Mergers & Acquisitions

Presented by: KAMLESH MEHRA

Definitions
A merger is a combination of two or more corporations in which only one corporation survives and the merged corporations go out of business. Statutory merger is a merger where the acquiring company assumes the assets and the liabilities of the merged companies.

A subsidiary merger is a merger of two companies where the target company becomes a subsidiary or part of a subsidiary of the parent company

Corporate Restructuring
Corporate restructuring is the process of redesigning one or more aspects of the business. Restructuring a corporate is often a necessity when the company has grown to the point that the original structure can no longer efficiently manage the output and general of the company. Corporate Restructuring refers to the changes in ownership,business mix,asset mix and alliances with a view to enhance the shareholder value.Hence corporate restructuring may involve ownership restructuring,business restructuring and asset restructuring.

Merger Vs Acquisition
Merger - A Merger may be defined as the combination of two or more independent business corporations into a single enterprise, usually involving the absorption of one or more firms by a dominant firm. Mergers may be broadly classified as Horizontal, Vertical or Conglomerate. Acquisition may be defined as an act of one enterprise of acquiring, directly or indirectly of shares, voting rights, assets or control over the management, of another enterprise .

Motives for Takeovers

Mergers and Acquisitions

Classifications Mergers and Acquisitions

1. 2. Horizontal
A merger in which two firms in the same industry combine. Often in an attempt to achieve economies of scale and/or scope. A merger in which one firm acquires a supplier or another firm that is closer to its existing customers. Often in an attempt to control supply or distribution channels. A merger in which two firms in unrelated businesses combine. Purpose is often to diversify the company by combining uncorrelated assets and income streams A merger or acquisition involving a Canadian and a foreign firm a either the acquiring or target company.

Vertical

3.

Conglomerate

4.

Cross-border (International) M&As

Mergers and Acquisition Activity

M&A activity seems to come in waves through the economic cycle domestically, or in response to globalization issues such as:

Formation and development of trading zones or blocks (EU, North America Free Trade Agreement Deregulation Sector booms such as energy or metals

Table 15 -1 on the following slide depicts major M&A waves since the late 1800s.

History of Mergers and Acquisitions

The First Wave 1897-1904
After 1883 depression Horizontal mergers Create monopolies Oligopolies The Clayton Act of 1914

The Second Wave 1916-1929 The Third Wave 1965-1969

Conglomerate Mergers Booming Economy

The Fourth Wave 1981-1989

Hostile Takeovers Mega-mergers

Mergers of 1990s
Strategic mega-mergers

Table 15 - 1 M&A Activity in Canada

Period
1895 - 1904

Major Characteristics of M&A Activity

Driven by economic expansion, U.S. transcontinental railroad, and the development of national U.S. capital markets Characterized by horizontal M&As 60 percent occurred in fragmented markets (chemical, food processing, mining) Driven by growth in transportation and merchandising, as well as by communications developments Characterized by vertical integration Driven by evasion of price and quota controls Characterized by conglomerate M&As Driven by aerospace industry Some firms merged to play the earnings per share "growth game" (discussed in the section The Effect of an Acquisition on Earnings per Share) Characterized by leveraged buyouts and hostile takeovers Many international M&As (e.g., Chrysler and Daimler-Benz, Seagram and Martell) Strategic motives were advanced (although the jury is still out on whether this was truly achieved) High technology/Internet M&As Many stock-financed takeovers, fuelled by inflated stock prices Many were unsuccessful and/or fell through as the Internet "bubble" burst Resource-based/international M&A activity Fuelled by strong industry fundamentals, low financing costs, strong economic conditions

1922 - 1929

1940 - 1947 1960s

1980s 1990s

1999 - 2001

2005 - ?

Source: Adapted in part from Weston, J.F., Wang, F., Chung, S., and Hoag, S. Mergers, Restructuring, and Corporate Control. Toronto: Prentice-Hall Canada, Inc., 1990.

Indian M&A Regulatory Environment

The Indian M&A environment is a strongly regulated by the following major pieces of legislation/bodies: The Companies Act, 1956 The Takeovers Code, 1997 The Monopolies and Restrictive Trade Practices Act, 1969 The Foreign Exchange Management Act, 1999 The Foreign Investment Promotion Board (FIPB) The Reserve Bank of India The Income Tax Act, 1961

Mergers, amalgamations, de-mergers, acquisitions of business units or divisions, are all governed by The Companies Act for all registered companies
Acquisition of shares in listed Indian companies is governed by The Takeover Code, 1997.

