MERGERS AND ACQUISITION
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.
strengthening retail outlets and sale depots to reationalise distribution. It has to aim at a suitable combination where it could have opportunities to supplement its funs by issuance of securities. to obtain new market outlets in possession of the offeree. • • • • • • 4. Strategic purpose
The Acquirer Company views the merger to achieve strategic objectives through alternative type of combinations which may be horizontal. 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. vertical. accounting valuation. to enhance gearing capacity. • • • • • 5. market extensional or other specified unrelated objectives depending upon the corporate
. to offer better satisfaction to consumers or users of the product.3. etc. 7. to improve EPS. General gains to improve its own image and attract superior managerial talents to manage its affairs. product expansional. strategic control of patents and copyrights. secure additional financial facilities. • •
Market expansion and strategy to eliminate competition and protect existing market. eliminate competition and strengthen its market position. but might feel resources constraints with limitation of funds and lack of skilled managerial personnel. Financial strength to improve liquidity and have direct access to cash resources.
6. borrow on better strength and greater assets backing. to dispose of surplus and outdated assets for cash out of combined enterprise.
Own developmental plans
The purpose of acquisition is basked by the offeror company’s own development plans. to avail of tax benefits. to reduce advertising cost and improve public image of the offeree company. to obtain new product for diversification or substitution of existing products and to enhance the product range.
(2) has control over product specifications. Types of Merger Vertical Combination It occurs when two firms. 8. 9. The combining corporate aim at circular combinations by pursuing this objective. scarcity of resources and purchased products. 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. combine. in vertical combinations. (1) it gains a strong position because of imperfect market of the intermediary products. The following main benefits accrue from the vertical combination to the acquirer company i. In other words. Thus. The acquiring company through merger of another unit attempts on reduction of inventories of raw material and finished goods. 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. each working at different stages in the production of the same good. 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.e. 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. various types of combinations distinct with each other in nature are adopted to pursue this objective like vertical or horizontal combination. Such integration could be operational or financial. Desired level of integration
Mergers and acquisitions are pursued to obtain the desired level of integration between the two combining business houses. reduction in investment in
. 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. the merging undertaking would be either a supplier or a buyer using its product as intermediary material for final production. implements it production plans as per objectives and economises on working capital investments. The acquiring firm belongs to the same industry as the target company. 2.strategy.
lowering average cost of capital and thereby raising present worth of the outstanding shares. a parent company has merged with its subsidiary ICICI Bank signifying down stream merger. Such mergers are very common in the corporate world.
. such as a merger between a bank and a leasing company..working capital. whereby a company's EPS decreases. increase in market segments and exercise of better control on market. subsidiary company with the parent ITC Ltd. and likewise. For example. The acquiring company obtain benefits in the form of economies of resource sharing and diversification. 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. Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase. Example: Prudential's acquisition of Bache & Company. but they have no mutual buyer/customer or supplier relationship. Congeneric mergers It occurs where two merging firms are in the same general industry. 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. Another instance of up stream merger is the merger of Bhadrachalam Paper Board. 4. the ICICI Ltd. reduction of advertising costs. 5. 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. recently. 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. Conglomerate Combination
It takes place when the two firms operate in different industries. merger enhances the overall stability of the acquirer company and creates balance in the company’s total portfolio of diverse products and production processes. It is amalgamations of two companies engaged in unrelated industries like DCM and Modi Industries.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. 3. elimination of competition concentration in product. Dilutive mergers are the opposite of above. 6.
Both companies' stocks are surrendered and new company stock is issued in its place. In the former case. also known as a takeover. The cash the target receives from the sell-off is paid back to its shareholders by dividend or through liquidation. In the pure sense of the term. This type of transaction leaves the target company as an empty shell. generating a second company separately listed on a stock exchange. This is known as a reverse takeover. The buyer buys the assets of the target company. From a legal point of view. however. a merger happens when two firms. if the buyer buys out the entire assets. in the latter case. of the target company being purchased. Ownership control of the company in turn conveys effective control over the assets of the company. Acquisition usually refers to a purchase of a smaller firm by a larger one.
. the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer.
Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were synonymous.
Types of acquisition
The buyer buys the shares. the purchase is called an acquisition. Sometimes. the buyer "swallows" the business and the buyer's stock continues to be traded. and therefore control. "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two. a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. An acquisition may be friendly or hostile. This kind of action is more precisely referred to as a "merger of equals". the terms merger and acquisition mean slightly different things. is the buying of one company (the ‘target’) by another. often of about the same size. 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. the companies cooperate in negotiations. 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. agree to go forward as a single new company rather than remain separately owned and operated. the target company ceases to exist. 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.Acquisition
The terms "demerger".
