MERGERS AND ACQUISITION

Mergers, Amalgamations & Takeovers all through the globe have become universal practices in the corporate world covering different sectors within the nations and across their borders for securing survival, growth, expansion and globalisation of the enterprise and achieving multitude of objectives.

Meaning of terms

1. Merger

Merger is defined as combination of two or more companies into a single company where one survives and the others lose their corporate existence. The survivor acquires the assets as well as liabilities of the merged company or companies. Generally, the company which survives is the buyer which retains its identity and the seller company is extinguished. Merger is also defined as amalgamation. Merger is the fusion of two or more existing companies. All assets, liabilities and stock of one company stand transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or a mix of the two or three modes.

2. Amalgamation

Ordinarily amalgamation means mergerHalsbury’s Laws of England describe amalgamation as a blending of two or more existing undertaking into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company which is to carry on the blended undertaking.Andhra Pradesh High Court held in S.S. Somayajulu v Hope Prudhomme & Co. the word “amalgamation” has no definite legal meaning. It contemplates a state of things under which two companies are so joined as to form a third entity, or one company is absorved into and blended with another company. Amalgamation does not involve a formation of a new company to carry on the business of the old company.

3. Consolidation

Consolidation is known as the fusion of two existing companies into a new company in which both the existing companies extinguish. Thus, consolidation is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and cease to exist. The mix-up assets of the two companies are known by a new name and the shareholders of two companies become shareholders of the new company. None of the consolidating firms legally survives.

4. Combination

Combination refers to mergers and consolidations as a common term used interchangeably but carrying legally distinct interpretation. All mergers, acquisitions, and

amalgamations are business combinations. Types of business combination are discussed in the following paragraphs.

5. Holding company

The relationship of the two companies when combine their resources are differently known as parent company which holds the equity stock of the other company knows as subsidiary and controls its affairs.

6. Acquisition

Acquisition in general sense is acquiring the ownership in the property.In the context of business combinations, an acquisition is the purchase by one company of a controlling interest in the share capital of another existing company. An acquisition may be affected by (a) agreement with the persons holding majority interest in the company management like members of the board or major shareholders commanding majority of voting power; (b) purchase of shares in open market; (c) to make takeover offer to the general body of shareholders; (d) purchase of new shares by private treaty; (e) acquisition of share capital or one company may be either all or any one of the following form of considerations viz. means of cash, issuance of loan capital, or insurance of share capital.

7. Takeover

A ‘takeover’ is acquisition and both the terms are used interchangeably.Takeover differs from merger in approach to business combinations i.e. the process of takeover, transaction involved in takeover, determination of the share exchange or cash price and the fulfilment of goals of combination all are different in takeovers than in mergers. For example, process of takeover is unilateral and the offeror company decides about the maximum price. Time taken in completion of transaction is less in takeover than in mergers, top management of the offeree company being more co-operative.

8. Reconstruction

The term ‘reconstruction’ has been used in section 394 alongwith the term ‘amalgamation’. The term has not been defined therein but it has been used in the sense not synonymous with amalgamation. In the Butterworth publication, the term has been explained as under:“By a reconstruction, a company transfers its undertaking and assets to a new company in consideration of the issue of the new company’s shares to the first company’s members and, if the first company’s debentures are not paid off, in further consideration of the new company issuing shares or debentures to the first company’s debenture holders in satisfaction of their claims. The result of the transaction is that the new company has the same assets and members and, if the new company issues debentures to the first holders as the first company, the first company has no undertaking to operate and is therefore usually wound up or dissolved.”

9. Restructuring

The term “restructuring” is used in the corporate literature for mergers and amalgamations. The term should carry the same meaning as reconstruction as explained above.

10. Demerger or corporate splits or division

Demerger or split or division of a company are the synonymous terms signifying a movement in the company just opposite to combination in any of the forms defined above.

Purpose of merger and acquisition

The company which proposes to acquire another company is knows differently in different modes of acquisition, the familiar ones are; ‘predator, offeror, corporate raider (for takeover bids), etc. The transferee company is also denoted as victim, offeree, acquire or target etc.The purpose for an offeror company for acquiring another company shall be reflected in the corporate objective. It has to decide the specific objectives to be achieved through acquisition. The basic purpose of merger or business combination is to achieve faster growth of the corporate business. Faster growth may be had through product improvement and competitive position i.e. enhanced profitability through enhanced production and efficient distribution of goods and services or by expanding the scope of the enterprise through “empire building” through acquisition of other corporate units. Other possible purposes for acquisition are shortlisted below:

1. Procurement of supplies

to safeguard the source of supplies of raw material or intermediary product; to obtain economies of purchases in the form of discount, savings in

transportation costs, overhead costs in buying department, etc. to share the benefits of suppliers economies by standardising the materials.

2. Revamping production facilities

to achieve economies of scale by amalgamating production facilities through more intensive utilisation of plan and resources; to standardise product specifications, improvement of quality of product,

expanding market and aiming at consumers satisfaction through strengthening after sale services;

to obtain improved production technology and know how from the offeree company to reduce cost, improve quality and produce competitive products to retain and improve market share.

3. Market expansion and strategy

to eliminate competition and protect existing market; to obtain new market outlets in possession of the offeree; to obtain new product for diversification or substitution of existing products and

to enhance the product range; strengthening retail outlets and sale depots to reationalise distribution; to reduce advertising cost and improve public image of the offeree company; strategic control of patents and copyrights.

4. Financial strength

to improve liquidity and have direct access to cash resources; to dispose of surplus and outdated assets for cash out of combined enterprise; to enhance gearing capacity, borrow on better strength and greater assets backing; to avail of tax benefits; to improve EPS.

5. General gains

to improve its own image and attract superior managerial talents to manage its affairs;

to offer better satisfaction to consumers or users of the product.

6. Own developmental plans

The purpose of acquisition is basked by the offeror company’s own development plans.A company thinks in terms of acquiring the other company only when it has arrived at its own development plan to expand its operations having examined its own internal strength where it might not have any problem of taxation, accounting valuation, etc. but might feel resources constraints with limitation of funds and lack of skilled managerial personnel. It has to aim at a suitable combination where it could have opportunities to supplement its funs by issuance of securities, secure additional financial facilities, eliminate competition and strengthen its market position.

7. Strategic purpose

The Acquirer Company views the merger to achieve strategic objectives through alternative type of combinations which may be horizontal, vertical, product expansional, market extensional or other specified unrelated objectives depending upon the corporate strategy. Thus, various types of combinations distinct with each other in nature are adopted to pursue this objective like vertical or horizontal combination.

8. Corporate friendliness

Although it is rare but it is true that business houses exhibit degrees of cooperative spirit despite competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of collaborations sharing goodwill of each other to achieve performance heights through business combinations. The combining corporate aim at circular combinations by pursuing this objective.

9. Desired level of integration

Mergers and acquisitions are pursued to obtain the desired level of integration between the two combining business houses. Such integration could be operational or financial. This gives birth to conglomerate combinations.

The purpose and the requirements of the offeror company go a long way in selecting a suitable partner for merger or acquisition in business combinations.

