M&A

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Merger

Merger is a broad term and it denotes the combination of two or more companies in such a way only one survives while the other is dissolved. A+B=A
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Acquisition

Acquiring control over a company means acquiring the right to control its management and policy decision.

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Shares may be purchased fro the market to acquire a controlling interest and the target company may be maintained as a subsidiary or division to or dissolve to merge. Seller may oppose the M & A but the buyer makes a direct bid to the sellers shareholder to acquire sellers shares and thus gain control of sellers 3/13/12

Takeover

Mergers, Acquisitions, and Takeovers: What are the Differences? v Merger A strategy through which two firms agree to integrate their operations on a relatively co-equal basis
v

Acquisition A strategy through which one firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio

Takeover A special 3/13/12 type of acquisition when the target firm did

Reasons for M & A and Problems in Achieving Success

Cost new product development/increased speed to market

M& A Increased market power

Increased diversification

Avoiding excessive competition

Overcoming entry barriers

Lower risk compared to developing new products

Learning and developing new capabilities

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Market Power Acquisitions

Horizontal Acquisitions

Acquisition of a company in the same industry in which the acquiring firm competes increases a firms market power by exploiting:
v

Cost-based synergies Revenue-based synergies

Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics

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Market Power Acquisitions (contd)

Horizontal Acquisitions

Acquisition of a supplier or distributor of one or more of the firms goods or services

Acquisitions

Vertical

Increases a firms market power by controlling additional parts of the value chain

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Market Power Acquisitions (contd)

Horizontal Acquisitions Vertical Acquisitions Conglomerate Acquisitions

Acquisition of non related companies

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Reasons for M&A and Problems in Achieving Success

Too large

M& A

Managers overly focused on acquisitions

Integration difficulties

Too much diversification

Inadequate evaluation of target

Large or extraordinary debt

Inability to achieve synergy

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Sales Enhancement and Operating Economies

Economies of Scale -- The benefits of size in which the average unit cost falls as volume increases.
v v v

Horizontal merger: best chance for economies Vertical merger: may lead to economies Conglomerate merger: few operating economies

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Strategic Acquisitions Involving Common Stock

Strategic Acquisition -- Occurs when one company acquires another as part of its overall business strategy. v When the acquisition is done for common stock, a ratio of exchange, which denotes the relative weighting of the two companies with regard to certain key variables, results.
v

A financial acquisition occurs when a buyout firm is motivated to purchase the company (usually to sell assets, cut costs, and manage the remainder

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efficiently), but keeps it as a stand-alone

Strategic Acquisitions Involving Common Stock

Example -- Company A will acquire Company B with shares of common stock.
Present earnings Company A $20,000,000 Company B $5,000,000 2,000,000 $2.50 $30.00 16 12

Shares outstanding Earnings per share Price per share $4.00

5,000,000

$64.00

Price / earnings ratio

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Strategic Acquisitions Involving Common Stock

Example -- Company B has agreed on an offer of $35 in common stock of Company A. Surviving Total earnings Company A $25,000,000

Shares outstanding*6,093,750 Earnings per share $4.10

Exchange ratio = $35 / $64 = .546875 * New shares from exchange = .546875 x 2,000,000= 1,093,750
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Strategic Acquisitions Involving Common Stock

v

The shareholders of Company A will experience an increase in earnings per share because of the acquisition [$4.10 post-merger EPS versus $4.00 pre-merger EPS].

The shareholders of Company B will experience a decrease in earnings per share because of the acquisition [.546875

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= $2.24 post-merger EPS versus

Strategic Acquisitions Involving Common Stock

v

Surviving firm EPS will increase any time the P/E ratio paid for a firm is less than the premerger P/E ratio of the firm doing the acquiring. [Note: P/E ratio paid for Company B is $35/$2.50 = 14 versus pre-merger P/E ratio of 16 for Company A.]

