Mergers & acquisitions for MBA

01.03.2011 Ulhas D Wadivkar 1

Syllabus : Mergers and Acquisitions –

• Case Studies

• Take over Defences

• Methods of Payment & Leverage

• Regulatory controls. • --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

• Books : Mergers, Restructuring and Corporate Control – Weston, Chung, Hong (Prentice Hall)

• Mergers & Acquisitions – Vol.-I to IV : ICFAI• Mergers & Acquisitions – Weston & Weaver – Tata

McGraw Hill.• Corporative Restricting & Merging Acquisition:

Mahesh Dubey – Mahaveer & Sons.


Mergers & Acquisitions-Definitions• The phrase mergers and acquisitions (abbreviated

M&A) refers to the aspect of Corporate Strategy, Corporate Finance and Management dealing with the buying, selling and combining of different Companies that can aid, finance, or help a growing company in a given industry to grow rapidly without having to create another business entity.

• In Business or in Economics a Merger is a combination of two Companies into one larger company.

• Such actions are commonly voluntary and involve Stock Swap or cash payment to the target. Stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal.


Mergers & Acquisitions-Definitions

• A merger can resemble a Takeover but result in a new company name (often combining the names of the original companies) and in new Branding; in some cases, terming the combination a “Merger" rather than an acquisition is done purely for political or marketing reasons.

• 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. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.


Acquisitions • 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 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's technically an Acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the takeover more palatable


Acquisitions

• 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

and is hostile, i.e. the Target Company does not want to

be purchased, then it regarded as 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.


Varieties of Mergers -1• Horizontal merger - Two companies that are in direct competition

and share the same product lines and markets.

• Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker. Vertical mergers occur when two firms, each working at different stages in the production of the same good, combine.

• Market-extension merger - Two companies that sell the same products in different markets.

• Product-extension merger - Two companies selling different but related products in the same market.

• Congeneric Merger / Concentric Mergers occur 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.

http://en.wikipedia.org/wiki/Vertical_integration


Varieties of Mergers -2• 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. The company will be one with a low P/E acquiring one with a high P/E.

• Conglomerate : When two companies that have no common business areas. There are two types of mergers that are distinguished by how the merger is financed. Each has certain implications for the companies involved and for investors:

• A) Purchase Mergers - As the name suggests, this kind of merger occurs when one company purchases another. The purchase is made with cash or through the issue of some kind of debt instrument; the sale is taxable. Acquiring companies often prefer this type of merger because it can provide them with a tax benefit. Acquired assets can be written-up to the actual purchase price, and the difference between the book value and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company.

http://en.wikipedia.org/wiki/EPS

http://en.wikipedia.org/wiki/P/E


http://en.wikipedia.org/wiki/EPS




Varieties of Mergers -3B) Consolidation Mergers - With this merger, a brand

new company is formed and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger

• In some of the merger deals, a company can buy another company with cash, stock or a combination of the two.

In smaller deals, one company acquires all the assets of another company.

Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Thus, Company Y becomes merely a shell and will eventually liquidate or enter another area of business.


Varieties of Mergers -4

• Reverse merger is an another type of acquisition is a

deal that enables a private company to get publicly-listed

in a relatively short time period. A reverse merger

occurs when a private company that has strong

prospects and is eager to raise financing buys a publicly-

listed shell company, usually one with no business and

limited assets. The private company reverse merges into

a “Shell” public company, and together they become an

entirely new public corporation with tradable shares.

• Takeover : An Acquisition where the Target Firm did not

solicit the bid of acquiring firm.


Why M& A ?

• One plus one makes three is the main idea and is special alchemy of a Merger or an Acquisition. The key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. Two companies together are more valuable than two separate companies - at least, that's the reasoning behind M&A.

• Especially, when times are tough; strong companies will act to buy other companies to create a more competitive, cost-efficient company. The companies will come together hoping to gain a greater market share or to achieve greater efficiency. Target companies will often agree to be purchased when they know they cannot survive alone.

• Synergy is the magic force that allows for enhanced cost efficiencies of the new business. Synergy takes the form of revenue enhancement and cost savings. By merging, the companies hope to benefit from the following:


Why M& A ?

• Staff reductions - Mergers tend to mean job losses. Mostly from reducing the number of staff members from accounting, marketing and other departments. Job cuts will also include the former CEO, who typically leaves with a compensation package.

• Economies of scale - Yes, size matters. A bigger company placing the orders can save more on costs. Mergers also translate into improved purchasing power to buy equipment or office supplies - when placing larger orders, companies have a greater ability to negotiate prices with their suppliers.

• Acquiring new technology - To stay competitive, companies need to stay on top of technological developments and their business applications. By buying a smaller company with unique technologies, a large company can maintain or develop a competitive edge.


Why M & A ?

