CTM :CHAPTER 3

MERGERS AND ACQUISITIONS - AN INTRODUCTION

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WHY ARE YOU HERE

To learn the basics of mergers and acquisitions To acquire knowledge about specialist M&A firms To know how to valuate a business To learn how to control brand considerations after a merger To know the effects of mergers on management
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AGENDA
What is a M&A? Differentiating M & A Common Ways of Business Valuation How Do We Get Finance? Specialist M&A Advisory Firms What Motives Lie Behind? Effects on Management Brand Building or Brand Destroying? Factors of the Merger Movement Merger Waves Cross Border M & A Major M&As

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WHAT IS A M&A?
An aspect of corporate strategy, corporate finance and strategic management. Deals with buying, selling, combining of different companies that can
Aid Finance Help

a growing company in a given industry grow rapidly without having to create a new business entity.

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ACQUISITION
Purchase of one company by another company.
Company 1 Company 2

Newly Formed Company

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TYPES OF ACQUISITIONS
Depending upon
Acquiree or merging is or isnt listed in public markets. How the communication is done and received by the target.

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THE FIRST CLASSIFICATION

ACQUISITION

PUBLIC (IF ACQUIREE LISTED IN PUBLIC MARKETS)

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PRIVATE (IF ACQUIREE NOT LISTED IN PUBLIC MARKETS

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THE SECOND CLASSIFICATION

ACQUISITION

FRIENDLY

HOSTILE

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CONFIDENTIALITY BUBBLE
Quite normal for M&A deal communication to take place in a so called confidentiality bubble. Here information flows are restricted due to confidentiality agreements.

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FRIENDLY ACQUISITIONS
Companies cooperate in negotiations. Synonymous to merger of equals.

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HOSTILE ACQUISITIONS
Takeover target unwilling to be purchased. It can also be if the acquiree company has no prior knowledge of offer. Hostile takeovers do turn friendly in the end. Most of the times. For the above thing to happen, offer is usually improved.

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REVERSE TAKEOVERS
Acquisition usually refers to purchase of smaller firm by larger firm. Sometimes, smaller firm acquire management control of a larger / longer established company. Keep its name for combined entity. Known as reverse takeover.

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REVERSE MERGER
Another type of acquisition. Is a deal enabling a private company to become a public company. The deal enables private company by listing in a short time period. Occurs when a private company has strong prospects and is eager to raise financing, buys a publicly listed shell company. Usually the public one is one with
No business Limited assets

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MERGER:WHY & WHY NOT

WHY IS IMPORTANT PROBLEM WITH MERGER i. Clash of corporate cultures ii. Increased business complexity iii. Employees may be resistant to change

i. Increase Market Share. ii. Economies of scale iii. Profit for Research and development. iv. Benefits on account of tax shields like carried forward losses or unclaimed depreciation. v. Reduction of competition.

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ACQUISITION:WHY & WHY NOT

WHY IS IMPORTANT
PROBLEM WITH ACUIQISITION

i. Increased market share. ii. Increased speed to market iii. Lower risk comparing to develop new products. iv. Increased diversification v. Avoid excessive competition

i. Inadequate valuation of target. ii. Inability to achieve synergy. iii. Finance by taking huge debt.

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Types of M&A
M&A

Market-extension merger

Product-extension merger

Conglomeration

Two companies that sell the same products in different markets

Two companies selling different but related products in the same market

Two companies that have no common business areas

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SOME STATISTICS
Achieving acquisition successfully has proven to be tough. Various studies show 50% of them are unsuccessful. Process very complex, many dimensions influence its outcome. Variety of structures used in securing asset control. Different tax and regulatory implications
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THE ACQUISITION PROCESS

Buyer buys shares of target company Ownership control conveys effective control over assets, but since company is going concern, liabilities come as well. Buyer buys assets of target company. Cash target receives from sell-off is paid back to its shareholders by
Dividend Through liquidation

If buyer buys out entire assets, then target company = empty shell. Buyer often cherry picks his assets

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SOME OTHER TERMS

There are some other terms used as well like:
Demergers Spin-off Spin-out

Sometimes used to indicate a situation where one company splits into two, generating a 2nd company separately listed on a stock exchange.
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DIFFERENTIATING MERGERS AND ACQUISITIONS

Both terms are often used synonymously. They mean slightly different things in reality.

