ASSIGNMENT SET 1 MF0002 MERGERS & ACQUISITIONS 1. Explain the types of merger with suitable examples.

Ans: Merger is defined as combination of two or more companies into a single company where one survives and the others lose their corporate existence. Types of Merger: 1. Vertical Combination: It is a process of joining of two or more companies involved in different stages of the production or distribution of the same product or service. That is, two or more companies which are engaged in the production of same goods or services but different stages of production or services join together. Merger of Coal Mining and Railway Company is the best example in which new product / services which complementary to existing product / services is added. The essential objective of such merger is: To ensure a ready market for the goods & services produced. To ensure a source of supply required for production of goods or services. To gain a strong position because of imperfect market of intermediary products, scarcity of resources. To control over product specialization.

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The various types of vertical combination are as explained below: Backward Integration: Such combination occurs when the firms acquire or create a company that supplies the firm raw materials or components and other inputs. b) Forward Vertical Integration: Such combination occurs when the firms acquire or create a company that purchases its products / services. The above concept of integration of firms can be depicted as below: Petroleum Exploration Backward Linkage Backward Linkage

Petroleum Production


Original Company

Sales to Wholesaler / Dealers

Forward Linkage Forward Linkage

Sales to Retailers


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Horizontal Combination: This is joining of two or more companies in same area of business. In this type of combination, two or more companies which are producing essentially the same product or providing the same services or which are in direct competition with each other join together. The combination of ACC Ltd. is the best example to quote here. Such merger results in: Economies of scale Operational economies Elimination of duplication facilities Reduces competition and number of companies Reduction in investment in working capital, advertisement cost etc. To have greater access to channels of distribution

3. Conglomerate Merger: This is joining of two or more companies whose businesses are not related with each other either vertically or horizontally. The companies involved in merger under this mode may be engaged in totally different lines of business. Manufacturing Company acquiring Insurance Company. Example - Gujarat Gas Ltd and Gujarth Finance Co. Ltd. The basic objectives of conglomerate mergers are:  Diversification of Activities  Reduction of Risk  Economies of large scale operations  Financial stabilities  Increase in profits  Attain managerial competence There are various types of conglomerate mergers in practice. They are: a) Financial Conglomerate: The important feature of financial conglomerate is:  Provide a flow of funds to each segment of their operations, exercise control  Undertake strategic planning but do not participate in operating decisions  Serves atleast five distinct economic functions  Improve risk-return ratios through diversifications  Avoids ‘gamblers ruin’-an adverse run of losses which might cause bankruptcy  Establishing programme of financial planning & control  Improved resource allocation to perform efficiently  Diverting internal cash flows from the unfavourable area to more attractive areas b) Managerial Conglomerate: The managerial conglomerate not only assumes financial responsibility and control, but also plays a role in operating decisions and provides staff enterprise and staff services to the operating entities. By providing managerial counsel and interactions on decision, managerial conglomerates increase the potential for improving performance. General management functions (planning, organizing etc) are reality transferable to all types of business firms. When any two firms of

unequal competence are combined, the total performance of the combined firm will be greater than the sum of the individual part. This defines SYNERGY in its most general forms. These economic benefits are achieved through corporate head quarters. 4. Concentric Merger: It is a combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. For example, combination of firms producing television, washing machines and kitchen appliances come under the concept concentric merger. The important benefits of concentric mergers are: Reducing of Risks Economies of large scale operations Financial stability Increase in profit Attain managerial competence The important reasons for adopting conglomerate strategy are: Achieve higher growth rate than expansion Effective use of Financial Resources Avail potential opportunities of profitable investments Achieve competitive advantage and stability Improve P/E Ratio and bring out higher market price of shares 5. Circular Combination: Under this combination, companies producing distinct products seek amalgamation to share common distribution and research facilities so as to obtain economies by elimination of cost on duplication & promoting market enlargement, Acquiring company obtains benefits in the form of economies of resource sharing and diversification. 2. Mergers and Acquisitions is regarded as a dynamic response to political, sociological and technological changes. In this context, explain the stages of M & A process. Ans: Mergers and acquisitions are transactions of great significance not only to the companies themselves but also to many other constituencies such as workers, managers, competitor communities and economies. Hence, the mergers and acquisition process needs to be viewed as a multi-stage process with each stage giving rise to distinct problems and challenges to companies understating such transactions. To understand the nature and sources of these problems we need a good understanding of the external context in which merger and acquisition take place. This context is not purely economic but includes political, sociological and technological contexts as well. The context is also ever changing. Thus merger and acquisition could be regarded as a dynamic response to these changes. The five stage model conceptualizes the merger and acquisition process as being driven by a variety of impulses, not all of them reducible to rational economic paradigms. Both

