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4.Basic Info Abt Merger and Acquisition

4.Basic Info Abt Merger and Acquisition

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Published by: Shilpa Wasnik on May 09, 2011
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Mergers, Amalgamations & Takeovers all through the globe have become universal practices in the corporate world covering different sectors within the nations and across their borders for securing survival, growth, expansion and globalisation of the enterprise and achieving multitude of objectives. Meaning of terms 1. Merger

Merger is defined as combination of two or more companies into a single company where one survives and the others lose their corporate existence. The survivor acquires the assets as well as liabilities of the merged company or companies. Generally, the company which survives is the buyer which retains its identity and the seller company is extinguished. Merger is also defined as amalgamation. Merger is the fusion of two or more existing companies. All assets, liabilities and stock of one company stand transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or a mix of the two or three modes. 2. Amalgamation

Ordinarily amalgamation means merger Halsbury’s Laws of England describe amalgamation as a blending of two or more existing undertaking into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company which is to carry on the blended undertaking. Andhra Pradesh High Court held in S.S. Somayajulu v Hope Prudhomme & Co. the word “amalgamation” has no definite legal meaning. It contemplates a state of things under which two companies are so joined as to form a third entity, or one company is absorved into and blended with another company. Amalgamation does not involve a formation of a new company to carry on the business of the old company. 3. Consolidation

Consolidation is known as the fusion of two existing companies into a new company in which both the existing companies extinguish. Thus, consolidation is mixing up of the two companies to make them into a new one in which both the existing companies lose their identity and cease to exist. The mix-up assets of the two companies are known by a new name and the shareholders of two companies become shareholders of the new company. None of the consolidating firms legally survives. 4. Combination

Combination refers to mergers and consolidations as a common term used interchangeably but carrying legally distinct interpretation. All mergers, acquisitions, and

amalgamations are business combinations. Types of business combination are discussed in the following paragraphs. 5. Holding company

The relationship of the two companies when combine their resources are differently known as parent company which holds the equity stock of the other company knows as subsidiary and controls its affairs. 6. Acquisition

Acquisition in general sense is acquiring the ownership in the property. In the context of business combinations, an acquisition is the purchase by one company of a controlling interest in the share capital of another existing company. An acquisition may be affected by (a) agreement with the persons holding majority interest in the company management like members of the board or major shareholders commanding majority of voting power; (b) purchase of shares in open market; (c) to make takeover offer to the general body of shareholders; (d) purchase of new shares by private treaty; (e) acquisition of share capital or one company may be either all or any one of the following form of considerations viz. means of cash, issuance of loan capital, or insurance of share capital. 7. Takeover

A ‘takeover’ is acquisition and both the terms are used interchangeably. Takeover differs from merger in approach to business combinations i.e. the process of takeover, transaction involved in takeover, determination of the share exchange or cash price and the fulfilment of goals of combination all are different in takeovers than in mergers. For example, process of takeover is unilateral and the offeror company decides about the maximum price. Time taken in completion of transaction is less in takeover than in mergers, top management of the offeree company being more co-operative. 8. Reconstruction

The term ‘reconstruction’ has been used in section 394 alongwith the term ‘amalgamation’. The term has not been defined therein but it has been used in the sense not synonymous with amalgamation. In the Butterworth publication, the term has been explained as under: “By a reconstruction, a company transfers its undertaking and assets to a new company in consideration of the issue of the new company’s shares to the first company’s members and, if the first company’s debentures are not paid off, in further consideration of the new company issuing shares or debentures to the first company’s debenture holders in satisfaction of their claims. The result of the transaction is that the new company has the same assets and members and, if the new company issues debentures to the first holders as the first company, the first company has no undertaking to operate and is therefore usually wound up or dissolved.”



The term “restructuring” is used in the corporate literature for mergers and amalgamations. The term should carry the same meaning as reconstruction as explained above. 10. Demerger or corporate splits or division

Demerger or split or division of a company are the synonymous terms signifying a movement in the company just opposite to combination in any of the forms defined above. Purpose of merger and acquisition The company which proposes to acquire another company is knows differently in different modes of acquisition, the familiar ones are; ‘predator, offeror, corporate raider (for takeover bids), etc. The transferee company is also denoted as victim, offeree, acquire or target etc. The purpose for an offeror company for acquiring another company shall be reflected in the corporate objective. It has to decide the specific objectives to be achieved through acquisition. The basic purpose of merger or business combination is to achieve faster growth of the corporate business. Faster growth may be had through product improvement and competitive position i.e. enhanced profitability through enhanced production and efficient distribution of goods and services or by expanding the scope of the enterprise through “empire building” through acquisition of other corporate units. Other possible purposes for acquisition are shortlisted below: 1. • • • 2. Procurement of supplies to safeguard the source of supplies of raw material or intermediary product; to obtain economies of purchases in the form of discount, savings in transportation costs, overhead costs in buying department, etc. to share the benefits of suppliers economies by standardising the materials. Revamping production facilities to achieve economies of scale by amalgamating production facilities through more intensive utilisation of plan and resources; • to standardise product specifications, improvement of quality of product, expanding market and aiming at consumers satisfaction through strengthening after sale services; • to obtain improved production technology and know how from the offeree company to reduce cost, improve quality and produce competitive products to retain and improve market share.

It has to aim at a suitable combination where it could have opportunities to supplement its funs by issuance of securities. to obtain new product for diversification or substitution of existing products and to enhance the product range. to improve EPS. accounting valuation. to avail of tax benefits. A company thinks in terms of acquiring the other company only when it has arrived at its own development plan to expand its operations having examined its own internal strength where it might not have any problem of taxation. to obtain new market outlets in possession of the offeree. product expansional. • • Market expansion and strategy to eliminate competition and protect existing market. General gains to improve its own image and attract superior managerial talents to manage its affairs. Financial strength to improve liquidity and have direct access to cash resources. market extensional or other specified unrelated objectives depending upon the corporate . • • • • • • 4. to reduce advertising cost and improve public image of the offeree company. borrow on better strength and greater assets backing. Own developmental plans The purpose of acquisition is basked by the offeror company’s own development plans. strengthening retail outlets and sale depots to reationalise distribution. etc. secure additional financial facilities. 7. eliminate competition and strengthen its market position. but might feel resources constraints with limitation of funds and lack of skilled managerial personnel. vertical. to offer better satisfaction to consumers or users of the product. Strategic purpose The Acquirer Company views the merger to achieve strategic objectives through alternative type of combinations which may be horizontal. • • • • • 5. 6. to enhance gearing capacity.3. to dispose of surplus and outdated assets for cash out of combined enterprise. strategic control of patents and copyrights.

reduction in investment in . various types of combinations distinct with each other in nature are adopted to pursue this objective like vertical or horizontal combination. the merging undertaking would be either a supplier or a buyer using its product as intermediary material for final production. The main purpose of such mergers is to obtain economies of scale in production by eliminating duplication of facilities and operations and broadening the product line. 9. (1) it gains a strong position because of imperfect market of the intermediary products. each working at different stages in the production of the same good. 8. Types of Merger Vertical Combination It occurs when two firms. Thus. This gives birth to conglomerate combinations. The purpose and the requirements of the offeror company go a long way in selecting a suitable partner for merger or acquisition in business combinations. The combining corporate aim at circular combinations by pursuing this objective. in vertical combinations. combine. The following main benefits accrue from the vertical combination to the acquirer company i. implements it production plans as per objectives and economises on working capital investments. (2) has control over product specifications. The acquiring company through merger of another unit attempts on reduction of inventories of raw material and finished goods. Horizontal combinations It takes place where the two merging companies produce similar product in the same industry It is a merger of two competing firms which are at the same stage of industrial process.strategy. A company would like to takeover another company or seek its merger with that company to expand espousing backward integration to assimilate the sources of supply and forward integration towards market outlets. 2.e. The acquiring firm belongs to the same industry as the target company. Desired level of integration Mergers and acquisitions are pursued to obtain the desired level of integration between the two combining business houses. scarcity of resources and purchased products. In other words. Corporate friendliness Although it is rare but it is true that business houses exhibit degrees of cooperative spirit despite competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of collaborations sharing goodwill of each other to achieve performance heights through business combinations. Such integration could be operational or financial.