Thus improved technology and transportation were forerunners to the Great Merger Movement. 2006). however. government passed the Sherman Act in 1890.that is. 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. 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. This type of cooperation led to widespread horizontal integration amongst firms of the era. simply allow the acquired firm to proclaim that the action is a merger of equals. 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. During the panic of 1893.In practice. due to the desire to keep costs low. prices are driven down. setting rules against price fixing and monopolies
. That is. even if it is technically an acquisition. with many firms in a market.S. To avoid this decline in prices.it is always regarded as an acquisition. But when the deal is unfriendly .
In the long run. In other words. the real difference lies in how the purchase is communicated to and received by the target company's board of directors. This resulted in shipment directly to market from this one location. as illustrated by the classic supply and demand model. as part of the deal's terms. firms found it profitable to collude and manipulate supply to counter any changes in demand for the good. the demand declined. 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. actual mergers of equals don't happen very often. supply of the product remains high. Usually. The U. when the target company does not want to be purchased . When demand for the good falls. one company will buy another and.
One of the major short run factors that sparked in The Great Merger Movement was the desire to keep prices high. employees and shareholders. 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. Focusing on mass production allowed firms to reduce unit costs to a much lower rate. These firms usually were capitalintensive and had high fixed costs. In addition.
Vertical and conglomerate mergers do not offer these economies. combined sales offices. synergy is possible in areas viz. The worth of the combined undertaking should be greater than the sum of the worth of the two separate undertakings i. etc. Merger of Hindustan Computers. The gains obtained by working together by amalgamated undertakings result into synergistic operating gains. the resultant economies are know as synergistic operating economies. plants management. 2+2 = 5. Eicher Farm technology and finance as the company could borrow increased funds from banks and institutions. staff facilities. Eicher had the synergy advantage in merging with subsidiaries Eicher Good Earch.e. Synergy means working together. Section 72A of Income Tax Act. These gains are most likely to occur in horizontal mergers in which there are more chances for eliminating duplicate facilities. 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. (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.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. finance and technology. Thus. (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. production. 1961 provides this incentive for reverse mergers for the survival of sick units. Such amalgamations result in creating conglomeratic undertakings. Hindustan Reprographics. 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. 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%. which lower the operating costs. Among others.
status and perquisites as the enterprise grows and expands because their salaries. perquisites and status often increase with the size of the enterprise. growth as a goal and many speculative goals etc. profit enhancement for the company.(4) Growth advantage Mergers and acquisitions are motivated with a view to sustain growth or to acquire growth. (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. Management may raise capital from the market or institutions to acquire the company on the strength of its assets. (6) Managerial motivates
Managers benefit in rank. 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. close down its loss making activities and sell off the profitable sector to make gains. acquirer shall be benefited by acquiring the assets of the company and selling them off subsequently. (8) Acquisition by management or leveraged buyouts The acquisition of a company can be had by the management personnel. There can be many situations to take over the assets of a company at discount viz. known as leveraged buyouts. The technique is used to nationalise traditional industries. achieving efficiency. 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.
. The assets may also be acquired at a discount to obtain a going concern cheaply. To develop new areas becomes costly. The resultant large company can offer better security for salary earners. It is known as management buyout. the acquirer might take over ungeared company and increase its debt secured on acquiree’s assets. (9) Other reasons There may be many other reasons motivating mergers in addition to the above ones viz. tax and accounting opportunities. (7) Acquisition of specific assets Surviving company may purchase only the assets of the other company in merger. The acquirer may motivate managerial support by assuring benefits of larger size of the company to the managerial staff. Thus. increasing market power. (iii) the existing management is incapable of utilising the assets. This practice is common in USA for over 25 years and quite in vogue in UK. (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. (ii) to acquire non-profit making company.
48 crores shares. In the above example of HCL.27 crores on merger in a new company called HCL equity of Rs.e. from the gains and achievements of the company i.1. managers and promoters of the combining companies. They can convert a closely-held and private limited company into a public company without contributing much wealth and without losing control. perks and fringe benefits. (3) Promoters’ gains Mergers do offer to company promoters the advantage of increasing the size of their company and the financial structure and strength.48 crores. was public company whereas the other three merging entities were private limited companies. (d) acquisition of human assets and other resources not available otherwise. 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.depending upon the circumstances and prevailing conditions within the company and the economy of the country. (b) economies of scale. through (a) realisation of monopoly profits. the opportunity gains in alternative investments. (e) better investment opportunity in combinations.40 lakhs in Hindustan Computers and they did not invest any money extra in getting shares worth Rs. At the same time. Motivation for mergers and acquisitions Mergers and acquisitions are caused with the support of shareholder.
