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mf0011

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 MF 0011 Mergers and Acquisitions Set- 1Q.1 What are the basic steps in strategic planning for a merger?Ans.Basic steps in Strategic planning in Merger :Any merger and acquisitioninvolve the following critical activities in strategic planning processes. Some of theessential elements in strategic planningprocesses of mergers and acquisitions are aslisted here below :1. Assessment of changes in the organization environment2. Evaluation of companycapacities and limitations3. Assessment of expectations of stakeholders4. Analysis of company, competitors, industry, domestic economy andinternationaleconomies5. Formulation of the missions, goals and polices6. Development of sensitivity to critical external environmental changes7.Formulation of internal organizational performance measurements8. Formulation of long range strategy programs9. Formulation of mid-rangeprogrammes and short-run plans10. Organization, funding and other methods to implement all of the proceedingelements11. Information flow andfeedback system for continued repetition of all essentialelements and for adjustment and changes at each stage12. Review and evaluation of all theprocessesIn each of these activities, staff and line personnel have important Responsibilities inthe strategic decision making processes. The scope of mergers and acquisition set thetone for the nature of mergers and acquisition activities and in turn affects the factorswhich have significant influence overthese activities. This can be seen by observingthe factors considered during the different stages of mergers and acquisition activities.Proper identificationof different phases and related activities smoothen the process of involved in mergerQ.2 What are the sources of operating synergy?Ans. Sources of Operating SynergyOperating synergies are those synergies thatallow firms to increase their operating income, increase growth or both. We wouldcategorizeoperating synergies into four types:1.Economies of scalethat may arise from the merger, allowing the combined firm tobecome more cost-efficient and profitable. Economics of scales can be seen in mergersof firms in the same businessFor example :two banks combining together to createa larger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken asan example of cost reducingoperating synergy. Both the banks after combination canexpect to cut costs considerably on account of sharing of their resources and thusavoidingduplication of facilities available.2.Greater pricing powerfrom reduced competition and higher market share, whichshould result in higher margins and operating income. This synergy is also morelikelyto show up in mergers of firms which are in the same line of business and should bemore likely to yield benefits when there are relatively few firms inthe business. Whenthere are more firms in the industry ability of firms to exercise relatively higher pricereduces and in such a situation the synergy doesnot seem to work as desired.Anexampleof limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. The two companies were in the same line of businessand were in direct competition with each other leading to a severe price war andincreased marketing costs. After the acquisition blow pastacquired a strong hold onthe market and operated under near monopoly situation. Another example is theacquisition of Tomco by Hindustan Lever.3.Combination of different functional strengths, combination of differentfunctional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues.The phenomenon can be understoodin cases where one company with an established brand name lends its reputation to acompany with upcomingproduct line or a company. A company with strongdistribution network merges with a firm that has products of great potential but isunable to reach themarket before its competitors can do so. In other words the twocompanies should get the advantage of the combination of theircomplimentary functional strengths.4.Higher growthin new or existing markets, arising from the combination of the twofirms. This would be case when a US consumer products firm acquires anemergingmarket firm, with an established distribution network and brand name recognition,and uses these strengths to increase sales of itsproducts.Operating synergies canaffect margins and growth, and through these the value of the firms involved in themerger or acquisition.Synergyresults from complementary activities. This can beunderstood with the following exampleExample :Consider a situation where thereare two firms A and B. Firm A is having substantial amount of financial resources(having enough surplus cash that canbe invested somewhere) while firm B is havingprofitable investment opportunities ( but is lacking surplus cash). If A and B combinewitheach other both can utilize each other strengths, for example here A can invest itsresource in the opportunities available to B. note that this canhappen only when thetwo firms are combined with each other or in other words they must act in a way as if they are one.Q.3Explain the process of a leveraged buyout.Ans.In the realm of increased globalized economy, mergers and acquisitions haveassumed significant importance both with the country as well as across theboarders.Such acquisitions need huge amount of finance to be provided. In search of an idealmechanism to finance and acquisition, the concept of 
 