6. such as a merger between a bank and a leasing company. but they have no mutual buyer/customer or supplier relationship. The acquiring company obtain benefits in the form of economies of resource sharing and diversification. elimination of competition concentration in product. 3. For example. recently. Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase. An alternative way of calculating this is if a company with a high price to earnings ratio (P/E) acquires one with a low P/E. Circular Combination companies producing distinct products seek amalgamation to share common distribution and research facilities to obtain economies by elimination of cost of duplication and promoting market enlargement. Congeneric mergers It occurs where two merging firms are in the same general industry. Such mergers are very common in the corporate world. a parent company has merged with its subsidiary ICICI Bank signifying down stream merger. The basic purpose of such amalgamations remains utilisation of financial resources and enlarge debt capacity through re-organising their financial structure so as to service the shareholders by increased leveraging and EPS. subsidiary company with the parent ITC Ltd. reduction of advertising costs. lowering average cost of capital and thereby raising present worth of the outstanding shares. and likewise. Another instance of up stream merger is the merger of Bhadrachalam Paper Board.A unique type of merger called a reverse merger is used as a way of going public without the expense and time required by an IPO. the ICICI Ltd. 5. whereby a company's EPS decreases. It is amalgamations of two companies engaged in unrelated industries like DCM and Modi Industries. Conglomerate Combination It takes place when the two firms operate in different industries.working capital. merger enhances the overall stability of the acquirer company and creates balance in the company’s total portfolio of diverse products and production processes. Within Stream Mergers Such mergers take place when subsidiary company merges with parent company or parent company merges with subsidiary company.. The former arrangement is called “down stream” merger whereas the latter is called ‘up stream’ merger. 4. Example: Prudential's acquisition of Bache & Company. Dilutive mergers are the opposite of above. increase in market segments and exercise of better control on market. .

the purchase is called an acquisition. An acquisition may be friendly or hostile. "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two. This is known as a reverse takeover. is the buying of one company (the ‘target’) by another. In the pure sense of the term. Both companies' stocks are surrendered and new company stock is issued in its place. Acquisition usually refers to a purchase of a smaller firm by a larger one. Distinction between Mergers and Acquisitions Although they are often uttered in the same breath and used as though they were synonymous. The cash the target receives from the sell-off is paid back to its shareholders by dividend or through liquidation. Sometimes. if the buyer buys out the entire assets. Types of acquisition • • The buyer buys the shares. agree to go forward as a single new company rather than remain separately owned and operated. the buyer "swallows" the business and the buyer's stock continues to be traded. The terms "demerger". .Acquisition An acquisition. the terms merger and acquisition mean slightly different things. in the latter case. a merger happens when two firms. This type of transaction leaves the target company as an empty shell. the companies cooperate in negotiations. This kind of action is more precisely referred to as a "merger of equals". Ownership control of the company in turn conveys effective control over the assets of the company. also known as a takeover. A buyer often structures the transaction as an asset purchase to "cherry-pick" the assets that it wants and leave out the assets and liabilities that it does not. a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. this form of transaction carries with it all of the liabilities accrued by that business over its past and all of the risks that company faces in its commercial environment. and therefore control. The buyer buys the assets of the target company. often of about the same size. the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. From a legal point of view. the target company ceases to exist. generating a second company separately listed on a stock exchange. however. When one company takes over another and clearly established itself as the new owner. but since the company is acquired intact as a going business. of the target company being purchased. In the former case.

supply of the product remains high. During the panic of 1893. To avoid this decline in prices.In practice. This type of cooperation led to widespread horizontal integration amongst firms of the era. it was advantageous for firms to merge and reduce their transportation costs thus producing and transporting from one location rather than various sites of different companies as in the past. It is quite normal though for M&A deal communications to take place in a so called 'confidentiality bubble' whereby information flows are restricted due to confidentiality agreements (Harwood. technological changes prior to the merger movement within companies increased the efficient size of plants with capital intensive assembly lines allowing for economies of scale. Short-run factors One of the major short run factors that sparked in The Great Merger Movement was the desire to keep prices high. Focusing on mass production allowed firms to reduce unit costs to a much lower rate. when the target company does not want to be purchased . When demand for the good falls. Thus improved technology and transportation were forerunners to the Great Merger Movement. Usually.it is always regarded as an acquisition. The U. Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words. firms found it profitable to collude and manipulate supply to counter any changes in demand for the good. In addition. with many firms in a market. A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. actual mergers of equals don't happen very often. government passed the Sherman Act in 1890. as part of the deal's terms. 2006). Long-run factors In the long run. due to the desire to keep costs low. the demand declined. These firms usually were capitalintensive and had high fixed costs. This resulted in shipment directly to market from this one location. prices are driven down. setting rules against price fixing and monopolies . even if it is technically an acquisition. as illustrated by the classic supply and demand model. one company will buy another and. however. But when the deal is unfriendly . That is.S. the real difference lies in how the purchase is communicated to and received by the target company's board of directors. simply allow the acquired firm to proclaim that the action is a merger of equals. employees and shareholders.that is.

(3) Taxation advantages Mergers take place to have benefits of tax laws and company having accumulated losses may merge with a profit earning company that will shield the income from taxation. But critics hold that diversification caused by merger of companies does not benefit the shareholders as they can get better returns by having diversified portfolios by holding individual shares of these companies. Merger of Hindustan Computers. Such amalgamations result in creating conglomeratic undertakings. Eicher had the synergy advantage in merging with subsidiaries Eicher Good Earch. Thus. etc. the resultant economies are know as synergistic operating economies. (2) Diversification Mergers and acquisitions are motivated with the objective to diversify the activities so as to avoid putting all the eggs in one basket and obtain advantage of joining the resources for enhanced debt financing and better serviceability to shareholders. synergy is possible in areas viz. finance and technology. These gains are most likely to occur in horizontal mergers in which there are more chances for eliminating duplicate facilities. which lower the operating costs. combined sales offices. Vertical and conglomerate mergers do not offer these economies. production. Eicher Farm technology and finance as the company could borrow increased funds from banks and institutions. The worth of the combined undertaking should be greater than the sum of the worth of the two separate undertakings i. 1961 provides this incentive for reverse mergers for the survival of sick units. Hindustan Telecommunications and Indian Computer Software Company into HCL Limited exhibited synergy in transfer of technology and resources to enable the company to cut down imports of components at a fabulous duty of 198%. Synergy means working together. Section 72A of Income Tax Act. Similarly. staff facilities. Among others. 2+2 = 5. The gains obtained by working together by amalgamated undertakings result into synergistic operating gains. But when two undertakings combine their resources and efforts they may with combined efforts produce better results than two separate undertakings because of savings in operating costs viz. plants management. .e.Reasons for merger or takeover There is not one single reason for a merger or takeover but a multitude of reasons cause mergers and acquisitions which are precisely discussed below: (1) Synergistic operating economies It is assumed that existing undertakings are operating at a level below optimum. Hindustan Reprographics.