. The sale of shares from one company’s shareholders to another and holding investment in shares should give rise to greater values i. The promoters of Hindustan Computers were allotted shares worth Rs.1. This gain was against their original investment of meagre Rs. only Hindustan Reprographics Ltd.1. (c) diversification of product line. Shareholders may gain from merger in different ways viz. 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. Mergers where all these things are the guaranteed outcome get support from managers.e. (1) From the standpoint of shareholders
Investments made by shareholders in the companies subject to merger should enhance in value. (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.
better living conditions and amenities. quality of products. any restrictions placed on such mergers will decrease the growth and investment activity with corresponding decrease in employment.e. etc. preventing the distribution of benefits resulting from diversification of production activity. 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. Such monopolists affect social and political environment to tilt everything in their favour to maintain their power and expand their business empire. merger of companies provides in the form of employment. after sales service. 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. Economic power is to be understood in specific limited sense as the ability to control prices and industries output as monopolists. environmental improvements. Diversification fosters and provides opportunities for advancement in career. Two sides of the impact as discussed by the researchers and academicians are: first. (3) General public affected in general having not been user or consumer of the worker in the companies under merger plan. Secondly. increased wages. Both workers and communities will suffer on lessening job opportunities. (2) Workers of the companies under combination. These advances result into deceleration of level of welfare and well being of the general public which are subjected to economic exploitation. (2) Workers community The benefit or loss from mergers to worker community will depend upon the level of satisfaction of their demands. (1) Consumers The economic gains realised from mergers (i. 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. 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. training in new skills amount may other alike benefits.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. (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. But in a free economy a monopolist does not stay for a longer period as other companies enter into the
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. more detailed ways of expressing the value of a business. it is difficult to generalise that mergers affect the welfare of general public adversely or favourably. a Review Engagement or an Audit. historical earnings valuation. Every. 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. as well as possibly others that are not mentioned above.field to reap the benefits of high prices set in by the monopolist. These reports generally get more detailed and expensive as the size of a company increases. in order to obtain a more accurate value. this is not always the case as there are many complicated industries which require more attention to detail. The information in the balance sheet or income statement is obtained by one of three accounting measures: a Notice to Reader. relative valuation (comparable company & comparable transactions). 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. regardless of size. There are other. 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. consumers and does not create hindrance in administration of the Government policies. Most often this information is expressed in a Letter of Opinion of Value (LOV) when the business is being valuated for interest's sake.
The five most common ways to valuate a business are
• • • • •
asset valuation. This enforces competition in the market as consumers are free to substitute the alternative products.
. however. Therefore. future maintainable earnings valuation.
Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. etc. Another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. and the debt will often be moved down onto the balance sheet of the acquired company. the sick company’s survival becomes more important for many strategic reasons and to conserve community interest. or raised by an issue of bonds. But a caveat in using cash is that it places constraints on the cash flow of the company. Alternatively. A cash deal would make more sense during a downward trend in the interest rates.
Factoring can provide the necessary extra to make a merger or sale work. the acquirer's stock may be offered as consideration. The law provides encouragement through tax relief for the companies that are profitable but get merged with the loss making
An acquisition can involve a combination of cash and debt.
Generally. 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. Acquisitions financed through debt are known as leveraged buyouts if they take the target private. 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 capital may be borrowed from a bank. But in many cases. or a combination of cash and stock of the purchasing entity. As a consequence of this merger the profit earning company survives and the loss making company extinguishes its existence. Various methods of financing an M&A deal exist:
Payment by cash.
extensive network of bank branches associated with it. negotiations for a merger between Deutsche and Dresdner Bank failed on April 5. 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. asset management. The new banking group intended to spin off its retail banking which was not making much profit in both the banks and costly. therefore. called as a Reverse Merger. 2000. and together they become an entirely new public corporation with tradable shares. The private company reverse merges into the public company.
The merger was to create the most powerful banking group in the world with the balance sheet total of nearly 2.
Deutsche – Dresdner Bank (Merger Failure)
The merger that was announced on march 7. Germany’s largest and the third largest bank respectively was considered as Germany’s response to increasingly tough competition markets. U. Security and loan banking and finally financially corporate clients ranging from major industrial corporation to the midscale companies.2 trillion marks and also in front of the planned Japanese book mergers of Sumitomo and Sukura Bank with 1. A reverse merger occurs when a private company that has strong prospects and is eager to rise financing buys a publicly listed shell company. But barely 2 months after announcing their agreement to form the largest bank in the world. based citigroup. where the new banking group was hoped to outside the traditionally dominant Swiss Bank.S. 2000 between Deutsche Bank and Dresdner Bank. with a balance sheet total amounting to 1.5 trillion marks and a stock market value around 150 billion marks. The future core business lines of the new merged Bank included investment Banking. With this kind of merger.1 position of the US and create new dimensions of aggressiveness in the international mergers.companies. the new bank would have reached the no.7 trillion marks as the balance sheet total. The merged bank was to retain the name Deutsche Bank but adopted the Dresdner Bank’s green corporate color in its logo. It is. usually one with no business and limited assets.