Types of Merger

Vertical Combination It occurs when two firms, each working at different stages in the production of the same good, combine.A company would like to takeover another company or seek its merger with that company to expand espousing backward integration to assimilate the sources of supply and forward integration towards market outlets. The acquiring company through merger of another unit attempts on reduction of inventories of raw material and finished goods, implements it production plans as per objectives and economises on working capital investments. In other words, in vertical combinations, the merging undertaking would be either a supplier or a buyer using its product as intermediary material for final production.

The following main benefits accrue from the vertical combination to the acquirer company i.e. (1) it gains a strong position because of imperfect market of the intermediary products, scarcity of resources and purchased products; (2) has control over product specifications.

2. Horizontal combinationsIt takes place where the two merging companies produce similar product in the same industryIt is a merger of two competing firms which are at the same stage of industrial process. The acquiring firm belongs to the same industry as the target company. The main purpose of such mergers is to obtain economies of scale in production by eliminating duplication of facilities and operations and broadening the product line, reduction in investment in working capital, elimination of competition concentration in product, reduction of advertising costs, increase in market segments and exercise of better control on market.

3. Circular Combination

companies producing distinct products seek amalgamation to share common distribution and research facilities to obtain economies by elimination of cost of duplication and promoting market enlargement. The acquiring company obtain benefits in the form of economies of resource sharing and diversification.

4. Conglomerate Combination

It takes place when the two firms operate in different industries.It is amalgamations of two companies engaged in unrelated industries like DCM and Modi Industries. The basic purpose of such amalgamations remains utilisation of financial resources and enlarge debt capacity through re-organising their financial structure so as to service the shareholders by increased leveraging and EPS, lowering average cost of capital and thereby raising present worth of the outstanding shares. merger enhances the overall stability of the acquirer company and creates balance in the company’s total portfolio of diverse products and production processes.

5. Within Stream Mergers

Such mergers take place when subsidiary company merges with parent company or parent company merges with subsidiary company. The former arrangement is called “down stream” merger whereas the latter is called ‘up stream’ merger. For example, recently, the ICICI Ltd. a parent company has merged with its subsidiary ICICI Bank signifying down stream merger. Such mergers are very common in the corporate world. Another instance of up stream merger is the merger of Bhadrachalam Paper Board, subsidiary company with the parent ITC Ltd. and likewise.

6. Congeneric mergers

It occurs where two merging firms are in the same general industry, but they have no mutual buyer/customer or supplier relationship, such as a merger between a bank and a leasing company. Example: Prudential's acquisition of Bache & Company.A unique type of merger called a reverse merger is used as a way of going public without the expense and time required by an IPO..

Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E.

Dilutive mergers are the opposite of above, whereby a company's EPS decreases.

Acquisition

An acquisition, also known as a takeover, is the buying of one company (the ‘target’) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover.

Types of acquisition

The buyer buys the shares, and therefore control, of the target company being purchased. Ownership control of the company in turn conveys effective control over the assets of the company, but since the company is acquired intact as a going business, this form of transaction carries with it all of the liabilities accrued by that business over its past and all of the risks that company faces in its commercial environment.

The buyer buys the assets of the target company. The cash the target receives from the sell-off is paid back to its shareholders by dividend or through liquidation. This type of transaction leaves the target company as an empty shell, if the buyer buys out the entire assets. A buyer often structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and leave out the assets and liabilities that it does not.

The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.

Distinction between Mergers and Acquisitions

Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things.

When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals". Both companies' stocks are surrendered and new company stock is issued in its place.

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it is technically an acquisition.

A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition.

Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders. It is quite normal though for M&A deal communications to take place in a so called 'confidentiality bubble' whereby information flows are restricted due to confidentiality agreements (Harwood, 2006).

Short-run factors

One of the major short run factors that sparked in The Great Merger Movement was the desire to keep prices high. That is, with many firms in a market, supply of the product remains high. During the panic of 1893, the demand declined. When demand for the good falls, as illustrated by the classic supply and demand model, prices are driven down. To avoid this decline in prices, firms found it profitable to collude and manipulate supply to counter any changes in demand for the good. This type of cooperation led to widespread horizontal integration amongst firms of the era. Focusing on mass production allowed firms to reduce unit costs to a much lower rate. These firms usually were capital-intensive and had high fixed costs.

Long-run factors

In the long run, due to the desire to keep costs low, it was advantageous for firms to merge and reduce their transportation costs thus producing and transporting from one location rather than various sites of different companies as in the past. This resulted in shipment directly to market from this one location. In addition, technological changes prior to the merger movement within companies increased the efficient size of plants with capital intensive assembly lines allowing for economies of scale. Thus improved technology and transportation were forerunners to the Great Merger Movement. The U.S. government passed the Sherman Act in 1890, setting rules against price fixing and monopolies

Reasons for merger or takeover

There is not one single reason for a merger or takeover but a multitude of reasons cause mergers and acquisitions which are precisely discussed below:

(1) Synergistic operating economiesIt is assumed that existing undertakings are operating at a level below optimum. But when two undertakings combine their resources and efforts they may with combined efforts produce better results than two separate undertakings because of savings in operating costs viz. combined sales offices, staff facilities, plants management, etc. which lower the operating costs. Thus, the resultant economies are know as synergistic operating economies. The worth of the combined undertaking should be greater than the sum of the worth of the two separate undertakings i.e. 2+2 = 5.

Synergy means working together. The gains obtained by working together by amalgamated undertakings result into synergistic operating gains. These gains are most likely to occur in horizontal mergers in which there are more chances for eliminating duplicate facilities. Vertical and conglomerate mergers do not offer these economies.

Among others, synergy is possible in areas viz. production, finance and technology. Merger of Hindustan Computers, Hindustan Reprographics, Hindustan Telecommunications and Indian Computer Software Company into HCL Limited exhibited synergy in transfer of technology and resources to enable the company to cut down imports of components at a fabulous duty of 198%. Similarly, Eicher had the synergy advantage in merging with subsidiaries Eicher Good Earch, Eicher Farm technology and finance as the company could borrow increased funds from banks and institutions.

(2) DiversificationMergers and acquisitions are motivated with the objective to diversify the activities so as to avoid putting all the eggs in one basket and obtain advantage of joining the resources for enhanced debt financing and better serviceability to shareholders. Such amalgamations result in creating conglomeratic undertakings. But critics hold that diversification caused by merger of companies does not benefit the shareholders as they can get better returns by having diversified portfolios by holding individual shares of these companies.

(3) Taxation advantagesMergers take place to have benefits of tax laws and company having accumulated losses may merge with a profit earning company that will shield the income from taxation. Section 72A of Income Tax Act, 1961 provides this incentive for reverse mergers for the survival of sick units.

(4) Growth advantageMergers and acquisitions are motivated with a view to sustain growth or to acquire growth. To develop new areas becomes costly, risky and difficult than to acquire a company in a growth sector even though the acquisition is on premium rather than investing in a new assets or new establishments.

(5) Production capacity reductionTo reduce capacity of production merger is sometimes used as a tool particularly during necessionary times as was in early 1980 in USA. The technique is used to nationalise traditional industries.

