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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
MF 0011 Mergers and Acquisitions 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.
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. Synergy results from complementary activities. LBO is a financing technique of purchasing a private company with the help of borrowed or debt capital. 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. the concept of Leverage Buyout (LBO) has emerged. The debt is usually secured on specific assets of the company. Typically. 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. Ans.3 Explain the process of a leveraged buyout. 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. These include : Senior debt : this is the debt which ranks ahead of all other debt and equity capital in the business. which means the lender can automatically acquire these assets if the company breaches its obligations under the relevant loan agreement. for example here A can invest its resource in the opportunities available to B. UMESH SINGH Page 111 . Subordinated debt : This debt ranks behind senior debt in order of priority on any liquidation. and through these the value of the firms involved in the merger or acquisition. 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). B and C. In search of an ideal mechanism to finance and acquisition. The terms of the subordinated debt are usually less stringent than senior debt. Q. Such acquisitions need huge amount of finance to be provided. If A and B combine with each other both can utilize each other strengths. Modes of purchase There are a number of types of financing which can be used in an LBO. This can be understood with the following example Example : Consider a situation where there are two firms A and 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. These obligations are usually quite stringent. unrated or low rated debt known as junk bond financing is utilized. therefore it has the lowest cost of debt. Bank loans are typically structured in up to three trenches : A. Repayment is usually required in one ‘bullet’ payment at the end of the term.MF 0011 Mergers and Acquisitions Assignment Operating synergies can affect margins and growth. The bank loans are usually held by a syndicate of banks and specialized funds. In the realm of increased globalized economy. Some times. mergers and acquisitions have assumed significant importance both with the country as well as across the boarders.
the acquirer should have regard to these political relationships.MF 0011 Mergers and Acquisitions Assignment Since subordinated debt gives the lender less security than senior debt. The technical integration is similar to the capability transfer discussed above. ideologies myths and rituals. The culture of an organization is embodied in its collective value systems. An enhanced return is made available to lenders by the grant of an ‘equity kicker’ which crystallizes upon an exit. Ordinary shares : This is the riskiest part of a LBOs capital structure. Loan stock : This can be a form of equity financing if it is convertible into equity capital. 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. An increasingly important form of subordinated debt is the high yield bond. which reflects interest ‘paid in kind’. ordinary shareholders will enjoy majority of the upside if the company is successful. Q. An important aspect of integration is the cultural integration of the acquiring and acquired firms. 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. A form of this is called a PIK. often listed on Indian markets. need to be integrated in order to achieve the value creation objectives of the acquirer. Ans.4 What are the cultural aspects involved in a merger. and generally includes an attached equity warrant. or rolled up into the principal. High yield bonds can either be senior or subordinated securities that are publicly placed with institutional investors. The integration of social interaction and political relationships represents the informal processes and systems which influence people’s ability and motivation to perform. They can motivate people and can become valuable sources of efficiency and effectiveness. if acquired employees are not to feel unfairly treated. They are fixed rate. The value chains of the acquirer and the acquired. This integration process has three dimensions: the technical. norms. beliefs. publicly traded. The following are the illustrative organizational diverse cultures which may have to be integrated during postmerger period: Strong top leadership versus Team approach UMESH SINGH Page 112 . long term securities with a looser covenant package than senior debt though they are subject to stringent reporting requirements. lending costs are typically higher. Give sufficient examples. political and cultural. At the time of integration. The question of whether loan stock is tax deductible should be investigated thoroughly with the company’s advisers. However.
values fast.The important features are: bureaucratic and hierarchical.)’ · 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.The important features are: emphasis on equality. flexibility and worker autonomy.The main characteristics are: essentially autocratic and suppressive of challenge. needs creative environment · Person/support .The main characteristics are: emphasis on team commitment. seeks to nurture personal development of individual members Poor cultural fit or incompatibility is likely to result in considerable fragmentation. efficient and standardized culture service · Task/achievement . emphasis on individual rather than group decision making · Role . Such stressful experience may lead to their loss of morale. task determines organization of work. UMESH SINGH Page 113 . which may be experienced as stressful by organizational members. emphasis on formal rules and procedures.MF 0011 Mergers and Acquisitions Assignment · 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. There are four different types of organizational culture as mentioned below: · Power . or product quality improver etc. uncertainty and cultural ambiguity.
