MF 0011 Mergers and Acquisitions Assignment

Set- 1

Q.1 What are the basic steps in strategic planning for a merger?

Ans. Basic steps in Strategic planning in Merger : Any merger and acquisition
involve the following critical activities in strategic planning processes. Some of the
essential elements in strategic planning processes of mergers and acquisitions are as
listed here below :

1. Assessment of changes in the organization environment

2. Evaluation of company capacities and limitations

3. Assessment of expectations of stakeholders

4. Analysis of company, competitors, industry, domestic economy and international

economies

5. Formulation of the missions, goals and polices

6. Development of sensitivity to critical external environmental changes
7. Formulation of internal organizational performance measurements
8. Formulation of long range strategy programs
9. Formulation of mid-range programmes and short-run plans
10. Organization, funding and other methods to implement all of the proceeding
elements
11. Information flow and feedback system for continued repetition of all essential
elements and for adjustment and changes at each stage
12. Review and evaluation of all the processes

In each of these activities, staff and line personnel have important Responsibilities in the
strategic decision making processes. The scope of mergers and acquisition set the tone
for the nature of mergers and acquisition activities and in turn affects the factors which
have significant influence over these activities. This can be seen by observing the
factors considered during the different stages of mergers and acquisition activities.
Proper identification of different phases and related activities smoothen the process of
involved in merger

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Q.2 What are the sources of operating synergy?

Ans. Sources of Operating Synergy

Operating synergies are those synergies that allow firms to increase their operating
income, increase growth or both. We would categorize operating synergies into four
types:

1. Economies of scale that may arise from the merger, allowing the combined firm to
become more cost-efficient and profitable. Economics of scales can be seen in mergers
of firms in the same business

For example : two banks combining together to create a larger bank. Merger of HDFC
bank with Centurian bank of Punjab can be taken as an example of cost reducing
operating synergy. Both the banks after combination can expect to cut costs
considerably on account of sharing of their resources and thus avoiding duplication of
facilities available.

2. Greater pricing power from reduced competition and higher market share, which
should result in higher margins and operating income. This synergy is also more likely
to show up in mergers of firms which are in the same line of business and should be
more likely to yield benefits when there are relatively few firms in the business. When
there are more firms in the industry ability of firms to exercise relatively higher price
reduces and in such a situation the synergy does not seem to work as desired.

An example of limiting competition to increase pricing power is the acquisition of

universal luggage by Blow Plast. The two companies were in the same line of business
and were in direct competition with each other leading to a severe price war and
increased marketing costs. After the acquisition blow past acquired a strong hold on the
market and operated under near monopoly situation.

Another example is the acquisition of Tomco by Hindustan Lever.

3. Combination of different functional strengths, combination of different functional

strengths may enhance the revenues of each merger partner thereby enabling each
company to expand its revenues. The phenomenon can be understood in cases where
one company with an established brand name lends its reputation to a company with
upcoming product line or a company. A company with strong distribution network
merges with a firm that has products of great potential but is unable to reach the market
before its competitors can do so. In other words the two companies should get the
advantage of the combination of their complimentary functional strengths.

4. Higher growth in new or existing markets, arising from the combination of the two
firms. This would be case when a US consumer products firm acquires an emerging
market firm, with an established distribution network and brand name recognition, and
uses these strengths to increase sales of its products.

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Operating synergies can affect margins and growth, and through these the value of the
firms involved in the merger or acquisition.

Synergy results from complementary activities. This can be understood with the
following example

Example : Consider a situation where there are two firms A and B. Firm A is having
substantial amount of financial resources (having enough surplus cash that can be
invested somewhere) while firm B is having profitable investment opportunities ( but is
lacking surplus cash). If A and B combine with each other both can utilize each other
strengths, for example here A can invest its resource in the opportunities available to B.
note that this can happen only when the two firms are combined with each other or in
other words they must act in a way as if they are one.

Q.3 Explain the process of a leveraged buyout.

Ans. In the realm of increased globalized economy, mergers and acquisitions have
assumed significant importance both with the country as well as across the boarders.
Such acquisitions need huge amount of finance to be provided. In search of an ideal
mechanism to finance and acquisition, the concept of Leverage Buyout (LBO) has
emerged. LBO is a financing technique of purchasing a private company with the help of
borrowed or debt capital. The leveraged buyout are cash transactions in nature where
cash is borrowed by the acquiring firm and the debt financing represents 50% or more
of the purchase price. Generally the tangible assets of the target company are used as
the collateral security for the loans borrowed by acquiring firm in order to finance the
acquisition. Some times, a proportionate amount of the long term financing is secured
with the fixed assets of the firm and in order to raise the balance amount of the total
purchase price, unrated or low rated debt known as junk bond financing is utilized.

Modes of purchase

There are a number of types of financing which can be used in an LBO. These include :

Senior debt : this is the debt which ranks ahead of all other debt and equity capital in
the business. Bank loans are typically structured in up to three trenches : A, B and C.

The debt is usually secured on specific assets of the company, which means the lender
can automatically acquire these assets if the company breaches its obligations under
the relevant loan agreement; therefore it has the lowest cost of debt. These obligations
are usually quite stringent. The bank loans are usually held by a syndicate of banks and
specialized funds. Typically, the terms of senior debt in an LBO will require repayment
of the debt 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 senior
debt. Repayment is usually required in one ‘bullet’ payment at the end of the term.

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Since subordinated debt gives the lender less security than senior debt, lending costs
are typically higher. An increasingly important form of subordinated debt is the high yield
bond, often listed on Indian markets. High yield bonds can either be senior or
subordinated securities that are publicly placed with institutional investors. They are
fixed rate, publicly traded, long term securities with a looser covenant package than
senior debt though they are subject to stringent reporting requirements.

