Merger,acquisition And Corporate Restructuring

Structure
Conceptual framework History of M&A Financial framework Corporate restructuring Accounting for amalgamation Tax benefits Exercise

CONCEPTIONAL FRAMEWORK
MEANING OF MERGERS ACQUSITIONS AMALAMATIONS TAKEOVERS ABSORPTIONS

TYPES OF MERGERS
HORIZONTAL MERGER SIMILAR LINES OF ACTIVITY as Ford announced the sale of the two British iconic cars to Tata Motors Ltd. Ford acquired Jaguar for $2.5 bn in 1989 and Land Rover for $2.75 bn in 2000 but put them on the market last year after posting losses of $12.6 bn in 2006 - the heaviest in its 103-year history.

 HDFC Bank's merger with Centurion Bank of Punjab and Walt Disney Company's acquisition of 17.2per cent stake in UTV Software Communication to increase its stake to 32.10 per cent in the company. In February 2008, as many as 38 cross-border deals were announced with total value of $2.80 billion, of which 27 were outbound deals with a value of $2.57 billion.

Diologic Report
Meanwhile, global financial information provider Diologic in its latest report said that India-targeted M&A volumes reached $11.9 billion through 345 deals so far this year. US was the leading acquiring country with deals worth 1.6 billion dollars, followed by the UK with $904 million and Germany with USD 584 million.

ADVANTAGES
REDUCTION OF COMPETITION PUTTING AN END TO PRICE CUTTING ECONOMIES OF SCALE IN PRODUCTION RESEACH AND DEVELOPMENT MARKETING AND MANAGEMENT

VERTICAL MERGER
FIRMS SUPPLYING RAW MATERIALS MERGE WITH FIRM THAT SELLS ADVANTAGE LOWER BUYING COST OF MATERIAL LOWER DISTRIBUITION COST ASSURED SUPPLIES AND MARKET COST ADVANTAGE

CONGLOMERATE MERGER
UNRELATED INDUSTRIES MERGE PURPOSE DIVERSIFICATION OF RISK Ex:Time warner-(they were into media & movie production) & AOL-(leading American website)

Expansion
Merger and Acquisition Asset acquisition Joint ventures Tender offer

Contraction
1.Spin off-shares in subsidiary distributed to its own shareholders Kotak Mahendra Capital finance Ltd formed a subsidiary called Kotak Mahendra Capital Corporation by spinning off its investment division. 2.Split off- A new company is created to takeover an existing division or unit. It does not result in any cash inflow to the parent company

HISTORY

The First wave

1897-1904-horizontal Mergers Monopolistic Market structure Mega merger between US Steel and Carnegie Steel.It also merged with 785 separate firms-75% of Steel production of US. More than 3000 companies disappeared. General Electric,Navistar, Standard Oil, Du-Point, American Tobacco-90% of market share Transformation of regional firms into national firms. Exploited the economies of scale.

Table-1
Year 1897 1898 1899 1900 1904 Number of mergers 69 303 1208 340 79

Problems of the first Wave

Financial factors Fraudulent financing Stock Market crash in 1904 and Banking panic of 1907 Closure of many banks and formation of Federal Reserve System. Easy finance ends here. The US President Teodore Roosevelt and President William Taft made a crack down on Large Monopolies. As a result: ???? What happened to Standard Oil?

Standard Oil(SO)
Broken in to 30 Companies. SO of New Jersey named EXXON SO of New York named MOBIL SO of California renamed CHEVRON SO of Indiana renamed AMOCO

The Second Wave

1916-1929 Oligopolies industry structure Industries like primary metals, petrolium products, food products, chemicals Outside the previously consolidated heavy manufacturing industries. Product extension merger like IBM and General Foods Vertical mergers In the mining and metal industries(1920)

Prominent Corporations
General Motors, IBM, Union Carbide, John DEERE Between 1926 and 1930- there were 4600 mergers took place Result of which between 1919 and 1930 12,000 manufacturing , mining,public utility and banking firms disappeared. This period rail transportation, motor vehicle transportation became national market. Radios in homes, entertainment enhanced the competition. Mass merchandising, national brand advertising

 Enhance productivity as a part of war effect. The firms were urged to work together rather than compete The second wave came to an end when stock market crashed on October 29,1929. Investment Bankers played in the first two phases of mergers.

The 1940s
The second world war with merger of small firms with larger firms Motive of tax relief High estate taxes There were no increased concentration of wealth Mergers were small.