Motivations for Mergers and Acquisitions

Creation of Synergy Motive for M&As

The primary motive should be the creation of synergy.

Synergy value is created from economies of integrating a target and acquiring a company; the amount by which the value of the combined firm exceeds the sum value of the two individual firms.

Motives and Determinants of Mergers

Synergy Effect
NAV= Vab (Va+Vb) P E Where Vab = combined value of the 2 firms

Vb = market value of the shares of firm B. Va = As measure of its own value P

Operating Synergy Financial Synergy

= premium paid for B

E = expenses of the operation

Diversification Economic Motives

Horizontal Integration Vertical Integration Tax Motives

Value Creation Motivations for M&As

Operating Synergies
Operating Synergies 1. Economies of Scale
Reducing capacity (consolidation in the number of firms in the industry) Spreading fixed costs (increase size of firm so fixed costs per unit are decreased) Geographic synergies (consolidation in regional disparate operations to operate on a national or international basis) Combination of two activities reduces costs Combining the different relative strengths of the two firms creates a firm with both strengths that are complementary to one another.

2. Economies of Scope

3. Complementary Strengths

Value Creation Motivations for M&A

Efficiency Increases and Financing Synergies
Efficiency Increases
New management team will be more efficient and add more value than what the target now has. The combined firm can make use of unused production/sales/marketing channel capacity

Financing Synergy
Reduced cash flow variability Increase in debt capacity Reduction in average issuing costs Fewer information problems

Value Creation Motivations for M&A

Tax Benefits and Strategic Realignments Tax Benefits
Make better use of tax deductions and credits Use them before they lapse or expire (loss carry-back, carryforward provisions) Use of deduction in a higher tax bracket to obtain a large tax shield Use of deductions to offset taxable income (non-operating capital losses offsetting taxable capital gains that the target firm was unable to use) New firm will have operating income to make full use of available CCA.

Strategic Realignments
Permits new strategies that were not feasible for prior to the acquisition because of the acquisition of new management skills, connections to markets or people, and new products/services.

Managerial Motivations for M&As

Managers may have their own motivations to pursue M&As. The two most common, are not necessarily in the best interest of the firm or shareholders, but do address common needs of managers 1. Increased firm size
Managers are often more highly rewarded financially for building a bigger business (compensation tied to assets under administration for example) Many associate power and prestige with the size of the firm.

2. Reduced firm risk through diversification

Managers have an undiversified stake in the business (unlike shareholders who hold a diversified portfolio of investments and dont need the firm to be diversified) and so they tend to dislike risk (volatility of sales and profits) M&As can be used to diversify the company and reduce volatility (risk) that might concern managers.

Valuation Issues in Corporate Takeovers

Mergers and Acquisitions

Valuation Issues
What is Fair Market Value?
Fair market value (FMV) is the highest price obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arms length, with neither party being under any compulsion to transact.
Key phrases in this definition:
1. Open and unrestricted market (where supply and demand can freely operate see Figure 15 -2 on the following slide) 2. Knowledgeable, informed and prudent parties 3. Arms length 4. Neither party under any compulsion to transact.

Valuation Issues Valuation Framework

Demand
Supply

P
S1

B1

P*
Q

Valuation Issues
Types of Acquirers
Determining fair market value depends on the perspective of the acquirer. Some acquirers are more likely to be able to realize synergies than others and those with the greatest ability to generate synergies are the ones who can justify higher prices. Types of acquirers and the impact of their perspective on value include: 1. Passive investors use estimated cash flows currently present 2. Strategic investors use estimated synergies and changes that are forecast to arise through integration of operations with their own 3. Financials valued on the basis of reorganized and refinanced operations 4. Managers value the firm based on their own job potential and ability to motivate staff and reorganize the firms operations. MBOs and LBOs Market pricing will reflect these different buyers and their importance at different stages of the business cycle.

Market Pricing Approaches

Reactive Pricing Approaches
1. 2.

Models reacting to general rules of thumb and the relative pricing compared to other securities Multiples or relative valuation Liquidation or breakup values

Proactive Models
1.
A valuation method to determine what a target firms value should be based on future values of cash flow and earnings Discounted cash flow (DCF) models

Reactive Approaches
Valuation Using Multiples
1.

Find appropriate comparators Individual firm that is highly comparable to the target Industry average if appropriate

2.

