Introduction to M&A

(Illustrated with the Piramal-Abbott Deal)

In May 2010 Piramal Healthcare Ltd and Abbott Laboratories Private Ltd
announced sale of Piramal’s Healthcare Solutions (branded generics) business
to Abbot for rupee equivalent of USD 3.72 billion; Abbott to pay USD 2.12 billion
upfront and four annual instalments of USD 400 million each from 2011 for
Piramal's Healthcare Solutions business.

This handout has been compiled from published

sources; it is to be used as a basis for class
room discussion. Though, alternative routes /
scenarios have been developed on different
aspects of the deal it is not intended to illustrate
either effective or ineffective handling of a
management situation.

Information on the deal has been collected from

sources considered to be reliable but it is
strongly suggested that this document should
not be used as a primary source of information
on the deal or on the companies. Its only
objective is to introduce M&A concepts in a
classroom.

Sachidanand Singh
July 2010
The Deal

On May 21, 2010 National Stock Exchange posted on its Corporate Announcements page:
"Piramal Healthcare Limited to sell its Domestic Formulations (Healthcare Solutions) business to
Abbott Laboratories". The accompanying Press Release revealed the following details: on May
21st Piramal’s Board approved the Company entering into a definitive agreement with Abbott of
Illinois, USA for Abbott to acquire Piramal’s Domestic Formulations (including mass market)
business for INR equivalent of USD 3.72 billion. USD 2.12 billion is payable in Indian rupees on
closing of the sale and USD 400 million is payable in Indian rupees on each of the next four
anniversaries of the closing starting from 2011.

The sale is conditional upon Piramal’s shareholders’ approval and other customary closing
conditions. As a term of the sale Piramal (the Company) and Piramal Enterprises Ltd (PEL, the
promoter) are not to engage in the business of generic pharmaceutical products in finished form
in India for a period of eight years following closing. However, Piramal would be free to
continue its retained business. As PEL is to give a guarantee for performance of all the
obligations of Piramal and its affiliates, Piramal’s Board agreed, subject to shareholders’
approval to pay PEL and its associates INR 350 crores, representing approximately 2% of the
consideration amount.

Market’s Reaction

On announcement the shares of Piramal Healthcare fell by 9%, before recovering and closing at
about 1% below the last close. Shares of Abbott (on NYSE) registered a handsome gain of 4.7%.

Piramal Healthcare closing prices on NSE

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Why did the selling company’s shares fell? Normally in an acquisition the target’s shares rise
and the acquirers’ fall. The reason for this behaviour of share prices lies in the deep rooted belief
of the markets that acquirers Overpayment in Acquisitions
usually overpay for targets. In
words of Warren Buffet: “The There is substantial evidence that acquirers overpay for
target firms. This overpayment is attributed to:
competitive nature of corporate a. Managerial self interest, i.e. an acquisition is made to
acquisition activity almost expand the domain of managers
b. Hubris- it is a Greek word that denotes pride which
guarantees the payment of a full - ultimately becomes the cause of ruin.
frequently more than full price c. Over estimation of synergies – particularly when
when a company buys the entire many firms pursue one target an acquirer may over-
bid and receive what is called “winners’ curse”
ownership of another enterprise”.
To be sure, Abbott competed with Public Announcement to Acquire Shares
other suitors for Piramal
SEBI (SAST) Regulations prescribe three threshold points
Healthcare's branded generics (of shareholding) for different types of shareholders,
business, which according to media based on their present shareholding. Whenever these
threshold points are reached the shareholder is required
reports included Pfizer, Sanofi- to make a public announcement to acquire certain percent
Aventis and GlaxoSmithKline. of shares in an open offer. In each case, for reaching the
threshold point, combined shareholdings of persons acting
Only two days before the together with one purpose (persons acting in concert) is to
announcement of the sale of be considered. For example if I and you are acting
Healthcare Solutions business to together with one purpose then threshold will be reached
when our shareholdings taken together meets the
Abbott, National Stock Exchange threshold point even though neither of us alone has
had asked the company to comment enough shares for meeting the threshold.
on the media reports that Pfizer
might buy a controlling stake in Persons with existing Threshold
holding
Piramal Healthcare Limited. 1. 0% to <15% 15%
Piramal Healthcare responded "We 2. 15% to <55% 5% in a year
3. 55% to <75% One share in a year
hereby confirm that there is no
proposal by the Promoter for
selling any stake in the Company."

It seems the market-men were expecting an open offer from the acquirer for 20% of shares held
by other shareholders; (other than the promoter group, who were expected to ink a deal with the
acquirer). The general expectations, it seems, were that the promoters of Piramal Healthcare
would agree with the acquirer to sell their shares at a very high premium to the prevailing share
prices; and the acquirer would be required to make open offer at such high price to the remaining
shareholders. The price chart shows a steady rise in share prices from middle of March 2010,
peaking around second week of May. The volumes chart (next page) supports this hypothesis.
Market-men consider restructuring of listed firms as arbitrage opportunities. Most arbitrage
operations are based on takeovers, friendly and unfriendly. With acquisition fever rampant, and
with bids sky-rocketing, arbitrageurs have generally made money. Many buy on rumours of

3
takeover, often with borrowed funds, and when they see that the deal is not likely to materialize
the way it was expected they get out of the shares very promptly. The price chart indicates
selling pressures building up two or three days before the date of announcement. The volume
chart shows the massive increase (some 50 times the average volume) during the three days
around date of announcement. Operators perhaps got the whiff that no open offer was
forthcoming.
Piramal Healthcare: shares traded in lacs
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Overpayments for acquisitions are often justified as control premiums or as price of synergy.
Since deal price is higher than the market price, the open offer comes at a higher price pushing
the market price up.

Arbitrage Control Premium

Traditionally, the word arbitrage, applied only It is the extra amount, over and above the
to simultaneous purchase and sale of securities market price of the target’s share that is paid
or foreign exchange in two different markets to by the acquirer. It is paid to control the
exploit tiny price differentials that might exist target. Is it justified? Only when by controlling
between, say, ICICI trading in dollars in New the target the acquirer can create more value
York and in rupees in Mumbai. i.e. when the acquirer can operate the target
more efficiently than the target’s management
Arbitrage - or “risk arbitrage,” as it is now OR when the target and acquirer becomes
sometimes called - includes the pursuit of more valuable together than what they were
profits from an announced corporate event separately. Usually it is described as synergy.
such as sale of the company, merger etc. In
most cases the arbitrageur expects to profit Synergy
regardless of the behaviour of the stock Synergy is the difference between values of A
market. The major risk he usually faces and B when together (i.e. after merger or
instead is that the announced event won’t acquisition) and sum of values of A and B
happen. (If the operator takes a position when they were separate. Together they
before announcement of a deal i.e. based on become more valuable – or so it is said.
hearsay, he also faces the risk of the deal not Synergy is claimed to be the reason for
being announced.) acquisitions in most cases.

