MF0011 MERGERS AND ACQUISITIONS

Q.1 Give the meaning of advantages and disadvantages of mergers and acquisitions? Explain
the types of Mergers and Acquisitions?
Advantages of mergers and acquisitions
Mergers and acquisitions are strategic decisions leading to the maximizing of company's growth by
enhancing its production and sales. The benefits of M & A are:
1. From the standpoint of shareholders: Shareholders may gain from mergers through
economies of scale, which helps in lowering of cost. This results in increased profits, better
investment opportunities which is not available otherwise, and the increment in the value of share
caused by the premium paid by the acquiring company to the acquirer company.
2. From the standpoint of Promoters: Promoters get the advantage of increasing the size of the
company, restructuring the financial composition of the firm and altering its strength as per their
requirement. Promoters can change a private company into a public company without
much investment and without losing control.
3. From the standpoint of Managers: Managers often look forward to mergers as an opportunity
to enhance their status financially and otherwise. They are also concerned about the overall growth
of the company and are ready to support mergers where these benefits are seen to accrue. On the
other hand managers work against combinations that generate fear about their future.
4. From the standpoint of Consumers: The benefits of mergers get passed to the consumers in
the form of better products and services at lower prices supported by enhanced after sales and
service.
Disadvantages of mergers and acquisitions
A merger has disadvantages too. One of the disadvantages is that a merger must be approved by
the stockholders of the firm. Typically, two-thirds (or even more) of the votes are required for
approval. Obtaining the necessary votes can be time-consuming and difficult. Furthermore, the
cooperation of the management of the target firm is a necessity. This cooperation is not easy or
cheap. There can also be diseconomies of scale if the business becomes too large. Clashes of
culture between different types of businesses Could happen and reduce the effectiveness of the
integration. Merger may create a conflict of objectives between the different businesses. In view of
sharing of services, staff positions may come down and this will result in employee dissatisfaction.
A merger can be extremely beneficial to all stakeholders of a business but if handled wrongly it
can cause serious disruption all round.
Q2-Write a note on the five-stage model of mergers and acquisitions?
The Five-Stage Model
A five-stage model of mergers and acquisitions was developed by the author Sudi Sudarsanam.
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.
Stage 1: Corporate strategy evolution

The goal of M & A is to achieve corporate and business strategic objectives. Corporate strategy
aims to achieve ways to optimize 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 M & A but is only one of several alternatives including, for instance, strategic alliances,
outsourcing, organic growth, etc. Generally, acquisitions are made by companies due to one or
more of the following strategic intents:

to gain market power

to achieve economies of scale
to internalize vertically linked operations to save cost on dealing with markets
to acquire complementary resources.

Stage 2: Organizing for acquisition

It is important to understand the decision process of acquisition because it has a bearing not only
on the quality of the decision and its value creation logic but also on the ultimate success of the
post-merger integration.
There are two primary perspectives here:
1. The rational perspective: This view is 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. The acquisition decision is assumed to be
a unified view which requires commitment from all managers within the firm.
2. The process perspective: This is based on soft human dimension. In this view 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, which is taken for granted in the rationalist
approach. The authors contention is that the M & A five-stage process model ensures
that the risk involved in value damage are potentially structural in their foundation, and managing
this risk effectively should be crucial while the acquisition is being considered.
Stage 3: Deal structuring and negotiation
The result of the processes described in Stages 1 and 2 is the specific target selection. Once the
selection has been made by the firm, the merger transaction has to be negotiated or a takeover bid
to be made. The deal making takes place in this stage. The deal structuring and negotiation
process is complex and involves many interconnected steps including:

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 defense strategies and tactics within the regulatory and
other parameters.

