By Siyu Wu
In this new series, I will introduce a wide variety of trends in the financial markets and provide some analysis of impacts of the trend. If you’re interested in learning more about finance, are preparing for interviews and want to gain some market knowledge, or want to know what’s going on in today’s business world, these articles will provide some insight! This month, we’ll introduce mergers and acquisitions (M&A), and discuss them in the context of the agricultural industry.
What are mergers and acquisitions?
Simply put, a merger is when two companies combine to form a new company, and an acquisition is when one company buys another company. These processes take at least six months, often many more months, from start to finish. At the beginning, the two companies’ boards will have many informal discussion to determine whether their intentions align. Following these discussion, there will be a formal negotiation, a letter of intent, due diligence, an agreement, and ultimately, the execution of a deal and transfer of payment. Because mergers and acquisitions are very complex, especially from the legal and accounting perspectives, companies will typically use advisory services from an investment bank to conduct the transaction.
Ultimately, the goal of mergers or acquisitions is to create synergy. Synergy refers to the idea that the whole is greater than the parts - so that when two companies combine their operations, the resulting company will be more profitable and efficient. When such transactions are successful, companies may take advantage of economies of scales, expand their market presence, and gain a competitive advantage.
M&A in the agricultural industry
Most recently, news broke regarding German drug and crop chemical producer Bayer’s takeover bid for US seeds company Monsanto. This transaction, which combines two large agribusinesses, may have surprised some. However, this was only one of many M&A transactions in the agricultural industry. Why is this case? As mentioned before, M&A deals can be profitable for the companies involved. In the case of agribusiness, there are many factors at play that make these transactions increasingly necessary for success. Here are some key points relevant to the Bayer-Monsanto deal, and to the rising trend of agricultural mergers and acquisitions.
Consolidations are frequent in shrinking industries. When the size of an industry gets smaller, demand for the industry’s products decrease and cause companies to be less profitable. To overcome these challenges, companies aim make deals that will allow them to create synergies, decreasing operating costs and increasing production efficiency. For companies in the agricultural industry, M&A transactions are increasingly present because of the shifting weather patterns and declining global farm economy. Prices for wheat and corn have fallen in the last four years, hurting seed and other farm-related companies.
Synergies not only benefit companies involved; they can also benefit customers. Another benefit of consolidation is often new innovation - when two companies are able to combine their research and development teams to create new, better products, the customers also benefit. However, if consolidation does not result in innovation, the benefits of a deal will only be short-term. Though you can grow profit in the short run without the creation of new products, it would be impossible to sustain profit growth over the long run. Therefore, unless Monsanto and Bayer can work together to produce innovative changes in an aging and shrinking agricultural industry, they may not be able to capture longer lasting profit gains.
Just because the deal was announced, doesn’t mean that the transaction will be completed. Mergers, especially ones as large as this one, come under intense scrutiny from regulatory bodies. Mostly, authorities are concerned that such a deal will significantly reduce competition in the industry, thus negatively impacting customers. For example, should Bayer and Monsanto consolidate, it would control over 25% of total market share for seeds and pesticides in the farm supplies industry. Should one company control too large of a market share, they can take advantage of customers by setting prices at a higher-than-desired level.
Though in this article, the agricultural industry was used as a key example, you’ll find M&A transactions in many other industries. Take the key lessons from this example and apply it to another industry to better understand why companies are making the choice to merge or consolidate. Mergers and acquisition transactions are an important component of capital markets, and having at least a fundamental understanding of these deals is helpful, especially when making conversation with an investment banker!
Siyu Wu is from Colorado and attends Princeton University, pursuing a degree in Economics and certificates in Finance and East Asian Studies. Siyu will graduate in 2018. She hopes to synthesize her interest in China and East Asia with her passion for finance to eventually work in a career related to international finance and Asian capital markets.