An Analytical View of Mergers and Acquistions

8/4/2019 An Analytical View of Mergers and Acquistions

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EXECUTIVE SUMMARY

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The topic selected by me is An Analytical View of Mergers and Acquisitions. This topic

mainly deals with knowing the meaning, procedure, valuation techniques, financing

techniques, role of Industry Life Cycle on M&A, Consideration involved in International

Mergers and Restructuring.

This topic mainly covers the Pre and Post merger success factors for adoption by firms

involved in M&A activity, why mergers are not always successful, what motivates

executives to initiate mergers and acquisitions what are the five sins of mergers and

acquisitions, and pros and cons of Mergers.

OBJECTIVES

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The main objectives of study are:

To know why organisations go for M&As.

To know how valuation is placed a firm in M&As.

To see whether wealth maximisation mode is applicable to M&As.

To improve the role of Intermediary professionals involved in M&A activity.

To know pre and post merger success factors in M&A.

To know why mergers are not always successful.

To analyse live case study on merger.

RESEARCH METHODOLOGY

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For carrying out this dissertation, I have used secondary data i.e. data is collected from various

sources (internet, company records, magazines, books, newspapers). I have used large secondary

data from academic texts, financial software package and business journals and magazines.

Since M&As is secretive activity till announcement of public officer for purchase of shares as

per SEBI guidelines, it is impossible to get Company officials to fill-in structured questionnaires

(to obtain primary data.) hence I resorted to personal interviews with key Company Officials to

obtain primary data.

LIMITATIONS

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Gathering of data was difficult as the data was collected from various newspapers,

journals, company records, books etc.

Due to the time constraints, it was really very difficult to collect much data.

As the data was collected from the past records, we can say that the data being collected

would be misleading.

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INTRODUCTION

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Growth is an essential ingredient to the success and vitality of many companies. Growth can be

either external or internal. In case of internal growth a firm acquires specific assets and finances

them by the retention of earnings or external financing. External growth, on the other hand,

involves the acquisition of another company.

All our daily newspapers are filled with cases of mergers, acquisitions, spin-offs, tender offers,

& other forms of corporate restructuring. Thus important issues both for business decision and

public policy formulation have been raised. No firm is regarded safe from a takeover possibility.

On the more positive side M&As may be critical for the healthy expansion and growth of the

firm. Successful entry into new product and geographical markets may require M&As at some

stage in the firm's development. Successful competition in international markets may depend oncapabilities obtained in a timely and efficient fashion through M&As. Many have argued that

mergers increase value and efficiency and move resources to their highest and best uses, thereby

increasing stakeholders value.

To opt for a merger is a complex affair, especially in terms of the technicalities involved. We

have discussed almost all factors, which the management may have to look into before going for

merger. Considerable amount of brainstorming would be required by the managements to reach

to a conclusion. E.g. a due diligence report would clearly identifies the status of the company in

respect of the financial position along with the networth and pending legal matters and details

about various contingent liabilities. Decision has to be taken after having discussed the pros &

cons of the proposed merger & the impact of the same on the business, administrative costs

benefits, addition to shareholders' value, tax implications including stamp duty and last but not

the least also on the employees of the Transferor or Transferee Company.

MEANING

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Mergers, takeovers, divestitures, spin off, and so on, referred to collectively as corporate

restructuring, have become major force in the financial and economic environment all over the

world.

A merger is popularly understood to be a fusion of two companies. In United Kingdoms

monopolies and Mergers Act of 1965 merger means two enterprises by or under the control of a

body corporate ceasing to be distinct enterprises. Merger is often known as amalgamation,

especially when merging two business entities.

A company acquires an undertaking and the consideration thereof paid by cash, share and such

other form as may be mutually agreed. Thus, essentially, in a merger, the Physical undertaking isrequired. Mergers are permanent form of combinations, which vest in management control and

provide centralized administration, which are not available in combination of holding company

and its party owned subsidiary.

Shareholders in the selling company gain form the merger as the offered to induce acceptance of

the merger offers much more price than the book value of shares. Amalgamation is an

arrangement whereby the assets of two companies are vested in one which has its shareholders

all or substantially all the shareholders of two companies.

Amalgamations are governed by section 390 to 396 of the companies act. Acquisitions, is a

preferred route of acquiring shares of the company when the buyers is Interested in a particular

business of the seller company, and not in the whole company. Acquisition may be carried out in

two ways. The company may adopt the route of Section 391 to 394 of the companies act 1956,

which is applicable to a full merger.

Alternatively, the transaction may be carried out in the form of an outright sale. A corporate

acquisition is the purchase by one company (the bidder or acquiring firm) of a substantial part of

the assets or securities of another (the target of acquired firm), normally for the purpose of

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restructuring the operation of the acquired entity. The purchase may be of a division of the target

firm, or all or a substantial part of the targets voting shares (mergers or partial take-overs). Bids

or sometimes directed towards the acquiring firms own shareholders, as in a minority buyout or

in a leveraged buyout (LBO) where a group of investors typically involving the firms owns

management acquires all the outstanding voting shares.

Takeover is normally an unfriendly acquisition by tender offer. Companies are sometimes

consolidated into a new company. This happens when the two companies are about the same

size. The shareholders of two companies which are consolidated give their share and are allotted

shares in the new company through purchase of portion of shares sometimes acquisition ofcontrol is preferred to full acquisition and act as a holding company. Holding company is a firm

that owns sufficient shares in one or more companies.

Types of Mergers

A. Vertical Mergers

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B. Horizontal Mergers

C. Circular Mergers

D. Conglomerate Mergers

E. Reverse Merger

A. Vertical Mergers

In vertical type of merger, the company either expands backwards towards the source of raw

material or forward in the direction of the customer. This is achieved by merging with either

a supplier or buyer, using its product or intermediary material for final production. When

merger or acquisition is done in the reverse order of the supply chain management it is

known as backward integration while when it is done to acquire business of the buyer of theexisting offering it is known as forward integration.

B. Horizontal Mergers

When two firms operating in the same line of business and catering to the same segment of

customer or operating at the same stage of industrial process merge together it is known to be

Horizontal type of merger. In simpler words when two competing firms merge together it is a

horizontal merger.

C. Circular Mergers

Companies producing distinct products or providing distinct services seek amalgamation to

share one or other common areas of operation like distribution network, agent network,

service centers, research facilities etc to obtain economies by elimination of duplication of

cost. Both the companies i.e. acquirer and target company get benefits in the form of

economies of resource sharing and diversification.

D. Conglomerate Mergers

Amalgamation of two companies engaged in unrelated industries. Such mergers are for the

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purposes like utilisation of financial resources, to enlarge debt-procuring capacity, diversify

the business risks, enter into new emerging fields, & also to take advantage of managerial

synergies.

E. Reverse Merger

There are two modes in which reverse merger are understood. First, the commonly known

mode of reverse merger is the merger of a healthy company into a sick / loss-making

company as compared to normal merger under which loss making company merges into

profit making company. Most of the time this mode is construed synonymous to reversemerger. However, technically, it is categorized as tax friendly merger.

Second mode of reverse merger is the merger of an unlisted company into a listed company.

Technically, it is categorized as listing friendly merger.

The prime purpose behind reverse merger is to get benefits of set off against loss and other tax

benefits available to loss making company, most of which are not available in normal merger. It

also avoids necessity of getting special permission under tax laws (section 72A of Income Tax

act, 1961 or under special statute for rehabilitation of sick industrial companies) other purposes

behind reverse merger could be savings in stamp duty, public issue expenses, getting quotation

on a stock exchange etc.

