Assignments on Mergers and Acquisitions and Strategic Alliances

Name: Partha Pratim Datta

Enrollment No.: 6010090809157

The Gucci-LVMH Battle

Ans 15 a. LVMH was interested in acquiring Gucci because of the following reasons:

1. At the very first instance it should be understood that LVMH was not interested in
Gucci but on the contrary the battle for creeping takeover of Gucci was initiated by
LVMH’s principal share holder and Chairman for acquiring the Luxury Brand and
controlling its business directives by holding the majority voting right. This was
primarily done for creating a global one product luxury group by merging the asset
base of both the companies and at the same time undertaking resource/ asset stripping
by acquiring a majority stake in Gucci. This was because Gucci was a leading
premium luxury brand dealer in the World and the fact that LVMH Group through its
Louis Vuitton Brand was the market leader in the world luxury leather goods,
apparels and other associated accessories with a 19% market share. Thus by
aquizition of the Gucci group it wanted to achieve economies of scale by having a
large market segment/market share led by established brands under the groups’ aegis
vis-à-vis production base. This can be corroborated by the fact that Gucci had high
quality, expensive, luxury brands viz. Yves Saint Laurent, Sergio Rossi and
Boucheron under its ageis where as LVMH had brands viz. Loius Vuitton, Christian
Dior, Givenchy under its aegis. Moreover, the fact that LVMH was interested in
acquiring Gucci’s assets base for creating a major global luxury product group could
be corroborated by the manner in which Arnault- the Chairman of LVMH increased
the open offer price for 100% acquisition of the open equity shares of the company in
the capital markets @ US$ 85/ share (at a premium to the marked to the market price
of the shares).
2. Secondly, with the Asian Market crisis of the South Asian economies especially that
of Thailand and Japan which emerged in mid 1990s, the LVMH group was facing
erosion of its market share/ market capitalization as the disposable income and the
purchasing power parity of the Asian customers for the luxury and premium goods
manufactured by the brand had decreased. All this while, LVMH group was relying
on the Japanese and Asian Markets for sale of its luxury products / brands but with
the onset of the Asian Currency crisis, the group was desperate to fall back upon/
capture a large market share/ chunk of the European and US market. This was
because the European and the US Market was immune from the Asian currency crisis
and the spending of disposable income for purchase of expensive, luxury products/
brands was growing @4 time more than the global rate. Considering the fact that,
Gucci had a better market share/ market capitalization rate than LVMH, the company
was desperate to acquire Gucci and thereby gain access to its established European
and US Markets. This can be corroborated by that that where as most of Gucci’s
brands were doing well and the sale of its branded products was up by 10% in FY
1997 vis-à-vis that of FY 1998, that in case of LVMH was restricted to only one
luxury brand i.e. “Louis Vuitton”.
 3. Thirdly, the other important reason why LVMH was interested in acquiring Gucci
was the fact that it wanted to get access to Gucci’s strength in product markets
(especially the geographical advantages) and the competitive capabilities in
designing and product positioning. This could be corroborated by the fact that even
tough Gucci’s creations/ products/ designer outfits were priced in the same range as
that of LVMH’s, but then the niche and the premium customers found it more
sleekly, stylishly designed and were more sophisticated and urbane in its outlook,
Because of the same, they were more in demand/ popular in the premium US Market
which supported and sponsored new design and style statement in the fashion world
more in comparison to the Asian Market. Thus it could be corroborated from the
aforementioned facts that Gucci vis-à-vis LVMH was better off in integrating its
operations across national markets (other European countries other than Italy as well
as in US) as well as achieve enhanced benefits from innovation and economies of
scale.
4. Thus it could be seen that it was for this reason that LVMH adopted the “ creeping
takeover” strategy to achieve a majority stake in the company and dominate its Board
of Directors and thereby control its management and business directives and
operations.

No, I do not believe that there will be any synergy of operations/ business plans and
marketing strategies from Gucci-LVMH alliance. This can be corroborated from that fact that
both Gucci and LVMH started off as family owned business groups that later diversified its
business operations so as to make foray into sectors like ready of wear apparel lines,
fragrances, shoe making, jewellery and other associated accessories. Thus over a period of
time they were globally well recognized luxury groups that had a well diversified portfolio of
luxury brands under its umbrella. Thus it could be seen that both the companies had more or
less similar business strategies i.e. inorganic growth of acquisition and opportunistic
expansion into overseas markets. This can be corroborated from the fact that while Gucci
acquired Yves Saint Laurant’s fragrance and ready to wear apparel lines , renowned shoe
maker Sergio Rossi to its umbrella of brand where as LVMH organized its business
operations into a division formats consisting of 5 important divisions i.e. wines and spirits,
fashion and leather goods, perfumes and cosmetics, watches and jewelry and selective
retailing. Thus it could be seen that whereas Gucci had a premium luxury/ exquisite perfume
brand in the form of Yves Saint Laurent under its umbrella while LVMH had a competing
perfume brand in the form of Christian Dior and Givenchy. Moreover, both the group
adopted more of less the same type of sales and marketing strategy of sale through group
operated multi product/ rand stores apart from sales through franchise stores. Moreover, the
geographic regional sales profile for both the group was quite similar barring Japan. This
could be corroborated from the table given below:
Luxury Brand Sales by Geographic Regions in FY 2000

Name of the Japan Asia Europe US and North Rest of the

Group America world
Gucci 22.50% 17.90% 30.40% 26.40% 2.80%
LVMH 15.00% 17.00% 34.00% 26.00% 8.00%
Source: Bear, Stearns & Co.Inc.
Thus with the looming Asian Market Currency crisis of the 1990s in the Asian Market
(Thailand in Particular) and Japan also in its grip and most of the premier luxury brands
making a beeline to tap the developed European and US market which was growing @4
times the growth rate exhibited by Asian markets it did not make sense for LVMH to acquire
the asset base of Gucci which had a major store presence in Japan i.e. (22.50% market share
of the Japanese Market of Gucci vis-à-vis 15.00% market share of LVMH.)

Moreover, it should be realized that both the group relied on more or less similar type of
marketing strategy i.e. of vehemently protecting the creativity, innovation , product
differentiation and strategic positioning of the established brands under its umbrella/ aegis.
Thus when both the groups assiduously/ zealously protected their individuality style
statement of designing and developing customized high value luxury products for the elite
niche clientle, publicity and brand positioning campaign, designers details and it did not
make sense for Gucci to be aggressively acquired by its intense competitor in the global
luxury product market at a time when the various luxury brands associated with the Gucci
umbrella (be it the products of the Gucci division or for that matter the products from the
acquired brands) were doing pretty well in the US and European markets. On the contrary
only the Louis Vuettion brand of the LVMH stable was operating profitably.
This could be corroborated from the following table:
(US$ Million)
Gucci-Fashion and Leather Portfolio LVMH- Fashion and Leather Portfolio
Items FY-1999- FY-2000- FY-2001- FY-1999- FY-2000- FY-2001-
2000 2001 2002 2000 2001 2002
Net Sales 2423.10 3753 3799.50 2021 2819 3180
revenue
realization
Operating 273.20 408.40 355.10 261.72 380.73 392.70
Profit

Source: LMVH and PRR Annual Report for 2000 and 2002

Thus it can be seen from the above table that there was very little difference as far as the
operating profit of for that matter the profit margins between Gucci and LVMH as far as
the operations for FY 1999-2000 was concerned. In fact in FY 1999 Gucci Operating
Profit was more than that of LVMH. Thus with high total operating profit earnings, the
share holders of Gucci would have demanded for more P/E ratio and correspondingly the
same would have put additional pressure on reducing/ recalculating the exchange rate
(ERB ) i.e. no of share of LVMH to be acquired / swapped with each share of Gucci.
Thus with a low ERB , the corresponding share price of the merged/ acquired entity had to
go up i.e PAB (ERB)>= P B where PAB could be considered the price of the acquired
/merged entity ; ERB the exchange ratio of the share of Gucci with that of LVMH and P B
the price of each equity share of Gucci. Thus the creeping take over price quoted @ $ 85/
equity share of Gucci by LVMH (tough $30/share more than the marked to market
price) , but then the share holders of Gucci would have found it to be on the lower end
considering the fact that they would have desired a greater percentage of premium
associated with the share of the merged entity = PAB considering a high overall
operational profit earnings E B in comparison to E A = earnings of LVMH prior to merger
with the latter. This in order to avoid paying extra premium to the equity shareholders of
Gucci on account of change of ownership, LVMH under the chairmanship of Arnault
adopted for creeping takeover of the majority share control of Gucci. Thus from the
aforementioned discussion it can be inferred that LVMH as a group was good at
acquiring established and uniquely positioned luxury brands under its aegis but was poor
at operational management of the brand for maintaining its market leadership position/
status. Thus by selling itself off to LVMH made no sense for the top management of
Gucci as the benefits were meager in comparison to the losses . This can be inferred by
the fact that the operational independence and the creativity/ individuality and unique
brand positioning in the minds of the potential customer would have been lost and the
company would have allowed its rival company to capture its market share/ position in
the premier/ niche luxury product market through sharing of the business strategies/
policies as the BoD would have greater representation of directors nominated by LVMH.
Moreover, it should be realized that Gucci had the ability to control its distribution
channels through centralized procurement operations. This is part of Gucci’s strategy in
the chain value to capture the value added instead of giving it to the middlemen such as
suppliers and retailers. The company also increased the number of their Directly
Operated Stores (DOS) as part of the marketing strategy so as to have more control of the
distribution process. This could be corroborated from that fact that in FY 2003, the DOS
accounted for 61.3% of revenues compared to a much lower 32.5% in 1999.On the
contrary, LVMH’s 5 important business divisions acted as independent SBU with their
own managers and distribution, sales and marketing channels. Thus there was no
operational synergy as far as the sales promotion, marketing and distribution mechanism
was concerned between GUCCI and LVMH. Thus, had the creeping takeover bid of
LVMH had fully succeeded for complete takeover of Gucci , then in that case Gucci
would have been compelled to share its aforementioned defensive strategies of ability to
control its distribution channels through centralized procurement operations with LVMH.
It would have also led to sharing of the shelf space in the directly operated stores of
Gucci with that of the products from the brands of LVMH. Thus the exclusivity,
uniqueness that is associated with the marketing of the branded luxurious products would
have been lost by the Gucci group to LVMH. Thus the losses outweighed the potential
benefits and this made De sole and Ford, the top leaders from the Gucci Group to put
forward the statement that there would be no synergies from the Gucci-LVMH alliance.

Ans 15 b. Comments on the defensive strategies adopted by Gucci for preventing the hostile
attempt for takeover of the management and administration of the company by the rival firm
LVMH were as follows:

Introduction: It has to be realized that what started off as a possible takeover concerns was
the 9.5% ownership of Gucci stock by the Italian fashion house Prada. At a later date, LVMH
under its President/CEO Bernard Arnault who had already made a bid for Gucci in 1994 but
considered the asking price of $350 Million too steep at that time made a reattempt to take
over the management reigms of the company in early 1999. LVMH was famous for buying
low priced but established brand name businesses and making them part of the LVMH
empire. In De Sole’s mind, Arnault no doubt had similar intentions for Gucci. Under U.S
regulations, LVMH was forced to report its 5% stake in Gucci which it did on Jan 6, 1999.
This led to a favorable increase in Gucci share price from $50 to $70 a share. On 12 Jan,
LVMH acquired Prada’s 9.5% ownership for $380 Million. By Jan 26, LVMH had acquired
a total ownership of 34.4% in the company with 20.15 Million shares out of a possible 58.51
Million shares. LVMH had invested $1.44 Billion in Gucci. Keeping in mind LVMH’s
operating principles, its motives were clear. The fact that it would eventually take over the
company, worried the CEO of Gucci De Sole. Looking for a way to prevent this, De Sole’s
first line of defense was

1. To invite employees into an ESOP ( Employees’ Stock Options Program). To

protect the share ownership however, De Sole instituted the ESOP scheme in 3
tranches namely in February and July 1999 and June 2000 the form of a Trust.
The ESOP option allowed De Sole and Ford to establish a possible 37 Million
new shares under an interest free loan, but with no dividend rights and no possible
transfers to a 3rd party, i.e. the shares were to be literally owned and controlled by
the management of Gucci. This underlined the fact that De Sole was trying to
prevent further hostile takeover attempts by Arnault. Thus the issuance of the
additional shares reduced the equity stake holding of LVMH in Gucci to go down
from 34% to 22%. This can be corroborated from the fact that even with the
ESOP purchase of 20.15 Million shares (25.6%) and subsequent dilution in
ownership of Gucci by its management, LVMH’s holdings in the stood at 22%.
Incidentally, 83% of the ESOP authorized by the share holders to be presented to
the extant as well as future officers, directors and employees were in fact granted
to De Sole and Ford, the President and CEO of Gucci. The shareholder rights
plan, colloquially known as a "poison pill", or simply "the pill" was a kind of
defensive tactic used by Gucci’s directors to prevent takeover bidders i.e. LVMH
from negotiating a price for sale of shares directly with shareholders, and instead
forcing the bidder to negotiate with the board. The typical shareholder rights plan
involves a scheme whereby shareholders will have the right to buy more shares at
a discount, if one shareholder buys a certain percentage of the company's shares.
The plan could be triggered, for instance, when any one shareholder buys 20% of
the company's shares, at which point every shareholder (except the one who
possesses 20%) will have the right to buy a new issue of shares at a discount. The
plan was issued by the Gucci’s board as an "option" attached to existing shares,
and only could be revoked at the discretion of the BoD. Thus it could be seen that
the ESOP/Shareholder rights plans brought out by Gucci as part of its defensive
plan or poison pills was a controversial decision because it hindered an active
active market for corporate control while on the other hand, giving the BoD of
Gucci the power to deter takeover bids.
2. Thus it could be seen that the ESOP Plan’s only intent was to prevent the hostile
takeover of the company by LVMH through complete buy out of the shares. This was
because as the ESOP was self financed by Gucci it forbid a transfer of ownership to a
third party. Moreover, the employees did not themselves invest in the ESOP. Such a
dilution with no corresponding investment served to reduce the holdings of
shareholders vis-a-vis the total ownership in the company. The total shares in Gucci
rose from 58.51 Mln before the ESOP to 78.66 Mln with the free floating shares of
38.36 Mln thereby reducing in terms of total ownership by the shareholders of the
firm from 65.6% to 48.8%.
3. Thirdly, when LVMH hit back on the aforementioned move of Gucci by stating that
the creation of virtual shares with no voting rights was a move to serve
management’s interests and was not the interests of Gucci shareholders by seeking an
injunction from an Amsterdam court, Gucci retaliated back by enrolling Morgan
 Stanley Dean Witter to its defense. LVMH had argued for voting rights,
transferability of the ESOP shares and redemption of the shares for capital.
4. Fourthly, in its defense, Gucci contacted Francois Pinnault of PPR , a rival French
conglomerate with a balance sheet size of 24.8 billion euros , involved in retailing,
credit and financial services B2B services and trading of luxury goods and products
to act as a white knight, whereby it would be buying out 40% of the equity stake in
Gucci as well as getting itself allotted seats in Gucci’s board as well as its strategic
and management committee.
5. Thus this measure undertaken by Gucci led to a 15.7% increase in Gucci share price,
from $70 to $81. Thus in this manner, by adopting the defensive strategies of ESOP
and PPR acting as the “white knight”, the company thwarted the aggressive takeover
bid by LVMH.