The third Wave-1965-1969

Merger activity reached its highest level during this period Booming of economy Conglomerate merger period-80% Diversification strategy It is because of ANTI TRUST enforcement Federal government adopted a stronger antitrust enforcement both with horizontal and verticle merger. 1963-1361 mergers; 1970-5152 mergers

Management sciences
Management principles were applied in industries. Management graduates were employed to manage conglomerate mergers. There were 6000 mergers which leads to 25000 firms disappeared. Investment Bankers do not finance most of these mergers Finance:-????

Finance for mergers

Equity financing Boom in stock market prices Many conglomerate merger failed The Revlon cosmetic entered into health care and failed and suffered in cosmetic industry.

The Fourth Wave-1981-1989

Recession in 1974-75 Hostile merger Take over or targeting on target companys board of directors. If the board accepts, it is considered friendly, and if it opposes it, it is deemed to be hostile. The great mergers such as Oil companies-21.6% Of dollar values of merger and acquisitions Drugs and medical equipment industries due to deregulation in some industries Deregulation of airline industries

 Investment bankers played an aggressive role. M&A advisory services became a lucrative source of income for Goldman Sachs Innovation in acquisition techniques

The Fifth Wave-1992-till date

Once again increased activity in merger in 1992 Mega mergers Strategic mergers Equity based Deregulations and technological changes Banking , telecommunications entertainment and media industries High growth in banking sectors in 1990 as banks grew greater than central banks. Banks fund M&A rather than new ventures.

Oligopoly market structure

Competition declined Very few competitors Example: Coco-Cola-44.5%,Pepsi-31.4%,Cadbury Schweppes-14.4% Globalisation Not confined to US companies 1995-US companies were acquired

1981-2395 1989-2366 1990-2074 companies 2001-7528 companies merged

Major Mergers in the telecom

Acquirer Vodafone MCL worldcom Bell atlantic AT&T SBC Target Mannes man Spirit GTE MeCaw Celluar Pacific Telesis

Major Mergers in Media and Entertainment sector

AOL Time Warner VIOCOM CBS WALT DISNEY CAPITAL ITIES/ABC AT&T MEDIA ONE TIME WARNER TURNER BRODCAST

M&A IN INDIA
License era-Unrelated diversification Conglomerate merger Friendly take over and hostile bids by buying equity shares Example: Swaraj paul attempted to raid on Escorts Ltd.and DCM Ltd but could not succeed. The Hindujas raided and took over Ashok leyland and Ennore Foundaries. Chhabria Group acquired stake in Shaw Wallace, Dunlop india and Falcon Tyres.

 Goenka group from culcutta took over Ceat tyres. The Obroi-Pleasant hotels of Rane group. 1989- Tata Tea acquired 50% of the equity shares of Consolidated Coffee Ltd from resident shareholders. merged to form HCL Ltd??.

HCL
Hindustan Computers, Hindustan Reprographic, Hindustan Telecommunications and Indian Software Ltd.

Comparative study
US Strategic Gains by invest ment bankers Capital goods Borrowed Earlier debt later by equity Anti trust India By default(ANZ& Standard chartered Not benefited by banks consumer goods cash/FDI MRTP later The competition bill 2001

FINANCIAL FRAMEWORK
IT COVERS THREE INTERRELATED ASPECTS 1.DETERMINING THE FIRMS VALUE 2.FINANCING TECHNIQUES IN MERGER 3.CAPITAL BUDGETING

DETERMINIG THE FIRMS VALUE

QUANTITATIVE FACTORS BASED ON 1. THE VALUE OF THE ASSETS BOOK VALUE OWNERS EQUITY DEPENDS ON FIXED ASSETS AND WORKING CAPITAL 2. APPRAISAL VALUE- INDEPENDENT APPRISAL AGENCIES 3. MARKET VALUE BASED ON STOCK MARKET QUATATIONS ,BUT CHANCE FOR SPECULATION 4. EARNING PER SHARE AND P/E RATIO IMPACT OF EPS AFTER MERGER

EXERCISE
COMPANY A NO. OF SHARES 2 LACS MARKET VALUE PER SHARE RS.25 EPS RS.3.125 COMPANY B NO. OF SHARES 1 LAC MARKET VALUE RS.18.75 EPS RS.2.5

CONCLUSIONS
EXCHANGE AT EPS NO EFFECT ON EPS AFTER MERGER EXCHANGE MORE THAN EPS RATIO COMPANY WITH LOWER EPS GAINS IF LESS THAN EPS RATIO COMPANY WITH HIGHER EPS BEFORE MERGER GAINS

