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MF 0011 Mergers & Acquisitions

Unit 2 Strategic Evaluation of M & A Opportunities


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Program : MBA
Semester : III
Subject Code : MF 0011
Subject Name : Mergers and Acquisitions
Unit Number : 2
Unit Title : Strategic Evaluation of M & A
Opportunities
Lecture Number :
Lecture Title : Strategic Evaluation of M & A
Opportunities
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Objectives:

After studying this unit, you should be able to:
Analyse the facets of strategy in a typical merger or
acquisition
Define selection criteria for identifying acquisitions
Explain the process of fixing price for acquisitions
Describe feasibility analysis for cash and stock transactions
Explain fair value: Institutional criteria
Discuss acquisition of sick companies
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Strategic Evaluation of M & A
Opportunities
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Introduction
Approaches for Selection Criteria
Fixing Price for Acquisition
Determination of Exchange Ratio
Feasibility Analysis: Cash Acquisitions
Feasibility Analysis: Acquisition for Stock
Fair Value: Institutional Criterion
Acquisition of Sick Companies: Historical Case
Summary
Glossary
Check Your Learning
Answers
Case Study
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Lecture Outline
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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An acquisition is a major event for any corporate entity and requires
considerable strategic inputs.
Some points to remember here are:
It is important to know what makes a merger a strategically sound decision.
The growth-by-acquisition strategy enthralled many investors and
companies during the bull market.
A well-timed and disciplined deals done might at times help companies to
build dominant positions in their respective industries. On the flip side some
mergers do not produce any significant benefit to the stockholder and might
have to be revoked.
There is no must-win formula for ensuring success of a merger, it is worth
recounting the strategic aspects to be looked into in a decision to acquire a
business.
Introduction
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Introduction (Cont.)
The sequence of competent management is:
Goal Setting Strategy Structure
Without strategic goal-setting and activity planning, the business model is
unlikely to succeed.
Therefore it is necessary to explore the strategic goals and action plans
associated with M & A activity.
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Approaches for Selection Criteria
Purpose of valuation is to locate possibilities of takeover:
Identification of target companies for takeover
Fixing exchange ratio in case the target company is finally selected for
acquisition
Approach to
Selection Criteria
Present Value
Analysis
Capital Assets
Pricing
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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The present value analysis is mostly similar to valuation on the basis
of steady-state earnings and/or dividends for listed companies.
The earnings or the target firm are projected and discounted at the
acquirers cost of capital to obtain a theoretical market price of the
shares of the target company.
This is then compared with the actual market price to determine the
net present value of investment in the target company.
Present Value Analysis
Click here to solve a problem on
Theoretical Price
Approaches for Selection Criteria
(Cont.)
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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This approach provides a superior theoretical framework as it also
factors the risk.
The basic logic behind the model is that if expected rate of return,
considering the risk element, exceeds the required rate of return,
the target company is a good buy.
Capital Assets Pricing
The required rate of return is calculated by solving the following equation:
E(R
j
) = R
f
+ [E(R
m
) R
f
] (B
j
)
Click here to solve a problem on
Rate of Return
Approaches for Selection Criteria
(Cont.)
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Fixing Price for Acquisition
Factors the price fixed for acquisition depends upon:
The keenness of the target company in getting sold
The extent to which acquirer is willing to go for the acquisition and
the willingness of shareholders of the buying company
Factors determining the strengths of two companies in mergers
or acquisitions:
Bargaining power
Liquidity
Strategic Assets
Management Capabilities
Tax loss carryovers
Production costs
Investment values
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Market price of
Shares
If both are listed companies, the stock exchange prices of the shares
of both the companies should be considered before commencement
of negotiations or announcement of the takeover bid.
Dividend Payout
Ratio
Dividend paid by both companies in the immediate past is important
as the shareholders want continuity of dividend income. If the target
companys DPR is lower than the acquirers, then its shareholders
may opt for share exchange for the growth company by sacrificing
the current dividend income for prospects of future growth in income
and capital appreciation.
Price Earnings
Ratio
PERs of both companies as well as the future growth rate of
combined company would be important factors.
Debt Equity Ratio
Company with low gearing offers positive factor to investors for
security and stability rather than growth potential with a geared
company having capacity to expand equity base.
Net Assets Value
(NAV)
NAV of the two companies should be compared. If the NAV is low,
the company has the threat of being pushed into liquidation.
Determination of Exchange Ratio
Factors determining the share exchange ratio in a share exchange merger
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Feasibility Analysis: Cash Acquisitions
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Considerations for feasibility assessment for cash payments in
takeovers and mergers
Quantum of
cash required
Liquidity of
the acquiring
company
Debt equity ratio
of the target
company
Post-merger debt capacity is assessed by multiplying acquirer's equity by targeted
debt equity ratio.
In cash transactions, the acquirer company's shareholders equity remains unchanged.
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Feasibility Analysis: Cash Acquisitions
(Cont.)
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Click here to a solve a
problem on Acquisition
for Cash
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Quantum of cash for acquiring the target company is assessed keeping in view the
liquidity of the combined company (post acquisition) as under:
Debt capacity post-merger