4
Deal structure

Key features of the deal announced by Slump Sale

Piramal and Abbot were:
1. It is sale of business, not sale of the
company. Piramal hived off a particular
business and sold it to Abbott.
2. Piramal is paying INR 350 crores to the
promoter group (PEL and associates)
for ensuring that all obligations under
Slump sale means transfer of one or more
undertakings as a result of the sale for a lump
sum consideration without values being assigned
to the individual assets and liabilities. Any profit
arising from slump sale shall be taxable as Long
Term Capital Gains (LTCG) if the undertaking(s)
is/are owned or held for more than 36 months
and as STCG if held for not more than 36
months.

the sale agreements by Piramal and the Undertaking

promoters are fulfilled
Undertaking includes any part of the undertaking
or a unit or division of the undertaking or a
A company’s business can be sold in two business activity as a whole but does not include
individual assets or liabilities or any combination
ways. One would be that the company itself thereof not constituting a business activity.
is sold in which case the buyers actually buy
the shares of the company and the company The net wealth of the undertaking (aggregate
value of the total assets of the undertaking
continues with its business the other would minus the value of liabilities as appearing in
be that the company sells its business and books of accounts) shall be to be the cost of
acquisition and the cost of improvement for the
after sale the company will not have any purpose of computation of capital No indexation
business but a whole lot of cash that it would would be given.
receive as the consideration for the business
it sold. Suppose company A owns two office blocks in Nariman Point, Mumbai. Its operations
consist of letting out the office space on medium term leases. A can sell the office blocks in
which case after the sale A would have no operating assets (i.e. no buildings to let out) but it
would have the cash it would receive for the office blocks it sold. On the other hand, the
shareholders of A can also sell the company A itself. In which case A will continue to own the
office blocks but the shares of A will be owned by the buyers and not by the earlier shareholders.
The first case would be sale of business and the second would be sale of company. What is more,
the shareholders of A can decide to sell one office block and retain the other. In this case A will
continue to own one office block and its shareholders will remain the same. Piramal has many
manufacturing facilities in India and abroad:
India
Pithampur, Dist. Dhar, M.P.
Mahad, Dist. Raigad, Maharashtra
Balkum, Thane, Maharashtra
Enravur Village, Chennai, Tamil Nadu
Digwal Village, Medak District, Andhra
Baddi, Dist. Solan, Himachal Pradesh
Pawne, Navi Mumbai, Maharashtra
Village Matoda, Sanand, Ahmedabad

5
Overseas
Morpeth, Northumberland, UK
Grangemouth, Stirlingshire,
UK
Aurora, Ontario, Canada
Bethlehem, Pennsylvania, USA
Piramal has organised its operations
in three different business groups:
Healthcare Solutions, Pharma
Solutions and Piramal Critical care.
In the instant deal, Piramal has sold
its Healthcare Solutions business
along with its plant at Baddi,
Himachal Pradesh to Abbott on a
slump sale basis. (Its Healthcare
Solution is also called its Branded
Generics business.)
Purchase Price Allocation
In a slump sale a business is sold for a lump sum. The
business would have a number of assets, qualifying for
different depreciation rates. The buyer of the business
cannot write off depreciation on the assets unless he has
the prices paid for individual assets, which is not available
in a slump sale. This problem is resolved by Purchase
Price Allocation (PPA). PPA is done in accordance with the
accounting standards, internationally (soon in India too) in
accordance with IFRS 3.
The PPA process allocates the cost of an acquired business
to the Fair Value of assets acquired and liabilities assumed
and it establishes useful lives for identified assets.
Whatever amount is seen to have been paid over and
above the fair value of assets acquired is treated as
goodwill.
We will see more on PPA in M&A accounting.
Valuing sale price per share
Cost of equity 0.19

Expected date of Amount in billions Time in Present

If we assume that the sale will get
inflow USD INR years value
closed in December 2010 (Piramal
31-Dec-10 2.12 101.76 0.5 93.28
has announced that the sale is likely
31-Dec-11 0.40 19.20 1.5 14.79
to close in second half on 2010) and
31-Dec-12 0.40 19.20 2.5 12.43
rupee dollar parity will be around 31-Dec-13 0.40 19.20 3.5 10.44
INR 48/USD over the next four 31-Dec-14 0.40 19.20 4.5 8.78
years and that Piramal’s cost of 139.72
equity is 19%, we can compute the
per share consideration of the deal. Number of shares outstanding (in billions) 0.209
Since whole of the company’s Outstanding stock options (in billions) 0.001
business is not on sale we need to 0.210
compute the approximate
Sale price per share (diluted) 665.58
contribution of the business on sale
to the market price of Piramal’s’ shares. Piramal’s Healthcare Solutions business grew by 24.6%
to reach Rs. 20.0 billion in FY 2009-10. Its total sales at Rs 36.7 billion registered a growth of
11.9%. It seems the business that was sold contributed over 50% of operating income and was
growing at a rate faster that the company’s growth rate. But we need to accept that the remaining
businesses – Pharma Solutions (which had negative growth in 2009-10) and Critical care
Solutions have excellent growth potential. We are of the view that conservatively, without doing
a detailed analysis, Healthcare Solutions can be valued at about 50% of the firm’s value. Thus
with average market price of Rs 450 a share, it is reasonable to assign the Healthcare Solutions
Business at Rs 225 per share. As against this 225, the table shows that the company is getting a

6
whopping Rs 665 per share for this business. However, on post tax basis the deal value would be
considerably less than Rs 665
Demerger
per share.
S19AA of the Income Tax Act defines “Demerger". Demerger
means the transfer, pursuant to a scheme of arrangement
The sale consideration is around under sections 391 to 394 of the Companies Act by a
Rs 17,500 crores but as only company of its one or more undertakings to any resulting
company in such a manner that -
about Rs. 10,000 crores will be § The transfer of the undertaking is on a going concern
received later this year, and rest basis;
over four years, we are valuing § All assets and liabilities of the undertaking, being
transferred by the transferor company (referred to in
the consideration at present the I T Act as the demerged company), immediately
value, Rs 14,000 crores. Though before the demerger, becomes the property of the
resulting company by virtue of the demerger;
the present value of the sale is § The assets and the liabilities of the undertaking(s)
14,000 crores, the Piramal will being transferred are transferred at values appearing
in the books of account immediately before the
have a tax liability (LTCG and demerger;
STCG) assuming that the selling § The resulting company issues, in consideration of the
demerger, its shares to the shareholders of the
price was Rs 17,500 crores. demerged company on a proportionate basis;
With this selling price, as a very § The shareholders holding not less than three-fourths
in value of the shares in the demerged company
rough estimate, we will keep
become shareholders of the resulting company or
taxes at Rs 3800 crores – to be companies by virtue of the demerger;
paid on closure of the deal. As
Chapter V of the Companies Act 1956: Arbitration,
this is about 6 months away, PV Compromises, Arrangements and Reconstructions
of this amount today with the
This Chapter provides most of the legal processes to be
same discount rate would be Rs followed in M&A activities. “Arrangement", here, means,
3500 crores. Deduct it from among other things, a reorganisation of the share capital and
14000 crores and divide the includes division of shares. If a company spins off a business,
a new company is created to take over the business being
result with 21 crores (diluted spun off and all shareholders of the company become
number of shares - the table has proportionate shareholders in the new company. A “Scheme
of Arrangement” is prepared for this purpose and after it
figures in billions; one billion = approved by the shareholders and creditors in different
100 crores) and we get post tax meetings it is submitted to the Company Law Appellate
Tribunal (earlier High Court). The Tribunal can approve the
per share sale price around 495. Scheme and allow for transfer of the company’s undertaking,
Since market price is around 450 allotment of shares in the new company and even dissolution
without winding up of the transferor company (if it transfers
a share (which has both the all its undertaking
business under sale and the
remaining business of Piramal) we reach an absurd conclusion that the market is assigning the
remaining business of Piramal a negative value or at best zero.

