Assignments on Mergers and Acquisitions and Strategic Alliances

Name: Partha Pratim Datta

Enrollment No.: 6010090809157

The Gucci-LVMH Battle

Ans 15 a. LVMH was interested in acquiring Gucci because of the following reasons:

1. At the very first instance it should be understood that LVMH was not interested in Gucci but on the contrary the battle for creeping takeover of Gucci was initiated by LVMH’s principal share holder and Chairman for acquiring the Luxury Brand and controlling its business directives by holding the majority voting right. This was primarily done for creating a global one product luxury group by merging the asset base of both the companies and at the same time undertaking resource/ asset stripping by acquiring a majority stake in Gucci. This was because Gucci was a leading premium luxury brand dealer in the World and the fact that LVMH Group through its Louis Vuitton Brand was the market leader in the world luxury leather goods, apparels and other associated accessories with a 19% market share. Thus by aquizition of the Gucci group it wanted to achieve economies of scale by having a large market segment/market share led by established brands under the groups’ aegis vis-à-vis production base. This can be corroborated by the fact that Gucci had high quality, expensive, luxury brands viz. Yves Saint Laurent, Sergio Rossi and Boucheron under its ageis where as LVMH had brands viz. Loius Vuitton, Christian Dior, Givenchy under its aegis. Moreover, the fact that LVMH was interested in acquiring Gucci’s assets base for creating a major global luxury product group could be corroborated by the manner in which Arnault- the Chairman of LVMH increased the open offer price for 100% acquisition of the open equity shares of the company in the capital markets @ US$ 85/ share (at a premium to the marked to the market price of the shares). 2. Secondly, with the Asian Market crisis of the South Asian economies especially that of Thailand and Japan which emerged in mid 1990s, the LVMH group was facing erosion of its market share/ market capitalization as the disposable income and the purchasing power parity of the Asian customers for the luxury and premium goods manufactured by the brand had decreased. All this while, LVMH group was relying on the Japanese and Asian Markets for sale of its luxury products / brands but with the onset of the Asian Currency crisis, the group was desperate to fall back upon/ capture a large market share/ chunk of the European and US market. This was because the European and the US Market was immune from the Asian currency crisis and the spending of disposable income for purchase of expensive, luxury products/ brands was growing @4 time more than the global rate. Considering the fact that, Gucci had a better market share/ market capitalization rate than LVMH, the company was desperate to acquire Gucci and thereby gain access to its established European and US Markets. This can be corroborated by that that where as most of Gucci’s brands were doing well and the sale of its branded products was up by 10% in FY 1997 vis-à-vis that of FY 1998, that in case of LVMH was restricted to only one luxury brand i.e. “Louis Vuitton”. 3. Thirdly, the other important reason why LVMH was interested in acquiring Gucci was the fact that it wanted to get access to Gucci’s strength in product markets (especially the geographical advantages) and the competitive capabilities in designing and product positioning. This could be corroborated by the fact that even tough Gucci’s creations/

products/ designer outfits were priced in the same range as that of LVMH’s, but then the niche and the premium customers found it more sleekly, stylishly designed and were more sophisticated and urbane in its outlook, Because of the same, they were more in demand/ popular in the premium US Market which supported and sponsored new design and style statement in the fashion world more in comparison to the Asian Market. Thus it could be corroborated from the aforementioned facts that Gucci vis-à-vis LVMH was better off in integrating its operations across national markets (other European countries other than Italy as well as in US) as well as achieve enhanced benefits from innovation and economies of scale. 4. Thus it could be seen that it was for this reason that LVMH adopted the “ creeping takeover” strategy to achieve a majority stake in the company and dominate its Board of Directors and thereby control its management and business directives and operations.

No, I do not believe that there will be any synergy of operations/ business plans and marketing strategies from Gucci-LVMH alliance. This can be corroborated from that fact that both Gucci and LVMH started off as family owned business groups that later diversified its business operations so as to make foray into sectors like ready of wear apparel lines, fragrances, shoe making, jewellery and other associated accessories. Thus over a period of time they were globally well recognized luxury groups that had a well diversified portfolio of luxury brands under its umbrella. Thus it could be seen that both the companies had more or less similar business strategies i.e. inorganic growth of acquisition and opportunistic expansion into overseas markets. This can be corroborated from the fact that while Gucci acquired Yves Saint Laurant’s fragrance and ready to wear apparel lines , renowned shoe maker Sergio Rossi to its umbrella of brand where as LVMH organized its business operations into a division formats consisting of 5 important divisions i.e. wines and spirits, fashion and leather goods, perfumes and cosmetics, watches and jewelry and selective retailing. Thus it could be seen that whereas Gucci had a premium luxury/ exquisite perfume brand in the form of Yves Saint Laurent under its umbrella while LVMH had a competing perfume brand in the form of Christian Dior and Givenchy. Moreover, both the group adopted more of less the same type of sales and marketing strategy of sale through group operated multi product/ rand stores apart from sales through franchise stores. Moreover, the geographic regional sales profile for both the group was quite similar barring Japan. This could be corroborated from the table given below:Luxury Brand Sales by Geographic Regions in FY 2000

Name of the Group

Japan Asia Europe US and North America

Rest of the world

Gucci 22.50% 17.90% 30.40% 26.40% 2.80%LVMH 15.00% 17.00% 34.00% 26.00% 8.00%Source: Bear, Stearns & Co.Inc.Thus with the looming Asian Market Currency crisis of the 1990s in the Asian Market (Thailand in Particular) and Japan also in its grip and most of the premier luxury brands making a beeline to tap the developed European and US market which was growing @4 times the growth rate exhibited by Asian markets it did not make sense for LVMH to acquire the asset base of Gucci which had a major store presence in Japan i.e. (22.50% market share of the Japanese Market of Gucci vis-à-vis 15.00% market share of LVMH.)

Moreover, it should be realized that both the group relied on more or less similar type of marketing strategy i.e. of vehemently protecting the creativity, innovation , product

differentiation and strategic positioning of the established brands under its umbrella/ aegis. Thus when both the groups assiduously/ zealously protected their individuality style statement of designing and developing customized high value luxury products for the elite niche clientle, publicity and brand positioning campaign, designers details and it did not make sense for Gucci to be aggressively acquired by its intense competitor in the global luxury product market at a time when the various luxury brands associated with the Gucci umbrella (be it the products of the Gucci division or for that matter the products from the acquired brands) were doing pretty well in the US and European markets. On the contrary only the Louis Vuettion brand of the LVMH stable was operating profitably. This could be corroborated from the following table:

(US$ Million)Gucci-Fashion and Leather Portfolio LVMH- Fashion and Leather Portfolio

Items FY-1999-2000

FY-2000-2001

FY-2001-2002

FY-1999-2000

FY-2000-2001

FY-2001-2002

Net Sales revenue realization

2423.10 3753 3799.50 2021 2819 3180

Operating Profit

273.20 408.40 355.10 261.72 380.73 392.70

Source: LMVH and PRR Annual Report for 2000 and 2002

Thus it can be seen from the above table that there was very little difference as far as the operating profit of for that matter the profit margins between Gucci and LVMH as far as the operations for FY 1999-2000 was concerned. In fact in FY 1999 Gucci Operating Profit was more than that of LVMH. Thus with high total operating profit earnings, the share holders of Gucci would have demanded for more P/E ratio and correspondingly the same would have put additional pressure on reducing/ recalculating the exchange rate (ERB ) i.e. no of share of LVMH to be acquired / swapped with each share of Gucci. Thus with a low ERB , the corresponding share price of the merged/ acquired entity had to go up i.e PAB (ERB)>= P B where PAB could be considered the price of the acquired /merged entity ; ERB the exchange ratio of the share of Gucci with that of LVMH and P B

the price of each equity share of Gucci. Thus the creeping take over price quoted @ $ 85/ equity share of Gucci by LVMH (tough $30/share more than the marked to market price) , but then the share holders of Gucci would have found it to be on the lower end considering the fact that they would have desired a greater percentage of premium associated with the share of the merged entity = PAB considering a high overall operational profit earnings E B in comparison to E A = earnings of LVMH prior to merger with the latter. This in order to avoid paying extra premium to the equity shareholders of Gucci on account of change of ownership, LVMH under the chairmanship of Arnault adopted for creeping takeover of the majority share control of Gucci. Thus from the aforementioned discussion it can be inferred that LVMH as a group was good at acquiring established and uniquely positioned luxury brands under its aegis but was poor at operational management of the brand for maintaining its market leadership position/ status. Thus by selling itself off to LVMH made no sense for the top management of Gucci as the benefits were meager in comparison to the losses . This can be inferred by the fact that the operational independence and the creativity/ individuality and unique brand positioning in the minds of the potential customer would have been lost and the

company would have allowed its rival company to capture its market share/ position in the premier/ niche luxury product market through sharing of the business strategies/ policies as the BoD would have greater representation of directors nominated by LVMH. Moreover, it should be realized that Gucci had the ability to control its distribution channels through centralized procurement operations. This is part of Gucci’s strategy in the chain value to capture the value added instead of giving it to the middlemen such as suppliers and retailers. The company also increased the number of their Directly Operated Stores (DOS) as part of the marketing strategy so as to have more control of the distribution process. This could be corroborated from that fact that in FY 2003, the DOS accounted for 61.3% of revenues compared to a much lower 32.5% in 1999.On the contrary, LVMH’s 5 important business divisions acted as independent SBU with their own managers and distribution, sales and marketing channels. Thus there was no operational synergy as far as the sales promotion, marketing and distribution mechanism was concerned between GUCCI and LVMH. Thus, had the creeping takeover bid of LVMH had fully succeeded for complete takeover of Gucci , then in that case Gucci would have been compelled to share its aforementioned defensive strategies of ability to control its distribution channels through centralized procurement operations with LVMH. It would have also led to sharing of the shelf space in the directly operated stores of Gucci with that of the products from the brands of LVMH. Thus the exclusivity, uniqueness that is associated with the marketing of the branded luxurious products would have been lost by the Gucci group to LVMH. Thus the losses outweighed the potential benefits and this made De sole and Ford, the top leaders from the Gucci Group to put forward the statement that there would be no synergies from the Gucci-LVMH alliance.

Ans 15 b. Comments on the defensive strategies adopted by Gucci for preventing the hostile attempt for takeover of the management and administration of the company by the rival firm LVMH were as follows:

Introduction: It has to be realized that what started off as a possible takeover concerns was the 9.5% ownership of Gucci stock by the Italian fashion house Prada. At a later date, LVMH under its President/CEO Bernard Arnault who had already made a bid for Gucci in 1994 but considered the asking price of $350 Million too steep at that time made a reattempt to take over the management reigms of the company in early 1999. LVMH was famous for buying low priced but established brand name businesses and making them part of the LVMH empire. In De Sole’s mind, Arnault no doubt had similar intentions for Gucci. Under U.S regulations, LVMH was forced to report its 5% stake in Gucci which it did on Jan 6, 1999. This led to a favorable increase in Gucci share price from $50 to $70 a share. On 12 Jan, LVMH acquired Prada’s 9.5% ownership for $380 Million. By Jan 26, LVMH had acquired a total ownership of 34.4% in the company with 20.15 Million shares out of a possible 58.51 Million shares. LVMH had invested $1.44 Billion in Gucci. Keeping in mind LVMH’s operating principles, its motives were clear. The fact that it would eventually take over the company, worried the CEO of Gucci De Sole. Looking for a way to prevent this, De Sole’s first line of defense was

1. To invite employees into an ESOP ( Employees’ Stock Options Program). To protect the share ownership however, De Sole instituted the ESOP scheme in 3 tranches namely in February and July 1999 and June 2000 the form of a Trust. The ESOP option

allowed De Sole and Ford to establish a possible 37 Million new shares under an interest free loan, but with no dividend rights and no possible transfers to a 3rd party, i.e. the shares were to be literally owned and controlled by the management of Gucci. This underlined the fact that De Sole was trying to prevent further hostile takeover attempts by Arnault. Thus the issuance of the additional shares reduced the equity stake holding of LVMH in Gucci to go down from 34% to 22%. This can be corroborated from the fact that even with the ESOP purchase of 20.15 Million shares (25.6%) and subsequent dilution in ownership of Gucci by its management, LVMH’s holdings in the stood at 22%. Incidentally, 83% of the ESOP authorized by the share holders to be presented to the extant as well as future officers, directors and employees were in fact granted to De Sole and Ford, the President and CEO of Gucci. The shareholder rights plan, colloquially known as a "poison pill", or simply "the pill" was a kind of defensive tactic used by Gucci’s directors to prevent takeover bidders i.e. LVMH from negotiating a price for sale of shares directly with shareholders, and instead forcing the bidder to negotiate with the board. The typical shareholder rights plan involves a scheme whereby shareholders will have the right to buy more shares at a discount, if one shareholder buys a certain percentage of the company's shares. The plan could be triggered, for instance, when any one shareholder buys 20% of the company's shares, at which point every shareholder (except the one who possesses 20%) will have the right to buy a new issue of shares at a discount. The plan was issued by the Gucci’s board as an "option" attached to existing shares, and only could be revoked at the discretion of the BoD. Thus it could be seen that the ESOP/Shareholder rights plans brought out by Gucci as part of its defensive plan or poison pills was a controversial decision because it hindered an active active market for corporate control while on the other hand, giving the BoD of Gucci the power to deter takeover bids. 2. Thus it could be seen that the ESOP Plan’s only intent was to prevent the hostile takeover of the company by LVMH through complete buy out of the shares. This was because as the ESOP was self financed by Gucci it forbid a transfer of ownership to a third party. Moreover, the employees did not themselves invest in the ESOP. Such a dilution with no corresponding investment served to reduce the holdings of shareholders vis-a-vis the total ownership in the company. The total shares in Gucci rose from 58.51 Mln before the ESOP to 78.66 Mln with the free floating shares of 38.36 Mln thereby reducing in terms of total ownership by the shareholders of the firm from 65.6% to 48.8%.3. Thirdly, when LVMH hit back on the aforementioned move of Gucci by stating that the creation of virtual shares with no voting rights was a move to serve management’s interests and was not the interests of Gucci shareholders by seeking an injunction from an Amsterdam court, Gucci retaliated back by enrolling Morgan Stanley Dean Witter to its defense. LVMH had argued for voting rights, transferability of the ESOP shares and redemption of the shares for capital. 4. Fourthly, in its defense, Gucci contacted Francois Pinnault of PPR , a rival French conglomerate with a balance sheet size of 24.8 billion euros , involved in retailing, credit and financial services B2B services and trading of luxury goods and products to act as a white knight, whereby it would be buying out 40% of the equity stake in Gucci as well as getting itself allotted seats in Gucci’s board as well as its strategic and management committee.5. Thus this measure undertaken by Gucci led to a 15.7% increase in Gucci share price, from $70 to $81. Thus in this manner, by adopting the defensive strategies of ESOP and

PPR acting as the “white knight”, the company thwarted the aggressive takeover bid by LVMH.