Differences in culture may lead to polarization. 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. An example of limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. allowing the combined firm to become more cost-efficient and profitable. which should result in higher margins and operating income. increase growth or both. Economies of scale that may arise from the merger. 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. Thus.MF 0011 Mergers and Acquisitions Assignment loss of commitment. negative evaluation of counterparts. 2. the acquirer must consider cultural risk in addition to strategic issues. Mergers between certain types can be disastrous. 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.5 Study a recent merger that you have read about and discuss the synergies that resulted from the merger. 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. merging firms must consciously and proactively seek to transform the cultures of their organizations. The two companies were in the same line of business UMESH SINGH Page 114 . The differences between the national and the organizational culture influence the cross-border acquisition integration. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. There are two main types of synergy : 1. We would categorize operating synergies into four types: 1. confusion and hopelessness and may have a dysfunctional impact on organizational performance. anxiety and ethnocentrism between top management teams of the acquired and acquiring firms. Financial synergy Operating Synergy Operating synergies are those synergies that allow firms to increase their operating income. Operating synergy 2. Ans. In assessing the advisability of an acquisition. 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. Q. Greater pricing power from reduced competition and higher market share.
After the acquisition blow past acquired a strong hold on the market and operated under near monopoly situation. Included are the following: • A combination of a firm with excess cash. In other words the two companies should get the advantage of the combination of their complimentary functional strengths. 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.MF 0011 Mergers and Acquisitions Assignment and were in direct competition with each other leading to a severe price war and increased marketing costs. This synergy is likely to show up most often when large firms acquire smaller firms. or cash slack. for example here A can invest its resource in the opportunities available to 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). Another example is the acquisition of Tomco by Hindustan Lever. Combination of different functional strengths. The increase in value comes from the projects that were taken with the excess cash that otherwise would not have been taken. Higher growth in new or existing markets. or when publicly traded firms acquire private businesses. with an established distribution network and brand name recognition. and through these the value of the firms involved in the merger or acquisition. This would be case when a US consumer products firm acquires an emerging market firm. the payoff can take the form of either higher cash flows or a lower cost of capital (discount rate). Operating synergies can affect margins and growth. Synergy results from complementary activities. 3. This can be understood with the following example Example : Consider a situation where there are two firms A and B. and uses these strengths to increase sales of its products. 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. UMESH SINGH Page 115 . 4. combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. (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. If A and B combine with each other both can utilize each other strengths. arising from the combination of the two firms. 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. Financial Synergy With financial synergies.
joint ventures are becoming an increasingly common way for companies to form strategic alliances. two or more “parent” companies agree to share capital. 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. It is thus a weak test of the synergy hypothesis. technology. as we show later in this chapter. The more important issues are whether that synergy can be valued and. Clearly.MF 0011 Mergers and Acquisitions • Assignment • Debt capacity can increase. Thus. Ans:. A stronger test of synergy is to evaluate whether merged firms improve their performance (profitability and growth) relative to their competitors. because when two firms combine. and other expenses. such as distribution channels. This result has to be interpreted with caution. Alternatively. many mergers fail. technology. human resources. including under valuation and a change in corporate control. a firm that is able to increase its depreciation charges after an acquisition will save in taxes. reducing your financial burden. Tax benefits can arise either from the acquisition taking advantage of tax laws or from the use of net operating losses to shelter income. product development. which creates a tax benefit for the combined firm. how to value it. This. Q. or take the form of a lower cost of capital for the combined firm. 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. or finance.As there are good business and accounting reasons to create a joint venture with a company that has complementary capabilities and resources. UMESH SINGH Page 116 . risks and rewards in a formation of a new entity under shared control. On this test. explain with an example of a joint venture. 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.6 What are the motives for a joint venture. This tax benefit can either be shown as higher cash flows. 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. In a joint venture. allows them to borrow more than they could have as individual entities. and increase its value. however. Broadly. if so. in turn. their earnings and cash flows may become more stable and predictable. since the increase in the value of the combined firm after a merger is also consistent with a number of other hypotheses explaining acquisitions. there is potential for synergy in many mergers. after takeovers.
