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Introduction

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Introduction

Business combinations, which may take forms of mergers, acquisitions,

amalgamation and takeovers, are important features of corporate structural

changes. They have played an important role in the external growth of a number of

leading companies the world over. In the United States, the first merger wave

occurred between 1890 and 1904 and the second began at the end of the World

War II and continues to the present day. About two-thirds of the large public

corporations in the USA have merger of amalgamation in their history. In India,

about 1180 proposals for amalgamation of corporate bodies involving about 2400

companies were filed with the High Courts during 1976-86. These formed 6 percent

of the 40,600 companies at work at the beginning of 1976. Mergers and acquisitions,

the way in which they are understood in the Western countries, have started taking

place in India in the recent years. A number of mega mergers and hostile takeovers

could be witnessed in India now.

1.1 Indian scenario

1) Economic liberalization and mergers

In India, despite unfavorable economic environment that had existed before early

1992s opening up of economy, takeover bid, mergers and amalgamations have not

been uncommon. From 1991, the number of mergers has speeded up. Mostly these

mergers had been amongst the firms within the same industry, which are known as

horizontal mergers. Mostly mergers have been in the spirit of the law as Companies

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Act, 1956 provides the procedure for friendly amalgamations and the Income-tax

Act, 1962 carries incentive of carry forward losses under section 72 A to the merged

company.

There have been three peculiar circumstances in India which discourage takeover

(1) Stake of financial institutions in the companies as predominant portion of capital

employed hails from financial institutions in the form of term loans giving rise for their

large equity stake. They generally, do not encourage takeovers but arrange mergers

with suitable partners under packaged deals for revival of sick units. (2) Obtaining of

industrial license has been a problem in India. (3) Another important aspect in India’s

corporate scene has been the existence of restrictive provisions in the laws which do

not encourage takeovers.

2) The beginning of corporate raids

Since 1986 onwards, both friendly takeover bids on negotiated basis and hostile bids

through hectic buying of equity shares of select companies from the stock market

have been reported frequently.

e.g. Swaraj Paul and Sethia groups attempted raids on Escorts Ltd and DCM Ltd but

did not succeed. (2) NRIs Hindujas raided and took over Ashok Leyland and Ennore

Foundries and secured strategic interests in IDL Chemicals and Astra IDL.

3) Rehabilitation takeovers

Board for Industrial and Financial Reconstruction (BIFR) has also been active for

arranging takeover of the undertakings that are sick and can be rehabilitated.

e.g. ITC LIMITED took over Punjab Anand Batteries Ltd.

Saha group taking over Kothari Electronics.3

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4) MRTP mergers

Section 23 of the MRTP Act, 1969 had stipulated Central Government’s approval for

mergers, amalgamation and takeovers of the companies subject to applicability of

MRTP Act. Sec 23, inter alias has now been omitted and no permission of the

Central Government is needed for mergers, amalgamation and takeovers of the

companies.

e.g. Tata Iron & Steel Co. amalgamated with Indian Tube Co.

Greaves Cotton amalgamated with Greaves Lombardini.

There could be several reasons for existing promoters to sell out and new

promoters to move in.

1. The existing promoters are tired of running the same old business; they just want

to get away and retire peacefully.

Example: The Bhabhas of Spencer & Co. (Madras) sold the company to the R.P

Goenka group partly for reasons of retirement.

2. The business needs more funds, which the existing promoters are either unable

or disinclined to bring in.

3. Example: Panyam Cements needed more funds for modernization from the wet

process to dry process. The old promoters, the Somappa group, sold the

company to the VBC group.

4. The unit becomes sick and the existing management is either unable or

disinterested in reviving it.

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Example: Neycer, a well-known sanitary-ware company, became sick after starting

a ceramic glazed tiles plant. The old promoters, the Seshasayee group, sold the

company to the Spartek group.

5. The new promoters, flush with funds, see a great opportunity in a particular

acquisition.

Example: Tata Tea acquired controlling interest in Consolidated Coffee, as tea and

coffee go together. Brooke Bond acquired Kothari General Foods, because of its

modern instant coffee plant.

6. The existing promoters plan to restructure their operations through some dis-

investments.

Example: The UB group sold away its loss making Western India Electronics to an

NRI and food division (manufacturing the Kissan brand of products) to Brooke Bond.

7. The acquisition may be partly for business reasons and partly for tax purpose

also.

Example: Ashok Leyland acquired two loss making auto-components units: Ductron

Castings (Hyderabad) and a clutch unit (Jabra). The loss of Ductron Castings can be

set-off against the profits of Ashok Leyland, thanks to scheme finalized by BIFR

(Board for Industrial and Financial Reconstruction).

8. Now and then, some groups reconstruct and realign some of their companies for

business and tax reasons.

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Example: Shaw Wallace prepared a scheme for the merger of its fourteen

subsidiaries with parent company.

Ceat took over and merged Noble Soya House (Both belonging to the R. P. Goenka

group).

1.2 Types of takeover arrangements

There are three types of take-over arrangements. Which are generally in vogue.

1. Acquire controlling interest and retain the acquired unit as a separate company.

Example: In 1988, Spartek Ceramics bought controlling interest in Neyveli Ceramics

and retained the latter as a separate company without going for a merger with

Spartek Ceramics.

2. Acquire controlling interest and merge it with the parent company*.

*Purchase of assets (with/without liabilities) without purchasing the company as a

whole

Example: In 1990, Ashok Leyland took over the control and management of Ductron

Casting Ltd., and merge it with the parent company. The shareholders of Ductron

were given shares in Ashok Leyland 3:1 ration (1 Ashok Leyland share for 3 Ductron

Castings shares).

In 1989, Oswal Agro Purchased the Chembur Plant for Union Carbide. It was

purchase of a division only for an agreed consideration. Union Carbide’s Chembur

plant became Oswal Petrochemicals, a division of Oswal Agro.

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In a takeover and merger exercise the market value of the acquiring company can

be effectively used to pay the acquired company without much or any actual cash

outflow.

Example: Let us assume that Bajaj Auto proposes to acquire LML Ltd.

The market price of Bajaj Auto’s share (Rs. 10 paid up) is Rs. 650 (December 2000)

and that of LML is Rs. 40. Suppose a liberal exchange ratio of 1:10 is fixed for 10

LML Bajaj Auto shares, 1 Bajaj Auto share will be issued.

Bajaj Auto 2000 LML 2000

Equity (Rs. In Crore) before merger 18.81 17.65

New Equity issued to LML Share holders. 1.77

Equity after merger 20.58 Nil.

Thus Bajaj Auto can Acquire the entire LML Capital of Rs. 17.65 Crores by just

adding a small sum Rs. 1.77 Crore to its equity base. The public shareholders of

LML will be immensely happy at the increase of their share value and get fantastic

dividends from Bajaj Auto (110%) as against no dividends from LML.

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Issues in

Mergers and Acquisitions

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Issues to be considered in mergers and acquisitions

The management of the company which is taking over another company, should

carefully examine the following aspects before a final decision is made:

1. How does the merger help the parent company? Does it add to the existing

strengths? Does it provide an assured source of raw materials? Does it provide

forward integration? Does it help in optimal utilization of existing resources?

2. Why should they takeover this particular unit, and not some other unit? What are

the unique features? How do they mesh-in with the existing features of the parent

company?

3. Why is the present management selling out? Is the unit inherently OK? Are there

any basic problems, which are not open to easy solution?

4. What kind of post-merger problems are likely to arise? Is the parent company

fully prepared to tackle them?

5. How financial institutions would react to the proposal? What new conditions are

likely to be imposed?

6. What would be the impact on the share prices of the parent company?

7. What would be the impact on the sales turnover, and profitability of the parent

company after the merger?

8. What is the right price for the unit? How should it be paid? What should be the

exchange ratio between the shares of the parent company and the merger

candidate?

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A word of caution, at this stage, many merchant bankers have impressive shopping

lists of companies available for sale. Some of these bankers are extremely

persuasive and sophisticated in their match-making practices. Even when one is

paying through his nose, he may be under the illusion that it is a steal. One should

be careful and be on the alert when dealing with the merchant bankers, specializing

in take-over deals.