One banking analyst explained that in order to obtain the "large reduction of costs necessary". the international investors rejected this concept of a socially acceptable merger. The Allianz had contrived the merger plans and was regarded as the actual winner. rising over 20 percent on the first day after news of the agreement to merge. on whose assessments large investors rely. Germany's market leader with investments of 175 billion marks. the Dresdner Bank would have had to go down. In return for its share of the Dresdner Bank. Banking analysts. 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. The Allianz is also interested in the retail banking business. the share values of the two institutions slumped by almost 30 percent. the asset management arm of the Deutsche Bank. this was to proceed by "socially acceptable" means. 20 % 30 %
. The dependency of their salary levels on the banks' share value (now sinking) also played a role. Although they intended a reduction of 16.000 jobs announced could only have been the start. It owns a 21. the pressure from the workforce increased. which would retain the majority of the two banks' smaller customers. Many started to look around for new employers offering safer prospects.000 jobs. areas that overlapped should not be shut down or broken up but merged and integrated. 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. This was insisted upon by both the union representatives on the supervisory board as well. stated that this type of merger would "set free too little synergy".What happened? The union of the two previous competitors should be carried out "by agreement”. A third point concerned asset management. the more open the contradictions and differences became. The reduction of 16. 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. the Allianz was to receive DWS. The boards of directors also lost control concerning the distribution of highly paid jobs in middle management. From the outset. in order to utilise these structures to sell their insurance. After a short initial rise. Only the shares of the insurance company Allianz AG increased. On the one hand. The more negotiations over the merger—which at first had only been roughly discussed in a small circle— turned to the details. In the merger plan. which has become unattractive to the banks.
Deutsche Bank was among the top 10 in the world. "Either Dresdner Kleinwort Benson is completely sold off. the so-called benchmark. Many customers consequently moved their accounts over to the competition. There would only have been jobs for some of the expert teams. Among the leading staff. But from the outset these considerations encountered resistance in the leading echelons of Deutsche Asset Management. which concentrate on certain industries or countries. which serves internationally mobile investors. We will not let our business be ruined. or at the most a few hundreds of its 7. which had already developed to be a global player. Breuer wanted to position the new bank at the highest place internationally in this sector. the trade with securities and the consultancy business concerning mergers. Another version is out of the question. also situated in London. without losing profits. investment banking.e.000 marks. Only in this way is it possible to grow or even survive in this hotly contested market.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. Moreover. Over 50 percent of bank profits are made within this area. The main point at issue became the fate of the bank's investment arm. Apart from asset management. In this area. so that almost nobody from DKB could have been taken over into Deutsche Asset Management. The top people at Deutsche Asset Management were not ready to undertake a new process of integration with DKB. with high profits arising from the stock market boom and the rapidly increasing wave of mergers. In the preliminary negotiations it had been agreed that DKB would be integrated into the new major bank.
. which the executive committee of the Dresdner Bank did not want to relinquish under any circumstances.i. which in the past year amounted to about 2. acquisitions and floatations—forms part of the most profitable business of the financial markets.6 billion euro. Deutsche Asset Management had only just integrated London's Morgan Grenfell and the American Bankers Trust. Those with less would be transferred to the new Bank 24." were widespread opinions. the administration and controlling departments would have almost completely overlapped with the structures of Deutsche Bank. so that only those succeed who score above the average. Meanwhile. aggressively headhunting whole teams of investment bankers with top salaries. DKB (Dresdner Kleinwort Benson).500 workforce will be taken over. nobody was prepared for a new round of haggling for positions with the people from DKB. The investment business is driven by expert teams. this division alone now contributed over 60 percent of Deutsche Bank's profits. the Deutsche Bank's investment arm. International comparisons are constantly drawn in this market.
the otherwise independent and self-assured Breuer stepped forward with trembling voice to publicly explain the failure of the merger. However. one of the most successful investment bankers with an annual salary of over 10 million marks. Their division head Edson Mitchell. However. At a press conference on March 9. After the merger was announced.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. do not lay down the procedure but
. Such bid is made for equity shares carrying voting rights. Finally. 1997 which. once an understanding is developed. 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". At the last joint session of the two boards of directors on April 5. which led to the withdrawal of the Dresdner Bank from the merger negotiations. continued to exert enormous pressure on Breuer via Joseph Ackermann. they immediately dispatched a message via the Financial Times that either the DKB was smashed up or sold off. 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. the division's chief executive. Walter from the Dresdner Bank was not prepared for this. he placed himself completely on the side of Ackermann. Breuer capitulated to the pressure of his subordinates. of course. since DKB was considered his "pearl". 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.