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Strategic Acquisitions Involving Common Stock

Example -- Company B has agreed on an offer of $45 in common stock of Company A.
Surviving $25,000,000 A Company

Total earnings

Shares outstanding* 6,406,250 Earnings per share

Exchange ratio = $45 / $64 = .703125 * New shares from exchange = .703125 x 2,000,000 = 1,406,250
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$3.90

Strategic Acquisitions Involving Common Stock of Company A will The shareholders

v

experience a decrease in earnings per share because of the acquisition [$3.90 post-merger EPS versus $4.00 pre-merger EPS]. The shareholders of Company B will experience an increase in earnings per share because of the acquisition [.703125 x
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$4.10 = $2.88 post-merger EPS versus

Strategic Acquisitions Involving Common Stock

v

Surviving firm EPS will decrease any time the P/E ratio paid for a firm is greater than the pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio paid for Company B is $45/$2.50 = 18 versus pre-merger P/E ratio of 16 for Company A.]
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What About Earnings Per Share (EPS)?

v

Merger decisions should not be considering the long-term consequences. The possibility of future earnings made without

With the merger Expected EPS ($)

Equa l

Without the merger

Time in the Future (years) Initially, EPS is less with the merger. Eventually, EPS is greater with the merger.

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growth may

Market Value Impact

Market price per share of X the acquiring company
Number of shares offered by the acquiring company for each share of the acquired company

Market price per share of the acquired company

v

The above formula is the ratio of exchange of market price. If the ratio is less than or nearly equal to 1, the shareholders of the acquired firm are not likely to have a monetary incentive to accept the merger offer from the acquiring firm.

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Market Value Impact

Example -- Acquiring Company offers to acquire Bought Company with shares of common stock at an exchange price of $40.

Acquiring Bought Company Present earnings Company $20,000,000 $6,000,000 Shares outstanding 6,000,000 2,000,000 Earnings per share $3.33 $3.00 Price per share $60.00 $30.00 Price / earnings ratio 18 10
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Market Value Impact

Exchange ratio = $40 / $60 =. 667 Market price exchange ratio = $60 x .667 / $30 = 1.33 Surviving Company Total earnings $26,000,000 Shares outstanding* 7,333,333 Earnings per share $3.55 Price / earnings ratio 18 Market price per share $63.90 * New shares from exchange = .666667 x 2,000,000 = 1,333,333
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Market Value Impact

v

Notice that both earnings per share and market price per share have risen because of the acquisition. The market price per share = (P/E) x (Earnings). Therefore, the increase in the market price per share is a function of an expected increase in earnings per share and the P/E ratio NOT declining.

The apparent increase in the market price is driven by the assumption that the P/E ratio will not change and that each dollar of earnings from the acquired firm will be priced the same as the acquiring firm before the acquisition (a P/E ratio of 18).
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Empirical Evidence on Mergers

v

Evidence on buying firms is mixed. It is acquiring firm shareholders gain. Some mergers do have synergistic benefits.
CUMULATIVE AVERAGE ABNORMAL RETURN (%)

not clear that

Selling compani es

Buying compani es

Announcement date TIME AROUND ANNOUNCEMENT (days)

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Developments in Mergers and Acquisitions

Roll-Up Transactions The combining of multiple small companies in the same industry to create one larger company. v Idea is to rapidly build a larger and more valuable firm with the acquisition of small- and mediumsized firms (economies of scale).
v

Provide sellers cash, stock, or cash and stock. Owners of small firms likely stay on as managers. If privately owned, a way to more rapidly grow towards going through an initial public offering

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Closing the Deal

Consolidation -- The combination of two or more firms into an entirely new firm. The old firms cease to exist.
v

Target is evaluated by the acquirer Terms are agreed upon Ratified by the respective boards Approved by a majority (usually two-thirds) of shareholders from both firms Appropriate filing of paperwork Possible consideration by The Antitrust Division of the Department of Justice or the Federal Trade

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Taxable or Tax-Free Transaction At the time of acquisition, for the selling

v

firm or its shareholders, the transaction is:

Taxable -- if payment is made by cash or with a debt instrument. Tax-Free -- if payment made with voting preferred or common stock and the transaction has a business purpose. (Note: to be a tax-free transaction a few more technical requirements must be met that depend on whether the purchase is for assets or the
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common stock of the acquired firm.)

