Mergers and Acquisitions

D S Prasad,
ICFAI Business School,
Hyderabad
 Introductory Aspects
• M&A is a generic term used to represent
different types of corporate restructuring
activities.
• Corporate restructuring involves restructuring
of assets, operations and contractual
relationships with various stakeholders.
• Corporate restructuring has facilitated
thousands of organizations to re-establish their
competitive advantage and respond more
quickly and effectively to new opportunities
and unexpected challenges.
Forms of Corporate
Restructuring
• Expansion : M&As, Tender Offers,
Asset acquisition, Joint Ventures
• Contraction : Spin- offs, Split- offs,
Split-ups, Divestitures, Equity carve-
outs, Asset sale.
• Corporate Control : Takeover
defenses, Share repurchases,
Exchange offers, Proxy contests.
• Changes in ownership structures:
LBOs, Junk bonds, Going
private, ESOPs and MLPs.
 29.1 The Basic Forms
of Acquisitions
• There are three basic legal procedures
that one firm can use to acquire another
firm:
– Merger or Consolidation
– Acquisition of Stock
– Acquisition of Assets
 Varieties of Takeovers

Merger

Acquisition Acquisition of Stock

Takeovers Proxy Contest Acquisition of Assets

Going Private
(LBO)
 Consolidation
• In a consolidation, two or more companies
combine to form a new company.
• Example: Hindustan Computers Ltd,
Hindustan Instruments Ltd, Indian
Software company Ltd and Indian
Reprographics Ltd combined to form HCL
Limited.
 Tender Offers
• Tender offer is a corporate finance term that typically refers to a
public, open offer (usually announced in a newspaper
advertisement) by an entity to all stockholders of a publicly traded
corporation to tender their stock for sale at a specified price for a
specified time, subject to the tendering of a minimum and maximum
number of shares.
• To induce the shareholders of the target company to sell, the
acquirer's offer price usually includes a premium over the current
market price of the target company's shares.
• For example, if a target corporation's stock were trading at a value
of $1/share, an acquiror might offer $1.15/share to its shareholders
on the condition that 51% of shareholders agree.
• Cash or other securities may be offered to the target company's
shareholders as consideration, although a tender offer in which
securities are offered as consideration is generally referred to as an
"exchange offer."
 Joint Ventures
• In a jv two companies enter into an
agreement to provide certain resources
towards the achievement of a particular
common business goal.
• It involves intersection of only a small
fraction of the activities of the companies
involved .
• JOINT VENTURE PARTNERS
• The following are some joint venture companies formed so far:

• NTPC - ALSTOM POWER SERVICES PVT. LTD. (NASL)

(Incorporated in 1999 and formerly known as NTPC-ABB ALSTOM POWER
SERVICES PVT. LTD)
• OBJECTIVE:Undertake Renovation & Modernisation of power stations in India and
other SAARC countries
• PROMOTERS' EQUITY:NTPC: 50%
ALSTOM Power Generation AG : 50%
UTILITY POWER TECH LTD
(Incorporated in 1996)
This JV has been promoted with Reliance Energy Limited (formerly BSES Limited) a
private sector Indian power company
• .OBJECTIVE:To undertake project construction, erection and supervision in power
sector and other sectors in India and abroad
• PROMOTERS' EQUITY:NTPC: 50%
REL: 50%
Contraction :Equity Carve-out
• Equity carve-out is an alternative to raising new
equity directly by the parent company.
• It occurs when a portion of a wholly owned
subsidiary's equity is offered for sale without
loss of control.
• Benefits: ECOs unlock the hidden value of one
of the company’s subsidiaries
• Many of these transactions are motivated by
investor’s desire for investment clarity.