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economic and non-economic factors affect the merger and acquisition process. The five stages of merger and acquisition process under 5-S model can be divided as below: 1. 2. 3. 4. 5. Corporate strategy development Organizing for acquisitions Deal structuring and negotiation Post-acquisition integration Post acquisition audit and organizational learning

The brief explanation of the above stages of merger is given below: Stage 1: Corporate strategy development Corporate strategy is concerned with the ways of optimizing the portfolios of businesses that a firm currently owns and with how this portfolio can be changed to serve the interests of the corporation’s stake holders. Merger and acquisition can serve the objectives of both corporate and business strategies despite their being the only one of several instruments. Effectiveness of merger and acquisition in achieving these objectives depends on the conceptual and empirical validity of the models upon which the corporate strategy is based. Given an appropriate corporate strategy model, mergers and acquisition is likely to fail to deliver sustainable competitive advantage. Corporate strategy analysis involves has evolved in recent years through several paradigms-industry structure-driven strategy, competition among strategic group, competence or resource based competition etc. Stage 2: Organizing for acquisitions One of the major reasons for the observed failure of many acquisitions may be that firms lack the organizational resources and capabilities for making acquisitions. It is also likely that the acquisition decision-making processes within firms are far from the models of economic rationality that one may assume. Thus a pre condition for a successful acquisition is that the firm organizes itself for effective acquisition making. An understanding of the acquisition decision making process is important, since it has a bearing on the quality of the acquisition decision and its value creation logic. At this stage the firm lays down the criteria for potential targets of acquisitions consistent with the strategic objectives and value creation logic of the firm’s corporate strategy and business model. Stage 3: Deal structuring and negotiation This stage consists of: Valuing target companies Choice of advisers (investment banker, lawyers, accountants etc) to the deal Obtaining and evaluating about the target from the target as well as from other sources. Performing due diligence Determining the range of negotiation parameters Negotiating the positions of senior management of both firms in the post-merger dispensation Developing the appropriate bid and defence strategies and tactics within the parameters set by the relevant regulatory regime etc.