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. COMPETITIVE BID Competitive bid can be made by any person within 2 1 days of public announcement of the offer made by the acquirer. Breuer did not succeed in getting the investment bankers onto his side. the procedure should be streamlined in terms of the SEBI Takeover Regulations. Made to look foolish by his own staff.
analyse the information through experts from financial.prescribe a restrictive drill to safeguard the interests of the investors and shareholder. If the directors of the target Company cooperate. and keep the information and appraisal results top secret.
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. (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. tax and legal angles. (2) Examine shareholders' profile
Potential bidder should examine the share register of the target company and see the profile of the shareholders i. the number and weight of institutional investors and small shareholders.e. (1) Collection of relevant information and its analysis
The potential bidder should collect all possible relevant information on the target or offeree company. accounting. (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.
. etc. it can also trace the dividend register to find out number of shareholders not traceable to design the course of its bid.
2000. group of shareholders oppose the proposal for bid. 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. (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. (10) Information about acceptance
The takeover offer is open for a limited time within which it should be accepted by the shareholders. the offeror can circularise its rejoinder to the criticism of the bid and alternatively can announce improvement of the bid conditions through press. (7) Approval under FEMA
Necessary approvals under the Foreign Exchange Management Act. etc. 1999 are required to be take by the companies. primarily under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations.
. the joint preliminary announcement could be made for awareness of shareholders of the main terms of the offer. the directors can also bring the fact tot he notice of the shareholders. (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. (9) Improvement of conditions by offeror
In case a. In case the board does not approve of the move. The offeror will take further steps for registration of shares in its own name as per provisions of the Companies Act. 1956 Stock Exchange Rules & Regulations. the merits of the takeover or merger and the advantages which will accrue to them from such amalgamation.(6)
Once the board of the offeree company shows a sympathetic view.
etc. for raising expectations for higher dividend. (iv) Capital structure reorganization
Proper capital structure is essential for enhanced profitability and brightening of the dividend prospects. In those cases where the company has excess liquidity there are chances of takeover raids. The company should have expert advice from financial
. (iii) Revaluation of Assets
Assets shown at depreciated historical costs in financial accounts understate the real value of assets. In pursuance of the provisions of the Companies Act. 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. product demand. industry outlook and resultant profit forecast and value appreciation. 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. the disclosure might miss the reliability and significance and invite criticism of directors keeping the shareholders in dark. or distribute the surplus to shareholders through bonus and rights issues. automatically. This will. For defence strategy it is common practice to revalue the assets periodically and incorporate them in the balance sheet. Company may take suitable steps to replace preference capital by loan capital. The company should use liquid resources for financial acquisition of assets. 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. 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.A. etc. therefore. After attempt of takeover bid. (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. 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. expansion programme. 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. The company should. Such valuation should be attested by recognized values. bolster up the price of its shares and frustrate the takeover bid. etc.
skipping of dividend. inter alia. (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. 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. 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. Such companies shall fall within the same management control and attract provisions of section 372 of the Companies Act. 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 management style. 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. the profit and dividend record of the offeror in existing companies should be focussed particularly. new business avenues. etc. This may also be done by issue of rights shares.
. 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. specific losses.consultants on the issue of capital restructuring before implementing any conceived plan to thwart away the takeover bid. ISSUE OF BLOCK OF SHARES TO FRIENDS AND ASSOCIATES
With a view to forestall a takeover bid. 1956. lower market experience and other similar denouncing factors should be highlighted about the offeror and its associate concerns. (vi) Other commercial aspects
The target company’s management in its defence strategy should. 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. C. A.
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. G. 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. H. E. loan. F. Non-voting shares are a convenient method of providing for any desired adjustment of control on a merger of two companies. non-voting right shares are only of one variety i.D.
. preference shares or cumulative convertible preference shares as against a wide variety of restricted or weighted voting rights equity shares under English Company Law. 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. it is necessary that its capital structure should contain loan capital by way of debentures either convertible in part or full or non-convertible. Management may retain shares with voting rights so that takeover bid could be thwarted away without voting support. This is so because any successful bidde can’t acquire compulsorily convertible securities.
The directors of a threadtened company may acquire another company for shares as a defensive measure to forestall the unwelcome takeover bid. 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. mortgage of the assets to financial institutions for long-term loans. 1956.e. etc. DISSEMINATION TO SHAREHOLDERS OF FAVORABLE FINANCIAL INFORMATION
To make the investors and the shareholders aware. keeping the assets in trust for security of debenture. CONVERTIBLE SECURITIES
To make the company less attractive to corporate raiders. 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. SHARES WITH NON-VOTING RIGHTS LIKE PREFERENCE SHARES
In India. 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. 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. options or warrants because liability towards repayments of principal and payment of interest discourages takeover bids. so far.