(5) Production capacity reduction To reduce capacity of production merger is sometimes used as a tool particularly during necessionary times as was in early 1980 in USA. (9) Other reasons There may be many other reasons motivating mergers in addition to the above ones viz. growth as a goal and many speculative goals etc. The acquirer may motivate managerial support by assuring benefits of larger size of the company to the managerial staff. status and perquisites as the enterprise grows and expands because their salaries. tax and accounting opportunities. Sometimes vertical mergers are done with the motive to secure source of raw material but acquirer may purchase the specific assets of the acquiree rather than acquiring the whole undertaking with assets and liabilities. (7) Acquisition of specific assets Surviving company may purchase only the assets of the other company in merger. acquirer shall be benefited by acquiring the assets of the company and selling them off subsequently. increasing market power.(4) Growth advantage Mergers and acquisitions are motivated with a view to sustain growth or to acquire growth. achieving efficiency. (i) the acquiree may be in possession of valuable land and property shown at depreciated value/historical costs in books of account which underestimates the current replacement value. perquisites and status often increase with the size of the enterprise. This practice is common in USA for over 25 years and quite in vogue in UK. It is known as management buyout. The resultant large company can offer better security for salary earners. There can be many situations to take over the assets of a company at discount viz. Management may raise capital from the market or institutions to acquire the company on the strength of its assets. The technique is used to nationalise traditional industries. (8) Acquisition by management or leveraged buyouts The acquisition of a company can be had by the management personnel. Thus. . (ii) to acquire non-profit making company. known as leveraged buyouts. (iii) the existing management is incapable of utilising the assets. profit enhancement for the company. risky and difficult than to acquire a company in a growth sector even though the acquisition is on premium rather than investing in a new assets or new establishments. To develop new areas becomes costly. The assets may also be acquired at a discount to obtain a going concern cheaply. (6) Managerial motivates Managers benefit in rank. the acquirer might take over ungeared company and increase its debt secured on acquiree’s assets. close down its loss making activities and sell off the profitable sector to make gains.

48 crores.depending upon the circumstances and prevailing conditions within the company and the economy of the country. (1) From the standpoint of shareholders Investments made by shareholders in the companies subject to merger should enhance in value. The factors which motivate the shareholders and managers to lend support to these combinations and the resultant consequences they have to bear are briefly noted below based on the research work done by various scholars globally.27 crores on merger in a new company called HCL equity of Rs. They can convert a closely-held and private limited company into a public company without contributing much wealth and without losing control.48 crores shares. perks and fringe benefits. . At the same time. (e) better investment opportunity in combinations. The promoters of Hindustan Computers were allotted shares worth Rs. In the above example of HCL. This gain was against their original investment of meagre Rs.e. (c) diversification of product line.40 lakhs in Hindustan Computers and they did not invest any money extra in getting shares worth Rs. through (a) realisation of monopoly profits.1. where managers have fear of displacement at the hands of new management in amalgamated company and also resultant depreciation from the merger then support from them becomes difficult. was public company whereas the other three merging entities were private limited companies. Motivation for mergers and acquisitions Mergers and acquisitions are caused with the support of shareholder. from the gains and achievements of the company i. Mergers where all these things are the guaranteed outcome get support from managers.1. the opportunity gains in alternative investments.1. (d) acquisition of human assets and other resources not available otherwise. The sale of shares from one company’s shareholders to another and holding investment in shares should give rise to greater values i. (b) economies of scale. (2) From the standpoint of managers Managers are concerned with improving operations of the company managing the affairs of the company effectively for all round gains and growth of the company which will provide them better deals in raising their status. (3) Promoters’ gains Mergers do offer to company promoters the advantage of increasing the size of their company and the financial structure and strength. Shareholders may gain from merger in different ways viz. only Hindustan Reprographics Ltd.e. managers and promoters of the combining companies.

merger of companies provides in the form of employment. better living conditions and amenities. increased wages. The balance of benefits in favour of consumers will depend upon the fact whether or not the mergers increase or decrease competitive economic and productive activity which directly affect the degree of welfare of the consumers through changes in price levels. preventing the distribution of benefits resulting from diversification of production activity. quality of products. Such monopolists affect social and political environment to tilt everything in their favour to maintain their power and expand their business empire. enhanced economies and diversification leading to lower costs and better quality products) are passed on to consumers in the form of lower prices and better quality of the product which directly raise their standard of living and quality of life.e. Diversification fosters and provides opportunities for advancement in career. Economic power is to be understood in specific limited sense as the ability to control prices and industries output as monopolists. merges with cash payment to shareholders provide opportunities for them to invest this money in other companies which will generate further employment and growth to the uplift of the economy in general. (3) General public affected in general having not been user or consumer of the worker in the companies under merger plan. The merger or acquisition of a company by a conglomerate or other acquiring company may have the effect on both the sides of increasing the welfare in the form of enhanced quality of life or decrease the welfare by creating unemployment through retrenchment and resultant lack of purchasing power and other miseries of life. (1) Consumers The economic gains realised from mergers (i. Both workers and communities will suffer on lessening job opportunities. training in new skills amount may other alike benefits. Secondly. But in a free economy a monopolist does not stay for a longer period as other companies enter into the . environmental improvements. (2) Workers of the companies under combination. (3) General Public Mergers result into centralised concentration of power in small number of corporate leaders which results in the concentration of an enormous aggregation of economic power in their hands. These advances result into deceleration of level of welfare and well being of the general public which are subjected to economic exploitation.Impact of mergers on general public Impact of mergers on general public could be viewed as aspect of benefits and costs to: (1) Consumers of the product of services. after sales service. etc. Two sides of the impact as discussed by the researchers and academicians are: first. any restrictions placed on such mergers will decrease the growth and investment activity with corresponding decrease in employment. (2) Workers community The benefit or loss from mergers to worker community will depend upon the level of satisfaction of their demands.

These values are determined for the most part by looking at a company's balance sheet and/or income statement and withdrawing the appropriate information. This enforces competition in the market as consumers are free to substitute the alternative products. future maintainable earnings valuation. . more detailed ways of expressing the value of a business. These reports generally get more detailed and expensive as the size of a company increases. Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. this is not always the case as there are many complicated industries which require more attention to detail. however. consumers and does not create hindrance in administration of the Government policies. it is difficult to generalise that mergers affect the welfare of general public adversely or favourably. There are other. as well as possibly others that are not mentioned above. Therefore. regardless of size. in order to obtain a more accurate value. merger of two or more companies has to be viewed from different angles in the business practices which protects the interest of the shareholders in the merging company and also serves the national purpose to add to the welfare of the employees. a Review Engagement or an Audit. Business valuation The five most common ways to valuate a business are • • • • • asset valuation. Most often this information is expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's sake. historical earnings valuation. Every. discounted cash flow (DCF) valuation Professionals who valuate businesses generally do not use just one of these methods but a combination of some of them. relative valuation (comparable company & comparable transactions). The information in the balance sheet or income statement is obtained by one of three accounting measures: a Notice to Reader.field to reap the benefits of high prices set in by the monopolist.