To structure a deal in which the company would have had no tax liability, Piramal would have
needed to demerge its Healthcare Solutions business. In the present deal it hived off the business.
Demerger is not defined in the Companies Act. But the Companies Act provides for carrying out
“reconstruction” of a company in Chapter V. The schematic describes the deal structured by

7
way of an arrangement to create a new company to undertake the Healthcare Solutions business
of Piramal.

Without Healthcare
Solutions

Piramal Demerges Healthcare Solutions Piramal

Healthcare business Healthcare

Piramal
Generics
Imaginary name has been given to the
new company being spun off. All
shareholders of PHL automatically
become proportionate shareholders in this
company and this company gets listed
without any IPO.

§ Piramal promoters sell their stake in this company to Abbot;

§ Abbot comes out with an open offer for 20% (or more) shares;
§ Sale of shares will attract capital gains tax at the hand of
shareholders
§ Indexation benefit is available in computing capital gain for sale of
shares, but not available in case of slump sale

In this structure as Piramal Healthcare Ltd (the company) is merely dividing business, for the
first stage i.e. demerger, there is no tax implication. For the second stage i.e. sale of shares in
Piramal Generics again tax would be applicable to only those shareholders who sell their shares.
In the current structure tax is being borne by the company i.e. by all members of the company.

But such a structure would need to follow a lengthy procedure and a deal with this structure
cannot be consummated expeditiously. First, a “Scheme of Arrangement” is required to be
prepared; then approval of the scheme needs to be obtained from shareholders and creditors;
finally sanction is required from Tribunal etc. Firms that actively contemplate selling a business
usually have that business organised as a subsidiary to make the process a little smoother.
Clearly sale of the branded generics does not appear to be culmination of a strategy nurtured over
years. Abbott offered excellent valuation and missing it to have a structure only for saving some
taxes could perhaps have been counterproductive.

8
Another major feature of the deal was that Abbott insisted that Piramal Enterprises Limited
(PEL) and its associates (i.e. the promoter group, PEL is a closely owned company that has
invested in Piramal Healthcare and other ventures of Ajay Piramal) give a guarantee that Piramal
Healthcare would fulfil all the obligations under the business sale agreement and that neither
Piramal Healthcare nor PEL and
its associates will operate in Transfer of an undertaking
branded generics market in S 293 of the Companies Act prohibits the Board of Directors of
India for eight years from the a public company, or of a private company which is a
date of closure. subsidiary of a public company from doing certain activities
except with the consent of members of the company (or
subsidiary) in general meeting.
The Companies Act provides
In terms of Sub-Section 293(1)(a) of the Companies Act Board
(in Chapter V, referred earlier) must obtain members’ consent in a general meeting to sell,
that sale of an undertaking be lease or otherwise dispose of the whole, or substantially the
approved by the shareholders in whole, of the undertaking of the company, or where the
company owns more than one undertaking, of the whole, or
a general meeting. The Act also substantially the whole, of any such undertaking.
provides for obtaining
The term ‘Undertaking’ in the present context means a unit, a
shareholders’ approval through project or a business as a going concern. It does not include
a postal ballot. Piramal has individual assets and liabilities or any combination thereof not
constituting a complete business.
sought a postal ballot to
expedite the closure. The notice Passing of resolutions by postal ballot
for postal ballot informed the S 192A of the Companies Act provides:
share-holders of the deal as • A listed public company may get any resolution passed
by means of a postal ballot, instead of transacting the
follows: business in general meeting of the company.
Piramal Healthcare Limited • A notice to all the shareholders, along with a draft
resolution explaining the reasons is required to be sent
proposes to sell its by the company by registered post to all shareholders
Domestic Formulation requesting them to send their assent or dissent in
(including the Mass Market writing on a postal ballot within a period of thirty days
from the date of posting of the letter.
Branded Formulations • A resolution assented to by required majority of the
business) as a going shareholders by means of postal ballot, is deemed to
have been duly passed at a general meeting convened
concern on a slump sale in that behalf.
basis, together with all its • Explanation- For the purposes of this section, "postal
ballot" includes voting by electronic mode.
assets except cash) and
current liabilities to Abbott Healthcare Private Limited (the Purchaser) for a total
consideration of rupee equivalent of USD 3,720 million.
The assets to be transferred include the manufacturing facilities at Baddi, Himachal Pradesh
and rights to some 350 brands and trademarks.
There is a non-compete covenant for eight years following completion of the sale and give
guarantee for the performance of PH’s obligations under the sale.
Board has approved payment of Rs 350 crores to PEL & associates by way of guarantee
commission.