ASPECTS RELATING TO MERGERS AND ACQUISITIONS

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There are several aspects relating to M&A that are worthy of study, important among of

them are:

1. What are the basic forces that lead to M&As. How do these interact with one another?

2. What are the managers true motives for M&As.

3. Why do M&As occur more frequently at some times than at other times? What are

segments of economy that stand to gain?

4. How mergers and acquisitions decisions could be evaluated.

5. What managerial process is involved in M&A decisions.

WHEN DOES A MERGER TAKES PLACE

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The selection of a business partner in a merger depends on the purpose of the merger or the

business objective. The merger could be between two related companies or non-related

companies.

The underlying reason for the merger is maximization of shareholders wealth. As with any

investment decision the cost of merger should be evaluated in terms of net present value of its

expected cash flow.

The objective of the merger is value creation. The factors that are responsible for value creation

are economies of scale, financial advantage, synergy and tax advantage.

Synergism: Merger helps in achieving operating economies. Marketing, accounting,

purchasing, and other operations can be consolidated. Mergers of firms manufacturing

complimentary products would result in an increase in total demand for products of the

acquiring company. The realization of such economies would enhance the value of the

merged company. The whole larger than the sum of the parts.

This is called Synergism. That is 2+2=5.

Complementary Resources: If two firms have complimentary resources, it may

make sense for them to merge. For example, a small firm with an innovative product may

need the engineering capability and marketing reach of a big firm.

Economies of scale: In addition to operating economies, economies of scale and

reduction of average cost with increase in volume, may be realized when the merging

companies are in the same line business. Such horizontal mergers eliminate duplication

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and concentrate a greater volume of activity in to a given facility. Vertical mergers where

company expands forwards towards the consumer or backwards towards the source of raw

material by giving a company control over distribution and purchasing also bring in

economies. There can be diseconomies of scale too. If the scale of operations and the size of

organization become too large and unwidely. The optimal scale of operation is the one at

which unit cost is minimal. Beyond this optimal point the unit costs tend to increase. The fig

below represent:

Strategic Benefits: The strategic advantages may be

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Optimal Scale

Average Cost

Scale of Operation

Behavior of Average Cost per Unit


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1. As a pre-emptive move it can prevent a competitor from establishing a similar

position in industry.

2. It offers a special timing advantage because the merger alternative unable affirms to

Leap frog several stages in the process of expansion.

3. It may entail less risk and even less cos.

4. In a saturated market simultaneous expansion ad replacement (through a merger)

makes more sense than creation of addition capacity through internal expansion.

Managerial Effectiveness: More effective management may also give

rise to synergy. Very often the entrenched management which is efficient can only be

dislodged may merge. Actually the acquisition makes sense if the acquirer can

provide better management. Mergers can also convey information on underlying

profitability of the bought company. Merger may give rise a positive signal if the

stock is believed to undervalued.

Tax Shield: Tax factor often motivate a merger. In the case of carry

forward losses, a sick company with cumulative taxes loses may have little prospect

of setting of such losses against future earning. By merging with a profit making

company (under section 72A of the income tax act), the carry forward can be

effectively utilized.

Holding company is often used as a device to acquire controlling interests.

With lower controlling interest the functions of the two companies are integrated to

realize economies of scale. On the other hand, the price pay is much less that the

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purchased. Capital requirement for achieving the same result as in the case of merger

is much less. The holding company benefits through its controlling interests from the

leverage aggregation or assets with small investments.

Finally, hubris hypothesis suggest that excess premium paid for the target

company benefits share holders but the shareholders of the acquiring company suffer

a diminishing in wealth. I stead of rational behavior, the bidder gets caught in hubris

an animal like spirit of arrogant pride and confidence where they would like to

acquire the company at any cost.

Sometimes specific shareholders of a closely held company who has a

controlling interest may want their company acquired by another that has an

established market for share. The shareholder of the closely held company by

merging with the publicly held company may obtain an improvement in liquidity of

their investments.

Merger is effected through either purchase of asset of share toward that of

tender offer or friendly takeover is made. Is assets are purchased buyer avoids hidden

or contingent liability. Its easy to negotiate assets purchased.

Share my purchase from the market to acquire a controlling inertest and the

target company may maintain as a subsidiary or division or dissolve to merger. For

merger, shareholders representing 75 percent of the value of shares of the Target

Company must approve.

DUBIOUS REASONS FOR MERGER

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Often mergers are motivated by desire to diversify lower financing cost, and achieve a higher

rate of earnings growth. Though these objectives look worthwhile, prima-facie, they are not

likely to enhance value.

Diversification: A commonly stated motive for mergers is to achieve risk reduction through

diversification. The extent, to which risk reduced, of course, depends on the correlation between

the earning of the merging entities. While negative correlation brings greater reduction in risk.

Positive correlation brings lesser reduction in risk.

Lower Financing Costs: The consequence of larger size and greater earnings stability, many

argue is to reduce cost of borrowing for the merged firm. The reason for this is that the creditorsof the merged firm enjoy better protection than the creditors of the merging firm independently.

If two firms A and B merger, the creditors of the merged firms (call it firm AB) are protected by

equity of both the firms. While this additional protection reduces the cost of debt, it imposes an

extra burden on the shareholders; shareholders of firm A must support the debt of firm B, and

vice versa in an efficiently operating market, the benefit to shareholders form lower cost of debt

would be offset by the additional burden by the-as a result there would be no net gain.

Earning Growth: A merger may create the appearance of growth in earnings. This may

stimulate a price rise if the investors are fooled.

An example may be given to illustrate this phenomenon.

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Suppose Ram Limited acquires Shyam Limited. The pre merger financial position of Ram

limited and Shyam Limited are shown in columns 1 and 2 of table 10.2 Ram Limited has

superior growth prospects and commands price earning multiple of Shyam Limited. On the other

hand, has inferior growth prospects and sells for a price earning multiple of 10. The merger is

not expected to create ant additional value based on the pre merger market prices. The

exchange ratio is 1:2 that is 1 share of Ram Limited as given in exchange for two shares of

Shyam Limited.

Financial position of Ram Limited and Shyam Limited

Particulars Ram Ltd Shyam Ltd Ram Limited after merger

Before BeforeMerger Merger

The Market Is

Smart

The Market Is

Foolish

1 2 3 4

Earnings per

share

Rs2 Rs2 Rs2.67 Rs2.67

Price per

share

Rs40 Rs20 Rs40 Rs53.4

Price-Earnings

ratio

Rs2 Rs2 Rs2.67 Rs2.67

Number of

shares

Rs20 Rs10 Rs15 Rs20

Total Earnings Rs20 ml Rs20 ml Rs40 ml Rs40 ml

Total Value Rs400 ml Rs200 ml Rs600 ml Rs800 ml

If the market is smart, the financial position of Ram Ltd, after the merger, will be as shown in

column 3 of the table above. Even though the earning per share rises the price-earning ratio falls

because the market recognizes that the growth prospect of the combined firm will not be as

bright as those of Ram Ltd alone. So the market price per share remains unchanged at Rs 40.

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Thus, the market value of the combined company is simply the sum of the market values of the

merging companies.

If the market is foolish, it may regards the 33 percent increase in earning per share as

reflection of true growth. Hence the priceearning ratio will not fall. With the higher earning per

share and an unchanged price-earning ratio, the market price per share of Ram Ltd will rise to Rs

53.4 this will lead to an increase in market value from Rs 600 to Rs 800 ml.

Thus if the market is foolish, it may be mesmerized by the magic of earning growth. Such an

illusion may work for a while in an inefficient market as the market becomes efficient the

illusionary gains are bound to disappear.

Hostile Takeover:

A tender offer to purchase share of another company at a fixed price from shareholder who

tender that may be made by the acquiring company. The tender offer allows the acquiring

company to bypass the management of the company.

