Mergers, Acquisitions and Corporate Restructuring

“Peter Drucker has written that the chief strategic resource of the ten years will be neither capital nor knowledge, but the ability to form powerful partnerships.” Objectives:  Define the concept of merger and acquisition  

Discuss the motives behind mergers Describe theories of mergers Discuss about the forms of mergers and acquisitions.

Background: • • • M&A are the most popular means of corporate restructuring Strong conceptual and technical skills are required Both America and Europe have experienced the spectacular waves of M&A.

In the US, merger was started • • • Between 1890-1904 At the end of world war I Later part of II world war and continues till today.

Profitable growth constitutes one of prime objective of the business organisations. Methods: • • Internal External

Internal: • • Through the process of introducing or developing new products By expanding or enlarging capacity of the existing product(s).

External:

By acquisitions of existing business firms in the form of mergers, acquisitions,takeovers,absorption, consolidation etc.

Meaning of Terms: MERGER Combination of two or more companies into a single company where one survives and the others lose their corporate existence. Generally, the co. which survives is the buyer, retains its identity and seller co. is extinguished. CONSOLIDATION Consolidation of two existing firms into a new company in which both the existing co’s extinguish. Eg. HCL Ltd. ACQUISITION Refers to a situation where one acquires another and the latter ceases to exist. It is an act of acquiring company effective control, by one co. over assets or mgt. of another co without any combination of companies. AMALGAMATION: •
• •

One or more companies may merge to form a new company. It contemplates a state of things under which two companies are so joined as to form a third party. blending of two or more companies into one, the shareholders of each blending co. become substantially the shareholders of the other co. which holds blended co’s.

Amalgamations are governed by sections 390 to 394 and 396 of the co’s Act requiring consent of the shareholders and creditors. Eg. Global Trust Bank TAKEOVER: Obtaining control over management of co. by other. Sale of shares is the simplest process of takeover. Under MRTP Act, takeover means acquisition of not less than 25%of the voting power in a co.

HOLDING COMPANY : Holds more than half of the nominal value of equity capital of another company, called subsidiary co. RESTRUCURING: It is re-organising through changing location of capital investment, use of super technology and displacement of labour altering capital base with a view to improve the performance. CORPORATE SPLIT OR DIVISION: Division takes place when part of its undertaking is transferred to newly formed co or to an existing co. Motives behind mergers: Buyers motive:  to increase the value of the firm’s stock price or P/E ratio  to increase the growth rate of the firm  to make good investment - purchasing instead of internal expansion  to improve the stability of the firms earnings and sales  to fill out the product line  to diversify the product line when existing products have reached their peak in the life cycle  to reduce competition
 to acquire a needful resource. Eg. High technology or innovative mgt.  to increase efficiency and profitability especially synergy of co’s.  for tax reasons – prior tax losses which will offset current or future

earnings. Sellers Motives  to increase the value of the owners stock and investment
 increase growth rate by receiving more resources from the acquiring

co.

 to acquire resources to stabilise operations and make them more

efficient  limit competition
 utilise under-utilised market power; human, physical and managerial

skills  overcome the problem of slow growth and profitability in one’s own industry  gain economies of scale & increase income proportionately with low investment Theories of Mergers (1) Operating This theory is based on operating synergy assumes that economies of scale do exist in the industry & prior to the merger, the firms are operating at levels of activities that fall short of achieving the potentials of economies of scale. Economies of scale arise due to indivisibility (2) Financial This theory postulates that the purpose of M&A is to:  Improve liquidity  Dispose of surplus and outdated assets for cash  Enhancing gearing capacity  Availing tax benefit  Improve EPS (3) MANAGERIAL SYNERGY OF MERGERS If a firm is merged with or takeover by another with better managerial efficiency, the overall managerial effeciency will be improved. Social gain and private gain Types of Merger VERTICAL COMBINATION:

Process of joining of two or more companies involved in different stages of the production or distribution of the same product or service. Merger of coal mining and railway co. – existing product service added. Eg. Oil industry Objectives: • •

Ensure ready market Ensure a source of supply required for production Gain strong position because of imperfect market of intermediary products, scarcity of resources Control over product specification.