It is possible that a hostile take-over specialist may raid one’s company. In the west,

merchant bankers have devised a scheme called Leveraged Buy Out (LBO) which

help the existing management to buy out their own company in the event of such

hostile take-over bid. A LBO can also be used to acquire another company.

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The process and stepsin effecting

a Merger or a Takeover

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The broad process and steps in effecting a merger or a takeover.

Mergers and takeovers normally go through at least the following bare minimum

sequence of steps.

Decision to acquire / merger

In many cases, it is a conscious step to expand / diversify or to achieve such other

objects and takeover or merger is one of the possibilities considered. Of course, in

many cases, an available opportunity may also induce company to initiate a merger

or a takeover. At this stage, the selection criteria relating to size and industry of the

target company and other aspects may also be laid down.

Searching a target company

Selecting a company for acquisition is a process, which may take months or may at

times be immediate. Normally the search process is assigned to professionals so

that apart from professional handling, secrecy is also assured. In recent times, an

aggressive style of making an unsolicited approach is also becoming common.

Advertisement in financial newspapers is also made to get wider choice. However

what seems to be often more successful is word of mouth reference.

Preliminary Review

A preliminary discussion may be initiated with the target company once such

company shows interest. The target company may allow a limited inspection of it’s

plant, books, balance sheets etc. though this may depend on the nature of the

industry and other circumstances. In other cases, summary financial figures are

provided with details of capacity, product mix etc.

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Negotiations

Negotiations regarding the purchase price are naturally one of the most important

steps. Careful documentation at this stage may be necessary to ensure that what is

the exact scope of assets and liabilities that would be acquired at the price

negotiated and what is excluded is clearly spelt out.

Entering into a Memorandum of Understanding

If the basic price is agreed upon, a MOU is often immediately entered into in which

the broad terms are clarified. The broad allocation of responsibilities of further steps

between the parties is also mentioned. The specific assumptions that are made

between the parties are also listed. An important provision is that the acquiring

company will be allowed to undertake a “due diligence” investigation of the affairs of

the company to ensure that the statements made by the other party are verified and

found to be true.

Entering into final agreement

Depending upon the form of transaction i.e. a merger or a takeover, the relevant

legal formalities may be complied with. Some of these may have to be observed

prior to entering into the final agreement.

Payment of consideration

Often provision is made for deferred payment where there is uncertainty about the

position of affairs of the target company. Depending upon the circumstances, some

amount may be retained.

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Post merger / takeover activities

This part is often stressed upon. In professionally managed companies, it may be

necessary to retain the confidence of the senior management about the attitude and

approach of the acquirer company. Cultural mismatch is one area which has to be

delicately handled.

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Overview of laws affecting Takeovers

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Overview of laws affecting Takeovers

Term takeover does not find a comprehensive definition in any statue; in fact there is

no explicit reference to that term, though each concerned statute has sought to take

one or more features of a takeover and regulate a transaction that has such

features. Nevertheless, takeover was attempted to be defined with reference to

several authoritative texts and sources. In brief, the essential elements of a

takeover can be described by saying that a takeover is gaining of management

control of a Company by acquiring controlling interest in it through acquisition of its

voting shares.

Here an overview is made of the various statues and provisions, which regulate a

takeover. It has to be noted that a takeover may, at times, need compliance with

several other laws merely because it has certain features, which are not essential for

it to qualify as a takeover. To take an example, takeover essentially implies

purchase of shares. However, if the purchaser is a non-resident or if the shares are

of a foreign Company, the RBI guidelines are complied with. However, those

provisions would be attracted in any case of purchase of shares, whether it involves

a takeover or not. Hence, it is found fit not to analyse such provisions, which do not

have direct or special connection with takeovers.

Various Statues affecting takeovers

In the subsequent paragraphs, a review is made of some of the provisions of law

affecting takeovers. An amalgamation principally involves transfer of the entire

undertaking of a company in exchange for shares of the transferee company which

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are distributed to the existing shareholders in the ratio of their holdings. Had there

not been a separate set of provision specifically dealing with such a situation, the

procedure to be followed to effect such a transaction would have been fairly

complicated. For e.g., first of all, the permission of the shareholders would have

been necessary for sale of the undertaking. Similarly the permission of each and

every one of the creditors, lenders and such other persons would have been

necessary as they would now have to recover their Owings from the amalgamated

company. Elaborate transfer agreements would have been necessary to ensure that

all the assets and liabilities are duly transferred. Apart from many other matters, one

last complicated step of winding up the company would be necessary. To obviate

such a procedure, The Companies Act provides for a relatively simple procedure for

amalgamation.

4.1 COMPANIES ACT, 1956

The Companies Act, 1956 has some provisions which regulate certain aspects of a

takeover. Some of the provisions are dealt with hereunder.

Acquisition of dominant undertakings.

Section 108A to 1081 deal with provisions relating to acquisition of dominant

undertakings. The types of transactions, which are covered, are specified in Section

108G. Essentially, however, it can be stated that any transaction whereby a

dominant undertaking acquires another undertaking or an undertaking is acquired by

which the acquirer undertaking becomes a dominant undertaking are covered. An

aspect to be noted is that the acquisition envisaged by acquisition of shares and not

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through outright purchase of the undertaking. Such transactions cannot be

undertaken without the approval of the Central Government.

Refusal of transfer of shares

One of the techniques adopted by the management to stall a takeover is to refuse

the registration of transfer of the shares purchased by the purchaser. Earlier in

respect of listed companies, the power of refusal of transfer of shares was regulated

by Section 22A of the Securities Contracts (Regulation) Act, 1956. This erstwhile

Section (which was omitted by the Depositories Ordinance 1995) stated that the

Board of Directors of a Company could not refuse transfer of shares (except in

specified circumstances) and, instead, in certain circumstances, if it found a fit case

to refuse transfer of shares, had to refer the matter to the Company Law Board. The

grounds under which the reference could be made were several ranging from

alleged non-compliance of laws to alleging that the transfer would lead to a

prejudicial change in the composition of the Board of Directors.

Section 22A of the Securities Contracts (Regulation) Act, 1956, as was pointed out

earlier, was omitted from the statue book by the Depositories Ordinance 1995. This

omission was partially compensated by the insertion of Section 111A to the

Companies Act, 1956. This Section now regulates refusal of transfer of shares of

public companies. A company is permitted now to refer to the Company Law Board

when it finds that a transfer of shares has contravened either the provisions of the

Sick Industrial) (Special Provision) Act, 1985 or the SEBI (Substantial Acquisition of

Shares and Takeovers) Regulations 1994.

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Section 395 – a special provision to regulate certain types of takeovers.

Section 395 concerns a special type of takeover and basically provided for

protection of minority and small shareholders of the Company.

As can be gathered from the Section, it provides for the situation when 90% or more

of the shares of a Company are bought out by a person. Under such circumstances,

the remaining shareholders have a right, at their option, to require the purchaser to

acquire their shares at a rate they have paid to other sellers. Similarly, the acquirer

of such 90% shares has himself a right to acquire the remaining 10% shares at

similar terms.

Other Provisions of the Companies Act, 1956

There are certain other provisions, which indirectly affect a takeover and hence

should be taken note of for compliance.

(i) Section 372A puts restriction on the acquiring Company not to buy beyond a

certain limit shares of the vendor Company i.e. up to 60% share capital.

Necessary approval for the purchase beyond the limits would be needed from the

Central Government and the shareholders in general meeting.

(ii) Section 81 of the Companies Act, 1956 requires that the approval of the

shareholders by a special resolution would be needed if the Company seeks to

issue shares to persons other than the present shareholders.

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SEBI (Substantial Acquisition of shares and Takeovers) Regulations 1994 and

provisions of the Listing Agreement

For the first time, in India, a statue, which aims to comprehensively cover various

aspects relating to takeover, has been notified. This statue, the SEBI (Substantial

Acquisition of shares and Takeovers) Regulations 1994, provides in detail the steps

that have to be taken when a takeover (as understood by these Regulations) is

sought to be made. These Regulations are a virtual superset of the provisions of the

Listing Agreement as contained in clauses 40A and 40B thereof.