Purchase of shares from the market or through the tender is likely to be expensive if the target

board is not receptive. A hostile takeover through a proxy fight is resorted.

GUIDE TO VALUE CREATING M & A

The guns are booming, empowered by the new takeover code, and emboldened by the

emergence of vulnerable quarries in a troubled economy, corporate India corner room

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buccaneers have unleashed the countrys third M&A wave. The new legal framework governing

M&A activity has opened the doors to hostile takeovers, setting out objective guidelines and

allowing the predator and the prey get on with their attack and defense maneuvers without the

securities & Exchange board of India having to step in as arbitrator. Simultaneously, the market

for corporate control has exploded, with M&A being accepted as vital means for corporate

restructuring and redirecting capital towards efficient management.

No wonder than, that in space of one blistering fortnight this past month, half a dozen M&A

battles were initiated. The predator lurking within Rs 8,342.5- crore Hindustan Lever resurfaced

with the negotiated acquisition of Rs 59.11 crore Lakme from the Rs 35,000- crore Tata

Group. A potent takeover Sud, targeting a 20 percent stake, was fired at the Rs 1,162.78 croreIndian Aluminium by the Rs1,146.72- crore Sterlite Industries. Alarmed by the prospects of

consolidation in the aluminium industry, the Rs 1,457.15-crore Hindalco immediately launched a

broadside against the Rs 162.28-crore Pennar aluminium bidding for a 13 percent chunk of the

company.

The benefits of a successful acquisition are powerful, offering as they do dominate market

shares, the strength of sheer size and unique competitive advantages.

Only recently unfettered from the rigid shackles of government control and exposed to market

forces corporate India will now have to chalk out and carry though long term corporate strategies

To enhance competitiveness and sustainability. They will have to index internal ability, and to

changes in their industries and in the overall economy-to best avail the opportunities available.

The prime motives behind employing M&A for restructuring

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Rectifying the distortions of the past decades of the licence raj, where growth and

diversification were led more by an ability to carry favour with the bureaucracy than

by the virtues of value creation.

Consolidation of small and fragmented players.

The compulsion to become world size because of the globalization of the economy,

requiring corporation to focus their areas of core competence and to form alliances

with global players.

The need to take advantage of the relaxation in government policy, which is allowing

companies to take decisions that are based on economic realities.

The use of M&A as corporate strategy raises important issues

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M&A may be critical to the healthy expansion of business as they evolve through success stages

of growth and development. For, both internal and external growth may be compatible with the

long-range evolution of the company. Successful entry into new geographic and product markets

often requires the speed, accompanied by an existing infrastructural framework that only M&A

can give access to. For these, as well as other reasons, some economists argue that M&As

increase value through efficiency gains,

Since there is little scope for companies to learn from experience as M&A is a sporadic and

time-consuming process. Importantly, how does a predator determine whether or not a

planned acquisition will prove beneficial?

The solution: Identify possible ways of improving future gains by carefully selecting the type

mergers, the target company, the anticipated efficiencies, and a management strategy that will

maximize potential synergy.

VALUE CREATION AS THE ULTIMATE OBJECTIVE OF M&A

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M&A IS BECOMING EASIER

Corporates restructuring is creating a market for both acquisition and disposal ofbusiness units. Two years of economic slowdown are causing shakeouts in manysectors, forcing losers to exit.

Share prices are low enough to make acquisition of large equity stakes feasible interms of price.

A formal takeover code has laid out the mechanism for both hostile and negotiatedtakeover.

The financial institutions are for the first time, willing to help the M&A game byselling their holding.


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The management challenge for any corporations is to optimize the allocation of scarce and

expensive resources such as capital, labour, research, training, and in order to increase

productivity. This in turn, will boost value. The corporate usually has several options, and must

assess the viability of each route given the expected increase in value it can provide. As there is

great uncertainly about the success of each strategy so far as long-term profitability is concerned,

even well intentioned moves do not often improve shareholder value. M&A too should be placed

within the framework of long range strategic planning.

Thus the objective of buying or selling business units and bringing in accompanying changes in

management should only be undertaken if M&A will yield value to the respective companies.

The basic motive of M&A can than be understood as an attempt to create value. The equation:

Synergy= Combined value of post M&A

A&B MINUS (value of company a PLUS value of company B)

Only if the synergy is positive will there be an economic justification for the merger. It must also

be remembered that there are several costs to an M&A maneuver the price the opportunity the

cost of the acquisition, and softer issue such as culture clashes, integration friction all of which

lead to a price having to be paid the companies coming together; while it isnt easy to factor

these in the attempt should be make a realistic assumption about such costs. Using these

calculations, the acquirer can then work out what his real cost of acquisition is.

Premium=price over market value PLUS

Other costs of integration

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The next step: Computing the actual value derived from the acquisition.

Net Value Gain= Synergy MINUS premium

From this simple analysis it is clear that mergers will fall if the expected synergy does not

exceed the premium paid, thereby creating no value for the bidder. However, many companies

do not realize that they to work specifically towards achieving these synergy. It is in fact,

possible to synergy-by carefully selecting the type of the merger, the target, and an optimum

management strategy. Thus, the acquirer should not only have a clear understanding of its

motivation for the M&A move, but must also link a management strategy to the motivation forthe acquisition. This will help the corporates improve their understanding of the correlation

between strategy and value-creation enable them to index the possible gains from M&A, Endure

realistic pricing, anticipate and, ultimately judge the impact on value.

FRAME WORK FOR OPTIMISING M&A VALUE

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External growth M&A is not only difficult, but rarely value creating. Many acquisitions fail due

to over-anticipated potential synergies, large premiums, different and opposing cultures, mixed

and confusing goals. There is an acute need for a holistic analysis of the M&A process, which

link strategy to the value drivers, in order to optimize the potential gains. What follows is simple

framework call it the value strategy chain for mapping specific strategies.

The Value-Strategy Chain Framework is a simple model for identifying strategies that will

improve the net gains from M&A. its strategies to the element of valuation, or value drivers. The

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Standalone value of

target (without any

takeover premium)

Value of

Synergies

Transaction

Costs

Value of

target to

acquires

Value of nextbest

alternative (nomerger

therefore

Net value gained

from acquisition

Value of acquirer Combined Value Price paid

(Including Premium)

THE VALUE CREATION FRAMEWORK


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implementation of these strategies will improve the performance of specific value drivers by

enhancing the efficiency of the merged company. To optimize synergies in M&A, companies

might have to target more than one value drive, thereby implementing over lapping strategies.

The Strategic Star benchmarks the relative position of these value drivers against industry

analysis. This prioritises the value drivers that the acquisition should target.

IDENTIFYING THE M&A VALUE DRIVERS

To optimize the value gain, it is obvious that the synergy should be maximized while the

premium is minimized. Thus:

Value created through M&A =Increase in synergy MINUS decrease in premium

INCREASING SYNERGY Synergies are possible from the efficiency gains that the post

acquisition entity can tap. These gains accure due to improvements in management, financials,

operations, and risk-control, as well from a reduction in some inefficiencies. If these synergies

are to be exploited, the value of the combination must exceed the sum of its parts

a) Achievement of progress and influence in industry.

b) Increased productivity by reason of more efficient and effective utilization of all

resources.

c) Often it is cheaper to bye or acquires an existing firm than to build a new business plant.

d) Under certain condition, market entry is more easily possible through acquisition of

existing firms.

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e) Merger or acquisition not only secures for an expanding firm the necessary working plant

and equipment more but also it may help the firm to avoid the problems of access to

scarce raw materials.