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Stage 4: Post-acquisition integration At his stage, the objective is to put in place a managed organization that can deliver the strategic and value expectations that drove the merger in the first place. The integration process also has to be viewed as a project and the firm must have the necessary project management capabilities and programme with well defined goals, teams, deadlines, performance benchmarks etc. Such a methodical process can unearth problems and provide solutions so that integration achieves the strategic and value creation goals. One of the major problems in post-merger integration is the integration of the merging firm’s information systems. This is particularly important in mergers that seek to leverage each company’s information on customers, markets or processes with that of the other company. Stage 5: Post-acquisition audit and organizational learning The importance of organizational to the success of future acquisitions needs much greater recognition, given the failure rate of acquisitions. Post-merger audit by internal auditors can be acquisition specific as well as being part of an annual audit. Internal auditor has a significant role in ensuring organizational learning and its dissemination. 3. Write short notes on: a. Spin off: The creation of an independent company is through the sale or distribution of new shares of an existing business / division of a parent company. It is a kind of de-merger when an existing parent company transforms into two or more separately re-organized different entity. The parent company distributes all the shares it owns in a controlled subsidiary to its own shareholder on a pro-rata basis. In this process, the parent company gains effect to making two of the one company. It may be in the form of subsidiary or a separate company. There is no money transaction in spin off. The transaction is treated as stock dividend and tax free exchange. Both companies exist and carry on business. It does not alter ownership proportion in any company. The newly created entity becomes an independent company taking its own decision and developing its own policies and strategies, which need not necessarily, be the same as those of the parent company. Spinoff is necessary for a company having brand equity or multi-product company enters into collaboration with a foreign company. Businesses wishing to ‘streamline’ their operations often sell less productive or unrelated subsidiary businesses as spin-offs. The spun-off companies are expected to be worth more as independent entities than as parts of a larger business. Businesses wishing to ‘streamline’ their operations often sell less productive or unrelated subsidiary businesses as spin-offs. The spun-off companies are expected to be worth more as independent entities than as parts of a large business. b. Equity Carved Out: It resembles to Initial Public Offering (IPO) of some portion of the common stock of a wholly owned subsidiary by the parent company. A parent firm makes a subsidiary public through an initial public offering (IPO) of shares, amounting to a partial sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the newly

traded subsidiary. Equity carved out is also a means of reducing their exposure to a riskier line of business. In the process of equity carved out, some of the shares of subsidiary are offered for sale to general public for increasing cash flow without loss of control. A carve out occurs when a parent company sells a minority (usually 20% or less) stake in a subsidiary for an IPO or rights offering. In this form of restructuring, an established brick-and-mortar company hooks up with the venture investors and a new management team to launch a spin off. In most cases, the parent company will spin-off the remaining interests to existing shareholders at a later date when the stock price is much higher. More and more companies are using equity carve-outs to boost shareholder value. A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is growing faster and carrying higher valuations than other businesses owned by the parent. A carve-out generates cash because shares in the subsidiary are sold to the public, but the issue also unlocks the value of the subsidiary unit and enhances the parent’s shareholder value. The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains some control. In these cases, some portion of the parent firm’s board of directors may be shared. Since the parent has a controlling stake, meaning both firms have common shareholders, the connection between the two will likely be strong. That said, sometimes companies carve-out a subsidiary not because it’s doing well, but because it is a burden. Such an intention won’t lead to a successful result, especially if a carved-out subsidiary is too loaded with debt or had trouble even when it was a part of the parent and is lacking an established track record for growing revenues and profits. Carve-outs can also create unexpected friction between the parent and subsidiary. Problems can arise as managers of the carved-out company should be accountable to their public shareholders as well as the owners of the parent company. This can create divided loyalties. c. Leverage Buy Outs (LBOs): It is a strategy involving the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. It is nothing but takeover of a company using the acquired firm’s assets and cash flow to obtain financing. In LBO, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. A LBO occurs when a financial sponsor gains control of a majority of a target company’s equity through the use of borrowed money or debt. The purpose of leveraged buy outs is to allow companies to make large acquisitions without having to commit a lot of capital. Leveraged buy outs are risky for the buyers if the purchase is highly leveraged. An LBO can be protected from volatile interest rates by an Interest Rate Swap, locking in a fixed interest rate, or an interest rate Cap which prevents the borrowing cost from rising above a certain level. LBO’s also have been financed with high yield debt or Junk Bonds and have also been done with the interest rate capped at a fixed level and interest costs above the cap added to the principal. For commercial banks, LBO’s are attractive because these financings have large up-front fees. They also fill the gap in corporate lending created, when large corporations begin using commercial paper and corporate bonds in place of bank loans.