Yes, I do not believe that PPR’s stake acquisition in Gucci was also a form of takeover albeit a form of negotiated bidding and subsequent acquisition with the approval and consent of the BoD of Gucci and subsequently ratified by the shareholders of the company. This was because the company had not attempted a buyout bid to aggressively acquire all the equity shares of the company. On the contrary, PPR acted as a white knight/ a friendly savior in the business world for Gucci by helping Gucci by willing to purchase its equity shares when it was midst of an attempted hostile takeover bid by LVMH. It may be understood that Gucci did not want to be taken over by LVMH.  The company felt capital market shareholders would not receive the proper premium for a takeover bid.  Furthermore, organizational shareholders such as the Italian managers and employees did not want to work for the French LVHM, due to perceptions of a loss of control and Italian pride.

In the present instance, the management of Gucci solicited help from a third party i.e. PPR a friendly firm to act as a "white knight" whereby it was issued a new set of equity securities such as preferred stock with voting rights. Moreover, the bidder company i.e. PPR also agreed to purchase the existing common shares at a premium price. This could be corroborated from the fact that PPR was willing to pay a premium for Gucci’s share, thus becoming the preferred potential owner in the eyes of De Sole and the capital market shareholders. Thus Gucci issued and sold 39 million new shares to PPR which it purchased by offering a bid price @US $75 per share, (a premium of US$4/share over a marked to market price of US$71/share). This decision of sale of common shares by the Gucci management to PPR gave PPR a 40% control on the voting rights/ controlling interest of the target Company i.e. Gucci and a representation in the form of 4 seats on the board of directors (BoD) of Gucci’s management. Tough there was a litigation move by LVHM to oppose the deal between PPR and Gucci but it failed. On the contrary, over the next four years, PPR eventually bought out the remaining 20% stake of Gucci held by LVHM @US$94/share thereby raising its stake in Gucci to 53.20% ( listed common stock holdings). Thus it can be seen that PPR’s stake acquisition in Gucci was a negotiated takeover with the consent and facilitation of the BoD of Gucci. The price, purchase consideration and other terms of purchase were thoroughly negotiated between the management of PPR(the white knight) and the target company (Gucci).The accepted deal was later submitted to the shareholders of Gucci by its management for approval. Similarly, the Management of Gucci also shared vital information as regards trading positions, revenue earnings, operating costs, profits etc. with the acquirers i.e. LVMH contrary to the position wherein the management refused to shell out any financial information to LVMH during its course of creeping takeover bid. Thus from the aforementioned discussion it can be concluded that PPR’s stake acquisition into the equity base of the company was a negotiated acquisition of the controlling stake of Gucci.

Fortis’s Acquisition of Wockhardt Hospitals

Ans 02 a. Comments on Fortis’s strategy of inorganic growth in the Indian health care industry with a special note on the rationale behind its acquisition of 10 Wockhardt hospitals. Critical analysis of the pros and cons of the acquisition

The Fortis’s strategy for inorganic growth in the Indian Health care industry can be attributed to the following facts:

Low and limited govt spending/ investment has provided significant opportunities for the private health care service providers as large investments are required to scale up the country’s infrastructure. This can be corroborated by the facts that India would need an additional 920000 beds entailing an investment of between US$ 32 billion and US$ 49.10 billion , assuming that 20% of these beds would be in the tertiary segment. The GoI is likely to meet only 15-20% of the investments required for the development of the beds. Thus the govt. spending on the health care sector will be low @0.87% of GDP in comparision to US and UK where the govt. spending is @7% of GDP. On the contrary, the share of the private sector in health care spending in India is as high as 78% most of which is out of pocket expenses. Thus this provides an ample scope to the private sector in general and Fortis Healthcare group in particular in developing the health care sector which is growing a CAGR @ 16% . Moreover, the Govt. is also facilitating the participation of the private industry in the health sector by initiating investor friendly policies and tax incentives. Secondly, the shift in the life style related diseases is growing to drive higher health care spends. This can be corroborated by the fact that based on demographic trends and disease profiles , the various lifestyle diseases viz. cardiovascular , asthma and cancer will become the most important segments and the inpatient spending in these lifestyle related diseases is set to increase by 50% on a YOY basis. Moreover, the number of cardiac related diseases and treatments in India is expected to grow from 1.50 million to 1.90 million/ year over 2010-2015 and would constitute 5.10% of all treatments. Moreover, with the increase in living standards, disposable income and literacy level, the demand and the willingness to pay for the best possible health care facilities is on the increase. Thus a growing population, changing patterns of diseases, rising income lvel , unmet clinical needs, growing demand for quality health care services are expected to drive the potential for growth of hi-tech devices. Thirdly, overburdened health care infrastructure and the high cost in the west has propelled India as a potential Medial Tourism Destination. The availability of highly skilled and trained doctors, nurses and paramedical staffs has propelled India as a much aspiring location. This can be corroborated by the fact that study undertaken by CII and Mckinsey study has shown that Indian Medical Tourism is expected to grow from a US$ 350 million industry to an US$ 2 billion industry by FY 2012. The number of medical tourists to be treated in India was also set to increase from just 10000 patients in early FY 2000 to atleast 180000 patients by end of FY 2012 and this number is et to grow @20-25% annually. These abovementioned factors provided the privates sector in general and the Fortis group in particular the leverage to develop business strategies for tapping / reaping benefits from the growth and development potential that existed in the sector.

In this context it should be understood that business strategy of Fortis Group for growth based on the value chain was to focus on development of multi specialty hospital chains through out India which were of the International Standards. This was because the super specialty hospitals had a higher profitability rate and shorter gestation period in comparison to the general hospitals. The fact can be corroborated from the graph given below: Business Strategy graph of Fortis Healthcare Group

Based on the above diagram it can be inferred that the primary services of Fortis was providing diagnostics and emergency healthcare services etc but it had also differentiated itself by providing specialized services with a focus on high margin medical facilities which catered to a. Cardiac Issues; b. Knee replacement; c. Neurological Sciences etc. In fact Fortis has acquired special status in terms of Cardiac issues when Fortis started off its medical services with Fortis Mohali Hospital in Punjab which was the region’s leading multi-specialty hospital with a super specialty in Heart. The infrastructure, human resources and the associated support services requited to provide these high quality health services and diagnostic facilities have a capital cost associated with them. It has occurred to the management of Fortis group that the inorganic growth prospects was far more beneficial than the organic growth model. This was because the Net Asset Value (NAV)/ valuation of target entity based on merger and acquisition proposition of other private sector hospitals of nearest private competitors along with complete takeover of its infrastructure/ Human Resources in terms of trained and super specialist doctors, trained nurses and paramedical staff/ IT facilities for hospital and patient care management viz. highest level of service quality from arrivals to departure with seamless registration and discharge with an element of warmth using the market approach of relative valuation / comparable company approach far outwitted the NAV of the comparable new/fresh capital investment to be made by the company for construction and commissioning of service of afresh of any multi-speciality/super-speciality hospitals. Secondly, the fact that the Fortis Healthcare Group was promoted by Ranbaxy which was one of India’s top brand in the pharmaceutical industry provided the Fortis management with easy access to much required capital and financial muscle required with acquisition of super specialty hospitals in and outside India. In this way it has promoted its business strategy of building a brand image of quality health care services in the country by differentiating itself by providing a narrow focus in terms of business activities and providing them at a high cost. Thirdly, the acquisition theory of inorganic growth also fits into the corporate strategy of Fortis i.e. market development in new markets where it wanted to sell its existing products of super specialty medical sevices

and in this case the locations of the 10 Wockhardt Hospitals at Mumbai, Bangalore and Kolkata were places where Fortis till date lacked its presence. Therefore the strategy of acquisition of Wockdardt’s established hospitals at these locations which accounted for more than 85% of the income stream for the target company was in unison with the corporate strategy from growth and business development of the company / group as a whole. This can be corroborated from the following diagram:

Therefore the theory of inorganic growth adopted by the management of the company is well justified. The rationale behind acquisition of 10 Wockhardt hospitals are operationalization of its corporate marketing strategy for business growth and development through intense market penetration in the existing markets with the existing products of providing super specialty medical health care in sectors like cardiology, neural sciences, nephrology, orthopedics and knee replacement etc. and at the same time to implement the strategy of market development in the new markets i.e. southern, western as well as eastern region of the country. This can be corroborated from the fact that acquisition deal of 10 wockhardt hospitals Fortis would be having 6 hospitals in Bangalore, 4 hospitals in Mumbai and a hospital each in Kolkata apart from a vast presence in NCR and a major facility in Chennai. Apart from the same the other important reason for acquisition of the hospitals was the reason that these hospitals were to deliver high end critical care to both domestic and international patients in the areas of Cardiac, Neuro Sciences Orthopaedics Minimal Invasive Surgery, Renal Sciences, Kidney and Liver transplants. Moreover, two of the acquired Wockhardt hospitals had the coveted international accreditation by JCI (Joint Commission International). Thus with this major acquisition, Fortis would have 3 JCI accreditated hospitals in its network. This would be positioning Fortis strongly as a quality destination of choice for Medical Value Travel. Moreover, the existing talented team of medical and non-medical professionals would have been absorbed by the company i.e. Forts and would have continued to run the operations to consistently deliver compassionate and high quality patient care. The pros and cons of the acquisition of the hospitals by Fortis are as follows: Pros: It would have allowed Fortis in getting a pan India presence in the health care sector as most of the multi/super specialty hospital of Fortis were located in Northern India. It had very little presence in the form of hospital and associated infrastructure facilities in the Western, Eastern and the Southern Region of the country. Thus acquisition of revenue/ profit generating hospitals which accounted for more than 85% of the revenue of Wockhardt and which did not add to any major liability of the company in the form of blocked capital served the business prospects of the without any additional liability. This would have allowed Fortis to emerge as the leading/ largest healthcare services provider in States like Haryana, Punjab, Delhi, Rajasthan, UP and

Maharashtra as well as grow into a company having a sales/ revenue reanings to the tune of US$ 1 billion by FY 20102. In addition it also allowed Fortis to fulfill its aspiration of owning 40 hospitals spread over various cities in India having a bed capacity of 6000 beds. Incidentally, the acquisition of the hospitals would have allowed the group to aggressively compete with the market leader i.e. Apollo Hospitals in terms of infrastructure capacity base. i.e. Apollo’s 8065 beds spread across 46 hospitals in comparison to Fortis’s 5180 beds spread across 38 hospitals in India. Incidentally, 2 of the 10 hospitals to be acquired by Fortis were in the construction phase. Thus, Fotis was interested to invest an additional amount of Rs. 2 billion in these ventures and the same would have propelled Fortis way ahead of the market leader Applo Hospitals as the leading super speciality health care service provide in the country in the private sector. Thirdly it would have allowed Fortis to consolidate its position in the super specialty health care sectors as orthopedics, renal care, cardiac and neuro sciences as most of the Wockhardt’s hospitals acquired by Fortis specialized in these medical branches. Fourthly, the acquisition of the hospital and takeover of all the specialized doctors, trained nurses and paramedic staff in the rollbooks of Fortis without any major retrenchment policy would have allowed the company to gain access to a talented pool of highly rained and experienced human resource base of 650 doctors and 1300 trained paramedic staff and nurses. In this manner the company would have saved recruitment cum training / skill development expenses. The same would have also allowed Fortis to gain access to Wockhardt’s acclaimed IT infrastructure for hospital management, its famous staff training cum education development programs designed and developed in partnership with PHMI as well as issues related to control and prevention of HIV/ AIDS treatment in the country. Moreover, three of the 10 hospitals that were being acquired by Fortis were accredited by the US based Joint Commission International (JCI). This would have allowed Fortis to increase the bench strength of qualified medical staff available under its disposal as well as number of internally accredited hospitals under its management control to 9250 trained doctors and nurses as well as 13 no of nationally/ internationally accredited hospitals. This would have allowed Fortis to greatly allure the international patients especially from the US and Europe to visit its hospital chain for international standard health care services as medical tourists and thereby gain benefit from the growth potential that existed in the International Medical Value Travel Sector. Last but not the least, the synergy that existed in the in the operational functionalities of Wockhardt and that of Fortis in terms of nurses training centre, purchase of supply of medical apparatus, medicines, drugs and other supplies, in-service training and skill upgradation of the staff ectc. would have allowed the acquiring company to scale up its health care services and thereby reach economies of scale by reducing the operational cost and thereby improving its profit margins. Cons: The deal had been stuck at a premium by Fortis at Rs. 9.09 billion which was way above the market expected value of Rs. 6.50 billion for the assets to be acquired. Therefore the it was a huge challenge on part of the Fortis management to oversee that the EBDITA of the future cash flow of these 10 Wockhardt hospitals remained in the range of >20% so as to ensure a decent pack back period of 7 years for recovering the huge capital investment made for acquisition. Moreover, 2 of the 10 hospitals that Fortis had acquired were under the construction phase. Moreover Rs. 1.9 billion out of Rs. 9.09 billion paid for the acquisition was made in the form of capital payment towards work-in-