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ACQUISITIONS FIRST
When one company takes over another, clearly establishes as its new owner. Legal View: target ceases to exist. Buyer swallows target Buyers stock continues to be traded.

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MERGERS NEXT
Happens when two firms agree to go forward as a single new company rather than remain separate. Often precisely termed as merger of equals. Firms are often of same size. Both companies stock surrendered New company stock put into place instead. Example: 1999 merger of Glaxo Wellcome and SmithKline Beecham, both firms ceased to exist and a new firm GlaxoSmithKline was created.
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DIFFERENCE BETWEEN MERGER AND ACQUISITION:

MERGER
i. Merging of two organization in to one. ii. It is the mutual decision. iii. Merger is expensive than acquisition(higher legal cost). iv. Through merger shareholders can increase their net worth. v. It is time consuming and the company has to maintain so much legal issues. vi. Dilution of ownership occurs in merger.

ACQUISITION
Buying one organization by another. ii. It can be friendly takeover or hostile takeover. iii. Acquisition is less expensive than merger. iv. Buyers cannot raise their enough capital. v. It is faster and easier transaction. vi. The acquirer does not experience the dilution of Irfan Inamdar 23 ownership. i.

MERGERS IN PRACTICE
Actually the principle of mergers of equals dont really happen. Usually one company buys another. Simply allow acquired firm to pronounce it as a merger, though technically it is an acquisition. Being purchased always portends negative connotations. Therefore, they term it as merger, makes takeover more acceptable. Example : takeover of Chrysler by Daimler-Benz in 1999. Purchase deal also a merger -> friendly takeovers. Hostile takeovers -> mainly acquisitions.

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COMMON WAYS OF BUSINESS VALUATION

Asset Valuation Historical Earnings Valuation Future Maintainable Earnings Valuation Relative Valuation Discounted Cash Flow Valuation

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ASSET VALUATION
Valuations are made for:

Excess or restricted cash Other non-operating assets and liabilities Lack of marketability discount Control premium Above or below market leases Excess salaries in case private companies
Working capital adjustment Deferred capital expenditures Cost of goods sold adjustment Non recurring professional fees and costs Certain non operating income/expense items
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Typical adjustments include:

VALUATION OF INTANGIBLE ASSETS

Can be made for intangible assets like:
Patents Copyrights Software Trade secrets Customer relationships

Uses either
Present value model Estimating the costs to recreate it

Process time consuming and costly Often necessary for financial reporting and intellectual property transactions. Stock markets give only an indirect value. Can be regarded as difference between its market capitalization and its book value.

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VALUATION OF MINING PROJECTS

Process of determining the value of a mining property. Sometimes required for:
Initial Public Offers Fairness opinions Litigations Mergers and acquisitions Shareholder related matters

Fair market value is standard value. CIMVal Standards are recognized standards for mining project valuations.
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HISTORICAL EARNINGS VALUATION

Uses EPS (Earnings Per Share) values for valuation of stock. Figures can be used for forecasting performance by visiting free financial sites such as Yahoo Finance.

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RELATIVE VALUATION
Generic term that refers to the notion of comparing asset price to market value of similar assets. Presumably spot pricing anomalies on securities market. Compare certain financial ratios such as:
Price to book value Price to earnings EV/EBITDA Mainly statistical and historical

Compare national or industry stock performance to economic and market fundamentals like:
GDP growth Interest rate Inflation forecasts Earnings growth National equity index

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DISCOUNTED CASH FLOW METHOD

Abbreviated as DCF Uses concepts of time value of money All future cash flows are estimated and discounted to give their present values(PVs). Sum of all future values, is net present value (NPV). Widely used in investment finance, real estate development, corporate financial management Most commonly used method is exponential discounting. Other methods are:
Hyperbolic discounting

Discount rate used is Weighted Average Cost of Capital (WACC).

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HOW DO WE GET FINANCE?

We can differentiate mergers and acquisitions by the way they are financed. Various methods of financing include:
Cash Stock

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THINK STRATEGIC!!!!
With pure cash deals, no doubt on real bid value. Contingency of share payment removed., Cash offer preempts competitors.