To sum up. There are two significant aspects of such an agreement viz. Much will depend upon economic circumstances. loyalty and patriotism To ward off takeover bids. the target company can refuse registration of transfer of any of the grounds given under relevant sections of the Companies Act.
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. 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. such appeal works well to raise sentiments of shareholders to support the board of directors and confide with the management. Similarly. In view of these circumstances the takeover game becomes unattractive to the bidders. 1956 or the rules framed thereunder for rendering service over a period of time. Particularly. independence of business and goodwill. it is the responsibility of the directors to accept a takeover bid or thwart it away in the interest of the company. (iii) Recourse to legal action
To dissuade the corporate raider.
B. displacement of managerial. 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. Many times. 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. Arguments could also be made of the possible consequences which follow on takeover like retrenchment of work force. 1956. etc. For
. technical and financial executives. shifting work place and all possible miseries resulting from the successful takeover bid.
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. 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. political climate and the prospects of the trade in which the company is engaged. takeover bid from a foreign controlled company could be warded off by invoking national interest and emotional feelings.I.
they should not indulge in fraudulent acts against the interest of the shareholders. such tactic is not allowed once the deal becomes knows and it unavoidable. This happens when the target company is quite larget than the predator. The possible motive for the management of the target company to do so is not to lose the management of the company. profit forecasts made by them in the context of fighting off the takeover bid should be realistic. (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. The term is known as “first class passengers’ in UK. These precious assets attract the raider to bid for the company’s control. based on viable assumptions. This defence is very much in vogue in UK but subject to regulations of ‘City Code’. (vii) Compensation packages viz: “Golden Parachutes” or “First Class Passengers” strategy
The term “Golden Parachute” again was coined in USA. sells these valuable assets at its own initiative leaving the rest of the company intact. . in its own interest. The term “crown jewels” was coined in USA in 1982. In some countries such as the UK.
(vi) ‘Pac-man' strategy This term was coined in America in 1982. When a company offers hefty compensations to its managers if they got ousted due to takeover.example. The company. 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. This reduces their resistance to take over.
. the company is said to offer golden parachutes. Instead of them or mortgage them to creditors so that the attraction of free assets to the predator is over. This strategy is adopted as a precautionary measure by the companies in USA and UK to make the takeover bid very expensive. Under this strategy the target company attempts to takeover the hostile raider. as a defence strategy. It envisages a termination package for senior executives and is used as a protection to the directors of the company against the takeover bids. In other words.
There are many variants in this strategy. Grey knight
A friendly party of the target company who seeks to takeover the predator. 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. All the above strategies are experience based
. The management of the Target Company may offer the acquirer for its shares a price higher than the market price. (ix) Swallowing “Poison Pills” strategy An acquiring company itself could become a target when it is bidding for another company. the target company may adopt a combination of various strategies for successfully averting the acquisition bid. In a takeover bid this could prove to be an expensive defence mechanism. For example. The tactics used by the acquiring company to make itself unattractive to a potential bidder is called poison pills. Such features in the bye-laws are called “Shark Repellent” character.(viii)
“Shark repellent” character
The companies change and amend their bye-laws and regulations to be less attractive for the corporate raider company. as a tactical strategy. (xi) Poison put A covenant allowing the bond holder to demand repayment in the event of a hostile takeover. Another example. For example. 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. The task of the bidder would become difficult since the number of shares to have voting control of the company will increase substantially. To sum up. Greenmail refers to an incentive offered by management of the target company to the potential bidder for not pursuing the takeover. which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. target company might raise borrowings distorting normal debt: equity ratio. (x) Green mail A large block of shares is held by an unfriendly company. 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. For example. US companies adopt this tactic as a precautionary measure against prospective bids.
and they are separately worth V P and VQ. then the entire advantage of merger will accrue to the shareholders of the acquiring firm. but it will also have to pay a price (say in cash) to Q. • Divestiture: In a divestiture the target company divests or spins off some of its businesses in the form of an independent. the scope for evolving more rapid strategies always remains for the target companies to defend their existence against takeover bids. and worth VPQ in combination. For P. respectively.(VP + VQ)]. Thus. the acquiring and the acquired firm may share the economic advantage between themselves. particularly in USA or UK and some of them have been tested in critical times by the companies in India also.
Value Created by Merger
A merger will make economic sense to the acquiring firm if its shareholders benefit. Nevertheless.VQ].. [VPQ . if firm P and firm Q merge.(VP + VQ) – (cash paid – VQ) The economic advantage i. i.