and innovation. 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. you and a JV partner can get your joint product to market faster and more efficiently. Strategic Reasons Synergistic Reasons: You may find a JV partner with whom you can create synergy. externally. development of diverse products. Set.MF 0011 Mergers and Acquisitions Assignment Connection to Technological Resources: You might want access to technological resources you couldn't afford on your own. Diversification . 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. and strategically. Share and Improve Technology and Skills: Two innovative companies can share technology to improve upon each other's ideas and skills.There could be many diversification reasons: access to diverse markets. or vice versa. Improve Speed to Market: With shared access to financial. Bring your product to market cheaper where the customer can enjoy the cost savings. Don't let a JV opportunity pass you by because you don't think it will fit in with your own small business.2 UMESH SINGH Page 117 . as well as your own understanding of technological processes. technology. and then find a joint venture partner that will fit with your needs. Strategic Move Against Competition: A JV may be able to better compete against another industry leader through the combination of markets. Help Economies of Scale: Together you and a JV partner can develop products or services that reduce total overall production expenses. technological. Small and big companies alike can benefit from the reasons listed above. and distribution resources. Analyze how your company can benefit internally. diversify the innovative working force. etc. which produces a greater result together than doing it on your own. Sharing innovative and proprietary technology can improve products.
Valuation Based on Stock Market Price If the target company is publicly held. Most target companies do not issue publicly traded stock. The current trading price of a company’s stock is not a good valuation tool if the stock is thinly traded. In this case. It is quite easy to look up the market capitalizations and financial information for thousands of publicly held 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.MF 0011 Mergers and Acquisitions Q. since the buyer must also account for the control premium. then the buyer can simply base its valuation on the current market price per share. then the target still has the option of going public and realizing value by selling shares to the general public. UMESH SINGH Page 118 . so other methods must be used to derive their valuation. so that the buyer’s estimate is far off from the value it would normally assign to the target. it is better to use a multi-day average of market prices. then eliminate these outlying values in order to obtain a median value for the company’s size range. it can adopt the unusual ploy of filing for an initial public offering while also being courted by the buyer. This gives the buyer solid grounds for making its offer. The table should be restricted to comparable companies in the same industry as that of the seller. and especially for those growing quickly – all of their cash is being used for growth. and of roughly the same market capitalization. and compare their results to see if several approaches arrive at approximately the same general valuation. If some of the information for other companies is unusually high or low. However. Using a variety of methods is especially important for valuing newer target companies with minimal historical results. While the most common is discounted cash flow. The buyer then converts this information into a multiples table. which itemizes a selection of valuations within the consulting industry. 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. given the expensive control measures mandated by the Sarbanes-Oxley Act and the stock lockup periods required for many new public companies. it is best to evaluate a number of alternative methods. since these figures are subject to significant daily fluctuation. Valuation Based on a Multiple Another option is to use a revenue multiple or EBITDA multiple. When a private company wants to be valued using a market price. a small number of trades can alter the market price to a substantial extent.1 What is the basis for valuation of a target company? Assignment Ans. multiplied by the number of shares outstanding. Overview of Acquisition Valuation Methods There are a number of acquisition valuation methods. The actual price paid is usually higher. By doing so. so cash flow is an inadequate basis for valuation. Also.