progress. Therefore the estimated immediate net cash flow was to accrue from the health care service operations from the currently operative 8 hospitals units only. Moreover there existed an element of risk against the investment made for acquisition of the under construction hospitals so as to ensure that the timely completion of the construction followed by commencement of service for ensuring that expected earnings and returns on investment and generation of revenues/ income against capital investment made for its acquisition. Moreover, recruitment of the staff, putting in place the medical apparatus, devises and the associated suppliers/ vendors etc. was an added risk. Thus the long Return on Investment (RoI) period was a negative factor. Apart from the same, since there was an element of debt associated with the acquisition process, thus the company had to ensure that the EBDITA had to sufficient so as to meet the debt obligations. Moreover, the acquisition process involved channeling Rs. 3.5 billion out of Rs. 100 billion mobilized from the rights issue. Thus the existing shareholders to whom the right issue were sold at a discount could become suspicious because management may be empire-building at their expense (the usual agency problem) associated with expansion through inorganic growth considering the fact that management was interested in greater market penetration in the existing established markets in the health care sector especially the large Metros like Bangalore, Mumbai, NCR and Delhi etc. places. Apart from the same, the intellectual integration of the trained medical staff staff, paramedics and the associated human resources from the Worckhardt hospitals with the Fortis management was an important challenge. Though Fortis management had decided to take over board all the staff including the acting CEO of Wockhardt Hospital Sri. Bali but then providing the right kind of working environment, work culture, freedom and space to work, job enrichment, rotation and motivation and retention of the staff brought forward from Wockhardt now under the Fortis management and control was a major concern and challenge associated with the acquisition process of 10 no. of Wockhardt hospitals by Fortis management. Last but not the least, the system integration of the Wockhardt’s Information Technology systems associated with hospital management, patient management/ CRM/ maintenance of patient data base and referral system to the concerned doctor depending upon his availability/ integration of the medical devices and apparatus. Management of the clinical department systems and processes for proper allocation of duties to the staff and its effective management, marketing intelligence and healthcare/ clinical information gathering and analysis system etc. with that of Fortis was a Herculean task and a major challenge that needed immediate attention. Thus the aforementioned discussion suitably summarizes the pros and cons associated with the acquisition of 10 no. of Wockhardt hospitals by Fortis. Ans 02 b. The various challenges that Fortis is going to face in the near future and the strategies that it could adopt for overcoming the same are as follows: High Investment and high cost business structure: Fortis faces the risks and challenges as high capital intensity, long gestation periods of the acquisition projects in the health care sector and technological obsolescence given its focus on super speciality segments of clinical treatment in its hospitals viz. cardiology, orthopedics and knee replacement and nephrology and the poor track record associated with its inability to effectively integrate any acquisition of health care hospitals under its management control. This can be corroborated by the fact that there were three separate litigations in process related to Fortis’s acquisition of Escorts Hospital or for that matter as relates to

acquisition of the Jeevan Mala Hospitals in Bangalore. As far as the Escorts Hospitals (EHIRCL) is involved it is drawn in a legal battle for - its right to a leasehold interest on the land on which it is located, the application of a condition in an allotment letter in respect of the EHIRC hospital site requiring the provision of free treatment to indigent patients at EHIRC, non-renewal of EHIRC’s nursing license and certain income tax exemptions claimed by EHIRC’s predecessors. It can be seen that EHIRCL contributes around 60% to the topline of Fortis Healthcare. Thus any negative judgment on the said litigation would impact the performance of the company and its growth prospects. The strategy of an amicable out of the court settlement as well as business policies that effectively abide by the SEBI guidelines associated with Mergers and Acquisition and effective valuation of the assets base of the companies (book value) at the time of acquisition as per Accounting Standards may be followed. Similarly, the business strategy of inorganic growth entails significant fixed costs and high operating leverage. Thus the profitability of the business plans and the consequent capital efficiency ratios depend upon the occupancy rates and realizations per bed. Thus if occupancy rates decline or for that matter Fortis is unable to scale up occupancies in its new hospitals, then the margins could come under pressure. Thus this challenge can be tackled by adopting an effective pricing strategy. This could be done by streamlining the respective clinical department operation and maintenance costs. A centralized procurement process of the supplies, clinical apparatus, effective duty scheduling of the doctors/ nurse and paramedics through effective operationalization of the hospital management system for optimal utilization of the skilled and trained human resources, effective improvement of the patient management system right from the time of registration at the hospital to the time of discharge for optimal utilization of the human resources Similarly, the company could expand its referral network for the hospitals, put in place increased % of community outreach programs to gain market share in the regions in which they operate and reducing the average length of stay of inpatients through effective patient care management. In this perspective, it can be seen that the average occupancy rate of 57%, still remained lower in comparison to that of its major competitor Apollo Hospitals. This is mainly on back of low occupancy rates in the Non-Metro regions wherein the average patient base for super speciality diseases viz. heart diseases, renal failure or orthopedic diseases were low and the paying capacity of the patients was also low. Thus the strategy that could be adopted fro the Tier-II cities viz. Jaipur and Raipur (where it is running a cardia centre with the approval of Chattisgarh Govt.) could be to establish multi specialty hospitals. This can help in improving the bed occupancy rates in the hospitals as the fall in bed occupancy rate for a particular clinical department could be compensated by another clinical department. A glaring example in this regard is the proposed commissioning of the services of a multi –speciality hospital by the Fortis Group at Shalimar Bagh in west Delhi which would be catering to the clinical departments of cardiology, mother and baby care, nephrology, neurology, opthopedics, trauma and emergencies as well as gastroenterology with 250 beds in the 1st phase of operations. Currently Fortis operations are concentrated in the northern part of the country, with most of the hospitals in the NCR region. This is in comparison to Apollo which is well diversified across the Key regions of India. This exposes the company to any adverse Economic, Regulatory or other developments occurring in the region. Thus

diversifying into Tier-II cities for the time being using the various central govt. incentives viz. tax holidays could be a implementable strategy. Next it can be seen that the company derives a major proportion of its major revenues through core hospital services unlike its peers Apollo, which is already in its next phase of development by setting up pharmacies and pathological laboratories across the country. Thus Apollo has a well reversed business model with around 50% of its revenues being contributed by pharmacies. Thus the Fortis company may take a cue from the business strategies being adopted by its rival Apollo and implement a suitable strategy at least in the Tier-II cities where its bed occupancy rate is low. Similarly intellectual integration of the skilled doctors, nurses, paramedical staff that the company acquires as part of its acquisition process with that of Fortis’s HR management system and consequently developing retention strategies is another area of concern. The effective strategy that the company may adopt can be involving the acquired staff in the business and the clinical management process post acquisition of the hospitals. This can be corroborated by the fact that CEO of the acquired Wockhardt hospital Mr. Bali continued with the Fortis Management that was taking business decision for the working of the Wockhardt hospitals post mergers. Providing ESOP of the acquiring company to the staff of the target company, acquiring company entering into a collaborative partner for academic exchange, hosting joint conferences and conducting joint clinical research with organizations such as the United States-based Partners Healthcare Systems Inc., which has members like Massachusetts General Hospital and the Brigham & Women’s Hospital in Boston, USA etc. could provide the acquired staff with the much needed leeway, space and scope to work in a changed work environment and a change of guard of the management. Moreover, accreditation of its hospitals by international agencies viz. JCI can help the company to improve its quality of patient care, introduce new and innovative procedures for the patients and also help attract overseas patients to the hospitals and tap the rapidly growing medical tourism sector. In addition, these associations would also provide a source of innovation and advanced clinical learning for the doctors and other personnel at the hospitals. Another challenge that the Fortis group could face in light of its aggressive growth phase is the shortage of skilled manpower. In order to cope up with the challenge, the company could develop strategies for catering to the field of medical education. The group could consider setting up new health cities with tertiary care hospitals and having campuses for dentistry, paramedics, nursing, clinical research centres and pathology labs. The students graduating from these institutes could be at a later date absorbed by Fortis into its health care system. . Thus the aforementioned discussion suitably summarizes the various challenges that Fortis could face as part of its business process operations and the suitable implementable strategies that could be adopted for overcoming these challenges.

The Betapharm Acquisition-: DRL’s Inorganic Growth Strategy in Europe

Ans 01 a. The advantages and the disadvantages associated with the adoption of organic and inorganic growth strategies in organizations:

Introduction: Organic growth means expanding one’s business and increasing turnover by carrying on doing what a particular business entity/ organization is doing, rather than through acquisitions (buying other businesses) or through moving into new markets. Under organic growth a business entity of for that matter the management of a company might take a strategic decision to move into a new geographic region or use a new sales, marketing, brand promotion or communication channel with the potential consumers, but then it still restricts its operational strategies restricted to the outer domain limit of the existing/ original business model. The company/ business organization/ entity does not force growth with outside investment and the rate of growth is more natural - hence the name organic.

The advantages associated with organic growth are as follows: Organic growth is typically much safer than rapid growth or growth through mergers and acquisitions, because a company/ business entity/ business unit uses its tried-and-tested existing business model with out much deviation or de-routing from the original corporate strategy. It gives the much needed leeway to the management of a company/ business entity to test/ critically analyze and interpret the advantages as well as the disadvantages associated with the existing business model/ corporate management strategy before moving onto another one. Secondly, it's also easier on the business entity’s finances as in the case of organic growth the business entity/ unit grows by reinvesting profit back into the existing business unit/ organization thereby avoiding the need for outside investment and the associated pressure from shareholders that often comes with it. Thirdly, in case of organic growth the growth rate of the organization/ business unit/ entity is natural and is not a forced growth so as to achieve the desired EBITDM so as to effectively service the debt ( in the event of debt being used for M&A) or ROE, if cash surplus/ equity base of the firm is used for the M&A proposal. Moreover, in organic growth the risk / uncertainty associated with the erosion of the share holders value / capital erosion is low as the business entity is guided by the tried and tested business model. The company is not nor guided by the fact that how the FCFF of the acquired firm and its impact on the P/L statement and Balance sheet of the acquiring company. Similarly, under organic growth the risk and uncertainty associated with cost synergies which are the traditional focus of M&A projects is totally avoided. It is often seen that M&A projects try for cost synergies through operations viz. leveraging each other's customer base or intellectual property for incremental revenue but then there are uncertainties and risks associated with it viz. in the form of high attrition rate under the changed management structure/ lower human performance output on account of job dissatisfaction etc. Last but not the least, is the advantage that organic growth is not dependent upon exceptionally skilled managers but rather on optimization of a portfolio of growth options.

The disadvantages associated with organic growth are as follows: Organic growth often takes longer than more aggressive M&A strategies as far as the achievement of overall growth of the company/ business entity is involved. Adoption of organic business growth strategies may act as a limiting factor if the management of the company/

business organization is keen on expanding rapidly through diversification by trying out lots of different business models and new ideas. Moreover, in order to grow organically, a company needs excellent leaders who have the skill and the vision required for adopting new innovation, skill enhancement as well as designing a log frame approach for implementing the innovative strategies. It also requires excellent managers to implement these innovative strategies viz. strategies for selling in new areas or through new channels or for that matter selling to new customers or selling more to existing customers, productivity enhancement through cost marginalization so as to judiciously channelise the cash accruals of the company and generate enough profits. Sometime these strategic skills may be lacking within the available staff of an organization and in that case the business-owners lookout for/ thrive on having outside investment and the guidance that come along with it.

Inorganic Growth: On the contrary, Inorganic growth is the rate of growth of business, sales expansion etc. of an existing business unit/ entity/ organization by increasing output and business reach by acquiring new businesses by way of mergers, acquisitions and take-overs. This kind of growth also takes place due to government directives, leading to enhancement of business in some identified priority sector/area. The inorganic growth rate also factors in the impact of foreign exchange movements or performance of other economies. An important tool for undertaking inorganic growth by an organization is through merger and acquisition. Thus the advantages associated with inorganic growth are as follows:

Advantage associated with obtaining quality staff or additional skills, knowledge of one’s own industry or sector and other business intelligence. For instance, a target company/ business entity with a good management and process systems will be useful to a acquisition which wants to improve its internal work process. Ideally, the target company/ business unit that an acquiring company chooses should have systems that complement its own and that which can adopt well with a running larger business unit. Moreover, acquisition and merger with other businesses can bring new skills and specialist departments to the business which helps the company to diversify well. Advantage associated with accessing funds or valuable assets for new development. Better production or distribution facilities are often less expensive to buy than to build. Thus an acquiring company can derive great value proposition by acquisition of target businesses that are only marginally profitable and have large unused capacity which can be bought at a small premium to net asset value. This helps the acquiring company with economies of scale, which reduces unit costs. This also helps in reducing competition if a rival is taken over. Advantage associated with operating leverage: This can be corroborated from the fact that if say business entity A is underperforming and is struggling with regional or national growth then it may be a less expensive to buy an existing business that is performing well than to expand internally. Advantage associated with accessing a wider customer base and increasing one’s market share. The target business may have distribution channels and systems

which can be used by the acquiring company as marketing channels for selling its own produce once it acquires the controlling stake. Advantages associated with diversification of the products, services and long-term prospects of one’s business. A target business may be able to offer an acquiring business house/ entity new products or services which the acquisition company can sell through its own exiting distribution channels. Moreover, product diversification also also in risk mitigation through spreading of associated risks. Advantages associated with reducing one’s production/ manufacturing costs and overheads: This can be achieved through sharing the marketing budgets between the target company and the acquiring company, through increased purchasing power of the merged entity and thereby lowering the operating/ production costs. Advantage associated through reduction of competition: Acquisition or for that matter buying up new intellectual property, products or services may be cheaper than developing this oneself. Moreover, through elimination of a competitor an acquiring firm can strive for a greater market share through horizontal integration, which means the business can often charge higher prices.

On the contrary the possible disadvantages associated with inorganic growth could be as follows:

Diseconomies of scale if business becomes too large, which leads to higher unit costs. Possibilities of clashes of culture between different types of businesses can occur, reducing the effectiveness of the integration. May lead to make some workers redundant, especially at management levels – this may have an effect on the motivation level of the newly merged entity. May lead to development of a conflict of objectives between different businesses, meaning decisions are more difficult to make and causing disruption in the running of the business.

Justification of the inorganic growth strategy adopted by DRL in Europe:

Europe was the 2nd most important generic drug market in the world in general and Germany in particular after US. This was because of the ageing European population as well as the increased public health costs. The increased public health cost was further fuelled by the fact that by 2011 , patents for branded/ proprietary dugs worth Euro 11.80 billion was expected to expire in major European markets like France, Germany and UK. This had opened up the market for the generic products to replace the patented drugs. Moreover, there was tremendous growth rate observed in the generic product market in Europe and Germany in particular backed by the revised rules and guidelines associated with operations in the generic drug market brought out by EMEA in 2006. This policy allured Indian companies like DRL to venture into the 2nd most important generic drug market in the world i.e. Europe in general and Germany in particular which had a market size of Euro 23.70 billion. Moreover, lowering of profit margins from 25% to 5% from sales operations in US generic market on account of intense competition and the fact that the patented drug companies were coming out with new generic versions of the drugs

where the patents were expiring was severely affecting the profit margin of DRL was DRL was exploring the possibility of diversification of its marketing operations in new generic markets considering its vast portfolio of generic products.

However, DRL did not have any presence/ ingression in the European market in general and the German Generic Drug market which accounted for 66% of the sales in Europe in particular. It need an entry platform for making an initial foray in the German Market for which it need an co-partner/ an allay which had a major share in the European Market and had sales/marketing the distribution channel, networking and relationship with doctors and pharmacists for helping DRL to sell its generic as well as innovative products in these new markets for the company. Moreover, there were major complexities/ difficulties associated with operations in Europe, viz. adherence to regulatory environment for registering the products, obtaining marketing authorization and the delivery channels for supplying of the generic products to the customers. Thus for a 1st timer company like DRL it was almost impossible to single handedly develop this regulatory and marketing and supply chain infrastructure single-handedly from the scratch in Germany by using an organic growth channel. Moreover, for a company like DRL which had a vast portfolio of generic and innovative drugs under its command, what it needed was a distribution and marketing channel so as to have a presence in the local markets . So it was looking out for local companies based in Europe which had a strong distribution infrastructure for helping it to market its products. Thus acquisition of a business entity which met the aforementioned parameters and matched its business as well as cultural perspective was the only way out as growing single handedly would have taken a long time and there were risks associated with the adherence to the regulatory requirements/ marketing of the products through brand value creation/ creation of the supply channels and developing a sizable market share within the least possible time limit and thereby provide a favorable ROE to the shareholders.