Need for a special set of provision for amalgamations

It is possible for a Company to affect the whole process of amalgamation under the

various other provisions of the Act. However, as can be seen from the following, the

whole process becomes cumbersome and unwieldy: -

(i) Approval of the shareholders would have to be taken for disposal of the whole of

the undertaking of the Company.

(ii) Approval of all the lenders would have to be taken who have given loans and

particularly where the loan is a secured one and the assets are being transferred.

(iii) Approval of all the creditors and other persons to whom money is owed would

have to be taken so that their dues may be assigned to the amalgamated

Company.

(iv)The elaborate winding up procedure would have to be followed. And so on.

Recognizing these practical difficulties, the Companies Act, 1956 contains a special

set of provisions to expedite amalgamations without prejudicially affecting the

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Overview of the provisions

The provisions for effecting an amalgamation are contained in Sections 390 to 394A

of the Act. As far as this Act is concerned, amalgamation is just another form of

arrangement or compromise, which is effected by a Company with its creditors

and/or members. Amalgamation as envisaged by these groups of Sections is

effected under the supervision and sanction of the Court. The broad scheme of the

provisions is as under: -

- Section 390 defines some terms

- Section 391 provides for common procedure for all types of arrangements including

amalgamation / mergers.

- Section 392 provides for power of court to supervise the amalgamation post-

sanction.

- Section 393 provides for disclosure requirements in connection with notices.

- Section 394 provides for special matters when amalgamation are involved.

- Section 394A provides for notifying the Central Government regarding any

proposed amalgamation.

Special advantages of effecting an amalgamation under the provision of the

Companies Act, 1956.

Certain special advantages accrue to the amalgamating and the amalgamated

Company if the amalgamation is made as provided for in these Sections. Some of

these are stated below: -

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(i) Sanction order of court is binding on all creditors and members and individual

permission of each such person is not necessary.

(ii) Approval of shareholders and other parties is by voting and approval is needed of

75% of persons present and voting.

(iii) The sanction order of the court itself transfers all the assets / liabilities without

any further act.

(iv)This method provides maximum benefits in tax, subject to certain additional

conditions.

(v) The procedure is fairly time bound.

Disadvantages of Section 394 amalgamation.

There are some disadvantages of a Section 394 amalgamation though some of

these disadvantages apply to all types of amalgamations: -

(i) Amalgamation is practically irreversible and a full demerger is almost impossible.

(ii) There is a fairly elaborate procedure to be followed.

(iii) It is necessary to take approval of the court i.e. it is not purely by private

arrangement.

(iv) It is relatively costlier.

(v) All the liabilities of the amalgamating Company, whether stated in boxes or not,

are transferred.

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Steps for effecting amalgamation under these provisions

The steps for effecting an amalgamation under the provisions contained in Section

390 to 394S are as follows :-

(i) Holding of meeting of Board of Directors of each Company to decide on

amalgamation of the two companies.

(ii) Appointment of valuers, solicitors, etc.

(iii) Drafting of scheme of amalgamation and, if required, a Memorandum of

Understanding between the two companies.

(iv)Meeting of Board of Directors of each company to approve the scheme of

amalgamation and deciding to approach court.

(v) Approaching court for calling of meeting of relevant parties.

(vi)Court issuing direction to call meetings.

(vii) Issuing notices and holding of meetings of the relevant parties in

accordance with the direction given.

(viii) Reporting to the court regarding results of meeting and applying for

grant of sanction.

(ix) Receipt of report from Official liquidation or Registrar of Companies / Company

Law Board regarding the affairs of the Companies not having been conducted in

prejudice to the interests of its members or to the public interest.

(x) Grant of sanction by court to amalgamation.

(xi) Filing of order of sanction with Registrar of companies.

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Issue considered by the Court for sanctioning amalgamation

The Court, while granting sanction to an amalgamation, does not act as a rubber

stamp. Even if all the procedures prescribed in these provisions are complied with, it

does not mean that the court is bound, without considering for itself the merits of the

scheme of amalgamation, to sanction the scheme. However, at the same time, it is

also well accepted that the court will be reluctant to refuse sanction to a scheme,

which has complied with the provisions and is approved by the parties concerned

with adequate percentage majority. The courts weight many considerations before

granting sanction. Some of such issues which are considered are given below :-

(i) Whether the requisite majority required by the provisions has approved the

scheme of amalgamation.

(ii) Whether the provision of the statute are duly complied with.

(iii) Whether alternative to the scheme of amalgamation may mean winding up of one

or more companies with consequent loss of production and jobs. The court will

try to avoid such closure to the extent possible.

(iv)Whether the majority have coerced or otherwise opposed the minority in

approving the scheme.

(v) Whether the scheme is such which and independent and honest member of the

Company, while wisely acting in respect of his own interest, can reasonably

approve.

(vi)Whether the relevant facts have been properly disclosed and there has been no

misrepresentation.

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That the scheme is one, which a reasonable man of business would approve, and

that it is fair and reasonable to all concerned.

Section 318

With the amalgamations taking place, the managing director or managers of the

amalgamated companies are likely to face with loss of office situations. In

connection with this, they may stipulate certain clauses in the amalgamation

procedures that compensation should be paid to them in connection with the loss of

office. This act prevents inclusion of such clauses unless the necessary limits and

conditions are observed.

Section 376

The managing director or managers may impose certain clauses in the

amalgamation agreement or objects in the articles of the company that unless they

have been appointed at the same position in the amalgamated company, the

amalgamation may not come into effect. The provisions of section 376, invalidates

any such clause in the agreement for amalgamation.

Section 81(1A)

Under this section a company may have to pass a resolution to get approval to issue

shares to persons other than the present shareholders of the company. The

authorized share capital may have to be increased to accommodate the additional

share capital accumulated while issuing shares during amalgamation.

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4.2 Foreign Exchange Regulation Act, 1973

In the case of an amalgamation, the following are the some of the acts may be

necessary, needing compliance with the provisions of that Act.

Issue of shares to non-residents

Amalgamation of a foreign company with an Indian Company

Issue of shares by a non-resident company to residents.

Indian parties have also issued a separate set of guidelines in respect of takeovers

of overseas companies.

4.3 Sick Industrial Companies Act, 1985

This act provides for revival and rehabilitation of sick companies. One of the

manners in which revival could be affected is amalgamating sick company with a

healthy company. Whereby the latter company would make attempts to revive it. To

encourage such a healthy company to take up such a risk, several concessions in

the form waiver of interest on loans, tax concessions etc. are offered. The act has

been successfully used in many cases though the process can be very time

consuming.

4.4 Monopolies and Restrictive Trade Practices Act, 1969

By the amendment act of 1991 and Supreme Court judgment in Hindustan Lever

Employees Union Vs. Hindustan Lever Ltd, it has been held that the MRTP act does

not apply to amalgamations and no attempt can be made to interpret the other

provisions of this act to require compliance in case of such transactions. Hence for

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all practical purposes, this act has become irrelevant for the purposes of compliance

while affecting amalgamations.

4.5 Stock Exchange Requirements

In case of amalgamations it is required that any circular, advertisements and notices

in connection with the amalgamation of a company with itself, would be required to

be sent promptly to the Stock Exchange. Apart from this requirement the

amalgamated company may need to list the shares, which are issued to the

shareholders of the amalgamating company.

4.6 Stamp Act

It will have to be seen as to what extent the transfer of assets pursuant to

amalgamation would attract stamp duty. The provisions may vary from state to state.

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VALUATION

Whether the transaction for change in corporate management is effected by a

takeover or an amalgamation, it is necessary to price the company and its shares.

The valuation of shares is not an exercise merely to comply with statutes but is also

a major business decision. It is necessary to find out what is the value of the shares

of both the amalgamating and the amalgamated Company to decide the share

exchange ratio. The essence of valuation is predicting the future.