and amortization) multiple for the same group of comparable public companies. but possibly at the expense of harming revenue growth.. so the forecast is unlikely to be aggressive. Revenue multiples are the best technique for valuing high-growth companies. This method is most useful for a turn-around situation or a fast growth company. since these entities are usually pouring resources into their growth. higher cost structures. then the revenue multiple can be re-named a trailing multiple (for historical 12-month revenue). or extending credit to financially weak customers. Thus.e. Conversely. The company knows that its stock price will drop if it does not achieve its forecast. If the comparable company provides one-year projections. and use that information to value the target. where there are few profits (if any). then it is entirely possible that the target is essentially buying revenues with low-margin products or services. because they may have lower market shares. if a target has sales of $100 million. depreciation. and the market capitalization for several public companies in the same revenue range is 1. it is useful to know some of the underlying characteristics of the companies that were previously sold. multiples can be misleading. the multiples may not be valid. The forward multiple gives a better estimate of value. When acquisitions occur within an industry. older products. If the revenue multiple reveals a high valuation and the EBITDA multiple a low one. However. Better yet. the best financial performers with the fewest underlying problems are the choicest acquisition targets. use both the revenue multiple and the EBITDA multiple in concert. and the forecast can be used as the basis for a forward multiple (for projected 12-month revenue). To avoid the risk of paying too much based on a revenue multiple.4 times revenue. The forward multiple should only be used if the forecast comes from guidance that is issued by a public company. if the revenue multiple yields a lower valuation than the EBITDA multiple. and so on. it is also possible to compile an EBITDA (i. and have minimal profits to report. or one where management is cutting costs to increase profits. and therefore will be acquired first. but it is not revealed through their profitability numbers. Such companies clearly have a great deal of value. this is more indicative of a late-stage company that is essentially a cash cow. because it incorporates expectations about the future. taxes. they will use the earlier multiples to justify similarly high prices. the revenue multiple method only pays attention to the first line of the income statement and completely ignores profitability. then the buyer could value the target at $140 million.MF 0011 Mergers and Acquisitions Assignment The buyer can then use this table to derive an approximation of the price to be paid for a target company. Valuation Based on Enterprise Value UMESH SINGH Page 119 . However. earnings before interest. When other companies in the same area later put themselves up for sale. For example. to see if the comparable multiple should be applied to the current target company. However.
while a great deal of information can be collected on-line through public filings or press releases. with the operations of the business itself being valued at essentially zero. and may also record a one-time gain on its books based on the asset sale. If the seller wishes to increase its price. In some situations.MF 0011 Mergers and Acquisitions Assignment Another possibility is to replace the market capitalization figure in the table with enterprise value. Interestingly. the value of the real estate is greater than the cash flow generated by the stores themselves. By doing so. In this case. For example. where some chains own the property on which their stores are situated. rather than those of the seller. while pocketing any remaining cash. The buyer then uses the value of the real estate as the primary reason for completing the deal. in the retailing industry. This type of valuation is especially important if the market is expanding rapidly right now. In essence. Valuation Based on Liquidation Value UMESH SINGH Page 120 . Valuation Based on Product Development Costs If a target has products that the buyer could develop in-house. it is a company’s theoretical takeover price. and the buyer will otherwise forego sales if it takes the time to pursue an in-house development path. 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. The enterprise value is a company’s market capitalization. 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. Investment bankers have access to this information through a variety of private databases. it could consider selling the real estate prior to the sale transaction. Valuation Based on Real Estate Values The buyer can also derive a valuation based on a target’s underlying real estate values. this is the only valuation technique where most of the source material comes from the buyer’s financial statements. minus any cash on hand. which may have a positive impact on its sale price. it is entirely possible that the purchase price is based entirely on the underlying real estate. and so is more likely to heavily discount the potential value of any real estate when making an offer. 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. the prospective buyer has no real estate experience. plus its total debt outstanding. 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. because the buyer would have to buy all of the stock and pay off existing debt. In cases where the business is financially troubled. This method only works in those isolated cases where the target has a substantial real estate portfolio.
For example. Friendly/Hostile Acquisitions : Friendly acquisitions tend to create greater economic value. This can yield surprising results if the seller owns infrastructure that originally required lengthy regulatory approval. which is the discounted cash flow method. An additional factor in this analysis is the time required to replace the target. and other assets can be sold off. Financing : Manageable debt levels should be ensured. properties. UMESH SINGH Page 121 . management capabilities. the buyer may be forced to pay a premium in order to gain quick access to a key market. yet simultaneously supportive of one another. it is essentially impossible to replace them at all. The analysis addresses the replacement of the seller’s key infrastructure. This method assumes that the ongoing value of the company as a business entity is eliminated. This is an analysis of what the selling entity would be worth if all of its assets were to be sold off. but the acquired business then fails utterly. and increase turnover of key executives in the firm being acquired. Ans. they usually supplement the primary method. Valuation Based on Replacement Cost The replacement value method yields a somewhat higher valuation than the liquidation value method.2 Discuss the factors in post-merger integration process. physical assets and intangible assets.MF 0011 Mergers and Acquisitions Assignment The most conservative valuation method of all is the liquidation value method. so that it can determine its downside risk in case it completes the acquisition. if the seller owns a chain of mountain huts that are located on government property. Q. 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. While all of the above methods can be used for valuation. It involves comprehensive analysis of firm characteristics such as financial condition. the buyer calculates what it would cost to duplicate the target company. leaving the individual auction prices at which its fixed assets.’ This tends to create economic value to a greater value that exists when the merging firms have identical or unrelated resources. It is useful for the buyer to at least estimate this number. Under this approach. A hostile acquisition can reduce the transfer of information during due diligence and merger integration. Complementary Resources : Occurs when the ‘primary resources of the acquiring and target firms are somewhat different. If the time period for replacement is considerable. less any outstanding liabilities. or only at vast expense.