Mezzanine finance : This is usually high risk subordinated debt and is regarded as a
type of intermediate financing between debt and equity and an alternative of high yield
bonds. 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 a PIK, which reflects
interest ‘paid in kind’, or rolled up into the principal, and generally includes an attached
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 be investigated thoroughly
with the company’s advisers.

Preference share : This forms part of a company’s share capital and usually gives
preference 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 sufficient
examples.

Ans. The value chains of the acquirer and the acquired, need to be integrated in order
to achieve the value creation objectives of the acquirer. This integration process has
three dimensions: the technical, political and cultural. The technical integration is similar
to the capability transfer discussed above. The integration of social interaction and
political relationships represents the informal processes and systems which influence
people’s ability and motivation to perform. At the time of integration, the acquirer should
have regard to these political relationships, if acquired employees are not to feel unfairly
treated.

An important aspect of integration is the cultural integration of the acquiring and

acquired firms. The culture of an organization is embodied in its collective value
systems, beliefs, norms, ideologies myths and rituals. They can motivate people and
can become valuable sources of efficiency and effectiveness. The following are the
illustrative organizational diverse cultures which may have to be integrated during post-
merger period:

Strong top leadership versus Team approach

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· Management by formal paper work versus management by wandering around

· Individual decision versus group consensus decision

· Rapid evaluation based on performance versus Long term relationship based on

loyalty

· Rapid feedback for changes versus formal bureaucratic rules and procedures

· Narrow career path versus movement through many areas

· Risk taking encouraged versus ‘one mistake you are out’

· Risky activities versus low risk activities

· Narrow responsibility arrangement versus ‘Everyone in this company is salesman (or

cost controller, or product quality improver etc.)’

· Learn from customer versus ‘We know what is best for the customer’

The above illustrative culture may provide basis for the classification of organizational
culture. 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 formal rules
and procedures; values fast, efficient and standardized culture service

· Task/achievement

- The main characteristics are: emphasis on team commitment; task determines

organization of work; flexibility and worker autonomy; needs creative environment

· Person/support

- The important features are: emphasis on equality; seeks to nurture personal

development of individual members

Poor cultural fit or incompatibility is likely 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,

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loss of commitment, confusion and hopelessness and may have a dysfunctional impact
on organizational performance. Mergers between certain types can be disastrous.
Differences in culture may lead to polarization, negative evaluation of counterparts,
anxiety and ethnocentrism between top management teams of the acquired and
acquiring firms. In assessing the advisability of an acquisition, the acquirer must
consider cultural risk in addition to strategic issues. The differences between the
national and the organizational culture influence the cross-border acquisition integration.
Thus, merging firms must consciously and proactively seek to transform the cultures of
their organizations.

Q.5 Study a recent merger that you have read about and discuss the synergies
that resulted from the merger.

Ans. Synergy is the additional value that is generated by the combination of two or
more than two firms creating opportunities that would not be available to the firms
independently.

There are two main types of synergy :

1. Operating synergy
2. Financial synergy

Operating Synergy

Operating synergies are those synergies that allow firms to increase their operating
income, increase growth or both. We would categorize operating synergies into four
types:

1. Economies of scale that may arise from the merger, allowing the combined firm to
become more cost-efficient and profitable. Economics of scales can be seen in mergers
of firms in the same business

For example : two banks combining together to create a larger bank. Merger of HDFC
bank with Centurian bank of Punjab can be taken as an example of cost reducing
operating synergy. Both the banks after combination can expect to cut costs
considerably on account of sharing of their resources and thus avoiding duplication of
facilities available.

2. Greater pricing power from reduced competition and higher market share, which
should result in higher margins and operating income. This synergy is also more likely
to show up in mergers of firms which are in the same line of business and should be
more likely to yield benefits when there are relatively few firms in the business. When
there are more firms in the industry ability of firms to exercise relatively higher price
reduces and in such a situation the synergy does not seem to work as desired.

An example of limiting competition to increase pricing power is the acquisition of

universal luggage by Blow Plast. The two companies were in the same line of business

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and were in direct competition with each other leading to a severe price war and
increased marketing costs. After the acquisition blow past acquired a strong hold on the
market and operated under near monopoly situation.

Another example is the acquisition of Tomco by Hindustan Lever.

3. Combination of different functional strengths, combination of different functional

strengths may enhance the revenues of each merger partner thereby enabling each
company to expand its revenues. The phenomenon can be understood in cases where
one company with an established brand name lends its reputation to a company with
upcoming product line or a company. A company with strong distribution network
merges with a firm that has products of great potential but is unable to reach the market
before its competitors can do so. In other words the two companies should get the
advantage of the combination of their complimentary functional strengths.

4. Higher growth in new or existing markets, arising from the combination of the two
firms. This would be case when a US consumer products firm acquires an emerging
market firm, with an established distribution network and brand name recognition, and
uses these strengths to increase sales of its products.

Operating synergies can affect margins and growth, and through these the value of the
firms involved in the merger or acquisition.

Synergy results from complementary activities. This can be understood with the
following example

Example : Consider a situation where there are two firms A and B. Firm A is having
substantial amount of financial resources (having enough surplus cash that can be
invested somewhere) while firm B is having profitable investment opportunities ( but is
lacking surplus cash). If A and B combine with each other both can utilize each other
strengths, for example here A can invest its resource in the opportunities available to B.
note that this can happen only when the two firms are combined with each other or in
other words they must act in a way as if they are one.

