A New Case for Mergers and Acquisitions

Nearly 40 percent of middle market companies express interest in mergers and acquisitions, with many actively looking for suitors. Traditionally, operational synergies have driven mergers - the idea that the target company and the acquiring company can enhance overall value post-acquisition. The companies' product portfolios or service offerings may complement each other, or a merger may eliminate redundant costs, bring enhanced purchasing power in negotiations with suppliers, or yield similar benefits of scale.

One area of synergy that is often overlooked but no less important following mergers and acquisitions is financial synergy.

Larger-sized companies usually have an edge in financing their projects, since they generally have better access to capital and cheaper rates. Whereas middle market firms may be relatively constrained in financing projects, many of these constraints may be lifted after a larger company has acquired them and projects that were previously shelved may be greenlighted.

An in-depth NCMM study written by Ohio State University Professors Michael Weisbach, Yeejin Jang, and Isil Eril makes just this case. "Do Acquisitions Relieve Target Firms' Financial Constraints?" financial synergies can significantly benefit target middle market companies after a merger.

The authors studied over 5,000 mergers from 2001 to 2008 in Europe, where data is available for both the target company and the acquiring company before and after a merger. Because of disclosure requirements in European countries, they could sample European acquisitions' continuing financial data pre- and post-acquisition. Data like that is impossible to compile in the United States due to the lack of availability.

The authors of the study found that target companies were significantly constrained prior to the mergers in terms of making internal investments, holding higher levels of cash reserves and closely connecting any investments to their cash flow levels. After the mergers, however, whether because they gained access to capital at lower costs or were relatively less constrained due to their larger sizes, the target companies invested more. These financial factors may be even more important in the United States, as the Fed tapers off its bond-buying stimulus, leading to higher costs of capital in general.

"Being acquired will lead target firms to evaluate investment opportunities using a lower cost of capital, and consequently undertake more of them," write the authors. Target firms after acquisition decreased cash holdings by 11 percent, freeing up more money for financing projects. Target firms were also found "to hold less cash [and] save less cash out of incremental cash flows" - a sure indication of lessening financial constraints post-acquisition. The study found that the smaller the target firm pre-acquisition, the more significant was the loosening of financial constraints post-acquisition.

Overall, the NCMM study finds that "investment [by target firms] significantly increases following the acquisition." Of course, the authors don't minimize the importance of traditional operational synergies as drivers of acquisitions. That said, they believe that target firms should give strong consideration to financial synergies that can result in more post-acquisition investment in projects that were placed on hold due to previous limitations.

Needless to say, these findings only cover European companies. The general trends should be the same here; however, a lack of sufficient financial data on U.S. mergers makes this claim difficult to confirm completely. The financial considerations in the report offer lessons in due diligence for both sides of any acquisition. Having cheaper access to capital for your middle market company, and simply having more of it, may be one of the most important elements of mergers and acquisitions deals.

Boston-based Chuck Leddy is an NCMM contributor and a freelance reporter who contributes regularly to The Boston Globe and Harvard Gazette. He also trains Fortune 500 executives in business-communication skills as an instructor for EF Education. Circle him on Google+.


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