Okay but laana:
What's up with these corporate marriages?
29th May 2021
Reading time ~ 4 minutes
Hi there,
Over the past week, there's been a lot of talk about Amazon acquiring MGM (yes, we're also thinking about the roaring lion), Gojek merging with Tokopedia, AT&T breaking up with WarnerMedia, and the likes. So for this week, we're going to dive into the world of corporate breakups and patch-ups a.k.a Mergers & Acquisitions (M&A), and talk about what it means for you.
Healthy relationships?
To start off, let's take the case of Amazon acquiring MGM Studios.
As you might know, Amazon has been aggressively growing its media side of the business through Amazon Studios and Prime Video. You can watch Amazon produced content (hello, Fleabag/ Marvelous Mrs. Maisel) or watch older content that they licensed from existing production houses like NBC, Warner Bros. etc on Prime. Now, Amazon Studios regularly produces movies, tv shows, etc. but producing new content takes time, effort, and a LOT of money. On the other hand, many of these production houses are already a part of huge media companies that now have their own streaming services, such as Peacock, Discovery+, limiting the content available to license.
Amazon recently reported that around 175 million folks watched content on Prime Video in 2020 - crazy! And Amazon wants these 175M users to keep coming back and continue watching content. It's not just because Prime Video is a good offering, but you could argue that it's because Prime video is bundled with the larger Amazon Prime subscription and the hope is that you won't just watch content but also buy something off of Amazon, using the benefits of Prime.
Enter: MGM
MGM is actually one of the few remaining studios that has stayed independent of large media companies, with classics like Rocky, James Bond, The Voice, Pink Panther, Shark Tank, and 4000+ other titles under its production. A quick and logical way for Amazon to bolster its content business would be to get the titles of MGM under its banner. This would entice users to continue coming back to Prime Video, and also benefit from any new titles that MGM produces. As you can tell, Amazon clearly sees merit in acquiring MGM.
You can read more about the merger here.
Okay, so what exactly are M&As?
A Merger or Acquisition (M&A) usually happens when two companies think that they can become more competitive in the market, be more efficient and grow better with the help of each other. For the acquirer (here, MGM) - there are similar benefits - access to Prime Video, where they can put their content, get valuable insights on their viewers, better growth prospects with Amazon's influence and money, and some $$$ for the owners (who have wanted to sell MGM for quite some time).
Now, in an acquisition, one company buys out and gets ownership of the other company. In mergers, two companies pool in resources and combine their businesses into one, with both maintaining some ownership, as defined in the contract. Indonesia's two biggest startups - ride-hailing giant - Gojek, and Tokopedia (an e-commerce marketplace) announced that they are merging into GoTo (1 point for creativity). Closer to home, some time ago - Vodafone and Idea merged into Vi. Reasons for mergers are similar - they see long-term benefits for both businesses as they grow together, share assets, supply chain, technology, and compete with others. For Vi, the more obvious reason was to join forces to compete with Jio.
Got it, so how does this work?
Mostly paperwork. In order to facilitate M&As, companies do a lot of research and due diligence on each other, evaluate the value of assets that the companies own and then basically come with a deal on the table.
M&A deals usually happen through a stock deal, a cash deal, or a combination of both (finance is wild). Cash deals are simple - i.e Company A gives ₹₹₹ to Company B and buys it out. In a stock deal, Company A will give its stock to company B and buy it out.
Now, in mergers, shareholders of both companies will get 50%-50% ownership in the new company that is formed by merging A & B. Sometimes, Company A will be like:
and demand more of the pie (mostly because Company A is worth more than Company B). So, instead of a 50-50 ownership, Company B's shareholders will be given Company A's shares as per a ratio, such as 1:2. Here, the value of 1 share of Company A is equal to the value of 2 shares of Company B. So if you owned 2 shares in Company B, it will get you 1 share of Company A in exchange. The ratio is usually determined in the deal agreement.
Okay, but are two big companies merging any good?
Well, it could lead to a monopoly so M&As are regulated by the government (these laws usually come under the anti-trust/ competition regulation). Essentially, the idea is that we live in a free market - and do not like one company ruling over an industry. If two huge companies decide to merge, then it's quite possible that they will dictate everything going on in that industry, from prices to industry standards, thwarting competition and new entrants. Facebook has been on fire for quite some time, for being "too big," exerting too much influence in the social media and content world - especially with acquisitions like Whatsapp and Instagram. Amazon similarly could face an uphill battle with MGM.
Got it, so what does this mean for me?
M&As are popular, and whether you have invested directly in stocks or through a mutual fund, you'll probably keep hearing about them.
Michael Mauboussin, regarded investment strategist, in his book Think Twice talks about how most of these M&A deals don't create value for the shareholders of the buying company (companies that are bought do fine, on average):
"Researchers estimate that when one company buys another, the acquiring company's stock goes down roughly two-thirds of the time."
The fact is that even though executives are aware of this, most of them believe that they can beat the odds. Mauboussin rightly mentions that in the long term, the benefit of buying the company should outweigh the cost. Take the below example:
It only makes sense for Company A to buy out Company B when the benefits - short-term and long-term, are more than the cost it will pay for the acquisition. If the benefit is lower, it will likely have a negative impact on the value of the business.
So, you'd assume that the acquiring company's board knows this and has the best of intentions in mind. However, oftentimes there are serious biases in play that lead to inept decision making (what psychologists call "Social Proof Tendency" and "Excessive Self Regard Tendency," among others).
More cynical, Warren Buffet in one of his letters to the shareholders mentions:
"...the sad fact is that most major acquisitions display an egregious imbalance: They are a bonanza for the shareholders of the acquiree; they increase the income and status of the acquirer's management; and they are a honey pot for the investment bankers [...]. But, alas, they usually reduce the wealth of the acquirer's shareholders, often to a substantial extent."
At the end of the day, an M&A is a relationship - there's a difference between making deals, and actually making the deal work. The blood, sweat, and tears are real - and how the company actually executes the combined strategy will inform its growth and value in the long term.
Not all M&As are bad or carried out with bad intentions, but it's always good to know what the risks are.
Thoughts?
Additional resources:
Indian Banks Merger / GoTo Merger
More on how mergers work
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