According to Harry Levinson many mergers have been disappointing in their result and painful

to their participants primarily due to psychological reasons. Research studies on the value of

mergers have shown that the growth rate and profitability of the combined organization tend to

decline as compared with the performance of the combining firms. Executives of the acquired

firm lose their status, authority and even jobs. From the social point of view merger give rise tomonopolistic conditions with increased concentration of economic and political power, higher

prices, and other abuses of monopoly.

Guide Lines for Effective Mergers

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Mergers and acquisition involve a complex set of decisions to be made as regards to financial

arrangement, organizational changes, thus it is necessary that-

a) First, a separate plan and programme should be drawn up so as to ensure a smooth

transition form the pre-merger to the post-merger stage:

b) Secondly, a executive responsibilities should be realigned for necessary implementation

of the plan and programmes:

c) Thirdly, the management information system should be redesigned for effective top

management control.

Due Diligence

Introduction

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Due diligence is carried out in order to determine the fair value of the target company and to

assess the benefits and problems of the proposed acquisition or merger by inquiring into all the

relevant aspects of the business to be acquired. Due Diligence are of following types:

Business Due Diligence

Industry Insights

Nature of the industry (Growing, Mature, Decline)

Evaluate the industry in which the company operates in terms of :

Industry life cycle

New start-ups

Mergers and acquisitions in the industry

Competitive environment

Regulatory environment

Social Standing or Public perceptions

Availability of investment funds

Trade Journals Reviews

Industry future outlook as expressed by relevant trade associations

Major factors affecting the industry; is the likelihood of the occurrence ofsuch factors, implications for the industry as well as the company of occurrence

of such factors

Company Insights

Comparative analysis

Market Share

Products, Services Financial Statement Ratios

Size

Management

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Fixed Assets

Capital Structure

Is the company average, above or below average in relation to its

industry? Why? Explain.

Value of Company's Goodwill. Impact on the goodwill due to change in

management

Willingness of outside agencies (suppliers) to continue with new

management. Any change in terms of contract, etc.

Restrictive Covenant terms in the Agreements

Regular Customer Base

Financial Due Diligence

The objective of the financial due diligence is to establish the veracity of disclosed financial

statements. However, review of internal control in terms of its effectiveness and adequacy, is

an additional objective in the course of financial investment. The process of establishing the

veracity of disclosed financial information generally involves

Establishing fairness of accounting policies adopted

Identification of off balance sheet items

Establishing authenticity of the disclosed financial figures.

Financial ratio analysis

Under / over valuation of assets and liabilities

Compliance with Accounting Standards

Ensuring liquidity and solvency position

Human resource Due Diligence

Human Resource due diligence involves the study of the employees of the company with

respect to their expertise, leadership qualities and ability to manage the entity. It is important

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to assess their qualifications, their pay structure, as well as the likelihood that they will

remain with the company.

Nos. of staff employed

Employee turnover for last three years

Analyse whether over or under staffed and cost of rectifying the same.

Any labour problems in the recent past?

Attachment towards the management

Wage increment contracts

Legal Due Diligence

Legal due diligence is undertaken to achieve the following objectives

To assess the impact of likely results of current and potentially pending litigation and

result of recently concluded litigation,

To ensure that the subject company has complied with the provisions of all the relevant

statutes and there would be no potential liability on account of non compliance,

To assess the current and anticipated future impact of government regulations on the

entity's cost level. It covers the Companies Act, Direct Tax laws like Income Tax, Wealth

Tax etc., Indirect Tax laws like Excise, Sales Tax etc., Labour Welfare laws like

Provident Fund, Employees State Insurance Act etc. The information to be collected in

Legal Due Diligence includes:

Names and addresses of the company's attorneys

Is a discussion with them appropriate, warranted?

Make inquiries of the company's management and attorney regarding possible lawsuits,

contract problems, etc.

Does the company have good legal records? If not, why not? Assess the implications.

Make inquiries of the company's management and legal concerning the likelihood of an

unfavorable law suits. Assess the implications to the extent there might be legal problems,

the company's investment risk might be significantly higher.

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Systems Due Diligence

Systems due diligence is undertaken to ensure that there is proper management and adequate

security of the data / information systems.

Material Procurement systems

Inventory Updating System

Logistics Support

Invoicing System

Review of IT security policy and procedures,

Review of software applications and operating systems, and

Review of disaster recovery and business continuity plans.

The result of the due diligence has got a direct bearing on determining the value and

viability of the investment. The report normally outlines the current status of IT adopted,

its scope, investment required for improvement and post investment action plan.

Tax Due Diligence

The analysis of various taxes is one of the most complex areas that is encountered during the

investigation.The objectives of a tax due diligence are

To analyse the impact of unpaid taxes/contingent liability

To assess the impact of likely results of current and potentially pending litigation and

result of recently concluded litigation,

To assess the liability towards deferred taxes

Extraordinary event:

In the due diligence a serious note of any extraordinary event or items should be taken care of.

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Why Are Management Mergers Not Always Successful?

Going by research evidence, merge have not been generally successful from the shareholders

point of view. The question therefore is what prevents the successful consummation of merger?

The possible reasons for failure of mergers may be one or more of the following lapses on the

part of the management.

1. Failure management to establish merger objectives which fit into the overall

corporate strategy.

2. Added synergy = Value of the combination MINUS sum of the parts

Just how can the value of the combination be maximized?

Value of combination = Discount Cash

Flows of combination = (revenues minus cost) / risks

Amounting as it does to the post - M&A DCFS, this value can be enhanced by either increasing

the revenues of the combined company, and/or reducing costs or the volatility of earnings.

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What Motivates Executives To Initiate Mergers And Acquisition?

Various considerations underlie the decision of the companies to merger or to go in for

acquisition of other companies. For a firm intending to acquire or take over another firm, merger

may be desirable to enable the existing management to achieve one or more of the following

goals:

1) To attain a higher growth rate than is possible through internal growth strategy.

2) To bring about an increase in the price earnings ratio and market price of shares.

3) To purchase a unit for better use of investable funds.

4) To reduce competition by acquiring competing firms.

5) To fill the gap in the existing product line.

6) To add new products (diversify) when the existing product has reached the peak in its life

cycle.

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7) To improve efficiency of operations and attain higher profitability through potential

synergistic effects.

OPTIMISING REVENUE GAINS

THE VALUE DRIVER Managerial synergy targets total revenue gains and can be

measured by jump in market share.

THE STRATEGY Management skills are an input to the production process, much as

capital and other forms of labour. These skills can range from company-specific to generic

management. The argument for taking over another company is the belief that some of theseskills and resources are transferable. When M&A targets larger total revenues and not the

cost cutting for value creation, this motivation provides the necessary efficiency to tackle

horizontal or related mergers.

THE PROBLEMS although many M&As are executed with these motives, managerial

synergies often remain elusive. There are several reasons for this. Its very difficult for

companies to accurately identify their relative managerial ability.

There exists very little evidence of managerial synergy since transfer of skills are difficult.

M&A is not necessary the only route for shareholders to replace inefficient

managements.

BOOSTING MARGINAL REVENUE THROUGH FINANCIAL SYNERGY

THE VALUE DRIVER. An increase in revenue per unit, or marginal price of the

companys product is possible when M&A leads to redirect its cash to industries more

attractive than the one it was in before the acquisition. Return on investment (ROI) improves

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when marginal revenue rises, so long as costs and investments remain unchanged. The

primary motive for these acquisition is channeling cash from unattractive industries to more

attractive industries.

THE STRATEGY. Empirical evidence suggests that in most cases of conglomerate

mergers, capital expenditure is the only functions that are brought under the supervision of

the new management. This is probably because companies believe in their ability to induce

financial synergy through M&A.

