nmims m & a presentation.1 (1)

8/7/2019 NMIMS M & A Presentation.1 (1)

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NMIMS University

Management of Mergers and Acquisitions


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I. Corporate Restructuring

This is an umbrella term, which covers different types such as merger,

acquisition, takeover etc.

There is no standard definition of corporate restructuring

Corporate restructuring can be defined as any change in the business

capacity or portfolio that is carried out by an inorganic route or a

change in the capital structure of a company that is not a part of its

ordinary course of business, or any change in the ownership of, or

control over the management of the company, or a combination

thereof.


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(a) Any change in the business capacity or portfolio that is carried out

by an inorganic route, or

(b) Any change in the capital structure of a company that is not in the

ordinary course of its business, or

(c) Any change in the ownership of a company or control over its

management, or a combination of any two or all of the above


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Any change in the business capacity or portfolio that is carried out by aninorganic route

Tata Motors launching Sumo and later on Indica

Acquisition of Jaguar Land Rover from Ford by Tata Motors, through itsstep down subsidiary, Jaguar Land Rover Limited

RILs backward integration from textiles to Polyester Filament Yarn (PFY)and Polyester Staple Fiber (PSF), and subsequently into Linear AlkylBenzene (LAB), Purified Terephthalic Acid (PTA), and Paraxylene (PX)

Merger of RPL, which set up a part of Hazira complex to manufactureEthylene Oxide (EO), Mono Ethylene Glycol (MEG), Vinyl ChlorideMonomer (VCM), Polyvinyl Chloride (PVC) and High DensityPolyethylene (HDPE) with RIL in 1991-92


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Acquisition of L&Ts cement division in the form of a separate company

named UltraTech Cement Limited by Grasim, by which the cement

capacity under the control of Grasim went up from 14 million tonnes to 31

million tonnes p.a. is a case of corporate restructuring by Grasim

For L&T this was reduction of its business portfolio and also amounted to

corporate restructuring of L&T.

Any change in the capital structure of a company that is not in theordinary course of its business

The capital structure is never static and changes almost daily.


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Any change in the ownership of a company or control over its

management, or a combination of any two or all of the above

Such a change could be affected through various methods such as: merger of two or more companies belonging to different promoters

de-merger of a company into two or more with control of the resulting

company passing on to other promoters

acquisition of a company

sell off of a company or its substantial assets delisting of a company


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The activities or changes which are not termed corporate restructuring

Initial creation of a corporate structure

Its various examples are:

Incorporation of a limited company Conversion of a proprietary concern into a company

Conversion of a partnership firm into a company

Conversion of a private company into a public company

Change in the internal command structure or hierarchy

Change in the business processes

Downsizing Other activities such as outsourcing, enterprise resource planning, total quality

management, franchising alliances, networking alliances, and licensing


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II. Various Forms of Corporate / Capital Structuring

a. Merger

b. Consolidation

c. Acquisitiond. Divestiture

e. De-merger (Spin Off /Split Up / Split Off)

f. Carve Out

g. Joint Venture

h. Reduction of Capitali. Buyback of Securities

j. De-listing of Securities


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III. Definitions

a. Merger

Involves combination of two (or more) companies such that one of

them survives.

b. Consolidation

Involves creation of an altogether new company owning assets and

liabilities of two or more companies, none of which survives.


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III. Definitions (continued)

Amalgamation

Merger by absorption

Merger by consolidation

Amalgamating company or Transferor company

Amalgamated company or Transferee company


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c. AcquisitionAn attempt or a process by which a company or companies or anindividual or a group of individuals acquires majority orcontrolling interest in another company called target company.

Acquiring control over a company means acquiring right to controlits management and policy decisions. Since, generally, a companyis managed under the supervision of its board of directors and allpolicy decisions are made by the board, acquiring control can also bedefined as acquiring right to appoint (and remove) majority of the

directors of a company.

In acquisition, unlike merger, the target companys identityremains intact


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There are many ways in which control over a company (called targetcompany) can be acquired:

1. By acquiring i.e. purchasing substantial percentage of the votingcapital of the target company;

2. By acquiring voting rights of the target company through a power ofattorney or through a proxy voting arrangement,

3. By acquiring control over an investment or holding company whether listed or unlisted that in turn holds controlling interest inthe target company,

4. By simply acquiring management control through a formal or

informal understanding or agreement with the existing person (s) incontrol of the target company.