Yes, I do not believe that PPR’s stake acquisition in Gucci was also a form of takeover
albeit a form of negotiated bidding and subsequent acquisition with the approval and
consent of the BoD of Gucci and subsequently ratified by the shareholders of the
company. This was because the company had not attempted a buyout bid to aggressively
acquire all the equity shares of the company. On the contrary, PPR acted as a white
knight/ a friendly savior in the business world for Gucci by helping Gucci by willing to
purchase its equity shares when it was midst of an attempted hostile takeover bid by
LVMH. It may be understood that Gucci did not want to be taken over by LVMH. The
company felt capital market shareholders would not receive the proper premium for a
takeover bid. Furthermore, organizational shareholders such as the Italian managers and
employees did not want to work for the French LVHM, due to perceptions of a loss of
control and Italian pride.

In the present instance, the management of Gucci solicited help from a third party i.e.
PPR a friendly firm to act as a "white knight" whereby it was issued a new set of equity
securities such as preferred stock with voting rights. Moreover, the bidder company i.e.
PPR also agreed to purchase the existing common shares at a premium price. This could
be corroborated from the fact that PPR was willing to pay a premium for Gucci’s share,
thus becoming the preferred potential owner in the eyes of De Sole and the capital market
shareholders. Thus Gucci issued and sold 39 million new shares to PPR which it
purchased by offering a bid price @US $75 per share, (a premium of US$4/share over a
marked to market price of US$71/share). This decision of sale of common shares by the
Gucci management to PPR gave PPR a 40% control on the voting rights/ controlling
interest of the target Company i.e. Gucci and a representation in the form of 4 seats on
the board of directors (BoD) of Gucci’s management. Tough there was a litigation move
by LVHM to oppose the deal between PPR and Gucci but it failed. On the contrary, over
the next four years, PPR eventually bought out the remaining 20% stake of Gucci held by
LVHM @US$94/share thereby raising its stake in Gucci to 53.20% ( listed common
stock holdings). Thus it can be seen that PPR’s stake acquisition in Gucci was a
negotiated takeover with the consent and facilitation of the BoD of Gucci. The price,
purchase consideration and other terms of purchase were thoroughly negotiated between
the management of PPR(the white knight) and the target company (Gucci).The accepted
deal was later submitted to the shareholders of Gucci by its management for approval.
Similarly, the Management of Gucci also shared vital information as regards trading
positions, revenue earnings, operating costs, profits etc. with the acquirers i.e. LVMH
contrary to the position wherein the management refused to shell out any financial
information to LVMH during its course of creeping takeover bid. Thus from the
aforementioned discussion it can be concluded that PPR’s stake acquisition into the
equity base of the company was a negotiated acquisition of the controlling stake of
Gucci.

Fortis’s Acquisition of Wockhardt Hospitals

Ans 02 a. Comments on Fortis’s strategy of inorganic growth in the Indian health care
industry with a special note on the rationale behind its acquisition of 10 Wockhardt
hospitals. Critical analysis of the pros and cons of the acquisition

The Fortis’s strategy for inorganic growth in the Indian Health care industry can be
attributed to the following facts:

• Low and limited govt spending/ investment has provided significant opportunities
for the private health care service providers as large investments are required to
scale up the country’s infrastructure. This can be corroborated by the facts that
India would need an additional 920000 beds entailing an investment of between
US$ 32 billion and US$ 49.10 billion , assuming that 20% of these beds would be
in the tertiary segment. The GoI is likely to meet only 15-20% of the investments
required for the development of the beds. Thus the govt. spending on the health
care sector will be low @0.87% of GDP in comparision to US and UK where the
govt. spending is @7% of GDP. On the contrary, the share of the private sector in
health care spending in India is as high as 78% most of which is out of pocket
expenses. Thus this provides an ample scope to the private sector in general and
Fortis Healthcare group in particular in developing the health care sector which is
growing a CAGR @ 16% . Moreover, the Govt. is also facilitating the
participation of the private industry in the health sector by initiating investor
friendly policies and tax incentives.
• Secondly, the shift in the life style related diseases is growing to drive higher
health care spends. This can be corroborated by the fact that based on
demographic trends and disease profiles , the various lifestyle diseases viz.
cardiovascular , asthma and cancer will become the most important segments and
the inpatient spending in these lifestyle related diseases is set to increase by 50%
on a YOY basis. Moreover, the number of cardiac related diseases and treatments
in India is expected to grow from 1.50 million to 1.90 million/ year over 2010-
2015 and would constitute 5.10% of all treatments. Moreover, with the increase in
living standards, disposable income and literacy level, the demand and the
willingness to pay for the best possible health care facilities is on the increase.
Thus a growing population, changing patterns of diseases, rising income lvel ,
unmet clinical needs, growing demand for quality health care services are
expected to drive the potential for growth of hi-tech devices.
• Thirdly, overburdened health care infrastructure and the high cost in the west has
propelled India as a potential Medial Tourism Destination. The availability of
highly skilled and trained doctors, nurses and paramedical staffs has propelled
India as a much aspiring location. This can be corroborated by the fact that study
undertaken by CII and Mckinsey study has shown that Indian Medical Tourism is
expected to grow from a US$ 350 million industry to an US$ 2 billion industry by
FY 2012. The number of medical tourists to be treated in India was also set to
increase from just 10000 patients in early FY 2000 to atleast 180000 patients by
end of FY 2012 and this number is et to grow @20-25% annually. These
abovementioned factors provided the privates sector in general and the Fortis
group in particular the leverage to develop business strategies for tapping /
reaping benefits from the growth and development potential that existed in the
sector.
• In this context it should be understood that business strategy of Fortis Group for
growth based on the value chain was to focus on development of multi specialty
hospital chains through out India which were of the International Standards. This
was because the super specialty hospitals had a higher profitability rate and
shorter gestation period in comparison to the general hospitals. The fact can be
corroborated from the graph given below:
• Business Strategy graph of Fortis Healthcare Group
•

•
• Based on the above diagram it can be inferred that the primary services of Fortis
was providing diagnostics and emergency healthcare services etc but it had also
differentiated itself by providing specialized services with a focus on high margin
medical facilities which catered to a. Cardiac Issues; b. Knee replacement; c.
Neurological Sciences etc. In fact Fortis has acquired special status in terms of
Cardiac issues when Fortis started off its medical services with Fortis Mohali
Hospital in Punjab which was the region’s leading multi-specialty hospital with a
super specialty in Heart.
• The infrastructure, human resources and the associated support services requited
to provide these high quality health services and diagnostic facilities have a
capital cost associated with them. It has occurred to the management of Fortis
group that the inorganic growth prospects was far more beneficial than the
organic growth model. This was because the Net Asset Value (NAV)/ valuation
of target entity based on merger and acquisition proposition of other private sector
hospitals of nearest private competitors along with complete takeover of its
infrastructure/ Human Resources in terms of trained and super specialist doctors,
 trained nurses and paramedical staff/ IT facilities for hospital and patient care
management viz. highest level of service quality from arrivals to departure with
seamless registration and discharge with an element of warmth using the market
approach of relative valuation / comparable company approach far outwitted the
NAV of the comparable new/fresh capital investment to be made by the company
for construction and commissioning of service of afresh of any multi-
speciality/super-speciality hospitals.
• Secondly, the fact that the Fortis Healthcare Group was promoted by Ranbaxy
which was one of India’s top brand in the pharmaceutical industry provided the
Fortis management with easy access to much required capital and financial
muscle required with acquisition of super specialty hospitals in and outside India.
In this way it has promoted its business strategy of building a brand image of
quality health care services in the country by differentiating itself by providing a
narrow focus in terms of business activities and providing them at a high cost.
Thirdly, the acquisition theory of inorganic growth also fits into the corporate
strategy of Fortis i.e. market development in new markets where it wanted to sell
its existing products of super specialty medical sevices and in this case the
locations of the 10 Wockhardt Hospitals at Mumbai, Bangalore and Kolkata were
places where Fortis till date lacked its presence. Therefore the strategy of
acquisition of Wockdardt’s established hospitals at these locations which
accounted for more than 85% of the income stream for the target company was in
unison with the corporate strategy from growth and business development of the
company / group as a whole. This can be corroborated from the following
diagram:

•
• Therefore the theory of inorganic growth adopted by the management of the
company is well justified.
• The rationale behind acquisition of 10 Wockhardt hospitals are operationalization
of its corporate marketing strategy for business growth and development through
intense market penetration in the existing markets with the existing products of
providing super specialty medical health care in sectors like cardiology, neural
sciences, nephrology, orthopedics and knee replacement etc. and at the same time
to implement the strategy of market development in the new markets i.e.
southern, western as well as eastern region of the country. This can be
corroborated from the fact that acquisition deal of 10 wockhardt hospitals Fortis
would be having 6 hospitals in Bangalore, 4 hospitals in Mumbai and a hospital
each in Kolkata apart from a vast presence in NCR and a major facility in
Chennai. Apart from the same the other important reason for acquisition of the
 hospitals was the reason that these hospitals were to deliver high end critical care
to both domestic and international patients in the areas of Cardiac, Neuro
Sciences Orthopaedics Minimal Invasive Surgery, Renal Sciences, Kidney and
Liver transplants. Moreover, two of the acquired Wockhardt hospitals had the
coveted international accreditation by JCI (Joint Commission International). Thus
with this major acquisition, Fortis would have 3 JCI accreditated hospitals in its
network. This would be positioning Fortis strongly as a quality destination of
choice for Medical Value Travel. Moreover, the existing talented team of medical
and non-medical professionals would have been absorbed by the company i.e.
Forts and would have continued to run the operations to consistently deliver
compassionate and high quality patient care.
• The pros and cons of the acquisition of the hospitals by Fortis are as follows:
• Pros: It would have allowed Fortis in getting a pan India presence in the health
care sector as most of the multi/super specialty hospital of Fortis were located in
Northern India. It had very little presence in the form of hospital and associated
infrastructure facilities in the Western, Eastern and the Southern Region of the
country. Thus acquisition of revenue/ profit generating hospitals which accounted
for more than 85% of the revenue of Wockhardt and which did not add to any
major liability of the company in the form of blocked capital served the business
prospects of the without any additional liability. This would have allowed Fortis
to emerge as the leading/ largest healthcare services provider in States like
Haryana, Punjab, Delhi, Rajasthan, UP and Maharashtra as well as grow into a
company having a sales/ revenue reanings to the tune of US$ 1 billion by FY
20102. In addition it also allowed Fortis to fulfill its aspiration of owning 40
hospitals spread over various cities in India having a bed capacity of 6000 beds.
Incidentally, the acquisition of the hospitals would have allowed the group to
aggressively compete with the market leader i.e. Apollo Hospitals in terms of
infrastructure capacity base. i.e. Apollo’s 8065 beds spread across 46 hospitals in
comparison to Fortis’s 5180 beds spread across 38 hospitals in India. Incidentally,
2 of the 10 hospitals to be acquired by Fortis were in the construction phase.
Thus, Fotis was interested to invest an additional amount of Rs. 2 billion in these
ventures and the same would have propelled Fortis way ahead of the market
leader Applo Hospitals as the leading super speciality health care service provide
in the country in the private sector.
• Thirdly it would have allowed Fortis to consolidate its position in the super
specialty health care sectors as orthopedics, renal care, cardiac and neuro sciences
as most of the Wockhardt’s hospitals acquired by Fortis specialized in these
medical branches. Fourthly, the acquisition of the hospital and takeover of all the
specialized doctors, trained nurses and paramedic staff in the rollbooks of Fortis
without any major retrenchment policy would have allowed the company to gain
access to a talented pool of highly rained and experienced human resource base of
650 doctors and 1300 trained paramedic staff and nurses. In this manner the
company would have saved recruitment cum training / skill development
expenses. The same would have also allowed Fortis to gain access to Wockhardt’s
acclaimed IT infrastructure for hospital management, its famous staff training
cum education development programs designed and developed in partnership with
 PHMI as well as issues related to control and prevention of HIV/ AIDS treatment
in the country. Moreover, three of the 10 hospitals that were being acquired by
Fortis were accredited by the US based Joint Commission International (JCI).
This would have allowed Fortis to increase the bench strength of qualified
medical staff available under its disposal as well as number of internally
accredited hospitals under its management control to 9250 trained doctors and
nurses as well as 13 no of nationally/ internationally accredited hospitals. This
would have allowed Fortis to greatly allure the international patients especially
from the US and Europe to visit its hospital chain for international standard health
care services as medical tourists and thereby gain benefit from the growth
potential that existed in the International Medical Value Travel Sector. Last but
not the least, the synergy that existed in the in the operational functionalities of
Wockhardt and that of Fortis in terms of nurses training centre, purchase of
supply of medical apparatus, medicines, drugs and other supplies, in-service
training and skill upgradation of the staff ectc. would have allowed the acquiring
company to scale up its health care services and thereby reach economies of scale
by reducing the operational cost and thereby improving its profit margins.
• Cons: The deal had been stuck at a premium by Fortis at Rs. 9.09 billion which
was way above the market expected value of Rs. 6.50 billion for the assets to be
acquired. Therefore the it was a huge challenge on part of the Fortis management
to oversee that the EBDITA of the future cash flow of these 10 Wockhardt
hospitals remained in the range of >20% so as to ensure a decent pack back period
of 7 years for recovering the huge capital investment made for acquisition.
Moreover, 2 of the 10 hospitals that Fortis had acquired were under the
construction phase. Moreover Rs. 1.9 billion out of Rs. 9.09 billion paid for the
acquisition was made in the form of capital payment towards work-in-progress.
Therefore the estimated immediate net cash flow was to accrue from the health
care service operations from the currently operative 8 hospitals units only.
Moreover there existed an element of risk against the investment made for
acquisition of the under construction hospitals so as to ensure that the timely
completion of the construction followed by commencement of service for
ensuring that expected earnings and returns on investment and generation of
revenues/ income against capital investment made for its acquisition. Moreover,
recruitment of the staff, putting in place the medical apparatus, devises and the
associated suppliers/ vendors etc. was an added risk. Thus the long Return on
Investment (RoI) period was a negative factor. Apart from the same, since there
was an element of debt associated with the acquisition process, thus the company
had to ensure that the EBDITA had to sufficient so as to meet the debt
obligations. Moreover, the acquisition process involved channeling Rs. 3.5 billion
out of Rs. 100 billion mobilized from the rights issue. Thus the existing
shareholders to whom the right issue were sold at a discount could become
suspicious because management may be empire-building at their expense (the
usual agency problem) associated with expansion through inorganic growth
considering the fact that management was interested in greater market penetration
in the existing established markets in the health care sector especially the large
Metros like Bangalore, Mumbai, NCR and Delhi etc. places. Apart from the same,
 the intellectual integration of the trained medical staff staff, paramedics and the
associated human resources from the Worckhardt hospitals with the Fortis
management was an important challenge. Though Fortis management had decided
to take over board all the staff including the acting CEO of Wockhardt Hospital
Sri. Bali but then providing the right kind of working environment, work culture,
freedom and space to work, job enrichment, rotation and motivation and retention
of the staff brought forward from Wockhardt now under the Fortis management
and control was a major concern and challenge associated with the acquisition
process of 10 no. of Wockhardt hospitals by Fortis management. Last but not the
least, the system integration of the Wockhardt’s Information Technology systems
associated with hospital management, patient management/ CRM/ maintenance of
patient data base and referral system to the concerned doctor depending upon his
availability/ integration of the medical devices and apparatus. Management of the
clinical department systems and processes for proper allocation of duties to the
staff and its effective management, marketing intelligence and healthcare/ clinical
information gathering and analysis system etc. with that of Fortis was a Herculean
task and a major challenge that needed immediate attention.
• Thus the aforementioned discussion suitably summarizes the pros and cons
associated with the acquisition of 10 no. of Wockhardt hospitals by Fortis.
Ans 02 b. The various challenges that Fortis is going to face in the near future and
the strategies that it could adopt for overcoming the same are as follows:

