MF0011 Slides Unit 03

MF0011 Mergers & Acquisitions
Unit 3 - Strategizing and Structuring M & A Activity

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Program : MBA
Semester : III
Subject Code : MF 0011
Subject Name : Mergers and Acquisitions
Unit Number : 3
Unit Title : Strategizing and Structuring M & A Activity
Lecture Number :
Lecture Title : Strategizing and Structuring M & A Activity
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Objectives:

After studying this unit, you should be able to:
Explain the merger process
Describe the key steps of strategic planning of a merger
Discuss the five-stage model
Explain the financial fallouts of a merger
Describe merger as a capital budgeting decision
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Strategizing and Structuring M & A
Activity
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Introduction
Merger Process: Steps
Step 1: Settings the Goals
Step 2: Selection Criteria and Information Collection
Step 3: Evaluation and Structuring the Offer
Step 4: Due Diligence and Documentation
Step 5: Investment Horizon and Disposal
Step 6: Making the Decision to Sell the Business
Basics Steps in Organising a Merger
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Lecture Outline
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Lecture Outline
The Five-Stage Model
Stage 1: Corporate Strategy Evolution
Stage 2: Organizing for Acquisition
Stage 3: Deal Structuring and Negotiation
Stage 4: Post-acquisition Integration
Stage 5: Post-acquisition Audit and Organizational Learning
Financial Aspects of Merger
Merger as a Capital Budgeting Decision
Summary
Glossary
Check Your Learning
Answers
Case Study
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Identification and evaluation of merger opportunities is a crucial initiative for
the growth of a business, and the exercise incorporates many strategic
thoughts and actions.
Another crucial initiative is the strategic structuring of a merger or
acquisition
The success of a merger is probably more because of excellent
implementation than brilliant ideation.
A takeover generally involves the acquisition of a certain block of equity capital
which enables the acquirer to exercise control over the affairs of the company.
In theory, the acquirer must buy more than 50% of the paid-up equity of the
acquired company to enjoy complete control.
In practice, however, effective control can be exercised with a smaller holding,
usually between 20% - 40%, because the remaining shareholders, scattered
and ill-organised, are not likely to challenge the control of the acquirer.
Introduction
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Merger Process: Introduction
Both Buyer and
Seller
Valuation
Due Diligence
Bidding
Negotiation
Paper Work
Buyer
Decision to buy
Funding
Identification of
target
Integration
Seller
Decision to sell
Identification of
potential buyer
Preparation of
Memorandum/ Offer
Post-sale
restructuring

Activities in a Merger
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Merger Process: Steps
Setting
the goals
Selection
criteria and
information
collection
Evaluation
and
structuring
the offer
Due diligence
and
documentation
Investment
horizon
and
disposal
Making
the
decision
to sell the
business
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Step 1: Setting the Goals
Common Goals of Merger

Acquire domain expertise and technology
Acquire market share and brand name
Acquire technology, products or intellectual property or some such assets
Acquire a geographical presence
Diversify into different businesses for a balanced portfolio
Reduce competition by acquiring competitors businesses
Create a dominant position by sheer size, and thereby reduce Overheads
and improve profits
Achieve growth of revenue, profit and assets
Create synergy between different business domains
Enhance security of sales and supply
Goals need to be set to align with the company's long-term and medium-term
strategies.
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Step 2: Selection Criteria and
Information Collection
Size of revenue,
profit and assets
Do not waste time chasing targets that don't fit your
bill
Management
quality and
entrepreneurial
flair
You might not want to buy only technical competence
but business expertise as well.
Identifiable market
and customer base
Validate the business model by sales to genuine,
preferably reputable customers. Beware of a company
that has numerous related party transactions.
Maturity of the
products, services
and technology
If the product or technology is only at its beta (early
development) stage, you need to assess the
investment required to finish the development and the
risk of failure.
The sales and
marketing channels
You don't want to reinvent the wheel and build
everything from scratch.
In this step you have to define the selection criteria, to make the right choice.
Some selection criteria generally used are:
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Step 3: Evaluation and Structuring
the Offer
The objective of crunching numbers of target's
financials is to determine if the future growth rate can
yield the expected return and assess any potential
liabilities by studying the balance sheet.
Crunch
Numbers
There are a few approaches regularly adopted to
determine the valuation of a business. You can use
one of these approaches or a combination.
Valuation
It is important that you compare your finding with the
market capitalisation of publicly listed companies in a
similar sector.
Compare
Market
Findings
After the valuation, you will need to consider the
other terms of the offer.
Consider terms
of the offer
All the terms will eventually be written into the term
sheet.
Prepare the
Term Sheet
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Step 3: Evaluation and Structuring the Offer
(Cont.)
A term sheet outlines the general structure of a proposed deal.
Some other matters that will be part of the offer include:
Method of paying the consideration
Board representation
Percentage shareholding required
Management changes, and
The administration of major business decisions.
The term sheet forms the basis for negotiation and is the cornerstone of the legal
documents.
Step 4: Due Diligence and
Documentation
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Due diligence process is one common thread that runs throughout much of the
M & A process.
Due diligence is the evaluation of the proposed merger in a detailed and
extensive manner.
It helps determine the kind of a fit that exists between two companies, and
whether it is strong enough to support the merger.
Due Diligence Components
Investment Fit
Strategic Fit
Marketing Fit
Operating Fit
Management Fit
Financial Fit
Click here for detailed
explanation on the components
of due diligence
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Step 4: Due Diligence and
Documentation (Cont.)
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To expose the major risks related to the proposed merger, due diligence has
to be broad and deep.
Market