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Acquisition of a target company through acquisition of its shares

How much percentage of shareholding an acquirer needs to acquirer?

There is no standard figure

Various Levels of Control

Absolute control

Practically absolute control

General control over a company

Substantial acquisition of shares can lead to three situations:

successful acquisition

partially unsuccessful acquisition

unsuccessful acquisition


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d. Divestiture

Out and out sale of all or substantially all the assets of the company

usually for cash. (But could also be for a combination of cash and

debt).

In short divestiture means sale of assets, but not in a piecemeal

manner.

It is also called slump sale under the Income Tax Act, 1961.

The consideration is normally payable in cash. It could be cash plus

debt but no part of consideration is payable in the form of equity

shares.


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e. De-merger (Spin Off /Split Up / Split Off)

Spin Off

Involves transfer of some of assets and liabilities of a company

normally of one of the business divisions- to a new company

whose shares are allotted to the original shareholders of the

company on a proportionate basis.

Split Up

Involves transfer of assts and liabilities to two or more companies

in which, again like spin off, the shares in each of the new

companies are allotted to the original shareholders of the

company on a proportionate basis.


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Split Off

It is a spin off with the difference that some of the shareholders of

the original company get shares in the new company in exchange of

their shares in the original company.

De-merged company

Resulting company


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f. Carve Out

Is a hybrid of divestiture and spin off. In this case, a company spins

off some the assets and liabilities to a new company and then sells a

part or all of the equity of a new company to a set of shareholders

which may or may not be the shareholders of the original company.

g. Joint Venture

It is an arrangement in which two or more companies contribute to

the equity capital of a new company.


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Normally joint ventures are formed to pool the resources of the partnersand carry out a business or a specific project beneficial to both the partnersbut which none of the partners wants to carry out under its own corporateentity for any one of the following reasons:

The venture may be highly risky Joint venture partners may be otherwise competitors

Neither of the partners may be willing to dilute control on hisbusinesses

To ensure that management control of the common business or projectis shared in the agreed proportion

To ensure that rewards of the common business or the project areshared in the predetermined ratio


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h. Reduction of CapitalThis is a legal process U/s 100 to 105 of the Companies Act, 1956 by

which a company is allowed to extinguish or reduce liability on any

of its shares in respect of share capital not paid up, or is allowed to

cancel any paid up share capital which is lost or is allowed to pay

off any paid up capital which is in excess of its requirement.

i. Buyback of Securities

This is a legal process U/s 77A, 77AA, and 77B of the Companies

Act, 1956 by which a company is allowed to buy back its shares or

other securities.


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Why would a company reduce its capital?

1. By extinguishing or reducing the liability in respect of share capital not

paid up (since not called as yet).

2. By writing off or canceling the capital which is lost

3. By paying off or returning excess capital that is not required by the

company


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j. De-listing of Securities

A company can list either its equity shares or preference shares or

debt securities on a stock exchange or exchanges. Therefore delisting

of a security could be delisting of any of the securities (and notnecessarily all) from any of the stock exchanges (and not necessarily

all).

When we refer to delisting of a company as a form of corporate

restructuring, we are mainly referring to delisting of its equity sharesfrom all stock exchanges


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IV. Pros and Cons of Organic and Inorganic Routes

a. Organic RoutePros:

Choice of Technology

Choice of Location

Milestone based consolidation

Overhead Control

Cons:

Slow Process

Does not eliminate or reduce competition immediately

Can involve disproportionate marketing expenditure

Regulatory hurdles Registration hurdles

Image / Brand hurdles

Funding for capacity expansion or marketing may be difficultto obtain but relatively easy for acquisition.


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IV. Pros and Cons of Organic and Inorganic Routes

b. Inorganic Route

Cons:

Valuation of target company may be difficult Acquirer may end up paying higher price

Post acquisition integration may pose serious problems in

terms of cultural integration, retrenchment or

redeployment of employees, software integration,

acceptance by customers and suppliers.