REDUCING MARGINAL COST THROUGH OPERATING STRATEGY

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VALUE

CREATION

MARKET VALUATION

MANAGERICAL SYNERGY

COMPANY SPECIFIC RISKS

FINANCIAL STRATEGY

EXCHANGE INEFFICIENCY

OPERATING SYNERGY

* M&A will either improve managementpractices or replace inefficientmanagement attractive industries

* Total revenue increases are measuredby market shares gains

* Inefficient valuation can beCorrected through M&A.

* The price to earnings ratioimproves

* Unsystematic risk can be reducedthrough specific diversification.

* Discount rate (Beta) will fall

Cash / resources are channeled fromunattractive to attractive industries

Rising marginal revenue can bemeasured by improved return on ininvestment.

Vertical integration will circumventmarket transactionFall in total costs is reflected inimproved gross margins.

Economies of scale can be achievedthrough horizontal M&AAverage cost, a proxy from marginalcost, will fall

THE SYNERGY MATRIX


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THE VALUE DRIVER: Marginal costs decline due to economics of scale, achieved

through improvements in operating efficiency arising from horizontal or related M&A. Since

marginal cost-is used as a proxy.

THE STRATEGY. The implicit assumption here is that the long run marginal cost curve

declines as the quantity produced increase, forcing down average cost per unit. This is

possible for several reasons. First the rationalization of customers and units produced.

Second, achieving critical mass allows certain cost advantage both as buyer and seller, as

intangible costs like marketing and overheads can be distributed over a largest production

base in industries where these principle hold, it makes sense to acquire large productioncapacities through M&A thus, horizontal or related M&A, which increase the size of the

operation, might result in cost reduction, and improve the competitive position of the

combined company.

Extensive research in the US, Europe, and Japan leads to the conclusion that mergers do not

generally increase profitability and that the profitability of acquired firms declined after they

were acquired. Company growth rates and market shares have been found either to decline or

at best to remain unchanged. Conglomerate mergers in the 50s and the 60s reduced company

efficiency and productivity. Vertical integration through merger can increase efficient.

Cost of changes in organization is often greater that the benefits claimed by the promoters of

takeovers. Higher the degree of diversification implied by the takeover the smaller the

likelihood of success. For horizontal mergers in which the acquired firm is not large however

the success rate is around 45 present.

Before a merger the share price of an acquiring firm outperform the market. At the time of

announcement of merger there is little change in the acquiring firms share price. The post

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acquisition performance of acquiring companys share price is below pre merger

performance and in many studies below that of the market.

Finding form 19 studies indicate that merger and acquisition benefit acquired firms shareholders

with a median gain of 19.7 percent, whereas acquiring firms shareholders suffer substantial

losses continuing for up to several years after the merger.

De Jong concludes that merger activity considerably increases national industrial concentration

ratios. This perhaps is most evident and plausible reason for mergers and acquisitions.

INTERNATIONAL MERGERS AND RESTRUCTURING

International mergers are subject to many of the same influences and motivations as

domestic mergers. However, they also present unique threats and opportunities. The issue of

merger versus other means of achieving international business goals (such as import/export,

licensing, joint ventures) builds on the fundamental issue in the theory of the firm whether to

transact across markets or to internalize transactions using managerial coordination within

the firm.

When firm choose to merge internationally, it implies that they have concluded this would

result in lower costs or higher productivity than alternative contractual means of achieving

international goals. In horizontal merger, intangible assets play an important role in both

domestic and international combinations. To exploit an intangible asset, such as knowledge,

it may require merger because of the public good nature of the assets. Attempts to exploit

intangible short of merger requires complex contracting, which is not only expensive, but

likely to be incomplete (especially when compounded by the problems of dealing with a

foreign environment) possibly leading to dissipation of the owners proprietary interest in the

asset. Similarly, vertically integrated firms exist to internalize markets for intermediate

products on both the domestic and international levels.

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Among the special factors impacting international mergers more than domestic are tariff

barriers and exchange rate relationships. Operating within a tariff barrier may be only means

of obtaining competitive access to a large market, for instance, the European Common

Market. Exchange rates are also important influence. A strong dollar makes US products

more expensive abroad, but reduces the cost of acquiring foreign firms. The reverse holds

when the dollar is weak, encouraging US exports and foreign acquisitions of US companies.

REASONS FOR INTERNATIONAL MERGERS

As already said though many of the motives for international mergers and acquisitions are

similar to those for purely domestic transactions, there are some unique reasons in the

international arena. These motives include the following:

GROWTH:

a. To achieve long-run strategic goals

b. For growth beyond the capacity of saturated domestic market

c. Market extension abroad and protection of market share at home

d. Size and economies of scale required for effective global competition

TECHONOLOGY:

a. To exploit technological knowledge advantage

b. To acquire technology when it is lacking

EXTERNAL ADVANTAGE IN DIFFERENTIATED PRODUCTS:

a. Strong correlation between multinationalisation and product differentiation is

reported. This may indicate an application of parents (acquirers) good

reputation.

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GOVERNMENT POLICY:

a. To circumvent protective tariff, quotas etc.

b. To reduce dependence on exports

EXCHANGE RATES:

a. Impact on relative costs of foreign vs. domestic acquisitions

b. Impact on value of repatriated profits.

POLITICAL AND ECONOMIC STABILITY:

a. To invest in a safe, predictable environment

DIFFERENTIAL LABOUR COSTS, PRODUCTIVE OF LABOUR

TO FOLLOW CLIENTS (especially for banks, accounting firms, management

consultancy firms and ancillaries)

DIVERSIFICATION:

a. By product line

b. Geographically

c. To reduce systemic risk

RESOURCE-POOR DOMESTIC COMPANY:

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a. To obtain assured sources of supply

The increasing globalization of competition in product market is extending rapidly into

internationalization of takeover market. The best target to achieve a firms expansion goals

may no longer be a domestic firm but a foreign one. International Merger and Acquisition

activity has experienced substantial growth over last 20 years and shows no signs of abating

in the future.

ROLE OF INDUSTRY LIFE CYCLE

The role of industry life cycle in mergers is in much dispute. It has never been supported by

rigorous empirical evidence. But it represents a useful concept for organizing ideas on business

activity if treated as suggested rather than a set fixed and established principles. In this spirit, the

concept is used as a framework for indicating when different types of mergers may have an

economic basis at different stages of an industrys development.

INTRODUCTION STAGE:

Newly created firm may sell to outside larger firms in a mature or declining industry, thereby

enabling larger firms to enter a new growth industry. These result in related or conglomerate

mergers. The smaller firms may wish to sell because they want to convert personal income to

capital gain and because they do not want to place large investments in the hands of managers

who do not have a long record of success. Horizontal merger between smaller firms also occur,

enabling such firms to pool management and capital resources.

EXPLOITATION STAGE:

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Mergers during this stage are similar to mergers in the introduction stage. The impetus for such

mergers is reinforced by the more visible indications of prospective growth and profit and by the

larger capital requirements of a higher growth rate.

MATURITY STAGE:

Mergers are undertaken to achieve economies of scale in research, production and marketing in

order to match the low cost and price performance of other firms, domestic or foreign. Some

acquisitions of smaller firms by larger firms take place for rounding out management skills of

the smaller firms and providing them with a wider financial base.

DECLINING STAGE:

Horizontal mergers are undertaken to ensure survival. Vertical mergers are carried out to

increase efficiency and profit margins. Concentric merger evolving firms in related industries

provided opportunities for synergy and carry over. Conglomerate acquisition of firms in growth

industries are undertaken to utilize the accumulating cash position of mature firms in declining

industries whose internal flow of funds exceeds the investment requirements of their traditions

lines of business.

