Mergers, acquisitions may top $25b in GCC as sector revives

Over 80% of regional investment bankers predict a pick-up

 Why not grow internally? Does the price of quicker development by

acquisition exceed the price paid for internal development i.e Quaker Oats acquisition of Snapple P&G and Gillette Nokia Siemens network

In down markets acquisition maybe cheaper

Use capital budgeting evaluation techniques

1+1=3 Reduction in Operating Costs Elimination of Duplicate Facilities

i.e. Marketing, Purchases Pharma comps. have cut R& D Banks--branches

Scale and Scope of Economies

Exxon Mobil, Bharti Airtel-Zain

Improved Distribution and Consolidation

Poor motive Vedanta-Cairns Energy

Exceptions like G.E. Share holders can diversify their portfolio more inexpensively They do not have to pay a premium Less transaction cost

Motive for large companies to acquire small companies

Banks, Financial Institutions Technology Companies

Retail business

Especially family owned enterprises

Harrods Qatar foundation Wrigleys Mars

Take advantage of high valuation

Commodities, Mining companies

Backward integration
i.e. Power Companies acquiring Coal Mines

Forward integration
i.e. Mining Companies acquiring cement

companies

Financial Synergy-increases debt capacity Redeployment of Capital Tax Benefits Pursuit of monopoly in case of horizontal integration

Low PE ratio High book value Under-valued assets Value company Steady cash flow Unused borrowing capacity Diversified shareholding Management amenable to takeover No anti-trust problems

Stock for Stock Cash for Stock or Assets Mixed Payments Leverage buyout Private equity funding Debt/bonds Bridge finance

Federal Securities Law Tender Offer Regulation Insider Trading Anti-Trust Policy Strategic Industry Government Involvement Government Approval SEC Approval Shareholders Approval

Buying company Target company Investment bankers/Advisors Bankers Lawyers Accountant firms Shareholders PR company

US Announced M&A Ranking - 01 Jan 2010 to 23 Aug 2010 Pos.

1 2 3

Advisor
Goldman Sachs Morgan Stanley JPMorgan

Value $m
183,741 162,195 143,861

No.
115 101 99

%share
26.4 23.3 20.7

2010 YTD
2 1 3

4
5 6 7 8 9 10

Credit Suisse Bank of America Merrill Lynch Deutsche Bank Barclays Capital
Lazard Citi UBS Total

143,053
131,126 121,359 119,552 91,518 84,587 81,177 695,384

81
105 76 69 59 59 81 8,217

20.6
18.9 17.5 17.2 13.2 12.2 11.7 100.0

9
5 14 6 8 4 10

Asia Pacific (ex Japan) Announced M&A Ranking - 01 Jan 2010 to 23 Aug 2010 Pos.
1 2 3 4 5 6 7 8 9 10

Advisor
Goldman Sachs Bank of America Merrill Lynch JPMorgan Barclays Capital BNP Paribas RBS UBS Morgan Stanley RBC Capital Markets Banco Santander SA Total

Value $m
93,969 87,686 81,298 75,644 69,502 65,628 52,212 50,620 47,353 46,170 470,501

No.
51 28 34 15 19 12 46 38 9 3 7,146

%share
20.0 18.6 17.3 16.1 14.8 14.0 11.1 10.8 10.1 9.8 100.0

2010 YTD
1 13 10 65 18 19 8 2 16 42

Estimate the discount rate or rates to use in the valuation

Discount rate can be either a cost of equity (if doing equity valuation) or a cost of capital (if valuing the firm) Discount rate can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real Discount rate can vary across time

Estimate the current earnings and cash flows on the asset, to either equity investors (CF to Equity) or to all claimholders (CF to Firm) Estimate the future earnings and cash flows on the firm being valued, generally by estimating an expected growth rate in earnings

Estimate when the firm will reach stable growth and what characteristics (risk & cash flow) it will have when it does
Choose the right DCF model for this asset and value it

Discounted Cash flow Valuation

Cash flows Firm: Pre-debt cash flow Equity: After debt cash flows Expected Growth Firm: Growth in Operating earnings Equity: Growth in Net Income/EPS

Firm is in stable growth: Grows at constant rate forever

Terminal Value Value Firm: Value of Firm Equity: Value of Equity

CF1

CF2

CF3

CF4

CF5

CFn
Forever

Discount Rate Firm: Cost of Capital Equity: Cost of equity

Length of Period of High Growth

Riskfree Rate: No default risk No reinvestment risk In same currency and in same terms (real or nominal as cash flows)