How large is the market being
targeted? Is it growing? What are the
major threats? Can a merger improve
it?

Customer

Who are the customers? Does our
business complement the targeted
customers? Can we provide new
services or products to these
customers?
Competition

Who is the competitor of the target
company? What are the barriers to
competition? How will a merger
change the competitive environment?

Legal

What legal issues are seen in the
target company and what more can
we expect from the merger? What is
the likely financial impact of these
issues?

Risk Areas of Due
Diligence
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Step 5: Investment Horizon and
Disposal
An acquisition that has long-term strategic benefits may be retained as a
strategic investment in the portfolio of an acquiring company which sees itself as
a long-term, corporate investor.
Corporate Investor
Look for building a sustainable business
with the acquired unit
Relies on dividend distribution from the
acquisition for return of investment
Financial Investor
Look for short- to medium-term results
Aims at return in the form of capital
gains upon selling the investment
Corporate investors too, at some point of time, dispose of the investment for
cash and move on. It is, therefore, important to have a clear exit strategy at
the time of making the acquisition.
Exit can take place by several methods:
Listing the acquired company
Trade sale to another investor, or
Resale to the original vendors.
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Step 6: Making the Decision to Sell the
Business
Deciding whether to sell or not, personal factors and economic realities
should be considered so that a proper balanced decision can be achieved.
Intelligent business owners appreciate that a business should not be sold
merely because there is a short-term downturn in business or due to some
sudden personal frustration.
Reasons
for Selling
Retirement
Dispute between
partners
Decreased
interest in the
business
Illness or death of
the principals
Flattening of sales
and earnings
Investment turning
out to be a losing
proportion
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Basics Steps in Organising a Merger
Click here for a detailed
explanation of the steps in
organizing a merger
Step 1: Pre-
acquisition
Review
Step 2:
Searching
and
Screening of
Target
Acquisitions
Step 3:
Valuation of
the Target
Company
Step 4:
Negotiation
Step 5:
Post-merger
Integration
Mergers and acquisitions are normally decided after thorough examination of all
facts and aspects.
Like capital budgeting decisions, these are difficult to reverse once they are put
through, and so the organisation has to be meticulous.
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Model advocated by author Prof. Sudi Sudarsanam.
To examine the issues that may contribute to the failure of
acquisition and value destruction.
Objective
This model advocates a view of M & A as a process rather than a
transaction.
The process is considered as a multi-stage one and a holistic view of
the process is required to appreciate the links between different
stages and develop effective value-creating M & A strategies.
Scope
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Stage 1
Corporate
Strategy
Evolution
Stage 2
Organising
for
Acquisition
Stage 3
Deal
Structuring
and
Negotiations
Stage 4
Post-
acquisition
Integration
Stage 5
Post-
acquisition
Audit and
Organisation
al Learning
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Stage 1: Corporate strategy evolution
Corporate strategy aims to achieve
ways to optimise the portfolio of
businesses that a firm has and how
that portfolio can be modified in the
interest of the shareholders.
Business strategy aims to
enhance the firms competitive
positioning on a sustainable
basis in its chosen markets.

Both the objectives can be met by:
Mergers & Acquisition
Strategic Alliances
Outsourcing
Organic Growth etc.