• High Investment and high cost business structure: Fortis faces the risks and
challenges as high capital intensity, long gestation periods of the acquisition
projects in the health care sector and technological obsolescence given its focus
on super speciality segments of clinical treatment in its hospitals viz. cardiology,
orthopedics and knee replacement and nephrology and the poor track record
associated with its inability to effectively integrate any acquisition of health care
hospitals under its management control. This can be corroborated by the fact that
there were three separate litigations in process related to Fortis’s acquisition of
Escorts Hospital or for that matter as relates to acquisition of the Jeevan Mala
Hospitals in Bangalore. As far as the Escorts Hospitals (EHIRCL) is involved it is
drawn in a legal battle for - its right to a leasehold interest on the land on which it
is located, the application of a condition in an allotment letter in respect of the
EHIRC hospital site requiring the provision of free treatment to indigent patients
at EHIRC, non-renewal of EHIRC’s nursing license and certain income tax
exemptions claimed by EHIRC’s predecessors. It can be seen that EHIRCL
contributes around 60% to the topline of Fortis Healthcare. Thus any negative
judgment on the said litigation would impact the performance of the company and
its growth prospects. The strategy of an amicable out of the court settlement as
well as business policies that effectively abide by the SEBI guidelines associated
with Mergers and Acquisition and effective valuation of the assets base of the
companies (book value) at the time of acquisition as per Accounting Standards
may be followed.
• Similarly, the business strategy of inorganic growth entails significant fixed costs
and high operating leverage. Thus the profitability of the business plans and the
 consequent capital efficiency ratios depend upon the occupancy rates and
realizations per bed. Thus if occupancy rates decline or for that matter Fortis is
unable to scale up occupancies in its new hospitals, then the margins could come
under pressure. Thus this challenge can be tackled by adopting an effective
pricing strategy. This could be done by streamlining the respective clinical
department operation and maintenance costs. A centralized procurement process
of the supplies, clinical apparatus, effective duty scheduling of the doctors/ nurse
and paramedics through effective operationalization of the hospital management
system for optimal utilization of the skilled and trained human resources, effective
improvement of the patient management system right from the time of registration
at the hospital to the time of discharge for optimal utilization of the human
resources Similarly, the company could expand its referral network for the
hospitals, put in place increased % of community outreach programs to gain
market share in the regions in which they operate and reducing the average length
of stay of inpatients through effective patient care management.
• In this perspective, it can be seen that the average occupancy rate of 57%, still
remained lower in comparison to that of its major competitor Apollo Hospitals.
This is mainly on back of low occupancy rates in the Non-Metro regions wherein
the average patient base for super speciality diseases viz. heart diseases, renal
failure or orthopedic diseases were low and the paying capacity of the patients
was also low. Thus the strategy that could be adopted fro the Tier-II cities viz.
Jaipur and Raipur (where it is running a cardia centre with the approval of
Chattisgarh Govt.) could be to establish multi specialty hospitals. This can help in
improving the bed occupancy rates in the hospitals as the fall in bed occupancy
rate for a particular clinical department could be compensated by another clinical
department. A glaring example in this regard is the proposed commissioning of
the services of a multi –speciality hospital by the Fortis Group at Shalimar Bagh
in west Delhi which would be catering to the clinical departments of cardiology,
mother and baby care, nephrology, neurology, opthopedics, trauma and
emergencies as well as gastroenterology with 250 beds in the 1 st phase of
operations.
• Currently Fortis operations are concentrated in the northern part of the country,
with most of the hospitals in the NCR region. This is in comparison to Apollo
which is well diversified across the Key regions of India. This exposes the
company to any adverse Economic, Regulatory or other developments occurring
in the region. Thus diversifying into Tier-II cities for the time being using the
various central govt. incentives viz. tax holidays could be a implementable
strategy.
• Next it can be seen that the company derives a major proportion of its major
revenues through core hospital services unlike its peers Apollo, which is already
in its next phase of development by setting up pharmacies and pathological
laboratories across the country. Thus Apollo has a well reversed business model
with around 50% of its revenues being contributed by pharmacies. Thus the Fortis
company may take a cue from the business strategies being adopted by its rival
Apollo and implement a suitable strategy at least in the Tier-II cities where its bed
occupancy rate is low.
 • Similarly intellectual integration of the skilled doctors, nurses, paramedical staff
that the company acquires as part of its acquisition process with that of Fortis’s
HR management system and consequently developing retention strategies is
another area of concern. The effective strategy that the company may adopt can
be involving the acquired staff in the business and the clinical management
process post acquisition of the hospitals. This can be corroborated by the fact that
CEO of the acquired Wockhardt hospital Mr. Bali continued with the Fortis
Management that was taking business decision for the working of the Wockhardt
hospitals post mergers. Providing ESOP of the acquiring company to the staff of
the target company, acquiring company entering into a collaborative partner for
academic exchange, hosting joint conferences and conducting joint clinical
research with organizations such as the United States-based Partners Healthcare
Systems Inc., which has members like Massachusetts General Hospital and the
Brigham & Women’s Hospital in Boston, USA etc. could provide the acquired
staff with the much needed leeway, space and scope to work in a changed work
environment and a change of guard of the management. Moreover, accreditation
of its hospitals by international agencies viz. JCI can help the company to
improve its quality of patient care, introduce new and innovative procedures for
the patients and also help attract overseas patients to the hospitals and tap the
rapidly growing medical tourism sector. In addition, these associations would also
provide a source of innovation and advanced clinical learning for the doctors and
other personnel at the hospitals.
• Another challenge that the Fortis group could face in light of its aggressive
growth phase is the shortage of skilled manpower. In order to cope up with the
challenge, the company could develop strategies for catering to the field of
medical education. The group could consider setting up new health cities with
tertiary care hospitals and having campuses for dentistry, paramedics, nursing,
clinical research centres and pathology labs. The students graduating from these
institutes could be at a later date absorbed by Fortis into its health care system.
• . Thus the aforementioned discussion suitably summarizes the various challenges
that Fortis could face as part of its business process operations and the suitable
implementable strategies that could be adopted for overcoming these challenges.

The Betapharm Acquisition-: DRL’s Inorganic Growth Strategy in Europe

Ans 01 a. The advantages and the disadvantages associated with the adoption of organic
and inorganic growth strategies in organizations:

• Introduction: Organic growth means expanding one’s business and increasing

turnover by carrying on doing what a particular business entity/ organization is
doing, rather than through acquisitions (buying other businesses) or through
moving into new markets. Under organic growth a business entity of for that
 matter the management of a company might take a strategic decision to move into
a new geographic region or use a new sales, marketing, brand promotion or
communication channel with the potential consumers, but then it still restricts its
operational strategies restricted to the outer domain limit of the existing/ original
business model. The company/ business organization/ entity does not force
growth with outside investment and the rate of growth is more natural - hence the
name organic.

The advantages associated with organic growth are as follows: Organic growth is
typically much safer than rapid growth or growth through mergers and acquisitions,
because a company/ business entity/ business unit uses its tried-and-tested existing
business model with out much deviation or de-routing from the original corporate
strategy. It gives the much needed leeway to the management of a company/ business
entity to test/ critically analyze and interpret the advantages as well as the disadvantages
associated with the existing business model/ corporate management strategy before
moving onto another one. Secondly, it's also easier on the business entity’s finances as in
the case of organic growth the business entity/ unit grows by reinvesting profit back into
the existing business unit/ organization thereby avoiding the need for outside investment
and the associated pressure from shareholders that often comes with it. Thirdly, in case of
organic growth the growth rate of the organization/ business unit/ entity is natural and is
not a forced growth so as to achieve the desired EBITDM so as to effectively service the
debt ( in the event of debt being used for M&A) or ROE, if cash surplus/ equity base of
the firm is used for the M&A proposal. Moreover, in organic growth the risk / uncertainty
associated with the erosion of the share holders value / capital erosion is low as the
business entity is guided by the tried and tested business model. The company is not nor
guided by the fact that how the FCFF of the acquired firm and its impact on the P/L
statement and Balance sheet of the acquiring company. Similarly, under organic growth
the risk and uncertainty associated with cost synergies which are the traditional focus of
M&A projects is totally avoided. It is often seen that M&A projects try for cost synergies
through operations viz. leveraging each other's customer base or intellectual property for
incremental revenue but then there are uncertainties and risks associated with it viz. in the
form of high attrition rate under the changed management structure/ lower human
performance output on account of job dissatisfaction etc. Last but not the least, is the
advantage that organic growth is not dependent upon exceptionally skilled managers but
rather on optimization of a portfolio of growth options.

The disadvantages associated with organic growth are as follows: Organic growth
often takes longer than more aggressive M&A strategies as far as the achievement of
overall growth of the company/ business entity is involved. Adoption of organic business
growth strategies may act as a limiting factor if the management of the company/
business organization is keen on expanding rapidly through diversification by trying out
lots of different business models and new ideas. Moreover, in order to grow organically,
a company needs excellent leaders who have the skill and the vision required for adopting
new innovation, skill enhancement as well as designing a log frame approach for
implementing the innovative strategies. It also requires excellent managers to implement
these innovative strategies viz. strategies for selling in new areas or through new channels
or for that matter selling to new customers or selling more to existing customers,
productivity enhancement through cost marginalization so as to judiciously channelise
the cash accruals of the company and generate enough profits. Sometime these strategic
skills may be lacking within the available staff of an organization and in that case the
business-owners lookout for/ thrive on having outside investment and the guidance that
come along with it.

Inorganic Growth: On the contrary, Inorganic growth is the rate of growth of business,
sales expansion etc. of an existing business unit/ entity/ organization by increasing output
and business reach by acquiring new businesses by way of mergers, acquisitions and
take-overs. This kind of growth also takes place due to government directives, leading to
enhancement of business in some identified priority sector/area. The inorganic growth
rate also factors in the impact of foreign exchange movements or performance of other
economies. An important tool for undertaking inorganic growth by an organization is
through merger and acquisition. Thus the advantages associated with inorganic growth
are as follows:

• Advantage associated with obtaining quality staff or additional skills,

knowledge of one’s own industry or sector and other business intelligence.
For instance, a target company/ business entity with a good management and
process systems will be useful to a acquisition which wants to improve its internal
work process. Ideally, the target company/ business unit that an acquiring
company chooses should have systems that complement its own and that which
can adopt well with a running larger business unit. Moreover, acquisition and
merger with other businesses can bring new skills and specialist departments to
the business which helps the company to diversify well.
• Advantage associated with accessing funds or valuable assets for new
development. Better production or distribution facilities are often less expensive
to buy than to build. Thus an acquiring company can derive great value
proposition by acquisition of target businesses that are only marginally profitable
and have large unused capacity which can be bought at a small premium to net
asset value. This helps the acquiring company with economies of scale, which
reduces unit costs. This also helps in reducing competition if a rival is taken over.
• Advantage associated with operating leverage: This can be corroborated
from the fact that if say business entity A is underperforming and is
struggling with regional or national growth then it may be a less expensive to buy
an existing business that is performing well than to expand internally.
• Advantage associated with accessing a wider customer base and increasing
one’s market share. The target business may have distribution channels and
systems which can be used by the acquiring company as marketing channels for
selling its own produce once it acquires the controlling stake.
• Advantages associated with diversification of the products, services and long-
term prospects of one’s business. A target business may be able to offer an
acquiring business house/ entity new products or services which the acquisition
company can sell through its own exiting distribution channels. Moreover,
 product diversification also also in risk mitigation through spreading of
associated risks.
• Advantages associated with reducing one’s production/ manufacturing costs
and overheads: This can be achieved through sharing the marketing budgets
between the target company and the acquiring company, through increased
purchasing power of the merged entity and thereby lowering the operating/
production costs.
• Advantage associated through reduction of competition: Acquisition or for
that matter buying up new intellectual property, products or services may be
cheaper than developing this oneself. Moreover, through elimination of a
competitor an acquiring firm can strive for a greater market share through
horizontal integration, which means the business can often charge higher prices.

On the contrary the possible disadvantages associated with inorganic growth could
be as follows:

• Diseconomies of scale if business becomes too large, which leads to higher unit
costs.
• Possibilities of clashes of culture between different types of businesses can occur,
reducing the effectiveness of the integration.
• May lead to make some workers redundant, especially at management levels –
this may have an effect on the motivation level of the newly merged entity.
• May lead to development of a conflict of objectives between different businesses,
meaning decisions are more difficult to make and causing disruption in the
running of the business.

Justification of the inorganic growth strategy adopted by DRL in Europe:

Europe was the 2nd most important generic drug market in the world in general and
Germany in particular after US. This was because of the ageing European population as
well as the increased public health costs. The increased public health cost was further
fuelled by the fact that by 2011 , patents for branded/ proprietary dugs worth Euro 11.80
billion was expected to expire in major European markets like France, Germany and UK.
This had opened up the market for the generic products to replace the patented drugs.
Moreover, there was tremendous growth rate observed in the generic product market in
Europe and Germany in particular backed by the revised rules and guidelines associated
with operations in the generic drug market brought out by EMEA in 2006. This policy
allured Indian companies like DRL to venture into the 2nd most important generic drug
market in the world i.e. Europe in general and Germany in particular which had a market
size of Euro 23.70 billion. Moreover, lowering of profit margins from 25% to 5% from
sales operations in US generic market on account of intense competition and the fact that
the patented drug companies were coming out with new generic versions of the drugs
where the patents were expiring was severely affecting the profit margin of DRL was
DRL was exploring the possibility of diversification of its marketing operations in new
generic markets considering its vast portfolio of generic products.
However, DRL did not have any presence/ ingression in the European market in general
and the German Generic Drug market which accounted for 66% of the sales in Europe in
particular. It need an entry platform for making an initial foray in the German Market for
which it need an co-partner/ an allay which had a major share in the European Market
and had sales/marketing the distribution channel, networking and relationship with
doctors and pharmacists for helping DRL to sell its generic as well as innovative
products in these new markets for the company. Moreover, there were major
complexities/ difficulties associated with operations in Europe, viz. adherence to
regulatory environment for registering the products, obtaining marketing authorization
and the delivery channels for supplying of the generic products to the customers. Thus for
a 1st timer company like DRL it was almost impossible to single handedly develop this
regulatory and marketing and supply chain infrastructure single-handedly from the
scratch in Germany by using an organic growth channel. Moreover, for a company like
DRL which had a vast portfolio of generic and innovative drugs under its command, what
it needed was a distribution and marketing channel so as to have a presence in the local
markets . So it was looking out for local companies based in Europe which had a strong
distribution infrastructure for helping it to market its products. Thus acquisition of a
business entity which met the aforementioned parameters and matched its business as
well as cultural perspective was the only way out as growing single handedly would have
taken a long time and there were risks associated with the adherence to the regulatory
requirements/ marketing of the products through brand value creation/ creation of the
supply channels and developing a sizable market share within the least possible time limit
and thereby provide a favorable ROE to the shareholders.