9
 The explanations attached to
the Notice gave the following
information:
Piramal Healthcare has the
following businesses:
Domestic formulations,
Custom manufacturing,
Critical care,
OTC consumer products,
Manufacture & supply of
API, vitamins and fine
chemicals, and
Diagnostic services.
Only domestic formulations
are being sold to Abott.
The Board feels that the sale
is in shareholders’ best
interests. The sale proceeds
will allow Piramal to invest
in the remaining businesses
with “renewed vigour” and
will also open up other
avenues for diversifying its
business.
The NCF constitutes only 2% of
the sale consideration and is far
lower than what is often paid to
promoters. The notice also
mentioned how the company
would benefit from the sale.
Essentially the sale would give
funds that can be invested in the
remaining businesses and would
also enable the company to
pursue new businesses. This
leads us to motives of the two
parties.
Non Compete Fee (NCF)
Acquirers, when acquiring a company, often pay a non-compete
fee to the promoters of the target in consideration for not
competing in the target’s line of operations for a certain
number of years. SEBI regulations provide that Acquirer offer
to buy shares from other shareholders (up to minimum 20%)
at the same price as that paid to the promoters. Should this
price include the NCF paid to the promoter?
Non-promoter shares are in most case not in a position to
compete. But if it is allowed that the acquirer need not pay NCF
to other shareholders then sale consideration may get skewed
with a heavy NCF component to reduce the acquisition cost.
At present the Regulations provide that if NCF is more than
25% of the sale consideration then it must be payable to other
shareholders. This is a disincentive for the acquirer, who would
not find any benefit from increasing NCF component in sale
consideration beyond 25%.
Cementrum’s acquisition of Mysore Cement Ltd (MSL)
In 2006 Heidelberg of Germany, through its subsidiary
Cementrum IB, acquired Mysore Cement Ltd (MSL). The Share
Subscription and Share Purchase Agreement (SSSPA) had three
parties – acquirer (Cementrum), target (MSL) and some
entities of S K Birla Group, promoter sellers. Interestingly S K
Birla himself was not part of the “promoter sellers”.
In terms of SSSPA the acquirer agreed to purchase from the
promoter sellers 8.48 percent of the paid up equity at Rs.58 a
share and also agreed to pay Rs 14.50 a share as NCF.
Subsequently acquirer came with an open offer at Rs 58 a
share. Many shareholders felt that the offer price should have
been Rs 72.50 (58+14.50) a share as paid to the promoter
seller. They complained to SEBI and SEBI too observed that “In
the facts of the instant case, the payment of non-compete fee
to the selling promoters does not appear to be justified”.
What were the facts of the instant case? The target was a sick
company. Though S K Birla Group entities were subject to non-
compete clause, S K Birla himself was free to compete! The
promoter sellers of the target company were only shareholders
and not taking any active part in the business and were not
quite capable of competing.
Acquirer, however, appealed to Securities Appellate Tribunal
(SAT) that observed that whether NCF should be paid and if so,
how much is a matter to be decided by the acquirer and the
target. If NCF is more than 25% of share price then it should
be added to the offer price as stipulated by regulation 20(8) of
the SEBI (SAST) Regulations. In this case it was just 25%
(58/4 = 14.5) and so the appeal was allowed.
10
Why did Piramal Sell?

In 2008 Ranbaxy was sold to Japan’s Daiichi Sankyo. Abbott has valued Piramal's formulations
business at about eight times its sales, which is almost twice that of what Daiichi paid for its
USD 4.6 billion purchase of a controlling stake in Ranbaxy Laboratories in June 2008. Clearly
Piramal got a much better valuation. (Incidentally in 2008, because of the global financial crisis,
financial asset prices had taken a nosedive.) But did Piramal sell only because the business was
getting a very good price? There are some entrepreneurs who build a business to sell and move
on to build another. Ajay
Piramal has not been one of Why M&As?
those, not till now at least. Only rational justification of M&A is creation of long term
shareholder value. M&A’s help firms achieve it through
different paths:
Pharma has not been a family
business of Piramals. Ajay Economy of scale: Combined companies can reduce fixed
costs by removing duplications in operations; can also
Piramal had inherited a defunct get better deal on purchases (cheaper by a dozen), thus
textile mill. He bought Nicholas increasing margins; merging firms are in same line of
Pharma in 1988 when its activity
market capitalisation was about Economy of scope: Same operating assets and processes
can be used for different products – Godrej engaged in
6 crores. He successfully personal care products used its distribution network to
nurtured the business, seizing market Good Knight a mosquito repellent. Cross-selling is
new opportunities as they but one example of economy of scope.
emerged and in less than twenty Increased market share: Gives better pricing power to
the combined entity, (risk violating competition laws)
two years he is selling about Geographical or other diversification: Acquisition of an
half of the business for over Rs existing player can save a lot of time in reaching critical
17,000 crores. That is some mass in a new geography or in a new product range
growth! Clearly he can create Vertical integration: This refers to acquisition of a
supplier or of a buyer. It assures supplies (steel plant
value. He has gone on record acquiring an iron ore mining firm) but assumes that in-
that when the money is house processes are more efficient and economical than
received from Abbott Piramal administering long term contracts.
Taxation: A company with high taxable income can buy a
Healthcare would retire debts
loss making one reduce its tax liability and also acquire
totalling Rs 1300 crores. We assets.
hope not. Considering the
company’s conservative debt Synergy is often cited as a motive. In fact synergy is the extra
value created by combining of the firms and this extra value
equity ratio it is not called for will come from any of the factors mentioned above.
and doing so is unlikely to add
value. On a TV show, talking to Anil Singhvi and Menaka Doshi soon after the announcement of
the deal, Ajay Piramal gave three reasons:

a. 45% of the business stays with Piramal Healthcare,

b. Money that’s now coming can be used to retire some Rs 1,300 crores in debt,
c. It will also provide funds for expanding the existing businesses and for undertaking new
businesses.

11
The second point is not a
reason. There is no urgency /
imminent need to retire debts as
explained in the box. But there
is no doubt that if Piramal had
to sell it is perhaps the best time
to sell. The business has clocked
over 24% annual growth for two
years; with growing income the
healthcare expenditure of
Indians is set to rise; and Indian
pharma market is attracting the
global players like never before.
But selling only to realize top
value does not gel with the
entrepreneurial spirit of Ajay
Piramal. Piramal seems happy
to keep the remaining business
and get funds to expand it. It
suggests that some changes in
the corporate priorities
(strategies for growth) have
been brewing in the Group.
Even technology, the great
motivator in M&A arena seems,
to have no role. Piramal has sold
branded generics, where
technology does not appear to
be an issue. On the other hand,
some of its retained businesses
are technology driven. There are
reasons to believe that the patent
regulations relating drugs that
changed in 2005 may undergo
further changes to ensure that the generic products are bioequivalent to original branded
products. Bioequivalence needs some explanation.
It seems same drug manufactured by two companies having the same molecular structure may
not have the same effect even when administered in same molar doses. (Molar doses imply dose
adjusted to the body weight for orals, blood quantity – in case of injections and so on.) This is
Some Dubious Motives
In practice most M&A’s do not deliver the expected value. The
reason at times is poor execution of post merger operations.
Many a time reason can be dubious motives of merger. Some
of the dubious motives are:
Diversification: Since shareholders can achieve
diversification faster and cheaper, they would not
generally pay a premium for a diversified firm.
Hubris: manager's overconfidence about expected
synergies from M&A which may results in overpayment
for the target
Empire-building: Managers want to lord over larger
operations, caring little for what value it creates. It is
rumoured that Tatas acquired Tinplate because it had the
best golf course in town!
Manager's compensation: If managers are paid on the
basis of total profit instead of profit per share, acquisition
can be used by them to improve their compensation.
Sellers’ motivations
Seeking retirement: Not uncommon in West where an
entrepreneur having made a fortune and no heir in sight
sells out. Nor common in India, given our prolific families,
not having an heir is quite rare.
Financial distress: Sale of Exide by S K Birla, reportedly to
tide over his losses in trading Malaysian palm oil. Sale of
Mysore Cements Limited that had persistent negative cash
flows to Heidelberg of Germany.
Selling when on top: Sale of the first mosquito repellent in
Indian markets, Good Knight, by Mohan Kumar to Godrej
could make an example. There are other lesser known
sales of this category in IT space.
Technology changes:
Increased competitive pressure: Sale of confectionary
business (Parry’s) by EID Parry to Lotte Confectionery
Company Limited of Korea in 2004; sale of aerated
beverages business by Parle to Coca Cola
Strategic change or changed corporate priorities: Tata
Steel’s sale of its cement business to La Farge.
Changes / anticipated changes in the regulatory regime:
Piramal?
12
because drugs manufactured with different processes may get absorbed at different rates. This
phenomenon has given rise to “bioequivalence”, which is defined as the absence of a significant
difference in the rate and extent to which the active ingredient in pharmaceutical equivalents
becomes available at the site of drug action (in the body) when administered at the same molar
dose under similar conditions.