Accounting Treatments -- A method of Purchase (method)

accounting treatment for a merger based on the market price paid for the acquired company. Pooling of Interests (method) -- A method of accounting treatment for a merger based on the net book value of the acquired companys assets. The balance sheets of the two companies were simply combined.
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A Ltd. Wishes to merge with B Ltd. The following are the Balance Sheets of both the companies Ltd Liabilities A Ltd B Ltd Assets A B Ltd.
Share Capital 10000 2000 8000 1500 6000 4000 31500 2100 500 2000 400 3500 2000 10500 Current Asset Misc Exp 12000 1000 31500 3000 500 10500
Eq Shares @10

Net Fixed Asset

14000

6500 500

Share Premium General Reserve P&L LTB Current Liability TOTAL 3/13/12

Investment 4500

Under the scheme of Merger the swap ratio has been fixed at 1:3 whereby 1 share in A Ltd would be issued for every 3 shares held in B Ltd. Make the Post merger Balance Sheet
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Post merger
interest method)
Liabilities Share Capital
Shares @10 Eq

(pooling of
Assets

10700 1400 2500 10000 1900 9500 6000 42000

Net Fixed Asset

20500

Capital Reserve Share Premium General Reserve P&L LTB Current Liability TOTAL 3/13/12

Investment

5000

Current Asset Misc Exp

15000 1500 4200

Under the scheme of Merger the swap ratio has been fixed at 1:3 whereby 1 share in A Ltd would be issued for every 3 shares held in B Ltd. Equity share capital of B is 2100 Make the Post merger Balance 3/13/12

A Ltd.Wishes to merge with B Ltd. The following are the Balance Sheets of both the companies A Ltd Liabilities A Ltd Assets
Share Capital 10000 2000 8000 1500 6000 4000 31500 Current Asset Misc Exp 12000 1000 31500
Eq Shares @10

Net Fixed Asset

14000

Share Premium General Reserve P&L LTB Current Liability TOTAL 3/13/12

Investment 4500

Let us see the above example under purchasing method with some additional details The assets and liabilities of B Ltd. Have to be considered as per revaluationFixed Assets- 5800 Investments-400 Current Assets- 2700 Current Liabilities- 2100 Long term Liabilities- 3700

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Purchase method
Liabilities Share Capital
Shares @10 Eq

Assets 10700 2400 2000 8000 1500 9700 6100 40400 Current Asset Misc Exp 14700 1000 40400 Investment 4900 Net Fixed Asset 19800

Capital Reserve Share Premium General Reserve P&L LTB Current Liability TOTAL 3/13/12

The capital reserve of Rs 2400 is the gain on the merger to A Ltd which is computed as

Total value of Assets of B Less : Total Liabilities 3100

8900 5800 =

Less purchase consideration

700

paid to shareholders of B
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Accounting Treatment of Goodwill -- The intangible assets of the Goodwill

acquired firm arising from the acquiring firm paying more for them than their book value.

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortized to income on a systematic basis over its useful life. Due to the nature of goodwill, it is frequently difficult to estimate its useful life with 3/13/12

Tender Tender OffersOffer -- An offer to buy current

shareholders stock at a specified price, often with the objective of gaining control of the company. The offer is often made by another company and usually for more than the present market price.
v

Allows the acquiring company to bypass the management of the company it wishes to acquire.

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Statutory Recognition for M &A

The Companies Act The IT Act The Competition Act

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Due Diligence

All schemes of mergers and buyouts involving outside interests are closed with a term sheet subject to due diligence review by independent agencies so as to verify the accuracy of the claims made in the Information Memorandum and the discussions and negotiations leading to the closure of deal.
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Restructuring through Split up

Methods under Equity Route Spin off or De SubsidizationThe parent companys holding the subsidiary is distributed pro rata to shareholders of the parent.

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Methods under the Asset RouteHive off An existing business segment or division is sold off to another company. De merger-(Hive off + Spin off) Shareholders of the transferor company are given shares pro-rata in the transferee company from inception.
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Role of IB/ MB

Advising on merger transactions including valuations & managing the merger process. Advise on cross border and domestic acquisitions Assisting companies in acquisitions preliminary research andidentifying prospective targets / buyers. Structuring the transaction, handling due diligence, valuations, assisting the company in the negotiation process and executing the 3/13/12