Syllabus : Mergers and Acquisitions

Case Studies
Take over Defences
Methods of Payment & Leverage
Regulatory controls.

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Books : Mergers, Restructuring and Corporate

Control Weston, Chung, Hong (Prentice Hall)
Mergers & Acquisitions Vol.-I to IV : ICFAI
Mergers & Acquisitions Weston & Weaver Tata
McGraw Hill.
Corporative Restricting & Merging Acquisition:
Mahesh Dubey Mahaveer & Sons.

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Mergers & Acquisitions-Definitions

The phrase mergers and acquisitions (abbreviated
M&A) refers to the aspect of Corporate Strategy,
Corporate Finance and Management dealing with the
buying, selling and combining of different Companies that
can aid, finance, or help a growing company in a given
industry to grow rapidly without having to create another
business entity.
In Business or in Economics a Merger is a combination of
two Companies into one larger company.
Such actions are commonly voluntary and involve Stock
Swap or cash payment to the target. Stock swap is often
used as it allows the shareholders of the two companies to
share the risk involved in the deal.
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Mergers & Acquisitions-Definitions

A merger can resemble a Takeover but result in a new
company name (often combining the names of the original
companies) and in new Branding; in some cases, terming
the combination a Merger" rather than an acquisition is
done purely for political or marketing reasons.
In the pure sense of the term, a Merger happens when two
firms, often of about the same size, agree to go forward as a
single new company rather than remain separately owned
and operated. This kind of action is more precisely referred
to as a Merger of equals." Both companies' stocks are
surrendered and new company stock is issued in its place.
For example, both Daimler-Benz and Chrysler ceased to
exist when the two firms merged, and a new company,
DaimlerChrysler, was created.
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Acquisitions
When one company takes over another and clearly
established itself as the new owner, the purchase is called
an Acquisition. From a legal point of view, the Target
company ceases to exist, the buyer "swallows" the
business and the buyer's stock continues to be traded.
In practice, however, actual mergers of equals don't
happen very often. Usually, one company will buy another
and, as part of the deal's terms, simply allow the acquired
firm to proclaim that the action is a merger of equals, even
if it's technically an Acquisition. Being bought out often
carries negative connotations, therefore, by describing the
deal as a merger, deal makers and top managers try to
make the takeover more palatable
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Acquisitions
A purchase deal will also be called a merger when both
CEOs agree that joining together is in the best interest of
both of their companies. But when the deal is unfriendly
and is hostile, i.e. the Target Company does not want to
be purchased, then it regarded as Acquisition.
Whether a purchase is considered a Merger or an
Acquisition really depends on whether the purchase is
friendly or hostile and how it is announced. In other
words, the real difference lies in how the purchase is
communicated to and received by the target company's
board of directors, employees and shareholders.
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Varieties of Mergers -1
Horizontal merger - Two companies that are in direct competition
and share the same product lines and markets.
Vertical merger - A customer and company or a supplier and
company. Think of a cone supplier merging with an ice cream
maker. Vertical mergers occur when two firms, each working at
different stages in the production of the same good, combine.
Market-extension merger - Two companies that sell the same
products in different markets.
Product-extension merger - Two companies selling different but
related products in the same market.
Congeneric Merger / Concentric Mergers occur where two
merging firms are in the same general industry, but they have no
mutual buyer/customer or supplier relationship, such as a merger
between a Bank and a Leasing company. Example: Prudential's
acquisition of Bache & Company.
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Varieties of Mergers -2
Accretive mergers are those in which an acquiring company's
earnings per share (EPS) increase. An alternative way of
calculating this is if a company with a high price to earnings ratio (
P/E) acquires one with a low P/E & Dilutive mergers are the
opposite of above, whereby a company's EPS decreases. The
company will be one with a low P/E acquiring one with a high P/E.
Conglomerate : When two companies that have no common
business areas. There are two types of mergers that are
distinguished by how the merger is financed. Each has certain
implications for the companies involved and for investors:
A) Purchase Mergers - As the name suggests, this kind of
merger occurs when one company purchases another. The
purchase is made with cash or through the issue of some kind of
debt instrument; the sale is taxable.
Acquiring companies often prefer this type of merger because it
can provide them with a tax benefit. Acquired assets can be
written-up to the actual purchase price, and the difference
between the book value and the purchase price of the assets can
depreciate annually, reducing taxes payable by the acquiring
company.
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Varieties of Mergers -3
B) Consolidation Mergers - With this merger, a brand
new company is formed and both companies are
bought and combined under the new entity. The tax
terms are the same as those of a purchase merger
In some of the merger deals, a company can buy
another company with cash, stock or a combination of
the two.
In smaller deals, one company acquires all the assets
of another company.
Company X buys all of Company Y's assets for cash,
which means that Company Y will have only cash (and
debt, if they had debt before). Thus, Company Y
becomes merely a shell and will eventually liquidate or
enter another area of business.
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Varieties of Mergers -4
Reverse merger is an another type of acquisition is a
deal that enables a private company to get publicly-listed
in a relatively short time period. A reverse merger
occurs when a private company that has strong
prospects and is eager to raise financing buys a publiclylisted shell company, usually one with no business and
limited assets. The private company reverse merges into
a Shell public company, and together they become an
entirely new public corporation with tradable shares.
Takeover : An Acquisition where the Target Firm did not
solicit the bid of acquiring firm.
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Why M& A ?