Various methods of financing an M&A deal exist: Cash Payment by cash. and the debt will often be moved down onto the balance sheet of the acquired company. Hybrids An acquisition can involve a combination of cash and debt. But a caveat in using cash is that it places constraints on the cash flow of the company. Acquisitions financed through debt are known as leveraged buyouts if they take the target private. A cash deal would make more sense during a downward trend in the interest rates. the sick company’s survival becomes more important for many strategic reasons and to conserve community interest. The law provides encouragement through tax relief for the companies that are profitable but get merged with the loss making . But in many cases. As a consequence of this merger the profit earning company survives and the loss making company extinguishes its existence. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders alone. Financing Financing capital may be borrowed from a bank. Another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. or a combination of cash and stock of the purchasing entity. the acquirer's stock may be offered as consideration. a company with the track record should have a less profit earning or loss making but viable company amalgamated with it to have benefits of economies of scale of production and marketing network.Financing M&A Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. or raised by an issue of bonds. Factoring Factoring can provide the necessary extra to make a merger or sale work. Reverse Merger Generally. etc. Alternatively.

the new bank would have reached the no. negotiations for a merger between Deutsche and Dresdner Bank failed on April 5. 2000 between Deutsche Bank and Dresdner Bank.2 trillion marks and also in front of the planned Japanese book mergers of Sumitomo and Sukura Bank with 1. called as a Reverse Merger. The merged bank was to retain the name Deutsche Bank but adopted the Dresdner Bank’s green corporate color in its logo.5 trillion marks and a stock market value around 150 billion marks. where the new banking group was hoped to outside the traditionally dominant Swiss Bank.S. The new banking group intended to spin off its retail banking which was not making much profit in both the banks and costly.7 trillion marks as the balance sheet total. with a balance sheet total amounting to 1. asset management. This would put the merged bank for ahead of the second largest banking group. Infact this type of merger is not a normal or a routine merger. Security and loan banking and finally financially corporate clients ranging from major industrial corporation to the midscale companies.1 position of the US and create new dimensions of aggressiveness in the international mergers. Deutsche – Dresdner Bank (Merger Failure) The merger that was announced on march 7. The merger was to create the most powerful banking group in the world with the balance sheet total of nearly 2. extensive network of bank branches associated with it. 2000. usually one with no business and limited assets. With this kind of merger.companies. based citigroup. Germany’s largest and the third largest bank respectively was considered as Germany’s response to increasingly tough competition markets. and together they become an entirely new public corporation with tradable shares. The private company reverse merges into the public company. But barely 2 months after announcing their agreement to form the largest bank in the world. therefore. It is. A reverse merger occurs when a private company that has strong prospects and is eager to rise financing buys a publicly listed shell company. U. The future core business lines of the new merged Bank included investment Banking. .

The more negotiations over the merger—which at first had only been roughly discussed in a small circle— turned to the details. Many started to look around for new employers offering safer prospects. After a short initial rise. the more open the contradictions and differences became. rising over 20 percent on the first day after news of the agreement to merge. the pressure from the workforce increased. The dependency of their salary levels on the banks' share value (now sinking) also played a role. stated that this type of merger would "set free too little synergy". Although they intended a reduction of 16. which would retain the majority of the two banks' smaller customers. the share values of the two institutions slumped by almost 30 percent. The Allianz is also interested in the retail banking business. A third point concerned asset management. the Dresdner Bank would have had to go down. In return for its share of the Dresdner Bank. There were several demonstrations by bank staff as it became increasingly clear that it was mainly Dresdner Bank employees from the branches and central administration who were on the blacklist. The reduction of 16.What happened? The union of the two previous competitors should be carried out "by agreement”. the international investors rejected this concept of a socially acceptable merger. the asset management arm of the Deutsche Bank. This was insisted upon by both the union representatives on the supervisory board as well. One banking analyst explained that in order to obtain the "large reduction of costs necessary". Germany's market leader with investments of 175 billion marks. this was to proceed by "socially acceptable" means. The boards of directors also lost control concerning the distribution of highly paid jobs in middle management. 20 % 30 % . which has become unattractive to the banks.000 jobs. It owns a 21. The Allianz had contrived the merger plans and was regarded as the actual winner.000 jobs announced could only have been the start. the Allianz was to receive DWS. it was intended that the Allianz would take a majority holding in the new Bank 24.7 percent share in the Dresdner Bank and has wanted to dispose of this for some time in order to concentrate on its own business. In the merger plan. From the outset. Banking analysts. in order to utilise these structures to sell their insurance. Only the shares of the insurance company Allianz AG increased. Shareholders of the two banks did not look kindly on the fact that the Allianz was to receive the golden egg without requiring any effort of its own. on whose assessments large investors rely. areas that overlapped should not be shut down or broken up but merged and integrated. On the one hand.

which the executive committee of the Dresdner Bank did not want to relinquish under any circumstances. The investment business is driven by expert teams. Many customers consequently moved their accounts over to the competition.500 workforce will be taken over.000 marks. so that only those succeed who score above the average. "Either Dresdner Kleinwort Benson is completely sold off. also situated in London. Deutsche Bank was among the top 10 in the world.i. which in the past year amounted to about 2. But from the outset these considerations encountered resistance in the leading echelons of Deutsche Asset Management. without losing profits. which serves internationally mobile investors.There was a nation-wide outcry by customers after a member of the Dresdner board announced that the merged bank was only interested in customers with over 200. Among the leading staff. Deutsche Asset Management had only just integrated London's Morgan Grenfell and the American Bankers Trust. acquisitions and floatations—forms part of the most profitable business of the financial markets. International comparisons are constantly drawn in this market. In the preliminary negotiations it had been agreed that DKB would be integrated into the new major bank. Over 50 percent of bank profits are made within this area. We will not let our business be ruined. The main point at issue became the fate of the bank's investment arm. the Deutsche Bank's investment arm. investment banking. DKB (Dresdner Kleinwort Benson). Those with less would be transferred to the new Bank 24. aggressively headhunting whole teams of investment bankers with top salaries. the administration and controlling departments would have almost completely overlapped with the structures of Deutsche Bank. There would only have been jobs for some of the expert teams. Moreover. so that almost nobody from DKB could have been taken over into Deutsche Asset Management. nobody was prepared for a new round of haggling for positions with the people from DKB. Another version is out of the question. with high profits arising from the stock market boom and the rapidly increasing wave of mergers.e.6 billion euro. this division alone now contributed over 60 percent of Deutsche Bank's profits. Breuer wanted to position the new bank at the highest place internationally in this sector. In this area. The top people at Deutsche Asset Management were not ready to undertake a new process of integration with DKB. the trade with securities and the consultancy business concerning mergers. which concentrate on certain industries or countries. Apart from asset management. Meanwhile. which had already developed to be a global player." were widespread opinions. . or at the most a few hundreds of its 7. Only in this way is it possible to grow or even survive in this hotly contested market. the so-called benchmark.