Moreover, the complexities associated with operations in the European Generic Drugs
market also compelled DRL to look out for a possible acquisition of a German firm. This
can be corroborated from the fact that EU polices regulating the generic drugs market
made design and development and production of generic drugs totally illegal for sales/
marketing as well as for clinical research purposes during the patent period of the
propitiatory drug. This compelled the European based drug companies to source for
companies outside Europe for carrying out clinical research for design and development
of quality generic products at a cheaper rate so that the same could be launched in the
market on the date of expiry of the patented drug. Thus, the European companies
restricted themselves for sales/marketing/ distribution of procured generic products
(outsourced for production to overseas countries). Thus, the European drug companies
were looking for vertical integration for sourcing generic products for sale through its
marketing channels. DRL wished to capture on this new developing potential business
proposition of the European Generic Drug market as it has the necessary world class
manufacturing base of generic products at cheaper cost. Thus, there existed a possibility
of synergistic gain through acquisition of a possible German based drug company.
Moreover, the acquired marketing channels could also be utilized for enhanced market
penetration of its own products thus helping in market gains and enhanced market power.
Thus it can be seen that inorganic growth strategies allowed DRL to overcome the initial
entry barriers associated with 1st time entry into a new market viz. overcoming customer
loyalty associated with the existing generic brands in the German market, high capital
expenses associated with brand promotion activities as well as brand differentiation
strategies for carving out a niche segment in the customer market. Incidentally, DRL
could have leveraged on the existing customer and brand loyalty support bases that Beta
pharm maintained with the doctors, paramedics and the pharmacists. This provided
economies of scale in the form of cost savings to the form. Moreover, the well
established marketing infrastructure of the company where by more than 200 of its 370
staff strength was involved as field marketing staff allowed the company to take
leverage of the marketing channel of the acquired firm and thereby develop increased
market power through greater reach to the potential customer. Developing this
infrastructure from the scratch would have been a difficult proposition for DRL had it
adopted the organic growth route because of the cost and the time involved.

Betapharm which was the 4th largest generic drug manufacturing company in Germany
fitted the best to these guidelines. Thus even if the amount paid by DRL for acquisition of
the firm @ Euro 480 million was considered to be a bit on the higher side but hen the
value proposition that DRL envisaged to derive over the foreseeable future was immense
and thus the company envisaged to recover the invested capital as the FCFF was
considered to be quite favorable. Thus this compelled the management of DRL to go all
out for an inorganic growth proposition for tapping the potential German Drug market.
Thus this led to inorganic business growth proposition in Europe by DRL.

Ans 01 b. The rationale behind DRL’s acquisition of betapharm are as follows:

Get an immediate access and foothold to the German Generic Drug market which the 2nd
biggest generic drug market in the world after the US. This was all the more needed
because of the decreasing profit margins the company was realizing from its US market
operations because of intense competition especially from innovative drug manufacturers
who came up with new generic innovations/ formulations to replace their proprietary
products immediately on the date of expiry. Thus competition was intense. On the
contrary Germany accounted for 66% of the generic drug sales in Europe more so
because of its ageing population and rising public health care costs. The company with a
wide portfolio of generic as innovative drugs wanted a share of this growing market
desperately more so because it did not have a strategic presence in these markets and
more so because of the pressure on its financial margin due to fierce competition in US
market. Thus the company needed a strong foot hold and a launching platform through
vertical integration with a European firm in the form of a well established marketing /
sales and distribution channel with good networking and relationship with doctors/
pharmacists, brand image and loyalty which could be leverage upon for large scale bulk
sales and marketing of its high quality generic and new innovative products. Betapharm,
the 4th largest German Generic Drug manufacturing company suited to the
aforementioned immediate need and requirement of DRL and suited the best so as to
meet its business and corporate needs. Apart from the same, the product portfolio of
Betapharm’s generic products was skewed towards chronic diseases viz. cardiovascular ,
CNS and gastrointestinal diseases where the medication period was quite prolong.
Moreover, with regulatory laws in Europe that prohibited generic drug design/
manufacture and clinical research during the patent phase of the innovative branded drug,
therefore most of the drug companies in Europe in general and Betapharm in particular
was outsourcing such generic drug research to overseas countries. Betapharm thus did
notr have any manufacturing base and had transformed itself to merely a pharma sales
and marketing company that procured these generic drugs in bulk from foreign firms.
This provided a potential business opportunity to DRL as acquisition of Betapharm
would have helped DRL to provide it with the much needed vertical integration for
continuous supply of generic drugs associated with the aforementioned chronic disease.
Thus through acquisition of Betapharm, DRL could have played with volumes and
thereby improve its profitability and financials. Incidentally Betapharm had a 3.5-4%
share in the German Generic Market with a revenue earning of Euro 186 million and a
incremental growth rate of 26%. Thus this would have helped the company in achieving
its ambition in becoming a US$1 billion mid-sized global pharma company by end of FY
2008. Thus with the aforementioned discussion suitably summarized the various rationale
that went with DRL’s acquisition of Betapharm.

The pros and cons of this cross border acquisition are as follows:

• Pros: The acquisition of Betapharm will provide DRL with a platform for
launching its business operation in the German Generic Drug market which was
the world’s 2nd biggest generic drug market and at the same time readily capture
atleast 3.5% market share of the potential market. This was all the more important
because there was growing demand for generic drugs in Europe because of the
high public health cost on account of ageing population.
• Secondly, Beta pharm was basically a drug sales and marketing company and did
not maintain any manufacturing plant of its own. On the contrary 200 of its 370
staff strength were basically field sales agents. Thus it could be seen that the
company had an extensive marketing and regulatory infrastructure coupled with
expertise in product registration, market authorization and innovative specific
environment specific marketing tools. Thus DRL was basically acquiring the
trained Human resource, sales and marketing channels, brand equity and good
will from the betapharm. The absence of acquisition of any immovable assets viz.
manufacturing plant provided the scope for a seamless, hassle free integration of
the acquired assets base with the existing assts of DRL. Moreover, the company
would also have been absolved of the ignominious decision of retrenchment of
acquired human resources of betapharm. Moreover, the acquisition of the
marketing/ sales and distribution channel and the regulatory infrastructure would
have provided the much needed leeway for DRL to market its large portfolio of
generic drugs in the growing Eupopean Market. This would have helped the
company in overcoming the intitial market penetration problem a company would
face while enetery a new market area.
• Thirdly, since betapharm was outsourcing all its production was procuring bulk
volumes of generic drugs for sales through its distribution channel, therefore
through the acquisition of the firm, DRL could have leveraged upon its low cost
manufacturing base of high quality generic drugs and innovative drug to the
fullest through backward vertical integration,
• Fourthly, the product width and depth of Betapharm was quite vast as it had more
than 145 brands under its domain. The company also had a well laid out strategic
 plan for launching of these branded generic products in the German markets in a
phased manner upto FY 2010 immediately on the expiry of the patent period of
the branded products or for that matter whose sales exceeded Euro 10 million.
Apart from the same the product portfolio of Betapharm catered to high value
and chronic illness like cardiovascular disease, CNS and gastro-intestinal disease
where the pharmaceutical treatment was prolong. Thus through acquisition of the
firm, would have provided DRL to tap these potential business development
avenues through diversification of the product portfolio into chronic clinical
disease sector as well as for playing in bulk volumes ( prolonged sales of life
saving drugs related to heart ailements, neuro-logical disorders, etc.). Thus the
acquisition would have helped DRL to increase its financial through increased
sales revenue generations and earnings.
• Fifthly, acquisition of Betapharm would also have helped DRL to adopt its
product/ brand differentiation strategy whereby Betapharm would differentiate is
product under the Beta brand.
• Last but not the least, there was business as well as cultural synergy/ similarity
betwwn the two firms. Both DRL as well as Betapharm were commiteed to the
cause of CSR and worked on issues related to social medicine and health
management as well as conducted research and studies on issues related to
practice of ethtical standards in health system management. While Betapharm
operated the “ Betapharm Institut” DRL operated the DRF and the Centre for
Social Initiative and Management. Thus this huge commonality, in corporate
culture helped Betapharm to merge into DRL’s working environment in a
hasslefree, smooth manner without much corporate discord.

Cons: The various challenges and difficulties associated with the overseas acquisition of
Betapharm company by DRL could be as follows:

• Since the capital involves in the acquisition deal was huge i.e. Euro 480 million
out of which Euro 80 million was paid in cash, therefore the company took a hit
in its internal cash accruals/ cash reserves. The cash reserves basically act as
cushion to the company in rainy days. Therefore the company was more prone to
operational risks. Moreover, a large debt was also taken by the company from the
CITI Bank for undertaking the deal. This can be cooroborated by the fact that the
total LT debt of the company increased from 22.18 Million INR in FY 2005 to
INR 20937.13 million on 3ist March, 2006. Thus debt servicing was a major
problem as the D/E ratio of the company had increased. Thus it could be seen that
the company was excessivekly dependent upon the cash realizations from its
operations in the German Drug Market. This was a risky business operational
proposition as the potential future cash flows of the company were being
concentrated to a single market of Germany and Europe. Thus any risk/ untoward
incident / downfall in its German operational market could have a severe effect on
the future projected cash flows of the company. Incidentally, the market share and
profit realizations of the company from its US operations were strained due to
severe competition from the branded generic drug manufacturers.
 • Thus the need of the hour was operational risk mitigation through diversification
to other markets i.e. UK , France etc. Secondly, the deal as it was a overseas one
could face foreign exchange risks, interest rate risk as well as regulatory and
market adherence risks.
• Apart from the same he company could face sovereign risks as the regulatory and
supervisory of for that matter Corporate tax / governance laws of the German
Govt. may have a severe adverse impact on the business operations and cash
accrual of the company. This can be corroborated by the fact that AVWG Act that
was enacted wef 1st May 2006 in Germany reduced the scope of profit earnings by
the drug companies operating in the German Market as governmental pressure
was put to reduce the cost of generic drugs by 20-25% so that the Govt. cut
reduce the public health cost and provide succor to the German public.

Tata Motors and Fiat Auto-Joining Forces

Ans 17 a. In my opinion the key reasons for Fiat’s poor performance in India can be
attributed to the following:

1. The company had a poor dealership network of car dealers coupled with the
coupled with the abysmally dismal and lackadaisical after sales customer
service and support system. Apart from the same the customers who bought
various models of the Fiat company launched in the Indian Market viz. Palio,
Sienna and the Palio Adventure also had to face problems associated with the
non availability of the auto spare parts for undertaking timely replacement and
over hauling of the cars. Thus these operational associated with the product
and services delivery mechanism severely tarnished the brand image and
associated brand loyalty of the customers. This can be corroborated from the
fact that one of the main agenda associated with the formation of JV with TM
by Fiat was to leverage on the extensive and vast network of dealership and
customer service support/ company authorized workshops for undertaking
sales and after sales serving and supply of spare parts of the selected brands of
Fiat Cars viz. Palio and Palio Adventure through its shared dealership network
in 11 prominent cities of the country which accounted for 70% of the sales
revenue generation from car sales for FIAL.
2. Secondly, the poor management of the advertisement and brand promotional
campaign of the company led to a poor brand positioning in the minds of the
potential customers in comparison with the other major international players
vying for a share of the rapidly growing Indian car market in particular which
was growing @20% p.a. and with an average sales of cars nearly touching 2.0
million units/p.a.. This could be corroborated from the fact that the market
share of Fiat in the Indian Auto market was hardly 1.7% in FY 2004-05 and a
dismal sales Y-o-Y car sales figures. This greatly affected the financials of the
FIAL .
3. Thirdly, the poor sales of its car models led to poor capacity utilization of its
existing manufacturing and production facilities at the Kurla and the
Ranjangaon Plants. Thus due to poor capacity utilization of its Indian
 Production bases, the overheads cost viz. in the form of salaries, taxes, rents
etc. were eating into the operational profits. Thus the aforementioned
discussion suitably summarizes the key reasons for Fiat’s poor performance in
India.

The various factors that made TM an attractive alliance partner for FIAL were as follows:

1. TM was the leading commercial vehicle and the 3rd largest passenger car
manufacturer in the country. Over the year TM had a developed a great amount of
goodwill/ brand loyalty and reputation in the Indian Car Market. Thus with the
development of the JV, Fiat wanted to take leverage of the goodwill/ brand image
as well as the wide and vast Pan India network of authorized dealers / workshops
and customer service centres that TM had for the sales, marketing and after sales
servicing and repair of its car models viz. Palio and Palio Adventure as well as
supply of spare parts. Thus by piggy backing on the dealership and customer
service and support network of TM, Fiat wanted to enhance its sales and
marketing reach to the untapped areas of the growing Indian small car market and
at the same time overcome/ solve the problem of poor dealership network and
customer service centres/ bases in India. This could be corroborated from the fact
that through the shared dealership network which consisted of 25 TM dealers and
3 Fiat India Dealers through its 44 outlets , FIAL wanted to improve upon its
dealership as well as customer service delivery levels in 11 prominent cities of
India which accounted for more than 70% of the total sales revenue for FIAL.
Thus the JV would have helped Fiat in improving its sales, marketing ,
distribution and after sales servicing standards in India without making sufficient
capital expenses for overhauling its distributorship base. Thus it would have
helped Fiat to make savings as far its operational expenses was concerned.
2. Moreover, the JV also allowed Fiat to leverage upon the financing arm of TM i.e.
Tata Motor Finance to finance the Fiat cars to the potential customers. Thus Fiat
was saved from investing the initial capital required fro setting up an independent
Auto financing subsidiary in India for supplementing its sales and marketing
operations. Thus through the leverage with TM it wanted to improve upon its
customer deliver systems/operations as well as its regain its lost image/ brand
reputation in the Indian car market. .
3. Secondly, through the JV with TM, FIAL could have sourced quality auto spare
parts/ components/ produced at a cheaper production cost vis-à-vis that in Europe
for its India as well as overseas operations. Incidentally, FIAL wanted the TM
dealers and customer service centers to supply and make available the spare parts
for its car models to the potential customers thereby overcoming the spare parts
scarcity problem that was severely denting its brand image / reputation in the
market. Moreover the Tata Group was one of the leading quality and low cost
manufacturer cum supplier of various auto components, spare parts and
assemblies in India because of associationship of large number of ancillary auto
component manufacturer under the TACO Group. Thus procurement of auto
components/ spare parts at cheaper cost could have provided economies of scale
and helped FIAL to lower its operational cost.
 4. Thirdly, because TM was the leading commercial vehicle manufacturer of India
with a market share of 69.90%, the company had a reliable network of gathering
marketing signals / sourcing market intelligence report on the basis of critical
analysis and interpreting of the buyers’ trend and choices. Through the JV, FIAL
wanted to utilize the market intelligence of TM for devising strategies for
restructuring its marketing operations for IVECO Truck Division in India.
5. Fourthly, the JV with TM would have allowed Fiat to gain from the
complementarities and synergies in the business operations that existed between
Tata and Fiat. This can be corroborated from the fact that while TM was in need
for Fiat’s new innovative technologies for design and manufacture of hi-tech
diesel and petrol engines for its Indica small cars as well as a platform as well as
its extensive dealership and marketing network for marketing TM’s products in
the European, Latin American and US market, Fiat on the contrary need the
goodwill/ brand image and the dealership and customer service network for
restructuring its India operations. Thus with the JV with TM the Fiat group could
gained from the royalties that it would have received for transfer of technologies
as regards manufacture of the new common rail diesel engines as well as Fire
Range of petrol engines to TM to be manufactures at the Ranjangaon plant. Apart
from the same, Fiat would have also received royalties from TM for utilizing its
extensive dealership network in Europe and Latin America for the sales
promotion of its India small car and other SUV/MUV etc.
6. Sixthly, the JV would have assisted Fiat in terms of improving its operational
efficiency through better and optimal utilization of the its available underused
manufacturing/ production infrastructure. This can be corroborated from the fact
that that Fiat allowed the paint shop of its Kurla Plant to be used by TM for
painting the cowls of Tatamobile 207 pickup trucks @3000-4000 bodies on a
monthly basis. Moreover, as part of its capital investment to the JV, Fiat
transferred its Ranjangaon manufacturing unit to the JV for manufacturing
250000 petrol /diesel engines and power transmission systems. Thus the
aforementioned discussion suitably summarizes the various reasons which made
TM as an attractive alliance partner for Fiat.