Adjust/normalize the data (income statement and balance sheet) for differences between target and comparator including:
Accounting differences LIFO versus FIFO Accelerated versus straight-line depreciation Age of depreciable assets Pension liabilities, etc. Different capital structures Price-earnings ratio (trailing) Value/EBITDA Price/Book Value Return on Equity

3.

Calculate a variety of ratios for both the target and the comparator including:

4.

Obtain a range of justifiable values based on the ratios

Reactive Approaches Liquidation Valuation

1. 2. 3.

Estimate the liquidation value of current assets Estimate the present value of tangible assets Subtract the value of the firms liability from estimated liquidation value of all the firms assets = liquidation value of the firm.

This approach values the firm based on existing assets and is not forward looking.

The Proactive Approach

Discounted Cash Flow Valuation
The key to using the DCF approach to price a target firm is to obtain good forecasts of free cash flow Free cash flows to equity holders represents cash flows left over after all obligations, including interest payments have been paid. DCF valuation takes the following steps: 1. Forecast free cash flows 2. Obtain a relevant discount rate 3. Discount the forecast cash flows and sum to estimate the value of the target

Discounted Cash Flow Analysis

Free Cash Flow to Equity
Free cash flow to equity net income / non cash items (amortization, deferred taxes, etc.) / changes in net working capital (not including cash and marketable securities ) net capital expenditur es

CF1 V0 kg

CF CFt CF1 CF2 V0 ... 1 2 (1 k ) (1 k ) (1 k ) t 1 (1 k )t

Valuation Issues
Valuation Framework

Time Period

Free Cash Flows

Ct VT V0 t T (1 k ) t 1 (1 k )
Discount Rate

Terminal Value

Accounting Implications of Takeovers

Mergers and Acquisitions

Accounting for Acquisitions

Historically firms could use one of two approaches to account for business combinations 1. Purchase method; and 2. Pooling-of-interest method (no longer allowed)
While more popular in other countries, the pooling of interest is no longer allowed by: CICA in Canada Financial Accounting Standards Board (FASB) in the U.S. and Internal Accounting Standards Board (IASB)

Accounting for Acquisitions

The Purchase Method
One firm assumes all assets and liabilities and operating results going forward of the target firm. How is this done? All assets and liabilities are expressed at their fair market value (FMV) as of the acquisition date. If the FMV > the target firms equity, the excess amount is goodwill and reported as an intangible asset on the left hand side of the balance sheet. Goodwill is no longer amortized but must be annually assessed to determine if has been permanently impaired in which case, the value will be written down and charged against earnings per share.

Example of the Purchase Method

Accounting for Acquisitions
Acquisitor purchases Target firm for $1,250 in cash on June 30, 2010.
Acquisitor PreMerger 10,000 6,000 16,000 8,000 2,000 2,000 4,000 16,000 Target Firm (Book Value) 1,200 800 2,000 800 200 400 600 2,000 Target Firm (Fair Market Value) 1,300 900 2,200 800 250 1,250 2,300

Current assets Long-term assets Goodwill Total Assets Current liabilities Long-term debt Common stock Retained earnings Total Claims

Example of the Purchase Method

Accounting for Acquisitions
Goodwill = Price paid MV of Target firm Equity
= $1,250 (MV of target assets MV of target Liabilities)

= $1,250 ($2,200 - $1,050)

= $100
Acquisitor PreMerger 10,000 6,000 16,000 8,000 2,000 2,000 4,000 16,000 Target Firm (Book Value) 1,200 800 2,000 800 200 400 600 2,000 Target Firm (Fair Market Acquisitor Post Value) Merger 1,300 11,300 900 6,900 100 2,200 18,300 800 250 1,250 2,300 8,800 2,250 3,250 4,000 18,300

Current assets Long-term assets Goodwill Total Assets Current liabilities Long-term debt Common stock Retained earnings Total Claims

Why Global M&As Fail !!!

Research has conclusively shown that most of the mergers fail to achieve their stated goals.

Some of the reasons identified are:

Corporate Culture Clash

Lack of Communication Loss of Key people and talent HR issues Lack of proper training

Clashes between management

Loss of customers due to apprehensions Failure to adhere to plans

Why M&As Fail !!! (contd)

Research indicates that senior executives who have personal experience with a merger or acquisition rate underestimating the importance and difficulty of integrating the two cultures as a major cause of M&A failures. Organizational Culture & Cultural Integration

"How we get things done around here" is a short yet evocative definition of Organizational culture. It includes the emotional, cognitive and behavioral patterns among employees and how they interact with colleagues, customers, suppliers, and other stakeholders in their original firms.
Organizational culture includes the informal practices and the implicit norms and values that, as much as the codified rules, silently guide the how of employees' daily work.