PRICE EARNING RATIO APPROACH

MEANING COMPUTATION : P/E RATIO = MP/EPS EPS = EAT/NO. OF EQUITY SHARES MARKET PRICE = P/E (NO. OF TIMES) * EPS

EXAMPLE
PRE MERGER SITUATION EAT NO. OF SHARES EPS FIRM A FIRM B 6,25,000 2,00,000 3.125 2,50,000 1,00,000 2.5

P/E RATIO(TIMES) MARKET PRICE PER SHARE(MPS) TOTAL MARKET VALUE (N*MPS) OR (EAT*P/E RATIO)

8 25 50,00,000

7.5 18.75 18,75,000

POST MERGER

SITUATION 1 (BASED ON CURRENT MARKET PRICE 2.5:3.125=.8 6.25+2.5=8.75 2.8 lakhs

SITUATION 2

EXCHANE RATIO/ SWAP RATIO (ASSUMING) EAT(COMBINED FIRM) NO. OF SHARES

1:1 8,75,000 2,00,000+1,00,000=3,00,000

EPS P/E RATIO (ASSUMED TO BE THE SAME) MPS

8.75/2.8=3.125 8

8,75,000/3,00,000=2.91/ 7.5

3.125*8=25

21.825

TOTAL MARKET VALUE

70,00,000

65,47,500

CONCLUSION
IF SHARES ARE EXCHANGED BASED ON CURRENT MARKET PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT HIGHER RATE THAN EXCHANGED BELOW THIS RATIO Boot strap effect

 MARKET VALUE AFTER MERGER = MARKET VALUE BEFORE MERGER = 68,75,000 NET GAIN = 15,00,000 ? IF EXCHANGE RATIO IS 2.5:1 WHO GAINS WHO LOSES ? IF EXCHANGE RATIO IS 1:1 WHO GAINS WHO LOSES ? HOW TO CALCULATE TOLERABLE SHARE EXCHANGE RATIO

DETERMINATION OF TOLERABLE SHARE EXCHANGE RATIO

TOTAL MV LESS: MINIMUM TO BE GIVEN TO B NET BENEFIT TO A NO. OF SHARES OF A TO A CO. SHARE HOLDERS DESIRED POST MERGER MPS NO. OF EQUTY SHARES TO BE ISSUED BASED ON DESIRED MARKET PRICE TOLERANCE SHARE EXCHANGE RATIO 75,00,000 10,00,000 65,00,000 1,00,000 65 PER SHARE 10,00,000/65 = 15,385 SHARES 50,000/15385 = 3.25 SHARES OF FIRM B, 1 SHARE IN FIRM A 1:3.25

CONCLUSION
FIRM WITH HIGHER P/E RATIO CAN ACQUIRE FIRM WITH LOWER P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET VALUE AFTER MERGER

CAPITAL BUDGETING
THE TARGET FIRM SHOULD BE VALUED BASED ON PV OF INCREMENTAL CASH INFLOWS

CORPORATE RESTRUCTURING
FINANCIAL RESTRUCTURING RESTRUCTURING SCHEMES : INTENAL AND EXTERNAL RESTRUCTURING DEMERGERS BUYOUTS

ACCOUNTING FOR AMALGAMATION

POOLING INTEREST METHOD CONDITIONS AS PER AS 14: 1. ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE ASSETS OF THE TRANSFREE CO. 2. AT LEAST 90% OF F.V OF EQUITY SHARE HOLDERS SHOULD BE SHAREHOLDERS OF NEW CO. 3. PURCHACE CONSIDERATION TO BE SETTLED BY THE NEW CO. 4. THE BUSINESS OF NEW CO. SHOULD CONTINUE 5. NO ADJUSTMENT IS INTENDED TO BE MADE TO BOOK VALUE OF ASSETS AND LIABILITIES OF TRANSFEROR CO.

OTHER ACCOUNTING TREATMENTS

1. CROSS HOLDINGS OF SHARES TO BE CANCELLED SUBSIQUENT TO MERGER 2. INTER CO. TRANSACTIONS LIKE DEBTORS AND CREDITORS SALE OF GOODS FROM ONE CO. TO ANOTHER 3. SALES TAX PAID ALREADY CAN NOT BE RECOVERED