Factors influencing valuation of shares : -

The process of valuation essentially involves an attempt to peep into the future and

ascertain what value would arise as a result of the holding of the shares. A small

shareholder may look forward to dividends and capital appreciation. A larger

shareholder may be interested in the earnings of the Company and influence he can

exert to provide for more distribution as well as to ensure better management of the

Company. The important consideration is the future of the Company and the amount

that may be distributed to the shareholders out of that here are some of the factors,

which are considered while valuation of shares

5.1 Factors affecting valuation

Transferability of Shares

Shares of private companies and, occasionally, public companies may have

restrictions placed on transfer of their shares. The articles of association of private

companies state that any shareholder seeking transfer of their shares should offer

them first to the existing shareholders.

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It is unarguable that an item, which cannot be sold or cannot be sold easily, has a

much lesser value than an item easily realizable. Hence while determining the value

of the share it is necessary to consider the effect of any restrictions on transfer of

shares over the value of shares.

Asset Base

It is always kept in mind what is the market value of the assets, if realized

piecemeal. It is found that many companies, in spite of having very valuable assets,

could not extract adequate returns from them as could comparably be obtained if

these assets are sold off and the amounts invested elsewhere. An adequate asset

base also gives some assurance to the shareholders over the safety of their

investments.

Quality of Management

The reputation and track record of the management has an important influence on

the valuation of shares. Valuation is basically an exercise of peeking into future and

if the management already has a reputation and track record, a sounder basis of

quantifying the future is available.

Industry in which the Company belongs

The industry in which the Company belongs will also have a strong influence over

the value of the shares. Industries, which for example have frequent ups and down,

industry, which is in a very mature stage, industries having very strong government

control, and regulation are viewed to be less favorable.

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Certain industries may be in a nascent stage with excellent potential for growth.

Market Price of the shares

Often it is felt that the price quoted on a stock exchange is not a good indicator of

the potential price of the share. A person seeking to take over the company would

normally pay a price for the share, which is much higher than what is quoted. This

he would obviously do only if he judges that the potential price and value of shares is

much more than the ruling price.

Size of shareholding

The size of shareholding affects the value of shares. Small quantity of shares does

not give any power to the holder to influence the management. At the same time

small lot of shares find a wider market and are, hence readily realizable. Larger lot

gives scope for involvement in the policy and working of the Company.

Corresponding disadvantage is that such quantity of shares may not find many

buyers and may take some time for disposal.

Economic situation

When the economy of a country is in the rising part of the business cycle , most

industries face growth, spurred by the general growth in demand and production.

Political Situation

The ruling party at the center determines economic policies, budgets, borrowings

etc. Uncertainty in the political situation has an adverse effect in determining future

trends.

Customers

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The level of sales and profitability depends, to a large extent, on the type of

customers a company has.

Ruling rate of return in alternative investments

The rate of return which alternative investments provide often influences the value of

the shares.

Quality and timing of future earnings

The quality of the earnings and its timing also affect the final value of the shares. If

the earnings may arise after long time, or if the cash flow is uneven, having larger

amounts of profits in distant periods, the value of the share may accordingly be

affected adversely.

Environmental effects

In recent times, stricter laws have resulted in higher burdens of cost over the

companies. Companies engaged in an area which affects the environment

adversely, may have to spend money on remedying the damage caused. Heavy tax

concession and liberal laws are encouraging environment friendly companies.

5.2 Methods of Valuation of Shares

There is no one method of valuation of shares, which is universally suitable, and as

per the facts of the particular company. Some of these are discussed below.

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Assets Method

This method is termed as the break – up value method. This method of valuation is

fairly simple. The market or realizable value of all the assets is determined. From

this aggregate value, the total liabilities, which would have to be paid including

selling costs and cost of dissolution, would be deducted. The resultant figure would

have to be allocated on the number of Equity Shares to get the value per share.

Yield Method

The yield method lays stress on the dividend return of the share and is therefore

suitable to an extent to shareholders having small quantity of shares or those who

are concerned with the periodical returns from a share. The yield from the share i.e.

the amount of dividend as a percentage of the market price is worked out. This after

due adjustments for factors listed, is compared with the ruling rate of return on

alternative investments. The value of share is accordingly determined.

Earning Method

This method is very popularly and widely accepted. The method follows the steps

below

Estimation of future maintainable profits

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The initial step is determination of the amount of profits that may be earned in the

future on a steady basis. Future profits estimation is done on the basis of plan,

appropriate adjustments are made for taxation, dividends on preference shares and

according to certain variants of this method for transfer to reserves.

Rate of capitalization

Benchmark capitalization rate is determined by considering returns from an

alternative but safe investments. The alternative rate is the cost of borrowings.

Capitalisation of future profits

The profits are capitalised by following formula

(Future Profits / Rate of capitalisation) x 100

Value per Share

The value determined as per the earlier step is divided by the number of equity

shares to get the value per share. Adjustments are made for partly paid up shares or

calls in arrears.

Discounted cash flow method

This method has also gained some popularity and is also suitable when the cash

flows in the future are uneven. The important advantage of this method is that it

takes into account the time value of money. Another advantage is that it takes into

account capital inflows / outflows also into account. This method involves the

following steps

Determine the number of years

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It is necessary to determine how far in the future the estimation is to be made. It

should not be too short or too long.

Determination of future cash flows

It is necessary to determine the net flow of cash for each of the future year. The

method is basically similar to that of future profits in the earning method.

Determining the end value of the business

The value of the business at the end of the period is determined. This method is

usually determined by one of the other methods of valuation such as assets method,

earning method, etc.

Determination of discounting rate

As this method determines the present value of the future inflows, it is necessary to

determine at what rate should the amounts be discounted.

Discounting the future cash flows

Using the discounting rate, the present value of the future cash flows and the value

of the business at the end of the period are determined to get a figure, which is the

value of the Company.

Value of the shares

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The value of the Equity shares would be the value of the Company as determined in

the earlier step divided by the number of Equity share.

Price / Earnings Method

This is yet another popular method, it has two steps

Determining the future Earnings per Share

An attempt is made what would be the future EPS. This is as good as determining

the future profits and dividing the amount by the number of Equity Shares.

Determining the appropriate Price – Earning Ratio

The price-earning ratio is determined by dividing the market price of the share by the

earning per share. It is felt that the price-earning ratio of similar company is often

same. The value of share is determined by multiplying the Price – Earning ratio with

the expected earnings per share.

Conclusion

While valuation of shares, though is not entirely scientific exercise, is based on some

sound methods of valuation, but very often the value so determined is ignored in the

process of making the deal and the importance of winning the deal has been often

found to be the deciding factor .

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Leveraged Buyouts (LBO)

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Leveraged buy outs

During the 1980s, a new scheme of corporate restructuring became extremely

popular in the USA and the Western Europe. This new scheme came to be known

as leveraged buy out (LBO). As the name implies, and LBO has to major aspects:

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Using the LBO, the management buys out the entire share holding of the

company from the public and gets it de-listed.

For buying shares on such a massive scale the management takes a loan and

thus leverages the transaction.

The LBO package is usually designed and structured by investment bankers.

An example will make the LBO transaction clear. Intricate details have deliberately

chosen to ignore for the sake of simplicity and brevity.

Example: XYZ Limited is a listed company in Bombay Stock Exchange. The paid-up

equity share capital is Rs. 2 Crore divided into 20 lakh shares of Rs. 10 each fully

paid-up.

The company is professionally managed. The Chairman and Managing Director

(who was the original promoter) hold 20% of the share capital. The public held the

rest 80%. No shareholder from public owns more than 5000 shares.

The shares of XYZ Limited are usually quoted at between Rs. 100 and Rs. 125. The

book value of the share (based on historical values) is Rs. 85. The break-up value

(based on current market value) will be around Rs. 400.

There was a hostile raid bye a take-over tycoon from Dubai on this company.

However, the Chairman, who purchased the 10% holding of the Dubai raider at an

undisclosed price, successfully stalled it.