.
 EXAMPLE
• The ECO of Conco, for example,
allows the parent, to exit the
depressed oil business and focus
on its core chemical business and
its growth business business such
as bio-technology
 Other types of Contraction
• Spin-offs: a transaction in which a company
distributes on a pro rata basis all of the shares it
owns in a subsidiary to its own shareholders.
• Split-offs: A new company is created to take
over the operations of an existing division or
unit. A portion of the existing shareholders
receives stock in a subsidiary (new company) in
exchange for parent company stock. It does not
result in any cash inflow to the parent
company.
 The major distinctions between equity
carve-outs and spin offs are
• Equity Carve out : Spin offs
• No reduction in asset base of the parent
company. Reduction in the asset base
of the parent company.
• No change in ownership. Change in the
ownership of the company.
 Divestiture
• A divestiture is a sale of a portion of the firm to
an outside party generally resulting in an
infusion of cash to the parent.
• Sell an undervalued operation that it determines
to be non-strategic or unrelated to the core
business.
• It is a form of expansion for the buying company.
• Ex: The Indian Government sold 10% share in
ONGC through a public issue.
 Exchange Offers
• Public Exchange Offers for PetroFina Shares May 18, 06
• This information is  based on the value of the Total share
BEFORE the four-for-one split, effective May 18, 2006.
• First Public Exchange Offer
Offer made in France, Belgium and the United States from May 6 to
June 4, 1999.
Basis of the offer: 9 Total shares for 2 PetroFina shares
Value of each Total share received: € 121.50
 
Offer re-opened for the remaining PetroFina shares from June 11 to
July 2, 1999
Basis of the offer: 9 Total shares for 2 PetroFina shares
Value of each Total share received: € 130
 
 Poison pills
• Shareholder Rights Plans
• The target company issues rights to existing
shareholders to acquire a large number of new
securities, usually common stock or preferred stock.
These new rights usually allow holders (other than an
acquirer) to convert the right into a large number of
common shares if anyone acquires more than a set
amount of the target's stock (typically 10-20%). This
immediately dilutes the percentage of the target owned
by the acquirer, and makes it more expensive to
acquire control of the target. This form of poison pill is
sometimes called a shareholder rights plan because it
provides shareholders (other than the bidder) with rights
to buy more stock in the event of a control acquisition.
 Changes in ownership structure: Leveraged
Buyout (LBO)

• The acquisition of another company using a

significant amount of borrowed money
(bonds or loans) to meet the cost of
acquisition.
• Often, the assets of the company being
acquired are used as collateral for the loans
in addition to the assets of the acquiring
company.
• The purpose of leveraged buyouts is to allow
companies to make large acquisitions
without having to commit a lot of capital.  
 LBOs – Problems
• In an LBO, there is usually a ratio of 90% debt to 10%
equity. Because of this high debt/equity ratio, the bonds
usually are not investment grade and are referred to as
junk bonds.
• Leveraged buyouts have had a notorious history,
especially in the 1980s when several prominent buyouts
led to the eventual bankruptcy of the
acquired companies.
• This was mainly due to the fact that the leverage ratio
was nearly 100% and the interest payments were so
large that the company's operating cash flows were
unable to meet the obligation.
 Management Buyout (MBO)
• When the managers and/or executives of a company
purchase controlling interest in a company from
existing shareholders.  
• In most cases, the management will buy out all the
outstanding shareholders and then take the
company private because it feels it has the expertise
to grow the business better if it controls the
ownership.
• Quite often, management will team up with a venture
capitalist to acquire the business because it's a
complicated process that requires significant
capital.
 Continued…
• As of 2006, the largest LBO to date was
the acquisition of HCA Inc. in 2006 by Kohlberg
Kravis Roberts & Co. (KKR), Bain & Co., and
Merrill Lynch. According to the Washington
Post, the three companies paid around $33
billion for the acquisition. 
• It can be considered ironic that a
company's success (in the form of assets on the
balance sheet) can be used against it as
collateral by a hostile company that acquires it.
• For this reason, some regard LBOs as an
especially ruthless, predatory tactic.
 Major KKR LBOs

• •KKR sponsored $25 billion hostile takeover of RJR Nabisco

• •Beatrice Foods
• –A hostile LBO by the ex-CEO of Esmark, a firm Beatrice had taken
over.