Financial Synergy

With financial synergies, the payoff can take the form of either higher cash flows or a
lower cost of capital (discount rate). Included are the following:

• A combination of a firm with excess cash, or cash slack, (and limited project
opportunities) and a firm with high-return projects (and limited cash) can yield a
payoff in terms of higher value for the combined firm. The increase in value
comes from the projects that were taken with the excess cash that otherwise
would not have been taken. This synergy is likely to show up most often when
large firms acquire smaller firms, or when publicly traded firms acquire private
businesses.

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• Debt capacity can increase, because when two firms combine, their earnings and
cash flows may become more stable and predictable. This, in turn, allows them
to borrow more than they could have as individual entities, which creates a tax
benefit for the combined firm. This tax benefit can either be shown as higher
cash flows, or take the form of a lower cost of capital for the combined firm.
• Tax benefits can arise either from the acquisition taking advantage of tax laws or
from the use of net operating losses to shelter income. Thus, a profitable firm that
acquires a money-losing firm may be able to use the net operating losses of the
latter to reduce its tax burden. Alternatively, a firm that is able to increase its
depreciation charges after an acquisition will save in taxes, and increase its
value.

Clearly, there is potential for synergy in many mergers. The more important issues are
whether that synergy can be valued and, if so, how to value it.

This result has to be interpreted with caution, however, since the increase in the value
of the combined firm after a merger is also consistent with a number of other
hypotheses explaining acquisitions, including under valuation and a change in corporate
control. It is thus a weak test of the synergy hypothesis. The existence of synergy
generally implies that the combined firm will become more profitable or grow at a faster
rate after the merger than will the firms operating separately. A stronger test of synergy
is to evaluate whether merged firms improve their performance (profitability and growth)
relative to their competitors, after takeovers. On this test, as we show later in this
chapter, many mergers fail.

Q.6 What are the motives for a joint venture, explain with an example of a joint
venture.

Ans:- As there are good business and accounting reasons to create a joint venture with
a company that has complementary capabilities and resources, such as distribution
channels, technology, or finance, joint ventures are becoming an increasingly common
way for companies to form strategic alliances. In a joint venture, two or more “parent”
companies agree to share capital, technology, human resources, risks and rewards in a
formation of a new entity under shared control. Broadly, the important reasons for
forming a joint venture can be presented below:

Internal Reasons to Form a JV

• Spreading Costs: You and a JV partner can share costs associated with
marketing, product development, and other expenses, reducing your financial
burden.
• Opening Access to Financial Resources: Together you and a JV partner might
have better credit or more assets to access bigger resources for loans and grants
than you could obtain on your own.

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Connection to Technological Resources: You might want access to technological

resources you couldn't afford on your own, or vice versa. Sharing innovative and
proprietary technology can improve products, as well as your own understanding
of technological processes.

Improving Access to New Markets: You and a JV partner can combine customer
contacts and together even form a joint product that accesses new markets.

Help Economies of Scale: Together you and a JV partner can develop products or
services that reduce total overall production expenses. Bring your product to
market cheaper where the customer can enjoy the cost savings.

External Reasons to Form a JV

Develop Stronger Innovative Product: Together you and a JV partner may be able to
share ideas to develop a product that is more competitive in your industry.

Improve Speed to Market: With shared access to financial, technological, and

distribution resources, you and a JV partner can get your joint product to market
faster and more efficiently.

Strategic Move Against Competition: A JV may be able to better compete against

another industry leader through the combination of markets, technology, and
innovation.

Strategic Reasons

Synergistic Reasons: You may find a JV partner with whom you can create synergy,
which produces a greater result together than doing it on your own.

Share and Improve Technology and Skills: Two innovative companies can share
technology to improve upon each other's ideas and skills.
Diversification - There could be many diversification reasons: access to diverse
markets, development of diverse products, diversify the innovative
working force, etc.

Don't let a JV opportunity pass you by because you don't think it will fit in with
your own small business. Small and big companies alike can benefit from the
reasons listed above. Analyze how your company can benefit internally,
externally, and strategically, and then find a joint venture partner that will fit with
your needs.

Set- 2

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Q.1 What is the basis for valuation of a target company?

Ans. Overview of Acquisition Valuation Methods

There are a number of acquisition valuation methods. While the most common is
discounted cash flow, it is best to evaluate a number of alternative methods, and
compare their results to see if several approaches arrive at approximately the same
general valuation. This gives the buyer solid grounds for making its offer.

Using a variety of methods is especially important for valuing newer target companies
with minimal historical results, and especially for those growing quickly – all of their cash
is being used for growth, so cash flow is an inadequate basis for valuation.

Valuation Based on Stock Market Price

If the target company is publicly held, then the buyer can simply base its valuation on
the current market price per share, multiplied by the number of shares outstanding. The
actual price paid is usually higher, since the buyer must also account for the control
premium. The current trading price of a company’s stock is not a good valuation tool if
the stock is thinly traded. In this case, a small number of trades can alter the market
price to a substantial extent, so that the buyer’s estimate is far off from the value it
would normally assign to the target. Most target companies do not issue publicly traded
stock, so other methods must be used to derive their valuation.

When a private company wants to be valued using a market price, it can adopt the
unusual ploy of filing for an initial public offering while also being courted by the buyer.
By doing so, the buyer is forced to make an offer that is near the market valuation at
which the target expects its stock to be traded. If the buyer declines to bid that high,
then the target still has the option of going public and realizing value by selling shares to
the general public. However, given the expensive control measures mandated by the
Sarbanes-Oxley Act and the stock lockup periods required for many new public
companies, a target’s shareholders are usually more than willing to accept a buyout
offer if the price is reasonably close to the target’s expected market value.