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Pros and Cons of Mergers and Acquisition

1. As a growth strategy, mergers and acquisitions have been quite popular in all advanced

countries. This is obviously because of the benefits expected to be derived by either or

both the combining firms.

a) Economies of large scale operation:

b) Better utilization of funds to increase profits:

c) Diversification of activities for stability and higher profits.

2. Managements failure to consider the relative merits of internal and external means of

achieving corporate goals.

3. Lack of serious consideration of the financial stake.

4. Insufficient familiarity of the management of acquiring firms with the business of the

acquired firms.

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5. Lack of preparedness with post merger planning, organization and control.

MUCH TO LEARN

The common for business managers to think takeovers and mergers in times in times of

industrial slowdown and recession. For investors though, mergers could possibly be the worst

idea that a manager could explore. Demerger may be a better alternate, but few managements are

receptive to such an idea.

This attitude on the part of promoter-run managements smacks of unwanted arrogance, but earns

little for investors. Late 80s and 90s witnessed an unending procession of failures. There have

been the occasional successes, like that of Hindustan Lever with Lipton, Domma Domma and

Brooke Bond. But millions have been sunk in to deals, the likes Orrisa synthetics with JK Corp

Fibers with JCT, which turned out to be disasters in their own right.

Yet, the industry refuses to see reason.

Merger is an idea fraught with danger. This ominous generalization seems inescapable given the

development of finance over the past 40 years. Business has seized upon new ideas jink bonds,

leveraged buy outs, derivatives only to push them far past their sensible application to a

seemingly inevitable disaster.

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Three basic precepts which formulated during the past 40 years seem most enduring earnings

can be bought if you cannot make them grow, do net fear additional debt and use derivatives to

manager risk. Quite naturally, conglomerating seemed splendid to manage corporates yields

running at 4-5 percent per annum. Weak accounting standards helped managements to report

higher earning per share (EPS) virtually out of thin air in the wake of many acquisitions. So

companies were off and running to leverage up and buy earning they could not increase on their

own. Almost the entire expansions by the Birlas and Singhanias into the core sector had been

funded through a liberal does of debt. Expansion linked tax benefits helped report higher EPS. It

not that diversification is a wrong concept. Companies like General Electric (GE)have proven

that there is value in diversification when done right. Also, companies need not grow to become

sound investments. They can instead use their spare cash to increase dividends or buy backshares. But such moves are commonly interpreted as failure of imagination.

Between 76 and 90, 35,000 mergers and acquisition worth $2.6 billion took place. Institutional

investors helped. Pension, funds, midwife by Bethelhem Steels ground breaking agreement in

49 to underwrite employee retirement costs, rapidly made funds the big guys in the market

place. Which along with the then strapping but still growing mutual funds (MFs) were assuming

dominant status on the bourses. Between 50 and 70 assets with MFs leaped from $2.5bn to $51

bn. Institutional investors traded more frequently and dealt in ever-larger blocks of stock. That

gave the market oceans of liquidity, making it simpler for predators to take huge position in

target companies.

The strategy worked at least until it reached investors. Profits for the 500 companies

compromising the standard and poor (S&P)index, nearly quadrupled between 70 and 80. But

stock prices, rattled by inflation and the oil price hikes of 73 and 79,and went no where. The

DOW cleared 1000 for the first time in 72 reached it again in 73 dropped and then waited nine

years to hit a new high. Do nothing stock prices only ratcheted up pressure to boost profits, often

leading to bad decisions that would later have to ruefully undone.

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The steady rise in debt that companies took on to grease the merger machines reflected a new

scientific financial theory being drummed into business school graduates. During the late 50s

and early 60s Merton Miller, Franco Modigliani and others has set a revolution in motion with

scholarly treatises on capital structure, dividends and a host of related financial topics which won

Nobel prizes for them.

An important idea to emerge from the classroom was the blurring of the divide between debt and

equity. Miller and Modigliani showed that at least theoretically the quantum of debt that a

company carries does not mater as long as the business generates sufficient cash flow to meet its

interest obligation. Their core insight about the acceptability of debt won converts and year after

year companies leveraged higher and higher and yet survived. So much so that the value of deals

announced during 95 alone hit $248.5 bn, surpassing the record of $246.9 attained in 88. Evenas deals grew a qualitative change was moving in these acquisition were no longer creating

conglomerates of the good old 60s,nor the debt laden leveraged buy outs of the 80s.

These were strategic deals, designed to be smart, friendly, full of synergy and great for

shareholders.

The factors, which drove corporate to bye other firms, were low capital costs, strong cash flows

and robust balance sheets in a low interest rate environment. Unfortunately costs of financing an

acquisition are neither low in this country nor have managers been able to produce something

that enhances earning. SRF is still struggling to keep its head over the waters. As always

institutional shareholders have slept. Otherwise they might have demanded that firms focus on

core business to maximize returns. May be push for demergers and sales. this reality is still to

creep in.

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WHY MERGERS AND ACQUISITIONS

The recent trends show a sharp increase in number of mergers and acquisitions happening

worldwide leading to the question that what drives the corporate intelligentsia to adopt M&As as

a corporate strategy. Analytical perspectives have to be put in to find out the reasons behind the

consolidations happening in the corporate world. There are some basic reasons that cause M&As

however, there is also a complex analysis behind recent increase in M&As.

Mergers and Acquisitions have inherent capacities to deliver operational and other advantages to

the corporations. These capacities become basic motives for corporate to adopt Mergers and

Acquisition as a corporate strategy and the same have been observed as general drivers behind

M&As. These capacities deliver:

Operational and other synergies,

Economies of scale,

Increase in marketing, financial, human and other strengths,

Moving forward or backward in the supply chain results in reduced overall costs, and

Tax benefits

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Moreover, mergers and acquisition being a strategic decision of an organization assumes great

impotence and hence has to be executed only with clear and definite goal in consideration. The

commonly observed goals behind M&As are:

I. Expansion & Growth

M&As as the strategy for growth and expansion, in corporate jargon popularly known as an

inorganic growth strategy. Stagnation in this dynamic world is akin to being in coma. Thus no

company can afford to stand still. Fulfilling growth objective of an organization, mergers and

acquisitions are considered as plausible alternative. This is also in consonance with public

companies. The shareholders have invested their funds on the assumption that their investment

will not only provide adequate returns but also capital appreciation. Such appreciation would bepossible only when the organization keeps expanding.

As far as expansion is concerned, M&As can provide geographic spread, product range

enhancement, customer base and segment increase. Moreover, managerial and operational skills

grow with experience and time, which creates a surplus of these resources in the firm. Expansion

ensures the best utilisation of such resources; the resulting synergy can be intelligently used for

further expansion/diversification.

II. Entry into new markets

M&As provide an effective platform to enter into new markets. Adding to existing customer

network through merger or acquisition is far more easier than creating a new network. However,

it is critical to analyse whether it will be economically justifiable or not considering other

parameters involved. Many times firms in the wake of cashing in on their core competence need

to penetrate into new market with lesser luxury of time due to the intensified nature of

competition, in such scenario M&As seem viable option to enter into the new markets. Product

life cycle, business expansion, new products launching are other issues pertaining to M&As as

entry strategy.

