Chapter-2Mergers and acquisitions

Meaning of Merger/ amalgamation

A merger is a combination of two or more businesses into one business. Laws in India use the term 'amalgamation' for merger. The Income Tax Act, 1961 (Section )defines amalgamation as the merger of one or more companies with another or the merger of two or more companies to form a new company, in such a way that all assets and liabilities of the amalgamating companies become assets and liabilities of the amalgamated company and shareholders not less than nine-tenths in value of the shares in the amalgamating company or companies become shareholders of the amalgamated company.

Example- Reliance merged with Bombay dyeing .

Mergers or amalgamations are of two forms

Merger through Absorption

An absorption is a combination of two or more companies into an 'existing company'. All companies except one lose their identity in such a merger. For example, absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring company (a buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist. TFL transferred its assets, liabilities and shares to TCL.

Merger through Consolidation A consolidation is a combination of two or more companies into

a 'new company'. In this form of merger, all companies are legally dissolved and a new entity is created. Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash or exchange of shares. For example, merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL Ltd.

Why Mergers? The Principal economic rationale of a merger is that the value of

the combined entity is expected to be greater than the sum of the independent values of the merging entities i.e. Synergy.

Mergers occur due to reasons of -Growth , Diversification, Economies of Scale, Managerial Effectiveness, Utilization of Tax shields, Lower Financing Costs, Strategic Benefit, Broadening of Capital Base.

Often Mergers intend to diversify, lower financing costs , achieve a higher rate of earnings growth . But Merger is not likely to result in any of the above if such merger is resorted due to reasons of concealing weakness of one unit through merger with another unit or to create an artificial appearance in the market / eyes of the public that the company is doing well

Types of mergers

Horizontal mergers► Horizontal mergers are those mergers where the companies

manufacturing similar kinds of commodities or running similar type of businesses merge with each other.

i. Horizontal Monopoly

ii. Horizontal Expansion

Examples of Horizontal Mergers

► The formation of Brook Bond Lipton India Ltd. through the merger of Lipton India and Brook Bond

► The merger of Bank of Mathura with ICICI (Industrial Credit and Investment Corporation of India) Bank

► The merger of BSES (Bombay Suburban Electric Supply) Ltd. with Orissa Power Supply Company

► The merger of ACC (erstwhile Associated Cement Companies Ltd.) with Damodar Cement

Advantages of Horizontal Merger:

a. Economies of scope b. Economies of scale

Vertical mergers► It occurs between firms in different stages of production

operation. A vertical combination represents a combination of firms engaged at different stages of production in an industry expanding its activities either forward towards the ultimate consumer or backward towards the suppliers of raw materials.

► For example, joining of a TV manufacturing assembling company and a TV marketing company or joining of a spinning company and a weaving company.

► Vertical mergers are commonly undertaken by firms as they seek to consolidate their production operations. For example Newspaper publishing companies, have been known to purchase pulp and paper mills, and even timber companies, to ensure a steady supply of newsprint.

► Media giants like Disney and Viacom have merged with production companies to ensure a stream of programming as well as television stations to ensure a retail market for their products.

Conglomerate mergers► Conglomerate mergers are those firms which are engaged in

unrelated types of business activity. It is collection of disassociation businesses. These mergers have the potential for improved resource allocation. They also have the potential for synergy and transfer of managerial capabilities Among conglomerate mergers, the following three types have been distinguished.