Valuation Based on a Multiple

Another option is to use a revenue multiple or EBITDA multiple. It is quite easy to look
up the market capitalizations and financial information for thousands of publicly held
companies. The buyer then converts this information into a multiples table, which
itemizes a selection of valuations within the consulting industry. The table should be
restricted to comparable companies in the same industry as that of the seller, and of
roughly the same market capitalization. If some of the information for other companies
is unusually high or low, then eliminate these outlying values in order to obtain a median
value for the company’s size range. Also, it is better to use a multi-day average of
market prices, since these figures are subject to significant daily fluctuation.

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The buyer can then use this table to derive an approximation of the price to be paid for
a target company. For example, if a target has sales of $100 million, and the market
capitalization for several public companies in the same revenue range is 1.4 times
revenue, then the buyer could value the target at $140 million. This method is most
useful for a turn-around situation or a fast growth company, where there are few profits
(if any). However, the revenue multiple method only pays attention to the first line of the
income statement and completely ignores profitability. To avoid the risk of paying too
much based on a revenue multiple, it is also possible to compile an EBITDA (i.e.,
earnings before interest, taxes, depreciation, and amortization) multiple for the same
group of comparable public companies, and use that information to value the target.

Better yet, use both the revenue multiple and the EBITDA multiple in concert. If the
revenue multiple reveals a high valuation and the EBITDA multiple a low one, then it is
entirely possible that the target is essentially buying revenues with low-margin products
or services, or extending credit to financially weak customers. Conversely, if the
revenue multiple yields a lower valuation than the EBITDA multiple, this is more
indicative of a late-stage company that is essentially a cash cow, or one where
management is cutting costs to increase profits, but possibly at the expense of harming
revenue growth.

If the comparable company provides one-year projections, then the revenue multiple
can be re-named a trailing multiple (for historical 12-month revenue), and the forecast
can be used as the basis for a forward multiple (for projected 12-month revenue). The
forward multiple gives a better estimate of value, because it incorporates expectations
about the future. The forward multiple should only be used if the forecast comes from
guidance that is issued by a public company. The company knows that its stock price
will drop if it does not achieve its forecast, so the forecast is unlikely to be aggressive.

Revenue multiples are the best technique for valuing high-growth companies, since
these entities are usually pouring resources into their growth, and have minimal profits
to report. Such companies clearly have a great deal of value, but it is not revealed
through their profitability numbers.

However, multiples can be misleading. When acquisitions occur within an industry, the
best financial performers with the fewest underlying problems are the choicest
acquisition targets, and therefore will be acquired first. When other companies in the
same area later put themselves up for sale, they will use the earlier multiples to justify
similarly high prices. However, because they may have lower market shares, higher
cost structures, older products, and so on, the multiples may not be valid. Thus, it is
useful to know some of the underlying characteristics of the companies that were
previously sold, to see if the comparable multiple should be applied to the current target
company.

Valuation Based on Enterprise Value

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Another possibility is to replace the market capitalization figure in the table with
enterprise value. The enterprise value is a company’s market capitalization, plus its total
debt outstanding, minus any cash on hand. In essence, it is a company’s theoretical
takeover price, because the buyer would have to buy all of the stock and pay off existing
debt, while pocketing any remaining cash.

Valuation Based on Comparable Transactions

Another way to value an acquisition is to use a database of comparable transactions to

determine what was paid for other recent acquisitions. Investment bankers have
access to this information through a variety of private databases, while a great deal of
information can be collected on-line through public filings or press releases.

Valuation Based on Real Estate Values

The buyer can also derive a valuation based on a target’s underlying real estate values.
This method only works in those isolated cases where the target has a substantial real
estate portfolio. For example, in the retailing industry, where some chains own the
property on which their stores are situated, the value of the real estate is greater than
the cash flow generated by the stores themselves. In cases where the business is
financially troubled, it is entirely possible that the purchase price is based entirely on the
underlying real estate, with the operations of the business itself being valued at
essentially zero. The buyer then uses the value of the real estate as the primary reason
for completing the deal. In some situations, the prospective buyer has no real estate
experience, and so is more likely to heavily discount the potential value of any real
estate when making an offer. If the seller wishes to increase its price, it could consider
selling the real estate prior to the sale transaction. By doing so, it converts a potential
real estate sale price (which might otherwise be discounted by the buyer) into an
achieved sale with cash in the bank, and may also record a one-time gain on its books
based on the asset sale, which may have a positive impact on its sale price.

Valuation Based on Product Development Costs

If a target has products that the buyer could develop in-house, then an alternative
valuation method is to compare the cost of in-house development to the cost of
acquiring the completed product through the target. This type of valuation is especially
important if the market is expanding rapidly right now, and the buyer will otherwise
forego sales if it takes the time to pursue an in-house development path. In this case,
the proper valuation technique is to combine the cost of an in-house development effort
with the present value of profits foregone by waiting to complete the in-house project.
Interestingly, this is the only valuation technique where most of the source material
comes from the buyer’s financial statements, rather than those of the seller.

Valuation Based on Liquidation Value

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The most conservative valuation method of all is the liquidation value method. This is
an analysis of what the selling entity would be worth if all of its assets were to be sold
off. This method assumes that the ongoing value of the company as a business entity
is eliminated, leaving the individual auction prices at which its fixed assets, properties,
and other assets can be sold off, less any outstanding liabilities. It is useful for the
buyer to at least estimate this number, so that it can determine its downside risk in case
it completes the acquisition, but the acquired business then fails utterly.