• Improved market reach and industry visibility - A merge may expand two companies' marketing and distribution, giving them new sales opportunities. Because of improved financial standing, Bigger firms have an easier time raising capital than smaller ones.

• Overcome the Entry barriers: M & A is one of the way for smooth market entry, as good will of another company and the brand gets transferred to new entities without initial hiccups. These costly barriers to entry otherwise would make “Start-ups” economically unattractive. e.g. “Belgian Fortis’ acquisition of American Banker’s Insurance Group”

• Eliminating the Cost of new product Development. Buying established business reduces risk of start-up ventures. e.g. “Watson Pharmaceuticals’ acquisition of Thera Tech”


Why M & A ?

• Lower risk compared to developing new products.

• Increased feasibility and speed of Diversification. This is a quick way to move into businesses when firm currently lacks experience and depth in industry. e.g. “CNET’s acquisition of “mySimon”.

• Acquisition is intended to avoid excessive competition and improve competitive balance of the industry and thereby Increased Market Power and allowing market entry in a timely fashion. Firms use acquisition to restrict its dependence on a single or a few products or markets. e.g. “ British Petroleum’s acquisition of U.S. Amoco.; Kraft Food’s acquisition of Boca Burger.; “General Electric’s acquisition of NBC.


Problems of M & A• Integration Difficulties: Differing financial and control systems

can make integration of firms difficult. e.g. “Intel’s acquisition of DEC’s semiconductor division.

• Inadequate Evaluation of Target: Competitive bid causes acquirer to overpay for firm. e.g. “Marks and Spencer’s acquisition of Brooks Brothers”

• Large or Extraordinary Debt : Costly debt can create onerous burden on cash outflows. e.g. “Agrbio Tech’s acquisition of dozens of small seed firms”

• Inability to Achieve Synergy: Justifying acquisitions can increase estimate of expected benefits. e.g. “ Quaker Oats and Snapple”

• Overly Diversified: Acquirer doesn’t have expertise required to manage unrelated businesses. e.g. “GE prior to selling businesses and refocusing”

• Managers Overly Focused on Acquisitions: Managers may fail to objectively assess the value of outcomes achieved through the firm’s acquisition strategy. e.g. “Ford and Jaguar”

• Too Large: Large business bureaucracy reduces innovation and flexibility.


10 Major Change Forces Contributing Merger activity

1. The pace of Technology has accelerated.

2. The costs of communication and Transportation have greatly reduced.

3. Hence markets have become international in scope.

4. The forms, sources and intensity of competition have expanded.

5. New Industries have emerged.

6. While regulations have increased in some areas, generally more deregulations have taken place in other industries.

7. Favourable economic and financial environments have persisted from 1982 to 1990 and from 1992 to 2000.

8. Within a general environment of strong economic growth, problems have developed in individual economics and industries.

9. Inequalities in income and wealth have been widening.

10. Valuation relationships and equity returns for most of 1990s have risen to levels significantly above long-term historical patterns.


Merger Motives at a Glance

SYNERGYShort Term Long Term Operating

Financial Synergy Financial Synergy Synergy

EPS & PE Efficiency Increased Debt Capacity Economies of Scale

Improved Liquidity Improved Capital No Growth in Industry

Tax Effects Redeployment Limited Competition

Reduction in Debt Acquiring Technical & Managerial Knowledge

Bankruptcy Costs Product Extension

Stabilising Earnings Market Extension

Reduction in in Risk and uncertainty


Merger Motives at a Glance

Target Undervaluation

* Market Inefficiency (Economic Disturbances)

*Inside Information

*Superior Analysis

* Displacing Inefficient Managers

Managerial Motives

* Power Needs * Size * Growth

* Executive Comparison * Insider

* Human Capital

* Risk Diversification


Peter Drucker’s Five Commandments for Successful Acquisition / Mergers

1. Acquirer must contribute something to the acquired Company.

2. A common core of unity is required.

3. Acquirer must respect the business of the acquired company

4. Within a year or so, acquiring company must be able to provide top management to the acquired company.

5. Within the first year of Merger, managements in both companies should receive promotions across the entities.

• Be sure there is some element of relatedness, but don’t be too restrictive in defending the scope of potential relatedness.

• Combining two companies is an activity involving substantial trauma and readjustment. Therefore, a strong emphasis on maintaining and enhancing managerial rewards and incentives is required in the post –merger period.

• The risk of mistakes stemming from wishful thinking are especially great in mergers. The planning may be sound from the standpoint of business or financial complementarities or relatedness. But if the price is not right, some one is going to hurt.

Major Challenges to Merger Success• Look into Three important areas : Due Diligence, Cultural

Factors & Implementation.• Due Diligence:

1. Check all legal Aspects including pension funding, environmental problems, product liabilities etc.

2. Check all business & management considerations involving examining accounting records, maintenance & quality equipments, possibility of cost controls, potentiality of product improvements,

3. management relationship with its employees, gaps in managerial capabilities, how these management systems will fit together, need to hire or fire managers, etc.