Stage 4: Post-acquisition integration

The objective of this important stage is to make the merged organization operational so that the
strategic value expectations can be delivered which drove the merger in the first place. Integration
of two organizations is not just about making changes in the organizational structure and instituting
a new hierarchy of authority. It involves integration of processes, systems, strategies, reporting
systems, etc. Above all, it also involves integrating people and changing

organizational culture of the merging firms, possibly to develop a new hybrid culture. Integration
of organizations may require change in the mindset and behavior of the people. It is, therefore,
necessary to address cultural issues during the integration process. Since it involves redistributing
the power between the merging firms, it is also a politically sensitive stage. Conflicts of interest
and loyalty will certainly come into play. This stage of the acquisition process is, therefore, a major
factor which determines the success of the acquisition.
Stage 5: Post-acquisition audit and organizational learning
Companies trying to grow through acquisitions need to develop acquisition making as a core
competence and excel in it. Companies possessing the right growth strategy through acquisition
and the necessary organizational capabilities to manage their acquisitions efficiently and
effectively can sustain their competitive advantage far longer and create sustained value for their
shareholders. For acquisition-making to become a firms core competence, possessing robust
organizational 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.
3- What do you understand by creating synergy? Give the prerequisites for the creation of
synergy. Describe the important forces contributing to mergers and acquisitions.
Creating Synergy
The creation of synergy is not automatic. Synergy requires a great deal of work on the part of
managers at the corporate and business levels. Creation of synergy does not require only the
material resources of the two companies. It demands effective integration of the combined units
human resource, physical assets and operations. The activities that create synergy include
combining similar processes, coordinating business units sharing common resources, and resolving
conflicts among business units. Managers often underestimate the magnitude of problems that arise
in integration efforts, resulting in a situation where creation of synergy becomes very difficult.
Prerequisites for the creation of synergy
There are certain requirements which must be met for synergy to be created. These requirements
termed as the building blocks for the creation of synergy must be fulfilled and seen into well
before and during the process of combination. These are strategic compatibility, organizational
compatibility, managerial actions, and value creation. When all the four exist then the chances of
the firm being able to create synergy are substantially higher.
1. Strategic compatibility: Strategic compatibility refers to the matching of organizations
strategic capabilities. There are various ways in which capabilities can be matched through a
merger. Thus, when combined firms or business organizations are both strong and/or weak in the
same business activities, the newly created combined firm displays the same capabilities , although
the magnitude of the strength or weakness is greater, and no synergy results.
2. Organizational compatibility: Organizational compatibility occurs when two organizations
have similar management processes, cultures, systems and structures. Organizational compatibility
from an operational point of view suggests that the integration processes that are developed and
used to combine the operations can be expected to bring about desired results effectively and
efficiently.
3. Managerial actions: The third building block for the creation of synergy is related to the
actions and initiatives that managers take for their firms to actually realize the competitive
benefits. Creation of synergy requires active involvement and participation of the management.
Managers must recognize the importance and magnitude of integration issues and the need to
involve human resources in implementing a combination.

4. Value creation: Value creation is the fourth synergy creation building block. The focus here is
on deriving benefits from synergy in excess of the costs to be incurred. The costs associated with
the following have to be controlled:
(a) Financing of the transaction
(b) Premium paid for purchase.
Important Forces Contributing to Mergers and Acquisitions
Some of these are:
Safeguarding the sources of raw material
Achieving economies of scale by combining production facilities through efficient
utilization of resources
Standardizing product specifications and improving product quality
Achieving improved technical knowhow from the combined entity to cut cost, improvise
on quality and produce better products to retain and improve market share.
Reducing competition and protecting existing market
Obtaining new markets
Enhancing borrowing power of the combined entity on better and enhanced asset backing
Gaining economies of scale and increase income with proportionately less investment
4- Demerger results in the transfer by a company of one or more of its undertakings
to another company. Give the meaning of demerger. What are the characteristics of
demerger? Explain the structure of demerger with an example.
A demerger results in the transfer by a company of one or more of its undertakings to another
company. The company whose undertaking is transferred is called the demerged company and the
company to which the undertaking is transferred is referred to as the resulting company. The term
Demerger has not been defined in the Companies Act, 1956. However, according to Sub-section
(19AA) of Section 2 of the Income Tax Act, demerger in relation to companies means transfer,
pursuant to a scheme of arrangement under Sections 391 to 394 of the Companies Act,
1956, by a demerged company of its one or more undertakings to any resulting company in such a
manner that all the property and liabilities of the undertaking being transferred by the demerged
company, immediately before the demerger, become the property and liabilities of the resulting
company by virtue of the demerger.
Characteristics of Demerger
Given below are the key characteristics of demerger:
1. Demerger is basically a scheme of arrangement under Sections 391 to 394 of the Companies Act
which requires:
approval by majority of shareholders holding shares that represent three-fourths value in a
meeting convened for the purpose
Sanction of the High Court.
2. Demerger results in transfer of one or more undertakings.
3. The transfer of undertakings is done by the demerged company, otherwise known as
Transferor Company. The company to which the undertaking is being transferred is known as
resulting company, otherwise known as Transferee Company.
Structure of Demerger
A demerger is distribution of the shares of a firms subsidiary to the shareholders of the firm on a
pro rata basis. Neither the dilution of equity nor the transfer of ownership from the current