(6) Managerial motivates

Managers benefit in rank, status and perquisites as the enterprise grows and expands because their salaries, perquisites and status often increase with the size of the enterprise. The acquirer may motivate managerial support by assuring benefits of larger size of the company to the managerial staff. The resultant large company can offer better security for salary earners.

(7) Acquisition of specific assetsSurviving company may purchase only the assets of the other company in merger. Sometimes vertical mergers are done with the motive to secure source of raw material but acquirer may purchase the specific assets of the acquiree rather than acquiring the whole undertaking with assets and liabilities.

The assets may also be acquired at a discount to obtain a going concern cheaply.There can be many situations to take over the assets of a company at discount viz. (i) the acquiree may be in possession of valuable land and property shown at depreciated value/historical costs in books of account which underestimates the current replacement value. Thus, acquirer shall be benefited by acquiring the assets of the company and selling them off subsequently; (ii) to acquire non-profit making company, close down its loss making activities and sell off the profitable sector to make gains; (iii) the existing management is incapable of utilising the assets, the acquirer might take over ungeared company and increase its debt secured on acquiree’s assets.

(8) Acquisition by management or leveraged buyoutsThe acquisition of a company can be had by the management personnel. It is known as management buyout. This practice is common in USA for over 25 years and quite in vogue in UK. Management may raise capital from the market or institutions to acquire the company on the strength of its assets, known as leveraged buyouts.

(9) Other reasonsThere may be many other reasons motivating mergers in addition to the above ones viz. profit enhancement for the company, achieving efficiency, increasing market power, tax and accounting opportunities, growth as a goal and many speculative goals etc.

depending upon the circumstances and prevailing conditions within the company and the economy of the country.

Motivation for mergers and acquisitionsMergers and acquisitions are caused with the support of shareholder, managers and promoters of the combining companies. The factors which motivate the shareholders and managers to lend support to these combinations and the resultant consequences they have to bear are briefly noted below based on the research work done by various scholars globally.

(1) From the standpoint of shareholders

Investments made by shareholders in the companies subject to merger should enhance in value. The sale of shares from one company’s shareholders to another and holding investment in shares should give rise to greater values i.e. the opportunity gains in alternative investments. Shareholders may gain from merger in different ways viz. from the gains and achievements of the company i.e. through (a) realisation of monopoly profits; (b) economies of scale; (c) diversification of product line; (d) acquisition of human assets and other resources not available otherwise; (e) better investment opportunity in combinations.

(2) From the standpoint of managersManagers are concerned with improving operations of the company managing the affairs of the company effectively for all round gains and growth of the company which will provide them better deals in raising their status, perks and fringe benefits. Mergers where all these things are the guaranteed outcome get support from managers. At the same time, where managers have fear of displacement at the hands of new management in amalgamated company and also resultant depreciation from the merger then support from them becomes difficult.

(3) Promoters’ gainsMergers do offer to company promoters the advantage of increasing the size of their company and the financial structure and strength. They can convert a closely-held and private limited company into a public company without contributing much wealth and without losing control. In the above example of HCL, only Hindustan Reprographics Ltd. was public company whereas the other three merging entities were private limited companies. The promoters of Hindustan Computers were allotted shares worth Rs.1.27 crores on merger in a new company called HCL equity of Rs.1.48 crores shares. This gain was against their original investment of meagre Rs.40 lakhs in Hindustan Computers and they did not invest any money extra in getting shares worth Rs.1.48 crores.

Impact of mergers on general publicImpact of mergers on general public could be viewed as aspect of benefits and costs to:

(1) Consumers of the product of services;

(2) Workers of the companies under combination;

(3) General public affected in general having not been user or consumer of the worker in the companies under merger plan.

(1) ConsumersThe economic gains realised from mergers (i.e. enhanced economies and diversification leading to lower costs and better quality products) are passed on to consumers in the form of lower prices and better quality of the product which directly raise their standard of living and quality of life. The balance of benefits in favour of consumers will depend upon the fact whether or not the mergers increase or decrease competitive economic and productive activity which directly affect the degree of welfare of the consumers through changes in price levels, quality of products, after sales service, etc.

(2) Workers communityThe benefit or loss from mergers to worker community will depend upon the level of satisfaction of their demands, merger of companies provides in the form of employment, increased wages, environmental improvements, better living conditions and amenities. The merger or acquisition of a company by a conglomerate or other acquiring company may have the effect on both the sides of increasing the welfare in the form of enhanced quality of life or decrease the welfare by creating unemployment through retrenchment and resultant lack of purchasing power and other miseries of life. Two sides of the impact as discussed by the researchers and academicians are: first, merges with cash payment to shareholders provide opportunities for them to invest this money in other companies which will generate further employment and growth to the uplift of the economy in general. Secondly, any restrictions placed on such mergers will decrease the growth and investment activity with corresponding decrease in employment. Both workers and communities will suffer on lessening job opportunities, preventing the distribution of benefits resulting from diversification of production activity. Diversification fosters and provides opportunities for advancement in career, training in new skills amount may other alike benefits.

(3) General PublicMergers result into centralised concentration of power in small number of corporate leaders which results in the concentration of an enormous aggregation of economic power in their hands. Economic power is to be understood in specific limited sense as the ability to control prices and industries output as monopolists. Such monopolists affect social and political environment to tilt everything in their favour to maintain their power and expand their business empire. These advances result into deceleration of level of welfare and well being of the general public which are subjected to economic exploitation. But in a free economy a monopolist does not stay for a longer period as other companies enter into the

field to reap the benefits of high prices set in by the monopolist. This enforces competition in the market as consumers are free to substitute the alternative products. Therefore, it is difficult to generalise that mergers affect the welfare of general public adversely or favourably. Every, merger of two or more companies has to be viewed from different angles in the business practices which protects the interest of the shareholders in the merging company and also serves the national purpose to add to the welfare of the employees, consumers and does not create hindrance in administration of the Government policies.

Business valuation

The five most common ways to valuate a business are

asset valuation, historical earnings valuation, future maintainable earnings valuation, relative valuation (comparable company & comparable transactions), discounted cash flow (DCF) valuation

Professionals who valuate businesses generally do not use just one of these methods but a combination of some of them, as well as possibly others that are not mentioned above, in order to obtain a more accurate value. These values are determined for the most part by looking at a company's balance sheet and/or income statement and withdrawing the appropriate information. The information in the balance sheet or income statement is obtained by one of three accounting measures: a Notice to Reader, a Review Engagement or an Audit.

Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. Most often this information is expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's sake. There are other, more detailed ways of expressing the value of a business. These reports generally get more detailed and expensive as the size of a company increases, however, this is not always the case as there are many complicated industries which require more attention to detail, regardless of size.

Financing M&A

Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:

Cash

Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders alone.

A cash deal would make more sense during a downward trend in the interest rates. Another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. But a caveat in using cash is that it places constraints on the cash flow of the company.

Financing

Financing capital may be borrowed from a bank, or raised by an issue of bonds. Alternatively, the acquirer's stock may be offered as consideration. Acquisitions financed through debt are known as leveraged buyouts if they take the target private, and the debt will often be moved down onto the balance sheet of the acquired company.