4. Ensure that acquired unit is worth more as apart of the acquiring firm than being left alone or with any other firm.


• Cultural Factors1. Check organisation’s values, traditions, norms, beliefs and

behaviour patterns.2. Check formal statements available, but observe informal

relationships and networks.3. Check management’s operating style. The firm must be

consistent in its formal statements of values and kinds of actions that are rewarded.

4. Check need of proactive employee training for growth through Merger.

5. Check cultural factors in addition to products, plant & equipments.

6. Check how the organisation has handled cultural factors in the past.

7. Cultures may move to similarity. Or differences may even be valued as sources of increased efficiency.


• Implementation

1. Implementation starts as condition for thinking about M & A.

2. The firm must have implemented all aspects of efficient operations before it can effectively combine organisations.

3. The acquiring firm must have shareholder value orientation with strategies and organisational structures compatible to multiple business units.

4. Mergers should further Corporate strategy, strengthening weaknesses, filling gaps, developing new growth opportunities and extending capabilities.

5. Integration leadership with management leadership qualities, experience with external constituencies and credibility with the various integration participants.

6. Provide early, frequent & clear integration messages. Lack of communications causes distress. Ensure quick integration.


10 Secrets to Successful Mergers & Acquisition1. Decide holes in your product / service grids that you have to fill but

cannot develop yourself & look for companies that can fill the holes.

2. Buy into companies by taking quick look at products you might want to own.

3. Move fast. Having decided that the opportunity is right, close the deal now or someone else will.

4. Do not kill over the price. If the deal is key to your company’s growth, pay now and add value later. Price will look cheap tomorrow.

5. Destroy uncertainty. Keep all employees whole. Protect employees for at least one year. Let them concentrate on job and not on job security. Issue new ID cards. Integrate your computer systems immediately.

6. Be ready to move the day the deal is announced. Hand over every employee a package that completely explains who you are, giving the contact people to ask questions. Compare benefits.


10 Secrets to Successful Mergers & Acquisition7. Form a mobile team of transition executives. Set up immediate

Internet access with your company. Link new employees with your people at your company at similar levels. Practice full access and full disclosure. This team should research every single job at the acquisition & bring that job into your firm’s job matrix.

8. Utilise acquired companies resources. Use acquired company’s skill set and send in your team where they don’t.

9. Sales & marketing: Do not change commission schedules and house account rules. Raise commissions or leave them alone, but never lower them.

10. Set up communication groups. Give new employees to voice concerns and gripes. Act on their suggestions. Offer bonuses for ideas that facilitate the acquisition’s integration into your company.01.03.2011 Ulhas D Wadivkar 23


Valuation - 1Asset Valuation: Disciplined procedure for arriving at a price.Historical earnings valuation,Future maintainable earnings valuation,Valuation as per Discounted Cash Flow (DCF) :

A key valuation tool in M&A, discounted cash flow analysis determines a company's current value according to its estimated future cash flows. Forecasted free cash flows (operating profit + depreciation + amortization of goodwill – capital expenditures – cash taxes - change in working capital) are discounted to a present value using the company's Weighted Average Costs of Capital (WACC). Few tools can rival this valuation method though it is tricky.

NPV = Cash Flow

(1+% Interest) raise to tt =1

t=n- Initial Capital

Relative Valuation: Comparable company & comparable transactions,

• One more method used is IRR i.e. Internal Rate of Return. This gives % rate of return at which NPV will become Zero.

• Free Cash Flow Basis is used mostly, while making Cash Payments for Merger & Acquisitions.

• Professionals who evaluate businesses generally do not use just one of these methods but a combination of some of them, as well as possibly many others that are not mentioned above, in order to obtain a more accurate value.


Valuation -2• These values are determined for the most part by looking

at a company's Balance Sheets and / or Income Statements 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 Value (LOV) when the business is being evaluated 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.


Valuation -3

Before Merging one must determine how much the company being acquired is really worth. There are, however, many legitimate ways to asses value of a target company by employing variety of methods and tools:

1. Comparative Ratios - The following are two examples of the many comparative metrics on which acquiring companies may base their offers:

• Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes an offer that is a multiple of the earnings of the target company. Looking at the P/E for all the stocks within the same industry group will give the acquiring company good guidance for what the target's P/E multiple should be.


Valuation - 4

• Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company makes an offer as a multiple of the revenues, again, while being aware of the price-to-sales ratio of other companies in the industry.

2. Replacement Cost - In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity's sake, assume the value of a company is simply the sum of all its equipment and staffing costs. However, it takes a long time to assemble good management, acquire property and get the right equipment. This method of establishing a price certainly wouldn't make much sense in a service industry where the key assets - people and ideas - are hard to value and develop


Methods of Payment

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.