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V. Takeover Tactics

Friendly Takeover

Hostile Takeover

Tactics of Hostile Takeover:

a. Dawn Raid

In this tactic brokers acting on behalf of predator / raiderswoop down on stock exchange (s) at the time of its openingand buy all available shares before the target / prey wakesup.

b. Bear HugRaider / Predator sends a very attractive tender offer meantfor the target / preys shareholders to the targets / preysmanagement and asks them to consider the same in theinterest of the shareholders.


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V. Takeover Tactics (continued)

c. Saturday Night Special

This is the same tactic as bear hug, but made on the Friday

or Saturday night asking for a decision by Monday. This is

also called Godfather Offer.

d. Direct Offer to the Shareholders of the Target Company

Raider makes a straight open offer to shareholders of the

target company without giving chance to the existing

management to evaluate the same.


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V. Takeover Tactics (continued)

Sound Tactics of Hostile Takeover in the Indian Context:

a. Market Accumulation followed by an Open Offer

b. Negotiated Deal with Financial Institutions followed by an Open Offer

c. Negotiated Deal with a Breakaway Promoter Faction followed by an

Open Offer

d. Direct Offer to the Shareholders of the Target Company


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VI. Defence Tactics

a. Crown Jewels

Target company sells its highly profitable or attractive

business / division to make the takeover bid less attractive tothe raider

b. Blank Cheque

Target company makes a preferential allotment to existing

promoters or friendly shareholders to increase the control of

promoter group. This may involve issuing a new class of

shares also.


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VI. Defence Tactics (continued)

c. Shark Repellents

The target company amends its charter i.e. MOA or AOA to

make the takeover expensive or impossible. E.g. stipulating a

certain minimum educational qualification for directors orstipulating that a supermajority would be required to approve

a merger

d. Poison Pill

The term poison pill is used to generally refer to any strategy,which upon successful acquisition by the acquirer creates

negative financial results and leads to value destruction.


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Poison pill can take various forms:

1. Issue rights / warrants to the existing shareholders entitling them toacquire large number of shares in the event an acquirers stake in thecompany reaches a certain level (say thirty percent). This is also called

shareholders rights plan.

2. Add to its charter a provision that gives the current shareholders a rightto sell their shares to the acquirer at an increased price (say hundredpercent above the last two or four weeks average price)

3. Borrow large long term funds from banks or financial institutions, orother lenders, for its genuine need. But the repayment terms would besuch that in the event of takeover of the target company the same wouldbecome repayable immediately.


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4. Borrow not for its genuine needs but for paying one time huge dividend

to the shareholders. This tactic is also called as leveraged cash

out

5. Buy back shares using borrowed funds. This is also called as leveraged

recap (orleveraged recapitalization).


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e. Poison Put

The tactics of leveraged recapitalization and leveraged cash

out discussed above are called as poison put by some

authors.

f. Scorched Earth Strategy

This is extreme form of Poison Pill that can endanger the

viability of the target immediately upon takeover being

successful.


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g. Pacman

Target company or its promoters start acquiring sizable

holding in raider, threatening to acquire the raider itself,

making it run for cover and forcing it to hammer out a truce.

h. Green Mail

The target company or existing promoters arrange through

friendly investors to accumulate large stock of its shares with

a view to raising its market price high to make the takeover

very expensive to the raider.


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Some times green mail is used to describe an arrangementcalled target block repurchase with standstill agreement.This means that the target company or its present promotersagree to buyback the shares being accumulated by the raiderat a substantial premium and in return the raider enters into

agreement that neither he nor any of his associates shallacquire any sizable stake in the target company for astipulated period of time.

i. White Knight

In this, the target company or its existing promoters enlistthe services of another company or group of investors to actas white knight and takeover the target thereby foiling thebid of the raider and retaining the control of existingpromoters


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j. Grey Knight

In this, the services of a friendly company or group of

investors are engaged to acquire shares of the raider itself to

keep the raider busy defending himself and eventually force

a truce.

k. Golden Parachute

The contractual guarantee of a fairly large sum of

compensation to top and / or senior executives of the target

company whose services are likely to be terminated in casethe takeover by the raider succeeds.


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VII. M&A Theories

Though primary motive is growth, there are other motives such as various

synergies etc. Also the growth motive has different dimensions.