In a way bioequivalence has arisen out process patent regime (the earlier Indian patent regime)
that recognized patents on pharmaceutical processes but not on pharmaceutical products. This
had spurred Indian companies to
reverse-engineer molecules of Selling a business to retire debts
the branded and patented drugs Many companies have been forced to sell businesses to retire
debts. Some fifteen years back India Cement had gone on a
of western companies and shopping spree buying cement plants to augment its capacity.
employ different processes to It had acquired businesses with borrowed money and when
debts became due it sold some of the businesses to meet the
get the same molecules. pressing creditors’ claims. B M Khaitan of Kolkata had raised a
Molecules synthesized by lot of debt acquire the Eveready business of defunct Union
different processes may lack Carbide by leveraging the Group’s assets. In the following
years B M Khaitan Group hived off and sold some of its tea
bioequivalence with the original assets to repay its maturing debts.
patented drug. (A very crude
Does Piramal need to retire its debts?
example could be sugar cubes
On stand alone basis Piramal’s debt add up to only 661 crores.
and sugar powder having the It includes working capital loans of Baddi plant, which will be
same molecules but dissolving assumed by Abbot. In consolidated accounts debts do add up
to 1300 crores, but still the debt equity ratio is a comfortable
in water at different rates.) 0.77. To be sure some debt restructuring is a must as the
secured debentures of the company are secured with, among
The regulatory regimes in many other assets, movable and immovable assets at Baddi that are
part of the business being sold.
countries including India do not
require generic drugs to be No company can create shareholder value by retiring debts
contracted at fair cost, unless the cost has since reduced
bioequivalent to the original substantially.
products; they require them to
Debt, Shareholders’ value and Restructuring
have the same active
Since cost of debt is generally lower than cost of equity, as
ingredients. But that is long as a firm has investments that yield return at a rate
changing. Mexico, for example, higher than the cost of debt, increasing leverage would add to
is in the process of changing its shareholders’ value. However debt increases the risk of a firm.
Different firms, taking into account their business risks decide
regime to require generics to be on a leverage ratio (i.e. debt equity ratio) that is ideal for
bioequivalent. It may have the them.
effect of putting a lot of In the short run the Pecking Order Paradigm comes into play
and a firm’s leverage may deviate from its target leverage,
domestic companies out of calling for capital restructuring.
business. Piramal might have
had to, and now Abbott may have to confront this regulatory change if and when the rules
change in India.

13
Piramal seem to have reached a fork in its operations. On one side was generic business with the
threat of bioequivalence looming over it. On the other side are custom manufacturing, critical
care, OTC consumer products, manufacture of API, vitamins and fine chemicals, and diagnostic
services. Generic was a big business and though it grew at 25% during last two years, big
pharma companies are gunning for emerging markets and competition is going to become very

The margin on generics is getting thinner in developed markets. Generics are being sold there on
generic name basis, not on brand
names. The pharmacist has become Can we have a truly global Indian pharma firm?
the key person in generic sale, there, In 2000 Ranbaxy, then an Indian owned firm had
not the doctor. It is quite different acquired Basics GmbH; in 2002 it took a 10% stake in
Nihon Pharmaceutical Industries, Japan with an option to
from the Indian model and the price hike its stake in future. The option gives inkling to
realized on a generic product is Ranbaxy’s strategic thoughts. The Japanese pharma
market is second in size only to the US market. With an
around 80% of the branded product. aging population the Japanese government is trying
Price has become the main driver of hard to bring down the cost of health care. The generic
market, Ranbaxy expected, is set to explode in Japan. In
sale and the need of an expensive 2004 Ranbaxy acquired RPG (Aventis) in France.
sales force is vastly reduced, as Dr
Other Indian companies too have acquired generic firms
Reddy’s Lab learnt after its USD 570 in Europe / USA. Wockhardt acquired Walis Laboratories
million acquisition of German firm of UK in 1998 and again CP Pharmaceuticals of UK in
Betapharm. The trend towards low 2003. Dr Reddy’s acquired BMS Laboratories and
Meridian Healthcare in the US. Sun Pharma MD Dilip
cost generics will only strengthen Sanghavi’s words in this regard are worth noting.
with time. With reduced margins, Sanghvi says that the acquisition would be driven by the
breadth of the portfolio of the target, its customer
only huge volume players will thrive coverage in the area of interests to him and
in generics. That attracts global manufacturing abilities in defined products.
biggies. Indian pharma majors on the The rush of Indian pharma majors to acquire companies
other hand cannot become global abroad was attributed to seeking operating synergies
through growth in size and through product & market
players as they do not have the extensions. It was expected that some Indian Pharma
resources. It seemed for some time firms may emerge as global players. It wa not all
that Ranbaxy will become the first smooth sailing though. Dr Reddy’s strategy in Germany
backfired. In the US many Indian Pharma manufacturers
Indian MNC in pharma, but the (Ranbaxy, Dr Reddy’s, Sun) were / are facing regulatory
promoters did not have the long term problems. And then Ranbaxy sold out.
commitment needed for that and sold Many leading Indian pharma firms have grown after
out. 1970, when FERA regulations made it difficult for MNCs.
Piramals’ growth too owes to acquisitions in India:
Roche, ICI, Rhone-Poulenc, Boehringer Mannheim, etc.
The reasons for Piramal’s selling can
Pharma players seem to have thrived (vs. MNC’s) on
be summarized as under: regulatory arbitrage and do not seem to have the long
term commitment of a Premji or a Ratan Tata.
With the entry of Big Pharma
in Indian generics the margins will suffer and competing with them will require
considerably more resources. Thus continuing with generics may imply committing
resources where the returns are likely to get lower.

