20.2Types of Mergers and Acquisitions

There are probably almost as many types of mergers and acquisitions as there are bid-

ders and targets. However, investment bankers find it useful to define three different

categories of M&Atransactions:

•	Strategic acquisitions.
•	Financial acquisitions.
•	Conglomerate acquisitions.

Acquisitions also are often categorized as being friendly or hostile. An offer made

directly to the firm’s management or its board of directors is characterized as a friendly

takeover. However, the managers of the target firm often object to being taken over,

forcing the bidding firm to make a hostile offer for the target firm.

In a hostiletakeover, the acquirer often bypasses the target’s management and

approaches the target company’s shareholders directly with a tender offer for the

purchase of their shares. Atenderofferis an offer to purchase a certain number of

shares at a specific price and on a specific date, generally for cash. Although a tender

offer is usually associated with a hostile takeover, it also is used in friendly takeovers

when the target’s management approves the offer before it is presented to shareholders.

Strategic Acquisitions

In many cases, strategic mergers can be viewed as horizontal mergers. Most of the

mergers during the turn of the 20th century (1893–1904) would be classified as

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horizontal or strategic mergers. This was also the case during the period leading up to

the Great Depression.

Astrategic acquisitioninvolves operating synergies, meaning that the two firms

are more profitable combined than separate. In the 1990s, strategic acquisitions became

much more popular and they are now the dominant form of acquisition.

The operating synergies in a strategic acquisition may occur because the com-

bining firms were former competitors. Alternatively, one firm may have products or

talents that fit well with those of another firm. For example, IBM’s purchase of Lotus

in 1995 can be characterized as a strategic acquisition. IBM believed that Lotus’s

software products (in particular, Lotus Notes) fit well with the overall strategy of

IBM’s software business. The Philip Morris acquisition of Kraft, described in the

chapter’s opening vignette, would also be considered a strategic acquisition. Philip

Morris and Kraft could benefit by combining their efforts in selling and promoting

their respective products.

Financial Acquisitions

Investment bankers generally classify an acquisition that includes no operating synergies

as a financial acquisition. In a financial acquisition, the bidder usually believes that the

price of the firm’s stock is less than the value of the firm’s assets. In contrast to strate-

gic acquisitions, financial acquisitions have declined substantially since the late 1980s.

Afinancial acquisition is sometimes motivated by the tax gains associated with the

acquisition. Alternatively, the acquirer may believe that the target firm’s assets are

undervalued because the stock market is ignoring important information. The most com-

mon motivation for a financial acquisition, however, is that the acquirer believes that

the target firm is undervalued relative to its assets because it is badly managed. In most

cases, a financial acquisition motivated by the acquirer’s dismal view of target man-

agement is hostile. This type of acquisition is sometimes referred to as a disciplinary

takeover.

For example, T. Boone Pickens, the CEO of Mesa Petroleum, made a bid for Gulf

Oil in 1983. Pickens’s motivation was that Gulf management was expending substantial

resources exploring for oil at a time when the price of oil made exploration unprofitable.

He believed that Gulf’s stock was priced low because of this unprofitable investment

in oil exploration and that a change of management could change this policy. Although

Pickens failed in his takeover attempt, Gulf was subsequently acquired by Chevron,

which substantially curtailed its exploration activity.

Financial acquisitions are often structured as leveraged buyouts (LBOs). In most

leveraged buyouts, an individual or a group, often led by a firm’s own management,

arranges to buy a public company and take it private. Thus, all of the publicly traded

shares are purchased and the firm ceases to be a public company. These are referred to

as leveragedbuyouts because the transactions are financed mainly with debt.

Because the acquirers in LBOs have no other assets, there are no potential syner-

gies. Hence, operating improvements must come from better management and improved

incentives. Kohlberg Kravis and Roberts’s leveraged buyout of RJR Nabisco is the most

well known example of this type of acquisition.

