INDIAN INSTITUTE OF MANAGEMENT BODHGAYA

Mergers, Acquisitions, and Divestments:

Strategic, Economic & Financial Aspects of Corporate Control

Project Assignment 2019

Every student team is required to study one merger or acquisition, either in India or abroad. Care should be
taken to ensure that the team has access to stock market and accounting data for the acquiring and the target
firm.

The objective of the project will be to assess the issues in mergers, like motivation for merger, its impact on
industry structure and competition, your valuation of the target company and comparing it to the actual price
paid. You will also assess the impact on share prices to estimate `wealth effects’ of merger, using `event study
method’.

Final Report Format (total of 15-20 pages plus annexures):

1. Contents

2. Executive Summary (one page)

3. Background of Merger and Chronology of Events (with citations & references).

4. Motivation for merger or acquisition.

5. Valuation of target firm stock using financial data from PROWESS, CMIE data base, Bloomberg or
company websites. (computations in an annexure; use at least, DCF, P/E ratio, book value, and any
other that may be relevant or possible.). Compare the results with the actual price paid for acquisition

6. Gains from merger (both target and bidder).

a. Choice of event date & period.
b. Data Description & Source
c. Methodology used and justification
d. Summary tables giving computation and results (Actual computation in annexure).
(The gains should be computed both in percentage terms as well in Rupee/dollar/Euro terms for both
the firms)
e. Discussion of the results and the statistical validity of your estimations

7. Impact of merger on Industry structure, rivals and others.

8. Conclusions

There are three main requirements from the term-paper: (1) an analysis of the strategic and economic rationale
behind the merger, and (2) impact of merger on industry structure, completion etc., and (3) an analysis of
abnormal returns, premium paid and the structure/ means of payment. Since you are analyzing a completed

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merger, you may have some comments on how the post-merger company has done so far.

The project report should not exceed 15-20 pages of text. In addition, you must provide the raw data used
in the report in the annexures. Tables, Charts and computations and statistical tests etc. must be provided in
addition to the main report in different annexures. All tables and charts should be properly labeled and
source(s) clearly cited (even in the text). Marks will be deducted for improper or incomplete labeling.

Suggested Outline

1. Brief history of the companies. Company strengths and weaknesses. Description of products,
market shares, distribution channels, technology etc. Discussion of synergy. [History of the
company can be brief, but strengths and weaknesses should be described in as much detail as
possible.] About 3-4 pages

2. Industry Analysis; brief discussion of changes in the industry around the time of the merger.
Role of M&A in corporate strategy. [Similar to what Clinton Haskell and William Karnes had done
for Beatrice.] About 2-3 pages

3. Recent history leading to the merger. [You should have a Table showing the important event dates
/ chronology and a brief description of these events. Use Conoco or City Services cases as a model]
About 2 pages

Standard ratio analysis should be used to supplement the discussion of strength and weakness. [See the use of
ROE and P/E ratio in George Baker's analysis of Beatrice. Or the valuation used by consultants in Gillette
case ]

The following ratios are most often used by practitioners:

(a) Growth Rates: PEG Ratio and 10 year or 5 year compound growth rates (CAGR) in Sales and EPS
of the two companies prior to the merger.

(b) Liquidity Ratios

(c) Leverage Ratios:

(i) Book Value of Total Debt/Book Value of Equity

(ii) Book Value of Long-term Debt/Book Equity
(iii) Book Value of Total Debt/Market Value of Equity
(iv) Interest and other fixed charge Coverage Ratio

(d) Operating Characteristics:

(i) Total Asset Turnover

(ii) Average Collection Period
(iii) Gross Profit Margin
(iv) ROE and ROA

(e) Investment Characteristics:

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 (i) Capital Expenditure as a percentage of Total Asset
(ii) R&D as a percentage of Total Assets

Most of these ratios are available from CMIE, Prowess, Bloomberg, Standard and Poor's Industry Survey, or
similar sources.
About 2 pages of summary. Ratios in appendix.

4. Description of the deal, valuation, analysis of abnormal returns & premium

Describe the transaction structure, accounting issues, mode of payment, financing, etc.

Give your comment/assessment of the structure and discuss why this structure was adopted and whether you
would recommend a different structure. For example, if it was a stock transaction with a fixed exchange ratio,
then explain why no collars or options were used. Please remember that the project will be graded on the
explanations and comments you make on the results.