Methods of Payment

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 of cash and stock of the purchasing entity.Factoring• Factoring can provide the extra to make a merger or sale

work. Hybrid can work as additional factor.


How good is M & A deal ?

• Acquiring companies nearly always pay a substantial

premium on the stock market value of the companies

they buy in the notion of Synergy. A merger benefits

shareholders when a company's post-merger share price

increases by the value of potential synergy. For buyers,

the premium represents part of the post-merger synergy

they expect can be achieved. The following equation

offers a good way to find minimum required synergy:

• Pre Merger Value of Both Firms + Synergy =

Pre Merger Stock Price X

Post Merger Number of Shares.


How good is M & A deal ?

Investors should start by looking for some of these simple criteria:

• A reasonable purchase price - A premium of, say, 10% above the market price seems within the bounds of level-headedness. A premium of 50%, on the other hand, requires synergy of stellar proportions for the deal to make sense. Stay away from companies that participate in such contests.

• Cash transactions - Companies that pay in cash tend to be more careful when calculating bids and valuations come closer to target. When stock is used as the currency for acquisition, discipline can go by the wayside.

• Sensible appetite – An acquiring company should be targeting a company that is smaller and in businesses that the acquiring company knows intimately. Synergy is hard to create from companies in disparate business areas. Sadly, companies have a bad habit of biting off more than they can chew in mergers.

• Mergers are awfully hard to get right, so investors should look for acquiring companies with a healthy grasp of reality.


Attributes of Effective Acquisitions

• Complementary Assets or Resources: Buying firms with assets that meet current needs to build competitiveness.

• Friendly Acquisitions: Friendly deals make integration go more smoothly.

• Careful Selection Process : Deliberate evaluation and negotiations is more likely to lead to easy integration and building synergies.

• Maintain Financial Slack: Provide enough additional financial resources so that profitable projects would not be foregone.

• Low-to-Moderate Debt: Merged firm maintains financial flexibility.

• Flexibility : Has experience at managing change and is flexible and adaptable.

• Emphasise Innovation: Continue to invest in R & D as part of the firm’s overall strategy.


The Evaluation of an Acquisition Target


Strategic Planning for Merger Activities1. Assessment of the changes in environment.2. Evaluation of company capabilities and limitations.3. Assessment of expectations of Stake holders.4. Analysis of company, competitors, industry, domestic economy

and international economy.5. Formulation of Missions, Goals, and policies for the master

strategy.6. Development of sensitivity to critical environmental changes.7. Formulation of internal organisation performance measurements8. Formulation of long range strategy programs.9. Formulation of midrange programs and short range plans.10. Organisation, funding and other methods to implement all

preceding elements.11. Information flow, feedback system for continued repetition of all

essential elements and for adjustments at each stage.12. Review and evaluation of all processes.


Sources of gains in M & AsA. Strategy1. Develop a new Strategic Vision2. Achieve long run Strategic goals3. Acquire capabilities in new industry.4. Obtain talent for fast moving industries.5. Add capabilities to expand role in a technologically

advancing industry.6. Quickly move into new products, markets.7. Apply a broad range capabilities and managerial skills in

new areas.B. Economies of Scale1. Cut production costs due to large volume.2. Combine R & D operations3. Increased R & D at controlled risk.4. Increased Sales force.5. Cut overhead costs.6. Strengthen distribution systems.


C. Economies of Scope1. Broaden Product line.2. Provide one stop shopping for all services3. Obtain complementary productsD. Extend advantages in differential productsE. Advantages of size1. Large size can afford high tech equipments.2. Spread the investments in the use of expensive equipments

over more units.3. Ability to get quantity discounts4. Better terms in deals.F. Best Practices1. Operating efficiencies-improve management of receivables,

inventions, fixed assets etc.2. Faster tactical implementation.3. Incentives for workers – rewards4. Better utilisation for resources.


G. Market Expansion1. Increased Market Share.2. Obtain access to new Markets.H. New Capabilities, Managerial Skills1. Apply a broad range of capabilities and managerial skills

in new areas.2. Acquire capabilities in new industry.3. Obtain talent for fast moving industries.I. Competition1. Achieve critical mass before rivals.2. Pre-empt acquisitions by competitors.3. Compete on EBIT growth for higher valuations.J. Customers1. Develop new key customer relationships.2. Follow Clients.3. Combined company can meet customers’ demand for a

wide range of services.


K. Technology1. Enter technologically dynamic industries.2. Seize opportunities in industries with developing

technologies.3. Exploit technological advantage.4. Add new R & D capabilities.5. Add key technological and complementary technological

capabilities.6. Add key Patents or Technology.7. Acquire technology for lagging areas.L. Shift in industry organisation1. Adjust to de-regulations – relaxed Government barriers,

geographic & new market extensions.2. Change in strategic scientific industry segment.M. Shift in product Strategy1. Eliminate industry excess capacity. Shift from over capacity

area to area with more favourable sales capacity.2. Exit a product area that has become area of speciality.