Ans 17 b. The possible disadvantages from the strategic alliance could as follows:

1. Brand dilution for Fiat : This is because Fiat stood for quality products especially
as far as small cars, sedans were concerned. Its hatch back versions like the Palio
or for that matter the sedan Linea was positioned to target the higher and premium
segment of the market in India. On the contrary the small car India from TM is
basically looked upon by the market analysts as the one targeted towards the true
middle class segment. Incidentally, its sedan i.e. Indigo was also priced lower
than the other B or C segment cars. Thus the sale of a premium segment car
through the dealership network of a Auto company whose products and brand
image stood for middle class segment/ mass consumption may lead to mismatch
of as regards positioning of the brand , its image and the product attributes in the
 mindframe of the potential customers of the two separate companies. This may in
in turn lead to brand dilution as far as Fiat Auto is concerned.
2. Incidentally, the technology incorporated in the cars from the TM’s stable were
inferior in comparision to the product quality standards demanded by the
customers of a manured car market like Europe or US. Thus by promoting the
sale of a technologically inferior car model which lacked the desired product
quality and the product features and attributes viz. presence of powerful fuel
efficient engine, power steering, power windows, ABS, Airbags, Anti Skid and
safety features etc. aspired by the common European buyer, Fiat was
diluting/doing away with the product quality standards associated with the brand.
This could seriously hamper the brand loyalty amongst the potential customers of
Fiat in its home country Europe.
3. Thirdly, there is a possibility of cannibalization of the products due to product
overlap: this can be corroborated from the fact that Fiat’s mid size sedan Petra
was targeted in the same market segment where TM’s Indigo was competing.
Thus the 2 different models from the same JV stable competed with one another
and cannibalized on the common potential customer group for increased sales
proposition. This was the reason why when the officials of TM realized the
aforementioned fact that it authorized its dealers nor to offer Fiat’s Petrea model
through its dealership outlets so as to retain its customer base and allure potential
customers to its Indigo model rather than Fiat’s Pera model.
4. Fourthly, another disadvantage associated with the JV was that the JV was
heavily loaded in favor of FIAL rather than the benefits getting equipotentially
benefiting both TM and FIAL as it was 50:50 JV. This could be corroborated
from the fact that Fiat’s capital for the venture came in the form of its Ranjangaon
manufacturing plant, would was to be used better. Moreover, it got to sell its
engines to a customer who guaranteed offtake. On the contrary the TM had to pay
the JV for the Manzas made in the plant, in addition to a royalty for the Fiat
engines it sourced under the technology transfer and joint production agreement.
Thus it could be seen that Tata Motors was depending heavily on Fiat for trying
out variations in the engine systems/power train for its Indica (small hatch back
car ) be it a modified diesel engine (CRDI engines) or for that matter a petrol
engine (Fire range). Thus unequal distribution of benefits could lead to resentment
amongst the partners which may lead to breakage to the collaborative partnership.
5. Last but not the least, the modalities and clear cut business strategies to be
adopted for channelizing the potentials that existed in the JV into monetary gains
were not clearly defined. This could be corroborated from the fact that though the
JV planned to jointly co-design and develop a new small car however, the unit
operations for operationalization of the plan was yet to be put into action.
Similarly, the action plan for launching the SUVss/MUV sand the pickup trucks
i.e. Tatamobile 207 from the stable of TM into the Latin American Markets using
the manufacturing as well as dealership/ marketing network base of Fiat was to be
fully operationalized.
6. The products and services to be rendered by JV was also facing intense
competition from the rapidly growing small car business in India. This could be
corroborated from the fact that Toyota which was planning to launch its small car
 Etios, which is specifically designed for the Indian market could make a deep
inroad into Tata and Fiat territory. Therefore there was every possibility that the
JV partners could break off from the collaborative deal and part ways in the event
of them finding greater value proposition in business propositions beyond the
domain of the JV.

Thus the actions that the JV partners could undertake for minimizing the potential of the
impact could be as follows:

1. Considering the fear of brand dilution and cannibalization of the product, it is

recommended that the common dealership and marketing arrangements for sale of
both TM and Fiat car models through the Tata Motors outlets may be done away
with. Fiat should look set up its own dealership network or may target the multi-
brand dealership outlets and networks for sale/ after sales servicing and repair of
its car models. In this context FIAL could have a talk with the new car
accessories/ spare parts suppliers company “Wheelsz” floated by Sri. Jagadish
Khattar, the ex CEO of MUL, India.
2. The current JV should specifically focus on 3 critical / important aspect s i.e.
transfer of technology from Fiat to TM for licensed production of the JTdi diesel
engines as well as “Fire Range” of petrol engines at the Ranjangaon plant to be
used by the TM for powering its car models, secondly putting in place the
operational modalities for joint design/ development/ prototype testing and
commercial production of small as well as mid size sedan for the India and the
European market with demand driven product features and attributes both for the
Indian and the Foreign market) through optimal utilization of the car
manufacturing plant of the JV company located at Ranjangaon and thirdly the
procurement of auto spare parts by FIAT from TACO (a subsidiary of TM).
3. Under the overall domain of the JV, fully independent SBU may have to be
formed for looking specifically into the aforementioned aspects. Thus it could be
seen that in this manner the benefits that are envisioned to accrue will be
equipotentially distributed amongst both the JV partners rather than being heavily
loaded in favor of a single partner. Incidentally, exclusive SBU for each of the 3
unit operations have to be channeled out within the overall domain of the JV for
giving focused attention to these exclusive business operations.
4. Last but not the least a separate agreement and business channel has to be
developed by Fiat exclusively with TACO for sourcing quality auto spare parts
and components. A proper supply chain management system for JIT supply of the
auto spares to the garages/ workshop of multi brand dealers may have to be put in
place.

Citigroup’s sale of Phibro: Ending the US$ 100 Million Pay Controversy

Ans 16 a. The various reasons that prompted Citigroup to sell off Phibro, its profit
making unit are as follows:
Introduction: Phibro was an aggressive energy trading company which formed part of the
Citigroup and under the tutelage its CEO and main trader was undertaking aggressive
bets in the energy commodities market (oil and gases) and was making profits based on
arbitrage that existed between the spot and the futures prices of these commodities.
Taking positions in the commodities futures market was possible due to easy and free
accessibility of large value capital from Citigroup (virtual owner of Phibro). However, in
light of the bankruptcy of the Citigroup as a whole in light of the subprime lending
financial crisis and subsequent receipt of the US Federal Reserve’s bailout package
totaling US$ 45 billion. Thus the main reasons for selling the profit making Phibro unit
by the Citigroup could be attributed to the following reasons:

• Thus the Citigroup in general and Phibro in particular come under the scanner of
the US Govt / Federal Reserve and public in general. Since the US govt’s bailout
package involved taxpayers money, the US Govt. in particular desired/ wanted
the accountability of the recapitalization amt and as per the T&C of the package
deal had constituted the Troubled Asset relief Program (TARP) Executive
Compensation headed by Feinberg for reviewing the pay packages
(compensation and bonuses) of the top executives of these companies. The issue
of review of executive compensation was undertaken for maintaining financial
prudence in light of the backdrop of severe recessionary pressure of the US
economy. Thus Feinberg had recommended to Citigroup the owner of Phibro to
restructure / renegotiate the pay package of its chief Trader and CEO Hall since
he was to receive a compensation cum bonus package for FY 2008 operations
totaling US$ 100 million.
• Secondly, the US Govt. was of the view that that payment of such huge
compensation cum bonus package to top executive of Phibro was unethical and
irresponsive in light of the severe recessionary pressure the US economy was
facing and considering the fact most of the top executives of the 30 firms which
had received the bailout package funding from the US Govt. had taken a pay cut
inclusive of the new Citigroup CEO Vikram Pandit.
• The US Govt. was also of the view that Phibro’s business model of undertaking
speculative trading in the Oil and Gas / Energy Commodity Futures market
amounted to proprietary trading using the governmental capital infusion. This
was unacceptable under the US Govt’s federal law for companies receiving US
Govt’s bailout packages. The US Govt. was therefore of the opinion that
proprietary trading was a highly risky business and amounted to amassing of
individual wealth at the expense of US Govt.s/ taxpayers money as well as
channelization of the US Federal Funds to the unproductive/ and non beneficial
sector of the economy. This was because the proprietary traders used important
internal information for undertaking mortgage arbitrage which severly hurted the
sentiments of the customers.
• Moreover, speculative trading led to price volatility of oil and gasses in the
energy market which hiked adverse supply shocks and added to recessionary
pressures.
• However, since the compensation and bonus package of Hall, CEO of Phibro was
governed by the contractual agreement he maintained with Citigroup therefore it
 could nor directly intervene in the issue. Instead of it, the US Govt was putting
indirect pressure on the Citigroup to renegotiate his compensation in light of the
federal pay restrictions.
• Moreover, there was public outcry against payment of such huge compensation
in light of the sever recessionary pressure on the US economy due the burst of the
sub prime lending fiasco. The US Govt.was also of the opinion that since
commercial banking was the core business of the Citigroup, therefore in light of
the financial crisis that had gripped the US economy, the group as a whole should
focus on its core business area of commercial/ investment and merchant banking
operations and should desisit from undertaking speculative trading business
through its subsidiary arms like Phibro as the risks associated with erosion of
capital was huge.
• This was because Proprietary trading occurred when a firm traded stocks,
bonds, currencies, commodities and their derivatives or other financial
instruments, with the firm's own money as opposed to its customers' money, so as
to make a profit for itself using various strategies such as index arbitrage,
statistical arbitrage, merger abitrage, fundamental analysis etc much like a hedge
fund. However, since the bank’s own funds are involved so as to take benefit of
the arbitrage therefore the % of operational risk involved is more thereby leading
to much volatile profits.
• Thus the US govt. was skeptical that at that particular juncture the
recapitalization amount should be used by the Citigroup in financial safe
ventures. Thus in light of the aforementioned issues, if Citigroup happened to go
ahead and pay the required compensation of US $100 million to Hall, then it
could have faced huge public ridicule / outcry and a possible political
repercussion from the members of the US Congress. There was a possibility of
the US Govt. putting in severe restrictions which in turn could have curtailed
future funding of the bailout package. Thus the US Govt. was putting legislative
pressure on Citigroup to sell off the firm so as to desist payment of the high
compensation amount.
• Moreover, in the difficult market situation, the Citigroup wished to restrict its
business operations which were client specific i.e. where the customer could be
easily traced in the event of a default, arousal of financial risk for recovery of
dues viz. credit card operations/ commercial banking/ investment banking
operations etc. On the contrary, the speculative energy trading business the risk
proposition was high and in the event of a default the recovery of dues was a
difficult proposition as bank’s own capital is involved.
• Moreover, Phiro CEO, Hall had a contractual pay agreement with Citigroup
whereby he was to receive compensation amounting to US$100 million which
included a profit sharing deal of 30% of the unit’s profit. The contractual
agreement superseded the US Federal reserve bailout package and thus was
outside its “federal pay restrictions domain”. Thus inspite of the critical financial
position of the Citigroup as a whole, the Citigroup was bound by law to pay the
compensation to Hall. Since in the event of Citigroup backtracking/ deviating
from the contractual agreement, Hall had threatened to move to the court of law
and sue the Citigroup for breach of the contractual agreement.
 • Last but not the least, the price that was offered by Occidental at US$250 million
was almost equal to the liquidation value of the assets of the company “ valued
using the asset approach at US$371 million. Thus it was virtually a not profit,
minimal loss deal for the Citigroup in light of the excessive pressure it was
receiving for sell off the company from US Govt. so as to absolve itself from
public and the political hue and cry/ resentment as well as the possible
controversies associated with US$100 million compensation payment deal.
Moreover, Citigroup feared that if Phirbo was not sold than in all possibility Hall
and his other trading members would quit the firm and join other lucrative firms
who were not constrained with the federal pay restrictions. In the event if it
happening, the market valuation of Phibro would have further decreased because,
the HR talent base of Hall and his group of traders was highly valued in the
Commodity futures/ financial market. In the absence of a highly skilled and
knowledgeable human resource base, the market analysts /valuers would have
further devalued Phibro. Thus the losses would have surmounted had Citigroup
delayed the sell-off proposition.

Thus Citigroup was in a difficult position and was embroiled in a turmoil between the US
Governmental directives/ a virtual confrontation with the US Govt. in light of the
excessive compensation to be paid to Hall/ the undue pressure, public outcry and the
severe political and public repercussion on one hand and the fear of long drawn legal
battle in the US courts against the probable law suit to be filed by the pleaders i.e Hall
and his trading group. Thus in order to avoid the serious repercussions that the company
would have faced associated with the compensation issue, the only alternative was to sell
of the firm to a 3rd party and absolve itself of the various controversies. Thus the
aforementioned discussion suitably summarizes the various reasons which prompted the
Citigroup to sell off its profit making unit.