shareholders is involved. After the distribution, the operations and management of the subsidiary
are separated from those of the parent. Since no cash transaction is involved in a demerger, it is a
unique mode of divesting assets. Thus, it cannot be motivated by a desire to generate cash to pay
off debt, as is often the case with other modes of divestitures.
Example
The structure of demerger can be understood from the following example of Bajaj Auto
Structure Prior to Demerger

Post Demerger Structure

5- Explain Employee Stock Ownership Plans (ESOP). Write down the rules of ESOP and
types of ESOP.
Employee-owned corporations are corporations owned wholly or in part by the employees.
Employees are usually given a share of the corporation after a certain length of employment or
they can buy shares at any time. A corporation owned entirely by its employees (a worker
cooperative) will not, therefore, have its shares sold on public stock markets. Employee-owned
corporations often adopt profit-sharing where the profits of the corporation are shared with the
employees. These types of corporations also often have boards of directors elected directly by the
employees. .

Rules of employee stock ownership plans (ESOP)

1. Vesting: Before an employee acquires entitlement to ESOP, he must work for a certain period,
which is referred to as the vesting period. If an employee leaves before vesting, he loses the right.
An ESOP must comply with minimum schedules for vesting, called as cliff vesting or graded
vesting. In cliff vesting, the first three years do not require vesting. There is 100% vesting after
three years of service. In graded vesting, there is 20% vesting in the second year of service and
20% is added for each year of service. After the sixth year, employees are 100% vested.
2. Distributions after termination: Distribution of vested benefits with retirement, disability or
death, takes places during the following plan year. The following are the exceptions to this rule:
(a) If the termination occurs for reasons other than the ones stated above, the distribution must
commence no later than the sixth plan year following termination.
(b) Repayment of the loans that have been taken against the ESOP benefits must be done.
Distribution occurs in the plan year after repayment.
(c) ESOP distributions comprise of a lump sum or equal payments over a five-year period.
Large amounts due could lead to an extended payment plan.
3. Distribution during employment: Cash or stock can be received directly by employees by
diversifying their accounts. Dividends may be paid by the employer to a participant who is at least
a 5% owner beyond the age of 70, although still working in the company. In some situations, a
plan may offer in-service distributions after a fixed number of years of service, once a specific age
is reached or with a hardship necessity.
4. Put Option: A put option is offered by some companies, for company stock bought via the
ESOP benefits plan. In this option, the employee can sell their company stock back to the
employer within 60 days after distribution and within 60 days during the follo
wing plan year.
5. Taxation: No tax is required to be paid by the employees on stock until they receive
distributions. Payments are subject to applicable taxes, and an additional 10% excise tax will be
levied. Dividends that have to be paid directly to participants on stock are taxable.
Types of ESOPs
There are two types of ESOPs leveraged and non-leveraged. Additionally, ESOPs may be
combined with or converted from other employee benefit plans.
1. Non-leveraged ESOPs Identified as an ESOP in the plan document that invests primarily in
company stock and meets certain legal requirements. The sponsoring employer contributes
newly issued or treasury stock and/or cash to buy stock from existing owners. Contributions
generally may equal 15% of the covered payroll (which usually is the combined payroll of all
employees eligible for participation) or, if the ESOP includes a money purchase pension plan
in which the employer commits to contribute a set percentage of covered payroll per year in
cash or stock, 15% plus the money purchase pension plan contribution percentage (from 1%
to 10%) up to a maximum of 25% of covered payroll.
2.