Cultural Integration is the meshing of the two different Organizational Cultures. And when two firms combine, deal-makers and process managers always should be careful to integrate the formal rules and policies which previously governed each separate firm.

Failure of Cultural Integration can have adverse impacts on the M&A transaction:

Clash between the two Managements and clash between Management & Employees.
Creates differences among employees which can result in operational inefficiencies. Negatively affects the value creation process after the transaction is complete Loss of Key employees

Negatively affects the strategic communication process.

List of Total Mergers and Acquisition(M & A) of Domestic deals, 2010 in India
Acquirer Target Sector Deal Domestic Deals in January, 2010: 32 Deals of value $2.16 Billion
Penta Homes ACC Agro Dutch Industries Encore Cement and Addictive Agriculture Cement

S ($4.26 mn, up from 32.5% to 57.7%)

A

Dalmia Cement
Havells India Gitanjali Gems Ranbaxy Laboratories Delta Corp Aptech

Orissa Cement
Standard Electricals Morellato India Biovel Lifesciences Advani Pleasure Cruise Maya Entertainment

Cement
Electricals Gems and Jewellery Health care Hospitality Media

S ($37.66mn, 45.4%)
A ($25.53mn) A ($1.06mn) A S (50.99%) A ($16.17mn)

Spice Retail
Spice Mobiles

Global Access
Spice Televentures

Retail
Telecom Real Estate and Infrastructure Telecom

A
M

DLF
GTL Infrastructure

DLF-Liand O Rourke
Aircels 17,500 telecom towers

S ($10.64mn, 100%)
A($1.78bn)

Top 10 Mergers & Acquisitions in India for 2010

Tata Chemicals buys British salt Tata Chemicals bought British Salt; a UK based white salt producing company for about US $ 13 billion. The acquisition gives Tata access to very strong brine supplies and also access to British Salts facilities as it produces about 800,000 tons of pure white salt every year Reliance Power and Reliance Natural Resources merger This deal was valued at US $11 billion and turned out to be one of the biggest deals of the year. It eased out the path for Reliance power to get natural gas for its power projects Airtels acquisition of Zain in Africa Airtel acquired Zain at about US $ 10.7 billion to become the third biggest telecom major in the world. Since Zain is one of the biggest players in Africa covering over 15 countries, Airtels acquisition gave it the opportunity to establish its base in one of the most important markets in the coming decade Abbotts acquisition of Piramal healthcare solutions Abbott acquired Piramal healthcare solutions at US $ 3.72 billion which was 9 times its sales. Though the valuation of this deal made Piramals take this move, Abbott benefited greatly by moving to leadership position in the Indian market GTL Infrastructure acquisition of Aircel towers This acquisition was worth about US $ 1.8 billion and brought GTL Infrastructure to the third position in terms of number of mobile towers 33000. The money generated gave Aircel the funds for expansion throughout the country and also for rolling out its 3G service

ICICI Bank buys Bank of Rajasthan This merger between the two for a price of Rs 3000 cr would help ICICI improve its market share in northern as well as western India. JSW and Ispat Ki Kahani Jindal Steel Works acquired 41% stake at Rs 2,157 cr in Ispat Industries to make it the largest steel producer in the country. This move would also help Ispat return to profitability with time Reckitt Benckiser goes shopping Reckitt acquired Paras Pharma at a price of US $ 726 million to basically strengthen its healthcare business in the country. This was Reckitts move to establish itself as a strong consumer healthcare player in the fast growing Indian market. Mahindra goes international Mahindra acquired a 70% controlling stake in troubled South Korea auto major Ssang Yong at US $ 463 million. Along with the edge it would give Mahindra in terms of the R & D capabilities, this deal would also help them utilise the 98 country strong dealer network of Ssang Yong Fortis Healthcare acquisitions Fortis Healthcare, the unlisted company owned by Malvinder and Shivinder Singh looks set to make it two in two in terms of acquisitions. After acquiring Hong Kongs Quality Healthcare Asia Ltd for around Rs 882 cr last month, they are planning on acquiring Dental Corp, the largest dental services provider in Australia at Rs 450 cr

In the current cycle of mergers and acquisitions activity, many companies are contemplating demergers or spin-offs of unrelated business units.