For example, merging of different businesses like manufacturing of cement products, fertilizer products, electronic products, insurance investment and advertising agencies. L&T and Voltas Ltd are examples of such mergers

Mechanics Of Merger

Merger has to be viewed from Legal , Tax and Accounting Consideration. The procedure for amalgamation/merger involves the following :- Examination of Object Clauses – Whether MOA of both the

companies provide for it or not Intimation to Stock Exchange of such intentions Approval of the draft amalgamation by the respective boards Application to the High Court so that it can convene the

meetings of shareholders and creditors for passing the amalgamation proposal

► 21 days Advance intimation notice to the shareholders and creditors and publication of the notice of meetings in two news papers, one vernacular and one English and filing of an affidavit in the court of law that the notice has been published

► Holding of Meetings of Shareholders and creditors and approval of the same by atleast 75% of the stake holders

► Petition to the court for confirmation and passing of orders . Court to fix the date of hearing and the notice about the same has to be published in the news paper. Court to find out as to whether the amalgamation is fair and reasonable . Court is empowered to modify the scheme of amalgamation and pass the orders accordingly

► Filing the order with the Registrar- Certified true copies of the court order must be filed with the Registrar of Companies within the time limit specified by the Court.

► Transfer of Assets and liabilities-All the assets and liabilities of the amalgamating company to be transferred to the amalgamated company strictly as per the court orders.

► Amalgamated company after fulfilling the provisions of the law to issue shares and debentures of the amalgamated company to be followed by listing .

► For tax purposes, the depreciation chargeable by the amalgamated company has to be based on the written down value of the assets before amalgamation . For accounting purposes , the depreciation charge may be based on the considertion paid for the assets .

► Subject to the fulfillment of certain conditions as laid down in the Income Tax relevant to section 2(a), the accumulated loss and the un absorbed depreciation of the amalgamating company shall be deemed to be the loss/depreciation of the amalgamated company for the previous year in which the amalgamation is effected

► No capital gains tax is applicable to the amalgamating company or its shareholders if they get shares in the amalgamated company

► Other important provisions :-The amalgamated company is liable to pay the taxes of the

amalgamating company.Expenses of amalgamation are not tax deductibleTaxes on the income of the amalgamating company , paid or

payable and income tax litigation expenses are tax deductible expenses for the amalgamated company

► Bad debt arising out of the debt of amalgamating company taken over by the amalgamated company are not deductible for tax purposes.

► The amalgamated company is entitled to get the refund of taxes by the amalgamating company

Acquisitions and Takeovers

An acquisition may be defined as an act of acquiring effective control by one company over assets or management of another company without any combination of companies. Thus, in an acquisition two or more companies may remain independent, separate legal entities, but there may be a change in control of the companies. When an acquisition is 'forced' or 'unwilling', it is called a takeover. Under the Monopolies and Restrictive Practices Act, takeover meant acquisition of not less than 25 percent of the voting power in a company. While in the Companies Act (Section 372), a company's investment in the shares of another company in excess of 10 percent of the subscribed capital can result in takeovers. An acquisition or takeover does not necessarily entail full legal control. A company can also have effective control over another company by holding a minority ownership. In theory acquirer must buy more than 50% of the paid-up equity of the acquired company to enjoy complete control .

Some of the Prominent Take Overs.

► Chhabrias Shaw Wallace► Goenkas Calcutta Ele.Supply Co► Hindujas Ashok Leyland► Satyam India World► Hindalco Indal► Mcleod Russell Union Carbide

Renamed “Eveready”

Types of Take overs/ Acquiistions

► Hostile takeover/ Acquisition –In this, the company which is to be bought has no information about the acquisition/ take over. The company, which would be sold is taken by surprise.

► Friendly- Inthis, the two companies cooperate with each other and settle matters related to acquisitions.

There are times when a much smaller company manages to take control of the management of a bigger company but at the same time retains its name for the combination of both the companies. This process is known as "reverse takeover

Take over guidelines► SEBI has issued detailed guidelines for regulating substantial

acquisition of shares and take overs of listed companies. Important guidelines relate to Notification procedure to be followed by the acquirer Offer Price Norms Contents of the Public Announcement to be made by the

acquirer► The purpose of SEBI guidelines is to

Impart greater transparency to takeover deals Ensure a greater amount of disclosure through public

announcement and offer document► Protect the interest of small shareholders

Take over Code ► Introduced in 1997 by SEBI Based on P.N.Bhagwati Committee

recommendations ► It is meant to ensure that takeovers happen in a fair, transparent

and equitable manner ► Take over means acquiring the control or management interest in

a target company► Major provisions: Informing the target company if the total

holding exceeds 5%: informing stock exchange if holding exceeds 15% making open offer to public if the proposed acquisition results in share holding in excess of 155. Code amended in 2002.