Leveraged ESOPs: A leveraged ESOP borrows money on the credit of the employer or other
related parties to buy company stock. It is only a qualified employee benefit plan that can do
this. The loan can be towards the ESOP itself or to the employer who then lends the money to
the ESOP (lenders generally prefer the latter). The loan from the company to the ESOP does
not have to be on the same terms, provided its terms are the equivalent of an arm's length

transaction. The loan can be used for any business purpose, such as buying stock from an
existing shareholder, acquiring new capital, buying a company, or refinancing debt.
6- Explain the factors in Post-merger Integration. Write down the five rules of Integration
Process.
Factors in Post-merger Integration
Some important factors that can decide the success or failure of a merger or acquisition are:
Due diligence: Thorough due diligence involves comprehensive analysis of the financial position,
management capabilities, physical assets and intangible assets of the target company. However, it
can result in failure of the project if done badly.
Financing: Manageable debt levels should be ensured.
Complementary resources: Ideal conditions for a merger are when the primary resources of the
acquiring and target firms are somewhat different, yet simultaneously supportive of one another.
Therefore, companies should seek for such a situation.
Friendly vs. hostile acquisitions: Friendly acquisitions tend to create greater economic value. A
hostile acquisition can reduce the transfer of information during due diligence and merger
integration, and increase turnover of key executives in the firm being acquired.
Synergy creation: Four foundations for creation of synergy are strategic fit, organizational fit,
managerial actions and value creation.
Organizational learning: All stakeholders should participate in the acquisition process to ensure
that relevant knowledge is spread throughout the firm, and is not lost if anyone involved leaves.
Information gained should also be recorded and its impact on the process studied and utilised.
Focus on core business: The lesser the common factors in the combining firms, the more
magnified are cultural and management differences. This in turn restrains the sharing of resources
and capabilities. The advantages of financial collaboration will not be sufficient to negate the
disadvantages of diversification between misaligned partners.
Five Rules of Integration Process
1. Starting the post merger integration (PMI) process early: The integration effort should start
much before the deal is closed and the contracts signed; in fact to this extent, the expression post
merger is itself a misnomer. It is essential to consider PMI issues at the very initial stage and plan
meticulously while choosing the target company. The main advantage is the preparedness for
potential risks and challenges. It also helps in evaluating the target companys culture. This is also
confirmed by the findings of Parenteau and Weston (2003).
2. The integration manager: A due diligence team (from areas like HR, finance, tax, technology
etc.) and one or more top managers are responsible for the acquisition. This team, which is
involved in the acquisition, achieves the best insight into the target company. However, the team is
either dissolved or moved to the next acquisition. The manager of the acquiring business unit has
the charge of running his own units. His main focus will be on operating results and customers and
not on integrating cultures, processes and people. GE Capital was one of the first companies to
realize this problem. To counter this they introduced the concept of an integration manager, a
dedicated position filled by an executive relieved of his regular duties for up to a year.
3. Speed: If the integration takes place faster, the company will start making profits from the
predicted collaboration earlier. The valuable resources that are engaged in the internal
reorganization should be released as soon as possible. But as A.T. Kearney discovered there is
no absolute merger integration speed. The integration speed should be prioritized based on what
steers competitive advantage most and therefore results in selective integration speed ). Apart from
customers, nearly all the companys stakeholders will respond positively to speed. This is because
a fast process reduces the impact of uncertainty of what is to come after the merger. This stands
true for both a companys suppliers and for its employees.

4. The people problem: A successful merger is the one which retains the key people of both the
companies. Efforts should be made to recognize and identify key managers, understand their
motivations and accordingly act upon them. Measures like long-term stay bonuses that are tied
to some performance measure will generate a positive atmosphere which in turn will improve the
chances of retention.
5. Keeping culture high on the agenda: All companies are different in what they do and the way
they get things done. This is founded in what is called the corporate culture. It has observable
and unobservable behavioral rules, norms of work organization and philosophies which help in
forming the internal hierarchies.