Valuation Based on Replacement Cost

The replacement value method yields a somewhat higher valuation than the liquidation
value method. Under this approach, the buyer calculates what it would cost to duplicate
the target company. The analysis addresses the replacement of the seller’s key
infrastructure. This can yield surprising results if the seller owns infrastructure that
originally required lengthy regulatory approval. For example, if the seller owns a chain
of mountain huts that are located on government property, it is essentially impossible to
replace them at all, or only at vast expense. An additional factor in this analysis is the
time required to replace the target. If the time period for replacement is considerable,
the buyer may be forced to pay a premium in order to gain quick access to a key
market.

While all of the above methods can be used for valuation, they usually supplement the
primary method, which is the discounted cash flow method.

Q.2 Discuss the factors in post-merger integration process.

Ans. Some important factors that can contribute to success or failure in mergers and
acquisitions are :

Due Diligence : Lack of due diligence has caused many merger failures. It involves
comprehensive analysis of firm characteristics such as financial condition, management
capabilities, physical assets and intangible assets.

Financing : Manageable debt levels should be ensured.

Complementary Resources : Occurs when the ‘primary resources of the acquiring

and target firms are somewhat different, yet simultaneously supportive of one another.’
This tends to create economic value to a greater value that exists when the merging
firms have identical or unrelated resources.

Friendly/Hostile Acquisitions : Friendly acquisitions tend to create greater economic

value. A hostile acquisition can reduce the transfer of information during due diligence
and merger integration, and increase turnover of key executives in the firm being
acquired.

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Synergy Creation : Four foundations to creation of synergy are strategic fit,

organizational fit, managerial actions and value creation.

Organizational Learning : Many people should participate in the acquisition process

to ensure knowledge about acquisitions is being spread throughout the firm, and isn’t
lost if one of the key people typically involved leaves. The learning process should be
managed, with steps taken to study and learn from acquisitions, with the information
gained recorded.

Focus on Core Business : Cultural and management differences are more greatly
magnified the less firms have in common, therefore constraining the sharing of
resources and capabilities. ‘ Result is that positive benefits from financial synergy are
not enough to offset the negative effects of diversification.;

Emphasis on Innovation : Innovation is critical to organizational competitiveness.

‘Companies that innovate enjoy the first-mover advantages of acquiring a deep
knowledge of new markets and developing strong relationships with key stakeholders in
those markets’.

Ethical Concerns/Opportunism : Risk in mergers and acquisitions are that the

information received may be incorrect, misleading or deceptive. Steps should be taken
to ensure that the information is accurate and hasn’t been manipulated by management
with the aim to making performance appear higher than it is.

Q.3 List out the defense strategies in the face of a hostile takeover bid.

Ans. Raid Techniques

Techniques used in raids are such as Techniques of raid takeover bid and tender offer.
The procedure for organizing takeovers includes collection of relevant information and
its analysis, examine shareholders' profile, investigation of title and searches into
indebtedness, examining of articles of association etc,. Defence against takeover bid
may be in the form of advance preventive measures for defence such as - joint holdings
or joint voting agreement, interlocking shareholdings or cross shareholdings, issue of
block of shares to friends and associates, defensive merger apart from other things.
Tactical defence' strategies include friendly purchase of shares, emotional attachment,
loyalty and patriotism, recourse to legal action, operation ‘White Knights', "Golden
Parachutes" etc,.

Four basic tactics or schemes can be carved out when we study the practice of
corporate raiding which are bankruptcy, corporate, litigation, and land schemes to be
the most widespread apart from the other supplementary tactics such as the creation
and presentation of false evidence in civil litigation. At least three causes can be
identified, first is the general uncertainty of property rights resulting from the
privatization of state assets, second cause is poor corporate governance and final

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cause of raiding is the fact that the legal system is simply not yet equipped to deal with
this novel form of crime. The court structure, the inadequacy of criminal law, the flaws in
criminal investigation, the problems of good faith purchaser and the verification of
corporate documents are also among the loopholes that can be identified. In order to
address this problem, a new bankruptcy law must be imposed with more stringent
screening and ethical requirements for trustees, expanding the time for judges to
consider and take decisions, and also expand debtors' rights to contest creditors'
petitions.

The corrupt acquisition of control over the target company usually by falsifying internal
corporate documents and/or corruptly obtaining control over a significant portion of the
voting stock or the board of directors of the target company is common in nature. The
raider may create a false power of attorney or other document authorizing him or a co-
conspirator to enter into transactions on behalf of the target company and then transfer
the target's assets to himself or affiliated companies or the raider bribes officials at state
registration agencies to alter the target company's registration documents to give him
and/or his confederates faux control over the target company. He then uses this control
to drain off the target's assets.

Another important tactic that may be used by raider is the creation and presentation of
false evidence in civil litigation. For example, in answering claims by victims, raiders
typically offer false evidence, such as fabricated contracts and corporate resolutions, to
"prove" the alleged legitimacy of their acquisitions. There are certain measures that
businesses can take to protect themselves. These measures include retaining qualified
legal counsel to draft and review all incorporation documents and contracts, retaining
corporate investigation firms to investigate partners and major customers, and, above
always complying with all relevant laws and regulations.