This event shook the Chairman, who then decided to purchase the balance of the

70% shares from the market through a LBO.

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M/s. Merbankers structured the LBO to suit the needs of the Chairman of XYZ

Limited on the following line:

The Chairman promotes a new company called XYZ Holding Limited.

A Consortium of banks will lend Rs. 21 Crore to XYZ Holdings Limited to buy all

the 70% shares of XYZ Limited from the market at Rs. 150.

After the purchase is completed, the subsidiary will be merged into the parent

company.

The loan of Rs. 21 Crore will be serviced from the profits of the operations of

XYZ Limited.

A part of the loan will be repaid through disposal of some surplus assets

(particularly land and buildings)

As long as the loan is outstanding, nominee directors of the lending bankers will

be on the board of XYZ Limited.

What is presented above is a fairly simplified version. In actual practice, quite a few

changes may be required. Some of them are indicated below.

When the present management of XYZ Limited offers to buy back the shares at

Rs. 150, the Dubai-based raider may offer to buy at much higher price.

Ultimately, the highest bidder wins the race. The LBO device may be used either

by the present management or by the raider.

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Instead of bank finance, a LBO may be financed through high-yield bonds (also

known as junk bonds), convertible bonds, partly through cash and party through

bonds, etc.

The repayment of the loan (taken from LBO) may be arranged through the sale

of subsidiaries, if any, in addition to sale of surplus land and buildings.

Example: The parent company of Britannia Industries Ltd (RJR Nabisco) was

acquired in a raid in USA by an Investment banking firm, KKR. Subsequently the

various subsidiaries including the one in India were sold off. That is how Mr. Rajan

Pillai could acquire Britannia Industries Ltd., along with some other subsidiaries for

RJR Nabisco.

LBO is a mixed bag with some advantages and disadvantages:

Advantages

If the public shareholders get a value higher than the market price (close to the

break-up value) they are benefited, at least, in the short run.

The owner-managers and /or professional managers can run the companies

without the fear of losing control from as hostile take over.

LBOs help to restructure the companies, basically weeding out inefficient and

incompetent management.

Disadvantages

As a LBO usually results in a very high portion of debt, servicing of the debt

becomes a great financial strain for the company in the post-LBO period.

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Example: The parent company of Nagarjuna Signode (Signode Corporation, USA)

was made private through an LBO by the management to ward off a possible

takeover bid. Subsequently, the debt burden became too much for the management

and they sold out the company to ITW (International Tool works).

Since the management resorts to asset stripping and jettisoning of the

subsidiaries to reduce the debt burden after and LBO, it might weaken the

company in the long run.

Continuity and stability will be adversely affected when bankers and stock market

experts start running manufacturing enterprises. The management focus tends to

shift to short term.

Some Policy issue

Joint-stock companies, which go public and get listed on the stock exchange,

promote a wide dispersal of share ownership. LBOs tend to result in reverse –

namely concentration of share ownership and economic power.

LBOs involve considerable debt financing, which works both ways. When the

operational profits are high, a high debt equity ratio results in high earnings per

share. When the operational profits are stagnating or low, a high debt-equity ratio

is not in the interest of the equity owners.

Financing an LOB transaction by way of so called junk bonds (i.e. high-yield

bonds) may lead to reckless financing affecting the long term stability of interest

rate structures. Default rates in junk bonds are quite high.

Example: The so-called junk bond king, Michael Milken, was fined in 1990 up to us

$600 million and given a 10-year prison sentence for several financial crimes

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committed during the 80s. Owing to these junk bond schemes, hundreds of savings

and Loan Associations (S&L) became bankrupt in the USA. To rescue the

unfortunate depositors in these failed S&Ls, the US Government may have to shell

out US $ 500 billion (Rs. 9,00,000 Crore).

LBOs and junk bonds help management as well as raiders. Thus they trend to

disturb the equilibrium by rocking the boat rather too often.

Conclusion

While LBOs ruled the roost in the corporate America in the 1980s, the fate of many

companies after a LBO in not all that flattering. None of the Japanese, Korean.

Taiwanese or Singaporean Companies went through LBO exercises. Under the

Indian Conditions, it is better not to encourage LBO. Even in USA, they are now

forecasting that many LBO companies may go public.

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Amalgamations

7.1 Definitions

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7

Amalgamations

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1. The following terms are used in this statement with the meanings specified:

(a) Amalgamation means an amalgamation pursuant to the provisions of the

Companies Act, 1956, or any other statute, which may be applicable to

companies.

(b) Transferor Company means the Company, which is amalgamated into another

Company.

(c) Transferee Company means the Company into which a transferor Company is

amalgamated.

(d) Reserve means the portion of earnings, receipt or other surplus of an enterprise

(whether capital or revenue) appropriated by the management for a general or a

specific purpose other than a provision for depreciation or diminution in the value

of assets or for a known liability.

(e) Amalgamation in the nature of merger is an amalgamation, which satisfies all the

following conditions.

(i) The assets and liabilities of the transferor Company become, after

amalgamation, the assets and liabilities of the transferee Company.

(ii) Shareholders holding not less than 90% of the face value of the equity shares

of the transferor Company (other than the equity shares already held therein,

immediately before the amalgamation, by the transferee Company or its

subsidiaries or their nominees) become equity shareholders of the transferee

Company by virtue of the amalgamation.

(iii) The consideration for the amalgamation receivable by those equity

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shareholders of the transferee Company is discharged by the transferee

Company wholly by the issue, of equity shares in the transferee Company,

except that cash may be paid in respect of any fractional shares.

(iv)The business of the transferor Company is intended to be carried on, after the

amalgamation, by the transferee Company.

(v) No adjustment is intended to be made to the book values of the assets and

liabilities of the transferor Company when they are incorporated in the

financial statements of the transferee Company except to ensure uniformity of

accounting policies.

(f) Amalgamation in the nature of purchase is an amalgamation, which does not

satisfy any one, or more of the conditions specified in sub-paragraph (e) above.

(g) Consideration for the amalgamation means the aggregate of the shares and

other securities issued and the payment made in the from of cash or other assets

by the transferee Company to the shareholders of the transferor Company.

(h) Fair value is the amount for which an asset could be exchanged between a

knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s

length transaction.

(i) Pooling of interests is a method of accounting for amalgamations the object of

which is to account for the amalgamating companies were intended to be

continued by the transferee Company. Accordingly, only minimal changes are

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made in aggregating the individual financial statements of the amalgamating

companies.

Types of Amalgamations

Generally speaking, amalgamations fall into two broad categories. In the first

category are those amalgamations where there is a genuine pooling not merely of

the assets and liabilities of the amalgamating companies but also of the

shareholders’ interests and of the businesses of these companies. Such

amalgamations are amalgamations, which are in the nature of ‘merger’ and the

accounting treatment of such amalgamations, should ensure that the resultant

figures of assets, liabilities, capital and reserves more or less represent the sum of

the relevant figures of the amalgamating companies. In the second category are

those amalgamations which are in effect a mode by which one Company acquires

another Company and, as a consequence, the shareholders of the Company which

is acquired normally do not continue to have a proportionate share in the equity of

the combined Company, or the business of the Company which is acquired is not

intended to be continued. Such amalgamations are amalgamations in the nature or

‘purchase’.

An amalgamation is classified as ‘amalgamation in the nature of merger when all the

conditions listed in paragraph (e) are satisfied. There are, however, differing views

regarding the nature of any further conditions that may apply. Some believe that, in

addition to an exchange of equity shares, it is necessary that the shareholders of the

transferor Company obtain a substantial share in the transferee Company even to

the extent that it should not be possible to identify any one parties dominant therein.

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This belief is based in part on the view that the exchange of control of one Company

for an insignificant share in a larger Company does not amount to a mutual sharing

of risks and benefits.

Others believe that the substance of an amalgamation in the nature of merger is

evidenced by meeting certain criteria regarding the relationship of the parties, such

as the former independence of the amalgamating companies, the manner of their

amalgamations, the absence of planned transactions that would undermine the

effect of the amalgamation, and the continuing participation by the management of

the transferor Company in the management of the transferee Company after the

amalgamation.