he placed himself completely on the side of Ackermann. continued to exert enormous pressure on Breuer via Joseph Ackermann. At the last joint session of the two boards of directors on April 5. they immediately dispatched a message via the Financial Times that either the DKB was smashed up or sold off. which led to the withdrawal of the Dresdner Bank from the merger negotiations. the otherwise independent and self-assured Breuer stepped forward with trembling voice to publicly explain the failure of the merger. Made to look foolish by his own staff. After the merger was announced. Tender Offer The acquirer pursues takeover without consent of the acquiree company by making a tender offer directly to the shareholders of the target company to sell (tender) their shares. of course. Procedure of organising takeover bids The procedure for organising takeover bids as narrated in the following paragraphs is based on international practices in particular the City Code. Breuer had to publicly assure the distrustful Walter that statements about the sale of DKB were "absolute nonsense" and that this company was a "jewel". PARTIAL BID Partial bid is understood when a bid is made for acquiring part of the shares of a class of capital where the offeror intends to obtain effective control of the offeree through voting power. Such bid is made for equity shares carrying voting rights. Walter from the Dresdner Bank was not prepared for this. Finally. once an understanding is developed. However. Their division head Edson Mitchell. the procedure should be streamlined in terms of the SEBI Takeover Regulations.The Deutsche Bank's London investment bankers were not prepared to compromise and used the weight of the share they contributed to the profits to pressure Breuer. the division's chief executive. since DKB was considered his "pearl". COMPETITIVE BID Competitive bid can be made by any person within 2 1 days of public announcement of the offer made by the acquirer. However. one of the most successful investment bankers with an annual salary of over 10 million marks. At a press conference on March 9. Breuer did not succeed in getting the investment bankers onto his side. Breuer capitulated to the pressure of his subordinates. do not lay down the procedure but . 1997 which.

. tax and legal angles. If the directors of the target Company cooperate.prescribe a restrictive drill to safeguard the interests of the investors and shareholder. and keep the information and appraisal results top secret. (1) Collection of relevant information and its analysis The potential bidder should collect all possible relevant information on the target or offeree company. (3) Investigation of title and searches into indebtedness Potential bidder should also have the searches carried out in Land Registry Office and Registrar of Companies office to find out the extent of encumbrance on offeree's properties and the indebtedness. This will ensure friendly takeover. the number and weight of institutional investors and small shareholders. it can also trace the dividend register to find out number of shareholders not traceable to design the course of its bid. (5) Representation on board The potential bidder should ensure first his entry or representation on the board of the offeree company and should win over some of the directors on the board to the suggested changes and explore possibility of offer being successfully discussed on the board for takeover bid on convenient terms. The following steps generally take place in a takeover bid.e. (4) Examining of articles of association The offeror should also examine the Articles of Association of the offeree company to ascertain the extent of power of directors with regard to borrowing restrictions. (2) Examine shareholders' profile Potential bidder should examine the share register of the target company and see the profile of the shareholders i. analyse the information through experts from financial. accounting. etc.

the directors can also bring the fact tot he notice of the shareholders.(6) Press announcement Once the board of the offeree company shows a sympathetic view. The offeror will take further steps for registration of shares in its own name as per provisions of the Companies Act. the merits of the takeover or merger and the advantages which will accrue to them from such amalgamation. (7) Approval under FEMA Necessary approvals under the Foreign Exchange Management Act. the joint preliminary announcement could be made for awareness of shareholders of the main terms of the offer. 2000. etc. group of shareholders oppose the proposal for bid. (11) Despatch of consideration With a view to complete the transaction with the shareholders of the offeree company the bidder should despatch consideration for the shares in the offeree company to the shareholders who have accepted the offer and submitted valid acceptances with the share certificates or other documents of title. primarily under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations. (10) Information about acceptance The takeover offer is open for a limited time within which it should be accepted by the shareholders. (9) Improvement of conditions by offeror In case a. . (8) Recommendations to shareholders Once the board of the offeree company agrees to the takeover bid it can bring to the notice of shareholders through circular. 1999 are required to be take by the companies. 1956 Stock Exchange Rules & Regulations. In case the board does not approve of the move. The offeror should announce information about the acceptance for the knowledge of shareholders to know the response in its favour and make their own judgement. the offeror can circularise its rejoinder to the criticism of the bid and alternatively can announce improvement of the bid conditions through press.

For defence strategy it is common practice to revalue the assets periodically and incorporate them in the balance sheet.A. The company should use liquid resources for financial acquisition of assets. for raising expectations for higher dividend. etc. therefore. (iv) Capital structure reorganization Proper capital structure is essential for enhanced profitability and brightening of the dividend prospects. or distribute the surplus to shareholders through bonus and rights issues. The company should. Company may take suitable steps to replace preference capital by loan capital. automatically. This will. etc. The threatened company should keep their shareholders abreast of all latest developments particularly about the financial strength of the company as evidenced by market coverage. expansion programme. 1956 declaration of final dividend is to be done at the annual general meeting of a company but interim dividend can be declared by the board to indicate the clear intentions of the company for stepping up the dividend. replacements. the company should in advance declare interim dividend and meet all statutory requirements of stock exchange of giving advance information and deciding date of closure of register of members. After attempt of takeover bid. product demand. Such valuation should be attested by recognized values. Disclosure of all these favourable aspects will keep the shareholders in good humour and they will always side with the existing management dislodging all the takeover bids. In those cases where the company has excess liquidity there are chances of takeover raids. bolster up the price of its shares and frustrate the takeover bid. COMMERCIAL STRATEGIES (i) Dissemination of favourable information To have defence against the offeror being critical of the company’s past performance the target company should be ready with profits forecast and performance information to demolish the offeror’s arguments. (iii) Revaluation of Assets Assets shown at depreciated historical costs in financial accounts understate the real value of assets. industry outlook and resultant profit forecast and value appreciation. In pursuance of the provisions of the Companies Act. The company should have expert advice from financial . (ii) Step up dividend and update share price record The fall in the market price of shares might occur due to restrictive dividend policy of the company. etc. the disclosure might miss the reliability and significance and invite criticism of directors keeping the shareholders in dark. Capital structure which is under geared or geared with tax inefficient preference capital instead of debenture stock or term loans exhibits poor financial performance of the company and is required to be reorganized for proper gearing and tax efficiency.