.(VP + VQ)
Suppose that firm P acquires firm Q. the cost of merging to P is [Cash paid . Thus Net economic advantage = economic advantage – cost of merging NEA = [VPQ . 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. subsidiary company. For example. the above list is not exhaustive but only illustrative.e. In practice.and have been successfully used in developed nations.e. represents the benefits resulting from operating efficiencies and synergy when two firms merge. VQ. it reduces the attractiveness of the existing business to the acquirer. then the economic advantage will occur if: VPQ > (VP + VQ) and it will equal to: EA = VPQ .e. the net economic advantage of merger (NEA) is positive if the economic advantage exceeds the cost of merging.. cash paid – VQ = 0. If the acquiring firm pays cash equal to the value of the acquired firm. After merger P will gain the present value of Q i. In different circumstances and even. Thus.
4.5 crore and the target firm. 2.1463 = Rs.5 crore to acquire Firm Q.
. 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.e. The value of P after merger (that is.. merger is special type of capital budgeting decision. Now Firm P after merger will have 15 lakh shares of total value of Rs.2 crore (i.5 crore. Firm Q has a total market value of Rs.25/0. rather than a specific asset..e.150 market value per share). 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.63 lakh x Rs.67. …………… X = 12 + 0.1. Firm P is considering the acquisition of Firm Q. 3 crore = Rs. Rs.166. The acquiring firm can issue shared to the target firm instead of paying cash. Thus. following the discounted cash flow (DCF) approach.5 crore
The economic advantage of Rs.000 shares (i.9 each. the combined value of the merged firms) is expected to be Rs. Firm Q may require 300. 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)] – (4.60 market value per share). DCF Evaluation of mergers In a merger or acquisition. the value of share exchanged. Thus. Firm P is required to pay Rs.18 crore (12 lakh shares of Rs.63 lakh shares of Rs.15 = Rs.82 = 14. Firm Q will get 2.9. in example 1. Rs.3 crore (5 lakh of Rs.3) = (4 – 1.18 X X .67 x 3 lakh). 170.5 crore (i.4.25 crore due to the operating efficiencies. 3 crore). Rs. Rs. 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.5 crore.170.Example 1 Firm P has a total market value of Rs. The cost of merger of Firm P is Rs.5 crore/Rs. Thus. In practice. 170..63 lakh shares And the new shares price will be: 25/0.5 .5 crore less the value of the acquired firm. The new share price will be: Rs. the acquiring firm is buying the business of the target firm.18 X = 12 X = 12/0. The worth of shares given to the shareholders of Firm Q will be Rs.25 crore.2.9) – Rs. In example.e.5) = Rs. 150) of the acquiring Firm P. Rs.0. 1. The acquiring firm should appraise merger as a capital budgeting decision. the effective cost of merger may be more when the merger is financed by issuing shares rather than paying cash. the number of shares to be exchanged may be based on the current market value of the acquiring firm. the cost of acquisitions to Firm P remains the same: (2. Thus.4 crore is divided between the acquiring firm Rs.166.
net cash flows (NCF) or free cash flows can be calculated as follows: NCF = EBIT (1 . capital expenditure and working capital. Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. Cash flows include adjustments for depreciation. As discussed earlier. Exchange Ratio The current market values of the acquiring and the acquired firms may be taken as the basis for exchange of shares. As discussed in the earlier lesson. Δ NWC ………………………… capital expenditure. DEP depreciation. In order to apply DCF technique. DCF approach is an important tool in analyzing mergers and acquisitions.The merger will be advantageous to the acquiring company if the present value of the target merger is greater than the cost of acquisition.
Consider the case of Sarangi Engineering and XL Equipment Company in example 2 for an approach for the financial evaluation of a merger. Nevertheless. The methodology for calculating the cost of capital has been discussed in the Lesson. In summary. T tax rate. 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
. The appropriate discount rate depends on the riskiness of the cash flows. Since the cash flows are expected from the target firm’s operation. • • • Estimation of cash flows Timing of cash flows Discount rate
Earnings are the basis for estimating cash flows. 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. its cost of capital should be calculated for discounting the cash flows. the following information is required.T) + DEP – Δ NWC – Δ CAPEX Where EBIT is earnings before interest and tax.