14
 Bioequivalence is hanging like a Damocles’ sword on generics business; if and when
bioequivalence appears in the India regulatory regime, generic manufacturers may have
to commit much more resources in developing or buying appropriate technologies.
The remaining businesses of Piramal have lots of potential. Globally the governments
(and the insurance companies) are very keen on bringing down healthcare costs. This will
put pressure on manufacturers to reduce cost of drug and pharma manufacturing will shift
from developed world to a country like India. Piramal is already present in custom
manufacturing space with Rs 1000 turnover and will have a significant advantage in this
business running it out of India (and from its global sites.)
Competing with Big Pharma in international generics markets require a lot more
resources than what Piramal can raise or commit.

Why did Abbott Buy?

Abbott is 122 years old and has

been present in India for 100
years. It has some very popular
brands such as the antacid
Digene and painkiller Brufen.
The sales turnover of Abbott
India Ltd (listed on NSE) is
however only around 8 crores a
year.
Abbott comes eighth in the
global pharmaceutical rankings
with 2009 revenues of $30.77
billion, which is about half of
industry leader Johnson &
Buyer Motivations
Motivation can vary depending on whether the buyer is a
strategic buyer or a financial buyer.
Strategic buyer goals
Diversify into new products/services/markets
Technology/skill sets/resources
Management leverage
Reduce competitors
Financial buyer goals
Efficiency - reduce costs, economies of scale
Growth - revenue, margin, profit
Accretion of earnings
Return on investment
Tax benefits
Big Pharma: Global League Table
Rank Company USD Bn Country

Johnson's revenues of $61.9 1 Johnsons& Johnson 61.90 USA

billion for the same year. It 2 Pfizer 50.01 USA

3 Roche 45.34 Switzerland
wants to catch-up with its bigger
4 GlaxoSmithKline 44.42 UK
rivals. This acquisition may be
5 Novartis 44.23 Switzerland
one of the ways to differentiate
6 Sanofi-Aventis 40.87 France
itself (from its bigger rivals) by
7 AstraZeneca 32.80 UK
gaining a strong toehold in an
8 Abbott Laboratories 30.77 USA
up and coming market like 9 Merck & Co 27.43 USA
India. Buying a running 10 Bayer Healthcare 22.23 Germany
operation is, many ways, more

15
efficient than starting a new operation, particularly in pharma:

1. A drug company has to take approval from the regulatory authorities before it can start
selling its products. It is a time consuming process.
2. Retailers have a large number of generic labels and they are wary of adding more.
3. Brand awareness needs to be created among doctors and public. This takes time and costs
money.
4. An acquisition comes with sales and distribution mechanism already in place. A new
company will have to recruit and train field staff, set up warehouses and establish the
distribution channel.
Forces driving Mergers & Acquisitions
Abbott had purchased pharma Over last twenty years Deregulation and Technology have
business of Belgian chemical giant been reshaping all businesses. Growing economic
Solvay for about USD 6.4 billion liberalisation has made it possible (even desirable) to enter
markets that were earlier considered “difficult”. Support
in September 2009. That services for manufacturing such as banking and insurance
acquisition too was in the direction are getting as sophisticated in emerging markets as they
are in major money centres of West.
of strengthening its presence in
emerging markets in Asia and Another fundamental force is changing demographics of the
developed world. Improved healthcare and growing
Eastern Europe. Solvay was preference for small families have increased the proportion
present in India through its of elder persons with a smaller workforce in the society.
This has stopped the markets from growing rapidly and has
subsidiary Solvay Pharma India also spurred shifting the production facilities to emerging
Ltd (SPIL, listed on BSE). The markets with abundant labour and where the market size
product portfolio of SPIL, broadly too is expanding.
spans women’s health, psychiatry, This has led to a consolidation phase and for immediate
ENT, neurology, gastroenterology, growth the firms are looking at acquisitions. Last year
(2009) saw a number of big ticket merger and acquisitions
and vaccines. SPIL’s sales in the in pharma: Pfizer and Wyeth, Merck & Co. and Schering
year ended Dec 2009 stood at Rs Plough, and Roche and Genentech.
248 crores, previous year 213 Frequent restructurings, mainly to adjust to the changing
crores, annual growth over 16 demographics and decoupling of developed markets from
emerging markets, are likely to stay with us for some time.
percent. SPIL has a very profitable
operation as evidenced from its dividend payment record. The combined turnover of SPIL and
AIL is in the range of 269 crores a year. Piramal’s Healthcare Business had recorded sales of Rs
2000 crores for the year ended March 2010.

Piramal's products cover dermatology, anti-infectives and nutritionals, while Abbott India is
focused on gastroenterology, pain, neurosciences and metabolic disorders, among other
categories. The acquisition increases Abbott’s product portfolio sharply. Increasing portfolio can
make sense only if Abbott wants to expand in India; and why should it not? Abbott expects
emerging markets will in the next few years account for 70% of the growth in the global
pharmaceutical industry, and India is "an important and critical part". Abbotts expects its Indian
revenue to grow to USD2.5 billion in the next decade, up from the current revenues of about

16
USD500 million (Abbott’s Valuation: Theory & Practice I
revenue combined with the
acquisition’s). If we take the Value of an asset (or a firm) should be the present value of
the cash flows associated with owning that asset. On the other
next decade to mean some 9 hand where we have active markets for assets we may be
years, this projection envisages lured into believing that the value of an assets is what it will
fetch in the market. That is confusing value with price. The
a little less than 20% two are often different.
compounded growth. (Since
pharma business in emerging Valuation methods are of two broad categories: asset based
and income based. Asset based methods value the assets of
markets is expected to grow at the firm and deduct the liabilities to arrive at the value of the
17%. Abbott foresees an firm. A major conceptual weakness of this method is it
equates value of firm with value of the physical assets the
increase in its market share as firm owns. A running firm often has other strengths that are
well.) In any case, pharma not reflected in its physical assets. For example its business
processes, its customers’ loyalty, its products’ reputation, its
sector is growing only at 3 to employees’ productivity and so on.
6% in developed markets and it
Income based methods indirectly capture these abstract
makes sense for an international strengths of a firm because income is a culmination of all
pharma major to ramp up its these strengths. Income based methods are further classified
as DCF Methods and Relative Valuation Methods. DCF method
operations in emerging markets, projects the cash flow that would be available in future and
particularly India. Abbot may discount those cash flow with an appropriate discount rate.
find it difficult to win market Relative methods take one or more parameter and compare
how that parameter is being valued by the market in similar
shares from its peers in firms. For example PE ratio is a commonly used valuation tool.
developed markets. Big pharma PE of 4 means the price of a share is four times earnings per
share, earnings mean net income i.e. profit after tax per
companies in developed share. At times firms are also valued as a multiple of top line
markets are facing two e.g. six times its sale.
challenges: slow growth and In M&A relative valuation is used quite often. Most of the
matured products that are restructuring cases go to courts and judges find a powerful
logic in “similar things selling at similar prices”. If one
difficult to replace with new aluminium smelter has recently changed hands at say Rs X
blockbuster drugs. The earlier per tonne of its smelting capacity then it is reasonable to
wave of M&A in pharma sector assume that another smelter too shall sell at prices derived by
same (almost same) formula. Of course adjustments are
internationally had been aimed required to be made for other features – mining license,
at acquiring super brands. That extent of deposits, useful life of major plants, and power
supply arrangements etc.
has now dried up growth is
expected from geographical Relative valuation gives an idea of market price, which is not
the same thing as value. Two parties may agree on a price to
diversification and that is going exchange a firm while the value of the firm may be quite
to be the theme song of the new different for them.
wave of global pharma M&A. Abbott’s only chance of improving its rank in the pecking order
is, it seems, by beating its peers in gaining a formidable presence in emerging markets. Abbott’s
motivations, thus, can be summarized in one sentence: to ensure first mover advantage in
emerging markets, among the Big Pharma. It can, of course, use the Indian manufacturing
facilities it is acquiring for producing generics for developed economies but that does not seem
to be an immediate objective.