Hybrids

An acquisition can involve a combination of cash and debt, or a combination of cash and stock of the purchasing entity.

Factoring

Factoring can provide the necessary extra to make a merger or sale work.

Reverse Merger

Generally, a company with the track record should have a less profit earning or loss making but viable company amalgamated with it to have benefits of economies of scale of production and marketing network, etc. As a consequence of this merger the profit earning company survives and the loss making company extinguishes its existence. But in many cases, the sick company’s survival becomes more important for many strategic reasons and to conserve community interest. The law provides encouragement through tax relief for the companies that are profitable but get merged with the loss making

companies. Infact this type of merger is not a normal or a routine merger. It is, therefore, called as a Reverse Merger.

A reverse merger occurs when a private company that has strong prospects and is eager to rise financing buys a publicly listed shell company, usually one with no business and limited assets. The private company reverse merges into the public company, and together they become an entirely new public corporation with tradable shares.

Deutsche – Dresdner Bank ( Merger Failure )

The merger that was announced on march 7, 2000 between Deutsche Bank and Dresdner Bank, Germany’s largest and the third largest bank respectively was considered as Germany’s response to increasingly tough competition markets.

The merger was to create the most powerful banking group in the world with the balance sheet total of nearly 2.5 trillion marks and a stock market value around 150 billion marks. This would put the merged bank for ahead of the second largest banking group, U.S. based citigroup, with a balance sheet total amounting to 1.2 trillion marks and also in front of the planned Japanese book mergers of Sumitomo and Sukura Bank with 1.7 trillion marks as the balance sheet total.

The new banking group intended to spin off its retail banking which was not making much profit in both the banks and costly, extensive network of bank branches associated with it.

The merged bank was to retain the name Deutsche Bank but adopted the Dresdner Bank’s green corporate color in its logo. The future core business lines of the new merged Bank included investment Banking, asset management, where the new banking group was hoped to outside the traditionally dominant Swiss Bank, Security and loan banking and finally financially corporate clients ranging from major industrial corporation to the mid-scale companies.

With this kind of merger, the new bank would have reached the no.1 position of the US and create new dimensions of aggressiveness in the international mergers. But barely 2 months after announcing their agreement to form the largest bank in the world, negotiations for a merger between Deutsche and Dresdner Bank failed on April 5, 2000.

What happened?

The union of the two previous competitors should be carried out "by agreement”, areas that overlapped should not be shut down or broken up but merged and integrated. Although they intended a reduction of 16,000 jobs, this was to proceed by "socially acceptable" means. This was insisted upon by both the union representatives on the supervisory board as well.

From the outset, the international investors rejected this concept of a socially acceptable merger. After a short initial rise, the share values of the two institutions slumped by almost 30 percent.

Banking analysts, on whose assessments large investors rely, stated that this type of merger would "set free too little synergy".

One banking analyst explained that in order to obtain the "large reduction of costs necessary", the Dresdner Bank would have had to go down. The reduction of 16,000 jobs announced could only have been the start.

Only the shares of the insurance company Allianz AG increased, rising over 20 percent on the first day after news of the agreement to merge. The Allianz had contrived the merger plans and was regarded as the actual winner. It owns a 21.7 percent share in the Dresdner Bank and has wanted to dispose of this for some time in order to concentrate on its own business.

The Allianz is also interested in the retail banking business, which has become unattractive to the banks, in order to utilise these structures to sell their insurance. In the merger plan, it was intended that the Allianz would take a majority holding in the new Bank 24, which would retain the majority of the two banks' smaller customers. A third point concerned asset management. In return for its share of the Dresdner Bank, the Allianz was to receive DWS, the asset management arm of the Deutsche Bank, Germany's market leader with investments of 175 billion marks.

Shareholders of the two banks did not look kindly on the fact that the Allianz was to receive the golden egg without requiring any effort of its own. The more negotiations over the merger—which at first had only been roughly discussed in a small circle—turned to the details, the more open the contradictions and differences became.

On the one hand, the pressure from the workforce increased. There were several demonstrations by bank staff as it became increasingly clear that it was mainly Dresdner Bank employees from the branches and central administration who were on the blacklist.

The boards of directors also lost control concerning the distribution of highly paid jobs in middle management. Many started to look around for new employers offering safer prospects. The dependency of their salary levels on the banks' share value (now sinking) also played a role.

30 %

20 %

There was a nation-wide outcry by customers after a member of the Dresdner board announced that the merged bank was only interested in customers with over 200,000 marks. Those with less would be transferred to the new Bank 24. Many customers consequently moved their accounts over to the competition.

The main point at issue became the fate of the bank's investment arm, DKB (Dresdner Kleinwort Benson), which the executive committee of the Dresdner Bank did not want to relinquish under any circumstances.

Apart from asset management, investment banking- i.e. the trade with securities and the consultancy business concerning mergers, acquisitions and floatations—forms part of the most profitable business of the financial markets, with high profits arising from the stock market boom and the rapidly increasing wave of mergers. Over 50 percent of bank profits are made within this area. Breuer wanted to position the new bank at the highest place internationally in this sector.

In the preliminary negotiations it had been agreed that DKB would be integrated into the new major bank. But from the outset these considerations encountered resistance in the leading echelons of Deutsche Asset Management, the Deutsche Bank's investment arm, also situated in London.

Deutsche Asset Management had only just integrated London's Morgan Grenfell and the American Bankers Trust, aggressively headhunting whole teams of investment bankers with top salaries. Meanwhile, this division alone now contributed over 60 percent of Deutsche Bank's profits, which in the past year amounted to about 2.6 billion euro. In this area, Deutsche Bank was among the top 10 in the world.

The top people at Deutsche Asset Management were not ready to undertake a new process of integration with DKB. The investment business is driven by expert teams, which concentrate on certain industries or countries. Only in this way is it possible to grow or even survive in this hotly contested market, which serves internationally mobile investors. International comparisons are constantly drawn in this market, so that only those succeed who score above the average, the so-called benchmark.

Moreover, the administration and controlling departments would have almost completely overlapped with the structures of Deutsche Bank, so that almost nobody from DKB could have been taken over into Deutsche Asset Management, which had already developed to be a global player, without losing profits. Among the leading staff, nobody was prepared for a new round of haggling for positions with the people from DKB. There would only have been jobs for some of the expert teams.

"Either Dresdner Kleinwort Benson is completely sold off, or at the most a few hundreds of its 7,500 workforce will be taken over. Another version is out of the question. We will not let our business be ruined," were widespread opinions.

The Deutsche Bank's London investment bankers were not prepared to compromise and used the weight of the share they contributed to the profits to pressure Breuer. After the merger was announced, they immediately dispatched a message via the Financial Times that either the DKB was smashed up or sold off. Walter from the Dresdner Bank was not prepared for this, since DKB was considered his "pearl". At a press conference on March 9, Breuer had to publicly assure the distrustful Walter that statements about the sale of DKB were "absolute nonsense" and that this company was a "jewel".