There is no incentive for the shareholders of the acquired firm. in a public company to 25 per cent of the total paid-up capital. These are precautionary measures against the takeover of pubic limited companies. a company must inform the transferee and the transferor within 60 days. the Foreign Exchange Regulation Act (FERA). acquisitions and takeovers. Also. 1961. the Monopolies and Restrictive Trade Practice (MRTP) Act. In India. 1973. 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. Refusal to Register the Transfer of Shares In order to defuse situation of hostile takeover attempts. If this is done. 1956. 1956. particularly minority shareholders.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. companies have been given power to refuse to register the transfer of shares. Regulation of Mergers and Takeover in India Mergers and acquisitions may degenerate into the exploitation of shareholders. mergers and acquisitions are regulatedthrough the provision of the Companies Act. 1969. by itself or in association of an individual or individuals purchases shares of another company in excess of its specified limit. or The transfer is prohibited by a court order. A refusal to register transfer is permitted • • • • A legal requirement relating to the transfer of shares have not be compiled with. The Companies Act also provides for the approval of shareholders and the Central Government when a company. the Income Tax Act. the Central Government needs to be intimated whenever such holding exceeds 10 per cent of the subscribed capital. The approval of the Central Government is necessary if such investment exceeds 10 per cent of the subscribed capital of another company. Legal Measures against Takeovers The Companies Act restricts and individual or a company or a group of individuals from acquiring shares.
. or The transfer is in contravention of the law. together with the shares held earlier. The Securities and Exchange Board in India (SEBI) has issued guidelines to regulate mergers. the price-earnings into remaining the same. and they would require a premium to be paid by the acquiring company. 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 not in the interest of the company and the public. 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. and the Securities and Controls (Regulations) Act.
the target company and the stock exchange shall be notified immediately. The offer has been approved by at least 90 per cent of the shareholders of the company whose transfer is involved.
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 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. Before the small shareholders know about the proposal. It would be unfair if the same high price is not offered to all the shareholders of prospective acquired company. 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. 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. 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 minority shareholders have been intimated within 2 months from the expiry of 4 months referred above. within 4 months of making the offer. banks and individuals) may get most of the benefits because of their accessibility to the brokers and the takeover deal makers.
Guidelines for Takeovers SEBI has provided guidelines for takeovers. The guidelines have been strengthened recently to protect the interests of the shareholders from takeovers. the interests of all shareholders should be protected without a prejudice to genuine takeovers. 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. The larger shareholders (including financial institutions.Protection of Minority Shareholders’ Interests In a takeover bid. it may be too late for them.
it is necessary to seek the permission of the shareholders. and the information should be make available to all the shareholders at the same time and in the same manner. Once the offer is make to other shareholders. the acquiring company should have the permission in its object clause to carry on the business of the acquired company. an individual or company can continue to purchase the share without making and offer to other shareholders until the shareholding exceeds 10 per cent. In a nutshell. Legal Procedures The following is the summary of legal procedures for merger or acquisition laid down in the Companies Act. in the absence of these provisions in the memorandum of association. 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. 1956: Permission for merger: Two or more companies can amalgamate only when amalgamation is permitted under their memorandum of association. its intention to continue the offeree company’s business and to make major change and long-term commercial justification for the offer. the offer price should not be less than the weekly average price in the past 6 months or the negotiated price. 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.•
Offer price: Once the offer is made to the remaining shareholders. particularly the small shareholders. Information to the stock exchange: The acquiring and the acquired companies should inform the stock exchanges where they are listed about the merger. details of the offerer’s existing holdings in the offeree company etc. Also. The main thrust is that public authorities should be notified within two days. Offer document: The offer document should contain.
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. the offer’s financial information. 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. The High Court would convene a meeting of the shareholders
. board or directors and the Company Law Board before affecting the merger. identity of the offerer.
A merger. The merger should be structured as pooling of interest. there is no revaluation of assets or creation of goodwill. 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. its certified true copies will be filed with the Registrar of Companies. Shareholders’ and creditors’ meetings: The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. In the case of acquisition. At least. 75 per cent of shareholders and creditors in separate meeting. The notice of meeting should be sent to them at least 21 days in advance. Pooling of Interests Method In the pooling of interests method of accounting. involves the absorption of the target company by the acquiring company. the Regional Director of the Company Law Board will be intimated. the balance sheet items and the profit and loss items of the merged firms are combined without recording the effects of merger. where the acquiring company purchases the shares of the target company.
. it can modify the scheme. These securities will be listed on the stock exchange. must accord their approval to the scheme.and creditors to approve the amalgamation proposal. the acquisition should be structured as a purchase. voting in person or by proxy. Thus. liabilities and other items of the acquiring and the acquired firms are simply added at the book values without making any adjustments. Sanction by the High Court: After the approval of shareholders and creditors. defined as amalgamation in India. the acquiring company will exchange shares and debentures and/or pay cash for the shares and debentures of the acquired company. which results in the uniting of the interests of the two companies. This implies that assets. The date of the court’s hearing will be published in two newspapers and also. with effect from the specified date. Accounting for Mergers and Acquisitions Mergers and acquisitions involve complex accounting treatment. If it deems so. on the petitions of the companies. Filling of the Court Order: After the Court order. the High Court will pass order sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. Payment by cash or securities: As per the proposal.