N. Globalisation

1. International Competition – to establish presence in foreign markets and strengthen position in domestic market.

2. Size & economies of scale required for global competition.

3. Growth opportunities outside domestic market.

4. Diversification – product, Geographically, reduce dependence on export or imports, reduce systematic risks.

O. Favourable product inputs - Obtain assured sources of supply of RMs, inexpensive & trained Labour, Locally manufactured inputs.

Q. Improved distribution in other countries.

R. Investment – acquire company, improve it , sell it.

S. Prevent Competitor from acquiring target company.

T. Create antitrust problem to deter potential acquirers.


Why M & A fail ? - 1• Plenty of Mergers don't work : Historical trends show that

roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market

• The motivations for merger can be flawed and estimated efficiencies from economies of scale prove elusive. Many a times problems associated with merged companies are beyond solution.

• Flawed Intentions: Mergers that have been encouraged by booming stock market spell trouble.

• Deals done with highly rated stock as currency are easy and cheap, but without any the strategic thinking behind them.

• Also, mergers are often attempt to imitate: just because somebody else has done a big merger. A merger may often have more to do with glory-seeking than business strategy.


Why M & A fail ? - 2• Most CEO’s get a big bonus for merger deals, no matter

what happens to the share price later. • Mergers sometimes are driven by generalized fear.

Globalization, the arrival of new technological developments or a fast-changing economic landscape, with idea that only big players will survive a more competitive world.

The Obstacles to Making it Work • Coping with a merger can make top managers spread

their time too thinly and neglect their core business, spelling doom.

• Too often, potential difficulties seem trivial to managers caught up in the thrill of the big deal.

• The chances for success are further hampered if the corporate cultures of the companies are very different.


Why M & A fail ? - 3

• When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It's a mistake to assume that personnel issues are easily overcome. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result can be resentment and shrinking productivity.

• More insight into the failure of mergers is found in the highly acclaimed study from McKinsey, a global consultancy. The study concludes that companies often focus too intently on cutting costs following mergers, while revenues, and ultimately, profits, suffer.


Why M & A fail ? - 4

• Merging companies can focus on integration and cost-cutting so much that they neglect day-to-day business, thereby prompting nervous customers to flee. This loss of revenue momentum is one reason so many mergers fail to create value for shareholders.

• But remember, not all mergers fail. Size and global reach can be advantageous, and strong managers can often squeeze greater efficiency out of badly run rivals. Nevertheless, the promises made by deal makers demand the careful scrutiny of investors. The success of mergers depends on how realistic the deal makers are and how well they can integrate two companies while maintaining day-to-day operations.


Summing up• M&A comes in all shapes and sizes, and investors need

to consider the complex issues involved in M&A. Let's sum up:

• A merger can happen when two companies decide to combine into one entity or when one company buys another. An acquisition always involves the purchase of one company by another.

• The functions of synergy allow for the enhanced cost efficiency of a new entity made from two smaller ones - synergy is the logic behind mergers and acquisitions.

• Acquiring companies use various methods to value their targets. Some of these methods are based on comparative ratios - such as the P/E and P/S ratios - replacement cost or discounted cash flow analysis.


Summing up

• An M&A deal can be executed by means of a cash transaction, stock-for-stock transaction or a combination of both. A transaction struck with stock is not taxable.

• Break up or de-merger strategies can provide companies with opportunities to raise additional equity funds, unlock hidden shareholder value and sharpen management focus. De-mergers can occur by means of divestitures, carve-outs spin-offs or tracking stocks.

• Mergers can fail for many reasons including a lack of management foresight, the inability to overcome practical challenges and loss of revenue momentum from a neglect of day-to-day operations.


Merger waves :• The economic history has been divided into Merger Waves based on

the merger activities in the business world as:

Period Name Facet

1889 -1904 1st Wave Horizontal Mergers

1916 -1929 2nd Wave Vertical Mergers

1965 - 1989 3rd Wave Diversified Conglomerate Mergers

1992 - 1998 4th Wave Congeneric Mergers, Hostile Takeovers, Corporate

Raiding

2000 onwards 5th Wave Cross Border Mergers


Major M&A from 2000 to present Rank Year Purchaser Purchased In Mil. - USD

1 2000 Fusion : America on Line : AOL

Time Warner $1,64,747

2 2000 Glaxo Wellcome Plc. Smith Kline Beecham plc.

$75,961

3 2004 Royal Dutch Petroleum Co.

Shell Transport & Trading Co.