17
Valuation
The deal value was generally
considered by the market to be
high. As the entire amount is not
being received on closure, the true
value of the deal is considerably
less than USD 3.12 billion. It is
interesting to compare the value of
this deal with that of another
pharma firm acquired by Abbott in
India recently.
In Sept 2009 Abbott and Solvay
had agreed for sale of Solvay’s
pharma, vaccine and diagnostic
products businesses to Abbott.
Pursuant to this agreement Abbott
acquired Solvay’s 68.85%
shareholding in Solvay Pharma
India Limited (CPIL). In terms of
SEBI (SAST) Regulations, Abbott
offered to buy up to 20% shares
from public shareholders. The
purchase price in the offer was Rs
3054.73 per share.
This price was arrived at on the
basis of SEBI’s pricing formula
(please see the box on the next
page). Under the purchase
agreement with Solvay their 68.85
shareholding in SPIL was allocated
Euro 70 million. Based on then
(Sept 25, 2009) prevailing rate of
Euro this price translates into Rs
1420.08 per share. However, the
shares on SIPL, listed on BSE
started rising right after the public
announcement of the acquisition of Solvay’s global pharma business by Abbott. Astute market
men saw an arbitrage opportunity here (refer to the box on page 4). The rise became sharper just
before the date of public announcement in India. That’s because on Feb 14 Abbott entered into a
Offer Price in Open Offers
Offer price in open offer to shareholders cannot be less
than:
1. The negotiated price between the acquirers and the
sellers
2. The average of high and low of weekly closing
prices during 26 weeks prior to the public
announcement
3. The average of daily high and low of two weeks
priors to the public announcement.
Applying the pricing formulae in Solvay case
There are two announcements – global and Indian
The average of weekly high and low of the
closing prices of shares during the twenty
six weeks period prior to the date of the Rs694.75
public announcement dated Sept 28, 2009
of the global acquisition
The average of the daily high and low of
the share prices during the two weeks
period prior to the date of the public Rs795.59
announcement dated Sept 28, 2009 of the
global acquisition
The average of weekly high and low of the
closing prices of shares during the twenty
Rs1,466.98
six weeks period prior to the date of the
public announcement in India
The average of the daily high and low of
the share prices during the two weeks
Rs3,054.72
period prior to the date of the public
announcement in India
18
definitive agreement with Valuation: Theory & Practice II
Solvay transferring latter’s Discounted Cash Flow (DCF) valuation is based on discounting
pharma business to Abbott and the future cash flows. It has sound economic rationale: value
on Feb 15 Abbott filed the of the business is present value of cash that one expects to
receive from the business. The cash expected from a business
required the required is the cash left after the business’s expansion needs are met.
information with SEC, the For growth the business would need to add new fixed assets
and would also need to increase its working capital. Thus the
security market regulator of the cash left for distribution among the owners of the business,
USA, where Abbott is called Free Cash Flow of Firm (FCFF) is determined by:
Net Profit + Depreciation + Interest*(1-Tax Rate) –
domiciled. Investments (in fixed assets as well as in working capital)

SIPL had 50,49,706 share. This FCFF is estimated for future years and each year’s FCFF is
discounted with the firm’s cost of capital. The cost of capital is
Since Abbott paid Rs 1420.08 the weighted average post tax cost of each type of capital
per share in its negotiated deal, availed by the firm. If a firm has only equity and debt and if
we assume that the ratio of debt and equity shall remain
SIPL was valued at constant in future, weighted average cost of capital (WACC) is
approximately USD 151 given by: KE*E% + KD*(1-T)*D%
million. Open offer was made at KE = Cost of equity
Rs 3054.72. Taking this as the KD = Cost of debt
T = Corporate tax rate
basis of valuation, SIPL gets E% = Ratio of equity and equity plus debt
valued at USD 324.7 million. D% = Ratio of debt and equity plus debt
SIPL’s turnover for the year
While determining D% and E%, market values of debt and
ended Dec 2009 stood at Rs 250 equity are considered, NOT book values. Cost of equity is
crores or USD 52.6 million. usually computed with Capital Market Pricing Model although
some analysts do use other models such as Fama & French’s
SIPL’s valuation as per the three factors model or the multi factor model.
negotiated price comes to USD
The value arrived at is value of the firm’s operations. If firm
151 million which is 2.9 times has non-operative assets, such as investments in securities or
its turnover. As per the offer land that are not required for operations, the value of these
non-operative assets is added to the discounted value of cash
price in the open offer SIPL gets flows. This gives us the Enterprise Value (EV). Value of equity
valued at 6.17 times its is obtained by deducting value of debt from the EV.
turnover.
DCF is quite popular with investment banking community and
equity analysts.
Since the open offer for SIPL
shares was made barely three months before the announcement of Piramal-Abbott deal the
valuation of SIPL gives right perspective for analyzing the valuation of Piramal’s Healthcare
Solutions business. Piramal’s Healthcare Solutions had recorded Rs 2000 crores turnover in
2009-2010. It translates into USD 421 million. Price of USD 3.72 billion means the business is
valued at 8.8 times the turnover. It is much higher than even the offer price valuation of SIPL. (It
should be noted that both SIPL and Piramal’s Healthcare Solutions had increased their turnover
in their last financial years by, approximately, 25 %.)