Ans 16 b. The consequences of this sell-off on Citigroup and on other US based

financial services companies would be as under:

• Since Phirbo was a profit making energy trading arm of the Citigroup therefore
through the sell of the profit making arm, the overall income in general and
trading income in particular feel sharply. This could be corroborated from the fact
that out of the total revenues of the Citigroup amounting US$ 52.8 billion,
revenues from energy trading amounted to US$ 667 million. The same could also
be corroborated from the fact that in FY 2010, Citigroup Inc.’s first-quarter
trading revenue fell by 30 % on account of sale of the LLC energy-trading unit in
October, 2009.
• The revenue generation from the energy trading business by Phibro provided the
Citigroup the much needed liquidity for repayment of the govt. debt as well as
squaring off the sticky loans and cleaning its balance sheet through repayment to
the outstanding creditors.
• This was because banks like Citibank of the Citigroup employed multiple desks of
traders devoted solely to proprietary trading with the hope of earning added
profits above that of market–making trading. These desks were thus considered to
 be somewhat similar to that of internal hedge funds within the bank, performing
in isolation away from client-flow traders. Thus returns from the operations from
Phibro which were higher than those expected from marked to market instruments
allowed the Citigroup in general to hedge off its operational risks. Thus Phibro
through its energy trading activities allowed the group to mitigate the operational
risks. But now with the sell-off the firm, these operational risks have to be
internally borne by the Citigroup by adopting other hedging measures.
• However, through the sell-off of Phibro energy trading firm, the Citigroup as a
whole was able to restructure/ re-engineer its assets base as well as is business
operations in light of the severe hit it had faced in its financial due to the sub-
prime lending fiasco. Taking aggressive bets and undertaking speculative/
proprietary energy trading operations was a risky business venture. The bailout
package received from US Govt, forbid the Citigroup from utilizing the same for
undertaking such business operations as it was risky and led to channelization of
public money towards unimportant sectors which contributed to the recession.
This was because speculative trading led to price volatility in the energy spot
market which led to adverse supply shock pressures. Thus through the sell off the
company was able to comply with the US Govt. directives of restricting its
business operations to core banking sectors only. Thus though the sell-off of
Phibro led to reduction of the asset base of the Citigroup as a whole by 25%, but
then the revenue realization from the sell-off was used by the company to
partially square off its outstanding debts and clean-off its balance sheet from
overall NPAs acquired through securitization of sub prime mortgages etc.
• As far as its impact on other US based financial services companies was
concerned it can be stated that the sell-off of these highly risky trading arms by
the Citigroup for restructuring the assets base of the company / minimizing the
operational risks of the business would now compel other banks and financial
institutions receiving US Federal Reserve’s bail out package to follow suit and
accordingly do the same. This could be corroborated from the fact that the step
taken by Citigroup put added pressure on. Investment banks such as Goldman
Sachs, Bank of America, JP Morgan Chase , Merrill Lynch who earned a
significant portion of their quarterly and annual profits through proprietary trading
to follow suit and restructure their business operations so that the VAR (value at
Risk) of the banks internal funds are minimized due to price risk variations
associated with arbitrage. This would help these companied which had received
bail out packages from the US Federal Reserve to comply with the various
governmental directives.

Valuing Sify’s Acquisition of India World

Ans 06 a.

Calculation of the Fair Market Value of India World.com in October 1999 using
the Page Viewers Multiplier Model

Step Sdetermination of the Market Capitalization of

No: 1 the Firm

Since the available information is not given therefore the value

of the market capitalization
of a similar firm of the industry i.e. Sify is
used for the model
Therefore ; Given the market capitalization of Sify on NASDAQ in October 1999
before acquisition = $ 2.90 billion
Therefore assuming the market capitalization of India
World .com

Therefore
assumptions
Market Capitalization of India
World (US$) 2.9 billion
Number of Page views (2nd quarter of FY
1999-2000) 70 million
Revenues earned from portal advertising
(2nd quarter of FY 1999-2000 in US$) 0.28 million
Theref
ore,
Average daily page views for the
IndiaWorld .com 0.78 million
Market value per daily
page view US$ 3728.57
Total revenues earned
for the year US$ 1.12 million
( assuming that the level of revenue earning for eachquarter
remained constant)
Calculation for estimation of revenue per
page view
Number of Page views for the
entire year 280 million
(assuming that the no. of viewers in each quarter of FY 1999-
2000 remained constant)
Revenue per
page view US$ 0.004
Price/ Revenue multiple in terms 932142.8
of page view 6
Assumptions for estimating the Fair Market Value of
India World.com
Given
Total earnings of India World .com for FY 1999-2000
before Tax and converting the same into US$
(exchange rate @1US$=INR 45.467)

Rs. 4.66 million

Total Earnings of India World
company before Tax US$ 0.1025 million
Accounting for Tax Rate @36%
and thereafter calculating
earnings of the company after
Tax (PAT) US$ 0.0656 million
Total no. of shares listed in the
stock exchange of India
World.com company 0.2 million
Therefore EPS of India World.com
company US$ 0.328
Price/ Revenue multiple in terms 932142.8
of page view 6
Therefore Market Price /share of India 305718.
World.com company US$ 75
Therefore the fair market value in terms of market capitalization of India
World.com company would be using the Page
Viewers Multiplier Model =(Market price/share X Total no. of shares of India
World.com listed in the stock exchange)
Therefore Fair Market Value of India
World.com company
US$ 61.144 Billion

Price/ Revenue multiple in terms of page 932142.

view for India World.com company 86

Ans 06 b. Discussion of whether the price paid for acquisition was justified by
comparison of the perceived synergies to the actual performance of Sify and India World.

• It could be seen that Sify was one of India’s largest ISP with a large number of
India centric portals which offered online easy business solutions to the internet
viewers as well as provided B2C connectivity/ e-commerce solutions to the
various Resident Indians who logged to the various websites designed and
maintained by the company/ web based support to the various companies which
registered and advertised its products and services over the net using the various
customer centric portals of Sify. The content matter of these portals/ information
uploaded therein mostly catered to the needs and the aspirations of onshore i.e.
Resident Indians. This could be corroborated by the fact that the various portals/
websites associated with the ISP viz. walletwatch.com carried real time updated
data of the stock prices of the shares of various companied listed at the various
stock exchanges of India. Though it helped the viewers to track their portfolio but
the information associated with the valuations/ variation of the stock prices listed
at the various international stock exchanges/ financial markets/ commodity
exchanges viz. NASDAQ/ LSE/ Nikki etc. were not properly uploaded or was
lacking. Since the NRIs residing offshore/ outside India were more interested on
getting a global perspective/ information about the variation in the stock prices at
the important global stock exchanges, the portals therefore were unable to cater to
these needs and aspirations.
• Moreover, the portals did not it did not have facilities/ web based services which
could be of benefit to the NRIs viz. facilities for web based remittance facilities to
send back money to India etc. features. Neither the content matter of the portals
under the ownership of Sify nor the sectoral coverage of the portals met the
needs/desires/ aspirations of the NRIs viz. information about the culture and
History / places of historical and archeological importance for information
regarding the modes/ avenues for visiting them / information about Indian
cuisines etc.
• The present portals only catered to the needs of the Resident Indians in 3
important sectors namely business and financial information/ Carnatic Music and
cars sales/ purchase and after sale servicing facilities. Portals relating to daily
news/ happenings through out the world/ sports/ cookery and cuisines as well as a
India based world wide web search engine. Thus inability to provide to the needs
and aspirations of the NRI customers was a huge gap / lacunae that existed in the
ISP operations of Sify. This was potential source of income to the company as it
reduced the page views/ hits/ clicks or for that matter revenue earnings in the form
of subscription fee by NRIs registering with web based services or for that matter
subscription earnings from online advertisement by corporate clients.
• On the contrary, the content matter of the e-portals and the sectoral coverage of
these portals designed/ developed and maintained by India World .com fully
catered to the need and aspirations of the NRI/ overseas client base. This could be
corroborated from the fact that the websites/ portals maintained by India
world.com received an average of 13.5 million page hits/ views per month. This
can be corroborated to price / revenue multiple factor in terms of page view
method of valuation of the company @ 932142.86. The same was considered
quite good considering the fact that most of the domcom companies had a
negative net earnings considering the fact that the proper monetization of the good
will and on that basis the client base accessing the websites of these companies
could not be easily ascertained because of its intangibility.
• Thus through acquisition of India world .com, Sify could have got access to its
NRI/ off shore Indians centric web portals viz. samachar.com; khel.com;
bawarchi.com etc. It would have also allowed Sify to take over the customer base
of India World under its domain as well as leverage upon the goodwill/ brand
following it maintained amongst the NRIs. This would have allowed Sify to
increase its client base by another 13.50 million NRIs to its existing resident
Indians client base of 13 million Indians. This would have improved the
probability of revenue earnings of the company based on page view multiplier
model.
• Moreover, acquisition of India World would have allowed Sify an opportunity for
cross selling the e-commerce/ B2C and other web bases solutions/ services to both
the existing Sify clienteles as well as the newly acquired customer base of India
World.com. Incidentally, it can be seen that the fair market value of India
World.com ISP Company based on the page view multiplier model stood at US$
61.144 Billion. On the contrary, the value paid by Sify for acquisition of the
company was INR 4.99 billion (corresponding to US$ 0.1097 billion with a
conversion rate of 1US$= INR 45.467). Thus it can be seen that the acquisition
 was undertaken at a discount and that acquisition of India World company by Sify
was of strategic importance for reasons stated above.
• Thus to conclude it could be stated that future prospects of Sify was quite bright
and the acquisiton of India World .com would have helped it in transforming itself
into a mega ISP with both Resident and NRI client base and a huge market
capitalization based on rise in the market price/share of the merged entity. This
would have led to capital appreciation of the equity share holders of the company.
Moreover, the fact that the 2nd half of the acquisition deal was undertaken through
transfer of stocks of Sify to the shareholders of India World.com suitably
corroborates the fact that Sify was confident of the probable increase in the future
cash flow value from business operations for the company as a whole after
acquisition of India World.com.

_______________________________________________________________________
_

TCL- Thomson Electronics Corporation: A Failed Joint Venture

Ans 19 a. Comments on the reasons that could have prompted TCL to expand globally
could be as follows:

1. Seeking new markets for growth due to increased labor cost and intense
competition in the domestic market on account of foray into the WTO:
Chinese companies in general and State Owned Enterprise (SOEs) like TCL are
going global so as to search for new markets, source raw materials at a cheaper
cost, source cheaper energy sources, advanced manufacturing and production
technology and highly skilled and trained global human resources and
management skills. This business strategy of going global is being driven by
growing labor costs in China and intensified competition from foreign
multinational corporations that have swayed into the Chinese markets following
Beijing’s formal entry into the World Trade Organization. Due to increased
competition, the cost of the CTVs, DVDs and other electronic goods had
decreased and the profit margin was under strain as far as TCL was concerned.
Moreover, due to the foray of low cost technol.ogically advanced products
especially from the Japanese companies, the domestic demand was under strain.
Thus it can be seen that the obvious impetus for Chinese companies’ like TCL’s
global expansion is China’s WTO entry, which came officially on December 11,
2001. WTO membership made it possible for Chinese companies to enjoy favored
nation status in expanding to global markets, but it also presented Chinese
companies with enhanced competition at home. Thus it can be seen that with
deregulation , companied like TCL were hindered by over capacity and were
facing intense profit pressure. As a result TCL was naturally looking aboard for
new markets with less competition and higher profit potential especially the other
growing Asian economies.
2. Acquiring advanced technologies and management skills: The top
management of companies like TCL want to innovate with acquisition of new
technologies so as to survive and grow in an increasingly competitive world. This
can be corroborated from the fact that TCL was also a OEM , manufacturing /
assembling CRT color TVs for leading brands like Toshiba, Panasonic etc.
brands. Thus in an intensely competitive market, majority of the product’s value
were being captured by their customers i.e. foreign companies with strong R&D
brands with deep relationship with end consumers which often left TCL with
razor thin profit margins which was less than 5%. Thus in order to improve upon
their share of profit margin, companies like TCL are viewing global partnerships
and foreign acquisitions as an attractive viable preposition. This was because
through JV partnership, a new entity jointly owned by TCL and the partnership
firm could be constituted and TCL thereby could benefit from the new advanced
management skill and innovative production technology like LCD technology etc.
which the JV partner would be bringing with itself.

3. Moreover, TCL, specialized in manufacture of mass volume of low cost and

inferior technology CRT based color TVs , and it wanted to go global in search of
new untapped markets, sourcing of TV components, electronic spare parts and
other raw materials at low and economical cost for minimizing the cost of
production, sourcing new advanced manufacturing technology using LCD for flat
screen TVs which were in great demand in the developed markets of Europe and
US for it was this new advanced technology that TCL lacked.

4. Judicious spending of Internal Accruals and Governmental support for

Chinese Companies for going global: Thirdly, it can be stated that companies
like TCL have accumulated enough reserve and surpluses (undisturbed and
ploughed in capital) on the basis of operational profit. This can be corroborated
from the fact that in FY 2003, TCL’s CRT based color TV business posted a
profit of 530 million Yuan domestically and 81 million Yuan through its overseas
operations. Thus it could be seen that TCL apart from investing its accumulated
capital was also receiving official encouragement from the Chinese banks as part
of the Chinese Govt’s national policy of “Going global” as part of the five-year
plan for 2001-2005. Incidentally many governmental organizations such as the
National development and Reform Commission (NDRC), the Min. of Finance,
Min. of Commerce and the State Administration of Foreign Exchange (SAFE)
had developed policies encouraging the Chinese companies to expand overseas in
the form of exclusive credit lines and low interest loans. Moreover, the Chinese
National Govt. also had reaffirmed state support to companies like TCL which
was basically a SOE , tough some of the companies of the business group were
listed in the Shenzhen Stock Exchange. Incidentally, the Chinese banks are well
poised to provide support by virtue of a strong Chinese economy (China’s GDP
was currently fourth in the world, and the country was No. 3 in foreign trade),
high savings rate and abundant foreign reserves.

5. Rising labor cost: Finally, the due to improvement in the GDP, robust economy
and improved per capita income, the labor costs was rising in China, making the
 country less competitive in some areas such as the manufacturing sector. Since
TCL was an entity associated with electronic goods manufacturing, therefore the
company was all the more facing the heat. Incidentally, as per market estimates
and expert reports the labor costs in China was supposed to rise by 30% to 50% in
the next three to five years.

6. This business strategy to go global can be attributed to the growing labor costs in
China and intensified competition from foreign multinational corporations in
China following Beijing’s entry into the World Trade Organization which had
provided a level playing field to the big multinational companied like Sharp,
Toshiba (Japanese companies) to make a big foray and capture a large segment of
the Chinese market by launching optimally priced LCD TVs. Thus the demand
for its CRT based color television sets in the domestic market was on the
decrease/decline. Thus the company need to frantically source for new overseas
markets in Asia, Europe and US for stabilizing its operational income and profit
margin. Thus the way out was by going global.

7. Circumventing the trade barriers imposed by the Developed Markets and at

the same time redce the shipping and transportation cost : The developed
market of US and Europe had imposed tariff barriers under the WTO agreements
in the form of Anti Dumping duties on various Chinese goods/ companied
including TCL for dumping goods especially clour TVS, DVDs, and other
electronic goods in the US markets at cost which was lees than the domestic
production cost . Thus it was hampering the progress / growth of the domestic US
companies. Thus in order to overcome these tariff barriers and to absolve itself of
litigation matters in the International Courts , the company decided to go global
by setting up manufacturing bases in overseas countries. This ensured that less
than 10% of the goods entering European and US Markets were originally
manufactured in China. On the contrary, fully or semi knocked down kits were
shipped to these developed markets and thereafter by using the services of the US
workers/ labor staff the goods were assembled for sale in these markets.
Moreover, by adopting a global perspective and thereby going in for ovreaseas
acquisition of manufacturing units viz. Schneider Electronics in Germany, TCL
wanted to set up manufacturing bases at strategic places whereby the
transportation/ transshipment time lag was shortened. This was because a
conventional TV set took 90 days to make and send to America by sea from
China. On the contary, by assembling the units at Germany and sending them
across the Atlantic would have reduced the time lag.