Let us look at the theoretical framework

Friedrich Trautwein has propagated the following theory. He classifies Merger

(incl. Acquisition) Motives or Theories as follows:


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VII. M&A Theories (continued)

a. Merger as Rational ChoiceMergers that benefit the bidders / raiders shareholders

y Monopoly Theory

(Wealth transfer from the targets customers)

y Efficiency Theory

(Net gains through synergies)

y Valuation Theory

(Wealth transfer through private information)

y Raider Theory

(Wealth transfer from the targets shareholders)

Mergers that benefit the bidders / raiders managers

Empire Building Theory


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b. Merger as Process Outcome

Process Theory

c. Merger as Macroeconomic Disturbances

Disturbance Theory


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Monopoly Theory

This theory explains M&A as being planned and executed to achieve Market

Share and Market Power including at times Pricing Power. In other words it

confirms that M&A is primarily used as growth strategy.

As mentioned earlier, the growth motive / strategy itself has different

dimensions:

a. Market leaders trying to consolidate their position furtherb. Profitable and Cash Rich companies trying to gain market leadership

c. India / Global entry Strategy


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1. King Fischer Airlines acquiring Deccan Airways and Jet

Airways acquiring Sahara Airlines.

2. Mittal Steel acquiring Arcelor

3. Tata Steel acquiring NatSteel and then Corus

4. Idea Cellular acquiring Spice Communication

5. Tata Tea acquiring Tetley

6. Daiichi Sankyo acquiring Ranbaxy

7. Vodafone acquiring Hutchison Essar

8. Grasim acquiring L&Ts UltraTech Cement Division.


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Manufacturing Synergy

Manufacturing Synergies can be achieved not only through vertical

acquisitions but also through horizontal acquisitions. It essentially involves

combining core competence of the acquirer company and target company in

the different areas of manufacturing, technology, design and development etc.

It could also mean rationalising usage of the combined manufacturing

capacities.

1. Tata Motors acquiring Daewoos commercial vehicle unit

2. M&M acquiring Jiangling Motors in China

3. Daiichi Sankyo acquiring Ranbaxy

4. Tata Steel taking over Corus


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Operations Synergy

Operations Synergy involves rationalising the combined operations in such a

manner that through sharing of facilities such as warehouses, transportation

facilities, software, common services such as Accounts & Finance, Tax, HR,Administration etc. duplication is avoided or logistic is improved leading to

quantumcost saving.

1. King Fischer Airlines acquiring Deccan Airways and Jet Airways

acquiring Sahara Airlines2. Star TV acquiring a stake in Balaji and Zee TV acquiring ETC

3. VSNL acquiring Tyco

4. Reliance acquiring FLAG


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Marketing Synergy

Marketing synergy involves using either common sales force, or distribution

channel or media to push the products and brands of both the acquirer and

target companies at lower costs.

1. Dilip Piramals VIP acquiring Universal Luggage

2. HLL acquiring Lakme brand and its cosmetics business


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Financial Synergy

Financial Synergy involves achieving either lower cost of capital or better

gearing ratio, or other improved financial parameters by combining both the

balance sheets.

Merger of Reliance Petrochemicals with Reliance Industries in the year 1991

-92.

As on 31-03-91 the RIL had following capital structurePUC Rs. 152.12 Crore

Reserves Rs. 995.53 Crore

Net Worth Rs.1147.65 Crore


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As on the same day RPL had PUC and Net Worth of Rs. 749.28 Crore. Its

refinery was just about to go on stream. Ambanis merged RPL with RIL at a

ratio of 10:1. This added only Rs. 74.93 Crore to PUC of RIL and whopping

Rs. 674.35 to its Reserves. Along with the retained earnings of Rs. 40.87 Crore

from 1991-92 operation RIL capital structure as on 31-12-92 became:

PUC Rs. 227.07 Crore

Reserves Rs. 1710.75Crore

Net Worth Rs. 1937.82 Crore


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Ambanis repeated the same thing in 1994-95 when they merged Reliance Poly

Ethylene Ltd. (RPEL) and Reliance Poly Propylene Ltd. (RPPL) with RIL and

added Rs. 99.58 Crore to PUC and Rs. 603.00 Crore to Reserves of RIL.


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Tax Synergy

Tax Synergy involves merging loss making company with a profitable one so

that the profitable company can get tax benefit by writing off accumulated

losses of the loss making company.