If we assume that Piramal’s cost of equity is 19% the deal value in PV terms becomes USD 2.91
billion (the first payment of 2.12 billion was some six month away in future when the deal was

19
announced). With USD 2.12 Winners’ Curse
billion as the deal value, the
In a competitive bid, where many buyers are bidding for one
business under sale gets valued asset on block, it is clear that all the bidders, except the
at 6.9 times the turnover. Even winner felt that the final price was too high or that the winner
has over paid. This thinking may lead to winner regretting its
after discounting the future bid and the remorse experienced by the winner is said to
payments, Piramal got a better come from the winner’s curse.
valuation than the value of SPIL For “winner’s curse” to happen, the asset must have the same
on the offer price basis, which value for all the bidders. If the asset on block is, say, a
currency note of Rs 1000, all the bids will stop just short of Rs
itself was some 2.15 times the 1000. But when bidders are bidding for a firm, the value of
value of SPIL in the deal the firm may be different for different bidders because
different bidders may look forward to realising different
negotiated between Abbott and synergies. They would bid, whatever is the fair value of the
Solvay, Belgium. asset plus a part of the value of the synergy they expect to
realise.
There is no doubt that the deal
value is on the higher side. The Value of Synergy
valuation is appropriate, says Synergy is the extra value created when two firms combine. If
value of A is VA and of B is VB and of the combined firm’s is
Ajay Piramal, chairman of the VAB then synergy = VAB-(VA+VB). Synergy can come from
group's holding company operational sources or from financial sources and is usually
referred to as operational synergy or financial synergy.
Piramal Enterprises. "It is the Examples of creating operational synergy are acquisition of a
best business available in India firm with idle capacity by one with overflowing orders,
and has been growing at 25% acquisition of a firm in a new market where acquirer wants to
enter etc. An example of creation of financial synergy is when
[annually] in the last two years." a firm with high taxable income combines with one that has
We are not convinced; SPIL’s accumulated losses (tax shields).
business too grew at 25% in If both A and B are bidding for a firm C, and B foresees higher
synergy form merger, the target (i.e. C) will be more valuable
2009 and at over 19% in 2008. for B than it will be for A. Expected synergies make the
Saikat Chaudhuri, a Wharton target’s valuation different for different bidders.
management professor, says
Value of Control
“the relatively higher valuation
If a firm is not operating optimally; for example if a firm has
makes sense for Abbott. Sure, it no debt and you feel that by replacing a part of equity with
is on the higher side, but we are debt you would lower the firm’s cost of funds without
also taking about a lot of increasing risk and thus, make the firm more valuable then
control of firm has some value for you. By controlling the firm
potential in these markets and you will create value that was not there before your control.
multiple synergies. There are But if a firm is running optimally and one cannot improve it in
any manner then one does not create value by controlling it
revenue synergies; the reach of and one should not pay any control premium.
generic drugs could be It may appear paradoxical, but a poorly run firm deserves
expanded globally, and control premium but an efficiently run firm does not.
(Remember, poorly run firm’s value on as is where is will be
Piramal's sales and distribution very low compared to the efficiently run firm)
network can be used to more
effectively market drugs that are developed elsewhere. On top of that, India is a growing
market." It is interesting to note the acquirer’s observation on deal value: “If you want the best

20
companies you will pay a premium; however, we feel it was the right price". But you do not
expect any buyer to admit that he has overpaid.

Different buyers may expect different degrees of benefits from combining with the target and
hence may value the target firm differently. Saikat Choudhuri mentioned multiple synergies but
specified only revenue synergy. Revenue synergy arises when the combined entity (here
Piramal’s hived off business and Abbott India jointly) generates more revenue than the sum of
revenues the two predecessors were generating independently. This mostly happens because of
cross-selling. Acquirers’ sales persons also promote the target’s products and vice versa.

To make a reasonable estimate of likely synergies one needs much more information on the two
businesses than is publicly available. In fact even the acquirers do not know the true details of
the financials of the target; though they have all public information on the target and whatever
information the target may have provided during the negotiation. The sale agreement invariably
makes the closure of the deal subject to certain conditions; these conditions allow the acquirers
to satisfy themselves on all aspects of the target. The process of ensuring that the acquirer gets
what it had assumed is called “Due Diligence”.

Due Diligence

The sale announcement made by Piramal had indicated the closing to take place later in the year
and had mentioned that closing is subject to statutory and the usual closing conditions. The
statutory conditions can relate to Companies Act (approval of shareholders for sale of an
undertaking), RBI (bringing in foreign exchange for direct investment) and compliance of other
numerous regulatory provisions. The usual closing conditions relate to the disclosures made by
the seller. After agreeing to buy, the buyer demands a right to investigate the business from
inside to assure itself that it is actually getting what the seller has assured. This investigation is
called “due diligence”.

Some twelve years ago, a news item had appeared: “Hindalco Industries Ltd (HIL) is about to
acquire 45 percent stake in India Foils Ltd (IFL) of Calcutta. IFL, a BM Khaitan group company,
plans to issue 90 lakh equity shares of Rs10 each at a premium of Rs35 each to HIL. It will also
be offering 55 lakh warrants. The warrants can be converted into equity shares of Rs10 each at a
premium of Rs35 per share on a private placement basis.” Shortly after appearance of such
media reports, both Aditya Birla Group and Williamson Magor announced agreement on
takeover of IFL by Hindalco. Later no reports came on this subject and it was learnt that the deal
was “off”. A team of Birla Group auditors had descended on India Foils and that was the last we
heard of the proposed takeover. It is reasonable to assume that in course of their due diligence

21
exercise the auditors found some “deal breaker”, i.e. some such finding that made the deal
unattractive for Aditya Birla Group.

We suppose Abbott’s lawyers and accountants must be busy going through the records of
Piramal’s relating to its Healthcare Solutions business.

What is Due Diligence?

The words “due diligence” have entered the investment banking jargon from the USA’s Securities Act
1933. Suppose I am selling shares of company A, describing it a good investment, you buy on my
suggestion and sooner rather than later A goes bankrupt. You will be justified in thinking that I duped
you. But I may have a valid defence if I can prove that I did whatever is normally required to be done
to collect all information on A. This defence is called “due diligence” defence in terms of USA’s
Security Act, 1933. If I have exercised due diligence in my investigations of A and have disclosed to
you all my findings, I would not be held liable for non-disclosure of information not uncovered in my
investigations.
Generally, due diligence refers to the care a reasonable person should take before entering into an
agreement or a transaction with another party. Thus, in M&A transactions due diligence implies an
investigation into a potential investment to confirm all material facts – to ensure that I am buying
what I think am buying. It is the test to check whether the factors driving the deal and making it look
attractive are real or illusory, whether the inside of the house is as attractive as the exterior.
If you buy a used car, you would like to get the car examined by a car expert, who would look under
the bonnet, examine the parts and gives you an estimate of its reasonable life and performance.
Getting the car examined by an expert would be the due diligence expected of you.
Acquirers assemble a team of legal and accountancy experts to examine the target’s documents,
contractual relationships, operating history and organizational structure. The buyers’ team asks the
questions and the sellers’ team organizes all the documents. If some undisclosed information is
discovered in this process, it will affect the deal value and in some cases may even scrap the deal.

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