7.2 Methods of Accounting for Amalgamations

There are two main methods of accounting for amalgamations:

(a) The pooling of interests method; and

(b) The purchase method.

The use of the pooling of interests method is confined to circumstances, which meet

the criteria, referred to in paragraph (e) for an amalgamation in the nature of merger.

The object of the purchase method is to account for the amalgamation by applying

the same principles as are applied in the normal purchase of assets. This method is

used in accounting for amalgamations in the nature of purchase.

The Pooling of Interest Method

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Under the pooling of interest method, the assets, liabilities and reserves of the

transferor Company are recorded by the transferee Company at their existing

carrying amounts.

If, at the time of the amalgamation, the transferor and the transferee companies

having conflicting accounting policies, a uniform set of accounting policies is adopted

following the amalgamation. The effects on the financial statements of any changes

in accounting policies are reported in accordance with Accounting Standard (AS)5,

‘Prior Period and Extraordinary Items and Changes in Accounting Policies’.

The Purchase Method

Under the purchase method, the transferee Company accounts for the

amalgamation either by incorporating the assets and liabilities at their existing

carrying amounts or by allocating the consideration to individual identifiable assets

and liabilities of the transferor Company on the basis of their fair values at the date

of amalgamation. The identifiable assets and liabilities include assets and liabilities

not recorded in the financial statements of the transferor Company.

Where assets and liabilities are restated on the basis of their face values, the

determination of fair values may be influenced by the intentions of the transferee

Company. For example, the transferee Company may have a specialised use for an

asset, which is not available to other potential buyers. The transferee Company may

intend to effect changes in the activities of the transferor Company which

necessitate the creation of specific provisions for the expected costs, e.g. planned

employee termination and plant relocation costs.

Consideration

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The consideration for the amalgamation may consist of securities, cash or other

assets. In determining the value of the consideration, an assessment is made of the

fair value of its elements. A variety of techniques is applied in arriving at fair value.

For example, when the consideration includes securities, the value fixed by the

statutory authorities may be taken to be the fair value. In case of other assets, the

fair value may be determined by reference to may apply. Some believe that, in

addition to an exchange of equity shares, it is necessary that the shareholders of the

transferor Company obtain a substantial share in the transferee Company obtain a

substantial share in the transferee Company even to the extent that it should not be

possible to identify any one party as dominant therein. This belief is based in part on

the view that the exchange of control of one Company for an insignificant share in a

larger Company does not amount to a mutual sharing of risks and benefits.

Many amalgamations recognize that adjustments may have to be made to the

consideration in the light of one or more future events. When the additional

payment is probable and can reasonably be estimated at the date of amalgamation,

it is included in the calculation of the consideration. In all other cases, the

adjustment is recognised as soon as the amount is determinable [see Accounting

Standard (AS) A, Contingencies and Events Occurring after the Balance Sheet

Date].

7.3 Treatment of Reserve on Amalgamation

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If the amalgamation is an ‘amalgamation in the nature of merger’, the identity of the

reserves is preserved and they appear in the financial statements of the transferee

Company in the same form in which they appeared in the financial statements of the

transferor Company. Thus, for example, the General Reserve of the transferor

Company becomes the General Reserve of the transferee Company, the Capital

Reserve of the transferor Company becomes the Capital Reserve of the transferee

Company and the Revaluation Reserve of the transferor Company becomes the

Revaluation Reserve of the transferee Company. As a result of preserving the

identity, reserves which are available for distribution as dividend before the

amalgamation would also be available for the amount recorded as share capital

issued (plus any additional consideration in the form of cash or other assets) and the

amount of share capital of the transferor Company is adjusted in reserves in the

financial statements of the transferee Company.

If the amalgamation is an ‘amalgamation in the nature of purchase’, the identity of

the reserves other than the statutory reserves dealt with in paragraph 18, is not

preserved. The amount of the consideration is deducted from the value of the net

assets of the transferor Company, acquired by the transferee Company. If the result

of the computation is negative, the difference is debited to goodwill arising on

amalgamation and dealt with in the manner stated in paragraphs 19=20. If the result

of the computation is positive, the difference is credited to Capital Reserve.

7.4 Treatment of Goodwill Arising on Amalgamation

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Goodwill arising on amalgamation represents a payment made in anticipation of

future income and it is appropriate to treat it as an asset to be amortised to income

on a systematic basis over its useful life. Due to the nature of goodwill, it is

frequently difficult to estimate its useful life with reasonable certainty. Such

estimation is, however made on a prudent basis. Accordingly, it is considered

appropriate to amortise goodwill over a period not exceeding five years unless a

somewhat longer period can be justified.

Factors, which may be considered in estimating the useful life of goodwill arising on

amalgamation, include.

(j) the foreseeable life of the business or industry ;

(ii) the effects of product obsolescence, changes in demand and other economic

factors ;

(iii) the service life expectancies of key individuals or groups of employees ;

(iv) expected actions by competitors or potential competitors; and

(vi) legal, regulatory and contractual provisions affecting the useful life.

Balance of Profit and Loss Account:

In the case of an ‘amalgamation in the nature of merger’, the balance of the Profit

and Loss Account appearing in the financial statements of the transferor Company is

aggregated with the corresponding balance appearing in the financial statements of

the transferee Company. Alternatively, it is transferred to the General Reserve, if

any.

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In the case of an ‘amalgamation in the nature of purchase’, the balance of the Profit

and Loss Account appearing in the financial statements of the transferor Company,

whether debit or credit, loses its identity.

Treatment of Reserves Specified in a Scheme of Amalgamation.

The scheme of amalgamation sanctioned under the provisions of the Companies

Act, 1956, or any other statute may prescribe the treatment to be given to the

reserves of the transferor Company after its amalgamation. Where the treatment is

so prescribed, the same is followed.

7.5 Disclosure.

For all amalgamations, the following disclosures are considered appropriate in the

first financial statements followed the amalgamation: names and general nature of

business of the amalgamating companies; effective date of amalgamation for

accounting purposes; the method of accounting used to reflect the amalgamation;

and particulars of the scheme sanctioned under a statute.

For amalgamations accounted for under the pooling of interests method, the

following additional disclosures are considered appropriate in the first financial

statements following the amalgamations :

(a) description and number of shares issued, together with the percentage of

each Company’s equity shares exchanged to effect the amalgamation;

(b) the amount of any difference between the consideration and the value of net

identifiable assets acquired, and the treatment thereof.

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For amalgamation accounted for under the purchase method, the following

additional disclosures are considered appropriate in the first financial statements

following the amalgamation:

(a) consideration for the amalgamation and a description of the consideration

paid or continently payable; and

(b) The amount of any difference between the consideration and the value of net

identifiable assets acquired, and the treatment thereof including the period of

amortization of any goodwill arising of amalgamation.

7.6 Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before the

issuance of the financial statements of either party to the amalgamation, disclosure

is made in accordance with as 4, ‘Contingencies and Events Occurring after the

Balance Sheet Date’, but the amalgamation is not incorporated in the financial

statements. In certain circumstances, the amalgamation may also provide additional

information affecting the financial statements themselves, for instance, by allowing

the going concern assumption to be maintained.

7.7 Post take over management issues

The most vital aspect of a take over is the post take-over management. By that time

the old promoters would have quit happily with their money, and the merchant

bankers with their fat fee. Now that you have the baby in your hands, how are you

going to hold it? This will decide the ultimate success of failure of the takeover.

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The post take-over management issues can be broadly understood from technical,

commercial, financial, managerial and human angles.

Technical Aspects

The existing technical team has to be carefully handled so that they are motivated to

stay and become more productive. Any vacuum in the technical team immediately

after the take over may have adverse consequences. The technology absorption,

the process validation parameters and the quality improvement programs should be

carefully assessed and modified wherever necessary.

Commercial Aspects

The funds-flow management should be paid adequate attention. Wastage and

leakage should be controlled. The relationship with the banks and financial

institutions should be maintained cordially.