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Valuation Theory

This theory explains that the M&A are planned and executed by the acquirer

who has better information about the valuation of the target than the stock

market as a whole and who estimates the real intrinsic value to be much higher

than the present market capitalization of the company. Therefore such an

acquirer is ready to pay premium to the present market price to acquire control

over the target company.

This theory is in sharp contrast to the Efficient Markets theory. What

Efficient Markets theory argues is that stock markets are perfect and

efficient when it comes to determining the right valuation of any company.


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Then how is it possible that the market capitalization is much below the true

intrinsic value of the company? Also, is there anything like true intrinsic value

of any company?

Rather than going into theoretical debate, we can look at this from different

practical aspects:

1. Though, by and large, markets are perfect, there are information gaps,

costs and also critical inside information. If acquirer becomes privy to

such information before the stock market, he will find the intrinsic value

of the company to be much higher than the market capitalization.


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2. The acquirer may have the same information about the company asstock market, but a different view on the future cash flows basedon his own reading of the future course of the economy or thecompany.

3. In case of those companies that have substantial off balance sheetassets or substantially undervalued non-operating assets, which arenot being encashed by the present management, the acquirer may

have a game plan to encash upon these assts and hence he would putmuch more value to the company than the stock market.


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4. Economies and stock markets always show a cyclical pattern. A boom

is followed by depression and vice-a-versa. During a phase of prolonged

depression in the economy and stock market, the market capitalizations

of companies go much below their replacement costs. Ratio of market

capitalization to replacement cost is known as Q Ratio. When depressionends and economy starts looking up, stock market starts valuing the

company progressively higher expecting better cash flows in the

improved times. In this sense a cash rich company planning to acquire

competitors, can find undervalued companies at the end of a

prolonged depression just before the boom picks up.


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5. In case of underperforming companies having strong brand (s), theacquirer may be confident of leveraging on such brands and generate

higher growth and cash flows and hence may put a much highervalue to the company than the stock market.


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Raider Theory

Rider Theory explains the M&A activity in the specific context of PE Fundswho acquire controlling stake in cash needy companies at much lowervaluation than potential or even present valuation, just to transfer thewealth from existing shareholders to themselves without any strategic

intent of running these companies themselves.

Empire Building Theory

Empire Building Theory tries to explain M&A as being planned and executedby the managers for expanding their own empire rather than crating

shareholder wealth.


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VIII. Intents of Target Companies

1. Exiting Non Profitable Business

Global Trust Bank being merged with OBC

NOCIL selling out to RIL

2. Exiting Non Synergistic or Non Core Business

L&T selling out Ultra Tech Cement Division to Grasim

3. Generate Cash Flow for Other Business (es)

India Cement selling 94.69% stake in Shri Vishnu

Cement to generate Rs. 385 Crore for funding its own

expansion


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VIII. Intents of Target Companies (continued)

4. Inability real or perceived to withstand

competition

} Lakme selling out to HLL

} Ramesh Chauhan selling out Thumps Up, GoldSpot to Coca Cola

5. Inability to achieve further growth

} Bazee.com selling to e-Bay

} Daksh e-Services selling to IBM

} Spice Telecom selling to IDEA


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VIII. Intents of Target Companies (continued)

6. Inability to mobilize further resources for business

growth

} Investment by Warburg Pincus in Max Group tofund Life Insurance and Healthcare businesses

} Notz Stucki investing in Camlin

} Deccan Airways selling out to King Fischer

Airlines


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IX. Typical Characteristics of Takeover Candidates

a. Low Market Capitalization vis--vis Intrinsic(Present/Potential) Value

b. Low Market Capitalization vis--vis Replacement

Cost of Assets

c. Low Market Capitalization vis--vis Book Value

d. Cash Flows in excess of Debt ServicingRequirements

e. Lowly Geared Companies

f. Moderate or low growth vis-a-vis Industry growth

g. Underperforming Companies

h. Unexploited Brand Potential

i. Undervalued and Saleable non operating assets.

j. Large off Balance Sheet Assets


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IX. Typical Characteristics of Takeover Candidates

(continued)

In all the above cases one basic requirement is low promoter holding

or willingness of Promoters or some of the promoters to sell their

stake.

nmims m & a presentation.1 (1)

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