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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.

The various types of vertical combination are as explained below:


a) 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

Petroleum Production Backward Linkage

Refining Original Company

Sales to Wholesaler / Dealers Forward Linkage

Sales to Retailers Forward Linkage


2. 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
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. Corporate strategy development


2. Organizing for acquisitions
3. Deal structuring and negotiation
4. Post-acquisition integration
5. 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.
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. Spin-
off 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
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 250
Furniture & Fittings 5 255
Current Assets:
Inventories 90
Debtors 25
Bank Balance 10 125
Total 380

2. Mode of Payment:
3. Calculation of present value of expected benefits:

Year end Expected benefits PV factor @ 14% present value of


expected benefits
(Rs.)
1 100 0.877 87.7
2 135 0.769 103.815
3 175 0.675 118.125
4 200 0.592 118.4
5 80 0.519 41.52
Total 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 xxx
Less: Liabilities taken over at agreed values xxx
Purchase consideration xxx
Add: Liquidation Expenses agreed to be paid by acquiring company xxx
Total Purchase consideration 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.