Moreover, the complexities associated with operations in the European Generic Drugs market also compelled DRL to look out for a possible acquisition of a German firm. This can be corroborated from the fact that EU polices regulating the generic drugs market made design and development and production of generic drugs totally illegal for sales/ marketing as well as for clinical research purposes during the patent period of the propitiatory drug. This compelled the European based drug companies to source for companies outside Europe for carrying out clinical research for design and development of quality generic products at a cheaper rate so that the same could be launched in the market on the date of expiry of the patented drug. Thus, the European companies restricted themselves for sales/marketing/ distribution of procured generic products (outsourced for production to overseas countries). Thus, the European drug companies were looking for vertical integration for sourcing generic products for sale through its marketing channels. DRL wished to capture on this new developing potential business proposition of the European Generic Drug market as it has the necessary world class manufacturing base of generic products at cheaper cost. Thus, there existed a possibility of synergistic gain through acquisition of a possible German based drug company. Moreover, the acquired marketing channels could also be utilized for enhanced market penetration of its own products thus helping in market gains and enhanced market power.

Thus it can be seen that inorganic growth strategies allowed DRL to overcome the initial entry barriers associated with 1st time entry into a new market viz. overcoming customer loyalty associated with the existing generic brands in the German market, high capital expenses associated with brand promotion activities as well as brand differentiation strategies for carving out a niche segment in the customer market. Incidentally, DRL could have leveraged on the existing customer and brand loyalty support bases that Beta pharm maintained with the doctors, paramedics and the pharmacists. This provided economies of scale in the form of cost savings to the form. Moreover, the well established marketing infrastructure of the company where by more than 200 of its 370 staff strength was involved as field marketing staff allowed the company to take leverage of the marketing channel of the acquired firm and thereby develop increased market power through greater reach to the potential customer. Developing this infrastructure from the scratch would have been a difficult proposition for DRL had it adopted the organic growth route because of the cost and the time involved.

Betapharm which was the 4th largest generic drug manufacturing company in Germany fitted the best to these guidelines. Thus even if the amount paid by DRL for acquisition of the firm @ Euro 480 million was considered to be a bit on the higher side but hen the value proposition that DRL envisaged to derive over the foreseeable future was immense and thus the company envisaged to recover the invested capital as the FCFF was considered to be quite favorable. Thus this compelled the management of DRL to go all out for an inorganic growth proposition for tapping the potential German Drug market. Thus this led to inorganic business growth proposition in Europe by DRL.

Ans 01 b. The rationale behind DRL’s acquisition of betapharm are as follows:

Get an immediate access and foothold to the German Generic Drug market which the 2nd

biggest generic drug market in the world after the US. This was all the more needed because of the decreasing profit margins the company was realizing from its US market operations because of intense competition especially from innovative drug manufacturers who came up with new generic innovations/ formulations to replace their proprietary products immediately on the date of expiry. Thus competition was intense. On the contrary Germany accounted for 66% of the generic drug sales in Europe more so because of its ageing population and rising public health care costs. The company with a wide portfolio of generic as innovative drugs wanted a share of this growing market desperately more so because it did not have a strategic presence in these markets and more so because of the pressure on its financial margin due to fierce competition in US market. Thus the company needed a strong foot hold and a launching platform through vertical integration with a European firm in the form of a well established marketing / sales and distribution channel with good networking and relationship with doctors/ pharmacists, brand image and loyalty which could be leverage upon for large scale bulk sales and marketing of its high quality generic and new innovative products. Betapharm, the 4th largest German Generic Drug manufacturing company suited to the aforementioned immediate need and requirement of DRL and suited the best so as to meet its business and corporate needs. Apart from the same, the product portfolio of Betapharm’s generic products was skewed towards chronic diseases viz. cardiovascular ,

CNS and gastrointestinal diseases where the medication period was quite prolong. Moreover, with regulatory laws in Europe that prohibited generic drug design/ manufacture and clinical research during the patent phase of the innovative branded drug, therefore most of the drug companies in Europe in general and Betapharm in particular was outsourcing such generic drug research to overseas countries. Betapharm thus did notr have any manufacturing base and had transformed itself to merely a pharma sales and marketing company that procured these generic drugs in bulk from foreign firms. This provided a potential business opportunity to DRL as acquisition of Betapharm would have helped DRL to provide it with the much needed vertical integration for continuous supply of generic drugs associated with the aforementioned chronic disease. Thus through acquisition of Betapharm, DRL could have played with volumes and thereby improve its profitability and financials. Incidentally Betapharm had a 3.5-4% share in the German Generic Market with a revenue earning of Euro 186 million and a incremental growth rate of 26%. Thus this would have helped the company in achieving its ambition in becoming a US$1 billion mid-sized global pharma company by end of FY 2008. Thus with the aforementioned discussion suitably summarized the various rationale that went with DRL’s acquisition of Betapharm.

The pros and cons of this cross border acquisition are as follows:

Pros: The acquisition of Betapharm will provide DRL with a platform for launching its business operation in the German Generic Drug market which was the world’s 2nd biggest generic drug market and at the same time readily capture atleast 3.5% market share of the potential market. This was all the more important because there was growing demand for generic drugs in Europe because of the high public health cost on account of ageing population. Secondly, Beta pharm was basically a drug sales and marketing company and did not maintain any manufacturing plant of its own. On the contrary 200 of its 370 staff strength were basically field sales agents. Thus it could be seen that the company had an extensive marketing and regulatory infrastructure coupled with expertise in product registration, market authorization and innovative specific environment specific marketing tools. Thus DRL was basically acquiring the trained Human resource, sales and marketing channels, brand equity and good will from the betapharm. The absence of acquisition of any immovable assets viz. manufacturing plant provided the scope for a seamless, hassle free integration of the acquired assets base with the existing assts of DRL. Moreover, the company would also have been absolved of the ignominious decision of retrenchment of acquired human resources of betapharm. Moreover, the acquisition of the marketing/ sales and distribution channel and the regulatory infrastructure would have provided the much needed leeway for DRL to market its large portfolio of generic drugs in the growing Eupopean Market. This would have helped the company in overcoming the intitial market penetration problem a company would face while enetery a new market area. Thirdly, since betapharm was outsourcing all its production was procuring bulk volumes of generic drugs for sales through its distribution channel, therefore through the acquisition of the firm, DRL could have leveraged upon its low cost manufacturing base

of high quality generic drugs and innovative drug to the fullest through backward vertical integration, Fourthly, the product width and depth of Betapharm was quite vast as it had more than 145 brands under its domain. The company also had a well laid out strategic plan for launching of these branded generic products in the German markets in a phased manner upto FY 2010 immediately on the expiry of the patent period of the branded products or for that matter whose sales exceeded Euro 10 million. Apart from the same the product portfolio of Betapharm catered to high value and chronic illness like cardiovascular disease, CNS and gastro-intestinal disease where the pharmaceutical treatment was prolong. Thus through acquisition of the firm, would have provided DRL to tap these potential business development avenues through diversification of the product portfolio into chronic clinical disease sector as well as for playing in bulk volumes ( prolonged sales of life saving drugs related to heart ailements, neuro-logical disorders, etc.). Thus the acquisition would have helped DRL to increase its financial through increased sales revenue generations and earnings. Fifthly, acquisition of Betapharm would also have helped DRL to adopt its product/ brand differentiation strategy whereby Betapharm would differentiate is product under the Beta brand. Last but not the least, there was business as well as cultural synergy/ similarity betwwn the two firms. Both DRL as well as Betapharm were commiteed to the cause of CSR and worked on issues related to social medicine and health management as well as conducted research and studies on issues related to practice of ethtical standards in health system management. While Betapharm operated the “ Betapharm Institut” DRL operated the DRF and the Centre for Social Initiative and Management. Thus this huge commonality, in corporate culture helped Betapharm to merge into DRL’s working environment in a hasslefree, smooth manner without much corporate discord.

Cons: The various challenges and difficulties associated with the overseas acquisition of Betapharm company by DRL could be as follows:

Since the capital involves in the acquisition deal was huge i.e. Euro 480 million out of which Euro 80 million was paid in cash, therefore the company took a hit in its internal cash accruals/ cash reserves. The cash reserves basically act as cushion to the company in rainy days. Therefore the company was more prone to operational risks. Moreover, a large debt was also taken by the company from the CITI Bank for undertaking the deal. This can be cooroborated by the fact that the total LT debt of the company increased from 22.18 Million INR in FY 2005 to INR 20937.13 million on 3ist March, 2006. Thus debt servicing was a major problem as the D/E ratio of the company had increased. Thus it could be seen that the company was excessivekly dependent upon the cash realizations from its operations in the German Drug Market. This was a risky business operational proposition as the potential future cash flows of the company were being concentrated to a single market of Germany and Europe. Thus any risk/ untoward incident / downfall in its German operational market could have a severe effect on the future projected cash flows of the company. Incidentally, the market share and profit realizations of the company from its US operations were strained due to severe competition from the branded generic drug manufacturers.

Thus the need of the hour was operational risk mitigation through diversification to other markets i.e. UK , France etc. Secondly, the deal as it was a overseas one could face foreign exchange risks, interest rate risk as well as regulatory and market adherence risks. Apart from the same he company could face sovereign risks as the regulatory and supervisory of for that matter Corporate tax / governance laws of the German Govt. may have a severe adverse impact on the business operations and cash accrual of the company. This can be corroborated by the fact that AVWG Act that was enacted wef 1 st

May 2006 in Germany reduced the scope of profit earnings by the drug companies operating in the German Market as governmental pressure was put to reduce the cost of generic drugs by 20-25% so that the Govt. cut reduce the public health cost and provide succor to the German public.

Tata Motors and Fiat Auto-Joining Forces

Ans 17 a. In my opinion the key reasons for Fiat’s poor performance in India can be attributed to the following:

1. The company had a poor dealership network of car dealers coupled with the coupled with the abysmally dismal and lackadaisical after sales customer service and support system. Apart from the same the customers who bought various models of the Fiat company launched in the Indian Market viz. Palio, Sienna and the Palio Adventure also had to face problems associated with the non availability of the auto spare parts for undertaking timely replacement and over hauling of the cars. Thus these operational associated with the product and services delivery mechanism severely tarnished the brand image and associated brand loyalty of the customers. This can be corroborated from the fact that one of the main agenda associated with the formation of JV with TM by Fiat was to leverage on the extensive and vast network of dealership and customer service support/ company authorized workshops for undertaking sales and after sales serving and supply of spare parts of the selected brands of Fiat Cars viz. Palio and Palio Adventure through its shared dealership network in 11 prominent cities of the country which accounted for 70% of the sales revenue generation from car sales for FIAL.2. Secondly, the poor management of the advertisement and brand promotional campaign of the company led to a poor brand positioning in the minds of the potential customers in comparison with the other major international players vying for a share of the rapidly growing Indian car market in particular which was growing @20% p.a. and with an average sales of cars nearly touching 2.0 million units/p.a.. This could be corroborated from the fact that the market share of Fiat in the Indian Auto market was hardly 1.7% in FY 2004-05 and a dismal sales Y-o-Y car sales figures. This greatly affected the financials of the FIAL .

3. Thirdly, the poor sales of its car models led to poor capacity utilization of its existing manufacturing and production facilities at the Kurla and the Ranjangaon Plants. Thus due to poor capacity utilization of its Indian Production bases, the overheads cost viz. in the form of salaries, taxes, rents etc. were eating into the operational profits. Thus

the aforementioned discussion suitably summarizes the key reasons for Fiat’s poor performance in India.

The various factors that made TM an attractive alliance partner for FIAL were as follows:

1. TM was the leading commercial vehicle and the 3rd largest passenger car manufacturer in the country. Over the year TM had a developed a great amount of goodwill/ brand loyalty and reputation in the Indian Car Market. Thus with the development of the JV, Fiat wanted to take leverage of the goodwill/ brand image as well as the wide and vast Pan India network of authorized dealers / workshops and customer service centres that TM had for the sales, marketing and after sales servicing and repair of its car models viz. Palio and Palio Adventure as well as supply of spare parts. Thus by piggy backing on the dealership and customer service and support network of TM, Fiat wanted to enhance its sales and marketing reach to the untapped areas of the growing Indian small car market and at the same time overcome/ solve the problem of poor dealership network and customer service centres/ bases in India. This could be corroborated from the fact that through the shared dealership network which consisted of 25 TM dealers and 3 Fiat India Dealers through its 44 outlets , FIAL wanted to improve upon its dealership as well as customer service delivery levels in 11 prominent cities of India which accounted for more than 70% of the total sales revenue for FIAL. Thus the JV would have helped Fiat in improving its sales, marketing , distribution and after sales servicing standards in India without making sufficient capital expenses for overhauling its distributorship base. Thus it would have helped Fiat to make savings as far its operational expenses was concerned. 2. Moreover, the JV also allowed Fiat to leverage upon the financing arm of TM i.e. Tata Motor Finance to finance the Fiat cars to the potential customers. Thus Fiat was saved from investing the initial capital required fro setting up an independent Auto financing subsidiary in India for supplementing its sales and marketing operations. Thus through the leverage with TM it wanted to improve upon its customer deliver systems/operations as well as its regain its lost image/ brand reputation in the Indian car market. .

3. Secondly, through the JV with TM, FIAL could have sourced quality auto spare parts/ components/ produced at a cheaper production cost vis-à-vis that in Europe for its India as well as overseas operations. Incidentally, FIAL wanted the TM dealers and customer service centers to supply and make available the spare parts for its car models to the potential customers thereby overcoming the spare parts scarcity problem that was severely denting its brand image / reputation in the market. Moreover the Tata Group was one of the leading quality and low cost manufacturer cum supplier of various auto components, spare parts and assemblies in India because of associationship of large number of ancillary auto component manufacturer under the TACO Group. Thus procurement of auto components/ spare parts at cheaper cost could have provided economies of scale and helped FIAL to lower its operational cost.

4. Thirdly, because TM was the leading commercial vehicle manufacturer of India with a market share of 69.90%, the company had a reliable network of gathering

marketing signals / sourcing market intelligence report on the basis of critical analysis and interpreting of the buyers’ trend and choices. Through the JV, FIAL wanted to utilize the market intelligence of TM for devising strategies for restructuring its marketing operations for IVECO Truck Division in India.