consultants on the issue of capital restructuring before implementing any conceived plan to thwart away the takeover bid. This agreement is entered into in collaboration with or with the cooperation of offeree company’s directors who wish to exercise effective control of the company. the directors issue block of shares to their friends and associates to continue maintaining their controlling interest and as a safeguard to the threads of dislodging their control position. Such companies shall fall within the same management control and attract provisions of section 372 of the Companies Act. If the interlocking of shareholdings is accompanied by joint voting agreement then the joint system of advance defence could be termed as ‘pyramiding’ as most safe device of defence. ISSUE OF BLOCK OF SHARES TO FRIENDS AND ASSOCIATES With a view to forestall a takeover bid. specific losses. new business avenues. (vi) Other commercial aspects The target company’s management in its defence strategy should. skipping of dividend. JOINT HOLDINGS OR JOINT VOTING AGREEMENT Two or more major shareholders may enter into agreement for block voting or block sale of shares rather than separate voting or separate sale of shares. inter alia. trace out the various discouraging commercial features of the functioning of the offeror company which may convince its own shareholders to thwart away the take over bid and at the same time should highlight own favourable commercial aspects with optimistic and promising futuristic view like new product development. B. The management style. C. 1956. etc. (v) Unsuitability of offeror Research based arguments should be prepared to show and convince the shareholders that the offeror is incapable of managing the business efficiently. This may also be done by issue of rights shares. A. lower market experience and other similar denouncing factors should be highlighted about the offeror and its associate concerns. INTERLOCKING SHAREHOLDINGS OR CROSS SHAREHOLDINGS Two or more group companies acquire shares of each other in large quantity or one company may distribute shares to the shareholders of its group company to avoid threads of takeover bids. prospects and future growth. . the profit and dividend record of the offeror in existing companies should be focussed particularly.

Non-voting shares are a convenient method of providing for any desired adjustment of control on a merger of two companies. G. Management may retain shares with voting rights so that takeover bid could be thwarted away without voting support.D. 1956. options or warrants because liability towards repayments of principal and payment of interest discourages takeover bids. non-voting right shares are only of one variety i. SHARES WITH NON-VOTING RIGHTS LIKE PREFERENCE SHARES In India. E. . This is possibly dine by putting the assets outside the control of the shareholders by entering into various types of financial arrangements like sale and lease back. For this purpose they put large block of shares of their own company in the hands of shareholders of the friendly company to make their own company least attractive for takeover bid. keeping the assets in trust for security of debenture. This type of behaviour on the part of the directors of the company elicit confidence of shareholders in their management and control which will in many ways help prevent any takeover bid to set in or to succeed.e. F. so far. CONVERTIBLE SECURITIES To make the company less attractive to corporate raiders. loan. preference shares or cumulative convertible preference shares as against a wide variety of restricted or weighted voting rights equity shares under English Company Law. This is so because any successful bidde can’t acquire compulsorily convertible securities. The dissemination of information about the company’s favourable features of operations and profitability go a long way in bringing the market price of share nearer to its true assets value. H. etc. it is necessary that its capital structure should contain loan capital by way of debentures either convertible in part or full or non-convertible. it is necessary that true earning position of the company should be told to them through press media or direct communications to ensure continuity of their interest in the management set up of the company. DEFENSIVE MERGER The directors of a threadtened company may acquire another company for shares as a defensive measure to forestall the unwelcome takeover bid. DEFERMENT OF SHAREHOLDERS COMPANY’S ASSETS CONTROL OVER THE Prudent board of directors make the chances of any takeover bid in near future dim by making the possession of the company’s assets less attractive. mortgage of the assets to financial institutions for long-term loans. This is done with the specific approval of shareholders in their general meetings in pursuance of sections 293(1) (a) and (b) of the Companies Act. DISSEMINATION TO SHAREHOLDERS OF FAVORABLE FINANCIAL INFORMATION To make the investors and the shareholders aware.

technical and financial executives. Many times. displacement of managerial. 1956. (i) TACTICAL DEFENCE STRATEGIES Friendly purchase of shares To stave off the takeover bid the directors of the company may persuade their friends and relatives to purchase the shares of the offeree company as they themselves cannot indulge into the g onal attachments. Particularly. For . loyalty and patriotism To ward off takeover bids. B. Much will depend upon economic circumstances. institutional shareholders might yield to these reasoning. the bidder will have to pay handsome compensation for terminating the agreement or the technical assistance or services provided under the said agreement might not be made available by any other outside party. such appeal works well to raise sentiments of shareholders to support the board of directors and confide with the management. In view of these circumstances the takeover game becomes unattractive to the bidders. To sum up. 1956 or the rules framed thereunder for rendering service over a period of time. Similarly. LONG-TERM SERVICE AGREEMENTS Directors having specialised skills in any specific technical field may enter into contract with the company with specific approval of shareholders and/or the Central Government under the Companies Act. shifting work place and all possible miseries resulting from the successful takeover bid.I. etc. the prospective bidder would not be attracted due to the fear of non-cooperation by such directors if the company is acquired without personal involvement of such directors and secondly. takeover bid from a foreign controlled company could be warded off by invoking national interest and emotional feelings. it is the responsibility of the directors to accept a takeover bid or thwart it away in the interest of the company. independence of business and goodwill. the board may make attempt to win over the shareholders through raising their emotions for continued association and attachment with the company as shareholder and raising fearsin their mind towards changes of the name of the company. In averting the takeover bid the directors are not absolved of their liability under the law for making any wrong statements and painting in words any unrealistic position into high hopes for the future of the company. political climate and the prospects of the trade in which the company is engaged. Arguments could also be made of the possible consequences which follow on takeover like retrenchment of work force. (iii) Recourse to legal action To dissuade the corporate raider. There are two significant aspects of such an agreement viz. the target company can refuse registration of transfer of any of the grounds given under relevant sections of the Companies Act.

The company. (vii) Compensation packages viz: “Golden Parachutes” or “First Class Passengers” strategy The term “Golden Parachute” again was coined in USA. profit forecasts made by them in the context of fighting off the takeover bid should be realistic. the company is said to offer golden parachutes. . as a defence strategy. This reduces their resistance to take over. It envisages a termination package for senior executives and is used as a protection to the directors of the company against the takeover bids. When a company offers hefty compensations to its managers if they got ousted due to takeover. (iv) Operation ‘White Knights’ White knight: A target company is said to use a white knight when its management offers to be acquired by a friendly company to escape from a hostile takeover. sells these valuable assets at its own initiative leaving the rest of the company intact. . Instead of them or mortgage them to creditors so that the attraction of free assets to the predator is over. In some countries such as the UK. In other words. The hostile acquirer may replace the management (v) Disposing of “Crown Jewels” The precious assets in the company are called “Crown Jewels” to depict the greed of the acquirer under the takeover bid.example. These precious assets attract the raider to bid for the company’s control. The term is known as “first class passengers’ in UK. (vi) ‘Pac-man' strategy This term was coined in America in 1982. This defence is very much in vogue in UK but subject to regulations of ‘City Code’. The possible motive for the management of the target company to do so is not to lose the management of the company. they should not indulge in fraudulent acts against the interest of the shareholders. The term “crown jewels” was coined in USA in 1982. This happens when the target company is quite larget than the predator. Under this strategy the target company attempts to takeover the hostile raider. This strategy is adopted as a precautionary measure by the companies in USA and UK to make the takeover bid very expensive. in its own interest. such tactic is not allowed once the deal becomes knows and it unavoidable. based on viable assumptions.

