total Debt / Total Equity
• Return on Investment (ROI) = (Net Profit / Investment) x 100
• Net Present Value (NPV) = Sum of Cash Flows / (1 + Discount Rate)^n, where n is the time period
• Internal Rate of Return (IRR) = Discount Rate at which NPV = 0
• Discounted Cash Flow (DCF) = Cash Flow / (1 + Discount Rate)^n, where n is the time period
• Capital Asset Pricing Model (CAPM) = Risk-Free Rate + Beta * (Market Return – Risk-Free Rate)
• Weighted Average Cost of Capital (WACC) = (Cost of Equity * Equity Weight) + (Cost of Debt * Debt Weight) + (Cost of Preferred Stock * Preferred Stock Weight)
• Synergy Calculation = Post-Merger Value – Pre-Merger Value
  Terminal Value (TV) = Cash Flow in the Final Year / (Discount Rate – Terminal Growth Rate)
• Free Cash Flow (FCF) = Operating Cash Flow – Capital Expenditures
• Market Value Added (MVA) = Market Value – Book Value
• Debt Service Coverage Ratio (DSCR) = Net Operating Income / Total Debt Service
• Return on Assets (ROA) = Net Income / Total Assets
• Return on Equity (ROE) = Net Income / Total Equity
• Dividend Discount Model (DDM) = Dividend per Share / (Cost of Equity – Dividend Growth Rate)
• Break-Even Analysis = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)
• Gross Profit Margin (GPM) = (Revenue – Cost of Goods Sold) / Revenue
• Earnings Per Share (EPS) = Net Income / Number of Shares Outstanding
• Book Value per Share = Total Equity / Number of Shares Outstanding
• Current Ratio = Current Assets / Current Liabilities
• Quick Ratio = (Current Assets – Inventory) / Current Liabilities
• Net Working Capital = Current Assets – Current Liabilities
• Debt Ratio = Total Debt / Total Assets
• EBITDA Margin = EBITDA / Revenue
• Price-to-Earnings Growth (PEG) Ratio = P/E Ratio / Earnings Growth Rate
• Return on Investment Capital (ROIC) = EBIT / (Total Equity + Total Debt – Cash)
• Payback Period = Initial Investment / Cash Inflows per Period
• Precedent Transaction Analysis = Valuation based on comparable transactions in the industry
• Comparable Company Analysis = Valuation based on similar companies in the industry
• Merger Arbitrage Spread = (Offered Price – Current Stock Price) / Current Stock Price
• Accretion/Dilution Analysis = Impact on earnings per share after the merger or acquisition
• Beta Calculation = Covariance (Stock Returns, Market Returns) / Variance (Market Returns)
• Terminal Growth Rate = Long-term growth rate assumed for perpetuity
• Dividend Yield = Dividend per Share / Market Price per Share
• Price-to-Book (P/B) Ratio = Market Price per Share / Book Value per Share
• Return on Capital (ROC) = EBIT / (Total Equity + Total Debt)
• Cash Conversion Cycle (CCC) = Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding
• Sensitivity Analysis = Assessing the impact of changing key variables on financial outcomes
• Leverage Ratio = Total Debt / EBITDA
• Cost Synergies = Cost savings achieved through the merger or acquisition
• Revenue Synergies = Increased revenue potential resulting from the merger or acquisition
• Earnings Yield = Earnings per Share / Market Price per Share
• Liquidity Ratio = Current Assets / Current Liabilities
• Terminal Multiple = Terminal Value / EBITDA
• Return on Sales (ROS) = Net Income / Revenue
• Break-Up Value = Liquidation value of a company’s assets after selling off its components

Mergers and acquisitions come in a number of forms, each serving a different strategic objective and offering unique benefits and/or challenges. As a result, understanding the different types of M&A activity is crucial to making good, informed decisions.

Whether pursuing horizontal, vertical, conglomerate, market extension, product extension, or reverse M&A, organisations must carefully evaluate the potential synergies, risks, and integration complexities associated with each type.

Likewise, understanding the drivers and numbers and drivers of the numbers are key.