Four basic tactics or schemes can be carved out when we study the practice of corporate raiding which are bankruptcy. and isn’t lost if one of the key people typically involved leaves. 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.. with steps taken to study and learn from acquisitions. At least three causes can be identified. ‘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’. corporate. Emphasis on Innovation : Innovation is critical to organizational competitiveness.joint holdings or joint voting agreement. examining of articles of association etc. The procedure for organizing takeovers includes collection of relevant information and its analysis.3 List out the defense strategies in the face of a hostile takeover bid. Tactical defence' strategies include friendly purchase of shares. ‘ Result is that positive benefits from financial synergy are not enough to offset the negative effects of diversification. Q. defensive merger apart from other things. first is the general uncertainty of property rights resulting from the privatization of state assets. litigation. managerial actions and value creation. organizational fit. investigation of title and searches into indebtedness. emotional attachment. therefore constraining the sharing of resources and capabilities. Ethical Concerns/Opportunism : Risk in mergers and acquisitions are that the information received may be incorrect. operation ‘White Knights'. loyalty and patriotism. with the information gained recorded. second cause is poor corporate governance and final UMESH SINGH Page 122 . The learning process should be managed. recourse to legal action.. Organizational Learning : Many people should participate in the acquisition process to ensure knowledge about acquisitions is being spread throughout the firm.. "Golden Parachutes" etc. interlocking shareholdings or cross shareholdings. examine shareholders' profile. Focus on Core Business : Cultural and management differences are more greatly magnified the less firms have in common. Ans.MF 0011 Mergers and Acquisitions Assignment Synergy Creation : Four foundations to creation of synergy are strategic fit. 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. issue of block of shares to friends and associates. Defence against takeover bid may be in the form of advance preventive measures for defence such as . Raid Techniques Techniques used in raids are such as Techniques of raid takeover bid and tender offer. misleading or deceptive.
and also expand debtors' rights to contest creditors' petitions. In the absence of a legal definition. These measures include retaining qualified legal counsel to draft and review all incorporation documents and contracts. the flaws in criminal investigation. The court structure. In commercial parlance. 1997 (Takeover Code). a new bankruptcy law must be imposed with more stringent screening and ethical requirements for trustees. in case of a takeover. The raider may create a false power of attorney or other document authorizing him or a coconspirator 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. expanding the time for judges to consider and take decisions. compliance of both the Takeover Code as well as that of the Act is necessary. the inadequacy of criminal law. The basic principle is that when acquisition becomes a takeover. UMESH SINGH Page 123 . For example. He then uses this control to drain off the target's assets. or in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations. or by a public offer in the open market with an intention to gain control over its management. In other words. 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. to "prove" the alleged legitimacy of their acquisitions. In order to address this problem. such as fabricated contracts and corporate resolutions.MF 0011 Mergers and Acquisitions Assignment cause of raiding is the fact that the legal system is simply not yet equipped to deal with this novel form of crime. 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. either through private negotiations with majority shareholders. and. the term takeover has to be understood from its commercial usage. A takeover is considered ‘hostile' when the management of the target company resists the attempted takeover. raiders typically offer false evidence. the problems of good faith purchaser and the verification of corporate documents are also among the loopholes that can be identified. the Takeover Code becomes applicable besides other provisions of the Act. Another important tactic that may be used by raider is the creation and presentation of false evidence in civil litigation. in answering claims by victims. retaining corporate investigation firms to investigate partners and major customers. from its shareholders. 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). There are certain measures that businesses can take to protect themselves. 1992 (SEBI Act).
