Define the terms ‘merger’ and ‘acquisition.’
A merger or an acquisition occur when the operations of two companies are combined such that subsequently, all of the operations of both companies are subsumed under a single holding company.
What is the difference between a merger and acquisition, and reasons why a business may choose to enter into both
One difference between a merger and an acquisition in lay terms relates to the relative size of the companies involved. If two companies of similar revenues combine, they are said to have merged. If a company combines with another company and the first company has a significantly larger amount of revenue than the second company, then the first company is said to have acquired the second company.
Formally, a true merger is where the companies cease to exist (new company shareholders get new shares). An acquisition is where both companies continue to exist as entities but the target becomes the sub of the other. It’s not really about the relative strength / revenue of the companies. Maybe in practice you will rarely find true mergers between companies who have vastly different revenues but that’s a statement about a practical matter not a “definition” of a merger vs an acquisition
Obtain synergies — there may be opportunities to reduce overall costs by e.g. eliminating duplicated capacities at the two headquarters; obtaining bulk discounts on supplies; eliminating headcount in operations; combining IT systems.
Increase negotiating power — the merged entity will be a larger player in all its operations and may be able to drive a harder bargain with suppliers, landlords, distributors, finance providers or retailers.The general aim of M&A activity is to produce a strengthened combined operation. This may be targeted in various ways, as outlined below.
Expand capacity — the merged entity will have a broader portfolio of capabilities or opportunities: the acquiring entity may gain e.g. vineyards/ grapes/locations that it previously lacked; a state-of-the-art IT system; a broad and well-designed distribution network; politically advantageous connections in an emerging market.
Conduct financial engineering — often, acquisition targets will be under- geared. This means that they fund their operations more with equity than with debt. This is inefficient because dividends payable to shareholders are not tax deductible whereas interest payments on debt are by contrast tax-deductible. This angle is often of interest to private equity players.
Enable investment — often target companies have lacked sufficient cashflow to develop and enhance their operations and the acquiring company can supply this to allow the combined company to fully exploit its opportunities. Again, this angle is often interesting to private equity.
Add expertise — an acquisition will also afford an opportunity to attract best-in-class management talent and employees at all levels together with improvements in training and staff development.
Brief overview of an example trade
Duckhorn Wine Company
The history of Duckhorn is a good example of how private equity activity has shaped the sector.
Duckhorn is based in Napa with 243Ha of vineyard estates in California and in Washington State; it had been family-owned and run since inception in 1976.
In 2007, it was acquired by GI Partners, a middle-market private equity fund originally aimed at providing investment diversification to major Californian pension funds. The purchase price was $300m.
GI worked on developing the management team during its ownership, both via external hires and internal promotions. Also, the product lineup was expanded, with the additional focus on the Decoy brand causing it to become “one of the industry’s top luxury wineries.” GI also invested more than $60 million in Duckhorn during their ownership. This money was used to:
- Add 140Ha of vines, allowing a significant expansion of production under both existing brands and new ones;
- Create state-of-the-art winemaking facilities via construction and acquisition;
- Introduce Canvasback, a boutique Cabernet Sauvignon from Washington State’s acclaimed Red Mountain;
- Expand distribution to a wider base of customers locally and internationally;
- Achieve significant industry recognition: Duckhorn now has what is recognised as the premier US luxury wine portfolio.
GI exited the investment in 2016 by selling Duckhorn for $750m to TSG Consumer, another private equity firm focussed on opportunities in the branded consumer sector. Given the initial purchase price of $300m and the stated investment of $60m, this represented an attractive IRR of 9.1% for GI assuming that the $60m of investment was distributed equally over the eight non-initial and non-final years of ownership.
Examples of how this merger/acquisition changed the broader wine industry.
The profitable nature of this investment for GI underlined the appeal of this sector to private equity investors more generally, as shown by the subsequent exit to a different private equity house.
It also showed that the opportunities to create value in the sector by adding investment and expertise were genuinely achievable in a relatively straightforward fashion.
Consequently, the deal increased the value of a restricted number of ultra-luxury US wine operations and brands while emphasising the importance of some scarce qualities such as quality vineyards in key locations and a brand portfolio which is ripe for expansion. That means not fully exploited yet also it was helpful for the purposes of the acquisition that Duckhorn had significant high-end brand identity and wide awareness among high-involvement consumers and specialist industry players.
The deal showed management teams that private equity could be an appropriate steward of assets, adding value while not impeding the expression of core values and creating rather than destroying employment. Finance of appropriate quantum and patience was shown to be available.
Duckhorn ended its period under GI ownership with greatly expanded distribution in all US states and in 50 countries on five continents. This showed the sector how distribution could be positively impacted under private equity ownership and investment.
The transaction stimulated further transactions in the US luxury wine sector.
In 2018, Duckhorn (still under the ownership of TSG) acquired Kosta Browne Winery from a Boston-based private equity firm JW Childs Associates. Thus Duckhorn has now become almost a private equity payer in its own right in the wine industry.
The President of Duckhorn Alex Ryan observed that “you can’t market your way out of a lower category into a higher one” which indicates that one motivating factor for the transaction was to expand product availability without dilution of brand identity. It has been noted elsewhere that it is possible but very difficult to improve brand identity — Symington’s has been attempting to move its Cockburn’s Port brand upmarket through significant and extended investment.
The stated aim of the transaction was to operate Kosta Browne as a separate unit but expand it via both organic growth and acquisitions, thus further underlining the likely future importance of M&A in the sector.
Ryan noted the importance of private equity in the wine sector, stating that it was “good to have scalable, professional investment coming in to the space” which illustrated “maturation.”
We can therefore for all of these reasons expect private equity involvement in the wine sector to continue to be of major and growing importance.
A banker involved in the sector commented as follows on the likely effects of further private equity involvement on the sector.
- Further consolidation between companies already involved in the sector
- More focus on capital appreciation under private equity than “lifestyle” under family ownership
- Consequent higher level of focus on expansion of businesses
- Higher production of existing brands — which may require broader distribution which in turn may increase compliance issues within the US three-tier market and internationally
- Expanded portfolio of brands with concomitant additional expenditure incurred in marketing, market research, segmentation analysis and advertising
- Interest in the question as to whether the successful strategy shown in the GI transaction is scalable viz. can the Duckhorn approach be replicated successfully at Kosta Browne? Are there saturation effects at the luxury end of the market?
- Are there opportunities at the value end of the market? Or are these already fully exploited by the major conglomerates? We may assume they have been running their businesses at maximum efficiency and with no lack of investment capital and management expertise.
- Continuing high multiples will be paid for established luxury wine assets which are now sought after by private equity as well as already established family owners and individual wealth family offices. This business is attractive since it is tangible, easy-to-understand and recession-proof, with potentially some lack of correlation to financial markets more generally.