Click for case studies

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III. Diversification

M & A, are motivated with the objective to diversify the activity so as to avoid putting all the

eggs in the same basket and obtain advantages of joining the resources for enhanced debt

financing and diversified risk proposition to shareholders. Such transactions result in creating

conglomerate organisations. But most critics hold that such diversification is dubious and do not

benefit the shareholders as they get better returns by having diversified portfolios by holding

individual shares of these firms. (e.g. Hindustan Lever Limited and Brooke Bond Lipton India

Limited)

Click for se studies

IV. Surplus liquidity

M&As can also occur due to surplus cash available with organisations. Deployment of such

liquidity is a question having multiple options. Investing such cash into existing organisations by

way of acquisitions is a worth considering option available with the CEOs. In recent trends, it

has been observed for cash-rich companies that prefer is given to use the cash for M&As rather

than distribute it as extra dividends to shareholders. That is why we see cash-rich firms making

acquisitions more often even in non-related industries. Such M&As also result for stagnant

industries merging their way into fresh woods and new pastures.


V. Tax Saving Motives

Many mergers are motivated by the aim of achieving benefits and concessions under the Direct

and Indirect laws. The benefits like carry forward of losses, deductions for infrastructure

industry, export incentives etc. can be utilised in a better manner by the combined entity.


VI. Corporate Restructuring

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M&As also emerge due to corporate restructuring exercises. Group companies formulate

schemes of amalgamation among themselves as part of corporate restructuring to take benefits as

mentioned above. M&As also work as a turnaround strategy for sick companies.


VII. Other Motives

Besides the points considered in the forgoing discussion there could be other strategic reasons

behind M&As. Companies do acquisitions to create entry barriers for others, merge themselves

with friendly corporations to avoid unwanted acquisitions, sometime demerger has to be

implemented to comply with regulations like antitrust proceedings, competition act etc.MOTIVE BEHIND RESTRUCTURING

As a contemporary corporate orthodoxy, external growth alternatives and corporate restructuring

have become obvious part of strategic thinking in every kind of corporate houses. Just a decade

ago the area was nonchalantly attributed to big and influential corporate. This strategic

phenomenon of small and medium enterprises.

Large number of enterprises is structured considering the then environment like taxation policy,

industrial & commerce policy, world trade policy etc. with drastic change in the environment,

such structure remained no more compatible. Hence new thought process emerged and

restructuring came on the table. However, due to lack of in-house expertise, time and cost

constraints, involvement of various agencies and legal complainces, even desired restructurings

are not implemented.

WHAT IS TO BE ACHIEVED THROUGH RESTRUCTURING

Optimum business scale, focus or core competence- the optimum business scale implies the

scale at which the product or services reduce at minimum possible cost. The same can be

achieved say expansion through mergers and acquisition. While specialization refers to focus

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on activity or activities and mastering on the same can be achieved through demeger, hive

off and sell off.

Optimum Capital Structure Capital is free to move globally opening new sources through

access to foreign capital markets.

Revival of ailing business

Maximization of shareholder values

Other benefits in the process such as synergy of operations- consolidation of market share

reduction of time and money while entering the new market/ foreign market, reducing

uncertainty of market share, keeping out competition, exit route for promoters, listing advantage

realization of stock market valuations.FIVE SINS OF ACQUISITIONS

The American Management Association examined 54 big mergers in the late 1980s and found

that roughly one-half of them led to fall in productivity or profits or both. As Warren Hellman

sys so many mergers fail to deliver what they promise that there should be a presumption of

failure. The burden of proof should be on shoeing that anything really good is likely to come out

of one.

It appears that acquisitions are plagued by five sins: straying too far afield, striving for bigness,

leaping before looking, overplaying and failing to integrate well.

Straying Too Far A Field: Very few firms have the ability to successfully manage diverse

business. As one study revealed, 42 percent of the acquisition that turned source were

conglomerate acquisition in which the acquirer and the acquired lacked familiarity with each

others business. The temptation to stray into unrelated areas that appear exotic and very

promising is often strong. However that reality is that such forays are often very risky.

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Striving for Bigness: Size is perhaps a very important yardstick by which most organization,

business or otherwise judge themselves. Hence there is a strong tendency on the part of

managers whose compensation is significantly influenced by size to build big empire. The

concern with size may lead to unwise acquisitions. Hence when evaluating an acquisition

proposal keep the attention focused on how it will create value for shareholders and not on how

it will increase the size of the company.

Leaping Before Looking: Failure to investigate fully business of the seller is rather common.

The problems are (a) the seller may exaggerate the worth of intangible assets (brand image,

technical know how, patents and copyrights and so on) (b) The accounting reports may be deftly

windows dressed and (c) the buyer may not be able to assess the hidden problems and contingent

liabilities or may simply brush them aside because of its infatuation with the target company.

Veterans in this game strongly argue that the negotiating parties must searchingly examine the

other sides motivations.

Overpaying: In a competitive bidding situation, the nave ones tend to bid more. Often the

highest bidder is one who overestimates value out of ignorance. Though the merges as the

winner happens to be in a way the unfortunate winner. This is referred to as the winners curse

hypothesis. As Copeland et al say In the heat of deal, the acquirer may find it all too easy to bid

up the price beyond the limits of a reasonable valuation. Remember the winners curse if you are

the winner in a bidding war, why did your competitors drop out?

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Failing to integrate well: Even the best strategy can be ruined by poor implementation. A pre-

condition for the success of an acquisition is the proper post-acquisition integration of two

different organizations. This is a complex task, which may not be handled well.

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MANAGING AN ACQUISITIONS PROGRAM

As the chances of failure in an acquisition are high, it should be planned carefully. It pays to

develop a disciplined acquisition program consisting of the following steps:

1. Manage the pre-acquisition phase2. Screen candidates

3. Evaluate the remaining candidates

4. Determine the mode of acquisition

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5. Negotiate and consummate the deal

6. Manage the post-acquisition

Step 1: Manage the pre acquisition Phase

A good starting point for the mergers and acquisition program is to do a through valuation of

your own company. This will enable you to understand well companys strengths and weakness

and deepen your insights into the structure of your industry. (it will also help you in identifying

ways and means of enhancing the value of your firm so that you can minimize the chances of

yourself becoming a potential acquisition candidate).

Armed with this knowledge you can do brain storming that will through up worthwhile

acquisition ideas. Look for opportunities that strengthen or leverage the core business or provide

functional economies of scale or result transfer of skill or technology.

Of course the entire exercise of identifying acquisition targets must be kept very confidential.

Should be market come to know of a proposed takeover, the price of target will rise and perhaps

jeopardize the deal itself.

Step 2: Screen Candidates

The ideas generated in the brainstorming sessions and the suggestions received from various

quarters (merchant bankers, consultants planner and so on) will have to be filtered. Use

screening criteria that make sense in your companys situation. For example you may eliminate

companies that are:

Too large (market capitalization of equity in excess of Rs100crore )or

Too small (revenues less than Rs10crore ) or

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Engaged in a totally unrelated activity or

Commanding a high price earnings multiple (in excess of 25 ) or

Not export oriented (exports account for less than 20 percent of the turnover) or

Not amenable to acquisition (existing management is not inclined to relinquish control)

Step 3: Evaluation must cover in great detail the following aspects

Operations, plant facilities, distribution network, sales personnel and finances (including hidden

and contingent liabilities). Pay special attention to the quality of management. Experienced,

competent, and dedicated management is a scarce resource. When a company is acquired, the

quality of its management is as, if not more, important as the rest of its assets.

Value each candidate as realistically range between 20 percent and 60 percent of the pre

acquisition market value, formulate a clear and coherent strategy that will enable you to earn the

premium you will most probably have to pay.

Step 4: Determine the Mode of Acquisition

As discussed earlier, the three major modes of acquisition are merger, purchase of assets, and

takeover. In addition, one may look at leasing a facility or entering into a management contract.

Through these do not tantamount to acquisition, they give the right to use and manage a complex

of assets at a much lesser cost and commitment. They may eventually lead to acquisition.