therefore. 2002. However. to or from India. The Takeover Code lays down the mandatory and compulsory disclosure of an acquisition if the acquirer intends to do. corporations became more adept at fighting hostile takeovers through mechanisms such as the poison pill. Thus. Further. obligations and restrictions upon the merchant bankers. compliance of only the Act is required.. the era of the corporate raider appears to be largely over. within the relevant market in India. These regulatory mechanisms also lays down the offences. if an acquisition results in a ‘combination'. assets and control of management have to be considered. If the acquisition results in either inflow or outflow of funds. 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. In Any combination that would result in appreciable adverse effect on competition. is for management and controlling shareholders to begin their preparations for a possible fight long before the battle is joined. Acquisition for the purpose of combination is not only the acquisition of shares or voting rights or control of management. In addition. then the provisions of the Competition Act 2002 also become applicable.. acquirers. primarily) and the credit lines dried up. UMESH SINGH Page 124 . the Takeover Code etc. and the approval of the Competition Commission of India is required. In the later 1980s the famous raiders suffered from a number of bad purchases that lost money (for their backers. acquisition of shares. 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.MF 0011 Mergers and Acquisitions Assignment while in case of acquisition. penalties in case of any violation. 2002. 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. 1956. voting rights. some of which are described below. The procedure in case an investor wants to takeover has been clearly laid down in the Companies Act. for the purposes of Competition Act. There are several principal weapons in the hands of target management to prevent takeovers. the company itself etc. but also acquisition of or control of assets of the target company. the permission from either the Reserve Bank of India or the Central Government may be required. The fi rst step in a company’s defence. Finally the overall price of the stock market increased. then the provisions of the Foreign Exchange Management Act 1999 would become applicable and in such a case.
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 amount of these should be more than four times the initial share capital. nominal value and type of shares held by shareholders. 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. the share register provides for the possibility to identify the owners of the shares. The parent transfers to subsidiaries the most valuable assets as a contribution to the share capital. This makes it much more difficult for the raider to identify who is the real owner of the shares. In particular. 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 raider may employ socalled “contract bankruptcy” in order to acquire the assets of the target. Subsidiaries then distribute the shares among themselves. • 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. • Prevent overdue debts. • If there is indirect evidence that a bankruptcy procedure is about to be launched. the preference should be given to a reputable registrar. Then the subsidiaries issue more shares. quantity. With joint stock companies this information is contained in the share register. Cross shareholding Several subsidiaries of a company (at least three) have to be established. In connection with this the following cautionary measures should be taken: • Monitor the creditors of company carefully. When implementing this Golden parachute UMESH SINGH Page 125 . • Check the track record of the share registrar in regards to its involvement in hostile takeovers in the past. the company should do its best to pay all outstanding debts. Instead. where the parent company owns 100% of share capital in each subsidiary. • Check who controls the registrar company. The result of such an operation is that the parent owns less that 25% of the share capital of each subsidiary.MF 0011 Mergers and Acquisitions Assignment 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. In other words the parent company does not even have a blocking shareholding. the share register contains information on the nominee holders.
MF 0011 Mergers and Acquisitions Assignment This measure discourages an unwanted takeover by offering lucrative benefits to the current top executives. Golden parachutes can be prohibitively expensive for the acquiring firm and.Mattel CEO Jill Barad’s USD 50 million departure payment. Benefits written into the executives’ contracts may include items such as stock options. 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. 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. according to a survey by Executive Compensation Advisory Services. and Citigroup Inc. Notable examples include ex. their purpose is legitimate: to protect creditors from being placed in a worse position than they visualised. John Reed’s USD 30 million in severance and USD 5 million per year for life. Compromises. 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. Also. The golden parachute defence is widely used by American companies. hefty severance pay and so on. Although one of the effects of change of control clauses is to discourage raiders. 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.4 What are the legal compliance issues a company has to adhere to in case of a merger. bonuses. 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. Arrangements and Reconstruction. who may lose their job if their company is taken over by another fi rm. Q. therefore. the other party to the agreement has the right to accelerate the debt or terminate the contract. the acquiring company should have the permission in its object clause to carry on the UMESH SINGH Page 126 . 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. 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). Ans. The presence of “golden parachute” plans at Fortune 1000 companies increased from 35% in 1987 to 81% in 2001. Explain through an example.