• •KKR’s$350 million takeover of Duracell

• –Worth over $4 billion

• •Other LBOs
• –Denny’s Restaurants, Dr. Pepper, Levi Strauss & Co., Uniroyal, and
ConocoChemicals
 Debt restructuring in the form of
LBOs
• Michael C Jensen4 of Harvard Business School argued and also
proved that private companies created more value than public
corporations in a seminal article published in Harvard Business
Review. But debt restructuring in the form of LBOs had its downside
too. The unsustainable debt burden was only met in the short term
usually by asset liquidation. Hence such high leverage, going
private transactions produced a level of financial risk, which usually
increased manifold with an economic downturn or interest rate
increase. The success rate of companies that were taken private
with the help of debt soon became low. The early '90s saw LBO as
passing its prime.
• Michael Milken was found guilty of insider trading and was barred
from the capital markets for life. Drexel closed down and the junk
bond market slowly but steadily declined
 Going Private
• Going Private refers to the transformation
of a public corporation into a privately held
firm.
• LBO by small group of investors is a way
of going private.
 ESOP
• In Bangalore, they say, each perfectly fluffed
cushion in every plush apartment has an ESOP
story to tell.
• If you have been wondering how your techie
friends manage to upgrade their cars and
houses even before you have finished writing
down the numbers, the answer usually would be
employee stock option plans, or ESOPs, as
they are called
 What are ESOPs?
• ESOPs are stocks of a company offered to an
employee either at the time of joining, or when
such a plan is introduced.
• The offer, or option to buy, is usually valid for a
fixed period, known as the vesting period, and
can either be exercised in phases during the
period, or at the end of it.
• The price the employee has to pay is usually
less than the market price. That is what makes
an ESOP attractive.
 Why ESOPs?
• The scorching progress of the stock markets in
the last couple of years has thrown up several
stories of regular blokes becoming millionaires
overnight through ESOPs, but one needs to be
cautious while treading that path to wealth.
• While tech companies were the early starters of
ESOPs, now several industries have embraced
this practice. But should you always go for
them? The answer is, no.
 What to do?
• ESOPs are usually used to control
attrition.
• At the time the offer is made, you only
have to agree to the schedule and the
price and usually don't have to buy
anything.
• Depending on the schedule, a part of your
stock option actually becomes yours,
whether it is every year or once in a
couple of years.
 Continued….
• On the date when the vesting period for your
stock options expires, you can decide whether
you want to buy it or not.
• If the stock markets are on an upswing and the
prospects of your are good, its share price would
be higher than the price at which your options
were offered. So, if things are looking up, you
can take the benefit and purchase the shares
after the vesting period is over.
• And if the market goes down, you can simply
refuse to purchase them.
 Master Limited Partnership (MLP)
• What It Is:
A master limited partnership (MLP) is a
publicly traded limited partnership. Shares
of ownership are referred to as units.
MLPs generally operate in the natural
resource, financial services, and real
estate industries.
 How It Works/Example

• Unlike a corporation, a master limited

partnership is considered to be the
aggregate of its partners rather than a
separate entity.
• However, the most distinguishing
characteristic of MLPs is that they
combine the tax advantages of a
partnership with the liquidity of a
publicly traded stock.
 CONTINUED…
• MLPs make distributions that are similar to
dividends, and these are generally paid
out on a quarterly basis.
 Advantages
• First, an MLP's earnings are taxed only once, at the
unitholder level. By contrast, the earnings of most
publicly traded corporations are taxed twice: once at the
corporate level, and once at the shareholder level. As a
result, the MLP can pay out significantly more of its
cashflow to unitholders than could a corporation as the
additional taxes levied on corporations are not payable
by an MLP
• Second, unlike virtually all publicly traded corporations,
the non-tax expenses of an MLP, such as depreciation,
directly benefit the unitholder since such expenses
diminish the taxable income passed through to the
unitholders.
 Merger Waves
• The First Wave – 1897-1904
• MAINLY HORIZONTAL MERGERS.
• The second wave – 1916-1929
• Many consolidations resulting in
oligopolistic industry.
• 1940s: no major technological changes or
dramatic developments in the nation’s
infrastructure
 Continued..
• Third Wave: 1965 – 1969 – booming
economy – conglomerate merger period
• Antitrust measures of govt forced firms
to go for conglomerate type mergers.
• Investment bankers did not finance –
equity financing – poor financial
performance – Revlon suffered-
 Fourth wave :1981-1989
• Hostile mergers - mega mergers – fortune
500 firms became acquirers were the
targets – oil and gas industry - drugs
and medical equipment - deregulation in
airlines - Investment bankers played
aggressive roles and their incomes went
up –increased use of debt to finance
acquisitions – LBO phenomenon emerged,
 Fifth wave 1992- till date
• Deals were financed thro equity –US firms
aggressively purchased foreign firms –
Deregulation and technological changes
led to high level of merger activity in the
fifth wave.
• Banking, telecom, entertainment and
media were some of the leading
consolidating industries.