$74,559

4 2006 AT & T Inc. Bell South Corporation

$ 72,671

5 2001 Comcast Corporation AT & T Broadband & Internet

$ 72,041

6 2004 Sanofi-Synthelabo SA Aventis SA $ 60,243

7 2002 Pfizer Inc. Pharmaica Corp. $ 59,515

8 2004 JP Morgan Chase Co Bank One Corp. $ 58,761

9 2009 Pfizer Inc. Wyeth $ 68,000


Defence against Takeovers - 1• Identify the part of your company that is most attractive

to the predator and dispose it off in such a way that it continues to allow your company to have access to it. Example: Transfer the sought after “Brand” to a fully owned associate company and work out on licensing agreement.

• Restructuring the company as defence against takeover:

a) Split a Division : This is generally done when companies have diversified in unrelated business and finds it difficult to harmonize and feel vulnerable. Example : BILT split into BILT Paper, BILT Investment Services & BILT Chemicals.

b) Form wholly owned subsidiaryc) Form Independent Companyd) Reverse Mergers :


Defence against Takeovers - 2• Take Advice of consultant / Parent Company /

Stakeholders: Example : Jhonson & Jhonson restructured itself in a manner that one Division started reporting to Switzerland and other to Singapore.

• Mergers & Amalgamations done within group to form a big company to compete with large companies. Example: BPL Ltd. Is amalgamation of its four companies namely BPL Sanyo, BPL Refrigeration & BPL Sanyo Utilities. Also merger of Brook Bond, Ponds, Lakme into HLL

• BPR : Business Process Re-engineering: Break away from outdated rules and fundamentals, remove many layers & unnecessary jobs. Re-write whole Business process on a clean slate. Jobs become redundant after some time, people don’t.

• Smart sizing: e.g. : Glaxo undertook disinvestments ICI & Ciba Geigy

• Benchmarking


Defence against Takeovers - 3• Best defence against Take over is to do good Financial

Housekeeping. Keep a tight rein on scrap value, large transfers, placing blocks of shares in friendly hands, making sure that assets value is properly reflected in share value.

• Delaying tactics legally, which is called as spoiling tactics.

• Greenmail to all shareholders.• Asset striping. Target company may strip the assets and

convert itself into a shell company.• Poison Pill : Make a special issue share with voting rights

exercisable after some time e.g.10 days or which after hostile takeover will yield, entitles share holders some lollypops, which will jack up cost of acquisition. E.g. “EL Paso Natural gas”

• The white Knight. (The third party friendly to incumbent management brought in to rescue from an undesired takeover)


Financial Defensive Measures - 1What makes a Company vulnerable?a) Low stock price in relation to the replacement cost of

assets or their potential earning power.b) Highly liquid balance sheet with large amount of excess

cash or significant unused debt capacity.c) Good cash flow relative to current stock prices.d) Subsidiaries or properties which can be sold without

affecting cash flow.e) Relatively small stock with the incumbent management.Steps to be taken : 1. Debt should be increased.2. With borrowed funds, repurchase the equity from

Market.3. Dividends on remaining shares should be increased.4. Loan repayment may be accelerated. 5. Securities portfolio should be liquidated.


Defensive Measures – Steps to be taken- Contd:

6. Cash flow from operation to be invested in positive net Value projects. Acquire other firms with excess liquidity available.

7. Divest Subsidiaries without impairing Cash Flows. 8. Adjustment in Assets and ownership structure.9. Issue a new class of preferred shares to common

shareholders with voting rights. Thereby diluting the holdings of the Bidder.

10.Create a consolidated Vote bank by share issues or by repurchasing from Market.

11.Leveraged recapitalisation known as Leveraged Cash Outs (LCO) where outside shareholders receive a large one-time cash dividend from newly borrowed funds and insiders receive new voting shares. There by raise the firm’s leverage to an abnormally high level and discourages the takeover.


Defensive Measures – Steps to be taken- Contd:12. Golden Parachutes: Separation clause of an employment

contract for loss of job under a change of control clause. (being criticised as reward for failure).

13. Anti-takeover Amendments: are included in Firm’s corporate charter. These are subjected to shareholder’s approval and law as it helps entrenchment of incumbent management.

14. Supermajority Amendments: Require two third to 90% share holder vote. Many times board has power to revoke this amendment.

15. Fair Price Amendment: The bidder should offer the highest price during a specified period, which is generally about 10-15% above the Market price or EV.

16. Classified Boards: Provides for staggered, or classified, boards to delay effective transfer of control in a takeover. New shareholders will have to wait till incumbent directors retire by turns.

17. Authorisation of preferred stocks: The board of directors are authorised to create a new class of securities with special voting rights; issued to friendly parties as defence against takeover.


Methods of Payment & Leverage -1

• The financing of M & A can be evaluated on two levels;

• Tactical: How to get the deal done? - Considerations are speed with which an acquisition can be carried out, the attractiveness of the form of payment to the seller, the coercive nature of offer etc.

• Strategic: How to live with it? – Issues with respect to buyer include the optimal capital Structure, tax implications, the future access to the Capital, financial flexibility, market timing etc.

