With takeovers playing an integral and successful role in our investment strategy since our inception, It’s worth taking a stroll down memory lane to revisit some of the basics. There are a few reasons why one company would want to take over another. The bottom line for most is obviously growth. Companies aim to grow sales, earnings, dividends etc., all to increase the value of shares and ultimately the return to shareholders. At least, that’s the theory. In this article, I explain some common reasons for company takeovers.
1. Complementary Products and/or Services
A company may make a takeover bid for another company if the target company, for example, manufactures products that are complementary to the bidding company, or provides services that complement the bidder’s.
This can take two forms:
- Firstly, companies bidding for others in a similar business. An example is digital payments company Square’s (NYSE: SQ) acquisition of the buy-now-pay-later company Afterpay (ASX: APT).
- Secondly, a business may choose to buy another in the same industry that operates at a different point in the supply chain. For example, a mining company might buy a refining company to get the profits from two stages of the resource exploitation process. That is, the mining and the refining.
2. Fashion
Sometimes, companies make radical changes to their core business by buying a company in a completely different industry.
We sometimes see this happen during booms, with companies scrambling to get into the latest fashionable industry.
3. Rebirth
In some situations, companies will alter their core business. It’s rare, but on occasion a company may take the view that its core industry has no future and is in decline, so makes a complete change to its core activities via an acquisition.
4. Diversification
Sometimes, albeit rarely, one company launches a takeover bid for another with unrelated products and services, in an effort to diversify operations.
A good (if somewhat ancient) example of this was when Publishing and Broadcasting Ltd launched a takeover for Crown Casino in 1999. This was an example of a media company taking over a gaming company, which had totally unrelated products and services, apart from some marketing synergies.
5. Other Reasons
Takeovers sometimes happen for reasons that don’t always make sense to market observers. Sometimes a company may buy another to get access to certain intellectual property or to eliminate a potential competitor before they become too powerful. This is sometimes referred to as a defensive takeover bid.
Although these other reasons for takeover bids exist, most bids are launched to grow a company in the quickest and easiest way possible.
Summary
Time has shown that the long-term result of takeovers on the share price of the bidding company depends enormously on the quality of the deal, and the ability of management to merge the two organisations. Some bids are ultimately positive for shareholders, while many are not.
While there are infinite specific reasons for takeover bids, In this article I’ve listed just a few of the basic ones to get you thinking about the merits and pitfalls of company takeovers.