One plus one makes three is the main idea and is special
alchemy of a Merger or an Acquisition. The key principle
behind buying a company is to create shareholder value
over and above that of the sum of the two companies. Two
companies together are more valuable than two separate
companies - at least, that's the reasoning behind M&A.
Especially, when times are tough; strong companies will
act to buy other companies to create a more competitive,
cost-efficient company. The companies will come together
hoping to gain a greater market share or to achieve greater
efficiency. Target companies will often agree to be
purchased when they know they cannot survive alone.
Synergy is the magic force that allows for enhanced cost
efficiencies of the new business. Synergy takes the form of
revenue enhancement and cost savings. By merging, the
companies hope to benefit
from the following:
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Why M& A ?

Staff reductions - Mergers tend to mean job losses.

Mostly from reducing the number of staff members from
accounting, marketing and other departments. Job cuts
will also include the former CEO, who typically leaves
with a compensation package.
Economies of scale - Yes, size matters. A bigger
company placing the orders can save more on costs.
Mergers also translate into improved purchasing power
to buy equipment or office supplies - when placing larger
orders, companies have a greater ability to negotiate
prices with their suppliers.
Acquiring new technology - To stay competitive,
companies need to stay on top of technological
developments and their business applications. By buying
a smaller company with unique technologies, a large
company can maintain or develop a competitive edge.
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Why M & A ?
Improved market reach and industry visibility - A merge
may expand two companies' marketing and distribution,
giving them new sales opportunities. Because of
improved financial standing, Bigger firms have an easier
time raising capital than smaller ones.
Overcome the Entry barriers: M & A is one of the way
for smooth market entry, as good will of another
company and the brand gets transferred to new entities
without initial hiccups. These costly barriers to entry
otherwise would make Start-ups economically
unattractive. e.g. Belgian Fortis acquisition of American
Bankers Insurance Group
Eliminating the Cost of new product Development.
Buying established business reduces risk of start-up
ventures. e.g. Watson Pharmaceuticals acquisition of
Thera Tech
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Why M & A ?
Lower risk compared to developing new products.
Increased feasibility and speed of Diversification. This
is a quick way to move into businesses when firm
currently lacks experience and depth in industry. e.g.
CNETs acquisition of mySimon.
Acquisition is intended to avoid excessive competition
and improve competitive balance of the industry and
thereby Increased Market Power and allowing market
entry in a timely fashion. Firms use acquisition to restrict
its dependence on a single or a few products or markets.
e.g. British Petroleums acquisition of U.S. Amoco.;
Kraft Foods acquisition of Boca Burger.; General
Electrics acquisition of NBC.
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Problems of M & A
Integration Difficulties: Differing financial and control systems can
make integration of firms difficult. e.g. Intels acquisition of DECs
semiconductor division.
Inadequate Evaluation of Target: Competitive bid causes acquirer
to overpay for firm. e.g. Marks and Spencers acquisition of Brooks
Brothers
Large or Extraordinary Debt : Costly debt can create onerous
burden on cash outflows. e.g. Agrbio Techs acquisition of dozens
of small seed firms
Inability to Achieve Synergy: Justifying acquisitions can increase
estimate of expected benefits. e.g. Quaker Oats and Snapple
Overly Diversified: Acquirer doesnt have expertise required to
manage unrelated businesses. e.g. GE prior to selling businesses
and refocusing
Managers Overly Focused on Acquisitions: Managers may fail to
objectively assess the value of outcomes achieved through the
firms acquisition strategy. e.g. Ford and Jaguar
Too Large: Large business bureaucracy reduces innovation and
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flexibility.

10 Major Change Forces Contributing Merger activity

1.
2.

The pace of Technology has accelerated.

The costs of communication and Transportation have greatly
reduced.
3. Hence markets have become international in scope.
4. The forms, sources and intensity of competition have expanded.
5. New Industries have emerged.
6. While regulations have increased in some areas, generally more
deregulations have taken place in other industries.
7. Favourable economic and financial environments have persisted
from 1982 to 1990 and from 1992 to 2000.
8. Within a general environment of strong economic growth,
problems have developed in individual economics and industries.
9. Inequalities in income and wealth have been widening.
10. Valuation relationships and equity returns for most of 1990s have
risen to levels significantly above long-term historical patterns.
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Merger Motives at a Glance

SYNERGY
Short Term
Financial Synergy
EPS & PE Efficiency
Improved Liquidity
Tax Effects

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Long Term
Operating
Financial Synergy
Synergy
Increased Debt Capacity Economies of Scale
Improved Capital
No Growth in Industry
Redeployment
Limited Competition
Reduction in Debt
Acquiring Technical &
Managerial Knowledge
Bankruptcy Costs
Product Extension
Stabilising Earnings Market Extension
Reduction in in Risk and
uncertainty

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Merger Motives at a Glance

Target Undervaluation
* Market Inefficiency (Economic Disturbances)
*Inside Information
*Superior Analysis
* Displacing Inefficient Managers
Managerial Motives
* Power Needs * Size * Growth
* Executive Comparison * Insider
* Human Capital
* Risk Diversification

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Peter Druckers Five Commandments for Successful

Acquisition / Mergers
1.
2.
3.
4.
5.

Acquirer must contribute something to the acquired Company.