The term ‘takeover' is nowhere defined in the Companies Act 1956 (Act) or in Securities
and Exchange Board of India Act, 1992 (SEBI Act), or in SEBI (Substantial Acquisition
of Shares and Takeovers) Regulations, 1997 (Takeover Code). In the absence of a
legal definition, the term takeover has to be understood from its commercial usage. In
commercial parlance, the term takeover denotes the act of a person or group of persons
(acquirer) acquiring shares or acquiring voting rights or both of a company (target
company), from its shareholders, either through private negotiations with majority
shareholders, or by a public offer in the open market with an intention to gain control
over its management. A takeover is considered ‘hostile' when the management of the
target company resists the attempted takeover.
The basic principle is that when acquisition becomes a takeover, the Takeover Code
becomes applicable besides other provisions of the Act. In other words, in case of a
takeover, compliance of both the Takeover Code as well as that of the Act is necessary,

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while in case of acquisition, compliance of only the Act is required. Further, if an

acquisition results in a ‘combination', then the provisions of the Competition Act 2002
also become applicable, and the approval of the Competition Commission of India is
required. If the acquisition results in either inflow or outflow of funds, to or from India,
then the provisions of the Foreign Exchange Management Act 1999 would become
applicable and in such a case, the permission from either the Reserve Bank of India or
the Central Government may be required.

The objective behind the Takeover Code is to bring transparency in takeover and
acquisition transactions in public listed companies and to ensure that if minority
shareholders are not given a raw deal through price fixation. The Takeover Code lays
down the mandatory and compulsory disclosure of an acquisition if the acquirer intends
to do. The procedure in case an investor wants to takeover has been clearly laid down
in the Companies Act, 1956, the Takeover Code etc,. These regulatory mechanisms
also lays down the offences, penalties in case of any violation, obligations and
restrictions upon the merchant bankers, acquirers, the company itself etc,. Acquisition
for the purpose of combination is not only the acquisition of shares or voting rights or
control of management, but also acquisition of or control of assets of the target
company. Thus, for the purposes of Competition Act, 2002, acquisition of shares, voting
rights, assets and control of management have to be considered. In Any combination
that would result in appreciable adverse effect on competition, within the relevant
market in India, would be declared null and void and such an effect is to be enquired by
the CCI for which the powers and the procedure is laid down under the Competition Act,
2002.

However, the era of the corporate raider appears to be largely over. In the later 1980s
the famous raiders suffered from a number of bad purchases that lost money (for their
backers, primarily) and the credit lines dried up. In addition, corporations became more
adept at fighting hostile takeovers through mechanisms such as the poison pill. Finally
the overall price of the stock market increased, which reduced the number of situations
in which a company's share price was low with respect to the assets that it controlled

Defence techniques
Preventive measures
Preventive measures against hostile takeovers are much more effective than reactive
measures implemented once takeover attempts have already been launched. The fi rst
step in a company’s defence, therefore, is for management and controlling shareholders
to begin their preparations for a possible fight long before the battle is joined. There are
several principal weapons in the hands of target management to prevent takeovers,
some of which are described below.

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Control over the register

The raider needs to know who the shareholders of the target are in order to approach
them with the offer to sell their shares. With joint stock companies this information is
contained in the share register. In particular, the share register provides for the
possibility to identify the owners of the shares, quantity, nominal value and type of
shares held by shareholders. So it is very important to ensure that non-authorized
persons do not have access to the share register of the company by taking the following
steps:
• Careful consideration is needed when choosing the registrar; the preference should be
given to a reputable registrar;
• Check the track record of the share registrar in regards to its involvement in hostile
takeovers in the past;
• Check who controls the registrar company. In case of transfer of shares to a nominee
holder (custodian or depository) information on the beneficiary owners of shares is not
stated in the share register. Instead, the share register contains information on the
nominee holders. This makes it much more difficult for the raider to identify who is the
real owner of the shares.

Control over debts

Creditor indebtedness of the company may be used by a raider as the principal or
auxiliary tool in the process of hostile takeover. In particular, the raider may employ so-
called “contract bankruptcy” in order to acquire the assets of the target. In connection
with this the following cautionary measures should be taken:
• Monitor the creditors of company carefully;
• Prevent overdue debts;
• If there is indirect evidence that a bankruptcy procedure is about to be launched, the
company should do its best to pay all outstanding debts;
• Accumulate all the debts and risks relating to commercial activity of the company on a
special purpose vehicle that does not hold any substantial assets.

Cross shareholding
Several subsidiaries of a company (at least three) have to be established, where the
parent company owns 100% of share capital in each subsidiary. The parent transfers to
subsidiaries the most valuable assets as a contribution to the share capital. Then the
subsidiaries issue more shares. The amount of these should be more than four times
the initial share capital. Subsidiaries then distribute the shares among themselves. The
result of such an operation is that the parent owns less that 25% of the share capital of
each subsidiary. In other words the parent company does not even have a blocking
shareholding. When implementing this

Golden parachute

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This measure discourages an unwanted takeover by offering lucrative benefits to the

current top executives, who may lose their job if their company is taken over by another
fi rm. The “triggering” events that enable the golden parachute clause are change of
control over the company and subsequent dismissal of the executive by a raider
provided that this dismissal is outside the executive’s control (for instance, reduction in
workforce2 or dismissal of the head of the board of directors due to the decision of the
general meeting of shareholders provided such additional ground for dismissal is stated
in the labour contract with the head of the board3). Benefits written into the executives’
contracts may include items such as stock options, bonuses, hefty severance pay and
so on. Golden parachutes can be prohibitively expensive for the acquiring firm and,
therefore, may make undesirable suitors think twice before acquiring a company if they
do not want to retain the target’s management nor dismiss them at a high price. The
golden parachute defence is widely used by American companies. The presence of
“golden parachute” plans at Fortune 1000 companies increased from 35% in 1987 to
81% in 2001, according to a survey by Executive Compensation Advisory Services.
Notable examples include ex- Mattel CEO Jill Barad’s USD 50 million departure
payment, and Citigroup Inc. John Reed’s USD 30 million in severance and USD 5
million per year for life.