Managerial Aspects

The senior management team should be evaluated in terms of result-orientation.

Dead wood should be removed. Talent should be encouraged. Efforts should be

made to build a cohesive team of top management.

Human Aspects

Most important is the human aspect. The existing team should not lose their morale

and motivation. They should be reassured about the continuance of good

management practices.

All these principles, when they are in a book, sound like simple motherhood

statements, don’t they? Well, that is what they are. If you do not follow these simple

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rules, you may end up the same way, as the old promoters would have sold out to

you: in search of buyers.

Examples: International Data Management Ltd. (IDM), a losing computer hardware

company, was taken over by HCL in January 1989, after 17 months of struggle in

running and reviving IDM, HCL got fed up and sold its controlling interest of 30% to

the Mittals Group (Engaged in Construction activities) and preferred to be sleeping

partner. HCL was compelled by circumstances again to buy back IDM within five

weeks throwing Mittals out. In the meantime IDM was reduced to shamble and the

turnaround became a nightmare. HCL is once again holding the baby.

The takeover of Neycer by Spartek seems to have run into several unexpected

problems. According to a report published in Economic Times (November 30, 1990),

Spartek invested almost Rs. 5 Crore in Neycer with no worthwhile results. Losses of

Neycer seem to have mounted to Rs. 5 Crore in 1990-91. The entire tiles plant of

Neycer had to be overhauled and revamped. Apart from the technological problems,

labour problems too seem to be rampant. The CEO of Spartek admitted that the

balance sheet of Neycer did not reflect the correct picture (at the time of take over).

The after-effects appear to be too severe for Spartek.

Management is not empire building through attractive exchange-ratios and fancy

financial footwork. Management is hard work, over a long period.

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8

Case Study

ICICI Bank & Bank of Madura

M&A

CASE STUDY

Recommendations of Narasimham Committee on banking sector reforms

The Narasimham Committee on banking sector reforms suggested that 'merger

should not be viewed as a means of bailing out weak banks. They could be a

solution to the problem of weak banks but only after cleaning up their balance sheet.’

Globally, the banking and financial systems have adopted information and

communications technology. This phenomenon has largely bypassed the Indian

banking system, and the committee feels that requisite success needs to be

achieved in the following areas:

– Bank automation

– Planning, standardization of electronic payment systems

– Telecom infrastructure

– Data warehousing network.

Mergers between banks and DFIs and NBFCs need to be based on synergies

and should make a sound commercial sense. Committee also opines that

mergers between strong banks/FIs would make for greater economic and

commercial sense and would be a case where the whole is greater than the sum

of its parts and have a "force multiplier effect". It also opined that mergers should

not be seen as a means of bailing out weak banks.

A weak bank, could be nurtured into healthy units. It also says, if there is no

voluntary response to a takeover of such banks, a restructuring commission for

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such PSBs can consider other options such as restructuring, merger

amalgamation, or if not closure.

The committee also opines that, while licensing new private sector banks, the

initial capital requirements need to be reviewed. It also emphasized on a

transparent mechanism for deciding the ability of promoters to professionally

manage the banks. The committee also feels that a minimum threshold capital

for old private banks also deserves attention and mergers could be one of the

options available for reaching the required threshold capitals. The committee also

opined that a promoter group cannot hold more than 40 percent of the equity of a

bank.

The Government has tried to find a solution on similar lines, and passed an

ordinance an September 4, 1993, and took the initiative to merge New Bank of India

(NBI) with Punjab National Bank (PNB). Ultimately, this turned out to be an unhappy

event. Following this, there was a long silence in the market till HDFC Bank

successfully took over Times Bank. Market gained confidence, and subsequently,

we witnessed two more mega mergers. The merger of Bank of Madhura with ICICI

Bank, and of Global Trust Bank with UTI Bank, emerging as a new bank, UTI-Global

bank.

With the success story of these mergers, can we expect few more mergers in 2002?

An overview of bank mergers in the recent past is presented in this case study.

While the private sector banks are on the threshold of improvement, the Public

Sector Banks (PSBs) are slowly contemplating automation to accelerate and cover

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the lost ground. To contend with new challenges posed by Private Sector Banks,

PSBs are pumping huge amounts to update their IT. But still, it looks like, public

sector banks need to shift the gears, accelerate their movements, in the right

direction by automating their branches and providing, Internet banking services.

Although large PSBs are slowly venturing into new areas, a few old big-sized banks

are still encountering problems of unionized staff though in the milder way, and the

employees are still finding their feet in new technologies.

The private sector banks, in order to compete with large and well established public

sector banks, are not only foraying into IT, but also shaking hands with peer banks

to establish themselves in the market. While one of the first initiatives was taken in

November, 1999, when Deepak Parekh of HDFC and S.M.Datta of Times bank

shook hands, created history. It is the first merger event in the history of Indian

banking, signaling that Indian banking sector joined the M&A bandwagon. Prior to

this private bank merger, there have been quite a few attempts made by the

government to rescue weak banks and synergies the operations to achieve scale

economics (but, unfortunately were futile). Presently, ‘Size’ of the bank is recognized

as one of the major strengths in the industry. And, mergers amongst strong banks

can be both a means to strengthen the base, and of course, to face the cutthroat

competition.

On the other hand, if the merger turns out to be mere arithmetical number crunching

of two balance sheets without a proper strategic outlook and reorienting goals, it

might result in disharmonious human resource problems.

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A few years ago any talk of bank mergers would have been something abnormal

and any suggestion on bank mergers would have been regarded as nothing short of

irreverence. For many years twenty public sector banks, and SBI GROUP

monopolized the Indian banking sector.

With the removal of entry barriers, in 1995, the emergence of nine private sector

banks has given a new glamorous outlook for the banking industry. The

technological savvy, customer oriented service, innovative products have become

the day’s meal.

Merger of ICICI Bank and BOM

The ICICI, one of largest financial institutions in India had an asset base of Rs.582

bn in 2000. It is an integrated wide spectrum of financial activities, with its presence

in almost all the areas of financial services, right from lending, investment and

commercial banking, venture capital financing, consultancy and advisory services to

on-line stock broking, mutual funds and custodial services. In July 1998, to synergize

its group operations, restructuring was designed, and as a result ICICI Bank has

emerged.

On April 1, 1999, in order to provide a sharp focus, ICICI Bank restructured its

business into three SBUs namely, corporate banking, retail banking and treasury.

This restructured model enabled the bank to provide cross-selling opportunities

through ICICI’s strong relationships with 1000 corporate entities in India.

The bank pioneered in taking initiatives and providing one stop financial solutions to

customers with speed and quality. In a way to reach customers, it has used multiple

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delivery channels including conventional branch outlets, ATMs, telephone call-

centers and also through Internet. The bank also ventured into a number of B2B and

B2C initiatives in the last year to maintain its leadership in India. The B2B solution

provided by the bank is aimed at facilitating on-line supply chain management for its

corporate clients by linking them with their suppliers and dealers in a closed

business loop. The bank is always ahead in advanced IT, and used as a competitive

tool to lure new customers.

In February 2000, ICICI Bank was one of the first few Indian banks to raise its capital

through American Depository Shares (ADS) in the international market, which has

received an overwhelming response for its issue of $175 mn, with a total order book

of USD 2.2 bn. At the time of filling the prospectus, with the US Securities and

Exchange Commission, the Bank had mentioned that the proceeds of the issue will

be used to acquire a bank.

As on March 31, 2000, bank had a network of 81 branches, 16 extension counters

and 175 ATMs. The capital adequacy ratio was at 19.64 percent of risk-weighted

assets, a significant excess of 9 percent over RBI’s benchmark.

ICICI Bank has been scouting for a private banker for merger, with a view to expand

its asset and client base and geographical coverage. Though it had 21 percent of

stake, the choice of Federal bank, was not lucrative due to the employee size

(6600), per employee business is as low at Rs.161 lakh and a snail pace of technical

upgradation. While, BOM had an attractive business per employee figure of Rs.202

lakh, a better technological edge and had a vast base in southern India when

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compared to Federal bank. While all these factors sound good, a cultural integration

would be a tough task ahead for ICICI Bank.