A common core of unity is required.
Acquirer must respect the business of the acquired company
Within a year or so, acquiring company must be able to provide top
management to the acquired company.
Within the first year of Merger, managements in both companies should
receive promotions across the entities.
Be sure there is some element of relatedness, but dont be too
restrictive in defending the scope of potential relatedness.
Combining two companies is an activity involving substantial trauma
and readjustment. Therefore, a strong emphasis on maintaining and
enhancing managerial rewards and incentives is required in the post
merger period.
The risk of mistakes stemming from wishful thinking are especially
great in mergers. The planning may be sound from the standpoint of
business or financial complementarities or relatedness. But if the price
is not right, some one is going to hurt.
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Major Challenges to Merger Success

Look into Three important areas : Due Diligence, Cultural
Factors & Implementation.
Due Diligence:
1. Check all legal Aspects including pension funding,
environmental problems, product liabilities etc.
2. Check all business & management considerations involving
examining accounting records, maintenance & quality
equipments, possibility of cost controls, potentiality of product
improvements,
3. management relationship with its employees, gaps in
managerial capabilities, how these management systems will
fit together, need to hire or fire managers, etc.
4. Ensure that acquired unit is worth more as apart of the
acquiring firm than being left alone or with any other firm.
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 Cultural Factors
1. Check organisations values, traditions, norms, beliefs and
behaviour patterns.
2. Check formal statements available, but observe informal
relationships and networks.
3. Check managements operating style. The firm must be
consistent in its formal statements of values and kinds of
actions that are rewarded.
4. Check need of proactive employee training for growth through
Merger.
5. Check cultural factors in addition to products, plant &
equipments.
6. Check how the organisation has handled cultural factors in the
past.
7. Cultures may move to similarity. Or differences may even be
valued as sources of increased efficiency.
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 Implementation
1. Implementation starts as condition for thinking about M & A.
2. The firm must have implemented all aspects of efficient
operations before it can effectively combine organisations.
3. The acquiring firm must have shareholder value orientation
with strategies and organisational structures compatible to
multiple business units.
4. Mergers should further Corporate strategy, strengthening
weaknesses, filling gaps, developing new growth opportunities
and extending capabilities.
5. Integration leadership with management leadership qualities,
experience with external constituencies and credibility with the
various integration participants.
6. Provide early, frequent & clear integration messages. Lack of
communications causes distress. Ensure quick integration.
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10 Secrets to Successful Mergers & Acquisition

1. Decide holes in your product / service grids that you have to fill but
cannot develop yourself & look for companies that can fill the holes.
2. Buy into companies by taking quick look at products you might
want to own.
3. Move fast. Having decided that the opportunity is right, close the
deal now or someone else will.
4. Do not kill over the price. If the deal is key to your companys
growth, pay now and add value later. Price will look cheap
tomorrow.
5. Destroy uncertainty. Keep all employees whole. Protect employees
for at least one year. Let them concentrate on job and not on job
security. Issue new ID cards. Integrate your computer systems
immediately.
6. Be ready to move the day the deal is announced. Hand over every
employee a package that completely explains who you are, giving
the contact people to ask questions. Compare benefits.
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10 Secrets to Successful Mergers & Acquisition

7. Form a mobile team of transition executives. Set up immediate
Internet access with your company. Link new employees with
your people at your company at similar levels. Practice full
access and full disclosure. This team should research every
single job at the acquisition & bring that job into your firms job
matrix.
8. Utilise acquired companies resources. Use acquired
companys skill set and send in your team where they dont.
9. Sales & marketing: Do not change commission schedules and
house account rules. Raise commissions or leave them alone,
but never lower them.
10. Set up communication groups. Give new employees to voice
concerns and gripes. Act on their suggestions. Offer bonuses
for ideas that facilitate the acquisitions integration into your
company.
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Valuation - 1
Asset Valuation: Disciplined procedure for arriving at a
price.
Historical earnings valuation,
Future maintainable earnings valuation,
Valuation as per Discounted Cash Flow (DCF) :
A key valuation tool in M&A, discounted cash flow analysis
determines a company's current value according to its
estimated future cash flows. Forecasted free cash flows
(operating profit + depreciation + amortization of goodwill
capital expenditures cash taxes - change in working
capital) are discounted to a present value using the
company's Weighted Average Costs of Capital (WACC).
Few tools can rival this valuation method though it is tricky.
NPV =
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t=n
t =1

Cash Flow

- Initial Capital

(1+% Interest) raise to t

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Relative Valuation: Comparable company &

comparable transactions,
One more method used is IRR i.e. Internal Rate of
Return. This gives % rate of return at which NPV will
become Zero.
Free Cash Flow Basis is used mostly, while making Cash
Payments for Merger & Acquisitions.
Professionals who evaluate businesses generally do not
use just one of these methods but a combination of
some of them, as well as possibly many others that are
not mentioned above, in order to obtain a more accurate
value.

Valuation -2
These values are determined for the most part by looking
at a company's Balance Sheets and / or Income
Statements and withdrawing the appropriate information.
The information in the balance sheet or income
statement is obtained by one of three Accounting
measures: a Notice to Reader, a Review Engagement or
an Audit.
Accurate business valuation is one of the most important
aspects of M&A as valuations like these will have a major
impact on the price that a business will be sold for. Most
often this information is expressed in a Letter of Opinion
Value (LOV) when the business is being evaluated for
interest's sake.
There are other, more detailed ways of expressing the
value of a business. These reports generally get more
detailed and expensive as the size of a company
increases, however, this is not always the case as there
are many complicated industries which require more
attention to detail, regardless
of size.
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Valuation -3

Before Merging one must determine how much the

company being acquired is really worth. There are,
however, many legitimate ways to asses value of a target
company by employing variety of methods and tools:
1. Comparative Ratios - The following are two examples of the
many comparative metrics on which acquiring companies
may base their offers:
Price-Earnings Ratio (P/E Ratio) - With the use of this ratio,
an acquiring company makes an offer that is a multiple of
the earnings of the target company. Looking at the P/E for
all the stocks within the same industry group will give the
acquiring company good guidance for what the target's P/E
multiple should be.
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Valuation - 4

Enterprise-Value-to-Sales Ratio (EV/Sales) - With this

ratio, the acquiring company makes an offer as a
multiple of the revenues, again, while being aware of the
price-to-sales ratio of other companies in the industry.