In a LBO, there is usually a ratio of 90% debt to 10% equity. Because of this debt-equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. In 1980 several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company’s operating cash flows were unable to meet the obligation. In the US, specialized LBO firms provide finance for acquisition against target company’s assets or cash flows. d. Concentric Mergers: It is a combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. For example, combination of firms producing television, washing machines and kitchen appliances come under the concept concentric merger. The important benefits of concentric mergers are: Reducing of Risks Economies of large scale operations Financial stability Increase in profit Attain managerial competence The important reasons for adopting conglomerate strategy are: Achieve higher growth rate than expansion Effective use of Financial Resources Avail potential opportunities of profitable investments Achieve competitive advantage and stability Improve P/E Ratio and bring out higher market price of shares e. Master Limited Partnerships (MLPs): MLPs are a type of limited partnership in which the shares are publicly traded. The limited partnership interests are divided unto units which are traded as shares of common stock. Shares of ownership are referred to as units. MLPs generally operate in the natural resource, financial services, and real estate industries. Unlike a corporation, a master limited partnership is considered to be the aggregate of its partners rather than a separate entity. There are two types of partners in this type of partnership. They are called as general partners and limited partners. The general partner is the party responsible for managing the business and bears unlimited liability. The general partner is typically the sponsor corporation or one of its operating subsidiaries. General partner receives compensation that is linked to the performance of the venture and is responsible for the operations pf the company and, in most cases, is liable for partnership debt. The limited partner is the person or group (retail investors) that provides the capital to the MLP and receives periodic income distributions from the MLPs cash flow. The limited partners have no day-to-day management role in the partnership. It has the advantage of limited liability for the limited partners. The transferability provides for continuity of life. MLP is not treated as an entity, it is treated as partnership for which income is allocated pro-rata to the partners. The advantage of MLPs is the

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combination of the tax benefits of a limited partnership with the liquidity of a publicly traded company. MLPs allow for pass-through income, meaning that they are not subject to corporate income taxes. The partnership does not pay taxes from the profit – the money is only taxed when unit holders receive distributions. The owners of an MLP are personally responsible for paying taxes on their individual portions of the MLP’s income, gains, losses, and deductions. This eliminates the ‘double taxation’ generally applied to corporations (whereby the corporation pays taxes on its income and the corporation’s shareholders also pay taxes on the corporation’s dividends). That is, MLP is taxed as partnership avoids double taxation and the business achieves a lower effective tax rate. The lower cost of capital resulting from the reduced effective tax rate provides the partnership with a competitive advantage when vying against corporations during competitive asset sales or bidding wars and can ultimately provide a higher return to unit holders. Different Types of MLPs: Roll Up MLP – Formed by the combination of two or more partnership into one publicly traded partnership. Liquidation MLP – Formed by a complete liquidation of a corporation into an MLP Acquisition MLPs – Formed by an offering of MLP interest to the public with the proceeds used to purchase assets. Roll Out MLPs – Formed by a corporations contribution of operating assets in exchange for general and limited partnership interest in MLP, followed by a public offerings of limited partnership interest by the corporations of the MLP or both. Start Up MLP – Formed by partnership that is initially privately held but later offers its interests to the public in order to finance internal growth. 4. Case Study Ans: 1. Calculation of cost of Acquisition: (Rs. In Lakhs) Fixed Assets: Plant & Machinery Furniture & Fittings Current Assets: Inventories Debtors Bank Balance Total 2. Mode of Payment: 250 5 90 25 10 255

125 380

3. Calculation of present value of expected benefits: Year end 1 2 3 4 5 Total Expected benefits 100 135 175 200 80 PV factor @ 14% 0.877 0.769 0.675 0.592 0.519 present value of expected benefits (Rs.) 87.7 103.815 118.125 118.4 41.52 469.56

