Yahoo announced today that it has reached an agreement to acquire Tumblr for $1.1 billion in cash. This post is written with an intention to shed light on why companies merge with or acquire other companies, while using Yahoo’s acquisition of Tumblr as a case study.

Mergers and Acquisitions (M&A) are corporate strategies to bring individual companies together, in order to create a bigger entity. It involves the sale and purchase of companies & organizations.

Difference between Mergers and Acquisitions

A merger is the practice of consolidation of operations between two companies, so as to operate as a new company.

Acquisitions typically involve one larger company purchasing a smaller company. This includes integrating the acquired company’s operations into its own or liquidating the acquired company’s assets.

Factors driving M&A

M&A is often driven by a company’s quest to increase shareholder value and create a competitive advantage. This is achieved by identifying synergies. Synergies occur when the outcome of the transaction has potential for achieving greater success than the individual entities could have prior to the transaction. In simple terms, synergy occurs when 2 + 2 = 5.

There are a variety of reasons why companies merge or acquire other companies. Some common reasons include:

  1. To achieve economies of scale
  2. To achieve economies of scope
  3. For cutting down costs
  4. With an intent of accelerating growth prospects
  5. To gain an increased market share and market influence
  6. In order to acquire new technology
  7. For the sake of diversification

Financing options

M&A transactions are financed either by using all-stock, all-cash, or a combination of both.

Mergers & Acquisitions

Case Study

In the battle of web giants to gain market share, Yahoo has been lagging considerably. Its competitors have implemented a number of indirect measures to increase their influence on users, by introducing complimenting services in social media and by introducing hardware that promote their technology. To be sure that Yahoo does not get left behind amongst the younger generation that thrive on social media, it has been actively trying to acquire proven service providers that can serve as a good entry point for it to tap this missed opportunity. In the past, it had acquired Flickr with a similar intention, but never did justice to the acquisition. It was also rumored to be in talks with Foursquare for an acquisition.

Synergies

Tumblr with its 108 million users world-over served a real answer to make the company a real tech player again, while also getting a stronger influence over the younger demographics.  As per the conference call hosted earlier today by Yahoo, it hopes to get search traffic from Tumblr users. Yahoo will bring in-stream ads to the Tumblr dashboard, at some point. It will also help Tumblr bloggers sell ads, if they want to. Yahoo may power Tumblr search and get some Tumblr users that way, while Tumblr receives traffic. Yahoo will also link more to Tumblr posts from Yahoo media properties, therefore making those properties more relevant to the types of people who like Tumblr.

Financing

The acquisition is an all cash deal. Many analysts believe that Yahoo has paid a high premium for the acquisition, given that Tumblr’s revenue for 2012 was only $13 million.

Keep in mind that Google, Facebook and Microsoft had rejected David Karp when he approached them with an offer to sell Tumblr. What are your thoughts on the acquisition? Is Yahoo overpaying? Will the companies integrate successfully and achieve synergies? Will it increase shareholder value? Young people dictate Tumblr’s culture, and their interest may dictate the outcome of this merger.

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