2.

Replacement Cost - In a few cases, acquisitions are

based on the cost of replacing the target company. For
simplicity's sake, assume the value of a company is
simply the sum of all its equipment and staffing costs.
However, it takes a long time to assemble good
management, acquire property and get the right
equipment. This method of establishing a price certainly
wouldn't make much sense in a service industry where
the key assets - people and ideas - are hard to value
and develop

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Methods of Payment
Financing M&A
Mergers are generally differentiated from acquisitions
partly by the way in which they are financed and partly
by the relative size of the companies. Various methods
of financing an M&A deal exist:
Cash
Payment by cash. Such transactions are usually termed
acquisitions rather than mergers because the
shareholders of the target company are removed from
the picture and the target comes under the (indirect)
control of the bidder's shareholders alone.
A cash deal would make more sense during a downward
trend in the interest rates. Another advantage of using
cash for an acquisition is that there tends to lesser
chances of EPS dilution for the acquiring company. But a
caveat in using cash is that it places constraints on the
cash flow of the company.
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Methods of Payment
Financing
Financing capital may be borrowed from a bank, or
raised by an issue of bonds. Alternatively, the acquirer's
stock may be offered as consideration. Acquisitions
financed through debt are known as Leveraged Buyouts
if they take the target private, and the debt will often be
moved down onto the Balance Sheet of the acquired
company.
Hybrids
An acquisition can involve a combination of cash and
debt or of cash and stock of the purchasing entity.
Factoring
Factoring can provide the extra to make a merger or sale
work. Hybrid can work as additional factor.
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How good is M & A deal ?

Acquiring companies nearly always pay a substantial
premium on the stock market value of the companies
they buy in the notion of Synergy. A merger benefits
shareholders when a company's post-merger share price
increases by the value of potential synergy. For buyers,
the premium represents part of the post-merger synergy
they expect can be achieved. The following equation
offers a good way to find minimum required synergy:
Pre Merger Value of Both Firms + Synergy

Pre Merger Stock Price X

Post Merger Number of Shares.
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How good is M & A deal ?

Investors should start by looking for some of these simple

criteria:
A reasonable purchase price - A premium of, say, 10% above
the market price seems within the bounds of levelheadedness. A premium of 50%, on the other hand, requires
synergy of stellar proportions for the deal to make sense. Stay
away from companies that participate in such contests.
Cash transactions - Companies that pay in cash tend to be
more careful when calculating bids and valuations come closer
to target. When stock is used as the currency for acquisition,
discipline can go by the wayside.
Sensible appetite An acquiring company should be targeting
a company that is smaller and in businesses that the acquiring
company knows intimately. Synergy is hard to create from
companies in disparate business areas. Sadly, companies
have a bad habit of biting off more than they can chew in
mergers.
Mergers are awfully hard to get right, so investors should look
for acquiring companies with a healthy grasp of reality.

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Attributes of Effective Acquisitions

Complementary Assets or Resources: Buying firms with
assets that meet current needs to build competitiveness.
Friendly Acquisitions: Friendly deals make integration go
more smoothly.
Careful Selection Process : Deliberate evaluation and
negotiations is more likely to lead to easy integration and
building synergies.
Maintain Financial Slack: Provide enough additional
financial resources so that profitable projects would not be
foregone.
Low-to-Moderate Debt: Merged firm maintains financial
flexibility.
Flexibility : Has experience at managing change and is
flexible and adaptable.
Emphasise Innovation: Continue to invest in R & D as part
of the firms overall strategy.
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The Evaluation of an Acquisition Target

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Strategic Planning for Merger Activities

1.
2.
3.
4.

Assessment of the changes in environment.

Evaluation of company capabilities and limitations.
Assessment of expectations of Stake holders.
Analysis of company, competitors, industry, domestic economy
and international economy.
5. Formulation of Missions, Goals, and policies for the master
strategy.
6. Development of sensitivity to critical environmental changes.
7. Formulation of internal organisation performance measurements
8. Formulation of long range strategy programs.
9. Formulation of midrange programs and short range plans.
10. Organisation, funding and other methods to implement all
preceding elements.
11. Information flow, feedback system for continued repetition of all
essential elements and for adjustments at each stage.
12. Review and evaluation of all processes.
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Sources of gains in M & As