ICICI Bank has announced a merger with 57-year-old Bank of Madura, with 263

branches, out of which 82 of them are in rural areas, with most of them in southern

India. As on the day of announcement of merger (09-12-00), Kotak Mahindra group

was holding about 12 percent stake in BOM, the Chairman BOM, Mr. K.M.

Tyagarajan, along with his associates was holding about 26 percent stake, Spic

group has about 4.7 percent, while LIC and UTI were having marginal holdings. The

merger will give ICICI Bank a hold on South Indian market, which has high rate of

economic development.

The board of Directors at ICICI has contemplated the following synergies emerging

from the merger:

Financial Capability: The amalgamation will enable them to have a stronger

financial and operational structure, which is suppose to be capable of greater

resource/deposit mobilization. And ICICI will emerge as one of the largest private

sector banks in the country.

Branch network: The ICICI’s branch network would not only increase by 264, but

also increases geographic coverage as well as convenience to its customers.

Customer base: The emerged largest customer base will enable the ICICI bank to

offer banking and financial services and products and also facilitate cross-selling of

products and services of the ICICI group.

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Tech edge: The merger will enable ICICI to provide ATMs, Phone and the Internet

banking and financial services and products to a large customer base, with expected

savings in costs and operating expenses.

Focus on Priority Sector: The enhanced branch network will enable the Bank to

focus on micro-finance activities through self-help groups, in its priority sector

initiatives through its acquired 87 rural and 88 semi-urban branches.

The swap ratio has been approved in the ratio of 1:2 – two shares of ICICI Bank for

every one share of BOM. The deal with BOM is likely to dilute the current equity

capital by around 12 percent. And the merger is expected to bring 20 percent gains

in EPS of ICICI Bank. And also the bank’s comfortable Capital Adequacy Ratio

(CAR) of 19.64 percent has declined to 17.6 percent.

Financial Standings of ICICI Bank and Bank of Madura

(Rs. in crore)

Parameters ICICI Bank Bank of Madura

1999-2000 1998-99 1999-2000 1998-99

Net worth 1129.90 308.33 247.83 211.32

Total Deposits 9866.02 6072.94 3631.00 3013.00

Advances 5030.96 3377.60 1665.42 1393.92

Net profit 105.43 63.75 45.58 30.13

Share capital 196.81 165.07 11.08 11.08

Capital Adequacy Ratio

19.64% 11.06% 14.25% 15.83%

Gross NPAs/ Gross Advances

2.54% 4.72% 11.09% 8.13%

Net NPAs /Net Advances

1.53% 2.88% 6.23% 4.66%

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The ‘Generation Gap’

Will the merger of 57-year old BOM, south based old generation bank with a fast

growing tech savvy new generation bank, help the latter? For sure, the stock

merger is likely to bring cheer to shareholders and bank employees of BOM, and

some amount of discomfort and anxiety to those of ICICI Bank.

The scheme of amalgamation will increase the equity base of ICICI Bank to Rs.

220.36 cr. ICICI Bank will issue 235.4 lakh shares of Rs.10 each to the share-

holders of BOM. The merged entity will have an increase of asset base over Rs.160

bn and a deposit base of Rs.131 bn. The merged entity will have 360 branches and

a similar number of ATMs across the country and also enable the ICICI to serve a

large customer base of 1.2 million customers of BOM through a wider network,

adding to the customer base to 2.7 million.

Managing rural branches

ICICI’s major branches are in major metros and cities, whereas BOM spread its

wings mostly in semi urban and city segments of south India. There is a task ahead

lying for the merged entity to increase dramatically the business mix of rural

branches of BOM. On the other hand, due to geographic location of its branches and

level of competition, ICICI Bank will have a tough time to cope with.

Managing Software:

Another task, which stands on the way is technology. While ICICI Bank, which is a

fully automated entity is using the package, Banks 2000, BOM has computerized 90

percent of its businesses and was conversant with ISBS software. The BOM

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branches are supposed to switch over to Banks 2000. Though it is not a difficult

task, with 80 percent computer literate staff would need effective retraining which

involves a cost. The ICICI Bank needs to invest Rs.50 crore, for upgrading BOM’s

263 branches.

Managing Human resources:

One of the greatest challenges before ICICI Bank is managing human resources.

When the head count of ICICI Bank is taken, it is less than 1500 employees; on the

other hand, BOM has over 2500. The merged entity will have about 4000 employees

which will make it one of the largest banks among the new generation private sector

banks. The staff of ICICI Bank are drawn from 75 various banks, mostly young

qualified professionals with computer background and prefer to work in metros or big

cities with good remuneration packages. While under the influence of trade unions

most of the BOM employees have low career aspirations. The announcement by

H.N. Sinor, CEO and MD of ICICI, that there would be no VRS or retrenchment,

creates a new hope amongst the BOM employees. It is a tough task ahead to

manage. On the other hand, their pay would be revised upwards. Is it not a

Herculean task to integrate two work cultures?

Crucial Parameters: How they stand

Name of the Bank

Book value of Bank on the day of merger announcement

Market price on the day of announcement of merger

Earnings per share

Dividend paid (in %)

P/E ratio

Profit per employee (in lakh) 1999-2000

Bank of Madura

183.0 131.60 38.7 55% 3% 1.73

ICICI Bank 58.0 169.90 5.4 15% - 7.83

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Managing Client base:

The client base of ICICI Bank, after merger, will be as big as 2.7 million from its past

0.5 million, an accumulation of 2.2 million from BOM. The nature and quality of

clients is not of uniform quality. The BOM has built up its client base for a long time,

in a hard way, on the basis of personalized services. In order to deal with the BOM’s

clientele, the ICICI Bank needs to redefine its strategies to suit to the new clientele.

The sentiments or a relationship of small and medium borrowers is hurt, it may be

difficult for them to reestablish the relationship, which could also hamper the image

of the bank.

Given the situation, we need to wait and view, as to how the ICICI will face this

challenge.

ICICI Bank and Bank of Madura: ICICI Bank, a large private sector bank (a strong

bank) took over Bank of Madura (relatively less strong bank) in order to expand its

customer base and branch network. When we look at the key parameters such as

net worth, total deposits, advances and NPAs (given in the table) the ICICI Bank is

in a much better position. The net worth of the former is four folds higher than the

latter. And in terms of total deposits and advances the former is three fold higher

than the latter. When we look at the NPA ratios, the gross NPAs to gross advances

and net NPAs to net advances and the non-performing assets are four fold higher in

latter case, than that of the former. The ICICI Bank which was looking for a strategic

alliance after it received its proceeds from ADS issue, had a tie up with BOM only to

expand its customer base and branch network. Although integration of different work

cultures and managing client bases of different cadres is a difficult task, one has to

wait and watch to what extent the alliance will be successful.

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Scenario

During the past five years, mergers and acquisitions have driven the financial

services sector. Former competitors are now allies, partners, and, in some cases,

merged organizations.

To remain competitive and meet goals such as delivering new products quickly,

achieving broad geographical reach, building products that can be easily replicated,

and providing real-time customer service, financial institutions must adopt and

implement technology solutions effectively.

Banks are consolidating and restructuring through mergers and acquisition. Mergers

are viewed as an effective solution for revamping weaker banks. After the merger of

HDFC Bank and Times Bank, ICICI Bank took an initiative to merge with Bank of

Madura. The consolidation will allow these banks to expand their operations

significantly and enhance their customer base.

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References

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REFERENCES

MERGERS et al – S RAMANUJAM

FINANCIAL MANAGEMENT – I.M. PANDEY

CORPORATE MERGERS AMALGAMATIONS & TAKEOVERS

– Dr. J.C.VERMA

ECONOMIC TIMES OF INDIA

NARSIMHAM COMMITTEE REPORT ON BANKING SECTOR REFORMS

ANNUAL REPORTS OF THE COMPANIES

ICFAI RESEARCH CENTER

BUSINESS STANDARD

equitymaster.com

Indiainfoline.com

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