ASSIGNMENT SET 2 MF0002 MERGERS & ACQUISITIONS 1. Mergers and acquisition requires a detailed planning for integration. Discuss the integration process of M & A. Ans: The most difficult part of merger or acquisition is the integration of the acquired company into the acquiring company. The difficulty of integration also depends on the degree of control desired by the acquirer. The post-merger and acquisition integration of the firm is a crucial task to be accomplished for effective performance. The post-merger integration process starts after the successful deal of merger. Extent of integration is defined by the need to maintain the separateness of the acquired business. Integration Planning: The success of an integration process depends upon the role of acquisition and the nature of managers involved in the transaction and implementation. The process of integration itself has to be planned so that the acquired or merged company integrates smoothly. Therefore, merger and acquisition requires a detailed planning for integration as given below: • Integration Plan: Once the merger or acquisition took place, the acquiring company should prepare a detailed strategic plan for integration based on its own and the target company’s strength and weakness. Communication: The plan of integration should be communicated to all employees and also their involvement in making integration smooth and easy and remove any ambiguity or fear in the minds of the staff. Authority and responsibility: In order to avoid any confusion and indecisiveness, the acquiring company should take all employees into confidence and decide the authority and responsibility relationships. Cultural integration: Management should focus the culture integration of the employees. A proper understanding of culture of two organizations, clear communication and training can help to bridge the cultural gaps. Skill and competencies up-gradation: The acquired company can conduct a survey of employees to make an assessment of the gaps in the skills and competencies. If there is difference in the skills and competencies of employees of merging company, management should prepare a plan for skill and competencies up-gradation through training. Structural Adjustments: The acquired company may design the new organization structure and redefine the roles, authorities and responsibilities of the employees.

Control System: It is to ensure that it is in control of all resources and activities of the merged entity. It must put proper financial control in place so that resources are optimally utilized and wastages is avoided. 2. What is purchase consideration, what are different types of purchase consideration?

Ans: The consideration for the amalgamation may consist of securities, cash or other assets. In determining the value of the consideration, an assessment is made of the fair value of its elements. A variety of techniques are applied in arriving at fair value. For example, when the consideration includes securities, the value fixed by the statutory authorities may be taken to be the fair value. In case of other assets, the fair value may be determined by reference to the market value of the assets given up. Where the market value of the assets given up cannot be reliably assessed, such assets may be valued at their respective net book values. Many amalgamations recognize that adjustments may have to be made to the consideration in the light of one or more future events. When the additional payment is probable and can reasonably be estimated at the date of amalgamation, it is included in the calculation of the consideration. In all other cases, the adjustment is recognized as soon as the amount is determinable. The amount of purchase consideration is determined by the following methods: • Lump-sum Method: When the acquiring company agrees to pay a lump-sum amount to the target company, it is called lump-sum payment of purchase consideration. Payment Method: Under this method, all payments made by the acquiring company to the acquired company are added. Cash xxx Shares xxx Debentures xxx Liquidation Expenses xxx Purchase consideration XXX In this case, the value of assets and liabilities taken over by the purchasing company need not be taken into account. Only payments are to be added to arrive at the amount pf purchase consideration. Net Asset Method: The purchase consideration under this method is determined as follows: Assets taken over at agreed values Less: Liabilities taken over at agreed values Purchase consideration Add: Liquidation Expenses agreed to be paid by acquiring company Total Purchase consideration