Leverage Buyout (LBO) hasemerged. LBO is a financing technique of purchasing a private company with the helpof borrowed or debt capital. Theleveraged buyout are cash transactions in naturewhere cash is borrowed by the acquiring firm and the debt financing represents 50%or more of thepurchase price. Generally the tangible assets of the target company areused as the collateral security for the loans borrowed by acquiring firm in ordertofinance the acquisition. Some times, a proportionate amount of the long termfinancing is secured with the fixed assets of the firm and in order to raisethe balanceamount of the total purchase price, unrated or low rated debt known as junk bondfinancing is utilized.Modes of purchaseThere are a number of types of financing which can be used in anLBO. These include :Senior debt :this is the debt which ranks ahead of all other debt and equity capital inthe business. Bank loans are typically structured in up to three trenches : A, B andC. The debt is usually secured on specific assets of the company, which means the lendercan automatically acquire these assets if the company breachesits obligations underthe relevant loan agreement; therefore it has the lowest cost of debt. These obligationsare usually quite stringent. Thebank loans are usually held by a syndicate of banksand specialized funds. Typically, the terms of senior debt in an LBO will requirerepayment of thedebt in equal annual installments over a period of approximately 7 years.Subordinated debt :This debt ranks behind senior debt in order of priority on any liquidation. The terms of the subordinated debt are usually less stringent than seniordebt.Repayment is usually required in one ¶bullet· payment at the end of the term.Since subordinated debt gives the lender less security thansenior debt, lending costsare typically higher. An increasingly important form of subordinated debt is the high yield bond, often listedon Indian markets. High yield bonds can either be senior orsubordinated securities that are publicly placed with institutional investors. Theyarefixed rate, publicly traded, long term securities with a looser covenant package thansenior debt though they are subject to stringent reportingrequirements.Mezzanine finance :This is usually high risk subordinated debt and is regarded as atype of intermediate financing between debt and equity and an alternative of highyieldbonds. An enhanced return is made available to lenders by the grant of an ¶equity kicker· which crystallizes upon an exit. A form of this is called aPIK, which reflectsinterest ¶paid in kind·, or rolled up into the principal, and generally includes anattached equity warrant.Loan stock :This can be a form of equity financing if it is convertible into equity capital. The question of whether loan stock is tax deductible should beinvestigatedthoroughly with the company·s advisers.Preference share :This forms part of a company·s share capital and usually givespreference shareholders a fixed dividend and fixed share of the company·s equity.Ordinary shares :This is the riskiest part of a LBOs capital structure. However,ordinary shareholders will enjoy majority of the upside if the company is successful.Q.4 What are the cultural aspects involved in a merger. Give sufficientexamples.Ans.The value chains of the acquirer and the acquired, need to be integrated inorder to achieve the value creation objectives of the acquirer. This integrationprocesshas three dimensions: the technical, political and cultural. The technical integration issimilar to the capability transfer discussed above. Theintegration of social interactionand political relationships represents the informal processes and systems whichinfluence people·s ability and motivation to perform. At the time of integration, theacquirer should have regard to these political relationships, if acquired employees arenot to feel unfairly treated.An important aspect of integration is the cultural integration of the acquiring andacquired firms. The culture of an organization is embodied in its collective valuesystems,beliefs, norms, ideologies myths and rituals. They can motivate people andcan become valuable sources of efficiency and effectiveness. The followingare theillustrative organizational diverse cultures which may have to be integrated duringpost-merger period:Strong top leadership versus Teamapproach· Management by formal paper work versus management by wandering around· Individual decision versus group consensus decision· Rapidevaluation based on performance versus Long term relationship based onloyalty · Rapid feedback for changes versus formal bureaucratic rules andprocedures· Narrow career path versus movement through many areas· Risk taking encouraged versus ¶one mistake you are out· · Risky activitiesversus low risk activities· Narrow responsibility arrangement versus ¶Everyone in this company is salesman (orcost controller, or product qualityimprover etc.)· · Learn from customer versus ¶We know what is best for the customer· The above illustrative culture may provide basis for theclassification of organizationalculture. There are four different types of organizational culture as mentioned below:·Power- The main characteristics are: essentially autocratic and suppressive of challenge; emphasis on individual rather than group decision making·Role- The important features are: bureaucratic and hierarchical; emphasis on formalrules and procedures; values fast, efficient and standardized cultureservice·Task/achievement- The main characteristics are: emphasis on team commitment;task determines organization of work; flexibility and worker autonomy; needscreativeenvironment·Person/support
 