5. Fourthly, the JV with TM would have allowed Fiat to gain from the complementarities and synergies in the business operations that existed between Tata and Fiat. This can be corroborated from the fact that while TM was in need for Fiat’s new innovative technologies for design and manufacture of hi-tech diesel and petrol engines for its Indica small cars as well as a platform as well as its extensive dealership and marketing network for marketing TM’s products in the European, Latin American and US market, Fiat on the contrary need the goodwill/ brand image and the dealership and customer service network for restructuring its India operations. Thus with the JV with TM the Fiat group could gained from the royalties that it would have received for transfer of technologies as regards manufacture of the new common rail diesel engines as well as Fire Range of petrol engines to TM to be manufactures at the Ranjangaon plant. Apart from the same, Fiat would have also received royalties from TM for utilizing its extensive dealership network in Europe and Latin America for the sales promotion of its India small car and other SUV/MUV etc.

6. Sixthly, the JV would have assisted Fiat in terms of improving its operational efficiency through better and optimal utilization of the its available underused manufacturing/ production infrastructure. This can be corroborated from the fact that that Fiat allowed the paint shop of its Kurla Plant to be used by TM for painting the cowls of Tatamobile 207 pickup trucks @3000-4000 bodies on a monthly basis. Moreover, as part of its capital investment to the JV, Fiat transferred its Ranjangaon manufacturing unit to the JV for manufacturing 250000 petrol /diesel engines and power transmission systems. Thus the aforementioned discussion suitably summarizes the various reasons which made TM as an attractive alliance partner for Fiat.

Ans 17 b. The possible disadvantages from the strategic alliance could as follows:

1. Brand dilution for Fiat : This is because Fiat stood for quality products especially as far as small cars, sedans were concerned. Its hatch back versions like the Palio or for that matter the sedan Linea was positioned to target the higher and premium segment of the market in India. On the contrary the small car India from TM is basically looked upon by the market analysts as the one targeted towards the true middle class segment. Incidentally, its sedan i.e. Indigo was also priced lower than the other B or C segment cars. Thus the sale of a premium segment car through the dealership network of a Auto company whose products and brand image stood for middle class segment/ mass consumption may lead to mismatch of as regards positioning of the brand , its image and the product attributes in the mindframe of the potential customers of the two separate companies. This may in in turn lead to brand dilution as far as Fiat Auto is concerned.

2. Incidentally, the technology incorporated in the cars from the TM’s stable were inferior in comparision to the product quality standards demanded by the customers of a manured car market like Europe or US. Thus by promoting the sale of a technologically inferior car model which lacked the desired product quality and the product features and attributes viz. presence of powerful fuel efficient engine, power steering, power windows, ABS, Airbags, Anti Skid and safety features etc. aspired by the common European buyer, Fiat was diluting/doing away with the product quality standards associated with the brand. This could seriously hamper the brand loyalty amongst the potential customers of Fiat in its home country Europe.

3. Thirdly, there is a possibility of cannibalization of the products due to product overlap: this can be corroborated from the fact that Fiat’s mid size sedan Petra was targeted in the same market segment where TM’s Indigo was competing. Thus the 2 different models from the same JV stable competed with one another and cannibalized on the common potential customer group for increased sales proposition. This was the reason why when the officials of TM realized the aforementioned fact that it authorized its dealers nor to offer Fiat’s Petrea model through its dealership outlets so as to retain its customer base and allure potential customers to its Indigo model rather than Fiat’s Pera model.

4. Fourthly, another disadvantage associated with the JV was that the JV was heavily loaded in favor of FIAL rather than the benefits getting equipotentially benefiting both TM and FIAL as it was 50:50 JV. This could be corroborated from the fact that Fiat’s capital for the venture came in the form of its Ranjangaon manufacturing plant, would was to be used better. Moreover, it got to sell its engines to a customer who guaranteed offtake. On the contrary the TM had to pay the JV for the Manzas made in the plant, in addition to a royalty for the Fiat engines it sourced under the technology transfer and joint production agreement. Thus it could be seen that Tata Motors was depending heavily on Fiat for trying out variations in the engine systems/power train for its Indica (small hatch back car ) be it a modified diesel engine (CRDI engines) or for that matter a petrol engine (Fire range). Thus unequal distribution of benefits could lead to resentment amongst the partners which may lead to breakage to the collaborative partnership.

5. Last but not the least, the modalities and clear cut business strategies to be adopted for channelizing the potentials that existed in the JV into monetary gains were not clearly defined. This could be corroborated from the fact that though the JV planned to jointly co-design and develop a new small car however, the unit operations for operationalization of the plan was yet to be put into action. Similarly, the action plan for launching the SUVss/MUV sand the pickup trucks i.e. Tatamobile 207 from the stable of TM into the Latin American Markets using the manufacturing as well as dealership/ marketing network base of Fiat was to be fully operationalized.

6. The products and services to be rendered by JV was also facing intense competition from the rapidly growing small car business in India. This could be corroborated from the fact that Toyota which was planning to launch its small car Etios, which is specifically designed for the Indian market could make a deep inroad into Tata

and Fiat territory. Therefore there was every possibility that the JV partners could break off from the collaborative deal and part ways in the event of them finding greater value proposition in business propositions beyond the domain of the JV.

Thus the actions that the JV partners could undertake for minimizing the potential of the impact could be as follows:

1. Considering the fear of brand dilution and cannibalization of the product, it is recommended that the common dealership and marketing arrangements for sale of both TM and Fiat car models through the Tata Motors outlets may be done away with. Fiat should look set up its own dealership network or may target the multi-brand dealership outlets and networks for sale/ after sales servicing and repair of its car models. In this context FIAL could have a talk with the new car accessories/ spare parts suppliers company “Wheelsz” floated by Sri. Jagadish Khattar, the ex CEO of MUL, India.2. The current JV should specifically focus on 3 critical / important aspect s i.e. transfer of technology from Fiat to TM for licensed production of the JTdi diesel engines as well as “Fire Range” of petrol engines at the Ranjangaon plant to be used by the TM for powering its car models, secondly putting in place the operational modalities for joint design/ development/ prototype testing and commercial production of small as well as mid size sedan for the India and the European market with demand driven product features and attributes both for the Indian and the Foreign market) through optimal utilization of the car manufacturing plant of the JV company located at Ranjangaon and thirdly the procurement of auto spare parts by FIAT from TACO (a subsidiary of TM).

3. Under the overall domain of the JV, fully independent SBU may have to be formed for looking specifically into the aforementioned aspects. Thus it could be seen that in this manner the benefits that are envisioned to accrue will be equipotentially distributed amongst both the JV partners rather than being heavily loaded in favor of a single partner. Incidentally, exclusive SBU for each of the 3 unit operations have to be channeled out within the overall domain of the JV for giving focused attention to these exclusive business operations.

4. Last but not the least a separate agreement and business channel has to be developed by Fiat exclusively with TACO for sourcing quality auto spare parts and components. A proper supply chain management system for JIT supply of the auto spares to the garages/ workshop of multi brand dealers may have to be put in place.

Citigroup’s sale of Phibro: Ending the US$ 100 Million Pay Controversy

Ans 16 a. The various reasons that prompted Citigroup to sell off Phibro, its profit making unit are as follows:

Introduction: Phibro was an aggressive energy trading company which formed part of the Citigroup and under the tutelage its CEO and main trader was undertaking aggressive

bets in the energy commodities market (oil and gases) and was making profits based on arbitrage that existed between the spot and the futures prices of these commodities. Taking positions in the commodities futures market was possible due to easy and free accessibility of large value capital from Citigroup (virtual owner of Phibro). However, in light of the bankruptcy of the Citigroup as a whole in light of the subprime lending financial crisis and subsequent receipt of the US Federal Reserve’s bailout package totaling US$ 45 billion. Thus the main reasons for selling the profit making Phibro unit by the Citigroup could be attributed to the following reasons:

Thus the Citigroup in general and Phibro in particular come under the scanner of the US Govt / Federal Reserve and public in general. Since the US govt’s bailout package involved taxpayers money, the US Govt. in particular desired/ wanted the accountability of the recapitalization amt and as per the T&C of the package deal had constituted the Troubled Asset relief Program (TARP) Executive Compensation headed by Feinberg for reviewing the pay packages (compensation and bonuses) of the top executives of these companies. The issue of review of executive compensation was undertaken for maintaining financial prudence in light of the backdrop of severe recessionary pressure of the US economy. Thus Feinberg had recommended to Citigroup the owner of Phibro to restructure / renegotiate the pay package of its chief Trader and CEO Hall since he was to receive a compensation cum bonus package for FY 2008 operations totaling US$ 100 million. Secondly, the US Govt. was of the view that that payment of such huge compensation cum bonus package to top executive of Phibro was unethical and irresponsive in light of the severe recessionary pressure the US economy was facing and considering the fact most of the top executives of the 30 firms which had received the bailout package funding from the US Govt. had taken a pay cut inclusive of the new Citigroup CEO Vikram Pandit.

The US Govt. was also of the view that Phibro’s business model of undertaking speculative trading in the Oil and Gas / Energy Commodity Futures market amounted to proprietary trading using the governmental capital infusion. This was unacceptable under the US Govt’s federal law for companies receiving US Govt’s bailout packages. The US Govt. was therefore of the opinion that proprietary trading was a highly risky business and amounted to amassing of individual wealth at the expense of US Govt.s/ taxpayers money as well as channelization of the US Federal Funds to the unproductive/ and non beneficial sector of the economy. This was because the proprietary traders used important internal information for undertaking mortgage arbitrage which severly hurted the sentiments of the customers.

Moreover, speculative trading led to price volatility of oil and gasses in the energy market which hiked adverse supply shocks and added to recessionary pressures.

However, since the compensation and bonus package of Hall, CEO of Phibro was governed by the contractual agreement he maintained with Citigroup therefore it could nor directly intervene in the issue. Instead of it, the US Govt was putting indirect pressure on the Citigroup to renegotiate his compensation in light of the federal pay restrictions.

Moreover, there was public outcry against payment of such huge compensation in light of the sever recessionary pressure on the US economy due the burst of the sub prime lending fiasco. The US Govt.was also of the opinion that since commercial banking was the core business of the Citigroup, therefore in light of the financial crisis that had gripped the US economy, the group as a whole should focus on its core business area of commercial/ investment and merchant banking operations and should desisit from undertaking speculative trading business through its subsidiary arms like Phibro as the risks associated with erosion of capital was huge.

This was because Proprietary trading occurred when a firm traded stocks, bonds, currencies, commodities and their derivatives or other financial instruments, with the firm's own money as opposed to its customers' money, so as to make a profit for itself using various strategies such as index arbitrage, statistical arbitrage, merger abitrage, fundamental analysis etc much like a hedge fund. However, since the bank’s own funds are involved so as to take benefit of the arbitrage therefore the % of operational risk involved is more thereby leading to much volatile profits.

Thus the US govt. was skeptical that at that particular juncture the recapitalization amount should be used by the Citigroup in financial safe ventures. Thus in light of the aforementioned issues, if Citigroup happened to go ahead and pay the required compensation of US $100 million to Hall, then it could have faced huge public ridicule / outcry and a possible political repercussion from the members of the US Congress. There was a possibility of the US Govt. putting in severe restrictions which in turn could have curtailed future funding of the bailout package. Thus the US Govt. was putting legislative pressure on Citigroup to sell off the firm so as to desist payment of the high compensation amount.

Moreover, in the difficult market situation, the Citigroup wished to restrict its business operations which were client specific i.e. where the customer could be easily traced in the event of a default, arousal of financial risk for recovery of dues viz. credit card operations/ commercial banking/ investment banking operations etc. On the contrary, the speculative energy trading business the risk proposition was high and in the event of a default the recovery of dues was a difficult proposition as bank’s own capital is involved.

Moreover, Phiro CEO, Hall had a contractual pay agreement with Citigroup whereby he was to receive compensation amounting to US$100 million which included a profit sharing deal of 30% of the unit’s profit. The contractual agreement superseded the US Federal reserve bailout package and thus was outside its “federal pay restrictions domain”. Thus inspite of the critical financial position of the Citigroup as a whole, the Citigroup was bound by law to pay the compensation to Hall. Since in the event of Citigroup backtracking/ deviating from the contractual agreement, Hall had threatened to move to the court of law and sue the Citigroup for breach of the contractual agreement.

Last but not the least, the price that was offered by Occidental at US$250 million was almost equal to the liquidation value of the assets of the company “ valued using the

asset approach at US$371 million. Thus it was virtually a not profit, minimal loss deal for the Citigroup in light of the excessive pressure it was receiving for sell off the company from US Govt. so as to absolve itself from public and the political hue and cry/ resentment as well as the possible controversies associated with US$100 million compensation payment deal. Moreover, Citigroup feared that if Phirbo was not sold than in all possibility Hall and his other trading members would quit the firm and join other lucrative firms who were not constrained with the federal pay restrictions. In the event if it happening, the market valuation of Phibro would have further decreased because, the HR talent base of Hall and his group of traders was highly valued in the Commodity futures/ financial market. In the absence of a highly skilled and knowledgeable human resource base, the market analysts /valuers would have further devalued Phibro. Thus the losses would have surmounted had Citigroup delayed the sell-off proposition.

Thus Citigroup was in a difficult position and was embroiled in a turmoil between the US Governmental directives/ a virtual confrontation with the US Govt. in light of the excessive compensation to be paid to Hall/ the undue pressure, public outcry and the severe political and public repercussion on one hand and the fear of long drawn legal battle in the US courts against the probable law suit to be filed by the pleaders i.e Hall and his trading group. Thus in order to avoid the serious repercussions that the company would have faced associated with the compensation issue, the only alternative was to sell of the firm to a 3rd party and absolve itself of the various controversies. Thus the aforementioned discussion suitably summarizes the various reasons which prompted the Citigroup to sell off its profit making unit.