xxx xxx xxx xxx XXX

The above amount of purchase consideration is discharged by the purchasing company as follows: Cash xxx Shares xxx Debentures xxx Purchase consideration XXX • Value of shares method: Under this method, the purchase consideration is calculated with reference to the value of shares (Net Asset or Market or capitalization or fair value) of two companies involved. 3. Write short notes on: a. White Square: The White Square is a modified form of a white knight. The difference being that the white square does not acquire control of the target. In a white square transaction, the target sells a block of its stock to a third party it considers to be friendly. The white square sometimes is required to vote its shares with the target management. These transactions often are accompanied by a stand-still agreement that limits the amount of additional target stock the white square can purchase for a specified period of time and restricts the sale of its target stock, usually giving the right of first refusal to the target. In return, the white square often receives a seat on the target board, generous dividends, and / or a discount on the target shares. Preferred stock enables the board to tailor the characteristics of that stock to fit the transaction and so usually is used in white square transaction. b. Crown Jewel: When a target company uses the tactics of divestiture, it is said to sell the “Crown Jewel”. The precious assets in the company are called “Crown Jewel” to depict the greed of the acquirer under the takeover bid. These precious assets attract the rider to bid for the company’s control. The company as a defense strategy, in its own interest, sells these valuable assets at its own initiative leaving the rest of the company intact. Instead of selling these valuable assets, the company may also lease them or mortgage them to creditors so that the attraction of free assets to the predator is over. As per SEBI takeover regulation, the above defense can be used only before the predator makes public announcement of its intention to takeover the target company. c. Poison Pill: Poison pills represent the creation of securities carrying special rights exercisable by a triggering event. The triggering event could be the accumulation of a specified percentage of target shares or the announcement of a tender offer. The special rights may take many forms but they all make it costlier to acquire control of the target firm. As a tactical strategy, the target company might issue convertible securities, which are converted into equity to deter the efforts pf the offer, or because such conversion dilutes the bidders shares and discourages acquisition. Another example, Target company might rise borrowing distorting normal Debt to Equity ratio. Poison pills can be adopted by the board of directors without shareholder approval. Although not required, directors often will submit poison pill adoptions to shareholders for ratification.

d. Staggered Board: A staggered board of directors (also known as a classified board) is a board that is made up of different classes of directors. Usually, there are three classes, with each class serving for a different term length than the other. Elections for the directors of staggered boards usually happen on an annual basis. At each election, shareholders are asked to vote to fill whatever positions of the board are vacant, or up for re-election. Terms of service for elected directors vary, but one-, three- and five-year terms are common. Information on corporate governance policies and board composition can be found in a public company's proxy statement. Generally, proponents of staggered boards sight two main advantages that staggered boards have over traditionally elected boards: board continuity and anti-takeover provisions - hostile acquirers have a difficult time gaining control of companies with staggered boards. Opponents of staggered boards, however, argue that they are less accountable to shareholders than annually elected boards and that staggering board terms tends to breed a fraternal atmosphere inside the boardroom that serves to protect the interests of management above those of shareholders According to a study conducted by three Harvard University professors and published in the Stanford Law Review, more than 70% of all companies that went public in 2001 had staggered boards. Despite their popularity, however, the study suggests that staggered boards tend to reduce shareholder returns more significantly than non-staggered boards in the event of a hostile takeover. When a hostile bidder tries to acquire a company with a staggered board, it is forced to wait at least one year for the next annual meeting of shareholders before it can gain control. Furthermore, hostile bidders are forced to win two seats on the board; the elections for these seats occur at different points in time (at least one year apart), creating yet another obstacle for the hostile bidder. Hostile bidders that manage to win one seat allow staggered boards the opportunity to defend the company they represent against the takeover by implementing a poison pill tactic to further deter the takeover, effectively guaranteeing continuity of management. Furthermore, in hostile takeover, hostile bidders tend to offer shareholders a premium for their shares, so in many cases, hostile takeovers are good for shareholders. They get to sell their shares for more money after a hostile bid than they would have before it occurred. According to the Harvard study, in the nine months after a hostile takeover bid was announced, shares in companies with staggered boards increased only 31.8%, compared to the average of 43.4% returned to stockholders of companies with non-staggered boards (Bebchuk, Coates and Subramanian; 2002). Although hostile takeovers are a fairly rare occurrence, the fact remains that boards are elected to represent shareholder interests; because staggered boards may deter takeovers (and the premiums paid for shares as a result of takeovers), this puts the two at odds. Even so, a staggered board does offer continuity of leadership, which surely has some value provided that the company is being led in the right direction in the first place.

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