The management of the Target Company may offer the acquirer for its shares a price higher than the market price. There are many variants in this strategy. Another example. For example. the target company may adopt a combination of various strategies for successfully averting the acquisition bid. US companies adopt this tactic as a precautionary measure against prospective bids. The tactics used by the acquiring company to make itself unattractive to a potential bidder is called poison pills. To sum up. as a tactical strategy. The task of the bidder would become difficult since the number of shares to have voting control of the company will increase substantially. shareholders approvals for approving combination proposal is fixed at minimum by 80-95% of the shareholders and to call shareholders meeting for this purpose 75% of the board of directors consent is needed. which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. Grey knight (xii) A friendly party of the target company who seeks to takeover the predator. (ix) Swallowing “Poison Pills” strategy An acquiring company itself could become a target when it is bidding for another company. the acquiring company may issue substantial amount of convertible debentures to its existing shareholders to be converted to its existing shareholders to be converted at a future date when it faces a takeover threat. (x) Green mail A large block of shares is held by an unfriendly company. For example. For example. the target company might issue convertible securities which are converted into equity to deter the efforts of the offeror because such conversion dilutes the bidder’s shares and discourages acquisition.(viii) “Shark repellent” character The companies change and amend their bye-laws and regulations to be less attractive for the corporate raider company. target company might raise borrowings distorting normal debt: equity ratio. Such features in the bye-laws are called “Shark Repellent” character. (xi) Poison put A covenant allowing the bond holder to demand repayment in the event of a hostile takeover. All the above strategies are experience based . Greenmail refers to an incentive offered by management of the target company to the potential bidder for not pursuing the takeover. In a takeover bid this could prove to be an expensive defence mechanism.

(VP + VQ)]. .. cash paid – VQ = 0. For P. Thus. the above list is not exhaustive but only illustrative. subsidiary company. i. • Divestiture: In a divestiture the target company divests or spins off some of its businesses in the form of an independent. If the acquiring firm pays cash equal to the value of the acquired firm. the cost of merging to P is [Cash paid . if firm P and firm Q merge. VQ. Value Created by Merger A merger will make economic sense to the acquiring firm if its shareholders benefit. the acquiring and the acquired firm may share the economic advantage between themselves. Merger will create an economic advantage (EA) when the combined present value of the merged firms is greater than the sum of their individual present values as separate entities. In different circumstances and even.e. For example. and they are separately worth V P and VQ. represents the benefits resulting from operating efficiencies and synergy when two firms merge. respectively. the scope for evolving more rapid strategies always remains for the target companies to defend their existence against takeover bids..(VP + VQ) – (cash paid – VQ) The economic advantage i. [VPQ . Thus Net economic advantage = economic advantage – cost of merging NEA = [VPQ . but it will also have to pay a price (say in cash) to Q.(VP + VQ) Suppose that firm P acquires firm Q.and have been successfully used in developed nations. After merger P will gain the present value of Q i. then the economic advantage will occur if: VPQ > (VP + VQ) and it will equal to: EA = VPQ . the net economic advantage of merger (NEA) is positive if the economic advantage exceeds the cost of merging. particularly in USA or UK and some of them have been tested in critical times by the companies in India also.e. and worth VPQ in combination. then the entire advantage of merger will accrue to the shareholders of the acquiring firm. Thus.e. it reduces the attractiveness of the existing business to the acquirer. In practice.VQ]. Nevertheless.

18 X X .15 = Rs. Rs.166.150 market value per share).0.Example 1 Firm P has a total market value of Rs..1463 = Rs. The acquiring firm incurs a cost (in buying the business of the target firm) in the expectation of a stream of benefits (in the form of cash flows) in the future.3) = (4 – 1. in example 1. Now Firm P after merger will have 15 lakh shares of total value of Rs. 170.63 lakh x Rs. 170. What is the net economic advantage to Firm P if it acquired Firm Q? It is the difference between the economic advantage and the cost of merger to P: NEA = [25 – (18+3)] – (4. Rs. Thus. Thus. The acquiring firm can issue shared to the target firm instead of paying cash.67 x 3 lakh).5 crore/Rs..3 crore (5 lakh of Rs.166. What is the value of the target firm to the acquiring firm after merger? This value should include the effect of operating efficiencies and synergy.5 crore The economic advantage of Rs. following the discounted cash flow (DCF) approach. Firm P is required to pay Rs. Thus. Firm Q will get 2. Rs. merger is special type of capital budgeting decision. the effective cost of merger may be more when the merger is financed by issuing shares rather than paying cash.170. the combined value of the merged firms) is expected to be Rs.25 crore due to the operating efficiencies. 3 crore = Rs.4.e. Rs.. the acquiring firm is buying the business of the target firm. 150) of the acquiring Firm P.2 crore (i.5 crore less the value of the acquired firm.63 lakh shares of Rs. In example.9) – Rs. …………… X = 12 + 0. The effect will be the same if the shares are exchanged in the ratio of cash-to-be-paid to combined value of the merged firms. 3 crore). The cost of merger of Firm P is Rs. Firm Q has a total market value of Rs.5 crore (i. The worth of shares given to the shareholders of Firm Q will be Rs.4. The acquiring firm should appraise merger as a capital budgeting decision. 2. In practice. Rs.e.000 shares (i.60 market value per share).82 = 14. .67.25/0. Firm Q may require 300. Thus. rather than a specific asset.5 crore.25 crore.5 crore to acquire Firm Q. the cost of acquisitions to Firm P remains the same: (2. Firm P is considering the acquisition of Firm Q.5 crore and the target firm.e. DCF Evaluation of mergers In a merger or acquisition. the value of share exchanged.18 crore (12 lakh shares of Rs.1. the number of shares to be exchanged may be based on the current market value of the acquiring firm.18 X = 12 X = 12/0.5) = Rs.63 lakh shares And the new shares price will be: 25/0.9 each. 1.2. The value of P after merger (that is. The new share price will be: Rs.5 crore.5 .4 crore is divided between the acquiring firm Rs.9.

Cash flows include adjustments for depreciation.The merger will be advantageous to the acquiring company if the present value of the target merger is greater than the cost of acquisition. the following steps are involved in the financial evaluation of a merger: • • • • • • • Identify growth and profitability assumptions and scenarios Project cash flows magnitudes and their timing Estimate the cost of capital Compute NPV for each scenario Decide if the acquisition is attractive on the basis of NPV Decide if the acquisitions should be financed through cash or exchange of shares Evaluate the impact of the merger on EPS and price-earnings ratio. The methodology for calculating the cost of capital has been discussed in the Lesson. T tax rate. The appropriate discount rate depends on the riskiness of the cash flows. the share exchange ratio (SER) would be as follows: Share price of the acquired firm Pb Share exchange ratio = Share price of the acquiring firm = Pb . Since the cash flows are expected from the target firm’s operation. In summary. Consider the case of Sarangi Engineering and XL Equipment Company in example 2 for an approach for the financial evaluation of a merger. DCF approach is an important tool in analyzing mergers and acquisitions. • • • Estimation of cash flows Timing of cash flows Discount rate Earnings are the basis for estimating cash flows. Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. net cash flows (NCF) or free cash flows can be calculated as follows: NCF = EBIT (1 . In order to apply DCF technique.T) + DEP – Δ NWC – Δ CAPEX Where EBIT is earnings before interest and tax. the following information is required. As discussed in the earlier lesson. its cost of capital should be calculated for discounting the cash flows. Δ NWC ………………………… capital expenditure. As discussed earlier. Nevertheless. Exchange Ratio The current market values of the acquiring and the acquired firms may be taken as the basis for exchange of shares. DEP depreciation. capital expenditure and working capital.