Change of control clauses (“Shark Repellents”)

The company may include in loan agreements or some other agreements conditional
covenants that in the event of the company passing under the control of a third party,
the other party to the agreement has the right to accelerate the debt or terminate the
contract. The result of such agreements is that a potential raider may not be sure
whether it will be able to benefit from important advantages enjoyed by the target.
Although one of the effects of change of control clauses is to discourage raiders, their
purpose is legitimate: to protect creditors from being placed in a worse position than
they visualised.

Q.4 What are the legal compliance issues a company has to adhere to in case
of a merger. Explain through an example.

Ans. There are only seven sections from section 390 to 396 in the Companies act
1956 which are related to the matters pertaining to Mergers and Acquisitions and have
been given in Chapter V under the heading Arbitration, Compromises, Arrangements
and Reconstruction.

The Act lays down the legal procedures for mergers or acquisitions :

• Permission for merger : Two or more companies can amalgamate only when
the amalgamation is permitted under their memorandum of association. Also, the
acquiring company should have the permission in its object clause to carry on the

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business of the acquired company. In the absence of these provisions in the

memorandum of association, it is necessary to seek the permission of the
shareholders, board of directors and the Company Law Board before affecting
the merger.

• Information to the stock exchange : The acquiring and the acquired

companies should inform the stock exchanges about the merger.

• Approval of board of directors : The board of directors of the individual

companies should approve the draft proposal for amalgamation and authorize
the managements of the companies to further pursue the proposal.

• Application in the high court : An application for approving the draft

amalgamation proposal duly approved by the board of directors of the individual
companies should be made to the High Court.

• Shareholders’ and creators’ meetings : The individual companies should hold

separate meetings of their shareholders and creditors for approving the
amalgamation scheme. At least, 75 percent of shareholders and creditors in
separate meetings, voting in person or by proxy, must accord their approval to
the scheme.

• Sanction by the high court : After the approval of the shareholders and
creditors, on the petitions of the companies, the High Court will pass an order,
sanctioning the amalgamation scheme after it is satisfied that the scheme is fair
and reasonable. The date of the court’s hearing will be published in two
newspapers, and also, the regional director of the Company Law Board will be
intimated.

• Filing of the court order : After the Court order, its certified true copies will be
filed with the Registrar of Companies.

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

• Payment by cash or securities : As per the proposal, the acquiring company

will exchange shares and debentures and/or cash for the shares and debentures
of the acquired company. These securities will be listed on the stock exchange.

Q.5 Take a cross border acquisition by an Indian company and critically evaluate.

Ans. In a study conducted in 2000 by Lehman Brothers, it was found that, on average,
large M&A deals cause the domestic currency of the target corporation to appreciate by

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1% relative to the acquirer's. For every $1-billion deal, the currency of the target
corporation increased in value by 0.5%. More specifically, the report found that in the
period immediately after the deal is announced, there is generally a strong upward
movement in the target corporation's domestic currency (relative to the acquirer's
currency). Fifty days after the announcement, the target currency is then, on average,
1% stronger.

The rise of globalization has exponentially increased the market for cross border M&A.
In 1996 alone there were over 2000 cross border transactions worth a total of
approximately $256 billion. This rapid increase has taken many M&A firms by surprise
because the majority of them never had to consider acquiring the capabilities or skills
required to effectively handle this kind of transaction. In the past, the market's lack of
significance and a more strictly national mindset prevented the vast majority of small
and mid-sized companies from considering cross border intermediation as an option
which left M&A firms inexperienced in this field. This same reason also prevented the
development of any extensive academic works on the subject.

Due to the complicated nature of cross border M&A, the vast majority of cross border
actions have unsuccessful results. Cross border intermediation has many more levels of
complexity to it then regular intermediation seeing as corporate governance, the power
of the average employee, company regulations, political factors customer expectations,
and countries' culture are all crucial factors that could spoil the transaction.[3][4]
Because of such complications, many business brokers are finding the International
Corporate Finance Group and organizations like it to be a necessity in M&A today.

Table 1.1 Largest M&A deals worldwide since 2000:

Rank Year Acquirer Target Transaction %

Value
(in Mil.
USD)
1 2000 Merger : America Online Inc.Time Warner 164,747 21.83
(AOL)
2 2000 Glaxo Wellcome Plc. SmithKline Beecham75,961 10.06
Plc.
3 2004 Royal Dutch Petroleum Co. Shell Transport &74,559 9.87
Trading Co
4 2006 AT&T Inc. BellSouth Corporation 72,671 9.62
5 2001 Comcast Corporation AT&T Broadband &72,041 9.54
Internet Svcs
6 2004 Sanofi-Synthelabo SA Aventis SA 60,243 7.98
7 2000 Spin-off : Nortel Networks 59,974 7.95

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Corporation
8 2002 Pfizer Inc. Pharmacia Corporation 59,515 7.89
9 2004 Merger : JP Morgan ChaseBank One Corporation 58,761 7.79
& Co.
10 2006 Pending: E.on AG Endesa SA 56,266 7.45
Total 754,738 100
Source: Institute of Mergers, Acquisitions and Alliances Research, Thomson Financial

Table: 1.1 and fig.1.1 show the ten largest M&A deals worldwide since 2000. Table and
figure reflects that the largest M & A deal during last 6 year was between American
Online Inc and. Time Warner of worth $ 164,747 million during 2000, which account
21.83% of total transaction value of top ten worldwide merger and acquisition deals.
While second largest deal was between Glaxo Wellcome Plc. & SmithKline Beecham
Plc. Of US $ 75,961 million which was also occurred during 2000, which was 10.06 % of
total transaction value of top ten worldwide M & a deals & third largest deal was
between Royal Dutch Petroleum Co. Shell Transport & Trading Co of worth US $
74,559 million, it is 9.87 % of total transaction value of top ten worldwide M & a deals.