Beta - Measures market risk

Risk Premium Premium for average risk investment

Type of Business

Operating Leverage

Financial Leverage

Base Equity Premium

Country Risk Premium

Cash flow to Firm EBIT (1-t) -(Cap EX-Depr) -Change in WC -=FCFF

Expected Growth Reinvestment Rate *Return on Capital

Firm is in stable growth: Grows at constant rate forever

Terminal Value = FCFF n+1/(r-gn) Value of Operating Assets + Cash & Non-op Assets =Value of Firm -Value of Debt = Value of Equity FCFF1 FCFF2 FCFF3

FCFF4

FCFF5

FCFF n
Forever

Discount at WACC=Cost of Equity (Equity/(Debt=Equity))+Cost of Debt(Debt/Debt+Equity))

Cost of Equity

Cost of Debt (Risk free Rate + Default Spread) (1-t)

Weights Based on Market Value

There is uncertainty surrounding benefits for mergers The Decision is partially irreversible at the time of takeover is important If of acquiring company is more then the target company then risk is higher . So low companies are better positioned for acquisitions -i.e. value companies SOTP valuation (sum of the parts valuation)

Enterprise value =market value of common stock+debt cash on hand EV/Ebidta of 6 to 7 is good EV= FCFF/WACC-g

EV=EPS*multiplier for industry

What is G (RR*ROC)

Misevaluation hypothesis especially in economic crisis Takeovers increase efficiency if bad targets are taken over by good bidders Bidders should have higher P/E then target and hence stock price correction 2 firms experiencing unequal growth rates merge, combined value will be less

230 airlines in the industry Regulations on Ownership

Asia pacific is the biggest market

Lufthansa in 2009 acquired Austrian Airlines, British Midland and Brussel Airlines Worldwide airline mergers value in 2010 is $12.8b

Vedanta paid $9.6b for 60% of Cairn India stake

Cairn Energy will sell 40% of Cairn India 20% from other shareholders of Cairn Energy Cash offer at $8.66 per share Vedanta will hold 31-40% and Sesa Goa 20% Vedanta paying a premium for non-

competition to Cairn Energy Cairn India produces 125k barrels of oil per day ONGC looking to make a counter bid

Acquirer buying 15 %, needs to make open offer for additional 20% Petroleum ministry approval required as Vedanta has no prior experience in oil and gas Tax authorities may tax Cairn India Sebi draft code No approval for non-compete fees 100% tender offer

Western companies want to do a quick integration But Asian companies want value creation by stability and growth Cost cutting and integration is slow Synergy is not the rationale Expansion into a new market Expansion into a related business line Acquisition of a new organizational capability Access to scarce resources

No micro managing Local recruitment rather then from Asia Board of supervisory committee appointed CEO intact board replaced with advisors or CEO replaced rest of the board intact CFO to report daily Smaller KPI Limited back office integration Focus on technology transfer Cross selling considered

 Gain

for both target and acquirer Positive Efficiency improvement Growth opportunities Better utilization of fixed assets Synergy Managerial economies Increased market power

Managers personal motive Over optimism, over confidence leads to overpay Hubris Indicators:

Recent organization performance Recent media praise CEO self importance CEO inexperience Middle East i.e. Emaar

Agency problems when shareholders have little incentive to monitor managers

Returns to buyers likely to be higher Strategic motivation Value acquiring Focused/related acquiring

Returns to buyers likely will be lower Opportunistic Motivation Momentum growth/glamour acquiring Lack of focus/unrelated diversification

Credible synergies
To use excess cash profitably

Incredible synergies
Just to use excess cash

Negotiated purchases of private firms

Cross borders for special advantage Go hostile Buy during cold M&A markets

Auctions of public firms

Cross borders naively Negotiate with resistant target Buy during hot M&A markets

Returns to buyers likely to be higher Pay with cash High tax benefits to buyer Finance with debt judiciously Stage the payments (earn outs)

Returns to buyers likely will be lower Pay with stock Low tax benefits to buyer Over -lever Pay fully up-front

Mergers of equals
Managers have significant stake Shareholder-oriented management Active investors Big good deals

Not a merger of equals

Managers have low or no stake Entrenched management Passive investors Big bad deals

2009 saw 1900 deals of $145b More cash deals Announcement and closing reduced from 130 days to 60 days Companies look for value Deal values are high during high stock prices Shareholders are unsure of the future

Boards responsibility to be:

1. Vigilant 2. Proactive

3. Prepared
4. Keep stock price up 5. Maintain long term viability of business

6. Keep growth-dont miss revenues

7. Avoid P/E slipping 8. Efficient capital structure