By: Peet Serfontein
Mergers and acquisitions (M&A) is a collective term used to describe when firms decide to join together (a merger) or when one
firm buys another outright (an acquisition). Companies pursue M&A deals for many reasons - from expanding into new markets to
achieving synergies. It is a common tool used by businesses to grow inorganically.
Financial markets pay close attention to these transactions as successful M&A can boost revenue and profitability thereby creating
shareholder value, while poorly conceived deals can destroy value.
Strategic objectives of M&A activity
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Market expansion: One common reason for making acquisitions is to enter new markets or segments that a company currently
does not serve. By buying an existing player in the desired space, the acquirer can instantly gain a foothold in a new geographic
region or product line. For example, Heineken's acquisition of South Africa's Distell was driven partly by a desire to expand in
African markets where Distell has a strong presence. Instead of building a brand from scratch in new regions or diversifying into
ciders, they bought a local leader that gave them immediate market access in African countries outside of South Africa and a
foothold in the fast-growing cider category.
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Covid-19 pandemic (2020): When the World Health Organisation officially declared Covid-19 a global pandemic in March 2020, financial markets reacted with unprecedented speed and severity. The S&P 500 dropped more than 30% in just over three weeks—the fastest bear market in history. In South Africa, the JSE All Share Index (ALSI) suffered a swift decline as investors fled emerging market assets. Safe-haven assets, particularly gold and US Treasuries, rallied sharply amid the uncertainty.
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Synergies (1+1=3 effect): Synergies come in two main forms: cost synergies (savings from eliminating duplicate costs or
achieving economies of scale) and revenue synergies (gaining additional sales through cross-selling or expanded distribution).
By merging, companies can often cut overlapping departments, bulk-buy supplies at discounts or share distribution networks
to lower costs. They can also sell each other's products to a broader customer base, boosting revenue. For instance, when
Standard Bank (South Africa) decided to fully acquire Liberty Holdings (an insurer) in 2021, the stated rationale was to create
scale and synergies between banking and insurance services - meaning the combined group could streamline operations and
cross-sell products more effectively. Effective synergies can make the merged entity more profitable than the sum of its parts.
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Diversification: Companies sometimes acquire others to diversify their business and reduce reliance on a single product,
customer, geography or industry. Diversification can spread risk and provide new growth opportunities. For example, in
2018 AT&T's $85 billion purchase of Time Warner was a notable case aimed at diversification - adding a major media and
entertainment arm (HBO, CNN, Warner Bros. studios, etc.) to AT&T's telecoms operations. This deal gave AT&T new content
assets and revenue sources beyond its traditional telecoms business. In general, diversification-motivated M&A helps
companies hedge against downturns in any one area by expanding its portfolio into others.
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Economies of scale: Many mergers are driven by the pursuit of scale. A larger combined company can often operate at lower
unit costs because it can spread fixed costs over a greater volume of business.
M&A is not without risks, however. The assumed synergies may not materialise, integration can be challenging, or the price paid
might turn out to be too high. That is why careful valuation of the target company is crucial before any merger or acquisition moves
forward.
How M&A deals are valued
Valuing a company in an M&A context is a complex task that blends art and science. Buyers want to ensure that they are paying
a fair price (or ideally a bargain), while sellers want maximum value for their shareholders. In financial markets, several standard
valuation methods are used to assess what a business is worth and to guide the price of a deal. The main methods include:
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Discounted Cash Flow (DCF) analysis: This involves forecasting a company's future cash flows and then discounting those
future cash flows back to present value using a required rate of return (often the weighted average cost of capital). In simpler
terms, DCF asks: "How much is all of this company's future profits worth in today's money?". To find the answer, analysts build
detailed financial models to project revenue growth, profit margins, and the company's investment needs over time. This
method can capture a company's unique prospects (including any synergies a buyer expects to achieve) and is very flexible
- one can adjust assumptions to see different scenarios. The main drawback is that a DCF valuation can be very sensitive to
forecasted assumptions and the analyst's assumptions can be wrong.