- The important features are: emphasis on equality; seeks to nurturepersonal development of individual membersPoor cultural fit or incompatibility islikely to result in considerable fragmentation,uncertainty and cultural ambiguity, which may be experienced as stressful by organizational members.Such stressful experience may lead to their loss of morale,loss of commitment, confusion and hopelessness and may have a dysfunctionalimpact onorganizational performance. Mergers between certain types can bedisastrous. Differences in culture may lead to polarization, negative evaluationof counterparts, anxiety and ethnocentrism between top management teams of theacquired and acquiring firms. In assessing the advisabilityof an acquisition, theacquirer must consider cultural risk in addition to strategic issues. The differencesbetween the national and the organizationalculture influence the cross-borderacquisition integration. Thus, merging firms must consciously and proactively seek totransform the cultures of theirorganizations.Q.5 Study a recent merger that you have read about and discuss the synergiesthat resulted from the merger.Ans.Synergy is the additional value that is generated by the combination of two ormore than two firms creating opportunities that would not beavailable to the firmsindependently. There are two main types of synergy :1.Operating synergy 2.Financial synergyOperating SynergyOperating synergies are those synergies that allow firms toincrease their operating income, increase growth or both. We wouldcategorizeoperating synergies into four types:1.Economies of scalethat may arise from the merger, allowing the combined firm tobecome more cost-efficient and profitable. Economics of scales can be seen in mergersof firms in the same businessFor example :two banks combining together to create alarger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as anexample of cost reducingoperating synergy. Both the banks after combination canexpect to cut costs considerably on account of sharing of their resources and thusavoidingduplication of facilities available.2.Greater pricing powerfrom reduced competition and higher market share, whichshould result in higher margins and operating income. This synergy is also morelikely to show up in mergers of firms which are in the same line of business and should bemore likely to yield benefits when there are relatively fewfirms in the business. Whenthere are more firms in the industry ability of firms to exercise relatively higher pricereduces and in such a situation thesynergy does not seem to work as desired.Anexampleof limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. The two companies were in the same line of businessand were in direct competition with each other leading to a severe price war andincreased marketing costs. After the acquisition blow pastacquired a strong hold onthe market and operated under near monopoly situation. Another example is theacquisition of Tomco by Hindustan Lever.3.Combination of different functional strengths, combination of differentfunctional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues.The phenomenon can be understoodin cases where one company with an established brand name lends its reputation to acompany with upcomingproduct line or a company. A company with strongdistribution network merges with a firm that has products of great potential but isunable to reach themarket before its competitors can do so. In other words the twocompanies should get the advantage of the combination of theircomplimentary functional strengths.4.Higher growthin new or existing markets, arising from the combination of the twofirms. This would be case when a US consumer products firm acquires anemergingmarket firm, with an established distribution network and brand name recognition,and uses these strengths to increase sales of itsproducts. Operating synergies canaffect margins and growth, and through these the value of the firms involved in themerger or acquisition.Synergy results from complementary activities. This can beunderstood with the following exampleExample :Consider a situation where thereare two firms A and B. Firm A is having substantial amount of financial resources(having enough surplus cash that canbe invested somewhere) while firm B is havingprofitable investment opportunities ( but is lacking surplus cash). If A and B combinewitheach other both can utilize each other strengths, for example here A can invest itsresource in the opportunities available to B. note that this canhappen only when thetwo firms are combined with each other or in other words they must act in a way as if they are one.Financial SynergyWith financial synergies, the payoff can take the form of eitherhigher cash flows or a lower cost of capital (discount rate). Included are thefollowing:yA combination of a firm with excess cash, or cash slack, (and limited projectopportunities) and a firm with high-return projects (and limitedcash) can yielda payoff in terms of higher value for the combined firm. The increase in valuecomes from the projects that were taken with the excess

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