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TAXES
Should be evaluated with counsel of
Competent tax advisors Competent accounting advisors

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CASH V/S SHARES

With a share deal, buyers capital structure might be affected and control of new company modified. If issuance of shares necessary, shareholders might prevent capital increase. Risk removed with cash transaction. In cash deal, balance sheet of buyer will be modified, liquidity ratios might decrease. In stock transactions, lower profitability ratios might show.
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THE CASH DEAL

If buyer pays cash, there are 3 main financing options:
Cash on Hand: consumes financial slack. May decrease debt rating. No major transaction costs, Issue of debt: consumes financial slack. May decrease debt rating. Increases cost of debt. Transaction costs include underwriting or closing costs of 1% to 3% of face value. Issue of stock: increases financial slack, may improve debt rating, reduce cost of debt, transaction costs include fees for preparation of proxy statement, an extraordinary shareholder meeting, registration.
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THE STOCK DEAL

If buyer pays with stock:
Issue of Stock Shares in Treasury: increases financial slack, improve debt rating, reduce cost of debt, transaction costs include brokerage fees if shares repurchased in market otherwise no major costs.

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LETS GENERALIZE
Stock will create flexibility. Transaction costs also to be considered but tend to have greater impact. Remember:
Buyers tend to offer stock when they believe their shares are overvalued and cash when undervalued.

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SPECIALIST M&A ADVISORY FIRMS

Provided usually by
Full service investment banks

Recently, specialized M&A firms have emerged. Sometimes referred to as Transition Companies. Assisting business referred to as companies in transition.
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CROSS SELLING
A bank buying a stock broking firm Manufacturer acquiring and selling complementary products.

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TAXATION
Profitable company can buy a loss maker to use targets loss as their advantage by reducing their tax liability. But there are certain regulations to follow.

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GEOGRAPHICAL DIVERSIFICATION
Designed to smooth company earnings Smoothens stock price Gives conservative investors more confidence But does not always deliver value to shareholders.

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RESOURCE TRANSFER
Resources unevenly distributed across firms. Can create value by
Overcoming information asymmetry Combining scarce resources

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VERTICAL INTEGRATION
Occurs when an upstream firm merges with a downstream firm. One reason is externality problem. Common example is double marginalization

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EFFECTS ON MANAGEMENT
M&A according to some studies destroy leadership continuity in target companies. Target companies lose 21% of their executives each year following an acquisition.

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BRAND CONSIDERATIONS
M&As often create brand problems. 4 different approaches:
Keep one name and discontinue other. Ex: United Airlines and Continental Airlines Merger. Keep one name and demote other: Caterpillar Inc. keeping Bucyrus International. Keep both names and use together: Pricewaterhouse Coopers. Discard both legacy names and adopt new one:
merger of Bell Atlantic and GTE which became Verizon Communications. This merger was successful. Merger of Yellow Freight and Roadway Corporation which became YRC Worldwide. This merger was partially successful, brand value lost.

Factors range from political to tactical. Ego as well as rational factors drive choice. Rational factors : brand value, costs involved with changing brands.
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THE MERGER MOVEMENT

Predominantly a US phenomenon. Short run factors: desire to keep prices high, Long run factors: reduction of transportation and production costs.

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MERGER WAVES
PERIOD 1897 1904 1916 1929 1965 1969 1981 1989 NAME FIRST WAVE SECOND WAVE THIRD WAVE FOURTH WAVE FACET HORIZONTAL MERGERS VERTICAL MERGERS DIVERSIFIED CONGLOMERATE MERGERS CONGENERIC MERGERS; HOSTILE TAKEOVERS; CORPORATE RAIDING CROSS BORDER MERGERS SHAREHOLDER ACTIVISM, LEVERAGED BUYOUTS, PRIVATE EQUITY 48

1992 2000 2003 2008

FIFTH WAVE SIXTH WAVE

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CROSS BORDER M&AS

Large M&A deals cause domestic currency of target corporation to appreciate by 1% Rise of globalization increased the necessity for MAIC trust accounts and securities cleaning services. In 1997 alone there were 2333 cross border M&A transactions, with a total of approx. $298 billion.
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MAJOR M&AS
RANK YEAR PURCHASER PURCHASERD TRANSACTION VALUE (IN MIL. USD) 52000

2008

INBEV INC.