8. No I donot approve of the approach adopted by TCL in achieving its global

expansion vision . The reasons are as follows:

1. Aggressive M&A and JV strategies with Governmental support without

developing a proper globalization strategy: M&A as well as formation of JVs
with overseas strategic partner has to be undertaken with proper assessment of the
value proposition of the merged entity in the consumer market in terms of its
innovative products/ brand positioning / marketing communication and brand
 loyalty. The articulation of why making a strategic green field investment and
how best the M&A/ JV strategy will help the company in strengthening its basis
of competition in terms of its cost position, brand strength or customer access and
loyalty were done away with. This can be corroborated by the fact that TCL
without updating the valuations of potential targets viz. acquisition of the
manufacturing base, inventory and the trademark of the obsolete, struggling and
bankrupt German TV manufacturing company Schneider AG so as to
aggressively make a foray into the alluring European Market. Thus it can be seen
that in the name of creating a world class Chinese Enterprise, the company was
going in for aggressive M&A strategy without proper valuation of the acquired
brands. This can be corroborated from the fact that the JV with Thompson for
acquiring the trademark license of its RCA brand was undertaken without fair
assessment of the fact that the brand was fast fading into oblivion due to the lack
of product innovation and for that matter the owners of the brand i.e. Thomson
group itself desired to sell off the brand rather than resurrect the brand.

2. Secondly, the series of failures of the various international acquisitions and

strategic JV forays signal to the fact that the strategy of aggressive overseas M&A
/ strategic alliance so as to become a leading global player with a significant
presence in the developed markets of the west lacked the finesse of critical
analysis of the marketing trends. The aspect of “ scope valuation vis-à-vis scale
valuation” from a M&A as well as strategic green field investment/ JV/ alliance
was not being critically analyzed and evaluated by the management of TCL. This
can be corroborated from the fact that rather than exploring the aspect of scope
valuation from its JV with Thomson NV of France and take cue of its extensive
R&D facilities/ expertise in LCD Televesion design and manufacturing
technology/ expertise in videography and media solutions for designing and
developing highly innovative products for a strategic level entry into the
developed markets of the US and Europe, TCL was more interested in utilizing
the scale valuation from these JVs by utilizing its manufacturing bases to
assemble technologically inferior CRT tube based projection TVS and DVDs so
as to escape the high anti dumping duties/ import tariffs and other protectionist
measures put in place by the EU and the US govts. Thus the crux of the issue was
to how best develop a synergistic linkage between scope and scale valuation from
the strategic alliances/ JVs depending upon the specific market needs and
conditions. Thus this aspect was not forth coming from the various strategic
moves of TCL initiated for globalization of the business.

3. Thirdly, the strategy of aggressive M&A and alliance without proper valuation of
the synergistic benefits is a risky venture as it lacks in the key element of process
innovation like manufacturing, logistics, marketing, sales as well as non core
areas such as HR, finance and accounting. This is because had a process
innovation system been in place then in that case the management of TCL could
have judiciously planned for effective production capacity utilization of the
acquired manufacturing base of Schneider AG TV manufacturing plant for
manufacturing flat screen plasma TVs rather than deciding to sell off the unit.
Moreover, a business risk management core group would have been put in place
 to mitigate the business risks through enhancement of the product mix of the
company/ sourcing the opportunities for design and development of new products
apart from CTVs and DVDs viz. music and sound systems/ multimedia and
videography systems/ electronic gadgets etc. through critical analysis of the
market signals based on market intelligence and surveys. Tough TCL tries to put
in place such core groups a s part of its JV measure with Thomson NV of France,
but then the operationalization of these core business groups were still at the
nebulous/ infantile stage and they were yet to reach a critical mass so as to
effectively contribute to the judicious decision making process by the top
management of TCL.

4. Thirdly, the strategy of aggressive acquisition of marginally valued/ loss making

manufacturing/ production companies of the developed economies and their asset
base in terms of their established brands and sales and marketing channels also
highlight the other critical factor where TCL was lacking i.e. the investment
required for brand building and the need for development of a globalization
strategy based on the differentiation strategy thereby achieving excellence
through product innovation. The same was not forthcoming through the JV /
partnership approach that TCL had forayed into. This could be corroborated by
the fact that even after the operationalization of the JV, TCL kept on harping on
the increased production of the CRT based projection TVs rather than expanding
the scope and aspect of innovating into the LCD based flat screen plasma TV
sector by leveraging upon the technological strength of the JV partners viz.
Thomson Group. The R&D spend of 1,5% of the net sales was also quite low in
comparison to the global standards being maintained by the MNCs. Incidentally,
the spending on brand innovation by other SOEs from China viz. Haier (an
electronic consumer durable goods manufacturing company) was quite substantial
in comparison to that of TCL.

5. ast but not the least the fact that a global branding strategy was not being put in
place by TCL. The multi branding strategy associated with the JV wherein the
trademark of the rand was being licensed to the merged JV entity was leading to
the dissemination of a complex communication mix to the international / global
consumer segment. Moreover, rather than strengthening the Chinese brand of
TCL globally, it was diluting the brand. May be the company could have done
good be pursuing a single global consumer brand of “TTE” or for that matter
taken the help of an European or US celebrity/ Athlete to promote the brand in
the developed US and Europe markets viz. how Li-Ning a top Chinese athletic
footwear company hired the services of Damon Jones, a US NBA Player from
the Cleveland Cavaliers to endore its products in US and build international
recognition.

6. Thus the aforementioned discussion suitably summarizes the various facts which
conveys the message that that the approach adopted by TCL for realizing its
vision for global expansion was risky and too aggressive.
Ans 19b. The factors that led to the failure of the TTE , the JV between TCL of
China and the Thomson Group of France could be as follows:

• Misjudgment/ miscalculation of part of the management of TCL to correctly

judge and assess the real worth/ potential its JV partner i.e. Thomson group was
contributing in the form of new LCD / flat screen plasma technology for design
and development of new generation flat screen color TV sets. The management
of TCL failed to realize the monetary value of the business potential, customer
demand and the corresponding market value proposition that the new emerging
LCD technology and subsequent manufacturing of the flat screen techno-color
TV sets could provide to the JV in terms of increased sales volume and
corresponding revenue realization. On the contrary since TCL was strong in the
CRT (projection color TV sets) and considering the fact that the company had a
majority stake 67% equity stake in the JV, it continued to channelize the entire
and resources of the JV in the design, development and increased production of
projection TVs. Thus by doing away with concentrating on the new emerging
LCD technology, the company lost on the business potential / market
capitalization / capturing of enhanced market share that existed for the LCD TVs
in the developed US and European markets.

• Secondly, there was failure on part of the management of TCL to properly

assess the brand value/ brand loyalty and following of Thomson’s assets
especially its RCA television brand in the developed US market. Though RCA
was a premium brand and was positioned so as to target the higher/ rich segment
of the US and European population, but then the market share of the RCA brand
was fast eroding in the US and the European market ( i.e. from a 10% market
share in FY 2003 in Europe to less than 7% market share in FY 2004 ). This was
mainly attributed to the fact that there was fall in prices of the higher end
segment models on account of stiff competition from the other major players like
Sharp, Toshiba, Sony, Samsung etc who had economies of scale on their side. On
the contrary, the original owner of the brand i.e. Thompson was interested in
selling off the brand because of the stiff competition it was facing from the
cheaper and technologically advanced Japanese Brands. Moreover, the
Thompson wanted to move out of its failing protuct portfolios of Colur TVs and
DVDs and wanted to diversify and venture into new business areas of providing
video and media solutions for the entertainment industry. Infact it wanted to sell
off its decreasing RCA brand and was thus looking for a partner which could
over the time acquire the brand and associated assets base. Thus the focus and the
attention need to restructure and revive the brand was not forthcoming from
Thomson even after the JV proposition. The same can also be corroborated from
the fact that the Thomson group did not contribute any amount towards the
working capital base of the JV because of the fact that it did not want the capital/
funds to be stuck in the form of obsolete asset base of CRT colour TV and
abnalogue DVD sets.

• On the contrary, TTE in general and the management of TCL in particular had
projected/ estimated an increasing trend of FCFF ( JV firm) based on the
 comfortable market share the RCA brand was holding. However, the deceasing
market share and the corresponding decrease in sales and revenue realization
severely jolted the overall actual net cash flow to the JV vis-à-vis the projected
value. Thus with the decrease in the actual net cash flow, the value proposition to
the share holders to the 2 firm was decreasing. The RoE was also decreasing as
the net income after tax (with share holders’ equity base remaining constant) was
decreasing. This could be corroborated from the fact that in the 3rd quarter of FY
2004, TCL posted a net loss of HK$ 58.28 million against a turnover of HK$
7.00 billion vis-a-vis a net profit of HK$ 137.63 million in FY 2003.

• Apart from the same, the JV failed to capitalize on the complementary strengths
and synergies that existed and if utilized could have propelled the JV to a great
heights. This can be corroborated from the fact that the Thomson group failed to
utilize the low cost manufacturing base of TCL and its sales outlets in China and
other Asian countries for intense market penetration with a well diversified
product portfolio / product mix based on Chinese design and subsequent
technological improvement through support from the R&D cell of Thomson. In
this manner the JV could have forayed to a greater extent in the rapidly
expanding Asian market. On the contrary, TCL in particular and the JV in
general failed to utilize and capitalize upon the extensive manufacturing and
R&D base of the Thomson group for the design and development of the new
multimedia and videography products as per the market needs of the developed
markets of Europe and US thereby diversifying into new market segments. On
the contrary, the JV kept on harping on restricting its product base to the Color
TV and DVD product segment only which was heavily saturated with major
players and where competition was cut throat and margin was meager. This can
be further corroborated from the fact that that instead of trying to utlize the
manufacturing / sales and marketing distribution base of Thomson in Europe,
TCL, the JV partner continued with the leased agreement with the Schneider AG
group of Germany for leasing in 24000 sq.m of Color TV manufacturing base at
Tuerkheim, Germany for manufacture of CRT TV sets.

• Last but not the least, instead of focusing on the synergistic growth and
development of the JV of TTE, TCL one of the JV partner tried to diversify its
business operations so as to quickly become a Forture 500 company by forming
a JV with the loss making French mobile phone company, Alcatel SA and
thereby forming TAMP. Subsequent losses in the JV further constrained the
financial position of the TCL and the company failed to infuse the needed capital
base into the TTE venture to turn around the losses i.e. streamlining the
production bases and marketing channels in Europe to produce the plasma flat
screen television sets by leveraging upon the production bases of Thomson at
France , Poland and other places.

Therefore the idea and the JV vision statement for achieving economies of scale and
operational advantage through combined R&D, design and manufacture of highly
innovative products remained in-operational to a large extent viz. foray in joint design
and development of music and sound recording / mixing systems / visual graphic
enhancement systems etc. The inadequate spending on R&D by TCL @1.5% of its turn
over in comparison to the industry average of atleast 3% also contributed to the
inadequacies. Thus it could be seen that while Thompson was intereted to use the JV
partner to sell off its fading color TV and DVD business so as to concentrate fully on the
entertainment support industry business where as TCL was interested in becoming one of
the world’s largest selling brand through aggressive and blatant merger & acquisition of
international brands and manufacturing base without making a fair assessment of the
brand value of the acquired company and the possible value proposition of the merged
entity. Thus due to dissimilarities in objectives/ operational goal led to the failure of the
JV.

The Polaris- Orbitech Merger

Ans 05 a. The reasons for the Polaris–Orbitech merger were as follows:

• Tapping the operational synergies that existed in the business operations of

Polaris and Orbitech. The can be corroborated from the fact that while Polaris
essentially catered to the design, development, operation and maintenance of the
end to end banking software solutions for retail banking operations to the Citibank
India, on the contrary, Orbitech exclusively provided baking solutions and
software support to the Citibank through its Orbipack-a financial suite that
covered end-to-end software solutions covering the entire gamut of the banking
and finance sector especially corporate banking/ treasury management, merchant
banking operations etc. Thus, it can be seen that through the merger of 2 entities
with one another, the merged entity would have been in a position to provide to
provide a complete end to end e-solutions for all kinds/ entire spectrum of
banking operations, financial dealings as well as insurance applications. The
lacunae that existed in the product mix of Polaris as regards availability of
software solutions/ modules/ GUI packages for investment banking operations/
merchant banking operations/ treasury management and banking operational risk
management could be easily plugged in through the merger operations. Thus the
merged entity could have provided this entire gamut of banking solutions to the
Citibank. Apart from the same, the merged entity would have emerged from the
shackles of excessive dependence on servicing to the needs and applications of a
single customer/ end user i.e. Citibank because these software solutions for the
banking/financial and insurance sectors could have been sold by the merged
entity to other banking/ financial and insurance companies. Thus the limitations
associated with the “exclusive client servicing clause” of providing solutions to
Citi Bank could be done away with. Apart from the same, through the
merger/unison of Polaris with orbi-tech, the domain knowledge/ expertise of
Polaris in say in the field of ERP could have been unionized/ synergized with the
domain knowledge of Orbi-tech in Retail Banking Operations so as to develop a
unique innovative products for ERP and Management in Commercial Banks
especially for its retail loaning and loan recovery operations.
• Apart from the same, the merger of Polaris with Orbi-tech would have given the
merged entity a greater leeway to broad base its product mix of software
 solutions based on the domain knowledge and expertise being brought in by the
skilled and experienced staff of both the entities viz. by broad basing the BFSI
sector into several micro-expertise domains/ fields viz. investment banking;
merchant banking; retail and commercial banking; MFs; stocks / bonds and
securities as well as insurance sectors. Incidentally it would have given the
merged entity to form a separate division based on the leverage of the expertise of
the HR from Orbitec-tech on project management to take care of the non-BFSI
(banking, financial services and insurance) sectors. It was estimated that the non-
BFSI sectors (such as SAP, BAAN and WebSphere implementations) could
contribute 25-30 per cent of the company's total revenue. Apart from the same,
the merged entity could have also decided to foray into the business process
outsourcing (BPO) segment. The BPO operations could have targeted the sectors
like call centre, transactions, technology, data centre and processing. Incidentally,
post merger Polaris was talking to two to three customers for making a foray into
this sector of the economy.
• Secondly, Orbi-tech a SEI and had a CMM- Level V rating presented to it by
Carnegie –Mellon University, Pittsburgh, Penn, US. This meant that Orbi-Tech
Company had excellent, world class process management skills associated with
design and development of key software solutions packages. These could have
been in the area of HR management, distribution of job profile and job rotation
and job enrichment, customer support service for effective system integration of
the software package module / banking solutions with the existing IT platform /
operating system base of the client company so as to debug the errors in the
software solutions. Thus the merged entity in particular and Polaris in particular
could have benefited as it could have implemented the process excellence
standards in all its aspects of business operations. Moreover, the merged entity
could have leveraged upon the accreditation/ process excellence label so as to
aggressively sell its products to a larger client base.
• Thirdly, the merged entity could have benefited from the fact that the extensive
sales/ marketing and distribution network base of Polaris established through
branch offices and wholly owned subsidiaries in overseas countries as well as the
extensive onshore networks in India. This could be corroborated from the fact that
Polaris in FY 1997 (prior to the merger, Polaris had developed wholly owned
subsidiaries in Singapore and with an overseas software development center at
Los Angeles) apart from offices in Chennai and Noida.
• Fourthly, the merged entity in general and Polaris in particular would have
benefited from getting access to the IPR and the associated knowledge base assets
of Orbi-tech especially 57 IPRs corresponding to 10 product lines corresponding
to software development for the financial sector/ project management and analysis
etc. sectors. Each of these product line had a business/ revenue generation
potential of US$ 20 million over a period of 5 years through licensing and receipt
of the royalty fee payment . Thus Polaris expected to encash on future cash flow
of US$ 200 million expected to be generated from the IPR controlled software
product base.
• Last but not the least, the important factor associated with the merger process of
Orbitech by Polaris, was the increased in value proposition corresponding to
 capital appreciation of the equity investment made by the share holders of Polaris.
This could be corroborated from the fact that the book value of the asset base
(tangible as well as intangible assets) of the merged entity increased had increased
to Rs. 1455 million as on 31 March, 2003 (post merger) from Rs. 497 million as
on 31 March, 2002 (pre merger position) against an investment of Rs. 633.8
million. Moreover, the amount available for appropriation for payment of
dividend had increased from Rs.628,070,669 as on 31 March 2002 to Rs.
1,025,490,104 as on 31 March 2003 (post merger). Similarly, the proposed
dividend payment to the share holders also increased from Rs. 89,578,388 as on
31 March, 2002 to Rs. 170,354,125 as on 31 March, 2003.
• Though, the announcement of the split ratio of the stocks of Polaris listed with
BSE and NSE led to dilution of the total capital holding /shareholder in the
company (change in face value of the share from Rs.10 to Rs. 5 /share), but the
corresponding recalculation of the exchange ratio/ swap ratio of stocks of Polaris
to be paid to the existing shareholders of Orbit-tech from the initial exchange
ratio of 1.4:1 i.e. 1.4 share of Polaris / share of Orbi-tech (14 newly issued
equity shares of Polaris with a face value of Rs. 5/share in exchange of 25 Orbi-
tech share each of face value of Rs. 2/share) to 0.4265:1 i.e. 42.65 newly issued
equity shares of Polaris to every 100 existing shares of Orbi-tech mitigated the
dilution of the share holding % of the existing Polaris share holders in the equity
holding base of merged entity. This in turn increased the proportionate share to
the net profit earnings to the apportioned to them visi-a-vis the then share holders
of the Orbi-tech (now merged with Polaris).

