Why did Facebook buy WhatsApp? – Mergers & Acquisitions Part I

Recently I had a video interview (a very interesting experience) where I was asked a question to the effect of

“Facebook recently bought Whatsapp for $16bn, why pay so much for such a small company?”

I thought this question would be a good starting point for looking at mergers and acquisitions – what they are, how they work, and why companies do them.
 In this first post I will look at the basic theory of mergers and acquisitions, and in the next one I will look at how this relates to Facebook’s acquisition of Whatsapp.

*Digs out A level Economics notes*

Why do some firms grow?

• Increase market share and power -become the dominant firm in an industry, have more control over price
• Increase sales -through larger brand recognition and more sales outlets
• Exploit economies of scale - increase in scale of production means lower average costs
• Risk-bearing economies - if product diversity is increased it can mean that a firm is better able to withstand downturns in the economic cycle or changes in the demand for specific products
• Benefit from greater profits - a firm aims to maximise profits and may be able to achieve this through expansion
• Gain market power - so as to prevent potential takeovers by larger predator firms and be better able to exploit the market

How do firms grow?

• Organic/internal growth – own growth
• Diversification – expansion into new markets by the creation of new products. A risky strategy for growth
• Inorganic/external growth – merging with another firm
• Merger -two businesses combine to form a new business. A ‘friendly’ form of growth. Both sets of shareholders consent to the merger
• Takeover - one business takes over another. Can be hostile. Shareholders sell to bidder

Types of merger

• Horizontal – a merger between firms that are at the same stage of the same production process, e.g. Amazon buying LoveFilm
• Vertical – merger between firms that are in different stages of the same production process, e.g. Ebay acquiring Paypal
• Conglomerate – a merger between firms that have no common interest, or very diverse divisions, e.g. Virgin Money, Virgin Airlines, Virgin Media etc

Read More:

Tutor2u – Unit 3 Micro: Business Growth, Takeovers and Mergers

Forbes - What Should Everyone Know About Mergers And Acquisitions?

Investing Answers – Mergers and Acquisitions (M&A)

The Guardian – Mergers and Acquisitons news

Reuters - Deals of the day- Mergers and acquisitions

Most of these notes were lifted straight from my A level notes so I have to give credit to Mr Edwards (my A level microeconomics teacher) and Geoff Riley (creator of this very helpful presentation on Tutor2u)

Keep an eye out for the next post about Facebook’s acquisition of Whatsapp!

Priscilla

(Read the next part of this post here!)