Ans 16 b. The consequences of this sell-off on Citigroup and on other US based financial services companies would be as under:

Since Phirbo was a profit making energy trading arm of the Citigroup therefore through the sell of the profit making arm, the overall income in general and trading income in particular feel sharply. This could be corroborated from the fact that out of the total revenues of the Citigroup amounting US$ 52.8 billion, revenues from energy trading amounted to US$ 667 million. The same could also be corroborated from the fact that in FY 2010, Citigroup Inc.’s first-quarter trading revenue fell by 30 % on account of sale of the LLC energy-trading unit in October, 2009. The revenue generation from the energy trading business by Phibro provided the Citigroup the much needed liquidity for repayment of the govt. debt as well as squaring off the sticky loans and cleaning its balance sheet through repayment to the outstanding creditors. This was because banks like Citibank of the Citigroup employed multiple desks of traders devoted solely to proprietary trading with the hope of earning added profits above that of market–making trading. These desks were thus considered to be somewhat similar to that of internal hedge funds within the bank, performing in isolation away from client-flow traders. Thus returns from the operations from Phibro which were higher than those expected from marked to market instruments allowed the Citigroup in general to hedge off its operational risks. Thus Phibro through its energy trading activities allowed the group to mitigate the operational risks. But now with the sell-off the firm, these

operational risks have to be internally borne by the Citigroup by adopting other hedging measures. However, through the sell-off of Phibro energy trading firm, the Citigroup as a whole was able to restructure/ re-engineer its assets base as well as is business operations in light of the severe hit it had faced in its financial due to the sub-prime lending fiasco. Taking aggressive bets and undertaking speculative/ proprietary energy trading operations was a risky business venture. The bailout package received from US Govt, forbid the Citigroup from utilizing the same for undertaking such business operations as it was risky and led to channelization of public money towards unimportant sectors which contributed to the recession. This was because speculative trading led to price volatility in the energy spot market which led to adverse supply shock pressures. Thus through the sell off the company was able to comply with the US Govt. directives of restricting its business operations to core banking sectors only. Thus though the sell-off of Phibro led to reduction of the asset base of the Citigroup as a whole by 25%, but then the revenue realization from the sell-off was used by the company to partially square off its outstanding debts and clean-off its balance sheet from overall NPAs acquired through securitization of sub prime mortgages etc. As far as its impact on other US based financial services companies was concerned it can be stated that the sell-off of these highly risky trading arms by the Citigroup for restructuring the assets base of the company / minimizing the operational risks of the business would now compel other banks and financial institutions receiving US Federal Reserve’s bail out package to follow suit and accordingly do the same. This could be corroborated from the fact that the step taken by Citigroup put added pressure on. Investment banks such as Goldman Sachs, Bank of America, JP Morgan Chase , Merrill Lynch who earned a significant portion of their quarterly and annual profits through proprietary trading to follow suit and restructure their business operations so that the VAR (value at Risk) of the banks internal funds are minimized due to price risk variations associated with arbitrage. This would help these companied which had received bail out packages from the US Federal Reserve to comply with the various governmental directives.

Valuing Sify’s Acquisition of India World

Ans 06 a.

Calculation of the Fair Market Value of India World.com in October 1999 using the Page Viewers Multiplier Model

Step No: 1 Sdetermination of the Market Capitalization of the Firm

Since the available information is not given therefore the value of the market capitalization of a similar firm of the industry i.e. Sify is used for the model

Therefore ; Given the market capitalization of Sify on NASDAQ in October 1999 before acquisition = $ 2.90 billionTherefore assuming the market capitalization of India World .com

Therefore assumptionsMarket Capitalization of India World (US$) 2.9 billionNumber of Page views (2nd quarter of FY 1999-2000) 70 million

Revenues earned from portal advertising (2nd quarter of FY 1999-2000 in US$) 0.28 millionTherefore,Average daily page views for the IndiaWorld .com 0.78 millionMarket value per daily page view US$ 3728.57Total revenues earned for the year US$ 1.12 million( assuming that the level of revenue earning for eachquarter remained constant)Calculation for estimation of revenue per page viewNumber of Page views for the entire year 280 million(assuming that the no. of viewers in each quarter of FY 1999-2000 remained constant) Revenue per page view US$ 0.004Price/ Revenue multiple in terms of page view 932142.86Assumptions for estimating the Fair Market Value of India World.comGiven

Total earnings of India World .com for FY 1999-2000 before Tax and converting the same into US$(exchange rate @1US$=INR 45.467)

Rs. 4.66 million

Total Earnings of India World company before Tax US$ 0.1025 million

Accounting for Tax Rate @36% and thereafter calculating earnings of the company after Tax (PAT) US$ 0.0656 millionTotal no. of shares listed in the stock exchange of India World.com company 0.2 millionTherefore EPS of India World.com company US$ 0.328Price/ Revenue multiple in terms of page view 932142.86Therefore Market Price /share of India World.com company US$ 305718.75Therefore the fair market value in terms of market capitalization of India World.com company would be using the Page Viewers Multiplier Model =(Market price/share X Total no. of shares of India World.com listed in the stock exchange)Therefore Fair Market Value of India World.com company

US$ 61.144 Billion

Price/ Revenue multiple in terms of page view for India World.com company 932142.86

Ans 06 b. Discussion of whether the price paid for acquisition was justified by comparison of the perceived synergies to the actual performance of Sify and India World.

It could be seen that Sify was one of India’s largest ISP with a large number of India centric portals which offered online easy business solutions to the internet viewers as well as provided B2C connectivity/ e-commerce solutions to the various Resident Indians who logged to the various websites designed and maintained by the company/ web based support to the various companies which registered and advertised its products and services over the net using the various customer centric portals of Sify. The content matter of these portals/ information uploaded therein mostly catered to the needs and the aspirations of onshore i.e. Resident Indians. This could be corroborated by the fact that the various portals/ websites associated with the ISP viz. walletwatch.com carried real time updated data of the stock prices of the shares of various companied listed at the various stock exchanges of India. Though it helped the viewers to track their portfolio but the information associated with the valuations/ variation of the stock prices listed at the various international stock exchanges/ financial markets/ commodity exchanges viz. NASDAQ/ LSE/ Nikki etc. were not properly uploaded or was lacking. Since the NRIs residing offshore/ outside India were more interested on getting a global perspective/ information about the variation in the stock prices at the important global stock exchanges, the portals therefore were unable to cater to these needs and aspirations. Moreover, the portals did not it did not have facilities/ web based services which could be of benefit to the NRIs viz. facilities for web based remittance facilities to send back money to India etc. features. Neither the content matter of the portals under the ownership of Sify nor the sectoral coverage of the portals met the needs/desires/ aspirations of the NRIs viz. information about the culture and History / places of historical and archeological importance for information regarding the modes/ avenues for visiting them / information about Indian cuisines etc. The present portals only catered to the needs of the Resident Indians in 3 important sectors namely business and financial information/ Carnatic Music and cars sales/ purchase and after sale servicing facilities. Portals relating to daily news/ happenings through out the world/ sports/ cookery and cuisines as well as a India based world wide web search engine. Thus inability to provide to the needs and aspirations of the NRI customers was a huge gap / lacunae that existed in the ISP operations of Sify. This was potential source of income to the company as it reduced the page views/ hits/ clicks or for that matter revenue earnings in the form of subscription fee by NRIs registering with web based services or for that matter subscription earnings from online advertisement by corporate clients. On the contrary, the content matter of the e-portals and the sectoral coverage of these portals designed/ developed and maintained by India World .com fully catered to the need and aspirations of the NRI/ overseas client base. This could be corroborated from the fact that the websites/ portals maintained by India world.com received an average of 13.5 million page hits/ views per month. This can be corroborated to price / revenue multiple factor in terms of page view method of valuation of the company @ 932142.86. The same was considered quite good considering the fact that most of the domcom companies had a negative net earnings considering the fact that the proper monetization of the good will and on that basis the client base accessing the websites of these companies could not be easily ascertained because of its intangibility. Thus through acquisition of India world .com, Sify could have got access to its NRI/ off shore Indians centric web portals viz. samachar.com; khel.com; bawarchi.com

etc. It would have also allowed Sify to take over the customer base of India World under its domain as well as leverage upon the goodwill/ brand following it maintained amongst the NRIs. This would have allowed Sify to increase its client base by another 13.50 million NRIs to its existing resident Indians client base of 13 million Indians. This would have improved the probability of revenue earnings of the company based on page view multiplier model. Moreover, acquisition of India World would have allowed Sify an opportunity for cross selling the e-commerce/ B2C and other web bases solutions/ services to both the existing Sify clienteles as well as the newly acquired customer base of India World.com. Incidentally, it can be seen that the fair market value of India World.com ISP Company based on the page view multiplier model stood at US$ 61.144 Billion. On the contrary, the value paid by Sify for acquisition of the company was INR 4.99 billion (corresponding to US$ 0.1097 billion with a conversion rate of 1US$= INR 45.467). Thus it can be seen that the acquisition was undertaken at a discount and that acquisition of India World company by Sify was of strategic importance for reasons stated above. Thus to conclude it could be stated that future prospects of Sify was quite bright and the acquisiton of India World .com would have helped it in transforming itself into a mega ISP with both Resident and NRI client base and a huge market capitalization based on rise in the market price/share of the merged entity. This would have led to capital appreciation of the equity share holders of the company. Moreover, the fact that the 2 nd

half of the acquisition deal was undertaken through transfer of stocks of Sify to the shareholders of India World.com suitably corroborates the fact that Sify was confident of the probable increase in the future cash flow value from business operations for the company as a whole after acquisition of India World.com.

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TCL- Thomson Electronics Corporation: A Failed Joint Venture

Ans 19 a. Comments on the reasons that could have prompted TCL to expand globally could be as follows:

1. Seeking new markets for growth due to increased labor cost and intense competition in the domestic market on account of foray into the WTO: Chinese companies in general and State Owned Enterprise (SOEs) like TCL are going global so as to search for new markets, source raw materials at a cheaper cost, source cheaper energy sources, advanced manufacturing and production technology and highly skilled and trained global human resources and management skills. This business strategy of going global is being driven by growing labor costs in China and intensified competition from foreign multinational corporations that have swayed into the Chinese markets following Beijing’s formal entry into the World Trade Organization. Due to increased competition, the cost of the CTVs, DVDs and other electronic goods had decreased and the profit margin was under strain as far as TCL was concerned. Moreover, due to the foray of low cost technol.ogically advanced products especially from the Japanese companies, the domestic demand was under strain. Thus it can be seen that the obvious impetus for Chinese companies’ like TCL’s global expansion is China’s WTO entry,

which came officially on December 11, 2001. WTO membership made it possible for Chinese companies to enjoy favored nation status in expanding to global markets, but it also presented Chinese companies with enhanced competition at home. Thus it can be seen that with deregulation , companied like TCL were hindered by over capacity and were facing intense profit pressure. As a result TCL was naturally looking aboard for new markets with less competition and higher profit potential especially the other growing Asian economies.

2. Acquiring advanced technologies and management skills: The top management of companies like TCL want to innovate with acquisition of new technologies so as to survive and grow in an increasingly competitive world. This can be corroborated from the fact that TCL was also a OEM , manufacturing / assembling CRT color TVs for leading brands like Toshiba, Panasonic etc. brands. Thus in an intensely competitive market, majority of the product’s value were being captured by their customers i.e. foreign companies with strong R&D brands with deep relationship with end consumers which often left TCL with razor thin profit margins which was less than 5%. Thus in order to improve upon their share of profit margin, companies like TCL are viewing global partnerships and foreign acquisitions as an attractive viable preposition. This was because through JV partnership, a new entity jointly owned by TCL and the partnership firm could be constituted and TCL thereby could benefit from the new advanced management skill and innovative production technology like LCD technology etc. which the JV partner would be bringing with itself.

3. Moreover, TCL, specialized in manufacture of mass volume of low cost and inferior technology CRT based color TVs , and it wanted to go global in search of new untapped markets, sourcing of TV components, electronic spare parts and other raw materials at low and economical cost for minimizing the cost of production, sourcing new advanced manufacturing technology using LCD for flat screen TVs which were in great demand in the developed markets of Europe and US for it was this new advanced technology that TCL lacked.

4. Judicious spending of Internal Accruals and Governmental support for Chinese Companies for going global: Thirdly, it can be stated that companies like TCL have accumulated enough reserve and surpluses (undisturbed and ploughed in capital) on the basis of operational profit. This can be corroborated from the fact that in FY 2003, TCL’s CRT based color TV business posted a profit of 530 million Yuan domestically and 81 million Yuan through its overseas operations. Thus it could be seen that TCL apart from investing its accumulated capital was also receiving official encouragement from the Chinese banks as part of the Chinese Govt’s national policy of “Going global” as part of the five-year plan for 2001-2005. Incidentally many governmental organizations such as the National development and Reform Commission (NDRC), the Min. of Finance, Min. of Commerce and the State Administration of Foreign Exchange (SAFE) had developed policies encouraging the Chinese companies to expand overseas in the form of exclusive credit lines and low interest loans. Moreover, the Chinese National Govt. also had reaffirmed state support to companies like TCL which was basically a SOE , tough some of the companies of the business group were listed in the Shenzhen Stock Exchange. Incidentally, the Chinese banks are well poised to provide

support by virtue of a strong Chinese economy (China’s GDP was currently fourth in  the world, and the country was No. 3 in foreign trade), high savings rate and abundant foreign reserves.

5. Rising labor cost: Finally, the due to improvement in the GDP, robust economy and improved per capita income, the labor costs was rising in China, making the country less competitive in some areas such as the manufacturing sector. Since TCL was an entity associated with electronic goods manufacturing, therefore the company was all the more facing the heat. Incidentally, as per market estimates and expert reports the labor costs in China was supposed to rise by 30% to 50% in the next three to five years.

6. This business strategy to go global can be attributed to the growing labor costs in China and intensified competition from foreign multinational corporations in China following Beijing’s entry into the World Trade Organization which had provided a level playing field to the big multinational companied like Sharp, Toshiba (Japanese companies) to make a big foray and capture a large segment of the Chinese market by launching optimally priced LCD TVs. Thus the demand for its CRT based color television sets in the domestic market was on the decrease/decline. Thus the company need to frantically source for new overseas markets in Asia, Europe and US for stabilizing its operational income and profit margin. Thus the way out was by going global.

7. Circumventing the trade barriers imposed by the Developed Markets and at the same time redce the shipping and transportation cost : The developed market of US and Europe had imposed tariff barriers under the WTO agreements in the form of Anti Dumping duties on various Chinese goods/ companied including TCL for dumping goods especially clour TVS, DVDs, and other electronic goods in the US markets at cost which was lees than the domestic production cost . Thus it was hampering the progress / growth of the domestic US companies. Thus in order to overcome these tariff barriers and to absolve itself of litigation matters in the International Courts , the company decided to go global by setting up manufacturing bases in overseas countries. This ensured that less than 10% of the goods entering European and US Markets were originally manufactured in China. On the contrary, fully or semi knocked down kits were shipped to these developed markets and thereafter by using the services of the US workers/ labor staff the goods were assembled for sale in these markets. Moreover, by adopting a global perspective and thereby going in for ovreaseas acquisition of manufacturing units viz. Schneider Electronics in Germany, TCL wanted to set up manufacturing bases at strategic places whereby the transportation/ transshipment time lag was shortened. This was because a conventional TV set took 90 days to make and send to America by sea from China. On the contary, by assembling the units at Germany and sending them across the Atlantic would have reduced the time lag.