The different problems associated with the merger of cross border IT software companies
could be as follows:

Offsetting Culture & Philosophical clashes: Cultural Integration: This happens

because the merger integration process is mostly based on wrong assumption about the
thinking, behavior, and expectations of people from two merged entities/organizations.
The most intriguing factor for the same is because the culture or the philosophy of the
two individual identities is taken granted for. The skilled workforce is though of as a
machine, perhaps, which will duly turn its output almost immediately, which is not the
case. In most merger scenarios, the employees of the purchased company are given
limited information about the turn of events until well after the deal is settled. Rumors flit
about what’s going on, and employees are left in limbo, bitter about the changes and
insecure about their jobs and their colleagues. If this goes on for too long, they can
become less productive as a psychological enlighten. Though the mathematics and
science has evolved and there are recent models to tap the complete potential of a merger
but the very simple opinion of human behavior before two organization join hands should
probably grasp precedence over every thing else. The two companies can identify these
‘human’ differences, gaze what’s respectable about each culture, and then choose jointly
how they can face the future as a unified force. It is therefore principal for today’s
managers to assess the cultural fit between the acquirer and target based on cultural
profile and managing the potential sources of clash even before the merger. It is
distinguished to identify the impact of cultural gap, and fabricate and finish strategies to
consume the information in the cultural profile to assess the impact that the differences
have. An important tool in this regard can be the dynamic model called “Pathfinder”
being used by GE Capital in this merger and acquisition ventures. The model
disintegrates the M&A process into four categories which are further divided into
subcategories. Initial or the pre- phase of the model involves the cultural assessments,
devising communication strategies and also evaluates strengths and weaknesses of the
business leaders, by choosing an integration manager. In the subsequent phase the
integration view is prepared for the purpose of building the foundation by formation of a
team of executives from the acquired and the acquiring company is formed. This is the
most vital phase as a sure slit communication strategy is developed to be deployed for
more than a 3 month period by lively senior management as well. In the third phase the
integration takes spot where the real implementation and correction measures are taken.
The processes like assessing the work toddle, assignment of roles etc are done at this
stage. This stage also involves continuous feedbacks and making famous corrections in
the implementation. The last phase involves assimilation process where integration
efforts are reassessed. This stage involves long term adjustment and looking for avenues
for improving the integration. This is also the period when the organization sincere starts
reaping the benefits of the acquisition.

Cost Management: Post merger saving costs also becomes a sterling challenge for the
corporate team in general and IT companies in particular. Thus it can be seen that there
could be duplications of processes within the current organizations which are needed to
be countered as a starting point. The lack of standardization around capital assets
purchased /items purchased, stocks, inventory, the flows of products and services all
through the distribution chain induces a colossal cost both in terms of time and proper
resources, which might prick the profit of the unusual company. A procurement
optimization could be effected in which all divisions could catch the same products
together, if possible and viable. Thus standardization of the vendors from whom both the
merged entities can procure the common hardware systems and control apparatus/ office
equipments etc. has to be effectively looked into so as to arrive at economies of scale.

Control Execution and urge of Integration: The need for effective control of the
merged entity immediately after signing of the merger agreement is an important issue in
cross border merger. Some of the obvious reasons for the same be as follows:

I. Legal Barriers- Cross-border mergers of IT companies could involve complex

transactions especially associated with handling of a significant number of legal entities,
listed or not, and which are governed by local rules (company law, market regulations,
self regulations). Not only is the foreign bidder IT company wishing to merge with an
overseas country disadvantaged or impeded by a potential lack of information, but also
some legal incompatibilities might appear in the merger process resulting in a deadlock,
even though the bid for merger is “friendly”. This legal uncertainty may constitute a
significant execution risk and act as a barrier to cross-border consolidation. This can be
corroborated from the fact that the IT sectors in some foreign overseas countries could
include institutions with complex legal setup resulting in opaque decision making
processes. Thus an Indian IT company if planning to merge with itself a foreign IT firm
then in that case it may so happen that the Indian IT company may be having a partial
understanding of all the parameters at stake, some of them not formalized. In such a
situation a significant failure risk may arise as the potential Indian IT company might not
have a clear understanding of who might approve or reject a merger proposal. Moreover,
in some cases, legal structures may not only complex but also prevent, de jure or de
facto, some institutions to be taken over or even merge (in the context of a friendly bid)
with institutions of a different type. Such restrictions are not specific to cross-border
mergers, but could provide part of the explanation of the low level of cross-border
M&As, since consolidation is possible within a group of similar institutions (at a
domestic level) whereas it is not possible with other types of institutions (which makes
any cross-border merger almost impossible). Moreover, even if an overseas merger of an
Indian IT company with an overaseas IT/ software company is successful, there may exist
impediments to effective control, i.e. there may be a risk that the acquiring company
( Indian IT company with a greater equity share holding in the merged entity) does not
acquire proportionate influence in the decision making process within the merged
company – while being exposed to disproportionate financial risks. This can be explained
notably by the existence of special voting rights, ineffective proxy voting or use of the
Administrative office by the overseas merged IT firm. Also barriers (or restrictions) to
sell shares could hamper the process.
II. Tax barriers As mentioned earlier, mergers and acquisitions are complex processes.
Despite some harmonized rules, taxation issues are mainly dealt with in national rules,
and are not always fully clear or exhaustive to ascertain the tax impact of a cross-border
merger or acquisition. This uncertainty on tax arrangements sometimes requires seeking
for special agreements or arrangements from the tax authorities on an ad hoc basis,
whereas in the case of a domestic deal the process is much more deterministic. Moreover,
the uncertainty on VAT regime applicable to software and IT products/ solutions and
services may put at risk the business model or envisaged synergies. This can be
corroborated from the fact that EU's VAT legislation in this area is badly in need of
modernisation and because of its inadequacies, there is an increasing tendency to resort to
litigation. Moreover, the impact of taxation on dividends might influence the
shareholders’ acceptance of a cross-border merger. Even though a seat transfer or a
quotation in another stock market might be justified for economic reasons, groups of
shareholders could be opposed to such an operation if it implies higher non-refundable
withholding tax, and thus lower returns on their investments.
III. Implications of supervisory rules and requirements The complexity of the
numerous supervisory approval processes in the case of a cross-border merger can also
pose a risk to the outcome of the transaction as some delays must be respected and adds
to the overall uncertainty. In particular, in the case of a merger between two parent
companies with subsidiaries in different countries, ‘indirect change of control’
regulations may require that all the national supervisors of all the subsidiaries must
approve the merger.Despite a common regulatory framework, there might be significant
divergences in supervisory practices at the level of institutions. Such divergences might
be explained by optionality in the harmonised rules, including provisions taken at
national level that exceed the harmonized provisions (‘superequivalent’ measures), or
lack of coherence in enforcement of common rules. The consequence is a limit on
homogeneous approaches, and therefore synergies, of risk control and risk management
within a cross-border group. Moreover, the multiple reporting requirements, in some
cases combined with a lack of transparency in terms of requirements and definitions, may
also impose a significant and costly administrative burden cross-border groups. Indeed, a
cross-border merger might cause heavier reporting requirements compared to those
imposed on the two entities that are being merged. Instead of creating cost synergies as in
a domestic merger, a cross-border might even create additional costs.

IV. Economic barriers- Problems associated could be that due to the fragmentation of
the equity markets may impose additional transaction cost on a cross-border merger. For
instance, the exchange of share mechanism can be complex, and more expensive, when
the two entities ( IT companies involved in the merger operations) are listed on different
stock exchanges. Thus the additional costs involved in the merger process might also
influence the bidder on the type of deals (i.e. cash vs. exchange of shares). Apart from the
same, in cross-border groups, there are also more non-overlapping fixed costs, which
cannot be spread over several countries. Indeed, even without legal, tax or prudential
barriers, there would remain differences between Member States that would require a
differentiated approach to be adapted tothe local environment. This limits potential
synergies. The most obvious example is language, and the implications in terms of
customer services for instance.

Streamlining Strategic Fit: Mergers with passage of time need to be fitted and
continuously aligned strategically, at all strategies level, corporate, business level and
functional level, which improves the profitability through reduction in overheads,
effective utilization of facilities, the ability to raise funds at a lower cost, and deployment
of surplus cash for expanding business with higher returns. It generally happens that the
sufficient time is taken for streamlining the strategic fit because of the difference in work
culture, working environment, job profile, language difference in approach and attitudes
towards work/ leverage, independence and freedom at the work place to do innovative
and creative work; difference in the pay packages/ employees benefits/ perks and benefits
etc. Thus if there is delay or for that matter if this trategic fit is not dynamic lack of
synergies results in merger failure. Thus in case of the Information technology and
software industry sector, this problem is of paramount importance.

Thus the aforementioned discussion suitably summarizes the problems associated with
the merger of cross border IT software companies.

Ans 05 b. The workings for valuation of the firm based on the FCFF method is as
follows:

Valuation of the Polaris Firm as per FCFF Valuation

Method

Base year Information Given (FY

2003):
(Rs. In Million)
Total Sales Revenue
Earnings 4017
Earnings before
interest and taxes 768
Depreciation 180
Capital Expenditure 250
Working capital as %
of revenue earnings 40%

High Growth Phase

Length of high
growth phase 5 years
Expected growth rate
in FCFF 8%
Beta 1.2
Cost of debt 7.50%
Debt Ratio 25%
Tax Rate of the firm 35%

Stable Growth Phase

Expected Growth rate 4%
Cost of Debt 6.50%
Debt Ratio 13%
Annual Market
Premium of the firm 5%
Risk Free Rate of
return on capital 5.50%

The forecasted cash

flow of the firm over (Rs. In
the next 5 years Million
period is as under: )

Beginn
High ing of
Growt stable
h growth
Phase phase
Item 2004 2005 2006 2007 2008 2009
895.7 967.458 1044.8 1128. 1173.5
EBIT 829.44 952 816 555 444 817
313.5 365.69 394.9 410.75
Tax @ 35% 290.304 28 338.611 9 55 4
582.2 679.15 733.4 762.82
PAT 539.136 67 628.848 6 89 8
291.6 340.12 367.3 382.02
Capital Exp. 270.000 00 314.928 2 32 5
209.9 244.88 264.4 275.05
Depreciation 194.400 52 226.748 8 79 8
Capital Exp.- 81.64 102.8 106.96
Depreciation 75.600 8 88.180 95.234 53 7
Change in Working 149.9 174.88 94.43
capital 138.828 34 161.928 3 7 98.214
350.6 409.03 536.1 557.64
FCFF 324.708 85 378.740 9 99 7
DF @ 9.84% p.a.
being the WACC
during the growth
phase 0.91 0.83 0.75 0.69 0.63
PV of FCFF@ WACC
during high growth 290.6 335.3
phase 295.61 5 285.77 280.97 1
Sum total of the PV
of FCFF @WACC
during the growth
phase 1488.31

Estimation of change
in Working Capital (Rs. In
requirement for the Million
firm )
High Stable
growth growth
phase phase
period period
Item 2004 2005 2006 2007 2008 2009 2010 2011 2012
Sales revenue 4338.36 4685. 5060.26 5465.0 5902. 6138.3 6383. 6639. 6904.
earnings of the firm 0 429 3 84 291 83 918 275 846
Working capital
requirement of the 1735.34 1874. 2024.10 2186.0 2360. 2455.3 2553. 2655. 2761.
firm 4 172 5 34 916 53 567 710 938
Change in Working
capital requirement 138.8 161.92 174.8 98.21 102.1 106.2
of the firm 28 149.934 8 83 94.437 4 43 28

Estimation for the

high growth phase
Cost of Debt 7.50%
Cost of equity to the
firm 11.50%
WACC during the
high growth phase 9.84%

Calculation of the
revised beta for the
stable phase
New beta= (old beta/
(1+1(1-t)*old
D/E))*((1+(1-t)New
D/E Ratio))
Value of New Beta 1.12
Cost of Debt 6.50%

Revised cost of
equity to the firm 11.10%
WACC during the
stable growth phase 10.20%
Therefore using the
growing concern
accounting standard
for the firm and
faluating the same
PV of a growing =PV= C/
Annuity (i-g)
PV = Present value of the
Where growing annuity
C= Annuity payment or
received as the case may
be = Rs. 557.65 million
i= the interest rate , here
in this case is thre
WACC=10.20%
g= expected growth
rate=4%
Therefore on solving
we get FVCFF during
the stable growth
phase of the firm= 8988.50

But this PV of Perpetuity is the terminal value at

the beginning of the 1st year of the stable growth
phase ; therefore the same needs to be

discounted at the rate of the WACC during the

course of the high growth phase to arrive at the PV
Therefore the PV of
the FCFF during the
course of the stable 5620.
growth phase= Rs. 959
Therefore Present
Value of the firm=
PVFCFF at high
growth phase+
PVFCFF at stable
growth phase
millio 5620.9 millio
PV of the Firm = Rs. 1488.31 n + 59 n
millio
PV of the Firm = Rs. 7109.27 n