A.
1.
2.
3.
4.
5.

Strategy
Develop a new Strategic Vision
Achieve long run Strategic goals
Acquire capabilities in new industry.
Obtain talent for fast moving industries.
Add capabilities to expand role in a technologically
advancing industry.
6. Quickly move into new products, markets.
7. Apply a broad range capabilities and managerial skills in
new areas.
B. Economies of Scale
1. Cut production costs due to large volume.
2. Combine R & D operations
3. Increased R & D at controlled risk.
4. Increased Sales force.
5. Cut overhead costs.
6. Strengthen distribution systems.
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C. Economies of Scope
1. Broaden Product line.
2. Provide one stop shopping for all services
3. Obtain complementary products
D. Extend advantages in differential products
E. Advantages of size
1. Large size can afford high tech equipments.
2. Spread the investments in the use of expensive equipments
over more units.
3. Ability to get quantity discounts
4. Better terms in deals.
F. Best Practices
1. Operating efficiencies-improve management of receivables,
inventions, fixed assets etc.
2. Faster tactical implementation.
3. Incentives for workers rewards
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Better utilisation for resources.
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G. Market Expansion
1.
Increased Market Share.
2.
Obtain access to new Markets.
H. New Capabilities, Managerial Skills
1.
Apply a broad range of capabilities and managerial skills
in new areas.
2.
Acquire capabilities in new industry.
3.
Obtain talent for fast moving industries.
I.
Competition
1.
Achieve critical mass before rivals.
2.
Pre-empt acquisitions by competitors.
3.
Compete on EBIT growth for higher valuations.
J. Customers
1.
Develop new key customer relationships.
2.
Follow Clients.
3.
Combined company can meet customers demand for a
wide range of services.
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K. Technology
1. Enter technologically dynamic industries.
2. Seize opportunities in industries with developing
technologies.
3. Exploit technological advantage.
4. Add new R & D capabilities.
5. Add key technological and complementary technological
capabilities.
6. Add key Patents or Technology.
7. Acquire technology for lagging areas.
L. Shift in industry organisation
1. Adjust to de-regulations relaxed Government barriers,
geographic & new market extensions.
2. Change in strategic scientific industry segment.
M. Shift in product Strategy
1. Eliminate industry excess capacity. Shift from over capacity
area to area with more favourable sales capacity.
2. Exit a product area that has become area of speciality.
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N. Globalisation
1. International Competition to establish presence in foreign
markets and strengthen position in domestic market.
2. Size & economies of scale required for global competition.
3. Growth opportunities outside domestic market.
4. Diversification product, Geographically, reduce
dependence on export or imports, reduce systematic risks.
O. Favourable product inputs - Obtain assured sources of
supply of RMs, inexpensive & trained Labour, Locally
manufactured inputs.
Q. Improved distribution in other countries.
R. Investment acquire company, improve it , sell it.
S. Prevent Competitor from acquiring target company.
T. Create antitrust problem to deter potential acquirers.
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Why M & A fail ? - 1

Plenty of Mergers don't work : Historical trends show that
roughly two thirds of big mergers will disappoint on their
own terms, which means they will lose value on the
stock market
The motivations for merger can be flawed and estimated
efficiencies from economies of scale prove elusive.
Many a times problems associated with merged
companies are beyond solution.
Flawed Intentions: Mergers that have been encouraged
by booming stock market spell trouble.
Deals done with highly rated stock as currency are easy
and cheap, but without any the strategic thinking behind
them.
Also, mergers are often attempt to imitate: just because
somebody else has done a big merger. A merger may
often have more to do with glory-seeking than business
strategy.
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Why M & A fail ? - 2

Most CEOs get a big bonus for merger deals, no matter
what happens to the share price later.
Mergers sometimes are driven by generalized fear.
Globalization, the arrival of new technological
developments or a fast-changing economic landscape,
with idea that only big players will survive a more
competitive world.
The Obstacles to Making it Work
Coping with a merger can make top managers spread
their time too thinly and neglect their core business,
spelling doom.
Too often, potential difficulties seem trivial to managers
caught up in the thrill of the big deal.
The chances for success are further hampered if the
corporate cultures of the companies are very different.
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Why M & A fail ? - 3

When a company is acquired, the decision is typically
based on product or market synergies, but cultural
differences are often ignored. It's a mistake to assume
that personnel issues are easily overcome. For example,
employees at a target company might be accustomed to
easy access to top management, flexible work schedules
or even a relaxed dress code. These aspects of a
working environment may not seem significant, but if
new management removes them, the result can be
resentment and shrinking productivity.
More insight into the failure of mergers is found in the
highly acclaimed study from McKinsey, a global
consultancy. The study concludes that companies often
focus too intently on cutting costs following mergers,
while revenues, and ultimately, profits, suffer.
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Why M & A fail ? - 4

Merging companies can focus on integration and costcutting so much that they neglect day-to-day business,
thereby prompting nervous customers to flee. This loss
of revenue momentum is one reason so many mergers
fail to create value for shareholders.
But remember, not all mergers fail. Size and global reach
can be advantageous, and strong managers can often
squeeze greater efficiency out of badly run rivals.
Nevertheless, the promises made by deal makers
demand the careful scrutiny of investors. The success of
mergers depends on how realistic the deal makers are
and how well they can integrate two companies while
maintaining day-to-day operations.
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Summing up
M&A comes in all shapes and sizes, and investors need
to consider the complex issues involved in M&A. Let's
sum up:
A merger can happen when two companies decide to
combine into one entity or when one company buys
another. An acquisition always involves the purchase of
one company by another.
The functions of synergy allow for the enhanced cost
efficiency of a new entity made from two smaller ones synergy is the logic behind mergers and acquisitions.
Acquiring companies use various methods to value their
targets. Some of these methods are based on
comparative ratios - such as the P/E and P/S ratios replacement cost or discounted cash flow analysis.
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Summing up
An M&A deal can be executed by means of a cash
transaction, stock-for-stock transaction or a combination
of both. A transaction struck with stock is not taxable.
Break up or de-merger strategies can provide companies
with opportunities to raise additional equity funds, unlock
hidden shareholder value and sharpen management
focus. De-mergers can occur by means of divestitures,
carve-outs spin-offs or tracking stocks.
Mergers can fail for many reasons including a lack of
management foresight, the inability to overcome
practical challenges and loss of revenue momentum
from a neglect of day-to-day operations.
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Merger waves :