the regional director of the Company Law Board will be intimated. sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. voting in person or by proxy. its certified true copies will be filed with the Registrar of Companies. board of directors and the Company Law Board before affecting the merger. with effect from the specified date. In the absence of these provisions in the memorandum of association. At least. • • Information to the stock exchange : The acquiring and the acquired companies should inform the stock exchanges about the merger. on the petitions of the companies. The date of the court’s hearing will be published in two newspapers. it is necessary to seek the permission of the shareholders. 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. large M&A deals cause the domestic currency of the target corporation to appreciate by UMESH SINGH Page 127 . 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.5 Take a cross border acquisition by an Indian company and critically evaluate.MF 0011 Mergers and Acquisitions Assignment business of the acquired company. 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. on average. 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. These securities will be listed on the stock exchange. • • • • • • Q. In a study conducted in 2000 by Lehman Brothers. and also. Filing of the court order : After the Court order. Shareholders’ and creators’ meetings : The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. Ans. must accord their approval to the scheme. the High Court will pass an order. Sanction by the high court : After the approval of the shareholders and creditors. it was found that. 75 percent of shareholders and creditors in separate meetings.
Shell Transport &74. there is generally a strong upward movement in the target corporation's domestic currency (relative to the acquirer's currency). 1% stronger. the report found that in the period immediately after the deal is announced.974 UMESH SINGH Page . Due to the complicated nature of cross border M&A. Cross border intermediation has many more levels of complexity to it then regular intermediation seeing as corporate governance. BellSouth Corporation 72. and countries' culture are all crucial factors that could spoil the transaction. the target currency is then. In the past.747 21. the power of the average employee.243 2000 Spin-off : Nortel Networks 59. In 1996 alone there were over 2000 cross border transactions worth a total of approximately $256 billion.041 Internet Svcs 2004 Sanofi-Synthelabo SA Aventis SA 60. Table 1.559 Trading Co 2006 AT&T Inc. For every $1-billion deal. 2004 Royal Dutch Petroleum Co.671 2001 Comcast Corporation AT&T Broadband &72.95 128 1 2 3 4 5 6 7 2000 Merger : America Online Inc.Time Warner (AOL) 2000 Glaxo Wellcome Plc.98 7.MF 0011 Mergers and Acquisitions Assignment 1% relative to the acquirer's.1 Largest M&A deals worldwide since 2000: Rank Year Acquirer Target Transaction % Value (in Mil.06 9. political factors customer expectations. Fifty days after the announcement. Because of such complications. on average. the currency of the target corporation increased in value by 0. the vast majority of cross border actions have unsuccessful results.83 10.961 Plc.87 9. The rise of globalization has exponentially increased the market for cross border M&A. 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.62 9. More specifically. SmithKline Beecham75. company regulations.54 7. This same reason also prevented the development of any extensive academic works on the subject.5%. 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. USD) 164. many business brokers are finding the International Corporate Finance Group and organizations like it to be a necessity in M&A today.
Nowadays.1 show the ten largest M&A deals worldwide since 2000.738 100 Source: Institute of Mergers.on AG Endesa SA 56. extra cash with Indian corporates.747 million during 2000. it is 9. 10 2006 Pending: E.559 million.89 9 2004 Merger : JP Morgan ChaseBank One Corporation 58. which account 21. Thomson Financial Table: 1. UMESH SINGH Page 129 . The increasing engagement of the Indian companies in the world markets.87 % of total transaction value of top ten worldwide M & a deals. news of Indian Companies acquiring a foreign businesses are more common than other way round. Acquisitions and Alliances Research.06 % of total transaction value of top ten worldwide M & a deals & third largest deal was between Royal Dutch Petroleum Co. Cross-border Merger and acquisition: India Until upto a couple of years back.79 & Co.961 million which was also occurred during 2000.266 7. Of US $ 75. Pharmacia Corporation 59.1 and fig.83% of total transaction value of top ten worldwide merger and acquisition deals. Time Warner of worth $ 164.MF 0011 Mergers and Acquisitions Assignment Corporation 8 2002 Pfizer Inc.1. other sectors are also now growing rapidly. Buoyant Indian Economy. this scenario has taken a sudden U turn. Government policies and newly found dynamism in Indian businessmenhave all contributed to this new acquisition trend.761 7. The Indian IT and ITES companies already have a strong presence in foreign markets. & SmithKline Beecham Plc.45 Total 754. Shell Transport & Trading Co of worth US $ 74. however.515 7. which was 10. and particularly in the US. the news that Indian companies having acquired American-European entities was very rare. Indian companies are now aggressively looking at North American and European markets to spread their wings and become the global players. is not only an indication of the maturity reached by Indian Industry but also the extent of their participation in the overall globalization process. While second largest deal was between Glaxo Wellcome Plc. Table and figure reflects that the largest M & A deal during last 6 year was between American Online Inc and. However.
