Business Insider

Peter R. Crabb: Corporate control, cash drive big companies’ acquisitions

With high unemployment and weak consumer spending, many businesses find their markets cold.

But one market is heating up — the market for corporate control.

AT&T announced plans to acquire T-Mobile. Texas Instruments is buying National Semiconductor. The financial markets themselves may combine with the European and NASDAQ bids for the New York Stock Exchange.

Big name deals like these are more common since large corporations are flush with cash in the improving economy.

Analysts are speculating that Boise-based Micron Technology is a takeover candidate following the TI announcement April 4 of its agreement to acquire National Semiconductor for about $6.5 billion.

What’s driving the action in the marketplace where companies are bought and sold?

There are three main ways that the control, and therefore management, of public corporations changes: proxy contests, leveraged buyouts, and mergers or acquisitions.

A proxy contest is an attempt by the firm’s owners or any outside party to place new directors on the board, who later replace management. A leveraged buyout, or LBO, occurs when a public corporation is taken private through share purchases by a group using borrowed funds.

Proxy contests are rare and LBOs can be costly. The most common method of business combination is a merger or acquisition.

In a merger, two firms combine their assets, liabilities and all operations into one. In the more common case of acquisition, the acquiring business buys all of the target company. The shareholders of the acquired company receive cash or stock in exchange for their shares in the old firm.

Acquisitions can be horizontal, vertical or conglomerate. Horizontal integration involves the acquisition of firms in the same industry, but often selling product in different markets. The combination thus serves to increase the company’s market share. Conversely, vertical integration seeks cost savings through the acquisition of suppliers to the firms’ industry. Very few firms seek to be conglomerates anymore — a single corporate structure for two or more firms in entirely different industries.

Today’s action is in horizontal integrations. AT&T and T-mobile, TI and National, and the NASDAQ/NYSE would all be combinations of companies with identical or similar product offerings.

The predominant motives for acquiring another business are increased scale or product synergies. Larger firms seek economies of scale — cost efficiencies achieved by spreading costs over more production. Value from synergies depends on economies of scope — lower costs achieved through the sale of complimentary of similar products.

Both motives appear at work in today’s marketplace.

Larger scale operations make sense in a more global economy. Consumer spending is slow in the United States but rising around the world. At the same time, customers are demanding more choices and services. Firms need a full product menu to compete.

Unfortunately, the market for corporate control is not always kind. History shows that acquiring firms usually reduce investor returns by overpaying for acquisitions, and industries with fewer players generally mean higher prices to consumers.

Business owners, both large and small, would be wise to grow the old-fashion way — earn it.