ANHEUSERBUSCH COMPANIES INC. BANK ONE CORP PHARMACIA CORPORATION

2 3 4

2004 2002 2000

JP MORGAN CHASE & CO PFIZER INC. SPIN-OFF: NORTEL NETWORKS CORPORATION PFIZER INC.
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58761 59515 59974

2009

WYETH

68000

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 January 30, 2007 Largest Indian take-over

1. Tata Steel-Corus: $12.2 became the 5billion largest

th

After the deal TATAS

STEEL co.
100 % stake in CORUS paying Rs 428/- per share
Image: B Mutharaman, Tata Steel MD; Ratan Tata, Tata chairman; J Leng, Corus chair; and P Varin, Corus CEO.

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2. Vodafone-Hutchison Essar: $11.1 billion

TELECOM sector 11th February 2007 2nd largest takeover deal 67 % stake holding in hutch
Image: The then CEO of Vodafone Arun Sarin visits Hutchison Telecommunications head office in Mumbai.

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3. Hindalco-Novelis: $6 billion

June 2008 Aluminium and copper sector Hindalco Acquired Novelis Hindalco entered the Fortune-500 listing of world's largest companies by sales revenues
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Image: Kumar Mangalam Birla (center), chairman of Aditya Birla Group.

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4. Ranbaxy-Daiichi Sankyo: $4.5 b

Pharmaceuticals sector June 2008 Acquisition deal largest-ever deal in the Indian pharma industry Daiichi Sankyo acquired the majority stake of more than 50 % in Ranbaxy for Rs 15,000 crore 15th biggest drugmaker
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Image: Malvinder Singh (left), ex-CEO of Ranbaxy, and Takashi Shoda, president and CEO of Daiichi Sankyo.

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5. ONGC-Imperial Energy:$2.8billion
January 2009 Acquisition deal Imperial energy is a biggest chinese co. ONGC paid 880 per share to the shareholders of imperial energy ONGC wanted to tap the siberian market
Image: Imperial Oil CEO Bruce March.

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6. NTT

November 2008 Telecom sector Acquisition deal Japanese telecom giant NTT DoCoMo acquired 26 per cent equity stake in Tata Teleservices for DoCoMo-Tataabout Tele: Rs $2.7 13,070b cr.

Image: A man walks past a signboard of Japan's biggest mobile phone operator NTT Irfan Inamdar Docomo Inc. in Tokyo.

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7. HDFC Bank-Centurion Bank of Punjab: $2.4 billion

February, 2008 Banking sector Acquisition deal CBoP shareholders got one share of HDFC Bank for every 29 shares held by them. 9,510 crore

Image: Rana Talwar (rear) Centurion Bank of Punjab chairman, Deepak Parekh, HDFC Bank chairman.

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8.

March 2008 (just a year after acquiring Corus) Automobile sector Acquisition deal Tata Motors-Jaguar Gave tuffLand competition to after signing the Rover: $2.3 M&M billion deal with ford

Image: A Union flag flies behind a Jaguar car emblem outside a dealership in Manchester, England.

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9. Sterlite-Asarco: $1.8 billion May 2008

Acquisition deal Sector copper

Image: Vedanta Group chairman Anil Agarwal.

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10. Suzlon-RePower: $1.7 billion

May 2007 Acquisition deal Energy sector Suzlon is now the largest wind turbine maker in Asia 5th largest in the world.
Image: Tulsi Tanti, chairman & M.D of Suzlon Energy Ltd.

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11. RIL-RPL merger: $1.68 billion

March 2009 Merger deal amalgamation of its subsidiary Reliance Petroleum with the parent company Reliance industries ltd. Rs 8,500 crore RIL-RPL merger swap ratio was at 16:1
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Image: Reliance Industries' chairman Mukesh Ambani.

Why India?
Dynamic government policies Corporate investments in industry Economic stability Ready to experiment attitude of Indian industrialists

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Amongst BRIC Nations, India second most targeted country for Mergers & Acquisitions(2010):

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MERGER & ACQUISITION(2010-11) :

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PROCESS OF MERGER & ACQUISITION IN INDIA:

The process of merger and acquisition has the following steps:

i. Approval of Board of Directors ii. Information to the stock exchange iii. Application in the High Court iv. Shareholders and Creditors meetings v. Sanction by the High Court vi. Filing of the court order vii. Transfer of assets or liabilities viii. Payment by cash and securities

Maximum Waiting period:210 days from the filing of notice(or the order of the commission Irfan Inamdar 65

Impact of Mergers and Acquisitions

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Why Mergers and Acquisitions Fail?