• Cash Consideration : a) Cash gives speed. Cash gives liquidity and preferable from point of view of seller against Shares, but tactically cash payment cannot be deferred and tax cannot be avoided. Also seller will not be able to have continuing equity interest in the combined company.


Methods of Payment & Leverage -2• The cash is organised through: • a) Commercial Banks – Against Securities at PLR+1 or

2%, normally for 7 years. • b) Private placement markets through ‘junk bonds’ –

These are high risk, high yield bonds issued to finance a leveraged buyout, a merger, normally for a troubled company. These junk bonds is a type of a debt issued by a company that is considered to be at a higher credit risk. Their liquidity is not same as other issues but they are meant to give high yield.

• c) Investment Banks bridge loans – This is in competition with Junk Bonds and is given by banks with their own capital for limited period to tide over the gap as interim financing for 180 – 365 days with interest rate higher than PLR + about 2% fees.


Methods of Payment & Leverage - 3

• Common Stock: Use of common stock to gain control of a Target Company has different tactical consideration with respect to Cash payments. Share holders of target Company are offered common stock of merged / buyer company at a ratio based on P/E ratios. This is lengthy process and is vulnerable to new offers, where, defensive measures being implemented by Target Company. If P/E ratio of acquirer company is better than target company; then Target company share holders are benefited and the move has strategic advantages.

• Convertible Preferred Stock: It is two tier front loaded acquisition. Approximately 50% of shares are purchased in a cash offer and lower value convertible preferred stocks are issued in a second step. Acquirer intending to issue common stock are concerned with current stock prices and sometime opt for this method. However present ‘poison pill’ defence and availability of ‘Junk Bonds’ have made this type of un-solicited acquisition less effective.


Methods of Payment & Leverage - 4• Contingency Payments: When Target Company and Acquirer

do not agree on price and there is a gap between bid and ask; the Acquirer agrees to make future payment as “earn out”, only if, target / merged company achieves certain financial objectives. Thus both parties share financial risk involved in mergers. The “earn out” formulae, extend over years and ensure that buyer has flexibility on overall disposition of investment; the seller is encouraged to manage business in better way as per expectation of buyer and both buyer and seller are treated fairly.

• A stock for stock helps target share holders to avoid Tax payment at the time of transfer. Capital gain Tax will have to be paid when the equity is actually sold. This method gives an indication that present assets of the acquirer are overvalued. On the other hand in Cash method it gives indication that assets of bidder are undervalued. Thus Stock for Stock is a bad news in market about bidder’s assets.



• Managerial Ownership refers to the percentage of equity held by management and insiders in the acquiring and Target firms. If Target / Acquirer management has large equity share percentage, then there are more chances of cash transactions for their shares.

• Growth Opportunity, Relative sizes, and Business Cycle of Target and Acquirer companies have lot of influence on methods of payments.

• Post Merger Financial Leverage: High Leverage firm by definition means a firm with a very small equity cushion. High Debt / Equity ratio firms are more susceptible to economic shocks than one with lower percentage of debt. Heavy debt increases efficiency. Top management does not have luxury to take inappropriate decisions. Though heavy leverage does increase threat of insolvency, the costs of insolvency are themselves is limited due to high debt. Leverage improves the efficiency of a ‘Post buy-out’ firm. Protections offered by equity cushions or coverage ratio are usually wasted by in-efficient Managements.



• Mergers & Acquisitions are more and more financed by

increased use of leverage. It is observed that loan

repayment of acquired company improves after merger.

Debt is one way to reduce problems aroused by placing

management powers with executives & directors. High

debt / equity ratio ensures that managers act in the

interests of investors. Debt holders impose rules and

restrictions on management.

• High debt / equity ratio plays a positive role in Corporate

Governance. Debt is a way of allocating cash to corporate

investors. Heavy debt does not fundamentally change

firm’s business or weakens it’s operations.



• Purchasing bondholders are also not injured by high debt. Their bond contracts are more carefully drafted to protect investors.

• It is a myth that increased debt in these M & A transactions, adversely affects existing creditors. Leverage improves the efficiency of the ‘Post buy-out’ firm.

• The risk of insolvency affecting employees, creditors, communities and others is taken care by extra safeguards built into leveraged transactions. One such technique is to finance the buy-out partly with an instrument called ‘Exchangeable Preferred Stocks’. This security provides for dividends without triggering insolvency. Later when interest on debt can be comfortably paid, these stocks can be used for more debts.


M & A – Regulatory Control - 1

Evolution of Regulatory control of Mergers and Acquisitions in India:

1. Procedures under Companies Act 1956.2. The SEBI takeover Regulation Code 1997.3. The recent changes made by SEBI in the take over

code.

