Mergers & Acquisitions

©2015 BSE Institute Limited

Introduction
What is a merger?

• Merger involves two or more companies joining

together to form a single company

• All the asset and liabilities of the merging companies

become part of the merged company

• Almost all the shareholders of the individual company

become shareholders of the merged company

• After merger, all companies other than the merged

entity cease to exist

• Merger is also referred as amalgamation

What is acquisition?
• The assets and liabilities of one company are taken over by
another company

• Typically, the acquirer becomes the shareholder of the acquired

company

• The shareholders of acquired company may be compensated in

the form of cash, or in the form of shares of acquirer or both

• Acquisition and takeover are two terms used interchangeably

• The acquired company continues to exist as a separate legal

entity

• Most M&As are in the form of acquisition

• Acquisitions can be friendly are hostile

What is hostile takeover?

• Hostile takeovers are acquisitions that are carried

against the will of the company’s management and
directors

• It involves going directly to the shareholders of the

target company or by getting the existing management
replaced

• Management uses several defense mechanism such

as poison pill, golden parachute and pacman defense
to defend against hostile takeovers
Special type M&As

©2015 BSE Institute Limited

Leveraged Buy Out

• Leveraged buy out refers to an acquisition

which is predominantly funded through debt

• Very common in PE deals

• Such buyouts provide higher returns but

creates higher risk
Reverse Merger

• A reverse merger is a transaction through

which unlisted private company shareholders
acquire the shares of a list public shell
company

• It is used as a process to get a private

company listed without going public
Why M&A? (1/2)

• Synergy benefits
• Cross selling opportunities
• Sharing best practices
• Increased bargaining power
• Shared services

• Inorganic growth
• Increase scale of business in short time

©2015 BSE Institute Limited

Why M&A? (2/2)

• Corporate Restructuring
• Control of group companies restructured for better
monitoring/control

• Tax benefits
• Takeover sick companies to set off their
accumulated losses and reduce taxes

• Regulatory/Government intervention
• Example: BofA take over of Merrylynch

©2015 BSE Institute Limited

Deal Structuring
Merger

Prior to merger After merger

Shareholders
Shareholders Shareholders of A and B
of A of B
Shares in C
Shares in A Shares in B

Company C
Company A Company B

Assets of A
Assets of A Assets of B
Assets of B

Liabilities of A Liabilities of B
Liabilities of A

Liabilities of B
Acquisition through asset transfer

Prior to acquisition After acquisition

Shareholders
Shareholders Shareholders of A
of A of B
Shares in A
Shares in A Shares in B

Company A
Company A Company B

Assets of A
Assets of A Assets of B
Assets of B

Liabilities of A Liabilities of B
Liabilities of A

Company A pays consideration to Company B Liabilities of B

towards transfer of net assets; Company B may
disburse it to shareholders and dissolve or use the
funds to start a new business
©2015 BSE Institute Limited
Acquisition through share transfer

Prior to acquisition After acquisition

Shareholders
Shareholders Shareholders of A
of A of B

Shares in A Shares in B
Shares in A Shares in B

Company A Company B
Company A Company B

Assets of A Assets of B
Assets of A Assets of B

Liabilities of A Liabilities of B
Liabilities of A Liabilities of B

Company A pays consideration to shareholders of

company B towards the shares; Company B
becomes subsidiary of A and continues to exist

©2015 BSE Institute Limited

Leveraged buy out
Shareholders
of A

Shares in A Special purpose Shares in B

vehicle (SPV)

Company A Shares in SPV Company B

Investment in
Assets of A Assets of B
B

Loan borrowed
Liabilities of A to acquired B Liabilities of B

• In LBO, the acquirer typically creates a SPV which borrows loan and
acquires shares of target
• Such a structure insulates acquirer from further liability if targets
performance declines

©2015 BSE Institute Limited

Market Overview
Global M&A activity on the rise

Source: Data produced by Remark taken from Mergermarket.com

Most transactions happen in the US

Source: Data produced by Remark taken from Mergermarket.com

While Power Sector is the largest,
Healthcare is growing faster

Source: Data produced by Remark taken from Mergermarket.com

India is among the top 5 destinations
for M&A

Source: Ernst & Young

M&A Activity in India is growing again

However, average
size per deal is
declining as
companies seem to
be getting wary of
mega acquisitions

Source: Ernst & Young

Most of the deals are happening
within India

Source: Ernst & Young

While most number deals are
happening in Technology space

Source: Ernst & Young

High valued transactions are happening
in Infra and Pharma

Source: Ernst & Young

The major investor in India was
United States

Source: Ernst & Young

Regulatory Environment
There are various laws that affect M&A

• Companies Act
• SEBI Take Over rules
• Competition Act
• FEMA
• Applies in case of overseas acquisition by Indian
company or acquisition of Indian company by
foreign entity
• Income Tax Act
Provisions of Company Law
• The acquired company need the approval of at least 75% of
creditors and shareholders in order to approve an acquisition

• In case of a merger, all the companies involved should get

approval from their creditors and shareholders

• Dissenting shareholders and creditors shall be paid the amount

due to them

• In case of 100% acquisition of a subsidiary then company shall

nominate another shareholder so that the minimum shareholders
is at least 2

• Under companies act 2013, if acquirer gets more than 90% then
he shall have the right to acquire remaining 10% at a value
determined by registrar
SEBI Takeover rule