However, Breuer did not succeed in getting the investment bankers onto his side. Their division head Edson Mitchell, one of the most successful investment bankers with an annual salary of over 10 million marks, continued to exert enormous pressure on Breuer via Joseph Ackermann, the division's chief executive. Finally, Breuer capitulated to the pressure of his subordinates. At the last joint session of the two boards of directors on April 5, he placed himself completely on the side of Ackermann, which led to the withdrawal of the Dresdner Bank from the merger negotiations. Made to look foolish by his own staff, the otherwise independent and self-assured Breuer stepped forward with trembling voice to publicly explain the failure of the merger.

PARTIAL BID

Partial bid is understood when a bid is made for acquiring part of the shares of a class of capital where the offeror intends to obtain effective control of the offeree through voting power. Such bid is made for equity shares carrying voting rights.

COMPETITIVE BID Competitive bid can be made by any person within 2 1 days of public announcement of the offer made by the acquirer.

Tender Offer The acquirer pursues takeover without consent of the acquiree company by making a tender offer directly to the shareholders of the target company to sell (tender) their shares.

Procedure of organising takeover bids

The procedure for organising takeover bids as narrated in the following paragraphs is based on international practices in particular the City Code. However, once an understanding is developed, the procedure should be streamlined in terms of the SEBI Takeover Regulations, 1997 which, of course, do not lay down the procedure but

prescribe a restrictive drill to safeguard the interests of the investors and shareholder. The following steps generally take place in a takeover bid.

(1) Collection of relevant information and its analysis

The potential bidder should collect all possible relevant information on the target or offeree company, analyse the information through experts from financial, accounting, tax and legal angles, and keep the information and appraisal results top secret.

(2) Examine shareholders' profile

Potential bidder should examine the share register of the target company and see the profile of the shareholders i.e. the number and weight of institutional investors and small shareholders. If the directors of the target Company cooperate, it can also trace the dividend register to find out number of shareholders not traceable to design the course of its bid.

(3) Investigation of title and searches into indebtedness

Potential bidder should also have the searches carried out in Land Registry Office and Registrar of Companies office to find out the extent of encumbrance on offeree's properties and the indebtedness.

(4) Examining of articles of association

The offeror should also examine the Articles of Association of the offeree company to ascertain the extent of power of directors with regard to borrowing restrictions, etc.

(5) Representation on board

The potential bidder should ensure first his entry or representation on the board of the offeree company and should win over some of the directors on the board to the suggested changes and explore possibility of offer being successfully discussed on the board for takeover bid on convenient terms. This will ensure friendly takeover.

(6) Press announcement

Once the board of the offeree company shows a sympathetic view, the joint preliminary announcement could be made for awareness of shareholders of the main terms of the offer.

(7) Approval under FEMA

Necessary approvals under the Foreign Exchange Management Act, 1999 are required to be take by the companies, primarily under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000.

(8) Recommendations to shareholders

Once the board of the offeree company agrees to the takeover bid it can bring to the notice of shareholders through circular, the merits of the takeover or merger and the advantages which will accrue to them from such amalgamation. In case the board does not approve of the move, the directors can also bring the fact tot he notice of the shareholders.

(9) Improvement of conditions by offeror

In case a. group of shareholders oppose the proposal for bid, the offeror can circularise its rejoinder to the criticism of the bid and alternatively can announce improvement of the bid conditions through press.

(10) Information about acceptance

The takeover offer is open for a limited time within which it should be accepted by the shareholders. The offeror should announce information about the acceptance for the knowledge of shareholders to know the response in its favour and make their own judgement.

(11) Despatch of consideration

With a view to complete the transaction with the shareholders of the offeree company the bidder should despatch consideration for the shares in the offeree company to the shareholders who have accepted the offer and submitted valid acceptances with the share certificates or other documents of title. The offeror will take further steps for registration of shares in its own name as per provisions of the Companies Act, 1956 Stock Exchange Rules & Regulations, etc.

A. COMMERCIAL STRATEGIES

(i) Dissemination of favourable information

To have defence against the offeror being critical of the company’s past performance the target company should be ready with profits forecast and performance information to demolish the offeror’s arguments.

The threatened company should keep their shareholders abreast of all latest developments particularly about the financial strength of the company as evidenced by market coverage, product demand, industry outlook and resultant profit forecast and value appreciation, etc. Disclosure of all these favourable aspects will keep the shareholders in good humour and they will always side with the existing management dislodging all the takeover bids. After attempt of takeover bid, the disclosure might miss the reliability and significance and invite criticism of directors keeping the shareholders in dark.

(ii) Step up dividend and update share price record

The fall in the market price of shares might occur due to restrictive dividend policy of the company. The company should, therefore. This will, automatically, bolster up the price of its shares and frustrate the takeover bid, for raising expectations for higher dividend, the company should in advance declare interim dividend and meet all statutory requirements of stock exchange of giving advance information and deciding date of closure of register of members, etc. In pursuance of the provisions of the Companies Act, 1956 declaration of final dividend is to be done at the annual general meeting of a company but interim dividend can be declared by the board to indicate the clear intentions of the company for stepping up the dividend.

(iii) Revaluation of Assets

Assets shown at depreciated historical costs in financial accounts understate the real value of assets. For defence strategy it is common practice to revalue the assets periodically and incorporate them in the balance sheet. Such valuation should be attested by recognized values.

(iv) Capital structure reorganization

Proper capital structure is essential for enhanced profitability and brightening of the dividend prospects. Capital structure which is under geared or geared with tax inefficient preference capital instead of debenture stock or term loans exhibits poor financial performance of the company and is required to be reorganized for proper gearing and tax efficiency. Company may take suitable steps to replace preference capital by loan capital. In those cases where the company has excess liquidity there are chances of takeover raids. The company should use liquid resources for financial acquisition of assets, replacements, expansion programme, etc. or distribute the surplus to shareholders through bonus and rights issues. The company should have expert advice from financial

consultants on the issue of capital restructuring before implementing any conceived plan to thwart away the takeover bid.

(v) Unsuitability of offeror

Research based arguments should be prepared to show and convince the shareholders that the offeror is incapable of managing the business efficiently. The management style, the profit and dividend record of the offeror in existing companies should be focussed particularly, specific losses, skipping of dividend, lower market experience and other similar denouncing factors should be highlighted about the offeror and its associate concerns.

(vi) Other commercial aspects

The target company’s management in its defence strategy should, inter alia, trace out the various discouraging commercial features of the functioning of the offeror company which may convince its own shareholders to thwart away the take over bid and at the same time should highlight own favourable commercial aspects with optimistic and promising futuristic view like new product development, new business avenues, prospects and future growth, etc.

A. JOINT HOLDINGS OR JOINT VOTING AGREEMENT

Two or more major shareholders may enter into agreement for block voting or block sale of shares rather than separate voting or separate sale of shares. This agreement is entered into in collaboration with or with the cooperation of offeree company’s directors who wish to exercise effective control of the company.

B. INTERLOCKING SHAREHOLDINGS OR CROSS SHAREHOLDINGS

Two or more group companies acquire shares of each other in large quantity or one company may distribute shares to the shareholders of its group company to avoid threads of takeover bids. Such companies shall fall within the same management control and attract provisions of section 372 of the Companies Act, 1956. If the interlocking of shareholdings is accompanied by joint voting agreement then the joint system of advance defence could be termed as ‘pyramiding’ as most safe device of defence.