Cultural Difference Flawed Intention No guiding principles No ground rules

No detailed investigating
Poor stake holder outreach
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How to Prevent the Failure

Continuous communication employees, stakeholders, customers, suppliers and government leaders. Transparency in managers operations Capacity to meet new culture higher management professionals must be ready to greet a new or modified culture. Talent management by the management
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A CASE STUDY MERGER BETWEEN AIR INDIA AND INDIAN AIRLINES

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MERGER BETWEEN AIR INDIA AND INDIAN AIRLINES

The government of India on 1 march 2007 approved the merger of Air India and Indian airlines. Consequent to the above a new company called National Aviation Company of India limited was incorporated under the companies act 1956 on 30 march 2007 with its registered office at New Delhi.
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aim of the merger

Create the largest airline in India and comparable to other airlines in Asia. Provide an Integrated international/ domestic footprint which will significantly enhance customer proposition and allow easy entry into one of the three global airline alliances, mostly Star Alliance with global consortium of 21 airlines. Enable optimal utilization of existing resources through improvement in load factors and yields on commonly serviced routes as well as deploy freed up aircraft capacity on alternate routes. The merger had created a mega company with combined revenue of Rs 150 billion ($3.7billion) and an estimated fleet size of 150. It had a diverse mix of aircraft for short and long haul resulting in better fleet utilization. Provide an opportunity to fully leverage strong assets, capabilities and infrastructure. Provide an opportunity to leverage skilled and experienced manpower available with both the Transferor Companies to the optimum potential. Provide a larger and growth oriented company for the people and the same shall be in larger public interest.
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aim of the merger

Potential to launch high growth & profitability businesses (Ground Handling Services, Maintenance Repair and Overhaul etc.) Provide maximum flexibility to achieve financial and capital restructuring through revaluation of assets. Economies of scale enabled routes rationalization and elimination of route duplication. This resulted in a saving of Rs1.86 billion, ($0.04 billion) and the new airlines will be offering more competitive fares, flying seven different types of aircraft and thus being more versatile and utilizing assets like real estate, human resources and aircraft better. However the merger had also brought close to $10 billion (Rs 440 billion) of debt. The new entity was in a better position to bargain while buying fuel, spares and other materials. There were also major operational benefits. Traffic rights - The protectionism enjoyed by the national carriers with regard to the traffic right entitlements is likely to continue even after the merger. This will ensure that the merged Airlines will have enough scope for continued expansion, necessitated due to their combined fleet strength.
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POST MERGER SCENAREO

NACIL's employee-to-aircraft ratio: at 222:1 (the global average is 150:1), resulting in a surplus employee strength of almost 10,000. Fleet Expansion: NACIL's fleet expansion seems out of sync with the times. Most airlines are actually rounding their fleet and cancelling orders for new planes. While NACIL plans to induct around 85 more aircrafts which means their debt going forward. Mutual Distrust and strong unions: Strong opposition from unions against managements cost-cutting decisions through their salaries have led to strikes by the employees. Increased Competition: Air Indias domestic market share dropped from 19.8% in August 2007, when the merger took place, to 13.9% in January 2008 before rising to 17.2% in February 2009. Lower load factor: The companys load factor is decreasing year by year, in 2005- 06 load factor is 66.2% which is more than present load factor. Air India load factor is likely to be low because of the much higher frequency operated on each route. Lower load factor could decrease the companys margins. 76
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Reasons for Failure

The merger coincided with a flurry of increased domestic and international competition. Weak management and organization structure. More attention to non-core issues such as long term fleet acquisitions and establishing subsidiaries for ground handling and maintenance, than to addressing the state of the flying business. Bloated workforce Unproductive work practices Political impediments to shedding staff
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SUCCESS & FAILURE RATE(2009-10):

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EXPERIENCES IN M&A
Learn from mistakes of others Define your objectives clearly Complete strategy to achieve goal. SWOT analysis for the merged business - a must Conservative attitude necessary at evaluation deskstrong arguments to support project Pick holes in strategy to get the best Will merged units be able to work at efficient / ideal level? Acquire expertise to interpret changes
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THANK YOU

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