8. No I donot approve of the approach adopted by TCL in achieving its global expansion vision . The reasons are as follows:

1. Aggressive M&A and JV strategies with Governmental support without developing a proper globalization strategy: M&A as well as formation of JVs with

overseas strategic partner has to be undertaken with proper assessment of the value proposition of the merged entity in the consumer market in terms of its innovative products/ brand positioning / marketing communication and brand loyalty. The articulation of why making a strategic green field investment and how best the M&A/ JV strategy will help the company in strengthening its basis of competition in terms of its cost position, brand strength or customer access and loyalty were done away with. This can be corroborated by the fact that TCL without updating the valuations of potential targets viz. acquisition of the manufacturing base, inventory and the trademark of the obsolete, struggling and bankrupt German TV manufacturing company Schneider AG so as to aggressively make a foray into the alluring European Market. Thus it can be seen that in the name of creating a world class Chinese Enterprise, the company was going in for aggressive M&A strategy without proper valuation of the acquired brands. This can be corroborated from the fact that the JV with Thompson for acquiring the trademark license of its RCA brand was undertaken without fair assessment of the fact that the brand was fast fading into oblivion due to the lack of product innovation and for that matter the owners of the brand i.e. Thomson group itself desired to sell off the brand rather than resurrect the brand.

2. Secondly, the series of failures of the various international acquisitions and strategic JV forays signal to the fact that the strategy of aggressive overseas M&A / strategic alliance so as to become a leading global player with a significant presence in the developed markets of the west lacked the finesse of critical analysis of the marketing trends. The aspect of “ scope valuation vis-à-vis scale valuation” from a M&A as well as strategic green field investment/ JV/ alliance was not being critically analyzed and evaluated by the management of TCL. This can be corroborated from the fact that rather than exploring the aspect of scope valuation from its JV with Thomson NV of France and take cue of its extensive R&D facilities/ expertise in LCD Televesion design and manufacturing technology/ expertise in videography and media solutions for designing and developing highly innovative products for a strategic level entry into the developed markets of the US and Europe, TCL was more interested in utilizing the scale valuation from these JVs by utilizing its manufacturing bases to assemble technologically inferior CRT tube based projection TVS and DVDs so as to escape the high anti dumping duties/ import tariffs and other protectionist measures put in place by the EU and the US govts. Thus the crux of the issue was to how best develop a synergistic linkage between scope and scale valuation from the strategic alliances/ JVs depending upon the specific market needs and conditions. Thus this aspect was not forth coming from the various strategic moves of TCL initiated for globalization of the business.

3. Thirdly, the strategy of aggressive M&A and alliance without proper valuation of the synergistic benefits is a risky venture as it lacks in the key element of process innovation like manufacturing, logistics, marketing, sales as well as non core areas such as HR, finance and accounting. This is because had a process innovation system been in place then in that case the management of TCL could have judiciously planned for effective production capacity utilization of the acquired manufacturing base of Schneider AG TV manufacturing plant for manufacturing flat screen plasma TVs rather than deciding to sell off the unit. Moreover, a business risk management core group would have been put in place to mitigate the business risks through enhancement of the product

mix of the company/ sourcing the opportunities for design and development of new products apart from CTVs and DVDs viz. music and sound systems/ multimedia and videography systems/ electronic gadgets etc. through critical analysis of the market signals based on market intelligence and surveys. Tough TCL tries to put in place such core groups a s part of its JV measure with Thomson NV of France, but then the operationalization of these core business groups were still at the nebulous/ infantile stage and they were yet to reach a critical mass so as to effectively contribute to the judicious decision making process by the top management of TCL.

4. Thirdly, the strategy of aggressive acquisition of marginally valued/ loss making manufacturing/ production companies of the developed economies and their asset base in terms of their established brands and sales and marketing channels also highlight the other critical factor where TCL was lacking i.e. the investment required for brand building and the need for development of a globalization strategy based on the differentiation strategy thereby achieving excellence through product innovation. The same was not forthcoming through the JV / partnership approach that TCL had forayed into. This could be corroborated by the fact that even after the operationalization of the JV, TCL kept on harping on the increased production of the CRT based projection TVs rather than expanding the scope and aspect of innovating into the LCD based flat screen plasma TV sector by leveraging upon the technological strength of the JV partners viz. Thomson Group. The R&D spend of 1,5% of the net sales was also quite low in comparison to the global standards being maintained by the MNCs. Incidentally, the spending on brand innovation by other SOEs from China viz. Haier (an electronic consumer durable goods manufacturing company) was quite substantial in comparison to that of TCL.

5. ast but not the least the fact that a global branding strategy was not being put in place by TCL. The multi branding strategy associated with the JV wherein the trademark of the rand was being licensed to the merged JV entity was leading to the dissemination of a complex communication mix to the international / global consumer segment. Moreover, rather than strengthening the Chinese brand of TCL globally, it was diluting the brand. May be the company could have done good be pursuing a single global consumer brand of “TTE” or for that matter taken the help of an European or US celebrity/ Athlete to promote the brand in the developed US and Europe markets viz. how Li-Ning a top Chinese athletic footwear company hired the services of Damon Jones, a US NBA Player from the Cleveland Cavaliers to endore its products in US and build international recognition.

6. Thus the aforementioned discussion suitably summarizes the various facts which conveys the message that that the approach adopted by TCL for realizing its vision for global expansion was risky and too aggressive.

Ans 19b. The factors that led to the failure of the TTE , the JV between TCL of China and the Thomson Group of France could be as follows:

Misjudgment/ miscalculation of part of the management of TCL to correctly judge and assess the real worth/ potential its JV partner i.e. Thomson group was

contributing in the form of new LCD / flat screen plasma technology for design and development of new generation flat screen color TV sets. The management of TCL failed to realize the monetary value of the business potential, customer demand and the corresponding market value proposition that the new emerging LCD technology and subsequent manufacturing of the flat screen techno-color TV sets could provide to the JV in terms of increased sales volume and corresponding revenue realization. On the contrary since TCL was strong in the CRT (projection color TV sets) and considering the fact that the company had a majority stake 67% equity stake in the JV, it continued to channelize the entire and resources of the JV in the design, development and increased production of projection TVs. Thus by doing away with concentrating on the new emerging LCD technology, the company lost on the business potential / market capitalization / capturing of enhanced market share that existed for the LCD TVs in the developed US and European markets.

Secondly, there was failure on part of the management of TCL to properly assess the brand value/ brand loyalty and following of Thomson’s assets especially its RCA television brand in the developed US market. Though RCA was a premium brand and was positioned so as to target the higher/ rich segment of the US and European population, but then the market share of the RCA brand was fast eroding in the US and the European market ( i.e. from a 10% market share in FY 2003 in Europe to less than 7% market share in FY 2004 ). This was mainly attributed to the fact that there was fall in prices of the higher end segment models on account of stiff competition from the other major players like Sharp, Toshiba, Sony, Samsung etc who had economies of scale on their side. On the contrary, the original owner of the brand i.e. Thompson was interested in selling off the brand because of the stiff competition it was facing from the cheaper and technologically advanced Japanese Brands. Moreover, the Thompson wanted to move out of its failing protuct portfolios of Colur TVs and DVDs and wanted to diversify and venture into new business areas of providing video and media solutions for the entertainment industry. Infact it wanted to sell off its decreasing RCA brand and was thus looking for a partner which could over the time acquire the brand and associated assets base. Thus the focus and the attention need to restructure and revive the brand was not forthcoming from Thomson even after the JV proposition. The same can also be corroborated from the fact that the Thomson group did not contribute any amount towards the working capital base of the JV because of the fact that it did not want the capital/ funds to be stuck in the form of obsolete asset base of CRT colour TV and abnalogue DVD sets.

On the contrary, TTE in general and the management of TCL in particular had projected/ estimated an increasing trend of FCFF ( JV firm) based on the comfortable market share the RCA brand was holding. However, the deceasing market share and the corresponding decrease in sales and revenue realization severely jolted the overall actual net cash flow to the JV vis-à-vis the projected value. Thus with the decrease in the actual net cash flow, the value proposition to the share holders to the 2 firm was decreasing. The RoE was also decreasing as the net income after tax (with share holders’ equity base remaining constant) was decreasing. This could be corroborated from the fact that in the 3rd quarter of FY 2004, TCL posted a net loss of HK$ 58.28 million against a turnover of HK$ 7.00 billion vis-a-vis a net profit of HK$ 137.63 million in FY 2003.

Apart from the same, the JV failed to capitalize on the complementary strengths and synergies that existed and if utilized could have propelled the JV to a great heights. This can be corroborated from the fact that the Thomson group failed to utilize the low cost manufacturing base of TCL and its sales outlets in China and other Asian countries for intense market penetration with a well diversified product portfolio / product mix based on Chinese design and subsequent technological improvement through support from the R&D cell of Thomson. In this manner the JV could have forayed to a greater extent in the rapidly expanding Asian market. On the contrary, TCL in particular and the JV in general failed to utilize and capitalize upon the extensive manufacturing and R&D base of the Thomson group for the design and development of the new multimedia and videography products as per the market needs of the developed markets of Europe and US thereby diversifying into new market segments. On the contrary, the JV kept on harping on restricting its product base to the Color TV and DVD product segment only which was heavily saturated with major players and where competition was cut throat and margin was meager. This can be further corroborated from the fact that that instead of trying to utlize the manufacturing / sales and marketing distribution base of Thomson in Europe, TCL, the JV partner continued with the leased agreement with the Schneider AG group of Germany for leasing in 24000 sq.m of Color TV manufacturing base at Tuerkheim, Germany for manufacture of CRT TV sets.

Last but not the least, instead of focusing on the synergistic growth and development of the JV of TTE, TCL one of the JV partner tried to diversify its business operations so as to quickly become a Forture 500 company by forming a JV with the loss making French mobile phone company, Alcatel SA and thereby forming TAMP. Subsequent losses in the JV further constrained the financial position of the TCL and the company failed to infuse the needed capital base into the TTE venture to turn around the losses i.e. streamlining the production bases and marketing channels in Europe to produce the plasma flat screen television sets by leveraging upon the production bases of Thomson at France , Poland and other places.

Therefore the idea and the JV vision statement for achieving economies of scale and operational advantage through combined R&D, design and manufacture of highly innovative products remained in-operational to a large extent viz. foray in joint design and development of music and sound recording / mixing systems / visual graphic enhancement systems etc. The inadequate spending on R&D by TCL @1.5% of its turn over in comparison to the industry average of atleast 3% also contributed to the inadequacies. Thus it could be seen that while Thompson was intereted to use the JV partner to sell off its fading color TV and DVD business so as to concentrate fully on the entertainment support industry business where as TCL was interested in becoming one of the world’s largest selling brand through aggressive and blatant merger & acquisition of international brands and manufacturing base without making a fair assessment of the brand value of the acquired company and the possible value proposition of the merged entity. Thus due to dissimilarities in objectives/ operational goal led to the failure of the JV.

The Polaris- Orbitech Merger

Ans 05 a. The reasons for the Polaris–Orbitech merger were as follows:

Tapping the operational synergies that existed in the business operations of Polaris and Orbitech. The can be corroborated from the fact that while Polaris essentially catered to the design, development, operation and maintenance of the end to end banking software solutions for retail banking operations to the Citibank India, on the contrary, Orbitech exclusively provided baking solutions and software support to the Citibank through its Orbipack-a financial suite that covered end-to-end software solutions covering the entire gamut of the banking and finance sector especially corporate banking/ treasury management, merchant banking operations etc. Thus, it can be seen that through the merger of 2 entities with one another, the merged entity would have been in a position to provide to provide a complete end to end e-solutions for all kinds/ entire spectrum of banking operations, financial dealings as well as insurance applications. The lacunae that existed in the product mix of Polaris as regards availability of software solutions/ modules/ GUI packages for investment banking operations/ merchant banking operations/ treasury management and banking operational risk management could be easily plugged in through the merger operations. Thus the merged entity could have provided this entire gamut of banking solutions to the Citibank. Apart from the same, the merged entity would have emerged from the shackles of excessive dependence on servicing to the needs and applications of a single customer/ end user i.e. Citibank because these software solutions for the banking/financial and insurance sectors could have been sold by the merged entity to other banking/ financial and insurance companies. Thus the limitations associated with the “exclusive client servicing clause” of providing solutions to Citi Bank could be done away with. Apart from the same, through the merger/unison of Polaris with orbi-tech, the domain knowledge/ expertise of Polaris in say in the field of ERP could have been unionized/ synergized with the domain knowledge of Orbi-tech in Retail Banking Operations so as to develop a unique innovative products for ERP and Management in Commercial Banks especially for its retail loaning and loan recovery operations. Apart from the same, the merger of Polaris with Orbi-tech would have given the merged entity a greater leeway to broad base its product mix of software solutions based on the domain knowledge and expertise being brought in by the skilled and experienced staff of both the entities viz. by broad basing the BFSI sector into several micro-expertise domains/ fields viz. investment banking; merchant banking; retail and commercial banking; MFs; stocks / bonds and securities as well as insurance sectors. Incidentally it would have given the merged entity to form a separate division based on the leverage of the expertise of the HR from Orbitec-tech on project management to take care of the non-BFSI (banking, financial services and insurance) sectors. It was estimated that the non-BFSI sectors (such as SAP, BAAN and WebSphere implementations) could contribute 25-30 per cent of the company's total revenue. Apart from the same, the merged entity could have also decided to foray into the business process outsourcing (BPO) segment. The BPO operations could have targeted the sectors like call centre, transactions, technology, data centre and processing. Incidentally, post merger Polaris was talking to two to three customers for making a foray into this sector of the economy. Secondly, Orbi-tech a SEI and had a CMM- Level V rating presented to it by Carnegie –Mellon University, Pittsburgh, Penn, US. This meant that Orbi-Tech Company