Less: Total debts of the two companies (pre-merger)

Plus: Total marketable securities of the two companies (pre-
merger)
____________

___________

___________
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Feasibility Analysis: Acquisition for
Stock
Steps for acquiring a Target Company Stock
Estimation of value of
acquirer's shares
Computation of
maximum number of
shares which acquirer
can exchange to acquire
target company under
different scenarios and
at minimum acceptable
rates of return
Evaluation of the impact
of the acquisition on the
earnings per share and
capital structure of the
acquirer
Click here to a solve a
problem on Acquisition
for Stock
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Fair Value: Institutional Criterion
All-India level financial institutions and banks follow the following criteria for
calculating the fair value.
Past Records of Company
The fair price is worked out on the
basis of the track record of the
company

Break-up Value
The break-up value of the equity
shares may be arrived at having
regard to the assets and liabilities of
the company
Earnings Capacity Value
Average earnings and yield rate and
capitalisation of earnings are
considered
Market Price
Market expectations regarding
dividend and capital appreciation are
important in determining the share
price.
BASIS FOR ARRIVING
AT FAIR PRICE
Click here for a detailed explanation of
the factors to be considered for
arriving at a fair price
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Acquisition of Sick Companies:
Historical Case
Let us consider a case of the tax-based financial synergy.
The case of Mahindra and Mahindra Ltd. with Mahindra Spicer Ltd. is a typical
example, though certainly not the only one.
Click here for a detailed case of
merger on Mahindra and Mahindra
Ltd with Mahindra Spicer Ltd
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Summary
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The valuation of a target company is very important in an acquisition.
Companies use different approaches to do the valuation, including present
value analysis and capital assets analysis.
While fixing the price for acquisition, the acquiring company should consider
the key factors like market price of the shares, DPR, PER, debt equity ratio
and NAV.
The acquisition can be by way of cash or stock.
In cash transactions, the acquirer company's shareholders equity remains
unchanged.
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Glossary
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CAPM: Capital Asset Pricing Model
DPR: The percentage of earnings paid to shareholders in dividends.
NAV: The market value of all securities owned by a mutual fund, minus its
total liabilities, divided by the number of shares issued.
Breakup value: The sum-of-parts value of a publicly traded company.
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Check Your Learning
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1. The basic purpose of valuation of a target company is to locate the
possibilities of _________________.
2. Under present value analysis the theoretical market value is compared with
the ______________ to determine the net present value on investments.
3. Under _______________ model if expected rate of return exceeds the
required rate of return then it is a good buy.
4. A takeover generally involves the acquisition of a certain block of
_____________ of the company.
5. In share exchange mergers the shareholders of the target company become
shareholders in the combined enterprise. (True/False)
6. Share exchange ratio is generally determined by the relative bargaining
strengths of the companies. (True/False)
7. Company with lower PER shows a record of high growth in earnings per
share. (True/False)
8. In ________________ the acquirer company's shareholders equity remains
unchanged.
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
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Check Your Learning
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9. Post-merger debt capacity is assessed by multiplying acquirer's equity by
targeted ______________________.
10.Market expectations regarding dividend and capital appreciation are
important factors in determining the __________________.
11.__________________ are excluded in calculating the breakup value of
equity shares.
12.The elements considered for fair price are the breakup value per share,
notational value based on earning and the __________________.
13.The expectations of _________________ would vary from time to time.
MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Answers
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1. Takeover.
2. Actual market price.
3. CAPM.
4. Equity capital.
5. True.
6. True.
7. False.
8. Cash transactions.
9. Debt equity ratio.
10.Share price.
11.Intangible assets.
12.Market value per share.
13.Yield.
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MF 0011 Mergers & Acquisitions
Unit 2 Strategic Evaluation of M & A Opportunities
Case Study
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Answer the following questions, based on the
given case:

Question
Discuss the benefits and losses of the overseas
acquisition.

Hint answer:
In overseas acquisition, a company can find the
other markets to sell its products. In the case
mentioned above, Dhunseri is exploring the
overseas opportunities due to labour shortage and
local regulations.
Click on the icon besides, to
analyse the case on Strategic
Evaluation of Mergers and
Acquisitions

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