In M&A, the acquirer looks for capabilities that can be leveraged to enhance the
competitive advantage of both the firms post-merger.
Achievement of the objectives depends both on the conceptual and empirical
validity of the strategy.
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Stage 1: Corporate strategy evolution
(Cont.)
Strategic Reasons for Acquisitions
To gain market power
To achieve economies of scale
To internalise vertically linked operations to
save cost on dealing with markets
To acquire complementary resources.
M & A generally seeks to create value through:
Enhancement of revenue while maintaining the existing cost base
Reduction in cost while maintaining the existing revenue levels
Generation of new resources and capabilities, thus leading to revenue growth or
cost reduction or both.
R
a
t
i
o
n
a
l

P
e
r
s
p
e
c
t
i
v
e

Based on hard economic,
strategic and financial evaluation
of the acquisition proposal and the
potential value creation.
The acquisition is basically a
matter of measurement of
expected costs and benefits. And
decision is assumed to be a
unified view which requires
commitment from all managers
within the firm.
P
r
o
c
e
s
s

P
e
r
s
p
e
c
t
i
v
e

This is based on soft human
dimension.
The process of decision-making
is more politically complex and
has to be carefully managed so
that the required clarity and
commitment of managers is
achieved,
Stage 2: Organizing for Acquisition
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Why is it important to understand the decision process of acquisition?
The decision of acquisition effects:
The quality of the decision
The value creation logic
The ultimate success of post-merger integration
Perspectives of decision process
Stage 3: Deal Structuring and
Negotiation
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Once the selection has been made by the firm, the merger transaction has
to be negotiated, and a takeover bid to be made.
In this process the deal-making takes place
Valuing the target
company
Choosing experts like
investment bankers, lawyers
and accountants as advisors
to the deal
Obtaining and evaluating
maximum intelligence
possible about the target
company
Performing due
diligence
Negotiating the senior
management positions of
the both firms in the post-
merger context
Developing the appropriate bid
and defence strategies and
tactics within the regulatory and
other parameters.
Some Interconnected Steps in Deal Structuring and Negotiation Process
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The objective of this important stage is to make the merged organisation
operational so that the strategic value expectations can be delivered which
drove the merger in the first place.
Organizations
Integration
Elements
Organization
Structure
Hierarchy
of
Authority
Processes
Systems Strategies
Reporting
systems
People
Culture
(Cont.)
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Preservation
There is a great need for autonomy
so that the capabilities of the
acquired firm are nurtured by the
acquirer with judicious and limited
intervention such as financial control
while allowing the acquired firm to
develop and exploit its capabilities to
the full.

Symbiosis/ Synergy
This refers to two firms initially co-
existing but gradually becoming
independent. Symbiosis-based
acquisitions need simultaneous
protection and permeability of the
boundary between the two firms.
Absorption
This means full consolidation of the
operations, organisation and culture
of both the firms over time.

Holding Company
This refers to involving no interaction
between portfolio companies, with
passive investment by parent more
in the nature of a financial portfolio
motivated by risk reduction and
reduction in capital costs
Need for Strategic Interdependence
N
e
e
d

f
o
r

O
r
g
a
n
i
z
a
t
i
o
n
a
l

A
u
t
o
n
o
m
y

Low
L
o
w

H
i
g
h

High
Stage 5: Post-acquisition Audit and
Organizational Learning
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Companies possessing the right growth strategy through acquisition and
the necessary organisational capabilities to manage their acquisitions
efficiently and effectively can sustain their competitive advantage far
longer and create sustained value for their shareholders.
Acquisition-making as Core Competence
Companies trying to grow through acquisitions need to develop acquisition-
making as a core competence and excel in it.
For acquisition-making to become a firms core competence, possessing
robust organisational learning capabilities is a must.
Developing such learning capabilities is thus integral to the M & A core
competence of building effort by multiple or serial acquirers. It is, or should
be, part of their competitive strategy.
Financial Aspects of Merger
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Financial constraints
If a firm has difficulty in putting through
its acquisition because of cash shortage, it
may have to do a stock deal or borrow the
funds .

Surplus cash
A firm which has surplus cash and does
not have opportunities to invest this cash
may either distribute it among its
shareholders or use it for acquisitions. The
shareholders may prefer increase in the
market value of their shares instead of
getting cash dividends and paying higher
income tax.
Debt capacity
The stability of cash flows increases the
capacity of the new entity to service a
larger amount of debt. The increased
borrowing allows interest tax shield and
reduced cost of capital.

Financing cost
Although the cost of capital is reduced by
enhanced debt capacity of the merged
firm, but this advantage has to be seen in
relation to the increase in shareholders
risk on account of the increased gearing.
Another aspect of financing costs is issue
costs.