Five sins of Acquisition► Straying too far a field :- The temptation to stray in to unrelated

areas that appear exotic and very promising is often strong.Such forays are often risky.

► Striving for bigness:- Size is perhaps a very important yardstick by which most organisations , business or otherwise judge themselves. The concern with size may lead to unwise acquistions

► Leaping before looking:- Failure to investigate fully the business of the seller is rather common .The problems here are that the seller may possibly exaggerate the worth of intangible assets(brand image, technical know-how , patents, copy rights and so on , the accounting reports might have been deftly window dressed , buyer may not be in a position to assess the hidden problems and contingent liabilities

► Over Paying :- In a competitive situation, , the naïve ones tend to bid more .Often the highest bidder is one who overestimates value out of ignorance . He may turn out to be an unfortunate winner in the game of acquistions.

► Failing to integrate well Even the best strategy can be ruined by poor implementation

Strategies taken to prevent take over.

People pillSandbagShark RepellentGolden parachuteRaiderSaturday Night SpecialMacaroni defense

Merger and Acquisition Process

Preliminary Assessment or Business Valuation

Phase of Proposal Exit Plan Structured Marketing Stages of Integration Once the process is initiated Closure of the deal of merger or

acquisition

Impact of Mergers and acquisitions

1.The impact of mergers and acquisitions on various sects of the company may differ.

2.Impact Of Mergers And Acquisitions on workers or employees

3.Impact of mergers and acquisitions on top level management

4.Impact of mergers and acquisitions on shareholders

Benefits of Mergers and Acquisitions

• Greater Value Generation• When the companies are weathering through the tough times.• When the companies are weathering through the tough times.• To improve profitability and EPS

Costs of Mergers and Acquisitions

Replacement Costs Discounted Cash Flow Method Comparative Ratio calculation method

Merger and acquisition accounting is done either by the purchase or pooling of interests methods.

► Purchase Method ► Pooling of Interests Method

Meaning of Slump sales Under the Indian tax law, 'slump sale' under Section2(42C) of the Income-tax Act, 1961. means the

transfer of one or more business undertakings. Under clause (19AA) of section 2 - "Undertaking" includes any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.

Bought Out Deals ► In a bought out deal , an existing company off-loads

a part of the promoters capital to a wholesaler instead of making a public issue .

► The wholesalers invariably is either a merchant banker or sometimes just a company with surplus cash

► These could be individuals and other smaller companies participating in the syndicate , in addition to the sponsors

► A bought out deal helps the companies mobilise the funds indirectly from the public and cost of raising funds is since public issue expenses are not involved

►Spin offsCorporate spin-offs are important

corporate restructurings that are associated with significant positive abnormal stock returns at their announcement. A spin-off separates diverse units of the firm and results in two companies that have dissimilar assets

Repurchase Options or Ready Forward ►Repos are the transactions where the

borrowing bank places with lender bank , certain acceptable security against funds to be borrowed .

►Both the banks agree to reverse this transaction on a pre-determined future date at agreed interest cost. These transactions are short tenure and provide flexibility to suit both lender and borrower

►No fixed period has been prescribed for this transaction. However generally repo transactions are for minimum period of 3 days to 14 days

►The interest rate is market determined and built in the structure of repo transactions

►Allowed only through SGL account with RBI in Mumbai

►Repo is a very popular mode of raising funds against its securities without altering its asset mix while lender finds a safe avenue giving attractive return

►Moreover the funds management for bothe borrower and lender improves as the date of reversal of transactions is known in advance.

Leveraged Buy Out

►It involves a transfer of ownership consummated mainly with debt.

►Generally , a leveraged buy out involves the acquistion of a division or a unit of a company

►Occasionally it entails the purchase of an entire company