4. Implications under Income Tax Act 1961.Procedures under Companies Act 1956 : a) Scheme of Amalgamation / Merger must be prepared

by both entities.

b) Approval of Board of Directors for the scheme is a first step.

c) Approval of scheme by Financial Institutions, Banks, ‘Trustees for Debenture’ holders.


M & A – Regulatory Control - 2d) Intimation to Stock Exchange about proposed

Amalgamation / Merger.e) Application to Court for directions.f) High Court Directions for the Members’ Meetingg) Holding the Shareholder’s General Meeting and passing

the resolution.h) Submission of Joint Petition to Court for Sanctioning the

Scheme.i) Issue of Notice to Regional Director’s Company Law Board

u/s 394 A:j) Filing Court’s order with ROC by both the Companies:k) Dissolution of Transferor Company.l) Transfer of Assets and Liabilities.m) Allotment of Shares to Share Holders of Transferor

Company.n) Listing Shares at Stock Exchange.o) Preservation of books of amalgamated Company.p) Post Merger Secretarial Obligations


M & A – Regulatory Control - 3The SEBI – Substantial Acquisition of Shares and Takeover Regulation Code 1997.

The act is not applicable to : 1. Public Issue. 2. Rights issue.3. Allotment to underwriters as per under-writing agreement.4. Inter se transfers amongst Relatives.5. Indian Promoters and Foreign Collaborators who are Share

holders.6. Acquisition of Shares in ordinary course of business.7. Acquisition by means of succession or inheritance.8. Acquisition of Shares by Government Companies.9. Transfer of Shares from State Level Financial Institutes.10. Transfer of Shares from venture Capital or foreign venture

Capital.11. Acquisition of Shares in Companies whose Shares are not

listed.


M & A – Regulatory Control - 4The SEBI – Substantial Acquisition of Shares and Takeover Regulation Code 1997.

• Company Board shall constitute a panel with majority of Independent Directors as Take-over Panel.

• The SEBI shall have power to issue directions to Board of Directors.

• Disclosure of Shareholding & Control in listed Company, indicating all persons or firms holding more than 5% of Shares.

• Continual Disclosures from every person holding 15% or more Shares.

• SEBI has power to call for information from Stock Exchanges and Companies.

• No acquirer shall acquire 15% or more voting rights, nor will he be working in concert with another person, unless such acquirer makes a Public Announcement to acquire Shares.


M & A – Regulatory Control - 5• No Acquirer shall acquire control over target Company,

unless such acquirer makes a Public Announcement to acquire Shares & acquires such shares in accordance with Regulations.

• Before making a Public Announcement, Acquirer shall appoint a Merchant Banker in Category -1.

• Timing : Public Announcement shall be made in all editions of one English, one Hindi National Daily & one Regional with wide circulation within four working days of entering into an agreement for acquisition of shares or voting rights.

• Submission of Offer Letter to the SEBI Board within 14 days of PA.

• The Public Offer made by Acquirer to shareholders shall be for a minimum 20% of voting capital. For 10% or less, acquirer shall make an offer for the outstanding shares remaining.


M & A – Regulatory Control - 6• Provision of Escrow to make deposits as per Act.• Payment of consideration payable in cash shall be made

to a special account crated for the purpose within 21 days.

• Bail out takeovers for a financial weak company shall be approved

General Obligations of BOD of Target Company: 1 During offer period BOD of Target Company shall not

sell, transfer, encumber or otherwise dispose off shares.2 Furnish a list of Share holders to Acquirer within 7 days

of PA3 Shall not appoint any additional Director after PA.4 Shall allow authorised personnel of Acquirer to visit and

observe.5 Shall allow acquirer & facilitate him in verification of the

securities.


M & A – Regulatory Control - 7Competitive Bid: Any other person who is desirous of making any offer, shall do so within 21 days of PA of 1st offer. The Acquirer can make an upward revision to his offer 7 days prior To the closure of offer. The acquirer cannot withdraw his offer; unless a) Statutory Approvals have been refused. b) The sole acquirer has died.c) Such circumstances as in the opinion of SEBI Merits

withdrawal.

SEBI’s right to investigate: SEBI can appoint Auditor to 1. Investigate into the complaints received from the investors.2. Investigate in the interest of securities’ market or

investor’s interest for any breach of regulations.3. To ascertain whether provisions of the Act & Regulation

are being complied with.


Implications under Income Tax Act, 1961:Tax concessions to amalgamating Company; Tax concessions to Share Holders of amalgamating Company; Tax concessions to R & D; Tax concessions to Expenditure for Patent Rights; Tax concessions to Expenditure for ‘know how’. Preliminary Expenses u/s 35D(5) : Shall be allowed for deduction.Amortisation expenditure allowed to be spread over in span of 5 years. Capital Expenses shall be allowed. Bad debts shall be allowed for deduction. Carry forward and set-off of Business Losses and Unabsorbed depreciation shall be allowed.

Date post:	29-Jan-2015
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Mergers & acquisitions for MBA

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