C. ISSUE OF BLOCK OF SHARES TO FRIENDS AND ASSOCIATES

With a view to forestall a takeover bid, the directors issue block of shares to their friends and associates to continue maintaining their controlling interest and as a safeguard to the threads of dislodging their control position. This may also be done by issue of rights shares.

D. DEFENSIVE MERGER

The directors of a threadtened company may acquire another company for shares as a defensive measure to forestall the unwelcome takeover bid. For this purpose they put large block of shares of their own company in the hands of shareholders of the friendly company to make their own company least attractive for takeover bid.

E. SHARES WITH NON-VOTING RIGHTS LIKE PREFERENCE SHARES

In India, so far, non-voting right shares are only of one variety i.e. preference shares or cumulative convertible preference shares as against a wide variety of restricted or weighted voting rights equity shares under English Company Law. Management may retain shares with voting rights so that takeover bid could be thwarted away without voting support. Non-voting shares are a convenient method of providing for any desired adjustment of control on a merger of two companies.

F. CONVERTIBLE SECURITIES

To make the company less attractive to corporate raiders, it is necessary that its capital structure should contain loan capital by way of debentures either convertible in part or full or non-convertible. This is so because any successful bidde can’t acquire compulsorily convertible securities, options or warrants because liability towards repayments of principal and payment of interest discourages takeover bids.

G. DISSEMINATION TO SHAREHOLDERS OF FAVORABLE FINANCIAL INFORMATION

To make the investors and the shareholders aware, it is necessary that true earning position of the company should be told to them through press media or direct communications to ensure continuity of their interest in the management set up of the company. The dissemination of information about the company’s favourable features of operations and profitability go a long way in bringing the market price of share nearer to its true assets value. This type of behaviour on the part of the directors of the company elicit confidence of shareholders in their management and control which will in many ways help prevent any takeover bid to set in or to succeed.

H. DEFERMENT OF SHAREHOLDERS CONTROL OVER THE COMPANY’S ASSETS

Prudent board of directors make the chances of any takeover bid in near future dim by making the possession of the company’s assets less attractive. This is possibly dine by putting the assets outside the control of the shareholders by entering into various types of financial arrangements like sale and lease back, mortgage of the assets to financial institutions for long-term loans, keeping the assets in trust for security of debenture, loan, etc. This is done with the specific approval of shareholders in their general meetings in pursuance of sections 293(1) (a) and (b) of the Companies Act, 1956.

I. LONG-TERM SERVICE AGREEMENTS

Directors having specialised skills in any specific technical field may enter into contract with the company with specific approval of shareholders and/or the Central Government under the Companies Act, 1956 or the rules framed thereunder for rendering service over a period of time. There are two significant aspects of such an agreement viz. the prospective bidder would not be attracted due to the fear of non-cooperation by such directors if the company is acquired without personal involvement of such directors and secondly, the bidder will have to pay handsome compensation for terminating the agreement or the technical assistance or services provided under the said agreement might not be made available by any other outside party. In view of these circumstances the takeover game becomes unattractive to the bidders.

B. TACTICAL DEFENCE STRATEGIES

(i) Friendly purchase of shares

To stave off the takeover bid the directors of the company may persuade their friends and relatives to purchase the shares of the offeree company as they themselves cannot indulge into the gonal attachments, loyalty and patriotism

To ward off takeover bids, the board may make attempt to win over the shareholders through raising their emotions for continued association and attachment with the company as shareholder and raising fearsin their mind towards changes of the name of the company, independence of business and goodwill, etc. Particularly, institutional shareholders might yield to these reasoning. Similarly, takeover bid from a foreign controlled company could be warded off by invoking national interest and emotional feelings. Much will depend upon economic circumstances, political climate and the prospects of the trade in which the company is engaged. Arguments could also be made of the possible consequences which follow on takeover like retrenchment of work force, displacement of managerial, technical and financial executives, shifting work place and all possible miseries resulting from the successful takeover bid. Many times, such appeal works well to raise sentiments of shareholders to support the board of directors and confide with the management.

(iii) Recourse to legal action

To dissuade the corporate raider, the target company can refuse registration of transfer of any of the grounds given under relevant sections of the Companies Act, 1956.

To sum up, it is the responsibility of the directors to accept a takeover bid or thwart it away in the interest of the company. In averting the takeover bid the directors are not absolved of their liability under the law for making any wrong statements and painting in words any unrealistic position into high hopes for the future of the company. For

example, profit forecasts made by them in the context of fighting off the takeover bid should be realistic, based on viable assumptions. In other words, they should not indulge in fraudulent acts against the interest of the shareholders.

(iv) Operation ‘White Knights’

White knight: A target company is said to use a white knight when its management offers to be acquired by a friendly company to escape from a hostile takeover. The possible motive for the management of the target company to do so is not to lose the management of the company. The hostile acquirer may replace the management

(v) Disposing of “Crown Jewels”

The precious assets in the company are called “Crown Jewels” to depict the greed of the acquirer under the takeover bid. These precious assets attract the raider to bid for the company’s control. The term “crown jewels” was coined in USA in 1982. The company, as a defence strategy, in its own interest, sells these valuable assets at its own initiative leaving the rest of the company intact. Instead of them or mortgage them to creditors so that the attraction of free assets to the predator is over. This defence is very much in vogue in UK but subject to regulations of ‘City Code’.. In some countries such as the UK, such tactic is not allowed once the deal becomes knows and it unavoidable.

(vi) ‘Pac-man' strategy

This term was coined in America in 1982. Under this strategy the target company attempts to takeover the hostile raider. This happens when the target company is quite larget than the predator.

(vii) Compensation packages viz: “Golden Parachutes” or “First Class Passengers” strategy

The term “Golden Parachute” again was coined in USA. The term is known as “first class passengers’ in UK. It envisages a termination package for senior executives and is used as a protection to the directors of the company against the takeover bids. This strategy is adopted as a precautionary measure by the companies in USA and UK to make the takeover bid very expensive. When a company offers hefty compensations to its managers if they got ousted due to takeover, the company is said to offer golden parachutes. This reduces their resistance to take over.

(viii) “Shark repellent” character

The companies change and amend their bye-laws and regulations to be less attractive for the corporate raider company. Such features in the bye-laws are called “Shark Repellent” character. US companies adopt this tactic as a precautionary measure against prospective bids. For example, shareholders approvals for approving combination proposal is fixed at minimum by 80-95% of the shareholders and to call shareholders meeting for this purpose 75% of the board of directors consent is needed.

(ix) Swallowing “Poison Pills” strategy

An acquiring company itself could become a target when it is bidding for another company. The tactics used by the acquiring company to make itself unattractive to a potential bidder is called poison pills. For example, the acquiring company may issue substantial amount of convertible debentures to its existing shareholders to be converted to its existing shareholders to be converted at a future date when it faces a takeover threat. The task of the bidder would become difficult since the number of shares to have voting control of the company will increase substantially.