INCOME TAX RELATED ISSUES FOR AMALGAMATION

CONDITIONS OF AMALGAMATION UNDER INCOME TAX ACT SEC 2 (1B) 1. ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE ASSETS OF THE TRANSFREE CO. 2. SHARE HOLDERS HOLDING NOT LESS THAN 3/4TH IN VALUE OF SHARES OTHER THAN SHARES ALREADY HELD SHOULD BECOME SHARE HOLDERS OF AMALGAMATED COMPANY EX. NO. OF SHARES OF Altd CO. 1,00,000 NO. OF SHARES HELD BY Bltd IN Altd IS 20,000 NOMINAL VALUE OF SHARE IS RS.10 ASSUME Altd MERGE WITH Bltd THEN 75% OF 1,00,000- 20,000 = 60,000 TO BE THE SHARE HOLDES OF B CO. NOTE:SHARE HOLDERS MAY BE EQUITY OR PREFERNCE SHARE HOLDERS

OTHER CONDITIONS
THE AMALGAMATED CO. IS AN INDIAN CO. EXCEPTION 1. IF SHARES OF INDIAN CO.HELD BY FOREIGN BEFORE MERGER AND SUCH FOREIGN CO. TAKEN OVER BY ANOTHER FOREIGN CO. 2. ATLEAST 25% OF THE FOREIGN CO. (BEFORE MERGER) TO BE SHARE HOLDERS OF THE NEW FOREIGN CO. ? WHAT IS THE BENEFIT TO THE AMALGAMATED CO. AMALGAMATING CO.(OLD CO.)

NO CAPITAL GAIN ON TRANSFER ON CAPITAL ASSETS BY THE TRANSFEROR CO. UNDER SEC 47(VI) OF I.T ACT ? CAN NEW CO. CARRY FORWAD AND SET OF LOSS AND DEPRECIATION SEC 72 A TO BE FULFILLED 1. ACCUMULATED LOSSES REMAIN UNABSORBED FOR 3 OR MORE YEARS 2. 75% OF BOOK VALUE TO BE HELD ATLEAST FOR 2 YEARS BEFORE AMALGAMATION 3. THE AMALGAMATED CO. CONTINUES TO HOLD 3/4TH OF BOOK VALUE ATLEAST FOR 5 YEARS 4. NEW CO. SHOULD CONTINUE FOR ANOTHER 5 YEARS 5. NEW CO. SHOULD ACHIEVE ATLEAST 50%OF INSTALLED CAPACITY BEFORE END OF 5 YEARS AND SHOULD CONTINUE FOR 5 YEARS

6. THE NEW AMALGAMATED CO. SHOULD FURNISH TO ASSESSING OFFICER ABOUT PARTICULARS OF PRODUCTION BENEFIT THIS SCHEME IS ALSO APPLICABLE TO BANKING INSTITUTIONS

?TATA VOLTAS & KELVINATOR HYDERABAD DIVISION vs. CBDT

EXAMPLE
A LTD AMALGAMATES WITH B LTD AS ON 2007
PARTICULARS DOES NOT SATISFY SEC 2(1B) & 72 A SATISFIES 2(1B) BUT DOES NOT SATISFY 72 A SATISFIES BOTH 2(1B) & 72 A NO CAPITAL GAIN TAX & ACCUMULATED LOSSES & UNABSORBED DEPERICIATION CAN BE CARRIED FORWARD

A MERGES WITH B NO BENEFIT TO DOES NOT (A GOES OUT) A&B ATTRACT CAPITAL GAIN FOR A BUT NO GAIN FOR B

? If b merges with a & b goes out of market who gains under above 3 situations ? If a&b merge with c what are the tax implication under above situations Assume b is a loss making co.& Have accumulated losses & unabsorbed depreciation ? If c is not an Indian co.

OTHER TAX BENEFITS

1. 2. 3. 4. 5. 6. 7. Expenditure on amalgamation or de-merger allowed under sec 35DD both revenue and capital expenditure allowed Expenditure on scientific research can be carried forward Expenditure on acquisition of patent rights copyrights depreciation can be provided Expenditure for obtaining license for tele-communication service can be written off Preliminary expenses Capital expenditure on family planning Bad debts are allowed

Tax Concession To Share Holders Of Amalgamating Co.

No capital gain tax provided, new co. is an Indian co.& Shareholders are acquired everything in shares

EXERCISE
PARTICULARS EAT EPS P/E RATIO CO. A 1,40,000 7 10 CO. B 37,500 7,500 5 40 8

NO. OF SHARES 20,000 MARKET PRICE 70

 Co. A is acquiring co. B Exchanging one share for every 1.5 shares of B ltd & p/e ratio will continue even after merger ? Are they better or worse of than they were before in merger ? Determine the range of minimum & maximum ratio between the two firms ? A is an Indian co. ? A is a foreign co. ? A merges with T & formed a new co. AT ltd ? What are the tax planning required before & after merger