Conglomerate Acquisitions

Athird type of acquisition, a conglomerate(or diversifying) acquisition, involves firms

with no apparent potential for operating synergies. In this sense, the conglomerate

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acquisition is similar to the financial acquisition described above. However,

conglomerate acquisitions are more likely to be motivated by financial synergies, which

lower a firm’s cost of capital, thus creating value even when the operations of merged

firms do not benefit from the combination. As we will discuss below, financial syner-

gies can arise because of taxes as well as because of the information and incentive prob-

lems discussed in Chapters 16–19.

Most of the mergers that occurred in the United States during the 1950s, 1960s,

and 1970s were conglomerate mergers. Apopular explanation for the predominance

of conglomerate mergers during that time was that regulators would not approve

most strategic combinations because of antitrust considerations. However, some

authors have noted that conglomerate acquisitions have also been common in coun-

tries without strong antitrust regulations.¹They have become much less common in

the 1980s and 1990s, reflecting either the loosening of antitrust rules that have

allowed more strategic combinations or an increase in the efficiency of financial

markets, which could have the effect of reducing the financial synergies associated

with a merger.

Anumber of large U.S. corporations were built up in the 1960s through conglom-

erate acquisitions. For example, ITT(International Telephone and Telegraph) was orig-

inally a communications company that developed and ran telephone systems in Europe

and Latin America. After ITT’s profits had been shaken by political risk, such as the

nationalization of ITT’s telephone system in Cuba, the CEO, Harold Geneen, recom-

mended in an internal document in 1963 that ITTadopt a policy of acquiring U.S. com-

panies. The first major purchase by ITTwas Avis Rent-a-Car, which was followed by

both big and small names. Bramwell Business College; the Nancy Taylor Secretarial

Finishing School of Chicago; Apcoa, the car-parking company; Continental Baking;

Pennsylvania Glass & Sand; Transportation Displays, the billboard rental company;

Hartford Insurance group; Howard Sams, the publisher; Levitt, the home construction

company; and Sheraton Hotels are just a few of ITT’s acquisitions. This diversification

strategy did not stop at the U.S. border. In France, for example, ITTacquired a pump

maker, two television set manufacturers, a lighting company, a contractor, and a

business school.

Many of the conglomerate acquisitions of the 1960s and 1970s proved to be unsuc-

cessful. Indeed, many of the disciplinary takeovers in the 1980s were initiated to break

up conglomerates formed earlier. For example, the RJR Nabisco leveraged buyout,

described in the chapter’s opening vignette, was first proposed as a bustup takeover.

The original plan was to separate the food and tobacco businesses. As it turned out,

some but not all of the food businesses were sold after the RJR Nabisco LBO. ITThas

also been the target of unwanted takeovers. Perhaps to preempt such takeovers, ITT

has sold off a number of the divisions acquired over the past 20 years. In 1996, ITT

split into three separate companies: an insurance business; an auto-parts and industrial

products company; and a hotel, casino, and entertainment company.

Summary of Mergers and Acquisitions

Exhibit 20.3 summarizes the three categories of acquisitions discussed in this section.

Note that individual acquisitions do not necessarily fit neatly into any one box. For

example, Philip Morris’s acquisition of Kraft is generally categorized as a strategic

¹See, for example, Matsusaka (1996) and Comment and Jarrell (1995).

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EXHIBIT20.3Types of Acquisitions

Type of Aquisition

Primary Motivation

Hostile or Friendly

Trend

Strategic	Operating synergies	Usually friendly	Increasing importance in the 1990s
Financial	Taxes, incentive improvements	Often hostile	Mainly a phenomenon of the 1980s

Conglomerate	Financial synergies, taxes,	Hostile or friendly	Mainly a phenomenon of the 1960s
	and incentives		and 1970s

acquisition. However, Philip Morris might have believed that an important source of

value in the acquisition was that Kraft was undervalued because of poor manage-

ment. If this were the case, the acquisition could also be categorized as a financial

acquisition.