There are many variants in this strategy. For example, as a tactical strategy, the target company might issue convertible securities which are converted into equity to deter the efforts of the offeror because such conversion dilutes the bidder’s shares and discourages acquisition. Another example, target company might raise borrowings distorting normal debt: equity ratio.

(x) Green mail

A large block of shares is held by an unfriendly company, which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. In a takeover bid this could prove to be an expensive defence mechanism. Greenmail refers to an incentive offered by management of the target company to the potential bidder for not pursuing the takeover. The management of the Target Company may offer the acquirer for its shares a price higher than the market price.

(xi) Poison put A covenant allowing the bond holder to demand repayment in the event of a hostile takeover.

(xii) Grey knight

A friendly party of the target company who seeks to takeover the predator.

To sum up, the target company may adopt a combination of various strategies for successfully averting the acquisition bid. All the above strategies are experience based

and have been successfully used in developed nations, particularly in USA or UK and some of them have been tested in critical times by the companies in India also. Nevertheless, the above list is not exhaustive but only illustrative. In different circumstances and even, the scope for evolving more rapid strategies always remains for the target companies to defend their existence against takeover bids.

Divestiture: In a divestiture the target company divests or spins off some of its businesses in the form of an independent, subsidiary company. Thus, it reduces the attractiveness of the existing business to the acquirer.

Value Created by Merger

A merger will make economic sense to the acquiring firm if its shareholders benefit. Merger will create an economic advantage (EA) when the combined present value of the merged firms is greater than the sum of their individual present values as separate entities. For example, if firm P and firm Q merge, and they are separately worth V P and VQ, respectively, and worth VPQ in combination, then the economic advantage will occur if:

VPQ > (VP + VQ)

and it will equal to:

EA = VPQ - (VP + VQ)

Suppose that firm P acquires firm Q. After merger P will gain the present value of Q i.e., VQ, but it will also have to pay a price (say in cash) to Q. Thus, the cost of merging to P is [Cash paid - VQ]. For P, the net economic advantage of merger (NEA) is positive if the economic advantage exceeds the cost of merging. Thus

Net economic advantage = economic advantage – cost of merging

NEA = [VPQ - (VP + VQ) – (cash paid – VQ)

The economic advantage i.e., [VPQ - (VP + VQ)], represents the benefits resulting from operating efficiencies and synergy when two firms merge. If the acquiring firm pays cash equal to the value of the acquired firm, i.e. cash paid – VQ = 0, then the entire advantage of merger will accrue to the shareholders of the acquiring firm. In practice, the acquiring and the acquired firm may share the economic advantage between themselves.

Example 1

Firm P has a total market value of Rs.18 crore (12 lakh shares of Rs.150 market value per share). Firm Q has a total market value of Rs.3 crore (5 lakh of Rs.60 market value per share). Firm P is considering the acquisition of Firm Q. The value of P after merger (that is, the combined value of the merged firms) is expected to be Rs.25 crore due to the operating efficiencies. Firm P is required to pay Rs.4.5 crore to acquire Firm Q. What is the net economic advantage to Firm P if it acquired Firm Q? It is the difference between the economic advantage and the cost of merger to P:

NEA = [25 – (18+3)] – (4.5 - 3) = (4 – 1.5) = Rs. 2.5 crore

The economic advantage of Rs.4 crore is divided between the acquiring firm Rs.2.5 crore and the target firm, Rs. 1.5 crore.

The acquiring firm can issue shared to the target firm instead of paying cash. The effect will be the same if the shares are exchanged in the ratio of cash-to-be-paid to combined value of the merged firms. In example, ……………

X = 12 + 0.18 XX - 0.18 X = 12X = 12/0.82 = 14.63 lakh shares

And the new shares price will be: 25/0.1463 = Rs.170.9. Firm Q will get 2.63 lakh shares of Rs. 170.9 each. Thus, the cost of acquisitions to Firm P remains the same: (2.63 lakh x Rs. 170.9) – Rs. 3 crore = Rs.1.5 crore.

In practice, the number of shares to be exchanged may be based on the current market value of the acquiring firm. Thus, in example 1, Firm Q may require 300,000 shares (i.e., Rs.4.5 crore/Rs. 150) of the acquiring Firm P. Now Firm P after merger will have 15 lakh shares of total value of Rs.25 crore. The new share price will be: Rs.25/0.15 = Rs.166.67. The worth of shares given to the shareholders of Firm Q will be Rs.5 crore (i.e., Rs.166.67 x 3 lakh). The cost of merger of Firm P is Rs.2 crore (i.e., the value of share exchanged, Rs.5 crore less the value of the acquired firm, Rs. 3 crore). Thus, the effective cost of merger may be more when the merger is financed by issuing shares rather than paying cash.

DCF Evaluation of mergers

In a merger or acquisition, the acquiring firm is buying the business of the target firm, rather than a specific asset. Thus, merger is special type of capital budgeting decision. What is the value of the target firm to the acquiring firm after merger? This value should include the effect of operating efficiencies and synergy. The acquiring firm should appraise merger as a capital budgeting decision, following the discounted cash flow (DCF) approach. The acquiring firm incurs a cost (in buying the business of the target firm) in the expectation of a stream of benefits (in the form of cash flows) in the future.

The merger will be advantageous to the acquiring company if the present value of the target merger is greater than the cost of acquisition.

Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. Nevertheless, DCF approach is an important tool in analyzing mergers and acquisitions. In order to apply DCF technique, the following information is required.

Estimation of cash flows Timing of cash flows Discount rate

Earnings are the basis for estimating cash flows. Cash flows include adjustments for depreciation, capital expenditure and working capital. As discussed in the earlier lesson, net cash flows (NCF) or free cash flows can be calculated as follows:

NCF = EBIT (1 - T) + DEP – Δ NWC – Δ CAPEX

Where EBIT is earnings before interest and tax, T tax rate, DEP depreciation, Δ NWC ………………………… capital expenditure.

The appropriate discount rate depends on the riskiness of the cash flows. Since the cash flows are expected from the target firm’s operation, its cost of capital should be calculated for discounting the cash flows. The methodology for calculating the cost of capital has been discussed in the Lesson.

In summary, the following steps are involved in the financial evaluation of a merger:

Identify growth and profitability assumptions and scenarios Project cash flows magnitudes and their timing Estimate the cost of capital Compute NPV for each scenario Decide if the acquisition is attractive on the basis of NPV Decide if the acquisitions should be financed through cash or exchange of shares Evaluate the impact of the merger on EPS and price-earnings ratio.

Consider the case of Sarangi Engineering and XL Equipment Company in example 2 for an approach for the financial evaluation of a merger.

Exchange Ratio

The current market values of the acquiring and the acquired firms may be taken as the basis for exchange of shares. As discussed earlier, the share exchange ratio (SER) would be as follows:

Share price of the acquired firm Pb

Share exchange ratio = Share price of the acquiring firm = Pb

The exchange ratio in terms of the market value of shares will keep the position of the shareholders in value terms unchanged after the merger since their proportionate wealth would remain at the pre-merger level. There is no incentive for the shareholders of the acquired firm, and they would require a premium to be paid by the acquiring company. could the acquiring company pay a premium and be better off in terms of the additional value of its shareholders? In the absence of net economic gain, the shareholders of the acquiring company would become worse-off unless the price-earnings ratio of the acquiring company remains the same as before the merger. For the shareholders of the acquiring firm to be better-off after the merger without any net economic gain either the price-earnings ratio will have to increase sufficiently higher or the share exchange ratio is low, the price-earnings into remaining the same.