Types of vertical combination: (1)Backward integration:occurs when the firms acquire or create a co. that supplies the raw material or components. (2) Forward vertical integration:occurs when the firms acquire or create a co. that purchases its products/services HORIZONTAL COMBINATION Involves two firms operating and competing in the same kind of business activity. Eg. ACC Ltd,& the acquisition in 1987 of American Motors by Chrysler represented a horizontal combination; Orissa Power supply co merged with BSES Ltd. Forming a larger firm may have the benefit of economies of scale.  Economies of scale  Elimination of duplication  Reduces competition & number of companies  Reduction in investment in WC, advertisement cost CONGLOMERATE MERGER Involve firms engaged in unrelated types of business activity or whose businesses are not related either vertically or horizontally. Eg. Borjan Tea Estate was merged with TATA Tea Ltd.; Videocon Narmada Electronics Ltd. Merged with Videocon International Ltd.

Objectives  Diversification of activities  Attain managerial competence  Financial stabilities  Economies of large scale production and reduction of risk. Conglomerate mergers divided into; (1) Financial (2) Managerial Financial - provide flow of funds to each segment of their operations, exercise control, and are the ultimate financial risk takers. Improves risk return ratios through diversifications. Managerial conglomerate: Managerial conglomerate not only assumes financial responsibility and control, but also plays a role in operating decisions and provides managerial counsel and interactions on decisions. This merger increases the potential for improving performance. Concentric Merger – is a combination of firms related to each other in terms of customer groups or customer functions or alternative technologies. Eg: combination of firms producing Television, washing machines and kitchen appliances. Circular 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 and promoting market enlargement. Eg. TATA’s , RPG group. Role of Industry Life Cycle  Introduction stage  Exploitation stage  Maturity stage  Decline stage Value Creation in Merger Marketing synergy Operating synergy Investment synergy

Management synergy

Corporate Restructuring
Objectives:  Define the concept of Corporate Restructuring  Discuss the characteristics of CR  Discuss the methods of CR Background: Corporate Restructuring has gained importance due to the following reasons:  Intense competition

Globalisation

 Technological change  Foreign investment  Initiation of structural reforms in industry due to LPG (shedding non core activities). Background It involves significant re-orientation, re-organisation or realignment of assets and liabilities of the organisation through conscious management action to improve future cash flow stream and to make more profitable and efficient. Meaning:

Corporate restructuring is an episodic exercise, not related to investments in new plant and machinery which involve a significant change in one or more of the following  Pattern of ownership and control  Composition of liability  Asset mix of the firm. It is a comprehensive process by which a co. can consolidate its business operations and strengthen its position for achieving the desired objectives:
(a) synegetic (b) competitive (c) successful

Rationale behind CR in order to increase organisations market value of shares, brand power and synergies. Characteristics Selling of portions of the co. such as a division that is no longer profitable or which has distracted management from its core business, can greatly improve the co’s balance sheet. (a) Changes in corporate mgt. ( usually with golden parachutes) (b) Retention of corporate management (c) Sale of under utilised assets (d) Outsourcing of operations such as payroll and technical support to a more efficient third party (e) Reorganisation of functions namely, marketing, sales (f) Renegotiation of labour contracts to reduce overhead (g) Refinancing of corporate debt to reduce int. payments (h) Moving operations (j) Forfeiture of all or part of the ownership shares by pre structuring stock holders Need and Rationale of restructuring:

to flatten organisation so that it could encourage culture of initiatives and innovations.

 to increase focus on core areas of work and to get closer to the customer  to reduce cost / level of hierarchy/ communication delay
 

to reshape the organisation for the new era. to develop organisation on the guidelines of consultant / stake holder.

Objectives • • • • • Growth Technology Government policy To reduce dependency on others Economic stability

Forms of Corporate Restructuring of Business Firms: I II III IV Expansion Sell-offs Corporate control Changes in ownership structure

Methods of restructuring (1) Joint Venture - A combination of subsets of assets contributed by two (or more) business entities for a specific business purpose and a limited duration. Each of the venture partners continues to exist as a separate firm, and the joint venture represents a new business enterprise. Eg. DCM group and Daewoo motors entered in to JV to form DCM DAEWOO Ltd. to manufacture automobiles in India. Venture can be for one specific project only, or a continuing business relationship such as Sony Ericsson. Reasons for JV (why JV ?)