Figure 1.7 billion in 2000-01.500 million. This is more than double the amount involved in US companies' acquisition of Indian counterparts.000 Steel Hindalco Novelis Canada 5. UMESH SINGH Page 130 .982 Steel Videocon Daewoo ElectronicsKorea 729 Electronics Corp. And almost 99 per cent of acquisitions were made with cash payments.2 Target Company Indian outbound deals. Reddy'sBetapharm Germany 597 Pharmaceutical Labs Suzlon Hansen Group Belgium 565 Energy Energy HPCL Kenya PetroleumKenya 500 Oil and Gas Refinery Ltd.2: The top 10 acquisitions made by Indian companies worldwide: Acquirer Country targeted Deal value ($Industry ml) Tata Steel Corus Group plc UK 12. Dr. which were valued at US$ 0. They went shopping across the globe and acquired a number of strategically significant companies. 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.Graphical representation of Indian outbound deals since 2000. This comprised 60 per cent of the total mergers and acquisitions (M&A) activity in India in 2006.MF 0011 Mergers and Acquisitions Assignment Table1. In fact. increased to US$ 4. 2006 will be remembered in India's corporate history as a year when Indian companies covered a lot of new ground.3 billion in 2005 . and further crossed US$ 15 billion-mark in 2006.
While overall sales are 10. 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.873 US $ million and purchase deals were 8249 US $ million during last five years. Table shows the cross border sales deals during 2000 were 1219 US $ million while purcahse deal were 910 US $ million.MF 0011 Mergers and Acquisitions Table 1.3 exhibit Cross –border merger and acquisition in India for the period 2000 to 2005.3 & figure 1. Identifying takeover opportunities the basic purpose of valuation of Target company is to locate the possibilities of takeover.3: (US $ Million) Cross-border Merger and Assignment acquisition: India Year Sales 2000 1219 2001 1037 2002 1698 2003 949 2004 1760 2005 4210 Total 10873 Source: UNCTAD world investment report 2006 Purchases 910 2195 270 1362 863 2649 8249 Table 1.6 Choose any firm of your choice and identify suitable acquisition opportunity and give reasons for the same.But during 2005. Some financial experts suggest selection criteria based on following two approaches. UMESH SINGH Page 131 . Ans. Q. So table clearly depicts that our cross border merger and acquisition sales deals are more then purchase deals. these have been increased to 4210 US $ million and 2649 US $ million.
here. 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.a. then the acquirer company has green signal for acquiring the target company.MF 0011 Mergers and Acquisitions Assignment 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. 54 – 50 = 4. In other words. Capital assets pricing : The above approach provides a superior theoretical framework and is helpful in identifying a merger partner.e. NPV is 4 per share. The above approach does not consider the risk posture of acquisition i. MPS for Target Co’s market price per share Rs. the portfolio effect. The result requires reconsideration. 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. E(Rj ) = Required return E(Rj ) = Expected return UMESH SINGH Page 132 . This is then compared with the actual market price to determine the net present value on investments. 50 -For Target Co’s merger @ 100% basis g for Target Co’s earning and dividend expected to grow at 8% p. the target company. 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. The required rate of return is calculated by solving the following equation : E(Rj ) = Rf+ [E(Rm) – Rf] (Bj) Where. then target company’s theoretical price is as under : P = P0 (1+g) / (k-g) = 1(1.e.10 – . The capital assets pricing model considers these aspects as discussed below.02 = 54 The theoretical price exceeds the Market Price i.08) / . The basic logic behind the model is that if expected rate of return exceeds the required rate of return. 1 per share.08 / .08 = 1.
MF 0011 Mergers and Acquisitions E(Rm) = Expected return for market index Rf = Risk free return Bj = Beta (normally determines past performance) j = Potential merger partner (target company) Assignment UMESH SINGH Page 133 .