Cross-border Merger and acquisition: India

Until upto a couple of years back, the news that Indian companies having acquired
American-European entities was very rare. However, this scenario has taken a sudden
U turn. Nowadays, news of Indian Companies acquiring a foreign businesses are more
common than other way round.

Buoyant Indian Economy, extra cash with Indian corporates, Government policies and
newly found dynamism in Indian businessmenhave all contributed to this new
acquisition trend. Indian companies are now aggressively looking at North American
and European markets to spread their wings and become the global players.

The Indian IT and ITES companies already have a strong presence in foreign markets,
however, other sectors are also now growing rapidly. The increasing engagement of the
Indian companies in the world markets, and particularly in the US, is not only an
indication of the maturity reached by Indian Industry but also the extent of their
participation in the overall globalization process.

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Table1.2: The top 10 acquisitions made by Indian companies worldwide:

Acquirer Target Company Country targeted Deal value ($Industry

ml)
Tata Steel Corus Group plc UK 12,000 Steel
Hindalco Novelis Canada 5,982 Steel
Videocon Daewoo ElectronicsKorea 729 Electronics
Corp.
Dr. Reddy'sBetapharm Germany 597 Pharmaceutical
Labs
Suzlon Hansen Group Belgium 565 Energy
Energy
HPCL Kenya PetroleumKenya 500 Oil and Gas
Refinery Ltd.
Ranbaxy Terapia SA Romania 324 Pharmaceutical
Labs
Tata Steel Natsteel Singapore 293 Steel
Videocon Thomson SA France 290 Electronics
VSNL Teleglobe Canada 239 Telecom

If you calculate top 10 deals itself account for nearly US $ 21,500 million. This is more
than double the amount involved in US companies' acquisition of Indian
counterparts.Graphical representation of Indian outbound deals since 2000.

Figure 1.2

Indian outbound deals, which were valued at US$ 0.7 billion in 2000-01, increased to
US$ 4.3 billion in 2005 , and further crossed US$ 15 billion-mark in 2006. In fact, 2006
will be remembered in India's corporate history as a year when Indian companies
covered a lot of new ground. They went shopping across the globe and acquired a
number of strategically significant companies. This comprised 60 per cent of the total
mergers and acquisitions (M&A) activity in India in 2006. And almost 99 per cent of
acquisitions were made with cash payments.

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Table 1.3: Cross-border Merger and acquisition: India

(US $ Million)

Year Sales Purchases

2000 1219 910
2001 1037 2195
2002 1698 270
2003 949 1362
2004 1760 863
2005 4210 2649
Total 10873 8249
Source: UNCTAD world investment report 2006

Table 1.3 & figure 1.3 exhibit Cross –border merger and acquisition in India for the
period 2000 to 2005. Table shows the cross border sales deals during 2000 were 1219
US $ million while purcahse deal were 910 US $ million.But during 2005, these have
been increased to 4210 US $ million and 2649 US $ million. While overall sales are
10,873 US $ million and purchase deals were 8249 US $ million during last five years.
So table clearly depicts that our cross border merger and acquisition sales deals are
more then purchase deals.

Q.6 Choose any firm of your choice and identify suitable acquisition
opportunity and give reasons for the same.

Ans. Identifying takeover opportunities

the basic purpose of valuation of Target company is to locate the possibilities of

takeover.

Valuation technique discussed above serves the purpose of identification of target

companies for takeover as well as serves the basic purpose of fixing exchange ratio in
case the target company is finally selected for acquisition.

Some financial experts suggest selection criteria based on following two approaches.

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Present value analysis : The present value analysis is more or less the same as
valuation on net maintaining earning basis for listed companies and the technique is the
same as used for dividend analysis. In other words, the earnings or the target firm are
projected and discounted at the acquirers cost of capital to obtain a theoretical market
price on the shares of the target company. This is then compared with the actual market
price to determine the net present value on investments. For calculating theoretical
price the following example will serve the purpose :

Given the following data

I=k=Acquirer Co’s cost of capital 10%

D0 = p0 For target co’s payout ratio at Rs. 1 per share.

MPS for Target Co’s market price per share Rs. 50

-For Target Co’s merger @ 100% basis

g for Target Co’s earning and dividend expected to grow at 8% p.a.

using above data and the formula for the constant annual growth rate of dividend d 0
(1+g) / (i-g) as discussed earlier in dividend approach, then target company’s theoretical
price is as under :
P = P0 (1+g) / (k-g) = 1(1.08) / .10 – .08 = 1.08 / .02 = 54
The theoretical price exceeds the Market Price i.e. 54 – 50 = 4. here, NPV is 4 per
share. The result requires reconsideration.
The above approach does not consider the risk posture of acquisition i.e. the portfolio
effect. The capital assets pricing model considers these aspects as discussed below.
Capital assets pricing : The above approach provides a superior theoretical
framework and is helpful in identifying a merger partner, the target company.
The basic logic behind the model is that if expected rate of return exceeds the required
rate of return, then the acquirer company has green signal for acquiring the target
company.
The required rate of return is calculated by solving the following equation :
E(Rj ) = Rf+ [E(Rm) – Rf] (Bj)
Where,
E(Rj ) = Required return
E(Rj ) = Expected return

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E(Rm) = Expected return for market index

Rf = Risk free return
Bj = Beta (normally determines past performance)

j = Potential merger partner (target company)

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