-to form strategic alliances: In a JV two or more co’s (parent co) agree to share their capital, technology, human resources, risk and rewards in formation of a new entity under shared control. Internal reasons: 1.build on co’s strengths 2. spreading cost and risk 3. improving access to financial resources 4. economies of scale & advantages of size 4. access to new technology Competitive goals: 1. influencing structural evolution of the industry 2. creation of stronger competitive units 3. defensive response to blurring industry boundries

Strategic goals: 1. synergies 2. transfer of technology / skills 3. diversification When do JV form:
 When an activity is uneconomical for an organisation do alone

 When the risk of the business has to be shared
 To pool distinctive competence of two or more organisations  To overcome hurdles such as- import quotas, tariff, national and

political interest etc. Benefits of JV  Combining complementary R&D or technologies  New product development  Financial support or sharing of economic risk

 Expansion of new domestic market  Ability to increase profit margins
 Developing or acquiring marketing or distribution expertise

Sell-offs: A sell-off is the outright sale of a company subsidiary. Normally, sell-offs are done because the subsidiary doesn’t fit into the parent co’s core strategy. It is usual practice of corporate to sell-off is to divest unprofitable or less profitable business so as to avoid further drain on its resources. 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. The parent co. distributes all the shares it owns in a controlled subsidiary to its own shareholder on a pro-rata basis. 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 & tax free exchange. Divestitures: is a transaction through which a firm sells a portion of its assets or a division to another company. It involves selling some of the assets or division for cash or securities to a third party which is an outsider. Divestiture is a form of contraction for the selling co. means of expansion for the purchasing company. Evaluation of divestiture (assessing is it worth or not) Steps: (1)Computation of decrease in cash flow after tax ( yr1….n) due to sale (2)Multiply by opportunity cost of capital factor relevant to division (3)Computation of present value of the selling firm (step1x2) (4)Computation of PV of obligations related to the liabilities of the division

(5)Present value lost due to sale of division (step 3-4). PV lost due to sale is <sale proceeds – Accept, vice versa. Equity Carve Out (ECO): A transaction in which a parent firm offers some of a subsidiary’s common stock to the general public, to bring in a cash infusion to the parent without loss of control. ECO is also a means of reducing their exposure to a riskier line of business and to boost shareholders value. Leveraged Buy Out (LBO) 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 co. using the acquired firm’s assets and cash flow to obtain financing. In LBO, the assets of the co. being acquired are used as collateral for the loans in addition to the assets of the acquiring co. LBO’s are generally found in capital intensive industries. Debt is obtained on the basis of co’s future earning potential. LBO’s are risky for the buyers if the purchase is highly leveraged. Management Buyout: is the form of corporate divestment by way of going private through managements purchase of all outstanding shares. It occurs when managers and executives of a co. purchase controlling interest in a co. from existing shareholders. Purpose of MBO – from management point of view may be: • to save their jobs, either if the business has been scheduled for closure or if an outside purchaser would bring in its own management team.

to maximise the finanacial benefits they receive from the success they bring to the company by taking the profits for themselves.

to ward off aggressive buyers.

The goal of an MBO may be to strengthen the manager’s interest in the success of the company. Key considerations in MBO are fairness to shareholders,price, the future business plan, and legal and tax issues. Benefits of MBO: • it provides an excellent opportunity for management of undervalued co’s to realise the intrinsic value of the company. • Lower agency cost: cost associated with conflict of interest between owners and managers.

Source of tax savings: since interest payments are tax deductible, pushing up gearing rations to fund a management buyout can provide large tax covers.

Ideal MBO candidates • •

Stable predictable earnings Undervalued market Unutilized debt capacity large amount of cash & cash equivalents Substantial asset base for use as collateral Low capital requirement expenditures

• • •

Master Limited Partnership (MLP’s) MLPs are a type of limited partnership in which the shares are publicly traded. The limited partnership interests are divided into 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. Types of partners General partners Limited partners Types of MLP’s Roll up MLP - formed by the combination two or more partnership into one publicly traded partnership. Liquidation MLPs - 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 interest by the corporations of the MLP or both. Start up MLP - formed by partnership that is initially privately held but later offers its interest to the public in order to finance internal growth.

Employees Stock Option Plan (ESOP) an ESOP is a type of defined contribution benefit plan that buys and holds stock. ESOP is a qualified, defined contribution, employee benefit plan designed to invest primarily in the stock of the sponsoring employer. Contributions are made by the sponsoring employer:

ESOPs are “qualified” in the sense that the ESOP’s sponsoring company, the selling shareholder and participants receive various tax benefits. It is a retirement plan in which the co. contributes its stock to the plan for the benefit of the company’s employees. With an ESOP, you never buy or hold the stock directly.