Financial Aspects
of Merger
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Merger is a special type of capital budgeting and should reflect the effect
of operating efficiencies and synergy.
In appraising the merger as a capital budgeting decision, it is crucial to
appraise the value of the combined entity including the synergy, and not
compute independently the present value of the target company minus
the cost of acquiring it.
Remember that after merger neither of the units is relevant, but only the
merged entity is.
Projecting cash flows of the merged company and evaluating its net
present value will therefore provide the proper answer.
(Cont.)
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Step 1
Step 2
Step 3
Step 4
Step 5
Step 6
Determine CF (X), the equity-related post-tax cash flows of the
acquiring firm, X, without the merger, over the relevant planning
horizon period.
Determine PV (X), the present value of CF (X) by applying a
suitable discount rate.
Determine CF (X), the equity-related post cash flows of the
combined firm X which consists of the acquiring firm X and the
acquired firm Y, over the planning horizon. These cash flows
must reflect the post-merger benefits.
Determine PV (X), the present value of CF (X).
Determine the ownership position (OP) of the shareholders of firm X
in the combined firm X.
Calculate NPV of the merger proposal from the point of view of X.
(Cont.)
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The ownership position (OP) of the shareholders of firm X in the combined
firm X is determined using the formula:
OP = Nx/[Nx + ER (Ny)]
Where,
Nx = number of outstanding equity shares of acquiring firm X before the
merger.
Ny= number of outstanding equity shares of acquired firm Y before the
merger.
ER = exchange ratio representing the number of shares of firm X exchanged
for every share of firm Y.
(Cont.)
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The NPV of the merger proposal from the point of view of X is calculated
using the formula:
NPV (X) = OP [PV (X)] PV (X)
Where,
NPV (X) = NPV of the merger proposal from the point of view of
shareholders of X
OP = ownership position of the shareholder of firm X
PV (X) = PV of the cash flows of the combined firm X
PV (X) = PV of the cash flows of firm X, before the merger
Click here for an illustration on
evaluating acquisition with a
framework
Summary
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Mergers and acquisitions have become an integral part of the strategic growth
initiative developed in an effort to restructure a business organisation.
The main motive behind a merger is to add value to an existing company by
making changes in the organisational, financial and operational structures.
The main principle is to enhance shareholder value, and the key to achieving
this is distinct value addition through the merger.
In tough times, strong companies act to buy other companies and create a
more competitive and cost-efficient company.
Companies plan mergers and acquisitions to gain greater market share,
achieve greater operational efficiency and enhance the market value of the
company.
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Glossary
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Due diligence: A detailed and extensive evaluation of the proposed merger
Absorption: Full consolidation of the operations, organisation and culture of
both the firms over time.
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1. Growth by M & A is not a privilege of giant multinational corporations.
(True/False)
2. The objective of M & A can be the security of supply and sales. (True/False)
3. Due diligence is the evaluation of the proposed merger in a detailed and
extensive manner. (True/False)
4. Due diligence is not concerned with the valuation of the target company.
(True/False)
5. Due diligence not only helps to reduce risk but also contributes to effective
management of the acquisition. (True/False)
6. The __________ phase is the most difficult phase in the M & A process.
7. Compatibility and fit should be assessed across a range of criteria size, kind
of business, ___________, core competencies, etc.
8. Due diligence is initiated after the selection of a ___________.
9. The five-stage model considers M & A as a ________________.

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Check Your Learning
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10.The goal of integration is to create an organisation which is able to achieve
the ______________ of the acquisition.
11.____________ developed the five-stage model.
12.Business strategy aims to enhance the firms ___________ in its chosen
markets on a sustainable basis.
13.Achievement of the objectives depends on both the conceptual and
____________ validity of the strategy.
14.The stability of cash flows ____________ the capacity of the new entity to
service a larger amount of debt.
15.A merged firm is able to realise ______________ in floatation and
transaction costs related to an issue of capital
16.Companies trying to grow through acquisitions need to develop acquisition-
making as a __________ and excel in it.
17.The merger will be advantageous to the acquiring firm if the present value of
the target merger is greater than the_____________.
Check Your Learning
Answers
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1. True.
2. True.
3. True.
4. False.
5. True.
6. Post-merger integration.
7. Capital structure.
8. Target company.
9. Process.
10.Strategic objectives
11.Sudi Sudarsanam
12.Competitive positioning.
13.Empirical.
14.increases
15.economies of scale
16.Core competence.
17.Cost of acquisition.
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Case Study
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Answer the following questions, based on the
given case:

Question
Make an analysis of the deal between Indian Oil-
BRPL.

Hint answer:
The deal is likely to be beneficial for both the
companies. IOC is holding 74% stake in BRPL.
BRPL has refining capacity of 2.35 million tonnes
of crude and has a net profit of Rs. 239 crore.
Click on the icon besides, to
analyse the case on
Strategizing and Structuring
M & A Activity

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MF0011 Mergers & Acquisitions

Unit 3 - Strategizing and Structuring M & A Activity

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