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What is a 'Merger'

A merger is an agreement that unites two existing companies into one new company. There are several types of mergers and also several reasons why companies complete mergers. Mergers and acquisitions are commonly done to expand a company’s reach, expand into new segments, or gain market share. All of these are done to please shareholders and create value.

BREAKING DOWN 'Merger'

A merger is the voluntary fusion of two companies on broadly equal terms into one new legal entity. The firms that agree to merge are roughly equal in terms of size, customers, scale of operations, etc. For this reason, the term "merger of equals" is sometimes used.

Mergers are most commonly done to gain market share, reduce costs of operations, expand to new territories, unite common products, grow revenues and increase profits, all of which should benefit the firms' shareholders. After a merger, shares of the new company are distributed to existing shareholders of both original businesses.

In 2015, there was a record $4.30 trillion worth of mergers and acquisitions announced. Deal making continues to be a popular way to grow revenue and earnings for companies of varying size.

Types of Mergers

There are five main types of company mergers:

• Conglomerate: This is a merger between two or more companies engaged in unrelated business activities. The firms may operate in different industries or different geographical regions. A pure conglomerate involves two firms that have nothing in common. A mixed conglomerate, on the other hand, takes place between organizations that, while operating in unrelated business activities, are actually trying to gain product or market extensions through the merger. Companies with no overlapping factors will only merge if it makes sense from a shareholder wealth perspective, that is, if the companies can create synergy. A conglomerate merger was formed when The Walt Disney Company merged with the American Broadcasting Company (ABC) in 1995.

• Congeneric: A congeneric merger is also known as a Product Extension merger. It occurs when two or more companies operate in the same market or sector with overlapping factors, such as technology, marketing, production processes, research and development (R&D), join to form a new business entity. A product extension merger is achieved when a new product line from one company is added to an existing product line of the other company. When two companies become one under a product extension, they are able to gain access to a larger group of consumers and, thus, bigger market share. An example of a congeneric merger is Citigroup's 1998 union with Travelers Insurance, two companies with complementing products.

• Market Extension: This type of merger occurs between companies that sell the same products but compete in different markets. Companies that engage in a market extension merger seek to gain access to a bigger market and, thus, a bigger client base. To extend their markets, Eagle Bancshares and RBC Centura merged in 2002.

• Horizontal: A horizontal merger occurs between companies operating in the same industry. The merger is typically part of consolidation between two or more competitors offering the same products or services. Such mergers are common in industries with fewer firms, and the goal is to create a larger business with greater market share and economies of scale since competition among fewer companies tends to be higher. The 1998 merger of Daimler-Benz and Chrysler is considered a horizontal merger.

• Vertical: When two companies that produce parts or services for a specific finished product merge, the union is referred to as a vertical merger. Vertical merger occurs when two companies operating at different levels within the same industry's supply chain combine their operations. Such mergers are done to increase synergies achieved through the cost reduction which results from merging with one or more supply companies. One of the most well-known examples of a vertical merger took place in 2000 when internet provider America Online (AOL) combined with media conglomerate Time Warner.

Examples of Mergers

Anheuser-Busch InBev is an example of how mergers work and unite companies together. The company is the result of multiple mergers, consolidation, and market extensions in the beer market. The newly named company, Anheuser-Busch InBev, is the result of the mergers of three large international beverage companies - Interbrew (Belgium), Ambev (Brazil), and Anheuser-Busch (United States). Ambev merged with Interbrew uniting the number three and five largest brewers in the world. When Ambev and Anheuser-Busch merged, it united the number one and two largest brewers in the world. This example represents both horizontal merger and market extension as it was industry consolidation but also extended the international reach of all the combined company’s brands.

The largest mergers in history have totaled over $100 billion each. In 2000, Vodafone acquired Mannesmann for $181 billion to create the world’s largest mobile telecommunications company. In 2000, AOL and Time Warner vertically merged in a $164 million deal considered one of the biggest flops ever. In 2014, Verizon Communications bought out Vodafone’s 45% stake in Vodafone Wireless for $130 billion.

Due to the large number of mergers, a mutual fund emerged, giving investors a chance to profit from merged deals. The fund captures the spread, or amount left between the offer price and trading price. The Merger Fund from Westchester Capital Funds has been around since 1989. The fund invests in companies that have publicly announced a merger or takeover. To invest in the fund, a minimum amount of $2,000 is required, and the fund does charge a higher 2.12% expense ratio. Since its inception in 1989, the fund has returned an average of 6.1% annually.

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