• It applies if the target company is listed or is in

the process of getting listed
• In case if the stake held by an investor is
exceeds 25%, then he shall make an open
offer to acquire at least another 26% stake
• The open offer shall be made for every 5%
increase in stake
• However, total shareholding shall not exceed
75%
• If investor intends to acquire more than 75%,
delisting procedure applies
Competition Act

• Approval from competition commission is

required in the following cases
• Combined assets of target and acquirer within India
exceeds Rs.1,500 crores
• Combined turnover within India exceeds Rs.4,500
crores
• Combined assets in India is greater than Rs.750
crore and combined asset globally is USD750
million
• Combined turnover in India is greater than
Rs.2,250 crores combined global turnover is grater
than USD2.25 billion
Income Tax Act

• In case of acquisition through transfer of asset,

any capital gains is taxable in the hands of
transferor company
• However, in case of merger, capital gains is
exempted subject to certain conditions
• In case of acquisition through transfer of
shares, any capital gain on sale of shares is
taxable in the hands of transferor shareholders
• In case of merger, subject to conditions,
accumulated loss of target company can be
set off against profits of acquirer
©2015 BSE Institute Limited
M&A Modeling and Valuation

©2015 BSE Institute Limited

Valuation

• Valuation for an M&A can be done through the

following three methods
• Cost based valuation: Acquirer values a company
based on the cost it may have to incur to build a
business of the same size
• Selling price based valuation: Acquirer values a
company based on valuation multiple that was paid
for a similar transaction in the past
• Income based valuation: Acquirer values the
company based on DCF or any other intrinsic
valuation methods
Valuation challenges in M&A

• Acquisition valuation involves assessment of

synergy; most often synergy is over estimated

• Unlike portfolio investments, acquisition

involves payment of control premium;

• Promoter group may want more than fair value

for giving up their “baby”

©2015 BSE Institute Limited

Valuation vs Negotiation

• Acquisitions typically involve negotiations on

the price to be paid
• Buyer always to pay as low as possible while seller
wants to get as high as possible
• Negotiation may arise either if the
management of target is not satisfied with
valuation or if a competitor also bids for the
same company
• Therefore, companies typically have valuation
range rather than a single valuation

©2015 BSE Institute Limited

Modeling Transaction Comps (1/2)

• In industries where there are significant

precedents for acquisition, deals are typically
valued using transaction comps
• Precedent transaction comps involve
calculating EV/EBIT(DA) or such ratios of prior
transactions
• EV is typically calculated based on the equity
consideration paid plus net debt
• Equity consideration for 100% stake will have to be
extrapolated if acquired stake is less than 100%
• EBIT/EBITDA should pertain to the period in which
the acquisition was done
©2015 BSE Institute Limited
Modeling Transaction Comps (2/2)
Illustration of a precedent transaction comp table
(Rs. In crores) (A) (B) (C)=(A)/(B) (D) (E)=(C)+(D) (F) (G)=(E)/(F)
Acquirer Target Date of Equity Stake Equity Net Debt EV EBITDA EV/EBIT
transaction considera Acquired Value DA
tion paid

Company A Company B 1-Jul-11 350 80% 437.50 64.30 501.80 45.20 11.10
Company C Company D 13-Nov-11 160 55% 290.91 134.30 425.21 65.00 6.54
Company E Company F 15-Nov-12 540 100% 540.00 - 540.00 40.00 13.50
Company G Company H 14-Mar-13 240 60% 400.00 161.30 561.30 85.10 6.60
Company I Company J 5-Dec-14 380 100% 380.00 242.50 622.50 75.60 8.23
Company K Company L 16-Sep-14 440 65% 676.92 399.90 1,076.82 125.60 8.57
Company M Company N 5-Mar-15 560 100% 560.00 520.00 1,080.00 143.50 7.53
Company O Company P 7-Jul-15 750 100% 750.00 313.50 1,063.50 117.50 9.05
Average 8.89

• While preparing comps it is important that the

various target companies in historical
transactions are in the same industry

©2015 BSE Institute Limited

Accretion/Dilution analysis (1/3)

• Investors gauge the value addition of an

acquisitions by analyzing if the acquisition is
likely to increase or decrease the EPS of the
company is future

• This involves creating a pro-forma income

statement of the combined enterprise to see if
the pro-forma EPS is greater than existing
EPS of the company

©2015 BSE Institute Limited

Accretion/Dilution analysis (2/3)

• It is important to segregate EPS accretion

resulting on account of true business benefits
from any accretion on account of increased
leverage

• Therefore, while creating a pro-forma it is

better to assume that existing capital structure
of the company is maintained (i.e. acquisition
is funded partly with cash and partly with
shares so that existing debt/equity is
maintained)
©2015 BSE Institute Limited
Accretion/Dilution analysis (3/3)

• Most often synergy benefits are over-

estimated

• Therefore pro-forma financials are generally

accompanied by a scenario analysis

• Accretion/Dilution models should analyze the

pro-forma EPS under different scenario to
analyze

©2015 BSE Institute Limited

THANK YOU

41