The choice of the mode of acquisition is guided by the regulations governing them, the time

frame the acquirer has in mind, the resources the acquirer wishes to deploy, the degree of control

the acquirer wants to exercise, and the extent to which the acquirer is willing to assume

contingent and hidden liabilities.

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Step 5: Negotiate and Consummate the Deal

For successful negotiation you should know how much is the value of the acquisition candidate

to you, to the present owner, and to the potential acquirers. While negotiating the deal

remembers the following advice of Copeland et al Your objective should be to pay one dollar

more than the value to the next highest bidder, and an amount that is less than the value of you.

This implies that you should identify not only the synergies that you would derive but also what

other acquirers may obtain. Further, you should assess the financial condition of the existing

owners and others potential acquirers.

Negotiation requires considerable skill. As Copeland at al says: Negotiation is an art. You

should choose your negotiating team carefully. The best number crunches are usually not thebest negotiators. Know the financial condition of the other side. Know the ownership structure

of the target company. And develop your bidding strategies in advance.

In general, acquirers gain a toehold in the target company by buying up to 10 percent of its stock

somewhat stealthily in the open market or through privately negotiated deals. Once the percent

limit is reached, SEBI guidelines require disclosure, which almost invariably leads to a run-up in

the price. Thus the relatively lower cost of pre announcement purchase helps in reducing the

average cost of acquisition.

Step 6: Manage the post-acquisition

Generally after the acquisition, the new controlling group tends to be much more ambitious and

is inclined to assume a higher degree of risk. It seeks to (a) quicken the pace of action in an

otherwise staid organization, (b) encourage a proactive, rather than a reactive, stance toward

external developments, and (c) emphasize achievement over adherence to organizational

procedures.

The changes sought to be introduced by the new controlling group are likely to challenge deep-

seated values, beliefs, styles, traditions, and practices. This may induce a sense of insecurity and

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discomfort- and even repugnance and hostility-in some quarters. Such reactions arise partly

because they genuinely believe that the objectives, strategies, values and style of the new

controlling group may not sub serve the interest of the organization. Many competent

professional managers believe that managing a complex multi-technology enterprise requires a

cultures and set of values which may be alien to the new group. Hence it depends upon the new

group to make adjustments in their values and styles and introduces changes, which are worked

out co-operatively. Mutual trust and confidence should be the bedlock for introducing changes

meant to galvanize the enterprise to reach greater heights of achievement.

In this context, two basic guidelines should be borne in mind:

Anticipate and solve problems early: The path of acquisition is strewn with problems. They

may arise on account of differences in administrative procedures, accounting systems, and

production methods and standards. More important, they stem from reaction of people affected

by the merger.

The merging firms, obsessed by the merger passion, may cavalierly brush aside such to be made

to think through the implications of the merger, anticipate problems that may Rockwell, Jr., a

veteran of mergers: the more thorns we extract at the outset, the less chance of infection later

on.

Treat people with dignity and concern: Making a merger work says Willard F Rockwell,

Jr., is the art of taking over a company without overtaking it. While acquiring a company, treat

people-management, employees, creditors, suppliers, customers-with dignity and concern. Effort

should be made to rock the boat as little as possible. Try to retain the management with minimal

interference, assure employees about their future with the organization, and maintain relations

with suppliers, customers, and others. If some changes are envisaged, disseminate information

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effectively. Clarity is the most potent antidote against morbid imagination. When people are

informed clearly about how their interests will be affected in the new setup, they imagine less

and their apprehensions dissolve.

Mergers & Acquisitions: Accounting

Amalgamation is a special type of transaction which involves the sale or purchase of the entire

business of a company and not merely sale of some assets. All over the world the accounting for

amalgamations is done on the basis of specific Accounting Standards issued for this purpose.

Accounting Standard 14 issued by the Institute of Chartered Accountants of India and

International Accounting Standard 22 deal with the accounting treatment for amalgamations.

Considering the special and extraordinary features of the accounting for amalgamations, I have

discussed all the aspects related to the Annual Accounts of companies such as accounting

treatment, disclosure requirements, Notice to shareholders, Auditors Report, Directors Report

and Notes to Accounts.

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Methods of Accounting

Accounting Standards (AS)

International Accounting Standards (IAS)

Disclosures in Accounting Statements

Notices

Director's Report

Auditor's Report

Notes Of Accounts

ACCOUNTING STANDARDS (AS)

Although the accounting treatment for amalgamations is covered by Accounting Standard 14, theknowledge of some other accounting standards is also essential for the proper accounting of

transactions arising from an amalgamation. Following are the AS

| AS 1 | AS 2 | AS 3 | AS 6 | AS 7 | AS 9 | AS 11 | AS 13 | AS 14 | AS 16 |

NOTICES

An amalgamation has to approved by the Shareholders of the Transferor and Transferee

companies. The Transferor and Transferee Company have to convene separate meetings of their

Shareholders for taking their consent to the Scheme of Amalgamation.

DIRECTOR'S REPORT

The perusal of the Directors Report in the Annual Accounts of companies gives us an idea of the

management's thinking on various issues.

AUDITOR'S REPORT

The comments made by the Auditors on the accounting treatment given to the transactions

arising out of an amalgamation is an important piece of information for the shareholders,

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creditors, customers, analysts, government authorities and other concerned persons as any

amalgamation directly affects their financial interests..

NOTES TO ACCOUNTS

The Notes to Accounts throw light on the accounting treatment given in the Annual Accounts.

METHODS OF ACCOUNTING

There are two methods of accounting depending upon the method of amalgamation

Amalgamation in the nature of merger - Pooling of Interest Method

Amalgamation in the nature of purchase - Purchase Method.

Pooling of interest method

Under this method, the assets, liabilities and reserves (whether capital, revenue or arising on

revaluation) of the Transferor Company are recorded at their existing carrying amount and in the

same form as at the date of amalgamation. The balance to the Profit & Loss Account of the

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Transferor Company is aggregated with the corresponding balance of the Transferee Company

or transferred to the General Reserves, if any. If, at the time of amalgamation, the Transferor

Company and Transferee Company have conflicting accounting policies, a uniform set of

accounting policies should be adopted following the amalgamation. The effect of change in

accounting policies on the financial statements should be reported in accordance with AS 5. The

difference between the amount recorded as share capital issued (plus additional consideration in

the form of cash or other assets) and the amount of share capital of the Transferor Company

should be adjusted in reserves. Thus goodwill or capital reserve does not arise in this case. The

salient features of this method are briefly given as under:

Applicable for merger amalgamation Total incorporation of final figures through journal

Adjustments through reserves only

No amalgamation adjustment a/c is required

Purchase method

Under this method, assets and liabilities of the Transferor Company are incorporated at their

existing carrying amounts or, alternatively, the consideration should be allocated to individual

assets and liabilities on the basis of their fair value on the date of amalgamation. The reserves

(whether capital or revenue or arising on revaluation) of the transferor company, other than the

statutory reserves, should not be included in the financial statement of the transferee company

except as stated in paragraph 5.4 Any excess of the amount of the consideration over the value of

the net assets of the transferor company acquired by the transferee company should be

recognized in the transferee companys financial statements as goodwill arising on

amalgamation. If the amount of consideration is lower than the value of net assets acquired, the

difference is treated as Capital Reserve. The goodwill arising on amalgamation should be

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amortised on a systematic basis over its useful life. The amortisation period should not exceed 5

years unless a somewhat longer period can be justified. Where the requirements of the relevant

statute for recording the statutory reserves in the books of the transferee company are complied

with, statutory reserves of the transferor company should be recorded in the financial statements

of the transferee company. The corresponding debit should

An Analytical View of Mergers and Acquistions

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