To buy (or merge), or not to buy (or merge)

There are many motivations for mergers or acquisitions and they certainly have an impact on share price, this week Alecto Minerals jumped 7.1% after completing the acquisition of Nubian Gold Exploration, an Ethiopian mining firm, International Power was lifted to its highest level in more than a year with the date approaching when GDF Suez can take full control. And yet it's an artificial change which can be as high as 30% but actually results in longer term shareholder wealth destruction.

It's been reported this week that Peugeot and General Motors (GM) are entering into a global alliance. With the specific aim of reducing costs and as long as the senior management can get along and the integrities of both companies remain intact, it should work well. It's neither a merger nor a full acquisitions, GM will own 7% of Peugeot and I think that in this case the right steps are being taken to increase shareholder wealth.

GM are strong in the global market, but not in Europe. Peugeot are weak in the world market but strong in Europe. Not rocket science is it? They've come together to create operating synergies (which will have the added benefit that they will reduce costs). Bringing the two companies together increases their buying power by combining their powers to achieve economies of scale. They're sharing some technical stuff too, platforms  I think they call them but the cars will be different, they won't be the same car with different badges on as we've seen before with other manufacturers.

Both companies have had problems, Peugeot made a 500m Euros loss during the second half of 2011, it's Europe's largest car manufacturer and it relies on this market for its sales, but as we all know, the European market has been under pressure for some time. Peugeot have reduced their costs, improved their processes and diversified in an attempt to improve their financial position. GM were rescued from bankruptcy by the US government less than three years ago and rely on their strong performance in North and South America, Asia and China. That said it's quite an achievement for GM, they've turned things around showing the US were right to bail them out.

At the moment, production will stay with each individual company, I suppose it's a bit like an insurance policy, if things get tougher financially, they can pool production and close factories. It would be controversial, as would sharing top management but Nissan and Renault have done it and they've just reported further investment in at the Sunderland plant. And anyway, if it increases shareholder wealth, don't they have an obligation to consider it?

The only down side to this arrangement (excluding employee uncertainty) is from the perspective of the suppliers to the two car manufacturers. Because they're combining their buying power, will this put excess pressure on smaller firms to cut their prices? Could be a bit domineering and overbearing. Competition and bullying, it's a fine line.

There are so many benefits with this type of deal rather than an outright acquisition or a merger, they both get to keep their identities but have access to each other's markets, they're taking minimal risk but will reap the benefits from economies of scale, entry to new markets and increase their chances of survival. Only time will tell whether it works, it relies on shared vision, requires diplomacy, shared technical skills but most of all a desire to make it work.

Source: BBC News, FT, Arnold