had excellent, world class process management skills associated with design and development of key software solutions packages. These could have been in the area of HR management, distribution of job profile and job rotation and job enrichment, customer support service for effective system integration of the software package module / banking solutions with the existing IT platform / operating system base of the client company so as to debug the errors in the software solutions. Thus the merged entity in particular and Polaris in particular could have benefited as it could have implemented the process excellence standards in all its aspects of business operations. Moreover, the merged entity could have leveraged upon the accreditation/ process excellence label so as to aggressively sell its products to a larger client base. Thirdly, the merged entity could have benefited from the fact that the extensive sales/ marketing and distribution network base of Polaris established through branch offices and wholly owned subsidiaries in overseas countries as well as the extensive onshore networks in India. This could be corroborated from the fact that Polaris in FY 1997 (prior to the merger, Polaris had developed wholly owned subsidiaries in Singapore and with an overseas software development center at Los Angeles) apart from offices in Chennai and Noida. Fourthly, the merged entity in general and Polaris in particular would have benefited from getting access to the IPR and the associated knowledge base assets of Orbi-tech especially 57 IPRs corresponding to 10 product lines corresponding to software development for the financial sector/ project management and analysis etc. sectors. Each of these product line had a business/ revenue generation potential of US$ 20 million over a period of 5 years through licensing and receipt of the royalty fee payment . Thus Polaris expected to encash on future cash flow of US$ 200 million expected to be generated from the IPR controlled software product base. Last but not the least, the important factor associated with the merger process of Orbitech by Polaris, was the increased in value proposition corresponding to capital appreciation of the equity investment made by the share holders of Polaris. This could be corroborated from the fact that the book value of the asset base (tangible as well as intangible assets) of the merged entity increased had increased to Rs. 1455 million as on 31 March, 2003 (post merger) from Rs. 497 million as on 31 March, 2002 (pre merger position) against an investment of Rs. 633.8 million. Moreover, the amount available for appropriation for payment of dividend had increased from Rs.628,070,669 as on 31 March 2002 to Rs. 1,025,490,104 as on 31 March 2003 (post merger). Similarly, the proposed dividend payment to the share holders also increased from Rs. 89,578,388 as on 31 March, 2002 to Rs. 170,354,125 as on 31 March, 2003. Though, the announcement of the split ratio of the stocks of Polaris listed with BSE and NSE led to dilution of the total capital holding /shareholder in the company (change in face value of the share from Rs.10 to Rs. 5 /share), but the corresponding recalculation of the exchange ratio/ swap ratio of stocks of Polaris to be paid to the existing shareholders of Orbit-tech from the initial exchange ratio of 1.4:1 i.e. 1.4 share of Polaris / share of Orbi-tech (14 newly issued equity shares of Polaris with a face value of Rs. 5/share in exchange of 25 Orbi-tech share each of face value of Rs. 2/share) to 0.4265:1 i.e. 42.65 newly issued equity shares of Polaris to every 100 existing shares of Orbi-tech mitigated the dilution of the share holding % of the existing Polaris share holders in the equity holding base of merged entity. This in turn increased the

proportionate share to the net profit earnings to the apportioned to them visi-a-vis the then share holders of the Orbi-tech (now merged with Polaris).

The different problems associated with the merger of cross border IT software companies could be as follows:

Offsetting Culture & Philosophical clashes: Cultural Integration: This happens because the merger integration process is mostly based on wrong assumption about the thinking, behavior, and expectations of people from two merged entities/organizations. The most intriguing factor for the same is because the culture or the philosophy of the two individual identities is taken granted for. The skilled workforce is though of as a machine, perhaps, which will duly turn its output almost immediately, which is not the case. In most merger scenarios, the employees of the purchased company are given limited information about the turn of events until well after the deal is settled. Rumors flit about what’s going on, and employees are left in limbo, bitter about the changes and insecure about their jobs and their colleagues. If this goes on for too long, they can become less productive as a psychological enlighten. Though the mathematics and science has evolved and there are recent models to tap the complete potential of a merger but the very simple opinion of human behavior before two organization join hands should probably grasp precedence over every thing else. The two companies can identify these ‘human’ differences, gaze what’s respectable about each culture, and then choose jointly how they can face the future as a unified force. It is therefore principal for today’s managers to assess the cultural fit between the acquirer and target based on cultural profile and managing the potential sources of clash even before the merger. It is distinguished to identify the impact of cultural gap, and fabricate and finish strategies to consume the information in the cultural profile to assess the impact that the differences have. An important tool in this regard can be the dynamic model called “Pathfinder” being used by GE Capital in this merger and acquisition ventures. The model disintegrates the M&A process into four categories which are further divided into subcategories. Initial or the pre- phase of the model involves the cultural assessments, devising communication strategies and also evaluates strengths and weaknesses of the business leaders, by choosing an integration manager. In the subsequent phase the integration view is prepared for the purpose of building the foundation by formation of a team of executives from the acquired and the acquiring company is formed. This is the most vital phase as a sure slit communication strategy is developed to be deployed for more than a 3 month period by lively senior management as well. In the third phase the integration takes spot where the real implementation and correction measures are taken. The processes like assessing the work toddle, assignment of roles etc are done at this stage. This stage also involves continuous feedbacks and making famous corrections in the implementation. The last phase involves assimilation process where integration efforts are reassessed. This stage involves long term adjustment and looking for avenues for improving the integration. This is also the period when the organization sincere starts reaping the benefits of the acquisition.

Cost Management: Post merger saving costs also becomes a sterling challenge for the corporate team in general and IT companies in particular. Thus it can be seen that there

could be duplications of processes within the current organizations which are needed to be countered as a starting point. The lack of standardization around capital assets purchased /items purchased, stocks, inventory, the flows of products and services all through the distribution chain induces a colossal cost both in terms of time and proper resources, which might prick the profit of the unusual company. A procurement optimization could be effected in which all divisions could catch the same products together, if possible and viable. Thus standardization of the vendors from whom both the merged entities can procure the common hardware systems and control apparatus/ office equipments etc. has to be effectively looked into so as to arrive at economies of scale.

Control Execution and urge of Integration: The need for effective control of the merged entity immediately after signing of the merger agreement is an important issue in cross border merger. Some of the obvious reasons for the same be as follows:

I. Legal Barriers- Cross-border mergers of IT companies could involve complex transactions especially associated with handling of a significant number of legal entities, listed or not, and which are governed by local rules (company law, market regulations, self regulations). Not only is the foreign bidder IT company wishing to merge with an overseas country disadvantaged or impeded by a potential lack of information, but also some legal incompatibilities might appear in the merger process resulting in a deadlock, even though the bid for merger is “friendly”. This legal uncertainty may constitute a significant execution risk and act as a barrier to cross-border consolidation. This can be corroborated from the fact that the IT sectors in some foreign overseas countries could include institutions with complex legal setup resulting in opaque decision making processes. Thus an Indian IT company if planning to merge with itself a foreign IT firm then in that case it may so happen that the Indian IT company may be having a partial understanding of all the parameters at stake, some of them not formalized. In such a situation a significant failure risk may arise as the potential Indian IT company might not have a clear understanding of who might approve or reject a merger proposal. Moreover, in some cases, legal structures may not only complex but also prevent, de jure or de facto, some institutions to be taken over or even merge (in the context of a friendly bid) with institutions of a different type. Such restrictions are not specific to cross-border mergers, but could provide part of the explanation of the low level of cross-border M&As, since consolidation is possible within a group of similar institutions (at a domestic level) whereas it is not possible with other types of institutions (which makes any cross-border merger almost impossible). Moreover, even if an overseas merger of an Indian IT company with an overaseas IT/ software company is successful, there may exist impediments to effective control, i.e. there may be a risk that the acquiring company ( Indian IT company with a greater equity share holding in the merged entity) does not acquire proportionate influence in the decision making process within the merged company – while being exposed to disproportionate financial risks. This can be explained notably by the existence of special voting rights, ineffective proxy voting or use of the Administrative office by the overseas merged IT firm. Also barriers (or restrictions) to sell shares could hamper the process. II. Tax barriers As mentioned earlier, mergers and acquisitions are complex processes. Despite some harmonized rules, taxation issues are mainly dealt with in national rules,

and are not always fully clear or exhaustive to ascertain the tax impact of a cross-border merger or acquisition. This uncertainty on tax arrangements sometimes requires seeking for special agreements or arrangements from the tax authorities on an ad hoc basis, whereas in the case of a domestic deal the process is much more deterministic. Moreover, the uncertainty on VAT regime applicable to software and IT products/ solutions and services may put at risk the business model or envisaged synergies. This can be corroborated from the fact that EU's VAT legislation in this area is badly in need of modernisation and because of its inadequacies, there is an increasing tendency to resort to litigation. Moreover, the impact of taxation on dividends might influence the shareholders’ acceptance of a cross-border merger. Even though a seat transfer or a quotation in another stock market might be justified for economic reasons, groups of shareholders could be opposed to such an operation if it implies higher non-refundable withholding tax, and thus lower returns on their investments.III. Implications of supervisory rules and requirements The complexity of the numerous supervisory approval processes in the case of a cross-border merger can also pose a risk to the outcome of the transaction as some delays must be respected and adds to the overall uncertainty. In particular, in the case of a merger between two parent companies with subsidiaries in different countries, ‘indirect change of control’ regulations may require that all the national supervisors of all the subsidiaries must approve the merger.Despite a common regulatory framework, there might be significant divergences in supervisory practices at the level of institutions. Such divergences might be explained by optionality in the harmonised rules, including provisions taken at national level that exceed the harmonized provisions (‘superequivalent’ measures), or lack of coherence in enforcement of common rules. The consequence is a limit on homogeneous approaches, and therefore synergies, of risk control and risk management within a cross-border group. Moreover, the multiple reporting requirements, in some cases combined with a lack of transparency in terms of requirements and definitions, may also impose a significant and costly administrative burden cross-border groups. Indeed, a cross-border merger might cause heavier reporting requirements compared to those imposed on the two entities that are being merged. Instead of creating cost synergies as in a domestic merger, a cross-border might even create additional costs.

IV. Economic barriers- Problems associated could be that due to the fragmentation of the equity markets may impose additional transaction cost on a cross-border merger. For instance, the exchange of share mechanism can be complex, and more expensive, when the two entities ( IT companies involved in the merger operations) are listed on different stock exchanges. Thus the additional costs involved in the merger process might also influence the bidder on the type of deals (i.e. cash vs. exchange of shares). Apart from the same, in cross-border groups, there are also more non-overlapping fixed costs, which cannot be spread over several countries. Indeed, even without legal, tax or prudential barriers, there would remain differences between Member States that would require a differentiated approach to be adapted tothe local environment. This limits potential synergies. The most obvious example is language, and the implications in terms of customer services for instance.

Streamlining Strategic Fit: Mergers with passage of time need to be fitted and continuously aligned strategically, at all strategies level, corporate, business level and functional level, which improves the profitability through reduction in overheads, effective utilization of facilities, the ability to raise funds at a lower cost, and deployment of surplus cash for expanding business with higher returns. It generally happens that the sufficient time is taken for streamlining the strategic fit because of the difference in work culture, working environment, job profile, language difference in approach and attitudes towards work/ leverage, independence and freedom at the work place to do innovative and creative work; difference in the pay packages/ employees benefits/ perks and benefits etc. Thus if there is delay or for that matter if this trategic fit is not dynamic lack of synergies results in merger failure. Thus in case of the Information technology and software industry sector, this problem is of paramount importance.

Thus the aforementioned discussion suitably summarizes the problems associated with the merger of cross border IT software companies.

Ans 05 b. The workings for valuation of the firm based on the FCFF method is as follows:

Valuation of the Polaris Firm as per FCFF Valuation Method

Base year Information Given (FY 2003):

(Rs. In Million)

Total Sales Revenue Earnings 4017

Earnings before interest and taxes 768

Depreciation 180

Capital Expenditure 250

Working capital as % of revenue earnings 40%

High Growth Phase

Length of high growth phase 5 years

Expected growth rate in FCFF 8%

Beta 1.2

Cost of debt 7.50%

Debt Ratio 25%

Tax Rate of the firm 35%

Stable Growth Phase

Expected Growth rate 4%

Cost of Debt 6.50%

Debt Ratio 13%

Annual Market Premium of the firm 5%

Risk Free Rate of return on capital 5.50%

The forecasted cash flow of the firm over the next 5 years period is as under:

(Rs. In Million)

High Growth Phase

Beginning of stable growth phase

Item 2004 2005 2006 2007 2008 2009

EBIT 829.44 895.7952 967.458816 1044.8555 1128.444 1173.5817

Tax @ 35% 290.304 313.528 338.611 365.699 394.955 410.754

PAT 539.136 582.267 628.848 679.156 733.489 762.828

Capital Exp. 270.000 291.600 314.928 340.122 367.332 382.025

Depreciation 194.400 209.952 226.748 244.888 264.479 275.058

Capital Exp.- Depreciation 75.600 81.648 88.180 95.234 102.853 106.967

Change in Working capital 138.828 149.934 161.928 174.883 94.437 98.214

FCFF 324.708 350.685 378.740 409.039 536.199 557.647

DF @ 9.84% p.a. being the WACC during the growth phase 0.91 0.83 0.75 0.69 0.63

PV of FCFF@ WACC during high growth phase 295.61 290.65 285.77 280.97 335.31

Sum total of the PV of FCFF @WACC during the growth phase 1488.31

Estimation of change in Working Capital requirement for the firm  

(Rs. In Million)  

High growth phase period

Stable growth phase period    

Item 2004 2005 2006 2007 2008 2009 2010 2011 2012  

Sales revenue earnings of the firm 4338.360 4685.429 5060.263 5465.084 5902.291 6138.383 6383.918 6639.275 6904.846  

Working capital requirement of the firm 1735.344 1874.172 2024.105 2186.034 2360.916 2455.353 2553.567 2655.710 2761.938  

Change in Working capital requirement of the firm 138.828 149.934 161.928 174.883 94.437 98.214 102.143 106.228  

 

Estimation for the high growth phase

Cost of Debt 7.50%

Cost of equity to the firm 11.50%

WACC during the high growth phase 9.84%

Calculation of the revised beta for the stable phase

New beta= (old beta/(1+1(1-t)*old D/E))*((1+(1-t)New D/E Ratio))

Value of New Beta 1.12

Cost of Debt 6.50%

Revised cost of equity to the firm 11.10%

WACC during the stable growth phase 10.20%

Therefore using the growing concern accounting standard for the firm and faluating the same

PV of a growing Annuity =PV= C/(i-g)

WherePV = Present value of the growing annuityC= Annuity payment or received as the case may be = Rs. 557.65 millioni= the interest rate , here in this case is thre WACC=10.20%

g= expected growth rate=4%

Therefore on solving we get FVCFF during the stable growth phase of the firm= 8988.50

But this PV of Perpetuity is the terminal value at the beginning of the 1st year of the stable growth phase ; therefore the same needs to be

discounted at the rate of the WACC during the course of the high growth phase to arrive at the PV

Therefore the PV of the FCFF during the course of the stable growth phase= Rs. 5620.959

Therefore Present Value of the firm= PVFCFF at high growth phase+ PVFCFF at stable growth phase

PV of the Firm = Rs. 1488.31 million + 5620.959 million

PV of the Firm = Rs. 7109.27 million