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Comparable company analysis (market multiples): This technique looks at how similar companies are valued by the financial
market as a benchmark for the target's value. In practice, analysts identify a peer group of companies in the same industry with
similar size or business models and examine their trading multiples - ratios like Price/Earnings (P/E) or Enterprise Value/EBITDA.
For example, if publicly traded peers are valued at 10 times P/E, and the target company earns R100 million in profit, one might
estimate the target's equity value at about 10 x R100m = R1 billion (assuming similar growth and risk). Comparable company
analysis is popular because market prices are current and readily observable, providing a reality check. It is especially useful for
getting a quick ballpark range of value. The drawback is that no two companies are exactly alike, which can result in either an
under or overvaluation of the company.
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Synergies (1+1=3 effect): Synergies come in two main forms: cost synergies (savings from eliminating duplicate costs or
achieving economies of scale) and revenue synergies (gaining additional sales through cross-selling or expanded distribution).
By merging, companies can often cut overlapping departments, bulk-buy supplies at discounts or share distribution networks
to lower costs. They can also sell each other's products to a broader customer base, boosting revenue. For instance, when
Standard Bank (South Africa) decided to fully acquire Liberty Holdings (an insurer) in 2021, the stated rationale was to create
scale and synergies between banking and insurance services - meaning the combined group could streamline operations and
cross-sell products more effectively. Effective synergies can make the merged entity more profitable than the sum of its parts.
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Precedent transactions analysis: This involves considering recent M&A deals involving similar companies (the "precedents")
to see what multiples were paid in those transactions. Essentially, it asks: "What have other buyers paid for comparable
businesses?" For instance, if companies in the same sector have been acquired for around 2 times revenue or 15 times EBITDA,
those metrics can guide the pricing of a new deal. Precedent transaction analysis is useful because it captures the control
premium often paid - acquirers typically pay more than the market trading price to convince shareholders to sell. This premium
accounts for gaining full control and any synergies the buyer expects. However, precedent data can become outdated if market
conditions change and each deal's context (strategic fit, competitive bidding, etc.) will be unique.
In practice, M&A valuations usually consider all these methods to triangulate a fair price. An adviser may compile a valuation
summary summarising the value range from DCF, comparables and precedent deals.
Often, an acquirer will need to offer a premium over the target's current share price to win shareholder approval. This premium
can range widely above the pre-deal share price, reflecting the added value the buyer believes it can create. The exact price
also depends on negotiation and sometimes competitive bidding - if multiple suitors are interested, the price can be driven up.
Importantly, once a deal is announced, the share market reacts by evaluating whether the price and rationale make sense. The
target's share typically jumps toward the offer price, while the acquirer's share might rise or fall depending on investors' view of the
deal's merits.
Selected case studies
Heineken's acquisition of Distell (South Africa)
In November 2021, Amsterdam-based Heineken announced a deal to acquire control of Distell Group Holdings, South Africa's
leading wine and spirits producer. The transaction was complex - Heineken combined Distell with its existing Southern African
business and bought a major stake in Namibia Breweries - creating a new African subsidiary valued at about €4 billion (roughly
R68 billion). In terms of price, the offer equated to R180 per Distell share, which was approximately the market price at the time
(about a 1.4% discount to the pre-deal share price). At the time, this was widely regarded as undervaluing the business but Distell's
anchor shareholder, Remgro, was able to get the deal over the line and received stock in the combined entity (instead of the price).
Microsoft's acquisition of Activision Blizzard (US)
Microsoft's $69 billion purchase of Activision Blizzard in 2023 brought blockbuster franchises like Call of Duty under its wing, as
the tech giant aims to expand its gaming content and leverage these titles for its Xbox and cloud streaming platforms. The deal was
announced in January 2022 and, after lengthy regulatory reviews, was completed in October 2023. Microsoft paid $95 per share
in an all-cash offer, valuing Activision Blizzard at around $68.7 billion to $69 billion. This price represented roughly a 45% premium
over Activision's stock price just before the deal was announced. Investors have questioned whether Microsoft potentially overpaid
for the acquisitions - the company had to make several compromises to gain regulatory approval and Activision's revenue growth
and free cash flow generation in the decade prior was not very strong. Time will tell if this ends up being a solid acquisition for
Microsoft or not.