A refusal to register transfer is permitted • • • • A legal requirement relating to the transfer of shares have not be compiled with. the Foreign Exchange Regulation Act (FERA). the Income Tax Act. For the shareholders of the acquiring firm to be better-off after the merger without any net economic gain either the price-earnings ratio will have to increase sufficiently higher or the share exchange ratio is low. acquisitions and takeovers. or The transfer is not in the interest of the company and the public. 1956. the Central Government needs to be intimated whenever such holding exceeds 10 per cent of the subscribed capital. could the acquiring company pay a premium and be better off in terms of the additional value of its shareholders? In the absence of net economic gain. The Companies Act also provides for the approval of shareholders and the Central Government when a company. or The transfer is in contravention of the law. particularly minority shareholders. the shareholders of the acquiring company would become worse-off unless the price-earnings ratio of the acquiring company remains the same as before the merger. . or The transfer is prohibited by a court order. and the Securities and Controls (Regulations) Act. Refusal to Register the Transfer of Shares In order to defuse situation of hostile takeover attempts. The Securities and Exchange Board in India (SEBI) has issued guidelines to regulate mergers. a company must inform the transferee and the transferor within 60 days. These are precautionary measures against the takeover of pubic limited companies. together with the shares held earlier. Legal Measures against Takeovers The Companies Act restricts and individual or a company or a group of individuals from acquiring shares. There is no incentive for the shareholders of the acquired firm. companies have been given power to refuse to register the transfer of shares. in a public company to 25 per cent of the total paid-up capital. If this is done. 1969. In India. The approval of the Central Government is necessary if such investment exceeds 10 per cent of the subscribed capital of another company. Also. and they would require a premium to be paid by the acquiring company. by itself or in association of an individual or individuals purchases shares of another company in excess of its specified limit. 1973. the Monopolies and Restrictive Trade Practice (MRTP) Act.The exchange ratio in terms of the market value of shares will keep the position of the shareholders in value terms unchanged after the merger since their proportionate wealth would remain at the pre-merger level. 1956. the price-earnings into remaining the same. mergers and acquisitions are regulatedthrough the provision of the Companies Act. Regulation of Mergers and Takeover in India Mergers and acquisitions may degenerate into the exploitation of shareholders. 1961.

The Companies Act provides that a purchaser can force the minority shareholder to sell their shares it: • • • The offer has been made to the shareholders of the company.Protection of Minority Shareholders’ Interests In a takeover bid. within 4 months of making the offer. The larger shareholders (including financial institutions. the target company and the stock exchange shall be notified immediately. Limit to share acquisition: An individual or a company can continue acquiring the shares of another company without making any offer to other shareholders until the individual or the company acquires 10 per cent of the voting capital. banks and individuals) may get most of the benefits because of their accessibility to the brokers and the takeover deal makers. besides holding at least 90 per cent of the value of shares should also form at least 75 per cent of the total holders of shares. Guidelines for Takeovers SEBI has provided guidelines for takeovers. it may be too late for them. • • . The guidelines have been strengthened recently to protect the interests of the shareholders from takeovers. If the purchaser is already in possession of more than 90 per cent of the aggregate value of all the shares of the company. a public offer to purchase a minimum of 20 per cent of the shares shall be made to the remaining shareholders through a public announcement. Public Offer: If the holding of the acquiring company exceeds 10 per cent. The offer has been approved by at least 90 per cent of the shareholders of the company whose transfer is involved. The salient features of the guidelines are: • Notification of takeover: If an individual or a company acquires 5 per cent or more of the voting capital of a company. and The minority shareholders have been intimated within 2 months from the expiry of 4 months referred above. the interests of all shareholders should be protected without a prejudice to genuine takeovers. It would be unfair if the same high price is not offered to all the shareholders of prospective acquired company. Before the small shareholders know about the proposal. the transfer of the shares of minority shareholders is possible if: • • The purchaser offers the same terms of all shareholders and The tenders who approve the transfer.

and the information should be make available to all the shareholders at the same time and in the same manner. the minimum offer price shall not be less than the average of the weekly high and low of the closing prices during the last six months preceding the date of announcement. board or directors and the Company Law Board before affecting the merger. Once the offer is make to other shareholders. the offer price should not be less than the weekly average price in the past 6 months or the negotiated price. the offer’s financial information.• Offer price: Once the offer is made to the remaining shareholders. 1956: Permission for merger: Two or more companies can amalgamate only when amalgamation is permitted under their memorandum of association. Information to the stock exchange: The acquiring and the acquired companies should inform the stock exchanges where they are listed about the merger. identity of the offerer. in the absence of these provisions in the memorandum of association. particularly the small shareholders. an individual or company can continue to purchase the share without making and offer to other shareholders until the shareholding exceeds 10 per cent. its intention to continue the offeree company’s business and to make major change and long-term commercial justification for the offer. Offer document: The offer document should contain. it is necessary to seek the permission of the shareholders. Disclosure: The offer should disclose the detailed terms of the offer. Application in the High Court: An application for approving the draft amalgamation proposal duly approved by the boards of directors of the individual companies should be made to the High Court. Legal Procedures The following is the summary of legal procedures for merger or acquisition laid down in the Companies Act. details of the offerer’s existing holdings in the offeree company etc. Also. the acquiring company should have the permission in its object clause to carry on the business of the acquired company. • • The objectives of the Companies Act and the guidelines for takeover are to ensure full disclosure about the mergers and takeovers and to protect the interests of the shareholders. In a nutshell. The High Court would convene a meeting of the shareholders . Approval of board of directors: The boards of the directors of the individual companies should approve the draft proposal for amalgamation and authorize the management of companies to further pursue the proposal. The main thrust is that public authorities should be notified within two days.

The merger should be structured as pooling of interest. Payment by cash or securities: As per the proposal. Accounting for Mergers and Acquisitions Mergers and acquisitions involve complex accounting treatment. Filling of the Court Order: After the Court order. the balance sheet items and the profit and loss items of the merged firms are combined without recording the effects of merger. on the petitions of the companies. Sanction by the High Court: After the approval of shareholders and creditors. its certified true copies will be filed with the Registrar of Companies. the acquiring company will exchange shares and debentures and/or pay cash for the shares and debentures of the acquired company. there is no revaluation of assets or creation of goodwill. which results in the uniting of the interests of the two companies. voting in person or by proxy. If it deems so. The date of the court’s hearing will be published in two newspapers and also. This implies that assets. 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. must accord their approval to the scheme. In the case of acquisition. At least. involves the absorption of the target company by the acquiring company. where the acquiring company purchases the shares of the target company. with effect from the specified date. These securities will be listed on the stock exchange. 75 per cent of shareholders and creditors in separate meeting.and creditors to approve the amalgamation proposal. defined as amalgamation in India. Thus. it can modify the scheme. The notice of meeting should be sent to them at least 21 days in advance. Shareholders’ and creditors’ meetings: The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. A merger. liabilities and other items of the acquiring and the acquired firms are simply added at the book values without making any adjustments. Pooling of Interests Method In the pooling of interests method of accounting. . the Regional Director of the Company Law Board will be intimated. the acquisition should be structured as a purchase. the High Court will pass order sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable.

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