The economic history has been divided into Merger Waves based on
the merger activities in the business world as:

Period

Name

Facet

1889 -1904

1st Wave

Horizontal Mergers

1916 -1929

2nd Wave

Vertical Mergers

1965 - 1989

3rd Wave

Diversified Conglomerate
Mergers

1992 - 1998

4th Wave

Congeneric Mergers, Hostile

Takeovers, Corporate
Raiding

2000 onwards

5th Wave

Cross Border Mergers

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Rank Year

Major M&A from 2000 to present

Purchaser
Purchased

In Mil. - USD

2000

Fusion : America on
Line : AOL

Time Warner

$1,64,747

2000

Glaxo Wellcome Plc.

Smith Kline
Beecham plc.

$75,961

2004

Royal Dutch
Petroleum Co.

Shell Transport &

Trading Co.

$74,559

2006

AT & T Inc.

Bell South
Corporation

$ 72,671

2001

Comcast Corporation

AT & T Broadband
& Internet

$ 72,041

2004

Sanofi-Synthelabo SA

Aventis SA

$ 60,243

2002

Pfizer Inc.

Pharmaica Corp.

$ 59,515

2004

JP Morgan Chase Co

Bank One Corp.

$ 58,761

2009

Pfizer Inc.

Wyeth

$ 68,000

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Defence against Takeovers - 1

a)

b)
c)
d)

Identify the part of your company that is most attractive

to the predator and dispose it off in such a way that it
continues to allow your company to have access to it.
Example: Transfer the sought after Brand to a fully
owned associate company and work out on licensing
agreement.
Restructuring the company as defence against
takeover:
Split a Division : This is generally done when
companies have diversified in unrelated business and
finds it difficult to harmonize and feel vulnerable.
Example : BILT split into BILT Paper, BILT Investment
Services & BILT Chemicals.
Form wholly owned subsidiary
Form Independent Company
Reverse Mergers :

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Defence against Takeovers - 2

Take Advice of consultant / Parent Company /
Stakeholders: Example : Jhonson & Jhonson
restructured itself in a manner that one Division started
reporting to Switzerland and other to Singapore.
Mergers & Amalgamations done within group to form a
big company to compete with large companies.
Example: BPL Ltd. Is amalgamation of its four
companies namely BPL Sanyo, BPL Refrigeration & BPL
Sanyo Utilities. Also merger of Brook Bond, Ponds,
Lakme into HLL
BPR : Business Process Re-engineering: Break away
from outdated rules and fundamentals, remove many
layers & unnecessary jobs. Re-write whole Business
process on a clean slate. Jobs become redundant after
some time, people dont.
Smart sizing: e.g. : Glaxo undertook disinvestments ICI
& Ciba Geigy
Benchmarking

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Defence against Takeovers - 3

Best defence against Take over is to do good Financial
Housekeeping. Keep a tight rein on scrap value, large
transfers, placing blocks of shares in friendly hands,
making sure that assets value is properly reflected in
share value.
Delaying tactics legally, which is called as spoiling tactics.
Greenmail to all shareholders.
Asset striping. Target company may strip the assets and
convert itself into a shell company.
Poison Pill : Make a special issue share with voting rights
exercisable after some time e.g.10 days or which after
hostile takeover will yield, entitles share holders some
lollypops, which will jack up cost of acquisition. E.g. EL
Paso Natural gas
The white Knight. (The third party friendly to incumbent
management brought in to rescue from an undesired
takeover)
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Financial Defensive Measures - 1

What makes a Company vulnerable?
a) Low stock price in relation to the replacement cost of
assets or their potential earning power.
b) Highly liquid balance sheet with large amount of excess
cash or significant unused debt capacity.
c) Good cash flow relative to current stock prices.
d) Subsidiaries or properties which can be sold without
affecting cash flow.
e) Relatively small stock with the incumbent management.
Steps to be taken :
1. Debt should be increased.
2. With borrowed funds, repurchase the equity from
Market.
3. Dividends on remaining shares should be increased.
4. Loan repayment may be accelerated.
5. Securities portfolio should be liquidated.
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Defensive Measures Steps to be taken- Contd:

6. Cash flow from operation to be invested in positive net
Value projects. Acquire other firms with excess liquidity
available.
7. Divest Subsidiaries without impairing Cash Flows.
8. Adjustment in Assets and ownership structure.
9. Issue a new class of preferred shares to common
shareholders with voting rights. Thereby diluting the
holdings of the Bidder.
10.Create a consolidated Vote bank by share issues or by
repurchasing from Market.
11.Leveraged recapitalisation known as Leveraged Cash
Outs (LCO) where outside shareholders receive a large
one-time cash dividend from newly borrowed funds and
insiders receive new voting shares. There by raise the
firms leverage to an abnormally high level and
discourages the takeover.
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Defensive Measures Steps to be taken- Contd:

12. Golden Parachutes: Separation clause of an employment
contract for loss of job under a change of control clause. (being
criticised as reward for failure).
13. Anti-takeover Amendments: are included in Firms corporate
charter. These are subjected to shareholders approval and law
as it helps entrenchment of incumbent management.
14. Supermajority Amendments: Require two third to 90% share
holder vote. Many times board has power to revoke this
amendment.
15. Fair Price Amendment: The bidder should offer the highest price
during a specified period, which is generally about 10-15%
above the Market price or EV.
16. Classified Boards: Provides for staggered, or classified, boards
to delay effective transfer of control in a takeover. New
shareholders will have to wait till incumbent directors retire by
turns.
17. Authorisation of preferred stocks: The board of directors are
authorised to create a new class of securities with special voting
rights; issued to friendly parties as defence against takeover.
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Methods of Payment & Leverage -1

The financing of M & A can be evaluated on two levels;
Tactical: How to get the deal done? - Considerations
are speed with which an acquisition can be carried out,
the attractiveness of the form of payment to the seller, the
coercive nature of offer etc.
Strategic: How to live with it? Issues with respect to
buyer include the optimal capital Structure, tax
implications, the future access to the Capital, financial
flexibility, market timing etc.
Cash Consideration : a) Cash gives speed. Cash gives
liquidity and preferable from point of view of seller against
Shares, but tactically cash payment cannot be deferred
and tax cannot be avoided. Also seller will not be able to
have continuing equity interest in the combined company.

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Methods of Payment & Leverage -2

The cash is organised through:
a) Commercial Banks Against Securities at PLR+1 or
2%, normally for 7 years.
b) Private placement markets through junk bonds
These are high risk, high yield bonds issued to finance a
leveraged buyout, a merger, normally for a troubled
company. These junk bonds is a type of a debt issued by
a company that is considered to be at a higher credit risk.
Their liquidity is not same as other issues but they are
meant to give high yield.
c) Investment Banks bridge loans This is in
competition with Junk Bonds and is given by banks with
their own capital for limited period to tide over the gap as
interim financing for 180 365 days with interest rate
higher than PLR + about 2% fees.
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Methods of Payment & Leverage - 3

Common Stock: Use of common stock to gain control of a
Target Company has different tactical consideration with respect
to Cash payments. Share holders of target Company are
offered common stock of merged / buyer company at a ratio
based on P/E ratios. This is lengthy process and is vulnerable
to new offers, where, defensive measures being implemented
by Target Company. If P/E ratio of acquirer company is better
than target company; then Target company share holders are
benefited and the move has strategic advantages.
Convertible Preferred Stock: It is two tier front loaded
acquisition. Approximately 50% of shares are purchased in a
cash offer and lower value convertible preferred stocks are
issued in a second step. Acquirer intending to issue common
stock are concerned with current stock prices and sometime opt
for this method. However present poison pill defence and
availability of Junk Bonds have made this type of un-solicited
acquisition less effective.
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Methods of Payment & Leverage - 4

Contingency Payments: When Target Company and Acquirer
do not agree on price and there is a gap between bid and ask;
the Acquirer agrees to make future payment as earn out, only
if, target / merged company achieves certain financial
objectives. Thus both parties share financial risk involved in
mergers. The earn out formulae, extend over years and
ensure that buyer has flexibility on overall disposition of
investment; the seller is encouraged to manage business in
better way as per expectation of buyer and both buyer and
seller are treated fairly.
A stock for stock helps target share holders to avoid Tax
payment at the time of transfer. Capital gain Tax will have to be
paid when the equity is actually sold. This method gives an
indication that present assets of the acquirer are overvalued.
On the other hand in Cash method it gives indication that assets
of bidder are undervalued. Thus Stock for Stock is a bad news
in market about bidders assets.

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Methods of Payment & Leverage - 5

Managerial Ownership refers to the percentage of equity held by
management and insiders in the acquiring and Target firms. If
Target / Acquirer management has large equity share percentage,
then there are more chances of cash transactions for their shares.
Growth Opportunity, Relative sizes, and Business Cycle of Target
and Acquirer companies have lot of influence on methods of
payments.
Post Merger Financial Leverage: High Leverage firm by
definition means a firm with a very small equity cushion. High Debt
/ Equity ratio firms are more susceptible to economic shocks than
one with lower percentage of debt. Heavy debt increases
efficiency. Top management does not have luxury to take
inappropriate decisions. Though heavy leverage does increase
threat of insolvency, the costs of insolvency are themselves is
limited due to high debt. Leverage improves the efficiency of a
Post buy-out firm. Protections offered by equity cushions or
coverage ratio are usually wasted by in-efficient Managements.
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Methods of Payment & Leverage - 6

Mergers & Acquisitions are more and more financed by
increased use of leverage. It is observed that loan
repayment of acquired company improves after merger.
Debt is one way to reduce problems aroused by placing
management powers with executives & directors. High
debt / equity ratio ensures that managers act in the
interests of investors. Debt holders impose rules and
restrictions on management.
High debt / equity ratio plays a positive role in Corporate
Governance. Debt is a way of allocating cash to corporate
investors. Heavy debt does not fundamentally change
firms business or weakens its operations.
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Methods of Payment & Leverage - 7

Purchasing bondholders are also not injured by high
debt. Their bond contracts are more carefully drafted to
protect investors.
It is a myth that increased debt in these M & A
transactions, adversely affects existing creditors.
Leverage improves the efficiency of the Post buy-out
firm.
The risk of insolvency affecting employees, creditors,
communities and others is taken care by extra
safeguards built into leveraged transactions. One such
technique is to finance the buy-out partly with an
instrument called Exchangeable Preferred Stocks. This
security provides for dividends without triggering
insolvency. Later when interest on debt can be
comfortably paid, these stocks can be used for more
debts.
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M & A Regulatory Control - 1

Evolution of Regulatory control of Mergers

and Acquisitions in India:
1.
2.
3.