Regulation of Mergers and Takeover in India

Mergers and acquisitions may degenerate into the exploitation of shareholders, particularly minority shareholders. In India, mergers and acquisitions are regulated-through the provision of the Companies Act, 1956, the Monopolies and Restrictive Trade Practice (MRTP) Act, 1969, the Foreign Exchange Regulation Act (FERA), 1973, the Income Tax Act, 1961, and the Securities and Controls (Regulations) Act, 1956. The Securities and Exchange Board in India (SEBI) has issued guidelines to regulate mergers, acquisitions and takeovers.

Legal Measures against Takeovers

The Companies Act restricts and individual or a company or a group of individuals from acquiring shares, together with the shares held earlier, in a public company to 25 per cent of the total paid-up capital. Also, the Central Government needs to be intimated whenever such holding exceeds 10 per cent of the subscribed capital. The Companies Act also provides for the approval of shareholders and the Central Government when a company, by itself or in association of an individual or individuals purchases shares of another company in excess of its specified limit. The approval of the Central Government is necessary if such investment exceeds 10 per cent of the subscribed capital of another company. These are precautionary measures against the takeover of pubic limited companies.

Refusal to Register the Transfer of Shares

In order to defuse situation of hostile takeover attempts, companies have been given power to refuse to register the transfer of shares. If this is done, a company must inform the transferee and the transferor within 60 days. A refusal to register transfer is permitted

A legal requirement relating to the transfer of shares have not be compiled with; or

The transfer is in contravention of the law; or The transfer is prohibited by a court order; or The transfer is not in the interest of the company and the public.

Protection of Minority Shareholders’ Interests

In a takeover bid, the interests of all shareholders should be protected without a prejudice to genuine takeovers. It would be unfair if the same high price is not offered to all the shareholders of prospective acquired company. The larger shareholders (including financial institutions, banks and individuals) may get most of the benefits because of their accessibility to the brokers and the takeover deal makers. Before the small shareholders know about the proposal, it may be too late for them. The Companies Act provides that a purchaser can force the minority shareholder to sell their shares it:

The offer has been made to the shareholders of the company; The offer has been approved by at least 90 per cent of the shareholders of the

company whose transfer is involved, within 4 months of making the offer, and The minority shareholders have been intimated within 2 months from the expiry

of 4 months referred above.

If the purchaser is already in possession of more than 90 per cent of the aggregate value of all the shares of the company, the transfer of the shares of minority shareholders is possible if:

The purchaser offers the same terms of all shareholders and The tenders who approve the transfer, besides holding at least 90 per cent of the

value of shares should also form at least 75 per cent of the total holders of shares.

Guidelines for Takeovers

SEBI has provided guidelines for takeovers. The guidelines have been strengthened recently to protect the interests of the shareholders from takeovers. The salient features of the guidelines are:

Notification of takeover: If an individual or a company acquires 5 per cent or more of the voting capital of a company, the target company and the stock exchange shall be notified immediately.

Limit to share acquisition: An individual or a company can continue acquiring the shares of another company without making any offer to other shareholders until the individual or the company acquires 10 per cent of the voting capital.

Public Offer: If the holding of the acquiring company exceeds 10 per cent, a public offer to purchase a minimum of 20 per cent of the shares shall be made to the remaining shareholders through a public announcement.

Offer price: Once the offer is made to the remaining shareholders, the minimum offer price shall not be less than the average of the weekly high and low of the closing prices during the last six months preceding the date of announcement.

Disclosure: The offer should disclose the detailed terms of the offer, identity of the offerer, details of the offerer’s existing holdings in the offeree company etc. and the information should be make available to all the shareholders at the same time and in the same manner.

Offer document: The offer document should contain, the offer’s financial information, its intention to continue the offeree company’s business and to make major change and long-term commercial justification for the offer.

The objectives of the Companies Act and the guidelines for takeover are to ensure full disclosure about the mergers and takeovers and to protect the interests of the shareholders, particularly the small shareholders. The main thrust is that public authorities should be notified within two days.

In a nutshell, an individual or company can continue to purchase the share without making and offer to other shareholders until the shareholding exceeds 10 per cent. Once the offer is make to other shareholders, the offer price should not be less than the weekly average price in the past 6 months or the negotiated price.

Legal Procedures

The following is the summary of legal procedures for merger or acquisition laid down in the Companies Act, 1956:

Permission for merger: Two or more companies can amalgamate only when amalgamation is permitted under their memorandum of association. Also, the acquiring company should have the permission in its object clause to carry on the business of the acquired company. in the absence of these provisions in the memorandum of association, it is necessary to seek the permission of the shareholders, board or directors and the Company Law Board before affecting the merger.

Information to the stock exchange: The acquiring and the acquired companies should inform the stock exchanges where they are listed about the merger.

Approval of board of directors: The boards of the directors of the individual companies should approve the draft proposal for amalgamation and authorize the management of companies to further pursue the proposal.

Application in the High Court: An application for approving the draft amalgamation proposal duly approved by the boards of directors of the individual companies should be made to the High Court. The High Court would convene a meeting of the shareholders

and creditors to approve the amalgamation proposal. The notice of meeting should be sent to them at least 21 days in advance.

Shareholders’ and creditors’ meetings: The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. At least, 75 per cent of shareholders and creditors in separate meeting, voting in person or by proxy, must accord their approval to the scheme.

Sanction by the High Court: After the approval of shareholders and creditors, on the petitions of the companies, the High Court will pass order sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. If it deems so, it can modify the scheme. The date of the court’s hearing will be published in two newspapers and also, the Regional Director of the Company Law Board will be intimated.

Filling of the Court Order: After the Court order, its certified true copies will be filed with the Registrar of Companies.

Transfer of assets and liabilities: The assets and liabilities of the acquired company will be transferred to the acquiring company in accordance with the approved scheme, with effect from the specified date.

Payment by cash or securities: As per the proposal, the acquiring company will exchange shares and debentures and/or pay cash for the shares and debentures of the acquired company. These securities will be listed on the stock exchange.

Accounting for Mergers and Acquisitions

Mergers and acquisitions involve complex accounting treatment. A merger, defined as amalgamation in India, involves the absorption of the target company by the acquiring company, which results in the uniting of the interests of the two companies. The merger should be structured as pooling of interest. In the case of acquisition, where the acquiring company purchases the shares of the target company, the acquisition should be structured as a purchase.

Pooling of Interests Method

In the pooling of interests method of accounting, the balance sheet items and the profit and loss items of the merged firms are combined without recording the effects of merger. This implies that assets, liabilities and other items of the acquiring and the acquired firms are simply added at the book values without making any adjustments. Thus, there is no revaluation of assets or creation of goodwill.