The deadline for submission of the final project report is 10 am on November 28, 2016. We hope to discuss
these reports in the last two weeks of the course

MEASUREMENT OF ABNORMAL RETURNS (PREDICTION ERROR)

The first step in measuring the effect on stock value of an "event" (announcement of a tender offer, share
repurchase, and so on) is to define an event period. Usually this is centered on the announcement date, which
is designated day 0(zero) in event time. The purpose of the event period is to capture all the effects on stock
price of the event (say fist announcement of merger or takeover). Longer periods will make sure all the effects
are captured, but the estimate is subject to more noise in the data. Many studies choose a period like days -5
to +5, that is from 5 days before the announcement to 5 days after the announcement. Note, day 0 is the date
the announcement is made for a particular firm by a bidder and could be different calendar dates for different
acquiring or bidding firms. In your project you must include an event window of -15 days to +15 days (you
are free to use other windows in addition to this 31 days window).

The next step is to calculate a predicted (or normal) return, Rˆ jt , for each day in the event period for each
firm. The predicted return represents the return that would be expected if no event took place. There are
basically three methods of calculating this predicted return. These are
(i) the mean adjusted return method,
(ii) the market model method, and
(iii) the market adjusted return method.

For most cases the three methods yield similar results. Next the residual, rjt, is calculated for each day for the
firm. The residual is the actual return for that day for the firm minus the predicted return, r jt = R jt - Rˆ jt .
The residual represents the abnormal return (AR) or prediction error (PE), that is, the part of the return that is
not predicted and is therefore an estimate of the change in firm value on that day which is caused by the event.
If you are calculating abnormal return for a sample of firms, for each day in event time the residuals are
averaged across firms to produce the average residual for that day. ARt, where r jt = R jt - Rˆ jt and N is the
number of firms in the sample. The reason for averaging across firms is that stock returns are noisy,
but the noise tends to cancel out when averaged across a large number of firms. Therefore, the more
firms in the sample the better the ability to distinguish the effect of an event. (Most of you will
however, study only one event and a single pair of firms). The final step is to cumulate the average
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residual for each day over the entire event period to produce the cumulative average residual, CAR,
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where CAR =  ARt . The cumulative average residual represents the average total effect of the
t = _15
event on the firm or across all firms in the sample.

(i) The Mean Adjusted Return Method

In the mean adjusted return method a "clean" period is chosen and the average daily return for the firm is
estimated for this period. The clean period may be before the event period, after the event period, or both, but
never includes the event period. The clean period includes days on which no information related to the event
is released, for example days - 240 to -40. The predicted return for a firm for each day in the event
period, using the mean adjusted return method, is just the mean daily return for the clean period for the firm.
That is:
- 41
 Rjt
t = -240
Rˆ jt = R j =
200

This predicted return is then used to calculate the residuals, average residuals, and cumulative average residual
as explained above.

(ii) The Market Model Method

To use the market model a clean period is chosen and the market model is estimated by running a regression
for the days in this period. The market model is:

R jt =  j +  j R mt + jt
where Rmt is the return on a market index (for example, the BSE Sensex) for day t,  j measures the
sensitivity of firm j to the market, this is, a measure of risk,  j measures the mean return over the period
not explained by the market, and jt is a statistical error term with E ( jt ) = 0 . The regression
produces estimates of  j and  j ; call these ˆ j and ˆ . The predicted return for a firm for a day in
j

the event period, is the return given by the market model on that day using these estimates. That is:

Rˆ jt = ˆ j + ˆ j R mt

where now Rmt is the return on the market index for the actual day in the event period. Since the market model
takes explicit account of both the risk associated with the market and mean returns, it is the most widely used
method.

As explained above, to estimate the Abnormal Returns (or Prediction Error or PE),

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 PE jt = R jt - ( ˆ + ˆ j R mt )
The t-statistic are calculated as:

PE jt
T=
Var ( PE jt )

where PEjt is the prediction error from the estimates market models and VAR (PE jt) is the variance of the
prediction error.

1 ( R m - Rˆ m )2
Var( PE jt ) =  (1 + +
2
j )
N (N - 1)Var( R m )

NJ
1
and ˆ =2
J  [ R jt - ( ˆ + ˆ j R mt ) ] 2
NJ - 2
t=1

where  2j is the residual variance from the market model regression: N is the number of observations
used to estimate the market model; Rmt is the market return on day t ; Rˆ m are the mean and variance of
the market return over the estimation period.

The cumulative abnormal returns for the event windows is calculated as shown below:

+T
CAR( - T to + T) =  ARi ,t
i = _T

All students must use this method and comment on the results. If the results are statistically
unacceptable, you must discuss why this is so. They may then use the following method

(iii) The Market Adjusted Return Method.

The market adjusted return method is the simplest of the methods. The predicted return for a firm for a day in
the event period is just the return on the market index for that day. That is:

Rˆ jt = R mt

The market adjusted return method can be thought of as an approximation to the market model where
 j = 0 and  j = 1 for all firms. Since  j is usually small and the average  j over all firms is 1,
this approximation usually is thought to produces acceptable results.