Procedures under Companies Act 1956.

The SEBI takeover Regulation Code 1997.
The recent changes made by SEBI in the take over
code.

4.

Implications under Income Tax Act 1961.

Procedures under Companies Act 1956 :

a)
b)
c)

Scheme of Amalgamation / Merger must be prepared

by both entities.
Approval of Board of Directors for the scheme is a first
step.
Approval of scheme by Financial Institutions, Banks,
Trustees for Debenture holders.

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M & A Regulatory Control - 2

d) Intimation to Stock Exchange about proposed Amalgamation /
Merger.
e) Application to Court for directions.
f) High Court Directions for the Members Meeting
g) Holding the Shareholders General Meeting and passing the
resolution.
h) Submission of Joint Petition to Court for Sanctioning the
Scheme.
i) Issue of Notice to Regional Directors Company Law Board
u/s 394 A:
j) Filing Courts order with ROC by both the Companies:
k) Dissolution of Transferor Company.
l) Transfer of Assets and Liabilities.
m) Allotment of Shares to Share Holders of Transferor Company.
n) Listing Shares at Stock Exchange.
o) Preservation of books of amalgamated Company.
p) Post Merger Secretarial Obligations
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M & A Regulatory Control - 3

The SEBI Substantial Acquisition of Shares and
Takeover Regulation Code 1997.
The act is not applicable to :
1.
Public Issue.
2.
Rights issue.
3.
Allotment to underwriters as per under-writing agreement.
4.
Inter se transfers amongst Relatives.
5.
Indian Promoters and Foreign Collaborators who are Share
holders.
6.
Acquisition of Shares in ordinary course of business.
7.
Acquisition by means of succession or inheritance.
8.
Acquisition of Shares by Government Companies.
9.
Transfer of Shares from State Level Financial Institutes.
10.
Transfer of Shares from venture Capital or foreign venture
Capital.
11.
Acquisition of Shares in Companies whose Shares are not
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M & A Regulatory Control - 4

The SEBI Substantial Acquisition of Shares and
Takeover Regulation Code 1997.
Company Board shall constitute a panel with majority of
Independent Directors as Take-over Panel.
The SEBI shall have power to issue directions to Board of
Directors.
Disclosure of Shareholding & Control in listed Company,
indicating all persons or firms holding more than 5% of
Shares.
Continual Disclosures from every person holding 15% or
more Shares.
SEBI has power to call for information from Stock
Exchanges and Companies.
No acquirer shall acquire 15% or more voting rights, nor
will he be working in concert with another person, unless
such acquirer makes a Public Announcement to acquire
Shares.
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M & A Regulatory Control - 5

No Acquirer shall acquire control over target Company,

unless such acquirer makes a Public Announcement to
acquire Shares & acquires such shares in accordance
with Regulations.
Before making a Public Announcement, Acquirer shall
appoint a Merchant Banker in Category -1.
Timing : Public Announcement shall be made in all
editions of one English, one Hindi National Daily & one
Regional with wide circulation within four working days
of entering into an agreement for acquisition of shares
or voting rights.
Submission of Offer Letter to the SEBI Board within 14
days of PA.
The Public Offer made by Acquirer to shareholders shall
be for a minimum 20% of voting capital. For 10% or
less, acquirer shall make an offer for the outstanding
shares remaining. Ulhas D Wadivkar
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M & A Regulatory Control - 6

Provision of Escrow to make deposits as per Act.
Payment of consideration payable in cash shall be made
to a special account crated for the purpose within 21
days.
Bail out takeovers for a financial weak company shall be
approved

General Obligations of BOD of Target Company:

1 During offer period BOD of Target Company shall not
sell, transfer, encumber or otherwise dispose off shares.
2 Furnish a list of Share holders to Acquirer within 7 days
of PA
3 Shall not appoint any additional Director after PA.
4 Shall allow authorised personnel of Acquirer to visit and
observe.
5 Shall allow acquirer & facilitate him in verification of the
securities.
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M & A Regulatory Control - 7

Competitive Bid: Any other person who is desirous of making
any offer, shall do so within 21 days of PA of 1st offer. The
Acquirer can make an upward revision to his offer 7 days prior
To the closure of offer. The acquirer cannot withdraw his offer;
unless
a) Statutory Approvals have been refused.
b) The sole acquirer has died.
c) Such circumstances as in the opinion of SEBI Merits
withdrawal.
SEBIs right to investigate: SEBI can appoint Auditor to
1. Investigate into the complaints received from the investors.
2. Investigate in the interest of securities market or
investors interest for any breach of regulations.
3. To ascertain whether provisions of the Act & Regulation
are being complied with.
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Implications under Income Tax Act, 1961:

Tax concessions to amalgamating Company;
Tax concessions to Share Holders of amalgamating
Company;
Tax concessions to R & D;
Tax concessions to Expenditure for Patent Rights;
Tax concessions to Expenditure for know how.
Preliminary Expenses u/s 35D(5) : Shall be allowed for
deduction.
Amortisation expenditure allowed to be spread over in span
of 5 years.
Capital Expenses shall be allowed.
Bad debts shall be allowed for deduction.
Carry forward and set-off of Business Losses and
Unabsorbed depreciation shall be allowed.
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